The following Management's Discussion and Analysis of Financial Condition and Results of Operations section contains forward-looking statements pertaining to, among other things, the expected continuation of our collaborative agreements, the receipt of research and development payments thereunder, the future achievement of various milestones in product development and the receipt of payments related thereto, the potential receipt of royalty payments, pre-clinical testing and clinical trials of potential products, the period of time that our existing capital resources will meet our funding requirements, and our financial results of operations. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various risks and uncertainties, including those set forth in this Annual Report on Form 10-K under the heading "Item 1A. Risk Factors." See "Forward-Looking Statements" in Part I of this Annual Report on Form 10-K.

Overview

We discover, develop and intend to commercialize drugs for the treatment of neurological and endocrine-related diseases and disorders. Our product candidates address some of the largest pharmaceutical markets in the world, including endometriosis, anxiety, depression, pain, diabetes, irritable bowel syndrome, insomnia, and other neurological and endocrine related diseases and disorders. To date, we have not generated any revenues from the sale of products. We have funded our operations primarily through private and public offerings of our common stock and payments received under research and development agreements. We are developing certain products with corporate collaborators and intend to rely on existing and future collaborators to meet funding requirements. We expect to generate future net losses due to increases in operating expenses as product candidates are advanced through the various stages of clinical development. As of December 31, 2008, we had an accumulated deficit of $703.3 million and expect to incur operating losses in the near future, which may be greater than losses in prior years. We currently have eight programs in various stages of research and development, including five programs in clinical development. While we independently develop many of our product candidates, we are in a collaboration for two of our programs.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon financial statements that we have prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses, and related disclosures. On an on-going basis, we evaluate these estimates, including those related to revenues under collaborative research agreements and grants, clinical trial accruals (research and development expense), debt, share-based compensation, investments, and fixed assets. Estimates are based on historical experience, information received from third parties and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The items in our financial statements requiring significant estimates and judgments are as follows:

Revenue Recognition

Revenues under collaborative research and development agreements are recognized as costs are incurred over the period specified in the related agreement or as the services are performed. These agreements are on a best-efforts basis, and do not require scientific achievement as a performance obligation, and provide for payment to be made when costs are incurred or the services are performed. All fees are nonrefundable to the collaborators. Upfront, nonrefundable payments for license fees and advance payments for sponsored research revenues received in excess of amounts earned are classified as deferred revenue and recognized as income over the contract or development period. Estimating the duration of the development period includes continual assessment of development stages and regulatory requirements. Milestone payments are recognized as revenue upon achievement of pre-defined scientific events, which requires substantive effort, and for which achievement of the milestone was not readily assured at the

inception of the agreement. Revenues from grants are recognized based on a percentage-of-completion basis as the related costs are incurred.

Clinical Trial Costs

Research and development (R&D) expenses include related salaries, contractor fees, facilities costs, administrative expenses and allocations of corporate costs. All such costs are charged to R&D expense as incurred. These expenses result from our independent R&D efforts as well as efforts associated with collaborations, grants and in-licensing arrangements. In addition, we fund R&D and clinical trials at other companies and research institutions under agreements, which are generally cancelable. We review and accrue clinical trials expense based on work performed, which relies on estimates of total costs incurred based on patient enrollment, completion of studies and other events. We follow this method since reasonably dependable estimates of the costs applicable to various stages of a research agreement or clinical trial can be made. Accrued clinical costs are subject to revisions as trials progress to completion. Revisions are charged to expense in the period in which the facts that give rise to the revision become known. Historically, revisions have not resulted in material changes to R&D costs, however a modification in the protocol of a clinical trial or cancellation of a trial could result in a charge to our results of operations.

