This discussion is intended to further the reader's understanding of the consolidated financial condition and results of operations of Neurogen Corporation ("Neurogen," "the Company," "we," "us," "our"). It should be read in conjunction with the financial statements in this quarterly report on Form 10-Q and our annual report on Form 10-K, as amended, for the year ended December 31, 2007.

Note Regarding Forward-looking Statements

Statements that are not historical facts, including statements about the Company's confidence and strategies, the status of various product development programs, the sufficiency of cash to fund planned operations and the Company's expectations concerning its development compounds, drug discovery technologies and opportunities in the pharmaceutical marketplace are "forward-looking statements" within the meaning of the Private Securities Litigations Reform Act of 1995 that involve risks and uncertainties and are not guarantees of future performance. These risks include, but are not limited to, difficulties or delays in development, testing, regulatory approval, production and marketing of any of the Company's drug candidates, in-licensing of drug candidates, collaborations and alliances, acquisitions or business combinations, the failure to attract or retain key personnel, any unexpected adverse side effects or inadequate therapeutic efficacy of the Company's drug candidates which could slow or prevent product development efforts, competition within the Company's anticipated product markets, the Company's dependence on corporate partners with respect to development funding, regulatory filings and manufacturing and marketing expertise, the uncertainty of product development in the pharmaceutical industry, inability to obtain sufficient funds through future collaborative arrangements, equity or debt financings or other sources to continue the operation of the Company's business, risk that patents and confidentiality agreements will not adequately protect the Company's intellectual property or trade secrets, dependence upon third parties for the manufacture of potential products, inexperience in manufacturing and lack of internal manufacturing capabilities, dependence on third parties to market potential products, lack of sales and marketing capabilities, potential unavailability or inadequacy of medical insurance or other third-party reimbursement for the cost of purchases of the Company's products, the Company's recent operational restructuring and other risks detailed in the Company's Securities and Exchange Commission filings, including its Annual Report on Form 10-K/A for the year ended December 31, 2007, each of which could adversely affect the Company's business and the accuracy of the forward-looking statements contained herein. Any new material changes in risk factors since the Annual Report on Form 10-K/A for the year ended December 31, 2007 are discussed further in Part II, Item 1A.

Overview

Since its inception in September 1987, Neurogen has been engaged in the discovery and development of drugs. We have not derived any revenue from product sales and have incurred, and expect to continue to incur, significant losses prior to deriving any such product revenues or earnings. Revenues to date have come from six collaborative research agreements, one license agreement and one technology transfer agreement.

During the first nine months of 2008, we restructured our research and development operations to suspend our active discovery operations. This involved reducing our discovery research and administrative support staff by approximately 70 employees in February 2008 and by approximately 45 employees in early April 2008. (See Footnote 6 to our condensed consolidated financial statements included herein.) This restructuring was a part of an initiative to focus our resources on advancing our four unpartnered clinical programs in insomnia, anxiety, restless legs syndrome, or RLS, and Parkinson's disease.

In the third quarter of 2008, we incurred significant expenses in conducting clinical trials and other development activities, such as formulation testing and toxicology studies, for aplindore, our lead compound in our RLS and Parkinson's disease programs and adipiplon, formerly NG2-73, our lead compound in our insomnia program. In February 2008, we commenced Phase 2 studies with aplindore, our dopamine partial agonist, in Parkinson's disease and in RLS, and in mid-October 2008, we announced initial results of those two trials.

The Phase 2 Parkinson's study was a dose-ranging, randomized, double-blind, placebo-controlled, parallel design exploratory study of the safety, tolerability, efficacy and pharmacokinetics of aplindore in patients with early-stage Parkinson's disease. The study enrolled 39 patients. The primary objective was to evaluate in five separate groups of patients the safety and tolerability of aplindore given twice daily over two weeks in varying titration schedules and across different dose ranges. Additionally, the study was designed to generate efficacy data with aplindore compared to placebo as measured by the mean change in the Unified Parkinson's Disease Rating Scale (UPDRS) Motor Score (Part III). Aplindore achieved statistically significant results versus placebo in each of the three lowest dose regimens tested. In addition, aplindore was generally well-tolerated, and there were no withdrawals due to adverse events or serious adverse events.

The Phase 2 RLS study was a placebo-controlled, single-blind, multi-center study designed to assess the efficacy, safety and tolerability of single doses of aplindore compared to placebo. The study enrolled 27 RLS patients with 26 patients receiving at least one aplindore treatment. The primary efficacy endpoint was the mean change in the Periodic Limb Movement Index, or PLMI, during sleep from baseline (placebo treatment night) to the highest achieved aplindore dose. In this study, aplindore achieved statistically significant results versus placebo at all doses tested. In addition, aplindore was well-tolerated with an incidence of adverse events similar to placebo in doses up to 0.2 milligrams.

