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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended March 31, 2006



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from
to

Commission File No. 000  50564



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RENOVIS, INC.

(Exact Name of Registrant as Specified in its Charter)



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|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|DELAWARE                                                       |  | 94-3353740                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)
|                                                               | 
|TWO CORPORATE DRIVE SOUTH SAN FRANCISCO, CALIFORNIA            |  | 94080                                  
|(Address of principal executive offices)                       |  | (Zip Code)                             

(650) 266-1400

Registrants telephone number, including area code



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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 ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined Rule 12b-2 of the Exchange Act). Check one:

Large accelerated filer ̈Accelerated filer   x                Non-accelerated filer ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ̈No  x

As of May 2, 2006, there were 29,221,705 shares of the registrants common stock, $.001 par value, outstanding, which is the only class of common or voting stock of the registrant issued.



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##### Table of Contents

Renovis, Inc.

INDEX



|           |  |                                                                                               |  |     
|---------- |  | --------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                               |  | Page
|Part I.    |  | Financial Information                                                                         |  |     
|           |  |                                                                                              
|           |  | Item 1. Financial Statements (Unaudited)                                                      |  |     
|           |  |                                                                                              
|           |  | Condensed Balance Sheets  March 31, 2006 and December 31, 2005                               |  | 3   
|           |  |                                                                                              
|           |  | Condensed Statements of Operations  Three Months ended March 31, 2006 and 2005               |  | 4   
|           |  |                                                                                              
|           |  | Condensed Statements of Cash Flows  Three months ended March 31, 2006 and 2005               |  | 5   
|           |  |                                                                                              
|           |  | Notes to Condensed Financial Statements                                                       |  | 6   
|           |  |                                                                                              
|           |  | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 12  
|           |  |                                                                                              
|           |  | Item 3. Quantitative and Qualitative Disclosures About Market Risk                            |  | 17  
|           |  |                                                                                              
|           |  | Item 4. Controls and Procedures                                                               |  | 17  
|           |  |                                                                                              
|Part II.   |  | Other Information                                                                             |  |     
|           |  |                                                                                              
|           |  | Item 1. Legal Proceedings                                                                     |  | 18  
|           |  |                                                                                              
|           |  | Item 1A. Risk Factors                                                                         |  | 18  
|           |  |                                                                                              
|           |  | Item 2. Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 26  
|           |  |                                                                                              
|           |  | Item 3. Defaults Upon Senior Securities                                                       |  | 26  
|           |  |                                                                                              
|           |  | Item 4. Submission of Matters to a Vote of Security Holders                                   |  | 26  
|           |  |                                                                                              
|           |  | Item 5. Other Information                                                                     |  | 26  
|           |  |                                                                                              
|           |  | Item 6. Exhibits                                                                              |  | 26  
|           | 
|Signatures |  | 27                                                                                           



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##### Table of Contents

RENOVIS, INC.

CONDENSED BALANCE SHEETS

(unaudited)

(in thousands, except share and per share data)



|                                                                                                                                                                                                                     |  |               |          |   |                  |   |          |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                                                                                                     |  | March 31,2006 |          |   | December 31,2005 |  
|Assets:                                                                                                                                                                                                              |  |               |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                                                                                            |  | $             | 73,273   |   |                  | $ | 8,149    |  
|Short-term investments                                                                                                                                                                                               |  |               | 39,670   |   |                  |   | 110,740  |  
|Prepaid expenses and other current assets                                                                                                                                                                            |  |               | 1,342    |   |                  |   | 1,082    |  
|                                                                                                                                                                                                                     |  |               |          |   |                  |   |          |  
|Total current assets                                                                                                                                                                                                 |  |               | 114,285  |   |                  |   | 119,971  |  
|                                                                                                                                                                                                                     |  |               |          |   |                  |   |          |  
|                                                                                                                                                                                                                     |  |              
|Property and equipment, net                                                                                                                                                                                          |  |               | 7,303    |   |                  |   | 6,428    |  
|Other assets                                                                                                                                                                                                         |  |               | 176      |   |                  |   | 213      |  
|                                                                                                                                                                                                                     |  |               |          |   |                  |   |          |  
|                                                                                                                                                                                                                     |  | $             | 121,764  |   |                  | $ | 126,612  |  
|                                                                                                                                                                                                                     |  |               |          |   |                  |   |          |  
|                                                                                                                                                                                                                     |  |              
|Liabilities and stockholders equity:                                                                                                                                                                                |  |               |          |   |                  |   |          |  
|Current liabilities                                                                                                                                                                                                  |  |               |          |   |                  |   |          |  
|Accounts payable                                                                                                                                                                                                     |  | $             | 1,289    |   |                  | $ | 1,050    |  
|Accrued compensation                                                                                                                                                                                                 |  |               | 1,362    |   |                  |   | 2,018    |  
|Loan payable, current portion                                                                                                                                                                                        |  |               | 1,593    |   |                  |   | 1,531    |  
|Deferred revenue, current portion                                                                                                                                                                                    |  |               | 5,900    |   |                  |   | 5,328    |  
|Other accrued liabilities                                                                                                                                                                                            |  |               | 1,526    |   |                  |   | 1,715    |  
|                                                                                                                                                                                                                     |  |               |          |   |                  |   |          |  
|Total current assets                                                                                                                                                                                                 |  |               | 11,670   |   |                  |   | 11,642   |  
|                                                                                                                                                                                                                     |  |               |          |   |                  |   |          |  
|                                                                                                                                                                                                                     |  |              
|Loan payable, noncurrent portion                                                                                                                                                                                     |  |               | 2,736    |   |                  |   | 2,908    |  
|Deferred revenue, noncurrent portion                                                                                                                                                                                 |  |               | 1,250    |   |                  |   | 2,500    |  
|Other long-term liabilities                                                                                                                                                                                          |  |               | 895      |   |                  |   | 964      |  
|                                                                                                                                                                                                                     |  |              
|Commitments                                                                                                                                                                                                          |  |               |          |   |                  |   |          |  
|Stockholders equity:                                                                                                                                                                                                |  |               |          |   |                  |   |          |  
|Preferred stock, $0.001 par value; 5,000,000 shares authorized at March 31, 2006 and December 31, 2005; none issued and
outstanding                                                                                  |  |               |         |   |                  |   |         |  
|Common stock, $0.001 par value; 100,000,000 shares authorized at March 31, 2006 and December 31, 2005; 29,063,929 and 28,927,205 shares
issued and outstanding at March 31, 2006 and December 31, 2005, respectively |  |               | 29       |   |                  |   | 29       |  
|Additional paid-in capital                                                                                                                                                                                           |  |               | 266,314  |   |                  |   | 267,454  |  
|Deferred stock compensation                                                                                                                                                                                          |  |               |         |   |                  |   | (4,898   | )
|Accumulated other comprehensive loss                                                                                                                                                                                 |  |               | (33      | ) |                  |   | (25      | )
|                                                                                                                                                                                                                     |  |              
|Accumulated deficit                                                                                                                                                                                                  |  |               | (161,097 | ) |                  |   | (153,962 | )
|                                                                                                                                                                                                                     |  |               |          |   |                  |   |          |  
|Stockholders equity                                                                                                                                                                                                 |  |               | 105,213  |   |                  |   | 108,598  |  
|                                                                                                                                                                                                                     |  |               |          |   |                  |   |          |  
|                                                                                                                                                                                                                     |  | $             | 121,764  |   |                  | $ | 126,612  |  
|                                                                                                                                                                                                                     |  |               |          |   |                  |   |          |  

See accompanying notes.



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RENOVIS, INC.

CONDENSED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except share and per share data)



|                                                            |  |                              |            |   |      |   |            |  
|----------------------------------------------------------- |  | ---------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                            |  | Three Months Ended March 31, |           
|                                                            |  | 2006                         |            |   | 2005 |  
|                                                            |  |                             
|Contract revenue                                            |  | $                            | 2,478      |   |      | $ | 656        |  
|Operating expenses:                                         |  |                              |            |   |      |   |            |  
|Research and development                                    |  |                              | 6,872      |   |      |   | 8,415      |  
|General and administrative                                  |  |                              | 3,903      |   |      |   | 2,533      |  
|                                                            |  |                              |            |   |      |   |            |  
|Total operating expenses                                    |  |                              | 10,775     |   |      |   | 10,948     |  
|                                                            |  |                             
|Loss from operations                                        |  |                              | (8,297     | ) |      |   | (10,292    | )
|Interest income                                             |  |                              | 1,262      |   |      |   | 413        |  
|Interest expense                                            |  |                              | (100       | ) |      |   | (111       | )
|                                                            |  |                              |            |   |      |   |            |  
|Net loss                                                    |  | $                            | (7,135     | ) |      | $ | (9,990     | )
|                                                            |  |                              |            |   |      |   |            |  
|                                                            |  |                             
|Basic and diluted net loss per share                        |  | $                            | (0.25      | ) |      | $ | (0.41      | )
|                                                            |  |                              |            |   |      |   |            |  
|                                                            |  |                             
|Shares used to compute basic and diluted net loss per share |  |                              | 28,976,250 |   |      |   | 24,527,116 |  
|                                                            |  |                              |            |   |      |   |            |  

See accompanying notes.



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RENOVIS, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)



|                                                                            |  |                             |         |   |      |   |         |  
|--------------------------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                            |  | Three Months EndedMarch 31, |        
|                                                                            |  | 2006                        |         |   | 2005 |  
|Cash flows from operating activities                                        |  |                             |         |   |      |   |         |  
|Net Loss                                                                    |  | $                           | (7,135  | ) |      | $ | (9,990  | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                             |         |   |      |   |         |  
|Loss on sale of fixed assets                                                |  |                             |        |   |      |   | 186     |  
|Depreciation and amortization                                               |  |                             | 436     |   |      |   | 753     |  
|Employee stock-based compensation                                           |  |                             | 2,296   |   |      |   | 1,032   |  
|Noncash interest and issuance of equity                                     |  |                             | 964     |   |      |   | 252     |  
|Changes in assets and liabilities:                                          |  |                             |         |   |      |   |         |  
|Prepaids and other assets                                                   |  |                             | (223    | ) |      |   | (644    | )
|Accounts payable                                                            |  |                             | 239     |   |      |   | (1,049  | )
|Accrued compensation                                                        |  |                             | (656    | ) |      |   | (293    | )
|Deferred revenue                                                            |  |                             | (678    | ) |      |   | (656    | )
|Other accrued liabilities                                                   |  |                             | (235    | ) |      |   | 29      |  
|                                                                            |  |                             |         |   |      |   |         |  
|Net cash used in operating activities                                       |  |                             | (4,992  | ) |      |   | (10,380 | )
|Cash flows from investing activities                                        |  |                             |         |   |      |   |         |  
|Capital expenditures                                                        |  |                             | (1,312  | ) |      |   | (820    | )
|Purchase of short-term investments                                          |  |                             | (23,963 | ) |      |   | (8,610  | )
|Sales of short-term investments                                             |  |                             | 87,625  |   |      |   | 12,650  |  
|Maturities of short-term investments                                        |  |                             | 7,400   |   |      |   | 7,100   |  
|                                                                            |  |                             |         |   |      |   |         |  
|Net cash provided by investing activities                                   |  |                             | 69,750  |   |      |   | 10,320  |  
|Cash flows from financing activities                                        |  |                             |         |   |      |   |         |  
|Principal payments on loan payable                                          |  |                             | (403    | ) |      |   | (399    | )
|Proceeds from loan payable                                                  |  |                             | 293     |   |      |   | 963     |  
|Proceeds from issuance of common stock, net of repurchases                  |  |                             | 476     |   |      |   | 376     |  
|                                                                            |  |                             |         |   |      |   |         |  
|Net cash provided by financing activities                                   |  |                             | 366     |   |      |   | 940     |  
|Net increase in cash and cash equivalents                                   |  |                             | 65,124  |   |      |   | 880     |  
|Cash and cash equivalents at beginning of period                            |  |                             | 8,149   |   |      |   | 5,580   |  
|                                                                            |  |                             |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                  |  | $                           | 73,273  |   |      | $ | 6,460   |  

See accompanying notes.



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RENOVIS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(unaudited)

1. Summary of Significant Accounting
Policies

The Company and Nature of Operations

Renovis, Inc. (the Company or Renovis) was incorporated in the State of Delaware on January 5, 2000. We are a biopharmaceutical company primarily focused on the discovery and development of drugs to treat neurological diseases and
disorders. We are located in South San Francisco, California.

The Company has sustained operating losses since inception and expects such losses to
continue over the next several years. Management plans to continue to finance the Companys operations with a combination of equity issuances, debt arrangements and revenues from corporate alliances with pharmaceutical companies. If adequate
funds are not available, the Company may be required to delay, reduce the scope of, or eliminate one or more of its research or development programs.

