ALGOS PHARMACEUTICAL CORP, 10-K, 2000-03-30

ALGOS PHARMACEUTICAL CORP
10-K, 2000-03-30
PHARMACEUTICAL PREPARATIONS

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________________________________________________________________________________

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-K

[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM ___________ TO ___________
COMMISSION FILE NO. 000 - 28844

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ALGOS PHARMACEUTICAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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<S> <C>
DELAWARE 22-3142274
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)

1333 CAMPUS PARKWAY
NEPTUNE, NJ 07753-6815
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (732) 938-5959

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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $0.01 par value

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $260 million, based on the last sales price of the
Common Stock as of March 1, 2000.

As of March 1, 2000, 17,421,345 shares of Common Stock, $0.01 par value, of
the registrant were issued and outstanding.

________________________________________________________________________________

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PART I

ITEM 1. BUSINESS

COMPANY OVERVIEW

Algos Pharmaceutical Corporation (the 'Company') is a leader in developing
proprietary pain management products. The Company's products combine existing
analgesics and anesthetics with an N-methyl-D-aspartate (NMDA)-receptor
antagonist drug, dextromethorphan, that has already been approved for human
use in other applications. Independent research and Algos' pre-clinical
studies and clinical trials conducted to date have shown that these products
may provide significantly superior pain relief compared to currently available
analgesics and anesthetics, including opioid drugs such as morphine,
hydrocodone, and oxycodone and anesthetic drugs such as lidocaine. Algos is
using its NMDA-receptor antagonist technology to develop other products
including an intranasal treatment for migraine and addiction treatment products.

The Company's lead product, MorphiDex'r', is a combination of morphine and
dextromethorphan with a proposed indication of moderate to severe cancer pain.
The United States market for moderate to severe pain products reached $2.2
billion in 1999. MorphiDex'TM' will compete in the strong opioid segment of this
market, which approached $1.2 billion in sales in the U.S. in 1999.

Algos filed a New Drug Application (NDA) with the United States Food and
Drug Administration (FDA) for its lead product, MorphiDex'r', in August 1998
and, in August 1999, received a not approvable letter from the FDA. FDA approval
of the NDA is required for Algos to sell MorphiDex'r' in the United States. Not
approvable letters are issued by the FDA for various reasons and outline
deficiencies that must be corrected prior to approval. Algos has initiated an
additional clinical trial as part of its plan to address the issues raised in
the letter.

In addition to MorphiDex'r', Algos or its development partners have a number
of other products in the pipeline which include:

opioid analgesic/NMDA-receptor antagonist combination products:
(1) HydrocoDex'TM', expected to be used primarily to treat moderate to
moderately severe post-operative pain, trauma pain, and chronic pain
conditions and (2) OxycoDex'TM', expected to be used primarily to treat
moderate to moderately severe pain, to be developed in collaboration with
Endo Pharmaceuticals Holdings Inc.;

an oral neuropathic pain product consisting of an NMDA-receptor antagonist
in combination with a potentially synergistic drug;

anesthetic/NMDA-receptor antagonist combination products: (1) LidoDex
NS'TM', an intranasal formulation of lidocaine and an NMDA-receptor
antagonist for the treatment of migraine headaches, to be developed in
collaboration with Interneuron Pharmaceuticals, Inc. and (2) LidoDex
IED'TM', an injectible local anesthetic/NMDA-receptor antagonist
combination product intended to provide fast onset and extended duration of
effect for use in in-patient and out-patient surgeries;

non-opioid analgesic/NMDA-receptor antagonist combination products licensed
to McNeil Consumer Products Company and expected to be used primarily to
treat mild pain: (1) a combination product consisting of an NMDA-receptor
antagonist and acetaminophen and (2) a combination product consisting of an
NMDA-receptor antagonist and an over-the-counter non-steroidal
anti-inflammatory drug, i.e., an NSAID; and

addiction treatment products including treatments for: (1) opiate
addiction, which Algos is developing in collaboration with the National
Institute on Drug Abuse (NIDA) of the National Institutes of Health (NIH)
and (2) nicotine addiction.

Algos is evaluating other applications of its proprietary NMDA-receptor
antagonist technology and may choose to advance such additional products to
clinical development. In addition, Algos may develop other platform technologies
for the management of pain. Algos' drug development program is based upon a
continuous review of clinical results, newly published scientific papers, the
possibility of joint development or research arrangements with research
institutes or commercial organizations, the

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availability of resources, including acceptable third party clinical facilities,
and available funds. Furthermore, based on clinical results, marketing studies
or other factors, Algos may elect to delay, modify, or suspend the development
of any of its products in development.

Algos intends to be a leader in developing pain management products by:

introducing superior proprietary products;

minimizing development time, cost and risk;

leveraging its proprietary technology across multiple product
opportunities;

outsourcing manufacturing and certain research and development functions to
efficiently deploy resources; and

maximizing market penetration and margin potential through a combination of
Algos direct sales and strategic alliances.

Algos believes that the markets in which it intends to compete offer
attractive opportunities. Favorable factors in the target analgesic and
anesthetic markets include:

high growth rates partially attributable to an increase in pain due to the
aging of the population;

heightened physician awareness of the benefits of effective pain treatment
including reductions in healing and recovery time;

the potential for rapid acceptance of new pain management pharmaceuticals
by members of the medical profession;

generally concentrated distribution channels that permit more
cost-effective selling and marketing; and

the potential for higher profit margins from branded proprietary products.

Algos believes that its analgesic and anesthetic products can be developed
cost effectively because:

the products combine existing drugs with extensive clinical safety
profiles; and

clinical trials for new analgesics and anesthetics are less costly and
quicker to conduct than clinical trials for many other pharmaceutical
product categories.

In the United States as of March 1, 2000, Algos owns or is exclusively
licensed under thirteen issued patents, two patent applications which have
received a notice of allowance and six pending patent applications. This patent
estate covers method and composition for NMDA-enhanced analgesics and
anesthetics. In addition, several foreign patent applications are pending.

On November 26, 1999, Algos entered into a definitive merger agreement
pursuant to which Algos will merge with a subsidiary of Endo Pharmaceuticals
Holdings Inc. in a tax-free transaction. In the transaction, Algos stockholders
will receive common stock of Endo and warrants to purchase additional shares of
common stock of Endo for nominal consideration. The warrants will become
exercisable only if the U.S. Food and Drug Administration approves Algos' New
Drug Application for MorphiDex'r' by December 31, 2002. The agreement places
restrictions on Algos' ability to enter into certain transactions, including
incurring debt, issuing additional shares of stock, paying dividends,
disposing of assets and entering into certain significant agreements. The
transaction is subject to the approval of Algos shareholders, regulatory
approvals and certain other conditions and is expected to be completed in the
second quarter of 2000. Algos stockholders should read the additional
information regarding the merger contained in Algos' preliminary proxy
statement filed with the Securities and Exchange Commission pursuant to
Section 14(a) of the Securities Exchange Act of 1934, as amended.

Algos was incorporated in Delaware in 1992. Its executive offices are
located at 1333 Campus Parkway, Neptune, New Jersey 07753-6815, and its
telephone number is (732) 938-5959.

This Annual Report on Form 10-K contains 'forward-looking' statements,
within the meaning of Section 27A of Securities Act of 1993, as amended, and
Section 21E of the Securities Exchange Act of 1934 that are based on
management's beliefs and assumptions, current expectations, estimates and
projections. Statements that are not historical facts, including statements that
are preceded by, followed

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by, or that include the words 'believes;' 'anticipates;' 'plans;' 'expects;'
'estimates;' or similar expressions and statements about Algos are
forward-looking statements. Many of the factors that will determine Algos'
future results are beyond the ability of Algos to control or predict. These
statements are subject to risks and uncertainties and, therefore, actual
results may differ materially. The reader should not rely on any
forward-looking statement. Algos undertakes no obligations to update any
forward-looking statements whether as a result of new information, future events
or otherwise. Important factors that may affect future results include, but are
not limited to: uncertainty associated with pre-clinical studies and clinical
trials and regulatory approval; uncertainty of market acceptance of new
products; impact of competitive products and pricing; product development;
changes in laws and regulations; customer demand; possible future litigation;
the availability of future financing and reimbursement policies of government
and private health insurers and others. Readers should evaluate any statements
in light of these important factors. See 'Risk Factors'.

CLINICAL DEVELOPMENT PROGRAMS

OPIOID ANALGESIC/NMDA-RECEPTOR ANTAGONIST PRODUCTS

Opioid analgesic drugs remain the most common 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).

Drawbacks to these drugs include unwanted side effects such as mental
clouding, respiratory depression, nausea and constipation and the development of
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, potentially increasing
unwanted side effects and the likelihood of drug dependence.

Clinical studies of Algos' opioid analgesic/NMDA-receptor antagonist
combination products indicate that these products may provide superior pain
relief as compared to equivalent dosage levels of the opioid analgesic alone, a
faster onset of meaningful pain relief and a longer duration of effect.
Preclinical studies also indicated efficacy of Algos' opioid
analgesic/NMDA-receptor antagonist combinations with repeated administrations
over time, when the opioid analgesic administered alone became less effective.

MorphiDex'r'

Morphine is an opiate used to treat moderate to severe pain, primarily
cancer pain. MorphiDex'r', Algos' lead product, is a combination of morphine
and dextromethorphan.

In August 1998, Algos filed an NDA with the FDA with a proposed indication
for the relief of moderate to severe cancer pain. The NDA consisted of data
from:

Safety, abuse liability, and pharmacokinetic/bioavailability studies;

Single-dose Phase II placebo-controlled efficacy studies;

Three multi-center Phase III studies to assess the clinical acceptability
and long-term safety of MorphiDex'r' in cancer and other chronic pain
patients.

On August 2, 1999, Algos received a not approvable letter from the FDA for
its NDA. FDA approval of the NDA is required for Algos to sell MorphiDex'r' in
the United States. Not approvable letters are issued by the FDA for various
reasons and outline deficiencies that must be corrected prior to approval. In
its letter to Algos, the FDA raised issues specifically related to the adequacy
of clinical trials, Algos' preclinical animal neurotoxicology models and a
high-dose pharmacokinetic study.

On December 13, 1999, Algos met with the FDA to the NDA for MorphiDex'r'.
Discussion at the meeting focused on efficacy and safety issues raised in the
FDA's not approvable letter. At the meeting, Algos resolved a number of issues
and intends to submit a plan to the FDA to address the remaining issues. The
plan will include the submission of data from an additional large single-dose
post-operative pain clinical trial that has already been initiated. However, no
assurance can be given as to whether or if

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MorphiDex'r' will be approved by the FDA or if additional studies will be
required. If the FDA requires Algos to perform further clinical work, the
potential approval of MorphiDex'r' could be substantially delayed.

HydrocoDex'TM'

Hydrocodone is an opiate derivative primarily used to treat moderate to
moderately severe post-operative, musculoskeletal, trauma-related and chronic
pain. The analgesic products containing hydrocodone that are sold commercially
in the U.S. are combination products containing non-narcotic analgesics. Current
hydrocodone products include Lorcet'r' and Vicodin'r'. HydrocoDex'TM' is a
hydrocodone, APAP and dextromethorphan combination product.

Algos has conducted single-dose Phase II clinical studies of HydrocoDex'TM'
as well as bioavailability and safety studies. Algos expects to complete
additional clinical studies in 2000.

OxycoDex'TM'

Oxycodone is an opiate derivative that forms the basis for a group of
products that are used for the treatment of moderate to moderately severe pain.
Current oxycodone products include Oxycontin'r', Percocet'r', Percodan'r' and
Tylox'r'. OxycoDex'TM' is a combination of oxycodone and dextromethorphan. In
1999, Endo Pharmaceuticals Inc., the marketer of Percocet'r' and Perocodan'r',
and Algos entered into a collaboration agreement, under which Endo and Algos
will work together exclusively to develop, manufacture and commercialize pain
management products containing oxycodone and dextromethorphan. Algos and Endo
plan to initiate Phase II clinical trials of OxycoDex'TM' in 2000.

NON-OPIOID ANALGESIC/NMDA-RECEPTOR ANTAGONIST PRODUCTS

Treatment for Neuropathic Pain

Independent studies suggest that both NMDA-receptor antagonists and certain
anticonvulsants may be useful in the treatment of neuropathic pain, persistent
pain resulting from certain abnormalities of the nervous system.

Algos is currently compiling the results of a Phase II clinical study to
evaluate the effect of a combination of an NMDA-receptor antagonist and an
existing anticonvulsant in patients with chronic neurophathic pain following
spinal cord injury.

Treatments for Mild Pain

In June 1996, Algos entered into a license agreement (the 'McNeil License
Agreement') with McNeil Consumer Products Company, an affiliate of Johnson &
Johnson, pursuant to which Algos granted McNeil the exclusive rights to
develop certain acetaminophen/NMDA antagonist combination products and certain
NSAID/NMDA-receptor antagonist combination products (ibuprofen and certain
other NSAIDs approved for OTC use) for the treatment of pain. Under the terms
of the McNeil License Agreement, McNeil is required to perform certain clinical
development activities to retain the license and to make payments to Algos
based on the achievement of certain milestones. An acetaminophen/NMDA-receptor
antagonist combination product and an NSAID/NMDA-receptor antagonist
combination product are currently under development by McNeil. McNeil may
terminate the license at its option upon 60 days notice.

ANESTHETIC/NMDA-RECEPTOR ANTAGONIST PRODUCTS

LidoDex NS'TM'

A project has been initiated with Interneuron Pharmaceuticals, Inc. to
develop LidoDex NS'TM', a combination of lidocaine and an NMDA-receptor
antagonist for the treatment of migraine headaches. This agreement has three
stages: (i) initial development which encompasses Investigational New Drug

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Application (IND) preparation, a Phase I safety study and a Phase II efficacy
study; (ii) Phase III clinicals; and (iii) marketing activities. Initial
development will be largely funded by Interneuron, while costs of Phase III
clinicals will be shared equally between Algos and Interneuron. An article in
the Journal of the American Medical Association concluded that intranasal
lidocaine provided rapid headache relief in more than half of the patients in
the cited study, but relapse was common. Algos is investigating whether LidoDex
NS'TM' may have a prolonged effect.

Interneuron performed preclinical toxicological studies in support of an
Investigational New Drug Application (IND) which Algos expects to file subject
to successful completion of additional preclinical studies.

Injectable Anesthetic

Algos, in collaboration with Brigham and Women's Hospital, Harvard
Medical School, conducted research into the potentiation of local injectable
anesthetics by NMDA-receptor antagonists. Pre-clinical studies indicated that
the NMDA-receptor 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, Algos believes that a
longer duration anesthetic may provide greater patient comfort when
post-surgical pain is most severe and could reduce the need for administering
certain analgesics for post-operative pain.

ADDICTION TREATMENT DRUGS

Opiate Addiction Treatment

NIDA estimates that there are two million opiate addicts in the United
States. Algos is developing NMDA-receptor antagonist-based products as
opiate addiction treatment drugs. Pre-clinical studies have indicated that the
use of NMDA-receptor antagonists may provide more effective control of opiate
cravings and dependence.

In 1997, Algos entered into a Cooperative Research and Development
Agreement with the NIDA, NIH to evaluate Algos' technology for the
treatment of heroin addiction. Under the terms of the agreement, NIDA will fund
certain clinical studies to assess a product's ability to reduce addict relapse
following detoxification on methadone, the current maintenance therapy for
heroin addiction. The studies, the first of which was completed in 1998, will
measure safety, withdrawal intensity, cross-tolerance and relapse.

Nicotine Addiction

Laboratory research and preclinical studies suggest that NMDA-receptor
antagonists may be useful in the treatment of addiction to other substances. The
Company is evaluating the results of a 1999 Phase II clinical study of the
effect of an NMDA-receptor antagonist on nicotine addiction.

OTHER PRODUCTS

Urge Urinary Incontinence

An estimated five million people in the U.S. suffer from urge urinary
incontinence. Existing urge urinary incontinence drugs generally have unpleasant
side effects and low levels of efficacy. Algos-sponsored pre-clinical studies
have indicated that NMDA-receptor antagonists may block the bladder micturition
reflex. A Phase II clinical trial at the Stanford University School of Medicine
evaluating an NMDA-receptor antagonist in urge incontinent patients has been
completed and additional studies may be initiated, subject to the availability
of Algos' clinical development resources.