In July 2008, we announced the suspension of an ongoing insomnia study comparing adipiplon with Ambien CRŽ. In this study, we observed a higher than anticipated rate of unwanted next-day effects suggesting the blood levels of adipiplon being administered in the study were too high. In previous studies, we simultaneously administered a controlled release and an immediate release form of adipiplon. In the suspended study the controlled release and immediate release components were laminated together into a single bi-layer tablet containing an aggregate of either 9 milligrams or 6 milligrams of adipiplon. Following suspension, we have broken the blind on data from the suspended study and conducted additional pharmacokinetic assessments of the bi-layer tablets used. The results of this investigation indicate that unwanted effects were observed in both the 6 milligram and the 9 milligram doses, but at a higher rate in the 9 milligram dose. Further, at the 9 milligram dose, we observed modestly higher pharmacokinetic variability than anticipated from previous studies where the controlled release portion and the immediate release portion, were administered simultaneously in individual tablets. To advance adipiplon in further development, we believe it would be necessary to reformulate adipiplon and examine doses that produce lower blood levels than those administered in the suspended study. Given our current focus on the development of aplindore in RLS and Parkinson's disease, we do not plan to advance adipiplon in further studies at this time.

As aplindore progresses through additional Phase 2 and Phase 3 studies, clinical trial and other development expenses related to these programs are expected to significantly increase. The actual amount of future development expenses is contingent on the results of ongoing studies. If studies progress, the cost of these activities would require us to raise additional income, for example through partnering with another firm to share costs or seeking new investments from equity partners.

Under our VR1 collaboration with Merck, Merck has the right to develop and commercialize collaboration drug candidates for all indications. To date, Merck's primary interest has been in exploring the utility of orally administered VR1 antagonists for chronic indications such as osteoarthritic pain and cough associated with upper airway disease. In previous exploratory clinical studies, Merck demonstrated proof-of-principle with the lead compound from the collaboration. Based upon their completion of additional clinical pharmacology studies, we believe Merck will not be moving forward into advanced studies for chronic oral administration in pain and cough, but instead has narrowed its focus to the consideration of the development of VR1 antagonists using non-oral routes of administration in these indications or for acute care indications, such as burn-induced pain.

Results of Operations

Results of operations may vary from period to period depending on numerous factors, including the timing of income earned under existing or future collaborative agreements, if any, the progress of our independent and partnered research and development projects, the size of our staff and the level of preclinical and clinical development spending on drug candidates in unpartnered programs. We believe our research and development costs could increase over the next several years as our drug development programs progress. In addition, general and administrative expenses would be expected to increase to support any expanded research and development activities.

Three Months Ended June 30, 2008 and 2007

Operating revenues. We had no operating revenues for the three months ended September 30, 2008 compared to $5.6 million for the same period in 2007. The decrease is a result of the conclusion of the research component of our VR1 collaboration with Merck Sharp & Dohme Limited, a subsidiary of Merck & Co., Inc., or Merck. As of September 30, 2007, license fee revenue consisted of $3.1 million of the initial $15.0 million license fee received in 2003, $0.6 million of the first $2.5 million anniversary license fee received in 2004, $0.9 million of the second $2.5 million anniversary license fee received in 2005, and $1.0 million of the final $2.0 million anniversary license payment received in 2006. The research and development revenue consisted of $1.4 million of a $3.0 million nonsubstantive milestone received from Merck in October 2006 and $0.4 million in research funding received in June 2007. The nonsubstantive milestone and the license payment were being recognized over the remaining contract period, which was accelerated due to the conclusion of the research program component of the Company's VR1 collaboration with Merck. The research funding was being recognized over the associated service period of three months. The research program and our remaining obligations concluded as of August 28, 2007, and as such, remaining unearned revenue was recognized ratably over the period between May 30 and August 28, 2007.

                              Three Months Ended
                                September 30,
                           2008            2007          Change
                                (in thousands)
License fees               $   -       $      5,640     $ (5,640 )
Research and development       -              1,859       (1,859 )

Total operating revenue    $   -       $      7,499     $ (7,499 )

We have no future revenues from corporate partners anticipated at this time; however, we are still eligible to receive milestone payments from Merck upon their achievement of certain development milestones.

