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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q





(Mark One)

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

For the quarterly period ended June 30, 2009

or



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

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, California     |  | 94404                                  
|(Address of principal executive offices)                       |  | (Zip Code)                             

Registrants telephone number, including area code: (650) 358-3300





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 Web site, 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 whether
the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer and smaller reporting
company in Rule 12b-2 of the Exchange Act.



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

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

Number of shares of common stock, $0.001 par value, outstanding as of July 31, 2009: 17,611,877









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##### Table of Contents

NEUROGESX, INC.

(A DEVELOPMENT STAGE COMPANY)

TABLE OF CONTENTS FOR FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2009



|              |  |                                                                                                                                                                                   |  |     
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|              |  |                                                                                                                                                                                   |  | Page
|PART I.       |  | FINANCIAL INFORMATION                                                                                                                                                             |  | 1   
|              |  | Item 1. Financial Statements (unaudited)                                                                                                                                          |  | 1   
|              |  | Condensed Consolidated Balance Sheets as of June 30, 2009 and December 31, 2008                                                                                                   |  | 1   
|              |  | Condensed Consolidated Statements of Operations for the three and six months ended June 
30, 2009 and 2008, and the period from May 28, 1998 (date of inception) to June 30, 2009 |  | 2   
|              |  | Condensed Consolidated Statements of Cash Flows for the six months ended June 
30, 2009 and 2008, and the period from May 28, 1998 (date of inception) to June 30, 2009           |  | 3   
|              |  | Notes to Condensed Consolidated Financial Statements                                                                                                                              |  | 4   
|              |  | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations                                                                                     |  | 15  
|              |  | Item 3. Quantitative and Qualitative Disclosures About Market Risk                                                                                                                |  | 25  
|              |  | Item 4T. Controls and Procedures                                                                                                                                                  |  | 26  
|              |  |                                                                                                                                                                                  
|PART II.      |  | OTHER INFORMATION                                                                                                                                                                 |  | 27  
|              |  | Item 1. Legal Proceedings                                                                                                                                                         |  | 27  
|              |  | Item 1A. Risk Factors                                                                                                                                                             |  | 27  
|              |  | Item 2. Unregistered Sales of Equity Securities and Use of Proceeds                                                                                                               |  | 49  
|              |  | Item 3. Defaults Upon Senior Securities                                                                                                                                           |  | 49  
|              |  | Item 4. Submission of Matters to a Vote of Security Holders                                                                                                                       |  | 49  
|              |  | Item 5. Other Information                                                                                                                                                         |  | 49  
|              |  | Item 6. Exhibits                                                                                                                                                                  |  | 50  
|              | 
|SIGNATURES    |  | 51                                                                                                                                                                               
|              | 
|EXHIBIT INDEX |  | 52                                                                                                                                                                               



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##### Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (Unaudited)

NeurogesX, Inc.

(A Development Stage Company)

Condensed Consolidated Balance Sheets

(in thousands)



|                                                 |  |              |          |   |                  |   |          |  
|------------------------------------------------ |  | ------------ | -------- | - | ---------------- | - | -------- | -
|                                                 |  | June 30,2009 |          |   | December 31,2008 |  
|                                                 |  | (unaudited)  |          |   | (Note 1)         |  
|Assets                                           |  |              |          |   |                  |   |          |  
|Current assets:                                  |  |              |          |   |                  |   |          |  
|Cash and cash equivalents                        |  | $            | 4,914    |   |                  | $ | 10,435   |  
|Short-term investments                           |  |              | 8,524    |   |                  |   | 14,071   |  
|Receivable from collaboration partner            |  |              | 48,787   |   |                  |   |         |  
|Prepaid expenses and other current assets        |  |              | 471      |   |                  |   | 412      |  
|Restricted cash                                  |  |              | 40       |   |                  |   | 40       |  
|                                                 |  |              |          |   |                  |   |          |  
|Total current assets                             |  |              | 62,736   |   |                  |   | 24,958   |  
|Property and equipment, net                      |  |              | 380      |   |                  |   | 468      |  
|Restricted cash                                  |  |              | 160      |   |                  |   | 160      |  
|Other assets                                     |  |              |         |   |                  |   | 4        |  
|                                                 |  |              |          |   |                  |   |          |  
|Total assets                                     |  | $            | 63,276   |   |                  | $ | 25,590   |  
|                                                 |  |              |          |   |                  |   |          |  
|Liabilities and Stockholders Equity             |  |              |          |   |                  |   |          |  
|Current liabilities:                             |  |              |          |   |                  |   |          |  
|Accounts payable                                 |  | $            | 490      |   |                  | $ | 370      |  
|Accrued compensation                             |  |              | 873      |   |                  |   | 1,039    |  
|Accrued research and development                 |  |              | 445      |   |                  |   | 1,067    |  
|Other accrued expenses                           |  |              | 915      |   |                  |   | 540      |  
|Deferred revenue                                 |  |              | 4,304    |   |                  |   |         |  
|Notes payable  current portion                  |  |              | 1,273    |   |                  |   | 2,833    |  
|                                                 |  |              |          |   |                  |   |          |  
|Total current liabilities                        |  |              | 8,300    |   |                  |   | 5,849    |  
|Non-current liabilities:                         |  |              |          |   |                  |   |          |  
|Deferred revenue                                 |  |              | 44,483   |   |                  |   |         |  
|Notes payable  non-current portion              |  |              |         |   |                  |   | 191      |  
|Deferred rent                                    |  |              | 354      |   |                  |   | 276      |  
|                                                 |  |              |          |   |                  |   |          |  
|Total non-current liabilities                    |  |              | 44,837   |   |                  |   | 467      |  
|                                                 |  |             
|Commitments and contingencies                    |  |              |          |   |                  |   |          |  
|                                                 |  |             
|Stockholders equity:                            |  |              |          |   |                  |   |          |  
|Common stock                                     |  |              | 18       |   |                  |   | 18       |  
|Additional paid-in capital                       |  |              | 210,296  |   |                  |   | 209,370  |  
|Deferred stock-based compensation                |  |              |         |   |                  |   | (2       | )
|Accumulated other comprehensive income           |  |              | 2        |   |                  |   | 32       |  
|Deficit accumulated during the development stage |  |              | (200,177 | ) |                  |   | (190,144 | )
|                                                 |  |              |          |   |                  |   |          |  
|Total stockholders equity                       |  |              | 10,139   |   |                  |   | 19,274   |  
|                                                 |  |              |          |   |                  |   |          |  
|Total liabilities and stockholders equity       |  | $            | 63,276   |   |                  | $ | 25,590   |  
|                                                 |  |              |          |   |                  |   |          |  

See accompanying notes.



1



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##### Table of Contents

NeurogesX, Inc.

(A Development Stage Company)

Condensed Consolidated Statements of Operations

(in thousands, except share and per share data)

(unaudited)



|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|----------------------------------------------------------------------------------------------- |  | --------------------------- | ---------- | - | ------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | ------------------------------------------------- | ---------- | - |  | - | -------- | -
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  | Period fromMay 28, 1998(inception) toJune 30,2009 |           
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   | 
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   | 
|                                                                                                |  | Three Months Ended June 30, |            |   | Six Months Ended June 30, |   |           
|                                                                                                |  | 2009                        |            |   | 2008                      |   |            | 2009 |  |   | 2008       |   | 
|Operating expenses:                                                                             |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|Research and development(1)                                                                     |  | $                           | 2,780      |   |                           | $ | 4,174      |      |  | $ | 5,106      |   |  | $                                                 | 9,955      |   |  | $ | 116,598  |  
|General and administrative(2)                                                                   |  |                             | 2,605      |   |                           |   | 2,863      |      |  |   | 4,794      |   |  |                                                   | 5,350      |   |  |   | 43,849   |  
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|Total operating expenses                                                                        |  |                             | 5,385      |   |                           |   | 7,037      |      |  |   | 9,900      |   |  |                                                   | 15,305     |   |  |   | 160,447  |  
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|                                                                                                |  |                             |            |   |                          
|Loss from operations                                                                            |  |                             | (5,385     | ) |                           |   | (7,037     | )    |  |   | (9,900     | ) |  |                                                   | (15,305    | ) |  |   | (160,447 | )
|Interest income                                                                                 |  |                             | 11         |   |                           |   | 285        |      |  |   | 45         |   |  |                                                   | 789        |   |  |   | 5,017    |  
|Interest expense                                                                                |  |                             | (68        | ) |                           |   | (214       | )    |  |   | (188       | ) |  |                                                   | (457       | ) |  |   | (2,906   | )
|Other income (expense), net                                                                     |  |                             | 10         |   |                           |   | 22         |      |  |   | 10         |   |  |                                                   | 39         |   |  |   | (2,937   | )
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|Net loss before cumulative effect of change in accounting principle                             |  |                             | (5,432     | ) |                           |   | (6,944     | )    |  |   | (10,033    | ) |  |                                                   | (14,934    | ) |  |   | (161,273 | )
|Cumulative effect of change in accounting principle                                             |  |                             |           |   |                           |   |           |      |  |   |           |   |  |                                                   |           |   |  |   | (32      | )
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|Net loss                                                                                        |  |                             | (5,432     | ) |                           |   | (6,944     | )    |  |   | (10,033    | ) |  |                                                   | (14,934    | ) |  |   | (161,305 | )
|Accretion of redeemable convertible preferred stock                                             |  |                             |           |   |                           |   |           |      |  |   |           |   |  |                                                   |           |   |  |   | (38,872  | )
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|                                                                                                |  |                             |            |   |                          
|Net loss attributable to common stockholders                                                    |  | $                           | (5,432     | ) |                           | $ | (6,944     | )    |  | $ | (10,033    | ) |  | $                                                 | (14,934    | ) |  | $ | (200,177 | )
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|                                                                                                |  |                             |            |   |                          
|Basic and diluted net loss per share attributable to common stockholders                        |  | $                           | (0.31      | ) |                           | $ | (0.40      | )    |  | $ | (0.57      | ) |  | $                                                 | (0.85      | ) |  |   |          |  
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|Shares used to compute basic and diluted net loss per share attributable to common stockholders |  |                             | 17,580,158 |   |                           |   | 17,516,667 |      |  |   | 17,574,455 |   |  |                                                   | 17,492,531 |   |  |   |          |  
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|Non-cash stock-based compensation expense included in operating expenses:                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|(1)    Research and development                                                                 |  | $                           | 189        |   |                           | $ | 215        |      |  | $ | 448        |   |  | $                                                 | 413        |   |  |   |          |  
|(2)    General and administrative                                                               |  |                             | 201        |   |                           |   | 180        |      |  |   | 449        |   |  |                                                   | 381        |   |  |   |          |  
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  
|                                                                                                |  | $                           | 390        |   |                           | $ | 395        |      |  | $ | 897        |   |  | $                                                 | 794        |   |  |   |          |  
|                                                                                                |  |                             |            |   |                           |   |            |      |  |   |            |   |  |                                                   |            |   |  |   |          |  

See accompanying notes.



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##### Table of Contents

NeurogesX, Inc.

