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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 September 30, 2010

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 October 29, 2010: 17,783,052









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NEUROGESX, INC.

TABLE OF CONTENTS FOR FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2010



|                                                                                                                 |  |      |    | 
|---------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                                                                                                 |  | Page |   
|PART I. FINANCIAL INFORMATION                                                                                    |  |      | 1  | 
|Item 1. Financial Statements (unaudited)                                                                         |  |      | 1  | 
|Condensed Consolidated Balance Sheets as of September 30, 2010 and December 31,
2009                             |  |      | 1  | 
|Condensed Consolidated Statements of Operations for the three and nine months ended September 
30, 2010 and 2009 |  |      | 2  | 
|Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and
2009            |  |      | 3  | 
|Notes to Condensed Consolidated Financial Statements                                                             |  |      | 4  | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations                    |  |      | 19 | 
|Item 3. Quantitative and Qualitative Disclosures About Market Risk                                               |  |      | 33 | 
|Item 4T. Controls and Procedures                                                                                 |  |      | 33 | 
|                                                                                                                 | 
|PART II. OTHER INFORMATION                                                                                       |  |      | 34 | 
|Item 1. Legal Proceedings                                                                                        |  |      | 34 | 
|Item 1A. Risk Factors                                                                                            |  |      | 34 | 
|Item 2. Unregistered Sales of Equity Securities and Use of Proceeds                                              |  |      | 57 | 
|Item 3. Defaults Upon Senior Securities                                                                          |  |      | 57 | 
|Item 4. [Removed and Reserved]                                                                                   |  |      | 57 | 
|Item 5. Other Information                                                                                        |  |      | 57 | 
|Item 6. Exhibits                                                                                                 |  |      | 58 | 
|                                                                                                                 | 
|SIGNATURES                                                                                                       |  |      | 59 | 
|                                                                                                                 | 
|EXHIBIT INDEX                                                                                                    |  |      | 60 | 



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PART I. FINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------

NEUROGESX, INC.

Condensed Consolidated Balance Sheets

(in thousands)



|                                                     |  |                   |          |   |                  |   |          |  
|---------------------------------------------------- |  | ----------------- | -------- | - | ---------------- | - | -------- | -
|                                                     |  | September 30,2010 |          |   | December 31,2009 |  
|                                                     |  | (unaudited)       |          |   | (Note 1)         |  
|Assets                                               |  |                   |          |   |                  |   |          |  
|Current assets:                                      |  |                   |          |   |                  |   |          |  
|Cash and cash equivalents                            |  | $                 | 13,645   |   |                  | $ | 29,695   |  
|Short term investments                               |  |                   | 44,094   |   |                  |   | 20,864   |  
|Receivable from collaborative partner                |  |                   |         |   |                  |   | 678      |  
|Trade receivable                                     |  |                   | 538      |   |                  |   |         |  
|Prepaid expenses and other current assets            |  |                   | 960      |   |                  |   | 711      |  
|Restricted cash                                      |  |                   | 290      |   |                  |   | 40       |  
|Inventories                                          |  |                   | 1,120    |   |                  |   | 58       |  
|                                                     |  |                   |          |   |                  |   |          |  
|Total current assets                                 |  |                   | 60,647   |   |                  |   | 52,046   |  
|                                                     |  |                  
|Property and equipment, net                          |  |                   | 852      |   |                  |   | 739      |  
|Other assets                                         |  |                   | 245      |   |                  |   |         |  
|Restricted cash                                      |  |                   | 120      |   |                  |   | 120      |  
|                                                     |  |                   |          |   |                  |   |          |  
|Total Assets                                         |  | $                 | 61,864   |   |                  | $ | 52,905   |  
|                                                     |  |                   |          |   |                  |   |          |  
|                                                     |  |                  
|Liabilities and stockholders equity (deficit)       |  |                   |          |   |                  |   |          |  
|Liabilities                                          |  |                   |          |   |                  |   |          |  
|Current Liabilities                                  |  |                   |          |   |                  |   |          |  
|Accounts payable                                     |  | $                 | 1,462    |   |                  | $ | 65       |  
|Accrued compensation                                 |  |                   | 1,592    |   |                  |   | 2,157    |  
|Accrued license fees                                 |  |                   |         |   |                  |   | 1,213    |  
|Accrued research and development                     |  |                   | 725      |   |                  |   | 670      |  
|Other accrued expenses                               |  |                   | 3,066    |   |                  |   | 1,222    |  
|Deferred product revenue, net                        |  |                   | 505      |   |                  |   |         |  
|Deferred collaborative revenue                       |  |                   | 7,242    |   |                  |   | 7,242    |  
|Long term obligations-current portion                |  |                   | 1,539    |   |                  |   |         |  
|Notes payable-current portion                        |  |                   |         |   |                  |   | 191      |  
|                                                     |  |                   |          |   |                  |   |          |  
|Total current liabilities                            |  |                   | 16,131   |   |                  |   | 12,760   |  
|                                                     |  |                  
|Non-current liabilities                              |  |                   |          |   |                  |   |          |  
|Deferred collaborative revenue                       |  |                   | 34,184   |   |                  |   | 39,601   |  
|Deferred rent                                        |  |                   | 164      |   |                  |   | 291      |  
|Long term obligations                                |  |                   | 41,265   |   |                  |   |         |  
|                                                     |  |                   |          |   |                  |   |          |  
|Total non-current liabilities                        |  |                   | 75,613   |   |                  |   | 39,892   |  
|                                                     |  |                  
|Stockholders equity (deficit):                      |  |                   |          |   |                  |   |          |  
|Common Stock                                         |  |                   | 18       |   |                  |   | 18       |  
|Additional paid-in capital                           |  |                   | 214,265  |   |                  |   | 212,254  |  
|Accumulated other comprehensive income (loss)        |  |                   | 5        |   |                  |   | (8       | )
|Accumulated deficit                                  |  |                   | (244,168 | ) |                  |   | (212,011 | )
|                                                     |  |                   |          |   |                  |   |          |  
|Total stockholders equity (deficit)                 |  |                   | (29,880  | ) |                  |   | 253      |  
|                                                     |  |                   |          |   |                  |   |          |  
|Total liabilities and stockholders equity (deficit) |  | $                 | 61,864   |   |                  | $ | 52,905   |  
|                                                     |  |                   |          |   |                  |   |          |  

See accompanying notes



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NEUROGESX, INC.

Condensed Consolidated Statements of Operations

(in thousands, except
share and per share information)

(unaudited)



|                                                            |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|----------------------------------------------------------- |  | -------------------------------- | ---------- | - | ------------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                            |  | Three Months Ended September 30, |            |   | Nine Months Ended September 30, |  
|                                                            |  | 2010                             |            |   | 2009                            |   |            | 2010 |  |   | 2009       |  
|Net product revenue                                         |  | $                                | 197        |   |                                 | $ |           |      |  | $ | 230        |   |  | $ |           |  
|Collaborative revenue                                       |  |                                  | 1,854      |   |                                 |   | 119        |      |  |   | 5,691      |   |  |   | 119        |  
|                                                            |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Total revenues                                              |  |                                  | 2,051      |   |                                 |   | 119        |      |  |   | 5,921      |   |  |   | 119        |  
|                                                            |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Operating expenses:                                         |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Cost of goods sold                                          |  |                                  | 54         |   |                                 |   |           |      |  |   | 99         |   |  |   |           |  
|Research and development                                    |  |                                  | 3,197      |   |                                 |   | 3,446      |      |  |   | 7,842      |   |  |   | 8,558      |  
|Selling, general and administrative                         |  |                                  | 9,577      |   |                                 |   | 3,380      |      |  |   | 26,878     |   |  |   | 8,168      |  
|                                                            |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Total operating expenses                                    |  |                                  | 12,828     |   |                                 |   | 6,826      |      |  |   | 34,819     |   |  |   | 16,726     |  
|                                                            |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Loss from operations                                        |  |                                  | (10,777    | ) |                                 |   | (6,707     | )    |  |   | (28,898    | ) |  |   | (16,607    | )
|Interest income                                             |  |                                  | 38         |   |                                 |   | 18         |      |  |   | 67         |   |  |   | 75         |  
|Interest expense                                            |  |                                  | (2,011     | ) |                                 |   | (28        | )    |  |   | (3,300     | ) |  |   | (142       | )
|Other expenses, net                                         |  |                                  | (10        | ) |                                 |   | (39        | )    |  |   | (26        | ) |  |   | (115       | )
|                                                            |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Net loss                                                    |  | $                                | (12,760    | ) |                                 | $ | (6,756     | )    |  | $ | (32,157    | ) |  | $ | (16,789    | )
|                                                            |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Basic and diluted net loss per share                        |  | $                                | (0.72      | ) |                                 | $ | (0.38      | )    |  | $ | (1.81      | ) |  | $ | (0.95      | )
|                                                            |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Shares used to compute basic and diluted net loss per share |  |                                  | 17,774,189 |   |                                 |   | 17,617,209 |      |  |   | 17,749,864 |   |  |   | 17,588,832 |  
|                                                            |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  

See accompanying notes.



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NEUROGESX, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)



|                                                                                      |  |                                |         |   |      |   |         |  
|------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                      |  | Nine Months EndedSeptember 30, |        
|                                                                                      |  | 2010                           |         |   | 2009 |  
|Operating activities                                                                  |  |                                |         |   |      |   |         |  
|Net loss                                                                              |  | $                              | (32,157 | ) |      | $ | (16,789 | )
|Adjustments to reconcile net loss to cash (used in)/provided by operating activities: |  |                                |         |   |      |   |         |  
|                                                                                      |  |                               
|Depreciation                                                                          |  |                                | 253     |   |      |   | 139     |  
|Amortization/accretion of debt issuance costs and debt discount                       |  |                                | 31      |   |      |   | 70      |  
|Amortization of investment premiums                                                   |  |                                | 361     |   |      |   | 80      |  
|Stock based compensation expense                                                      |  |                                | 1,780   |   |      |   | 1,621   |  
|Disposal of property and equipment                                                    |  |                                | 2       |   |      |   |        |  
|Changes in operating assets and liabilities:                                          |  |                                |         |   |      |   |         |  
|Restricted cash                                                                       |  |                                | (250    | ) |      |   |        |  
|Trade receivables                                                                     |  |                                | (538    | ) |      |   |        |  
|Receivable from collaboration partner                                                 |  |                                | 678     |   |      |   |        |  
|Prepaid expenses and other current assets                                             |  |                                | (206    | ) |      |   | (358    | )
|Inventories                                                                           |  |                                | (1,062  | ) |      |   |        |  
|Accounts payable                                                                      |  |                                | 1,397   |   |      |   | 154     |  
|Accrued compensation                                                                  |  |                                | (565    | ) |      |   | 182     |  
|Accrued license fees                                                                  |  |                                | (1,213  | ) |      |   | 1,213   |  
|Accrued research and development                                                      |  |                                | 55      |   |      |   | (877    | )
|Other accrued expenses                                                                |  |                                | 1,798   |   |      |   | 586     |  
|Accrued interest payable on long term obligations                                     |  |                                | 3,269   |   |      |   |        |  
|Deferred product revenue                                                              |  |                                | 505     |   |      |   |        |  
|Deferred collaborative revenue                                                        |  |                                | (5,416  | ) |      |   | 48,668  |  
|Deferred rent                                                                         |  |                                | (82     | ) |      |   | 140     |  
|                                                                                      |  |                                |         |   |      |   |         |  
|Net cash (used in)/provided by operating activities                                   |  |                                | (31,360 | ) |      |   | 34,829  |  
|                                                                                      |  |                                |         |   |      |   |         |  
|Investing activities                                                                  |  |                                |         |   |      |   |         |  
|Purchases of short-term investments                                                   |  |                                | (62,833 | ) |      |   | (16,555 | )
|Proceeds from maturities of short-term investments                                    |  |                                | 39,254  |   |      |   | 22,001  |  
|Purchases of property and equipment                                                   |  |                                | (366    | ) |      |   | (51     | )
|                                                                                      |  |                                |         |   |      |   |         |  
|Net cash (used in)/provided by investing activities                                   |  |                                | (23,945 | ) |      |   | 5,395   |  
|                                                                                      |  |                                |         |   |      |   |         |  
|Financing activities                                                                  |  |                                |         |   |      |   |         |  
|Repayment of notes payable                                                            |  |                                | (191    | ) |      |   | (2,350  | )
|Proceeds from issuance of long term obligations                                       |  |                                | 39,215  |   |      |   |        |  
|Proceeds from issuance of common stock                                                |  |                                | 231     |   |      |   | 159     |  
|                                                                                      |  |                                |         |   |      |   |         |  
|Net cash provided by/(used in) financing activities                                   |  |                                | 39,255  |   |      |   | (2,191  | )
|                                                                                      |  |                                |         |   |      |   |         |  
|                                                                                      |  |                               
|Net (decrease)/increase in cash and cash equivalents                                  |  |                                | (16,050 | ) |      |   | 38,033  |  
|Cash and cash equivalents, beginning of period                                        |  |                                | 29,695  |   |      |   | 10,435  |  
|                                                                                      |  |                                |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                              |  | $                              | 13,645  |   |      | $ | 48,468  |  
|                                                                                      |  |                                |         |   |      |   |         |  
|Supplemental cash flow information                                                    |  |                                |         |   |      |   |         |  
|Cash paid for interest                                                                |  | $                              |        |   |      | $ | 165     |  
|                                                                                      |  |                                |         |   |      |   |         |  

