Severity. Pain can be classified into three categories of severity: mild, moderate and severe. It is important to determine a patient’s particular level of pain since doing so will influence the type of drugs or other treatments prescribed by physicians and other health care providers. Because there are no clear differentiating factors among the three categories of pain severity, health care providers frequently determine severity by gauging the extent to which pain interferes with a patient’s daily function or by relying on a patient’s own opinion of the severity of his or her pain. In clinical trials, for example, the severity of pain in patients is sometimes measured by patients on a numerical scale with ratings of 1 to 4 corresponding to mild pain, 4 to 6 corresponding to moderate pain, and 6 to 10 corresponding to severe pain. Examples of mild pain include headaches or joint pain, and examples of moderate pain include the types of pain often associated with minor surgery or some forms of arthritis. Patients experiencing severe pain often suffer from a serious underlying illness, such as AIDS or cancer. Severe pain can also result from major surgery, nerve damage, advanced arthritis or cancer.

Pain Management Market

      Pain is a worldwide problem with serious health and economic consequences. The medical effort to treat pain, known as pain management, addresses a large and under-served market. Global Industry Analysts, Inc. estimates that the worldwide prescription market for pain drugs totaled over $28 billion in 2003. IMS Health estimates that nearly $18 billion was spent in 2003 on prescription pain drugs in the United States. In the United States:

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      According to a Global Strategic Business Report published in 2004 by Global Industry Analysts, Inc., the prescription pain management market is anticipated to grow at a compounded annual growth rate of 9% through 2010 due to a number of factors, including:

Analgesic Drugs

      Drugs that treat pain are referred to as analgesics, and the type of analgesic selected for treatment depends principally upon the severity of the pain. For mild pain, weak analgesics such as acetaminophen or nonsteroidal antiinflammatory drugs, or NSAIDs, such as ibuprofen are used. For moderate pain, NSAIDs, weak opioids such as codeine or short-acting formulations of strong opioids may be used. Severe pain requires strong opioids such as morphine, oxycodone, hydrocodone or fentanyl.

      The table below sets forth selected major classes of analgesics, examples of product brands within each class and the corresponding prescription revenues in 2003 for each class as prescribed to treat pain, as reported by IMS Health:

Source: IMS Health, IMS National Sales Perspectives™; Retail and Provider, December 2003.

Shortcomings of Current Pain Management

      Despite widespread clinical use of drugs for pain, pain management remains less than optimal due to a variety of factors, including:

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      Given doctors’ and patients’ desire to achieve adequate control of pain, and the significant shortcomings associated with existing treatments, doctors and patients often struggle to find an appropriate balance between pain relief and adverse side effects. With both over- and under-treatment of pain, patients may be suffering unnecessarily, have poor quality of life and have difficulty meeting their social, familial and work-related commitments.

Our Solution

      Based on our preclinical and clinical trials to date, we believe our three product candidates, if approved, will be able to offer patients tangible benefits over existing treatments for the indications targeted by each of our product candidates.

      ALGRX 4975: ALGRX 4975 is our product candidate for the treatment of site-specific, severe or intractable pain. We believe ALGRX 4975 represents a novel approach to the treatment of pain because it provides long-lasting analgesia with a single administration to a discrete part of the body and because it acts via a different mechanism than any current prescription analgesic. As a result, ALGRX 4975 avoids many of the side effects of existing pain therapies. In addition, whereas many existing opioids are not particularly effective for certain types of severe pain or require frequent dosing, ALGRX 4975, by harnessing capsaicin’s ability to cause changes in nerve endings lasting up to 16 weeks, has been shown in clinical trials to provide meaningful, long-lasting pain relief following a single administration. We expect that if ALGRX 4975 does provide more meaningful pain relief with fewer side effects than opioid analgesics, treatment with ALGRX 4975 can result in improved quality of life for many patients.

      ALGRX 3268: ALGRX 3268 is intended to provide rapid, easy-to-administer local analgesia to reduce the pain associated with needle-stick procedures in children and in adults who have fear of needle insertion. Existing therapeutic products have an onset of analgesia of at least 10 minutes, although the most frequently used products must be applied 30 to 60 minutes prior to a needle-stick procedure. This delay creates logistical difficulties in administering needle-stick procedures and creates a significant barrier to use in busy emergency rooms, oncology suites and pediatric offices. Furthermore, existing products are formulated as creams and patches, which may be perceived by health care staff and patients as messy and

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      ALGRX 1207: ALGRX 1207, our preclinical product candidate, is the first new molecular entity from a new class of local anesthetics that will potentially treat patients with certain types of neuropathic pain and be used for pre-procedural administration to reduce the pain associated with surgical procedures on the skin. These types of pain are not well-treated by current analgesic therapy. The most common existing treatments for these conditions consist of patches or creams containing a local anesthetic. These patches and creams have a slow onset of pain relief, and the desired efficacy may not be achieved due to the poor penetration into the skin by the anesthetics used in these products. In addition, these treatments are often inconvenient to use. Based on nonclinical studies in animals, ALGRX 1207 has been shown to provide analgesia more rapidly following direct administration to skin and with a longer-lasting effect than currently available topical anesthetics. In addition, we believe that ALGRX 1207, if approved, could address the pain associated with a wide variety of procedures involving the skin, including dermatological surgery, cosmetic skin treatments and catheter placement, as well as the pain arising from surgical incisions that does not subside after the surgery has taken place.

Strategy

      Given the shortcomings of current therapies and the economic impact of pain on society, our goal is to become a leading pharmaceutical company focused on the commercialization of drugs to treat acute and chronic pain. The key elements of our strategy for achieving this goal are as follows:

      We currently have five distinct programs in various stages of research and development in the areas of acute and chronic pain management. Each of our product candidates is in a different stage of development, has a different mechanism of action and seeks to treat different types of pain conditions. In building our product pipeline, we intend to leverage our management’s experience and understanding of the unmet medical needs in treating pain, the mechanisms of action of existing therapies and the mechanisms of pain. We intend to acquire or in-license additional products or product candidates from a wide range of sources, including academic centers and biotechnology and pharmaceutical companies, in both domestic and international markets.

      We believe that our scientific expertise is broadly applicable across a wide range of drugs. Our management team has over 100 years of cumulative experience in the pharmaceutical industry, including having previously led the research and development, approval and commercialization of numerous products for pain. Our Chief Executive Officer, Ronald M. Burch, M.D., Ph.D., has spent over 16 years developing drugs for pain management, and our President and Chief Operating Officer, Paul R. Hamelin, R.Ph., has spent over seven years marketing, developing and commercializing pain drugs, including participating in the development and launch of Celebrex® in several countries. We believe that our management team’s experience in the planning and management of clinical trials will help us maximize the relevance and utility of our clinical trial programs. We plan to rely on this experience in seeking to obtain regulatory approval for our current product candidates in the United States and, where appropriate, the rest of the world.

      We currently retain all global commercialization rights to our product candidates. We intend to build a specialized sales and marketing organization to market our products to physicians and health care

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      We intend to form collaborations and partnerships with leading pharmaceutical, biotechnology or specialty pharmaceutical companies, both domestically and internationally, to augment our internal clinical and regulatory resources and to accelerate the implementation of our strategies. We believe these selective partnerships will extend and ensure our ability to market products in a resource-efficient manner in certain markets in the United States and in large foreign markets such as Europe and Japan.