Basis of Preparation

The Company has prepared the condensed financial statements following the requirements of the Securities and
Exchange Commission for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. generally accepted accounting principles can be condensed or omitted. In the opinion of
management, the financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results. Revenues, expenses, assets and liabilities can vary during
each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year. The information included in this quarterly report on Form 10-Q should be read in conjunction with the
financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2005.

The condensed balance
sheet amounts at December 31, 2005, have been derived from audited financial statements.

Reclassifications

Certain reclassifications have been made to prior period amounts to conform to the current period presentation.

Use of Estimates

The preparation of financial statements in
conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those
estimates.

Business Segments

Statement of
Financial Accounting Standards (SFAS) No. 131,Disclosures about Segments of an Enterprise and Related Information, requires an enterprise to report segment information based on how management internally evaluates the operating
performance of its business units (segments). Our operations are confined to one business segment: the development of drugs to treat neurological diseases and disorders.

Revenue Recognition

The Companys revenues are generated by complex collaborative research and licensing
arrangements. Revenues under such agreements may include upfront payments, research funding, milestone payments and royalties. In accordance with Emerging Issues Task Force (EITF) Issue No. 00-21,Revenue Arrangements with Multiple
Deliverables, we evaluate whether the delivered element under these arrangements has value to our collaborative partner or licensee on a stand-alone basis and whether objective and reliable evidence of fair value of the undelivered element
exists. Arrangements with multiple deliverables that do not meet these criteria are treated as one unit of accounting for the purposes of revenue recognition.

Revenues from nonrefundable upfront technology license fees, for product candidates where we are providing continuing services related to product development, are deferred and recognized as revenues ratably over the estimated period of
performance under the research agreement. The performance period is estimated at the inception of the arrangement and is periodically reevaluated. The reevaluation of the performance period may shorten or lengthen the period during which the
deferred revenue is recognized which would result in an acceleration or delay of expected revenue recognition.

Research funding is recognized as revenue
as the related effort is performed.

Milestone payments we receive under collaborative arrangements are recognized as revenues upon achievement of the
milestone events, which represent the culmination of the earnings process, and when collectability is reasonably assured. Milestone payments are triggered either by the results of our research efforts or by events external to us, such as regulatory
approval to market a product or the achievement of specified sales levels by a marketing partner or licensee. Accordingly, the milestone payments are substantially at risk at the inception of the contract, and the amounts of the payments assigned
thereto are commensurate with the milestone achieved. Upon the achievement of a milestone event, we have no future performance obligations related to that milestone as the milestone payments we receive are nonrefundable.



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Stock-based Compensation

On January 1, 2006, we adopted SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)), that addresses the accounting for share-based payment transactions in which an enterprise receives
employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprises equity instruments or that may be settled by the issuance of such equity instruments. The
statement eliminates the ability to account for share-based compensation transactions, as we formerly did, using the intrinsic value method as prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees(APB 25), and generally requires that such transactions be accounted for using a fair-value-based method and recognized as expenses in our statement of operations. Prior to January 1, 2006, we accounted for options granted to employees
using the intrinsic value method in accordance with APB 25.

We adopted SFAS 123(R) using the modified prospective method which requires the
application of the accounting standard as of January 1, 2006. Our financial statements as of and for the first quarter of 2006 reflect the impact of adopting SFAS 123(R). In accordance with the modified prospective method, the financial
statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). See Note 7 Stock-based Compensation for further details.

Stock-based compensation expense recognized during the period is based on the value of the portion of stock-based payment awards that is ultimately expected to vest.
Stock-based compensation expense recognized in the statement of operations during the first quarter of 2006 included compensation expense for stock-based payment awards granted prior to, but not yet vested, as of December 31, 2005 based on the
grant date fair value estimated in accordance with the pro forma provisions of SFAS 148 and compensation expense for the stock-based payment awards granted subsequent to December 31, 2005, based on the grant date fair value estimated in
accordance with SFAS 123(R). As stock-based compensation expense recognized in the statement of operations for the first quarter of 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures.
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. In the pro forma information required under SFAS 148 for the periods prior
to 2006, we accounted for forfeitures as they occurred.

2. Comprehensive Loss

SFAS No. 130,Reporting Comprehensive Income, requires components of other comprehensive income, including gains and losses on available-for-sale investments, to be included as part of total comprehensive
income. Comprehensive loss for the three months ended March 31, 2006 and 2005 are as follows (in thousands):



|                                                         |  |                             |        |   |      |   |        |  
|-------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                                         |  | Three Months EndedMarch 31, |       
|                                                         |  | 2006                        |        |   | 2005 |  
|Net loss                                                 |  | $                           | (7,135 | ) |      | $ | (9,990 | )
|Unrealized gains (loss) on available-for-sale securities |  |                             | (8     | ) |      |   | 17     |  
|                                                         |  |                             |        |   |      |   |        |  
|Comprehensive loss                                       |  | $                           | (7,143 | ) |      | $ | (9,973 | )

3. Net Loss Per Share

Basic net loss per share is calculated by dividing the net loss by the weighted-average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted net loss per share is computed by
dividing the net loss by the weighted-average number of common share equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, common stock subject to repurchase by the Company, preferred
stock, options and warrants are considered to be common stock equivalents and are only included in the calculation of diluted net loss per share when their effect is dilutive.



|                                                                                          |  |                                                |            |   |      |   |            |  
|----------------------------------------------------------------------------------------- |  | ---------------------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                          |  | Three Months Ended March 31,                   |           
|                                                                                          |  | 2006                                           |            |   | 2005 |  
|                                                                                          |  | (in thousands, except share andper share data) |           
|Historical:                                                                               |  |                                                |            |   |      |   |            |  
|Numerator:                                                                                |  |                                                |            |   |      |   |            |  
|Net loss(1)                                                                               |  | $                                              | (7,135     | ) |      | $ | (9,990     | )
|                                                                                          |  |                                                |            |   |      |   |            |  
|Denominator:                                                                              |  |                                                |            |   |      |   |            |  
|Weighted average common shares outstanding                                                |  |                                                | 29,052,204 |   |      |   | 24,690,528 |  
|Less: Weighted average unvested common shares subject to repurchase                       |  |                                                | (75,954    | ) |      |   | (163,412   | )
|                                                                                          |  |                                                |            |   |      |   |            |  
|Denominator for basic and diluted net loss per share                                      |  |                                                | 28,976,250 |   |      |   | 24,527,116 |  
|                                                                                          |  |                                                |            |   |      |   |            |  
|Basic and diluted net loss per share(1)                                                   |  | $                                              | (0.25      | ) |      | $ | (0.41      | )
|                                                                                          |  |                                                |            |   |      |   |            |  
|Historical outstanding dilutive securities not included in net loss per share calculation |  |                                                |            |   |      |   |            |  
|Preferred stock                                                                           |  |                                                |           |   |      |   |           |  
|Options to purchase common stock                                                          |  |                                                | 3,767,002  |   |      |   | 3,113,014  |  
|Warrants                                                                                  |  |                                                | 33,358     |   |      |   | 57,222     |  
|                                                                                          |  |                                                |            |   |      |   |            |  
|                                                                                          |  |                                                | 3,800,360  |   |      |   | 3,170,236  |  
|                                                                                          |  |                                                |            |   |      |   |            |  



|(1) | Net loss for the three months ended March 31, 2006 includes $2,296,000 of stock-based
compensation expense. The effect of recording stock-based compensation expense on basic and diluted loss per share was $(0.08) per share for the three months ended March 31, 2006.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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4. Collaboration Agreements

Pfizer

On May 26, 2005, the Company entered into a collaborative research agreement and a license and royalty agreement with
Pfizer to research, develop and commercialize small molecule compounds which work by targeting the vanilloid receptor (VR1). The collaboration focuses on treatments for pain, urinary incontinence and other diseases and disorders.

Under the agreements, the Company received an upfront license fee of $10,000,000 in July 2005. In addition to the upfront license fee, the agreements with Pfizer also
provide the Company with research funding in excess of $7,000,000 over a two-year research period. Pfizer also has the option to extend the agreements for up to two additional years subject to additional funding requirements. Additionally, the
Company will be eligible to receive research, development, approval and commercialization milestone payments resulting in total potential payments to the Company greater than $170,000,000 through successful achievement of research development and
commercialization milestones for each product candidate resulting from the collaboration. Upon commercialization of a product resulting from the collaboration, the Company would be entitled to receive royalties on net sales by Pfizer.

The Company applied EITF Issue No. 00-21 in evaluating the appropriate accounting for the agreements, which became effective on June 28, 2005. In accordance with
this guidance, the Company identified the initial license transfer and the research and development services as the deliverables under the agreements and concluded that they should be accounted for as a single unit of accounting based upon the
determination that these deliverables were linked and did not have stand-alone value. The Company also determined that the achievement of each milestone for which it is eligible for milestone payments represents a separate earnings process. The
Company believes that each of these milestones, such as the commencement of a Phase I clinical trial or the filing of an NDA, is well-defined, substantive, measurable and reasonable relative to risk and effort. Accordingly, the Company concluded
that such payments should be recognized as revenue when the milestone is achieved and collectability is reasonably assured.

In accordance with the
evaluation discussed above, the Company began amortizing the upfront payment from Pfizer ratably in the third quarter of 2005 over the estimated research term of two years. The Company also began recognizing the research funding in the third quarter
of 2005. During the three months ended March 31, 2006, the Company recognized $2,150,000 in revenue related to the agreements. As of March 31, 2006, deferred revenue under the agreements was $7,150,000.

Genentech

On December 31, 2003, the Company entered into
a collaborative research, development and license agreement with Genentech for the discovery and development of drugs that inhibit pathological or tumor angiogenesis and promote nerve re-growth following nervous system injury. Under the terms of the
agreement, Genentech paid the Company an upfront license and technology access fee of $5,250,000 in January 2004 and made a $3,000,000 equity purchase concurrent with our initial public offering. The Company deferred the $5,250,000 upfront payment
and began recognizing it on a straight-line basis over the two-year estimated research period of the agreement. In July 2005, we revised the estimated completion date of the research period under the agreement by two months to February 2006 from our
previous estimate of December 2005. Accordingly, we recognized the remaining deferred revenue on a straight-line basis through February 2006. The Company recognized $328,000 and $656,000 in revenue related to this agreement during the three months
ended March 31, 2006 and 2005, respectively. The funded research period under this agreement ended in February 2006. The agreement with Genentech remains in effect and we will continue to coordinate our separate research efforts through the
Joint Research Committee that was established to guide the program. We are eligible to receive future milestones and royalty payments on therapeutic products emerging from the collaboration that are developed and commercialized by Genentech.

5. Other Current Accrued Liabilities

Other current
accrued liabilities consist of the following (in thousands):



|                                              |  |               |       |                  |   |      
|--------------------------------------------- |  | ------------- | ----- | ---------------- | - | -----
|                                              |  | March 31,2006 |       | December 31,2005
|Professional fees                             |  | $             | 745   |                  | $ | 569  
|Facilities-related                            |  |               | 143   |                  |   | 356  
|Proceeds from early exercise of stock options |  |               | 82    |                  |   | 104  
|Deferred rent                                 |  |               | 227   |                  |   | 139  
|Accrued other                                 |  |               | 329   |                  |   | 547  
|                                              |  |               |       |                  |   |      
|Other current accrued liabilities             |  | $             | 1,526 |                  | $ | 1,715
|                                              |  |               |       |                  |   |      

6. Loan Payable

In February 2004, the Company entered into a credit facility with a lender that provides up to an aggregate of $5,000,000 to finance the purchase of laboratory and computer equipment and certain leasehold improvements. In March 2005, the
lender provided for a credit facility of $3,500,000 which was available for the Company to draw down through December 31, 2005. During the quarter ended March 31, 2006, the lender extended the draw down period through March 31, 2006.
As of March 31, 2006, the Company had borrowed an aggregate of approximately $6,234,000 under these facilities. Payments are due in monthly installments over a period ranging from 42 to 48 months at interest rates ranging from 8.80% to 10.19%
and are secured by the assets financed.



8



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##### Table of Contents

7. Stock-Based Compensation

Employee Stock Purchase Plan

The Company has an employee stock purchase plan for all eligible employees. Under the plan, shares of
the Companys common stock may be purchased over an offering period with a maximum duration of two years at 85% of the lower of the fair market value on the first day of the applicable offering period or on the last day of the six-month
purchase period. Employees may purchase shares having a purchase price not exceeding 20% of their gross compensation during an offering period. No shares were purchased during the three months ended March 31, 2005 or 2006. Our employee stock
purchase plan contains an evergreen provision that automatically increases, on each January 1, the number of shares reserved for issuance under the employee stock purchase plan by the lesser of 194,444 or 0.75% of our outstanding
shares on such date, or a lesser amount as determined by our Board of Directors. At March 31, 2006, 820,203 shares of common stock were available for future issuance under the plan.

