Working as a team, Neurocrine’s R&D and clinical development groups possess the skills and experience to identify, select and optimize new compounds, to screen for therapeutic development, and to advance these compounds effi ciently through clinical trials. Neurocrine’s research and development eff orts are focused on neurological and endocrine diseases and disorders. stcudorP 3 esahP 2 esahP 1 esahP lacinilcerP noitacidnI Elagolix Elagolix Endometriosis Benign Prostatic Hyperplasia CRF1 Antagonist (561679) CRF1 Antagonist (586529) CRF2 Peptide Agonist (Urocortin 2) VMAT2 (Selective Vesicular Monoamine Transporter 2 Inhibitor) Glucose Dependent Insulin Seretagogues GnRH Antagonist Anxiety / Depression Anxiety / Depression Cardiovascular Movement Disorders (and other CNS indications) Type II Diabetes Women’s & Men’s Health AED’s Epilepsy/Bipolar Our product candidates address some of the largest pharmaceutical markets in the world including endometriosis, anxiety, depression, pain, diabetes, benign prostatic hyperplasia (BPH), irritable bowel syndrome (IBS) and other neurological and endocrine related diseases and disorders. Dear Shareholders, Just over a year ago we began reshaping Neurocrine into a leaner organization focused on creating novel and important new therapies. In this brief period a new Neurocrine is beginning to emerge; with three programs in Phase II development, a novel treatment for movement disorders poised to enter the clinic, multiple earlier stage discovery and research efforts in neurological and endocrine based diseases and disorders, supported by a strong balance sheet. ELAGOLIX Elagolix, our orally active Gonadotropin-Releasing Hormone (GnRH) antagonist compound for the treatment of endometriosis, has been making significant progress in the clinic with three ongoing Phase IIb trials. During 2008 the drug met its endpoints in the Petal Study, our first Phase IIb clinical trial, an assessment of the impact of elagolix on bone mineral density. The results of this 252 person study demonstrated that elagolix had minimal impact on bone mineral density at the conclusion of the six months of treatment. Additionally, secondary endpoints were evaluated that showed both a statistical and clinically meaningful reduction in endometriosis symptoms. Following the success of this study, we reported on the results of our second study, Lilac Petal, a placebo controlled Phase IIb study designed to more fully explore the dose range and evaluate several exploratory endpoints. The top-line results of this study were reported in March of 2009 and elagolix was shown to be very well tolerated by patients and efficacious in treating the predominant painful symptoms of endometriosis. This trial will continue treating the patients for an additional three months and we will report the full data set in mid-summer of this year. Our third ongoing Phase IIb study, Tulip Petal, is being conducted in Central Eastern Europe. We expect the results from this study to be available in early fourth quarter of 2009. With the conclusion of these trials we will request an end of Phase II meeting with the FDA at the end of this year. The GnRH program is broad based with a number of potential indications in both women’s health and men’s health. We have several back-up compounds and follow-on compounds behind elagolix. We have created an extensive patent estate covering composition of matter, formulation, manufacturing and methods of use. Several of these patents are now issued and we anticipate upon approval elagolix will have 14 years of patent protection, the maximum patent term allowable. CRF1 Our Corticotropin-Releasing Factor Receptor 1 Antagonist (CRF) collaboration with GlaxoSmithKline (GSK) is maturing. GSK completed two Phase II studies this past year with compound 876008 for social anxiety and irritable bowel syndrome (IBS). While we were disappointed with the results of these trials, GSK remains committed to the CRF program as evidenced by the advancing of a second lead compound, 561679, into a Phase II major depression study. This study is designed to assess safety and efficacy of this compound in approximately 150 subjects with Major Depressive Disorder. We anticipate reporting the results of this study in the second half of 2010. GSK has also moved another compound, 586529, into Phase I development with a successful single escalating dose trial in 2008. UROCORTIN 2 Congestive heart failure is a condition where the heart muscle is weakened and cannot pump enough blood to supply all the organs in the body. Urocortin 2, an endogenous peptide ligand of the CRF2 receptor, is abundantly expressed in the cardiovascular system, most notably the heart and cerebral arterial system. Urocortin 2 and its receptor have been shown to have an array of effects on the cardiovascular system and metabolism. Early on we completed two Phase IIa studies which demonstrated positive hemodynamic effects in virtually all patients without serious adverse events, abnormalities in electrocardiograms or significant changes in renal function. This past year we were tasked with completing the necessary preclinical toxicology work to allow for periods of infusion of urocortin 2 up to 14 days. This toxicology work has been successfully completed, essentially fulfilling the required FDA preclinical package and allowing for further clinical development of this peptide. We will be collaborating with the Christchurch Cardioendocrine Research Group at the Christchurch School of Medicine and Health Sciences in New Zealand on a study of Urocortin 2 in the treatment of 50 Acute Decompensated Heart Failure patients. Recruitment for this should begin in 2009 pending final approval by the various regulatory oversight bodies. VMAT 2 We look forward to moving a new small molecule compound into human clinical trials this year. Vesicular Monoamine Transporter 2 (VMAT2) is a protein concentrated in the brain that is essential for the transmission of nerve impulses between neurons. Neurocrine research and discovery efforts have identified a highly selective VMAT2 inhibitor that is effective in regulating the levels of dopamine release during nerve communication, while at the same time reducing the likelihood of “off target” side effects. This compound will move into Phase I clinical trials in 2009 and we believe will be effective in the management of hyperkinetic movement disorders characterized by involuntary bodily movements such as tardive dyskinesia and Huntington’s disease. RESEARCH Our research scientists are focusing their efforts on diseases and disorders of the central nervous and endocrine systems. We are also focusing our efforts on novel targets in pain, metabolic diseases, and anticonvulsants for the treatment of epileptic seizures as well as ongoing research with our GnRH antagonists to further develop additional candidates for preclinical and clinical studies. In the face of the current worldwide economic crisis, we have been rigorously establishing R&D priorities, and diligently monitoring our operating costs and managing our cash. Because of this prudent and cautious planning, Neurocrine has been able to meet both our scientific and financial goals for 2008. We are poised for the future with a strong balance sheet and strong pipeline. With new leadership comes change and this past year exemplified those changes as a new Neurocrine begins to come into view. Each year brings new challenges and tough decisions that have to be made. We will continue to address those challenges while continuing to enhance shareholder value. I want to thank you, our shareholders, for your continued support as we weather this economic storm. I’d also like to thank our employees for their hard work and dedication to our Company. Regards, Kevin C. Gorman, Ph.D. President and Chief Executive Officer NEUROCRINE BIOSCIENCES, INC. 12780 El Camino Real San Diego, CA 92130 Notice of Annual Meeting of Stockholders To Be Held on May 29, 2009 TO THE STOCKHOLDERS: NOTICE IS HEREBY GIVEN that the 2009 Annual Meeting of Stockholders of Neurocrine Biosciences, Inc., a Delaware corporation (the “Company”), will be held on May 29, 2009, at 8:30 a.m. local time, at the Company’s corporate headquarters located at 12780 El Camino Real, San Diego, California 92130, for the following purposes as more fully described in the Proxy Statement accompanying this Notice: 1. To elect the three nominees for Class I Director named herein to the Board of Directors to serve for a term of three years; 2. To ratify the appointment of Ernst & Young LLP as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2009; 3. To approve an amendment to the Company’s 2003 Incentive Stock Plan, as amended, to increase the number of shares of common stock reserved for issuance thereunder from 5,300,000 to 5,800,000; 4. To consider a stockholder proposal to declassify the Board of Directors; and 5. To transact such other business as may properly come before the Annual Meeting or any continuation, adjournment or postponement thereof. Only stockholders of record at the close of business on April 1, 2009 are entitled to receive notice of and to vote at the Annual Meeting. All stockholders are cordially invited to attend the Annual Meeting in person. However, to assure your representation at the Annual Meeting, you are urged to mark, sign, date and return the enclosed proxy card as promptly as possible in the postage prepaid envelope, or vote by telephone or internet (instructions have been provided on your proxy card). Stockholders attending the Annual Meeting may vote in person even if they have returned a proxy. By Order of the Board of Directors, Margaret Valeur-Jensen, J.D., Ph.D. Corporate Secretary San Diego, California April 21, 2009 Important Notice Regarding the Availability of Proxy Materials for the Stockholders’ Meeting to be Held on May 29, 2009 at 8:30 a.m. Local Time at 12780 El Camino Real, San Diego, California 92130. The proxy statement and annual report to stockholders are available at www.proxyvote.com. Please have the control number on your proxy card available. (This page intentionally left blank) TABLE OF CONTENTS Page About the Annual Meeting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What is the purpose of the Annual Meeting? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Who can attend the Annual Meeting?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Who is entitled to vote at the Annual Meeting? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What constitutes a quorum?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . How do I vote? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Can I vote by telephone or electronically? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Can I change my vote after I return my proxy card?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What are the Board’s recommendations? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What vote is required to approve each item? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Who counts the votes? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What proxy materials are available on the Internet? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Who are the principal stockholders, and how much stock does management own? . . . . . . . . . . Section 16(a) Beneficial Ownership Reporting Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . Proposal One: Election of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vote Required . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Nominees for Election at the Annual Meeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Who are the remaining directors that are not up for election this year? . . . . . . . . . . . . . . How often did the Board meet during fiscal 2008?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What are the various committees of the Board and which directors are on those committees? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What is our director nomination process? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What is our process for stockholder communications with the Board of Directors? . . . . . . What is our policy regarding Board member attendance at the Company’s Annual Meeting? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Report of the Audit Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Audit and non-audit fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Audit Committee policy regarding pre-approval of audit and permissible non-audit 1 1 1 1 1 2 2 2 2 3 3 3 4 4 6 6 6 6 7 8 9 9 10 11 11 12 13 services of our independent registered public accounting firm . . . . . . . . . . . . . . . . . 13 Proposal Two: Ratification of Appointment of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vote Required . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proposal Three: Approval of an Amendment to the 2003 Incentive Stock Plan, as Amended. . General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vote Required . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Summary of the 2003 Incentive Stock Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Plan Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Equity Compensation Plans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Summary of the 2001 Stock Option Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Summary of the Employment Commencement Nonstatutory Stock Option . . . . . . . . . . . . . 14 14 14 14 14 15 15 21 22 22 25 TABLE OF CONTENTS Page Proposal Four: Stockholder Proposal to Declassify the Board of Directors. . . . . . . . . . . . . . . . General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vote Required . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Executive Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Compensation Discussion and Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Overview and Role of the Compensation Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Compensation Philosophy and Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Role of Peer Group, Compensation Surveys and Consultants . . . . . . . . . . . . . . . . . . . . . . . Compensation Consultant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Establishment of 2008 Employee Retention Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Role of Executive Officers in Compensation Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . Components of Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chief Executive Officer Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Executive Officer Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Compensation Committee Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Compensation Committee interlocks and insider participation . . . . . . . . . . . . . . . . . . . . . . Executive Compensation and Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Summary Compensation Table . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Grants of Plan-Based Awards Table. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Agreements with Named Executive Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Option Cancellation Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Outstanding Equity Awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Nonqualified Deferred Compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Option Exercises and Stock Vested. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Potential Payments upon Termination or Change-In-Control . . . . . . . . . . . . . . . . . . . . . . . . Compensation of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Related Person Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 25 27 28 29 29 29 30 30 30 31 31 35 35 37 37 38 38 38 40 40 41 42 44 45 45 50 52 52 53 53 Neurocrine Biosciences, Inc. 12780 El Camino Real San Diego, California 92130 PROXY STATEMENT The enclosed Proxy is solicited on behalf of Neurocrine Biosciences, Inc., a Delaware corporation (the “Company”), for use at its 2009 Annual Meeting of Stockholders to be held on May 29, 2009 beginning at 8:30 a.m., local time, or at any continuations, postponements or adjournments thereof for the purposes set forth in this Proxy Statement and the accompanying Notice of Annual Meeting of Stockholders. The Annual Meeting will be held at the Company’s corporate headquarters, located at 12780 El Camino Real, San Diego, California 92130. The Company’s phone number is (858) 617-7600. This proxy statement is being first mailed on or about April 21, 2009 to all stockholders entitled to vote at the Annual Meeting. ABOUT THE ANNUAL MEETING What is the purpose of the Annual Meeting? At our Annual Meeting, stockholders will act upon the matters outlined in the Notice of Annual Meeting of Stockholders on the cover page of this proxy statement, including the election of the three nominees for director named herein, ratification of the appointment of Ernst & Young LLP as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2009, approval of an amendment increasing the number of shares of common stock reserved for issuance under the Company’s 2003 Incentive Stock Plan, as amended (the “2003 Plan”) from 5,300,000 to 5,800,000, and consideration of a stockholder proposal to declassify the Board of Directors. In addition, management will report on the performance of the Company and respond to questions from stockholders. Who can attend the Annual Meeting? All stockholders of record at the close of business on April 1, 2009 (the “Record Date”), or their duly appointed proxies, may attend the Annual Meeting. If you attend, please note that you may be asked to present valid picture identification, such as a driver’s license or passport. Cameras, recording devices and other electronic devices will not be permitted at the Annual Meeting. Please also note that if you hold your shares in “street name” (that is, through a broker or other nominee), you will need to bring a copy of a brokerage statement reflecting your stock ownership as of the record date and check in at the registration desk at the Annual Meeting. Who is entitled to vote at the Annual Meeting? Stockholders of record at the close of business on the Record Date are entitled to receive notice of and to participate in the Annual Meeting. At the close of business on the Record Date, 38,677,454 shares of the Company’s common stock, $0.001 par value per share, were issued and outstanding. If you were a stockholder of record on that date, you will be entitled to vote all of the shares that you held on that date at the Annual Meeting, or any postponements or adjournments of the Annual Meeting. Each outstanding share of the Company’s common stock will be entitled to one vote on each proposal considered at the Annual Meeting. What constitutes a quorum? The presence at the Annual Meeting, in person or by proxy, of the holders of a majority of the aggregate voting power of the common stock outstanding on the Record Date will constitute a quorum, permitting the Company to conduct its business at the Annual Meeting. As of the Record Date, 38,677,454 shares of common stock, representing the same number of votes, were outstanding. Thus, the presence of the holders of common stock representing at least 19,338,728 shares will be required to establish a quorum. The presence of a quorum will be determined by the Inspector of Elections (the “Inspector”). Proxies received but marked as abstentions as well as “broker non-votes” will be included in the calculation of the number of shares considered to be present at the Annual Meeting. Broker non-votes occur when a holder of shares in “street name” does not give instructions to the broker or nominee holding the shares as to how to vote on matters deemed “non-routine” under applicable regulations. How do I vote? If you complete and properly sign the accompanying proxy card and return it to the Company, it will be voted as you direct. If you are a registered stockholder (that is, if you hold your stock in certificate form or are a Neurocrine employee who participated in the Employee Stock Purchase Program and attend the Annual Meeting), you may deliver your completed proxy card in person. “Street name” stockholders who wish to vote at the Annual Meeting will need to obtain a proxy form from the institution that holds their shares. The cost of solicitation of proxies will be borne by the Company. The Company will reimburse expenses incurred by brokerage firms and other persons representing beneficial owners of shares in forwarding solicitation material to beneficial owners. To assist in soliciting proxies (votes), the Company may retain Innisfree, a professional proxy solicitation firm, at an approximate cost of $10,000, plus certain out-of-pocket expenses. Proxies also may be solicited by certain of the Company’s directors, officers and regular employees, without additional compensation, personally, by telephone or by other appropriate means. Can I vote by telephone or electronically? If you are a registered stockholder you may vote by telephone, or electronically through the Internet, by following the instructions included with your proxy card. If your shares are held in “street name,” please check your proxy card or contact your broker or nominee to determine whether you will be able to vote by telephone or electronically. The deadline for voting by telephone or electronically is 11:59 p.m., Eastern Time, on May 28, 2009. Can I change my vote after I return my proxy card? Yes. Even after you have submitted your proxy, you may change your vote at any time before the proxy is exercised by filing with the Corporate Secretary of the Company either a notice of revocation or a duly executed proxy bearing a later date. Your proxy will also be revoked if you attend the Annual Meeting and vote in person. Attendance at the Annual Meeting will not by itself revoke a previously granted proxy. What are the Board’s recommendations? Unless you give other instructions on your proxy card, the persons named as proxy holders on the proxy card will vote in accordance with the recommendations of the Board of Directors. The Board’s recommenda- tion is set forth together with the description of each item in this proxy statement. In summary, the Board recommends a vote: (cid:129) (cid:129) (cid:129) for election of the three nominees for director named herein (see Proposal One); for ratification of the appointment of Ernst & Young LLP as the Company’s independent registered public accounting firm for fiscal 2009 (see Proposal Two); for approval of the amendment to the Company’s 2003 Incentive Stock Plan, as amended, to increase the number of shares of common stock reserved for issuance thereunder from 5,300,000 to 5,800,000 (see Proposal Three); and (cid:129) against the stockholder proposal to declassify the Board of Directors (see Proposal Four). 2 With respect to any other matter that properly comes before the meeting, the proxy holders will vote as recommended by the Board of Directors or, if no recommendation is given, in their own discretion. What vote is required to approve each item? Election of Directors. The affirmative vote of a plurality of the votes cast at the Annual Meeting is required for the election of directors. A properly executed proxy marked “WITHHOLD AUTHORITY” with respect to the election of one or more directors will not be voted with respect to the director or directors indicated, although it will be counted for purposes of determining whether there is a quorum. Other Items. For each other item, the affirmative vote of the holders of a majority of the shares represented in person or by proxy and entitled to vote on the item will be required for approval. A properly executed proxy marked “ABSTAIN” with respect to any such matter will not be voted, although it will be counted for purposes of determining the number of shares represented in person or by proxy at the Annual Meeting. Accordingly, an abstention will have the effect of a negative vote. If you hold your shares in “street name” through a broker or other nominee, your broker or nominee may not be permitted to exercise voting discretion with respect to some of the matters to be acted upon. Thus, if you do not give your broker or nominee specific instructions, your shares may not be voted on and will not be counted in determining the number of shares represented in person or by proxy at the Annual Meeting. Shares represented by such “broker non-votes” will, however, be counted in determining whether there is a quorum. Who counts the votes? Votes cast by proxy or in person at the Annual Meeting will be tabulated by the Inspector. What proxy materials are available on the Internet? The proxy statement and annual report to stockholders are available on the Internet at www.proxyvote.- com. Please have the control number on your proxy card available. 3 STOCK OWNERSHIP Who are the principal stockholders, and how much stock does management own? The following table sets forth the beneficial ownership of the Company’s common stock as of February 28, 2009 by (i) each of the current and former executive officers named in the table under the heading “Summary Compensation Table,” (ii) each current director, (iii) all current directors and executive officers as a group and (iv) all persons known to the Company to be the beneficial owners of more than 5% of the Company’s common stock. A total of 38,689,508 shares of the Company’s common stock were issued and outstanding as of February 28, 2009. Name and Address of Beneficial Owner (1) Number of Shares of Common Stock Acquirable Within 60 Days (3) Total Number of Shares of Common Stock Beneficially Owned (4) Number of Shares of Common Stock Owned (2) Percent Ownership Biotechnology Value Fund Group (5) . . . . . . . . . . . 6,235,047 — 6,235,047 16.1% 900 North Michigan Avenue, Suite 1100, Chicago, IL 60611 Federated Investors, Inc. (6) . . . . . . . . . . . . . . . . . . 4,624,889 — 4,624,889 12.0% Federated Investors Tower, Pittsburgh, PA 15222-3779 Barclays Global Investors, NA (7) . . . . . . . . . . . . . 400 Howard Street, San Francisco, CA 94105 Dimensional Fund Advisors, LP (8) . . . . . . . . . . . . Palisades West, Building One, 6300 Bee Cave Road, Austin, TX 78746 Kevin C. Gorman, Ph.D. . . . . . . . . . . . . . . . . . . . . Timothy P. Coughlin . . . . . . . . . . . . . . . . . . . . . . . Margaret Valeur- Jensen, J.D., Ph.D. . . . . . . . . . . . Christopher F. O’Brien, M.D. . . . . . . . . . . . . . . . . Dimitri E. Grigoriadis, Ph.D. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Haig P. Bozigian, Ph.D. Gary A. Lyons. . . . . . . . . . . . . . . . . . . . . . . . . . . . Corinne H. Lyle. . . . . . . . . . . . . . . . . . . . . . . . . . . W. Thomas Mitchell . . . . . . . . . . . . . . . . . . . . . . . Joseph A. Mollica, Ph.D. . . . . . . . . . . . . . . . . . . . Richard F. Pops . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stephen A. Sherwin, M.D. . . . . . . . . . . . . . . . . . . . . . . Wylie W. Vale, Ph.D. All current executive officers and directors as a 2,509,380 — 2,509,380 2,435,859 — 2,435,859 78,802 22,574 37,546 22,449 7,187 8,614 440,156 — 1,000 — — — 231,372 320,816 130,988 220,322 116,666 64,614 61,189 673,329 49,744 81,744 128,326 97,744 115,244 100,173 399,618 153,562 257,868 139,115 71,801 69,803 1,113,485 49,744 82,744 128,326 97,744 115,244 331,545 group (13 persons) . . . . . . . . . . . . . . . . . . . . . . . 858,389 2,160,899 3,010,599 6.5% 6.3% 1.0% * * * * * 2.8% * * * * * * 7.3% * Represents beneficial ownership of less than one percent (1%) of the outstanding shares of the Compa- ny’s common stock as of February 28, 2009. (1) The address of each individual named is c/o Neurocrine Biosciences, Inc., 12780 El Camino Real, San Diego, CA 92130, unless otherwise indicated. (2) Represents shares of common stock owned, excluding shares of common stock subject to stock options and restricted stock awards that are listed under the heading “Number of Shares of Common Stock Acquirable Within 60 Days,” by the named parties as of February 28, 2009. 4 (3) Shares of common stock subject to stock options currently exercisable or exercisable within 60 days of February 28, 2009, regardless of exercise price, and shares of common stock acquirable within such period pursuant to restricted stock awards, are deemed to be outstanding for computing the percentage ownership of the person holding such options and the percentage ownership of any group of which the holder is a member, but are not deemed outstanding for computing the percentage of any other person. (4) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commis- sion and generally includes voting or investment power with respect to securities. Except as indicated by footnote, and subject to community property laws where applicable, the persons named in the table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. (5) Based on Amendment No. 3 to Schedule 13G filed by Biotechnology Value Fund, L.P. (“BVF”), Biotech- nology Value Fund II, L.P. (“BVF2”), BVF Investments, L.L.C. (“BVLLC”), Investment 10, L.L.C. (“ILL10”), BVF Partners L.P. (“Partners”) and BVF Inc. (“BVF Inc.”) on February 13, 2009, reporting ownership as of December 31, 2008. According to such filing, BVF beneficially owned 1,425,047 shares of Common Stock, BVF2 beneficially owned 979,000 shares of Common Stock, BVLLC beneficially owned 3,419,000 shares of Common Stock and ILL10 beneficially owned 412,000 shares of Common Stock. Beneficial ownership by Partners and BVF Inc. includes 6,235,047 shares of Common Stock. Pur- suant to the operating agreement of BVLLC, Partners is authorized, among other things, to invest the funds of Samana Capital, L.P., the majority member of BVLLC, in shares of the Common Stock benefi- cially owed by BVLLC and to vote and exercise dispositive power over those shares of the Common Stock. Partners and BVF Inc. share voting and dispositive power over shares of the Common Stock bene- ficially owned by BVF, BVF2, BVLLC and those owned by ILL10, on whose behalf Partners acts as an investment manager, and, accordingly, Partners and BVF Inc. have beneficial ownership of all of the shares of the Common Stock owned by such parties. (6) Based on Amendment No. 3 to Schedule 13G filed by Federated Investors, Inc. (“Federated”) on February 17, 2009, reporting ownership as of December 31, 2008. According to such filing, Federated is the parent holding company of Federated Equity Management Company of Pennsylvania and Federated Global Investment Management Corp. (the “Investment Advisers”), which act as investment advisers to registered investment companies and separate accounts that own shares of common stock in the Company (the “Reported Securities”). The Investment Advisers are wholly owned subsidiaries of FII Holdings, Inc., which is a wholly owned subsidiary of Federated. All of Federated’s outstanding voting stock is held in the Voting Shares Irrevocable Trust (the “Trust”) for which John F. Donahue, Rhodora J. Donahue and J. Christopher Donahue act as trustees (collectively, the “Trustees”). The Trustees have joined in filing the Schedule 13G because of the collective voting control that they exercise over Federated. Federated, the Trust, and each of the Trustees disclaim beneficial ownership of the Reported Securities. (7) Based on Schedule 13G dated February 5, 2009 reporting ownership as of December 31, 2008, filed jointly by Barclays Global Investors, NA., Barclays Global Fund Advisors, Barclays Global Investors, LTD, Barclays Global Investors Japan Limited, Barclays Global Investors Canada Limited, Barclays Global Investors Australia Limited and Barclays Global Investors (Deutschland) AG. According to this Schedule 13G, Barclays Global Investors, NA. reported beneficial ownership of 1,349,596 shares, sole voting power as to 1,135,951 shares and sole dispositive power as to 1,349,596 shares; and Barclays Global Fund Advisors reported beneficial ownership of 1,159,784 shares, sole voting power as to 1,159,784 shares and sole dispositive power as to 1,159,784 shares. (8) Based on Schedule 13G filed by Dimensional Fund Advisors LP (“Dimensional”) on February 9, 2009, reporting ownership as of December 31, 2008. According to such filing, Dimensional is an investment advisor registered under Section 203 of the Investment Advisors Act of 1940, furnishes investment advice to four investment companies registered under the Investment Company Act of 1940, and serves as investment manager to certain other commingled group trusts and separate accounts. These investment companies, trusts and accounts are the “Funds”. In its role as investment advisor or manager, Dimen- sional possesses investment and/or voting power over the securities of the Company described in this schedule that are owned by the Funds, and may be deemed to be the beneficial owner of the shares of 5 the Company held by the Funds. However, all securities reported in this schedule are owned by the Funds. Dimensional disclaims beneficial ownership of such securities. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires the Company’s officers and directors, and persons who beneficially own more than ten percent of a registered class of the Company’s equity securities, to file reports of ownership on Form 3 and reports of changes in ownership on Form 4 or Form 5 with the SEC. Such officers, directors and 10% stockholders are also required by SEC rules to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, and written representations from certain reporting persons, the Company believes that its officers, directors and 10% stockholders complied with all Section 16(a) filing requirements applicable to them during the fiscal year ended December 31, 2008. PROPOSAL ONE: ELECTION OF DIRECTORS General The Company’s Bylaws provide that the Board of Directors will be comprised of eight directors. The Company’s Certificate of Incorporation provides that the Board of Directors is divided into three classes. There are currently three directors in Class I (Joseph A. Mollica, Ph.D., Wylie W. Vale, Ph.D. and W. Thomas Mitchell), three directors in Class II (Corinne H. Lyle, Richard F. Pops, and Stephen A. Sherwin, M.D.), and two directors in Class III (Gary A. Lyons and Kevin C. Gorman, Ph.D.). With the exception of Kevin C. Gorman, Ph.D., who is the President and Chief Executive Officer of Neurocrine Biosciences, Inc., and Gary A. Lyons, who is the former President and Chief Executive Officer of Neurocrine Biosciences, Inc. all current members of the Board of Directors meet the definition of “independent director” under the Nasdaq Stock Market qualification standards. The directors in Class I hold office until the 2009 Annual Meeting of Stockholders, the directors in Class II hold office until the 2010 Annual Meeting of Stockholders and the directors in Class III hold office until the 2011 Annual Meeting of Stockholders (or, in each case, until their earlier resignation, removal from office, or death). After each such election, the directors in each such case will then serve in succeeding terms of three years and until a successor is duly elected and qualified. Officers of the Company serve at the discretion of the Board of Directors. There are no family relationships among the Company’s directors and executive officers. The term of office for directors Joseph A. Mollica, Ph.D., Wylie W. Vale, Ph.D. and W. Thomas Mitchell, will expire at the 2009 Annual Meeting. At the 2009 Annual Meeting, the stockholders will elect three Class I directors for a term of three years. Vote Required The nominees receiving the highest number of affirmative votes of the shares present in person or represented by proxy at the 2009 Annual Meeting and entitled to vote on the election of directors will be elected to the Board of Directors. Votes withheld from any director are counted for purposes of determining the presence or absence of a quorum, but have no other legal effect under Delaware law. Unless otherwise instructed, the proxy holders will vote the proxies received by them for the Company’s nominees named below. If any of the Company’s nominees is unable or declines to serve as a director at the time of the Annual Meeting, the proxies will be voted for any nominee who is designated by the present Board of Directors to fill the vacancy. It is not expected that any of the Company’s nominees will be unable or will decline to serve as a director. The Board of Directors unanimously recommends that stockholders vote “FOR” the nominees named below. 6 Nominees for Election at the Annual Meeting All of the nominees (Joseph A. Mollica, Ph.D., Wylie W. Vale, Ph.D. and W. Thomas Mitchell) are currently Class I directors of the Company. All of the nominees were previously elected to the Board of Directors by the Company’s stockholders. Information about the nominees is set forth below: Name of Director Age Position in the Company Joseph A. Mollica, Ph.D. (1) . . . . . . . . . W. Thomas Mitchell (1)(2) . . . . . . . . . . Wylie W. Vale, Ph.D. (3) . . . . . . . . . . . . Chairman of the Board 68 63 Director 67 Director (1) Member of the Nominating/Corporate Governance Committee. (2) Member of the Audit Committee. (3) Member of the Compensation Committee. Director Since 1997 2002 1992 Joseph A. Mollica, Ph.D. has served as a director of the Company since June 1997 and became Chairman of the Board in April 1998. From 2004 to 2008, Dr. Mollica served as the Chairman of the Board of Pharmacopeia Drug Discovery, Inc., a biopharmaceutical company focused on drug discovery and develop- ment. From 1994 to 2004, Dr. Mollica served as the Chairman of the Board of Directors, President and Chief Executive Officer of Accelrys, the former parent of Pharmacopeia Drug Discovery. From 1987 to December 1993, Dr. Mollica served as Vice President, Medical Products of DuPont Company and then as President and CEO of DuPont Merck Pharmaceutical Company from 1991 to 1993. At Ciba-Geigy, where he was employed from 1966 to 1986, he served in a variety of positions of increasing responsibility, rising to Senior Vice President of Ciba-Geigy’s Pharmaceutical Division. He is currently on the board of directors of Redpoint Bio Corporation, a company focused on developing compounds to affect taste. He received his B.S. from the University of Rhode Island, his M.S. and Ph.D. from the University of Wisconsin and his Sc.D.h.c. from the University of Rhode Island. W. Thomas Mitchell has served on Neurocrine’s Board of Directors since November 2002. He is the former Chairman of the Board and Chief Executive Officer of Genencor International, a biotechnology company. Under his guidance, Genencor’s revenues grew from under $30 million to over $325 million. In addition, he successfully managed the acquisition and integration of three major businesses to build the global enterprise that is now Genencor. An industry leader, Mr. Mitchell has participated in a number of important policy initiatives including the 1999 federal executive order that created the national bioenergy initiative. He also served as a member of the Governor’s Council on Biotechnology in California, which was responsible for helping to improve the state’s competitiveness in the mid-1990’s. Mr. Mitchell previously served on the Board of Directors of DJO, Inc. a medical device company, where he was a member of the audit committee. He also served on the Advisory Boards of the Chemical Engineering School at Cornell University and the University of Iowa’s School of Engineering. Mr. Mitchell received his B.S. in chemical engineering from Drexel University. He also completed the Executive Development Program at the University of Michigan. Wylie W. Vale, Ph.D. is one of the Company’s academic co-founders, Chief Scientific Advisor, and a member of the Company’s Founding Board of Scientific and Medical Advisors. Dr. Vale has served as a director of the Company since September 1992. He is The Helen McLoraine Professor of Molecular Neurobiology at The Salk Institute for Biological Studies and is the Senior Investigator and Head of The Clayton Foundation Laboratories for Peptide Biology at The Salk Institute, where he is a former member of the Board of Trustees and former Chairman of the Faculty. He is also an Adjunct Professor of Medicine at the University of California, San Diego. In addition, Dr. Vale is recognized for his work on the molecular, pharmacological and biomedical characterization of neuroendocrine peptides, growth factors and their receptors. In recognition of his discoveries, he has received numerous awards and he is a member of the American Academy of Arts and Sciences, the Institute of Medicine and the National Academy of Sciences. Dr. Vale is a co-founder and member of the Board of Directors of Acceleron Pharma, Inc., a biotechnology company focused on musculoskeletal and metabolic therapeutics. He is a past President of both the American 7 Endocrine Society and the International Society of Endocrinology. Dr. Vale received a B.A. in biology from Rice University and a Ph.D. in physiology and biochemistry from the Baylor College of Medicine. Who are the remaining directors that are not up for election this year? The Class II and III directors will remain in office after the 2009 Annual Meeting. The names and certain other current information about the directors whose terms of office continue after the Annual Meeting are set forth below: Name of Director Age Position in the Company Director Since Kevin C. Gorman, Ph.D. . . . . . . . . . . . . Corinne H. Lyle (1) . . . . . . . . . . . . . . . . Gary A. Lyons . . . . . . . . . . . . . . . . . . . Richard F. Pops (1)(2) . . . . . . . . . . . . . . Stephen A. Sherwin, M.D. (2)(3) . . . . . . 51 President, Chief Executive Officer and Director 49 Director 58 Director 47 Director 60 Director 2008 2004 1993 1998 1999 (1) Member of the Audit Committee. (2) Member of the Compensation Committee. (3) Member of the Nominating/Corporate Governance Committee. Kevin C. Gorman, Ph.D. has been employed with the Company since 1993. He was appointed President and Chief Executive Officer in January 2008 after having served as Executive Vice President and Chief Operating Officer since September 2006 and prior to that, as Executive Vice President and Chief Business Officer and Senior Vice President of Business Development. He has served on the Board of Directors since January 2008. From 1990 until 1993, Dr. Gorman was a principal of Avalon Medical Partners, L.P. where he was responsible for the early stage founding of the Company and several other biotechnology companies such as Onyx Pharmaceuticals, Metra Biosystems, IDUN and ARIAD Pharmaceuticals. Dr. Gorman received his Ph.D. in immunology and M.B.A. in Finance from the University of California, Los Angeles and did further post-doctoral training at The Rockefeller University. Corinne H. Lyle has served on the Board of Directors since June 2004. She is a Corporate Vice President of and the President of Global Operations for Edwards Lifesciences, a global leader in products and technologies to treat advanced cardiovascular disease and the leading heart valve company in the world. From 2003 to 2005, she served as Chief Financial Officer and Treasurer for Edwards. From October 1998 until February 2003, she served as Vice President, Chief Financial Officer of Tularik, Inc., a company involved in the discovery and development of drugs based on gene regulation. Prior to joining Tularik, she was Executive Director-Health Care Group at Warburg Dillon Read LLC, an investment bank. She currently serves on the Board of Directors and is Chairman of the audit committee of Onyx Pharmaceuticals, a biopharmaceutical company that develops small molecule cancer treatments. Ms. Lyle received her undergraduate degree in industrial engineering from Stanford University and her M.B.A. from Harvard Business School. Gary A. Lyons has served as a director of the Company since joining Neurocrine in February 1993. Mr. Lyons served as the President and Chief Executive Officer of the Company from February 1993 through January 2008. Prior to joining the Company, Mr. Lyons held a number of senior management positions at Genentech including Vice President of Business Development and Vice President of Sales. Mr. Lyons currently serves on the Boards of Directors for Rigel Pharmaceuticals, Inc., a biotechnology company focused on developing drugs for the treatment of inflammatory/autoimmune and metabolic diseases, Vical Incorporated, a biotechnology company focused on the prevention and treatment of serious or life-threatening diseases and Facet Biotech Corporation, a biotechnology company dedicated to identifying and developing new oncology drugs. Mr. Lyons holds a B.S. in marine biology from the University of New Hampshire and an M.B.A. from Northwestern University’s J.L. Kellogg Graduate School of Management. Richard F. Pops has served on the Board of Directors since April 1998. Mr. Pops became Chairman of Alkermes, Inc. in April 2007. From February 1991 to April 2007, Mr. Pops had been Chief Executive Officer 8 of Alkermes. Under his leadership, Alkermes has grown from a privately held company with 25 employees to a publicly traded pharmaceutical company with more than 500 employees in multiple locations in the United States. In addition to Alkermes, he currently serves on the Board of Directors of: CombinatoRx, Inc., a company focused on developing new medicines built from synergistic combinations of approved drugs; Acceleron Pharma, Inc., a biotechnology company focused on musculoskeletal and metabolic therapeutics; the Biotechnology Industry Organization; the New England Healthcare Institute; Pharmaceutical Research and Manufacturers of America (PhRMA) and Harvard Medical School Board of Fellows. He received a B.A. in economics from Stanford University in 1983. Stephen A. Sherwin, M.D. was elected to the Board of Directors in April 1999. Since March 1990, Dr. Sherwin has served as Chief Executive Officer and Director of Cell Genesys, Inc., a biotechnology company. In March 1994, he was elected as Chairman of the Board of Cell Genesys. From 1983 to 1990, Dr. Sherwin held various positions at Genentech, Inc., a biotechnology company, most recently as Vice President of Clinical Research. Prior to 1983, Dr. Sherwin held various positions on the staff of the National Cancer Institute. Dr. Sherwin also serves as Chairman of the Board of Ceregene, Inc., a biotechnology company he co-founded in 2001 focused on developing neurotrophic growth factor treatments for major neurodegenerative disorders and a former subsidiary of Cell Genesys. Dr. Sherwin was also a co-founder of Abgenix, a company focused on the discovery, development and manufacture of human therapeutic antibodies, which was acquired by Amgen in 2006 and was a former subsidiary of Cell Genesys. Dr. Sherwin is a member of the Board of Directors of Rigel Pharmaceuticals, Inc., a biotechnology company focused on developing drugs for inflammatory/autoimmune and metabolic diseases, and is also a director of the Biotechnology Industry Organization. He holds a B.A. in biology from Yale and an M.D. from Harvard Medical School and is board-certified in internal medicine and medical oncology. How often did the Board meet during fiscal 2008? The Board of Directors of the Company held a total of nine meetings during 2008. During 2008, the Board of Directors had an Audit Committee, a Compensation Committee and a Nominating/Corporate Governance Committee. Charters for each of these committees have been established and approved by the Board of Directors and copies of the charters of the Audit and Compensation Committees have been posted on the Company’s website at www.neurocrine.com. During 2008, no director attended fewer than 75% of the aggregate of the total number of meetings of the Board of Directors and the total number of meetings held by all committees of the Board of Directors on which such director served. What are the various committees of the Board and which directors are on those committees? The Company’s Audit Committee is comprised entirely of directors who meet the independence requirements set forth in Nasdaq Stock Market Rule 4350(d)(2)(A). Information regarding the functions performed by the committee, its membership, and the number of meetings held during the fiscal year is set forth in the “Report of the Audit Committee,” included in this annual proxy statement. The current members of the audit committee are Corinne H. Lyle, Richard F. Pops, and W. Thomas Mitchell. The Board of Directors has determined that Corinne H. Lyle and Richard F. Pops are “audit committee financial experts” within the meaning of item 407(d)(5) of SEC Regulation S-K. During 2008, the Compensation Committee consisted of directors Richard F. Pops, Stephen A. Sherwin, M.D. and Wylie W. Vale, who became a member of the Compensation Committee in February 2008. This committee met three times during 2008. The Compensation Committee reviews and recommends to the Board the compensation of executive officers and other employees of the Company. Each of the current members of the Compensation Committee is an independent director as defined by Nasdaq Stock Market Rule 4200(a)(15). The Company also has a Nominating/Corporate Governance Committee currently comprised of W. Thomas Mitchell, Joseph A. Mollica, Ph.D. and Stephen A. Sherwin, M.D; all of whom are independent directors as defined by Nasdaq Stock Market Rule 4200(a)(15). The Nominating/Corporate Governance Committee is responsible for developing and implementing policies and practices relating to corporate governance, including administration of the Company’s Code of Business Conduct and Ethics which is 9 available on the Company’s website at www.neurocrine.com. The functions of this committee also include consideration of the composition of the Board and recommendation of individuals for election as directors of the Company. The Nominating/Corporate Governance Committee will consider nominees recommended by stockholders provided such nominations are made pursuant to the Company’s Bylaws and applicable law. The committee met once during 2008 to recommend the slate of directors that was approved at the 2008 Annual Meeting of Stockholders. The committee met in early 2009 to recommend that the Board of Directors nominate Joseph A. Mollica, Ph.D., Wylie W. Vale, Ph.D. and W. Thomas Mitchell for re-election as Class I directors for the upcoming three-year term. What is our director nomination process? Director qualifications In selecting non-incumbent candidates and reviewing the qualifications of incumbent candidates for the Board of Directors, the Nominating/Corporate Governance Committee considers the Company’s corporate governance principles, which include the following: Directors should possess the highest ethics, integrity and values, and be committed to representing the long-term interest of the stockholders. They also must have experience they can draw upon to help direct the business strategies of the Company together with sound judgment. They must be actively engaged in the pursuit of information relevant to the Company’s business and must constructively engage their fellow Board members and management in dialogue and the decision-making process. Directors must be willing to devote sufficient time to carrying out their duties and responsibilities effectively, and should be committed to serve on the Board for an extended period of time. Directors should offer their resignation in the event of any significant change in their personal circumstances, including a change in their principal job responsibilities. In evaluating director nominees, the Nominating/Corporate Governance Committee considers the following factors: the appropriate size of the Company’s Board of Directors; personal and professional integrity, ethics and values; experience in corporate management, such as serving as an officer or former officer of a publicly held company; and experience as a board member of another publicly held company. The Nominating/Corporate Governance Committee’s goal is to assemble a Board of Directors that brings to the Company a variety of perspectives and skills derived from high quality business and professional experience. In doing so, the Nominating/Corporate Governance Committee also considers candidates with appropriate non-business backgrounds. Other than the foregoing, there are no stated minimum criteria for director nominees, although the Nominating/Corporate Governance Committee may also consider such other facts as it may deem are in the best interests of the Company and its stockholders. The Nominating/Corporate Governance Committee does, however, believe that at least one, and, preferably, several, members of the Board of Directors, meet the criteria for an “audit committee financial expert” as defined by Securities and Exchange Commission rules. The Nominating/Corporate Governance Committee also believes it appropriate for certain key members of the Company’s management to participate as members of the Board of Directors. Identification and evaluation of nominees for directors The Nominating/Corporate Governance Committee identifies nominees for director by first evaluating the current members of the Board of Directors willing to continue in service. Current members with qualifications and skills that are consistent with the Nominating/Corporate Governance Committee’s criteria for Board of Directors service and who are willing to continue in service are considered for re-nomination, balancing the value of continuity of service by existing members of the Board of Directors with that of obtaining a new perspective. If any member of the Board of Directors does not wish to continue in service or if the Board of Directors decides not to re-nominate a member for re-election, the Nominating/Corporate Governance Committee identifies the desired skills and experience of a new nominee in light of the criteria above. The Nominating/Corporate Governance Committee generally polls the Board of Directors and members of 10 management for their recommendations and may also seek input from third-party search firms. The Nominat- ing/Corporate Governance Committee may also seek input from industry experts or analysts. The Nominating/ Corporate Governance Committee reviews the qualifications, experience and background of the candidates. Final candidates are then interviewed by the Company’s independent directors and executive management. In making its determinations, the Nominating/Corporate Governance Committee evaluates each individual in the context of the Company’s Board of Directors as a whole, with the objective of assembling a group that can best perpetuate the success of the Company and represent stockholder interests through the exercise of sound judgment. After review and deliberation of all feedback and data, the Nominating/Corporate Governance Committee makes its recommendation to the Board of Directors. We have not received director candidate recommendations from the Company’s stockholders and do not have a formal policy regarding consideration of such recommendations. However, any recommendations received from stockholders will be evaluated in the same manner that potential nominees suggested by board members, management or other parties are evaluated. Accordingly, our Board of Directors believes a formal policy regarding consideration of such recommendations is unnecessary. What is our process for stockholder communications with the Board of Directors? Stockholders of the Company wishing to communicate with the Company’s Board of Directors or an individual director may send a written communication to the Board of Directors or such director c/o Neurocrine Biosciences, Inc., 12780 El Camino Real, San Diego, CA 92130, Attn: Corporate Secretary. Each communi- cation must set forth: (cid:129) (cid:129) the name and address of the Company stockholder on whose behalf the communication is sent; and the number of Company shares that are owned beneficially by such stockholder as of the date of the communication. Each communication will be reviewed by the Company’s Corporate Secretary to determine whether it is appropriate for presentation to the Board or such director. Examples of inappropriate communications include advertisements, solicitations or hostile communications. Communications determined by the Corporate Secretary to be appropriate for presentation to the Board or such director will be submitted to the Board or such director on a periodic basis. What is our policy regarding Board member attendance at the Company’s Annual Meeting? The Company does not have a formal policy regarding attendance by members of the Board of Directors at the Annual Meeting. Joseph A. Mollica, Ph.D. and Kevin C. Gorman represented the Board of Directors at the 2008 Annual Meeting of Stockholders. 