(A Development Stage Company)

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)



|                                                                                        |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|--------------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | ------------------------------------------------- |  | - | -------- | -
|                                                                                        |  |                          |         |   |      |   |         | Period fromMay 28, 1998(inception) toJune 30,2009 | 
|                                                                                        |  |                          |         |   |      |   |        
|                                                                                        |  |                          |         |   |      |   |        
|                                                                                        |  | Six Months EndedJune 30, |         |  
|                                                                                        |  | 2009                     |         |   | 2008 |   |        
|Operating activities                                                                    |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|Net loss                                                                                |  | $                        | (10,033 | ) |      | $ | (14,934 | )                                                 |  | $ | (161,305 | )
|Adjustments to reconcile net loss to net cash used in operating activities:             |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|Depreciation and amortization                                                           |  |                          | 96      |   |      |   | 84      |                                                   |  |   | 1,642    |  
|Amortization of debt issuance costs                                                     |  |                          | 56      |   |      |   | 99      |                                                   |  |   | 548      |  
|Amortization/accretion of investment premiums/(discounts), net                          |  |                          | 53      |   |      |   | (528    | )                                                 |  |   | (1,035   | )
|Stock-based compensation                                                                |  |                          | 897     |   |      |   | 794     |                                                   |  |   | 9,352    |  
|(Gain)/loss on sales of short-term investments                                          |  |                          |        |   |      |   | (39     | )                                                 |  |   | 8        |  
|(Gain)/loss on disposal of fixed assets                                                 |  |                          |        |   |      |   |        |                                                   |  |   | 87       |  
|Revaluation of preferred stock warrant liability                                        |  |                          |        |   |      |   |        |                                                   |  |   | 2,888    |  
|Changes in operating assets and liabilities:                                            |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|Prepaid expenses and other current assets                                               |  |                          | (55     | ) |      |   | (58     | )                                                 |  |   | (467     | )
|Other assets                                                                            |  |                          |        |   |      |   |        |                                                   |  |   | (106     | )
|Accounts payable                                                                        |  |                          | 120     |   |      |   | (727    | )                                                 |  |   | 490      |  
|Accrued compensation                                                                    |  |                          | (166    | ) |      |   | 93      |                                                   |  |   | 873      |  
|Accrued research and development                                                        |  |                          | (622    | ) |      |   | 197     |                                                   |  |   | 445      |  
|Deferred rent                                                                           |  |                          | 140     |   |      |   | 98      |                                                   |  |   | 440      |  
|Other accrued expenses                                                                  |  |                          | 315     |   |      |   | (826    | )                                                 |  |   | 843      |  
|                                                                                        |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|Net cash used in operating activities                                                   |  |                          | (9,199  | ) |      |   | (15,747 | )                                                 |  |   | (145,297 | )
|                                                                                        |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|                                                                                        |  |                          |        
|Investing activities                                                                    |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|Purchases of short-term investments                                                     |  |                          | (10,036 | ) |      |   | (40,088 | )                                                 |  |   | (197,279 | )
|Proceeds from maturities of short-term investments                                      |  |                          | 15,500  |   |      |   | 21,251  |                                                   |  |   | 156,854  |  
|Proceeds from sales of short-term investments                                           |  |                          |        |   |      |   | 13,749  |                                                   |  |   | 32,929   |  
|Change in restricted cash                                                               |  |                          |        |   |      |   |        |                                                   |  |   | (200     | )
|Proceeds from disposal of property and equipment                                        |  |                          |        |   |      |   |        |                                                   |  |   | 8        |  
|Purchases of property and equipment                                                     |  |                          | (8      | ) |      |   | (136    | )                                                 |  |   | (2,117   | )
|                                                                                        |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|Net cash provided by/(used in) investing activities                                     |  |                          | 5,456   |   |      |   | (5,224  | )                                                 |  |   | (9,805   | )
|                                                                                        |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|                                                                                        |  |                          |        
|Financing activities                                                                    |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|Proceeds from notes payable                                                             |  |                          |        |   |      |   |        |                                                   |  |   | 11,092   |  
|Repayment of notes payable                                                              |  |                          | (1,804  | ) |      |   | (1,948  | )                                                 |  |   | (9,792   | )
|Proceeds from issuance of redeemable convertible preferred stock, net of issuance costs |  |                          |        |   |      |   |        |                                                   |  |   | 96,187   |  
|Proceeds from issuance of warrants                                                      |  |                          |        |   |      |   | 14      |                                                   |  |   | 150      |  
|Proceeds from issuance of common stock                                                  |  |                          | 26      |   |      |   | 2,381   |                                                   |  |   | 62,379   |  
|                                                                                        |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|Net cash provided by/(used in) financing activities                                     |  |                          | (1,778  | ) |      |   | 447     |                                                   |  |   | 160,016  |  
|                                                                                        |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|Net increase/(decrease) in cash and cash equivalents                                    |  |                          | (5,521  | ) |      |   | (20,524 | )                                                 |  |   | 4,914    |  
|Cash and cash equivalents, beginning of period                                          |  |                          | 10,435  |   |      |   | 31,478  |                                                   |  |   |         |  
|                                                                                        |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|Cash and cash equivalents, end of period                                                |  | $                        | 4,914   |   |      | $ | 10,954  |                                                   |  | $ | 4,914    |  
|                                                                                        |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|                                                                                        |  |                          |        
|Supplemental cash flow information                                                      |  |                          |         |   |      |   |         |                                                   |  |   |          |  
|Cash paid for interest                                                                  |  | $                        | 132     |   |      | $ | 377     |                                                   |  | $ | 2,289    |  
|                                                                                        |  |                          |         |   |      |   |         |                                                   |  |   |          |  

See accompanying notes.



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##### Table of Contents

NEUROGESX, INC.

(A DEVELOPMENT STAGE COMPANY)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)

Note 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 most advanced product candidate, Qutenza (formerly NGX-4010), a
dermal patch containing a high concentration of synthetic capsaicin, is designed to manage pain associated with peripheral neuropathic pain conditions. In May 2009, Qutenza received a marketing authorization (MA) in the European Union
for the treatment of peripheral neuropathic pain in non-diabetic adults, 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).

In the United States, the Company submitted to the U.S. Food and Drug Administration (FDA) a new drug application (NDA) for
Qutenza for the management of pain associated with postherpetic neuralgia (PHN) in October 2008, which was filed by the FDA in December 2008. The Companys NDA was originally given a Prescription Drug User Fee Act
(PDUFA) date of August 16, 2009. However, on August 5, 2009, the FDA extended the PDUFA date to November 16, 2009 to provide time for a full review of a submission made to the FDA in late July 2009. The submission
contained various data and analyses provided in response to FDA requests.

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. Since its inception, the Company has
devoted substantially all of its efforts to the development of Qutenza, the preparation for potential commercialization of Qutenza and the development of other potential products, establishing its offices, recruiting personnel, performing business
and financial planning, and raising capital. Accordingly, the Company is considered to be in the development stage. The Company has not generated any revenue to date and has incurred operating and net losses each year since inception in 1998.

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.



4



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Basis of Presentation

The accompanying unaudited condensed consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim
financial information on the same basis as the annual consolidated financial statements and in accordance with instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by GAAP for complete financial statements. The unaudited condensed consolidated interim financial statements include all adjustments (consisting only of normal recurring adjustments) that management believes are necessary for the
fair statement of the balances and results for the periods presented. These unaudited condensed consolidated interim financial statement results are not necessarily indicative of results to be expected for the full fiscal year or any future interim
period.

The balance sheet at December 31, 2008 has been derived from the audited consolidated financial statements at that date. The
unaudited condensed consolidated interim financial statements and related disclosures have been prepared with the presumption that users of such information have read or have access to the audited consolidated financial statements for the preceding
fiscal year. Accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2008 contained in the Companys 2008 Form 10-K. The
Company has evaluated its subsequent events for disclosure in this Quarterly Report on Form 10-Q through August 14, 2009, the date in which the financial statements were issued.

Use of Estimates

The preparation of financial statements in conformity with GAAP 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.

Note 2. Summary of Significant Accounting Policies

Inventory

The Company will capitalize future costs associated with inventory to be sold in the United States, including internal and external costs of manufacture,
and the cost of acceptance and release of products which are approved for sale. Internal costs primarily consist of supply chain management and quality assurance. External costs primarily include the cost of product manufacture, as charged by our
third party manufacturers as well as transportation and packaging costs. Purchase of material from our third party manufacturers is either recorded as research and development expense if received prior to FDA approval or, if FDA approval has been
received, will be capitalized at such time that title is transferred. As of June 30, 2009, Qutenza was not an approved product in the United States, and accordingly, costs associated with product manufacturing have been recorded as research and
development expense on the Companys statement of operations.

Prepaid Collaboration Supplies

Costs to manufacture product for supply to Astellas under its supply agreement, including internal labor costs and third party manufacturing, packaging
and transportation costs, for products which have been approved for sale, are carried as prepaid collaboration supplies on the Companys balance sheet until such time as those supplies are delivered to Astellas. Upon delivery to Astellas, such
amounts are recorded as a component of Collaboration revenue on the Companys statement of operations, net of the reimbursement for those expenses due from the collaboration partner. The Company expects the net profit or loss on collaboration
supplies will not be material.



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Revenue Recognition

NeurogesX entered into the Astellas Agreement which provides for an exclusive license 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, which the Company anticipates may be within 18 to 24 months of the execution of the Astellas Agreement. Potential revenue under this
arrangement includes upfront non-refundable fees and may include 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. Reported revenue
will also include net profit or loss in connection with the Supply Agreement, which the Company expects to be immaterial.

Revenue
recognized from collaborative agreements is based upon the provisions of Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition, Emerging Issues Task Force (EITF), Issue No. 07-1, Accounting for Collaboration
Arrangements (EITF 07-1), and EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21).

In accordance with EITF 00-21, multiple element arrangements are analyzed 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 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 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 undelivered elements of the arrangement would then 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.

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.

With respect to the Astellas Agreement
and related agreements, the Company views this arrangement as a multiple element arrangement with the key elements 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 in accordance with EITF 00-21. Further, the agreement provides 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 will
recognize 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.



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As of June 30, 2009, the upfront license fees are subject to a refund right, which expires upon
transfer of the Companys MA for Qutenza in the European Union to Astellas. Therefore, commencement of revenue recognition of the upfront license fee is being deferred until such time as this refund right expires.

Milestone revenue upon achievement of certain product sales levels and royalty revenue on net sales of products will be recognized as earned in
accordance with contract terms, when third party results are reported and collection is reasonably assured.

In the financial statements,
Collaboration revenue represents revenue associated with the Astellas Agreement and related agreements, including amortization of up-front fees and payments associated with the licensing option for NGX-1998, milestone revenue upon achievement of
certain product sales levels, royalty revenue on net sales of products, and net profit or loss on collaboration supplies. Deferred revenue arises from the excess of cash received or receivable over cumulative revenue recognized over the term of the
Companys continuing obligations.

Stock-Based Compensation

Effective January 1, 2006 the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123R,
Share-Based Payment(SFAS No. 123R). Under SFAS No. 123R, 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 the Company has elected to amortize on a straight-line basis. The Company has applied the provisions of Staff Accounting Bulletin No. 110, which allows for the utilization of a simplified method in
determining the expected term of an option. Because non-cash stock compensation expense is based on awards ultimately expected to vest, it has been reduced by an estimate for future forfeitures. SFAS No. 123R requires forfeitures to be
estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company adopted the provisions of SFAS No. 123R using the prospective transition method. Under the
prospective transition method, beginning January 1, 2006, compensation cost recognized includes:



| |  |  | compensation cost for all share-based payments granted prior to, but not yet vested as of December 31, 2005, based on the intrinsic value in accordance with
the provisions of APB No. 25, and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | compensation cost for all share-based payments granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the
provisions of SFAS No. 123R.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

All awards granted, modified, or settled after the date of adoption are accounted for
using the measurement, recognition, and attribution provisions of SFAS No. 123R. The Company has elected to use the Black-Scholes option valuation model to estimate the fair value of stock options. Stock compensation expense relating to options
with acceleration of vesting dependant upon the achievement of milestones is recognized 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.
| | - |  | -----------------------------------------------



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The following tables show the assumptions used to compute stock-based compensation expense for stock
options granted to employees and members of the board of directors and the assumptions used to compute stock-based compensation expense for the Companys Employee Stock Purchase Plan (ESPP) for the three and six-month periods ended
June 30, 2009 and 2008 using the Black-Scholes valuation model:



|                         |  |                             |  |                           |  |            |  |           
|------------------------ |  | --------------------------- |  | ------------------------- |  | ---------- |  | ----------
|                         |  | Three Months Ended June 30, |  | Six Months Ended June 30,
|                         |  | 2009                        |  | 2008                      |  | 2009       |  | 2008      
|Stock Options            |  |                             |  |                           |  |            |  |           
|Expected dividend yield  |  | 0%                          |  | 0%                        |  | 0%         |  | 0%        
|Expected volatility      |  | 67%                         |  | 70%                       |  | 67  70%   |  | 70%       
|Expected life (in years) |  | 6.0                         |  | 6.0                       |  | 6.0        |  | 6.0       
|Risk-free interest rate  |  | 2.9%                        |  | 3.4%                      |  | 1.8  2.9% |  | 3.1  3.4%
|                         |  |                             |  |                          
|ESPP                     |  |                             |  |                           |  |            |  |           
|Expected dividend yield  |  | 0%                          |  | 0%                        |  | 0%         |  | 0%        
|Expected volatility      |  | 56  89%                    |  | 44  68%                  |  | 56  89%   |  | 44  68%  
|Expected life (in years) |  | 0.5  1.0                   |  | 0.5  1.0                 |  | 0.5  1.0  |  | 0.5  1.0 
|Risk-free interest rate  |  | 0.3  2.1%                  |  | 1.9  5.0%                |  | 0.3  2.1% |  | 1.9  5.0%

Comprehensive Loss

The Company reports comprehensive loss and its components as part of total stockholders equity. Comprehensive loss is comprised of net loss and changes in unrealized gains (losses) on available-for-sale
investments. For the three and six months ended June 30, 2009 and 2008, comprehensive loss was as follows:



|                                     |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------ |  | --------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                     |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                                     |  | 2009                        |        |   | 2008                      |   |        | 2009 |  |   | 2008    |  
|Net loss                             |  | $                           | (5,432 | ) |                           | $ | (6,944 | )    |  | $ | (10,033 | ) |  | $ | (14,934 | )
|Changes in unrealized gains (losses) |  |                             | (7     | ) |                           |   | (199   | )    |  |   | (30     | ) |  |   | 3       |  
|                                     |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Total comprehensive loss             |  | $                           | (5,439 | ) |                           | $ | (7,143 | )    |  | $ | (10,333 | ) |  | $ | (14,931 | )
|                                     |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |         |  

The fluctuation in accumulated other comprehensive income represents the net change in fair value
for invested assets as a result of changes in interest rates and other factors affecting fair value and as a result of sales of investments prior to their maturities. The cumulative effect of these periodic fluctuations is reflected as accumulated
other comprehensive income on the Companys balance sheet.