See accompanying notes



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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 first commercial product, Qutenza®, is a localized dermal delivery system designed to treat certain neuropathic pain conditions and was approved by the
United States Food and Drug Administration (FDA) in November 2009 for the management of neuropathic pain associated with postherpetic neuralgia (PHN). In April 2010, the Company made Qutenza commercially available in the
United States through a specialty distribution and specialty pharmacy network and is being commercialized in the U.S. by the Companys sales force.

In May 2009, Qutenza received a marketing authorization (MA) in the European Union for the treatment of peripheral neuropathic pain in non-diabetic adults, either alone or in combination with
other medicinal products for pain. In June 2009, the Company entered into a Distribution, Marketing and License Agreement (the Astellas Agreement) with Astellas Pharma Europe Ltd. (Astellas or Collaborative
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). Astellas has made Qutenza commercially available in Austria, Germany, the United Kingdom, Ireland, Greece, Portugal and the Netherlands.

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.

During the third quarter of 2009, the Company transitioned out of the development stage.

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 U.K. and marketing approval submission. The subsidiary has no assets other than the initial capital totaling one Pound Sterling.

Basis of Presentation

The accompanying unaudited condensed consolidated interim financial statements have been prepared in accordance with generally accepted accounting principles 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
periods.



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The balance sheet at
December 31, 2009 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, 2009 contained in the Companys 2009 Form 10-K.

Use of
Estimates and Assumptions

The preparation of financial statements in conformity with U.S. GAAP requires management to
make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Thus, actual results could differ from those estimates. Certain reclassifications of amounts previously reported have been made to
the accompanying consolidated financial statements in order to maintain consistency and comparability between periods presented.

Note 2.
Summary of Significant Accounting Policies

Product revenue

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



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



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

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

The Company has established terms pursuant to distribution agreements with its customers providing for payment
within 120 days of the date of shipment. Such distribution agreements generally have a term of one year. Upon expiration of the existing distributor agreements, the Company will evaluate such payment terms.



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The application of the
Companys revenue recognition policy resulted in the recognition of $197,000 and $230,000 from gross shipments of $494,000 and $802,000 for the three and nine months ended September 30, 2010, respectively. The Companys gross
shipments are reduced for chargebacks, certain fees paid to distributors and product sales allowances including rebates to qualifying federal and state government programs. At September 30, 2010, net deferred product revenues totaled $505,000.

Revenue from Astellas Agreement

In June 2009, NeurogesX entered into the Astellas Agreement which provides for an exclusive license by the Company to Astellas for the promotion, distribution and marketing of Qutenza in the Licensed
Territory, an option to license NGX-1998, a product candidate that is a non-patch liquid formulation of capsaicin, in the Licensed Territory, participation on a joint steering committee and, through a related supply agreement entered into with
Astellas (the Supply Agreement), supply of product until direct supply arrangements between Astellas and third party manufacturers are established, which the Company anticipates may be within 18 to 24 months from the execution of the
Astellas Agreement. Revenue under this arrangement includes upfront non-refundable fees and may also include additional option payments for the development of and license to NGX-1998, milestone payments upon achievement of certain product sales
levels and royalties on product sales.

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

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

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

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



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

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

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

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

Cost of goods sold

Cost of goods sold includes costs to procure, manufacture and distribute Qutenza including certain fixed costs incurred in the distribution channel as well as The Regents of the University of California,
or UC, and Lohmann Therapie-Systeme AG or LTS royalties. Costs associated with the manufacture of Qutenza prior to FDA approval were previously expensed as research and development in the period incurred. Cost of goods sold associated with deferred
product revenue will be deferred and recognized in the same period as the associated product revenue. At September 30, 2010, the Company had deferred Cost of goods sold of $37,000.

Inventory

Inventories are determined at the lower of cost or market
value with cost determined under the specific identification method. Inventories consist of raw materials, work in process and finished goods. Raw materials include certain starting materials used in the production of the active pharmaceutical
ingredient of Qutenza. Work in process includes the bulk inventory of the active pharmaceutical ingredient, patches and cleansing gel of Qutenza that are in the process of being manufactured or have completed manufacture and are awaiting final
packaging, including related internal labor and overhead costs. Finished goods include the final packaged kits that contain the Qutenza patch and cleansing gel and that are ready for commercial sale. Qutenza received FDA approval for sale in the
United States during the fourth quarter of 2009; costs incurred prior to FDA approval had been recorded as research and development expense on the Companys condensed consolidated statement of operations. On a quarterly basis, the Company
analyzes its inventory levels and writes down inventory that has become obsolete, inventory that has a cost basis in excess of the expected net realizable value and inventory that is in excess of expected requirements based upon anticipated product
revenues. As a result of the recent product launch of Qutenza, the expected requirements based on product revenue and the timing of production runs are subject to significant judgment and management estimate.



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Prepaid Collaboration Supplies

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

StockBased Compensation

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 dependent 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.
| | - |  | -----------------------------------------------

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 nine month periods ended September 30, 2010 and 2009 using the BlackScholes valuation model:



|                         |  |                                 |           |   |                                |  |           |      |  |  |           |   |  |  |           |  
|------------------------ |  | ------------------------------- | --------- | - | ------------------------------ |  | --------- | ---- |  |  | --------- | - |  |  | --------- | -
|                         |  | Three Months EndedSeptember 30, |           |   | Nine Months EndedSeptember 30, | 
|                         |  | 2010                            |           |   | 2009                           |  |           | 2010 |  |  | 2009      |  
|Stock Options            |  |                                 |           |   |                                |  |           |      |  |  |           |   |  |  |           |  
|Expected dividend yield  |  |                                 | 0         | % |                                |  | 0         | %    |  |  | 0         | % |  |  | 0         | %
|Expected volatility      |  |                                 | 66        | % |                                |  | 67        | %    |  |  | 66  72   | % |  |  | 67  70   | %
|Expected life (in years) |  |                                 | 6.0       |   |                                |  | 6.0       |      |  |  | 6.0       |   |  |  | 6.0       |  
|Riskfree interest rate  |  |                                 | 1.7       | % |                                |  | 2.9       | %    |  |  | 1.7  2.8 | % |  |  | 1.8  2.9 | %
|                         |  |                                 |           |  
|ESPP                     |  |                                 |           |   |                                |  |           |      |  |  |           |   |  |  |           |  
|Expected dividend yield  |  |                                 | 0         | % |                                |  | 0         | %    |  |  | 0         | % |  |  | 0         | %
|Expected volatility      |  |                                 | 46  89   | % |                                |  | 56  89   | %    |  |  | 46  89   | % |  |  | 56  89   | %
|Expected life (in years) |  |                                 | 0.5  1.0 |   |                                |  | 0.2 1.0  |      |  |  | 0.5  1.0 |   |  |  | 0.2  1.0 |  
|Riskfree interest rate  |  |                                 | 0.2  0.5 | % |                                |  | 0.2  2.1 | %    |  |  | 0.1  0.5 | % |  |  | 0.2  2.1 | %



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Comprehensive Loss

The Company reports comprehensive loss and its components as part of total stockholders equity (deficit).
Comprehensive loss is comprised of net loss and unrealized gains (losses) on available-for-sale investments. For the three and nine months ended September 30, 2010 and 2009, comprehensive loss was as follows:



|                                     |  |                                  |         |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------ |  | -------------------------------- | ------- | - | ------------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                     |  | Three Months Ended September 30, |         |   | Nine Months Ended September 30, |  
|(in thousands)                       |  | 2010                             |         |   | 2009                            |   |        | 2010 |  |   | 2009    |  
|Net loss                             |  | $                                | (12,760 | ) |                                 | $ | (6,756 | )    |  | $ | (32,157 | ) |  | $ | (16,789 | )
|Changes in unrealized gains (losses) |  |                                  |        |   |                                 |   | 2      |      |  |   | 13      |   |  |   | (28     | )
|                                     |  |                                  |         |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Total comprehensive loss             |  | $                                | (12,760 | ) |                                 | $ | (6,754 | )    |  | $ | (32,144 | ) |  | $ | (16,817 | )
|                                     |  |                                  |         |   |                                 |   |        |      |  |   |         |   |  |   |         |  

The fluctuation in accumulated other comprehensive income (loss) 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 resulting in unrealized gains or losses. The cumulative effect of these periodic fluctuations is reflected as other comprehensive income (loss) on
the accompanying condensed consolidated balance sheets.