Other Equity Incentive Plans

The Company has equity incentive plans for directors, officers, employees and
non-employees. Stock options granted to existing employees under these plans generally vest at the rate of 1/48thper month such that the options will be fully vested after four years. Stock options granted to new employees generally vest 25% one year after the vesting commencement date with the remainder vesting at a rate of
1/36thper month. Stock options granted to directors generally vest quarterly over one year. All stock options
expire ten years from the date of grant. Stock options issued prior to 2004 were exercisable immediately, subject to repurchase rights held by us, which lapsed over the vesting period. Our equity incentive plan contains an evergreen
provision that automatically increases, on each January 15, by the lesser of 3.5% of the Companys outstanding shares of common stock on that date, or 1,055,555 shares, or such lesser amount as determined by our Board of Directors. At
March 31, 2006, 423,318 shares were available for future grant under our equity incentive plans.

Pro forma Information for Periods Prior to the
Adoption of SFAS 123(R)

Prior to the adoption of SFAS 123(R), the Company provided the disclosures required under SFAS 123, Accounting for
Stock-Based Compensation, as amended by SFAS 148, Accounting for Stock-Based Compensation  Transition and Disclosures. The pro-forma information for the three months ended March 31, 2005 was as follows (in thousands, except per
share amounts):



|                                                                                                |  |   |         |  
|----------------------------------------------------------------------------------------------- |  | - | ------- | -
|Net loss, as reported                                                                           |  | $ | (9,990  | )
|                                                                                                |  |   |         |  
|Plus: Employee stock compensation expense based on intrinsic value method                       |  |   | 1,032   |  
|Less: Employee stock compensation expense determined under the fair value method for all awards |  |   | (1,772  | )
|                                                                                                |  |   |         |  
|Net loss, pro forma                                                                             |  | $ | (10,730 | )
|                                                                                                |  |   |         |  
|Net loss per share:                                                                             |  |   |         |  
|Basic and diluted, as reported                                                                  |  | $ | (0.41   | )
|                                                                                                |  |   |         |  
|Basic and diluted, pro forma                                                                    |  | $ | (0.44   | )
|                                                                                                |  |   |         |  

Impact of the Adoption of SFAS No. 123(R)

The Company adopted SFAS 123(R) using the modified prospective transition method beginning January 1, 2006. Accordingly, during the three-month period ended
March 31, 2006, the Company recorded stock-based compensation expense for awards granted prior to, but not yet vested, as of December 31, 2005, as if the fair value method required for pro forma disclosure under SFAS 123 were in
effect for expense recognition purposes, adjusted for estimated forfeitures. For stock-based awards granted after January 1, 2006, the Company recognized compensation expense based on the estimated grant date fair value method using the
Black-Scholes valuation model. The Company is recognizing compensation expense using a straight-line amortization method. Because SFAS 123(R) requires that stock-based compensation expense be based on awards that are ultimately expected to
vest, stock-based compensation for the three-month period ended March 31, 2006 has been reduced for estimated forfeitures. When estimating forfeitures, we consider voluntary termination behaviors as well as trends of actual option forfeitures.
The impact on the results of operations of recording stock-based compensation for the three-month period ended March 31, 2006 was as follows (in thousands, except per share amounts):



|                                            |  |   |       |  
|------------------------------------------- |  | - | ----- | -
|Research and development                    |  | $ | 1,050 |  
|General and administrative                  |  |   | 1,246 |  
|                                            |  |   |       |  
|Total stock-based compensation              |  | $ | 2,296 |  
|                                            |  |   |       |  
|Effect on loss per share, basic and diluted |  | $ | (0.08 | )
|                                            |  |   |       |  

Due to our net loss position, a windfall tax benefit was not realized during the period.



9



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##### Table of Contents

Prior to the adoption of SFAS 123(R), the intrinsic value of the Companys unvested stock options was recorded as
deferred stock compensation as of December 31, 2005. Upon the adoption of SFAS 123(R) in January 2006, the deferred stock compensation balance of $4,898,000 was reclassified to additional paid-in-capital.

Valuation Assumptions

The Company calculated the fair value
of each option grant on the date of grant using the Black-Scholes option valuation model and the straight-line attribution approach. Option valuation models require the input of subjective assumptions and these assumptions can vary over time. The
weighted-average assumptions used are as follows:



|                                    |  |                            |   |  |      |  
|----------------------------------- |  | -------------------------- | - |  | ---- | -
|                                    |  | Three months EndedMarch 31 |  
|                                    |  | 2006                       |   |  | 2005 |  
|Stock option plan:                  |  |                            |   |  |      |  
|Expected stock price volatility     |  | 63                         | % |  | 80   | %
|Risk-free interest rate             |  | 4.4                        | % |  | 3.8  | %
|Dividend yield                      |  | 0                          |   |  | 0    |  
|Expected life of options (in years) |  | 4.23                       |   |  | 5    |  
|Employee stock purchase plan:       |  |                            |   |  |      |  
|Expected stock price volatility     |  | 75                         | % |  | 80   | %
|Risk-free interest rate             |  | 3.6                        | % |  | 2.9  | %
|Dividend yield                      |  | 0                          |   |  | 0    |  
|Expected life of options (in years) |  | 0.5-2                      |   |  | 0.5  |  

The Companys computation of expected volatility for the first quarter of 2006 is based on a combination of
historical volatilities of peer companies and market-based implied volatility from traded options on the Companys common stock. Peer companies historical volatilities are used in the determination of expected volatility due to the short
trading history of the Companys common stock, which is approximately two years as of March 31, 2006. In selecting the peer companies, the Company considered the following factors: industry, stage of life cycle, size, and financial
leverage. The computation of the expected volatility for our employee stock purchase plan for the first quarter of 2006 is based upon a combination of our historical volatility and our market-based implied volatility. Our computation of expected
life in 2006 was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. The interest rate for periods
within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant.

The following table summarizes the
activity under our equity incentive plans for the three months ended March 31, 2006 (in thousands, except per share amounts):



|                                      |  |           |   |  |                               |       |                                                    |      |                         |   |       
|------------------------------------- |  | --------- | - |  | ----------------------------- | ----- | -------------------------------------------------- | ---- | ----------------------- | - | ------
|                                      |  | Shares    |   |  | WeightedAverageExercise Price |       | WeightedAverageRemainingContractual Life(in years) |      | AggregateIntrinsicValue
|Outstanding at January 1, 2006        |  | 2,637,749 |   |  | $                             | 6.51  |                                                    |      |                         |   |       
|Granted                               |  | 1,272,478 |   |  | $                             | 18.19 |                                                    |      |                         |   |       
|Exercised                             |  | (124,512  | ) |  | $                             | 4.00  |                                                    |      |                         |   |       
|Cancelled                             |  | (18,713   | ) |  | $                             | 6.33  |                                                    |      |                         |   |       
|                                      |  |           |   |  |                               |       |                                                    |      |                         |   |       
|Outstanding at March 31, 2006         |  | 3,767,002 |   |  | $                             | 10.55 |                                                    | 8.57 |                         | $ | 40,614
|                                      |  |           |   |  |                               |       |                                                    |      |                         |   |       
|Options exercisable at March 31, 2006 |  | 1,892,348 |   |  | $                             | 5.79  |                                                    | 7.79 |                         | $ | 29,387
|                                      |  |           |   |  |                               |       |                                                    |      |                         |   |       

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards
and the quoted price of our common stock for 3,764,002 options that were in-the -money at March 31, 2006. As of March 31, 2006, there was approximately $21,069,000 of total unrecognized compensation cost related to unvested share-based
compensation arrangements granted under our stock plans. That cost is expected to be recognized over a weighted-average period of 3.10 years

The total
intrinsic value of options exercised during the three-month periods ended March 31, 2006 and 2005 was $1,871,000 and $610,000, respectively determined as of the date of exercise. The estimated fair value of shares vested during the three-month
periods ended March 31, 2006 and 2005 was $1,901,000 and $1,382,000, respectively. The weighted average grant date fair value of options granted during the three months ended March 31, 2006 and 2005 was $10.07 and $7.75 per share,
respectively, based on the assumptions in the Black-Scholes option valuation model discussed above.

Non-Employee Stock Compensation

Stock compensation arrangements to non-employees are accounted for in accordance with SFAS No. 123R and EITF Issue No. 96-18,Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling, Goods or Services, using a fair value approach. The compensation costs of these arrangements are subject to re-measurement
over the vesting terms as earned. During the three months ended March 31, 2006 and 2005, the Company granted stock options to purchase 42,111 and 30,611 shares of common stock, respectively, to consultants. Compensation expense related to
non-employee stock option grants was $740,000 and $245,000 for the three months ended March 31, 2006 and 2005, respectively.



10



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##### Table of Contents

The following table illustrates the weighted average assumptions for the Black-Scholes model used in determining the fair
value of options granted to non-employees:



|                                    |  |                             |   |  |      |  
|----------------------------------- |  | --------------------------- | - |  | ---- | -
|                                    |  | Three Months EndedMarch 31, |  
|                                    |  | 2006                        |   |  | 2005 |  
|Dividend yield:                     |  | 0                           |   |  | 0    |  
|Risk-free interest rate             |  | 4.43                        | % |  | 4.67 | %
|Volatility:                         |  | 64                          | % |  | 80   | %
|Expected life of options (in years) |  | 10                          |   |  | 10   |  



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##### Table of Contents

|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

The following discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result
of various factors, including those set forth under Part II, Item 1A, Risk Factors. You should read the following discussion and analysis of our financial condition and results of operations together with our interim financial statements
and the related notes appearing at the beginning of this report. The interim financial statements and this Managements Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial
statements and notes thereto for the year ended December 31, 2005 and the related Managements Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K filed
with the Securities and Exchange Commission on March 14, 2006.

Overview

We are a biopharmaceutical company with a primary focus on the discovery, development and commercialization of drugs to treat neurological disease and disorders. Our most advanced product candidate, NXY-059, is a
novel free radical trapping neuroprotectant in Phase III clinical trials for the treatment of acute ischemic stroke (AIS) with our exclusive licensee, AstraZeneca AB (AstraZeneca). Upon commercialization of NXY-059 we are entitled to receive
mid-teen royalties on worldwide net sales. AstraZeneca is responsible for funding and conducting all of the clinical trials with NXY-059 as well as all activities related to manufacturing and commercialization. We are currently conducting drug
discovery programs in the areas of cytoprotection, pain and inflammatory diseases. In addition to the relationship with AstraZeneca, we have a collaboration with Pfizer, Inc. (Pfizer) to discover and develop product candidates targeting the
vanilloid receptor, VR1, and a collaboration with Genentech, Inc. (Genentech) in the areas of nerve growth and anti-angiogenesis. In addition to these partnered programs, we are independently pursuing drug discovery programs targeted at
next-generation cytoprotectants that act similarly to NXY-059 and certain purinergic receptors that are implicated in a broad spectrum of pain and inflammatory diseases.

In May 2003, our exclusive licensee, AstraZeneca, initiated two multi-national, multi-center, randomized, double-blinded Phase III clinical trials (SAINT I and SAINT II) to test NXY-059 versus placebo in AIS patients.
In May 2005, we announced top line results from SAINT I in coordination with AstraZeneca. These results showed that the SAINT I trial involving more than 1,700 patients was the first international Phase III trial of a neuroprotectant in AIS to meet
its primary endpoint. In SAINT I, NXY-059 showed a statistically significant reduction in disability compared to placebo after AIS as measured on the Modified Rankin Scale (mRS) at 90 days (p=0.038). The clinical benefit was evident at the earliest
time point assessed (7 days) and persisted through the end of the study (90 days). We also announced that the prespecified analysis of neurological recovery as measured on the National Institute of Health Stroke Scale (NIHSS) did not show a
statistically significant difference between the treatment and placebo groups. The clinical significance of these findings will be assessed in light of the outcome of the ongoing global Phase III trial (SAINT II) planned to involve approximately
3,200 patients.

In August 2004, AstraZeneca initiated a global Phase IIb trial (CHANT) to assess safety and tolerability of NXY-059 in patients with acute
intracerebral hemorrhage (ICH). In March 2006, we announced, in coordination with AstraZeneca, preliminary results from the Phase IIb CHANT trial which involved 603 patients from 20 countries. An analysis of the data showed that the safety and
tolerability of NXY-059 was similar to placebo, with comparable mortality rates (20% in each group) and no difference between the NXY-059 and placebo groups on the secondary endpoint of stroke outcomes after ICH in the study.

Previously in 2005, we were independently conducting clinical trials with two product candidates known as REN-1654 and REN-850. In August 2005, we announced our decision
to discontinue development of REN-1654 as an oral medication based upon the modest effectiveness observed at the maximum dose tested in our Phase II studies and safety findings that would limit testing of higher oral doses. In June 2005, we
announced our decision to end future development of REN-850 based on a review of interim data from a Phase Ia study.