Net Loss Per Share

Basic 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 and without consideration of common stock equivalents. Diluted net loss per share is computed by dividing the net loss attributable to common
stockholders by the weighted-average number of common share and share equivalents outstanding for 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 equivalent shares but have been excluded from the calculation of diluted net loss per share as their effect is anti-dilutive.



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|                                                                                                                                                         |  |                                                |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------- | ---------- | - | ------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                                                                                                                         |  | Three Months Ended June 30,                    |            |   | Six Months Ended June 30, |  
|                                                                                                                                                         |  | 2009                                           |            |   | 2008                      |   |            | 2009 |  |   | 2008       |  
|                                                                                                                                                         |  | (in thousands except share and per share data) |           
|Numerator:                                                                                                                                               |  |                                                |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net loss attributable to common stockholders                                                                                                             |  | $                                              | (5,432     | ) |                           | $ | (6,944     | )    |  | $ | (10,033    | ) |  | $ | (14,934    | )
|                                                                                                                                                         |  |                                                |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Denominator:                                                                                                                                             |  |                                                |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Weighted-average common shares outstanding                                                                                                               |  |                                                | 17,580,471 |   |                           |   | 17,518,081 |      |  |   | 17,574,912 |   |  |   | 17,494,194 |  
|Less: Weighted-average unvested common shares subject to repurchase                                                                                      |  |                                                | (313       | ) |                           |   | (1,415     | )    |  |   | (457       | ) |  |   | (1,663     | )
|                                                                                                                                                         |  |                                                |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Denominator for basic and diluted net loss per share attributable to common stockholders                                                                 |  |                                                | 17,580,158 |   |                           |   | 17,516,667 |      |  |   | 17,574,455 |   |  |   | 17,492,531 |  
|                                                                                                                                                         |  |                                                |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|                                                                                                                                                         |  |                                                |            |  
|Basic and diluted net loss per share attributable to common stockholders                                                                                 |  | $                                              | (0.31      | ) |                           | $ | (0.40      | )    |  | $ | (0.57      | ) |  | $ | (0.85      | )
|                                                                                                                                                         |  |                                                |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|                                                                                                                                                         |  |                                               
|                                                                                                                                                         |  | For the Three andSix Months EndedJune 30,      |            |   |                           |  
|                                                                                                                                                         |  | 2009                                           |            |   | 2008                      |   |            |      | 
|Outstanding securities not included in diluted net loss per share attributable to common stockholder calculation as their impact would be
anti-dilutive: |  |                                                |            |   |                           |   |            |      | 
|Options to purchase common stock                                                                                                                         |  |                                                | 2,029,631  |   |                           |   | 1,480,999  |      | 
|Warrants outstanding                                                                                                                                     |  |                                                | 1,265,846  |   |                           |   | 1,265,846  |      | 
|Common stock subject to repurchase                                                                                                                       |  |                                                | 209        |   |                           |   | 1,296      |      | 
|                                                                                                                                                         |  |                                                |            |   |                           |   |            |      | 
|                                                                                                                                                         |  |                                                | 3,295,686  |   |                           |   | 2,748,141  |      | 
|                                                                                                                                                         |  |                                                |            |   |                           |   |            |      | 

Recently Issued Accounting Standards

Adopted in 2009

In April 2009,
the FASB issued two Staff Positions (FSPs) that are intended to provide additional application guidance and enhance disclosures about fair value measurements and impairments of securities. FSP FAS 115-2 and FAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments, provides guidance that an entity should evaluate whether a) it intends to sell or b) it will be required to sell a debt security when evaluating whether an impairment is other than temporary.
This FSP also establishes criteria for when to recognize a write-down through earnings versus other comprehensive income. FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, expands the fair value
disclosures required for all financial instruments within the scope of SFAS No. 107, Disclosures about Fair Value of Financial Instruments, to interim periods. Both of these FSPs are effective for interim and annual reporting periods
ending after June 15, 2009. The adoption of these FSPs did not have a material impact on the Companys financial position or results of operations.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS No. 165), which establishes general standards of accounting for, and requires disclosure of, events that occur after the
balance sheet date but before financial statements are issued or are available to be issued. The Company adopted the provisions of SFAS No. 165 for the quarter ended June 30, 2009. The adoption of SFAS No. 165 did not have a material
effect on the Companys financial position or results of operations.

In December 2007, the EITF issued EITF Issue 07-1, Accounting
for Collaborative Arrangements(EITF 07-1), which applies to collaborative arrangements where no separate legal entity exists and in which the parties are active participants and are exposed to significant risks and rewards that
depend on the success of the activity. This issue, among other things, requires certain income statement presentation of transactions



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with third parties and of payments between parties to the collaborative arrangement, along with disclosure about the nature and purpose of the arrangement.
The provisions of EITF 07-1 are effective for fiscal years beginning on or after December 15, 2008. The Company adopted EITF 07-1 on January 1, 2009. The adoption of EITF 07-1 did not have a material impact on the Companys financial
position or results of operations.

FASB Staff Position FAS 157-2, Effective Date of FASB Statement No. 157, (FSP
No. 157-2) delayed the effective date of SFAS No. 157, Fair Value Measurements (SFAS No. 157), for non-financial assets and non-financial liabilities except for items that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008. The Company adopted FSP No. 157-2 on January 1, 2009. Since the Company does not currently have assets
or liabilities that are required to be measured on a non-recurring basis, the adoption of FSP No. 157-2 did not have a material impact on the Companys financial position or results of operations.

Note 3. License Agreements

COLLABORATION
AGREEMENT - ASTELLAS

In June 2009, NeurogesX entered into the Astellas Agreement for an exclusive license to commercialize Qutenza
in the Licensed Territory. The Astellas Agreement provides 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 provides 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. Other elements of the Astellas Agreement include milestone payments of up to 65,000,000 Euro to be made if
certain predefined sales thresholds of the products licensed under the agreement are met and royalties, as a percentage of net sales of products under the agreement, with such royalties starting in the high teens and escalating into the mid twenties
as revenues increase. The Astellas Agreement is cancellable and upfront payments are subject to refund if the MA for Qutenza in the European Union is not transferred to Astellas by June 2010, or if the MA is not maintained by the Company prior to
its transfer to Astellas. The Company will 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, not to exceed ten years.
On the seventh anniversary of the Astellas Agreement, the Company has the right to opt-out of participation on the joint steering committee. The Astellas Agreement further provides that the Company will deliver a certain set of data related to
certain development activities for NGX-1998 and that upon such delivery and agreement as to further development activities, 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.

As of June 30, 2009, the Company recorded a receivable from Astellas totaling $48,787,000. The Company also recorded deferred revenue totaling $48,787,000, of which $4,304,000 is reflected as the current portion
of deferred revenue. 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. The Company expects to commence recognizing revenue once the MA for Qutenza has been transferred to Astellas, which the Company estimates to be by the end of 2009.
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.



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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 the Companys direct Cost of Goods without markup for
profit. The Company will report amounts received from product transactions under EITF 07-1, net of direct costs incurred as a component of Collaboration revenue. The Company expects the net profit or loss on collaboration supplies will not be
material.

UNIVERSITY OF CALIFORNIA

In October 2000 and as amended, the Company licensed certain patents from the University of California (UC) for high-concentration 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). The amount of the Sublicense Fee payable to UC, as a result of the Astellas license payment in July 2009, is subject to contractual interpretation but the Company currently believes its obligations may range
between $1,000,000 to $2,000,000 and could potentially reach a maximum of $2,700,000 if the full proceeds from Astellas were deemed applicable. The Company will record the sublicense fee in research and development expense in the period in which the
upfront payments from Astellas are received.

LTS LOHMAN THERAPIE-SYSTEME AG

In January 2007, the Company entered into a Commercial Supply and License Agreement (LTS Agreement) with LTS Lohman 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 three months ended June 30, 2009, the Company received market approval of Qutenza in the
European Union and as a result, paid LTS the one time milestone payment of 100,000, or approximately $140,000, which was charged to research and development expense.

Note 4. Cash and Cash Equivalents and Short-Term Investments

The following are summaries of the
Companys cash, cash equivalents and short-term investments (in thousands):



|                            |  |               |        |                      |   |                       |  |                     |   |  |   |       
|--------------------------- |  | ------------- | ------ | -------------------- | - | --------------------- |  | ------------------- | - |  | - | ------
|                            |  | AmortizedCost |        | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | Estimated FairValue
|As of June 30, 2009:        |  |               |        |                      |   |                       |  |                     |   |  |   |       
|Cash and money market funds |  | $             | 4,914  |                      | $ |                      |  | $                   |  |  | $ | 4,914 
|U.S. Treasury securities    |  |               | 3,773  |                      |   | 1                     |  |                     |  |  |   | 3,774 
|Commercial paper*           |  |               | 4,749  |                      |   | 1                     |  |                     |  |  |   | 4,750 
|                            |  |               |        |                      |   |                       |  |                     |   |  |   |       
|                            |  | $             | 13,436 |                      | $ | 2                     |  | $                   |  |  | $ | 13,438
|                            |  |               |        |                      |   |                       |  |                     |   |  |   |       
|Reported as:                |  |               |        |                      |   |                       |  |                     |   |  |   |       
|Cash and cash equivalents   |  |               |        |                      |   |                       |  |                     |   |  | $ | 4,914 
|Short-term investments      |  |               |        |                      |   |                       |  |                     |   |  |   | 8,524 
|                            |  |               |        |                      |   |                       |  |                     |   |  |   |       
|                            |  |               |        |                      |   |                       |  |                     |   |  | $ | 13,438
|                            |  |               |        |                      |   |                       |  |                     |   |  |   |       



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|                            |  |               |        |                      |   |                       |  |                     |   |  |   |       
|--------------------------- |  | ------------- | ------ | -------------------- | - | --------------------- |  | ------------------- | - |  | - | ------
|                            |  | AmortizedCost |        | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | Estimated FairValue
|As of December 31, 2008:    |  |               |        |                      |   |                       |  |                     |   |  |   |       
|Cash and money market funds |  | $             | 9,933  |                      | $ |                      |  | $                   |  |  | $ | 9,933 
|U.S. Treasury securities    |  |               | 14,541 |                      |   | 32                    |  |                     |  |  |   | 14,573
|                            |  |               |        |                      |   |                       |  |                     |   |  |   |       
|                            |  | $             | 24,474 |                      | $ | 32                    |  | $                   |  |  | $ | 24,506
|                            |  |               |        |                      |   |                       |  |                     |   |  |   |       
|Reported as:                |  |               |        |                      |   |                       |  |                     |   |  |   |       
|Cash and cash equivalents   |  |               |        |                      |   |                       |  |                     |   |  | $ | 10,435
|Short-term investments      |  |               |        |                      |   |                       |  |                     |   |  |   | 14,071
|                            |  |               |        |                      |   |                       |  |                     |   |  |   |       
|                            |  |               |        |                      |   |                       |  |                     |   |  | $ | 24,506
|                            |  |               |        |                      |   |                       |  |                     |   |  |   |       



|* | All reported commercial paper is guaranteed in full by the Federal Deposit Insurance Corporation through the Temporary Liquidity Guarantee Program.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------

At June 30, 2009 and December 31, 2008, the contractual maturities of all of the Companys investments were less than one year. During the
three and six months ended June 30, 2008, the Company received approximately $7,704,000 and $13,749,000, respectively, in gross proceeds from the sales of certain short-term investments in commercial paper and recognized approximately $22,000
and $39,000 in realized gains, which were recorded as other income. These gains were computed on a specific identification basis. The Company did not sell any of its investments prior to maturity during the three and six months ended June 30,
2009.

