Pernix Sleep, Inc. - FORM 10-K

Attached files

file	filename
EX-31.2 - EXHIBIT 31.2 - Pernix Sleep, Inc.	c13382exv31w2.htm
EX-31.1 - EXHIBIT 31.1 - Pernix Sleep, Inc.	c13382exv31w1.htm
EX-32.2 - EXHIBIT 32.2 - Pernix Sleep, Inc.	c13382exv32w2.htm
EX-23.1 - EXHIBIT 23.1 - Pernix Sleep, Inc.	c13382exv23w1.htm
EX-32.1 - EXHIBIT 32.1 - Pernix Sleep, Inc.	c13382exv32w1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)


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

For the fiscal year ended December 31, 2010


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

For the transition period from to

Commission file number: 000-51665

Somaxon Pharmaceuticals, Inc.

(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		20-0161599 (I.R.S. Employer Identification No.)

3570 Carmel Mountain Road, Suite 100, San Diego, CA (Address of principal executive offices)		92130 (Zip Code)

(858) 876-6500
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class		Name of Each Exchange on Which Registered

Common Stock, par value $0.0001 per share		Nasdaq Capital Market

Securities registered pursuant to Section 12(g) of the Act:
None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes o No þ

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 for such shorter period that the registrant was required to submit and post such files).

Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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):


Large accelerated filer o	Accelerated filer þ	Non-accelerated filer o	Smaller reporting company o
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o No þ

As of June 30, 2010, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $108.3 million, based on the closing price of the registrant’s common stock on the Nasdaq Capital Market of $3.60 per share.

The number of outstanding shares of the registrant’s common stock, par value $0.0001 per share, as of February 15, 2011 was 45,004,991.

SOMAXON PHARMACEUTICALS, INC.

FORM 10-K — ANNUAL REPORT
For the Fiscal Year Ended December 31, 2010

Table of Contents


	Page

PART I

Item 1 Business		1

Item 1A Risk Factors		18

Item 1B Unresolved Staff Comments		42

Item 2 Properties		42

Item 3 Legal Proceedings		42

Item 4 Reserved		42

PART II

Item 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		43

Item 6 Selected Financial Data		46

Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations		47

Item 7A Quantitative and Qualitative Disclosures about Market Risk		58

Item 8 Financial Statements and Supplementary Data		58

Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		58

Item 9A Controls and Procedures		58

Item 9B Other Information		59

PART III

Item 10 Directors, Executive Officers and Corporate Governance		60

Item 11 Executive Compensation		66

Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		86

Item 13 Certain Relationships and Related Transactions, and Director Independence		88

Item 14 Principal Accountant Fees and Services		89

PART IV

Item 15 Exhibits and Financial Statement Schedules		90

Signatures		93

Exhibit 23.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I

Forward-Looking Statements

Any statements in this report and the information incorporated herein by reference about our expectations, beliefs, plans, objectives, assumptions or future events or performance that are not historical facts are forward-looking statements. You can identify these forward-looking statements by the use of words or phrases such as “believe,” “may,” “could,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “seek,” “plan,” “expect,” “should,” or “would.” Among the factors that could cause actual results to differ materially from those indicated in the forward-looking statements are risks and uncertainties inherent in our business including, without limitation, our ability to successfully commercialize Silenor; our reliance on our co-promotion partner, P&G, and our contract sales force provider, Publicis, for critical aspects of the commercial sales process for Silenor; the performance of P&G and Publicis and their adherence to the terms of their contracts with us; our ability to ensure adequate and continued supply of Silenor to successfully meet anticipated market demand; our ability to achieve market acceptance of Silenor; the ability of our sales management personnel to effectively manage the sales representatives employed by Publicis; our ability to raise sufficient capital to fund our operations, including patent infringement litigation, and the impact of any financing activity on the level of our stock price; our ability to comply with the covenants under our secured loan agreement with Comerica Bank; the potential for an event of default under the secured loan agreement, and the corresponding risk of acceleration of repayment and potential foreclosure on the assets pledged to secure the line of credit; changes in healthcare regulation and reimbursement policies; our ability to successfully enforce our intellectual property rights and defend our patents, including any developments relating to the recent submission of abbreviated new drug applications for generic versions of Silenor 3 mg and 6 mg tablets and related patent litigation; the scope, validity and duration of patent protection and other intellectual property rights for Silenor; whether the approved label for Silenor is sufficiently consistent with such patent protection to provide exclusivity for Silenor; the possible introduction of generic competition of Silenor; our ability to operate our business without infringing the intellectual property rights of others; estimates of the potential markets for Silenor and our ability to compete in these markets; inadequate therapeutic efficacy or unexpected adverse side effects relating to Silenor that could result in recalls or product liability claims; other difficulties or delays in development, testing, manufacturing and marketing of Silenor; the timing and results of post-approval regulatory requirements for Silenor, and the FDA’s agreement with our interpretation of such results; and other risks detailed below in Part I — Item 1A “Risk Factors.”

Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee future results, events, levels of activity, performance or achievement. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law.

Corporate Information

We were incorporated in Delaware in August 2003. Our principal executive offices are located at 3570 Carmel Mountain Road, Suite 100, San Diego, CA 92130, and our telephone number is (858) 876-6500. Our website address is www.somaxon.com. The information on, or accessible through, our website is not part of this report. Unless the context requires otherwise, references in this report and the information incorporated herein by reference to “Somaxon,” “we,” “us” and “our” refer to Somaxon Pharmaceuticals, Inc.

We have received a trademark registration from the U.S. Patent and Trademark Office, or USPTO, for our corporate name, SOMAXON PHARMACEUTICALS, for use in connection with pharmaceutical preparations for the treatment of neurological, psychiatric and rheumatologic disorders. We have obtained foreign trademark registrations for the trademark SOMAXON PHARMACEUTICALS in Europe, Canada, Japan and Australia. We have received trademark registrations for the trademark SILENOR in the U.S., Europe and Canada. All other trademarks, trade names and service marks appearing in this report are the property of their respective owners. Use or display by us of other parties’ trademarks, trade dress or products is not intended to and does not imply a relationship with, or endorsement or sponsorship of, us by the trademark or trade dress owners.


Item 1.		Business

Overview

We are a specialty pharmaceutical company focused on the in-licensing, development and commercialization of proprietary branded products and late-stage product candidates to treat important medical conditions where there is an unmet medical need and/or high-level of patient dissatisfaction, currently in the central nervous system therapeutic area. In March 2010, the U.S. Food and Drug Administration, or FDA, approved our New Drug Application, or NDA, for Silenor^® 3 mg and 6 mg tablets for the treatment of insomnia characterized by difficulty with sleep maintenance. Silenor was made commercially available by prescription in the United States in September 2010.

Our principal focus is on commercial activities relating to Silenor. We have increased our headcount from five employees as of March 2010 to 40 employees as of February 15, 2011. We commercially launched Silenor in September 2010 with 110 sales representatives provided to us on an exclusive basis under our contract sales agreement with Publicis Touchpoint Solutions, Inc., or Publicis, and an additional 105 sales representatives provided to us under our co-promotion agreement with The Procter & Gamble Distributing Company LLC, or P&G. In February 2011, we engaged Publicis to provide us with an additional 35 sales representatives. As a result, we believe that as of the early second quarter of 2011 Silenor will be supported by 250 sales representatives, all of whom will promote Silenor in the primary detail position. We have also established the manufacturing and distribution channel for Silenor through agreements with third-party suppliers and service providers, and we have established reimbursement coverage for Silenor with numerous private and government payors.

We believe that Silenor is highly differentiated from other available insomnia treatments, and could have significant advantages in the large insomnia market. Based on data from IMS Health, in 2010 the prescription market for the treatment of insomnia grew approximately 6% compared to 2009 to more than 71 million prescriptions. According to IMS Health, the insomnia market accounted for approximately $2 billion in sales in 2010.

Silenor for Insomnia

It is estimated that approximately one-third, or 70 million, of adult Americans are affected by insomnia. One study has found that approximately 20% of those who suffer from insomnia are treated with prescription medications. Silenor was approved by the FDA for the treatment of insomnia characterized by difficulty with sleep maintenance in March 2010, and we commercially launched the product in the United States in September 2010. We believe that Silenor has the potential to offer significant benefits to patients with insomnia.

Silenor is an oral tablet formulation of doxepin at dosages of 3 mg and 6 mg. Doxepin has been marketed and used for over 35 years at dosages from 75 mg to 300 mg per day and is indicated for the treatment of depression and anxiety. However, the available dosages of doxepin for the treatment of depression and anxiety have historically been seldom used in the treatment of insomnia as they leave many patients reporting next-day residual effects and other undesirable side effects. According to IMS Health data, doxepin accounted for less than 0.1% of the insomnia prescriptions written during 2010.

We believe that Silenor, which utilizes doxepin at low dosages of 3 mg and 6 mg, does not exhibit the same pharmacologic effects as high-dose doxepin. Our clinical development program for Silenor included four Phase 3 clinical trials, and the primary efficacy endpoint achieved statistical significance in each trial. Our clinical trials for Silenor also demonstrated a favorable safety and tolerability profile, including a low dropout rate, an adverse event profile comparable to placebo, no clinically meaningful next-day residual effects and no evidence of amnesia, complex sleep behaviors, hallucinations, tolerance or withdrawal effects.

Silenor binds to H1 receptors in the brain and blocks histamine, which is believed to play an important role in the regulation of sleep. The leading approved insomnia medications, Ambien, Lunesta and Sonata, work by binding and activating a different set of brain receptors known as gamma aminobutyric acid, or GABA, receptors. Currently approved GABA receptor-activating drugs are designated by the Drug Enforcement Administration, or DEA, as Schedule IV controlled substances, which require additional registration and administrative controls. Silenor is not designated as a controlled substance, and according to its FDA-approved labeling, Silenor does not appear to have any potential for dependency, addiction or abuse.

Our Strategy

Our goal is to become a leading specialty pharmaceutical company dedicated to creating value for our shareholders through maximizing the potential of our marketed product Silenor and commercializing promising products that treat medical conditions where there is an unmet medical need or a high level of patient dissatisfaction. Specifically, we intend to:

•

Maximize the value of Silenor. Silenor was approved by the FDA for the treatment of insomnia characterized by difficulty with sleep maintenance in March 2010, and we commercially launched the product in the U.S. in September 2010. We believe that Silenor is highly differentiated from currently available insomnia treatments and could have significant advantages in a large market. We continue to strategically invest in sales and marketing activities to maximize revenue growth and market share, and we intend to engage in life cycle management activities relating to Silenor, including potential over-the-counter, or OTC, opportunities.

•

Selectively evaluate other products and late-stage product candidates that are differentiated. We intend to selectively evaluate products and product candidates that are differentiated and meet unmet medical needs or address areas of patient dissatisfaction. To reduce risks, costs and time-to-market, we intend to focus our efforts on currently-marketed products and late-stage product candidates.

•

Fully leverage our commercial organization. We intend to fully utilize the capacity we have within our existing sales force or any future expansion of our sales force with the goal of maximizing its productivity and profitability for the benefit of our promoted brand(s) and shareholder value.

•

Establish collaborations and outsourcing arrangements. We have entered into strategic collaborations and outsourcing arrangements to drive growth and profitability. We believe that leveraging the capabilities of third parties will allow us to add efficiency to our operations and expand our commercial reach, including potentially outside of the United States.

Silenor Market and Commercialization

Disease Background and Market Opportunity

Sleep is essential for human performance, general health and well-being. Insomnia, the most common sleep complaint across all stages of adulthood, is a condition characterized by difficulty falling asleep, waking frequently during the night or too early, or waking up feeling unrefreshed. It is estimated that approximately one-third, or 70 million, of adult Americans are affected by insomnia. One study has found that only approximately 20% of those who suffer from insomnia are currently treated with prescription medications. Chronic insomnia, insomnia lasting more than four weeks, is often associated with a wide range of adverse conditions, including mood disturbances, difficulties with concentration and memory, and certain cardiovascular, pulmonary and gastrointestinal disorders. Chronic sleep deprivation has also been associated with an increased risk of depression, diabetes and obesity, among other disorders. The National Institutes of Health 2005 State-of-the-Science Conference statement on the treatment of insomnia stated that estimates placed the direct and indirect annual costs of chronic insomnia at tens of billions of dollars, but cautioned that such estimates were based on many assumptions and varied extensively.

The U.S. market for prescription products to treat insomnia grew to approximately 64 million prescriptions in 2010 according to IMS Health, a growth rate of 2% for the year. According to IMS Health, the insomnia market accounted for approximately $2 billion in sales in 2010.

Limitations of Current Therapies

According to a recent Sleep in America Poll, 65% of respondents reported experiencing insomnia symptoms a few nights a week. In addition, 42% of respondents often experienced awakenings during the night or waking up too early without being able to go back to sleep, which is referred to as sleep maintenance, and 29% had difficulty falling asleep, which is referred to as sleep onset. Historically, insomnia therapies have addressed sleep onset rather than sleep maintenance and duration. Only recently have therapies been approved with indications for sleep maintenance, although the ability of previously-available drugs to maintain sleep throughout the night without unwanted next-day residual effects remains limited.

The current market-leading prescription products for the treatment of insomnia include GABA-receptor agonists such as Ambien, zolpidem, the generic form of Ambien, in various formulations, Ambien CR, a controlled-release formulation of Ambien, zolpidem ER, the generic form of Ambien CR, Lunesta, Sonata and zaleplon, the generic form of Sonata, in various formulations, melatonin agonists such as Rozerem, several hypnotic benzodiazepines such as temazapam (Restoril) and flurazepam (Dalmane), and sedating antidepressants such as trazodone (Desyrel).

According to physicians that we surveyed in our market research, one of the primary reasons they prescribe sedating antidepressants for the treatment of insomnia is that they generally are not associated with the risk of dependency such as that associated with GABA-receptor agonists. As a result, sedating antidepressants are not Schedule IV controlled substances, and there are no restrictions on their duration of use. As an example, it is estimated that the majority of trazodone prescriptions are prescribed off-label for the treatment of insomnia.

With respect to patients, our pre-launch market research indicated that the market is still underserved due in large part to characteristics associated with many of the then-marketed products. For example, 41% of patients claimed that their medication did not provide them with a full night’s sleep, almost one-third of patients claimed they woke feeling groggy, and 33% claimed to have suffered from memory impairment at some time after taking medication, with almost 80% reporting that they found memory lapse somewhat or very scary. Additionally, 24% of patients on prescription insomnia medication claimed that they were dependent on their medication and could not sleep without it.

In addition, drugs prescribed for insomnia have been associated with many other unwanted side effects, such as dry mouth, unpleasant taste, blurred vision, residual next-day effects, amnesia, hallucinations, physical and psychological dependence, complex sleep behaviors such as sleep driving, hormonal changes and gastrointestinal effects. We believe that drugs with improved tolerability would be well received by both physicians and patients and will have the potential to accelerate the growth in the market.

Silenor and its Benefits

We believe that Silenor offers a number of benefits:

•

Non-scheduled. Because Silenor is not a Schedule IV controlled substance, it can be made available to physicians, facilitating initial physician and patient trial without the additional sampling regulation that applies to controlled substances.

•

Safety and tolerability. In our clinical trials for Silenor, there was a low dropout rate, an adverse event profile comparable to placebo and no clinically meaningful next-day residual effects, and we did not observe any amnesia, complex sleep behaviors, hallucinations, tolerance or withdrawal effects or any effect on QT interval prolongation. In addition, high-dose doxepin has been prescribed for over 40 years for depression at up to 50 times our proposed maximum dosage for the treatment of insomnia.

•

Efficacy. Silenor is indicated for the treatment of insomnia characterized by difficulty with sleep maintenance. Silenor is the first and only non-scheduled prescription sleep medication approved by the FDA for the treatment of the most commonly reported nighttime symptoms of insomnia: waking frequently during the night and/or waking too early and being unable to return to sleep. Silenor is approved for the treatment of both transient, or short term, and chronic, or long term, insomnia characterized by difficulty with sleep maintenance in both adults and elderly patients.

Commercialization

Our commercial strategy is multi-faceted and geared toward maximizing the value of products we commercialize. We are committed to driving prescription growth and market share through experienced sales representatives providing in-person promotion to high-prescribing physicians. These efforts are complemented by on-line and other non-personal promotional initiatives that target both physicians and patients. We are also focused on ensuring broad patient access to our products by negotiating agreements with leading commercial managed care organizations and with government payors. The goals of these efforts are to achieve preferred formulary status relative to our branded competitors and to minimize patients’ out-of-pocket costs.

We believe that the commercial success of Silenor largely depends on gaining access to the highest prescribing physicians of insomnia treatments. We have built a sales and marketing infrastructure focused on timely and informative education of these physicians and their office personnel in the effective and appropriate use of Silenor. We accomplish this through in-person promotional and educational programs, product sampling, and other non-personal promotional activities such as telemarketing, e-detailing and web-based programs. The field sales representatives each undergo a rigorous training program focused on our product attributes, disease background, competitive products and our sales techniques, as well as compliance with applicable laws.

We commercially launched Silenor in September 2010 with 110 sales representatives provided to us on an exclusive basis under our contract sales agreement with Publicis and managed by our sales management personnel, and an additional 105 sales representatives provided to us under our co-promotion agreement with P&G. The Somaxon-managed field-based sales force promotes Silenor primarily to psychiatrists, neurologists, sleep specialists, pain and addiction specialists and other high prescribing physicians of insomnia products. The P&G sales force promotes Silenor primarily to primary care physicians.

In February 2011, we engaged Publicis to provide us with an additional 35 sales representatives. As a result, we believe that as of the early second quarter of 2011, Silenor will be supported by 250 sales representatives, all of whom will promote Silenor in the primary detail position.

We also have contracted with a third party national account management firm with extensive experience in reimbursement contracting to engage in discussions with managed care plans and government sponsored systems such as Medicare Part D, the VA/ DOD and Medicaid, where they will be seeking favorable managed care formulary treatment for Silenor. Our goal in this effort is to achieve a formulary position on commercial payor and government sponsored plans that will make Silenor available to patients at a lower out-of-pocket cost, and/or on a less restrictive basis.

Publicis Contract Sales Agreements

In July 2010, we entered into a Professional Detailing Services Agreement with Publicis and a Supplement to the Services Agreement, and we entered into an amendment to the Supplement in February 2011. Under these agreements, Publicis provides sales support to promote Silenor in the United States through 110 full-time sales representatives, one regional field coordinator and one national business director, all of whom are employees of Publicis. Publicis is in the process of recruiting an additional 35 full-time sales representatives and an additional regional field coordinator, and we expect all of these additional people to be deployed as of the early second quarter of 2011.

In consideration for Publicis’ services under the Publicis agreements, we paid Publicis a portion of the fees for the start-up and additional recruiting phases of the engagements upon signing and the remainder upon completion of the applicable services. We also pay Publicis a fixed monthly fee, which fee is subject to certain quarterly adjustments based on actual staffing levels. During the term of the Publicis agreements, a portion of Publicis’ management fee is subject to payment by us only to the extent that specified performance targets are achieved. The performance targets relate to the initial scale-up activities and recruiting, turnover and vacancy rates, call attainment rates and specified sales goals. In addition, we are obligated to reimburse Publicis for approved pass-through costs, which primarily include bonus, meeting and travel costs and certain administrative expenses.

We may hire representatives of Publicis upon 30 days notice to Publicis by paying certain fees to Publicis.

The initial term of the Publicis agreements runs through August 29, 2012. We may extend the term of the agreements by providing Publicis with written notification no later than 90 days prior to the expiration of the initial term, subject to agreement on compensation terms with Publicis. Prior to the first anniversary of the deployment of Publicis’ sales representatives, we have the right to terminate the agreements upon 90 days written notice and payment to Publicis of a termination fee in a specified amount. We have the right to terminate the Publicis agreements at any time after the one year anniversary of the deployment of Publicis’ sales representatives without paying a termination fee. Somaxon may also terminate the agreements by hiring a specified number of sales representatives without paying a termination fee. In addition, either party may terminate the agreements upon an uncured material breach by the other party, upon the bankruptcy or insolvency of the other party or if a change in law renders the performance of a material obligation of the agreements unlawful.

P&G Co-Promotion Agreement

In August 2010, we entered into a Co-Promotion Agreement with P&G. Under the agreement, P&G provides primary care physician sales support to promote Silenorin the United States through its team of full-time sales representatives. P&G is required to provide a minimum number of primary details each quarter to certain primary care healthcare professionals and a minimum number of calls to pharmacists each year during the term of the agreement. Beginning as of January 1, 2011, P&G is also providing us with certain managed care support services. We have also granted to P&G a right of first negotiation relating to rights to develop and market Silenor as an OTC medication in the U.S.

In consideration for P&G’s services under the co-promotion agreement, we pay P&G a fixed fee and a royalty fee as a percentage of U.S. net sales on a quarterly basis during the term of the agreement. The agreement also provides for financial penalties in the event that either party fails to deliver specified minimum detailing requirements under certain circumstances. Each party will be responsible for the costs of maintaining and operating its own sales force, and we are responsible for all other costs pertaining to the commercialization of Silenor.

The term of the agreement runs through December 31, 2012, and we will pay P&G a reduced royalty fee based on U.S. net sales of Silenor for a period of one year after the expiration of the agreement or its earlier termination under certain circumstances. Beginning as of June 30, 2012, the parties will discuss in good faith the continuation of the collaboration upon mutually-agreed terms and conditions. We have the right to terminate the agreement upon 90 days written notice if P&G fails to provide at least 75% of its minimum detailing obligations. P&G may cure such shortfall within the 90 days following the written notice provided there is no other breach of the minimum detailing obligations within the prior 12 month period. Either party may terminate the agreement upon 90 days written notice to the other party, although no such termination may be effective prior to December 31, 2011. P&G may terminate the agreement if Silenor is withdrawn from the market for longer than three months as the result of a legal requirement or 30 days after the end of a calendar quarter in which the market share for Silenor is less than 75% of the Silenor market share immediately prior to the loss of Silenor’s market exclusivity in the United States.

In addition, either party may terminate the agreement upon a large scale recall or withdrawal of Silenor from the U.S. market resulting from a significant safety risk that is not due to tampering, a remediable manufacturing problem or other defect that can be cured after such risk is discovered. Either party may also terminate the agreement upon an uncured material breach by the other party, upon the bankruptcy or insolvency of the other party or a force majeure event that lasts for at least six months.

Technology In-Licenses

In a license agreement entered into in August 2003, which was amended and restated in September 2010, we acquired the exclusive, worldwide license from ProCom One, Inc., or ProCom, to certain patents to develop and commercialize low dosages of doxepin for the treatment of insomnia. Although our license to the low-dose doxepin patents is a worldwide license, we currently intend to develop and commercialize Silenor in the United States only, since patent protection for the current dosage form is limited to the United States. The term of the license extends until the last licensed patent expires, which is expected to occur no earlier than 2020. The license agreement is terminable at any time by us with 30 days notice if we believe that the use of the product poses an unacceptable safety risk or if it fails to achieve a satisfactory level of efficacy. Either party may terminate the agreement with 30 days notice if the other party commits a material breach of its obligations and fails to remedy the breach within 90 days, or upon the filing of bankruptcy, reorganization, liquidation, or receivership proceedings relating to the other party.

As consideration for the license, we have paid an aggregate of $2.5 million in combined upfront and milestone payments. We are also obligated to pay a royalty on worldwide net sales of the licensed products. We have the right to grant sublicenses to third parties. We also issued 84,000 shares of common stock to ProCom One contemporaneously with our Series A preferred stock financing.

In October 2006, we entered into a supply agreement pertaining to a certain ingredient used in our formulation for Silenor. In August 2008, we amended our supply agreement to provide us with the exclusive right to use this ingredient in combination with doxepin. As part of the amendment, we made an upfront license payment of $0.2 million and are obligated to pay a royalty on worldwide net sales of Silenor beginning as of the expiration of the statutory exclusivity period for Silenor in each country in which Silenor is marketed. Such royalty is only payable if one or more patents under the license agreement continue to be valid in each such country and a patent relating to our formulation for Silenor has not issued in such country.

Intellectual Property

Silenor Patents and Patent Applications

We are the exclusive licensee of four U.S. patents from ProCom claiming the use of low dosages of doxepin and other antidepressants. U.S. Patent No. 6,211,229, “Treatment of Transient and Short Term Insomnia,” covers dosages of doxepin from 0.5 mg to 20 mg for use in the treatment of transient insomnia and expires in February 2020.

U.S. Patent No. 5,502,047, “Treatment for Insomnia,” claims the treatment of chronic insomnia using doxepin and expires in March 2013. Due to some prior art that we identified, we initiated a reexamination of our “Treatment for Insomnia” patent. The reexamination proceedings terminated and the United States Patent and Trademark Office, or USPTO, issued a reexamination certificate narrowing certain claims, so that the broadest dosage ranges claimed by us are 0.5 mg to 20 mg for otherwise healthy patients with chronic insomnia and for patients with chronic insomnia resulting from depression, and 0.5 mg to 4 mg for all other chronic insomnia patients. We also requested reissue of this same patent to consider some additional prior art and to add intermediate dosage ranges below 10 mg. In two office actions relating to this reissue request, the USPTO raised no prior art objections to 32 of the 34 claims we were seeking and raised a prior art objection to the other two, as well as some technical objections. Each of the claims objected to by the USPTO related to dosage ranges having an upper limit of approximately 10 mg or higher. After further review of the prior art submitted, the USPTO withdrew all of its prior art objections. We then determined that the proposed addition of the intermediate dosage ranges and the resolution of the technical objections no longer warranted continuation of the reissue proceeding. As a result, we elected not to continue that proceeding. Because Silenor’s approved indication is consistent with the subject matter of our patent claims, we believe that our licensed patents will restrict the ability of competitors to market doxepin with identical drug labeling.

Additionally, we have the exclusive license from ProCom to a third patent in the series, U.S. Patent No. 5,643,897, which is a divisional of the ’047 patent and claims the treatment of chronic insomnia using amitriptyline, trimipramine, trazodone and mixtures thereof in a daily dosage of 0.5 mg to 20 mg. This patent expires in March 2013. A fourth patent to which we have an exclusive license from ProCom, U.S. Patent No. 6,344,487, claims a method of treating insomnia with low dosage forms (0.5 mg to 10 mg) of nortriptyline. This patent expires in June 2020.

In addition, pursuant to our agreement with a supplier for a key ingredient used in our formulation of Silenor, we have the exclusive right to use this ingredient in combination with doxepin, and the exclusive license to the related patents and patent applications. We submitted for listing six of these issued patents in the FDA’s publication “Approved Drug Product with Therapeutic Equivalence Evaluations,” commonly known as the Orange Book.

In addition in February 2011, we received a Notice of Allowance from the USPTO for claims under U.S. patent application no. 11/781,165, which application is exclusively assigned to us. This patent application generally relates to dosing Silenor 3mg and 6mg tablets at least three hours after a meal to promote faster onset of action and reduce the potential for next-day residual sedation. A Notice of Allowance is the official notification that the USPTO finds the claimed subject matter allowable and intends to issue the patent pending payment of the issue fee. Given this action, we expect the patent to issue in the second quarter of 2011. If the patent is ultimately issued as we expect, this patent will expire no earlier than July 2027. The pharmacokinetic changes that result from dosing Silenor within three hours after a meal have important implications relating to both the efficacy and safety of the product that are described in the Silenor prescribing information. As a result, we plan to list the patent in the Orange Book once it is issued.

We have filed multiple other patent applications resulting from unexpected findings from our development program. A brief summary of the content of these patent applications includes:

•

Formulations and manufacturing processes,

•

Methods of preventing early awakenings and improving sleep efficiency,

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Methods of treating insomnia without sedative tolerance, rebound insomnia or weight gain, and

•

Methods of treating insomnia in the elderly.

We have included these findings in our approved prescribing information and, if the patents issue, we intend to list them in the Orange Book. The combination of these patents, if issued, and our label could result in our patent protection being extended to 2028.

We have also filed multiple patent applications relating to potential future products containing doxepin for the treatment of insomnia. A brief summary of the content of these patent applications includes:

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Orally disintegrating formulations,

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Combination drug formulations, and

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Method of treating insomnia with ultra low dose doxepin.

Silenor Patent Litigation

On November 3, 2010, we received a notice from each of Actavis Elizabeth LLC and Mylan Pharmaceuticals Inc. that each had filed with the FDA an Abbreviated New Drug Application, or ANDA, for a generic version of Silenor 3 mg and 6 mg tablets. Each of the notices included a “paragraph IV certification” with respect to seven of the eight patents listed in the Orange Book for Silenor. A paragraph IV certification is a certification by a generic applicant that in the opinion of that applicant, the patents listed in the Orange Book for a branded product are invalid, unenforceable, and/or will not be infringed by the manufacture, use or sale of the generic product.

On December 15, 2010, we, together with ProCom, filed suit in the United States District Court for the District of Delaware against each of Actavis Elizabeth LLC and Actavis Inc., or collectively, Actavis, and Mylan Pharmaceuticals Inc. and Mylan, Inc., or collectively, Mylan. The lawsuit alleges that Actavis and Mylan have each infringed U.S. Patent No. 6,211,229 by filing their ANDAs relating to Silenor prior to the expiration of this patent. Pursuant to the provisions of the Hatch-Waxman Act, FDA final approval of each of the Actavis and Mylan ANDAs can occur no earlier than May 3, 2013, unless there is an earlier court decision that the ‘229 patent is not infringed and/or invalid or unless any party to the action is found to have failed to cooperate reasonably to expedite the infringement action. At this time, other patents listed in the Orange Book for Silenor have not been asserted against either Mylan or Actavis.

On December 23, 2010, we received a notice from Par Pharmaceutical, Inc. that it had filed with the FDA an ANDA for a generic version of Silenor 3 mg and 6 mg tablets. This notice included a “paragraph IV certification” with respect to seven of the eight patents listed in the Orange Book for Silenor.

On February 2, 2011, we, together with ProCom, filed suit in the United States District Court for the District of Delaware against Par Pharmaceutical, Inc. and Par Pharmaceutical Companies, Inc., or collectively, Par. The lawsuit alleges that Par has infringed U.S. Patent No. 6,211,229 by filing its ANDA relating to Silenor prior to the expiration of this patent. Pursuant to the provisions of the Hatch-Waxman Act, FDA final approval of the Par ANDA can occur no earlier than June 23, 2013, unless there is an earlier court decision that the ‘229 patent is not infringed and/or invalid or unless any party to the action is found to have failed to cooperate reasonably to expedite the infringement action. At this time, other patents listed in the Orange Book for Silenor have not been asserted against Par.

We intend to vigorously enforce our intellectual property rights relating to Silenor, but we cannot predict the outcome of these matters. Any adverse outcome in this litigation could result in one or more generic versions of Silenor being launched before the expiration of the listed patents, which could adversely affect our ability to successfully execute our business strategy to increase sales of Silenor and would negatively impact our financial condition and results of operations, including causing a significant decrease in our revenues and cash flows.

Other Intellectual Property

Although we have taken steps to protect our trade secrets and unpatented know-how, including entering into confidentiality agreements with third parties and confidential information and inventions agreements with employees, consultants and advisors, third parties may still obtain this information or we may be unable to protect our rights. Enforcing a claim that a third party illegally obtained and is using our trade secrets or unpatented know-how is expensive and time consuming, and the outcome is unpredictable. In addition, courts outside the United States may be less willing to protect trade secret information. Moreover, our competitors may independently develop equivalent knowledge, methods and know-how, and we would not be able to prevent their use.

Third Party Intellectual Property

Numerous U.S. and foreign issued patents and pending patent applications, which are owned by third parties, exist in the fields in which we are operating. Because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our products or product candidates may infringe.

We may be exposed to, or threatened with, future litigation by third parties having patent or other intellectual property rights alleging that our products or product candidates infringe their intellectual property rights. If any of these intellectual property rights was found to cover our products or product candidates or their uses, we could be required to pay damages and could be restricted from commercializing our products or from using our proprietary technologies unless we obtained a license to the intellectual property rights. A license may not be available to us on acceptable terms, if at all. In addition, during litigation, the patent holder could obtain a preliminary injunction or other equitable right, which could prohibit us from making, using or selling our products.

There is a substantial amount of litigation involving patent and other intellectual property rights in the biotechnology and pharmaceutical industries generally. If a third party claims that we or our collaborators infringe its intellectual property rights, we may face a number of issues, including but not limited to:

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infringement and other intellectual property claims which, with or without merit, may be expensive and time-consuming to litigate and may divert our management’s attention from our core business;

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substantial damages for infringement, including treble damages and attorneys’ fees, which we may be required to pay if a court decides that the product or product candidate at issue infringes on or violates the third party’s rights;

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a court prohibiting us from selling or licensing the product or product candidate or using the proprietary technology unless the third party licenses its technology to us, which it is not required to do;

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if a license is available from the third party, we may have to pay substantial royalties or fees or grant cross-licenses to our technology; and

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redesigning our products or product candidates so they do not infringe, which may not be possible or may require substantial funds and time.

No assurance can be given that patents issued to third-parties do not exist, have not been filed, or could not be filed or issued, which contain claims covering our products or product candidates or methods. Because of the number of patents issued and patent applications filed in our technical areas or fields, we believe there is a risk that third parties may allege that they have patent rights encompassing our products or product candidates or methods.

Research and Development

To date, our research and development expenses have consisted primarily of costs associated with our clinical trials managed by contract research organizations, or CROs, our non-clinical development program for Silenor, submitting and seeking approval of the NDA for Silenor, regulatory expenses, drug development costs, salaries and related employee benefits, and share-based compensation expense. During 2010, our most significant research and development costs were salaries, benefits, and share-based compensation expense and costs associated with our development program for Silenor. During 2009, our most significant research and development costs were salaries, benefits, and share-based compensation expense, costs associated with the conduct of the continuing two-year carcinogenicity study for Silenor, costs associated with the resubmission of the Silenor NDA to the FDA and drug development costs pertaining to Silenor. In 2008, our most significant costs were associated with our non-clinical development program for Silenor, a standard clinical trial that we voluntarily conducted during 2008 to evaluate the potential for ECG effects of doxepin and the preparation and submission of our NDA for Silenor.

Silenor Competition

The FDA-approved products that are currently available for the treatment of insomnia consist of sedative hypnotics, including GABA-receptor agonists, hypnotic benzodiazepines and a melatonin agonist. In addition, products such as sedating antidepressants and other products which are not approved for the treatment of insomnia are sometimes prescribed for such use.

Ambien, a GABA-receptor agonist, and its generic equivalents have historically been the market share leaders in the insomnia segment. Generic versions of Ambien (zolpidem) entered the market in April 2007. According to data obtained from IMS Health, generic versions of Ambien accounted for nearly 60% of insomnia prescriptions in 2010. In September 2005, Sanofi-Synthélabo, Inc. launched Ambien CR, a controlled-release version of Ambien. Unlike Ambien, Ambien CR is indicated for the treatment of sleep maintenance insomnia and does not have a label restriction limiting the length of time of its use. Generic versions of Ambien CR, called zolpidem ER, entered the market in October 2010. Ambien CR accounted for approximately 7% of insomnia prescriptions in 2010, zolpidem ER contributed less than 1% and branded Ambien accounted for approximately 1% of insomnia prescriptions in 2010, according to data obtained from IMS Health.

Lunesta, marketed by Sunovion Pharmaceuticals Inc., a wholly-owned subsidiary of Dainippon Sumitomo Pharma Co., Ltd., is a GABA-receptor agonist that was approved in December 2004 by the FDA and was launched in the second quarter of 2005. Lunesta accounted for approximately 7% of insomnia prescriptions in 2010 according to data obtained from IMS Health. Lunesta is indicated for the treatment of insomnia and has been shown to decrease sleep latency and increase sleep maintenance. It was the first of several products to have the short-term use restriction removed from its label.

Sonata, a GABA-receptor agonist sold by Pfizer Inc. for the treatment of insomnia, and its generic equivalents accounted for less than 1% of insomnia prescriptions in 2010 according to data obtained from IMS Health.

Rozerem was launched by Takeda Pharmaceuticals North America, Inc. in September 2005 and accounted for nearly 1% of insomnia prescriptions in 2010 according to data obtained from IMS Health. Rozerem is indicated for the treatment of insomnia characterized by difficulty with sleep onset. It was the first drug approved for the treatment of insomnia that is not a Schedule IV controlled substance. With the exception of Rozerem, the approved medications for the treatment of insomnia all act on GABA receptors and are designated as Schedule IV controlled substances. Takeda Pharmaceuticals North America, Inc. conducted a clinical trial to evaluate the administration of a combination of Takeda’s product Rozerem and 3 mg of doxepin in patients with insomnia. We are unaware of the results of this trial.

A number of companies are marketing reformulated versions of previously approved GABA-receptor agonists. In March 2009, Meda AB and Orexo AB received approval from the FDA for Edluar, formerly known as Sublinox, a sublingual tablet formulation of zolpidem, for the short-term treatment of insomnia. Meda and Orexo launched this product in the U.S. in September of 2009.

In December 2008, NovaDel Pharma, Inc. received approval from the FDA for ZolpiMist, an oral mist formulation of zolpidem for the short-term treatment of insomnia characterized by difficulties with sleep initiation. In November 2009, NovaDel and ECR Pharmaceuticals Company, Inc., a wholly owned subsidiary of Hi-Tech Pharmacal Co., Inc., entered into an exclusive license and distribution agreement to commercialize and manufacture ZolpiMist in the United States and Canada. ECR Pharmaceuticals launched the product in the United States in February 2011.

The remaining market is comprised of older generic benzodiazepines and sedative antidepressants. In addition to the currently approved or off-label products for the treatment of insomnia, a number of new products may enter the insomnia market over the next several years. While the new entrants would bring additional competition to the insomnia market, they would also increase the awareness of insomnia and further expand the market. Additionally, we believe market growth will also be driven by the aging of the population and emerging awareness of the links between sleep, health and overall well-being.

Transcept Pharmaceuticals, Inc. submitted an NDA for Intermezzo, a low-dose sublingual tablet formulation of zolpidem, in 2008, and in October 2009, Transcept announced that it received a complete response letter from the FDA relating to such NDA. Transcept held a meeting with the FDA in January 2010 to discuss the implications of the complete response letter, and resubmitted its NDA for the product in January 2011. The FDA assigned a Prescription Drug User Fee Act of 1992, or PDUFA, action date of July 14, 2011 for completion of the NDA review. Transcept and Purdue Pharmaceutical Products L.P. have entered into an exclusive license and collaboration agreement to commercialize Intermezzo in the United States.

Alexza Pharmaceuticals, Inc. has announced positive results from a Phase 1 clinical trial of an inhaled formulation of zaleplon, the active pharmaceutical ingredient in Sonata. In July 2010, Alexza announced that it was advancing this product candidate into Phase 2 clinical trials during the first half of 2011 for the treatment of insomnia in patients who have difficulty falling asleep, including those patients who awaken in the middle of the night and have difficulty falling back asleep. Somnus Therapeutics, Inc. has announced positive results from two Phase 1 clinical trials of a delayed-release formulation of zaleplon and has initiated Phase 2 clinical trials of that product candidate.

Vanda Pharmaceuticals Inc. has completed two Phase 3 insomnia clinical trials of tasimelteon, a melatonin receptor agonist. Tasimelteon received orphan drug designation status for non-24 hour sleep/wake disorder in blind individuals with no light perception. Vanda has initiated a Phase 3 clinical trial for tasimelteon to treat this disorder. Vanda has announced that it plans to conduct additional clinical trials and plans to file an NDA with the FDA by the first quarter of 2013.

Merck & Co., Inc. has MK-4305, an orexin antagonist, in Phase 3 clinical trials for the treatment of insomnia and MK-6096 in Phase 2 clinical trials for the treatment of insomnia. Merck has announced that it plans to file regulatory applications for MK-4305 in 2012.

Several other companies, including Sunovion Pharmaceuticals, are evaluating 5HT2 antagonists as potential hypnotics, and Eli Lilly and Company is evaluating a potential hypnotic that is a dual histamine/5HT2 antagonist. Additionally, several companies are evaluating new formulations of existing compounds and other compounds for the treatment of insomnia.

On December 15, 2010, we, together with ProCom, filed suit in the United States District Court for the District of Delaware against each of Actavis and Mylan. The lawsuit alleges that Actavis and Mylan have each infringed U.S. Patent No. 6,211,229 by filing their ANDAs relating to Silenor prior to the expiration of this patent. Pursuant to the provisions of the Hatch-Waxman Act, FDA final approval of each of the Actavis and Mylan ANDAs can occur no earlier than May 3, 2013, unless there is an earlier court decision that the ‘229 patent is not infringed and/or invalid or unless any party to the action is found to have failed to cooperate reasonably to expedite the infringement action. At this time, other patents listed in the Orange Book for Silenor have not been asserted against either Mylan or Actavis.

On February 2, 2011, we, together with ProCom, filed suit in the United States District Court for the District of Delaware against Par. The lawsuit alleges that Par has infringed U.S. Patent No. 6,211,229 by filing its ANDA relating to Silenor prior to the expiration of this patent. Pursuant to the provisions of the Hatch-Waxman Act, FDA final approval of the Par ANDA can occur no earlier than June 23, 2013, unless there is an earlier court decision that the ‘229 patent is not infringed and/or invalid or unless any party to the action is found to have failed to cooperate reasonably to expedite the infringement action. At this time, other patents listed in the Orange Book for Silenor have not been asserted against Par.

We intend to vigorously enforce our intellectual property rights relating to Silenor, but given the unpredictability of patent litigation, we cannot predict the outcome of these matters.

