ALGOS PHARMACEUTICAL CORP, 424B1, 1996-09-26

ALGOS PHARMACEUTICAL CORP
424B1, 1996-09-26
PHARMACEUTICAL PREPARATIONS

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PROSPECTUS

[LOGO]

3,500,000 SHARES
ALGOS
PHARMACEUTICAL
CORPORATION
COMMON STOCK
---------------------------

All of the shares of Common Stock (the 'Common Stock') of Algos
Pharmaceutical Corporation ('Algos'or the 'Company') offered hereby (the
'Offering') are being sold by the Company. At the request of the Company, the
Underwriters have reserved 300,000 shares of Common Stock for sale at the
initial public offering price to certain of the Company's employees and certain
other persons. If such shares are not purchased by such employees or other
persons they will be offered by the Underwriters to the public upon the terms
and conditions set forth in this Prospectus. See 'Underwriting.'

Johnson & Johnson Development Corporation, an affiliate of Johnson &
Johnson, has expressed an interest in purchasing 10% of the Offering, up to $6.5
million worth of the shares of Common Stock offered hereby, at the public
offering price.

Prior to the Offering, there has been no public market for the Common
Stock. See 'Underwriting' for information relating to the factors that were
considered in determining the initial public offering price. Subject to notice
of issuance, the Common Stock has been approved for quotation on the Nasdaq
National Market under the symbol 'ALGO.'
---------------------------

THE SHARES OF COMMON STOCK OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE 'RISK FACTORS' BEGINNING ON PAGE 6.
---------------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION,
NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE
SECURITIES COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.

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<CAPTION>
Underwriting
Price to Discounts and Proceeds to
Public Commissions (1) Company (2)
<S> <C> <C> <C>

Per Share.................................... $14.00 $0.98 $13.02
Total(3)..................................... $49,000,000 $3,430,000 $45,570,000
</TABLE>

(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See 'Underwriting.'

(2) Before deducting expenses payable by the Company estimated at $800,000.

(3) The Company has granted to the Underwriters a 30-day option to purchase up
to 525,000 additional shares on the same terms and conditions as set forth
above, solely to cover over-allotments, if any. If such option is exercised
in full, the total Price to Public, Underwriting Discounts and Commissions
and Proceeds to Company will be $56,350,000, $3,944,500 and $52,405,500,
respectively. See 'Underwriting.'
---------------------------

The shares of Common Stock offered by this Prospectus are offered by the
Underwriters, subject to prior sale, to withdrawal, cancellation or modification
of the offer without notice, to delivery and to acceptance by the Underwriters
and to certain further conditions. It is expected that delivery of certificates
representing the shares of Common Stock will be made at the offices of Lehman
Brothers Inc., New York, New York, on or about October 1, 1996.

---------------------------

LEHMAN BROTHERS COWEN & COMPANY

September 25, 1996

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The following table lists the Company's ten products in development that
have reached Phase II clinical trials or are scheduled for Phase II or Phase III
clinical trials in 1996, their respective intended therapeutic indications and
current stage of development. There can be no assurance that any of these
products will be developed successfully or approved by the FDA.

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<CAPTION>
ALGOS PRODUCTS IN DEVELOPMENT

PRODUCT INDICATION STAGE OF DEVELOPMENT
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<S> <C> <C>
NARCOTIC ANALGESICS
MorphiDex'tm' Moderate to severe Pivotal Phase II clinical trial
pain (primarily cancer pain) completed.
Additional Phase II and III clinical
trials in progress or scheduled in
1996.
Two Phase I/II clinical trials
completed.

HydrocoDex SR'tm' and HydrocoDex Moderate to moderately severe pain Phase II clinical trial scheduled in
Plus'tm' (primarily post-operative, 1996.
musculoskeletal and trauma-related
pain)

OxycoDex'tm' Moderate to moderately severe pain Phase II clinical trial in progress.
(primarily post-operative pain) Additional Phase II clinical trial
scheduled in 1996.

NON-NARCOTIC ANALGESICS
Ibuprofen/NMDA Antagonist Over-the-counter ('OTC') analgesic Phase II clinical trial completed.
Combination Additional Phase II clinical trial
scheduled in 1996.

Acetaminophen/NMDA Antagonist OTC analgesic Phase II clinical trial in progress.
Combination

ANESTHETICS
Lidocaine/NMDA Antagonist Extended duration anesthetic Phase I/II clinical trial scheduled
Combination in 1996.

OTHERS
Urge Urinary Incontinence Treatment Urge urinary incontinence Phase II clinical trial in progress.

Opiate Addiction Treatment Opiate addiction Phase II clinical trial scheduled in
1996.

Cocaine Addiction Treatment Cocaine addiction Phase II clinical trial scheduled in
1996.
</TABLE>

The following are trademarks of the Company: MorphiDex'tm', HydrocoDex
SR'tm', HydrocoDex Plus'tm' and OxycoDex'tm'.
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IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMPANY'S
COMMON STOCK AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.

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PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and the financial statements
and notes thereto appearing elsewhere in this Prospectus. Unless otherwise
indicated, all information in the Prospectus (i) gives effect to a 8.30-for-1
stock split in the form of a stock dividend declared in May 1996, and (ii)
assumes no exercise of the Underwriters' over-allotment option.

THE COMPANY
Algos Pharmaceutical Corporation ('Algos' or the 'Company') is a leader in
developing a new generation of proprietary pain management products. The Company
develops its proprietary pain management products by combining existing
analgesic or anesthetic drugs with N-methyl-D-aspartate ('NMDA') antagonist
drugs that have been approved for human use in other applications. Independent
research and the Company's pre-clinical studies and clinical trials conducted to
date have shown that the Company's products may significantly improve pain
relief over currently available analgesics, including narcotic drugs such as
morphine, hydrocodone and oxycodone and non-narcotic analgesics such as
acetaminophen (e.g. Tylenol'r'), ibuprofen (e.g. Advil'r') and naproxen (e.g.
Aleve'r'). The Company is also developing a local anesthetic product that has
the potential to provide greater anesthetic effect with longer and more
controlled duration than existing products. The Company's analgesic and
anesthetic products will target markets with combined 1995 U.S. sales estimated
at $6.4 billion. In addition, the Company is using its NMDA antagonist
technology to develop products to treat urge urinary incontinence and opiate and
cocaine addiction.

The Company believes that its analgesic and anesthetic products have the
potential for more rapid market introduction than many other new drugs because
(i) the Company's products combine existing drugs whose separate safety profiles
are known and established and (ii) clinical trials for new analgesics and
anesthetics historically have achieved statistically significant results with
fewer patients than may be required for many other drugs. As a result, the
Company currently anticipates that it will file its first New Drug Application
('NDA') with the Food and Drug Administration ('FDA') in 1997.

The Company has ten products that have reached Phase II clinical trials or
are scheduled for Phase II or Phase III clinical trials in 1996. The Company has
completed or is currently conducting eleven clinical trials and has scheduled
additional clinical trials to commence in 1996. A pivotal Phase II clinical
efficacy trial has been completed with MorphiDex'tm' demonstrating statistically
significant superior pain relief over morphine.

The Company's products that have reached Phase II clinical trials or are
scheduled for Phase II or Phase III clinical trials consist of:

(i) four narcotic analgesic/NMDA antagonist combination products:
MorphiDex'tm', expected to be used primarily to treat cancer pain,
HydrocoDex SR'tm' and HydrocoDex Plus'tm', expected to be used
primarily to treat moderate to moderately severe post-operative,
musculoskeletal and trauma-related pain, and OxycoDex'tm', expected to
be used primarily to treat moderate to moderately severe
post-operative pain;

(ii) two over-the-counter ('OTC') analgesic/NMDA antagonist combination
products: a combination product of an NMDA antagonist with
acetaminophen, the largest selling OTC analgesic, and a combination
product of an NMDA antagonist with ibuprofen, the largest selling OTC
non-steroidal anti-inflammatory drug ('NSAID');

(iii) one injectable local anesthetic/NMDA combination product intended to
provide greater anesthetic effect with longer and more controlled
duration for use in dental procedures and in-patient and out-patient
surgeries;

(iv) one product that uses an NMDA antagonist intended as a treatment for
urge urinary incontinence, a condition which afflicts an estimated
five million people in the U.S.; and

(v) two products intended as treatments for opiate and cocaine addiction,
which the Company expects to develop in collaboration with the
National Institute on Drug Abuse ('NIDA'), National Institutes of
Health ('NIH').

In June 1996, the Company entered into a license agreement with McNeil
Consumer Products Company ('McNeil'), an affiliate of Johnson & Johnson,
pursuant to which the Company granted McNeil the exclusive right to develop
acetaminophen/NMDA antagonist combination products and certain NSAID/NMDA
antagonist combination products for the treatment of pain (the 'McNeil License
Agreement'). The McNeil License Agreement: (i) grants McNeil an exclusive
worldwide license to manufacture and market such products; (ii) provides for an
initial payment of $2.0 million to

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the Company and subsequent payments of up to an additional $8.0 million upon the
achievement of certain milestones generally relating to product development and
patent issuances; and (iii) provides for the payment of royalties to the Company
on net sales of the licensed products. McNeil will bear all of the costs of
developing products it selects, except for approximately $500,000 to be borne by
the Company. McNeil will be required to pay minimum royalties, provided that
certain conditions have been met, even if McNeil has not commenced marketing of
an acetaminophen product or an NSAID product.

In June 1996, the Company entered into a letter of intent with NIDA, NIH,
pending formal approval of a cooperative research and development agreement (a
'CRADA'), to conduct joint research on a methadone/NMDA antagonist combination
drug as a potential treatment for opiate addiction.

The Company believes that the markets in which it intends to compete offer
attractive opportunities. Favorable factors in the target analgesic markets
include: high growth rates partially attributable to the rapidly growing
population segment aged 65 and older; increasing recognition of the therapeutic
benefits of effective pain treatment including reductions in healing and
recovery time; generally concentrated distribution channels that permit more
cost-effective selling and marketing; lack of recent product innovation which
has resulted in market segments comprised largely of older off-patent drugs;
higher profit margins from branded proprietary products; and the potential for
rapid acceptance of new pain management pharmaceuticals by members of the
medical profession. The market for local anesthetics also presents attractive
opportunities for the Company's controlled duration product because existing
local anesthetics have limited and less controllable duration which restricts
their use in surgery. The Company believes the markets for its products to treat
urge urinary incontinence and drug addiction present significant opportunities
because of the lack of satisfactory pharmaceutical treatments and the large
potential market sizes.

The Company's strategic goal is to establish a leading position in the pain
management pharmaceutical market. The Company intends to achieve this goal by:
(i) introducing superior proprietary products; (ii) minimizing development time,
cost and risk; (iii) leveraging its proprietary technology across multiple
product opportunities; (iv) outsourcing to efficiently deploy resources; and (v)
maximizing market penetration and margin potential through a combination of
Company direct sales and strategic alliances.

The Company seeks to protect its proprietary position by, among other
methods, filing United States and foreign patent applications with respect to
the development of its products. The Company has exclusive licenses for three
issued U.S. patents and six U.S. patent applications pending and holds one
additional U.S. patent application pending.

To date, the Company has generated no product revenues and has experienced
net losses in each year since its inception. At June 30, 1996, the Company had
an accumulated deficit of approximately $4.9 million.

The Company was incorporated in Delaware in 1992. Its executive offices are
located at Collingwood Plaza, 4900 Route 33, Neptune, New Jersey 07753, and its
telephone number is (908) 938-5959.

THE OFFERING

<TABLE>
<S> <C>
Common Stock offered by
the Company................................... 3,500,000 shares
Common Stock to be outstanding after the
Offering...................................... 15,544,123 shares(1)
Use of Proceeds................................. To fund research and product development, the establishment of
a direct sales force, working capital and for other general
corporate purposes. See 'Use of Proceeds.'
Proposed Nasdaq National Market symbol.......... ALGO
</TABLE>

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(1) Excludes an aggregate of 1,115,665 shares of Common Stock reserved for
issuance upon the exercise of outstanding options and warrants, including
the conversion of the Company's Series B Convertible Preferred Stock, $.01
par value per share (the 'Series B Preferred Stock'). See 'Management and
Key Scientific Advisors -- Stock Option Plans' and 'Description of Capital
Stock.'

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SUMMARY FINANCIAL INFORMATION

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<CAPTION>
SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
---------------------------------------- ----------------------
1992 1993 1994 1995 1995 1996
----- ----- ------- ------- ------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................... $ 96(1) $ 215(1) $ -- $ -- $ -- $ 1,500
Operating expenses:
Research and development............... 125 40 654 1,615 801 1,004
General and administrative............. 369 436 623 760 396 1,628
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Total operating expenses.......... 494 476 1,277 2,375 1,197 2,632
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Interest income............................. 13 4 153 253 138 77
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Net loss.................................... $(385) $(257) $(1,124) $(2,122) $(1,059) $(1,055)
----- ----- ------- ------- ------- -----------
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Pro forma net loss per common share(2)...... $ (0.17) $ (0.09)
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Pro forma weighted average common shares
outstanding(2)............................ 12,199 12,329
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</TABLE>

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<CAPTION>
JUNE 30, 1996
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AS
ACTUAL ADJUSTED(3)
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(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents(4)............................................................... $2,505 $47,329
Working capital............................................................................ 3,268 48,335
Total assets............................................................................... 4,903 49,430
Deficit accumulated during the development stage........................................... (4,943) (4,943)
Total stockholders' equity................................................................. 3,649 48,419
</TABLE>

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(1) Represents revenues from consulting activities in which the Company has
ceased to engage.

(2) Adjusted to give effect to the automatic conversion of all outstanding
shares of Series A Preferred Stock (the 'Series A Preferred Stock') into
Common Stock upon consummation of the Offering. See Note 2 to the Financial
Statements.

(3) As adjusted to give effect to the Offering at the initial public offering
price of $14.00 per share (after deducting the underwriting discounts and
commissions and estimated offering expenses) and the receipt of the net
proceeds therefrom. See 'Use of Proceeds' and 'Capitalization.'

(4) Does not include $2.0 million received from McNeil on July 5, 1996 pursuant
to the McNeil License Agreement of which $500,000 is committed to fund the
Company's portion of development costs under the McNeil License Agreement.

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RISK FACTORS

An investment in the shares of Common Stock offered hereby involves a high
degree of risk. The following factors, in addition to the other information in
this Prospectus, should be carefully considered in evaluating the Company and
its business before purchasing the shares of Common Stock offered hereby.

Early Stage of the Company; Continuing Losses; Uncertainty of Future
Profitability

Since its formation in January 1992, the Company has been engaged primarily
in organizational and start-up activities, conducting research and development
programs, recruiting officers and key scientists, and negotiating and
consummating technology licensing and research agreements. The Company has no
revenues from product sales and no history of manufacturing or marketing. To
date, substantially all of its funding has been provided by contributions of
capital made by its founders, through a private placement of 700,000 shares of
its Series A Preferred Stock and an initial payment from McNeil pursuant to the
McNeil License Agreement. There can be no assurance that the Company will have
any source of product revenue or that its operations will eventually generate
sufficient revenues to achieve profitability. The Company has experienced losses
since its inception. The Company had accumulated losses of approximately $4.9
million through June 30, 1996, and losses are continuing and are expected to
continue for the foreseeable future. Therefore, the Company has a limited
history upon which investors may base an evaluation of its likely performance.
The Company's prospects must be considered in light of the problems, expenses,
complications and delays frequently encountered in connection with the formation
of a new business, the development of new pharmaceutical products, including
obtaining the necessary regulatory approvals, the utilization of unproven
technology and the competitive environment in which the Company plans to
operate.

Uncertainty Associated with Pre-Clinical Studies and Clinical Trials

In order to receive regulatory approval to sell its products commercially,
the Company must demonstrate in pre-clinical studies and clinical trials that
its potential products are safe and effective in humans. To date, four clinical
trials have been completed on two of the Company's products. Although the
results of the Company's initial pre-clinical studies and clinical trials to
date have been encouraging, the results of initial pre-clinical studies and
clinical trials are not by themselves predictive of results that will be
obtained from subsequent or more extensive trials. Furthermore, there can be no
assurance that clinical trials of products under development will demonstrate
the safety and efficacy of such products to the extent necessary to obtain
regulatory approvals. Many pharmaceutical companies have suffered significant
setbacks in advanced clinical trials, even after promising results in earlier
trials. The failure to adequately demonstrate the safety and efficacy of a
product could delay or prevent regulatory approval of such product and could
have a material adverse effect on the Company.

The rate of completion of clinical trials is dependent upon, among other
factors, the enrollment of patients. Patient accrual is a function of many
factors, including the size of the patient population, the proximity of patients
to clinical sites, the eligibility criteria for the study and the existence of
competitive clinical trials. Delays in planned patient enrollment in the
Company's current trials or future clinical trials may result in increased
costs, program delays or both, which could have a material adverse effect on the
Company. There can be no assurance that if clinical trials are completed the
Company will be able to submit an NDA as scheduled or that any such application
will be reviewed and approved by the FDA in a timely manner, or at all. See
'Business -- Government Regulation.'

Uncertainty of Market Acceptance

Even if regulatory approvals are obtained, uncertainty exists as to whether
the Company's products will be accepted by the market. A number of factors may
limit the market acceptance of the Company's products, including the timing of
regulatory approvals and market entry relative to competitive products, the
availability of alternative products, the price of the Company's products
relative to alternative products, the availability of third-party reimbursement
and the extent of marketing efforts by third-party distributors or agents
retained by the Company. There can be no assurance of the Company's ability, or
the length of time required, to achieve market acceptance of the Company's

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products. In addition, certain of the Company's products contain narcotic
ingredients that may require stringent record-keeping obligations, strict
storage requirements and other limitations on such products' availability that
may limit the commercial usage of such products. See 'Business -- Market
Overview' and ' -- Products.'

Certain Risks Associated With the McNeil License Agreement

The McNeil License Agreement extends until the later of the expiration of
the Company's patent rights or ten years from the date of execution, provided
that the McNeil License Agreement is terminable: (i) by either party in the
event of a breach by the other party upon 90 days notice or upon certain events
of bankruptcy; (ii) by McNeil, at any time after one year from the effective
date of the agreement; and (iii) by the Company upon certain other
circumstances. Under certain circumstances, the McNeil License Agreement could
terminate with respect to either acetaminophen or NSAID products without
terminating with respect to the other category. In the event of a termination by
McNeil, McNeil must pay all royalty payments and milestone payments due, if any,
through the date of termination and the technology licensed by McNeil reverts to
the Company. In such event, the Company retains the rights to the results of the
two clinical studies funded by the Company, and McNeil retains the rights to the
results of the clinical studies funded by McNeil during the term of the McNeil
License Agreement.

Competition and Technological Changes, Uncertainty and Obsolescence

The Company's success will depend, in part, upon its ability to
successfully achieve market share at the expense of existing and established
products in the Company's target markets. The Company's products will be
competing directly with the products of companies that are well-established and
which may have a significantly higher degree of brand and name recognition and
substantially more financial resources than those of the Company. The Company is
also in competition with other pharmaceutical companies, hospitals, research
organizations, individual scientists and non-profit organizations engaged in the
development of new pain management pharmaceuticals. Many of these companies and
entities have greater research and development capacities, experience,
recognition and marketing, financial and managerial resources than the Company
and represent significant competition for the Company. Also, the Company's
competitors may succeed in developing competing technologies and obtaining FDA
approval for products more rapidly than the Company. There can be no assurance
that developments by others will not render the Company's products or
technologies non-competitive or obsolete.

Government Regulation; No Assurance of United States or Foreign Regulatory
Approval

The FDA and comparable agencies in foreign countries impose substantial
requirements on the introduction of therapeutic pharmaceutical products through
lengthy and detailed laboratory and clinical testing and other costly and
time-consuming procedures. Satisfaction of these requirements typically takes a
number of years, varies substantially based upon the type, complexity and
novelty of the pharmaceutical products and is subject to uncertainty. Government
regulation also affects the manufacture and marketing of pharmaceutical
products. Regulatory approvals, if granted, may include significant limitations
on the indicated uses for which a product may be marketed. The FDA actively
enforces regulations prohibiting marketing of products for non-indicated use.
Failure to comply with applicable regulatory requirements can result in, among
other things, government imposed fines, suspensions of approvals, seizures or
recalls of products, operating restrictions and criminal prosecutions.
Furthermore, changes in existing regulations or adoption of new regulations
could prevent the Company from obtaining, or affect the timing of, future
regulatory approvals. The effect of government regulation may be to delay
marketing of the Company's new products for a considerable period of time, to
impose costly procedures upon the Company's activities and to furnish a
competitive advantage to larger companies that compete with the Company. There
can be no assurance that FDA or other regulatory approval for any products
developed by the Company will be granted on a timely basis, if at all. Any such
delay in obtaining, or failure to obtain, such approvals would adversely affect
the marketing of the Company's products and the ability to generate product
revenue. The Company is also subject to certain Drug Enforcement Agency ('DEA')
regulations, including restrictions on storage,

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transportation and administration, for its narcotic products. Government
regulation may increase at any time, creating additional hurdles for the
Company. The extent of potentially adverse government regulation which might
arise from future legislation or administrative action cannot be predicted. See
'Business -- Government Regulation.'

Need for Additional Funds

The amount and timing of the Company's expenditures will depend on the
progress of its research and development, the cost and timing of regulatory
approvals, general market conditions, relationships with potential strategic
partners, changes in the focus and direction of the Company's research and
development programs, competitive and technological advances and other factors.
The Company's cash requirements may vary materially from those now planned and
no assurance can be given that development costs will not exceed the amounts
budgeted for such purposes. The Company may require additional funding for its
research and product development programs, operating expenses, regulatory
clearances and sales and marketing expenses. Adequate funds for these purposes,
whether obtained through financial markets or through collaborative or other
arrangements with partners or from other sources, may not be available when
needed or on terms acceptable to the Company. Insufficient funds may require the
Company to delay, scale back or eliminate certain of its research and
development programs or to make arrangements with third parties to commercialize
products or technologies that the Company would otherwise seek to develop
itself. As a result, the Company may not be able to independently develop any or
all of the products described in this Prospectus. To the extent the Company
raises additional capital by issuing securities, further dilution to investors
may result.

Limited Sales and Marketing Experience

The Company intends to market and sell certain of its products, if
successfully developed and approved, through a direct sales force in the United
States. The Company currently has no marketing and sales staff, and has yet to
establish any product distribution channels. In order to market its products
directly, the Company must develop a sales force with technical expertise. There
can be no assurance that the Company will be able to successfully establish a
direct sales organization or distribution channels. Failure to establish a sales
force capability in the U.S. may have a material adverse effect on the Company.

Dependence on Qualified Personnel

Because of the specialized scientific nature of the Company's business, the
Company is highly dependent upon its ability to attract and retain qualified
scientific and technical personnel. The loss of significant scientific and
technical personnel or the failure to recruit additional key scientific and
technical personnel could have a material adverse effect on the Company. While
the Company has consulting agreements with certain key individuals and
institutions and has employment agreements with its key executives, there can be
no assurance that the Company will be successful in retaining such personnel or
their services under existing agreements. See 'Management and Key Scientific
Advisors' and ' -- Executive Compensation and Employment Agreements.' The loss
of John Lyle, the Company's Chief Executive Officer, could have a material
adverse effect on the Company. The Company currently maintains a $6.0 million
life insurance policy on Mr. Lyle. There is intense competition for qualified
personnel in the areas of the Company's activities, and there can be no
assurance that the Company will be able to continue to attract and retain the
qualified personnel necessary for the development of its business.

