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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2008

OR

For the transition period from               to          

Commission File Number:

0-30319

THERAVANCE, INC.

(Exact Name of Registrant as Specified in its Charter)

901 Gateway Boulevard

South San Francisco, CA 94080

(Address of Principal Executive Offices including Zip Code)

(650) 808-6000

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x  No  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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

Yes  o  No  x

The number of shares of registrant’s common stock outstanding on July 31, 2008 was 52,128,451.

The number of shares of registrant’s Class A common stock outstanding on July 31, 2008 was 9,401,499.

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

THERAVANCE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

*                    Condensed consolidated balance sheet at December 31, 2007 has been derived from audited consolidated financial statements.

See accompanying notes to condensed consolidated financial statements.

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THERAVANCE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)
(Unaudited)

(1)             Revenue includes amounts from GSK, a related party, of $2,830 and $5,654 for the three and six months ended June 30, 2008, respectively, and $2,824 and $5,649 for the three and six months ended June 30, 2007, respectively.

See accompanying notes to condensed consolidated financial statements.

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THERAVANCE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)
(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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Theravance, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1.  Basis of Presentation and Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Theravance, Inc. (the Company) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of the Company’s management, the unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, consisting of only normal recurring adjustments, necessary for the fair presentation of the Company’s financial position at June 30, 2008, the results of operations for the three and six months ended June 30, 2008 and 2007 and the cash flows for the six months ended June 30, 2008 and 2007. The results for the three and six months ended June 30, 2008 are not necessarily indicative of the results of operations to be expected for the year ending December 31, 2008 or any other period.

The condensed consolidated balance sheet at December 31, 2007 has been derived from audited consolidated financial statements, which are contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission (SEC) on February 26, 2008 (2007 10-K). The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the 2007 10-K.

Use of Management’s Estimates

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates based upon current assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual conditions may differ materially from the Company’s current assumptions. This may result in the Company’s estimates being incorrect and may require it to record adjustments to its financial position, results of operations or cash flows.

Segment Reporting

The Company has determined that it operates in only one segment, which is the research and development of human therapeutics. Revenues are primarily generated from collaborations with the Company’s partners located in the United Kingdom and Japan. All long-lived assets are maintained in the United States.

Inventory

Inventory is stated at the lower of cost or market and is included with prepaid and other current assets. Inventory consists of $5.5 million of commercial launch supplies of the Company’s product candidate telavancin which is currently under regulatory review. Under the Company’s 2005 License, Development and Commercialization Agreement with Astellas Pharma Inc. (Astellas), the Company is responsible to deliver to Astellas approximately six months of first commercial sale stock (as defined) in preparation for the regulatory approval and commercialization of telavancin in the United States. If the Company’s product candidate is approved by the U.S. Food and Drug Administration (FDA), the inventory costs would be reimbursed through a milestone payment.

If the regulatory approval of telavancin is substantially further delayed or denied by the necessary regulatory bodies, or if new information becomes available that suggests that the telavancin inventory will not be realizable, the Company may be required to expense a portion or all of the capitalized inventory costs. A portion of the amount that may be expensed would be eligible for reimbursement through alternative arrangements with Astellas under terms of the Company’s collaboration agreement.

Bonus Accruals

The Company has short- and long-term bonus programs. Bonuses are determined based on various criteria, including the achievement of corporate, departmental and individual goals. Bonus accruals are estimated based on various factors, including target bonus percentages per level of employee and probability of achieving the goals upon which bonuses are based. The Company’s management periodically reviews the progress made towards the goals under the bonus programs. As bonus accruals are dependent upon management’s judgments of the likelihood of achieving the various goals, in some cases over a period of time in excess of twelve months, it is possible for bonus expense to vary significantly in future periods

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if changes occur in those management estimates. During the three months ended June 30, 2008, the Company reduced the accrual balances by $0.7 million for its non-officer long-term bonus program established in 2004 due to the reduction in force which was announced in April 2008. As of June 30, 2008, the Company had approximately $7.3 million remaining to be paid under its non-officer long-term bonus program. These payments are scheduled to be made in December of 2008 and 2009.

Other-than-Temporary Impairment Assessment

The Company reviews its investment portfolio to identify and evaluate investments that have indications of possible impairment. Factors considered in determining whether a loss is other-than-temporary include the length of time and extent to which fair value has been less than the cost basis, the financial condition and near-term prospects of the investee, credit quality and the Company’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. If the Company determines that an investment impairment is other-than-temporary, the investment is written down with a charge recorded in interest and other income, net.

Fair Value of Share-based Payment Awards

The Company uses the fair value method of accounting for share-based compensation arrangements in accordance with Financial Accounting Standards Board (FASB) Statement No. 123(R), “Share-based Payment” (SFAS 123(R)). The Company adopted SFAS 123(R) on January 1, 2006 using the modified prospective method of transition. Under this method, compensation expense is recognized beginning with the effective date of adoption of SFAS 123(R) for all share-based payments (i) granted after the effective date of adoption and (ii) granted prior to the effective date of adoption and that remain unvested on the date of adoption. Share-based compensation arrangements covered by SFAS 123(R) currently include stock options granted, restricted shares issued and restricted stock unit awards (RSUs) granted under the 2004 Equity Incentive Plan, as amended, and purchases of common stock by the Company’s employees at a discount to the market price during offering periods under the Company’s Employee Stock Purchase Plan, as amended (ESPP). The estimated fair value of stock options, restricted shares and RSUs (excluding performance-contingent RSUs) is expensed on a straight-line basis over the expected term of the grant. The fair value of performance-contingent RSUs is expensed during the term of the award when the Company determines that it is probable that certain performance conditions will be met. Compensation expense for purchases under the ESPP is recognized based on the estimated fair value of the common stock during each offering period and the percentage of the purchase discount.

In conjunction with the adoption of SFAS 123(R), the Company changed its method of expensing the value of stock-based compensation from the accelerated method to the straight-line single-option method. Compensation expense for all share-based payment awards granted prior to January 1, 2006 will continue to be recognized using the accelerated method over the vesting period, while compensation expense for all share-based payment awards granted on or subsequent to January 1, 2006 is recognized using the straight-line single-option method. Stock-based compensation expense for stock options has been reduced for estimated forfeitures so that compensation expense is based on options ultimately expected to vest. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company’s estimated annual forfeiture rate for stock options remained unchanged at 4% for the three months ended June 30, 2008 based on its historical forfeiture experience. The effect of the reduction in force announced in April 2008 was excluded from the Company’s estimated forfeiture rate as it was deemed to be a deviation from historical trends.

