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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-K

(Mark One)



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

For the fiscal year ended December 31, 2010

Or



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

For the transition period from
 to

Commission file number: 001-33438

NEUROGESX, INC.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|Delaware                                                       |  | 94-3307935                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)

2215 Bridgepointe Parkway, Suite 200

San Mateo, CA 94404

(650) 358-3300

(Address, including zip code, of registrants principal executive offices and telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Common
Stock, $0.001 par value

Name of exchange on which registered: The Nasdaq Stock Market LLC (NASDAQ Global Market)

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act.    Yes   ̈    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act.    Yes   ̈    No  x

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 has submitted electronically and posted on its corporate Website, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files).    Yes   ̈    No   ̈

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and
will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):



|                                                                          |  |                                      
|------------------------------------------------------------------------- |  | -------------------------------------
|Large accelerated filer   ̈                                                |  | Accelerated filer                    ̈
|Non-accelerated filer     ̈  (Do not check if a
smaller reporting company) |  | Smaller reporting company  x         

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates was $74.7 million computed by reference
to the last sales price of $6.63 as reported by the NASDAQ Global Market, as of the last business day of the Registrants most recently completed second fiscal quarter, June 30, 2010. This calculation does not reflect a determination that
certain persons are affiliates of the Registrant for any other purpose.

The number of shares outstanding of the
Registrants common stock on February 28, 2011 was 17,870,440 shares.





DOCUMENTS
INCORPORATED BY REFERENCE

Portions of the Registrants Proxy Statement for its 2011 Annual Meeting of Stockholders
(the Proxy Statement), to be filed with the Securities and Exchange Commission, are incorporated by reference to Part III of this Annual Report on Form 10-K.











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NEUROGESX,
INC.

FORM 10-K

Year Ended December 31, 2010

INDEX



|             |  |                                                                                                               |    |      |    | 
|------------ |  | ------------------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|             |  |                                                                                                               |    | Page |   
|PART I       |  |                                                                                                               | 1  |     
|ITEM 1.      |  | BUSINESS                                                                                                      |    |      | 2  | 
|ITEM 1A.     |  | RISK FACTORS                                                                                                  |    |      | 24 | 
|ITEM 1B.     |  | UNRESOLVED STAFF COMMENTS                                                                                     |    |      | 44 | 
|ITEM 2.      |  | PROPERTIES                                                                                                    |    |      | 44 | 
|ITEM 3.      |  | LEGAL PROCEEDINGS                                                                                             |    |      | 44 | 
|ITEM 4.      |  | REMOVED AND RESERVED                                                                                          |    |      | 44 | 
|PART II      |  |                                                                                                               | 45 |     
|ITEM 5.      |  | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
 SECURITIES |    |      | 45 | 
|ITEM 6.      |  | SELECTED FINANCIAL DATA                                                                                       |    |      | 47 | 
|ITEM 7.      |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS                         |    |      | 48 | 
|ITEM 7A.     |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS                                                   |    |      | 61 | 
|ITEM 8.      |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                   |    |      | 62 | 
|ITEM 9.      |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE                          |    |      | 92 | 
|ITEM 9A.     |  | CONTROLS AND PROCEDURES                                                                                       |    |      | 92 | 
|ITEM 9B.     |  | OTHER INFORMATION                                                                                             |    |      | 92 | 
|PART III     |  |                                                                                                               | 93 |     
|ITEM 10.     |  | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                        |    |      | 93 | 
|ITEM 11.     |  | EXECUTIVE COMPENSATION                                                                                        |    |      | 93 | 
|ITEM 12.     |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS                |    |      | 93 | 
|ITEM 13.     |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                                     |    |      | 94 | 
|ITEM 14.     |  | PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                        |    |      | 94 | 
|PART IV      |  |                                                                                                               | 95 |     
|ITEM 15.     |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES                                                                       |    |      | 95 | 
|             |  |                                                                                                              
|EXHIBIT 23.1 |  |                                                                                                               |    |      |    | 
|EXHIBIT 31.1 |  |                                                                                                               |    |      |    | 
|EXHIBIT 31.2 |  |                                                                                                               |    |      |    | 
|EXHIBIT 32.1 |  |                                                                                                               |    |      |    | 



-i-



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PART I

This report contains forward-looking statements that are based upon current expectations within the meaning of the Private Litigation
Securities Reform Act of 1995. We intend that such statements be protected by the safe harbor created thereby. Forward-looking statements involve risks and uncertainties and our actual results and the timing of events may differ significantly from
those results discussed in the forward-looking statements. Examples of such forward-looking statements include, but are not limited to, statements about or relating to:



| |  |  | Our plans with regard to the commercialization of Qutenza® in the United States and the plans of Astellas Pharma Europe Ltd., or Astellas for commercialization of Qutenza pursuant to the terms of the Distribution, Marketing
Agreement and License Agreement or the Astellas Agreement;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the sufficiency of existing resources to fund our operations beyond December 31, 2011;
| | - |  | --------------------------------------------------------------------------------------



| |  |  | capital requirements and our needs for additional financing including the potential forms such financing may take;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | our proposed distribution and sales strategies including our plans for sales, marketing and manufacturing;
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | efforts to expand the scope of indications in which our capsaicin-based product candidates are approved, and the timing of potential clinical trials in
connection with such expansion;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the scope and size of research and development efforts and programs, including with respect to development of additional product candidates;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | anticipated development of NGX-1998 and other potential product candidates;
| | - |  | ---------------------------------------------------------------------------



| |  |  | the potential benefits of, and markets for, our product candidates;
| | - |  | -------------------------------------------------------------------



| |  |  | losses, costs, expenses, expenditures and cash flows;
| | - |  | -----------------------------------------------------



| |  |  | potential competitors and competitive products;
| | - |  | -----------------------------------------------



| |  |  | future payments under lease obligations and equipment financing lines;
| | - |  | ----------------------------------------------------------------------



| |  |  | patents and our and others intellectual property; and
| | - |  | ------------------------------------------------------



| |  |  | expected future sources of revenue and capital.
| | - |  | -----------------------------------------------

We undertake no obligation to, and expressly disclaim any obligation to, revise or update the forward-looking statements made herein or the risk factors, whether as a result of new information, future
events or otherwise. Forward-looking statements involve risks and uncertainties, which are more fully discussed in the Risk Factors section and elsewhere in this Annual Report, including, but not limited to, those risks and uncertainties
relating to:



| |  |  | physician or patient reluctance to use Qutenza or payer coverage for Qutenza and for the procedure to administer it, which may impact physician
utilization of Qutenza;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our inability to obtain additional financing if necessary;
| | - |  | ----------------------------------------------------------



| |  |  | changing standards of care and the introduction of products by competitors or alternative therapies for the treatment of indications we target;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | difficulties or delays in development, testing, obtaining regulatory approval for, and undertaking production and marketing of our drug candidates;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the uncertainty of protection for our intellectual property, through patents, trade secrets or otherwise; and
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | potential infringement of the intellectual property rights or trade secrets of third parties.
| | - |  | ---------------------------------------------------------------------------------------------



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When used in
this Annual Report, unless otherwise indicated, NeurogesX, the Company, we, our and us refers to NeurogesX, Inc. and its subsidiaries.

Qutenza® and Neurogesx® are registered
trademarks in the United States. We have also applied for these trademarks in several other countries. Other service marks, trademarks and trade names referred to in this Annual Report on Form 10-K are the property of their respective
owners.



|Item 1. | Business
|------- | --------

Overview

We are a
biopharmaceutical company focused on developing and commercializing novel pain management therapies. We are assembling a portfolio of pain management products and product candidates based on known chemical entities to develop innovative new
therapies that we believe may offer substantial advantages over currently available treatment options. Our initial focus is on the management of chronic peripheral neuropathic pain conditions.

Our first commercial product, Qutenza, became commercially available in the United States and in certain European countries in the first
half of 2010. Qutenza is a dermal delivery system designed to topically administer capsaicin to treat certain neuropathic pain conditions and was approved by the U.S, Food and Drug Administration, or FDA in November 2009 for the management of
neuropathic pain associated with postherpetic neuralgia, or PHN. Qutenza is the first prescription strength capsaicin product approved in the United States.

In May 2009, Qutenza received a marketing authorization or MA, in the European Union for the treatment of peripheral neuropathic pain in non-diabetic adults, either alone or in combination with other
medicinal products for pain. In June 2009, we entered into the Astellas Agreement, under which we granted Astellas an exclusive license to commercialize Qutenza in the European Economic Area, which includes the 27 countries of the European Union,
Iceland, Norway, and Liechtenstein as well as Switzerland, certain countries in Eastern Europe, the Middle East and Africa, which we refer to as the Licensed Territory. Qutenza was made available on a country by country basis commencing in April,
2010 and by year end was available in seventeen European countries. Astellas anticipates introducing Qutenza in additional European Union countries, as well as non-European Union countries, within their territory during 2011.

In April 2010, we borrowed $40.0 million from Cowen Healthcare Royalty Partners, L.P., or Cowen Royalty, and we agreed to repay Cowen
Royalty up to $106.0 million as the amount due to Cowen Royalty may be reduced in accordance with certain prepayment provisions of the agreement.

The debt, together with accrued interest will be repaid through Cowen Royalty receiving all of the proceeds we receive under the Astellas Agreement until our payment obligations are satisfied in full,
after which Cowen will have no ongoing participation in our business.

We plan to submit a supplemental new drug application,
or sNDA, in the first half of 2011 in pursuit of a label expansion for Qutenza in the United States. The label expansion would include patients with HIV-associated neuropathy, or HIV-AN, also known as HIV-distal sensory polyneuropathy, or HIV-DSP.

In November 2010, we treated the first patient in a Phase 2 clinical study of NGX-1998, a liquid formulation of
high-concentration capsaicin. The Phase 2, adaptive-design, clinical study is being conducted in patients with postherpetic neuralgia, or PHN in two stages. The objective of the study is to select the appropriate pretreatment regimen, if any and the
concentration of NGX-1998 for further evaluation in a Phase 3 clinical program. The first stage, which was completed in February 2011, was designed to determine the shortest tolerable topical anesthetic pretreatment regimen. The second stage will
evaluate two NGX-1998 dose concentrations using the pretreatment regimens determined during stage 1. Based on the results from the first stage, the second stage of the study is being conducted without the use of a topical anesthetic pretreatment
regimen. The Astellas Agreement provides Astellas an option to exclusively license NGX-1998 in the Licensed Territory. If Astellas was to exercise its option, they would partner with us on the Phase III clinical trials and share equally in the cost
of the trials.



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In addition to Qutenza and NGX-1998, we have a series of compounds which represent an early
stage pipeline of potential product candidates consisting of prodrugs of acetaminophen for potential use in acute pain, including traumatic pain, post-surgical pain and fever. These product candidates are in the pre-clinical stage of development and
may or may not be the subject of further development in 2011 or beyond. Further, we are currently seeking development partners for our acetaminophen prodrug product candidates.

We hold worldwide commercial rights to all of our products and product candidates, with the exception of rights given to Astellas. We are
actively engaged in discussions with potential commercial partners in geographic regions other than the United States and Licensed Territory under the Astellas Agreement.

Our Strategy

Our goal is to become a leading biopharmaceutical company
focused on the development and commercialization of novel pain management therapies. Key elements of our strategy for achieving this goal include:

Maximize the value of Qutenza through expansion of our patient base throughout the world. Qutenza became commercially available in the United States, or U.S., in the first half of 2010 through our
own, dedicated sales force. Our U.S. sales and marketing efforts in 2010 targeted thought leaders in neuropathic pain as well as pain specialists with a high volume of prescriptions for the treatment of PHN. The goal was to differentiate Qutenza
clinically and then to train the healthcare professionals and their staff on how to administer Qutenza and other important elements of the treatment, such as managing a patients ability to tolerate a Qutenza treatment. Additionally, we
provided support to the healthcare professionals in obtaining reimbursement. We also worked to establish treatment centers in hospitals and large pain practices. We believe we were successful in these initiatives and have started the process of
creating an infrastructure to support the treatment of PHN patients.

During 2011, we expect to refine our sales efforts by
further focusing our direct sales activities on physicians who practice in larger hospitals and institutional settings as we believe this will result in the most efficient use of our specialty sales force resources. Additionally we intend to
evaluate potential co-promotion opportunities to achieve broader awareness of Qutenza particularly in primary care and specialist practices that our own direct sales force cannot currently address. Also in 2011, we plan on introducing new
programs to increase patient awareness of Qutenza and affect referral patterns from primary care physicians and other healthcare providers to encourage these providers to refer their PHN patients to established Qutenza treatment centers. We believe
that educating patients and their primary care physicians on the benefits of Qutenza and the treatment option of using an established treatment center will increase referrals into those centers. We evaluate our sales forces effectiveness in
order to allocate resources to territories that require more sales effort and conversely eliminate sales coverage when not needed. We are also evaluating the possibility of co-promoting Qutenza with a marketing partner in the United States in order
to broaden the reach across our target markets as well as increase the treatment volume in the established treatment centers.

We believe that patient access to Qutenza in the United States in 2011 may benefit from our successful efforts in obtaining a
Qutenza-specific J-code from the Centers for Medicare and Medicaid Services, or CMS, which became effective on January 1, 2011. The issuance of the J-code is expected to improve the efficiency of reimbursement process to healthcare
professionals for all customer segments from large hospitals to individual physicians.

In Europe, the Middle East and Africa,
we have established a commercial partnership with Astellas. Through this partnership, Qutenza became commercially available in seventeen European countries in 2010 and may become available in additional countries in 2011. We may establish
distribution partnerships with pharmaceutical distributors in the Latin American and Asian regions during 2011.

Obtain
broader market access through expansion of approved indications.We plan to continue to develop our capsaicin-based products and product candidates to address indications beyond currently labeled indications. We expect such development efforts
in the United States in 2011 will focus on Qutenza and NGX-1998 and in



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the European Economic Area may include development efforts sponsored by Astellas. To date in the United States, we have conducted two Phase 3 studies of Qutenza in HIV-AN, one of which met
its primary endpoint. In addition, we have conducted a Phase 2 open-label study of Qutenza in patients with HIV-AN and in one Phase 2 open-label study that included patients with painful diabetic neuropathy, or PDN. We met with the FDA in October
2010 to discuss the potential for filing a sNDA for the management of neuropathic pain in patients with HIV-AN. Based on the outcome of that meeting, we plan to submit a sNDA in the first half of 2011 utilizing the data from the two previously
completed Phase 3 studies. We believe treatment of HIV-AN patients is important for many reasons including that there are currently no FDA approved treatments for HIV-AN. If achieved, the label expansion to include HIV-AN would allow us to reach a
new group of neuropathic pain patients while leveraging our current United States sales force and their relationships with pain specialists.

NGX-1998, a liquid formulation which uses the same active ingredient as in Qutenza, is also being developed for the treatment of neuropathic pain conditions and may be developed to address indications
beyond Qutenzas currently labeled indications. The target profile for NGX-1998 is to provide safety, efficacy and tolerability that is at least comparable to Qutenza with a significantly shorter application time. In November 2010, we dosed the
first patient with NGX-1998 in a Phase 2 clinical study in patients with PHN. This Phase 2, adaptive-design, clinical study is being conducted in two stages. The first stage, which was completed in February 2011, was designed to determine the
shortest tolerable anesthetic pretreatment regimen. The results of the first stage found that NGX-1998 could be tolerated without the use of a topical anesthetic as a pretreatment regimen. The second stage will evaluate two NGX-1998 dose
concentrations using the pretreatment regimens determined during stage 1. Final results from this study are expected to be available in the first half of 2012.

In Europe, follow-up measures required the conduct of an additional safety study in the labeled indication (peripheral neuropathic pain in non-diabetic adults) and an efficacy and safety study in patients
with PDN. In addition to a long-term safety study in the labeled indication, Astellas currently plans to commence enrollment in two studies in the PDN patient population (efficacy and long-term safety) later this year. These studies may allow label
expansion to include diabetic neuropathy patients in Europe. Under the Astellas Agreement, Astellas will conduct and pay for development work required in support of regulatory requirements in the Licensed Territory, including EMEA post market
commitments. Currently, we are evaluating whether, in addition to the studies being performed by Astellas, additional studies will be required to obtain a possible label expansion in the United States in PDN.

Expand our product portfolio. Our model is to develop innovative therapies based on known chemical entities, balancing market
opportunity with a favorable clinical and regulatory pathway. We have begun to expand our product candidate pipeline through the pre-clinical evaluation of our acetaminophen prodrug candidates. Further, we may expand our product candidate pipeline
through in-license or acquisition of product candidates. The expansion of our product candidate pipeline is important to our continued success. As we commercialize Qutenza with our own sales force, we believe an opportunity may exist to leverage
that commercial presence through in-license or co-promotion of additional commercial products. Leveraging our sales force is a long term strategic objective.

Qutenza

Qutenza is a non-narcotic analgesic formulated in a localized
treatment patch containing an 8% concentration of synthetic capsaicin. Capsaicin is released from the patch and, with the aid of penetration enhancers, penetrates into the skin during application without significant absorption of capsaicin into the
bloodstream. Accordingly, we believe that users of Qutenza are unlikely to experience the common central nervous system side effects of systemically administered drugs used to treat neuropathic pain such as anti-convulsants, anti-depressants and
opioids and the potential for abuse and addiction associated with some of these drugs. FDA labeling in the United States requires Qutenza to be administered by a physician or by a health care professional under the direct supervision of a physician
in a non-invasive process that involves pre-treating the painful area with a topical anesthetic, followed by the application of Qutenza. Patches are cut to conform to the area to be treated. After the specified application period (60 minutes for
PHN), the patch is removed and



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residual capsaicin is removed from the skin with a proprietary cleansing gel. Qutenza has been shown to provide a clinically meaningful reduction in peripheral neuropathic pain for up to
12 weeks in certain of our clinical studies. As noted on its label, the most common adverse reactions to Qutenza were application site redness, pain, itching and papules. The majority of these reactions were transient and self limited. Serious
adverse reactions included application site pain and increased blood pressure. Application associated pain can be treated with local cooling either alone or in conjunction with appropriate analgesic medication such as opioids. Blood pressure
increases during or shortly after Qutenza treatment were on average less than 10 mm Hg, although some patients had greater increases and these changes lasted for approximately 2 hours after patch removal.

Qutenza can be used alone or in conjunction with other pain medications and as such may have place as first line or additive therapy.

Qutenza has been approved by the FDA for the management of neuropathic pain associated with PHN and is the first prescription
strength product containing capsaicin, Qutenzas active ingredient. Qutenza has also been approved in the European Union for the treatment of peripheral neuropathic pain in non-diabetic adults, either alone or in combination with other
medicinal products for pain.

Neuropathic Pain

Pain results from sensory nerve stimulation often associated with actual or potential tissue damage. Pain is transmitted by specific nerve fibers that carry the pain signal across the nervous system to
the brain, where it is recognized as pain. Pain can be acute or chronic. Acute pain is short in duration and tends to be reactive or protective against actual or potential tissue injury. Chronic pain lasts over an extended period of time and often
serves no useful purpose. There are two broad categories of chronic pain, inflammatory and neuropathic. Inflammatory pain is associated with tissue damage, often occurring from injury or from inflammatory conditions, such as osteoarthritis or lower
back pain. This class of pain is often treated with prescription drugs that act systemically, including opioids, and over-the-counter anti-inflammatory drugs.

Neuropathic pain is a type of chronic pain that results from injury to, or dysfunction of, nerves. The injury can be to the central nervous system, consisting of the brain and spinal cord, or to the
peripheral nervous system, consisting of all other nerves. Neuropathic pain can occur in any part of the body and can significantly impair the affected individuals quality of life. It can result from viruses, as is the case with PHN and HIV,
or diseases, such as diabetes. Neuropathic pain can also result from the use of drugs that treat viruses or other diseases, such as drugs used to treat HIV or cancer.

Postherpetic Neuralgia

PHN is a painful condition affecting sensory
nerve fibers. It is a complication of shingles, a second outbreak of the varicella-zoster virus, which initially causes chickenpox. Following an initial infection, some of the virus can remain dormant in nerve cells. Years later, age, illness,
stress, medications or other factors that are not well understood can lead to reactivation of the virus. The rash and blisters associated with shingles usually heal within about six weeks, but some people continue to experience pain for years
thereafter. This pain is known as postherpetic neuralgia, or PHN. PHN may occur in almost any area, but is especially common on the torso.

According to the Centers for Disease Control, or CDC, there are approximately 1.0 million cases of shingles in the United States each year, and approximately one in five shingles sufferers go on to
develop PHN. The likelihood of developing PHN from shingles increases with age, with approximately 25% of people over 55, 50% of people over 60, and 75% of people over 70 estimated to eventually develop PHN after contracting shingles. Estimates of
the number of people suffering from PHN in the United States range from under 200,000 to 500,000. We have been granted an orphan designation for capsaicin for the management of neuropathic pain in patients with postherpetic neuralgia by the
FDAs Office of Orphan Products Development.



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Capsaicin-Induced Effects on
Peripheral Neuropathic Pain

Peripheral neuropathic pain results from injured or diseased nerve endings that can send
aberrant pain signals to the brain in the absence of harmful stimuli, inappropriately causing the sensation of pain. We believe capsaicin can reduce the ability of these nerve fibers to initiate pain signals for a sustained period of time. Capsaicin
is a naturally occurring substance that is responsible for making chili peppers pungent.

Products containing low
concentrations of capsaicin, including creams, lotions and patches, have long been sold over-the-counter for the treatment of minor arthritis, back and muscle pain, as well as for other conditions. Low-concentration capsaicin topical products have
not been a viable treatment for chronic peripheral neuropathic pain conditions due in part to poor patient compliance resulting from the treatment of already painful skin with a compound that causes burning sensations, as well as the inconvenience
of multiple daily applications. We believe that high-concentration capsaicin cream also does not appear to constitute a viable therapy because application causes significant patient discomfort, creams can allow the capsaicin to disperse beyond the
treatment area, and existing creams have not been optimally formulated to allow capsaicin to penetrate the skin. To address the intrinsic limitations of existing, over the counter capsaicin therapies, we have developed Qutenza and are developing
NGX-1998, utilizing prescription-strength capsaicin.

Existing Treatments and their Limitations

While there are a number of products currently available for the management of neuropathic pain in general and PHN specifically, we
believe that the market is still underserved due to the limitations of current therapies. The primary limitations of current therapies relate to their modest efficacy, unwanted systemic side effects, cumbersome treatment regimens, potential for
abuse and drug-drug interaction.

Because patients react to pain and to pain therapies in many ways and because no one therapy
offers complete pain relief to all patients without significant side effects, a single standard of care does not exist for the management of neuropathic pain. Initial systemic treatment typically involves one of a few anti-convulsants or
anti-depressants. To the extent that the initial therapy does not provide adequate pain relief, the physician may try other anti-convulsants, anti-depressants or opioids alone or in combination, to treat the pain. These systemic treatments are often
limited by side effects including dizziness, sedation, confusion, constipation and the potential for drug dependence. Due to these side effects, patient compliance is often poor and physicians often reduce dosing to less than optimal levels which
limits the ability of these drugs to reduce pain. Additionally, topical analgesics have limited efficacy and cumbersome treatment regimens. For these reasons, we believe there is an opportunity for localized, non-systemic analgesics to be used
broadly either alone or in combination with other pain medications to reduce the patients pain.

Commercialization of Qutenza

United States

We launched Qutenza in the United States in April 2010 with a focused approach towards building an infrastructure to support long term success of the product. This approach consisted of contacting and
training thought leaders in neuropathic pain, establishing treatment centers in hospitals and pain clinics, getting Qutenza on formulary at key hospitals in major metropolitan areas and establishing an efficient reimbursement process.

When we launched Qutenza in the United States, our own sales force was comprised of approximately 40 sales representatives and sales
management personnel in three regions. Our sales organization is expected to continue to focus on hospital and large institution based thought leaders in neuropathic pain and pain specialists with a significant practice in treating PHN patients.
During 2010, we targeted and met with approximately 7,000 healthcare professionals who specialize in treating pain. These include pain specialists, neurologists, anesthesiologists, and specialists in physical medicine and rehabilitation, among
others. During 2011, we expect to expand our efforts to a broader array of healthcare professionals who treat PHN patients, to PHN patients and to primary care physicians. To support this effort, we recently improved the efficiency and oversight of
the sales



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organization by adding two sales managers, redistributed the account managers from three territories to five and thus improved the ratio of management to account managers. We plan to continue to
evaluate our sales force and may change the size or the assigned territories of the sales force as we refine our focus in 2011. Our field sales force is aided by a commercial team consisting of reimbursement and commercial payer specialists in
addition to non-field based support personnel.

We believe that timely and informative training of healthcare professionals
and their office personnel in the effective and efficient use of Qutenza is a critical success factor for the commercialization of Qutenza in the United States. To promote physician knowledge in both the techniques to apply the Qutenza patch and in
helping patients to tolerate the potential discomfort associated with a Qutenza application, we have developed a training program that we believe is best communicated through in-person training sessions performed by our sales force. In addition,
training materials are available through a number of alternative venues including video, compact disc and web site access. We believe that this approach may have limited sales of Qutenza in 2010 as it is very labor intensive; however, we believe it
will promote the long-term commercial success of Qutenza.

In addition, we focused on pain centers, clinics and hospital
outpatient facilities that we believe have the physical space available to accommodate the Qutenza treatment. We have created a web site with a find a doctor function to direct interested patients or referring physicians to healthcare
professionals trained to administer Qutenza. As of December 31, 2010, there were over 250 medical professionals registered on the find a doctor web site. During 2011 we plan to increase patient volume into the established facilities
by marketing the benefits of Qutenza directly to patients and primary care physicians.

Reimbursement

During 2010, we met our goal of securing reimbursement under Medicare Part B for Qutenza and the related application
procedure. Within the first month of commercial availability, Qutenza was confirmed under Medicare Part B and we received a temporary C-code for use beginning in July 2010. In November 2010, CMS granted a unique, Level II Health Care Common
Procedural Coding System, or J-code, for Qutenza which became effective on January 1, 2011. The issuance of the J-code is expected to improve the efficiency of reimbursement process to healthcare professionals for all customer segments from
large hospitals to individual physicians.

Manufacturing

We manufacture Qutenza through the use of contract manufacturers. There are multiple primary raw material components of our active
ingredient, synthetic capsaicin, all but one is generally available from more than one supplier. We currently obtain our supplies of synthetic capsaicin from Formosa Laboratories, Inc., or Formosa, in Taiwan, who obtains the raw materials from
qualified suppliers. While Formosa is our sole supplier currently, other potential suppliers exist and we may consider qualifying a second source of supply in the future.

The Qutenza patch is manufactured exclusively by LTS Lohmann Therapie-Systeme AG, or LTS, in Germany. LTS manufactures the patch using a proprietary process which includes combining the active ingredient
with adhesives and penetration enhancers and applying that mixture to a backing to create a dermal delivery system. Our commercial supply and license agreement with LTS establishes standard commercial terms on which product will be supplied, as well
as continuing the licenses initially granted in our clinical supply agreement. The term of the commercial supply and license agreement extends until January 2020 and automatically renews for additional two year terms, unless terminated by either
party with two years prior written notice. LTS has an alternative manufacturing site in the United States which is not currently an approved site for the manufacture of Qutenza. We may decide in the future to seek approval for that site as an
alternative source of supply of Qutenza.



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We have engaged
Contract Pharmaceuticals Limited Canada, or Contract Pharmaceuticals, as the manufacturer of our cleansing gel, a component of the Qutenza treatment, which is used to cleanse residual capsaicin from the skin after a Qutenza application. While we
currently have only one supplier for the cleansing gel, we believe there are a number of potential suppliers which we may evaluate as alternative sources of supply.

Distribution

We distribute Qutenza through a network of specialty
distributors and specialty pharmacies. Healthcare professionals access Qutenza primarily through one of two distribution models. In one model, the physician practice will take ownership of Qutenza, after having acquired it through a specialty
distributor. Under this model, known as buy and bill, the physician is able to bill payers (or patients) for Qutenza, as well as for their professional services related to its administration. In the second model, known as
assignment of benefit, the physician would order the product for a specific patient. A contracted specialty pharmacy would dispense Qutenza for that patient, bill the patients health plan for Qutenza, and ship it to the treating
physician for administration. The treating physician would administer Qutenza and bill the patients health plan for his or her professional services related to its administration. This model is also known as the drop ship model.

Our distribution strategy does not include making Qutenza available in retail pharmacies, as is usually the case for
self-administered products. As a result, we expect that product shipments will generally be limited and that our specialty distributors and specialty pharmacies will stock relatively small quantities of Qutenza. In December 2009, we signed a three
year agreement with Integrated Commercialization Solutions, Inc., or ICS, to outsource our finished goods warehousing, distribution, and customer service activities related to Qutenza. Our finished goods are held by ICS in their warehouse and ICS
ships from that location to our specialty distributors and specialty pharmacies based on orders received.

Territories
outside of the United States.

Astellas License Agreement and Supply Agreement

In June 2009, we entered into the Astellas Agreement, under which Astellas was granted an exclusive license to promote, distribute and
market Qutenza in the Licensed Territory. Qutenza was made available on a country by country basis commencing in April, 2010 and by year end was available in seventeen European countries. Astellas anticipates introducing Qutenza in additional
European Union countries, as well as non-European Union countries, within their territory during 2011. The Astellas Agreement provides for Astellas to be responsible for seeking regulatory approvals in the remainder of the Licensed Territory.
Astellas has indicated that it expects to seek approval in additional countries during 2011.

The Astellas Agreement provided
for an upfront payment for past development and the commercialization rights granted to Astellas, of 30.0 million Euro, or $41.8 million. In addition, the Astellas Agreement provided for an upfront payment of 5.0 million Euro, or $7.0
million, for future development expenses and an option to license NGX-1998. Other elements of the Astellas Agreement include future milestone payments of up to 65.0 million Euro if certain predefined sales thresholds of the products licensed
under the agreement are met and royalty payments, as a percentage of net sales of products under the agreement, with royalty rates starting in the high teens and escalating into the mid twenties as revenues increase. These royalty payments are
subject to a reduction upon entry of generic competition in the Licensed Territory. The Astellas Agreement requires us to participate on a joint steering committee with Astellas to oversee the development and commercialization activities related to
Qutenza and NGX-1998 during the term of the agreement, but not to exceed ten years. On the seventh anniversary of the Astellas Agreement, we have the unilateral right to opt-out of participation on the joint steering committee. Additionally, the
agreement provides for Astellas commitment to perform certain studies to support the marketing and promotion of Qutenza in the Licensed Territory, and Astellas is responsible for conducting certain post European Commission approval marketing
commitments, including a safety study in on-label indications.



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The terms of the Astellas Agreement also provide for the development and potential
commercial marketing and distribution of NGX-1998. Astellas development work with, and the right to distribute and market NGX-1998 in the Licensed Territory, are tied to affirmative opt-in provisions of the Astellas Agreement. Such provisions
allow for Astellas to carry out its election by making (in addition to the initial upfront payment of 5.0 million Euro received by us as described above) two additional NGX-1998 option payments totaling 5.0 million Euro, each made at the
election of Astellas after receipt from us of certain clinical development deliverables relating to the development of NGX-1998. If Astellas exercises such option by making all such payments, the Astellas Agreement provides that post-election
development expenses for NGX-1998 will be shared equally by us and Astellas, and Astellas shall have the exclusive right to commercialize NGX-1998 in the Licensed Territory. If Astellas does not exercise its option to commercialize NGX-1998, the
Astellas Agreement terms preclude us from marketing NGX-1998 in the Licensed Territory for a period of time. The Astellas Agreement will remain effective on a country-by-country and product-by-product basis until the later of ten years after the
first commercial sale, expiration or abandonment of the last valid patent claim or expiration of all applicable periods of regulatory data exclusivity. The Astellas Agreement may be terminated in the event of material breach or insolvency by either
party, and Astellas may terminate the agreement for any reason without penalty, consequence or compensation on a country-by-country and product-by-product basis upon written notice to us.

Pursuant to a Supply Agreement that we entered into with Astellas in connection with our entry into the Astellas Agreement, we have
agreed to provide Astellas with a sufficient supply of components of Qutenza to support its commercialization efforts, subject to certain limitations, until it can establish a direct supply relationship with product manufacturers. The Supply
Agreement requires us to provide Qutenza to Astellas at a contractually agreed upon cost for materials and our related labor and overhead. We anticipate that Astellas may establish direct supply relationships with one or more of the three principal
manufacturers of components of Qutenza and that the Supply Agreement will be terminated with respect to any manufacturer for which a direct supply relationship has been established. The three principal manufacturers identified in the Supply
Agreement are LTS, Formosa, and Contract Pharmaceuticals.

In April 2010, we borrowed $40.0 million from Cowen Royalty. Such
debt is secured by and will be repaid from future royalty, milestone, option and other payments from Astellas. Under the arrangement, we are obligated to pay Cowen Royalty all royalty, milestone, option and other payments until we have paid them
$90.0 million. Additionally, we are obligated to pay Cowen Royalty five percent of amounts we receive from Astellas for royalty, milestone, option and other payments between $90.0 million and $106.0 million. These amounts due to Cowen Royalty may be
reduced in accordance with certain prepayment provisions of the agreement.

Rest of World

Qutenza is not currently approved in countries other than the United States and the European Economic Area and certain additional
countries in the Licensed Territory. We retain rights to all markets other than the Licensed Territory and we are currently working to identify potential commercialization partners in other world markets.

Competition

We expect
that Qutenza will compete against, and may be used in combination with, well-established products currently used both on and off-label in our target indications. The most directly competitive currently marketed products in the United States are
Lidoderm, an FDA-approved 5% lidocaine topical patch for the treatment of PHN marketed by Endo Pharmaceuticals, and Lyrica, an oral anti-convulsant, marketed by Pfizer for use in the treatment of PHN. In January 2011, Depomed Inc. received FDA
approval for Gralise, a formulation of gabapentin that is a once daily tablet for the treatment of PHN. In addition to these branded drugs, the FDA has approved gabapentin (Neurontin) for use in the treatment of PHN. Pfizer has also received FDA
approval of Lyrica for the treatment of PDN, fibromyalgia and epilepsy indications. The FDA has approved Cymbalta from Eli Lilly & Co, or Eli Lilly, for use in the treatment of PDN, general anxiety disorder and depression; however we
believe Cymbalta is used in PHN patients.



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In addition to
existing approved therapies for PHN, there are many other companies working to develop new drugs and other therapies to treat pain in general and neuropathic pain in particular, including Eli Lilly, Pfizer, UCB Pharma SA, GlaxSmithKline plc, Merz,
GW Pharmaceuticals, Novartis AG, Novo Nordisk A/S, Dainippon Pharmaceutical Co Ltd., AVANIR Pharmaceuticals, Xenoport, EpiCept, Newron Pharmaceuticals SpA, WEX Pharmaceuticals, Arcion Therapeutics Inc., Endo Pharmaceuticals, AstraZeneca plc,
Bristol-Myers Squibb Co., Bio3 Research Srl, Relevare Pharmaceuticals Ltd., and Ortho-McNeil-Janssen Pharmaceuticals. Many of the compounds in development by such companies are already marketed for other indications, such as anti-depressants,
anti-convulsants or opioids. In addition, physicians employ other interventional procedures, such as nerve stimulation or nerve blocks, to treat patients with difficult to treat neuropathic pain conditions. Furthermore, new developments, including
the development of other drug technologies and methods of preventing the incidence of disease, such as vaccines including Zostavax, occur in the biopharmaceutical industry at a rapid pace. Any of these developments may render our products or product
candidates obsolete or noncompetitive.

We expect to compete on, among other things, the safety, efficacy and duration of
action of Qutenza.

Competing successfully will depend on our continued ability to attract and retain skilled and experienced
personnel and to identify, secure the rights to and develop pharmaceutical products and compounds and to exploit these products and compounds commercially before others are able to develop competitive products. However, our ability to compete may be
adversely affected because insurers and other third-party payers in some cases seek to encourage the use of generic products making branded products less attractive, from a cost perspective, to buyers.

Qutenza in other Neuropathic Pain Indications

In addition to PHN, we have studied Qutenza in two other neuropathic pain indicationsHIV-AN and PDN as set forth in the following table. Although Qutenza is approved in the European Union for
neuropathic pain in non-diabetic adults, in the United States, additional studies beyond those listed in the below table may be required to gain approval in other neuropathic pain indications.



|                 |  |                               |  |             |  |                       |  |                                             
|---------------- |  | ----------------------------- |  | ----------- |  | --------------------- |  | --------------------------------------------
|Indication       |  | Development Activity          |  | TrialNumber |  | Number ofParticipants |  | Status                                      
|HIV-AN           |  | Phase 3                       |  | C119        |  | 494                   |  | Completed; primary endpoint not met         
|                 |  | Phase 3                       |  | C107        |  | 307                   |  | Completed; primary endpoint met (p = 0.0026)
|                 |  | Open-label safety study       |  | C118        |  | 106*                  |  | Completed                                   
|                 |  | Phase 2                       |  | C109        |  | 12                    |  | Completed                                   
|                 |  |                               |  |            
|PDN, PHN, HIV-AN |  | Open-label tolerability study |  | C111        |  | 117**                 |  | Completed                                   



|* | C118 evaluated the safety of applications of Qutenza over a 12 month period. Of the 106 patients enrolled, 52 patients had HIV-AN and 54 patients
had PHN.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------

|** | C111 evaluated the effect of topical anesthetic alternatives on tolerability of Qutenza and included 91 PDN patients, 25 PHN patients and 1 HIV-AN patient.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------

General Trial Design Criteria. Because all of our trials have focused on the treatment of peripheral
neuropathic pain, although in different indications, we have generally been able to employ a similar design in each trial. Patients in each of our trials have to be at least 18 years old and have intact, unbroken skin over the painful area to
be treated. Patients could be taking stable doses of other chronic pain medications, but could not be using any topical pain medications on the affected areas. Our blinded trials involve a randomly selected treated group and a control group. The
treated patients receive a single application of our Qutenza dermal delivery system in its standard formulation, containing an 8% concentration of synthetic capsaicin. Our control group patients receive a single application of a low-dose version of
our Qutenza dermal delivery system,



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containing 0.04% capsaicin. The control groups receive a low-dose capsaicin to ensure that these patients can feel the heat sensation produced by the active ingredient, so that they could not
tell that they are receiving the control. All patients receive a topical local anesthetic for one hour prior to application of the patch. The patch is then applied to all patients for a prescribed duration, usually 30 or 60 minutes, although in
some of our studies we also tested durations of 90 minutes. The amount of active ingredient delivered to the patient is dependent on the duration of patch application, since the capsaicin is absorbed into the skin over time. In our open-label
extension studies, the control group is eliminated and all participants may receive additional single application treatments of Qutenza, typically when pain has returned but not more frequently than once every 12 weeks.

