I got that timeout before, but after unplugging and pluging the USB in, it took off.
When you switch the jumper to UP and plug it back in, does the red D5 LED come on in the front?
I did some further messing and got the timeout while playing with the height of the shield just a tiny bit. I pushed it back down and it took off uploading (after unplugging and plugging the USB). I really hate intermittent problems!
You do not have to pull the Atmega, the shield holds the microcontroller in reset when you put it in UP or PC so it uses your 16u2 chip to talk to the shield not the Atmega.