Our Product Pipeline

      Our product pipeline consists of two clinical product candidates, ALGRX 4975 and ALGRX 3268, and one preclinical product candidate, ALGRX 1207. ALGRX 4975 is currently in several phase II clinical trials and is being developed as two formulations in three clinical development programs. We have recently commenced one of two phase III clinical trials for ALGRX 3268, and we expect to file an IND application for ALGRX 1207 with the FDA in the second half of 2005. The following table summarizes the current status of our product candidates in clinical and preclinical development and of our research program:

      ALGRX 4975 is our product candidate for the treatment of site-specific severe or intractable pain. These types of pain are poorly treated with existing drugs, many of which have well-documented and severe side effects. We are developing two formulations of ALGRX 4975 to potentially treat patients with severe pain: a gel formulation for use during a variety of surgical procedures, including bunion removal surgery, total knee replacement and abdominal surgeries, such as hernia repair or hysterectomy; and an

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      The active ingredient in ALGRX 4975 is capsaicin. Capsaicin is currently marketed over-the-counter for topical administration in the form of low dose, non-sterile creams and patches, which tend to be poorly absorbed into the skin. There are many brands of capsaicin creams and patches, including Capzasin-P® (Chattem) and Zostrix® (Rodlen Laboratories). These formulations are generally crude preparations of capsaicin that may contain other chemical entities. Over-the-counter capsaicin creams and patches are used topically by consumers to relieve pain in conditions such as osteoarthritis, postherpetic neuralgias, psoriasis and diabetic neuropathy.

      ALGRX 4975, if approved, would be used in different clinical settings than current over-the-counter products. Currently, there are no FDA-approved uses of capsaicin for analgesia or other indications inside the body. Results of our clinical trials suggest that capsaicin, when used in the manner and doses we are investigating, may have analgesic properties previously unknown to clinical investigators. We currently own or license three patents and 12 patent applications related to our capsaicin technology, compounds and their applications in pharmaceutical development or their use as pharmaceuticals. We believe these issued patents and pending patents, if and when issued, will provide us with intellectual property protection in the methods of purification, manufacture, medical usage and formulation of capsaicin.

      Three major classes of nerves, or neurons, Ad, Ab and C, transmit sensory information through the body’s nervous system. Pain signals are transmitted by two of those classes: Ad and C neurons. Ad neurons transmit signals rapidly giving rise to sharp pain sensations, whereas C neurons transmit signals slowly giving rise to severe dull, aching or throbbing pain sensations. For example, if a person hits his thumb with a hammer, there is an immediate, sharp pain that lasts only for an instant, which is transmitted by Ad neurons, followed by a dull, aching, throbbing pain that may last for a considerable time, which is transmitted by C neurons.

      Capsaicin works to relieve pain by causing localized degradation of the C neuron endings and is the only analgesic known to relieve pain by this mechanism. Capsaicin’s activity results from its ability to bind to and activate a type of ion channel on the surface of neurons called vanilloid receptor 1, or VR1, which is involved in the transmission of pain signals to the brain. Under normal circumstances, when the VR1 ion channel is activated, usually by changes in pH, it opens for a short time, causing the C neurons to transmit a pain signal toward the brain. When capsaicin binds to and activates VR1, it causes a series of events within the cell that degrade the pain-sensing endings of the C neuron, thereby preventing the neuron from transmitting pain signals. Our animal and human studies have demonstrated that following capsaicin treatment, the C neuron terminals usually regenerate over a period of 12 to 16 weeks. This unique action is the basis for what we believe will be ALGRX 4975’s ability, if approved, to provide meaningful, long-lasting pain relief following a single administration. Because VR1 is found only on C neurons, capsaicin reduces only the long-term noxious pain associated with transmission by these neurons. Capsaicin does not affect the short-lasting, sharp adaptive pain carried by Ad neurons, or the fine touch, temperature and place perception signals carried by Ab neurons. As a consequence, ALGRX 4975 may be a highly specific pain therapeutic that provides long-lasting analgesia.

      We believe the effects of capsaicin are confined exclusively to the region of application because of low distribution to other areas of the body after ALGRX 4975 is administered. After injection into a joint

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      Based on our clinical trial results to date, we believe that ALGRX 4975 may provide significant pain relief to patients in postsurgical situations by acting only at the site of application and without causing sedation or other side effects, thereby potentially reducing rehabilitation time following some procedures. We also believe ALGRX 4975 may provide significant pain relief to patients with post-trauma neuropathic pain or who suffer from severe musculoskeletal pain. We expect that if ALGRX 4975 provides more meaningful pain relief with fewer side effects than opioid analgesics, it may result in improved quality of life for many patients.

ALGRX 4975 — Capsaicin for the Treatment of Severe Postsurgical Pain

      We are developing ALGRX 4975 for use during a variety of surgical procedures to treat severe postsurgical pain. Opioid analgesics are commonly used for the treatment of severe postsurgical pain. The common delivery method for in-hospital pain relief is a patient controlled morphine pump that provides opioid analgesic infusions directly into the spinal fluid. The process is expensive, may cause infections, and since the pain relief from opioid analgesics is relatively brief, the patient goes through cycles of pain relief followed by increased pain. We believe that ALGRX 4975, by providing long-lasting analgesia without sedation, may mitigate the cyclical nature of patient-controlled morphine and also alleviate the increase in pain suffered by many patients following discharge from the hospital, as they transition from opioid analgesic infusions to oral opioids.

      Use of opioids following certain types of surgery such as total knee replacement may also extend rehabilitation time. For such patients, walking as soon as possible after surgery is an important factor for both preventing blood clots from forming in the veins of the legs and for maintaining range of motion of the knee. Patients taking opioid analgesics immediately after surgery may be too sedated or drowsy to walk, thereby diminishing the ability to get out of bed. We believe that ALGRX 4975, if approved, will provide strong analgesia that could reduce the amount of opioids taken by patients and therefore decrease rehabilitation time.

      In our trials to date, we have only used a liquid form of ALGRX 4975, but we plan to use the gel formulation in later trials because we believe that a gel formulation will offer improvements over the liquid

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      In November 2003, we completed a randomized, double-blind, placebo-controlled phase II clinical trial of ALGRX 4975 in 40 patients evaluating postsurgical pain following bunion removal surgery at a single center in the United Kingdom. Just prior to closure of the surgical wound, either 1,000 ug of ALGRX 4975 or placebo was instilled into the wound. The primary endpoint of this trial was to record the use of opioid rescue medication. The opioid rescue medication consisted of opioids given to a patient in the absence of adequate pain relief from the placebo or ALGRX 4975 during the first 24 hours following surgery. Secondary endpoints included the use of rescue medication during the first 72 hours following surgery, the quantity of rescue medication used, and the patient pain scores measured on a visual analog scale, or VAS, a commonly used chart that patients are given to rate the severity of their pain, from zero representing no pain to 10 representing extreme pain. Several safety endpoints were also evaluated, including pain on administration and wound healing.

      This trial demonstrated a statistically significant reduction in the use of rescue medication during the first 72 hours following surgery in patients receiving ALGRX 4975 as compared to patients receiving placebo. During the first 72 hours, 45% of patients who received ALGRX 4975 requested rescue medication compared to 90% in patients who received placebo. Further, this trial indicated that VAS pain scores were reduced in patients who received ALGRX 4975 as compared to patients who received placebo. No safety concerns were identified in this study.