We have a limited history of
operations. Since our inception we have generated all of our revenues from agreements with corporate partners. During 2003, we recorded $4,500,000 in contract revenue related to milestone payments that we received from AstraZeneca following its
receipt of regulatory approval to commence Phase III trials for NXY-059. Upon achievement of certain future milestones involving the filing and approval of marketing applications in the U.S. and E.U. or Japan, AstraZeneca is obligated to make
additional payments to us totaling up to $7,500,000.

In December 2003, we entered into a collaborative research, development and license agreement with
Genentech for the discovery and development of drugs that inhibit pathological or tumor angiogenesis and promote nerve re-growth following nervous system injury. Under the terms of the agreement, Genentech paid us an upfront license and technology
access fee of approximately $5,250,000 in January 2004 and made a $3,000,000 equity purchase concurrent with our initial public offering. We deferred the upfront payment and are recognizing it as contract revenue on a straight-line basis over the
estimated research period. In July 2005, we revised the estimated completion date of the research period under the agreement to February 2006 from our previous estimate of December 2005. We recognized $328,000 and $656,000 related to this agreement
during the three months ended March 31, 2006 and 2005, respectively. The funded research period under this agreement ended in February 2006. The agreement with Genentech remains in effect after February 2006 and we will continue to coordinate
our separate research efforts through the Joint Research Committee that was established to guide the program. We are also eligible to receive future milestones and royalty payments on therapeutic products emerging from the collaboration that are
developed and commercialized by Genentech. In exchange, Genentech obtained exclusive worldwide rights to research, develop, manufacture and commercialized protein-based therapeutics and other drug compositions for the treatment of cancer and other
diseases in which mechanisms underlying new blood vessel growth play a significant role. Unless Genentech exercises certain rights and makes additional payments to us, we will have the right to develop and commercialize products arising from the
collaboration that are specifically useful for the treatment of central and peripheral nervous system diseases and conditions. We would be required to make royalty payments, and in certain cases milestone payments, to Genentech on products that we
develop and commercialize under the collaboration.

In May 2005, we entered into a collaborative research agreement and a license and royalty agreement
with Pfizer to research, develop and commercialize small molecule compounds that target the vanilloid receptor, VR1. The collaboration focuses on treatments for pain, urinary incontinence and other diseases and disorders. Under the agreements, we
received an upfront license fee of $10,000,000 in July 2005. We have deferred the upfront license fee and are recognizing it as contract revenue on a straight-line basis over the estimated research period of two years. In addition to the upfront
license fee, the Pfizer collaboration also provides us with research funding in excess of $7,000,000 which is being recognized over the estimated research period. Accordingly, we recognized $2,150,000 in contract revenue related to these agreements
during the three months ended March 31, 2006. Pfizer has the option to extend the agreements for up to two additional years subject to additional funding requirements. Additionally, we will be eligible to receive research, development, approval
and commercialization milestone payments resulting in total potential payments to the Company greater than $170,000,000 through successful achievement of research development and commercialization milestones for each product resulting from the
collaboration. Upon commercialization of a product resulting from the collaboration, we will be entitled to receive royalties on net sales by Pfizer.

As
of March 31, 2006, we had an accumulated deficit of $161,097,000 and approximately $112,943,000 in cash, cash equivalents and short-term investments. We anticipate that our current cash, cash equivalents and short-term investments will enable
us to maintain our currently planned operations for more than the next 12 months. However, changes to our current operating plan may require us to consume our capital resources sooner than we expect.



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We expect to incur substantial and increasing losses for the next several years as we:



| |  |  | expand our research and development programs; and
| | - |  | -------------------------------------------------



| |  |  | advance new product candidates into clinical development from our existing research programs.
| | - |  | ---------------------------------------------------------------------------------------------

In addition, we may acquire or in-license technology and products and may also acquire or invest in businesses that are complementary to our own.

Revenues

To date, all of our revenue has been earned under agreements with AstraZeneca, Genentech and Pfizer. We do
not expect to generate revenue from product sales or royalties for at least the next several years, if at all. We seek to generate revenue from a combination of product sales, upfront fees and milestone payments in connection with collaborative or
strategic relationships, and royalties resulting from the license of our intellectual property. We expect that any revenue we generate will fluctuate from quarter to quarter as a result of the timing and amount of milestone payments we may receive
from our collaborative or strategic relationships, as well as those we may receive upon the sale of our products, to the extent any are successfully commercialized. Revenue derived from collaborative and strategic relationships helps us fund our
operations and may increase in the future if we are successful in achieving milestones in our existing collaborations, licensing our technology and establishing new collaborations or strategic relationships. If we are unsuccessful in these goals,
our revenues will decline and we may be required to limit our research and development, clinical trial, manufacturing and marketing efforts.

Research
and Development Expenses

Our research and development (R&D) expenses consist primarily of costs associated with research, preclinical development
and clinical trials involving product opportunities in the areas of cytoprotection, pain and inflammatory diseases. We do not incur research and development costs for NXY-059, which is licensed exclusively to AstraZeneca.

The expenses we incur in connection with our research, preclinical and clinical development consist primarily of:



| |  |  | employee compensation;
| | - |  | ----------------------



| |  |  | supplies and materials;
| | - |  | -----------------------



| |  |  | costs for consultants, contract research and clinical trials (including non-cash expenses for options granted to non-employees);
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | license fees;
| | - |  | -------------



| |  |  | facilities and overhead costs;
| | - |  | ------------------------------



| |  |  | funded R&D at other companies and research institutions;
| | - |  | --------------------------------------------------------



| |  |  | manufacturing of clinical drug supplies; and
| | - |  | --------------------------------------------



| |  |  | depreciation of equipment.
| | - |  | --------------------------

R&D costs, including some upfront fees
and milestones paid to collaborators, are expensed as incurred. The timing of upfront fees and milestone payments in the future may cause variability in our future R&D expenses.

During the three months ended March 31, 2006 and 2005, we incurred research and development expenses of $6,872,000 and $8,415,000, respectively. The majority of research and development expense incurred relates
to our preclinical R&D programs. For the three months ended March 31, 2005, we incurred $6,415,000 in R&D expense relating to our preclinical programs and $2,000,000 relating to clinical development activities. For the three months
ended March 31, 2006, all of the R&D expense incurred related to our preclinical programs. Research and development expense for the three months ended March 31, 2006 decreased by $1,543,000 as compared to the corresponding period in
2005, primarily reflecting our decisions to end two clinical development programs, both of which involved multiple Phase II clinical studies that were ongoing throughout the first two quarters of 2005. Preclinical R&D expense increased in 2006
from 2005 as a result of our investments in preclinical activities in the areas of cytoprotection, pain and neuroinflammatory diseases. The increase in expense in 2006 is the result of adding key personnel in chemistry and pharmacology to support
expansion of our preclinical programs, including our program with Pfizer to identify antagonists of the vanilloid receptor, VR1. We also maintained our effort to identify and advance molecules with properties similar to NXY-059 that we believe could
be useful in a range of ischemic conditions, and we invested in certain pilot programs to build our internal pipeline of new investment opportunities.

Development timelines and costs are difficult to estimate and may vary significantly for each product candidate and from quarter to quarter. The process of seeking regulatory approvals, and the subsequent compliance with applicable
regulations, requires the expenditure of substantial resources.

General and Administrative Expenses

General and administrative expenses consist primarily of compensation for employees in executive and operational functions, including finance, human resources and
business development. Other significant costs include facilities costs and professional fees for accounting and legal services, including legal services associated with obtaining and maintaining patents. We anticipate incurring increases in general
and administrative expenses, such as increased costs for legal services, insurance and investor relations. These increases will also likely include the hiring of additional personnel.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are
based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts
of assets, liabilities and expenses and related disclosure of contingent assets and liabilities. We review our estimates on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe to be
reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in the notes to our financial statements included in
this report, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements.



13



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Revenue Recognition

The Companys revenues are generated by complex collaborative research and licensing arrangements. Revenues under such agreements may include upfront payments, research funding, milestone payments and royalties. In accordance with
Emerging Issues Task Force (EITF) Issue No. 00-21,Revenue Arrangements with Multiple Deliverables, we evaluate whether the delivered element under these arrangements has value to our collaborative partner or licensee on a stand-alone basis
and whether objective and reliable evidence of fair value of the undelivered element exists. Arrangements with multiple deliverables that do not meet these criteria are treated as one unit of accounting for the purposes of revenue recognition.

Revenues from nonrefundable upfront technology license fees, for product candidates where we are providing continuing services related to product
development, are deferred and recognized as revenues ratably over the estimated period of performance under the research agreement. The performance period is estimated at the inception of the arrangement and is periodically reevaluated. The
reevaluation of the performance period may shorten or lengthen the period during which the deferred revenue is recognized which would result in an acceleration or delay of expected revenue recognition.

Research funding is recognized as revenue as the related effort is performed.

Milestone payments we receive under collaborative arrangements are recognized as revenues upon achievements of the milestone events, which represent the culmination of the earnings process, and when collectability is reasonably assured.
Milestone payments are triggered either by the results of our research efforts or by events external to us, such as regulatory approval to market a product or the achievement of specified sales levels by a marketing partner or licensee. Accordingly,
the milestone payments are substantially at risk at the inception of the contract, and the amounts of the payments assigned thereto are commensurate with the milestone achieved. Upon the achievement of a milestone event, we have no future
performance obligations related to that milestone as the milestone payments we receive are nonrefundable.

Stock Compensation

Beginning on January 1, 2006, we began accounting for all stock-based awards to employees and directors under the provisions of Statement of Financial Accounting
Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)), which requires the recognition of the fair value of stock-based compensation. Under the fair value recognition provisions for SFAS 123(R), stock-based
compensation cost is estimated at the grant date based on the fair value of the awards expected to vest and recognized as expense ratably over the requisite service period of the award. We have used the Black-Scholes valuation model to estimate fair
value of our stock-based awards which requires various judgmental assumptions including estimating stock price volatility, forfeiture rates and expected life. Our computation of expected volatility is based on a combination of peer companies
historical volatilities and our market-based implied volatility. In addition, we consider many factors when estimating expected forfeitures and expected life, including types of awards, employee class and historical experience. If any of the
assumptions used in the Black-Scholes model change significantly, stock-based compensation expense may differ materially in the future from that recorded in the current period.

We adopted SFAS 123(R) using the modified prospective method which requires the application of the accounting standard as of January 1, 2006. Our financial statements as of and for the first quarter of 2006
reflect the impact of SFAS 123(R). In accordance with the modified prospective method, the financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R).

Clinical Study Activities and Other Expenses from Third-Party Contract Research Organizations

Some of our research and development, including certain preclinical and clinical study activity, is conducted by various third parties, including contract research organizations, which may also provide contractually
defined administration and management services. We recognize expenses for these contracted activities based upon a variety of factors, including estimated and actual labor hours, actual and estimated patient enrollment rates, clinical site
initiation activities and other activity-based factors. On a regular basis, our estimates of these costs are reconciled to actual invoices from the service providers, and adjustments are made accordingly.

Results of Operations

Comparison of the Three Months Ended
March 31, 2006 and 2005

Revenue

Total
revenue and dollar and percentage changes as compared to the prior period are as follows (dollar amounts are in thousands):



|                        |  |                             |       |   |      |   |    
|----------------------- |  | --------------------------- | ----- | - | ---- | - | ---
|                        |  | Three Months EndedMarch 31,
|                        |  | 2006                        |       |   | 2005
|Pfizer collaboration    |  | $                           | 2,150 |   |      | $ |   
|Genentech collaboration |  |                             | 328   |   |      |   | 656
|                        |  |                             |       |   |      |   |    
|Total revenue           |  | $                           | 2,478 |   |      | $ | 656
|Dollar increase         |  | $                           | 1,822 |   |      |   |    
|Percentage increase     |  |                             | 278   | % |      |   |    

The increase in revenue in 2006 as compared to 2005 resulted from a collaborative research agreement and a license
and royalty agreement with Pfizer that we signed in May 2005. Under the agreements we received an upfront license fee of $10,000,000 in July 2005. We recorded the upfront license fee as deferred revenue and are recognizing it as contract revenue on
a straight-line basis over the estimated research period of two years. In addition to the upfront license fee, the agreements with Pfizer also provide the Company with total research funding of more than $7,000,000 during the two-year research
period.

We expect that any revenue we may earn will fluctuate from quarter to quarter as a result of the timing and amount of any milestone payments we
earn or any new collaborations into which we may enter in the future. For the year ending December 31, 2006, we presently anticipate contract revenue from existing agreements of $8,800,000 to $9,200,000.