New Product Development, Generally

Algos is considering a number of other possible products. The Company's
drug development program is based upon a continuous review of clinical results,
newly published scientific

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papers, the possibility of joint development or research arrangements with
research institutions or commercial organizations, the availability of
resources, including acceptable third party clinical facilities and available
funds. Accordingly, the Company's development program is subject to revision and
change at any time without notice. The preceding discussion with respect to the
Company's plans is a description of the Company's present intentions as of the
date of this report, and the Company does not expect to update this schedule
prior to its next annual report, although it may choose to do so. Its product
development schedule and plans for drug development constitute forward-looking
statements and are subject to the numerous contingencies and risks set forth
under 'Risk Factors.'

SCIENTIFIC OVERVIEW

Opioids activate mu receptors triggering an intracellular defense mechanism
from N-methyl-D-aspartate (NMDA) receptors in the brain and spinal cord.
Sensitized NMDA receptors overactivate protein kinase C (PKC) which desensitizes
the mu receptors resulting in reduced analgesia. The introduction of
dextromethorphan, a noncompetitive NMDA-receptor antagonist, inhibits the
activation of PKC. Combining an opioid analgesic with dextromethorphan in an
optimal ratio prevents the desensitization of the mu receptor, thereby
increasing the analgesic effect.

CORPORATE AND GOVERNMENT COLLABORATIONS

On November 26, 1999, Endo Pharmaceuticals and Algos entered into a
collaboration agreement, under which Endo Pharmaceuticals and Algos will
work together exclusively to develop, manufacture and commercialize pain
management products containing the combination of oxycodone and dextromethorphan
molecules. Under this collaboration agreement, each party granted to the other
party a sole and exclusive worldwide license to its respective know-how, patent
rights and trademark rights used in connection with the collaboration. Endo
Pharmaceuticals and Algos will share equally the costs associated with, and
profits generated by, the collaboration, after adjustments with respect to
reduced sales of Endo products resulting from sales of products that the parties
developed under the collaboration agreement. The collaboration agreement will
continue in effect until the parties to the agreement mutually agree in writing
to terminate the agreement or the patent rights licensed under the collaboration
agreement expire.

In June 1996, Algos entered into a license agreement (the McNeil
License Agreement) with McNeil Consumer Products Company, an affiliate of
Johnson & Johnson, pursuant to which Algos granted McNeil the exclusive
rights to develop certain acetaminophen/NMDA-receptor antagonist combination
products and certain NSAID/NMDA-receptor antagonist combination products
(ibuprofen and certain other NSAIDs approved for OTC use) for the treatment of
pain. The McNeil License Agreement resulted in an initial payment of $2.0
million by McNeil to Algos in 1996, a milestone payment of $1.0 million in
1997 based upon the entry into a large-scale clinical trial of a licensed
product containing acetaminophen, and provides for additional payments of up to
$7.0 million by McNeil upon the achievement of certain milestones, generally
relating to product development and patent issuances. In addition, Algos
will be entitled to receive royalty payments from McNeil based upon net product
sales subject to 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.
McNeil will bear substantially all costs of developing products it selects. The
McNeil License Agreement extends until the later of the expiration of Algos'
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 upon 60 days notice; 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 Algos.
In such event, Algos retains the rights to the results of two clinical studies
funded by Algos and McNeil retains the rights to the results of the clinical

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studies funded by McNeil during the term of the McNeil License Agreement. See
'Business -- Patents, Trade Secrets and Licenses -- Licenses.'

In 1996, Algos entered into a development and marketing collaboration
and license agreement with Interneuron Pharmaceuticals, Inc. (Interneuron) for
the development and commercialization of a product to treat acute migraine
headache. The agreement grants to Interneuron rights, co-exclusive with Algos,
to use Algos patents and know-how to manufacture and market the product. In the
initial stage of development, Algos will supply formulation development in
support of the IND and Interneuron will perform toxicology, Phase I safety and
Phase I/II safety and efficacy studies. Thereafter, the companies will generally
share equally the remaining development costs, including clinical trials,
regulatory activities, and manufacturing scale-up, and similarly share in
marketing and profits of the resulting product, if any. After the initial stage
of development, the agreement may be terminated by either company with the
terminating party retaining an interest in a resulting product, either in the
form of a royalty on sales or the repayment of certain of its development costs.

In 1997, Algos entered into a Cooperative Research and Development
Agreement with NIDA, NIH, to conduct joint research on a methadone/NMDA-receptor
antagonist combination drug as a potential treatment for opiate addiction. Under
the agreement, NIDA and the Company will jointly develop research protocols for
up to five clinical studies designed primarily to test dextromethorphan for
safety, tolerability and efficacy when co-administered with methadone. NIDA will
conduct the clinical studies and provide certain statistical and analytic
services. Algos will provide NIDA with drug supplies and scientific and
administrative support. The agreement provides for joint ownership of inventions
made jointly by NIDA and Algos and provides Algos with an option to license
any patent rights developed by NIDA. The agreement may be terminated by either
party at any time upon 30 days notice.

In 1999, Algos granted a paid-up license under three of its patents to
Cambridge NeuroScience, Inc. to develop products discovered by or on behalf of
Cambridge NeuroScience for the treatment of pain. In exchange, Algos received
the right to negotiate to develop and/or commercialize these products.

ACADEMIC AND RESEARCH COLLABORATIONS

THE MEDICAL COLLEGE OF VIRGINIA

In 1994, Algos 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 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.

BETH ISRAEL HEALTH CARE SYSTEM

Algos has entered into agreements with Beth Israel Health Care System.
Under the terms of the agreements, the Company will provide a total of $750,000
over a five-year period to fund certain costs of clinical trials in pain
medicine and palliative care of which $300,000 had been paid through
December 31, 1999. The Company may contract with Beth Israel Health Care System
for the conduct of trials under the direction of Dr. Russell Portenoy which
would be separately funded. Beth Israel has agreed to give priority to the
scheduling of clinical studies requested by Algos. The Company can terminate the
agreement at any time upon providing continued funding for a period of six
months.

TECHNICAL DEVELOPMENT AND PRODUCTION

Algos generally seeks to contract third parties for formulation
development, manufacture of clinical trial materials and scale-up work. Algos
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

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

MARKETING

Algos plans to market its products either directly or through co-promotion
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 key prescribing
physicians, pain management centers, hospitals, hospices, health maintenance
organizations and pharmaceutical buying groups. Algos does not expect to
establish a direct sales capability until such time as one or more of its
products in development approaches marketing approval from the FDA. Although
Algos believes that it will be able to recruit an effective marketing and sales
force at that time, no assurance can be given that it will be able to do so. 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 under 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. No assurance can be given that any of the Company's
products will gain significant market acceptance.

COMPETITION

Algos' 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.

Algos 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 markets in which Algos' products are expected to compete have
grown rapidly in the last five years. In addition, there have been numerous
potentially competitive products introduced and development programs initiated.
As a result, competition within these markets may become more costly and
complex. The Company's opioid analgesic and anesthetic products, when developed
and marketed, will primarily compete with products currently marketed by a small
number of 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 world. 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

Algos 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 and their uses. Algos plans to prosecute
and defend its patent applications, issued patents and proprietary information.
Algos' ability to compete effectively will depend in part on its ability
to develop and maintain proprietary aspects of its planned products. As of March
1, 2000 the Company owns or is

<PAGE>
exclusively licensed under thirteen U.S. patents, two pending U.S. patent
applications for which it has received a notice of allowance and six other
pending U.S. patent applications and several corresponding pending foreign
patent applications.

Of the issued U.S. patents, nine are licensed from The Medical College of
Virginia and four are owned by Algos. The patents, issued between 1994 and
1999, cover methods and compositions for the Company's NMDA technology to treat
pain and to inhibit tolerance to and dependence on addictive analgesic
substances.

Reflecting Algos' 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-receptor antagonists for the management of
acute, chronic, pre-operative and post-operative pain states, (ii) the use of
NMDA-receptor antagonists for the potentiation of local anesthesia and
(iii) the use of NMDA-receptor antagonists for reducing the frequency of
nicotine consumption, for treating migraine and for treating other conditions
such as urge urinary incontinence.

Algos 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.

Algos 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 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.

Algos' 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. 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. 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. Other
entities may obtain patents which cover aspects of the

<PAGE>
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. See 'Risk
Factors -- Uncertain Ability to Protect Proprietary Technology.'

LICENSES

Algos has licensed from The Medical College of Virginia 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). The Company is obligated to
pay royalties for the life of the patent equal to 4% of net sales of licensed
products. If a product is combined with a drug or other substance for which the
Company is to pay 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 Company pays no
license signing fees or milestone payments. The McNeil License Agreement is a
sublicense agreement of the Company's license agreement with The Medical College
of Virginia.

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 Algos' combination of dextromethorphan
with analgesics such as morphine, and local anesthetics such as lidocaine as
new drugs and require the filing of an NDA and approval by the FDA. However,
since the components have been separately approved by the FDA, management
believes that the risks associated with the development of these new proprietary
combinations 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 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, and 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 becomes 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, absorption, 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

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

EMPLOYEES

At March 1, 2000, Algos had 33 employees. In addition, the Company engages
consultants from time to time to perform services on a per diem or hourly basis.

ITEM 2. PROPERTIES

Algos' executive offices are currently located at 1333 Campus Parkway,
Neptune, New Jersey 07753. The leased property consists of approximately
21,000 square feet of office space.

ITEM 3. LEGAL PROCEEDINGS

There are no legal proceedings pending against Algos.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

<PAGE>
PART II

ITEM 5. MARKET PRICE

As of March 1, 2000, Algos had approximately 105 shareholders of record
and believes that the number of beneficial holders exceeds 2,000. Common
stock of the Company is traded on the NASDAQ Stock Market under the symbol
'ALGO.' The following table sets forth the range of the highest and lowest
reported sales prices for Algos' common stock in 1998 and 1999:

<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
Year Ended December 31, 1998:
First Quarter........................................... 34 26 1/2
Second Quarter.......................................... 39 1/2 23 3/4
Third Quarter........................................... 36 19 9/16
Fourth Quarter.......................................... 29 3/4 18 1/2
Year Ended December 31, 1999:
First Quarter........................................... 33 5/8 24 3/8
Second Quarter.......................................... 30 1/8 19 7/8
Third Quarter........................................... 28 3/4 7 5/8
Fourth Quarter.......................................... 18 8 1/4
</TABLE>

Algos has never declared or paid any cash dividends on its capital stock.

ITEM 6. SELECTED FINANCIAL DATA

The selected financial information set forth below should be read in
conjunction with 'Management's Discussion and Analysis of Financial Condition
and Results of Operations' and with Algos' financial statements and related
notes contained elsewhere in this report.

<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues.................................. $ -- $ 2,000 $ 1,000 $ -- $ --
Operating expenses:
Research and development.............. 1,615 3,344 9,799 13,086 9,508
Selling, general and administrative... 760 2,466 2,459 4,813 10,286
------- ------- ------- -------- --------
Total operating expenses.......... 2,375 5,810 12,258 17,899 19,794
------- ------- ------- -------- --------
Interest income........................... 253 723 2,435 2,029 2,051
Net loss.................................. $(2,122) $(3,087) $(8,823) $(15,870) $(17,743)
------- ------- ------- -------- --------
------- ------- ------- -------- --------
Net loss per common share, basic and
diluted................................. $(0.35) $(0.36) $(0.56) $(0.98) $(1.02)
Weighted average common shares
outstanding, basic and diluted.......... 6,003 8,535 15,863 16,144 17,355

</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
(IN THOUSANDS)
Balance Sheet Data:
<S> <C> <C> <C> <C> <C>
Cash, cash equivalents, marketable
securities and interest receivable...... $ 3,707 $48,576 $41,658 $ 50,497 $ 34,970
Working capital........................... 3,419 47,932 36,368 44,216 31,253
Total assets.............................. 3,820 49,202 42,360 52,430 36,309
Deficit accumulated during the development
stage................................... (3,888) (6,976) (15,798) (31,668) (49,411)
Total stockholders' equity................ 3,521 48,228 39,759 49,518 32,358
</TABLE>

<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

GENERAL

Algos, a development stage company, is engaged primarily in the development
and commercialization of proprietary pharmaceutical products. Since its
formation in January 1992, Algos has devoted a substantial amount of its efforts
to licensing technology, recruiting key management and staff, developing
products, filing patent and regulatory applications and raising capital.

Algos has incurred losses since its inception and expects to incur losses in
the future. Algos' product development expenses may increase as additional drugs
are developed. In August 1999, Algos received a not approvable letter from the
FDA regarding a new drug application filed in 1998 for its most developmentally
advanced drug, MorphiDex'r'. Algos will incur additional development costs for
MorphiDex'r' in connection with amending the new drug application and delay
certain expenses associated with pre-commercialization activities such as the
establishment of a sales force, the preparation of promotional plans and
materials, additions to and changes in financial and operating systems, and
related administrative activities.

RESULTS OF OPERATIONS

FISCAL YEAR ENDED DECEMBER 31, 1999 COMPARED TO THE FISCAL YEAR ENDED
DECEMBER 31, 1998

Revenue:

Algos, which is in the development stage, earned no revenue in 1999 and
1998.

Research and development:

In 1999, research and development expenses were $9.5 million, a decrease of
$3.6 million, or 27%, from 1998. In 1999, expenses decreased due to the impact
in 1998 of large-scale, clinical trials and toxicology studies of MorphiDex'r'.
These effects were partially offset by the costs of obtaining drug supplies and
manufacturing of full-scale demonstration batches of MorphiDex'r' in 1999 and
expenses related to Phase II clinical studies of other products.

Selling, general and administrative:

In 1999, selling, general and administrative expenses were $10.3 million, an
increase of approximately $5.5 million from 1998. The increase was primarily
attributable to expenses incurred in preparation for the possible future
commercialization of products, including fees to sales and marketing
consultants, educational materials and activities, and the addition of marketing
personnel, as well as the general expansion of Algos' business activities. Algos
expects to delay certain other expenses associated with the possible
commercialization of products pending amendments to the MorphiDex'r' new drug
application. In addition, in 1999, Algos incurred professional fees and other
expenses in connection with its merger agreement with Endo.

FISCAL YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE FISCAL YEAR ENDED
DECEMBER 31, 1997

Revenue:

Algos, which is in the development stage, earned no revenue in 1998. In
1997, Algos earned a $1.0 million contractual milestone payment under the McNeil
License Agreement upon McNeil's initiation of a large-scale clinical trial of a
licensed product.

Research and development:

In 1998, research and development expenses were $13.1 million, an increase
of approximately $3.3 million or 34%, from 1997. The significant increase in
1998 expenses was primarily attributable to large-scale, advanced clinical
trials for MorphiDex'r' and the expansion of Algos' development staff. The

<PAGE>
impact of these increases was partially offset by reduced expenses related to
bioavailability studies and the costs of manufacturing small-scale regulatory
test batches of MorphiDex'r', which occurred in 1997.

Selling, general and administrative:

In 1998, selling, general and administrative expenses were $4.8 million, an
increase of $2.4 million or 96%, from 1997. The 1998 results include expenses
related to preparations for the possible future commercialization of
MorphiDex'r', including the addition of sales and marketing personnel. Algos
incurred increased general and administrative costs to support its business
activities, including the addition of administrative personnel and the
relocation and expansion of Algos' headquarters facilities in April 1998.

Interest income:

Interest income decreased 17% in 1998 to $2.0 million as a result of lower
average cash and securities balances prior to the November 1998 private
placement of common stock and a warrant and lower interest rates.

