We are a development stage company and have incurred significant net losses since our inception. As of September 30, 2009, we had an accumulated deficit of $176.1 million. We expect our accumulated deficit to continue to increase as we seek FDA approval of Silenor, seek to commercialize Silenor and potentially pursue development of other product candidates. 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 gross proceeds of $6.0 million and net proceeds of $5.7 million. We believe, based on our current operating plan, that our cash, cash equivalents and marketable securities as of September 30, 2009 will be sufficient to fund our operations through the expected duration of the FDA's review of our resubmission of the Silenor NDA and through the second quarter of 2010. We will need to obtain additional funds to finance our operations beyond that point, or if our operating plan is modified to accelerate commercialization activities relating to Silenor. 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 cannot assure that such funding will be available on reasonable terms, or at all. Additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. If we are unsuccessful in our efforts to maintain sufficient financial resources, including by raising additional funds when needed, we may be required to reduce or curtail our operations and costs, and we may be unable to continue as a going concern.
Revenues
As a development stage company, we have not generated any revenues to date, and we do not expect to generate any revenues from licensing, achievement of milestones or product sales until we enter into a strategic collaboration or are able to commercialize Silenor.
License Fees
Our license fees consist of the costs incurred to in-license our product candidates. We expense all license fees and milestone payments for acquired development and commercialization rights to operations as incurred since the underlying technology associated with these expenditures relates to our research and development efforts and has no alternative future use at this time.
In March 2009, we entered into an agreement with BioTie Therapies Corp., or BioTie, to mutually terminate our license for nalmefene for the treatment of impulse control and substance abuse disorders. Pursuant to the termination agreement, BioTie paid us a $1.0 million termination fee which we included as an offset to our license fees. In June 2009, we exercised our contractual right to terminate our agreement with the University of Miami for nalmefene for the treatment of nicotine dependence. We have no further commitments under our nalmefene program.
Research and Development Expenses
To date, our research and development expenses consist primarily of costs associated with clinical trials managed by our contract research organizations, costs associated with our non-clinical development program for Silenor, costs associated with submitting and seeking approval of our NDA for Silenor, regulatory expenses, drug development costs, salaries and related employee benefits, as well as share-based compensation expense. For the nine months ended September 30, 2009 our most significant internal research and development costs 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, including the conduct of our continuing two-year carcinogenicity study and the resubmission of our Silenor NDA to the FDA.
We expense all research and development expenses to operations as incurred. Although we are not currently contemplating any new clinical or non-clinical studies, we expect our research and development expenses to remain a significant component of our operating expenses in the future as we seek NDA approval for Silenor and continue our Silenor drug development program, including the conduct of our ongoing non-clinical study.
At this time, due to the risks inherent in the regulatory approval process for our NDA for Silenor, and because it is uncertain whether we will pursue other drug development programs, we are unable to estimate with any certainty the costs we will incur in the continued development of product candidates for potential commercialization. Non-clinical and

clinical development timelines, the probability of success and the costs of development of product candidates vary widely. The lengthy process of completing non-clinical testing, conducting clinical trials and seeking regulatory approval requires the expenditure of substantial resources. Any failure by us or delay in completing development work or obtaining regulatory approval for Silenor or any future product candidates would cause our research and development expense to increase and, in turn, have a material adverse effect on our results of operations.
We cannot forecast with any degree of certainty whether Silenor will be subject to future collaborations or other strategic transactions, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements. As a result, we cannot be certain when and to what extent we will receive cash inflows from the commercialization of Silenor or collaboration agreements, if at all.
Marketing, General and Administrative Expenses Our marketing, general and administrative expenses consist primarily of salaries, benefits, share-based compensation expense, advertising, market research costs, insurance and facility costs, and professional fees related to our marketing, administrative, finance, human resources, legal and internal systems support functions. For the nine month period ended September 30, 2009, our most significant marketing, general and administrative expenses were salaries and benefits, severance costs, professional service fees and share-based compensation expense. We would anticipate increases in marketing, general and administrative expenses if Silenor is approved by the FDA and we begin preparing for its commercialization.
Interest and Other Income
Interest and other income consist primarily of interest earned on our cash, cash equivalents, and marketable securities.
Interest and Other (Expense)
Interest and other (expense) consist primarily of interest expense incurred on our outstanding debt. In March 2009, we repaid in full our outstanding secured credit facility which resulted in no future interest expense under this loan obligation.
Critical Accounting Policies and Estimates Management's discussion and analysis of our financial condition and results of operations is based on our condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these condensed 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 condensed financial statements.
Going Concern
We believe, based on our current operating plan, that our cash, cash equivalents and marketable securities as of September 30, 2009 will be sufficient to fund our operations through the expected duration of the FDA's review of our resubmission of the Silenor NDA and through the second quarter of 2010. We will need to obtain additional funds to finance our operations beyond that point, or if our operating plan is modified to accelerate commercialization activities relating to Silenor.
We have not derived any revenue from product sales to date, and we have incurred losses from operations and negative cash flows since inception. We expect our losses to continue to increase as we pursue regulatory approval of our Silenor NDA, seek to commercialize Silenor and potentially pursue development of other product candidates. 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 cannot assure such funding will be available on reasonable terms, or at all. Additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants.