Uncertain Ability to Protect Proprietary Technology

The Company's success, competitive position and amount of potential future
income will depend in part on its ability to obtain patent protection relating
to the technologies, processes and products it is developing and may develop in
the future. The Company's policy is to seek patent protection and enforce
intellectual property rights. With respect to its products, the Company holds
one U.S. patent application pending and has exclusive licenses for three issued
U.S. patents and six U.S. patent

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applications pending. No assurance can be given that any patent issued or
licensed to the Company will provide protection against competitive products or
otherwise be commercially viable. In this regard, the patent position of
pharmaceutical compounds and compositions is particularly uncertain. Even issued
patents may later be modified or revoked by the United States Patent and
Trademark Office ('PTO') or in legal proceedings. Moreover, the Company believes
that obtaining foreign patents may be more difficult than obtaining domestic
patents because of differences in patent laws, and accordingly, its patent
position may be stronger in the U.S. than abroad. In addition, foreign patents
may be more difficult to protect and/or the remedies available may be less
extensive than in the U.S. Patent applications in the U.S. are maintained in
secrecy until patents issue and, since publication of discoveries in the
scientific or patent literature tends to lag behind actual discoveries, the
Company cannot be certain that it was the first creator of the inventions
covered by pending patent applications or the first to file patent applications
on such inventions. No assurance can be given that any of the Company's pending
patent applications will be allowed, or if allowed, whether the scope of the
claims allowed will be sufficient to protect the Company's products.

The Company also expects to rely upon trade secrets, know-how, continuing
technological innovations and licensing opportunities to develop and maintain
its competitive position. There can be no assurance that others will not
independently develop substantially equivalent proprietary information or be
issued patents that may prevent the sale of the Company's products or know-how
or require licensing and the payment of significant fees or royalties by the
Company in order to produce its products. Moreover, there can be no assurance
that the Company's technology does not infringe upon any valid claims of patents
owned by others. If the Company were found to be infringing on a patent held by
another, the Company might have to seek a license to use the patented
technology. There can be no assurance that, if required, the Company would be
able to obtain such a license on terms acceptable to the Company, if at all. If
a legal action were to be brought against the Company or its licensors, the
Company could incur substantial costs in defending itself, and there can be no
assurance that such an action would be resolved in the Company's favor. If such
a dispute were to be resolved against the Company, the Company could be subject
to significant damages and the testing, manufacture or sale of one or more of
the Company's technologies or proposed products, if developed, could be
enjoined.

No assurance can be given as to the degree of protection any patents will
afford, whether patents will be issued or whether the Company will be able to
avoid violating or infringing upon patents issued to others. Despite the use of
confidentiality agreements and non-compete agreements, which themselves may be
of limited effectiveness, it may be difficult for the Company to protect its
trade secrets. See 'Business -- Patents, Trade Secrets and Licenses' and 'Risk
Factors -- Dependence on Qualified Personnel.'

Uncertain Availability of Health Care Reimbursement

The Company's ability to commercialize its pain management products may
depend in part on the extent to which reimbursement for the costs of such
products will be available from government health administration authorities,
private health insurers and others. There can be no assurance that third-party
insurance coverage will be adequate for the Company to establish and maintain
price levels sufficient for realization of an appropriate return on its
investment. Government, private insurers and other third-party payers are
increasingly attempting to contain health care costs by limiting both coverage
and the level of reimbursement for new products approved for marketing by the
FDA and by refusing, in some cases, to provide any coverage for uses of approved
products for indications for which the FDA has not granted marketing approval.
If adequate coverage and reimbursement levels are not provided by government and
third-party payers for uses of the Company's products, the market acceptance of
these products could be adversely affected.

No Product Liability Insurance

The Company will be exposed to potential product liability risks, which are
inherent in the testing, manufacturing and marketing of human therapeutic
products. The Company is contractually obligated under certain of its license
agreements to indemnify the individuals and/or institutions from whom it has

<PAGE>
<PAGE>
licensed the technology against claims relating to the manufacture and sale of
the products to be sold by the Company. McNeil, however, has agreed to indemnify
the Company for third party claims or suits resulting from the manufacture, use
or sale of the products pursuant to the McNeil License Agreement. The Company's
indemnification liability, as well as direct liability to consumers for any
defects in the products sold, could expose the Company to substantial risk and
losses. Because the Company's products are still in their development stages,
the Company has not purchased any product liability insurance. The Company plans
to purchase such product liability insurance as it deems appropriate prior to
marketing its products. McNeil is required by the McNeil License Agreement to
maintain product liability insurance and may self-insure to cover its
indemnification obligations to the Company. However, there can be no assurance
that the Company will be able to obtain or maintain such insurance on acceptable
terms or that any insurance obtained will provide adequate coverage against
potential liabilities.

Concentration of Ownership

Upon completion of the Offering, the Company's directors and officers will
beneficially own approximately 23.9% of the Common Stock. In addition, upon
completion of the Offering, the Company's largest stockholder, Unifina AG, and
related investors will control approximately 11.0% of the Common Stock. As a
result, these stockholders, if they acted together, would have the ability to
influence significantly the election of the Company's directors as well as the
management and policies of the Company. This concentration of ownership may have
the effect of delaying or preventing a change of control of the Company. See
'Principal Stockholders.'

No Prior Trading Market; Possible Volatility of Stock Price

Prior to the Offering, there has been no public market for shares of the
Common Stock, and there can be no assurance that a regular trading market will
develop after the Offering. The initial public offering price for the Common
Stock was determined by negotiations between the Company and the Underwriters.
See 'Underwriting.' The stock market has from time to time experienced
significant price and volume fluctuations that may be unrelated to the operating
performance of particular companies. In addition, the market price of the Common
Stock may prove to be highly volatile. Announcements of technological
innovations, regulatory matters or new commercial products by the Company or its
competitors, developments or disputes concerning patent or proprietary rights,
publicity regarding actual or potential clinical results relating to products
under development by the Company or its competitors, regulatory developments in
both the U.S. and foreign countries, public concern as to the safety of
pharmaceutical products, and economic and other external factors, as well as
period-to-period fluctuations in financial results, may have a significant
impact on the market price of the Common Stock.

Forward Looking Statements

This Prospectus contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, as amended (the 'Exchange Act') concerning the
Company's operations, economic performance and financial conditions, including,
in particular, the likelihood of the Company's success in developing and
bringing to market the products which it currently has under development. These
statements are based upon a number of assumptions and estimates which are
inherently subject to significant uncertainties and contingencies, many of which
are beyond the control of the Company and reflect future business decisions
which are subject to change. Some of these assumptions inevitably will not
materialize, and unanticipated events will occur which will affect the Company's
results. Consequently, actual results will vary from the statements contained
herein and such variance may be, and is likely to be, material. Prospective
investors should not place undue reliance on this information.

<PAGE>
<PAGE>
Shares Eligible for Future Sale

Of the 15,544,123 shares of Common Stock to be outstanding after the
Offering, no shares, other than the 3,500,000 shares of Common Stock sold in the
Offering, will be immediately eligible for resale in the public market without
restriction, after taking into consideration the effect of lock-up agreements
entered into by all officers, directors and all other existing stockholders of
the Company (the 'Lock-up Agreements'). Beginning 180 days after the date of
this Prospectus, after taking into consideration the effect of the Lock-up
Agreements, approximately 11,840,358 additional shares of Common Stock will
become eligible for resale in the public market, subject as to certain of such
shares to compliance with applicable provisions of Rules 144 and 701. See
'Shares Eligible for Future Sale.'

Certain stockholders of the Company who own shares of the Company's capital
stock prior to the Offering are entitled to certain registration rights with
respect to their shares, including a demand registration right which is
exercisable after 270 days from the date of this Prospectus and certain
'piggyback' registration rights which are exercisable in connection with
registrations of shares initiated by the Company. Such rights are not applicable
to the Offering. The Series B Preferred Stock is convertible into an aggregate
of 100,000 shares of Common Stock, subject to customary anti-dilution
adjustments, at any time after February 1, 1997. Holders of the Series B
Preferred Stock have the right to require the Company to register the resale of
the Common Stock that such holders receive upon conversion of the Series B
Preferred Stock into Common Stock. See 'Description of Capital Stock --
Registration Rights.'

If any such stockholders cause a large number of shares to be sold in the
public market, such sales may have an adverse effect on the market price of the
Common Stock and its ability to raise capital.

Dilution; Absence of Dividends

Purchasers of shares of Common Stock offered hereby will experience
immediate and substantial dilution of $10.89 in net tangible book value per
share, based on the initial public offering price of $14.00 per share. See
'Dilution.' The Company has never declared or paid any cash dividends on its
capital stock. The Company currently intends to retain earnings, if any, to
support its growth strategy and does not anticipate paying cash dividends in the
foreseeable future. Payment of future dividends, if any, will be at the
discretion of the Company's Board of Directors after taking into account various
factors, including the Company's financial condition, operating results, current
and anticipated cash needs and plans for expansion. See 'Dividend Policy.'

Effect of Anti-Takeover Provisions

The Company's Amended and Restated Certificate of Incorporation provides
for a classified Board of Directors commencing with the 1996 annual meeting of
stockholders and that members of the Board of Directors may be removed only for
cause upon the affirmative vote of holders of at least a majority of the shares
of capital stock of the Company entitled to vote. The Company's Amended and
Restated Certificate of Incorporation requires that any action required or
permitted to be taken by stockholders of the Company must be effected at a duly
called annual or special meeting of stockholders and may not be effected by any
consent in writing, and will require reasonable advance notice by a stockholder
of a proposal or director nomination which such stockholder desires to present
at any annual or special meeting of stockholders. Special meetings of
stockholders may be called only by the Chief Executive Officer or, if none, the
President of the Company or by the Board of Directors. In addition, the Board of
Directors has the authority, without further action by the stockholders, to fix
the rights and preferences of, and issue shares of, Preferred Stock. The Company
is subject to the anti-takeover provisions of Section 203 of the Delaware
General Corporation Law, which prohibits the Company from engaging in a
'business combination' with an 'interested stockholder' for a period of three
years after the date of the transaction in which the person first becomes an
'interested stockholder,' unless the business combination is approved in a
prescribed manner. The application of these provisions could have the effect of
delaying or preventing a change of control of the Company. Certain other
provisions of the Company's Amended and Restated Certificate of Incorporation
could also have the effect of delaying or preventing changes of control or
management of the Company, which could adversely affect the market price of the
Common Stock. See 'Description of Capital Stock.'

<PAGE>
<PAGE>
USE OF PROCEEDS

The net proceeds to the Company from the sale of the 3,500,000 shares of
Common Stock offered hereby are estimated to be approximately $44.8 million
($51.6 million if the Underwriters' over-allotment option is exercised in full),
after deducting estimated underwriting discounts and commissions and offering
expenses payable by the Company.

The Company intends to use approximately $32.0 million of the net proceeds
of the Offering to fund anticipated research and product development activities
and the planned establishment of the Company's direct sales force. The remaining
proceeds will be used for working capital and for other general corporate
purposes including the expansion of ongoing and scheduled preclinical studies
and clinical trials or additional pre-clinical studies and clinical trials, if
necessary, and the development of product line extensions and the initiation of
development programs for the Company's next generation of pain management
products for which the Company has not allocated any specific amounts. The
Company believes it is prudent to raise the additional capital at this time
since product development costs are inherently uncertain and actual development
costs may exceed budgeted amounts. A portion of the net proceeds also may be
used to acquire technology, licenses, or companies that complement the business
of the Company, although currently there are no agreements or other arrangements
regarding any such acquisitions by the Company. The amount and timing of such
expenditures will depend on a number of factors, including progress of the
Company's research and development programs, the number and breadth of these
programs, the progress of the development and commercialization efforts of the
Company, the ability of the Company to establish and maintain strategic
alliances and licensing arrangements, competing technological and marketing
developments, the costs involved in preparing, filing, prosecuting, maintaining,
and enforcing patent claims and other proprietary rights, progress in the
regulatory process, and other factors. The Company believes that the net
proceeds from the Offering, together with interest thereon and the Company's
existing capital resources will be sufficient to fund its operations for the
research and development of the products currently in clinical trials and other
working capital requirements for approximately three years. Pending such uses,
the net proceeds will be invested in interest bearing or income producing
accounts.

DIVIDEND POLICY

The Company has never declared or paid any cash dividends on its capital
stock. The Company currently intends to retain earnings, if any, to support its
growth strategy and does not anticipate paying cash dividends in the foreseeable
future. Payment of future dividends, if any, will be at the discretion of the
Company's Board of Directors after taking into account various factors,
including the Company's financial condition, operating results, current and
anticipated cash needs and plans for expansion.

<PAGE>
<PAGE>
CAPITALIZATION

The following table sets forth the capitalization of the Company at June
30, 1996, (i) on an actual basis and (ii) as adjusted to give effect to the
Offering and the automatic conversion of all outstanding shares of Series A
Preferred Stock of the Company into Common Stock upon the consummation of the
Offering. See 'Use of Proceeds.' The information presented below should be read
in conjunction with 'Management's Discussion and Analysis of Financial Condition
and Results of Operations' and the Company's historical financial statements and
the notes thereto included elsewhere in this Prospectus.

<TABLE>
<CAPTION>
JUNE 30, 1996
ACTUAL AS ADJUSTED(1)
------- --------------
(DOLLARS IN THOUSANDS)

<S> <C> <C>
Stockholders' equity(2):
Preferred Stock: 10,000,000 shares authorized;
Convertible Series A Preferred Stock, 872,500 shares authorized (actual); 0 shares
authorized (as adjusted); 707,500 shares issued and outstanding (actual); 0
shares issued and outstanding (as adjusted)...................................... $ 7 $ 0
Convertible Series B Preferred Stock, 100,000 shares authorized (actual and as
adjusted); 100,000 shares issued and outstanding (actual and as adjusted)........ 1 1
Common Stock: 50,000,000 shares authorized; 6,171,876 issued and outstanding
(actual); 15,544,123 issued and outstanding (as adjusted)......................... 62 155
Additional paid-in capital........................................................... 9,435 54,119
Unearned compensation expense........................................................ (913) (913)
Deficit accumulated during the development stage..................................... (4,943) (4,943)
------- --------------
Total stockholders' equity................................................... 3,649 48,419
------- --------------
Total capitalization......................................................... $ 3,649 $ 48,419
------- --------------
------- --------------
</TABLE>

- ------------

(1) As adjusted to reflect the Offering at the initial public offering price of
$14.00 per share for the Common Stock, after deducting estimated
underwriting discounts and commissions and estimated offering expenses
payable by the Company and to give effect to the automatic conversion of all
outstanding shares of Series A Preferred Stock into Common Stock upon
consummation of the Offering.

(2) Gives effect to the Company's Amended and Restated Certificate of
Incorporation that became effective after June 30, 1996.

<PAGE>
<PAGE>
DILUTION

The net tangible book value per share of the Common Stock as of June 30,
1996 was $0.29 per share, after giving effect to the automatic conversion of all
outstanding Series A Preferred Stock into an aggregate of 5,872,247 shares of
Common Stock upon consummation of the Offering. 'Net tangible book value per
share' represents the total tangible assets less total liabilities and the
liquidation preference of the Series B Preferred Stock, divided by the number of
shares of Common Stock outstanding after giving effect to the automatic
conversion of Series A Preferred Stock into shares of Common Stock.

Dilution per share represents the excess of the amount per share paid by
purchasers of Common Stock in the Offering and the pro forma net tangible book
value per share assuming completion of the Offering as of June 30, 1996, at the
initial public offering price of $14.00 per share. After giving effect to the
sale of 3,500,000 shares and the receipt of net proceeds of $44,770,000, the pro
forma net tangible book value per share on June 30, 1996 would have been $3.11
per share, which represents an immediate increase in the net tangible book value
of $2.82 to existing stockholders and an immediate dilution of $10.89 in net
tangible book value per share to purchasers of shares of Common Stock offered
hereby, as illustrated by the following table:

<TABLE>
<S> <C> <C>
Assumed initial public offering price per share....................................... $14.00
Net tangible book value per share at June 30, 1996.................................... $0.29
Increase per share attributable to new investors...................................... 2.82
-----
Pro forma net tangible book value per share after the Offering........................ 3.11
------
Dilution per share to new investors................................................... $10.89
------
------
</TABLE>

The following table summarizes, on a pro forma basis as of June 30, 1996,
the difference between the number of shares of Common Stock purchased from the
Company, the total consideration paid to the Company and the average price per
share paid by existing holders of Common Stock and by new investors purchasing
shares of Common Stock in the Offering at the initial public offering price of
$14.00 per share, before deducting underwriting discounts and commissions and
estimated offering expenses payable by the Company:

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
--------------------- ---------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------

<S> <C> <C> <C> <C> <C>
Existing stockholders.................. 12,044,123 77.5% $ 7,869,600 13.8% $ 0.65
New investors.......................... 3,500,000 22.5 49,000,000 86.2 14.00
---------- ------- ----------- -------
Total............................. 15,544,123 100.0% $56,869,600 100.0%
---------- ------- ----------- -------
---------- ------- ----------- -------
</TABLE>

The above calculations exclude 678,940 shares of Common Stock issuable upon
the exercise of outstanding options at a weighted average exercise price of
$0.13, 296,725 shares of Common Stock issuable upon the exercise of outstanding
warrants at an exercise price of $1.20 and 100,000 shares of Common Stock
issuable upon the conversion of the Series B Preferred Stock after February 1,
1997. The issuance of any such shares will result in further dilution to new
investors.

<PAGE>
<PAGE>
SELECTED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)

The selected financial information set forth below with respect to the
Company's statements of operations for each of the years ended December 31,
1993, 1994 and 1995 and the balance sheet data at each of December 31, 1994 and
1995 are derived from the financial statements of the Company audited by Coopers
& Lybrand L.L.P., independent accountants. The statements of operations data for
the year ended December 31, 1992 and the balance sheet data at each of December
31, 1992 and 1993 are derived from the Company's financial statements not
included herein. The selected financial information for the six months ended
June 30, 1995 and 1996 are derived from unaudited financial statements included
herein. The unaudited financial statements include all adjustments, consisting
only of normal recurring adjustments, which the Company considers necessary for
a fair presentation of the financial position and the results of operations for
these periods. Operating results for the six months ended June 30, 1996 are not
necessarily indicative of the results that may be expected for the entire year
ending December 31, 1996 or for any future period. This data should be read in
conjunction with 'Management's Discussion and Analysis of Financial Condition
and Results of Operations' and with the Company's financial statements and
related notes contained elsewhere in this Prospectus.

<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
---------------------------------------- ----------------------
1992 1993 1994 1995 1995 1996
----- ----- ------- ------- ------- -----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues...................................... $ 96(1) $ 215(1) $ -- $ -- $ -- $ 1,500
Operating expenses:
Research and development................. 125 40 654 1,615 801 1,004
General and administrative............... 369 436 623 760 396 1,628
----- ----- ------- ------- ------- -----------
Total operating expenses............ 494 476 1,277 2,375 1,197 2,632
----- ----- ------- ------- ------- -----------
Interest income............................... 13 4 153 253 138 77
----- ----- ------- ------- ------- -----------
Net loss...................................... $(385) $(257) $(1,124) $(2,122) $(1,059) $(1,055)
----- ----- ------- ------- ------- -----------
----- ----- ------- ------- ------- -----------
Pro forma net loss per common share(2)........ $ (0.17) $ (0.09)
------- -----------
------- -----------
Pro forma weighted average common shares
outstanding(2).............................. 12,199 12,329
------- -----------
------- -----------
</TABLE>

<TABLE>
<CAPTION>
JUNE 30, 1996
DECEMBER 31, ----------------------
---------------------------------------- AS
1992 1993 1994 1995 ACTUAL ADJUSTED(3)
----- ----- ------- ------- ------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents(4).................. $ 288 $ 124 $ 5,634 $ 3,707 $ 2,505 $47,329
Working capital............................... 180 81 5,503 3,419 3,268 48,335
Total assets.................................. 330 153 5,765 3,820 4,903 49,430
Deficit accumulated during the development
stage....................................... (385) (642) (1,766) (3,888) (4,943) (4,943)
Total stockholders' equity.................... 214 108 5,618 3,521 3,649 48,419
</TABLE>

- ------------

(1) Represents revenues from consulting activities in which the Company has
ceased to engage.

(2) Adjusted to give effect to the automatic conversion of all outstanding
shares of Series A Preferred Stock upon consummation of the Offering. See
Note 2 to the Financial Statements.

<PAGE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

Certain information set forth herein contains forward-looking statements as
such term is defined in Section 27A of the Securities Act of 1933 and Section
21E of the Exchange Act. Certain factors discussed herein could cause actual
results to differ materially from those in the forward-looking statements. See
'Risk Factors -- Forward Looking Statements.'

OVERVIEW

Algos, a development stage company, is engaged primarily in the development
and commercialization of proprietary pharmaceutical products. Since its
formation in January 1992, the Company has devoted a substantial amount of its
efforts to licensing technology, recruiting key management and staff, developing
products, filing patents and other regulatory applications and raising capital.
To date, the Company has earned no revenue from its planned principal line of
business.

The Company has incurred losses since its inception and expects to incur
significant operating losses in the future. The Company expects that its product
development expenses will increase significantly during 1996 and in future years
as the drugs that the Company currently has under development move into advanced
clinical trials and as additional drugs are considered for development. In
addition, the Company expects that its personnel costs will increase
significantly in the future, primarily as a result of the planned development of
a direct sales force.

RESULTS OF OPERATIONS

SIX MONTHS ENDED JUNE 30, 1996 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1995

Revenue

In the 1996 period, the Company recognized $1,500,000 of license revenue.
This amount represents the initial payment of $2,000,000 due under the McNeil
License Agreement and received in July 1996, less $500,000 which is currently
restricted for the funding of future development costs.

Research and Development

In the 1996 period, research and development expenses increased $202,801,
to $1,003,585 from $800,784 in 1995. The 1996 period included increased expenses
related to the Company's clinical trials, including fees to clinical
investigators which increased approximately $243,000. Increased compensation to
employees and consultants was offset by reduced spending on pre-clinical
studies.

General and Administrative Expenses

In the 1996 period, general and administrative expenses increased
$1,231,726 to $1,628,184 from $396,458 in 1995. The increase was due primarily
to a charge of $915,000 in the 1996 period relating to the issuance of Series B
Preferred Stock in connection with an amendment to the license agreement with
The Medical College of Virginia and amortization of unearned compensation
expense of approximately $189,000 in connection with the grant of stock options.
Higher professional fees and compensation expenses also contributed to the
increase.

YEAR ENDED DECEMBER 31, 1995 COMPARED TO THE YEAR ENDED DECEMBER 31, 1994

Research and Development

In 1995, research and development expenses increased $961,229, to
$1,614,943 from $653,714 in 1994. This increase was primarily attributable to
the Company's pre-clinical studies in the field of NMDA antagonists. In 1995,
direct costs associated with pre-clinical studies and clinical trials were
approximately $542,000 and formulation development, drug supplies and related
analytical services totaled approximately $265,000. Compensation expense
increased as a result of the addition of employees and consultants. Spending on
other programs also contributed to the increase in 1995

<PAGE>
<PAGE>
expenditures. Expenses in 1994 consisted primarily of employee and consultant
compensation as the Company established its research management team and
initiated sponsored research programs at three universities.

