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8-K

 
Other

Adolor 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-Q

 


 

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

For the quarterly period ended September 30, 2006

OR

 

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

Commission File Number: 000-30039

 


ADOLOR CORPORATION

(Exact Name of Registrant as Specified in its Charter)

 


 

Delaware   31-1429198

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

700 Pennsylvania Drive

Exton, Pennsylvania 19341

(Address of Principal Executive Offices and Zip Code)

484-595-1500

(Registrant’s Telephone Number, Including Area Code)

 


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.    x  Yes     ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

Number of shares outstanding of the issuer’s Common Stock, par value $0.0001 per share, as of October 13, 2006: 45,915,693 shares.

 



Table of Contents

ADOLOR CORPORATION

FORM 10-Q

SEPTEMBER 30, 2006

INDEX

 

         Page No.

PART I.

   FINANCIAL INFORMATION  

ITEM 1.

   Financial Statements (Unaudited):  
   Consolidated Balance Sheets at September 30, 2006 and December 31, 2005   3
   Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005, and the period from August 9, 1993 (inception) to September 30, 2006   4
   Consolidated Statements of Stockholders’ Equity   5
   Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005, and the period from August 9, 1993 (inception) to September 30, 2006   8
   Notes to Consolidated Financial Statements   9

ITEM 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations   14

ITEM 3.

   Quantitative and Qualitative Disclosures About Market Risk   23

ITEM 4.

   Controls and Procedures   23

PART II.

   OTHER INFORMATION  

ITEM 1.

   Legal Proceedings   24

ITEM 1A.

   Risk Factors   24

ITEM 6.

   Exhibits   37
   Signatures   38

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ADOLOR CORPORATION

(A Development Stage Company)

Consolidated Balance Sheets

(Unaudited)

 

    

September 30,

2006

   

December 31,

2005

 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 4,022,057     $ 1,729,099  

Short-term investments (Note 4)

     198,099,906       101,346,020  

Accounts receivable from agreements (Note 5)

     4,232,919       3,214,834  

Prepaid expenses and other current assets

     3,601,148       2,452,191  
                

Total current assets

     209,956,030       108,742,144  

Equipment and leasehold improvements, net

     7,365,730       8,197,470  

Other assets

     302,753       297,003  
                

Total assets

   $ 217,624,513     $ 117,236,617  
                

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 942,526     $ 3,353,296  

Accrued expenses

     14,156,450       11,395,407  

Deferred licensing fees and rent– current

     4,329,192       4,329,192  
                

Total current liabilities

     19,428,168       19,077,895  

Deferred licensing fees and rent– non-current

     28,218,529       31,465,432  

Other liabilities

     235,000       —    
                

Total liabilities

     47,881,697       50,543,327  
                

Commitments and Contingencies (Note 7)

    

Stockholders’ equity:

    

Series A Junior Participating preferred stock, $0.01 par value; 35,000 shares authorized; none issued and outstanding

     —         —    

Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued and outstanding

     —         —    

Common stock, par value $0.0001 per share; 99,000,000 shares authorized; 45,913,305 and 39,106,362 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively

     4,591       3,911  

Additional paid-in capital

     527,691,387       373,751,232  

Deferred compensation

     —         (1,263 )

Unrealized gains/(losses) on available for sale securities

     133,403       (297,460 )

Deficit accumulated during the development stage

     (358,086,565 )     (306,763,130 )
                

Total stockholders’ equity

     169,742,816       66,693,290  
                

Total liabilities and stockholders’ equity

   $ 217,624,513     $ 117,236,617  
                

The accompanying notes are an integral part of the consolidated financial statements.

 

3


Table of Contents

ADOLOR CORPORATION

(A Development Stage Company)

Consolidated Statements of Operations

(Unaudited)

Three and nine months ended September 30, 2006 and 2005 and the period from August 9, 1993

(inception) to September 30, 2006

 

     Three months ended September 30     Nine months ended September 30    

Period from August 9,

1993 (inception) to

September 30,

2006

 
     2006     2005     2006     2005    

Contract revenues (Note 5)

   $ 5,274,588     $ 4,738,414     $ 10,801,683     $ 11,462,372     $ 102,789,851  
                                        

Operating expenses incurred during the development stage:

          

Research and development

     15,496,036       14,526,331       43,061,456       35,349,464       345,783,923  

Marketing, general and administrative

     10,495,160       6,282,488       26,105,792       19,567,944       146,073,658  
                                        

Total operating expenses

     25,991,196       20,808,819       69,167,248       54,917,408       491,857,581  
                                        

Loss from operations

     (20,716,608 )     (16,070,405 )     (58,365,565 )     (43,455,036 )     (389,067,730 )

Interest income

     2,548,822       871,226       6,505,116       2,512,360       30,793,405  

Other income / (expense)

     (4,748 )     (11,079 )     537,014       (11,079 )     187,760  
                                        

Net loss

     (18,172,534 )     (15,210,258 )     (51,323,435 )     (40,953,755 )     (358,086,565 )

Undeclared dividends attributable to mandatorily redeemable convertible preferred stock

     —         —         —         —         10,546,314  

Beneficial conversion feature on mandatorily redeemable convertible preferred stock

     —         —         —         —         48,905,779  
                                        

Net loss allocable to common stockholders

   $ (18,172,534 )   $ (15,210,258 )   $ (51,323,435 )   $ (40,953,755 )   $ (417,538,658 )
                                        

Basic and diluted net loss per share

   $ (0.40 )   $ (0.39 )   $ (1.16 )   $ (1.05 )  
                                  

Shares used in computing basic and diluted net loss per share

     45,780,926       39,087,516       44,332,185       39,086,858    
                                  

The accompanying notes are an integral part of the consolidated financial statements.

 

4


Table of Contents

ADOLOR CORPORATION

(A Development Stage Company)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the period from August 9, 1993 (inception) to December 31, 2002, for the years ended

December 31, 2003, 2004, and 2005, and the nine months ended September 30, 2006

 

    

Common stock

   

Additional

paid-in

capital

   

Deferred

compensation

    Unrealized
gain (loss)
on
available
for sale
securities
   Deficit
Accumulated
during the
development
stage
    Total
stockholders’
equity
 
  

Number

of shares

    Amount             

Inception, August 9, 1993

   —       $ —       $ —       $ —       $ —      $ —       $ —    

Issuance of common stock to founder in November 1994 at $.001 per share

   100,000       10       12,490       (12,400 )     —        —         100  

Issuance of restricted stock in November 1994 and May 1996

   565,411       57       72,355       (66,767 )     —        —         5,645  

Issuance of common stock for technology license agreements in December 1995 at $.125 per share

   50,000       5       6,245       —         —        —         6,250  

Issuance of common stock for services in April 1999 at $3.736 per share

   3,570       —         13,339       —         —        —         13,339  

Value attributed to issuance of warrants

   —         —         60,000       —         —        —         60,000  

Notes issued to employees for stock options exercised

   —         —         (1,056,488 )     —         —        —         (1,056,488 )

Payments on notes granted to employees for stock options

   —         —         424,516       —         —        —         424,516  

Interest receivable converted to principal on employee notes

   —         —         (118,873 )     —         —        —         (118,873 )

Accretion of Series H preferred stock issuance costs

   —         —         (281,794 )     —         —        —         (281,794 )

Forfeiture of stock options

   (70,246 )     (7 )     (1,706,296 )     1,706,303       —        —         —    

Exercise of stock options

   2,119,731       212       2,658,258       —         —        —         2,658,470  

Unrealized gain on investments

   —         —         —         —         343,947      —         343,947  

Conversion of preferred shares

   18,818,421       1,882       80,381,821       —         —        —         80,383,703  

Net proceeds from initial public offering

   6,900,000       690       95,375,779       —         —        —         95,376,469  

Reduction of estimated offering costs

   —         —         400,000       —         —        —         400,000  

Net proceeds from issuance of newly registered shares of common stock

   3,000,000       300       58,962,347       —         —        —         58,962,647  

Issuance of common stock for bonus awards

   7,350       —         320,307       (2,172 )     —        —         318,135  

Deferred compensation resulting from grant of stock options

   —         —         23,766,004       (23,766,004 )     —        —         —    

Accelerated amortization and cancellation of deferred compensation resulting from the acceleration of vesting of stock options

   —         —         (28,555 )     2,884,232       —        —         2,855,677  

Amortization of deferred compensation

   —         —         —         15,549,770       —        —         15,549,770  

Net loss

   —         —         —         —         —        (155,173,797 )     (155,173,797 )
                                                     

Balance, December 31, 2002

   31,494,237     $ 3,149     $ 259,261,455     $ (3,707,038 )   $ 343,947    $ (155,173,797 )   $ 100,727,716  
                                                     

The accompanying notes are an integral part of the consolidated financial statements.

 

5


Table of Contents

ADOLOR CORPORATION

(A Development Stage Company)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY—Continued

For the period from August 9, 1993 (inception) to December 31, 2002, for the years ended

December 31, 2003, 2004 and 2005, and for the nine months ended September 30, 2006

 

     Common stock   

Additional
paid-in

capital

    Deferred
compensation
   

Unrealized

gain (loss)
on
available
for sale
securities

    Deficit
Accumulated
during the
development
stage
    Total
stockholders’
equity
 
  

Number

of shares

    Amount           

Balance, December 31, 2002

   31,494,237     $ 3,149    $ 259,261,455     $ (3,707,038 )   $ 343,947     $ (155,173,797 )   $ 100,727,716  

Payments on notes granted to employees for stock options

   —         —        546,681       —         —         —         546,681  

Interest receivable converted to principal on employee notes

   —         —        (10,051 )     —         —         —         (10,051 )

Forfeiture of stock and stock options

   (1,001 )     —        —         —         —         —         —    

Exercise of stock options

   386,798       39      1,029,322       —         —         —         1,029,361  

Issuance of common stock for bonus awards and under an employment agreement

   9,259       1      (96,537 )     —         —         —         (96,536 )

Issuance of common stock for technology license agreements

   3,829       —        50,006       —         —         —         50,006  

Unrealized loss on investments

   —         —        —         —         (122,723 )     —         (122,723 )

Net proceeds from issuance of newly registered shares of common stock

   6,900,000       690      111,584,379       —         —         —         111,585,069  

Deferred compensation resulting from grant of stock options adjustment

   —         —        145,007       (145,007 )     —         —         —    

Cancellations and accelerated amortization of deferred compensation resulting from the acceleration of vesting of stock options

   —         —        (318,827 )     567,482       —         —         248,655  

Amortization of deferred compensation

   —         —        —         2,526,975       —         —         2,526,975  

Net loss

   —         —        —         —         —         (51,206,219 )     (51,206,219 )
                                                     

Balance, December 31, 2003

   38,793,122       3,879      372,191,435       (757,588 )     221,224       (206,380,016 )     165,278,934  

Payments on notes granted to employees for stock options

   —         —        2,754       —         —         —         2,754  

Interest receivable converted to principal on employee notes

   —         —        (2,935 )     —         —         —         (2,935 )

Exercise of stock options

   287,223       29      1,056,575       —         —         —         1,056,604  

Unrealized loss on investments

   —         —        —         —         (684,681 )     —         (684,681 )

Deferred compensation resulting from grant of stock options adjustment

   —         —        357,602       (357,602 )     —         —         —    

Amortization of deferred compensation

   —         —        —         1,095,725       —         —         1,095,725  

Net loss

   —         —        —         —         —         (43,586,484 )     (43,586,484 )
                                                     

Balance, December 31, 2004

   39,080,345       3,908      373,605,431       (19,465 )     (463,457 )     (249,966,500 )     123,159,917  

Payments on notes granted to employees for stock options

   —         —        15,742       —         —         —         15,742  

Interest receivable converted to principal on employee notes

   —         —        (3,136 )     —         —         —         (3,136 )

Exercise of stock options

   26,017       3      133,195       —         —         —         133,198  

Unrealized gain on investments

   —         —        —         —         165,997       —         165,997  

Amortization of deferred compensation

   —         —        —         18,202       —         —         18,202  

Net loss

   —         —        —         —         —         (56,796,630 )     (56,796,630 )
                                                     

Balance, December 31, 2005

   39,106,362     $ 3,911    $ 373,751,232     $ (1,263 )   $ (297,460 )   $ (306,763,130 )   $ 66,693,290  
                                                     

The accompanying notes are an integral part of the consolidated financial statements.

 

6


Table of Contents

ADOLOR CORPORATION

(A Development Stage Company)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY—Continued

For the period from August 9, 1993 (inception) to December 31, 2002, for the years ended

December 31, 2003, 2004 and 2005, and for the nine months ended September 30, 2006

 

     Common stock   

Additional
paid-in

capital

    Deferred
compensation
    Unrealized
gain (loss)
on
available
for sale
securities
    Deficit
Accumulated
during the
development
stage
    Total
stockholders’
equity
 
  

Number

of shares

   Amount           

Balance, December 31, 2005

   39,106,362    $ 3,911    $ 373,751,232     $ (1,263 )   $ (297,460 )   $ (306,763,130 )   $ 66,693,290  

Net proceeds from issuance of newly registered shares of common stock

   5,750,000      575      135,054,860       —         —         —         135,055,435  

Compensation expense under FAS 123R

   —        —        6,801,106       —         —         —         6,801,106  

Reclassification of stock options issued to consultants

   —        —        (300,428 )     —         —         —         (300,428 )

Reclassification of stock options exercised by consultants

   —        —        86,380       —         —         —         86,380  

Payments on notes granted to employees for stock options

   —        —        35,809       —         —         —         35,809  

Interest receivable converted to principal on employee notes

   —        —        (766 )     —         —         —         (766 )

Exercise of stock options

   1,056,943      105      12,263,194       —         —         —         12,263,299  

Unrealized gain on investments

   —        —        —         —         430,863       —         430,863  

Amortization of deferred compensation

   —        —        —         1,263       —         —         1,263  

Net loss

   —        —        —         —         —         (51,323,435 )     (51,323,435 )
                                                    

Balance, September 30, 2006

   45,913,305    $ 4,591    $ 527,691,387     $ —       $ 133,403     $ (358,086,565 )   $ 169,742,816  
                                                    

 

7


Table of Contents

ADOLOR CORPORATION

(A Development Stage Company)

Consolidated Statements of Cash Flows

(Unaudited)

 

    

Nine months ended

September 30,

   

Period from

August 9, 1993

(inception) to

September 30,

2006

 
     2006     2005    

Net cash flows from operating activities:

      

Net loss

   $ (51,323,435 )   $ (40,953,755 )   $ (358,086,565 )

Adjustments to reconcile net loss to net cash used in operating activities:

      

Non-cash compensation expense

     6,823,321       14,434       29,339,925  

Non-cash warrant value

     —         —         60,000  

Depreciation expense

     1,960,938       2,016,990       12,250,089  

Non-cash proceeds from the trade of equipment

     —         —         120,000  

(Gain)/loss on the sale of equipment

     —         —         (42,698 )

Issuance of common stock for technology license agreements

     —         —         56,256  

Changes in assets and liabilities:

      

Accounts receivable from collaboration agreements

     (1,018,085 )     (332,869 )     (4,232,919 )

Prepaid expenses and other current assets

     (1,148,957 )     866,372       (3,601,148 )

Other assets

     (5,750 )     (197,003 )     (302,753 )

Accounts payable

     (2,410,770 )     (2,454,030 )     942,526  

Deferred licensing fees and rent

     (3,246,903 )     (3,246,903 )     32,547,721  

Accrued expenses

     2,761,043       1,671,833       14,156,450  
                        

Net cash used in operating activities

     (47,608,598 )     (42,614,931 )     (276,793,116 )
                        