Note 5. Fair Value Measurements

The Company adopted the provisions of SFAS No. 157 effective January 1, 2008. The standard describes 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.



12



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In accordance with SFAS No. 157, 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 June 30, 2009 and December 31, 2008 (in thousands):



|                                                                                   |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|---------------------------------------------------------------------------------- |  | ---------------------------------------------------------- | ------ | ----------------------------------------- | - | -------------------------------------- |  | ----- | - |  | - | ------
|                                                                                   |  | Quoted Pricesin ActiveMarkets forIdentical Assets(Level 1) |        | SignificantOtherObservableInputs(Level
2) |   | SignificantUnobservableInputs(Level 3) |  | Total
|Fair Value Measurements at June 30, 2009:                                          |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|Components of cash equivalents and short- term investments measured at fair value: |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|Money market funds                                                                 |  | $                                                          | 4,539  |                                           | $ |                                       |  | $     |  |  | $ | 4,539 
|U.S. Treasury securities                                                           |  |                                                            | 3,774  |                                           |   |                                       |  |       |  |  |   | 3,774 
|Commercial paper                                                                   |  |                                                            |       |                                           |   | 4,750                                  |  |       |  |  |   | 4,750 
|                                                                                   |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|Total financial assets measured at fair value                                      |  | $                                                          | 8,313  |                                           | $ | 4,750                                  |  | $     |  |  |   | 13,063
|                                                                                   |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|                                                                                   |  |                                                            |        |                                          
|Components of cash and cash equivalents not measured at fair value:                |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|Operating cash                                                                     |  |                                                            |        |                                           |   |                                        |  |       |   |  |   | 375   
|                                                                                   |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|Total cash and cash equivalents and short- term investments                        |  |                                                            |        |                                           |   |                                        |  |       |   |  | $ | 13,438
|                                                                                   |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|                                                                                   |  |                                                            |        |                                          
|Fair Value Measurements at December 31, 2008:                                      |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|Components of cash equivalents and short- term investments measured at fair value: |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|Money market funds                                                                 |  | $                                                          | 9,496  |                                           | $ |                                       |  | $     |  |  | $ | 9,496 
|U.S. Treasury securities                                                           |  |                                                            | 14,573 |                                           |   |                                       |  |       |  |  |   | 14,573
|                                                                                   |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|Total financial assets measured at fair value                                      |  | $                                                          | 24,069 |                                           | $ |                                       |  | $     |  |  |   | 24,069
|                                                                                   |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|                                                                                   |  |                                                            |        |                                          
|Components of cash and cash equivalents not measured at fair value:                |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|Operating cash                                                                     |  |                                                            |        |                                           |   |                                        |  |       |   |  |   | 437   
|                                                                                   |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       
|Total cash and cash equivalents and short-term investments                         |  |                                                            |        |                                           |   |                                        |  |       |   |  | $ | 24,506
|                                                                                   |  |                                                            |        |                                           |   |                                        |  |       |   |  |   |       

Note 6. Stockholders Equity

2000 Stock Incentive Plan and 2007 Stock Plan

During the six months ended June 30, 2009,
the Company granted options to purchase a total of 702,142 shares of the Companys common stock to employees and members of the board of directors with a fair value of approximately $719,000 that is expected, as of June 30, 2009 to be
amortized through 2013. During the six months ended June 30, 2008, the Company granted options to purchase a total of 420,750 shares of the Companys common stock to employees and members of the board of directors with a fair value of
approximately $1,319,000 that is expected, as of June 30, 2009, to be amortized through 2012.

Of the options granted during the six
months ended June 30, 2009, options to purchase a total of 256,892 shares of the Companys common stock were granted to executive officers as part of their 2008 bonus consideration. In an effort to conserve the Companys cash
resources, all executive officers were paid 50% of the earned 2008 bonus amount in the form of cash, with the remainder paid in stock options. The fair value of these stock options was approximately $202,000 and was recorded during the six months
ended June 30, 2009 as these options were vested in full upon grant.



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On July 22, 2009, the board of directors approved certain amendments to the Companys 2007
Stock Plan (Stock Plan). The amendments increased the initial option grant for new non-employee directors from 13,333 to 20,000 shares of common stock of the Company; increased the annual option grants for non-employee directors, other
than the Chairman of the board of directors, from 5,000 to 10,000 shares of common stock of the Company (Annual Grant); and provided for, in lieu of the Annual Grant, an annual option grant of 15,000 shares of common stock of the Company
for the Chairman of the board of directors, with the remaining terms of such grant, including vesting, being otherwise substantially the same as the Annual Grant terms.

Note 7. Income Taxes

The Company anticipates a net operating loss for the year 2009. The Company
recorded no federal or California income tax expense for the six months ended June 30, 2009.

During the second quarter of 2009, the
Company entered into the Astellas Agreement and recorded deferred revenue of approximately $48,787,000. For tax purposes, the Company will elect to use the deferral method under Revenue Procedure 2004-34. Under Revenue Procedure 2004-34, the
deferral method allows taxpayers to defer advanced payments to the next succeeding year to the extent that the advance payments are not recognized in the taxable year of receipt.

For the six months ended June 30, 2009, the total amount of unrecognized tax benefits has not significantly changed from that which was disclosed in
the Companys 2008 Form 10-K. These unrecognized tax benefits, if recognized, would not affect the effective tax rate for the periods prior to June 30, 2009 and there were no interest or penalties accrued related to uncertain tax
positions.

The Company files income tax returns in the U.S. federal and California state tax jurisdictions. The tax years 2002 to 2008
remain open to examination by the U.S. and California tax authorities. The Company does not anticipate the total unrecognized tax benefits will change significantly due to the settlement of audits and the expiration of statute of limitations within
the next 12 months.

Note 8. Commitments and Contingencies

During the three months ended June 30, 2009 the Company issued non-cancellable purchase orders to its suppliers of the various components of Qutenza. These purchase orders, which represent both supply to Astellas
as well as potentially saleable product for the U.S. market, if Qutenza is approved, totaled approximately $715,000, approximately half of which is expected to be reimbursed to the Company by Astellas upon delivery of such components. The Company
will record these amounts in its financial statements when title has transferred to the Company.

Note 9. Subsequent Events

In July 2009, the Company received $48,787,000 from Astellas, which reflected the full amount recorded on its balance sheet at June 30, 2009 as
Receivable from collaboration partner. In connection with the receipt of this upfront amount in July 2009, a sublicense fee payable to UC was incurred, the amount of which is subject to contractual interpretation. The Company currently believes its
obligations to UC for upfront payments may range between $1,000,000 to $2,000,000 and could potentially reach a maximum of $2,700,000 if the full proceeds from Astellas were deemed applicable.



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##### Table of Contents

ITEM 2. 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.

This report
contains forward-looking statements that are based upon current expectations within the meaning of the Private 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 the results discussed in the forward-looking statements. Examples of such forward-looking statements include, but are not limited to,
statements about or relating to:



| |  |  | the timing of U.S. Food and Drug Administrations, or FDA, review of the new drug application, or NDA, for Qutenza that was submitted in October 2008 and the
potential receipt of correspondence from the FDA by the extended Prescription Drug User Fee Act, or PDUFA, date;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the size and timing of any additional clinical trials requested by the FDA with respect to our NDA for Qutenza;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | the timing of potential launch of Qutenza by Astellas Pharma Europe Ltd., or Astellas, in the European Union;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | the expected activities and obligations of us and Astellas under the Distribution, Marketing and License Agreement, or the Astellas Agreement;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | potential milestone and royalty payments under the Astellas Agreement;
| | - |  | ----------------------------------------------------------------------



| |  |  | the sufficiency of existing resources to fund our operations for at least the next twelve months;
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | capital requirements and our needs for additional financing;
| | - |  | ------------------------------------------------------------



| |  |  | potential additional partners for Qutenza in the United States or other markets and for our acetaminophen and opioid prodrug product candidates;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | efforts to expand the scope of indications in which our capsaicin-based product candidates are used;
| | - |  | ----------------------------------------------------------------------------------------------------



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



| |  |  | plans associated with NGX-1998 including potential for advancing the development program later this year or early next year;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



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



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



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##### Table of Contents

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



| |  |  | our plans for sales, marketing and manufacturing;
| | - |  | -------------------------------------------------



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



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



| |  |  | time period estimates serving as a basis for revenue recognition in connection with the Astellas Agreement; 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 described in the section of this quarterly report entitled Risk Factors, including, but not limited to, those risks and uncertainties relating
to:



| |  |  | difficulties or delays in development, testing, obtaining regulatory approval for, and undertaking production and marketing of our drug candidates, including
difficulties or delays in Astellas launch of Qutenza in the European Union;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | potential return of the upfront payments received under the Astellas Agreement in the event the European Union marketing approval, or MA, for Qutenza is not
transferred to Astellas by June 2010;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our or Astellas inability to meet respective obligations under the Astellas Agreement;
| | - |  | ---------------------------------------------------------------------------------------



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



| |  |  | unexpected adverse side effects or inadequate therapeutic efficacy of our drug candidates could slow or prevent product approval or approval for particular
indications (including the risk that current and past results of clinical trials or preclinical studies are not indicative of future results of clinical trials, and the difficulties associated with clinical trials for pain indications);
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | positive results in clinical trials may not be sufficient to obtain FDA or European regulatory approval;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | potential for delays in or the inability to complete commercial partnership relationships;
| | - |  | ------------------------------------------------------------------------------------------



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



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



| |  |  | 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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##### Table of Contents

The following discussion should be read in conjunction with the section of this quarterly report entitled
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 which
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 most advanced product candidate, Qutenza, a dermal patch containing
a high concentration of synthetic capsaicin, is designed to manage pain associated with peripheral neuropathic pain conditions. In May 2009, Qutenza received an MA in the European Union for the treatment of peripheral neuropathic pain in
non-diabetic adults, alone or in combination with other medicinal products for pain. In June 2009, we entered into the Astellas Agreement, where we granted Astellas the exclusive right to promote, distribute and market Qutenza in the European
Economic Area, or EEA, as well as certain countries in Eastern Europe, the Middle East and Africa, which we refer to as the Licensed Territory.

We submitted to the FDA an NDA for Qutenza for the management of pain associated with PHN in October 2008 which was filed by the FDA in December 2008. Our NDA was originally given a PDUFA date of August 16, 2009. However, on
August 5, 2009, the FDA extended the PDUFA date to November 16, 2009 to provide time for a full review of a submission made to the FDA in late July 2009. The submission contained various data and analyses provided in response to FDA
requests.

Our earlier stage product candidate pipeline consists of:



| |  |  | NGX-1998, a non-patch liquid formulation of capsaicin for potential use in neuropathic pain conditions;
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | NGX-1576, NGX-9674 and NGX-5752, prodrugs of acetaminophen for potential use in acute pain including traumatic pain, post-surgical pain and fever; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | NGX-6052, an opioid prodrug for potential use in chronic pain indications.
| | - |  | --------------------------------------------------------------------------

NGX-1998 has completed three Phase 1 studies and we are currently planning the design and timing of this program, activities for which may resume late
this year or early 2010. The other product candidates are all in the pre-clinical stage of development and activities relating to such other product candidates are currently suspended while we seek development partners. Other than the rights granted
to Astellas, we hold commercial rights to our product candidates in all other markets including the United States and are actively engaged in discussions with potential commercial partners. Further, we are currently seeking development partners for
our acetaminophen and opioid prodrug product candidates.

We were incorporated in 1998 as Advanced Analgesics, Inc., and commenced
operations in 2000 as NeurogesX, Inc. From inception through 2001 our primary activities were related to formulation development and preclinical studies of our lead product candidate, Qutenza. Since 2002, our focus has expanded to include clinical
development of Qutenza, establishing sources of supply and manufacturing processes for Qutenza and, more recently, regulatory activities including those related to our MAA and NDA. Our focus has also expanded to include preparation for potential
commercialization of Qutenza should marketing approval be attained in the United States, development of NGX-1998, a liquid formulation of the same active ingredient used in Qutenza, and limited preclinical development of certain prodrug product
candidates.