Research and development expenses. Research and development expenses were $6.3 million and $12.9 million for the three months ended September 30, 2008 and 2007, respectively. The decrease in research and development costs in the period ended September 30, 2008 compared to the same period ended 2007 was primarily due to a $5.0 million reduction in internal research and development expenses associated with our reductions in force and a $2.3 million decrease in outsourced non-clinical expenses. Outsourced non-clinical development expenses, such as toxicology studies, chemical manufacturing, formulations and stability studies for all of our unpartnered programs decreased in 2008 compared to the same period in 2007 due to a decrease in the number and size of programs in development. A $0.7 million overall increase in outsourced clinical trials was attributable to a $1.9 million increase in clinical expenses for our Parkinson's disease and RLS programs offset by a $0.5 million decrease in clinical trial activity in our discontinued obesity program and a decrease of $0.7 million in the costs associated with the development of adipiplon for insomnia and anxiety.

                                                 Three Months Ended
                                                    September 30,
                                                 2008           2007        Change
                                                   (in thousands)
Outsourced clinical expenses
Insomnia and anxiety                           $     879      $  1,569     $   (690 )
Obesity                                                -           508         (508 )
Parkinson's disease and RLS                        1,982            45        1,937
Total outsourced clinical expenses                 2,861         2,122          739
Outsourced non-clinical development expenses       1,289         3,612       (2,323 )
Internal expenses
Salary and benefits                                1,145         4,699       (3,554 )
Supplies and research                                232         1,129         (897 )
Computer and office supplies                         100           154          (54 )
Facilities and utilities                             456           894         (438 )
Travel and other costs                               194           293          (99 )
Total internal expenses                            2,127         7,169       (5,042 )

Total research and development expenses        $   6,277      $ 12,903     $ (6,626 )

As mentioned above, unless currently unpartnered programs are partnered, we retain all rights to the programs, and we expect that development costs will increase as each program progresses.

General and administrative expenses. General and administrative expenses were $2.0 million and $3.0 million for the three months ended September 30, 2008 and 2007, respectively. This decrease was primarily due to a $0.5 million decrease in salaries and benefits expense. General and administrative expenses also decreased as a result of a decrease in patent and administrative expenses. As a result of the restructuring plan, we prosecuted fewer patents during the third quarter of 2008 compared to the same period in 2007. In addition, the decrease in administrative expense is associated with a decrease in legal expenses. Capitalized legal expenses associated with the financing transaction in April 2008 were netted against the equity proceeds.

Three Months Ended September 30, 2008 2007 Change

Total general and administrative expenses $ 1,987 $ 3,044 $ (1,057 )

Restructuring charges. Restructuring charges were $3.2 million for the three months ended September 30, 2008. We had no restructuring charges in the third quarter of 2007. The restructuring charge in the third quarter of 2008 is associated with the an estimated incremental impairment charge of $2.6 million related to the buildings that are available for sale as well as a $0.6 million write-down of equipment held for sale that will be disposed as part of the sale of the buildings.

Changes in fair value of warrants to purchase common stock. In the third quarter of 2008, we recorded a non-recurring gain on Warrants to purchase Common Stock of $4.7 million in connection with our April 2008 financing. The financing is discussed further in Liquidity and Capital Resources. (See also the Footnote 4 and Footnote 5 to our condensed consolidated financial statements.)

Other income (expense). Other income, net of interest expense, was $0.1 million for the three months ended September 30, 2008, compared to $0.5 million for the same period in 2007. The decrease is a result of our lower cash and marketable securities balance over the period.

Income tax benefit. The State of Connecticut provides companies with the opportunity to forego certain research and development tax credit carryforwards in exchange for cash. For the three months ended September 30, 2008, the Company recorded an income tax benefit of $0.02 million for the sale of R&D credits generated during this period to the State of Connecticut compared to the $0.04 million for the same period in 2007. The decrease in sale of R&D credits is attributable to a reduction in our research and development expenses.

Net loss and Net loss attributable to common stockholders. As a result of the above, the Company recognized a loss of $6.5 million for the third quarter of 2008 as compared to $7.9 million for the same period in the prior year. In addition, the Company recognized a net loss attributable to common stockholders of $31.7 million for the three months ended September 30, 2008 compared to $7.9 million for the same period in 2007 as a result of $25.2 million of deemed preferred dividends in 2008 from our April 2008 financing.