Manufacturing

We have entered into a non-exclusive manufacturing services agreement with Patheon for the manufacture of commercial quantities of our Silenor 3 mg and 6 mg tablets. Although we are not required to purchase any minimum quantity of Silenor under the agreement, we have agreed to purchase from Patheon not less than specified percentages of our total annual commercial requirements from all suppliers of Silenor, which vary depending upon annual volume. The agreement provides for an initial five-year term that began upon commencement of the manufacturing services, and thereafter automatically continues for successive twelve-month terms unless terminated by written notice at least eighteen months prior to the end of the then-current term. Either party may terminate the agreement upon written notice if the other party has failed to remedy a material breach of any of its representations, warranties or other obligations under the agreement within 60 days following receipt of written notice of such breach. In addition, either party may immediately terminate the agreement upon written notice if (1) the other party is declared insolvent or bankrupt by a court of competent jurisdiction, (2) a voluntary petition of bankruptcy is filed in any court of competent jurisdiction by such other party or (3) the agreement is assigned by such other party for the benefit of creditors. We have the right to terminate the agreement upon 30 days prior written notice in the event that any governmental agency takes any action, or raises any objection, that prevents us from importing, exporting, purchasing or selling the product candidate. In addition, we have the right to terminate the agreement upon twelve months’ prior written notice in connection with our partnering, collaboration, licensing, sublicensing, co-promotion, sale or divestiture of rights to the product candidate, provided that no such termination shall be effective before the third anniversary of the commencement date.

We have also entered into agreements with Plantex USA, Inc. to manufacture our supply of doxepin active pharmaceutical ingredient and with Anderson Packaging, Inc. to package Silenor finished products, and we have another agreement in place for the supply of a key ingredient contained in our formulation for Silenor. In August 2008, we entered into an amendment to our supply agreement providing us with the exclusive right to use this ingredient in combination with doxepin. Pursuant to the amended supply agreement, we made an upfront license payment of $0.2 million and are obligated to pay a royalty on worldwide net sales of Silenor beginning as of the expiration of the statutory exclusivity period for Silenor in each country in which Silenor is marketed. This royalty is only payable if one or more patents under the license agreement continue to be valid in each such country and a patent relating to our formulation for Silenor has not issued in such country.

We sell Silenor through pharmaceutical wholesalers, who in turn distribute the products to retail pharmacies, mail order pharmacies, hospitals and other institutional customers. We have retained third-party service providers to perform a variety of functions related to the distribution of our products, including logistics management, sample accountability, storage and transportation.

Government Regulation

Governmental authorities in the United States and other countries extensively regulate the testing, manufacturing, labeling, storage, record-keeping, advertising, promotion, export, marketing and distribution, among other things, of pharmaceutical products. In the United States, the FDA, under the Federal Food, Drug, and Cosmetic Act and other federal statutes and regulations, subjects pharmaceutical products to rigorous review. If we do not comply with applicable requirements, we may be fined, the government may refuse to approve our marketing applications or allow us to manufacture or market our products, and we may be criminally prosecuted.

We and our manufacturers and CROs may also be subject to regulations under other federal, state, and local laws, including the Occupational Safety and Health Act, the Environmental Protection Act, the Clean Air Act and import, export and customs regulations as well as the laws and regulations of other countries.

FDA Approval Process

To obtain approval of a new product from the FDA, we must, among other requirements, submit data supporting safety and efficacy as well as detailed information on the manufacture and composition of the product and proposed labeling, including a proposed proprietary name for the product. The testing and collection of data and the preparation of necessary applications are expensive and time-consuming. The FDA may not act quickly or favorably in reviewing these applications, and we may encounter significant difficulties or costs in our efforts to obtain FDA approvals that could delay or preclude us from marketing our products.

The process required by the FDA before a new drug may be marketed in the United States generally involves the following: completion of non-clinical laboratory and animal testing in compliance with FDA regulations, submission of an IND, which must become effective before human clinical trials may begin, performance of adequate and well-controlled human clinical trials to establish the safety and efficacy of the proposed drug for its intended use, and submission and approval by the FDA of an NDA. The sponsor typically conducts human clinical trials in three sequential phases, but the phases may overlap. In Phase 1 clinical trials, the product is tested in a small number of patients or healthy volunteers, primarily for safety at one or more dosages. In Phase 2 clinical trials, in addition to safety, the sponsor evaluates the efficacy of the product on targeted indications, and identifies possible adverse effects and safety risks in a patient population. Phase 3 clinical trials typically involve testing for safety and clinical efficacy in an expanded population at geographically-dispersed test sites.

Clinical trials must be conducted in accordance with the FDA’s good clinical practices requirements. The FDA may order the partial, temporary or permanent discontinuation of a clinical trial at any time or impose other sanctions if it believes that the clinical trial is not being conducted in accordance with FDA requirements or presents an unacceptable risk to the clinical trial patients. The institutional review board, or IRB, generally must approve the clinical trial design and patient informed consent at each clinical site and may also require the clinical trial at that site to be halted, either temporarily or permanently, for failure to comply with the IRB’s requirements, or may impose other conditions.

The applicant must submit to the FDA the results of the non-clinical and clinical trials, together with, among other things, detailed information on the manufacture and composition of the product and proposed labeling, in the form of an NDA, including payment of a user fee, unless the applicant qualifies for a waiver of the user fee. The FDA reviews all NDAs submitted before it accepts them for filing and may request additional information rather than accepting an NDA for filing. Once the submission is accepted for filing, the FDA begins an in-depth review of the NDA. Under the policies agreed to by the FDA under PDUFA, the FDA has ten months in which to complete its review of a standard NDA and respond to the applicant. The review process and the PDUFA goal date may be extended by three months if the FDA requests or the NDA sponsor otherwise provides additional information or clarification regarding information already provided in the submission within the three months prior to the PDUFA goal date. If the FDA’s evaluations of the NDA and the clinical and manufacturing procedures and facilities are favorable, the FDA may issue an approval letter, authorizing commercial marketing of the drug for a specified indication. If the FDA is not sufficiently satisfied with the information in the NDA to issue an approval letter, the FDA may issue a complete response letter, which usually will describe all of the specific deficiencies that the FDA has identified in the NDA and when possible, recommend actions that the NDA sponsor may take to address the identified deficiencies.

On March 18, 2010, the FDA notified us that it approved our NDA for Silenor 3 mg and 6 mg tablets for the treatment of insomnia characterized by difficulty with sleep maintenance.

Section 505(b)(1) New Drug Applications

The approval process described above is premised on the applicant being the owner of, or having obtained a right of reference to, all of the data required to prove the safety and effectiveness of a drug product. This type of marketing application, sometimes referred to as a “full” or “stand-alone” NDA, is governed by Section 505(b)(1) of the Federal Food, Drug, and Cosmetic Act. A Section 505(b)(1) NDA contains full reports of investigations of safety and effectiveness, which includes the results of non-clinical studies and clinical trials, together with detailed information on the manufacture and composition of the product, in addition to other information.

Section 505(b)(2) New Drug Applications

As an alternate path to FDA approval for new indications, formulations or strengths of previously-approved products, a company may file a Section 505(b)(2) NDA, instead of a “stand-alone” or “full” NDA filing under Section 505(b)(1) as described above. Section 505(b)(2) of the Federal Food, Drug, and Cosmetic Act was enacted as part of the Drug Price Competition and Patent Term Restoration Act of 1984, otherwise known as the Hatch-Waxman Amendments. Section 505(b)(2) permits the submission of an NDA where at least some of the information required for approval comes from studies not conducted by or for the applicant and for which the applicant has not obtained a right of reference. The Hatch-Waxman Amendments permit the applicant to rely upon the FDA’s findings of safety and effectiveness for an approved product or on published information. We submitted our NDA for Silenor under Section 505(b)(2), and as such it relied, in part, on the FDA’s previous findings of safety and effectiveness for doxepin.

To the extent that the Section 505(b)(2) applicant is relying on the FDA’s findings for an already-approved product, the applicant is required to certify to the FDA concerning any patents listed for the approved product in the FDA’s Orange Book publication. Specifically, the applicant must certify that: (1) the required patent information relating to the listed patent has not been filed in the NDA for the approved product; (2) the listed patent has expired; (3) the listed patent has not expired, but will expire on a particular date and approval is sought after patent expiration; or (4) the listed patent is invalid or will not be infringed by the manufacture, use or sale of the new product. A certification that the new product will not infringe the already approved product’s Orange Book-listed patents or that such patents are invalid is called a paragraph IV certification. If the applicant does not challenge the listed patents, the Section 505(b)(2) application will not be approved until all the listed patents claiming the referenced product have expired. The Section 505(b)(2) application may also not be approved until any non-patent exclusivity, such as exclusivity for obtaining approval of a new chemical entity, listed in the Orange Book for the referenced product has expired.

Notwithstanding the approval of many products by the FDA pursuant to Section 505(b)(2), over the last few years, certain brand-name pharmaceutical companies and others have objected to the FDA’s interpretation of Section 505(b)(2). If these companies successfully challenge the FDA’s interpretation of Section 505(b)(2), the FDA may be required to change its interpretation of Section 505(b)(2). This could delay or even prevent the FDA from approving any Section 505(b)(2) NDA that we submit.

Regulatory Status and Requirements

In connection with the approval of our NDA for Silenor, the FDA imposed certain requirements upon us. The FDA has required us to implement a risk evaluation and mitigation strategy, or REMS, consisting of a medication guide and a timetable for assessment of its effectiveness. We are also required to complete a standard clinical trial assessing the safety and efficacy of Silenor in children aged 6 to 16 pursuant to the Pediatric Research Equity Act of 2003, or PREA, and to submit the final results of this trial by March 2015.

The Hatch-Waxman Act

Under the Hatch-Waxman Act, newly-approved drugs and indications benefit from a statutory period of non-patent marketing exclusivity. The Hatch-Waxman Act provides five-year marketing exclusivity to the first applicant to gain approval of an NDA for a new chemical entity, meaning that the FDA has not previously approved any other new drug containing the same active moiety. Hatch-Waxman prohibits the submission of an ANDA, or a Section 505(b)(2) NDA for another version of such drug during the five-year exclusive period; however, as explained above, submission of an ANDA or Section 505(b)(2) NDA containing a paragraph IV certification is permitted after four years, which may trigger a 30-month stay of approval of the ANDA or Section 505(b)(2) NDA. Protection under Hatch-Waxman will not prevent the submission or approval of another full NDA; however, the subsequent applicant would be required to conduct its own non-clinical and adequate and well-controlled clinical trials to demonstrate safety and effectiveness. The Hatch-Waxman Act also provides three years of marketing exclusivity for the approval of new and supplemental NDAs, including Section 505(b)(2) NDAs, for, among other things, new indications, formulations, or strengths of an existing drug, if new clinical investigations that were conducted or sponsored by the applicant are essential to the approval of the application. We received three years of marketing exclusivity for Silenor.

We intend to vigorously enforce our intellectual property rights relating to Silenor, but given the unpredictability of patent litigation, we cannot predict the outcome of these matters.

Pediatric Exclusivity

The Best Pharmaceuticals for Children Act, which was signed into law January 4, 2002, and which reauthorized Section 111 of the 1997 FDA Modernization Act, provides in some cases an additional six months of exclusivity for new or marketed drugs for specific pediatric studies conducted at the written request of the FDA. PREA authorizes the FDA to require pediatric studies for drugs to ensure the drugs’ safety and efficacy in children. PREA requires that certain NDAs or supplements to NDAs contain data assessing the safety and effectiveness for the claimed indication in all relevant pediatric subpopulations. Dosing and administration must be supported for each pediatric subpopulation for which the drug is safe and effective. The FDA may also require this data for approved drugs that are used in pediatric patients for the labeled indication, or where there may be therapeutic benefits over existing products. The FDA may grant deferrals for submission of data, or full or partial waivers from PREA. We received a waiver from PREA requirements for children below age 6, and a deferral of submission of final pediatric study data until March 2015 for children aged 6 to 16.

Other Regulatory Requirements

Any approved product that we market may also be subject to a number of post-approval regulatory requirements. If we seek to make certain changes to an approved product, such as promoting or labeling a product for a new indication, making certain manufacturing changes or product enhancements or adding labeling claims, we will need FDA review and approval before the change can be implemented. While physicians may use products for indications that have not been approved by the FDA, we may not label or promote the product for an indication that has not been approved. Securing FDA approval for new indications or product enhancements and, in some cases, for manufacturing and labeling claims, is generally a time-consuming and expensive process that may require us to conduct clinical trials under the FDA’s IND regulations. Even if such studies are conducted, the FDA may not approve any change in a timely fashion, or at all. In addition, adverse experiences associated with use of the products must be reported to the FDA, and FDA rules govern how we can label, advertise or otherwise commercialize our products.

There are post-marketing safety surveillance requirements that we will need to meet to continue to market an approved product. The FDA also may, in its discretion, require additional post-marketing testing and surveillance to monitor the effects of approved products or place conditions on any approvals that could restrict the sale or use of these products. The FDA has required us to develop a REMS, to ensure that the benefits of Silenor outweigh its risks. A REMS can include information to accompany the product, such as a patient package insert or a medication guide, a communication plan, elements to assure safe use, and an implementation system, and must include a timetable for assessment of the REMS. Our REMS for Silenor consists of a medication guide and a timetable for assessment of its effectiveness. In addition, the FDA may require modifications to the REMS at a later date if warranted by new safety information. Any future requirements imposed by the FDA may require substantial expenditures.

The FDA has also requested that all manufacturers of sedative-hypnotic drug products modify their product labeling to include stronger language concerning potential risks. These risks include severe allergic reactions and complex sleep-related behaviors, which may include sleep-driving. The FDA also recommended that the drug manufacturers conduct clinical studies to investigate the frequency with which sleep-driving and other complex behaviors occur in association with individual drug products. Our approved label for Silenor includes warnings relating to risks of complex sleep behaviors.

In addition to FDA restrictions on marketing of pharmaceutical products, several other types of state and federal laws have been applied to restrict certain marketing practices in the pharmaceutical industry in recent years. These laws include anti-kickback statutes and false claims statutes. The federal health care program anti-kickback statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce or in return for purchasing, leasing, ordering or arranging for the purchase, lease or order of any health care item or service reimbursable under Medicare, Medicaid or other federally financed health care programs. This statute has been interpreted to apply to arrangements between pharmaceutical manufacturers on the one hand and prescribers, purchasers and formulary managers on the other. Violations of the anti-kickback statute are punishable by imprisonment, criminal fines, civil monetary penalties and exclusion from participation in federal health care programs. Although there are a number of statutory exemptions and regulatory safe harbors protecting certain common activities from prosecution or other regulatory sanctions, the exemptions and safe harbors are drawn narrowly, and practices that involve remuneration intended to induce prescribing, purchases or recommendations may be subject to scrutiny if they do not qualify for an exemption or safe harbor.

Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government, or knowingly making, or causing to be made, a false statement to have a false claim paid. Recently, several pharmaceutical and other health care companies have been prosecuted under these laws for allegedly inflating drug prices they report to pricing services, which in turn are used by the government to set Medicare and Medicaid reimbursement rates, and for allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product. In addition, certain marketing practices, including off-label promotion, may also violate false claims laws. The majority of states also have statutes or regulations similar to the federal anti-kickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor.

In addition, we and the manufacturers upon which we rely for the manufacture of our products are subject to requirements that drugs be manufactured, packaged and labeled in conformity with current good manufacturing practice, or cGMP. To comply with cGMP requirements, manufacturers must continue to spend time, money and effort to meet requirements relating to personnel, facilities, equipment, production and process, labeling and packaging, quality control, record-keeping and other requirements. The FDA periodically inspects drug manufacturing facilities to evaluate compliance with cGMP requirements.

Also, as part of the sales and marketing process, pharmaceutical companies frequently provide samples of approved drugs to physicians. This practice is regulated by the FDA and other governmental authorities, including, in particular, requirements concerning record-keeping and control procedures.

The U.S. Congress recently enacted legislation to reform the healthcare system. A major goal of the new healthcare reform law was to provide greater access to healthcare coverage for more Americans. Accordingly, the new healthcare reform law requires individual U.S. citizens and legal residents to maintain qualifying health coverage, imposes certain requirements on employers with respect to offering health coverage to employees, amends insurance regulations regarding when coverage can be provided and denied to individuals, and expands existing government healthcare coverage programs to more individuals in more situations. Among other things, the new healthcare reform law specifically:

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established annual, non-deductible fees on any entity that manufactures or imports certain branded prescription drugs, beginning in 2011;

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increased minimum Medicaid rebates owed by manufacturers under the Medicaid Drug Rebate Program, retroactive to January 1, 2010;

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redefined a number of terms used to determine Medicaid drug rebate liability, including average manufacturer price and retail community pharmacy, effective October 2010;

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extended manufacturers’ Medicaid rebate liability to covered drugs dispensed to individuals who are enrolled in Medicaid managed care organizations, effective March 2010;

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expanded eligibility criteria for Medicaid programs by, among other things, allowing states to offer Medicaid coverage to additional individuals beginning April 2010 and by adding new mandatory eligibility categories for certain individuals with income at or below 133 percent of the Federal Poverty Level beginning 2014, thereby potentially increasing manufacturers’ Medicaid rebate liability;

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established a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in and conduct comparative clinical effectiveness research;

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required manufacturers to participate in a coverage gap discount program, under which they must agree to offer 50 percent point-of-sale discounts off negotiated prices of applicable brand drugs to eligible beneficiaries during their coverage gap period, as a condition for the manufacturer’s outpatient drugs to be covered under Medicare Part D, beginning 2011; and

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increased the number of entities eligible for discounts under the Public Health Service pharmaceutical pricing program, effective January 2010.

Some states are also considering legislation that would control the prices of drugs, and state Medicaid programs are increasingly requesting manufacturers to pay supplemental rebates and/or requiring prior authorization by the state program. It is likely that federal and state legislatures and health agencies will continue to focus on additional healthcare reform in the future.

There have been a number of other legislative and regulatory proposals aimed at changing the healthcare system and pharmaceutical industry, including reductions in the cost of prescription products, changes in the levels at which consumers and healthcare providers are reimbursed for purchases of pharmaceutical products, proposals concerning reimportation of pharmaceutical products and proposals concerning safety matters. For example, in an attempt to protect against counterfeit drugs, the federal government and numerous states have enacted pedigree legislation. In particular, California has enacted legislation that requires development of an electronic pedigree to track and trace each prescription drug at the saleable unit level through the distribution system. California’s electronic pedigree requirement is scheduled to take effect beginning in January 2015.

Outside of the United States, our ability to market our products will also depend on receiving marketing authorizations from the appropriate regulatory authorities. The foreign regulatory approval process includes all of the risks associated with the FDA approval process described above. The requirements governing the conduct of clinical trials and marketing authorization vary widely from country to country.

Third-Party Reimbursement and Pricing Controls

In the United States and elsewhere, sales of pharmaceutical products depend in significant part on the availability of reimbursement to the consumer from third-party payors, such as government and private insurance plans. Third-party payors are increasingly challenging the prices charged for medical products and services. It is and will continue to be time-consuming and expensive for us or our strategic collaborators to go through the process of seeking reimbursement from Medicare and private payors. Our products may not be considered cost effective, and coverage and reimbursement may not be available or sufficient to allow us to sell our products on a competitive and profitable basis.

In many foreign markets, including the countries in the European Union, pricing of pharmaceutical products is subject to governmental control. In the United States, there have been, and we expect that there will continue to be, a number of federal and state proposals to implement similar governmental pricing control.

While we cannot predict whether such legislative or regulatory proposals will be adopted, the adoption of such proposals could have a material adverse effect on our business, financial condition and profitability.

Employees

As of February 15, 2011, we had 40 employees, consisting of drug development and manufacturing, regulatory affairs, marketing and administration. We believe our relations with our employees are good.

Available Information

We make available free of charge on or through our internet website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. Our internet address is www.somaxon.com. Information is also available through the Securities and Exchange Commission’s website at www.sec.gov or is available at the Securities and Exchange Commission’s Public Reference Room located at 100 F Street, NE, Washington DC, 20549. Information on the operation of the Public Reference Room is available by calling the Securities and Exchange Commission at 800-SEC-0330.


Item 1A.		Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this report, before deciding whether to invest in shares of our common stock. The occurrence of any of the following risks could harm our business, financial condition, results of operations or growth prospects. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.

Risks Related to Our Business

Our success is dependent on the success of Silenor (doxepin).

To date, the majority of our resources have been focused on the development of Silenor, and substantially all of our resources are now focused on the commercialization of Silenor. Our ability to generate revenue in the near term will depend solely on the success of this product. Accordingly, any disruption in our ability to generate revenues from the sale of Silenor or lack of success in its commercialization will have a substantial adverse impact on our business.

We may require substantial additional funding and may be unable to raise capital when needed, which could force us to delay, reduce or eliminate planned activities.

We began generating revenues from the commercialization of Silenor late in the third quarter of 2010, and our operations to date have generated substantial needs for cash. We expect our negative cash flows from operations to continue until we are able to generate significant cash flows from the commercialization of Silenor.

In November 2010, we completed a public offering of 8,800,000 shares of our common stock at a public offering for aggregate net proceeds of approximately $24.8 million, and at December 31, 2010 we had cash, cash equivalents, and short-term investments totaling $54.8 million. We believe, based on our current operating plan, that our cash, cash equivalents and short-term investments as of December 31, 2010 will be sufficient to fund our operations through at least the first quarter of 2012; however, our financial resources may not be adequate through such period due to many factors, including but not limited to the rate of growth of Silenor sales and the actual cost of commercial activities.

We are responsible for the costs relating to the commercialization of Silenor. As a result, commercial activities relating to Silenor are likely to result in the need for substantial additional funds. Our future capital requirements will depend on, and could increase significantly as a result of, many factors, including:

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our success in generating cash flows from the commercialization of Silenor, together with our co-promotion partner P&G;

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the costs of establishing or contracting for commercial programs and resources;

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the terms and timing of any future collaborative, licensing and other arrangements that we may establish;

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

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

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the rate of progress and cost of our non-clinical studies, clinical trials and other development activities;

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the scope, prioritization and number of development programs we pursue; and

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the effect of competing technological and market developments.

In February 2011, we entered into a loan agreement with Comerica Bank, or Comerica, pursuant to which we may request advances in an aggregate outstanding amount not to exceed $15.0 million. Amounts borrowed under the loan agreement may be repaid and re-borrowed at any time prior to February 7, 2013. We have no amounts outstanding under the loan agreement. Our ability to borrow under the loan agreement depends upon a number of conditions and restrictions, and we cannot be certain that we will satisfy all borrowing conditions at a time when we desire to borrow such amounts. For example, our ability to borrow at any given time is subject to the representations and warranties we made to Comerica under the loan agreement being generally true and correct at such time. Furthermore, we are subject to a number of affirmative and negative covenants, each of which we must be in compliance with at the time of any proposed borrowing. If we have not satisfied these various conditions, or an event of default otherwise has occurred, we may be unable to borrow amounts under the loan agreement, and may be required to repay any amounts previously borrowed.

In addition to the amounts available under our Comerica facility, we intend to obtain any additional funding we may require through strategic relationships, public or private equity or debt financings, assigning receivables or royalty rights, or other arrangements and cannot assure that such funding will be available on reasonable terms, or at all.

If we are unsuccessful in raising additional required funds, we may be required to delay, scale-back or eliminate plans or programs relating to our business, relinquish some or all rights to Silenor, or renegotiate less favorable terms with respect to such rights than we would otherwise choose. In addition, if we do not meet our payment obligations to third parties as they come due, we may be subject to litigation claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management, and may result in unfavorable results that could further adversely impact our financial condition. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders would result. If we raise additional funds by incurring debt financing, the terms of the debt may involve significant cash payment obligations as well as covenants and specific financial ratios that may restrict our ability to operate our business.

We, our co-promotion partner, P&G, and our contract sales force provider, Publicis, will need to retain qualified sales and marketing personnel and collaborate in order to successfully commercialize Silenor.

In August 2010, we entered into a co-promotion agreement with P&G, under which its sales representatives will provide a minimum number of primary details to certain healthcare professionals and a minimum number of calls to pharmacists promoting Silenor. In addition, in July 2010, we retained Publicis to provide 110 sales representatives to promote Silenor under the terms of a contract sales agreement. In February 2011 we engaged Publicis to provide an additional 35 sales representatives to promote Silenor that we expect to be fully deployed in the early second quarter of 2011. These representatives are employees of Publicis but will be hired to our specifications and will be managed by our team of Somaxon sales management personnel. As a result, Silenor is now supported by 215 field sales representatives who promote Silenor in the primary detail position, and this will be increased to 250 sales representatives once the deployment of the additional sales representatives is complete. However, there can be no assurance that we and Publicis will be able to identify suitable candidates to fill the additional 35 positions on this timeframe, which may result in delaying our ability to increase in-person promotional efforts for Silenor. To the extent we, P&G and Publicis are not successful in retaining qualified sales and marketing personnel, we may not be able to effectively market Silenor.

We and P&G each have the right to terminate the co-promotion agreement at any time following December 31, 2011 by providing at least 90 days prior written notice, as well as other more limited termination rights. While our agreement with P&G requires its field sales representatives to promote our products in a minimum number of primary details to target physicians and a minimum number of pharmacy calls, we cannot be sure that P&G’s efforts will be successful.

Our agreement with Publicis will cause us to incur significant costs, and we cannot be sure that the efforts of the contract sales force, together with any efforts made by P&G to promote our products, will generate sufficient awareness or demand for our products. If we determine that the contract sales force is not successful and we decide to terminate our agreement with Publicis prior to the one-year anniversary of the deployment of the contract sales force, we will incur termination fees.

Any revenues we receive from sales of Silenor will largely depend upon the efforts P&G and Publicis, which in many instances will not be within our control. If we are unable to maintain our co-promotion agreement with P&G, to maintain our contract sales agreement with Publicis or to effectively establish alternative arrangements to market our products, our business could be adversely affected. In addition, despite our arrangements with P&G and Publicis, we still may not be able to cover all of the prescribing physicians for insomnia at the same level of reach and frequency as our competitors, and we ultimately may need to further expand our selling efforts in order to effectively compete.

If Silenor or any other product we commercialize does not achieve broad market acceptance, the revenues that we generate from its sale will be limited.

The commercial success of Silenor or any other product which we commercialize will depend upon the acceptance of the product by the medical community and reimbursement of the product by third-party payors, including government payors. The degree of market acceptance of any approved product will depend on a number of factors, including:

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the scope and effectiveness of our sales, marketing and distribution resources and strategies, or those of our collaborators, if any;

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our ability to provide acceptable evidence of safety and efficacy and physician and patient understanding of differential indications for use, such as sleep maintenance;

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pricing and cost effectiveness;

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availability of alternative treatments, including, in the case of Silenor, a number of competitive products already approved for the treatment of insomnia or expected to be commercially launched in the future;

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off-label substitution by chemically similar or equivalent products, including for Silenor the off-label use of higher-dose generic formulations of doxepin approved and available for the treatment of depression and anxiety;

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prevalence and severity of any adverse side effects;

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limitations or warnings contained in the FDA-approved labeling of Silenor or any other product that we commercialize;

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relative convenience and ease of administration; and

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our ability to obtain sufficient third-party coverage or reimbursement.

If Silenor or any other product that we commercialize does not achieve an adequate level of acceptance by physicians, health care payors and patients, or adequate payment and reimbursement levels are not provided, or if those policies increasingly favor generic products, we may not generate sufficient revenue from the product, and we may not become or remain profitable. In addition, our efforts to educate the medical community and third-party payors on the benefits of Silenor or any other product that we commercialize may require significant resources and may never be successful.

Restrictions on or challenges to our patent rights relating to our products and limitations on or challenges to our other intellectual property rights may limit our ability to prevent third parties from competing against us.

Our success will depend on our ability to obtain and maintain patent protection for Silenor and any other product candidate we develop or commercialize, preserve our trade secrets, prevent third parties from infringing upon our proprietary rights and operate without infringing upon the proprietary rights of others. The patent rights that we have in-licensed relating to Silenor are limited in ways that may affect our ability to exclude third parties from competing against us. In particular, we do not hold composition of matter patents covering the active pharmaceutical ingredient of Silenor. Composition of matter patents on active pharmaceutical ingredients are a particularly effective form of intellectual property protection for pharmaceutical products as they apply without regard to any method of use or other type of limitation. As a result, competitors who obtain the requisite regulatory approval can offer products with the same active ingredients as our products so long as the competitors do not infringe any method of use or formulation patents that we may hold.

The principal patent protection that covers, or that we expect will cover, Silenor consists of method of use patents. This type of patent protects the product only when used or sold for the specified method. However, this type of patent does not limit a competitor from making and marketing a product that is identical to our product for an indication that is outside of the patented method. Moreover, physicians may prescribe such a competitive identical product for off-label indications that are covered by the applicable patents. Although such off-label prescriptions may induce or contribute to the infringement of method of use patents, the practice is common and such infringement is difficult to prevent or prosecute.

Because products with active ingredients identical to ours have been on the market for many years, there can be no assurance that these other products were never used off-label or studied in such a manner that such prior usage would not affect the validity of our method of use patents. Due to some prior art that we identified, we initiated a reexamination of one of the patents we have in-licensed covering Silenor, (specifically, U.S. Patent No. 5,502,047, “Treatment for Insomnia”) which claims the treatment of chronic insomnia using doxepin in a daily dosage of 0.5 mg to 20 mg and expires in March 2013. The reexamination proceedings terminated and the USPTO issued a reexamination certificate narrowing certain claims, so that the broadest dosage ranges claimed by us are 0.5 mg to 20 mg for otherwise healthy patients with chronic insomnia and for patients with chronic insomnia resulting from depression, and 0.5 mg to 4 mg for all other chronic insomnia patients. We also requested reissue of this same patent to consider some additional prior art and to add intermediate dosage ranges below 10 mg. In two office actions relating to this reissue request, the USPTO raised no prior art objections to 32 of the 34 claims we were seeking and raised a prior art objection to the other two, as well as some technical objections. Each of the claims objected to by the USPTO related to dosages above 10 mg. After further review of the prior art submitted, the USPTO withdrew all of its prior art objections. We then determined that the proposed addition of the intermediate dosage ranges and the resolution of the technical objections no longer warranted continuation of the reissue proceeding. As a result, we elected not to continue that proceeding.

We also have multiple internally developed pending patent applications. No assurance can be given that the USPTO or other applicable regulatory authorities will allow pending applications to result in issued patents with the claims we are seeking, or at all.

Patent applications in the United States are confidential for a period of time until they are published, and publication of discoveries in scientific or patent literature typically lags actual discoveries by several months. As a result, we cannot be certain that the inventors of the issued patents that we in-licensed were the first to conceive of inventions covered by pending patent applications or that the inventors were the first to file patent applications for such inventions.

In addition, third parties may challenge our in-licensed patents and any of our own patents that we may obtain, which could result in the invalidation or unenforceability of some or all of the relevant patent claims, or could attempt to develop products utilizing the same active pharmaceutical ingredients as our products that do not infringe the claims of our in-licensed patents or patents that we may obtain.

When a third party files an ANDA for a product containing doxepin for the treatment of insomnia at any time during which we have patents listed for Silenor in the FDA’s Orange Book publication, the applicant will be required to certify to the FDA concerning the listed patents. Specifically, the applicant must certify that: (1) the required patent information relating to the listed patent has not been filed in the NDA for the approved product; (2) the listed patent has expired; (3) the listed patent has not expired, but will expire on a particular date and approval is sought after patent expiration; or (4) the listed patent is invalid or will not be infringed by the manufacture, use or sale of the new product. A certification that the new product will not infringe the Orange Book-listed patents for Silenor or that such patents are invalid is called a paragraph IV certification.

On November 3, 2010, we received a notice from each of Actavis Elizabeth LLC and Mylan Pharmaceuticals Inc. that each had filed with the FDA an ANDA for a generic version of Silenor 3 mg and 6 mg tablets. Each of the notices included a paragraph IV certification with respect to seven of the eight patents listed in the Orange Book for Silenor.

On December 23, 2010, we received a notice from Par Pharmaceuticals, Inc. that it had filed with the FDA an ANDA for a generic version of Silenor 3 mg and 6 mg tablets. This notice included a paragraph IV certification with respect to seven of the eight patents listed in the Orange Book for Silenor.

Certain pharmaceutical companies’ patent settlement agreements with generic pharmaceutical companies have been challenged by the U.S. Federal Trade Commission alleging a violation of Section 5(a) of the Federal Trade Commission Act, and any patent settlement agreement that we may enter into with any generic pharmaceutical company may be subject to similar challenges, which will be both expensive and time consuming and may render such settlement agreements unenforceable.

We also rely upon unpatented trade secrets and improvements, unpatented know-how and continuing technological innovation to develop and maintain our competitive position, which we seek to protect, in part, by confidentiality agreements with our collaborators, employees and consultants. We also have invention or patent assignment agreements with our employees and certain consultants. There can be no assurance that inventions relevant to us will not be developed by a person not bound by an invention assignment agreement with us. There can be no assurance that binding agreements will not be breached, that we would have adequate remedies for any breach, or that our trade secrets will not otherwise become known or be independently discovered by our competitors.

Litigation or other proceedings to enforce or defend intellectual property rights is often very complex in nature, expensive and time-consuming, may divert our management’s attention from our core business and may result in unfavorable results that could adversely impact our ability to prevent third parties from competing with us.

The patent rights that we have in-licensed covering Silenor are limited to certain low-dosage strengths in the United States, and our market opportunity for this product may be limited by the lack of patent protection for higher dosage strengths for which generic formulations are available and the lack of patent protection in other territories.

Although we have an exclusive, worldwide license for Silenor for the treatment of insomnia through the life of the last issued patent to expire, we do not have patent protection for Silenor in any jurisdiction outside the United States. In addition, although our in-licensed patent for the treatment of transient insomnia is scheduled to expire in 2020 and our patent that is expected to issue relating to the food effect of Silenor would expire in 2027, our in-licensed patent for the treatment of chronic insomnia is scheduled to expire in March 2013. Accordingly, in the absence of additional patents or other alternatives to obtain additional exclusivity rights for Silenor, a competitor could attempt to market doxepin for a chronic insomnia indication as early as March 2013. Furthermore, the patent protection in the United States for Silenor for the treatment of insomnia is limited to dosages ranging from a lower limit of 0.5 mg to various upper limits up to 20 mg of the active ingredient, doxepin. Doxepin is prescribed at dosages ranging from 75 mg to 300 mg daily for the treatment of depression and anxiety and is available in generic form in strengths as low as 10 mg in capsule form, as well as in a concentrated liquid form dispensed by a marked dropper and calibrated for 5 mg. As a result, we may face competition from the off-label use of these or other dosage forms of generic doxepin. Off-label use occurs when a drug that is approved by the FDA for one indication is prescribed by physicians for a different, unapproved indication.

In addition, we do not have patent protection for Silenor in any jurisdiction outside the United States. Others may attempt to commercialize low-dose doxepin in the European Union, Canada, Mexico or other markets where we do not have patent protection for Silenor. Due to the lack of patent protection for doxepin in territories outside the United States and the potential for correspondingly lower prices for the drug in those markets, it is possible that patients will seek to acquire low-dose doxepin in those other territories. The off-label use of generic doxepin in the United States or the importation of doxepin from foreign markets could adversely affect the commercial potential for Silenor and adversely affect our overall business and financial results. We have submitted additional patent applications for Silenor in the United States and outside the United States, but we cannot assure that these will result in issued patents or additional protection in the United States or other jurisdictions.

We are subject to uncertainty relating to healthcare reform measures, reimbursement policies and regulatory proposals which, if not favorable to Silenor or any other product that we commercialize, could hinder or prevent our commercial success.

Our ability to successfully commercialize Silenor and any other product to which we obtain rights will depend in part on the extent to which governmental authorities, private health insurers and other organizations establish appropriate coverage and reimbursement levels for the cost of our products and related treatments. The continuing efforts of the government, insurance companies, managed care organizations and other payors of healthcare services to contain or reduce costs of healthcare may adversely affect:

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the ability to obtain a price we believe is fair for our products;

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the ability to generate revenues and achieve or maintain profitability;

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the future revenues and profitability of our potential customers, suppliers and collaborators; and

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the availability of capital.

The U.S. Congress recently enacted legislation to reform the healthcare system. A major goal of the new healthcare reform law was to provide greater access to healthcare coverage for more Americans. Accordingly, the new healthcare reform law required individual U.S. citizens and legal residents to maintain qualifying health coverage, imposed certain requirements on employers with respect to offering health coverage to employees, amended insurance regulations regarding when coverage can be provided and denied to individuals, and expanded existing government healthcare coverage programs to more individuals in more situations. Among other things, the new healthcare reform law specifically:

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established annual, non-deductible fees on any entity that manufactures or imports certain branded prescription drugs, beginning in 2011;

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increased minimum Medicaid rebates owed by manufacturers under the Medicaid Drug Rebate Program, retroactive to January 1, 2010;

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redefined a number of terms used to determine Medicaid drug rebate liability, including average manufacturer price and retail community pharmacy, effective October 2010;

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extended manufacturers’ Medicaid rebate liability to covered drugs dispensed to individuals who are enrolled in Medicaid managed care organizations, effective March 2010;

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established a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in and conduct comparative clinical effectiveness research;

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increased the number of entities eligible for discounts under the Public Health Service pharmaceutical pricing program, effective January 2010.

While this legislation will, over time, increase the number of patients who have insurance coverage for our products, it also is likely to adversely affect our results of operations. Some states are also considering legislation that would control the prices of drugs, and state Medicaid programs are increasingly requesting manufacturers to pay supplemental rebates and/or requiring prior authorization by the state program. It is likely that federal and state legislatures and health agencies will continue to focus on additional healthcare reform in the future.

As a result of these or other reform measures, we may determine to change our current manner of operation or change our contract arrangements, any of which could harm our ability to operate our business efficiently or on the scale we would like and our ability to raise capital. In addition, in certain foreign markets, the pricing of prescription drugs is subject to government control and reimbursement may in some cases be unavailable or insufficient.

Current healthcare reform measures and any future legislative proposals to reform healthcare or reduce government insurance programs may result in lower prices for Silenor and any other product that we commercialize or exclusion of Silenor or any such other product from coverage and reimbursement programs. Either of those could harm our ability to market our products and significantly reduce our revenues from the sale of our products.

Managed care organizations are increasingly challenging the prices charged for medical products and services and, in some cases, imposing restrictions on the coverage of particular drugs. Many managed care organizations negotiate the price of medical services and products and develop formularies which establish pricing and reimbursement levels. Exclusion of a product from a formulary can lead to its sharply reduced usage in the managed care organization’s patient population. The process for obtaining coverage can be lengthy and costly, and we expect that it could take several months before a particular payor initially reviews our product and makes a decision with respect to coverage. For example, third-party payors may require cost-benefit analysis data from us in order to demonstrate the cost-effectiveness of any product we might bring to market. For any individual third-party payor, we may not be able to provide data sufficient to gain reimbursement on a similar or preferred basis to competitive products, or at all.

In addition, many insurers and other healthcare payment organizations encourage the use of less expensive alternative generic brands and OTC products through their prescription benefits coverage and reimbursement policies. The availability of generic prescription and OTC products for the treatment of insomnia has created, and will continue to create, a competitive reimbursement environment. Insurers and other healthcare payment organizations frequently make the generic or OTC alternatives more attractive to the patient by providing different amounts of reimbursement so that the net cost of the generic or OTC product to the patient is less than the net cost of a prescription branded product to the patient. Aggressive pricing policies by our generic or OTC product competitors and the prescription benefit policies of insurers could have a negative effect on our product revenues and profitability.

The competition among pharmaceutical companies to have their products approved for reimbursement also results in downward pricing pressure in the industry and in the markets where our products compete. In some cases, we may discount our products in order to obtain reimbursement coverage, and we may not be successful in any efforts we take to mitigate the effect of a decline in average selling prices for our products. Declines in our average selling prices would also reduce our gross margins.

In addition, once reimbursement at an agreed level is approved by a third-party payor, we may lose that reimbursement entirely. As reimbursement is often approved for a period of time, this risk is greater at the end of the time period, if any, for which the reimbursement was approved.

We may face additional challenges with regard to reimbursement which could affect our ability to successfully commercialize Silenor or any other product candidate that we commercialize, including:

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the variability of reimbursement rates likely to be caused by the use of miscellaneous drug codes and procedure codes may discourage physicians from providing Silenor or any other product candidate that we commercialize to certain or all patients depending on their insurance coverage;

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the initial use of “miscellaneous drug codes” for billing Silenor or any other product candidate that we commercialize until such time as specific drug codes are approved could result in slow and/or inaccurate reimbursement and thereby discourage product use;

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an increase in insurance plans that place more cost liability onto patients may limit patients’ willingness to pay for Silenor or any other product candidate that we commercialize and thereby discourage uptake; and

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unforeseen changes in federal health care policy guidelines may negatively impact a physician practice’s willingness to provide novel treatments.

If our products are not included within an adequate number of formularies or adequate reimbursement levels are not provided, or if those policies increasingly favor generic or OTC products, our overall business and financial condition would be adversely affected.

Further, there have been a number of legislative and regulatory proposals concerning reimportation of pharmaceutical products and safety matters. For example, in an attempt to protect against counterfeit drugs, the federal government and numerous states have enacted pedigree legislation. In particular, California has enacted legislation that requires development of an electronic pedigree to track and trace each prescription drug at the saleable unit level through the distribution system. California’s electronic pedigree requirement is scheduled to take effect beginning in January 2015. Compliance with California and future federal or state electronic pedigree requirements will likely require an increase in our operational expenses and will likely be administratively burdensome.