11 REPORT OF THE AUDIT COMMITTEE The following Report of the Audit Committee does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Company filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent the Company specifically incorporates this Report by reference therein. The Audit Committee is currently comprised of directors Corinne H. Lyle, Richard F. Pops, and W. Thomas Mitchell. All current committee members satisfy the definition of independent director as established in the Nasdaq Stock Market qualification requirements. The Audit Committee met four times during the year ended December 31, 2008. The Audit Committee oversees the Company’s financial reporting process on behalf of the Board of Directors. Management has the primary responsibility for the Company’s financial statements and the reporting process, including the Company’s systems of internal controls. In fulfilling its oversight responsibilities, the Audit Committee has reviewed and discussed with management the Company’s audited financial statements as of and for the year ended December 31, 2008 with management, including a discussion of the quality, not just the acceptability, of the accounting principles, the reasonableness of significant judgments and the clarity of disclosures in the financial statements. The Audit Committee also has reviewed and discussed the Company’s audited financial statements as of and for the year ended December 31, 2008 with the Company’s independent registered public accounting firm, who are responsible for expressing an opinion on the conformity of those audited financial statements with accounting principles generally accepted in the United States, as well as their judgments as to the quality, not just the acceptability, of the Company’s accounting principles and such other matters as are required to be discussed with the Audit Committee under Statement on Auditing Standards No. 114 (The Auditor’s Communication with Those Charged with Governance), as adopted by the Public Company Accounting Oversight Board (United States) (the “PCAOB”) in Rule 3200T. The independent registered public accounting firm also is responsible for performing an independent audit of the Company’s internal control over financial reporting in accordance with the auditing standards of the PCAOB. In addition, the Audit Committee has discussed the independent registered public accounting firm’s independence from management and the Company, including the matters in the written disclosures and the letter from the independent registered public accounting firm required by applicable requirements of the PCAOB and considered the compatibility of non- audit services with the auditors’ independence. The Audit Committee discussed with the Company’s independent registered public accounting firm the overall scope and plans for their audits. The Audit Committee meets with the independent registered public accounting firm, with and without management present, to discuss the results of their examinations, their evaluations of the Company’s internal controls, and the overall quality of the Company’s financial reporting. In reliance on the reviews and discussions referred to above, the Audit Committee recommended to the Board of Directors that the audited financial statements be included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, for filing with the Securities and Exchange Commission. The Audit Committee and the Board are also seeking stockholder ratification of the selection of the Company’s independent registered public accounting firm for the year ending December 31, 2009. Respectfully submitted by: AUDIT COMMITTEE Corinne H. Lyle W. Thomas Mitchell Richard F. Pops 12 Audit and non-audit fees The aggregate fees billed to the Company by Ernst & Young LLP, the Company’s independent registered public accounting firm (“Ernst & Young”), for the indicated services for each of the last two fiscal years were as follows: Audit fees (1) Audit related fees (2) Tax fees (3) All other fees (4) Total 2008 2007 $348,188 6,000 — — $502,669 22,829 — — $354,188 $525,498 (1) Audit fees consist of fees for professional services performed by Ernst & Young LLP for the integrated audit of the Company’s annual financial statements and internal control over financial reporting and review of financial statements included in the Company’s 10-Q filings, and services that are normally provided in connection with statutory and regulatory filings or engagements. (2) Audit related fees consist of fees for assurance and related services performed by Ernst & Young LLP that are reasonably related to the performance of the audit or review of the Company’s financial statements. (3) Tax fees consist of fees for professional services performed by Ernst & Young LLP with respect to tax compliance, tax advice and tax planning. (4) All other fees consist of fees for other permissible work performed by Ernst & Young LLP that does not meet with the above category descriptions. The Audit Committee has considered whether the provision of non-audit services is compatible with maintaining the independence of Ernst & Young LLP, and has concluded that the provision of such services is compatible with maintaining the independence of that firm. All of the services rendered by Ernst & Young LLP were pre-approved by the Audit Committee in accordance with the Audit Committee pre-approval policy described below. Audit Committee policy regarding pre-approval of audit and permissible non-audit services of our independent registered public accounting firm The Company’s Audit Committee has established a policy that all audit and permissible non-audit services provided by the Company’s independent registered public accounting firm will be pre-approved by the Audit Committee. These services may include audit services, audit-related services, tax services and other services. The Audit Committee considers whether the provision of each non-audit service is compatible with maintaining the independence of the Company’s registered public accounting firm. Pre-approval is detailed as to the particular service or category of services and is generally subject to a specific budget. The Company’s independent registered public accounting firm and management are required to periodically (at least quarterly) report to the Audit Committee regarding the extent of services provided by the independent registered public accounting firm in accordance with this pre-approval, and the fees for the services performed to date. 13 PROPOSAL TWO: RATIFICATION OF APPOINTMENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM General The Audit Committee has selected Ernst & Young LLP to audit the financial statements of the Company for the current fiscal year ending December 31, 2009. Ernst & Young LLP has audited the Company’s financial statements since 1992. Representatives of Ernst & Young LLP are expected to be present at the Annual Meeting, will have the opportunity to make a statement if they so desire, and are expected to be available to respond to appropriate questions. Stockholders are not required to ratify the selection of Ernst & Young LLP as the Company’s independent registered public accounting firm. However, the Audit Committee is submitting the selection of Ernst & Young LLP to the stockholders for ratification as a matter of good corporate practice. If the stockholders fail to ratify the selection, the Audit Committee will reconsider whether or not to retain that firm. Even if the selection is ratified, the Audit Committee in their discretion may direct the selection of a different independent registered public accounting firm at any time during the year if they determine that such a change would be in the best interests of the Company and its stockholders. Vote Required The affirmative vote of the holders of a majority of the shares represented in person or by proxy at the Annual Meeting will be required to approve and ratify the Audit Committee’s selection of Ernst & Young LLP. The Board of Directors unanimously recommends voting “FOR” approval and ratification of such selection. In the event of a negative vote on such ratification, the Audit Committee will reconsider its selection. PROPOSAL THREE: APPROVAL OF AN AMENDMENT TO THE 2003 INCENTIVE STOCK PLAN, AS AMENDED INCREASE OF 500,000 SHARES General The 2003 Incentive Stock Plan, as amended, of Neurocrine Biosciences, Inc. (the “2003 Plan”) was originally approved by the Board of Directors and the stockholders of the Company in 2003. The Board has approved an increase in the number of shares of common stock reserved for issuance under the 2003 Plan from 5,300,000 to 5,800,000, subject to stockholder approval at the Annual Meeting. The Board believes that the proposed increase in the number of shares of common stock reserved for issuance under the 2003 Plan will allow the Company to attract and retain valuable employees and continue to provide its employees, consultants and directors with a proprietary interest in the Company. At the Company, equity awards foster an ownership culture and are a critical tool for driving stockholder value and for recruiting, retaining and motivating employees. The Company grants annual equity awards to employees as an incentive to retain its work force and remain competitive. The terms of the Company’s annual equity awards and the Company’s employee policies are designed to align employee and stockholder interests. The Company grants equity awards to a broad group of employees and such awards constitute a significant component of the Company’s employees’ total compensation. The Company’s equity awards contain long-term vesting and provisions designed to encourage employees to focus on the Company’s long-term goals and success. If our stockholders do not approve the amendment to the Incentive Stock Plan, the Company strongly believes that it will be unable to successfully use equity as part of its compensation program, as most of its competitors in the industry do, putting the Company at a significant disadvantage and compromising its ability to enhance stockholder value. 14 The 2003 Plan authorizes the grant to our employees of options that qualify as incentive stock options under Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”). The 2003 Plan also authorizes the grant of nonstatutory stock options, restricted stock awards, restricted stock units and stock bonus awards (collectively “Equity Awards”) to our employees, directors and consultants. The 2003 Plan also provides that certain nonstatutory stock options will be automatically granted to non-employee directors and the Chairman of the Board of Directors of the Company, as described below. As of April 1, 2009, under the 2003 Plan there were options outstanding to purchase 2,103,280 shares of common stock, and 1,021,583 shares were available for future Equity Awards; 14,750 shares were outstanding as part of the Company’s stock bonus program; 1,364,016 shares were subject to outstanding restricted stock units; and 796,371 shares previously issued upon exercise of options, restricted stock units and stock bonuses granted under the Plan are now outstanding shares of common stock. As of April 1, 2009, there were approximately 130 employees and directors eligible to receive grants under the 2003 Plan. The closing price of the Company’s common stock on April 1, 2009 was $3.71. Since the inception of the Company through April 1, 2009, under all equity plans, 14.6 million options have been granted, 4.4 million option grants have been exercised at a weighted average price of $13.00, and 6.6 million option grants have been cancelled, representing approximately 30%, and 45%, respectively, of the total options granted since inception of the Company. Additionally, 2.6 million restricted stock units have been granted of which, 0.9 million have vested and 0.6 million have been cancelled as of April 1, 2009. Vote Required At the Annual Meeting, the stockholders are being asked to approve the amendment to the 2003 Plan to increase the number of shares reserved for issuance thereunder. The affirmative vote of the holders of a majority of the shares represented in person or by proxy at the Annual Meeting will be required to approve the amendment of the 2003 Plan. The Board of Directors unanimously recommends voting “FOR” the approval of the amendment to the 2003 Plan. Summary of the 2003 Incentive Stock Plan The essential features of the 2003 Plan are summarized below. This summary does not purport to be complete and is subject to, and qualified by reference to, all provisions of the 2003 Plan. General. The purpose of the 2003 Plan is to enable the Company to attract and retain the best available personnel, to provide additional incentives to the employees, directors and consultants of the Company and to promote the success of the Company’s business. Administration. The 2003 Plan is administered by the Board of Directors or a committee appointed by the Board (the Board or any such committee, the “Administrator”). The 2003 Plan may be administered by different committees with respect to different groups of employees and consultants. The Administrator may make any determinations deemed necessary or advisable for the 2003 Plan. All decisions, determinations and interpretations of the Administrator shall be final and binding on all holders. Subject to stockholder approval of this Proposal Three, an aggregate of 5,800,000 shares of common stock is reserved for issuance under the 2003 Plan. Stock subject to the 2003 Plan may be unissued shares or reacquired shares, bought on the market or otherwise. If any award granted under the 2003 Plan expires or otherwise becomes unexercisable without being exercised in full, the shares of common stock not acquired pursuant to such award again become available for issuance under the 2003 Plan. Eligibility. Nonstatutory stock options, restricted stock awards, restricted stock units and stock bonus awards may be granted under the 2003 Plan to employees, directors and consultants of the Company and any parent or subsidiary of the Company. Incentive stock options may be granted only to employees. The Administrator, in its discretion, selects the employees, directors and consultants to whom awards may be granted, the time or times at which such awards shall be granted, and the number of shares subject to each such grant. The 2003 Plan also provides that certain nonstatutory stock options will be automatically granted to non-employee directors and the Chairman of the Board of Directors of the Company, as described below. 15 Limitations. Sections 162(m) of the Internal Revenue Code places limits on the deductibility for federal income tax purposes of compensation paid to certain executive officers of the Company. In order to preserve the Company’s ability to deduct the compensation income associated with awards granted to such persons, the 2003 Plan provides that no employee may be granted, in any fiscal year of the Company, awards covering more than 250,000 shares of common stock. Notwithstanding this limit, however, in connection with an employee’s initial employment, he or she may be granted awards covering up to an additional 250,000 shares of common stock. Terms and Conditions of Options. Each option is evidenced by a stock option agreement between the Company and the optionee, and is subject to the following additional terms and conditions: Exercise Price. The Administrator determines the exercise price of options at the time the options are granted. The exercise price of a stock option may not be less than 100% of the fair market value of the common stock on the date such option is granted. In the case of an incentive stock option granted to an optionee who owns more than 10% of all classes of stock of the Company or any parent or subsidiary of the Company, the exercise price may not be less than 110% of the fair market value of the common stock on the date such option is granted. The fair market value of the common stock is generally determined with reference to the closing sale price for the common stock on the date the option is granted or the last preceding date for which such quotation exists. Exercise of Option; Form of Consideration. The Administrator determines when options become exercisable and may, in its discretion, accelerate the vesting of any outstanding option. The means of payment for shares issued upon exercise of an option is specified in each option agreement. The 2003 Plan permits payment to be made to the extent permitted under applicable laws by cash, check, other shares of common stock of the Company (with some restrictions), cashless exercise, any other form of consideration permitted by applicable law, or any combination thereof. Term of Option. The term of options granted under the 2003 Plan may be no more than ten years from the date of grant. Additionally, the maximum term for options granted after January 1, 2006 is seven years. In the case of an incentive stock option granted to an optionee who owns more than 10% of all classes of stock of the Company or any parent or subsidiary of the Company, the term of the option may be no more than five years from the date of grant. No option may be exercised after the expiration of its term. Limited Exception to Minimum Vesting Restrictions. Up to five percent (5%) of the total number of shares of Common Stock available for issuance under the Plan may in the aggregate be issued as awards of Restricted Stock, Restricted Stock Units, Stock Bonuses or a combination thereof that are not subject to the minimum vesting requirements set forth in the Plan. Stock Subject to the Plan. Except for adjustments upon changes in capitalization or merger, the aggregate number of shares of common stock with respect to which awards of restricted stock, restricted stock units, stock bonuses or a combination thereof shall be made under the 2003 Plan shall not exceed 50% of the aggregate number of shares of common stock available under the 2003 Plan. Termination of Employment. If an optionee’s employment or consulting relationship terminates for any reason (other than death, retirement or disability), then all options held by the optionee under the 2003 Plan expire on the earlier of (1) the date set forth in his or her notice of grant (which date may not be more than three months after the date of such termination in the case of an incentive stock option or six months after the date of such termination in the case of a nonstatutory stock option), or (2) the expiration date of such option. To the extent the option is exercisable at the time of the optionee’s termination, the optionee may exercise all or part of his or her option at any time before it terminates. Nonstatutory stock options granted to directors pursuant to the automatic grant provisions of the 2003 Plan will expire on the earlier of (1) three months after the date of termination of the director’s service relationship for any reason (other than death or disability) or (2) the expiration date of such option. Disability. If an optionee’s employment or consulting relationship terminates as a result of disability, then all options held by such optionee under the 2003 Plan expire on the earlier of (1) six months from 16 the date of such termination (or such longer period of time not exceeding 12 months as determined by the Administrator) or (2) the expiration date of such option. The optionee (or the optionee’s estate or a person who has acquired the right to exercise the option by bequest or inheritance) may exercise all or part of the option at any time before such expiration to the extent that the option was exercisable at the time of such termination. Nonstatutory stock options granted to directors pursuant to the automatic grant provisions of the 2003 Plan will expire on the earlier of (1) 12 months after the date of termination of the director’s service relationship as a result of disability or (2) the expiration date of such option. Death. In the event of an optionee’s death: (1) during the optionee’s employment or consulting relationship with the Company, the option may be exercised, at any time within six months of the date of death (or such longer period of time as determined by the Administrator, but no later than the expiration date of such option) by the optionee’s estate or a person who has acquired the right to exercise the option by bequest or inheritance, but only to the extent that the optionee’s right to exercise the option would have accrued if he or she had remained an employee or consultant of the Company six months after the date of death; or (2) within 30 days (or such other period of time not exceeding three months as determined by the Administrator) after the optionee’s employment or consulting relationship with the Company terminates, the option may be exercised at any time within six months (or such other period of time as determined by the Administrator at the time of grant of the option) following the date of death (but in no event later than the expiration date of the option) by the optionee’s estate or a person who has acquired the right to exercise the option by bequest or inheritance, but only to the extent of the optionee’s right to exercise the option at the date of termination. In the event of a director’s death while serving on the Board or within 30 days after such director’s service with the Company terminates, nonstatutory stock options granted to such director pursuant to the automatic grant provisions of the 2003 Plan will expire on the earlier of (1) 12 months after the date of the director’s death or (2) the expiration date of such option. Retirement. The 2003 Plan provides that upon the retirement of any Company employee at age 55 or greater following five or more years of service to the Company, all stock options held by such employee will vest and be exercisable for a term of three years from the date of retirement. Additionally, all other stock based awards will fully vest upon retirement with five years of service and age 55. Other Provisions. The stock option agreement may contain other terms, provisions and conditions not inconsistent with the 2003 Plan as may be determined by the Administrator. Automatic Director Grants. Options granted to non-employee directors are “nonstatutory stock options” to purchase shares of common stock under the 2003 Plan. Any new non-employee director will be granted an option to purchase 25,000 shares of common stock on the date of his or her initial election or appointment to the Board of Directors (a “First Option”). In addition, each non-employee director and the Chairman of the Board of Directors will be automatically granted an annual option (a “Subsequent Option”) to purchase, in the case of a non-employee director, 12,000 shares, and in the case of the Chairman of the Board of Directors, 15,000 shares, each on the date of each annual meeting of the stockholders of the Company, if on such date, he or she has served on the Board of Directors for at least six months and will be continuing in office following the meeting. The exercise price of the options automatically granted to directors will be equal to 100% of the fair market value of a share of common stock on the date of grant. First Options and Subsequent Options shall become exercisable in cumulative monthly installments of 1⁄12 of the shares subject to such option on each of the monthly anniversaries of the date of grant of the option, commencing with the first such monthly anniversary, such that each such option shall be 100% vested on the first anniversary of its date of grant. No portion of an option automatically granted to a director will be exercisable after the 7th anniversary after the date of option grant. Additionally, an option automatically granted to a director will be exercisable after the termination of the director’s services as described above. Restricted Stock Awards. A restricted stock award gives the purchaser a period of no longer than six months from the date of grant to purchase common stock. The Administrator shall establish the purchase price, if any, and form of payment for each restricted stock award, which purchase price shall be no less than 17 100% of the fair market value per share on the date of grant; provided that the purchase price per share for a restricted stock award may be reduced on a dollar-for-dollar basis to the extent the restricted stock award is granted to the purchaser in lieu of cash compensation otherwise payable to the purchaser. In all cases, legal consideration shall be required for each issuance of a restricted stock award. A restricted stock award is accepted by the execution of a restricted stock purchase agreement between the Company and the purchaser, accompanied by the payment of the purchase price for the shares. Unless the Administrator determines otherwise, the restricted stock purchase agreement shall give the Company a repurchase option exercisable upon the voluntary or involuntary termination of the purchaser’s employment or consulting relationship with the Company for any reason (including death and disability). The purchase price for any shares repurchased by the Company shall be the original price paid by the purchaser. The repurchase option lapses at a rate determined by the Administrator. Stock Bonus Awards. The Administrator may grant a stock bonus award to an employee, director or consultant that gives the recipient the right to purchase or receive a certain number of shares of common stock. The Administrator shall establish the purchase price and form of payment for each stock bonus award, which purchase price shall be no less than 100% of the fair market value per share on the date of grant; provided that the purchase price per share for a stock bonus award may be reduced on a dollar-for-dollar basis to the extent the stock bonus award is granted to the purchaser in lieu of cash compensation otherwise payable to the recipient. A stock bonus award is accepted by the execution of a stock bonus agreement between the Company and the recipient, accompanied by the payment of the purchase price for the shares, if any. Unless the Administrator determines otherwise, the stock bonus agreement shall give the Company a repurchase option exercisable upon the voluntary or involuntary termination of the recipient’s employment or consulting relationship with the Company for any reason (including death and disability). The purchase price for any shares repurchased by the Company shall be the original price paid by the purchaser. The repurchase option lapses at a rate determined by the Administrator. Restricted Stock Unit Awards. The Administrator may grant restricted stock units to an employee, director or consultant that gives the recipient the right to purchase or receive a certain number of shares of common stock. The Administrator is required to establish the purchase price and form of payment for each restricted stock unit award, which purchase price may be no less than 100% of the fair market value per share on the date of grant; provided that the purchase price per share for a restricted stock unit may be reduced on a dollar-for-dollar basis to the extent the restricted stock unit is granted to the purchaser in lieu of cash compensation otherwise payable to the recipient. The restricted stock unit conveys no rights as a stockholder to the recipient. A restricted stock unit is accepted by the execution of a restricted stock unit agreement between the Company and the recipient, accompanied by the payment of the purchase price for the shares, if any. Minimum Vesting Requirements for Restricted Stock, Stock Bonus and Restricted Stock Unit Awards. Except as provided below, all restricted stock awards, stock bonus awards and restricted stock unit awards that are not performance awards may not vest any earlier than in pro-rata installments over a three year period measured from the date of grant, and such awards that are performance awards may not vest prior to the completion of one year of continuous service from the date of grant. However, vesting may occur earlier upon death, disability, retirement, or a change-in-control. Additionally, up to five percent of the total number of shares of common stock available for issuance under the 2003 Plan may in the aggregate be issued as any combination of restricted stock awards, stock bonus awards and restricted stock unit awards that are not subject to the foregoing vesting restrictions. Awards Not Transferable. Awards may not be sold, pledged, transferred, or disposed of in any manner other than by will or by the laws of descent and distribution, or with respect to awards other than incentive stock options, with the Administrator’s consent, and may be exercised, during the lifetime of the holder, only by the holder or such transferees as have been transferred an award with the Administrator’s consent. If the Administrator makes an award transferable, such award shall contain such additional terms and conditions, as the Administrator deems appropriate. 18 Adjustments upon Changes in Capitalization. In the event that any dividend, distribution, stock split, reverse stock split, stock dividend, combination, reclassification, reorganization, merger, consolidation, split-up, repurchase, liquidation, dissolution or sale, transfer, exchange or other disposition of all or substantially all of the assets of the Company, exchange of common stock or other securities of the Company or other similar corporate transaction or event, in the Administrator’s discretion, affects the common stock such that an adjustment is determined by the Administrator to be appropriate in order to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the 2003 Plan or with respect to awards granted under the 2003 Plan, appropriate adjustments shall be made in the number and kind of shares of stock (or other securities or property) subject to the 2003 Plan, the number and kind of shares of stock (or other securities or property) subject to any award outstanding under the 2003 Plan, and the exercise or purchase price of any such award. In the event of a liquidation or dissolution, any unexercised awards will terminate. The Administrator shall notify the award holders 15 days prior to the consummation of the liquidation or dissolution. Unless otherwise provided in the award agreement, in the event of a merger, sale of all or substantially all of the assets of the Company, tender offer or other transaction or series of related transactions resulting in a change of ownership of more than 50% of the voting securities of the Company, each outstanding award may be assumed or an equivalent option or right may be substituted by the successor corporation. The vesting of each outstanding award shall accelerate (i.e. become exercisable immediately in full) in any of the following events: (1) if the successor corporation refuses to assume the awards, or to substitute substantially equivalent awards, in which case the Administrator shall notify the award holders and the awards shall be fully vested and exercisable for 15 days following such notice, and all unexercised awards at the end of such period shall terminate, (2) if the employment of the optionee is involuntarily terminated without cause within one year following the date of closing of the merger or acquisition, or (3) if the merger or acquisition is not approved by the members of the Board of Directors in office prior to the commencement of such merger or acquisition. Amendment and Termination of the 2003 Plan. The 2003 Plan will continue in effect until terminated by the Board; provided that no incentive stock option may be granted under the 2003 Plan after May 22, 2013. The Board may amend, alter, suspend or terminate the 2003 Plan, or any part thereof, at any time and for any reason. However, the 2003 Plan requires stockholder approval for any amendment to the 2003 Plan to the extent necessary to comply with applicable laws, rules and regulations. No action by the Board or stockholders may alter or impair any award previously granted under the 2003 Plan without the consent of the holder. Federal Income Tax Consequences Incentive Stock Options. An optionee who is granted an incentive stock option does not recognize taxable income at the time the option is granted or upon its exercise, although the exercise is an adjustment item for alternative minimum tax purposes and may subject the optionee to the alternative minimum tax. Upon a disposition of the shares more than two years after grant of the option and one year after exercise of the option, any gain or loss is treated as long-term capital gain or loss. If these holding periods are not satisfied, the optionee recognizes ordinary income at the time of disposition equal to the difference between the exercise price and the lower of (1) the fair market value of the shares at the date of the option exercise or (2) the sale price of the shares. Any gain or loss recognized on such a premature disposition of the shares in excess of the amount treated as ordinary income is treated as long-term or short-term capital gain or loss, depending on the holding period. A different rule for measuring ordinary income upon such a premature disposition may apply if the optionee is also an officer, director or 10% stockholder of the Company. Unless limited by Section 162(m) of the Code, the Company is entitled to a deduction in the same amount as the ordinary income recognized by the optionee. Nonstatutory Stock Options. An optionee does not recognize any taxable income at the time he or she is granted a nonstatutory stock option. Upon exercise, the optionee recognizes taxable income generally measured by the excess of the then fair market value of the shares over the exercise price. Any taxable income recognized in connection with an option exercise by an employee of the Company is subject to tax withholding by the Company. Unless limited by Section 162(m) of the Code, the Company is entitled to a deduction in the 19 same amount as the ordinary income recognized by the optionee. Upon a disposition of such shares by the optionee, any difference between the sale price and the optionee’s exercise price, to the extent not recognized as taxable income as provided above, is treated as long-term or short-term capital gain or loss, depending on the holding period. Restricted Stock Awards; Stock Bonuses. For federal income tax purposes, if an individual is granted a restricted stock award or a stock bonus, the recipient generally will recognize taxable ordinary income equal to the excess of the common stock’s fair market value over the purchase price, if any. However, to the extent the common stock is subject to certain types of restrictions, such as a repurchase right in favor of the Company, the taxable event will be delayed until the vesting restrictions lapse unless the recipient makes a valid election under Section 83(b) of the Code. If the recipient makes a valid election under Section 83(b) of the Code with respect to restricted stock, the recipient generally will recognize ordinary income at the date of acquisition of the restricted stock in an amount equal to the difference, if any, between the fair market value of the shares at that date over the purchase price for the restricted stock. If, however, a valid Section 83(b) election is not made by the recipient, the recipient will generally recognize ordinary income when the restrictions on the shares of restricted stock lapse, in an amount equal to the difference between the fair market value of the shares at the date such restrictions lapse over the purchase price for the restricted stock. With respect to employees, the Company is generally required to withhold from regular wages or supplemental wage payments an amount based on the ordinary income recognized. Generally, the Company will be entitled to a business expense deduction (subject to the requirement of reasonableness, the provisions of Section 162(m) of the Code and the satisfaction of a tax reporting obligation) equal to the taxable ordinary income realized by the recipient. Upon disposition of the common stock, the recipient will recognize a capital gain or loss equal to the difference between the selling price and the sum of the amount paid for such common stock, if any, plus any amount recognized as ordinary income upon acquisition (or the lapse of restrictions) of the common stock. Such gain or loss will be long-term or short-term depending on how long the common stock was held. Slightly different rules may apply to recipients who are subject to Section 16(b) of the Exchange Act. Restricted Stock Unit Awards. For federal income tax purposes, if an individual is granted a restricted stock unit award, the recipient generally will not recognize taxable income upon such issuance. However, when a restricted stock unit award vests and/or the underlying shares are issued to the recipient, the recipient generally will recognize taxable ordinary income equal to the excess of the common stock’s fair market value over the purchase price, if any, on the vesting or distribution date. With respect to employees, the Company is generally required to withhold from regular wages or supplemental wage payments an amount based on the ordinary income recognized. Generally, the Company will be entitled to a business expense deduction (subject to the requirement of reasonableness, the provisions of Section 162(m) of the Code and the satisfaction of a tax reporting obligation) equal to the taxable ordinary income realized by the recipient. Upon disposition of the common stock, the recipient will recognize a capital gain or loss equal to the difference between the selling price and the sum of the amount paid for such common stock, if any, plus any amount recognized as ordinary income upon acquisition (or the lapse of restrictions) of the common stock. Such gain or loss will be long-term or short-term depending on how long the common stock is held. Slightly different rules may apply to recipients who are subject to Section 16(b) of the Exchange Act. Potential Limitation on Company Deductions. Section 162(m) of the Code denies a deduction to any publicly held corporation for compensation paid to certain “covered employees” in a taxable year to the extent that compensation exceeds $1 million for a covered employee. It is possible that compensation attributable to awards granted in the future under the 2003 Plan, when combined with all other types of compensation received by a covered employee from the Company, may cause this limitation to be exceeded in any particular year. Certain kinds of compensation, including qualified “performance-based compensation,” are disregarded for purposes of the deduction limitation. In accordance with Treasury regulations issued under Section 162(m) of the Code, compensation attributable to stock options will qualify as performance-based compensation, provided that: (1) the stock award plan contains a per-employee limitation on the number of shares for which awards may be granted during a specified period; (2) the per-employee limitation is approved by the stockholders; (3) the award is granted by a compensation committee comprised solely of “outside directors”; and (4) the exercise price of the award is no less than the fair market value of the stock on the date of grant. 20 Restricted stock awards and stock bonus awards qualify as performance-based compensation under the Treasury regulations only if: (1) the award is granted by a compensation committee comprised solely of “outside directors”; (2) the award is earned (typically through vesting) only upon the achievement of an objective performance goal established in writing by the compensation committee while the outcome is substantially uncertain; (3) the compensation committee certifies in writing prior to the earning of the awards that the performance goal has been satisfied; and (4) prior to the earning of the award, stockholders have approved the material terms of the award (including the class of employees eligible for such award, the business criteria on which the performance goal is based, and the maximum amount (or formula used to calculate the amount) payable upon attainment of the performance goal). The 2003 Plan has been designed to permit the compensation committee to grant stock options, restricted stock awards, restricted stock unit awards and stock bonus awards which will qualify as “performance-based compensation.” However, restricted stock awards, restricted stock unit awards and stock bonus awards granted to date have not been structured to so qualify. The foregoing is only a summary of the effect of federal income taxation upon optionees, holders of restricted stock awards, restricted stock unit awards or stock bonus awards and the Company with respect to the grant and exercise of awards under the 2003 Plan. It does not purport to be complete, and does not discuss the tax consequences of the employee’s or consultant’s death or the provisions of the income tax laws of any municipality, state or foreign country in which the employee or consultant may reside. Plan Benefits The following table sets forth information as of the Record Date about grants under the 2003 Plan during the fiscal year ended December 31, 2008 to the executive officers, directors and employees identified below. 2003 Incentive Stock Plan Name and Position Kevin C. Gorman, Ph.D. President, Chief Executive Officer and Director . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Timothy P. Coughlin Vice President and Chief Financial Officer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Margaret Valeur-Jensen, J.D., Ph.D. Executive Vice President, General Counsel and Secretary . . . . . . . . . . . . . . . . . . . . . . . . . . Christopher F. O’Brien, M.D. Senior Vice President, Clinical Development and Chief Medical Officer . . . . . . . . . . . . . . Dimitri E. Grigoriadis, Ph.D. Number of Restricted Stock Unit Awards Subject to Vesting Dollar Value of Restricted Stock Unit Awards (1) Number of Shares Subject to Options Granted 125,000 $ 400,000 45,000 100,000 $ 320,000 30,000 100,000 $ 320,000 30,000 100,000 $ 320,000 30,000 Vice President of Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000 $ 320,000 30,000 Haig P. Bozigian, Ph.D. Senior Vice President, Pharmaceutical and Preclinical Development . . . . . . . . . . . . . . . . . Gary A. Lyons 100,000 $ 320,000 30,000 Former President and Chief Executive Officer (2) . . . . . . . . . . . . . . . . . . . . . . . . . . All current Executive Officers as a group . . . . . . . . . . . . . . . . . . . . . All current Non-Executive Directors as a group (3) . . . . . . . . . . . . . . All current Non-Executive Officer employees as a group . . . . . . . . . . — 625,000 — 454,000 21 — $2,000,000 $1,452,800 — 195,000 — 110,000 264,000 (1) Value based on the closing price of the Company’s common stock on December 31, 2008 of $3.20. (2) Mr. Lyons did not receive any grants in his capacity as an executive officer during the fiscal year ended December 31, 2008. However, he did receive an option grant in his capacity as a current non-executive director. (3) Pursuant to the terms of the 2003 Plan, non-employee directors are entitled to receive First Options and Subsequent Options as described in “Automatic Director Grants” above. Currently the Company has seven non-employee directors, all of whom are eligible to receive Subsequent Options on the day of the Annual Meeting. The actual value realized upon exercise of an option will depend on the excess, if any, of the stock price over the exercise price on the date of exercise. Only non-employee directors of the Company are eligible to receive automatic grants under the 2003 Plan. All other grants under the 2003 Plan are within the discretion of the Board or its committee and the benefits of such grants are, therefore, not determinable. Equity Compensation Plans The following table sets forth information regarding all of the Company’s equity compensation plans as of December 31, 2008. Number of Securities to be Issued upon Exercise of Outstanding Options, Warrants and Rights (a) Weighted Average Exercise Price of Outstanding Options, Warrants and Rights (b) Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column a) (c) 4,897,559 168,149 5,065,708 $15.08 $28.09 $15.51 1,004,792 — 1,004,792 Plan Category Equity compensation plans approved by security holders (1) Equity compensation plans not approved by security holders (2) Total (1) Number of shares remaining available for future issuance under equity compensation plans as of December 31, 2008 is from the 2003 Plan. The shares available for issuance under the 2003 Plan may be issued in the form of option awards, restricted stock awards, restricted stock unit awards or stock bonus awards subject to limitations set forth in the 2003 Plan. The amounts in this table do not include the shares covered by the amendment to the 2003 Plan discussed in Proposal Three. (2) Consists of shares of common stock issuable under the Company’s 2001 Stock Option Plan, as amended (the “2001 Plan”) under which no further awards will be made, and an employment commencement non- statutory stock option award. See the descriptions below. Summary of the 2001 Stock Option Plan The essential features of the 2001 Plan are summarized below. This summary does not purport to be complete and is subject to, and qualified by reference to, all provisions of the 2001 Plan. General. The purpose of the 2001 Plan was to attract and retain the best available personnel, to provide additional incentive to the employees and consultants of the Company and to promote the success of the Company’s business. Effective May 22, 2003, options and stock purchase rights may no longer be granted under the 2001 Plan. Administration. The 2001 Plan may generally be administered by the Board of Directors or a Committee appointed by the Board (in either case, the “Administrator”). The Administrator may make any determinations deemed necessary or advisable for the Plan. 22 Eligibility. Nonstatutory stock options and stock purchase rights may have been granted under the 2001 Plan to employees and consultants (including officers and directors) of the Company and any parent or subsidiary of the Company; provided that the aggregate number of shares issued or reserved for issuance pursuant to options granted to persons other than officers exceeded fifty percent (50%) of the total number of shares issued or reserved for issuance pursuant to options granted under the 2001 Plan. The Administrator, in its discretion, selected the employees and consultants to whom options and stock purchase rights may have been granted, the time or times at which such options and stock purchase rights were granted, and the number of shares subject to each such grant. Terms and Conditions of Options. Options granted under the 2001 Plan were nonstatutory stock options. Each such option is evidenced by a stock option agreement between the Company and the optionee, and is subject to the following additional terms and conditions: Exercise Price. The Administrator determined the exercise price of options at the time the options were granted. The exercise price of a nonstatutory stock option was no less than the par value per share on the date of grant. The fair market value of the common stock was determined with reference to the closing sale price for the common stock (or the closing bid if no sales were reported) on the last market trading day prior to the date the option was granted. Exercise of Option; Form of Consideration. The Administrator determines when options become exercisable and may, in its discretion, accelerate the vesting of any outstanding option. The means of payment for shares issued upon exercise of an option is specified in each option agreement. The Plan permits payment to be made by cash, check, bearing a market rate of interest, other shares of common stock of the Company (with some restrictions), cashless exercise, any other form of consideration permitted by applicable law, or any combination thereof. Term of Option. The term of options is no more than 10 years from the date of grant. No option may be exercised after the expiration of its term. Termination of Employment. If an optionee’s employment or consulting relationship terminates for any reason (other than death, retirement or disability), then all options held by the optionee under the 2001 Plan expire on the earlier of (i) the date set forth in his or her notice of grant (which date is typically six months after the date of such termination), or (ii) the expiration date of such option. To the extent the option is exercisable at the time of the optionee’s termination, the optionee may exercise all or part of his or her option at any time before it terminates. Disability. If an optionee’s employment or consulting relationship terminates as a result of disability, then all options held by such optionee under the 2001 Plan expire on the earlier of (i) six months from the date of such termination (or such other period of time as determined by the Administrator) or (ii) the expiration date of such option. The optionee (or the optionee’s estate or a person who has acquired the right to exercise the option by bequest or inheritance) may exercise all or part of the option at any time before such expiration to the extent the right to exercise would have accrued had the optionee remained an employee or consultant for a period of six months from the time of termination due to disability. Death. In the event of an optionee’s death: (i) during the optionee’s employment or consulting relationship with the Company, the option may be exercised, at any time within six months of the date of death (or at such later time as may be determined by the Administrator but in no event later than the expiration date of such option) by the optionee’s estate or a person who has acquired the right to exercise the option by bequest or inheritance, but only to the extent that the optionee’s right to exercise the option would have accrued if he or she had remained an employee or consultant of the Company six months after the date of death; or (ii) within 30 days (or such other period of time as determined by the Administrator) after the optionee’s employment or consulting relationship with the Company terminates, the option may be exercised at any time within six months (or such other period of time as determined by the Administrator) following the date of death (but in no event later than the expiration date of the option) by the optionee’s estate or a person who has acquired the right to exercise the option by bequest 23 or inheritance, but only to the extent of the optionee’s right to exercise the option at the date of termination. Retirement. The 2001 Plan provides that upon the retirement of any Company employee at age 55 or greater following five or more years of service to the Company, all stock options held by such employee will vest and be exercisable for a term of three years from the date of retirement. Nontransferability of Options. Unless otherwise determined by the Administrator, options granted under the 2001 Plan are not transferable other than by will or the laws of descent and distribution, and may be exercisable during the optionee’s lifetime only by the optionee. Other Provisions. The stock option agreement may contain other terms, provisions and conditions not inconsistent with the 2001 Plan as may be determined by the Administrator. Stock Purchase Rights. A stock purchase right gives the purchaser a period of no longer than six months from the date of grant to purchase common stock. The purchase price of common stock purchased pursuant to a stock purchase right granted under the 2001 Plan was determined in the same manner as for nonstatutory stock options. Each such stock purchase right was accepted by the execution of a restricted stock purchase agreement between the Company and the purchaser, accompanied by the payment of the purchase price for the shares. Unless the Administrator determines otherwise, the restricted stock purchase agreement gives the Company a repurchase option exercisable upon the voluntary or involuntary termination of the purchaser’s employment or consulting relationship with the Company for any reason (including death and disability). The purchase price for any shares repurchased by the Company shall be the original price paid by the purchaser. The repurchase option lapses at a rate determined by the Administrator. A stock purchase right is nontransfer- able other than by will or the laws of descent and distribution, and may be exercisable during the optionee’s lifetime only by the optionee. Adjustments upon Changes in Capitalization. In the event that the stock of the Company changes by reason of any stock split, reverse stock split, stock dividend, combination, reclassification or other similar change in the capital structure of the Company effected without the receipt of consideration, appropriate adjustments shall be made in the number and class of shares of stock subject to the 2001 Plan, the number and class of shares of stock subject to any option or stock purchase right outstanding under the 2001 Plan, and the exercise price of any such outstanding option or stock purchase right. In the event of a liquidation or dissolution, any unexercised options or stock purchase rights will terminate. The Administrator shall notify the optionee 15 days prior to the consummation of the liquidation or dissolution. To the extent it has not been previously exercised, the option or stock purchase right shall terminate immediately prior to the consummation of such proposed action. In connection with any merger, consolidation, acquisition of assets or like occurrence involving the Company, each outstanding option or stock purchase right may be assumed or an equivalent option or right may be substituted by the successor corporation. The vesting of each outstanding option or stock purchase right shall accelerate (i.e. become exercisable immediately in full) in any of the following events: (1) if the successor corporation refuses to assume the option or stock purchase rights, or to substitute substantially equivalent options or rights, (2) if the employment of the optionee is involuntarily terminated without cause within one year following the date of closing of the merger or acquisition, or (3) if the merger or acquisition is not approved by the members of the Board of Directors in office prior to the commencement of such merger or acquisition. Amendment and Termination of the Plan. The Board may amend, alter, suspend or terminate the 2001 Plan, or any part thereof, at any time and for any reason. However, the 2001 Plan requires stockholder approval for any amendment to the 2001 Plan to the extent necessary to comply with applicable laws, rules and regulations. No action by the Board or stockholders may alter or impair any option or stock purchase right previously granted under the 2001 Plan without the consent of the optionee. Unless terminated earlier, the Plan shall terminate ten years from the date of its approval by the stockholders or the Board of the Company, whichever is earlier. 