LIQUIDITY AND CAPITAL RESOURCES

In 1999, 1998 and 1997, spending for Algos' product development efforts and
other pre-commercialization activities resulted in net cash outflows from
operations of $15.5 million, $15.3 million and $7.3 million, respectively. Algos
funded this spending primarily from accumulated cash balances at December 31,
1996, which resulted from Algos' 1996 public offering of common stock. In
November 1998, to provide greater financial flexibility, Algos raised $24.9
million in a private sale of common stock and a warrant. In 1998, net cash
outflows from operations increased significantly from 1997 as a result of Algos'
expanded development programs. In 1999, net cash outflows from operations
increased slightly as the effect of lower development expenses in the period
offset increased spending for other pre-commercialization activities.

Algos expects to incur product development expenses as clinical trials of
MorphiDex'r' and HydrocoDex'TM' continue and other drugs that the Company
currently has under development move into advanced clinical trials and as
additional drugs are developed and research and development staff increased. In
August 1999, Algos received a not approvable letter from the FDA regarding its
new drug application for MorphiDex'r'. Algos will incur additional development
costs associated with amending the MorphiDex'r' new drug application. Algos
currently expects that as a stand-alone entity its cash and marketable
securities at December 31, 1999 will be sufficient to fund its development
activities through the year 2001 and support a resubmission of the new drug
application based upon Algos' current schedule of clinical trials and level of
business activities. However, if additional trials are necessary or advisable,
or if additional products are developed, Algos may require additional funds. In
the event that internally generated funds are insufficient for such efforts,
Algos will need to raise additional capital. We cannot assure you that Algos
would be able to obtain such additional financing on terms acceptable to Algos.
Algos' future funding requirements will depend on a number of factors,
including: the results of its development efforts; the timing and costs of
obtaining required regulatory approvals; the amount of resources required for
activities in preparation for the possible commercialization of MorphiDex'r';
the commercialization of competing products; the execution of licensing or other
collaborative research agreements on terms acceptable to Algos; and the cost of
prosecuting and defending patents.

NET OPERATING LOSSES

At December 31, 1999, Algos had accumulated net operating loss carryforwards
of approximately $48 million for federal and state tax purposes. Federal
carryforwards expire in 2009 through 2019 and are available to reduce future
taxable income recognized in the carryforward period, if any. Due to the
uncertainty of future taxable income, Algos has established a valuation
allowance for these carryforwards and has not recognized their potential benefit
on a current basis. The future utilization of

<PAGE>
these carryforwards may be limited by Section 382 of the Internal Revenue Code
related to changes ownership of Algos.

OTHER

Generally, Algos' results of operations are not significantly affected by
seasonal factors and Algos does not believe that inflation has had a significant
impact on its business.

Statement of Financial Accounting Standards (SFAS) No. 133, 'Accounting for
Derivative Instruments and Hedging Activities' is effective in the year 2001.
Based on Algos' current business activities, the statement is not expected to
have a material impact on Algos' financial statements.

YEAR 2000

Algos has evaluated the impact of the year 2000 computer issue and completed
upgrading, modifying and testing critical applications and systems to
accommodate year 2000 dating. This includes computer systems, office machines,
phone and security systems, off the shelf systems and applications, custom
software applications and accounting systems. In addition, Algos has evaluated
its communications with all of its significant suppliers and vendors regarding
their year 2000 compliance.

To date, the year 2000 issue has not had a material affect on the business
and operations of Algos. However, Algos or its third-party contractors may make
additions to and changes in existing computer applications and systems and/or
the use of such systems that could affect Algos' exposure to the year 2000
issue. In addition, there is no assurance that year 2000 issues will not be
discovered in the future.

Algos has not incurred more than $10,000 of costs to date related to the
year 2000 issue and does not expect that the future cost of its compliance
program will be material to its business, financial condition or results of
operations.

<PAGE>
ITEM 8. FINANCIAL STATEMENTS

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors & Stockholders of
ALGOS PHARMACEUTICAL CORPORATION:

In our opinion, the accompanying balance sheets and the related statements
of operations, stockholders' equity, and cash flows present fairly, in all
material respects, the financial position of Algos Pharmaceutical Corporation (a
development stage enterprise) (the 'Company') at December 31, 1999 and 1998, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1999 and for the period January 1, 1992 (date
of inception) to December 31, 1999, in conformity with accounting principles
generally accepted in the United States. 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 of these statements in accordance with auditing standards generally
accepted in the United States, which 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, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.

PRICEWATERHOUSECOOPERS LLP

Florham Park, New Jersey
February 14, 2000

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

<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1998 1999
---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents............................... $ 37,025 $ 30,752
Marketable securities, current.......................... 9,002 4,011
Interest receivable..................................... 417 207
Prepaid expenses and other current assets............... 684 234
-------- --------
Total current assets................................ 47,128 35,204
Marketable securities, noncurrent....................... 4,053
Restricted cash......................................... 150 150
Property and equipment, net............................. 1,099 955
-------- --------
Total assets........................................ $ 52,430 $ 36,309
-------- --------
-------- --------

LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities:
Accounts payable........................................ $ 2,118 $ 3,499
Other current liabilities............................... 794 452
-------- --------
Total current liabilities........................... 2,912 3,951
-------- --------

Commitments
Stockholders' equity:
Preferred stock......................................... -- --
Common stock, $.01 par value, 50,000,000 shares
authorized, 17,028,649 and 17,403,895 shares
outstanding as of December 31, 1998 and 1999,
respectively.......................................... 170 174
Additional paid-in-capital.............................. 81,627 81,700
Unearned compensation expense........................... (611) (105)
Deficit accumulated during the development stage........ (31,668) (49,411)
-------- --------
Total stockholders' equity.......................... 49,518 32,358
-------- --------
Total Liabilities and stockholders' equity.......... $ 52,430 $ 36,309
-------- --------
-------- --------
</TABLE>

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

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

<TABLE>
<CAPTION>
CUMULATIVE FROM
FOR THE YEAR ENDED DECEMBER 31, INCEPTION TO
------------------------------- DECEMBER 31,
1997 1998 1999 1999
---- ---- ---- ---------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenues...................................... $ 1,000 $ -- $ -- $ 3,311

Operating expenses:
Research and development.................. 9,799 13,086 9,508 38,170
Selling, general and administrative....... 2,459 4,813 10,286 22,213
-------- -------- -------- --------
Total operating expenses.............. 12,258 17,899 19,794 60,383
-------- -------- -------- --------
Loss from operations.......................... (11,258) (17,899) (19,794) (57,072)
Interest income............................... 2,435 2,029 2,051 7,661
-------- -------- -------- --------
Net loss...................................... (8,823) (15,870) (17,743) (49,411)
-------- -------- -------- --------
-------- -------- -------- --------
Net loss per common share, basic and
diluted..................................... $ (0.56) $ (0.98) $ (1.02)
-------- -------- --------
-------- -------- --------
Weighted average common shares outstanding,
basic and diluted.......................... 15,862,563 16,144,484 17,354,863
---------- ---------- ----------
---------- ---------- ----------

</TABLE>

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

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

<TABLE>
<CAPTION>
CUMULATIVE FROM
FOR THE YEAR ENDED DECEMBER 31, INCEPTION TO
--------------------------------- DECEMBER 31,
1997 1998 1999 1999
---- ---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................... $ (8,823) $(15,870) $(17,743) $(49,411)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization........... 51 142 371 676
Amortization of unearned compensation... 278 370 299 1,372
Amortization of discount on marketable
securities............................ (79) (67) (114) (262)
Common stock issued for technology...... 125
Preferred stock issued for services..... 25
Preferred stock issued under license
agreement............................. 915
Changes in assets and liabilities:
Interest receivable................. (485) 68 210 (207)
Prepaid expenses.................... 14 (368) 450 (234)
Other assets........................ 119 90
Accounts payable.................... 1,405 256 1,381 3,499
Other current liabilities........... 223 54 (342) 452
-------- -------- -------- --------
Net cash used in operating activities....... (7,297) (15,325) (15,488) (43,050)
-------- -------- -------- --------
Cash flows from investing activities:
Investment in marketable securities......... (37,813) (29,097) (9,842) (76,753)
Redemption of Marketable Securities......... 16,816 37,037 19,000 72,854
Purchases of property and equipment......... (111) (1,095) (227) (1,631)
-------- -------- -------- --------
Net cash used in investing activities....... (21,108) 6,845 8,931 (5,530)
-------- -------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of preferred stock,
net....................................... 6,659
Proceeds from issuance of common stock,
net....................................... 75 25,259 284 72,673
-------- -------- -------- --------
Net cash provided by financing activities... 75 25,259 284 79,332
-------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents................................... (28,330) 16,779 (6,273) 30,752
Cash and cash equivalents, beginning of
period........................................ 48,576 20,246 37,025
-------- -------- -------- --------
Cash and cash equivalents, end of period........ $ 20,246 $ 37,025 $ 30,752 $ 30,752
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>

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

<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE PERIOD FROM INCEPTION TO DECEMBER 31, 1996

<TABLE>
<CAPTION>
DEFICIT
CONVERTIBLE ACCUMULATED
PREFERRED STOCK COMMON STOCK ADDITIONAL UNEARNED DURING THE TOTAL
----------------- ------------------- PAID IN COMPENSATION DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL EXPENSE STAGE EQUITY
------ ------ ------ ------ ------- ------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of Common Stock,
January 1992, $.10 per
share....................... 4,841,664 $ 48 $ 452 $ 500
Issuance of Common Stock for
technology, January 1992,
$.10 per share.............. 968,336 10 90 100
Net loss..................... (385) (385)
-------- --- ---------- ---- ------- ------- -------- --------
Balance, December 31, 1992... 5,810,000 58 542 (385) 215
Capital contributions,
including $25,000 of
technology.................. 150 150
Net loss..................... (257) (257)
-------- --- ---------- ---- ------- ------- -------- --------
Balance, December 31, 1993... 5,810,000 58 692 (642) 108
Issuance of Series A
Preferred Stock, May through
August 1994, $10.00 per
share, net of offering
costs....................... 700,000 7 6,602 6,609
Issuance of Series A
Preferred Stock for
services, May 1994, $10.00
per share................... 2,500 25 25
Exercise of stock options.... 415
Net loss..................... (1,124) (1,124)
-------- --- ---------- ---- ------- ------- -------- --------
Balance, December 31, 1994... 702,500 7 5,810,415 58 7,319 (1,766) 5,618
Exercise of stock options.... 199,615 2 23 25
Net loss..................... (2,122) (2,122)
-------- --- ---------- ---- ------- ------- -------- --------
Balance, December 31, 1995... 702,500 7 6,010,030 60 7,342 (3,888) 3,521
Issuance of Series B
Preferred Stock under
license agreement, June
1996, $9.15 per share....... 100,000 1 914 915
Issuance of Common Stock,
October 1996, $14.00 per
share, net of offering
costs....................... 3,625,000 36 46,350 46,386
Exercise of stock options.... 161,821 2 17 19
Exercise of warrants......... 5,000 50 50
Conversion of Series A
Preferred Stock............. (707,500) (7) 5,872,250 59 (52)
Unearned compensation
expense..................... 1,281 (1,281)
Amortization of unearned
compensation expense........ 425 425
Net loss..................... (3,087) (3,087)
-------- --- ---------- ---- ------- ------- -------- --------
Balance, December 31, 1996... 100,000 $ 1 15,669,101 $157 $55,902 $ (856) $ (6,975) $ 48,229
-------- --- ---------- ---- ------- ------- -------- --------
-------- --- ---------- ---- ------- ------- -------- --------
</TABLE>

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

<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE THREE YEARS ENDED DECEMBER 31, 1999

<TABLE>
<CAPTION>
DEFICIT
CONVERTIBLE ACCUMULATED
PREFERRED STOCK COMMON STOCK ADDITIONAL UNEARNED DURING THE TOTAL
----------------- ------------------- PAID IN COMPENSATION DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL EXPENSE STAGE EQUITY
------ ------ ------ ------ ------- ------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996... $100,000 $ 1 15,669,101 $157 $55,902 $(856) $ (6,975) $ 48,229
Exercise of stock options.... 133,630 1 15 16
Exercise of warrants......... 48,970 1 58 59
Conversion of Series B
Preferred Stock............. (100,000) (1) 100,000 1
Unearned compensation
expense..................... 176 (176)
Amortization of unearned
compensation expense........ 278 278
Net loss..................... (8,823) (8,823)
-------- --- ---------- ---- ------- ----- -------- --------
Balance, December 1997....... 15,951,701 160 56,151 (754) (15,798) 39,759
Exercise of stock options.... 59,850 291 291
Exercise of warrants......... 17,098 21 21
Issuance of Common Stock and
Warrants, November 1998, net
of offering costs........... 1,000,000 10 24,937 24,947
Unearned compensation
expense..................... 227 (227)
Amortization of unearned
compensation expense........ 370 370
Net loss..................... (15,870) (15,870)
-------- --- ---------- ---- ------- ----- -------- --------
Balance, December 1998....... 17,028,649 170 81,627 (611) (31,668) 49,518
Exercise of stock options.... 374,250 4 390 394
Exercise of warrants......... 996 1 1
Costs of stock issuance...... (111) (111)
Adjustment of unearned
compensation expense due to
forfeitures................. (207) 207
Amortization of unearned
compensation expense........ 299 299
Net loss..................... (17,743) (17,743)
-------- --- ---------- ---- ------- ----- -------- --------
Balance, December 1999....... 17,403,895 $174 $81,700 $(105) $(49,411) $ 32,358
-------- --- ---------- ---- ------- ----- -------- --------
-------- --- ---------- ---- ------- ----- -------- --------
</TABLE>

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

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

1. ORGANIZATION

Algos Pharmaceutical Corporation (the 'Company'), is engaged primarily in
the development of proprietary analgesic and anesthetic products. 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. The Company is subject to a number of risks
common to companies in similar stages of development. These include, but are not
limited to, the lack of assurance of successful product development and
regulatory approval, the absence of manufacturing, marketing and distribution
capabilities, the risk of technological obsolescence, changes in pricing and
customer demand and the ability to obtain future financing.

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. These estimates and assumptions affect the reported amounts of
assets and liabilities and the 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.

All dollar amounts are in thousands.

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, CASH EQUIVALENTS, AND RESTRICTED CASH

The Company considers money market securities that mature within three
months of purchase to be cash equivalents. A bank certificate of deposit that
serves as collateral for an irrevocable letter of credit required by the terms
of the Company's lease agreement is included in restricted cash.

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 ten years. Leasehold improvements
are depreciated over the term of the lease. 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 fee revenue is recognized when contract milestones are attained or
when otherwise earned in accordance with the terms of the underlying agreements.

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

<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

assets and liabilities using enacted tax rates in effect for the years in which
the differences are expected to reverse.

LOSS PER SHARE

Basic per share amounts are calculated by dividing the net loss applicable
to common stock by the weighted average number of common shares outstanding
during the period. Diluted per share amounts are calculated by dividing the net
loss applicable to common stock by the sum of the weighted average number of
common shares outstanding and dilutive common share equivalents. Since the
Company incurred losses in all periods presented, options and warrants to
purchase 1,028,405, 1,563,537 and 1,190,901 shares of common stock that were
outstanding at December 31, 1997, 1998, and 1999, respectively, were not
included in diluted per share calculations, as their effect would be
antidilutive.

3. MARKETABLE SECURITIES

Marketable securities at December 31, 1998 and 1999 include the following
debt securities:

<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR UNREALIZED
COST MARKET VALUE GAINS (LOSSES)
---- ------------ --------------
<S> <C> <C> <C>
U.S. Treasury and federal agency debt
securities at December 31, 1998....... $13,055 $13,035 $(20)
U.S. Treasury and federal agency debt
securities at December 31, 1999....... $ 4,011 $ 3,993 $(18)
</TABLE>

The securities are classified as held-to-maturity securities and are stated
at their amortized cost. Noncurrent marketable securities have maturities in
excess of one year and less than two years.

