Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to them. In some cases you can identify forward-looking statements by words such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential” and similar expressions intended to identify forward-looking statements. Examples of these statements include, but are not limited to, statements regarding: the implications of interim or final results of our clinical trials, the progress of our research programs, including clinical testing, the extent to which our issued and pending patents may protect our products and technology, our ability to identify new product candidates, the potential of such product candidates to lead to the development of commercial products, our anticipated timing for initiation or completion of our clinical trials for any of our product candidates, our future operating expenses, our future losses, our future expenditures for research and development, and the sufficiency of our cash resources. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us and described in Part II, Item 1A of this Quarterly Report on Form 10-Q and our other filings with the SEC. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from those we expect. Except as required by law, we assume no obligation to update these forward-looking statements, whether as a result of new information, future events or otherwise.

The following discussion and analysis should be read in conjunction with the unaudited financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with the audited consolidated financial statements and related notes thereto included as part of our Annual Report on Form 10-K for the year ended December 31, 2012.

About AcelRx Pharmaceuticals

We are a development stage specialty pharmaceutical company focused on the development and commercialization of innovative therapies for the treatment of acute and breakthrough pain. Our lead product candidate, the Sufentanil NanoTab PCA System, or the NanoTab System or ARX-01, is designed to improve the management of moderate-to-severe acute post-operative pain in patients in the hospital setting. Although widely used, the current standard of care for patients with post-operative pain, intravenous patient-controlled analgesia, or IV PCA, has been shown to cause harm and inconvenience to patients following surgery because of the side effects of commonly used IV PCA opioids, the invasive IV needle route of delivery and the inherent potential for programming and delivery errors associated with the complexity of infusion pumps.

The Sufentanil NanoTab PCA System

The Sufentanil NanoTab PCA System is an investigational pre-programmed, non-invasive, handheld system that allows post-operative patients to self-dose with sublingual sufentanil NanoTabs to manage their post-operative pain. The NanoTab System is designed to address the limitations of IV PCA by offering:

NanoTab System Phase 3 Clinical Program

Summary

Our Phase 3 program for the NanoTab System consists of three Phase 3 clinical trials. We have reported top-line results from two of these three clinical trials and expect to report top-line data from the final planned Phase 3 trial in the second quarter of 2013. Prior to our Phase 3 program, we completed three successful Phase 2 clinical trials of sufentanil NanoTabs in the post-operative setting. These Phase 2 clinical trials demonstrated analgesic efficacy, a low adverse event profile and excellent device functionality. During our End of Phase 2 meeting with the FDA, the FDA stated that the demonstration of efficacy versus placebo in two Phase 3 clinical trials, with a total safety database of at least 600 patients exposed to sufentanil, should suffice to support a new drug application, or NDA. We have designed our Phase 3 clinical trials based on the feedback from the FDA.

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Phase 3 Clinical Trials for the NanoTab System

Active comparator trial (IAP 309)

In November 2012, we reported top-line data showing that the NanoTab System had met its primary endpoint of non-inferiority in the Phase 3 open-label active comparator trial designed to compare the efficacy and safety of the NanoTab System (15 mcg/dose) to IV PCA with morphine (1mg/dose) for the treatment of moderate-to-severe acute post-operative pain.

Top-line primary endpoint results of this Phase 3 clinical trial demonstrate that:

Additional study results showed the NanoTab System demonstrated a significantly faster onset of pain relief and reduction in pain intensity compared to IV PCA morphine that separated at 45 minutes and achieved statistical significance at 1, 2 and 4 hours (p<0.01). Furthermore, there were statistically fewer patients in the NanoTab Systems group that experienced oxygen desaturation to a level less than 95% compared to the IV PCA morphine group (p=0.028).

Throughout the course of the trial, 7.3% of patients treated with the NanoTab System dropped out of the trial prematurely due to lack of efficacy compared to 8.9% of patients treated with IV PCA morphine. Additionally, 7.3% of the patients treated with the NanoTab System dropped out of the trial due to an adverse event compared to 10.0% of the IV PCA morphine patients. We observed 13 patients who experienced serious adverse events, or SAEs, in the trial, of whom three patients experienced serious adverse events assessed as possibly or probably related to the trial drug, one was related to the NanoTab System and two were related to IV PCA morphine.