24 Summary of the Employment Commencement Nonstatutory Stock Option The Company granted an employment commencement nonstatutory stock option award (the “Option”) to one of the current executive officers of the Company in connection with, and as an inducement to, his employment with the Company. The essential features of the Option are summarized below. This summary does not purport to be complete and is subject to, and qualified by reference to, all provisions of the Option Agreement with the executive officer. The Option covers the right to purchase an aggregate of 55,000 shares of the Company’s common stock at an exercise price of $52.82 per share. The Option is nonstatutory for tax purposes and may not be transferred other than by will or the laws of descent and distribution. Exercise of Option; Form of Consideration; Term of Options. The Option vests and becomes exercisable with respect to 25% of the shares 12 months after issuance and with respect to an additional 1⁄48 of the shares each month thereafter, subject to the Optionee continuing to be an employee or consultant. The Option permits payment to be made by cash, check, other shares of common stock of the Company (with some restrictions), cashless exercise, any other form of consideration permitted by applicable law, or any combination thereof. The term of the Option is 10 years from the date of grant. The Option may not be exercised after the expiration of its term. Termination of Employment; Retirement. If the Optionee’s employment terminates for any reason other than death or disability, then his Option expires on the earlier of (i) 90 days after the date of such termination or (ii) the expiration date of such Option. If the Optionee’s employment terminates upon death or disability, then his Option expires on the earlier of (i) six months after the date of such termination or (ii) the expiration date of such Option. The Option provides that upon the retirement of the Optionee at age 55 or greater following five or more years of service to the Company, his Option will vest and be exercisable for a term of three years from the date of retirement. Adjustments upon Changes in Capitalization. In the event that the stock of the Company changes by reason of any stock split, reverse stock split, stock dividend, combination, reclassification or other similar change in the capital structure of the Company effected without the receipt of consideration, appropriate adjustments shall be made in the number and class of shares of stock subject to the Option and the exercise price of the Option. In connection with any merger, consolidation, acquisition of assets or like occurrence involving the Company, the Option may be assumed or an equivalent option or right may be substituted by the successor corporation. The vesting of the Option right shall accelerate (i.e., become exercisable immediately in full) in any of the following events: (1) if the successor corporation refuses to assume the Option, or to substitute substantially equivalent options, (2) if the employment of the Optionee is involuntarily terminated without cause within one year following the date of closing of the merger or acquisition, or (3) if the merger or acquisition is not approved by the members of the Board of Directors in office prior to the commencement of such merger or acquisition. PROPOSAL FOUR: STOCKHOLDER PROPOSAL TO DECLASSIFY THE BOARD OF DIRECTORS General The Comptroller of the City of New York is the custodian and trustee of the New York City Teachers’ Retirement System, the New York City Police Pension Fund and the New York City Fire Department Pension Fund and the custodian of the New York City Board of Education Retirement System. The address of such stockholders is: The City of New York, Office of the Comptroller, Bureau of Asset Management, 1 Centre Street, New York, NY 10007-2341. The stockholders identified above own an aggregate of 74,664 shares of our common stock and have submitted the following proposal for consideration in this proxy statement. We are not responsible for any of the contents of the language of the stockholder proposal, which is included below in italics and between quotation marks. The Board unanimously opposes this stockholder proposal for the reasons stated in the 25 “Statement in Opposition of the Stockholder Proposal to Declassify the Board of Directors,” which follows the stockholder proposal. “Submitted by William C. Thompson, Jr., Comptroller, City of New York, on behalf of the Boards of Trustees of the New York City Teachers’ Retirement System, the New York City Police Pension Fund, the New York City Fire Department Pension Fund, and the New York City Board of Education Retirement System BE IT RESOLVED, that the stockholders of Neurocrine Biosciences, Inc. request that the Board of Directors take the necessary steps to declassify the Board of Directors and establish annual elections of directors, whereby directors would be elected annually and not by classes. This policy would take effect immediately, and be applicable to the re-election of any incumbent director whose term, under the current classified system, subsequently expires. SUPPORTING STATEMENT We believe that the ability to elect directors is the single most important use of the shareholder franchise. Accordingly, directors should be accountable to shareholders on an annual basis. The election of directors by classes, in our opinion, minimizes accountability and precludes the full exercise of the rights of shareholders to approve or disapprove annually the performance of a director or directors. In addition, since only a fraction of the Board of Directors is elected annually, we believe that classified boards could frustrate, to the detriment of long-term shareholder interest, the efforts of a bidder to acquire control or a challenger to engage successfully in a proxy contest. We urge your support for the proposal to repeal the classified board and establish that all directors be elected annually.” STATEMENT IN OPPOSITION OF THE STOCKHOLDER PROPOSAL TO DECLASSIFY THE BOARD OF DIRECTORS Our Certificate of Incorporation currently provides for a “classified board,” which is divided into three classes. The members of each class are elected to serve staggered three-year terms. The current classified board structure has been in place since our initial public offering in 1996. This same non-binding stockholder proposal was submitted at our 2007 and 2008 Annual Meetings of Stockholders. At the 2007 and 2008 meetings, the proposal received approximately 54% and 68%, respectively, of the votes cast on the proposal (including abstentions) and was therefore approved, but the affirmative votes represented substantially less than half of our outstanding shares as of the record date for the meetings. As described below, the vote that would be necessary to actually repeal the classified board provisions of our Certificate of Incorporation would be the affirmative vote of the holders of a majority of our outstanding common stock — a threshold beyond the affirmative votes cast in favor of the proposal at the 2007 and 2008 Annual Meetings. In addition, we continue to believe that our classified board structure offers important advantages and continues to be in the best interests of the Company and our stockholders. Continuity and Stability. We believe that a classified Board enhances continuity and stability in our management and policies since a majority of the directors at any given time will have had prior experience and familiarity with our business. This continuity and stability fosters a greater focus on long-term strategic planning and other areas of oversight, thereby enhancing our value to stockholders. We believe that the long- term perspective resulting from Board continuity and stability is particularly important for a company such as ours that is engaged in the research and development of pharmaceutical products, given the significant time, money and effort that is required to successfully develop and commercialize such products, the fundamentally unpredictable nature of drug development, and the inherent volatility in stock prices for biotechnology and pharmaceutical companies. Moreover, this continuity helps us attract and retain qualified individuals willing to commit the time and dedication necessary to understand the Company, our operations and our competitive environment — and who we believe are therefore better positioned to make decisions that benefit our stockholders. 26 Protection Against Hostile Bidders. In the event of an unfriendly or unsolicited effort to take over or restructure the Company, the classified Board structure facilitates our ability to obtain the best outcome for stockholders by giving us time to negotiate with the entity seeking to gain control of the Company and to consider alternative methods of maximizing stockholder value. If a corporation has a classified board and a hostile bidder stages and wins a proxy contest at the corporation’s annual meeting, the bidder can replace approximately one-third of the existing directors at that meeting, meaning that the bidder would need to stage and win a second proxy contest at the next annual meeting to gain control of the board. In contrast, if the corporation’s board was declassified, a hostile bidder could at the first annual meeting replace a majority of the directors with directors who are friendly to the bidder. Declassification of the Board would eliminate these benefits and therefore provide us with less time to evaluate a takeover proposal, negotiate the best result for all stockholders and consider alternatives. Accountability to Stockholders. In the opinion of the Board, directors of a classified board are just as accountable to stockholders as those on an annually elected board. Since approximately one-third of our directors stand for election each year, stockholders have the opportunity annually to vote against, or withhold their votes from, those directors as a way of expressing any dissatisfaction with the Board or management. Moreover, the entire Board can be replaced in the course of three annual meetings, all held within approximately two years. Our directors believe that they are no less attentive to stockholder concerns as a result of having been elected to three-year terms, and that they are equally accountable to the stockholders in years when they do not face re-election. The Board is committed to the highest quality of corporate governance and has adopted Corporate Governance Guidelines that, among other things, focus on the independence of our directors and the effective performance and functioning of the Board. Effect of the Stockholder Proposal. Approval of the stockholder proposal requires the affirmative vote of the holders of a majority of the shares represented in person or by proxy at the meeting. However, approval of the proposal would not automatically eliminate the classified Board, as it is a non-binding proposal requesting that the Board take the necessary steps to declassify the Board. A formal amendment repealing the classified board provisions of our Certificate of Incorporation would need to be approved by the Board and submitted to our stockholders at a subsequent meeting, and it would require approval by the affirmative vote of the holders of a majority of our outstanding common stock. Vote Required The affirmative vote of the holders of a majority of the shares represented in person or by proxy at the Annual Meeting will be required to approve the stockholder proposal to declassify the Board of Directors. The Board of Directors unanimously recommends voting “AGAINST” the stockholder proposal to declassify the Board of Directors. 27 EXECUTIVE OFFICERS As of the Record Date, the executive officers of the Company were as follows: Name Position Age Kevin C. Gorman, Ph.D. . . . . . . . . . . . . . . . Timothy P. Coughlin. . . . . . . . . . . . . . . . . . . . . . . Margaret E. Valeur- Jensen, J.D., Ph.D. Christopher F. O’Brien, M.D. . . . . . . . . . . . . Haig P. Bozigian, Ph.D. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dimitri E. Grigoriadis, Ph.D. 51 42 52 52 51 51 President, Chief Executive Officer and Director Vice President and Chief Financial Officer Executive Vice President, General Counsel and Corporate Secretary Senior Vice President and Chief Medical Officer Senior Vice President of Development Vice President of Research See above for biographical information concerning Kevin C. Gorman, Ph.D. Timothy P. Coughlin was appointed Vice President and Chief Financial Officer in September 2006 after having served as Vice President, Controller. He is responsible for Accounting, Finance, Information Technol- ogy, Operations and Investor Relations. Prior to joining Neurocrine in 2002, he was with CHI, a nationwide integrated healthcare delivery system where he served as Vice President, Financial Services. Mr. Coughlin also served as a Senior Manager in the Health Sciences practice of Ernst & Young LLP, and its predecessors, from 1989 to 1999. Mr. Coughlin holds a Bachelor’s degree in Accounting from Temple University and a Master’s degree in International Business from San Diego State University. Mr. Coughlin is a certified public accountant in both California and Pennsylvania. Margaret E. Valeur-Jensen, J.D., Ph.D. became Executive Vice President, General Counsel and Corporate Secretary of the Company in February 2005 after having served as Senior Vice President, General Counsel and Corporate Secretary since January 2000. She joined the Company as Vice President, General Counsel and Secretary in October 1998. She is responsible for all corporate and patent law practices at the Company, Quality Assurance, and serves as Corporate Secretary. From 1995 to 1998, Dr. Valeur-Jensen served as Associate General Counsel, Licensing and Business Law of Amgen. From 1991 to 1995, she served first as Corporate Counsel and later as Senior Counsel, Licensing for Amgen. Prior to joining Amgen, Dr. Valeur- Jensen practiced law at Davis, Polk & Wardell. She earned a J.D. degree from Stanford University, a Ph.D. in biochemistry and molecular biology from Syracuse University, and was a Post-Doctoral Fellow at Massachu- setts General Hospital and Harvard Medical School. Christopher F. O’Brien, M.D. became Chief Medical Officer in January 2007 after having served as Sr. Vice President of Clinical Development since 2005. He is responsible for Clinical Operations, Regulatory Affairs, Drug Safety, Biostatistics and Data Management. Prior to joining Neurocrine, he was Chief Medical Officer at Prestwick Pharmaceuticals from 2003 to 2005 and Senior Vice President of Global Medical Affairs at Elan Pharmaceuticals from 2000 to 2003. Dr. O’Brien is currently on the board of directors of Verifax Corporation, a biometrics company focused on developing a dynamic signature verification system. Dr. O’Brien is a Board Certified Neurologist and obtained his undergraduate degree in Neuroscience from Boston University, his medical degree and residency training from the University of Minnesota and fellowship training from the University of Rochester School of Medicine. In addition, Dr. O’Brien holds an appointment as Associate Professor (voluntary) in the Neuroscience Department at the University of California, San Diego. Haig P. Bozigian, Ph.D. was appointed Senior Vice President of Pharmaceutical and Preclinical Development in December 2006 after having served as Vice President of Preclinical Development. He is responsible for all pre-clinical, chemical and pharmaceutical development. Dr. Bozigian joined Neurocrine in 1997. With extensive expertise in CNS related new product development, Dr. Bozigian has participated in research and development for more than 20 years. Prior to joining Neurocrine, Dr. Bozigian served as Director of Pharmaceutical Development at Procyte Corporation, Associate Director of Pharmacokinetics and Drug Metabolism at Sphinx Pharmaceuticals and as a Clinical Pharmacokineticist at GlaxoSmithKline. Dr. Bozigian earned his B.S. in Microbiology from the University of Massachusetts, his M.S. in Pharmacodynamics and 28 Toxicology from the University of Nebraska Medical Center, and earned his Ph.D. in Pharmaceutical Sciences from the University of Arizona. Dimitri E. Grigoriadis, Ph.D., became Vice President of Research in January 2007 and oversees all research functions including drug discovery, biology and chemistry. Dr. Grigoriadis joined Neurocrine in 1993, established the Pharmacology and drug screening groups and was most recently a Neurocrine Fellow and Vice President of Discovery Biology. Prior to joining Neurocrine, he was a Senior Scientist in the Neuroscience group at the Du Pont Pharmaceutical Company from 1990 to 1993. Dr. Grigoriadis received his B.Sc. from the University of Guelph in Ontario Canada, and his M.Sc. and Ph.D. in Pharmacology from the University of Toronto, Ontario, Canada. He conducted his postdoctoral research at the National Institute on Drug Abuse from 1987 to 1990. COMPENSATION DISCUSSION AND ANALYSIS Overview and Role of the Compensation Committee The Compensation Committee (“Committee”) reviews and recommends to the Board of Directors for approval the Company’s executive compensation policies. The specific roles of the Committee include: (cid:129) reviewing and, if necessary, revising the compensation philosophy of the Company; (cid:129) reviewing and approving corporate goals and objectives relating to the compensation of the Company’s executive officers, and evaluating the performance of the Company’s executive officers in light of the Company’s goals and objectives; (cid:129) reviewing and approving all employment agreements and compensation for all executive officers and guidelines for salaries, merit salary increases, bonus payments, stock based grants and performance stock based grants for all other employees of the Company; (cid:129) reviewing and approving all promotions to executive officers and all new hires of executive officers; (cid:129) managing and reviewing equity incentive, employee pension and benefit plans; (cid:129) managing and reviewing the grant of perquisite benefits; (cid:129) managing and reviewing executive officer and director indemnification and insurance matters; and (cid:129) overseeing the preparation of, and approving, this section of the Company’s annual proxy statement. Compensation Philosophy and Objectives The Committee’s philosophy in establishing the Company’s compensation policy for executive officers and other employees is to: (cid:129) create a structure designed to attract and retain highly skilled individuals by establishing salaries, benefits, and incentive compensation which compare favorably with those for similar positions in other biotechnology companies; and (cid:129) align compensation plans to both short-term and long-term goals and objectives of the Company. In light of the Company’s philosophy, the Committee attempts to provide a mix of compensation between base salary and cash bonuses such that approximately 30% to 40% of the executive officer’s total cash compensation is at risk and that non-cash compensation is structured to provide a reward for corporate and individual performance. The Committee believes that this approach provides an appropriate incentive for executive officers to attain the Company’s long-term strategic and performance goals, and also retains and motivates key executive officers. Although current general economic conditions in 2008 played a role in 29 determining the amount of compensation awards for 2009, the Company made no changes to its compensation philosophy and objectives due to these conditions. Role of Peer Group, Compensation Surveys and Consultants In order to evaluate the Company’s competitive position in the industry related to executive compensation, the Committee has historically reviewed and analyzed the compensation packages, including base salary levels, cash bonus awards and equity awards, offered by other biotechnology and pharmaceutical companies within a designated peer group. As a result of a significant reduction of the Company’s workforce, changes to the management team and a significant decrease in the Company’s market capitalization in late 2007 and early 2008, the Committee believed that the 2007 peer group of companies no longer represented an appropriate peer group for the Company. Accordingly, when reviewing the Company’s executive compensation policies for 2008 and making recommendations to the Board regarding such policies, and in setting 2008 compensation levels, the Committee used information obtained directly from the Radford Global Life Sciences Survey (“Radford Survey”). The Radford Survey is the leading source for compensation information in the biotechnology industry. Because the Committee viewed the Company as being in a transition stage due to the events described above, the Committee used data from the overall results and similarly sized company sections of the Radford Survey in setting 2008 compensation levels. During 2008, the Committee determined that the Company would have completed its transition by year end and therefore established a new peer group to be used in setting 2009 compensation levels. This peer group was selected based on a variety of factors including business scope, market capitalization, stage of development, location and/or competition for talent, and consists of Acadia Pharmaceuticals, Inc., Alexza Pharmaceuticals, Inc., Arena Pharmaceuticals, Inc., CombinatoRx, Inc., Cytokinetics Incorporated, Dendreon Corporation, Geron Corporation, Halozyme Therapeutics, Inc., Incyte Corporation, Indevus Pharmaceuticals, Inc., Infinity Pharmaceuticals, Inc., ISIS Pharmaceuticals, Inc., Metabasis Therapeutics, Inc., Peregrine Pharmaceuticals, Inc., Rigel Pharmaceuticals, Inc., Santarus, Inc., Seattle Genetics, Inc., Somaxon Pharmaceuticals, Inc., Sunesis Pharmaceuticals, Inc., Theravance, Inc., Trubion Pharmaceuticals, Inc. and Vical Incorporated. Compensation Consultant The Committee used the services of Remedy Compensation Consulting (the “Compensation Consultant”) as a third party compensation consultant for establishing 2008 and 2009 compensation levels. The Compensa- tion Consultant worked closely with the Committee in re-defining the peer group for 2009. The Compensation Consultant was engaged directly by the Committee, and its contract and related services are at the sole discretion of the Committee. Establishment of 2008 Employee Retention Program In February 2008, the Board approved an employee retention program (“the Retention Program”) to provide the Company with a mechanism to retain its non-officer and executive officer employees who were not subject to the December 2007 reduction in the Company’s workforce. At the time, the Committee believed that employee and executive retention over the following two to three years was critical. As part of the Retention Program, the Board approved a one-time cash retention amount and the issuance of RSUs and stock options to its executive officers. The Retention Program was intended to provide both a short-term incentive to stay and a long-term incentive to help the Company meet its goals and objectives as well as retain those receiving the equity awards. The Committee reviewed each compensation component separately and in total versus the data obtained from the Radford Survey and determined that the executive compensation components of the Retention Program fell within the targeted ranges for executive compensation set forth below. 30 Role of Executive Officers in Compensation Decisions The Committee makes all final decisions regarding compensation for all executive officers (other than compensation for the President and Chief Executive Officer, which is decided by all non-employee members of the Board of Directors), including determining equity awards. The President and Chief Executive Officer annually reviews the performance of each executive officer (other than himself). The Committee reviews competitive market data for base salary, cash bonuses and equity awards. In addition, both the Committee and the Chief Executive Officer consulted with the Compensation Consultant in establishing the compensation levels for 2008 and 2009. From this review, conclusions and recommendations, including proposed base salary adjustments and annual award amounts, are presented to the Committee for its consideration and approval. The Committee, in its sole discretion, can accept, modify or reject any of the recommendations. Components of Compensation The Company’s compensation for executive officers consists of six components: base salary, cash bonuses, equity awards, deferred compensation benefits, retirement benefits as provided under the Company’s 401(k) plan, and severance agreements and other benefits. Due to the importance of the role, higher level of responsibility and enhanced stockholder accountability, the President and Chief Executive Officer typically receives a greater total compensation package, including stock equity grants. Base salaries, cash bonuses and equity award components of compensation are targeted at or above the average rates reflected by the Radford Survey for 2008 compensation and the peer group for 2009 compensation. Generally, this means targeting each of these three components between the 50th and 75th percentile of the actual benefits for all incumbents in an appropriately comparable position as reflected by the Radford Survey for 2008 compensation and the peer group for 2009 compensation. Using significant discretion, the Committee considers each executive’s respon- sibilities, experience, and contribution to goals when determining the appropriate compensation level for each executive within the target percentiles. In turn, these same components, when added together, are also within these same targeted percentiles for compensation levels as compared to the Radford Survey for 2008 compensation and the peer group for 2009 compensation. There is no direct correlation between how amounts paid for one component affect amounts paid under another component. Each of these six components is described below. Base Salary The base salary component of compensation is designed to compensate executive officers competitively at levels necessary to attract and retain qualified executives in the pharmaceutical and biotechnology industry. For 2008 and 2009 compensation, base salaries have been targeted between the 50th and 75th percentiles of rates reflected by the Radford Survey and the 2009 peer group, respectively, to enable the Company to attract, motivate, reward and retain highly skilled executives. As a general matter, the base salary for each executive officer is initially established through negotiation at the time the officer is hired, taking into account such officer’s qualifications, experience, prior salary, and competitive salary information. Year-to-year adjustments to each executive officer’s base salary are based upon personal performance for the year, changes in the general level of base salaries of persons in comparable positions within the industry, and the average merit salary increase for such year for all employees of the Company established by the Committee, as well as other factors the Committee judges to be pertinent during an assessment period. In making base salary decisions, the Committee exercises its judgment to determine the appropriate weight to be given to each of these factors. Cash Bonuses The Committee’s philosophy in establishing the Company’s cash bonus compensation strategy for executive officers and other employees is to provide a mix of compensation between base salary and total cash compensation such that approximately 30% to 40% of the total target cash compensation is at risk for executives during 2009. The cash bonus targets at plan were set between the 50th and 75th percentiles of target bonuses reflected by the Radford Survey for 2008 compensation and the peer group for 2009 compensation to enable the Company to attract, motivate, reward and retain highly skilled executives for 31 short-term performance. This supports the achievement of annual Company goals and objectives by basing compensation on a pay-for-performance basis. To promote a pay-for-performance environment, the Company maintains a discretionary performance- based annual bonus program for its executive officers. Bonus payments are linked to the attainment of overall corporate goals established by the Board of Directors and individual performance for each executive officer. The Board of Directors establishes the target and maximum potential amount of each officer’s bonus payment annually, based upon the recommendation of the Committee. Normally an appropriate weight is given to each of the various goals used to calculate the amount of each executive officer’s bonus payment as determined by the Committee in its sole discretion. In February 2008, the Board approved the Company’s performance goals for 2008 along with eligible bonus percentages and weighting for executive officers. The Board decreased the President and Chief Executive Officer’s bonus target percentage to 60% of base salary for 2008; this placed the President and Chief Executive Officer’s target bonus closer to the 50th percentile of bonus targets in the Radford Survey. All other executive officers’ eligible bonus at target remained at 50% of their respective base salaries and maximum bonus payouts (which was the same as in 2007) as both the target and maximum levels were substantially similar to the Radford Survey data. In addition, the Company no longer has an executive in the position of Chief Operating Officer. The performance goals for 2008 related to our lead development programs which comprise mainly GnRH, CRF, and urocortin 2, our earlier stage research and development programs and general administration activities. The Committee assigned a weighting of 55%, 25% and 20%, respec- tively, for each of these areas. Some of the specific 2008 goals were as follows: for the GnRH and urocortin 2 programs, the continuation of various clinical and pre-clinical development studies and entering into a research and development partnership for GnRH; for our earlier stage research and development program goals, the continuation of various pre-clinical development studies, preparation for clinical studies and various research and drug discovery goals; and for general administrative activities, maintaining the projected cash burn, exceeding the NASDAQ biotechnology and composite indices’ returns, and supplementing the early stage drug development pipeline. In general, achievement of the Company’s goals determines the initial bonus pool for the Company, which is then allocated to the executive officers based on the individual performance of each executive officer during the year. As in previous years, the 2008 executive bonuses were discretionary and there were no formulaic calculations for determining the actual amount of the bonus for each executive. Accordingly, the Board or the Committee may, in its sole discretion, eliminate any individual bonus or reduce or increase the amount of compensation payable with respect to any individual bonus. An executive officer must be an employee of the Company on the date of payment to qualify for a bonus. Any executive officer who leaves the employment of the Company, voluntarily or involuntarily, prior to the payment, is ineligible for any bonus. An employee who becomes an executive officer during the fiscal year may be eligible for a pro-rated bonus at the option of the Committee, provided the executive has been employed a minimum of three months during the calendar year. No clawback provisions have been adopted at this time. The Committee believes that the performance goals established for bonuses do not encourage excessive risk taking or have potential for encouraging behavior that may impact the Company negatively in future years. For 2008, executive officers were eligible for the following bonuses as a percentage of annualized base salary: Executive Officer Minimum Payout Target Percentage Maximum Payout President and Chief Executive Officer . . . . . . . . All Other Executive Officers . . . . . . . . . . . . . . . 0% 0% 60% 50% 120% 100% In reviewing performance for 2008, the Committee determined that a majority of the corporate goals had been met. Goals for GnRH included generation of positive top-line results for the 603 study, and initiation of the 702 and 703 studies for GnRH; however, the goal of obtaining a partnership was not reached. Other goals achieved included the pre-clinical work for urocortin 2, and the advancement of another compound, a VMAT2 inhibitor, which is now ready for clinical development. Most of the early stage research and development 32 program goals were completed, including various pre-clinical development studies, preparation for clinical studies and advancement of drug candidates in the research and drug discovery areas. General administrative goals achieved include maintaining the projected cash burn, ending 2008 with over $100 million in cash and investments and reorganizing the Company in early 2008. Notwithstanding the achievement of the majority of the corporate goals for the year, the Committee determined that no annual bonus payment would be awarded to the executive officers for 2008. This was primarily due to the failure to obtain a partnership for the GnRH program coupled with the need for the Company to conserve cash at this time. In February 2009, the Board approved the Company’s performance goals for 2009 along with eligible bonus percentages and weighting for executive officers. The performance goals for 2009 include goals for lead development programs, research and general administration. GnRH program goals include continuation of various clinical and pre-clinical development studies and entering into a partnership for GnRH. Early stage research and development program goals include various pre-clinical development studies, preparation for clinical studies and various research and drug discovery goals. VMAT2 goals include initiating a Phase I trial and other pre-clinical activities. General administrative activities include maintaining the projected cash burn and budgetary goals. Equity Awards The Committee provides the Company’s executive officers with long-term incentive compensation through grants of stock options, restricted stock units (“RSU“s) and/or stock bonuses under the Company’s equity compensation plans. These equity-based programs provide the Company’s executive officers with the opportu- nity to purchase and maintain an equity interest in the Company and to share in the appreciation of the value of the Company’s common stock. The Committee believes that these grants directly motivate an executive to maximize long-term stockholder value and create an effective tool for incentivizing and retaining those executives who are most responsible for influencing stockholder value by further aligning our executive’s interests with those of our stockholders by increasing the reward to our executives when our stock price increases. The grants also utilize vesting periods that encourage key executives to continue in the employ of the Company. The Committee considers each grant subjectively, considering factors such as the individual performance of the executive officer, the anticipated contribution of the executive officer to the attainment of the Company’s long-term strategic performance goals, and to retain and motivate key executives. The equity awards for each year are set between the 50th and 75th percentiles of the actual benefits reflected by the Radford Survey for 2008 and by the peer group in 2009 to enable the Company to attract, motivate, and retain highly skilled executives. Long-term incentives granted in prior years are also taken into consideration, but do not play a significant role in current year determinations. It has been our practice to make equity-based awards to our executives on an annual basis. Annual stock option awards typically vest over three years and have a seven year term. Additionally, all stock option awards are priced based upon the closing price of the Company’s common stock on the date of grant, which is also the approval date, by the Committee or Board of Directors. RSU awards typically vest over three years. The Committee typically reviews Company and executive performance during the first quarter of each year to determine the amount and types of awards to be granted. Prior year actual gains from the exercise of vested equity grants are not considered in the determination of current year compensation. The Company does not maintain any equity ownership guidelines for its executive officers. Deferred Compensation Plan Currently, employees at the Vice President level or above, inclusive of members of the Board of Directors, are eligible to participate in the Company’s Deferred Compensation Plan (the “NQDC Plan”). Under the terms of the NQDC Plan, each eligible participant may elect to defer all or a portion of cash salary and bonus compensation, and RSUs received for services to the Company. The plan was established for the purpose of providing retirement and other benefits on behalf of such employees. The plan is intended to be a nonqualified unfunded top-hat plan maintained primarily for the purpose of providing deferred compensation benefits for a select group of management or highly compensated employees. We do not provide a match on 33 executive deferrals under the deferred compensation plan. We maintain this plan for the purpose of providing a competitive benefit allowing our executives an opportunity to defer income tax payments on their cash and equity compensation. Retirement Benefits The terms of the Company’s 401(k) Savings Plan (the “401k Plan”), provide for executive officer and broad-based employee participation. Under the 401k Plan, all Company employees are eligible to receive basic matching contributions from the Company that vest three years from date of hire and monthly thereafter. The Company’s basic matching contribution for the 401k Plan for 2008 was $0.50 for each dollar on the first 6% of each participant’s pretax contributions and was calculated on a payroll-by-payroll basis subject to applicable Federal matching limits ($6,900 in 2008). Beyond the basic matching contribution, the Company made no discretionary contributions to the 401k Plan in 2008. Severance Agreements and other Benefits Executive officers are eligible to participate in the Company’s employee benefit plans on the same terms as all other full-time employees. These plans include medical, dental and life insurance. In addition to the benefits available to all employees, we provide our executive officers with certain additional benefits that we believe reflect market standards and are reasonable and necessary to attract and/or retain each of our executive officers and, in the case of the tax planning services described below, allow the executive officers to realize the full benefit of the other elements of compensation we provide. Executive officers are also provided with one annual physical examination. Executive officers are eligible for four weeks of vacation from date of hire through ten years of employment, and five weeks of vacation per year thereafter. Additionally, all executive officers, as well as all other full-time employees, are eligible to receive a one-time additional two week vacation benefit after ten years of service. In certain cases, the Company may provide relocation expense reimbursement and related tax gross-up benefits, and tax preparation and planning services, to the executive officers. In addition, executive officers are eligible to receive severance benefits in connection with terminations of employment due to death, disability, or termination without cause or constructive termination (including following a change-in-control) as set forth below and more fully described in Potential Payments upon Termination or Change-In-Control. The Board updated the executive severance agreements most recently in 2007 to reflect competitive market standards. In revising the agreements, the Board relied on input provided by Hewitt and Associates, a third party consultant, which provided a competitive analysis using primarily the 2007 peer group data and Committee recommendations. The Committee believes that the executive severance arrangements continue to reflect current market standards and severance benefits competitive with those provided by our peer group. The Committee believes that in order to continue to retain the services of our key executive officers, it is important to provide them with some income and benefit protection against an involuntary termination of employment. Compensation components for executive officers in the event of death include partial stock award acceleration, prorata bonus payment, payments for accrued base salary, vested deferred compensation, any accrued vacation and any accrued benefits under any plans of the Company in which the executive officer is a participant and any appropriate business expenses incurred by the executive officer. In the event of death, there is no base salary continuation. Compensation components for executive officers in the event of a qualifying long-term disability include partial stock award acceleration, prorata bonus payment, limited base salary continuation, payments for accrued base salary, limited Company-paid health insurance benefits, vested deferred compensation, and any accrued vacation and any accrued benefits under any plans of the Company in which the executive officer is a participant. Compensation components for executive officers in the event of termination by the Company without cause or termination by the executive officer due to constructive termination include payments for accrued base salary, cash compensation payments, partial stock award acceleration, limited Company-paid health 34 insurance benefits, vested deferred compensation, and any accrued vacation and any accrued benefits under any plans of the Company in which the executive officer is a participant. Eligibility for these benefits under either situation requires a signed release agreement by the executive officer. Compensation components for executive officers in the event of a termination by the Company without cause or termination by the executive officer due to constructive termination following a change-in-control include payments for accrued base salary, a cash compensation payment, cash compensation for the value of all outstanding stock awards, limited Company-paid health insurance benefits, vested deferred compensation, and any accrued vacation and any accrued benefits under any plans of the Company in which the executive officer is a participant. The change-in-control benefits also contain certain tax gross-up provisions. Eligibility for these benefits requires a signed release agreement by the executive officer. The compensation committee believes that in order to continue to retain the services of our key executive officers and focus their efforts on stockholder interests when considering strategic alternatives, it is important to provide them with enhanced income and benefit protection against loss of employment in connection with a change-in-control of our company and thereby align the interests of our stockholders and our executive officers. However, we do not provide for such benefits solely in the event of a change-in-control because we believe that our executives are materially harmed only if a change in control results in our executives’ involuntary loss of employment, reduced responsibilities, reduced compensation, or other adverse change in the nature of the employment relationship. Chief Executive Officer Compensation In January 2008, Dr. Gorman was promoted to President and Chief Executive Officer and his annualized base salary became $440,000 reflecting a 10% promotional increase over his 2007 base salary. Dr. Gorman’s new base salary was established based upon increased responsibilities and significantly similar to the Radford Survey data. Dr. Gorman’s current base salary is slightly below the median for the 2009 peer group. In February 2008, Dr. Gorman was awarded a one-time cash payment under the Retention Program in the amount of $240,000, 60% of which was paid immediately and 40% of which was paid in December 2008. This was the same payment schedule used in the Retention Program for all non-officer employees. In February 2008, Dr. Gorman was also awarded 125,000 RSUs and a stock option to purchase 45,000 shares under the Retention Program that ratably vest on an annual basis over three years. Due to the unmet goal of obtaining a partnership for our lead program, GnRH, the general downturn in the economy, and the need for the Company to conserve capital at this time, the Committee recommended, and the Board of Directors approved in January 2009, no change in Dr Gorman’s base salary for 2009, and no cash bonus or equity awards to Dr. Gorman for 2008 performance. In January 2008, Mr. Lyons and the Company’s Board of Directors reached mutual agreement that Mr. Lyons would no longer serve as the President and Chief Executive Officer of the Company, and Dr. Gorman was appointed President and Chief Executive Officer. For the remainder of the year, Mr. Lyons was compensated pursuant to the severance provisions in his employment agreement. Other Executive Officer Compensation The compensation of all other executive officers is reviewed annually as discussed above. In January 2008, Dr. O’Brien, Dr. Grigoriadis and Dr. Bozigian became executive officers of the Company. Base Salary Effective January 1, 2008, the executive officers’ annualized base salaries became as follows: $300,000 for Mr. Coughlin, $395,000 for Dr. Valeur-Jensen, $375,000 for Dr. O’Brien, and $285,000 for each of Dr. Grigoriadis and Dr. Bozigian. Mr. Coughlin’s annualized base salary was determined through a combina- tion of individual performance, initial success in the role of Chief Financial Officer and his prior annualized base salary being below the Company’s targeted range. Dr. Valeur-Jensen’s annualized base salary was determined through a combination of individual performance and her prior annualized base salary being near the top of the Company’s targeted range. Dr. O’Brien’s annualized base salary was determined through a 35 combination of individual performance, additional responsibilities in regulatory affairs and his prior annualized base salary being near the top of the Company’s targeted range. Both Dr. Bozigian and Dr. Griogriadis’ annualized base salaries were determined through a combination of individual performance and their prior annualized base salaries being at or below the Company’s targeted range. Due to the unmet goal of obtaining a partnership for our lead program, GnRH, the general downturn in the economy, and the desire of the Company to conserve capital at this time, the Committee recommended, and the Board of Directors approved in January 2009, no change in the executive officers’ base salary for 2009. Executive officer base salaries, as is, are within the peer group compensation parameters described in the Components of Compensation section above except for Mr. Coughlin, Dr. Grigoriadis and Dr. Bozigian whose base salaries are slightly below the 50th percentile. Retention Program Cash Payments. The Committee established the Retention Program as described in more detail above. As a result of the Retention Program, each executive officer, other than Dr. Grigoriadis, was awarded a one- time cash payment under the Retention Program, 60% of which was paid immediately and 40% of which was paid at the end of 2008, assuming the executive officer remained in good standing as an employee at such time. This is the same payment schedule was used in the Retention Program for all non-officer employees. Under the Retention Program, Mr. Coughlin received a total cash award of $138,000, Dr. Valeur-Jensen received a total cash award of $190,000, Dr. O’Brien received a total cash award of $140,000, and Dr. Bozigian received a total cash award of $104,000 in each case in accordance with the payment schedule described above. Dr. Grigoriadis was not awarded a cash retention payment as the Company had agreed to forgive a loan to Dr. Grigoriadis which the Committee determined would make his additional participation in the Retention Program inappropriate. In 2001, the Company and Dr. Grigoriadis entered into a loan agreement pursuant to which the Company provided a home loan in the principal amount of $230,000 to Dr. Grigoriadis secured by the real property and Dr. Grigoriadis’ Company stock. Due to the prohibition on loans to executive officers under the Sarbanes-Oxley Act, prior to his promotion to an executive officer of the Company, Dr. Grigoriadis was given the option of repaying the loan in full and participating in the Retention Program at the officer level or foregoing participation in the Retention Program as a result of the forgiveness of the loan. Dr. Grigoriadis elected to forego participation in the Retention Program and the loan was forgiven prior to his promotion on January 10, 2008. Long-Term Incentives. Long-term incentives are awarded to individuals to align the sharing of value creation between stockholders and executive officers. Long-term incentive awards are also used as a key retention and motivational tool. In February 2008, the Committee implemented the Retention Program and awarded the following long-term incentive grants: Dr. Valeur-Jensen, Mr. Coughlin, Dr. O’Brien, Dr. Grigoriadis, and Dr. Bozigian were each granted 100,000 RSUs and a stock option to purchase 30,000 shares. The Committee awarded long-term incentives that were within the compensation parameters described in the Components of Compensation section above. In addition, the mix of the awards was heavily weighted in favor of RSUs over stock options, which the Committee believes reinforces retention of the executive. These RSUs and stock option awards vest ratably on an annual basis over three years. The exercise price of the stock options was $5.12 based on the closing price of the Company’s common stock on the date of grant. Cash Bonuses and Equity Awards Due to the unmet goal of obtaining a partnership for our lead program, GnRH, and the desire of the Company to conserve capital at this time, the Committee recommended, and the Board of Directors approved in January 2009, no performance cash bonuses or equity awards to any of the executive officers for 2008 performance. Rising or falling stock prices had no bearing on 2008 equity and bonus awards as none were given. 36 Deferred Compensation Plan For each year of the NQDC Plan, the Company may, but is not required to, make contributions to any of the executive officers’ NQDC plan accounts. During 2008, the Company did not make any such contributions. Two executive officers elected to make voluntary contributions to the NQDC Plan during 2008 as described in the Nonqualified Deferred Compensation Table below. Tax Considerations Internal Revenue Code Section 162(m) The Committee considers the potential impact under Internal Revenue Code Section 162(m) whereby we can only deduct up to $1.0 million of the compensation we pay to named executive officers each taxable year unless such compensation is “performance-based compensation” within the meaning of the Internal Revenue Code. The Committee has determined that any gain related to the exercise of a stock option granted under any of our stockholder-approved stock option plans with an exercise price at least equal to the fair value of our common stock on the date of grant qualifies under the Internal Revenue Code as performance-based compensation and therefore is not subject to the $1.0 million limitation. However, deductibility is not the sole factor used by the committee in ascertaining appropriate levels or manner of compensation and corporate objectives may not necessarily align with the requirements for full deductibility under Section 162(m). Accordingly, we may enter into executive compensation arrangements under which payments are not deductible under Section 162(m). Internal Revenue Code Section 409A Section 409A of the Internal Revenue Code governs deferred compensation arrangements. The Committee reviewed our deferred compensation programs with the assistance of our counsel to ensure the programs are compliant with Section 409A and has determined the programs are compliant within the meaning of Internal Revenue Code Section 409A. COMPENSATION COMMITTEE REPORT The Compensation Committee of the Company has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this Proxy Statement. Respectfully submitted by: COMPENSATION COMMITTEE Richard F. Pops Stephen A. Sherwin, M.D. Wylie W. Vale, Ph.D. 37 Compensation Committee interlocks and insider participation During 2008, the Compensation Committee consisted of Richard F. Pops, Stephen A. Sherwin, M.D. and Wylie W. Vale, Ph.D., who became a member of the Compensation Committee in February 2008. No interlocking relationship exists between any current member of the Compensation Committee and any member of any other company’s Board of Directors or compensation committee. EXECUTIVE COMPENSATION AND OTHER INFORMATION Summary Compensation Table. The following table sets forth the compensation paid by the Company for the fiscal years ended December 31, 2006, 2007 and 2008 to the current and former executive officers named below (the “Named Executive Officers”). Bonus amounts for 2008 were earned under a retention program as discussed above. All other years’ bonus awards represent traditional annual performance bonuses: Summary Compensation Table Salary (2) Year Bonus (2) Stock Awards (3) Option Awards (4) Name and Title(1) Kevin C. Gorman, Ph.D. President and Chief Executive Officer $ 102,056 . . . . . . . . . . 2006 $339,792(6) $ 2007 $400,000(7) $ $ 258,885 2008 $440,000(8) $240,000(8) $ 431,578 — — Vice President and Chief Financial Officer Timothy P. Coughlin . . . . . . . . . . . . . 2006 $220,500(9) $ 75,000 — $137,500 $115,000 — 2007 $275,000(10) $ 2008 $300,000 . . . 2006 $348,125 $ $ 221,173 $ 363,396 $ 95,162 2007 $380,000(11) $ $ 238,547 2008 $395,000(12) $190,000(12) $ 376,956 $ 321,789 Executive Vice President, General Counsel and Secretary Margaret Valeur-Jensen, J.D., Ph.D. Christopher F. O’Brien, M.D. . . . . . . . 2008 $375,000 $140,000 All Other (5) $ 7,726 $ 18,082 $ 30,471 $ 6,863 $ 10,131 $ 22,853 $ 8,611 $ 21,616 $ 26,109 $ 18,004 Total Compensation $ 847,082 $1,189,610 $1,519,487 $ 434,783 $ 775,015 $1,106,772 $ 942,186 $1,117,404 $1,350,780 $ 926,837 $ 397,508 $ 512,643 $ 377,438 — $ 132,420 $ 268,711 $ 283,023 $ 375,288 $ 477,241 $ 362,715 72,044 $ Senior Vice President, Clinical Development and Chief Medical Officer Dimitri E. Grigoriadis, Ph.D. Vice President of Research . . . . . . . 2008 $285,000 $ — $ 267,289 Haig P. Bozigian, Ph.D. . . . . . . . . . . . 2008 $285,000 $104,000 $ 268,339 $ $ 71,536 $251,124 $ 874,949 91,669 $ 21,124 $ 770,132 Senior Vice President, Pharmaceutical and Preclinical Development Gary A. Lyons . . . . . . . . . . . . . . . . . 2006 $600,000 2007 $600,000 2008 $125,000 Former President and Chief Executive Officer $ $ $ — — — $1,237,365 $ $ $1,642,833 — $ 134,087 — $ 297,970 $ 10,470 $ 31,279 $850,680 $3,490,668 $ 765,366 $1,273,650 (1) The titles and capacities set forth in the table above are as of the Record Date. During 2007, Mr. Lyons served as the Company’s President and Chief Executive Officer and Dr. Gorman served as the Company’s Executive Vice President and Chief Operating Officer. On January 10, 2008, Mr. Lyons and the Compa- ny’s Board of Directors reached mutual agreement that Mr. Lyons would no longer serve as the President and Chief Executive Officer of the Company, and Dr. Gorman was appointed President and Chief Execu- tive Officer. Mr. Coughlin and Dr. Gorman became the Chief Financial Officer and Chief Operating Offi- cer, respectively, on September 18, 2006. Drs. O’Brien, Grigoriadis and Bozigian were named to their current positions in January 2008, and Securities and Exchange Commission rules do not require their compensation for prior years to be reported. (2) Salary and bonus figures represent amounts earned during each respective fiscal year, regardless of whether part or all of such amounts were paid in subsequent fiscal year(s). Bonuses earned for 2006 and 2007 were based on performance for the year. Bonuses earned for 2008 were awarded pursuant to the Retention Program. (3) Stock awards granted to executive officers consist of restricted stock units and stock bonuses and may be subject to deferred delivery arrangements. The amounts shown are the share-based compensation costs recognized in accordance with SFAS 123R during the applicable fiscal year for stock awards vested 38 during the applicable year. The assumptions used to calculate the value of stock awards are set forth under Note 8 of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC on February 4, 2009. The grant date fair values of stock awards for 2006, 2007 and 2008 are based on per share prices of $10.17, $11.44 and $5.12 respectively. (4) The amounts shown are the compensation costs recognized in accordance with SFAS 123R during the applicable fiscal year for any option awards vested during the applicable year. The assumptions used to calculate the value of stock awards are set forth under Note 8 of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC on February 4, 2009. The grant date fair values of option awards for 2006, 2007 and 2008 are based on per share Black-Scholes values of $21.41, $6.64 and $2.93, respectively (except for 2007 awards to Gary A. Lyons which were based on a per share Black-Scholes value of $6.31). (5) Includes all other compensation as described in the table below. (6) Of this amount, Dr. Gorman deferred the receipt of $84,948 under the NQDC Plan. (7) Of this amount, Dr. Gorman deferred the receipt of $140,000 under the NQDC Plan (8) Of these amounts, Dr. Gorman deferred the receipt of $88,000 in salary and $36,000 in bonus under the NQDC Plan, as also reported in the Nonqualified Deferred Compensation Table below. (9) Of this amount, Mr. Coughlin deferred the receipt of $11,025 under the NQDC Plan. (10) Of this amount, Mr. Coughlin deferred the receipt of $13,750 under the NQDC Plan. (11) Of this amount, Dr. Valeur-Jensen deferred the receipt of $76,000 under the NQDC Plan. (12) Of these amounts, Dr. Valeur-Jensen deferred the receipt of $79,000 in salary and $112,347 in bonus under the NQDC Plan, as also reported in the Nonqualified Deferred Compensation Table below. All Other Compensation Table Name Kevin C. Gorman, Ph.D. . . . . . Timothy P. Coughlin . . . . . . . . Margaret Valeur-Jensen, Ph.D. . . Christopher F. O’Brien, M.D. . . Dimitri E. Grigoriadis, Ph.D. . . . Year 2006 2007 2008 2006 2007 2008 2006 2007 2008 2008 2008 Haig P. Bozigian, Ph.D. . . . . . . 2008 Gary A. Lyons . . . . . . . . . . . . 2006 2007 2008 401(k) Employer Match Insurance Premiums (1) Stock Option Cancellation Fee (2) Annual Medical Exam Loan Forgiveness Severance Total Other $6,600 $6,750 $6,900 $6,396 $6,750 $6,900 $6,600 $6,750 $6,900 $6,900 $6,900 $6,900 $6,600 $6,750 $2,135 $ 1,126 $11,232 $23,571 $ 467 $ 2,275 $15,953 $ 1,153 $10,238 $19,209 $11,104 $14,224 $14,224 $ 3,870 $24,429 $ 3,613 $ — $100 $ — $ — $ — $ — $ — $100 $ — $ — $ — $ — $ — $100 $ — $ — $ $ — $ $ — $ $ — $ $1,106 $ $ — $ $ $ 858 $4,528 $ $ — $ — $ — $ — $ — $ — $ — $ — $ — $ — $ $ — $ $ — $230,000 — $ $ 7,726 — $ — $ 18,082 — $ 30,471 — $ 6,863 — $ 10,131 — $ 22,853 — $ 8,611 — $ 21,616 — $ 26,109 — $ 18,004 — $251,124 $ — $ — $ — $ 21,124 $ — $ $ — $ $ — $ — $ — $ — $844,932 — $ 10,470 — $ 31,279 $850,680 (1) The amounts in this column represent the costs for insurance premiums and related tax gross-up amounts. (2) The amounts in this column represent nominal payments made to the named executive in exchange for the cancellation of certain stock options previously granted by the Company. 39 Grant of Plan-Based Awards Table. The following table sets forth certain information regarding stock and option awards granted by the Company pursuant to the 2003 Plan during the year ended December 31, 2008 to the Named Executive Officers below: Grants of Plan-Based Awards Table All Other Stock Awards: No. of Shares or Units Grant Date (1) All Other Option Awards: No. of Securities Underlying Options Exercise or Base Price of Option Awards (1) Grant Date Fair Value of Stock and Option Awards (2) Name Kevin C. Gorman, Ph.D. . . . . . 