The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and notes to condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. This discussion contains forward looking statements that involve risks and uncertainties. When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that characterize our business. In particular, we encourage you to review the risks and uncertainties described in Part II Item 1A "Risk Factors" included elsewhere in this report. These risks and uncertainties could cause actual results to differ materially from those projected in forward-looking statements contained in this report or implied by past results and trends. Forward-looking statements are statements that attempt to forecast or anticipate future developments in our business and we encourage you to review the examples of our forward-looking statements under the heading "Cautionary Note Regarding Forward-Looking Statements" that appears at the end of this discussion. These statements, like all statements in this report, speak only as of their date (unless another date is indicated), and we undertake no obligation to update or revise these statements in light of future developments.

Overview

We are a specialty pharmaceutical company focused on developing and commercializing innovative products to meet unmet medical needs in neurology and psychiatry. Our goal is to build a broad portfolio of products through a combination of internal development, acquisition and in-licensing activities, and to utilize our specialty sales force to promote our products in our target markets. We apply novel formulations and drug delivery technologies to known drug compounds, and to compounds with the same mechanism of action or similar chemical structure as marketed products, to improve patient care by, among other things, improving efficacy, reducing adverse side effects or increasing patient compliance relative to existing therapies. Since our inception in 2003, we have built a commercial operation and assembled a portfolio of products and product candidates that currently includes two marketed products, one product candidate in late Phase III clinical development and several product candidates in various stages of clinical development.

Our marketed products and late-stage product candidate are:

• Xyrem (sodium oxybate) oral solution. Xyrem is the only product approved by the U.S. Food and Drug Administration, or FDA, for the treatment of both excessive daytime sleepiness and cataplexy in patients with narcolepsy. Narcolepsy is a chronic neurologic disorder caused by the brain's inability to regulate sleep-wake cycles. According to the National Institutes of Health, 150,000 or more individuals in the U.S. are affected by narcolepsy. We promote Xyrem in the U.S. for its FDA-approved indications to sleep specialists, neurologists, pulmonologists and psychiatrists through our specialty sales force. We have significantly increased U.S. sales of Xyrem since acquiring the rights to Xyrem in June 2005. We have licensed the rights to commercialize Xyrem in 54 countries outside of the U.S. to UCB Pharma Limited, or UCB, and in Canada to Valeant Canada Limited, or Valeant. UCB currently markets Xyrem in 14 countries.

• Luvox CR (fluvoxamine maleate) Extended-Release Capsules. Once-Daily Luvox CR was approved by the FDA for the treatment of both obsessive compulsive disorder and social anxiety disorder on February 28, 2008. We began promoting Luvox CR through our specialty sales force in April 2008. Luvox CR is a once-daily extended-release formulation of fluvoxamine, a selective serotonin reuptake inhibitor, or SSRI. According to the National Institute of Mental Health, obsessive compulsive disorder and social anxiety disorder affect approximately 2.2 million and 15 million adults in the U.S., respectively. Luvox CR was developed by Solvay Pharmaceuticals, Inc., or Solvay, in collaboration with Elan Pharma International Limited, or Elan. We obtained the exclusive rights to market and distribute Luvox CR in the U.S. from Solvay in January 2007. Solvay retained the rights to market and distribute Luvox CR outside of the U.S.

• JZP-6 (sodium oxybate). We are developing sodium oxybate, the active pharmaceutical ingredient in Xyrem, for the treatment of fibromyalgia. According to the American College of Rheumatology, between two and four percent of the U.S. population suffers from fibromyalgia. The program includes two Phase III pivotal clinical trials and a long term safety trial. In November 2008 and June 2009, we announced positive top-line results from our first and second Phase III pivotal clinical trials, respectively. The two randomized, double-blind, placebo-controlled studies demonstrated that sodium oxybate significantly decreased pain and fatigue and improved daily function and patient global impression of change, in patients with fibromyalgia. We plan to submit a new drug application, or NDA, for JZP-6 by the end of 2009. If our NDA is approved by the FDA, we expect to market JZP-6 in the U.S. to specialists who treat fibromyalgia patients, through an expanded specialty sales force and/or in partnerships with third parties. We have granted UCB the commercialization rights to JZP-6 in 54 countries outside of the U.S.