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##### Table of Contents

We are a development stage company. To date, we have not generated any revenues and have funded our
operations primarily by selling equity securities, establishing debt facilities and through a collaboration agreement with Astellas. We have incurred significant losses since our inception. As of June 30, 2009, we had a deficit accumulated
during the development stage of approximately $200.2 million, of which approximately $38.9 million represents non-cash charges for the accretion of redeemable convertible preferred stock. We had cash, cash equivalents and short-term investments
totaling $13.4 million at June 30, 2009 and during the six months ended 2009, we used cash of $9.2 million in operating activities and approximately $1.8 million in repayment of our notes payable. We expect to continue to incur annual operating
losses over the next several years and those losses may increase as we continue our efforts to gain marketing approval, prepare for potential commercialization and, if approved, commercialize Qutenza in the United States. Additionally, we expect to
resume development of NGX-1998 and potentially our other product candidates. With respect to our notes payable, at June 30, 2009, the outstanding balance was approximately $1.3 million. This balance is scheduled to be fully repaid by January
2010.

Critical Accounting Policies and Significant Judgments and Estimates

As of the date of the filing of this quarterly report, we believe that there have been no material changes to our critical accounting policies during the
three months ended June 30, 2009 compared to those discussed in our 2008 Form 10-K, filed on March 26, 2009, other than those discussed below:

Revenue Recognition

We entered into the Astellas Agreement in June of 2009, which grants
Astellas an exclusive license to promote, distribute and market Qutenza in the Licensed Territory, grants an option to exclusively license NGX-1998 (a non-patch liquid formulation of capsaicin) in the Licensed Territory, obligates us to participate
on a joint steering committee and through a related supply agreement entered into along with the Astellas Agreement, requires us to supply Qutenza components to Astellas until direct supply arrangements are established between Astellas and the
manufacturers of such components. Revenue under this arrangement is expected to include upfront non-refundable fees, option payments for the development of and license to NGX-1998, milestone payments upon achievement of certain product sales
levels, royalties on product sales, and net profit or loss on collaboration supplies.

We view the Astellas Agreement and related
agreements as a multiple element arrangement with the key elements 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, which we anticipate may occur between 18 to 24 months from the execution of the Astellas
Agreement. Because not all of these elements have both standalone value and objective and reliable evidence of fair value, we are accounting for them as a single unit of accounting in accordance with Emerging Issues Task Force Issue No. 00-21,
Revenue Arrangements with Multiple Deliverables. Further, as the Astellas Agreement provides for a joint steering committee and we believe that our involvement in that committee is a substantive performance obligation under the arrangement,
we plan to recognize revenue associated with upfront payments and future license fees related to NGX-1998, if any, ratably over the term of the performance obligations with respect to the joint steering committee, which we estimate to be the last
delivered item in the arrangement. We have estimated this performance obligation to be delivered ratably through June 2016. As of June 30, 2009, the upfront license fees are subject to a refund right, which expires upon transfer of our MA for
Qutenza in the European Union to Astellas, which we expect to occur by the end of 2009. Therefore, revenue recognition of the upfront license fee is being deferred until such time as this refund right expires.



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##### Table of Contents

Results of Operations

In accordance with our revenue recognition policy, we have recorded no revenue in the three months ended June 30, 2009 related to the Astellas agreement as upfront amounts are refundable until we complete the
transfer or our MA in the European Union to Astellas, which we expect will occur by the end of 2009. Upon transfer of the MA, we expect to commence recording revenue from the upfront payments under the Astellas Agreement, which total approximately
$48.8 million, over the remaining service period of the joint steering committee, on a straight line basis. Our mandatory service under the joint steering committee expires in June 2016.

Upon launch of Qutenza by Astellas, we expect to commence recording royalty revenue based upon net sales of Qutenza in the Astellas Territory. We
currently anticipate that Qutenza may be launched in certain countries of the European Union in the first half of 2010.

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, are recorded to research and development expense
if delivery of such components occurs prior to FDA approval.

Since our inception, Qutenza has accounted for over 90% of our external
research and development expenses. Specifically, in the three months ended June 30, 2009 and 2008, our external research and development costs totaled $0.9 million and $1.7 million, respectively, and of these amounts 99% and 89%,
respectively, were incurred in programs related to Qutenza. In the six months ended June 30, 2009 and 2008, our external research and development costs totaled $1.4 million and $5.1 million, respectively, and of these amounts 98% and 91%,
respectively, were incurred in programs related to Qutenza. We commence tracking the separate, external costs of a project when we determine that a project has a reasonable chance of entering clinical development. We use our internal research and
development resources across several projects and many resources are not attributable to specific projects. Accordingly, we do not account for our internal research and development costs on a project basis. However, 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.

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 product candidates. Currently we are primarily focused on completing the development, through regulatory approval, of our lead product candidate, Qutenza, for patients with PHN in the
United States and are planning the entry into phase 2 of NGX-1998, with the assistance of our collaboration partner in Europe. We submitted an NDA in the United States for Qutenza for the management of pain associated with PHN in October 2008, and
the NDA was filed by the FDA in December 2008. Our NDA was originally given a PDUFA date of August 16, 2009. However, in response to certain requests from the FDA, we have provided additional data and analyses which was classified by the FDA as
a major amendment to the NDA. As a result of this amendment, on August 5, 2009,



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the FDA notified us that it was extending the PDUFA date to November 16, 2009 to provide time for a full review of the submission. When we do receive a
response from the FDA on our NDA, we anticipate receiving either an approval or a complete response letter from the FDA on our NDA. 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.

We anticipate that our overall research and development expenses, excluding non-cash stock-based
compensation expense, may begin to increase over the next few quarters, perhaps significantly, as we resume development activities for NGX-1998 and also invest in pre-commercialization infrastructure such as establishment of pharmacovigilence and
medical affairs functions and other market support related activities. Additionally, we anticipate a significant increase in our third quarter Research and development expenses as a result of the sublicense fee payable to the University of
California, resulting from the receipt of upfront payments under the Astellas Agreement.

Our general and administrative expenses consist
primarily of salaries and benefits, professional fees related to our administrative, finance, human resource, legal and information technology functions, marketing expenses, 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 general and administrative expenses will increase in the second half of 2009 and continuing to
increase over the next several years, if Qutenza is approved in the United States. These increases are likely to be attributable to increasing marketing activities in anticipation of and upon receipt of, required regulatory approvals, the costs of
hiring and deploying a sales force in the United States and infrastructure costs to support a commercial launch of our product should we achieve FDA approval, and the costs of being a public company, as well as the need to add additional personnel
in all of the key functional areas that support growth of our general operations, including accounting and finance, legal and human resources.

Comparison of Three Months Ended June 30, 2009 and 2008



|                                    |  |                                    |        |   |                    |   |        |                      |  |   |        |   |  |     |   
|----------------------------------- |  | ---------------------------------- | ------ | - | ------------------ | - | ------ | -------------------- |  | - | ------ | - |  | --- | --
|                                    |  | Three Months EndedJune 30,         |        |   | Increase(Decrease) |   |        | % Increase(Decrease) | 
|                                    |  | 2009                               |        |   | 2008               |   |        |                     
|                                    |  | (in thousands, except percentages) |       
|Research and development expenses   |  | $                                  | (2,780 | ) |                    | $ | (4,174 | )                    |  | $ | (1,394 | ) |  | (33 | )%
|General and administrative expenses |  |                                    | (2,605 | ) |                    |   | (2,863 | )                    |  |   | (258   | ) |  | (9  | )%
|Interest income                     |  |                                    | 11     |   |                    |   | 285    |                      |  |   | (274   | ) |  | (96 | )%
|Interest expense                    |  |                                    | (68    | ) |                    |   | (214   | )                    |  |   | (146   | ) |  | (68 | )%
|Other income (expense), net         |  |                                    | 10     |   |                    |   | 22     |                      |  |   | (12    | ) |  | (55 | )%

Research and Development Expenses. Research and development expenses decreased
approximately $1.4 million, or 33%, to $2.8 million for the three months ended June 30, 2009 from $4.2 million for the same period in 2008. The year over year change was attributable to, in part, a decision to reduce our non-clinical and
clinical development expenses related both to potential label expansion of Qutenza as well as our other product candidate programs. This was due to our desire to preserve cash resources to support our regulatory submissions processes in both the
United States and the European Union and to devote resources to certain pre-commercialization activities. Specifically, our research and development expenses declined primarily as a result of a $0.7 million decrease in clinical study costs
associated with Qutenza. In the second quarter of 2009, we conducted a small-scale study in response to an FDA request for additional data related to our NDA, whereas in the second quarter of 2008, we were in the process of winding down our most
recent Phase 3 clinical trial, which had been substantially completed in early 2008. Also contributing to the year over year change was a $0.6 million decrease in employee related costs commensurate with our reduced clinical trial activity.
Additional decreases include a $0.2 million decrease in spending related to NGX-1998 and our



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earlier stage product candidates, a $0.2 million reduction in regulatory expenses associated with the preparation of our NDA in the second quarter of 2008
and support for our MAA. These decreases were partially offset by a $0.2 million increase related to manufacturing development costs in support of Qutenza and a $0.1 million increase in licensing fee expense in connection with a one-time milestone
payment to our manufacturer of Qutenza patches as a result of receiving MAA approval.

General and Administrative Expenses. General
and administrative expenses decreased approximately $0.3 million, or 9%, to $2.6 million for the three months ended June 30, 2009 from $2.9 million for the same period in 2008. The year over year change was due to a $0.4 million decrease in
certain pre-commercialization activities including participation in key medical conferences, marketing materials development and medical education, as well as a $0.1 million reduction in marketing employee related expenses. These decreases were
partially offset by a $0.2 million increase in professional fees, including legal and accounting fees.

Interest income. Interest
income decreased approximately $0.3 million, or 96%, to less than $0.1 million for the three months ended June 30, 2009 from $0.3 million for the same period in 2008. The year over year change was primarily attributable to a decrease in our
average investment balances. Also contributing to the decrease was a decline in the rate of return on our invested assets as rates declined in the market, in general, and as we moved our invested assets to investments of lower relative risk in light
of events in the credit markets.

Interest expense. Interest expense decreased approximately $0.1 million, or 68%, to $0.1 million
for the three months ended June 30, 2009 from $0.2 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.

Comparison of Six Months Ended June 30, 2009 and 2008



|                                    |  |                                    |        |   |                    |   |        |                      |  |   |        |   |  |     |   
|----------------------------------- |  | ---------------------------------- | ------ | - | ------------------ | - | ------ | -------------------- |  | - | ------ | - |  | --- | --
|                                    |  | Six Months EndedJune 30,           |        |   | Increase(Decrease) |   |        | % Increase(Decrease) | 
|                                    |  | 2009                               |        |   | 2008               |   |        |                     
|                                    |  | (in thousands, except percentages) |       
|Research and development expenses   |  | $                                  | (5,106 | ) |                    | $ | (9,955 | )                    |  | $ | (4,849 | ) |  | (49 | )%
|General and administrative expenses |  |                                    | (4,794 | ) |                    |   | (5,350 | )                    |  |   | (556   | ) |  | (10 | )%
|Interest income                     |  |                                    | 45     |   |                    |   | 789    |                      |  |   | (744   | ) |  | (94 | )%
|Interest expense                    |  |                                    | (188   | ) |                    |   | (457   | )                    |  |   | (269   | ) |  | (59 | )%
|Other income (expense), net         |  |                                    | 10     |   |                    |   | 39     |                      |  |   | (29    | ) |  | (74 | )%

Research and Development Expenses. Research and development expenses decreased
approximately $4.8 million, or 49%, to $5.1 million for the six months ended June 30, 2009 from $10.0 million for the same period in 2008. The year over year change was attributable to, in part, a decision to reduce our non-clinical and
clinical development expenses related both to potential label expansion of Qutenza as well as our other product candidate programs. Specifically, our research and development expenses declined primarily as a result of a $2.8 million decrease in
clinical study costs associated with Qutenza. During the six months ended June 30, 2009, we conducted a small-scale study in response to an FDA request, whereas in the same period in 2008, we were in the process of winding down our most recent
Phase 3 clinical trial. Also contributing to the year over year change was a $1.1 million decrease in employee related costs commensurate with our reduced clinical trial activity. Additional decreases include a $0.4 million decrease in spending
related to NGX-1998 and our earlier stage product candidates as these programs were deferred to preserve cash resources, a $0.4 million reduction in regulatory expenses associated with the preparation of our NDA in the first half of 2008 and support
for our ongoing MAA review process in Europe in the first half of 2008 and a $0.2 million decrease related to manufacturing development costs in support of Qutenza. These decreases were partially offset by a $0.1 million increase in licensing fees
in connection with the one-time payment to our manufacturer of Qutenza patches as a result of receiving MAA approval.



