PAIN THERAPEUTICS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

OR

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

COMMISSION FILE NUMBER: 000-29959
PAIN THERAPEUTICS, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 91-1911336
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

REMI BARBIER
PRESIDENT AND CHIEF EXECUTIVE OFFICER
416 BROWNING WAY
SOUTH SAN FRANCISCO, CA 94080
(650) 624-8200
(Address, including zip code, or registrant's principal executive offices and
telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $0.001
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 voting stock held by non-affiliates of the
Registrant was approximately $116,242,333 as of February 28, 2002, based upon
the closing price on the Nasdaq National Market reported for such date. This
calculation does not reflect a determination that certain persons are affiliates
of the Registrant for any other purpose. The number of shares outstanding of the
Registrant's common stock on February 28, 2002 was 27,166,603 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for its 2002 Annual Meeting of
Stockholders (the "Proxy Statement"), to be filed with the Securities and
Exchange Commission, are incorporated by reference to Part III of this Form 10-K
Report.
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PAIN THERAPEUTICS, INC.

FORM 10-K

INDEX

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PART I

Our business is subject to numerous risks and uncertainties. See "Risk
Factors."

This document contains forward-looking statements that are based upon
current expectations that are within the meaning of the Private Securities
Reform Act of 1995. It is the Company's intent that such statements be protected
by the safe harbor created thereby. Forward-looking statements involve risks and
uncertainties and our actual results and the timing of events may differ
significantly from the results discussed in the forward-looking statements.
Examples of such forward-looking statements include, but are not limited to:
statements about future operating losses and anticipated operating and capital
expenditures; statements about the potential benefits of our products;
statements about the size and scope of potential markets for our products;
statements relating to the timing, breadth, status or anticipated results of the
clinical development of our products; statements relating to the protection of
our intellectual property; statements about expected future sources of revenue;
statements about potential competitors or products; statements about future
market acceptance of our products; statements about expenses increasing
substantially or fluctuating; statements about future expectations regarding
trade secrets, technological innovations, licensing agreements and outsourcing
of certain business functions; statements about future non-cash charges related
to option grants; statements about anticipated hiring; statements about the
sufficiency of our current resources to fund our operations over the next twelve
months; statements about increasing cash requirements; statements about future
negative operating cash flows; statements about fluctuations in our operating
results; statements about potential additional applications of our technology;
and statements about development of our internal systems and infrastructure.
Such forward-looking statements involve risks and uncertainties, including, but
not limited to, those risks and uncertainties relating to difficulties or delays
in development, testing, regulatory approval, production and marketing of the
Company's drug candidates, unexpected adverse side effects or inadequate
therapeutic efficacy of the Company's drug candidates that could slow or prevent
product approval (including the risk that current and past results of clinical
trials are not indicative of future results of clinical trials), the uncertainty
of patent protection for the Company's intellectual property or trade secrets,
potential infringement of the intellectual property rights or trade secrets of
third parties and the Company's ability to obtain additional financing if
necessary. In addition such statements are subject to the risks and
uncertainties discussed in the "Risk Factors" section and elsewhere in this
document.

ITEM 1. BUSINESS

OVERVIEW

Pain Therapeutics, Inc., is developing a new generation of opioid
painkillers with improved clinical benefits. We believe our drugs will offer
enhanced pain relief and reduced tolerance/physical dependence or addiction
potential compared to existing opioid painkillers. If approved by the Food and
Drug Administration, or FDA, we believe our proprietary drugs could replace many
existing opioid painkillers commonly used to treat moderate to severe pain. The
Company was incorporated in Delaware in May 1998.

INDUSTRY BACKGROUND

CLINICAL PAIN

Clinical pain is any unpleasant sensation that occurs as a result of injury
or disease. Pain can have a protective role by warning of imminent or actual
tissue damage, which can help prevent additional injury. Pain can also trigger a
biological response that helps to preserve or regenerate damaged tissue. In this
respect, pain is usually a normal, predictable response to events such as
surgery, trauma and illness.

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TYPES OF PAIN AND PAIN RELIEF

Drugs are often used to reduce or eliminate pain, especially when the pain
is severe. The type of drug used to relieve pain depends on both the severity
and the duration of the pain. Pain can be classified into three categories of
severity:

Mild Pain. Almost everyone experiences mild pain, such as headaches
or joint pain, at one time or another. People typically treat mild pain
with over-the-counter drugs such as aspirin and acetaminophen.

Moderate Pain. Pain resulting from minor surgery or arthritis are
examples of moderate pain. Physicians typically prescribe opioid
painkillers to treat moderate pain. Opioid painkillers come in three
varieties: weak opioids, strong opioids and synthetic opioids. Weak opioids
such as hydrocodone or codeine are generally used to treat patients with
moderate pain.

Severe Pain. Patients experiencing severe pain often suffer from a
serious underlying illness, such as AIDS or cancer. Severe pain can also
result from major surgery, nerve damage or undetermined causes. Patients
experiencing severe pain often require a strong opioid, such as morphine or
oxycodone, to achieve adequate pain relief.

Pain can also be classified in terms of its duration as either acute or
chronic. Acute pain, such as pain resulting from knee surgery, is brief and
rarely results in long-term consequences. Most acute pain subsides within hours,
days or weeks. Chronic pain persists long after an injury has healed, and
typically results from a chronic illness or appears spontaneously and persists
for undefined reasons. Examples of chronic pain include chronic lower back pain,
and pain resulting from bone cancer or advanced arthritis. The effect of chronic
pain tends to be more pervasive than that of acute pain. Chronic pain often
affects a patient's mood, personality and social relationships. As a result, a
patient with chronic pain commonly suffers from both their state of physical
pain as well as a general decline in their quality of life.

In general, the more severe or chronic the pain, the more likely an opioid
painkiller will be prescribed to treat the pain. The following diagram
illustrates the types of pain which physicians typically treat with opioid
painkillers:

[DIAGRAM]
PAIN MANAGEMENT MARKET

The medical effort to treat pain, known as pain management, addresses a
large market. Clinical pain is a worldwide problem with serious health and
economic consequences. For example, in the United States:

- medical economists estimate that the effects of pain result in
approximately $100 billion of costs annually, including costs associated
with an estimated 515 million lost work days;

- according to the National Institutes of Health, approximately 40 million
Americans are unable to find relief from their pain;

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- more than 30 million Americans suffer chronic pain for which they visit a
doctor;

- approximately one million cancer patients suffer from severe pain at any
given time; and

- an estimated 10% of the more than 200,000 AIDS patients suffer severe
pain.

Drugs are the key element in the treatment of pain. The worldwide market
for pain drugs totaled over $13 billion in 1999. In the United States and
Western Europe the corresponding market for pain drugs totaled over $9 billion.
The pain management market has grown significantly in recent years and is
expected to continue to grow significantly. The U.S. market for prescription
pain drugs has grown by approximately 15% per year during the past five years
due to a number of factors, including:

- a rapidly aging population;

- patients' demand for effective pain relief;

- increasing recognition of the therapeutic and economic benefits of
effective pain management by physicians and healthcare providers and
payers; and

- longer survival times for patients with painful chronic conditions, such
as cancer and AIDS.

This accelerating growth rate appears to be attributable in part to recent
innovations in the treatment of mild pain. For example, COX-2 inhibitors, which
are non-opioid prescription pain relievers, were launched in 1999 and achieved
first-year sales exceeding $1.0 billion and sales for 2001 exceeding $5.0
billion in the United States. COX-2 inhibitors have fewer side effects than
aspirin, and sell for more than twenty times the price of aspirin. The success
of COX-2 inhibitors demonstrates the potential for rapid market acceptance and
premium pricing of pain products that offer reduced side effects.

There have been few scientific innovations in the area of opioid
painkillers since morphine was discovered in 1865. Sales of opioid painkillers
in the United States consist primarily of older off-patent pain drugs, such as
morphine and oxycodone. Notwithstanding the lack of novel drugs, U.S. opioid
painkiller sales were approximately $3.0 billion in 2000.

Approximately 90% of U.S. patients who receive opioids are treated on an
outpatient basis. A portion of these patients receives care at one of the 3,400
specialty pain programs. The relatively low number of pain treatment centers
allows for focused distribution channels for pain management products. This
market structure permits midsize pharmaceutical companies to market and sell
pain products cost-effectively.

OPIOID DRUGS

The history of opium use dates back more than 3,000 years. Today, the use
of opioid drugs to treat patients with moderate to severe pain is widely
accepted throughout the world. Opioids are the drugs of preference for many
caregivers because they have an extensive clinical history, are easy to use and
are available in a variety of doses and formulations. In the United States,
Europe and Japan, physicians use a variety of strong, weak and synthetic opioids
to manage patients' pain.

OPIOID DRUG SEGMENTS

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Patients experiencing acute pain require fast acting, short-lived opioids
and rapid delivery. The most common acute use of opioids is post-surgical pain.
Opioid drugs used to treat acute pain include intravenous morphine and
hydrocodone, which provide rapid pain relief.

In contrast, patients experiencing chronic severe pain often require
long-term, regular use of opioid drugs. Because rapid dose adjustments are not
necessary, patients experiencing chronic pain typically use opioid drugs in
sustained release formulations. Such formulations include fentanyl patches,
sustained release morphine and oxycodone. Although curing chronic pain is
possible, it is infrequent. The aim of using opioid drugs for patients with
chronic pain is to decrease pain and suffering while improving overall physical
and mental functions.