02/27/2008 02/27/2008 Timothy P. Coughlin . . . . . . . . 02/27/2008 02/27/2008 Margaret Valeur- Jensen, J.D., Ph.D. Christopher F. . . . . . . . 02/27/2008 02/27/2008 O’Brien, M.D. . . . . . . . . . . 02/27/2008 02/27/2008 Dimitri E. Grigoriadis, Ph.D. . . 02/27/2008 02/27/2008 . . . . . 02/27/2008 02/27/2008 N/A Gary Lyons . . . . . . . . . . . . . . Haig P. Bozigian, Ph.D. 125,000 — 100,000 — 100,000 — 100,000 — 100,000 — 100,000 — N/A — 45,000 — 30,000 — 30,000 — 30,000 — 30,000 — 30,000 N/A $5.12 $5.12 $5.12 $5.12 $5.12 $5.12 $5.12 $5.12 $5.12 $5.12 $5.12 $5.12 N/A $640,000 $131,850 $512,000 $ 87,900 $512,000 $ 87,900 $512,000 $ 87,900 $512,000 $ 87,900 $512,000 $ 87,900 N/A (1) All options and awards were granted and approved on the same date with an exercise price equal to the closing market price of the Company’s common stock on date of grant. All option awards are time-based awards, which vest annually over three years and have an option term of seven years. (2) Reflects the grant date per share Black-Scholes value of $2.93 for option awards and the grant date per share value of $5.12 for stock awards granted on February 27, 2008 which was calculated in accordance with SFAS 123R. To assist in understanding the data in the tables above, the following is a description of the employment agreements currently in place between the Company and the Named Executive Officers: Agreements with Named Executive Officers Kevin C. Gorman, Ph.D. has an employment contract that provides that: (i) Dr. Gorman will serve as the Company’s Executive Vice President and Chief Operating Officer commencing on August 1, 2007 at an initial annual salary of $400,000, subject to annual adjustment by the Board of Directors (subsequent to entering into the employment contract, Dr. Gorman was promoted to President and Chief Executive Officer and his annual salary was increased to $440,000); (ii) the agreement terminates upon death, disability, termination by the Company with or without cause, constructive termination or voluntary resignation; (iii) Dr. Gorman is eligible for a discretionary annual bonus as determined by the Board of Directors, based upon achieving certain performance criteria; and (iv) each year starting in 2007 and continuing for the term of the agreement, Dr. Gorman will be eligible to receive stock option awards with the number of shares and exercise price as shall be determined by the Board of Directors. Timothy P. Coughlin has an employment contract that provides that: (i) Mr. Coughlin will serve as the Company’s Vice President and Chief Financial Officer commencing on August 1, 2007 at an initial annual salary of $275,000, subject to annual adjustment by the Board of Directors (subsequent to entering into the employment contract, Mr. Coughlin’s annual base salary was increased to $300,000); (ii) the agreement terminates upon death, disability, termination by the Company with or without cause, constructive termination or voluntary resignation; (iii) Mr. Coughlin is eligible for a discretionary annual bonus as determined by the 40 Board of Directors, based upon achieving certain performance criteria; and (iv) each year starting in 2007 and continuing for the term of the agreement, Mr. Coughlin will be eligible to receive stock option awards with the number of shares and exercise price as shall be determined by the Board of Directors. Margaret E. Valeur-Jensen, J.D., Ph.D. has an employment contract that provides that: (i) Dr. Valeur-Jensen will serve as the Company’s Executive Vice President, General Counsel and Corporate Secretary commencing on August 1, 2007 at an initial annual salary of $380,000, subject to annual adjustment by the Board of Directors (subsequent to entering into the employment contract, Dr. Valeur-Jensen’s annual base salary was increased to $395,000); (ii) the agreement terminates upon death, disability, termination by the Company with or without cause, constructive termination or voluntary resignation; (iii) Dr. Valeur-Jensen is eligible for a discretionary annual bonus as determined by the Board of Directors, based upon achieving certain performance criteria; and (iv) Dr. Valeur- Jensen is eligible to receive stock option awards with the number of shares and exercise price as shall be determined by the Board of Directors. Christopher F. O’Brien, M.D. has an employment contract that provides that:(i) Dr. O’Brien will serve as the Company’s Senior Vice President, Clinical Development and Chief Medical Officer commencing on August 1, 2007 at an initial annual salary of $350,000, subject to annual adjustment by the Board of Directors (subsequent to entering into the employment contract, Dr. O’Brien’s annual base salary was increased to $375,000); (ii) the agreement terminates upon death, disability, termination by the Company with or without cause, constructive termination or voluntary resignation; (iii) Dr. O’Brien is eligible for a discretionary annual bonus as determined by the Board of Directors, based upon achieving certain performance criteria; and (iv) Dr. O’Brien is eligible to receive stock option awards with the number of shares and exercise price as shall be determined by the Board of Directors. Dimitri E. Grigoriadis, Ph.D. has an employment contract that provides that: (i) Dr. Grigoriadis will serve as the Company’s Vice President, Research commencing on August 1, 2007 at an initial annual salary of $260,000, subject to annual adjustment by the Board of Directors (subsequent to entering into the employment contract, Dr. Grigoriadis’ annual base salary was increased to $285,000); (ii) the agreement terminates upon death, disability, termination by the Company with or without cause, constructive termination or voluntary resignation; (iii) Dr. Grigoriadis is eligible for a discretionary annual bonus as determined by the Board of Directors, based upon achieving certain performance criteria; and (iv) Dr. Grigoriadis is eligible to receive stock option awards with the number of shares and exercise price as shall be determined by the Board of Directors. Haig P. Bozigian, Ph.D. has an employment contract that provides that: (i) Dr. Bozigian will serve as the Company’s Senior Vice President, Pharmaceutical and Preclinical Development commencing on August 1, 2007 at an initial annual salary of $260,000, subject to annual adjustment by the Board of Directors (subsequent to entering into the employment contract, Dr. Bozigian’s annual base salary was increased to $285,000); (ii) the agreement terminates upon death, disability, termination by the Company with or without cause, constructive termination or voluntary resignation; (iii) Dr. Bozigian is eligible for a discretionary annual bonus as determined by the Board of Directors, based upon achieving certain performance criteria; and (iv) Dr. Bozigian is eligible to receive stock option awards with the number of shares and exercise price as shall be determined by the Board of Directors. Gary A. Lyons and the Company’s Board of Directors reached a mutual agreement that Mr. Lyons would no longer serve as the President and Chief Executive Officer of the Company effective January 10, 2008. In connection with his departure, Mr. Lyons is receiving severance benefits substantially in accordance with Section 6.5 of his prior employment contract with the Company, which required payment of 2 times the amount of his annual base salary and target annual bonus to be paid equally over 24 months, an acceleration of unvested shares that would have vested during the 24 subsequent months after the date of termination, and payment of COBRA benefits for a period of 24 months following termination. Mr. Lyons continues to serve as a member of the Board of Directors of the Company. Option Cancellation Agreements. On October 24, 2007, the Company entered into Stock Option Cancellation Agreements with certain of the Company’s executive officers and directors, pursuant to which certain stock options with exercise prices in excess of $50.00, previously granted to each such executive 41 officer or director were cancelled in exchange for a nominal payment by the Company of $100 in the aggregate. The Stock Option Cancellation Agreements indicated that other than such nominal payment, the applicable executive officer or director had not received, and would not receive, any additional consideration in exchange for the cancellation of such options. Accordingly, while each such executive officer or director will be eligible to receive future equity grants in connection with the Company’s regular grant practices, no such executive officer or director will receive any future equity award in exchange for the cancellation of such options. Outstanding Equity Awards. The following table sets forth the outstanding equity awards held by the Named Executive Officers at December 31, 2008: Outstanding Equity Awards at Fiscal Year End Table Name Kevin C. Gorman, Ph.D. . . . . . . . . . KCG Family Trust (6) . . . . . . . . . . Timothy P. Coughlin . . . . . . . . . . . Margaret Valeur-Jensen, J.D., Ph.D. . . Christopher F. O’Brien M.D. . . . . . . Option Awards Stock Awards Award Grant and Commencement of Vesting Date Number of Securities Underlying Unexercised Options Exercisable Number of Securities Underlying Unexercised Options Unexercisable Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options Number of Shares or Units of Stock That Have Not Vested (1) Market Value of Shares or Units of Stock That Have Not Vested (1) Option Exercise Price Option Expiration Date 06/01/1999 04/06/2000 04/18/2001 05/24/2001 02/07/2002 05/22/2003 02/18/2005 01/19/2006 01/11/2007 01/11/2007 02/27/2008 02/27/2008 04/06/2000 09/30/2002 07/23/2004 10/20/2004 10/21/2004 09/20/2005 01/11/2007 01/11/2007 02/27/2008 02/27/2008 02/22/2000 04/18/2001 05/24/2001 02/07/2002 05/22/2003 02/18/2005 01/19/2006 01/19/2006 01/11/2007 01/11/2007 02/27/2008 02/27/2008 10/31/2005 09/26/2006 11/14/2006 01/03/2007 02/27/2008 02/27/2008 — — — — — — — — — — — — — — — — 100(8) — — — — — — — — — — — — — — — — — — — — — — — 15,000(2) 17,144(2) 10,000(2) 20,000(2) 35,000(2) 40,000(2) 23,957(2) — 36,000(5) — — — 30,006(2) 11,000(7) 3,750(2) 4,000(2) — 2,031(2) 33,333(5) — — — 20,000(2) 5,000(2) 12,500(2) 18,229(2) 23,698(2) 21,353(2) 8,500(2) — 33,333(5) — — — — — — — — — 1,043 — 72,000(5) — 45,000(5) — — — — — — 469(2) 66,667(5) — 30,000(5) — — — — — — 1,043(2) — — 66,667(5) — 30,000(5) — 55,000(3)(7) — — 9,167(5) — 30,000(5) — — 18,333(5) — — — 42 $ 4.88 06/01/2009 $19.44 04/06/2010 $24.33 04/18/2011 $35.14 05/24/2011 $36.79 02/07/2012 $48.51 05/22/2013 $40.39 02/18/2015 — $11.44 01/11/2014 — $ 5.12 02/27/2015 $19.44 04/06/2010 $41.00 09/30/2012 $44.70 07/23/2014 $45.04 10/20/2014 $44.77 10/21/2014 $47.88 09/20/2015 $11.44 01/11/2014 $ 5.12 02/27/2015 — — — — $34.50 02/22/2010 $24.33 04/18/2011 $35.14 05/24/2011 $36.79 02/07/2012 $48.51 05/22/2013 $40.39 02/18/2015 $60.95 01/19/2013 — $11.44 01/11/2014 — $ 5.12 02/27/2015 $52.82 10/31/2015 $ 8.92 11/14/2013 — $ 5.12 02/27/2015 — — — — — — — — — — — — — — — — — — — 358 112(4) $ — — — 42,000(5) $134,400 — — — 125,000(5) $400,000 — — — — — — — — — — — — — — — 38,667(5) $123,734 — — — 100,000(5) $320,000 — — — — — — — — — — — — — — 358 112(4) $ — — — 38,667(5) $123,734 — — — 100,000(5) $320,000 — — — 13,334(5) $ 42,669 — — 6,667(5) $ 21,334 — — — 100,000(5) $320,000 Option Awards Stock Awards Award Grant and Commencement of Vesting Date Number of Securities Underlying Unexercised Options Exercisable Number of Securities Underlying Unexercised Options Unexercisable Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options Number of Shares or Units of Stock That Have Not Vested (1) Market Value of Shares or Units of Stock That Have Not Vested (1) Option Exercise Price Option Expiration Date 06/01/1999 09/26/2006 09/26/2006 09/26/2006 09/26/2006 09/26/2006 09/26/2006 09/26/2006 01/03/2007 02/27/2008 02/27/2008 03/02/1999 06/01/1999 08/16/1999 04/03/2000 03/22/2001 09/26/2006 09/26/2006 09/26/2006 09/26/2006 09/26/2006 01/03/2007 02/27/2008 02/27/2008 03/02/1999 02/22/2000 04/18/2001 05/24/2001 02/07/2002 05/22/2003 05/26/2004 02/18/2005 01/19/2006 03/16/2007 03/16/2007 03/02/1999 02/22/2000 04/18/2001 05/24/2001 — 4,000(2) 313(5) 624(5) 1,579(5) 3,158(5) 1,250(5) 2,500(5) 1,042(5) 2,083(5) 1,084(5) 2,166(5) — — 3,375(5) 6,750(5) — — 30,000(5) — — — — 1,559(2) — 605(2) — 376(2) — 526(2) — 792(2) 2,709(5) 5,416(5) 834(5) 1,666(5) — — 625(5) 1,250(5) 2,834(5) 5,666(5) — — 30,000(5) — — — — 15,627(2) — 4,676(2) — 2,409(2) — 2,188(2) — 125,000(2) 110,000(2) — 50,000(2)(3) — 75,000(2)(9) — 30,000(2) — 56,666(10) 28,334(11) — 7,292(2) 85,324(2) 7,591(2) 87,812(2) — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — $ 4.88 06/01/2009 $10.90 07/23/2013 $10.90 09/26/2013 $10.90 06/22/2010 $10.90 06/26/2011 $10.90 07/05/2012 — $10.90 09/05/2012 — $ 5.12 02/27/2015 — — $ 5.38 03/02/2009 $ 4.88 06/01/2009 $ 4.13 08/16/2009 $21.00 04/03/2010 $15.81 03/22/2011 $10.90 09/05/2012 $10.90 03/21/2012 $10.90 04/21/2013 $10.90 09/26/2013 — $ 5.12 02/27/2015 — — — — $ 5.38 03/02/2009 $34.50 02/22/2010 $24.33 04/18/2011 $35.14 05/24/2011 $36.79 02/07/2012 $48.51 05/22/2013 $57.51 05/26/2014 $40.39 02/18/2015 $60.95 01/19/2013 $10.98 03/16/2014 — $ 5.38 03/02/2009 $34.50 02/22/2010 $24.33 04/18/2011 $35.14 05/24/2011 — — — — — — — — — — — — — 8,334(5) $ 26,669 — 6,667(5) $ 21,334 — — — 100,000(5) $320,000 — — — — — — — — — — — — — — — 10,000(5) $ 32,000 — — — — 3,334(5) $ 10,669 — — — 100,000(5) $320,000 — — — — — — — — — — — — — — — — — — — — — 85,000(8) $272,000 — — — — — — — — Name Dimitri E. Grigoriadis, Ph.D. . . . . . . Haig P. Bozigian, Ph.D. . . . . . . . . . Gary A. Lyons . . . . . . . . . . . . . . . GEL Family LLC (6) . . . . . . . . . . . (1) Stock awards granted to executive officers consist of RSUs and restricted stock, which are subject to deferred delivery arrangements. The market value of RSUs and restricted stock that have not vested is derived by multiplying the num- ber of RSUs and restricted stock that have not vested as of December 31, 2008 by $3.20, the closing price of the Company’s common stock on December 31, 2008. (2) Vests monthly over four years. (3) On November 7, 2005, the Company accelerated vesting on all unvested stock options to purchase shares of common stock that were held by then-current employees and had an exercise price per share equal to or greater than $50.00. The acceleration of these stock options was undertaken to eliminate the future compensation expense associated with the adoption of SFAS 123R in the Company’s consolidated statements of operations. (4) Vests monthly over three years. (5) Vests annually over three years. (6) As of December 31, 2008 these options were held by limited liability companies formed by the executive officer listed immediately above the limited liability company for estate planning purposes. (7) Vests monthly over four years, subject to an initial one-year “cliff”. (8) Vests 50% upon FDA approval of indiplon and 50% upon commercialization of indiplon. 43 (9) Options are subject to accelerated vesting provisions based on certain years of service and age upon retirement. Mr. Lyons satisfied these requirements in April 2007. (10) Options are subject to accelerated vesting provisions based on severance arrangements. (11) Options are not subject to accelerated vesting provisions. These options will vest on the 3rd anniversary of the grant date. Nonqualified Deferred Compensation. The following table sets forth information regarding the compen- sation deferred into the Company’s NQDC Plan in the fiscal year ended December 31, 2008 by the Named Executive Officers: Nonqualified Deferred Compensation Table Name Kevin C. Gorman, Ph.D. . . . . . . . . . . . . . Timothy P. Coughlin . . . . . . . . . . . . . . . . Margaret Valeur- Jensen, J.D., Ph.D. . . . . . . . . . . . . . Christopher F. O’Brien, M.D. Dimitri E. Grigoriadis, Ph.D. . . . . . . . . . . . . . . . . . . . . . . Haig P. Bozigian, Ph.D. Gary A. Lyons . . . . . . . . . . . . . . . . . . . . Year 2008 2008 2008 2008 2008 2008 2008 Executive Contributions in Last FY (1) Aggregate Earnings/(Losses) in Last FY $124,000 — $191,347 — — — — $(282,565) $ (9,132) $(236,105) $ (28,743) — (335) $ $(823,075) Aggregate Balance at Last FYE (2) $ 575,047 17,629 $ $ 522,047 55,486 $ — 800 $ $1,433,703 (1) Consists of cash contributions from salary and/or bonus payments paid by the Company in 2008. (2) Aggregate balance includes the value of stock based awards subject to future vesting for all Named Executive Officers who contributed stock based awards to the NQDC Plan. Under the terms of the NQDC Plan, executive officers are eligible to defer base salary, bonus and/or special equity awards, such as RSUs. Generally, elections must be made by December 31 of each preceding year and are irrevocable once made. Because the Company expects to incur liabilities under the terms of the NQDC Plan, the Company elected, but was not required to, establish a rabbi trust with the intention to make contributions to the trust to provide a source of funds to assist in meeting its potential liabilities under the terms of the NQDC Plan. Upon receipt of an eligible participant’s deferral election, the Company maintains a bookkeeping account on behalf of such participant. Benefits are paid to participants based on an elected payout schedule over a period of up to 15 years that may commence on an elected specified date, or if earlier, upon separation from service. Upon death or termination for cause, funds are paid out within 60 days following the event. Funds may also be withdrawn for hardship under some circumstances. Executive officers’ accounts under the NQDC Plan are credited with deferrals made by him or her, and are thereafter adjusted to record earnings and losses matching the performance of various phantom investment options selected by the executive officer. All cash deferrals are 100% vested upon contribution. All equity award contributions vest according to the terms of the individual award. 44 Option Exercises and Stock Vested. The following table sets forth stock awards that vested during fiscal 2008 along with their respective values at December 31, 2008 for the Named Executive Officers: Option Exercises and Stock Vested Table Name Kevin C. Gorman, Ph.D. . . . . . . . . . . . . . . Timothy P. Coughlin. . . . . . . . . . . . . . . . . . Margaret Valeur- Jensen, J.D., Ph.D. . . . . . . . . . . . . . . . . . Christopher F. O’Brien, M.D. . . . . . . . . . . . Dimitri E. Grigoriadis, Ph.D. Haig P. Bozigian, Ph.D. . . . . . . . . . . . . . . . Gary A. Lyons . . . . . . . . . . . . . . . . . . . . . . Option Awards (1) Stock Awards (2) Number of Shares Acquired on Exercise Value Realized on Exercise Number of Shares Acquired on Vesting Value Realized on Vesting (3) — — — — — — — $ — $ — $ — $ — $ — $ — $ — 22,459 19,333 20,760 16,666 11,666 11,682 7,474 $117,482 $101,885 $108,536 $ 81,097 $ 56,347 $ 57,127 $ 38,694 (1) There were no stock option exercises by the Named Executive Officers during 2008. (2) Information relates to stock awards, which consist of RSUs and restricted stock that vested during 2008. (3) Calculated by multiplying the number of shares acquired on vesting during fiscal 2008 by the closing price of the Company’s common stock at the vesting date. Potential Payments Upon Termination or Change-in-Control. The following tables set forth the potential severance benefits payable to the Named Executive Officers (excluding Gary A. Lyons, who was no longer employed by the Company as of December 31, 2008) in the event of a termination prior to or following a change in control, assuming such event occurred on December 31, 2008. As previously noted in the discussion that follows the “Nonqualified Deferred Compensation Table,” our Named Executive Officers may receive payments under our NQDC Plan in the event of termination of employment, based on an elected payout schedule of up to 15 years. Payout amounts under our NQDC Plan are additional to those set forth in the following table: Potential Payment upon Termination Table* Name Salary (1) Bonus (2) Accrued Compensation (3) Stock Awards (4) Medical (5) Total Kevin C. Gorman, Ph.D. . . . . . . . . $550,000 $330,000 Timothy P. Coughlin . . . . . . . . . . . $375,000 $187,500 Margaret Valeur- Jensen, J.D., Ph.D. . . . . . . . . . . $493,750 $246,875 Christopher F. O’Brien, M.D. . . . . . $375,000 $187,500 Dimitri E. Grigoriadis, Ph.D. . . . . . $285,000 $142,500 Haig P. Bozigian, Ph.D. . . . . . . . . . $285,000 $142,500 $62,336 $31,477 $56,513 $32,135 $34,255 $28,817 $401,066 $337,066 $25,092 $24,792 $1,368,494 $ 955,835 $337,066 $160,000 $144,000 $144,000 $15,709 $14,237 $16,332 $16,332 $1,149,913 $ 768,872 $ 622,087 $ 616,649 * Reflects a termination without cause or due to a constructive termination, or deemed termination, prior to a change in control. (1) Based on salary as of December 31, 2008. (2) Based on bonus targets established by the Board of Directors for 2008. (3) Accrued compensation is comprised of vacation pay earned and unpaid as of December 31, 2008 and a one-time additional two week vacation benefit for eligible employees. (4) All options held by the Named Executive Officers at December 31, 2008 had an exercise price greater than the Company’s closing price of its common stock at December 31, 2008. Therefore, using the intrinsic method or cash value method to calculate the expense associated with accelerating options results in $0 under both 45 calculations. The amounts in this column represent the market value of unvested restricted stock units as of December 31, 2008 that would vest in accordance with the executive officers’ employment agreements. Restricted stock unit values were derived using the closing market price on December 31, 2008 of $3.20. (5) Medical is comprised of health insurance premiums for the period specified in each executive officer’s employ- ment contract. Potential Payment upon Change-in-Control Table* Name Severance (1) Bonus (2) Kevin C. Gorman, Ph.D. . . . . . Timothy P. Coughlin . . . . . . . . $880,000 $600,000 $528,000 $300,000 Margaret Valeur- Jensen, J.D., Ph.D. . . . . . . . Christopher F. O’Brien, M.D. . . Dimitri E. Grigoriadis, Ph.D. Haig P. Bozigian, Ph.D. . . . . . . . $790,000 $562,500 $427,500 $427,500 $395,000 $281,250 $213,750 $213,750 Accrued Compensation (3) Stock Awards (4) Medical (5) Statutory Tax Gross-up (6) Total $62,336 $31,477 $56,513 $32,135 $34,255 $28,817 $534,400 $443,734 $40,147 $39,667 $673,536 $2,718,419 $403,867 $1,818,745 $443,734 $384,003 $368,003 $362,669 $25,134 $21,356 $24,497 $24,497 $500,814 $2,211,195 $ $ $ — $1,281,244 — $1,068,005 — $1,057,233 * Reflects benefits to be provided upon a termination without cause, or constructive termination, within a specified time following a change in control. (1) Based on salary as of December 31, 2008. (2) Based on bonus targets established by the Board of Directors for 2008. (3) Accrued compensation is comprised of vacation pay earned and unpaid as of December 31, 2008 and a one-time additional two week vacation benefit for eligible employees. (4) All options held by the Named Executive Officers at December 31, 2008 had an exercise price greater than the Company’s closing price of its common stock at December 31, 2008. Therefore, using the intrinsic method or cash value method to calculate the expense associated with accelerating options results in $0 under both calcula- tions. The amounts in this column represent the market value of unvested restricted stock units as of Decem- ber 31, 2008 that would be paid to the Named Executive Officer in accordance with the executive officers’ employment agreements. Restricted stock unit values were derived using the closing market price on Decem- ber 31, 2008 of $3.20. (5) Medical is comprised of health insurance premiums for the period specified in each executive officer’s employ- ment contract. (6) Tax gross-up if total payments exceed 2.99 times base amount by 15% or more. Potential Payment upon Termination by Disability Table* Name Kevin C. Gorman, Ph.D. . . . . . . Timothy P. Coughlin . . . . . . . . . Margaret Valeur- Jensen, J.D., Ph.D. . . . . . . . . Christopher F. O’Brien, M.D. . . Dimitri E. Grigoriadis, Ph.D. . . . . . . . . . Haig P. Bozigian, Ph.D. Base Salary (1) Bonus (2) $550,000 $375,000 $264,000 $150,000 $493,750 $375,000 $285,000 $285,000 $197,500 $187,500 $142,500 $142,500 Accrued Compensation (3) Stock Awards (4) Medical (5) Total $62,336 $31,477 $56,513 $32,135 $34,255 $28,817 $401,066 $337,066 $25,092 $24,792 $1,302,493 $ 918,335 $337,066 $160,000 $144,000 $144,000 $15,709 $14,237 $16,332 $16,332 $1,100,538 $ 768,872 $ 622,087 $ 616,649 * Reflects a termination due to disability. (1) Based on salary as of December 31, 2008. (2) Based on bonus targets established by the Board of Directors for 2008. (3) Accrued compensation is comprised of vacation pay earned and unpaid as of December 31, 2008 and one-time additional two week vacation benefit for eligible employees. 46 (4) All options held by the Named Executive Officers at December 31, 2008 had an exercise price greater than the Company’s closing price of its common stock at December 31, 2008. Therefore, using the intrinsic method or cash value method to calculate the expense associated with accelerating options results in $0 under both calcula- tions. The amounts in this column represent the market value of unvested restricted stock units as of Decem- ber 31, 2008 that would vest in accordance with the Named Executive Officers’ employment agreements. Restricted stock unit values were derived using the closing market price on December 31, 2008 of $3.20. (5) Medical is comprised of health insurance premiums for the period specified in each executive officer’s employ- ment contract. Potential Payment upon Termination by Death* Name . . . . . . . . . . . . . . . . . . . Kevin C. Gorman, Ph.D. Timothy P. Coughlin . . . . . . . . . . . . . . . . . . . . . . Margaret Valeur- Jensen, J.D., Ph.D. . . . . . . . . . . . Christopher F. O’Brien, M.D. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dimitri E. Grigoriadis, Ph.D. Haig P. Bozigian, Ph.D. . . . . . . . . . . . . . . . . . . . . Bonus (1) $264,000 $150,000 $197,500 $187,500 $142,500 $142,500 Accrued Compensation (2) Stock Awards (3) $62,336 $31,477 $56,513 $32,135 $34,255 $28,817 $401,066 $337,066 $337,066 $160,000 $144,000 $144,000 Total $727,402 $518,543 $591,079 $379,635 $320,755 $315,317 * Reflects a termination due to death. (1) Based on bonus targets established by the Board of Directors for 2008. (2) Accrued compensation is comprised of vacation pay earned and unpaid as of December 31, 2008 and one-time additional two week vacation benefit for eligible employees. (3) All options held by the Named Executive Officers at December 31, 2008 had an exercise price greater than the Company’s closing price of its common stock at December 31, 2008. Therefore, using the intrinsic method or cash value method to calculate the expense associated with accelerating options results in $0 under both calcula- tions. The amounts in this column represent the market value of unvested restricted stock units as of Decem- ber 31, 2008 that would vest in accordance with the Named Executive Officers’ employment agreements. Restricted stock unit values were derived using the closing market price on December 31, 2008 of $3.20. The following is a description of the arrangements under which the Named Executive Officers may be entitled to potential payments upon a termination without cause or resignation due to a constructive termination (including following a change in control) or upon disability or death. Resignation due to constructive termination may include an executive’s resignation following one or more of the following material adverse changes in the nature of executive’s employment, as specified in the agreement, that is not cured following notification: (cid:129) (cid:129) a significant reduction in the executive or the executive supervisor’s duties or responsibilities, a material reduction in base salary, (cid:129) material relocation, or (cid:129) material breach of the executive’s employment agreement. Dr. Gorman is entitled to 1.25 times the amount of his annual base salary and target annual bonus to be paid equally over 15 months, an acceleration of unvested shares that would have vested over the 15 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a period of 15 months following termination in the event that the Company terminates his employment without cause, or he resigns due to a constructive termination. In the event of such termination within a specified time following a change of control, Dr. Gorman is entitled to 2 times the amount of his annual base salary and annual target bonus to be paid in one lump sum, a cash amount equal to the value of all unvested stock awards and all vested and outstanding stock awards, and payment of COBRA benefits to continue then-current coverage for a period of 24 months following termination. In addition, the Company has agreed to reimburse Dr. Gorman for the increase in federal and state income taxes payable by him by reason of the benefits 47 provided in connection with such a termination in connection with a change in control if the total payment exceeds 2.99 of his base amount by more than 15%. In the event of termination due to disability, Dr. Gorman is entitled to 15 months of base salary paid semi-monthly over 15 months, a lump sum amount equal to his target annual bonus multiplied by a fraction the numerator of which is the number of full months of employment by Dr. Gorman in the fiscal year and the denominator of which is 12, an acceleration of unvested shares that would have vested over the 15 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a period of 15 months following termination. In the event of a termination due to Dr. Gorman’s death, his beneficiaries or estate, would be entitled to an acceleration of unvested shares that would have vested over the 15 continuous months after the date of termination, a lump sum amount equal to his target annual bonus multiplied by a fraction the numerator of which is the number of full months of employment by Dr. Gorman in the fiscal year and the denominator of which is 12 and any accrued and unpaid compensation on the date of termination. Mr. Coughlin is entitled to 1.25 times the amount of his annual base salary and target annual bonus to be paid equally over 15 months, an acceleration of unvested shares that would have vested over the 15 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a period of 15 months following termination in the event that the Company terminates his employment without cause, or he resigns due to a constructive termination. In the event of such termination within a specified time following a change of control, Mr. Coughlin is entitled to 2 times his annual base salary and annual target bonus to be paid in one lump sum, a cash amount equal to the value of all unvested stock awards and all vested and outstanding stock awards, and payment of COBRA benefits to continue then-current coverage for a period of 24 months following termination. In addition, the Company has agreed to reimburse Mr. Coughlin for the increase in federal and state income taxes payable by him by reason of the benefits provided in connection with such a termination in connection with a change in control if the total payment exceeds 2.99 of his base amount by more than 15%. In the event of termination due to disability, Mr. Coughlin is entitled to 15 months of base salary paid semi-monthly over 15 months, a lump sum amount equal to his target annual bonus multiplied by a fraction the numerator of which is the number of full months of employment by Mr. Coughlin in the fiscal year and the denominator of which is 12, an acceleration of unvested shares that would have vested over the 15 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a period of 15 months following termination. In the event of a termination due to Mr. Coughlin’s death, his beneficiaries or estate, would be entitled to an acceleration of unvested shares that would have vested over the 15 continuous months after the date of termination, a lump sum amount equal to his target annual bonus multiplied by a fraction the numerator of which is the number of full months of employment by Mr. Coughlin in the fiscal year and the denominator of which is 12 and any accrued and unpaid compensation on the date of termination. Dr. Valeur-Jensen is entitled to 1.25 times the amount of her annual base salary and target annual bonus to be paid equally over 15 months, an acceleration of unvested shares that would have vested over the 15 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a period of 15 months following termination in the event that the Company terminates her employment without cause, or she resigns due to a constructive termination. In the event of such termination within a specified time following a change of control, Dr. Valeur-Jensen is entitled to 2 times the amount of her annual base salary and annual target bonus to be paid in one lump sum, a cash amount equal to the value of all unvested stock awards and all vested and outstanding stock awards, and payment of COBRA benefits to continue then-current coverage for a period of 24 months following termination. In addition, the Company has agreed to reimburse Dr. Valeur-Jensen for the increase in federal and state income taxes payable by her by reason of the benefits provided in connection with such a termination in connection with a change in control if the total payment exceeds 2.99 of her base amount by more than 15%. In the event of termination due to disability, Dr. Valeur-Jensen is entitled to 15 months of base salary paid semi-monthly over 15 months, a lump sum amount equal to her target annual bonus multiplied by a fraction the numerator of which is the number of full months of employment by Dr. Valuer-Jensen in the fiscal year and the denominator of which is 12, an acceleration of unvested shares that would have vested over the 15 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a period of 15 months following termination. In the event of a termination due to Dr. Valeur-Jensen’s death, her beneficiaries or 48 estate, would be entitled to an acceleration of unvested shares that would have vested over the 15 continuous months after the date of termination, a lump sum amount equal to her target annual bonus multiplied by a fraction the numerator of which is the number of full months of employment by Dr. Valeur-Jensen in the fiscal year and the denominator of which is 12 and any accrued and unpaid compensation on the date of termination. Dr. O’Brien is entitled to 1.0 times the amount of his annual base salary and target annual bonus to be paid equally over 12 months, an acceleration of unvested shares that would have vested over the 12 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a period of 12 months following termination in the event that the Company terminates his employment without cause, or he resigns due to a constructive termination. In the event of such termination within a specified time following a change of control, Dr. O’Brien is entitled to 1.5 times the amount of his annual base salary and annual target bonus to be paid in one lump sum, a cash amount equal to the value of all unvested stock awards and all vested and outstanding stock awards, and payment of COBRA benefits to continue then-current coverage for a period of 18 months following termination. In addition, the Company has agreed to reimburse Dr. O’Brien for the increase in federal and state income taxes payable by him by reason of the benefits provided in connection with such a termination in connection with a change in control if the total payment exceeds 2.99 of his base amount by more than 15%. In the event of termination due to disability, Dr. O’Brien is entitled to 12 months of base salary paid semi-monthly over 12 months, a lump sum amount equal to his target annual bonus multiplied by a fraction of the numerator of which is the number of full months of employment by Dr. O’Brien in the fiscal year and the denominator of which is 12, an acceleration of unvested shares that would have vested over the 12 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a period of 12 months following termination. In the event of a termination due to Dr. O’Brien’s death, his beneficiaries or estate, would be entitled to an acceleration of unvested shares that would have vested over the 12 continuous months after the date of termination, a lump sum amount equal to his target annual bonus multiplied by a fraction the numerator of which is the number of full months of employment by Dr. O’Brien in the fiscal year and the denominator of which is 12 and any accrued and unpaid compensation on the date of termination. Dr. Grigoriadis is entitled to 1.0 times the amount of his annual base salary and target annual bonus to be paid equally over 12 months, an acceleration of unvested shares that would have vested over the 12 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a period of 12 months following termination in the event that the Company terminates his employment without cause, or he resigns due to a constructive termination. In the event of such termination within a specified time following a change of control, Dr. Grigoriadis is entitled to 1.5 times the amount of his annual base salary and annual target bonus to be paid in one lump sum, a cash amount equal to the value of all unvested stock awards and all vested and outstanding stock awards, and payment of COBRA benefits to continue then-current coverage for a period of 18 months following termination. In addition, the Company has agreed to reimburse Dr. Grigoriadis for the increase in federal and state income taxes payable by him by reason of the benefits provided in connection with such a termination in connection with a change in control if the total payment exceeds 2.99 of his base amount by more than 15%. In the event of termination due to disability, Dr. Grigoriadis is entitled to 12 months of base salary paid semi-monthly over 12 months, a lump sum amount equal to his target annual bonus multiplied by a fraction the numerator of which is the number of full months of employment by Dr. Grigoriadis in the fiscal year and the denominator of which is 12, an acceleration of unvested shares that would have vested over the 12 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a period of 12 months following termination. In the event of a termination due to Dr. Grigoriadis’ death, his beneficiaries or estate, would be entitled to an acceleration of unvested shares that would have vested over the 12 continuous months after the date of termination, a lump sum amount equal to his target annual bonus multiplied by a fraction the numerator of which is the number of full months of employment by Dr. Grigoriadis in the fiscal year and the denominator of which is 12 and any accrued and unpaid compensation on the date of termination. Dr. Bozigian is entitled to 1.0 times the amount of his annual base salary and target annual bonus to be paid equally over 12 months, an acceleration of unvested shares that would have vested over the 12 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a 49 period of 12 months following termination in the event that the Company terminates his employment without cause, or he resigns due to a constructive termination. In the event of such termination within a specified time following a change of control, Dr. Bozigian is entitled to 1.5 times the amount of his annual base salary and annual target bonus to be paid in one lump sum, a cash amount equal to the value of all unvested stock awards and all vested and outstanding stock awards, and payment of COBRA benefits to continue then-current coverage for a period of 18 months following termination. In addition, the Company has agreed to reimburse Dr. Bozigian for the increase in federal and state income taxes payable by him by reason of the benefits provided in connection with such a termination in connection with a change in control if the total payment exceeds 2.99 of his base amount by more than 15%. In the event of termination due to disability, Dr. Bozigian is entitled to 12 months of base salary paid semi-monthly over 12 months, a lump sum amount equal to his target annual bonus multiplied by a fraction the numerator of which is the number of full months of employment by Dr. Bozigian in the fiscal year and the denominator of which is 12, an acceleration of unvested shares that would have vested over the 12 continuous months after the date of termination, and payment of COBRA benefits to continue then-current coverage for a period of 12 months following termination. In the event of a termination due to Dr. Bozigian’s death, his beneficiaries or estate, would be entitled to an acceleration of unvested shares that would have vested over the 12 continuous months after the date of termination, a lump sum amount equal to his target annual bonus multiplied by a fraction the numerator of which is the number of full months of employment by Dr. Bozigian in the fiscal year and the denominator of which is 12 and any accrued and unpaid compensation on the date of termination. Compensation of Directors. The following table sets forth the compensation paid by the Company for the fiscal year ended December 31, 2008 to the directors of the Company named below: Name Directors Compensation Table Fees Earned or Paid in Cash (1) Option Awards (2) All Other Compensation Kevin C. Gorman, Ph.D. (3) . . . . . . . . Gary A. Lyons (4). . . . . . . . . . . . . . . . W. Thomas Mitchell (5) . . . . . . . . . . . Joseph A. Mollica, Ph.D. (6) . . . . . . . . Richard F. Pops (7) . . . . . . . . . . . . . . . Stephen A. Sherwin, M.D. (8) . . . . . . . Corinne H. Lyle (9) . . . . . . . . . . . . . . Wylie W. Vale, Ph.D (10) . . . . . . . . . . $ — $36,000 $61,000 $65,000 $64,000 $52,000 $57,000 $ — $ — $24,052 $58,956 $75,700 $58,956 $58,956 $58,956 $58,956 $ — $ — $ — $ — $ — $ — $ — $62,500(11) Total $ — $ 60,052 $119,956 $140,700 $122,956 $110,956 $115,956 $121,456 (1) Amounts in this column reflect amounts paid in cash in 2008, except for Dr. Mollica and Mr. Lyons who deferred receipt of cash payments of $65,000 and $35,478 ($36,000 in cash director fees as reported in the table above, less applicable withholdings due to Mr. Lyons’ employment by the company during a portion of 2008), respec- tively, into the Company’s NQDC Plan as listed in the Directors Nonqualified Deferred Compensation Table. (2) The amounts shown are the compensation costs recognized by Neurocrine in fiscal 2008 for option awards granted in and prior to 2008 as determined pursuant to SFAS 123R. The assumptions used to calculate the value of option awards are set forth under Note 8 of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC on Febru- ary 4, 2009. (3) During 2008, Dr. Gorman was an employee of the Company, and as such, did not receive any compensation for service on the Board of Directors. As of December 31, 2008, Dr. Gorman had outstanding options to purchase 315,144 shares of common stock and 175,000 outstanding RSUs and stock awards, of which a portion are subject to deferred delivery arrangements per the Company’s NQDC Plan. As of December 31, 2008, the KCG Family Limited Liability Company had outstanding options to purchase 30,006 shares of common stock. (4) Mr. Lyons served as our President and Chief Officer until January 10, 2008, and in connection with his departure, is receiving severance benefits. The table above reflects solely the compensation paid by the Company to Mr. Lyons for his service as a director following January 10, 2008. As of December 31, 2008, Mr. Lyons had out- standing options to purchase 514,900 shares of common stock and 112,500 outstanding RSUs, 27,500 of which 50 are subject to deferred delivery arrangements per the Company’s NQDC Plan. As of December 31, 2008, the GEL Family Limited Liability Company had outstanding options to purchase 188,019 shares of common stock. (5) As of December 31, 2008 Mr. Mitchell had outstanding options to purchase 83,000 shares of common stock. (6) As of December 31, 2008 Dr. Mollica had outstanding options to purchase 130,000 shares of common stock. (7) As of December 31, 2008 Mr. Pops had outstanding options to purchase 99,000 shares of common stock. (8) As of December 31, 2008 Dr. Sherwin had outstanding options to purchase 116,500 shares of common stock. (9) As of December 31, 2008 Ms. Lyle had outstanding options to purchase 51,000 shares of common stock. (10) As of December 31, 2008 Dr. Vale had outstanding options to purchase 87,000 shares of common stock. As of December 31, 2008, the WBV Limited Liability Company had outstanding options to purchase 14,429 shares of common stock. (11) Reflects fees paid pursuant to a consulting agreement with Dr. Vale in lieu of cash director fees. $50,000 repre- sents Dr. Vale’s annual consulting fee and $12,500 represents a catch-up payment due to a change in the method of payment, from payment quarterly in arrears to payment quarterly in advance as required by his consulting agreement. The consulting agreement with Dr. Vale was terminated in February 2009 and Dr. Vale will thereafter be compensated through regular cash director fees. See “Related Person Transactions” below. Directors Compensation Summary Non-employee directors are reimbursed for expenses incurred in connection with performing their duties as directors of the Company. Directors who are not employees or consultants of the Company receive a $30,000 annual retainer and $2,000 for each regular meeting of the Board of Directors. The Company has agreed to provide Joseph A. Mollica, Ph.D. as Chairman of the Board an additional $20,000 making his total annual cash retainer $50,000. In addition to the cash compensation set forth above, the Chairman of the Audit Committee, Corinne H. Lyle, receives an additional $19,000 annual cash retainer. The Chairman of the Compensation Committee, Richard F. Pops, receives an additional $12,000 annual cash retainer. The Chairman of the Nominating/Corporate Governance Committee, W. Thomas Mitchell, receives an additional annual cash retainer of $9,000. Each other director who is a member of the Audit Committee, the Compensation Committee or the Nominating/Corporate Governance Committee receives an annual cash retainer of $12,000, $7,000 and $5,000 respectively, for each Committee on which he or she serves. Each non-employee director is eligible to participate in the Company’s NQDC Plan. In addition to non- employee directors of the Company, the Company’s officers, vice presidents, and higher ranking employees are also eligible to participate in the NQDC Plan. For the year 2008, Joseph A. Mollica, Ph.D. and Gary A. Lyons elected to defer 100% of their director cash compensation from the Company pursuant to the NQDC Plan. Additionally, each non-employee director receives a grant of nonstatutory options to purchase 15,000 shares of the Company’s common stock (except that Joseph A. Mollica, Ph.D. as Chairman of the Board, receives options to purchase 20,000 shares) at each Annual Meeting of Stockholders, provided that such non-employee director has been a director of the Company for at least six months prior to the date of such Annual Meeting. Each new non-employee director is automatically granted a nonstatutory stock option to purchase 25,000 shares of the Company’s common stock upon the date such person joins the Board of Directors. All options granted to non-employee directors are subject to a seven year term and vest monthly over the one-year period following the date of grant and have exercise prices equal to the fair market value of the Company’s common stock on the date of the grant. 51 Nonqualified Deferred Compensation. The following table sets forth the compensation deferred into the Company’s NQDC Plan in the fiscal year ended December 31, 2008 by the directors of the Company named below: Directors Nonqualified Deferred Compensation Table Name Gary A. Lyons . . . . . . . . . . . . . . . . . . . . . . . . . . Joseph A. Mollica, Ph.D. Director Contributions in Last FY (1) Aggregate Earnings/(Loss) In Last FY Aggregate Balance at Last FYE $35,478 $65,000 $ (10,519) $(126,942) $ 24,959 $318,645 Year 2008 2008 (1) Consists of board fees earned during 2008. Additional information Executive officers of the Company serve at the discretion of the Board of Directors. There are no family relationships among any of the directors, executive officers or key employees of the Company. No director, executive officer, key employee, promoter or control person of the Company has, in the last five years, been subject to bankruptcy proceedings, criminal proceedings or legal proceedings related to the violation of state or federal commodities or securities laws. RELATED PERSON TRANSACTIONS Review, approval or ratification of related person transactions In accordance with the Company’s Audit Committee Charter, the Company’s Audit Committee is responsible for reviewing and approving the terms and conditions of all related person transactions. In connection with its review, approval or ratification of related person transactions, the Company’s Audit Committee takes into account all relevant available facts and circumstances in determining whether such transaction is in the best interests of the Company and its stockholders. Any transaction that would disqualify a director from meeting the “independent director” standard as defined under the Nasdaq Stock Market rules requires review by the Company’s audit committee prior to entering into such transaction. For all other related person transactions the Company reviews all agreements and payments for related person transactions and based on this review, a report is made to the Company’s audit committee quarterly disclosing all related person transactions during that quarter, if any. All related person transactions shall be disclosed in the Company’s applicable filings with the Securities and Exchange Commission as required under SEC rules. Related person transactions during fiscal 2008 During 2008, the Company had a consulting agreement with Wylie W. Vale, Ph.D. pursuant to which Dr. Vale spent a significant amount of time performing services for the Company, and was prohibited from providing consulting services to or participating in the formation of any company in Neurocrine’s field of interest or that may be competitive with Neurocrine. Dr. Vale’s agreement provided for an annual consulting fee of $50,000 in exchange for his consulting services to the Company. The consulting agreement was terminated in February 2009 and Dr. Vale will thereafter be compensated through regular cash director fees. In addition, during 2008, the Company paid approximately $425,000 to the Salk Institute, where Dr. Vale is a professor and head of the Clayton Foundation Laboratories for Peptide Biology, for license and patent expenses related to our corticotropin-releasing factor programs. 52 OTHER MATTERS As of the date of this Proxy Statement, the Company knows of no other matters to be submitted to the stockholders at the Annual Meeting. If any other matters properly come before the Annual Meeting, it is the intention of the persons named in the enclosed proxy card to vote the shares they represent as the Board of Directors may recommend. ADDITIONAL INFORMATION “Householding” of Proxy Materials. The Securities and Exchange Commission has adopted rules that permit companies and intermediaries such as brokers to satisfy delivery requirements for proxy statements with respect to two or more stockholders sharing the same address by delivering a single proxy statement addressed to those stockholders. This process, which is commonly referred to as “householding,” potentially provides extra convenience for stockholders and cost savings for companies. The Company, and some brokers, household proxy materials, delivering a single proxy statement to multiple stockholders sharing an address unless contrary instructions have been received from the affected stockholders. Once you have received notice from your broker or us that they or we will be householding materials to your address, householding will continue until you are notified otherwise or until you revoke your consent. If, at any time, you no longer wish to participate in householding and would prefer to receive a separate proxy statement, please notify your broker if your shares are held in a brokerage account or us if you hold registered shares. Advance Notice Procedures. To be considered for inclusion in next year’s proxy materials, a stockholder must submit his, her or its proposal in writing by December 23, 2009, which is the first business day after the date that is 120 days prior to the first anniversary of the mailing date of this proxy statement, to the Company’s Corporate Secretary at 12780 El Camino Real, San Diego, California 92130. Any proposal must comply with the requirements as to form and substance established by the Securities and Exchange Commission for such proposal to be included in our proxy statement. Stockholders are also advised to review our bylaws, which contain additional requirements about advance notice of stockholder proposals and director nominations. 53 (This page intentionally left blank) UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K (Mark One) ¥ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2008 OR n TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number: 0-22705 NEUROCRINE BIOSCIENCES, INC. (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 12780 El Camino Real, San Diego, CA (Address of principal executive office) 33-0525145 (I.R.S. Employer Identification Number) 92130 (Zip Code) Registrant’s telephone number, including area code: (858) 617-7600 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered Common Stock, $0.001 par value The NASDAQ Stock Market Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes n No ¥ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes n No ¥ Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 of 15(d) of the Exchange Act from their obligations under those Sections. 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 ¥ No n Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¥ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer n Accelerated filer ¥ Non-accelerated filer n (Do not check if a smaller reporting company) Smaller reporting company n Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes n No ¥ The aggregate market value of the common equity held by non-affiliates of the registrant as of June 30, 2008 totaled approximately $118,167,063 based on the closing price for the registrant’s Common Stock on that day as reported by the Nasdaq Stock Market. Such value excludes Common Stock held by executive officers, directors and 10% or greater stockholders as of June 30, 2008. The identification of 10% or greater stockholders as of June 30, 2008 is based on Schedule 13G and amended Schedule 13G reports publicly filed before June 30, 2008. This calculation does not reflect a determination that such parties are affiliates for any other purposes. As of January 23, 2009, there were 38,673,788 shares of the registrant’s Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Document Description Portions of the registrant’s notice of annual meeting of stockholders and proxy statement to be filed pursuant to Regulation 14A within 120 days after registrant’s fiscal year end of December 31, 2008 are incorporated by reference into Part III of this report. 10-K Part III, ITEMS 10, 11, 12, 13, 14 TABLE OF CONTENTS PART I Business .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 1. Item 1A. Risk Factors.. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 1B. Unresolved Staff Comments .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Properties. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 2. Legal Proceedings . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 3. Submission of Matters to a Vote of Security Holders. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 4. PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 6. Selected Financial Data . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations . .. . Item 7A. Quantitative and Qualitative Disclosures about Market Risk . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Financial Statements and Supplementary Data . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 8. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . .. . Item 9A. Controls and Procedures. .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 9B. Other Information . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . PART III Item 10. Directors, Officers and Corporate Governance . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 11. Executive Compensation .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Item 12. Matters . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 13. Certain Relationships and Related Transactions, and Director Independence . . . .. . . .. . .. . . .. . . .. . Principal Accountant Fees and Services . . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Item 14. Page 3 15 25 26 26 26 27 28 29 41 42 68 68 70 70 70 70 70 70 Item 15. Exhibits and Financial Statement Schedules . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . 71 PART IV PART I FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K and the information incorporated herein by reference contain forward- looking statements that involve a number of risks and uncertainties. Although our forward-looking statements reflect the good faith judgment of our management, these statements can only be based on facts and factors currently known by us. Consequently, these forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from results and outcomes discussed in the forward-looking statements. Forward-looking statements can be identified by the use of forward-looking words such as “believes,” “expects,” “hopes,” “may,” “will,” “plan,” “intends,” “estimates,” “could,” “should,” “would,” “continue,” “seeks,” “pro forma,” or “anticipates,” or other similar words (including their use in the negative), or by discussions of future matters such as the development of new products, technology enhancements, possible changes in legislation and other statements that are not historical. These statements include but are not limited to statements under the captions “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” as well as other sections in this report. You should be aware that the occurrence of any of the events discussed under the heading “Item 1A. Risk Factors” and elsewhere in this report could substantially harm our business, results of operations and financial condition and that if any of these events occurs, the trading price of our common stock could decline and you could lose all or a part of the value of your shares of our common stock. The cautionary statements made in this report are intended to be applicable to all related forward-looking statements wherever they may appear in this report. We urge you not to place undue reliance on these forward- looking statements, which speak only as of the date of this report. Except as required by law, we assume no obligation to update our forward-looking statements, even if new information becomes available in the future. ITEM 1. BUSINESS We were originally incorporated in California in January 1992 and were reincorporated in Delaware in May 1996. 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. 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 have entered into a collaboration for two of our programs. 3 Our Product Pipeline The following table summarizes our most advanced product candidates currently in clinical development, those currently in research, and those subject to regulatory review, and is followed by detailed descriptions of each program: Program Target Indication Status Commercial Rights Products in clinical development: Elagolix . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. CRF1 Antagonist (561679) . . . .. . . .. . . .. . . .. . . .. CRF2 Peptide Agonist — urocortin 2 . . . .. . . .. CRF1 Antagonist (586529) . . . .. . . .. . . .. . . .. . . .. Elagolix . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. Research programs: Vesicular Monoamine Transporter 2 Inhibitor (VMAT2) . .. . . .. . . .. . . .. . . .. . . .. . . .. Glucose Dependent Insulin Secretagogues . .. Antiepileptic Drugs. .. . .. . . .. . . .. . . .. . . .. . . .. . . .. Endometriosis Mood Disorders Cardiovascular Mood Disorders, Irritable Bowel Syndrome Benign Prostatic Hyperplasia, Uterine Fibroids Movement Disorders, Schizophrenia Type II Diabetes Epilepsy, Bipolar Disorder GnRH Antagonists . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. Hormone Dependent Diseases, Oncology Products subject to regulatory review: Indiplon 5mg and 10mg capsules .. . . .. . . .. . . .. Insomnia Indiplon 15mg tablets . .. . . .. . . .. . . .. . . .. . . .. . . .. Insomnia Phase II Phase II Phase II Phase I Neurocrine GlaxoSmithKline/ Neurocrine Neurocrine GlaxoSmithKline/ Neurocrine Phase I Neurocrine Development Neurocrine Research Research Neurocrine Neurocrine Research Neurocrine FDA has deemed approvable FDA has deemed not approvable Neurocrine/Dainippon Sumitomo Pharma Co. Neurocrine “Phase II” indicates that we or our collaborators are conducting clinical trials on groups of patients afflicted with a specific disease in order to determine preliminary efficacy, optimal dosages and expanded evidence of safety. “Phase I” indicates that we or our collaborators are conducting clinical trials with a smaller number of patients to determine early safety profile, maximally tolerated dose and pharmacological properties of the product in human volunteers. “Development” indicates a compound has been selected to move into clinical trials. “Research” indicates identification and evaluation of compound(s) in laboratory and preclinical models. “CRF1 and CRF2” refer to two CRF receptor subtypes. Products Under Clinical Development Elagolix — Gonadotropin-Releasing Hormone (GnRH) Antagonist Gonadotropin-releasing hormone, or GnRH, is a peptide that stimulates the secretion of the pituitary hormones that are responsible for sex steroid production and normal reproductive function. Researchers have found that chronic administration of GnRH agonists, after initial stimulation, reversibly shuts down this transmitter pathway 4 and is clinically useful in treating hormone-dependent diseases such as endometriosis, uterine fibroids and benign prostatic hyperplasia (BPH). Several companies have developed peptide GnRH agonists on this principle, such as Lupron» and Zoladex», and according to their manufacturers, their annual worldwide sales in 2007 totaled $3 billion (EvaluatePharma). However, since they are peptides, they must be injected via a depot formulation rather than the preferred oral route of administration. In addition, GnRH agonists can take up to several weeks to exert their desired effect once the initial stimulation has occurred, a factor not seen with the use of GnRH antagonists. More importantly, until the desired effects are maximal, they have shown a tendency to exacerbate the condition via a hormonal flare. The ultimate profound suppression effect observed with GnRH agonists is similar to that seen after menopause and can be associated with hot flashes and the loss of bone mineral density. Orally active, nonpeptide GnRH antagonists potentially offer several advantages over injectable GnRH peptide drugs, including rapid onset of hormone suppression without a hormonal flare. Also, injection site reactions commonly observed in peptide depots are avoided and dosing can be rapidly discontinued if necessary — a clinical management option not available with long-acting depot injections. Importantly, by using GnRH antagonists, it may be possible to alter the level of pituitary GnRH suppression and thereby titrating circulating estrogen levels. Using this approach, an oral GnRH antagonist may provide patients relief from the painful symptoms of endometriosis while avoiding the need for the active management of bone loss. Endometriosis. Endometriosis is associated with a multitude of symptoms, some of the most common of which include pain related both to menstruation (dysmenorrhea) and sexual intercourse (dyspareunia) as well as chronic pelvic pain throughout the menstrual cycle, infertility, and menorrhagia, among many others. The wide range of symptoms associated with endometriosis serves to complicate and delay diagnosis due to the significant overlap of symptoms with the disease profiles of other conditions. Datamonitor (2007) estimates that there are approximately 7.5 million women in the United States who suffer from the symptoms of endometriosis. With annual healthcare costs and endometriosis-related productivity losses of approximately $4,000 per patient, the annual direct and indirect costs of endometriosis are estimated to exceed $20 billion in the United States alone (S Simoens et al Human Reproduction Update 2007, 13 395). We believe that the availability of an oral treatment, lacking the side effect profile of the currently available peptide GnRH agonists, may be a desirable alternative to current therapies and ultimately encourage a higher treatment rate. Several Phase I clinical trials of our lead, orally active nonpeptide GnRH antagonist, elagolix, for endometri- osis have been completed. These studies demonstrated that elagolix was safe and well tolerated. Dose-dependent hormonal suppression with once a day elagolix was observed in doses ranging from 50mg and 400mg /day. The reduction in estradiol has been correlated with a reduction in pain and other symptoms of endometriosis and is a useful biomarker for safety and efficacy. Based on the results of these Phase I trials, we completed two separate exploratory three-month Phase IIa trials, during 2006, in endometriosis patients to assess efficacy and tolerability of elagolix. Efficacy in these Phase II studies was assessed by the Composite Pelvic Sign and Symptoms Score (CPSSS) and Visual Analog Scale (VAS) industry-standard and validated measures utilized for evaluating pain reduction in endometriosis patients. In addition to the standard clinical and laboratory assessments of safety, a biomarker for bone resorption (n-telopeptide) was also measured to assess potential impact on bone mineral density. The first of the two randomized, placebo controlled Phase IIa three-month trials in patients with endometriosis involved doses of 75mg and 150mg elagolix given once daily. The second Phase IIa study involved doses of 50mg and 100mg elagolix given twice daily to more fully explore dose response. Taken together, these trials indicate that a reduction in pain associated with endometriosis, as measured by CPSSS and VAS, is possible with benefit occurring within the first two weeks for some women. The magnitude of pain reduction is roughly comparable to that seen with depo-subQ provera 104TM (DMPA-SC) and Lupron» although direct comparison to these treatments was not part of these Phase IIa trials. Average estradiol levels were reduced in a dose-related manner and, most importantly, do not fall into the post-menopausal range associated with GnRH agonist treatments. Furthermore, no increase in bone resorption was evident as shown by stable mean n-telopeptide levels. During 2007, we also completed a bridging study comparing elagolix drug formulations (tablets and solutions) we have used in clinical trials to date to new formulations of tablets. The successful completion of this study allowed us to select what we anticipate to be our final commercial formulation tablet. 5 During 2008, we completed the dosing and 6-month follow up of a Phase IIb study in which 252 patients, with a laparoscopic diagnosis of endometriosis, were treated over a 6-month period. This multi-center, randomized, double-blind, double-dummy study consisted of three treatment groups, elagolix 150mg once a day, elagolix 75mg twice daily, and an active control, DMPA-SC. The primary purpose of this study was to assess the impact of six months of treatment of elagolix on bone mineral density as measured by dual energy x-ray absorptiometry (DXA) scan at the conclusion of treatment and at 6 and 12 months post treatment. This study also assessed, as secondary endpoints, the impact of treatment on endometriosis symptoms as measured by CPSSS and VAS. Top-line results were released in September 2008 and showed that elagolix met the primary endpoint by having minimal impact on bone mineral density at the conclusion of treatment. This study also showed that elagolix had both a statistical and clinically meaningful reduction in endometriosis symptoms as measured by CPSSS with an 86% responder rate in the 150mg once daily elagolix arm of the study. This study confirmed our decision to move forward with once daily dosing as elagolix displayed approximately the same efficacy whether given once or twice daily and a superior safety profile for bone mineral density. Additional data from this study is expected to be released during 2009 which will include the DXA scans from both 6 and 12 months post treatment, and various pharmacokinetic and pharmacodynamic analyses. We are conducting two additional Phase IIb studies of elagolix to fully explore its dose range, to evaluate modified endpoints proposed by the U.S. Food and Drug Administration (FDA), and to evaluate elagolix in a comparator trial with a monthly injection of leuprolide (Prostap» SR). Both of these trials are utilizing our selected commercial formulation tablet for six months of treatment. These two trials are designed to assess elagolix against placebo (and Prostap» SR) for an initial three months and after completing three months of treatment the non- elagolix treatment arms are re-randomized into either 150mg or 250mg of elagolix once daily for an additional three months. The first additional Phase IIb trial was fully enrolled as of December 31, 2008 and consists of three arms, elagolix 150mg once daily, elagolix 250mg once daily, and placebo. We randomized 155 subjects with a laparoscopic diagnosis of endometriosis in this trial. The initial three month treatment period for this trial concluded in December 2008 and we expect top-line results in the first quarter of 2009. The second additional Phase IIb trial is currently enrolling in Central Eastern Europe and consists of four arms, elagolix 150mg once daily, elagolix 250mg once daily, Prostap» SR 3.75mg, and placebo. We expect to enroll approximately 180 subjects, with a laparoscopic diagnosis of endometriosis, in this trial. Top-line data from the initial three month treatment period is expected in the third quarter of 2009. We expect to have an end of Phase II meeting with the FDA in late 2009, the purpose of which would be to agree with the FDA on the design of the pivotal Phase III program for elagolix in endometriosis. We expect elagolix Phase III clinical trials to commence in early 2010. Benign Prostatic Hyperplasia. BPH is defined by the enlargement of the prostate gland. In BPH, as the prostate grows larger and presses against the urethra, normal flow of urine is hindered. Researchers have determined that dihydrotestosterone (DHT), a derivative of testosterone, contributes to prostate enlargement. Equally impor- tant, men who do not generate DHT do not develop BPH. Accordingly, by using a small molecule GnRH antagonist, one can suppress the production of testosterone, and indirectly DHT, and potentially ameliorate the symptoms of BPH. More recent clinical and pre-clinical data indicate that transient suppression of testosterone may trigger a decrease in the size of the prostate and thereby permit intermittent treatment with a drug such as elagolix without untoward side effects. Moderate to severe BPH affects an estimated 20 million men in the United States (UroToday). Additionally, more than 50% of all men over the age of 50 suffer from the symptoms of BPH (The National Institute of Diabetes & Kidney Diseases). Worldwide sales of current treatments for BPH exceeded $4 billion in 2007 (EvaluatePharma). During 2004, we conducted a Phase I single dose study to assess the safety, tolerability, pharmacokinetics and pharmacodynamics of our GnRH antagonist in healthy males. The results of this trial demonstrated that our GnRH antagonist effectively reduced testosterone production when compared to placebo. In 2005, we filed an Investi- gational New Drug application to initiate a multiple dose Phase I study in males. A second study was completed in 2006 and those results demonstrate that a dose-related reduction of testosterone was achieved and that two weeks of GnRH antagonist treatment is generally safe and well tolerated in healthy males. 6 Corticotropin-Releasing Factor (CRF) Receptor1 Antagonist According to Datamonitor (2007), the prevalence of major depressive disorder exceeds 20 million in the United States alone with an estimated 121 million sufferers worldwide. Estimates based on data from the National Institute of Mental Health and the U.S. Census Bureau, Population Division also indicate that in 2007 over 20 million Americans suffer from a debilitating anxiety disorder. In 2007, the worldwide branded market for depression therapeutics was nearly $11 billion (Med Ad News). Depression. Depression is one of a group of neuropsychiatric disorders that is characterized by extreme feelings of despair, loss of body weight, decreased aggressiveness and sexual behavior, and loss of sleep. Researchers believe that depression results from a combination of environmental factors, including stress, as well as an individual’s biochemical vulnerability, which is genetically predetermined. The most frequently prescribed antidepressant therapies are drugs that inhibit the reuptake of the neurotransmitters serotonin, nore- pinephrine and dopamine and include drugs such as Zoloft», Paxil», Lexapro», Prozac», Cymbalta», Pristiq», Wellbutrin» and Effexor» as well as certain generic equivalents. These compounds act by inhibiting the reuptake of neurotransmitters back into presynaptic neurons thus effectively increasing their levels and enhancing activity in the brain. However, because these drugs affect a wide range of neurotransmitters, they have been associated with a number of adverse side effects. While newer, more selective drugs offer some safety improvement, side effects remain problematic. Two of the biggest limitations of most existing antidepressant therapies are their slow onset of action and their negative effects on libido. Anxiety. Anxiety is among the most commonly observed group of central nervous system disorders, which includes phobias or irrational fears, panic attacks, and other syndromes. Of the pharmaceutical agents that other companies currently market for the treatment of anxiety disorders, benzodiazepines, such as Valium» and Xanax» and the anxiolytics BuSpar» and Effexor» as well as certain generic equivalents are the most frequently prescribed. Several side effects, however, limit the utility of these anti-anxiety drugs. Most problematic among these are drowsiness, memory difficulties, drug dependency and withdrawal reactions following the termination of therapy. Researchers have identified what they believe to be the central mediator of the body’s stress responses or stress-induced disorders (including depression and anxiety). This mediator is a brain chemical known as corti- cotropin-releasing factor, or CRF. CRF is overproduced in clinically depressed patients and may be dysregulated in individuals with anxiety disorders. Current research indicates that clinically depressed patients and patients with anxiety experience dysfunction of the hypothalamic-pituitary-adrenal axis, the system that manages the body’s overall response to stress. This amplifies production of CRF, and induces the physical effects that are associated with stress that can lead to depression or anxiety. The novelty and specificity of the CRF mechanism of action and the prospect of improving upon selective serotonin reuptake inhibitor therapy represents a market opportunity both to better serve patients and expand the overall treatment of depression. We also believe that CRF offers a novel mechanism of action and the advantage of being more selective, thereby providing increased efficacy with reduced side effects in anxiety when compared to benzodiazepines. We have a strategic position in the CRF field through our intellectual property portfolio and relationship with experts in the neuropsychiatric field. We have further characterized the CRF receptor system and have identified additional members of the CRF receptor family. We have patent rights on two receptor subtypes termed CRF1 and CRF2, and we have pending patent applications on small molecule organic compounds modulating the CRF receptors. The first clinical trial to offer evidence of proof of concept of CRF antagonists in addressing depression (and anxiety as a co-examined variable) was a Phase IIa open label trial we conducted in 1999 pursuant to collaborations with Janssen Pharmaceutica (Janssen) in the field of CRF antagonists. Results from this trial indicated that the drug candidate was safe and well tolerated and demonstrated anti-depressant activity as measured by a widely-accepted depression scale known as the Hamilton Depression Scale. In this trial, the drug candidate was administered to 20 patients with major depressive disorder. Results from the trial, as reported in the Journal of Psychiatric Research, showed that treatment response, as defined by more than a 50% reduction in Hamilton Depression Scores, occurred in 50% of the patients in the low dose group and 80% of the patients in the higher dose group. Additionally, the drug candidate demonstrated a reduction in Hamilton Anxiety Scores from baseline in both treatment groups at all times after dosing. While development of our first generation CRF antagonist was discontinued for safety reasons by our 7 collaborator Janssen, we were encouraged by these results which we believe support the hypothesized mechanism of action. Our CRF antagonist research collaboration with Janssen was terminated in March 2002. In July 2001, we announced our second CRF antagonist collaboration, a worldwide collaboration with GlaxoSmithKline (GSK), to develop and commercialize CRF antagonists for psychiatric, neurological and gastrointestinal diseases. Under the terms of this agreement, GSK sponsored and we jointly conducted a research program and collaborated in the development of our current lead compounds, as well as novel back-up candidates and second generation compounds identified through the collaborative research. The sponsored research portion of the collaboration was completed in 2005. During 2004, GSK advanced one of the lead CRF1 drug candidates arising out of our collaboration into Phase I clinical trials. The trial was a double-blind, placebo-controlled, single-dose study to evaluate safety and pharma- cokinetics of a range of escalating doses. This study was followed by the successful completion of a placebo- controlled double blind multiple dose Phase I study. GSK has completed a Phase II clinical trial with CRF1 receptor antagonist compound, 876008, for social anxiety disorder (SocAD). In this double-blind, randomized, placebo controlled, multiple dose study to evaluate the safety and efficacy of the CRF1 receptor antagonist compound in patients with SocAD, no statistically significant differences were observed in the key efficacy endpoints between 876008 and placebo at 12 weeks. This study included more than 200 adult subjects and assessed efficacy, safety, tolerability and pharmacokinetics of the compound. The compound was generally well tolerated with no serious adverse events reported. GSK has advanced a second lead CRF1 receptor antagonist compound, 561679, into a Phase II depression study during 2008. This multicenter randomized, double-blind, placebo-controlled trial is designed to assess the safety and efficacy of 561679 in approximately 150 subjects with Major Depressive Disorder. Results are expected in 2010. GSK has also completed a successful Phase I single dose escalating clinical trial with 586529, an additional CRF1 receptor antagonist compound. Irritable Bowel Syndrome. Research has also suggested that CRF plays a role in the control or modulation of the gastrointestinal system. Studies have demonstrated that central administration of CRF acts to inhibit emptying of the stomach while stimulating bowel activity, and suggest that overproduction of CRF in the brain may be a main contributor to stress-related gastrointestinal disorders. IBS is a gastrointestinal inflammatory disease that affects between 25 to 45 million people in the United States, accounting for over $20 billion in direct and indirect costs each year, according to the International Foundation for Functional Gastrointestinal Disorders. IBS can be a lifelong, intermittent disease, involving chronic or recurrent abdominal pain and frequent diarrhea or constipation. Some patients with IBS report the onset of symptoms of the disease following a major life stress event, such as death in the family, which suggests that the causes of IBS may be related to stress. In addition, most IBS sufferers also experience anxiety and depression. GSK has completed a Phase II clinical trial assessing the CRF1 receptor antagonist compound 876008 in IBS. In this double-blind, randomized, placebo controlled study to evaluate the safety and efficacy of 876008 in patients with IBS, no statistically significant differences were observed in the key efficacy endpoints between 876008 and placebo. Approximately 130 patients meeting established diagnostic criteria for IBS were entered into this cross- over design trial. CRF2 Receptor Peptide Agonist (Urocortin 2) Congestive heart failure (CHF) is a condition where the heart cannot pump enough blood to supply all of the body’s organs. It is a result of narrowing of the arteries combined with high blood pressure, which results in increased respiration as well as edema from water retention. In the case of acute symptomology, CHF patients will eventually experience a rapid deterioration and require urgent treatment in the hospital. According to 2008 data from the American Heart Association, over 5 million people experience CHF and about 660,000 new cases are diagnosed each year in the United States. CHF becomes more prevalent with age and the number of cases is expected to grow as the overall age of the population increases. Current treatment options include a cocktail of drugs 8 consisting of diuretics to remove excess water, beta blockers and digitalis to improve heart muscle contraction, and/or ACE inhibitors and vasodilators to expand blood vessels. There are in excess of one million hospitalizations each year in the United States for CHF (AMA 2009). Urocortin 2 is an endogenous peptide ligand of the CRF2 receptor present in the cardiovascular system, notably the heart and cerebral arterial system. Urocortin 2 plays a role in the control of the hormonal, cardiovascular, gastrointestinal, and behavioral responses to stress, and has an array of effects on the cardiovascular system and metabolism. Based on preclinical efficacy and safety data, together with its known role in human physiology, we believe that urocortin 2 may have positive hemodynamic effects on cardiac output and blood pressure which may benefit patients with acute CHF. During 2005, we completed a Phase II placebo controlled dose-escalation study to evaluate the safety, pharmacokinetics and pharmacodynamics of two dose levels of urocortin 2 in patients with stable CHF. Results of this study demonstrated a dose-related increase in cardiac output of up to 50% with only a modest increase (6%) in heart rate. We completed an additional Phase II study evaluating urocortin 2 over four-hour infusions in patients with stable CHF in the first half of 2006. The treatments were generally well tolerated without serious adverse events, abnormalities in electrocardiograms or significant changes in renal function. Positive hemodynamic effects were noted in virtually all patients with increases in cardiac output ranging from 6% to 54%. During 2008, we completed the necessary preclinical work to allow for periods of infusion of urocortin 2 up to 14 days. This substantially completes all of the preclinical toxicology work required by the FDA. Further development of urocortin 2 for CHF and other acute care cardiovascular diseases is highly dependent upon partnering of this program. Research Programs Our research and development focus is on addressing diseases and disorders of the central nervous system and endocrine system, which include therapeutic categories ranging from diabetes to stress-related disorders and neurodegenerative diseases. Central nervous system and endocrinology drug therapies are among the largest therapeutic categories, accounting for over $60 billion in worldwide drug sales in 2007 according to Med Ad News. Vesicular Monoamine Transporter 2 Inhibitor (VMAT2) VMAT2 is a protein concentrated in the human brain that is essential for the transmission of nerve impulses between neurons. VMAT2 is primarily responsible for re-packaging and transporting monamines (dopamine, norepinephrine, serotonin, and histamine) among nerve cells. Specifically, dopamine enables neurotransmission among nerve cells that are involved in voluntary and involuntary motor control. We have identified one highly selective VMAT2 inhibitor that is effective in regulating the levels of dopamine release during nerve communication, while at the same time having minimal impact on the other monoamines thereby reducing the likelihood of “off target” side effects. We have developed this novel compound to provide very predictable plasma and brain concentrations and therefore allow for exposure that we expect to be well tolerated in patients. We believe that this clinical candidate will be effective in the management of hyperkinetic movement disorders characterized by involuntary bodily movements as seen in patients suffering from Tardive Dyskinesia, and Huntington’s disease. Additionally, the modulation of dopamine pathways may also be useful for patients suffering from schizophrenia, one population at risk for Tardive Dyskinesia. We anticipate moving this compound into Phase I clinical trials in 2009. Glucose Dependent Insulin Secretagogues Type II diabetes affects more than 23 million Americans (Datamonitor 2007), and is growing at epidemic proportions world-wide. The disease is characterized by reduced ability to secrete and respond to insulin. Drugs which can enhance the secretion of insulin in response to rising blood glucose levels can improve blood glucose 9 control without increased risk of hypoglycemia. Our scientists are optimizing small molecule compounds that act in this way in order to discover novel oral therapies for glucose control in diabetes. Antiepileptic Drugs Anticonvulsants are utilized in the treatment of epileptic seizures by suppressing the rapid firing of neurons that initiate a seizure. Anticonvulsants also have a mood stabilizing effect that has proved beneficial in bipolar disease. In 2007 anticonvulsants sold approximately $11 billion worldwide (EvaluatePharma, MedAd News). GnRH Antagonists As previously mentioned, GnRH antagonists may be useful in treating certain hormone dependent diseases. Our discovery work in nonpeptide GnRH antagonists continues to focus on endometriosis, uterine fibroids, benign prostatic hyperplasia and oncology indications as we continue to develop additional candidates for preclinical and clinical trials. Programs Subject to Regulatory Review Indiplon Indiplon is a non-benzodiazepine GABAA receptor agonist for the treatment of insomnia which acts via the same mechanism as the currently marketed non-benzodiazepine therapeutics. We obtained the rights to indiplon through an exclusive worldwide sublicense agreement that we entered into with DOV Pharmaceutical, Inc. (DOV) in June 1998. 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 develop- ment, 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. The 2006 FDA Approvable Letter requested that we reanalyze data from certain preclinical and clinical studies to support approval of indiplon 5mg and 10mg capsules for sleep initiation and middle of the night dosing. The 2006 FDA Approvable Letter also requested reexamination of the safety analyses. We held an end-of-review meeting with the FDA related to the 2006 FDA Approvable Letter in August 2006. This meeting was specifically focused on determining the actions needed to bring indiplon capsules from Approvable to Approval in the resubmission of the NDA for indiplon capsules. At the meeting, the FDA requested that the resubmission include further analyses and modifications of analyses previously submitted to address questions raised by the FDA in the initial review. This reanalysis was completed. The FDA also requested, and we completed, a supplemental pharmacokinetic/food effect profile of indiplon capsules including several meal types. On June 12, 2007, we resubmitted our NDA for indiplon 5mg and 10mg capsules seeking clearance to market indiplon capsules for the treatment of insomnia. The FDA accepted the NDA resubmission and established a Prescription Drug User Fee Act (PDUFA) date of December 12, 2007. On December 12, 2007 we received an action letter from the FDA stating the indiplon 5mg and 10mg capsules are approvable (2007 FDA Approvable Letter). The 2007 FDA Approvable Letter acknowledged that the resubmitted NDA had addressed the issues raised in the 2006 FDA Approvable Letter, but set forth new requirements. The new requirements set forth in the 2007 FDA 10 Approvable Letter are the following: (i) an objective/subjective clinical trial in the elderly, (ii) a safety study assessing the rates of adverse events occurring with indiplon when compared to a marketed product, and (iii) a preclinical study to evaluate indiplon administration during the third trimester of pregnancy. In July 2008 we held an end-of-review meeting with the FDA to discuss the 2007 FDA Approvable Letter. We are currently awaiting the final minutes of this meeting. After receipt of the 2007 FDA Approvable Letter, we ceased all indiplon clinical development activities in the United States as well as all pre-commercialization activities. Our Business Strategy Our goal is to become the leading biopharmaceutical company focused on neurological and endocrine-related diseases and disorders. The following are the key elements of our business strategy: Continuing to Advance and Build Our Product Portfolio Focused on Neurological and Endocrine-Related Diseases and Disorders. We believe that by continuing to advance and build our product pipeline, we can mitigate some of the clinical development risks associated with drug development. We currently have eight programs in various stages of research and development, including five programs in clinical development. We take a portfolio approach to managing our pipeline that balances the size of the market opportunities with clear and defined clinical and regulatory paths to approval. We do this to ensure that we focus our internal development resources on innovative therapies with improved probabilities of technical and commercial success. Identifying Novel Drug Targets to Address Unmet Market Opportunities. We seek to identify and validate novel drug targets for internal development or collaboration. For example, the novel drug candidates we have identified to regulate CRF, which is believed to be the central mediator of the body’s stress response, may represent the first new breakthrough for anxiety and depression in over 25 years. GnRH antagonists, compounds designed to reduce the secretions of sex steroids, may represent the first novel non-peptide, non-injectible means of treatment of endometriosis. The creativity and productivity of our discovery research group will continue to be a critical component for our continued success. Our team has a goal of delivering one innovative clinical compound each year to fuel our research and development pipeline. Research and development costs were $55.3 million, $82.0 million, and $97.7 million for the years ended December 31, 2008, 2007 and 2006, respectively. Selectively Establishing Corporate Collaborations with Global Pharmaceutical Companies to Assist in the Development of Our Products and Mitigate Financial Risk while Retaining Significant Commercial Upside. We leverage the development, regulatory and commercialization expertise of our corporate collaborators to accelerate the development of certain of our potential products, while typically retaining co-promotional rights, and at times commercial rights, in North America. We intend to further leverage our resources by selectively entering into additional strategic alliances to enhance our internal development and commercialization capabilities by licensing our technology. Acquiring Rights to Complementary Drug Candidates and Technologies. We plan to continue to selectively acquire rights to products in various stages of development to take advantage of our drug development capabilities. For example, during 2003, we licensed our urocortin 2 product candidate from the Research Development Foundation. Our Corporate Collaborations and Strategic Alliances One of our business strategies is to utilize strategic alliances to enhance our development and commercial- ization capabilities. The following is a summary of our significant collaborations/alliances: GlaxoSmithKline (GSK). In July 2001, we announced a worldwide collaboration with an affiliate of GSK to develop and commercialize CRF antagonists for psychiatric, neurological and gastrointestinal diseases. Under the terms of this agreement, we and GSK will conduct a collaborative research program and collaborate in the development of our current lead compounds, as well as novel back-up candidates and second generation compounds identified through the collaborative research. In addition, we will be eligible to receive milestone payments as compounds progress through the research and development process, royalties on future product sales and co-promotion rights in the U.S. in some circumstances. GSK may terminate the agreement at its discretion upon 90 days prior written notice to us. In such event, we may be entitled to specified payments and all product rights 11 would revert to us. As of December 31, 2008, we had recorded revenues of $4.5 million in license fees, $29.8 million in milestone payments, $19.5 million in sponsored research and $1.4 million in reimbursement of development costs, over the life of the agreement. The sponsored research portion of this collaboration agreement concluded in 2005. Dainippon Sumitomo Pharma Co. Ltd. (DSP). In October 2007, we announced an exclusive license agreement with DSP to develop and commercialize indiplon in Japan. Under the terms of the agreement DSP made an up-front payment to us of $20.0 million and is responsible for all future development, marketing and commercialization costs of indiplon in Japan. We will be eligible to receive additional milestone payments upon specified future events related to the development and commercialization of indiplon in Japan. Should all milestones be achieved, we may be entitled to additional payments totaling up to $115.0 million. We are also entitled to royalties from DSP on future sales of indiplon in Japan. As of December 31, 2008, we had recorded revenue of $3.4 million in license fees from DSP over the life of the agreement. Intellectual Property We seek to protect our lead compounds, compound libraries, expressed proteins, synthetic organic processes, formulations, assays, cloned targets, screening technology and other technologies by filing, or by causing to be filed on our behalf, patent applications in the United States and abroad. These applications have resulted in the issuance of approximately 73 United States patents. Additionally, we have licensed from institutions such as The Salk Institute, DOV, Research Development Foundation and others the rights to issued United States patents, pending United States patent applications, and issued and pending foreign filings. We face the risk that one or more of the above patent applications may be denied. We also face the risk that issued patents that we own or license may be challenged or circumvented or may otherwise not provide protection for any commercially viable products we develop. The technologies we use in our research, as well as the drug targets we select, may infringe the patents or violate the proprietary rights of third parties. If this occurs, we may be required to obtain licenses to patents or proprietary rights of others in order to continue with the commercialization of our products. In addition to the granted and potential patent protection, the United States, the European Union and Japan all provide data protection for new medicinal compounds. If this protection is available, no competitor may use the original applicant’s data as the basis of a generic marketing application during the period of data protection. This period of exclusivity is five years in the United States, six years in Japan and six to ten years in the European Union, measured from the date of FDA, or corresponding foreign, approval. Manufacturing and Distribution We currently rely on, and will continue to rely on, contract manufacturers to produce sufficient quantities of our product candidates for use in our preclinical and anticipated clinical trials. In addition, we intend to rely on third parties to manufacture any products that we may commercialize in the future. We have established an internal pharmaceutical development group to develop manufacturing methods for our product candidates, to optimize manufacturing processes, and to select and transfer these manufacturing technologies to our suppliers. We continue to contract with multiple manufacturers to ensure adequate product supply and to mitigate risk. There currently are a limited number of these manufacturers. Furthermore, some of the contract manufacturers that we have identified to date only have limited experience at manufacturing, formulating, analyzing and packaging our product candidates in quantities sufficient for conducting clinical trials or for commercialization. We currently have no distribution capabilities. In order to independently commercialize any of our product candidates, we must either internally develop distribution capabilities or make arrangements with third parties to perform these services. Marketing and Sales We currently have limited experience in marketing or selling pharmaceutical products. Under our collab- oration agreement with GSK we may have the opportunity to co-promote any products resulting from the 12 collaboration in the United States. To market any of our other products independently would require us to develop a sales force with technical expertise along with establishing commercial infrastructure and capabilities. Government Regulation Regulation by government authorities in the United States and foreign countries is a significant factor in the development, manufacture and marketing of our proposed products and in our ongoing research and product development activities. All of our products will require regulatory approval by government agencies prior to commercialization. In particular, human therapeutic products are subject to rigorous preclinical studies and clinical trials and other approval procedures of the FDA and similar regulatory authorities in foreign countries. Various federal and state statutes and regulations also govern or influence testing, manufacturing, safety, labeling, storage and record-keeping related to such products and their marketing. The process of obtaining these approvals and the subsequent compliance with appropriate federal and state statutes and regulations require the expenditure of substantial time and financial resources. Preclinical studies generally are conducted in laboratory animals to evaluate the potential safety and the efficacy of a product. Drug developers submit the results of preclinical studies to the FDA as a part of an IND application that must be approved before clinical trials can begin in humans. Typically, clinical evaluation involves a time consuming and costly three-phase process. Phase I Clinical trials are conducted with a small number of patients to determine the early safety profile, maximum tolerated dose and pharmacological properties of the product in human volunteers. Phase II Clinical trials are conducted with groups of patients afflicted with a specific disease in order to determine preliminary efficacy, optimal dosages and expanded evidence of safety. Phase III Large-scale, multi-center, comparative clinical trials are conducted with patients afflicted with a specific disease in order to determine safety and efficacy as primary support for regulatory approval by the FDA to market a product candidate for a specific disease. The FDA closely monitors the progress of each of the three phases of clinical trials that are conducted in the United States and may, at its discretion, reevaluate, alter, suspend or terminate the testing based upon the data accumulated to that point and the FDA’s assessment of the risk/benefit ratio to the patient. To date, we have also conducted some of our clinical trials in Europe, Oceania, and South Africa. Clinical trials conducted in foreign countries may also be subject to oversight by regulatory authorities in those countries. Once Phase III trials are completed, drug developers submit the results of preclinical studies and clinical trials to the FDA in the form of an NDA or a biologics licensing application for approval to commence commercial sales. In response, the FDA may grant marketing approval, request additional information or deny the application if the FDA determines that the application does not meet regulatory approval criteria. FDA approvals may not be granted on a timely basis, or at all. Furthermore, the FDA may prevent a drug developer from marketing a product under a label for its desired indications, which may impair commercialization of the product. If the FDA approves the NDA, the drug becomes available for physicians to prescribe in the United States. After approval, the drug developer must submit periodic reports to the FDA, including descriptions of any adverse reactions reported. The FDA may request additional studies, known as Phase IV, to evaluate long-term effects. The FDA may also require a Risk Evaluation and Mitigation Strategy (REMS) safety plan upon approval. In addition to studies requested by the FDA after approval, a drug developer may conduct other trials and studies to explore use of the approved compound for treatment of new indications. The purpose of these trials and studies and related publications is to broaden the application and use of the drug and its acceptance in the medical community. We will also have to complete an approval process similar to that in the United States in virtually every foreign target market for our products in order to commercialize our product candidates in those countries. The approval procedure and the time required for approval vary from country to country and may involve additional testing. Foreign approvals may not be granted on a timely basis, or at all. In addition, regulatory approval of prices is required in most countries other than the United States. The resulting prices may not be sufficient to generate an acceptable return to us or our corporate collaborators. 13 Competition The biotechnology and pharmaceutical industries are subject to rapid and intense technological change. We face, and will continue to face, competition in the development and marketing of our product candidates from biotechnology and pharmaceutical companies, research institutions, government agencies and academic institu- tions. Competition may also arise from, among other things: (cid:129) other drug development technologies; (cid:129) methods of preventing or reducing the incidence of disease, including vaccines; and (cid:129) new small molecule or other classes of therapeutic agents. Developments by others may render our product candidates or technologies obsolete or noncompetitive. We are performing research on or developing products for the treatment of several disorders including endometriosis, anxiety, depression, pain, diabetes, irritable bowel syndrome, insomnia, and other neurological and endocrine related diseases and disorders. Lupron Depot», marketed by TAP Pharmaceuticals, and Synarel» and Depo-Provera», marketed by Pfizer, are gonadotropin-releasing hormone peptide agonists that have been approved for the treatment of endometriosis, infertility, and central precocious puberty. Additionally, Proscar», an enzyme inhibitor marketed by Merck, and Flomax», an alpha blocker marketed by Boehringer Ingelheim Pharmaceuticals, are both used in the treatment of benign prostatic hyperplasia. These drugs may compete with any small molecule gonadotropin-releasing hormone antagonists we develop for these indications. Potential indications for our small molecule CRF antagonists include anxiety disorders, depression, and irritable bowel syndrome, among others, our drug candidates will be commercialized in well-established markets. In the area of anxiety disorders, our product candidates will compete with products such as Valium», marketed by Hoffman-La Roche, Xanax», marketed by Pfizer, BuSpar», marketed by Bristol-Myers Squibb, Zoloft», marketed by Pfizer, Wellbutrin», marketed by GSK and Effexor», marketed by Wyeth, among others, as well as any generic alternatives for each of these products. In the area of depression, our product candidates will compete with products in the antidepressant class, including Prozac» and Cymbalta», marketed by Eli Lilly, Zoloft», marketed by Pfizer, Paxil», marketed by GSK, Effexor», marketed by Wyeth, and Lexapro», marketed by Forest Laboratories, among others. In the area of irritable bowel syndrome, our product candidates will compete with such products as Lotronex» marketed by Prometheus Laboratories Inc. in the United States. Some technologies under development by other pharmaceutical companies could result in additional commercial treatments for depression and anxiety. In addition, a number of companies also are conducting research on molecules to block CRF, which is the same mechanism of action employed by our compounds. In the area of insomnia, Ambien», Sonata», Lunesta», and Rozerem» are currently marketed by Sanofi- Aventis, King Pharmaceuticals, Inc., Sepracor, Inc., and Takeda Pharmaceutical Company, respectively. During 2006, Sanofi-Aventis launched a controlled-release formulation of Ambien» called Ambien CR» and during 2007, generic Ambien» or zolpidem also entered the insomnia market. Somaxon Pharmaceuticals is developing Silenor», a H1 antagonist, for the treatment of insomnia, which has completed Phase III clinical trials and for which the PDUFA date is in February 2009. In the area of schizophrenia, our product candidates will compete with such products as Geodon», marketed by Pfizer, Zyprexa», marketed by Eli Lilly, Risperdal», marketed by Janssen, and Seroquel», marketed by AstraZe- neca, among others. If one or more of these products or programs are successful, it may reduce or eliminate the market for our products. 14 Compared to us, many of our competitors and potential competitors have substantially greater: (cid:129) capital resources; (cid:129) research and development resources, including personnel and technology; (cid:129) regulatory experience; (cid:129) preclinical study and clinical testing experience; (cid:129) manufacturing and marketing experience; and (cid:129) production facilities. Any of these competitive factors could harm our business, prospects, financial condition and results of operations, which could negatively affect our stock price. Employees As of January 31, 2009, we had approximately 125 employees, of which 38 hold Ph.D., M.D. or equivalent degrees. None of our employees are represented by a collective bargaining arrangement, and we believe our relationship with our employees is good. Recruiting and retaining qualified scientific personnel to perform research and development work in the future will be critical to our success. We may not be able to attract and retain personnel on acceptable terms given the competition among biotechnology, pharmaceutical and health care companies, universities and non-profit research institutions for experienced scientists. In addition, we rely on a number of consultants to assist us in formulating our research and development strategies. Insurance We maintain product liability insurance for our clinical trials. We intend to expand our insurance coverage to include the sale of commercial products if marketing approval is obtained for products in development. However, insurance coverage is becoming increasingly expensive, and 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. In addition, we may not be able to obtain commercially reasonable product liability insurance for any products approved for marketing. Available Information Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available on our website at www.neurocrine.com, when such reports are available on the Securities and Exchange Commission website at www.sec.gov. Additionally, copies of our annual report will be made available, free of charge, upon written request. ITEM 1A. RISK FACTORS The following information sets forth risk factors that could cause our actual results to differ materially from those contained in forward-looking statements we have made in this Annual Report on Form 10-K and those we may make from time to time. If any of the following risks actually occur, our business, operating results, prospects or financial condition could be harmed. Additional risks not presently known to us, or that we currently deem immaterial, may also affect our business operations. Risks Related to Our Company We depend on continuing our current collaborations and developing additional collaborations to develop and commercialize our product candidates. Our strategy for fully developing and commercializing our products is dependent upon maintaining our current arrangements and establishing new arrangements with research collaborators, corporate collaborators and others, particularly as it relates to our GnRH and urocortin 2 programs. We have active collaboration agreements with GlaxoSmithKline and Dainippon Sumitomo Pharma Co. Ltd. and previously have had collaborations with Pfizer, 15 Wyeth, Johnson & Johnson, Novartis, Taisho and Eli Lilly and Company. We historically have been dependent upon these corporate collaborators to provide adequate funding for a number of our programs. Under these arrangements, our corporate collaborators are typically responsible for: (cid:129) selecting compounds for subsequent development as drug candidates; (cid:129) conducting preclinical studies and clinical trials and obtaining required regulatory approvals for these drug candidates; and (cid:129) manufacturing and commercializing any resulting drugs. Because we expect to continue to rely heavily on corporate collaborators, the development and commer- cialization of our programs would be substantially delayed if one or more of our current or future collaborators: (cid:129) failed to select a compound that we have discovered for subsequent development into marketable products; (cid:129) failed to gain the requisite regulatory approvals of these products; (cid:129) did not successfully commercialize products that we originate; (cid:129) did not conduct its collaborative activities in a timely manner; (cid:129) did not devote sufficient time and resources to our partnered programs or potential products; (cid:129) terminated its alliance with us; (cid:129) developed, either alone or with others, products that may compete with our products; (cid:129) disputed our respective allocations of rights to any products or technology developed during our collaborations; or (cid:129) merged with a third party that wants to terminate the collaboration. These issues and possible disagreements with current or future corporate collaborators could lead to delays in the collaborative research, development or commercialization of many of our product candidates. Furthermore, disagreements with these parties could require or result in litigation or arbitration, which would be time-consuming and expensive. If any of these issues arise, it may delay the development and commercialization of drug candidates and, ultimately, our generation of product revenues. Our clinical trials may fail to demonstrate the safety and efficacy of our product candidates, which could prevent or significantly delay their regulatory approval. Before obtaining regulatory approval for the sale of any of our potential products, we must subject these product candidates to extensive preclinical and clinical testing to demonstrate their safety and efficacy for humans. Clinical trials are expensive, time-consuming and may take years to complete. In connection with the clinical trials of our product candidates, we face the risks that: (cid:129) the product candidate may not prove to be effective; (cid:129) we may discover that a product candidate may cause harmful side effects; (cid:129) the results may not replicate the results of earlier, smaller trials; (cid:129) we or the FDA or similar foreign regulatory authorities may suspend the trials; (cid:129) the results may not be statistically significant; (cid:129) patient recruitment may be slower than expected; (cid:129) patients may drop out of the trials; and (cid:129) regulatory requirements may change. 