14



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##### Table of Contents

Research and Development Expenses

Total research and development (R&D) expenses and dollar and percentage changes as compared to the prior period are as follows (dollar amounts are in thousands):



|                    |  |                             |        |    |      |   |      
|------------------- |  | --------------------------- | ------ | -- | ---- | - | -----
|                    |  | Three Months EndedMarch 31,
|                    |  | 2006                        |        |    | 2005
|Total R&D expense   |  | $                           | 6,872  |    |      | $ | 8,415
|Dollar decrease     |  | $                           | (1,543 | )  |      |   |      
|Percentage decrease |  |                             | (18    | )% |      |   |      

Specific changes in R&D expense between these periods include:



| |  |  | external clinical trial costs, manufacturing cost of clinical trial supplies and other costs related to pharmacology and in vivo studies decreased by $1,660,000 in the first quarter
of 2006 as compared to the corresponding period in 2005 primarily due to our decisions to end clinical development programs involving REN-1654 and REN-850.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | amortization of intangible assets decreased to $0 in the first quarter of 2006 from $287,000 during the corresponding period in 2005 because due to the underlying intangible assets
were fully amortized as of the end of 2005;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | non-cash stock compensation increased by $376,000 for options granted to employees in the first quarter as compared to the corresponding period in 2005 primarily due to our
accounting for employee share-based compensation under the fair value method in accordance with SFAS 123(R) as of January 1, 2006. Prior to January 1, 2006 we accounted for options granted to employees using the intrinsic value method in
accordance with APB 25. In the first quarter of 2006 we recorded $1,050,000 in share-based compensation expense in accordance with SFAS 123(R). In the first quarter of 2005 we recorded $ 674,000 utilizing the intrinsic value method of measuring
stock compensation in accordance with APB 25; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | costs of supplies and materials increased by $246,000 in the first quarter of 2006 as compared to the corresponding period in 2005 as a result of increased pre-clinical activities
performed in-house.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We expect R&D expenses to increase in the future as we make additional investments in our preclinical research
programs and also advance product candidates into clinical trials. However, we currently do not have estimates of total costs of clinical trials nor the cost to reach regulatory approval for any drug candidate as all drug candidates are subject to
an uncertain and lengthy regulatory process which may not result in obtaining the necessary regulatory approval.

General and Administrative Expenses

Total general and administrative (G&A) expenses and dollar and percentage changes as compared to the prior period are as follows (dollar amounts
are in thousands):



|                    |  |                             |       |   |      |   |      
|------------------- |  | --------------------------- | ----- | - | ---- | - | -----
|                    |  | Three Months EndedMarch 31,
|                    |  | 2006                        |       |   | 2005
|Total G&A expense   |  | $                           | 3,903 |   |      | $ | 2,533
|Dollar increase     |  | $                           | 1,370 |   |      |   |      
|Percentage increase |  |                             | 54    | % |      |   |      

Specific changes in G&A expense between periods include:



| |  |  | non-cash stock compensation increased by $888,000 for grants to employees and non-employee directors. In the first quarter of 2006 we recorded $1,246,000 under the fair value method
of measuring stock compensation in accordance with SFAS 123(R). In the first quarter of 2005 we recorded $358,000 based on the intrinsic value method of measuring stock compensation in accordance with APB 25; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | consulting expense increased by $279,000 in the first quarter of 2006 as compared to the corresponding period in 2005 primarily due to stock compensation expense for stock options
granted to consultants.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We expect G&A expenses to increase in the future, reflecting increased support activities as we move preclinical
products into clinical trials.

Interest Income

Total
interest income and dollar and percentage changes as compared to the prior period are as follows (dollar amounts are in thousands):



|                      |  |                             |       |   |      |   |    
|--------------------- |  | --------------------------- | ----- | - | ---- | - | ---
|                      |  | Three Months EndedMarch 31,
|                      |  | 2006                        |       |   | 2005
|Total interest income |  | $                           | 1,262 |   |      | $ | 413
|Dollar increase       |  | $                           | 849   |   |      |   |    
|Percentage increase   |  |                             | 206   | % |      |   |    

The increase in interest income in the first quarter of 2006 as compared to the corresponding period in 2005 was
primarily attributable to a higher rate of return on our investment portfolio and higher average investment balances due to our common stock offering in September 2005, which resulted in net proceeds of $50,426,000.



15



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##### Table of Contents

Interest Expense

Interest expense was nominally lower in the first quarter of 2006 as compared to the corresponding period in 2005. The decrease was primarily due to the lower aggregate interest rates on our debt balances.

2006 Financial Guidance

We expect our operating
expenses to increase as we move preclinical products into clinical trials. For the year ending December 31, 2006, the Company presently anticipates:



| |  |  | total contract revenue from existing agreements of $8,800,000 to $9,200,000. This estimate includes approximately $300,000 from our collaboration with Genentech related to the
completion of the research period under our agreement in February 2006; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | total operating expenses, including stock-based compensation of $10,000,000 to $13,000,000 to be recognized upon the adoption of SFAS No. 123(R), of $48,000,000 to $56,000,000.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Liquidity and Capital Resources

To
date, we have funded our operations primarily through the sale of equity securities as well as through equipment and leasehold improvement financing. As of March 31, 2006, we had received approximately $221,455,000 from the sale of equity
securities. In February 2004, we received approximately $71,345,000 from our initial public offering of common stock and concurrent private placement with Genentech. In September 2005, we completed a public offering of common stock under which we
received net proceeds of approximately $50,429,000. In addition, since inception to March 31, 2006, we financed the purchase of equipment and leasehold improvements with debt totaling approximately $12,929,000, of which $4,329,000 was
outstanding at that date. These obligations are secured by the purchased equipment and leasehold improvements, bear interest at rates ranging from approximately 8.8% to 11.66% and are due in monthly installments through March 2010.

As of March 31, 2006, we had $112,943,000 in cash, cash equivalents and short-term investments as compared to $118,889,000 as of December 31, 2005, a decrease
of $5,946,000. The decrease resulted primarily from cash used in operating activities, capital purchases and principal payments on outstanding debt related to capital purchases. Our cash and investments are invested in a diversified portfolio of
financial instruments, including money market instruments, corporate notes and bonds, government or governmental agency securities and other debt securities issued by financial institutions and other issuers with strong credit ratings.

Net cash used in operating activities was $4,992,000 for the three months ended March 31, 2006 as compared to $10,380,000 in the corresponding period in 2005.
The $5,388,000 decrease in cash used in operations in 2006 primarily reflected a decrease in net operating loss of $2,855,000 as a result of an increase in contract revenue and a decrease in R&D expenses primarily due to our decisions to end
clinical development programs involving REN-1654 and REN-850.

Net cash provided by investing activities was $69,750,000 for the three months ended
March 31, 2006 as compared to $10,320,000 in the corresponding period in 2005. Net cash provided by investing activities in 2006 and 2005 resulted primarily from proceeds received from sales and maturities of short-term investments partially
offset by capital expenditures and purchases of short-term investments.

Net cash provided by financing activities was $366,000 for the three months ended
March 31, 2006 as compared to $940,000 in the corresponding period in 2005 and primarily reflected $476,000 in proceeds received from the issuance of common stock upon option exercises and $293,000 in proceeds received from financing of
equipment purchased through our existing credit facilities partially offset by principal payments of $403,000 on these financings. Net cash provided by financing activities in 2005 primarily reflected $376,000 in proceeds received from the issuance
of common stock upon option exercises and $963,000 in proceeds received from financing of equipment purchased through our existing credit facilities partially offset by principal payments of $399,000 on these financings.

We have entered into a variety of license agreements relating to our research and development efforts, most of which relate to product candidates in the early stage of
preclinical development. We have a cancelable license agreement relating to our product candidate in clinical trials, NXY-059. Under this agreement, we are required to pay $25,000 annually in minimum royalty payments through NDA approval (if
obtained) and $100,000 annually in minimum royalty payments after NDA approval. Additionally, low-single digit royalties are payable on net product sales.

Our future capital uses and requirements depend on numerous forward-looking factors. These factors include but are not limited to the following:



| |  |  | the progress of preclinical development and laboratory testing and clinical trials;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | the time and costs involved in obtaining regulatory approvals;
| | - |  | --------------------------------------------------------------



| |  |  | delays that may be caused by evolving requirements of regulatory agencies;
| | - |  | --------------------------------------------------------------------------



| |  |  | the number of product candidates we pursue;
| | - |  | -------------------------------------------



| |  |  | the costs involved in filing and prosecuting patent applications and enforcing or defending patent claims;
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | our plans to establish sales, marketing and/or manufacturing capabilities;
| | - |  | --------------------------------------------------------------------------



| |  |  | our ability to establish, enforce and maintain selected strategic alliances and activities required for product commercialization;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | the acquisition of technologies, products and other business opportunities that require financial commitments; and
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | our revenues, if any, from successful development and commercialization of our products.
| | - |  | ----------------------------------------------------------------------------------------

Based upon our current operating plan we believe that our cash and cash equivalents as of March 31, 2006 will be sufficient to meet our projected operating requirements for more than the next 12 months.

Until we can generate significant cash from our operations, we expect to continue to fund our operations with existing cash resources. We will be required
to seek additional sources of funding to complete development and commercialization of our products. When we raise funds in the future, we may be required to raise those funds through public or private financings, strategic relationships or other
arrangements. We cannot assure you that such funding will be available on terms attractive to us, or at all. Furthermore, any additional equity financing may be dilutive to stockholders; and debt financing, if available, may involve restrictive
covenants. Our failure to raise capital as and when needed could have a negative impact on our financial condition and our ability to pursue our business strategy.



16



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##### Table of Contents

We did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred
to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading
activities involving non-exchange traded contracts. Therefore, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships. We do not have relationships or transactions
with persons or entities that derive benefits from their non-independent relationship with us or our related parties.

We filed a registration statement on
Form S-3 with the SEC to be able to sell from time to time up to $100,000,000 of any combination of debt securities, common stock, preferred stock and warrants. The SEC declared this registration statement effective in May 2005. Any actual sale will
be offered using a prospectus in amounts, at prices and at terms determined at the time of an offering and may be sold directly by us to investors, through agents or through underwriters or dealers. In September 2005, we sold 4,000,000 shares of
common stock to the public at $13.50 per share for gross proceeds of $54,000,000. As of December March 31, 2006, $46,000,000 remains available for issuance under this registration statement.



|Item 3. | Quantitative and Qualitative Disclosures about Market Risk
|------- | ----------------------------------------------------------

Our
primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term marketable securities. Due to the nature
of our short-term investments, we believe that we are not subject to any material market risk exposure. We do not have any foreign currency or other derivative financial instruments.



|Item 4. | Controls and Procedures
|------- | -----------------------

We maintain disclosure controls and
procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and
forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is
required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), we
carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the
reasonable assurance level.

There has been no change in our internal controls over financial reporting during our most recent quarter that has materially
affected, or is reasonably likely to materially affect, our internal controls over financial reporting.



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##### Table of Contents

Part II. OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------

We are not currently a party to any material
legal proceedings. We may from time to time become a party to various legal proceedings arising in the ordinary course of business.



|Item 1A. | Risk Factors
|-------- | ------------

An investment in our common stock is very risky.
You should carefully consider the risks described below, together with all of the other information in this report, and in our Annual Report on Form 10-K for the year ended December 31, 2005 before making a decision to invest in our common
stock. If any of the following risks actually occur, our business, financial condition, results of operations and growth prospects could be adversely affected. In this case, the trading price of our common stock could decline and you may lose all or
part of your investment in our common stock. Additional risks and uncertainties, not presently known to us, or that we presently deem as immaterial, may also adversely affect our business. If any of these additional risks and uncertainties occur,
the trading price of our common stock could decline, and you may lose all or part of your investment.

Risks Related to Our Company

Clinical trials may fail to demonstrate the safety and efficacy of our product candidates, which could prevent or significantly delay their
regulatory approval.

Our future success is dependent upon, among other factors, our ability to develop working products and our ability to
successfully complete clinical trials. All of our potential products currently are in research, preclinical development or clinical testing, and commercialization of those products will not occur for at least the next several years, if at all. All
of our potential products will require extensive additional research and development prior to any commercial introduction. There can be no assurance that any of our research and development and clinical trial efforts will result in viable new
products. For example, in July 2004, we announced our decision to discontinue efforts to commercialize REN-213, an intravenous drug candidate we were developing for the treatment of acute post-operative pain. In August 2005, based on results of our
Phase II clinical trials with REN-1654 in patient volunteers with post-herpetic neuralgia and sciatica, we announced that we were discontinuing development of REN-1654 as an oral medication. In June 2005 we announced our decision to discontinue
efforts to develop REN-850 for the treatment of multiple sclerosis.

Any failure or substantial delay in completing clinical trials for our product
candidates, including NXY-059, may severely harm our business. Before obtaining regulatory approval for the sale of any of our potential products or the potential products of our current and future strategic partners and licensees, we and our
strategic partners or licensees must subject these product candidates to extensive preclinical and clinical testing to demonstrate their safety and efficacy in humans. The success of this preclinical and clinical testing is critical to achieving our
product development goals. If our product development efforts are unsuccessful, we will not obtain regulatory approval for them, we will not generate sales from them, and our business and results of operations would be adversely affected.