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General and Administrative Expenses. General and administrative expenses decreased approximately
$0.6 million, or 10%, to $4.8 million for the six months ended June 30, 2009 from $5.4 million for the same period in 2008. The year over year change was due to a $0.6 million decrease in certain pre-commercialization activities including
marketing materials development, participation in key medical conferences and medical education, as well as a $0.1 million reduction in marketing employee related expenses. These decreases were partially offset by a $0.2 million increase in
professional fees, including legal and accounting fees.

Interest income. Interest income decreased approximately $0.7 million, or
94%, to less than $0.1 million for the six months ended June 30, 2009 from $0.8 million for the same period in 2008. The year over year change was primarily attributable to a decrease in our average investment balances. Also contributing to the
decrease was a decline in the rate of return on our invested assets as rates declined in the market, in general, and as we moved our invested assets to investments of lower relative risk in light of events in the credit markets.

Interest expense. Interest expense decreased approximately $0.3 million, or 59%, to $0.2 million for the six months ended June 30, 2009 from
$0.5 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.

Changes in Financial Condition

As a
result of the execution of the Astellas Agreement during the quarter ended June 30, 2009, we reported material changes in our financial condition. Specifically we recorded a receivable for the upfront amount due from Astellas for approximately
$48.8 million, which was subsequently paid in full in July 2009. We recorded the offset to this receivable in deferred revenue, $4.3 million of which was recorded as a current liability. The total deferred revenue balance of $48.8 million is
expected to be recognized as revenue beginning in the fourth quarter of 2009 on a straight-line basis through June 2016.

Liquidity and Capital
Resources

Since our inception through June 30, 2009, we have financed our operations primarily through private placements and a
public offering of our equity securities and, to a lesser extent, through debt facilities. Through June 30, 2009, we have received approximately $158.7 million from the sale of our equity securities, net of issuance costs. 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 approximately $38.1
million. On December 28, 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 on January 3, 2008, we completed the second and final closing of this
private placement of our common stock and warrants resulting in additional net cash proceeds of $2.3 million.

As of June 30, 2009, we
had approximately $13.4 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 $4.3 million, of $58.7 million. Our working
capital increased significantly during the second quarter as a result of the recording of a receivable from Astellas of approximately $48.8 million in connection with the execution of the Astellas Agreement on June 19, 2009. Subsequent to
June 30, 2009, the full receivable balance of approximately $48.8 million was collected from Astellas in July 2009 and becomes non-refundable upon our transfer of our MA to Astellas, a process we expect to complete by the end of 2009.



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Upon collection of the receivable from Astellas, we became obligated to pay a portion of the collected amount to University of California under our License
Agreement with University of California for certain intellectual property rights. Although the amount of payment which will be due to the University of California in February 2010 is the subject of contract interpretation, we anticipate the amount
of such payment to range between $1 million and $2 million and could potentially reach a maximum of $2.7 million if the full proceeds from Astellas are deemed applicable.

Our cash and investment balances are typically held in a variety of interest bearing instruments including corporate bonds, commercial paper, 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 liquidity and capital preservation. 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. In response to a broad based tightening of credit and worsening economic environment in the fourth quarter of 2008, and to protect the
principal balances and maintain liquidity of our investments, we converted all of our investment holdings into U.S. Treasury or money market funds consisting of only U.S. Treasury securities and commercial paper guaranteed in full by the Federal
Deposit Insurance Corporation through the Temporary Liquidity Guarantee Program as of June 30, 2009. Our sales of investments in other than U.S. Treasury securities in 2008 were generally conducted at or near cost, however certain individual
investments were sold at either a gain or loss that were not material individually or in the aggregate.

Net cash used in operating
activities was approximately $9.2 million and $15.8 million during the six months ended June 30, 2009 and 2008, respectively. Net cash used in each of these periods was primarily a result of external research and development expenses, internal
personnel costs associated with our research and development programs and infrastructure costs supporting our research and development activities. Included in net cash used in operating activities are net changes in assets and liabilities affecting
cash. As a result of the collection of the receivable from Astellas subsequent to the end of the second quarter, we expect to report a significant increase in cash provided by operating activities in the third quarter of 2009. However, after
adjusting for the affects of the Astellas payment, we anticipate that operating expenses and cash use will likely increase in the second half of 2009, with the majority of that increase occurring in the fourth quarter and into next year, if Qutenza
is approved on the extended PDUFA date, as our spending associated with pre-commercialization activities accelerate and we potentially begin activities associated with the NGX-1998 development program.

Net cash provided by investing activities was approximately $5.5 million during the six months ended June 30, 2009 and net cash used in investing
activities was approximately $5.2 million during the six months ended June 30, 2008. Investing activities consist primarily of the purchase, sale and maturity of marketable securities. The net cash provided by investing activities during the
six months ended June 30, 2009 reflected maturities of marketable securities in excess of the amount purchased during this period. Net cash used in investing activities during the six months ended June 30, 2008 reflected the investment of
a majority of the net proceeds generated from our private placement of common stock and warrants, completed in January 2008, in short-term investments in the 2008 period. Purchases of property and equipment were not significant during these periods.
We expect that property and equipment expenditures may increase if our NDA for Qutenza is approved by the FDA. Such increase is expected to relate to the capital needs for infrastructure to support commercial operations.

Net cash used in financing activities was approximately $1.8 million during the six months ended June 30, 2009 and net cash provided by financing
activities was approximately $0.4 million during the six months ended June 30, 2008. Financing activities consisted of principal repayments on our venture loan financing arrangements in both periods. However, these principal repayments were
offset in the 2008 period by net proceeds from the sale of our common stock and warrants.



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



| |  |  | potential refund to Astellas of up-front payments received by us in connection with entry into the Astellas Agreement, if we fail to transfer the Qutenza MA by June
2010;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



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



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



| |  |  | the costs and timing of post-approval regulatory commitments, if any;
| | - |  | ---------------------------------------------------------------------



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



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



| |  |  | 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 June 30, 2009, we had approximately $13.4 million in cash, cash equivalents and short-term investments and the balance of our notes payable
totaled approximately $1.3 million. We also reported a receivable from our collaboration partner of $48.8 million, which was subsequently collected in full in July 2009. During the six months ended June 30, 2009, we used a total of
approximately $9.2 million in operating activities and approximately $1.8 million in the repayment of notes payable. We currently anticipate that our cash uses for the remainder of the year will likely increase as a result of an expected increase in
our pre-commercialization activities for Qutenza in the United States and to a lesser extent the plan to resume our development activities related to NGX-1998. We anticipate that our existing cash and investments will be sufficient to meet our
projected operating requirements through at least the next twelve months.

To date, we have incurred recurring net losses and negative cash
flows from operations. 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 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 and there is the potential that upfront payments from Astellas could be refunded if we are unsuccessful in transferring our MA to Astellas by June 2010.



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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, if approved for marketing,
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.

Contractual Obligations

There have been no material changes to our disclosures regarding contractual obligations set forth in our 2008 Form 10-K, filed on March 26, 2009.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We believe there has been no material change in our exposure to market risk from that discussed in our Form 10-K filed for the year ended
December 31, 2008, other than those set forth below:

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 oversee scale up to supply Astellas with our product components for commercial sale in the European Union and to supply the U.S. market if regulatory approval is received, 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 currency 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 if 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.
Management evaluates its net exposure to foreign currency exchange rate risk on a periodic basis and has the discretion to engage in certain hedging activities if appropriate.



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ITEM 4T. 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 Quarterly Report on Form 10-Q. 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) Changes in internal control over financial reporting

There was no change in our internal control over
financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

(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 disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our
disclosure control system are met.



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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

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 obtain U.S. regulatory approval for our lead product candidate, Qutenza.

Our success depends
substantially on obtaining United States regulatory approval for our most advanced product candidate, Qutenza, a dermal patch containing a high concentration of synthetic capsaicin. Regulatory approval in the United States requires the completion of
extensive non-clinical and clinical evaluation of a product candidate to demonstrate substantial evidence of safety and efficacy of the product candidate, as well as development of manufacturing processes which demonstrate the ability to reliably
and consistently produce the product candidate under current Good Manufacturing Practice regulations. Each of these elements of our Qutenza development program include certain judgments of applicable regulatory requirements of what will ultimately
be deemed acceptable to the regulatory authority including the FDAs evaluation of additional data, such as a responder analysis and other secondary endpoints when evaluating whether our product can be approved. The FDA in reviewing
our application will evaluate all components of that program including conducting audits of clinical sites used in our clinical trials and inspecting our manufacturing sites to ensure compliance with regulatory requirements. There can be no
assurance that any or all aspects of our development program or our manufacturing processes will satisfy the regulatory requirements for approval, the failure of which to do so would significantly delay or even prevent approval of our product
candidate and seriously harm our ability to generate significant revenue. During its review of our NDA, the FDA has requested certain additional information from us, including responses to specific questions, additional clinical data and analyses
and updates of certain data to current standards of presentation. Response to certain of these requests were deemed a major amendment and resulted in the FDA extending our PDUFA date by three months to November 16, 2009. There can be no
assurance that the FDA will not make further requests for information or data from us in connection with the review of our NDA for Qutenza, that we will be able to respond to such requests in a timely manner, or at all, or that the FDA will not call
for further extensions of the PDUFA date in connection with any further information or data submissions. Further, there can be no assurance that information previously provided in response to the FDAs requests adequately addresses their
inquiry.

Qutenza has been evaluated in three completed Phase 3 clinical trials for the management of pain associated with PHN, one of
which did not meet its primary endpoint, and two completed Phase 3 clinical trials for the management of pain associated with HIV-DSP, one of which did not meet its primary endpoint.



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The FDA generally requires successful completion of at least two adequate and well-controlled Phase 3 clinical trials for each indication for which we seek
marketing approval before submission of an NDA. Although our analyses of two Phase 3 studies in PHN indicated that their primary endpoints were met, the FDA may not agree with our analyses and may require that we complete additional studies or
perform other activities to support an approval of the PHN indication. If we do not receive marketing approval from the FDA we will not be able to commercialize Qutenza in the United States. Further, if the FDA delays approval as a result of
requirements to conduct additional clinical studies, remediation of manufacturing deficiencies, or for other reasons, commercialization of Qutenza could be significantly delayed. We may not have adequate financial or other resources to pursue this
product candidate through regulatory approval or through commercialization. Significant delay or the inability to commercialize Qutenza in the United States would significantly harm our business and as a result we may be unable to become profitable
or continue our operations, or, even if we are able to commercialize in the United States, there can be no assurance that we can become profitable. As a consequence of any of these factors, our stock price would be adversely affected. We have filed
an NDA with the FDA for Qutenza for PHN. We are continuing to evaluate whether to seek approval for Qutenza in HIV-DSP and whether additional studies would be necessary to achieve such an approval. If we decide to seek approval in HIV-DSP, we would
do so no sooner than after the FDA has completed its review of the PHN NDA submission, which we anticipate may occur by the extended PDUFA date of November 16, 2009, but could be significantly longer. Further, we may decide not to conduct
further Qutenza studies in HIV-DSP and ultimately may not seek approval of Qutenza in the HIV-DSP indication, in which case our potential revenues could be negatively impacted.

We will require substantial additional funding and may be unable to raise capital when needed.

We had cash, cash equivalents and short-term investments totaling $13.4 million at June 30, 2009 and during the six months ended June 30, 2009,
we used a total of $9.2 million in operating activities and approximately $1.8 million in the repayment of notes payable. We expect our negative cash flows from operations to continue beyond potential regulatory approval in the United States and
product launch of Qutenza and there can be no assurance that we will ever achieve positive cash flows from operations. We believe, based on our current operating plan that our cash, cash equivalents, short-term investments and cash received in July
2009 from Astellas will be sufficient to fund our operations through at least the next twelve months. However, our planned activities beyond 2009 including the ongoing initiatives associated with the establishment of a sales and marketing
organization to launch Qutenza, if approved, in the United States, support of our obligations under our commercial arrangement with Astellas, and continuing our development programs for NGX-1998 and our other development programs will require
substantial additional funding. There can be no assurance that additional funding will be available on terms that are acceptable, if at all.