Generic pricing plans, such as those implemented by Wal-Mart, CVS, Rite Aid and Walgreens, may affect the market for our products.

In September 2006, Wal-Mart began offering certain generic drugs at $4 per prescription, and various other retailers including CVS, Rite Aid and Walgreens currently offer generic drugs at similar prices. Some retailers have also offered certain generic drugs for free on a limited basis. These and many other retailers have significant market presence, and any decision by them to make generic analogs of our products available at substantially lower prices may have a material adverse effect on the market for our products and our ability to generate revenues from their sale.

Even though Silenor received regulatory approval, it will still be subject to substantial ongoing regulation.

Even though U.S. regulatory approval has been obtained for Silenor, the FDA has imposed restrictions on its indicated uses or marketing and imposed ongoing requirements for post-approval studies or other activities. For example, the approved use of Silenor is limited to the treatment of insomnia characterized by sleep maintenance difficulty. In addition, the FDA has required us to implement a REMS consisting of a medication guide and a timetable for assessment of its effectiveness. We are also required to complete a standard clinical trial assessing the safety and efficacy of Silenor in children aged 6 to 16 pursuant to PREA, and to submit final results of this trial by March 2015. Any issues relating to these restrictions or requirements could have an adverse impact on our ability to achieve market acceptance of Silenor and generate revenues from its sale.

Silenor is also subject to ongoing FDA requirements for the labeling, packaging, storage, advertising, promotion, record-keeping and submission of safety and other post-market information. For example, the FDA may require modifications to our REMS for Silenor at a later date if warranted by new safety information. Any future requirements imposed by the FDA may require substantial expenditures.

In addition, all marketing activities associated with Silenor, as well as marketing activities related to any other products that we promote, are subject to numerous federal and state laws governing the marketing and promotion of pharmaceutical products. The FDA regulates post-approval promotional labeling and advertising to ensure that such activities conform to statutory and regulatory requirements. Such regulation and FDA review could require us to alter our marketing materials or strategy, incur additional costs or delay certain of our promotional activities.

In addition to FDA restrictions, the marketing of prescription drugs is subject to laws and regulations prohibiting fraud and abuse under government healthcare programs. For example, the federal health care program anti-kickback statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce or in return for purchasing, leasing, ordering or arranging for the purchase, lease or order of any health care item or service reimbursable under Medicare, Medicaid or other federally financed health care programs. This statute has been interpreted to apply to arrangements between pharmaceutical manufacturers on the one hand and prescribers, purchasers and formulary managers on the other. Although there are a number of statutory exemptions and regulatory safe harbors protecting certain common activities from prosecution or other regulatory sanctions,

the exemptions and safe harbors are drawn narrowly, and practices that involve remuneration intended to induce prescribing, purchases or recommendations may be subject to scrutiny if they do not qualify for an exemption or safe harbor. Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government, or knowingly making, or causing to be made, a false statement to have a false claim paid. Recently, several pharmaceutical and other health care companies have been prosecuted under these laws for allegedly inflating drug prices they report to pricing services, which in turn are used by the government to set Medicare and Medicaid reimbursement rates, and for allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product. In addition, certain marketing practices, including off-label promotion, may also violate false claims laws. The majority of states also have statutes or regulations similar to the federal anti-kickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, which apply regardless of the payor. If we fail to comply with applicable FDA regulations or other laws or regulations relating to the marketing of Silenor or any other product, we could be subject to criminal prosecution, civil penalties, seizure of products, injunction, or exclusion of such products from reimbursement under government programs, as well as other regulatory actions.

Approved products, manufacturers and manufacturers’ facilities are subject to continual review and periodic inspections. If a regulatory agency discovers previously unknown problems with a product, such as adverse events of unanticipated severity or frequency, or problems with the facility where the product is manufactured, a regulatory agency may impose restrictions on that product or on us, including requiring withdrawal of the product from the market.

The distribution of pharmaceuticals is also regulated by state regulatory agencies, including the requirement to obtain and maintain distribution permits or licenses in many states. Compliance with these requirements may require the expenditure of substantial resources and could impact the manner and scope of our distribution operations. If we fail to comply with applicable state regulations relating to the distribution of Silenor or any other product we market, we could be subject to criminal prosecution, civil penalties, seizure of products, injunctions, or other regulatory actions.

We have implemented a comprehensive compliance program and related infrastructure, but we cannot provide absolute assurance that we are or will be in compliance with all potentially applicable laws and regulations. If our operations relating to Silenor fail to comply with applicable regulatory requirements, a regulatory agency may:

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issue warning letters or untitled letters;

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impose civil or criminal penalties, including fines;

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suspend regulatory approval;

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impose requirements to conduct additional clinical, non-clinical or other studies;

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suspend any ongoing clinical trials;

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refuse to approve pending applications or supplements to approved applications filed by us;

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impose restrictions on operations, including costly new manufacturing requirements; or

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seize or detain products or require a product recall.

In addition to P&G and Publicis, we rely on other third parties to perform many other necessary services for our commercial products, including services related to the storage and distribution of our products.

We have retained third-party service providers to perform a variety of functions related to the sale and distribution of our products, key aspects of which are out of our direct control. For example, we rely on one third-party service provider to provide key services related to warehousing and inventory management, distribution, contract administration and chargeback processing, accounts receivable management and call center management, and, as a result, most of our inventory is stored at a single warehouse maintained by the service provider. We also utilize third parties to perform various other services for us relating to e-detailing, sample processing, and regulatory monitoring, including adverse event reporting, safety database management and other product maintenance services.

We place substantial reliance on the third-party providers that perform services for us. If these third-party service providers fail to effectively provide services to us, fail to comply with applicable laws and regulations, fail to meet expected deadlines, or otherwise do not carry out their contractual duties to us, or encounter physical or natural damage at their facilities, our ability to successfully commercialize Silenor would be significantly impaired, or we could be subject to regulatory sanctions. We do not currently have the internal capacity to perform these important commercial functions, and we may not be able to maintain commercial arrangements for these services on reasonable terms.

Our future reporting and payment obligations under governmental purchasing and rebate programs will be complex and may involve subjective decisions, and any failure to comply with those obligations could subject us to penalties and sanctions, which in turn could have a material adverse effect on our business and financial condition.

As a condition of reimbursement by various federal and state healthcare programs, we will need to calculate and report certain pricing information to federal and state healthcare agencies. The regulations regarding the reporting of such pricing information are complex. Our calculations and methodologies will be subject to review and challenge by the applicable governmental agencies, and it is possible that such reviews could result in material changes to our calculations. In addition, because our calculations and the judgments involved in making these calculations will involve subjective decisions and complex methodologies, these calculations are subject to the risk of errors. Any failure to comply with governmental reporting and payment obligations could result in civil and/or criminal sanctions.

We expect intense competition in the marketplace for Silenor and any other product to which we acquire rights, and new products may emerge that provide different and/or better therapeutic alternatives for the disorders that our products are intended to treat.

Silenor competes with well established drugs approved for the treatment of insomnia, including the branded and generic versions of Sanofi-Synthélabo, Inc.’s Ambien and Ambien CR, Pfizer’s Sonata, and Lunesta, marketed by Sunovion Pharmaceuticals Inc., a wholly-owned subsidiary of Dainippon Sumitomo Pharma Co., Ltd., all of which are GABA-receptor agonists, and Takeda Pharmaceuticals North America, Inc.’s Rozerem, a melatonin receptor antagonist.

A number of companies are marketing reformulated versions of previously approved GABA-receptor agonists. For example, Meda AB and Orexo AB launched Edluar, formerly known as Sublinox, a sublingual tablet formulation of zopidem in the third quarter of 2009. ECR Pharmaceuticals Company, Inc., a wholly owned subsidiary of Hi-Tech Pharmacal Co., Inc., launched NovaDel Pharma, Inc.’s ZolpiMist, an oral mist formulation of zolpidem, in the United States in February 2011.

In addition to the currently approved products for the treatment of insomnia, a number of new products may enter the insomnia market over the next several years. Transcept Pharmaceuticals, Inc. submitted an NDA for Intermezzo, a low-dose sublingual tablet formulation of zolpidem in 2008, and in October 2009, Transcept announced that it received a complete response letter from the FDA relating to such NDA. Transcept resubmitted its NDA for the product in January 2011. The FDA assigned a PDUFA action date of July 14, 2011 for completion of the NDA review. Transcept and Purdue Pharmaceutical Products L.P. have entered into an exclusive license and collaboration agreement to commercialize Intermezzo in the United States.

Alexza Pharmaceuticals, Inc. has announced positive results from a Phase 1 clinical trial of an inhaled formulation of zaleplon, the active pharmaceutical ingredient in Sonata. In July 2010, Alexza announced that it was advancing this product candidate into Phase 2 clinical trials during the first half of 2011 for the treatment of insomnia in patients who have difficulty falling asleep, including those patients who awake in the middle of the night and have difficulty falling back asleep. Somnus Therapeutics, Inc. has announced positive results from two Phase 1 clinical trials of a delayed-release formulation of zaleplon and has initiated Phase 2 clinical trials of that product candidate.

Vanda Pharmaceuticals Inc. has completed two Phase 3 clinical trials of tasimelteon, a melatonin receptor agonist. Tasimelteon received orphan drug designation status for non-24 hour sleep/wake disorder in blind individuals with no light perception. Vanda has initiated a Phase 3 clinical trial for tasimelteon to treat this disorder. Vanda has announced that it plans to conduct additional clinical trials and plans to file an NDA with the FDA by the first quarter of 2013.

Several other companies, including Sunovion Pharmaceuticals, are evaluating 5HT2 antagonists as potential hypnotics, and Eli Lilly and Company is evaluating a potential hypnotic that is a dual histamine/5HT2 antagonist. Additionally, several other companies are evaluating new formulations of existing compounds and other compounds for the treatment of insomnia.

Furthermore, generic versions of Ambien, Ambien CR and Sonata have been launched and are priced significantly lower than approved, branded insomnia products. Sales of all of these drugs may reduce the available market for, and could put downward pressure on, the price we are able to charge for Silenor, which could ultimately limit our ability to generate significant revenues.

Upon the expiration of, or successful challenge to, our patents covering Silenor, generic competitors may introduce a generic version of Silenor at a lower price. Some generic manufacturers have also demonstrated a willingness to launch generic versions of branded products before the final resolution of related patent litigation (known as an “at-risk launch”). A launch of a generic version of Silenor could have a material adverse effect on our business and we could suffer a significant loss of sales and market share in a short period of time.

The biotechnology and pharmaceutical industries are subject to rapid and intense technological change. We face, and will continue to face, competition in the development and marketing of Silenor or any other product candidate to which we acquire rights from academic institutions, government agencies, research institutions and biotechnology and pharmaceutical companies. There can be no assurance that developments by others, including the development of other drug technologies and methods of preventing the incidence of disease, will not render Silenor or any other product candidate that we develop obsolete or noncompetitive.

Compared to us, many of our potential competitors have substantially greater:

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capital resources;

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manufacturing, distribution and sales and marketing resources and experience;

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research and development resources, including personnel and technology;

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regulatory experience;

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experience conducting non-clinical studies and clinical trials, and related resources; and

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expertise in prosecution of intellectual property rights.

As a result of these factors, our competitors may develop drugs that are more effective and less costly than ours and may be more successful than we are in manufacturing, marketing and selling their products. Our competitors may also obtain patent protection or other intellectual property rights or seek to invalidate or otherwise challenge our intellectual property rights, limiting our ability to successfully commercialize products.

In addition, manufacturing efficiency and selling and marketing capabilities are likely to be significant competitive factors. We currently have no commercial manufacturing capability and more limited sales and marketing infrastructure than many of our competitors and potential competitors.

If the manufacturers upon whom we rely fail to produce our products in the volumes that we require on a timely basis, or to comply with stringent regulations applicable to pharmaceutical drug manufacturers, we may face delays in the development and commercialization of, or be unable to meet demand for, our products and may lose potential revenues.

We do not manufacture Silenor, and we do not plan to develop any capacity to do so. We have a contract with Patheon Pharmaceuticals Inc. to manufacture our future required clinical supplies, if any, of Silenor, and we have entered into a manufacturing and supply agreement with Patheon to manufacture our commercial supply of Silenor. We have also entered into agreements with Plantex USA, Inc. to manufacture our supply of doxepin active pharmaceutical ingredient and with Anderson Packaging, Inc. to package Silenor finished products, and we have another agreement in place for the supply of a key ingredient contained in our formulation for Silenor.

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 and validating initial production. These problems include difficulties with production costs and yields, quality control, including stability of the product and quality assurance testing, shortages of qualified personnel, as well as compliance with strictly enforced federal, state and foreign regulations. Our manufacturers may not perform as agreed or may terminate their agreements with us. Additionally, our manufacturers may experience manufacturing difficulties due to resource constraints or as a result of labor disputes or unstable political environments. If our manufacturers were to encounter any of these difficulties, or otherwise fail to comply with their contractual obligations, our ability to sell Silenor or any other product candidate that we commercialize or provide any product candidates to patients in our clinical trials would be jeopardized. Any delay or interruption in the supply of clinical trial supplies could delay the completion of our clinical trials, increase the costs associated with maintaining our clinical trial program and, depending upon the period of delay, require us to commence new clinical trials at significant additional expense or terminate the clinical trials completely. In addition, any delay or interruption in our ability to meet commercial demand for Silenor will result in the loss of potential revenues.

In addition, all manufacturers 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 also likely to conduct inspections of our manufacturers’ facilities as part of their review of any marketing applications we submit. These cGMP requirements include quality control, quality assurance and the maintenance of records and documentation. Manufacturers of our products 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 our manufacturers’ failure to adhere to applicable laws or for other reasons, we may not be able to obtain regulatory approval for or successfully commercialize our products.

Moreover, our manufacturers and suppliers may experience difficulties related to their overall businesses and financial stability, which could result in delays or interruptions of our supply of Silenor. We do not have alternate manufacturing plans in place at this time. If we need to change to other manufacturers, the FDA and comparable foreign regulators must approve these manufacturers’ facilities and processes prior to our use, which would require new testing and compliance inspections, and the new manufacturers would have to be educated in or independently develop the processes necessary for production.

Any of these factors could adversely affect the commercial activities for Silenor or suspend clinical trials, regulatory submissions, and required approvals for any other product candidate that we develop, or entail higher costs or result in our being unable to effectively commercialize our products. Furthermore, if our manufacturers failed to deliver the required commercial quantities of raw materials, including bulk drug substance, or finished product on a timely basis and at commercially reasonable prices, we would likely be unable to meet demand for our products and we would lose potential revenues.

Our failure to successfully acquire, develop and market additional product candidates or approved products and integrate them into our operations may impair our ability to grow.

As part of our growth strategy, we intend to selectively evaluate products and product candidates that we believe may be a strategic fit with our business. Because we neither have, nor currently intend to establish, internal research capabilities, we would be dependent upon pharmaceutical and biotechnology companies, university scientists and other researchers to sell or license products to us. The success of this strategy will depend upon our ability to identify, select and acquire promising pharmaceutical product candidates and products. However, future acquisitions may entail numerous operational and financial risks, including:

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exposure to unknown liabilities;

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disruption of our business and diversion of our management’s time and attention to develop acquired products or technologies;

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incurrence of substantial debt or dilutive issuances of securities to pay for acquisitions;

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higher than expected acquisition and integration costs;

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increased amortization expenses;

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difficulty and cost in combining the operations and personnel of any acquired businesses with our operations and personnel;

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impairment of relationships with key suppliers or customers of any acquired businesses due to changes in management and ownership; and

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inability to retain key employees of any acquired businesses.

We have limited resources to identify and execute the evaluation, acquisition or in-licensing of third-party products, businesses and technologies and integrate them into our current infrastructure. In particular, we may compete with larger pharmaceutical companies and other competitors in our efforts to establish new collaborations and in-licensing opportunities. These competitors likely will have access to greater financial resources than us and may have greater expertise in identifying and evaluating new opportunities. Moreover, we may devote resources to potential acquisitions or in-licensing opportunities that are never completed, or we may fail to realize the anticipated benefits of such efforts.

Further, any product candidate that we acquire may require additional development efforts prior to commercial sale, including extensive clinical testing and approval by the FDA and applicable foreign regulatory authorities. All product candidates are prone to risks of failure typical of pharmaceutical product development, including the possibility that a product candidate will not be shown to be sufficiently safe and effective for approval by regulatory authorities. In addition, we cannot assure you that any products that we develop or approved products that we acquire will be manufactured or produced profitably, successfully commercialized or widely accepted in the marketplace.

If we are sued for infringing intellectual property rights of third parties, it will be costly and time consuming, and an unfavorable outcome in that litigation would have a material adverse effect on our business.

Our commercial success depends upon our ability, together with our collaborators, to manufacture, market and sell Silenor or any other product candidates that we develop and use our proprietary technologies without infringing the proprietary rights of third parties. Numerous U.S. and foreign issued patents and pending patent applications, which are owned by third parties, exist in the fields in which we and our collaborators are operating. As the biotechnology and pharmaceutical industry expands and more patents are issued, the risk increases that our operations may give rise to claims that our products infringe the patent rights of others. Because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our products or proprietary technologies may infringe.

We may be exposed to, or threatened with, future litigation by third parties having patent or other intellectual property rights alleging that our products and/or proprietary technologies infringe their intellectual property rights. If our products, proprietary technologies or their uses infringe any of these intellectual property rights, we or our collaborators could be required to pay damages and could be unable to commercialize our products or use our proprietary technologies unless we or they obtained a license. A license may not be available to us or our collaborators on acceptable terms, or at all. In addition, during litigation, the intellectual property rights holder could obtain a preliminary injunction or other equitable right which could prohibit us from making, using or selling our products, technologies or methods.

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infringement and other intellectual property claims which, with or without merit, may be expensive and time-consuming to litigate and may divert our management’s attention from our core business;

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substantial damages for infringement, including treble damages and attorneys’ fees, which we may have to pay if a court decides that the product at issue infringes on or violates the third party’s rights;

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a court prohibiting us from selling or licensing the product unless the third party licenses its product rights to us, which it is not required to do;

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if a license is available from the third party, we may have to pay substantial royalties, fees and/or grant cross-licenses to our products; and

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redesigning our products or processes so they do not infringe, which may not be possible or may require substantial funds and time.

No assurance can be given that patents do not exist, have not been filed, or could not be filed or issued, which contain claims covering our products, technology or methods. Because of the substantial number of patents issued and patent applications filed in our field, we believe there is a risk that third parties may allege they have patent rights encompassing our products, technology or methods.

We depend on a limited number of wholesaler customers for the retail distribution of Silenor, and if we lose significant wholesaler customers, our business could be harmed.

Our customers for our Silenor product include some of the nation’s leading wholesale pharmaceutical distributors, such as Cardinal Health, Inc., McKesson Corporation and AmerisourceBergen Corporation, and major drug chains. The loss of any of these companies as a wholesaler customer or a material reduction in their purchases or in the prices they are willing to pay for our products could harm our business, financial condition and results of operations.

Materials necessary to manufacture Silenor or any other product candidate that we develop or commercialize may not be available on commercially reasonable terms, or at all, which may delay development and commercialization.

Although we have contracted with suppliers of doxepin and other key raw materials for Silenor, we largely rely on our manufacturers to purchase from third-party suppliers the other materials necessary to produce our product candidates. Suppliers may not sell these materials to our manufacturers at the time we need them or on commercially reasonable terms. We do not have any control over the process or timing of the acquisition of these materials by our manufacturers. If our manufacturers or we are unable to purchase these materials for Silenor or any other product candidate that we commercialize, there would be a shortage in supply, which would materially affect our ability to generate sales revenues. If our manufacturers are unable to obtain these materials for our non-clinical studies or clinical trials of any other product candidate that we develop, product testing and potential regulatory approval could be delayed or suspended, significantly impacting our development programs.

Silenor or any other product candidate that we develop may cause undesirable side effects or have other properties that could delay or prevent their regulatory approval or commercialization.

Undesirable side effects caused by Silenor or any other product candidate that we develop could interrupt, delay or halt clinical trials, result in the denial or suspension of regulatory approval by the FDA or other regulatory authorities for any or all targeted indications, or cause us to evaluate the future of our development programs. Any of these occurrences could delay or prevent us from continuing to sell Silenor or from commercializing any product candidate that we develop. In addition, the FDA may require, or we may undertake, additional clinical trials to support the safety profile of Silenor or any proposed changes to the labeling for Silenor.

Silenor will be subject to continual review by the FDA, and we cannot assure you that newly discovered or developed safety issues will not arise. With the use of any marketed drug by a wide patient population, serious adverse events may occur from time to time that initially do not appear to relate to the drug itself, and only if the specific event occurs with some regularity over a period of time does the drug become suspect as having a causal relationship to the adverse event. Any safety issues could cause us to suspend or cease marketing of our approved products, cause us to modify how we market our approved products, subject us to substantial liabilities, and adversely affect our revenues and financial condition.

In addition, if we or others identify undesirable side effects caused by Silenor or any other product candidate that we commercialize:

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regulatory authorities may require the addition of labeling statements, such as a “black box” warning or a contraindication;

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regulatory authorities may withdraw their approval of the product or place restrictions on the way it is prescribed;

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we may be required to change the way the product is administered, conduct additional clinical trials, change the labeling of the product or implement a new or amended REMS;

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we may be subject to related liability; and

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our reputation may suffer.

Any of these events could prevent us from achieving or maintaining market acceptance of the affected product or could substantially increase the costs and expenses of commercializing the affected product, which in turn could delay or prevent us from generating significant revenues from its sale.

We may never receive approval or commercialize our products outside of the United States.

In order to market any products outside of the United States, we must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods. The time required to obtain approval in other countries might differ from that required to obtain FDA approval. The regulatory approval process in other countries may include all of the risks regarding FDA approval in the United States as well as other risks. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may have a negative effect on the regulatory process in others. Failure to obtain regulatory approval in other countries or any delay or setback in obtaining such approval could limit the uses of the product candidate and have an adverse effect on potential royalties and product sales. Such approval may be subject to limitations on the indicated uses for which the product may be marketed or require costly, post-marketing follow-up studies.

We have licensed Silenor from a third party. If we default on any of our obligations under that license, or if the licensor exercises a right to terminate the license, we could lose rights to Silenor.

We in-licensed rights to Silenor through an exclusive licensing arrangement, and we may enter into similar licenses in the future. Under our license agreement for Silenor, we are required to use commercially reasonable efforts to commercialize Silenor. In addition, our licensor for Silenor has the contractual right to terminate the license agreement upon the breach by or a specified insolvency event involving us. In the event that our licensor for Silenor terminates the license agreement, even though we would maintain ownership of our clinical data and the other intellectual property we have developed relating to Silenor, we would be unable to continue our commercialization activities relating to Silenor and our business and financial condition would be materially harmed.

We will need to increase the size of our organization, and we may experience difficulties in managing growth.

We have increased our headcount from 5 full-time employees at January 1, 2010 to 40 full-time employees as of February 15, 2011. Our management and personnel, systems and facilities currently in place may not be adequate to support the growth required to support our commercialization efforts. Our need to effectively manage our operations, growth and various projects requires that we:

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manage our commercial efforts effectively while carrying out our contractual obligations to collaborators and other third parties and complying with all applicable laws, rules and regulations;

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continue to improve our operational, financial and management controls, reporting systems and procedures; and

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attract, train and retain sufficient numbers of talented employees.

We may be unable to successfully implement these tasks on a larger scale and, accordingly, may not achieve our commercial goals.

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

The sale of approved products and the use of product candidates by us in clinical trials expose 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. Regardless of merit or eventual outcome, liability claims may result in:

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decreased demand for our products;

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impairment of our business reputation;

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withdrawal of clinical trial participants;

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costs of related litigation;

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substantial monetary awards to patients or other claimants;

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loss of revenues; and

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the inability or lack of commercial rationale to continue development or commercial activities relating to Silenor or any other product candidate we develop.

We have obtained product liability insurance coverage for commercial product sales of Silenor, including coverage for product liability claims, but our insurance coverage may not reimburse us at all or may not be sufficient to reimburse us for any 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. On occasion, large judgments have been awarded in class action lawsuits based on drugs that had unanticipated side effects. A successful product liability claim or series of claims brought against us could cause our stock price to fall and, if judgments exceed our insurance coverage, could decrease our cash and adversely affect our business.

We may not be able to manage our business effectively if we are unable to attract and retain key personnel.

We may not be able to attract or retain qualified management, scientific, clinical and commercial personnel in the future due to the intense competition for qualified personnel among biotechnology, pharmaceutical and other businesses, particularly in the San Diego, California area. If we are not able to attract and retain necessary personnel to accomplish our business objectives, we may experience constraints that will significantly impede the achievement of our development or commercialization objectives, our ability to raise additional capital and our ability to implement our business strategy. In particular, if we lose any members of our senior management team, we may not be able to find suitable replacements, and our business may be harmed as a result.

We are highly dependent on the product acquisition, development, regulatory and commercialization expertise of our senior management. If we lose one or more of the members of our senior management team or other key employees, our ability to implement 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 our industry with the breadth of skills and experience required to develop, gain regulatory approval of and commercialize products successfully. Competition to hire from this limited pool is intense, and we may be unable to hire, train, retain or motivate these additional key personnel.

In addition, we have advisors who assist us in formulating our product development, clinical, regulatory and commercialization strategies. These advisors are not our employees and may have commitments to, or consulting or advisory contracts with, other entities that may limit their availability to us, or may have arrangements with other companies to assist in the development or commercialization of products that may compete with ours.

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

Even though Silenor has received regulatory approval, before obtaining regulatory approvals for the commercial sale of any other product candidate we develop, we must demonstrate through clinical trials that the product candidate is safe and effective for use in each target indication.

The results from clinical trials that we complete may not be predictive of results obtained in future clinical trials, and there can be no assurance that we will demonstrate sufficient safety and efficacy to obtain the requisite regulatory approvals or result in marketable products. A number of companies in the biotechnology and pharmaceutical industries have suffered significant setbacks in advanced clinical trials, even after promising results in earlier studies. If any product candidate that we develop is not shown to be safe and effective in clinical trials, or if the FDA does not deem the product candidate to be sufficiently safe and effective to warrant marketing approval, our business, financial condition and results of operations would be materially harmed.

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

As is commonplace in our industry, we employ individuals who were previously employed at other biotechnology, specialty pharma or pharmaceutical companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.

Risks Related to Our Finances and Capital Requirements

Capital raising activities, such as issuing securities, incurring debt, assigning receivables or royalty rights or entering into collaborations or other strategic transactions, may cause dilution to existing stockholders or a reduction in our stock price, restrict our operations or require us to relinquish proprietary rights and may be limited by applicable laws and regulations.

Based on our recurring losses, negative cash flows from operations and working capital levels, we may need to raise substantial additional funds. If we are unable to maintain sufficient financial resources, including by raising additional funds when needed, our business, financial condition and results of operations will be materially and adversely affected.

Because we may need to raise additional capital to fund our business, among other things, we may conduct substantial equity offerings. For example, in November 2010, we completed a public offering of 8,800,000 shares of our common stock for aggregate net proceeds of approximately $24.8 million, and in March 2010, we completed a public offering of 6,900,000 shares of our common stock for aggregate net proceeds of approximately $52.7 million. In July 2009, we completed a private placement of 5.1 million shares of our common stock at a price of $1.05 per share and seven-year warrants to purchase up to 5.1 million additional shares of our common stock, exercisable in cash or by net exercise at a price of $1.155 per share, for aggregate net proceeds of $5.7 million. We also have two effective shelf registration statements on Form S-3 filed with the SEC under which we may offer from time to time up to an aggregate of approximately $67.1 million in any combination of debt securities, common and preferred stock and warrants.

To the extent that we raise any required additional capital by issuing equity securities, our existing stockholders’ ownership will be diluted. Any such dilution of the holdings of our current stockholders may result in downward pressure on the price of our common stock.

Any debt, receivables or royalty 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. For example, our ability to borrow under our loan agreement with Comerica depends upon a number of conditions and restrictions, and we cannot be certain that we will satisfy all borrowing conditions at a time when we desire to borrow such amounts under the loan agreement. Our ability to borrow under our Comerica loan agreement at any given time is subject to the representations and warranties we made to Comerica under such loan agreement being generally true and correct at such time. Furthermore, we are subject to a number of affirmative and negative covenants, each of which we must be in compliance with at the time of any proposed borrowing.

Debt financing, receivables assignments, royalty interest assignments and other types of financing are often coupled with an equity component, such as warrants to purchase stock. For example, in connection with our July 2009 private placement of equity securities, we issued to the investors warrants to purchase 5.1 million shares of our common stock, 2.3 million of which have not been exercised as of December 31, 2010. To the extent that any of these warrants, or any additional warrants that are outstanding or that we issue in the future, are exercised by their holders, dilution of our existing stockholders’ ownership interests will result.

If we raise additional funds through collaborations or other strategic transactions, it may be necessary to relinquish potentially valuable rights to our potential products or proprietary technologies, or grant licenses on terms that are not favorable to us.

In addition, rules and regulations of the SEC or other regulatory agencies may restrict our ability to conduct certain types of financing activities, or may affect the timing of and the amounts we can raise by undertaking such activities. For example, under current SEC regulations, if the aggregate market value of our common stock held by non-affiliates, or our public float, is less than $75 million, the amount that we can raise through primary public offerings of securities in any twelve-month period using one or more registration statements on Form S-3 may be limited to an aggregate of one-third of our public float. As of December 31, 2010, our public float was greater than $75 million.

Any future indebtedness under our loan agreement with Comerica could adversely affect our financial health.

Under our loan agreement with Comerica, we may incur up to $15 million of indebtedness. Such indebtedness could have important consequences. For example, it could:

	•		impair our ability to obtain additional financing in the future for working capital needs, capital expenditures and general corporate purposes;

	•		increase our vulnerability to general adverse economic and industry conditions;

	•		make it more difficult for us to satisfy other debt obligations we may incur in the future;

	•		require us to dedicate a substantial portion of our cash flows from operations to the payment of principal and interest on our indebtedness, thereby reducing the availability of our cash flows to fund working capital needs, capital expenditures and other general corporate purposes;

	•		limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

	•		place us at a disadvantage compared to our competitors that have less indebtedness; and

	•		expose us to higher interest expense in the event of increases in interest rates because our indebtedness under the loan agreement with Comerica may bear interest at a variable rate.

Covenants in our loan agreement with Comerica may limit our ability to operate our business.

Under our loan agreement with Comerica, we are subject to specified affirmative and negative covenants, including limitations on our ability: to undergo certain change of control events; to convey, sell, lease, license, transfer or otherwise dispose of assets, other than in certain specified circumstances; to create, incur, assume, guarantee or be liable with respect to certain indebtedness; to grant liens; to pay dividends and make certain other restricted payments; and to make certain investments. In addition, under the loan agreement we are required to maintain a balance of cash with Comerica in an amount of not less than $5.0 million and to maintain 50% of any other cash balances with Comerica, and any other cash and investments must be covered by a control agreement for the benefit of Comerica. We are also subject to specified financial covenants with respect to a minimum liquidity ratio and, once we have two consecutive quarters of profitability, minimum EBITDA requirements, as defined in the loan agreement.

Although we believe we were in compliance with all of our non-financial and financial covenants as of entering into the loan agreement, our future ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial, and industry conditions. If we default under the loan agreement because of a covenant breach or otherwise, any outstanding amounts could become immediately due and payable, which would negatively impact our liquidity and reduce the availability of our cash flows to fund working capital needs, capital expenditures and other general corporate purposes.

We have never been profitable and we may not be able to generate revenues sufficient to achieve profitability.

We only began generating revenues from the commercialization of Silenor late in the third quarter of 2010, we have not been profitable since inception, and it is possible that we will not achieve profitability. We incurred net losses of $38.8 million for the year ended December 31, 2010, and have accumulated losses totaling $216.9 million since inception. We expect to continue to incur significant operating losses and capital expenditures. As a result, we will need to generate significant revenues to achieve and maintain profitability. We cannot assure you that we will achieve significant revenues, or that we will ever achieve profitability. Even if we do achieve profitability, we cannot assure you that we will be able to sustain or increase profitability on a quarterly or annual basis in the future. If revenues grow more slowly than we anticipate or if operating expenses exceed our expectations or cannot be adjusted accordingly, our business, results of operations and financial condition will be materially and adversely affected.

Our quarterly operating results may fluctuate significantly.

We expect our operating results to be subject to quarterly fluctuations. The revenues we generate, if any, and our operating results will be affected by numerous factors, including:

•

the scope and effectiveness of commercial activities relating to Silenor or any other product that we may commercialize, alone or with a collaborator;

•

commercial activities of our competitors;

•

our entering into collaborations;

•

developments in our current intellectual property lawsuits with Actavis, Mylan and Par;

•

any other intellectual property infringement lawsuit in which we may become involved;

•

our addition or termination of development programs or funding support;

•

variations in the level of expenses related to development of any product candidate that we develop;

•

non-cash charges which we incur, including relating to share-based compensation; and

•

regulatory developments.

If our quarterly operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Furthermore, any quarterly fluctuations in our operating results may, in turn, cause the price of our stock to fluctuate substantially. We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.

The use of our net operating loss and tax credit carryforwards may be limited.

Net operating loss carryforwards and research and development credits may expire and not be used. As of December 31, 2010, we had generated federal net operating loss carryforwards of approximately $181.8 million and state net operating loss carryforwards of approximately $176.6 million, the majority of which were generated in California. As of December 31, 2010, we had generated federal research and development tax credits of $4.3 million and California research and development tax credits of $2.0 million. Both federal net operating loss carryforwards and federal research and development tax credits have a 20-year carryforward period and begin to expire in 2023 and 2024, respectively. California net operating loss carryforwards have a ten year carryforward period and begin to expire in 2013; however, California has currently suspended the use of net operating loss carryforwards to offset taxable income. California research and development tax credits have no expiration.

Pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of our net operating loss and credit carryforwards will be limited in the event a cumulative change in ownership of more than 50 percent occurs within a three-year period. We determined that such an ownership change occurred as of March 31, 2010 as a result of various stock issuances used to finance our development activities. This ownership change resulted in limitations on the utilization of our tax attributes, including our net operating loss carryforwards and tax credits. A portion of the remaining net operating losses limited by Section 382 becomes available for use each year.

If additional changes in ownership occur as a result of future financing events, then additional net operating loss carryforwards and research and development credit carryovers could be eliminated or restricted.

Negative conditions in the global credit markets may have an impact on the value of our investment securities.

Our investment securities consist primarily of money market funds and corporate and United States government agency notes. We do not have any auction rate securities. In recent years there has been concern in the credit markets regarding the value of a variety of mortgage-backed securities and the resultant effects on various securities markets. While we do not believe that our investment securities have significant risk of default or illiquidity, we cannot provide absolute assurance that our investments are not subject to adverse changes in market value. If the credit ratings of the security issuers deteriorate and any decline in market value is determined to be other-than-temporary, we would be required to adjust the carrying value of the investments through impairment charges.

Risks Relating to Securities Markets and Investment in Our Stock

There may not be a viable public market for our common stock, and market volatility may affect our stock price and the value of your investment.

Our common stock had not been publicly traded prior to our initial public offering, which was completed in December 2005, and an active trading market may not develop or be sustained. We have never declared or paid any cash dividends on our capital stock. We currently intend to retain all available funds and any future earnings to support operations and finance the growth and development of our business. We do not intend to pay cash dividends on our common stock for the foreseeable future. Therefore, investors will have to rely on appreciation in our stock price and a liquid trading market in order to achieve a gain on their investment. The market prices for securities of biotechnology and pharmaceutical companies have historically been highly volatile, and the market has from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. Since our initial public offering on December 15, 2005 through December 31, 2010, the trading prices for our common stock have ranged from a high of $21.24 to a low of $0.18.

The market price of our common stock may fluctuate significantly in response to a number of factors, most of which we cannot control, including:

•

variations in our quarterly operating results;

•

events affecting our existing in-license agreements, our co-promotion agreement with P&G, our contract sales agreement with Publicis, and any future collaborations or other strategic transactions, commercial agreements and grants;

•

announcements of new products or technologies, commercial relationships or other events by us or our competitors;

•

developments in our current intellectual property lawsuits with Actavis, Mylan and Par;

•

any other intellectual property infringement lawsuit in which we may become involved;

•

regulatory approval or other changes in the regulatory status of our products or product candidates;

•

decreased coverage and changes in securities analysts’ estimates of our financial performance;

•

regulatory developments in the United States and foreign countries;

•

fluctuations in stock market prices and trading volumes of similar companies;

•

sales of large blocks of our common stock, including sales by our executive officers, directors and significant stockholders;

•

announcements concerning financing activities;

•

additions or departures of key personnel; and

•

discussion of us or our stock price by the financial and scientific press and in online investor communities.

The realization of any of the risks described in these “Risk Factors” could have a dramatic and material adverse impact on the market price of our common stock. In addition, class action litigation has often been instituted against companies whose securities have experienced periods of volatility or declines in market price. Any such litigation brought against us could result in substantial costs and a diversion of management’s attention and resources, which could hurt our business, operating results and financial condition.

If we are unable to comply with the minimum requirements for listing on the Nasdaq Capital Market, we may be delisted from the Nasdaq Capital Market, which would likely cause the liquidity and market price of our common stock to decline.

Our stock is listed on the Nasdaq Capital Market. In order to continue to be listed on the Nasdaq Capital Market, we must meet specific quantitative standards, including maintaining a minimum bid price of $1.00 for our common stock, a public float of $1.0 million, and either $2.5 million in stockholders equity or a market capitalization of $35 million. We are currently in compliance with these standards, but it is possible that we may fail to be in compliance in the future.

If the Nasdaq Stock Market provides us with a notice of non-compliance, we may provide a plan to achieve and sustain compliance with continued listing requirements. If we submit the plan and it is accepted by Nasdaq, Nasdaq may grant us a period of up to 105 days from the date of the notice of non-compliance within which to regain compliance with the listing requirements. If Nasdaq determines that our plan is not sufficient to achieve and sustain compliance, or if we are unable to achieve compliance within such period, Nasdaq will provide written notice that our securities will be delisted. At such time, we may appeal the decision to a Nasdaq Listing Qualifications Panel. If that appeal is unsuccessful, our securities would be delisted.

If we were to be delisted from the Nasdaq Capital Market, trading, if any, in our shares may continue to be conducted on the Over-the-Counter Bulletin Board or in a non-Nasdaq over-the-counter market, such as the “pink sheets.” Delisting of our shares would result in limited release of the market price of those shares and limited analyst coverage and could restrict investors’ interest in our securities. Also, a delisting could have a material adverse effect on the trading market and prices for our shares and our ability to issue additional securities or to secure additional financing. In addition, if our shares were not listed and the trading price of our shares was less than $5.00 per share, our shares could be subject to Rule 15g-9 under the Exchange Act which, among other things, requires that broker/dealers satisfy special sales practice requirements, including making individualized written suitability determinations and receiving a purchaser’s written consent prior to any transaction. In such case, our securities could also be deemed to be a “penny stock” under the Securities Enforcement and Penny Stock Reform Act of 1990, which would require additional disclosure in connection with trades in those shares, including the delivery of a disclosure schedule explaining the nature and risks of the penny stock market. Such requirements could severely limit the liquidity of our securities and our ability to raise additional capital in an already challenging capital market.

If our executive officers, directors and largest stockholders choose to act together, they may be able to control our operations and act in a manner that advances their best interests and not necessarily those of other stockholders.

As of February 15, 2011, our executive officers, directors and holders of 5% or more of our outstanding common stock beneficially owned approximately 50.8% of our common stock. As a result, these stockholders, acting together, would likely be able to control all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. The interests of this group of stockholders may not always coincide with our interests or the interests of other stockholders, and they may act in a manner that advances their best interests and not necessarily those of other stockholders.

If we are unable to maintain an effective registration statement for the resale of shares under our July 2009 private placement, or if we are delisted from the Nasdaq Capital Market, Nasdaq Global Market, the New York Stock Exchange or the American Stock Exchange, we may be required to pay liquidated damages.

In July 2009, we issued 5.1 million shares of common stock at $1.05 per share and seven-year warrants to purchase up to 5.1 million additional shares of common stock, exercisable in cash or by net exercise at a price of $1.155 per share, for aggregate gross proceeds of $6.0 million and net proceeds of $5.7 million after deducting offering costs of $0.3 million. In connection with the private placement, we agreed to register for resale both the shares of common stock purchased by the investors and the shares of common stock issuable upon exercise of the warrants. The resale registration statement was filed and declared effective by the SEC in August 2009. We also agreed to other customary obligations regarding registration, including matters relating to indemnification, maintenance of the registration statement and payment of expenses.

We may be liable for liquidated damages if we do not maintain the effectiveness of the registration statement or the listing of our common stock on the Nasdaq Capital Market, the Nasdaq Global Market, the New York Stock Exchange or the American Stock Exchange, in each case for a period of ten consecutive days or for more than thirty days in any 365-day period. The amount of the liquidated damages is one percent per applicable ten or thirty day period, subject to an aggregate maximum of eight percent per calendar year, of the aggregate purchase price of the common stock purchased in the private placement then held by each investor that are registrable securities.

Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws may delay or prevent an acquisition of us or a change in our management. These provisions include a classified board of directors, a prohibition on actions by written consent of our stockholders, and the ability of our 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 percent of our outstanding voting stock from merging or combining with us. Although we believe these provisions collectively provide for an opportunity to receive higher bids by requiring potential acquirors to negotiate with our board of directors, they would apply even if an offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.

We expend substantial costs and management resources as a result of laws and regulations relating to corporate governance matters.