Net cash flows from investing activities:

      

Purchases of equipment and leasehold improvements

     (1,129,198 )     (941,504 )     (19,849,300 )

Proceeds from the sale of equipment

     —         —         169,518  

Purchase of short-term investments

     (311,323,023 )     (63,870,046 )     (1,162,605,133 )

Maturities/sales of short-term investments

     215,000,000       106,731,813       964,638,630  
                        

Net cash (used in) / provided by investing activities

     (97,452,221 )     41,920,263       (217,646,285 )
                        

Net cash flows from financing activities:

      

Net proceeds from issuance of common stock

     135,055,435       —         401,379,620  

Net proceeds from issuance of mandatorily redeemable convertible preferred stock and Series B warrants

     —         —         78,501,909  

Proceeds from Series D mandatorily redeemable convertible preferred stock subscription

     —         —         600,000  

Net proceeds from exercise of common stock options and issuance of restricted common stock

     12,263,299       12,263       16,090,188  

Proceeds from notes payable-related parties

     —         —         1,000,000  

Proceeds from notes payable

     —         —         1,832,474  

Payment of notes payable

     —         —         (1,832,474 )

Proceeds received on notes receivable

     35,809       112       1,025,502  

Interest receivable converted to principal on notes

     (766 )     (3,135 )     (135,761 )
                        

Net cash provided by financing activities

     147,353,777       9,240       498,461,458  
                        

Net increase/(decrease) in cash and cash equivalents

     2,292,958       (685,428 )     4,022,057  

Cash and cash equivalents at beginning of period

     1,729,099       6,935,417       —    
                        

Cash and cash equivalents at end of period

   $ 4,022,057     $ 6,249,989     $ 4,022,057  
                        

Supplemental disclosure of cash flow information:

      

Cash paid for interest

   $ —       $ —       $ 240,438  
                        

Cash received from sale of Pennsylvania research and development tax credits

     551,158       —         551,158  

Supplemental disclosure of non-cash financing activities:

      

Unrealized gains (losses) on available for sale securities, net

     430,863       59,087       133,403  

Deferred compensation from issuance of common stock, restricted common stock and common stock options

     —         —         24,496,376  

Issuance of common stock for technology license agreements or for services

     —         —         19,589  

Conversion of Series A through H (excluding D) preferred stock for common stock

     —         —         80,383,703  

Conversion of stock subscription to Series D mandatorily redeemable preferred stock

     —         —         600,000  

Conversion of bridge financing, including accrued interest, to Series B mandatorily redeemable preferred stock

     —         —         1,019,787  
                        

The accompanying notes are an integral part of the consolidated financial statements.

 

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Adolor Corporation

(A Development Stage Company)

Notes to Consolidated Financial Statements

September 30, 2006

(Unaudited)

1. ORGANIZATION AND BUSINESS ACTIVITIES

Adolor (the “Company”) is a development stage biopharmaceutical corporation that was formed in 1993. Since inception, the Company has specialized in the discovery and development of prescription pain management products and expects to commercialize products that are successfully developed. Adolor has a number of product candidates in development, ranging from preclinical studies to pivotal clinical trials. The Company’s most advanced product candidate, Entereg® (alvimopan), is intended to selectively block the unwanted effects of opioid analgesics on the gastrointestinal (GI) tract. For the global development and commercialization of Entereg® as a monotherapy, the Company is collaborating with Glaxo Group Limited (Glaxo) in multiple indications. Separately, the Company is also developing products that combine alvimopan with an opioid analgesic. In addition to products based on alvimopan, the Company is developing a Delta opioid agonist which is currently in phase I clinical safety testing. Additional product candidates are in preclinical development for the treatment of moderate-to-severe pain conditions.

Currently, the Company’s revenues are derived from its collaboration and co-promotion agreements with Glaxo. The Company has not generated any product sales revenues, has incurred operating losses since inception, and has not achieved profitable operations. The Company’s deficit accumulated during the development stage through September 30, 2006 aggregated approximately $358.1 million, and the Company expects to continue to incur substantial losses in future periods. The Company is highly dependent on the success of its research, development and licensing efforts and, ultimately, upon regulatory approval and market acceptance of its products under development, particularly its lead product candidate, Entereg®. Subsequent to September 30, 2006, the Company determined that it will not continue pursuing development of its sterile lidocaine patch program. This decision has no impact on the September 30, 2006 Consolidated Balance Sheet as all development costs have been charged to expense.

Interim Financial Information

The consolidated financial statements include the accounts of Adolor Corporation and its wholly owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation. Effective June 14, 2005, Adolor transacted the dissolution of its wholly owned subsidiary. The information at September 30, 2006 and for periods ended September 30, 2006 and 2005, is unaudited but includes all adjustments (consisting only of normal recurring adjustments) which, in the opinion of management, are necessary to state fairly the financial information set forth in accordance with U.S. generally accepted accounting principles. The interim results are not necessarily indicative of results to be expected for the full fiscal year. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2005 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.

Use of Estimates

The preparation of the Company’s Consolidated Financial Statements in conformity with U.S. generally accepted accounting principles requires management to adopt critical accounting policies and to make estimates and assumptions that affect the amounts reported in its financial statements and accompanying notes. The estimates we make are principally in the areas of contract revenue recognition and research and development expense accrual. Actual results could differ materially from those estimates.

2. RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards 123 (revised 2004), “Share-Based Payment” (SFAS 123R), which requires measurement of all employee stock-based compensation awards using a fair-value method and the recording of such expense in the Consolidated Financial Statements. In addition, the adoption of SFAS 123R requires additional accounting changes related to the income tax effects and disclosure regarding the cash flow effects resulting from share-based payment arrangements. In January 2005, the SEC issued Staff Accounting Bulletin No. 107, which provides supplemental implementation guidance for SFAS 123R. The Company selected the Black-Scholes option pricing model as the method to estimate the fair value for the Company awards and recognizes compensation expense on a straight-line basis over the requisite service period. The Company adopted SFAS 123R in the first quarter of fiscal 2006 (See Note 6).

 

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In November 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards” (FSP 123R-3). The Company has elected to adopt the alternative transition method provided in FSP 123R-3 for calculating the tax effects of stock-based compensation under SFAS 123R. The alternative transition method provides a “short-cut” method to determine the beginning balance of the additional paid-in capital pool related to the tax effects of employee stock-based compensation and the subsequent impact on the additional paid in capital pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that were outstanding upon adoption of SFAS 123R.

3. COMPREHENSIVE LOSS

The following is the reconciliation of net loss to comprehensive loss for the three and nine months ended September 30, 2006 and 2005:

 

     Three months ended September 30,     Nine months ended September 30,  
     2006     2005     2006     2005  

Net loss

   $ (18,172,534 )   $ (15,210,258 )   $ (51,323,435 )   $ (40,953,755 )

Unrealized gains/(losses) on available for sale securities, net

     295,892       1,896       430,863       59,087  
                                

Comprehensive loss

   $ (17,876,642 )   $ (15,208,362 )   $ (50,892,572 )   $ (40,894,668 )
                                

4. SHORT-TERM INVESTMENTS

Short-term investments consist of investment grade fixed income securities with original maturities of greater than three months. All investments are classified as “available for sale” and are considered current assets, as management has the option to sell them at any time.

The following summarizes the short-term investments at September 30, 2006 and December 31, 2005:

 

     Cost   

Gross

unrealized

gains

  

Gross

unrealized

losses

    Fair value

U.S. Government obligations at September 30, 2006

   $ 197,966,503    $ 148,432    $ (15,029 )   $ 198,099,906
                            

U.S. Government obligations at December 31, 2005

   $ 101,643,480    $ —      $ (297,460 )   $ 101,346,020
                            

At September 30, 2006, maturities of investments were as follows:

 

Less than 1 year

   $  188,044,682    $  139,003    $ (15,029 )   $  188,168,656

1-2 years

     9,921,821      9,429      —         9,931,250
                            
   $ 197,966,503    $ 148,432    $ (15,029 )   $ 198,099,906
                            

5. CONTRACT REVENUES

Contract revenues for the three and nine months ended September 30, 2006 and 2005 consist of the following:

 

     Three months ended September 30,    Nine months ended September 30,
     2006    2005    2006    2005

Amortization of up-front license fees

   $ 1,041,669    $ 1,041,669    $ 3,125,007    $ 3,125,007

Collaborative agreement cost reimbursement

     3,599,469      2,361,745      5,737,701      5,412,365

Co-promotion revenue

     633,450      1,335,000      1,938,975      2,925,000
                           

Total contract revenues

   $ 5,274,588    $ 4,738,414    $ 10,801,683    $ 11,462,372
                           

In April 2002, the Company entered into a collaboration agreement with Glaxo for the exclusive worldwide development and commercialization of Entereg® for certain indications. Under the terms of the agreement, Glaxo paid the Company a non-refundable and non-creditable signing fee of $50.0 million during the quarter ended June 30, 2002. The $50.0 million signing fee is reflected in deferred licensing fees and is expected to be recognized as revenue on a straight-line basis through April 2014, the estimated performance period under the collaboration agreement. Revenue related thereto of approximately $1.0 million and $3.1 million was recognized in each of the three and nine month periods ended September 30, 2006 and 2005. In the third quarter of 2004, upon acceptance for review of the Company’s New Drug Application by the Food and Drug Administration, and under the terms of the collaboration agreement, the Company recognized $10.0 million in milestone revenue received from Glaxo.

 

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External expenses for research and development and marketing activities incurred by each company in the United States are reimbursed by the other party pursuant to contractually agreed percentages. Reimbursement amounts owed to the Company by Glaxo are recorded gross on the Consolidated Statements of Operations as contract revenues. The Company recorded collaborative agreement cost reimbursement revenues of approximately $3.6 million and $2.4 million and $5.7 million and $5.4 million, respectively, in the three and nine months ended September 30, 2006 and 2005 under this arrangement. As of September 30, 2006, approximately $3.6 million was receivable from Glaxo for reimbursement of expenses incurred by the Company pursuant to the collaboration agreement.

Glaxo has certain rights to terminate the collaboration agreement. Glaxo also has the right to terminate its rights and obligations with respect to the acute-care indications, or its rights and obligations for the chronic-care indications. Glaxo has the right to terminate the collaboration agreement for breach of the agreement by the Company or for safety related reasons as defined in the collaboration agreement. Glaxo’s rights to terminate the acute-care indications or the chronic-care indications are generally triggered by failure to achieve certain milestones within certain timeframes, adverse product developments or adverse regulatory events. For example, because the postoperative ileus (POI) product has not been commercially sold as of December 31, 2005, Glaxo now possesses the right to terminate the collaboration agreement with respect to the POI product and the other products, defined as the Adolor Products, under the collaboration agreement.

The Company has established a hospital-focused sales force which, under a co-promotion agreement, collaborates with Glaxo representatives to co-promote Glaxo’s anti-thrombotic agent, Arixtra®. Under the terms of the co-promotion agreement, Glaxo will provide payments to Adolor at a contractual rate for the Adolor sales representatives deployed on Arixtra®. The Company recognized co-promotion revenue of approximately $0.6 million and $1.3 million and $1.9 million and $2.9 million, respectively, in the three and nine months ended September 30, 2006 and 2005 related thereto. At September 30, 2006, approximately $0.6 million was receivable from Glaxo pursuant to this agreement.

6. ACCOUNTING FOR STOCK-BASED COMPENSATION

The Company has two stock-based compensation plans (the “Plans”) under which options have typically been granted at a price equal to fair market value of the Company’s common stock on the date of grant. Options granted under the Plans vest at such dates as are determined in connection with their issuance and expire not more than ten years from the date of grant. Upon share option exercise, new shares of the Company’s common stock are issued. The Company does not expect to repurchase shares of its common stock through the remainder of 2006.

Effective January 1, 2006, the Company adopted the fair value measurement and recognition provisions of Statement of Financial Accounting Standards 123 (revised 2004), “Share-Based Payment” (SFAS 123R), using the modified prospective basis transition method. Under this method, stock-based compensation expense recognized to date in fiscal 2006 includes: (a) compensation expense for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation expense for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated using the Black-Scholes option pricing model. The Company recognizes compensation expense for awards granted after December 31, 2005 on a straight-line basis over the requisite service period.

In addition, SFAS No. 123R addresses financial instruments issued as part of share-based payment arrangements in exchange for employee services. Certain of the Company’s share-based payment arrangements are outside the scope of SFAS No. 123R and are subject to Emerging Issues Task Force (“EITF”) Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” which requires the stock options held by certain non-employee consultants to be accounted for as liability awards. The fair value of these vested and unexercised awards was estimated using the Black-Scholes option pricing model and $0.3 million was reclassified from equity to liability as of January 1, 2006. The fair value of the award is remeasured at each financial statement date until the award is settled or expires. During the three and nine months ended September 30, 2006, $258,000 of income and $21,000 of expense was recorded based on the remeasurement of these options. As of September 30, 2006, stock options to acquire 30,334 shares of common stock held by non-employee consultants remained unexercised. As a result of adopting SFAS 123R on January 1, 2006, and the impact of EITF 00-19, the Company’s net loss and basic and diluted net loss per share for the three and nine month period ended September 30, 2006 are $2.1 million and $6.8 million and $0.05 and $0.15 higher than if the Company had continued to account for share-based compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25), the Company’s previously adopted standard for such matters. The following table summarizes the total stock-based compensation expense resulting from stock options included in the Consolidated Statement of Operations.

 

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Three months ended

September 30, 2006

  

Nine months ended

September 30, 2006

Selling, general and administrative

   $ 1,659,835    $ 4,629,883

Research and development

     458,158      2,192,154
             

Total stock-based compensation expense

   $ 2,117,993    $ 6,822,037
             

Prior to January 1, 2006, the Company accounted for the Plans under the recognition and measurement provisions of APB No. 25, and related Interpretations, as permitted by Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (SFAS 148).

The following table illustrates the effect on the net loss and the net loss per share for the three and nine months ended September 30, 2005 as if the Company had applied the fair value recognition provisions of SFAS 123R to options granted under the Company’s stock option plans. For purposes of this pro forma disclosure, the value of the options is estimated using the Black-Scholes option pricing model and amortized to expense over the options’ vesting periods:

 

    

Three months ended

September 30, 2005

   

Nine months ended

September 30, 2005

 

Net loss, as reported

   $ (15,210,258 )   $ (40,953,755 )

Add: Stock-based employee compensation expense included in reported net loss

     —         3,130  

Deduct: Total stock-based employee compensation expense determined under fair value based method

     (1,901,445 )     (5,233,006 )
                

Pro forma net loss

   $ (17,111,703 )   $ (46,183,631 )
                

Net loss per share:

    

Basic and diluted-as reported

   $ (0.39 )   $ (1.05 )

Basic and diluted-pro forma

   $ (0.44 )   $ (1.18 )

The fair value of stock options granted to employees was estimated using the Black-Scholes option pricing model with the following weighted-average assumptions for the three and nine months ended September 30, 2006 and 2005, respectively.

 

    

Three months ended

September 30,

   

Nine months ended

September 30,

 
     2006     2005     2006     2005  

Expected dividend yield

     —         —         —         —    

Expected stock price volatility

     69.4  %     65.6  %     66.1  %     68.5 %

Risk-free interest rate

     4.79 %     4.24  %     4.47  %     3.91  %

Expected life (in years)

     6.0       4.0       6.0       4.0  

Weighted-average fair value at grant date

   $ 14.71     $ 4.85     $ 10.92     $ 5.18  

Expected volatility for the remaining life of the option is based upon historical volatility and the expected life is based upon the simplified method. The risk-free interest rate is calculated using the U.S. Treasury yield curves in effect at the time of grant, for the periods within the contractual life of the options.