General Objectives. The primary objective, or endpoint, of each of our Phase 3 clinical trials has been to assess the percent
change in average pain from baseline to weeks 2-8, in the case of PHN, or to weeks 2-12, in the case of HIV-AN. If the primary endpoint is not met, the trial is generally considered to have been unsuccessful. Determining if the
primary endpoint has been achieved is based on statistical analysis that has been defined in the protocol, the measurement of which is known as the p value. A successful trial is generally based on meeting a p value of less than 0.05,
which means that there is a greater than 95% likelihood that the drug was responsible for the difference in effect observed between the treated patients and those receiving a placebo (or in our case, a control patch). The primary method of assessing
baseline pain and pain over the course of the study is a Numeric Pain Rating Scale, or NPRS. Eligible subjects had moderate to severe neuropathic pain with a baseline average NPRS score, as measured over a period of one to two weeks prior to
treatment, typically of 3 to 9 (with 0 = no pain and 10 = worst possible pain). Secondary efficacy measures included methods of assessing pain other than with NPRS, such as the Patient and Clinical Global Impression of Change, Gracely Pain Scale,
Short-Form McGill Pain Questionnaire, and Brief Pain Inventory, as well as the proportion of responders, which are defined as patients who experience a certain minimal threshold of pain relief such as, the percentage of patients who
achieve at least a 30% reduction in pain as measured by the NPRS. Each of our studies also assessed safety and tolerability.

General Safety Findings. Our clinical trials have consistently demonstrated that Qutenza is well tolerated. In our Phase 3
trials, over 98% of subjects completed the prescribed duration of patch application, both during the double-blind phase and during the open-label phase of our trials. Treatment-related adverse events have primarily consisted of application-site
issues, such as redness, pain, burning, itching, dryness or swelling. Most of these events have been mild to moderate, however, severe application site events have been observed. The application site reactions have been generally short term and
managed with the application of cool compresses, ice or the use of short-acting opioids to relieve the treatment-related discomfort. Transient changes in blood pressure have been observed during the treatment and appear to follow treatment-related
changes in pain. We have not seen evidence of increased side effects with repeated treatment. In our clinical trials there have been three serious adverse events (totaling less than 1%) related to Qutenza, two related to pain and one case of
hypertension.

Clinical Trial Results

Painful HIV-Associated Neuropathy

We have conducted two controlled
studies, an open-label extension study and an open-label long-term safety study evaluating the effect of Qutenza in subjects with HIV-AN. Overall, 632 subjects have received Qutenza in these studies with over 1,000 Qutenza treatments being
administered. We met with the FDA in October 2010 to discuss our desire to expand Qutenzas label to include patients with HIV-AN. Based on the outcome of that meeting, we plan to file a sNDA in the first half of 2011 utilizing the data from
the two previously completed studies. We were granted fast track designation of Qutenza for treatment of HIV-AN in July 2004. Following the filing of the sNDA, the FDA will make a final determination if we will receive a priority review. There are
currently no FDA approved drugs for the treatment of this disease. Based upon our communications with the FDA, we believe we are likely to receive a priority review and that the sNDA will likely be presented to an Advisory Committee during the
review cycle, however, there can be no assurance that such priority review will be granted or that such presentation will occur.



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Background
on HIV-AN. HIV-AN is caused primarily by three factors: direct activation of cells known as sensory neurons by the HIV virus, the immune systems fight against the infection and certain drugs administered to treat HIV. Painful HIV-AN is
characterized by significant pain in the feet and hands.

Potential Market. According to Frost & Sullivan,
neuropathic pain is a common neurological complication of antiretroviral treatments of HIV and affects approximately 15% of the HIV-infected community. In July 2010, CDC estimated that there are more than one million people living with HIV in the
United States. There are currently no specific treatments approved in the United States or Europe for HIV-AN. Estimates as to the number of people currently with HIV-AN in the United States vary from under 200,000 to nearly 300,000. The Mattson Jack
Group estimated in 2007 that there were approximately 270,000 and 136,000 people with HIV-AN in the United States and in the United Kingdom, France, Germany, Italy and Spain, combined, respectively.

Clinical Trial Results

C119 Phase 3 Clinical Trial.In February 2008, we completed a randomized, double-blind, controlled trial performed at 77 sites in the United States, Canada, Australia and the United Kingdom.
Inclusion criteria included pain due to HIV-AN or neurotoxic antiretroviral drug exposure for at least two months and average NPRS scores during the screening period of three to nine, inclusive. The primary objective of this study was to assess
efficacy, safety, and tolerability of two doses of Qutenza, 30- and 60-minute applications, over the 12-week study period. The primary efficacy assessment was the change in average pain from baseline in weeks 2-12. We enrolled 494
subjects and randomly assigned them to receive either a 30-minute or 60-minute application of Qutenza or control patches according to a 2:1 allocation scheme for each dose.

Study C119 did not meet its primary endpoint. Overall there was a 29.5% reduction in pain in the Qutenza treatment group, a result that was consistent with what we have observed in other Qutenza studies.
The control group reported a 24.5% reduction in pain from baseline, a control group response greater than we observed in our prior HIV-AN Phase 3 study. The p-value for this comparison was p=0.1. For the individual dose groups, the 30-minute Qutenza
group achieved a 26.2% reduction in pain from baseline compared to the 30-minute control group, which reported a 19.1% reduction in pain. The p-value for this comparison was p=0.1. The 60-minute dose group reported a 32.8% reduction in pain from
baseline, however, the 60-minute control group reported a 30.0% reduction in pain (p=0.5).

C107 Phase 3 Clinical
Trial. In 2005, we completed a randomized, double-blind, controlled, dose finding study of Qutenza for the treatment of HIV-AN performed at 32 sites in the United States. The primary objective of this study was to assess efficacy, safety, and
tolerability of Qutenza. Efficacy was measured in terms of change in average pain from baseline to weeks 2-12. The study consisted of a 12-week randomized, double-blind, controlled phase and a 40-week open-label extension. Three
different dose levels (30-, 60- and 90-minute applications) were evaluated together, and then each dose level was evaluated individually. The study also provided information about the efficacy, safety, and tolerability of repeated treatment with
Qutenza over one year. A total of 307 subjects were enrolled at 32 clinical sites in the United States, divided approximately equally among the 30-, 60- and 90-minute dose levels, with three patients treated with Qutenza for every one
subject treated with the control.

The results of the study demonstrated that in the aggregate, across all active treatment
groups, Qutenza significantly reduced pain in subjects with HIV-AN compared to the control group. Subjects treated with Qutenza demonstrated a mean reduction in pain score from baseline of 22.8% that was statistically greater than the 10.7% decrease
in the control group (p = 0.0026).

Among the individual dose groups, the 90-minute Qutenza group demonstrated a mean
reduction in pain of 24.7% that was significantly greater than the decrease of 10.7% reported by the control group (p = 0.005). The 60-minute Qutenza group also demonstrated a greater reduction in pain scores of 15.8%, but the difference from
control was not statistically significant. The 30-minute Qutenza group had a mean percent decrease from baseline



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of 27.7%, which was similar to the pain reduction reported for the 90-minute Qutenza group (p=0.0007). The effect of treatment was maintained for up to 12 weeks, with the Qutenza group
demonstrating significantly greater pain reduction compared to the control group during the second week and at each subsequent week through week 12. Among several secondary measures of pain relief, all three doses showed meaningful improvement
compared to control. This study demonstrated that treatment with Qutenza was generally well tolerated. A single Qutenza treatment provided a stable reduction in pain over a 12-week period. Although the pre-specified statistical testing of the
primary analysis stopped after the 60-minute dose was found not to have reached statistical significance, the data from all the active dosing groups, including evaluation of secondary endpoints, support the conclusion that all the Qutenza doses
tested (30-, 60-, and 90-minute) provided pain relief in subjects with HIV-AN. Repeated treatments for up to one year in an open-label extension study appeared to have been equally efficacious, generally well tolerated and without cumulative
toxicity.

C118 Phase 2 Clinical TrialSafety. This study was a multicenter, open-label trial of Qutenza for the
treatment of peripheral neuropathic pain in patients with HIV-AN or PHN. The primary objective of this study was to assess the safety of up to four repeated applications of Qutenza for the treatment of HIV-AN and PHN. The study enrolled a total of
106 patients (52 HIV-AN and 54 PHN). Qutenza treatments were generally well tolerated with greater than 98% of subjects completing the prescribed duration of treatment. We believe the study demonstrated that Qutenza was not associated with
increasing toxicity following multiple treatment cycles. Further, clinical assessments suggested no impairment of protective nerve function (such as the ability to feel touch or heat) over the one year study period.

Prior Clinical Experience. In 2003, we completed C109, an open-label pilot study of prescription strength capsaicin patches in the
treatment of HIV-AN. The primary objective of this study was to obtain preliminary information on the efficacy, safety, and tolerability of Qutenza in subjects with HIV-AN. This Phase 2, multicenter, open-label trial enrolled 12 subjects
at three clinical sites in the United States. Subjects received a single 60-minute treatment with Qutenza and were followed for 12 weeks. This study demonstrated that treatment with Qutenza was feasible and was generally well-tolerated. The
study also provided preliminary evidence of efficacy indicating that Qutenza could reduce pain associated with HIV-AN for 12 weeks after treatment.

Painful Diabetic Neuropathy

Background on PDN. PDN is caused
by injury to the sensory nerves, which arises from the toxic effects of glucose, some glucose metabolites and damage to blood vessels associated with nerves. The condition causes progressive pain or loss of feeling in the toes, feet, legs, hands and
arms. Like HIV-AN, PDN is typically first felt as pain in the feet and hands. To fulfill a condition of approval of the MAA, Astellas has submitted and received approval from the Committee for Medicinal Products for Human Use, or CHMP of the
European Medicines Agency, or EMA to conduct two protocols evaluating Qutenza in patients with PDN. One protocol is a long-term safety study and the other is a controlled efficacy study. These studies are planned to run concurrently beginning in
2011 with the safety study to be conducted in the European Union and the efficacy study to be conducted in North America. We plan to assess to what extent we will be able to use, if at all, the data from these studies to meet the requirements for a
US regulatory submission.

Potential Market. The CDC currently estimates that 25.8 million people in the United
States have diabetes, of which it is estimated by Jain PharmaBiotech 2008, or Jain, that 6.0 million suffered from some form of neuropathy. The number of PDN sufferers in the United States is currently estimated by Jain to be 3.0 million.
According to The Mattson Jack Group, there are approximately 2.85 million people with PDN in the United Kingdom, France, Germany, Italy and Spain, combined.

Clinical Trial Results

Phase 2a Clinical Trial Description. In
2004, we completed C111, a randomized, open-label multicenter evaluation of the tolerability of treatment with Qutenza in conjunction with pre-patch topical application of one



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of three lidocaine 4%-based local anesthetic products. The study enrolled 25 subjects with PHN, 91 subjects with PDN and 1 subject with HIV-AN. Tolerability of the procedure was similar
among all topical anesthetics tested. Preliminary efficacy data were obtained for the PHN group and the PDN group. PHN subjects experienced a 27.7% reduction in pain over weeks 2 through 12; pain was reduced by 31.4% in PDN subjects. This data
suggests that PDN may respond similarly to treatment with Qutenza.

Our Other Product Development Programs

Our current product development programs are focused on candidates in the field of pain with a primary focus on peripheral neuropathic
pain. We retain worldwide rights to these product candidates with the exception of NGX-1998 for which we have granted Astellas an option to license in the Licensed Territory. Our portfolio consists of the following product candidates:



|                       |  |                                              |  |                                                                                            
|---------------------- |  | -------------------------------------------- |  | -------------------------------------------------------------------------------------------
|Product Candidate      |  | Indication                                   |  | Phase of Development                                                                       
|NGX-1998               |  | Peripheral neuropathic pain                  |  | IND filed in June 2008. Three Phase 1 studies completed. Phase 2 commenced in November 2010
|                       |  |                                             
|Acetaminophen Prodrugs |  | Traumatic pain, post-surgical pain and fever |  | Preclinical developmentseeking outlicense partner                                         

NGX-1998Liquid High-Concentration Topical Capsaicin

We are
developing a liquid formulation of the same active ingredient in Qutenza for the treatment of peripheral neuropathic pain, as well as potentially for other chronic pain syndromes. NGX-1998 is intended to provide:



| |  |  | Rapid Delivery: Deliver capsaicin more rapidly into the skin than Qutenza without significant amounts of capsaicin entering the bloodstream,
thereby potentially shortening the treatment without impacting the safety or efficacy profile. By reducing treatment time, a larger base of healthcare professionals may be willing to administer NGX-1998.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Improved Comfort: Reduce treatment-related discomfort. We believe that the rapid delivery of capsaicin may reduce the need for pre-treatment
with a local anesthetic, as the extremely rapid skin delivery of capsaicin could quickly inhibit the activity of nerve fibers.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Expanded Indications: The liquid formulation can be applied to many places on the body that pose a challenge for a patch formulation, expanding
the potential indications to include such pain syndromes as arthritis and vulvodynia.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

An investigational
new drug application, or IND, was filed for NGX-1998 in June 2008, under which we have conducted one Phase 1 study to evaluate potential control formulations for future controlled clinical studies. In addition, NGX-1998 has been evaluated in two
Phase 1 clinical studies under an exploratory IND. In one study, we tested multiple liquid capsaicin formulations in order to identify those with the highest surrogate efficacy and tolerability characteristics. A second study involving 30 healthy
volunteers evaluated the effect of NGX-1998 on epidermal nerve fiber density, which we believe may be a surrogate measure of efficacy. Each volunteer was treated with NGX-1998 for 5, 15 and 25 minutes as well as a 60-minute application of Qutenza.
Epidermal nerve fiber density was measured by punch biopsy seven days after treatment for the treated areas and for one placebo treated area from each volunteer that was taken as a control. In addition, the study evaluated treatment related
discomfort at each of the treatment times. Results of the study indicate that each of the three NGX-1998 treatment times produced comparable nerve fiber density reduction as that observed following a 60-minute application of Qutenza and all groups
showed a statistically significant reduction in nerve fiber density compared to control. The study also indicated a significant reduction in treatment related discomfort between all of the NGX-1998 treatment groups and Qutenza.



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In November 2010, we treated the first patient in a Phase 2 clinical study of NGX-1998. The
Phase 2, adaptive-design, clinical study is being conducted in patients with postherpetic neuralgia, or PHN in two stages. The objective is to select the appropriate pretreatment and concentration of NGX-1998 for further evaluation in a Phase 3
clinical program. The first stage, which was completed in February 2011, was designed to determine the shortest tolerable topical anesthetic pretreatment regimen. The second stage will evaluate two NGX-1998 dose concentrations using the pretreatment
regimens determined during stage 1. Based on the results from that stage the second stage of the study is being conducted without the use of a topical anesthetic pretreatment regimen. Final results from this study are expected to be announced in the
first half of 2012. The Astellas Agreement provides Astellas an option to exclusively license NGX-1998 in the Licensed Territory. If Astellas exercises this option, it is obligated to partner with us on the Phase 3 clinical trials and share equally
in the cost of the trials.

Acetaminophen ProdrugsPreclinical Program

Acetaminophen, first approved by the FDA for marketing in the United States in 1955, is the most widely used drug for
pain relief and the reduction of fever in the United States and is currently available in numerous pharmaceutical products. Acetaminophen is often perceived to be safer than other non-steroidal anti-inflammatory drugs, or NSAIDs. Acetaminophen in
intravenous formulations has been available in the European Union since 2002, marketed by Bristol-Myers Squib under the trade name Perfalgan®. The same formulation was launched in January 2011 in the US by Cadence Pharmaceuticals under the trade name
OFIRMEV®. These parenteral formulations require a 15-minute, 100 mL infusion, as these formulations provide only
10 mg of acetaminophen per mL due to acetaminophens modest water solubility. Despite this inconvenient dosing requirement, Perfalgan has become the market-leading injectable analgesic in the European Union. Although no U.S. sales figures are
yet available, as of March 2011, OFIRMEV has been accepted on the formularies of 203 U.S. hospitals.

Two major limitations
exist regarding full utilization of acetaminophen as an injectable pain medicine. First, is the requirement of an intravenous drip bag and a 15-minute infusion. Second, is acetaminophen-induced liver toxicity, which is the most common cause of acute
liver failure in the United States. In 2009, the FDA convened an Advisory Committee Meeting to address the public health problem of liver injury related to the use of acetaminophen, with the result that liver hepatotoxicity warnings on
acetaminophen-containing products were expanded and restrictions were placed on the amount of acetaminophen in prescription pain medicines.

We believe that we have the potential to overcome these two limitations to expanded utilization of parenteral acetaminophen through the discovery of novel prodrugs To address the modest water solubility
of acetaminophen, we have designed prodrugs with greatly improved water solubility (up to 30 times more water soluble). To address the potential for liver damage, we have developed prodrugs which couple acetaminophen to molecules known to prevent
acetaminophen induced-liver toxicity. We have evaluated several of these prodrugs in preclinical studies, including in animal models. One such study in mice indicated that certain dose levels of one prodrug produced less liver-toxicity than
equivalent doses of acetaminophen, with parallel pharmacokinetic data showing equivalent acetaminophen blood levels between prodrug- and acetaminophen- treated mice.

Opioid Analgesic Prodrug Preclinical Program

Opioid analgesics, a mainstay
of pain management, are used to manage pain associated with a wide variety of acute and chronic conditions, but are known to have acute adverse side effects. We have designed and synthesized prodrugs of a number of commonly prescribed opioid
analgesics that we believe could have lower acute adverse effects. We are evaluating our strategy for the development of the opioid prodrugs but do not expect significant development activities in 2011.

Patents and Proprietary Rights

Our success will depend in part on our ability to protect Qutenza and future products and product candidates by obtaining and maintaining a strong proprietary position both in the United States and in
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develop and maintain our proprietary position, we will rely on patent protection, regulatory protection, trade secrets, know-how, continuing technological innovations and licensing opportunities.

The commercial success of Qutenza depends, in part, on a device patent granted in the United States, and corresponding
patents granted in certain European Union countries, Canada and Hong Kong. The device patent covers the use of a prescription-strength capsaicin dermal delivery system for the treatment of neuropathic pain. The United States device patent expires in
December 2017 (although we have applied for patent term restoration due to certain regulatory delay in the application process, which, if granted would extend the expiration date), with the corresponding patents outside the United States expiring at
approximately the same time. We exclusively license these patents on a worldwide basis from the University of California. We do not currently own, and do not have rights under this license agreement, to any issued patents that cover Qutenza other
than in the United States, certain European Union countries, Canada and Hong Kong.

In addition, we licensed a method patent
granted in the United States from the University of California concerning the use of prescription strength capsaicin delivery for the treatment of neuropathic pain. This patent expires in November 2016. Although our rights under the license
agreement are worldwide, there are no corresponding granted patents or patent applications relating to this patent outside the United States. Two of the three inventors named in the method patent did not assign their patent rights to the
University of California. These non-assigning inventors have made various claims related to inventorship and other matters. In late 2010, we entered into negotiations with these non-assigning inventors to settle any and all claims and to
have them assign their rights related to the method patent and any other related patent rights that may exist at the time we enter into a final binding settlement agreement. We anticipate that any settlement will include us making cash payments
and us issuing stock or stock options to them. We estimate the current cash and estimated fair value of the stock or stock options to be issued to approximate $1.0 million. We further anticipate that approximately 50% of the cash settlement amount
will be recovered over time, through a reduction in amounts due to the University of California under our license agreement with them. Our estimate of the value of the potential settlement has been recorded within selling general and
administrative expense for the year ended December 31, 2010.

Under the terms of our license agreement with the University
of California, we are required to pay royalties on net sales of the licensed product up to a maximum of $1.0 million per annum as well as a percentage of upfront and milestone payments resulting from the sublicense of our rights under the
agreement. As a result of the Astellas Agreement, in February 2010 we paid a sublicense fee totaling $1.2 million to the University of California. In addition, we were also required to make three annual cash payments in an aggregate amount of
$12,000. The last of these payments was made in February 2010. Such agreement terminates on a country by country basis as to products covered by it on the date that such products are not covered by a claim of either an unexpired patent or a patent
application that has been outstanding less than 10 years from its filing date.

We currently license the rights from LTS to
three pending U.S. patent applications, patents granted in certain European Union countries and pending patent applications in certain European Union countries, Canada and more than ten other foreign countries, each filed and prosecuted by LTS.
These patents and patent applications contain claims covering the composition and manufacture of microreservoir patch, which includes the type of patch used in Qutenza. We license the rights to these patents and patent applications on a worldwide
basis under a January 2007 exclusive commercial supply and license agreement with LTS, which is subject to certain purchase and other obligations. The first of the issued patents licensed under the commercial supply and license agreement expires in
June 2020, with the last expiration date among such patents being September 2025. During 2009, as a result of achieving marketing approval for Qutenza, we made a onetime milestone payment to LTS of approximately $0.1 million. The term of the
commercial supply and license agreement extends until January 2020 and automatically renews for additional two year terms, unless terminated by either party with two years prior written notice.

We have also filed several patent applications in the United States, European Union, and certain other countries relating to kits,
methods and formulations to remove residual capsaicin left on the skin after a topical



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application of capsaicin, as well as a number of patent applications which deal with differing formulations and delivery models of capsaicin at varying concentrations, including an application
that supports our NGX-1998 program. We have also filed patent applications related to our acetaminophen prodrugs which contain both composition and method claims. The patent positions of pharmaceutical companies like us are generally uncertain and
involve complex legal, scientific and factual questions. In addition, the coverage claimed in a patent application can be significantly reduced before the patent is issued. Consequently, we do not know whether any of the products or product
candidates we acquire or license will result in the issuance of patents or, if any patents are issued, whether they will provide significant proprietary protection or will be circumvented or challenged and found to be unenforceable or invalid. Other
parties may own patent rights that might be infringed by our products or other activities. In limited instances, patent applications in the United States and certain other jurisdictions are maintained in secrecy until patents issue, and since
publication of discoveries in the scientific or patent literature often lags behind actual discoveries, we cannot be certain of the priority of inventions covered by pending patent applications. Moreover, we may have to participate in interference
proceedings declared by the U.S. Patent and Trademark Office to determine priority of invention or in opposition proceedings in a foreign patent office, any of which could result in substantial cost to us, even if the eventual outcome is favorable
to us. There can be no assurance that a court of competent jurisdiction would hold the patents, if issued, valid. An adverse outcome could subject us to significant liabilities to third parties, require disputed rights to be licensed from third
parties or require us to cease using such technology. To the extent prudent, we intend to bring litigation against third parties that we believe are infringing our patents. We also rely on trade secret protection for our confidential and proprietary
information. No assurance can be given that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose such technology or that we can meaningfully
protect our trade secrets. However, we believe that the substantial costs and resources required to develop technological innovations will help us protect our products. Our competitors or other intellectual property holders may assert that our
products or trademarks and the methods we employ are covered by their intellectual property rights. For example, we have received a letter indicating a possible trademark conflict for Qutenza® from a company claiming that our trademark was similar to theirs. While we believe that these assertions do not have merit and that we have defenses to them, there
can be no assurance that we will be successful in defending our trademark. We intend to continue to use the Qutenza trademark and to vigorously defend our use of such trademark against such assertions.

It is our policy to require our employees, consultants, contractors, or scientific and other advisors, to execute confidentiality
agreements upon the commencement of employment or consulting relationships with us. These agreements provide that all confidential information developed or made known to the individual during the course of the individuals relationship with us
is to be kept confidential and not disclosed to third parties except in specific circumstances. These agreements provide that all inventions related to our business that are conceived by the individual during the course of our relationship, shall be
our exclusive property. There can be no assurance, however, that these agreements will provide meaningful protection or adequate remedies for our trade secrets in the event of unauthorized use or disclosure of such information.

Government Regulation

United States

Regulation by governmental authorities in the United States and other countries is a significant factor in the development, manufacture and marketing of pharmaceuticals. Our product and product candidates
require regulatory approval by governmental agencies prior to commercialization. Specifically, Qutenza is subject to significant ongoing review and evaluation by regulatory authorities which could result in discovery of previously unknown problems,
side effects or other factors that may affect the marketing approval, including causing a withdrawal of such approval or may require significant additional investment by the company to maintain the marketing approval.

Our products candidates are subject to rigorous preclinical testing and clinical trials and other premarketing approval requirements by
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foreign statutes and regulations govern or affect the manufacturing, safety, labeling, storage, record-keeping and marketing of pharmaceutical products. The lengthy process of seeking required
approvals and the continuing need for compliance with applicable statutes and regulations require the expenditure of substantial resources. When and if regulatory approval is obtained for any of our product candidates, the approval may be limited in
scope, which may significantly limit the indicated uses for which our product candidates may be marketed, promoted and advertised. Additionally, approval may be conditioned upon our agreement to conduct further studies, which could either delay our
planned product launch and/or significantly increase our costs in order to comply with these commitments. Following is a discussion of the regulatory environment that is typically applicable to pharmaceutical product candidates.

Preclinical Studies

Before testing any compounds with potential therapeutic value in human subjects in the United States, stringent governmental requirements for preclinical data must be satisfied. Preclinical testing
includes both in vitro and in vivo laboratory evaluation and characterization of the safety and efficacy of a drug and its formulation. Preclinical testing results obtained from these studies, including tests in several animal species,
are submitted to the FDA as part of an IND, and are reviewed by the FDA prior to the commencement of human clinical trials. These preclinical data must provide an adequate basis for evaluating both the safety and the scientific rationale for the
initial trials in human volunteers.

Clinical Trials

If a company wants to conduct clinical trials in the United States to test a new drug in humans, an IND must be prepared and submitted
with the FDA. The IND becomes effective, if not rejected or put on clinical hold by the FDA, within 30 days of filing the application. In addition, an Institutional Review Board must review and approve the trial protocol and monitor the trial
on an ongoing basis. The FDA may, at any time during the 30-day review period or at any time thereafter, impose a clinical hold on proposed or ongoing clinical trials. If the FDA imposes a clinical hold, clinical trials cannot commence or recommence
without FDA authorization and then only under terms authorized by the FDA. The IND application process can result in substantial delay and expense.

Clinical Trial Phases

Clinical trials typically are conducted in three
sequential phases, Phases 1, 2 and 3, with Phase 4 trials potentially conducted after marketing approval. These phases may be compressed, may overlap or may be omitted in some circumstances.



| |  |  | Phase 1 clinical trials. After an IND becomes effective, Phase 1 human clinical trials can begin. These trials evaluate a drugs
safety profile and the range of safe dosages that can be administered to healthy volunteers or patients, including the maximum tolerated dose that can be given to a trial subject. Phase 1 trials also determine how a drug is absorbed,
distributed, metabolized and excreted by the body, and duration of its action.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Phase 2 clinical trials. Phase 2 clinical trials are generally designed to establish the optimal dose, to evaluate the potential
effectiveness of the drug in patients who have the target disease or condition and to further ascertain the safety of the drug at the dosage given in a larger patient population.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Phase 3 clinical trials. In Phase 3 clinical trials, the drug is usually tested in a controlled, randomized trial comparing the
investigational new drug to a control (which may be an approved form of therapy) in an expanded and well-defined patient population and at multiple clinical sites. The goal of these trials is to obtain definitive statistical evidence of safety and
effectiveness of the investigational new drug regime as compared to control in defined patient populations with a given disease and stage of illness.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Additionally, the Food and Drug Administration Amendments Act of 2007, or FDAAA, requires
that all controlled clinical trials conducted for our drug candidates be included in a clinical trials registry database that is available and accessible to the public through the internet. If we fail to properly participate in the clinical trial
database registry we would be subject to significant civil monetary penalties.

Manufacturing Process Development

In order to gain marketing approval, a product candidates manufacturing process must be evaluated through a lengthy
and detailed review process to ensure that it can be consistently manufactured to meet predetermined specifications. A robust manufacturing process must be developed and validated for both the active ingredient and the formulated product candidate
which ensures that the product can be reproducibly manufactured at the intended commercial scale. Appropriate specifications must be developed and approved to ensure that the quality and safety of the product can be assured. Analytical methods used
for quality control testing must be developed and validated to ensure each lot of product meets the approved specifications. Stability testing of active ingredient and drug product must be performed to provide evidence that the product remains
stable over time and that a shelf life for the product can be established. The FDA reviews the adequacy of the manufacturing process, specifications, quality control testing and stability during the New Drug Application, or NDA, process. In
addition, an inspection of the manufacturing site is performed to ensure the adequacy of the manufacturing facility to meet both the technical manufacturing requirements and compliance to current good manufacturing practices, or cGMP, regulations.

New Drug Application

After completion of clinical trials, if there is substantial evidence that the drug is both safe and effective, an NDA is prepared and submitted for the FDA to review. The NDA must contain all of the
essential information on the drug gathered to that date, including data from preclinical studies and clinical trials, and the content and format of an NDA must conform with all FDA regulations and guidelines. In addition, the FDA generally requires
successful completion of at least two adequate and well-controlled Phase 3 clinical trials to gain marketing approval for an indication. Accordingly, the preparation and submission of an NDA is an expensive and time consuming undertaking.

The FDA reviews all NDAs submitted before it accepts them for filing and may request additional information from the sponsor
rather than accepting an NDA for filing. In such an event, the NDA must be submitted with the additional information and, again, is subject to review before filing. Once the submission is accepted for filing, the FDA begins an in-depth review of the
NDA. By law, the FDA has 180 days in which to review the NDA and respond to the applicant. Under the goals and policies agreed to by the FDA under the Prescription Drug User Fee Act IV, or PDUFA, the FDA has 10 months from the submission date
in which to complete its initial review of a standard NDA and respond to the applicant and six months from the submission date for a priority NDA. The FDA may meet its PDUFA requirements by completing its initial review within the specified
time-frames 90% of the time. Additionally, the FDA does not always meet the PDUFA goal dates for standard or priority NDAs. The review process is often significantly extended as a result of FDA requests for additional information and clarification.
The FDA may refer the application to an appropriate advisory committee, typically a panel of clinicians, for review, evaluation and a recommendation as to whether the application should be approved and the scope of any approval. The FDA is not bound
by the recommendation, but gives great weight to it. Upon completion of the FDAs review of the NDA, it issues either an approval letter or a complete response letter. A complete response letter may describe any activities which may be required
to gain approval or may indicate that a product candidate is not approvable.

The Hatch-Waxman Act

Under the Drug Price Competition and Patent Term Restoration Act of 1984, known as the Hatch-Waxman Act, newly approved drugs may benefit
from a statutory period of non-patent data exclusivity in the United



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States. The Hatch-Waxman Act provides 5 years of data exclusivity to the first applicant to gain approval of an NDA under Section 505(b) of the Food, Drug and Cosmetic Act for a new chemical
entity. A drug qualifies as a new chemical entity if the FDA has not previously approved any other drug containing the same active ingredient. Hatch-Waxman provides data exclusivity by prohibiting abbreviated new drug applications, or ANDAs, and
505(b)(2) applications, which are marketing applications where the applicant does not own or have a legal right of reference to all the data required for approval, to be submitted by another company for another version of such drug during the
exclusivity period. Protection under Hatch-Waxman will not prevent the filing or approval of a full NDA under Section 505(b)(1) for the same active ingredient, although the applicant would be required to conduct its own adequate and
well-controlled clinical trials to demonstrate safety and effectiveness. Qutenza was granted new chemical entity status by the FDA and has therefore been granted five year data exclusivity under the Hatch-Waxman Act.

The Hatch-Waxman Act also provides three years of data exclusivity for the approval of supplemental NDAs for new indications, dosages or
strengths of an existing drug if new clinical investigations are essential to the approval. This three-year exclusivity covers only the changes associated with the supplemental NDA and does not prohibit the FDA from approving ANDAs for drugs
containing the original active ingredient.

The Hatch-Waxman Act also permits a patent extension term of up to five years as
compensation for patent term lost during product development and the FDA regulatory review process. However, patent extension cannot extend the remaining term of a patent beyond a total of 14 years. The patent term restoration period is
generally one-half the time between the effective date of an IND and the submission date of an NDA, plus the time between the submission date of an NDA and the approval of that application. Only one patent applicable to an approved drug is eligible
for the extension and it must be applied for prior to expiration of the patent. The U.S. Patent and Trademark Office, in consultation with the FDA, reviews and approves the application for patent term extension. We have submitted an application for
patent term extension for the device patent licensed from the University of California, and we believe that we may be eligible for an approximately four and a half year extension to the term for this patent.

Orphan Drug Designation

The FDA may grant orphan drug designation to drugs intended to treat a rare disease or condition that affects fewer than 200,000 individuals in the United States. Orphan drug designation must be requested
before submitting an NDA. If the FDA grants orphan drug designation, the generic identity of the therapeutic agent and its potential orphan use are disclosed publicly by the FDA. Orphan drug designation does not convey any advantage in, or shorten
the duration of, the regulatory review and approval process. If a product that has orphan drug designation subsequently receives FDA approval for the indication for which it has such designation, the product is entitled to orphan exclusivity, which
means the FDA may not approve any other applications to market the same drug for the same indication, except in very limited circumstances, for up to seven years after receiving FDA approval.

We were granted orphan status for the use of capsaicin for the management of neuropathic pain in patients with PHN and HIV-AN. When
appropriate, we may seek orphan status for additional indications and products. We cannot predict the ultimate impact, if any, of orphan status on the timing or likelihood of FDA approval for use of Qutenza on additional, orphan indications or on
any of our potential future products.

Fast Track Designation and Priority Review

The FDAs fast track program is intended to facilitate the development and expedite the review of drugs that are intended for the
treatment of a serious or life-threatening condition for which there is no effective treatment and which demonstrate the potential to address unmet medical needs for their condition. We were granted fast track designation of Qutenza for treatment of
HIV-AN in July 2004. When appropriate, we intend to seek additional fast track designations for our product candidates. We cannot predict the ultimate impact, if any, of the



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fast track process on the timing or likelihood of FDA approval on any proposed label expansion for Qutenza or on any of our potential future products.

In some cases, after an NDA has been accepted for review by the FDA, the FDA may designate a product for priority review. A product is
eligible for priority review, or review within a targeted six-month time frame from the time an NDA is accepted for filing, if the product provides a significant improvement compared to marketed products in the treatment, diagnosis or prevention of
a disease. A fast-track designated product generally meets the FDAs criteria for priority review. We cannot guarantee any of our products will receive a priority review designation, or if a priority designation is received, that review or
approval will be faster than conventional FDA procedures.

Following our expected filing of the sNDA to expand the Qutenza
label to include patients with HIV-AN, the FDA will make a final determination if we will receive a priority review. There are currently no approved drugs for the treatment of this disease. Based upon our communications with the FDA, we believe that
we are likely to receive a priority review and that the sNDA will likely be presented to an Advisory Committee during the review cycle, however, there can be no assurance that such priority review will be granted or that such presentation will
occur.

Other Regulatory Requirements

Any products we manufacture or distribute under FDA approvals are subject to pervasive and continuing regulation by the FDA, including record-keeping requirements and reporting of adverse experiences with
the products. Drug manufacturers and their subcontractors are required to register with the FDA and, where appropriate, state agencies, and are subject to periodic unannounced inspections by the FDA and state agencies for compliance with cGMP,
regulations which impose procedural and documentation requirements upon us and each third party manufacturer we utilize.

The
FDA closely regulates the marketing and promotion of drugs. The FDA expects that a company will make only those claims relating to safety and efficacy that are consistent with their products approved package insert. Failure to meet these
expectations can result in adverse publicity, warning letters, corrective advertising and potential civil and criminal penalties. Physicians may prescribe legally available drugs for uses that are not described in the products labeling and
that differ from those tested by us and approved by the FDA. Such off-label uses are common across medical specialties. Physicians may believe that such off-label uses are the best treatment for many patients in varied circumstances. The FDA does
not regulate the behavior of physicians in their choice of treatments. The FDA does, however, restrict manufacturers from communicating on the subject of off-label use.

The FDAs policies may change and additional government regulations may be enacted which could affect Qutenza and our future product candidates or approval of new indications for our products. We
cannot predict the likelihood, nature or extent of adverse governmental regulations that might arise from future legislative or administrative action, either in the United States or abroad.

European Union

Clinical Trials

In common with the United States, the various phases of
preclinical and clinical research in the European Union are subject to significant regulatory controls. The regulatory controls on clinical research in the European Union are now largely harmonized following the implementation of the Clinical Trials
Directive 2001/20/EC, or CTD. Compliance with the national implementations of the CTD has been mandatory from May 1, 2004. However, variations in the member state regimes continue to exist, particularly in the small number of member states that
have yet to implement the CTD fully. Clinical trials must be separately authorized in each European Union member state where they are conducted.



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All member
states currently require regulatory and independent ethics committee approval of interventional clinical trials, as well as informed consent and other measures to protect the interest of human subjects. European regulators and ethics committees also
require the submission of adverse event reports during a study and a copy of the final study report. Procedures exist to suspend studies if necessary to protect the safety of subjects.

Our MA for Qutenza has been transferred to Astellas pursuant to the Astellas Agreement and as a result, Astellas is responsible for
ongoing maintenance and post approval requirements associated with Qutenzas MA. In addition, Astellas is responsible for future regulatory applications in the Licensed Territory. Astellas also has an option to license our product candidate,
NGX-1998. If they elect to exercise this option, Astellas will be responsible for regulatory matters associated with this product candidate in the Astellas Territory. If Astellas does not exercise this option, we have agreed to not seek regulatory
approval for NGX-1998 in the Licensed Territory.

Approvals Outside of the United States and the Licensed Territory

We will also be subject to a wide variety of foreign regulations governing the development, manufacture and marketing
of our products should we decide to seek regulatory approvals in other world markets. The approval process varies from country to country and the time needed to secure approval may be longer or shorter than that required for FDA approval. We offer
no assurance that clinical trials conducted in one country will be accepted by other countries or that approval in one country will result in approval in any other country.

Third-Party Reimbursement and Pricing Controls

General. In the
United States and elsewhere, patients access to pharmaceutical products depends in significant part on the coverage and reimbursement of a product or service by third party payers, such as government programs, private insurance plans and
employers. Third party payers increasingly are challenging the medical necessity of and prices charged for medical products and services. We may be unable to achieve reimbursement from some payers because they may not consider our products to be
reasonable and necessary or cost-effective. Furthermore, it is possible that even if payers are willing to reimburse for our products, the reimbursement levels may not be sufficient to allow us to sell our products on a competitive and
profitable basis.