Double-blind, placebo-controlled, abdominal surgery trial (IAP 310)

In March 2013, we reported top-line data results demonstrating that the NanoTab System met its primary endpoint in a pivotal Phase 3 trial designed to compare the efficacy and safety of the NanoTab System to placebo in the management of acute post-operative pain after major open abdominal surgery. Adverse events reported in the trial were generally mild or moderate in nature and similar in both placebo and treatment groups. Utilizing a randomized, double-blind, placebo-controlled design, this pivotal Phase 3 trial enrolled 178 adult patients at 13 U.S. sites.

The primary endpoint evaluated pain intensity over the 48-hour study period compared to baseline, or Summed Pain Intensity Difference (SPID-48), in patients following major open abdominal surgery. Patients receiving sufentanil NanoTabs demonstrated a significantly greater SPID-48 (pain reduction) compared to placebo-treated patients during the study period (105.6 and 55.6, respectively; p=0.001).

Eighty, or 70.2%, of the sufentanil NanoTab-treated patients completed the 48-hour study period, compared to 30, or 51.7%, of placebo-treated patients. Reasons for drop-out in the sufentanil-treated and placebo-treated groups were adverse events (5.3% and 6.9%, respectively), lack of efficacy (16.7% and 31.0%, respectively) and other (7.9% and 10.3%, respectively).

Treatment-emergent adverse events occurred in 64.0% of sufentanil-treated patients and 67.2% of placebo-treated patients. Adverse events with an occurrence greater than 5% in either the sufentanil group or the placebo group were nausea (30.7% and 41.4%, respectively), fever (14.9% and 8.6%, respectively), vomiting (8.8% and 6.9%, respectively), itching (8.8% and 0.0%, respectively), oxygen saturation decrease (6.1% and 1.7%, respectively), and hypertension (2.6% and 5.2%, respectively). Itching, a frequently observed side effect of opioids, was the only adverse event that was significantly different between the groups (p=0.017). All reported cases of itching in the trial were mild in nature.

Only one patient, in the sufentanil group, experienced a serious adverse event, which was determined to be unrelated to the study drug by the investigator.

Double-blind, placebo-controlled, orthopedic surgery trial (IAP 311)

In August 2012, we initiated a Phase 3 clinical trial with the NanoTab System in a double-blind, placebo-controlled trial for a minimum of 48 hours and up to 72 hours in patients who are undergoing a total hip or knee replacement. The objective is to compare the efficacy and safety of the Sufentanil NanoTab PCA System to placebo in the management of acute post-operative pain after major orthopedic surgery. Approximately 420 patients were randomly assigned to treatment with sufentanil or placebo. The primary endpoint is the sum of pain intensity difference to baseline (SPID) over 48 hours. Dosing of the final subject in this trial occurred in the first week of April 2013, and we expect to receive top-line data from this trial later in the second quarter of 2013. Key secondary endpoints include an assessment of different imputation strategies for the use of rescue opioids, pain intensity and relief scores and patient and healthcare professional Global Assessments and Ease of Care questionnaires.

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ARX-04- Sufentanil Single Dose NanoTab

Summary

We are also developing a Sufentanil Single-Dose NanoTab, or ARX-04, for the treatment of moderate-to-severe acute pain on the battlefield, in the emergency room or in ambulatory care facilities. In May 2011, we announced that the U.S. Army Medical Research and Materiel Command, or USAMRMC, awarded us a $5.6 million grant to support Phase 2 development and Phase 3 readiness of ARX-04 for the treatment of moderate-to-severe acute pain. The term of the grant ends on January 31, 2014.

Phase 2 Clinical Trial

In November 2012, we initiated a Phase 2 placebo-controlled, dose-finding trial, in which 101 patients were randomized following bunionectomy surgery in a 2:2:1 ratio to 30 mcg sufentanil, 20 mcg sufentanil or placebo treatment arms. In April 2013, we reported that the trial successfully met its primary endpoint. The primary endpoint evaluated pain intensity over the 12-hour study period compared to baseline, or Summed Pain Intensity Difference (SPID-12), in patients following bunionectomy surgery. Patients receiving 30 mcg sufentanil NanoTabs, which were administered by a healthcare professional, no more frequently than once per hour, had significantly greater pain reduction as measured by SPID-12 than placebo-treated patients (p=0.003). The 20 mcg sufentanil-treated patients did not achieve SPID-12 scores that differentiated from placebo, thus confirming that 30 mcg is the minimally effective dose when ARX-04 is dosed no more frequently than once per hour. Adverse events reported in the study were generally mild-to-moderate in nature, with two serious adverse events of post-surgical infection reported, both of which were determined by the investigator to be unrelated to study drug. In addition, two patients dropped out of the study due to adverse events, one patient’s discontinuation considered unrelated to study drug and the other considered probably related to study drug, both in the 30 mcg-treated group. AcelRx will present these top-line data to USAMRMC, and intends to hold an End of Phase 2 meeting with the FDA to define the Phase 3 program for ARX-04. The remainder of the period under the grant, which ends on January 31, 2014, will be focused primarily on package development for ARX-04 and other Phase 3 readiness activities.