General and Administrative Expenses

In 1995, general and administrative expenses increased $136,821, to
$760,040 from $623,219 in 1994. This increase was primarily attributable to
additional employee compensation and related taxes and benefits. In addition,
general office expenses such as rent, utilities, and supplies increased as a
result of increased business activities and employment.

Interest Income

In 1995, interest income increased $99,301, to $252,548 from $153,247 in
1994 as a result of the investment of proceeds from the Company's private
placement of Series A Preferred Stock, which was completed in August 1994.

YEAR ENDED DECEMBER 31, 1994 COMPARED TO THE YEAR ENDED DECEMBER 31, 1993

Revenue

In 1993, the Company earned $214,584 for performing certain consulting
services unrelated to its planned principal operations. Effective January 1,
1994, the consulting contract was assigned to another corporation. The Company
will not earn any revenue or incur any expenses in the future in connection with
that consulting contract.

Research and Development

In 1994, research and development expenses increased $613,714, to $653,714
from $40,000 in 1993. This increase was principally attributable to the
Company's establishment of its research management team and initiation of
sponsored research programs at three universities.

General and Administrative Expenses

In 1994, general and administrative expenses increased $187,562, to
$623,219 from $435,657 in 1993. This increase was due principally to
professional fees related to patent investigations and applications, sponsored
research programs and other general corporate expenses.

Interest Income

Interest income of $153,247 in 1994 was derived primarily from the
investment of proceeds from the private placement of Series A Preferred Stock,
which was completed in August 1994. The Company earned interest income of $4,433
in 1993 from the investment of capital contributions by the Company's founders.

LIQUIDITY AND CAPITAL RESOURCES

General

In 1995, 1994, and 1993, spending for the Company's product development
efforts and related activities resulted in net cash outflows from operations of
$1,929,321, $991,928 and $289,277, respectively. Accumulated cash balances at
December 31, 1992, which resulted from the Company's initial capitalization
together with additional investments by the Company's founders, were sufficient
to provide operating funds into 1994. In 1994, in order to initiate its planned
product development programs, the Company sold 700,000 shares of Series A
Preferred Stock in a private placement, resulting in net proceeds of $6,609,015.
A portion of these funds were used to fund the Company's development efforts in
1995 and the first six months of 1996. At June 30, 1996, the Company had cash

<PAGE>
<PAGE>
and cash equivalents of $2,504,603 and current liabilities of $1,254,174. In
addition, the Company received $2.0 million from McNeil on July 5, 1996 pursuant
to the McNeil License Agreement, of which $500,000 is committed to fund the
Company's portion of development costs under the McNeil License Agreement.
Without the proceeds of the Offering, the Company believes that current cash and
cash equivalents are sufficient to fund a reduced level of operations for at
least the next 12 months.

The Company expects to invest substantial funds in the development of its
products and to continue to generate significant losses for the foreseeable
future. Its funding requirements will depend on a number of factors, including
the results of the Company's development efforts, the timing and cost of
obtaining required regulatory approvals, the development of competing
technologies, the amount of resources required for the establishment of
marketing and distribution capabilities, the execution of licensing or other
collaborative research agreements on terms acceptable to the Company, and the
cost of prosecuting and defending patents. The Company currently expects that
the proceeds from the Offering will be sufficient to fund its operations for the
development of products currently in clinical trials, based upon the Company's
presently anticipated schedule of clinical trials, and other working capital
requirements for approximately three years. If, however, additional trials are
deemed to be necessary, the Company may require additional funds to complete
such trials. Accordingly, in the event that the proceeds of the Offering,
revenue and income from successful product introductions or other internally
generated funds are insufficient for such efforts, the Company will need to
raise additional funds by incurring debt, issuing additional equity or through
collaborative or license arrangements. See 'Risk Factors -- Need for Additional
Funds.'

Net Operating Loss Carryforwards

At December 31, 1995 and June 30, 1996, the Company had accumulated net
operating loss carryforwards of approximately $2,900,000 and $2,100,000,
respectively, which expire in 2009 and 2010 and are available to reduce future
taxable income recognized in the carryforward period, if any. Due to the
uncertainty of future taxable income, the Company has established a valuation
allowance for these carryforwards and has not recognized their potential benefit
on a current basis. The future utilization of these carryforwards may be limited
by Section 382 of the Internal Revenue Code related to changes in Company
ownership.

Other

Generally, the Company's results of operations are not significantly
affected by seasonal factors and the Company does not believe that inflation has
had or is likely to have a significant impact on its business.

In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ('SFAS') No. 123 -- 'Accounting for Stock
Based Compensation,' which generally requires disclosure of the impact on
earnings of stock based employee compensation arrangements. The Company plans to
adopt the disclosure requirements of SFAS No. 123 effective January 1, 1996.

<PAGE>
<PAGE>
BUSINESS

COMPANY OVERVIEW

Algos is a leader in developing a new generation of proprietary pain
management products. The Company develops its proprietary pain management
products by combining existing analgesic or anesthetic drugs with NMDA
antagonist drugs that have been approved for human use in other applications.
Independent research and the Company's pre-clinical studies and clinical trials
conducted to date have shown that the Company's products may significantly
improve pain relief over currently available analgesics, including narcotic
drugs such as morphine, hydrocodone and oxycodone and non-narcotic analgesics
such as acetaminophen (e.g. Tylenol'r'), ibuprofen (e.g. Advil'r') and naproxen
(e.g. Aleve'r'). The Company is also developing a local anesthetic product that
has the potential to provide greater anesthetic effect with longer and more
controlled duration than existing products. The Company's analgesic and
anesthetic products will target markets with combined 1995 U.S. sales estimated
at $6.4 billion. In addition, the Company is using its NMDA antagonist
technology to develop products to treat urge urinary incontinence and opiate and
cocaine addiction.

The Company's products that have reached Phase II clinical trials or are
scheduled for Phase II or Phase III clinical trials consist of:

(ii) two OTC analgesic/NMDA antagonist combination products: a combination
product of an NMDA antagonist with acetaminophen, the largest selling
OTC analgesic, and a combination product of an NMDA antagonist with
ibuprofen, the largest selling OTC NSAID;

(iv) one product that uses an NMDA antagonist intended as a treatment for
urge urinary incontinence, a condition which afflicts an estimated
five million people in the U.S.; and

(v) two products intended as treatments for opiate and cocaine addiction,
which the Company expects to develop in collaboration with NIDA, NIH.

COMPANY STRATEGY

The Company's strategic goal is to establish a leading position in the pain
management pharmaceutical market. The Company intends to achieve this goal by
implementing the following strategy:

Introducing superior proprietary products. Based on the results of
independent research, pre-clinical studies and initial clinical trials, the
Company believes its products will provide superior efficacy over

<PAGE>
<PAGE>
currently available narcotic, non-narcotic and anesthetic products. The Company
intends to build significant market share in both the OTC and prescription pain
management markets.

Minimizing development time, cost and risk. The Company attempts to reduce
drug development time and cost at each stage of the development process. The
Company believes that it will be able to develop its initial products faster
than other types of new drugs because all of the Company's initial products are
combinations of, or forms of, existing approved drugs. For its pre-clinical
studies, the Company is able to save time and expense by drawing upon the
experience of many highly regarded researchers in the pain management field
through its collaborations with established academic research institutions.
Similarly, for its clinical trials, the Company collaborates with researchers
who have the experience and the facilities to design timely and cost-effective
trials. In addition, the Company believes that new analgesic and anesthetic
products have the potential for more rapid market introduction than many other
types of drugs.

Leveraging its proprietary technology across multiple product
opportunities. Through extensive pre-clinical research, Algos has identified
multiple potential products using NMDA antagonist technology. As a result, Algos
has developed ten pharmaceutical products that have progressed to Phase II
clinical trials or are scheduled for Phase II or Phase III clinical trials in
1996.

Outsourcing to efficiently deploy resources. The Company intends to
continue to contract the resources of well-recognized commercial organizations
to perform pre-clinical studies, clinical trials and pharmaceutical development
on behalf of the Company. In addition, the Company intends to outsource its
manufacturing functions to third party suppliers.

Maximizing market penetration and margin potential through a combination of
Company direct sales and strategic alliances. In market segments with relatively
concentrated distribution channels, such as prescription analgesics that are
sold to individual hospitals, health maintenance organizations and
pharmaceutical buyer groups, the Company plans to maximize its margins by
marketing these products through a direct sales force. In market segments that
will require large or specialized sales capabilities, such as OTC analgesic
products and certain foreign countries, the Company will seek strategic
alliances with leading pharmaceutical companies. The Company believes such
alliances enhance its ability to identify new products as well as quickly
develop and commercialize such products.

MARKET OVERVIEW

The Company is developing products that will target the narcotic and
non-narcotic analgesic markets, the local anesthetic market, the urge urinary
incontinence market and the market for treatment of opiate and cocaine
addiction.

The Analgesic Market

The Company's analgesic products will target markets with combined 1995
U.S. sales estimated at $6.4 billion. The Company believes that the analgesic
market presents attractive opportunities based upon the following factors: high
growth rates partially attributable to the rapidly growing population segment
aged 65 and older; increasing recognition of the therapeutic benefits of
effective pain treatment including reductions in healing and recovery time;
generally concentrated distribution channels that permit more cost-effective
selling and marketing; lack of recent product innovation which has resulted in
market segments comprised largely of older off-patent drugs; higher profit
margins from branded proprietary products; and the potential for rapid
acceptance of new pain management pharmaceuticals by members of the medical
profession.

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<PAGE>
The following table identifies the estimated size of the U.S. market
segments which the Company's analgesic products are expected to target.

<TABLE>
<CAPTION>
ESTIMATED
ANALGESIC MARKET SEGMENTS REPRESENTATIVE BRANDS 1995 U.S. SALES
- ------------------------- --------------------- ---------------
(IN MILLIONS)
<S> <C> <C>
Prescription Anti-Arthritics (NSAIDs) Lodine, Voltaren, Relafen $ 1,714
Prescription Anti-Migraine Imitrex 373
Prescription Narcotics:
Non-injectable Morphine MS Contin 247
Hydrocodone Based Products Vicodin 315
Oxycodone Based Products Percocet, Percodan 73
Codeine Based Products Tylenol with codeine 87
Synthetic Narcotics Darvon 237
-------
Prescription Narcotics Total 959
Synthetic Non-Narcotics Toradol, Ultram, Stadol NS 500
-------
Prescription Total 3,546
OTC Analgesics:
NSAIDs Advil, Motrin, Aleve, Orudis 853
Aspirin Bayer 617
Acetaminophen Tylenol 1,220
Topical Analgesics 213
-------
OTC Analgesics Total 2,903
-------
Total Analgesic Market $ 6,449
-------
-------
</TABLE>

- ------------

Source: IMS, Inc. and A.C. Nielsen.

The Anesthetic Market

In 1995, the injectable local anesthetic market in the U.S. was estimated
at $164 million. The market for local anesthetics is believed to present
attractive opportunities for a controlled duration product because existing
local anesthetics have limited and less controllable duration which restricts
their use in surgery. The Company believes that a controlled, extended duration
local anesthetic, if successfully developed, would have the potential to
significantly expand this market segment.

The Urge Urinary Incontinence Market

An estimated five million people in the U.S. suffer from urge urinary
incontinence. While sales of urge urinary incontinence drugs in the U.S. were
estimated at $84 million in 1995, U.S. sales of incontinence supplies (including
adult protective undergarments) were significantly higher at an estimated $1.1
billion in 1994. This was due, in part, to a lack of satisfactory pharmaceutical
treatments. The Company believes that if satisfactory drugs for treating urge
urinary incontinence were introduced, the market size for urge urinary
incontinence drugs could grow considerably.

The Drug Abuse Treatment Market

NIDA estimates that there are two million opiate addicts in the United
States and 1.5 to 2 million cocaine abusers. The Company believes that these
opiate addict and cocaine abuser populations represent a large potential market
for effective pharmaceutical treatment.

<PAGE>
<PAGE>
PRODUCTS

The following table describes the ten products developed by Algos that have
reached Phase II clinical trials or are scheduled to reach Phase II or Phase III
clinical trials in 1996.

<TABLE>
<CAPTION>
ALGOS PRODUCTS IN DEVELOPMENT

PRODUCT INDICATION STAGE OF DEVELOPMENT
------- ---------- --------------------
<S> <C> <C>
NARCOTIC ANALGESICS
MorphiDex'tm' Moderate to severe pain Pivotal Phase II clinical trial completed.
(primarily cancer pain) Additional Phase II and III clinical trials in
progress or scheduled in 1996.
Two Phase I/II clinical trials completed.
HydrocoDex SR'tm' and Moderate to moderately severe Phase II clinical trial scheduled in 1996.
HydrocoDex Plus'tm' pain (primarily
post-operative,
musculoskeletal and
trauma-related pain)
OxycoDex'tm' Moderate to moderately severe Phase II clinical trial in progress.
pain (primarily Additional Phase II clinical trial
post-operative pain) scheduled in 1996.

NON-NARCOTIC ANALGESICS
Ibuprofen/NMDA Antagonist OTC analgesic Phase II clinical trial completed.
Combination Additional Phase II clinical trial scheduled in
1996.
Acetaminophen/NMDA OTC analgesic Phase II clinical trial in progress.
Antagonist Combination

ANESTHETICS
Lidocaine/NMDA Antagonist Extended duration anesthetic Phase I/II clinical trial scheduled in 1996.
Combination

OTHERS
Urge Urinary Incontinence Urge urinary incontinence Phase II clinical trial in progress.
Treatment
Opiate Addiction Treatment Opiate addiction Phase II clinical trial scheduled in 1996.

Cocaine Addiction Treatment Cocaine addiction Phase II clinical trial scheduled in 1996.
</TABLE>

NARCOTIC ANALGESICS

Narcotic analgesic drugs remain the most common and useful treatment for
moderate to severe pain in both acute and chronic conditions. These drugs
consist of naturally occurring opiates (e.g. morphine), opiate derivatives (e.g.
codeine, hydrocodone, oxycodone), and synthetic opiates (e.g. methadone). One of
the most significant drawbacks to these drugs is the development of rapid
tolerance and physical dependence. Tolerance refers to the condition under which
a drug dose that was initially effective in producing analgesia becomes less
effective with repeated administrations. Therefore, to alleviate the same level
of pain, the drug dose has to be increased over time. However, increasing the
drug dose may produce an increase in unwanted side effects such as mental
clouding, nausea and constipation and may also increase the potential for drug
dependence.

Pre-clinical studies of the Company's narcotic analgesic/NMDA antagonist
combination products indicated superior first-dose analgesic effects as compared
to equivalent dosage levels of the narcotic analgesic alone and greater efficacy
when administered over periods during which the narcotic analgesic

<PAGE>
<PAGE>
administered alone became less effective. The Company believes that its new
products, if proven effective in humans in producing superior analgesic effects
and reducing tolerance and side effects, could replace a significant portion of
the narcotic analgesics currently in use for acute and chronic pain and could be
used in chronic pain cases where physicians have been reluctant to use
narcotics.

MorphiDex'tm'

MorphiDex'tm', the Company's most developmentally advanced product, is
designed to treat moderate to severe pain and will be used primarily for
treating cancer pain. MorphiDex'tm' is the trade name for the Company's patented
morphine and dextromethorphan combination product. The addition of an NMDA
antagonist to morphine is intended to increase analgesic effectiveness, reduce
the development of tolerance to morphine and reduce the development of
hyperalgesia in cases of chronic administration.

The Company expects to use MorphiDex'tm' to target the market for morphine
products. In 1995, U.S. sales of morphine products were approximately $247
million and non-U.S. sales were approximately $500 million. This market is
believed to be growing at an estimated rate of 18% per year, which is largely
attributable to the rapidly growing population segment aged 65 and older in the
United States, Europe and Japan.

The Company's research and development activities with respect to
MorphiDex'tm' include:

(i) pre-clinical pharmacology studies which indicate that morphine
tolerance may be significantly reduced by co-administration with an
NMDA antagonist;

(ii) pre-clinical toxicology and drug safety studies comparing the
combination of dextromethorphan and morphine to the individual drugs;

(iii) one completed, double blind Phase I/II clinical trial to assess
safety and abuse liability which indicates product safety and
possible lower abuse potential;

(iv) one completed, double blind Phase I/II clinical trial in chronic pain
patients which indicates that a combination of morphine or morphine
equivalents together with an NMDA antagonist is safe at projected
therapeutic dose levels and that such a combination may provide
superior pain relief over morphine; and

(v) one completed pivotal Phase II clinical efficacy trial in oral
surgery patients which indicates statistically significant superior
pain relief with MorphiDex'tm' over morphine alone.

In addition, four additional clinical trials are currently underway which
the Company expects will lead to an NDA filing in the second half of 1997.

HydrocoDex'tm' SR and HydrocoDex Plus'tm'

Hydrocodone is a narcotic primarily used to treat moderate to moderately
severe post-operative, musculoskeletal and trauma-related pain. The analgesic
products containing hydrocodone that are sold commercially in the U.S. are
combination products containing acetaminophen. In 1995, the market for such
products in the U.S. was approximately $315 million with an estimated growth
rate of 15% per year.

HydrocoDex SR'tm' is the trade name for the Company's sustained release
product that combines hydrocodone and dextromethorphan. Currently there are no
sustained release hydrocodone products on the market because the dosage size
required to achieve a sustained effect when combined with acetaminophen is too
large for practical application. The Company expects that, if approved and
successfully brought to market, HydrocoDex SR'tm' will provide physicians with
the ability to prescribe an effective sustained release hydrocodone analgesic
for the first time.

HydrocoDex Plus'tm' is the trade name for the Company's immediate release
product that combines hydrocodone, dextromethorphan and acetaminophen. The
Company believes that HydrocoDex Plus'tm' may broaden the current market for
hydrocodone/acetaminophen combination products because equal or greater
therapeutic effect may be achieved by administering lower doses of the
hydrocodone component of the product, thereby potentially creating a product
with a lower abuse potential.

<PAGE>
<PAGE>
The Company is planning to begin a Phase II clinical trial in the second
half of 1996 intended to show that the addition of an NMDA antagonist increases
the efficacy of products containing hydrocodone. The results of pre-clinical
studies for these products have been favorable.

OxycoDex'tm'

Oxycodone is an opiate narcotic that, in combination with acetaminophen or
aspirin, forms the basis for a group of products which are broadly used for the
treatment of moderate to moderately severe post-operative and other types of
pain. In 1995, the U.S. market for such products was estimated at $73 million.

The Company is currently in the process of developing an immediate release
combination product consisting of oxycodone, acetaminophen and dextromethorphan.
Pre-clinical studies have indicated that an NMDA antagonist may increase the
efficacy of oxycodone. In April 1996, the National Institute of Dental Research
('NIDR') commenced a clinical trial comparing the efficacy of oxycodone alone
and in combination with an NMDA antagonist. Additional clinical trials are
scheduled to be conducted in 1996.

NON-NARCOTIC ANALGESICS

The Company has two non-narcotic analgesics in development: an
ibuprofen/NMDA antagonist combination product and an acetaminophen/NMDA
antagonist combination product. In 1995, the OTC NSAID market in the U.S. which
included ibuprofen totaled an estimated $853 million. The total U.S. OTC market
for acetaminophen was estimated at $1.2 billion. The Company has licensed
certain NSAID/NMDA antagonist products (including ibuprofen) and its
acetaminophen/NMDA antagonist products to McNeil. See ' -- Corporate and
Government Collaborations.'

Ibuprofen/NMDA Antagonist Combination

Pre-clinical studies have indicated that the analgesic efficacy of several
NSAIDs, such as ibuprofen and naproxen, may be increased when combined with an
NMDA antagonist. The Company believes that an OTC product based upon a
combination of existing dosage levels of an NSAID with an NMDA antagonist would
offer analgesic efficacy that is superior to existing OTC analgesics and could
have the potential to achieve rapid market acceptance. In addition, at dosage
levels where the NSAID indicated no analgesic effect by itself, a significant
analgesic effect was indicated by the addition of an NMDA antagonist. As a
result, an NSAID/NMDA antagonist combination product may also be formulated to
give an equivalent analgesic effect while lowering the NSAID dosage and thus
potentially reducing certain dosage related side effects of NSAIDs, such as
gastrointestinal bleeding and ulcers.

An initial Phase II clinical trial has indicated that an NSAID (ibuprofen)
in combination with an NMDA antagonist may have an increased analgesic effect
when compared to the NSAID alone in dental surgery patients who experienced
greater surgical trauma (i.e. patients who had surgery which lasted longer than
30 minutes). The study also indicated that for dental patients in certain lower
trauma categories (i.e. patients whose surgery lasted less than 30 minutes) both
ibuprofen alone and ibuprofen in combination with an NMDA antagonist had a
significantly better analgesic effect when compared to a placebo and that
ibuprofen alone and ibuprofen in combination with an NMDA antagonist were both
similarly effective in relieving the patient's pain. Although the Company
believes that these results are encouraging, additional clinical trials are
necessary in order to submit an NDA to the FDA.

Acetaminophen/NMDA Antagonist Combination

The Company has sponsored pre-clinical studies to evaluate acetaminophen in
combination with NMDA antagonists. The results indicate that combining an NMDA
antagonist with acetaminophen may increase the efficacy of acetaminophen. In a
placebo-controlled Phase II clinical trial conducted by NIDR, patients taking a
scheduled regimen of an NMDA antagonist (dextromethorphan) before and after oral
surgery required substantially less acetaminophen after the surgery to relieve
pain.

<PAGE>
<PAGE>
ANESTHETICS (LIDOCAINE/NMDA ANTAGONIST COMBINATION)

Injectable Anesthetic

The injectable local anesthetic market was estimated at $164 million in the
U.S. in 1995. Sales consist primarily of older off-patent drugs. Although
research indicates that the administration of analgesics preceding surgery may
improve surgical outcomes, the limited duration of existing injectable
anesthetics limits their use in surgery.

The Company, in collaboration with Brigham and Women's Hospital, Harvard
Medical School, is conducting research into the potentiation of local
anesthetics by NMDA antagonists. Pre-clinical studies have indicated that the
NMDA antagonist, dextromethorphan, may increase the depth and duration of
anesthesia of lidocaine. With the current emphasis on preemptive analgesia, same
day surgery and shorter hospital stays, the Company believes that a longer
duration anesthetic may provide greater patient comfort when post surgical pain
is most severe. A Phase I/II clinical trial is planned for late 1996.

Anti-Migraine

Reported results of an independently conducted clinical trial indicate that
intra-nasal lidocaine provides rapid relief of migraine headache, but that
relapse is common. Since the NMDA antagonist dextromethorphan may enhance the
efficacy of lidocaine and is also effective in inhibiting neuropathic pain, an
intra-nasal lidocaine/dextromethorphan combination product may be a more
effective anti-migraine treatment. Pre-clinical studies are planned for late
1996.

OTHERS

Urge Urinary Incontinence Treatment

An estimated five million people in the U.S. suffer from urge urinary
incontinence. While sales of urge urinary incontinence drugs in the U.S. were
estimated at $84 million in 1995, U.S. sales of incontinence supplies (including
adult protective undergarments) were an estimated $1.1 billion in 1994. This was
due, in part, to a lack of satisfactory urge urinary incontinence drugs.
Existing urge urinary incontinence drugs generally have unpleasant side effects
and low levels of efficacy. The Company believes that if satisfactory drugs for
treating urge urinary incontinence are introduced, consumer demand for an urge
urinary incontinence drug could increase considerably.