Share Based Payments

We grant stock options to purchase our common stock to our employees and directors under our 2003 Incentive Stock Plan (the 2003 Plan) and grant stock options to certain employees pursuant to Employment Commencement Nonstatutory Stock Option Agreements. We also grant certain employees stock bonuses and restricted stock units under the 2003 Plan. Additionally, we have outstanding options that were granted under option plans from which we no longer make grants. The benefits provided under all of these plans are subject to the provisions of revised Statement of Financial Accounting Standards (SFAS) 123 (SFAS 123R), "Share-Based Payment," which we adopted effective January 1, 2006. We elected to use the modified prospective application in adopting SFAS 123R and therefore have not restated results for periods prior to its adoption. The valuation provisions of SFAS 123R apply to new awards and to awards that are outstanding on the adoption date and subsequently modified or cancelled. Our results of operations for fiscal 2008 were impacted by the recognition of non-cash expense related to the fair value of our share-based compensation awards. Share-based compensation expense recognized under SFAS 123R for the years ended December 31, 2008, 2007 and 2006 was $8.0 million, $10.0 million and $14.4 million, respectively.

Stock option awards and restricted stock units generally vest over a three to four year period and expense is ratably recognized over those same time periods. However, due to certain retirement provisions in our stock plans, share-based compensation expense may be recognized over a shorter period of time, and in some cases the entire share-based compensation expense may be recognized upon grant of the share-based compensation award. Employees who are age 55 or older and have five or more years of service with us are entitled to accelerated vesting of certain unvested share-based compensation awards upon retirement. This retirement provision leads to variability in the quarterly expense amounts recognized under SFAS 123R, and therefore individual share-based compensation awards may impact earnings disproportionately in any individual fiscal quarter.

The determination of fair value of stock-based payment awards on the date of grant using the Black-Scholes model is affected by our stock price, as well as the input of other subjective assumptions. These assumptions include, but are not limited to, the expected term of stock options and our expected stock price volatility over the term of the awards. Our stock options have characteristics significantly different from those of traded options, and changes in the assumptions can materially affect the fair value estimates.

SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. If actual forfeitures vary from our estimates, we will recognize the difference in compensation expense in the period the actual forfeitures occur or when options vest.

Real Estate

In December 2007, we closed the sale of our facility and associated real property for a purchase price of $109.0 million. Concurrent with the sale we retired the entire $47.7 million in mortgage debt previously outstanding

with respect to the facility and associated real property, and received cash of $61.0 million net of transaction costs and debt retirement. Upon the closing of the sale of the facility and associated real property, we entered into a lease agreement whereby we leased back the facility for an initial term of 12 years pursuant to which we lease our corporate headquarters comprised of two buildings.

Under the terms of the lease, we pay a base annual rent of $7.6 million (subject to an annual fixed percentage increase, as set forth in the agreement), plus a 3.5% annual management fee, property taxes and other normal and necessary expenses associated with the lease such as utilities, repairs and maintenance, etc. In lieu of a cash security deposit under the lease agreement, Wells Fargo Bank, N.A. issued on our behalf a letter of credit in the amount of $5.7 million. The letter of credit is secured by a deposit of $6.4 million with the same bank. We have the right to extend the lease for two consecutive ten-year terms and will have the first right of refusal to lease, at market rates, any facilities built on the sold vacant lot. Additionally, we had a repurchase right to all of the properties which could have been exercised during the fourth year of the lease.

In accordance with SFAS 98, "Accounting for Leases: Sale-Leaseback Transactions Involving Real Estate, Sales-Type Leases of Real Estate, Definition of the Lease Term, and Initial Direct Costs of Direct Financing Leases" (SFAS 98) and SFAS 66, "Accounting for Sales of Real Estate" (SFAS 66) at the close of the transaction, we initially deferred the gain on the sale of the building and related vacant parcel due to the repurchase right. We also established a long-term liability of $108.7 million, essentially the gross proceeds from the real estate sale, and continued to carry the conveyed real estate assets on our balance sheet as of December 31, 2007.

Effective December 10, 2008, we entered into a first amendment to the lease. The lease amendment provides for the renovation of the front building in a manner that facilitates multiple tenant usage and establishes a mechanism for us to terminate our use of the front building. We continue to occupy the rear building.

Pursuant to the terms of the lease amendment, we are obligated to reimburse the landlord for the total cost of renovating a portion of the front building such that the front building becomes suitable for multiple tenant usage. We and the landlord will work in good faith to use commercially reasonable efforts to keep the total cost of the renovation from exceeding $5.5 million. We made a one-time payment of $1.0 million toward renovation costs in January 2009. We will reimburse the landlord for the balance of the renovation costs over a four year period through an increase in monthly rental payments (currently estimated at $108,000 per month) which began in October 2008. Furthermore, the lease amendment provides that the landlord shall seek to enter into leases with replacement tenants for portions of the front building. In connection with each replacement lease, we shall be granted a pro rata reduction in rent under the lease. We are required to pay all tenant improvement costs, lease termination costs and leasing commissions in connection with each replacement lease.