If we are unable to maintain sufficient financial resources, including by raising additional funds when needed, 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 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.
The financial statements contained herein do not include any adjustments that might result from the outcome of this uncertainty, except that at December 31, 2008, our outstanding debt was classified as a current liability, the debt discount and debt issuance costs were fully accreted, the final lump sum payment and fair value of the warrants issued in lieu of the prepayment penalty were fully accrued, and the related restricted cash collateralizing this debt was classified as a current asset. We repaid the entire outstanding balance of the debt in full in March 2009.
License Fees
To date, the costs related to patents and acquisition of our intellectual property have been expensed as incurred since the underlying technology associated with these expenditures is in connection with our development efforts and has no alternative future use. Certain of our license agreements contain provisions which obligate us to make milestone payments or provide other consideration if specified events occur. For instance, upon FDA approval of Silenor, we would owe a $1.0 million milestone payment to our licensor. Determining whether these events will occur, and the timing of such events, requires judgment on the part of management. As of September 30, 2009, we have not recognized this milestone in our financial statements.
Additionally, we would capitalize costs related to our intellectual property once technological feasibility has been established, and such capitalized amounts would be amortized over the expected life of the intellectual property. 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.
Research and Development Expenses
Our research and development costs are expensed as incurred and include expenditures relating to our NDA filing, drug development costs and non-clinical studies for Silenor. Measurement of research and development expenses performed by external service providers often requires judgment as we may not have been invoiced or otherwise notified of actual costs incurred, making it necessary to estimate the efforts completed to date and the related expense. The period over which services are performed, the level of services performed as of a given date and the cost of such services are often subjective determinations. Our principal vendors operate within terms of contracts which establish program costs and estimated timelines. We assess the status of our programs through regular discussions between our program management personnel and the related vendors. Based on these assessments, we determine the progress of our programs in relation to the scope of work outlined in the contracts, and recognize the related amount of expense accordingly. We adjust our estimates as actual costs become known to us. Changes in estimates could materially affect our results of operations.
Share-based Compensation
Share-based compensation expense for employees and directors is recognized in the Statement of Operations over the expected service period based on the estimated grant date fair value for the award. The grant date fair value for stock options is determined using an option valuation model, such as the Black-Scholes model which we use. The grant date fair value is affected by many complex and subjective assumptions, including estimates of our future volatility, the expected term for our stock options, which takes into consideration expected option exercise behavior, and the number of shares expected to ultimately vest.
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 generally estimate our expected future volatility based on 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 apply a formula-driven approach in determining the expected term for our share-based awards pursuant to guidance from Staff Accounting Bulletins, from the Securities and Exchange Commission, or SEC. Share-based compensation is based on awards expected