Company-sponsored pre-clinical studies have indicated that NMDA antagonists
may block the bladder micturition reflex. A Phase II clinical trial is currently
being conducted at the Stanford University School of Medicine to evaluate an
NMDA antagonist in urge incontinent patients. If successful, these agents may
offer a novel, safe and effective treatment for urge urinary incontinence.

Opiate and Cocaine Addiction Treatment Drugs

NIDA estimates that there are two million opiate addicts in the United
States and 1.5 to 2 million cocaine abusers. These opiate addict and cocaine
abuser populations represent a large potential market for effective treatment
drugs. The Company is developing an NMDA antagonist-based product as an opiate
addiction treatment drug. NIDA is planning a Phase II clinical study in
collaboration with the Company to test this opiate addiction treatment drug. In
addition, the Company is developing a cocaine addiction treatment drug.
Pre-clinical studies have indicated that NMDA antagonists may have potential for
the treatment of dependence on opiate narcotics and cocaine abuse.

SCIENTIFIC OVERVIEW

A key element of the Company's technology is the use of NMDA antagonists,
which block the NMDA receptor. NMDA receptors are believed to be present in
nerve cells in the brain and spinal cord. There is increasing evidence that
there may also be peripheral NMDA receptors.

The important role of the NMDA receptor in pain response has become
recognized among scientists and clinicians. Research indicates that the NMDA
receptor plays a role in neuropathic pain,

<PAGE>
<PAGE>
development of tolerance to and dependence on narcotic analgesics, and
development of hyperalgesia due to chronic administration of opiate narcotics.
According to current scientific theory, activation of this receptor results in a
cascade of intracellular events beginning with the influx of extracellular
calcium. This influx of calcium results in activation of the enzyme protein
kinase C and its subsequent translocation from cytosol to the membrane. Through
protein phosphorylation, enduring changes then occur in the membrane
constituents including receptors. This cascade of events beginning with the
activation of the NMDA receptor has been implicated in numerous neuroplastic
phenomena such as post-tetanic potentiation resulting in sensitized and overly
active nerve cells and consequently may cause spontaneous pain and/or increased
sensitivity to pain.

It is believed that narcotic analgesics reduce pain by binding to opiate
receptors located on nerve cells in the brain and spinal cord. Although the
initial effect of this binding is to inhibit the nerve cell and thereby reduce
pain, opiate receptor activation is also believed to stimulate the NMDA receptor
leading to the cascade of events described in the previous paragraph. Many
researchers believe that increased NMDA receptor activation represents the
underlying cellular mechanism of opiate tolerance and dependence. Pre-clinical
studies indicate that by blocking the NMDA receptor, tolerance to and dependence
on opiates may be reduced and the development of hyperalgesia prevented. The
involvement of the NMDA receptor in dependence is also the basis for development
of NMDA antagonists to treat drug addiction.

CORPORATE AND GOVERNMENT COLLABORATIONS

In June 1996, the Company entered into the McNeil License Agreement with
McNeil, an affiliate of Johnson & Johnson, pursuant to which the Company granted
McNeil the exclusive right to develop acetaminophen/NMDA antagonist combination
products and certain NSAID/NMDA antagonist combination products (ibuprofen and
certain other NSAIDs approved for OTC use) for the treatment of pain. The McNeil
License Agreement provides for an initial payment of $2.0 million by McNeil
(funded on July 5, 1996) to the Company and additional payments of up to $8.0
million by McNeil upon the achievement of certain milestones generally relating
to product development and patent issuances. In addition, the Company will be
entitled to receive royalty payments from McNeil based upon net product sales.
McNeil will bear all the costs of developing products it selects, except for
approximately $500,000 to be borne by the Company. McNeil will be required to
pay minimum royalties commencing a certain time after execution of the
agreement, provided that certain conditions have been met, even if McNeil has
not commenced marketing of an acetaminophen product or an NSAID product. The
McNeil License Agreement extends until the later of the expiration of the
Company's patent rights or ten years, provided that the McNeil License Agreement
is terminable: (i) by either party in the event of a material breach by the
other party upon 90 days' notice or upon certain events of bankruptcy; (ii) by
McNeil, at any time after one year from the effective date of the agreement; and
(iii) by the Company under certain circumstances. Under certain circumstances,
the McNeil License Agreement could terminate with respect to either
acetaminophen or NSAID products without terminating with respect to the other
category. In the event of a termination by McNeil, McNeil must pay all royalty
payments and milestone payments due through the date of termination and the
technology licensed by McNeil reverts to the Company. In such event, the Company
retains the rights to the results of the two clinical studies funded by the
Company, and McNeil retains the rights to the results of the clinical studies
funded by McNeil during the term of the McNeil License Agreement. See
' -- Patents, Trade Secrets and Licenses -- Licenses.'

In June 1996, the Company entered into a letter of intent with NIDA, NIH,
pending formal approval of a CRADA to conduct joint research on a methadone/NMDA
antagonist combination drug as a potential treatment for opiate addition.

ACADEMIC AND RESEARCH COLLABORATIONS

Virginia Commonwealth University, The Medical College of Virginia

In 1994, the Company entered into a collaborative research agreement with
The Medical College of Virginia with the option for subsequent annual renewals.
Under the terms of this agreement, The

<PAGE>
<PAGE>
Medical College of Virginia provides pre-clinical research exclusively to the
Company in the field of: (i) prevention of tolerance to and dependence on
opiates, opiate derivatives and opioids; (ii) treatment of chronic pain; and
(iii) treatment of neuropathic pain, under the direction of David J. Mayer, Ph.D
and Donald D. Price, Ph.D., Professors, Department of Anesthesiology, The
Medical College of Virginia.

Brigham and Women's Hospital

In 1995, the Company entered into a research agreement with Brigham and
Women's Hospital, Inc., a teaching affiliate of Harvard Medical School. Under
the terms of this agreement, Brigham and Women's Hospital performs pre-clinical
research exclusively for the Company in the field of long lasting anesthetics
under the direction of Gary R. Strichartz, Ph.D., Professor of Anesthesia
(Pharmacology). The research is designed to measure certain characteristics and
effects of various anesthetic/NMDA antagonist combinations covered by the
Company's existing or pending patents.

Stanford University

The Company has entered into a series of research agreements with Stanford
University. Under the direction of Christos E. Constantinou, Ph.D. of the
Stanford University School of Medicine, certain NMDA antagonists were tested in
pre-clinical studies to assess their potential for use in the treatment of urge
urinary incontinence. The studies were conducted with products that are the
subject of one of the Company's pending patent applications. In addition,
Christopher Payne, M.D. is currently conducting a clinical trial to further test
the potential of such NMDA antagonists for the treatment of urge urinary
incontinence.

CLINICAL TRIAL COLLABORATIONS

Clinical trials with several major research institutions and medical
centers have commenced, and several others are scheduled for commencement in the
near future. The institutions with which the Company collaborates include:

Johns Hopkins Bayview Medical Center, Baltimore, Maryland
Memorial Sloan-Kettering Cancer Center, New York City, New York
Emory University Hospital Medical Center, Atlanta, Georgia
Stanford University School of Medicine, Palo Alto, California
University of Pennsylvania, Philadelphia, Department of Veterans Affairs
Medical Center, Philadelphia, Pennsylvania
Royal North Shore Hospital, University of Sydney, Australia
National Institute of Dental Research, National Institutes of Health,
Bethesda, Maryland
Rivers Center Research Corporation, Columbia, Maryland
SCIREX Corporation, Austin, Texas

The Company generally conducts clinical studies directly with the principal
investigators and also by the use of Contract Research Organizations ('CROs')
that provide additional manpower as required to manage several study programs
simultaneously. The Company's management is experienced at selecting and
managing CROs for conducting clinical studies.

TECHNICAL DEVELOPMENT AND PRODUCTION

The Company generally seeks to contract third parties for formulation
development, manufacture of clinical trial materials and scale-up work. The
Company generally selects third party contractors that it believes have the
capability to commercially manufacture the products. The key advantage to this
approach is that the third party contractor which performed the developmental
work will have the equipment, operational parameters and validated testing
procedures already in place for the commercial manufacture of the Company's
products. The Algos management team is experienced in selecting and managing
activities at third party contract companies. By selecting qualified third party
contractors or

<PAGE>
<PAGE>
by choosing development partners that provide full scale contract manufacturing
services, the Company believes it will be able to shorten development time and
scale-up to production.

MARKETING

Algos plans to market its products either directly or through co-marketing
or licensing agreements with pharmaceutical companies. The Company's marketing
strategy is to develop a direct sales force in the U.S. in market segments with
relatively concentrated distribution channels to target hospitals, health
maintenance organizations and pharmaceutical buyer groups. Algos does not expect
to establish a direct sales capability until such time as one or more of its
products in development receives marketing approval from the FDA. In market
segments that require large or specialized sales capabilities, such as OTC
analgesic products and certain foreign countries, the Company will seek
strategic alliances with leading pharmaceutical companies such as the McNeil
License Agreement. Implementation of this strategy will depend on the market
potential of the Company's products, its financial resources and timely
regulatory approvals.

COMPETITION

The Company's products under development are expected to address several
different markets. The Company's proposed products will be competing with
currently existing or future products of other companies. Competition among
these products will be based on, among other things, product efficacy, safety,
reliability, availability, price and patent position. Many of the Company's
existing or potential competitors have substantially greater financial,
technical and human resources than the Company, may be better equipped to
develop, manufacture and market products and have more extensive experience in
pre-clinical testing and human clinical trials. These companies may develop and
introduce products and processes competitive to those of the Company.

The Company competes with pharmaceutical companies that develop, produce
and market products in the United States, Europe and elsewhere. In addition,
academic institutions, government agencies and other public and private
organizations conducting research may seek patent protection, discover new drugs
or establish collaborative arrangements for drug research. The Company's
narcotic analgesic and anesthetic products, when developed and marketed, will
compete with products generally marketed by medium-sized pharmaceutical
companies. In other analgesic segments, such as antiarthritic and OTC analgesic
products, the Company's products, when developed and marketed, will compete with
products marketed by some of the largest pharmaceutical companies in the U.S. In
these segments, the Company may enter into license agreements with
pharmaceutical companies having greater resources than the Company.

PATENTS, TRADE SECRETS AND LICENSES

Patent Rights

The Company seeks to protect is proprietary position by, among other
methods, filing United States and foreign patent applications with respect to
the development of its products and their uses. The Company plans to prosecute
and defend its patent applications, issued patents and proprietary information.
The Company's ability to compete effectively will depend in part on its ability
to develop and maintain proprietary aspects of its planned products. The Company
has an exclusive license for three U.S. patents and six pending U.S. patent
applications under its agreement with The Medical College of Virginia, and
several corresponding pending foreign patent applications. The Company also owns
one pending U.S. patent application and plans to file additional patent
applications.

Reflecting the Company's major research and development direction, its
patent program is primarily focused on securing intellectual property rights to
technology for the following categories of its business: (i) the use of
pharmacologically acceptable NMDA antagonists for the management of acute,
chronic, pre-operative and post-operative pain states, (ii) the use of NMDA
antagonists for the potentiation of local anesthesia and (iii) the use of NMDA
antagonists for the treatment of other conditions such as urge urinary
incontinence. The Company is employing an aggressive dual-level

<PAGE>
<PAGE>
strategy of claiming its drug discoveries mechanistically and in terms of
specific therapeutics. This strategy is intended to maximize the Company's
opportunities for obtaining the broadest possible patent protection and at the
same time, result in issued patents with complementary and mutually reinforcing
claims.

Of the patents issued to The Medical College of Virginia, U.S. Patent No.
5,321,012 entitled 'Inhibiting the Development of Tolerance to and/or Dependence
on a Narcotic Addictive Substance' (issued June 14, 1994) claims compositions
and methods for inhibiting the development of tolerance to and/or dependence on
a variety of narcotic analgesics including codeine, fentanyl, heroin,
hydrocodone, morphine and oxycodone employing any one of several specific
nontoxic NMDA antagonists including dextromethorphan and dextrorphan; U.S.
Patent No. 5,352,683 entitled 'Method for the Treatment of Chronic Pain' (issued
October 4, 1994) claims a method for treating chronic pain employing any one of
several specific nontoxic NMDA antagonists such as those previously mentioned
and, U.S. Patent No. 5,502,058 entitled 'Method for the Treatment of Pain'
(issued March 26, 1996) covers a method of alleviating preexisting or
prospectively occurring pain employing dextromethorphan or dextrorphan in
combination with lidocaine.

The Company has been notified that U.S. Patent No. 5,556,838 will be issued
on or about September 17, 1996. This patent claims a composition containing any
nontoxic NMDA antagonist, or any nontoxic substance that blocks a major
intracellular consequence of NMDA receptor activation, and any one of several
addictive substances, including morphine. A related patent application covers a
companion method for inhibiting the development of tolerance to and/or
dependence on such addictive substances. In addition, the Company has been
assigned a pending U.S. patent application covering the treatment of urinary
incontinence which has recently been examined. A corresponding regional
application designating numerous foreign jurisdictions has been filed.

The patent positions of pharmaceutical firms, including the Company, are
generally uncertain and involve complex legal and factual questions.
Consequently, even though the Company is currently prosecuting its patent
applications with the U.S. Patent and Trademark Office ('PTO') and certain
foreign patent authorities, the Company does not know whether any of its
applications will result in the issuance of any patents, or if any patents
issue, whether they will provide significant proprietary protection or will be
circumvented or invalidated. Since patent applications in the U.S. are
maintained in secrecy until patents issue, and since publication of discoveries
in the scientific or patent literature tend to lag behind actual discoveries by
several months, the Company cannot be certain that it was the first creator of
inventions claimed by pending patent applications or that the Company was the
first to file patent applications for such inventions. See 'Risk
Factors -- Uncertain Ability to Protect Proprietary Technology.'

The Company also relies upon trade secrets, know-how, continuing innovation
and licensing opportunities to develop and maintain its competitive position. It
is the Company's current practice to require its employees, consultants, members
of its Medical and Research Advisory Board, sponsored researchers and other
advisors to execute confidentiality agreements upon the commencement of
employment or consulting relationships with the Company. These agreements
provide that all confidential information developed or made known to the
individual during the course of the individual's relationship with the Company
is to be kept confidential and not disclosed to third parties, subject to
certain exceptions. In the case of employees, the agreements provide that all
inventions conceived by the individual shall be the exclusive property of the
Company. There can be no assurance, however, that these agreements will provide
meaningful protection for the Company's trade secrets or adequate remedies in
the event of unauthorized use or disclosure of such information.

The Company engages in collaborations and sponsored research agreements and
enters into pre-clinical and clinical testing agreements with academic and
research institutions and U.S. government agencies, such as NIH. Consistent with
pharmaceutical industry and academic standards, and the rules and regulations
under the Federal Technology Transfer Act of 1986, these agreements may provide
that developments and results will be freely published, that information or
materials supplied by the Company will not be treated as confidential and that
the Company may be required to negotiate a license to any such developments and
results in order to commercialize products incorporating them. There can be no
assurance that the Company will be able to successfully obtain any such license
at a

<PAGE>
<PAGE>
reasonable cost or that such developments and results will not be made available
to competitors of the Company on an exclusive or a non-exclusive basis.

The Company's success depends in part on its ability to obtain patent
protection for its products and to preserve its trade secrets and operate
without infringing on the proprietary rights of third parties. No assurance can
be given that the Company's pending patent applications will be approved or that
any patents will provide competitive advantages for its products or will not be
successfully challenged or circumvented by its competitors. No assurance can be
given that patents do not exist or could not be filed which would have an
adverse effect on the Company's ability to market its products or maintain its
competitive position with respect to its products. The Company's patents may not
prevent others from developing competitive products using related technology.
Other entities may obtain patents which cover aspects of the Company's products
or processes which are necessary for or useful to the development, manufacture
or use of the Company's products. As a result, the Company may be required to
obtain licenses from others to develop, manufacture or market such products.
There can be no assurance that the Company will be able to obtain any such
licenses on commercially reasonable terms, if at all.

No assurance can be given that any patent issued to, or licensed by, the
Company will provide protection that has commercial significance. In this regard
the patent position of pharmaceutical compounds and compositions is particularly
uncertain. Even issued patents may be later modified or revoked by the PTO in
proceedings instituted by the Company or others. In addition, no assurance can
be given that the Company's patents will afford protection against competitors
with similar compounds or technologies, that others will not obtain patents
claiming aspects similar to those covered by the Company's patents or
applications, or that the patents of others will not have an adverse effect on
the ability of the Company to do business. The Company's patents may not prevent
others from developing competitive positions using related technology.

Licenses

The Company has entered into a license agreement, which was last amended in
June 1996 (the 'Amendment'), with The Medical College of Virginia for certain
patents or pending patent applications owned by The Medical College of Virginia
in the field of pain management in the country in which any such product or part
thereof is made, used, sold or manufactured. In consideration for the terms of
the Amendment, the Company issued 100,000 shares of Series B Preferred Stock to
The Medical College of Virginia. The Company pays no license signing fees or
milestone payments. Royalties for the life of the patent equal 4% of net sales.
If a product is combined with a drug or other substance for which the Company is
paying an additional royalty, the royalty rate paid to The Medical College of
Virginia is generally reduced by the amount of such additional royalty. If the
Company enters into sublicensing agreements for a covered product, the Company
will pay The Medical College of Virginia 50% of royalty payments received from
such sublicensees' net sales for each year until the payments total $500,000 for
such year, 33% until the payments total an additional $500,000 for such year and
25% thereafter. The McNeil License Agreement is a sublicense agreement of the
Company's license agreement with The Medical College of Virginia.

The Company has entered into a license agreement with MIT for an exclusive
worldwide license in connection with patent rights relating to a patent owned by
MIT. This patent covers a process for the ultrasound enhancement of transdermal
drug delivery.

GOVERNMENT REGULATION

In the U.S., pharmaceutical products intended for therapeutic or diagnostic
use in humans are subject to rigorous FDA regulation. The process of completing
clinical trials and obtaining FDA approvals for a new drug is likely to take a
number of years and require the expenditure of substantial resources. There can
be no assurance that any product will receive such approval on a timely basis,
if at all. See 'Risk Factors -- Government Regulation; No Assurance of United
States or Foreign Regulatory Approval.'

Applicable FDA regulations treat the Company's combination of
dextromethorphan with analgesics such as morphine, acetaminophen and ibuprofen
and local anesthetics such as lidocaine as

<PAGE>
<PAGE>
new drugs and require the filing of an NDA and approval by the FDA. However,
since each of these drugs has been separately approved by the FDA, management
believes that the risks associated with the development of these new proprietary
drugs are less than the risks inherent in new molecular drug discovery.

The steps required before a new pharmaceutical product for use in humans
may be marketed in the U.S. include (i) pre-clinical studies, (ii) submission to
the FDA of an Investigational New Drug application ('IND'), which must become
effective before human clinical trials commence, (iii) adequate and
well-controlled human clinical trials to establish the safety and effectiveness
of the product, (iv) submission of an NDA to the FDA, and (v) FDA approval of
the NDA prior to any commercial sale or shipment of the product.

Pre-clinical studies include laboratory evaluation of product chemistry and
formulation, as well as animal studies, to assess the potential safety and
effectiveness of the product. The results of the pre-clinical studies are
submitted to the FDA as a part of an IND and are reviewed by the FDA prior to
the commencement of human clinical trials. Unless the FDA objects to, or
otherwise responds to, an IND, the IND will become effective 30 days following
its receipt by the FDA.

Clinical trials are typically conducted in three sequential phases,
although phases may overlap. In Phase I, the investigational new drug usually is
administered to healthy human subjects and is tested for safety (adverse
effects), dosage, tolerance, metabolism, distribution, excretion and
pharmacodynamics (clinical pharmacology). Phase II involves studies in a limited
patient population to (i) determine the effectiveness of the investigational new
drug for specific indications, (ii) determine dosage tolerance and optimal
dosage and (iii) identify possible adverse effects and safety risks. When an
investigational new drug is found to be effective and to have an acceptable
safety profile in Phase II evaluation, Phase III trials are undertaken to
further evaluate clinical effectiveness and to further test for safety within an
expanded patient population at geographically dispersed clinical study sites.
For analgesic drugs, Phase II analgesic efficacy studies have historically
served as the pivotal studies for an NDA. Phase III studies for these products
normally focus greater attention on safety in larger patient populations rather
than efficacy. There can be no assurance that Phase I, Phase II or Phase III
testing will be completed successfully within any specified time period, if at
all, with respect to any of the Company's products subject to such testing.
Furthermore, the FDA may suspend clinical trials at any time there is concern
that the participants are being exposed to an unacceptable health risk.

The results of pharmaceutical development, pre-clinical studies and
clinical trials are submitted to the FDA in the form of an NDA for approval of
the marketing and commercial shipment of the product. The FDA may require
additional testing or information before approving the NDA. The FDA may deny an
NDA approval if safety, efficacy or other regulatory requirements are not
satisfied. Moreover, if regulatory approval of the product is granted, such
approval may require post-marketing testing and surveillance to monitor the
safety of the product or may entail limitations on the indicated uses for which
the product may be marketed. Finally, product approval may be withdrawn if
compliance with regulatory standards is not maintained or if problems occur
following initial marketing.

At present, pharmaceutical products generally may not be exported from the
U.S. for other than research purposes until the FDA has approved the product for
marketing in the U.S. However, a company may apply to the FDA for permission to
export finished products or partially processed products to a limited number of
countries prior to obtaining FDA approval for marketing in the U.S.

The Company is also subject to regulation under federal and state laws,
including the Occupational Safety and Health Act, the Environmental Protection
Act, the Clean Air Act, national restrictions on technology transfer, and
import, export and customs regulations. In addition, all of the Company's
products that contain narcotics are subject to DEA regulations relating to
storage, distribution and physician prescribing procedures. There can be no
assurance that any portion of the regulatory framework under which the Company
currently operates will not change and that such change will not have a material
effect on the current and anticipated operations of the Company.

Whether or not FDA approval has been obtained, approval of a pharmaceutical
product by comparable governmental regulatory authorities in foreign countries
must be obtained prior to the commencement of clinical trials and subsequent
marketing of such product in such countries. The

<PAGE>
<PAGE>
approval procedure varies from country to country, and the time required may be
longer or shorter than that required for FDA approval.

EMPLOYEES

At June 30, 1996, the Company had nine employees and two executive
consultants, including five Ph.Ds and/or MDs. In addition, the Company engages
consultants from time to time to perform services on a per diem or hourly basis.

FACILITIES

The Company's executive office, located at Collingwood Plaza, 4900 Route
33, Neptune, New Jersey 07753, is leased under a five-year agreement, which
expires in 1997. The lease is renewable for two consecutive five-year periods.
The leased property consists of approximately 2,000 square feet of office and
storage space. The Company is in the process of expanding its facilities to meet
anticipated future staffing.

LEGAL PROCEEDINGS

There are no legal proceedings pending against the Company.

<PAGE>
<PAGE>
MANAGEMENT AND KEY SCIENTIFIC ADVISORS

DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES

Set forth below is information regarding directors and executive officers
of the Company as of August 15, 1996.