ARX-02 and ARX-03

In addition to our NanoTab System and ARX-04, our product candidate pipeline consists of two other sufentanil-based product candidates. The Sufentanil NanoTab BTP Management System, or ARX-02, is a pain management system for the treatment of cancer patients who suffer from breakthrough pain, or BTP. The Sufentanil/Triazolam NanoTab, or ARX-03, is a single, fixed-dose product designed to provide mild sedation, anxiety reduction and pain relief for patients undergoing painful procedures in a physician’s office. We have successfully completed Phase 2 clinical trials for ARX-02 and ARX-03. Future development of ARX-02 and ARX-03 is contingent on identification of corporate partnership resources.

Development of therapeutic products is costly and is subject to a lengthy and uncertain regulatory process by the United States Food and Drug Administration, or FDA. Adverse events in both our own clinical program and other programs may have a negative impact on regulatory approval, the willingness of potential commercial partners to enter into agreements and the perception of the public.

Financial Overview

We are a development stage company with a limited operating history. We have incurred net losses and generated negative cash flows from operations since inception and expect to incur losses in the future as we continue our research and development activities. We believe that continued investment in research and development is critical to attaining our strategic objectives. In order to develop our product candidates as commercially viable therapeutics, we expect to expend significant resources for expertise in the manufacturing, regulatory affairs, clinical research and other aspects of pharmaceutical development. In addition, as we pursue commercial development of our product candidates we expect the business aspects of our company to become more complex. We may be required in the future to add personnel and incur additional costs related to the maturation of our business.

Our net loss for the three months ended March 31, 2013 was $12.8 million. In addition, our net losses were $33.4 million and $20.1 million during the years ended December 31, 2012 and 2011, respectively. As of March 31, 2013, we had an accumulated deficit of $134.8 million. As of March 31, 2013, we had cash, cash equivalents and investments totaling $48.2 million compared to $59.8 million as of December 31, 2012.

To date, we have funded our operations primarily through the sale of equity securities and the issuance of debt instruments. In December 2012, we completed an underwritten public offering, pursuant to which we sold 14,375,000 shares of our common stock at a public offering price of $3.31 per share for an aggregate offering price of $47.6 million. As a result of the offering, we received net proceeds of $44.1 million, after underwriting discounts, commissions and offering expenses totaling $3.5 million. In June 2012, we completed a private placement of our common stock, in which we issued an aggregate of 2,922,337 shares of common stock and warrants to purchase up to 2,630,103 shares of common stock, for net proceeds of $9.1 million, after deducting costs related to the offering of $0.9 million. In June 2011, we entered into a loan and security agreement with Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc., collectively referred to as Hercules, under which we borrowed $20.0 million in two tranches of $10.0 million each, represented by secured convertible term promissory notes. The interest rate is 8.50%, with the initial 12 months of

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the facility requiring interest only payments. The notes issued pursuant to the loan and security agreement mature on December 1, 2014. According to the terms of the Hercules agreement, beginning on July 1, 2012, we began repaying Hercules principal, with equal monthly payments of $742,000, consisting of both principal and interest payments, to continue until the maturity date of the loan. As of March 31, 2013, we had a debt balance of $14.2 million.

Since our inception in July 2005, we have not generated any revenue from the sale of our products and do not anticipate generating any product revenues for the foreseeable future, if at all. We have recognized revenue associated with our grant from the USAMRMC of $4.4 million since inception of the grant, but continued funding from the USAMRMC is contingent upon their review and approval of our continued research and development activities associated with the grant. In addition, there can be no assurance that we will receive other research-related grant awards or produce other collaborative agreement revenues in the future.

Critical Accounting Estimates

The accompanying discussion and analysis of our financial condition and results of operations are based upon our financial statements and the related disclosures, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts in our financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe 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. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. Our critical accounting policies and estimates are detailed in our Annual Report on Form 10-K for the year ended December 31, 2012. There have been no significant changes in our critical accounting policies and estimates during the three months ended March 31, 2013 from those previously disclosed in our Annual Report on Form 10-K.