Recent Accounting Pronouncements

In June 2007, the Emerging Issues Task Force (EITF) ratified a consensus on EITF Issue No. 07-3 (EITF 07-3), “Accounting for Non-Refundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities”, which concluded that non-refundable advance payments for goods or services for use in research and development activities should be deferred and capitalized. EITF 07-3 is effective for the Company beginning in the first quarter of fiscal year 2008. The Company adopted EITF 07-3 effective January 1, 2008 and has determined that the adoption had no material impact on its financial position, results of operations and cash flows.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. SFAS 157 is effective for the Company beginning in the first quarter of fiscal year 2008. In February 2008, the FASB issued Statement of Financial Position No. 157-2, which delays the effective date of SFAS 157 for non-financial assets and non-financial liabilities and is effective for fiscal years beginning after November 15, 2008. The Company adopted SFAS 157 effective January 1, 2008 for financial assets and liabilities and has determined that the adoption had no material impact on our financial position, results of operations and cash flows.

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Reclassification of Prior Period Amounts

Certain prior period amounts related to the classification of interest and other income, net, and interest expense in the condensed consolidated statements of operations have been reclassified to conform to the current period’s presentation. These reclassifications had no impact on previously reported results of operations or stockholders’ equity (net capital deficiency).

2.  Net Loss per Share

Basic net loss per common share (Basic EPS) is computed by dividing net loss by the weighted-average number of common shares outstanding during the period, less shares subject to repurchase. Diluted net loss per common share (Diluted EPS) is computed by dividing net loss by the weighted-average number of common shares outstanding during the period, less shares subject to repurchase, plus dilutive potential common shares and shares subject to repurchase. Diluted EPS is identical to Basic EPS for all periods presented since potential common shares are excluded from the calculation, as their effect is anti-dilutive. The Company’s potentially dilutive common shares include outstanding options to purchase shares of common stock, outstanding restricted stock unit awards and common shares issuable upon the conversion of convertible debt.

At June 30, 2008, potential common shares consist of approximately 10,723,000 shares issuable upon the exercise of stock options, approximately 1,607,000 shares issuable under performance-contingent restricted stock unit awards and approximately 460,000 shares issuable under restricted stock unit awards. At June 30, 2007, potential common shares consist of approximately 11,283,000 shares issuable upon the exercise of stock options, 1,826,000 shares issuable under performance-contingent restricted stock unit awards and approximately 18,000 shares issuable upon the exercise of warrants. (The outstanding warrant subsequently expired on October 5, 2007 without being exercised and as a result, no stock was issued under the warrant).

3.  Comprehensive Loss

Comprehensive loss is comprised of net loss and other comprehensive income (loss), which consists of net unrealized gains and losses on the Company’s available-for-sale securities. The components of comprehensive loss are as follows:

4.  Restructuring Charges

In response to the completion of its Phase 3 development activities with telavancin and to reduce its overall cash burn rate, the Company announced on April 21, 2008 a plan to reduce its workforce by approximately 40% through layoffs from all departments throughout the organization. On April 23, 2008, the Company notified the employees impacted by the plan. For the three months ended June 30, 2008, the Company recorded charges totaling $5.1 million related to severance, other termination benefits and outplacement services.

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The following table summarizes the accrual balance and utilization by cost type for the restructuring for the three months ended June 30, 2008:

The remaining accrual as of June 30, 2008 is primarily related to employee severance and related benefits that are expected to be paid within the next six months. As such, the restructuring accrual is recorded as a current liability within accrued personnel-related expenses. Several of the Company’s employees impacted by the plan have future service requirements extending beyond June 30, 2008. As a result, the Company anticipates that approximately $0.7 million of additional severance and other termination benefits will be recognized over their service periods during the second half of 2008. The execution of the restructuring plan is expected to be completed by December 31, 2008.

5.  Collaboration and Licensing

2005 License, Development and Commercialization Agreement with Astellas

In November 2005, the Company entered into a collaboration arrangement with Astellas for the development and commercialization of telavancin. In July 2006, Japan was added to the telavancin collaboration, thereby giving Astellas worldwide rights to this potential medicine. Through June 30, 2008, the Company had received $159.0 million in upfront, milestone and other fees from Astellas, which are being amortized ratably over the estimated period of performance (the estimated development and commercialization period). The Company recognized $2.7 million and $2.5 million in revenue for the three months ended June 30, 2008 and 2007, respectively, and $5.5 million and $4.6 million in revenue for the six months ended June 30, 2008 and 2007, respectively. As of June 30, 2008, the Company was eligible to receive up to $60.0 million in remaining milestone payments related to regulatory filings and approvals in various regions of the world.

If telavancin is commercialized, the Company will be entitled to receive royalties on global sales of telavancin by Astellas that, on a percentage basis, range from the high teens to the upper twenties depending on sales volume. Under this arrangement, the Company will be responsible for substantially all costs to develop and obtain U.S. regulatory approval for telavancin for complicated skin and skin structure infections (cSSSI) and hospital-acquired pneumonia (HAP), and Astellas will be responsible for substantially all costs associated with commercialization and further development of telavancin.

Horizon Program with GSK

In November 2002, the Company entered into its Horizon collaboration agreement with GlaxoSmithKline plc (GSK) to develop and commercialize a long-acting beta₂ agonist (LABA) product candidate for the treatment of asthma and chronic obstructive pulmonary disease (COPD). Each company contributed four LABA product candidates to the collaboration. Four large Phase 2b asthma studies commenced in December 2007, one with the lead LABA, GW642444 (‘444), and three with the lead inhaled corticosteroid (ICS) GW685698 (‘698), and in February 2008 a large Phase 2b COPD study with ‘444 was initiated.

The Company is entitled to receive the same royalties on product sales of medicines from the Horizon collaboration, regardless of whether the product candidate originated with Theravance or with GSK. The royalty structure is downward tiering and would result in an average percentage royalty rate in the low- to mid-teens at annual net sales of up to approximately $4.0 billion and the average royalty rate would decline to single digits at annual net sales of more than $6.0 billion for sales of single-agent LABA medicines and combination LABA/ICS medicines, which would be combined for the purposes of this royalty calculation. For other products combined with a LABA from the Horizon collaboration, such as a combination LABA/LAMA medicine, which are launched after a LABA/ICS combination medicine, royalties are upward tiering and range from the mid-single digits to 10%. However, if GSK is not selling a LABA/ICS combination product at the time that the first other LABA combination is launched, then the royalties described above for the LABA/ICS combination medicine are applicable.

As of June 30, 2008, the Company had received upfront and milestone payments from GSK of $60.0 million related to the clinical progress of its candidates. GSK has determined to focus the collaboration’s resources on the development of the lead LABA, ‘444, a GSK-discovered compound, together with the lead ICS. Accordingly, the Company does not expect to receive any further milestone payments from the Horizon program. In the event that a LABA product candidate discovered by GSK is successfully developed and commercially launched in multiple locations of the world, the Company will be

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obligated to make payments to GSK of up to $220.0 million. Based on available information, the Company does not estimate that a significant portion of these potential milestone payments to GSK is likely to be made in the next three years.