As a public reporting company, we must comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations adopted by the SEC and by the Nasdaq Stock Market, including expanded disclosures, accelerated reporting requirements and more complex accounting rules. Compliance with Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, and other requirements has caused us to expend substantial costs and management resources and will continue to do so. Additionally, these laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or board committees or as executive officers. In June 2007, the Public Company Accounting Oversight Board approved Auditing Standard No. 5, and at the same time, the SEC issued guidance for management for complying with the requirements of Section 404. This auditing standard and the related management guidance provides a more risk-based approach to compliance and testing under Section 404. However, we still do and expect to continue to incur substantial costs and to devote significant resources to corporate governance matters.

We are also subject to changing rules and regulations of federal and state government as well as the stock exchange on which our common stock is listed. These entities, including the Public Company Accounting Oversight Board, the SEC and the Nasdaq Stock Market, have issued a significant number of new and increasingly complex requirements and regulations over the course of the last several years and continue to develop additional regulations and requirements in response to laws enacted by Congress. On July 21, 2010, the Dodd-Frank Wall Street Reform and Protection Act, or the Dodd-Frank Act, was enacted. There are significant corporate governance and executive compensation-related provisions in the Dodd-Frank Act that require the SEC to adopt additional rules and regulations in these areas such as “say on pay” and proxy access, and the SEC has since issued final rules implementing “say on pay” measures. Our efforts to comply with corporate governance and related requirements have resulted in, and are likely to continue to result in, an increase in expenses and a diversion of management’s time from other business activities.

If we, or the third-party service providers on which we rely, fail to comply with Section 404 and the other corporate governance laws and regulations applicable to us, or if our independent registered public accounting firm cannot complete any required attestation of our evaluation of our internal controls in a timely manner, we could be subject to regulatory scrutiny and a loss of public confidence in our corporate governance or internal controls, which could have an adverse effect on our business and our stock price.


Item 1B.		Unresolved Staff Comments

We do not have any unresolved staff comments relating to our periodic or current reports.


Item 2.		Properties

We lease approximately 6,000 square feet of space for our headquarters in San Diego, California subject to a lease arrangement that will expire in May 2011. We have no laboratory, research or manufacturing facilities.


Item 3.		Legal Proceedings

Pursuant to the provisions of the Hatch-Waxman Act, FDA final approval of each of the Actavis and Mylan ANDAs can occur no earlier than May 3, 2013, and FDA final approval of the Par ANDA can occur no earlier than June 23, 2013, unless in either case there is an earlier court decision that the ‘229 patent is not infringed and/or invalid or unless any party to the action is found to have failed to cooperate reasonably to expedite the infringement action. At this time, other patents listed in the Orange Book for Silenor have not been asserted against Mylan, Actavis or Par.


Item 4.		Reserved

PART II


Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock has been traded on the Nasdaq Stock Market since December 15, 2005 under the symbol SOMX. Prior to such time, there was no public market for our common stock. The following table sets forth the high and low sales prices per share of our common stock as reported on the Nasdaq Stock Market for the period indicated.


	Price Range
	High		Low
Year Ended December 31, 2009
First Quarter	$	2.50	$	0.18
Second Quarter	$	1.65	$	0.32
Third Quarter	$	4.78	$	0.70
Fourth Quarter	$	4.80	$	0.90

Year Ended December 31, 2010
First Quarter	$	10.60	$	1.10
Second Quarter	$	9.10	$	3.41
Third Quarter	$	5.48	$	2.65
Fourth Quarter	$	3.98	$	2.52

As of February 25, 2011, there were approximately 11,247 holders of record of our common stock.

Performance Graph

The following graph illustrates a comparison of the total cumulative stockholder return on our common stock to two indices: the Nasdaq Composite Index and the Nasdaq Pharmaceuticals Index. The graph assumes an initial investment of $100 on January 1, 2006.


	December 31,
	2010		2009		2008		2007		2006
Somaxon Pharmaceuticals, Inc.	$	31.65	$	10.85	$	13.87	$	52.36	$	142.61
Nasdaq Composite Index	$	125.92	$	106.57	$	73.31	$	122.14	$	110.38
Nasdaq Pharmaceutical Index	$	116.66	$	107.62	$	95.78	$	102.94	$	97.88

The foregoing graph and table are furnished solely with this report, and are not filed with this report, and shall not be deemed incorporated by reference into any other filing under the Securities Act or the Exchange Act, whether made by us before or after the date hereof, regardless of any general incorporation language in any such filing, except to the extent we specifically incorporate this material by reference into any such filing.

Dividend Policy

We have never declared or paid any cash dividends on our capital stock. We currently intend to retain all available funds and any future earnings to support operations and finance the growth and development of our business and do not intend to pay cash dividends on our common stock for the foreseeable future. Any future determination related to our dividend policy will be made at the discretion of our board of directors.

Securities Authorized for Issuance under Equity Compensation Plans

The following table summarizes securities available under our equity compensation plans as of December 31, 2010 (in thousands, except per share data).


	Weighted				Shares		Total shares
	average per		Shares		issuable upon		issuable		Number of
	share		issuable upon		vesting of		under		securities
	exercise price		exercise of		outstanding		current		available for
	of stock		outstanding		restricted		outstanding		future
	options		stock options		stock units		awards		issuance
Equity compensation plans approved by security holders:
2004 Equity Incentive Award Plan	$	4.28		143		—		143		—
2005 Equity Incentive Award Plan		3.85		3,239		125		3,364		2,131

Total Equity Incentive Award Plans	$	3.86		3,382		125		3,507		2,131
2005 Employee Stock Purchase Plan								—		1,102

Total Equity compensation plans approved by security holders	$	3.86		3,382		125		3,507		3,233


Equity compensation plans not approved by security holders:
None.

We have share-based awards outstanding under the Somaxon Pharmaceuticals, Inc. 2004 Equity Incentive Award Plan and the 2005 Equity Incentive Award Plan for the benefit of our eligible employees, consultants, and directors. The 2004 Equity Incentive Award Plan was discontinued in November 2005 upon the adoption of the 2005 Equity Incentive Award Plan. No additional share-based awards will be granted under the 2004 Equity Incentive Award Plan and all share-based awards that are repurchased, forfeited, cancelled or expire will become available for grant under the 2005 Equity Incentive Award Plan. The 2005 Employee Stock Purchase Plan was adopted at the time of our initial public offering.

Stock options granted under the 2005 Equity Incentive Award Plan have an exercise price equal to the fair market value of the underlying common stock at the date of grant, have a ten year life and generally vest over a period of between one and four years for our employees and between one and three years for members of our board of directors, with some awards vesting upon the achievement of certain performance conditions. The vesting of the stock options issued pursuant to our one-time stock option exchange program which was completed in June 2009 is such that one-third vested immediately upon issuance of the replacement awards and the remaining two-thirds vest in equal monthly installments over the following two year period such that all the shares will be fully vested in June 2011.

Restricted shares of our common stock have also been granted under the 2005 Equity Incentive Award Plan, a portion of which vested upon the acceptance of our NDA for Silenor and the remainder of which vested upon approval of our NDA for Silenor.

Awards of restricted stock units, or RSUs, have also been granted under the 2005 Equity Incentive Award Plan. With respect to unvested RSUs held by our employees as of December 31, 2009, half vested upon the approval by the FDA of our NDA for Silenor, and the remainder vested on December 1, 2010. Members of our board of directors received their quarterly retainers for service on the Board of Directors, or committees thereof, and their fees for attending meetings of the Board, and committees thereof, through March 2010 in RSUs. All of these RSUs vested on December 1, 2010.

The 2005 Equity Incentive Award Plan and 2005 Employee Stock Purchase Plan contain “evergreen” provisions which allow for annual increases in the number of shares available for future issuance. The 2005 Equity Incentive Award Plan’s evergreen provision provides for annual increases in the number of shares available for grant equal to the lesser of: (i) 2,000,000 shares, (ii) 5% of the then-total outstanding shares of capital stock (45,004,000 shares were outstanding at December 31, 2010), or (iii) such lesser amount as determined by the board of directors. Pursuant to this evergreen provision, on January 1, 2011, the number of shares available for grant under the 2005 Equity Incentive Award Plan increased by 2,000,000 shares, resulting in a total of 4,131,000 shares available for grant at that time. The 2005 Employee Stock Purchase Plan’s evergreen provision provides for annual increases in the number of shares available for grant equal to the lesser of: (i) 300,000 shares, (ii) 1% of the then-total outstanding shares of capital stock (45,004,000 shares were outstanding at December 31, 2010), or (iii) such lesser amount as determined by the board of directors. Pursuant to this evergreen provision, on January 1, 2011, the number of shares available for grant under the 2005 Employee Stock Purchase Plan increased by 300,000 shares, resulting in a total of 1,402,000 shares available for grant at that time.

Recent Sales of Unregistered Securities

None.

Issuer Repurchases of Equity Securities

None.


Item 6.		Selected Financial Data

The selected statement of operations data for the years ended December 31, 2010, 2009 and 2008, and the balance sheet data as of December 31, 2010 and 2009 have been derived from our audited financial statements included elsewhere in this annual report. The selected statement of operations data for the years ended December 31, 2007 and 2006, and the balance sheet data as of December 31, 2008, 2007 and 2006 have been derived from audited financial statements which are not included in this Form 10-K. Historical results are not necessarily indicative of future results. The selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related notes included elsewhere in this annual report (amounts in thousands, except per share data).


	Year Ended December 31,
	2010			2009			2008			2007			2006
Statement of Operations Data:
Net product sales	$	1,382		$	—		$	—		$	—		$	—
Cost of sales		244			—			—			—			—

Gross profit		1,138			—			—			—			—
Operating Expenses:
Selling, general and administrative		36,579			10,874			18,809			15,614			11,744
Research and development		3,566			4,337			16,546			12,694			37,462
License fees		—			(999	)		165			490			1,165

Total operating expenses		40,145			14,212			35,520			28,798			50,371

Loss from operations		(39,007	)		(14,212	)		(35,520	)		(28,798	)		(50,371	)

Interest and other income		262			30			903			2,387			3,961
Interest and other (expense)		(68	)		(261	)		(2,610	)		—			—

Net loss	$	(38,813	)	$	(14,443	)	$	(37,227	)	$	(26,411	)	$	(46,410	)

Basic and diluted net loss per share	$	(1.16	)	$	(0.69	)	$	(2.04	)	$	(1.45	)	$	(2.58	)

Shares used to calculate net loss per share		33,593			20,952			18,281			18,187			17,981


	As of December 31,
	2010			2009			2008			2007			2006
Balance Sheet Data:
Cash, cash equivalents and short-term investments	$	54,817		$	5,165		$	14,290		$	37,100		$	57,914
Working capital		52,407			3,404			4,258			34,385			51,334
Total assets		65,131			6,411			23,717			38,717			59,452
Total debt		—			—			15,000			—			—
Accumulated deficit		(216,852	)		(178,039	)		(163,596	)		(126,369	)		(99,958	)
Total stockholders’ equity		54,264			4,241			5,106			35,176			52,357


Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Financial Data” and our financial statements and related notes appearing elsewhere in this annual report. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to those set forth under the caption “Risk Factors” in this annual report.

Overview

Background

We are a specialty pharmaceutical company focused on the in-licensing, development and commercialization of proprietary branded products and late-stage product candidates to treat important medical conditions where there is an unmet medical need and/or high-level of patient dissatisfaction, currently in the central nervous system therapeutic area. In March 2010, the FDA approved our NDA for Silenor 3 mg and 6 mg tablets for the treatment of insomnia characterized by difficulty with sleep maintenance. Silenor was made commercially available by prescription in the United States in September 2010.

Our principal focus is on commercial activities relating to Silenor. We have increased our headcount from 5 employees as of March 2010 to 40 employees as of February 15, 2011. We commercially launched Silenor in September 2010 with 110 sales representatives provided to us on an exclusive basis under our contract sales agreement with Publicis, and an additional 105 sales representatives provided to us under our co-promotion agreement with P&G. In February 2011, we engaged Publicis to provide us with an additional 35 sales representatives. As a result, we believe that as of the early second quarter of 2011 Silenor will be supported by 250 sales representatives, all of whom will promote Silenor in the primary detail position. We have also established the manufacturing and distribution channel for Silenor through agreements with third-party suppliers and service providers, and we have established reimbursement coverage for Silenor with numerous private and government payors.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, expenses and related disclosures. Actual results could differ from those estimates. We believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

We recognize revenue from product sales when it is realized or realizable and earned. Revenue is realized or realizable and earned when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) our price to the buyer is fixed or determinable; and (4) collectability is reasonably assured. Revenue from sales transactions where the buyer has the right to return the product is recognized at the time of sale only if (1) our price to the buyer is substantially fixed or determinable at the date of sale, (2) the buyer has paid us, or the buyer is obligated to pay us and the obligation is not contingent on resale of the product, (3) the buyer’s obligation to us would not be changed in the event of theft or physical destruction or damage of the product, (4) the buyer acquiring the product for resale has economic substance apart from that provided by us, (5) we do not have significant obligations for future performance to directly bring about resale of the product by the buyer, and (6) the amount of future returns can be reasonably estimated.

We sell Silenor to wholesale pharmaceutical distributors. Our returned goods policy generally permits our customers to return products up to six months before and up to twelve months after the expiration date of the product. We authorize returns for expired or damaged products in accordance with our returned goods policy and issue credit to our customers for expired or damaged returned product. We do not exchange product from inventory for returned product. As of December 31, 2010, we have not received any returns.

We are unable to reliably estimate returns at this time. Therefore, we have determined that shipment of product to wholesale distributors does not meet the criteria for revenue recognition at the time of shipment. Until we are able to reliably estimate returns, we will defer revenue recognition until the right of return no longer exists, which is the earlier of Silenor being dispensed through patient prescriptions or the expiration of the right of return. We estimate patient prescriptions dispensed using an analysis of third-party information. For the year ended December 31, 2010, we recognized product revenue of $1.4 million, which was net of estimated product sales discounts and allowances. At December 31, 2010, we had a deferred revenue balance of $3.5 million which was also recorded net of estimated product sales discounts and allowances. We have also deferred the related cost of product sales and recorded such amount as finished goods inventory held by others, which was $0.3 million as of December 31, 2010.

Until we can reliably estimate product returns, we will continue to recognize revenue upon the earlier to occur of prescription units dispensed or the expiration of the right of return. In order to develop a methodology and provide a basis for estimating future product returns on sales to customers at the time of product shipment, we are analyzing many factors, including industry data of product return rates, and tracking the Silenor product return history, taking into account product expiration dating at the time of shipment and levels of inventory in the wholesale channel. We may use some or all of these factors in establishing a basis for estimating future product returns on sales to customers at the time of product shipment.

Product Sales Discounts and Allowances

We record product sales discounts and allowances at the time of sale and report revenue net of such amounts in the same period that product sales are recorded. In determining the amount of product sales discounts and allowances, we must make significant judgments and estimates. If actual results vary from our estimates, we may need to adjust these estimates, which could have an effect on product revenue in the period of adjustment. Our product sales discounts and allowances and the specific considerations we use in estimating these amounts include:

Prompt Pay Discounts. As an incentive for prompt payment, we offer a 2% cash discount to customers. We expect that all customers will comply with the contractual terms to earn the discount. We recorded the discount as an allowance against accounts receivable and a reduction of revenue. At December 31, 2010 and 2009, the allowance for prompt pay discounts was $114,000 and $0, respectively.

Product Launch Discounts. For a limited time that ended September 30, 2010, we offered additional discounts to wholesale distributors for product purchased. We recorded the discount as an allowance against accounts receivable and a reduction of revenue based on orders placed. At December 31, 2010 and 2009, the allowance for product launch discounts was $277,000 and $0, respectively.

Patient Discount Programs. We offer discount card programs to patients who are prescribed Silenor under which the patient receives a discount on his or her prescription. We reimburse pharmacies for this discount through a third-party vendor. We estimate the total amount that will be redeemed based on the dollar amount of the discount, the timing and quantity of distribution and historical redemption rates. We accrued the discount and recognized a reduction of revenue. At December 31, 2010 and 2009, the accrual for patient discount programs was $182,000 and $0, respectively.

Distribution Service Fees. We pay distribution service fees to each wholesaler for distribution and inventory management services. We accrued for the fees based on contractually defined terms with each wholesaler and recognized a reduction of revenue. At December 31, 2010 and 2009, the accrual for distribution service fees was $276,000 and $0, respectively.

Chargebacks. We provide discounts to federal government qualified entities with whom we have contracted. These federal entities purchase products from the wholesalers at a discounted price, and the wholesalers then charge back to us the difference between the current retail price and the contracted price the federal entity paid for the product. We accrued chargebacks based on contract prices and sell-through sales data obtained from third-party information. At December 31, 2010 and 2009, the accrual for chargebacks was $9,000 and $0, respectively.

Rebates. We participate in certain rebate programs, which provide discounted prescriptions to qualified insured patients. Under these rebate programs, we pay a rebate to the third-party administrator of the program. We accrued rebates based on contract prices, estimated percentages of product sold to qualified patients and estimated levels of inventory in the distribution channel. At December 31, 2010 and 2009, the accrual for rebates was $6,000 and $0, respectively.

The following table summarizes the activity for the year ended December 31, 2010 associated with product sales discounts and allowances, with amounts shown in thousands. There was no activity in 2009 for product sales discounts and allowances.


													Total
													Accrued
	Prompt		Product		Patient						Charge-		Sales
	Pay		Launch		Discount			Distribution			backs and		Discounts
	Discounts		Discounts		Fees			Service Fees			Rebates		and Allowances
Balance at January 1, 2010	$	—	$	—	$	—		$	—		$	—	$	—
Provision made for sales during period		114		277		214			410			15		1,030
Payments		—		—		(32	)		(134	)		—		(166	)

Balance at December 31, 2010	$	114	$	277	$	182		$	276		$	15	$	864

For a limited time that ended September 30, 2010, we offered stocking allowances on the first order made by wholesale distributors and retail pharmacies. As of December 31, 2010, we had no remaining obligations for stocking allowances.

Cost of Sales

Cost of sales include the costs to manufacture, package, and ship Silenor, including personnel costs associated with manufacturing oversight, as well as royalties associated with our license agreement with ProCom.

Inventory

Our inventories are valued at the lower of cost, on a FIFO basis, or net realizable value. We analyze our inventory levels quarterly and write down inventory that has become obsolete, or has a cost basis in excess of its expected net realizable value, as well as any inventory quantities in excess of expected requirements. Expired inventory is disposed of and the related costs are written off. We did not record a reserve for expired inventory as of December 31, 2010.

Capitalized License Fees

License fees related to our intellectual property are capitalized once technological feasibility has been established. Costs incurred to in-license our product candidates subsequent to FDA approval of our NDA for Silenor have been capitalized and recorded as an intangible asset. Capitalized amounts are amortized on a straight line basis over the expected life of the intellectual property commencing with the commercial launch of the related product. Determining when technological feasibility has been achieved, and determining the related amortization period for capitalized intellectual property, requires the use of estimates and subjective judgment.

Share-based Compensation

Share-based compensation expense for employees and directors is recognized in the statement of operations based on estimated amounts, including the grant date fair value, the probability of achieving performance conditions and the expected service period for awards with conditional vesting provisions. For stock options, we estimate the grant date fair value using the Black-Scholes valuation model which requires the use of multiple subjective inputs including an estimate of future volatility, expected forfeitures and the expected term of the awards. Our stock did not have a readily available market prior to our initial public offering in December 2005, creating a relatively short history from which to obtain data to estimate volatility for our stock price. Consequently, we estimate our expected future volatility based on a combination of both comparable companies and our own stock price volatility to the extent such history is available. Our future volatility may differ from our estimated volatility at the grant date. We estimate the expected term of our options using guidance provided by the SEC’s Staff Accounting Bulletin, or SAB, No. 107 and SAB No. 110. This guidance provides a formula-driven approach for determining the expected term. Share-based compensation recorded in our statement of operations is based on awards expected to ultimately vest and has been reduced for estimated forfeitures. Our estimated forfeiture rates may differ from actual forfeiture rates which would affect the amount of expense recognized during the period. Estimated forfeitures are adjusted to actual amounts as they become known.

We recognize the value of the portion of the awards that are expected to vest on a straight-line basis over the awards’ requisite service periods. The requisite service period is generally the time over which our share-based awards vest. Some of our share-based awards vested upon achieving certain performance conditions, generally pertaining to approval of the Silenor NDA by the FDA, the commercial launch of Silenor, or the achievement of other strategic objectives. Share-based compensation expense for awards with performance conditions is recognized over the period from the date the performance condition are determined to be probable of occurring through the time the applicable condition is met. If the performance condition is not considered probable of being achieved, then no expense is recognized until such time the performance condition is considered probable of being met. At that time, expense is recognized over the period during which the performance condition is likely to be achieved.

Determining the likelihood and timing of achieving performance conditions is a subjective judgment made by management which may affect the amount and timing of expense related to these share-based awards. Share-based compensation is adjusted to reflect the value of options which ultimately vest as such amounts become known in future periods. As a result of these subjective and forward-looking estimates, the actual value of our stock options realized upon exercise could differ significantly from those amounts recorded in our financial statements.

Income Taxes

Our income tax expense consists of current and deferred income tax expense or benefit. Current income tax expense or benefit is the amount of income taxes expected to be payable or refundable for the current year. A deferred income tax asset or liability is recognized for the future tax consequences attributable to tax credits and loss carryforwards and to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2010, we have established a valuation allowance to fully reserve our net deferred tax assets. Tax rate changes are reflected in income during the period such changes are enacted. Changes in ownership may limit the amount of net operating loss carryforwards that can be utilized in the future to offset taxable income. In addition, the state of California has currently suspended the use of net operating loss carryforwards to offset taxable income.

Results of Operations

Comparisons of the Years Ended December 31, 2010, 2009 and 2008

Product Sales. Net product sales for 2010, 2009, and 2008 are summarized in the following table (in thousands, except percentages).


								Dollar Change					Percent Change
	Years Ended December 31,							2010 vs.			2009 vs.		2010 vs.		2009 vs.
	2010			2009		2008		2009			2008		2009		2008
Gross product sales	$	1,704		$	—	$	—	$	1,704		$	—		N/A		N/A
Discounts and allowances		(322	)		—		—		(322	)		—		N/A		N/A

Total net product sales	$	1,382		$	—	$	—	$	1,382		$	—		N/A		N/A

Product sales represent sales of Silenor for which we have recognized revenue. We recognized net product sales of $1,382,000 for 2010 and had no product sales in 2009 and 2008 as sales of Silenor commenced in the third quarter of 2010. Reductions from gross to net product sales, which include allowances for discounts, stocking incentives, patient discount programs, distribution service fees, chargebacks and rebates, totaled $322,000 for 2010, compared to $0 in the same period in 2009 and 2008. As a percentage of gross sales, the reductions were 18.9% for 2010.

Net product sales are expected to increase in 2011 over 2010 primarily due to Silenor being commercially available for all of 2011 and our continuing marketing efforts.

Cost of Sales. Cost of sales includes the costs to manufacture, package, and ship Silenor, including personnel costs associated with manufacturing oversight, as well as royalties associated with our license agreement. Cost of sales for 2010, 2009, and 2008 are summarized in the following table (in thousands, except percentages).

Dollar Change

Percent Change

Years Ended December 31,

2010 vs.

2009 vs.

2010 vs.

2009 vs.

2010

2009

2008

2009

2008

2009

2008

Cost of sales

244

—

244

—

N/A

We recognized cost of sales of $244,000 for 2010 relating to product dispensed through prescriptions, which we estimated using an analysis of third-party information. We had no cost of sales in 2009 and 2008 as sales of Silenor commenced in the third quarter of 2010. Gross profit was $1,138,000 for 2010. Expressed as a percentage of net product sales, gross margin was 82.3% in 2010.

Selling, General and Administrative Expense. Our selling, general and administrative expenses consist primarily of salaries, benefits, share-based compensation expense, advertising and market research costs, insurance and facility costs, and professional fees related to our marketing, administrative, finance, human resources, legal and internal systems support functions. Selling, general and administrative expense for 2010, 2009 and 2008 are summarized in the following tables (in thousands, except percentages).


							Dollar Change					Percent Change
	Years Ended December 31,						2010 vs.		2009 vs.			2010 vs.			2009 vs.
	2010		2009		2008		2009		2008			2009			2008
Marketing, personnel and other costs	$	31,167	$	6,237	$	14,555	$	24,930	$	(8,318	)		400	%		(57	)%
Share-based compensation		5,412		4,637		4,254		775		383			17	%		9	%

Total selling, general and administrative expenses	$	36,579	$	10,874	$	18,809	$	25,705	$	(7,935	)		236	%		(42	)%


Sales and marketing	$	24,591	$	1,461	$	6,388	$	23,130	$	(4,927	)		1,583	%		(77	)%
General and administrative		11,988		9,413		12,421		2,575		(3,008	)		27	%		(24	)%

Total selling, general and administrative expenses	$	36,579	$	10,874	$	18,809	$	25,705	$	(7,935	)		236	%		(42	)%

Selling and marketing expenses increased $23.1 million for 2010 compared to 2009 due to the costs associated with the commercial activities and launch of Silenor. Launch costs included the training and deployment of Somaxon’s sales representatives, sample distribution, and other promotional spending and consulting costs. General and administrative expenses increased $2.6 million for 2010 compared to 2009 primarily due to an increase in salary and benefits expense resulting from an increase in overall headcount in 2010 compared to 2009.

Selling and marketing expenses decreased $4.9 million for 2009 compared to 2008 primarily due to a reduction in market preparation activities as a result of the delay in the FDA approval process for Silenor. Personnel and related costs also decreased as a result of our cost reduction measures, including a reduction in headcount. The decrease in personnel costs from the reduction in workforce was partially offset by expenses incurred in conjunction with severance arrangements entered into during 2009. General and administrative expenses decreased $3.0 million for 2009 compared to 2008 primarily due to a reduction in personnel and related costs as a result of our cost reduction measures, including a reduction in headcount and lower legal, audit and consulting fees during 2009. The decrease in personnel costs from the reduction in workforce was partially offset by expenses incurred in conjunction with severance arrangements entered into during 2009.

We expect our selling, general and administrative expenses to increase in 2011 over 2010 levels as we focus on sales and marketing activities for Silenor throughout the full year and as we expect to have an overall increase in headcount for 2011 compared to 2010. We are unable to estimate with certainty our future selling, general and administrative expenses, in part because we cannot forecast with any degree of certainty the cost of commercial activities, the likelihood of commercial success, and to what degree such activities would affect our capital requirements.

Research and Development Expense. Our most significant research and development costs during 2010 were salaries, benefits, and share-based compensation expense related to our research and development personnel while our most significant external costs were associated with our development program for Silenor. Research and development expense for 2010, 2009 and 2008 are summarized in the following table (in thousands, except percentages).


							Dollar Change						Percent Change
	Years Ended December 31,						2010 vs.			2009 vs.			2010 vs.			2009 vs.
	2010		2009		2008		2009			2008			2009			2008
Personnel and other costs	$	1,824	$	1,732	$	6,190	$	92		$	(4,458	)		5	%		(72	)%
Silenor development work		448		1,079		8,311		(631	)		(7,232	)		(58	)%		(87	)%
Share-based compensation		1,294		1,526		2,045		(232	)		(519	)		(15	)%		(25	)%

Total research and development expense	$	3,566	$	4,337	$	16,546	$	(771	)	$	(12,209	)		(18	)%		(74	)%

Research and development expense decreased $0.8 million for 2010 compared to 2009 primarily due to lower development expenses and share-based compensation expense. Silenor development expenses decreased because of the lower level of activity relating to both the NDA and non-clinical studies during 2010 as compared to 2009. Share-based compensation was lower in 2010 as 2009 included the additional cost of our one-time stock option exchange program that was completed in June 2009 and the impact of accelerated option vesting arrangements under severance-related agreements.

Research and development expense decreased $12.2 million for 2009 compared to 2008 primarily due to a decrease in drug development activities for Silenor as a result of the completion during 2008 of our cardiac study for Silenor and the delay in the FDA approval process for Silenor. Offsetting these reductions in expense was a payment to our Silenor packaging supplier for purchase authorizations for certain expired raw materials. Personnel and other costs decreased as a result of a reduction in headcount, which occurred as part of our cost reduction measures. This reduction in headcount also caused a decrease in share-based compensation expense, but this decrease was partially offset by accelerated vesting and continued vesting under consulting arrangements for certain employees whose employment was terminated. The consulting arrangements were considered non-substantive for accounting purposes, and the full value of the awards expected to vest over the consulting arrangement was expensed at the time employment was terminated. The decrease in share-based compensation expense was further offset by share-based compensation expense incurred in conjunction with our one-time stock option exchange program in June 2009.

We expect our research and development expenses to decrease in 2011 over 2010 levels as we focus on commercial activities relating to Silenor. We are unable to estimate with certainty our future research and development expenses in part because we cannot forecast with any degree of certainty whether we will potentially pursue the development of other product candidates, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements.

License fees. License fees for 2010, 2009 and 2008 are summarized in the following table (in thousands, except percentages).


								Dollar Change					Percent Change
	Years Ended December 31,							2010 vs.		2009 vs.			2010 vs.			2009 vs.
	2010		2009			2008		2009		2008			2009			2008
License fees	$	—	$	(999	)	$	165	$	999	$	(1,164	)		(100	)%		(705	)%

We had no license fees expense in 2010. In March 2009, we entered into an agreement with a third party to mutually terminate our license for nalmefene. Pursuant to the termination agreement, the third party paid us a $1.0 million termination fee which we included as a reduction of license fees for 2009.

License fees decreased $1.2 million for 2009 compared to 2008 primarily due to the termination payment relating to our nalmefene license agreement. Also contributing to the decrease was a payment we made of $0.2 million during the third quarter of 2008 under a license arrangement for the exclusive rights to purchase a certain ingredient used in our formulation for Silenor.

Interest and Other Income. Interest and other income for 2010, 2009 and 2008 are summarized in the following table (in thousands, except percentages).


							Dollar Change					Percent Change
	Years Ended December 31,						2010 vs.		2009 vs.			2010 vs.			2009 vs.
	2010		2009		2008		2009		2008			2009			2008
Interest and other income	$	262	$	30	$	903	$	232	$	(873	)		773	%		(97	)%

Interest and other income increased $0.2 million for 2010 compared to 2009 primarily due to the $0.2 million one-time grant that we were awarded under the Qualifying Therapeutic Discovery Project program included in the Patient Protection and Affordable Health Care Act of 2010.

Interest and other income decreased $0.9 million for 2009 compared to 2008 due to lower average cash and marketable security balances as well as lower interest rates compared to the prior year.

Interest and Other (Expense). Interest and other (expense) for 2010, 2009 and 2008 are summarized in the following table (in thousands, except percentages).


										Dollar Change				Percent Change
	Years Ended December 31,									2010 vs.		2009 vs.		2010 vs.			2009 vs.
	2010			2009			2008			2009		2008		2009			2008
Interest and other (expense)	$	(68	)	$	(261	)	$	(2,610	)	$	193	$	2,349		(74	)%		(90	)%

Interest and other (expense) decreased $0.2 million for 2010 compared to 2009 due to the repayment in full of our debt obligations in March 2009.

Interest and other (expense) decreased $2.3 million for 2009 compared to 2008 due to our March 2009 debt repayment.

Liquidity and Capital Resources

As of December 31, 2010, we had $54.8 million in cash, cash equivalents and short-term investments, representing an increase of $49.7 million from December 31, 2009. The increase was due to two public offerings of our common stock we conducted in 2010. In March 2010, we completed a public offering of 6,900,000 shares of our common stock for aggregate net proceeds of approximately $52.7 million. In November 2010, we completed a public offering of 8,800,000 shares of our common stock for aggregate net proceeds of approximately $24.8 million.

We have invested a substantial portion of our available cash in marketable securities. The capital markets have recently been highly volatile and there has been a lack of liquidity for certain financial instruments, especially those with exposure to mortgage-backed securities and auction rate securities. All of our investments in marketable securities and money market funds continue to be highly rated, highly liquid and have readily determinable fair values. As a result, none of our securities are considered to be impaired.

We expect to continue to incur losses and have negative cash flows from operations in the foreseeable future as we continue our commercial activities for Silenor, commercialize any other products to which we obtain rights and potentially pursue the development of other product candidates. As a result, we may need to obtain additional funds to finance our operations in the future. Until we can generate significant cash from our operations, we intend to obtain any additional funding we require through strategic relationships, public or private equity or debt financings, assigning receivables or royalty rights, or other arrangements and we cannot assure such funding will be available on reasonable terms, or at all.

We believe, based on our current operating plan, that our cash, cash equivalents and short-term investments as of December 31, 2010 will be sufficient to fund our operations through at least the first quarter of 2012. The actual period of time through which our financial resources will be adequate to support our operations could vary based upon many factors, including but not limited to the rate of growth of Silenor sales and the actual cost of commercial activities.

Our future capital uses and requirements depend on numerous forward-looking factors. These factors include but are not limited to the following:

•

our success in generating cash flows from the commercialization of Silenor, together with our co-promotion partner P&G;

•

the costs of establishing or contracting for commercial programs and resources;

•

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

•

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

•

the rate of progress and cost of our non-clinical studies, clinical trials and other development activities;

•

the scope, prioritization and number of development programs we pursue; and

•

the effect of competing technological and market developments.

We may not be successful in obtaining additional financing when needed. If available, financing may not be obtained on terms favorable to us or our stockholders. If we are unsuccessful in raising sufficient additional funds, our growth plans and our financial condition or results of operations could be materially adversely impacted, and we may be required to delay, scale-back or eliminate plans or programs relating to our business, relinquish some or all of our rights to Silenor, renegotiate less favorable terms with respect to such rights than we would otherwise choose or cease operating as a going concern. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our financial statements, and it is likely that investors will lose all or a part of their investment.

If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders would likely result. If we raise additional funds by incurring debt financing, the terms of the debt may involve significant cash payment obligations as well as covenants and specific financial ratios that may restrict our ability to operate our business.

We have two effective shelf registration statements on Form S-3 filed with the SEC under which we may offer from time to time up to an aggregate of approximately $67.1 million in any combination of debt securities, common and preferred stock and warrants. These registration statements could allow us to seek additional financing, subject to the SEC’s rules and regulations relating to eligibility to use Form S-3.

As a result of recent volatility in the capital markets, the cost and availability of credit has been and may continue to be adversely affected. Concern about the stability of the markets in general and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide funding to borrowers. Continued turbulence in the United States and international markets and economies may adversely affect our ability to obtain additional financing on terms acceptable to us, or at all. If these market conditions continue, they may limit our ability to timely replace maturing liabilities and to access the capital markets to meet liquidity needs.

In March 2010, the President signed the Patient Protection and Affordable Care Act, which makes extensive changes to the delivery of health care in the United States. This act includes numerous provisions that affect pharmaceutical companies, some of which are effective immediately and others of which will be taking effect over the next several years. For example, the act seeks to expand health care coverage to the uninsured through private health insurance reforms and an expansion of Medicaid. The act will also impose substantial costs on pharmaceutical manufacturers, such as an increase in liability for rebates paid to Medicaid, new drug discounts that must be offered to certain enrollees in the Medicare prescription drug benefit, an annual fee imposed on all manufacturers of brand prescription drugs in the United States, and an expansion of an existing program requiring pharmaceutical discounts to certain types of hospitals and federally subsidized clinics. The act also contains cost-containment measures that could reduce reimbursement levels for health care items and services generally, including pharmaceuticals. It also will require reporting and public disclosure of payments and other transfers of value provided by pharmaceutical companies to physicians and teaching hospitals. These measures could result in decreased potential returns from our pharmaceutical products and any development efforts.

Cash Flows

Net cash used in operations was $29.7 million for 2010 compared to $9.6 million in 2009. The increase in net cash used in operating activities was primarily due to an increase in our net loss in 2010 as compared to 2009.

Net cash used in investing activities was $35.7 million for 2010 compared to net cash provided by investing activities of $11.2 million in 2009. Results for 2010 reflect purchases of $46.5 million of marketable securities, proceeds from the sale of marketable securities of $12.3 million, and a $1.0 million milestone payment to ProCom under our license agreement which became due as a result of the approval by the FDA of our NDA for Silenor. Results for 2009 reflect purchases of marketable securities of $2.5 million, proceeds from the sale of marketable securities of $5.6 million, and the release of restricted cash of $8.1 million in connection with the repayment of our bank debt. The increase in purchases of marketable securities is due to the investment of proceeds received from our public offerings in 2010.

Net cash provided by financing activities was $81.3 million for 2010 compared to net cash used in financing activities of $7.6 million in 2009. Our 2010 results reflect cash proceeds of $77.6 million from our public offerings and proceeds of $3.8 million from the exercise of warrants and stock options. Results for 2009 reflect the repayment of $15.0 million of our bank debt and cash proceeds of $5.7 million from the issuance of common stock and warrants in July 2009.

Loan Agreement

On February 7, 2011, we entered into a loan agreement with Comerica, pursuant to which we may request advances in an aggregate outstanding amount not to exceed $15.0 million. The revolving loan bears interest at a variable rate of interest, per annum, at our option of either LIBOR plus 3.00% or Comerica’s prime rate plus 0.50%, which as of February 2011 were 3.26% and 3.75%, respectively. Interest payments on advances made under the loan agreement are due and payable in arrears on the first business day of each month during the term of the loan agreement. Amounts borrowed under the loan agreement may be repaid and re-borrowed at any time prior to February 7, 2013, subject to certain conditions. Once we have two consecutive quarters of profitability, the amounts we borrow are limited to a percentage of our accounts receivable. There is a non-refundable unused commitment fee equal to 0.25% per annum on the difference between the amount of the revolving line and the average daily balance outstanding thereunder during the term of the loan agreement, payable quarterly in arrears. The loan agreement will remain in full force and effect for so long as any obligations remain outstanding or Comerica has any obligation to make credit extensions under the loan agreement.

Amounts borrowed under the loan agreement are secured by substantially all of our personal property, excluding intellectual property. Under the loan agreement, we are subject to certain affirmative and negative covenants, including limitations on our ability to: undergo certain change of control events; convey, sell, lease, license, transfer or otherwise dispose of assets, other than in certain specified circumstances; create, incur, assume, guarantee or be liable with respect to certain indebtedness; grant liens; pay dividends and make certain other restricted payments; and make certain investments. In addition, under the loan agreement, we are required to maintain a cash balance with Comerica in an amount of not less than $5.0 million and to maintain 50% of any other cash balances with Comerica and any other cash or investments must be covered by a control agreement for the benefit of Comerica. We are also subject to specified financial covenants with respect to a minimum liquidity ratio and, once we have two consecutive quarters of profitability, minimum EBITDA requirements. We have currently met all of our obligations under the loan agreement.

Litigation

We intend to vigorously enforce our intellectual property rights relating to Silenor, but we cannot predict the outcome of these matters.

The prosecution of the lawsuits against Actavis, Mylan and Par will increase our cash expenditures. Any adverse outcome in this litigation could result in one or more generic versions of Silenor being launched before the expiration of the listed patents, which could adversely affect our ability to successfully execute our business strategy to increase sales of Silenor and would negatively impact our financial condition and results of operations, including causing a significant decrease in our revenues and cash flows.

Contractual Obligations

The following table describes our commitments to settle contractual obligations in cash as of December 31, 2010 (in thousands):


	Payments Due By Period
			2012		2014
			through		through		After
	2011		2013		2015		2015		Total
Non-cancellable purchase orders	$	2,273	$	—	$	—	$	—	$	2,273
Other contractual obligations		6,426		250		—		—		6,676
Operating lease obligations		65		21		4		—		90

Total	$	8,764	$	271	$	4	$	—	$	9,039

We entered into a license agreement with ProCom to acquire the rights to develop and commercialize Silenor. Pursuant to this agreement, we obtained exclusive, sub-licensable rights to the patents and know-how for certain indications. This license agreement required us to pay an upfront payment as well as additional payments upon the achievement of specific development and regulatory approval milestones. We are also obligated to pay royalties under the agreement until the expiration of the applicable patents. Royalty payments due under the terms of the in-license agreement are recorded as an accrued liability as of December 31, 2010. The royalty payments will be recognized as an expense when the related shipment is recognized as revenue. Future royalty payments are not included in the table above because we cannot reasonably estimate them at this time.

In July 2010, we entered into a professional detailing services agreement with Publicis, under which Publicis has agreed to provide sales support to promote Silenorin the U.S. through 110 full-time sales representatives, one regional field coordinator and one national business director, all of whom will be employees of Publicis. In February 2011 we entered into an amendment with Publicis, under which Publicis has agreed to provide sales support to promote Silenorin the U.S. through an additional 35 full-time sales representatives and one additional regional field coordinator, all of whom will be employees of Publicis. Prior to the first anniversary of the deployment of Publicis’ initial 110 sales representatives, we have the right to terminate the services agreement upon 90 days written notice and payment to Publicis of a termination fee in a specified amount. We have estimated this specified amount as of December 31, 2010 and included this amount in the table above.

In August 2010, we entered into a co-promotion agreement with P&G, under which P&G will provide sales support to promote Silenor in the U.S. through its team of full-time sales representatives. Beginning in January 2011, P&G will also provide certain managed care support services. We will recognize the revenue from Silenor product sales generated by the promotional efforts of P&G. Under the terms of the agreement, we are required to pay P&G a fixed fee and a royalty fee as a percentage of U.S. net sales, in each case on a quarterly basis during the term of the agreement. We have included the amounts of the fixed fees in the table above. At December 31, 2010, fixed fees due amounted to $1.4 million, which is recorded as an accrued liability and is not reflected in the table above. Future royalty payments are not included in the table above because we cannot reasonably estimate them at this time.