In many foreign countries, particularly the countries in the European Union, the pricing of prescription
drugs is subject to direct governmental control and is influenced by drug reimbursement programs that employ a variety of price control mechanisms. In the European Union, governments influence the price of pharmaceutical products through their
pricing and reimbursement rules and control of national health care systems that fund a large part of the cost of such products to consumers. The approach taken varies from country to country. Some jurisdictions operate positive and/or negative list
systems under which products may only be marketed once a reimbursement price has been agreed. Other member states allow companies to fix their own prices for medicines, but monitor and control company profits. The downward pressure on health care
costs in general, particularly prescription drugs, has become very intense. As a result, increasingly high barriers are being erected to restrict the entry of new products, as exemplified by the National Institute for Clinical Excellence in the
United Kingdom which evaluates the data supporting new medicines and passes reimbursement recommendations to the government. In addition, in some countries cross-border imports from low-priced markets (parallel imports) exert a commercial pressure
on pricing within a country. With regard to Qutenza, Astellas is responsible for seeking pricing approvals in the Licensed Territory.

In the United States, there have been, and we expect that there will continue to be, a number of federal and state proposals to implement means by which the government can negotiate lower drug prices for
Medicare and Medicaid beneficiaries. While we cannot predict whether such legislative bills will become law, their enactment could have a material adverse effect on our business, financial condition and results of operations.

Medicare. We market Qutenza for use in the treatment of pain associated with PHN. We expect that in the United States a majority
of the patients who are treated with Qutenza for this indication will be Medicare



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beneficiaries. CMS is the agency within the Department of Health and Human Services that administers both the Medicare and Medicaid programs. Because Qutenza is a dermal delivery system that in
accordance with its FDA approved label must be applied by a physician or a health care professional working under the close supervision of a physician, two elements of Medicare reimbursement are relevant to Qutenza: the availability of reimbursement
for services to administer Qutenza and the availability of reimbursement for Qutenza itself.

CMS has the authority not to
cover particular products or services if it determines that they are not reasonable and necessary for the treatment of Medicare beneficiaries. CMS may make a national coverage determination, or NCD, for a product, which establishes on a
nationwide basis the indications that will be covered, and any restrictions or limitations. However, for most new drugs that are eligible for payment, CMS does not create an NCD. For Qutenza, coverage under Medicare Part B has been confirmed in all
Medicare regions and the amount of reimbursement for the Qutenza treatment procedure is being determined on a region by region basis. Although we have local coverage determinations, CMS or a third party may request an NCD independent of us. If such
request is made, we cannot assure you that such NCD will contain favorable coverage terms.

In July 2010, CMS granted Qutenza
pass-through status under Medicares Hospital Outpatient Prospective Payment System and issued a temporary C-code such that regional contractors can make these pass-through payments to hospitals submitting claims for Qutenza. The
C-code (C9268capsaicin, patch, 10 cm2) became effective on July 1, 2010. In November 2010, CMS granted a unique, Level II Health Care Common Procedural Coding System, or J-code, for Qutenza which became effective on January 1, 2011.
The issuance of the J7335 improves the efficiency of the reimbursement process for all customer segments, from large hospitals to individual physicians.

All eleven Medicare contractors are covering and reimbursing for medically necessary services related to the administration of Qutenza. Reimbursement for such services is being made to the physician
and / or a hospital, depending on where Qutenza is applied. Medicare payment for physician and/or outpatient hospital services related to the administration of Qutenza is determined according to prospectively set payment rates, linked to a
procedure code established by the American Medical Association. These codes, called Current Procedural Terminology, or CPT codes, describe the procedure performed or services rendered. Currently, eight of eleven Medicare contractors are requiring
the Qutenza application procedure be billed using an existing evaluation and management, or E&M, CPT code. The remaining three contractors have requested Qutenza administration be billed with miscellaneous or unlisted codes.

Under Medicare Part B, reimbursement for Qutenza is currently limited to 106% of the manufacturers average sales price (as
defined by statute and regulation). CMS has been considering other changes to Medicare reimbursement that could result in lower payments for physician-administered drugs, and Congress may also consider legislation that would mandate lower
reimbursement levels. A reduction in reimbursement levels could materially and adversely affect our revenue.

Medicaid.
Most State Medicaid programs have established preferred drug lists, or PDLs, and the process, criteria and timeframe for obtaining placement on the PDL varies from State to State. A federal law establishes a minimum rebate, currently 23.1%, that a
manufacturer must pay for Medicaid utilization of a brand-name product, and many States have established supplemental rebate programs as a condition for including a drug product on a PDL. Submitting a PDL application to each State will be a
time-consuming and expensive process, and it is not clear how many or which State programs will accept the applications. Review times for these applications can vary from weeks to 14 months or more.

Private Insurance Reimbursement. Commercial insurers usually offer two types of benefits: medical benefits and pharmacy benefits.
In most private insurance plans, physician-administered drugs are provided under the medical benefit. If private insurers decide to cover Qutenza, they will reimburse for the drug and its administration in a variety of ways, depending on the
insurance plans policies, employer and benefit manager input and contracts with their physician network. Like Medicare and Medicaid, commercial insurers have the authority to place coverage and utilization limits on physician-administered
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reimbursement methodologies for a product similar to those adopted by Medicare. Revenue for Qutenza may be materially and adversely affected if private payers make unfavorable reimbursement
decisions or delay making favorable reimbursement decisions.

Employees

As of February 28, 2011 we had 106 employees, of which 25 are in research and development positions, 28 are in general and
administrative positions and 53 are in sales and marketing positions. None of our employees are represented by a labor union or are the subject of a collective bargaining agreement.

Facilities

We lease approximately 26,386 square feet of space in our
headquarters in San Mateo, California under a lease that expires in July 2012. We have no laboratory, research or manufacturing facilities.

Form of Organization

We
were incorporated in California as Advanced Analgesics, Inc. on May 28, 1998 and changed our name to NeurogesX, Inc. in September 2000. In February 2007, we reincorporated into Delaware.

Available Information

We file electronically with the Securities and
Exchange Commission, or SEC, our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act. The
public may read or copy any materials we file with the SEC at the SECs Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov.

You may obtain a free copy of our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and
amendments to those reports on the day of filing with the SEC on our website on the World Wide Web at http://www.neurogesx.com or by contacting our corporate offices by calling 650-358-3300. Information contained on our website is not part of this
report or any other report filed with the SEC.



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

You should consider carefully the risk factors described below, and all other information contained in or incorporated by reference in this quarterly report on Form 10-Q before making an investment
decision. If any of the following risks actually occur, they may materially harm our business, financial condition, operating results or cash flows. As a result, the market price of our common stock could decline, and you could lose all or part of
your investment. Additional risks and uncertainties that are not yet identified or that we think are immaterial may also materially harm our business, operating results or financial condition and could result in a complete loss of your investment.

Risks Related to our Business

Our success depends on our ability to effectively commercialize our product Qutenza® (capsaicin) 8% patch.

Our product Qutenza® (capsaicin) 8% patch, was approved by the FDA
in November 2009 for the management of neuropathic pain associated with PHN. Our commercial success depends on our ability to



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successfully launch and commercialize Qutenza in the United States. Prior to receiving FDA marketing approval, our commercialization activities were limited and, as a result, many of our proposed
activities to create product awareness or promote market acceptance have only recently been initiated and as such their effect may take some time to be realized, if at all. Although we launched Qutenza in April 2010, we may not know how effective
our launch is until six to eight quarters after the launch date, if at all, due to Qutenzas nature as an office administered product, its expected duration of effect resulting in prolonged periods between product use for a particular patient,
and due to our targeted commercialization strategy. Additionally, successful commercialization of Qutenza will depend on a number of factors as further discussed in this Risk Factors section, which include risks related to obtaining adequate
reimbursement, continuing to devote sufficient management and financial resources to maintain a qualified sales force, continuing to build infrastructure to support commercial operations and ensuring sufficient product supply. There can be no
assurance that we will be able to continue to devote sufficient financial resources to hire, retain and manage the personnel required to maximize the commercial potential of Qutenza or that such commercialization will result in significant product
sales of Qutenza. If the commercial launch of Qutenza does not meet our expectations, it would significantly and negatively impact our revenue and results of operations. In addition, we are establishing inventory levels of Qutenza based upon our
expectations of future product sales. If actual product sales are significantly lower than our expectations, our inventory levels may be excessive. If Qutenza supplies remain in inventory for significantly longer than anticipated, such supplies may
not be suitable for sale due to expiration of their shelf lives, which would require us to write off the cost of such expired product.

Our strategy for launching Qutenza in the United States may result in lower than expected near term revenue and could result in a lower overall revenue potential for Qutenza.

We launched Qutenza with a field sales organization of approximately 40 representatives and managers. We have tasked the sales force with
focusing initially on thought leaders in neuropathic pain as well as U.S. pain specialists with a significant practice in treating PHN patients in major markets in the United States. Our current approach to launching Qutenza contemplates significant
interaction with healthcare professionals to facilitate educating staff involved with administering and billing for Qutenza and involves a combination of sales representatives, clinical educators and reimbursement specialists, all of whom we believe
are necessary to enable healthcare professionals that use Qutenza to have:



| |  |  | access to product information and training concerning the proper use and administration of Qutenza; and
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | support in seeking reimbursement for Qutenza, as well as the services involved in administering Qutenza.
| | - |  | --------------------------------------------------------------------------------------------------------

As a result of this approach, we do not expect to initially market Qutenza to a large number of healthcare professionals. While we may
expand our sales and marketing efforts if financial and other resources allow, our initial focused strategy may result in reduced market penetration by Qutenza and lower product revenues in the near term and potentially longer. As a result, our
financial results and our stock price could suffer.

If healthcare professionals are not adequately reimbursed for
Qutenza or their time and services in administering Qutenza, it is likely that they will not prescribe Qutenza.

Because many people suffering from PHN are elderly, in order for Qutenza to be economically viable in the United States, we will need
Medicare coverage for Qutenza to have significant market penetration. We understand that all of the Medicare contractors that process claims for Medicare are covering Qutenza under Part B and consequently, we believe that Medicare Part B
coverage for Qutenza is in place nationwide. Although Medicare Part B coverage is in place, Medicare policymakers or local contractors may determine that Qutenza is reasonable and necessary only under limited circumstances. Currently, three
contractors have published detailed coverage criteria for Qutenza. If a significant portion of contractors establish restrictive coverage policies for Qutenza, our business would be harmed, not only because Medicare beneficiaries represent a
substantial portion of our target market, but also because Medicares coverage policies would likely affect the determination of many state Medicaid programs and could influence private payers.



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The use of
Qutenza is reimbursable under Medicare Part B and the amounts of reimbursement available to the healthcare professionals for the treatment procedure are known in most cases, since 8 of the 11 contractors have instructed healthcare professionals to
bill using established evaluation and management codes that have payment rates associated with them. Three contractors have requested that healthcare professionals use a miscellaneous / unlisted code for the Qutenza application procedure. One of
these three contractors set a payment rate that we consider inadequate. We are working with local healthcare professionals to advocate for an adjustment to this payment rate that we believe more accurately reflects the resources necessary to
administer Qutenza. In the case of another of these contractors, the reimbursement amounts for the Qutenza treatment procedure appear acceptable to local providers. The payment rate has not been confirmed at the final contractor requesting a
miscellaneous/unlisted code. We continue to work with local healthcare professionals to determine payment amounts in this contractors service area. If the payment rate proves inadequate, such a rate could create a significant barrier to
healthcare professionals adoption of Qutenza. Additionally, the timing and process for healthcare professionals to receive reimbursement for use of Qutenza may be a lengthy and uncertain process which can also create a barrier for healthcare
professionals adoption of Qutenza. In either case, these factors could serve to seriously limit the market opportunity for Qutenza.

We also will need to obtain favorable coverage and reimbursement decisions for Qutenza from private insurers, including managed care organizations. We expect that private insurers will consider the
efficacy, cost-effectiveness and safety of Qutenza in determining whether to provide reimbursement for Qutenza and at what level. At this time, we are aware of two large national plans and ten regional plans, including seven state-based Blue
Cross Blue Shield plans that have published coverage criteria for Qutenza. Other private insurers and managed care plans are providing access to Qutenza on a case-by-case basis while they determine their coverage and reimbursement policies for
Qutenza. Obtaining these coverage and reimbursement decisions will be a time consuming process requiring substantial resources and Qutenza patients or providers may not receive adequate reimbursement from private insurers.

We expect to experience pricing pressures in connection with the sale of Qutenza and our potential future products, due to the trend
toward programs and legislation aimed at reducing healthcare costs, including the recently passed federal healthcare reform legislation as well as the increasing influence of managed care organizations. In many foreign countries, particularly
the countries of the European Union, the pricing of prescription drugs is subject to direct governmental control and is influenced by drug reimbursement programs that employ a variety of price control mechanisms. In these countries, pricing
negotiations with governmental authorities or reimbursement programs can take 6 to 12 months or longer after the receipt of regulatory marketing approval for a product. To obtain reimbursement or pricing approval in some countries, we or our
collaborators may be required to conduct additional studies, such as a study to evaluate the cost-effectiveness of Qutenza compared to other currently available therapies. If reimbursement for Qutenza is unavailable, delayed or limited in scope
or amount, or if pricing is set at unsatisfactory levels, our business would be materially harmed.

Qutenza and our
product candidates may never achieve market acceptance.

The commercial success of Qutenza or any other product
candidates we develop, if approved, will depend on, among other things, acceptance by healthcare professionals, patients and payers. Market acceptance of, and demand for, any products that we develop and commercialize will depend on many factors,
including:



| |  |  | the ability to obtain adequate pricing and sufficient insurance and other third party payer coverage and reimbursement;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | with respect to Qutenza, healthcare professionals and patients willingness and ability to accommodate the time necessary for each Qutenza treatment;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | patient acceptance of the treatment procedure, efficacy or safety of Qutenza;
| | - |  | -----------------------------------------------------------------------------



| |  |  | availability, relative cost and relative efficacy and safety of alternative and competing treatments;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | the effectiveness of our or our collaborators sales, marketing and distribution strategy;
| | - |  | ------------------------------------------------------------------------------------------



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| |  |  | publicity concerning our products or competing products and treatments;
| | - |  | -----------------------------------------------------------------------



| |  |  | potential product recalls; and
| | - |  | ------------------------------



| |  |  | post marketing approval pharmacovigilance or other studies showing safety issues not seen in previous studies.
| | - |  | --------------------------------------------------------------------------------------------------------------

If Qutenza, or our product candidates if approved, fail to gain market acceptance, we may be unable to earn sufficient revenue to
continue our business.

We outsource the manufacturing of Qutenza and our other product candidates and accordingly
depend on other parties for our manufacturing operations. If these manufacturers fail to meet our requirements and strict regulatory requirements, Qutenza commercialization efforts and further product development efforts may be negatively affected.

We currently depend on four contract manufacturers as single source suppliers for the components of Qutenza: an
intermediate material used in the synthesis of capsaicin, synthetic capsaicin, the dermal delivery system and the associated cleansing gel. We have entered into long-term commercial supply agreements for these components. In addition we have entered
into a long-term agreement for the assembly of the Qutenza treatment kits in the United States. If relationships with any of these manufacturers is terminated, or if any manufacturer is unable to produce required quantities on a timely basis or at
all, our operations would be negatively impacted and our business harmed.

Any products we or our contract manufacturers
manufacture or distribute under FDA approvals are subject to pervasive and continuing regulation by the FDA, including record-keeping requirements and reporting of adverse experiences with the products. Drug manufacturers and their subcontractors
are required to register with the FDA and, where appropriate, state agencies, and are subject to periodic unannounced inspections by the FDA and state agencies for compliance with cGMP, regulations which impose procedural and documentation
requirements upon us and each third party manufacturer we utilize. This ongoing regulation and evaluation results in an obligation on us to continually evaluate the manufacturing process, the applicability of our analytical methods and the
specifications that are used to release product for sale and evaluate long term stability of our product to ensure they continue to meet their objective of ensuring that such processes and methods enable the consistent manufacture of product that
meets regulatory approved specifications. This process often results in identification of matters that can result in changes to specifications, analytical methods and manufacturing processes as part of normal and ongoing process improvement. However
this process can identify matters that can have significant implications including the potential for reduction in applicable product shelf life, suspension of product commercialization, or requirement of product recalls, all of which would have a
material adverse effect on us. We are undertaking such ongoing process improvement processes with our contract manufacturers and we cannot assure you that the outcome of such initiatives will not have a material effect on our business.

Reliance on contract manufacturers exposes us to additional risks, including:



| |  |  | failure of current and future manufacturers to comply with strictly-enforced regulatory requirements;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | failure to manufacture products that meet our specifications throughout their shelf lives;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | failure to deliver sufficient quantities in a timely manner;
| | - |  | ------------------------------------------------------------



| |  |  | the possibility that we may terminate a contract manufacturer and need to engage a replacement;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | the possibility that current and future manufacturers may not be able to manufacture our product candidates and products without infringing the
intellectual property rights of others;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the possibility that current and future manufacturers may not have adequate intellectual property rights to provide for exclusivity and prevent
competition; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | insufficiency of intellectual property rights to any improvements in the manufacturing processes or new manufacturing processes for our products.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



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Any of these
factors could result in insufficient supply of Qutenza to meet demand which would have a significant impact on our financial results and adversely impact any revenues we may derive from Qutenza. With respect to our product candidates, such factors
could result in significant delay or suspension of clinical trials, regulatory submissions, or receipt of required approvals, all of which could significantly harm our business.

Because our third party manufacturers operate outside of the United States, and many of the raw materials and the labor that are used to
manufacture Qutenza and our product candidates are based in foreign countries, we may experience currency exchange rate risks, even though, in some instances our contracts are denominated in U.S. dollars. We do not currently engage in forward
contracts to hedge this currency risk and as a result, may suffer adverse financial consequences as a result of this currency risk.

Materials used by these entities to manufacture our product candidates originate outside the United States, including certain materials which may be sourced from China and India. The FDA has increased its
diligence with regard to foreign-sourced materials and manufacturing processes. Increased FDA scrutiny of foreign manufacturers could result in delays in product availability, which could have a negative impact on our business.

Furthermore, because we are currently required to supply Qutenza to Astellas under the Supply Agreement, the foregoing risks to us
related to supply of Qutenza and its components could also harm Astellas ability to commercialize Qutenza in the Licensed Territory. Whether we supply Qutenza to Astellas or Astellas enters into direct supply arrangements with our suppliers,
Astellas ability to generate revenue and in turn our ability to generate royalty and sales-milestone revenue, would be impacted by these foregoing risks relating to manufacturing.

If we are unable to establish, maintain and grow an effective sales, marketing and distribution infrastructure or enter into
collaborations with partners to perform these functions, we will not be successful in commercializing Qutenza or our product candidates.

In order to successfully commercialize Qutenza or any of our product candidates, we must devote sufficient resources to develop a capable sales, marketing and distribution infrastructure or enter into
collaborations with partners to perform these services for us. We may be unable to devote the resources necessary to develop a suitable sales, marketing and distribution infrastructure. We have entered into the Astellas Agreement to market Qutenza
in the Licensed Territory, and we may enter into additional partnering or other distribution arrangements for commercialization outside the United States. While we have a direct sales and marketing organization in the United States for
commercializing Qutenza, we may explore the possibilities to enter into collaborations with partners for commercializing Qutenza in the United States. Our establishment of Astellas as our collaboration partner for the Licensed Territory could limit
the potential collaboration options we have for the United States and other countries, or could render potential collaborators less inclined to enter into an agreement with us because of such relationship. Similarly, if we enter into an agreement
with a collaboration partner in the United States, such agreement may negatively impact our ability to seek additional strategic relationships. Factors that may inhibit our efforts to develop an internal sales, marketing and distribution
infrastructure and ability to commercialize our products successfully include:



| |  |  | lack of available financial resources;
| | - |  | --------------------------------------



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



| |  |  | the inability of sales personnel to obtain prescriber demand for our products;
| | - |  | ------------------------------------------------------------------------------



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



| |  |  | unforeseen costs and expenses associated with maintaining and expanding a sales and marketing organization.
| | - |  | -----------------------------------------------------------------------------------------------------------



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We also may not be able to enter into collaborations on acceptable terms, if at all, and we
may face competition in our search for partners with whom we may collaborate. If we are not able to maintain and expand an effective sales, marketing and distribution infrastructure, or collaborate with a partner to perform these functions, we may
be unable to commercialize our product candidates successfully, which would adversely affect our business and financial condition.

Qutenza is distributed through a small network of third-party specialty distributors and specialty pharmacies and we rely on a single third party logistics partner; if any of the distributors are
unable or unwilling to distribute Qutenza on commercially favorable terms, or at all, or if the third party logistics partner is unable or unwilling to perform its function, our business could be adversely affected.

We distribute Qutenza through a small network of third party specialty distributors and specialty pharmacies that generally sell,
distribute or provide Qutenza to hospitals or healthcare professionals. All of our Qutenza shipments are through these distributors. In addition, we rely on a single third party logistics provider to manage our warehouse, packaging and shipping
functions as well as certain customer and account administrative functions. Our business would be harmed if any of these distributors was unable or unwilling to distribute Qutenza or unable or unwilling to purchase Qutenza on commercially favorable
terms to us. It is possible that distribution partners could decide to change their policies or fees, or both, in the future. This could result in their refusal to distribute smaller volume products, or cause higher product distribution costs, lower
margins or the need to find alternative methods of distributing products. Such alternative methods may not exist or may not be economically viable.

Our success will depend, in part, on the successful efforts of our collaboration partner in the European Union, certain countries in Eastern Europe, the Middle East and Africa.

The success of sales of Qutenza in the Licensed Territory will be dependent on Astellas ability to successfully launch and
commercialize Qutenza pursuant to the Astellas Agreement. The manner in which Qutenza is launched, including the timing of launch in each country of the European Union and the pricing that will be established in each such country, will have a
significant impact on the ultimate success of Qutenza in the European Union, and ultimately the success of the overall commercial arrangement with Astellas. If commercial launch of Qutenza throughout the Licensed Territory is delayed or prevented,
our revenues will suffer and our stock price will decline. Further, if sales of Qutenza are less than anticipated, our stock price will decline. The outcome of Astellas commercialization efforts could also have an effect on investors
perception of potential sales of Qutenza in the United States, which could cause a decline in our stock price if such efforts are unsuccessful.

The Astellas Agreement provides for Astellas to be responsible for conducting certain studies for Qutenza in the European Union, both to satisfy post-marketing commitments that were made in conjunction
with the Qutenza MA in the European Union and to carry out in support of Astellas commercialization plans for Qutenza in the Licensed Territory. The planning and execution of these studies will be primarily the responsibility of Astellas, and
may not be carried out in accordance with our indicated preferences, or may yield results that are detrimental to Astellas sales of Qutenza in the Licensed Territory or detrimental in our efforts to develop or commercialize Qutenza outside the
Licensed Territory, including in the United States. Together with Astellas, we may attempt to design such studies with a view toward having the resulting data be supportive of other regulatory and commercial efforts in both the European Union and
the United States, such as potential label expansion studies that may be carried out with respect to use of Qutenza to treat pain associated with PDN. However, such studies may have limited or no utility to support such efforts and may negatively
impact our revenues.

Within the Licensed Territory, regulatory approval for Qutenza has been obtained within the European
Economic Area and Georgia. Other regulatory jurisdictions in the Licensed Territory may require further clinical and manufacturing activities to gain approval for sales of Qutenza in these countries. There can be no assurance that these activities
will be successful and that approval in these countries will be obtained in a timely manner, if



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at all. Further, there can be no assurance that such clinical or manufacturing activities will not negatively impact the regulatory processes in the European Economic Area, United States or other
markets where regulatory approval of Qutenza may have been obtained or may be in the process of being sought.

The Astellas
Agreement requires us to expend resources in support of our commercial relationship with Astellas. Although we believe that our contractual arrangement with Astellas provides for reimbursement for many of these activities, the time and financial
costs of managing such a relationship can be significant and to occur at a time when we are executing the commercialization of Qutenza in the United States.

The Supply Agreement we entered into in connection with the Astellas Agreement requires us to supply components of Qutenza to Astellas at the same cost we obtain such components from our third-party
manufacturers. Because we have never overseen commercial manufacturing processes and quantities of these components, we may incur non-reimbursable costs related to manufacturing scale up, quality assurance and release, which could negatively impact
our financial results. Such Supply Agreement also provides for Astellas to enter into direct supply relationships with our current suppliers to replace the need for us to provide Astellas with pass-through supply of Qutenza components. There can be
no assurance that the establishment of such separate supply relationships will not negatively impact our ability to obtain our own supply of Qutenza components in support of our commercialization of Qutenza in the United States or other markets
outside the Licensed Territory that we seek to commercialize.

The Astellas Agreement grants to Astellas an option to
exclusively license our second generation product, NGX-1998. In connection with this option, we are required to execute a development plan for NGX-1998 and achieve certain objectives. After completion of an initial set of objectives, Astellas may
make an additional payment to us to retain its option to license NGX-1998 until further agreed upon development of NGX-1998 has been performed by us. Upon completion of these objectives, Astellas may elect to make a final payment to us in order to
exercise its option. If Astellas determines not to make one of these payments, the option to license NGX-1998 will expire, Astellas will not be required to provide further funding for NGX-1998, and we would be precluded from marketing NGX-1998 in
the Licensed Territory for a period of time. If Astellas fails to exercise its options with respect to NGX-1998, we will be unable to generate revenues from potential sales of NGX-1998 in the Licensed Territory, and our business will be harmed.

Astellas commercialization of Qutenza in the Licensed Territory may result in lower levels of income to us than if we
marketed Qutenza in the Licensed Territory on our own. Astellas may not fulfill its obligations or commercialize Qutenza as quickly as we would like. We could also become involved in disputes with Astellas, which could lead to delays in or
termination of the Astellas Agreement and time-consuming and expensive litigation or arbitration. If Astellas terminates or breaches its agreement with us, or otherwise fails to complete its obligations in a timely manner, the chances of
successfully developing or commercializing Qutenza in the Licensed Territory would be materially and adversely affected.

Qutenza will be subject to ongoing regulatory requirements and may face regulatory or enforcement action.

Any product candidate for which regulatory approval is obtained is subject to significant review and ongoing and changing regulation by
the FDA, the EMA, and other regulatory agencies. These ongoing regulatory requirements may include, but are not limited to:



| |  |  | obtaining additional post-approval clinical study data;
| | - |  | -------------------------------------------------------



| |  |  | regulatory review of advertising, promotional and education activities for the product;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | establishment and monitoring of pharmacovigilance programs; and
| | - |  | ---------------------------------------------------------------



| |  |  | periodic regulatory agency inspections and reviews of third-party manufacturing facilities and processes.
| | - |  | ---------------------------------------------------------------------------------------------------------



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Regulatory authorities have recently increased their enforcement efforts including in the
areas of advertising, marketing and promotion. Failure to comply with regulatory requirements may subject us or our collaboration partner to administrative and judicially-imposed sanctions. These may include warning letters, adverse publicity, civil
and criminal penalties, injunctions, product seizures or detention, product recalls, total or partial suspension of production, and refusal to approve pending product marketing applications.

Even if regulatory approval to market a particular product candidate is obtained, the approval could be conditioned on conducting
additional costly post-approval studies or could limit the indicated uses included in such products labeling. For example, the Qutenza MA owned by Astellas in the European Union requires the conduct of certain post-authorization follow up
measurers including ongoing evaluations of safety of Qutenzas use in the labeled indications, as well as clinical evaluation in patients with PDN, although the timing of clinical evaluations in PDN has not yet been determined. Astellas did
initiate a long term safety study in patients with PHN, HIV-AN and/or other painful peripheral neuropathies (excluding diabetics) in the third quarter of 2010. These studies, which are funded by Astellas pursuant to Astellas Agreement, may prove
difficult and expensive to complete and their results may identify safety, efficacy or other issues related to Qutenzas use that could hinder or prevent commercialization efforts. Moreover, the product may later be found in the course of these
studies or through our pharmacovigilance programs to cause adverse effects that limit its use, force us or our partner to withdraw it from the market or impede or delay the ability to obtain regulatory approvals in additional countries.

We are subject to various regulations pertaining to the marketing of our products.

We are subject to various federal and state laws pertaining to healthcare fraud and abuse, including inducing, facilitating or encouraging
submission of false claims to government programs and prohibitions on the offer of payment or acceptance of kickbacks or other remuneration for the purchase of Qutenza. Specifically, these anti-kickback laws make it illegal for a prescription drug
manufacturer to solicit, offer, or pay any remuneration in exchange for purchasing, leasing or ordering any service or items including the purchase or prescription of a particular drug for which payment may be made under a federal healthcare
program. Because of the sweeping language of the federal anti-kickback statute, many potentially beneficial business arrangements would be prohibited if the statute were strictly applied. To avoid this outcome, the U.S. Department of Health and
Human Services has published regulations  known as safe harbors  that identify exceptions or exemptions to the statutes prohibitions. Arrangements that do not fit within the safe harbors are not automatically deemed to
be illegal, but must be evaluated on a case-by-case basis for compliance with the statute. We seek to comply with anti-kickback statutes and if necessary to fit within one of the defined safe harbors; we are unaware of any violations of
these laws. However, due to the breadth of the statutory provisions and the absence of uniform guidance in the form of regulations or court decisions, there can be no assurance that our practices will not be challenged under anti-kickback or similar
laws. Violations of such restrictions may be punishable by civil or criminal sanctions, including fines and civil monetary penalties, as well as the possibility of exclusion from U.S. federal healthcare programs (including Medicaid and
Medicare). Any such violations could have a material adverse effect on our business, financial condition, results of operations and cash flows.

In addition, the FDA has the authority to regulate the claims we make in marketing our prescription drug products to ensure that such claims are true, not misleading, supported by scientific evidence and
consistent with the labeled use of the drug. Failure to comply with FDA requirements in this regard could result in, among other things, warning letters, suspensions of approvals, seizures or recalls of products, injunctions against a products
manufacture, distribution, sales and marketing, operating restrictions, civil penalties and criminal prosecutions. Any of these FDA actions could negatively impact our product sales and profitability.



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We face
potential product liability exposure, and if successful claims are brought against us, we may incur substantial liability and may have to limit our commercialization efforts for Qutenza or our development efforts with respect to our product
candidates.

The use of our product candidates in clinical trials and the sale of Qutenza expose us to the risk of
product liability claims. Product liability claims might be brought against us by consumers, health care providers, pharmaceutical companies or others selling our products. If we cannot successfully defend ourselves against these claims, we will
incur substantial liabilities. Regardless of merit or eventual outcome, liability claims may result in:



| |  |  | decreased demand for our product candidates;
| | - |  | --------------------------------------------



| |  |  | impairment of our business reputation;
| | - |  | --------------------------------------



| |  |  | costs of related litigation;
| | - |  | ----------------------------



| |  |  | substantial monetary awards to patients or other claimants;
| | - |  | -----------------------------------------------------------



| |  |  | loss of revenues;
| | - |  | -----------------



| |  |  | the inability to commercialize our product candidates; and
| | - |  | ----------------------------------------------------------



| |  |  | withdrawal of clinical trial participants.
| | - |  | ------------------------------------------

Although we currently have product liability insurance coverage with limits that we believe are customary and adequate to provide us with coverage for foreseeable risks associated with our Qutenza
commercialization or product candidate development efforts, our insurance coverage may not reimburse us or may be insufficient to reimburse us for the actual expenses or losses we may suffer. Moreover, in the future, 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.

Our
products are expected to face substantial competition which may result in others discovering, developing or commercializing products before or more successfully than us or our collaborators.

Qutenza competes against more established products marketed by large pharmaceutical companies with far greater name recognition and
resources than we or Astellas have. The most directly-competitive currently-marketed products in the United States are Lidoderm, an FDA-approved 5% lidocaine topical patch for the treatment of PHN marketed by Endo Pharmaceuticals, and Lyrica, an
oral anti-convulsant, marketed by Pfizer for use in the treatment of PHN. In January 2011, Depomed Inc. received FDA approval for Gralise, a formulation of gabapentin that is a once daily tablet for the treatment of PHN. In addition to these branded
drugs, the FDA has approved gabapentin (Neurontin) for use in the treatment of PHN. Gabapentin is marketed by Pfizer and multiple generic manufacturers, and is the most widely-prescribed drug in the United States for treatment of neuropathic pain.
Pfizer has also received FDA approval for Lyrica for the treatment of PDN, fibromyalgia, epilepsy and general anxiety disorder. Additionally, a number of products that are approved for other diseases are used by physicians to treat PHN.

Competition may become stronger and more direct and products in development, including products that we are unaware of, may compete with
Qutenza. There are many other companies working to develop new drugs and other therapies to treat pain in general and neuropathic pain in particular, including Eli Lilly & Co, Pfizer, UCB Pharma SA, GlaxSmithKline plc, Merz, GW
Pharmaceuticals, Novartis AG, Novo Nordisk A/S, Dainippon Pharmaceutical Co Ltd., AVANIR Pharmaceuticals, Xenoport, EpiCept, Newron Pharmaceuticals SpA, WEX Pharmaceuticals, Arcion Therapeutics Inc., Endo Pharmaceuticals, AstraZeneca plc,
Bristol-Myers Squibb Co., Bio3 Research Srl, Relevare Pharmaceuticals Ltd., and Ortho-McNeil-Janssen Pharmaceuticals. Many of the compounds in development by such companies are already marketed for other indications, such as anti-depressants,
anti-convulsants or opioids. In addition, physicians employ other interventional procedures, such as nerve stimulation or nerve blocks, to treat patients with difficult to treat neuropathic pain conditions.



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Furthermore, new developments, including the development of other drug technologies and methods of preventing the incidence of disease, such as vaccines including Zostavax, occur in the
biopharmaceutical industry at a rapid pace. Any of these developments may render our products or product candidates obsolete or noncompetitive.

Many of our potential competitors, either alone or together with their partners, have substantially greater financial resources, research and development programs, clinical trial and regulatory
experience, expertise in prosecution of intellectual property rights, and manufacturing, distribution and sales and marketing capabilities than we and Astellas do. As a result of these factors, our competitors may:



| |  |  | initiate or withstand substantial price competition more successfully;
| | - |  | ----------------------------------------------------------------------



| |  |  | have greater success in recruiting skilled scientific workers from the limited pool of available talent;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | more effectively negotiate third-party licenses and strategic alliances;
| | - |  | ------------------------------------------------------------------------



| |  |  | take advantage of acquisition or other opportunities more readily than we can; and
| | - |  | ----------------------------------------------------------------------------------



| |  |  | develop product candidates and market products that are less expensive, safer, more effective or involve more convenient treatment procedures than our
current and future products.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The life sciences industry is characterized by rapid technological change. If
we fail to stay at the forefront of technological change our products may be unable to compete effectively.

The efforts
of government entities and third party payers to contain or reduce the costs of health care may adversely affect our sales and limit the commercial success of our products.

In certain foreign markets, pricing or profitability of pharmaceutical products is subject to various forms of direct and indirect
governmental control, including the control over the amount of reimbursements provided to the patient who is prescribed specific pharmaceutical products.

In the United States, there have been, and we expect there will continue to be, various proposals to implement similar controls. For example, the health care reform act passed in March 2010, increased the
rebate levels for pharmaceutical products sold to Medicaid patients by eight percent. The commercial success of our products could be limited if federal or state governments adopt any such proposals. In addition, in the United States and elsewhere,
sales of pharmaceutical products depend in part on the availability of reimbursement to the consumer from third party payers, such as government and private insurance plans. These third party payers are increasingly utilizing their significant
purchasing power to challenge the prices charged for pharmaceutical products and seek to limit reimbursement levels offered to consumers for such products. We expect these third party payers to focus their cost control efforts on our products,
especially with respect to prices of and reimbursement levels for products prescribed outside their labeled indications. In these cases, their efforts may negatively impact our product sales and profitability.

We may not be able to maintain orphan drug exclusivity for Qutenza in PHN and HIV-AN or obtain orphan designation in additional
indications or product candidates.

We rely, in part, on the market exclusivity afforded orphan drugs for the
commercialization of Qutenza in the United States. The FDA has granted us orphan drug status with regard to Qutenza for the management of neuropathic pain in patients with PHN and as a consequence, Qutenza is entitled to orphan exclusivitythat
is, for seven years, the FDA may not approve any other applications to market the same drug for the same indication, except in very limited circumstances. Additionally, the FDA has granted us orphan drug status for HIV-AN, an indication for which we
currently do not have an FDA-approved product. We may be unable to obtain orphan drug designations for any additional product candidates or exclusivity for any future product candidates or our potential competitors may obtain orphan drug exclusivity
for capsaicin-based products



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competitive with our product candidates in indications other than PHN before we do, in which case we may be excluded from that market for the exclusivity period. In addition, orphan drug
designation previously granted may be withdrawn under certain circumstances. Even if we obtain orphan drug exclusivity for any of our product candidates, we may not be able to maintain it if a competitive product based on the same active compound is
shown to be clinically superior to our product. Although obtaining FDA approval to market a product with orphan exclusivity can be advantageous, there can be no assurance that it would provide us with a significant commercial advantage.

The Hatch-Waxman Act data exclusivity and any equivalent regulatory data exclusivity protection in other jurisdictions for Qutenza,
may not prevent new competition which may negatively impact our financial results.

The Hatch-Waxman Act provides five
years of data exclusivity to the first applicant to gain approval of an NDA under Section 505(b) of the Food, Drug and Cosmetic Act for a new chemical entity. Qutenza has been recognized by the FDA as a new chemical entity and therefore has
been granted five year data exclusivity under the Hatch-Waxman Act. Hatch-Waxman provides data exclusivity by prohibiting abbreviated new drug applications, or ANDAs, and 505(b)(2) applications, which are marketing applications where the applicant
does not own or have a legal right of reference to all the data required for approval, to be submitted by another company for another version of such drug during the exclusivity period. Protection under Hatch-Waxman will not prevent the filing or
approval of a full NDA under Section 505(b)(1) for the same active ingredient, although the applicant would be required to conduct its own adequate and well-controlled clinical trials to demonstrate safety and effectiveness.

Even though Qutenza has been granted five year Hatch-Waxman data exclusivity in the United States and ten-year market exclusivity which
may be extended to eleven-year market exclusivity upon meeting certain criteria and eight-year data exclusivity by the EMA, there can be no assurance that the exclusivity granted will effectively prevent competition, either generic or otherwise.
Such competition could significantly harm our business.