Clinical trials are expensive, time-consuming and typically take years to complete. In connection with clinical trials, we face the risks that:



| |  |  | a product candidate may not prove to be efficacious;
| | - |  | ----------------------------------------------------



| |  |  | we may discover that a product candidate may cause harmful side effects;
| | - |  | ------------------------------------------------------------------------



| |  |  | patients may die or suffer other adverse medical effects for reasons that may not be related to the product candidate being tested;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | the results may not confirm the positive results of earlier trials; and
| | - |  | -----------------------------------------------------------------------



| |  |  | the results may not meet the level of statistical significance required by the FDA or other regulatory agencies.
| | - |  | ----------------------------------------------------------------------------------------------------------------

The results in early phases of clinical testing are based upon limited numbers of patients and a limited follow-up period and our success may not be indicative of
results in a large number of patients or long-term efficacy. A number of companies in the pharmaceutical and biotechnology industries have suffered significant setbacks in late stage clinical trials even after achieving promising results in earlier
development activities, including previous late-stage clinical trials. The results from the Phase III SAINT I trial for NXY-059 may not be predictive of results obtained in the second Phase III clinical trial, SAINT II. If a larger population of
patients does not experience positive results, or if these results do not have a lasting effect, our products may not receive approval from the FDA. In addition, even if the primary endpoint of the SAINT II trial is achieved, if the SAINT II trial
does not demonstrate positive trends or statistically significant benefits with respect to neurological impairment measured using the NIHSS, our ability to obtain regulatory approval for NXY-059 in certain jurisdictions outside the United States
could be impaired and market acceptance for NXY-059 could be adversely affected. The potential market opportunity for NXY-059 will also likely depend in part on whether NXY-059 may be labeled for administration prior to a CT scan. Failure to
demonstrate the safety and effectiveness of our product candidates in larger patient populations could have a material adverse effect on our business that would cause our stock price to decline significantly.

Failure to enroll patients for clinical trials may cause delays in developing our product candidates.

We may encounter delays or rejections if we, our strategic partners or licensees are unable to enroll enough patients to complete clinical trials. Patient enrollment
depends on many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites, the eligibility criteria for the trial and the number and size of ongoing clinical trials sponsored by
others that seek to enroll similar patients. When one product candidate is evaluated in multiple clinical trials simultaneously, patient enrollment in ongoing trials can be adversely affected by negative results from completed trials. At various
times, NXY-059 has been involved in multiple clinical trials that were enrolling patients simultaneously. Any delays in planned patient enrollment may result in increased costs and delays, which could harm our ability to develop products.



18



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##### Table of Contents

The independent clinical investigators and contract research organizations that we and our strategic partners or
licensees rely upon to conduct clinical trials may not be diligent, careful or timely, and may make mistakes in the conduct of our trials.

We
depend on independent clinical investigators and contract research organizations (CROs) to conduct our clinical trials under their agreements with us or, in the case of NXY-059, with AstraZeneca. We are not employing these investigators, and we
cannot control the amount or timing of resources that they devote to our programs. Our contracts with these investigators involve fixed fees. If the costs of performing the clinical trials exceed estimates, these investigators may fail to devote
sufficient time and resources to our drug development programs, fail to enroll patients as rapidly as expected, or otherwise fail to perform in a satisfactory manner, regulatory approval and our introductions of new products will be delayed. We
contract with CROs for execution of our clinical trials for our product candidates other than NXY-059. Failure of the CROs to meet their obligations could adversely affect clinical development of our product candidates. Moreover, these independent
investigators and CROs may also have relationships with other commercial entities, some of which may compete with us. If independent investigators and CROs assist our competitors, it could harm our competitive position.

We depend on our licensee, AstraZeneca, for the completion of the NXY-059 clinical program and for the commercialization of NXY-059.

Under our exclusive license agreement with AstraZeneca, AstraZeneca is responsible for all aspects of clinical development of NXY-059. If NXY-059 receives regulatory
approval, AstraZeneca will be responsible for marketing and sales of the commercial product. Because AstraZeneca is responsible for these functions, we have no control over the development schedule or, if NXY-059 receives regulatory approval, the
marketing plan for NXY-059. If the clinical trials for NXY-059 are not successful, NXY-059 will not be commercialized. Moreover, if AstraZeneca elects to terminate the clinical program for NXY-059, the rights to develop and market NXY-059 will
revert to us. If these rights revert to us, we will have to fund the clinical programs for NXY-059 on our own, seek a strategic partner or licensee for clinical development or abandon NXY-059.

Our reliance on AstraZeneca poses a number of risks, including the following:



| |  |  | AstraZeneca has discretion to elect whether to pursue the development of NXY-059 or to modify or abandon the clinical program at any time;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we cannot control whether AstraZeneca will devote sufficient resources to the clinical program and, if NXY-059 is approved by the FDA or other regulatory agencies, the marketing
plan for the commercial drug product;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | although we have no history of royalty payment disputes, even if NXY-059 is approved and commercialized, disputes may arise in the future with respect to the calculation of royalty
payments based on net sales related to NXY-059; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | if AstraZeneca perceives that the market opportunity for NXY-059 or its profit margin from the sale of NXY-059 is too small to justify commercialization, the interests and
motivations of AstraZeneca may not be, or may not remain, aligned with ours.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If any of these risks materialize, it could delay the
development schedule for NXY-059 and impair its commercialization.

If we or our strategic partners or licensees fail to obtain U.S. regulatory
approvals for product candidates under development, including our lead product candidate, NXY-059, we will not be able to generate revenue in the U.S. market from the commercialization of product candidates.

We must receive FDA approval for each of our product candidates before we can commercialize or sell that product candidate in the United States, and AstraZeneca, our
licensee for NXY-059, must receive regulatory approval for NXY-059 and commercialize or sell NXY-059 before we will receive royalties. The FDA can limit or deny their approval for many reasons, including:



| |  |  | a product candidate may be found to be unsafe or ineffective;
| | - |  | -------------------------------------------------------------



| |  |  | regulators may interpret data from preclinical testing and clinical trials differently and less favorably than the way we interpret it;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | regulators may not approve the manufacturing processes or facilities that we or our strategic partners or licensees use; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | regulators may change their approval policies or adopt new regulations.
| | - |  | -----------------------------------------------------------------------

Failure to obtain FDA approval or any delay or setback in obtaining such approval could:



| |  |  | adversely affect our ability to market any drugs we develop independently or with strategic partners or licensees;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | impose additional costs and diminish any competitive advantages that we may attain; and
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | adversely affect our ability to generate royalties or product revenues.
| | - |  | -----------------------------------------------------------------------

Any such failures or delays in the regulatory approval process for any of our product candidates would delay or diminish our receipt of product revenues, if any, and would materially adversely affect our business, financial condition and
results of operations.

Even if we obtain FDA approval, our product candidate may not be approved for all indications that we request, which could limit
the uses of our product and adversely impact our potential royalties and product sales. If FDA approval of a product is granted, such approval may be subject to limitations on the indicated uses for which the product may be marketed or require
costly, post-marketing follow-up studies. As to any product for which marketing approval is obtained, the labeling, packaging, adverse event reporting, storage, advertising, promotion and record keeping related to the product will be subject to
extensive regulatory requirements. The subsequent discovery of previously unknown problems with the product may result in restrictions on the product, including withdrawal of the product from the market. We may be slow to adapt, or we may never
adapt, to changes in existing requirements or adoption of new requirements or policies.

If we fail to comply with applicable U.S. regulatory requirements,
we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution.



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##### Table of Contents

If we or our strategic partners or licensees fail to obtain regulatory approvals in other countries for product
candidates under development, we will not be able to generate revenue in such countries from the commercialization of product candidates.

In order
to market our products outside of the United States, we and our strategic partners and licensees must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. Approval procedures vary
among countries and can involve additional product testing and additional administrative review periods. The time required to obtain approval in other countries might differ from that required to obtain FDA approval. The regulatory approval process
in other countries may include all of the risks detailed above regarding FDA approval in the United States. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in
one country may negatively impact the regulatory process in others. Failure to obtain regulatory approval in other countries or any delay or setback in obtaining such approval could have the same adverse effects detailed above regarding FDA approval
in the United States, including the risks that our product candidate may not be approved for all indications that we request, which could limit the uses of our product and adversely impact our potential royalties and product sales, and that such
approval may be subject to limitations on the indicated uses for which the product may be marketed or require costly, post-marketing follow-up studies.

If
we fail to comply with applicable foreign regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution.

Even if our product candidates are approved and commercialized, competitive products may impede market acceptance of our products.

Hospitals, physicians or patients may conclude that our potential products are less safe or effective or otherwise less attractive than existing drugs. Even if approved
and commercialized, NXY-059, or any future product candidates, may fail to achieve market acceptance with hospitals, physicians or patients. If our products do not receive market acceptance for any reason, our revenue potential could be diminished
which would materially adversely affect our business, financial condition and results of operations.

Further, our competitors may develop new products
that could be more effective or less costly, or that may seem more cost-effective, than our products. For example, although we believe that NXY-059 would not face direct competition from products currently available to stroke victims, a number of
organizations are conducting clinical trials of neuroprotectant drug candidates which, if approved and commercialized, would compete with NXY-059. Competitors developing such products include Astellas Pharma, Inc., D-Pharm Ltd., IVAX
Pharmaceuticals, Inc., Paion AG, Ferrer Grupo and Vertex Pharmaceuticals Incorporated.

Most of our competitors have substantially greater capital
resources, research and development staffs, facilities and experience in conducting clinical trials and obtaining regulatory approvals, as well as in manufacturing and marketing pharmaceutical products. As a result, they may achieve product
commercialization or patent protection earlier than we can, if at all. Hospitals, physicians, patients or the medical community in general may not accept and use any products that we may develop.

We have no experience selling, marketing or distributing products and no internal capability to do so.

If we receive regulatory approval to commence commercial sales of any of our product candidates for which we have retained marketing rights, we will have to establish a
sales and marketing organization with appropriate technical expertise and supporting distribution capability. At present, we have no sales or marketing personnel. Factors that may inhibit our efforts to commercialize our products without strategic
partners or licensees include:



| |  |  | our inability to recruit and retain adequate numbers of effective sales and marketing personnel;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | the inability of sales personnel to obtain access to or persuade adequate numbers of physicians to prescribe our products;
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | the lack of complementary products to be offered by sales personnel, which may put us at a competitive disadvantage against companies with broader product lines; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | unforeseen costs associated with creating an independent sales and marketing organization.
| | - |  | ------------------------------------------------------------------------------------------

As an alternative to establishing our own sales and marketing organization, we may engage a pharmaceutical or other healthcare company with an existing distribution system and direct sales organization to assist us.
We may not be able to successfully establish sales and distribution capabilities either on our own or in collaboration with third parties or gain market acceptance for our products. To the extent we enter co-promotion or other licensing
arrangements, any revenues we receive will depend on the efforts of third parties and we may not succeed.

If our partners, licensees or contract
manufacturers of our products fail to devote sufficient time and resources to our concerns, or if their performance is substandard, our clinical trials and product introductions may be delayed and our costs may rise.

We have no manufacturing facilities, and we have no experience in the commercial manufacturing of drugs and no experience in designing drug manufacturing processes. We
depend on our partners, licensees and contract manufacturers to produce our product candidates for clinical trials and to manufacture, supply, store and distribute any resulting products.

While we have not experienced problems with our partners, licensees or contract manufacturers to date, our reliance on these third parties exposes us to the following
risks, any of which could delay or prevent the completion of our clinical trials, the approval of our product candidates by the FDA or other regulatory agencies, or the commercialization of our products, result in higher costs or deprive us of
potential product revenues:



| |  |  | Drug manufacturers are obliged to operate in accordance with FDA-mandated current good manufacturing practices, or cGMPs. A failure of any of our partners, licensees or contract
manufacturers to establish and follow cGMPs and to document their adherence to such practices may lead to significant delays in the availability of material for clinical trials and may delay or prevent filing or approval of marketing applications
for our products.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changing contract manufacturers may be difficult and the number of potential manufacturers is limited. Changing manufacturers may require re-validation of the manufacturing
processes and procedures in accordance with FDA-mandated cGMPs. Such re-validation may be costly and time-consuming. It may be difficult or impossible for us to find replacement manufacturers on acceptable terms quickly, or at all.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



20



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Drug manufacturers are subject to ongoing periodic unannounced inspections by the FDA and corresponding state and foreign
agencies to ensure strict compliance with cGMPs, other government regulations and corresponding foreign standards. We are not aware of any violations by our partners, licensees or contract manufacturers of any of these regulations or standards.
While we are obligated to audit the performance of our contractor manufacturers, we do not have control over their compliance with these regulations and standards. Failure by our partners, licensees, contract manufacturers or us to comply with
applicable regulations could result in sanctions that would have a material adverse effect on our business, including fines, injunctions, civil penalties, failure of the government to grant premarket approval of drugs, delays, suspension or
withdrawal of approvals, seizures or recalls of product, operating restrictions and criminal prosecutions.