The lease amendment also terminated our right to repurchase any portion of the facility or real property. As a result of the termination of the repurchase right, during the fourth quarter of 2008, we removed from our balance sheet the long-term liability of $108.7 million and the related previously conveyed real estate assets of $69.6 million. Additionally, we began to recognize the deferred gain of $39.1 million on the sale of the real estate in accordance with SFAS 66 and SFAS 98. During 2008, we recognized $3.5 million of the deferred gain and will recognize the balance of the deferred gain over the remaining lease term.

As a result of signing the lease amendment and physically vacating the front building we triggered a cease-use date for the front building and have estimated lease termination costs in accordance with SFAS 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146). Estimated lease termination costs for the front building include the net present value of future minimum lease payments, taxes, insurance, construction, and maintenance costs from the cease-use date to the end of the remaining lease term net of estimated sublease rental income. During the fourth quarter of 2008, we recorded an expense of $15.7 million for the net present value of these estimated lease termination costs, of which $0.3 million was paid in 2008. Additionally, certain other costs such as leasing commissions and legal fees will be expensed by us as incurred in conjunction with the sublease of the vacated office space.

Asset Impairment

In accordance with SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," (SFAS 144) if indicators of impairment exist, we assess the recoverability of the affected long-lived assets by determining whether the carrying value of such assets can be recovered through undiscounted future operating cash flows. If impairment is indicated, we measure the amount of such impairment by comparing the carrying value of the asset to the estimated fair value of the related asset, which is generally determined based on the present value of the expected future cash flows.

During the fourth quarter of 2007, we recognized a non-cash impairment charge to earnings related to the impairment of a prepaid royalty. This prepaid royalty arose out of our acquisition, in February 2004, of Wyeth's financial interest in indiplon for approximately $95.0 million, consisting of $50.0 million in cash and $45.0 million in our common stock. This transaction decreased our overall royalty obligation on sales of indiplon from six percent to three and one-half percent. The receipt of the 2007 FDA Approvable Letter in December 2007 raised a significant amount of uncertainty regarding future development of indiplon. Based on this significant uncertainty, we determined that the prepaid royalty was impaired, and that a non-cash charge of $94.0 million related to this impairment was required under SFAS 144.

Results of Operations for Years Ended December 31, 2008, 2007 and 2006

The following table summarizes our primary sources of revenue during the periods
presented:


                                                        Year Ended December 31,
                                                     2008        2007         2006
                                                             (In thousands)

     Revenues under collaboration agreements:
     Pfizer                                         $     -     $    12     $ 29,660
     GlaxoSmithKline                                  1,034         126        9,074
     Dainippon Sumitomo Pharma Co. Ltd.               2,932         487            -
     Other                                                -         500          500

     Total revenue under collaboration agreements     3,966       1,125       39,234
     Grant income                                         9          99            -

     Total revenues                                 $ 3,975     $ 1,224     $ 39,234

Our revenues for the year ended December 31, 2008 were $4.0 million compared with $1.2 million in 2007. This increase in revenues was primarily due to revenue recognized in 2008 under our collaboration agreements with DSP and GSK. License fees revenue recognized under our DSP agreement was $2.9 million in 2008. Additionally, during 2008, we recognized a $1.0 million milestone payment under our GSK collaboration agreement related to clinical advancements of our CRF program. During 2007, we entered into an exclusive licensing agreement with DSP for indiplon in Japan, under which we recognized $0.5 million in revenue, as well as $0.5 million in revenue related to the out-licensing of our IL-4 program.

Our revenues for the year ended December 31, 2007 were $1.2 million compared with $39.2 million in 2006. This decrease in revenues was primarily due to revenue recognized in 2006 under our former collaboration agreement with Pfizer which was terminated in June 2006. License fees, sponsored development revenue and sales force allowance revenue recognized under our Pfizer agreement were $6.5 million, $6.6 million and $16.5 million, respectively, in 2006. Additionally, during 2006, we recognized $9.0 million in milestones under our GSK collaboration agreement. The 2006 milestones recognized under the GSK agreement related to clinical advancements and initiation of two Phase II clinical trials for generalized social anxiety disorder and irritable bowel syndrome in our CRF program. During 2007, we entered into an exclusive licensing agreement with DSP for indiplon in Japan, under which we recognized $0.5 million in revenue.