Net Loss Per Share

Basic net loss per share is calculated by dividing the net loss by the weighted-average number of common shares outstanding 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 by the weighted-average number of common shares 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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The following table is
a reconciliation of the numerator and denominator used in the calculation of basic and diluted net loss per share:



|                                                                                                                                        |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|--------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ------------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                                                                                                        |  | Three Months Ended September 30, |            |   | Nine Months Ended September 30, |  
|(in thousands except share and per share data)                                                                                          |  | 2010                             |            |   | 2009                            |   |            | 2010 |  |   | 2009       |  
|Numerator:                                                                                                                              |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Net loss                                                                                                                                |  | $                                | (12,760    | ) |                                 | $ | (6,756     | )    |  | $ | (32,157    | ) |  | $ | (16,789    | )
|                                                                                                                                        |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Denominator:                                                                                                                            |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Weighted-average common shares outstanding                                                                                              |  |                                  | 17,774,189 |   |                                 |   | 17,617,314 |      |  |   | 17,749,864 |   |  |   | 17,589,172 |  
|Less: Weighted-average unvested common shares subject to repurchase                                                                     |  |                                  |           |   |                                 |   | (105       | )    |  |   |           |   |  |   | (340       | )
|                                                                                                                                        |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Denominator for basic and diluted net loss per share                                                                                    |  |                                  | 17,774,189 |   |                                 |   | 17,617,209 |      |  |   | 17,749,864 |   |  |   | 17,588,832 |  
|                                                                                                                                        |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Basic and diluted net loss per share                                                                                                    |  | $                                | (0.72      | ) |                                 | $ | (0.38      | )    |  | $ | (1.81      | ) |  | $ | (0.95      | )
|                                                                                                                                        |  |                                  |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|                                                                                                                                       
|Using the treasury stock method, common equivalent shares that were excluded from the calculation of net loss per share are as
follows: | 
|                                                                                                                                        |  |                                 
|                                                                                                                                        |  | Three Months Ended September 30, |            |   | Nine Months EndedSeptember 30,  |  
|                                                                                                                                        |  | 2010                             |            |   | 2009                            |   |            | 2010 |  |   | 2009       |  
|Shares issuable upon the exercise of stock options                                                                                      |  |                                  | 849,420    |   |                                 |   | 957,296    |      |  |   | 971,467    |   |  |   | 657,605    |  

Recently Issued and Adoption of
New Accounting Standards

In October 2009, the Financial Accounting Standards Board (FASB) issued
Accounting Standards Update (ASU) No. 2009-13, Revenue Recognition (ASC Topic 605)  Multiple-Deliverable Revenue Arrangements. This guidance modifies previous guidance for multiple element arrangements by allowing the
use of the best estimate of selling price in the absence of vendor-specific objective evidence (VSOE) or third party evidence (TPE) of selling price for determining the selling price of a deliverable. A vendor is
now required to use its best estimate of the selling price when VSOE or TPE of the selling price is not available. In addition, the residual method of allocating arrangement consideration is no longer permitted. This ASU is effective for revenue
arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and early adoption is permitted. The Company has not early adopted ASU No. 2009-13 and is currently evaluating whether the adoption of the
new guidance will have a material impact on the Companys consolidated financial statements.

In April 2010, the FASB
issued ASU No. 2010-17, Revenue RecognitionMilestone Method (ASC Topic 605): Milestone Method of Revenue Recognition (ASU No. 2010-17). This ASU codifies the consensus reached in EITF Issue No. 08-9, Milestone
Method of Revenue Recognition. The amendments to the Codification provide guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development
transactions.



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Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to
meet certain criteria to be considered substantive. Milestones should be considered substantive in their entirety and may not be bifurcated. An arrangement may contain both substantive and non-substantive milestones, and each milestone should be
evaluated individually to determine if it is substantive. ASU No. 2010-17 is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Early
adoption is permitted. If a vendor elects early adoption and the period of adoption is not the beginning of the entitys fiscal year, the entity should apply ASU No. 2010-17 retrospectively from the beginning of the year of adoption. The
Company has not early adopted ASU No. 2010-17 and is currently evaluating whether the adoption of the new guidance will have a material impact on the Companys consolidated financial statements.

Note 3. License Agreements

COLLABORATION AGREEMENT - ASTELLAS

In June 2009, NeurogesX entered
into the Astellas Agreement whereby the Company provided an exclusive license to Astellas to commercialize Qutenza in the Licensed Territory. The Astellas Agreement provided for an upfront payment for past development and the commercialization
rights granted, of 30,000,000 Euro, or $41,817,000. In addition, the agreement provided for an upfront payment of 5,000,000 Euro, or $6,970,000, for future development expenses and an option to license NGX-1998, a product candidate entering a Phase
2 clinical trial in the fourth quarter of 2010. Other elements of the Astellas Agreement include future milestone payments of up to 65,000,000 Euro if certain predefined sales thresholds of the products licensed under the agreement are met and
royalties, as a percentage of net sales of products under the agreement, with such royalties starting in the high teens and escalating into the mid twenties as revenues increase. In addition, Astellas is responsible for UC and LTS royalties on net
sales in the Licensed Territory. The Company is participating on a joint steering committee with Astellas to oversee the development and commercialization activities related to Qutenza and NGX-1998 during the term of the agreement, not to exceed ten
years. On the seventh anniversary of the Astellas Agreement, the Company has the unilateral right to opt-out of participation on the joint steering committee. The Astellas Agreement further provides that upon delivery of certain data related to
NGX-1998, Astellas may pay two additional NGX-1998 option payments totaling 5,000,000 Euro. Subsequent to Astellas exercise of the option to exclusively license NGX-1998 in the Territory, both companies would cooperate on Phase III clinical
trials and will share such costs equally.

As of September 30, 2010, the Company has deferred revenue totaling
$41,426,000 of which $7,242,000 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 commenced recognizing revenue related to the upfront and option payments upon transfer of
the MA for Qutenza to Astellas, which occurred in September 2009, and accordingly, recognized $119,000 collaborative revenue for the three months ended September 2009. Collaborative revenue recognized for the three and nine months ended
September 30, 2010 were $1,854,000 and $5,691,000, respectively. 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 contractually agreed upon costs per unit which are intended to reflect the Companys direct cost of goods and related internal labor and overhead costs without mark-up for profit. The Company reported amounts received from product
transactions net of direct costs incurred as a component of Collaborative revenue.

For the three and nine months ended
September 30, 2010, the Company included in Collaborative revenue $28,000 and $274,000, respectively, from product transactions, net of direct costs incurred as a component of Collaborative revenue. There were no collaborative product revenues
recorded in the same periods of the prior year.

UNIVERSITY OF CALIFORNIA

In October 2000 and as amended, the Company licensed certain patents from the 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). As a result of the Astellas license payment received in July 2009, the Company recorded as a research and development expense the UC Sublicense Fee totaling
$1,213,000 during the third quarter of 2009. This amount was subsequently paid to UC in the quarter ended March 31, 2010. The Company recognized $1,000 in royalty expense due to UC for the nine months ended September 30, 2010 related to
Qutenza product sales in the United States.

LTS LOHMANN THERAPIE-SYSTEME AG

In January 2007, the Company entered into a Commercial Supply and License Agreement (LTS Agreement) with LTS to manufacture
commercial and clinical supply of Qutenza. Under the terms of the agreement, upon first market approval of Qutenza, the Company paid a $140,000 milestone payment in the second quarter of 2009, which was charged to research and development expense.
Additionally, 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. The Company recognized $4,000 in royalty expense due to LTS Lohmann Therapie-Systeme
AG for the nine months ended September 30, 2010 related to Qutenza product sales in the United States.

At
September 30, 2010, the Company has a liability for UC and LTS royalties owed for approximately $11,000 for gross product shipments related to the nine months ended September 30, 2010.



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

The following are summaries of cash, cash equivalents and short-term investments:



|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|--------------------------- |  | ------------- | ------ |  | -------------------- | - | - | --------------------- |  | - | ------------------- | - |  | - | ------ | 
|(in thousands)              |  | AmortizedCost |        |  | GrossUnrealizedGains |   |   | GrossUnrealizedLosses |  |   | Estimated FairValue |  
|As of September 30, 2010:   |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Cash and money market funds |  | $             | 11,392 |  |                      | $ |  |                       |  | $ |                    |   |  | $ | 11,392 | 
|U.S. Treasury securities    |  |               | 46,342 |  |                      |   | 5 |                       |  |   |                    |   |  |   | 46,347 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Total                       |  | $             | 57,734 |  |                      | $ | 5 |                       |  | $ |                    |   |  | $ | 57,739 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Reported as:                |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Cash and cash equivalents   |  |               |        |  |                      |   |   |                       |  |   |                     |   |  | $ | 13,645 | 
|Short-term investments      |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   | 44,094 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Total                       |  |               |        |  |                      |   |   |                       |  |   |                     |   |  | $ | 57,739 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|As of December 31, 2009:    |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Cash and money market funds |  | $             | 20,651 |  |                      | $ |  |                       |  | $ |                    |   |  | $ | 20,651 | 
|U.S. Treasury securities    |  |               | 29,916 |  |                      |   |  |                       |  |   | (8                  | ) |  |   | 29,908 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Total                       |  | $             | 50,567 |  |                      | $ |  |                       |  | $ | (8                  | ) |  | $ | 50,559 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Reported as:                |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Cash and cash equivalents   |  |               |        |  |                      |   |   |                       |  |   |                     |   |  | $ | 29,695 | 
|Short-term investments      |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   | 20,864 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 
|Total                       |  |               |        |  |                      |   |   |                       |  |   |                     |   |  | $ | 50,559 | 
|                            |  |               |        |  |                      |   |   |                       |  |   |                     |   |  |   |        | 

At September 30, 2010 and December 31, 2009, the contractual maturities of investments held were
less than one year. The Company did not sell any of its investments prior to maturity during the three and nine months ended September 30, 2010 or during the year ended December 31, 2009.



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Note 5. Inventories

The components of inventories are as follows:



|                   |  |                   |       |  |                  |   |    | 
|------------------ |  | ----------------- | ----- |  | ---------------- | - | -- | 
|(in thousands)     |  | September 30,2010 |       |  | December 31,2009 |  
|Raw materials      |  | $                 | 7     |  |                  | $ |   | 
|Work in process(1) |  |                   | 895   |  |                  |   | 58 | 
|Finished goods     |  |                   | 218   |  |                  |   |   | 
|                   |  |                   |       |  |                  |   |    | 
|Total inventories  |  | $                 | 1,120 |  |                  | $ | 58 | 
|                   |  |                   |       |  |                  |   |    | 

|(1) | Included in the work in process is $383,000 of product awaiting final packaging.
|--- | --------------------------------------------------------------------------------

The above inventory balances are costs capitalized since the Company received FDA approval for the sale of Qutenza in the US market in
the fourth quarter of 2009. Prior to FDA approval, all related US inventory costs were expensed to research and development. On a quarterly basis, the Company analyzes its inventory levels and writes down inventory that has become obsolete,
inventory that has a cost basis in excess of the expected net realizable value and inventory that is in excess of expected requirements based upon anticipated product revenues. No such allowances were considered necessary as of September 30,
2010.

Note 6. Fair Value Measurements

The Company utilizes the following fair value hierarchy to measure fair value. The hierarchy consists of three levels of inputs, of which the first two are considered observable and the last unobservable.