SHORTCOMINGS OF CURRENT PAIN MANAGEMENT

Despite widespread clinical use of opioids, pain management remains less
than optimal. At all doses, opioid painkillers have significant adverse side
effects that limit their usefulness. Adverse side effects include: respiratory
depression, nausea, vomiting, dizziness, sedation, mental clouding,
constipation, urinary retention and severe itching. In addition, chronic use of
opioid painkillers can lead to the need for increasing dosage, and potentially,
addiction. Concerns about addiction often influence clinicians to prescribe less
than adequate doses of opioids. Many patients dislike the adverse side effects
of opioid treatment and voluntarily take less than the prescribed dosage. In all
cases, however, patients and clinicians must reach an appropriate balance
between pain relief and adverse side effects. In addition, patients often use a
process of trial and error with different opioids to identify an opioid that
yields the optimal balance between pain relief and adverse side effects. Some
patients may even prefer to endure pain rather than to withstand the side
effects of opioid therapy. As a result, many patients are seriously
under-treated and may be suffering from pain unnecessarily. In particular,
infants and children receive disproportionately fewer and lower doses of opioid
painkillers than adults.

Historically, there have been few scientific innovations with the opioid
painkillers used to treat moderate to severe pain. To date, product innovations
have focused on increasing convenience, rather than improving clinical benefits.
For example, novel dosing or delivery systems make it more convenient for
patients to use opioid drugs, but these more convenient formulations neither
enhance pain relief nor reduce adverse side effects.

OUR SOLUTION

We are developing a new generation of drugs that address the shortcomings
of existing opioid painkillers. We believe our drugs will offer enhanced pain
relief and reduced tolerance/physical dependence or addiction potential as
compared to many of today's commonly prescribed opioid painkillers.

If approved by the FDA, we believe our drugs could replace many commonly
used opioid painkillers. We also believe our drugs could be used in chronic pain
cases where physicians have been reluctant to prescribe opioid painkillers due
to concerns about adverse side effects or addiction.

Our product candidates use a novel technology developed at Albert Einstein
College of Medicine. Our technology combines very low doses of opioid
antagonists with standard opioid painkillers. We believe that the addition of a
low dose of an opioid antagonist to opioid painkillers has an unexpected and
beneficial effect. We believe that this effect includes enhancing potency and
attenuating tolerance/physical dependence or addiction potential.

STRATEGY

Our goal is to build a leading specialty pharmaceutical company in pain
management. We intend to achieve this goal by:

Building a Drug Franchise in Pain Medications. We intend to develop
drugs that we believe may have broad use for patients with moderate to
severe pain where the use of an opioid painkiller is

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appropriate. We believe this approach may help alleviate physicians'
current tendency to under-prescribe opioid painkillers.

Focusing on Clinical Development and Late Stage Products. We continue
to focus on managing clinical trials including our two lead product
candidates which are in various stages of Phase II clinical trials. The
conduct of human trials is a complex, highly regulated and highly
specialized effort. We believe that our clinical development focus will
enable us to generate product revenues earlier than if we were discovering
and developing new chemical entities.

Retaining Significant Rights. We currently retain worldwide
commercialization rights to all of our technology and pain management
product candidates in all markets and indications. In general, we intend to
independently develop our product candidates through late-stage clinical
trials. As a result, we expect to capture a greater percentage of the
profits from drug sales than we would if we outlicensed our drugs earlier
in the development process. In market segments that require large or
specialized sales forces, such as the market for morphine products, we may
seek sales and marketing alliances with third parties. We believe that such
alliances will enable us to commercialize our drugs rapidly and
cost-effectively.

Using Our Technology to Develop Multiple Drugs for Both Pain and
Non-Pain Indications. We are initially focusing our efforts on developing
opioid painkillers. However, we believe our technology can be broadly
applied to additional segments of the pain market, as well as non-pain
indications.

Outsourcing Key Functions. We intend to continue to outsource
preclinical studies, clinical trials, formulation and manufacturing. We
believe outsourcing will produce significant time savings and allow for
more efficient deployment of our resources.

PRODUCTS IN DEVELOPMENT

We have four painkillers in various stages of Phase II clinical trials.
Each product is a proprietary combination of opioids. The first component is an
opioid agonist, such as morphine. The second component is an opioid antagonist,
such as naltrexone or naloxone. Adding an antagonist to an agonist at usual
clinical doses blocks the action of the agonist. This effect is clinically
useful, for example, to reverse heroin overdose. At a very low-dose, however,
studies indicate that this effect is different: a very low-dose of an opioid
antagonist can enhance pain relief and attenuate the development of tolerance
and addiction. Our technology takes advantage of this effect by combining opioid
agonists with low doses of opioid antagonists. Company sponsored research and
development expenditures were $4.0 million, $12.6 million and $11.7 million in
1999, 2000 and 2001, respectively.

Our trials are designed to produce clinical information about how our
painkillers perform compared to placebo and existing opioid drugs. We plan to
test each of our products in several clinical settings of pain in order to
support a broad approval by the FDA for use of the drug for the relief of
moderate to severe acute and chronic pain. FDA guidelines recommend that we
demonstrate efficacy of our new painkillers in more than one clinical
presentation of pain, such as post-operative pain, cancer pain and various types
of trauma and arthritis pain. Because clinical models differ in their
sensitivity to detect pain, we expect to complete Phase II studies in multiple
clinical models of pain. We have designed most clinical trials to date as
randomized, double-blind, placebo-controlled, dose-ranging studies. A randomized
study is one in which patients are randomly assigned to the various study
treatment arms. A double-blind study is one in which the patient, the physician
and the Company's study monitor are unaware if the patient is receiving placebo
or study drug in order to preserve the integrity of the trial and reduce bias. A
placebo-controlled study is one in which a subset of patients is purposefully
given inactive medication.

MORVIVA(TM)

MorViva(TM) is the brand name for our next generation version of morphine.
We are developing this drug candidate to treat patients with severe pain in
acute or chronic settings. We have both oral and injectible versions of
MorViva(TM) on file with the FDA under separate investigational new drug
applications, or INDs. Oral MorViva(TM) (previously known as PTI-555) consists
of a proprietary combination of morphine plus low-

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dose naltrexone. Injectible MorViva(TM) (previously known as PTI-501) consists
of a proprietary combination of morphine plus low-dose naloxone. If the FDA
approves MorViva(TM), we believe it could be an effective substitute for
morphine. The principal use of morphine is the treatment of patients suffering
from chronic or acute severe pain, such as cancer pain or pain that follows
major surgery or trauma.

More than 1,000 patients have been enrolled in various studies of
MorViva(TM) completed to date. The purpose of these trials was to obtain
pharmacokinetics data and to demonstrate the safety or the efficacy of morphine
in combination with different low doses of naltrexone or naloxone in various
clinical settings of pain.

In October 2001, we announced results of a Phase II clinical trial with
oral MorViva(TM). This trial was a multi-center, randomized, double-blind,
placebo and active controlled clinical study comparing oral MorViva(TM) to
morphine sulfate and placebo. The trial enrolled 210 male patients with moderate
to severe pain following major oral surgery significant enough to warrant opioid
analgesia. Immediately after surgery, patients were randomly assigned to receive
a single oral dose of MorViva(TM), morphine sulfate or placebo. The primary
endpoint of pain relief was achieved with a high degree of statistical
significance against both morphine (p<0.01) and placebo (p<0.001). In this trial
MorViva(TM) was well tolerated and was not associated with any reported serious
adverse events, either during the trial or the subsequent follow-up period. The
percentage of patients reporting any drug related adverse events during the 24
hours following dosing was approximately the same in the morphine and
MorViva(TM) treatment groups.

In March 2002, we announced the results of a preclinical experiment to test
the hypothesis that MorViva(TM) offers minimal opioid tolerance and physical
dependence following chronic administration. In this experiment, two groups of
healthy mice were given chronic doses of either morphine or MorViva(TM) over ten
days. The mice that received morphine quickly became tolerant to drug and no
longer responded to a standard assay of analgesia by day three. Mice that
received MorViva(TM) did not show drug tolerance; these mice showed a continuous
analgesic response during the entire seven day study (p<0.01). Furthermore, when
morphine tolerant mice were switched over to MorViva(TM), these mice showed an
analgesic response without subsequent redevelopment of tolerance (p<0.01). These
results demonstrate the ability of MorViva(TM) to prevent and to reverse opioid
tolerance in lab animals after chronic treatment. At the end of the study, mice
were given naloxone to reverse the effects of morphine. Mice that had been
receiving morphine went into a classic opioid withdrawal behavior, indicating
the presence of physical dependence. Mice that had been receiving MorViva(TM)
did not do so, indicating the absence of physical dependence (p<0.01).

Based on these encouraging results, and the results of earlier clinical
studies, we are designing and conducting new trials to further demonstrate
MorViva's(TM) safety and efficacy in different clinical settings of pain.

OXYTREX(TM)

In April 2001, we announced the addition of OxyTrex(TM) (previously known
as PTI-801) to the Company's pipeline. OxyTrex(TM) is the brand name for our
next generation version of immediate release oxycodone. In 2001, sales of
various formulations of oxycodone exceeded $1 billion in the U.S. We are
developing this drug candidate to treat patients with moderate to severe pain in
a chronic setting. OxyTrex(TM) consists of a proprietary combination of
immediate release oral oxycodone plus low-dose naltrexone. If the FDA approves
OxyTrex(TM), we believe it could be an effective substitute for immediate
release oral oxycodone. The principal use of oxycodone is the treatment of
patients suffering from chronic moderate to severe pain, such as chronic lower
back pain.

To date, we have limited clinical data using OxyTrex(TM). Approximately 20
patients have received OxyTrex(TM) in two pharmacokinetic and safety studies
completed to date. The purpose of these trials was to obtain pharmacokinetics
data and to demonstrate the safety of a fixed dose of immediate release
oxycodone in combination with different low doses of naltrexone in human
volunteers and patients with chronic pain. Low-dose naltrexone is an active
ingredient in both oral MorViva(TM) and OxyTrex(TM).

In January 2002, we announced that the Medicines Control Agency and the
local Institutional Review Board approved our protocol to conduct a clinical
study of OxyTrex(TM) in the U.K. We plan to initiate a

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Phase II study in England in the first quarter of 2002 and if the results of
this trial are positive then we expect these clinical results to support
regulatory filings for approval in both the U.S. and Europe.