Research and development expenses decreased to $55.3 million during 2008 compared to $82.0 million in 2007. The $26.7 million decrease in research and development expenses was primarily due to cost savings related to our staff reductions in 2007. The decrease in research and development staff levels reduced personnel costs by

$15.2 million (44%) in 2008 compared to 2007. External development costs decreased by $5.1 million to $19.2 million in 2008 compared to $24.3 million in 2007. External development costs related to our Pro Drugs and urocortin 2 programs increased by $1.5 million and $1.2 million, respectively, in 2008 compared to 2007. External development costs related to our subsequently halted indiplon and valnoctamide programs included expenses of $6.3 million during 2007. Additionally, laboratory costs decreased by $2.2 million during 2008 compared to 2007, primarily due to the staff reductions mentioned above. We currently have eight programs in various stages of research and development, including five programs in clinical development.

Research and development expenses decreased to $82.0 million during 2007 compared to $97.7 million in 2006. The $15.7 million decrease in research and development expenses was primarily due to cost savings related to our staff reductions in 2006. The decrease in research and development staff levels reduced personnel costs by $9.2 million (21%) in 2007 compared to 2006. External development costs decreased by $3.0 million to $24.3 million in 2007 compared to $27.3 million in 2006. External development costs for our GnRH clinical program increased to $16.7 million in 2007 compared to $11.1 million during 2006. External development costs related to our urocortin 2 and sNRI programs decreased by $2.3 million and $1.7 million, respectively, in 2007 compared to 2006. External development costs related to our subsequently cancelled APL and H1 programs included expenses of $6.6 million during 2006. Additionally, laboratory costs decreased by $2.6 million during 2007 compared to 2006, primarily due to the staff reductions mentioned above.

We expect research and development expenses to decrease during 2009 compared to 2008, primarily due to cost savings efforts, and the winding down of the Phase II program for elagolix.

Sales, general and administrative expenses decreased to $20.2 million in 2008 compared to $37.5 million during 2007 and $54.9 million during 2006. The $17.3 million decrease in expenses from 2007 to 2008 resulted primarily from staff reductions in 2007 and costs for pre-commercialization activities related to indiplon in 2007. The $17.4 million decrease in expenses from 2006 to 2007 resulted primarily from the severance program enacted in 2006, offset partially by increased costs for pre-commercialization activities related to indiplon.

We expect sales, general and administrative expenses to decrease during 2009 primarily due to the cost savings efforts, and the dismissal of the shareholder lawsuits during the fourth quarter of 2008.

During 2008, we recognized $15.7 million in cease-use expense under SFAS 146, related to the front building of our corporate headquarters and the amendment of our facilities lease as discussed above.

During 2007, we recognized a $94.0 million non-cash impairment charge to earnings under SFAS 144 related to the impairment of a prepaid royalty as discussed above.

Other (expense) income decreased to $(1.3) million in 2008 compared with $4.9 million during 2007. Other income was $6.1 million during 2006. The decrease from 2007 to 2008 resulted primarily from rent payments of $7.0 million made under our facilities sale-leaseback agreement that are recorded as interest expense in accordance with SFAS 98. Additionally, investment income for 2008 was lower than in the prior year period, primarily due to lower cash balances coupled with lower overall interest rates. Additionally, during 2008, we recognized $3.5 million in gains on sale of assets under SFAS 66 and SFAS 98 related to the real estate transaction discussed above. The decrease in other income from 2006 to 2007 was due to lower investment income due to lower average investment balances.

Our net loss for 2008 was $88.6 million, or $2.30 per share, compared to $207.3 million, or $5.45 per share, in 2007 and $107.2 million, or $2.84 per share, in 2006. The decrease in net loss from 2007 to 2008 was primarily due to the impairment charge of $94.0 million in 2007 and cost savings in 2008 related to the staff reductions in 2007. The increase in net loss from 2006 to 2007 was due primarily to the impairment charge of $94.0 million in 2007.