16 For example, there is uncertainty regarding future development of indiplon as described below under the risk factor entitled “There is uncertainty regarding future development of our product candidate, indiplon, and we may not be able to meet the requirements to receive regulatory approvals for it.” In addition, late stage clinical trials are often conducted with patients having the most advanced stages of disease. During the course of treatment, these patients can die or suffer other adverse medical effects for reasons that may not be related to the pharmaceutical agent being tested but which can nevertheless adversely affect clinical trial results. Any failure or substantial delay in completing clinical trials for our product candidates may severely harm our business. If we cannot raise additional funding, we may be unable to complete development of our product candidates. We may require additional funding to continue our research and product development programs, to conduct preclinical studies and clinical trials, for operating expenses and to pursue regulatory approvals for product candidates, for the costs involved in filing and prosecuting patent application and enforcing or defending patent claims, if any, as well as costs associated with litigation matters, product in-licensing and any possible acquisitions, and we may require additional funding to establish manufacturing and marketing capabilities in the future. We believe that our existing capital resources, together with investment income, and future payments due under our strategic alliances, will be sufficient to satisfy our current and projected funding requirements for at least the next 12 months. However, these resources might be insufficient to conduct research and development programs as planned. If we cannot obtain adequate funds, we may be required to curtail significantly one or more of our research and development programs or obtain funds through additional arrangements with corporate collaborators or others that may require us to relinquish rights to some of our technologies or product candidates. Our future capital requirements will depend on many factors, including: (cid:129) continued scientific progress in our research and development programs; (cid:129) the magnitude of our research and development programs; (cid:129) progress with preclinical testing and clinical trials; (cid:129) the time and costs involved in obtaining regulatory approvals; (cid:129) the costs involved in filing and pursuing patent applications and enforcing patent claims; (cid:129) competing technological and market developments; (cid:129) the establishment of additional strategic alliances; (cid:129) the cost of commercialization activities and arrangements, including manufacturing of our product candidates; and (cid:129) the cost of product in-licensing and any possible acquisitions. We intend to seek additional funding through strategic alliances, and may seek additional funding through public or private sales of our securities, including equity securities. For example, we have an effective shelf registration statement on file with the Securities and Exchange Commission which allows us to issue shares of our common stock from time to time for an aggregate initial offering price of up to $150 million. In addition, we have previously financed capital purchases and may continue to pursue opportunities to obtain additional debt financing in the future. Recently, the credit markets and the financial services industry have been experiencing a period of unprecedented turmoil and upheaval characterized by the bankruptcy, failure, collapse or sale of various financial institutions and an unprecedented level of intervention from the United States federal government. These events have generally made equity and debt financing more difficult to obtain. Accordingly, additional equity or debt financing might not be available on reasonable terms, if at all. Any additional equity financings will be dilutive to our stockholders and any additional debt financings may involve operating covenants that restrict our business. 17 Our restructuring activities could result in management distractions, operational disruptions and other difficulties. As a result of the uncertainty in the future development of indiplon capsules and tablets, we initiated restructuring activities in an effort to reduce operating costs, including a work force reduction announced in December 2007. Employees whose positions were eliminated in connection with this reduction may seek future employment with our competitors. Although all employees are required to sign a confidentiality agreement with us at the time of hire, we cannot assure you that the confidential nature of our proprietary information will be maintained in the course of such future employment. We also entered into a December 2008 amendment to our facilities lease, under which our landlord will seek to enter into leases with replacement tenants for portions of the front building of our corporate headquarters, thereby reducing our rent under the lease. Our landlord may not be successful in entering into leases with replacement tenants on favorable terms, or at all. Any additional restructuring efforts could divert the attention of our management away from our operations, harm our reputation and increase our expenses. We cannot assure you that we will not undertake additional restructuring activities, that any of our restructuring efforts will be successful, or that we will be able to realize the cost savings and other anticipated benefits from our previous or future restructuring plans. In addition, if we continue to reduce our workforce, it may adversely impact our ability to respond rapidly to any new growth opportunities. There is uncertainty regarding future development of our product candidate, indiplon, and we may not be able to meet the requirements to receive regulatory approvals for it. On December 12, 2007 we received an action letter from the FDA stating that indiplon 5mg and 10mg capsules are approvable (2007 FDA Approvable Letter). The 2007 FDA Approvable Letter acknowledged that our resubmitted NDA for indiplon 5mg and 10mg capsules had addressed the issues raised in a previous approvable letter, but set forth new requirements. The new requirements set forth in the 2007 FDA Approvable Letter are the following: (i) an objective/subjective clinical trial in the elderly, (ii) a safety study assessing the rates of adverse events occurring with indiplon when compared to a marketed product and (iii) a preclinical study to evaluate indiplon administration during the third trimester of pregnancy. After receipt of the 2007 FDA Approvable Letter, we ceased all indiplon clinical development activities in the United States as well as all pre-commercialization activities. We met with the FDA in July 2008 to discuss the 2007 FDA Approvable Letter and we are awaiting the finalization of the written minutes of this meeting from the FDA. The process of preparing and resubmitting the NDA for indiplon would require significant resources and could be time consuming and subject to unanticipated delays and cost. As a result of the 2007 FDA Approvable Letter, there is a significant amount of uncertainty regarding the future development of indiplon. Should the NDA be refiled, the FDA could again refuse to approve the NDA, or could still require additional data analysis or clinical trials, which would require substantial expenditures by us and would further delay the approval process. Even if our indiplon NDA is approved, the FDA may determine that our data do not support elements of the labeling we have requested. In such a case, the labeling actually granted by the FDA could limit the commercial success of the product. The FDA could also require Phase IV, or post-marketing, trials to study the long-term effects of indiplon and could withdraw its approval based on the results of those trials. The FDA could require a Risk Evaluation and Mitigation Strategy (REMS) program for indiplon that could limit the commercial success of the product. We face the risk that for any of the reasons described above, as well as other reasons set forth herein, indiplon may never be approved by the FDA or commercialized anywhere in the world. If we determine that it is impractical or we are unable to refile the NDA, or the FDA refuses to accept or approve the resubmitted NDA for any reason or we experience a further delay in approval and subsequent commercialization of indiplon, our business and reputation may be harmed and our stock price could decline. We have a history of losses and expect to incur losses and negative operating cash flows for the near future, and we may never achieve sustained profitability. Since our inception, we have incurred significant net losses, including net losses of $88.6 million and $207.3 million for the years ended December 31, 2008 and 2007, respectively. As a result of ongoing operating 18 losses, we had an accumulated deficit of $703.3 million and $614.7 million as of December 31, 2008 and 2007, respectively. We do not expect to be profitable for the year ending December 31, 2009 or the foreseeable future. We have not yet obtained regulatory approvals of any products and, consequently, have not generated revenues from the sale of products. Even if we succeed in developing and commercializing one or more of our drugs, we may not be profitable. We also expect to continue to incur significant operating and capital expenditures as we: (cid:129) seek regulatory approvals for our product candidates; (cid:129) develop, formulate, manufacture and commercialize our drugs; (cid:129) in-license or acquire new product development opportunities; (cid:129) implement additional internal systems and infrastructure; and (cid:129) hire additional clinical, scientific and marketing personnel. We also expect to experience negative cash flow for the near future as we fund our operating losses, in-licensing or acquisition opportunities, and capital expenditures. We will need to generate significant revenues to achieve and maintain profitability and positive cash flow. We may not be able to generate these revenues, and we may never achieve profitability in the future. Our failure to achieve or maintain profitability could negatively impact the market price of our common stock. Even if we become profitable, we cannot assure you that we would be able to sustain or increase profitability on a quarterly or annual basis. Because our operating results may vary significantly in future periods, our stock price may decline. Our quarterly revenues, expenses and operating results have fluctuated in the past and are likely to fluctuate significantly in the future. Our revenues are unpredictable and may fluctuate, among other reasons, due to our achievement of product development objectives and milestones, clinical trial enrollment and expenses, research and development expenses and the timing and nature of contract manufacturing and contract research payments. A high portion of our costs are predetermined on an annual basis, due in part to our significant research and development costs. Thus, small declines in revenue could disproportionately affect operating results in a quarter. Because of these factors, our operating results in one or more future quarters may fail to meet the expectations of securities analysts or investors, which could cause our stock price to decline. We license some of our core technologies and drug candidates from third parties. If we default on any of our obligations under those licenses, we could lose our rights to those technologies and drug candidates. We are dependent on licenses from third parties for some of our key technologies. These licenses typically subject us to various commercialization, reporting and other obligations. If we fail to comply with these obligations, we could lose important rights. For example, we have licensed indiplon from DOV Pharmaceutical, Inc. (DOV). In addition, we license some of the core technologies used in our collaborations from third parties, including the CRF receptor we license from The Salk Institute and use in our CRF1 program, and urocortin 2 which we license from Research Development Foundation. Other in-licensed technologies, such as the GnRH receptor we license from Mount Sinai School of Medicine, will be important for future collaborations for our elagolix program. If we were to default on our obligations under any of our licenses, we could lose some or all of our rights to develop, market and sell products covered by these licenses. Likewise, if we were to lose our rights under a license to use proprietary research tools, it could adversely affect our existing collaborations or adversely affect our ability to form new collaborations. We also face the risk that our licensors could, for a number of reasons, lose patent protection or lose their rights to the technologies we have licensed, thereby impairing or extinguishing our rights under our licenses with them. Because the development of our product candidates is subject to a substantial degree of technological uncertainty, we may not succeed in developing any of our product candidates. All of our product candidates are in research, clinical development or in registration with the FDA. Only a small number of research and development programs ultimately result in commercially successful drugs. Potential 19 products that appear to be promising at early stages of development may not reach the market for a number of reasons. These reasons include the possibilities that the potential products may: (cid:129) be found ineffective or cause harmful side effects during preclinical studies or clinical trials; (cid:129) fail to receive necessary regulatory approvals on a timely basis or at all; (cid:129) be precluded from commercialization by proprietary rights of third parties; (cid:129) be difficult to manufacture on a large scale; or (cid:129) be uneconomical to commercialize or fail to achieve market acceptance. If any of our products encounters any of these potential problems, we may never successfully market that product. We have limited marketing experience, sales force or distribution capabilities, and if our products are approved, we may not be able to commercialize them successfully. Although we do not currently have any marketable products, our ability to produce revenues ultimately depends on our ability to sell our products if and when they are approved by the FDA. We currently have limited experience in marketing and selling pharmaceutical products. If we fail to establish successful marketing and sales capabilities or fail to enter into successful marketing arrangements with third parties, our product revenues will suffer. The independent clinical investigators and contract research organizations that we rely upon to conduct our clinical trials may not be diligent, careful or timely, and may make mistakes, in the conduct of our trials. We depend on independent clinical investigators and contract research organizations (CROs) to conduct our clinical trials under their agreements with us. The investigators are not our employees, and we cannot control the amount or timing of resources that they devote to our programs. If independent investigators fail to devote sufficient time and resources to our drug development programs, or if their performance is substandard, it may delay or prevent the approval of our FDA applications and our introduction of new drugs. The CROs we contract with for execution of our clinical trials play a significant role in the conduct of the trials and the subsequent collection and analysis of data. Failure of the CROs to meet their obligations could adversely affect clinical development of our products. Moreover, these independent investigators and CROs may also have relationships with other commercial entities, some of which may compete with us. If independent investigators and CROs assist our competitors at our expense, it could harm our competitive position. We have no manufacturing capabilities. If third-party manufacturers of our product candidates fail to devote sufficient time and resources to our concerns, or if their performance is substandard, our clinical trials and product introductions may be delayed and our costs may rise. We have in the past utilized, and intend to continue to utilize, third-party manufacturers to produce the drug compounds we use in our clinical trials and for the potential commercialization of our future products. We have no experience in manufacturing products for commercial purposes and do not currently have any manufacturing facilities. Consequently, we depend on, and will continue to depend on, several contract manufacturers for all production of products for development and commercial purposes. If we are unable to obtain or retain third-party manufacturers, we will not be able to develop or commercialize our products. The manufacture of our products for clinical trials and commercial purposes is subject to specific FDA regulations. Our third-party manufacturers might not comply with FDA regulations relating to manufacturing our products for clinical trials and commercial purposes or other regulatory requirements now or in the future. Our reliance on contract manufacturers also exposes us to the following risks: (cid:129) contract manufacturers may encounter difficulties in achieving volume production, quality control and quality assurance, and also may experience shortages in qualified personnel. As a result, our contract manufacturers might not be able to meet our clinical schedules or adequately manufacture our products in commercial quantities when required; 20 (cid:129) switching manufacturers may be difficult because the number of potential manufacturers is limited. It may be difficult or impossible for us to find a replacement manufacturer quickly on acceptable terms, or at all; (cid:129) our contract manufacturers may not perform as agreed or may not remain in the contract manufacturing business for the time required to successfully produce, store or distribute our products; and (cid:129) drug manufacturers are subject to ongoing periodic unannounced inspection by the FDA, the DEA, and other agencies to ensure strict compliance with good manufacturing practices and other government regulations and corresponding foreign standards. We do not have control over third-party manufacturers’ compliance with these regulations and standards. Our current dependence upon third parties for the manufacture of our products may harm our profit margin, if any, on the sale of our future products and our ability to develop and deliver products on a timely and competitive basis. If we are unable to retain and recruit qualified scientists or if any of our key senior executives discontinues his or her employment with us, it may delay our development efforts. We are highly dependent on the principal members of our management and scientific staff. The loss of any of these people could impede the achievement of our development objectives. Furthermore, recruiting and retaining qualified scientific personnel to perform research and development work in the future is critical to our success. We may be unable to attract and retain personnel on acceptable terms given the competition among biotechnology, pharmaceutical and health care companies, universities and non-profit research institutions for experienced scientists. In addition, we rely on a significant number of consultants to assist us in formulating our research and development strategy. All of our consultants are employed by employers other than us. They may have commitments to, or advisory or consulting agreements with, other entities that may limit their availability to us. We may be subject to claims that we or our employees have wrongfully used or disclosed alleged trade secrets of their former employers. As is commonplace in the biotechnology industry, we employ individuals who were previously employed at 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. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. Governmental and third-party payors may impose sales and pharmaceutical pricing controls on our products that could limit our product revenues and delay profitability. The continuing efforts of government and third-party payors to contain or reduce the costs of health care through various means may reduce our potential revenues. These payors’ efforts could decrease the price that we receive for any products we may develop and sell in the future. In addition, third-party insurance coverage may not be available to patients for any products we develop. If government and third-party payors do not provide adequate coverage and reimbursement levels for our products, or if price controls are enacted, our product revenues will suffer. If physicians and patients do not accept our products, we may not recover our investment. The commercial success of our products, if they are approved for marketing, will depend upon the acceptance of our products as safe and effective by the medical community and patients. The market acceptance of our products could be affected by a number of factors, including: (cid:129) the timing of receipt of marketing approvals; (cid:129) the safety and efficacy of the products; 21 (cid:129) the success of existing products addressing our target markets or the emergence of equivalent or superior products; and (cid:129) the cost-effectiveness of the products. In addition, market acceptance depends on the effectiveness of our marketing strategy, and, to date, we have very limited sales and marketing experience or capabilities. If the medical community and patients do not ultimately accept our products as being safe, effective, superior and/or cost-effective, we may not recover our investment. Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses. Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq rules, are creating uncertainty for companies such as ours. These laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and management time related to compliance activities. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of our internal controls over financial reporting requires the commitment of significant financial and managerial resources. We expect these efforts to require the continued commitment of significant resources. If we fail to comply with these laws, regulations and standards, our reputation may be harmed and we might be subject to sanctions or investigation by regulatory authorities, such as the Securities and Exchange Commission. Any such action could adversely affect our financial results and the market price of our common stock. The price of our common stock is volatile. The market prices for securities of biotechnology and pharmaceutical companies historically have been highly volatile, and the market has from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. Over the course of the last 12 months, the price of our common stock has ranged from approximately $2 per share to approximately $6 per share. The market price of our common stock may fluctuate in response to many factors, including: (cid:129) the results of our clinical trials; (cid:129) developments concerning our strategic alliance agreements; (cid:129) announcements of technological innovations or new therapeutic products by us or others; (cid:129) general economic and market conditions; (cid:129) developments in patent or other proprietary rights; (cid:129) developments related to the FDA approval process for indiplon; (cid:129) future sales of our common stock by existing stockholders; (cid:129) comments by securities analysts; (cid:129) fluctuations in our operating results; (cid:129) government regulation; (cid:129) health care reimbursement; (cid:129) failure of any of our product candidates, if approved, to achieve commercial success; and (cid:129) public concern as to the safety of our drugs. 22 Negative conditions in the global credit markets may impair the liquidity of a portion of our investment portfolio. Our investment securities consist of auction rate securities, corporate debt securities and government agency securities. As of December 31, 2008, our long-term investments included (at par value) $22.6 million of high-grade (AAA rated) auction rate securities issued by student loan providers. All of these auction rate securities have experienced failed auctions due to lack of liquidity at the time their interest rates were to reset. The recent negative conditions in the global credit markets have prevented some investors from liquidating their holdings, including their holdings of auction rate securities. As a result, certain of these types of securities are not fully liquid and we could be required to hold them until they are redeemed by the issuer, a future auction for these securities is successful, another secondary market evolves for these securities, or they mature. In the event we need to access the funds that are in an illiquid state, we may not be able to do so without a potential loss of principal. As of December 31, 2008, the carrying value of all auction rate securities had been reduced by $3.9 million, from $22.6 million to $18.7 million, reflecting an estimated change in fair market value due primarily to a lack of liquidity. Although the auction rate securities continue to pay interest according to their stated terms, based on valuation models, we have recorded a unrealized loss for an other-than-temporary change in valuation of $3.9 million. If the credit ratings of the security issuers deteriorate or if uncertainties in these markets continue and any decline in market value is determined to be other-than-temporary, we would be required to adjust the carrying value of the investment through an impairment charge, which could negatively affect our financial condition, cash flow and reported earnings. Risks Related to Our Industry We may not receive regulatory approvals for our product candidates or approvals may be delayed. Regulation by government authorities in the United States and foreign countries is a significant factor in the development, manufacture and marketing of our proposed products and in our ongoing research and product development activities. Any failure to receive the regulatory approvals necessary to commercialize our product candidates would harm our business. The process of obtaining these approvals and the subsequent compliance with federal and state statutes and regulations require spending substantial time and financial resources. If we fail or our collaborators or licensees fail to obtain or maintain, or encounter delays in obtaining or maintaining, regulatory approvals, it could adversely affect the marketing of any products we develop, our ability to receive product or royalty revenues, our recovery of prepaid royalties, and our liquidity and capital resources. All of our products are in research and development, and we have not yet received regulatory approval to commercialize any product from the FDA or any other regulatory body. In addition, we have limited experience in filing and pursuing applications necessary to gain regulatory approvals, which may impede our ability to obtain such approvals. In particular, human therapeutic products are subject to rigorous preclinical testing and clinical trials and other approval procedures of the FDA and similar regulatory authorities in foreign countries. The FDA regulates, among other things, the development, testing, manufacture, safety, efficacy, record keeping, labeling, storage, approval, advertising, promotion, sale and distribution of biopharmaceutical products. Securing FDA approval requires the submission of extensive preclinical and clinical data and supporting information to the FDA for each indication to establish the product candidate’s safety and efficacy. The approval process may take many years to complete and may involve ongoing requirements for post-marketing studies. Any FDA or other regulatory approval of our product candidates, once obtained, may be withdrawn. If our potential products are marketed abroad, they will also be subject to extensive regulation by foreign governments. We face intense competition, and if we are unable to compete effectively, the demand for our products, if any, may be reduced. The biotechnology and pharmaceutical industries are subject to rapid and intense technological change. We face, and will continue to face, competition in the development and marketing of our product candidates from academic institutions, government agencies, research institutions and biotechnology and pharmaceutical companies. 23 Competition may also arise from, among other things: (cid:129) other drug development technologies; (cid:129) methods of preventing or reducing the incidence of disease, including vaccines; and (cid:129) new small molecule or other classes of therapeutic agents. Developments by others may render our product candidates or technologies obsolete or noncompetitive. We are performing research on or developing products for the treatment of several disorders including endometriosis, anxiety, depression, pain, diabetes, irritable bowel syndrome, insomnia, and other neurological and endocrine related diseases and disorders, and there are a number of competitors to products in our research pipeline. If one or more of our competitors’ products or programs are successful, the market for our products may be reduced or eliminated. Compared to us, many of our competitors and potential competitors have substantially greater: (cid:129) capital resources; (cid:129) research and development resources, including personnel and technology; (cid:129) regulatory experience; (cid:129) preclinical study and clinical testing experience; (cid:129) manufacturing and marketing experience; and (cid:129) production facilities. If we are unable to protect our intellectual property, our competitors could develop and market products based on our discoveries, which may reduce demand for our products. Our success will depend on our ability to, among other things: (cid:129) obtain patent protection for our products; (cid:129) preserve our trade secrets; (cid:129) prevent third parties from infringing upon our proprietary rights; and (cid:129) operate without infringing upon the proprietary rights of others, both in the United States and internationally. Because of the substantial length of time and expense associated with bringing new products through the development and regulatory approval processes in order to reach the marketplace, the pharmaceutical industry places considerable importance on obtaining patent and trade secret protection for new technologies, products and processes. Accordingly, we intend to seek patent protection for our proprietary technology and compounds. However, we face the risk that we may not obtain any of these patents and that the breadth of claims we obtain, if any, may not provide adequate protection of our proprietary technology or compounds. We also rely upon unpatented trade secrets and improvements, unpatented know-how and continuing technological innovation to develop and maintain our competitive position, which we seek to protect, in part, through confidentiality agreements with our commercial collaborators, employees and consultants. We also have invention or patent assignment agreements with our employees and some, but not all, of our commercial collaborators and consultants. However, if our employees, commercial collaborators or consultants breach these agreements, we may not have adequate remedies for any such breach, and our trade secrets may otherwise become known or independently discovered by our competitors. In addition, although we own a number of patents, the issuance of a patent is not conclusive as to its validity or enforceability, and third parties may challenge the validity or enforceability of our patents. We cannot assure you how much protection, if any, will be given to our patents if we attempt to enforce them and they are challenged in court or in other proceedings. It is possible that a competitor may successfully challenge our patents or that challenges will result in limitations of their coverage. Moreover, competitors may infringe our patents or 24 successfully avoid them through design innovation. To prevent infringement or unauthorized use, we may need to file infringement claims, which are expensive and time-consuming. In addition, in an infringement proceeding a court may decide that a patent of ours is not valid or is unenforceable, or may refuse to stop the other party from using the technology at issue on the grounds that our patents do not cover its technology. Interference proceedings declared by the United States Patent and Trademark Office (USPTO) may be necessary to determine the priority of inventions with respect to our patent applications or those of our licensors. Litigation or interference proceedings may fail and, even if successful, may result in substantial costs and be a distraction to management. We cannot assure you that we will be able to prevent misappropriation of our proprietary rights, particularly in countries where the laws may not protect such rights as fully as in the United States. The technologies we use in our research as well as the drug targets we select may infringe the patents or violate the proprietary rights of third parties. We cannot assure you that third parties will not assert patent or other intellectual property infringement claims against us or our collaborators with respect to technologies used in potential products. If a patent infringement suit were brought against us or our collaborators, we or our collaborators could be forced to stop or delay developing, manufacturing or selling potential products that are claimed to infringe a third party’s intellectual property unless that party grants us or our collaborators rights to use its intellectual property. In such cases, we could be required to obtain licenses to patents or proprietary rights of others in order to continue to commercialize our products. However, we may not be able to obtain any licenses required under any patents or proprietary rights of third parties on acceptable terms, or at all. Even if our collaborators or we were able to obtain rights to the third party’s intellectual property, these rights may be non-exclusive, thereby giving our competitors access to the same intellectual property. Ultimately, we may be unable to commercialize some of our potential products or may have to cease some of our business operations as a result of patent infringement claims, which could severely harm our business. We face potential product liability exposure far in excess of our limited insurance coverage. The use of any of our potential products in clinical trials, and the sale of any approved products, may expose us to liability claims. These claims might be made directly by consumers, health care providers, pharmaceutical companies or others selling our products. We have obtained limited product liability insurance coverage for our clinical trials in the amount of $10 million per occurrence and $10 million in the aggregate. However, our insurance may not reimburse us or may not be sufficient to reimburse us for any expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive, and we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses due to liability. We intend to expand our insurance coverage to include the sale of commercial products if we obtain marketing approval for product candidates in development, but we may be unable to obtain commercially reasonable product liability insurance for any products approved for marketing. On occasion, juries have awarded large judgments in class action lawsuits based on drugs that had unanticipated side effects. A successful product liability claim or series of claims brought against us would decrease our cash reserves and could cause our stock price to fall. Our activities involve hazardous materials, and we may be liable for any resulting contamination or injuries. Our research activities involve the controlled use of hazardous materials. We cannot eliminate the risk of accidental contamination or injury from these materials. If an accident occurs, a court may hold us liable for any resulting damages, which may harm our results of operations and cause us to use a substantial portion of our cash reserves, which would force us to seek additional financing. ITEM 1B. UNRESOLVED STAFF COMMENTS None. 25 ITEM 2. PROPERTIES We lease our two building facility which has approximately 200,000 square feet of laboratory and office space in San Diego, California. We sold our facility and associated real property for $109.0 million in a sale leaseback transaction in December 2007 and entered into a twelve year lease with the purchaser. In December 2008, we entered into an amendment to the lease to provide for the renovation of the front building of our facility in a manner that facilitates multiple tenant usage and establishes a mechanism for us to terminate our use of the front building. We are obligated to reimburse the landlord for the total cost of renovating the front building so that it becomes suitable for multiple tenant usage. We and the landlord will work together in good faith to use commercially reasonable efforts to keep the cost of the renovation from exceeding $5.5 million. The landlord will seek to enter into leases with replacement tenants for portions of the front building, which would result in pro rata reductions of our rent under the lease. In each such instance, we would pay the landlord a rent release fee as well as all applicable tenant improvement costs and leasing commissions. The amendment also terminated our prior right to repurchase the facility and associated real property. We believe that our property and equipment are generally well maintained and in good operating condition. ITEM 3. LEGAL PROCEEDINGS 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. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 26 PART II ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our common stock is traded on the Nasdaq Global Select Market under the symbol “NBIX.” The following table sets forth for the periods indicated the high and low sale price for our common stock. These prices do not include retail markups, markdowns or commissions. High Low Year Ended December 31, 2007 1st Quarter . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . $14.88 14.38 2nd Quarter .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . 12.34 3rd Quarter . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . 13.07 4th Quarter . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . Year Ended December 31, 2008 1st Quarter . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . $ 5.96 6.10 2nd Quarter .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . 6.05 3rd Quarter . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . 5.07 4th Quarter . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . $10.03 11.13 9.20 4.11 $ 4.41 4.16 4.00 2.13 As of January 30, 2009, there were approximately 67 stockholders of record of our common stock. We have not paid any cash dividends on our common stock since inception and do not anticipate paying cash dividends in the foreseeable future. Information about our equity compensation plans is incorporated herein by reference to Item 12 of Part III of this Annual Report on Form 10-K. Recent Sales of Unregistered Securities There were no unregistered sales of equity securities during fiscal 2008. Stock Performance Graph and Cumulative Total Return The graph below shows the cumulative total stockholder return assuming the investment of $100 on the date specified (and the reinvestment of dividends thereafter) in each of (i) Neurocrine Biosciences, Inc.’s common stock, (ii) the Nasdaq Composite Index and (iii) the Nasdaq Biotechnology Index. The comparisons in the graph below are based upon historical data and are not indicative of, or intended to forecast, future performance of our common stock or Indexes. D O L L A R S 140 120 100 80 60 40 20 - 12/03 12/04 12/05 12/06 12/07 12/08 NEUROCRINE BIOSCIENCES, INC. NASDAQ COMPOSITE NASDAQ BIOTECHNOLOGY * $100 INVESTED ON 12/31/03 IN STOCK OR INDEX - INCLUDING REINVESTMENT OF DIVI- DENDS AT FISCAL YEARS ENDING DECEMBER 31. 27 ITEM 6. SELECTED FINANCIAL DATA The following selected financial data have been derived from our audited financial statements. The infor- mation set forth below is not necessarily indicative of our results of future operations and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. STATEMENT OF OPERATIONS DATA Revenues: Sponsored research and development.. . . .. Milestones and license fees . . . .. . . .. . . .. . . .. Sales force allowance . .. . . .. . . .. . . .. . . .. . . .. Grant income and other revenues .. . . .. . . .. $ Total revenues .. . .. . . .. . . .. . . .. . . .. . . .. . . .. Operating expenses: Research and development.. . . .. . . .. . . .. . . .. Sales, general and administrative .. . . .. . . .. Cease-use expense . .. . . .. . . .. . . .. . . .. . . .. . . .. Asset impairment . . .. . . .. . . .. . . .. . . .. . . .. . . .. Total operating expenses . . . .. . . .. . . .. . . .. Loss from operations . .. . . .. . . .. . . .. . . .. . . .. . . .. Other income: Gain (loss) on sale/disposal of assets .. . . .. Interest (expense) income, net.. . . .. . . .. . . .. Total other (expense) income . . .. . . .. . . .. 2008 47 3,919 — 9 3,975 55,291 20,240 15,742 — 91,273 2007 2006 (In thousands, except for loss per share data) 2005 2004 $ 139 986 — 99 1,224 81,985 37,481 — 94,000 $ 6,716 16,038 16,480 — 39,234 97,678 54,873 — — 213,466 152,551 $ 9,187 92,702 22,000 — $ 27,156 57,612 — 408 123,889 85,176 106,628 42,333 — — 148,961 115,066 22,444 — — 137,510 (87,298) (212,242) (113,317) (25,072) (52,334) 3,578 (4,893) (1,315) 129 4,814 4,943 (473) 6,585 6,112 23 2,858 2,881 (136) 6,776 6,640 Loss before income taxes .. . . .. . . .. . . .. . . .. . . .. Income taxes . . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. (88,613) — (207,299) — (107,205) — (22,191) — (45,694) 79 Net loss . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. $ (88,613) $(207,299) $(107,205) $ (22,191) $ (45,773) Net loss per common share: Basic and diluted . . .. . . .. . . .. . . .. . . .. . . .. . . .. $ (2.30) $ (5.45) $ (2.84) $ (0.60) $ (1.26) Shares used in calculation of net loss per common share: Basic and diluted . . .. . . .. . . .. . . .. . . .. . . .. . . .. BALANCE SHEET DATA Cash, cash equivalents and short-term 38,449 38,009 37,722 36,763 36,201 investments . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. Working capital .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. Total assets . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. Long-term debt .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. Accumulated deficit . . .. . . .. . . .. . . .. . . .. . . .. . . .. Total stockholders’ equity . . . .. . . .. . . .. . . .. . . .. $ 80,473 55,329 118,182 — (703,263) 36,774 $ 179,385 153,041 276,654 — (614,650) 118,697 $ 182,604 173,542 389,677 49,152 (407,351) 314,716 $ 273,068 245,617 483,123 53,590 (300,146) 390,104 $ 301,129 254,230 519,217 59,452 (277,955) 393,827 28 ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 29 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, admin- istrative 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 30 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. 31 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: 2008 Year Ended December 31, 2007 (In thousands) 2006 Revenues under collaboration agreements: Pfizer . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . . $ — $ GlaxoSmithKline .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . . Dainippon Sumitomo Pharma Co. Ltd. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . . Other . . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . . 1,034 2,932 — 12 126 487 500 Total revenue under collaboration agreements . .. . . .. . . .. . . .. . . .. . .. . . .. . . . Grant income .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . . 3,966 9 1,125 99 $29,660 9,074 — 500 39,234 — 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 advance- ments 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 32 $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 33 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 preclinical and clinical studies to support approval of indiplon 5mg and 10mg capsules for sleep initiation and middle of the night dosing. The 2006 FDA Approvable Letter also requested reexamination of the safety analyses. We held an end-of-review meeting with the FDA related to the 2006 FDA Approvable Letter in August 2006. This meeting was specifically focused on determining the actions needed to bring indiplon capsules from Approvable to Approval in the resubmission of the NDA for indiplon capsules. At the meeting the FDA requested that the resubmission include further analyses and modifications of analyses previously submitted to address questions raised by the FDA in the initial review. This reanalysis was completed. The FDA also requested, and we completed, a supplemental pharmacokinetic/food effect profile of indiplon capsules including several meal types. On June 12, 2007, we resubmitted our NDA for indiplon 5mg and 10mg capsules seeking clearance to market indiplon capsules for the treatment of insomnia. The FDA accepted the NDA resubmission and established a Prescription Drug User Fee Act (PDUFA) date of December 12, 2007. On December 12, 2007 we received an action 34 letter from the FDA stating the indiplon 5mg and 10mg capsules are approvable (2007 FDA Approvable Letter). The 2007 FDA Approvable Letter acknowledged that the resubmitted NDA had addressed the issues raised in the 2006 FDA Approvable Letter, but set forth new requirements. The new requirements set forth in the 2007 FDA Approvable Letter are the following: (i) an objective/subjective clinical trial in the elderly, (ii) a safety study assessing the rates of adverse events occurring with indiplon when compared to a marketed product and (iii) a preclinical study to evaluate indiplon administration during the third trimester of pregnancy. On October 31, 2007, we entered into an exclusive license agreement with DSP, under which we licensed rights to indiplon to DSP and agreed to collaborate with DSP on the development and commercialization of indiplon in Japan. Pursuant to the license agreement, among other things, we received an up-front license fee of $20 million. We are also eligible to receive additional milestone payments upon specified future events related to the development and commercialization of indiplon in Japan. Should all milestones be achieved, we may be entitled to payments totaling an additional $115 million. Additionally, we are entitled to royalties from DSP on future sales of indiplon in Japan. In July 2008 we held an end-of-review meeting with the FDA to discuss the 2007 FDA Approvable Letter. We are currently awaiting the final minutes of this meeting. After receipt of the 2007 FDA Approvable Letter, we ceased all indiplon clinical development activities in the United States as well as all pre-commercialization activities. Restructuring programs and tender offer. In July 2006 and August 2006, we announced a restructuring program to prioritize research and development efforts and implement cost containment measures. As a result, we terminated our entire sales force in July 2006 and reduced our research and development and general and administrative staff in San Diego by approximately 100 employees in August 2006. In connection with this restructuring, we recorded a one-time charge of approximately $9.5 million in 2006, of which $2.8 million was included in research and development expense and $6.7 million was included in sales, general and administrative expense. Restructuring charges are comprised of salary continuation, outplacement services, and other miscel- laneous costs related to these reductions in force. Substantially all of these expenses were paid in cash during 2006. In September 2006, we completed a tender offer to holders of outstanding options to purchase our common stock under our 2003 Plan and certain prior option plans. The offer was open to eligible employees and active consultants who held options with an exercise price of $20.00 or higher per share as of September 25, 2006. Certain executives and members of the Board of Directors were not eligible to participate in the offer. Approximately 2.0 million options were exchanged or amended resulting in approximately 1.0 million new or amended option grants and approximately 1.0 million cancelled option grants at completion of the offer. New or amended options under the Offer vest annually over a period of three years and have a weighted average exercise price of $10.90. Unamortized share based compensation expense, net of forfeiture rate, related to the offer totaled approximately $8.7 million and is being amortized over 3 years commencing on the completion of the offer. In December 2007, after receipt of the 2007 FDA Approvable Letter, we announced another restructuring program to implement cost containment measures and to focus research and development efforts. As a result, we reduced our research and development and general and administrative staff in San Diego by approximately 125 employees. In connection with this restructuring, we recorded a one-time charge of approximately $6.9 million in the fourth quarter of 2007, of which $4.9 million was included in research and development expense and $2.0 million was included in general and administrative expense. Restructuring charges are comprised of salary continuation, outplacement services, and other miscellaneous costs related to these reductions in force. Substan- tially all of these expenses were paid in cash during the first quarter of 2008. During 2008, we incurred an additional one-time net charge of $2.1 million for severance related to certain executives and other personnel departing the Company, primarily all of which was included in general and administrative expense. Liquidity and Capital Resources At December 31, 2008, our cash, cash equivalents, and investments totaled $101.5 million compared with $179.4 million at December 31, 2007. This decrease was primarily a result of our operating loss of $88.6 million for the year ended December 31, 2008. At December 31, 2007, our cash, cash equivalents, and investments totaled 35 $179.4 million compared with $182.6 million at December 31, 2006. This $3.2 million decrease was primarily a result of our operating loss of $207.3 million for the year ended December 31, 2007, which included $94.0 million of non-cash expenditures related to the prepaid royalty impairment charge. The operating loss was offset by net cash received from our sale-leaseback transaction of $61.0 million and upfront license fees received from DSP of $20.0 million. Net cash used in operating activities during 2008 was $74.2 million compared to $59.3 million in 2007. This increase was primarily due to severance payments of $7.4 million, and the timing of accounts payable and reductions in accounts receivable. Net cash used in operating activities during 2007 was $59.3 million compared to $99.3 million in 2006. This decrease was primarily due to up-front fees received from DSP of $20.0 million, and the timing of accounts payable and reductions in accounts receivable. Net cash provided by investing activities during 2008 was $44.4 million compared to $20.8 million in 2007 and $120.3 million in 2006. These fluctuations resulted primarily from timing differences in investment purchases, sales and maturities and the fluctuations in our portfolio mix between cash equivalents and short-term investment holdings. We expect similar fluctuations to continue in future periods. Capital equipment purchases for 2008, 2007 and 2006 were $1.3 million, $0.6 million, and $3.1 million, respectively. Gross receipts from sales of equipment in 2008 totaled $0.6 million. Net capital equipment purchases for 2009 are expected to be $0.1 million. Net cash used in financing activities during 2008 was $1.5 million compared to cash provided of $57.2 million in 2007 and $10.1 million in 2006. During 2007, we closed the sale of our facility and associated real property for a purchase price of $109.0 million and retired $47.7 million in mortgage debt related to the property. Other debt repayments (primarily related to equipment loans) were $1.5 million, $4.5 million and $5.8 million in 2008, 2007 and 2006, respectively. We had no outstanding debt at December 31, 2008. Additionally, cash proceeds from the issuance of common stock upon exercise of outstanding stock options and pursuant to our employee stock purchase plan were $34,000, $0.6 million and $15.8 million in 2008, 2007 and 2006, respectively. The amount and frequency of stock-related transactions are dependent upon the market performance of our common stock. Auction Rate Securities. Our long-term investments at December 31, 2008 included (at par value) $22.6 million of auction rate securities. With the liquidity issues experienced in global credit and capital markets, these auction rate securities have experienced multiple failed auctions as the amount of securities submitted for sale has exceeded the amount of purchase orders, and as a result, these affected securities are currently not liquid. All of our auction rate securities are secured by student loans, which are backed by the full faith and credit of the federal government (up to approximately 98% of the value of the student loan). Additionally, all of our auction rate securities maintain the highest credit rating of AAA. All of these securities continue to pay interest according to their stated terms (generally 120 basis points over the ninety-one day United States Treasury bill rate) with interest rates resetting every 7 to 28 days. While it is not our intent to hold these securities until their stated ultimate maturity dates, these investments are scheduled to ultimately mature between 2030 and 2047. The valuation of our auction rate securities investment portfolio is subject to uncertainties that are difficult to predict. The fair values of these securities were estimated utilizing a discounted cash flow analysis as of December 31, 2008. The significant assumptions of this valuation model were discount margins ranging from 259 to 339 basis points which are based on industry recognized student loan sector indices, an additional liquidity discount of 150 basis points and an estimated term to liquidity of 6 to 8 years. Other items this analysis considers are the collateralization underlying the security investments, the creditworthiness of the counterparty, and the timing of expected future cash flows. These securities were also compared, when possible, to other observable market data with similar characteristics as the securities held by us. Although the auction rate security investments continue to pay interest according to their stated terms, based on valuation models of the individual securities, we have recognized in the consolidated statement of operations an unrealized loss of approximately $3.9 million in investment income, net for auction rate securities that we have concluded that an other-than-temporary impairment exists. The carrying value in long-term investments for these auction rate securities at December 31, 2008 was $18.7 million. During the fourth quarter of 2008, UBS AG (UBS) extended an offer of Auction Rate Securities Rights (ARS Rights) to holders of illiquid auction rate securities that were maintained by UBS as of February 13, 2008. The ARS Rights provide the holder with the ability to sell the auction rate securities, along with the ARS Rights, to UBS at the par value of the auction rate securities, during an applicable exercise period. The ARS Rights grant UBS the sole 36 discretion and right to sell or otherwise dispose of auction rate securities at any time up until July 2, 2012, without any prior notification of the holder, so long as the holder receives a payment of par upon any sale or disposition. The ARS Rights are not transferable, not tradeable, and will not be quoted or listed on any securities exchange or any other trading network. The offer period for the ARS Rights closed on November 14, 2008 and ARS Rights were issued by UBS during the fourth quarter of 2008. We have elected to participate in the ARS Rights program for all of our outstanding auction rate securities maintained by UBS. We have $14.6 million (at par value) of ARS that are maintained by UBS. Under the terms of the ARS Rights offer, our applicable exercise period begins on June 30, 2010 and ends July 2, 2012. Additionally, we are eligible for a loan of up to 75% of the market value of the auction rate securities, should a loan be needed. It is our intention to sell the auction rate securities and ARS Rights to UBS on June 30, 2010. We elected to measure the ARS Rights under the fair value option of SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115” (SFAS 159), to mitigate volatility in reported earnings due to their linkage to the auction rate securities and recorded other income of approximately $2.4 million, and a corresponding long term investment. Simultaneously, due to the ARS Rights granted by UBS, we made a one-time election to transfer the related auction rate security holdings from available- for-sale securities to trading securities. As a result of this transfer, we recognized an other-than-temporary loss of approximately $2.6 million, and reversed the related temporary valuation allowance that was previously recorded in other comprehensive loss. The recording of the ARS Rights and the recognition of the other-than-temporary impairment loss resulted in a $0.2 million net impact to the consolidated statement of operations for the year ended December 31, 2008. We anticipate that any future changes in the fair value of the ARS Rights will be offset by the changes in the fair value of the related auction rate securities with no material net impact to the consolidated statement of operations. The ARS Rights will continue to be measured at fair value under SFAS 159 until the earlier of their maturity or exercise. The two remaining auction rate securities continue to be treated as available-for-sale investments. These auction rate securities have a par value of $8.0 million on which we have recognized a $1.3 million unrealized loss for an other-than-temporary impairment in the consolidated statement of operations. Changes to estimates and assumptions used in estimating the fair value of the auction rate securities and related ARS Rights may provide materially different values. In addition, actual market exchanges, if any, may occur at materially different amounts. For example, a reduction of the expected term to redemption assumption by 2 years for the auction rate securities and related ARS Rights yielded a net increase in the valuation of these investments of $0.3 million. Other factors that may impact the valuation of our auction rate securities and related ARS Rights include changes to credit ratings of the securities as well as to the underlying assets supporting those securities, rates of default of the underlying assets, underlying collateral value, discount rates, counterparty risk and ongoing strength and quality of market credit and liquidity. At present, in the event we need to access the funds that are in an illiquid state, we may not be able to do so without the possible loss of principal, until a future auction for these investments is successful, another secondary market evolves for these securities, until they are redeemed by the issuer or until they mature. If we are unable to sell these securities in the market or they are not redeemed, we could be required to hold them to maturity. We do not have a need to access these funds for operational purposes in 2009, nor the outstanding auction rate securities with UBS prior to June 30, 2010, the beginning of the ARS Rights exercise period. We will continue to monitor and evaluate these investments on an ongoing basis for impairment. Shelf Registration Statement. In November 2007, we filed a shelf registration statement with the Securities and Exchange Commission, which was declared effective in December 2007. The shelf registration statement allows us to issue shares of our common stock from time to time for an aggregate initial offering price of up to $150 million. The specific terms of offerings, if any, under the shelf registration statement would be established at the time of such offerings. 