We have contracted with various consultants and other vendors to assist in clinical trial work, pre-clinical studies, data analysis, and activities to support the marketing of Silenor. The contracts are generally terminable at any time, but obligate us to reimburse the providers for any time or costs incurred through the date of termination. We also have employment agreements with each of our current executive officers that provide for severance payments and accelerated vesting for certain share-based awards if their employment with us is terminated under specified circumstances.

Off-Balance Sheet Arrangements

We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standard Board, or FASB, issued Accounting Standards Update, or ASU, No. 2009-13 “Revenue Recognition,” which provides guidance on recognizing revenue in arrangements with multiple deliverables. This standard impacts the determination of when the individual deliverables included in a multiple element arrangement may be treated as a separate unit of accounting. It also modifies the manner in which the consideration received from the transaction is allocated to the multiple deliverables and no longer permits the use of the residual method of allocating arrangement consideration. This accounting standard is effective for the first reporting period beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of ASU 2009-13 to have a material impact on the financial statements.


Item 7A.		Quantitative and Qualitative Disclosures about Market Risk

Our cash and cash equivalents at December 31, 2010 consists primarily of money market funds and available-for-sale securities. The primary objective of our investment activities is to preserve principal while maximizing the income we receive from our investments without significantly increasing risk. We also periodically invest in U.S. government debt securities. To the extent we hold securities other than money market funds, our primary exposure to market risk is interest rate sensitivity. This means that a change in prevailing interest rates may cause the value of the investment to fluctuate. For example, if we purchase a security that was issued with a fixed interest rate and the prevailing interest rate later rises, the value of our investment will probably decline. To minimize this risk, we intend to continue to maintain our portfolio of cash, cash equivalents and marketable securities in a variety of securities consisting of money market funds and United States government debt securities, all with various maturities. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate. We also generally time the maturities of our investments to correspond with our expected cash needs, allowing us to avoid realizing any potential losses from having to sell securities prior to their maturities.

Recently, there has been concern in the credit markets regarding the value of a variety of mortgage-backed securities and the resultant effect on various securities markets. Our cash is invested in accordance with a policy approved by our board of directors which specifies the categories, allocations, and ratings of securities we may consider for investment. We do not believe our cash and cash equivalents have significant risk of default or illiquidity. We made this determination based on discussions with our treasury managers and a review of our holdings. While we believe our cash and cash equivalents are well diversified and do not contain excessive risk, we cannot provide absolute assurance that our investments will not be subject to future adverse changes in market value.


Item 8.		Financial Statements and Supplementary Data

See the list of financial statements filed with this report under Part IV — Item 15 below.


Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.


Item 9A.		Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Securities and Exchange Commission Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2010.

Management’s Report on Internal Control over Financial Reporting

Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

Management is responsible for establishing and maintaining adequate internal control over our financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting. Management has used the framework set forth in the report entitled “Internal Control—Integrated Framework” published by the Committee of Sponsoring Organizations of the Treadway Commission to evaluate the effectiveness of our internal control over financial reporting. Based on its evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2010, the end of our most recent fiscal year. This effectiveness of internal control over financial reporting as of December 31, 2010 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


Item 9B.		Other Information

Not applicable.

PART III


Item 10.		Directors, Executive Officers and Corporate Governance

Board of Directors

At March 3, 2011, our board of directors consisted of the following members:


Name	Age	Position with the Company
David F. Hale	62	Chairman of the Board
Richard W. Pascoe	47	Director, President and Chief Executive Officer
Erle T. Mast	48	Director, Chairman of the Audit Committee
Kurt von Emster	43	Director, Chairman of the Nominating/Corporate Governance Committee
Terrell A. Cobb	61	Director
Michael L. Eagle	63	Director
Faheem Hasnain	52	Director
Thomas G. Wiggans	59	Director, Chairman of the Compensation Committee

David F. Hale is one of our co-founders and has served as Chairman of the Board of Directors since our founding in August 2003. He also served as our interim Chief Executive Officer from January 2008 until August 2008. Mr. Hale has served as Chairman and Chief Executive Officer of Hale BioPharma Ventures since May 2006. Mr. Hale served as President and Chief Executive Officer of CancerVax Corporation, a biotechnology company, from October 2000 until it merged with Micromet AG in 2006. He served as a director of CancerVax from December 2000 until the merger with Micromet Inc., and he currently serves as Chairman of Micromet’s board of directors. Prior to joining CancerVax, he was President and Chief Executive Officer of Women First HealthCare, Inc., a specialty pharmaceutical company, from January 1998 to May 2000. Mr. Hale served as President, Chief Executive Officer and Chairman of Gensia Inc., a pharmaceutical company which became Gensia Sicor, from May 1987 to November 1997. Prior to joining Gensia, Mr. Hale was President, Chief Operating Officer and Chief Executive Officer of Hybritech Inc. Mr. Hale serves as Chairman of the Board of Santarus, Inc. and the privately held companies SkinMedica, Inc., Ridge Diagnostics, Automedics, Inc., Advantar Laboratories, Crisi Medical Systems and Neurelis, Inc. He also was a founder and serves as a member of the Board of Directors of Conatus Pharmaceuticals, Inc., and served on the Board of Directors of Verus Pharmaceuticals, Inc. Mr. Hale was formerly a director of Metabasis Therapeutics, Inc. from 1998 through January 2010, including its Chairman of the Board from 2006 through January 2010.

Mr. Hale is a member of the boards of directors of industry organizations including BIOCOM/San Diego and the Biotechnology Industry Organization (BIO), is a member of the board of directors of Rady Children’s Hospital and Health Center and the Sanford-Burnham Medical Research Institute and was Chairman of CONNECT from July 2004 to January 2011. Mr. Hale received a B.A. degree in Biology and Chemistry from Jacksonville State University. Mr. Hale’s depth and diversity of experience on boards of directors and in senior management of public and private specialty pharmaceutical companies, as well as his personal and professional integrity, ethics and values, led the board of directors to conclude that Mr. Hale should serve as a director of the company and as its non-executive chairman of the board.

Richard W. Pascoe joined as our President and Chief Executive Officer in August 2008. Before joining us, Mr. Pascoe was the Chief Operating Officer at ARIAD Pharmaceuticals, an emerging oncology company, where he led commercial operations, manufacturing, information services, program and alliance management and business development. Mr. Pascoe held a series of senior management roles at King Pharmaceuticals, Inc., including senior vice president of neuroscience marketing and sales and vice president positions in both international sales and marketing and hospital sales. He also held positions in the commercial groups at Medco Research, Inc. (which was acquired by King), COR Therapeutics, Inc. (where he helped lead the successful launch of eptifibatide [Integrilin^®]), B. Braun Interventional and the BOC Group. Mr. Pascoe served as a commissioned officer in the United States Army following his graduation from the United States Military Academy at West Point where he received a B.S degree in Leadership. Mr. Pascoe’s appointment as our President and Chief Executive Officer and the board’s belief that the company’s chief executive officer should serve on the board, as well as Mr. Pascoe’s depth and diversity of experience in senior management of public specialty pharmaceutical companies and his personal and professional integrity, ethics and values, led the board of directors to conclude that Mr. Pascoe should serve as a director of the company.

Erle T. Mast has served on our board of directors since June 2008. Mr. Mast currently serves as Executive Vice President and Chief Financial Officer and is a co-founder of Clovis Oncology, Inc., an emerging biopharmaceutical company. Previously, Mr. Mast was Chief Financial Officer of Pharmion Corporation from 2002 until its acquisition by Celgene Corporation in March 2008. Mr. Mast was also an Executive Vice President of Pharmion from February 2007 until the acquisition. He was Vice President of Finance for Dura Pharmaceuticals, Inc. from 1997 until its acquisition by Elan Corporation, plc in 2000, and thereafter he was Chief Financial Officer of Elan’s Global Biopharmaceuticals business until 2002. Prior to that, Mr. Mast was a partner with Deloitte & Touche, LLP. Mr. Mast has been a director of Zogenix, Inc. since 2008 and was a director of Verus Pharmaceuticals, Inc. from 2007 to 2009. Mr. Mast graduated from California State University, Bakersfield with a degree in business administration. Mr. Mast’s depth and diversity of experience on boards of directors and in senior management of public and private specialty pharmaceutical companies, including his specific experience and skills that qualify Mr. Mast to be our “audit committee financial expert” as that term is defined in the rules and regulations established by the SEC, as well as his personal and professional integrity, ethics and values, led the board of directors to conclude that Mr. Mast should serve as a director of the company.

Kurt von Emster, CFA has served as a member of our board of directors since August 2005. Mr. von Emster is currently Managing Director of venBio LLC. From November 2000 through February 2009, Mr. von Emster was a General Partner and Portfolio Manager for the MPM BioEquities Fund. Prior to joining MPM, Mr. von Emster spent 11 years with Franklin Templeton Group as a Vice President and Portfolio Manager where he managed over $2 billion in health and biotech funds. In his tenure at Franklin, Mr. von Emster was responsible for building the health care group and was responsible for conceiving and developing seven different life science investment products for Franklin. Mr. von Emster holds the Chartered Financial Analyst designation (CFA), is a member of the Association for Investment Management and Research and is a member of the Security Analysts of San Francisco. Mr. von Emster currently serves on the board of directors of Metabolex, a private drug development company. Mr. von Emster is a past director of Facet Biotech Corporation, a public biotech company sold to Abbott Labs in 2010 and past Board Observer at Acceleron Pharmaceuticals, a private biotechnology company. He has a degree from the University of California at Santa Barbara in Business and Economics and in 2010, completed the Director College Executive Education Program at the Rock Center for Corporate Governance at Stanford University. Mr. von Emster’s depth and diversity of experience on boards of directors of public and private biotechnology companies and in evaluating and investing in biotech companies, as well as his personal and professional integrity, ethics and values, led the board of directors to conclude that Mr. von Emster should serve as a director of the company.

Terrell A. Cobb has served as a member of our board of directors since August 2003. Mr. Cobb is the founder and currently serves as President of ProCom One, a drug development company, a position he has held since 1998. We license Silenor from ProCom One, Inc. as described in further detail under Part III — Item 13, “Certain Relationships and Related Transactions, and Director Independence” of this report. From 1995 to the present, Mr. Cobb has served as a consultant focusing on business development activities in the pharmaceutical industry. Mr. Cobb previously spent 15 years in various positions at Johnson and Johnson. Mr. Cobb has founded four specialty pharmaceutical companies, has held senior management positions in several start-up organizations, including Pharmaco and Scandipharm, and has acted as an advisor and consultant to other drug development companies. He received a B.A. degree from Mercer University in Chemistry and Psychology. Mr. Cobb’s depth and diversity of experience on boards of directors and in senior management of public and private specialty pharmaceutical companies, as well as his personal and professional integrity, ethics and values, led the board of directors to conclude that Mr. Cobb should serve as a director of the company. In addition, ProCom One has the right to designate one member of our board of directors, and ProCom One has designated Mr. Cobb to serve in such role.

Michael L. Eagle has served on our board of directors since May 2007. Mr. Eagle served as Vice President of Manufacturing for Eli Lilly and Company from 1994 through 2001 and held a number of executive management positions with Eli Lilly and its subsidiaries throughout his career there. Since retiring from Eli Lilly, he has served as a founding member of Barnard Life Sciences, LLC. Mr. Eagle earned his B. S. degree in mechanical engineering from Kettering University and an M.B.A. from the Krannert School of Management at Purdue University. He serves on the board of directors of Cadence Pharmaceuticals and on the Board of Trustees of the La Jolla Playhouse and Futures for Children. Mr. Eagle’s depth and diversity of experience on boards of directors and in senior management of public and private pharmaceutical and medical device companies, as well as his personal and professional integrity, ethics and values, led the board of directors to conclude that Mr. Eagle should serve as a director of the company.

Faheem Hasnain has served on our board of directors since September 2010. Mr. Hasnain is currently president, chief executive officer and a director of Receptos, Inc., a position he has held since December 2010. Previously, Mr. Hasnain was president, chief executive officer and a director of Facet Biotech Corporation from December 2008 until its acquisition by Abbott Laboratories in April 2010. Mr. Hasnain was president, chief executive officer and a director of PDL BioPharma, Inc. from October 2008 until Facet Biotech was spun off from PDL BioPharma in December 2008. From October 2004 to September 2008, Mr. Hasnain served at Biogen Idec Inc., most recently as executive vice president in charge of the oncology/rheumatology strategic business unit. Prior to Biogen Idec, Mr. Hasnain was president of Oncology Therapeutics Network, a subsidiary of Bristol-Myers Squibb Company, from March 2002 to September 2004. From 2000 to 2002, Mr. Hasnain served as vice president, global eBusiness, at GlaxoSmithKline and, from 1988 to 2000, he served in key commercial and entrepreneurial roles within GlaxoSmithKline and its predecessor organizations, spanning global eBusiness, international commercial operations, sales and marketing. Mr. Hasnain received a B.H.K. and B.Ed. from the University of Windsor Ontario in Canada. Mr. Hasnain’s depth and diversity of experience on boards of directors and in senior management of public and private specialty and non-specialty pharmaceutical companies, as well as his personal and professional integrity, ethics and values, led the board of directors to conclude that Mr. Hasnain should serve as a director of the company.

Thomas G. Wiggans has served on our board of directors since June 2008. Mr. Wiggans served as Chief Executive Officer of Peplin, Inc. from August 2008 until Peplin’s acquisition by LEO Pharma A/S in November 2009, and as Chairman of Peplin’s Board of Directors from October 2007 until such acquisition. Mr. Wiggans served as Chief Executive Officer of Connetics Corporation from 1994 until December 2006 when Connetics was acquired by Stiefel Laboratories, Inc. Mr. Wiggans was also Chairman of the Board of Connetics from January 2006 until the acquisition. From 1992 to 1994, Mr. Wiggans served as President and Chief Operating Officer of CytoTherapeutics Inc. He served in various positions at Ares-Serono Group from 1980 to 1992, including President of its U.S. pharmaceutical operations and Managing Director of its U.K. pharmaceutical operations. Mr. Wiggans currently serves on the boards of directors of Sangamo Biosciences, Inc., Onyx Pharmaceuticals, Inc. and Victory Pharma Inc. Mr. Wiggans also serves as Chairman of the Board of Excaliard Pharmaceuticals, Inc. He is also on the Board of Trustees of the University of Kansas Endowment Association. In addition, Mr. Wiggans is Chairman of the Biotechnology Institute, a non-profit educational organization. Mr. Wiggans holds a B.S. in Pharmacy from the University of Kansas and an M.B.A. from Southern Methodist University. Mr. Wiggans’ depth and diversity of experience on boards of directors and in senior management of public and private specialty pharmaceutical companies, as well as his personal and professional integrity, ethics and values, led the board of directors to conclude that Mr. Wiggans should serve as a director of the company.

Director Nomination Process and Other Corporate Governance Matters

Director Qualifications

In evaluating director nominees, the nominating/corporate governance committee considers the following factors:

•

personal and professional integrity, ethics and values;

•

experience in corporate management, such as serving as an officer or former officer of a publicly held company;

•

experience in our industry and with relevant social policy concerns;

•

experience as a board member of another publicly held company;

•

diversity of expertise and experience in substantive matters pertaining to our business relative to other board members; and

•

practical and mature business judgment.

The nominating/corporate governance committee’s goal is to assemble a board of directors that brings to our company a variety of perspectives and skills derived from high quality business and professional experience.

Other than the foregoing, there are no stated minimum criteria for director nominees, although the nominating/corporate governance committee may also consider such other factors as it may deem to be in the best interests of our company and our stockholders. The nominating/corporate governance committee does, however, believe it appropriate for at least one, and preferably, several, members of our board of directors to meet the criteria for an “audit committee financial expert” as defined by SEC rules, and that a majority of the members of our board of directors meet the definition of “independent director” under the Nasdaq Stock Market qualification standards. The nominating/corporate governance committee also believes it appropriate for our President and Chief Executive Officer to serve as a member of our board of directors.

Identification and Evaluation of Nominees for Directors

The nominating/corporate governance committee identifies nominees for director by first evaluating the current members of our board of directors willing to continue in service. Current members with qualifications and skills that are consistent with the nominating/corporate governance committee’s criteria for board service and who are willing to continue in service are considered for re-nomination, balancing the value of continuity of service by existing members of our board of directors with that of obtaining a new perspective.

If any member of our board of directors does not wish to continue in service or if our board of directors decides not to re-nominate a member for re-election, the nominating/corporate governance committee identifies the desired skills and experience of a new nominee in light of the criteria above. The nominating/corporate governance committee generally polls our board of directors and members of management for their recommendations. The nominating/corporate governance committee may also review the composition and qualification of the boards of directors of our competitors, and may seek input from industry experts or analysts. The nominating/corporate governance committee reviews the qualifications, experience and background of the candidates. In making its determinations, the nominating/corporate governance committee evaluates each individual in the context of our board of directors as a whole, with the objective of assembling a group that can best perpetuate the success of our company and represent stockholder interests through the exercise of sound business judgment. After review and deliberation of all feedback and data, the nominating/corporate governance committee makes its recommendation to our board of directors. Historically, the nominating/corporate governance committee has not relied on third-party search firms to identify director candidates. The nominating/corporate governance committee may in the future choose to do so in those situations where particular qualifications are required or where existing contacts are not sufficient to identify an appropriate candidate.

We have not received director candidate recommendations from our stockholders, and we do not have a formal policy regarding consideration of such recommendations. However, any recommendations received from stockholders will be evaluated in the same manner that potential nominees suggested by board members, management or other parties are evaluated.

Board Leadership and Risk Oversight

We believe it is the chief executive officer’s responsibility to manage the company and the chairman’s responsibility to lead the board. As directors continue to have more oversight responsibilities than ever before, we believe it is beneficial to have an independent chairman whose sole job is leading the board. By having another director serve as chairman of the board, Mr. Pascoe will be able to focus his entire energy on managing the company.

We believe our chief executive officer and our chairman have an excellent working relationship. By clearly delineating the role of the chairman position in our corporate governance guidelines, we ensure there is no duplication of effort between the chief executive officer and the chairman. We believe this provides strong leadership for our board, while also positioning Mr. Pascoe as the leader of the company in the eyes of our collaborators, vendors, employees and other stakeholders.

Our board has five independent members and three non-independent members. A number of our independent board members are currently serving or have served as members of senior management of other public companies and have served as directors of other public companies. We have three board committees comprised solely of independent directors, each with a different independent director serving as chair of the committee. We believe that the number of independent, experienced directors that make up our board, along with the independent oversight of the board by the non-executive chairman, benefits our company and our stockholders.

Our audit committee is primarily responsible for overseeing the company’s risk management processes on behalf of the full board. The audit committee receives reports from management at least quarterly regarding the company’s assessment of risks. In addition, the audit committee reports regularly to the full board of directors, which also considers the company’s risk profile. The audit committee and the full board of directors focus on the most significant risks facing the company’s business and the company’s general risk management strategy, and also ensure that risks undertaken by the company are consistent with the board’s appetite for risk. While the board oversees the company’s risk management, company management is responsible for day-to-day risk management processes. We believe this division of responsibilities is the most effective approach for addressing the risks facing our company and that our board leadership structure supports this approach.

Pursuant to our bylaws and our corporate governance guidelines, our board determines the best board leadership structure for our company from time to time. As part of our annual board self-evaluation process, we evaluate our leadership structure to ensure that the board continues to believe that it provides the optimal structure for our company and stockholders. We recognize that different board leadership structures may be appropriate for companies in different situations. We believe our current leadership structure, with Mr. Pascoe serving as chief executive officer and Mr. Hale serving as chairman of the board, is the optimal structure for our company at this time.

Audit Committee and Financial Expert

Our audit committee currently consists of Mr. Mast (chair), Mr. Eagle, and Mr. von Emster, each of whom our board of directors has determined is independent within the meaning of the independent directors standards of the SEC and the Nasdaq Stock Market, Inc. Our board of directors has determined that Mr. Mast qualifies as an “audit committee financial expert” as that term is defined in the rules and regulations established by the SEC.

Audit Committee Report

The audit committee oversees our financial reporting process on behalf of our board of directors. Management has the primary responsibility for the financial statements and the reporting process, including the systems of internal controls. In fulfilling its oversight responsibilities, the audit committee reviewed the audited financial statements in our annual report with management, including a discussion of any significant changes in the selection or application of accounting principles, the reasonableness of significant judgments, the clarity of disclosures in the financial statements and the effect of any new accounting initiatives.

The audit committee reviewed with PricewaterhouseCoopers LLP, who are responsible for expressing an opinion on the conformity of these audited financial statements with generally accepted accounting principles, their judgments as to the quality, not just the acceptability, of our accounting principles and such other matters as are required to be discussed with the audit committee under generally accepted auditing standards, including the matters required to be discussed by Statement on Auditing Standards No. 61, as amended, Communication with Audit Committees. In addition, the audit committee has discussed with PricewaterhouseCoopers LLP their independence from management and our company, has received from PricewaterhouseCoopers LLP the written disclosures and the letter required by the Public Company Accounting Oversight Board, Rule 3526 Communication with Audit Committees Concerning Independence, and has considered the compatibility of non-audit services with the independence of our registered public accounting firm.

The audit committee met with PricewaterhouseCoopers LLP to discuss the overall scope of their audit. The meetings with PricewaterhouseCoopers LLP were held, with and without management present, to discuss the results of their examination, their comments on our internal controls and the overall quality of our financial reporting.

Based on the reviews and discussions referred to above, the audit committee has recommended to our board of directors that the audited financial statements be included in our annual report for the year ended December 31, 2010.

This Audit Committee Report is furnished solely with this report, and is not filed with this report, and shall not be deemed incorporated by reference into any other filing under the Securities Act or the Exchange Act, whether made by us before or after the date hereof, regardless of any general incorporation language in any such filing, except to the extent we specifically incorporate this material by reference into any such filing.

The foregoing report has been furnished by the audit committee.

Erle T. Mast, Chairman
Michael L. Eagle
Kurt von Emster

Executive Officers

At March 3, 2011, our executive officers consisted of the following:


Name	Age	Position with the Company
Richard W. Pascoe	47	President and Chief Executive Officer
Tran B. Nguyen	37	Senior Vice President and Chief Financial Officer
Jeffrey W. Raser	50	Senior Vice President, Chief Commercial Officer
Brian T. Dorsey	42	Senior Vice President, Technical Operations
Matthew W. Onaitis	40	Senior Vice President, General Counsel and Secretary

See “Board of Directors” for the biography of Mr. Pascoe.

Tran B. Nguyen has served as our Vice President and Chief Financial Officer since April 2010 and as our Senior Vice President and Chief Financial Officer since February 2011. Mr. Nguyen brings to the Company more than 10 years of finance experience primarily focused in the life science industry. Previously, Mr. Nguyen was Vice President and Chief Financial Officer at Metabasis Therapeutics, Inc., a biopharmaceutical company, where he was responsible for managing all finance and accounting activities, and played a significant role in strategic and operating decisions from March 2009 until the company was sold to Ligand Pharmaceuticals Incorporated in January 2010. Prior to joining Metabasis, Mr. Nguyen was a Vice President in the Healthcare Investment Banking group at Citi Global Markets, Inc. from May 2007 until January 2009, where he was responsible for senior and junior relationship management of small-to-large-cap biotechnology and specialty pharma companies on the West Coast. Mr. Nguyen served in the Healthcare Investment Banking group at Lehman Brothers, Inc. as a Vice President from January 2006 until April 2007, and as an associate from July 2004 until December 2005 where he was responsible for executing various transactions including equity, equity-linked, debt, and mergers and acquisitions for small-to-large-cap biotechnology and specialty pharma companies. Mr. Nguyen received a B.A. in Economics and Psychology from Claremont McKenna College, and an M.B.A. from the Anderson School of Management at U.C.L.A.

Jeffrey W. Raser is one of our co-founders and served as our Senior Vice President, Sales and Marketing since our inception in August 2003 until April 2010, when Mr. Raser was named our Senior Vice President, Chief Commercial Officer. From 2000 to 2003, Mr. Raser was the Senior Vice President, Corporate Development and Marketing for CancerVax Corporation, a biopharmaceutical company focused on the development of immunotherapeutic products for the treatment of cancer. Prior to CancerVax, from 1998 to 2000 he served as Senior Vice President of Sales and Marketing for Women First HealthCare, a specialty pharmaceutical company. Mr. Raser also held a variety of positions at Roche Laboratories, a pharmaceutical company, in sales, marketing and strategic planning and at Lederle Laboratories, a pharmaceutical company, in government and corporate affairs. Mr. Raser holds a B.A. from Franklin and Marshall College.

Brian T. Dorsey joined us as Executive Director, Manufacturing and Program Management in March 2005. He was later promoted to Vice President, Manufacturing and Program Management in November 2006, named Vice President, Product Development in January 2007 and named Senior Vice President, Technical Operations in April 2010. From April 2002 to March 2005, Mr. Dorsey served as Head of Project Management, Medical Writing and Library Services at Maxim Pharmaceuticals Inc., a biopharmaceutical company. From May 2001 to April 2002, Mr. Dorsey served as Director, Head of Biopharmaceutical Project Management at Baxter Bioscience, a division of Baxter Healthcare Corporation. Previously, Mr. Dorsey served as a Global Project Leader / Project Director at Pfizer Global Research and Development (Agouron). Mr. Dorsey received his B.S. in chemistry and his Masters degree in executive leadership, both from the University of San Diego.

Matthew W. Onaitis joined us as Vice President, Legal Affairs and Secretary in May 2006. He was later promoted to Vice President, General Counsel and Secretary in January 2007 and named Senior Vice President, General Counsel and Secretary in April 2010. From January 2006 to May 2006, Mr. Onaitis served as Associate General Counsel at Biogen Idec Inc., a biopharmaceutical company. From June 2004 to December 2005, Mr. Onaitis was Director, Legal Affairs at Elan Corporation plc, a biopharmaceutical company. Mr. Onaitis practiced corporate and commercial law in private practice from 1998 to June 2004, which included a secondment to Elan from October 2003 to June 2004. Mr. Onaitis holds a J.D. from Stanford Law School and a B.S. in mechanical engineering from Carnegie Mellon University.

Section 16(a) Beneficial Ownership Reporting Compliance

Under Section 16(a) of the Exchange Act, directors, officers and beneficial owners of 10% or more of our common stock are required to file with the SEC on a timely basis initial reports of beneficial ownership and reports of changes regarding their beneficial ownership of our common stock. Officers, directors and 10% beneficial owners are required by SEC regulations to furnish us with copies of all Section 16(a) forms that they file.

Based solely on our review of the copies of such forms received and the written representations from certain reporting persons, we have determined that no officer, director or 10% beneficial owner known to us was delinquent with respect to their reporting obligations as set forth in Section 16(a) of the Exchange Act during the fiscal year ended December 31, 2010, except for one Form 4 by Mr. Dorsey that was one day late.

Code of Ethics

We have established a Code of Business Conduct and Ethics that applies to our officers, directors and employees which is available on our internet website at www.somaxon.com. The Code of Ethics contains general guidelines for conducting the business of our company consistent with the highest standards of business ethics, and is intended to qualify as a “code of ethics” within the meaning of Section 406 of the Sarbanes-Oxley Act of 2003 and Item 406 of Regulation S-K.


Item 11.		Executive Compensation

Compensation Discussion and Analysis

Executive Summary

This Compensation Discussion and Analysis describes our overall compensation policies and practices and specifically analyzes the total compensation for the following executive officers, also referred to herein as our Named Executive Officers:

•

Richard W. Pascoe, President, Chief Executive Officer and Director,

•

Tran B. Nguyen, Senior Vice President and Chief Financial Officer,

•

Jeffrey W. Raser, Senior Vice President and Chief Commercial Officer,

•

Brian T. Dorsey, Senior Vice President, Technical Operations, and

•

Matthew W. Onaitis, Senior Vice President and General Counsel.

All of our compensation programs are designed to attract and retain key employees and to motivate them to achieve key strategic performance measures to create long-term shareholder value. With respect to the compensation of our Named Executive Officers, we believe that their compensation should largely reflect their success as a management team in meeting key corporate objectives, rather than as individual contributors. As a result, we believe that the performance of the executives in managing our company, considered in light of general economic and specific company, industry and competitive conditions, should be the main basis for determining their overall compensation.

Our compensation program is designed to achieve these objectives through a combination of the following types of compensation: base salary, performance-based cash bonus awards, performance-based equity awards and time-based equity awards. Base salary is intended to provide a baseline level of compensation for our Named Executive Officers. The remaining types of compensation, which in the aggregate represent the majority of our Named Executive Officers’ total compensation as shown in our Summary Compensation Table below, tie compensation directly to the achievement of corporate objectives, increases in our stock price or both. Each element of our executive compensation program is discussed in greater detail below.

We believe that the total compensation received by our Named Executive Officers relating to 2010 was appropriate when viewed in light of the following key corporate achievements during 2010:

•

On March 17, 2010, the FDA approved our NDA for Silenor for the treatment of insomnia characterized by difficulty with sleep maintenance.

•

On March 31, 2010, we completed a public offering of common stock to fund the commercialization of Silenor, the net proceeds from the sale of which, after underwriting discounts and commissions and estimated offering expenses, were approximately $52.7 million.

•

On August 25, 2010, we entered into a co-promotion agreement with P&G relating to Silenor, which included a right of first negotiation for P&G regarding OTC rights to Silenor.

•

On September 20, 2010, full-scale, field-based promotion of Silenor began with the deployment of our 110 contract sales representatives and P&G’s 105 sales representatives, targeting approximately 35,000 physicians and 25,000 pharmacies across the U.S.

•

In November 2010, we completed an additional public offering of common stock to fund the commercialization of Silenor, the net proceeds of which, after underwriting discounts and commissions and estimated offering expenses, were approximately $24.8 million.

•

Our stock price increased 192% from December 31, 2009 to December 31, 2010.

Overview of Total Compensation and Process

Elements of total compensation for our Named Executive Officers include:

•

base salary, which is initially negotiated with the executive when the executive is hired and is reviewed by the compensation committee annually,

•

annual cash bonus awards, which reward annual company performance based on pre-determined objectives,

•

performance-based equity awards, which reward company performance based on pre-determined criteria for key corporate objectives,

•

time based equity awards, which reward company performance as reflected in its stock price over time, and

•

other benefits, such as health insurance benefits.

Each of these is described in more detail below.

The compensation committee has the primary authority to determine our company’s compensation philosophy and to establish compensation for our Named Executive Officers. Each year, generally in the first quarter, the compensation committee, which consists entirely of independent members of our board of directors, reviews the performance of each of our Named Executive Officers during the previous year. In connection with this review, the compensation committee typically reviews and resets base salaries for our Named Executive Officers, determines their annual cash bonuses relating to prior year performance, approves elements of the incentive bonus plan for the current year, including target bonuses and corporate objectives, and grants equity awards to our Named Executive Officers and certain other eligible employees. The compensation committee also has the discretion to make adjustments to executive compensation at other times during the year.

In making these compensation decisions, it has been the practice of our compensation committee to review the historical levels of each element of each Named Executive Officer’s total compensation (salary, bonus, equity awards and other benefits) and to compare each element with that of the executive officers in an appropriate group of comparable specialty pharmaceutical companies.

With respect to the compensation committee’s executive compensation review in early 2010, the committee authorized management to engage Barney & Barney Compensation Consulting, or Barney & Barney, to perform an assessment of our group of comparable specialty pharmaceutical companies. Our management reviewed with Barney & Barney the comparison group that we used in 2009, and this review resulted in a new comparison group for 2010 that possessed the following characteristics at the time of selection:

•

market capitalizations below $350 million,

•

most advanced product in Phase 2b or with a product approved or commercialized in the last 24 months,

•

less than 175 employees, and

•

a reasonable expectation that we could compete with these companies to fill senior management positions.

The compensation committee then approved the companies comprising the comparison group. The companies in the group were:


•	Acadia Pharmaceuticals Inc.	•	Neurocrine BioSciences, Inc.

•	Alexza Pharmaceuticals, Inc.	•	NeurogesX, Inc.

•	ARIAD Pharmaceuticals, Inc.	•	Orexigen Therapeutics, Inc.

•	Biocryst Pharmaceuticals Inc.	•	Pain Therapeutics, Inc.

•	Bionovo Inc.	•	Poniard Pharmaceuticals, Inc.

•	Cypress Bioscience Inc.	•	Questcor Pharmaceuticals, Inc.

•	Dyax Corp.	•	Telik, Inc.

•	Dynavax Technologies Corp.	•	Transcept Pharmaceuticals Inc.

•	Ligand Pharmaceuticals, Inc.	•	Trubion Pharmaceuticals, Inc.

•	MDRNA, Inc.	•	Vanda Pharmaceuticals Inc.

The changes made to the selection criteria for the 2010 comparison group reflected a desire on the part of the compensation committee to include for their consideration on a forward-looking basis, in advance of the commercialization of Silenor, a small number of companies having commercial operations. The committee reviewed compensation information relating to this sub-group both separately and as part of the entire comparison group, in each case in light of the company’s status with respect to commercialization efforts, in connection with determining 2010 compensation.

Barney & Barney compiled competitive executive compensation information from each of the companies in this comparison group for the compensation committee to review and analyze in making executive compensation decisions during 2010.

With respect to the compensation committee’s executive compensation review in early 2011, the committee authorized management to engage Barney & Barney to perform another assessment of our group of comparable specialty pharmaceutical companies. Our management reviewed with Barney & Barney the comparison group that we used in 2010, and this review resulted in a new comparison group for 2011 that possessed the following characteristics at the time of selection:

•

market capitalizations between $100 and $500 million,

•

most advanced product in a pivotal clinical trial, NDA filed, FDA approved but awaiting launch, or marketed,

•

less than 250 employees, and

•

a reasonable expectation that we could compete with these companies to fill senior management positions.

The compensation committee then approved the companies comprising the comparison group. The companies in the group were:


•	Affymax Inc.	•	Ligand Pharmaceuticals, Inc.

•	Allos Therapeutics, Inc.	•	MAP Pharmaceuticas, Inc.

•	Arena Pharmaceuticals, Inc.	•	Neurocrine Biosciences, Inc.

•	Avanir Pharmaceuticals, Inc.	•	Neurogesx Inc.

•	Biocryst Pharmaceuticals, Inc.	•	Optimer Pharmaceuticals, Inc.

•	Cadence Pharmaceuticals Inc.	•	Orexigen Therapeutics, Inc.

•	Columbia Laboratories Inc.	•	Pain Therapeutics, Inc.

•	Cornerstone Therapeutics, Inc.	•	Santarus, Inc.

•	Dyax Corp.	•	Spectrum Pharmaceuticals, Inc.

•	Dynavax Technologies Corp.	•	Sunesis Pharmaceuticals, Inc.

•	GTX Inc.	•	Transcept Pharmaceuticals, Inc.

•	Idenix Pharmaceuticals, Inc.	•	Vanda Pharmaceuticals, Inc.

The changes made to the selection criteria for the 2011 comparison group reflect a desire on the part of the compensation committee to include additional companies having commercial operations as a result of the launch of Silenor. The committee intends to review compensation information relating to this sub-group both separately and as part of the entire comparison group, in each case in light of the company’s status with respect to commercialization efforts, in considering future compensation determinations.

With respect to Named Executive Officers for which the publicly available competitive information from the comparison group was not sufficient to provide meaningful analysis in 2010 and 2011, Barney & Barney provided the compensation committee with competitive information relating to such officers’ positions from one or more executive compensation surveys.

With respect to survey data not relating to our comparison groups that was reviewed by the compensation committee in 2010 and 2011, the identities of the individual companies included in the surveys were not provided to the compensation committee, and the compensation committee did not refer to individual compensation information for such companies. Instead, the compensation committee only referred to statistical summaries of such surveys.

While we believe that comparisons to market data are a useful tool, we do not believe that it is appropriate to establish executive compensation levels based solely on a comparison to competitive data. While compensation paid by other companies is a factor that the compensation committee considers in assessing the reasonableness of compensation, the compensation committee does not rely entirely on that data to determine executive officer compensation. Instead, the compensation committee incorporates flexibility into our compensation programs and in the assessment process to respond to and adjust for the evolving business environment. As a result of this approach, there are no comparative guidelines, such as percentiles, used by our compensation committee in making compensation determinations relative to the compensation data from our comparison group. In addition, the compensation committee has discretion to make stock awards to executive officers that are outside of the ranges in previously-approved stock option grant guidelines. Our compensation committee relies upon the judgment of its members in making executive compensation decisions, after reviewing the following factors:

•

our performance against corporate objectives for the previous year,

•

difficulty in achieving desired results in the previous year and the current year,

•

the value of the executive’s unique leadership and other skills and capabilities to support our long-term performance,

•

historical compensation versus performance,

•

status relative to similarly-situated executives from our comparison group or from compensation surveys,

•

the executive’s performance generally, including against individual objectives, if any, for the previous year, and

•

the impact that any compensation awards that are payable in cash would have on our cash position.

The data regarding the compensation history and the relevant comparison group for each Named Executive Officer are provided to our Chief Executive Officer, the Chairman of the Board and the compensation committee. Our Chief Executive Officer then makes compensation recommendations to the compensation committee with respect to the executive officers who report to him. Our Chairman of the Board makes compensation recommendations to the compensation committee with respect to the Chief Executive Officer. The compensation committee considers, but is not bound to accept, these recommendations with respect to executive officer compensation. No executive officer is present at the time that his or her compensation is being discussed or determined.

Our policy for allocating between long-term and currently paid compensation is to ensure adequate base compensation to attract and retain personnel, while providing incentives to maximize long-term value for our company and our stockholders. A significant percentage of total compensation is allocated to incentive compensation as a result of this philosophy. We have no pre-established policy or target for the allocation between either cash and non-cash or short-term and long-term incentive compensation. Rather, the compensation committee reviews historical and competitive information and applies its judgment in light of the company’s then-current circumstances regarding current and long-term goals to determine the appropriate level and mix of incentive compensation.

Elements of Executive Compensation

Summary Compensation Table

The following “Summary Compensation Table” summarizes the compensation received by the Named Executive Officers in the fiscal years ended December 31, 2010, 2009 and 2008. This table provides an all-inclusive presentation of the various cash and non-cash elements that comprise total compensation for each of the Named Executive Officers. Except as set forth below, no Named Executive Officer earned any pension or other nonqualified deferred compensation, or perquisites exceeding $10,000 during 2010, 2009 or 2008.


											Non-Equity
			Salary		Bonus		Stock		Option		Incentive Plan		All Other
Name and Principal Position	Year		($)		($) (1)		Awards ($) (2)		Awards ($) (3)		Compensation ($) (4)		Compensation ($)		Total ($)
Richard W. Pascoe, President, Chief Executive Officer and Director (5)		2010	$	456,250	$	112,050	$	429,500	$	1,283,536	$	209,875	$	—	$	2,491,211
		2009	$	415,000	$	—	$	—	$	1,461,045	$	—	$	—	$	1,876,045
		2008	$	163,484	$	—	$	24,200	$	1,313,800	$	—	$	206,845	$	1,708,329

Tran B. Nguyen, Senior Vice President and Chief Financial Officer (6)		2010	$	206,193	$	—	$	206,500	$	1,234,226	$	66,394	$	42,163	$	1,755,476

Jeffrey W. Raser, Senior Vice President and Chief Commercial Officer		2010	$	300,038	$	56,732	$	343,600	$	962,652	$	96,612	$	—	$	1,759,634
		2009	$	270,150	$	—	$	—	$	831,989	$	—	$	—	$	1,102,139
		2008	$	268,484	$	38,588	$	15,125	$	293,166	$	—	$	—	$	615,363

Brian T. Dorsey, Senior Vice President, Technical Operations		2010	$	284,500	$	53,130	$	257,700	$	641,768	$	91,609	$	—	$	1,328,707
		2009	$	253,000	$	—	$	—	$	786,025	$	—	$	—	$	1,039,025
		2008	$	250,029	$	34,500	$	15,125	$	244,305	$	—	$	—	$	543,959

Matthew W. Onaitis, Senior Vice President and General Counsel		2010	$	280,313	$	49,613	$	257,700	$	641,768	$	90,261	$	—	$	1,319,655
		2009	$	236,250	$	—	$	—	$	957,609	$	—	$	—	$	1,193,859
		2008	$	234,797	$	33,750	$	15,125	$	244,305	$	—	$	—	$	527,977


(1)		Amounts listed under the “Bonus” column for 2010 reflect the discretionary bonuses paid to each of the Named Executive Officers in April 2010. Amounts listed under the “Bonus” column for 2008 reflect the amounts paid to each of the Named Executive Officers in April 2008 related to the acceptance by the FDA of our NDA for Silenor.

(2)		The “Stock Awards” column is the grant date fair value of stock awards issued during each respective year, adjusted where applicable for our assessment of the probability that performance conditions will be achieved. The grant date fair value was determined in accordance with the provisions of FASB ASC Topic 718. For information about the assumptions used in the calculation of grant date fair value, see the notes to our audited financial statements included in this report. The RSUs with performance conditions granted during 2010 were considered probable of achieving their vesting conditions at the date of grant and the full grant date fair value of such RSUs is included in the “Stock Awards” column above. The stock awards with performance conditions granted during 2008 and 2009 were not considered probable of achieving their vesting conditions at the date of grant. Therefore the grant date fair value of such performance awards for purposes of the Summary Compensation Table was zero. The full grant date fair value of all stock awards granted during 2008 and 2009 which vested upon achieving performance conditions is, however, provided in the table following the footnotes to this Summary Compensation Table.