4. PROPERTY AND EQUIPMENT, NET

Property and equipment consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1998 1999
---- ----
<S> <C> <C>
Leasehold improvements...................................... $ 516 $ 505
Office furniture and equipment.............................. 631 643
Computer equipment.......................................... 257 236
------ ------
1,404 1,384
Less accumulated depreciation............................... 305 429
------ ------
$1,099 $ 955
------ ------
------ ------
</TABLE>

5. OTHER CURRENT LIABILITIES

Other current liabilities consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1998 1999
---- ----
<S> <C> <C>
Accrued compensation........................................ $319 $229
Accrued research expenses................................... 475 223
---- ----
$794 $452
---- ----
---- ----
</TABLE>

<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

6. INCOME TAXES

At December 31, 1999, the Company had available net operating loss
carryforwards and research and development credits for federal income tax
purposes of approximately $48,000 and $1,500, respectively, which expire in the
years 2009 through 2019. At December 31, 1999, the Company had available net
operating loss carryforwards and research and development credits for state
income tax purposes of approximately $48,300 and $1,100, respectively, which
expire in the years 2000 through 2006. The tax benefits related to approximately
$2,922 of the federal and state net operating losses at December 31, 1999 relate
to stock option deductions and will be credited to additional paid-in capital if
recognized. The use of federal 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. Due to the uncertainty of their
realization, a full valuation allowance has been established for the potential
income tax benefit of net operating loss and credit carryforwards and temporary
differences. The increase in the valuation allowance amounted to $4,745, $7,563
and $9,587 in 1997, 1998, and 1999, respectively. Deferred tax assets
(liabilities) for federal and state income taxes consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
---- ----
<S> <C> <C>
Net operating loss carryforwards........................ $ 12,283 $ 20,662
Research and development tax credits.................... 1,900 2,600
License costs........................................... 339 317
Accrued liabilities and other........................... 225 714
Depreciation and amortization........................... (4) 37
-------- --------
Total deferred tax assets........................... 14,743 24,330
Valuation allowance..................................... (14,743) (24,330)
-------- --------
Net deferred tax assets................................. $ 0 $ 0
-------- --------
-------- --------
</TABLE>

7. COMMITMENTS

LICENSE AGREEMENTS

The Company has licensed from a university certain patents and pending
patent applications in the field of pain management. The Company is required to
pay royalties equal to 4% of sales of licensed products. In addition, the
Company will pay the university 50% of royalty payments received from any
sublicensees until such payments total $500,000 for a given year, 33% until the
payments total an additional $500,000 for such year and 25% thereafter.

LEASES

Minimum payments under the Company's operating lease for its administrative
offices are as follows:

<TABLE>
<S> <C>
2000........................................................ $ 269
2001........................................................ 269
2002........................................................ 269
2003........................................................ 297
2004........................................................ 311
Balance of term............................................. 1,036
</TABLE>

The agreement provides the Company with an option to extend the lease term
for an additional five-year period and an option to purchase the building which
is exercisable between April 29, 2001 and April 28, 2003.

<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Rent expense amounted to $58, $239 and $269 for the years ended
December 31, 1997, 1998, and 1999 respectively and $634 cumulatively from the
date of inception.

RESEARCH CONTRACTS

The Company routinely contracts with universities, medical centers, contract
research organizations and other institutions for the conduct of research and
clinical studies on the Company's behalf. These agreements are generally for the
duration of the contracted study and contain provisions that allow the Company
to terminate the study prior to its completion.

EMPLOYMENT AGREEMENTS

At December 31, 1999, the Company's minimum obligation for base salaries
under employment agreements with officers amounted to approximately $615.

CONTINGENCIES

In the normal course of business, the Company is party to claims or
litigation relating to various matters. The Company believes that the outcome of
any current claims or litigation would not have a material adverse effect on its
results of operations, cash flows or financial position.

8. SIGNIFICANT AGREEMENTS

In 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 has received payments amounting to $3,000 through
December 31, 1999 and may receive additional payments based on the achievement
of certain milestones, generally related to product development and patent
issuances, and royalties based on sales of licensed products, if any. McNeil is
responsible for development of the licensed products. In addition, the Company
will receive royalties based on sales of licensed products, if any. McNeil may
terminate the agreement upon 60 days notice.

In 1996, the Company entered into a development and marketing collaboration
and license agreement with Interneuron Pharmaceuticals, Inc. for the development
and commercialization of a product to treat migraine headache. The agreement
grants to Interneuron rights, co-exclusive with Algos, to use Algos patents and
know-how to manufacture and market the product. The development program is
currently in an initial stage in which it is expected that Interneuron's
development costs will exceed those of Algos. The agreement provides that the
companies will generally share equally the remaining developments costs,
including pre-clinical studies, clinical trials, and regulatory activities, and
similarly share in marketing and profits of the resulting product, if any. After
the initial stage of development, the agreement may be terminated by either
party with the terminating party retaining an interest in any resulting product,
either in the form of a royalty on sales or the repayment of certain of its
development costs.

In 1996, the Company contributed certain intangible assets having no book
value to a newly formed company, U.S. Dermatologics, Inc, and received preferred
stock with an aggregate stated value and liquidation preference of $2,800 and
all of the transferee's common stock. The common stock was subsequently
distributed to the Company's stockholders, warrant holders and certain of its
employees. The preferred stock provided for an annual cumulative dividend of
30%, payable in the form of cash or common stock, and a share of other earnings.
The Company recorded no gain in connection with the transaction, as management
believed that realization was not assured. In 1998, the Company received $198
for certain consulting and administrative services provided to U.S.
Dermatologics, Inc. during a transitional period, which ended in 1998. In 1999,
the preferred stock was exchanged for shares of U.S.

<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Dermatologics, Inc. common stock representing approximately 10% of U.S.
Dermatologics, Inc.'s total outstanding common stock.

In 1999, the Company and Endo Pharmaceuticals Holdings Inc. entered into a
collaboration agreement, pursuant to which the Company and Endo Pharmaceuticals
will develop, manufacture and commercialize pain management products containing
the combination of oxycodone and dextromethorphan. Pursuant to the collaboration
agreement, each party granted to the other a sole and exclusive worldwide
license to its respective know-how, patent rights and trademark rights used in
connection with the collaboration. The companies will share equally the costs
associated with, and profits generated, by the collaboration, after adjustments
with respect to reduced sales of Endo products resulting from sales of products
that the parties developed under the collaboration agreement. The collaboration
agreement will continue in effect until the parties to the agreement mutually
agree in writing to terminate the agreement or the patent rights licensed under
the collaboration agreement expire.

In 1999, the Company granted a paid-up license under three of the Company's
patents to Cambridge NeuroScience, Inc. to develop products discovered by or on
behalf of Cambridge NeuroScience for the treatment of pain. In exchange, the
Company received the right to negotiate to develop and/or commercialize these
products.

9. STOCKHOLDERS' EQUITY

In May 1996, the Company effected an 8.3-for-1 stock split of its Common
Stock in the form of a stock dividend. All historical Common Stock and per share
data have been restated to reflect the stock split.

CONVERTIBLE PREFERRED STOCK

The Company is authorized to issue 10,000,000 shares of $.01 par value per
share preferred stock with rights, preferences and limitations determined by the
Board of Directors of the Company.

In 1994, the Company issued a total of 702,500 shares of convertible Series
A Preferred Stock and received net proceeds of $6,609 and services valued at
$25. In 1996, an additional 5,000 shares were issued upon conversion of an
outstanding warrant. In connection with the Company's 1996 initial public
offering of Common Stock, each outstanding share of convertible Series A
Preferred Stock was converted to 8.3 shares of Common Stock.

In 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 expense of $915 for the estimated fair value of
the stock. In 1997, the holders converted each share of convertible Series B
Preferred Stock into one share of Common Stock.

WARRANTS

In 1994, in connection with the sale of convertible Series A Preferred
Stock, certain selling agents received warrants to purchase an aggregate of
40,750 shares of convertible Series A Preferred Stock. In connection with the
Company's 1996 initial public offering of Common Stock, outstanding warrants to
purchase an aggregate of 35,750 shares of convertible Series A Preferred Stock
were converted to warrants to purchase an aggregate of 296,725 shares of Common
Stock. The warrants entitle the holders to purchase shares of Common Stock at an
exercise price of $1.20 per share and expire in 2001. Of these warrants,
warrants to purchase 230,657 and 229,661 shares of Common Stock were outstanding
and exercisable as of December 31, 1998 and 1999, respectively.

In 1998, the Company sold 1,000,000 shares of its Common Stock together with
a warrant to purchase 250,000 shares of common stock for an aggregate purchase
price of $25,000. For financial statement purposes, the Company has assigned
$2,000 of the aggregate purchase price to the estimated

<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

fair value of the warrant. The warrant, which is outstanding and exercisable at
December 31, 1999, entitles the holder to purchase shares of Common Stock at an
exercise price of $25.00 per share and expires in 2003.

STOCK OPTION PLANS

The Company's 1996 Stock Option Plan permits the grant of non-qualified
stock options and incentive stock options to purchase an aggregate of 1,215,000
shares of authorized but unissued or reacquired shares of Common Stock. The
Compensation Committee of the Board of Directors 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 vesting period of options, to establish the
contractual life of options, and to take all other actions for the
administration of the 1996 Stock Option Plan. The 1996 Stock Option Plan permits
the Compensation Committee to allow payment of the option exercise price to be
made in cash 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. Unless sooner terminated by the Board of Directors, the 1996 Stock
Option Plan will expire in 2006.

The Company's 1996 Non-Employee Director Stock Option Plan (the Director
Plan) covers 283,000 authorized but unissued or reacquired shares of Common
Stock and is intended to assist the Company in attracting and retaining
qualified non-employee directors. The Director Plan is administered by the Board
of Directors and provides for automatic grants of non-qualified stock options to
purchase 10,000 shares of Common Stock to each non-employee director at the time
of initial 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 generally 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
non-employee director continues to serve as a director of the Company. In
addition, each non-employee director shall be granted an option to purchase
10,000 shares of Common Stock on an annual basis. Unless sooner terminated by
the Board of Directors, the Director Plan will expire in 2006.

Prior to 1997, the Company granted stock options under prior plans.

The following table summarizes stock option activity for the years ended
December 31, 1997, 1998, and 1999:

NUMBER WEIGHTED AVERAGE
OF SHARES EXERCISE PRICE
--------- --------------
<S> <C> <C>
Outstanding January 1, 1997. 752,440 1.39
Granted............................................ 166,500 $16.62
Exercised.......................................... (133,630) $ 0.12
Cancelled.......................................... (4,660) $ 4.21
--------
Outstanding December 31, 1997...................... 780,650 $ 4.81
Granted............................................ 382,520 $31.34
Exercised.......................................... (59,850) $ 4.86
Cancelled.......................................... (20,440) $15.98
--------
Outstanding December 31, 1998...................... 1,082,880 $13.97
Granted............................................ 340,200 $26.97
Exercised.......................................... (374,250) $ 1.05
Cancelled.......................................... (337,590) $29.61
--------
Outstanding December 31, 1999...................... 711,240 $19.56
--------
--------
</TABLE>

Options exercisable at December 31, 1997, 1998 and 1999 were 503,216,
656,230 and 409,447 respectively.

<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

A summary of stock options outstanding as of December 31, 1999 is as
follows:

<TABLE>
<CAPTION>
NUMBER OF WEIGHTED AVERAGE WEIGHTED AVERAGE
RANGE OF EXERCISE PRICES: SHARES REMAINING CONTRACT LIFE EXERCISE PRICE
- ------------------------- ------ ----------------------- --------------
<S> <C> <C> <C>
$0.12 - $0.13................ 153,550 1.9 $ 0.13
$10.00 - $15.00.............. 86,000 5.4 $14.37
$15.01 - $20.00.............. 56,100 6.1 $17.21
$20.01 - $25.00.............. 10,840 6.1 $22.47
$25.01 - $30.00.............. 264,720 6.0 $26.50
$30.01 - $40.00.............. 140,030 6.0 $31.65
-------
711,240 4.8 $19.56
-------
-------
</TABLE>

Stock options exercisable as of December 31, 1999:

<TABLE>
<CAPTION>
NUMBER OF WEIGHTED AVERAGE
RANGE OF EXERCISE PRICES: SHARES EXERCISE PRICE
- ------------------------- ------ --------------
<S> <C> <C>
$0.12 - $0.13.................................... 153,550 $ 0.13
$10.00 - $15.00.................................. 76,400 $14.29
$15.01 - $20.00.................................. 43,250 $17.20
$20.01 - $25.00.................................. 2,810 $22.52
$25.01 - $30.00.................................. 75,107 $26.51
$30.01 - $40.00.................................. 58,330 $31.76
-------
409,447 $14.07
-------
-------
</TABLE>

Weighted average exercise price of options granted during the year:

<TABLE>
<CAPTION>
EXERCISE PRICE: 1997 1998 1999
- --------------- ---- ---- ----
<S> <C> <C> <C>
Equal to market value of stock...................... $16.62 $31.35 $26.89
Less than market value of stock..................... $31.31
Greater than market value of stock.................. $28.43
</TABLE>

Weighted average fair value at grant date of options granted during the
year:

<TABLE>
<CAPTION>
EXERCISE PRICE: 1997 1998 1999
- --------------- ---- ---- ----
<S> <C> <C> <C>
Equal to market value of stock...................... $11.13 $20.53 $14.94
Less than market value of stock..................... $23.03
Greater than market value of stock.................. $13.69
</TABLE>

The fair value of each option grant in 1997, 1998 and 1999 was estimated on
the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions: no dividend yield, expected lives of
five years, expected volatility of 60%, and risk-free interest rates of 6.3%,
5.4% and 4.7% for 1997, 1998 and 1999, respectively.

The Company records compensation expense for stock option grants in
accordance with APB No. 25, 'Accounting for Stock Issued to Employees.' Had the
Company elected to record compensation for stock option grants in accordance
with SFAS No. 123, 'Accounting for Stock-Based Compensation,' the Company's pro
forma net loss and loss per share amounts would be as follows:

<TABLE>
<CAPTION>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Net loss........................................ $(9,480) $(18,218) $(20,047)
Net loss per common share, basic and diluted.... $(0.60) $(1.13) $(1.16)
</TABLE>

Pro forma amounts are not likely to be representative of amounts in future
years, as additional options are awarded and vested.

<PAGE>
ALGOS PHARMACEUTICAL CORPORATION
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

In 1998, Algos granted certain options subject to shareholder approval of an
increase of 800,000 in the number of shares of Common Stock issuable under the
1996 Stock Option Plan. Unearned compensation expense was recorded for the
increase in the market value of Common Stock between the grant date and the June
1998 approval date. Unearned compensation expense related to stock option grants
is amortized over the vesting period of the grants, generally four years.

10. OTHER RELATED PARTY TRANSACTIONS

Certain directors and shareholders of the Company have been associated with
law firms that rendered various legal services to the Company. The Company
recorded charges of approximately $165, $47 and $900 in 1997, 1998 and 1999
respectively, and $1,737 from the date of inception, for those services,
including services rendered in connection with the issuance of stock. As of
December 31, 1998 and 1999, $14 and $773 of these charges were unpaid,
respectively.

11. MERGER AGREEMENT WITH ENDO PHARMACEUTICALS HOLDINGS INC.

On November 26, 1999, the Company entered into a definitive merger agreement
pursuant to which Algos will merge with a subsidiary of Endo Pharmaceuticals
Holdings Inc. in a tax-free transaction. In the transaction, Algos shareholders
will receive common stock of Endo and warrants to purchase additional shares of
common stock of Endo for nominal consideration. The warrants will become
exercisable only if the U.S. Food and Drug Administration approves Algos' New
Drug Application for MorphiDex by December 31, 2002. The agreement places
restrictions on the Company's ability to enter into certain transactions,
including incurring debt, issuing additional shares of stock, paying dividends,
disposing of assets and entering into certain significant agreements. The
transaction is subject to the approval of Algos shareholders, regulatory
approvals and certain other conditions and is expected to be completed by the
second quarter of 2000.

<PAGE>
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE

Not Applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Set forth below are the directors and executive officers of the Company as
of March 15, 2000.

DIRECTORS

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
John W. Lyle.............................. 55 President and Chief Executive Officer and
Director
Donald G. Drapkin......................... 52 Director
Michael Hyatt............................. 54 Director
Roger H. Kimmel........................... 53 Director
James R. Ledley........................... 53 Assistant Secretary and Director
Dieter A. Sulser.......................... 51 Director
</TABLE>

Messers. Hyatt and Ledley are in the class of Directors whose term will
expire in 2000. Messers. Kimmel and Sulser are in the class of Directors whose
term will expire in 2001. Messers Lyle and Drapkin are in the class of Directors
whose term will expire in 2002.