In March 2002, we announced the results of a preclinical experiment to test
the hypothesis that OxyTrex(TM) offers minimal opioid tolerance and physical
dependence following chronic administration. In this experiment, two groups of
healthy mice were given chronic doses of either oxycodone or OxyTrex(TM) over
seven days. Mice that received oxycodone quickly developed drug tolerance. In
contrast, mice that received OxyTrex(TM) showed an absence of opioid tolerance.
In addition in this experiment, OxyTrex(TM) was shown to be more potent than
oxycodone over the entire duration of the study. At the end of the study, mice
were given naloxone to reverse the effects of oxycodone. Mice that had been
receiving oxycodone went into a classic opioid withdrawal behavior, indicating
the presence of physical dependence. Mice that had been receiving OxyTrex(TM)
did not do so, indicating the absence of physical dependence (p<0.01).

Based on these encouraging safety results, we are designing and conducting
clinical trials to demonstrate OxyTrex's(TM) safety and efficacy in different
clinical settings of pain.

PTI-701

PTI-701 is a next generation version of hydrocodone. In 2000, U.S. sales of
hydrocodone and similar weak opioids exceeded $500 million. We are developing
this proprietary combination drug to treat patients with acute moderate to
severe pain. PTI-701 is a proprietary combination of hydrocodone, acetaminophen
and low-dose naltrexone. If the FDA approves PTI-701, we believe it could be an
effective substitute for hydrocodone/acetaminophen combination. In the US, all
hydrocodone products are sold in combination with acetaminophen.

We are currently developing PTI-701 on a very limited basis. In 2001 we
made the clinical development of PTI-701 a lower priority in order to focus our
financial resources on MorViva(TM) and OxyTrex(TM). We conducted no significant
clinical activities with regard to PTI-701 in 2001. No significant trials are
planned in the near future using PTI-701.

PTI-601

PTI-601 is a next generation version of tramadol. In 2000, U.S. sales of
tramadol exceeded $500 million. We are developing this proprietary combination
drug to treat patients with moderate pain in an acute setting. PTI-601 is a
combination of tramadol and low-dose naltrexone. If the FDA approves PTI-601, we
believe it could be an effective substitute for tramadol. Tramadol is
principally used to treat patients with acute or chronic moderate pain, such as
arthritis pain.

We are currently developing PTI-601 on a very limited basis. In 2001 we
made the clinical development of PTI-601 a lower priority in order to focus our
financial resources on MorViva(TM) and OxyTrex(TM). In February 2001, we
announced the completion of a 350 patient Phase II clinical trial using PTI-601.
The clinical results of this study have not been publicly disclosed. We
conducted no further clinical activities with regard to PTI-601 in 2001. No
significant trials are planned in the near future using PTI-601.

OTHER PRODUCT CANDIDATES

We believe the use of low-dose opioid antagonists, either alone or in
combination with existing opioid drugs, may have commercial applications beyond
our current product candidates. We believe that our technology can be broadly
applied to additional segments of the pain market, as well as non-pain
indications. Until we undertake preclinical studies and clinical trials, we
cannot be certain that our technology will have such additional applications.

MANUFACTURING

We have no manufacturing facilities. We have entered into agreements with
qualified third parties for the formulation and manufacture of our clinical
supplies. These supplies and the manufacturing facilities must

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comply with U.S. Drug Enforcement Agency, or DEA, regulations and current good
manufacturing practices, or GMPs, enforced by the FDA. We plan to continue to
outsource formulation and manufacturing.

TECHNOLOGY OVERVIEW

According to the current understanding of pain mediation, opioid
painkillers produce their pain relieving effect by activating an inhibitory
pathway in the nervous system. Inhibitory pathways inhibit the transmission of
pain signals into the brain. Scientists at Albert Einstein College of Medicine
have published results suggesting that opioids also stimulate an excitatory
pathway in the nervous system. The excitatory pathway partially counteracts pain
inhibition and is believed to be a major cause of adverse side effects
associated with opioid use, including the development of tolerance and
addiction. In vitro studies on isolated nerve cells have helped researchers
detect and analyze the unique properties of the inhibitory and excitatory
pathways. At the normal clinical doses, the activation of the excitatory pathway
was previously undetected probably due to masking by the inhibitory pathway.

Published results suggest that the selective blockade of the excitatory
pathway promotes the pain relieving potency of morphine in mice by blocking the
excitatory pain-enhancing effect. In addition, preclinical studies have
demonstrated that co-treatment with a very low dose of an opioid antagonist,
such as naloxone or naltrexone, preferentially blocks the excitatory pathway
over the inhibitory pathway, thereby enhancing morphine's ability to inhibit
pain.

We believe that the excitatory pathway plays an important role in
modulating the adverse side effects of opioid use. After repeated administration
of morphine or other opioid painkillers, increasing doses of opioids are
required in order to obtain the same level of pain relief, a process known as
tolerance. If chronic opioid treatment is terminated abruptly, withdrawal
symptoms rapidly appear. Continued administration of opioids prevents the
appearance of withdrawal symptoms, at which point a patient is considered
dependent. Published results also show that tolerance and dependence in mice are
due to sustained activation of the excitatory pathway, and that tolerance and
dependence can be prevented by co-administration of low-dose naltrexone, a pure
opioid antagonist. At very low concentrations, we believe such opioid
antagonists preferentially block excitatory pathways. These results provided the
rationale for our human clinical trials.

The low-dose effect is the most important component of our technology
wherein a very low dose of an opioid antagonist is combined with an opioid
painkiller. Optimal dose ratios of low-dose opioid antagonist to opioid
painkiller depend on their specific pharmacology and the mode of administration.
Published preclinical and clinical dose response studies provide guidance in
formulating optimal ratios of low-dose opioid antagonist to opioid painkiller
for clinical development.

Upon our formation in May 1998, we licensed our technology from Albert
Einstein College of Medicine. We have a worldwide exclusive license to the
technology and all intellectual rights arising from the technology. Our license
rights terminate, upon the expiration of the patents used to protect the
technology, which are scheduled to expire no earlier than September 2012.
Pursuant to the terms of the license, we paid Albert Einstein College of
Medicine a one time licensing fee and are required to pay clinical milestone
payments and royalties based on a percentage of net drug sales. If a product is
combined with a drug or other substance for which we are paying an additional
royalty, the royalty that we pay to Albert Einstein College of Medicine will be
reduced by one-half of the amount of such additional royalty.

Albert Einstein College of Medicine originally received grants from the
U.S. federal government to research some of the technology that we license. The
terms of these grants provide the U.S. federal government with a non-exclusive,
non-transferable paid-up license to practice inventions made with federal funds.
Thus, our licenses are non-exclusive to the extent of the U.S. government's
license. If the U.S. government exercises its rights under this license, it
could make use of the same technology that we license and the size of our
potential market could thereby be reduced.

We seek to protect our technology by, among other methods, filing and
prosecuting U.S. and foreign patents and patent applications with respect to our
technology and products and their uses. The issued patents are scheduled to
expire no earlier than September 2012. We plan to prosecute and defend our
patent

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applications, issued patents and proprietary information. The patent portfolio
includes five issued U.S. patents, one U.S. Notice of Allowance and three
pending U.S. patent applications relating to the low-dose opioid antagonist
technology under our license agreement with Albert Einstein College of Medicine,
and eleven corresponding pending foreign patent applications or issued patents.
Our competitive position and potential future revenues will depend in large part
upon our ability to protect our intellectual property from challenges and to
enforce our patent rights against potential infringers. If our competitors are
able to successfully challenge the validity of our patent rights, based on the
existence of prior art or otherwise, they would be able to market products that
contain features and clinical benefits similar to those of our products, and
demand for our products could decline as a result.

The focus of our patent strategy is to secure and maintain intellectual
property rights to technology for the following categories of our business:

- the clinical use of a low-dose opioid antagonist, either alone or in
combination with an opioid painkiller, for pain management and opioid and
other addiction;

- the use of a low-dose opioid antagonist to render opioid-based anesthesia
products, such as fentanyl or fentanyl analogs, more effective; and

- the clinical use of a low-dose opioid antagonist, either alone or in
combination with any opioid painkiller, for the treatment of other
conditions.

GOVERNMENT REGULATION

Regulation by governmental authorities in the United States and other
countries is a significant factor in the manufacture and marketing of
pharmaceuticals and in our ongoing research and development activities. All of
our products will require regulatory approval by governmental agencies prior to
commercialization. In particular, human therapeutic products are subject to
rigorous preclinical testing and clinical trials and other pre-marketing
approval requirements by the FDA and regulatory authorities in other countries.
In the United States, various federal, and in some cases state statutes and
regulations also govern or impact upon the manufacturing, safety, labeling,
storage, record-keeping and marketing of our products. The lengthy process of
seeking required approvals and the continuing need for compliance with
applicable statutes and regulations, require us to spend substantial resources.
Regulatory approval, when and if obtained, may be limited in scope which may
significantly limit the indicated uses for which our products may be marketed.
Further, approved drugs, as well as their manufacturers, are subject to ongoing
review and discovery of previously unknown problems with such products which may
result in restrictions on their manufacture, sale or use or in their withdrawal
from the market.

Applicable FDA regulations treat our combination of opioid painkillers,
such as morphine, and low-dose opioid antagonists, such as naloxone, as new
drugs and require the filing of a New Drug Application, or NDA, and approval by
the FDA prior to commercialization in the United States. Our clinical trials
seek to demonstrate that an opioid painkiller/low-dose opioid antagonist
combination produces greater beneficial effects than either drug alone.

THE DRUG APPROVAL PROCESS

We will be required to complete several activities before we can market any
of our drugs for human use in the United States, including:

- preclinical studies;

- submission to the FDA of an IND which must become effective before human
clinical trials commence;

- adequate and well-controlled human clinical trials to establish the
safety and efficacy of the product candidate;

9

- submission to the FDA of an NDA; and

- FDA approval of the NDA prior to any commercial sale or shipment of the
drug.