 

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The following table summarizes employee stock option activity for the nine month period ended September 30, 2006:

 

     Options    

Weighted

Average

Exercise

Price

  

Weighted

Average

Remaining

Contractual

Life

  

Aggregate

Intrinsic

Value

Outstanding at January 1, 2006

   4,350,774     $ 13.00      

Granted

   1,105,460       16.84      

Exercised

   (1,056,943 )     11.60      

Forfeited, cancelled or expired

   (226,182 )     14.39      
                  

Outstanding at September 30, 2006

   4,173,109       14.30    7.4    $ 7,265,493
                        

Exercisable at September 30, 2006

   2,506,419     $ 14.29    6.6    $ 4,628,731
                        

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value that would have been received by the option holders had all option holders exercised their options on September 30, 2006. Intrinsic value is determined by calculating the difference between the Company’s closing stock price on the last trading day of the third quarter of fiscal 2006 and the exercise price, multiplied by the number of options. The total intrinsic value of options exercised during the three and nine month periods ended September 30, 2006 was $40,000 and $12.7 million, respectively. The total number of in- the-money options exercisable as of September 30, 2006 was 1.2 million. As of September 30, 2006, total unrecognized compensation cost related to unvested stock options was $14.1 million, which will be amortized over the weighted average remaining service period of 2.7 years.

In May 2006, the 2003 Stock-based Incentive Compensation Plan was amended to increase the number of shares of common stock authorized for issuance under the 2003 Plan by 2,500,000. There were 252,051 and 3,048,800 options available for future grant under the 1994 and 2003 plans, respectively, as of September 30, 2006.

7. LEGAL PROCEEDINGS

On April 21, 2004, a lawsuit was filed in the United States District Court for the Eastern District of Pennsylvania against the Company, one of its directors and certain of its officers seeking unspecified damages on behalf of a putative class of persons who purchased the Company’s common stock between September 23, 2003 and January 14, 2004. The complaint alleges violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), in connection with the announcement of the results of certain studies in the Company’s Phase III clinical trials for Entereg®, which allegedly had the effect of artificially inflating the price of the Company’s common stock. This suit has been consolidated with three subsequent actions asserting similar claims under the caption: In re Adolor Corporation Securities Litigation, No. 2:04-cv-01728. On December 29, 2004, the district court issued an order appointing the Greater Pennsylvania Carpenters’ Pension Fund, as Lead Plaintiff. The appointed Lead Plaintiff filed a consolidated amended complaint on February 28, 2005. That Complaint purported to extend the class period, so as to bring claims on behalf of a putative class of Adolor shareholders who purchased stock between September 23, 2003 and December 22, 2004. The Complaint also adds as defendants the Company’s Board of Directors asserting claims against them and the other defendants for violation of Section 11 and Section 15 of the Securities Act of 1933 in connection with the Company’s public offering of stock in November 2003. The Company and the management and director defendants moved to dismiss the Complaint on April 29, 2005. The plaintiffs responded to the motion to dismiss on June 28, 2005, and the defendants’ reply was filed on August 12, 2005. The Company believes that the allegations are without merit and intends to vigorously defend the litigation.

On August 2, 2004, two shareholder derivative lawsuits were filed in the United States District Court for the Eastern District of Pennsylvania, purportedly on behalf of the Company, against its directors and certain of its officers seeking unspecified damages for various alleged breaches of fiduciary duty and waste. The allegations are similar to those set forth in the class action complaints, involving the announcement of the results of certain studies in the Company’s Phase III clinical trials for Entereg®. On November 12, 2004, the Derivative Plaintiff filed an amended Complaint. On December 13, 2004, the Company filed a motion challenging the standing of the Derivative Plaintiff to file the derivative litigation on its behalf. On December 13, 2004, the Company’s directors and officers moved to dismiss the Complaint for the failure to state a claim. Plaintiffs responded to the Company’s and the directors’ and officers’ motions on January 27, 2005. The Company and the Directors and Officers filed reply briefs on February 18, 2005.

The Company has not accrued any amount in the consolidated financial statements as of September 30, 2006 for these matters.

 

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8. PUBLIC OFFERING

On February 10, 2006, the Company filed a shelf registration statement which will allow it to offer up to 6,000,000 shares of common stock from time to time in one or more public offerings. On February 22, 2006, the Company closed a public offering of 5,750,000 shares (including the underwriters’ over allotment) of common stock at $25.00 per share. The Company received net proceeds from the offering of approximately $135.1 million.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Various statements made in this Quarterly Report on Form 10-Q are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include those which express plan, anticipation, intent, contingency, goals, targets or future development and/or otherwise are not statements of historical fact. We have based these forward-looking statements on our current expectations and projections about future events and they are subject to risks and uncertainties known and unknown which could cause actual results and developments to differ materially from those expressed or implied in such statements. These forward-looking statements include statements about the following:

 

    the status and anticipated timing of regulatory review and approval, if any, for our product candidates;

 

    our product development efforts, including results from clinical trials;

 

    anticipated dates of clinical trial initiation, completion and announcement of trial results by us and our collaborators;

 

    anticipated trial results and regulatory submission dates for our product candidates by us and our collaborators;

 

    analysis and interpretation of data by regulatory authorities;

 

    anticipated operating losses and capital expenditures;

 

    our intentions regarding the establishment of collaborations;

 

    anticipated efforts of our collaborators;

 

    estimates of the market opportunity and the commercialization plans for our product candidates;

 

    our intention to rely on third parties for manufacturing;

 

    the scope and duration of intellectual property protection for our products;

 

    the scope of third party patent rights;

 

    our ability to raise additional capital; and

 

    our ability to acquire or in-license products or product candidates.

In some cases, you can identify forward-looking statements by terminology such as “may”, “will”, “should”, “could”, “would”, “expect”, “plan”, “anticipate”, “believe”, “estimate”, “target”, “goal”, “continue”, or the negative of such terms or other similar expressions. Factors that might cause or contribute to differences include, but are not limited to, those discussed in Part II Item 1A. Risk Factors of this Quarterly Report and discussed in our other Securities and Exchange Commission (“SEC”) filings.

We urge you to carefully review and consider the disclosures found in these filings, all of which are available in the SEC EDGAR database at www.sec.gov. Given the uncertainties affecting pharmaceutical companies in the development stage, you are cautioned not to place undue reliance on any such forward-looking statements, any of which may turn out to be wrong due to inaccurate assumptions, unknown risks, uncertainties or other factors. We undertake no obligation to (and expressly disclaim any such obligation to) publicly update or revise the statements made herein or the risk factors that may relate thereto whether as a result of new information, future events or otherwise.

The following discussions should be read in conjunction with our Consolidated Financial Statements and related notes thereto included elsewhere in this Quarterly Report and the Risk Factors in Part II Item 1A of this Report.

 

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Company

Overview

We are a development stage biopharmaceutical corporation that was founded in 1993. Since our inception, we have specialized in the discovery and development of prescription pain management products and expect to commercialize products that we successfully develop. We have a number of product candidates in various stages of development, ranging from preclinical studies to pivotal clinical trials. Our most advanced product candidate, Entereg® (alvimopan), is intended to selectively block the unwanted effects of opioid analgesics on the gastrointestinal (GI) tract. For the global development and commercialization of Entereg® as a monotherapy, we are collaborating with Glaxo Group Limited (Glaxo) in multiple indications. Separately, we are also developing products that combine alvimopan with an opioid analgesic. In addition to products based on alvimopan, we are developing a Delta opioid agonist which is currently in phase I clinical safety testing. Additional product candidates are in preclinical development for the treatment of moderate-to-severe pain conditions.

Entereg® (alvimopan)

Opioid analgesics provide pain relief by stimulating opioid receptors located in the central nervous system. There are, however, opioid receptors throughout the body, including the GI tract. By binding to the receptors in the GI tract, opioid analgesics can slow gut motility and disrupt normal GI function that allows for the passage, absorption and excretion of ingested solid materials. This disruption can cause patients to experience significant discomfort and abdominal pain and may result in their reducing or eliminating their pain medication.

Entereg® is a small molecule, mu-opioid receptor antagonist intended to block the adverse side effects of opioid analgesics on the GI tract without affecting analgesia. We are developing Entereg® for both acute and chronic conditions. The acute indication currently under development is the management of postoperative ileus (POI), a GI condition characterized by the slow return of gut function that can result from GI or other surgeries. Entereg® is also being developed to treat opioid-induced bowel dysfunction (OBD), which is a condition characterized by a number of GI symptoms, including constipation, that often results from chronic use of opioid analgesics to treat persistent pain conditions.

In April 2002, we entered into a collaboration agreement with Glaxo for the exclusive worldwide development and commercialization of Entereg® for certain indications. We are responsible for development of acute indications, such as POI, and Glaxo is responsible for development of chronic indications, such as OBD. In the United States, we intend to co-promote Entereg® with Glaxo and share profits that result from the sale of the product. For commercial sales of Entereg® for POI in the United States, Adolor would receive 45% and Glaxo would receive 55% of the net sales less certain agreed upon costs, and subject to certain adjustments. After the first three years each party’s share would become 50%. For commercial sales of Entereg® for OBD in the United States, Adolor would receive 35% and Glaxo would receive 65% of the net sales less certain agreed upon costs, and subject to certain adjustments. Under the collaboration agreement, we have the right to convert our right to receive a profit share for OBD in the United States to a royalty on net sales of 20%. Outside the United States, Glaxo is responsible for the development and commercialization of Entereg®, and we would receive royalties on net sales. We may receive additional milestone payments of up to $210 million under the collaboration agreement upon the successful achievement of certain clinical and regulatory objectives, including up to $40 million related to the POI indication and up to $25 million related to the OBD indication.

POI Clinical Development Program

We have invested a significant portion of our time and financial resources since our inception in the development of Entereg®, and our potential to achieve revenues from product sales in the foreseeable future is dependent largely upon obtaining regulatory approval for and successfully commercializing Entereg®, especially in the United States. We have completed four Phase III clinical studies of Entereg® for the management of postoperative ileus (POI), and submitted a New Drug Application (NDA) for Entereg® 12 mg capsules to the Food and Drug Administration (FDA) in June 2004. Additionally, Glaxo has completed a Phase III study evaluating Entereg® in POI conducted in Europe, Australia and New Zealand (Study 001). Our NDA was amended in April 2005 to include data from Study 001.

In July 2005, we announced the receipt of an approvable letter from the FDA for Entereg® 12 mg capsules, under review for the management of POI by acceleration of GI function following bowel resection surgery. An approvable letter is a letter from the FDA to an NDA applicant indicating that the FDA may approve the NDA if specific additional information is submitted or specific conditions are agreed upon. The approvable letter indicated that before the application for Entereg® may be approved, it will be necessary to provide additional proof of efficacy to the FDA to support the use of Entereg® following bowel resection surgery. The FDA indicated that this may be achieved by demonstrating statistically significant results in at least one additional clinical study, and that this could potentially be addressed with positive results from our Study 14CL314 (Study 314). The FDA also indicated that we must provide justification that the median reduction in time to gastrointestinal recovery seen in bowel resection patients treated with Entereg® is clinically meaningful.

 

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After a meeting with the FDA regarding the approvable letter, we reported that the FDA confirmed that the Study 314 design represented an adequate and well controlled study, the results of which could potentially provide the additional proof of efficacy requested by the FDA in the approvable letter. The FDA confirmed that the “GI2” endpoint, representing time to recovery of GI function, and defined as the last to occur of upper GI recovery (solid food) and lower GI recovery (bowel movement), was acceptable as the primary endpoint of the study. As it was with our previous studies, the FDA confirmed that the hazard ratio will be the measure used to determine statistical significance.

In February 2006, we announced top line results of Study 314. The Phase III study enrolled 654 patients scheduled to undergo large or small bowel resection surgery. For the primary GI2 endpoint of Study 314, a statistically significant difference was achieved as compared to placebo (Cox proportional hazard model) hazard ratio = 1.53; P<0.001. A statistically significant difference in favor of Entereg® was achieved for each of the secondary time to event endpoints.

In May 2006, we announced that the FDA accepted as complete our response to the July 2005 NDA approvable letter for Entereg® for the management of POI. The FDA informed us that the response is considered a class 2 resubmission with a user fee goal date of November 9, 2006. In addition, based on informal communication with the FDA, we expect that there will not be an Advisory committee meeting for the pending NDA.

Our Entereg® POI Phase III clinical program in support of the NDA submitted in June 2004 included four studies. Three of these studies (POI 14CL302, POI 14CL308 and POI 14CL313) were double-blind, placebo-controlled multi-center studies, each designed to enroll patients scheduled to undergo certain types of major abdominal surgery and receiving opioids for pain relief. Under the protocols, patients were randomized into three arms to receive placebo, 6 mg or 12 mg doses of Entereg®. The primary endpoint in these three efficacy studies was time to recovery of GI function (GI3), a composite measure of the time to recovery of both upper and lower GI function, as defined by time to tolerability of solid foods, and time to first flatus or first bowel movement, whichever occurred last. The fourth POI clinical study in our Phase III program, POI 14CL306, was a double-blind, placebo-controlled multi-center observational safety study under which patients were randomized to receive either Entereg® 12 mg (413 patients) or placebo (106 patients). GI3 was included as one of the secondary endpoints in the study. Glaxo also completed a Phase III study (Study SB-767905/001), Study 001, evaluating Entereg® in POI. We have conducted an additional study in support of our pending NDA, Study 314. The protocol for Study 314 provides that the initial dose of Entereg® should be administered 30 to 90 minutes prior to surgery, as compared to our previous Phase III studies where the first dose was required to be administered (at least) 120 minutes prior to surgery. The primary endpoint of Study 314 is time to recovery of GI function, GI2, a composite measure of the time to recovery of both upper and lower GI function, as defined by time to tolerability of solid foods, and time to first bowel movement, whichever occurred last. Study 314 has also been designed to evaluate certain secondary endpoints.

Study 302. In April 2003, we announced top-line results of our first POI Phase III clinical study, POI 14CL302. Study POI 14CL302 enrolled 451 patients and was designed to include large bowel resection patients and radical hysterectomy patients, as well as simple hysterectomy patients (22% of enrolled patients). A statistically significant difference was achieved in the primary endpoint of the study in patients in the Entereg® 6 mg treatment group compared to patients in the placebo group (Cox proportional hazard model, hazard ratio = 1.45; P<0.01). A positive trend was observed in the primary endpoint of the study for the Entereg® 12 mg treatment group; however, the difference from placebo was not statistically significant (Cox proportional hazard model, hazard ratio = 1.28; P = 0.059). A difference in favor of the Entereg® treatment groups versus placebo was observed for all secondary endpoints, including time to hospital discharge order written. The most frequently observed adverse events in both the placebo and treatment groups were nausea, vomiting and abdominal distension.

The hazard ratio measures the degree of difference between the study drug group and the placebo group. A hazard ratio of 1 would indicate no difference between the study drug group and the placebo group in the probability of achieving the endpoint. A hazard ratio of 1.5 means that subjects receiving drug are 50% more likely to achieve the endpoint, on average, during the course of the data collection period. Statistical analyses estimate the probability that an effect is produced by the drug. This probability is generally expressed as a “P value” which is an estimate of the probability that any difference measured between the drug group and the placebo group occurred by chance. For example, when a P value is reported as P<0.05, the probability that the study demonstrated a drug effect by chance is less than 5%.