Our fast track designation for development of
Qutenza for management of pain associated with HIV-associated neuropathy may not actually lead to a faster development or regulatory review or approval process.

A product intended for the treatment of a serious or life-threatening condition that demonstrates the potential to address unmet medical needs for such a condition may be submitted to the FDA for
fast track designation. Although we received fast track designation from the FDA for Qutenza for the treatment of HIV-AN, and the indication is eligible for priority review, there is no assurance that, when we file a supplemental NDA for
Qutenza in HIV-AN, that we will experience a faster development process, review process or approval, compared to conventional FDA standards, or that the product will be approved for such indication at all. We plan to submit the supplemental NDA in
2011, however, we may find no benefit in the fast track designation afforded the HIV-AN indication.

Our clinical trials
may fail to demonstrate adequately the safety and efficacy of our product candidates, which could prevent or delay regulatory approval and commercialization.

Before obtaining regulatory approvals for the commercial sale of our product candidates, we must demonstrate through lengthy, complex and expensive preclinical testing and clinical trials that the product
is both safe and effective for use in each target indication. Clinical trial results from the study of neuropathic pain are inherently difficult to predict. The primary measure of pain is subjective patient feedback, which can be influenced by
factors outside of our control, and can vary widely from day to day for a particular patient, and from patient to patient and site to site within a clinical study. The results we have obtained in completed clinical trials may not be predictive of
results from our ongoing or future trials. Additionally, we may suffer significant setbacks in advanced clinical trials, even after promising results in earlier studies.



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Some of our trial results have been negatively affected by factors that had not been fully
anticipated prior to our examination of the trial results. For example, we have from time to time observed a significant placebo effect within our control groupsa phenomenon in which a sham treatment or, in the case of our studies,
a low-dose capsaicin treatment that we believed would not be effective, results in a beneficial effect. Although we design our clinical study protocols to address known factors that may negatively affect our study results, there can be no assurance
that our protocol designs will be adequate or that factors that we may or may not be aware of or anticipate, will not have a negative effect on the results of our clinical trials, which could significantly disrupt our efforts to obtain regulatory
approvals and commercialize our product candidates. Furthermore, once a study has commenced, we may voluntarily suspend or terminate our clinical trials if at any time we believe that they present an unacceptable safety risk to patients. However,
clinical trials in other indications or in a larger patient population could reveal more frequent, more severe or additional side effects that were not seen or deemed unrelated in earlier studies, any of which could interrupt, delay or halt clinical
trials of our product candidates and could result in the FDA or other regulatory authorities stopping further development of or denying approval of our product candidates. Based on results at any stage of clinical trials, we may decide to repeat or
redesign a trial, modify our regulatory strategy or even discontinue development of one or more of our product candidates.

A
number of companies in the biotechnology and pharmaceutical industries have suffered significant setbacks in advanced clinical trials, even after obtaining promising results in earlier trials. If our product candidates are not shown to be both safe
and effective in clinical trials, the resulting delays in developing other compounds and conducting associated preclinical testing and clinical trials, as well as the potential need for additional financing, would have a material adverse effect on
our business, financial condition and results of operations.

Even though certain of our clinical trials for Qutenza
have met their primary endpoints, certain other studies have not met their primary endpoints and, our clinical trials for other indications, if we or our collaborator decide to conduct them, may not succeed, which would adversely impact our long
term success.

We have not prepared for or conducted any Qutenza clinical trials for indications other than PHN, HIV-AN
and PDN. Generally, two successful Phase 3 clinical trials are required to obtain regulatory approval in the U.S. We have conducted two Phase 3 clinical trials with Qutenza for patients with HIV-AN, one of which met its primary endpoint and one
which did not meet its primary endpoint. Based on the regulatory process to date, we believe the data we have from the two Phase 3 clinical trials may be sufficient to gain approval for the HIV-AN indication. However, given that only one HIV-AN
controlled study met its primary endpoint and that the pre-specified analysis plan in that study did not allow for examination of the recommended dose, the FDA may not accept the data submitted as sufficient for approval of the HIV-AN indication. If
the sNDA is not approved, Qutenza will not be marketable for this indication in the United States and this may harm our ability to generate revenue. We have also conducted one Phase 2 clinical trial that evaluated the use of Qutenza in patients with
PDN. PDN represents a much larger market opportunity than either PHN or HIV-AN, and unless required clinical trials are successfully completed and regulatory approvals are obtained for the use of Qutenza for PDN patients, Qutenza will not be
marketable for this indication in the United States and the European Union and possibly in other countries. If this occurs, our long-term ability to succeed may be significantly and negatively impacted. We believe that to market Qutenza in the
United States for PDN, we may have to conduct two successful Phase 3 trials and we may be required to perform additional safety studies. We are evaluating development programs for Qutenza in PDN and may decide not to conduct studies in PDN beyond
those that may be required by post-marketing requirements associated with the MA. If we do not have a sufficient number of successful studies in or have sufficient data to demonstrate the safety or efficacy in PDN, we may not gain approval for
Qutenza in this indication, which will significantly harm our ability to potentially generate revenue.

Results of clinical
trials of Qutenza for patients with PHN or HIV-AN do not necessarily predict the results of clinical trials involving other indications. If additional clinical studies are conducted with Qutenza in PDN or other indications, those studies may fail to
show desired safety and efficacy for management of pain associated with PDN and other indications, despite results from earlier clinical trials involving PDN, PHN and/or HIV-AN.



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Any failure or significant delay in completing clinical trials for Qutenza with PDN and other indications, or in receiving regulatory approval involving such indications, may significantly harm
our business.

Delays in the commencement or completion of clinical testing could result in increased costs to us and
delay our ability to generate revenues.

We do not know whether future clinical trials will begin on time or be
completed on schedule, if at all. The commencement and completion of clinical trials can be disrupted for a variety of reasons, including difficulties in:



| |  |  | availability of financial resources;
| | - |  | ------------------------------------



| |  |  | addressing issues that could be raised by the FDA or European or other national health authorities regarding safety, design, scope and objectives of
future clinical studies;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | recruiting and enrolling patients to participate in a clinical trial;
| | - |  | ---------------------------------------------------------------------



| |  |  | obtaining regulatory or Institutional Review Board/Ethics Committee approval to commence a clinical trial;
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | reaching agreement on acceptable terms with prospective clinical research organizations and trial sites;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | manufacturing sufficient quantities of a product candidate; and
| | - |  | ---------------------------------------------------------------



| |  |  | obtaining institutional review board approval to conduct a clinical trial at a prospective site.
| | - |  | ------------------------------------------------------------------------------------------------

A clinical trial may also be suspended or terminated by the entity conducting the trial (us or Astellas, as the case may be), the FDA or
other regulatory authorities due to a number of factors, including:



| |  |  | failure to conduct the clinical trial in accordance with regulatory requirements or in accordance with clinical protocols;
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | inspection of the clinical trial operations or trial site by the FDA or other regulatory authorities resulting in the imposition of a clinical hold;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | unforeseen safety issues; or
| | - |  | ----------------------------



| |  |  | inadequate patient enrollment or lack of adequate funding to continue the clinical trial.
| | - |  | -----------------------------------------------------------------------------------------

In addition, changes in regulatory requirements and guidance may occur and may cause a need to amend clinical trial protocols to reflect
these changes, which could impact the cost, timing or successful completion of a clinical trial. If delays are experienced in the commencement or completion of a clinical trial, the commercial prospects for our products or product candidates and our
ability to generate product revenues may be harmed. Many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials may also lead to the denial or revocation of regulatory approval of a product or product
candidate.

We rely on third parties to conduct our non-clinical studies and clinical trials. If these third parties do
not perform as contractually required or otherwise expected, we may not be able to obtain regulatory approval for our product candidates.

We do not currently conduct non-clinical studies and clinical trials on our own, and instead rely on third parties, such as contract research organizations, medical institutions, clinical investigators
and contract laboratories, to assist us with our non-clinical and clinical trials. We are also required to comply with regulations and standards, commonly referred to as good clinical practices and good laboratory practices, for conducting,
recording and reporting the results of non-clinical and clinical trials to assure that data and reported results are credible and accurate and that the trial participants are adequately protected. If these third parties do not successfully meet
their regulatory obligations, meet expected deadlines, or if the quality or accuracy of the data



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they obtain is compromised due to the failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our non-clinical development activities or clinical trials may
be extended, delayed, suspended, terminated, or potentially may be required to be performed again. Any of these factors may result in significant delay or failure to obtain regulatory approval for our product candidates.

We depend on our key personnel. If we are not able to retain them, our business will suffer.

We are highly dependent on the principal members of our management and scientific staff. The competition for skilled personnel among
biopharmaceutical companies in the San Francisco Bay Area is intense and the employment services of our scientific, management and other executive officers are terminable at-will. If we lose one or more of these key employees, our ability to
implement and execute our business strategy successfully could be seriously harmed. Replacing key employees may be difficult and may take an extended period of time because of the limited number of individuals in our industry with the breadth of
skills and experience required to develop, gain regulatory approval of and commercialize products successfully. We do not carry key man life insurance on any of our key personnel.

Risks Related to Our Finances and Capital Requirements

We have
incurred operating losses in each year since inception and expect to continue to incur substantial and increasing losses for the foreseeable future.

We have incurred operating and net losses each year since our inception in 1998. Our net loss for the year ended December 31, 2010 and 2009 was approximately $44.5 million and $21.9 million,
respectively. As of December 31, 2010 we had an accumulated deficit of approximately $256.5 million. We had cash, cash equivalents and short-term investments totaling $46.8 million at December 31, 2010, and for the year ended
December 31, 2010, we used cash of approximately $42.4 million in operating activities. We expect to continue to incur losses for several years, as we commercialize Qutenza and continue other research and development activities. If Qutenza does
not achieve market acceptance in the United States or the European Union, we will not generate significant product related revenue. We cannot assure you that we will be profitable even if Qutenza is successfully commercialized. If we fail to achieve
and maintain profitability, or if we are unable to fund our continuing losses, you could lose all or part of your investment.

If we do not raise additional capital, we may be forced to delay, reduce or eliminate our commercialization efforts or development
programs.

Our future capital requirements will depend on, and could increase significantly as a result of many
factors, including:



| |  |  | the costs of establishing, maintaining and expanding sales and marketing infrastructure, distribution capabilities and a sales force and other market
support functions such as medical affairs and pharmacovigilance;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the conduct of manufacturing activities including the manufacture of commercial product supply and clinical product supply;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



| |  |  | the success of the commercialization of our products;
| | - |  | -----------------------------------------------------



| |  |  | the costs of carrying out our obligations under our commercial arrangement with Astellas;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | our ability to establish and maintain strategic collaborations, including licensing, distribution and other arrangements that we have or may establish;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the progress of our development programs including the number, size and scope of clinical trials and non-clinical development;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | the costs and timing of additional regulatory approvals;
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| |  |  | the costs involved in enforcing or defending patent claims or other intellectual property rights; and
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | the extent to which we acquire or invest in other products, technologies and businesses.
| | - |  | ----------------------------------------------------------------------------------------

We intend to seek additional funding through strategic alliances and/or debt facilities or other financing vehicles which may include the
public or private sales of our equity securities. There can be no assurance, however, that additional funding will be available on reasonable terms, if at all. If adequate funds are not available, we may be required to further delay, reduce the
scope of, or eliminate one or more of our planned development, commercialization or expansion activities.

Raising
additional funds by issuing securities or through licensing arrangements may cause dilution to existing stockholders, restrict our operations or require us to relinquish proprietary rights.

To the extent that we raise additional capital by issuing equity securities, our existing stockholders ownership will be diluted.
Royalty monetization structures may require us to give up or assign certain rights to certain current and future assets. Any debt financing we enter into may involve covenants that restrict our operations. These restrictive covenants may include
limitations on additional borrowing and specific restrictions on the use of our assets, as well as prohibitions on our ability to create liens, pay dividends, redeem our stock or make investments. In addition, if we raise additional funds through
licensing arrangements, it may be necessary to relinquish potentially valuable rights to our potential products or proprietary technologies, or grant licenses on terms that are not favorable to us.

Failure to meet our loan obligation with Cowen Royalty could adversely affect our financial condition.

Under the terms of our Financing Agreement with Cowen Royalty, we are obligated to pay Cowen Royalty, substantially all of the payments
that may be due to us under the Astellas Agreement, until Cowen Royalty has received $90 million of such payments; and thereafter 5% of the Astellas Agreement payments until Cowen Royalty has received $106 million of such payments.

Our obligation to pay these payments during the term of the financing Agreement is secured under a security agreement by rights that we
have to the revenue interests under the Astellas Agreement, and by intellectual property and our other rights to the extent necessary or used to commercialize products covered by the Astellas Agreement in the Licensed Territory.

Because these obligations will in the near term divert all revenues that we may receive under the Astellas Agreement, our financial
position and ability to continue operations would be adversely impacted if we required further capital, even if Astellas was successfully commercializing our products in the Licensed Territory. Furthermore, the arrangement under the Financing
Agreement may make us less attractive to potential acquirers, and in the event that we exercised our change of control pay-off option to terminate the Financing Agreement in order to carry out a change of control, the payment of such funds out of
our available cash or acquisition proceeds would reduce acquisition proceeds for our stockholders.

Risks Related to our Intellectual
Property

The commercial success, if any, of Qutenza depends, in part, on the rights we have under certain patents.

The commercial success, if any, of Qutenza depends, in part, on a patent granted in the United States and device
patents granted in Canada, Hong Kong and certain countries of Europe concerning the use of a dermal delivery system for prescription strength capsaicin delivery for the treatment of neuropathic pain. We exclusively license these patents from the
University of California. We do not currently own, and do not have rights under this license to any issued patents that cover Qutenza outside Europe, Hong Kong, Canada and the United States. Although we have filed for an extension of the term for
one of the patents licensed from the University of California, there can be no assurance that such extension will be granted.



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In addition to other patents and patent applications which have been licensed under our
agreements with third party manufacturers, including the issued patents and pending applications licensed under our commercial supply agreement for Qutenza, we also license a method patent granted in the United States from the University of
California concerning the delivery of prescription strength capsaicin for the treatment of neuropathic pain. Two of the three inventors named in the method patent did not assign their patent rights to the University of California. These two
inventors asserted a claim of inventorship rights to the device patent. In late 2010, we entered into negotiations with these inventors to settle any and all claims and to have them assign their rights related to the method patent and any other
related patent rights that may exist at the time we enter into a final binding settlement agreement. We anticipate that any settlement will include us making a cash payment and us issuing stock or stock options to them. The absence of exclusive
rights to utilize such patent exposes us to a greater risk of direct competition and could materially harm our business.

If we are unable to maintain and enforce our proprietary rights, we may not be able to compete effectively or operate profitably.

Our commercial success will depend, in part, on obtaining and maintaining patent protection, trade secret protection
and regulatory protection (such as Hatch-Waxman protection or orphan drug designation) of our proprietary technology and information as well as successfully defending against third-party challenges to our proprietary technology and information. We
will be able to protect our proprietary technology and information from use by third parties only to the extent that valid and enforceable patents, trade secrets or regulatory protection cover them and we have exclusive rights to utilize them.

Our commercial success will continue to depend in part on the patent rights we own, the patent rights we have licensed, the
patent rights of our collaborators and suppliers and the patent rights we may obtain related to future products we may market. Our success also depends on our and our licensors, collaborators and suppliers ability to maintain these
patent rights against third-party challenges to their validity, scope or enforceability. Further, we do not fully control the patent prosecution of our licensed patent applications. There is a risk that our licensors will not devote the same
resources or attention to the prosecution of the licensed patent applications as we would if we controlled the prosecution of the patent applications, and the resulting patent protection, if any, may not be as strong or comprehensive as if we had
prosecuted the applications ourselves.

The patent positions of biopharmaceutical companies can be highly uncertain and
involve complex legal and factual questions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in such companies patents has emerged to date in the United States. The patent
situation outside the United States is even more uncertain. Changes in either the patent laws or in interpretations of patent laws in the United States or other countries may diminish the value of our intellectual property. Accordingly, we cannot
predict the breadth of claims that may be allowed or enforced in our patents or in third-party patents. For example:



| |  |  | we or our licensors might not have been the first to make the inventions covered by each of our pending patent applications and issued patents;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we or our licensors might not have been the first to file patent applications for these inventions;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | others may independently develop similar or alternative technologies or duplicate any of our technologies;
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | it is possible that none of our pending patent applications or the pending patent applications of our licensors will result in issued patents;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our issued patents and the issued patents of our licensors may not provide a basis for commercially viable products, or may not provide us with any
competitive advantages, or may be challenged and invalidated by third parties;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we may not develop additional proprietary technologies or product candidates that are patentable; or
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | the patents of others may have an adverse effect on our business.
| | - |  | -----------------------------------------------------------------



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We also rely on
trade secrets to protect our technology, especially where we do not believe patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. While we seek to protect confidential information, in part, by
confidentiality agreements with our employees, consultants, contractors, or scientific and other advisors, they may unintentionally or willfully disclose our information to competitors. If we were to enforce a claim that a third party had illegally
obtained and was using our trade secrets, it would be expensive and time consuming, and the outcome would be unpredictable. In addition, courts outside the United States are sometimes less willing to protect trade secrets.

If we are not able to defend the patent or trade secret protection position of our technologies and product candidates, then we will not
be able to exclude competitors from developing or marketing competing products, and we may not generate enough revenue from product sales to justify the cost of development of our product candidates and to achieve or maintain profitability.

If we are sued for infringing intellectual property rights of other parties, such litigation will be costly and time
consuming, and an unfavorable outcome would have a significant adverse effect on our business.

Although we believe that we would have valid defenses to allegations that our current product candidates, production
methods and other activities infringe the valid and enforceable intellectual property rights of any third parties of which we are aware, we cannot be certain that a third party will not challenge our position in the future. Other parties may own
patent or other intellectual property rights that might be infringed by our products, trademarks or activities. There has been, and we believe that there will continue to be, significant litigation and demands for licenses in our industry regarding
patent and other intellectual property rights. Our competitors or other patent or intellectual property holders may assert that our products or trademarks and the methods we employ are covered by their intellectual property rights. For example, in
2009 we received a letter indicating a possible trademark conflict for Qutenza® from a company claiming that our
trademark was similar to theirs. While we believe that these assertions do not have merit and that we have defenses to them, there can be no assurance that we will be successful in defending our trademark. We intend to continue to use the Qutenza
trademark and to vigorously defend our use of such trademark against such assertions. These parties could bring claims against us that would cause us to incur substantial expenses and, if successful against us, could cause us to pay substantial
damages or possibly prevent us from commercializing our product candidates using the Qutenza trademark which would have a significant negative effect on the Qutenza launch and global commercialization efforts. Further, if a patent infringement suit
were brought against us, we could be forced to stop or delay research, development, manufacturing or sales of the product or product candidate that is the subject of the suit, or if a trademark infringement suit were brought against us or our
collaboration partner Astellas, we or Astellas could be forced to cease using the name Qutenza in connection with our product.

As a result of intellectual property infringement claims, or in order to avoid potential claims, we may choose to seek, or be required to
seek, a license from the third party and would most likely be required to pay license fees or royalties or both. These licenses may not be available on acceptable terms, or at all. Even if we were able to obtain a license, the rights may be
non-exclusive, which would give our competitors access to the same intellectual property. Ultimately, we could be prevented from commercializing a product, or be forced to cease some aspect of our business operations if, as a result of actual or
threatened infringement claims, we or our collaborators are unable to enter into licenses on acceptable terms. This could harm our business significantly.

We may incur substantial costs as a result of litigation or other proceedings relating to patent and other intellectual property rights.

The cost to us of any litigation or other proceedings relating to intellectual property rights, even if resolved in our favor, could be
substantial. Some of our potential competitors, other patent or intellectual property holders may be better able to sustain the costs of complex patent litigation because they have substantially greater resources. Uncertainties resulting from the
initiation and continuation of any litigation could have a material adverse effect on our ability to continue our operations. Should third parties file patent applications, or be issued



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patents claiming technology also claimed by us in pending applications, we may be required to participate in interference proceedings in the U.S. Patent and Trademark Office to determine priority
of invention which could result in substantial costs to us or an adverse decision as to the priority of our inventions. An unfavorable outcome in an interference proceeding could require us to cease using the technology or to license rights from
prevailing third parties. There is no guarantee that any prevailing party would offer us a license or that we could acquire any license made available to us on commercially acceptable terms.

If we fail to comply with our obligations in the agreements under which we license development or commercialization rights to
products or technology from third parties, we could lose license rights that are important to our business.

We are a
party to a number of technology licenses that are important to our business and expect to enter into additional licenses in the future. For example, we hold licenses from The University of California and LTS under patents and patent applications
relating to Qutenza. These licenses impose various commercialization, milestone payment, royalty, insurance and other obligations on us. If we fail to comply with these obligations, the licensor may have the right to terminate the license, in which
event we would not be able to market products covered by the license, including Qutenza.

We may be subject to damages
resulting from claims that our employees or we 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. If we fail in defending such claims, in addition to paying monetary damages, 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 potential products, which could severely harm our business. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.

Risks Related to an Investment in our Common Stock

We expect that our stock price will fluctuate significantly, and you may not be able to resell your shares at or above your investment price.

The stock market has experienced significant volatility, particularly with respect to pharmaceutical, biotechnology and other life
sciences company stocks. The volatility of pharmaceutical, biotechnology and other life sciences company stocks often does not relate to the operating performance of the companies represented by the stock. Factors that could cause volatility in the
market price of our common stock include, but are not limited to:



| |  |  | failure to meet market expectations with respect to the launch of Qutenza by us in the United States and by Astellas in the European Union;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | inability of us and Astellas to successfully commercialize Qutenza in the United States and the Licensed Territory, respectively;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | potential inability to preserve or raise sufficient capital to maintain our operations;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | potential negative stock market reaction in the event we raise or attempt to raise additional equity capital;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | failure to meet revenue estimates and revenue growth rates;
| | - |  | -----------------------------------------------------------



| |  |  | actual or anticipated quarterly variations in our results of operations or those of our collaborators or competitors;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



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| |  |  | third-party healthcare reimbursement policies or determinations;
| | - |  | ----------------------------------------------------------------



| |  |  | product recalls, reported incidents of unanticipated adverse effects with respected to Qutenza, or other negative publicity related to Qutenza;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | general economic conditions and slow or negative growth of our expected markets;
| | - |  | --------------------------------------------------------------------------------



| |  |  | delay in entering, or termination of, strategic partnership relationships;
| | - |  | --------------------------------------------------------------------------



| |  |  | failure or delays in entering additional product candidates into clinical trials or in commencing additional clinical trials for current product
candidates;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | results from and any delays related to the clinical trials for our product candidates;
| | - |  | --------------------------------------------------------------------------------------



| |  |  | our ability to develop and market new and enhanced product candidates on a timely basis;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | announcements by us or our collaborators or competitors of new commercial products, clinical progress or the lack thereof, significant contracts,
commercial relationships or capital commitments;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | issuance of new or changed securities analysts reports or recommendations for our stock or the discontinuation of one or more securities
analysts research coverage for our stock;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | inclusion in or removal from stock indices such as the Russell 3000;
| | - |  | --------------------------------------------------------------------



| |  |  | developments or disputes concerning our intellectual property or other proprietary rights;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | commencement of, or our involvement in, litigation;
| | - |  | ---------------------------------------------------



| |  |  | changes in governmental statutes or regulations or in the status of our regulatory approvals;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | market conditions in the life sciences sector; and
| | - |  | --------------------------------------------------



| |  |  | any major change in our board or management.
| | - |  | --------------------------------------------

If the ownership of our common stock continues to be highly concentrated, it may prevent you and other stockholders from influencing significant corporate decisions and may result in conflicts of
interest that could cause our stock price to decline.

Our executive officers, directors and their affiliates and 5%
stockholders beneficially own or control approximately 58% of the outstanding shares of our common stock as of December 31, 2010 (after giving effect to the exercise of all of their outstanding vested options and warrants exercisable within 60
days of such date). Accordingly, these executive officers, directors and their affiliates and significant stockholders acting as a group, will have substantial influence over the outcome of corporate actions requiring stockholder approval, including
the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transactions. These stockholders may also delay or prevent a change of control of us, even if such a change of
control would benefit our other stockholders. The significant concentration of stock ownership may adversely affect the trading price of our common stock due to investors perception that conflicts of interest may exist or arise.

Future sales of shares by existing stockholders could cause our stock price to decline.

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. In particular, the significant concentration of stock ownership may adversely affect the trading price of our common stock in the event that certain large stockholders elect to sell the shares
of our common stock held by them.These sales might also make it more difficult for us to sell equity securities at a time and price that we deem appropriate.



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If we fail to meet the requirements for continued listing on the NASDAQ Global Market
and do not meet initial listing requirements to transfer to the NASDAQ Capital Market, our common stock could be delisted from trading, which would adversely affect the liquidity of our common stock and our ability to raise additional capital.

Our common stock is currently listed on the NASDAQ Global Market and to maintain our listing, we must meet certain
financial requirements in accordance with the rules of the NASDAQ Stock Market LLC, or Nasdaq. Although we have maintained our listing status on the NASDAQ Global Market since our initial listing on May 2, 2007, there can be no assurance that
we will maintain our listing on this market in the future.

If we are delisted from the NASDAQ Global Market, we can apply to
be listed on the NASDAQ Capital Market or other exchanges, which generally have lower standards for listing. Any potential delisting of our common stock would adversely affect the liquidity of our common stock and our ability to raise additional
capital.

We will continue to incur increased costs and demands upon management as a result of complying with the laws
and regulations affecting public companies, which could affect our operating results.

As a public company, we will
continue to incur significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We also have incurred and will incur costs associated with
corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002, the Dodd-Frank Act of 2010, as well as new rules implemented by the Securities and Exchange Commission and the NASDAQ Stock Market LLC. We expect these
rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly.

Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our
stockholders to replace or remove our current management.

Provisions in our certificate of incorporation and bylaws
may delay or prevent an acquisition of us or a change in our management. These provisions include a classified board of directors, a prohibition on actions by written consent of our stockholders and the ability of our board of directors to issue
preferred stock without stockholder approval. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits stockholders owning in excess of 15%
of our outstanding voting stock from merging or combining with us. Although we believe these provisions collectively provide for an opportunity to receive higher bids by requiring potential acquirers to negotiate with our board of directors, they
would apply even if the offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for
stockholders to replace members of our board of directors, which is responsible for appointing the members of our management.

Events in the credit markets have, and will continue to, impact our investment returns.

As a result of events in the credit markets, we maintain an investment portfolio of primarily U.S. Treasury securities. As a result of the
credit crisis and our shift in investments, we anticipate that our investment returns will be below our historic rates of return. These lower returns will likely continue for some time and we cannot predict when market conditions will improve and
when higher yielding investment options may be available to us.



43



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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, have contractual restrictions against paying cash dividends
and currently intend to retain our future earnings to fund the development and growth of our business. As a result, capital appreciation, if any, of our common stock will be an investors sole source of gain for the foreseeable future.



|Item  1B. | Unresolved Staff Comments
|--------- | -------------------------

There are no unresolved staff comments regarding any of our periodic or current reports.



|Item 2. | Properties
|------- | ----------

We lease approximately 26,386 square feet of office space located at 2215 Bridgepointe Parkway, Suite 200, San Mateo, California until 2012. We believe that these facilities are suitable
and adequate for our current needs.



|Item 3. | Legal Proceedings
|------- | -----------------

We are subject to various legal disputes that arise in the normal course of business. These include or may include employment matters, contract disputes, intellectual property matters, product liability
actions, and other matters. We do not know whether we would prevail in these matters nor can it be assured that a remedy could be reached on commercially viable terms, if at all. Based on currently available information, we do not believe that any
of these disputes will have a material adverse impact on our business, results of operations, liquidity or financial position.



|Item 4. | Removed and Reserved
|------- | --------------------



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PART II



|Item 5. | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
|------- | ------------------------------------------------------------------------------------------------------------

Our common stock is quoted on the NASDAQ Global Market under the symbol NGSX. The following table sets forth the high and low
sales price per share of our common stock as reported on the NASDAQ Global Market for the periods indicated.



|               |  |            |       |  |     |   |      | 
|-------------- |  | ---------- | ----- |  | --- | - | ---- | 
|               |  | Sale Price |      
|               |  | High       |       |  | Low |  
|Fiscal 2009:   |  |            |       |  |     |   |      | 
|First Quarter  |  | $          | 3.70  |  |     | $ | 0.89 | 
|Second Quarter |  | $          | 6.90  |  |     | $ | 2.01 | 
|Third Quarter  |  | $          | 9.20  |  |     | $ | 5.54 | 
|Fourth Quarter |  | $          | 9.09  |  |     | $ | 7.15 | 
|               |  |           
|Fiscal 2010:   |  |            |       |  |     |   |      | 
|First Quarter  |  | $          | 9.99  |  |     | $ | 6.88 | 
|Second Quarter |  | $          | 10.60 |  |     | $ | 6.52 | 
|Third Quarter  |  | $          | 7.55  |  |     | $ | 5.06 | 
|Fourth Quarter |  | $          | 7.55  |  |     | $ | 5.32 | 

We did not declare or
pay any cash dividends on our common stock during our fiscal years ended December 31, 2009 and 2010. We currently expect to retain future earnings, if any, for use in the operation and expansion of our business and do not in the foreseeable
future anticipate paying any cash dividends. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend upon our results of operations, financial condition and other factors the Board of
Directors, in its discretion, deems relevant. As of February 28, 2011 there were 39 holders of record of our common stock, one of which is Cede & Co., a nominee for Depository Trust Company, or DTC. All of the shares of our common
stock held by brokerage firms, banks and other financial institutions as nominees for beneficial owners are deposited into participant accounts at DTC, and are therefore considered to be held of record by Cede & Co. as one stockholder.

The information regarding the securities authorized for issuance under our equity compensation plans is set forth in
Item 12 of this Annual Report on Form 10-K.



45



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Comparison of Historical
Cumulative Total Return (*) Among NeurogesX, Inc., the NASDAQ Composite Index and the NASDAQ Biotechnology Index

LOGO



|                           |  |          |     |  |                              |  |        |            |  |  |            |  |  |            |       |  |  |  |        | 
|-------------------------- |  | -------- | --- |  | ---------------------------- |  | ------ | ---------- |  |  | ---------- |  |  | ---------- | ----- |  |  |  | ------ | 
|                           |  |          |     |  | Cumulative TotalReturn as
of | 
|                           |  | 5/2/2007 |     |  | 12/31/2007                   |  |        | 12/31/2008 |  |  | 12/31/2009 |  |  | 12/31/2010 |      
|NeurogesX, Inc.            |  |          | 100 |  |                              |  | 62.05  |            |  |  | 11.41      |  |  |            | 75.22 |  |  |  | 62.05  | 
|NASDAQ Composite Index     |  |          | 100 |  |                              |  | 103.69 |            |  |  | 61.65      |  |  |            | 88.71 |  |  |  | 103.72 | 
|NASDAQ Biotechnology Index |  |          | 100 |  |                              |  | 97.52  |            |  |  | 85.21      |  |  |            | 98.53 |  |  |  | 113.32 | 



|(*) | The above graph shows the cumulative total stockholder return of an investment of $100 in cash on May 2, 2007, the date our stock began to trade on the NASDAQ
Global Market, through December 31, 2009 for: (i) our common stock; (ii) the NASDAQ Composite Index; and (iii) the NASDAQ Biotechnology Index. All values assume reinvestment of the full amount of all dividends. Stockholder
returns over the indicated period should not be considered indicative of future stockholder returns.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
information contained under this caption Comparison of Historical Cumulative Total Return(*) Among NeurogesX, Inc., the NASDAQ Composite Index and the NASDAQ Biotechnology Index shall not be deemed to be soliciting material or to be
filed with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that we specifically
incorporate it by reference into such filing.



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|Item 6. | Selected Financial Data
|------- | -----------------------

The following selected financial data should be read in conjunction with Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations and
Item 8, Financial Statements and Supplemental Data of this Form 10-K.



|                                                                                                                              |  |                                                |            |   |      |   |            |      |  |   |            |   |  |      |           |   |  |   |         |  
|----------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | - |  | ---- | --------- | - |  | - | ------- | -
|                                                                                                                              |  | Years Ended December 31,                       |           
|                                                                                                                              |  | 2010                                           |            |   | 2009 |   |            | 2008 |  |   | 2007       |   |  | 2006 |          
|                                                                                                                              |  | (in thousands except share and per share data) |           
|Consolidated Statement of Operations Data:                                                                                    |  |                                                |            |   |      |   |            |      |  |   |            |   |  |      |           |   |  |   |         |  
|Net product revenue                                                                                                           |  | $                                              | 688        |   |      | $ |           |      |  | $ |           |   |  | $    |          |   |  | $ |        |  
|Collaboration revenue                                                                                                         |  |                                                | 7,578      |   |      |   | 2,006      |      |  |   |           |   |  |      |          |   |  |   |        |  
|Operating expenses:                                                                                                           |  |                                                |            |   |      |   |            |      |  |   |            |   |  |      |           |   |  |   |         |  
|Cost of goods sold                                                                                                            |  |                                                | 541        |   |      |   |           |      |  |   |           |   |  |      |          |   |  |   |        |  
|Research and development                                                                                                      |  |                                                | 11,151     |   |      |   | 11,235     |      |  |   | 16,104     |   |  |      | 25,321    |   |  |   | 20,919  |  
|Selling, general and administrative                                                                                           |  |                                                | 36,383     |   |      |   | 12,420     |      |  |   | 10,182     |   |  |      | 7,455     |   |  |   | 6,110   |  
|                                                                                                                              |  |                                                |            |   |      |   |            |      |  |   |            |   |  |      |           |   |  |   |         |  
|Total operating expenses                                                                                                      |  |                                                | 48,075     |   |      |   | 23,655     |      |  |   | 26,286     |   |  |      | 32,776    |   |  |   | 27,029  |  
|                                                                                                                              |  |                                                |            |   |      |   |            |      |  |   |            |   |  |      |           |   |  |   |         |  
|Loss from operations                                                                                                          |  |                                                | (39,809    | ) |      |   | (21,649    | )    |  |   | (26,286    | ) |  |      | (32,776   | ) |  |   | (27,029 | )
|Interest (expense) income, net                                                                                                |  |                                                | (5,315     | ) |      |   | (187       | )    |  |   | 314        |   |  |      | 499       |   |  |   | 180     |  
|Other income (expense), net                                                                                                   |  |                                                | 608        |   |      |   | (31        | )    |  |   | (63        | ) |  |      | 321       |   |  |   | (3,296  | )
|                                                                                                                              |  |                                                |            |   |      |   |            |      |  |   |            |   |  |      |           |   |  |   |         |  
|Net loss                                                                                                                      |  |                                                | (44,516    | ) |      |   | (21,867    | )    |  |   | (26,035    | ) |  |      | (31,956   | ) |  |   | (30,145 | )
|Accretion of redeemable convertible preferred stock                                                                           |  |                                                |           |   |      |   |           |      |  |   |           |   |  |      | (4,626    | ) |  |   | (11,293 | )
|                                                                                                                              |  |                                                |            |   |      |   |            |      |  |   |            |   |  |      |           |   |  |   |         |  
|Net loss attributable to common stockholders                                                                                  |  | $                                              | (44,516    | ) |      | $ | (21,867    | )    |  | $ | (26,035    | ) |  | $    | (36,582   | ) |  | $ | (41,438 | )
|                                                                                                                              |  |                                                |            |   |      |   |            |      |  |   |            |   |  |      |           |   |  |   |         |  
|Basic and diluted net loss per share attributable to common stockholders(1)                                                   |  | $                                              | (2.51      | ) |      | $ | (1.24      | )    |  | $ | (1.49      | ) |  | $    | (4.06     | ) |  | $ | (116.20 | )
|                                                                                                                              |  |                                                |            |   |      |   |            |      |  |   |            |   |  |      |           |   |  |   |         |  
|Weighted average number of shares used to compute basic and diluted net loss per share attributable to common
stockholders(1) |  |                                                | 17,768,881 |   |      |   | 17,610,796 |      |  |   | 17,519,415 |   |  |      | 9,017,627 |   |  |   | 356,600 |  



|                                                     |  |                    |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|---------------------------------------------------- |  | ------------------ | -------- | - | ---- | - | -------- | ---- |  | - | -------- | - |  | ---- | -------- | - |  | - | -------- | -
|                                                     |  | As of December 31, |         
|                                                     |  | 2010               |          |   | 2009 |   |          | 2008 |  |   | 2007     |   |  | 2006 |         
|                                                     |  | (in thousands)     |         
|Consolidated Balance Sheet Data:                     |  |                    |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |          |  
|Cash and cash equivalents and short-term investments |  | $                  | 46,830   |   |      | $ | 50,559   |      |  | $ | 24,506   |   |  | $    | 52,851   |   |  | $ | 13,902   |  
|Working capital                                      |  |                    | 32,615   |   |      |   | 39,286   |      |  |   | 19,109   |   |  |      | 44,139   |   |  |   | 578      |  
|Restricted cash                                      |  |                    | 410      |   |      |   | 160      |      |  |   | 200      |   |  |      | 240      |   |  |   |         |  
|Total assets                                         |  |                    | 50,850   |   |      |   | 52,905   |      |  |   | 25,590   |   |  |      | 54,185   |   |  |   | 14,818   |  
|Preferred stock warrant liability                    |  |                    |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   | 7,549    |  
|Long term obligationnon-current portion             |  |                    | 2,222    |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Notes payablenon-current portion                    |  |                    |         |   |      |   |         |      |  |   | 191      |   |  |      | 3,024    |   |  |   | 6,737    |  
|Deferred revenue                                     |  |                    | 40,178   |   |      |   | 46,843   |      |  |   |         |   |  |      |         |   |  |   |         |  
|Long term obligation                                 |  |                    | 42,622   |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Redeemable convertible preferred stock               |  |                    |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   | 116,164  |  
|Accumulated deficit                                  |  |                    | (256,527 | ) |      |   | (212,011 | )    |  |   | (190,144 | ) |  |      | (164,109 | ) |  |   | (127,527 | )
|Total stockholders (deficit) equity                 |  |                    | (41,291  | ) |      |   | 253      |      |  |   | 19,274   |   |  |      | 41,361   |   |  |   | (122,066 | )



|(1) | See Note 2 of the notes to the consolidated financial statements for an explanation of the method used to calculate the net loss per share attributable to common
stockholders and the number of shares used in the computation of the per share amounts.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|Item 7. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

This discussion and analysis should be read in conjunction with our financial statements and accompanying notes included elsewhere in
this report. Operating results are not necessarily indicative of results that may occur in future periods. Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the
factors which affect our business, including without limitation the disclosures made in Item 1A of Part I of this Annual Report under the caption Risk Factors.