EXECUTIVE OFFICERS

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
John W. Lyle.............................. 55 President and Chief Executive Officer
Frank S. Caruso, Ph.D..................... 63 Executive Vice President, Research and
Development
Robert Sosnowski.......................... 41 Vice President, Sales and Marketing
Gary R. Anthony........................... 39 Treasurer and Chief Financial Officer
</TABLE>

Mr. Lyle has been President and Chief Executive Officer and a Director of
Algos 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., a
public orthopaedic pharmaceutical company formed in 1986. He served as
Osteotech, Inc.'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 President of
CIBA-GEIGY Corporation's Self-Medication Division. 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.

Mr. Drapkin has been Director of Algos since January 1994. Mr. Drapkin has
been Vice Chairman and Director of MacAndrews & Forbes Holdings Inc., and
various of its affiliates since 1987. Mr. Drapkin is a Director of the following
corporations: Anthracite Capital, Inc., BlackRock Asset Investors, The Molson
Companies Limited, Nexell Therapeutics, Inc., Playboy Enterprises, Inc., Revlon,
Inc., Revlon Consumer Products Corporation, The Warnaco Group, Inc. and Weider
Nutrition International, Inc. (On December 27, 1996, Marvel, Marvel Holdings,
Marvel Parent and Marvel III, of which Mr. Drapkin was a Director on such date,
and several subsidiaries of Marvel filed voluntary petitions for reorganization
under Chapter 11 of the United States Bankruptcy Code.) Mr. Drapkin is a member
of the Compensation and Audit Committees of the Company's Board of Directors.

Mr. Hyatt has been a Director of Algos since November 1996. For more than
five years, Mr. Hyatt has been a Senior Managing Director of Bear Stearns &
Co., Inc.

Mr. Kimmel has been a Director of Algos 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 Weider

<PAGE>
Nutrition International, Inc. and TSR Paging, Inc. Mr. Kimmel is a member of the
Compensation Committee of the Company's Board of Directors.

Mr. Ledley has been a Director of Algos since January 1992. Mr. Ledley
also serves as Assistant Secretary for the Company. Since 1995, he 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. Ledley is a member of the Compensation and Audit
Committees of the Company's Board of Directors.

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

Dr. Caruso joined Algos as Executive Vice President, Research &
Development 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. He
holds a Ph.D. and M.S. in Pharmacology, both from the University of Rochester,
School of Medicine and Dentistry and a B.S. in Biology from Trinity College.

Mr. Sosnowski joined Algos in 1999. From 1997 to 1998, Mr. Sosnowski
was Director, Sales Operations for Centocor, Inc. and from 1995 to 1997, he was
Executive Director at The Liposome Company. In these positions, Mr. Sosnowski
was responsible for various aspects of new pharmaceutical product launches,
including the establishment of sales force operations, alignments and
recruitment, marketing and medical education. Mr. Sosnowski holds a B.S. degree
in Biology from the University of Connecticut, Storrs.

Mr. Anthony joined Algos in 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 financial
reporting and the development and implementation of accounting practices and
internal control systems. Mr. Anthony holds a B.S. in Accounting from Monmouth
College.

COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934

Section 16(a) of the Exchange Act requires directors, officers and persons
who beneficially own more than 10% of a registered class of stock of Algos
to file initial reports of ownership (Forms 3) and reports of changes in
beneficial ownership (Forms 4 and 5) with Commission and the Nasdaq. Such
persons are also required under the rules and regulations promulgated by the
Commission to furnish Algos with copies of all Section 16(a) forms they file.

Based solely on a review of the copies of such forms, as amended furnished
to the Company, the Company believes that all Section 16(a) filing requirements
applicable to its directors, officers and greater than 10% beneficial owners
were compiled with, except that Ronald Goldblum, Donald Johnson, Terence Novak
and George Wagner filed Forms 5 late.

<PAGE>
ITEM 11. EXECUTIVE COMPENSATION

SUMMARY EXECUTIVE COMPENSATION TABLE

The following table sets forth the annual, long-term and other compensation
of Algos' Chief Executive Officer and other most highly compensated executives
whose annual salary and bonus exceeded $100,000:

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
---------------------------------- -------------------- -------
OTHER RESTRICTED OPTIONS
ANNUAL STOCK (# OF LTIP ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARDS SHARES) PAYOUTS COMPENSATION
- --------------------------- ---- ------ ----- ------------ ------ ------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
John W. Lyle
President & Chief
Executive Officer....... 1999 $324,000 $ -- -- -- 80,000 -- --
1998 $300,000 $140,000 -- -- -- -- --
1997 $275,000 $137,500 -- -- 40,000 -- --
Frank S. Caruso
Executive Vice President
Research & Development... 1999 $205,000 $ -- -- -- 40,000 -- --
1998 $194,250 $ 60,000 -- -- 10,000 -- --
1997 $185,000 $ 61,050 -- -- 24,000 -- --
W. Bradford Middlekauff
Vice President, Business
Development and General
Counsel(a).............. 1999 $138,500 $ 27,000 -- -- 15,000 -- --
1998 $ 63,438 -- -- -- 40,000 -- --
Robert E. Sosnowski
Vice President, Sales and
Marketing(b)............ 1999 $144,128 $ 8,000 -- -- 15,000 -- $33,406(f)

George M. Wagner
Vice President,
Regulatory Affairs(c)... 1999 $117,500 -- -- -- 6,000 -- --
1998 $104,200 $ 20,000 -- -- -- -- --
1997 $ 53,437 $ 5,000 -- -- 10,000 -- --
Ronald Goldblum
Vice President,
Clinical Research(d).... 1999 $179,835 $ 15,000 -- -- 8,000 -- --
1998 $118,500 $ 12,500 -- -- 60,000 -- $59,395(f)
Terence S. Novak
Executive Vice President,
Sales & Marketing(e).... 1999 $137,222 -- -- -- 17,000 -- --
1998 $147,222 $ 25,000 -- -- 83,000 -- --
</TABLE>

- ---------

(a) Mr. Middlekauff's employment with Algos commenced August 1998 and
terminated February 2000.

(b) Mr. Sosnowski's employment with Algos commenced January 1999.

(d) Dr. Goldblum's employment with Algos commenced May 1998 and
terminated December 1999.

(e) Mr. Novak's employment with Algos commenced April 1998 and terminated
June 1999.

(f) Relocation expense compensation.

<PAGE>
The following table sets forth for each of the named executive officers
certain information regarding stock option grants during 1999:

OPTION/SAR GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE AT
ASSUMED ANNUAL RATES OF STOCK
PRICE APPRECIATION FOR
INDIVIDUAL GRANT OPTION TERM
--------------------------------------------------- -------------------------------
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/SARS EXERCISE
UNDERLYING GRANTED TO OR BASE
OPTIONS/SARS EMPLOYEES IN PRICE EXPIRATION
NAME GRANTED FISCAL YEAR ($/SH) DATE 5% ($) 10% ($)
- ---- ------------ ------------ ------ ---- ------ -------
<S> <C> <C> <C> <C> <C> <C>
John W. Lyle......... 11,607 4 $28.43 1/04/04 $ 91,164 $ 201,449
68,393 24 $25.84 1/31/06 $ 729,933 $2,021,349
Frank S. Caruso...... 40,000 14 $25.84 1/31/06 $ 426,905 $1,182,196
Ronald Goldblum...... 8,000 3 $25.84 1/31/06 $ 85,381 $ 236,439
Terence S. Novak..... 17,000 6 $25.84 1/31/06 $ 181,435 $ 502,433
W. Bradford
Middlekauff........ 15,000 5 $25.84 1/31/06 $ 160,089 $ 443,324
Robert E.
Sosnowski.......... 15,000 5 $25.84 1/31/06 $ 160,089 $ 443,324
George M. Wagner..... 6,000 2 $25.84 1/31/06 $ 64,036 $ 177,329
</TABLE>

The following table sets forth for each of the named executive officers the
value realized from stock options exercised during 1999 and the number and value
of exercisable and unexercisable stock options held at December 31, 1999:

AGGREGATED OPTION EXERCISES IN LAST YEAR AND YEAR END OPTION VALUES

<TABLE>
<CAPTION>
NUMBER OF SHARES VALUE OF UNEXERCISED
OF UNDERLYING IN-THE-MONEY
SHARES UNEXERCISED OPTIONS OPTIONS
ACQUIRED ON VALUE --------------------------- ---------------------------
EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
-------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
John W. Lyle............. 224,100 $5,712,863 182,800 70,000 $1,443,200 --
Frank S. Caruso.......... 66,400 $1,751,600 51,300 31,000 $ 81,300 --
W. Bradford Middlekauff.. -- -- 23,750 31,250 -- --
Robert E. Sosnowski...... -- -- 3,750 11,250 -- --
George M. Wagner......... -- -- 9,000 7,000 -- --
Ronald Goldblum.......... -- -- 15,000 -- -- --
Terence S. Novak......... -- -- -- -- -- --
</TABLE>

EMPLOYMENT AGREEMENTS

Mr. Lyle's employment agreement with Algos expires on December 31,
2000 and is automatically renewable for successive one-year terms unless
terminated by either Mr. Lyle or Algos. Mr. Lyle's employment agreement
provides that he will be employed as the President and Chief Executive Officer
of the Company and that Algos will use its best efforts to cause him to be
elected to the Board of Directors for the term of the agreement. Mr. Lyle is
entitled to a minimum increase of 8% per year or such greater increase as the
Board of Directors, in its sole discretion, deems appropriate to the preceding
year's base salary and for bonuses for individual accomplishment of key
milestone events in such amounts and on such terms as the Board of Directors may
determine.

Dr. Caruso's employment agreement with Algos expires on December 31,
2000 and is automatically renewable for successive one-year terms unless
terminated by either Dr. Caruso or Algos. Dr. Caruso is entitled to a 5%
increase per year or such greater increase as the Board of Directors, in its
sole discretion, deems appropriate to the preceding year's base salary and is
entitled to receive continuing payments equal to twelve months salary in the
event of his termination by Algos without cause. Dr. Caruso 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.

<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 Algos and are reimbursed for reasonable travel expenses
incurred in connection with their attendance at such meetings. Non-employee
Directors upon first appointment or election to the Board of Directors will
receive an option grant under Algos' 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 in one-third installments upon each of the first,
second and third annual meetings of stockholders following the date of grant
subject to the Director's continued Board membership. In addition, on the date
of the first meeting of the Board of Directors in each calendar year, each
non-employee Director will be granted options to purchase 10,000 shares of
Common Stock, at the fair market value on the date of grant, which shall vest on
the first anniversary of the date of grant.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

Mr. Kimmel and Mr. Ledley are members of the Compensation Committee of the
Company's Board of Directors. See 'Certain Relationships and Related
Transactions' for a description of certain of their business relationships with
the Company.

REPORT OF THE COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION

Compensation Policy and Company Performance. The executive compensation
program has been designed with the goal of motivating, rewarding and retaining
executives with the level of talent and ability required to guide Algos'
growth, efficiently manage its resources, achieve its long-range business
objectives and successfully maintain its position as a leader in developing a
new generation of proprietary pain management products. The compensation program
provides the means of achieving these goals by creating incentives to
accomplishing short-term and long-term objectives, by rewarding exceptional
performance that contributes to the business and by utilizing competitive base
salaries that recognize a policy of career continuity.

Algos' financial well being is highly dependent upon the success of
its long-term growth strategy. The nature of this strategy requires long-term
and significant investments, which may take years to generate returns to
stockholders. Therefore, executive compensation decisions are oriented toward
long-term corporate performance and may not fluctuate as greatly as year-to-year
corporate financial results.

The fundamental principle of the compensation program is to compensate
executives for their performance and for the level of responsibility
corresponding to their positions. Assessments of both individual and corporate
performance influence compensation levels. The Compensation Committee recognizes
the importance of fostering a performance-based environment that motivates
individual achievement. Thus, executives are regularly given recognition for the
year's results, which are not necessarily financial results, and provided with
incentives to augment their successes in the future.

The Compensation Committee makes compensation determinations for all of
Algos' senior management, including the individuals whose compensation is
detailed in this proxy. Compensation decisions for all executives, including
John W. Lyle, Algos' Chief Executive Officer, are based on the criteria
disclosed above.

There are three primary elements of Algos' compensation program: base
salary, bonus payments and awards under the 1994 Option Plan and the 1996 Option
Plan (together, the 'Stock Plans').

Base Salaries. A competitive base salary is necessary to the development and
retention of capable management and is consistent with Algos' long-term goals.

Current base salary levels for executives result from a review of Algos'
business performance and general economic factors. Within this framework,
executive salaries are governed in part by various employment agreements and
are determined based on individual performance, level of responsibility within
Algos and experience.

<PAGE>
Bonus Payments. Targeted cash bonus payments are awarded to executives in
recognition of contributions to the business during the prior year. An
executive's contributions to the business are measured, in part, by his or her
success in meeting certain goals established by such executive and Algos'
Chief Executive Officer. The amount of the bonuses awarded in any calendar year
is determined by reference to the terms of the executive employment agreements,
Algos' competitive position, assessment of progress in attaining long-term
goals and business performance considerations. Because of Algos' developmental
stage, these business performance considerations do not include traditional
measurements such as annual cash flow, earnings per share and return on
investments, but rather, how well Algos has achieved its targeted developmental
goals. None of these measurements is given a specific weight. No formula was
used in determining the aggregate amount of the bonuses awarded to executives
in 1999.

The specific cash bonus an executive receives is dependent on individual
performance and level of responsibility. Assessment of an individual's relative
performance is made annually based on a number of factors, including initiative,
business judgment, knowledge of the industry and management skills.

Awards under the Stock Plans. Awards under the Stock Plans are designed to
promote an identity of interests between management and stockholders. Under the
Stock Plans, Algos' executives are eligible to receive grants of options
to purchase Common Stock at or above fair market value on the date of the grant.
Typically, grants of stock options are subject to a significant vesting period.
This approach is designed to increase long-term stockholder value, as the
maximum benefit of this element of executive compensation is only realized if
stock price appreciation occurs over a number of years.

Awards of stock options were granted to certain executives in the first
quarter of 1999 based on individual performance (determined as described above
under ' -- Bonus Payments') and level of responsibility. Award levels are
generally intended to be sufficient in size to provide a strong incentive for
executives to work for long-term business interests and increase such
executives' ownership in the business. See 'Executive Compensation -- Summary
Compensation Table' and 'Executive Compensation -- Option/SAR Grants in Last
Fiscal Year.'

Policy on the Deductibility of Compensation. Section 162(m) of the Internal
Revenue Code of 1986 as amended (the 'Code'), limits a public company's federal
income tax deduction for compensation paid in excess of $1,000,000 to any of its
five most highly compensated executive officers. However, certain
performance-based compensation, including awards of stock options, is excluded
from the $1,000,000 limit if specific requirements are met.

While the tax impact of any compensation arrangement is one factor which is
considered by the Compensation Committee, such impact is evaluated in light of
the compensation policies discussed above. The Compensation Committee's
compensation determinations have generally been designed to maximize Algos'
federal income tax deduction for possible application in future years.
However, from time to time compensation may be awarded which is not fully
deductible if it is determined that such award is consistent with the overall
design of the compensation program and in the best interests of Algos and
its stockholders.

Chief Executive Officer Compensation. The Chief Executive Officer's salary
is determined based upon Mr. Lyle's employment agreement and the competitive
salary framework described under ' -- Base Salaries,' above, recognizing Algos'
significant growth and the increasing complexity of its business. The minimum
base salary and minimum annual increases set forth in Mr. Lyle's employment
agreement were determined based on the Board of Directors' judgment concerning
his individual contributions to the business, level of responsibility and
career experience. Although none of these factors were given a specific weight,
primary consideration was given to Mr. Lyle's individual contributions to the
business. No particular formulas or measures were used. In 1999, Mr. Lyle
did not receive a Bonus Award. In determining the degree to which the Company
achieved its business objectives the Compensation Committee considered primarily
the significance of the approval and launch of MorphiDex'r', which was not
achieved in 1999.