Preclinical tests include laboratory evaluation of product chemistry and
formulation, as well as animal studies to assess the potential safety of the
product. Preclinical safety tests must be conducted by laboratories that comply
with FDA regulations regarding Good Laboratory Practice, or GLP regulations. We
submitted the results of preclinical tests to the FDA as part of our INDs prior
to commencing clinical trials. We may be required to conduct additional
toxicology studies concurrently with the clinical trials.

Based on preclinical testing, an IND is filed with the FDA to begin human
testing of the drug. The IND becomes effective if not rejected by the FDA within
30 days. The IND must indicate the results of previous experiments, how, where
and by whom the new studies will be conducted, the chemical structure of the
compound, the method by which it is believed to work in the human body, any
toxic effects of the compound found in the animal studies and how the compound
is manufactured. All clinical trials must be conducted in accordance with Good
Clinical Practice, or GCP, regulations. In addition, an Institutional Review
Board, or IRB, generally comprised of physicians at the hospital or clinic where
the proposed studies will be conducted, must review and approve the IND. The IRB
also continues to monitor the study. We must submit progress reports detailing
the results of the clinical trials to the FDA at least annually. In addition,
the FDA may, at any time during the 30-day period or at any time thereafter,
impose a clinical hold on proposed or ongoing clinical trials. If the FDA
imposes a clinical hold, clinical trials cannot commence or recommence without
FDA authorization and then only under terms authorized by the FDA. In some
instances, the IND application process can result in substantial delay and
expense.

Clinical trials are typically conducted in three sequential phases which
may overlap. Phase I tests typically take approximately one year to complete.
The tests study a drug's safety profile, and may include the safe dosage range.
The Phase I clinical studies also determine how a drug is absorbed, distributed,
metabolized and excreted by the body, and the duration of its action. In
addition, we may, to the extent feasible, assess pain relief in our Phase I
trials. Based on discussions with the FDA, our current opioid development
programs were allowed to proceed into Phase II studies. In Phase II clinical
trials, controlled studies are conducted on volunteer patients with the targeted
disease or condition. The primary purpose of these tests is to evaluate the
effectiveness of the drug on the volunteer patients as well as to determine if
there are any side effects. These studies may be conducted concurrently with
Phase I clinical trials. In addition, Phase I/II clinical trials may be
conducted to evaluate not only the efficacy of the drug on the patient
population, but also its safety. We currently have four opioid painkillers in
various stages of Phase II clinical trials. During Phase III clinical trials,
the drug is studied in an expanded patient population and in multiple sites.
Physicians monitor the patients to determine efficacy and to observe and report
any reactions that may result from long-term or expanded use of the drug.

The FDA publishes industry guidelines specifically for the clinical
evaluation of painkillers. We rely in part on these guidelines to design a
clinical strategy for the approval of each of our product candidates. In
particular, FDA guidelines recommend that we demonstrate efficacy of our new
painkillers in more than one clinical model of pain, typically including dental
pain. Other acceptable clinical models of pain include post-operative pain,
cancer pain and various types of trauma and arthritis pain. Since models differ
in their pain intensity and their sensitivity to detect pain, we expect to
complete several Phase II studies in multiple clinical models of pain. Upon a
clear demonstration of the safety and efficacy of painkillers in multiple
clinical models of pain, the FDA has historically approved painkillers with
broad indications. Such general purpose labeling often takes the form of "for
the management of moderate to severe pain."

We may not successfully complete Phase I, Phase II or Phase III testing
within any specified time period, or at all, with respect to any of our product
candidates. Furthermore, we or the FDA may suspend clinical trials at any time
in response to concerns that participants are exposed to an unacceptable health
risk.

After the completion of clinical trials, if there is substantial evidence
that the drug is safe and effective, an NDA is filed with the FDA. The NDA must
contain all of the information on the drug gathered to that date, including data
from the clinical trials. NDAs are often over 100,000 pages in length.

10

The FDA reviews all NDAs submitted before it accepts them for filing and
may request additional information rather than accepting a NDA for filing. In
such an event, the NDA must be resubmitted with the additional information and,
again, is subject to review before filing. Once the submission is accepted for
filing, the FDA begins an in-depth review of the NDA. Under the Federal Food,
Drug and Cosmetic Act, the FDA has 365 days in which to review the NDA and
respond to the applicant. The review process is often significantly extended by
FDA requests for additional information or clarification regarding information
already provided in the submission. The FDA may refer the application to an
appropriate advisory committee, typically a panel of clinicians, for review,
evaluation and a recommendation as to whether the application should be
approved. The FDA is not bound by the recommendation of an advisory committee.
If FDA evaluations of the NDA and the manufacturing facilities are favorable,
the FDA may issue either an approval letter, or an approvable letter which
usually contains a number of conditions that must be met in order to secure
final approval of the NDA. When and if those conditions have been met to the
FDA's satisfaction, the FDA will issue an approval letter, authorizing
commercial marketing of the drug for certain indications. If the FDA's
evaluation of the NDA submission or manufacturing facilities is not favorable,
the FDA may refuse to approve the NDA or issue a not approvable letter.

If the FDA approves the NDA, the drug becomes available for physicians to
prescribe. Periodic reports must be submitted to the FDA, including descriptions
of any adverse reactions reported. The FDA may request additional post marketing
studies, or Phase IV studies, to evaluate long-term effects of the approved
drug.

OTHER REGULATORY REQUIREMENTS

The FDA mandates that drugs be manufactured in conformity with current
GMPs. If the FDA approves any of our product candidates we will be subject to
requirements for labeling, advertising, record keeping and adverse experience
reporting. Failure to comply with these requirements could result, among other
things, in suspension of regulatory approval, recalls, injunctions or civil or
criminal sanctions. We may also be subject to regulations under other federal,
state, and local 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,
any of our products that contain narcotics will be subject to DEA regulations
relating to manufacturing, storage, distribution and physician prescribing
procedures. It is possible that any portion of the regulatory framework under
which we operate may change and that such change could have a negative impact on
our current and anticipated operations.

The Controlled Substances Act imposes various registration, record-keeping
and reporting requirements, procurement and manufacturing quotas, labeling and
packaging requirements, security controls and a restriction on prescription
refills on certain pharmaceutical products. A principal factor in determining
the particular requirements, if any, applicable to a product is its actual or
potential abuse profile. The DEA regulates chemical compounds as Schedule I, II,
III, IV or V substances, with Schedule I substances considered to present the
highest risk of substance abuse and Schedule V substances the lowest risk. Any
of our product candidates that contains a scheduled substance will be subject to
regulation by the DEA.

COMPETITION

Our success will depend, in part, upon our ability to achieve market share
at the expense of existing and established and future products in the relevant
target markets. Existing and future products, therapies, technological
approaches or delivery systems will compete directly with our products.
Competing products may provide greater therapeutic benefits for a specific
indication, or may offer comparable performance at a lower cost. Companies that
currently sell generic or proprietary opioid formulations include Roxane
Laboratories, Purdue Pharma, Janssen Pharmaceutica, Abbott Laboratories,
Cephalon, Endo Pharmaceuticals, Elkins-Sinn, Watson Laboratories, Ortho-McNeil
Pharmaceutical and Forest Pharmaceuticals. Alternative technologies are being
developed to increase opioid potency, as well as alternatives to opioid therapy
for pain management, several of which are in clinical trials or are awaiting
approval from the FDA. Such alternatives include Elan's Ziconotide(TM) and Endo
Pharmaceuticals' MorphiDex(R).

11

We compete with fully integrated pharmaceutical companies, smaller
companies that are collaborating with larger pharmaceutical companies, academic
institutions, government agencies and other public and private research
organizations. Many of these competitors have opioid painkiller products already
approved by the FDA or in development and operate larger research and
development programs in these fields than we do. In addition, many of these
competitors, either alone or together with their collaborative partners, have
substantially greater financial resources than we do, as well as significantly
greater experience in:

- developing drugs;

- undertaking preclinical testing and human clinical trials;

- obtaining FDA and other regulatory approvals of drugs;

- formulating and manufacturing drugs; and

- launching, marketing, distributing and selling drugs.

Developments by competitors may render our product candidates or
technologies obsolete or non-competitive.

EMPLOYEES

As of December 31, 2001, we had approximately 33 employees. We engage
consultants from time to time to perform services on a per diem or hourly basis.

ITEM 2. PROPERTIES

We currently lease approximately 10,500 square feet of space in South San
Francisco, California which is used as general office space. Lease payments
under this lease agreement total $1.8 million and commenced in October 2000
through the ten year term of the lease. In April 2001 we completed the build-out
of tenant improvements and relocated to this facility, and subsequently
terminated existing sublease agreements on 6,150 square feet of space also
located in South San Francisco, California. We believe that this facility will
be adequate and suitable for our current needs.

ITEM 3. LEGAL PROCEEDINGS

We are not a party to any legal proceedings.

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

None.

EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth certain information regarding our executive
officers as of December 31, 2001:

Remi Barbier, our founder, has served as our President, Chief Executive
Officer and Chairman since our inception in May 1998. Prior to that time, Mr.
Barbier helped in the growth or founding of: Exelixis Inc., a functional
genomics company, ArQule, a chemistry company, and EnzyMed (now owned by Albany

12

Molecular Research), a chemistry company. Mr. Barbier served as Chief Operating
Officer of Exelixis from January 1996 to May 1998. Prior to that, he was Vice
President of Corporate Development and Clinical Project Manager of Xoma
Corporation, a biotechnology company, from October 1993 to December 1995. Mr.
Barbier received his B.A. from Oberlin College and his M.B.A. from the
University of Chicago. He is a Director of Mendel Biotechnology, Inc. and Poetic
Genetics, Inc.