      In December 2004, we completed a second randomized, double-blind, placebo-controlled phase II clinical trial of ALGRX 4975 in 182 patients evaluating postsurgical pain following bunion removal surgery at two centers in the United States. In this trial, three dose levels of ALGRX 4975, 100 ug, 500 ug and 1,000 ug, were compared to placebo. The primary endpoint of this clinical trial was the magnitude and duration of pain relief in those patients receiving ALGRX 4975 compared to those receiving placebo. Secondary endpoints included the use of rescue medication from the time of surgery to awakening the next morning, a period usually lasting 18 to 20 hours, and from the time of surgery to discharge, a period usually lasting approximately 32 hours, and the quantity of rescue medication used. Several safety endpoints were also evaluated, including pain on administration and wound healing.

      This trial demonstrated a statistically significant reduction in the magnitude of pain suffered during the first 32 hours following surgery by those subjects who received ALGRX 4975 in the 500 ug or 1,000 ug doses, compared to subjects who received placebo. Furthermore, during the first 18 to 20 hours, fewer patients who received ALGRX 4975 requested rescue medication compared to patients who received placebo; these results were statistically significant. No safety concerns were identified in this study.

      We are currently conducting a randomized, double-blind, placebo-controlled phase II clinical trial in 48 patients to evaluate the safety and efficacy of ALGRX 4975 in the treatment of postsurgical pain following hernia repair at multiple centers in Denmark. In this trial, 1,000 ug of ALGRX 4975 or placebo will be applied to the cut surfaces of connective tissue, muscle and skin prior to closing the surgical wound. The primary endpoint will be the use of rescue medications following surgery. Secondary endpoints will include the amount of rescue medication used and VAS pain scores. A variety of safety endpoints will be evaluated in this trial, including pain on administration and wound healing.

      We filed a clinical trials exemption, or CTX, for ALGRX 4975 with the Medicine and Healthcare Products Regulatory Agency in the United Kingdom in June 2003 and commenced our first clinical trial in

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ALGRX 4975 — Capsaicin for Injection for Post-Trauma Neuropathic Pain

      We are developing an injectable formulation of ALGRX 4975 to potentially treat patients with post-trauma neuropathic pain. Post-trauma neuropathic pain is a form of neuropathic pain that remains long after traumatic injuries such as limb amputations, accidents or injuries caused by repeated physical stresses applied to the same area of the body. Post-trauma neuropathic pain is not well-treated with currently available drugs, which include tricyclic antidepressants and antiepileptic agents that are prescribed “off-label” for this type of pain. These drugs demonstrate meaningful efficacy in only a minority of patients. When drugs are unsuccessful in providing meaningful pain relief, patients suffering from post-trauma neuropathic pain sometimes consider other procedures that may alleviate pain. One option is surgery to remove the offending nerve, although this procedure results in side effects such as the lack of sensation and compromised motor function. A second option involves killing nerves by injecting them with alcohol or formaldehyde, which also has side effects similar to surgical removal. We believe that ALGRX 4975 may provide long-lasting, effective pain relief in these patients without the side effects caused by damaging or killing nearby nerves.

      We are currently enrolling patients in a randomized, double-blind, placebo-controlled phase II clinical trial of ALGRX 4975 in patients with Morton’s neuroma or related neuromas at two centers in the United States. Morton’s neuroma is an abnormal enlargement of two nerves that are located between the bones of the feet. This enlargement is typically seen in women who wear high-heeled shoes and in long-distance runners, all of whom subject their feet to repetitive stresses. The primary endpoint of this trial will be to evaluate the magnitude of pain relief for 1,000 ug of ALGRX 4975 compared to placebo, measured for each of the four weeks following administration. Safety endpoints to be evaluated in this trial will include pain on administration. Pharmacokinetics, which measures the time required for the administered drug to reach the bloodstream, and the time over which the drug is then removed from the blood due to metabolism, will also be assessed.

      Our clinical trial program for post-trauma neuropathic pain is being conducted under the IND application that we submitted to the FDA in May 2004. Our first clinical trial under the IND application is a phase II clinical trial studying Morton’s neuroma. In addition to our phase II clinical trial studying Morton’s neuroma, we expect to initiate phase II clinical trials to study other types of post-trauma neuropathic pain. Based on the results of those studies, we will develop a phase III program.

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ALGRX 4975 — Capsaicin for Injection for Musculoskeletal Diseases

      We are developing an injectable formulation of ALGRX 4975 to potentially treat patients with pain resulting from musculoskeletal diseases such as osteoarthritis and tendonitis. Early-stage osteoarthritis is usually treated using acetaminophen and, as pain increases, COX-2 inhibitors. As the disease progresses and joint damage increases, most patients reach a point at which they do not experience sufficient pain relief from COX-2 inhibitors. At this point, patients have several options. Some patients opt for hyaluronic acid injections directly into the joint space. The injected hyaluronic acid acts as a lubricant to enhance joint mobility, thereby reducing pain. Other patients may begin using opioid analgesics, which provide better pain relief than the COX-2 inhibitors, but still may not provide adequate pain relief. We believe that by administering ALGRX 4975 directly into the joint space, approximately once every three to four months, patients may experience meaningful pain relief with few side effects. Because joint replacement is usually the only remaining option for patients whose pain from osteoarthritis becomes intolerable, the potential ability to delay these procedures through more adequate pain relief could represent a substantial advance over the current range of therapeutic options.

      In April 2003, we completed a randomized, double-blind, placebo-controlled phase I clinical trial of ALGRX 4975 in 16 patients in one center in the United Kingdom, the first study of ALGRX 4975 in humans. In this study, ALGRX 4975 was injected directly into the knee joint space of patients with end-stage osteoarthritis who were scheduled for knee replacement surgery. Patients were allocated to one of four treatment groups based on the time between the administration of ALGRX 4975 or placebo and the date scheduled for the patient’s surgery, which were two days, four days, 10 days or 14 days after injection of ALGRX 4975. Patients received either a 10 ug, 100 ug, or 300 ug dose of ALGRX 4975 or placebo. Each patient received an injection of the local anesthetic lidocaine directly into the joint space 10 minutes prior to injection of ALGRX 4975 in order to alleviate the transient pain experienced by patients upon injection of capsaicin. Since this was a phase I clinical trial, the primary endpoints evaluated safety of ALGRX 4975. Secondary endpoints included pharmacokinetics and pain relief assessed using a VAS pain scale. Furthermore, because all patients in this trial subsequently underwent surgery, this study allowed for the direct examination of the knee to evaluate side effects caused by the drug.

      This phase I clinical trial demonstrated that ALGRX 4975 was well-tolerated. Although dose-related pain on administration was found despite pretreatment with lidocaine, pain was adequately managed in all patients with placement of an icepack on the knee. Pain reduction was also observed in this trial following the administration of ALGRX 4975. When assessed on the scheduled day of surgery, pain was found to be reduced on average by 64% when compared to patients’ baseline scores. The pain reduction data from this trial was not statistically significant because this trial was designed to demonstrate safety rather than efficacy.