(3)		The “Option Awards” column is the grant date fair value of stock options granted during each respective year, adjusted where applicable for our assessment of the probability that performance conditions will be achieved. The grant date fair value was determined in accordance with the provisions of FASB ASC Topic 718 using the Black-Scholes valuation model with assumptions described in more detail in the notes to our audited financial statements included in this report. None of the stock options with performance conditions that were granted in 2009 and 2008 were considered probable of achieving their vesting conditions at the date of grant. Therefore the grant date fair value of such performance awards for purposes of the Summary Compensation Table was zero. No performance-based stock options were granted during 2010. The full grant date fair value of stock options which vested upon achieving performance conditions is, however, provided in the table following the footnotes to the Summary Compensation Table. Amounts included in the “Option Awards” column for 2009 include the fair value of replacement awards granted in our stock option exchange program which was completed in June 2009. The fair value of the replacement awards granted in the stock option exchange program is the sum of the unrecognized expense from the original award at the time of the exchange, plus the incremental value from the replacement award. The incremental value is the difference between the fair value of the replacement award and the fair value of the original award at the time of exchange.

(4)		Amounts reflect the bonuses earned during 2010 under our 2010 Incentive Plan. Such bonuses were paid in February 2011.

(5)		Mr. Pascoe became our President and Chief Executive Officer in August 2009. Amounts included in “All Other Compensation” reflect the sum of: (a) a $25,000 signing bonus paid at the time Mr. Pascoe joined us, plus the gross-up for taxes of $18,668 on such signing bonus, and (b) amounts reimbursed to Mr. Pascoe of $102,276 incurred in connection with his relocation to San Diego, California from Massachusetts, plus $60,901 for the gross-up for taxes on these reimbursed expenses to the extent such amounts were taxable. Amounts reimbursed for his relocation include reimbursement for temporary living expenses in San Diego, reasonable expenses relating to the sale of Mr. Pascoe’s home in Massachusetts, closing costs associated with the purchase of a primary residence in San Diego and moving of household goods.

(6)		Mr. Nguyen became our Vice President and Chief Financial Officer in April, 2010, and Mr. Nguyen was promoted to Senior Vice President and Chief Financial Officer in February 2011. Amounts included in “All Other Compensation” reflect amounts reimbursed to Mr. Nguyen of $34,672 incurred in connection with his relocation to San Diego, California from San Mateo, California, plus $7,491 for the gross-up for taxes on these reimbursed expenses to the extent such amounts were taxable. Amounts reimbursed for his relocation include reimbursement for temporary living expenses in San Diego and moving of household goods.

The following table provides the full grant date fair values for all share-based awards that were excluded from the Summary Compensation Table (see footnotes 2 and 3 above) that were granted with performance-based vesting conditions, assuming that the highest level of performance would be achieved in each case.


			Grant Date				Grant Date			Option
			Fair Value			Stock Award	Fair Value			Award
			of Stock			Vesting	of Option			Vesting
Name	Year		Awards $ (1)			Conditions	Awards (2)			Conditions
Richard W. Pascoe		2010	$	—			$	—			—
		2009	$	100,001	(3)		$	119,947	(4)
		2008	$	228,400	(5)		$	—			—

Tran B. Nguyen		2010	$	—			$	—			—

Jeffrey W. Raser		2010	$	—			$	—			—
		2009	$	47,219	(3)		$	79,965	(4)
		2008	$	30,250	(5)		$	—			—

Brian T. Dorsey		2010	$	—			$	—			—
		2009	$	43,864	(3)		$	79,965	(4)
		2008	$	30,250	(5)		$	—			—

Matthew W. Onaitis		2010	$	—			$	—			—
		2009	$	41,089	(3)		$	79,965	(4)
		2008	$	30,250	(5)		$	—			—


(1)		The “Grant Date Fair Value of Stock Awards” is based on the closing stock price of our common stock on the date of grant and is determined in accordance with the provisions of FASB ASC Topic 718. For information about the assumptions used in the calculation of grant date fair value, see the notes to our audited financial statements included in this report.


(2)		The “Grant Date Fair Value of Option Awards” is the grant date fair value of stock options granted during each respective year. The grant date fair value was determined in accordance with the provisions of FASB ASC Topic 718 using the Black-Scholes valuation model with assumptions described in more detail in the notes to our audited financial statements included in this report.

(3)		Amounts reflect the value of RSUs which would have vested upon completion of financing activities resulting in at least $25 million of non-restricted cash proceeds by December 31, 2009. This financing goal was not achieved, and all of the listed stock awards granted during 2009 were subsequently forfeited.

(4)		Amounts reflect the value of stock options of which 50% vested upon FDA approval of the Silenor NDA and 50% vested upon the completion of a strategic relationship with regards to the commercialization of Silenor.

(5)		Amounts reflect the value of RSUs of which 50% vested upon FDA approval of the Silenor NDA and 50% vested in connection with the first commercial sale of Silenor in the United States.

Base Salary

Base salary is intended to provide a baseline of compensation that does not fluctuate, absent merit-based increases. As a general matter, the base salary for each Named Executive Officer is initially established through negotiation at the time the officer is hired, taking into account the officer’s qualifications, experience, prior salary and competitive salary information. Each of our Named Executive Officers has entered into an employment agreement with us that prohibits the compensation committee from decreasing his base salary as part of this annual review process.

Each year, the compensation committee reviews the base salary levels of each of the Named Executive Officers, which includes an analysis of the prior year’s individual and corporate performance, historical compensation awards, our budget for merit increases, anticipated contribution to the current year’s corporate goals and comparisons to data from the companies in our comparison group and compensation surveys, if applicable, with respect to each such executive officer. Salaries are also reviewed in the case of promotions or other significant changes in responsibilities.

In April 2010, following approval of the NDA for Silenor, the compensation committee determined to increase salaries based on the criteria set forth above. In February 2011, the compensation committee again determined to increase salaries based on the criteria set forth above. The base salaries for each of 2010 and 2011 are as follows:


	Base Salary
Named Executive Officer	2009		2010		2011
Richard W. Pascoe	$	415,000	$	470,000	$	484,100
Tran B. Nguyen	$	—	$	285,000	$	303,850
Jeffrey W. Raser	$	270,150	$	310,000	$	319,300
Brian T. Dorsey	$	253,000	$	295,000	$	303,850
Matthew W. Onaitis	$	236,250	$	295,000	$	303,850

The percentage increase in base salaries for our Named Executive Officers from 2009 to 2010 ranged from 13% to 16% and reflected the compensation committee’s acknowledgement that the Named Executive Officers did not receive a base salary adjustment during 2009 due to the company’s then-current cash position. As a result, following the FDA’s approval of our NDA for Silenor, the compensation committee, after reviewing comparable company information provided by our compensation consultant and the individual contributions of our Named Executive Officers during 2009, determined to approve the foregoing increases.

The percentage increase in base salaries for each of Messrs. Pascoe, Raser, Dorsey and Onaitis from 2010 to 2011 was 3%, reflecting the compensation committee’s determination that the base salaries for these Named Executive Officers were generally appropriate, subject to a merit increase that is consistent with industry averages provided by our compensation consultant. Mr. Nguyen’s base salary increased 6.6% from 2010 to 2011, reflecting an increase as a result of his promotion in February 2011 to Senior Vice President and Chief Financial Officer.

Bonus Awards

It is the compensation committee’s objective to have a significant percentage of each Named Executive Officer’s total compensation be contingent upon our performance and his contribution toward our performance. This allows our Named Executive Officers to receive bonus compensation in the event certain specified corporate performance objectives are achieved.

2010 Discretionary Bonuses. While the compensation committee established a formal incentive plan for 2009, due to the delay in the approval by the FDA of our NDA for Silenor, none of the corporate objectives under the 2009 bonus program were achieved during 2009. However, in light of the approval of Silenor in March 2010, the completion of a financing in March 2010 to fund commercialization activities for Silenor and the efforts of the Named Executive Officers in achieving these important corporate objectives, the compensation committee determined that some form of cash bonus compensation was appropriate. As a result, in April 2010, as part of the compensation committee’s annual review of the compensation levels of our Named Executive Officers, the compensation committee approved the discretionary bonuses to be paid to our executive officers that are listed in the Summary Compensation Table above.

2010 Incentive Plan. Also in April 2010, our compensation committee adopted the 2010 Incentive Plan. This plan was designed to reward our Named Executive Officers for the achievement of annual performance goals during 2010. Pursuant to the 2010 Incentive Plan, the Named Executive Officers were eligible to receive bonuses ranging from zero to 150% of their target bonuses based entirely on the achievement of corporate performance goals. For 2010, the target bonus percentage for our Chief Executive Officer was 50% of his base salary, and the target bonus percentage for each other Named Executive Officer was 35% of his base salary. Our 2010 corporate performance goals were established by our board of directors and included objectives relating to: (1) establishing a strategic collaboration regarding Silenor, which was weighted at 40% of our overall strategic objectives, (2) our financing activities, which was weighted at 20% of our overall strategic objectives, and (3) commercializing Silenor, which was weighted at 40% of our overall strategic objectives.

With respect to establishing a strategic collaboration regarding Silenor, our goal was to complete a collaboration approved by our board of directors by the end of 2010. Our financial objectives primarily related to completing one or more financings in 2010 to generate sufficient cash to meet our cash needs for the initial commercialization of Silenor. Our objective relating to commercializing Silenor was primarily to establish a commercial organization, commercially launch Silenor and generate prescriptions.

With respect to our corporate goals, under the 2010 Incentive Plan, our compensation committee places performance into one of four categories: excellent in view of prevailing conditions, acceptable in view of prevailing conditions, meeting some but not all objectives, or not acceptable in view of prevailing conditions. Each of these categorizations results in a range of multipliers to the target amount of the bonus. The compensation committee has discretion with respect to the actual multiplier to apply in each case. For 2010, the ranges were 75% to 150% for excellent performance, 50% to 75% for acceptable performance, 25% to 50% for performance meeting some but not all objectives and 0% for unacceptable performance. The primary factor in the determination of the bonus is the achievement of corporate objectives, but the compensation committee may also take other factors into account, such as individual contribution to corporate goals, historical compensation awards, anticipated contribution to future corporate goals and the impact that the payment of bonuses in cash would have on our cash position. As a result, the ultimate payment of bonuses is within the subjective discretion of our compensation committee, notwithstanding performance relating to pre-established corporate objectives.

In February 2011, the compensation committee undertook its annual review of the compensation levels and performance of the company and each of the Named Executive Officers. In connection with this process, the committee assessed our overall performance and determined that we met our corporate objectives at the 92% level. This was based upon the determinations of the committee that each of our corporate goals relating to a strategic partnership relating to Silenor and financing activities were met at the 100% level, and our corporate goal relating to the commercialization of Silenor was met at the 80% level. Based upon this analysis, the compensation committee granted bonuses pursuant to the 2010 Incentive Plan as listed in the Summary Compensation Table above.

In February 2011, our compensation committee adopted the 2011 Incentive Plan. This plan is designed to reward our Named Executive Officers for the achievement of annual performance goals. Pursuant to the 2011 Incentive Plan, the Named Executive Officers are eligible to receive bonuses ranging from zero to 150% of their target bonuses based entirely on the achievement of corporate performance goals. For 2011, the target bonus percentage for our Chief Executive Officer was increased to 55% of his base salary, and the target bonus percentage for each other Named Executive Officer was increased to 40% of his base salary. Our 2011 corporate performance goals were established by our board of directors and include objectives relating to: (1) the commercial success of Silenor, (2) securing an additional product candidate, (3) extending the Silenor franchise, and (4) effectively managing corporate resources.

Equity-Based Awards

We generally provide equity-based incentive award compensation to our Named Executive Officers through grants of stock options and RSUs. We have also previously awarded restricted stock to our Named Executive Officers. Stock awards allow us to:

•

enhance the link between the creation of stockholder value and long-term executive incentive compensation,

•

provide an opportunity for increased equity ownership by executives, and

•

maintain competitive levels of total compensation.

Stock award grant levels are determined based on market data and vary among the Named Executive Officers based on their positions and performance. Newly hired or promoted Named Executive Officers also typically receive stock option grants in connection with those events. We have guidelines that provide ranges of options to be granted to our employees, including our Named Executive Officers, based on their positions and whether the grants are being made in connection with hiring or on a performance basis thereafter. These guidelines were adopted by our compensation committee after considering recommendations provided by our independent compensation consultant that were based upon option grant data from our comparison group and the statistical summaries of compensation data presented to them based on available surveys. Our compensation committee considers the ranges contained in our guidelines in making determinations regarding the size of option grants, but it is not bound to comply with these ranges.

In making determinations relating to the size of equity awards, the compensation committee takes into account a number of factors, such as the relative performance of the executive, individual scope of duties, the value of existing long-term incentive awards, prior contributions to company performance, the importance to the company of anticipated future performance, the size of prior grants and competitive market data. Based upon these factors, the compensation committee determines the size of equity awards at levels it considers appropriate to create a meaningful opportunity for reward predicated on the creation of long-term stockholder value.

In addition, the board of directors has implemented a policy regarding the grant of equity awards. With respect to equity awards that may be granted to our Named Executive Officers, this policy provides that:

•

equity awards may be granted only at meetings of the compensation committee or the board of directors,

•

the grant date shall be the date that the meeting approving the equity award was held, or if later, the date of commencement of employment of a newly-hired executive officer,

•

the exercise price of a stock option may not be less than the fair market value of a share of our common stock on the grant date,

•

grants of equity awards to executive officers shall not be permitted if the compensation committee determines that at the time of grant its members are in possession of material, non-public information concerning the company, and

•

the material terms of each equity award are communicated to the executive officer in a timely manner.

The policy also provides that equity awards can be granted outside the terms of the policy in the event of unique circumstances or when time is of the essence, but that we shall not have any program, plan or practice to coordinate the timing of equity awards with the release by us of material non-public information or any other investor relations activities.

The stock options that have been granted to our executive officers typically have a ten year term and vest over four years, with 25% vesting after one year and the remainder vesting in equal monthly installments over the subsequent three years. Prior to the exercise of an option, the holder has no rights as a stockholder with respect to the shares subject to such option, including voting rights and the right to receive dividends or dividend equivalents.

We do not have any security ownership requirements for our executive officers.

In April 2010, in connection with its annual review of the compensation levels and performance of the company and our Named Executive Officers, the compensation committee granted RSUs and stock options to each of our executive officers. These RSUs and options are listed in the “Grants of Plan-Based Awards” table below. The awards of the options and RSUs to the Named Executive Officers in April 2010 reflected a desire on the part of the compensation committee to motivate the Named Executive Officers to drive the creation of stockholder value, and the vesting schedules of the awards generally were intended to provide incentive for the Named Executive Officers to maintain their employment with the company. The performance based vesting trigger on the RSUs was intended to motivate the Named Executive Officers to effectuate the commercial launch of Silenor in a timely manner.

In February 2011, in connection with its annual review of the compensation levels and performance of the company and our Named Executive Officers, on February 18, 2011, the compensation committee approved awards of stock options to the Named Executive Officers, which stock option awards will be granted effective March 7, 2011. The exercise price per share of such stock options will be the closing price per share of our common stock on March 7, 2011. The number of stock options to be received by each Named Executive Officer is as follows:


	Number of Stock
Named Executive Officer	Options Received
Richard W. Pascoe		250,000
Tran B. Nguyen		100,000
Jeffrey W. Raser		100,000
Brian T. Dorsey		100,000
Matthew W. Onaitis		100,000

All of such stock options will vest based on our standard four-year vesting schedule described above.

Also in February 2011, the compensation committee approved two sets of RSU awards to each of our Named Executive Officers, which RSU awards will be awarded effective March 7, 2011. One set of RSUs will be subject to time-based vesting and will vest as follows: one third of such RSUs will vest on December 31, 2011, another one third of such RSUs will vest on December 31, 2012 and the remaining one-third of such RSUs will vest on December 31, 2013. The number of such time-based RSUs to be received by each Named Executive Officer is as follows:


	Number of RSUs
Named Executive Officer	Received
Richard W. Pascoe		75,000
Tran B. Nguyen		30,000
Jeffrey W. Raser		30,000
Brian T. Dorsey		30,000
Matthew W. Onaitis		30,000

The second set of RSUs will be subject to performance-based vesting and will vest during the first quarter of 2012 on the second business day following the public release of our audited financial statements for the fiscal year ended December 31, 2011, subject to attainment of certain corporate performance objectives during 2011. The number of such performance-based RSUs to be received by each Named Executive Officer is as follows:


	Number of RSUs
Named Executive Officer	Received
Richard W. Pascoe		50,000
Tran B. Nguyen		50,000
Jeffrey W. Raser		50,000
Brian T. Dorsey		50,000
Matthew W. Onaitis		50,000

The awards of the options and RSUs to the Named Executive Officers in February 2011 reflect a desire on the part of the compensation committee to motivate the Named Executive Officers to drive the creation of stockholder value, and the vesting schedules of the awards are intended to provide incentive for the Named Executive Officers to maintain their employment with the company. In addition, the awards of the performance-based RSUs reflect a desire on the part of the compensation committee to provide incentive for the Named Executive Officers to cause us to achieve key corporate objectives.

For a description of the change of control provisions applicable to the stock awards granted to our Named Executive Officers, see “Severance Benefits and Change of Control Arrangements” below.

Outstanding Equity Awards at Fiscal Year End

The following table summarizes the outstanding stock options and RSUs as of December 31, 2010 held by our Named Executive Officers.


	Option Awards													Stock Awards
								Equity										Equity		Equity
								Incentive Plan										Incentive Plan		Incentive Plan
				Number of		Number of		Awards:										Awards:		Awards:
				Securities		Securities		Number of						Number of				Number of		Market or Payout
				Underlying		Underlying		Securities						Shares or		Market		Unearned Shares,		Value of Unearned
				Unexercised		Unexercised		Underlying						Units of		Value of		Units or Other		Shares, Units or
				Options (#		Options (#		Unexercised				Option		Stock that		Stock that		Rights that		Other Rights
	Award			Exercisable)		Unexercisable)		Unearned		Option Exercise		Expiration		Have Not		Has Not		Have not		that Have
Name	Grant Date			(1)		(1)		Options (#)		Price ($/Share)		Date		Vested (#)(2)		Vested ($)(3)		Vested (#)		not Vested ($)

Richard W. Pascoe		6/9/2009	(4)		171,110		72,223			$	1.23
		7/16/2009	(5)		150,000		—			$	1.17		7/15/2019
		4/1/2010			—		200,000			$	8.59		3/31/2020		33,334		105,002		—	$	—

					321,110		272,223		—						33,334	$	105,002		—	$	—

Tran B. Nguyen		4/12/2010			—		200,000		—	$	8.26		4/11/2020		25,000	$	78,750		—	$	—

Jeffrey W. Raser		3/2/2005			7,500		—			$	2.40		3/1/2015
		7/19/2005			83,333		—			$	3.00		7/18/2015
		6/9/2009	(4)		97,665		36,334			$	1.23
		7/16/2009	(5)		60,000		—			$	1.17		7/15/2019
		4/1/2010			—		150,000			$	8.59		3/31/2020		26,667		84,001		—	$	—

					248,498		186,334		—						26,667	$	84,001		—	$	—

Brian T. Dorsey		6/9/2009	(4)		42,087		32,621			$	1.23
		7/16/2009	(5)		100,000					$	1.17		7/15/2019
		4/1/2010					100,000			$	8.59		3/31/2020		20,000		63,000		—	$	—

					142,087		132,621		—						20,000	$	63,000		—	$	—

Matthew W. Onaitis		6/9/2009	(4)		51,209		34,136			$	1.23
		7/16/2009	(5)		100,000		—			$	1.17		7/15/2019
		4/1/2010			—		100,000			$	8.59		3/21/2020		20,000		63,000		—	$	—

					151,209		134,136		—						20,000	$	63,000		—	$	—


(1)		Except as described under footnotes 4 and 5 below, all of the stock options in this column vest such that 25% are vested one year after the vesting commencement date and 1/48^th vest on the first day of each calendar month thereafter until all options are fully vested on the first day of the 48^th month after grant.

(2)		Except for Mr. Nguyen, stock included under equity incentive plan awards include RSUs in which 50% of the amount included in the table above will vest on January 1, 2012 and 50% will vest on January 1, 2013. For Mr. Nguyen, one third of the RSUs will vest on April 12, 2011, one third will vest on January 1, 2012, and the remaining one third will vest on January 1, 2013.

(3)		The value of stock awards is based on a closing stock price of $3.15 per share on December 31, 2010.

(4)		Denotes stock options that were granted under our stock option exchange program which was completed in June 2009. Such stock options vest such that one-third were vested at grant, with the remaining two-thirds vesting over the subsequent two years. The expiration dates for these stock options range between March 15, 2015 and February 16, 2019.

(5)		Denotes stock options that vested 50% upon FDA approval of our NDA for Silenor and 50% upon the completion of a strategic relationship regarding the commercialization of Silenor.

Grants of Plan-Based Awards Table

The following table summarizes equity-based and incentive plan awards granted to our Named Executive Officers during the last fiscal year.


														All Other		All Other
														Stock		Option
														Awards:		Awards:		Exercise or		Grant Date
			Estimated Future Payouts Under							Estimated Future Payouts Under				Number of		Number of		Base Price of		Fair Value
			Non-Equity Incentive Plan Awards (1)							Equity Incentive Plan Awards				Shares of		Securities		Option		of Stock
			Threshold	Target			Maximum			Threshold	Target		Maximum	Stock or		Underlying		Awards		and Option
Name	Grant Date		($)	($)			($)			(#)	(#) (2)		(#)	Units (#) (3)		Options (#)		($/Share)		Awards (4)
Richard W. Pascoe		N/A		$	235,000		$	352,500
		4/1/2010										16,666								$	143,161
		4/1/2010													33,334					$	286,339
		4/1/2010															200,000	$	8.59	$	1,283,536

Tran B. Nguyen		N/A		$	71,875	(5)	$	107,813	(5)
		4/1/2010													25,000					$	206,500
		4/1/2010															200,000	$	8.26	$	1,234,226

Jeffrey W. Raser		N/A		$	108,500		$	162,750
		4/1/2010										13,333								$	114,530
		4/1/2010													26,667					$	229,070
		4/1/2010															150,000	$	8.59	$	962,652

Brian T. Dorsey		N/A		$	103,250		$	154,875
		4/1/2010										10,000								$	85,900
		4/1/2010													20,000					$	171,800
		4/1/2010															100,000	$	8.59	$	641,768

Matthew W. Onaitis		N/A		$	103,250		$	154,875
		4/1/2010										10,000								$	85,900
		4/1/2010													20,000					$	171,800
		4/1/2010															100,000	$	8.59	$	641,768


(1)		Amount represents potential target and maximum bonus payments under our 2010 Incentive Plan. For more information about the 2010 Incentive Plan, please see the discussion under “—Bonus Awards” above.

(2)		Represents RSUs that were scheduled to vest upon the first open trading window under our insider trading policy after the first commercial sale of Silenor in the United States. All of these awards vested on December 1, 2010.

(3)		Other than for Mr. Nguyen, represents RSUs that will vest 50% on January 1, 2012 and 50% on January 1, 2013. For Mr. Nguyen, one-third will vest on April 12, 2011, one-third will vest on January 1, 2012 and one-third will vest on January 1, 2013.

(4)		For RSUs, the grant date fair value is calculated as the number of shares multiplied the stock price at the date of grant. For stock options, the grant date fair value is calculated using the Black-Scholes valuation model with the assumptions outlined in our audited financial statements included in this report. In this table, the full grant-date fair value of share-based awards having performance-based vesting conditions is listed without adjusting for the probability of achieving the applicable vesting conditions as the RSUs with performance conditions granted during 2010 were considered probable of achieving their vesting conditions at the date of grant.

(5)		Mr. Nguyen’s target and maximum bonus amounts represent prorated amounts, as Mr. Nguyen joined the company on April 12, 2010.

Stock Option Exercises and Stock Vested Table

The following table summarizes the exercises of stock options and the vesting of restricted stock and RSUs for our Named Executive Officers during our last fiscal year.


	Option Awards				Stock Awards
	Number of Shares				Number of
	Acquired on		Value Realized		Shares Acquired		Value Realized
Name	Exercise (#)		on Exercise ($) (1)		on Vesting (#)		on Vesting ($) (2)
Richard W. Pascoe		190,000	$	674,564		56,666	$	177,432
Tran B. Nguyen		—	$	—		—	$	—
Jeffrey W. Raser		174,000	$	575,377		53,333	$	289,741
Brian T. Dorsey		121,000	$	483,986		50,000	$	280,775
Matthew W. Onaitis		119,454	$	384,010		50,000	$	280,775


(1)		The “Value Realized on Exercise” for an option award represents the stock price per share on the date of exercise less the exercise price per share of such option award multiplied by the number of shares for which such option award was exercised.

(2)		The “Value Realized on Vesting” for stock awards is based on a stock price on the date that the RSUs and restricted stock vested.

Other Benefits

In order to attract, retain and pay market levels of compensation, we provide our Named Executive Officers and our other employees the following benefits and perquisites.

Medical Insurance

The company provides to each Named Executive Officer and their spouses and children such health, dental and vision insurance coverage as the company may from time to time make available to its other eligible employees.

Life, Disability and Long-term Care Insurance

We provide each Named Executive Officer such disability, life and/or long-term care insurance as we may from time to time make available to our other eligible employees.

Pension Benefits

We do not provide pension arrangements or post-retirement health coverage for our executives or employees. Our Named Executive Officers and other eligible employees are eligible to participate in our 401(k) defined contribution plan. We currently do not make matching contributions to the 401(k) plan.

Nonqualified Deferred Compensation

We do not provide any nonqualified defined contribution or other deferred compensation plans.

Perquisites

We generally limit the perquisites that we make available to our Named Executive Officers, particularly in light of recent developments with respect to corporate crime and abuse involving perquisites. Our executives are entitled to few benefits with de minimis value that are not otherwise available to all of our employees.

Post-Termination Benefits

Severance Benefits and Change of Control Arrangements

We believe that reasonable severance benefits for our Named Executive Officers are important because it may be difficult for our Named Executive Officers to find comparable employment within a short period of time. We also believe that it is important to protect our Named Executive Officers in the event of a change of control transaction involving us. In addition, it is our belief that the interests of stockholders will be best served if the interests of our senior management are aligned with them, and providing change of control benefits should eliminate, or at least reduce, the reluctance of senior management to pursue potential change of control transactions that may be in the best interests of stockholders. Accordingly, the employment agreements we have entered into with each of our Named Executive Officers provide for severance benefits in specified circumstances, as well as benefits in connection with a change of control.

Richard W. Pascoe:

Mr. Pascoe entered into an employment agreement with us in August 2008. The employment agreement provides Mr. Pascoe with certain severance benefits in the event his employment is terminated as a result of his disability. Specifically, in the event of such a termination, Mr. Pascoe will receive any accrued but unpaid base salary and unused paid time-off as of the date of termination, a lump-sum severance payment equal to 12 months of base salary, and, in the discretion of our board of directors, a pro-rated bonus for the year in which the termination occurs.

The employment agreement also provides Mr. Pascoe with certain severance benefits in the event his employment is terminated by us other than for cause or if he resigns with good reason. Specifically, in the event of such a termination or resignation, Mr. Pascoe will receive any accrued but unpaid base salary and unused paid time-off as of the date of termination, a lump-sum severance payment equal to 12 months of base salary, 12 months of health care benefits continuation at our expense, in the discretion of our board of directors, a pro-rated bonus for the year in which the termination or resignation occurs and 12 months of the portion of the monthly premiums for his life insurance and disability insurance coverage that are borne by us. In addition, that portion of the Mr. Pascoe’s stock awards, and any unvested shares issued upon the exercise of such stock awards, which would have vested if Mr. Pascoe had remained employed for an additional 12 months, will immediately vest on the date of termination or resignation and Mr. Pascoe will be entitled to exercise such stock awards for 180 days following the date of termination.

In the event of a change of control of the company, 50% of Mr. Pascoe’s unvested stock awards will immediately become vested and exercisable on the date of the change of control and any remaining unvested stock awards will become vested and exercisable on the one year anniversary of the date of the change of control. In addition, in the event Mr. Pascoe’s employment is terminated by us other than for cause or if he resigns with good reason, in each case within 12 months of a change of control, all of Mr. Pascoe’s unvested stock awards will immediately become vested and exercisable on the date of termination and Mr. Pascoe will be entitled to exercise such stock awards for 180 days following the date of termination.

Named Executive Officers other than Mr. Pascoe:

Messrs. Nguyen, Raser, Dorsey and Onaitis entered into employment agreements with us upon joining the company.

The employment agreements, as amended to date, provide each executive with certain severance benefits in the event his employment is terminated as a result of his disability. Specifically, in the event of such a termination, each executive will receive any accrued but unpaid base salary and unused paid time-off as of the date of termination, a lump-sum severance payment equal to 12 months of base salary, and, in the discretion of our board of directors, a pro-rated bonus for the year in which the termination occurs.

The employment agreements also provide each executive with certain severance benefits in the event his employment is terminated by us other than for cause or if the executive resigns with good reason. Specifically, in the event of such a termination or resignation, each executive will receive any accrued but unpaid base salary and unused paid time-off as of the date of termination, a lump-sum severance payment equal to 12 months of base salary, 12 months of health care benefits continuation at our expense, and in the discretion of our board of directors a pro-rated bonus for the year in which the termination or resignation occurs. In addition, that portion of the executive’s stock awards, and any unvested shares issued upon the exercise of such stock awards, which would have vested if the executive had remained employed for an additional 12 months, will immediately vest on the date of termination or resignation and the executive will be entitled to exercise such stock awards for 180 days following the date of termination.

In the event of a change of control of the company, 50% of each executive’s unvested stock awards will immediately become vested and exercisable on the date of the change of control and any remaining unvested stock awards will become vested and exercisable on the one year anniversary of the date of the change of control. In addition, in the event an executive’s employment is terminated by us other than for cause or if the executive resigns with good reason, in each case within 12 months of a change of control, all of such executive’s unvested stock awards will immediately become vested and exercisable on the date of termination and the executive will be entitled to exercise such stock awards for 180 days following the date of termination.

Definitions Applicable to All Executive Employment Agreements:

For purposes of all of the employment agreements with our Named Executive Officers, “cause” means, generally, the executive’s breach of the non-solicitation, nondisparagement or confidentiality provisions of the employment agreement, the executive’s conviction by, or entry of a plea of guilty or nolo contendere in, a court of competent and final jurisdiction for any crime involving moral turpitude or punishable by imprisonment in the jurisdiction involved, the executive’s commission of an act of fraud, the executive’s continuing, willful failure or refusal to perform his or her duties as required by the employment agreement, the executive’s gross negligence, insubordination or material violation of any duty of loyalty to us or any other material misconduct on the part of the executive, the executive’s commission of any act which is detrimental to our business or goodwill, or the executive’s breach of any other provision of the employment agreement after he or she has been afforded a specified period to correct the alleged breach.

For purposes of all of the employment agreements with our Named Executive Officers, “good reason” means, generally, a material diminution in the executive’s base compensation, a material diminution in the executive’s authority, duties or responsibilities, a material diminution in the authority, duties or responsibilities of the supervisor to whom the executive is required to report (or, in the case of Mr. Pascoe, a requirement that he reports to an employee rather than our board of directors), a material change in the geographic location at which the executive must perform his or her duties, or any other action or inaction that constitutes a material breach by us of our obligations to the executive under the employment agreement.

For purposes of all of the employment agreements with our Named Executive Officers, “change in control” has the same meaning as given to that term in our 2005 Equity Incentive Award Plan.

Potential Payments Upon Termination or Change in Control:

If the employment of each of our Named Executive Officers was terminated due to disability or was terminated without cause, or if each resigned for good reason, the estimated benefits that each would receive under their employment agreements as of December 31, 2010 would be as follows:


							Received if Terminated Without Cause or
	Received if Terminated due to Disability						Resigned for Good Reason
													Intrinsic		Intrinsic
													Value of		Value of
													Additional		Additional
			Unused Paid						Unused Paid		Health Care		Vested Stock		Vested
Name	Salary ($)		Time-off ($)		Total ($)		Salary ($)		Time-off ($)		Benefits ($)		Options ($) (1)		Shares ($) (2)		Total ($)
Richard W. Pascoe	$	470,000	$	47,605	$	517,605	$	470,000	$	47,605	$	24,992	$	138,668	$	—	$	681,265
Tran B. Nguyen	$	285,000	$	7,681	$	292,681	$	285,000	$	7,681	$	21,362	$	—	$	26,249	$	340,292
Jeffrey W. Raser	$	310,000	$	26,034	$	336,034	$	310,000	$	26,034	$	25,471	$	69,761	$	—	$	431,266
Brian T. Dorsey	$	295,000	$	30,447	$	325,447	$	295,000	$	30,447	$	24,945	$	62,632	$	—	$	413,024
Matthew W. Onaitis	$	295,000	$	34,039	$	329,039	$	295,000	$	34,039	$	24,938	$	65,541	$	—	$	419,518


(1)		The intrinsic value of additional vested stock options shown above is the difference between the closing stock price of $3.15 per share at December 31, 2010 and the exercise price. A portion of options that would vest within 12 months of December 31, 2010 have an exercise price that exceeds the underlying stock price. For those options, the intrinsic value at December 31, 2010 is zero and not reflected in the table above.

(2)		The intrinsic value of additional vested shares shown above is the number of shares that would vest within 12 months of December 31, 2010, multiplied by the closing stock price of $3.15 per share at December 31, 2010. All of our outstanding RSUs are time-based and vest upon continued service. As of December 31, 2010, only Mr. Nguyen had unvested RSUs that will vest in 2011 and therefore only the value of those RSUs is included in the table above.

If a change in control was consummated at December 31, 2010 and the employment of each of our Named Executive Officers was terminated without cause, or if an executive resigned for good reason, the estimated benefits that each would receive under their employment agreements would be as follows:


	Received if Terminated Without Cause
	or Resigned for Good Reason in Connection with a Change of Control
							Intrinsic Value		Intrinsic Value
							of Additional		of Additional
			Unused Paid		Health Care		Vested Stock		Vested Shares
Name	Salary ($)		Time-off ($)		Benefits ($)		Options ($) (1)		($) (2)		Total ($)
Richard W. Pascoe	$	470,000	$	47,605	$	24,992	$	138,668	$	105,002	$	786,267
Tran B. Nguyen	$	285,000	$	7,681	$	21,362	$	—	$	78,750	$	392,793
Jeffrey W. Raser	$	310,000	$	26,034	$	25,471	$	69,761	$	84,001	$	515,267
Brian T. Dorsey	$	295,000	$	30,447	$	24,945	$	62,632	$	63,000	$	476,024
Matthew W. Onaitis	$	295,000	$	34,039	$	24,938	$	65,541	$	63,000	$	482,518


(1)		The intrinsic value of additional vested stock options shown above is the difference between the closing stock price of $3.15 per share at December 31, 2010 and the exercise price. A portion of options that would vest within 12 months of December 31, 2010 have an exercise price that exceeds the underlying stock price. For those options, the intrinsic value at December 31, 2010 is zero and not reflected in the table above.

(2)		The intrinsic value of additional vested restricted shares, RSUs and stock options is based on a closing stock price of $3.15 per share at December 31, 2010.

Policy Regarding Tax Deductibility of Compensation

Section 162(m) of the Internal Revenue Code of 1986, as amended, or the code, generally disallows a tax deduction to public companies for compensation in excess of $1 million paid to the corporation’s Chief Executive Officer and four other most highly paid executive officers. Qualifying performance-based compensation will not be subject to the deduction limitation if certain requirements are met.

The non-performance based compensation paid in cash to our executive officers in 2010 did not exceed the $1 million limit per officer, and the compensation committee does not anticipate that the non-performance based compensation to be paid in cash to our executive officers for 2011 will exceed that limit. In addition, our 2005 Equity Incentive Award Plan has been structured so that any compensation paid in connection with the exercise of option grants under that plan with an exercise price equal to the fair market value of the option shares on the grant date will qualify as performance-based compensation and it will not be subject to the $1 million deduction limitation.

We periodically review the potential consequences of Section 162(m) and may structure the performance-based portion of our executive compensation to comply with certain exemptions in Section 162(m). However, we reserve the right to use our judgment to authorize compensation payments that do not comply with the exemptions in Section 162(m) when we believe that such payments are appropriate and in the best interests of the stockholders, after taking into consideration changing business conditions or the officer’s performance.

Compensation Committee Report

We have reviewed and discussed with management the Compensation Discussion and Analysis provisions to be included in this report. Based on the reviews and discussions referred to above, we recommend to the board of directors that the Compensation Discussion and Analysis referred to above be included in this report.

Compensation Committee

Thomas G. Wiggans (Chair)
Michael L. Eagle
Kurt von Emster

Compensation of our Board of Directors

We compensate non-employee directors for their service on our board of directors under our Director Compensation Policy.

Under the current Director Compensation Policy, each non-employee director is eligible to receive a quarterly retainer of $6,250, or $25,000 annually, for service on our board of directors.

Our non-employee directors also receive retainers for their service on board committees. The Chairman of the audit committee of the board of directors receives a quarterly retainer of $2,500, or $10,000 per year. Each other member of our audit committee receives a quarterly retainer of $750, or $3,000 per year. Each member of the compensation committee of our board of directors receives a quarterly retainer of $625, or $2,500 per year, and each member of the nominating/corporate governance committee of our board of directors receives a quarterly retainer of $250, or $1,000 per year.

Each non-employee director is also eligible to receive an incremental stipend of $1,500 for each board meeting attended in person, or $750 for each board meeting attended by telephone, and $1,000 for each committee meeting attended in person, or $500 for each committee meeting attended by telephone. We reimburse our non-employee directors for their reasonable expenses incurred in attending meetings of our board of directors and committees of the board of directors.

In November 2008 our board of directors, upon the recommendation of the compensation committee, amended our Director Compensation Policy to provide that non-employee directors would receive their quarterly retainers for service on the board of directors or committees of the board and their fees for attending meetings of the board and committees of the board in RSUs. After each calendar quarter, each director received a number of RSUs calculated by dividing the total amount of such retainers and fees due to such director relating to such quarter by the closing price of our common stock on the Nasdaq Capital Market on the last trading day of such quarter. We discontinued this process in April 2010 and again began paying retainers and per-meeting fees in cash. All of the RSUs granted in lieu of cash retainers and meeting fees vested on December 1, 2010.

In April 2010, the compensation committee reviewed compensation levels of our board of directors. The compensation committee recommended to the board of directors that the quarterly retainer of our non-Executive Chairman of the Board be increased from $25,000, or $100,000 per year, to $28,000, or $112,000 per year, effective retroactively to April 1, 2010. The board of directors adopted this change to the Director Compensation Policy in April 2010.

Our directors may participate in our stock incentive plans and employee-directors may participate in our employee stock purchase plan. Any non-employee director who is elected to our board of directors is granted an option to purchase 35,000 shares of our common stock on the date of his or her initial election to our board of directors. In addition, on the date of each annual meeting of our stockholders, (1) each continuing non-employee director will be eligible to receive an option to purchase 15,000 shares of common stock, (2) the non-Executive Chairman of the Board will be eligible to receive an additional annual option to purchase 25,000 shares of common stock (for a total of 40,000 shares), (3) the Chairman of our audit committee will be eligible to receive an additional annual option to purchase 5,000 shares of common stock (for a total of 20,000 shares) and (4) the Chairmen of our nominating/corporate governance committee and our compensation committee will be eligible to receive an additional annual option to purchase 2,500 shares of common stock (for a total of 17,500 shares each). Such options will have an exercise price per share equal to the fair market value of our common stock on such date. The initial options granted to non-employee directors described above will vest over three years in 36 equal monthly installments on each monthly anniversary of the date of grant, subject to the director’s continuing service on our board of directors on those dates. The annual options granted to non-employee directors described above will vest in 12 equal monthly installments on each monthly anniversary of the date of grant, subject to the director’s continuing service on our board of directors (and, with respect to grants to a Chairman of the Board or board committee, service as Chairman of the Board or a committee) on those dates. The term of each option granted to a non-employee director shall be ten years.

Director Compensation Table

The following table summarizes our director compensation for each of our directors except Mr. Pascoe for the year ended December 31, 2010. Please see the tables relating to our Named Executive Officers for information relating to Mr. Pascoe.


	Fees Earned						All Other
	or Paid in		Stock Awards		Option Awards		Compensation
Name and Principal Position	Cash ($)		($) (1)		($) (2)		($)		Total ($)
David F. Hale, Chairman of the Board	$	96,000	$	28,500	$	132,116	$	—	$	256,616
Erle T. Mast, Director, Chairman of the Audit Committee	$	41,000	$	13,284	$	66,058	$	—	$	120,342
Kurt von Emster, Director, Chairman of the Nominating / Corporate Governance Committee	$	36,151	$	11,111	$	57,801	$	—	$	105,063
Terrell A. Cobb, Director	$	27,750	$	9,249	$	49,543	$	—	$	86,542
Michael L. Eagle, Director	$	34,875	$	13,622	$	49,543	$	—	$	98,040
Kurt C. Wheeler, former Director (4)	$	—	$	—	$	—	$	—	$	—
Faheem Hasnain, Director (5)	$	9,451	$	—	$	105,086	$	—	$	114,537
Thomas G. Wiggans, Director, Chairman of the Compensation Committee	$	32,375	$	12,618	$	57,801	$	—	$	102,794
Jesse I. Treu, Ph.D., former Director, former Chairman of Compensation Committee (3)	$	—	$	11,873	$	—	$	—	$	11,873


(1)		From November 2008 through March 2010, members of our board of directors received RSUs in lieu of cash compensation. The RSUs vested on the first open trading window under our insider trading policy following the first commercial sale of Silenor in the United States, which occurred on December 1, 2010. The “Stock Awards” column is the grant date fair value of these RSUs issued to our non-employee directors during 2010. Although these RSUs vested based on performance conditions, those performance conditions were considered probable of being achieved at the date of grant and the full grant date fair value of such RSUs is included in the “Stock Awards” column above. The grant date fair value was determined in accordance with the provisions of FASB ASC Topic 718. For information about the assumptions used in the calculation of grant date fair value, see the notes to our audited financial statements included in this report. As of December 31, 2010, none of our non-employee directors held any outstanding stock awards.