37 Factors That May Affect Future Financial Condition and Liquidity We anticipate increases in expenditures as we continue to expand our research and development activities. Because of our limited financial resources, our strategies to develop some of our programs include collaborative agreements with major pharmaceutical companies and sales of our common stock in both public and private offerings. Our collaborative agreements typically include a partial recovery of our research costs through license fees, contract research funding and milestone revenues. Our collaborators are also financially and managerially responsible for clinical development and commercialization. In these cases, the estimated completion date would largely be under the control of the collaborator. We cannot forecast, with any degree of certainty, which other proprietary products or indications, if any, will be subject to future collaborative arrangements, in whole or in part, and how such arrangements would affect our capital requirements. The following table summarizes our contractual obligations at December 31, 2008 and the effect such obligations are expected to have on our liquidity and cash flows in future periods. Our license, research and clinical development agreements are generally cancelable with written notice in 0-180 days. In addition to the minimum payments due under our license and research agreements, we may be required to pay up to $22.3 million in milestone payments, plus sales royalties, in the event that all scientific research under these agreements is successful. Some of our clinical development agreements contain incentives for time-sensitive activities. Addi- tionally, our facility lease agreement calls for us to maintain $50.0 million in cash and investments at all times, or increase our security deposit by $5.0 million. Contractual Obligations Total Less than 1 Year 1 - 3 Years (In thousands) 3 - 5 Years More than 5 Years Operating leases . .. . . .. . .. . . .. . . .. . . .. . Property lease(1). . .. . . .. . .. . . .. . . .. . . .. . License and research agreements . .. . Clinical development agreements . .. . $ 50 126,702 595 12,904 $ 50 9,895 140 10,884 $ — $ — 21,949 20,689 210 245 — 2,020 Total contractual obligations.. . . .. . $140,251 $20,969 $22,954 $22,159 $ — 74,169 — — $74,169 (1) Property lease payments includes base rent plus other estimated operating costs that the Company is obligated to pay under the terms of the lease. The funding necessary to execute our business strategies is subject to numerous uncertainties, which may adversely affect our liquidity and capital resources. Completion of clinical trials may take several years or more, but the length of time generally varies substantially according to the type, complexity, novelty and intended use of a product candidate. It is also important to note that if a clinical candidate is identified, the further development of that candidate can be halted or abandoned at any time due to a number of factors. These factors include, but are not limited to, funding constraints, safety or a change in market demand. An important element of our business strategy is to pursue the research and development of a diverse range of product candidates for a variety of disease indications. We pursue this goal through proprietary research and development as well as searching for new technologies for licensing opportunities. This allows us to diversify against risks associated with our research and development spending. To the extent we are unable to maintain a diverse and broad range of product candidates, our dependence on the success of one or a few product candidates would increase. The nature and efforts required to develop our product candidates into commercially viable products include research to identify a clinical candidate, preclinical development, clinical testing, FDA approval and commer- cialization. This process may cost in excess of $1 billion and can take in excess of 10 years to complete for each product candidate. We test our potential product candidates in numerous pre-clinical studies to identify disease indications for which our product candidates may show efficacy. We may conduct multiple clinical trials to cover a variety of indications for each product candidate. As we obtain results from trials, we may elect to discontinue clinical trials for certain product candidates or for certain indications in order to focus our resources on more promising product 38 candidates or indications. The duration and the cost of clinical trials may vary significantly over the life of a project as a result of differences arising during the clinical trial protocol, including, among others, the following: (cid:129) we or the FDA or similar foreign regulatory authorities may suspend the trials; (cid:129) we may discover that a product candidate may cause harmful side effects; (cid:129) patient recruitment may be slower than expected; and (cid:129) patients may drop out of the trials. For each of our programs, we periodically assess the scientific progress and merits of the programs to determine if continued research and development is economically viable. Certain of our programs have been terminated due to the lack of scientific progress and lack of prospects for ultimate commercialization. Because of the uncertainties associated with research and development of these programs, we may not be successful in achieving commercialization. As such, the ultimate timeline and costs to commercialize a product cannot be accurately estimated. Our product candidates have not yet achieved FDA regulatory approval, which is required before we can market them as therapeutic products in the United States. In order to proceed to subsequent clinical trial stages and to ultimately achieve regulatory approval, the FDA must conclude that our clinical data establish safety and efficacy. We must satisfy the requirements of similar regulatory authorities in foreign countries in order to market products in those countries. The results from preclinical testing and early clinical trials may not be predictive of results in later clinical trials. It is possible for a candidate to show promising results in clinical trials, but subsequently fail to establish sufficient safety and efficacy data necessary to obtain regulatory approvals. As a result of the uncertainties discussed above, among others, the duration and completion costs of our research and development projects are difficult to estimate and are subject to considerable variation. Our inability to complete our research and development projects in a timely manner or our failure to enter into collaborative agreements, when appropriate, could significantly increase our capital requirements and could adversely impact our liquidity. These uncertainties could force us to seek additional, external sources of financing from time to time in order to continue with our business strategy. Our inability to raise additional capital, or to do so on terms reasonably acceptable to us, would jeopardize the future success of our business. We also may be required to make further substantial expenditures if unforeseen difficulties arise in other areas of our business. In particular, our future capital requirements will depend on many factors, including: (cid:129) continued scientific progress in our research and development programs; (cid:129) the magnitude of our research and development programs; (cid:129) progress with preclinical testing and clinical trials; (cid:129) the time and costs involved in obtaining regulatory approvals; (cid:129) the costs involved in filing and pursuing patent applications and enforcing patent claims; (cid:129) competing technological and market developments; (cid:129) the establishment of additional collaborations and strategic alliances; (cid:129) the cost of manufacturing facilities and of commercialization activities and arrangements; and (cid:129) the cost of product in-licensing and any possible acquisitions. We believe that our existing capital resources, together with investment income and future payments due under our strategic alliances, will be sufficient to satisfy our current and projected funding requirements for at least the next 12 months. However, we cannot guarantee that our existing capital resources and anticipated revenues will be sufficient to conduct and complete all of our research and development programs as planned. We will require additional funding to continue our research and product development programs, to conduct preclinical studies and clinical trials, for operating expenses, to pursue regulatory approvals for our product 39 candidates, for the costs involved in filing and prosecuting patent applications and enforcing or defending patent claims, if any, for the cost of product in-licensing and for any possible acquisitions, and we may require additional funding to establish manufacturing and marketing capabilities in the future. We may seek to access the public or private equity markets whenever conditions are favorable. For example, we have an effective shelf registration statement on file with the Securities and Exchange Commission which allows us to issue shares of our common stock from time to time for an aggregate initial offering price up to $150 million. We may also seek additional funding through strategic alliances and other financing mechanisms. We cannot assure you that adequate funding will be available on terms acceptable to us, if at all. Any additional equity financings will be dilutive to our stockholders and any additional debt may involve operating covenants that may restrict our business. If adequate funds are not available through these means, we may be required to curtail significantly one or more of our research or development programs or obtain funds through arrangements with collaborators or others. This may require us to relinquish rights to certain of our technologies or product candidates. To the extent that we are unable to obtain third-party funding for such expenses, we expect that increased expenses will result in increased losses from operations. We cannot assure you that we will successfully develop our products under development or that our products, if successfully developed, will generate revenues sufficient to enable us to earn a profit. Interest Rate Risk We are exposed to interest rate risk on our short-term investments. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest in highly liquid and high quality government and other debt securities. To minimize our exposure due to adverse shifts in interest rates, we invest in short-term securities and ensure that the maximum average maturity of our investments does not exceed 36 months. If a 10% change in interest rates were to have occurred on December 31, 2008, this change would not have had a material effect on the fair value of our investment portfolio as of that date. Due to the short holding period of our investments, we have concluded that we do not have a material financial market risk exposure. New Accounting Pronouncements In December 2007, the FASB issued SFAS 141 (revised 2007), “Business Combinations” (SFAS 141(R)). SFAS 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired in connection with business combinations. SFAS 141(R) also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141(R) is effective for fiscal years beginning on or after December 15, 2008. We do not expect the adoption of SFAS 141(R) to have a material effect on our consolidated results of operations and financial condition. In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of Accounting Research Bulletin No. 51” (SFAS 160). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008. We do not expect the adoption of SFAS 160 to have a material effect on our consolidated results of operations and financial condition. In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133” (SFAS 161). SFAS 161 applies to all derivative instruments and related hedged items accounted for under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133). SFAS 161 requires entities to provide greater transparency about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. We do not expect the adoption of SFAS 161 to have a material effect on our consolidated results of operations and financial condition. 40 We also adopted the following accounting standards in 2008, none of which had a material effect on our consolidated results of operations during such period or financial condition at the end of such period: (cid:129) Emerging Issues Task Force EITF Issue 07-3, “Accounting for Non-Refundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities” (cid:129) SFAS 162, “The Hierarchy of Generally Accepted Accounting Principles” We adopted SFAS 157, “Fair Value Measurements” (SFAS 157) and SFAS 157-3, “Determining the Value of a Financial Asset When the Market for That Asset Is Not Active” (SFAS 157-3). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157-3 expanded on the implementation guidance in SFAS 157 for estimating the present value of future cash flows for some hard-to-value financial instruments such as auction rate securities. The adoption of SFAS 157 and SFAS 157-3 did not have a material impact on our consolidated results of operations and financial position. We adopted SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115.” SFAS 159 permits companies to choose to measure certain financial assets and liabilities at fair value (the “fair value option”). If the fair value option is elected, any upfront costs and fees related to the item must be recognized in earnings and cannot be deferred, e.g. debt issue costs. The fair value election is irrevocable and may generally be made on an instrument-by-instrument basis, even if a company has similar instruments that it elects not to fair value. At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings. The adoption of SFAS 159 did not have a material impact on our consolidated results of operations and financial position as the fair value option was not elected for any of our financial assets or financial liabilities at the date of adoption. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information required by this item is contained in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Interest Rate Risk.” Such information is incorporated herein by reference. 41 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NEUROCRINE BIOSCIENCES, INC. INDEX TO THE FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Consolidated Balance Sheets . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Consolidated Statements of Operations . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Consolidated Statements of Stockholders’ Equity . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Consolidated Statements of Cash Flows .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Notes to the Consolidated Financial Statements . . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . Page 43 44 45 46 47 48 42 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders Neurocrine Biosciences, Inc. We have audited the accompanying consolidated balance sheets of Neurocrine Biosciences, Inc. as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Neurocrine Biosciences, Inc. at December 31, 2008 and 2007, and the consolidated results of its operations and its consolidated cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, Neurocrine Biosciences, Inc. changed its method of accounting and disclosures for fair value measurements and fair value reporting of financial assets and liabilities in accordance with Statement of Financial Accounting Standards No. 157, Fair Value Measurements, and Statement of Financial Accounting Standards No. 159, the Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Neurocrine Biosciences, Inc.’s internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 2, 2009, expressed an unqualified opinion thereon. San Diego, California February 2, 2009 /s/ Ernst & Young LLP 43 NEUROCRINE BIOSCIENCES, INC. Consolidated Balance Sheets December 31, 2008 2007 (In thousands, except for par value and share totals) Current assets: ASSETS Cash and cash equivalents . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . $ 68,467 12,006 Short-term investments, available-for-sale . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . 39 Receivables under collaborative agreements .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . 911 Other current assets .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . $ 99,664 79,721 27 3,536 Total current assets . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Property and equipment, net . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Long-term investments .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Restricted cash . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Other non-current assets . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . 81,423 6,191 21,057 6,409 3,102 182,948 82,598 — 6,399 4,709 Total assets .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . $ 118,182 $ 276,654 Current liabilities: LIABILITIES AND STOCKHOLDERS’ EQUITY Accounts payable . . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . $ Accrued liabilities . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Current portion of deferred revenues . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Current portion of cease-use liability . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Current portion of deferred gain on sale of real estate .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Current portion of long-term debt .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Total current liabilities . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Deferred revenues . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Deferred gain on sale of real estate . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Deferred rent .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Leaseback financing obligation . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Cease-use liability . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Other liabilities . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Total liabilities . . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . 1,599 10,905 2,936 7,870 2,784 — 26,094 11,676 32,867 110 — 7,527 3,134 81,408 $ 3,776 21,717 2,928 — — 1,486 29,907 14,595 — — 108,745 — 4,710 157,957 Commitments and contingencies Stockholders’ equity: Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued and outstanding . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Common stock, $0.001 par value; 110,000,000 shares authorized; issued and outstanding shares were 38,598,789 at December 31, 2008 and 38,273,979 at December 31, 2007 . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Additional paid-in capital . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Accumulated other comprehensive loss . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . Accumulated deficit .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . — — 39 741,568 (1,570) (703,263) 38 733,542 (233) (614,650) Total stockholders’ equity . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . 36,774 118,697 Total liabilities and stockholders’ equity . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . $ 118,182 $ 276,654 See accompanying notes. 44 NEUROCRINE BIOSCIENCES, INC. Consolidated Statements of Operations Year Ended December 31, 2007 (In thousands, except loss per share data) 2006 2008 Revenues: Sponsored research and development . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Milestones and license fees . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Sales force allowance . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Grant income . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. $ Total revenues . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Operating expenses: Research and development . . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Sales, general and administrative . . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Cease-use expense .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Asset impairment. . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. 47 3,919 — 9 3,975 55,291 20,240 15,742 — $ 139 986 — 99 1,224 81,985 37,481 — 94,000 $ 6,716 16,038 16,480 — 39,234 97,678 54,873 — — Total operating expenses . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. 91,273 213,466 152,551 Loss from operations .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Other (expense) and income: (87,298) (212,242) (113,317) Gain (loss) on sale/disposal of assets . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Investment income, net . . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Interest expense . . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. 3,578 2,132 (7,025) Total other (expense) and income . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. (1,315) 129 8,737 (3,923) 4,943 (473) 10,307 (3,722) 6,112 Net loss .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. $(88,613) $(207,299) $(107,205) Net loss per common share: Basic and diluted . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. $ (2.30) $ (5.45) $ (2.84) Shares used in the calculation of net loss per common share: Basic and diluted . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. 38,449 38,009 37,722 See accompanying notes. 45 NEUROCRINE BIOSCIENCES, INC. Consolidated Statements of Stockholders’ Equity Common Stock Shares Amount Additional Paid-in Capital BALANCE AT DECEMBER 31, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37,132 Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized gain on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance of common stock for option exercises . . . . . . . . . . . . . . . . . . . . . . . . Issuance of common stock for exercise of warrants . . . . . . . . . . . . . . . . . . . Share-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance of common stock pursuant to the Employee Stock Purchase Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BALANCE AT DECEMBER 31, 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37,906 Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized gain on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Share-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reclassification of share-based compensation liability. . . . . . . . . . . . . . . . . Issuance of common stock for restricted share units vested . . . . . . . . . . . Issuance of common stock for option exercises . . . . . . . . . . . . . . . . . . . . . . . . BALANCE AT DECEMBER 31, 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,274 Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized loss on investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Share-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance of common stock for restricted share units vested . . . . . . . . . . . Issuance of common stock for option exercises . . . . . . . . . . . . . . . . . . . . . . . . BALANCE AT DECEMBER 31, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,599 $37 — — — — — — 579 1 147 — — — 48 — 38 — — — — — — — — — — 290 — 78 — 38 — — — — — — — — 1 316 9 — $39 $691,717 — — — 15,368 44 14,365 436 721,930 — — — 9,983 933 105 591 733,542 — — — 7,993 — 33 $741,568 Accumulated Other Comprehensive (Loss) Income (In thousands) Accumulated Deficit Total Stockholders’ Equity $(1,504) — 1,603 $(300,146) (107,205) — $ 390,104 (107,205) 1,603 — — — — — 99 — (332) — — — — — (233) — (1,337) — — — — $(1,570) — (105,602) 15,369 — — 44 14,365 — — (407,351) (207,299) — 436 314,716 (207,299) (332) — (207,631) 9,983 — 933 — 105 — 591 — 118,697 (614,650) (88,613) (88,613) — (1,337) (89,950) — 7,993 — 1 — 33 — $ 36,774 $(703,263) See accompanying notes. 46 NEUROCRINE BIOSCIENCES, INC. Consolidated Statements of Cash Flows 2008 Years Ended December 31, 2007 (In thousands) 2006 $(88,613) $(207,299) $(107,205) CASH FLOW FROM OPERATING ACTIVITIES Net loss .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. (Gain)/loss on sale/abandonment of assets .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Fair value adjustment for auction rate security rights. . . .. . . .. . . .. . . .. . . .. (Gain)/loss on sale of investments . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Fair value adjustment for auction rate securities . .. . .. . . .. . . .. . . .. . . .. . . .. Cease-use expense .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Deferred revenues . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Deferred rent. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Asset impairment. . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Loan forgiveness on notes receivable . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Non-cash stock compensation expense .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Change in operating assets and liabilities: Accounts receivable and other current assets . . .. . .. . . .. . . .. . . .. . . .. . . .. Other non-current assets . . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Other non-current liabilities . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Accounts payable and accrued liabilities . . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Net cash used in operating activities . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. CASH FLOW FROM INVESTING ACTIVITIES Purchases of short-term investments . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Sales/maturities of short-term investments . . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Deposits and restricted cash .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Proceeds from sales of property and equipment . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Purchases of property and equipment, net . . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Net cash provided by investing activities .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. CASH FLOW FROM FINANCING ACTIVITIES Issuance of common stock . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Principal payments on debt . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Leaseback financing obligation.. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Net cash (used in) provided by financing activities . .. . .. . . .. . . .. . . .. . . .. . . .. 7,610 (3,578) (2,350) 412 3,894 15,397 (2,911) 110 — — 7,993 2,613 (185) (1,576) (12,989) (74,173) (36,986) 82,132 1 603 (1,322) 44,428 34 (1,486) — (1,452) 9,404 (129) — (812) — — 17,523 — 94,000 305 9,983 7,491 278 56 9,866 10,566 473 — 32 — — (6,537) — — 50 14,365 (4,812) (508) (43) (5,715) (59,334) (99,334) (94,638) 117,130 (1,161) 129 (624) 20,836 591 (52,155) 108,745 57,181 18,683 80,981 (64,044) 186,910 525 — (3,110) 120,281 15,849 (5,763) — 10,086 31,033 49,948 Net (decrease) increase in cash and cash equivalents . . .. . . .. . . .. . . .. . . .. . . .. Cash and cash equivalents at beginning of the year .. . .. . . .. . . .. . . .. . . .. . . .. (31,197) 99,664 Cash and cash equivalents at end of the year .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. $ 68,467 $ 99,664 $ 80,981 SUPPLEMENTAL DISCLOSURES Supplemental disclosures of cash flow information: Interest paid on debt obligations . . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Taxes paid. . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. $ $ 74 $ — $ 3,090 $ — $ 3,694 — See accompanying notes. 47 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 2008 NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business Activities. Neurocrine Biosciences, Inc. (the Company or Neurocrine) incorporated in California in 1992 and reincorporated in Delaware in 1996. The Company discovers, develops and intends to commercialize drugs for the treatment of neurological and endocrine-related diseases and disorders. The Company’s 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. Subsidiaries of the Company include Neurocrine Continental, Inc. (formerly Neurocrine Commercial Oper- ations, Inc.), a Delaware corporation and wholly owned subsidiary of the Company, and Neurocrine HQ Inc., a Delaware corporation and wholly owned subsidiary of the Company, both of which are primarily inactive. During 2008, the Company dissolved Science Park Center LLC and Neurocrine International LLC, which previously were subsidiaries of the Company. Principles of Consolidation. The consolidated financial statements include the accounts of Neurocrine as well as its wholly owned subsidiaries. We do not have any significant interests in any variable interest entities. All intercompany transactions and balances have been eliminated in consolidation. Use of Estimates. The preparation of financial statements in conformity with accounting principles gen- erally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. Reclassifications. Certain reclassifications have been made to previously reported amounts to conform to current presentations. Cash Equivalents. The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Short-Term Investments Available-for-Sale. In accordance with Statement of Financial Accounting Stan- dards (SFAS) No. 115, “Accounting for Certain Debt and Equity Securities,” (SFAS 115) short-term investments are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported in other comprehensive loss. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. Realized gains and losses and declines in value judged to be other-than-temporary, if any, on available-for- sale securities are included in other income or expense. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income. Concentration of Credit Risk. Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and short-term investments. The Company has established guidelines to limit its exposure to credit expense by placing investments with high credit quality financial institutions, diversifying its investment portfolio and placing investments with maturities that maintain safety and liquidity. Collaboration Agreements. During the years ended December 31, 2008, 2007 and 2006, collaborative research and development agreements accounted for substantially all of the Company’s revenue. Property and Equipment. Property and equipment are stated at cost and depreciated over the estimated useful lives of the assets using the straight-line method. Building costs were depreciated over an average estimated useful life of 25 years and equipment is over three to seven years. Leasehold improvements are depreciated over the shorter of their estimated useful lives or the remaining lease term. 48 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) Industry Segment and Geographic Information. The Company operates in a single industry segment — the discovery and development of therapeutics for the treatment of neurological and endocrine related diseases and disorders. The Company had limited foreign based operations for the years ended December 31, 2008, 2007 and 2006. Other Non-Current Assets. Other non-current assets include $3.1 million and $4.7 million, respectively, of mutual fund investments related to the Company’s nonqualified deferred compensation plan for certain employees as of December 31, 2008 and 2007, respectively. Net unrealized losses related to these mutual funds were approximately $1.6 million and $0.2 million as of December 31, 2008 and December 31, 2007, respectively. All of the assets held in the Company’s nonqualified deferred compensation plan are recorded at fair value in accordance with SFAS 115 with fair value disclosures presented in accordance with SFAS No. 157, “Fair Value Measurements,” (SFAS 157) (as described in Note 4). The values are categorized as Level 1 assets as they have been obtained from quoted prices in active markets for identical assets. Additionally, the Company has recorded a corresponding liability for the deferred compensation plan in other liabilities. The participants in the deferred compensation plan may select from a variety of deemed investment options and have the ability to make changes in such deemed investments on a daily basis, subject to Plan limitations. A participant may elect to receive all or a portion of his or her deferred compensation on a fixed payment date of his or her choosing and may delay that fixed date, subject to plan limitations. The Board of Directors may, at its sole discretion, suspend or terminate the plan. Impairment of Long-Lived Assets. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (SFAS 144) if indicators of impairment exist, the Company assesses 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 the carrying amount is not recoverable, the Company measures the amount of any impairment by comparing the carrying value of the asset to the present value of the expected future cash flows associated with the use of the asset. The Company carried as a long-lived asset on its balance sheet a prepaid royalty arising from its acquisition in February 2004 of Wyeth’s financial interest in the Company’s drug candidate, indiplon, for $95.0 million, consisting of $50.0 million in cash and $45.0 million in the Company’s common stock. During the fourth quarter of 2007, the Company received a second “approvable” letter from the United States Food and Drug Administration. This second letter requested additional preclinical and clinical trials, which raised a significant amount of uncertainty regarding future clinical development of indiplon. Based on this significant uncertainty, the Company determined that the prepaid royalty was impaired, and a non-cash charge of $94.0 million related to this impairment was required under SFAS 144 to write the value down to zero. Fair Value of Financial Instruments. Financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities, are carried at cost, which management believes approximates fair value because of the short-term maturity of these instruments. Revenue Recognition. Revenues under collaborative research agreements are recognized as research costs and 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 received from the Company’s collaborative partners are nonrefundable. 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. 49 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) License fees are received in exchange for a grant to use the Company’s proprietary technologies on an as-is basis for the term of the collaborative agreement. Milestones are received for specific scientific achievements determined at the beginning of the collaboration. These achievements are substantive and are based on the success of scientific efforts. Comprehensive Income/Loss. Comprehensive income/loss is calculated in accordance with SFAS No. 130, “Comprehensive Income”, (SFAS 130). SFAS 130 requires the disclosure of all components of comprehensive income/loss, including net income and changes in equity during a period from transactions and other events and circumstances generated from non-owner sources. The Company’s other comprehensive income/loss consisted of unrealized gains and losses on investments and is reported in the statements of stockholders’ equity. Research and Development Expenses. Research and development (R&D) expenses include related salaries, contractor fees, clinical trial costs, facilities costs, administrative expenses and allocations of corporate costs. All such costs are charged to R&D expense as incurred. These expenses result from the Company’s independent R&D efforts as well as efforts associated with collaborations and in-licensing arrangements. In addition, the Company funds R&D at other companies and research institutions under agreements, which are generally cancelable. The Company reviews and accrues clinical trial expenses based on work performed, which relies on estimates of total costs incurred based on patient enrollment, completion of patient studies and other events. The Company follows 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. Restructuring. During 2008, the Company incurred a net charge of $2.1 million, primarily included in general and administrative expense, for severance related to certain executives and other personnel departing the Company. During the fourth quarter of 2007, the Company announced staff reductions of approximately 125 employees at its San Diego campus, as part of its restructuring program to prioritize its research and development programs. As a result, the Company communicated to affected employees a plan of organizational restructuring through involuntary terminations. Pursuant to SFAS No. 112, “Employers’ Accounting for Postemployment Benefits” and SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” (SFAS 146) the Company recorded a charge of approximately $6.9 million in 2007, of which $4.9 million was included in research and development and $2.0 million was included in sales, general and administrative expense. The majority of this amount was paid out in the first quarter of 2008. During 2006, the Company eliminated its entire sales force and also reduced its research and development and general and administrative staff in San Diego by approximately 100 employees. Pursuant to SFAS 146, the Company recorded a charge of approximately $9.5 million in 2006 related to this reduction in workforce, of which $2.8 million was included in research and development expense and $6.7 million was included in sales, general and administrative expense. Substantially all costs were paid out in cash during 2006. As of December 31, 2008, the Company had a remaining balance of approximately $1.6 million of accrued restructuring expenses included in the consolidated balance sheet. The liability will be paid over the remaining contractual period of certain severance agreements. The changes to the accrued liability during 2008 are as follows (in thousands): Accrual balance as of December 31, 2007 . .. . . .. . .. . . .. . . .. . . .. . Additional accruals . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . Payments .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . Adjustments . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . $ 6,924 2,463 (7,397) (412) Accrual balance as of December 31, 2008 . .. . . .. . .. . . .. . . .. . . .. . $ 1,578 50 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) Retention Program. On February 27, 2008, the Board of Directors of the Company approved an employee retention program (Retention Program) to provide the Company with a mechanism to retain its non-officer and executive officer employees who were not subject to the Company’s restructuring programs. As part of the Retention Program, the Board approved a one-time cash retention payment totaling $3.2 million, 60% of which was paid in the first quarter of 2008 and the remaining 40% of which was paid in the fourth quarter of 2008. In addition, the Board approved the issuance of restricted stock units (RSUs) covering an aggregate of 1.2 million shares and stock options covering an aggregate of 501,000 shares to its executive officers and certain employees, all of which were issued in the first quarter of 2008. Share-Based Compensation. Prior to January 1, 2006, the Company accounted for share-based compen- sation under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (APB 25). Under APB 25, the Company measured compensation expense for its share-based compensation using the intrinsic value method, that is, as the excess, if any, of the fair market value of the Company’s stock at the grant date over the amount required to be paid to acquire the stock, and provided the disclosures required by SFAS 123, “Accounting for Stock-Based Compensation,” (SFAS 123) and SFAS 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” (SFAS 148). Effective January 1, 2006, the Company began recording compensation expense associated with stock options and other equity-based compensation in accordance with SFAS No. 123 (revised 2004), “Share-Based Payment,” (SFAS 123R) using the modified prospective transition method and therefore has not restated results for prior periods. Under the modified prospective transition method, share-based compensation expense for 2006 includes: 1) compensation expense for all share-based awards granted on or after January 1, 2006 as determined based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R; and 2) compensation expense for share-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123. The Company recognizes compen- sation expense on a straight-line basis over the requisite service period of the award, which is generally four years; however, certain provisions in the Company’s equity compensation plans provide for shorter vesting periods under certain circumstances. On August 1, 2007, the Company amended and restated the Neurocrine Biosciences, Inc. Nonqualified Deferred Compensation Plan (the Plan). Under the terms of the amended and restated Plan, the Company is now required to distribute shares in order to settle any share-based compensation deferred into the Plan by participants. Additionally, participants can no longer diversify share-based awards that are placed into the Plan. In accordance with SFAS 123R and Emerging Issues Task Force 97-14, “Accounting for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested”, the Company has reclassified the portion of the liability representing our obligation related to share-based compensation that had vested as of the date of the Plan modification to additional paid-in-capital. There was no effect on our previously reported net income or accu- mulated deficit. Investment Income. Investment income is comprised of interest and dividends earned on cash, cash equivalents and investments as well as gains and losses realized from activity in the Company’s investment portfolio. The following table presents certain information related to the components of investment income (in thousands): Years Ended December 31, 2007 2006 2008 Interest income . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . Dividends .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . Realized gains/(losses), net . . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . 4,039 70 (1,977) 7,817 108 812 10,237 102 (32) Total . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . $ 2,132 $8,737 $10,307 51 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) Net Loss Per Share. The Company computes net loss per share in accordance with SFAS No. 128, “Earnings Per Share” (SFAS 128). Under the provisions of SFAS 128, basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and common equivalent shares outstanding during the period. Potentially dilutive securities comprised of incremental common shares issuable upon the exercise of stock options and warrants, were excluded from historical diluted loss per share because of their anti-dilutive effect. Dilutive common stock equivalents would include the dilutive effects of common stock options and warrants for common stock. Potentially dilutive securities totaled 39,000, 1.2 million and 1.0 million for the years ended December 31, 2008, 2007 and 2006, respectively, and were excluded from the diluted earnings per share because of their anti-dilutive effect. Impact of Recently Issued Accounting Standards. In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS 141(R)). SFAS 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired in connection with business combinations. SFAS 141(R) also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141(R) is effective for fiscal years beginning on or after December 15, 2008. The Company does not expect the adoption of SFAS 141(R) to have a material effect on its consolidated results of operations and financial condition. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of Accounting Research Bulletin No. 51” (SFAS 160). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008. The Company does not expect the adoption of SFAS 160 to have a material effect on its consolidated results of operations and financial condition. In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133” (SFAS 161). SFAS 161 applies to all derivative instruments and related hedged items accounted for under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133). SFAS 161 requires entities to provide greater transparency about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company does not expect the adoption of SFAS 161 to have a material effect on its consolidated results of operations and financial condition. The Company also adopted the following accounting standards in 2008, none of which had a material effect on its consolidated results of operations during such period or financial condition at the end of such period: (cid:129) Emerging Issues Task Force EITF Issue 07-3, “Accounting for Non-Refundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities” (cid:129) SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” The Company adopted SFAS 157, “Fair Value Measurements” (SFAS 157) and SFAS No. 157-3, “Deter- mining the Value of a Financial Asset When the Market for That Asset Is Not Active” (SFAS 157-3). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157-3 expanded on the implementation guidance in SFAS 157 for estimating the present value 52 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) of future cash flows for some hard-to-value financial instruments such as auction rate securities. The adoption of SFAS 157 and SFAS 157-3 did not have a material impact on the Company’s consolidated results of operations and financial position; however additional disclosure has been added to the financial statements in Note 4. The Company adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities- Including an amendment of FASB Statement No. 115” (SFAS159). SFAS 159 permits companies to choose to measure certain financial assets and liabilities at fair value (the “fair value option”). If the fair value option is elected, any upfront costs and fees related to the item must be recognized in earnings and cannot be deferred, e.g. debt issue costs. The fair value election is irrevocable and may generally be made on an instrument-by-instrument basis, even if a company has similar instruments that it elects not to measure at fair value. At the adoption date, unrealized gains and losses on existing items for which the fair value option has been elected are reported as a cumulative adjustment to beginning retained earnings. The adoption of SFAS 159 did not have a material impact on the Company’s consolidated results of operations and financial position as the fair value option was not elected for any of the Company’s financial assets or financial liabilities at the date of adoption. NOTE 2. SHORT-TERM INVESTMENTS The following is a summary of short-term investments classified as available-for-sale securities (in thousands): Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value December 31, 2008 Securities of government-sponsored enterprises . . . .. . Corporate debt securities . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . $ 9,919 2,039 Total investments .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . $11,958 December 31, 2007 Securities of government-sponsored enterprises . . . .. . Corporate debt securities . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . Other debt securities . . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . $18,264 46,880 14,600 Total investments .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . $79,744 $80 — $80 $ 9 3 — $12 $ — (32) $(32) $ (5) (30) — $(35) $ 9,999 2,007 $12,006 $18,268 46,853 14,600 $79,721 The amortized cost and estimated fair value of debt securities by contractual maturity at December 31, 2008 are shown below (in thousands): Amortized Cost Estimated Fair Value Due in 12 months or less . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . . $11,958 $12,006 The following table presents certain information related to sales of short-term available-for-sale securities (in thousands): Years Ended December 31, 2007 2006 2008 Proceeds from sales . . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . $82,132 $117,130 $186,910 NOTE 3. LONG-TERM INVESTMENTS The Company’s long-term investments at December 31, 2008 included (at par value) $22.6 million of auction rate securities. With the liquidity issues experienced in global credit and capital markets, these auction rate securities have experienced multiple failed auctions as the amount of securities submitted for sale has exceeded the amount of purchase orders, and as a result, these affected securities are currently not liquid. All of the Company’s 53 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) auction rate securities are secured by student loans, which are backed by the full faith and credit of the federal government (up to approximately 98% of the value of the student loan). Additionally, all of the Company’s auction rate securities maintain the highest credit rating of AAA. All of these securities continue to pay interest according to their stated terms (generally 120 basis points over the ninety-one day United States Treasury bill rate) with interest rates resetting every 7 to 28 days. While it is not the Company’s intent to hold these securities until their stated ultimate maturity dates, these investments are scheduled to ultimately mature between 2030 and 2047. The valuation of the Company’s auction rate securities investment portfolio is subject to uncertainties that are difficult to predict. The fair values of these securities are estimated utilizing a discounted cash flow analysis as of December 31, 2008. The significant assumptions of this valuation model were discount margins ranging from 259 to 339 basis points which are based on industry recognized student loan sector indices, required rate of return of 150 basis points and an estimated term to liquidity of 6 to 8 years. Other items this analysis considers are the collateralization underlying the security investments, the creditworthiness of the counterparty, and the timing of expected future cash flows. These securities were also compared, when possible, to other observable market data with similar characteristics as the securities held by the Company. Although the auction rate security investments continue to pay interest according to their stated terms, based on valuation models of the individual securities, the Company has recognized in the consolidated statement of operations a loss of approximately $3.9 million on auction rate securities in other income and expense for which for the Company has concluded that an other-than- temporary impairment exists. The carrying value in long-term investments for these auction rate securities at December 31, 2008 is $18.7 million. During the fourth quarter of 2008, UBS AG (UBS) extended an offer of Auction Rate Securities Rights (ARS Rights) to holders of illiquid auction rate securities that were maintained by UBS as of February 13, 2008. The ARS Rights provide the holder with the ability to sell the auction rate securities, along with the ARS Rights, to UBS at the par value of the auction rate securities, during an applicable exercise period. The ARS Rights grant UBS the sole discretion and right to sell or otherwise dispose of auction rate securities at any time up until July 2, 2012, without any prior notification of the holder, so long as the holder receives a payment of par upon any sale or disposition. The ARS Rights are not transferable, not tradeable, and will not be quoted or listed on any securities exchange or any other trading network. The offer period for the ARS Rights closed on November 14, 2008 and ARS Rights were issued by UBS during the fourth quarter of 2008. The Company has elected to participate in the ARS Rights program for all of its outstanding auction rate securities maintained by UBS. The Company has $14.6 million (par value) of ARS that are maintained by UBS. Under the terms of the ARS Rights offer, the applicable exercise period begins on June 30, 2010 and ends July 2, 2012. Additionally, the Company is eligible for a loan of up to 75% of the market value of the auction rate securities, should a loan be needed. It is the Company’s intention to sell the auction rate securities and ARS Rights to UBS on June 30, 2010. The Company elected to measure the ARS Rights under the fair value option of SFAS 159 to mitigate volatility in reported earnings due to their linkage to the auction rate securitites, and recorded income of approximately $2.4 million, and a corresponding long term investment. The ARS Rights were valued in a similar fashion to the auction rate securities as described above. Simultaneously, due to the ARS Rights granted by UBS, the Company made a one-time election to transfer the related auction rate security holdings from available-for-sale securities to trading securities. As a result of this transfer, the Company recognized an other-than-temporary loss of approx- imately $2.6 million, and reversed the related temporary valuation allowance that was previously recorded in other comprehensive loss. The recording of the ARS Rights and the recognition of the other-than-temporary impairment loss resulted in a $0.2 million net impact to the consolidated statement of operations for the year ended December 31, 2008. The Company anticipates that any future changes in the fair value of the ARS Rights will be offset by the changes in the fair value of the related auction rate securities with no material net impact to the consolidated statement of operations. The ARS Rights will continue to be measured at fair value under SFAS 159 until the earlier of their maturity or exercise. 54 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) The two remaining auction rate securities continue to be treated as available-for-sale investments. These auction rate securities have a par value of $8.0 million on which the Company has recognized a $1.3 million unrealized loss for an other-than-temporary impairment in the consolidated statement of operations. At present, in the event the Company needs to access the funds that are in an illiquid state, the Company may not be able to do so without the possible loss of principal, until a future auction for these investments is successful, another secondary market evolves for these securities, until they are redeemed by the issuer or they mature. If the Company is unable to sell these securities in the market or they are not redeemed, the Company could be required to hold them to maturity. Changes to estimates and assumptions used in estimating the fair value of the auction rate securities and related ARS Rights may provide materially different values. In addition, actual market exchanges, if any, may occur at materially different amounts. For example, a reduction of the expected term to redemption assumption by 2 years for the auction rate securities and related ARS Rights yielded a net increase in on the valuation of these investments of $0.3 million. Other factors that may impact the valuation of our auction rate securities and related ARS Rights include changes to credit ratings of the securities as well as to the underlying assets supporting those securities, rates of default of the underlying assets, underlying collateral value, discount rates, counterparty risk and ongoing strength and quality of market credit and liquidity. NOTE 4. FAIR VALUE MEASUREMENTS As described in Note 1, the Company adopted SFAS 157 on January 1, 2008. SFAS 157, which among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: Level 1: Observable inputs such as quoted prices in active markets; Level 2: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. Cash, cash equivalents, and investments measured at fair value as of December 31, 2008 are classified below based on the three fair value hierarchy tiers described above (in millions): Description Cash & money market funds. . . .. . . .. . . .. Commercial paper(1) .. . . .. . . .. . . .. . . .. . . .. Corporate debt securities(1) . .. . . .. . . .. . . .. Securities of government-sponsored enterprises(1) . . . .. . .. . . .. . . .. . . .. . . .. . . .. Auction rate securities(2).. . . .. . . .. . . .. . . .. ARS Rights (Note 3).. . . .. . . .. . . .. . . .. . . .. 