We or our strategic partners or licensees
may not be able to manufacture our product candidates in commercial quantities, which would prevent us from commercializing our product candidates.

To date, our product candidates have been manufactured in small quantities for preclinical and clinical trials. If any of these product candidates are approved by the FDA or other regulatory agencies for commercial sale, they will need to
be manufactured in larger quantities. We or our strategic partners or licensees, as applicable, may not be able to successfully increase the manufacturing capacity, whether in collaboration with contract manufacturers or independently, for any of
our product candidates in a timely or economic manner, or at all. Significant scale-up of manufacturing may require additional validation studies, which the FDA must review and approve. If we or our strategic partners or licensees are unable to
successfully increase the manufacturing capacity for a product candidate, the regulatory approval or commercial launch of that product candidate may be delayed or there may be a shortage in supply. Our product candidates require precise, high
quality manufacturing. Failure to achieve and maintain these high manufacturing standards, including the incidence of manufacturing errors, could result in patient injury or death, product recalls or withdrawals, delays or failures in product
testing or delivery, cost overruns or other problems that could seriously hurt our business.

If we are unable to retain and recruit qualified
scientists or if any of our key executives, key employees or key consultants discontinues his or her employment or consulting relationship with us, it may delay our development efforts or otherwise harm our business.

We are highly dependent on the key members of our management and scientific staff, especially our chief executive officer, Corey Goodman, Ph.D. The loss of any of our key
employees or key consultants could impede the achievement of our research and development objectives. Furthermore, recruiting and retaining qualified scientific personnel to perform research and development work in the future is critical to our
success. We may be unable to attract and retain personnel on acceptable terms given the competition among biotechnology, pharmaceutical and health care companies, universities and non-profit research institutions for experienced scientists. We
maintain key man insurance on Dr. Goodman. We do not maintain key man insurance policies on any of our other officers or employees. All of our employees are employed at will and, therefore, each employee may
leave our employment at any time.

We have a history of losses and we may never achieve sustained profitability.

Since our inception, we have incurred significant net losses, including net losses of $31,980,000, $39,941,000, $41,872,000, $25,077,000 and $11,359,000, respectively,
for the years ended December 31, 2005, 2004, 2003, 2002 and 2001. As of March 31, 2006, our cumulative net loss was $161,097,000. None of our product candidates has completed development or received required regulatory approvals and,
consequently, we have not generated revenues from the sale of products and do not expect to do so for at least the next several years. Even if one or more of our product candidates is commercialized, we expect to incur substantial losses for the
foreseeable future. The development and sale of our products will require completion of clinical trials and significant additional research and development activities. We expect to continue to incur significant operating and capital expenditures and
anticipate that our expenses will increase substantially in the foreseeable future as we:



| |  |  | expand our research and development programs; and
| | - |  | -------------------------------------------------



| |  |  | advance new product candidates into clinical development from our existing research programs.
| | - |  | ---------------------------------------------------------------------------------------------

We also expect to experience negative cash flow for the foreseeable future as we fund our operating losses and capital expenditures. We will need to generate significant revenues to achieve profitability. Our ability
to generate revenues and achieve profitability depends on successful completion of clinical trials, our additional research and development efforts, our ability to successfully commercially introduce our products, market acceptance of our products,
the competitive position of our products and the other risk factors set forth in this report. We may not be able to generate these revenues, and we may never achieve profitability. Our failure to achieve, sustain and/or increase profitability on a
quarterly or annual basis could negatively impact the market price of our common stock.

If we cannot raise additional capital on acceptable terms,
we may be unable to complete planned clinical trials, obtain regulatory approvals or commercialize our product candidates.

We believe that existing
cash reserves will fund our planned activities for more than the next 12 months. However, we will require substantial future capital in order to continue to conduct the research and development, clinical and regulatory activities necessary to bring
our product candidates to market and to establish commercial manufacturing, sales and marketing capabilities. During the three months ended March 31, 2006, our net cash used in operating activities was $4,992,000 and we had capital expenditures
of $1,312,000. Our future capital requirements depend on many factors, including:



| |  |  | the progress of preclinical development and laboratory testing and clinical trials;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | the time and costs involved in obtaining regulatory approvals;
| | - |  | --------------------------------------------------------------



| |  |  | delays that may be caused by evolving requirements of regulatory agencies;
| | - |  | --------------------------------------------------------------------------



| |  |  | the number of product candidates we pursue;
| | - |  | -------------------------------------------



| |  |  | the costs involved in filing and prosecuting patent applications and enforcing or defending patent claims;
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | our plans to establish sales, marketing and/or manufacturing capabilities;
| | - |  | --------------------------------------------------------------------------



| |  |  | our ability to establish, enforce and maintain selected strategic alliances and activities required for product commercialization;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



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| |  |  | the acquisition of technologies or products and other business opportunities that require financial commitments; and
| | - |  | --------------------------------------------------------------------------------------------------------------------



| |  |  | our revenues, if any, from successful development and commercialization of our products.
| | - |  | ----------------------------------------------------------------------------------------

We intend to seek additional funding through strategic collaborations. We face intense competition from many other companies in the pharmaceutical and biotechnology industry for corporate collaborations, as well as
for establishing relationships with academic and research institutions and for obtaining licenses to proprietary technology. If we are unable to attract and retain corporate partners to develop, introduce and market our products, our business may be
materially and adversely affected. Our strategy and any reliance on corporate partners, if we are able to establish such collaborative relationships, are subject to additional risks. Our partners may not devote sufficient resources to the
development, introduction and marketing of our products or may not pursue further development and commercialization of products resulting from collaborations with us. If a corporate partner elects to terminate its relationship with us, our ability
to develop, introduce and market our products may be significantly impaired and we may be forced to discontinue the product altogether. We may not be able to negotiate alternative corporate partnership agreements on acceptable terms, if at all. The
failure of any future collaboration efforts could have a material adverse effect on our ability to develop, introduce and market our products and, consequently, could have a material adverse effect on our business, results of operations and
financial condition.

In addition to strategic collaborations, we may seek funding through private or public sales of our securities, entering into credit
arrangements or by licensing all or a portion of our technology. This funding may significantly dilute existing stockholders or may limit our rights to our technology.

We filed a registration statement on Form S-3 with the SEC to be able to sell from time to time up to $100,000,000 of any combination of debt securities, common stock, preferred stock and warrants. The SEC declared
this registration statement effective in May 2005. Any actual sale will be offered via prospectus in amounts, at prices and at terms determined at the time of an offering and may be sold directly by us to investors, through agents or through
underwriters or dealers. In September 2005, we sold 4,000,000 shares of common stock to the public at $13.50 per share for gross proceeds of $54,000,000. As of March 31, 2006, $46,000,000 remains available under this registration statement.

We may not be able to obtain additional funding on reasonable terms, or at all. If we cannot obtain adequate funds, we may:



| |  |  | terminate or delay preclinical development or clinical trials for one or more of our product candidates;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | delay establishment, or fail to establish, sales, marketing and/or manufacturing capabilities;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | curtail significant product development programs that are designed to identify new product candidates;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | not be in a position to acquire technologies or pursue other business opportunities that require financial commitments; and/or
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | relinquish rights to our technologies or product candidates.
| | - |  | ------------------------------------------------------------

Risks Related to Our Industry

Claims that we infringe a third partys intellectual property may give rise to burdensome
litigation, result in potential liability for damages or stop our development and commercialization efforts.

Third parties may assert patent or
other intellectual property infringement claims against us or our strategic partners or licensees with respect to technologies used in our potential products. While we have conducted patent searches to determine whether the technologies used in our
products infringe patents held by third parties, we expect that numerous patent applications are currently pending and may be filed in the future for technologies generally related to our technologies, including many patent applications that remain
confidential after filing. Due to these factors and the inherent uncertainty in conducting patent searches, we may violate third-party patent rights that we have not yet identified.

U.S. and foreign patents have been issued to third parties in the same fields as some of our product candidates. There may also be patent applications filed by these or other parties in the United States and various
foreign jurisdictions that are in the same fields as some of our product candidates. These patent applications, if issued, could subject us to infringement actions. Although we have received communications from a third party alleging that we may
infringe certain patents held by the third party, we do not believe there is a reasonable basis for an action claiming that we are infringing any valid and enforceable patents of such third party. To date we have not been subject to any infringement
actions.

The owners or licensees of these and other patents may file one or more infringement actions against us. Patent litigation can involve complex
factual and legal questions and its outcome is uncertain. Any claim relating to infringement of patents that is successfully asserted against us may cause us to pay substantial damages.

Even if we were to prevail, any litigation could be costly and time-consuming and would divert the attention of our management and key personnel from our business operations. Furthermore, as a result of a patent
infringement suit brought against us or our strategic partners or licensees, we or our strategic partners or licensees may be forced to stop or delay developing, manufacturing or selling potential products, including NXY-059, that are claimed to
infringe a third partys intellectual property unless that party grants us or our strategic partners or licensees rights to use its intellectual property. In such cases, we may be required to obtain licenses to patents or proprietary rights of
others in order to continue to commercialize our products. However, we may not be able to obtain any licenses required under any patents or proprietary rights of third parties on acceptable terms, or at all. Even if our strategic partners, licensees
or we were able to obtain rights to the third partys intellectual property, these rights may be non-exclusive, thereby giving our competitors access to the same intellectual property. Ultimately, we may be unable to commercialize some of our
potential products or may have to discontinue development of a product candidate, such as NXY-059, or cease some of our business operations as a result of patent infringement claims, which could severely harm our business.



22



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We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed
alleged trade secrets of their former employers.

Many of our employees were previously employed at universities or other biotechnology or
pharmaceutical companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets
or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to
management. If we fail in defending such claims, in addition to paying money claims, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to
commercialize certain product candidates, which could severely harm our business.

If we are unable to protect our intellectual property rights, our
competitors may develop and market products with similar features that may reduce demand for our potential products.

The following factors are
important to our success:



| |  |  | receiving patent protection for our product candidates;
| | - |  | -------------------------------------------------------



| |  |  | not infringing on the intellectual property rights of others;
| | - |  | -------------------------------------------------------------



| |  |  | preventing others from infringing our intellectual property rights; and
| | - |  | -----------------------------------------------------------------------



| |  |  | maintaining our patent rights and trade secrets.
| | - |  | ------------------------------------------------

We will be able to
protect our intellectual property rights in patents and trade secrets from unauthorized use by third parties only to the extent that such intellectual property rights are covered by valid and enforceable patents or are effectively maintained as
trade secrets.

We try to protect our proprietary position by filing U.S. and foreign patent applications related to our proprietary technology, inventions
and improvements that are important to the development of our business. Because the patent position of biotechnology and pharmaceutical companies involves complex legal and factual questions, the issuance, scope and enforceability of patents cannot
be predicted with certainty. Patents, if issued, may be challenged, invalidated or circumvented. U.S. patents and patent applications may also be subject to interference proceedings and U.S. patents may be subject to reexamination proceedings in the
U.S. Patent and Trademark Office (and foreign patents may be subject to opposition or comparable proceedings in the corresponding foreign patent office), which proceedings could result in either loss of the patent or denial of the patent application
or loss or reduction in the scope of one or more of the claims of the patent or patent application. In addition, such interference, reexamination and opposition proceedings may be costly. Thus, any patents that we own or license from others may not
provide any protection against competitors. Our pending patent applications, those we may file in the future or those we may license from third parties may not result in patents being issued. If issued, they may not provide us with proprietary
protection or competitive advantages against competitors with similar technology. Furthermore, others may independently develop similar technologies or duplicate any technology that we have developed. We rely on third-party payment services for the
payment of foreign patent annuities and other fees. Non-payment or delay in payment of such fees, whether intentional or unintentional, may result in loss of patents or patent rights important to our business.

Many countries, including certain countries in Europe, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties (for
example, the patent owner has failed to work the invention in that country, or the third party has patented improvements). In addition, many countries limit the enforceability of patents against government agencies or government
contractors. In these countries, the patent owner may have limited remedies, which could materially diminish the value of the patent. Compulsory licensing of life-saving drugs is also becoming increasingly popular in developing countries either
through direct legislation or international initiatives. Such compulsory licenses could be extended to include some of our product candidates, which could limit our potential revenue opportunities. Moreover, the legal systems of certain countries,
particularly certain developing countries, do not favor the aggressive enforcement of patent and other intellectual property protection which makes it difficult to stop infringement.

In addition, our ability to enforce our patent rights depends on our ability to detect infringement. It is difficult to detect infringers who do not advertise the compounds that are used in their products. Any
litigation to enforce or defend our patent rights, even if we were to prevail, could be costly and time-consuming and would divert the attention of our management and key personnel from our business operations.