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
DIRECTORS AND EXECUTIVE OFFICERS
John W. Lyle.............................. 52 President and Chief Executive Officer and Director
Frank S. Caruso, Ph.D. ................... 59 Executive Vice President for Research and Development
Gastone Bello, Ph.D. ..................... 65 Executive Vice President for Technology Transfer and
Manufacturing
*Donald G. Drapkin........................ 48 Director
Roger H. Kimmel........................... 49 Director
*James R. Ledley.......................... 49 Assistant Secretary and Director
Dieter A. Sulser.......................... 47 Director

KEY EMPLOYEES
Donald A. Johnson, Ph.D................... 41 Senior Vice President for Pharmaceutical Development
Gary R. Anthony........................... 35 Chief Financial Officer
</TABLE>

- ------------

* Members of Audit Committee.

MR. LYLE has served as President and Chief Executive Officer and a director
of the Company since its formation in January 1992. Mr. Lyle served as President
and Chief Executive Officer of OmniCorp Holdings, Inc. in 1991. Prior to
founding the Company, Mr. Lyle was one of the founders of Osteotech, Inc., an
orthopaedic pharmaceutical company formed in 1986. He served as Osteotech's
Chairman and Chief Executive Officer from 1989 to 1991 and as President from
1986 to 1989. From 1981 to 1986, Mr. Lyle served as the President of CIBA-GEIGY
Corporation's CIBA Self-Medication, Inc. From 1975 to 1981, Mr. Lyle held
various positions at Johnson & Johnson. Mr. Lyle holds a B.S. in Marketing
Management and a M.B.A. in General Management, both from the University of
Southern California.

DR. CARUSO joined Algos in 1994. From 1985 to 1993, Dr. Caruso served as
Vice President, Research & Development at Roberts Pharmaceutical Corporation
with responsibility for worldwide pre-clinical and clinical research and
development activities. From 1980 to 1985, Dr. Caruso served as Director,
Clinical Pharmacology, for Revlon Health Care. From 1963 to 1980, Dr. Caruso
served in various positions at Bristol-Myers Company, including Director,
Clinical Research-Analgesics and Central Nervous System. He holds a Ph.D. and a
M.S. in Pharmacology, both from the University of Rochester, School of Medicine
and Dentistry and a B.S. in Biology from Trinity College.

DR. BELLO joined Algos in 1994. During 1992 and 1993, Dr. Bello performed
consulting services for the Company. Also in 1992, he served on a task force
organized by the U.S. Department of State to assess the status of the
pharmaceutical industry in the former Soviet Union. From 1975 to 1991, Dr. Bello
served as CIBA-GEIGY Pharmaceutical Division Senior Vice President of Technical
Operations and was a member of the Management Committee where he was responsible
for chemical and pharmaceutical production, materials management, distribution,
engineering, safety and ecology. Dr. Bello served as President and a member of
the Board of Directors of CIBA-GEIGY Caribe, Caguas, Puerto Rico from 1990 to
1991. He served as a member of the Board of Directors of Geneva Pharmaceutical
from 1982 to 1991 and a member of the Board of Directors of Alza Corporation
from 1978 to 1982. Dr. Bello serves on the Board of Overseers, New Jersey
Institute of Technology. He received his Ph.D. in Chemistry from the University
of Trieste in Trieste, Italy.

MR. DRAPKIN has been a director of the Company since January 1994. Mr.
Drapkin has been Vice Chairman and Director of MacAndrews and Forbes Holdings,
Inc., Revlon Group Incorporated and Andrews Group Incorporated for more than
five years and is a director of Revlon, Inc., Marvel Entertainment Group, Inc.
and The Coleman Company.

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<PAGE>
MR. KIMMEL has been a director of the Company since July 1996. Mr. Kimmel
has been a partner of the law firm of Latham & Watkins for more than five years.
Mr. Kimmel is also a director of TSR Paging, Inc.

MR. LEDLEY has been a director of the Company since January 1992. Since
1995, he has been a member of the law firm of Kleinberg, Kaplan, Wolff & Cohen,
P.C. From 1980 to 1995 he was a member of the law firm of Varet & Fink P.C.
(previously known as Milgrim Thomajan & Lee P.C.).

MR. SULSER has been a director of the Company since May 1995. Since 1991,
Mr. Sulser has served as Head of Investment Banking for the ERB Group of
Companies, based in Zurich, Switzerland. Mr. Sulser is also General Manager of
Unifina Holding AG, an affiliate of the ERB Group of Companies.

DR. JOHNSON joined Algos in 1994. Prior to joining Algos, Dr. Johnson
served as President of Pharmaceutical Development Laboratories, Inc., a contract
research laboratory. From 1991 to 1993, Dr. Johnson was Business Director of
Applied Analytical Industries, Inc. where he developed marketing strategies,
research plans and budgets for numerous new drug contract development projects.
From 1990 to 1991, he served as Manager of Drug Delivery Systems at Noven
Pharmaceuticals and was responsible for the research and development of
transdermal drug delivery systems. From 1986 to 1990, Dr. Johnson served as
Group Leader of Pharmaceutical Research at Schering-Plough Research. Dr. Johnson
holds a Ph.D. and a M.S. in Pharmaceutics and a B.S. in Pharmacy from the
University of Wisconsin-Madison.

MR. ANTHONY joined Algos in January 1996. Prior to joining Algos, Mr.
Anthony engaged in the private practice of accounting, providing services to
pharmaceutical companies. From 1987 to 1993, he served as Controller for Roberts
Pharmaceutical Corporation where his responsibilities included public company
financial reporting, the development and implementation of accounting practices
and internal control systems, income tax planning and compliance, cash
management and analysis of acquisitions. From 1983 to 1987 he served on the
audit staff of Coopers & Lybrand. Mr. Anthony holds a B.S. in Accounting from
Monmouth College.

EXECUTIVE CONSULTANTS

FREDRICK L. MINN, M.D., PH.D., MEDICAL DIRECTOR. Dr. Minn has served as
Medical Director since 1994 under the terms of an independent consulting
agreement with the Company. From 1989 to 1994, Dr. Minn served as Senior
Clinical Research Fellow at the Robert Wood Johnson Pharmaceutical Research
Institute ('PRI') and Clinical Research Fellow at McNeil Pharmaceutical from
1976 to 1988. From 1974 to 1980, Dr. Minn served as Consulting Insurance
Examiner for Insurance Company of North America and from 1974 to 1976 served as
Assistant Director of Clinical Pharmacology for Squibb Institute for Medical
Research.

RONALD L. BUCHANAN, PH.D., DIRECTOR OF LICENSING. Dr. Buchanan has served
as Director of Licensing since 1994 under the terms of an independent consulting
agreement with the Company. Prior to becoming Director of Licensing for the
Company, Dr. Buchanan served in various positions at Bristol-Myers Squibb,
including Senior Director of Licensing, from 1991 to 1993.

<PAGE>
<PAGE>
MEDICAL AND RESEARCH ADVISORY BOARD

The Company's objective is to build a proprietary technology base for its
products and establish drug development programs as expeditiously and
efficiently as possible. To meet this objective, the Company has established
consulting relationships with many of the leading scientists and clinicians in
pain management. These scientific and medical advisors, at the request of the
Company, review the Company's individual research programs, advise on clinical
study design and provide direction on new product development. Scientific and
medical advisors are compensated on a retainer or per diem basis. The Company's
Medical and Research Advisory Board currently includes the following
individuals:

<TABLE>
<CAPTION>
NAME POSITION
---- --------
<S> <C>
William T. Beaver, M.D.................... Professor of Pharmacology and Anesthesia, Department of Pharmacology,
Georgetown University School of Medicine.
Gary J. Bennett, Ph.D..................... Chief, Neuropathic Pain and Pain Measurement Section, Neurobiology
and Anesthesiology Branch, National Institute of Dental Research,
National Institutes of Health.
Michael J. Cousins, M.D................... Professor and Department Head, Department of Anesthesia and Pain
Management, University of Sydney, Royal North Shore Hospital,
Australia.
George E. Ehrlich, M.D.................... President, George E. Ehrlich Associates and Chairman, FDA Advisory
Committee on Rheumatology and Arthritis Drugs.
Howard L. Fields, M.D., Ph.D.............. Professor, Departments of Neurology and Physiology and Vice Chairman,
Department of Neurology, University of California, San Francisco.
Richard H. Gracely, Ph.D.................. Research Psychologist, Neuropathic Pain and Pain Measurement Section,
Neurobiology and Anesthesiology Branch, National Institute of
Dental Research, National Institutes of Health.
Raymond W. Houde, M.D..................... Senior Attending Physician Emeritus, Departments of Medicine and
Neurology, Memorial Sloan-Kettering Cancer Center.
Jerome H. Jaffe, M.D...................... Director, Office of Scientific Analysis and Evaluation and Associate
Director, Center for Substance Abuse Treatment, Substance Abuse and
Mental Health Services Administration.
Donald R. Jasinski, M.D................... Chief, Center for Chemical Dependence, Francis Scott Key Medical
Center, Professor, Departments of Medicine, Anesthesiology and
Critical Care Medicine, Johns Hopkins University School of
Medicine.
Robert Langer, Sc.D....................... Kenneth J. Germeshausen Professor of Chemical and Biomedical
Engineering, Massachusetts Institute of Technology and Research
Associate, Department of Surgery, Children's Hospital.
Louis Lasagna, M.D........................ Dean, Sackler School of Graduate Biomedical Sciences, Academic Dean
of the Medical School, Professor of Psychiatry (Clinical
Pharmacology), Professor of Pharmacology, Tufts University.
David J. Mayer, Ph.D...................... Professor, Department of Anesthesiology, The Medical College of
Virginia.
Donald D. Price, Ph.D..................... Professor, Department of Anesthesiology, Director of Research, The
Medical College of Virginia.
Gary R. Strichartz, Ph.D.................. Professor of Anesthesia (Pharmacology), Vice Chairman for Research,
Brigham and Women's Hospital, Harvard Medical School.
Vittorio Ventafridda, M.D., Ph.D.......... Liaison Officer, World Health Organization Cancer Unit, Scientific
Director, Fondazione Floriani, Milano, Italy; Consultant, Instituto
Europeo di Oncologia (I.E.O.), Milano, Italy.
</TABLE>

<PAGE>
<PAGE>
COMPENSATION OF OUTSIDE DIRECTORS

Non-employee members of the Board of Directors will receive cash
compensation of $1,500 per meeting attended as consideration for their services
as directors of the Company and are reimbursed for reasonable travel expenses
incurred in connection with their attendance of such meetings. Non-employee
directors upon appointment or election to the Board of Directors will receive an
option grant under the Company's 1996 Non-Employee Director Stock Option Plan to
purchase 10,000 shares of Common Stock, at the fair market value on the date of
grant, vesting over a three-year period upon each anniversary of the date of
grant. In addition, on the date of each annual meeting of stockholders held
after the date of the Offering, each non-employee director who will continue to
serve as a director for the following year, and also has served as a director
for the last six months prior to the date of the annual meeting, shall receive
an option to purchase 5,000 shares of Common Stock, at the fair market value at
the date of grant, vesting over a one year period. See 'Stock Option Plans.'

EXECUTIVE COMPENSATION AND EMPLOYMENT AGREEMENTS

Executive Compensation

The following tables set forth the annual, long-term, and other
compensation of the Company's Chief Executive Officer and other most highly
compensated executives (collectively, the 'Named Officers') whose annual base
salaries equal or exceed $100,000.

SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
----------------------------------------
OTHER
ANNUAL
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION
- ------------------------------ ---- -------- ------- ------------

<S> <C> <C> <C> <C>
John W. Lyle,
President and Chief
Executive Officer........... 1995 $235,000 $75,000 --
Frank S. Caruso,
Executive Vice President for
Research and Development.... 1995 165,000 25,000 --

<CAPTION>
LONG-TERM COMPENSATION
--------------------------------------------

AWARDS
------------------- PAYOUTS
RESTRICTED OPTIONS ----------------------
STOCK (# OF LTIP ALL OTHER
NAME AND PRINCIPAL POSITION AWARDS SHARES) PAYOUTS COMPENSATION
- ---------------------------- ---------- ------- ------- ------------
<S> <C> <C> <C> <C>
John W. Lyle,
President and Chief
Executive Officer........... -- -- -- --
Frank S. Caruso,
Executive Vice President for
Research and Development.... -- -- -- --
</TABLE>

The following table sets forth for each of the named executive officers the
value realized from stock options exercised during 1995 and the number and value
of exercisable and unexercisable stock options held at December 31, 1995:

<TABLE>
<CAPTION>
AGGREGATED OPTION EXERCISES IN LAST YEAR AND YEAR END OPTION VALUES

NUMBER OF SHARES
OF UNDERLYING
SHARES UNEXERCISED OPTIONS
ACQUIRED ON VALUE ----------------------------
EXERCISE(1) REALIZED EXERCISABLE UNEXERCISABLE
----------- -------- ----------- -------------
<S> <C> <C> <C> <C>

John W. Lyle........ 74,700 -- 74,700 149,400
Frank S. Caruso..... 49,800 -- 49,800 99,600

<CAPTION>
AGGREGATED OPTION EXERCISES IN LAST YEAR AND YEAR END OPTION VALUES

VALUE OF UNEXERCISED
IN-THE-MONEY OPTIONS(2)
----------------------------
EXERCISABLE UNEXERCISABLE
------------ -------------
<S> <C> <C>
John W. Lyle........ -- --
Frank S. Caruso..... -- --
</TABLE>

- ------------

(1) All such options were exercised in January 1995. The Board of Directors
determined that the exercise price of the options did not exceed the fair market
value of the Common Stock at the time of exercise. Accordingly, there was no
value realized at the time of exercise.

(2) Based on the fair market value of the Common Stock as of December 31,
1995 ($0.12 per share) as determined by the Board of Directors, the Company
determined that there were no in-the-money options at December 31, 1995.

Employment Agreements

Each of Mr. Lyle and Drs. Caruso and Bello has an employment agreement with
the Company which expires December 31, 1997. Each employment agreement is
automatically renewable for

<PAGE>
<PAGE>
successive one-year terms unless terminated by either the employee or the
Company. Mr. Lyle's agreement provides that Mr. Lyle will be employed as the
President and Chief Executive Officer of the Company and that the Company will
use its best efforts to cause Mr. Lyle to be elected to the Board of Directors
for the term of the agreement. Dr. Caruso's agreement provides that he will be
employed as the Executive Vice President for Research and Development. Dr.
Bello's agreement provides that he will be employed as the Executive Vice
President for Technology Transfer and Manufacturing. Under the agreements, each
executive will be entitled to certain upward adjustments to the preceding year's
base salary. Drs. Caruso and Bello are entitled to receive continuing payments
amounting to twelve months and six months salary, respectively, in the event of
their termination by the Company without cause. Each executive may also receive
bonuses for individual accomplishment of key milestone events in such amounts
and on such terms as the Board of Directors may determine. Mr. Lyle's agreement
acknowledges that during the employment period he will also serve as Chief
Executive Officer of U.S. Medical Development, Inc. ('USMDI'), a Delaware
corporation incorporated on January 4, 1994 by the founders of the Company. The
agreements provide the executives with certain rights under the 1994 Stock
Option Plan. See 'Stock Option Plans.'

STOCK OPTION PLANS

1994 Stock Option Plan

Effective January 1994, the Company established the Algos Pharmaceutical
Corporation 1994 Stock Option Plan (the '1994 Option Plan') under which key
employees may be granted options to purchase shares of the Common Stock. The
1994 Option Plan is intended to assist the Company in attracting and retaining
employees of outstanding ability and to promote the identification of their
interests with those of the stockholders of the Company. The Company has
reserved a total of 830,000 shares of Common Stock for issuances under the plan.

Unless sooner terminated by the Board of Directors, the 1994 Option Plan
will expire ten years after its inception. The 1994 Option Plan is administered
by the Board of Directors, which has the authority to select eligible employees,
grant options under the plan and determine the terms, price, and form of payment
for each grant. Awards under the 1994 Option Plan will generally be granted at
an exercise price equal to the then fair market value per share of Common Stock.
Options granted under the 1994 Option Plan shall not be transferable and upon an
employee's death, all options that have been granted to such employee are
generally deemed to be exercisable.

1996 Stock Option Plan

In April 1996, the Company adopted the Algos Pharmaceutical Corporation
1996 Stock Option Plan (the '1996 Option Plan'). The 1996 Option Plan is
intended to assist the Company in attracting and retaining key employees and
independent consultants of outstanding ability and to promote the identification
of their interests with those of the stockholders of the Company. The 1996
Option Plan permits the grant of non-qualified stock options and incentive stock
options to purchase shares of Common Stock covering 415,000 authorized but
unissued or reacquired shares of Common Stock, subject to adjustment to reflect
events such as stock dividends, stock splits, recapitalizations, mergers or
reorganizations of or by the Company.

Unless sooner terminated by the Board of Directors, the 1996 Option Plan
will expire on January 31, 2006. Such termination will not affect the validity
of any option outstanding under the 1996 Option Plan on the date of termination.

Prior to the Offering, the Board of Directors will administer the 1996
Stock Option Plan. Following the closing of the Offering, the Compensation
Committee of the Board of Directors (the 'Committee') will administer the 1996
Stock Option Plan (which is intended to satisfy the requirements of Rule 16b-3
under the Exchange Act, and Section 162(m) of the Internal Revenue Code of 1986,
as amended (the 'Code')). Subject to the terms and conditions of the 1996 Option
Plan, the Committee has the authority to select the persons to whom grants are
to be made, to designate the number of shares of Common Stock to be covered by
such grants, to determine the exercise price of options, to establish the period
of exercisability of options, and to make all other determinations and to take
all other actions necessary or advisable for the administration of the 1996
Option Plan. The dates on which options first become exercisable and on which
they expire shall be set forth in individual option agreements setting

<PAGE>
<PAGE>
forth the specific terms of the options, subject to the requirements of the 1996
Stock Option Plan. Such agreements will generally provide that options expire
within one year following the termination of the optionee's status as an
employee or consultant of the Company (or a subsidiary) although the Committee
may provide that options continue to be exercisable following a termination
without 'Cause' (as defined in the 1996 Stock Option Plan) or otherwise. The
Committee also may, in its discretion, provide by the terms of an option that
such option will expire at specified times following, or become exercisable in
full upon, the occurrence of certain specified 'extraordinary corporate events'
including a merger, consolidation or dissolution of the Company, or a sale of
substantially all of the Company's assets, but in such event the Committee may
also give optionees the right to exercise their outstanding options in full
during some period prior to such event, even though the rights have not yet
otherwise become fully exercisable. Notwithstanding the foregoing, upon a
'Corporate Transaction' (as defined in the 1996 Stock Option Plan), all
outstanding options shall become immediately exercisable if not assumed by the
surviving corporation.

Incentive stock options ('Incentive Stock Options') granted under the 1996
Stock Option Plan will be designed to comply with the provisions of the Code and
will be subject to certain restrictions contained in the Code. Among such
restrictions, Incentive Stock Options must have an exercise price not less than
the fair market value of a share of Common Stock on the date of grant, may only
be granted to employees, must expire within a specified period of time following
the optionee's termination of employment, and must be exercised within the ten
years after the date of grant.

In the case of an incentive stock option granted to an individual who owns
(or is deemed to own) at least 10% of the total combined voting power of all
classes of stock of the Company, the exercise price must be at least 110% of the
fair market value of a share of Common Stock on the date of grant and must
expire five years after grant. Furthermore, the 1996 Option Plan provides that
the aggregate fair market value (determined at the time the option is granted)
of shares with respect to which incentive stock options may be exercisable for
the first time during any calendar year, may not exceed $100,000 per employee.
Options for shares, the fair market value of which exceeds the $100,000 per year
limit, will be treated as non-qualified stock options.

Options intended to satisfy the requirements for 'performance-based
compensation' under Section 162(m) of the Code must also have an exercise price
of not less than fair market value on the date granted and must comply with
other limitations and restrictions.

The 1996 Option Plan may be amended by the Committee, subject to
stockholder approval if such approval is then required by applicable law or in
order for the 1996 Option Plan and options granted thereunder to continue to
satisfy the requirements of Rule 16b-3 under the Exchange Act or Section 162(m)
of the Code.

The 1996 Option Plan permits the payment of the option exercise price to be
made in cash (which may include an assignment of the right to receive the cash
proceeds from the sale of Common Stock subject to the option pursuant to a
'cashless exercise' procedure) or by delivery of shares of Common Stock valued
at their fair market value on the date of exercise or delivery of other
property, or by a recourse promissory note payable to the Company, or by a
combination of the foregoing. As a condition of exercise, optionees must also
provide for the payment of withholding tax obligations of the Company in
connection with such exercise.

Options granted under the 1996 Option Plan shall not be transferable
otherwise than by will, by the laws of descent and distribution or pursuant to a
qualified domestic relations order (as defined in the Code), and may be
exercised during the optionee's lifetime only by the optionee or, in the event
of the optionee's legal disability, by the optionee's legal representative.

1996 Non-Employee Director Stock Option Plan

In April 1996, the Company also adopted the 1996 Non-Employee Director
Stock Option Plan (the 'Director Plan') covering 83,000 authorized but unissued
or reacquired shares of Common Stock, subject to adjustment to reflect events
such as stock dividends, stock splits, recapitalizations, mergers or
reorganizations of or by the Company. The Director Plan is intended to assist
the Company in attracting and retaining qualified non-employee directors
('Outside Directors').

Following the consummation of the Offering, the Director Plan will be
administered by the Board of Directors and options granted under the Director
Plan are intended to satisfy the requirements of

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<PAGE>
Rule 16b-3 under the Exchange Act. The Director Plan provides for automatic
grants of non-qualified stock options to purchase 10,000 shares of Common Stock
to each Outside Director at the time of appointment or election to the Board of
Directors.

The exercise price of the options shall be the fair market value of a share
of Common Stock on the date of grant. Each option shall become exercisable in
cumulative annual installments of one-third on each of the first three annual
meetings of the Company's stockholders following the date of grant so long as
the Outside Director continues to serve as a director of the Company; provided,
however, to the extent permitted by Rule 16b-3, the Board of Directors may
accelerate the exercisability of options upon the occurrence of certain
specified extraordinary corporate transactions or events and provided further,
that in any event, upon the occurrence of a 'Corporate Transaction' of the
Company (as defined in the Director Plan) all outstanding options shall become
immediately exercisable. No portion of an option shall be exercisable after the
tenth anniversary of the date of grant and no portion of an option shall become
exercisable following termination of the Outside Director's services as director
of the Company.

Unless sooner terminated by the Board of Directors, the Director Plan will
expire ten years after the date of its adoption. Such expiration will not affect
the validity of any option outstanding on the date of termination.

Each Outside Director serving as a director of the Company as of the close
of each subsequent annual stockholders' meeting at which directors are elected
shall be granted an option to purchase 5,000 shares of Common Stock.

CERTAIN FEDERAL INCOME TAX CONSEQUENCES WITH RESPECT TO OPTIONS UNDER THE 1994
OPTION PLAN, 1996 OPTION PLAN AND THE DIRECTOR PLAN

An optionee generally will not recognize taxable income on the grant of a
non-qualified stock option under the 1994 Option Plan, 1996 Option Plan or the
Director Plan, but will recognize ordinary income on the exercise of such
option. The amount of income recognized on the exercise of an option generally
will be equal to the excess, if any, of the fair market value of the shares at
the time of exercise over the aggregate exercise price paid for the shares,
regardless of whether the exercise price is paid in cash or in shares or other
property. Where ordinary income is recognized by an optionee in connection with
the exercise of an option, the Company generally will be entitled to a deduction
equal to the amount of ordinary income so recognized.