Study 313. In September 2003, we announced top-line results of our second POI Phase III clinical study, POI 14CL313. Study POI 14CL313 enrolled 510 patients and was designed to include large bowel resection patients, small bowel resection patients and radical hysterectomy patients, and exclude simple hysterectomy patients. A statistically significant difference was achieved in the primary endpoint of the study, time to recovery of GI function, in both the Entereg® 6 mg and 12 mg treatment groups compared to the placebo group (Cox proportional hazard model; for 6 mg group, hazard ratio = 1.28; P <

 

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0.05; for 12 mg group, hazard ratio = 1.54; P < 0.01). A difference in favor of Entereg® was observed for all of the secondary endpoints in both the 6 mg and 12 mg treatment groups, including time to hospital discharge order written. The most frequently observed adverse events in both the placebo and treatment groups were nausea, vomiting and hypotension.

Study 306. In October 2003, we announced top-line results of our third POI Phase III clinical study, POI 14CL306, which enrolled 519 patients. This study was designed to assess safety as its primary endpoint, and to assess efficacy as a secondary endpoint and to enroll only patients scheduled to undergo simple hysterectomy procedures. Study POI 14CL306 was the first study where dosing continued on an out-patient basis after patients were discharged from the hospital. Entereg® was generally well tolerated in this observational safety study with 93% of patients completing treatment in the Entereg® 12 mg treatment group and 92% of patients completing treatment in the placebo group. The most frequently observed adverse events in both the placebo and treatment groups were nausea, vomiting and constipation. The results in GI3, one of the secondary endpoints in the study, were not statistically significant as compared to placebo.

Study 308. In January 2004, we announced top-line results of our fourth POI Phase III clinical study, POI 14CL308. Study POI 14CL308 enrolled 666 patients, and was designed to include large bowel resection patients, small bowel resection patients and radical hysterectomy patients, as well as simple hysterectomy patients (14% of enrolled patients). A positive trend was observed in the primary endpoint of the study when each of the Entereg® 6 mg and 12 mg treatment groups was compared to the placebo group (Cox proportional hazard model; for 6 mg group, hazard ratio = 1.20, P=0.08; for 12 mg group, hazard ratio = 1.24, P=0.038). Due to the multiple dose comparison to a single placebo group, a P-value of less than 0.025 would have been required in the 12 mg dose group to be considered statistically significant. A difference in favor of Entereg® was observed for all of the secondary endpoints in both the 6 mg and 12 mg treatment groups, including time to hospital discharge order written. The most frequently observed adverse events in both the placebo and treatment groups were nausea, vomiting and pruritis.

Study 001. In December 2004, we reported top line results from a Phase III clinical study of Entereg® in POI, Study 001. Study 001 was conducted in Europe, Australia and New Zealand by Glaxo and enrolled 741 bowel resection patients, and 170 radical hysterectomy patients. The prespecified primary analysis group only included the bowel resection patients. The primary endpoint results (GI3) of the study were (Cox proportional hazard model) for the 6 mg group, hazard ratio = 1.22 (P=0.042); and for the 12 mg group, hazard ratio = 1.13 (P=0.20), each as compared to placebo. These results are not statistically significant; due to the multiple dose comparison to a single placebo group, a P-value of less than 0.025 would be required in the 6 mg dose group to be considered statistically significant. The most frequently observed adverse events were nausea, vomiting and pyrexia.

Study 314. In February 2006, we announced top-line results of our Phase III clinical study, POI 14CL314, which enrolled 654 patients scheduled to undergo large or small bowel resection. For the primary GI2 endpoint of Study 314, a statistically significant difference was achieved as compared to placebo (Cox proportional hazard model) hazard ratio = 1.53, P<0.001. A statistically significant difference in favor of Entereg® was achieved for each of the secondary time to event endpoints. Under the protocol patients were randomized to receive placebo or 12 mg of Entereg® twice daily. While GI3 was the primary endpoint for pivotal studies in our NDA, GI2 has been measured in each study. The data for the effect on time to GI2 recovery for bowel resection patients (MITT population) for the 12 mg dose of Entereg® as an additional analysis is as follows: in Study 302, the hazard ratio was 1.400 and the P-value 0.029; in Study 308, the hazard ratio was 1.365 and the P-value 0.017; in Study 313, the hazard ratio was 1.625 and the P-value <0.001; and in Study 001, the hazard ratio was 1.299 and the P-value 0.008. The most frequently observed adverse events were nausea, vomiting and abdominal distension.

OBD and Chronic Constipation Clinical Development Programs

Entereg® is being developed by Glaxo for the treatment of OBD in patients taking opioid analgesics for persistent pain conditions. In September 2006, we and Glaxo announced the top-line results from two Phase III registration studies, Studies SB-767905/012 (Study 012) and SB-767905/013 (Study 013) of alvimopan for the treatment of OBD in patients with chronic non-cancer pain, and one Phase 2b study, Study 767905/008 (Study 008) in patients with chronic cancer pain taking opioids and experiencing symptoms associated with OBD. Enrollment is complete in Glaxo’s Phase III long term safety study, Study767905/014 (Study 014), which is currently ongoing.

In September 2005, we and Glaxo announced the start of Phase III clinical testing to evaluate Entereg® for the treatment of OBD. The Phase III clinical program, which is being led by Glaxo, is comprised of three studies with an expected enrollment of approximately 1,700 patients in North America, Europe and other parts of the world. Two of the three Phase III OBD studies, Study 012 and Study 013, are randomized, double-blind, placebo controlled, multicenter studies each designed to enroll approximately 480 adults who are taking opioid therapy for persistent non-cancer pain and have resulting OBD. Under the protocols, the patients are randomized to one of two Entereg® arms (0.5 mg. once daily or 0.5 mg. twice daily) or to placebo for twelve weeks of treatment. The primary objective of these confirmatory studies is to compare Entereg® with placebo for efficacy in the treatment of OBD.

 

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The third Phase III OBD study, Study SB-767905/014 (Study 014), is a randomized, double-blind, placebo controlled study designed to enroll approximately 750 adults who are taking opioid therapy for persistent non-cancer pain and have OBD. Under the protocol, the patients are randomized to Entereg® (0.5 mg. twice daily) or placebo for twelve months of treatment. The primary objective of this Phase III long-term safety study is to compare Entereg® with placebo for safety and tolerability in the treatment of OBD. The primary safety endpoint is based on the frequency of reported adverse events.

Study 012. In September 2006, we and Glaxo announced top-line results from a Phase III clinical study of Entereg in OBD, Study 012. Study 012 enrolled 518 patients with chronic non-cancer pain who had experienced symptoms of OBD, defined as having less than 3 SBMs (defined as bowel movements with no laxative in the previous 24 hours) a week plus one or more bowel movement symptoms (incomplete evacuation, straining, hard/small pellets) for 25% of bowel movements. This study achieved statistical significance for the primary endpoint – the proportion of patients who had a weekly average of three or more SBMs and an increase from baseline of one or more SBMs a week over the 12-week treatment period. In patients treated with alvimopan 0.5 mg twice daily, 72% met the primary endpoint compared with 48% of patients receiving placebo (p less than 0.001). In patients treated with alvimopan 0.5 mg once daily, 61% met the primary endpoint compared with 48% of patients receiving placebo (p=0.065).

Study 013. In September 2006, we and Glaxo also announced top-line results from a Phase III clinical study of Entereg in OBD, Study 013. Study 013 enrolled 485 patients with chronic non-cancer pain. In both groups of patients treated with alvimopan, 0.5 mg twice and once daily, over the 12-week treatment period, 63% met the primary endpoint compared with 56% of patients receiving placebo (p=0.214 & p=0.259 respectively). These results are not statistically significant.

Alvimopan was generally well tolerated in these Studies 012 and 013. Adverse events (AEs) affecting the gastrointestinal (GI) tract were the most common in both studies occurring in 24-33% of alvimopan-treated patients, compared with 22% on placebo. These included abdominal pain, diarrhea, nausea and vomiting.

Study 008. In September 2006, we and Glaxo also announced top-line results from a Phase 2b clinical study of Entereg in patients with chronic cancer pain taking opioids and experiencing symptoms associated with OBD, Study 008. Study 008 enrolled 233 patients. The primary endpoint in this study was the change in frequency of spontaneous complete bowel movements (SCBMs), defined as a bowel movement with no laxative use in the previous 24 hours that provides the subject with a feeling of complete evacuation. The average weekly change from baseline for the three week treatment period was 1.9, 1.8 and 2.1 SCBMs for patients treated with alvimopan 0.5 mg twice daily, 1.0 mg once and twice daily, respectively, compared to 1.6 SCBMs in those receiving placebo. These differences were not statistically significant. The safety and tolerability of alvimopan in this cancer pain study were similar to that seen in the placebo group.

Study SB767905/011 (Study 011). In March 2005, we and Glaxo announced top-line results from a Phase IIb study of Entereg® in OBD. In Study 011, in 522 non-cancer patients with OBD, all three oral Entereg® dosage regimens achieved statistically significant effects on the primary and secondary endpoints compared with placebo. The primary endpoint was the change from baseline in weekly frequency of SBMs over the first half of the 6-week treatment period. All groups reported an SBM frequency of approximately 1 per week during the baseline period. The average weekly change from baseline over weeks 1-3 was 3.36 SBM for the Entereg® 0.5 mg, twice daily treatment group, 3.29 SBM for the Entereg® 1mg, once daily treatment group and 4.17 SBM for the Entereg® 1 mg, twice daily treatment group compared to 1.65 SBM for the placebo group. All Entereg® treatment groups were statistically significantly different from placebo at the P<0.001 level. In this Phase IIb study adverse events affecting the GI tract were the most common, occurring in 30%-43% of Entereg® treated patients, compared to 36% on placebo. The most frequently reported adverse events were abdominal pain, nausea and diarrhea and GI adverse events were also the most common reason for study withdrawal. In the Phase IIa study in chronic constipation, there were no statistically significant differences from placebo for any dose of Entereg® in the primary or secondary endpoints, or in key subgroups.

 

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Combination Product

We are developing an analgesic product candidate that combines alvimopan and an opioid analgesic. This combination is intended to produce the pain relief of an opioid while reducing constipating side effects. During the second quarter of 2006 we commenced a Phase 2 dose ranging study in which alvimopan is co-administered with hydrocodone/APAP. This study is intended to enroll approximately 300 patients undergoing ambulatory shoulder surgery for rotator cuff repair.

During the third quarter of 2006, the Investigational New Drug Application (IND) for the acute combination product, coformulated hydrocodone/APAP and alvimopan, was activated and we initiated a phase I pharmacokinetic study to compare the co-formulated product with the co-administered products.

Sterile Patch Program (ADL 8-7223)

We have determined not to continue pursuing development of our sterile lidocaine patch program. As a result, on October 27, 2006, we provided notice to EpiCept Corporation that we were terminating our License Agreement dated July 23, 2003, under which we licensed exclusive rights to develop and commercialize in North America a sterile lidocaine patch. Also as a result, on October 27, 2006, we provided notice to Corium International, Inc. that we were terminating our Scale Up and Commercial Supply Agreement dated November 16, 2005.

Delta Agonist Program

We submitted an IND to the FDA for ADL5859, our novel oral compound, which was designed by our researchers to target the Delta opioid receptor. The Delta receptor is one of three opioid receptors that modulate pain. On January 30, 2006, we announced that the FDA requested additional preclinical safety studies and additional information regarding our proposed Phase 1 protocol. Following our response to the FDA’s request for additional studies and information, the FDA lifted the clinical hold on our ADL 5859 IND. During the third quarter 2006, we commenced a Phase I clinical trial of ADL5859 designed to investigate the safety, tolerability and pharmacokinetics of a single dose of ADL5859 in healthy volunteers.

Discovery / In-Licensing

We maintain a research effort directed at the discovery of compounds that elicit potential analgesic effects by targeting peripheral and central opioid receptors, as well as certain non-opioid receptors.

We believe there are opportunities to expand our product portfolio through the acquisition or in-licensing of products and/or product development candidates and intend to continue to explore and evaluate such opportunities.

Competitive Environment

We operate in a highly regulated and competitive environment. Our competitors include fully integrated pharmaceutical companies and biotechnology companies, universities and public and private research institutions. Many of the organizations competing with us have substantially greater capital resources, larger research and development staffs and facilities, greater experience in drug development and in obtaining regulatory approvals, and greater manufacturing and marketing capabilities than we do.

Commercialization

We maintain a marketing organization to support our development efforts. We have also established a hospital-focused sales force which is currently engaged in the detailing of Glaxo’s anti-thrombotic agent, Arixtra®, under our co-promotion arrangement with Glaxo. This sales force could also potentially focus on Entereg® if FDA approval is received.

We have a small manufacturing organization to manage our relationships with third parties for the manufacture and supply of products for preclinical, clinical and commercial purposes. We maintain commercial supply agreements with certain of these third party manufacturers. We presently do not maintain our own manufacturing facilities.

In June 2004, we entered into a Distribution Agreement with Glaxo under which, upon our receipt of regulatory approvals, Glaxo will perform certain distribution and contracting services for Entereg® on our behalf for a fee. Outside the United States, we intend to rely on Glaxo for sales and marketing of Entereg® and expect to supply Glaxo with bulk capsules for commercial sale for POI under a Supply Agreement we entered into with Glaxo in September 2004. As we develop additional product candidates we may enter into strategic marketing or co-promotion agreements with, and grant additional licenses to, pharmaceutical companies to gain access to additional markets both domestically and internationally.

Collaboration and Other Agreements With Glaxo

In April 2002, we entered into a collaboration agreement with Glaxo for the exclusive worldwide development and commercialization of Entereg® for certain indications. Under the terms of the collaboration agreement, Glaxo paid us a non-

 

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refundable and non-creditable signing fee of $50.0 million during the quarter ended June 30, 2002. Additionally, in the third quarter of 2004, we recognized $10.0 million in revenue under this agreement relating to achieving the milestone of acceptance for review of our NDA by the FDA. We may receive additional milestone payments of up to $210.0 million over the remaining term of the agreement upon the successful achievement, if any, of certain clinical and regulatory objectives including up to $40 million related to the POI indication and up to $25 million related to the chronic OBD indication. The milestone payments relate to substantive achievements in the development lifecycle and it is anticipated that these will be recognized as revenue if and when the milestones are achieved.

We and Glaxo have agreed to develop Entereg® for a number of acute and chronic indications which would potentially involve the use of Entereg® in in-patient and out-patient settings. In the United States, we and Glaxo intend to co-develop and intend to co-promote Entereg® and share profits that result from the sale of product. For commercial sales of Entereg® for POI in the United States, Adolor would receive forty-five percent (45%) and Glaxo would receive fifty-five percent (55%) of the net sales less certain agreed upon costs, and subject to certain adjustments. After the first three years each party’s share would become fifty percent (50%). For commercial sales of Entereg® for OBD in the United States, we would receive thirty-five percent (35%) and Glaxo would receive sixty-five percent (65%) of the net sales less certain agreed upon costs, and subject to certain adjustments. Under the collaboration agreement, we have the right to convert our right to receive a profit share for OBD in the United States to a royalty on net sales of twenty percent (20%). We have overall responsibility for development activities for acute care indications such as POI, and Glaxo has overall responsibility for development activities for chronic care indications such as OBD. Outside the United States, Glaxo is responsible for the development and commercialization of Entereg® for all indications, and we would receive royalties on net sales, if any.