Nadav Friedmann, M.D., Ph.D., has served as director of Pain Therapeutics,
Inc. since September 1998. In October 2001 Dr. Friedmann joined the Company as
our Chief Operating Officer. Dr. Friedmann is the owner and President of EMET
Research Inc., a consulting firm in the pharmaceutical industry. Dr. Friedmann
was President and Chief Executive Officer of Daiichi Pharmaceutical Corporation,
a pharmaceutical company, from 1997 to April 2000, and before that was a
Consultant to the Board of Directors of Daiichi Pharmaceutical Co., Ltd. in
Tokyo from 1995 to 1997. From 1992 to 1995, Dr. Friedmann served as Vice
President, Clinical Research at Xoma Corporation. From 1980 to 1991, Dr.
Friedmann held various leadership positions with Johnson and Johnson, a
healthcare company, including the position of Vice President and Head of
Research of J&J Biotechnology Center. Prior to that, Dr. Friedmann was Medical
Director of Abbott Laboratories. Dr. Friedmann is a graduate of Albert Einstein
College of Medicine, where he received an M.D., and of the University of
California, San Diego, where he received a Ph.D. degree in Biochemistry.

Edmon R. Jennings joined Pain Therapeutics, Inc. in February 2000. Prior to
that time, Mr. Jennings held senior management positions at Genentech, Inc.,
including Vice President of Corporate Development from December 1995 to January
2000, Vice President of Sales and Marketing from January 1994 to December 1995
and Vice President of Sales from December 1990 to December 1993. Prior to
Genentech, Mr. Jennings held positions with Bristol-Myers Oncology and Bristol
Laboratories, both of which were divisions of Bristol-Myers (now Bristol-Myers
Squibb), a pharmaceutical company, for approximately twelve years. In May 2001,
Mr. Jennings became a member of the Board of Directors for ViroLogic, Inc. Mr.
Jennings received his B.A. from the University of Michigan.

David L. Johnson, CPA, joined Pain Therapeutics, Inc. in January 2000. From
November 1998 to December 1999, Mr. Johnson was an independent financial
consultant, and acted as Chief Financial Officer at Aradigm, a drug delivery
technology company. From October 1997 to November 1998, Mr. Johnson held
positions as Vice President of Finance and Administration of Elan
Pharmaceuticals North America and Vice President of Finance and Chief Financial
Officer of Athena Neurosciences, both of which were divisions of Elan
Pharmaceuticals, a pharmaceutical company. From September 1996 to October 1997,
Mr. Johnson was Director of Finance at Gilead Sciences, a biopharmaceutical
company. From January 1995 to September 1996, Mr. Johnson was an independent
financial consultant and provided accounting services to Chiron, a biotechnology
company. From June 1993 to December 1994, Mr. Johnson was Director of Financial
Planning and Operational Analysis at Chiron. Mr. Johnson is a former member of
the audit staff of KPMG LLP, our auditors. Mr. Johnson received his B.S. in
Accounting from Oklahoma State University.

Grant Schoenhard, Ph.D., joined Pain Therapeutics, Inc. in September 2000
as Vice President of Preclinical Development. In September 2001 Dr. Schoenhard
was promoted to Chief Scientific Officer. From February 2000 to September 2000,
Dr. Schoenhard was a consultant and provided pharmacodynamic research and
development services to various organizations. From September 1998 to February
2000, Dr. Schoenhard was Senior Director of Pharmacokinetics, Drug Metabolism
and Pharmacology at Genentech, Inc. From 1974 to July 1998, Dr. Schoenhard held
various management positions, including Executive Director of Pharmacokinetics,
Drug Metabolism and Radiochemistry at Searle, a pharmaceutical company of
Monsanto Corporation. Since December 1998, Dr. Schoenhard has been a member of
the Board of Directors of LC Resources, Inc. Dr. Schoenhard is also Adjunct
Professor of Pharmacology, School of Medicine, University of Pennsylvania. Dr.
Schoenhard received his B.S. from Michigan State University and his M.S. and
Ph.D. from Oregon State University.

13

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock has been quoted on the Nasdaq National Market under the
symbol "PTIE" since our initial public offering on July 14, 2000. Prior to this
time, there was no public market for our stock. The following table sets forth
the high and low closing sales prices per share of our common stock as reported
on the Nasdaq National Market for the periods indicated. We currently expect to
retain future earnings, if any, for use in the operation and expansion of our
business and have not and do not anticipate paying any cash dividends in the
foreseeable future. As of February 28, 2002 there were 121 holders of record of
our common stock.

On July 19, 2000, we completed our initial public offering (the "IPO")
pursuant to a Registration Statement on Form S-1 (File No. 333-32370). In the
IPO, we sold an aggregate of 5,750,000 shares of common stock (including an
over-allotment option of 750,000 shares) at $12.00 per share. The IPO generated
aggregate gross proceeds of approximately $69,000,000 for the Company. The
aggregate net proceeds to the Company were approximately $62,939,000, after
deducting underwriting discounts and commissions of approximately $4,830,000 and
expenses of the offering of approximately $1,231,000. From the time of receipt
through December 31, 2001 all of the net proceeds of the initial public offering
were invested primarily in short-term, investment grade, interest bearing U.S.
government securities or money market funds. As of December 31, 2001 all of our
cash and cash equivalents were in money market and checking funds.

14

ITEM 6. SELECTED FINANCIAL DATA

15

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

This discussion and analysis should be read in conjunction with our
financial statements and accompanying notes included elsewhere in this report.
Operating results are not necessarily indicative of results that may occur in
future periods.

The following discussion contains forward-looking statements that are based
upon current expectations that are within the meaning of the Private Securities
Reform Act of 1995. It is the Company's intent that such statements be protected
by the safe harbor created thereby. Forward-looking statements involve risks and
uncertainties and our actual results and the timing of events may differ
significantly from the results discussed in the forward-looking statements.
Examples of such forward-looking statements include, but are not limited to:
statements about future operating losses and anticipated operating and capital
expenditures; statements about the potential benefits of our products;
statements about the size and scope of potential markets for our products;
statements relating to the timing, breadth, status or anticipated results of the
clinical development of our products; statements relating to the protection of
our intellectual property; statements about expected future sources of revenue;
statements about potential competitors or products; statements about future
market acceptance of our products; statements about expenses increasing
substantially or fluctuating; statements about future expectations regarding
trade secrets, technological innovations, licensing agreements and outsourcing
of certain business functions; statements about future non-cash charges related
to option grants; statements about anticipated hiring; statements about the
sufficiency of our current resources to fund our operations over the next twelve
months; statements about increasing cash requirements; statements about future
negative operating cash flows; statements about fluctuations in our operating
results; statements about potential additional applications of our technology;
and statements about development of our internal systems and infrastructure.
Such forward-looking statements involve risks and uncertainties, including, but
not limited to, those risks and uncertainties relating to difficulties or delays
in development, testing, regulatory approval, production and marketing of the
Company's drug candidates, unexpected adverse side effects or inadequate
therapeutic efficacy of the Company's drug candidates that could slow or prevent
product approval (including the risk that current and past results of clinical
trials are not indicative of future results of clinical trials), the uncertainty
of patent protection for the Company's intellectual property or trade secrets,
potential infringement of the intellectual property rights or trade secrets of
third parties and the Company's ability to obtain additional financing if
necessary. In addition such statements are subject to the risks and
uncertainties discussed in the "Risk Factors" section and elsewhere in this
document.

OVERVIEW

Pain Therapeutics, Inc. is developing a new generation of opioid
painkillers with improved clinical benefits. We believe our drugs will offer
enhanced pain relief and reduced tolerance/physical dependence or addiction
potential compared to existing opioid painkillers. We conduct our research and
development programs through a combination of internal and collaborative
programs. Our management relies on arrangements with universities, contract
research organizations and clinical research sites for a significant portion of
our product development efforts.

We currently have four opioid painkillers in various stages of Phase II
clinical trials, including our two lead product candidates, MorViva(TM) and
OxyTrex(TM), and two other product candidates, PTI-701 and PTI-601:

- MorViva(TM) is the brand name for our product previously known as PTI-501
(injectible version) and PTI-555 (oral version) which we are developing
to treat patients with severe pain.

- OxyTrex(TM) is the brand name for our product previously known as PTI-801
which we are developing to treat patients with moderate to severe pain in
a chronic setting.

- PTI-701 is the next generation version of hydrocodone, which we are
developing to treat patients with acute moderate to severe pain.

- PTI-601 is the next generation version of tramadol, which we are
developing to treat patients with moderate pain in an acute setting.

16

Based on the results of multiple Phase I and Phase II studies completed for
MorViva(TM) and two pharmacokinetic and safety studies completed for
OxyTrex(TM), we are designing and conducting clinical trials to demonstrate the
safety and efficacy of these two drug candidates in different clinical settings
of pain. We are currently developing PTI-701 and PTI-601 on a very limited basis
in order to focus our financial resources on MorViva(TM) and OxyTrex(TM). No
significant trials are planned in the near future using PTI-701 or PTI-601.

We have yet to generate any revenues from product sales. We have not been
profitable and, since our inception, we have incurred a cumulative deficit of
approximately $36.7 million through December 31, 2001. These losses have
resulted principally from costs incurred in connection with research and
development activities, including costs of preclinical and clinical trials as
well as clinical supplies associated with our product candidates, salaries and
other personnel related costs, including the amortization of deferred
compensation associated with options granted to employees and non-employees, and
general corporate expenses. Our operating results may fluctuate substantially
from period to period as a result of the timing and enrollment rates of clinical
trials for our product candidates, our need for clinical supplies, as well as
the re-measurement of certain deferred stock compensation.

We expect to incur significant additional operating losses for the next
several years. We also expect to continue to incur significant operating and
capital expenditures and anticipate that our expenses will increase
substantially in the foreseeable future as we:

- continue to undertake preclinical and clinical trials for our product
candidates;

- seek regulatory approvals for our product candidates;

- develop, formulate, manufacture and commercialize our drugs;

- implement additional internal systems and develop new infrastructure;

- acquire or in-license additional products or technologies, or expand the
use of our technology;

- maintain, defend and expand the scope of our intellectual property; and

- hire additional personnel.

