We start off in Boston at Sam Weiss' bowling alley. Agent Olivia Dunham shows up to return her shoes (they let you keep them? Poor alley management). Dunham says that she got her memories back so she won't need Sam's help anymore. He lends a sympathetic ear about Agent Charlie Francis' death (where was he when we needed him a few episodes ago?!).
He offers Dunham another "project" to help her make sense of it all, adding that her life is something like a nightmare. As he slips her a piece of paper with the new project on it, he says "I hope you don't have anything against the color red."
In Seattle, a man named Greg - with ill-fitting suit pants - walks into his office. He's told that his boss is not pleased with him. As he heads towards his boss's office, his co-workers all appear as monsters to him. He walks into his boss's conference room and the boss immediately lays into him. Big mistake. Greg sees his boss as a demon, and strikes him with his briefcase, again and again. As he is pulled off of the bloodied boss, we see Greg's eyes shoot wildly about.
In Boston, Walter and Peter Bishop are moving into their new apartment. Walter sets up his bed in the middle of the living room, much to the disdain of Peter. "Don't worry, son," he says. "I promise to wear my shorts to bed so if you bring any young ladies home there won't be any embarrassing moments." Agent Astrid Farnsworth arrives with a housewarming present - bread for good luck. She also gives Peter a case file on Seattle Greg, adding "Whatever happened to that man wasn't normal." Peter tells Walter to pack a bag; they're going to Seattle.
In Seattle, Dunham and the Bishops visit Greg at the hospital. We learn that he's been asleep for 16 hours (nice life). Walter appears to be uncomfortable and does not want to go in and meet with Greg. Dunham and Peter interview Greg, who reveals that he cannot remember anything from his attack. He says that it seemed like the office had been infiltrated by "creatures" and his boss was their leader. As he revisits this, he begins to have a seizure in his hospital bed and dies, but not before his hair turns stark white.
Walter and Peter perform an autopsy on Greg, and Peter notes that Walter has been acting weird ever since they arrived in Seattle. Walter determines that Greg died of acute exhaustion. Walter asks that the body be sent back to his lab in Boston and tells Peter that he does not like Seattle - it "has a smell. It's wet." The whole city reminds him of the insane asylum he lived in (Fox will not be hired to do Seattle's tourism commercials). He begs Peter to go home, telling him to stay and help Agent Dunham. As they prepare to send Walter back to Boston, Agent Dunham asks the Seattle doctor for a business card. Odd; she also asked their cab driver for a business card, too.
Dunham and Peter interview Greg's widow. Peter asks if Greg had any sleep issues; apparently, he used to sleepwalk. The widow says that he saw a number of specialists and was cured of his ailment. Dunham asks for the names of the specialists; Peter asks to if Greg kept a "sleep journal". (We keep one of these. It reads: Dear Journal, ZZzzzzzz").
In Boston, Walter has gotten the body back to his lab. The agent who shepherded him home seems quite frazzled by the trip. During the autopsy, Walter finds an odd incision in Greg's body.
At the hotel in Seattle, after they compare pajamas, Peter and Dunham discuss Greg's sleep journal. Peter says that Greg was having nightmares about demons - much like the ones he saw at the office. He reveals that he used to have nightmares as a child until Walter helped him. As they discuss this, Dunham receives a message: there's been another incident. A woman drover her car into a motorcyclist and then died at the scene, her hair turned bright white. The dead woman's husband tells Dunham that he was on the phone with her during the accident. She told him that she saw a monster.
Back in Boston, Walter removes Greg's brain, with help from Astrid and Agent Kashner, who seems less than pleased to be assisting. Walter finds a computer chip in Greg's brain and calls Peter. The computer chip is located on the part of the brain that regulates sleep. Peter looks at the body of the dead woman in Seattle and finds a similar incision on her neck.
In New York, Agent Broyles discusses the computer chip with Nina Sharp. Massive Dynamic has determined that the chip acts much like a pacemaker, monitoring sleep cycles. It has been traced back to a doctor in Seattle. Dunham and Peter go to meet with this researcher, Dr. Nayak. Both Greg and Ellen - the woman in the car accident - were patients of the good doctor. The doctor confesses to putting the chips in Ellen and Greg's brains; he says that it was part of a study that has 80 more subjects.
Dr. Nayak brings Dunham and Peter back to his office, which they find in shambles; someone has broken in and stolen the patients' files. Dr. Novak asks his research assistant, Zach - who looks shifty - for the names of the test subjects. The computer chip has apparently cured all the major sleep disorders; Dr. Nayak cannot figure out why people would be acting in such a way. Dunham asks Dr. Novak for his business card.