The term of the collaboration agreement varies depending on the indication and the territory. The term of the collaboration agreement for the POI indication in the United States is ten years from the first commercial sale of Entereg® in that indication, if any. Generally, the term for the OBD indication in the United States is fifteen years from the first commercial sale of Entereg® in that indication, if any. In the rest of the world, the term is generally fifteen years from the first commercial sale of Entereg®, if any, on a country-by-country and indication-by-indication basis.

Glaxo has certain rights to terminate the collaboration agreement. Glaxo also has the right to terminate its rights and obligations with respect to the acute-care indications, or its rights and obligations for the chronic-care indications. Glaxo has the right to terminate the collaboration agreement for breach of the agreement by us or for safety related reasons as defined in the collaboration agreement. Glaxo’s rights to terminate the acute-care indications or the chronic-care indications are generally triggered by failure to achieve certain milestones within certain timeframes, adverse product developments or adverse regulatory events. For example, because the postoperative ileus (“POI”) product has not been commercially sold as of December 31, 2005, Glaxo now possesses the right to terminate the collaboration agreement with respect to the POI product and the other products defined as the Adolor Products under the collaboration agreement.

In June 2004, we entered into a Distribution Agreement with Glaxo under which, upon our receipt of regulatory approvals, Glaxo will perform certain distribution and contracting services for Entereg® on our behalf for a fee. Outside of the United States we intend to rely on Glaxo for sales and marketing of Entereg®, and expect to supply Glaxo with bulk capsules for sale under a Supply Agreement we entered into with Glaxo in September 2004.

External expenses for research and development and marketing activities incurred by each company in the United States are reimbursed by the other party pursuant to contractually agreed percentages. Contract reimbursement amounts owed to us by Glaxo are recorded gross on our Consolidated Statements of Operations as cost reimbursement under collaborative agreement revenue. Amounts reimbursable to Glaxo by us are recorded as research and development or marketing expense, as appropriate, on our Consolidated Statements of Operations.

Liquidity and Capital Resources

We have experienced negative operating cash flow since our inception and have funded our operations primarily from the proceeds received from the sale of our equity securities, as well as from contract revenues. Cash, cash equivalents and short-term investments were approximately $202.1 million at September 30, 2006, and $103.1 million at December 31, 2005, representing 92.9% and 87.9% of our total assets, respectively. We invest excess cash principally in United States Treasury obligations.

The increase in cash, cash equivalents and short-term investments was primarily the result of the Company’s public offering of 5,750,000 shares of common stock at $25.00 per share in February 2006. The Company received net proceeds from the offering of approximately $135.1 million. This increase was partially offset by cash used in operating activities of $47.6 million.

 

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We believe that our current financial resources and sources of liquidity are adequate to fund operations into 2008 based upon our expectations of the level of research and development, marketing and administrative activities necessary to achieve our strategic objectives.

The following is a summary of selected cash flow information for the nine months ended September 30, 2006 and 2005:

 

     Nine Months Ended September 30,  
     2006     2005  

Net loss

   $ (51,323,435 )   $ (40,953,755 )

Adjustments for non-cash operating items

     8,784,259       2,031,424  
                

Net cash operating loss

     (42,539,176 )     (38,922,331 )

Net change in assets and liabilities

     (5,069,422 )     (3,692,600 )
                

Net cash used in operating activities

   $ (47,608,598 )   $ (42,614,931 )
                

Net cash (used in)/provided by investing activities

   $ (97,452,221 )   $ 41,920,263  
                

Net cash provided by financing activities

   $ 147,353,777     $ 9,240  
                

Net Cash Used in Operating Activities and Operating Cash Flow Requirements Outlook

Net operating cash outflows for the nine months ended September 30, 2006 have resulted primarily from research and development expenditures associated with our product candidates, including development expenses for Entereg®, compensation costs, and marketing, general and administrative expenses. These outflows were partially offset by amounts received under agreements with Glaxo.

We expect to continue to use cash resources to fund operating losses. We expect that our operating losses in future periods will increase as a result of continuing research and development expenses relating to Entereg® and increased spending relating to other product development programs, as well as increased costs incurred in preparation for the potential commercialization of Entereg®. Further, we may license or acquire product candidates from others which would require additional cash outlays.

Net Cash Used In Investing Activities and Investing Requirements Outlook

Net cash used in investing activities for the nine months ended September 30, 2006 relates primarily to the purchase of investments, combined with expenditures for laboratory equipment and information technology to support our research and development activities. The increase as compared to the nine months ended September 30, 2005 was due to the investment of proceeds from our recent stock offering.

We expect to continue to fund operations through the maturities of investments in our portfolio. We expect to continue to require investments in information technology, laboratory and office equipment to support our research and development activities, and potential commercialization activities.

Net Cash Provided By Financing Activities and Financing Requirements Outlook

Net cash inflows provided by financing activities for the nine months ended September 30, 2006 have resulted primarily from our sale of 5,750,000 shares of common stock at $25.00 per share. We received net proceeds from the offering of approximately $135.1 million. In addition, we received $12.3 million upon the exercise of stock options in the nine months ended September 30, 2006.

We may never receive regulatory approval for any of our product candidates, generate product sales revenues, achieve profitable operations or generate positive cash flows from operations, and even if profitable operations are achieved, these may not be sustained on a continuing basis. We have invested a significant portion of our time and financial resources since our inception in the development of Entereg®, and our potential to achieve revenues from product sales in the foreseeable future is dependent largely upon obtaining regulatory approval for and successfully commercializing Entereg®, especially in the United States. Although we received an approvable letter from the FDA for Entereg® in July 2005, there is no assurance that the FDA will approve Entereg® in the future. We expect to continue to use our cash and investments resources to fund operating and investing activities. We believe that our existing cash, cash equivalents and short-term investments of approximately $202.1 million as of September 30, 2006 will be sufficient to fund operations into 2008. Prior to exhausting our current cash reserves, we may need to raise additional funds to finance our operating activities. If we do not raise additional cash, we may be required to curtail or limit certain marketing support and research and development activities. A

 

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curtailment of certain activities would delay or possibly prevent development of certain of our products. We may seek to obtain additional funds through equity or debt financings or strategic alliances with third parties. These financings could result in substantial dilution to the holders of our common stock. Any such required financing may not be available in amounts or on terms acceptable to us.

Results of Operations

This section should be read in conjunction with the more detailed discussion under “Liquidity and Capital Resources.”

Contract revenues. Our contract revenues were approximately $5.3 million and $4.7 million for the three months ended September 30, 2006 and 2005, respectively and were approximately $10.8 million and $11.5 million for the nine months ended September 30, 2006 and 2005. The increase in revenues for the three months was primarily due to an increase in revenues of $1.2 million resulting from increased expenses incurred by us and reimbursable by Glaxo under our collaboration agreement partially offset by a decrease in co-promotion revenues of $0.7 million from our Arixtra co-promotion agreement with Glaxo. The decrease for the nine months ended September 30, 2006 was primarily the result of a reduction in co-promotion revenues of $1.0 million relating to our Arixtra co-promotion agreement with Glaxo.

Research and development expenses were approximately $15.5 million for the three months ended September 30, 2006 as compared to approximately $14.5 million for the three months ended September 30, 2005. This increase was principally related to increases in compensation expense of $0.5 million relating to the implementation of FAS 123R, and increased expenses relating to our combination product development program. These increases were partially offset by the decrease in expenses related to our Delta program.

Research and development expenses were approximately $43.1 million for the nine months ended September 30, 2006 as compared to approximately $35.3 million for the nine months ended September 30, 2005. Expenses increased principally due to a greater compensation expense of $2.2 million resulting from the implementation of FAS 123R, and increased expenses associated with our sterile lidocaine patch program, and combination product development program.

Our research and development expenses can be identified as internal or external expenses. Internal expenses include expenses such as personnel, laboratory operating and overhead related expenses. These expenses totaled approximately $6.5 million and $5.7 million in the three months ended September 30, 2006 and 2005, respectively, and approximately $19.4 and $16.4 million in the nine months ended September 30, 2006 and 2005, respectively. These internal research and development expenses are largely related to our Entereg® development efforts. External expenses include expenses incurred with clinical research organizations, contract manufacturers, and other third party vendors and can be allocated to significant research and development programs as follows:

 

     Three months ended September 30,    Nine months ended September 30,
     2006    2005    2006    2005

Entereg® Program

   $ 5,775,287    $ 5,834,488    $ 14,099,280    $ 13,709,293

Combination Product

     1,101,162      —        3,013,188      —  

Sterile Lidocaine Patch Program

     730,121      813,235      2,704,313      1,032,826

Delta Program

     791,450      1,380,848      2,052,636      2,277,653

Other Programs

     586,728      784,899      1,800,101      1,886,470
                           

Total

   $ 8,984,748    $ 8,813,470    $ 23,669,518    $ 18,906,242
                           

There are significant risks and uncertainties inherent in the preclinical and clinical studies associated with each of our research and development programs. These studies may yield varying results that could delay, limit or prevent a program’s advancement through the various stages of product development and significantly impact the costs to be incurred, and time involved, in bringing a program to completion. As a result, the cost to complete such programs, as well as the period in which net cash inflows from such programs are expected to commence, are not reasonably estimable.

Marketing, general and administrative expenses. Our marketing, general and administrative expenses increased to approximately $10.5 million for the three months ended September 30, 2006 from approximately $6.3 million in the three months ended September 30, 2005 and to approximately $26.1 million for the nine months ended September 30, 2006 from approximately $19.6 million for the nine months ended September 30, 2005. The expense increase principally related to increased personnel expenses, including expenses associated with the implementation of FAS 123R, combined with additional marketing and sales expenses.

Interest Income. Our interest income increased to $2.5 million for the three months ended September 30, 2006 from approximately $0.9 million in the three months ended September 30, 2005 and to approximately $6.5 million for the nine months ended September 30, 2006 from approximately $2.5 million for the nine months ended September 30, 2005. This was primarily due to an increase in short-term investments resulting from the proceeds from the sale of common stock in February 2006 in addition to higher interest rates.

 

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Other income (expense). Our other income increased to approximately $0.5 million for the nine months ended September 30, 2006 and represents cash received from the sale of our Pennsylvania research and development tax credits.

Net Loss Outlook

We have not generated any product sales revenues, have incurred operating losses since inception and have not achieved profitable operations. Our deficit accumulated during the development stage through September 30, 2006 aggregated approximately $358.1 million, and we expect to continue to incur substantial losses in future periods. We expect that our operating losses in future periods will increase as a result of continued research and development expenses relating to Entereg® and increased expenses relating to other product development programs, as well as increased costs incurred in preparation for the potential commercialization of Entereg®.

We are highly dependent on the success of our research, development and licensing efforts and, ultimately, upon regulatory approval and market acceptance of our products under development, particularly our lead product candidate, Entereg®. We may never receive regulatory approval for any of our product candidates, generate product sales revenues, achieve profitable operations or generate positive cash flows from operations, and even if profitable operations are achieved, these may not be sustained on a continuing basis.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

A substantial portion of our assets consists of investment grade fixed income securities (U.S. Treasury obligations). The market value of such investments fluctuates with current market interest rates. In general, as rates increase, the market value of a debt instrument would be expected to decrease. The opposite is also true. To minimize such market risk, we have in the past and, to the extent possible, will continue in the future to hold such debt instruments to maturity at which time the debt instrument will be redeemed at its stated or face value. Due to the short duration and nature of these instruments, we do not believe that we have a material exposure to interest rate risk related to our investment portfolio. The investment portfolio at September 30, 2006 was approximately $198.1 million, and the weighted-average interest rate return on the portfolio was approximately 5.0%, with maturities of investments ranging up to 13 months.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

For the quarterly period ended September 30, 2006, we carried out an evaluation, under the supervision and with the participation of our management, including our Interim President and Chief Executive Officer and our Vice President, Finance and Chief Financial Officer (the principal finance and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, or the Exchange Act, as of the end of the period covered by this report. Based upon this evaluation, our Interim President and Chief Executive Officer and our Vice President, Finance and Chief Financial Officer concluded that as of September 30, 2006, our disclosure controls and procedures were effective.

Our management, including our Interim President and Chief Executive Officer and our Vice President, Finance and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all errors or fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met and our disclosure controls and procedures are designed to provide this reasonable assurance. Based upon the evaluation discussed above, our Interim President and Chief Executive Officer and our Vice President, Finance and Chief Financial Officer concluded that, as of September 30, 2006, our disclosure controls and procedures were effective at providing such reasonable assurance. Because of inherent limitations in all control systems, no evaluation of control can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the three month period ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On April 21, 2004, a lawsuit was filed in the United States District Court for the Eastern District of Pennsylvania against the Company, one of its directors and certain of its officers seeking unspecified damages on behalf of a putative class of persons who purchased Company common stock between September 23, 2003 and January 14, 2004. The complaint alleges violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), in connection with the announcement of the results of certain studies in the Company’s Phase III clinical trials for Entereg®, which allegedly had the effect of artificially inflating the price of the Company’s common stock. This suit has been consolidated with three subsequent actions asserting similar claims under the caption: In re Adolor Corporation Securities Litigation, No. 2:04-cv-01728. On December 29, 2004, the district court issued an order appointing the Greater Pennsylvania Carpenters’ Pension Fund, as Lead Plaintiff. The appointed Lead Plaintiff filed a consolidated amended complaint on February 28, 2005. That Complaint purported to extend the class period, so as to bring claims on behalf of a putative class of Adolor shareholders who purchased stock between September 23, 2003 and December 22, 2004. The Complaint also adds as defendants the Company’s Board of Directors asserting claims against them and the other defendants for violation of Section 11 and Section 15 of the Securities Act of 1933 in connection with the Company’s public offering of stock in November 2003. The Company and the management and director defendants moved to dismiss the Complaint on April 29, 2005. The plaintiffs responded to the motion to dismiss on June 28, 2005, and the defendants’ reply was filed on August 12, 2005. The Company believes that the allegations are without merit and intends to vigorously defend the litigation.

On August 2, 2004, two shareholder derivative lawsuits were filed in the United States District Court for the Eastern District of Pennsylvania, purportedly on behalf of the Company, against its directors and certain of its officers seeking unspecified damages for various alleged breaches of fiduciary duty and waste. The allegations are similar to those set forth in the class action complaints, involving the announcement of the results of certain studies in the Company’s Phase III clinical trials for Entereg®. On November 12, 2004, the Derivative Plaintiff filed an amended Complaint. On December 13, 2004, the Company filed a motion challenging the standing of the Derivative Plaintiff to file the derivative litigation on its behalf. On December 13, 2004, the Company’s directors and officers moved to dismiss the Complaint for the failure to state a claim. Plaintiffs responded to the Company’s and the directors’ and officers’ motions on January 27, 2005. The Company and the Directors and Officers filed reply briefs on February 18, 2005.

ITEM 1A. RISK FACTORS

As further described herein, our performance and financial results are subject to risks and uncertainties including, but not limited to, the following specific risks:

We are highly dependent on achieving success in the clinical testing, regulatory approval and commercialization of our lead product candidate, Entereg®, which may never be approved for commercial use.