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      In December 2003, we completed a randomized, double-blind, placebo-controlled phase II clinical trial of ALGRX 4975 in 12 patients with end-stage osteoarthritis of the knee at one center in the United Kingdom. In this study, patients received treatment with either a single dose of 1,000 ug of ALGRX 4975 or placebo. Knee replacement surgery was scheduled between three and six weeks following the administration of ALGRX 4975. As in the previous study, injection of ALGRX 4975 was preceded by injection of lidocaine into the joint space. The primary endpoint of this trial was to evaluate the magnitude of pain and duration of reduction in pain at week three following administration of ALGRX 4975 since no patient had undergone surgery at that time.

      In this study, ALGRX 4975 was shown to reduce pain at each of the assessed time points (weeks one, two, three, four, five and six) compared to the pain experienced by patients prior to the administration of ALGRX 4975. This trial demonstrated a statistically significant reduction in pain at week three. At all time points, pain was found to have been reduced by approximately 50% to 60% in the patients treated with ALGRX 4975. Pain was not meaningfully reduced in patients who received placebo. Most patients who received injections of ALGRX 4975 experienced transient burning pain (the median lasting 20 minutes) upon administration of ALGRX 4975. In most of these patients, ice packs were used to manage the transient pain.

      Two clinical trials are ongoing in osteoarthritis of the knee. In the first, a randomized, double-blind, placebo-controlled trial in 52 patients at one center in the United States, either 300 ug of ALGRX 4975 or placebo is injected into the knee joint space, following lidocaine, in patients who no longer receive adequate pain relief from NSAIDs. The primary efficacy endpoint is the magnitude and length of time that arthritis pain is reduced in the treated knee following a single administration, which will be evaluated at one and two weeks following administration, then monthly until treatment failure, or the point in time at which patients cease to experience analgesia. A variety of safety endpoints will be evaluated, including pain on administration.

      We are conducting a second, open-label, phase II clinical trial in 54 patients at two centers in Poland. Lidocaine will be injected into the joint and, at various times thereafter, either a single dose of ALGRX 4975 or placebo will be injected. In other subjects, a set dose of lidocaine will be injected, followed by a daily dose of ALGRX 4975 at three weekly intervals. The primary endpoint of this trial will be the efficacy of lidocaine administration to reduce pain after administration of ALGRX 4975.

      We are currently conducting a randomized, double-blind, placebo-controlled phase II trial of ALGRX 4975 in 40 patients with tennis elbow at two centers in Slovakia. In this trial, 100 ug of ALGRX 4975 is being compared to placebo. The primary endpoint of this trial will be magnitude and duration of pain relief compared to placebo. There will be several safety endpoints of this trial including pain on administration.

      We initiated our first clinical trial, a phase I clinical trial in end stage osteoarthritis, in November 2002 under approval from the Institutional Review Board of Charing Cross Hospital in London, England. The trial was designed to provide safety data on ALGRX 4975. We then filed a CTX in the United Kingdom and initiated a phase II clinical trial in end-stage osteoarthritis. In September 2003, we submitted an IND application to the FDA. In August 2004, we initiated a phase II clinical trial in osteoarthritis in the United States. We also initiated a phase II clinical trial in tendonitis in November 2004 in Slovakia, also under the IND. Because osteoarthritis is a long term chronic condition, often suffered by the elderly, the FDA typically requires longer trials with a larger amount of patients for osteoarthritis drugs. We expect that the next phase II clinical trial for osteoarthritis will include multiple

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      Currently, we retain worldwide marketing rights to ALGRX 4975, and if we receive regulatory approval to market this product, we intend to create a sales and marketing team to launch the product in the United States. Because we expect that ALGRX 4975, if approved, would have two formulations, address multiple indications and be utilized across different physician specialties, we plan to pursue multiple sales and marketing strategies tailoring our efforts to specific market segments. We expect that our own sales and marketing infrastructure would target certain markets for ALGRX 4975 in the United States, and we may also seek a development and marketing partner to maximize the opportunity for this product candidate in other market segments in the United States. In major markets abroad, we intend to collaborate with or create co-development or co-marketing partnerships with pharmaceutical companies who have greater sales and marketing capabilities than we do. We expect that these partners would help fund the development costs of ALGRX 4975 and the costs associated with the launch of ALGRX 4975 outside the United States.

ALGRX 3268 (PowderJect® Dermal Lidocaine)

      ALGRX 3268 (PowderJect® Dermal Lidocaine) is our product candidate that delivers a powder formulation of the local anesthetic lidocaine into the skin using our proprietary needle-free dispenser. ALGRX 3268 is intended to provide rapid, easy-to-administer local analgesia to reduce the pain associated with needle-stick procedures in children and also in adults who have fear of needle insertion. The primary market for ALGRX 3268 is the estimated 42 million needle-stick procedures that are performed on children in the United States each year. We believe that this market is highly under-served by existing products, and we believe that the medical community is interested in reducing the pain associated with needle-stick procedures. In fact, a joint recommendation from the American Academy of Pediatrics and American Pain Society has urged consideration of local anesthetics and strategies to soothe and minimize distress even for simple procedures such as blood draws. We also believe that there is an opportunity to serve the adult market, which consists of an estimated 315 million procedures annually where blood is drawn or intravenous lines are inserted.

      Existing therapeutic products have an onset of analgesia of at least 10 minutes, although the most frequently used products direct the health care provider to apply the products at least 30 to 60 minutes prior to a needle-stick procedure. This delay requires that a patient first be seen by a nurse or other caregiver in order to have the analgesic product applied; the patient must then wait until appropriate analgesia ensues, after which the needle-stick procedure can be done. In practice, this creates logistical difficulties and other inconveniences as patients and health care providers must wait for analgesia to set in. These inconveniences are a significant barrier to use in busy emergency rooms, oncology suites and pediatric offices. Furthermore, existing products are formulated as creams and patches, which may be perceived by health care providers and patients as messy and cumbersome to use. By contrast, ALGRX 3268 uses a convenient application procedure, and our clinical trials to date have shown that it is effective in one minute following administration. We believe these are important factors for increasing physician use of analgesia prior to needle-stick procedures.

      ALGRX 3268 contains lidocaine, a currently used, commercially approved drug, in powder form. ALGRX 3268 is designed to deliver lidocaine powder exclusively into the skin with a sterile, single-use, needle-free disposable dispenser. Pressing a button on the dispenser releases compressed helium gas from an enclosed cylinder, which ruptures the cassette that contains the lidocaine powder. The lidocaine powder is accelerated in the gas stream and penetrates the skin, where it provides analgesia to the skin at the site of application. Based on the results of our clinical trials to date, ALGRX 3268 is effective in one minute following administration. We believe this rapid onset will allow the health care provider to prepare and

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      Development of ALGRX 3268 was initiated by Chiroscience Group plc and PowderJect Pharmaceuticals plc. Our license to this technology was acquired by us in connection with our acquisition of certain of PowderJect’s assets in 2002. In a series of clinical trials conducted by Chiroscience and PowderJect, nearly 2,000 administrations of this product were given to adults and children using various doses of lidocaine powder and various helium pressures which are measured in units called bars. These trials were intended to help refine the powder injection device. Since in-licensing this product candidate, we have completed our clinical program for ALGRX 3268 through phase II in approximately 1,100 adults and children using various doses of lidocaine powder and various helium pressures. We had an end of phase II meeting with the FDA in November 2004, and we recently commenced one of two phase III clinical trials for ALGRX 3268. We expect to commence our second phase III clinical trial in the first quarter of 2005 and anticipate an NDA filing at the end of 2005.

