Pain is a worldwide problem with serious health and economic consequences. The medical effort to treat pain, known as pain management, addresses a large and under-served market. Global Industry Analysts, Inc. estimates that the worldwide prescription market for pain drugs totaled over $28 billion in 2003. IMS Health estimates that nearly $18 billion was spent in 2003 on prescription pain drugs in the United States. In the United States medical economists estimate that pain results in approximately $100 billion of costs annually, as reported by the National Institutes of Health (NIH). Pain in the hospital is associated with increased length of stay, longer recovery times and poorer patient outcomes, all of which have health care quality and cost implications. Approximately 25 million Americans experience acute pain each year due to injury or surgery, according to the American Pain Society and approximately 48 million Americans suffer chronic pain, according to the National Pain Survey published in 1999 by Ortho-McNeil Pharmaceutical, Inc.

According to a Global Strategic Business Report published in 2004 by Global Industry Analysts, Inc., the prescription pain management market is anticipated to grow at a compounded annual growth rate of 9% through 2010 due to a number of factors, including: a rapidly aging population with an increasing need and desire to address pain-related ailments; longer survival times for patients with painful chronic conditions, such as cancer and AIDS; patients’ increased demand for effective pain relief; and increasing recognition of the therapeutic and economic benefits of effective pain management by physicians, other health care providers and payors.

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

ALGRX 4975 is the Company’s product candidate for the treatment of site-specific severe or intractable pain. The Company is developing two formulations of ALGRX 4975 to potentially treat patients with severe pain: a gel formulation for intraoperative use in a variety of surgical procedures, including bunion removal surgery, total knee replacement and abdominal surgeries, such as hernia repair or hysterectomy; and an injectable formulation for post-trauma neuropathic pain and pain resulting from musculoskeletal diseases, such as osteoarthritis and tendonitis.

ALGRX 3268 (PowderJect® Dermal Lidocaine) is the Company’s product candidate that delivers a powder formulation of the local anesthetic lidocaine into the skin using its proprietary needle-free dispenser. ALGRX 3268 is intended to provide rapid, easy-to-administer local analgesia to reduce the pain associated with needle-stick procedures in children and also in adults who have fear of needle insertion.

ALGRX 1207, the preclinical product candidate, is a new molecular entity the Company is developing as a topical local anesthetic to potentially treat patients with certain types of neuropathic pain and for pre-procedural administration to reduce the pain associated with surgical procedures on the skin. The Company believes that a simple-to-use local anesthetic with a long duration of action and deep penetration into the skin would provide significant analgesia and would therefore represent an improvement over existing patches and creams. Based on preclinical studies in animals, ALGRX 1207 has been shown to provide analgesia following direct administration to skin more rapidly and with a longer-lasting effect than currently available topical anesthetics. In addition, the Company believes that ALGRX 1207, if approved, could address the pain associated with a wide variety of procedures involving the skin, including dermatological surgery, cosmetic skin treatments, and catheter placement, as well as the pain arising from surgical incisions that does not subside after the surgery has taken place.

Research and development expenses were $17.2 million for the year ended December 31, 2004, compared with $12.2 million for the year ended December 31, 2003.

General and administrative expenses were $6.5 million for the year ended December 31, 2004, compared with $3.5 million for the year ended December 31, 2003.

Interest expense was $24.0 thousand for the year ended December 31, 2004, compared with $107.0 thousand for the year ended December 31, 2003.

Interest and other income, net was $0.6 million for the year ended December 31, 2004, compared with $86.0 thousand for the year ended December 31, 2003.