Overview

We are a biopharmaceutical company focused on developing and
commercializing novel pain management therapies. We are assembling a portfolio of pain management product candidates based on known chemical entities to develop innovative new therapies that we believe may offer substantial advantages over currently
available treatment options. Our initial focus is on the management of chronic peripheral neuropathic pain conditions.

Our
first commercial product is a dermal delivery system designed to treat certain neuropathic pain conditions that was approved by the United States Food and Drug Administration, or FDA in November 2009 for the management of neuropathic pain associated
with postherpetic neuralgia, or PHN. Qutenza, the first prescription strength capsaicin product approved in the United States, became commercially available in the first half of 2010 in the United States, through a specialty distribution and
specialty pharmacy network supported by our own sales force, and in certain European countries through our collaborator Astellas Pharma Europe Ltd., or Astellas.

In May 2009, Qutenza received a marketing authorization or MA, in the European Union for the treatment of peripheral neuropathic pain in non-diabetic adults, either alone or in combination with other
medicinal products for pain. In June 2009, we entered into a Distribution, Marketing and License Agreement, or Astellas Agreement, under which Astellas was granted an exclusive license to commercialize Qutenza in the European Economic Area, which
includes the 27 countries of the European Union, Iceland, Norway, and Liechtenstein as well as Switzerland, certain countries in Eastern Europe, the Middle East and Africa, which we refer to as the Licensed Territory. Qutenza was made available on a
country by country basis commencing in April, 2010 and by year end was available in seventeen European countries. Astellas anticipates introducing Qutenza in additional European Union countries as well as non-European Union countries within their
territory during 2011. We recognize royalty revenue based upon Astellas reported net sales of Qutenza in the Licensed Territory. We recognize royalty revenue from Astellas on a quarter lag basis due to timing of Astellas reporting such
royalties to us.

We plan to submit a supplemental new drug application, or sNDA, in the first half of 2011 in pursuit of a
label expansion for Qutenza in the United States, or U.S. The label expansion would include patients with HIV-associated neuropathy, or HIV-AN, also known as HIV-distal sensory polyneuropathy, or HIV-DSP. The submission is expected to utilize data
from two completed Phase 3 studies in patients with HIV-AN, one of which did not meet its primary endpoint. Our plans for continued Qutenza development efforts with respect to PDN are being evaluated in light of Astellas plans for market
support studies and satisfaction of the European Medicines Agency, or EMA, post-approval regulatory commitments.

In November
2010, we treated the first patient in a Phase 2 clinical study of NGX-1998, a liquid formulation of high-concentration capsaicin, in patients with PHN. The Phase 2, adaptive-design, clinical study is being conducted in two stages. The objective of
the study is to select the appropriate pretreatment and concentration of NGX-1998 for further evaluation in a Phase 3 clinical program. The first stage is designed to determine the shortest tolerable anesthetic pretreatment regimen. The second stage
will evaluate two NGX- 1998 dose concentrations using the pretreatment regimens determined during stage 1. Based on the results from the first stage, the second stage of the study is being conducted without the use of a topical anesthetic
pretreatment regimen. The Astellas Agreement provides Astellas an option to exclusively license NGX-1998 in the Licensed Territory. If Astellas was to exercise its option, they would cooperate with us on the Phase 3 clinical trials and share equally
in the cost of the trials.



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We also have a series of compounds which represent an early stage pipeline of potential
product candidates which include various prodrugs of acetaminophen for potential use in acute pain, including traumatic pain, post-surgical pain and fever and various prodrugs of opioids for potential use in chronic pain indications. These other
product candidates are in the pre-clinical stage of development and may or may not be the subject of further development in 2011 or beyond. We are currently seeking development partners for our acetaminophen prodrug programs.

To date we have not generated any significant product revenues and have funded our operations primarily by selling equity securities,
establishing debt facilities and through the Astellas Agreement. Our net loss for the fiscal years ended December 31, 2010 and 2009 was $44.5 million and $21.9 million, respectively, and as of December 31, 2010 we had an accumulated
deficit of $256.5 million. We had cash, cash equivalents and short-term investments totaling $46.8 million at December 31, 2010 and during the year ended December 31, 2010, we used cash of $42.4 million in operating activities. We expect
to continue to incur annual operating losses for the foreseeable future, and expect that our operating loss for the year ending December 31, 2011 will be consistent with our operating loss for the year ended December 31, 2010,as we
continue our sales and marketing efforts relating to Qutenza in the U.S., conduct the Phase 2 clinical study of NGX-1998 and pursue a label expansion for Qutenza in the U.S.

In April 2010, we borrowed $40.0 million from Cowen Healthcare Royalty Partners, L.P., or Cowen Royalty, and we agreed to repay Cowen Royalty up to $106 million by assigning Cowen Royalty one hundred
percent of royalty, milestone, option and other payments that we may receive under the Astellas Agreement until our repayment obligation is satisfied in full.

We anticipate that our existing cash and investments will be sufficient to meet our projected operating requirements through at least December 31, 2011.

Critical Accounting Policies and Significant Judgments and Estimates

Our managements discussion and analysis of our financial condition and results of operations is 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 assumptions that affect the reported amounts of assets, liabilities, expenses and related disclosures. Actual results could differ from those
estimates.

While our significant accounting policies are described in more detail in Note 2 of Notes to Consolidated
Financial Statements included elsewhere 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.

Product revenue

In April 2010, we made Qutenza commercially available in the United States to our specialty distributor and specialty pharmacy customers. Under the agreements with our customers, the customers take title
to the product upon shipment and only have the right to return damaged product, product shipped in error and expired or short-dated product. As Qutenza is new to the marketplace, we are currently assessing the flow of product through our
distribution channel, and cannot currently reasonably estimate returns. Until such time as an estimate of returns can be made we are recognizing Qutenza product revenues, and related product costs, at the later of:



| |  |  | the time the product is shipped by the customer to healthcare professionals, and
| | - |  | --------------------------------------------------------------------------------



| |  |  | the date of cash collection.
| | - |  | ----------------------------

Healthcare professionals are generally ordering Qutenza in small quantities only after they have identified a patient for treatment. We believe that revenue recognition upon the later of customer shipment
to the end user



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and the date of cash collection is appropriate until we have sufficient data on cash collection and return patterns of our customers. We are performing additional procedures to further analyze
shipments made by our customers by utilizing shipping data provided by our customers to determine when product is shipped by the customers to healthcare professionals and are evaluating ending inventory levels at our customers each month to assess
the risk of product returns.

We have established terms pursuant to distribution agreements with our specialty distributor
customers providing for payment within 120 days of the date of shipment to our specialty distributor customers and 30 days of the date of shipment to our specialty pharmacy customers. Such distribution agreements generally have a term of three
years.

The application of the above revenue recognition policy resulted in the recognition of net revenue of $688,000 from
gross shipments of $1.4 million for the year ended December 31, 2010. Our gross shipments are reduced for chargebacks, certain fees paid to distributors and product sales allowances including rebates to qualifying federal and state government
programs. At December 31, 2010, net deferred product revenues totaled $577,000.

Revenue from the Astellas
Agreement

In June 2009, we entered into the Astellas Agreement which provides for an exclusive license by us to
Astellas for the promotion, distribution and marketing of Qutenza in the Licensed Territory, an option to license NGX-1998, a product candidate that is a non-patch liquid formulation of capsaicin, in the Licensed Territory, participation on a joint
steering committee and, through a related supply agreement entered into with Astellas (the Supply Agreement), supply of product until direct supply arrangements between Astellas and third party manufacturers are established, some of
which we anticipate to occur in mid-2011. Revenue under this arrangement includes upfront non-refundable fees and may also include additional option payments for the development of and license to NGX-1998, milestone payments upon achievement of
certain product sales levels and royalties on product sales.

We analyze multiple element arrangements, such as the Astellas
Agreement, to determine whether the various performance obligations, or elements, can be separated or whether they must be accounted for as a single unit of accounting. The determination of whether an element can be separated or accounted for as a
single unit of accounting is based on the availability of evidence with regard to standalone value of each delivered element. If the fair value of all undelivered performance obligations can be determined, then all obligations would then be
accounted for separately as performed. If any delivered element is considered to either: 1) not have standalone value or 2) have standalone value but the fair value of any of the undelivered performance obligations are not determinable, then any
delivered elements of the arrangement would be accounted for as a single unit of accounting and the multiple elements would be grouped and recognized as revenue over the longest estimated performance obligation period.

Significant management judgment is required in determining the level of effort required under an arrangement and the period over which
the performance obligations are estimated to be completed. In addition, if we are involved in a joint steering committee as part of a multiple element arrangement that is accounted for as a single unit of accounting, an assessment is made as to
whether the involvement in the steering committee constitutes a performance obligation or a right to participate.

Revenue
recognition of non-refundable upfront license fees commences when there is a contractual right to receive such payment, the contract price is fixed or determinable, the collection of the resulting receivable is reasonably assured and there are no
further performance obligations under the license agreement.

We view the Astellas Agreement and related agreements, as a
multiple element arrangement with the key deliverables consisting of an exclusive license to Qutenza in the Licensed Territory, an obligation to conduct certain development activities associated with NGX-1998, participation on a joint steering
committee and supply



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of Qutenza components to Astellas until such time that Astellas can establish a direct supply relationship with product vendors. Because not all of these elements have both standalone value and
objective and reliable evidence of fair value, we are accounting for such elements as a single unit of accounting. Further, the agreement provides for our mandatory participation in a joint steering committee, which we believe represents a
substantive performance obligation and also the estimated last delivered element under the Astellas Agreement and related agreements. Therefore, we are recognizing revenue associated with upfront payments and license fees ratably over the term of
the joint steering committee performance obligation. We estimate this performance obligation will be delivered ratably through June 2016.

At the inception of the Astellas Agreement, the upfront license fees were subject to a refund right, which expired upon transfer of our MA for Qutenza in the European Union to Astellas. In September 2009,
the transfer of the MA to Astellas was completed and, therefore, the upfront license fees became non-refundable and revenue recognition of the upfront license fees commenced.

In the accompanying financial statements, collaboration revenue represents revenue associated with the Astellas Agreement and related agreements. Deferred collaboration revenue arises from the excess of
cash received or receivable over cumulative revenue recognized for the period.

Under the terms of the Astellas Agreement, we
earn royalties based on each sale of Qutenza into the Licensed Territory. The royalty rate is tiered based on the level of sales achieved. These royalties are considered contingent consideration as we have no remaining contract performance
obligation and, therefore, the royalties are excluded from the single unit of accounting discussed above. We report royalty revenue based upon Astellas reported net sales of Qutenza in the Licensed Territory. We recognize royalty revenue from
Astellas on a quarter lag basis due to the timing of Astellas reporting such royalties to us.

Additionally, we can earn
milestone payments from Astellas if Astellas achieves certain sales levels as outlined in the Astellas Agreement. As these payments are contingent on Astellas performance, they are excluded from the single unit of accounting discussed above.
The milestones will be recorded as revenue when earned as we have no remaining contract performance obligation.

We recognize
revenue net of related costs for collaboration supplies sold to Astellas upon the product being delivered to Astellas. The revenue and related costs of the product supplied to Astellas are included in collaboration revenue. Prior to delivery to
Astellas, the costs accumulated for the manufacturing of the collaboration supplies are included as Prepaid expenses on our balance sheet.

Stock-Based Compensation

We account for our stock-based
compensation in accordance with the fair value recognition provisions of current authoritative guidance. Under the authoritative guidance, stock-based awards, including stock options, are recorded at fair value as of the grant date and recognized to
expense over the employees requisite service period (generally the vesting period), which we have elected to amortize on a straight-line basis. Because non-cash stock compensation expense is based on awards ultimately expected to vest, it has
been reduced by an estimate for future forfeitures. We estimate forfeitures at the time of grant and revised, if necessary, in subsequent periods.

We estimate the fair value of options granted using the Black-Scholes option valuation model and the assumptions used shown in Note 11 to the Consolidated Financial Statements in Item 8 of this
Annual Report on Form 10-K. Significant judgment is required on the part of management in determining the proper assumptions used in this model. The assumptions used in the Black-Scholes option valuation model include the risk free interest rate,
expected term, expected volatility and expected dividend yield. We base our assumptions on historical data where available or when not available, on a peer group of companies. However, these assumptions consist of estimates of future market
conditions, which are inherently uncertain, and therefore subject to managements judgment. See Note 11 of Notes to Consolidated Financial Statements included elsewhere in this report for further detail.



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Inventories

Inventories are valued at the lower of cost or market with cost determined under the specific identification method. Inventories consist of raw materials, work in process and finished goods. Raw materials
include certain starting materials used in the production of the active pharmaceutical ingredient of Qutenza. Work in process includes the bulk inventory of the active pharmaceutical ingredient, patches and cleansing gel of Qutenza that are in the
process of being manufactured or have completed manufacture and are awaiting final packaging, including related internal labor and overhead costs. Finished goods include the final packaged kits that contain the Qutenza patch and cleansing gel and
that are ready for commercial sale. Qutenza received FDA approval for sale in the United States during the fourth quarter of 2009; costs incurred prior to FDA approval had been recorded as research and development expense on our condensed
consolidated statement of operations. On a quarterly basis, we analyze our inventory levels and write down inventory that has become obsolete, inventory that has a cost basis in excess of the expected net realizable value and inventory that is in
excess of expected requirements based upon anticipated product revenues. During the year ended December 31, 2010, we recorded a charge to cost of goods sold of $0.4 million for Qutenza patches which we do not expect to sell prior to their
expiration date. As a result of the recent product launch of Qutenza, the expected inventory requirements based on product revenue and the timing of production runs are subject to significant judgment and management estimate.

Clinical Trials

We accrue and expense costs for clinical trial activities performed by third parties, including clinical research organizations and clinical investigators, based upon estimates made, as of the reporting
date, of the work completed through the reporting date as a percentage of the total work contracted for under our agreements with such third parties. We make our estimates at the end of each reporting period after discussion with internal personnel
and outside service providers and thorough evaluation as to progress or stage of completion of trials or services. On a periodic basis we adjust our estimated clinical trial costs to reflect actual expenses incurred to date. Due to the nature of the
estimation of clinical trial costs, we may be required to make changes to our estimates in the future as we become aware of additional information about the status or conduct of clinical trials.

Long term obligations

On April 30, 2010, the Company entered into a Financing Agreement (the Financing Agreement) with Cowen Healthcare Royalty Partners, L.P., a limited partnership organized under the laws of the
State of Delaware (Cowen Royalty). Under the terms of the Financing Agreement, the Company borrowed $40 million from Cowen Royalty (the Borrowed Amount) and the Company agreed to repay such Borrowed Amount together with a
return to Cowen Royalty, out of royalty, milestone, option and certain other payments (collectively, Revenue Interest) that the Company may receive under the Astellas Agreement.

The accounting for the Financing Arrangement requires us to make certain estimates and assumptions, including the timing and extent of
royalty, milestone, option and other payments to be received from Astellas and an internal rate of return we are to pay to Cowen. Changes in the estimated Revenue Interest payments can result in changes in our classification of the current and long
term portions of the amounts payable pursuant to the Financing Agreement, as well as the internal rate of return paid to Cowen.

We are also required to make assumptions for the calculation of the estimated fair market value of the Long term obligation disclosed in
the footnotes to our financial statements. The key assumptions required for the estimated fair market value calculation are estimates of the amounts and timing of the future royalty revenues and other payments to be received from Astellas, the
amount and timing of payments to Cowen Royalty to repay the Borrowed Amount and an estimated cost of capital

The estimate of
the future royalty revenues and other payments to be received from Astellas is subject to significant variability due to the recent product launch, regulatory process still to be conducted for significant portions of the Astellas territory and the
extended time period associated with the Cowen Financing Agreement, and thus are subject to significant uncertainty (see further discussion of this Long term obligation under Liquidity and Capital Resources).



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Results of Operations

In November 2009, we received marketing approval from the FDA for Qutenza for the management of neuropathic pain associated with PHN. In April, 2010, we launched Qutenza in the United States. We are
marketing and selling Qutenza in the United States through a team of approximately 40 sales professionals. We have established a distribution network to allow health care providers to access Qutenza through specialty distributors and specialty
pharmacies. We are marketing Qutenza to high volume prescribing physicians who treat PHN patients in private practices, hospitals, military treatment facilities and veterans associations. Our approach requires considerable time and effort to educate
and train physicians and their staff prior to their initial Qutenza treatments.

We commenced recording collaboration revenue
for the upfront payments from Astellas in 2009, when the upfront payment of $48.8 million received from Astellas became nonrefundable as a result of our transfer of the Qutenza MA to Astellas. We recognized $7.2 million of the upfront payment as
revenue in 2010 and $2.0 million in 2009. As of December 31, 2010, we have $39.6 million remaining in deferred collaborative revenue which will be recognized on a straight line basis over the remaining service period of the joint steering
committee, which we estimate will expire in June 2016. Under our Supply Agreement with Astellas, we are obligated to supply product, at a contractual price which approximates our cost, until such time as Astellas establishes its own supply
relationship.

As of December 31, 2010, Astellas has made Qutenza commercially available in seventeen European countries
and Astellas has informed us that it is continuing its focus on intensive site training on a country by country basis. We believe that Astellas plans to expand Qutenza availability in the European Union and seek regulatory approvals in certain
countries in the remainder of the Licensed Territory in 2011.

Cost of goods sold includes the cost of products sold, costs
associated with services provided by our third-party logistics partner for managing the shipping, billing and other administrative functions associated with the distribution channel and also includes royalty obligations due to our intellectual
property licensors, UC and LTS. We recognize costs associated with our third party logistics provider in the period in which those costs are incurred, however, costs to manufacture product and royalty obligations due to third parties are deferred
and recognized in the period in which the associated revenue is recognized. Costs associated with the manufacture of Qutenza prior to regulatory approval were previously expensed in the period in which those costs were incurred. We believe that the
effect on cost of goods sold of previously expensed materials prior to approval is immaterial as compared to what cost of goods sold would have been if such costs were expensed in the period that the product was sold.

Our research and development expenses consist of internal and external costs. Our internal costs are primarily employee salaries and
benefits, contract employee expense, non-cash stock compensation expense, allocated facility and other overhead costs. Our external costs are primarily expenses related to the development of product candidates including formulation development,
manufacturing process development, non-clinical studies, clinical trial costs, such as the cost of clinical research organizations and clinical investigators, milestone payments to our licensors in connection with the use of certain intellectual
property, and costs associated with preparation and filing of regulatory submissions. Additionally, external and internal costs related to manufacturing and quality assurance activities for production batches of our active pharmaceutical ingredient,
patches and cleansing gel, which are destined for commercial sale in the United States, were recorded to research and development expense if purchase of such components occurred prior to FDA approval.

We commence tracking the separate, external costs of a project when we determine that a project has a reasonable chance of entering
clinical development. Senior management discusses the possibility of entering clinical development, along with the possibility of meeting other regulatory milestones, throughout the development cycle. These discussions include consideration of the
costs and time required to bring the project to market and the potential market acceptance. We do not maintain and evaluate research and development costs by specific therapeutic indications within a program due to the difficulties in allocating
such costs to specific



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indications. We use our internal research and development resources across several projects and many resources may not be attributable to specific projects or indications. Thus, we do not
allocate the internal resources to specific development programs. Over time, we believe that our internal costs are expended on our development projects generally in proportion to our external development costs for such project relative to total
external development costs

In the years ended December 31, 2010, 2009 and 2008, our research and development costs
totaled $11.2 million, $11.2 million and $16.1 million, respectively. The following table reflects the distribution of our research and development costs by development program:

Year ended December 31;

(in thousands)



|     |  |         |       |  |          |   |       |                                        |  |   |                |  |  |       |       |  |  |   |        | 
|---- |  | ------- | ----- |  | -------- | - | ----- | -------------------------------------- |  | - | -------------- |  |  | ----- | ----- |  |  | - | ------ | 
|     |  | Qutenza |       |  | NGX-1998 |   |       | AcetaminophenProdrug andOpioid Prodrug |  |   | Internal costs |  |  | Total |      
|2010 |  | $       | 1,159 |  |          | $ | 2,757 |                                        |  | $ | 199            |  |  | $     | 7,036 |  |  | $ | 11,151 | 
|2009 |  |         | 3,634 |  |          |   | 133   |                                        |  |   | 6              |  |  |       | 7,462 |  |  |   | 11,235 | 
|2008 |  |         | 5,780 |  |          |   | 609   |                                        |  |   | 502            |  |  |       | 9,213 |  |  |   | 16,104 | 

The process of
conducting preclinical testing and clinical trials necessary to obtain marketing approvals in the United States and other regions is costly and time consuming. The probability of success for each product candidate and clinical trial may be affected
by a variety of factors, including, among others, patient enrollment, manufacturing capabilities, successful clinical results, our funding, and competitive and commercial viability. As a result of these and other factors, we are unable to determine
the duration and completion costs of current or future clinical stages of our product candidates or when or to what extent we will generate revenues from commercialization and sale of any of our unapproved product candidates. In November 2010, we
treated the first patient in a Phase 2 clinical study of NGX-1998. NGX-1998 is our most advanced product candidate and costs to complete development of NGX-1998 could be significant. Pursuant to the Astellas Agreement, we might receive future option
payments related to this program at Astellas election; however, we are obligated to pay any such amounts to Cowen Royalty under the terms of the Financing Agreement. Further, if Astellas exercises its option to license NGX-1998, Astellas would
be responsible for 50% of the costs incurred for Phase 3 clinical development. If we do not obtain regulatory approval for NGX-1998 or our other product candidates, or for other indications for Qutenza, our ability to achieve additional revenue, our
operating results, and our financial position will be adversely affected.

Our overall research and development expenses,
excluding non-cash stock-based compensation expense increased in 2010 as compared to 2009. We expect that it will continue to increase during 2011 as we expand development activities for NGX-1998 including the on-going Phase 2 clinical study and
initiate activities with the intent of filing a sNDA for Qutenzas label expansion to cover patients with HIV-AN.

Our
selling, general and administrative expenses consist primarily of salaries and benefits, including those of our sales, marketing, commercial operations and administrative functions such as finance, human resources, legal, medical affairs and
information technology. Additionally, selling, general and administrative expenses include marketing expenses, commercialization costs, pharmacovigilance costs and costs associated with our status as a public company and patent costs. In addition,
general and administrative expenses include allocated facility, basic operational and support costs and insurance costs. We anticipate that our selling, general and administrative expenses may increase over the next several years as a result of our
commercialization of Qutenza. These increases are likely to be attributable to increasing marketing activities, costs to maintain and potentially grow our U.S. sales force and infrastructure costs to support commercial operations, and may include
adding additional personnel in certain of the key functional areas that support growth of our general operations, including accounting and finance, legal and human resources.



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Comparison of Years Ended December 31, 2010 and 2009



|                                             |  |                                    |         |   |                    |   |         |                     |  |  |        |   |  |  |      |   
|-------------------------------------------- |  | ---------------------------------- | ------- | - | ------------------ | - | ------- | ------------------- |  |  | ------ | - |  |  | ---- | --
|                                             |  | Year Ended December 31,            |         |   | Increase(Decrease) |   |         | %Increase(Decrease) | 
|                                             |  | 2010                               |         |   | 2009               |   |         |                    
|                                             |  | (in thousands, except percentages) |        
|Product revenue                              |  | $                                  | 688     |   |                    | $ |        |                     |  |  | 688    |   |  |  | 100  | % 
|Collaboration revenue                        |  |                                    | 7,578   |   |                    |   | 2,006   |                     |  |  | 5,572  |   |  |  | 278  | % 
|Cost of goods sold                           |  |                                    | (541    | ) |                    |   |        |                     |  |  | 541    |   |  |  | 100  | % 
|Research and development expenses            |  |                                    | (11,151 | ) |                    |   | (11,235 | )                   |  |  | (84    | ) |  |  | (1   | %)
|Selling, general and administrative expenses |  |                                    | (36,383 | ) |                    |   | (12,420 | )                   |  |  | 23,963 |   |  |  | 193  | % 
|Interest income                              |  |                                    | 98      |   |                    |   | 89      |                     |  |  | 9      |   |  |  | 10   | % 
|Interest expense                             |  |                                    | (5,413  | ) |                    |   | (276    | )                   |  |  | 5,112  |   |  |  | 1852 | % 
|Other income (expense), net                  |  |                                    | 608     |   |                    |   | (31     | )                   |  |  | 614    |   |  |  | 1981 | % 

Product Revenue.
Due to the limited history of product returns and cash collections from our customers, (specialty distributors and specialty pharmacies), we recognize revenue for Qutenza at the later of the time our customers ship product to healthcare
professionals and cash collections are received by us from our customers. We recorded gross shipments of Qutenza to our customers totaling $1.4 million in 2010. Based on our revenue recognition methodology, we recognized net revenue of $688,000 as
Qutenza revenue for the year. We have deferred product revenue of $577,000 at December 31, 2010 which is reported net of associated cost of goods sold of $52,000 in our condensed consolidated balance sheet as at December 31, 2010.

Collaboration Revenue. Collaboration revenue increased $5.6 million, or 278%, to $7.6 million for the year ended
December 31, 2010, compared to $2.0 million for the year ended December 31, 2009. This increase was primarily attributable to the amortization of upfront payments received pursuant to the Astellas Agreement over a full fiscal year and the
recognition of $0.3 million of collaboration revenue under our Supply Agreement with Astellas.

Cost of goods sold.
Cost of goods sold totaled $541,000 for the year ended December 31, 2010. Cost of goods sold includes $153,000 for the cost of the finished goods sold that were recognized as revenue in 2010 and a charge of $388,000 for Qutenza patches which we
do not expect to sell prior to their expiration date. The cost of the finished goods sold includes fixed costs of $112,000 and variable costs of $41,000. As our product revenue increases over time, we expect that our gross margin will improve and
may approximate 90%.

Research and Development expenses. Research and development expenses were $11.2 million for each
of the years ended December 31, 2010 and 2009. During 2010 we incurred higher expenses of $1.6 million related to the preparation and commencement of our Phase 2 study of NGX-1998 and higher expenses of $0.2 million related to our prodrug
program. However, these expenses were offset by a $1.2 million decrease in royalties paid to UC in 2009 relating to the Astellas Agreement, a $0.3 million decrease in clinical consulting fees related to our 2009 MA and NDA preparation costs and a
$0.4 million decrease in stock-based compensation costs due to the achievement of performance based milestones and the granting of options which vested immediately in 2009. We expect 2011 research and development expense to be higher than the 2010
level due to our Phase 2 clinical study of NGX-1998 and our pursuit of a label expansion for Qutenza in the United States.

Selling, General and Administrative expenses. Selling, general and administrative expenses increased $24.0 million, or 193%, to
$36.4 million for the year ended December 31, 2010, from $12.4 million for the same period in 2009. This increase was due in large part to the commercial launch of Qutenza in the United States in April 2010. Specifically, the increases included
$8.5 million in costs associated with our sales and commercial operation organization including compensation and benefit costs and travel expenses; $9.1 million increase in expenses for marketing materials development and other launch related
marketing costs; $1.6 million in costs due to an increase in general and administrative salary and related expenses, temporary help and consultants, professional service fees and other public company costs; $1.6 million of costs associated with our
medical affairs organization including salary and related expenses; $1.0 million in estimated settlement costs; $0.7



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million increase in facilities and office expenses due to expansion of headcount to support commercialization; and a $0.2 million increase in stock-based compensation costs due to the granting of
options to employees and officers. We expect that selling, general and administrative expenses may increase in 2011 over 2010 levels, however, the rate of such increase is expected to be significantly lower than the increase from 2009 to 2010.

Interest expense.Interest expense was $5.4 million for the year ended December 31, 2010 as compared to $0.3
million for the same period in 2009. This increase was primarily due to interest on the $40 million Long term obligation related to the Financing Agreement entered into with Cowen Royalty in April 2010.

Other income (expense), net.Other income for the year ended December 31, 2010 primarily consisted of a grant earned under
Section 48D of the Internal Revenue Code (as enacted on March 23, 2010 by the Patient Protection and Affordable Care Act). We applied for a grant based upon certain of our 2009 and 2010 research and development activities. The
payment for the 2009 grant of $407,000 was received in 2010 where as the 2010 grant of $226,000 is expected to be received in early 2011.

Comparison of Years Ended December 31, 2009 and 2008



|                                             |  |                                    |         |   |                    |   |         |                     |  |  |        |   |  |  |     |   
|-------------------------------------------- |  | ---------------------------------- | ------- | - | ------------------ | - | ------- | ------------------- |  |  | ------ | - |  |  | --- | --
|                                             |  | Year Ended December 31,            |         |   | Increase(Decrease) |   |         | %Increase(Decrease) | 
|                                             |  | 2009                               |         |   | 2008               |   |         |                    
|                                             |  | (in thousands, except percentages) |        
|Collaboration revenue                        |  | $                                  | 2,006   |   |                    | $ |        |                     |  |  | 2,006  |   |  |  |    |   
|Research and development expenses            |  |                                    | (11,235 | ) |                    |   | (16,104 | )                   |  |  | (4,869 | ) |  |  | (30 | %)
|Selling, general and administrative expenses |  |                                    | (12,420 | ) |                    |   | (10,182 | )                   |  |  | 2,238  |   |  |  | 22  | % 
|Interest income                              |  |                                    | 89      |   |                    |   | 1,106   |                     |  |  | (1,017 | ) |  |  | (92 | %)
|Interest expense                             |  |                                    | (276    | ) |                    |   | (792    | )                   |  |  | (516   | ) |  |  | (65 | %)

Collaboration
Revenue. Collaboration revenue of $2.0 million recorded in the year ended December 31, 2009 consisted primarily of $1.9 million attributed to the amortization of upfront payments received pursuant to the Astellas Agreement.

Research and Development expenses. Research and development expenses decreased $4.9 million, or 30%, to $11.2 million in the year
ended December 31, 2009 from $16.1 million for the same period in 2008. Our lower spending in research and development reflects our decision to focus our cash and human resources on those activities directly in support of gaining marketing
approval for Qutenza in the United States and the European Union as well as certain limited pre-commercialization activities. Specifically, the decrease was attributable to a $2.7 million decrease in clinical study costs as we completed the Phase 3
clinical program which supported our NDA filing in 2008; a $1.7 million decrease in employee related costs commensurate with our reduced clinical trial activity; a $1.0 million decrease in spending related to NGX-1998 and our earlier stage product
candidates as these programs were deferred to preserve cash resources; a $0.5 million reduction in regulatory expenses associated with the preparation and submission of our NDA in 2008 and support for our MA; a $0.2 million decrease in quality
assurance costs associated with clinical trial activity in 2008; a $0.2 million decrease associated with the capitalization of employee related costs attributable to the manufacture of commercial product for sale in both the Astellas Licensed
Territory and the United States; and a $0.1 million decrease in manufacturing related costs. These decreases were partially offset by a $1.2 million charge representing the sublicense fee payable to the University of California in connection with
the receipt of upfront payments from Astellas under the Astellas Agreement as well as a $0.3 million increase in non-cash stock-based compensation expense.

Selling, General and Administrative expenses. Selling, general and administrative expenses increased $2.2 million, or 22%, to $12.4 million in the year ended December 31, 2009 from $10.2
million for the same period in 2008. The year over year change was due to a $0.7 million increase in non-cash stock-based compensation expense primarily associated with the grant of fully vested stock options to certain of our officers and a $1.0
million increase in selling, general and administrative employee related expenses as a result of an increase in



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staffing in support of commercialization activities including the establishment of a medical affairs function. Also contributing to the year over year change was a $0.4 million increase in costs
associated with work to support our pricing and reimbursement strategies.

Interest income. Interest income decreased
$1.0 million, or 92%, to less than $0.1 million for the year ended December 31, 2009 from $1.1 million for the same period in 2008. This change was primarily attributable to a decline in the prevailing interest rates, in general, and lower
rates obtained as we moved our invested assets to those with lower relative risk in light of events in the credit markets.

Interest expense.Interest expense decreased $0.5 million, or 65%, to $0.3 million for the year ended December 31, 2009 from
$0.8 million for the same period in 2008. This decrease was related to the reduction in the outstanding principal balance of notes payable as a result of the scheduled payoff and repayment of principal on the remaining outstanding notes payable.

Liquidity and Capital Resources

Since our inception through December 31, 2010, we have funded our operations primarily by selling equity securities, establishing debt facilities and through a collaboration agreement with Astellas.
On May 7, 2007, we completed an initial public offering of our common stock which resulted in net cash proceeds, after deducting total expenses including underwriting discounts and commissions and other-offering related expenses, of $38.1
million. In December 2007, we completed the first closing of a private placement of our common stock and warrants resulting in net cash proceeds of $21.5 million and in January 2008, we completed the second and final closing of this private
placement of our common stock and warrants resulting in net cash proceeds of $2.3 million. In April 2010, we borrowed $40.0 million under a Financing Agreement with Cowen Royalty.

As of December 31, 2010, we had approximately $46.8 million in cash, cash equivalents and short-term investments. We also had
working capital, adjusted to exclude the current portion of non-cash deferred revenue of approximately $7.8 million, of $40.4 million. During 2010, our cash and investment balances were generally held in money market funds and obligations of U.S.
government agencies. Cash in excess of immediate operational requirements is invested in accordance with our investment policy primarily with a view to capital preservation and liquidity. Further, to reduce portfolio risk, our investment policy
specifies a concentration limit of 10% in any one issuer or group of issuers of corporate bonds or commercial paper at the time of purchase. Our investment holdings at December 31, 2010 consist solely of U.S. Treasury and money market funds
consisting of only U.S. Treasury securities.

Net cash used by operating activities was $42.4 million in 2010. Net cash
provided by operating activities in 2009 was $29.2 million primarily resulting from the receipt of an upfront payment under the Astellas Agreement, partially offset by our net loss during the period. After adjusting for the affects of the Astellas
payment, our net cash used in operating activities would have been $17.7 million in 2009. Net cash used in operating activities was $27.3 million in 2008. The increase in cash used in operating activities in 2010 as compared to 2009 resulted
primarily from funding the sales and marketing efforts related to the launch of Qutenza, supporting our research and development efforts and growth in our general and administrative expenses. After adjusting for the affects of the Astellas payment,
the 2009 cash used in operating activities was significantly lower than our net cash used in operations in 2008 due to our decision in 2009 to limit our spending on research and development activities in order to focus resources on supporting our
regulatory processes in both the United States and the European Union and to certain pre-commercialization activities. Included in net cash provided by and used in operating activities are net changes in assets and liabilities affecting cash. We
anticipate that cash used in operating activities may modestly increase in 2011 as a result of our efforts to increase sales of Qutenza in the United States while conducting the Phase 2 clinical study of NGX-1998 and pursing a label expansion for
Qutenza in the United States.

Net cash used in investing activities was $18.2 million and $7.4 million in 2010 and 2009,
respectively. Net cash provided by investing activities was $7.8 million in 2008. Investing activities consisted primarily of the purchase, sale and maturity of marketable securities and to a lesser extent, the purchase of capital equipment.



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Fluctuations in our investing activities have primarily been driven by the timing and receipt of proceeds from financing activities and the upfront payments from Astellas. We expect that property
and equipment expenditures in 2011 will remain at historical levels in 2011.

Net cash generated in financing activities in
2010 was $39.6 million, primarily due to the proceeds received from the Cowen Royalty financing. Net cash used in financing activities was $2.5 million and $1.6 million in 2009 and 2008, respectively.

On April 30, 2010, we entered into a Financing Agreement with Cowen Royalty. Under the terms of the Financing Agreement, we borrowed
$40 million from Cowen Royalty and we agreed to repay the borrowed amount together with a return to Cowen Royalty, as described below, out of royalty, milestone, option and certain other payments that we may receive under the Astellas Agreement
including payments that Astellas may make to us to maintain its option to commercialize NGX-1998 in the Licensed Territory, (we refer to such payments under the Astellas Agreement as the Revenue Interest).

Under the Financing Agreement, we are obligated to pay to Cowen Royalty:



| |  |  | All of the Revenue Interest payments due to us under the Astellas Agreement, until Cowen Royalty has received $90 million of Revenue Interest payments;
and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 5% of the Revenue Interest payments due to us under the Astellas Agreement for Revenue Interests received by Cowen Royalty over $90 million and until
Cowen Royalty has received $106 million of Revenue Interest payments.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We also have the option to pay a
prepayment amount to terminate the Financing Agreement at our election at any time or in connection with a change of control of NeurogesX. Such amount is set at a base amount of $76 million (or $68 million if it is being exercised in connection with
a change of control), or, if higher, an amount that generates a specified internal rate of return on the borrowed amount as of the date of prepayment, in each case reduced by the Revenue Interest payments received by Cowen Royalty up to the date of
prepayment.

Our obligation to pay the Revenue Interests during the term of the Financing Agreement is secured by our rights
to the Revenue Interests under the Astellas Agreement, and by intellectual property and other rights we have to the extent necessary or used to commercialize products covered by the Astellas Agreement in the Licensed Territory.

Unless terminated earlier pursuant to a prepayment, the Financing Agreement also terminates on the earlier of:



| |  |  | The time when Cowen Royalty has received at least $106 million of Revenue Interest payments; or
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | The maturity date, which is the latest to occur of 10 years following the first commercial sale of Qutenza in the Licensed Territory or the last to
expire of any patents or regulatory exclusivity covering the products commercialized under the Astellas Agreement in the Licensed Territory.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If Cowen Royalty has not received Revenue Interest payments totaling at least $40 million by the maturity date, we will be obligated to pay to Cowen Royalty the difference between such amount and the
Revenue Interests paid to Cowen Royalty under the Financing Agreement up to such date.

In addition, in the event we default
under the Financing Agreement, we are obligated to pay to Cowen the borrowed amount together with interest accrued thereon from the effective date of the Financing Agreement, to the date of repayment at a rate equal to the lesser of the 19% rate of
interest or the maximum rate permitted by law, less Revenue Interest payments received by Cowen Royalty.

Financing activities
in 2009 and 2008 consisted primarily of principal repayments on a venture loan financing arrangement which originated in 2006 offset by the exercise of stock options and issuance of stock to



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employees pursuant to our employee stock purchase plan. In addition to these activities, financing activities in 2008 also included a $2.3 million sale of our common stock and warrants in a
private placement transaction.