      The following table describes the status of our clinical trials for ALGRX 3268:

      The clinical development program for ALGRX 3268 consisted of evaluation of safety and efficacy in adults and children following application at either the antecubital fossa located at the inside of the elbow or back of the hand, after which pain was elicited by means of inserting a needle into a vein and drawing blood. The studies in adults were phase I clinical trials performed in normal volunteers, whereas the studies in children were phase II clinical trials performed in children visiting clinics for scheduled blood draws.

      In October 2002, we completed a randomized, double-blind, placebo-controlled phase I clinical trial that studied the safety and efficacy of ALGRX 3268 in adults at one center in the United States. Three configurations of the device were used in this study: 0.25 mg of lidocaine and 20 bar helium pressure; 0.50 mg and 20 bar; and 0.50 mg and 40 bar. For each configuration of the device, we evaluated skin irritation caused by the lidocaine particle injection. We examined the patients’ skin for the appearance of redness, swelling, and pinpoint blood spots. Each of these effects was measured using a five-point scale, on which scores of three or higher are considered clinically significant. Neither of the configurations with 20 bar helium pressure caused clinically significant redness, swelling or pinpoint blood spots, whereas the configuration with 40 bar helium pressure caused scores of three or greater in several subjects. Thus, we concluded that a device using 40 bar pressure was not acceptable.

      Following administration of ALGRX 3268 at the antecubital fossa, it was found that each of the three configurations of ALGRX 3268 used in this trial reduced pain on needle insertion in a statistically significant manner compared with placebo when administered one, three or five minutes prior to needle insertion. With all configurations, efficacy was not apparent when ALGRX 3268 was administered

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      In July 2003, we completed a randomized, double-blind, placebo-controlled phase I clinical trial that studied the safety and efficacy of ALGRX 3268 in adults at one center in the United States. Two configurations of the device were used in this study: 0.50 mg at 20 bar; and 0.50 mg at 40 bar. Skin irritation caused by lidocaine particle injection was evaluated for each configuration. We examined patients’ skin for the appearance of redness, swelling, and pinpoint blood spots. Each of these was measured using a five-point scale, on which scores of three or higher are considered clinically significant. The configuration with 20 bar helium pressure caused no clinically significant redness, swelling or pinpoint blood spots, whereas the configuration with 40 bar helium pressure caused scores of three or greater in several subjects. Thus, we concluded that a device using 40 bar pressure was not acceptable.

      Following administration at the back of the hand, it was found that both of the configurations of ALGRX 3268 used in this trial reduced pain on needle insertion in a statistically significant manner compared with placebo when administered one, three or five minutes prior to needle insertion. With each configuration, efficacy was not apparent when ALGRX 3268 was administered 10 minutes or more prior to needle insertion. We were also able to conclude from this study that the configuration with 0.50 mg of lidocaine delivered at 20 bar pressure was the most suitable for further development to provide procedural analgesia at the back of the hand.

      In December 2002, we completed a randomized, double-blind, placebo-controlled phase I clinical trial at one center in the United States that studied the circulation of ALGRX 3268 in the blood of adult subjects after administration. Lidocaine circulating in the blood at concentrations of approximately 100 ng/ml or more may be associated with heart rhythm abnormalities and seizures. Thus, we investigated the amount of lidocaine circulating in the blood following administration of ALGRX 3268 in the antecubital fossa in adults. We found that following administration of a dose of 0.50 mg of ALGRX 3268 at 20 bar helium pressure, the concentration of lidocaine in each subject’s blood plasma was below five ng/ml at every time point of the study. Thus, this trial demonstrated that, following administration of ALGRX 3268, the concentration of lidocaine in the blood was at a level unlikely to cause adverse side effects. The low blood concentrations of lidocaine in this trial resulted from the very small dose necessary to achieve local anesthesia with this highly-targeted method.

      In July 2003, we completed a randomized, double-blind, placebo-controlled phase II clinical trial that studied the safety and efficacy of ALGRX 3268 in children at one center in Poland. Two configurations of the device were used in the trial: 0.25 mg at 20 bar; and 0.50 mg at 20 bar. Skin irritation caused by particle injection was evaluated in this trial. We examined patients’ skin for the appearance of redness, swelling, and pinpoint blood spots. Each of these was measured using a five-point scale, on which scores of three or higher are considered clinically significant. Neither of the device configurations used in this trial caused clinically significant redness, swelling or the appearance of pinpoint blood spots.

      Following administration at the antecubital fossa, it was found that a dose of 0.25 mg of ALGRX 3268 at 20 bar helium pressure did not reduce pain on needle insertion in a statistically significant manner when administered one to three minutes prior to needle insertion. In contrast, a dose of 0.50 mg of ALGRX 3268 at 20 bar helium pressure was found to reduce pain on needle insertion in a statistically significant manner in children aged three to 12 years and in children 13 to 18 years of age when compared to placebo. Therefore, we determined that the configuration of ALGRX 3268 most suitable for further

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      In January 2004, we completed a randomized, double-blind, placebo-controlled phase II clinical trial that studied the safety and efficacy of ALGRX 3268 in children at one center in Poland. Skin irritation caused by lidocaine particle injection was evaluated in this study. We examined the patients’ skin for the appearance of redness, swelling and pinpoint blood spots. Each of these was measured using a five-point scale, on which scores of three or higher are considered clinically significant. In this study, ALGRX 3268 did not cause clinically significant redness, swelling or pinpoint blood spots.

      Following administration at the antecubital fossa, it was found that a dose of 0.25 mg of ALGRX 3268 at 20 bar helium pressure did not reduce pain on needle insertion in a statistically significant manner when administered one to three minutes prior to needle insertion. In contrast, a dose of 0.5 mg of ALGRX 3268 at 20 bar helium pressure was shown to reduce pain on needle insertion in a statistically significant manner in children aged three to seven when compared to placebo. Children aged eight to 18 years of age reported only mild pain on needle insertion, and ALGRX 3268 did not further reduce pain in a statistically significant manner. Given the lack of reports of pain in the older age groups, we decided to conduct an additional clinical study.

      In August 2004, we completed a randomized, double-blind, placebo-controlled phase II clinical trial that studied the safety and efficacy of ALGRX 3268 in children at one center in the United States. Skin irritation caused by lidocaine particle injection was evaluated in this study. We examined the patients’ skin for the appearance of redness, swelling and pinpoint blood spots. Each of these was measured using a five-point scale, on which scores of three or higher are considered clinically significant. In this study, ALGRX 3268 did not cause clinically significant redness, swelling or pinpoint blood spots.

      In this trial, a dose of 0.5 mg of ALGRX 3268 at 20 bar helium pressure administered one to three minutes prior to needle insertion, was shown to reduce pain in a statistically significant manner in children aged three to 12 and in children aged 13 to 18 when compared to placebo.

      In November 2004, we initiated a randomized, double-blind, placebo-controlled phase III clinical trial to study the safety and efficacy of ALGRX 3268 in up to six centers in the United States. We will study the reduction in needle-stick pain caused by 0.50 mg of lidocaine at 20 bar helium pressure in 500 children aged three to 18, when applied three minutes prior to needle-stick procedures at the antecubital fossa or back of hand. The safety indices to be measured in this study include redness, swelling and the appearance of pinpoint blood spots.