Results of Operations

Three Months Ended March 31, 2013 and 2012

Revenue

To date, we have not generated any revenue from commercial sales. We do not expect to receive any such revenue from any product candidate that we develop until we obtain regulatory approval and commercialize our products or enter into collaborative agreements with third parties. In May 2011, we received a grant award of $5.6 million from the USAMRMC for the development of ARX-04, a Sufentanil NanoTab for the treatment of moderate-to-severe acute pain. Revenue related to this grant award is recognized as the related research and development expenses are incurred.

Revenue was $0.9 million and $0.3 million for the three months ended March 31, 2013 and 2012, respectively, and was generated from our grant with the USAMRMC. From inception of the grant through March 31, 2013, we have generated revenue of $4.4 million. We expect the remaining $1.2 million of the USAMRMC grant to be earned by January 31, 2014, the termination date of the grant.

Research and Development Expenses

Conducting research and development is central to our business model. The majority of our operating expenses in 2013 and 2012 have been for research and development activities related to ARX-01. Research and development expenses included the following:

Product candidates in late stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of late stage clinical trials. We anticipate that research and development expenses for the remaining quarters of 2013 will be substantially lower than the first quarter of 2013 due to lower clinical development expenses associated with our NanoTab System and ARX-04 programs, partially offset by higher expenses associated with preparatory activities to submit an NDA to the FDA and activities associated with preparing for the potential commercialization of the NanoTab System. Total operating expenses for 2013 are anticipated to be modestly higher than they were in 2012.

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We track external development expenses on a program-by-program basis. Our development resources are shared among all of our programs. Compensation and benefits, facilities, depreciation, stock-based compensation, and development support services are not allocated specifically to projects and are considered research and development overhead. Below is a summary of our research and development expenses during the three months ended March 31, 2013 and 2012 (in thousands):

Due to the inherently unpredictable nature of product development, development timelines and the probability of success, development costs can differ materially from expectations. While we are currently focused on advancing the NanoTab System and ARX-04, and subsequently ARX-02 and ARX-03, our future research and development expenses will depend on the clinical success of each product candidate as well as ongoing assessments of the commercial potential of our product candidates. In addition, we cannot predict which product candidates may be subject to future collaborations, when these arrangements will be secured, if at all, and to what degree these arrangements would affect our development plans and capital requirements.

Total research and development expenses for the three months ended March 31, 2013 and 2012 were as follows (in thousands, except percentages):

The $4.5 million increase during the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 was primarily attributable to an increase of $3.4 million related to Phase 3 clinical trial development for our NanoTab System program. In addition, there was an increase of $0.7 million related to our ARX-04 development program, and an increase in personnel related expenses, including stock-based compensation.

General and Administrative Expenses

General and administrative expenses consisted primarily of salaries, benefits and stock-based compensation for personnel in administration and finance and business development activities. Other significant expenses included legal expenses to pursue patent protection of our intellectual property, allocated facility costs and professional fees for general legal, audit and consulting services. We expect general and administrative expenses to increase in connection with operating as a public company and as we continue to build our corporate infrastructure in support of our product candidates in development and in preparation for potential commercialization of the NanoTab System.

Total general and administrative expenses for the three months ended March 31, 2013 and 2012 were as follows (in thousands, except percentages):

General and administrative expenses were relatively consistent over the comparative periods.

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Interest expense for both periods pertains to interest on our loan and security agreement with Hercules, which expires in December 2014. Effective July 2012, we began paying down the outstanding balance in equal monthly payments of $742,000, which consist of principal and interest. The $0.1 million decrease during the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 was due to a lower average debt balance during the three months ended March 31, 2013 as compared to the three months ended March 31, 2012.

Other Income (Expense), net

Other income (expense), net during the periods noted below consisted primarily of the change in the fair value of our warrants, or PIPE warrants, issued in connection with our private placement of our common stock, which was completed in June 2012, and our contingent put option liability associated with the loan and security agreement with Hercules. The account also reflects interest earned on our cash and investments balances.

Total other income (expense), net for the three months ended March 31, 2013 and March 31, 2012 was as follows (in thousands):

The $1.8 million decrease in other income (expense) during the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 was primarily attributable to the increase in the estimated fair value of our PIPE warrants. The warrants are remeasured at the end of each reporting period utilizing the Black-Scholes option-pricing model, and the increase was primarily driven by a higher share price of AcelRx common stock on March 31, 2013, compared to the share price on December 31, 2012. The income during the three months ended March 31, 2012 primarily reflected the change in fair value of the contingent put option liability associated with the loan and security agreement with Hercules.