Contractual obligations represent future cash commitments and liabilities under agreements
with third parties, and exclude contingent liabilities for which we cannot reasonably predict future payment. The following table represents our total contractual obligations, including principal and interest, at December 31, 2010, aggregated
by type (in thousands):



|                               |  |                        |       |  |      |   |       |               |  |   |               |  |  |                    |     |  |  |   |   | 
|------------------------------ |  | ---------------------- | ----- |  | ---- | - | ----- | ------------- |  | - | ------------- |  |  | ------------------ | --- |  |  | - | - | 
|                               |  | Payments due by period |      
|Contractual Obligations        |  | Total                  |       |  | 2011 |   |       | 2012 and 2013 |  |   | 2014 and 2015 |  |  | 2016 andthereafter |    
|Operating Lease Obligations(1) |  | $                      | 1,041 |  |      | $ | 634   |               |  | $ | 407           |  |  | $                  |    |  |  | $ |  | 
|Long term obligations (2)      |  |                        |      |  |      |   |      |               |  |   |              |  |  |                    |    |  |  |   |  | 
|Purchase obligations(3)        |  |                        | 3,000 |  |      |   | 2,503 |               |  |   | 309           |  |  |                    | 188 |  |  |   |  | 
|                               |  |                        |       |  |      |   |       |               |  |   |               |  |  |                    |     |  |  |   |   | 
|Total                          |  | $                      | 4,041 |  |      | $ | 3,137 |               |  | $ | 716           |  |  | $                  | 188 |  |  | $ |  | 
|                               |  |                        |       |  |      |   |       |               |  |   |               |  |  |                    |     |  |  |   |   | 



|(1) | Represent our future minimum rental commitments for our noncancelable operating lease obligations for our facilities and office equipment.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Under the terms of the Cowen Royalty agreement, payments are contingent upon cash received from Astellas under the Astellas Agreement (refer above for discussion).
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Consists of commitments to third party manufacturers of Qutenza and NGX-1998 for manufacturing, stability. The $3.0 million commitment includes $1.1 million for
stability and related services, $1.1 million of commitments related to supply of Qutenza to Astellas, $0.7 million related to product manufacturing costs for the U.S. market, and $0.1 million for the Phase 2 study for NGX-1998.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In addition to the above, we have commitments to pay royalties on certain patents we licensed from the
University of California for prescription strength capsaicin for neuropathic pain. Under the terms of this license agreement we are required to pay royalties on net sales of the licensed product up to a maximum of $1,000,000 per annum as well as a
percentage of upfront and milestone payments or payments resulting from the sublicensing of our rights under the agreement.

We also have commitments to pay royalties under a Commercial Supply and License Agreement with LTS to manufacture commercial and clinical
supply of Qutenza. Under the terms of the agreement, we are required to pay a transfer price for product purchased under the agreement as well as a royalty on net sales of product purchased under such agreement.

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



| |  |  | the success of the commercialization of our products;
| | - |  | -----------------------------------------------------



| |  |  | the costs of establishing sales and marketing infrastructure, distribution capabilities and a sales force;
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | the scope and cost of commercial activities including, but not limited to, costs associated with pharmacovigilance and medical affairs activities;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the conduct of manufacturing activities;
| | - |  | ----------------------------------------



| |  |  | the costs of carrying out our obligations under our commercial arrangement with Astellas;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | our ability to establish and maintain strategic collaborations, including licensing and other arrangements that we have or may establish;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the costs and timing of seeking regulatory approvals;
| | - |  | -----------------------------------------------------



| |  |  | the progress of our development programs including the number, size and scope of clinical trials and non-clinical development;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



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| |  |  | the costs involved in enforcing or defending patent claims or other intellectual property rights; and
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | the extent to which we acquire or invest in other products, technologies and businesses.
| | - |  | ----------------------------------------------------------------------------------------

At December 31, 2010, we had $46.8 million in cash, cash equivalents and short-term investments. During the year ended
December 31, 2010, we used a total of $42.4 million of cash in operating activities. We anticipate that cash used in operating activities may increase in 2011 as a result of our efforts to increase sales of Qutenza in the United States while
conducting the Phase 2 clinical study of NGX-1998 and pursing a label expansion for Qutenza in the United States. We anticipate that our existing cash and investments will be sufficient to meet our projected operating requirements beyond
December 31, 2011.

To date, we have incurred recurring net losses and negative cash flows from operations, after
excluding the upfront cash received from Astellas in 2009. Until we can generate significant cash from our operations, if ever, we expect to continue to fund our operations with existing cash resources generated from the proceeds of offerings of our
equity securities and proceeds from one or more collaboration agreements as well as potentially through royalty monetization, debt financing or the sale of other equity securities. However, we may not be successful in obtaining additional
collaboration agreements, or in receiving milestone or royalty payments under those agreements. In addition, we cannot be sure that our existing cash and investment resources will be adequate or that additional financing will be available when
needed or that, if available, financing will be obtained on terms favorable to us or our stockholders. Having insufficient funds may require us to delay or potentially eliminate some or all of our development programs, relinquish some or even all
rights to product candidates at an earlier stage of development or negotiate less favorable terms than we would otherwise choose. Failure to obtain adequate financing also may adversely affect the launch of our product candidates or our ability to
continue in business. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders would likely result. If we raise additional funds by incurring debt financing, the terms of the debt may involve
significant cash payment obligations as well as covenants and specific financial ratios that may restrict our ability to operate our business.

Off-balance Sheet Arrangements

Since inception, we have not engaged in any off-balance sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities.

Recently Issued Accounting Standards

Not Yet Adopted

In October 2009, the Financial Accounting Standards
Board (FASB) issued Accounting Standards Update (ASU) No. 2009-13, Revenue Recognition (ASC Topic 605)Multiple-Deliverable Revenue Arrangements. This guidance modifies previous guidance for multiple element
arrangements by allowing the use of the best estimate of selling price in the absence of vendor-specific objective evidence (VSOE) or third party evidence (TPE) of selling price for determining the selling price
of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price is not available. In addition, the residual method of allocating arrangement consideration is no longer permitted. This
ASU is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and early adoption is permitted. We did not early adopt ASU No. 2009-13. We currently only have one revenue
agreement with multiple elements, the Astellas Agreement. This ASU is effective for us beginning on January 1, 2011 and the adoption of the new guidance will not have a material impact on the our consolidated financial statements as we do not
anticipate making a material modification to the Astellas Agreement. If we were to enter into new multiple element arrangements or make a material modification to the Astellas Agreement, the contract would be accounted for under the provisions of
ASU No. 2009-13.

In April 2010, the FASB issued ASU No. 2010-17, Revenue RecognitionMilestone Method (ASC
Topic 605): Milestone Method of Revenue Recognition (ASU No. 2010-17). This ASU codifies the consensus



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reached in EITF Issue No. 08-9, Milestone Method of Revenue Recognition. The amendments to the Codification provide guidance on defining a milestone and determining when it may
be appropriate to apply the milestone method of revenue recognition for research or development transactions. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the
milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. Milestones should be considered substantive in their entirety and may not be bifurcated. An arrangement may contain both substantive and
non-substantive milestones, and each milestone should be evaluated individually to determine if it is substantive. ASU No. 2010-17 is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those
years, beginning on or after June 15, 2010. Early adoption is permitted. If a vendor elects early adoption and the period of adoption is not the beginning of the entitys fiscal year, the entity should apply ASU No. 2010-17
retrospectively from the beginning of the year of adoption. We did not early adopt ASU No. 2010-17. This ASU is effective for us beginning on January 1, 2011 and the adoption of the new guidance will not have a material impact on our
consolidated financial statements.

Adopted in 2010

None.



|Item 7A. | Quantitative and Qualitative Disclosures About Market Risks
|-------- | -----------------------------------------------------------

Interest Rate and Market Risk

Our exposure to market risk is confined to
our cash, cash equivalents and short term investments which have maturities of less than one year. The goal of our investment policy is primarily liquidity and capital preservation while attempting to maximize the income we receive without assuming
significant risk. To achieve these objectives our investment policy allows us to maintain a portfolio of cash equivalents and short term investments in a variety of securities, including U.S. government agencies, corporate bonds, commercial paper
and money market funds. Further, to reduce portfolio risk through diversification, our investment policy specifies a concentration limit of 10% in any one issuer or group of issuers of corporate bonds or commercial paper at the time of purchase. Our
cash and investments as of December 31, 2010 consisted of U.S. Treasury securities and money market funds consisting of only U.S. Treasury securities.

If interest rates rise, the market value of our investments may decline, which could result in a realized loss if we are forced to sell an investment before its scheduled maturity. A hypothetical increase
in interest rates by 25 basis points would not result in a material decrease in the fair value of our net investment position.

Foreign
Currency Exchange Rate Risk

Our third party manufacturers including the manufacturer of our active pharmaceutical
ingredient, trans-capsaicin, the manufacturer of Qutenza and the manufacturer of our cleansing gel, are located in countries outside the United States. As a result, we may experience changes in product supply costs as a result of changes in exchange
rates between the U.S. dollar and the local currency where the manufacturing activities occur. In addition, as we continue to scale up supply of our product components to Astellas for commercial sale in the European Union and to supply the U.S.
market, our exposure to foreign currency exchange rates, primarily the Euro, will increase.

Amounts paid to us by Astellas
under the Astellas Agreement may be based in Euro or other currencies which will then be converted to U.S. dollars before payment to us. To the extent that these potential receipts are greater than our net payable exposure in Euro to our suppliers
mentioned above, and to the extent that the timing of these potential payments and receipts differ, we will have a net receivable exposure in Euro once Qutenza is launched in the European Union and certain other foreign territories.

We currently do not engage in foreign currency hedging activities as the short-term exposure to fluctuations in foreign currency is
relatively small.



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|Item 8. | Financial Statements and Supplementary Data
|------- | -------------------------------------------

NEUROGESX, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                          |  |      |    | 
|--------------------------------------------------------- |  | ---- | -- | 
|                                                          |  | Page |   
|Report of Independent Registered Public Accounting Firm   |  |      | 63 | 
|Consolidated Balance Sheets                               |  |      | 64 | 
|Consolidated Statements of Operations                     |  |      | 65 | 
|Consolidated Statements of Stockholders (Deficit) Equity |  |      | 66 | 
|Consolidated Statements of Cash Flows                     |  |      | 68 | 
|Notes to Consolidated Financial Statements                |  |      | 69 | 



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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of NeurogesX, Inc.

We have audited the accompanying consolidated balance sheets of NeurogesX, Inc. as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders (deficit)
equity, and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the
Companys internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated
financial position of NeurogesX, Inc. at December 31, 2010 and 2009, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally
accepted accounting principles.

/s/    ERNST & YOUNG LLP

Palo Alto, California

March 30, 2011



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NEUROGESX, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share
data)



|                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------ | -------- | - | ---- | - | -------- | -
|                                                                                                                                                                                                 |  | December 31, |         
|                                                                                                                                                                                                 |  | 2010         |          |   | 2009 |  
|Assets                                                                                                                                                                                           |  |              |          |   |      |   |          |  
|Current assets:                                                                                                                                                                                  |  |              |          |   |      |   |          |  
|Cash and cash equivalents                                                                                                                                                                        |  | $            | 8,705    |   |      | $ | 29,695   |  
|Short-term investments                                                                                                                                                                           |  |              | 38,125   |   |      |   | 20,864   |  
|Trade receivables                                                                                                                                                                                |  |              | 607      |   |      |   |         |  
|Receivable from collaboration partner                                                                                                                                                            |  |              | 65       |   |      |   | 678      |  
|Inventories                                                                                                                                                                                      |  |              | 786      |   |      |   | 58       |  
|Prepaid expenses and other current assets                                                                                                                                                        |  |              | 1,082    |   |      |   | 711      |  
|Restricted cash                                                                                                                                                                                  |  |              | 290      |   |      |   | 40       |  
|                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total current assets                                                                                                                                                                             |  |              | 49,660   |   |      |   | 52,046   |  
|Property and equipment, net                                                                                                                                                                      |  |              | 809      |   |      |   | 739      |  
|Restricted cash                                                                                                                                                                                  |  |              | 120      |   |      |   | 120      |  
|Other assets                                                                                                                                                                                     |  |              | 261      |   |      |   |         |  
|                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total assets                                                                                                                                                                                     |  | $            | 50,850   |   |      | $ | 52,905   |  
|                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Liabilities and Stockholders (Deficit) Equity                                                                                                                                                   |  |              |          |   |      |   |          |  
|Current liabilities:                                                                                                                                                                             |  |              |          |   |      |   |          |  
|Accounts payable                                                                                                                                                                                 |  | $            | 1,544    |   |      | $ | 65       |  
|Accrued compensation                                                                                                                                                                             |  |              | 1,867    |   |      |   | 2,157    |  
|Accrued license fee                                                                                                                                                                              |  |              |         |   |      |   | 1,213    |  
|Accrued research and development                                                                                                                                                                 |  |              | 582      |   |      |   | 670      |  
|Other accrued expenses                                                                                                                                                                           |  |              | 3,011    |   |      |   | 1,222    |  
|Deferred product revenue, net                                                                                                                                                                    |  |              | 577      |   |      |   |         |  
|Deferred collaboration revenue                                                                                                                                                                   |  |              | 7,242    |   |      |   | 7,242    |  
|Long term obligationscurrent portion                                                                                                                                                            |  |              | 2,222    |   |      |   |         |  
|Notes payablecurrent portion                                                                                                                                                                    |  |              |         |   |      |   | 191      |  
|                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total current liabilities                                                                                                                                                                        |  |              | 17,045   |   |      |   | 12,760   |  
|                                                                                                                                                                                                 |  |             
|Non-current liabilities:                                                                                                                                                                         |  |              |          |   |      |   |          |  
|Deferred collaboration revenue                                                                                                                                                                   |  |              | 32,359   |   |      |   | 39,601   |  
|Deferred rent                                                                                                                                                                                    |  |              | 115      |   |      |   | 291      |  
|Long term obligations                                                                                                                                                                            |  |              | 42,622   |   |      |   |         |  
|                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total non-current liabilities                                                                                                                                                                    |  |              | 75,096   |   |      |   | 39,892   |  
|                                                                                                                                                                                                 |  |             
|Commitments and contingencies                                                                                                                                                                    |  |              |          |   |      |   |          |  
|                                                                                                                                                                                                 |  |             
|Stockholders (deficit) equity:                                                                                                                                                                  |  |              |          |   |      |   |          |  
|Common stock, $0.001 par value;100,000,000 shares authorized at December 31, 2010 and 2009; 17,869,108 and 17,725,959
shares issued and outstanding at December 31, 2010, and 2009, respectively |  |              | 18       |   |      |   | 18       |  
|Additional paid-in capital                                                                                                                                                                       |  |              | 215,220  |   |      |   | 212,254  |  
|Accumulated other comprehensive (loss) income                                                                                                                                                    |  |              | (2       | ) |      |   | (8       | )
|Accumulated deficit                                                                                                                                                                              |  |              | (256,527 | ) |      |   | (212,011 | )
|                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total stockholders (deficit) equity                                                                                                                                                             |  |              | (41,291  | ) |      |   | 253      |  
|                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Total liabilities and stockholders (deficit) equity                                                                                                                                             |  | $            | 50,850   |   |      | $ | 52,905   |  
|                                                                                                                                                                                                 |  |              |          |   |      |   |          |  

See accompanying notes.



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NEUROGESX, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)



|                                                            |  |                         |            |   |      |   |            |      |  |   |            |  
|----------------------------------------------------------- |  | ----------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                            |  | Year Ended December 31, |           
|                                                            |  | 2010                    |            |   | 2009 |   |            | 2008 | 
|Net product revenue                                         |  | $                       | 688        |   |      | $ |           |      |  | $ |           |  
|Collaboration revenue                                       |  |                         | 7,578      |   |      |   | 2,006      |      |  |   |           |  
|                                                            |  |                         |            |   |      |   |            |      |  |   |            |  
|Total revenues                                              |  |                         | 8,266      |   |      |   | 2,006      |      |  |   |           |  
|                                                            |  |                         |           
|Operating expenses:                                         |  |                         |            |   |      |   |            |      |  |   |            |  
|Cost of goods sold                                          |  |                         | 541        |   |      |   |           |      |  |   |           |  
|Research and development                                    |  |                         | 11,151     |   |      |   | 11,235     |      |  |   | 16,104     |  
|Selling, general and administrative                         |  |                         | 36,383     |   |      |   | 12,420     |      |  |   | 10,182     |  
|                                                            |  |                         |            |   |      |   |            |      |  |   |            |  
|Total operating expenses                                    |  |                         | 48,075     |   |      |   | 23,655     |      |  |   | 26,286     |  
|                                                            |  |                         |            |   |      |   |            |      |  |   |            |  
|Loss from operations                                        |  |                         | (39,809    | ) |      |   | (21,649    | )    |  |   | (26,286    | )
|Interest income                                             |  |                         | 98         |   |      |   | 89         |      |  |   | 1,106      |  
|Interest expense                                            |  |                         | (5,413     | ) |      |   | (276       | )    |  |   | (792       | )
|Other income (expense), net                                 |  |                         | 608        |   |      |   | (31        | )    |  |   | (63        | )
|                                                            |  |                         |            |   |      |   |            |      |  |   |            |  
|Net loss                                                    |  | $                       | (44,516    | ) |      | $ | (21,867    | )    |  | $ | (26,035    | )
|                                                            |  |                         |            |   |      |   |            |      |  |   |            |  
|Basic and diluted net loss per share                        |  | $                       | (2.51      | ) |      | $ | (1.24      | )    |  | $ | (1.49      | )
|                                                            |  |                         |            |   |      |   |            |      |  |   |            |  
|Shares used to compute basic and diluted net loss per share |  |                         | 17,768,881 |   |      |   | 17,610,796 |      |  |   | 17,519,415 |  
|                                                            |  |                         |            |   |      |   |            |      |  |   |            |  

See accompanying notes.



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NEUROGESX, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS (DEFICIT) EQUITY

(in
thousands, except share and per share data)



|                                                                                                    |  |              |            |  |                          |   |    |                                 |  |   |                                            |   |  |                    |     |   |                                   |   |     |   |  |   |          |   |  |   |         |  
|--------------------------------------------------------------------------------------------------- |  | ------------ | ---------- |  | ------------------------ | - | -- | ------------------------------- |  | - | ------------------------------------------ | - |  | ------------------ | --- | - | --------------------------------- | - | --- | - |  | - | -------- | - |  | - | ------- | -
|                                                                                                    |  | Common Stock |            |  | AdditionalPaid-inCapital |   |    | DeferredStock-BasedCompensation |  |   | AccumulatedOtherComprehensive(Loss) Income |   |  | AccumulatedDeficit |     |   | TotalStockholdersEquity(Deficit) |  
|                                                                                                    |  | Shares       |            |  | Amount                   |   |    |                                 |  |   |                                           
|Balances at December 31, 2007                                                                       |  |              | 17,096,806 |  |                          | $ | 17 |                                 |  | $ | 205,417                                    |   |  | $                  | (15 | ) |                                   | $ | 51  |   |  | $ | (164,109 | ) |  | $ | 41,361  |  
|Issuance of common stock upon exercise of stock options for cash at $0.90 - $3.75 per share         |  |              | 36,706     |  |                          |   |   |                                 |  |   | 86                                         |   |  |                    |    |   |                                   |   |    |   |  |   |         |   |  |   | 86      |  
|Issuance of common stock at $2.25 - $3.75 per share upon vesting of early exercised stock options   |  |              | 1,503      |  |                          |   |   |                                 |  |   | 4                                          |   |  |                    |    |   |                                   |   |    |   |  |   |         |   |  |   | 4       |  
|Issuance of common stock under the Employee Stock Purchase Plan                                     |  |              | 51,217     |  |                          |   |   |                                 |  |   | 94                                         |   |  |                    |    |   |                                   |   |    |   |  |   |         |   |  |   | 94      |  
|Issuance of common stock for cash at $6.18 per share, net of $100 issuance costs                    |  |              | 382,170    |  |                          |   | 1  |                                 |  |   | 1,847                                      |   |  |                    |    |   |                                   |   |    |   |  |   |         |   |  |   | 1,848   |  
|Issuance of warrants to purchase common stock to investors at $0.125 per share including fair value |  |              |           |  |                          |   |   |                                 |  |   | 434                                        |   |  |                    |    |   |                                   |   |    |   |  |   |         |   |  |   | 434     |  
|Reversal of deferred stock-based compensation in connection with employee terminations              |  |              |           |  |                          |   |   |                                 |  |   | (4                                         | ) |  |                    | 4   |   |                                   |   |    |   |  |   |         |   |  |   |        |  
|Amortization of deferred stock-based compensation                                                   |  |              |           |  |                          |   |   |                                 |  |   |                                           |   |  |                    | 9   |   |                                   |   |    |   |  |   |         |   |  |   | 9       |  
|Compensation expense relating to stock options granted to consultants                               |  |              |           |  |                          |   |   |                                 |  |   | 2                                          |   |  |                    |    |   |                                   |   |    |   |  |   |         |   |  |   | 2       |  
|Stock-based compensation                                                                            |  |              |           |  |                          |   |   |                                 |  |   | 1,490                                      |   |  |                    |    |   |                                   |   |    |   |  |   |         |   |  |   | 1,490   |  
|Comprehensive loss:                                                                                 |  |              |            |  |                          |   |    |                                 |  |   |                                            |   |  |                    |     |   |                                   |   |     |   |  |   |          |   |  |   |         |  
|Change in unrealized gain/(loss) on investments                                                     |  |              |           |  |                          |   |   |                                 |  |   |                                           |   |  |                    |    |   |                                   |   | (19 | ) |  |   |         |   |  |   | (19     | )
|Net loss                                                                                            |  |              |           |  |                          |   |   |                                 |  |   |                                           |   |  |                    |    |   |                                   |   |    |   |  |   | (26,035  | ) |  |   | (26,035 | )
|                                                                                                    |  |              |            |  |                          |   |    |                                 |  |   |                                            |   |  |                    |     |   |                                   |   |     |   |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                                            |  |              |            |  |                          |   |    |                                 |  |   |                                            |   |  |                    |     |   |                                   |   |     |   |  |   |          |   |  |   | (26,054 | )
|                                                                                                    |  |              |            |  |                          |   |    |                                 |  |   |                                            |   |  |                    |     |   |                                   |   |     |   |  |   |          |   |  |   |         |  
|Balance at December 31, 2008                                                                        |  |              | 17,568,402 |  |                          | $ | 18 |                                 |  | $ | 209,370                                    |   |  | $                  | (2  | ) |                                   | $ | 32  |   |  | $ | (190,144 | ) |  | $ | 19,274  |  

See accompanying
notes.



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NEUROGESX, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS (DEFICIT) EQUITY

(in thousands, except share and per share data)



|                                                                                                  |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   |         |  
|------------------------------------------------------------------------------------------------- |  | ------------ | ---------- |  | ------------------------ | - | -- | ------------------------------- |  | - | ------------------------------------------ |  |  | ------------------ | -- | - | --------------------------------- | - | --- | - |  | - | -------- | - |  | - | ------- | -
|                                                                                                  |  | Common Stock |            |  | AdditionalPaid-inCapital |   |    | DeferredStock-BasedCompensation |  |   | AccumulatedOtherComprehensive(Loss) Income |  |  | AccumulatedDeficit |    |   | TotalStockholdersEquity(Deficit) |  
|                                                                                                  |  | Shares       |            |  | Amount                   |   |    |                                 |  |   |                                           
|Balance at December 31, 2008                                                                      |  |              | 17,568,402 |  |                          | $ | 18 |                                 |  | $ | 209,370                                    |  |  | $                  | (2 | ) |                                   | $ | 32  |   |  | $ | (190,144 | ) |  | $ | 19,274  |  
|Issuance of common stock upon exercise of stock options for cash at $1.20 - $7.54 per share       |  |              | 104,262    |  |                          |   |    |                                 |  |   | 288                                        |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   | 288     |  
|Issuance of common stock at $3.00 - $3.75 per share upon vesting of early exercised stock options |  |              | 785        |  |                          |   |    |                                 |  |   | 2                                          |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   | 2       |  
|Issuance of common stock under the Employee Stock Purchase Plan                                   |  |              | 52,510     |  |                          |   |    |                                 |  |   | 77                                         |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   | 77      |  
|Stock-based compensation                                                                          |  |              |            |  |                          |   |    |                                 |  |   | 2,517                                      |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   | 2,517   |  
|Amortization of deferred stock-based compensation                                                 |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    | 2  |   |                                   |   |     |   |  |   |          |   |  |   | 2       |  
|Comprehensive loss:                                                                               |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   |         |  
|Change in unrealized gain/(loss) on investments                                                   |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   | (40 | ) |  |   |          |   |  |   | (40     | )
|Net loss                                                                                          |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   | (21,867  | ) |  |   | (21,867 | )
|                                                                                                  |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                                          |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   | (21,907 | )
|                                                                                                  |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   |         |  
|Balance at December 31, 2009                                                                      |  |              | 17,725,959 |  |                          | $ | 18 |                                 |  | $ | 212,254                                    |  |  | $                  |   |   |                                   | $ | (8  | ) |  | $ | (212,011 | ) |  | $ | 253     |  
|Issuance of common stock upon exercise of stock options for cash at $0.90 - $8.32 per share       |  |              | 79,869     |  |                          |   |    |                                 |  |   | 258                                        |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   | 258     |  
|Issuance of common stock under the Employee Stock Purchase Plan                                   |  |              | 63,280     |  |                          |   |    |                                 |  |   | 354                                        |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   | 354     |  
|Stock-based compensation                                                                          |  |              |            |  |                          |   |    |                                 |  |   | 2,354                                      |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   | 2,354   |  
|Comprehensive loss:                                                                               |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   |         |  
|Change in unrealized gain/(loss) on investments                                                   |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   | 6   |   |  |   |          |   |  |   | 6       |  
|Net loss                                                                                          |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   | (44,516  | ) |  |   | (44,516 | )
|                                                                                                  |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                                          |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   | (44,510 | )
|                                                                                                  |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   |         |  
|Balances at December 31, 2010                                                                     |  |              | 17,869,108 |  |                          | $ | 18 |                                 |  | $ | 215,220                                    |  |  | $                  |   |   |                                   | $ | (2  | ) |  | $ | (256,527 | ) |  | $ | (41,291 | )
|                                                                                                  |  |              |            |  |                          |   |    |                                 |  |   |                                            |  |  |                    |    |   |                                   |   |     |   |  |   |          |   |  |   |         |  

See accompanying notes.



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NEUROGESX, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                      |  | Year Ended December 31, |        
|                                                                                      |  | 2010                    |         |   | 2009 |   |         | 2008 | 
|Operating activities                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                              |  | $                       | (44,516 | ) |      | $ | (21,867 | )    |  | $ | (26,035 | )
|Adjustments to reconcile net loss to cash (used in) provided by operating activities: |  |                         |         |   |      |   |         |      |  |   |         |  
|Depreciation                                                                          |  |                         | 343     |   |      |   | 184     |      |  |   | 181     |  
|Amortization of debt issuance costs                                                   |  |                         | 54      |   |      |   | 123     |      |  |   | 198     |  
|Amortization/accretion of investment premiums/(discounts), net                        |  |                         | 520     |   |      |   | 130     |      |  |   | (651    | )
|Stock-based compensation                                                              |  |                         | 2,354   |   |      |   | 2,492   |      |  |   | 1,500   |  
|Loss on sales of short-term investments                                               |  |                         |        |   |      |   |        |      |  |   | 8       |  
|Loss/(gain) on disposal of fixed assets                                               |  |                         | 2       |   |      |   |        |      |  |   | 5       |  
|Changes in operating assets and liabilities:                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Restricted cash                                                                       |  |                         | (250    | ) |      |   |        |      |  |   |        |  
|Trade receivables                                                                     |  |                         | (607    | ) |      |   |        |      |  |   |        |  
|Receivable from collaboration partner                                                 |  |                         | 613     |   |      |   | (678    | )    |  |   |        |  
|Prepaid expenses and other current assets                                             |  |                         | (344    | ) |      |   | (310    | )    |  |   | 183     |  
|Inventories                                                                           |  |                         | (729    | ) |      |   | (58     | )    |  |   |        |  
|Accounts payable                                                                      |  |                         | 1,479   |   |      |   | (305    | )    |  |   | (1,342  | )
|Accrued compensation                                                                  |  |                         | (289    | ) |      |   | 1,118   |      |  |   | 359     |  
|Accrued research and development                                                      |  |                         | (87     | ) |      |   | (397    | )    |  |   | (478    | )
|Accrued license fees                                                                  |  |                         | (1,213  | ) |      |   | 1,213   |      |  |   |        |  
|Accrued interest payable on long term obligations                                     |  |                         | 5,306   |   |      |   |        |      |  |   |        |  
|Deferred product revenue, net                                                         |  |                         | 577     |   |      |   |        |      |  |   |        |  
|Deferred collaboration revenue                                                        |  |                         | (7,242  | ) |      |   | 46,843  |      |  |   |        |  
|Deferred rent                                                                         |  |                         | (123    | ) |      |   | 114     |      |  |   | 144     |  
|Other accrued expenses                                                                |  |                         | 1,735   |   |      |   | 585     |      |  |   | (1,326  | )
|                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash (used in) provided by operating activities                                   |  |                         | (42,417 | ) |      |   | 29,187  |      |  |   | (27,254 | )
|                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Investing activities                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Purchases of short-term investments                                                   |  |                         | (90,029 | ) |      |   | (37,459 | )    |  |   | (64,363 | )
|Proceeds from maturities of short-term investments                                    |  |                         | 72,254  |   |      |   | 30,496  |      |  |   | 39,360  |  
|Proceeds from sales of short-term investments                                         |  |                         |        |   |      |   |        |      |  |   | 32,929  |  
|Change in restricted cash                                                             |  |                         |        |   |      |   | 40      |      |  |   | 40      |  
|Proceeds from disposal of property and equipment                                      |  |                         |        |   |      |   |        |      |  |   | 2       |  
|Purchases of property and equipment                                                   |  |                         | (415    | ) |      |   | (456    | )    |  |   | (203    | )
|                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash (used in) provided by investing activities                                   |  |                         | (18,190 | ) |      |   | (7,379  | )    |  |   | 7,765   |  
|                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Financing activities                                                                  |  |                         |         |   |      |   |         |      |  |   |         |  
|Repayment of notes payable                                                            |  |                         | (191    | ) |      |   | (2,913  | )    |  |   | (4,015  | )
|Proceeds from issuance of long term obligations                                       |  |                         | 39,505  |   |      |   |        |      |  |   |        |  
|Payment of long term obligation issuance costs                                        |  |                         | (309    | ) |      |   |        |      |  |   |        |  
|Proceeds from issuance of warrants                                                    |  |                         |        |   |      |   |        |      |  |   | 14      |  
|Proceeds from issuance of common stock                                                |  |                         | 612     |   |      |   | 365     |      |  |   | 2,447   |  
|                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) financing activities                                   |  |                         | 39,617  |   |      |   | (2,548  | )    |  |   | (1,554  | )
|                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Net (decrease) increase in cash and cash equivalents                                  |  |                         | (20,990 | ) |      |   | 19,260  |      |  |   | (21,043 | )
|Cash and cash equivalents, beginning of period                                        |  |                         | 29,695  |   |      |   | 10,435  |      |  |   | 31,478  |  
|                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents, end of period                                              |  | $                       | 8,705   |   |      | $ | 29,695  |      |  | $ | 10,435  |  
|                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  
|Supplemental cash flow information                                                    |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash paid for interest                                                                |  | $                       | 53      |   |      | $ | 181     |      |  | $ | 634     |  
|                                                                                      |  |                         |         |   |      |   |         |      |  |   |         |  

See accompanying notes.



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



|1. | The Company
|-- | -----------

Nature
of Operations

NeurogesX, Inc. (the Company) is a biopharmaceutical company focused on developing and
commercializing novel pain management therapies. The Company is assembling a portfolio of pain management product candidates based on known chemical entities to develop innovative new therapies which the Company believes may offer substantial
advantages over currently available treatment options. The Companys initial focus is on the management of chronic peripheral neuropathic pain conditions.

The Companys first commercial product, Qutenza®, became commercially available in United States and in certain European countries in the first half of 2010. Qutenza, the first prescription strength capsaicin
product is a dermal delivery system designed to treat certain neuropathic pain conditions and was approved by the United States Food and Drug Administration (FDA) in November 2009 for the management of postherpetic neuralgia
(PHN).

In May 2009, Qutenza received a marketing authorization (MA) in the European Union for the
treatment of peripheral neuropathic pain in non-diabetic adults, either alone or in combination with other medicinal products for pain. In June 2009, the Company entered into a Distribution, Marketing and License Agreement (the Astellas
Agreement) with Astellas Pharma Europe Ltd. (Astellas or Collaboration Partner), under which Astellas was granted an exclusive license to commercialize Qutenza in the European Economic Area, which includes the 27
countries of the European Union, Iceland, Norway, and Liechtenstein as well as Switzerland, certain countries in Eastern Europe, the Middle East and Africa (Licensed Territory). Qutenza was made available on a country by country basis
commencing in April 2010 and by year end was available in seventeen European countries.

The Company was incorporated in
California as Advanced Analgesics, Inc. on May 28, 1998 and changed its name to NeurogesX, Inc. in September 2000. In February 2007, the Company reincorporated into Delaware. The Company is located in San Mateo, California.

Certain amounts in the prior years consolidated financial statements have been reclassified to conform to the current-year
presentation.

Principles of Consolidation

The accompanying financial statements include the accounts of the Company and its wholly-owned subsidiary, NeurogesX UK Limited, which was
incorporated as of June 1, 2004. NeurogesX UK Limited was established for the purposes of conducting clinical trials in the UK and marketing approval submission. The subsidiary has no assets other than the initial formation capital totaling one
Pound Sterling.

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.



|2. | Summary of Significant Accounting Policies
|-- | ------------------------------------------

Cash and Cash Equivalents and Short Term Investments

The Company
considers all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents. The Company invests its available cash balances in bank deposits, money market funds, U.S. government
securities and other investment grade debt securities that have strong credit ratings.



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Management determines the appropriate classification of securities at the time of
purchase. To date, all marketable securities have been classified as available-for-sale, and are carried at fair value as determined based on quoted market prices or other observable market inputs with unrealized gains and losses reported as a
component of accumulated other comprehensive income (loss) in stockholders equity. The Company views its available-for-sale portfolio as available for use in current operations. Accordingly, the Company has classified all investments as short
term.

The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization is included in interest income. Realized gains and losses and declines in value judged to be other-than-temporary for available-for-sale securities, if any, are included in other income/(expense), net and have not been significant
to date. Realized gains and losses are computed on a specific identification basis. Interest and dividends are included in interest income.

Concentrations of Credit Risk and Financial Instruments

The Company
invests cash that is not currently being used for operational purposes in accordance with its investment policy. The policy allows for the purchase of low risk debt securities issued by U.S. government agencies and highly rated corporations subject
to concentration limits of 10% of any one issuer or group of issuers at the time of purchase, with the exception of debt securities issued by U.S. government agencies where the Company is not subject to any concentration limit. The maturities of
these securities on a weighted-average basis may be no longer than 12 months. The Company believes that it has established guidelines for investment of its excess cash that maintains safety and liquidity through its policies on diversification
and investment maturity.

Financial instruments that potentially subject the Company to concentrations of credit risk consist
of cash and cash equivalents and short term investments, available for sale investment securities in high-credit quality corporate debt, and debt securities issued by the U.S. government and government-sponsored enterprises.

The Company utilizes a network of seven specialty distributors and specialty pharmacies to distribute Qutenza. For the year ended
December 31, 2010, five of the distributors each accounted for more than 10% of the 2010 gross product shipments and one such distributor accounted for 38% of the 2010 gross product shipments. As of December 31, 2010, the Company had accounts
receivable balances due from four of the distributors in amounts in excess of 10% of the total accounts receivable balance and one such distributors accounts receivable balance represented 45% of the total. If any of these distributors were to
discontinue distributing Qutenza, the Companys product revenue would be negatively impacted, at least in the short term.

The Company currently depends on four contract manufacturers as single source suppliers for the components of Qutenza. The Company has
entered into long-term commercial supply agreements for these components. In addition, the Company entered into a long-term agreement for the assembly of the Qutenza treatment kits in the United States. If relationships with any of these
manufacturers is terminated, or if any manufacturer is unable to produce required quantities on a timely basis or at all, the Companys operations would be negatively impacted and our business harmed.

Trade Receivables

Trade accounts receivable are recorded net of allowances for customer chargebacks related to government rebate programs, doubtful accounts and sales returns. Estimates for customer chargebacks for
government rebates and sales returns are based on contractual terms, historical trends and our expectations regarding the utilization



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



rates for these programs. The estimate for our allowance for doubtful accounts is determined based on existing contractual payment terms, historical payment patterns of our customers and
individual customer circumstances. To date, we have not determined that an allowance for uncollectible accounts receivable has been required.

Inventories

Inventories are determined at the lower of cost or
market value with cost determined under the specific identification method. Inventories consist of raw materials, work in process and finished goods. Raw materials include certain starting materials used in the production of the active
pharmaceutical ingredient of Qutenza. Work in process includes the bulk inventory of the active pharmaceutical ingredient, patches and cleansing gel of Qutenza that are in the process of being manufactured or have completed manufacture and are
awaiting final packaging, including related internal labor and overhead costs. Finished goods include the final packaged kits that contain the Qutenza patch and cleansing gel and that are ready for commercial sale. Qutenza received FDA approval for
sale in the United States during the fourth quarter of 2009; costs incurred prior to FDA approval had been recorded as research and development expense on the Companys condensed consolidated statement of operations. On a quarterly basis, the
Company analyzes its inventory levels and writes down inventory that has become obsolete, inventory that has a cost basis in excess of the expected net realizable value and inventory that is in excess of expected requirements based upon anticipated
product revenues. During the year ended December 31, 2010, the Company recorded a charge to Cost of goods sold of $0.4 million for Qutenza patches which the Company does not expect to sell prior to their expiration date. As a result of the
recent product launch of Qutenza, the expected inventory requirements based on product revenue and the timing of production runs are subject to significant judgment and management estimate. The Company expects that its sales forecast will change
over time and thus it will review the quantities of inventories on hand versus the sales forecast on a recurring basis in the near term.

Prepaid Collaboration Supplies

Costs to manufacture product under
the supply agreement with Astellas, including internal labor costs and third party manufacturing, packaging and transportation costs are classified as prepaid collaboration supplies, which are included in Prepaid expenses and other current assets on
the Companys consolidated balance sheet, until such time as those supplies are delivered to Astellas.