      In March 2002, the IND application for ALGRX 3268 was transferred to us by PowderJect Technologies Inc. All of our clinical trials to date have been conducted under this IND application. In November 2004, we had an end of phase II meeting with the FDA to discuss our results to date and to discuss our proposed phase III clinical program and manufacturing plan. Based on the results of this meeting, we initiated a phase III clinical trial. If our phase III clinical trial program is successful, we expect to submit an NDA with the FDA at the end of 2005 seeking marketing approval for ALGRX 3268.

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      In preparation for the potential approval and launch of ALGRX 3268, our most advanced product candidate, we plan to build a sales and marketing team to target the most highly concentrated U.S. market segments for this product candidate. We believe such a sales team will be able to market ALGRX 3268 to hospital- and medical center-based pediatric centers, emergency rooms, urgent care centers and pediatric and adult oncology centers within the top 50 to 100 major metropolitan areas in the United States. In addition to building our own sales and marketing team within the United States, we will also evaluate partnering with one or more pharmaceutical companies to help penetrate primary care markets and other specialty health care audiences not highly concentrated in hospitals or major medical centers within the United States. We expect that such partners would also have marketing responsibility for ALGRX 3268 in key regions outside the United States, including Europe and Japan.

ALGRX 1207 — Topical local anesthetic for painful conditions of the skin

      ALGRX 1207, our preclinical product candidate, is a new molecular entity we are developing as a topical local anesthetic to potentially treat patients with certain types of neuropathic pain and for pre-procedural administration to reduce the pain associated with surgical procedures on the skin. Nearly two million patients in the United States suffer from the types of neuropathic pain that are readily treatable by topical application of drugs. Among the various types of neuropathic pain, the most severe is postherpetic neuralgia, which has a prevalence of approximately 200,000 patients in the United States. The most common neuropathic pain condition results from diabetic polyneuropathy, which is caused by nerve damage in patients with diabetes as a result of high circulating levels of blood sugar. Symptoms of diabetic polyneuropathy include numbness, pain, tingling or burning in the hands, lower legs and feet, and of the more than 3.5 million patients in the United States who suffer from diabetic polyneuropathy, approximately 14% of these patients experience pain as one of the symptoms. Neuropathic pain is also experienced in patients with HIV. Nearly one million people in the United States are infected with HIV, and, among those people, approximately 20% experience pain as a result of nerve damage caused by HIV infection.

      Postherpetic neuralgia and diabetic polyneuropathy are not well-treated by current analgesic therapy. In the United States, the most common treatment involves application of patches containing a local anesthetic to the painful area. Lidoderm® (Endo) is the most commonly used treatment for postherpetic neuralgia. As with other existing topical treatments, Lidoderm® is inconvenient to use and requires that large patches be worn for 12 hours and then removed for 12 hours in order to avoid harmful side effects. For some neuropathic pain diseases, such as painful HIV polyneuropathy and painful diabetic polyneuropathy, application of patches is difficult. To treat the pain associated with such diseases, creams containing local anesthetics must first be applied, followed by application of a dressing. Both patches and creams containing local anesthetics have a slow onset of pain relief, and efficacy may be poor due to the poor penetration of skin by the local anesthetics that are currently available. We believe that a simple-to-use local anesthetic with a long duration of action and deep penetration into the skin would provide significant analgesia and would therefore represent an improvement over existing patches and creams. Based on nonclinical studies in animals, ALGRX 1207 has been shown to provide analgesia following direct administration to skin more rapidly and with a longer-lasting effect than currently available topical anesthetics. In addition, we believe that ALGRX 1207, if approved, could address the pain associated with a wide variety of procedures involving the skin, including dermatological surgery, cosmetic skin treatments, and catheter placement, as well as the pain arising from surgical incisions that does not subside after the surgery has taken place.

      To date, ALGRX 1207 has been studied in nonclinical trials. In these animal studies, analgesia following the administration of ALGRX 1207 was demonstrated within ten minutes of application,

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      ALGRX 1207 is currently undergoing drug safety evaluation and formulation development in nonclinical trials. We plan to file an IND covering ALGRX 1207 with the FDA in the second half of 2005 and, thereafter, evaluate the safety and effectiveness of ALGRX 1207 in humans in phase I clinical trials.

Intellectual Property

      The following factors are important to our success:

      We actively seek, when appropriate, protection for our products, technologies and proprietary information through U.S. and foreign patents. In addition, we rely upon trade secrets and contractual arrangements to protect our proprietary information.

      As of September 30, 2004, we own or license approximately 10 U.S. patents, 30 U.S. patent applications, 90 foreign patents and 140 foreign patent applications related to our technologies, compounds and their applications in pharmaceutical development or their use as pharmaceuticals. We face the risk that one or more of the above patent applications may be denied. We also face the risk that our issued patents may be challenged or circumvented or may otherwise not provide protection for any commercially viable products we develop. We also note that U.S. patents and patent applications may be subject to interference proceedings, and U.S. patents may be subject to reexamination proceedings in the U.S. Patent and Trademark Office and foreign patents may be subject to opposition or comparable proceedings in the corresponding foreign patent office, which could result in either loss of the patent or denial of the patent application or loss or reduction in the scope of one or more of the claims of the patent or patent application. In addition, such interference, reexamination and opposition proceedings may be costly. Furthermore, an adverse decision in an interference proceeding can result in a third party receiving the very patent rights sought by us, which in turn could affect our ability to market a potential product to which that patent filing was directed. In the event that we seek to enforce any of our owned or exclusively licensed patents against an infringing party, it is likely that the party defending the claim will seek to invalidate the patents we assert, which, if successful, would result in the entire loss of our patent or the relevant portion of our patent and not just with respect to that particular infringer. Any litigation to enforce or defend our patent rights, even if we were to prevail, could be costly and time-consuming and would divert the attention of our management and key personnel from our business operations.

      In addition, our ability to assert our patents against a potential infringer depends on our ability to detect the infringement in the first instance. Many countries, including certain European countries, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties in some circumstances. For example, compulsory licenses may be required in cases where the patent owner has failed to “work” the invention in that country, or the third party has patented improvements. In addition, many countries limit the enforceability of patents against government agencies or government contractors. In these countries, the patent owner may have limited remedies, which could materially diminish the value of the patent. Compulsory licensing of life saving drugs is also becoming increasingly popular in developing countries either through direct legislation or international initiatives. Such compulsory licenses could be extended to include some of our product candidates, which could limit our potential revenue opportunities. Moreover, the legal systems of certain countries, particularly certain

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      Our success will also depend in part upon our not infringing patents issued to others. If our product candidates are found to infringe the patents of others, our development, manufacture and sale of such potential products could be severely restricted or prohibited. In fact, one of our issued European patents covering capsaicin for injection has been challenged by Grunenthal, a German pharmaceutical company, in the European Patent Court. In response to this challenge, we submitted proposed modifications to the patent which the patent court approved and published in November 2004. The amended patent can be objected to by Grunenthal or any other third party within two months following publication of the amended patent by the court. If any future challenge by Grunenthal or any other party is ultimately successful in invalidating the patent, the ability of third parties to market competing technologies to ALGRX 4975 in Europe could be enhanced.