Furthermore, in connection with Astellas ability to terminate the Astellas Agreement if the Qutenza MA is not transferred to Astellas by June 2010 or if we do not maintain such approval prior to transfer, we could be obligated to
return the 35 million Euro up-front payment we received in connection with execution of the Astellas Agreement. If this were to occur, our business would be seriously harmed and we would have a critical cash shortage that we would likely only
be able to mitigate on extremely punitive terms, if at all.

Our success will depend, in part, on the successful efforts of our
collaboration partner in 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 we entered in June 2009. 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 overall commercial
arrangement with Astellas. If launch of commercial sales of Qutenza in the Licensed Territory is delayed or



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prevented, our revenues will suffer and our stock price will decline. Further, if launch and resulting sales of Qutenza are not deemed successful, 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, if approved by the FDA, which could also cause a decline in our
stock price.

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 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, and, even if carried out in accordance with such preferences, 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. We and Astellas 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.

To date, the only portion of the Licensed
Territory in which regulatory approval for Qutenza has been obtained is the European Union. 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 at all. Further, there can be no assurance that such clinical or manufacturing
activities will not negatively impact the regulatory processes in the European Union, 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 is expected to be significant and to occur at a time when we are preparing for the potential
commercialization of Qutenza in the United States, if approved. As a result, our cost of operations are likely to increase as we hire additional personnel and contract with third-parties to assist us in setting up and maintaining the infrastructure
necessary to support our commercial relationship with Astellas in addition to our own pre-commercialization efforts.

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 potential 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 prepare 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



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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 NeurogesX 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 would be materially and adversely affected.

We have no manufacturing capabilities and depend on other parties for our manufacturing operations. If these manufacturers fail to meet our
requirements and strict regulatory requirements, our product development efforts may be negatively affected, we may not be able to obtain regulatory approval for our product candidates and our and our collaboration partners commercialization
efforts may be materially harmed.

We currently depend on three contract manufacturers as single source suppliers for the components
of our Qutenza product candidate: synthetic capsaicin, the dermal patch and the associated cleansing gel. We have entered into long term commercial supply agreements for these components. In addition we anticipate entering into long-term agreements
for the assembly of the Qutenza treatment kits in the United States as well as certain materials used in the manufacture of our products. If we are unable to enter into long term relationships with these suppliers, if our relationship 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 delayed and our business harmed.

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



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



| |  |  | failure of current and future manufacturers to complete the development and scale-up of the manufacturing process including adequately analyzing and documenting the
source and chemical make-up of ingredients that make up our product candidate and the ability to reliably and consistently produce the product candidate under current Good Manufacturing Practice regulations;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | failure to manufacture to our specifications, or 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
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



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

Any of these factors could result in significant delay or suspension of our clinical trials, regulatory submissions,
receipt of required approvals or commercialization of our products and harm our business.

Before a new drug can be marketed in the United
States, three consecutive manufacturing runs have to be completed and those manufacturing runs need to be validated to ensure that manufacturing processes are reliable. Required validation of the manufacturing processes of our third party suppliers
to secure FDA approval for Qutenza has not yet been completed. While our plans contemplate having these process validations complete in 2009, if validation of our third party supplier manufacturing processes is delayed or if our suppliers fail to
complete the requisite validation batches, even if all other aspects of our NDA are approvable by the FDA, commercial sales in the United States may need to be delayed until validation can be successfully completed, if at all.

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 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
which may result in increased costs of maintaining foreign manufacturing and could lengthen or delay the regulatory review process required to gain approval for our product candidates and could potentially prevent approval of our product candidates.

Furthermore, we are currently required to supply Qutenza to Astellas under our Supply Agreement with Astellas. As a result, 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.

Our product candidates may never achieve market acceptance even if they obtain regulatory approvals.

Even if regulatory approvals for the commercial sale of our product candidates are obtained, the commercial success of these product candidates will
depend on, among other things, acceptance by physicians and patients. Market acceptance of, and demand for, any products that we develop and that are commercialized will depend on many factors, including:



| |  |  | the ability to provide acceptable evidence of safety and efficacy;
| | - |  | ------------------------------------------------------------------



| |  |  | the ability to obtain adequate pricing and sufficient insurance coverage and reimbursement;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | 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;
| | - |  | ------------------------------------------------------------------------------------------



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



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| |  |  | the ability to produce product in commercial quantities sufficient to meet demand.
| | - |  | ----------------------------------------------------------------------------------

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

If physicians are not adequately reimbursed for 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 for this indication in
the United States, we will need Medicare coverage for Qutenza, if Qutenza is approved by the FDA for marketing. Medicare policymakers or local contractors that process claims for Medicare may determine that Qutenza is not reasonable and
necessary for Medicare beneficiaries or is reasonable and necessary only under limited circumstances. If Medicare policymakers or a significant portion of contractors determine that Qutenza is not reasonable and necessary for and deny or
significantly limit reimbursement 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 decisions would likely affect the
determination of many state Medicaid programs and private payors.

Even if Qutenza is covered by Medicare, we cannot determine whether that
coverage will be primarily under Medicare Part B or Medicare Part D. Although products administered by a physician, as we expect Qutenza will be, are ordinarily covered by Medicare Part B, which also reimburses the physician for
services in administering the product, Medicare Part B does not currently provide reimbursement for the use of topical patches in the treatment of peripheral neuropathic pain. Obtaining coverage for Qutenza and its related administration under
Part B is important to our future success, and there is a possibility that our efforts to achieve such a change in a policy will not be successful or if successful, will likely take one or more years to achieve. Any delay in achieving
reimbursement under Part B will have a negative impact on our ability to generate revenues.

Part D may provide reimbursement for
Qutenza, but we do not view Part D coverage as being as favorable as Part B coverage, because each Part D plan establishes its own formulary and may or may not decide to include Qutenza, or if it does, may seek to negotiate
significantly lower prices in order to include the product in their formularies. Additionally, Part D does not include reimbursement for the physicians administration of the product, although such services may be covered under existing
evaluation and management codes available for reimbursement of office visits. Patient preparation and Qutenza application time is significant and may take two hours or longer, which significantly impacts a physicians ability to see other
patients and, consequently, the physicians revenue. If physicians are not adequately reimbursed for their time and services in administering Qutenza, it is likely that they will not prescribe Qutenza, which would significantly impair our
ability to obtain revenues.

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. Obtaining these coverage and
reimbursement decisions will be a time consuming process requiring substantial resources and we may not receive adequate reimbursement of Qutenza from private insurers.

We expect to experience pricing pressures in connection with the sale of Qutenza, if approved, and our potential future products, due to the trend toward programs and legislation aimed at reducing healthcare costs, 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



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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.

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

In order to commercialize any of our product
candidates successfully, we must either acquire or internally develop a capable sales, marketing and distribution infrastructure or enter into collaborations with partners to perform these services for us. The acquisition or development of a capable
sales, marketing and distribution infrastructure will require substantial resources, which may divert the attention of our management and key personnel and negatively impact our product development efforts. 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 currently intend to develop a direct sales and marketing
organization in the United States for Qutenza because we believe that we can best serve our target customers with a focused, specialty sales force, we are currently evaluating the potential for commercializing Qutenza in the United States with a
collaboration partner. 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 product candidates 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 access to or convince adequate numbers of physicians to prescribe our products;
| | - |  | --------------------------------------------------------------------------------------------------------------------------



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



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

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 build a 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.



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Even if our product candidates receive regulatory approval, they will be subject to ongoing
regulatory requirements, including possible commitments to perform post market authorization activities, and may face regulatory or enforcement action.

Any product candidate for which regulatory approval is obtained will be subject to significant review and ongoing and changing regulation by the FDA, the European Medicines Agency, or EMEA, 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.
| | - |  | ---------------------------------------------------------------------------------------------------------

Failure to comply with regulatory requirements may subject us or our collaborative 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, our MA in the European Union requires the conduct of certain post authorization commitments 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. These studies 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 to cause adverse effects that limit
or prevent its widespread 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 face potential product liability exposure, and if successful claims are brought against us, we may incur substantial liability for a product
candidate and may have to limit its commercialization.

The use of our product candidates in clinical trials and the sale of any
products for which we obtain marketing approval 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;
| | - |  | --------------------------------------



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



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



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



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



| |  |  | the inability to commercialize our product candidates.
| | - |  | ------------------------------------------------------

Although we currently have product liability insurance coverage for our clinical trials with limits that we believe are customary and adequate to provide us with coverage for foreseeable risks associated with our
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, insurance coverage is becoming increasingly expensive and, 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. We intend to expand our insurance coverage to include the sale of commercial products in advance
of commercial launch of the product. However, we may be unable to obtain commercially reasonable product liability insurance for any products approved for marketing.

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 is expected to compete against more established products marketed by large pharmaceutical companies with far greater name
recognition and resources than we or Astellas have. Qutenza is also expected to compete with medications that are potentially prescribed for off-label use. 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 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 of Lyrica for the treatment of PDN, fibromyalgia, epilepsy and general anxiety disorder. The FDA has approved Cymbalta from Eli Lilly for use in the treatment of PDN, general anxiety disorder, depression and fibromyalgia.

Prior to any market launch, 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 GlaxoSmithKline, Newron Pharmaceuticals S.p.A, Depomed Inc., Novartis AG,
UCB S.A, Pfizer and Eli Lilly. Many of the compounds in development by such companies are already marketed for other indications, such as anti-depressants or anti-seizure drugs. 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, 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:



| |  |  | 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;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | commercialize competing products before we or Astellas can launch any of our products;
| | - |  | --------------------------------------------------------------------------------------



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| |  |  | 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; and
| | - |  | ----------------------------------------------------------------------------



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

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.

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

We intend to 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 treatment of PHN as well as HIV-DSP. 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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. We may be unable to obtain orphan drug designations for any additional product candidates or exclusivity for any of our product candidates, or our potential competitors may obtain orphan drug exclusivity for
capsaicin-based products competitive with our product candidates 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.

We may not be able to obtain Hatch-Waxman Act data exclusivity or equivalent regulatory data exclusivity protection in other jurisdictions for
Qutenza.

In addition, we may be able to rely, in part, on Hatch-Waxman exclusivity for Qutenza in the United States. 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. 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. Our
NDA for Qutenza was filed as a 505(b)(2) application as our application referenced certain publicly available preclinical data regarding capsaicin. Therefore, if another product containing the same active ingredient as Qutenza is approved before
Qutenza, then our potential approval could be delayed by five years. However, in such event, we believe we can petition the FDA to modify our application to be under Section 505(b)(1). Such petition would require the FDAs approval, and
there can be no assurance that such petition would be granted by the FDA. While we believe that the FDA has not approved another product containing the active ingredient of Qutenza, a highly pure synthetic capsaicin, there can be no assurance that a
competing product containing a synthetic capsaicin will not achieve approval before Qutenza or that Qutenza will be able to qualify for the five-year Hatch-Waxman exclusivity.



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We are aware of a company that may file an NDA for a product candidate that contains a low concentration
of a closely related compound to capsaicin. While we believe that this product, should it be approved by the FDA, may not preclude the granting of data exclusivity under Hatch-Waxman to Qutenza, we can make no assurance to such belief. If we are
unable to achieve data exclusivity, our revenues could be significantly harmed.

Even though Qutenza has been granted ten-year market
exclusivity and eight-year data exclusivity by the EMEA, there can be no assurance that the exclusivity granted will effectively prevent competition, either generic or otherwise, in the European Union. Such competition could significantly harm our
business.

Our fast track designation for development of Qutenza for treatment of painful 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-DSP, there is no assurance that, if we decide to file an NDA for Qutenza in HIV-DSP, that we will experience a faster development process, review or approval, compared to conventional FDA standards, or that the
product will be approved at all. Further, we anticipate the FDA will, as is the case with other indications, require two successful Phase 3 studies in HIV-DSP to support an approval for that indication, and therefore, we may never seek approval for
HIV-DSP or we will likely need to conduct one or more additional Phase 3 studies prior to submission of an NDA for HIV-DSP. The FDA may also withdraw our fast track designation if it believes that the designation is no longer supported by data from
our clinical development program.