Property
and Equipment

Property and equipment are stated at cost, less accumulated depreciation. Depreciation is determined
using the straight-line method and recorded over the estimated useful lives of the respective assets, generally three to five years. Leasehold improvements are amortized over the life of the lease or the useful economic life, whichever is shorter.

Product revenue

In April 2010, the Company made Qutenza commercially available in the United States to its specialty distributor and specialty pharmacy customers. Under the Companys agreements with its customers,
the customers take title to the product upon shipment and only have the right to return damaged product, product shipped in error and expired or short-dated product. As Qutenza is new to the marketplace, the Company is currently assessing the flow
of product through its distribution channel, and cannot currently reasonably estimate returns. Until such time as an estimate of returns can be made the Company is recognizing Qutenza product revenues, and related product costs, at the later of:



| |  |  | the time the product is shipped by the customer to healthcare professionals, and
| | - |  | --------------------------------------------------------------------------------



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





| |  |  | the date of cash collection.
| | - |  | ----------------------------

Healthcare professionals are generally ordering Qutenza in small quantities only after they have identified a patient for treatment. The Company believes that revenue recognition upon the later of
customer shipment to the end user and the date of cash collection is appropriate until the Company has sufficient data on the cash collection and return patterns of its customers. The Company is performing additional procedures to further analyze
shipments made by our customers by utilizing shipping data provided by our customers to determine when product is shipped by customers to healthcare professionals and are evaluating ending inventories at our customers each month to assess the risk
of product returns.

The Company has established terms pursuant to distribution agreements with its customers providing for
payment within 120 days of the date of shipment to its specialty distributor customers and 30 days of the date of shipment to its specialty pharmacy customers. Such distribution agreements generally have a term of three years.

The application of the Companys revenue recognition policy resulted in the recognition of net revenue of $688,000 from gross
shipments of $1.4 million for the year ended December 31, 2010. The Companys gross shipments are reduced for chargebacks, certain fees paid to distributors and product sales allowances including rebates to qualifying federal and state
government programs. At December 31, 2010, net deferred product revenues totaled $577,000.

Revenue from the
Astellas Agreement

In June 2009, NeurogesX entered into the Astellas Agreement which provides for an exclusive license
by the Company to Astellas for the promotion, distribution and marketing of Qutenza in the Licensed Territory, an option to license NGX-1998, a product candidate that is a non-patch liquid formulation of capsaicin, in the Licensed Territory,
participation on a joint steering committee and, through a related supply agreement entered into with Astellas (the Supply Agreement), supply of product until direct supply arrangements between Astellas and third party manufacturers are
established. The Company anticipates certain of the direct supply arrangements will be established in mid-2011. Revenue under this arrangement includes upfront non-refundable fees and may also include additional option payments for the
development of and license to NGX-1998, milestone payments upon achievement of certain product sales levels and royalties on product sales.

The Company analyzes multiple element arrangements, such as the Astellas Agreement, to determine whether the various performance obligations, or elements, can be separated or whether they must be
accounted for as a single unit of accounting. The determination of whether an element can be separated or accounted for as a single unit of accounting is based on the availability of evidence with regard to standalone value of each delivered
element. If the fair value of all undelivered performance obligations can be determined, then all obligations would then be accounted for separately as performed. If any delivered element is considered to either: 1) not have standalone value or 2)
have standalone value but the fair value of any of the undelivered performance obligations are not determinable, then any delivered elements of the arrangement would be accounted for as a single unit of accounting and the multiple elements would be
grouped and recognized as revenue over the longest estimated performance obligation period.

Significant management judgment
is required in determining the level of effort required under an arrangement and the period over which the performance obligations are estimated to be completed. In addition, if the Company is involved in a joint steering committee as part of a
multiple element arrangement that is accounted for as a single unit of accounting, an assessment is made as to whether the involvement in the steering committee constitutes a performance obligation or a right to participate.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Revenue recognition of non-refundable upfront license fees commences when there is a
contractual right to receive such payment, the contract price is fixed or determinable, the collection of the resulting receivable is reasonably assured and there are no further performance obligations under the license agreement.

The Company views the Astellas Agreement and related agreements, as a multiple element arrangement with the key deliverables consisting
of an exclusive license to Qutenza in the Licensed Territory, an obligation to conduct certain development activities associated with NGX-1998, participation on a joint steering committee and supply of Qutenza components to Astellas until such time
that Astellas can establish a direct supply relationship with product vendors. Because not all of these elements have both standalone value and objective and reliable evidence of fair value, the Company is accounting for such elements as a single
unit of accounting. Further, the agreement provides for the Companys mandatory participation in a joint steering committee, which the Company believes represents a substantive performance obligation and also the estimated last delivered
element under the Astellas Agreement and related agreements. Therefore, the Company is recognizing revenue associated with upfront payments and license fees ratably over the term of the joint steering committee performance obligation. The Company
estimates this performance obligation will be delivered ratably through June 2016.

At the inception of the Astellas
Agreement, the upfront license fees were subject to a refund right, which expired upon transfer of the Companys MA for Qutenza in the European Union to Astellas. In September 2009, the transfer of the MA to Astellas was completed and,
therefore, the upfront license fees became non-refundable and revenue recognition of the upfront license fees commenced.

In
the accompanying financial statements, Collaboration revenue represents revenue associated with the Astellas Agreement and related agreements. Deferred collaboration revenue arises from the excess of cash received or receivable over cumulative
revenue recognized for the period.

Under the terms of the Astellas Agreement, the Company earns royalties based on each sale
of Qutenza into the Licensed Territory. The royalty rate is tiered based on the level of sales achieved. These royalties are considered contingent consideration as there is no remaining contract performance obligation of the Company and, therefore,
the royalties are excluded from the single unit of accounting treatment discussed above. The Company reports royalty revenue based upon Astellas reported net sales of Qutenza in the Licensed Territory. The Company recognizes royalty revenue
from Astellas on a quarter lag basis due to the timing of Astellas reporting such royalties to the Company.

Additionally, the
Company can earn milestone payments from Astellas if Astellas achieves certain sales levels as outlined in the Astellas Agreement. As these payments are contingent on Astellas performance, they are excluded from the single unit of accounting
treatment discussed above. The milestones will be recorded as revenue when earned as there is no remaining contractual performance obligation of the Company.

The Company recognizes the revenue net of related costs for collaboration supplies sold to Astellas upon product being delivered to Astellas. The revenue and related costs of the product supplied to
Astellas are included in Collaboration Revenue. Prior to delivery to Astellas, the costs accumulated for the manufacturing of the collaboration supplies are included as Prepaid expenses on the Companys balance sheet.

Cost of goods sold

Cost of goods sold includes costs to procure, manufacture and distribute Qutenza including certain shipping and handling costs incurred in the distribution channel as well as royalties payable to The
Regents of the University of California, or UC, and Lohmann Therapie-Systeme AG or LTS. Costs associated with the



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



manufacture of Qutenza prior to FDA approval were previously expensed as research and development in the period incurred. Cost of goods sold associated with deferred product revenue will be
deferred and recognized in the same period as the associated product revenue. At December 31, 2010, the Company had deferred Cost of goods sold of $52,000.

During the year ended December 31, 2010, the Company recorded a charge of $0.4 million for Qutenza patches which the Company does not expect to sell prior to their expiration date.

Research and Development

The Company expenses research and development costs as incurred. Research and development expenses include personnel and personnel related costs, costs associated with pre-clinical and clinical
development activities, such as clinical trials, including amounts paid to clinical research organizations and clinical investigators; product and manufacturing costs, such as process development, clinical product supply costs and the cost of
commercially saleable product that is manufactured prior to market approval for that product candidate; internal and external costs associated with the Companys regulatory compliance and quality assurance functions including the costs of
outside consultants and contractors that assist in the process of submitting and maintaining regulatory filings; and overhead costs including allocated facility and related expenses.

Clinical Trials

The Company accrues and expenses costs for clinical trial activities performed by third parties, including clinical research organizations and clinical investigators, based upon estimates of the work
completed over the life of the individual study in accordance with agreements established with contract research organizations and clinical trial sites. The Company determines these estimates through discussion with internal personnel and outside
service providers as to progress or stage of completion of trials or services pursuant to contracts with numerous clinical trial centers and clinical research organizations and the agreed upon fee to be paid for such services.

Advertising Costs

The Company expenses both the production costs and the communication costs of advertising as incurred. Advertising expense which includes Qutenzas website development, eLearning, eMarketing, media
campaigns, patient testimonial videos and other items was $5.8 million and $0.7 million for the years ended December 31, 2010 and 2009, respectively.

Interest Expense

Interest expense is comprised of interest relating
to the Companys long term obligations, the accretion of the debt discount, and the amortization of debt issuance costs recorded as Prepaid expenses and other current assets and Other assets on the consolidated balance sheet.

Other income (expense), net

Other income in 2010 results primarily from income tax credits earned under Section 48D of the Internal Revenue Code (as enacted on March 23, 2010 by the Patient Protection and Affordable
Care Act). We applied for a credit based upon certain of our 2009 and 2010 research and development activities. The payment for the 2009 credit of $407,000 was received in 2010 where as the 2010 credit of $226,000 is expected to be received in
early 2011.



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Income taxes

The Company utilizes the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are
determined based on differences between financial reporting and tax reporting bases of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. Uncertain
tax positions are evaluated and if appropriate, the amount of unrecognized tax benefits are recorded within deferred tax assets, as further described in Note 12. Valuation allowances are established when necessary to reduce deferred tax assets to
the amounts expected to be realized. Currently, there is no provision for income taxes as the Company has incurred operating losses to date.

Comprehensive (Loss)/Income

Comprehensive (loss)/income includes
net loss and other comprehensive (loss)/income. For each of the years ended December 31, 2010, 2009 and 2008, the difference between comprehensive loss and net loss represented net unrealized gains or losses on available-for-sale securities.

Net Loss Per Share

Basic and diluted net loss per share is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding during the period less the
weighted average unvested common shares subject to repurchase. For purposes of this calculation, warrants and options to purchase common stock are considered to be common stock equivalents but have been excluded from the calculation of diluted net
loss per share as their effect is anti-dilutive.



|                                                                    |  |                                                |            |   |      |   |            |      |  |   |            |  
|------------------------------------------------------------------- |  | ---------------------------------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                    |  | Year Ended December 31,                        |           
|                                                                    |  | 2010                                           |            |   | 2009 |   |            | 2008 | 
|                                                                    |  | (in thousands except share and per share data) |           
|Numerator:                                                          |  |                                                |            |   |      |   |            |      |  |   |            |  
|Net loss                                                            |  | $                                              | (44,516    | ) |      | $ | (21,867    | )    |  | $ | (26,035    | )
|                                                                    |  |                                                |            |   |      |   |            |      |  |   |            |  
|Denominator:                                                        |  |                                                |            |   |      |   |            |      |  |   |            |  
|Weighted-average common shares outstanding                          |  |                                                | 17,768,881 |   |      |   | 17,611,189 |      |  |   | 17,520,778 |  
|Less: Weighted-average unvested common shares subject to repurchase |  |                                                |           |   |      |   | (393       | )    |  |   | (1,363     | )
|                                                                    |  |                                                |            |   |      |   |            |      |  |   |            |  
|Denominator for basic and diluted net loss per share                |  |                                                | 17,768,881 |   |      |   | 17,610,796 |      |  |   | 17,519,415 |  
|                                                                    |  |                                                |            |   |      |   |            |      |  |   |            |  
|Basic and diluted net loss per share                                |  | $                                              | (2.51      | ) |      | $ | (1.24      | )    |  | $ | (1.49      | )
|                                                                    |  |                                                |            |   |      |   |            |      |  |   |            |  
|                                                                    |  |                                                |           
|Outstanding securities not included in diluted net loss per share:  |  |                                                |            |   |      |   |            |      |  |   |            |  
|Options to purchase common stock                                    |  |                                                | 3,002,493  |   |      |   | 2,264,535  |      |  |   | 1,392,560  |  
|Warrants outstanding                                                |  |                                                | 1,265,846  |   |      |   | 1,265,846  |      |  |   | 1,265,846  |  
|Common stock subject to repurchase                                  |  |                                                |           |   |      |   |           |      |  |   | 785        |  
|                                                                    |  |                                                |            |   |      |   |            |      |  |   |            |  
|                                                                    |  |                                                | 4,268,339  |   |      |   | 3,530,381  |      |  |   | 2,659,191  |  
|                                                                    |  |                                                |            |   |      |   |            |      |  |   |            |  



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Recently Issued Accounting Standards

Not Yet Adopted

In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2009-13, Revenue Recognition (ASC Topic 605) 
Multiple-Deliverable Revenue Arrangements. This guidance modifies previous guidance for multiple element arrangements by allowing the use of the best estimate of selling price in the absence of vendor-specific objective evidence
(VSOE) or third party evidence (TPE) of selling price for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price is not
available. In addition, the residual method of allocating arrangement consideration is no longer permitted. This ASU is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010
and early adoption is permitted. The Company did not early adopt ASU No. 2009-13. The Company currently only has one revenue agreement with multiple elements, the Astellas Agreement. This ASU is effective for the Company beginning on
January 1, 2011 and the adoption of the new guidance will not have a material impact on the Companys consolidated financial statements as the Company does not anticipate making a material modification to the Astellas Agreement. If the
Company was to enter into new multiple element arrangements or make a material modification to the Astellas Agreement, the contract would be accounted for under the provisions of ASU No. 2009-13.

In April 2010, the FASB issued ASU No. 2010-17, Revenue RecognitionMilestone Method (ASC Topic 605): Milestone Method of
Revenue Recognition (ASU No. 2010-17). This ASU codifies the consensus reached in EITF Issue No. 08-9, Milestone Method of Revenue Recognition. The amendments to the Codification provide guidance on defining a
milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as
revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. Milestones should be considered substantive in their entirety and may not be bifurcated. An arrangement
may contain both substantive and non-substantive milestones, and each milestone should be evaluated individually to determine if it is substantive. ASU No. 2010-17 is effective on a prospective basis for milestones achieved in fiscal years, and
interim periods within those years, beginning on or after June 15, 2010. Early adoption is permitted. If a vendor elects early adoption and the period of adoption is not the beginning of the entitys fiscal year, the entity should apply
ASU No. 2010-17 retrospectively from the beginning of the year of adoption. The Company did not early adopt ASU No. 2010-17. This ASU is effective for the Company beginning on January 1, 2011 and the adoption of the new guidance will
not have a material impact on the Companys consolidated financial statements.

Adopted in 2010

None.



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



|3. | Cash and Cash Equivalents and Short Term Investments
|-- | ----------------------------------------------------

The following are summaries of cash, cash equivalents and short term investments (in thousands):



|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|--------------------------- |  | ------------- | ------ |  | -------------------- | - | - | --------------------- |  | - | ------------------- | - |  | - | ------ | 
|                            |  | AmortizedCost |        |  | GrossUnrealizedGains |   |   | GrossUnrealizedLosses |  |   | Estimated FairValue |  
|As of December 31, 2010:    |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Cash and money market funds |  | $             | 6,705  |  |                      | $ |  |                       |  | $ |                    |   |  | $ | 6,705  | 
|Commercial paper            |  |               | 2,000  |  |                      |   |  |                       |  |   |                    |   |  |   | 2,000  | 
|U.S. Treasury securities    |  |               | 38,127 |  |                      |   | 1 |                       |  |   | (3                  | ) |  |   | 38,125 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|                            |  | $             | 46,832 |  |                      | $ | 1 |                       |  | $ | (3                  | ) |  | $ | 46,830 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Reported as:                |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Cash and cash equivalents   |  |               |        |  |                      |   |   |                       |  |   |                     |   |  | $ | 8,705  | 
|Short-term investments      |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   | 38,125 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  | $ | 46,830 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|As of December 31, 2009:    |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Cash and money market funds |  | $             | 20,651 |  |                      | $ |  |                       |  | $ |                    |   |  | $ | 20,651 | 
|U.S. Treasury securities    |  |               | 29,916 |  |                      |   |  |                       |  |   | (8                  | ) |  |   | 29,908 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|                            |  | $             | 50,567 |  |                      | $ |  |                       |  | $ | (8                  | ) |  | $ | 50,559 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Reported as:                |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Cash and cash equivalents   |  |               |        |  |                      |   |   |                       |  |   |                     |   |  | $ | 29,695 | 
|Short-term investments      |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   | 20,864 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  | $ | 50,559 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 

At December 31, 2010 and 2009, the contractual maturities of investments held were one year or less.
The Company did not sell any of its investments prior to maturity during the year ended December 31, 2010.

The
Companys restricted cash of $0.3 million at December 31, 2010 is primarily related to contractual obligations of the Companys credit card program.



|4. | Fair Value Measurements
|-- | -----------------------

The Company discloses its cash, cash equivalents and short term investments under a fair value hierarchy based on three levels of inputs,
of which the first two are considered observable and the last unobservable, that may be used to measure fair value, which are the following:

Level 1Quoted prices in active markets for identical assets or liabilities.

Level 2Inputs other than quoted prices included within Level 1 that are observable, either directly or indirectly, such as quoted
prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the
assets or liabilities.



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



In accordance with Codification Topic 820, the following table represents the
Companys financial assets (cash equivalents and short-term investments) measured at fair value on a recurring basis and their level within the fair value hierarchy as of December 31, 2010 and December 31, 2009 (in thousands):



|                                                                                  |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|--------------------------------------------------------------------------------- |  | ---------------------------------------------------------- | ------ |  | ----------------------------------------- | - | - | --------------------------------------- |  | - | ----- |  |  | - | ------ | 
|                                                                                  |  | Quoted Pricesin ActiveMarkets forIdentical Assets(Level 1) |        |  | SignificantOtherObservableInputs(Level 2) |   |   | SignificantUnobservableInputs(Level
 3) |  |   | Total | 
|Fair Value Measurements at December 31, 2010:                                     |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Components of cash equivalents and short-term investments measured at fair value: |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Money market funds                                                                |  | $                                                          | 6,370  |  |                                           | $ |  |                                         |  | $ |      |  |  | $ | 6,370  | 
|Commercial paper                                                                  |  |                                                            | 2,000  |  |                                           |   |  |                                         |  |   |      |  |  |   | 2,000  | 
|U.S. Treasury securities                                                          |  |                                                            | 38,125 |  |                                           |   |  |                                         |  |   |      |  |  |   | 38,125 | 
|                                                                                  |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Total financial assets measured at fair value                                     |  | $                                                          | 46,495 |  |                                           | $ |  |                                         |  | $ |      |  |  |   | 46,495 | 
|                                                                                  |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Components of cash and cash equivalents not measured at fair value:               |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Operating cash                                                                    |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   | 335    | 
|                                                                                  |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Total cash and cash equivalents and short-term investments                        |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  | $ | 46,830 | 
|                                                                                  |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Fair Value Measurements at December 31, 2009:                                     |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Components of cash equivalents and short-term investments measured at fair value: |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Money market funds                                                                |  | $                                                          | 20,037 |  |                                           | $ |  |                                         |  | $ |      |  |  | $ | 20,037 | 
|U.S. Treasury securities                                                          |  |                                                            | 29,908 |  |                                           |   |  |                                         |  |   |      |  |  |   | 29,908 | 
|                                                                                  |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Total financial assets measured at fair value                                     |  | $                                                          | 49,945 |  |                                           | $ |  |                                         |  | $ |      |  |  |   | 49,945 | 
|                                                                                  |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Components of cash and cash equivalents not measured at fair value:               |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Operating cash                                                                    |  |                                                            |        |  |                                           |   |   | 614                                     | 
|                                                                                  |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 
|Total cash and cash equivalents and short-term investments                        |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  | $ | 50,559 | 
|                                                                                  |  |                                                            |        |  |                                           |   |   |                                         |  |   |       |  |  |   |        | 



|5. | Inventory
|-- | ---------

The components
of inventories are as follows:



|                   |  |                  |     |  |                  |   |    | 
|------------------ |  | ---------------- | --- |  | ---------------- | - | -- | 
|(in thousands)     |  | December 31,2010 |     |  | December 31,2009 |  
|Raw materials      |  | $                | 7   |  |                  | $ |   | 
|Work in process(1) |  |                  | 581 |  |                  |   | 58 | 
|Finished goods     |  |                  | 198 |  |                  |   |   | 
|                   |  |                  |     |  |                  |   |    | 
|Total inventories  |  | $                | 786 |  |                  | $ | 58 | 
|                   |  |                  |     |  |                  |   |    | 



|(1) | Included in work in process at December 31, 2010 is $356,000 of product awaiting final packaging.
|--- | -------------------------------------------------------------------------------------------------



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The above inventory balances are costs capitalized since the Company received FDA
approval for the sale of Qutenza in the US market in the fourth quarter of 2009. Prior to FDA approval, all related US inventory costs were expensed to research and development. On a quarterly basis, the Company analyzes its inventory levels and
writes down inventory that has become obsolete, inventory that has a cost basis in excess of the expected net realizable value and inventory that is in excess of expected requirements based upon anticipated product revenues. In the year ended
December31, 2010, the Company recorded a charge to Cost of goods sold of $0.4 million for Qutenza patches which the Company does not expect to sell prior to their expiration date.



|6. | Property and Equipment
|-- | ----------------------

Property and equipment consists of the following (in thousands):



|                                                |  |              |        |   |      |   |       |  
|----------------------------------------------- |  | ------------ | ------ | - | ---- | - | ----- | -
|                                                |  | December 31, |       
|                                                |  | 2010         |        |   | 2009 |  
|Computer equipment                              |  | $            | 745    |   |      | $ | 555   |  
|Leasehold improvements                          |  |              | 275    |   |      |   | 275   |  
|Software                                        |  |              | 373    |   |      |   | 120   |  
|Office furniture and equipment                  |  |              | 327    |   |      |   | 288   |  
|Marketing related equipment                     |  |              | 149    |   |      |   |      |  
|Research equipment                              |  |              | 46     |   |      |   | 44    |  
|Construction in progress                        |  |              | 146    |   |      |   | 372   |  
|                                                |  |              |        |   |      |   |       |  
|                                                |  |              | 2,061  |   |      |   | 1,654 |  
|Less: accumulated depreciation and amortization |  |              | (1,252 | ) |      |   | (915  | )
|                                                |  |              |        |   |      |   |       |  
|Property and equipment, net                     |  | $            | 809    |   |      | $ | 739   |  
|                                                |  |              |        |   |      |   |       |  

Depreciation expense was $343,000, $184,000 and $181,000 for the years ended December 31, 2010, 2009
and 2008, respectively. Construction in progress primarily represents acquisition of software that was not yet placed into service by December 31, 2010.



|7. | Long Term Obligation
|-- | --------------------

On
April 30, 2010, the Company entered into a Financing Agreement (the Financing Agreement) with Cowen Healthcare Royalty Partners, L.P., a limited partnership organized under the laws of the State of Delaware (Cowen
Royalty). Under the terms of the Financing Agreement, the Company borrowed $40 million from Cowen Royalty (the Borrowed Amount) and the Company agreed to repay such Borrowed Amount together with a return to Cowen Royalty, as
described below, out of royalty, milestone, option and certain other payments (collectively, Revenue Interest) that the Company may receive under the Astellas Agreement or a replacement licensee, as a result of commercializing the
Companys product, Qutenza, in the Licensed Territory, including payments that Astellas may make to the Company to maintain its option to commercialize NGX-1998 in the Licensed Territory.

Under the Financing Agreement, the Company is obligated to pay to Cowen Royalty:



| |  |  | All of the Revenue Interest payments due to the Company under the Astellas Agreement, until Cowen Royalty has received $90 million of Revenue Interest
payments; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 5% of the Revenue Interest payments due to the Company under the Astellas Agreement for Revenue Interests received by Cowen Royalty over $90 million
and until Cowen Royalty has received $106 million of Revenue Interest payments.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The Company also has the option to pay a prepayment amount to terminate the Financing
Agreement at the Companys election at any time or in connection with a change of control of the Company. Such amount is set at a base amount of $76 million (or $68 million if it is being exercised in connection with a change of control), or,
if higher, an amount that generates a specified internal rate of return, as noted below, on the Borrowed Amount as of the date of prepayment, in each case reduced by the Revenue Interest payments received by Cowen Royalty up to the date of
prepayment.

The obligation of the Company to pay Revenue Interests during the term of the Financing Agreement is secured by
rights that the Company has to Revenue Interests under the Astellas Agreement, and by intellectual property and other rights of the Company to the extent necessary or used to commercialize products covered by the Astellas Agreement in the Licensed
Territory.

Unless terminated earlier pursuant to a prepayment, the Financing Agreement also terminates on the earlier of:



| |  |  | The time when Cowen Royalty has received at least $106 million of Revenue Interest payments; or
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | The maturity date, which is the latest to occur of 10 years following the first commercial sale of Qutenza in the Licensed Territory or the last to
expire of any patents or regulatory exclusivity covering the products commercialized under the Astellas Agreement in the Licensed Territory.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If Cowen Royalty has not received Revenue Interest payments totaling at least $40,000,000 by the maturity date, the Company will be obligated to pay to Cowen Royalty the difference between such amount and
the Revenue Interests paid to Cowen Royalty under the Financing Agreement up to such date.

In addition, in the event of the
Companys default under the Financing Agreement, the Company is obligated to pay to Cowen the borrowed amount together with interest accrued thereon from the effective date of the Financing Agreement, to the date of repayment at an internal
rate of return equal to the lesser of the 19% rate of interest or the maximum rate permitted by law, less any Revenue Interest payments received by Cowen Royalty.

The upfront cash receipt of $40,000,000 less a discount of $494,000 in cost reimbursements paid to Cowen Royalty and was recorded as a Long term obligation at issuance. The carrying value of the
non-current portion of Long term obligation at December 31, 2010, including accrued interest of $3,133,000, is $42,622,000 and the estimated fair market value is $40,870,000. The Company received $49,000 of royalty payments from Astellas in
2010, and consistent with the provisions of the arrangement, the Company paid that amount to Cowen as a reduction of the obligation. The best estimate of future payments, the timing of which determines the short and long term classification of the
obligation under the Financing Agreement, was based upon returning to Cowen Royalty an internal rate of return of 19% through Revenue Interest payments. Under this methodology, the Company recorded interest expense of approximately $5,409,000 during
the year ended December 31, 2010. The accrued interest on the Long term debt obligation is presented on the consolidated balance sheet as of December 31, 2010 in two components, the Long term obligationcurrent portion, which totals
$2,222,000 and the remaining $3,133,000 included in Long term obligation.

The Company capitalized $313,000 of debt issuance
costs related to the agreement which are being amortized over the term. At December 31, 2010, the unamortized debt issuance costs were $260,000 and are included in Prepaid expenses and other current assets and Other
assets on the Companys consolidated balance sheet. The Company is accreting the discount of $494,000 to interest expense over the term of the related debt.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The estimated fair market value of the Long term obligation was calculated using the
income method of valuation. The key assumptions required for the calculation were an estimate of the future royalty revenues to be received from Astellas and an estimated cost of capital. Managements estimate of the future royalty revenues to
be received from Astellas is subject to significant variability due to the recent product launch, regulatory process still to be conducted for significant portions of the Astellas territory and the extended time period associated with the Cowen
Financing Agreement, and thus are subject to significant uncertainty.



|8. | Notes Payable
|-- | -------------

In July
2006, the Company entered into a venture loan agreement with two venture finance institutions for an aggregate note payable amount of $10,000,000, of which $5,000,000 was drawn in July 2006 and the remaining $5,000,000 was drawn in September 2006.
The loan was fully repaid in January 2010. These notes bore interest at 12.21% and 11.75%, respectively.

A debt premium of
$469,000 related to the initial fair value of warrants to purchase 840,000 shares of Series C2 preferred stock issued in connection with the loan agreement was recorded upon issuance of the notes. Upon closing of the Companys Initial
Public Offering, (IPO), in May 2007, these warrants were converted into warrants to purchase 56,000 shares of the Companys common stock. As of December 31, 2009, the entire debt premium had been fully amortized, and interest expense for
the debt premium for the years ended December 31, 2009 and 2008 was $80,000 and $156,000, respectively.

Interest
expense, including expense associated with the valuation of warrants, recognized in connection with all loans was $276,000 and $792,000 for the years ended December 31, 2009 and 2008, respectively.



|9. | Commitments and Contingencies
|-- | -----------------------------

Operating Leases

The Company entered into an operating lease in
September 2007 for its corporate headquarters, consisting of approximately 26,386 square feet of office space in San Mateo, California. The lease, which expires in July 2012, includes total base rent of $2.3 million, a period of free rent and rent
escalation, all of which are accounted for on a straight line basis over the lease term. Also included in the terms of the lease is a tenant improvement allowance of $106,000, which was received in 2009, was recorded to deferred rent and is being
amortized on a straight-line basis over the remaining term of the lease. The Companys obligation under the sublease is secured by a letter of credit in the amount of $240,000, and in accordance with the provisions of the sublease agreement,
the Company can reduce the letter of credit, if certain conditions are met, by $40,000 on each of the first three anniversaries of the lease commencement date. As a result of having met these conditions, the Company reduced the letter of credit to
$120,000 at December 31, 2010, of which the full amount is secured by a certificate of deposit that is included in the Companys balance sheet at December 31, 2010 as Restricted cash. The Company has a deferred rent liability of
$291,000 as of December 31, 2010, of which $115,000 is classified as a non-current liability.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Total rent expense under all operating leases, which also includes rent expense for
certain office equipment, was $463,000, $467,000 and $489,000 for the years ended December 31, 2010, 2009 and 2008, respectively. Future minimum payments under all noncancelable operating lease obligations are as follows as of December 31,
2010 (in thousands):



|                             |  |   |       | 
|---------------------------- |  | - | ----- | 
|Year End December 31,        |  |   |      
|2011                         |  | $ | 634   | 
|2012                         |  |   | 391   | 
|2013                         |  |   | 16    | 
|2014 and beyond              |  |   |      | 
|                             |  |   |       | 
|Total minimum lease payments |  | $ | 1,041 | 
|                             |  |   |       | 

Purchase Obligations

The Company has issued non-cancellable purchase orders to third party manufacturers of Qutenza and NGX-1998 for manufacturing, stability and related services including reimbursable amounts from Astellas
for the supply of Qutenza based on the Astellas Agreement. These purchase orders totaled $3.0 million as of December 31, 2010 and included $1.1 million for stability and related services, $1.1 million of commitments related to supply of
Qutenza to Astellas, $0.7 million related to product manufacturing costs for the U.S. market, and $0.1 million for the Phase 2 study for NGX-1998. The Company anticipates it will pay $2.5 million, $0.3 million and $0.2 million in the years ended
December 31, 2011, 2012, and 2013, respectively, for these obligations. Actual payments for purchases from these third party manufactures were $3.2 million, $1.7 million and $1.7 million during the years ended December 31, 2010,
2009 and 2008, respectively.

Indemnifications

In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and
warranties and generally provide for various indemnifications including indemnification from claims resulting from clinical trial activities and intellectual property matters. The Companys liability under these agreements is unknown because it
involves the potential for future claims that may be made against the Company, but have not yet been made. To date, the Company has not received any claims under its various indemnification obligations. However, the Company may record charges in the
future as a result of these indemnification obligations.

The Company, as permitted under Delaware law and in accordance with
its bylaws, indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer or director is or was serving at the Companys request in such capacity. The Company may terminate the
indemnification agreements with its officers and directors upon 90 days written notice, but termination will not affect claims for indemnification relating to events occurring prior to the effective date of termination. The maximum amount of
potential future indemnification is unlimited. The Company believes the fair value of these indemnification agreements is minimal. Accordingly, the Company has not recorded any liabilities for these agreements as of December 31, 2010.

Legal Matters

The Company is subject to various legal disputes that arise in the normal course of business which include or may include employment matters, contract disputes, intellectual property matters, product
liability actions, and other matters. The Company does not know whether it would prevail in these matters nor can it be assured that



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



any remedy could be reached on commercially viable terms, if at all. Based on currently available information, the Company does not believe that any of these disputes will have a material adverse
impact on the Companys results of operations, liquidity or financial position. The Company records a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company
recorded a $1.0 million charge in 2010 related to intellectual property matters as discussed in Note 10.



|10. | License Agreements
|--- | ------------------

Collaboration AgreementAstellas

In June 2009, NeurogesX entered into the Astellas Agreement granting Astellas an exclusive license to commercialize Qutenza in the Licensed Territory. The Astellas Agreement provided for an upfront
payment for past development and the commercialization rights granted, of 30,000,000 Euro, or $41,817,000. In addition, the agreement provided for an upfront payment of 5,000,000 Euro, or $6,970,000, for future development expenses and an option to
license NGX-1998, a product candidate in Phase 1 development at that time. Other elements of the Astellas Agreement include future milestone payments of up to 65,000,000 Euro if certain predefined sales thresholds of the products licensed under the
agreement are met and royalties, as a percentage of net sales made by Astellas of products under the agreement, with such royalties starting in the high teens and escalating into the mid twenties as revenues increase. The Company is participating on
a joint steering committee with Astellas to oversee the development and commercialization activities related to Qutenza and NGX-1998 during the term of the agreement, not to exceed ten years. On the seventh anniversary of the Astellas Agreement, the
Company has the unilateral right to opt-out of participation on the joint steering committee. The Astellas Agreement further provides that upon delivery of certain data related to NGX-1998, Astellas may pay two additional NGX-1998 option payments
totaling 5,000,000 Euro. Subsequent to Astellas exercise of the option to exclusively license NGX-1998 in the Territory, both companies would cooperate on Phase III clinical trials and will share such costs equally.

The Company commenced recognizing revenue related to the upfront and option payments upon transfer of the MA for Qutenza to Astellas,
which occurred in September 2009 and accordingly recognized $1,944,000 as Collaboration revenue in the year ended December 31, 2009. In 2010, the Company recognized $7,242,000 as Collaboration revenue related to the upfront and option payments.
As of December 31, 2010, the Company had deferred revenue totaling $39,601,000, of which $7,242,000 is reflected as current. The Astellas upfront license fee and option payments are accounted for as a single unit of accounting, and accordingly,
such payments will be recognized ratably through June 2016, which is the Companys estimate of its substantive performance obligation period related to the joint steering committee. Subsequent option exercise payments received, if any, are
expected to be recognized ratably over the remaining estimated period of performance.

The agreement will remain effective on
a country-by-country and product-by-product basis until the later of ten years after the first commercial sale, expiration or abandonment of the last valid patent claim or expiration of all applicable periods of regulatory exclusivity. Astellas may
terminate the agreement for any reason without penalty, consequence or compensation on a country-by-country and product-by-product basis upon written notice to the Company.

Pursuant to the Supply Agreement, the Company has agreed to provide Astellas with a sufficient supply of Qutenza to support their commercialization efforts until Astellas can establish a direct supply
relationship with product vendors. These products will be charged to Astellas at contractually agreed upon costs per unit which are intended to reflect the Companys direct cost of goods and related internal labor and overhead costs without
mark-up for profit. The Company reported amounts received from product transactions net of direct costs incurred as a component of Collaboration revenue.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



For the years ended December 31, 2010 and 2009, the Company included in
Collaboration revenue $287,000 and $62,000 from product transactions, net of direct costs incurred as a component of Collaboration revenue, respectively.

For the year ended December 31, 2010, the Company recognized $49,000 in royalty revenue related to the Astellas Agreement.

University Of California

In October 2000 and as amended, the
Company licensed certain patents, including a method patent, from the University of California (UC) for prescription strength capsaicin for neuropathic pain. Under the terms of the agreement, the Company is required to pay royalties on
net sales of the licensed product up to a maximum of $1,000,000 per annum as well as a percentage of upfront and milestone payments received by the Company from sublicensing the Companys rights under the agreement (Sublicense Fee).
As a result of the Astellas license payment received in July 2009, the Company accrued a $1,213,000 sublicense fee to research and development expense during the third quarter of 2009, which was paid in February 2010. The Company recognized $4,000
in royalty expense due to UC for the year ended December 31, 2010 related to Qutenza product sales in the United States.

Two of the three inventors named in the method patent did not assign their patent rights to UC. These non-assigning inventors have
made various claims related to inventorship and other matters. In 2010, the Company entered into negotiations with these non-assigning inventors to settle any and all claims and to have them assign their rights related to the method patent and
any other related patent rights that may exist at the time we enter into a final binding settlement agreement. The Company anticipates that a final settlement may include the Company issuing stock or stock options to the two non-assigning
inventors and making current and future cash payments. The current cash and estimated fair value of the stock or stock options to be issued as part of a potential settlement is currently estimated to approximate $1.0 million. The Company anticipates
that approximately 50% of the cash settlement amount will be recovered over time, through a reduction in amounts due to the University of California under the Companys license agreement with them. During the year ended December 31, 2010,
the Company recorded a $1.0 million charge within selling, general and administrative expense representing its estimate of the potential settlement and such amount is included in Other accrued expenses on the consolidated balance sheet.

LTS Lohmann Therapie-Systeme AG

In January 2007, the Company entered into a Commercial Supply and License Agreement (LTS Agreement) with LTS Lohmann Therapie-Systeme AG (LTS) to manufacture commercial and
clinical supply of Qutenza. Under the terms of the agreement, the Company is required to pay a transfer price for product purchased as well as a royalty on net sales of product purchased under the LTS Agreement. Additionally, upon first market
approval of Qutenza, the Company is required to make a one time milestone payment of 100,000. During the second quarter of 2009, the Company received market approval of Qutenza in the European Union and as a result, paid LTS a one-time
milestone payment of 100,000, or approximately $140,000, which was charged to research and development expense. The Company recognized $12,000 in royalty expense due to LTS Lohmann Therapie-Systeme AG for the year ended December 31, 2010
related to Qutenza product sales in the United States.

The Companys December 31, 2010 balance sheet includes a
liability for royalties due UC and LTS totaling $12,000 related to gross product shipments in the year ended December 31, 2010.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



|11. | Stockholders Equity
|--- | --------------------

Common Stock

The Company completed its IPO and sold 4,000,000 shares of common stock at $11.00 per share on May 7, 2007. Gross proceeds from the offering totaled approximately $44,000,000. The net offering
proceeds to the Company, after deducting expenses of approximately $5,914,000, totaled $38,085,000. Upon closing of the IPO, all of the outstanding shares of the Companys redeemable convertible preferred stock converted to 8,722,013 shares of
the Companys common stock.