      Patent litigation can involve complex factual and legal questions and its outcome is uncertain. Any claim relating to infringement of patents that is successfully asserted against us may require us to pay substantial damages. Even if we were to prevail, any litigation could be costly and time-consuming and would divert the attention of our management and key personnel from our business operations. Furthermore, if a patent infringement suit were brought against us or our future strategic partners or licensees, if any, we or they may 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 strategic partners or licensees rights to use its intellectual property. In such cases, we may 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 strategic partners, licensees 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.

      Much of our technology and many of our processes depend upon the knowledge, experience and skills of our scientific and technical personnel. To protect rights to our proprietary know-how and technology, we generally require all employees, contractors, consultants, advisors, visiting scientists and collaborators as well as potential collaborators to enter into confidentiality agreements that prohibit the disclosure of confidential information. The agreements with employees and consultants also require disclosure and assignment to us of ideas, developments, discoveries and inventions. These agreements may not effectively prevent disclosure of our confidential information or provide meaningful protection for our confidential information.

      Many of our employees were previously employed by 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. If we fail in defending such claims, in addition to paying money claims, we may lose valuable intellectual property rights or personnel.

License Agreements

      In August 2001, we entered into an agreement with James N. Campbell, M.D., Richard A. Meyer, M.S. and Marco Pappagallo, M.D. to acquire the exclusive, worldwide license to U.S. Patent Application No. 09/041294 (U.S. Patent No. 5,962,532) and all applications and products relating thereto directed to methods and kits for relieving pain using capsaicin and an anesthetic. The technology licensed under the

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      In August 2001, we entered into a non-exclusive, worldwide license agreement with Marco Pappagallo, M.D. for U.S. Provisional Patent Application No. 60/006,385 and U.S. Utility Patent Application No. 08/746,207 (U.S. Patent No. 6,248,788) directed to methods of treating neuropathic pain using capsaicin anesthetic, and all applications and patents relating thereto. The licensed technology relates to the use of capsaicin for pain relief. The primary patent underlying the license expires on November 6, 2016. This license agreement makes reference to the August 2001 license agreement between us and Drs. Campbell and Pappagallo and Mr. Meyer and provides that if Dr. Pappagallo develops or has any right to any technology under U.S. Patent No. 6,248,788 relating to an injectable product or service using capsaicin and its analogues for pain relief, the technology will be licensed to us pursuant to the terms of the August 2001 license agreement with Drs. Campbell and Pappagallo and Mr. Meyer. We are also obligated to pay up to $222,000 in milestone payments, and we have made no milestone payments to date. Of the $222,000 in milestone payments, $40,000 is payable upon the first administration to a subject using licensed technology in a phase I clinical trial, $66,000 is payable upon the first administration to a subject using licensed technology in a phase III clinical trial and $116,000 is payable upon FDA approval of the first product using licensed technology. With respect to the licensed technology, we are obligated to pay Dr. Pappagallo royalties on any future sales by us or our sublicensees of transdermal or topical products or services developed from the licensed technology. If at any time Dr. Pappagallo becomes the exclusive owner of the licensed technology, the royalty payments that we are obligated to pay will increase and we will be obligated to make milestone payments of up to $666,000. Our rights under the agreement can be terminated on 10 days’ written notice if we fail to fulfill any material obligation under the agreement and the failure is not cured by us within 180 days of receiving notice of such failure. We can terminate the agreement upon 30 days’ prior notice for any reason or upon 10 days’ prior notice for the failure of any counterparty to fulfill a material obligation not cured within 90 days of our giving notice of the failure. The license is subject to a sublicense to the inventors for research and development, with no right to commercialization.

      In March 2002, we acquired from PowderJect Research Limited a license to intellectual property consisting of over 150 patents and applications relating to the methods and apparatus for the delivery of powder forms of medications. The technology licensed under this agreement with PowderJect includes the

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      The term of the license commenced on March 22, 2002 and continues until the expiration of the last patent to expire licensed under the agreement unless the agreement is otherwise terminated. The primary patents licensed under the agreement and used by us in connection with ALGRX 3268 expire in 2014. The agreement can be terminated by either party if the other party ceases to do business in the ordinary course, or assigns all or substantially all of its assets for the benefit of creditors. Either party can also terminate for material breach if not cured within 60 days of notice or if not cured within 30 days of notice if the breach relates to payment provisions. The license agreement also implemented an intellectual property sharing arrangement pursuant to which we and PowderMed Limited are obligated to share with one another any improvements and modifications to the licensed technology. The sharing arrangement expires on March 22, 2007.

      In October 2004, we entered into an agreement with Bridge Pharma, Inc. under which we acquired the exclusive worldwide license to proprietary technology relating to certain analgesic and local anesthetic pharmaceutical agents and compounds. The licensed technology relates to our product candidate, ALGRX 1207. The agreement also grants us the right to research, develop, sell, import or otherwise commercialize products based on such compounds, provided such products are an analgesic and/or local anesthetic for human or animals in any route of administration, including without limitation, dermal, mucosal, dental, ophthalmic or injection. Upon execution of the agreement, we paid Bridge Pharma, Inc. an up-front license fee consisting of a cash payment of $1 million and the issuance of 1,600,000 shares of our common stock. We are obligated to pay Bridge Pharma, Inc. royalties on any future sales by us or our sublicensees and additional payments if we achieve certain clinical, regulatory and commercial milestones. We are required to pay milestone payments upon the commencement of phase I, II and III clinical trials and upon the occurrence of certain events including the filing of a new drug application, the regulatory approval for each of the first and second products using the licensed technology and the reaching certain revenue thresholds from sales of products using the licensed technology. To date, we have paid no milestone payments. We are obligated to spend a minimum of $1 million for product development in each calendar year during the term of the agreement commencing in 2005 and ending on the first commercial sale of a product using the licensed technology. We are also responsible under the Bridge Pharma agreement for paying expenses associated with any patent prosecution and maintenance relating to the underlying technology and for certain costs associated with the research, development, regulatory filings and approvals and commercialization of products using the underlying technology. The term of the agreement commenced on October 28, 2004 and continues until our obligation to pay royalties to Bridge Pharma, Inc. expires, or earlier if terminated by either party. Either party may terminate the agreement for material breach if not cured within 60 days of notice, or with immediate effect if the other party makes an

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Government Regulation

      The FDA and comparable regulatory agencies in foreign countries, as well as local and state or other regional governmental agencies, impose substantial requirements upon the clinical development, manufacture and marketing of pharmaceutical products. These agencies and other federal, state and local entities regulate research and development activities and the testing, manufacture, quality control, safety, effectiveness, labeling, storage, record keeping, approval, advertising and promotion of our products.

      The process required by the FDA before product candidates may be marketed in the United States generally involves the following:

      The testing and approval process requires substantial time, effort and financial resources, and we cannot be certain that any new approvals for our product candidates will be granted on a timely basis, if at all.