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.

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, as is the case in our most recent Phase 3 study in HIV-DSP, 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. In our completed Phase 3 trials there have been three serious



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adverse events (totaling less than 1%) related to Qutenza, two related to pain and one case of hypertension. In our PHN studies C108 and C110, more cardiac
adverse events occurred in subjects treated with Qutenza than subjects receiving the control patch. Evaluation of these adverse events did not indicate that they were treatment related. In our most recent PHN studies, C116 and C117, a similar number
of subjects in the Qutenza and control groups had cardiac events. However, future late stage 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.

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 raised by the FDA or European health authorities regarding safety, design, scope and objectives of future clinical studies;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | obtaining regulatory 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;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | 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 clinical and
non-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 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.

Even though certain of our clinical trials for Qutenza in treatment of PHN and HIV-DSP have met their primary endpoints, certain other studies in
these indications 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-DSP and PDN. We have conducted one Phase 2 clinical
trial for the use of Qutenza for the management of PDN. PDN represents a much larger market opportunity than either PHN or HIV-DSP, 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 future indications, including PDN, we will have to conduct two successful Phase 3 trials for those indications, and that for PDN in particular, we may be required to perform additional
safety studies. We are evaluating our development programs related to PDN in Qutenza and may decide not to conduct studies in PDN beyond those that may be required by post-marketing requirements associated with our MA. If we decide not to conduct
the required number of Phase 3 studies in PDN that meet their primary endpoint, we will 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-DSP 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,



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PHN and/or HIV-DSP. 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.

We have limited experience in regulatory affairs.

We have limited experience in preparing, submitting and prosecuting regulatory filings including NDAs, MAAs and other applications
necessary to gain regulatory approvals. Moreover, some of our product candidates are based on novel applications of therapies that have not been extensively tested in humans, and the regulatory requirements governing these types of products may be
less well defined or more rigorous than for conventional products. As a result of these factors, in comparison to our competitors, we may require more time and incur greater costs to obtain and maintain regulatory approvals of products that we
develop, license or acquire.

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 not
generated any revenue to date and we have incurred operating and net losses each year since our inception in 1998. Our net loss for the three months ended June 30, 2009 was approximately $5.4 million. As of June 30, 2009 we had an
accumulated deficit of approximately $200.2 million. We had cash, cash equivalents and short-term investments totaling $13.4 million at June 30, 2009 and for the six months ended June 30, 2009, we used cash of $9.2 million in operating
activities. We expect to continue to incur losses for several years, as we seek regulatory approval for and commercialize Qutenza, and continue other research and development activities. If Qutenza does not gain regulatory approval in the United
States or does not achieve market acceptance in the United States or the European Union, we will not generate revenue. We cannot assure you that we will be profitable even if Qutenza is 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 development programs or commercialization efforts.

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



| |  |  | potential refund to Astellas of up-front payments received by us in connection with entry into the Astellas Agreement, if we fail to transfer the Qutenza MA by June
2010;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

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



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



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



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



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



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



| |  |  | the costs and timing of post-approval regulatory commitments, if any;
| | - |  | ---------------------------------------------------------------------



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



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



| |  |  | 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, 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. 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.



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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 device 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 patch for high-concentration 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. One or more of the inventors named in the method patent described below may assert a claim of
inventorship rights to such patent, which may result in our loss of exclusive use of this patent. Although we do not believe these individuals are co-inventors, there can be no assurance that we would prevail if such a claim were asserted. The
absence of exclusive rights to utilize such patent exposes us to a greater risk of direct competition and could materially harm our business.

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 high-concentration 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. As a result, our rights under this patent are non-exclusive. Anesiva, a company focused on the development and commercialization of treatments for pain, including injection
or infiltration of capsaicin for post-surgical pain, osteoarthritis or interdigital neuroma, has licensed from one of the non-assigning inventors the right to use the technology under the method patent. There can be no assurances that other entities
will not similarly obtain rights to use the technology under the method patent. If other entities license the right to use this patent, we may face more products competitive with Qutenza and our business will suffer.

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.



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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.
| | - |  | -----------------------------------------------------------------

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. For example, in June 2005, Winston Laboratories
sent us a letter informing us of their U.S. patent related to cis-capsaicin, and suggested that our synthetic capsaicin formulation could infringe this patent. We responded in August 2005 by denying any infringement. In 2007, Winston
reiterated its claim and offered to discuss a license to its patent. We responded by denying infringement. We believe that our products, if commercialized, will not infringe the Winston patent, which is



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due to expire in 2009 in the United States and in June 2010 in the European Union, but may be extended under certain circumstances. 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, we recently 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. 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 patent 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 patent 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 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 Lohmann Therapie-Systeme AG under patents and patent
applications relating to Qutenza, our lead product candidate. 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.



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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:



| |  |  | delays in the process of seeking or our ability to obtain regulatory approvals;
| | - |  | -------------------------------------------------------------------------------



| |  |  | inability to transfer, or maintain prior to transfer, the Qutenza MA to Astellas and the potential resulting refund by us of monies paid by Astellas to us;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | failure to meet market expectations with respect to potential product launch timing, including, but not limited to, a delay in, or prevention of, Astellas
commercialization activities with respect to Qutenza in the European Union;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



| |  |  | 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;
| | - |  | ----------------------------------------------------------------------------------------



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| |  |  | 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;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



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



| |  |  | changes in governmental 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 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, including, but not limited to, the requirement to maintain a minimum
closing bid price of at least $1.00 per share for our common stock and certain other quantitative standards. 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 our bid price deteriorates or if we fail to meet other requirements.

On July 17, 2009 we received a Nasdaq Staff Deficiency Letter indicating that, due to the vacancy created by the resignation of our former chairman of the audit committee of the board of directors, we failed to comply with the Nasdaq
Stock Market audit committee composition requirements for continued listing as set forth in Nasdaq Marketplace Rule 5605(c)(2)(A), which requires that a companys audit committee be comprised of at least three members, each of whom are
independent. Under Nasdaq Marketplace Rule 5605(c)(4)(B) we have until the earlier of our next annual shareholders meeting or June 29, 2010 to name a third director as a member of the audit committee so that we regain compliance with the
requirements of Nasdaq Marketplace Rule 5605(c)(2)(A). An active search for a replacement director is currently underway and we expect to fill the current vacancy on the audit committee within the timeframe required by Nasdaq Marketplace Rule
5605(c)(4)(B).

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.



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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, 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.

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 68% of the outstanding shares of our
common stock as of June 30, 2009 (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, including sales by our executive officers, of shares of common stock in the market, or the perception that these sales could occur. These sales might
also make it more difficult for us to sell equity securities at a time and price that we deem appropriate.

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 acquirors 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.



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

As a result of events in the credit markets, we have converted all of our investment holdings into U.S. Treasury securities and those
corporate securities that are fully backed by the United States Government. 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.

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 investors sole source of gain for the foreseeable future.



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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON
SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Our Annual Meeting of Stockholders was held on May 28, 2009 in
San Mateo, California. Of the 17,569,291 shares of the Companys common stock entitled to vote at the meeting, 13,218,813 shares of common stock, or 75.2% of the total eligible votes to be cast, were represented at the meeting in person or by
proxy, constituting a quorum. The voting results were as follows:

The stockholders elected Jean-Jacques Bienaime and Robert Nelsen as
Class II directors, to serve for a three-year term until their successors are duly elected and qualified. The votes were as follows:



|                      |  |            |  |         
|--------------------- |  | ---------- |  | --------
|Name                  |  | For        |  | Withheld
|Jean-Jacques Bienaime |  | 12,973,746 |  | 245,067 
|Robert Nelsen         |  | 13,201,968 |  | 16,845  

Our other directors with terms of office that continued after the 2009 Annual Meeting of
Stockholders were Anthony A. DiTonno, Neil M. Kurtz and Bruce A. Peacock. Bruce Peacock subsequently resigned from the board of directors, effective June 29, 2009.

The stockholders ratified the selection by the Audit Committee of the Board of Directors of Ernst & Young LLP as the Companys independent registered public accounting firm for the fiscal year ending
December 31, 2009. The votes were as follows:



|           |  |         |  |         |  |                
|---------- |  | ------- |  | ------- |  | ---------------
|For        |  | Against |  | Abstain |  | Broker Non-Vote
|13,178,602 |  | 38,348  |  | 1,863   |  |               

ITEM 5. OTHER INFORMATION

None.



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ITEM 6. EXHIBITS



|              |  |                                                                                                                                                                          
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                      
|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 (1)       |  | Warrant to Purchase Series A Preferred Stock by and between NeurogesX, Inc. and Silicon Valley Bank, dated as of December 14, 2000.                                      
|              | 
|4.5 (1)       |  | Warrant to Purchase Series B Preferred Stock by and between NeurogesX, Inc. and Silicon Valley Bank, dated as of May 1, 2002.                                            
|              | 
|4.6 (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.          
|              | 
|4.7 (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.         
|              | 
|4.8 (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.                         
|              | 
|4.9 (1)       |  | Form of First Warrant to Purchase Series C2 Preferred Stock.                                                                                                             
|              | 
|4.10 (1)      |  | Form of Second Warrant to Purchase Series C2 Preferred Stock.                                                                                                            
|              | 
|4.11 (2)      |  | Registration Rights Agreement by and between NeurogesX, Inc. and certain investors, dated as of December 23, 2007.                                                       
|              | 
|4.12 (2)      |  | Form of Warrant to Purchase Common Stock.                                                                                                                                
|              | 
|10.1 (3)     |  | Distribution, Marketing and License Agreement between NeurogesX, Inc. and Astellas Pharma Europe Limited, effective as of June 19, 2009.                                 
|              | 
|10.2 (3)     |  | Supply Agreement between NeurogesX, Inc. and Astellas Pharma Europe Limited, effective as of June 19, 2009.                                                              
|              | 
|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/A, filed with the Securities and Exchange Commission on July 1, 2009.
|--- | -----------------------------------------------------------------------------------------------------------------------------------

| | 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.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.



|                       |  |  |  |                                             
|---------------------- |  |  |  | --------------------------------------------
|Dated: August 14, 2009 |  |  |  | NEUROGESX, INC.                             
|                       |  |  |  | (Registrant)                                
|                       |  | 
|                       |  |  |  | /s/    Anthony A. DiTonno                   
|                       |  |  |  | Anthony A. DiTonno                          
|                       |  |  |  | President and Chief Executive Officer       
|                       |  |  |  | (Principal Executive Officer)               
|                       |  | 
|                       |  |  |  | /s/    Stephen F. Ghiglieri                 
|                       |  |  |  | Stephen F. Ghiglieri                        
|                       |  |  |  | Chief Financial Officer                     
|                       |  |  |  | (Principal Financial and Accounting Officer)



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EXHIBIT INDEX



|              |  |                                                                                                                                                                          
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                      
|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 (1)       |  | Warrant to Purchase Series A Preferred Stock by and between NeurogesX, Inc. and Silicon Valley Bank, dated as of December 14, 2000.                                      
|              | 
|4.5 (1)       |  | Warrant to Purchase Series B Preferred Stock by and between NeurogesX, Inc. and Silicon Valley Bank, dated as of May 1, 2002.                                            
|              | 
|4.6 (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.          
|              | 
|4.7 (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.         
|              | 
|4.8 (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.                         
|              | 
|4.9 (1)       |  | Form of First Warrant to Purchase Series C2 Preferred Stock.                                                                                                             
|              | 
|4.10 (1)      |  | Form of Second Warrant to Purchase Series C2 Preferred Stock.                                                                                                            
|              | 
|4.11 (2)      |  | Registration Rights Agreement by and between NeurogesX, Inc. and certain investors, dated as of December 23, 2007.                                                       
|              | 
|4.12 (2)      |  | Form of Warrant to Purchase Common Stock.                                                                                                                                
|              | 
|10.1 (3)     |  | Distribution, Marketing and License Agreement between NeurogesX, Inc. and Astellas Pharma Europe Limited, effective as of June 19, 2009.                                 
|              | 
|10.2 (3)     |  | Supply Agreement between NeurogesX, Inc. and Astellas Pharma Europe Limited, effective as of June 19, 2009.                                                              
|              | 
|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/A, filed with the Securities and Exchange Commission on July 1, 2009.
|--- | -----------------------------------------------------------------------------------------------------------------------------------

| | 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.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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