The Company recorded the upfront and milestone payments as deferred revenue and they are being amortized ratably over the Company’s estimated period of performance. Collaboration revenue was $1.7 million for each of the three months ended June 30, 2008 and 2007, and $3.4 million for each of the six months ended June 30, 2008 and 2007. Subsequent development milestones, if any, will be recorded as deferred revenue when received and amortized over the remaining period of performance. Additionally, certain costs related to the collaboration are reimbursable by GSK as an offset to research and development expense. For each of the three and six months ended June 30, 2008 and 2007, reimbursable costs related to the collaboration were not material.

2004 Strategic Alliance with GSK

In March 2004, the Company entered into its strategic alliance with GSK for the development and commercialization of product candidates in a variety of therapeutic areas. In connection with the strategic alliance, the Company received a $20.0 million payment from GSK in May 2004. This payment is being amortized over the initial period during which GSK may exercise its right to license certain of its programs under the agreement, which the Company currently estimates to be through September 2011.

The alliance provides GSK with an option to license exclusive development and commercialization rights to product candidates from all of the Company’s full drug discovery programs initiated prior to September 1, 2007, on pre-determined terms and on an exclusive, worldwide basis. The remaining programs that GSK has the right to license are (i) a peripheral Opioid-Induced Bowel Dysfunction (PUMA) program, (ii) a AT1 Receptor—Neprilysin Inhibitor hypertension (ARNI) program and (iii) a MonoAmine Reuptake Inhibitor chronic pain (MARIN) program. Upon licensing a program, GSK is responsible for funding all future development, manufacturing and commercialization activities for product candidates in that program. In addition, GSK is obligated to use diligent efforts to develop and commercialize product candidates from any program that it licenses. Consistent with the Company’s strategy, it is obligated at its sole cost to discover two structurally different product candidates for any programs that are licensed by GSK under the alliance. If these programs are successfully advanced through development by GSK, the Company is entitled to receive clinical, regulatory and commercial milestone payments based on performance and royalties on any sales of medicines developed from these programs. For product candidates licensed to date under this agreement, the royalty structure for a product containing one of the Company’s compounds as a single active ingredient would result in an average percentage royalty rate in the low double digits. If a product is successfully commercialized, in addition to any royalty revenue it receives, the total upfront and milestone payments that it could receive in any given program that GSK licenses range from $130.0 million to $162.0 million for programs with single-agent medicines and up to $252.0 million for programs with both a single-agent and a combination medicine. If GSK chooses not to license a program, the Company retains all rights to the program and may continue the program alone or with a third party. To date, GSK has licensed two of its COPD programs under the terms of the strategic alliance:  LAMA and MABA. GSK has chosen not to license the Company’s bacterial infections program, anesthesia program and Gastrointestinal Motility Dysfunction program. There can be no assurance that GSK will license any other programs under the terms of the alliance agreement or at all, which could have an adverse effect on the Company’s business and financial condition.

In August 2004, GSK exercised its right to license the Company’s long-acting muscarinic antagonist program (LAMA) pursuant to the terms of the strategic alliance. The Company received a $5.0 million payment from GSK in connection with the licensing of this program. Through June 30, 2008, the Company received a milestone payment of $3.0 million from GSK related to clinical progress of its candidate. These payments are amortized ratably over the estimated period of performance (the product development period). The Company recognized $0.2 million for each of the three months ended June 30, 2008 and 2007, and $0.4 million for each of the six months ended June 30, 2008 and 2007 in revenue related to the LAMA program. Additionally, the Company has been reimbursed by GSK for certain costs related to the LAMA program as an offset to research and development expense. For the three and six months ended June 30, 2008 and 2007, reimbursable costs were not material. We recently announced that GSK had informed us it intends to return the LAMA program to Theravance because the current formulation of the lead product candidate, TD-4208, is incompatible with GSK’s proprietary inhaler device. Deferred revenue related to the LAMA license with GSK was $4.6 million at June 30, 2008. The Company and GSK are currently discussing the transfer of information and materials to the Company and the Company intends to explore partnerships with other companies for the further development of TD-4208.

In March 2005, GSK exercised its right to license the Company’s bifunctional muscarinic antagonist-beta₂ agonist (MABA) program pursuant to the terms of the strategic alliance. The Company received a $5.0 million payment from GSK in connection with the license of the Company’s MABA program. Through June 30, 2008, the Company received a milestone payment of $3.0 million from GSK related to clinical progress of its candidate and has earned a $10.0 million milestone payment for the successful achievement of proof-of-concept in the MABA Phase 2 study.  The Company received the $10.0 million milestone payment from GSK in July 2008. These amounts are being amortized ratably over the estimated period of

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performance (the product development period). Collaboration revenue related to the MABA program was $0.3 million for each of the three months ended June 30, 2008 and 2007, and $0.5 million for each the six months ended June 30, 2008 and 2007. Additionally, the Company is reimbursed by GSK for certain costs related to the MABA program as an offset to research and development expense. Reimbursements for the three and six months ended June 30, 2008 and 2007 were not material.

6.  Marketable Securities

The Company invests in a variety of highly liquid investment-grade securities. The following is a summary of the Company’s available-for-sale securities at June 30, 2008:

The estimated fair value amounts have been determined by the Company using available market information. At June 30, 2008, 100% of marketable securities have contractual maturities within twelve months. Average duration of available-for-sale securities was approximately two months at June 30, 2008. The Company has determined that the gross unrealized losses on its marketable securities at June 30, 2008 were temporary in nature.

7.  Fair Value Measurements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, provides a consistent framework for measuring fair value GAAP and expands fair value financial statement disclosure requirements. SFAS 157 does not require any new fair value measurements. It only applies to accounting pronouncements that already require or permit fair value measures, except for standards that relate to share-based payments (SFAS 123(R)). The Company adopted SFAS 157 effective January 1, 2008.

SFAS 157’s valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions. SFAS 157 classifies these inputs into the following hierarchy:

Level 1 Inputs – Quoted prices for identical instruments in active markets.

Level 2 Inputs – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 Inputs – Unobservable inputs and little, if any, market activity for the assets.

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The fair value of these financial assets was determined using the following inputs at June 30, 2008:

SFAS 157 requires separate disclosure of assets and liabilities measured at fair value on a recurring basis from those measured at fair value on a nonrecurring basis.