Product revenue will depend on our ability to receive regulatory approvals
for, and successfully market, our product candidates. In the event that our
development efforts result in regulatory approval and successful
commercialization of our product candidates, we will generate revenue from
direct sales of our products and/or, if we license our products to future
collaborators, from the receipt of license fees and royalties from licensed
products.

Sources of revenue for the foreseeable future may also include payments
from potential collaborative arrangements, including license fees, funded
research payments, milestone payments and royalties based on revenues received
from products commercialized under such arrangements.

CRITICAL ACCOUNTING POLICIES

We believe that of our significant accounting policies (see Note 2 of Notes
to Financial Statements), the policies regarding Research and Development Costs
and Non-cash Stock Based Compensation are most important to the portrayal of our
financial condition and results of operations.

Research and Development Costs

Research and development costs are expensed as incurred and consist of drug
development work associated with our product candidates, primarily including
costs of preclinical and clinical trials, clinical supplies and related
formulation and design costs, research payments to the Albert Einstein College
of Medicine and salaries and other personnel related expenses including non-cash
stock based compensation. Research and development expenses are expected to
increase significantly over the next several years as our development efforts
are expanded and our product candidates enter into various stages of clinical
trials, and may vary significantly from period to period due to the timing of
these activities. There will also continue to be

17

future non-cash charges included in research and development expenses for stock
based compensation related to options granted to employees and consultants.

Non-Cash Stock Based Compensation

Deferred stock compensation for options granted to employees represents the
difference between the exercise price of the option and the fair value of our
common stock on the date of grant in accordance with Accounting Principles Board
Opinion No. 25 and its related interpretations. Deferred compensation for non-
employees is recorded at the fair value of the options granted in accordance
with Statement of Financial Accounting Standards No. 123 and is periodically
re-measured until the underlying options vest in accordance with Emerging Issues
Task Force No. 96-18. The fair value of options granted to non-employees is
estimated using a Black-Scholes option valuation model. The model considers a
number of factors, including the market price and expected volatility of our
common stock at the date of measurement or re-measurement. The compensation
expense related to all grants is amortized over the vesting period of the
related stock options in accordance with Financial Accounting Standards Board
Interpretation No. (FIN) 28.

The amount of compensation expense we record could fluctuate significantly
from period to period as a result of: (a) the periodic re-measurement of
deferred stock compensation for non-employees principally as a result of
fluctuations in the market price of our common stock, (b) the amount of
additional options granted to non-employees and (c) the method by which deferred
stock compensation is amortized as charges to operations.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2001 AND 2000

Agreement with Albert Einstein College of Medicine

In May 1998, we entered into an exclusive, worldwide license agreement with
Albert Einstein College of Medicine for all patents and pending patent
applications relating to low-dose opioid antagonist technology. Our license
rights terminate upon the expiration of the patents used to protect the
technology, which are scheduled to expire no earlier than September 2012.
Pursuant to the terms of the license agreement, in 1998 we paid Albert Einstein
College of Medicine a one-time licensing fee, which was recognized as license
fee expense in accordance with Financial Accounting Standards No. 2, Accounting
for Research and Development Costs, as this technology has no alternative future
use. In addition, we have paid Albert Einstein College of Medicine research
payments that have been recognized as research and development expense. We are
also required to make milestone payments to Albert Einstein College of Medicine
upon the achievement of certain regulatory and clinical events. In the aggregate
these success based milestones may total up to $4.8 million including amounts
due upon receipt of our first drug approval in the U.S. and in specified foreign
countries. We must pay Albert Einstein College of Medicine royalties based on a
percentage of net sales of our products. If a product is combined with a drug or
other substance for which we are paying an additional royalty, the royalty rate
we pay to Albert Einstein College of Medicine will be reduced by one-half of the
amount of such additional royalty.

Research and Development

Research and development expense consists of non-cash stock based
compensation (as described below) and other research and development expense.
Other research and development expense consists of drug

18

development work associated with our product candidates, primarily including
costs of preclinical, clinical trials, clinical supplies and related formulation
and design costs, research payments to the Albert Einstein College of Medicine
and salaries and other personnel related expenses. Other research and
development expense was $11.6 million in the 2001 period compared to $8.7
million in the 2000 period. The period to period increase of $2.9 million was
primarily due to increases in preclinical and clinical development activities,
clinical supplies and related formulation and design costs, salaries and other
personnel related costs associated with increases in staff to support these
activities. Other research and development expenses are expected to increase
significantly over the next several years as our development efforts are
expanded and our product candidates enter into various stages of clinical
trials, and may vary from period to period due to the timing of these
activities.

General and Administrative

General and administrative expense consists of non-cash stock based
compensation (as described below) and other general and administrative expense.
Other general and administrative expense consists primarily of salaries and
other personnel related expenses to support our activities, consulting and
professional services expenses, facilities expenses and other general corporate
expenses. Other general and administrative expenses were $4.5 million in the
2001 period compared to $2.9 million in the 2000 period. The period to period
increase of $1.6 million was primarily due to increases in salaries and other
personnel related costs associated with increased staffing, consulting and
professional services expenses and other general corporate expenses.

Non-Cash Stock Based Compensation

Deferred stock compensation for options granted to employees represents the
difference between the exercise price of the option and the fair value of our
common stock on the date of grant in accordance with Accounting Principles Board
Opinion No. 25 and its related interpretations. Deferred compensation for non-
employees is recorded at the fair value of the options granted in accordance
with Statement of Financial Accounting Standards No. 123 and is periodically
re-measured until the underlying options vest in accordance with Emerging Issues
Task Force No. 96-18. The fair value of options granted to non-employees is
estimated using a Black-Scholes option valuation model. The model considers a
number of factors, including the market price and expected volatility of our
common stock at the date of measurement or re-measurement. The compensation
expense related to all grants is amortized over the vesting period of the
related stock options in accordance with FIN 28.

The amount of compensation expense we record could fluctuate significantly
from period to period as a result of: (a) the periodic re-measurement of
deferred stock compensation for non-employees principally as a result of
fluctuations in the market price of our common stock, (b) the amount of
additional options granted to non-employees and (c) the method by which deferred
stock compensation is amortized as charges to operations.

In connection with the grant of stock options to employees as well as the
re-measurement of deferred stock compensation for grants of stock options to
non-employees, we recorded a decrease in deferred compensation on the balance
sheet of $2.1 million for the period ended December 31, 2001 compared to an
increase of $6.2 million for the period ended December 31, 2000. These amounts
were recorded as a component of stockholders' equity (deficit) and are being
amortized as charges to operations. We recognized non-cash stock based
compensation expense for options granted as well as restricted stock purchase
agreements as components of both research and development expense and general
and administrative expense

19

totaling $1.2 million and $8.7 million for the periods ended December 31, 2001
and 2000, respectively. The decrease was principally the result of the lower
market price of our common stock at the end of 2001 as compared to 2000, the
amortization methodology utilized in accordance with FIN 28 and the inclusion of
$2.6 million of compensation expense related to restricted stock purchase
agreements in the 2000 period. There will also continue to be future non-cash
charges for the amortization of deferred compensation related to options granted
to employees and consultants.

Interest Income

Interest income increased to $3.0 million for the year ended December 31,
2001 from $2.8 million for the year ended December 31, 2000. This increase
resulted from higher average balances of cash and cash equivalents principally
as a result of the completion of our initial public offering in July 2000,
partially offset by declining interest rates in the 2001 period.

Return to Series C Preferred Stockholders for Beneficial Conversion Feature

In February 2000 we issued 3,044,018 shares of Series C redeemable
convertible preferred stock for $14.2 million, net of issuance costs. We
determined that our series C preferred stock was issued with a beneficial
conversion feature. The beneficial conversion feature has been recognized by
allocating a portion of the preferred stock proceeds equal to the intrinsic
value of that feature, limited to the net proceeds received ($14.2 million), to
additional paid-in capital. The intrinsic value is calculated at the date of
issue as the difference between the conversion price of the preferred stock and
the fair value of our common stock, into which the preferred stock is
convertible, multiplied by the number of common shares into which the preferred
stock is convertible, limited to the net proceeds received. As our series C
preferred stock was convertible into common stock at the option of the holder,
at the issuance date of the preferred stock the entire $14.2 million discount
resulting from the allocation of proceeds to the beneficial conversion feature
has been treated as a dividend and recognized as a return to the preferred
stockholders for purposes of computing basic and diluted loss per share in the
period ended December 31, 2000. Upon completion of our initial public offering
in July 2000, all of our convertible preferred and redeemable convertible
preferred stock automatically converted into common stock on a one to one basis.

YEARS ENDED DECEMBER 31, 2000 AND 1999

Research and Development

Research and development expense consists of non-cash stock based
compensation (as described below) and other research and development expense.
Other research and development expenses were $8.7 million in the 2000 period
compared to $2.5 million in the 1999 period. The increase of $6.2 million was
primarily due to increases in clinical development activities for our product
candidates and increases in salaries and other personnel related costs
associated with increasing staffing in support of these activities.

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General and Administrative

General and administrative expense consists of non-cash stock based
compensation (as described below) and other general and administrative expense.
Other general and administrative expenses were $2.9 million in the 2000 period
compared to $0.6 million in the 1999 period. The increase of $2.3 million was
primarily attributable to salaries and other personnel related costs associated
with increased staffing, consulting and professional services expenses.

Non-Cash Stock Based Compensation

In connection with the grant of stock options to employees as well as the
re-measurement of deferred stock compensation for grants of stock options to
non-employees, we recorded an increase in deferred compensation on the balance
sheet of $6.2 million for the period ended December 31, 2000 and $6.5 million
for the period ended December 31, 1999. These amounts were recorded as a
component of stockholders' equity (deficit) and are being amortized as charges
to operations. We recognized non-cash stock based compensation expense for
options granted as well as restricted stock purchase agreements as components of
both research and development expense and general and administrative expense,
which totaled $8.7 million and $1.6 million for the period ended December 31,
2000 and 1999, respectively. The increase was principally the result of the
market price of our common stock at the end of 2000, the amortization
methodology utilized in accordance with FIN 28 and the inclusion of compensation
expense related to restricted stock purchase agreements in the 2000 period.
There will also continue to be future non-cash charges for the amortization of
deferred compensation related to options granted to employees and consultants.