(2)		The “Option Awards” column is the grant date fair value of option awards issued to our non-employee directors during 2010, calculated in accordance with the provisions of FASB ASC Topic 718. See the assumptions used in the Black-Scholes model in the notes to our audited financial statements included in this report. During 2010, our non-employee directors were granted stock options to purchase the following numbers of shares of our common stock: Mr. Hale, 40,000 shares; Mr. Mast, 20,000 shares; Mr. von Emster, 17,500 shares; Mr. Cobb, 15,000 shares; Mr. Eagle, 15,000 shares; Mr. Wiggans, 17,500 shares; and Mr. Hasnain, 35,000 shares.

(3)		Dr. Treu did not stand for re-election at the Annual Meeting on June 9, 2010.

(4)		Mr. Wheeler resigned from our board of directors and the compensation and nominating/corporate governance committees thereof effective as of March 18, 2010.

(5)		Mr. Hasnain became a director in September 2010.

Compensation Committee Interlocks and Insider Participation

Mr. Wiggans (chair) and Messrs. Eagle and von Emster served on our compensation committee during the 2010 fiscal year. Dr. Treu and Mr. Wheeler also served on our compensation committee for part of 2010. No member of the compensation committee was at any time during the 2010 fiscal year or at any other time an officer or employee of the company. None of our executive officers serve, or in the past year has served as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our compensation committee. None of our executive officers serve, or in the past year has served, as a member of the compensation committee of any entity that has one or more executives serving on our board of directors.


Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The following table sets forth information regarding the beneficial ownership of our common stock as of February 15, 2011 for:

•

each of our Named Executive Officers as defined in Part III — Item 11, “Executive Compensation” of this report;

•

each of our directors;

•

each person known by us to beneficially own more than 5% of our common stock; and

•

all of our Named Executive Officers and directors as a group.

Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and includes voting and investment power with respect to the securities. Except as indicated by footnote, and subject to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. The number of shares of common stock used to calculate the percentage ownership of each listed person includes the shares of common stock underlying options held by such persons that are exercisable as of April 16, 2011, which is 60 days after February 15, 2011.

Percentage of beneficial ownership is based on 45,004,991 shares of common stock outstanding as of February 15, 2011. Unless otherwise indicated, the address for the following stockholders is c/o Somaxon Pharmaceuticals, Inc., 3570 Carmel Mountain Road, Suite 100, San Diego, CA 92130.


	Shares		Percent
	Beneficially		Beneficially
Name and Address of Beneficial Owner	Owned		Owned
5% Stockholders:
Funds affiliated with MPM Capital, L.P. (1) 601 Gateway Boulevard, Suite 350 South San Francisco, CA 94080		5,909,155		12.8	%
Ingalls & Snyder, LLC (2) 61 Broadway New York, NY 10006		5,016,000		11.1	%
Federated Investors, Inc. (3) 5800 Corporate Drive Pittsburgh, PA 15222		3,816,535		8.5	%
Scale Venture Management I, LLC, (formerly BAVP, L.P.) (4) 950 Tower Lane, Suite 700 Foster City, CA 94404		3,002,858		6.6	%
Funds affiliated with Putnam, LLC d/b/a Putnam Investments (5) One Post Office Square Boston, MA 02109		2,818,431		6.3	%
Directors and Named Executive Officers:
David F. Hale (6)		685,494		1.5	%
Erle T. Mast (7)		108,479		*
Faheem Hasnain (8)		6,805		*
Kurt von Emster (9)		156,802		*
Terrell A. Cobb (10)		148,732		*
Michael L. Eagle (11)		96,293		*
Thomas G. Wiggans (12)		78,145		*
Richard W. Pascoe (13)		457,633		*
Tran B. Nguyen (14)		60,833		*
Matthew W. Onaitis (15)		243,002		*
Brian T. Dorsey (16)		212,284		*
Jeffrey W. Raser (17)		310,219		*
Named Executive Officers and directors as a group (12 persons) (18)		2,564,721		5.5	%


*		Indicates beneficial ownership of less than 1% of the total outstanding common stock.


(1)		Funds affiliated with MPM Capital L.P. include the following holdings:


			Number
			of Warrants
	Number		Exercisable within 60
Shareholder Name	of Shares		days of February 15, 2011
MPM Asset Management Investors 2006 BVIII LLC		68,399		18,848
MPM BioVentures III GmbH & Co. Beteiligungs KG		326,317		89,923
MPM BioVentures III Parallel Fund, L.P.		116,646		32,144
MPM BioVentures III, L.P.		259,654		71,553
MPM BioVentures III-QP, L.P.		3,861,546		1,064,125

Total		4,632,562		1,276,593


		MPM BioVentures III GP, L.P. and MPM BioVentures III LLC are the direct and indirect general partners of MPM BioVentures III-QP, L.P., MPM BioVentures III GmbH & Co. Beteiligungs KG, MPM BioVentures III, L.P. and MPM BioVentures III Parallel Fund, L.P. The members of MPM BioVentures III LLC and MPM Asset Management Investors 2006 BVIII LLC are Luke Evnin, Ansbert Gadicke, Nicholas Galakatos, Dennis Henner, Nicholas Simon III, Michael Steinmetz and Mr. Wheeler, who disclaim beneficial ownership of these shares except to the extent of their pecuniary interest therein.

(2)		The voting and disposition of the shares held by Ingalls & Snyder was obtained from the Schedule 13-G/A filed by Ingalls & Snyder on February 14, 2011.

(3)		The voting and disposition of the shares held by Federated Investors, Inc. was obtained from the Schedule 13-G/A filed by Federated Investors, Inc. on February 9, 2011.

(4)		Shares held by Scale Venture Management I, LLC include warrants to purchase 510,638 shares of our common stock within 60 days of February 15, 2011. The voting and disposition of the shares held by Scale Venture Management I, LLC was obtained from the Schedule 13-G/A filed by BAVP, L.P. on July 8, 2010.

(5)		The voting and disposition of the shares held by Putnam, LLC d/b/a Putnam Investments was obtained from the Schedule 13-G/A filed by Putnam, LLC d/b/a Putnam Investments on February 14, 2011.

(6)		Shares held by David F. Hale include 347,507 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011.

(7)		Shares held by Erle T. Mast include 61,849 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011.

(8)		Shares held by Faheem Hasnain include 6,805 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011.

(9)		Shares held by Kurt von Emster include 87,170 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011 and warrants to purchase 42,553 shares of our common stock within 60 days of February 15, 2011.

(10)		Shares held by Terrell A. Cobb include 105,428 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011.

(11)		Shares held by Michael L. Eagle include 58,980 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011.

(12)		Shares held by Thomas G. Wiggans include 51,619 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011.

(13)		Shares held by Richard W. Pascoe include 419,258 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011.

(14)		Shares held by the Tran B. Nguyen include 50,000 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011 and 8,333 RSUs which vest within 60 days of February 15, 2011.

(15)		Shares held by Matthew W. Onaitis include 198,965 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011.

(16)		Shares held by Brian T. Dorsey include 188,832 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011.

(17)		Shares held by Jeffrey W. Raser include 310,219 shares of common stock subject to outstanding options which are exercisable within 60 days of February 15, 2011.

(18)		Includes 1,886,632 shares of common stock subject to outstanding options and 42,553 warrants which are exercisable within 60 days of February 15, 2011.


Item 13.		Certain Relationships and Related Transactions, and Director Independence

We describe below transactions and series of similar transactions, since the beginning of fiscal year 2010, with respect to which we were a party, will be a party, or otherwise benefited, in which:

•

the amounts involved exceeded or will exceed $120,000; and

•

a director, executive officer, holder of more than 5% of our common stock or any member of their immediate family had or will have a direct or indirect material interest.

We also describe below certain other transactions with our directors, executive officers and stockholders. We believe that the terms obtained or consideration that we paid or received, as applicable, in connection with the transactions described below were comparable to terms available or the amounts that would be paid or received, as applicable, in arm’s-length transactions.

Pursuant to our Audit Committee Charter, the audit committee of our board of directors is responsible for reviewing and approving all transactions with related parties. We have not adopted written procedures for review of, or standards for approval of, these transactions, but instead the audit committee of our board of directors intends to review such transactions on a case by case basis. In addition, the compensation committee of our board of directors and/or our board of directors will review and approve all compensation-related policies involving our directors and executive officers.

Our board of directors has determined that the members of our board of directors, with the exception of Mr. Hale, Mr. Cobb and Mr. Pascoe, none of whom serve on our audit committee, compensation committee, or nominating and corporate governance committee, are independent within the meaning of the independent director standards of the SEC and the Nasdaq Stock Market, Inc. Additional information concerning the independence of the members of our board of directors and the committees of the board of directors is set forth under Part III — Item 10, “Directors, Executive Officers and Corporate Governance.”

Employment Agreements and Change of Control Arrangements

We have entered into employment agreements, which are described in Part III — Item 11, “Executive Compensation” of this report, with our executive officers.

Indemnification of Officers and Directors

Our restated certificate of incorporation and our bylaws provide that we will indemnify each of our directors and officers to the fullest extent permitted by the Delaware General Corporation Law. Further, we have entered into indemnification agreements with each of our directors and officers, and we have purchased a policy of directors’ and officers’ liability insurance that insures our directors and officers against the cost of defense, settlement or payment of a judgment under certain circumstances.

Other Transactions

The approval of the NDA for Silenor in March 2010 triggered a $1,000,000 milestone payment obligation to ProCom One. Mr. Cobb, a member of our board of directors, is a co-founder and President of ProCom One. Pursuant to the Amended and Restated License Agreement with ProCom One, ProCom also receives a royalty on the sales of Silenor. Mr. Cobb received 1,000 RSUs during 2010 as compensation for his services on our board of directors. These RSUs vested on December 1, 2010.


Item 14.		Principal Accountant Fees and Services

Audit and All Other Fees

The following table presents fees for services rendered by PricewaterhouseCoopers LLP, our independent registered public accounting firm, for 2010 and 2009 in the following categories:


	2010		2009
Audit fees (1)	$	315,000	$	325,000
Audit related fees (2)		—		—
Tax fees (3)		51,000		13,000
All other fees (4)		—		—

Total	$	366,000	$	338,000


(1)		Audit fees consist of fees for professional services performed by PricewaterhouseCoopers LLP for the audit of our annual financial statements, review of our quarterly financial statements, review of our registration statements on Forms S-3 and related services that are normally provided in connection with statutory and regulatory filings or engagements.

(2)		Audit related fees consist of fees billed for assurance and related services performed by PricewaterhouseCoopers LLP that are reasonably related to the performance of the audit or review of our financial statements.

(3)		Tax fees consist of fees for professional services performed by PricewaterhouseCoopers LLP with respect to tax compliance, tax advice and tax planning.

(4)		All other fees consist of fees for other permissible work performed by PricewaterhouseCoopers LLP that is not included within the above category descriptions. There were no such fees incurred during 2010 or 2009.

The audit committee has considered whether the provision of non-audit services is compatible with maintaining the independence of PricewaterhouseCoopers LLP, and has concluded that the provision of such services is compatible with maintaining the independence of our registered public accounting firm.

Audit Committee Policy Regarding Pre-Approval of Audit and Permissible Non-Audit Services of Our Independent Registered Public Accounting Firm

The audit committee has established a policy that all audit and permissible non-audit services provided by our independent registered public accounting firm will be pre-approved by the audit committee, and all such services were pre-approved in accordance with this policy during the fiscal years ended December 31, 2010 and 2009. These services may include audit services, audit-related services, tax services and other services. The audit committee considers whether the provision of each non-audit service is compatible with maintaining the independence of our registered public accounting firm. Pre-approval is detailed as to the particular service or category of services and is generally subject to a specific budget. Our independent registered public accounting firm and management are required to periodically report to the audit committee regarding the extent of services provided by the independent registered public accounting firm in accordance with this pre-approval, and the fees for the services performed to date.

PART IV


Item 15.		Exhibits and Financial Statement Schedules

(a)

Documents filed as part of this report.

1. The following financial statements of Somaxon Pharmaceuticals, Inc. and Report of PricewaterhouseCoopers LLP, independent registered public accounting firm, are included in this report:

•

Report of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm

•

Balance Sheets as of December 31, 2010 and 2009

•

Statements of Operations for the years ended December 31, 2010, 2009 and 2008

•

Statements of Cash Flows for the years ended December 31, 2010, 2009 and 2008

•

Statements of Stockholders’ Equity and Comprehensive Loss for years ended December 31, 2010, 2009 and 2008

•

Notes to Financial Statements

2. List of financial statement schedules. All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.

3. List of exhibits required by Item 601 of Regulation S-K. See part (b) below.

(b)

Exhibits.


Exhibit
Number			Description

	3.1	(1)	Amended and Restated Certificate of Incorporation of the Registrant

	3.2	(2)	Amended and Restated Bylaws of the Registrant

	4.1	(3)	Form of the Registrant’s Common Stock Certificate

	4.2	(4)	Amended and Restated Investor Rights Agreement dated June 2, 2005

	4.3	(5)	Warrant issued to Silicon Valley Bank dated May 21, 2008

	4.4	(5)	Warrant issued to Oxford Finance Corporation dated May 21, 2008

	4.5	(5)	Warrant issued to Kingsbridge Capital Limited dated May 21, 2008

	4.6	(6)	Form of Warrant issued to certain Purchasers under the Securities Purchase Agreement dated July 2, 2009

	10.1	(1)	Form of Director and Executive Officer Indemnification Agreement

	10.2	#(1)	Director Compensation Policy

	10.3	#(4)	2004 Equity Incentive Award Plan and forms of option agreements thereunder

	10.4	#(7)	Amended and Restated 2005 Equity Incentive Award Plan

	10.5	#(8)	2005 Employee Stock Purchase Plan and form of Offering Document thereunder

	10.6	#(9)	2010 Incentive Plan

	10.7	#(10)	2011 Incentive Plan

	10.8	#(11)	Form of Amended and Restated Employment Agreement


Exhibit
Number			Description

	10.9	#(12)	Employment Agreement between the Registrant and Richard W. Pascoe dated August 7, 2008

	10.10	#(13)	Employment Agreement between the Registrant and Tran Nguyen dated April 12, 2010

	10.11	#(14)	Amendment to Employment Agreement between the Registrant and Tran Nguyen dated September 15, 2010

	10.12	#(15)	Form of Director Restricted Stock Unit Award Grant Notice and Restricted Stock Unit Award Agreement

	10.13	#(15)	Form of Employee Restricted Stock Unit Award Grant Notice and Restricted Stock Unit Award Agreement

	10.14	#(15)	Restricted Stock Unit Award Grant Notice and Restricted Stock Unit Award Agreement between the Registrant and David F. Hale dated November 28, 2008

	10.15	#(11)	Form of Restricted Stock Purchase Agreement

	10.16	#(11)	Restricted Stock Purchase Agreement between the Registrant and David F. Hale dated October 8, 2007

	10.17	(6)	Securities Purchase Agreement between the Registrant and the Purchasers identified therein dated July 2, 2009

	10.18	(14)	Amended and Restated License Agreement by and between the Registrant and ProCom One, Inc. dated September 15, 2010

	10.19	(4)	Common Stock Purchase Agreement by and among the Registrant, ProCom One, Inc. and Terrell A. Cobb dated April 15, 2004

	10.20	†(16)	Manufacturing Services Agreement between the Registrant and Patheon Pharmaceuticals Inc. dated February 1, 2006

	10.21	†(17)	Professional Detailing Services Agreement between the Registrant and Publicis Touchpoint Solutions, Inc. dated July 14, 2010

	10.22	†(18)	Supplement No. 1 to the Professional Detailing Services Agreement between the Registrant and Publicis Touchpoint Solutions, Inc. dated February 7, 2011

	10.23	†(19)	Co-Promotion Agreement between the Registrant and The Procter & Gamble Distributing Company, LLC dated August 24, 2010

	10.24	(20)	Loan and Security Agreement by and between the Registrant and Comerica Bank dated as of February 7, 2011

	10.25	(20)	LIBOR Addendum to Loan and Security Agreement by and between the Registrant and Comerica Bank dated as of February 7, 2011

	10.26	(21)	Agreement of Termination between the Registrant and BioTie Therapies Corp. dated March 12, 2009

	10.27	(22)	Separation Agreement between the Registrant and Susan E. Dubé dated April 14, 2009

	10.28	(22)	Separation Agreement between the Registrant and James J. L’Italien dated May 1, 2009

	10.29	(22)	Separation Agreement between the Registrant and Meg M. McGilley dated May 14, 2009


Exhibit
Number			Description

	10.30	(23)	Lease Agreement between the Registrant and PRII Gateway Torrey Hills LLC dated as of April 22, 2010

	10.31	(24)	Sublease between the Registrant and aAd Capital Management, L.P. dated April 22, 2009

	10.32	(24)	Sublease Amendment and Termination Agreement between the Registrant and Avnet, Inc. dated April 23, 2009

	23.1		Consent of PricewaterhouseCoopers LLP, independent registered public accounting firm

	31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14 and Rule 15d-14 of the Securities Exchange Act of 1934, as amended

	31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14 and Rule 15d-14 of the Securities Exchange Act of 1934, as amended

	32.1	*	Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003

	32.2	*	Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003


#		Indicates management contract or compensatory plan.

†		Confidential treatment has been granted as to certain portions, which portions have been omitted and filed separately with the Securities and Exchange Commission.

*		These certifications are being furnished solely to accompany this annual report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are not to be incorporated by reference into any filing of Somaxon Pharmaceuticals, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.

(1)		Filed with Amendment No. 3 to the Registrant’s Registration Statement on Form S-1 on November 30, 2005.

(2)		Filed with Registrant’s Current Report on Form 8-K on December 6, 2007.

(3)		Filed with Amendment No. 4 to the Registrant’s Registration Statement on Form S-1 on December 13, 2005.

(4)		Filed with the Registrant’s Registration Statement on Form S-1 on October 7, 2005.

(5)		Filed with Registrant’s Current Report on Form 8-K on May 22, 2008.

(6)		Filed with Registrant’s Current Report on Form 8-K on July 8, 2009.

(7)		Filed with Registrant’s Definitive Proxy Statement on April 30, 2009.

(8)		Filed with the Registrant’s Registration Statement on Form S-8 on December 15, 2005.

(9)		Filed with Registrant’s Current Report on Form 8-K on April 7, 2010.

(10)		Filed with Registrant’s Current Report on Form 8-K on February 14, 2011.

(11)		Filed with Registrant’s Annual Report on Form 10-K on March 12, 2008.

(12)		Filed with Registrant’s Current Report on Form 8-K on August 7, 2008.

(13)		Filed with Registrant’s Current Report on Form 8-K on April 14, 2010.

(14)		Filed with the Registrant’s Quarterly Report on Form 10-Q on November 10, 2010.

(15)		Filed with Registrant’s Annual Report on Form 10-K on March 13, 2009.

(16)		Filed with the Registrant’s Quarterly Report on Form 10-Q on May 11, 2006

(17)		Filed with Registrant’s Current Report on Form 8-K/A on July 21, 2010.

(18)		Filed with Registrant’s Current Report on Form 8-K/A on February 11, 2011.

(19)		Filed with Registrant’s Current Report on Form 8-K on August 25, 2010.

(20)		Filed with Registrant’s Current Report on Form 8-K on February 8, 2011.

(21)		Filed with Registrant’s Current Report on Form 10-Q on May 8, 2009.

(22)		Filed with Registrant’s Current Report on Form 10-Q on August 7, 2009.

(23)		Filed with Registrant’s Current Report on Form 8-K on April 28, 2010.

(24)		Filed with Registrant’s Current Report on Form 8-K on April 24, 2009.

(c)

Financial Statement Schedule. See Item 15(a)(2) above.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.


	SOMAXON PHARMACEUTICALS, INC.
Dated: March 4, 2011	By:	/s/ Richard W. Pascoe
		Richard W. Pascoe
		President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Signature	Title	Date

/s/ Richard W. Pascoe Richard W. Pascoe	President and Chief Executive Officer	March 4, 2011

/s/ Tran B. Nguyen Tran B. Nguyen	Senior Vice President and Chief Financial Officer	March 4, 2011

/s/ David F. Hale David F. Hale	Chairman of the Board of Directors	March 4, 2011

/s/ Terrell A. Cobb Terrell A. Cobb	Director	March 4, 2011

/s/ Michael L. Eagle Michael L. Eagle	Director	March 4, 2011

/s/ Erle T. Mast Erle T. Mast	Director	March 4, 2011

/s/ Faheem Hasnain Faheem Hasnain	Director	March 4, 2011

/s/ Kurt von Emster Kurt von Emster	Director	March 4, 2011

/s/ Thomas G. Wiggans Thomas G. Wiggans	Director	March 4, 2011

EXHIBIT INDEX


Exhibit
Number			Description
	3.1	(1)	Amended and Restated Certificate of Incorporation of the Registrant

	3.2	(2)	Amended and Restated Bylaws of the Registrant

	4.1	(3)	Form of the Registrant’s Common Stock Certificate

	4.2	(4)	Amended and Restated Investor Rights Agreement dated June 2, 2005

	4.3	(5)	Warrant issued to Silicon Valley Bank dated May 21, 2008

	4.4	(5)	Warrant issued to Oxford Finance Corporation dated May 21, 2008

	4.5	(5)	Warrant issued to Kingsbridge Capital Limited dated May 21, 2008

	4.6	(6)	Form of Warrant issued to certain Purchasers under the Securities Purchase Agreement dated July 2, 2009

	10.1	(1)	Form of Director and Executive Officer Indemnification Agreement

	10.2	#(1)	Director Compensation Policy

	10.3	#(4)	2004 Equity Incentive Award Plan and forms of option agreements thereunder

	10.4	#(7)	Amended and Restated 2005 Equity Incentive Award Plan

	10.5	#(8)	2005 Employee Stock Purchase Plan and form of Offering Document thereunder

	10.6	#(9)	2010 Incentive Plan

	10.7	#(10)	2011 Incentive Plan

	10.8	#(11)	Form of Amended and Restated Employment Agreement

	10.9	#(12)	Employment Agreement between the Registrant and Richard W. Pascoe dated August 7, 2008

	10.10	#(13)	Employment Agreement between the Registrant and Tran Nguyen dated April 12, 2010

	10.11	#(14)	Amendment to Employment Agreement between the Registrant and Tran Nguyen dated September 15, 2010

	10.12	#(15)	Form of Director Restricted Stock Unit Award Grant Notice and Restricted Stock Unit Award Agreement

	10.13	#(15)	Form of Employee Restricted Stock Unit Award Grant Notice and Restricted Stock Unit Award Agreement

	10.14	#(15)	Restricted Stock Unit Award Grant Notice and Restricted Stock Unit Award Agreement between the Registrant and David F. Hale dated November 28, 2008


Exhibit
Number			Description
	10.15	#(11)	Form of Restricted Stock Purchase Agreement

	10.16	#(11)	Restricted Stock Purchase Agreement between the Registrant and David F. Hale dated October 8, 2007

	10.17	(6)	Securities Purchase Agreement between the Registrant and the Purchasers identified therein dated July 2, 2009

	10.18	(14)	Amended and Restated License Agreement by and between the Registrant and ProCom One, Inc. dated September 15, 2010

	10.19	(4)	Common Stock Purchase Agreement by and among the Registrant, ProCom One, Inc. and Terrell A. Cobb dated April 15, 2004

	10.20	†(16)	Manufacturing Services Agreement between the Registrant and Patheon Pharmaceuticals Inc. dated February 1, 2006

	10.21	†(17)	Professional Detailing Services Agreement between the Registrant and Publicis Touchpoint Solutions, Inc. dated July 14, 2010

	10.22	†(18)	Supplement No. 1 to the Professional Detailing Services Agreement between the Registrant and Publicis Touchpoint Solutions, Inc. dated February 7, 2011

	10.23	†(19)	Co-Promotion Agreement between the Registrant and The Procter & Gamble Distributing Company, LLC dated August 24, 2010

	10.24	(20)	Loan and Security Agreement by and between the Registrant and Comerica Bank dated as of February 7, 2011

	10.25	(20)	LIBOR Addendum to Loan and Security Agreement by and between the Registrant and Comerica Bank dated as of February 7, 2011

	10.26	(21)	Agreement of Termination between the Registrant and BioTie Therapies Corp. dated March 12, 2009

	10.27	(22)	Separation Agreement between the Registrant and Susan E. Dubé dated April 14, 2009

	10.28	(22)	Separation Agreement between the Registrant and James J. L’Italien dated May 1, 2009

	10.29	(22)	Separation Agreement between the Registrant and Meg M. McGilley dated May 14, 2009

	10.30	(23)	Lease Agreement between the Registrant and PRII Gateway Torrey Hills LLC dated as of April 22, 2010

	10.31	(24)	Sublease between the Registrant and aAd Capital Management, L.P. dated April 22, 2009

	10.32	(24)	Sublease Amendment and Termination Agreement between the Registrant and Avnet, Inc. dated April 23, 2009


Exhibit
Number			Description
	23.1		Consent of PricewaterhouseCoopers LLP, independent registered public accounting firm

	31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14 and Rule 15d-14 of the Securities Exchange Act of 1934, as amended

	31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14 and Rule 15d-14 of the Securities Exchange Act of 1934, as amended

	32.1	*	Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003

	32.2	*	Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003


#		Indicates management contract or compensatory plan.

†		Confidential treatment has been granted as to certain portions, which portions have been omitted and filed separately with the Securities and Exchange Commission.

*		These certifications are being furnished solely to accompany this annual report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are not to be incorporated by reference into any filing of Somaxon Pharmaceuticals, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.

(1)		Filed with Amendment No. 3 to the Registrant’s Registration Statement on Form S-1 on November 30, 2005.

(2)		Filed with Registrant’s Current Report on Form 8-K on December 6, 2007.

(3)		Filed with Amendment No. 4 to the Registrant’s Registration Statement on Form S-1 on December 13, 2005.

(4)		Filed with the Registrant’s Registration Statement on Form S-1 on October 7, 2005.

(5)		Filed with Registrant’s Current Report on Form 8-K on May 22, 2008.

(6)		Filed with Registrant’s Current Report on Form 8-K on July 8, 2009.

(7)		Filed with Registrant’s Definitive Proxy Statement on April 30, 2009.

(8)		Filed with the Registrant’s Registration Statement on Form S-8 on December 15, 2005.

(9)		Filed with Registrant’s Current Report on Form 8-K on April 7, 2010.

(10)		Filed with Registrant’s Current Report on Form 8-K on February 14, 2011.

(11)		Filed with Registrant’s Annual Report on Form 10-K on March 12, 2008.

(12)		Filed with Registrant’s Current Report on Form 8-K on August 7, 2008.

(13)		Filed with Registrant’s Current Report on Form 8-K on April 14, 2010.

(14)		Filed with the Registrant’s Quarterly Report on Form 10-Q on November 10, 2010.

(15)		Filed with Registrant’s Annual Report on Form 10-K on March 13, 2009.

(16)		Filed with the Registrant’s Quarterly Report on Form 10-Q on May 11, 2006

(17)		Filed with Registrant’s Current Report on Form 8-K/A on July 21, 2010.

(18)		Filed with Registrant’s Current Report on Form 8-K/A on February 11, 2011.

(19)		Filed with Registrant’s Current Report on Form 8-K on August 25, 2010.

(20)		Filed with Registrant’s Current Report on Form 8-K on February 8, 2011.

(21)		Filed with Registrant’s Current Report on Form 10-Q on May 8, 2009.

(22)		Filed with Registrant’s Current Report on Form 10-Q on August 7, 2009.

(23)		Filed with Registrant’s Current Report on Form 8-K on April 28, 2010.

(24)		Filed with Registrant’s Current Report on Form 8-K on April 24, 2009.

SOMAXON PHARMACEUTICALS, INC.

INDEX TO FINANCIAL STATEMENTS


Report of Independent Registered Public Accounting Firm			F-1

Financial Statements

Balance Sheets			F-2

Statements of Operations			F-3

Statements of Cash Flows			F-4

Statements of Stockholders’ Equity and Comprehensive Loss			F-5

Notes to Financial Statements			F-6

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Somaxon Pharmaceuticals, Inc.

In our opinion, the accompanying balance sheets and the related statements of operations, of stockholders’ equity and comprehensive loss and of cash flows present fairly, in all material respects, the financial position of Somaxon Pharmaceuticals, Inc. at December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our audits (which were integrated audits for 2010 and 2008). We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PricewaterhouseCoopers LLP
San Diego, California

March 4, 2011

F-1

SOMAXON PHARMACEUTICALS, INC.

BALANCE SHEETS
(in thousands, except par value)


	December 31,
	2010			2009
ASSETS
Current assets
Cash and cash equivalents	$	21,008		$	5,165
Short-term investments		33,809			—
Accounts receivable, net		5,584			—
Inventory		991			—
Other current assets		1,882			409

Total current assets		63,274			5,574
Property and equipment, net		755			777
Intangibles, net		1,102			—
Other assets		—			60

Total assets	$	65,131		$	6,411


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	1,709		$	355
Accrued liabilities		5,699			1,815
Deferred revenue		3,459			—

Total current liabilities		10,867			2,170


Commitments and contingencies: (Notes 4 and 5)

Stockholders’ equity
Preferred stock, $0.0001 par value; 10,000 shares authorized, none issued and outstanding		—			—
Common stock and additional paid-in capital; $0.0001 par value; 100,000 shares authorized; 45,004 and 25,248 shares outstanding at December 31, 2010 and 2009, respectively		271,117			182,280
Accumulated deficit		(216,852	)		(178,039	)
Accumulated other comprehensive loss		(1	)		—

Total stockholders’ equity		54,264			4,241

Total liabilities and stockholders’ equity	$	65,131		$	6,411

The Accompanying Notes are an Integral Part of these Financial Statements

F-2

SOMAXON PHARMACEUTICALS, INC.

STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)


	Year ended December 31,
	2010			2009			2008
Net product sales	$	1,382		$	—		$	—
Cost of sales		244			—			—

Gross profit		1,138			—			—

Operating expenses
Selling, general and administrative		36,579			10,874			18,809
Research and development		3,566			4,337			16,546
License fees		—			(999	)		165

Total operating costs and expenses		40,145			14,212			35,520

Loss from operations		(39,007	)		(14,212	)		(35,520	)
Interest and other income		262			30			903
Interest and other expense		(68	)		(261	)		(2,610	)

Net loss	$	(38,813	)	$	(14,443	)	$	(37,227	)


Basic and diluted net loss per share	$	(1.16	)	$	(0.69	)	$	(2.04	)

Shares used to calculate net loss per share		33,593			20,952			18,281

The Accompanying Notes are an Integral Part of these Financial Statements

F-3

SOMAXON PHARMACEUTICALS, INC.

STATEMENTS OF CASH FLOWS
(in thousands)


	Year ended December 31,
	2010			2009			2008
Cash flows from operating activities
Net loss	$	(38,813	)	$	(14,443	)	$	(37,227	)
Adjustments to reconcile net loss to net cash used in operating activities:
Share-based expense		6,706			6,163			6,299
Depreciation and amortization		392			83			115
Amortization of investment discount or premium		132			(38	)		196
Accretion of debt discount and issuance costs		—			—			1,145
Loss on disposal of equipment and technology development costs		119			2			—
Changes in operating assets and liabilities
Accounts receivable		(5,584	)		—			—
Inventory		(991	)		—			—
Other current and non-current assets		(1,213	)		70			287
Accounts payable		1,354			(1,470	)		651
Accrued current liabilities		4,743			73			(581	)
Deferred revenue		3,459			—			—

Net cash used in operating activities		(29,696	)		(9,560	)		(29,115	)


Cash flows from investing activities
Purchases of property and equipment		(392	)		(74	)		(712	)
Payments for technology rights		(1,000	)		—			—
Payments for technology development costs		(200	)		—			—
Purchases of marketable securities		(46,457	)		(2,505	)		(13,090	)
Sales and maturities of marketable securities		12,317			5,639			34,296
Restricted cash		—			8,100			(7,500	)

Net cash (used in) provided by investing activities		(35,732	)		11,160			12,994


Cash flows from financing activities
Issue common stock, net of costs		77,556			5,732			—
Exercise of stock options		2,285			173			25
Exercise of warrants		1,474			1,475			—
Purchase of treasury stock		(44	)		—			(50	)
Repayment of debt		—			(15,000	)		—
Net proceeds from issuance of debt		—			—			14,777

Net cash provided by (used in) financing activities		81,271			(7,620	)		14,752

Increase (decrease) in cash and cash equivalents		15,843			(6,020	)		(1,369	)
Cash and cash equivalents at beginning of the period		5,165			11,185			12,554

Cash and cash equivalents at end of the period	$	21,008		$	5,165		$	11,185


Non-cash investing and financing activities
Common stock issued to settle severance obligation	$	860		$	—		$	—
Warrants related to Loan Agreement		—			44			922
Committed Equity Financing Facility Warrant		—			—			389

Supplemental cash flow information
Cash paid for interest	$	—		$	984		$	762

The Accompanying Notes are an Integral Part of these Financial Statements

F-4

SOMAXON PHARMACEUTICALS, INC.

STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS
(In thousands, except per share amounts)


	Common Stock and									Other
	Additional Paid-in									Accumulated
	Capital						Accumulated			Comprehensive
	# Shares			$ Amount			Deficit			Income (Loss)			Total
Balance at January 1, 2008		18,433		$	161,497		$	(126,369	)	$	48		$	35,176

Net loss		—			—			(37,227	)		—			(37,227	)
Unrealized loss on available-for-sale securities		—			—			—			(39	)		(39	)

Comprehensive loss		—			—			—			—			(37,266	)
Warrants issued pursuant to Loan Agreement		—			922			—			—			922
Warrants issued pursuant to the Committed Equity Financing Facility		—			389			—			—			389
Financing cost of Committed Equity Financing Facility Warrant		—			(389	)		—			—			(389	)
Exercise of stock options		8			25			—			—			25
Repurchase of restricted stock		(11	)		(50	)		—			—			(50	)
Share-based compensation		—			6,299			—			—			6,299

Balance at December 31, 2008		18,430			168,693			(163,596	)		9			5,106


Net loss		—			—			(14,443	)		—			(14,443	)
Unrealized loss on available-for-sale securities		—			—			—			(9	)		(9	)

Comprehensive loss		—			—			—			—			(14,452	)
Warrants issued pursuant to loan payoff		—			44			—			—			44
Issue common stock		5,106			5,732			—			—			5,732
Issue common stock pursuant to vesting of restricted stock units		166			—			—			—			—
Exercise of warrants for cash		1,277			1,475			—			—			1,475
Net share settlement of warrants		183			—			—			—			—
Exercise of stock options		116			173			—			—			173
Repurchase of restricted stock		(30	)		—			—			—			—
Share-based compensation		—			6,163			—			—			6,163

Balance at December 31, 2009		25,248			182,280			(178,039	)		—			4,241


Net loss		—			—			(38,813	)		—			(38,813	)
Unrealized loss on available-for-sale securities		—			—			—			(1	)		(1	)

Comprehensive loss		—			—			—			—			(38,814	)
Issue common stock		15,700			77,556			—			—			77,556
Issue common stock to settle severance obligations		111			860			—			—			860
Exercise of warrants for cash		1,278			1,474			—			—			1,474
Net share settlement of warrants		330			—			—			—			—
Exercise of stock options		1,610			2,285			—			—			2,285
Issue common stock pursuant to vesting of restricted stock units		738			—			—			—			—
Repurchase of restricted stock		(11	)		(44	)		—			—			(44	)
Share-based compensation		—			6,706			—			—			6,706

Balance at December 31, 2010		45,004		$	271,117		$	(216,852	)	$	(1	)	$	54,264

The Accompanying Notes are an Integral Part of these Financial Statements

F-5

SOMAXON PHARMACEUTICALS, INC.

Notes to Financial Statements

Note 1. Organization and Summary of Significant Accounting Policies

Business

Somaxon Pharmaceuticals, Inc. (“Somaxon”, “the Company”, “we”, “us” or “our”), is specialty pharmaceutical company focused on the in-licensing, development and commercialization of proprietary branded products and late-stage product candidates to treat important medical conditions where there is an unmet medical need and/or high-level of patient dissatisfaction, currently in the central nervous system therapeutic area. In March 2010, the U.S. Food and Drug Administration, or FDA, approved our New Drug Application, or NDA, for Silenor^® 3 mg and 6 mg tablets for the treatment of insomnia characterized by difficulty with sleep maintenance. Silenor was made commercially available by prescription in the United States in September 2010.

Capital Resources

Since inception, our operations have been financed primarily through the sale of equity securities and the proceeds from the exercise of warrants and stock options. We have incurred losses from operations and negative cash flows since inception, and we expect to continue to incur substantial losses for the foreseeable future as we continue our commercial activities for Silenor, commercialize any other products to which we obtain rights and potentially pursue the development of other product candidates. As a result, we may need to obtain additional funds to finance our operations in the future. Until we can generate significant cash from our operations, we intend to obtain any additional funding we require through strategic relationships, public or private equity or debt financings, assigning receivables or royalty rights, or other arrangements and we cannot assure such funding will be available on reasonable terms, or at all.

If we are unsuccessful in raising sufficient additional funds, our growth plans and our financial condition or results of operations could be materially adversely impacted, and we may be required to delay, scale-back or eliminate plans or programs relating to our business, relinquish some or all of our rights to Silenor, renegotiate less favorable terms with respect to such rights than we would otherwise choose or cease operating as a going concern. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our financial statements, and it is likely that investors will lose all or a part of their investment. These financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

Cash and Cash Equivalents

All highly liquid investments with maturities of three months or less at the time of purchase are considered to be cash equivalents. Investments with maturities at the date of purchase greater than three months are classified as marketable securities. At December 31, 2009, our cash and cash equivalents consisted primarily of money market funds. At December 31, 2010, our cash and cash equivalents consisted primarily of available-for-sale securities that have an original maturity date of three months or less. All of our cash equivalents have liquid markets and high credit ratings.

F-6

Marketable Securities

Our investments in marketable securities are classified as available-for-sale securities. Available-for-sale securities are carried at fair market value, with unrealized gains and losses reported as a component of stockholders’ equity in accumulated other comprehensive income/loss. Interest and dividend income is recorded when earned and included in interest income. Premiums and discounts on marketable securities are amortized and accreted, respectively, to maturity and included in interest income. Marketable securities with a maturity date of less than one year as of the balance sheet date are classified as short-term investments, and investments with a maturity of three months or less from date of purchase are classified as cash equivalents. Marketable securities with a maturity of more than one year as of the balance sheet date are classified as long-term investments. We assess the risk of impairment related to securities held in our investment portfolio on a regular basis and noted no impairment during the year ended December 31, 2010.

Concentration of Credit Risk, Significant Customers and Sources of Supply

Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments, and accounts receivable. We maintain accounts in federally insured financial institutions in excess of federally insured limits. We also maintain investments in money market funds and similar short-term investments that are not federally insured. However, management believes we are not exposed to significant credit risk due to the financial positions of the depository institutions in which these deposits are held and of the money market funds and other entities in which these investments are made. Additionally, we have established guidelines regarding the diversification of our investments and their maturities that are designed to maintain safety and liquidity.

We sell our product primarily to established wholesale distributors in the pharmaceutical industry.

The following table sets forth customers who represented 10% or more of our revenues for the years ended December 31, 2010, 2009 and 2008.


	Year ended December 31,
	2010			2009		2008

Integrated Commercialization Solutions, Inc.		100	%		—		—

All of the accounts receivable balance as of December 31, 2010 represents amounts due from one wholesale distributor. Credit is extended based on an evaluation of the customer’s financial condition. We evaluate the collectability of our accounts receivable based on a variety of factors, including the length of time the receivables are past due and the financial health of the customer, and we will use our historical experience in the future. Based upon the review of these factors, we did not record an allowance for doubtful accounts at December 31, 2010.

We rely on third-party manufacturers for the production of Silenor and single source third-party suppliers to manufacture key components of Silenor. If our third-party manufacturers are unable to continue manufacturing Silenor, or if we lost our single source suppliers used in the manufacturing process, we may not be able to meet market demand for our product.

Inventory

Our inventories are valued at the lower of cost (FIFO) or net realizable value. We analyze our inventory levels quarterly and write down inventory that has become obsolete or has a cost basis in excess of its expected net realizable value, as well as any inventory quantities in excess of expected requirements. We did not record a reserve for inventory as of December 31, 2010.

F-7

Intangible Assets

Our intangible assets consist of the costs incurred to in-license our product and technology development costs relating to our websites. Prior to the FDA approval of our NDA for Silenor, we had expensed all license fees and milestone payments for acquired development and commercialization rights to operations as incurred since the underlying technology associated with these expenditures related to our research and development efforts and had no alternative future use at the time. Costs related to our intellectual property are capitalized once technological feasibility has been established. Capitalized amounts are amortized on a straight line basis over the expected life of the intellectual property. Licenses fees began being amortized upon the first sales of Silenor to wholesalers in August 2010 and are being amortized over the expected life of the intellectual property, which we estimate to be approximately ten years. Costs incurred in the planning stage of a website are expensed, while costs incurred in the development stage are capitalized and will be amortized over the expected life of the product associated with the website once the asset is placed in service.