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

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

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



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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 September 30, 2010 and December 31, 2009:



|                                                                                   |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|---------------------------------------------------------------------------------- |  | ---------------------------------------------------------- | ------ |  | ----------------------------------------- | - | - | -------------------------------------- |  | - | ----- |  |  | - | ------ | 
|(in thousands)                                                                     |  | Quoted Pricesin ActiveMarkets forIdentical Assets(Level 1) |        |  | SignificantOtherObservableInputs(Level 2) |   |   | SignificantUnobservableInputs(Level 3) |  |   | Total | 
|Fair Value Measurements at September 30, 2010:                                     |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|Components of cash equivalents and short- term investments measured at fair value: |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|Money market funds                                                                 |  | $                                                          | 11,021 |  |                                           | $ |  |                                        |  | $ |      |  |  | $ | 11,021 | 
|U.S. Treasury securities                                                           |  |                                                            | 46,347 |  |                                           |   |   |                                        |  |   |      |  |  |   | 46,347 | 
|                                                                                   |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|Total financial assets measured at fair value                                      |  | $                                                          | 57,368 |  |                                           | $ |  |                                        |  | $ |      |  |  | $ | 57,368 | 
|                                                                                   |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|Operating cash                                                                     |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   | 371    | 
|                                                                                   |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|Total cash and cash equivalents and short- term investments                        |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  | $ | 57,739 | 
|                                                                                   |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|Fair Value Measurements at December 31, 2009:                                      |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|Components of cash equivalents and short- term investments measured at fair value: |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|Money market funds                                                                 |  | $                                                          | 20,037 |  |                                           | $ |  |                                        |  | $ |      |  |  | $ | 20,037 | 
|U.S. Treasury securities                                                           |  |                                                            | 29,908 |  |                                           |   |  |                                        |  |   |      |  |  |   | 29,908 | 
|                                                                                   |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|Total financial assets measured at fair value                                      |  | $                                                          | 49,945 |  |                                           | $ |  |                                        |  | $ |      |  |  | $ | 49,945 | 
|                                                                                   |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|Operating cash                                                                     |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   | 614    | 
|                                                                                   |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 
|Total cash and cash equivalents and short- term investments                        |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  | $ | 50,559 | 
|                                                                                   |  |                                                            |        |  |                                           |   |   |                                        |  |   |       |  |  |   |        | 

Note 7. Stockholders Equity

2007 Stock Plan

During the nine months ended September 30,
2010, the Company granted options to purchase a total of 1,029,039 shares of the Companys common stock to employees, officers and non-employee directors with a fair value of $4,736,000 which is expected to be amortized through 2014. Employees
were granted options to purchase 672,000 shares of the Companys common stock with a fair value of $3,143,000, and officers were granted options to purchase 302,039 shares of the Companys common stock with a fair value of $1,334,000.
Additionally, the Company granted options to purchase 55,000 shares of the Companys common stock to non-employee directors with a fair value of $259,000.

Of the 302,039 options granted to officers during the nine months ended September 30, 2010, options to purchase a total of 22,039 and 280,000 shares were granted to executive officers as part of
their bonus consideration and as stock option grants, respectively. The fair value of these 22,039 options was $97,000 and was expensed during the nine months ended September 30, 2010 as these options were vested in full upon grant. The fair
value of the 280,000 options granted was $1,237,000 and is expected to be amortized through 2014.



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



|                              |  |                    |           |  
|----------------------------- |  | ------------------ | --------- | -
|                              |  | OptionsOutstanding |          
|Balance at December 31, 2009  |  |                    | 2,264,535 |  
|Grants                        |  |                    | 1,029,039 |  
|Exercises                     |  |                    | (36,431   | )
|Cancellations                 |  |                    | (125,002  | )
|                              |  |                    |           |  
|Balance at September 30, 2010 |  |                    | 3,132,141 |  
|                              |  |                    |           |  

Non-cash stock based compensation expenses included in operating expenses for the three and nine months
ended September 30, 2010 and September 30, 2009 were as follows:



|                                             |  |                                |     |  |                               |   |     |      |  |   |       |  |  |   |       | 
|-------------------------------------------- |  | ------------------------------ | --- |  | ----------------------------- | - | --- | ---- |  | - | ----- |  |  | - | ----- | 
|                                             |  | Three
MonthsEndedSeptember 30, |     |  | Nine
MonthsEndedSeptember 30, |  
|(in thousands)                               |  | 2010                           |     |  | 2009                          |   |     | 2010 |  |   | 2009  | 
|Cost of goods sold                           |  | $                              | 9   |  |                               | $ |    |      |  | $ | 9     |  |  | $ |      | 
|Research and development expenses            |  |                                | 178 |  |                               |   | 148 |      |  |   | 504   |  |  |   | 596   | 
|Selling, general and administrative expenses |  |                                | 467 |  |                               |   | 576 |      |  |   | 1,267 |  |  |   | 1,025 | 
|                                             |  |                                |     |  |                               |   |     |      |  |   |       |  |  |   |       | 
|Total                                        |  | $                              | 654 |  |                               | $ | 724 |      |  | $ | 1,780 |  |  | $ | 1,621 | 
|                                             |  |                                |     |  |                               |   |     |      |  |   |       |  |  |   |       | 



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Note 8. Commitments and
Contingencies

The Company has issued non-cancellable purchase orders to third party manufacturers of Qutenza and NGX-1998
for manufacturing, stability and related services including reimbursable amounts from Astellas for the supply of Qutenza based on the Astellas Agreement. These purchase orders totaled approximately $2,500,000 as of September 30, 2010 and
included approximately $1,250,000 of commitments related to supply of Qutenza to Astellas, approximately $476,000 related to product manufacturing costs for the U.S. market, and approximately $538,000 for stability and related services. The Company
has made certain purchase commitments totaling $233,000 leading up to the Phase 2 study for NGX-1998. The Company will record these amounts in its financial statements when title to the applicable materials has transferred to the Company.

Note 9. Long Term Obligations

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

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



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



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

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

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

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



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



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

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

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

The upfront cash receipt of $40,000,000 less a discount of $494,000 in cost reimbursements paid to Cowen Royalty and was recorded as a Long term obligation along with the related long term accrued
interest payable of $1,729,000 as of September 30, 2010. The carrying value of the Long term obligation at September 30, 2010 is $41,266,000 and the estimated fair market value is $40,500,000. The best estimate of future payments was based
upon returning to Cowen Royalty an internal rate of return of 19% through Revenue Interest payments. Under this methodology, the Company recorded interest expense of approximately $3,269,000. The Company has not made any payments to Cowen Royalty
since the inception of the Financing Agreement. The accrued interest on the Long term debt obligation is presented on the condensed consolidated balance sheet as of September 30, 2010 in two components, the Long term obligation-current portion,
which totals $1,539,000 and the remaining $1,729,000 included in Long term obligation.

The Company capitalized $313,000 of
debt issuance costs related to the agreement which are being amortized over the term of the related debt using the straight-line method, which approximates the effective interest method. At September 30, 2010, the unamortized debt issuance
costs were $293,000 and are included in other assets on the Companys condensed consolidated balance sheet. The Company is accreting the discount of $494,000 to interest expense over the term of the related debt, using the straight-line method,
which approximates the effective interest method.

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



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|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:



| |  |  | our plans with regard to our sales efforts for Qutenza® in the United States;
| | - |  | -----------------------------------------------------------------------------



| |  |  | the plans of Astellas Pharma Europe Ltd., or Astellas, for commercialization and development of Qutenza pursuant to the terms of the Distribution,
Marketing Agreement and License Agreement or the Astellas Agreement;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our plans, and the timing, associated with our proposed Supplemental New Drug Application, or sNDA, submission for Qutenza with the U.S. Food and Drug
Administration, or FDA;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | efforts to expand the scope of indications in which our capsaicin-based product candidates are approved and may be marketed;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | the scope, size and timing of research and development efforts and programs, including with respect to anticipated development of NGX-1998 and
additional product candidates;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | expected timing of initial enrollment for a planned Phase 2 clinical trials for NGX-1998;
| | - |  | -----------------------------------------------------------------------------------------



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



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



| |  |  | estimates or expectations upon which we base our revenue recognition;
| | - |  | ---------------------------------------------------------------------



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



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



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



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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:



| |  |  | our ability to build and manage an effective sales force and supporting infrastructure to successfully commercialize Qutenza;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | physician or patient reluctance to use Qutenza including possible reluctance due to inadequate or inconvenient payer coverage for Qutenza and for the
procedure to administer Qutenza;.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to obtain sufficient insurance coverage and reimbursement;
| | - |  | ----------------------------------------------------------------------



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



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



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



| |  |  | Astellas ability and efforts to effectively commercialize Qutenza in the territory covered by the Astellas Agreement;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | 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.
| | - |  | ---------------------------------------------------------------------------------------------

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 that we believe may offer substantial advantages over currently available treatment options. Our initial focus is on the management of chronic peripheral neuropathic pain conditions.

Our first commercial product, Qutenza is a localized dermal delivery system designed to treat certain neuropathic pain conditions and was
approved by the FDA in November 2009 for the management of neuropathic pain associated with postherpetic neuralgia, or PHN. Qutenza is commercially available in the United States through a specialty distribution and specialty pharmacy network
supported by our own sales force.

In May 2009, Qutenza received a Marketing Approval, or MA, in the European Union for the
treatment of peripheral neuropathic pain in non-diabetic adults, either alone or in combination with other medicinal products for pain. In June 2009, we entered into the Astellas Agreement, under which we granted to Astellas an exclusive license to
commercialize Qutenza in the European Economic Area, which includes the 27 countries of the European Union, Iceland, Norway, and Liechtenstein as well as



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Switzerland, certain countries in Eastern Europe, the Middle East and Africa, which we refer to as the Licensed Territory. As of September 30, 2010, Astellas has made Qutenza
commercially available in Austria, Germany, the United Kingdom, Ireland, Greece, Portugal and the Netherlands and Astellas has informed us that it is continuing its focus on intensive site training in the early stages of product availability, on a
country by country basis. We believe that Astellas plans to expand Qutenza availability in the European Union and seek regulatory approvals in certain countries in the remainder of the Licensed Territory through the end of 2010 and into 2011. We
will record royalty revenue based upon Astellas reported net sales of Qutenza in the Licensed Territory. We recognize royalty revenue from Astellas on a quarter lag basis due to timing of Astellas reporting such royalties to us. During the
third quarter, we recorded royalty income which was not material based upon net sales in the Licensed Territory during the quarter ended June 30, 2010.

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

Our lead product candidate, NGX-1998 is a topical liquid formulation of capsaicin for potential use in neuropathic pain conditions and
has been evaluated in three Phase 1 studies. In the first three quarters of 2010, we have been preparing for a Phase 2 clinical trial for NGX-1998. That trial, referred to as C204, began in the fourth quarter.

We also have a series of compounds which represent an early stage pipeline of potential product candidates which include various prodrugs
of acetaminophen for potential use in acute pain, including traumatic pain, post-surgical pain and fever and various prodrugs of opioids for potential use in chronic pain indications. These other product candidates are in the pre-clinical stage of
development and may or may not be the subject of further development in 2010 or beyond. We are currently seeking development partners for our acetaminophen and opioid prodrug programs.

To date, we 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. We had cash, cash equivalents and short-term investments totaling $57.7 million at September 30, 2010 and during the nine months ended September 30, 2010 we
used $31.4 million in operating activities. We expect to continue to incur annual operating losses over the next several years and our operating expenses are expected to increase in the coming years as we continue our sales and marketing efforts of
Qutenza in the United States, seek label expansion for Qutenza in the United States and resume our development activities associated with NGX-1998 and potentially other product candidates. As a result of increased operating expenses, our operating
losses may increase over the next few years, dependent in part on the amount of Qutenza sales revenues during these periods. On April 30, 2010, we entered into a $40 million Financing Agreement with Cowen Healthcare Royalty Partners, L.P., or
Cowen Royalty. The agreement creates a debt obligation that will be repaid through and secured by royalties and future milestone payments payable to us by Astellas that we refer to as Revenue Interests. We believe that this structure provides us
with capital to continue executing our operating plan. We anticipate that our existing cash and investments will be sufficient to meet our projected operating requirements through at least the next twelve months.



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Critical Accounting Policies and
Significant Judgments and Estimates

As of the date of the filing of this quarterly report, there have been no material
changes to our critical accounting policies during the nine months ended September 30, 2010 compared to those discussed in our 2009 Form 10-K, filed on March 19, 2010, other than those discussed below:

Product revenue

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



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



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

Physicians are generally ordering Qutenza in small quantities only after they have identified a patient for treatment. We believe that revenue recognition upon the later of customer shipment to the end
user and the date of cash collection is appropriate until we have sufficient data on cash collection and return patterns of our customers. We are utilizing shipping data provided by our customers to determine when product is shipped by the customers
to physicians and are evaluating ending inventory levels at our customers each month. We are performing additional procedures to further analyze shipments made by our customers to physicians and the risk of product returns.