An optionee generally will not recognize taxable income upon either the
grant or exercise of an incentive stock option granted under the 1996 Option
Plan. Generally, upon the sale or other taxable disposition of the shares of the
Common Stock acquired upon exercise of an incentive stock option, the optionee
will recognize long-term capital gain in an amount equal to the excess, if any,
of the amount realized in such disposition over the option exercise price,
provided that no disposition of the shares has taken place within either (a) one
year from the date of exercise or (b) two years from the date of grant of the
incentive stock option. If the shares of the Common Stock are sold or otherwise
disposed of before the end of the one-year and two-year periods specified above,
the difference between the incentive stock option exercise price and the fair
market value of the shares on the date of the incentive stock option's exercise
generally will be taxable as ordinary income; the balance of the amount realized
from such disposition, if any, will be taxed as capital gain. If the shares of
the Common Stock are disposed of before the expiration of the one-year and
two-year periods and the amount realized is less than the fair market value of
the shares at the date of exercise, the optionee's ordinary income generally is
limited to excess, if any, of the amount realized in such disposition over the
option exercise price paid. The Company (or other employer corporation)
generally will be entitled to a tax deduction with respect to an incentive stock
option only to the extent the optionee has ordinary income upon sale or other
disposition of the shares of the Common Stock.

The rules governing the tax treatment of options and an optionee's receipt
of shares in connection with such grants are quite technical, so that the above
description of tax consequences is necessarily general in nature and does not
purport to be complete. Moreover, statutory provisions are, of course, subject
to change, as are their interpretations, and their application may vary in
individual circumstances. Finally, the tax consequences under applicable state
law may not be the same as under the federal income tax laws.

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<PAGE>
PRINCIPAL STOCKHOLDERS

The following table sets forth certain information with respect to the
beneficial ownership of the Common Stock as of August 15, 1996 (after giving
effect to the automatic conversion of the Series A Preferred Stock into Common
Stock upon consummation of the Offering) by (i) each person who is known by the
Company to own beneficially more than 5% of the Common Stock, (ii) each
director, (iii) each executive officer and (iv) all directors and executive
officers of the Company as a group. Unless otherwise indicated, the address of
each beneficial owner is c/o the Company, Collingwood Plaza, 4900 Route 33,
Neptune, New Jersey 07753.

<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
BENEFICIALLY OWNED
----------------------
NUMBER OF SHARES PRIOR TO AFTER
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED (a) OFFERING OFFERING**
------------------------ ---------------------- -------- ----------

<S> <C> <C> <C>
DIRECTORS AND EXECUTIVE OFFICERS
John W. Lyle(b)................................................ 1,517,516 12.5% 9.7%
Frank S. Caruso(c)............................................. 240,700 2.0 1.5
Gastone Bello.................................................. 116,200 * *
Donald G. Drapkin(d)........................................... 16,600 * *
Roger H. Kimmel(e)............................................. 1,592,526 13.2 10.2
James R. Ledley................................................ 103,750 * *
Dieter A. Sulser(f)............................................ 153,550 1.3 *
Directors and Executive Officers as a group(g)...................... 3,740,842 30.8 23.9
OTHER PRINCIPAL STOCKHOLDERS
Unifina Holding AG and related investors(h).................... 1,734,700 14.2 11.0
Karen Lyle(i).................................................. 1,517,516 12.5 9.7
Michael Hyatt(j)............................................... 1,193,561 9.9 7.7
Lawrence Canarelli(k).......................................... 871,500 7.2 5.6
Gilbert Goldstein(l)........................................... 850,750 7.1 5.5
Paul Shapiro(m)................................................ 809,250 6.7 5.2
Morris J. Kramer(n)............................................ 809,246 6.7 5.2
Inez Kimmel(o)(q).............................................. 707,193 5.9 4.5
Gail Albert(p)................................................. 664,000 5.5 4.3
</TABLE>

- ------------

* represents less than 1.0%

** assumes no exercise of the Underwriters' over-allotment option

(a) For purposes of this table, a person or group is deemed to have 'beneficial
ownership' of any shares which such person has the right to acquire within
60 days after the date of this Prospectus. For purposes of calculating the
percentage of outstanding shares held by each person named above, any
shares which such person has the right to acquire within 60 days after the
date of the Prospectus are deemed to be outstanding, but not for the
purpose of calculating the percentage ownership of any other person.

(b) Includes (i) 74,700 shares of Common Stock owned directly by Mr. Lyle, (ii)
1,363,966 shares of Common Stock and options to purchase 4,150 shares of
Common Stock owned by Karen Lyle, wife of Mr. Lyle, as to which Mr. Lyle
disclaims beneficial ownership, (iii) options to purchase 74,700 shares of
Common Stock, and excludes 664,000 shares of Common Stock held in a trust
for the benefit of the children of Mr. and Mrs. Lyle, as to which shares
Mr. Lyle has neither the power of disposition nor the power to vote.

(c) Excludes a total of 24,900 shares held in trust for the benefit of the
children of Dr. Caruso, as to which shares Dr. Caruso has neither the power
of disposition nor the power to vote.

(d) Excludes a total of 809,246 shares of Common Stock held in six trusts for
the benefit of the children of Mr. Drapkin, as to which shares Mr. Drapkin
has neither the power of disposition nor the power to vote.

(e) Includes (i) 707,193 shares of Common Stock owned directly by Inez Kimmel,
wife of Mr. Kimmel and (ii) 885,333 shares held in two trusts for which Mr.
Kimmel serves as trustee and as to which shares Mr. Kimmel holds either the
sole or the shared power of disposition and power to vote, and excludes
343,060 shares of Common Stock held in two trusts for the benefit of the
children of Mr. and Mrs. Kimmel, as to which shares Mr. Kimmel has neither
the power of disposition nor the power to vote.

(f) Includes 141,100 shares of Common Stock and 12,450 warrants to purchase
shares of Common Stock owned directly by Gaby Sulser, wife of Mr. Sulser,
as to which Mr. Sulser disclaims beneficial ownership and excludes
1,734,700 shares beneficially owned by Unifina Holding AG, as to which
shares Mr. Sulser disclaims beneficial ownership. Mr. Sulser is the General
Manager of Unifina Holding AG.

(g) Includes options and warrants to purchase 91,300 shares of Common Stock.

<PAGE>
<PAGE>
(footnotes continued from previous page)

(h) Consists of 1,577,000 shares of Common Stock and 157,700 warrants to
purchase shares of Common Stock held by EBC Zurich AG. The address of
Unifina Holding AG is Zurcherstrasse 62; CH 8406, Winterthur, Switzerland
and the address of EBC Zurich AG is Bellariastrasse 23; CH 8027, Zurich,
Switzerland. Excludes (i) 166,000 shares of Common Stock and warrants to
purchase 16,600 shares of Common Stock held by Mr. Rolf P. Erb, Chairman of
EBC Zurich AG and a member of the board of directors of Unifina Holding AG,
as to which shares each of Unifina Holding AG and EBC Zurich AG disclaim
beneficial ownership and (ii) 141,100 shares of Common Stock and warrants
to purchase 12,450 shares of Common Stock beneficially owned by Mr. Sulser,
General Manager of Unifina Holding AG, as to which shares Unifina Holding
AG disclaims beneficial ownership.

(i) Includes (i) 1,363,966 shares of Common Stock and options to purchase 4,150
shares of Common Stock, owned directly by Mrs. Lyle and (ii) 74,700 shares
of Common Stock and options to purchase 74,700 shares of Common Stock owned
by directly by John Lyle, husband of Mrs. Lyle, as to which Mrs. Lyle
disclaims beneficial ownership, and excludes 664,000 shares of Common Stock
held in a trust for the benefit of the children of Mr. and Mrs. Lyle, as to
which shares Mrs. Lyle has neither the power of disposition nor the power
to vote.

(j) Includes (i) 829,751 shares of Common Stock owned directly by Mr. Hyatt and
(ii) 363,810 shares held in three trusts for which Mr. Hyatt serves as
trustee and as to which shares Mr. Hyatt holds either the sole or the
shared power of disposition or the power to vote, and excludes 221,333
shares of Common Stock held in a trust for the benefit of the children of
Mr. Hyatt, as to which shares Mr. Hyatt has neither the power of
disposition nor the power to vote.

(k) Includes 664,000 shares of Common Stock deemed to be beneficially owned by
each of Mrs. Albert and Mr. Canarelli in their shared capacity as trustees
for a trust as to which shares each of Mrs. Albert and Mr. Canarelli share
the power of disposition and the power to vote.

(l) Includes 809,250 shares of Common Stock deemed to be beneficially owned by
Mr. Goldstein in his capacity as trustee for a trust as to which shares Mr.
Goldstein has the shared power of disposition and power to vote.

(m) Includes 809,250 shares of Common Stock deemed to be beneficially owned by
Mr. Shapiro in his capacity as trustee for a trust as to which shares Mr.
Shapiro has the shared power of disposition and power to vote.

(n) Includes 809,246 shares of Common Stock deemed to be beneficially owned by
Mr. Kramer in his capacity as trustee for a trust as to which shares Mr.
Kramer holds the power of disposition and the power to vote.

(o) Excludes (i) 885,333 shares of Common Stock beneficially owned by Roger
Kimmel, husband of Mrs. Kimmel, as trustee and as to which Mr. Kimmel holds
either the sole or shared power of disposition and power to vote and (ii)
343,060 shares of Common Stock held in two trusts for the benefit of the
children of Mr. and Mrs. Kimmel.

(p) Includes 664,000 shares of Common Stock deemed to be beneficially owned by
each of Mrs. Albert and Mr. Canarelli in their shared capacity as trustees
for a trust as to which shares each of Mrs. Albert and Mr. Canarelli share
the power of disposition and the power to vote.

(q) As of September 24, 1996, these shares are held by the Estate of Inez
Kimmel.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Mr. Roger H. Kimmel, a director of the Company, is a partner at Latham &
Watkins which performs legal services for the Company from time to time. See
'Legal Matters.'

Mr. James R. Ledley, a director of the Company, is a member of the law firm
of Kleinberg, Kaplan, Wolff & Cohen, P.C. which performs legal services for the
Company from time to time.

<PAGE>
<PAGE>
DESCRIPTION OF CAPITAL STOCK

Upon consummation of the Offering, the authorized capital stock of the
Company will consist of 50,000,000 shares of Common Stock, $.01 par value per
share, and 10,000,000 shares of Preferred Stock, $.01 par value per share,
100,000 of which have been designated as Series B Preferred Stock.

COMMON STOCK

Holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. Holders of Common
Stock are not entitled to cumulative voting rights. Holders of Common Stock are
entitled to receive ratably such dividends as may be declared by the Board of
Directors out of funds legally available therefor. The Company does not
anticipate any cash dividends on Common Stock will be paid in the foreseeable
future. See 'Dividend Policy.' In the event of a liquidation, dissolution or
winding up of the Company, holders of Common Stock are entitled to share ratably
in all assets remaining after payment of liabilities, and payments to holders of
Preferred Stock. The holders of Common Stock have no preemptive rights and no
right to convert their Common Stock into any other securities. There are no
redemption or sinking fund provisions applicable to the Common Stock. All the
outstanding shares of Common Stock are, and the shares of Common Stock into
which the Preferred Shares will be converted upon completion of the Offering
will be, validly issued, fully paid and non-assessable.

PREFERRED STOCK

Under its Amended and Restated Certificate of Incorporation, the Company
has authority to issue 10,000,000 shares of Preferred Stock, $.01 par value per
share. The Board of Directors has the authority, without approval of the
stockholders, to issue shares of Preferred Stock in one or more series and to
fix the number of shares and the rights, preferences, privileges,
qualifications, restrictions and limitations of each series. Prior to the
Offering, 100,000 shares of Series B Preferred Stock were issued and outstanding
and such shares will remain issued and outstanding upon consummation of the
Offering. The Series B Preferred Stock is convertible, at the option of the
holder, into Common Stock at any time after February 1, 1997. The holders of
Series B Preferred Stock will receive one share of Common Stock for each share
of Series B Preferred Stock owned by such holder, subject to certain
anti-dilution provisions.

REGISTRATION RIGHTS

The holders of the Common Stock and Series A Preferred Stock prior to the
Offering (the 'Stockholders'), are parties to a stockholders' agreement (the
'Stockholders' Agreement') which provides such Stockholders with certain
registration rights. Under the Stockholders' Agreement, and upon the automatic
conversion of the Series A Preferred Stock to shares of Common Stock, the
Stockholders are entitled to certain registration rights with respect to shares
of Common Stock, including a demand registration right which is exercisable on
one occasion after 270 days from the date of this Prospectus and certain
'piggyback' registration rights which are exercisable in connection with
registrations of shares initiated by the Company.

At any time after February 1, 1997, holders of the Series B Preferred Stock
have the right to require the Company to register the resale of the Common Stock
that such holders receive upon conversion of the Series B Preferred Stock.

DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS

Upon the consummation of the Offering, the Company will be subject to the
provisions of Section 203 of the Delaware General Corporation Law, an
anti-takeover law. In general, Section 203 prohibits a publicly-held Delaware
corporation from engaging in a 'business combination' with an 'interested
stockholder' for a period of three years after the date of the transaction in
which the person became an interested stockholder unless such transaction was
approved in a prescribed manner or another prescribed exception applies. For
purposes of Section 203, a 'business combination' is defined broadly to include
a merger, asset sale or other transaction resulting in a financial benefit to
the interested stockholder, and subject to certain exceptions, an 'interested
stockholder' is a person who, together with affiliates and associates owns (or
within three years prior, did own) 15% or more of the corporation's voting
stock.

Upon consummation of the Offering, the Company's Amended and Restated
By-Laws provide for a Board of Directors classified into three classes, with the
Directors elected at the Company's 1996 annual meeting divided into three
classes and serving initial terms expiring at the 1997, 1998 and 1999

<PAGE>
<PAGE>
annual stockholders' meetings, respectively. Thereafter, Directors in each class
will be elected for three year terms. No determination has yet been made as to
the selection of any of the current directors for nomination for election in a
particular class. All directors elected to the Company's classified Board of
Directors will serve until the election and qualification of their successors or
their earlier resignation or removal. The Board of Directors is authorized to
create new directorships and to fill such positions so created and is permitted
to specify the class to which such new position is assigned, and the person
filling such position would serve for the term applicable to that class. The
Board of Directors (or its remaining members, even though less than a quorum) is
also empowered to fill vacancies on the Board of Directors occurring for any
reason for the remainder of the term of the class of Directors in which the
vacancy occurred. After classification of the Board of Directors, Directors may
only be removed for cause. These provisions are likely to increase the time
required for stockholders to change the composition of the Board of Directors.

The Company's Amended and Restated By-Laws also provide that, for
nomination to the Board of Directors or for other business to be properly
brought by a stockholder before a meeting of stockholders, the stockholder must
first have given timely notice thereof in writing to the Secretary of the
Company. To be timely, a stockholder's notice generally must be delivered not
less than sixty days nor more than ninety days prior to the annual meeting. If
the meeting is not an annual meeting, the notice must generally be delivered not
more than ninety days prior to the special meeting and not later than the later
of sixty days prior to the special meeting and ten days following the day on
which public announcement of the meeting is first made by the Company. Only such
business shall be conducted at a special meeting of stockholders as is brought
before the meeting pursuant to the Company's notice of meeting. The notice by a
stockholder must contain, among other things, certain information about the
stockholder delivering the notice and, as applicable, background information
about the nominee or a description of the proposed business to be brought before
the meeting.

The Company's Amended and Restated Certificate of Incorporation also
requires that any action required or permitted to be taken by stockholders of
the Company must be effected at a duly called annual or special meeting of
stockholders and may not be effected by a consent in writing. Special meetings
may be called only by the Chairman of the Board or the President of the Company
or by the majority of the whole Board of Directors.

The Delaware General Corporation Law provides generally that the
affirmative vote of a majority of the shares entitled to vote on any matter is
required to amend a corporation's certificate of incorporation or by-laws,
unless the corporation's certificate of incorporation or by-laws, as the case
may be, requires a greater percentage. The Company's Amended and Restated
Certificate of Incorporation requires the affirmative vote of the holders of at
least 66 2/3% of the outstanding voting stock of the Company to amend or repeal
any of the provisions discussed in this section entitled 'Delaware Law and
Certain Charter and By-Law Provisions' relating to the Amended and Restated
Certificate of Incorporation or to reduce the number of authorized shares of
Common Stock and Preferred Stock. Such 66 2/3% vote is also required for any
amendment to or repeal of the Company's Amended and Restated By-Laws by the
stockholders. The Amended and Restated By-Laws may also be amended or repealed
by a majority vote of the Board of Directors. Such 66 2/3% stockholder vote
would be in addition to any separate class vote that might in the future be
required pursuant to the terms of any Preferred Stock that might then be
outstanding.

The provisions of the Company's Amended and Restated Certificate of
Incorporation and Amended and Restated By-Laws discussed above could make more
difficult or discourage a proxy contest or other change in the management of the
Company or the acquisition or attempted acquisition of control by a holder of a
substantial block of the Company's stock. It is possible that such provisions
could make it more difficult to accomplish, or could deter, transactions which
stockholders may otherwise consider to be in their best interests.

As permitted by the Delaware General Corporation Law, the Company's Amended
and Restated Certificate of Incorporation provides that Directors of the Company
shall not be personally liable to the Company or its stockholders for monetary
damages for breach of their fiduciary duties as Directors, except for liability
(i) for any breach of their duty of loyalty to the Company and its stockholders,
(ii) for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law, (iii) for unlawful payments of
dividends or unlawful stock repurchases or redemptions, as provided

<PAGE>
<PAGE>
in Section 174 of the Delaware General Corporation Law or (iv) for any
transaction from which the Director derives an improper personal benefit.

The Company's Amended and Restated Certificate of Incorporation and Amended
and Restated By-Laws provide that the Company shall indemnify its Directors and
officers to the fullest extent permitted by Delaware law and advance expenses to
such Directors and officers to defend any action for which rights of
indemnification are provided.

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this Offering, the Company will have 15,544,123 shares
of Common Stock outstanding (assuming no exercise of any of the outstanding
options and warrants to purchase Common Stock outstanding as of June 30, 1996
and assuming the Underwriters' over-allotment option is not exercised), of which
12,044,123 are 'restricted' shares within the meaning of Rule 144 under the
Securities Act of 1933, as amended (the 'Securities Act'), and may not be resold
except pursuant to an effective registration statement under the Securities Act
or an applicable exemption from registration, including Rule 144 of the
Securities Act.

In general, under Rule 144, as currently in effect, a person (or persons
whose shares are aggregated), including an 'affiliate', as defined in the
Securities Act, is entitled to sell in any three-month period a number of shares
beneficially owned for at least two years that does not exceed the greater of
(i) 1% of the then outstanding shares of Common Stock or (ii) the average weekly
trading volume in the Common Stock during the four calendar weeks preceding such
sale. Sales under Rule 144 are also subject to certain requirements as to the
manner of sale, notice and the availability of current public information about
the Company. A person who is not an affiliate and has beneficially held such
shares for at least three years is entitled to sell such shares under Rule
144(k) without regard to the volume, manner of sale, notice or public
information requirements. Subject to the agreement with the underwriters
described in the next paragraph, as of August 22, 1996, 11,640,743 of the
restricted shares became eligible for sale in the public market in reliance on
Rule 144, 3,912,054 of which may be sold without regard to volume limitations.

For a period of 180 days after the closing of the Offering, without the
written consent of Lehman Brothers Inc., the Company and all of its existing
stockholders have agreed not to offer, sell or contract to sell, grant any
option to purchase or otherwise dispose of any shares of Common Stock other than
issuances pursuant to employee compensation plans, transfers among such
stockholders, certain pledges, transfers in the case of death or permanent
disability, certain transfers for the benefit of family members and the making
of certain limited charitable donations.

An employee, officer or director of or consultant to the Company who
purchased or was awarded shares or options to purchase shares pursuant to a
written compensatory plan or contract is entitled to rely on the resale
provision of Rule 701 under the Securities Act, which permits Affiliates to sell
their Rule 701 shares without having to comply with Rule 144's holding period
restrictions, in each case commencing 90 days after the Effective Date and
permits non-affiliates to sell their Rule 701 shares without having to comply
with the holding period, public information, volume and notice provisions of
Rule 144.

Under the Stockholders' Agreement, holders of shares of Common Stock issued
prior to the Offering or issuable under certain options and warrants outstanding
prior to the Offering are entitled to certain registration rights with respect
to their shares, including a demand registration right which is exercisable on
one occasion after 270 days from the date of this Prospectus and certain
'piggyback' registration rights which are exercisable in connection with
registrations of shares initiated by the Company. The Series B Preferred Stock
is convertible into an aggregate of 100,000 shares of Common Stock, subject to
certain anti-dilution provisions, at any time after February 1, 1997. See
'Description of Capital Stock -- Registration Rights.'

Prior to the Offering, there has been no public market for securities of
the Company. No predictions can be made as to the effect, if any, that sales of
shares or the availability of shares for sale will have on the prevailing market
price of the Common Stock. In addition, the Company cannot predict the number of
shares that may be sold in the future pursuant to Rule 144 or the timing of such
sales. Sales of a substantial number of Restricted Shares could have a
significant adverse effect on the market price of the Common Stock.

<PAGE>
<PAGE>
CERTAIN UNITED STATES FEDERAL TAX CONSIDERATIONS FOR
NON-UNITED STATES HOLDERS

The following is a general discussion of certain United States federal
income and estate tax consequences of the ownership and disposition of Common
Stock by a holder who is not a United States person (a 'Non-U.S. Holder'). For
these purposes, the term 'United States person' is defined as any person who is
a citizen or resident of the United States, a corporation or a partnership or
other entity created or organized in the United States or under the laws of the
United States or of any State, or an estate or trust whose income is includible
in gross income for United States federal income tax purposes regardless of its
source. An individual may, subject to certain exceptions, be deemed to be a
resident alien (as opposed to a non-resident alien) for federal income tax
purposes in several circumstances, including by virtue of being present in the
United States on at least 31 days in the calendar year and for an aggregate of
at least 183 days during the three-year period ending in the current calendar
year (counting for such purposes all of the days present in the current year,
one-third of the days present in the immediately preceding year, and one-sixth
of the days present in the second preceding year). Resident aliens are subject
to United States federal tax as if they were United States citizens and
residents.

This discussion is based on provisions of the Internal Revenue Code of
1986, as amended (the 'Code'), existing and proposed regulations promulgated
thereunder and administrative and judicial interpretations thereof as of the
date hereof, all of which are subject to change. This discussion does not
address all aspects of United States federal income and estate taxes and does
not deal with non-United States and U.S. state and local consequences that may
be relevant to Non-U.S. Holders in light of their personal circumstances. Each
prospective purchaser of Common Stock is advised to consult a tax advisor with
respect to current and possible future tax consequences of acquiring, holding
and disposing of Common Stock.