8.  Commitments

Guarantees and Indemnifications

The Company indemnifies its officers and directors for certain events or occurrences, subject to certain limits. The Company believes the fair value of these indemnification agreements is minimal. Accordingly, the Company has not recognized any liabilities relating to these agreements as of June 30, 2008.

Purchase Obligations

At June 30, 2008, the Company had outstanding purchase obligations, primarily for services from contract research and manufacturing organizations, totaling $3.5 million.

9.  Convertible Subordinated Notes

On January 23, 2008, the Company closed an underwritten public offering of $172.5 million aggregate principal amount of unsecured convertible subordinated notes which will mature on January 15, 2015. The financing raised proceeds, net of issuance costs, of $166.7 million. The notes bear interest at the rate of 3.0% per year, which is payable semi-annually in arrears in cash on January 15 and July 15 of each year, beginning on July 15, 2008. The notes are convertible, at the option of the holder, into shares of the Company’s common stock at an initial conversion rate of 38.6548 shares per $1,000 principal amount of the notes, subject to adjustment in certain circumstances, which represents an initial conversion price of approximately $25.87 per share. The debt issuance costs, which are included in other long-term assets, are being amortized on a straight-line basis over the life of the notes.

Holders of the notes will be able to require the Company to repurchase some or all of their notes upon the occurrence of a fundamental change (as defined) at 100% of the principal amount of the notes being repurchased plus accrued interest and unpaid interest. The Company may not redeem the notes prior to January 15, 2012. On or after January 15, 2012 and prior to the maturity date, the Company, upon notice of redemption, may redeem for cash all or part of the notes if the last reported sale price of its common stock has been greater than or equal to 130% of the conversion price then in effect for at least 20 trading days during any 30 consecutive trading day period prior to the date on which it provides notice of redemption. The redemption price will equal 100% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest up to but excluding the redemption date.

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10.  Stock-Based Compensation

Valuation Assumptions

The assumptions used to value employee stock-based compensation expense for stock options granted and employee stock purchase plan issuances were as follows:

Stock-based compensation expense consists of the compensation cost for employee share-based awards, including employee stock options, RSUs and restricted stock, and the value of options and RSUs issued to non-employees for services rendered. The following table discloses the allocation of stock-based compensation expense included in the unaudited condensed consolidated statements of operations:

As of June 30, 2008, there was $26.3 million and $6.5 million of total unrecognized compensation cost related to unvested stock options and RSUs (excluding performance-contingent RSUs), respectively. This cost is expected to be recognized over a weighted-average period of approximately 2.47 years and 3.42 years, respectively. The Company has not recognized, and does not expect to recognize in the near future, any tax benefit related to employee stock-based compensation costs as a result of the full valuation allowance on the Company’s net deferred tax assets including deferred tax assets related to its net operating loss carryforwards.

Equity Incentive Plans

2008 New Employee Equity Incentive Plan

In January 2008, the Company adopted the 2008 New Employee Equity Incentive Plan (the 2008 Plan) and reserved 500,000 shares of common stock for issuance under the 2008 Plan. The 2008 Plan provides for the granting of non-qualified stock options, restricted stock awards and RSUs to newly hired employees. As of June 30, 2008, no options, restricted stock or RSUs were issued and outstanding under the 2008 Plan.

2004 Equity Incentive Plan

During the six months ended June 30, 2008, the Company granted stock options to purchase 1,500 shares at an average exercise price of $12.97 per share and granted 89,394 RSUs that vest over time which have a weighted-average fair value of $12.98 per share under the 2004 Equity Incentive Plan, as amended (the 2004 Plan). As of June 30, 2008, total shares remaining available for issuance under the 2004 Plan were 1,041,354.

The performance-contingent RSUs granted to date have dual triggers of vesting based upon the successful achievement of certain corporate operating milestones, as well as a requirement for continued employment through certain dates in late 2009 and early 2010. The issuance of shares underlying the RSUs would occur, if at all, on the respective dates in 2009 and 2010. Expense associated with these RSUs would be recognized in increments, if at all, during 2008 through

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2009, depending on the probability of meeting the performance conditions. During the three months ended March 31, 2008, the Compensation Committee of the Company’s Board of Directors approved management’s recommendation to modify certain performance milestones and cancel 25% of the performance-contingent RSUs held by senior management. Accordingly, the maximum potential expense associated with the RSUs if all of the milestones are successfully achieved on time could be up to approximately $59.6 million, which decreased $6.7 million from December 31, 2007 (allocated as $37.8 million for research and development expense and $21.8 million for general and administrative expense). During the three months ended June 30, 2008, due to the reduction in force announced in April 2008, the maximum potential expense associated with the performance-contingent RSUs if all of the milestones are successfully achieved on time was further reduced to approximately $53.4 million, which decreased $6.2 million from March 31, 2008 (allocated as $33.1 million for research and development expense and $20.3 million for general and administrative expense). As of June 30, 2008, the Company had determined that none of the requisite performance conditions were probable and as a result, no compensation expense has been recognized. As vesting of these RSUs is dependent upon the successful achievement of the performance conditions, the expense associated with these RSUs may vary significantly from period to period.

The following table summarizes equity award activity under the 2008 Plan and the 2004 Plan and related information:

No options were granted with exercise prices less than fair value of common stock on the date of grant during the six months ended June 30, 2008 or the year ended December 31, 2007.

The total intrinsic value of the options exercised for the three months ended June 30, 2008 and 2007 was $1.6 million and $9.1 million, respectively, and the total fair value of options vested is $4.1 million and $0.5 million for the three months ended June 30, 2008 and 2007, respectively. The total intrinsic value of the options exercised during the six months ended June 30, 2008 and 2007 was $1.8 million and $12.1 million, respectively, and the total fair value of options vested was $12.4 million and $1.2 million for the six months ended June 30, 2008 and 2007, respectively.

Employee Stock Purchase Plan

On April 22, 2008, the Company’s stockholders approved an amendment to the ESPP which increased the number of shares authorized for issuance under the ESPP from 625,000 to 925,000 shares. The total number of remaining shares available for issuance under the ESPP at June 30, 2008 was 354,206. The total stock-based compensation expense recognized related to the ESPP under SFAS 123(R) for the three and six months ended June 30, 2008 was $35,000 and $0.4 million, respectively, and $0.4 million and $0.8 million for the three and six months ended June 30, 2007, respectively.

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Reserved Shares

The Company has reserved shares of common stock for future issuance under the 2008 Plan, the 2004 Plan and the ESPP as follows (shares in thousands):

11.  Related Party Transactions

Related Parties

The Company’s related parties include its directors, executive officers and GSK. Transactions with executive officers and directors include notes receivable, described below. Transactions with GSK are described in Note 5.