We have established terms pursuant to distribution agreements with our customers providing for payment within 120 days of the date of
shipment. Such distribution agreements generally have a term of one year. Upon expiration of the existing distributor agreements, we plan to evaluate such payment terms.

The application of the above revenue recognition policy resulted in the recognition of $197,000 and $230,000 from total gross shipments of $494,000 and $802,000 for the three and nine months ended
September 30, 2010, respectively. Our gross shipments are reduced for chargebacks, certain fees paid to our distributors and product sales allowances including rebates to qualifying federal and state government programs. At September 30,
2010, net deferred product revenues totaled $505,000.

Revenue from Astellas Agreement

In June 2009, we entered into the Astellas Agreement which provides for an exclusive license by us to Astellas for the promotion,
distribution and marketing of Qutenza in the Licensed Territory, an option to license NGX-1998 in the Licensed Territory, participation on a joint steering committee and, through a related supply agreement entered into with Astellas, or the Supply
Agreement, supply of product until direct supply arrangements between Astellas and third party manufacturers are established, which we anticipate may be within 18 to 24 months from the execution of the Astellas Agreement. Revenue under this
arrangement includes upfront non-refundable fees and may also include additional option payments for the development of and license to NGX-1998, milestone payments upon achievement of certain product sales levels and royalties on product sales.



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

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

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

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

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

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

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



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

Cost of goods sold

Cost of goods sold includes costs to procure, manufacture and distribute Qutenza including certain fixed costs incurred in the distribution channel as well as royalties paid to The Regents of the
University of California, or UC, and LTS Lohmann Therapie-Systeme AG or LTS pursuant to our agreements with such entities. Costs associated with the manufacture of Qutenza prior to FDA approval were previously expensed as research and development in
the period incurred. Cost of goods sold associated with deferred product revenue will be deferred and recognized in the same period as the associated product revenue. At September 30, 2010, we had deferred Cost of goods sold of $37,000.

Inventory

Inventories are determined at the lower of cost or market value with cost determined under the specific identification method. Inventories consist of raw materials, work in process and finished goods. Raw
materials include certain starting materials used in the production of the active pharmaceutical ingredient of Qutenza. Work in process includes the bulk inventory of the active pharmaceutical ingredient, patches and cleansing gel of Qutenza that
are in the process of being manufactured by our third party contract manufacturers or have completed manufacture and are awaiting final packaging, including related internal labor and overhead costs. Finished goods include the final packaged kits
that contain the Qutenza patch and cleansing gel and that are ready for commercial sale. Qutenza received FDA approval for sale in the United States during the fourth quarter of 2009, and accordingly, all product manufacturing costs incurred
subsequent to FDA approval in the U.S. market were capitalized to inventory. Such costs incurred prior to FDA approval had been recorded as research and development expense in the accompanying condensed consolidated statement of operations. As a
result, inventory balances for the next few quarters may reflect a lower average per unit cost. On a quarterly basis, Management analyzes its inventory levels and writes down inventory that has become obsolete, inventory that has a cost basis in
excess of the expected net realizable value and inventory that is in excess of expected requirements based upon anticipated product revenues. As a result of the recent product launch of Qutenza, the expected requirements based on product revenue and
the timing of production runs are subject to significant judgement and management estimate.

Long term obligations

Under our Financing Agreement with Cowen Royalty, we recorded the upfront cash receipt of $40.0 million, less the
$494,000 in cost reimbursements paid to Cowen Royalty as a Long term obligation. Based upon our best estimate of future Revenue Interest payments, interest expense was calculated using the straight line method, which approximates the effective
interest method. Our best estimate of future Revenue Interest payments was based upon returning to Cowen Royalty an internal rate of return of 19% through future Revenue Interest receipts from Astellas.

Results of Operations

In November 2009, we received marketing approval from the FDA for Qutenza for the management of neuropathic pain associated with PHN. In
April, 2010, we launched Qutenza in the United States. We are marketing and selling Qutenza in the United States through a team of approximately 40 sales professionals.



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We have established a distribution network to allow health care providers to access Qutenza through specialty distributors and specialty pharmacies. We are marketing Qutenza to high volume
prescribing physicians who treat PHN patients in private practices, hospitals, military treatment facilities and veterans associations. Our focus requires considerable time and effort to educate and train physician offices prior to their initial
Qutenza treatments.

We commenced recording Collaborative revenue for the upfront payments from Astellas in 2009, when the
upfront payment of $48.8 million received from Astellas became nonrefundable as a result of our transfer of the Qutenza MA to Astellas. As of September 30, 2010, $41.4 million is the remaining deferred collaborative revenue which will be
recognized on a straight line basis over the remaining service period of the joint steering committee, which we estimate will expire in June 2016. Under our Supply Agreement with Astellas, we are obligated to supply product, at our cost, until such
time as Astellas establishes its own supply relationship.

As of September 30, 2010, Astellas has made Qutenza
commercially available in Austria, Germany, the United Kingdom, Ireland, Greece, Portugal and the Netherlands and Astellas has informed us that it is continuing its focus on intensive site training in the early stages of product availability, on a
country by country basis. We believe that Astellas plans to expand Qutenza availability in the European Union and seek regulatory approvals in certain countries in the remainder of the Licensed Territory through the end of 2010 and into 2011. We
will record royalty revenue based upon Astellas reported net sales of Qutenza in the Licensed Territory. We recognize royalty revenue from Astellas on a quarter lag basis due to timing of Astellas reporting such royalties to us. During
the third quarter, we recorded royalty income which was not material based upon net sales in the Licensed Territory during the quarter ended June 30, 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 associated with the ongoing support of Qutenza in approved indications, activities related to development of Qutenza in potential additional indications and activities related to related to
NGX-1998 and our other product candidates. 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. 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 do not maintain and evaluate research and development costs by specific
therapeutic indications within a program due to the difficulties in allocating such costs to specific indications. We use our internal research and development resources across several projects and many resources may not be attributable to specific
projects or indications. However, to the extent possible, we account for our internal research and development costs on a project-by-project basis. 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. Additionally, prior to FDA approval of Qutenza, external and internal costs related to manufacturing of Qutenza were recorded to research and
development expense in the period incurred.

The process of conducting preclinical testing and clinical trials necessary to
obtain marketing approvals in the United States and other regions is costly and time consuming. The probability of success for each product candidate and clinical trial may be affected by a variety of factors, including, among others, patient
enrollment, manufacturing capabilities, successful clinical results, our funding, and competitive and commercial viability. As a result of these and other factors, we are unable to determine the duration and completion costs of current or future
clinical stages of our product candidates or when or to what extent we will generate revenues from commercialization and sale of any of our unapproved product candidates. Currently, we are preparing for the entry of NGX-1998 into Phase 2 clinical
development. NGX-1998 is our most advanced product candidate and costs to complete development of NGX-1998 could be significant. Pursuant to the Astellas Agreement, we might receive future option payments related to this program at Astellas
election, however, we are obligated to pay any such amounts to Cowen Royalty under the terms of the Financing Agreement. Further, if Astellas exercises its option to license NGX-1998, Astellas would be responsible for 50% of the costs incurred for
Phase 3 clinical development.



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Our overall research
and development expenses, excluding non-cash stock-based compensation expense increased in the third quarter from the second quarter of 2010. We expect that it will continue to increase in the fourth quarter and during 2011, as we expand development
activities for NGX-1998 to include a Phase 2 clinical study and initiate activities towards filing a sNDA for Qutenzas label expansion to cover patients with HIV-associated neuropathy.

Our selling, general and administrative expenses consist primarily of salaries and benefits, including those of our sales, marketing,
commercial operations and administrative functions such as finance, human resources, legal, medical affairs and information technology. Additionally, selling, general and administrative expenses include marketing expenses, commercialization costs,
pharmacovigilance costs and costs associated with our status as a public company and patent costs. In addition, general and administrative expenses include allocated facility, basic operational and support costs and insurance costs. We anticipate
that our selling, general and administrative expenses may increase significantly over the next several years as a result of our commercialization of Qutenza. These increases are likely to be attributable to increasing marketing activities, costs to
maintain and potentially grow our U.S. sales force and infrastructure costs to support commercial operations, 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 the Three Months Ended September 30, 2010 and
2009



|                                             |  |                                 |        |   |            |   |        |            |  |   |            |   |  |  |      |   
|-------------------------------------------- |  | ------------------------------- | ------ | - | ---------- | - | ------ | ---------- |  | - | ---------- | - |  |  | ---- | --
|                                             |  | Three Months EndedSeptember 30, |        |   | $ Increase |   |        | % Increase | 
|(in thousands)                               |  | 2010                            |        |   | 2009       |   |        | (Derease)  |  |   | (Decrease) |  
|Product revenue                              |  | $                               | 197    |   |            | $ |       |            |  | $ | 197        |   |  |  | 100  | % 
|Collaborative revenue                        |  |                                 | 1,854  |   |            |   | 119    |            |  |   | 1,735      |   |  |  | 1458 | % 
|Cost of goods sold                           |  |                                 | (54    | ) |            |   |       |            |  |   | (54        | ) |  |  | 100  | % 
|Research and development expenses            |  |                                 | (3,197 | ) |            |   | (3,446 | )          |  |   | 249        |   |  |  | (7   | %)
|Selling, general and administrative expenses |  |                                 | (9,577 | ) |            |   | (3,380 | )          |  |   | (6,197     | ) |  |  | 183  | % 
|Interest income                              |  |                                 | 38     |   |            |   | 18     |            |  |   | 20         |   |  |  | 111  | % 
|Interest expense and other                   |  |                                 | (2,021 | ) |            |   | (67    | )          |  |   | (1,954     | ) |  |  | 2916 | % 

Product Revenue.
Due to limited history of product returns and cash collections from our customers, (specialty distributors and specialty pharmacies), we recognize revenue for Qutenza at the later of the time our customers ships product to physicians and cash
collections received by us from our customers. We recorded gross shipments of Qutenza to our customers totaling $494,000 in the third quarter of 2010. Based on our revenue recognition methodology, we recognized $197,000 as Qutenza revenue for the
third quarter 2010. We have deferred product revenue of $505,000 at September 30, 2010 which is reported net of associated cost of goods sold of $37,000 in our condensed consolidated balance sheet as at September 30, 2010.

Collaborative Revenue. Collaborative revenue of $1.9 million recorded in the three months ended September 30, 2010 consisted
of $1.8 million of the amortization of upfront payments received pursuant to the Astellas Agreement as well as $0.1 million of Collaborative revenue under our Supply Agreement with Astellas. Collaborative revenue of approximately $119,000 was
recorded in the three months ended September 30, 2009 and resulted from the commencement of amortization of upfront milestone payments received under the Astellas Agreement in late September 2009.



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Under our Supply
Agreement with Astellas, we are obligated to supply product, at a contractually agreed upon cost for materials and our related labor and overhead, until such time as Astellas establishes its own supply relationship with suppliers. The majority of
this revenue results from our having expensed certain product costs in periods prior to receiving regulatory approval and subsequently, selling that product to Astellas during this quarter. Going forward, we do not expect to make a significant net
profit or loss on sales of product to Astellas.