DIVIDENDS

The Company does not currently intend to pay cash dividends on shares of
Common Stock. See 'Dividend Policy.' In the event that dividends are paid on
shares of Common Stock, except as described below, such dividends paid to a
Non-U.S. Holder of Common Stock generally will be subject to withholding of
United States federal income tax at a 30% rate or such lower rate as may be
specified by an applicable income tax treaty, unless the dividends are
effectively connected with the conduct of a trade or business of the Non-U.S.
Holder within the United States (or attributable to a U.S. permanent
establishment of the Non-U.S. Holder, if an income tax treaty applies). Under
current United States Treasury regulations, dividends paid to an address outside
the United States, absent definite knowledge to the contrary, may be presumed to
be paid to a resident of such country for purposes of the withholding discussed
above, and, under the current interpretation of United States Treasury
regulations, for purposes of determining the applicability of a reduced rate of
withholding under a tax treaty. Thus, Non-U.S. Holders receiving dividends at
addresses outside the United States currently are not required to file forms
with the payor in order to obtain the benefit of an applicable treaty rate.
Under proposed United States Treasury regulations not currently in effect,
however, a Non-U.S. Holder of Common Stock who wishes to claim the benefit of an
applicable treaty rate would be required to satisfy applicable certification and
other requirements.

If the dividend is effectively connected with the conduct of a United
States trade or business of a Non-U.S. Holder who has properly filed a Form 4224
(or similar statement) with the withholding agent with respect to the taxable
year in which the dividend is paid, no withholding is required. Instead the
dividend (as adjusted by any applicable deductions) would be subject to regular
United States federal income tax. In addition, all or a portion of any such
effectively connected dividends received by a non-U.S. corporation may, under
certain circumstances, be subject to an additional 'branch profits tax' at a 30%
rate or such lower rate as may be specified by an applicable income tax treaty.

A Non-U.S. Holder of Common Stock eligible for a reduced rate of United
States withholding tax pursuant to a tax treaty may obtain a refund of any
excess amounts currently withheld by filing an appropriate claim for refund with
the Internal Revenue Service ('IRS').

<PAGE>
<PAGE>
GAIN ON DISPOSITION OF COMMON STOCK

A Non-U.S. Holder generally will not be subject to United States federal
income tax (and no tax generally will be withheld) with respect to gain
recognized on a sale or other disposition of Common Stock so long as (i) the
gain is not effectively connected with a trade or business of the Non-U.S.
Holder within the United States, (ii) in the case of a Non-U.S. Holder who is a
non-resident alien individual and holds the Common Stock as a capital asset,
such holder is not present in the United States for 183 or more days in the
taxable year of the sale or other disposition, and (iii) the Company is not and
has not been within the preceding five years a 'United States real property
holding corporation' for United States federal income tax purposes (assuming the
Common Stock is regularly traded on an established securities market). The
Company believes that it is not, has at no time been, and does not anticipate
becoming a 'United States real property holding corporation' for United States
federal income tax purposes. In addition, the Company believes that the Common
Stock will be treated as regularly traded on an established securities market.

If the capital gain is effectively connected with the conduct of a trade or
business of the Non-U.S. Holder within the United States, or if the Company is
or has been within the preceding five years a United States real property
holding corporation and the Non-U.S. Holder is more than a five percent
stockholder (applying certain attribution rules), the capital gain would be
subject to regular United States federal income tax. In addition, with respect
to corporate Non-U.S. Holders, the 'branch profits tax' described above may also
apply. An individual Non-U.S. Holder who is present in the United States for 183
days or more in the taxable year of sale or other disposition and holds the
Common Stock as a capital asset will generally be taxed at a rate of 30% on any
net capital gain recognized during any year on such stock if either (i) such
individual has a 'tax home' (as defined for United States federal income tax
purposes) in the United States or (ii) the gain is attributable to an office or
other fixed place of business maintained by such individual in the United States
and no treaty exemption applies.

UNITED STATES INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING TAX

The Company must report annually to the IRS and to each Non-U.S. Holder the
amount of dividends paid to, and the tax withheld with respect to, such holder.
These information reporting requirements apply regardless of whether withholding
was reduced or eliminated by an applicable tax treaty. Copies of these
information returns may also be made available under the provisions of a
specific treaty or agreement to the tax authority in the country in which the
Non-U.S. Holder resides. Under temporary United States Treasury regulations,
United States backup withholding tax (which generally is a withholding tax
imposed at the rate of 31% on certain payments to persons that fail to furnish
certain information under the United States information reporting requirements)
and information reporting with respect to such tax will generally not apply to
dividends paid on Common Stock to a Non-U.S. Holder at an address outside the
United States.

As a general matter, backup withholding and information reporting also will
not apply to a payment of the proceeds of a sale of Common Stock by or through a
foreign office of a foreign broker. Information reporting requirements (but not
backup withholding) will apply, however, to a payment of the proceeds of a sale
of Common Stock by a foreign office of a broker that is a United States person,
that derives 50% or more of its gross income for certain periods from the
conduct of a trade or business in the United States, or that is a 'controlled
foreign corporation' (generally, a foreign corporation controlled by United
States stockholders) with respect to the United States, unless the broker has
documentary evidence in its records that the holder is a Non-U.S. Holder and
certain other conditions are met, or the holder otherwise establishes an
exemption. Payment by a United States office of a broker of the proceeds of a
sale of Common Stock is subject to both backup withholding and information
reporting unless the holder certifies under penalties of perjury that it is a
Non-U.S. Holder, or otherwise establishes an exemption.

Backup withholding (at a flat 31% rate) is not an additional tax. Rather,
the tax liability of persons subject to backup withholding will be reduced by
the amount of tax withheld. If withholding results in an overpayment of taxes, a
Non-U.S. Holder may obtain a refund by filing the appropriate claim for refund
with the IRS.

<PAGE>
<PAGE>
These backup withholding and information reporting rules are under review
by the United States Treasury, and their application to the Common Stock could
be changed prospectively by future regulations. On April 15, 1996, the IRS
issued proposed Treasury Regulations concerning the withholding of tax and
reporting for certain amounts paid to non-resident individuals and foreign
corporations. The proposed regulations would, among other changes, eliminate the
presumption under current regulations with respect to dividends paid to
addresses outside the United States. See 'Dividends on Common Stock.' The
proposed Treasury Regulations, if adopted in their present form, would be
effective for payments made after December 31, 1997. Prospective purchasers of
Common Stock should consult their tax advisors concerning the potential adoption
of such Treasury Regulations and the potential effect on the Common Stock.

FEDERAL ESTATE TAXES

Common Stock held (or treated as owned) by an individual Non-U.S. Holder at
the time of death will be included in such holder's gross estate for United
States federal estate tax purposes and may be subject to United States federal
estate tax, unless an applicable estate tax treaty provides otherwise. Estates
of non-resident aliens are generally allowed a statutory credit which is the
equivalent of an exclusion of $60,000 of assets from U.S. estate tax. Tax
treaties may permit a larger credit.

<PAGE>
<PAGE>
UNDERWRITING

Under the terms and subject to the conditions contained in the Underwriting
Agreement, the form of which is filed as an exhibit to the Registration
Statement of which this Prospectus forms a part, the Underwriters named below,
for whom Lehman Brothers Inc. and Cowen & Company are acting as representatives
(the 'Representatives'), have severally agreed to purchase from the Company, and
the Company has agreed to sell to each Underwriter, the aggregate number of
shares of Common Stock set forth opposite the name of each such Underwriter
below:

<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
- ------------ ---------

<S> <C>
Lehman Brothers Inc. ...................................................................... 1,005,000
Cowen & Company............................................................................ 1,005,000
Bear, Stearns & Co. Inc. .................................................................. 90,000
CS First Boston Corporation................................................................ 90,000
Dillon, Read & Co. Inc. ................................................................... 90,000
A.G. Edwards & Sons, Inc. ................................................................. 90,000
Everen Securities, Inc. ................................................................... 90,000
Hambrecht & Quist LLC...................................................................... 90,000
Montgomery Securities...................................................................... 90,000
Morgan Stanley & Co. Incorporated.......................................................... 90,000
Oppenheimer & Co., Inc. ................................................................... 90,000
PaineWebber Incorporated................................................................... 90,000
Smith Barney Inc. ......................................................................... 90,000
Robert W. Baird & Co. Incorporated......................................................... 50,000
Fahnestock & Co. Inc. ..................................................................... 50,000
Furman Selz LLC............................................................................ 50,000
Gruntal & Co., Incorporated................................................................ 50,000
Janney Montgomery Scott Inc. .............................................................. 50,000
Legg Mason Wood Walker, Incorporated....................................................... 50,000
Needham & Company, Inc. ................................................................... 50,000
The Robinson-Humphrey Company, Inc. ....................................................... 50,000
Sands Brothers & Co., Ltd. ................................................................ 50,000
Southeast Research Partners Inc. .......................................................... 50,000
---------
Total................................................................................. 3,500,000
---------
---------
</TABLE>

The Company has been advised by the Representatives that the Underwriters
propose to offer the shares of Common Stock to the public at the initial public
offering price set forth on the cover page hereof, and to certain dealers at
such initial public offering price less a selling concession not in excess of
$0.55 per share. The Underwriters may allow, and such dealers may reallow, a
concession not in excess of $0.10 per share to certain other Underwriters or to
certain other brokers or dealers. After the initial offering to the public, the
offering price and other selling terms may be changed by the Representatives.

The Underwriting Agreement provides that the obligations of the
Underwriters to pay for and accept delivery of the shares of Common Stock
offered hereby are subject to approval of certain legal matters by counsel and
to certain other conditions, including the condition that no stop order
suspending the effectiveness of the Registration Statement is in effect and no
proceedings for such purpose are pending or threatened by the Securities and
Exchange Commission and that there has been no material adverse change or any
development involving a prospective material adverse change in the condition of
the Company from that set forth in the Registration Statement otherwise than as
set forth or contemplated in this Prospectus, and that certain certificates,
opinions and letters have been received from the Company and its counsel. The
Underwriters are obligated to take and pay for all of the above shares of Common
Stock if any such shares are taken.

The Company and the Underwriters have agreed in the Underwriting Agreement
to indemnify each other against certain liabilities, including liabilities under
the Securities Act.

<PAGE>
<PAGE>
The Company has granted to the Underwriters an option to purchase up to an
additional 525,000 shares of Common Stock, exercisable solely to cover
over-allotments, at the initial public offering price, less the underwriting
discounts and commissions shown on the cover page of this Prospectus. Such
option may be exercised at any time until 30 days after the date of the
Underwriting Agreement. To the extent that the option is exercised, each
Underwriter will be committed to purchase a number of the additional shares of
Common Stock proportionate to each Underwriter's initial commitment as indicated
in the preceding table.

The Representatives of the Underwriters have informed the Company that the
Underwriters do not intend to confirm sales to accounts over which they exercise
discretionary authority.

For a period of 180 days after the closing of the Offering, without the
written consent of Lehman Brothers Inc., the Company and all of its existing
stockholders have agreed not to offer, sell or contract to sell, grant any
option to purchase or otherwise dispose of any shares of common stock other than
issuance pursuant to employee compensation plans, transfers among such
stockholders, certain pledges, transfers in the case of death or permanent
disability, certain transfers for the benefit of family members and the making
of certain limited charitable donations.

At the request of the Company, the Underwriters have reserved up to 300,000
shares of Common Stock for sale at the initial public offering price to certain
of the Company's employees and certain other persons. The number of shares of
Common Stock available for sale to the general public will be reduced to the
extent these persons purchase such reserved shares. If such reserved shares are
not purchased by such employees and other persons, they will be offered by the
Underwriters to the public upon the same terms and conditions set forth in this
Prospectus. Johnson & Johnson Development Corporation, an affiliate of Johnson &
Johnson, has expressed an interest in purchasing 10% of the Offering, up to $6.5
million worth of the shares of Common Stock offered hereby, at the public
offering price. See 'Business -- Corporate and Government Collaborations.'

Prior to the Offering, there has been no public market for the Common
Stock. The initial public offering price was negotiated between the Company and
the Representatives. Among the factors considered in determining the initial
public offering price of the Common Stock, in addition to the prevailing market
conditions, were the Company's historical performance, capital structure,
estimates of the business potential and earnings prospects of the Company, an
assessment of the Company's management and consideration of the above factors in
relation to market values of companies in related business and other factors
deemed relevant.

LEGAL MATTERS

Certain legal matters in connection with the Offering will be passed upon
for the Company by Latham & Watkins. Roger Kimmel, a director of the Company, is
a partner of Latham & Watkins and is the executor of the estate of Mrs. Inez
Kimmel, his deceased wife, which owns shares of the Common Stock directly and
through certain related trusts. In addition, two trusts that have been
established for the benefit of Mr. Kimmel's children own shares of the Common
Stock. See 'Principal Stockholders.' In addition, certain other partners of
Latham & Watkins, in the aggregate, own less than 2.0% of the Common Stock.
Certain legal matters in connection with the Offering will be passed upon for
the Underwriters by Kramer, Levin, Naftalis & Frankel.

EXPERTS

The balance sheets of Algos Pharmaceutical Corporation (a development stage
enterprise) as of December 31, 1995 and 1994 and the statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1995, included in this Prospectus, have been included herein
in reliance on the report of Coopers & Lybrand L.L.P., independent accountants,
given on the authority of that firm as experts in accounting and auditing.

The statements in this Prospectus set forth under the captions 'Risk
Factors -- Uncertain Ability to Protect Proprietary Technology' and
'Business -- Patents, Trade Secrets and Licenses' have been reviewed and
approved by Dilworth & Barrese, patent counsel to the Company, as experts on
such matters, and are included herein in reliance upon such review and approval.
Mr. Peter Dilworth, a partner of Dilworth & Barrese, owns less than 1.0% of the
Common Stock.

<PAGE>
<PAGE>
ADDITIONAL INFORMATION

The Company has filed with the Securities and Exchange Commission (the
'Commission'), Washington, D.C. 20549, a Registration Statement on Form S-1
under the Securities Act with respect to the shares of Common Stock offered
hereby. This Prospectus does not contain all the information set forth in the
Registration Statement and the exhibits and schedules thereto. For further
information with respect to the Company and the Common Stock offered hereby,
reference is made to the Registration Statement and to the exhibits and
schedules filed therewith. Statements contained in this Prospectus as to the
contents of any contract or other document referred to are not necessarily
complete, and in each instance reference is made to the copy of such contract or
other document filed as an exhibit to the Registration Statement, each such
statement being qualified in all respects by such reference. A copy of the
Registration Statement may be inspected without charge at the offices of the
Commission at 450 Fifth Street, N.W. Washington D.C. 20549, and copies of all or
any part of the Registration Statement may be obtained from the public Reference
Section of the Commission, Washington, D.C. 20549 upon the payment of the fees
prescribed by the Commission. The Commission also maintains a site on the World
Wide Web, the address of which is http://www.sec.gov, that contains reports,
proxy and information statements and other information regarding issuers, such
as the Company, that file reports electronically with the Commission.

<PAGE>
<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----

<S> <C>
Report of Independent Accountants.......................................................................... F-2
Balance Sheets as of December 31, 1994 and 1995 and June 30, 1996 (unaudited).............................. F-3
Statements of Operations for the years ended December 31, 1993, 1994 and 1995 and six months ended June 30,
1995 and 1996 (unaudited) and cumulative from inception to June 30, 1996 (unaudited)..................... F-4
Statements of Cash Flows for the years ended December 31, 1993, 1994 and 1995 and six months ended June 30,
1995 and 1996 (unaudited) and cumulative from inception to June 30, 1996 (unaudited)..................... F-5
Statements of Changes in Stockholders' Equity from date of inception (January 1, 1992) to December 31, 1995
and the six months ended June 30, 1996 (unaudited)....................................................... F-6
Notes to Financial Statements.............................................................................. F-7
</TABLE>

F-1

<PAGE>
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS

The Board of Directors and Stockholders
ALGOS PHARMACEUTICAL CORPORATION:

We have audited the accompanying balance sheets of Algos Pharmaceutical
Corporation (a development stage enterprise) as of December 31, 1995 and 1994,
and the related statements of operations, stockholders' equity and cash flows
for each of the three years in the period ended December 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Algos Pharmaceutical
Corporation as of December 31, 1995 and 1994 and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1995, in conformity with generally accepted accounting principles.

COOPERS & LYBRAND L.L.P.

Princeton, New Jersey
February 7, 1996,
except as to the fourth
paragraph of
Note 9, for
which the date is
May 21, 1996

F-2

<PAGE>
<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- JUNE 30,
1994 1995 1996
----------- ----------- -----------
(UNAUDITED)

<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents (Notes 2 and 3)....................... $ 5,633,971 $ 3,707,100 $ 2,504,603
Accounts receivable (Note 8).................................... -- -- 2,000,000
Prepaid expenses................................................ 16,533 11,057 17,629
----------- ----------- -----------
Total current assets....................................... 5,650,504 3,718,157 4,522,232
Property and equipment, net (Notes 2 and 4).......................... 113,986 100,704 82,506
Other assets......................................................... 916 1,591 298,531
----------- ----------- -----------
Total assets............................................... $ 5,765,406 $ 3,820,452 $ 4,903,269
----------- ----------- -----------
----------- ----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................ $ 55,926 $ 158,297 $ 550,326
Other current liabilities (Note 5).............................. 91,175 141,335 703,848
----------- ----------- -----------
Total current liabilities.................................. 147,101 299,632 1,254,174
----------- ----------- -----------
Commitments (Note 7) -- -- --
Stockholders' equity:
Preferred stock, $.01 par value: 10,000,000 shares authorized:
Convertible Series A; 872,000 shares authorized; 702,500,
702,500, and 707,500, respectively, issued and
outstanding; $10,537,500, $10,537,500, and $10,612,500,
respectively, aggregate liquidation preference........... 7,025 7,025 7,075
Convertible Series B; 100,000 shares authorized; 0, 0 and
100,000, respectively, issued and outstanding; $0, $0 and
$100,000, respectively, aggregate liquidation
preference............................................... -- -- 1,000
Common stock, $.01 par value; 50,000,000 shares authorized;
5,810,415, 6,010,030, and 6,171,876, respectively, issued and
outstanding................................................... 58,104 60,100 61,719
Additional paid-in-capital...................................... 7,318,936 7,341,890 9,434,961
Unearned compensation expense................................... -- -- (912,708)
Deficit accumulated during the development stage................ (1,765,760) (3,888,195) (4,942,952)
----------- ----------- -----------
Total stockholders' equity................................. 5,618,305 3,520,820 3,649,095
----------- ----------- -----------
Total liabilities and stockholders' equity................. $ 5,765,406 $ 3,820,452 $ 4,903,269
----------- ----------- -----------
----------- ----------- -----------
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-3

<PAGE>
<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
FOR THE YEARS ENDED FOR THE SIX MONTHS CUMULATIVE FROM
DECEMBER 31, ENDED JUNE 30, INCEPTION TO
------------------------------------- ------------------------- JUNE 30,
1993 1994 1995 1995 1996 1996
--------- ----------- ----------- ----------- ----------- ---------------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Revenues (Note 8).......... $ 214,584 $ -- $ -- $ -- $ 1,500,000 $ 1,811,000
--------- ----------- ----------- ----------- ----------- ---------------
Operating expenses:
Research and
development (Note
2).................. 40,000 653,714 1,614,943 800,784 1,003,585 3,437,242
General and
administrative
expenses............ 435,657 623,219 760,040 396,458 1,628,184 3,816,446
--------- ----------- ----------- ----------- ----------- ---------------
Total operating
expenses....... 475,657 1,276,933 2,374,983 1,197,242 2,631,769 7,253,688
--------- ----------- ----------- ----------- ----------- ---------------
Loss from operations....... (261,073) (1,276,933) (2,374,983) (1,197,242) (1,131,769) (5,442,688)
Interest income............ 4,433 153,247 252,548 138,673 77,012 499,736
--------- ----------- ----------- ----------- ----------- ---------------
Net loss................... $(256,640) $(1,123,686) $(2,122,435) $(1,058,569) $(1,054,757) $(4,942,952)
--------- ----------- ----------- ----------- ----------- ---------------
--------- ----------- ----------- ----------- ----------- ---------------
Pro forma (unaudited) (Note
2):
Net loss per common
share............... $(0.17) $(0.09)
------ ------
------ ------
Weighted average
number of common
shares
outstanding......... 12,199,217 12,328,907
---------- ----------
---------- ----------
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-4

<PAGE>
<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
1993 1994 1995
--------- ----------- -----------

<S> <C> <C> <C>
Cash flows from operating activities:
Net loss................................ $(256,640) $(1,123,686) $(2,122,435)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization...... 8,065 18,115 35,782
Amortization of unearned
compensation..................... -- -- --
Common stock issued for
technology....................... 25,000 -- --
Preferred stock issued for services
rendered......................... -- 25,000 --
Preferred stock issued under
license agreement................ -- -- --
Changes in assets and liabilities:
Accounts receivable........... -- -- --
Prepaid expenses.............. 3,737 (14,096) 5,476
Other assets.................. 1,237 600 (675)
Accounts payable.............. (7,038) 25,549 102,371
Other current liabilities..... (63,638) 76,590 50,160
--------- ----------- -----------
Net cash used in operating
activities.................. (289,277) (991,928) (1,929,321)
--------- ----------- -----------
Cash flows from investing activities:
Purchases of property and equipment..... (425) (106,757) (22,500)
--------- ----------- -----------
Net cash used in investing activities... (425) (106,757) (22,500)
--------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of preferred
stock, net of offering costs.......... -- 6,609,015 --
Proceeds from issuance of common stock
and capital contributions............. 125,000 50 24,950
Deferred financing costs................ -- -- --
--------- ----------- -----------
Net cash provided by financing
activities............................ 125,000 6,609,065 24,950
--------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents................................ (164,702) 5,510,380 (1,926,871)
Cash and cash equivalents, beginning of
period..................................... 288,293 123,591 5,633,971
--------- ----------- -----------
Cash and cash equivalents, end of period..... $ 123,591 $ 5,633,971 $ 3,707,100
--------- ----------- -----------
--------- ----------- -----------

<CAPTION>
CUMULATIVE
FOR THE SIX MONTHS ENDED FROM
JUNE 30, INCEPTION
-------------------------- TO JUNE 30,
1995 1996 1996
---- ---- ----
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss................................$ (1,058,569) $(1,054,757) $(4,942,952)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization...... 17,383 22,253 89,512
Amortization of unearned
compensation..................... -- 198,432 198,432
Common stock issued for
technology....................... -- -- 125,000
Preferred stock issued for services
rendered......................... -- -- 25,000
Preferred stock issued under
license agreement................ -- 915,000 915,000
Changes in assets and liabilities:
Accounts receivable........... -- (2,000,000) (2,000,000)
Prepaid expenses.............. (458) (6,572) (17,629)
Other assets.................. (675) -- (1,591)
Accounts payable.............. 70,686 149,029 307,326
Other current liabilities..... (1,175) 562,513 703,848
------------ ----------- -----------
Net cash used in operating
activities.................. (972,808) (1,214,102) (4,598,054)
------------ ----------- -----------
Cash flows from investing activities:
Purchases of property and equipment..... (8,772) (4,055) (172,018)
------------ ----------- -----------
Net cash used in investing activities... (8,772) (4,055) (172,018)
------------ ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of preferred
stock, net of offering costs.......... -- 50,000 6,659,015
Proceeds from issuance of common stock
and capital contributions............. 24,900 19,600 669,600
Deferred financing costs................ -- (53,940) (53,940)
------------ ----------- -----------
Net cash provided by financing
activities............................ 24,900 15,660 7,274,675
------------ ----------- -----------
Net increase (decrease) in cash and cash
equivalents................................ (956,680) (1,202,497) 2,504,603
Cash and cash equivalents, beginning of
period..................................... 5,633,971 3,707,100 --
------------ ----------- -----------
Cash and cash equivalents, end of period.....$ 4,677,291 $ 2,504,603 $ 2,504,603
------------ ----------- -----------
------------ ----------- -----------
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-5