Liquidity and Capital Resources

Liquidity

We have incurred losses and generated negative cash flows from operations since inception, and we expect to continue to incur significant losses and negative cash flows for the foreseeable future. We have funded our operations primarily through the issuance of equity securities and debt financings. From inception through March 31, 2013, we have received net proceeds of $54.9 million from the sale of convertible preferred stock, $88.1 million from the sale of common stock and $41.4 million from our debt arrangements.

As of March 31, 2013, we had cash, cash equivalents and investments totaling $48.2 million compared to $59.8 million as of December 31, 2012. The decrease was primarily attributable to capital required to fund our continuing operations, including advancement of our lead product candidate, the NanoTab System, through Phase 3 clinical trials. Our most significant use of capital pertains to salaries and benefits for our employees and clinical trial expenses related to our development programs.

Our cash and investment balances are held in a variety of interest bearing instruments, including obligations of U.S. government agencies, money market funds and time deposits. Cash in excess of immediate requirements is invested with a view toward capital preservation and liquidity.

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Cash Flows from Operating Activities

The primary use of cash for our operating activities during these periods was to fund the development of our product candidates. Our cash used for operating activities also reflected changes in our working capital and adjustments for non-cash charges, such as depreciation and amortization of our fixed assets, stock-based compensation, interest expense related to our debt financings and the revaluation of our PIPE warrant liability. Cash used in operating activities of $9.7 million during the three months ended March 31, 2013 reflected a net loss of $12.8 million, partially offset by aggregate non-cash charges of $2.8 million and a net change of $0.3 million in our net operating assets and liabilities. Non-cash charges primarily included $1.8 million for the change in fair value of our PIPE warrant and $0.8 million for stock-based compensation. The net change in our operating assets and liabilities was primarily a result of an increase in accounts payable of $1.7 million and a decrease in accrued liabilities of $1.3 primarily related to our Phase 3 clinical trials for ARX-01.

Cash used in operating activities of $7.8 million during the three months ended March 31, 2012 reflected a net loss of $7.1 million, partially offset by aggregate non-cash charges of $0.9 million and a net change of $1.6 million in our net operating assets and liabilities. Non-cash charges primarily included $0.5 million for stock-based compensation and $0.2 million for interest on our debt. The net change in our operating assets and liabilities was primarily a result of an increase in prepaid expenses and other current assets of $1.1 million, primarily due to prepayments related to our Phase 3 clinical trials for ARX-01.

Cash Flows from Investing Activities

Our investing activities have consisted primarily of our capital expenditures and purchases and sales and maturities of our available-for-sale investments.

During the three months ended March 31, 2013, cash provided by investing activities of $0.6 million was primarily as a result of $9.0 million in proceeds from the maturity of investments, partially offset by $8.4 million for purchases of investments.

During the three months ended March 31, 2012, cash provided by investing activities of $4.3 million was primarily as a result of $15.2 million in proceeds from the maturity of investments, partially offset by $10.4 million for purchases of investments.

Cash Flows from Financing Activities

Cash flows from financing activities primarily reflect proceeds from the sale of our securities, proceeds from our debt financings and payments made on such debt financings. As of March 31, 2013, we had outstanding debt of $14.2 million.

During the three months ended March 31, 2013, cash used in financing activities of $1.8 million was primarily due to payments on our loan and security agreement with Hercules.

During the three months ended March 31, 2012, cash provided by financing activities of $0.1 million was a result of purchases made under our 2011 Employee Stock Purchase Plan.

Operating Capital and Capital Expenditure Requirements

We expect our rate of cash usage to increase in the future, in particular to support our product development activities. We believe that our available cash resources, will be sufficient to fund our operations into the third quarter of 2014, including support for our continuing development of our product candidates, clinical trials and commercial readiness activities. Future capital requirements will be substantial and we will need to raise additional capital to fund our operations, including product candidate development activities. Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially. Additional capital may not be available in terms acceptable to us, or at all. If adequate funds are not available, or if the terms underlying potential funding sources are unfavorable, our business and our ability to develop our technology and product candidates would be harmed.

Our future capital requirements will depend on many forward looking factors and are not limited to the following:

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Off-Balance Sheet Arrangements

Through March 31, 2013, we have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities.

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