We have invested a significant portion of our time and financial resources since our inception in the development of Entereg®, and our potential to achieve revenues from product sales in the foreseeable future is dependent upon obtaining regulatory approval for and successfully commercializing Entereg®, especially in the United States. Prior to commercialization of Entereg® in the United States for any indication, the FDA would have to approve Entereg® for commercial sale. Drug development is a highly uncertain process. We received an approvable letter from FDA for Entereg® for POI in July 2005, however, there is no assurance that the FDA will approve Entereg® for POI in the future. Phase III clinical testing of Entereg® in OBD began in September 2005 with the initiation of two identically designed Phase III registration studies conducted by Glaxo (Studies 012 and 013) and one long term safety study, Study 014. In September 2006, we along with Glaxo announced that Study 012 achieved statistical significance in its primary endpoint while Study 013 did not achieve statistical significance in its primary endpoint. We along with Glaxo also announced top-line results from a Phase 2b investigation of alvimopan in patients with cancer pain treated with opioid analgesics. The results in the primary endpoints for this Phase 2b study were not statistically significant. Glaxo is reviewing the results of these studies to determine potential next steps in the development of Entereg® for OBD. Study 014 is ongoing and there is no assurance that Study 014 will be successful or that Entereg® will be approved for OBD, POI or any other indication. Additionally, foreign country regulatory approval is required prior to commercialization of Entereg® outside of the United States. There is no assurance that Glaxo will seek approval of Entereg® in countries outside the United States, or that such approval would be obtained.

Although we received an approvable letter from the FDA for Entereg® in POI, our NDA for Entereg® may not be approved. Study 314 results may not satisfy the FDA requirement for additional evidence of efficacy to support approval of our NDA.

In July 2005, we announced the receipt of an approvable letter from the FDA for Entereg® 12 mg capsules. Before the application for Entereg® may be approved, it will be necessary to provide additional proof of efficacy to the FDA to support the use of Entereg® following bowel resection surgery. The FDA indicated that this may be achieved by demonstrating

 

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statistically significant results in at least one additional clinical study, and that this could potentially be addressed with positive results from Study 314. The FDA also indicated that we must provide justification that the median reduction in time to gastrointestinal recovery seen in bowel resection patients treated with Entereg® is clinically meaningful.

After a meeting with the FDA regarding the approvable letter, we reported that the Study 314 design represented an adequate and well-controlled study, the results of which could potentially provide the additional proof of efficacy requested by the FDA in the approvable letter. The FDA confirmed that the GI2 endpoint, representing time to recovery of GI function, and defined as the last to occur of upper GI recovery (solid food) and lower GI recovery (bowel movement), was acceptable as the primary endpoint of the study. As with our previous studies, the FDA confirmed that the hazard ratio will be the measure used to determine statistical significance.

Although we believe Study 314 yielded positive results, there is no assurance that the FDA will conclude that the results of Study 314 or the results obtained in our prior studies support the approval of Entereg® in POI. Further, there is no assurance that the FDA will conclude that any reduction in median time to GI recovery observed in the studies included in our NDA and in Study 314 is clinically meaningful. There is no assurance that the FDA will not raise additional issues, or that our NDA for Entereg® will be approved. FDA approval of our NDA is contingent on many factors, including a favorable review of all preclinical and clinical data, as well as information with respect to the manufacture of Entereg®. In May 2006, we announced that the FDA accepted as complete our response to the July 2005 NDA approvable letter for Entereg® for the management of POI. The FDA informed us that the response is considered a class 2 resubmission with a user fee goal date of November 9, 2006. In addition, based on informal communication with the FDA, we expect that there will not be an Advisory committee meeting for the pending NDA. With regard to any studies we may conduct, including Study 314, the FDA or other regulatory agencies may evaluate the results of such study by different methods or conclude that the clinical trial results are not statistically significant or clinically meaningful, or that there were human errors in the conduct of the clinical trials or otherwise. Even if we believe we have met the FDA guidelines for submission of data and information to the NDA, there is a risk that the FDA will require additional data and information that may require additional time to accumulate, or that we are unable to provide.

Certain results from Phase III clinical trials showed that the differences in the primary endpoint analyses between Entereg® and placebos were not statistically significant.

Our Entereg® POI Phase III program initially consisted of four studies, POI 14CL302, POI 14CL313, POI 14CL308 and POI 14CL306. Based on the results from these studies we submitted an NDA for Entereg® 12 mg capsules in June 2004. In study POI 14CL302, the difference from placebo in the primary endpoint, GI3, for the Entereg® 12 mg treatment group was not statistically significant. In study POI 14CL308, the difference from placebo for GI3 was not statistically significant in either the Entereg® 6 mg or the 12 mg treatment groups. Even though the P-value for the 12 mg dose group of study POI 14CL308 was below 0.05, it is not considered formally statistically significant because of the multiple dose comparison. In studies involving multiple dose comparisons, statisticians control the overall study error rate (i.e. the likelihood that the drug response occurred by chance) by requiring that each of the multiple dose comparisons meet a P-value of P<0.05 to show statistical significance. In the event that one of the dose comparisons in any of these POI Phase III studies does not reach a significance level of P<0.05, the other dose comparison in that study needs to reach a significance level of P<0.025 to be considered statistically significant. In study POI 14CL306, GI3 was analyzed as one of the secondary efficacy endpoints, and the difference from placebo for this endpoint was not statistically significant.

Glaxo conducted a Phase III clinical study (Study 001) of Entereg® in POI in Europe, Australia and New Zealand. Our NDA was amended in April 2005 to include data from Study 001. In this study, the difference from placebo in the primary endpoint, GI3, was not statistically significant in either the 6 mg or 12 mg treatment groups.

We along with Glaxo recently announced top-line results from two registration Phase III studies of Entereg® for the treatment of OBD in patients with chronic non-cancer pain. In one of those studies, Study 013, the result in the primary endpoint was not statistically significant. We along with Glaxo also announced top-line results from a Phase 2b investigation of alvimopan in patients with cancer pain treated with opioid analgesics. The results in the primary endpoints for this Phase 2b study were not statistically significant.

These results or future results that fail to achieve statistical significance may make it more difficult to achieve regulatory approval of Entereg® in POI, OBD or any other indication.

Additionally, while our NDA for use of Entereg® in POI includes data from both the 6 mg and 12 mg treatment groups, we have requested approval for the 12 mg treatment group. The FDA may not grant such approval.

 

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Unfavorable results or adverse safety findings from any clinical study will adversely affect our ability to obtain regulatory approval for Entereg®.

We and Glaxo expect to continue to clinically evaluate Entereg® in both acute and chronic conditions. We are conducting, or planning to conduct, additional studies of Entereg® in the United States. Unfavorable results in any study may adversely affect our ability to obtain FDA or other regulatory approval of Entereg®, and even if approved, may adversely affect market acceptance for Entereg®.

The most frequent adverse events in both the placebo and treatment groups in study POI 14CL302 were nausea, vomiting and abdominal distension. The most frequent adverse events in both the placebo and treatment groups in study POI 14CL313 were nausea, vomiting and hypotension. The most frequent adverse events in both the placebo and treatment groups in study POI 14CL306 were nausea, vomiting and constipation. The most frequent adverse events in both the placebo and treatment groups in study POI 14CL308 were nausea, vomiting and pruritis. The most frequent adverse events in both placebo and treatment groups in study POI 14CL314 were nausea, vomiting and abdominal distention.

Additional clinical trials of Entereg®, conducted by us or our collaborator, Glaxo, could produce undesirable or unintended side effects that have not been evident in our clinical trials conducted to date. In addition, in patients who take multiple medications, drug interactions with Entereg® could occur that can be difficult to predict. Our Entereg® clinical trials are testing whether Entereg® is able to selectively block the effects of narcotic analgesics in the GI tract, and they are subject to the risk that the use of Entereg® with narcotic analgesics may result in unexpected toxicity, or increase the side effects associated with the individual products to an unacceptable level, or interfere with the efficacy of the narcotic analgesic. In addition, assessing clinical trial results of Entereg® in combination with narcotic analgesics may add to the complexity of interpreting the study results. These events, among others, may make it more difficult for us to obtain regulatory approval for Entereg®.

Entereg® may not be successfully developed for chronic use.

Results from the clinical studies conducted to date in OBD are not necessarily indicative of the results that may be obtained in further studies, or in clinical studies in the POI indication. Phase III clinical testing of Entereg® in OBD began in September 2005. In September 2006 we along with Glaxo announced the results from two identically designed Phase III registration studies in OBD in patients with chronic non-cancer pain conducted by Glaxo (Studies 012 and 013). Study 012 achieved statistical significance in its primary endpoint while Study 013 did not achieve statistical significance in its primary endpoint. We also announced top-line results from a Phase 2b investigation of alvimopan in patients with cancer pain treated with opioid analgesics. The results in the primary endpoints for this Phase 2b study were not statistically significant. Glaxo is reviewing the results of these studies to determine potential next steps in the development of Entereg® for OBD. The long-term safety study (Study 014) in OBD is ongoing. This study may not be successful. The long-term animal toxicity studies necessary to support further development of Entereg® for chronic use are on-going. Adverse safety findings in any of these ongoing studies could adversely affect our prospects for Entereg®, including its prospects for use in POI.

If we are unable to commercialize Entereg®, our ability to generate revenues will be impaired and our business will be harmed.

We have not yet commercialized any products or technologies, and we may never do so. If Entereg® is not approved by the FDA, our ability to achieve revenues from product sales will be impaired and our stock price will be materially and adversely affected. FDA approval is contingent on many factors, including clinical trial results and the evaluation of those results. Even if Entereg® is approved by the FDA for marketing, we will not be successful unless Entereg® gains market acceptance. The degree of market acceptance of Entereg® will depend on a number of factors, including:

 

    the breadth of the indication for which Entereg® may receive approval;

 

    the establishment and demonstration in the medical community of the safety and clinical efficacy of Entereg® and its potential advantages over competitive products; and

 

    pricing and reimbursement policies of government and third-party payors, such as insurance companies, health maintenance organizations and other plan administrators.

Physicians, patients, payors or the medical community in general may be unwilling to accept, utilize or recommend Entereg®.

 

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Patient enrollment may be slow and patients may discontinue their participation in clinical studies, which may negatively impact the results of these studies, and extend the timeline for completion of our and our collaborator’s development programs for our product candidates.

The time required to complete clinical trials is dependent upon, among other factors, the rate of patient enrollment. Patient enrollment is a function of many factors, including:

 

    the size of the patient population;

 

    the nature of the clinical protocol requirements;

 

    the diversion of patients to other trials or marketed therapies;

 

    the ability to recruit and manage clinical centers and associated trials;

 

    the proximity of patients to clinical sites; and

 

    the patient eligibility criteria for the study.

We are subject to the risk that patients enrolled in our and our collaborator’s clinical studies for our product candidates may discontinue their participation at any time during the study as a result of a number of factors, including, withdrawing their consent or experiencing adverse clinical events which may or may not be related to our product candidates under evaluation. We are subject to the risk that if a large number of patients in any one of our studies discontinue their participation in the study, the results from that study may not be positive or may not support an NDA for regulatory approval of our product candidates.

We may suffer significant setbacks in advanced clinical trials, even after promising results in earlier trials.

Product candidates that appear to be promising at earlier stages of development may not reach the market or be marketed successfully for a number of reasons, including, but not limited to, the following:

 

    researchers may find during later preclinical testing or clinical trials that the product candidate is ineffective or has harmful side effects;

 

    the number and types of patients available for extensive clinical trials may vary;

 

    new information about the mechanisms by which a drug candidate works may adversely affect its development;

 

    one or more competing products may be approved for the same or a similar disease condition, raising the hurdles to approval of the product candidate;

 

    the product candidate may fail to receive necessary regulatory approval or clearance; or

 

    competitors may market equivalent or superior products.

Our stock price may be volatile, and your investment in our stock could decline in value

The market price for our common stock has been highly volatile and may continue to be highly volatile in the future. For example, since January 1, 2005, the closing price of our common stock reached a low of $8.09 per share on February 17, 2005 and a high of $27.45 per share on March 2, 2006.

The market price for our common stock is highly dependent on the success of our product development efforts, and in particular, clinical trial results and regulatory review results.

The following additional factors may have a significant impact on the market price of our common stock:

 

    developments concerning our collaborations, including our collaboration with Glaxo;

 

    announcements of technological innovations or new commercial products by our competitors or us;

 

    developments concerning proprietary rights, including patents;

 

    publicity regarding actual or potential medical results relating to products under development by our competitors or us;

 

    regulatory developments in the United States and foreign countries;

 

    litigation;

 

    economic and other external factors or other disasters or crises;

 

    period-to-period fluctuations in our financial results; and

 

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    the general performance of the equity markets and, in particular, the biopharmaceutical sector of the equity markets.

Following periods of volatility and decline in the market price of a particular company’s securities, securities class action litigation has often been brought against that company.

We have been named in a purported class action lawsuit and related derivative lawsuits.

On April 21, 2004, a lawsuit was filed in the United States District Court for the Eastern District of Pennsylvania against us, one of our directors and certain of our officers seeking unspecified damages on behalf of a putative class of persons who purchased our common stock between September 23, 2003 and January 14, 2004. The complaint alleges violations of Section 10(b) and section 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), in connection with the announcement of the results of certain studies in the our Phase III clinical trials for Entereg®, which allegedly had the effect of artificially inflating the price of the our common stock. This suit has been consolidated with three subsequent actions asserting similar claims under the caption: In re Adolor Corporation Securities Litigation, No. 2:04-cv-01728. On December 29, 2004, the district court issued an order appointing the Greater Pennsylvania Carpenters’ Pension Fund as Lead Plaintiff. The appointed Lead Plaintiff filed a consolidated amended complaint on February 28, 2005. The Complaint purported to extend the class period, so as to bring claims on behalf of a putative class of Adolor shareholders who purchased stock between September 23, 2003 and December 22, 2004. The Complaint also adds as defendants our Board of Directors asserting claims against them and the other defendants for violation of Section 11 and Section 15 of the Securities Act of 1933 in connection with our public offering of stock in November 2003. We and our management and director defendants moved to dismiss the Complaint on April 29, 2005. The plaintiffs responded to the motion to dismiss on June 28, 2005, and the defendants’ reply was filed on August 12, 2005. We believe that the allegations are without merit and intend to vigorously defend the litigation.

On August 2, 2004, two shareholder derivative lawsuits were filed in the United States District Court for the Eastern District of Pennsylvania, purportedly on behalf of us, against our directors and certain of our officers seeking unspecified damages for various alleged breaches of fiduciary duty and waste. The allegations are similar to those set forth in the class action complaints, involving the announcement of the results of certain studies in our Phase III clinical trials for Entereg®. On November 12, 2004, the Derivative Plaintiff filed an amended Complaint. On December 13, 2004, we filed a motion challenging the standing of the Derivative Plaintiff to file the derivative litigation on its behalf. On December 13, 2004, our directors and officers moved to dismiss the Complaint for failure to state a claim. Plaintiffs responded to the Company’s and our directors’ and officers’ motions on January 27, 2005. We and our directors and officers filed reply briefs on February 18, 2005.

We may become involved in additional litigation of this type in the future. Litigation of this type is often extremely expensive, highly uncertain and diverts management’s attention and resources.

If we continue to incur operating losses for a period longer than anticipated, we may be unable to continue our operations.