Our other product candidates in clinical development are JZP-8 (intranasal clonazepam), being developed for the treatment of recurrent acute repetitive seizures in epilepsy patients who continue to have seizures while on stable anti-epileptic regimens, JZP-4 (elpetrigine), being developed for the treatment of epilepsy and bipolar disorder, and JZP-7 (ropinirole gel), being developed for the treatment of restless legs syndrome. We do not anticipate significant additional development progress on JZP-8, JZP-4 or JZP-7 unless or until we partner a program or otherwise obtain additional funding that we believe is sufficient to continue a program's development.

We did not timely make the quarterly interest payment of $4.5 million that was due on December 31, 2008 or the quarterly interest payments of $5.1 million due on each of June 30, 2009 and March 31, 2009 to the holders of the $119.5 million principal amount of senior secured notes, or the Senior Notes, which constituted events of default under our agreement with the holders of the Senior Notes, or Senior Note Agreement, and permitted LB I Group Inc., as the holder of more than 50% of the principal amount outstanding, to accelerate payment of the Senior Notes. As a result of the default, interest on the Senior Notes accrued on the outstanding principal amount at an annual default rate of 17% (instead of 15%) effective January 1, 2009. On July 7, 2009, we paid $14.6 million to the holders of the Senior Notes which represented all of the accrued and unpaid interest as of June 30, 2009. On September 29, 2009, we paid our quarterly interest payment of $4.5 million to the holders of the Senior Notes which represented interest calculated at the default rate of 17% for the period from July 1 to July 7, 2009, and at the non-default rate of 15% for the remainder of the quarter.

On July 7, 2009, we completed a private placement of units consisting of 1,895,734 shares of common stock and warrants to purchase 947,867 shares of our common stock at a price of $3.6925 per unit, for net proceeds of $6.8 million.

Revenues

Product Sales, Net

The following is a summary of our product sales, net:



                                       Three Months Ended       Nine Months Ended
                                         September 30,            September 30,
                                        2009         2008        2009        2008
                                                     (In thousands)
        Xyrem                        $    25,038   $ 14,234   $   65,119   $ 37,980
        Luvox CR(1)                        4,954      1,957       12,670      2,671
        Antizol and Antizol-Vet(2)            -         831           -       5,106

        Total                        $    29,992   $ 17,022   $   77,789   $ 45,757

(1) Includes sales of the active pharmaceutical ingredient in Luvox CR of $126,000 and $253,000 in the three and nine months ended September 30, 2008, respectively.

(2) We sold our rights to Antizol® (fomepizole) and Antizol-Vet®in August 2008.

Xyrem (sodium oxybate) oral solution. Revenues from sales of Xyrem primarily represent sales in the U.S. to Express Scripts. Revenues from international sales of Xyrem under our agreements with UCB and Valeant have not been material. The FDA has granted Xyrem orphan drug exclusivity in the U.S. for both excessive daytime sleepiness and cataplexy in patients with narcolepsy. This provided marketing exclusivity in the U.S. until July 2009 for the cataplexy indication and provides marketing exclusivity in the U.S. until November 2012 for the excessive daytime sleepiness indication. In addition to orphan drug exclusivity, Xyrem is covered by two formulation patents that are listed in the FDA's approved drug products with therapeutic equivalence evaluation document, or Orange Book. The patents will expire in 2020. An additional process patent that covers the product is not listed in the Orange Book and expires in 2019.

Luvox CR (fluvoxamine maleate) extended release capsules. Revenues from sales of Luvox CR primarily represent product dispensed through prescriptions in the United States. Luvox CR has three years of marketing exclusivity beginning on February 28, 2008, the date the product was approved by the FDA. In addition, a U.S. patent covering the orally administered formulation of extended-release fluvoxamine, requiring the release of fluvoxamine over a period of not less than 12 hours, was issued to Elan and is listed in the FDA's Orange Book. The patent expires in 2020.