      Prior to commencing the first human clinical trial, we must submit an IND application to the FDA. The IND application automatically becomes effective 30 days after receipt by the FDA, unless the FDA, within the 30-day time period, raises concerns or questions about the preclinical drug testing or nonclinical safety evaluation in animals, or the design or conduct of the first proposed clinical trial and places the study on clinical hold. In such a case, the IND sponsor and the FDA must resolve any outstanding concerns before the clinical trial may begin. Our submission of an IND application may not result in FDA authorization to commence a clinical trial. In fact, with respect to our first IND application for ALGRX 4975 and our IND application for ALGRX 3268, the FDA placed our clinical trials on hold. In the case of ALGRX 3268, the FDA requested the results from several nonclinical studies regarding the ways in which particles were ejected from the device. In the case of ALGRX 4975, the FDA requested that we provide them with the results of an ongoing osteoarthritis clinical trial then underway in the United Kingdom under the clinical trials exemption. In both cases, the FDA subsequently lifted each hold to allow us to initiate or continue the trials after we submitted the information they had requested. A separate submission to the existing IND application must be made for each successive clinical trial conducted during product development, and the FDA must not object to the submission before each clinical trial may start and continue. Further, an independent institutional review board for investigation in human subjects within each medical center in which an investigator wishes to participate in the clinical trial must review and approve the preclinical drug testing and nonclinical safety evaluation and efficacy in animals or prior human trials as well as the design and goals of the proposed clinical trial before the clinical trial commences at that center. Regulatory authorities or an institutional review board or the sponsor may suspend a clinical trial at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk.

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      For purposes of NDA approval, human clinical trials are typically conducted in three sequential phases that may overlap.

      The FDA may require, or companies may pursue, additional clinical trials after a product is approved. These so-called phase IV clinical studies may be made a condition to be satisfied after a drug receives approval. The results of phase IV clinical studies may confirm the effectiveness of a product and may provide important safety information to augment the FDA’s voluntary adverse drug reaction reporting system.

      The results of product development, preclinical studies and clinical trials are submitted to the FDA as part of an NDA, or as part of an NDA supplement. The FDA may deny approval of an NDA or NDA supplement if the applicable regulatory criteria are not satisfied, or it may require additional clinical data or an additional pivotal phase III clinical trial. Even if such data are submitted, the FDA may ultimately decide that the NDA or NDA supplement does not satisfy the criteria for approval. The FDA may withdraw product approval, once issued, if ongoing regulatory standards are not met or if safety problems occur after the product reaches the market. In addition, the FDA may require testing and surveillance programs to monitor the effect of approved products which have been commercialized, and the FDA has the power to prevent or limit further marketing of a product based on the results of these post-marketing programs.

      Satisfaction of FDA requirements or similar requirements of state, local and foreign regulatory agencies typically takes several years and the actual time required may vary substantially based upon the type, complexity and novelty of the product or disease. Typically, if a drug product is intended to treat a chronic disease, as is the case with some of the product candidates we are developing, safety and efficacy data must be gathered over an extended period of time, which can range from one to three years or more. Government regulation may delay or prevent marketing of product candidates for new indications for a considerable period of time and impose costly procedures upon our activities. The FDA or any other regulatory agency may not grant approvals for new indications for our product candidates on a timely basis, if at all. Success in early stage clinical trials does not ensure success in later stage clinical trials. Data obtained from clinical activities is not always conclusive and may be susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. Even if a product candidate receives regulatory approval, the approval may be significantly limited to specific disease states, patient populations and dosages. Further, even after regulatory approval is obtained, later discovery of previously unknown problems with a product may result in restrictions on the product or even complete withdrawal of the product from the market. Delays in obtaining, or failures to obtain, additional regulatory approvals for our

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      Any products manufactured or distributed by us pursuant to FDA approvals are subject to continuing regulation by the FDA, including record-keeping requirements and reporting of adverse experiences with the drug. Drug manufacturers and their subcontractors are required to register their establishments with the FDA and certain state agencies, and are subject to periodic unannounced inspections by the FDA and certain state agencies for compliance with good manufacturing practices, which impose certain procedural and documentation requirements upon us and our third party manufacturers. We cannot be certain that we or our present or future suppliers will be able to comply with the good manufacturing practices regulations and other FDA regulatory requirements. If our present or future suppliers are not able to comply with these requirements, the FDA may halt our clinical trials, require us to recall a drug from distribution, or withdraw approval of the NDA for that drug.

      The FDA closely regulates the marketing and promotion of drugs. A company is permitted to make only those claims relating to safety and efficacy that are approved by the FDA. Failure to comply with these requirements can result in adverse publicity, warning letters, corrective advertising and potential civil and criminal penalties. Physicians may prescribe legally available drugs for uses that are not described in the product’s labeling and that differ from those tested by us and approved by the FDA. Such off-label uses are common across medical specialties. Physicians may believe that such off-label uses are the best treatment for many patients in varied circumstances. The FDA does not regulate the behavior of physicians in their choice of treatments. The FDA does, however, restrict manufacturers’ communications on the subject of off-label use.

      The FDA’s policies may change, and additional government regulations may be enacted which could prevent or delay regulatory approval of our product candidates or approval of new diseases for our product candidates. We cannot predict the likelihood, nature or extent of adverse governmental regulation that might arise from future legislative or administrative action, either in the United States or abroad.

Supply Agreement

      In March 2002, we entered into a supply agreement with PowderJect Technologies Limited to supply us with the cylinders that are a key component in the dispenser for ALGRX 3268. PowderJect Technologies Limited is part of the Chiron group of companies operating under the Chiron Corporation. PowderJect Technologies Limited is currently our sole supplier of cylinders, and we currently have no alternate supplier or source of cylinders. The cylinders are exclusively manufactured for PowderJect Technologies Limited by The BOC Group plc pursuant to supply and manufacturing agreements by and between PowderJect Technologies Limited and the third party manufacturer. We are not a party to any agreements with that third party manufacturer. If The BOC Group plc breaches its obligations to PowderJect Technologies Limited and the breach results in PowderJect Technologies Limited’s inability to supply us with cylinders, PowderJect Technologies Limited, under the terms of its supply agreement with us, must take all reasonable steps to enforce its rights under its agreements with The BOC Group plc and seek remedies that are in the best interest of AlgoRx and PowderJect Technologies Limited, including without limitation, seeking specific performance or injunctive relief. Although we have not experienced any shortages of cylinders to date, our inability to obtain the cylinders for any reason could substantially impair our development activities or the production, marketing and distribution of ALGRX 3268.

      The term of our supply agreement with PowderJect Technologies Limited commenced on March 22, 2002 and continues until the later of March 22, 2012 and the termination of the agreement with the third party manufacturer, unless terminated earlier. We have an option to extend the term of the agreement until March 2014, if the agreement with the third party manufacturer terminates on mutually agreeable terms before March 2010. We can terminate our supply agreement with PowderJect Technologies Limited on account of a material uncured breach. If we materially breach our payment obligations under the supply agreement with PowderJect Technologies Limited, PowderJect Technologies Limited can suspend its supply obligations to us if we fail to cure the breach within 60 days of the date of notice of such

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Manufacturing

      We have no manufacturing facilities. We have entered into arrangements with various third parties for the formulation and manufacture of our clinical supplies. These supplies and the manufacturing facilities must comply with regulations and current good laboratory practices or cGLPs, and current good manufacturing practices or cGMPs, enforced by the FDA. We plan to continue to outsource formulation and manufacturing for our clinical trials and potential commercialization. Other than for the cylinder used in ALGRX 3268 described above, we believe that there are alternate manufacturers available to produce our clinical supplies and, if our product candidates are approved by the FDA, commercial supplies of our product components.