We also rely on trade secrets, know-how and technology, which are not protected by patents, to maintain our competitive position. We try to protect this information by
entering into confidentiality agreements with parties that have access to it, such as our strategic partners, collaborators, employees and consultants. Any of these parties may breach these agreements and disclose our confidential information or our
competitors might learn of the information in some other way. If any trade secret, know-how or other technology not protected by a patent were to be disclosed to or independently developed by a competitor, our business, financial condition and
results of operations could be materially adversely affected.

Governmental and third-party payors may impose sales and pharmaceutical pricing
restrictions or controls on our potential products that could limit our future product revenues and adversely affect profitability.

The commercial
success of our potential products is substantially dependent on whether third-party reimbursement is available for the ordering of our products by the medical profession for use by their patients. Medicare, Medicaid, health maintenance organizations
and other third-party payors may not cover or provide adequate payment for our potential products. They may not view our potential products as cost-effective and reimbursement may not be available to consumers or may not be sufficient to allow our
potential products to be marketed on a competitive basis. Likewise, legislative or regulatory efforts to control or reduce health care costs or reform government health care programs could result in lower prices or rejection of our potential
products. Changes in reimbursement policies or health care cost containment initiatives that limit or restrict reimbursement for our products may cause our future product revenues, if any, to decline.

Competition in the biotechnology and pharmaceutical industries is intense, and if we fail to compete effectively our financial results will suffer.

Our business is characterized by extensive research efforts, rapid developments and intense competition. Our competitors may have or may develop
superior technologies or approaches to the development of competing products, which may provide them with competitive advantages. Our potential products may not compete successfully. We believe that successful competition in our industry depends on
product efficacy, safety, reliability, availability, timing, scope of regulatory approval, acceptance and price, among other things. Important factors to our success also include speed in developing product candidates, completing clinical
development and laboratory testing, obtaining regulatory approvals and manufacturing and selling commercial quantities of potential products to the market.

We expect competition to increase as technological advances are made and commercial applications broaden. In commercializing our initial product candidates and any additional product candidates, we will face substantial competition from
pharmaceutical, biotechnology and other companies, universities and research institutions.



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Many of our competitors have substantially greater capital resources, research and development staffs, facilities and
experience in conducting clinical trials and obtaining regulatory approvals, as well as in manufacturing and marketing pharmaceutical products. Many of our competitors may achieve product commercialization or patent protection earlier than we
achieve commercialization or patent protection, if at all. Furthermore, we believe that some of our competitors have used, and may continue to use, litigation to gain a competitive advantage.

Rapid technological change could make our products obsolete.

Biopharmaceutical technologies have undergone rapid and significant change and we expect that they will continue to do so. Any compounds, products or processes that we or our strategic partners or licensees develop may become obsolete or
uneconomical before achieving significant revenues. Rapid technological change could also make our products obsolete or uneconomical.

We face
potential product liability exposure far in excess of our limited insurance coverage.

The use of any of our product candidates in clinical trials,
and the sale of any approved products, may expose us to product liability claims. These claims might be made directly by consumers, health care providers, pharmaceutical companies or others selling our products. We have obtained limited product
liability insurance coverage for our clinical trials in the amount of $5,000,000 per occurrence and $5,000,000 in the aggregate. However, our insurance may not reimburse us or may not be sufficient to reimburse us for expenses or losses we may
suffer. Moreover, insurance coverage is becoming increasingly expensive, and we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses due to liability. If we obtain marketing
approval for any of our product candidates in development, we intend to expand our insurance coverage to include the sale of commercial products, but we may be unable to obtain commercially reasonable product liability insurance for any products
approved for marketing. On occasion, juries have awarded large judgments in class action lawsuits based on drugs that had unanticipated side effects. In addition, the pharmaceutical and biotechnology industries, in general, have been subject to
significant medical malpractice litigation. A successful product liability claim or series of claims brought against us would decrease our cash reserves and could cause our stock price to fall.

Our activities involve hazardous materials and we may be liable for any resulting contamination or injuries.

Our research activities involve the use of hazardous materials. We cannot eliminate the risk of accidental contamination or injury from these materials. If an accident
occurs, we may be liable for any resulting damages, which may decrease our cash reserves and could cause our stock price to fall.

If we are unable
to complete our assessment as to the adequacy of our internal control over financial reporting within the required time periods as required by Section 404 of the Sarbanes-Oxley Act of 2002, or in the course of such assessments identify and
report material weaknesses in our controls, our investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our common stock.

As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission adopted rules requiring public companies to include a report of
management on the companys internal controls over financial reporting in their Annual Reports on Form 10-K. This report is required to contain an assessment by management of the effectiveness of the companys internal controls over
financial reporting. In addition, the independent registered public accounting firm auditing a public companys financial statements must attest to and report on managements assessment of the effectiveness of the companys internal
controls over financial reporting. Although our management has determined, and our independent registered public accounting firm has attested, that our internal control over financial reporting was effective as of December 31, 2005, and we
intend to continue to diligently and vigorously review our internal controls over financial reporting in order to ensure compliance with the Section 404 requirements if our independent registered public accounting firm is not satisfied in the
future with our internal controls over financial reporting or the level at which these controls are documented, designed, operated or reviewed, or if said firm interprets the requirements, rules or regulations differently from us, then they may
decline to attest to managements assessment or may issue a report that is qualified or has a scope limitation. We anticipate to continue to expend resources in developing the necessary documentation and testing procedures required by
Section 404; however, there is a risk that in the future we will not comply with all of the requirements imposed by Section 404. In addition, the very limited sized of our organization could lead to conditions that could be considered
material weaknesses, such as those related to segregation of duties that is possible in larger organizations but significantly more difficult in smaller organizations. Also, controls related to our general information technology infrastructure may
not be as comprehensive as in the case of a larger organization with more sophisticated capabilities and more extensive resources. It unclear how such circumstances could be interpreted in the future in the context of an assessment of internal
controls over financial reporting. If we fail to implement required new or improved controls, we may be unable to comply with the requirements of Section 404 in in the future. This could result in an adverse reaction in the financial markets
due to a loss of confidence in the reliability of our financial statements, which could cause the market price of our common stock to decline or could limit our ability to obtain additional financing.

Risks Related to Our Common Stock

We expect
that our stock price will fluctuate significantly.

Prior to our initial public offering, you could not buy or sell our common stock publicly. An
active public market for our common stock may not develop or be sustained. The stock market, particularly in recent years, has experienced significant volatility particularly with respect to pharmaceutical and biotechnology stocks. The volatility of
pharmaceutical and biotechnology stocks often does not relate to the operating performance of the companies represented by the stock. Factors that could cause this volatility in the market price of our common stock include:



| |  |  | the results from our clinical trial programs, including the clinical trials involving NXY-059 and any future trials we may conduct;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | FDA or international regulatory actions;
| | - |  | ----------------------------------------



| |  |  | failure of any of our product candidates, if approved, to achieve commercial success;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | announcements of the introduction of new products by us or our competitors;
| | - |  | ---------------------------------------------------------------------------



| |  |  | market conditions in the pharmaceutical and biotechnology sectors;
| | - |  | ------------------------------------------------------------------



| |  |  | developments concerning intellectual property rights;
| | - |  | -----------------------------------------------------



24



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| |  |  | litigation or public concern about the safety of our potential products;
| | - |  | ------------------------------------------------------------------------



| |  |  | comments by securities analysts;
| | - |  | --------------------------------



| |  |  | actual and anticipated fluctuations in our quarterly operating results;
| | - |  | -----------------------------------------------------------------------



| |  |  | deviations in our operating results from the estimates of securities analysts;
| | - |  | ------------------------------------------------------------------------------



| |  |  | rumors relating to us or our competitors;
| | - |  | -----------------------------------------



| |  |  | additions or departures of key personnel;
| | - |  | -----------------------------------------



| |  |  | third party reimbursement policies; and
| | - |  | ---------------------------------------



| |  |  | developments concerning current or future strategic alliances.
| | - |  | --------------------------------------------------------------

These and
other external factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of
our common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock have instituted securities class action litigation against the company that issued the stock. If any of our stockholders brought a
lawsuit against us, we could incur substantial costs defending the lawsuit. Such a lawsuit could also divert the time and attention of our management.

Future sales of common stock by our existing stockholders may cause our stock price to fall.

The market price of our common stock
could decline as a result of sales by our existing stockholders of shares of common stock in the market, or the perception that these sales could occur. These sales might also make it more difficult for us to sell equity securities at a time and
price that we deem appropriate.

Our directors and management exercise significant control over our company.

If acting together, our directors and executive officers and their affiliates can influence our management and affairs and all matters requiring stockholder approval,
including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control of our company and might affect the market price of our common
stock.

Provisions of Delaware law or our charter documents and stockholder rights plan could delay or prevent an acquisition of our company, even if
the acquisition would be beneficial to our stockholders, and could make it more difficult for stockholders to change management.

Provisions of our
certificate of incorporation and bylaws may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which stockholders might otherwise receive a premium for
their shares. This is because these provisions may prevent or frustrate attempts by stockholders to replace or remove our current management.

These
provisions include:



| |  |  | a classified board of directors;
| | - |  | --------------------------------



| |  |  | a prohibition on stockholder action through written consent;
| | - |  | ------------------------------------------------------------



| |  |  | a requirement that special meetings of stockholders be called only by (i) the Chairman of the Board of Directors, (ii) the Chief Executive Officer, or (iii) the Board
of Directors pursuant to a resolution adopted by a majority of the total number of authorized directors;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | advance notice requirements for stockholder proposals and nominations;
| | - |  | ----------------------------------------------------------------------



| |  |  | a requirement of approval of not less than 662/3% of all outstanding shares of our capital stock entitled to vote to amend any bylaws by stockholder action, or to amend certain provisions of our certificate of incorporation; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the authority of the Board of Directors to issue preferred stock with such terms as the Board of Directors may determine.
| | - |  | -------------------------------------------------------------------------------------------------------------------------

As a result, these provisions and others available under Delaware law could limit the price that investors are willing to pay in the future for shares of our common
stock.

In addition, in March 2005, we adopted a stockholder rights plan. Although the rights plan will not prevent a takeover, it is intended to encourage
anyone seeking to acquire our company to negotiate with our board prior to attempting a takeover by potentially significantly diluting an acquirers ownership interest in our outstanding capital stock. The existence of the rights plan may also
discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.



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We have never paid dividends on our capital stock, and we do not anticipate paying any cash dividends in the
foreseeable future.

We have paid no cash dividends on any of our classes of capital stock to date and we currently intend to retain our future
earnings, if any, to fund the development and growth of our businesses. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds
|------- | -----------------------------------------------------------

Our
Registration Statement on Form S-1 (Reg. No. 333-109806) in connection with our initial public offering was declared effective by the SEC on February 4, 2004. We completed our initial public offering on February 10, 2004 for gross
proceeds of $75,900,000. The Company paid the underwriters a commission of $5,313,000 and incurred offering expenses of $2,187,000. After deducting the underwriters commission and the offering expenses, the Company received net proceeds of
approximately $68,400,000.

Our Registration Statement on Form S-3 (Reg. No. 333-122762) was declared effective by the SEC on May 23, 2005. We
completed a public offering under this Registration Statement on September 28, 2005 for gross proceeds of $54,000,000. The Company paid the underwriters a commission of $3,240,000 and incurred offering expenses of $331,000. After deducting the
underwriters commission and the offering expenses, the Company received net proceeds of approximately $50,429,000.

No payments for such expenses
were made directly or indirectly to (i) any of our directors, officers or their associates, (ii) any person(s) owning 10% or more of any class of our equity securities or (iii) any of our affiliates.

The net proceeds have been invested in short-term investment grade securities and money market accounts.

We have begun to use, and intend to continue to use, these proceeds for general corporate purposes, including clinical trials, research and development expenses, general and administrative expenses, manufacturing
expenses and potential acquisitions of companies, products and technologies that complement our businesses.

Issuer Purchases of Equity Securities

We did not have any repurchases of common stock during the three months ended March 31, 2006.



|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------



| | (a) | None
| | --- | ----



| | (b) | None
| | --- | ----



|Item 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------

There were no
matters submitted to a vote of the security holders during the quarter ended March 31, 2006.



|Item 5. | Other Information
|------- | -----------------



| | (a) | None
| | --- | ----



| | (b) | None
| | --- | ----



|Item 6. | Exhibits
|------- | --------



|               |  |                                                                                   
|-------------- |  | ----------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                           
|31.1           |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer.            
|               | 
|31.2           |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer.            
|               | 
|32             |  | Section 1350 Certification of Chief Executive Officer and Chief Financial Officer.



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##### Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned thereunto duly authorized as of the 9th day of May, 2006.



Renovis, Inc./s/ John C. DoyleJohn C. DoyleChief Financial Officer(Principal financial and accounting officer)




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