Peter tells Dunham and Walter that he thinks the chip is being used as a type of mind control. Walter says he could test the chip to determine what it can do, but would like a student subject to test it on. Peter makes him promise that he won't do this. "All right, no students," Walter agrees.
As Peter and Dunham discuss the case, Dunham's glances at a picture of her and Agent Charlie Francis; she becomes still. Peter tells her that whatever it was that she killed, it wasn't Charlie Francis. Dunham tells the story of the first time she met Charlie Francis and says that she has to face it that Charlie is gone and is not coming back. She leaves, barely containing her tears as she makes her exit.
Meanwhile, in a Dr. Klaw-esque lab, a man accesses Dr. Nayak's list of sleep patients before coming across the file of a waitress. The man chooses to access the bio-chip. We see Zach, Dr. Nayak's assistant, ask the mystery man if he really wants to increase her dose. As he does so, we see the waitress begin to feel the affects. Hamburgers and hot dogs on the grill suddenly become human hands. She picks up a butcher's knife and advances towards the chef.
In Boston, Walter asks Agent Kashner to smell something for him. Kreshner determines that the concoction smells like raspberry...and then promptly passes out.
In Seattle, Agent Dunham gets a call from Sam Weiss. He asks her if she got the business cards, and reveals that he asked her to get a business card from everyone that was wearing red (just our luck - we were wearing pink tonight). He tells her to lay the eight business cards out in front of her and tells her to circle a letter in every name, both first and last, on the cards. He tells her to write all those letters down and then find the phrase in that jumble of letters. He tells her that she'll find whatever she needs to hear. Agent Broyles interrupts the exercise by telling Dunham that Dr. Nayak's files have been wiped clean.
The doctor cannot believe that anyone on his staff would do such a thing. Whoever is doing it has done it again; Peter arrives to tell Dunham that there's been another attack - at the restaurant, where Diane, the waitress, has killed a co-worker (who she accuses of being a cannibal) before she died. Dr. Nayak tells Dunham and Peter that Zach, his lab assistant, skipped work. As they go search his apartment, Dr. Nayak finds a note at his office. The note warns him to "stop talking to the feds or wind up like Zach." Dunham and Peter find Zach dead in his apartment.
In Boston, Walter admits to Astrid that he drugged Agent Kashner. Walter is testing the chip on Kashner; however, instead of implanting the chip on Kashner's brain, Walter is using a net device to replicate the chip's effects. Walter synchs his brain to the sleeping Kashner's, and begins to understand what the chip can do.
In Seattle, Dunham and Peter meet with Dr. Nayak and let hum know that they will catch the person behind the attacks. After they leave, the doctor calls a phone number and leaves a message: "I told them. I showed them your damn note. So you might as well stop." Walter calls Peter and lets him know that the chips aren't mind contol devices, but are instead are processing massive amounts of data: they are stealing dreams. Walter believes that the chips have the capability to turn on a dream state while the subjects are awake, triggering the attacks. Walter surmises that someone is stealing these dreams to experience them for himself. Dunham says that they are dealing with an addict. Dunham reveals that her step-father was an addict, a drunk. He had two personalities - one when he was sober and one when he wasn't, as if he were two different people.
Dunham compares the handwriting in the list of patients Dr. Nayak gave them to the death threat he received. The handwriting matches. At the doctor's house, he plays his answering machine messages - hearing the same message he left earlier, telling himself to stop. The doctor heads to his basement and logs into his Dr. Klaw computer, pulling up another subject. As the doctor lounges in his chair, getting high off the dreams, we see the chip take hold of his latest subject - a small plane pilot. The man, Jack, looks at his co-pilot and sees a distorted face. He aims the sea plane at a cruise ship anchored in the harbor. Dunham and Peter storm the doctor's home and find that he's logged into Jack's dreams. Dunham fires into the computer, breaking the link with the dream. The good doctor is killed when the link is severed; luckily for the sea plane pilot and his passengers, the plane's flight attendant pulls a Karen Black and saves the plane from disaster.
Back in Boston, Dunham visits the grave of Charlie Francis. After leaving the site, she tries the word jumble that Sam Weiss told her to do. As the letters become clear, she reads the phrase "You're gonna be fine."
In his new apartment, Peter awakes from a dream in which he remembers a childhood memory: young Peter waking up in a dark room, asking his father what's wrong. As young Peter screams, he is pulled from his bed. In the present, Walter tells Peter that he was talking in his sleep. Peter recounts the dream. As the episode ends, Walter asks Peter, "And the rest, you don't remember it?" Peter tells him that he does not; Walter looks worried at the screen fades to black.