Conclusion. Algos has had, and continues to have, an appropriate and
competitive compensation program. The balance of a competitive base salary
position, bonus payments and significant emphasis on long-term incentives is a
foundation designed to build stability and to support

<PAGE>
the Company's continued growth. This report is submitted by the members of the
Compensation Committee:

COMPENSATION COMMITTEE
Donald G. Drapkin
Roger H. Kimmel
James R. Ledley

THE PRECEDING 'REPORT OF THE COMPENSATION COMMITTEE ON EXECUTIVE
COMPENSATION' AND THE 'STOCK PERFORMANCE CHART' THAT APPEARS IMMEDIATELY
HEREAFTER SHALL NOT BE DEEMED TO BE SOLICITING MATERIAL OR TO BE FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION UNDER THE SECURITIES ACT OF 1933, AS AMENDED,
OR THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, OR INCORPORATED BY REFERENCE
IN ANY DOCUMENTS SO FILED.

STOCK PERFORMANCE CHART

As part of the executive compensation information presented in this Proxy
Statement, the Securities and Exchange Commission (the 'Commission') requires a
comparison of stock performance for Algos with stock performance of a broad
equity market index and an appropriate industry index. The following chart
compares the cumulative total stockholder return on the Common Stock during the
period from September 25, 1996 the effective date of Algos' initial public
offering to December 31, 1999 with the cumulative total return on the Nasdaq
Composite Index and a peer group index of Nasdaq pharmaceutical companies. The
comparison assumes $100 was invested on September 25, 1996 in the Common Stock
and in each of the foregoing indices and assumes reinvestment of dividends, if
any. The stock performance shown on the following chart is not necessarily
indicative of future performance.

[PERFORMANCE GRAPH]

<TABLE>
<CAPTION>
September 25 December 31
------------ ---------------------------------
1996 1996 1997 1998 1999
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Nasdaq Composite Index 100.00 105.03 128.26 177.35 325.00
Peer Group Index 100.00 98.98 102.21 130.02 242.97
Algos Pharmaceutical Corporation 100.00 80.36 214.29 185.71 78.57
- ----------------------------------------------------------------------------------
</TABLE>

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table provides information regarding the ownership of Algos
common stock as of February 29, 2000 by: (1) each stockholder who is known to
Algos to own beneficially more than 5% of Algos common stock; (2) Algos' chief
executive officer and the other named executive officers of Algos; (3) each
director of Algos; and (4) all directors and executive officers as a group.

<PAGE>

<TABLE>
<CAPTION>
SHARES
BENEFICIALLY
OWNED
-------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT
- ------------------------ ------ -------
<S> <C> <C>
Directors and Executive Officers:
John W. Lyle(a)......................................... 1,531,254 8.7%
Frank S. Caruso(b)...................................... 353,100 2.0
Ronald Goldblum(c)...................................... 15,000 *
W. Bradford Middlekauff(d).............................. 23,750 *
Robert E. Sosnowski(e).................................. 4,250 *
George M. Wagner(f)..................................... 9,000 *
Terence S. Novak(g)..................................... 500 *
Donald G. Drapkin(h).................................... 36,600 *
Michael Hyatt(i)........................................ 1,864,024 10.7
Roger H. Kimmel(j)...................................... 938,525 5.4
James R. Ledley(k)...................................... 137,950 *
Dieter A. Sulser(l)..................................... 173,550 *
Directors and Executive Officers as a group(m).......... 4,430,310 24.8

Other Principal Stockholders:
Endo Pharmaceuticals Holdings Inc.
and related investors(n)............................ 4,213,422 23.7
Unifina Holding, A.G. and related investors(o).......... 1,734,700 9.9
Karen Lyle(p)........................................... 1,531,254 8.7
Biotech Target S.A. and related investors(q)............ 1,699,500 9.6
Lawrence Canarelli(r)................................... 871,500 5.0
</TABLE>

- ---------

* Represents less than one percent.

(a) Includes (i) 1,344,916 shares of Algos common stock and options to purchase
3,500 shares of Algos common stock owned by Karen Lyle, wife of Mr. Lyle,
as to which Mr. Lyle disclaims beneficial ownership, (ii) 38 shares owned
by Mr. Lyle's son and (iii) options to purchase 182,800 shares of Algos
common stock owned directly by Mr. Lyle. Excludes 660,000 shares of Algos
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.

(b) Includes (i) 1,000 shares of Algos common stock owned directly by Mrs.
Caruso, wife of Dr. Caruso, as to which Dr. Caruso disclaims beneficial
ownership, (ii) 7,200 shares of Algos common stock held in a trust for
which Dr. Caruso serves as trustee and as to which shares Dr. Caruso holds
either the sole or the shared power of disposition and the power to vote
and (iii) options to purchase 41,300 shares of Algos common stock. Excludes
a total of 24,900 shares held in trust for the benefit of the children of
Dr. and Mrs. Caruso, as to which shares Dr. Caruso has neither the power of
disposition nor the power to vote.

(c) Includes options to purchase 15,000 shares of Algos common stock. Dr.
Goldblum ceased to be employed by Algos in December, 1999.

(d) Includes options to purchase 23,750 shares of Algos common stock. Mr.
Middlekauff ceased to be employed by Algos in February 2000.

(e) Includes options to purchase 3,750 shares of Algos common stock.

(f) Includes options to purchase 9,000 shares of Algos common stock. Mr. Wagner
ceased to be employed by Algos in January 2000.

(g) Mr. Novak ceased to be employed by Algos in June 1999. As a result,
information regarding the share holdings of Mr. Novak are no longer
available to Algos. Accordingly, the share numbers shown represent the
number of shares he had at the time he left his employment at Algos.

(h) Includes (i) 16,600 shares owned directly by Mr. Drapkin and (ii) options
to purchase 20,000 shares of Algos common stock. Excludes a total of
809,244 shares of Algos common stock held in six trusts
(footnotes continued on next page)

<PAGE>
(footnotes continued from previous page)
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.

(i) Includes (i) 829,551 shares of Algos common stock owned directly by Mr.
Hyatt, (ii) 1,004,473 shares held in 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 (iii) options to
purchase 30,000 shares of Algos common stock. Excludes 221,332 shares of
Algos 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.

(j) Includes (i) 30,000 shares owned directly by Mr. Kimmel, (ii) 878,525
shares held in 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 (iii) options to purchase 30,000 shares
of Algos common stock.

(k) Includes (i) 109,450 shares owned directly by Mr. Ledley, (ii) a total of
8,500 shares of Algos common stock held in trusts, as to which shares Mr.
Ledley holds either the sole or the shared power of disposition and power
to vote and (iii) options to purchase 20,000 shares of Algos common stock.

(l) Includes (i) options to purchase 20,000 shares of Algos common stock and
(ii) 141,100 shares of Algos common stock and 12,450 warrants to purchase
shares of Algos common stock owned directly by Gaby Tschofen Sulser, wife
of Mr. Sulser, as to which Mr. Sulser disclaims beneficial ownership.
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.

(m) Includes options and warrants to purchase 411,550 shares of Algos common
stock.

(n) Endo Pharmaceuticals Holdings, Inc. may be deemed to have acquired
beneficial ownership of 4,213,422 shares of Algos Common Stock pursuant to
certain voting agreements with Algos shareholders (See Change of "Control
of Registrant-Voting Agreements"). These shares include 1,531,216 shares
beneficially owned by John W. Lyle and Karen Lyle, 345,900 shares
beneficially owned by Frank S. Caruso, 36,600 shares beneficially owned by
Donald G. Drapkin, 1,864,024 shares beneficially owned by Michael Hyatt,
251,322 beneficially owned by Roger H. Kimmel, and 129,450 shares
beneficially owned by James R. Ledley. Other than as set forth in the
agreements, Endo has no right or power to vote, direct the voting of,
dispose or direct the disposition of, the Common Stock.

A majority of the outstanding capital stock of Endo is beneficially owned
by Kelso Investment Associates V, L.P., a Delaware limited partnership
("KIA V"), and Kelso Equity Partners V, L.P., a Delaware limited
partnership ("KEP V"). The general partner of KIA V is Kelso Partners V,
L.P. ("KPV"). The general partners of KPV and KEP V are Frank T. Nickell,
Thomas R. Wall, IV, George E. Matelich, David I. Wahrhaftig, Frank K.
Bynum, Jr., Philip E. Berney and Joseph S. Schuchert (such individuals,
collectively, the "Principals"). Endo, KIA V, KEP V, KPV and the Principals
disclaim beneficial ownership of any shares of Algos Common Stock that may
be voted by Endo. The business address for these entities is c/o Kelso &
Company, 320 Park Avenue, 24th Floor, New York, New York 10022.

(o) Consists of 1,577,000 shares of Algos common stock and 157,700 warrants to
purchase shares of Algos 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 Zurcherstrasse 32, CH-8400, Winterhur,
Switzerland. Excludes (i) 166,000 shares of Algos common stock and warrants
to purchase 16,600 shares of Algos 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 Algos common
stock, warrants to purchase 12,450 shares of Algos common stock and options
to purchase 20,000 shares of Algos common stock beneficially owned by Mr.
Sulser, General Manager of Unifina Holding AG, as to which shares Unifina
Holding AG disclaims beneficial ownership.

(p) Includes (i) 1,344,916 shares of Algos common stock and options to purchase
3,500 shares of Algos common stock, owned directly by Mrs. Lyle and
(ii) options to purchase 182,800 shares of Algos common stock owned
directly by John W. Lyle, husband of Mrs. Lyle, as to which Mrs. Lyle
disclaims beneficial ownership. Excludes 660,000 shares of Algos 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.

(q) Includes warrants to purchase 250,000 shares of Algos common stock. Biotech
Target S.A. is a wholly-owned subsidiary of BB Biotech AG. The address
of BB Biotech AG is Vordergasse 3, 8200 Schaffhausen, CH/Switzerland and
the address of Biotech Target S.A. is Swiss Bank Tower, Panama 1, Republic
of Panama. As of December 31, 1999, based on Schedule 13 G/A filed in
February 2000 jointly by Biotech Target S.A. and BB Biotech AG.

(r) Includes 660,000 shares of Algos common stock deemed to be beneficially
owned by Mr. Canarelli in his capacity as trustee for a trust as to which
shares Mr. Canarelli has shared power of disposition and the power to vote.

CHANGE IN CONTROL OF THE REGISTRANT

On November 26, 1999, Algos Pharmaceutical Corporation entered into an
Agreement and Plan of Merger with Endo Pharmaceuticals Holdings Inc. and Endo's
wholly owned subsidiary, Endo Inc. The merger agreement provides that, upon
satisfaction of certain conditions, the Company will merge into Endo, Inc., with
Endo, Inc. surviving the merger as a wholly owned subsidiary of Endo.

Voting Agreements

In connection with the Merger, certain stockholders of the Company who own
approximately 24% of the outstanding Company Common Stock in the aggregate have
each agreed, pursuant to a separate voting agreement with Endo, to vote in their
capacities as stockholders in favor of the merger and against any competing
offer. These stockholders are: Karen B. Lyle, Michael Hyatt, the Trust Under the
Will of Inez L. Kimmel, Frank S. Caruso, John W. Lyle, the Hyatt Family Trust,
the Todd Kimmel Trust, the Melissa Kimmel Trust, Roger H. Kimmel, the Frank S.
Caruso Irrevocable Trust, the Anita Hyatt Family Trust, James R. Ledley, Donald
G. Drapkin and Patricia Caruso. Under the agreements, Endo has been granted an
irrevocable proxy, coupled with an interest, from each of the Stockholders to
vote the respective shares of Common Stock solely in the certain circumstances
described below:

(A) In favor of the merger of the Company with and into Endo, Inc. , the
execution and delivery by the Company of the Agreement and Plan of Merger, dated
as of November 26, 1999, by and among Endo, Endo Inc. and the Company and the
approval of the terms thereof and each of the other actions contemplated by the
merger agreement and the voting agreements and any actions required in
furtherance of the merger agreement and the voting agreements; and

(B) Against the following actions (other than the merger and the transactions
contemplated by the merger agreement): (1) any extraordinary corporate
transaction, such as a merger, consolidation or other business combination
involving the Company; (2) a sale, lease or transfer of a material amount of
assets of the Company or a reorganization, recapitalization, dissolution or
liquidation of the Company; (3)(a) any change in the majority of the board of
directors of the Company; (b) any material change in the present capitalization
of the Company or any of its subsidiaries or any amendment of the certificate of
incorporation or similar governing document of the Company; (c) any other
material change in the corporate structure or business of the Company; or (d)
any other action, which, in the case of each of the matters referred to in
clauses (a), (b) or (c) above, is intended, or could reasonably be expected, to
impede, interfere with, delay, postpone, discourage or materially adversely
affect the contemplated economic benefits to Endo and Endo Inc. of the merger or
the transactions contemplated by the merger agreement or the voting agreements.

Under the Voting Agreements, each of the Stockholders has agreed to: (1) not
transfer (sale, gift, pledge or dispose), consent to any transfer or enter into
any contract or option with respect to any such transfer of any Common Stock
that would result in that Stockholder no longer having the power to vote or
cause to be voted the Common Stock; (2) not grant any proxy or power-of-attorney
with respect to the Common Stock; (3) not deposit the Common Stock into a voting
trust or enter into a voting agreement; (4) not request that the Company
register the transfer of Common Stock interests; (5) waive appraisal rights; and
(6) not to take any action that would restrict, limit or interfere with the
performance of that Stockholder's obligations under the Voting Agreements or the
Merger Agreement.

The voting agreements were entered into as a condition to, and in consideration
for, the merger agreement. The purpose of entering into the voting agreements
was to facilitate the merger.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Mr. Roger H. Kimmel, a Director of Algos is a partner at Latham & Watkins
which performs legal services for Algos from time to time.

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

In August 1996, Algos entered into a transfer agreement (the 'Transfer
Agreement') with U.S. Dermatologics, Inc., formerly PharmaDyn, Inc., pursuant to
which Algos transferred certain intangible assets having no book value and which
were unrelated to any of Algos' products in development to U.S. Dermatologics,
Inc. and received redeemable preferred stock with an aggregate stated value and
liquidation preference of $2.8 million and all of U.S. Dermatologics, Inc.
common stock. The common stock was subsequently distributed to Algos'
stockholders, warrant holders and certain of its employees. The preferred stock
provided for an annual cumulative dividend of 30%, in the form of cash or common
stock, and a share of other earnings. Pursuant to the transfer agreement, U.S.
Dermatologics, Inc. licensed to Algos certain rights with respect to sales of
pharmaceutical products that may result from the assets that were transferred
for which Algos will pay royalties at rates Algos believes are consistent with
fair market value. Algos entered into a services agreement with U.S.
Dermatologics, Inc. to provide certain consulting and administrative services
for a transitional period. The services agreement expired in June 1998. The
Company's charges for services provided amounted to approximately $198,000,
which was paid in 1998. In 1999, the preferred stock was exchanged for shares
of U.S. Dermatologics, Inc. common stock representing approximately 10% of U.S.
Dermatologics, Inc.'s total outstanding common stock. Messrs. Hyatt, Kimmel,
Ledley and Sulser are members of the board of directors of U.S. Dermatologics,
Inc. Messrs. Hyatt, Kimmel and Lyle and Unifina Holding, A.G. beneficially own
approximately 7%, 6%, 8% and 9% respectively, of the outstanding common stock
of U.S. Dermatologics, Inc.