The carrying values of our intangible assets are periodically reviewed to determine if the facts and circumstances suggest that a potential impairment may have occurred. We had no impairment of our intangible assets for the year ended December 31, 2010.

Property and Equipment

Property and equipment is stated at cost less accumulated depreciation. Depreciation is accounted for using the straight-line method over the estimated useful life of the asset or the shorter of the lease term or the estimated useful life for leasehold improvements. Useful lives generally range from three years for computer equipment to five years for furniture, equipment and tooling.

Impairment of Long-Lived Assets

We assess the recoverability of our long-lived assets by determining whether the carrying value of such assets can be recovered through undiscounted future operating cash flows. If impairment is indicated, we measure the amount of such impairment by comparing the fair value to the carrying value. We did not consider our long-lived assets to be impaired as of December 31, 2010.

Revenue Recognition

We recognize product revenue from product sales when it is realized or realizable and earned. Revenue is realized or realizable and earned when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) our price to the buyer is fixed or determinable; and (4) collectability is reasonably assured. Revenue from sales transactions where the buyer has the right to return the product is recognized at the time of sale only if (1) our price to the buyer is substantially fixed or determinable at the date of sale, (2) the buyer has paid us, or the buyer is obligated to pay us and the obligation is not contingent on resale of the product, (3) the buyer’s obligation to us would not be changed in the event of theft or physical destruction or damage of the product, (4) the buyer acquiring the product for resale has economic substance apart from that provided by us, (5) we do not have significant obligations for future performance to directly bring about resale of the product by the buyer, and (6) the amount of future returns can be reasonably estimated.

We are unable to reliably estimate returns at this time. Therefore, we have determined that shipment of product to wholesale distributors does not meet the criteria for revenue recognition at the time of shipment. Until we are able to reliably estimate returns, we defer revenue recognition until the right of return no longer exists, which is the earlier of Silenor being dispensed through patient prescriptions or the expiration of the right of return. We estimate patient prescriptions dispensed using an analysis of third-party information. For the year ended December 31, 2010, we recognized product revenue of $1.4 million, which was net of estimated product sales discounts and allowances. At December 31, 2010, we had a deferred revenue balance of $3.5 million which was also recorded net of estimated product sales discounts and allowances. We have also deferred the related cost of product sales and recorded such amount as finished goods inventory held by others, which was $0.3 million as of December 31, 2010.

F-8

Product Sales Discounts and Allowances

Patient Discount Programs. We offer discount card programs to patients of Silenor under which the patient receives a discount on his or her prescription. We reimburse pharmacies for this discount through a third-party vendor. We estimate the total amount that will be redeemed based on the dollar amount of the discount, the timing and quantity of distribution and historical redemption rates. We accrued the discount and recognized a reduction of revenue. At December 31, 2010 and 2009, the accrual for patient discount programs was $182,000 and $0, respectively.

Distribution Service Fees. We pay distribution services fees to each wholesaler for distribution and inventory management services. We accrued for the fees based on contractually defined terms with each wholesaler and recognized a reduction of revenue. At December 31, 2010 and 2009, the accrual for distribution service fees was $276,000 and $0, respectively.

Chargebacks. We provide discounts to federal government qualified entities with whom we have contracted. These federal entities purchase products from the wholesalers at a discounted price, and the wholesalers then charge back to us the difference between the current retail price and the contracted price the federal entity paid for the product. We accrued chargebacks based on contract prices and sell-through sales data obtained from third party information. At December 31, 2010 and 2009, the accrual for chargebacks was $9,000 and $0, respectively.

F-9

Cost of Sales

Cost of sales includes the costs to manufacture, package, and ship Silenor, including personnel costs associated with manufacturing oversight, as well as royalties associated with our license agreement with ProCom One, Inc. (“ProCom”).

Share-Based Compensation Expense

Share-based expense for employees and directors is recognized in the statement of operations based on estimated amounts, including the grant date fair value, the probability of achieving performance conditions and the expected service period for awards with conditional vesting provisions. We estimate the grant date fair value for our stock option awards using the Black-Scholes valuation model which requires the use of multiple subjective inputs including estimated future volatility, expected forfeitures and the expected term of the stock option award. Our stock did not have a readily available market prior to our initial public offering in December 2005, creating a relatively short history from which to obtain data to estimate the volatility of our stock price. Consequently, we estimate expected future volatility based on a combination of both comparable companies and our own stock price volatility to the extent such history is available. The expected term for stock options is estimated using guidance provided by the Securities and Exchange Commission (“SEC”) in Staff Accounting Bulletin (“SAB”) No. 107 and SAB 110. This guidance provides a formula-driven approach for determining the expected term. Share-based compensation is based on awards expected to ultimately vest and has been reduced for estimated forfeitures. The estimated forfeiture rates may differ from actual forfeiture rates which would affect the amount of expense recognized during the period. Estimated forfeitures are adjusted to actual amounts as they become known.

We recognize the value of the portion of the awards that are ultimately expected to vest on a straight-line basis over the award’s requisite service period. The requisite service period is generally the time over which our share-based awards vest. Some of our share-based awards vested upon achieving certain performance conditions, generally pertaining to the commercial launch of Silenor or the achievement of other strategic objectives. Share-based compensation expense for awards with performance conditions is recognized over the period from the date the performance condition is determined to be probable of occurring through the time the applicable condition is met. If the performance condition is not considered probable of being achieved, no expense is recognized until such time the performance condition is considered probable of being met.

Income Taxes

Comprehensive Income (Loss)

Comprehensive income (loss) is net income (loss) plus certain other items that are recorded directly to stockholders’ equity, which for Somaxon consists of changes in unrealized gains and losses on marketable securities classified as available-for-sale. We report comprehensive income (loss) in the Statement of Stockholders’ Equity and Comprehensive Loss. In the event an available-for-sale security is sold prior to its maturity, the related unrealized gain or loss on the investment is recognized in the income statement on a specific identification basis. We did not have any realized gains or losses on sales of available-for-sale securities for the year ended 2010 and had insignificant realized gains and losses on sales of available-for-sale securities for each of the years ended 2009 and 2008.

Net Loss per Share

Basic earnings per share (“EPS”) excludes the effects of common stock equivalents. It is calculated by dividing net income or loss applicable to common stockholders by the weighted average number of common shares outstanding for the period, which is net of the weighted average number of unvested common shares outstanding that are subject to repurchase. Diluted EPS is computed in the same manner as basic EPS, but includes the effects of common stock equivalents to the extent they are dilutive, using the treasury-stock method. For Somaxon, basic and diluted EPS are equivalent because we incurred a net loss in all periods presented, causing any potentially dilutive securities to be anti-dilutive.

F-10

Net loss per share was determined as follows (in thousands, except per share amounts):


	Year ended December 31,
	2010			2009			2008
Numerator
Net loss	$	(38,813	)	$	(14,443	)	$	(37,227	)


Denominator
Weighted average common shares outstanding		33,615			21,077			18,427
Weighted average unvested common shares subject to repurchase		(22	)		(125	)		(146	)

Denominator for basic and diluted net loss per share		33,593			20,952			18,281

Basic and diluted net loss per share	$	(1.16	)	$	(0.69	)	$	(2.04	)


Weighted average anti-dilutive securities not included in diluted net loss per share
Weighted average stock options outstanding		3,566			4,496			4,234
Weighted average warrants outstanding		3,028			2,903			248
Weighted average restricted stock units outstanding		715			1,198			57
Weighted average unvested common shares subject to repurchase		22			125			146

Total weighted average anti-dilutive securities not included in diluted net loss per share		7,331			8,722			4,685

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-13 “Revenue Recognition,” which provides guidance on recognizing revenue in arrangements with multiple deliverables. This standard impacts the determination of when the individual deliverables included in a multiple element arrangement may be treated as a separate unit of accounting. It also modifies the manner in which the consideration received from the transaction is allocated to the multiple deliverables and no longer permits the use of the residual method of allocating arrangement consideration. This accounting standard is effective for the first year beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of ASU 2009-13 to have a material impact on our financial statements.

Note 2. Fair Value of Financial Instruments

Cash and investment holdings, accounts receivable, accounts payable and accrued liabilities are presented in the financial statements at their carrying amounts, which are reasonable estimates of fair value due to their short maturities.

The fair value of financial assets and liabilities is measured under a framework that establishes “levels” which are defined as follows: Level 1 fair value is determined from observable, quoted prices in active markets for identical assets or liabilities. Level 2 fair value is determined from quoted prices for similar items in active markets or quoted prices for identical or similar items in markets that are not active. Level 3 fair value is determined using the entity’s own assumptions about the inputs that market participants would use in pricing an asset or liability. The fair value of our investment holdings is summarized in the following tables (in thousands):


	December 31, 2010
	Total Fair		Fair Value Determined Under:
	Value		(Level 1)		(Level 2)		(Level 3)

Commercial paper	$	18,415	$	—	$	18,415	$	—
U.S. government agency securities		30,628		—		30,628		—

Total	$	49,043	$	—	$	49,043	$	—

F-11


	December 31, 2009
	Total Fair		Fair Value Determined Under:
	Value		(Level 1)		(Level 2)		(Level 3)

Money market funds	$	4,627	$	4,627	$	—	$	—

Total	$	4,627	$	4,627	$	—	$	—

Commercial paper and U.S. government agency securities are classified as part of either cash and cash equivalents or short-term investments in the balance sheets. The carrying value of short-term investments consisted of the following as of December 31, 2010 (in thousands):


	Amortized		Unrealized		Unrealized			Fair Market
	Cost		Gains		Losses			Value
Commercial paper	$	18,415	$	—	$	—		$	18,415
U.S. government agency securities		30,629		2		(3	)		30,628

Total	$	49,044	$	2	$	(3	)	$	49,043

Available-for-sale marketable securities with maturities of three months or less from date of purchase have been classified as cash equivalents, and amounted to $15.2 million as of December 31, 2010. As of December 31, 2009, we did not hold any available-for-sale marketable securities.

Note 3. Composition of Certain Balance Sheet Items

Accounts Receivable

Accounts receivable, net consisted of the following (in thousands):


	December 31,
	2010			2009
Accounts receivable for product sales, gross	$	5,975		$	—
Allowances for discounts		(391	)		—

Total accounts receivable	$	5,584		$	—

Inventory

Inventory consisted of the following (in thousands):


	December 31,
	2010		2009
Raw materials	$	45	$	—
Work in process		162		—
Finished goods inventory held by the Company		515		—
Finished goods inventory held by others		269		—

Total inventory	$	991	$	—

Other Current Assets

Other current assets consisted of the following (in thousands):


	December 31,
	2010		2009
Deposits and other prepaid expenses	$	641	$	352
Prepaid sales and marketing expenses		529		—
Other miscellaneous receivable		274		—
Interest receivable		206		—
Other current assets		232		57

Total other current assets	$	1,882	$	409

F-12

Property and Equipment

Property and equipment consisted of the following (in thousands):


	December 31,
	2010			2009
Tooling	$	832		$	772
Computer equipment		354			147
Furniture and equipment		66			58

Property and equipment, at cost		1,252			977
Less: accumulated depreciation		(497	)		(200	)

Property and equipment, net	$	755		$	777

Depreciation expense was $347,000, $83,000 and $115,000 for the years ended 2010, 2009 and 2008, respectively.

Intangible Assets

Intangible assets consisted of the following (in thousands):


	December 31,
	2010			2009
License fees	$	1,000		$	—
Technology development costs relating to websites		147			—
Less: accumulated amortization		(45	)		—

Total intangible assets, net	$	1,102		$	—

Amortization expense was $45,000 for the year ended 2010 and $0 for the years ended 2009 and 2008. We estimate the aggregate amortization expense for the next five years to be $120,000 per year.

Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):


	December 31,
	2010		2009
Accrued fees and royalties	$	1,566	$	—
Accrued compensation and benefits		1,329		156
Accrued severance		293		1,659
Accrued liability to third party sales organization		842		—
Accrued product discounts and allowances		473		—
Other accrued expenses		1,196		—

Total accrued liabilities	$	5,699	$	1,815

From March through May 2009, we terminated the employment of thirteen employees as part of a general cost reduction initiative resulting from ongoing delays in the Silenor NDA approval process. Each of the terminated employees entered into a separation agreement and a separate consulting arrangement with us. We paid $513,000 to these former employees during 2009 under these separation agreements, and had a remaining deferred severance obligation of $1,659,000 as of December 31, 2009. During 2010, we settled $860,000 of this deferred severance obligation through the issuance of common stock and paid $506,000 to these former employees. The remaining deferred severance obligation was settled in January 2011.

F-13

Note 4. License Agreements

In August 2003, we entered into an exclusive worldwide in-license agreement with ProCom to develop and commercialize Silenor for the treatment of insomnia. This agreement was amended and restated in September 2010. The term of the license extends until the last licensed patent expires, which is expected to occur no earlier than 2020. The license agreement is terminable by us at any time with 30 days notice if we believe that the use of the product poses an unacceptable safety risk or if it fails to achieve a satisfactory level of efficacy. Either party may terminate the agreement with 30 days notice if the other party commits a material breach of its obligations and fails to remedy the breach within 90 days, or upon the filing of bankruptcy, reorganization, liquidation, or receivership proceedings. Costs related to the licensed intellectual property made after approval of the Silenor NDA by the FDA in March 2010 have been capitalized and included in intangibles in our balance sheet as of December 31, 2010. Capitalized amounts are amortized on a straight line basis over the expected life of the intellectual property which we estimate to be approximately 10 years. Royalty payments due under the terms of the agreement are recorded in accrued liabilities as of December 31, 2010. The royalty payments will be recognized as an expense in cost of sales when the related shipments of product are recognized as revenue.

In October 2006, we entered into a supply agreement pertaining to a certain ingredient used in the formulation for Silenor. In August 2008, this supply agreement was amended to provide us with the exclusive right to use this ingredient in combination with doxepin. Pursuant to the amendment, we are obligated to pay a royalty on worldwide net sales of Silenor beginning as of the expiration of the statutory exclusivity period for Silenor in each country in which Silenor is marketed. Such royalty is only payable if one or more patents under the license agreement continue to be valid in each such country and a patent relating to our formulation for Silenor has not issued in such country.

Note 5. Commitments and contingencies

Commitments

In July 2010, we entered into a professional detailing services agreement with Publicis Touchpoint Solutions, Inc. (“Publicis”), under which Publicis will provide sales support to promote Silenorin the U.S. through 110 full-time sales representatives, one regional field coordinator and one national business director, all of whom will be employees of Publicis. We will recognize the revenue from Silenor product sales generated by the promotional efforts of the sales organization. Under the terms of the agreement, we were required to pay a one-time start up fee, and we are required to pay a fixed monthly fee, which is subject to certain quarterly adjustments based on actual staffing and spending levels. During the term of the agreement, a portion of Publicis’ management fee will be subject to payment by us only to the extent that specified performance targets are achieved. The performance targets relate to initial scale-up activities, turnover and vacancy rates, call attainment and specified sales goals. In addition, we are obligated to reimburse the sales organization for approved pass-through costs, which primarily include bonuses, meeting and travel costs and certain administrative expenses.

The services agreement has an initial two-year term, and may be extended by us by providing Publicis with written notification no later than 90 days prior to the expiration of the initial term, subject to agreement on compensation terms with Publicis. Prior to the first anniversary of the deployment of Publicis’ sales representatives, we have the right to terminate the services agreement upon 90 days written notice and payment to Publicis of a termination fee in a specified amount. We have the right to terminate the services agreement upon 90 days written notice after the one year anniversary of the deployment of Publicis’ sales representatives without paying a termination fee. We may also terminate the services agreement without paying a termination fee by hiring a specified number of sales representatives. In addition, either party may terminate the services agreement upon an uncured material breach by the other party, upon the bankruptcy or insolvency of the other party or if a change in law renders the performance of a material obligation of the services agreement unlawful. If termination occurs during the initial two-year term, we assume financial responsibility for the remaining lease payments for the sales representatives’ vehicles which have a two-year lease term.

We entered into an amended and restated agreement with Publicis in February 2011, as discussed in Note 11 “Subsequent Events”.

F-14

In August 2010, we entered into a co-promotion agreement with P&G under which P&G will provide sales support to promote Silenor in the U.S. through its team of full-time sales representatives. Beginning in January 2011, P&G will also provide certain managed care support services. We will recognize the revenue from Silenor product sales generated by the promotional efforts of P&G. Under the terms of the agreement, we are required to pay P&G a fixed fee and a royalty fee as a percentage of U.S. net sales, in each case on a quarterly basis during the term of the agreement. The fees are recognized as a sales, general, and administrative expense and are recorded in accrued liabilities as of December 31, 2010. The agreement also provides for financial penalties in the event that either party fails to deliver specified minimum detailing requirements under certain circumstances. Each party will be responsible for the costs of training, maintaining and operating its own sales force, and we are responsible for all other costs pertaining to the commercialization of Silenor.

The term of the agreement is from August 2010 through December 2012, and we will pay P&G a reduced royalty fee based on U.S. net sales of Silenor for one year after the expiration of the agreement or its earlier termination under certain circumstances. Beginning as of June 30, 2012, the parties will discuss in good faith the continuation of the collaboration upon mutually-agreed terms and conditions. We have the right to terminate the agreement upon 90 days written notice if P&G fails to provide at least 75% of its minimum detailing obligations. Beginning October 1, 2011, P&G may cure such shortfall for a calendar quarter one time each calendar year during the calendar quarter immediately following such shortfall. Either party may terminate the agreement upon 90 days written notice to the other party, although no such termination may be effective prior to December 31, 2011. P&G may terminate the agreement if Silenor is withdrawn from the market for longer than three months as the result of a legal requirement or 30 days after the end of a calendar quarter in which the market share for Silenor is less than 75% of the Silenor market share immediately prior to the loss of Silenor’s market exclusivity in the U.S. In addition, either party may terminate the agreement upon a large scale recall or withdrawal of Silenor from the U.S. resulting from a significant safety risk that is not due to tampering, a remediable manufacturing problem or other defect that can be cured after such risk is discovered. Either party may also terminate the agreement upon an uncured material breach by the other party, upon the bankruptcy or insolvency of the other party or a force majeure event that lasts for at least six months.

We have contracted with various consultants, drug manufacturers, wholesalers, and other vendors to assist in clinical trial work, data analysis, and commercialization activities for Silenor. The contracts are terminable at any time, but obligate us to reimburse the providers for any time or costs incurred through the date of termination. At December 31, 2010, we had $2.3 million of non-cancellable purchase orders outstanding.

We have employment agreements with certain of our current employees that provide for severance payments and accelerated vesting for certain share-based awards if their employment is terminated under specified circumstances.

Leasing arrangements

In April 2010, we entered into a new lease arrangement to rent approximately 6,000 square feet of office space for 12 months beginning on May 1, 2010 for a monthly rental of $18,000 plus other pass-through charges. Rent expense for 2010, 2009, and 2008 was $178,000, 88,000, and $1,371,000, respectively.

Litigation

In November 2010, we received a notice from each of Actavis Elizabeth LLC and Mylan Pharmaceuticals Inc. that each has filed with the FDA an Abbreviated New Drug Application (“ANDA”) for a generic version of Silenor 3 mg and 6 mg tablets. The notices each included a “paragraph IV certification” with respect to seven of the eight patents listed in the FDA’s Approved Drug Products with Therapeutic Equivalence Evaluations, commonly known as the Orange Book, for Silenor. A paragraph IV certification is a certification by a generic applicant that in the opinion of that applicant, the patent(s) listed in the Orange Book for a branded product are invalid, unenforceable, and/or will not be infringed by the manufacture, use or sale of the generic product.

F-15

On December 15, 2010, we, together with ProCom, filed suit in the United States District Court for the District of Delaware against each of Actavis Elizabeth LLC and Actavis Inc. (collectively, “Actavis”), and Mylan Pharmaceuticals Inc. and Mylan, Inc., (collectively, “Mylan”). The lawsuit alleges that Actavis and Mylan have each infringed U.S. Patent No. 6,211,229 by filing ANDAs seeking approval from the FDA to market generic versions of Silenor 3 mg and 6 mg tablets prior to the expiration of this patent. Pursuant to the provisions of the Hatch-Waxman Act, FDA final approval of each of the Actavis and Mylan ANDAs can occur no earlier than May 3, 2013, unless there is an earlier court decision that the ‘229 patent is not infringed and/or invalid or unless any party to the action is found to have failed to cooperate reasonably to expedite the infringement action. At this time, other patents listed in the Orange Book for Silenor have not been asserted against either Mylan or Actavis.

On December 23, 2010, we received a notice from Par Pharmaceuticals, Inc. that it has filed with the FDA an ANDA for a generic version of Silenor 3 mg and 6 mg tablets. This notice included a “paragraph IV certification” with respect to seven of the eight patents listed in the Orange Book for Silenor.

We filed suit against Par in February 2011 as discussed in Note 11 “Subsequent Events”.

We intend to vigorously enforce our intellectual property rights relating to Silenor, but cannot predict the outcome of these matters.

Note 6. Stockholders’ Equity

Public Offerings of Common Stock

In March 2010, we issued 6,900,000 shares of common stock in a public offering of our stock. The net proceeds from the offering, after underwriting discounts and commissions and offering costs of $4,180,000, were approximately $52,745,000.

In November 2010, we issued 8,800,000 shares of common stock in a public offering of our stock. The net proceeds from the offering, after underwriting discounts and commissions and offering costs of $1,149,000, were approximately $24,811,000.

Private Placement of Common Stock

In July 2009, we issued in a private placement 5,106,000 shares of common stock at $1.05 per share and warrants to purchase up to 5,106,000 shares of common stock at $0.125 per share for aggregate combined gross proceeds of $6,000,000. Net proceeds from the offering were $5,732,000 after deducting financing costs of $268,000. The warrants have seven-year terms, an exercise price of $1.155, are immediately exercisable, and expire in July 2016. The warrants do not include a net cash settlement provision or any other provisions that would create liability classification and are included in stockholders’ equity. In connection with the private placement, we filed a registration statement with the SEC for the resale of both the shares of common stock purchased by the investors and the shares of common stock issuable upon exercise of the warrants. The resale registration statement was declared effective by the SEC in August 2009. We also agreed to other customary obligations regarding registration, including matters relating to indemnification, maintenance of the registration statement and payment of expenses.

We may be liable for liquidated damages if we do not maintain the effectiveness of the registration statement or the listing of its common stock on the Nasdaq Capital Market, the Nasdaq Global Market, the New York Stock Exchange or the American Stock Exchange, in each case for a period of ten consecutive days or for more than thirty days in any 365-day period. The amount of the liquidated damages is one percent per applicable ten or thirty day period, subject to an aggregate maximum of eight percent per calendar year, of the aggregate purchase price of the common stock purchased in the private placement then held by each investor that are registrable securities. We do not believe it is probable that it will be required to pay liquidated damages and have not recognized any amounts in the financial statements related to such potential liquidated damages.

F-16

Warrants

At December 31, 2010, we have warrants outstanding to purchase 2,417,632 shares of our common stock. These warrants are immediately exercisable, have remaining terms of three to eight years, exercise prices ranging from $1.155 to $5.4175 per share, and a weighted average exercise price of $1.41 per share.

Preferred Stock

Concurrent with our initial public offering in December 2005, 10,000,000 shares of preferred stock were authorized, none of which have been issued or are outstanding as of December 31, 2010.

Note 7. Share-Based Compensation

We have issued and intend to continue to issue stock options, restricted stock units (“RSUs”) and restricted stock awards under our equity incentive award plans. We have equity awards outstanding under both our 2004 Equity Incentive Award Plan (the “2004 Plan”) and our 2005 Equity Incentive Award Plan (the “2005 Plan”). During 2010, we had the following types of equity awards outstanding:

•

Stock Options: Stock options generally have ten-year terms and vest over a period of between one and four years and are service-based. The exercise price for our stock options is generally equal to the closing stock price at the date of grant.

•

Restricted Stock Units: RSUs, which are convertible into an equivalent number of shares of common stock upon vesting, have been granted to employees and members of our board of directors. The majority of our outstanding RSUs vested during 2010 upon achieving certain criteria relating to matters such as approval of the NDA for Silenor by the FDA and the commercialization of Silenor.

•

Restricted Stock: All of our restricted stock awards were initially granted to employees and members of our board of directors, but certain former employees continued to vest in their restricted stock awards under consulting agreements entered into upon termination of their employment. All of our restricted stock vested during 2010.

We issue equity awards under our 2005 Plan. The 2005 Plan contains an “evergreen provision” that allows annual increases in the number of shares available for issuance on the first day of each year through January 1, 2015 in an amount equal to the lesser of: (i) 2,000,000 shares, (ii) 5% of the outstanding capital stock on each January 1, or (iii) an amount determined by our board of directors. As of December 31, 2010, an aggregate of 2,131,000 shares of common stock were authorized and available for issuance under the 2005 Plan. Under the evergreen provision, on January 1, 2011, an additional 2,000,000 shares became available for issuance under the 2005 Plan.

We also have an employee stock purchase plan (“ESPP”) which allows employees to contribute up to 20% of their cash earnings, subject to certain maximums, to be used to purchase shares of our common stock on each semi-annual purchase date. The purchase price is equal to 95% of the market value per share on each purchase date. Our ESPP is non-compensatory pursuant to the provisions of generally accepted accounting principles for share-based compensation expense. The ESPP contains an “evergreen provision” with annual increases in the number of shares available for issuance on the first day of each year through January 1, 2015 equal to the lesser of: (i) 300,000 shares, (ii) 1% of the outstanding capital stock on each January 1, or (iii) an amount determined by our board of directors. As of December 31, 2010, an aggregate of 1,102,000 shares of common stock were authorized and available for issuance under the ESPP. Under the evergreen provision, on January 1, 2011, an additional 300,000 shares were authorized under our ESPP. No shares have been issued under the ESPP through December 31, 2010.

Share-Based Compensation Expense

The following table summarizes share-based compensation expense recognized in 2010, 2009, and 2008:


	Year ended December 31,
	2010		2009		2008
Share-based compensation expense included in selling, general and administrative expense	$	5,412	$	4,637	$	4,254
Share-based compensation expense included in research and development expense		1,294		1,526		2,045

Total share-based compensation expense	$	6,706	$	6,163	$	6,299

F-17

Included in the table for 2009 is the effect of the termination of employment for certain individuals which created an acceleration of share-based compensation expense. During 2009, fifteen employees ceased employment and entered into a consulting agreement with us. Also, in 2009 upon separation from the Company, certain individuals received accelerated vesting of their share-based awards. As a result of such non-substantive consulting arrangements and accelerated vesting, we recognized $2,360,000 of share-based compensation expense during 2009 on the dates of termination.

The table above also includes compensation costs of $658,000 in 2009 from our one-time stock option exchange program that was completed in June 2009. Under the program, employees and directors as of March 1, 2009 were eligible to exchange their stock options having exercise prices above $1.00 for the grant of a lesser number of replacement awards having an exercise price of $1.23. In total, 4,320,000 stock options were tendered in exchange for 2,880,000 replacement awards. One-third of the replacement awards vested upon grant and the remaining two-thirds vest in equal monthly installments over the following two year period such that all the shares will be fully vested in June 2011, subject to the participant’s continued service.

Stock Options

We use the Black-Scholes model to estimate the grant date fair value of stock options. To calculate these fair values, the following assumptions were used:

Year Ended December 31,

2010

2009

2008

Risk free interest rate

2.5% to 3.0%

1.9% to 2.9%

2.6% to 3.6%

Expected term

5.25 to 6.25 years

Expected volatility

86% to 88%

74% to 84%

64% to 74%

Weighted average volatility

87%

78%

69%

Expected dividend yield

Fair value of underlying stock

$2.69 to $8.59

$1.17 to $2.18

$0.98 to $4.93

Weighted average fair value of stock options granted

$4.89

$1.19

$2.85

The following table summarizes our stock options as of December 31, 2010 and the activity for the year then ended (share and dollar amounts in thousands, except per-share exercise prices):


						Weighted
				Weighted		Average		Aggregate
				Average		Contractual		Intrinsic Value
	Shares			Exercise Price		Term (in years)		(in thousands)
Outstanding at December 31, 2009		3,828		$	1.45
Granted		1,591			6.58
Exercised		(1,610	)		1.45			$	5,883
Forfeited		(427	)		1.48

Outstanding at December 31, 2010		3,382		$	3.86		8.3	$	3,200


Vested and exercisable at December 31, 2010		1,574		$	1.66		7.48	$	2,637

The intrinsic value of an equity award is the difference between the fair value of the underlying stock and its exercise price. If the exercise price equals or exceeds the fair value of the underlying stock, then the award is considered to have a zero intrinsic value. The following table summarizes certain information for options (in thousands).


	Year ended December 31,
	2010		2009		2008
Fair value of vested stock options	$	1,563	$	—	$	20
Intrinsic value of exercised stock options	$	5,883	$	225	$	8

F-18

Unrecognized compensation expense related to non-vested stock options totaled $7.1 million as of December 31, 2010. Such compensation expense is expected to be recognized over a weighted-average period of 1.65 years.

We did not realize any tax benefits from option exercises during 2010, 2009 and 2008.

Restricted Stock Units and Awards

Restricted Stock Units — The following table summarizes our restricted stock units as of December 31, 2010 and the activity during the year then ended (share numbers in thousands):


	Employee and Director
	Awards
				Weighted
				Average
				Grant Date		Consultant			Total
				Fair Value		Awards			Awards
	# Shares			per Share		# Shares			# Shares
December 31, 2009		740		$	0.87		107			847
Granted		187			8.55		—			187
Vested		(679	)		1.56		(59	)		(738	)
Forfeited		(123	)		0.96		(48	)		(171	)

December 31, 2010		125		$	8.52		—			125

The intrinsic value of an RSU is equal to our stock price. The intrinsic value of vested RSUs was $2,161,000, $235,000, and zero during 2010, 2009, and 2008, respectively. The weighted average grant date fair value per share for RSUs granted in 2009 and 2008 was $1.28 and $1.21, respectively. Unrecognized compensation expense related to non-vested RSUs totaled $0.7 million as of December 31, 2010. Such compensation expense is expected to be recognized over a weighted-average period of 1.42 years.

Restricted Stock Awards — At December 31, 2009, there were 60,000 nonvested restricted stock awards for employees and directors and 45,000 nonvested restricted stock awards for consultants. The weighted average grant date fair value per share, which is used in recording share-based compensation expense for employees and directors, was $11.40 for nonvested restricted stock awards as of December 31, 2009. (Share-based expense for consultant awards is measured using the stock price at the date of vesting and therefore there is no weighted average grant date fair value per share.) During 2010, all of these outstanding restricted stock awards vested, resulting in compensation expense of $861,000. In connection with the settlement of the tax obligations associated with the vesting of these awards, certain shareholders surrendered 11,000 shares with a fair value of $44,000. At December 31, 2010, we do not have any non-vested restricted stock awards outstanding. The intrinsic value of restricted stock is equal to our stock price. The intrinsic value of vested restricted stock awards was $414,000, zero, and $210,000 in 2010, 2009, and 2008, respectively.

Note 8. Income taxes

We have incurred losses since inception, so no current income tax provision or benefit has been recorded. Significant components of our net deferred tax assets are shown in the table below (amounts are in thousands).


	December 31,
	2010			2009
Deferred Tax Assets:
Net operating loss carryforwards	$	71,038		$	56,657
Research and development credits		4,752			4,738
Capitalized research and development		360			495
Non-cash compensation expense		3,270			6,607
Other, net		1,982			922

Total deferred tax assets		81,402			69,419
Valuation allowance		(81,402	)		(69,419	)

Net deferred tax assets	$	—		$	—

F-19

At December 31, 2010, we had generated federal net operating loss carryforwards of $181,843,000 and state net operating loss carryforwards of $176,628,000 on the respective tax return bases. We have generated windfall tax benefits from the settlement of certain share-based awards. These tax benefits have not been reflected in the table of deferred tax assets presented above since the tax deduction increases our net operating loss carryforward and does not result in a cash tax savings in the current year. The tax benefit will be recorded as a credit to additional paid-in capital in the year the deduction reduces income taxes payable. However, the net operating loss carryforwards related to these windfall tax benefits of approximately $1,199,000 are included in the federal and state net operating loss carryforward amounts of $181,843,000 and $176,628,000, respectively. Unless previously utilized, the federal and state tax loss carryforwards will begin to expire in 2023 and 2013, respectively.

We have federal and state research and development tax credit carryforwards at December 31, 2010 of $4,282,000 and $1,954,000, respectively. The federal research and development credits will begin to expire in 2024 and the state research and development credits do not expire.

Pursuant to Sections 382 and 383 of the Internal Revenue Code (“IRC”), annual use of our net operating loss and credit carryforwards may be limited in the event a cumulative change in ownership of more than 50% occurs within a three-year period. We determined that such an ownership change occurred as of March 31, 2010 as defined in the provisions of Section 382 of the IRC as a result of various stock issuances used to finance our operations. Such ownership change resulted in annual limitations on the utilization of tax attributes, including net operating loss carryforwards and tax credits.

We have not performed a Section 382 analysis since March 31, 2010. There is a risk that additional changes in ownership could have occurred since that date. If a change in ownership were to have occurred, additional net operating loss carryforwards and research and development credit carryovers could be eliminated or restricted. If eliminated, the related asset would be removed from the deferred tax asset with a corresponding reduction in the valuation allowance.

The following table provides a reconciliation between income taxes computed at the federal statutory rate and our provision for income taxes (amounts are in thousands):


	Year Ended December 31,
	2010			2009			2008
Federal income taxes at 34%	$	(13,231	)	$	(4,911	)	$	(12,657	)
State income taxes, net of federal benefit		(1,779	)		(15	)		(2,246	)
Research and development credits		—			(116	)		(517	)
Share-based compensation expense		(1,741	)		5,069			552
Tax effect of non-deductible expenses and credits		44			(3	)		(7	)
Increase in valuation allowance		16,707			(24	)		14,875

Provision for income taxes	$	—		$	—		$	—

Income tax accounting and reporting may contain uncertain income tax positions. The accounting for uncertain income taxes recognized in an entity’s financial statements requires a recognition threshold and measurement of uncertain tax positions taken or expected to be taken on a tax return. The impact of an uncertain income tax position on the income tax return is recognized at the largest amount that is cumulatively more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.

The following table summarizes our unrecognized tax benefit activity (amounts are in thousands):


	Year Ended December 31,
	2010		2009
Unrecognized tax benefits at the beginning of the year	$	910	$	877
Gross decreases related to prior year tax positions		0		0
Gross increases related to current year tax positions		0		33
Settlements		None		None
Lapse of statute of limitations		None		None

Unrecognized tax benefits at year end	$	910	$	910

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The unrecognized tax benefits have been recorded as a reduction of the related deferred tax asset. Because our deferred tax assets are fully reserved, none of the amount included in the balance of unrecognized tax benefits would affect the effective tax rate if recognized. We are subject to taxation in each of the jurisdictions in which we operate. We are currently not under examination by the Internal Revenue Service or any other taxing authority. Our tax years from inception in 2003 and forward can be subject to examination by the tax authorities due to the carryforward of net operating losses and research and development credits. Our accounting policy is to record interest and penalties related to unrecognized tax benefits in income tax expense. No interest or penalties have been accrued as of December 31, 2010.

Note 9. Related Party Transactions

We have in-licensed certain intellectual property from ProCom (see Note 3, “License Agreements”). As part of the license agreement, ProCom has the right to designate one nominee for election to our board of directors. ProCom designated Terrell A. Cobb, a principal of ProCom, for nomination as a member of our board of directors. In 2010, we paid ProCom $1,000,000 for license fees and $235,000 for royalty payments pursuant to the terms of this agreement. At December 31, 2010, $16,000 is recorded in accrued liabilities for ProCom royalty payments.

The license agreement also provided a consulting arrangement for Mr. Cobb and Dr. Neil Kavey, who is the other principal of ProCom. Under the consulting agreements, we paid an aggregate of $59,000, $135,000, and $170,000 for consulting services for the years ended 2010, 2009 and 2008, respectively. Pursuant to the consulting arrangements, payments ceased for Mr. Cobb in April 2008. Payments to Dr. Kavey under that consulting arrangement ended in April 2010 and a subsequent consulting agreement was entered into which terminates in September 2011.

Mr. Cobb and Dr. Kavey have an aggregate of 134,000 stock options outstanding of which 116,000 were vested as of December 31, 2010. The weighted average exercise price of the outstanding options was $3.70 and the weighted average exercise price of the vested stock options was $3.86. None of the stock options had been exercised as of December 31, 2010. In addition, 49,000 RSUs granted to Mr. Cobb vested in 2010 in connection with the first commercial sale of Silenor in the United States.

In July 2009, we raised $6,000,000 through a private placement of 5,106,000 shares of our common stock and seven-year warrants to purchase up to 5,106,000 additional shares of our common stock. Among the investors in the private placement were: (1) a trust of which Kurt von Emster, a member of our board of directors, is a trustee and beneficiary; (2) investment funds affiliated with Jesse I. Treu, Ph.D., a member of our board of directors through June 2010, and (3) investment funds affiliated with Kurt C. Wheeler, a member of our board of directors through March 2010.

Note 10. Selected Quarterly Financial Information (Unaudited)

The following table presents our unaudited quarterly results of operations for 2010 and 2009 (in thousands, except per share data). The sum of the quarterly per share amounts may not equal the amounts presented for the full year due to differences in the weighted average number of shares outstanding as calculated on a quarterly compared to an annual basis.


	First Quarter			Second Quarter			Third Quarter			Fourth Quarter			Year
2010:
Net product sales	$	—		$	—		$	38		$	1,344		$	1,382
Gross profit	$	—		$	—		$	35		$	1,103		$	1,138
Loss from operations	$	(4,165	)	$	(5,716	)	$	(12,902	)	$	(16,224	)	$	(39,007	)
Net loss	$	(4,165	)	$	(5,721	)	$	(12,900	)	$	(16,027	)	$	(38,813	)
Basic and diluted net loss per share	$	(0.16	)	$	(0.16	)	$	(0.37	)	$	(0.42	)	$	(1.16	)

2009:
Net product sales	$	—		$	—		$	—		$	—		$	—
Gross profit	$	—		$	—		$	—		$	—		$	—
Loss from operations	$	(4,308	)	$	(6,138	)	$	(1,845	)	$	(1,921	)	$	(14,212	)
Net loss	$	(4,544	)	$	(6,137	)	$	(1,843	)	$	(1,919	)	$	(14,443	)
Basic and diluted net loss per share	$	(0.25	)	$	(0.33	)	$	(0.08	)	$	(0.08	)	$	(0.69	)

F-21

Note 11. Subsequent Events

Loan Agreement

On February 7, 2011, we entered into a loan agreement with Comerica, pursuant to which we may request advances in an aggregate outstanding amount not to exceed $15.0 million. The revolving loan bears interest at a variable rate of interest, per annum, at our option of either LIBOR plus 3.00% or Comerica’s prime rate plus 0.50%, which as of February 2011 was 3.75%. Interest payments on advances made under the loan agreement are due and payable in arrears on the first business day of each month during the term of the loan agreement. Amounts borrowed under the loan agreement may be repaid and re-borrowed at any time prior to February 7, 2013, subject to certain conditions. Once we have two consecutive quarters of profitability, the amounts we borrow are limited to a percentage of our accounts receivable. There is a non-refundable unused commitment fee equal to 0.25% per annum on the difference between the amount of the revolving line and the average daily balance outstanding thereunder during the term of the loan agreement, payable quarterly in arrears. The loan agreement will remain in full force and effect for so long as any obligations remain outstanding or Comerica has any obligation to make credit extensions under the loan agreement.

Amended and Restated Supplement with Publicis

On February 7, 2011 we entered into an amended and restated agreement with under which Publicis will recruit and deploy for us an additional 35 sales representatives that will exclusively promote Silenor, as well as one additional regional field coordinator. In consideration for Publicis’ services under the Publicis agreements, we paid Publicis a portion of the fees for the start-up and additional recruiting phases of the engagements upon signing and the remainder upon completion of the applicable services. We also pay Publicis a fixed monthly fee, which fee is subject to certain quarterly adjustments based on actual staffing levels. During the term of the Publicis agreements, a portion of Publicis’ management fee is subject to payment by us only to the extent that specified performance targets are achieved. The performance targets relate to initial scale-up and recruiting activities, turnover and vacancy rates, call attainment and specified sales goals. In addition, we are obligated to reimburse the sales organization for approved pass-through costs, which primarily include bonuses, meeting and travel costs and certain administrative expenses.

Litigation

On February 2, 2011, we together with Pro Com One, Inc., filed suit in the United States District Court for the District of Delaware against Par Pharmaceutical, Inc. and Par Pharmaceutical Companies, Inc. (collectively, “Par”). The lawsuit alleges that Par has infringed U.S. Patent No. 6,211,229 by filing an ANDA seeking approval from the FDA to market generic versions of Silenor 3 mg and 6 mg tablets prior to the expiration of this patent. Pursuant to the provisions of the Hatch-Waxman Act, FDA final approval of the Par ANDA can occur no earlier than June 23, 2013, unless there is an earlier court decision that the ‘229 patent is not infringed and/or invalid or unless any party to the action is found to have failed to cooperate reasonably to expedite the infringement action. At this time, other patents listed in the Orange Book for Silenor have not been asserted against Par. We intend to vigorously enforce our intellectual property rights relating to Silenor, but cannot predict the outcome of this matter.

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Pernix Sleep, Inc. - FORM 10-K - March 4, 2011

Attached files

Pernix Sleep, Inc. Reports

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