We believe our existing cash, cash equivalents and short-term investments as of September 2006 of approximately $202.1 million will be sufficient to fund operations into 2008. We have generated operating losses since we began operations in November 1994. We expect to continue to generate such losses and will need additional funds that may not be available in the future. We have no products that have generated any revenue and, as of September 30, 2006, we have incurred a cumulative net loss of approximately $358.1 million. During the calendar years ended December 31, 2005 and 2004, we incurred operating losses of approximately $60.2 million and $46.1 million, respectively, and net losses of approximately $56.8 million and $43.6 million, respectively. During the nine month period ended September 30, 2006, we incurred operating losses of approximately $58.4 million and net losses of approximately $51.3 million. We expect to incur substantial losses for at least the next several years and expect that these losses will increase as we expand our research and development and sales and marketing activities. If we fail to obtain the capital necessary to fund our operations, we will be forced to curtail our operations and we will be unable to develop products successfully. We do not know whether additional financing will be available when needed, or that, if available, we will obtain financing on terms favorable to our stockholders or to us. If adequate funds are not available on acceptable terms, our ability to fund our operations, products or technologies or otherwise respond to competitive pressures could be significantly delayed or limited, and we may have to reduce or cease our operations. If additional funds become available there can be no assurance that we can predict the time and costs required to complete development programs or that we will not substantially exceed our budgets.

 

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We are dependent on our collaborators to perform their obligations under our collaboration agreements.

In April 2002, we and Glaxo entered into a collaboration agreement for the exclusive worldwide development and commercialization of Entereg® for certain indications. We and Glaxo agreed to develop Entereg® for a number of indications, both acute and chronic, which would potentially involve the use of Entereg® in in-patient and out-patient settings. In the United States, we have the right to co-develop and to co-promote Entereg® with Glaxo, and share development expenses and commercial returns, if any, pursuant to contractually agreed percentages. We have overall responsibility for the development of acute care indications such as POI, and Glaxo has overall responsibility for the development of chronic care indications such as OBD. We and Glaxo are required to use commercially reasonable efforts to develop the indications for which we and they are respectively responsible. We and Glaxo have established numerous joint committees to collaborate in the development of Entereg®. These committees meet at regularly scheduled intervals. We depend on Glaxo to provide us with substantial assistance and expertise in the development of Entereg®. Any failure of Glaxo to perform its obligations under our agreement could negatively impact our product candidate, Entereg®, and could lead to our loss of potential revenues from product sales and milestones that may otherwise become due under our collaboration agreement and would delay our achievement, if any, of profitability. Glaxo has extensive experience in the successful commercialization of product candidates which would be difficult for us to replace if the collaboration agreement was not in place. In the near term, our success will largely depend upon the success of our collaboration with Glaxo to further develop Entereg® and our success in obtaining regulatory approval to commercialize Entereg®.

The term of the collaboration agreement varies depending on the indication and the territory. The term of the collaboration agreement for the POI indication in the United States is ten years from the first commercial sale of Entereg® in that indication, if any. Generally, the term for the OBD indication in the United States is fifteen years from the first commercial sale of Entereg® in that indication, if any. In the rest of the world, the term is generally fifteen years from the first commercial sale of Entereg®, if any, on a country-by-country and indication-by-indication basis.

Glaxo has certain rights to terminate the collaboration agreement. Glaxo also has the right to terminate its rights and obligations with respect to the acute-care indications, or its rights and obligations for the chronic-care indications. Glaxo has the right to terminate the collaboration agreement for breach of the agreement by us or for safety related reasons as defined in the collaboration agreement. Glaxo’s rights to terminate the acute-care indications or the chronic-care indications are generally triggered by failure to achieve certain milestones within certain timeframes, adverse product developments or adverse regulatory events. For example, because the POI product has not been commercially sold as of December 31, 2005, Glaxo now possesses the right to terminate the collaboration agreement with respect to the POI Product and the other products defined as the Adolor Products under the collaboration agreement. If Glaxo terminates the collaboration agreement, we may not be able to find a new collaborator to replace Glaxo, and our business will be adversely affected.

Our corporate collaborators, including Glaxo, may determine not to proceed with one or more of our drug discovery and development programs. If one or more of our corporate collaborators reduces or terminates funding, we will have to devote additional internal resources to product development or scale back or terminate some development programs or seek alternative corporate collaborators.

We have limited commercial manufacturing capability and expertise. If we are unable to contract with third parties to manufacture our products in sufficient quantities, at an acceptable cost and in compliance with regulatory requirements, we may be unable to obtain regulatory approvals, or to meet demand for our products.

Completion of our clinical trials and commercialization of our product candidates require access to, or development of, facilities to manufacture a sufficient supply of our product candidates. We have depended and expect to continue to depend on third parties for the manufacture of our product candidates for preclinical, clinical and commercial purposes. We may not be able to contract for the manufacture of sufficient quantities of the products we develop, or even to meet our needs for pre-clinical or clinical development. Our products may be in competition with other products for access to facilities of third parties and suitable alternatives may be unavailable. Consequently, our products may be subject to delays in manufacture if outside contractors give other products greater priority than our products. It is difficult and expensive to change contract manufacturers for pharmaceutical products, particularly when the products are under regulatory review in an NDA process. Our dependence upon others for the manufacture of our products may adversely affect our future profit margin and our ability to commercialize products, if any are approved, on a timely and competitive basis.

To receive regulatory approval for Entereg®, our contract manufacturers will be required to obtain approval for their manufacturing facilities to manufacture Entereg®, and there is a risk that such approval may not be obtained. We are required to submit, in an NDA, information and data regarding chemistry, manufacturing and controls which satisfies the FDA that our contract manufacturers are able to make Entereg® in accordance with current Good Manufacturing Practices (“cGMP”). Under cGMPs, we and our manufacturers will be required to manufacture our products and maintain records in a prescribed manner with respect to manufacturing, testing and quality control activities. We are dependent on our third party

 

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manufacturers to comply with these regulations in the manufacture of our products and these parties may have difficulties complying with cGMPs. The failure of any third party manufacturer to comply with applicable government regulations could substantially harm and delay or prevent regulatory approval and marketing of Entereg®.

We maintain a relationship with Torcan Chemical Ltd. for the supply of the active pharmaceutical ingredient (“API”) in Entereg®. We also maintain a relationship with Girindus AG as an additional supplier of API for Entereg®. We maintain a relationship with Pharmaceutics International Inc. for the supply of Entereg® finished capsules, and a relationship with Sharp Corporation for the packaging of Entereg® finished capsules. We also rely upon these parties for the performance of scale-up and other development activities, and for the maintenance and testing of product pursuant to applicable stability programs.

Clinical trials in our Phase III Entereg® program use drug product incorporating active pharmaceutical ingredient manufactured by two different contract manufacturing facilities, one of which is no longer in business. Our efforts to obtain regulatory approval for Entereg® may be impaired as a result of using material from two different contract manufacturing facilities.

We also expect to depend on third parties to manufacture product candidates we may acquire or in-license, and will need to develop our own internal capabilities and external relationships in that regard.

If we are unable to fully develop sales, marketing and distribution capabilities or enter into agreements with third parties to perform these functions, we will not be able to commercialize products.

We currently have no distribution capability and limited sales and marketing capabilities. In order to commercialize products, if any are approved, we must internally develop sales, marketing and distribution capabilities or make arrangements with third parties to perform these services. If we obtain regulatory approval, we intend to sell some products directly in certain markets and rely on relationships with established pharmaceutical companies to sell products in certain markets. To sell any of our products directly, we must fully develop a marketing and field force with technical expertise, as well as supporting distribution capabilities. We may not be able to establish in-house sales and distribution capabilities or relationships with third parties. To the extent that we enter into co-promotion or other licensing arrangements, our product revenues may be lower than if we directly marketed and sold our products, and any revenues we receive will depend upon the efforts of third parties, which efforts may not be successful.

We have limited experience in conducting and managing the clinical trials necessary to obtain regulatory approval and depend on third parties to conduct our clinical trials.

We have limited experience in managing clinical trials, and delays or terminations of clinical trials we are conducting or may undertake in the future could impair our development of product candidates. Delay or termination of any clinical trials could result from a number of factors, including adverse events, enrollment requirements, rate of enrollment, competition with other clinical trials for eligible patients and other factors. We are subject to the risk that subjects enrolled in our clinical studies may discontinue their participation at any time during the study as a result of a number of factors, including, withdrawing their consent or experiencing adverse clinical events which may or may not be judged related to our product candidates under evaluation.

We contract with third parties to conduct our clinical trials, and are subject to the risk that these third parties fail to perform their obligations properly and in compliance with applicable FDA and other governmental regulations. The failure of any third party to comply with any governmental regulations would substantially harm our development efforts and delay or prevent regulatory approval of our product candidates.

Our ability to enter into new collaborations and to achieve success under existing collaborations is uncertain.

We have entered into, and may in the future enter into, collaborative arrangements, including our arrangement with Glaxo, for the marketing, sale and distribution of our product candidates, which require, or may require, us to share profits or revenues. We may be unable to enter into additional collaborative licensing or other arrangements that we need to develop and commercialize our product candidates. Moreover, we may not realize the contemplated benefits from such collaborative licensing or other arrangements. These arrangements may place responsibility on our collaborative partners for preclinical testing, human clinical trials, the preparation and submission of applications for regulatory approval, or for marketing, sales and distribution support for product commercialization. These arrangements may also require us to transfer certain material rights or issue our equity securities to corporate partners, licensees and others. Any license or sublicense of our commercial rights may reduce our product revenue. Moreover, we may not derive any revenues or profits from these arrangements.

We cannot be certain that any of these parties, including Glaxo, will fulfill their obligations in a manner consistent with our best interests. Collaborators may also pursue alternative technologies or drug candidates, either on their own or in collaboration with others, that are in direct competition with us.

 

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Our quarterly operating results may fluctuate significantly depending on the initiation of new corporate collaboration agreements, the activities under current corporate collaboration agreements or the termination of existing corporate collaboration agreements.

Because our product candidates are in development, there is a high risk that further development and testing will demonstrate that our product candidates are not suitable for commercialization.

We have no products that have received regulatory approval for commercial sale. All of our product candidates, including Entereg®, are in development, and we face the substantial risks of failure inherent in developing drugs based on new technologies. Our product candidates must satisfy rigorous standards of safety and efficacy before the FDA and foreign regulatory authorities will approve them for commercial use. To satisfy these standards, we will need to conduct significant additional research, animal testing, or preclinical testing, and human testing, or clinical trials.

Preclinical testing and clinical development are long, expensive and uncertain processes. Failure can occur at any stage of testing. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful. Based on results at any stage of clinical trials, we may decide to discontinue development of our product candidates. Even if we obtain approval and begin marketing a product, on-going clinical trials, including for other indications, may result in additional information that could affect our ability or decision to continue marketing the drug.

We intend to explore opportunities to expand our product portfolio by acquiring or in-licensing products and/or product development candidates. Although we conduct extensive evaluations of product candidate opportunities as part of our due diligence efforts, there can be no assurance that our product development efforts related thereto will be successful or that we will not become aware of issues or complications that will cause us to alter, delay or terminate our product development efforts.

The concept of developing peripherally acting opioid antagonist drugs is relatively new and may not lead to commercially successful drugs.

Peripherally acting compounds given to patients as potential drugs are designed to exert their effects outside the brain and spinal cord, in contrast to centrally acting compounds which are designed to exert their effects on the brain or spinal cord. We are developing Entereg® as a peripherally acting opioid antagonist. An opioid antagonist is designed to block the effects of the opioid at the receptor level; in the case of Entereg®, it is designed to block the unwanted effects of opioid analgesics on the gastrointestinal tract. Since there are no products on the market comparable to our product candidates, we do not have any historical or comparative sales data to rely upon to indicate that peripherally acting opioid antagonist drugs will achieve commercial success in the marketplace. Market acceptance of our product candidates will depend on a number of factors, including:

 

    perceptions by members of the health care community, including physicians, of the safety and efficacy of our product candidates;

 

    cost-effectiveness of our product candidates relative to competing products;

 

    the availability of government or third-party payor reimbursement for our product candidates; and

 

    the effectiveness of marketing and distribution efforts by us and our collaborators.

Other products that are currently sold for pain management are already recognized as safe and effective and have a history of successful sales in the United States and elsewhere. Our new products in this area, if any, will be competing with drugs that have been approved by the FDA and have demonstrated commercial success in the United States and elsewhere.

Reduction in the use of opioid analgesics would reduce the potential market for Entereg®.

If the use of drugs or techniques which reduce the requirement for mu-opioids increases, the demand for Entereg® would be decreased. Various techniques to reduce the use of opioids are used in an attempt to reduce the impact of opioid side effects. The use of local anesthetics in epidural catheters during and after surgery with the continuation of the epidural into the post-operative period can reduce or eliminate the use of opioids. Non-steroidal inflammatory agents may also reduce total opioid requirements. Continuous infusion of local anesthetic into a wound or near major nerves can reduce the use of opioids in limited types of procedures and pain states. Novel analgesics which act at non-mu-opioid receptors are under development. Many companies have developed and are developing analgesic products that compete with opioids or which, if approved, would compete with opioids. If these analgesics reduce the use of opioids, it would have a negative impact on the potential market for Entereg®.

 

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If competitors develop and market products that are more effective, have fewer side effects, are less expensive than our product candidates or offer other advantages, our commercial opportunities will be limited.

Other companies have product candidates in development to treat the conditions we are seeking to ultimately treat and they may develop effective and commercially successful products. Our competitors may succeed in developing products either that are more effective than those that we may develop, or that they market before we market any products we may develop.

We believe that Progenics Pharmaceuticals, Inc. is developing methylnaltrexone for the treatment of indications like those being targeted by us in both the acute and chronic settings. There are products already on the market for use in treating irritable bowel syndrome which may be evaluated for utility in opioid induced bowel dysfunction. There may be additional competitive products about which we are not aware. If our competitors are able to reach the commercial market before we are, this could have a material adverse effect on our ability to reach the commercial market and sell our products.

Our competitors include fully integrated pharmaceutical companies and biotechnology companies, universities and public and private research institutions. Many of the organizations competing with us have substantially greater capital resources, larger research and development staffs and facilities, greater experience in drug development and in obtaining regulatory approvals, and greater manufacturing and marketing capabilities than we do. These organizations also compete with us to:

 

    attract qualified personnel;

 

    attract partners for acquisitions, joint ventures or other collaborations; and

 

    license proprietary technology.

Our Delta agonist Program May Not Lead to Successful Drug Candidates.

The Delta receptor is one of three opioid receptors (mu, delta and kappa) that modulate pain. To date there have been no selective Delta agonist compounds successfully developed and approved by the FDA. We had an active delta agonist discovery program. We submitted an IND to the FDA in December 2005 to begin clinical testing of our first novel oral Delta agonist product candidate, ADL5859. In January 2006 we announced the FDA requested additional preclinical safety studies and additional information regarding our proposed Phase 1 protocol. Following our response to the FDA’s request for additional studies and information, the FDA lifted the clinical hold on our delta IND for ADL5859. During the third quarter of 2006, we commenced a Phase I clinical trial of ADL5859 designed to investigate the safety, tolerability and pharmacokinetics of a single dose of ADL5859 in healthy volunteers.

We may not be successful in our Delta agonist development program. Development of Delta agonists may not lead to commercially successful drugs.

Our business could suffer if we cannot attract, retain and motivate skilled personnel and cultivate key academic collaborations.

We are a small company, and our success depends on our continued ability to attract, retain and motivate highly qualified management and scientific personnel. Our Chief Executive Officer is serving on an interim basis and we have commenced a search for a replacement CEO. We may not be successful in attracting a qualified individual to us. Our success also depends on our ability to develop and maintain important relationships with leading academic institutions and scientists. Competition for personnel and academic collaborations is intense. In particular, our product development programs depend on our ability to attract and retain highly skilled chemists, biologists and clinical development personnel. If we lose the services of any of these personnel it could impede significantly the achievement of our research and development objectives. In addition, we will need to hire additional personnel and develop additional academic collaborations as we continue to expand our research and development activities. We do not know if we will be able to attract, retain or motivate personnel or maintain relationships. We do not maintain key man life insurance on any of our employees.