Interest Income

Interest income increased to $2.8 million for the year ended December 31,
2000 from $0.2 million for the year ended December 31, 1999. This increase
resulted from higher average balances of cash and cash equivalents following the
sale of our series B and series C redeemable convertible preferred stock in the
fourth quarter of 1999 and the first quarter of 2000, respectively, and the
completion of our initial public offering in July 2000.

RELATED PARTY TRANSACTIONS

The Company had outstanding full recourse loans aggregating $51,246 and
$157,168 to certain officers and employees of the Company at December 31, 2000
and 2001, respectively. The notes bear interest at rates ranging from 5.5% to
8.0% and have maturities through January 2004. An officer of the Company is also
a director of a private company that provided preclinical drug development
services to the Company totaling $388,805 in 2001. In October 2001, a former
officer of the Company was retained as a consultant. For these services he
received $65,000 in 2001. An officer and director of the Company is also the
president of a consulting firm in the pharmaceutical industry that provided
$48,000 in clinical trial design, data review and interpretational services to
the Company in 2001.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, we have financed our operations primarily through the
private placement of our preferred stock and the public sale of our common
stock. We intend to continue to use these proceeds to fund research and
development activities, capital expenditures, working capital and other general
corporate purposes. As of

21

December 31, 2001, cash and cash equivalents were $65.3 million. Currently, our
cash and cash equivalents are primarily invested in money market funds.

Net cash used in operating activities was $12.4 million for the year ended
December 31, 2001 compared to $7.4 million in 2000 and $2.7 million in 1999.
Cash used in operating activities related primarily to the funding of net
operating losses partially offset by non-cash charges related to amortization of
deferred stock compensation as well as stock issuances pursuant to stock
purchase agreements in the 2000 period.

Our investing activities used cash of $1.3 million in each of the years
ended December 31, 2001 and 2000 compared to $38,545 in 1999. Investing
activities consisted of purchases of property and equipment as well as the
funding of tenant improvements in conjunction with the build-out of new office
space in the 2000 and 2001 periods. We expect to continue making investments in
our infrastructure to support our operations.

Our financing activities provided cash of $0.1 million for the year ended
December 31, 2001 compared to $78.3 million for the year ended December 31, 2000
and $9.7 million in 1999. The 2000 amount consisted primarily of net cash
proceeds of $15.2 million from the issuance of our series C redeemable
convertible preferred stock in February 2000 and net proceeds of $62.9 million
from our initial public offering in July 2000. The 1999 cash flows from
financing activities were primarily the result of the issuance of $9.7 million
of our Series B redeemable convertible preferred stock.

We currently lease approximately 10,500 square feet of general office
space. Lease payments under this lease agreement total $1.8 million and
commenced in October 2000 through the ten-year term of the lease. In April 2001
we completed the build-out of tenant improvements and relocated to this facility
and subsequently terminated existing sublease agreements on 6,150 feet of space.

In addition to office space we also lease equipment pursuant to operating
leases. Our leases expire at various dates through 2010. Under the terms of all
of our leases, future minimum lease payments are as follows:

2002........................................................ $186,249
2003........................................................ 184,638
2004........................................................ 178,878
2005........................................................ 177,726
2006 and thereafter......................................... 844,198

Under the terms of our license agreement with Albert Einstein College of
Medicine, we are required to make milestone payments upon the achievement of
certain regulatory and clinical events. In the aggregate these success-based
milestones may total up to $4.8 million including amounts due upon receipt of
our first drug approval in the U.S. and in specified foreign countries. We also
must pay Albert Einstein College of Medicine royalties based on a percentage of
net sales of our products. If a product is combined with a drug or other
substance for which we are paying an additional royalty, the royalty rate we pay
to Albert Einstein College of Medicine will be reduced by one-half of the amount
of such additional royalty.

Since our inception we have incurred a cumulative deficit of approximately
$36.7 million, including a net loss of $14.3 million in 2001, and we expect to
incur significant additional operating losses for the next several years. Since
inception we have used $22.7 million of cash in operating activities and $2.7
million of cash in investing activities. Since inception, $90.7 million of cash
has been provided by financing activities. At December 31, 2001 cash and cash
equivalents were $65.3 million. We expect our cash requirements to increase in
the foreseeable future as we continue to undertake preclinical and clinical
trials for our product candidates; seek regulatory approvals for our product
candidates; develop, formulate, manufacture and commercialize our drugs;
implement additional internal systems and develop new infrastructure; acquire or
in-license additional products or technologies, or expand the use of our
technology; maintain, defend and expand the scope of our intellectual property;
and hire additional personnel. The amount and timing of cash requirements will
depend on regulatory and market acceptance of our products, if any, and the
resources we devote to researching and developing, formulating, manufacturing,
commercializing and supporting our products. We believe that our current
resources should be sufficient to fund our operations for at least the next

22

twelve months. We may seek additional future funding through public or private
financing within this timeframe, if such funding is available and on terms
acceptable to us.

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS No. 142"), which establishes financial accounting and reporting
for acquired goodwill and other intangible assets and supersedes APB Opinion No
17, "Intangible Assets." SFAS No. 142 addresses how intangible assets that are
acquired individually or with a group of other assets (but not those acquired in
a business combination) should be accounted for in financial statements upon
their acquisition, and after they have been initially recognized in the
financial statements. The provisions of SFAS No. 142 are effective for fiscal
years beginning after December 15, 2001. Pain Therapeutics, Inc. will adopt SFAS
No. 142 during the first quarter of fiscal 2002. Management does not expect the
adoption of SFAS No. 142 to have a material impact on the Company's financial
position and results of operations.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which is
effective for fiscal years beginning after December 15, 2001 and interim periods
within those fiscal periods. SFAS No. 144 supersedes SFAS No. 121 "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of" and parts of APB Opinion No. 30 ("Opinion 30"), "Reporting the Results of
Operations -- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,"
however, SFAS No. 144 retains the requirement of Opinion 30 to report
discontinued operations separately from continuing operations and extends that
reporting to a component of an entity that either has been disposed of (by sale,
by abandonment or in a distribution to owners) or is classified as held for
sale. SFAS No. 144 addresses financial accounting and reporting for the
impairment of certain long-lived assets and for long-lived assets to be disposed
of. Pain Therapeutics, Inc. will adopt SFAS No. 144 during the first quarter of
fiscal 2002. Management does not expect the adoption of SFAS No. 144 to have a
material impact on the Company's financial position and results of operations.

RISK FACTORS

You should carefully consider the following risk factors and all other
information contained in this Form 10-K. Risks and uncertainties, in addition to
those we describe below, that are not presently known to us, or that we
currently believe are immaterial may also impair our business operations. If any
of the following risks occur, our business, operating results and financial
condition could be seriously harmed. In addition, the trading price of our
common stock could suddenly decline due to the occurrence of any of these risks.

OUR BRIEF OPERATING HISTORY MAY MAKE IT DIFFICULT FOR YOU TO EVALUATE THE
SUCCESS OF OUR BUSINESS TO DATE AND TO ASSESS ITS FUTURE VIABILITY.

We were founded in May 1998 and we are still in the development stage. Our
operations to date have been limited to organizing and staffing our company,
acquiring, developing and securing our technology and undertaking preclinical
studies and clinical trials. We have not yet demonstrated our ability to obtain
regulatory approval, formulate and manufacture product or conduct sales and
marketing activities. Consequently, any predictions you make about our future
success or viability may not be as accurate as they could be if we had a longer
operating history.

WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR SUBSTANTIAL LOSSES AND NEGATIVE
OPERATING CASH FLOWS FOR THE FORESEEABLE FUTURE.

We have incurred net losses each year since our inception, including a net
loss of approximately $14.3 million in the year ended December 31, 2001. As a
result of ongoing operating losses, we had an accumulated deficit of $36.7
million as of December 31, 2001. We are not currently profitable. Even if we
succeed in developing and commercializing one or more of our drugs, we expect to
incur substantial losses for the foreseeable future and may never become
profitable. We also expect to continue to incur significant

23

operating and capital expenditures and anticipate that our expenses will
increase substantially in the foreseeable future as we:

- continue to undertake preclinical and clinical trials for our product
candidates;

- seek regulatory approvals for our product candidates;

- develop, formulate, manufacture and commercialize our drugs;

- implement additional internal systems and develop new infrastructure;

- acquire or in-license additional products or technologies, or expand the
use of our technology;

- maintain, defend and expand the scope of our intellectual property; and

- hire additional personnel.

We also expect to experience negative cash flow for the foreseeable future
as we fund our operating losses and capital expenditures. As a result, we will
need to generate significant revenues to achieve and maintain profitability. If
we cannot successfully develop and commercialize our products, we will not be
able to generate such revenues or achieve profitability in the future. Our
failure to achieve or maintain profitability could negatively impact the market
price of our common stock.

IF WE CANNOT RAISE ADDITIONAL CAPITAL ON ACCEPTABLE TERMS, WE MAY BE UNABLE TO
COMPLETE PLANNED ADDITIONAL CLINICAL TRIALS OF ANY OR SOME OF OUR PRODUCT
CANDIDATES.

Until we receive regulatory approval and commercialize one or more of our
products, we will have to fund all of our operations and capital expenditures
from cash on hand. We expect that our current cash and cash equivalents on hand
will be sufficient to meet our working capital and capital expenditure needs for
at least the next twelve months. However, if we experience unanticipated cash
requirements, we may need to raise additional funds much sooner and additional
financing may not be available on favorable terms, if at all. Even if we succeed
in selling additional equity securities to raise funds, our existing
stockholders' ownership percentage would be reduced and new investors may demand
rights, preferences or privileges senior to those of existing stockholders. If
we do not succeed in raising additional funds, we may be unable to complete
planned clinical trials or obtain FDA approval of our product candidates, and we
could be forced to discontinue product development, reduce sales and marketing
efforts and forego attractive business opportunities.