Robert V. Gunderson, Jr. is a director of the Company. The Company has engaged Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP, of which Mr. Gunderson is a partner, as its primary legal counsel. Fees totaling $0.3 million were incurred in the ordinary course of business for each of the six months ended June 30, 2008 and 2007, respectively.

Notes Receivable

The Company has provided loans to certain of its employees primarily to assist them with the purchase of a primary residence, which collateralizes the resulting loans. Interest receivable was approximately $29,000 and $26,000 as of June 30, 2008 and December 31, 2007, respectively, and is included in prepaid and other current assets. The Company accrues interest on the notes at rates of up to 8.0%. The outstanding loans at June 30, 2008 had maturity dates ranging from July 2008 to January 2013.

12.  Income Taxes

The Company adopted Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) effective January 1, 2007. The adoption of FIN 48 did not result in an adjustment to the beginning balance of the Company’s accumulated deficit.

Under FIN 48, the Company has unrecognized tax benefits of $33.2 million as of January 1, 2008. If the Company is eventually able to recognize these uncertain positions, $33.2 million of the unrecognized benefit would reduce its effective tax rate. The Company currently has a full valuation allowance against its net deferred tax asset which would impact the timing of the effective tax rate benefit should any of these uncertain tax positions be favorably settled in the future.

The Company is subject to federal and state examination for years 1996 and forward, by virtue of the tax attributes carrying forward from those years. There are no tax examinations currently in progress.

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

Forward-Looking Statements

The information in this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements involve substantial risks, uncertainties and assumptions. All statements contained herein that are not of historical fact, including, without limitation, statements regarding our strategy, future operations, future financial position, future revenues, projected costs, prospects, plans, intentions, expectations, goals and objectives, may be forward-looking statements. The words “anticipates,” “believes,” “designed,” “estimates,” “expects,” “intends,” “may,” “objective,” “plans,” “projects,” “pursue,” “will,” “would” and similar expressions (including the negatives thereof) are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions, expectations or objectives disclosed in our forward-looking statements and the assumptions underlying our forward-looking statements may prove incorrect. Therefore, you should not place undue reliance on our forward-looking statements. Actual results or events could materially differ from the plans, intentions, expectations and objectives disclosed in the forward-looking statements that we make. Factors that we believe could cause

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actual results or events to differ materially from our forward-looking statements include, but are not limited to those discussed below in “Risk Factors” in Item 1A of Part II and in the subsection entitled “Liquidity and Capital Resources” in this Item 2. All forward-looking statements in this document are based on information available to us as of the date hereof and we assume no obligation to update any such forward-looking statements.

Executive Summary

Theravance is a biopharmaceutical company with a pipeline of internally discovered product candidates. Theravance is focused on the discovery, development and commercialization of small molecule medicines across a number of therapeutic areas including respiratory disease, bacterial infections and gastrointestinal motility dysfunction. Our key programs include:  telavancin for the treatment of serious Gram-positive bacterial infections with Astellas Pharma Inc., the Horizon program with GlaxoSmithKline plc, and the Gastrointestinal Motility Dysfunction program. By leveraging our proprietary insight of multivalency to drug discovery focused primarily on validated targets, we are pursuing a next generation strategy designed to discover superior medicines in areas of significant unmet medical need.

Our net loss for the three months ended June 30, 2008 was $27.0 million compared to $45.1 million during the same period of 2007, or a 40% decrease. Revenue recognized under our collaboration agreements for the three months ended June 30, 2008 increased by 4% when compared to the same period of 2007. For the three months ended June 30, 2008, research and development costs decreased by 54% while general and administrative costs decreased by 23% when compared to the same period of 2007. For the three months ended June 30, 2008, we recorded restructuring charges totaling $5.1 million for reducing our workforce by approximately 40% in response to the completion of our Phase 3 development activities with telavancin and to reduce our overall cash burn rate. Cash, cash equivalents and marketable securities totaled $232.3 million at June 30, 2008, an increase of $103.1 million since December 31, 2007. This increase was primarily due to the net proceeds of $166.7 million received from our convertible subordinated notes offering in January 2008, offset by the net usage of cash in operations.

Following are updates on the progress of our clinical programs:

Respiratory Programs

Horizon

We expect completion of enrollment in the Phase 2b asthma dose-ranging study with GW642444 (‘444) in the third quarter 2008. The Phase 2b dose-ranging studies with the lead inhaled corticosteroid (ICS) GW685698 (‘698) for patients with mild asthma and for patients with severe asthma have recently completed enrollment. The Phase 2b study with ‘698 for patients with moderate asthma continues to enroll patients with results now expected in early 2009.

Enrollment remains on track for the large Phase 2b chronic obstructive pulmonary disease (COPD) dose-ranging study with the lead long-acting beta₂ agonist (LABA), ‘444. We expect to report top-line data from this study in the first half of 2009.

Inhaled Bifunctional Muscarinic Antagonist-Beta₂ Agonist (MABA) Program

We recently reported positive clinical results from our Phase 2 study in the MABA program with our lead investigational compound, GSK961081 (‘081), for the treatment of COPD. ‘081 administered once daily to COPD patients demonstrated 24-hour bronchodilation on day 14 that was statistically greater than placebo, and comparable to a combination therapy active control of salmeterol dosed twice daily plus tiotropium dosed once daily. ‘081 was generally well tolerated throughout the 14-day study. In conjunction with the successful achievement of proof-of-concept in this Phase 2 clinical study, we earned a milestone payment of $10.0 million from GlaxoSmithKline plc (GSK).

Inhaled Long-Acting Muscarinic Antagonist (LAMA) Program

We recently reported clinical results from our Phase 1 study in the LAMA program with our lead investigational compound, GSK1160724 (TD-4208), for the treatment of COPD. TD-4208 administered as a single dose to healthy volunteers was generally well tolerated, with a similar incidence of adverse events to placebo. In addition, TD-4208 demonstrated evidence of bronchodilation in volunteers sensitive to muscarinic antagonists. We also announced GSK’s intent to return the LAMA program to us because the current formulation of the compound is incompatible with GSK’s proprietary inhaler device. Both parties are currently discussing the transfer of information and materials back to us.

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Bacterial Infections Programs

Telavancin

We plan on submitting to the U.S. Food and Drug Administration (FDA) a New Drug Application (NDA) for telavancin in the treatment of hospital-acquired pneumonia (HAP) caused by Gram-positive bacteria including resistant pathogens such as methicillin-resistant Staphylococcus aureus (MRSA) in the fourth quarter 2008.

On July 24, 2008, we announced that the FDA had not yet made a decision regarding the NDA for telavancin for the treatment of complicated skin and skin structure infections (cSSSI). The Prescription Drug User Fee Act (PDUFA) date for action by the FDA was July 21, 2008, and as of August 6, 2008, we had not received an action letter from the FDA.