Cost of goods sold. Cost of goods sold totaled $54,000 for the three
months ended September 30, 2010. Cost of goods sold includes the cost of products sold, costs associated with services provided by our third-party logistics partner for managing the shipping, billing and other administrative functions
associated with the distribution channel and also includes royalty obligations due to our intellectual property licensors, UC and LTS. During the three month period ended September 30, 2010, a large percentage of our cost of goods sold is fixed.
Thus, we expect our gross margin percentage to increase as product revenues increase. We recognize costs associated with our third party logistics provider in the period in which those costs are incurred, however, costs to manufacture product and
royalty obligations due to third parties are deferred and recognized in the period in which the associated revenue is recognized. Costs associated with the manufacture of Qutenza prior to regulatory approval were previously expensed in the period in
which those costs were incurred. We believe that the effect on cost of goods sold of pre-approval expensing of such manufacturing costs is immaterial as compared to what cost of goods sold would have been if such costs were expensed in the period
that the product was sold.

Research and Development expenses. Research and development expenses decreased by $0.2
million or 7%, to $3.2 million for the three months ended September 30, 2010 from $3.4 million or for the same period in 2009. The decrease was attributable to a $1.2 million decrease resulting from royalties paid to the UC in 2009, partially
offset by a $0.8 million increase in the current period associated with the preparation of our Phase 2 study of NGX-1998. During both periods, we were engaged primarily in activities supported by our internal personnel including the management of
regulatory processes to gain approval in both Europe and the United States during 2009 and in 2010, the maintenance of the New Drug Application or NDA in the United States for Qutenza. Further, whereas in 2009, we were engaged in conducting a small
clinical study at the request of the FDA in support of our NDA. In 2010, we were engaged in the planning and preparatory work associated with the initiation of a Phase 2 study for our lead product candidate, NGX-1998. Over the remainder of this year
and into 2011, we expect that our research and development costs may increase due to the continued development of NGX-1998, including our Phase 2 study which began in October, nonclinical activities, and formulation development work .In addition,
costs may increase for our planned submission of an sNDA for Qutenzas HIV-AN indication.

Selling, General and
Administrative expenses. Selling, general and administrative expenses increased $6.2 million, or 183%, to $9.6 million for the three months ended September 30, 2010, from $3.4 million for the same period in 2009. This increase was due in
large part to the continuing commercialization efforts of Qutenza in the United States which began in April 2010. Specifically, the increases included $2.1 million in costs associated with our sales and commercial operation organization including
salary and related expenses; $2.7 million increase in expenses for marketing materials development and other launch related marketing costs; $0.5 million in cost increase due to the expansion of our medical affairs department; and $0.5 million in
costs due to an increase in general and administrative salary and related expenses, temporary help and consultants, professional service fees and other public company costs. These increases were offset by a $0.1 million decrease in stock-based
compensation costs due to the granting of options to employees and officers in 2009 that immediately vested and a decrease in legal fees of $0.1 million primarily due to fees incurred in the 2009 period associated with the Astellas Agreement. We
anticipate that Selling, general and



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administrative expenses may continue to increase on a sequential quarter basis as we continue our Qutenza commercialization efforts including the potential expansion of our sales and commercial
operations organization and Qutenza marketing efforts.

Interest expense.Interest expense was $2.0 million for the
three months ended September 30, 2010 as compared to $28,000 for the same period in 2009. This increase was primarily due to interest on the $40 million Long term obligation related to the Financing Agreement entered into with Cowen Royalty, in
April 2010.

Comparison of the Nine months Ended September 30, 2010 and 2009



|                                             |  |                                |         |   |            |   |        |            |  |   |            |   |  |  |      |   
|-------------------------------------------- |  | ------------------------------ | ------- | - | ---------- | - | ------ | ---------- |  | - | ---------- | - |  |  | ---- | --
|                                             |  | Nine Months EndedSeptember 30, |         |   | $ Increase |   |        | % Increase | 
|(in thousands)                               |  | 2010                           |         |   | 2009       |   |        | (Decrease) |  |   | (Decrease) |  
|Product revenue                              |  | $                              | 230     |   |            | $ |       |            |  | $ | 230        |   |  |  | 100  | % 
|Collaborative revenue                        |  |                                | 5,691   |   |            |   | 119    |            |  |   | 5,572      |   |  |  | 4682 | % 
|Cost of goods sold                           |  |                                | (99     | ) |            |   |       |            |  |   | (99        | ) |  |  | 100  | % 
|Research and development expenses            |  |                                | (7,842  | ) |            |   | (8,558 | )          |  |   | 716        |   |  |  | (8   | %)
|Selling, general and administrative expenses |  |                                | (26,878 | ) |            |   | (8,168 | )          |  |   | (18,710    | ) |  |  | 229  | % 
|Interest income                              |  |                                | 67      |   |            |   | 75     |            |  |   | (8         | ) |  |  | (11  | %)
|Interest expense and other                   |  |                                | (3,326  | ) |            |   | (257   | )          |  |   | (3,069     | ) |  |  | 1194 | % 

Product Revenue.
Since the U.S. launch of Qutenza in April 2010, we recorded gross shipments of Qutenza to our specialty distributor and specialty pharmacy customers totaling $0.8 million, of which $0.2 million was recognized as Qutenza revenue for nine months ended
September 30, 2010. Due to limited history of product returns and cash collections from our customers, we recognize revenue for Qutenza at the later of the time our customers ships product to physicians and cash collections received by us from
our customers. Deferred revenue of $505,000 is reported net of associated cost of goods sold of $37,000 on our condensed consolidated balance sheet as at September 30, 2010.

Collaborative Revenue. Collaborative revenue of $5.7 million recorded in the nine months ended September 30, 2010 consisted
of $5.4 million of the amortization of upfront payments received pursuant to the Astellas Agreement as well as $0.3 million of Collaborative revenue under our Supply Agreement with Astellas. For the nine months ended September 30, 2009, we
recorded Collaborative revenue of approximately $0.1 million, reflecting the amortization of upfront payments received pursuant to the Astellas Agreement. Collaborative revenue under the Supply Agreement resulted from a difference between the
carrying cost of supply sold to Astellas and the contractual transfer price for those supplies. Under our Supply Agreement with Astellas, we are obligated to supply product, at a contractually agreed upon cost for materials and our related labor and
overhead, until such time as Astellas establishes its own supply relationship with suppliers.

Cost of goods sold. Cost
of goods sold totaled $99,000 for the nine months ended September 30, 2010. Cost of goods sold includes the cost of products sold, costs associated with services provided by our third-party logistics partner for managing the shipping, billing
and other administrative functions associated



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with the distribution channel and also includes royalty obligations due to our intellectual property licensors, UC and LTS. During the nine month period ended September 30, 2010, a large
percentage of our cost of goods sold is fixed. Thus, we expect our gross margin percentage to increase as product revenues increase. We recognize costs associated with our third party logistics provider in the period in which those costs are
incurred, however, costs to manufacture product and royalty obligations due to third parties are deferred and recognized in the period in which the associated revenue is recognized. We believe that the effect on cost of goods sold of pre-approval
expensing of such manufacturing costs is immaterial as compared to what cost of goods sold would have been if such costs were expensed in the period that the product was sold.

Research and Development expenses. Research and development expenses decreased $0.7 million, or 8%, to $7.8 million for the nine months ended September 30, 2010 from $8.6 million for the same
period in 2009. The decrease was attributable to a $1.2 million decrease resulting from royalties paid to the UC in 2009, related to the Astellas agreement that did not repeat in 2010. Additionally, a $0.3 million decrease in expenses driven by
clinical consulting fees related to our MA and our NDA preparation costs incurred in 2009. These decreases were partially offset by $0.7 million higher costs for the preparations of our Phase 2 study of NGX-1998. During both periods, we were engaged
primarily in activities supported by our internal personnel including the management of regulatory processes to gain approval in both Europe and the United States during 2009 and in 2010, the maintenance of the NDA in the United States for Qutenza.
Further, whereas in 2009, we were engaged in conducting a small clinical study at the request of the FDA in support of our NDA. In 2010, we were engaged in the planning and preparatory work associated with the initiation of a Phase 2 study for our
lead product candidate, NGX-1998.

Selling, General and Administrative expenses.Selling, general and administrative
expenses increased $18.7 million, or 229%, to $26.9 million for the nine months ended September 30, 2010, from $8.2 million for the same period in 2009. This increase was due in large part to the commercial launch of Qutenza in the United
States in April 2010. Specifically, the increases included a $6.3 million in costs associated with our sales and commercial operation organization including salary and related expenses; $8.4 million increase in expenses for marketing materials
development and other launch related marketing costs; $1.4 million in costs due to an increase in general and administrative salary and related expenses, temporary help and consultants, professional service fees and other public company costs; $1.5
million of costs associated with our medical affairs organization including salary and related expenses; and a $0.2 million increase in stock-based compensation costs due to the granting of options to employees and officers. These increases were
offset by a decrease in legal fees of $ 0.3 million primarily due to fees incurred in the 2009 period associated with the Astellas Agreement.

Interest expense.Interest expense was $3.3 million for the nine months ended September 30, 2010 as compared to $0.1 million for the same period in 2009. This increase was primarily due to
interest on the $40 million Long term obligation related to the Financing Agreement entered into with Cowen Royalty in April 2010.

Liquidity and Capital Resources

Since our inception through September 30, 2010, we have funded our operations primarily by selling equity securities, establishing debt facilities and through a collaboration agreement with Astellas.
In May 2007, we completed an initial public offering of our common stock which, after deducting total expenses including underwriting discounts and commissions and other-offering related expenses, resulted in net cash proceeds of $38.1 million. In
December 2007, we completed the first closing of a private placement of our common stock and warrants resulting in net cash proceeds of $21.5 million and in January 2008, we completed the second and final closing of this private placement of our
common stock and warrants resulting in net cash proceeds of $2.3 million. In April 2010, we borrowed $40.0 million under a Financing Agreement with Cowen Healthcare Royalty Partners, L.P.



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As of
September 30, 2010, we had approximately $57.7 million in cash, cash equivalents and short-term investments. We also had working capital of $52.3 million, adjusted to exclude the current portion of deferred revenue which totals $7.7
million. 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 capital preservation and liquidity. Further, to reduce portfolio risk, our investment policy specifies a concentration limit of 10% in any one
issuer or group of issuers of corporate bonds or commercial paper at the time of purchase. Our investment holdings at September 30, 2010 consist solely of U.S. Treasury securities and money market funds consisting of only U.S. Treasury
securities.

Net cash used in operating activities was $31.4 million in the nine months ended September 30, 2010 as
compared to $34.8 million of cash provided in the nine months ended September 30, 2009. This decrease was primarily due to the $48.7 million received as the upfront payment under the Astellas Agreement in the nine months ended
September 30, 2009. Net cash used in the each of these periods consisted of sales and marketing expenses associated with the launch of first commercial product, Qutenza, which was launched in April 2010, infrastructure costs in support of our
commercial operations and research and development expenses related to the maintenance of our approved NDA and our other development programs including the preparation for entering Phase 2 clinical development of NGX-1998. Also included in our cash
usage in the nine months ended September 30, 2010 was the payment of the sublicense fee due to the UC resulting from the upfront payments received under the Astellas Agreement and cash payments made for the 2009 Employee Bonus Plan. We
anticipate for the next few quarters that cash used in operating activities will continue at approximately the same level as the third quarter and potentially at higher levels in 2011.

Net cash used in and provided by investing activities was $23.9 million and $5.4 million for the nine months ended September 30,
2010 and 2009, respectively. Investing activities consisted of the purchase and maturity of marketable securities, and the purchase of capital equipment. Property and equipment expenditures increased in the nine months ended September 30, 2010,
compared with the same period in 2009, due to the capital needs for the infrastructure expansion to support our commercial operations. There were significant short term investment purchases in the 2010 period resulting from investing of the cash
received from the Cowen Financing Agreement.

Net cash provided by and used in financing activities was $39.3 million and $2.2
million in the nine months ended September 30, 2010 and 2009, respectively. Financing activities consist of proceeds from the long term obligations related to the Financing Agreement with Cowen Royalty as of September 30, 2010, principal
repayments on our venture loan financing arrangements in both periods, with the final principal payment made in January 2010, along with the exercise of stock options.

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



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



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



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



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



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



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



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



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



| |  |  | 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 September 30, 2010, we had $57.7 million in cash, cash equivalents and short-term investments. We anticipate that our operating
expenses may increase from recent levels for the remainder of 2010 and throughout 2011. As a result, depending on the amount and growth of product revenues from our sales of Qutenza, our cash usage may also increase during these periods. The
increases in operating expenses may result from costs related to our commercialization activities for Qutenza and resumption of development activities related to NGX-1998 and potentially our other development programs. On April 30, 2010, we
entered into the Financing Agreement with Cowen Royalty. This agreement created a debt obligation that is to be repaid through and secured in part by royalties and future milestone payments payable to us by under the Astellas Agreement. A further
description of the terms of the Financing Agreement is set forth in Note 9 of our Condensed Consolidated Financial Statements included Part I, Item 1of this quarterly report on Form 10-Q. We anticipate that our existing cash and investments
will be sufficient to meet our projected operating requirements through at least the next twelve months.

On August 12,
2010, we filed a universal shelf registration statement on Form S-3 with the U.S. Securities and Exchange Commission, or SEC. The shelf registration statement was declared effective by the SEC on September 24, 2010. By using a shelf
registration statement, we may sell securities which may consists of common stock, preferred stock, debt securities, warrants or depositary shares from time to time in one or more offerings.

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 through
debt financing or the sale of other equity securities. However, we may not be successful in obtaining additional collaboration agreements, or in receiving milestone or royalty payments under those agreements. In addition, we cannot be sure that our
existing cash and investment resources will be adequate or that additional financing will be available when needed or that, if available, financing will be obtained on terms favorable to us or our stockholders. Having insufficient funds may require
us to delay or potentially eliminate some or all of our development programs, relinquish some or even all rights to product candidates at an earlier stage of development or negotiate less favorable terms than we would otherwise choose. Failure to
obtain adequate financing also



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may adversely affect the launch of our product candidates or our ability to continue in business. If we raise additional funds by issuing equity securities, substantial dilution to existing
stockholders would likely result. If we raise additional funds by incurring debt financing, the terms of the debt may involve significant cash payment obligations as well as covenants and specific financial ratios that may restrict our ability to
operate our business.

Off Balance Sheet Arrangements

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

Contractual Obligations

There have been no material changes to our disclosures set forth on our 2009 Form 10-K, filed on March 19, 2010 regarding contractual
obligations other than as set forth in Note 8 and Note 9 of our financial statements included Part I, Item 1 of this quarterly report on Form 10-Q.

Recently Issued and Adoption of New Accounting Standards

In October 2009,
the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2009-13, Revenue Recognition (ASC Topic 605)  Multiple-Deliverable Revenue Arrangements, or ASU 2009-13. This guidance modifies
previous guidance for multiple element arrangements by allowing the use of the best estimate of selling price in the absence of vendor-specific objective evidence, or VSOE, or third party evidence, or TPE, of selling price for
determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price is not available. In addition, the residual method of allocating arrangement consideration
is no longer permitted. ASU 2009-13 is effective for fiscal years beginning on or after June 15, 2010 and early adoption is permitted. We have not early adopted ASU No. 2009-13 and are currently evaluating whether the adoption of the new
guidance will have a material impact on our consolidated financial statements.

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



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|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, 2009.

Foreign Currency Exchange Rate Risk

Our third party manufacturers including the manufacturer of our active pharmaceutical ingredient, 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, if product supply
requirements for Qutenza increase, our exposure to foreign currency exchange rates, primarily in 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 different 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 or payable exposure.

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



|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

During 2010, we implemented an enterprise resource system, or ERP system, to replace our legacy financial accounting system and are making appropriate changes to internal controls and procedures over
financial reporting as the year progresses. Other than the changes required by the implementation of the ERP system, none of which materially impaired or significantly altered the effectiveness of our internal controls and procedures over financial
reporting, there were no material changes in our internal controls over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.

(c) Limitations on the Effectiveness of Controls



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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.

PART II. OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------

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



|ITEM 1A. | RISK FACTORS
|-------- | ------------

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

Risks Related to our Business

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

Our product Qutenza® (capsaicin) 8% patch, was approved by the FDA
in November 2009 for the management of neuropathic pain associated with PHN. Our commercial success depends on our ability to successfully launch and commercialize Qutenza in the United States. Prior to receiving FDA marketing approval, our
commercialization activities were limited and, as a result, many of our proposed activities to create product awareness or promote market acceptance have only recently been initiated and as such their effect may take some time to be realized, if at
all. Although we launched Qutenza in April 2010, we may not know how effective our launch is until four to six quarters after the launch date, if at all, due to Qutenzas nature as an office administered product, its expected duration of effect
resulting in prolonged periods between product use for a particular patient, and due to our targeted commercialization strategy. Additionally, successful commercialization of Qutenza will depend on a number of factors as further discussed in the
Risk Factors section of this quarterly report on Form 10-Q, but include risks related to obtaining adequate reimbursement, our maintaining a qualified sales force, continuing to build infrastructure to support commercial operations and ensuring
sufficient product supply. These activities require significant management attention and financial resources. There can be no assurance that we will be able to sufficiently hire, retain and manage the personnel required to successfully commercialize
Qutenza or that such commercialization will result in significant product sales of Qutenza. If the commercial launch of Qutenza does not meet our expectations, it would significantly and negatively impact our revenue and results of operations. In
addition, we are establishing inventory levels of Qutenza based upon our expectations of future



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product sales. If actual product sales are significantly lower than our expectations, our inventory levels may be excessive. If Qutenza supplies remain in inventory for significantly longer than
anticipated, such supplies may not be suitable for sale due to expiration of their shelf lives, which would require us to write off the cost of such expired product.

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

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



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



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

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

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

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

The use of Qutenza is reimbursable under Medicare Part B and the amounts of reimbursement
available to the physician for the treatment procedure are known in most cases, since 9 of the 12 contractors have instructed physicians to bill using established evaluation and management codes that have payment rates associated with them. One
contractor has requested physicians use a miscellaneous / unlisted code for the Qutenza application procedure and set a payment rate that which we consider inadequate. We are working with local physicians to advocate for an adjustment to this
payment rate that we believe more accurately reflects the resources necessary to administer Qutenza. In the case of two other contractors, the reimbursement amounts for the Qutenza treatment procedure are not yet known because these contractors also
have requested physicians use a miscellaneous / unlisted code. We continue to work with local physicians to determine payment amounts in these contractors service areas. If payment rates prove inadequate, such rates



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could create a significant barrier to physician adoption of Qutenza. Additionally, the timing and process for physicians to receive reimbursement for use of Qutenza may be a lengthy and
uncertain which can also create a barrier for physician adoption of Qutenza. In either case, these factors could serve to seriously limit the market opportunity for Qutenza.

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

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

Qutenza and our
product candidates may never achieve market acceptance

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



| |  |  | the ability to obtain adequate pricing and sufficient insurance and other third party payer coverage and reimbursement;
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| |  |  | with respect to Qutenza, physicians and patients willingness and ability to accommodate the time necessary for each Qutenza treatment;
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| |  |  | patient acceptance of the treatment procedure, efficacy or safety of Qutenza;
| | - |  | -----------------------------------------------------------------------------



| |  |  | availability, relative cost and relative efficacy and safety of alternative and competing treatments;
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| |  |  | the effectiveness of our or our collaborators sales, marketing and distribution strategy;
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| |  |  | publicity concerning our products or competing products and treatments;
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| |  |  | potential product recalls; and
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| |  |  | post marketing approval pharmacovigilance or other studies showing safety issues not seen in previous studies.
| | - |  | --------------------------------------------------------------------------------------------------------------

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

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

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

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



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



| |  |  | failure to manufacture products that meet our specifications throughout their shelf lives;
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| |  |  | failure to deliver sufficient quantities in a timely manner;
| | - |  | ------------------------------------------------------------



| |  |  | the possibility that we may terminate a contract manufacturer and need to engage a replacement;
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| |  |  | the possibility that current and future manufacturers may not be able to manufacture our product candidates and products without infringing the
intellectual property rights of others;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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

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

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



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

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

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

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



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



| |  |  | our inability to recruit and retain adequate numbers of effective sales and marketing personnel;
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| |  |  | the inability of sales personnel to obtain prescriber demand for our products;
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| |  |  | the lack of complementary products to be offered by sales personnel, which may put us at a competitive disadvantage relative to companies with more
extensive product lines; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

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



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

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

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

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

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

To date, the only portion of the Licensed Territory in which regulatory approval for Qutenza has been obtained is the European Economic
Area. 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 Economic Area,
United States or other markets where regulatory approval of Qutenza may have been obtained or may be in the process of being sought.



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

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

The Astellas Agreement grants to Astellas an option to
exclusively license our second generation product, NGX-1998. In connection with this option, we are required to 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 final payment to us in order to
exercise its option. If Astellas determines not to make one of these payments, the option to license NGX-1998 will expire, Astellas will not be required to provide further funding for NGX-1998, and we would be precluded from marketing NGX-1998 in
the Licensed Territory for a period of time. If Astellas fails to exercise its options with respect to NGX-1998, we will be unable to generate revenues from potential sales of NGX-1998 in the Licensed Territory, and our business will be harmed.

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

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

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



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



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



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

Regulatory authorities have recently increased their enforcement efforts including in the areas of advertising, marketing and promotion.
Failure to comply with regulatory requirements may subject us or our 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, the Qutenza MA owned by Astellas in the European Union requires the conduct of certain post-authorization follow up measurers including ongoing evaluations of safety of Qutenzas use in the
labeled indications, as well as clinical evaluation in patients with PDN, although the timing of clinical evaluations in PDN has not yet been determined. Astellas did initiate a long term safety study in patients with PHN, HIV-AN and/or other
painful peripheral neuropathies (excluding diabetics) in the third quarter of 2010. These studies, which are funded by Astellas pursuant to Astellas Agreement, may prove difficult and expensive to complete and their results may identify safety,
efficacy or other issues related to Qutenzas use that could hinder or prevent commercialization efforts. Moreover, the product may later be found in the course of these studies or through our pharmacovigilance programs to cause adverse effects
that limit its use, force us or our partner to withdraw it from the market or impede or delay the ability to obtain regulatory approvals in additional countries.

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

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

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



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

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



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



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



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



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



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



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

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

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

Qutenza 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. 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 for Lyrica for the treatment of PDN, fibromyalgia, epilepsy and general anxiety disorder.
Additionally, a number of products that are approved for other diseases are used by physicians to treat PHN.