<PAGE>
<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK
----------------- -------------------
SHARES AMOUNT SHARES AMOUNT
-------- ------ --------- -------

<S> <C> <C> <C> <C>
Balance, January 1, 1992 (Inception)
Issuance of common stock, January 1992, $.10 per
share........................................... -- $-- 4,841,664 $48,417
Issuance of common stock for technology, January
1992, $.10 per share............................ -- -- 968,336 9,683
Net loss.......................................... -- -- -- --
-------- ------ --------- -------
Balance, December 31, 1992........................ -- -- 5,810,000 58,100
Capital contributions, including $25,000 of
technology...................................... -- -- -- --
Net loss.......................................... -- -- -- --
-------- ------ --------- -------
Balance, December 31, 1993........................ -- -- 5,810,000 58,100
Issuance of preferred stock, May through August
1994, $10.00 per share, net of offering costs... 700,000 7,000 -- --
Issuance of preferred stock for services rendered,
May 1994, $10.00 per share...................... 2,500 25 -- --
Exercise of stock options......................... -- -- 415 4
Net loss.......................................... -- -- -- --
-------- ------ --------- -------
Balance, December 31, 1994........................ 702,500 7,025 5,810,415 58,104
Exercise of stock options......................... -- -- 199,615 1,996
Net loss.......................................... -- -- -- --
-------- ------ --------- -------
Balance, December 31, 1995........................ 702,500 7,025 6,010,030 60,100
Exercise of stock options (unaudited)............. -- -- 161,846 1,619
Exercise of preferred stock warrants
(unaudited)..................................... 5,000 50 -- --
Issuance of Series B preferred stock under license
agreement, June 1996, $9.15 per share
(unaudited)..................................... 100,000 1,000 -- --
Unearned compensation expense (unaudited)......... -- -- -- --
Amortization of unearned compensation expense
(unaudited)..................................... -- -- -- --
Net loss (unaudited).............................. -- -- -- --
-------- ------ --------- -------
Balance, June 30, 1996 (unaudited)................ 807,500 $8,075 6,171,876 $61,719
-------- ------ --------- -------
-------- ------ --------- -------

<CAPTION>
DEFICIT
ACCUMULATED
ADDITIONAL UNEARNED DURING THE TOTAL
PAID-IN COMPENSATION DEVELOPMENT STOCKHOLDERS'
CAPITAL EXPENSE STAGE EQUITY
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Balance, January 1, 1992 (Inception)
Issuance of common stock, January 1992, $.10 per
share...........................................$ 451,583 $ -- $ -- $ 500,000
Issuance of common stock for technology, January
1992, $.10 per share............................ 90,317 -- -- 100,000
Net loss.......................................... -- -- (385,434) (385,434)
------------ ------------ ------------ -------------
Balance, December 31, 1992........................ 541,900 -- (385,434) 214,566
Capital contributions, including $25,000 of
technology...................................... 150,000 -- -- 150,000
Net loss.......................................... -- -- (256,640) (256,640)
------------ ------------ ------------ -------------
Balance, December 31, 1993........................ 691,900 -- (642,074) 107,926
Issuance of preferred stock, May through August
1994, $10.00 per share, net of offering costs... 6,602,015 -- -- 6,609,015
Issuance of preferred stock for services rendered,
May 1994, $10.00 per share...................... 24,975 -- -- 25,000
Exercise of stock options......................... 46 -- -- 50
Net loss.......................................... -- -- (1,123,686) (1,123,686)
------------ ------------ ------------ -------------
Balance, December 31, 1994........................ 7,318,936 -- (1,765,760) 5,618,305
Exercise of stock options......................... 22,954 -- -- 24,950
Net loss.......................................... -- -- (2,122,435) (2,122,435)
------------ ------------ ------------ -------------
Balance, December 31, 1995........................ 7,341,890 -- (3,888,195) 3,520,820
Exercise of stock options (unaudited)............. 17,981 -- 19,600
Exercise of preferred stock warrants
(unaudited)..................................... 49,950 -- -- 50,000
Issuance of Series B preferred stock under license
agreement, June 1996, $9.15 per share
(unaudited)..................................... 914,000 -- -- 915,000
Unearned compensation expense (unaudited)......... 1,111,140 (1,111,140) -- --
Amortization of unearned compensation expense
(unaudited)..................................... -- 198,432 -- 198,432
Net loss (unaudited).............................. -- -- (1,054,757) (1,054,757)
------------ ------------ ------------ -------------
Balance, June 30, 1996 (unaudited)................$ 9,434,961 $ (912,708) $(4,942,952) $ 3,649,095
------------ ------------ ------------ -------------
------------ ------------ ------------ -------------
</TABLE>

The accompanying notes are an integral part of these financial statements.

F-6

<PAGE>
<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
(INFORMATION RELATING TO THE SIX MONTHS ENDED JUNE 30, 1995 AND JUNE 30, 1996
AND CUMULATIVE FROM THE DATE OF INCEPTION IS UNAUDITED)

NOTES TO FINANCIAL STATEMENTS

1. ORGANIZATION

Algos Pharmaceutical Corporation (the 'Company'), is engaged primarily in
the development of proprietary pain management pharmaceuticals.

Since its formation in January 1992, the Company has devoted a substantial
portion of its efforts to developing products, licensing technology, filing
regulatory applications and raising capital and has earned no significant
revenue from its planned principal operations.

The Company is subject to a number of risks common to companies in similar
stages of development including, but not limited to, the lack of assurance of
successful product development, the absence of manufacturing facilities, the
need to raise substantial additional funds and risk of technological
obsolescence.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.

DEVELOPMENT STAGE ENTERPRISE

The accompanying statements have been prepared in accordance with the
provisions of Statement of Financial Accounting Standard (SFAS) No. 7,
'Accounting and Reporting by Development Stage Enterprises.'

CASH AND CASH EQUIVALENTS

The Company considers securities with maturities of three months or less,
when purchased, to be cash equivalents.

PROPERTY AND EQUIPMENT, NET

Property and equipment are recorded at cost less accumulated depreciation.
Depreciation is provided on the straight-line method over the estimated useful
lives of the assets which range from three to seven years. Gains and losses on
depreciable assets retired or sold are recognized in the statement of operations
in the year of disposal. Repairs and maintenance expenditures are expensed as
incurred.

REVENUE

License fees are recognized as revenue when earned in accordance with the
terms of the underlying agreements.

F-7

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

RESEARCH AND DEVELOPMENT COSTS

Expenditures for research and development are expensed as incurred.

INCOME TAXES

The Company accounts for income taxes under the provisions of SFAS No. 109,
'Accounting for Income Taxes.' SFAS No. 109 requires recognition of deferred tax
assets and liabilities for the expected future tax consequences of temporary
differences between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect for the years in which the
differences are expected to reverse.

STOCK BASED COMPENSATION

In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, 'Accounting for Stock Based Compensation.' Beginning in 1996, SFAS No. 123
requires expanded disclosures of stock-based compensation arrangements with
employees and encourages, but does not require, the recognition of employee
compensation expense related to stock compensation based on the fair value of
the equity instrument granted. Companies that do not adopt the fair value
recognition provisions of SFAS No. 123 and continue to follow the existing APB
Opinion 25 rules to recognize and measure compensation, will be required to
disclose the pro forma amounts of net income and earnings per share that would
have been reported had the company elected to follow the fair value recognition
of SFAS No. 123. The Company has elected to adopt the disclosure requirements of
this pronouncement.

EARNINGS PER SHARE

Pro forma net loss per common share is based on the net loss and the
weighted average number of common shares after giving effect to the conversion
of all preferred stock as of January 1, 1995. Pursuant to Securities and
Exchange Commission Staff Accounting Bulletin No. 83, all common shares and
stock options and warrants granted by the Company during the twelve months prior
to the filing date of the Registration Statement have been included in the
calculation of weighted average common shares and common share equivalents
outstanding as if they were outstanding for all periods presented. Outstanding
stock options and warrants granted prior to this twelve-month period have not
been included in the calculation of historical net loss per common share because
inclusion of such shares would be antidilutive.

Historical net loss per common share is as follows:

<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED
FOR THE YEARS ENDED DECEMBER 31, JUNE 30,
----------------------------------- ----------------------
1993 1994 1995 1995 1996
--------- --------- --------- --------- ---------

<S> <C> <C> <C> <C> <C>
Net loss per common share........................ $(0.04) $(0.19) $(0.35) $(0.18) $(0.17)
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Weighted average common shares and common share
equivalents outstanding........................ 5,810,000 5,810,050 6,002,635 5,982,922 6,144,700
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>

Historical net loss per common share is based on the weighted average
number of common shares outstanding during the periods presented.

F-8

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

INTERIM FINANCIAL INFORMATION

The financial information presented as of June 30, 1996, and for the six
months ended June 30, 1995 and 1996 and the cumulative amounts from the date of
inception is unaudited but, in the opinion of management, reflects all
adjustments (which consist of normal accruals) necessary for a fair presentation
of such financial statements.

3. CONCENTRATION OF CREDIT RISK

Cash and cash equivalents consist primarily of shares of a money market
fund which invests primarily in securities of the United States government.

4. PROPERTY AND EQUIPMENT, NET

Property and equipment consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- JUNE 30,
1994 1995 1996
-------- -------- --------

<S> <C> <C> <C>
Office furniture................................................... $ 58,354 $ 61,119 $ 61,119
Computer equipment................................................. 56,370 73,453 77,508
Office equipment................................................... 24,617 26,447 26,447
Leasehold improvements............................................. 6,121 6,944 6,944
-------- -------- --------
145,462 167,963 172,018
Less accumulated depreciation...................................... 31,476 67,259 89,512
-------- -------- --------
$113,986 $100,704 $ 82,506
-------- -------- --------
-------- -------- --------
</TABLE>

5. OTHER CURRENT LIABILITIES

Other current liabilities consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------- JUNE 30,
1994 1995 1996
------- -------- --------
<S> <C> <C> <C>
Deferred revenue..................................................... $ -- $ -- $500,000
Accrued compensation................................................. 79,000 118,100 68,100
Accrued research expenses............................................ -- 23,235 135,748
Advances payable..................................................... 12,175 -- --
------- -------- --------
$91,175 $141,335 $703,848
------- -------- --------
------- -------- --------
</TABLE>

6. INCOME TAXES

Prior to March 1, 1994, the Company had elected to be treated as an S
Corporation for federal income tax reporting purposes. Under this election, the
Company's stockholders were responsible for reporting the Company's federal
taxable loss on their personal tax returns. In connection with the issuance of
Series A Preferred Stock, the Company's S status terminated and the corporation
converted to C Corporation status. The C Corporation assumed the tax bases of
the assets and liabilities of the S Corporation as of the termination date.
Accordingly, the Company records deferred taxes for the effect of cumulative
temporary differences in accordance with the provisions of SFAS No. 109,
'Accounting for Income Taxes' for federal tax purposes as of the termination
date. For state tax purposes, the Company has been treated as a C Corporation
since inception.

F-9

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

At December 31, 1995, the Company had available net operating loss
carryforwards and research and development credits for federal income tax
purposes of approximately $2,997,000 and $70,000, respectively, which expire in
the years 2009 through 2010. At June 30, 1996, the Company had available net
operating loss carryforwards of approximately $2,100,000. Due to the uncertainty
of their realization, no income tax benefits have been recorded by the Company
for these net operating loss or credit carryforwards as valuation allowances
have been established for any such benefits. The use of these net operating loss
and credit carryforwards may be subject to limitations under section 382 of the
Internal Revenue Code pertaining to changes in stock ownership.

The increase in the valuation allowance amounted to $406,100 and $906,300
in 1994 and 1995, respectively.

Deferred tax assets and (liabilities) for federal and state income taxes
consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1994 1995
--------- -----------
<S> <C> <C>
Net operating loss carryforwards............................................ $ 382,000 $ 1,236,800
Research and development tax credits........................................ 20,000 70,000
Depreciation and amortization............................................... 2,500 2,400
Accrued liabilities and other............................................... 1,600 3,200
--------- -----------
Total deferred tax assets.............................................. 406,100 1,312,400
Valuation allowance......................................................... (406,100) (1,312,400)
--------- -----------
Net deferred tax assets................................................ $ 0 $ 0
--------- -----------
--------- -----------
</TABLE>

7. COMMITMENTS AND CONTINGENT LIABILITIES

COLLABORATIVE RESEARCH AGREEMENTS

In 1994, the Company entered into collaborative research agreements with
three universities. Under the terms of the agreements, the universities agreed
to provide research exclusively to the Company in the field of pain management
in exchange for funding of the research by the Company. The Company was granted
rights to enter into exclusive, worldwide licenses to make, have made, use and
sell products under any patent application and patent rights resulting from the
research agreement and is required to pay royalties on sales of products
incorporating licensed technology.

The Company expensed $10,000, $182,000 and $118,000 in 1993, 1994 and 1995,
respectively, and $510,000 cumulatively from the date of inception, under these
agreements. Quarterly expenses are mutually agreed to by the Company and each
university.

In addition, the Company has entered into various research and consulting
agreements which are generally one year or less in duration.

LICENSING AGREEMENTS

The Company has a license agreement with a university for certain pain
management technology which requires the Company to pay royalties of 4% of sales
of licensed products and a share of royalties received from sublicensees. A
second license agreement requires annual maintenance fees of $10,000 in addition
to royalties based on sales.

F-10

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

EMPLOYMENT AGREEMENTS

The Company has employment agreements with certain officers and employees
which provide them with continued compensation for periods of six months to two
years in the event of their termination, without cause, by the Company. As of
December 31, 1995, the aggregate amount of the Company's minimum obligation
under these agreements is $751,000.

LEASES

In April 1992, the Company entered into a five year lease agreement for its
office facilities with minimum lease payments of approximately $1,900 per month.
This lease may be canceled by the Company upon four and one-half months notice
and payment of not more than $3,500. The Company is responsible for all
operating expenses associated with the facility. Rent expense amounted to
$11,000, $12,608 and $21,841 for the years ended December 31, 1993, 1994, and
1995, respectively, $11,240 in the six months ended June 30, 1996, and $64,939
cumulatively from the date of inception.

8. REVENUES

In June 1996, the Company entered into a license agreement with McNeil
Consumer Products Company, an affiliate of Johnson & Johnson, which provides
McNeil with exclusive worldwide marketing rights to certain of the Company's
products under development. The Company received an initial payment of
$2,000,000 in July 1996 and may receive additional payments based on the
achievement of certain milestones. McNeil will be responsible for substantially
all of the remaining development costs in excess of $500,000. In addition, the
Company will receive royalties based on sales of licensed products, if any. The
agreement may be terminated by McNeil after one year. The Company recorded
accounts receivable of $2,000,000, revenue of $1,500,000, and deferred revenue
of $500,000 in connection with the transaction.

Prior to 1994 the Company had an agreement to provide consulting services.
Revenues recognized under this agreement amounted to $214,584 in the year ended
December 31, 1993 which represented all of the Company's revenues. The Company
expensed $104,000 in 1993 which was paid to an executive of the Company for
services provided relating to this agreement. Revenues and expenses recognized
under this agreement, since inception were $311,000 and $214,500, respectively.
This agreement was not related to pain management technology and was assigned to
a new corporation in January 1994. The Company will not receive any additional
revenue related to this contract.

9. STOCKHOLDERS' EQUITY

The Company is authorized to issue shares of preferred stock with rights,
preferences and limitations determined by the Board of Directors of the Company,
872,500 of which have been designated Series A and 100,000 of which have been
designated Series B.

Shares of Series A Preferred Stock have preference to Common Stock in
liquidation and are convertible into shares of Common Stock and will
automatically convert upon the consummation of an initial public offering. The
Series A Preferred stockholders are entitled to receive dividends payable on
Common Stock based upon the number of shares of Common Stock into which a share
of Series A Preferred Stock is then convertible. In addition, the Series A
Preferred stockholders are entitled to vote as a class to elect one member of
the Board of Directors of the Company.

In June 1996, the Company issued 100,000 shares of convertible Series B
Preferred Stock in connection with an amendment to a license agreement with a
university and recorded an administrative

F-11

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

expense of $915,000. Shares of Series B Preferred Stock carry dividend rights
equal to shares of Series A Preferred Stock and are convertible into an equal
number of shares of Common Stock at any time on or after February 1, 1997.

On May 21, 1996, the Board of Directors authorized the filing of a
registration statement with the Securities and Exchange Commission for the sale
of Common Stock. If the offering pursuant to the registration statement is
consummated under the terms presently anticipated, all shares of the Series A
Preferred Stock will convert to Common Stock and the Preferred Stock warrants
will convert to Common Stock warrants. The Series A Preferred Stock and
Preferred Stock warrants will convert at a rate of 8.30 common shares for each
preferred share or underlying warrant. In addition, the Board of Directors
authorized a 8.30-for-1 split of all outstanding shares of Common Stock and
authorized an increase in the authorized number of common shares to 50,000,000.
Such split and increase in the authorized number of common shares shall be
consummated upon the effective date of the registration statement. In addition,
upon the closing of the initial public offering, the total number of shares of
preferred stock authorized will be 10,000,000 par value $.01. All references to
common stock, options and per share data have been restated to give effect to
this split.

The Company maintains stock options plans under which options to purchase
shares of common stock have been granted to directors and employees which vest
over periods of up to four years.

Information with respect to options under the plans is as follows:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------
AVAILABLE PRICE
FOR GRANT SHARES PER SHARE
--------- -------- ------------

<S> <C> <C> <C>
Balance, December 31, 1993..................................... -- -- $ --

Authorized..................................................... 834,150 -- --
Granted........................................................ (772,730) 772,730 .12 - .13
Exercised...................................................... -- (415) .12
--------- --------
Balance, December 31, 1994..................................... 61,420 772,315 .12 - .13

Authorized..................................................... 41,500 -- --
Granted........................................................ (24,900) 24,900 .12
Exercised...................................................... -- (199,615) .12 - .13
--------- --------
Balance, December 31, 1995..................................... 78,020 597,600 .12 - .13

Authorized..................................................... 498,000 -- --
Granted........................................................ (243,190) 243,190 .12 - .13
Exercised...................................................... -- (161,850) .12
--------- --------
Balance, June 30, 1996......................................... 332,830 678,940 .12 - .13
--------- --------
--------- --------
</TABLE>

As of December 31, 1995, 217,460 options were exercisable at prices ranging
from $0.12 to $0.13 per share. In connection with certain option grants made in
March and April 1996, the Company has recorded unearned compensation expense
amounting to $1,111,140, which will be amortized over the vesting period.
Options to purchase 24,900 shares are exercisable immediately, the remainder
vest over a four year period.

In connection with the sale of Series A Preferred Stock, certain selling
agents received warrants to purchase an aggregate of 40,750 shares of Series A
Preferred Stock at an exercise price of $10.00 per share which expire on the
earlier of 2004 or five years after an initial public offering of stock by the
Company. Warrants to purchase 5,000 shares were exercised in May 1996.

F-12

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

10. RELATED PARTY TRANSACTION

A director of the Company has been associated with law firms that rendered
various legal services to the Company. The Company paid approximately $3,000,
$95,000 and $16,000 in 1993, 1994 and 1995, respectively, and $22,000 for the
six months ended June 30, 1996, and $165,000 cumulatively from the date of
inception, for these services.

A second director of the Company, appointed in July 1996, is associated
with a law firm which performs legal services for the Company from time to time.
The Company paid approximately $0, $68,000 and $0 in 1993, 1994 and 1995,
respectively, and $68,000 cumulatively from the date of inception for these
services and has accrued approximately $217,000 for services rendered in the six
months ended June 30, 1996, primarily related to the initial public offering.

11. SUBSEQUENT EVENTS (UNAUDITED)

In August 1996, the Company contributed certain intangible assets having no
book value to PharmaDyn, Inc. ('PharmaDyn'), a newly formed company, and
received preferred stock with an aggregate stated value and liquidation
preference of $2,800,000 and all of PharmaDyn's common stock. The common stock
was subsequently distributed to the Company's stockholders, warrant holders and
certain of its employees. The preferred stock provides for an annual cumulative
dividend of 30% which may be paid in the form of cash or PharmaDyn common stock
and a share of other earnings. The preferred stock may be redeemed at any time
for par plus accrued dividends at PharmaDyn's option and at the Company's option
at the end of two years. The Company recorded no gain in connection with the
transactions as management believes that at the present time realization of the
redemption value is not assured.

In September 1996, the Company granted to a consultant options to purchase
30,000 shares at an exercise price equal to the public offering price. The
options vest over a five-year period.

F-13

<PAGE>
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]

<PAGE>
<PAGE>
____________________________________ ___________________________________

NO DEALER, SALES REPRESENTATIVE OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE
ANY INFORMATION OR MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING,
OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR BY ANY OF THE UNDERWRITERS. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY ANY SECURITIES
OTHER THAN THE SHARES OF COMMON STOCK TO WHICH IT RELATES OR AN OFFER TO, OR A
SOLICITATION OF, ANY PERSON IN ANY JURISDICTION IN WHICH SUCH AN OFFER OR
SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT
THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY OR THAT THE INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.

------------------------
TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----

<S> <C>
Prospectus Summary..................................................................................................... 3
Risk Factors........................................................................................................... 6
Use of Proceeds........................................................................................................ 12
Dividend Policy........................................................................................................ 12
Capitalization......................................................................................................... 13
Dilution............................................................................................................... 14
Selected Financial Information......................................................................................... 15
Management's Discussion and Analysis of Financial Condition and Results of Operations.................................. 16
Business............................................................................................................... 19
Management and Key Scientific Advisors................................................................................. 33
Principal Stockholders................................................................................................. 40
Certain Relationships and Related Transactions......................................................................... 41
Description of Capital Stock........................................................................................... 42
Shares Eligible for Future Sale........................................................................................ 44
Certain United States Federal Tax Considerations for Non-United States Holders......................................... 45
Underwriting........................................................................................................... 48
Legal Matters.......................................................................................................... 49
Experts................................................................................................................ 49
Additional Information................................................................................................. 50
Index to Financial Statements.......................................................................................... F-1
</TABLE>

------------------------
UNTIL OCTOBER 20, 1996 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK OFFERED HEREBY, WHETHER OR
NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS REQUIREMENT IS IN ADDITION TO THE OBLIGATIONS OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.

3,500,000 SHARES

[LOGO]

ALGOS
PHARMACEUTICAL
CORPORATION

COMMON STOCK

--------------------------
PROSPECTUS
SEPTEMBER 25, 1996
--------------------------

LEHMAN BROTHERS
COWEN & COMPANY

____________________________________ ___________________________________

STATEMENT OF DIFFERENCES
------------------------

The trademark symbol shall be expressed as 'tm'
The registered trademark symbol shall be expressed as 'r'
The dagger symbol shall be expressed as `D'