As previously announced, the FDA had indicated that it did not expect to take final action on the telavancin cSSSI NDA prior to completing its further evaluation of study site monitoring and study conduct in the ATLAS Phase 3 program, nor prior to resolution of the manufacturing issues not specifically related to telavancin that were cited in the approvable letter received in October 2007.

Telavancin is also under review for its safety and efficacy by regulatory authorities in Europe for the treatment of complicated skin and soft tissue infections and in Canada for the treatment of cSSSI.

Gastrointestinal (GI) Motility Dysfunction Program

We continue to evaluate the data and the study site audit from a previously conducted thorough QTc study of TD-5108, our lead compound, which evaluated the potential for QT prolongation. We currently anticipate initiating a drug-drug interaction (DDI) study later in 2008. We intend to meet with the FDA later in 2008 to discuss the thorough QTc study and appropriate next steps, including conducting another thorough QTc study if necessary. If we conduct another thorough QTc study, it likely would occur in the first half of 2009. We continue to evaluate the potential of this compound in chronic constipation, constipation-predominant irritable bowel syndrome and other indications.

Critical Accounting Policies

Restructuring Charges

As defined in Statement of Financial Accounting Standards No.146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146), we record costs and liabilities associated with exit and disposal activities at fair value in the period the liability is incurred. Restructuring charges consist of charges related to employee severance and benefits. Charges related to employee severance and benefits are determined based on the estimated severance and fringe benefit charge for identified employees. Our estimates of future liabilities may change, requiring us to record additional restructuring charges or reduce the amount of liabilities recorded. We will reassess restructuring accruals on a quarterly basis to reflect changes in the costs of the restructuring activities and we will record new restructuring accruals as liabilities are incurred.

As of the date of the filing of this quarterly report, we believe there have been no other material changes or additions, aside from the application of SFAS 146, to our critical accounting policies and estimates during the three and six months ended June 30, 2008 compared to those discussed in our Annual Report on Form 10-K filed on February 26, 2008 (2007 10-K).

Collaboration and Licensing Agreements

2005 License, Development and Commercialization Agreement with Astellas

In November 2005, we entered into a collaboration arrangement with Astellas for the development and commercialization of telavancin. In July 2006, Japan was added to our telavancin collaboration, thereby giving Astellas worldwide rights to this potential medicine. Through June 30, 2008, we had received $159.0 million in upfront, milestone and other fees from Astellas, which are being amortized ratably over the estimated period of performance (the estimated development and commercialization period). We recognized $2.7 million and $2.5 million in revenue for the three months ended June 30, 2008 and 2007, respectively, and $5.5 million and $4.6 million in revenue for the six months ended June 30, 2008 and 2007, respectively. As of June 30, 2008, we were eligible to receive up to $60.0 million in remaining milestone payments related to regulatory filings and approvals in various regions of the world.

If telavancin is commercialized, we will be entitled to receive royalties on global sales of telavancin by Astellas that, on a percentage basis, range from the high teens to the upper twenties depending on sales volume. Under this arrangement, we will be responsible for substantially all costs to develop and obtain U.S. regulatory approval for telavancin for cSSSI and

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HAP, and Astellas will be responsible for substantially all costs associated with commercialization and further development of telavancin.

Horizon Program with GSK

In November 2002, we entered into our Horizon collaboration agreement with GSK to develop and commercialize a LABA product candidate for the treatment of asthma and COPD. Each company contributed four LABA product candidates to the collaboration. Four large Phase 2b asthma studies commenced in December 2007, one with the lead LABA, ‘444 and three with the lead ICS ‘698, and in February 2008, a large Phase 2b COPD study with ‘444 was initiated.

We are entitled to receive the same royalties on product sales of medicines from the Horizon collaboration, regardless of whether the product candidate originated with Theravance or with GSK. The royalty structure is downward tiering and would result in an average percentage royalty rate in the low- to mid-teens at annual net sales of up to approximately $4.0 billion and the average royalty rate would decline to single digits at annual net sales of more than $6.0 billion for sales of single-agent LABA medicines and combination LABA/ICS medicines, which would be combined for the purposes of this royalty calculation. For other products combined with a LABA from the Horizon collaboration, such as a combination LABA/LAMA medicine, which are launched after a LABA/ICS combination medicine, royalties are upward tiering and range from the mid-single digits to 10%. However, if GSK is not selling a LABA/ICS combination product at the time that the first other LABA combination is launched, then the royalties described above for the LABA/ICS combination medicine are applicable.

As of June 30, 2008, we had received upfront and milestone payments from GSK of $60.0 million related to the clinical progress of our candidates. GSK has determined to focus the collaboration’s resources on the development of the lead LABA, ‘444, a GSK-discovered compound, together with the lead ICS. Accordingly, we do not expect to receive any further milestone payments from the Horizon program. In the event that a LABA product candidate discovered by GSK is successfully developed and commercially launched in multiple locations of the world, we will be obligated to make payments to GSK of up to $220.0 million. Based on available information, we do not estimate that a significant portion of these potential milestone payments to GSK are likely to be made in the next three years.

We recorded the upfront and milestone payments as deferred revenue and they are being amortized ratably over our estimated period of performance. Collaboration revenue was $1.7 million for each of the three months ended June 30, 2008 and 2007 and $3.4 million for each of the six months ended June 30, 2008 and 2007. Subsequent development milestones, if any, will be recorded as deferred revenue when received and amortized over the remaining period of performance. Additionally, certain costs related to the collaboration are reimbursable by GSK as an offset to research and development expense. For each of the three and six months ended June 30, 2008 and 2007, reimbursable costs related to the collaboration were not material.

2004 Strategic Alliance with GSK

In March 2004, we entered into our strategic alliance with GSK for the development and commercialization of product candidates in a variety of therapeutic areas. In connection with the strategic alliance, we received a $20.0 million payment from GSK in May 2004. This payment is being amortized over the initial period during which GSK may exercise its right to license certain of our programs under the agreement, which we currently estimate to be through September 2011.