Competition may
become stronger and more direct and products in development, including products that we are unaware of, may compete with Qutenza. There are many other companies working to develop new drugs and other therapies to treat pain in general and
neuropathic pain in particular, including Eli Lilly & Co, Pfizer, UCB Pharma SA, GlaxSmithKline plc, Merz, GW Pharmaceuticals, Novartis AG, Novo Nordisk A/S, Dainippon Pharmaceutical Co Ltd., AVANIR Pharmaceuticals, Xenoport, EpiCept,
Newron



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Pharmaceuticals SpA, WEX Pharmaceuticals, Arcion Therapeutics Inc., Endo Pharmaceuticals, AstraZeneca plc, Bristol-Myers Squibb Co., Bio3 Research Srl, Relevare Pharmaceuticals Ltd. Depomed Inc.,
and Ortho-McNeil-Janssen Pharmaceuticals. Many of the compounds in development by such companies are already marketed for other indications, such as anti-depressants, anti-convulsants or opioids. In addition, physicians employ other interventional
procedures, such as nerve stimulation or nerve blocks, to treat patients with difficult to treat neuropathic pain conditions. Furthermore, new developments, including the development of other drug technologies and methods of preventing the incidence
of disease, such as vaccines including Zostavax, occur in the biopharmaceutical industry at a rapid pace. Any of these developments may render our products or product candidates obsolete or noncompetitive.

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



| |  |  | initiate or withstand substantial price competition more successfully;
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| |  |  | have greater success in recruiting skilled scientific workers from the limited pool of available talent;
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| |  |  | more effectively negotiate third-party licenses and strategic alliances;
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| |  |  | take advantage of acquisition or other opportunities more readily than we can; and
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| |  |  | 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.
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The life sciences industry is characterized by rapid technological change. If
we fail to stay at the forefront of technological change our products may be unable to compete effectively.

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

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

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



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

We rely, in part, on the market exclusivity afforded orphan drugs for the commercialization of Qutenza in the United States. The FDA has granted us orphan drug status with regard to Qutenza for the
management of PHN and as a consequence, Qutenza is entitled to orphan exclusivitythat is, for seven years, the FDA may not approve any other applications to market the same drug for the same indication, except in very limited circumstances.
Additionally, the FDA has granted us orphan drug status for HIV-AN, an indication for which we currently do not have an FDA-approved product. We may be unable to obtain orphan drug designations for any additional product candidates or exclusivity
for any future product candidates, or our potential competitors may obtain orphan drug exclusivity for capsaicin-based products competitive with our product candidates in indications other than PHN before we do, in which case we may be excluded from
that market for the exclusivity period. In addition, orphan drug designation previously granted may be withdrawn under certain circumstances. Even if we obtain orphan drug exclusivity for any of our product candidates, we may not be able to maintain
it if a competitive product based on the same active compound is shown to be clinically superior to our product. Although obtaining FDA approval to market a product with orphan exclusivity can be advantageous, there can be no assurance that it would
provide us with a significant commercial advantage.

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

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

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

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

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



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

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

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

We have not prepared for or conducted any Qutenza clinical trials for indications other than PHN, HIV-AN and PDN. We have conducted two
Phase 3 clinical trials with Qutenza for patients with HIV-AN, one of which met its primary endpoint and one which did not meet its primary endpoint. We have also conducted one Phase 2 clinical trial that evaluated the use of Qutenza in patients
with PDN. PDN represents a much larger market opportunity than either PHN or HIV-AN, and unless required clinical trials are successfully completed and regulatory approvals are obtained for the use of Qutenza for PDN patients,



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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 HIV-AN and PDN, we may 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 development programs for Qutenza in PDN and may decide not to conduct studies in PDN beyond those that may be required by post-marketing requirements associated
with our MA. If we do not conduct the required number of Phase 3 studies in either HIV-AN or PDN that meet their primary endpoint, we may not gain approval for Qutenza in these indications, which will significantly harm our ability to potentially
generate revenue.

Results of clinical trials of Qutenza for patients with PHN or HIV-AN do not necessarily predict the
results of clinical trials involving other indications. If additional clinical studies are conducted with Qutenza in PDN or other indications, those studies may fail to show desired safety and efficacy for management of pain associated with PDN and
other indications, despite results from earlier clinical trials involving PDN, PHN and/or HIV-AN. Any failure or significant delay in completing clinical trials for Qutenza with PDN and other indications, or in receiving regulatory approval
involving such indications, may significantly harm our business.

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

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



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



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



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



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



| |  |  | reaching agreement on acceptable terms with prospective clinical research organizations and trial sites;
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| |  |  | 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 non-clinical and clinical trials to assure that data and reported results are credible and accurate and that the trial participants are adequately protected. If these third parties do not successfully meet
their regulatory obligations, meet expected deadlines, or if the quality or accuracy of the data 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 have met their primary endpoints, certain
other studies have not met their primary endpoints and, our clinical trials for other indications, if we or our collaborator decide to conduct them, may not succeed, which would adversely impact our long term success.

We have not prepared for or conducted any Qutenza clinical trials for indications other than PHN, HIV-AN and PDN. We have conducted two
Phase 3 clinical trials with Qutenza for patients with HIV-AN, one of which met its primary endpoint and one which did not meet its primary endpoint. We have also conducted one Phase 2 clinical trial that evaluated the use of Qutenza in patients
with PDN. PDN represents a much larger market opportunity than either PHN or HIV-AN, and unless required clinical trials are successfully completed and regulatory approvals are obtained for the use of Qutenza for PDN patients, Qutenza will not be
marketable for this indication in the United States and the European Union and possibly in other countries. If this occurs, our long-term ability to succeed may be significantly and negatively impacted. We believe that to market Qutenza in the
United States for future indications, including HIV-AN and PDN, we may 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
development programs for Qutenza in PDN and may decide not to conduct studies in PDN beyond those that may be required by post-marketing requirements associated with our MA. If we do not conduct the required number of Phase 3 studies in either
HIV-AN or PDN that meet their primary endpoint, we may not gain approval for Qutenza in these indications, which will significantly harm our ability to potentially generate revenue.



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Results of clinical
trials of Qutenza for patients with PHN or HIV-AN do not necessarily predict the results of clinical trials involving other indications. If additional clinical studies are conducted with Qutenza in PDN or other indications, those studies may fail to
show desired safety and efficacy for management of pain associated with PDN and other indications, despite results from earlier clinical trials involving PDN, PHN and/or HIV-AN. 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 depend on our key personnel. If we are not able to retain them, our business will suffer.

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

Risks Related to Our Finances and
Capital Requirements

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

We have incurred operating and net losses each year
since our inception in 1998. Our net loss for the three and nine months ended September 30, 2010 and twelve months ended December 31, 2009 was approximately $12.8 million, $32.2 million and $21.9 million, respectively. As of
September 30, 2010 we had an accumulated deficit of approximately $244.2 million. We had cash, cash equivalents and short-term investments totaling $57.7 million at September 30, 2010, and for the nine months ended September 30, 2010,
we used cash of approximately $31.4 million in operating activities. We expect to continue to incur losses for several years, as we commercialize Qutenza and continue other research and development activities. If Qutenza does not achieve market
acceptance in the United States or the European Union, we will not generate significant product related revenue. We cannot assure you that we will be profitable even if Qutenza is successfully commercialized. If we fail to achieve and maintain
profitability, or if we are unable to fund our continuing losses, you could lose all or part of your investment.

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

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



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



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



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



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



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



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



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



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

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

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

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

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

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

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

Because these obligations will in the near term divert all revenues that we may receive under the Astellas Agreement, our financial
position and ability to continue operations would be adversely impacted if we required further capital, even if Astellas was successfully commercializing our products in the Licensed Territory. Furthermore, the arrangement under the Financing
Agreement may make us less attractive to



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potential acquirers, and in the event that we exercised our change of control pay-off option to terminate the Financing Agreement in order to carry out a change of control, the payment of such
funds out of our available cash or acquisition proceeds would reduce acquisition proceeds for our stockholders.

Risks Related to our
Intellectual Property

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

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



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applications. There is a risk that our licensors will not devote the same resources or attention to the prosecution of the licensed patent applications as we would if we controlled the
prosecution of the patent applications, and the resulting patent protection, if any, may not be as strong or comprehensive as if we had prosecuted the applications ourselves.

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



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



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



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



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



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



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



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

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.



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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, would not infringe the Winston patent, which we believe expired in 2009 in the United States and may have expired in June 2010 in the European Union, but may be extended under
certain circumstances. While we believe that the Winston patent expired in 2009 in the United States and June 2010 in the European Union, there can be no assurance that the patent was not extended, unbeknownst to us. 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 using the Qutenza trademark which would have a significant
negative effect on the Qutenza launch and global commercialization efforts. Further, if a patent infringement suit were brought against us, we could be forced to stop or delay research, development, manufacturing or sales of the product or product
candidate that is the subject of the suit, or if a trademark infringement suit were brought against us or our collaboration partner Astellas, we or Astellas could be forced to cease using the name Qutenza in connection with our product.

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

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

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



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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 under patents and patent applications
relating to Qutenza. These licenses impose various commercialization, milestone payment, royalty, insurance and other obligations on us. If we fail to comply with these obligations, the licensor may have the right to terminate the license, in which
event we would not be able to market products covered by the license, including Qutenza.

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

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

Risks Related to an Investment in our Common Stock

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

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



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



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



| |  |  | potential inability to preserve or raise sufficient capital to maintain our operations;
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| |  |  | failure to meet revenue estimates and revenue growth rates;
| | - |  | -----------------------------------------------------------



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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

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

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



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

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

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

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

Our executive officers, directors and their affiliates and 5% stockholders beneficially own or control approximately 58% of the outstanding shares of our common stock as of September 30, 2010 (after
giving effect to the exercise of all of their outstanding vested options and warrants exercisable within 60 days of such date). Accordingly, these executive officers, directors and their affiliates and significant stockholders acting as a group,
will have substantial influence over the outcome of corporate actions requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate
transactions. These stockholders may also delay or prevent a change of control of us, even if such a change of control would benefit our other stockholders. The significant concentration of stock ownership may adversely affect the trading price of
our common stock due to investors perception that conflicts of interest may exist or arise.

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

The market price of our common stock could
decline as a result of sales by our existing stockholders, 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 acquirers to negotiate with our board of directors, they would apply even if the offer may be considered beneficial by



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some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders
to replace members of our board of directors, which is responsible for appointing the members of our management.

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

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

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

We have paid no cash dividends on any of our classes of capital stock to date, have contractual restrictions against paying cash dividends
and currently intend to retain our future earnings to fund the development and growth of our business. As a result, capital appreciation, if any, of our common stock will be an investors sole source of gain for the foreseeable future.



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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. | [REMOVED AND RESERVED]
|------- | ----------------------



|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)       |  | Amendment No. 2 to the Third Amended and Restated Investors Rights Agreement by and between NeurogesX, Inc. and certain stockholders, dated as of August 5,
2010.       
|              | 
|31.1          |  | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                  
|              | 
|31.2          |  | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                  
|              | 
|32.1          |  | Certifications of the Principal Executive Officer and the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.
Section 1350).



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

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

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



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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: November 8, 2010 |  |  |  | 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                                                         
|                        |  |  |  | Executive Vice President, Chief Operating Officer and 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)       |  | Amendment No. 2 to the Third Amended and Restated Investors Rights Agreement by and between NeurogesX, Inc. and certain stockholders, dated as of August 5,
2010.       
|              | 
|31.1          |  | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                  
|              | 
|31.2          |  | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                  
|              | 
|32.1          |  | Certifications of the Principal Executive Officer and the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.
Section 1350).



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

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

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



60