<PAGE>
PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)(1) Financial Statements:

<TABLE>
<CAPTION>
PAGE
NO. DESCRIPTION
- --- -----------
<C> <S>
16 -- Report of Independent Accountants
17 -- Balance Sheets as of December 31, 1998 and 1999
18 -- Statements of Operations for the years ended December 31,
1997, 1998 and 1999 and cumulative from inception to
December 31, 1999
19 -- Statements of Cash Flows for the years ended December 31,
1997, 1998 and 1999 and cumulative from inception to
December 31, 1999
20 -- Statements of Changes in Stockholders' Equity from
inception to December 31, 1999
22 -- Notes to Financial Statements
</TABLE>

(a)(3) Exhibits:

<TABLE>
<CAPTION>
EXHIBIT
NO. TITLE
--- -----
<C> <S>
1.1 -- Purchase and Registration Rights Agreement, dated as of
November 9, 1999(6)
2.1 -- The Merger Agreement, dated November 26, 1999, by and among
Endo Pharmaceutical Holdings Inc., Endo Inc. and Algos
Pharmaceutical Corporation (the "Merger Agreement"). (7)
3.1 -- Amended and Restated Certificate of Incorporation of
Algos Pharmaceutical Corporation(1)
3.2 -- Amended and Restated By-laws of Algos Pharmaceutical
Corporation(1)
4.1 -- Form of Stock Certificate of Common Stock(1)
4.2 -- Warrant to Purchase 250,000 Shares of Common Stock of
Algos Pharmaceutical Corporation and Biotech Target S.A.,
a Panamanian corporation, dated November 9, 1998(6)
5.1 -- Opinion of Latham & Watkins as to the validity of the
Common Stock(1)
10.1.1 -- Employment Agreement with Respect to John W. Lyle(4)
10.1.3 -- Employment Agreement with Respect to Frank S. Caruso(1)
10.1.4 -- Employment Agreement with Respect to Joseph Sardella(5)
10.2.1 -- 1994 Stock Option Plan(1)
10.2.2 -- 1996 Stock Option Plan(1)
10.2.3 -- 1996 Non-Employee Director Stock Option Plan(2)
10.3.1 -- Algos Pharmaceutical Corporation Stockholders'
Agreement(1)
10.4.1 -- License Agreement with The Medical College of
Virginia(1)(A)
10.4.2 -- License Agreement with McNeil Consumer Products
Company(1)(A)
10.5 -- Lease Agreement with Commercial Realty & Resources
Corp.(3)
21 -- Subsidiaries of the Registrant(1)
23.1 -- Consent of PricewaterhouseCoopers LLP
27 -- Financial Data Schedule, December 31, 1999
99 -- Risk Factors
99.1 -- Form of Warrant Agreement of Endo Pharmaceutical Holdings Inc.
(attached as Exhibit C to the Merger Agreement). (7)
99.2 -- Form of Warrant Agreement of Endo Pharmaceutical Holdings Inc.
(attached as Exhibit I to the Merger Agreement). (7)
99.3 -- Form of Stockholder Voting Agreement between Endo
Pharmaceuticals Holdings Inc. and the stockholder named therein
(attached as Exhibit B to the Merger Agreement). (7)
99.4 -- Form of Employment Agreement between Endo Pharmaceuticals
Holdings Inc. and John W. Lyle (attached as Exhibit H to the
Merger Agreement). (7)
99.5 -- Letter Agreement, dated November 26, 1999, among Algos
Pharmaceutical Corporation, KIA V, L.P. and KEP V, L.P. (7)
</TABLE>

- ---------

(1) Incorporated by reference to the Registrant's registration statement on
Form S-1 declared effective on September 25, 1996.

(2) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996.

(3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1997.

(4) Incorporated by Reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997

(5) Incorporated by Reference to the Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 1998.

(6) Incorporated by Reference to the Registrant's registration statement on
Form S-3 dated March 10, 1999.

(7) Incorporated by reference to the Registrant's Current Report on Form 8-K
dated November 26, 1999.

<PAGE>
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) the Securities Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

ALGOS PHARMACEUTICAL CORPORATION

By: /s/ JOHN W. LYLE
.................................

JOHN W. LYLE
PRESIDENT AND CHIEF EXECUTIVE
OFFICER

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>
/S/ JOHN W. LYLE President, Chief Executive Officer March 30, 2000
......................................... and Director
JOHN W. LYLE

/S/ DONALD G. DRAPKIN Director March 30, 2000
.........................................
DONALD G. DRAPKIN

/S/ MICHAEL HYATT Director March 30, 2000
.........................................
MICHAEL HYATT

/S/ ROGER H. KIMMEL Director March 30, 2000
.........................................
ROGER H. KIMMEL

/S/ JAMES R. LEDLEY Assistant Secretary and Director March 30, 2000
.........................................
JAMES R. LEDLEY

/S/ DIETER A. SULSER Director March 30, 2000
.........................................
DIETER A. SULSER

/S/ GARY ANTHONY Chief Financial Officer and March 30, 2000
......................................... Principal Accounting Officer
GARY ANTHONY
</TABLE>

STATEMENT OF DIFFERENCES

The trademark symbol shall be expressed as .................................'TM'
The registered trademark symbol shall be expressed as ......................' r'

<PAGE>

CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (File No. 333-71851) any on Form S-3 (File No. 333-74189)
of Algos Pharmaceutical Corporation (a development stage enterprise) of our
report dated February 14, 2000 relating to the financial statements, which
appears in this Form 10-K.

PricewaterhouseCoopers LLP

Florham Park, New Jersey
March 30, 2000

<ARTICLE> 5
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-1-1999
<PERIOD-END> DEC-31-1999
<CASH> 30,752
<SECURITIES> 4,011
<RECEIVABLES> 207
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 35,204
<PP&E> 1,384
<DEPRECIATION> 429
<TOTAL-ASSETS> 36,309
<CURRENT-LIABILITIES> 3,951
<BONDS> 0
<COMMON> 174
0
0
<OTHER-SE> 32,358
<TOTAL-LIABILITY-AND-EQUITY> 36,309
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 19,794
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (17,743)
<INCOME-TAX> 0
<INCOME-CONTINUING> (17,743)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (17,743)
<EPS-BASIC> (1.02)
<EPS-DILUTED> (1.02)

<PAGE>

RISK FACTORS

Algos operates in a rapidly changing environment that involves a number of
risks that may significantly affect Algos' results, some of which are beyond
Algos' control. The following discussion highlights some of these risks, and
others are discussed elsewhere in other documents filed by Algos with the
Securities and Exchange Commission.

IF WE ARE UNABLE TO DEVELOP A MARKETABLE PRODUCT FROM WHICH WE CAN DERIVE
REVENUES, WE ARE UNLIKELY TO ACHIEVE PROFITABILITY.

We have no revenues from product sales and no history of commercial
manufacturing or marketing. To date, substantially all of our funding has been
provided by contributions of capital made by our founders, sales of our stock
and payments received under a license agreement with McNeil Consumer Products
Company with whom we are working to develop an over-the-counter pain reliever.
As a result, we have experienced losses since our inception and losses are
continuing and are expected to continue.

We have a limited history upon which you may base an evaluation of our
likely performance and there is a risk that we will not be able to develop a
marketable product and/or achieve profitability. Algos' prospects must be
considered in light of the potential problems, expenses, complications and
delays encountered in connection with the formation of a new business and the
development of new pharmaceutical products, including obtaining the necessary
regulatory approvals, the utilization of unproven technology and the competitive
market environment in which Algos plans to operate.

IF WE ARE UNABLE TO ADEQUATELY DEMONSTRATE THE SAFETY AND EFFECTIVENESS OF
OUR PRODUCTS IN HUMANS, WE MAY NOT BE ABLE TO PROCURE NECESSARY REGULATORY
APPROVALS TO BRING OUR PRODUCTS TO MARKET.

In order to receive regulatory approval to sell our products, Algos must
demonstrate that our potential products are safe and effective in humans.
Although the results of Algos' trials to date have been encouraging, the results
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.
Therefore, there is a risk that we may fail to adequately demonstrate the safety
and efficacy of our products which could delay or prevent regulatory approval of
our products and prevent them from being sold.

The speed with which we complete our clinical trials is dependent upon,
among other factors, the ability to locate and enroll suitable patients at
acceptable facilities. Accordingly, delays in planned patient enrollment in
Algos' current trials or future clinical trials may result in increased costs,
program delays or both, which may delay the ability of Algos to begin generating
revenues.

We currently do not have regulatory approval to sell any products. The FDA
and comparable agencies in foreign countries impose substantial requirements on
the introduction of pharmaceutical products including lengthy and detailed
laboratory and clinical testing and other costly and time-consuming procedures.
Satisfaction of these requirements typically takes a number of years and varies
substantially based upon the type, complexity and novelty of the pharmaceutical
products. There can be no assurance that if clinical trials are completed, Algos
will be able to submit a New Drug Application or that any such application will
be reviewed and approved by the FDA in a timely manner, or at all. 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, which may reduce the
size of the market for Algos' product. See 'Business -- Government Regulation'.

IF ALGOS PRODUCTS ARE NOT ACCEPTED BY THE MARKET, ALGOS WILL NOT BE ABLE TO
ACHIEVE PROFITABILITY.

Even if regulatory approvals are obtained and Algos products prove to be
superior to alternative products on the market, uncertainty exists as to Algos'
ability, or the length of time required, to achieve

<PAGE>
market acceptance of Algos products. A number of factors may limit the market
acceptance of Algos products, including:

the availability of alternative products with greater name and brand
recognition than Algos,

the price of Algos 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 Algos.

Furthermore, some of the Algos products contain opioid ingredients that may
require stringent record-keeping obligations, strict storage requirements and
other limitations on such products' availability that could limit the
distribution and commercial usage of such products. In light of these factors,
there is a significant risk that Algos will not be able to gain market
acceptance for its products which may prevent us from achieving profitability.

OUR SUBSTANTIAL RELIANCE ON THE CAPITAL MARKETS IN ORDER TO MEET OUR
FINANCIAL REQUIREMENTS MAY BE DILUTIVE OF THE VALUE OF ALGOS COMMON STOCK AND
MAY IMPEDE OUR ABILITY TO DEVELOP AND COMMERCIALIZE OUR PRODUCTS.

As a development stage company, Algos requires substantial amounts of
funding for its research and product development programs, operating expenses,
regulatory approvals and sales and marketing expenses, and no assurance can be
given that development and commercialization costs will not exceed the amounts
budgeted for such purposes. Because we do not currently generate any revenues
from product sales, we are dependent on our existing cash and our ability to
raise additional capital in order to fund our operations until we can begin
marketing our products. Any material delay in the marketing of our products may
require us to raise additional capital. Algos has limited financial resources
and its substantial reliance on the capital markets to satisfy its financial
requirements may dilute the value of Algos common stock. Conversely, if Algos is
unable to obtain sufficient funds through the financial markets or through
collaborative or other arrangements on a timely basis, there is a risk that
Algos may be required to delay, scale back or eliminate certain of its research,
development or commercialization programs or to make arrangements with third
parties to develop or commercialize products or technologies that Algos would
otherwise seek to develop or commercialize itself. In the event this occurs,
Algos may not be able to independently develop or commercialize any or all of
its products.

IF ALGOS IS UNABLE TO SUCCESSFULLY MARKET AND SELL OUR PRODUCTS, WE MAY BE
FORCED TO LICENSE OUR PRODUCTS TO OTHERS WHICH WILL HAVE AN ADVERSE EFFECT ON
ALGOS' PROFITABILITY.

Algos intends to market and sell some or all of its products, if
successfully developed and approved, through a direct sales force in the United
States. However, Algos currently has limited marketing and sales staff, and has
yet to establish any product distribution channels. If we are unable to develop
a sales force with technical expertise or to establish appropriate distribution
channels, we may be forced to license products we have developed to third
parties instead of directly marketing them which may reduce our profitability.

IF ALGOS IS UNABLE TO ACQUIRE SUFFICIENT SUPPLIES FROM THIRD PARTIES, THEN
ALGOS' ABILITY TO DELIVER OUR PRODUCTS TO THE MARKET MAY BE IMPEDED.

For instance, Algos currently uses a single contract manufacturer for
supplies of its most developmentally advanced product, MorphiDex'r', and
suppliers of raw materials are limited. The regulatory qualification of
additional suppliers and/or manufacturers may require significant time and
expense. In addition, the acquisition of opioid ingredients as components of
certain Algos products is subject to quota restrictions imposed and administered
by the DEA. Accordingly, there is a risk that

<PAGE>
Algos will be unable to obtain its requested quantities of opioid ingredients
which could be detrimental to Algos' ability to bring its product to market.

IF ALGOS IS UNABLE TO ATTRACT AND RETAIN QUALIFIED PERSONNEL, WE MAY NOT BE
ABLE TO MAINTAIN OUR COMPETITIVE POSITION.

Because of the specialized scientific nature of Algos' business, we are
highly dependent upon our 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 Algos' ability to develop and deliver
our products to market in a competitive manner. While Algos has consulting
agreements with certain key individuals and institutions and has employment
agreements with certain key executives, there can be no assurance that Algos
will be successful in retaining such personnel or their services under existing
agreements. The loss of John Lyle, Algos' Chief Executive Officer, could have a
material adverse effect on Algos because of the loss of Mr. Lyle's expertise and
because we would need to expend time and financial resources to seek a new Chief
Executive Officer which would materially slow our efforts to develop and
commercialize our products. Algos currently maintains a $6.0 million life
insurance policy on Mr. Lyle. There is intense competition for qualified
personnel in the areas of Algos' activities, and there can be no assurance that
Algos will be able to continue to attract and retain the qualified personnel
necessary for the development of its business.

IF WE ARE UNABLE TO PATENT OUR TECHNOLOGY OR ARE FOUND TO HAVE VIOLATED OR
INFRINGED ON THE PATENTS OF OTHERS, THIS WOULD ADVERSELY AFFECT OUR ABILITY TO
GENERATE REVENUES AND WE MAY NOT BE ABLE TO RECEIVE AN APPROPRIATE RETURN ON OUR
INVESTMENT.

Algos' policy is to seek patent protection and enforce intellectual property
rights. However, no assurance can be given that any patents will be allowed or
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. Because we are a
development stage company without brand name recognition for our products, our
ability to successfully patent and protect the technologies we are developing or
may develop in the future is especially crucial to our ability to generate
future revenues and maintain our competitive position. However, there is a risk
that Algos' pending patent applications may not be allowed, or if they are
allowed, that the scope of the claims allowed will be insufficient to protect
Algos products. Furthermore, even issued patents may later be modified or
revoked by the United States Patent and Trademark Office, the PTO, or in legal
proceedings. Any of these outcomes would reduce future revenues and the return
on any investment in Algos.

In addition, no assurance can be given as to whether Algos will be able to
avoid violating or infringing upon patents issued to others. If Algos were found
to be infringing on a patent held by another, Algos might have to seek a license
to use the patented technology. There can be no assurance that, if required,
Algos would be able to obtain such a license on terms acceptable to Algos, if at
all. If a legal action were to be brought against Algos or its licensors or
licensees, Algos could incur substantial costs in defending itself, and there
can be no assurance that such an action would be resolved in Algos' favor. If a
patent infringement dispute were to be resolved against Algos, Algos could be
subject to significant damages and the manufacture or sale of one or more of
Algos' technologies or proposed products, if developed, could be stopped.

IF THIRD-PARTY REIMBURSEMENT FOR OUR PRODUCTS IS UNAVAILABLE OR INADEQUATE,
WE MAY NOT BE ABLE TO REALIZE AN APPROPRIATE RETURN ON OUR INVESTMENT AND/OR THE
MARKET ACCEPTANCE OF OUR PRODUCTS COULD BE ADVERSELY AFFECTED.

<PAGE>
generic alternatives that are currently available, there is a risk that insurers
will be unwilling to provide coverage for our product. If adequate coverage and
reimbursement levels are not provided by government and third-party payers for
uses of Algos products, the market acceptance of our products could be adversely
affected and/or Algos may not be able to establish and maintain price levels
sufficient for the realization of an appropriate return on our investment.

IF ALGOS INCURS INDEMNIFICATION LIABILITY, OR A PRODUCTS LIABILITY SUIT IS
SUCCESSFULLY PROSECUTED AGAINST US, WE MAY NOT HAVE SUFFICIENT FUNDS TO PAY THE
RESULTING LIABILITY.

Algos will be exposed to potential product liability risks, which are
inherent in the testing, manufacturing and marketing of human therapeutic
products. In addition, Algos is contractually obligated under certain of our
license agreements to indemnify the individuals and/or institutions from whom we
have licensed the technology against claims relating to the manufacture and sale
of the products to be sold by Algos. Algos' indemnification liability, as well
as direct liability to consumers for any defects or health risks in the products
sold, could expose Algos to substantial losses which would reduce earnings and
funds available for research and development activities.