The alliance provides GSK with an option to license exclusive development and commercialization rights to product candidates from all of our full drug discovery programs initiated prior to September 1, 2007, on pre-determined terms and on an exclusive, worldwide basis. The remaining programs that GSK has the right to license are (i) our peripheral Opioid-Induced Bowel Dysfunction (PUMA) program, (ii) our AT1 Receptor—Neprilysin Inhibitor hypertension (ARNI) program and (iii) our MonoAmine Reuptake Inhibitor chronic pain (MARIN) program. Upon licensing a program, GSK is responsible for funding all future development, manufacturing and commercialization activities for product candidates in that program. In addition, GSK is obligated to use diligent efforts to develop and commercialize product candidates from any program that it licenses. Consistent with our strategy, we are obligated at our sole cost to discover two structurally different product candidates for any programs that are licensed by GSK under the alliance. If these programs are successfully advanced through development by GSK, we are entitled to receive clinical, regulatory and commercial milestone payments based on performance and royalties on any sales of medicines developed from these programs. For product candidates licensed to date under this agreement, the royalty structure for a product containing one of our compounds as a single active ingredient would result in an average percentage royalty rate in the low double digits. If a product is successfully commercialized, in addition to any royalty revenue we receive, the total upfront and milestone payments that we could receive in any given program that GSK licenses range from $130.0 million to $162.0 million for programs with single-agent medicines and up to $252.0 million for programs with both a single-agent and a combination medicine. If GSK chooses not to license a program, we retain all rights to the program and may continue the program alone or with a third party. To date, GSK has licensed two

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of our COPD programs under the terms of the strategic alliance:  LAMA and MABA. GSK has chosen not to license our bacterial infections program, our anesthesia program and our Gastrointestinal Motility Dysfunction program. There can be no assurance that GSK will license any other programs under the terms of the alliance agreement or at all, which could have an adverse effect on our business and financial condition.

In August 2004, GSK exercised its right to license our LAMA program pursuant to the terms of the strategic alliance. We received a $5.0 million payment from GSK in connection with the licensing of this program. Through June 30, 2008, we received a milestone payment of $3.0 million from GSK related to clinical progress of our candidate. These payments are amortized ratably over the estimated period of performance (the product development period). We recognized $0.2 million for each of the three months ended June 30, 2008 and 2007 and $0.4 million for each of the six months ended June 30, 2008 and 2007 in revenue related to the LAMA. Additionally, we have been reimbursed by GSK for certain costs related to the LAMA program as an offset to research and development expense. For the three and six months ended June 30, 2008 and 2007, reimbursable costs were not material. We recently announced that GSK had informed us it intends to return the LAMA program to us because the current formulation of the lead product candidate, TD-4208, is incompatible with GSK’s proprietary inhaler device. We and GSK are currently discussing the transfer of information and materials to us and we intend to explore partnerships with other companies for the further development of TD-4208.

In March 2005, GSK exercised its right to license our MABA program pursuant to the terms of the strategic alliance. We received a $5.0 million payment from GSK in connection with the license of our MABA program. Through June 30, 2008, we received a milestone payment of $3.0 million from GSK related to clinical progress of our candidate and earned a $10.0 million milestone payment for the successful achievement of proof-of-concept in the MABA Phase 2 study.  We received the $10.0 million milestone payment from GSK in July 2008. These amounts are being amortized ratably over the estimated period of performance (the product development period). Collaboration revenue related to the MABA program was $0.3 million for each of the three months ended June 30, 2008 and 2007 and $0.5 million for each of the six months ended June 30, 2008 and 2007. The next milestone associated with the MABA program is payable upon initiation of a Phase 3 program. Additionally, we are reimbursed by GSK for certain costs related to the MABA program as an offset to research and development expense. Reimbursements for the three and six months ended June 30, 2008 and 2007 were not material.

RESULTS OF OPERATIONS

Revenue

Revenue for the three and six months ended June 30, 2008 and 2007 primarily consisted of the amortization of upfront and milestone payments from GSK related to our Horizon collaboration and our strategic alliance and from Astellas related to our telavancin collaboration. The table below reflects the upfront and milestone payments received and earned through June 30, 2008:

Upfront and milestone payments received and earned from GSK and Astellas have been deferred and are being amortized ratably into revenue over the applicable estimated performance periods with end dates ranging between 2011 and 2021. Future revenue will include the ongoing amortization of remaining deferred revenue, which consists of $136.4 million of upfront and milestone payments received through June 30, 2008 under our agreement with Astellas and $52.1 million of upfront and milestone payments received through June 30, 2008 under our agreements with GSK. Deferred revenue related to the LAMA license with GSK was $4.6 million at June 30, 2008. GSK recently informed us that it intends to return the LAMA program to us because the current formulation of the lead product candidate is incompatible with GSK’s proprietary

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inhaler device. As a result, we expect to recognize the remaining deferred revenue related to the LAMA license in the second half of 2008, pending the execution of an appropriate license agreement with GSK.

Research and development

Research and development expenses, as compared to the prior year periods, were as follows:

Research and development expenses decreased for the three and six months ended June 30, 2008 compared to the same periods in 2007 primarily due to a decrease in external costs, lower employee related expenses and stock-based compensation costs primarily due to the reduction in force.

External research and development costs decreased for the three and six months ended June 30, 2008 compared to the same periods in 2007 primarily due to the completion of our Phase 3 HAP studies for telavancin and our Phase 2 clinical studies for TD-5108, our GI Motility Dysfunction compound and for TD-1792, our investigational antibiotic.

Employee-related expenses decreased for the three and six months ended June 30, 2008 compared to the same periods in 2007 primarily due to lower costs related to our non-officer long-term bonus program. In addition, during the three months ended June 30, 2008, we reduced our non-officer long-term bonus accrual by $0.7 million due to the reduction in force. Stock-based compensation expenses decreased for the three and six months ended June 30, 2008 compared to the same periods in 2007 primarily due to the reduction in force. Stock-based compensation expense includes expenses related to employee stock options, restricted stock unit awards (RSUs), employee stock purchase plan issuances and the value of options and RSUs issued to non-employees for services rendered. Facilities, depreciation and other allocated expenses decreased for the three and six months ended June 30, 2008 compared to the same periods of 2007 primarily due to lower supplies and facilities administration costs in 2008.

During 2007, we granted performance-contingent RSUs to certain research and development employees, the vesting of which is tied to the successful achievement of certain corporate operating milestones during 2009, as well as a requirement for continued employment through certain dates in late 2009 and early 2010. The expense associated with these performance-contingent RSUs would be recognized in increments if the achievement of the performance conditions becomes probable. During the three months ended March 31, 2008, the Compensation Committee of our Board of Directors approved management’s recommendation to modify certain performance milestones and cancel 25% of the performance-contingent RSUs held by senior management, thereby reducing the maximum potential research and development expense to approximately $37.8 million, a decrease of $0.5 million from December 31, 2007. During the three months ended June 30, 2008, due to the reduction in force announced in April 2008, the maximum potential research and development expense was reduced to approximately $33.1 million, a decrease of $4.7 million from March 31, 2008. We determined that no requisite performance conditions were probable and as a result, no compensation expense was recognized during the period. In July 2008, the Compensation Committee amended the performance-contingent RSUs held by non-executive employees such that half of the shares underlying these RSUs will vest over time, and the other half will remain subject to certain performance targets. As a result, the maximum potential research and development expense associated with the performance-contingent RSUs, if all of the applicable performance milestones are successfully achieved on time, was further reduced to approximately $21.4 million.