Antizol (fomepizole). Revenues from sales of Antizol in the U.S. primarily represent sales to pharmaceutical wholesalers. We sold our rights to and interests in Antizol and Antizol-Vet, along with the associated product registrations, commercial inventory and trademarks, for $5.8 million and recorded a gain of $3.9 million in the third quarter of 2008.

Royalties, Net

We receive royalties primarily from international distributors of our products, typically based on their net sales of our products. Royalty income was $532,000 and $440,000 in the three months ended September 30, 2009 and 2008, respectively, and $1.5 million and $1.3 million in the nine months ended September 30, 2009 and 2008, respectively. Although we do not expect royalty revenues to comprise a substantial portion of our revenues, we expect royalty revenues to increase as sales of Xyrem by UCB increase.

Contract Revenues

Almost all of our contract revenues consist of upfront or milestone payments received from UCB. During the nine months ended September 30, 2009, upon the completion of the last patient in our second Phase III pivotal clinical trial of sodium oxybate for the treatment of fibromyalgia, we recognized as revenue a $10.0 million nonrefundable milestone payment we received from UCB in July 2008 that was previously recorded as deferred revenue. In addition, we recognized contract revenues of $280,000 in each of the three months ended September 30, 2009 and 2008 and $840,000 in each of the nine months ended September 30, 2009 and 2008 related to previously deferred upfront payments which are being recognized as contract revenue ratably through 2019, the expected performance period under the agreement.

Research and Development Expenses

Conducting a significant amount of research and development has been central to our business model. Since our formation in 2003 through September 30, 2009, we incurred approximately $288.8 million in research and development expenses. In the latter part of 2008, in order to preserve our cash resources, we significantly curtailed our investment in research and development programs other than JZP-6. Our ability to invest in research and development is dependent upon our obtaining additional cash resources.

Our research and development expenses consisted of expenses incurred in identifying, developing and testing our product candidates. These expenses consisted primarily of fees paid to contract research organizations and other third parties to assist us in managing, monitoring and analyzing our clinical trials, clinical trial costs paid to sites and investigators' fees, costs of non-clinical studies, including toxicity studies in animals, costs of contract manufacturing services, costs of materials used in clinical trials and non-clinical studies, fees paid to third parties for development candidates or drug delivery or formulation technologies that we have licensed, allocated expenses such as facilities and information technology that support our research and development activities, and related personnel expenses, including stock-based compensation. Research and development costs are expensed as incurred, including payments made under our license agreements for product candidates in development.

We designate development projects to which we have allocated significant research and development resources with the term "JZP" and a unique number. Earlier-stage development and product lifecycle extension projects are included in "Terminated and other projects" in the following table. Early product concept feasibility studies and other research activities are included in "R&D support" in the following table. The expenditures summarized in the following table reflect costs directly attributable to each development candidate and to our "Terminated and other projects." We do not allocate salaries, benefits or other indirect costs to our development candidates or "Terminated and other projects," but include these costs in "R&D support" in the following table. The following table summarizes our research and development expenses for the nine months ended September 30, 2009 and for JZP projects currently under development and Luvox CR from project inception through September 30, 2009 (in thousands):

                                     Project Inception to     Nine Months Ended
                                      September 30, 2009      September 30, 2009
    JZP-6                           $               92,399   $             19,975
    JZP-4                                           22,189                     68
    Luvox CR(1)                                      9,676                     -
    JZP-7                                            8,497                    694
    JZP-8                                            6,634                    339
    Terminated and other projects                                             312
    R&D support                                                             8,856

    Total                                                    $             30,244

(1) Our research and development expenses for Luvox CR consisted primarily of expenses in connection with the scale-up for commercial manufacturing of Luvox CR, including the cost of inventory manufactured prior to FDA approval on February 28, 2008. Expenses subsequent to FDA approval were either expensed as part of cost of product sales as a period expense or capitalized in inventory.

The process of developing and obtaining FDA approval of products is costly and time consuming. Development activities and clinical trials can take years to complete, and failure can occur any time during the clinical trial process. Although we design our development programs to mitigate risk, the successful development of our product candidates is highly uncertain. Development

timelines, probability of success and development costs vary widely among product candidates. As a result, we are unable to determine the time and completion costs related to the development of our product candidates or estimate when, or to what extent, we will generate revenues from the commercialization and sale of any of our product candidates.

Critical Accounting Policies and Significant Estimates

To understand our financial statements, it is important to understand our critical accounting policies and estimates. The preparation of our financial statements in conformity with United States generally accepted accounting principles requires us 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 revenues and expenses during the reporting period. Significant estimates and assumptions are required in the determination of revenue recognition, in particular related to our agreement with UCB, sales deductions for estimated specialty distributor and wholesaler fees, prompt payment discounts, Medicaid and TRICARE rebates, chargebacks, customer rebates, and royalties. Significant estimates and assumptions are also required to determine whether to capitalize intangible assets, the amortization periods for identifiable intangible assets, the potential impairment of goodwill and other intangible assets, the determination of excess and obsolete inventory reserves, stock-based compensation and accrued expenses. Some of these judgments can be subjective and complex, and, consequently, actual results may differ from these estimates. For any given individual estimate or assumption we make, there may also be other estimates or assumptions that are reasonable. Although we believe our estimates and assumptions are reasonable, they are based upon information available at the time the estimates and assumptions were made.

Our critical accounting policies and significant estimates are detailed in our Annual Report on Form 10-K for the year ended December 31, 2008. Other than the estimates described below, our critical accounting policies and significant estimates have not changed substantially from those previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008.

For information on additional significant estimates and assumptions please see the "Liquidity and Capital Resources" section below.

Intangible Assets

In February 2009, we amended our product license agreement with Solvay for the rights to market Luvox CR and Luvox in the U.S. such that the then existing $14.0 million current payment obligation, a $5.0 million obligation related to a milestone of uninterrupted supply of Luvox CR and future royalty and other obligations were replaced with an obligation to pay a total of $19.0 million. As a result we recorded an addition of $5.0 million to the gross carrying amount of the intangible asset related to Luvox CR developed technology during the nine months ended September 30, 2009.

In response to a notice we received in August 2009 of the filing of an abbreviated new drug application with the FDA by a third party for a generic version of Luvox CR, we tested the intangible asset related to Luvox CR developed technology for impairment as of September 30, 2009. Based on the estimated undiscounted cash flows related to the asset, we determined that the asset was not impaired but that its remaining estimated useful life should be shortened. As of September 30, 2009, the carrying value of the asset is being amortized over its remaining estimated useful life of 2.7 years.

Stock-Based Compensation

On September 30, 2009, the Compensation Committee of our Board of Directors approved an increase in the number of shares available for issuance under our ESPP for the current purchase period and for the next three six-month purchase periods. The total compensation cost related to the increase not yet recognized as of September 30, 2009, was $3.0 million and will be recognized over the next 1.7 years.

Results of Operations

Comparison of Three and Nine Months Ended September 30, 2009 and 2008



                                       Three Months Ended                                           Nine Months Ended
                                         September 30,         Increase/        Increase/             September 30,         Increase/        Increase/
                                        2009         2008      (Decrease)       (Decrease)          2009          2008      (Decrease)       (Decrease)
                                                (In thousands)                                               (In thousands)
Product sales, net                   $    29,992   $ 17,022   $     12,970              76 %      $ 77,789      $ 45,757   $     32,032              70 %
Royalties, net                               532        440             92              21 %         1,522         1,308            214              16 %
Contract revenues                            285        284              1               0 %        10,854           854         10,000             N/A (1)
Cost of product sales (excluding
amortization of acquired developed
technology)                                2,338      5,525         (3,187 )           (58 )%        6,856        10,619         (3,763 )           (35 )%
Research and development                   7,644     12,149         (4,505 )           (37 )%       30,244        55,274        (25,030 )           (45 )%
Selling, general and
administrative                            15,061     24,329         (9,268 )           (38 )%       42,934        91,218        (48,284 )           (53 )%
Amortization of intangible assets          2,057      3,487         (1,430 )           (41 )%        5,611         9,454         (3,843 )           (41 )%
Interest income                                2        353           (351 )           (99 )%           29         1,700         (1,671 )           (98 )%
Interest expense                           5,384      5,355             29               1 %        17,034        14,377          2,657              18 %
Other income (expense), net                    1         19            (18 )           (95 )%           (4 )           6            (10 )          (167 )%
Gain on sale of product rights                -       3,918         (3,918 )           N/A (1)          -          3,918         (3,918 )           N/A (1)

(1) Comparison to prior period is not meaningful.