Nine months ended September 30, 2008 and 2007

Operating revenues. We had no operating revenues for the nine months ended September 30, 2008 compared to $15.4 million for the same period in 2007. The decrease is a result of the conclusion of the research component of our VR1 collaboration with Merck. As of September 30, 2007, license fee revenue consisted of $6.0 million of the initial $15.0 million license fee received in 2003, $1.2 million of the first $2.5 million anniversary license fee received in 2004, $1.7 million of the second $2.5 million anniversary license fee received in 2005, and $2.0 million of the final $2.0 million anniversary license payment received 2006. The research and development revenue consisted of $2.7 million of a $3.0 million nonsubstantive milestone received from Merck in October 2006 and $1.8 million in research funding received in June 2007, March 2007 and December 2006. The nonsubstantive milestone and the license payment were being recognized over the remaining contract period, which was accelerated due to the conclusion of the research program component of the Company's VR1 collaboration with Merck. The research funding was being recognized over the associated service period of three months. The research program and our remaining obligations concluded as of August 28, 2007, and as such, remaining unearned revenue was recognized ratably over the period between May 30 and August 28, 2007.

                               Nine months ended
                                 September 30,
                           2008            2007           Change
                                (in thousands)
License fees               $   -       $      10,872     $ (10,872 )
Research and development       -               4,565        (4,565 )

Total operating revenue    $   -       $      15,437     $ (15,437 )

We have no future revenues from corporate partners anticipated at this time; however, we are still eligible to receive milestone payments from Merck upon their achievement of certain development milestones.

Research and development expenses. Research and development expenses were $26.3 million and $48.2 million for the nine months ended September 30, 2008 and 2007, respectively. The decrease in research and development costs in the period ended September 30, 2008 compared to the same period ended 2007 was primarily due to a $13.7 million reduction in internal research and development expenses (see table below) associated with the restructuring plans that occurred in 2008. The reduction in internal research and development expenses included a noncash credit of $1.9 million associated with the cancellation of stock options of employees terminated in the 2008 restructurings offset by noncash expense of $1.5 million for options that continue to vest. The decrease in research and development expenses is also due to an overall $5.4 million decrease in outsourced clinical trials expense including a $2.0 million decrease in clinical trial activity in our discontinued obesity program and a $9.3 million decrease in costs for our insomnia program partially offset by a $5.9 million increase in clinical expenses for the Parkinson's disease and RLS programs. Outsourced non-clinical development expenses, such as toxicology studies, chemical manufacturing, formulations and stability studies for all of our unpartnered programs, decreased by $2.8 million in 2008 compared to the same period in 2007 due to a decrease in the number and size of programs in development.

Nine months ended September 30, 2008 2007 Change

Total research and development expenses $ 26,326 $ 48,199 $ (21,873 )

As mentioned above, unless currently unpartnered programs are partnered, we retain all rights to the programs, and we expect that development costs will increase as each program progresses.

General and administrative expenses. General and administrative expenses were $4.9 million and $10.3 million for the nine months ended September 30, 2008 and 2007, respectively. This decrease was primarily due to a $2.7 million decrease in salaries and benefits expense, including a noncash credit of $1.1 million for cancellation of stock options as a result of employee terminations offset by noncash expense of $1.0 million for options which continue to vest. General and administrative expenses also decreased as a result of decreases in patents expense and administrative expense. As a result of the restructuring plan, we prosecuted fewer patents during the first nine months of 2008 compared to the same period in 2007. In addition, the decrease in administrative expense is associated with a decrease in legal expenses. Capitalized legal expenses associated with the financing transaction in April 2008 were netted against the equity proceeds.

                                              Nine months ended
                                                September 30,
                                              2008          2007        Change
                                                (in thousands)
Salary and benefits                         $   2,074     $  4,809     $ (2,735 )
Supplies                                          259          566         (307 )
Patents                                           469        1,578       (1,109 )
Administrative                                  1,519        2,230         (711 )
Travel, facilities and other costs                585        1,091         (506 )

Total general and administrative expenses   $   4,906     $ 10,274     $ (5,368 )

Restructuring charges. Restructuring charges were $15.5 million for the nine months ended September 30, 2008. We had no restructuring charges in the first nine months of 2007. The restructuring charge in 2008 is associated with the reductions in workforce announced on February 5, 2008 and April 8, 2008. As part of these plans, we eliminated approximately 115 employee positions inclusive of both administrative and research functions, representing approximately 78% of our total workforce. Affected employees were eligible for a severance package that includes severance pay, continuation of benefits and outplacement services. Charges of $5.1 million were recorded in the nine-month period ended September 30, 2008, including $4.9 million related to employee separation costs and $0.2 million related to outplacement and administrative fees. We also recorded, in the nine months ended 2008, an estimated asset impairment charge of $9.8 million related to the buildings that are available for sale and a write-down of equipment of $0.6 million related to assets held for sale that will be disposed with the sale of the buildings.

Change in fair value of warrants to purchase common stock. In the nine months ended September 30, 2008, we recorded a non-recurring gain on Warrants to purchase Common Stock of $16.7 million in connection with our April 2008 financing. The financing is discussed further in Liquidity and Capital . . .