to ultimately vest and is reduced for estimated forfeitures. Our estimated forfeiture rates may differ from forfeitures actually experienced, which would affect the amount of expense recognized during the period.
Certain of our share-based awards vest upon the achievement of performance conditions. Share-based compensation expense for these awards 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. 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. For example, we filed a resubmission of our Silenor NDA in June 2009, resulting in a PDUFA action date of December 4, 2009. While the analyses included in our NDA resubmission were focused on the issues raised by the FDA in its Complete Response Letter relating to our NDA, the regulatory approval process is inherently complex, and clinical and non-clinical data is subject to varying interpretations. As a result, as of September 30, 2009, we do not consider FDA approval of the NDA for Silenor to be probable in accordance with the criteria used for accounting purposes. Accordingly, we have not recognized in our financial statements expense related to certain of our performance 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 realized with respect to our share-based awards could differ significantly from the amounts recorded in our financial statements.
In June 2009, we completed a one-time stock option exchange program for employees and directors as of March 1, 2009. Under the program, eligible participants were able to elect to exchange all of their stock options having exercise prices above $1.00 for the grant of a lesser number of replacement awards having an exercise price of the greater of $1.00 or the closing price of our common stock on the Nasdaq Stock Market on June 9, 2009. The participants received two new options for every three options tendered for exchange. All of the eligible participants tendered some or all of their stock options for exchange. In total, 4,320,000 stock options were tendered in exchange for 2,880,000 replacement awards. The exercise price of the replacement awards was $1.23 per share, which was the closing price of our common stock on June 9, 2009. One-third of the replacement awards were vested upon grant and the remainder of the replacement stock options will vest, subject to the participant's continued service, in equal monthly installments over the following two year period such that all the awards will be fully vested in June 2011.
The fair value of the replacement awards is generally expensed over the new award's vesting period, except for participants under non-substantive consulting arrangements. For these participants, the fair value for the portion of the replacement award vesting through the end of the consulting agreement is expensed immediately upon exchange. In total, the stock option exchange program, along with the immediate vesting of replacement awards, resulted in $658,000 of non-cash compensation expense during the second quarter of 2009. The remaining incremental fair value of the replacement awards immediately after the options were exchanged of $449,000, along with the remaining unrecognized grant date fair value from the original awards, will be recognized over the replacement award's remaining service period through June 2011 for employees and directors.
Debt and Interest Expense
In May 2008, we entered into a loan agreement with Silicon Valley Bank and Oxford Finance Corporation under which we borrowed $15.0 million, less debt issuance costs of $0.2 million, for net proceeds of $14.8 million. In connection with entering the loan agreement, we issued warrants to purchase an aggregate amount of 239,000 shares of common stock at an exercise price of $4.385 per share. In March 2009, we repaid the entire remaining $13.7 million principal amount of the loan, together with the final payment of $0.6 million required under the loan agreement. As part of the repayment, we issued to Oxford Finance Corporation 200,000 warrants to purchase common stock having a ten-year term and an exercise price of $0.25 per share, which the lenders agreed to accept in lieu of the $0.9 million prepayment penalty required under the loan agreement. We no longer have any obligations under the loan agreement.
At December 31, 2008, we fully accreted the debt discount and debt issuance costs, and accrued the $0.6 million final payment and the value of the warrants issued in lieu of the prepayment penalty. The debt was classified as a current liability and the related restricted cash of $7.5 million which collateralized the debt was classified as a current asset.

Net Operating Losses and Tax Credit Carryforwards We have incurred significant net operating losses to date. As of December 31, 2008, we had federal net operating loss carryforwards of $132.4 million and California net operating loss carryforwards of $129.6 million. Federal net operating loss carryforwards begin to expire 20 years after being generated and California net operating loss carryforwards begin to expire ten years after being generated. We also have research and development credits as of December 31, 2008 of $4.1 million for federal purposes and $1.9 million for California purposes. Federal research and development credits begin to expire 20 years after being generated and California research and development credits do not expire. We have fully reserved our net operating loss carryforwards and research and development credits until such time that it is more likely than not that they will be realized.
Pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of our net operating loss carryforwards and tax credits 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 June 30, 2005 due to various stock issuances used to finance our development activities. This ownership change resulted in limitations on the utilization of tax attributes, including net operating loss carryforwards and tax credits. We estimate that $0.3 million of our California net operating loss carryforwards were effectively eliminated. Additionally, $18.3 million of our federal net operating loss carryforwards, $17.3 million of our state net operating loss carryforwards and $0.9 million of our federal research and development credits were subject to the
Section 382 limitation. A portion of the limited net operating loss carryforwards becomes available for use each year. At December 31, 2008, we estimate that $8.6 million of our federal net operating loss carryforwards and $7.7 million of our state net operating loss carryforwards remain limited. Net operating loss carryforwards and research and development credits generated subsequent to the ownership change are currently not subject to limitations, but could be limited in the future if additional ownership changes occur. As of November 2, 2009, we have not updated our Section 382 analysis, which was completed in conjunction with our initial public offering in December 2005. Results of Operations
Comparisons of the Three Months Ended September 30, 2009 and September 30, 2008
License fees. License fees for the three months ended September 30, 2009 and 2008 were as follows (in thousands, except percentages):

                                  Three Months Ended
                                     September 30,                 Change
                                 2009            2008       Dollar       Percent
           Silenor              $     -         $   150     $  (150 )        (100 )%
           Nalmefene                  -               3          (3 )        (100 )%

           Total license fees   $     -         $   153     $  (153 )        (100 )%

License fees decreased $0.2 million due to a license arrangement entered into during the third quarter of 2008 for the exclusive rights to purchase a certain ingredient used in our formulation for Silenor. We were also obligated to make immaterial annual payments to the University of Miami pertaining to our nalmefene program. In June 2009, we exercised our contractual right to terminate our license agreement with the University of Miami, resulting in no further obligations under our nalmefene program.

Research and Development Expense. Research and development expense for the three months ended September 30, 2009 and 2008 were as follows (in thousands, except percentages):

                                            Three Months Ended
                                               September 30,                  Change
. . .