Product Sales, Net

The increase in product sales, net in the three and nine months ended September 30, 2009, as compared to the same periods in 2008, was primarily due to increases of $10.8 million and $27.1 million in Xyrem sales, respectively, and the launch of Luvox CR in March 2008, offset by decreases in Antizol sales as a result of the sale of our Antizol product rights in August 2008. The increase in Xyrem sales was substantially due to significant price increases in 2008 and a 27% price increase in May 2009, and to a lesser extent increases in sales volumes of 10% and 11% in the three and nine months ended September 30, 2009, respectively, as compared to the same periods in 2008.

Royalties, Net

The increase in royalties, net in the three and nine months ended September 30, 2009, as compared to the same periods in 2008, was entirely due to the increase in royalties we received under our agreement with UCB related to UCB's sales of Xyrem.

Contract Revenues

UCB made a nonrefundable milestone payment of $10.0 million in July 2008 which, upon the completion of the last patient in our second Phase III pivotal clinical trial of sodium oxybate for the treatment of fibromyalgia, was recorded as contract revenue in the nine months ended September 30, 2009 and was previously recorded as deferred revenue. In addition, we recognized contract revenues of $285,000 and $284,000 in the three months ended September 30, 2009 and 2008, respectively, and $854,000 in each of the nine months ended September 30, 2009 and 2008, primarily related to previously deferred upfront payments which are being recognized as contract revenues ratably through 2019, the expected performance period under our agreement with UCB.

Cost of Product Sales

The decrease in cost of product sales in the three and nine months ended September 30, 2009, as compared to the same periods in 2008, was due to:

• higher Antizol cost of product sales in the 2008 periods as a result of the sale of our Antizol product rights in 2008,

• higher Luvox CR cost of product sales in the 2008 periods related to excess inventory, and

• higher Luvox CR cost of product sales in the 2008 periods related to failed lots, partially offset by,

• higher material costs primarily related to the growth in our Luvox CR product sales in 2009.

Research and Development Expenses

Lower research and development expenses in the three and nine months ended September 30, 2009, as compared to the same periods in 2008, resulted from lower spending on all of our JZP and other projects and Luvox CR, for which we incurred research and development expenditures in the two months prior to approval of the product by the FDA in February 2008. Expenditures on JZP-6 are expected to comprise the majority of our research and development expenses in the remainder of 2009, unless or until we partner a program or otherwise obtain financing to fund our other programs. As a result, research and development expenses will be significantly lower in 2009 than in 2008.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were lower in the three and nine months ended September 30, 2009, as compared to the same periods in 2008, primarily due to a reduction in the number of employees as a result of our three reductions in force in 2008 and to lower marketing expenses. Selling, general and administrative expenses will be significantly lower in 2009 than in 2008 as a result of the reductions in force and careful control of marketing expenses.

Amortization of Intangible Assets

Our intangible assets consist primarily of developed technology related to Xyrem and Luvox CR which are amortized on a straight-line basis over their estimated useful lives. Amortization costs in the three and nine months ended September 30, 2009 were lower as compared to the same periods in 2008, primarily due to the sale of our rights to and interests in Antizol and Antizol-Vet in August 2008 and a $29.8 million write down of the Luvox CR intangible asset in 2008. Amortization costs will be lower in 2009 than in 2008 primarily due to the write down of the Luvox CR intangible asset.

Interest Income

Interest income was lower in the three and nine months ended September 30, 2009, as compared to the same periods in 2008, due to lower average cash balances and to lower average interest rates.

Interest Expense

Interest expense relates primarily to interest on the Senior Notes, and, to a lesser extent, interest on our liability under a government settlement. The increase in interest expense in the nine months ended September 30, 2009, as compared to the same period in 2008, was primarily due to interest expense recorded on the additional $40.0 million principal amount of the Senior Notes we . . .