Companies and universities that have licensed technology and product candidates to us are sophisticated entities that could develop similar products to compete with products we hope to develop.

Licensing product candidates from other companies, universities, or individuals does not prevent such parties from developing competitive products for their own commercial purposes, nor from pursuing patent protection in areas that are competitive with us. The individuals who created these technologies are sophisticated scientists and business people who may continue to do research and development and seek patent protection in the same areas that led to the discovery of the product candidates that they licensed to us. The development and commercialization by us of successful products is also likely to attract additional research by our licensors and by other investigators who have experience in developing products for the pain management market. By virtue of their previous research activities, these companies, universities, or individuals may be able to develop and market competitive products in less time than might be required to develop a product with which they have no prior experience.

 

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If we breach our licensing agreements, we will lose significant benefits and may be exposed to liability for damages.

We may breach our license agreements and may thereby lose rights that are important. We are subject to various obligations with respect to license agreements, including development responsibilities, royalty and other payments and regulatory obligations. If we fail to comply with these requirements or otherwise breach a license agreement or contract, the licensor or other contracting party may have the right to terminate the license or contract in whole or in part or change the exclusive nature of the arrangement. In such event we would not only lose all or part of the benefit of the arrangement but also may be exposed to potential liabilities for breach in the form of damages or other penalties.

Because we are not certain we will obtain necessary regulatory approvals to market our products in the United States and foreign jurisdictions, we cannot predict whether or when we will be permitted to commercialize any of our products.

The pharmaceutical industry is subject to stringent regulation by a wide range of authorities. We cannot predict whether we will obtain regulatory clearance for any product candidate we develop. We cannot market a pharmaceutical product in the United States until it has completed rigorous preclinical testing and clinical trials and the FDA’s extensive regulatory premarket approval process. Satisfaction of regulatory requirements typically takes many years, is dependent upon the type, complexity and novelty of the product and requires the expenditure of substantial resources for research and development, testing, manufacturing, quality control, labeling and promotion of drugs for human use. Since neither the FDA nor international regulatory authorities have approved peripherally restricted narcotic antagonist drugs for marketing, there is additional uncertainty as to whether our research and clinical approaches to developing new products for the pain management market will lead to drugs that the FDA will consider safe and effective for indicated uses. Before receiving FDA approval to market a product, we must demonstrate that the product candidate is safe and effective in the patient population that is intended to be treated. Outside the United States, our ability to market a product is also contingent upon receiving a marketing authorization from the appropriate regulatory authorities, and is subject to similar risks and uncertainties.

We do not know whether our current or future preclinical and clinical studies will demonstrate sufficient safety and efficacy necessary to obtain the requisite regulatory approvals, or will result in marketable products. Any failure to adequately demonstrate the safety and efficacy of our product candidates will prevent receipt of FDA and foreign regulatory approvals and, ultimately, commercialization of our product candidates. Regulatory authorities may refuse or delay approval as a result of many other factors, including changes in regulatory policy during the period of product development and regulatory interpretations of clinical benefit and clinical risk. Regulatory clearance that we may receive for a product candidate will be limited to those diseases and conditions for which we have demonstrated in clinical trials that the product candidate is safe and efficacious. Even if we receive regulatory approval for our product candidates we must comply with applicable FDA post marketing regulations governing manufacturing, promotion, labeling, and reporting of adverse events and other information, as well as other regulatory requirements. Failure to comply with applicable regulatory requirements could subject us to criminal penalties, civil penalties, recall or seizure of products, withdrawal of marketing approval, total or partial suspension of production or injunction, as well as other regulatory actions against our product or us.

If we market products in a manner that violates health care fraud and abuse laws, we may be subject to civil or criminal penalties.

In addition to FDA restrictions on marketing of pharmaceutical products, several other types of state and federal health care fraud and abuse laws have been applied to restrict certain marketing practices in the pharmaceutical industry in recent years. These laws include antikickback statutes and false claims statutes.

The federal health care program antikickback statute prohibits, among other things, knowingly and willfully offering, paying, soliciting, or receiving remuneration to induce or in return for purchasing, leasing, ordering, or arranging for the purchase, lease or order of any health care item or service reimbursable under Medicare, Medicaid, or other federally financed health care programs. This statute has been interpreted to apply to arrangements between pharmaceutical manufacturers on one hand and prescribers, purchasers, and formulary managers on the other. Although there are a number of statutory exemptions and regulatory safe harbors protecting certain common activities from prosecution, the exemptions and safe harbors are drawn narrowly, and practices that involve remuneration intended to induce prescribing, purchases, or recommendations may be subject to scrutiny if they do not qualify for an exemption or safe harbor. Our practices may not in all cases meet all of the criteria for safe harbor protection from antikickback liability.

Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government, or knowingly making, or causing to be made, a false statement to get a false claim paid.

 

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Recently, several pharmaceutical and other health care companies have been prosecuted under these laws for a variety of alleged promotional and marketing activities, such as allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product; reporting to pricing services inflated average wholesale prices that were then used by federal programs to set reimbursement rates; engaging in off-label promotion that caused claims to be submitted to Medicaid for non-covered off-label uses; and submitting inflated best price information to the Medicaid Rebate Program to reduce liability for Medicaid Rebates. The majority of states also have statutes or regulations similar to the federal antikickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a manufacturer’s products from reimbursement under government programs, criminal fines, and imprisonment.

Because of the breadth of these laws and the narrowness of the safe harbors, it is possible that some of our business activities could be subject to challenge under one or more of such laws.

The federal Controlled Substances Act might impose significant restrictions, licensing and regulatory requirements on the manufacturing, distribution and dispensing of certain of our product candidates.

The federal Controlled Substances Act imposes significant restrictions, licensing and regulatory requirements on the manufacturing, distribution and dispensing of controlled substances. Therefore, we must determine whether the Drug Enforcement Administration (“DEA”) would consider any of our product candidates to be a controlled substance. We believe that it is unlikely that any of our product candidates, other than those which may act on the central nervous system, may be subject to regulation as controlled substances.

Facilities that conduct research, manufacture or distribute controlled substances must be registered to perform these activities and have the recordkeeping, reporting security, control and accounting systems required by the DEA to prevent loss and diversion. Failure to maintain compliance, particularly as manifested in loss or diversion, can result in significant regulatory action, including civil, administrative or criminal penalties. In addition, individual state laws may also impose separate regulatory restrictions and requirements, including licenses, recordkeeping and reporting. We believe that it is unlikely that any of our product candidates, other than those which may act on the central nervous system, may be subject to regulation as controlled substances.

We are planning to develop products that contain alvimopan and an opioid. For products that contain alvimopan and an opioid, we would be required to comply with the restrictions, licensing and regulatory requirements relating to controlled substances.

We may not obtain FDA approval to conduct clinical trials that are necessary to satisfy regulatory requirements.

Clinical trials are subject to oversight by institutional review boards and the FDA and:

 

    must conform with the FDA’s good clinical practice regulations;

 

    must meet requirements for institutional review board oversight;

 

    must meet requirements for informed consent;

 

    are subject to continuing FDA oversight; and

 

    may require large numbers of test subjects.

Before commencing clinical trials in humans, we must submit to the FDA an Investigational New Drug Application, or IND. The FDA may decide not to permit the clinical trial to go forward. In addition, we, or the FDA, may suspend ongoing clinical trials at any time if the subjects participating in the trials are exposed to unacceptable health risks, or if the FDA finds deficiencies in the IND application or the conduct of the trials.

It is difficult and costly to protect our intellectual property rights, and we cannot ensure the protection of these rights; we may be sued by others for infringing their intellectual property.

Our commercial success will depend in part on obtaining patent protection on our products and successfully defending these patents against third party challenges. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. Accordingly, we cannot predict the breadth of claims allowed in our patents or those of our collaborators.

Others have filed and in the future are likely to file patent applications covering products and technologies that are similar, identical or competitive to ours, or important to our business. We cannot be certain that any patent application owned by a third party will not have priority over patent applications filed or in-licensed by us, or that we or our licensors will not be involved in interference proceedings before the United States Patent and Trademark Office.

 

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Although no third party has asserted a claim of infringement against us, others may hold proprietary rights that will prevent our product candidates from being marketed unless we can obtain a license to those proprietary rights. Any patent related legal action against our collaborators or us claiming damages and seeking to enjoin commercial activities relating to our products and processes could subject us to potential liability for damages and require our collaborators or us to obtain a license to continue to manufacture or market the affected products and processes. We cannot predict whether we or our collaborators would prevail in any of these actions or that any license required under any of these patents would be made available on commercially acceptable terms, if at all. There has been, and we believe that there will continue to be, significant litigation in the industry regarding patent and other intellectual property rights. If we become involved in litigation, it could consume substantial managerial and financial resources.

We rely on trade secrets to protect technology in cases when we believe patent protection is not appropriate or obtainable. However, trade secrets are difficult to protect. While we require employees, academic collaborators and consultants to enter into confidentiality agreements, we may not be able to protect adequately our trade secrets or other proprietary information. Our research collaborators and scientific advisors have rights to publish data and information in which we have rights. If we cannot maintain the confidentiality of our technology and other confidential information in connection with our collaborations, our ability to receive patent protection or protect our proprietary information may be imperiled.

We are a party to various license agreements that give us rights to use specified technologies in our research and development processes. If we are not able to continue to license such technology on commercially reasonable terms, our product development and research may be delayed. In addition, we generally do not fully control the prosecution of patents relating to in-licensed technology, and accordingly are unable to exercise the same degree of control over this intellectual property as we exercise over our internally developed technology.

Our ability to generate revenues will be diminished if we fail to obtain acceptable prices or an adequate level of reimbursement for our products from third-party payors.

Our ability to commercialize pharmaceutical products, alone or with collaborators, may depend in part on the extent to which reimbursement for the products will be available from:

 

    government and health administration authorities; or

 

    private health insurers and third party payors.

The continuing efforts of government and third-party payors to contain or reduce the costs of health care through various means may limit our commercial opportunity. For example, in some foreign markets, pricing and profitability of prescription pharmaceuticals are subject to government control. In the United States, we expect that there will continue to be a number of federal and state proposals to implement pharmaceutical pricing and cost control measures under government health care programs such as Medicare and Medicaid. Increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical products. Significant uncertainty exists as to the reimbursement status of newly approved health care products. Cost control initiatives could adversely affect our and our collaborator’s ability to commercialize our products, decrease the price that any of our collaborators or we would receive for any products in the future, and may impede patients’ ability to obtain reimbursement under their insurance programs for our products.

If we engage in an acquisition or business combination, we will incur a variety of risks that could adversely affect our business operations or our stockholders.

From time to time we have considered, and we will continue to consider in the future, if and when any appropriate opportunities become available, strategic business initiatives intended to further the development of our business. These initiatives may include acquiring businesses, technologies or products or entering into a business combination with another company. If we do pursue such a strategy, we could, among other things:

 

    issue equity securities that would dilute our current stockholders’ percentage ownership;

 

    incur substantial debt that may place strains on our operations;

 

    spend substantial operational, financial and management resources in integrating new businesses, technologies and products;

 

    assume substantial actual or contingent liabilities; or

 

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    merge with, or otherwise enter into a business combination with, another company in which our stockholders would receive cash or shares of the other company or a combination of both on terms that our stockholders may not deem desirable.

We are not in a position to predict what, if any, collaborations, alliances or other transactions may result or how, when or if these activities would have a material effect on us or the development of our business.

If product liability lawsuits are successfully brought against us, we may incur substantial liabilities and may have to limit or cease commercialization of our products.

The testing and marketing of medical products entail an inherent risk of product liability. If we cannot successfully defend ourselves against product liability claims, we may incur substantial liabilities or be required to limit or cease commercialization of our products. We currently carry clinical trial insurance at a level we believe is commercially reasonable but do not carry product liability insurance. Our corporate collaborators or we may not be able to obtain insurance at a reasonable cost, if at all. There is no assurance that our clinical trial insurance will be adequate to cover claims that may arise.

We enter into various agreements where we indemnify third parties such as manufacturers and investigators for certain product liability claims related to our products. These indemnification obligations may cause us to pay significant sums of money for claims that are covered by these indemnifications.

If we use biological and hazardous materials in a manner that causes injury or violates laws, we may be liable for damages.

Our research and development activities involve the controlled use of potentially harmful biological materials as well as hazardous materials, chemicals and various radioactive compounds. We use radioactivity in conducting biological assays and we use solvents that could be flammable in conducting our research and development activities. We cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of these materials. We do not maintain a separate insurance policy for these types of risks. In the event of contamination or injury, we could be held liable for damages that result, and any liability could exceed our resources. We are subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations could be significant.

Certain provisions of our charter documents and under Delaware law may make an acquisition of us, which may be beneficial to our stockholders, more difficult.

Provisions of our amended and restated certificate of incorporation and restated by-laws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders.

We have shares of our common stock and preferred stock available for future issuance without stockholder approval. The existence of unissued common stock and preferred stock may enable our board of directors to issue shares to persons friendly to current management or to issue preferred stock with terms that could render more difficult or discourage a third party attempt to obtain control of us by means of a merger, tender offer, proxy contest or otherwise, which would protect the continuity of our management.

Our amended and restated certificate of incorporation provides for our board of directors to be divided into three classes, with the term of one such class expiring each year, and we have eliminated the ability of our stockholders to consent in writing to the taking of any action pursuant to Section 228 of the Delaware General Corporation Law.

In addition, we adopted a shareholder rights plan, the effect of which may be to make an acquisition of the Company more difficult.

Under our collaboration agreement with Glaxo, there are certain limitations on Glaxo’s ability to acquire our securities. During and for one year after the term of the collaboration agreement, Glaxo and its affiliates will not, alone or with others, except as permitted under limited circumstances:

 

    acquire or agree to acquire, directly or indirectly, any direct or indirect beneficial ownership or interest in any of our securities or securities convertible into or exchangeable for any of our securities;

 

    make or participate in any solicitation of proxies to vote in connection with us;

 

    form, join or in any way participate in a group with respect to our voting securities;

 

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    acquire or agree to acquire, directly or indirectly, any of our assets or rights to acquire our assets, unless we are selling those assets at that time; or

 

    otherwise seek to change the control of us or propose any matter to be voted on by our stockholders or nominate any person as a director of us who is not nominated by the then incumbent directors.

These limitations make it more difficult for Glaxo to acquire us, even if such an acquisition would benefit our stockholders. The limitations do not prevent Glaxo, among other things, from acquiring our securities in certain circumstances following initiation by a third party of an unsolicited tender offer to purchase more than a certain percentage of any class of our publicly traded securities.

ITEM 6. EXHIBITS:

The following exhibits are filed as part of this Report on Form 10-Q:

 

10.1   Agreement dated August 8, 2006 between the Company and David M. Madden (incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Company on August 9, 2006) 4
31.1   Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 1
31.2   Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 1
32.1   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 1
32.2   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 1

1 Filed herewith.
4 Compensation plan or arrangement in which directors or executive officers are eligible to participate.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  ADOLOR CORPORATION
Date: October 31, 2006   By:  

/s/ David Madden

    David Madden
    Interim President and Chief Executive Officer
  By:  

/s/ Thomas P. Hess

    Thomas P. Hess
    Vice President, Finance and
    Chief Financial Officer

 

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