Algos currently carries certain liability insurance for our clinical trial
activities and we plan to purchase such product liability insurance as we deem
appropriate prior to marketing our products. McNeil Consumer Products Company is
required by its license agreement to maintain product liability insurance and
may self-insure to cover its indemnification obligations to Algos. However,
there can be no assurance that Algos will be able to obtain or maintain such
insurance on acceptable terms or that any insurance obtained will provide
adequate coverage against potential liabilities.

IF THE MCNEIL LICENSE AGREEMENT IS TERMINATED AND ALGOS DESIRES TO DEVELOP
AND COMMERCIALIZE ITS OVER-THE-COUNTER PRODUCTS, ALGOS MAY BE FORCED TO DO SO
ITSELF WHICH MAY REDUCE PROFITS.

We are relying on McNeil to commercialize products involving acetaminophen,
ibuprofen and certain other over-the-counter pain relievers. Acetaminophen is
the active ingredient in Tylenol and ibuprofen is the active ingredient in
Motrin, both of which are manufactured by McNeil. If the agreement with McNeil
is terminated, then in the event that we desire to develop and commercialize our
products, we may be forced to do so ourselves. Because Algos does not have the
same level of resources as McNeil, this may reduce any potential future revenues
we may otherwise generate.

The license agreement dated June 26, 1996 with McNeil Consumer Products
Company extends until the later of the expiration of Algos' patent rights or ten
years from the date of execution, provided that the agreement is terminable:

by either party in the event of a breach by the other party upon 90 days
notice or upon certain events of bankruptcy;

by McNeil Consumer Products Company, at any time upon 60 days notice; and

by Algos upon certain other circumstances.

IF ALGOS' COMPETITORS SUCCEED IN DEVELOPING COMPETING TECHNOLOGIES MORE
RAPIDLY THAN ALGOS, THE PRODUCTS WE ARE DEVELOPING MAY BE RENDERED OBSOLETE
WHICH WOULD PREVENT US FROM SUCCESSFULLY COMPETING IN OUR TARGET MARKETS.

As a development stage company, Algos' success will largely depend upon its
ability to successfully achieve market share at the expense of existing and
established products in Algos' target markets. A number of pharmaceutical
companies are developing pain relief products. Many of Algos' competitors have a
significantly higher degree of brand name recognition and substantially more
financial resources than those of Algos. They also may have greater research and
development capacities, experience, recognition and marketing, financial and
managerial resources than Algos. Accordingly, if Algos' competitors succeed in
developing competing technologies and obtaining FDA approval for products more
rapidly than Algos, Algos products or technologies may be rendered
non-competitive or obsolete in which case we would be unable to compete in our
target market.

<PAGE>
A THIRD PARTY MAY HAVE DIFFICULTY SUCCESSFULLY MOUNTING A TAKEOVER BID FOR
CONTROL OF ALGOS WHICH COULD PREVENT YOU FROM MAXIMIZING THE VALUE OF YOUR ALGOS
COMMON STOCK AND COULD MAKE YOUR INVESTMENT LESS LIQUID.

The ownership of Algos is concentrated, with a small group of stockholders,
directors, officers and related investors owning approximately 40% of the common
stock. These stockholders, if they acted together, would have the ability to
influence significantly the election of Algos' directors as well as the
management and policies of Algos. This concentration of ownership may have the
effect of delaying or preventing a change of control of Algos. Certain other
provisions of Algos' Amended and Restated Certificate of Incorporation could
also have the effect of delaying or preventing changes of control or management
of Algos, which could adversely affect the market price and liquidity of our
common stock. In addition, Algos is subject to the anti-takeover provisions of
Section 203 of the Delaware General Corporation Law, which prohibits Algos 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 Algos and could make
your investment less liquid.

IF WE, OUR CONTRACTORS OR OTHER ENTITIES ARE UNABLE TO ADEQUATELY ADDRESS
THE POTENTIAL DISRUPTIONS TO COMPUTER SYSTEMS THAT MAY OCCUR DUE TO THE ADVENT
OF THE YEAR 2000, WE MAY NOT BE ABLE TO EFFECTIVELY DEVELOP OR COMMERCIALIZE OUR
PRODUCTS.

A potential problem exists for all companies that rely on computers as the
year 2000 approaches. Computer software applications and systems that use only
the last two digits of a year to refer to a year may not properly recognize the
year 2000. This could cause a disruption of our operations, including, among
other things, a temporary inability to engage in normal business activities.
Because new development projects have not yet commenced and because we have not
completed our preparations for the commercialization and marketing of our
products, our assessment of our readiness with respect to the potential year
2000 computer problem will be ongoing.

With respect to product development activities at Algos, if certain
manufacturing, data management or statistical applications do not function
properly, the conduct of studies or the analysis and reporting of study results
could be delayed and the timing of subsequent development activities and
regulatory filings could be adversely affected.

Algos may make significant additions to and changes in its existing computer
software applications and systems and/or the use of these systems in
anticipation of the possible commercialization of products. If Algos makes any
of these additions or changes, it would affect Algos' exposure to the potential
year 2000 computer problem since Algos would become more reliant on its computer
software applications and systems. If Algos commercializes products, it expects
to place significant dependence on the third parties' computer systems for
purchasing, production, customer order entry and invoicing and other related
activities. A disruption in these systems could result in lost revenue from
inventory shortages, improper execution of customer orders and/or delays in the
resolution and collection of outstanding invoices.

As part of our development and commercialization efforts, we will ask our
outside vendors, manufacturers, suppliers and service providers whether they
and/or any additional information systems and software that we acquire from them
are year 2000 compliant. However, these parties may be unable or unwilling to
make assurances of their year 2000 compliance. And, even if we do receive
assurances of year 2000 compliance, the parties making the assurances may not in
fact be year 2000 compliant. In the event any of our outside vendors,
manufacturers, suppliers and service providers are not year 2000 compliant, we
will likely be prevented from developing or commercializing some or all of our
products in a timely or efficient manner.

UNCERTAINTY ASSOCIATED WITH PRE-CLINICAL STUDIES AND CLINICAL TRIALS

In order to receive regulatory approval to sell its products commercially,
Algos must demonstrate in pre-clinical studies and clinical trials that its
potential products are safe and effective in humans. Although the results of
Algos' pre-clinical studies and clinical trials to date have been encouraging,
the

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results of 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 Algos.

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 Algos'
current trials or future clinical trials may result in increased costs, program
delays or both, which could have a material adverse effect on Algos. There can
be no assurance that if clinical trials are completed Algos will be able to
submit a New Drug Application or that any such application will be reviewed and
approved by the United States Food and Drug Administration (FDA) in a timely
manner, or at all. See 'Business -- Government Regulation.'

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 Algos from obtaining, or affect the timing of, future regulatory
approvals. The effect of government regulation may be to delay marketing of
Algos' new products for a considerable period of time, to impose costly
procedures upon Algos' activities and to furnish a competitive advantage to
larger companies that compete with Algos. There can be no assurance that FDA or
other regulatory approval for any products developed by Algos 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 Algos' products and the
ability to generate product revenue. Algos is also subject to certain United
States Drug Enforcement Agency (DEA) regulations including restrictions on
storage, transportation and administration, for its narcotic products that could
limit the distribution and commercial usage of such products. Government
regulation may increase at any time creating additional hurdles for Algos. The
extent of potentially adverse government regulation which might arise from
future legislation or administrative action cannot be predicted. See
'Business -- Government Regulation.'

UNCERTAINTY OF MARKET ACCEPTANCE

Even if regulatory approvals are obtained, uncertainty exists as to whether
Algos' products will be accepted by the market. A number of factors may limit
the market acceptance of Algos' products, including the timing of regulatory
approvals and market entry relative to competitive products, the availability of
alternative products, the price of Algos' 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 Algos. There
can be no assurance of Algos' ability, or the length of time required, to
achieve market acceptance of Algos' products. In addition, some of Algos'
products contain narcotic ingredients that may require stringent record-keeping
obligations, strict storage requirements and other limitations on such products'
availability that could limit the distribution and commercial usage of such
products.

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NEED FOR ADDITIONAL FUNDS

The amount and timing of Algos' expenditures will depend on the progress of
its research and development, the cost and timing of regulatory approvals, the
amount of spending on sales, marketing and distribution activities in connection
with the possible commercialization of MorphiDex'r', general market conditions,
relationships with potential strategic partners, changes in the focus and
direction of Algos' research and development programs, competitive and
technological advances and other factors. Algos' 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. Algos 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 Algos. Insufficient funds may
require Algos to delay, scale back or eliminate certain of its research,
development or commercialization programs or to make arrangements with third
parties to develop or commercialize products or technologies that Algos would
otherwise seek to develop or commercialize itself. As a result, Algos may not be
able to independently develop or commercialize any or all of the products
described in this report.

LIMITED SALES AND MARKETING EXPERIENCE

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

RELIANCE ON THIRD-PARTY MANUFACTURERS

Algos currently uses, and expects to continue to use, outside contractors to
manufacture drug supplies for its clinical trials. In addition, Algos currently
intends to use outside contractors to manufacture products approved for sale, if
any. There is no assurance that supplies from any such contractor will not be
reduced or interrupted due to FDA and/or DEA regulatory requirements or other
reasons. Such a reduction or interruption could have a material adverse effect
on Algos' development and commercialization activities. Algos currently uses a
single contract manufacturer for supplies of its most developmentally advanced
product, MorphiDex'r', and suppliers of raw materials are limited. The
regulatory qualification of additional suppliers and/or manufacturers may
require significant time and expense. In addition, the acquisition of narcotics
as components of certain of Algos' products is subject to quota restrictions
imposed and administered by the DEA. There is no assurance that Algos will be
able to obtain its requested quantities of such narcotics.

DEPENDENCE ON QUALIFIED PERSONNEL

Because of the specialized scientific nature of Algos' business, Algos 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 Algos. While Algos has consulting
agreements with certain key individuals and institutions and has employment
agreements with its key executives, there can be no assurance that Algos will be
successful in retaining such personnel or their services under existing
agreements. The loss of John Lyle, Algos' Chief Executive Officer, could have a
material adverse effect on Algos. Algos currently maintains a $6.0 million life
insurance policy on Mr. Lyle. There is intense competition for qualified
personnel in the areas of Algos' activities, and there can be no assurance that
Algos will be able to continue to attract and retain the qualified personnel
necessary for the development of its business.

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UNCERTAIN ABILITY TO PROTECT PROPRIETARY TECHNOLOGY

Algos' 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. Algos' policy is to seek patent protection and enforce intellectual
property rights. No assurance can be given that any patent issued or licensed to
Algos 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, Algos 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 United States than abroad. In addition, foreign patents may be more
difficult to protect and/or the remedies available may be less extensive than in
the United States. Patent applications in the United States are maintained in
secrecy until patents issue and, since publication of discoveries in the
scientific or patent literature tends to lag behind actual discoveries, Algos
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 Algos' pending patent
applications will be allowed, or if allowed, whether the scope of the claims
allowed will be sufficient to protect Algos' products.

Algos 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 Algos' products or know-how or
require licensing and the payment of significant fees or royalties by Algos in
order to produce its products. Moreover, there can be no assurance that Algos'
technology does not infringe upon any valid claims of patents owned by others.
If Algos were found to be infringing on a patent held by another, Algos might
have to seek a license to use the patented technology. There can be no assurance
that, if required, Algos would be able to obtain such a license on terms
acceptable to Algos, if at all. If a legal action were to be brought against
Algos or its licensors or licensees, Algos could incur substantial costs in
defending itself, and there can be no assurance that such an action would be
resolved in Algos' favor. If such a dispute were to be resolved against Algos,
Algos could be subject to significant damages and the testing, manufacture or
sale of one or more of Algos' 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 Algos 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 Algos to protect its trade
secrets. See 'Risk Factors -- Dependence on Qualified Personnel.'

UNCERTAIN AVAILABILITY OF HEALTH CARE REIMBURSEMENT

Algos' 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 Algos 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 Algos' products, the market acceptance of these
products could be adversely affected.

LIMITED PRODUCT LIABILITY INSURANCE

Algos will be exposed to potential product liability risks, which are
inherent in the testing, manufacturing and marketing of human therapeutic
products. Algos is contractually obligated under

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certain of its license agreements to indemnify the individuals and/or
institutions from whom it has licensed the technology against claims relating to
the manufacture and sale of the products to be sold by Algos. McNeil Consumer
Products Company, however, has agreed to indemnify Algos for third party claims
or suits resulting from the manufacture, use or sale of the products pursuant to
the McNeil License Agreement. Algos' indemnification liability, as well as
direct liability to consumers for any defects in the products sold, could expose
Algos to substantial risk and losses. Algos currently carries certain liability
insurance for its clinical trial activities but does not have product liability
insurance covering commercial use of its products. Algos plans to purchase such
product liability insurance as it deems appropriate prior to marketing its
products. McNeil Consumer Products Company is required by the McNeil License
Agreement to maintain product liability insurance and may self-insure to cover
its indemnification obligations to Algos. However, there can be no assurance
that Algos will be able to obtain or maintain such insurance on acceptable terms
or that any insurance obtained will provide adequate coverage against potential
liabilities.

CERTAIN RISKS ASSOCIATED WITH THE MCNEIL LICENSE AGREEMENT

The McNeil License Agreement extends until the later of the expiration of
Algos' 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 Consumer Products Company at any time upon 60 days
notice; and (iii) by Algos upon certain other circumstances. Under certain
circumstances, the McNeil License Agreement could terminate with respect to
either acetaminophen or non-steroidal anti-inflammatory drug products without
terminating with respect to the other category. In the event of a termination by
McNeil Consumer Products Company, 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 Algos. In such event, Algos retains the
rights to the results of the two clinical studies funded by Algos, and McNeil
Consumer Products Company retains the rights to the results of the clinical
studies funded by it during the term of the McNeil License Agreement.

COMPETITION AND TECHNOLOGICAL CHANGES, UNCERTAINTY AND OBSOLESCENCE

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

CONCENTRATION OF OWNERSHIP

Algos' directors and officers beneficially own approximately 24% of Algos
common stock and two additional stockholders and related investors control
approximately 17% of the common stock (assuming all warrants held by such
entities are currently exercisable). As a result, these stockholders, if they
acted together, would have the ability to influence significantly the election
of Algos' directors as well as the management and policies of Algos. This
concentration of ownership may have the effect of delaying or preventing a
change of control of Algos.

POSSIBLE VOLATILITY OF STOCK PRICE

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. The market price of Algos

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common stock may prove to be highly volatile from a variety of variable
influences. Announcements of technological innovations, regulatory matters or
new commercial products by Algos or its competitors, developments or disputes
concerning patent or proprietary rights, publicity regarding actual or potential
clinical results relating to products under development by Algos or its
competitors, regulatory developments in both the United States and foreign
countries, public concern as to the safety of pharmaceutical products, 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 Algos
common stock. The timing and amount of Algos' development and commercialization
expenditures are subject to significant uncertainties; operating results for any
accounting period may not be indicative of expected results for future periods.

ABSENCE OF DIVIDENDS

Algos has never declared or paid any cash dividends on its capital stock.
Algos 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 Algos'
Board of Directors after taking into account various factors, including Algos'
financial condition, operating results, current and anticipated cash needs and
plans for expansion.

EFFECT OF ANTI-TAKEOVER PROVISIONS

Algos' Amended and Restated Certificate of Incorporation provides for a
classified Board of Directors 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 Algos entitled to vote. Algos'
Amended and Restated Certificate of Incorporation requires that any action
required or permitted to be taken by stockholders of Algos 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 Chairman of the Board or the President of
Algos or by the majority of the whole of 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. Algos is subject to the anti-takeover provisions of Section 203
of the Delaware General Corporation Law, which prohibits Algos 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 Algos. Certain other provisions of
Algos' Amended and Restated Certificate of Incorporation could also have the
effect of delaying or preventing changes of control or management of Algos,
which could adversely affect the market price of the common stock.