IF OUTSIDE RESEARCHERS FAIL TO DEVOTE SUFFICIENT TIME AND RESOURCES TO OUR DRUG
DEVELOPMENT PROGRAMS, OR IF THEIR PERFORMANCE IS SUBSTANDARD, OUR REGULATORY
SUBMISSIONS AND OUR PRODUCT INTRODUCTIONS MAY BE DELAYED.

We depend on independent investigators and collaborators, such as
universities and medical institutions, to conduct our clinical trials under
agreements with us. These collaborators are not our employees and we cannot
control the amount or timing of resources that they devote to our programs.
These investigators may not assign as great a priority to our programs or pursue
them as diligently as we would if we were undertaking such programs ourselves.
If outside collaborators fail to devote sufficient time and resources to our
drug development programs, or if their performance is substandard, the approval
of our regulatory submissions and our introductions of new drugs will be
delayed. These collaborators may also have relationships with other commercial
entities, some of whom may compete with us. If outside collaborators assist our
competitors at our expense, our competitive position could be harmed.

IF WE ARE UNABLE TO DESIGN, CONDUCT AND COMPLETE CLINICAL TRIALS SUCCESSFULLY,
WE WILL NOT BE ABLE TO SUBMIT A NEW DRUG APPLICATION TO THE FDA.

In order to obtain FDA approval of any of our product candidates, we must
submit to the FDA a New Drug Application, or NDA, which demonstrates that the
product candidate is safe for humans and effective for its intended use. This
demonstration requires significant research and animal tests, which are referred
to as preclinical studies, as well as human tests, which are referred to as
clinical trials. We have four product

24

candidates in various stages of clinical trials including MorViva(TM)
(previously known as PTI-501 (injectible version) and PTI-555 (oral version)),
OxyTrex(TM) (previously known as PTI-801), PTI-701 and PTI-601. We have
completed multiple Phase I and Phase II studies for MorViva(TM) and two
pharmacokinetic and safety studies for OxyTrex(TM), and we are designing and
conducting clinical trials to demonstrate the safety and efficacy of these two
drug candidates in different clinical settings of pain. No significant trials
are planned in the near future for PTI-701 or PTI-601. We will have to commit
substantial time and additional resources to conducting further preclinical and
clinical studies in several types of pain before we can submit NDAs with respect
to any of these product candidates. Our other product candidates are at a much
earlier stage of development and will require extensive preclinical and clinical
testing before we can make any decision to proceed with their clinical
development.

Human clinical trials are very expensive and difficult to design and
implement, in part because they are subject to rigorous requirements. The
clinical trial process is also time consuming. We estimate that clinical trials
of our leading product candidates will take a minimum of three years or more to
complete and may take longer. If we or the FDA believe the participating
patients are being exposed to unacceptable health risks, we would have to
suspend our clinical trials. Furthermore, failure can occur at any stage of the
trials, and we could encounter problems that cause us to abandon clinical trials
or to repeat clinical studies.

Even if our clinical trials are completed as planned, their results may not
support our product claims. Success in pre-clinical testing and early clinical
trials does not ensure that later clinical trials will be successful, and the
results of later clinical trials may not replicate the results of prior clinical
trials and pre-clinical testing. The clinical trial process may fail to
demonstrate that our product candidates are safe for humans and effective for
indicated uses. Such failure would cause us to abandon a product candidate and
may delay development of other product candidates.

IF WE FAIL TO OBTAIN THE NECESSARY REGULATORY APPROVALS, WE WILL NOT BE ALLOWED
TO COMMERCIALIZE OUR DRUGS AND WILL NOT GENERATE PRODUCT REVENUES.

Satisfaction of all regulatory requirements typically takes many years, is
dependent upon the type, complexity and novelty of the product candidate and
requires the expenditure of substantial resources for research and development
and testing. Our research and clinical approaches may not lead to drugs that the
FDA considers safe for humans and effective for indicated uses. The FDA may
require us to conduct additional clinical testing or to commit to perform
post-marketing studies, in which cases we would have to expend additional
unanticipated time and resources. The approval process may also be delayed by
changes in government regulation, future legislation or administrative action or
changes in FDA policy that occur prior to or during our regulatory review.
Delays in obtaining regulatory approvals may:

- delay commercialization of, and product revenues from, our product
candidates;

- impose costly procedures on us; and

- diminish any competitive advantages that we may otherwise enjoy.

Even if we comply with all FDA requests, the FDA may ultimately deny one or
more of our NDAs, and we may never obtain regulatory approval for any of our
product candidates. If we fail to achieve regulatory approval of any of our
leading product candidates we will have fewer saleable products and
corresponding product revenues. Even if we receive regulatory approval of our
products, such approval may involve limitations on the indicated uses or
marketing claims we may make for our products. Further, later discovery of
previously unknown problems could result in additional regulatory restrictions,
including withdrawal of products.

In foreign jurisdictions, we must receive marketing authorizations from the
appropriate regulatory authorities before we can commercialize our drugs.
Foreign regulatory approval processes generally include all of the requirements
and risks associated with the FDA approval procedures described above.

25

IF PHYSICIANS AND PATIENTS DO NOT ACCEPT AND USE OUR DRUGS, WE WILL NOT ACHIEVE
SUFFICIENT PRODUCT REVENUES AND OUR BUSINESS WILL SUFFER.

Even if the FDA approves our drugs, physicians and patients may not accept
and use them. Acceptance and use of our drugs will depend on a number of factors
including:

- perceptions by members of the healthcare community, including physicians,
about the safety and effectiveness of our drugs;

- cost-effectiveness of our drugs relative to competing products;

- availability of reimbursement for our products from government or
healthcare payers; and

- effectiveness of marketing and distribution efforts by us and our
licensees and distributors, if any.

Because we expect to rely on sales generated by our current lead product
candidates for substantially all of our product revenues for the foreseeable
future, the failure of any of these drugs to find market acceptance would harm
our business and could require us to seek additional financing.

IF THIRD-PARTY MANUFACTURERS OF OUR PRODUCT CANDIDATES FAIL TO DEVOTE SUFFICIENT
TIME AND RESOURCES TO OUR CONCERNS, OR IF THEIR PERFORMANCE IS SUBSTANDARD, OUR
CLINICAL TRIALS AND PRODUCT INTRODUCTIONS MAY BE DELAYED AND OUR COSTS MAY RISE.

We have no manufacturing facilities and have limited experience in drug
product development and commercial manufacturing. We lack the resources and
expertise to formulate, manufacture or to test the technical performance of our
product candidates. We currently rely on a limited number of experienced
personnel and a small number of contract manufacturers and other vendors to
formulate, test, supply, store and distribute drug supplies for our clinical
trials. Our reliance on a limited number of vendors exposes us to the following
risks, any of which could delay our clinical trials, and consequently delay FDA
approval of our product candidates and commercialization of our products, result
in higher costs or deprive us of potential product revenues:

- Contract commercial manufacturers, their sub-contractors or other third
parties we rely on, may encounter difficulties in achieving the volume of
production needed to satisfy clinical needs or commercial demand, may
experience technical issues that impact quality, and may experience
shortages of qualified personnel to adequately staff production
operations. The use of alternate manufacturers may be difficult because
the number of potential manufacturers that have the necessary
governmental licenses to produce narcotic products is limited.
Additionally, FDA must approve any alternative manufacturer of our
product before we may use the alternative manufacturer to produce our
clinical supplies. It may be difficult or impossible for us to find a
replacement manufacturer on acceptable terms quickly, or at all. Our
contract manufacturers and vendors may not perform as agreed or may not
remain in the contract manufacturing business for the time required to
successfully produce, store and distribute our products.

- Approved third party commercial drug manufacturers may subsequently be
stopped from producing, storing, shipping or testing our drug products
due to their non-compliance with federal, state or local regulations.
Drug manufacturers are subject to ongoing periodic unannounced inspection
by the FDA, the DEA and corresponding state agencies to ensure strict
compliance with good manufacturing practice and other government
regulations and corresponding foreign standards. We do not have control
over third-party manufacturers' compliance with these regulations and
standards.

- If any third-party manufacturer makes improvements in the manufacturing
process for our products, we may not own, or may have to share, the
intellectual property rights to such innovation.

26

IF WE ARE UNABLE TO DEVELOP OUR OWN SALES, MARKETING AND DISTRIBUTION
CAPABILITIES, OR IF WE ARE NOT SUCCESSFUL IN CONTRACTING WITH THIRD PARTIES FOR
THESE SERVICES ON FAVORABLE TERMS, OUR PRODUCT REVENUES COULD BE DISAPPOINTING.

We currently have no sales, marketing or distribution capabilities. In
order to commercialize our products, if any are approved by the FDA, we will
either have to develop such capabilities internally or collaborate with third
parties who can perform these services for us. If we decide to commercialize any
of our drugs ourselves, we may not be able to hire the necessary experienced
personnel and build sales, marketing and distribution operations which are
capable of successfully launching new drugs and generating sufficient product
revenues. In addition, establishing such operations will take time and involve
significant expense. On the other hand, if we decide to enter into co-promotion
or other licensing arrangements with third parties, we may be unable to locate
acceptable collaborators because the significant number of recent business
combinations among pharmaceutical companies has resulted in a reduced number of
potential future collaborators. Even if we are able to identify one or more
acceptable collaborators, we may not be able to enter into any collaborative
arrangements on favorable terms, or at all. In addition, due to the nature of
the market for pain management products, it may be necessary for us to license
all or substantially all of our product candidates to a single collaborator,
thereby eliminating our opportunity to commercialize other pain management
products independently. If we enter into any collaborative arrangements, our
product revenues are likely to be lower than if we marketed and sold our
products ourselves. In addition, any revenues we receive would depend upon the
efforts of our collaborators which may not be adequate due to lack of attention