On December 28, 2007, the Company completed the first closing of a private placement in
which the Company sold 3,638,741 shares of common stock at $6.18 per share and warrants at $0.125 per share to purchase an additional 1,091,622 shares of its common stock. The stock and warrants were offered solely to accredited investors. On
January 3, 2008, the Company completed the second closing of the private placement in which the Company issued 382,170 shares of common stock at $6.18 per share and warrants at $0.125 per share to purchase an additional 114,651 shares of its
common stock. The warrants from both closings have a term of five years, contain a net-exercise provision, and have an exercise price of $8.034 per share. The fair value of the warrants issued in the first closing was $3,411,000 and the fair value
of the warrants issued in the second closing was approximately $420,000. The fair value of the warrants issued in both closings was allocated from the net proceeds of the financing and was recorded in additional paid-in capital. The net cash
proceeds to the Company from both closings, after deducting expenses of $1,195,000 totaled $23,805,000.

2000 Stock
Incentive Plan

The Companys 2000 Stock Incentive Plan (the 2000 Plan) provides for the grant of
incentive and nonstatutory stock options by the board of directors to employees, officers, directors, and consultants of the Company. Incentive stock options may be granted with exercise prices not less than estimated fair value, and nonstatutory
stock options may be granted with an exercise price of not less than 85% of the estimated fair value of the common stock on the date of grant. Options granted under the 2000 Plan expire no later than 10 years from the date of grant. Options
granted and shares underlying stock purchase rights issued under the 2000 Plan vest over periods determined by the board of directors, generally over four to six years. Unvested shares of common stock purchased under stock purchase rights are
subject to a repurchase option by the Company upon termination of the purchasers employment or services. The repurchase right lapses over a period of time as determined by the board of directors. At December 31, 2010 and 2009 there were
no stock purchase rights outstanding that were subject to a repurchase right by the Company. For certain options, vesting accelerates upon the achievement of specified milestones.

The 2000 Plan automatically terminated on June 5, 2010 as the plan provisions included an automatic termination 10 years after
its adoption by the board of directors. The termination does not impact unexercised stock options outstanding.

The 2000 Plan
allows for the early exercise of stock options prior to vesting. The Company has issued an aggregate of 11,945 shares of common stock pursuant to the early exercise of stock options, which are not deemed to be issued until those shares vest. As of
December 31, 2010 and 2009, all early exercised shares were fully vested.

2007 Stock Plan

The Companys 2007 Stock Plan provides for the grant of incentive stock options by the Companys board of directors to employees
and for the grant of nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance units and performance shares to its employees, directors and consultants.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The Companys board of directors has the authority to determine the terms of the awards, including exercise price, the number of shares subject to each such award, the exercisability of the
awards and consideration payable upon exercise. Incentive stock options may be granted with exercise prices at least equal to the fair market value of the Companys common stock on the date of grant. The term of an incentive stock option
granted under this plan may not exceed ten years, except that with respect to any participant who owns 10% of the voting power of all classes of the Companys outstanding stock as of the grant date, the term must not exceed five years and the
exercise price must equal at least 110% of the fair market value on the date of grant.

Upon adoption of the plan, the Company
reserved 1,333,333 shares of its common stock for issuance under the 2007 Stock Plan. Any shares returned to the 2000 Stock Incentive Plan as a result of termination of options or the repurchase of shares issued under the 2000 Stock Incentive Plan
are added to the 2007 Stock Plan. In addition, the 2007 Stock Plan provides for annual increases in the number of shares available for issuance thereunder on the first day of each fiscal year, beginning with the Companys 2008 fiscal year,
equal to the lesser of:



| |  |  | 5% of the outstanding shares of the Companys common stock on the last day of the immediately preceding fiscal year;
| | - |  | --------------------------------------------------------------------------------------------------------------------



| |  |  | 1,333,333 shares; or
| | - |  | --------------------



| |  |  | such other amount as the Companys board of directors may determine.
| | - |  | --------------------------------------------------------------------

The Companys 2007 Stock Plan also provides for the automatic grant of non-statutory options to the Companys non-employee
directors. Each non-employee director that is newly appointed to the board of directors will receive an initial option to purchase 20,000 shares upon such appointment. Additionally, non-employee directors who have been directors for at least six
months will receive a subsequent option to purchase 10,000 shares immediately following each annual meeting of the Companys stockholders.

2007 Employee Stock Purchase Plan

Under the Companys 2007
Employee Stock Purchase Plan (the Purchase Plan), eligible employees can participate and purchase common stock semi-annually through accumulated payroll deductions. The Purchase Plan is administered by the Companys board of
directors or a committee appointed by the Companys board of directors. Under the Purchase Plan eligible employees may purchase stock at 85% of the lower of the fair market value of a share of Common Stock on the offering date or the exercise
date. The Purchase Plan provides for consecutive, overlapping twelve-month offering periods generally starting on the first trading day on or after May 15 and November 15 of each year. There are two 6-month purchase periods in each
offering period. Eligible employees may contribute up to 15% of their eligible compensation which includes a participants straight time gross earnings, commissions, overtime and shift premium, exclusive of payments for incentive compensation,
bonuses and other compensation. A participant may purchase a maximum of 1,333 shares of common stock per purchase period. If the fair market value of the Companys common stock at the end of a purchase period is less than the fair market value
at the beginning of the offering period, participants will be withdrawn from the then current offering period following the purchase of shares on the purchase date and automatically will be re-enrolled in a new offering period.

The Purchase Plan was effective upon the completion of the Companys IPO, at which time a total of 333,333 shares of the
Companys common stock were made available for sale. Annual increases in the number of shares available for issuance will be made on the first day of each fiscal year, beginning with the Companys 2008 fiscal year. The annual increases
will be equal to the lesser of: (a) 2% of the outstanding shares of the Companys common stock on the first day of the fiscal year; (b) 533,333 shares; or (c) such other amount as may



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



be determined by the Companys board of directors. During the years ended December 31, 2010, 2009 and 2008, 63,280, 52,510 and 51,217 shares were issued, respectively. As of
December 31, 2010, 1,198,843 shares were reserved for future issuance under the Purchase Plan.

The following table
summarizes stock option activity under both the 2000 Stock Incentive and 2007 Stock plans:



|                             |  |                           |            |   |                     |  |           |                                |  |   |      | 
|---------------------------- |  | ------------------------- | ---------- | - | ------------------- |  | --------- | ------------------------------ |  | - | ---- | 
|                             |  |                           |            |   | Options Outstanding | 
|                             |  | Shares Availablefor Grant |            |   | Number of Shares    |  |           | Weighted-AverageExercise Price | 
|Balance at December 31, 2007 |  |                           | 1,019,638  |   |                     |  | 1,135,365 |                                |  | $ | 5.69 | 
|Additional shares authorized |  |                           | 854,954    |   |                     |  |          |                                |  |   |     | 
|Options granted              |  |                           | (486,750   | ) |                     |  | 486,750   |                                |  | $ | 4.37 | 
|Options exercised            |  |                           |           |   |                     |  | (38,210   | )                              |  | $ | 2.39 | 
|Options canceled             |  |                           | 190,360    |   |                     |  | (190,360  | )                              |  | $ | 5.79 | 
|                             |  |                           |            |   |                     |  |           |                                |  |   |      | 
|Balance at December 31, 2008 |  |                           | 1,578,202  |   |                     |  | 1,393,545 |                                |  | $ | 5.31 | 
|Additional shares authorized |  |                           | 878,459    |   |                     |  |          |                                |  |   |     | 
|Options granted              |  |                           | (1,061,642 | ) |                     |  | 1,061,642 |                                |  | $ | 3.85 | 
|Options exercised            |  |                           |           |   |                     |  | (105,247  | )                              |  | $ | 2.76 | 
|Options canceled             |  |                           | 85,405     |   |                     |  | (85,405   | )                              |  | $ | 7.68 | 
|                             |  |                           |            |   |                     |  |           |                                |  |   |      | 
|Balance at December 31, 2009 |  |                           | 1,480,424  |   |                     |  | 2,264,535 |                                |  | $ | 4.65 | 
|Additional shares authorized |  |                           | 886,297    |   |                     |  |          |                                |  |   |     | 
|Options granted              |  |                           | (1,109,539 | ) |                     |  | 1,109,539 |                                |  | $ | 7.39 | 
|Options exercised            |  |                           |           |   |                     |  | (79,869   | )                              |  | $ | 3.23 | 
|Options canceled             |  |                           | 291,712    |   |                     |  | (291,712  | )                              |  | $ | 7.08 | 
|                             |  |                           |            |   |                     |  |           |                                |  |   |      | 
|Balance at December 31, 2010 |  |                           | 1,548,894  |   |                     |  | 3,002,493 |                                |  | $ | 5.47 | 
|                             |  |                           |            |   |                     |  |           |                                |  |   |      | 

Stock-Based Compensation Expense

The Company recognizes stock-based compensation cost for all share-based payments granted subsequent to December 31, 2005.
Stock-based compensation expense for awards made to employees and directors is measured at the date of grant, based on the fair value of the award, and is recognized as expense on a straight-line basis over the requisite service period. During the
years ended December 31, 2010, 2009 and 2008, total stock-based compensation expense recorded was $2,354,000, $2,492,000 and $1,490,000, respectively.

The fair value for the Companys employee stock options was estimated at the date of grant using the Black-Scholes valuation model with the following average assumptions:



|                        |  |                         |      |  |      |  |      |      |  |  |      | 
|----------------------- |  | ----------------------- | ---- |  | ---- |  | ---- | ---- |  |  | ---- | 
|                        |  | Year Ended December 31, |     
|                        |  | 2010                    |      |  | 2009 |  |      | 2008 | 
|Expected volatility     |  |                         | 66%  |  |      |  | 70%  |      |  |  | 70%  | 
|Expected term (years)   |  |                         | 6.0  |  |      |  | 6.0  |      |  |  | 6.0  | 
|Risk-free interest rate |  |                         | 2.8% |  |      |  | 2.2% |      |  |  | 3.0% | 
|Dividend yield          |  |                         | 0%   |  |      |  | 0%   |      |  |  | 0%   | 



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The Companys computation of expected volatility for the years ended
December 31, 2010, 2009 and 2008 is based on an average of the historical volatility of a peer-group of similar companies. The Companys computation of expected term in the years ended December 31, 2010, 2009 and 2008 utilizes the
simplified method. The risk-free interest rate for periods within the term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Stock compensation expense relating to options with acceleration of vesting dependent
upon the achievement of milestones is recognized on a straight-line basis over a period which is the shorter of:



| |  |  | the Companys evaluation of the probability of achievement of each respective milestone and the related estimated date of achievement; or
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the otherwise stated time-based vesting period.
| | - |  | -----------------------------------------------

The following table represents stock option activity for the year ended December 31, 2010:



|                                           |  |                 |           |   |                               |   |      |                                       |  |  |                         |  |  |   |           | 
|------------------------------------------ |  | --------------- | --------- | - | ----------------------------- | - | ---- | ------------------------------------- |  |  | ----------------------- |  |  | - | --------- | 
|                                           |  | Number ofShares |           |   | Weighted-AverageExercisePrice |   |      | Weighted-AverageRemainingContractLife |  |  | AggregateIntrinsicValue | 
|Outstanding options at beginning of period |  |                 | 2,264,535 |   |                               | $ | 4.65 |                                       |  |  |                         |  |  |   |           | 
|Granted                                    |  |                 | 1,109,539 |   |                               |   | 7.39 |                                       |  |  |                         |  |  |   |           | 
|Exercised                                  |  |                 | (79,869   | ) |                               |   | 3.23 |                                       |  |  |                         |  |  |   |           | 
|Forfeited                                  |  |                 | (289,463  | ) |                               |   | 7.08 |                                       |  |  |                         |  |  |   |           | 
|Expired                                    |  |                 | (2,249    | ) |                               |   | 5.90 |                                       |  |  |                         |  |  |   |           | 
|                                           |  |                 |           |   |                               |   |      |                                       |  |  |                         |  |  |   |           | 
|Outstanding options at end of period       |  |                 | 3,002,493 |   |                               | $ | 5.47 |                                       |  |  | 7.36                    |  |  | $ | 5,193,000 | 
|                                           |  |                 |           |   |                               |   |      |                                       |  |  |                         |  |  |   |           | 
|Exercisable options at end of period       |  |                 | 1,863,819 |   |                               | $ | 4.71 |                                       |  |  | 6.64                    |  |  | $ | 4,472,000 | 
|                                           |  |                 |           |   |                               |   |      |                                       |  |  |                         |  |  |   |           | 

The weighted-average grant date fair value of stock options granted during the years ended December 31,
2010, 2009 and 2008 was $4.53, $2.47 and $2.81 per share, respectively. Total intrinsic value of options exercised for the years ended December 31, 2010, 2009 and 2008 was $301,000, $511,000, and $45,000, respectively. Cash received from stock
option exercises and employee stock purchases under its employee stock purchase plan for the years ended December 31, 2010, 2009 and 2008 were $612,000, $365,000 and $2,447,000, respectively. Because of the Companys net operating losses,
the Company did not realize any tax benefits for the tax deductions from share-based payment arrangements during the years ended December 31, 2010, 2009 and 2008. As of December 31, 2010, the total unamortized compensation expense related
to stock-based awards granted to employees and directors was $5,162,000 and it is expected to be amortized over the next 3.9 years.

The Company accounts for its Purchase Plan as a compensatory plan and recorded compensation expense of approximately $207,000, $67,000 and $118,000 for the years ended December 31, 2010, 2009 and
2008, respectively. The estimated fair value of shares granted under the Purchase Plan was determined at the date of grant using the Black-Scholes pricing model with the following assumptions:



|                         |  |                          |  |            |  |           
|------------------------ |  | ------------------------ |  | ---------- |  | ----------
|                         |  | Years Ended December 31,
|                         |  | 2010                     |  | 2009       |  | 2008      
|Expected dividend yield  |  | 0%                       |  | 0%         |  | 0%        
|Expected volatility      |  | 50  89%                 |  | 56  89%   |  | 44  83%  
|Expected life (in years) |  | 0.5 to 1.0               |  | 0.5 to 1.0 |  | 0.5 to 1.0
|Risk-free interest rate  |  | 0.21  0.5%              |  | 0.2  2.1% |  | 0.8  5.0%



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Warrants to Purchase Common Stock

In May 2007, the Company completed its IPO as a result of which all of the existing shares of the Companys preferred stock were
converted to common stock. At the time of the completion of the IPO, the Company had outstanding warrants to purchase 33,600 shares of its Series A preferred stock, 20,000 shares of its Series B preferred stock, and 840,000 shares of its Series C2
preferred stock. Upon closing of the Companys IPO, warrants to purchase 893,600 shares of the Companys preferred stock converted to warrants to purchase 59,573 shares of the Companys common stock. These warrants remain outstanding
at December 31, 2010. Of these warrants to purchase 59,573 shares of the Companys stock, warrants to purchase 56,000 shares of the Companys common stock automatically exercise in the event of an acquisition of the Company. The
Company performed a final remeasurement to determine the fair value of such financial instruments immediately prior to the conversion. The resulting fair value of $426,000 was reclassified to additional paid-in capital during the year ended
December 31, 2007.

In connection with the private placement of common stock in December 2007 and January 2008, the
Company issued the investors warrants to purchase 1,206,273 share of common stock at $8.034 per share. The warrants became exercisable immediately upon issuance and expire five years from issuance. The fair value of the warrants to purchase
1,091,622 shares of common stock issued in conjunction with the first closing of the private placement in December 2007 was approximately $3,411,000 and was determined using the Black-Scholes method with the following assumptions: expected
volatility of 67%, a dividend yield of 0%, a risk-free interest rate of 3.52%, and an expected life of five years. The fair value of the warrants to purchase 114,651 shares of common stock issued in conjunction with the second closing of the private
placement in January 2008 was approximately $420,000 and was determined using the Black-Scholes method with the following assumptions: expected volatility of 67%, a dividend yield of 0%, a risk-free interest rate of 3.26%, and an expected life of
five years. The fair value of the warrants issued was allocated from the proceeds of the financing. All of the 1,206,273 warrants remain outstanding at December 31, 2010.



|12. | Income Taxes
|--- | ------------

Due to the
ongoing operating losses and the inability to recognize any income tax benefit, there is no provision for income taxes.

Deferred tax assets and liabilities reflect the net tax effects of net operating loss and tax credit carryovers and the temporary
differences between the carrying amounts of assets and liabilities for financial reporting and the amounts used for income tax purposes. Significant components of the Companys deferred tax assets are as follows (in thousands):



|                                           |  |                         |         |   |      |   |         |  
|------------------------------------------ |  | ----------------------- | ------- | - | ---- | - | ------- | -
|                                           |  | Year Ended December 31, |        
|                                           |  | 2010                    |         |   | 2009 |  
|Deferred revenue                           |  | $                       | 16,392  |   |      | $ |        |  
|Accrued expenses and other current assets  |  |                         | 1,103   |   |      |   | 392     |  
|Net operating loss carryforward            |  |                         | 48,451  |   |      |   | 47,333  |  
|Capitalized research                       |  |                         | 4,944   |   |      |   | 6,797   |  
|Research and development and other credits |  |                         | 4,867   |   |      |   | 2,713   |  
|Basis difference in fixed assets           |  |                         | 260     |   |      |   | 200     |  
|Stock options                              |  |                         | 1,641   |   |      |   | 1,394   |  
|                                           |  |                         |         |   |      |   |         |  
|Total deferred tax assets                  |  |                         | 77,658  |   |      |   | 58,829  |  
|Valuation allowance                        |  |                         | (77,658 | ) |      |   | (58,829 | )
|                                           |  |                         |         |   |      |   |         |  
|Net deferred tax assets                    |  | $                       |        |   |      | $ |        |  
|                                           |  |                         |         |   |      |   |         |  



89



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Realization of deferred tax assets is dependent upon future earnings, if any, the timing
and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. The valuation allowance increased by $18.8 million and $9.0 million during 2010 and 2009, respectively, and decreased by
$2.4 million during 2008. Our deferred tax assets reflect an estimate of the potential limitation of our utilization of our net operating loss carryforwards and research and development and other credits.

As of December 31, 2010, the Company had net operating loss carryforwards for federal income tax purposes of approximately $143.6
million which will begin to expire in the year 2020 and federal research and development tax credits of approximately $4.7 million which will begin to expire in the year 2020. The Company also had orphan drug credits of approximately $2.4 million
which will begin to expire in the year 2029.

As of December 31, 2010, the Company had net operating loss carryforwards
for state income tax purposes of approximately $145.5 million which will begin to expire in the year 2012 and state research and development tax credits of approximately $4.5 million which have no expiration date.

Utilization of the net operating losses may be subject to substantial annual limitation due to federal and state ownership limitations.
The annual limitation could result in the expiration of the net operating losses before utilization.

The Company received
payments of $46.8 million from Astellas related to the License Agreement in 2009 and deferred that amount to future years for book purposes. For tax purposes, the Company elected to use the deferral method to reflect the upfront payments from
Astellas for tax purposes. In accordance with IRS Revenue Procedure 2004-34, the deferral method allowed the Company to defer this advance payment to 2010 for tax purposes.

The Company utilizes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company
classifies interest and penalties as a component of tax expense.

The Company had unrecognized tax benefits of $2.1 million
and $1.8 million as of December 31, 2010 and December 31, 2009, respectively, all of which are offset by a full valuation allowance. These unrecognized tax benefits, if recognized, would not affect the effective tax rate for the periods
presented. There was no interest or penalties accrued at the adoption date or for any period presented. The Company does not believe it is reasonably possible that its unrecognized tax benefits will significantly change within the next twelve
months.

The Company files income tax returns in the U.S. federal and various state tax jurisdictions. The tax years 2000 to
2010 remain open to examination by the U.S. and state tax authorities.



90



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NEUROGESX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



A reconciliation of the change in the unrecognized tax benefits balance from
January 1, 2008 to December 31, 2010 is as follows:



|                                                    |  |                      |        |  
|--------------------------------------------------- |  | -------------------- | ------ | -
|(In thousands)                                      |  | Federal andState Tax |       
|Balance as of January 1, 2008                       |  | $                    | 2,832  |  
|Additions for tax positions related to current year |  |                      | 103    |  
|Additions for tax positions related to prior years  |  |                      | (1,307 | )
|                                                    |  |                      |        |  
|Balance at December 31, 2008                        |  |                      | 1,628  |  
|Additions for tax positions related to current year |  |                      | 159    |  
|Additions for tax positions related to prior years  |  |                      | 7      |  
|                                                    |  |                      |        |  
|Balance at December 31, 2009                        |  |                      | 1,794  |  
|Additions for tax positions related to current year |  |                      | 255    |  
|Additions for tax positions related to prior years  |  |                      | 24     |  
|                                                    |  |                      |        |  
|Balance at December 31, 2010                        |  | $                    | 2,073  |  
|                                                    |  |                      |        |  



|13. | Unaudited Quarterly Information
|--- | -------------------------------

Certain unaudited quarterly financial information for the years ended December 31, 2010 and 2009 is presented below:



|                                     |  |                                          |        |   |               |   |         |              |  |   |               |   |  |   |         |  
|------------------------------------ |  | ---------------------------------------- | ------ | - | ------------- | - | ------- | ------------ |  | - | ------------- | - |  | - | ------- | -
|                                     |  | FirstQuarter                             |        |   | SecondQuarter |   |         | ThirdQuarter |  |   | FourthQuarter |  
|                                     |  | (In thousands, except per share amounts) |       
|2010                                 |  |                                          |        |  
|Product revenue                      |  | $                                        |       |   |               | $ | 33      |              |  | $ | 197           |   |  | $ | 458     |  
|Collaboration revenue                |  | $                                        | 1,786  |   |               | $ | 2,051   |              |  | $ | 1,854         |   |  | $ | 1,887   |  
|Net Loss                             |  | $                                        | (9,163 | ) |               | $ | (10,233 | )            |  | $ | (12,760       | ) |  | $ | (12,360 | )
|Basic and diluted net loss per share |  | $                                        | (0.52  | ) |               | $ | (0.58   | )            |  | $ | (0.72         | ) |  | $ | (0.69   | )
|                                     |  |                                          |        |  
|2009                                 |  |                                          |        |   |               |   |         |              |  |   |               |   |  |   |         |  
|Collaboration revenue                |  | $                                        |       |   |               | $ |        |              |  | $ | 119           |   |  | $ | 1,887   |  
|Net Loss                             |  | $                                        | (4,602 | ) |               | $ | (5,432  | )            |  | $ | (6,756        | ) |  | $ | (5,077  | )
|Basic and diluted net loss per share |  | $                                        | (0.26  | ) |               | $ | (0.31   | )            |  | $ | (0.38         | ) |  | $ | (0.29   | )



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|Item 9. | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
|------- | ------------------------------------------------------------------------------------

None.



|Item 9A. | Controls and Procedures
|-------- | -----------------------



| | (a) | Evaluation of disclosure controls and procedures
| | --- | ------------------------------------------------

Our management evaluated, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of
the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded, subject to the limitations described below, that our disclosure controls and
procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in
Securities and Exchange Commission, or SEC, rules and forms, and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosures.



| | (b) | Internal control over financial reporting
| | --- | -----------------------------------------

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. We maintain a system of internal controls that is designed to provide reasonable
assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Management assessed our internal control over financial reporting as of December 31, 2010, the end of our last fiscal year.
Management based its assessment on criteria established in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Managements assessment included evaluation of
such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies and our overall control environment.

Based on our assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2010 to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles.

There have not been any changes in our internal controls over financial reporting (as such item is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our fiscal quarter ended
December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

The information contained under this caption Internal control over financial reporting shall not be deemed to be filed with the SEC, nor shall such information be incorporated by reference
into any future filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that we specifically incorporate it by reference into such filing.



| | (c) | Limitations on the Effectiveness of Controls
| | --- | --------------------------------------------

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the controls are met. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Accordingly, our controls and procedures are designed to provide reasonable, not absolute, assurance that
the objectives of our control system are met.



|Item 9B. | Other Information
|-------- | -----------------



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PART III



|Item 10. | Directors, Executive Officers and Corporate Governance
|-------- | ------------------------------------------------------

The information required to be disclosed under this Item, other than as set forth below, is incorporated by reference from our Proxy
Statement for our 2010 Annual Meeting of Stockholders where it appears under the heading Directors and Executive Officers.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Exchange Act requires our officers and directors, and persons who beneficially own more than ten percent of a registered class of our equity securities, to file reports of
ownership and changes in ownership with the SEC. Such officers, directors and ten-percent stockholders are also required by SEC rules to furnish us with copies of all forms that they file pursuant to Section 16(a). Based solely on our review of
the copies of such forms received by us, or written representations from certain reporting persons, we believe that during fiscal 2010, our executive officers, directors and ten-percent stockholders complied with all applicable filing requirements.

Code of Ethics

We have adopted a Code of Ethics that applies to all directors, officers and employees of the Company. We publicize the Code of Ethics through posting the policy on our website, http://www.neurogesx.com.
We will disclose on our website any waivers of, or amendments to, our Code of Ethics.



|Item 11. | Executive Compensation
|-------- | ----------------------

The information required by this Item is incorporated by reference from our definitive Proxy Statement referred to in Item 10 above where it appears under the heading Executive Compensation and
other Matters.



|Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|-------- | ----------------------------------------------------------------------------------------------

The information required by this Item regarding security ownership of certain beneficial owners and management is incorporated by
reference from our definitive Proxy Statement referred to in Item 10 above where it appears under the heading Security Ownership of Certain Beneficial Owners and Management.

The following table summarizes the securities authorized for issuance under our equity compensation plans as of December 31, 2010:



|                                                       |  |                                                                                      |           |  |                                                                      |   |      |                                                                                         |  |  |           | 
|------------------------------------------------------ |  | ------------------------------------------------------------------------------------ | --------- |  | -------------------------------------------------------------------- | - | ---- | --------------------------------------------------------------------------------------- |  |  | --------- | 
|Plan Category                                          |  | Number ofSecurities tobe Issued UponExercise ofOutstandingOptions,Warrants
andRights |           |  | WeightedAverageExercisePrice ofOutstandingOptions,Warrantsand
Rights |   |      | Number ofSecuritiesRemainingAvailable forFutureIssuanceUnder
EquityCompensationPlans(1) | 
|Equity compensation plans approved by stockholders     |  |                                                                                      | 3,002,493 |  |                                                                      | $ | 5.47 |                                                                                         |  |  | 3,998,574 | 
|Equity compensation plans not approved by stockholders |  |                                                                                      | 1,265,846 |  |                                                                      | $ | 8.18 |                                                                                         |  |  |          | 
|                                                       |  |                                                                                      |           |  |                                                                      |   |      |                                                                                         |  |  |           | 
|Total                                                  |  |                                                                                      | 4,268,339 |  |                                                                      | $ | 6.27 |                                                                                         |  |  | 3,998,574 | 
|                                                       |  |                                                                                      |           |  |                                                                      |   |      |                                                                                         |  |  |           | 



|(1) | The number of authorized shares under the 2007 Stock Plan automatically increases on January 1 of each year by a number of shares equal to the lesser of
(i) 1,333,333 shares, (ii) 5.0% of the outstanding shares on the last day of the immediately preceding fiscal year, or (iii) an amount determined by the Board of Directors. The number of authorized shares under the 2007 Employee
Stock Purchase Plan automatically increases on January 1 of each year by a number of shares equal to the lesser of (i) 533,333 shares, (ii) 2.0% of the outstanding shares on such date, or (iii) an amount determined by the
Board of Directors.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|Item 13. | Certain Relationships and Related Transactions, and Director Independence
|-------- | -------------------------------------------------------------------------

The information required by this Item is incorporated by reference from our definitive Proxy Statement referred to in Item 10 above
where it appears under the heading Certain Business Relationships and Related Party Transactions.



|Item 14. | Principal Accounting Fees and Services
|-------- | --------------------------------------

The information required by this Item is incorporated by reference from our definitive Proxy Statement referred to in Item 10 above where it appears under the heading Principal Accountant Fees
and Services.



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PART IV



|Item 15. | Exhibits and Financial Statement Schedules
|-------- | ------------------------------------------



| | (a) | The following documents are filed as part of this Form 10-K:
| | --- | ------------------------------------------------------------



| | (1) | Financial Statements (included in Part II of this report):
| | --- | ----------------------------------------------------------



| |  |  | Report of Independent Registered Public Accounting Firm
| | - |  | -------------------------------------------------------



| |  |  | Consolidated Balance Sheets
| | - |  | ---------------------------



| |  |  | Consolidated Statements of Operations
| | - |  | -------------------------------------



| |  |  | Consolidated Statements of Stockholders Equity (Deficit)
| | - |  | ---------------------------------------------------------



| |  |  | Consolidated Statements of Cash Flows
| | - |  | -------------------------------------



| |  |  | Notes to Consolidated Financial Statements
| | - |  | ------------------------------------------



| | (2) | Financial Statement Schedules:
| | --- | ------------------------------

NoneAll financial statement schedules are omitted because the information is inapplicable or presented in the notes to the financial
statements.



| | (3) | Exhibits:
| | --- | ---------



|              |  |                                                                                                                                                                      
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Title                                                                                                                                                        
|3.1(1)        |  | Amended and Restated Certificate of Incorporation.                                                                                                                   
|              | 
|3.2(1)        |  | Amended and Restated Bylaws.                                                                                                                                         
|              | 
|4.1(1)        |  | Specimen Common Stock Certificate.                                                                                                                                   
|              | 
|4.2(1)        |  | Third Amended and Restated Investors Rights Agreement by and between NeurogesX, Inc. and certain stockholders, dated as of November 14, 2005.                       
|              | 
|4.3(2)        |  | Amendment No. 1 to the Third Amended and Restated Investors Rights Agreement by and between NeurogesX, Inc. and certain stockholders, dated as of December 28,
2007.
|              | 
|4.4(3)        |  | Amendment No. 2 to the Third Amended and Restated Investors Rights Agreement by and between NeurogesX, Inc. and certain stockholders, dated as of August 5,
2010.   
|              | 
|4.5(1)        |  | Warrant to Purchase Series A Preferred Stock by and between NeurogesX, Inc. and Silicon Valley Bank, dated as of December 14, 2000.                                  
|              | 
|4.6(1)        |  | Warrant to Purchase Series B Preferred Stock by and between NeurogesX, Inc. and Silicon Valley Bank, dated as of May 1, 2002.                                        
|              | 
|4.7(1)        |  | Warrant to Purchase Shares of Series C2 Preferred Stock by and between NeurogesX, Inc. and Horizon Technology Funding Company II LLC, dated as of July 7,
2006.      
|              | 
|4.8(1)        |  | Warrant to Purchase Shares of Series C2 Preferred Stock by and between NeurogesX, Inc. and Horizon Technology Funding Company III LLC, dated as of July 7,
2006.     
|              | 
|4.9(1)        |  | Warrant to Purchase Shares of Series C2 Preferred Stock by and between NeurogesX, Inc. and Oxford Finance Corporation, dated as of July 7, 2006.                     
|              | 
|4.10(1)       |  | Form of First Warrant to Purchase Series C2 Preferred Stock.                                                                                                         
|              | 
|4.11(1)       |  | Form of Second Warrant to Purchase Series C2 Preferred Stock.                                                                                                        



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|              |  |                                                                                                                                              
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Title                                                                                                                                
|4.12(2)       |  | Registration Rights Agreement by and between NeurogesX, Inc. and certain investors, dated as of December 23, 2007.                           
|              | 
|4.13(2)       |  | Form of Warrant to Purchase Common Stock                                                                                                     
|              | 
|10.1(4)       |  | 2007 Stock Plan as amended.                                                                                                                  
|              | 
|10.2(1)       |  | 2007 Employee Stock Purchase Plan.                                                                                                           
|              | 
|10.3(1)       |  | Form of Indemnification Agreement entered into between NeurogesX, Inc. and each of its directors and officers.                               
|              | 
|10.4(5)       |  | Exclusive License Agreement between NeurogesX, Inc. and The Regents of the University of California, executed as of October 6, 2008.         
|              | 
|10.5(1)      |  | Clinical Supply, Development and License Agreement between NeurogesX, Inc. and LTS Lohmann Therapie-Systeme AG, dated as of January 15, 2004.
|              | 
|10.6(6)      |  | Manufacturing and Supply Agreement, effective as of August 19, 2008 between NeurogesX, Inc. and Formosa Laboratories, Inc.                   
|              | 
|10.7(5)      |  | Commercial Supply and License Agreement with Lohmann Therapie-Systeme AG and NeurogesX, Inc., effective as of January 2007.                  
|              | 
|10.8(5)       |  | Amended and Restated Executive Employment Agreement by and between NeurogesX, Inc. and Anthony DiTonno, effective as of December 31, 2008.   
|              | 
|10.9(5)       |  | Amended and Restated Executive Employment Agreement by and between NeurogesX, Inc. and Stephen Ghiglieri, effective as of December 31, 2008. 
|              | 
|10.10(5)      |  | Amended and Restated Executive Employment Agreement by and between NeurogesX, Inc. and Keith Bley, effective as of December 31, 2008.        
|              | 
|10.11(5)      |  | Amended and Restated Executive Employment Agreement by and between NeurogesX, Inc. and Michael Markels, effective as of December 31, 2008.   
|              | 
|10.12(5)      |  | Amended and Restated Executive Employment Agreement by and between NeurogesX, Inc. and Jeffrey Tobias, effective as of December 31, 2008.    
|              | 
|10.13(5)      |  | Amended and Restated Executive Employment Agreement by and between NeurogesX, Inc. and Russell Kawahata, effective as of December 31, 2008.  
|              | 
|10.14(5)      |  | Amended and Restated Executive Employment Agreement by and between NeurogesX, Inc. and Susan Rinne, effective as of December 31, 2008.       
|              | 
|10.15(7)      |  | Sublease between NeurogesX, Inc. and Oracle USA, Inc., dated September 6, 2007.                                                              
|              | 
|10.16(2)      |  | Securities Purchase Agreement by and between NeurogesX, Inc. and certain investors, dated as of December 23, 2007.                           
|              | 
|10.17(8)      |  | Distribution, Marketing and License Agreement between NeurogesX, Inc. and Astellas Pharma Europe Limited, effective as of June 19, 2009.     
|              | 
|10.18(8)      |  | Supply Agreement between NeurogesX, Inc. and Astellas Pharma Europe Limited, effective as of June 19, 2009.                                  
|              | 
|10.19(9)     |  | Financing Agreement between NeurogesX, Inc. and Cowen Healthcare Royalty Partners, L.P., dated as of April 30,
2010.                         



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|              |  |                                                                                                                                                                          
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Title                                                                                                                                                            
|23.1          |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                
|              | 
|24.1          |  | Power of Attorney (see page 98).                                                                                                                                         
|              | 
|31.1          |  | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                  
|              | 
|31.2          |  | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                  
|              | 
|32.1          |  | Certifications of the Principal Executive Officer and the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.
Section 1350).



|(1) | Incorporated by reference from our registration statement on Form S-1, registration number 333-140501, declared effective by the Securities and Exchange
Commission on May 1, 2007.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference from our Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 28, 2007.
|--- | --------------------------------------------------------------------------------------------------------------------------------------

|(3) | Incorporated by reference from our Current Report on Form 8-K, filed with the Securities and Exchange Commission on August 10, 2010.
|--- | ------------------------------------------------------------------------------------------------------------------------------------

|(4) | Incorporated by reference from our Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 7, 2010.
|--- | ---------------------------------------------------------------------------------------------------------------------------------

|(5) | Incorporated by reference from our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 26, 2009.
|--- | -----------------------------------------------------------------------------------------------------------------------------------

|(6) | Incorporated by reference from our Current Report on Form 8-K, filed with the Securities and Exchange Commission on August 22, 2008.
|--- | ------------------------------------------------------------------------------------------------------------------------------------

|(7) | Incorporated by reference from our Quarterly Report on Form 10-Q, filed with the Securities and Exchange Commission on November 14, 2007.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------

|(8) | Incorporated by reference from our Current Report on Form 8-K/A, filed with the Securities and Exchange Commission on July 1, 2009.
|--- | -----------------------------------------------------------------------------------------------------------------------------------

|(9) | Incorporated by reference from our Current Report on Form 8-K, filed with the Securities and Exchange Commission on May 6, 2010.
|--- | --------------------------------------------------------------------------------------------------------------------------------

| | Confidential treatment has been requested for portions of this exhibit. These portions have been omitted from this filing and have been filed separately with the
Securities and Exchange Commission.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | Exhibits
| | --- | --------

The exhibits listed
under Item 14(a)(3) hereof are filed as part of this Form 10-K other than Exhibit 32.1 which shall be deemed furnished.



| | (c) | Financial Statement Schedules
| | --- | -----------------------------

All financial statement schedules are omitted because the information is inapplicable or presented in the notes to the financial
statements.



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##### Table of Contents



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.



NEUROGESX, INC.By:

/S/    ANTHONY A.
DITONNOAnthony A. DiTonnoPresident, Chief Executive Officer and Director


Dated: March 30, 2011

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Anthony A. DiTonno and
Stephen F. Ghiglieri, and each of them, his true and lawful attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report on Form 10-K and to file the same, with
exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by
virtue hereof.

Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on the dates indicated.



|                                                   |  |                                                                                                                              |  |               
|-------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------- |  | --------------
|Signature                                          |  | Title                                                                                                                        |  | Date          
|                                                   |  |                                                                                                                             
|/S/    ANTHONY A.
DITONNO Anthony A. DiTonno       |  | President, Chief Executive Officerand Director (Principal Executive Officer)                                                 |  | March 30, 2011
|                                                   |  |                                                                                                                             
|/S/    STEPHEN F.
GHIGLIERI Stephen F. Ghiglieri   |  | Executive Vice President, Chief Operating Officer and Chief Financial Officer (Principal Financial and Accounting Executive) |  | March 30, 2011
|                                                   |  |                                                                                                                             
|/S/    JEAN-JACQUES
BIENAIME Jean-Jacques Bienaimé |  | Chairman of the Board of Directors                                                                                           |  | March 30, 2011
|                                                   |  |                                                                                                                             
|/S/    NEIL M.
KURTZ Neil M. Kurtz                 |  | Director                                                                                                                     |  | March 30, 2011
|                                                   |  |                                                                                                                             
|/S/    ROBERT T.
NELSEN Robert T. Nelsen           |  | Director                                                                                                                     |  | March 30, 2011
|                                                   |  |                                                                                                                             
|/S/    BRAD
GOODWIN Brad Goodwin                   |  | Director                                                                                                                     |  | March 30, 2011
|                                                   |  |                                                                                                                             
|/S/    JOHN
ORWIN John Orwin                       |  | Director                                                                                                                     |  | March 30, 2011
|                                                   |  |                                                                                                                             
|/S/    STEVEN
NELSON Steven Nelson                 |  | Director                                                                                                                     |  | March 30, 2011



98