12/31/2008 $ 64.9 10.0 2.0 10.0 18.7 2.4 Fair Value Measurements at December 31, 2008 Using Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $ 64.9 10.0 2.0 10.0 — — $ — — — — — — $ — — — — 18.7 2.4 Total .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. $108.0 $ 86.9 $ — $ 21.1 55 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) Activity for cash, cash equivalents, and investments measured at fair value during the twelve month period ended December 31, 2008 using significant unobservable inputs (Level 3) is presented in the table below (in thousands): Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Beginning balance as of December 31, 2007 . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. Transfers into Level 3 . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. Purchases, sales, issuances and settlements, net .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. Total unrealized losses included in other comprehensive income . . . .. . . .. . . .. . . .. Total unrealized losses included in other income and (expense) .. . . .. . . .. . . .. . . .. Ending balance . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. Amount of total losses for the year included in other income and expense in the consolidated statement of operations attributable to the change in unrealized losses relating to assets still held at the reporting date. . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. $ — 22.6 — — (1.5) $21.1 $ (1.5) (1) Securities are classified as available-for-sale. (2) The Company transferred a portion of its auction rate securities from available-for-sale to trading in the fourth quarter of 2008. The fair value of these auction rate securities was estimated based on the following: (i) the underlying structure of each security; (ii) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; (iii) consideration of the probabilities of default, auction failure, or repurchase at par for each period; (iv) the expected term to liquidity; and (v) its market required rate of return. NOTE 5. PROPERTY AND EQUIPMENT Property and equipment at December 31, 2008 and 2007 consist of the following (in thousands): 2008 2007 Land. . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . Buildings . . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . Tenant improvements . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . Furniture and fixtures . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . Equipment . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . $ — $ 25,370 56,919 — — 1,108 3,177 1,989 43,212 42,059 Less accumulated depreciation . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . 45,156 (38,965) 128,678 (46,080) Property and equipment, net .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . $ 6,191 $ 82,598 For the years ended December 31, 2008, 2007 and 2006, depreciation expense was $7.6 million, $9.4 million and $10.6 million, respectively. During 2008, 2007 and 2006, the Company recognized a gain (loss) of approx- imately $113,000, $129,000 and $(473,000), respectively, related to disposal of equipment. During 2007, the Company sold its corporate headquarters through a sale-leaseback transaction as more fully described in Note 7. 56 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) NOTE 6. ACCRUED LIABILITIES Accrued liabilities at December 31, 2008 and 2007 consist of the following (in thousands): 2008 2007 Accrued employee benefits . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . Accrued severance costs .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . Accrued development costs . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . Other accrued liabilities . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . $ 2,879 1,578 2,985 3,463 $ 4,114 6,924 4,386 6,293 $10,905 $21,717 NOTE 7. COMMITMENTS AND CONTINGENCIES Real Estate. In December 2007, the Company closed the sale of its facility and associated real property for a purchase price of $109.0 million. As part of the sale the Company 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, the Company entered into a lease agreement whereby it leased back the facility for an initial term of 12 years. This lease has been characterized as an operating lease for financial reporting purposes. Under the terms of the lease, the Company pays a basic 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 the Company’s 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 carried as restricted cash on the balance sheet. The Company has 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, the Company 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 No. 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 No. 66, “Accounting for Sales of Real Estate” (SFAS 66) the Company initially deferred the gain on the sale of the building and related vacant parcel due to the repurchase right. The Company established a long-term liability of $108.7 million upon the close of the transaction, essentially the gross proceeds from the real estate sale, and the conveyed real estate assets remained on the Company’s balance sheet as of December 31, 2007. Effective December 10, 2008, the Company 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 also establishes a mechanism for the Company to terminate its use of the front building. The Company continues to occupy the rear building. Pursuant to the terms of the lease amendment, the Company is 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. The Company 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. The Company made a one-time payment of $1.0 million toward renovation costs in January 2009 and 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) beginning 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, the 57 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) Company shall be granted a pro rata reduction in rent under the lease. The Company is required to pay all tenant improvement costs, lease termination costs and leasing commissions in connection with each replacement lease. The lease amendment also terminated the Company’s 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, the Company removed from its balance sheet the long-term liability of $108.7 million and the related previously conveyed real estate related assets of $69.6 million. Additionally, the Company 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, the Company 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, the Company triggered a cease-use date for the front building and has estimated lease termination costs in accordance with 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, the Company 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 the Company as incurred in conjunction with the sublease of the vacated office space. Rent Expense. Rent expense was $1.1 million, $0.3 million and $1.2 million for the years ended December 31, 2008, 2007 and 2006, respectively. Rent paid under the leaseback for the facility was treated as interest expense in accordance with SFAS 98 for the period where the repurchase right existed. This charge totaled $7.0 million and $0.6 million in 2008 and 2007, respectively. The Company recognizes rent expense on a straight- line basis. Equipment Loans. The Company had entered into equipment financing arrangements with lenders to finance equipment purchases, which expired on various dates through the year 2008 and bore interest at rates between 6.3% and 7.3%. The debt obligations were repayable in monthly installments and were secured by the financed equipment. Amounts outstanding under these loans at December 31, 2007 totaled $1.5 million. These equipment loans were fully repaid during 2008. Product Liability. The Company’s business exposes it to liability risks from its potential drug products. A successful product liability claim or series of claims brought against the Company could result in payment of significant amounts of money and divert management’s attention from running the business. The Company may not be able to maintain insurance on acceptable terms, or the insurance may not provide adequate protection in the case of a product liability claim. To the extent that product liability insurance, if available, does not cover potential claims, the Company would be required to self-insure the risks associated with such claims. The Company believes that it carries reasonably adequate insurance for product liability claims. Licensing and Research Agreements. The Company has entered into licensing agreements with various universities and research organizations, which are generally cancelable at the option of the Company with terms ranging from 0-180 days written notice. Under the terms of these agreements, the Company has received licenses to research tools, know-how and technology claimed, in certain patents or patent applications. The Company is required to pay fees, milestones and/or royalties on future sales of products employing the technology or falling under claims of a patent, and some of the agreements require minimum royalty payments. Some of the agreements also require the Company to pay expenses arising from the prosecution and maintenance of the patents covering the licensed technology. The Company continually reassesses the value of the license agreements and cancels them when research efforts are discontinued on these programs. If all licensed and research candidates are successfully developed, the Company may be required to pay milestone payments of approximately $22.3 million over the lives of these agreements, in addition to royalties on sales of the affected products at rates ranging up to 6%. Due to the 58 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) uncertainties of the development process, the timing and probability of the milestone and royalty payments cannot be accurately estimated. Related Party Transactions. The Company has entered into agreements with a research facility for technology. A director of the Company is an employee of this research facility. During the years ended Decem- ber 31, 2008, 2007 and 2006, the Company paid approximately $425,000, $80,000 and $375,000, respectively, to the research facility for this technology. Clinical Development Agreements. The Company has entered into agreements with various vendors for the pre-clinical and clinical development of its product candidates, which are generally cancelable at the option of the Company for convenience or performance, with terms ranging from 0-180 days written notice. Under the terms of these agreements, the vendors provide a variety of services including conducting pre-clinical development research, manufacturing clinical compounds, enrolling patients, recruiting patients, monitoring studies, data analysis and regulatory filing assistance. Payments under these agreements typically include fees for services and reimburse- ment of expenses. Some agreements also may include incentive bonuses for time-sensitive activities. The timing of payments due under these agreements was estimated based on current schedules of clinical studies in progress. Payment schedules for commitments and contractual obligations at December 31, 2008 are as follows (in thousands): Fiscal Year Property Lease(1) Operating Leases Licenses and Research Agreements Clinical Development Agreements 2009 . . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. 2010 . . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. 2011 . . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. 2012 . . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. 2013 . . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. Thereafter .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. $ 9,895 10,192 10,497 10,812 11,137 74,169 $ Total minimum payments . . .. . . .. . . .. . . .. . . .. . . .. $126,702 $ 50 — — — — — 50 $ $ 140 140 105 105 105 — 595 $ 10,884 1,483 537 — — — $ 12,904 (1) Property lease payments includes base rent plus other estimated operating costs that the Company is obligated to pay under the terms of the lease. NOTE 8. SHARE-BASED COMPENSATION Share-Based Compensation Plans. The Company grants stock options, restricted stock units and stock bonuses (collectively, share-based compensation) to its employees and directors under the 2003 Incentive Stock Plan, as amended (the 2003 Plan) and grants stock options to certain employees pursuant to Employment Commencement Nonstatutory Stock Options. Until June 30, 2006, eligible employees could also purchase shares of the Company’s common stock at 85% of the fair market value on the last day of each six-month offering period under the Company’s Amended and Restated Employee Stock Purchase Plan. The benefits provided under these plans are share-based compensation subject to the provisions of SFAS 123R. Since 1992, the Company has authorized a total of 14.7 million shares of common stock for issuance pursuant to its 1992 Plan, 1996 Director Option Plan, 1997 Northwest Neurologic, Inc. Restated Incentive Stock Plan, 2001 Plan, several Employment Commencement Nonstatutory Stock Option Agreements and the 2003 Plan (collectively, the Option Plans). The Option Plans provide for the grant of stock options, restricted stock, restricted stock units, and stock bonuses to officers, directors, employees, and consultants of the Company. Currently, all new grants of stock options are made from the 2003 Plan or through Employment Commencement Nonstatutory Stock Option Agreements. As of December 31, 2008, of the 14.7 million shares reserved for issuance under the Option Plans, 59 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) 2.1 million of these shares were originally reserved for issuance pursuant to the terms of the Company’s 1992 Plan, 1996 Director Stock Option Plan and 2001 Plan and would currently be available for issuance but for the Company’s determination in 2003 not to make further grants under these plans; 6.4 million were issued upon exercise of stock options previously granted or pursuant to restricted stock or stock bonus awards; 5.1 million were subject to outstanding options and restricted stock units; and 1.0 million remained available for future grant under the 2003 Plan. Share awards made under the 2003 Plan that are later cancelled due to forfeiture or expiration return to the pool available for future grants. The Company issues new shares upon the exercise of stock options, the issuance of stock bonus awards and vesting of restricted stock units. The Company’s net loss for the years ended December 31, 2008, 2007 and 2006 includes $8.0 million $10.0 million and $14.4 million of compensation expense respectively, related to the Company’s share-based compensation awards. The compensation expense related to the Company’s share-based compensation arrange- ments is recorded as components of sales, general and administrative expense and research and development expense ($4.1 million and $3.9 million, respectively, for the year ended December 31, 2008). SFAS 123R requires that cash flows resulting from tax deductions in excess of the cumulative compensation cost recognized for options exercised (excess tax benefits) be classified as cash inflows provided by financing activities and cash outflows used in operating activities. Due to the Company’s net loss position, no tax benefits have been recognized in the consolidated statements of cash flows. In November 2005, the FASB issued Staff Position (FSP) No. FAS 123(R)-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards” (FSP 123R-3). Neurocrine has elected to adopt the alternative transition method provided in the FSP 123R-3 for calculating the tax effects of stock-based compen- sation pursuant to SFAS 123R. The alternative transition method includes simplified methods to establish the beginning balance of the APIC pool related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and consolidated statements of cash flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123R. Vesting Provisions of Share-Based Compensation. Stock options granted under the Option Plans primarily have terms of up to ten years from the date of grant, and generally vest over a three to four-year period. Stock bonuses granted under the Option Plans generally have vesting periods ranging from two to four years. Restricted stock units granted under the Option Plans generally have vesting periods of three years. The expense recognized under SFAS 123R is generally recognized ratably over the vesting period. However, certain retirement provisions in the Option Plans provide that employees who are age 55 or older, and have five or more years of service with the Company will be entitled to accelerated vesting of all of the unvested stock option awards upon retirement from the Company. In these cases, 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. Effective January 1, 2006, the maximum contractual term for all options granted from the 2003 Plan was reduced to seven years. Stock Options. The exercise price of all options granted during the years ended December 31, 2008, 2007 and 2006 was equal to the market value on the date of grant. The estimated fair value of each option award granted was determined on the date of grant using the Black-Scholes option valuation model with the following weighted- average assumptions for option grants during the years ended December 31, 2008, 2007 and 2006: Risk-free interest rate . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . Expected volatility of common stock . . .. . . .. . . .. . . .. . . .. . .. . . .. . . Dividend yield . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . Expected option term. . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . 4.75 years 2.7% 69% 0.0% 4.8% 65% 0.0% 4.75 years 4.6% 62% 0.0% 4.3 years Years Ended December 31, 2007 2008 2006 60 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) The risk-free interest rate assumption is based upon observed interest rates appropriate for the expected term of the Company’s employee stock options. The expected volatility is based on the historical volatility of the Company’s stock. The Company has not paid any dividends on common stock since its inception and does not anticipate paying dividends on its common stock in the foreseeable future. Per Staff Accounting Bulletin 107, the Company used the simplified method to compute the expected option term for all options granted. The simplified method was used because the contractual life of the amended or exchanged options varied from approximately three to seven years. The simplified method was used for all subsequent grants because the decline in the Company’s stock price has decreased the exercise activity of option holders and we do not have sufficient historical exercise data to provide a more reasonable basis upon which to estimate expected term. Share-based compensation expense recognized in the Consolidated Statement of Operations for the year ended December 31, 2008 is based on awards ultimately expected to vest, net of estimated forfeitures. 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. Pre-vesting forfeitures for awards with monthly vesting terms were estimated to be 0% in 2008 based on historical experience. The effect of pre-vesting forfeitures for awards with monthly vesting terms has historically been negligible on the Company’s recorded expense. Pre-vesting forfeitures for awards with annual vesting terms were estimated at 5% in 2008 based on historical employee turnover experience. The effect of the restructurings has been excluded from the historical review of employee turnover. The Company’s determination of fair value is affected by the Company’s stock price as well as a number of assumptions that require judgment. The weighted-average fair values of options granted during the years ended December 31, 2008, 2007 and 2006, estimated as of the grant date using the Black-Scholes option valuation model, were $2.86, $6.60 and $9.73, respectively. Tender Offer. On September 26, 2006, the Company completed a Tender Offer (Offer) to holders of outstanding options to purchase its common stock under the 2003 Plan, 1992 Incentive Stock Plan (the 1992 Plan) and 2001 Stock Option Plan, as amended (the 2001 Plan). The Offer was for holders of options under the 2003 Plan to cancel their options in exchange for a lesser number of new options (at a two-for-one exchange ratio) to purchase shares of the Company’s common stock issued under the 2003 Plan and for holders of options under the 1992 Plan and 2001 Plan to cancel one-half of their options and amend their remaining options to purchase shares of the Company’s common stock. The Offer was open to eligible employees and active consultants of the Company who held options with an exercise price of $20.00 or higher per share as of September 25, 2006. Certain executives and members of the Board of Directors were not eligible to participate in the Offer. Approximately 2.0 million options were exchanged or amended resulting in approximately 1.0 million new or amended option grants and approx- imately 1.0 million cancelled option grants at the completion of the Offer. New or amended options under the Offer vest annually over a period of three years and have a weighted average exercise price of $10.90. Share based compensation expense related to the Offer totaled approximately $8.7 million and is being amortized over 3 years commencing on September 26, 2006. A summary of the status of the Company’s stock options as of December 31, 2008 and of changes in options outstanding under the plans during the year ended December 31, 2008 is as follows (in thousands, except for weighted average exercise price data): Outstanding at January 1 . .. . . .. Granted/amended . .. . . .. . . .. . . .. Exercised. . . .. . . .. . . .. . . .. . . .. . . .. Canceled . . . .. . . .. . . .. . . .. . . .. . . .. Options 4,144 626 (8) (1,164) Outstanding at December 31 .. 3,598 2008 2007 Weighted Average Exercise Price Options Weighted Average Exercise Price Options 2006 Weighted Average Exercise Price 4,264 604 (78) (646) 4,144 $28.49 11.44 7.60 45.53 $23.74 6,544 1,609 (578) (3,311) 4,264 $38.32 16.87 26.62 42.36 $28.49 $23.74 4.99 4.17 19.85 $21.78 61 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) Options outstanding at December 31, 2008 have a weighted average remaining contractual term of 3.9 years. For the year ended December 31, 2008, share-based compensation expense related to stock options was $3.7 million. As of December 31, 2008, there is approximately $3.0 million of unamortized compensation cost related to stock options. Compensation cost associated with unvested stock option awards as of December 31, 2008 is expected to be recognized over a remaining weighted-average vesting period of 1.3 years. As of December 31, 2008, there are approximately 2.7 million options exercisable with a weighted average exercise price of $26.57 and a weighted-average remaining contractual term of 3.4 years. The total intrinsic value, which is the amount (if any) by which the exercise price was exceeded by the sale price of the Company’s common stock on the date of sale, of stock option exercises during the years ended December 31, 2008, 2007, and 2006 was $13,000, $0.4 million and $18.1 million, respectively. As of December 31, 2008 the total intrinsic value, of options outstanding and exercisable was $0. Cash received from stock option exercises for the years ended December 31, 2008, 2007 and 2006 was $33,000, $0.6 million and $15.4 million, respectively. On October 24, 2007, the Company entered into Stock Option Cancellation Agreements with certain of its executive officers and directors, pursuant to which certain stock options previously granted to each such executive officer or director, were cancelled in exchange for a nominal payment by the Company of $100 in the aggregate. The Stock Option Cancellation Agreements indicated that other than such nominal payment, the applicable executive officer or director had not received, and would not receive, any additional consideration in exchange for the cancellation of such options. Accordingly, while each such executive officer or director will be eligible to receive future equity grants in connection with the Company’s regular grant practices, no such executive officer or director will receive any future equity award in exchange for the cancellation of such options. The Company recognized approximately $0.4 million of compensation expense in conjunction with the cancellations. Restricted Stock Units. Beginning in January 2006, certain employees are eligible to receive restricted stock units under the 2003 Plan. In accordance with SFAS 123R, the fair value of restricted stock units is estimated based on the closing sale price of the Company’s common stock on the Nasdaq Global Select Market on the date of issuance. The total number of restricted stock awards expected to vest is adjusted by estimated forfeiture rates, which has been estimated at 5% based on historical experience of restricted stock awards. As of December 31, 2008, there is approximately $6.2 million of unamortized compensation cost related to restricted stock units, which is expected to be recognized over a remaining weighted-average vesting period of 1.9 years. The restricted stock units, at the election of eligible employees, may be subject to deferred delivery arrangement. For the year ended December 31, 2008, share-based compensation expense related to restricted stock units was $4.3 million. A summary of the status of the Company’s restricted stock units as of December 31, 2008, 2007, and 2006 and of changes in restricted stock units outstanding under the plan for the three years ended December 31, 2008 is as follows (in thousands, except for weighted average grant date fair value per unit): 2008 Weighted Average Grant Date Fair Value per Unit Number of Units 2007 Weighted Average Grant Date Fair Value per Unit Number of Units 2006 Weighted Average Grant Date Fair Value per Unit Number of Units Restricted stock units outstanding at January 1 . . . . . . . . . . . . . . . . . . . . . . . Restricted stock units granted . . . . 1,066 1,212 Restricted stock units cancelled. . (520) Restricted stock units converted $11.12 5.07 9.55 896 484 (32) $13.11 11.49 11.17 into common shares . . . . . . . . . . . . . . (308) 11.09 (282) 10.86 Restricted stock units outstanding at December 31. . . . . . . . . . . . . . . . . . . 1,450 $ 6.58 1,066 $11.12 — 914 (18) — 896 $ — 13.07 10.90 — $13.11 Employee Stock Purchase Plan. The Company had reserved 725,000 shares of common stock for issuance under the 1996 Employee Stock Purchase Plan, as amended (the Purchase Plan). The Purchase Plan had a six-month 62 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) contribution period with purchase dates of June 30 and December 31 each year. Effective January 1, 2006, the Purchase Plan was amended such that the purchase price of common stock would be at 85% of the fair market value per share of common stock on the date on which the shares are purchased. As of June 30, 2006, 640,000 shares had been issued pursuant to the Purchase Plan. The Company recognized approximately $77,000 in share-based compensation expense related to the purchase on June 30, 2006. Effective July 1, 2006, the Company terminated the Purchase Plan as a result of a review of the Purchase Plan’s effectiveness in providing long-term share ownership to the Company’s employees. In addition, the Purchase Plan had an insufficient amount of shares available to allow full participation by employees. Warrants. The Company has outstanding warrants to purchase 3,940 shares of common stock at $52.05 that expire in December 2012. The following shares of common stock are reserved for future issuance at December 31, 2008 (in thousands): Share based compensation plans . . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . Warrants .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . 6,055 4 Total . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . 6,059 NOTE 9. SIGNIFICANT COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS Dainippon Sumitomo Pharma Co., Ltd. On October 31, 2007, the Company entered into an exclusive license agreement with Dainippon Sumitomo Pharma Co. Ltd. (DSP), under which the Company licensed rights to indiplon to DSP and agreed to collaborate with DSP on the development and commercialization of indiplon in Japan. Pursuant to the license agreement, among other things, the Company received an up-front license fee of $20.0 million. The Company is also eligible to receive additional milestone payments upon specified future events related to the development and commercialization of indiplon in Japan. Should all milestones be achieved, the Company may be entitled to payments totaling an additional $115.0 million. Additionally, the Company is entitled to royalties from DSP on future sales of indiplon in Japan. For the years ending December 31, 2008 and 2007, the Company amortized into revenue $2.9 million and $0.5 million, respectively, of the upfront license fee under the DSP agreement. Pfizer. In December 2002, the Company entered into an exclusive worldwide collaboration with Pfizer, Inc. (Pfizer) to complete the clinical development of, and to commercialize, indiplon for the treatment of insomnia. Under the terms of the agreement, Pfizer and Neurocrine collaborated in the completion of the indiplon Phase III clinical program. During 2003, the Company received an upfront license fee of $100.0 million under the collaboration. For the year ended December 31, 2006, the Company recognized revenue of $6.6 million from the reim- bursement of clinical development expenses under the Pfizer agreement. The Company also amortized into revenue $6.5 million of the upfront license fee for the year ended December 31, 2006. The Company also recognized $16.5 million from Pfizer during 2006 as a sales force allowance for the building and operation of the Company’s 200-person sales force. On June 22, 2006 the Company and Pfizer agreed to terminate the collaboration and license agreements to develop and co-promote indiplon effective December 19, 2006. As a result, the Company reacquired all worldwide rights for indiplon capsules and tablets and is responsible for any further costs associated with development, registration, marketing and commercialization of indiplon. The Company obtained rights to indiplon pursuant to a 1998 Sublicense and Development Agreement with DOV Pharmaceutical, Inc. (DOV) and is responsible for specified milestone payments and royalties to DOVon net sales under the license agreement. Wyeth licensed the indiplon technology to DOV in 1998 in exchange for milestone payments and royalties on future sales of indiplon. On February 26, 2004, the Company entered into 63 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) several agreements with Wyeth and DOV pursuant to which the Company acquired Wyeth’s financial interest in indiplon for approximately $95.0 million, consisting of $50.0 million in cash and $45.0 million of the Company’s common stock. The agreements among the Company, Wyeth and DOV provide that the Company will make milestone and royalty payments to DOV net of amounts that DOV would have been obligated to pay to Wyeth such that the Company will retain all milestone, royalty and other payments on indiplon commercialization that would have otherwise been payable to Wyeth, effectively decreasing the Company’s royalty obligation on sales of indiplon from six percent to three and one-half percent. This transaction was recorded as a prepaid royalty and was to be amortized over the commercialization period of indiplon, based primarily upon total estimated indiplon sales (see Note 1 for a discussion of the impairment of the prepaid royalty). Additionally, the Company is responsible for specified milestone payments up to $3.5 million to DOV Pharmaceutical under the license agreement, of which $2.0 million was paid during 2004, $1.0 million was paid in 2007 and the balance is payable upon commercial- ization of indiplon. GlaxoSmithKline. In July 2001, the Company announced a worldwide collaboration with GlaxoSmithKline (GSK) to develop and commercialize CRF antagonists for psychiatric, neurological and gastrointestinal diseases. Under the terms of this agreement, the Company and GSK will conduct a collaborative research program for up to five years and collaborate in the development of Neurocrine’s current lead CRF compounds, as well as novel back-up candidates and second generation compounds identified through the collaborative research. In addition, the Company will be eligible to receive milestone payments as compounds progress through the research and development process, royalties on future product sales and co-promotion rights in the U.S. under some conditions. GSK may terminate the agreement at its discretion upon prior written notice to the Company. In such event, the Company may be entitled to certain payments and all product rights would revert to Neurocrine. For each of the years ended December 31, 2008, 2007 and 2006, the Company recognized $1.0 million, $0.1 million and $9.1 million, respectively, in revenue under the GSK agreement. The sponsored research portion of this collab- oration agreement ended in 2005. NOTE 10. INCOME TAXES On July 13, 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB No. 109”. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted the provisions of FIN 48 on January 1, 2007. There were no unrecognized tax benefits as of the date of adoption. As a result of the implementation of FIN 48, the Company did not recognize an increase in the liability for unrecognized tax benefits. There are no unrecognized tax benefits included in the balance sheet that would, if recognized, affect the effective tax rate. The adoption of FIN 48 did not impact the Company’s financial condition, results of operations or cash flows. The Company’s practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had no accrual for interest or penalties on the Company’s balance sheets at December 31, 2007 and at December 31, 2008, and has not recognized interest and/or penalties in the statement of operations for the year ended December 31, 2008. The Company is subject to taxation in the United States and various state jurisdictions. The Company’s tax years for 1993 and forward are subject to examination by the United States and California tax authorities due to the carry forward of unutilized net operating losses and R&D credits. At December 31, 2008, the Company had net deferred tax assets of $69.3 million. Due to uncertainties surrounding the Company’s ability to generate future taxable income to realize these assets, a full valuation has 64 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) been established to offset the net deferred tax asset. Additionally, the future utilization of the Company’s net operating loss and research and development credit carry forwards to offset future taxable income may be subject to an annual limitation, pursuant to Internal Revenue Code Sections 382 and 383, as a result of ownership changes that may have occurred previously or that could occur in the future. Although the Company determined that an ownership change had not occurred through January 31, 2007, it is possible that an ownership change occurred subsequent to that date. The Company has not completed an update of its Section 382 analysis subsequent to January 31, 2007. Until this analysis has been updated, the Company has removed the deferred tax assets for net operating losses of $227.2 million and research and development credits of $38.8 million generated through 2008 from its deferred tax asset schedule and has recorded a corresponding decrease to its valuation allowance. Due to the existence of the valuation allowance, future changes in the Company’s unrecognized tax benefits will not impact the Company’s effective tax rate. At December 31, 2008, the Company had Federal and California income tax net operating loss carry forwards of approximately $587.0 million and $488.9 million, respectively. The Federal and California tax loss carry forwards will begin to expire in 2010 and 2012, unless previously utilized. In addition, the Company has Federal and California research and development tax credit carry forwards of $26.8 million and $18.5 million, respectively. The Federal research and development tax credit carry forwards began expiring in 2007 and will continue to expire unless utilized. There were $186,000 of Federal research and development tax credit carryforwards that have expired through 2008. The California research and development tax credit carryforwards carry forward indefinitely. The Company also has Federal Alternative Minimum Tax credit carryforwards of approximately $256,000, which will carry forward indefinitely. At December 31, 2008, approximately $88.3 million of the net operating loss carry forwards relate to stock option exercises, which will result in an increase to additional paid-in capital and a decrease in income taxes payable at the time when the tax loss carryforwards are utilized. Significant components of the Company’s deferred tax assets as of December 31, 2008 and 2007 are listed below. A valuation allowance of $69.3 million and $65.8 million at December 31, 2008 and 2007, respectively, has been recognized to offset the net deferred tax assets as realization of such assets is uncertain. Amounts are shown in thousands as of December 31, of the respective years (in thousands): 2008 2007 Deferred tax assets: Capitalized research and development . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . $ 3,000 2,000 Deferred compensation . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . 8,000 FAS 123R expense . . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . 600 Unrealized losses on investments . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . 6,800 Deferred revenue . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . 14,500 Deferred gain on sales leaseback . . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . 26,000 Intangibles . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . 6,300 Cease-use expense . . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . 2,500 Other . . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . $ 4,000 2,800 6,600 100 8,000 13,700 28,500 — 2,200 Total deferred tax assets.. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . Deferred tax liabilities: Fixed assets .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . Total deferred tax liabilities . . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . 69,700 65,900 400 400 100 100 Net deferred tax asset . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . Valuation allowance .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . 69,300 (69,300) 65,800 (65,800) Net deferred tax assets . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . . $ — $ — 65 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) The provision for income taxes on earnings subject to income taxes differs from the statutory Federal rate at December 31, 2008, 2007 and 2006, due to the following (in thousands): 2008 2007 2006 Federal income taxes at 35% . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . . $(31,014) (5,095) State income tax, net of Federal benefit. .. . . .. . . .. . . .. . . .. . .. . . .. . . . 785 Tax effect on non-deductible expenses . . .. . . .. . . .. . . .. . . .. . .. . . .. . . . 34,237 Removal of net operating losses and R&D credits . .. . . .. . .. . . .. . . . 3,521 Change in valuation allowance .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . . (2,434) Other . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . . $ (72,472) (11,906) 700 231,548 (144,800) (3,070) $(37,522) (6,170) (1,854) — 45,546 — $ — $ — $ — NOTE 11. RETIREMENT PLAN The Company has a 401(k) defined contribution savings plan (401(k) Plan). The 401(k) Plan is for the benefit of all qualifying employees and permits voluntary contributions by employees up to 60% of base salary limited by the IRS-imposed maximum. The Company matches 50% of employee contributions up to 6% of eligible compensation, with cliff vesting over four years. Employer contributions were $430,000, $690,000 and $1,152,000 for the years ended December 31, 2008, 2007, and 2006, respectively. NOTE 12. LEGAL 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 the Company and certain of its 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, the Company 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, the Company 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 the Company’s 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 the Company 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, 66 NEUROCRINE BIOSCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS — (Continued) 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. NOTE 13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) The following is a summary of the quarterly results of operations of the Company for the years ended December 31, 2008 and 2007 (unaudited, in thousands, except for loss per share data): 2007 Revenues . . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . $ Operating expenses . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . Net loss .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . Net loss per share: Quarters Ended Mar 31 Jun 30 Sep 30 Dec 31 Year Ended Dec 31 104 27,378 (25,720) $ 48 27,596 (26,364) $ 540 29,366 (27,240) $ 532 129,126 (127,975) $ 1,224 213,466 (207,299) Basic and diluted . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . $ (0.68) $ (0.69) $ (0.72) $ (3.35) $ (5.45) Shares used in the calculation of net loss per share: Basic and diluted . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . 37,908 37,969 37,990 38,165 38,009 2008 Revenues . . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . $ 1,751 22,513 Operating expenses . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . Net loss .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . (21,077) Net loss per share: $ 734 20,851 (20,971) $ 761 16,465 (17,711) $ 729 31,444 (28,854) $ 3,975 91,273 (88,613) Basic and diluted . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . $ (0.55) $ (0.55) $ (0.46) $ (0.75) $ (2.30) Shares used in the calculation of net loss per share: Basic and diluted . . .. . . .. . . .. . . .. . .. . . .. . . .. . . .. . . 38,330 38,421 38,446 38,599 38,449 67 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. ITEM 9A. CONTROLS AND PROCEDURES We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the timelines specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost- benefit relationship of possible controls and procedures. As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the year covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level. Management’s Report on Internal Control Over Financial Reporting Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that: (1) Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; (2) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorization of our management and directors; and (3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Management is responsible for establishing and maintaining adequate internal control over financial reporting for the company. Management has used the framework set forth in the report entitled Internal Control-Integrated Framework published by the Committee of Sponsoring Organizations of the Treadway Commission, known as COSO, to evaluate the effectiveness of our internal control over financial reporting. Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2008. Ernst & Young, LLP, our independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting, which is included herein. There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 68 Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting The Board of Directors and Stockholders Neurocrine Biosciences, Inc. We have audited Neurocrine Biosciences, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Neurocrine Biosciences’ manage- ment is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Neurocrine Biosciences, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008 based, on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2008 of Neurocrine Biosciences, Inc. and our report dated February 2, 2009 expressed an unqualified opinion thereon. San Diego, California February 2, 2009 /s/ Ernst & Young LLP 69 ITEM 9B. OTHER INFORMATION None PART III ITEM 10. DIRECTORS, OFFICERS AND CORPORATE GOVERNANCE Information required by this item will be contained in our Definitive Proxy Statement for our 2009 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days of December 31, 2008. Such information is incorporated herein by reference. We have adopted a code of ethics that applies to our Chief Executive Officer, Chief Financial Officer, and to all of our other officers, directors, employees and agents. The code of ethics is available at the Corporate Governance section of the Investors page on our website at www.neurocrine.com. We intend to disclose future amendments to, or waivers from, certain provisions of our code of ethics on the above website within four business days following the date of such amendment or waiver. ITEM 11. EXECUTIVE COMPENSATION Information required by this item will be contained in our Definitive Proxy Statement for our 2009 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days of December 31, 2008. Such information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Information required by this item will be contained in our Definitive Proxy Statement for our 2009 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days of December 31, 2008. Such information is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE Information required by this item will be contained in our Definitive Proxy Statement for our 2009 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A, with the Securities and Exchange Commission within 120 days of December 31, 2008. Such information is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information required by this item will be contained in our Definitive Proxy Statement for our 2009 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A, with the Securities and Exchange Commission within 120 days of December 31, 2008. Such information is incorporated herein by reference. 70 PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Documents filed as part of this report. 1. List of Financial Statements. The following are included in Item 8 of this report: Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets as of December 31, 2008 and 2007 Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006 Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2008, 2007 and 2006 Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006 Notes to the Consolidated Financial Statements (includes unaudited Selected Quarterly Financial Data) 2. List of all Financial Statement schedules. All schedules are omitted because they are not applicable or the required information is shown in the Financial Statements or notes thereto. 3. List of Exhibits required by Item 601 of Regulation S-K. See part (b) below. (b) Exhibits. The following exhibits are filed as part of, or incorporated by reference into, this report: Exhibit Number Description Certificate of Incorporation (1) Certificate of Amendment to Certificate of Incorporation (16) Bylaws (1) Certificate of Amendment of Bylaws (8) Certificate of Amendment to Bylaws (17) Form of Common Stock Certificate (1) 1992 Incentive Stock Plan, as amended (6) 1996 Director Stock Option Plan, as amended, and form of stock option agreement (1) 3.1 3.2 3.3 3.4 3.5 4.1 10.1 10.2 10.3* Research and License Agreement dated October 15, 1996, between the Registrant and Eli Lilly and 10.4 10.5* Company (2) Form of incentive stock option agreement and nonstatutory stock option agreement for use in connection with 1992 Incentive Stock Plan (19) Sub-License and Development Agreement dated June 30, 1998, by and between DOV Pharmaceutical, Inc. and the Registrant (3) 10.6* Collaboration and License Agreement dated January 1, 1999, by and between American Home Products Corporation acting through its Wyeth Laboratories Division and the Registrant (4) 10.7* Collaboration and License Agreement between the Registrant and Glaxo Group Limited dated July 20, 2001 (7) 2001 Stock Option Plan, as amended August 6, 2002 and October 15, 2002 (9) Neurocrine Biosciences, Inc. Nonqualified Deferred Compensation Plan, as amended (5) 10.8 10.9 10.10 Neurocrine Biosciences, Inc. 2003 Incentive Stock Plan, as amended and form of stock option agreement and restricted stock unit agreement (21) Tax Indemnity Agreement between the Registrant and Gary Lyons (10) Tax Indemnity Agreement between the Registrant and Margaret Valeur-Jensen (10) Tax Indemnity Agreement between the Registrant and Kevin Gorman (10) 10.11 10.12 10.13 10.14 Assignment and License Agreement dated February 26, 2004 by and among Wyeth Holdings Corporation and the Registrant (11) 71 Exhibit Number 10.15 Stock Purchase Agreement dated March 15, 2004 by and among Wyeth Holdings Corporation and the Registrant (11) Description 10.16 Consent Agreement and Amendment dated February 25, 2004 by and among Wyeth Holdings 10.17 10.18 Corporation, the Registrant and DOV Pharmaceutical, Inc. (11) License Agreement dated February 25, 2004 by and among Wyeth Holdings Corporation and DOV Pharmaceutical, Inc. (11) Employment Commencement Nonstatutory Stock Option Agreement between the Registrant and Christopher O’Brien (14) 10.19 Amendment dated February 7, 2006 to Collaboration and License Agreement between the Registrant and Glaxo Group Limited (18) 10.20 Consulting Agreement dated November 15, 2006 between the Registrant and Wylie Vale (15) 10.21** License Agreement dated October 31, 2007 between the Registrant and Dainippon Sumitomo Pharma Co. Ltd. (20) 10.22** Amendment dated October 29, 2007 to Sub-License and Development Agreement dated June 30, 10.23 10.24 10.25 10.26 10.27 10.28 10.29 10.30 1998, by and between DOV Pharmaceutical, Inc. and the Registrant (20) Lease dated December 4, 2007, between the Registrant and DMH Campus Investors, LLC (13) Letter of Credit dated December 3, 2007, issued by Wells Fargo Bank, N.A. for the benefit of DMH Campus Investors, LLC (13) Employment Agreement dated August 1, 2007 between the Company and Gary A. Lyons (12) Employment Agreement dated August 1, 2007 between the Company and Kevin C. Gorman, Ph.D. (12) Employment Agreement dated August 1, 2007 between the Company and Margaret E. Valeur-Jensen, Ph.D. (12) Employment Agreement dated August 1, 2007 between the Company and Timothy P. Coughlin (12) Employment Agreement dated August 1, 2007 between the Company and Christopher F. O’Brien M.D. (20) Employment Agreement dated August 1, 2007 between the Company and Dimitri E. Grigoriadis, Ph.D. (20) Employment Agreement dated August 1, 2007 between the Company and Haig Bozigian, Ph.D. (20) 10.31 10.32** First Amendment to Lease dated December 10, 2008 between the Company and DMH Campus 21.1 23.1 31.1 31.2 Investors, LLC Subsidiaries of the Registrant Consent of Independent Registered Public Accounting Firm Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934 Certification of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934 32*** Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1) Incorporated by reference to the Company’s Registration Statement on Form S-1 (Registration No. 333-03172) (2) Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1996 filed on March 31, 1997 (3) Incorporated by reference to the Company’s Quarterly Report on Form 10-Q filed on August 14, 1998 (4) Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998 filed on March 31, 1999 (5) Incorporated by reference to the Company’s Quarterly Report on Form 10-Q filed on November 2, 2007 72 (6) Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on July 16, 2001 (7) Incorporated by reference to the Company’s Quarterly Report on Form 10-Q filed on August 14, 2001 (8) Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997 filed on April 10, 1998 (9) Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002 filed on March 4, 2003 (10) Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 filed on March 15, 2004 (11) Incorporated by reference to the Company’s Report on Form 8-K filed on March 17, 2004, as amended (12) Incorporated by reference to the Company’s Quarterly Report on Form 10-Q filed on August 3, 2007 (13) Incorporated by reference to the Company’s Report on Form 8-K filed on December 10, 2007 (14) Incorporated by reference to the Company’s Report on Form 8-K filed on November 1, 2005 (15) Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006 filed on February 9, 2007 (16) Incorporated by reference to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2006 (17) Incorporated by reference to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2004 (18) Incorporated by reference to the Company’s Report on Form 8-K filed on February 13, 2006 (19) Incorporated by reference to the Company’s Registration Statement on Form S-8 filed on June 26, 1998. (20) Incorporated by reference to the Company’s Annual Report on Form 10-K filed on February 11, 2008. (21) Incorporated by reference to the Company’s Quarterly Report on Form 10-Q filed on August 1, 2008 * Confidential treatment has been granted with respect to certain portions of the exhibit. ** Confidential treatment has been requested with respect to certain portions of the exhibit. *** These certifications are being furnished solely to accompany this annual report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of Neurocrine Biosciences, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing. (c) Financial Statement Schedules. See Item 15(a)(2) above. 73 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SIGNATURES NEUROCRINE BIOSCIENCES, INC. A Delaware Corporation By: /s/ Kevin C. Gorman Kevin C. Gorman President and Chief Executive Officer Date: February 3, 2009 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: Signature Title Date /s/ Kevin C. Gorman Kevin C. Gorman /s/ Timothy P. Coughlin Timothy P. Coughlin Joseph A. Mollica /s/ Joseph A. Mollica /s/ Gary A. Lyons Gary A. Lyons /s/ Corinne H. Lyle Corinne H. Lyle /s/ W. Thomas Mitchell W. Thomas Mitchell /s/ Richard F. Pops Richard F. Pops /s/ Stephen A. Sherwin Stephen A. Sherwin /s/ Wylie W. Vale Wylie W. Vale President, Chief Executive Officer and Director (Principal Executive Officer) February 3, 2009 Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) February 3, 2009 Chairman of the Board of Directors February 3, 2009 Director February 3, 2009 Director February 3, 2009 Director February 3, 2009 Director February 3, 2009 Director February 3, 2009 Director February 3, 2009 74 (This page intentionally left blank) (This page intentionally left blank) Neurocrine Biosciences Corporate Information COR POR ATE MANAGEMENT Kevin C. Gorman, Ph.D. President and Chief Executive Offi cer Margaret E. Valeur-Jensen, Ph.D., JD Executive Vice President, General Counsel and Corporate Secretary Timothy P. Coughlin, CPA Vice President, Chief Financial Offi cer Christopher F. O’Brien, M.D. Chief Medical Offi cer Haig Bozigian, Ph.D. Senior Vice President, Pharmaceutical and Preclinical Development Dimitri E. Grigoriadis, Ph.D. Vice President, Research Hernand W. Wilson Vice President, Information Technology BOAR D OF DIR ECTORS Joseph A. Mollica, Ph.D. Chairman of the Board, Neurocrine Biosciences, Inc. and Former Chairman of the Board, Pharmacopeia Drug Discovery, Inc. Kevin C. Gorman, Ph.D. President and Chief Executive Offi cer, Neurocrine Biosciences, Inc. Gary A. Lyons Former President and Chief Executive Offi cer, Neurocrine Biosciences, Inc. Corinne Lyle President, Global Operations, Edwards Lifesciences Corporation W. Th omas Mitchell Former Chairman of the Board and Chief Executive Offi cer, Genencor International Richard F. Pops Chairman, Alkermes, Inc. Stephen A. Sherwin, M.D. Chairman and Chief Executive Offi cer, Cell Genesys, Inc. Wylie W. Vale, Ph.D. Professor & Head, Th e Clayton Foundation, Laboratories for Peptide Biology, Th e Salk Institute STOCKHOLDER INFOR MATION Transfer Agent American Stock Transfer Auditors Ernst & Young LLP 12780 EI Camino Real San Diego, CA 92130 (858) 617-7600 www.neurocrine.com