Litigation matters. On June 19, 2007, Construction Laborers Pension Trust of Greater St. Louis filed a purported class action lawsuit in the United States District Court for the Southern District of California under the caption Construction Laborers Pension Trust of Greater St. Louis v. Neurocrine Biosciences, Inc., et al., 07-cv-1111-IEG-RBB. On June 26, 2007, a second purported class action lawsuit with similar allegations was also filed. On October 16, 2007, both lawsuits were consolidated into one purported class action under the caption In

re Neurocrine Biosciences, Inc. Securities Litigation, 07-cv-1111-IEG-RBB. The court also selected lead plaintiffs and ordered them to file a consolidated complaint. On November 30, 2007, lead plaintiffs filed the Consolidated Amended Complaint (CAC), which alleged, among other things, that we and certain of our officers and directors violated federal securities laws by making allegedly false and misleading statements regarding the progress toward FDA approval and the potential for market success of indiplon in the 15 mg dosage unit. On January 11, 2008, we and the individual defendants filed a motion to dismiss the CAC. Following a hearing on April 22, 2008, the court granted the motion to dismiss but gave the lead plaintiffs leave to file a second amended complaint. On June 11, 2008, the lead plaintiffs filed the Second Consolidated Amended Complaint (SAC). On July 8, 2008, we and the individual defendants filed a motion to dismiss the SAC. The court granted the motion to dismiss on September 23, 2008 but gave lead plaintiffs further leave to file a Third Consolidated Amended Complaint (TAC). On October 23, 2008, rather than filing a TAC, the lead plaintiffs filed a Notice of Election to Stand on the SAC, requesting that the court enter a final judgment dismissing the matter. On November 3, 2008, the court entered a final judgment dismissing the matter with prejudice. On December 31, 2008, the time elapsed for lead plaintiffs to appeal the court's final judgment to the Ninth Circuit Court of Appeals.

In addition, on June 25, 2007, a shareholder derivative complaint was filed in the Superior Court of the State of California for the County of San Diego by Ralph Lipeles under the caption, Lipeles v. Lyons. The complaint was brought purportedly on our behalf against certain current and former officers and directors and alleges, among other things, that the named officers and directors breached their fiduciary duties by directing us to make allegedly false statements about the progress toward FDA approval and the potential for market success of indiplon in the 15mg dosage unit. All proceedings in this matter were stayed pending resolution of the motion to dismiss the federal class action lawsuit. Following the dismissal of the federal class action lawsuit, on November 19, 2008, the plaintiff in the derivative action filed a request for dismissal of the derivative action. The court entered an order dismissing the derivative action without prejudice on November 20, 2008.

Indiplon developments. Based on the results of preclinical studies and Phase I, Phase II and Phase III clinical trials on indiplon, as well as a non-clinical data package related to indiplon manufacturing, formulation and commercial product development, we assembled and filed NDAs with the FDA for both indiplon capsules and indiplon tablets. On May 15, 2006, we received two complete responses from the FDA regarding our indiplon capsule and tablet NDAs. These responses indicated that indiplon 5mg and 10mg capsules were approvable (2006 FDA Approvable Letter) and that the 15mg tablets were not approvable (FDA Not Approvable Letter).

The FDA Not Approvable Letter for the tablets requested that we reanalyze certain safety and efficacy data and questioned the sufficiency of the objective sleep maintenance clinical data with the 15mg tablet in view of the fact that the majority of our indiplon tablet studies were conducted with doses higher than 15mg. We held an end-of-review meeting with the FDA related to the FDA Not Approvable Letter in October 2006. This meeting was specifically focused on determining the actions needed to bring indiplon tablets from Not Approvable to Approval in the resubmission of the NDA for indiplon tablets. The FDA has requested additional long-term safety and efficacy data with the 15mg dose for the adult population and the development of a separate dose for the elderly population. In discussions, we and the FDA noted positive efficacy data for sleep maintenance with both indiplon capsules and tablets. The evaluation of indiplon for sleep maintenance includes both indiplon capsules and tablets.

The 2006 FDA Approvable Letter requested that we reanalyze data from certain . . .