Research and development expenses for the second half of 2008 are expected to be driven largely by costs associated with the preparation for and submission of our telavancin NDA for HAP and a Phase 3-enabling study with TD-5108. We anticipate personnel-related research and development expenses will decrease as a result of our workforce restructuring which was begun in the second quarter of 2008.

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Under our agreement with Astellas, we are responsible for completion of the cSSSI and HAP telavancin Phase 3 programs, publication of the results of these studies, preparation and submission of a NDA to the FDA for the cSSSI indication and subsequently for the HAP indication, and manufacture of approximately six months of first commercial sale stock for launch in the United States. The telavancin cSSSI NDA remains under regulatory review and we plan to submit our telavancin NDA for HAP late in the fourth quarter of 2008. We are reliant on the efforts of third parties, including contract research organizations, consultants and contract manufacturing organizations for the completion of these obligations. While we cannot predict the time frame in which all of these responsibilities will be completed, we anticipate that our aggregate external costs associated with our obligations with regard to telavancin described above will be towards the upper end of the range of $155.0 million to $165.0 million. In addition, if the regulatory approval of telavancin is substantially further delayed or denied by the necessary regulatory bodies, or if new information becomes available that suggests that the telavancin inventory will not be realizable, we may be required to expense a portion or all of the capitalized inventory costs and/or have additional inventory manufactured.

We have not provided program costs in detail because we do not track, and have not tracked, all of the individual components (specifically the internal cost components) of our research and development expenses on a program basis. We do not have the systems and processes in place to accurately capture these costs on a program basis.

General and administrative

General and administrative expenses, as compared to the prior year period, were as follows:

General and administrative expenses decreased for the three and six months ended June 30, 2008 compared to the same periods in 2007 primarily due to the reduction in force and lower external costs.

During 2007, we granted performance-contingent RSUs to certain general and administrative employees, the vesting of which is tied to the successful achievement of certain corporate operating milestones during 2009, as well as a requirement for continued employment through certain dates in late 2009 and early 2010. The expense associated with these performance-contingent RSUs would be recognized in increments if the achievement of the performance conditions becomes probable. During the three months ended March 31, 2008, the Compensation Committee of our Board of Directors approved management’s recommendation to modify certain performance milestone targets and cancel 25% of the performance-contingent RSUs held by senior management, thereby reducing the maximum potential general and administrative expense to approximately $21.8 million, a decrease of $6.2 million from December 31, 2007. During the three months ended June 30, 2008, due to the reduction in force announced in April 2008, the maximum potential general and administrative expense was reduced to approximately $20.3 million, a decrease of $1.5 million from March 31, 2008. We determined that no requisite performance conditions were probable and as a result, no compensation expense was recognized during the quarter. In July 2008, the Compensation Committee amended the performance-contingent RSUs held by non-executive employees such that half of the shares underlying these RSUs will vest over time, and the other half will remain subject to certain performance targets. As a result, the maximum potential general and administrative expense associated with the performance-contingent RSUs, if all of the applicable performance milestones are successfully achieved on time, was further reduced to approximately $17.3 million.

Restructuring charges

In response to the completion of our Phase 3 development activities with telavancin and to reduce our overall cash burn rate, we announced on April 21, 2008 a plan to reduce our workforce by approximately 40% through layoffs from all departments throughout our organization. On April 23, 2008, we notified the employees impacted by the plan. For the three months ended June 30, 2008, we recorded charges totaling $5.1 million related to severance, other termination benefits and outplacement services.

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The following table summarizes the accrual balance and utilization by cost type for the restructuring for the three months ended June 30, 2008:

The remaining accrual as of June 30, 2008 is related to employee severance and related benefits and is expected to be paid within the next six months. As such, the restructuring accrual is recorded as a current liability within accrued personnel-related expenses. Several of our employees impacted by the plan have future service requirements extending beyond June 30, 2008. As a result, we anticipate that approximately $0.7 million of additional severance and other termination benefits will be recognized over their service periods during the second half of 2008. The execution of the plan is expected to be completed by the end of 2008.

If we determine that any assets are impaired in the future, we may incur additional non-cash restructuring charges.

Interest and other income, net

Interest and other income, net, as compared to the prior year period, were as follows:

Interest and other income, net includes interest income earned on cash, cash equivalents and marketable securities, net realized gains on marketable securities, investment management fees on investments and net sublease income on facilities. Interest and other income, net decreased for the three and six months ended June 30, 2008 compared to the same periods in 2007 primarily due to a lower percentage of our portfolio being invested in corporate notes and securities, as well as lower average market rates of return during the periods in 2008.

We expect interest and other income to fluctuate in the future due to changes in average cash, cash equivalents and marketable securities balances and market interest rates.

Interest expense

Interest expense, as compared to the prior year period, was as follows:

*  Calculation is not meaningful

Interest expense primarily consists of interest expense and debt amortization costs on our convertible subordinated notes issued in January 2008, as well as interest expense on other debt arrangements. Interest expense increased for the three and six months ended June 30, 2008 compared to the same periods in 2007 primarily due to the interest expense on our convertible subordinated notes.

Income taxes

We adopted Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) effective January 1, 2007. The adoption of FIN 48 did not result in an adjustment to the beginning balance of our accumulated deficit. Under FIN 48, we have unrecognized tax benefits of $33.2 million as of January 1, 2008. If we are eventually able to recognize these uncertain positions, $33.2 million of the unrecognized benefit would reduce our effective tax rate. We currently have a full valuation allowance against our net deferred tax asset which would impact the timing of the effective tax rate benefit should any of these uncertain tax positions be favorably settled in the future.

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We are subject to federal and state examination for years 1996 and forward, by virtue of the tax attributes carrying forward from those years. We have no tax examinations currently in progress.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2008 and December 31, 2007, we had $232.3 million and $129.3 million, respectively, in cash, cash equivalents and marketable securities, in each case excluding $3.8 million in restricted cash that was pledged as collateral for certain of our leased facilities.

We believe that our cash, cash equivalents and marketable securities will be sufficient to meet our anticipated operating needs for at least the next twelve months based upon current operating and spending assumptions. If the activities related to telavancin, TD-5108, or our discovery programs are not successfully completed on schedule or cost significantly more than forecast; if the regulatory approval of telavancin is significantly further delayed; or if we are unsuccessful in our partnering activities, then the need for additional capital will increase. We cannot guarantee that future financing will be available in amounts or on terms acceptable to us, if at all. This could leave us without adequate financial resources to fund our operations as presently conducted.

Cash Flows

Cash flows, as compared to the prior year period, were as follows: