ADOLOR CORP - 10-K Annual Report

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ No ¨

The approximate aggregate market value of Common Stock held by non-affiliates of the registrant was $342,033,637 as of June 28, 2002, the last business day of the registrant’s most recently completed second fiscal quarter. (For purposes of determining this amount only, the registrant has defined affiliates as including (a) the executive officers of the registrant as of June 28, 2002, (b) all directors of the registrant as of June 28, 2002 and (c) each stockholder that informed the registrant that as of June 28, 2002 it was the beneficial owner of 10% or more of the outstanding common stock of the registrant.)

The number of shares of the registrant’s Common Stock outstanding as of March 10, 2003 was 31,524,794 shares.

Portions of the definitive proxy statement (the “Definitive Proxy Statement”) to be filed with the Securities and Exchange Commission in connection with the Company’s Annual Meeting of Stockholders for the fiscal year ended December 31, 2002 are incorporated by reference into Part III of this Report.

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This Annual Report on Form 10-K includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward looking statements include those which express plan, anticipation, intent, contingency 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:

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 elsewhere in this Report in sections entitled “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” (including a subsection thereof entitled “Certain Risks Related to our Business”) 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 and from us. 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.

Market data and forecasts used in this Report, including, for example, estimates of the size and growth rates of the pain management market, have, in some cases, been obtained from independent industry sources. We have not independently verified the data obtained from these sources and we cannot assure you of the accuracy or completeness of the data. Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and the additional uncertainties accompanying any estimates of future market size.

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The following discussion should be read in conjunction with our audited Consolidated Financial Statements and related Notes thereto included elsewhere in this Report and the sections of this Report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” (including a subsection thereof entitled “Certain Risks Related to our Business”).

We are a development stage biopharmaceutical corporation that was formed in 1993. We discover, develop and plan to commercialize proprietary pharmaceutical products for the treatment of pain and the side effects that are caused by current pain treatments. We have a number of small molecule product candidates that are in various stages of development ranging from preclinical studies to Phase III clinical trials. Our lead product candidate, alvimopan, is designed to selectively block the unwanted effects of opioid analgesics on the gastrointestinal tract. Our other product candidates are being designed as analgesics to treat moderate-to-severe pain and itch. Additionally, we are exploring the development of an analgesic product candidate that would be a combination of alvimopan and an opioid that would be intended to produce the pain relief of an opioid while reducing side effects, such as constipation, nausea and vomiting.

Alvimopan is being evaluated in acute and chronic indications. We have completed three Phase II clinical trials and we are currently conducting Phase III clinical trials studying the use of alvimopan for the management of postoperative ileus (bowel dysfunction) that frequently follows abdominal surgery when opioids are used for pain relief. We have also completed several Phase II and one Phase III clinical trial studying the use of alvimopan for reversal of the severe constipating effects associated with chronic use of opioids.

In April 2002, we entered into a collaboration agreement with Glaxo Group Limited (“Glaxo”) for the exclusive worldwide development and commercialization of alvimopan for certain indications. The companies have agreed to co-develop alvimopan for a number of indications, both acute and chronic, which would potentially involve the use of alvimopan in in-patient and out-patient settings. Under the terms of the collaboration agreement, Glaxo paid us a non-refundable and non-creditable signing fee of $50 million during the quarter ended June 30, 2002 and we may receive milestone payments of up to $220 million over the term of the agreement upon the successful achievement, if any, of certain clinical and regulatory objectives.

In the United States, we and Glaxo will co-develop and intend to co-promote alvimopan and share development expenses and commercial returns, if any. We have overall responsibility for development activities for acute-care indications such as postoperative ileus and Glaxo has overall responsibility for the development activities for chronic care indications such as opioid bowel dysfunction associated with the chronic use of opioids. Outside the United States, Glaxo will be responsible for the development and commercialization of alvimopan, and we will receive royalties on sales revenues, if any. Glaxo has certain rights to terminate the collaboration agreement as well as to terminate its rights and obligations with respect to the acute-care indications and/or chronic-care indications. A significant portion of our revenue for 2002 was from reimbursement of expenses from Glaxo under our collaboration agreement and we expect such revenues to be substantially reduced in future periods as we expect the related reimbursable expense to decrease.

We have additional compounds in clinical development that are designed to elicit their effects by targeting peripheral opioid receptors, including kappa receptors. Our first kappa agonist compound, ADL 10-0101, is being studied in early clinical trials for the treatment of pain. Following positive results in two small exploratory clinical trials with ADL 10-0101, we commenced three additional exploratory clinical trials in visceral pain. These trials did not demonstrate adequate pain relief in patients. We have recently completed studies to identify the maximally tolerated dose in both males and females. Using this new information, we plan to initiate during 2003, Phase II studies of a higher dose of ADL 10-0101 than previously studied.

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We have completed Phase I studies with a second kappa agonist compound, ADL 10-0116, an orally active compound that is designed for use in the treatment of inflammatory pain conditions. These studies identified the maximally tolerated doses in both males and females. We plan to initiate Phase II studies of ADL 10-0116 in 2003.

Finally, we have been evaluating ADL 2-1294, a peripheral mu opioid agonist, in pre-clinical development for treating a variety of pain conditions. The active ingredient of ADL 2-1294 is loperamide. We are currently in preclinical development exploring intra-articular administration of ADL 2-1294 for relief of pain. We have previously maintained collaborative programs with corporate partners evaluating the use of ADL 2-1294 in dermal pain and itch as well as ophthalmic pain which were terminated by our collaboration partners. We are evaluating whether to seek another partner to continue to develop dermal ADL 2-1294 for pain or itch indications. We presently have no plans to continue the ophthalmic program.

We have a small marketing organization to support our development efforts. We plan to build a sales force in the United States and expand our marketing organization to co-promote alvimopan, if regulatory approval is received, along with Glaxo to surgeons, oncologists and pain management specialists in hospital-care settings. We intend to rely on Glaxo for sales and marketing of alvimopan outside the United States. 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.

Over 100 million patients experience acute or chronic pain annually in the United States caused by headache, muscle strains and sprains, arthritis, trauma, cancer, surgery and back injuries, among others. Because pain impairs one’s ability to carry out a productive life, pain in general and chronic pain in particular are serious health and economic problems.

There has been an increasing focus on pain management in the healthcare industry. Published guidelines of the World Health Organization and the United States Agency for Health Care Policy and Research encourage the use of stronger analgesic therapy for treating pain. In 1991, the American Board of Medical Specialties designated the treatment of pain as a recognized specialty for physicians. The number of physicians receiving specialty training in pain management increased from 446 in 1993, the first year in which certifications were granted, to a total of over 3,900 in 2001. In addition, since 1999, all United States hospitals and health care facilities have been required to assess the adequacy of pain treatment for each patient on a daily basis to achieve accreditation by the Joint Commission on Accreditation of Healthcare Organizations.

Types of Pain. Pain is commonly classified into three broad categories based upon its presumed cause and sensory characteristics: somatic pain, visceral pain and neuropathic pain. Somatic pain can be produced by injuries to skin, muscle, bones or joints and is typically characterized as a sharp pain that is localized to an area of injury. Visceral pain can be produced by distention, injury or inflammation of internal organs and is typically characterized by diffuse, poorly localized, dull and vague pain. Neuropathic pain can be produced by injuries or inflammation of nerves and is typically characterized by diffuse, burning pain. Patients may simultaneously experience more than one type of pain.

Pain Management Market. Prescription pain management sales for the twelve months ended December 31, 2002, were reported by IMS Health, Retail and Provider Perspective^™, 2/2003, (IMS Health) a pharmaceutical information and consulting company, to be $15.6 billion in the United States. Growth in the pain management market has been significant in recent years and is expected to continue. The prescription pain management market grew 5.4% in 2002 over 2001, primarily driven by the increased use of opioids.

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Sales of prescription pain management products in the United States as reported by IMS Health are shown in the following table:

The pain management market for drugs used to treat patients with moderate-to-severe and mild-to-moderate pain is growing due to the following factors:

Current Therapies to Counteract Pain. Opioid analgesics such as morphine are considered to be the most effective analgesics and are widely used to treat patients with moderate-to-severe pain. These opioid analgesics produce pain relief by stimulating opioid receptors in the central nervous system, which consists of the brain and spinal cord. Advances in opioid analgesics during the past 20 years have primarily been in improved methods for the delivery of existing narcotic opioid rather than the discovery of new drugs. Patients who suffer severe pain may simultaneously receive more than one formulation of opioid analgesic and may also receive other classes of analgesic medications.

Non-opioid analgesics, including acetaminophen and non-steroidal anti-inflammatory drugs, or NSAIDs, such as ibuprofen, are widely used to treat mild-to-moderate pain. NSAIDs are thought to produce analgesia by inhibiting activity of cyclooxygenase enzymes (COX-l and COX-2), thereby reducing inflammation at the site of injury or disease. Some NSAIDs require a prescription and others are available as over-the-counter medications. Recent advances in NSAID analgesia have focused primarily on reducing adverse gastrointestinal (GI) side effects.

Although morphine and other opioid analgesics are considered to be the most effective analgesics for moderate-to-severe pain, many patients who use them do not obtain complete pain relief, and they are ineffective for other patients. Opioid analgesics also produce a wide range of adverse effects that may include opioid bowel dysfunction, sedation, nausea, vomiting, decreased respiratory function, addiction and in some instances, death. In addition, due to their potential for abuse, most opioid analgesics are strictly regulated by the United States Drug Enforcement Agency, or DEA, under the Controlled Substances Act, which imposes strict registration, record-keeping and reporting requirements, security controls and restrictions on narcotic analgesic prescriptions.

Although NSAIDs are generally effective for mild-to-moderate pain, many patients are unable to tolerate NSAIDs because of GI side effects. Traditional NSAIDs can produce significant adverse effects on the stomach and GI tract, including GI ulcers and bleeding. In addition, prolonged use of NSAIDs can cause liver and kidney failure.

Pain Transmission Signals. When tissues such as the skin, muscles and joints become inflamed or are injured, pain receptors in those tissues are activated, and electrical pain signals are transmitted from the injured

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tissues through nerve fibers into the spinal cord. Within the spinal cord, the electrical pain signals are received by a second set of nerve fibers that continue the transmission of the signal up the spinal cord and into the brain. Within the brain, additional nerve fibers transmit the electrical signals to the “pain centers” of the brain where these signals are perceived as pain. Pain receptors are also present in internal, or visceral, organs such as the intestines, uterus, cervix and bladder. These pain receptors also send pain signals via similar pathways to the brain when these organs are inflamed or distended.

Opioid Receptors Block Pain Transmission Signals. Opioid receptors located on the surface of nerves that transmit pain signals block transmission of pain when activated by drugs specific for those receptors. There are three types of opioid receptors, mu, kappa and delta, each of which produces analgesia when activated. Virtually all marketed opioid analgesic drugs interact with mu opioid receptors in the brain and spinal cord. When these central nervous system mu opioid receptors are activated with opioid analgesics such as morphine, the perception of pain is reduced. However, activating these opioid receptors in the brain with morphine-like opioid analgesics often results in serious side effects such as sedation, decreased respiratory function and addiction. Because of the potential to cause addiction, drugs that are able to activate mu opioid receptors in the brain (morphine-like opioid analgesics) are regulated, or scheduled, under the Controlled Substances Act.

Compounds that activate kappa opioid receptors in the brain also produce analgesia and sedation but are far less likely than morphine to decrease respiratory function. Studies in animals and humans suggest that opioid drugs that activate the kappa receptors are unlikely to cause addiction. However, prototype kappa opioid compounds that were designed to work in the brain have produced other adverse central nervous system side effects, including visual and auditory disturbances, unpleasant mood changes and hallucinations. These side effects have prevented the development of kappa analgesics that act on receptors in the central nervous system.

Peripheral Opioid Analgesia. Scientists have shown that mu and kappa opioid receptors are present on nerve endings in the skin, joints, eyes and visceral organs. Activation of these opioid receptors, which are outside of the central nervous system, with mu or kappa opioid analgesics reduces pain related to injury or inflammation by decreasing pain signal transmission from the peripheral nerves into the spinal cord. Proof-of-concept studies in animals and humans have shown that small doses of morphine, applied locally to inflamed tissues such as skin, joints and eyes are effective in reducing pain.

These findings have created the opportunity for us to potentially develop an entirely new class of analgesics that may selectively stimulate opioid receptors in inflamed tissues but not stimulate opioid receptors in the central nervous system thereby avoiding the central nervous system side effects of opioids. These pain medications are called peripheral analgesics. In preclinical studies, our peripheral mu opioid analgesics demonstrated positive results and our peripheral kappa opioid analgesics demonstrated positive results in blocking the visceral pain originating from internal organs such as the bowel and cervix. Because our peripheral analgesics are designed to have limited ability to cross the blood-brain barrier at therapeutic doses, they have the potential not to cause addiction or other adverse central nervous system side effects, such as sedation, decreased respiratory function or addiction. As a result, we expect that these analgesics may not be subject to United States Drug Enforcement Agency regulation under the Controlled Substances Act.

Peripheral Opioid Receptors in the GI Tract. Just as there are opioid receptors on peripheral nerves that regulate the transmission of pain signals into the spinal cord, there are also opioid receptors in the gastrointestinal tract that regulate functions such as motility and water secretion and absorption. Stimulation of these gastrointestinal mu opioid receptors by morphine or other opioid analgesics causes constipation associated with opioid bowel dysfunction. Scientists have shown that blocking these receptors with opioid receptor antagonist drugs during administration of morphine or other opioid analgesics may prevent or reverse the effects of opioid bowel dysfunction. However, currently marketed opioid receptor antagonist drugs also cross the blood-brain barrier and enter the brain where they can block the primary pain relieving effects of opioid analgesics such as

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morphine. These findings have created the opportunity to develop a new class of opioid antagonists which, when taken with opioid analgesics, are designed to block the side effects of the opioid analgesics on the GI tract but not the desired analgesic activity of opioid drugs because they are designed not to cross the blood-brain barrier.

Development of Peripherally-Restricted Products. We use our biological, chemical and analytical technology expertise to create proprietary peripheral opioid agonists (analgesics) and opioid antagonists.

Within our analgesia program, we use computer-assisted chemical design technology and medicinal chemistry to synthesize compounds that we design to have limited ability to pass through the blood-brain barrier into the central nervous system. We then use cloned human mu, kappa and delta opioid receptors to select the compounds that are effective at very low concentrations and that are highly specific for one receptor type over other receptor types. We conduct preclinical studies to confirm the analgesic activity of the compounds and to confirm that the compounds have limited ability to pass through the blood-brain barrier. We have demonstrated in a number of preclinical trials of inflammatory and visceral pain that our peripherally restricted kappa analgesics can produce the same or better pain relief as narcotic analgesics, such as morphine, without causing central nervous system side effects. In addition, we have demonstrated that our peripheral kappa analgesic was active in preclinical trials for the relief of itch. Similarly, we have shown in preclinical and clinical trials that our opioid antagonists, including our lead compound, alvimopan, block the adverse side effects of opioid analgesics on the GI tract without appearing to affect clinical analgesia.

Itch sensations are carried by nerves of the same type that carry pain signals to the brain, and we have found that many of our peripherally-restricted analgesics can reduce the perception of itch in preclinical trials. These compounds may be effective as topical, injectable or oral medications for relieving itch in a wide variety of diseases including eczema and allergic dermatitis.

Peripherally-active analgesics may not relieve all types of pain. Therefore, the development of centrally-active analgesics with reduced side effects is one of our longer-term goals.

Our goal is to build a profitable pharmaceutical company specializing in the discovery, licensing, acquisition, development and commercialization of prescription pain management products. We plan to pursue this objective by implementing the following strategies:

Focusing On Opioid Receptors in Pain Management. We focus on clinical conditions that can be treated by either stimulating or blocking opioid receptors. These conditions include acute (postoperative ileus) and chronic opioid bowel dysfunction, and various pain conditions including inflammatory pain, itch and visceral pain. We have biological and chemical expertise to support drug discovery, including expertise in opioid receptors in analgesic pathways, cloned human opioid, orphan and chimeric receptors and the chemical synthesis of compounds that do not readily cross the blood-brain barrier. We are using our knowledge about opioid receptors to develop alvimopan, ADL 2-1294, ADL 10-0101, and ADL 10-0116, all of which are peripherally acting opioid receptor compounds, for a variety of clinical indications. We spent approximately $71.7 million in 2002, approximately $36.0 in 2001 and approximately $15.9 million in 2000 on research and development activities. We funded most of these expenditures internally, however, in 2002, certain of our development costs related to alvimopan were reimbursed by Glaxo in accordance with the terms of our collaboration agreement.

Implementing a Commercial Strategy that will Combine Marketing and Product Development Alliances with our own Product Development and Marketing Organization. We have entered into a worldwide collaboration agreement with Glaxo to co-develop and commercialize alvimopan. Under the terms of that agreement, we have overall responsibility for development activities for acute-care indications, such as postoperative ileus, and Glaxo has overall responsibility for development activities for chronic care indications, such as opioid bowel dysfunction associated with the chronic use of opioids. We have established a small marketing organization and

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we plan to build a sales organization and expand the marketing organization in the future. We plan to maintain commercial rights in the United States for a number of our other product candidates. We intend to market certain of our product candidates to the hospital market, including surgeons, oncologists and pain management specialists. In addition, we have established and will continue selectively to establish collaborations with pharmaceutical companies and leading academic institutions to enhance our research, development and commercialization activities. We believe our biological and chemical expertise to support drug discovery will continue to generate opportunities for collaborative arrangements.

Implementing an In-Licensing/Acquisition Strategy. We believe there are opportunities to expand our product portfolios by the acquisition or in-licensing of products and/or product development candidates to complement our internal development efforts. We intend to explore in-licensing or acquisition of products or product candidates or technology, as well as acquisition of companies.

Our product candidates are currently in the stage of development as set forth below and further described in the discussion following the chart.

Alvimopan, which is also known as ADL 8-2698, is a peripherally-acting mu opioid receptor antagonist that is designed to block the adverse side effects of opioid analgesics on the GI tract without blocking their beneficial analgesic effects. We are developing alvimopan to manage or prevent postoperative ileus and opioid bowel dysfunction. More than 1,900 healthy volunteers and patients have received alvimopan in opioid bowel dysfunction, postoperative ileus and safety clinical studies to date.

Postoperative ileus, often defined as a general impairment of gastrointestinal motility, is a recognized after effect of open abdominal surgery. Postoperative ileus is characterized by abdominal distention, lack of bowel

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sounds and lack of passage of flatus and stool. Other symptoms include nausea, vomiting, bloating and stomach cramps. These symptoms may prevent drinking or eating, prolong recovery from surgery, and extend the average length of stay in hospitals. Opioids are almost universally used for the treatment of acute, post-surgical pain, and may prolong the duration of postoperative ileus. Since virtually all patients receive morphine or other narcotic analgesics for pain relief after major surgery, current postoperative pain treatment may actually slow recovery of normal bowel function, delay time until patients can drink or eat, delay hospital discharge and therefore increase the cost of medical care.

Currently there are no United States Food and Drug Administration (“FDA”) approved pharmaceutical products for the management of postoperative ileus. Nearly all of the patients having open abdominal surgery will experience postoperative ileus, but other surgical procedures also produce postoperative ileus. Based on our estimates in the last year, more than 4.3 million surgeries of all types result in some degree of postoperative ileus in the U.S. We believe that a portion of these patients will comprise the potential market for an alvimopan postoperative ileus product. Alvimopan is being studied in Phase III clinical trials investigating whether alvimopan will reduce the duration of postoperative ileus in the yearly estimated 1.1 million patients undergoing abdominal surgery in the last year and taking opioid analgesics.

Our fourth POI clinical study in our Phase III program (POI 14CL306) is a double-blind placebo-controlled multi-center study designed to enroll approximately 500 patients scheduled to undergo total abdominal simple hysterectomy and receiving opioids for pain relief. Under this protocol, patients are randomized to receive either alvimopan 12 mg (approximately 400 patients) or placebo (approximately 100 patients). Under the protocol for this study, patients receive initial doses of alvimopan in the hospital and continue taking alvimopan twice daily at home for a maximum of seven days of continuous treatment. Enrollment in this study has been completed. This study was designed to assess safety and will also assess efficacy in this POI patient population.

We have previously completed three Phase II clinical trials with alvimopan for the management of POI in patients undergoing major abdominal surgery when opioids are used for pain relief.

Our first alvimopan Phase II clinical trial compared 1 mg or 6 mg doses of alvimopan vs. placebo in 78 patients undergoing partial colectomy or simple or radical hysterectomy surgical procedures. These data showed a dose-dependent effect and that patients receiving the higher dose of alvimopan experienced shorter time to the first flatus (P<0.04), time to first bowel movement (P<0.02), time to eating a solid diet (P=0.0001), and time to discharge from the hospital (P=0.0001). The results of this clinical trial were reported in the September 27, 2001, issue of the New England Journal of Medicine (A. Taguchi et al., N Engl J Med 345: 935-940, 2001).

Our second Phase II clinical trial was a multi-center, double-blind and placebo-controlled trial in 65 patients undergoing abdominal surgery who were randomized to receive placebo or 12 mg of alvimopan twice per day. The median times for the recovery of GI function and time to discharge from the hospital, the endpoints of the trial, were improved by 14 and 4 hours, respectively. The differences were not statistically significant. Alvimopan did not appear to reduce the beneficial analgesic effects of systemic opioid narcotics administered to patients. One alvimopan treated patient experienced protracted nausea which was possibly related to the study medication.

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The third Phase II trial was a multi-center, double-blind, and placebo-controlled trial in 153 patients who were randomized to receive placebo, 3 mg, 6 mg or 12 mg of alvimopan twice per day. No serious adverse events were attributed to alvimopan and the patients did not appear to experience any loss of analgesia. The median time for the recovery of GI function, the primary clinical endpoint, showed that all alvimopan groups had shorter median GI recovery times compared to placebo. Overall the study did not reach statistical significance. We did a retrospective review of the data and found that in the patients who had a surgical duration greater than the median (1.8 hours), the median time to gastrointestinal recovery versus placebo was greater than 1.6 days for all the alvimopan treatment groups.

Coordinated rhythmic contractions of the intestines move the intestinal contents forward as a part of the normal digestive process. When morphine, codeine, oxycodone, hydrocodone or similar narcotic analgesics enter the gastrointestinal tract, they activate opioid receptors and disrupt these normal rhythmic movements. This disruption may cause uncoordinated non-propulsive intestinal contractions or cramps. The dose of morphine required to disrupt bowel function is lower than the dose of morphine required to produce pain relief. Morphine can produce symptoms of opioid bowel dysfunction that include hard and dry stools, straining with bowel movements and inability to completely evacuate the bowels. Patients may also experience abdominal cramping or spasms with bloating and abdominal distention. The discomfort associated with opioid bowel dysfunction can be so severe as to cause patients to limit dosing of the opioid analgesic and therefore reduce the degree of pain relief.

Alvimopan is designed to selectively block the intestinal opioid receptors and to restore normal bowel function while allowing morphine and other opioid analgesics to produce their desired analgesic effects.

Laxative and stool lubricant medications are used in an attempt to treat opioid bowel dysfunction in patients receiving chronic opioid analgesic therapy, but they are only fully effective in a limited patient population. Based on our market research, 70% of physicians report that they are dissatisfied or only somewhat satisfied with currently available therapies for the management of opioid bowel dysfunction.

In November 2002, we announced topline results of a Phase III clinical trial (OBD 13CL304) of our product candidate, alvimopan, in opioid bowel dysfunction (OBD) patients. This outpatient study enrolled 168 patients who were chronic users of opioids, such as morphine and codeine, primarily for pain relief, and whose bowel function had been impaired as a result of opioid treatment. The patients received once daily dosing for 21 days of either a 0.5 mg or 1 mg dose of alvimopan or placebo. The primary endpoint of the study was the proportion of patients having a bowel movement within 8 hours after each dose of study medication during the 21-day treatment period. On average, the proportion of patients who had at least one bowel movement within eight hours of each dose during the 21-day treatment period was 43% (p<0.001 versus placebo) for alvimopan 0.5 mg, 55% (P<0.001 vs. placebo) for alvimopan 1 mg, and 29% for placebo. In this study, alvimopan was well tolerated; the most frequently occurring adverse events versus placebo included diarrhea, abdominal cramps, nausea and vomiting. Additional clinical studies will be required before filing any regulatory approval application for alvimopan in OBD. Prior to initiating the additional Phase III clinical studies that will be required, we are planning with our collaboration partner, Glaxo, additional studies for chronic OBD investigating longer duration of patient exposure and different dosing strategies, as well as longer duration preclinical toxicology studies. Results from this study in OBD are not necessarily indicative of the results that may be reported from the clinical studies in the POI indication. The results of the study, OBD 13CL304 have not been submitted to, nor reviewed by, any regulatory agency.

We believe that alvimopan may also have an important use in patients following discharge from the hospital who continue on short-term opioids for the relief of pain and in other short-term users of opioids for pain relief.

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Just as patients receiving chronic opioid analgesics experience constipation, cramping, bloating, and other symptoms of opioid bowel dysfunction, some patients receiving short-term opioid analgesic therapy experience similar symptoms, which may cause them to reduce their dose of or discontinue their opioid analgesics. Patients taking opioid analgesics on a short-term basis are also more susceptible to experience opioid-induced nausea and vomiting. We believe that alvimopan may be useful in reducing these adverse effects and in maintaining normal gastrointestinal function in patients receiving opioid analgesics for pain relief.

As part of our postoperative ileus development program, we are conducting a double-blind, placebo-controlled, multi-center, clinical trial of alvimopan in approximately 500 patients undergoing simple hysterectomy designed to assess safety and which will also assess efficacy of alvimopan in postoperative ileus (POI 14CL306). Enrollment in this study has been completed. The protocol for this study calls for patients to receive initial doses of alvimopan in the hospital and to continue taking alvimopan at home for a maximum of seven days of continuous treatment. This is our first clinical trial where post surgical patients are to continue receiving doses of alvimopan after hospital discharge. As such, this same study may provide further information to allow us to assess the potential for conducting additional clinical trials for acute opioid bowel dysfunction.

We use advanced chemical design technology to create proprietary topical, injectable and oral peripheral kappa opioid receptor-specific compounds that are designed to have limited ability to cross the blood-brain barrier at therapeutic doses. These compounds are intended to produce more pain relief than acetaminophen or NSAIDs and equivalent pain relief to mu opioid analgesics. We intend to develop oral product candidates to address broader markets in chronic inflammatory pain, such as the market for prescription arthritis pain products, that according to IMS Health data, accounted for approximately $6.2 billion in United States prescription sales in the twelve months ended December 31, 2002. Moderate-to-severe pain often requires the use of narcotic analgesics. We believe that our kappa opioid analgesics may have the potential to be the first kappa opioid analgesics to address the pain of chronic inflammatory disease and visceral pain without producing adverse psychological effects associated with previously studied centrally acting kappa opioid analgesics, including visual and auditory disturbances, unpleasant mood changes and hallucinations. Preclinical studies show that our kappa opioid analgesics are particularly effective in models of visceral pain. We are currently evaluating two peripheral kappa opioid agonists, ADL 10-0101 and ADL 10-0116, in early stage clinical testing.

Visceral pain can be caused by inflammation or distention of abdominal organs as a result of surgical or diagnostic procedures or from acute or chronic disease. Data from the United States Centers for Disease Control and Prevention, or CDC, indicate that there are over 12 million annual visits to doctors offices for acute abdominal pain and 5.4 million annual GI endoscopy diagnostic procedures, a portion of which we believe will comprise our potential patient population for our ADL 10-0101 product candidate.

Many disease states, burns, abrasions or surgical procedures may cause inflammatory pain. Minor inflammatory pain is currently treated with over-the-counter medications containing emollients or local anesthetics. Emollients are soothing but have little or no analgesic activity; local anesthetics have a relatively short duration of action and may be irritating to the skin. Moderate-to-severe inflammatory pain is frequently treated with NSAIDs or opioid analgesics. Data from the CDC indicate that there are over 44 million annual cases of inflammatory pain, a portion of which we believe will comprise our potential patient population for our ADL 10-0101 product, or our ADL 10-0116 product.

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In 2001, we completed an exploratory Phase II clinical trial in six patients of ADL 10-0101 in the treatment of moderate-to-severe visceral pain of chronic pancreatitis. In this trial, mean pain scores for patients receiving ADL 10-0101 were reduced by 38% and 64% at 30 minutes to four hours, respectively, after initiation of a 30 minute infusion of ADL 10-0101. The patients receiving placebo had reduction of 14% and 0%, respectively, at these same time periods. None of the patients reported central nervous system side effects.

Three additional Phase II exploratory studies were initiated in 2001 to evaluate the ability of ADL 10-0101 to reduce acute or chronic visceral pain. All three studies utilized the same dose of ADL 10-0101 that was used in our first chronic pancreatitis pain study. The first study was in patients with pain of chronic pancreatitis. Fourteen patients were enrolled in the study, including five who received placebo and nine who received a single intravenous dose of ADL 10-0101 in a double-blind and placebo-controlled trial. Preliminary results indicate that ADL 10-0101 did not meet the primary endpoint of reduction in pain scores versus placebo. Three patients reported mild, but not dose-limiting, central nervous system side effects that were characterized by the investigator as possibly related to the ADL 10-0101. The second study was in three patients undergoing hysteroscopy. Patients were administered a single intravenous dose of ADL 10-0101 to evaluate the ability of ADL 10-0101 to reduce visceral pain caused by uterine distention. The primary endpoint in this study was adequacy of pain relief such that the patients would not require other medications for pain relief. All three patients required administration of additional analgesic and anesthetic agents to complete the procedure. The third study was a double-blind and placebo-controlled study in twenty patients undergoing routine colonoscopy to evaluate the ability of ADL 10-0101 to reduce pain resulting from distention of the colon. Ten patients received an infusion of ADL 10-0101 and eleven patients received a placebo infusion. There were no clinically meaningful differences in the results between the two groups in the study.

Following those studies, a Phase I study was conducted in 2002 to determine the maximum tolerable dose (defined as no central nervous system side effects such as visual and auditory disturbances or unpleasant mood changes) and the pharmacological profile of a single intravenous dose of ADL 10-0101. Using this new information, we plan to initiate during 2003, Phase II studies of a higher dose of ADL 10-0101 than previously studied.

In preclinical inflammatory pain trials, ADL 10-0116 demonstrated a longer duration of action than ADL 10-0101 and was active when administered orally. As an orally active compound, ADL 10-0116 may have the potential to address a market that cannot be addressed by ADL 10-0101 by treating acute and chronic pain conditions in clinical indications where an injectable product would not be used.

Two single dose Phase I clinical studies of ADL 10-0116 were completed in 2002. The maximum tolerable single oral dose of ADL 10-0116 was determined from these studies in men and women. A Phase II proof of concept study to evaluate the effectiveness of ADL 10-0116 in standard pain models is planned for 2003.

The active ingredient in all of our formulations of ADL 2-1294 is loperamide, the same active ingredient in the over-the-counter anti-diarrheal product, Imodium^® A-D. The composition of matter patent for loperamide has expired, but we have secured method-of-use and formulation patents for pain and itch indications. Loperamide, like morphine, is a potent mu opioid receptor stimulant. Unlike morphine, loperamide does not readily cross the blood-brain barrier to enter the central nervous system. The compound is also very poorly absorbed from the intestinal tract following oral administration. As a result, the compound does not cause sedation or depress

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respiratory function, is not considered to be addictive and is one of the few mu opioid agonists that is not scheduled as a controlled substance. We are currently in preclinical development exploring intra-articular administration of ADL 2-1294 for relief of pain.

Kwang Dong Pharmaceutical Co., Ltd. (“Kwang Dong”) has licensed the right to develop and market dermal formulations of ADL 2-1294 in South Korea and North Korea for dermal pain. To date, we have not transferred sufficient technology under the license agreement to allow commercialization of ADL 2-1294 in South Korea and North Korea. As a result we do not anticipate material revenues under the license agreement in the foreseeable future. Kwang Dong also made an equity investment in the Company.

In 2000, Santen Pharmaceutical Co., Ltd., of Japan (“Santen”), licensed the worldwide rights, except in South Korea and North Korea, to develop and market ADL 2-1294 formulations for ophthalmic pain. On February 6, 2003, we received notification from Santen that it was discontinuing its development efforts and terminating our agreement. We presently have no plans to continue the ophthalmic program for ADL 2-1294.

The Consumer Healthcare Division of GlaxoSmithKline, our former development partner for the commercialization of ADL 2-1294 in dermal indications terminated our agreement related thereto. They informed us that they were unable to discern a significant difference between the ADL 2-1294 and placebo groups in a Phase II proof-of-concept clinical study in dermal itch of eczema. We are evaluating whether to seek another partner to continue to develop dermal ADL 2-1294 for pain or itch indications.

Joint pain after arthroscopic surgery limits mobility and recovery. Injection of morphine into a joint can reduce pain from arthroscopic surgery. ADL 2-1294 demonstrated analgesic activity in preclinical studies of joint pain. We have incorporated ADL 2-1294 into two prototypic formulations suitable for delivery to joints following surgical procedures. These formulations may also provide benefits after injection into painful inflamed joints as an alternative to cortisone therapy. Market research from Solucient Outpatient View reports that, in the United States, there were 1.6 million outpatient arthroscopic knee surgical procedures in 2000 and market research indicates that approximately 2.7 million patients receive local injections of corticosteroids for joint pain, a portion of which we believe will comprise our potential patient population for a long-acting analgesic injectable product.

We have conducted preliminary preclinical formulation and safety studies in animals. We plan to continue to evaluate the further development of this product candidate for joint pain.

We are exploring the development of an analgesic product candidate that would be a combination of alvimopan and an opioid. We believe that a single oral dosage form combining both alvimopan and a short acting oral opioid analgesic, in fixed doses, may have the potential to reduce the side effects of morphine and other opioid analgesics such as constipation, nausea and vomiting.

We believe that it may be possible to avoid the serious central nervous system adverse events that were reported with kappa opioid product candidates that were being developed by other companies by using compounds that stimulate kappa opioid receptors in the brain in the same manner that a naturally occurring substance does such as a peptide. We have designed and constructed artificial kappa opioid receptors to use as discovery tools to find small synthetic organic molecules that are not peptides but have the same effect as the

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natural peptides. These artificial receptors allow us to identify kappa compounds that interact with different parts of the kappa receptor and, our research is directed at identifying kappa compounds that may have analgesic activity without significant adverse central nervous system side effects.

In April 2002, we entered into a collaboration agreement with Glaxo for the exclusive worldwide development and commercialization of alvimopan for certain indications. We and Glaxo have agreed to co-develop alvimopan for a number of indications, both acute and chronic, which would potentially involve the use of alvimopan in in-patient and out-patient settings. Under the terms of the collaboration agreement, Glaxo paid us a non-refundable and non-creditable signing fee of $50 million during the quarter ended June 30, 2002 and we may receive milestone payments of up to $220 million over the term of the agreement, upon the successful achievement, if any, of certain regulatory objectives. In 2002, the revenue contributed through the collaboration agreement accounted for approximately 96% of our total consolidated revenue. For additional information concerning our consolidated revenues, net loss and total assets, see our Consolidated Financial Statements included elsewhere in this Report.

In the United States, both companies will co-develop and intend to co-promote alvimopan and share development expenses and commercial returns, if any. We have overall responsibility for development activities for acute-care indications, such as postoperative ileus and Glaxo has overall responsibility for development activities for chronic care indications such as opioid bowel dysfunction associated with the chronic use of opioids. Outside the United States, Glaxo will be responsible for the development and commercialization of alvimopan, and we will receive royalties on sales revenues, if any. Glaxo has certain rights to terminate the collaboration agreement. 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 also has the right to terminate its rights and obligations with respect to the acute-care indications and/or the chronic-care indications. 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.

Under the terms of the Glaxo collaboration agreement for collaboration products being developed in the United States, out-of-pocket costs and expenses from third parties for research and development and marketing activities incurred by each company will be combined on an indication by indication basis. We are primarily responsible for the completion of the POI development program and we receive reimbursement from Glaxo at a defined percentage of out-of-pocket costs and expenses from third parties subject to adjustment and netting, if any. Such contract reimbursement amounts paid to us will be recorded gross on our consolidated statements of operations pursuant to Emerging Issues Task Force (EITF) No. 99-19 and 01-14 as contract reimbursement revenue. In addition, Glaxo is primarily responsible for the completion of the OBD development program and will receive reimbursement from us at a defined percentage of out-of-pocket costs and expenses from third parties subject to adjustment and netting, if any. Although the collaboration agreement was executed in April 2002, the cost sharing arrangement described above was retroactive to January 1, 2002.

In November 1997, we entered into a license agreement with Kwang Dong Pharmaceutical Co., Ltd. relating to the development and commercialization in South Korea and North Korea of our product candidate ADL 2-1294 for the indication of topical dermal pain. In addition, in November 1997, we entered into a stock purchase agreement with Kwang Dong pursuant to which Kwang Dong purchased for $1.2 million, 960,000 shares of our series D convertible preferred stock which were subsequently converted to 192,000 shares of common stock. The license agreement with Kwang Dong provides for, among other things, our transfer to Kwang Dong of

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technology and data developed by us relating to the topical formulation of ADL 2-1294. We devoted significant internal efforts and expenditures to the development of a formulation for this indication. To date, we have not transferred sufficient technology under the license agreement to allow commercialization of ADL 2-1294 in South and North Korea. As a result, we do not anticipate material revenues under the license agreement in the foreseeable future.

On April 25, 2000, we entered into a license agreement with Santen Pharmaceutical Co., Inc. (“Santen”) granting Santen an exclusive royalty-bearing license to develop and sell ADL 2-1294 ophthalmic formulations in the field of ophthalmic pain in all countries other than South and North Korea. On February 6, 2003, Santen notified us that they were terminating this license agreement. We presently have no plans to continue the ophthalmic program for ADL 2-1294. Under the license agreement, we earned a total of $1.0 million in license fees.

In November 1996, Roberts Laboratories Inc. (Roberts) licensed from Eli Lilly certain intellectual property rights relating to alvimopan. In June 1998, we entered into an Option and License Agreement with Roberts under which we licensed from Roberts the rights Roberts had licensed from Eli Lilly for alvimopan. Under our Option and License Agreement we have paid $600,000 to Roberts. We are obligated to pay milestone payments to Roberts and Eli Lilly upon the achievement of certain clinical and regulatory milestones that in the aggregate may total up to $1.9 million. We are also responsible for the costs to develop alvimopan. In addition, if alvimopan receives regulatory approval, we are obligated to pay royalties to Roberts and Eli Lilly on commercial sales of alvimopan. Under the terms of our arrangements, the license to alvimopan expires on the later of either the life of the last to expire of the licensed Eli Lilly patents or fifteen years from November 5, 1996, following which we will have a fully paid up license.

In August 2002, we expanded our intellectual property rights related to alvimopan by entering into a separate exclusive license agreement with Eli Lilly under which we obtained an exclusive license to six issued U.S. patents and related foreign equivalents and know-how relating to peripherally selective opioid antagonists. We paid Eli Lilly $4.0 million upon signing the agreement and are subject to additional clinical and regulatory milestone payments and royalty payments to Eli Lilly on sales, if any, of new products utilizing the licensed technology. Under this license agreement, we agreed to pay Eli Lilly a $4.0 million dollar payment upon acceptance by a regulatory authority of the first application for marketing authorization for alvimopan.

We have licensed technology from academic institutions and entities including the University of California at Los Angeles, the University of California at San Diego, Oregon Health Sciences University, Arch Development Corporation and the National Institutes of Health.

We licensed from the University of California at Los Angeles the exclusive right to use cloned delta opioid receptors to discover new drug candidates. The term of the license agreement is tied to the lifetime of the valid and existing patents licensed under the agreement and is currently expected to expire in 2016.

We licensed from the University of California at San Diego the right to develop and commercialize ADL 2-1294, loperamide, as a peripheral opioid analgesic for pain. The term of the license agreement is tied to the lifetime of the valid and existing patents licensed under the agreement and is currently expected to expire in 2015.

We licensed from Oregon Health Sciences University the right to use the human orphanin FQ opioid receptor ligand in our research program. The license expires in 2015.

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We licensed from Arch Development Corporation the exclusive right to use cloned mammalian kappa receptors to discover new drug candidates. The term of the license agreement is tied to the lifetime of the valid and existing patents licensed under the agreement and is currently expected to expire in 2017.

We licensed from the National Institutes of Health the right to use the cloned human mu receptor on a nonexclusive basis for discovering new drug candidates. The license expires in 2011.

In September 2001, the National Institutes of Health awarded us three Small Business Innovation Research (SBIR) grants to fund research into novel compounds for pain relief. These grants have been completed and we have not applied for renewal of these grants or any new SBIR grants.

Our industry is very competitive. It is characterized by extensive research and development efforts and rapid technological progress. New developments occur and are expected to continue to occur at a rapid pace. Discoveries or commercial developments by our competitors may render some or all of our potential products obsolete, subject to competition or non-competitive. This would have a material adverse effect on our business, financial condition and results of operations. Our competitive position also depends on our ability to attract and retain qualified scientific and other personnel, develop effective proprietary products, implement development and marketing plans, obtain patent protection and secure adequate capital resources. We believe that our ability to compete successfully is based on our technical expertise in opioid receptors and will depend upon our ability to maintain advanced scientific technologies, to develop a differentiated product pipeline, to obtain successful regulatory approval for novel pain management pharmaceuticals, and to sustain patent protection for our portfolio.

We face competition in our specific areas of focus. Our product candidate, alvimopan, is under investigation for use in POI and OBD in patients who are taking opioids for pain relief. If the use of opioids in these patient populations decreases, the potential market for alvimopan would be adversely affected. There are various surgical techniques in use and under investigation to reduce the use of opioids in patients in order to reduce the impact of opioid side effects in these patients. If new techniques become widely adopted which reduce the use of opioids, it would have a negative impact on the potential market for alvimopan. In addition, 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 alvimopan.

We believe that another Company is developing methylnaltrexone for potential use with opioids for bowel dysfunction. We also believe a European specialist pharmaceutical company with a focus on the gastrointestinal market, is in preclinical development in the area of peripheral opioid antagonists for use in opioid induced constipation. There are currently FDA approved products for use in treating irritable bowel syndrome in which others may explore for utility in our areas of development for alvimopan. 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.

If our analgesic product candidates complete development and are approved, our success will depend, in part, upon our ability to achieve market share successfully at the expense of existing and established products in the relevant target markets. Many companies currently sell either generic or proprietary narcotic analgesic formulations. In addition, a number of technologies are being developed to increase opioid analgesic potency as well as to provide alternatives to opioid analgesic therapy for pain management. We face competition in our development of our pain product candidates. Several large and well know pharmaceutical companies are

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developing and have developed novel pain products, including Johnson & Johnson, Pfizer Inc., Merck & Co., Inc. and others. Several of these product candidates are in clinical trials or are awaiting approval from the FDA. Some of these competitors are also developing compounds targeting peripheral activity. Merck KGA is developing asimadoline as a peripherally selective kappa opioid analgesic for the treatment of pain associated with irritable bowel syndrome.

We face, and will continue to face, intense competition in the development, manufacturing, marketing and commercialization of our product candidates from academic institutions, government agencies, research institutions, biotechnology and pharmaceutical companies, including potentially, our collaborators. There can be no assurance that developments by others will not render our product candidates or technologies obsolete or noncompetitive. There can be no assurance that we will be able to compete successfully with such companies. The existence of products developed by our competitors, or other products or treatments of which we are not aware, or products or treatments that may be developed in the future, may adversely affect the marketability of products developed by us. Such companies may succeed in discovering and developing pharmaceutical products more rapidly than us or pharmaceutical products that are safer, more effective or less costly than any we may develop. Such companies also may be more successful than us in production and marketing. Smaller companies may also prove to be significant competitors, particularly through collaborative arrangements with large pharmaceutical and established biotechnology companies. Academic institutions, governmental agencies and other public and private research organizations also conduct clinical trials, seek patent protection and establish collaborative arrangements for the development of products for the pain market.

We have established internal marketing capability, however, at the present time we have no sales force. Many of our competitors and potential competitors have substantially greater capital resources, manufacturing and marketing experience, research and development resources and production facilities than we do. Many of these competitors also have significantly greater experience than we do in undertaking preclinical testing and clinical trials of new pharmaceutical products and obtaining FDA and other regulatory approvals.

There can be no assurance that we will be able to compete successfully with such companies. The existence of products developed by our competitors, or other products or treatments of which we are not aware, or products or treatments that may be developed in the future may adversely affect the marketability of products developed by us.

Our industry requires highly specialized expertise in a wide variety of disciplines and is characterized by collaborative and cooperative endeavors among participants. This dynamic involves the receipt of assistance from third parties, the payment of royalties or other value in exchange for this assistance, and the risks of dependence upon third parties. Intra-industry discussion and interchange is an ongoing process, covering subject matters ranging from basic research to strategic alliance; a strategic alliance may substantially broaden or narrow the scope of a company’s activities or otherwise affect the ability of a company to control and direct its own affairs. We have participated in this process for years and intend to continue to do so. We may enter into, or may refuse or fail to enter into, licensing, partnership or collaborative arrangements or strategic alliances which accord to other companies rights with respect to one or more of our compounds, technologies or programs or in which we acquire new rights and obligations. During intra-industry discussions, agendas may substantially broaden or may substantially narrow from those anticipated at the outset; most frequently, discussions serve only as information exchange and do not lead to transactions of any kind. The fact of intra-industry discussion activity should not be misunderstood as an indication that our business, strategies or prospects are about to change; on the other hand, the unpredictable nature of ubiquitous industry interchange may lead to developments which neither we nor others may be in a position to anticipate. As discussed above under “Our Strategy,” we intend to develop industry collaborations and relationships to achieve our objectives. However, we are not in a position to predict what, if any, collaborations, alliances or transactions we may enter into in addition to those described elsewhere in this description of our business.

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We seek United States and international patent protection for major components of our technology. We also rely on trade secret protection for certain of our confidential and proprietary information, and we use license agreements both to access external technologies and assets and to convey certain intellectual property rights to others. Our commercial success will be dependent in part on our ability to obtain commercially valuable patent claims and to protect our intellectual property rights and to operate without infringing upon the proprietary rights of others.

As of December 31, 2002, we owned or had rights, whether by geography, by field or otherwise, to approximately 172 issued or published patents, of which 47 are issued in the United States and 125 are issued in foreign countries, and we owned nine (9) United States patent applications and numerous foreign patent applications relating to technologies used in our business.

We have or have licensed patents and patent applications related to (i) ADL 2-1294, (ii) peripheral kappa analgesics, (iii) alvimopan and (iv) opioid receptors and ligands. The patents related to ADL 2-1294 expire between 2015 and 2018. The patents related to kappa receptor analgesics expire between 2016 and 2019. The patents related to alvimopan expire between 2011 and 2019 and include a U.S. patent claiming composition of matter which expires in 2011 which may be eligible for patent term extension. We also have U.S. patents claiming the use of alvimopan in postoperative ileus and the combination of alvimopan plus an opioid agonist, both of these patents expire in 2019. The patents related to opioid receptors and ligands expire between 2015 and 2018. These expiration dates are all based on the presumption that the applicable maintenance fees are paid and the patents, if challenged, are not held to be invalid.

The patent positions of pharmaceutical, biopharmaceutical and biotechnology companies, including ours, are generally uncertain and involve complex legal and factual questions. Our business could be hurt by any of the following:

In addition, patent law relating to the scope of claims in the technology field in which we operate is still evolving. The degree of future protection for some of our rights, therefore, is uncertain. Furthermore, others may independently develop similar or alternative technologies, duplicate any of our technologies, and if patents are licensed or issued to us, design around the patented technologies licensed to or developed by us. In addition, we could incur substantial costs in litigation if we have to defend ourselves in patent suits brought by third parties or if we initiate such suits.

Enactment of legislation implementing the General Agreement on Tariffs and Trade has resulted in certain changes to United States patent laws that became effective on June 8, 1995. Most notably, the term of patent protection for patent applications filed on or after June 8, 1995 is no longer a period of 17 years from the date of issuance. The new term of United States patents will commence on the date of issuance and terminate 20 years from the earliest effective filing date of the application. Because the time from filing to issuance of biotechnology patent applications is often more than three years, a 20-year term from the effective date of filing may result in a substantially shortened period of patent protection which may harm our patent position.

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With respect to proprietary know-how that is not patentable and for processes for which patents are difficult to enforce, we rely on trade secret protection and confidentiality agreements to protect our interests. We believe that several elements of our drug discovery system involve proprietary know-how, technology or data that are not covered by patents or patent applications. We have taken security measures to protect our proprietary know-how and technologies and confidential data and continue to explore further methods of protection. While we require all employees, consultants and potential business partners to enter into confidentiality agreements, we may not be able to protect adequately our trade secrets or other proprietary information. Others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets. In the case of arrangements with our potential business partners that require the sharing of data, our policy is to make available to our potential business partners only such data as is relevant to our agreements with such customers, under controlled circumstances, and only during the contractual term of those agreements, and subject to a duty of confidentiality on the part of our customer. However, such measures may not adequately protect our data. Any material leak of confidential data into the public domain or to third parties may cause our business, financial condition and results of operations to be harmed.

We are a party to various license agreements that give us rights to use technologies and biological materials in our research and development processes. We may not be able to maintain such rights on commercially reasonable terms, if at all. Failure by us or our licensors to maintain such rights could harm our business.

We currently do not have commercial or clinical trial manufacturing capabilities and do not intend to develop such capabilities for any product candidate in the near future. We plan to rely on third parties for the manufacture, packaging and distribution of alvimopan and our other product candidates in accordance with Current Good Manufacturing Practices (“cGMP”) of the U.S. Food and Drug Administration and other regulatory standards. This dependence on contract manufacturers may restrict our ability to develop and deliver products on a timely, profitable and competitive basis. These contract manufacturers generally have multiple projects and they may give our projects a lower priority than other projects they are managing.

We maintain a relationship with Torcan Chemical Ltd. for the supply of the active pharmaceutical ingredient (“API”) in alvimopan. We also maintain a relationship with Girindus AG as an additional supplier of API for alvimopan. We maintain a relationship with Pharmaceutics International Inc for the supply of alvimopan finished capsules, and a relationship with Sharp Corporation for the packaging of alvimopan finished capsules. We have no formal commercial supply arrangement as yet with any of these parties. 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.

We also intend to contract with third party manufacturers for the manufacture of API and finished product for our product candidates other than alvimopan. Earlier stage new chemical entities are synthesized in our laboratories, and scale-up quantities and materials for preclinical toxicology evaluations are produced by qualified third parties.

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There can be no assurance that our third party manufacturers and suppliers will be successful in the development, scale-up and supply of alvimopan and our other product candidates. Any failures in this area could have a material adverse effect on our current and anticipated operations.

In the United States, pharmaceutical and diagnostic products intended for use in humans are subject to rigorous FDA regulation. The process of completing clinical trials and obtaining FDA approvals for a new drug is likely to take a number of years and require the expenditure of substantial resources. There can be no assurance that any of our products will receive FDA approval.

The usual steps required before a new pharmaceutical product for use in humans may be marketed in the United States include:

Preclinical studies include laboratory evaluation of product chemistry and formulation, as well as preclinical studies, to assess the potential safety and efficacy of the product. The results of the preclinical studies are submitted to the FDA as a part of an IND and are reviewed by the FDA prior to the commencement of human clinical trials. Unless the FDA objects to, or otherwise responds to, an IND submission, the IND becomes effective 30 days following its receipt by the FDA.

Human clinical trials are typically conducted in three sequential phases that may overlap:

Scientists use statistical techniques to compare responses produced by drugs versus placebos in clinical trials of drug effectiveness. Statistical analyses estimate the probability that a positive effect is actually produced by the drug. This probability is expressed as a “P-value” which refers to the likelihood that a drug response occurred just “by chance.” When a P-value is reported as P<0.05, the probability that the drug produced its effect “by chance” is less than 5% and the probability that the drug produced a positive effect is greater than 95%. When a P-value is reported as P<0.01, the probability that the drug produced the positive effect is greater than 99%. In clinical studies where the study design includes making multiple test comparisons, for example, comparing more than one dose level of a treatment to placebo, there are statistical techniques to control the

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overall study error rate (i.e. the likelihood that the drug response occurred by chance) for the multiple test comparisons. Under these statistical techniques, if any one of the test comparisons is not statistically significant, these techniques require the other test comparison group(s) to have a P-value substantially less than 0.05 to be statistically significant.

The FDA mandates that drugs be manufactured in conformity with cGMP regulations and at facilities approved to manufacture such drugs. If approval is granted, requirements for labeling, advertising, record keeping and adverse experience reporting will apply. Failure to comply with these requirements could result, among other things, in suspension of regulatory approval, recalls, injunctions or civil or criminal sanctions. We may also be subject to regulations under other federal, state, and local laws, including the Occupational Safety and Health Act, the Environmental Protection Act, the Clean Air Act, national restrictions on technology transfer, import, export, and customs regulations, and health care fraud and abuse laws. In addition, any of our products that contain one of our product candidates in combination with narcotic analgesics will be subject to DEA regulations relating to manufacturing, storage, distribution and physician prescribing procedures. There can be no assurance that any portion of the regulatory framework under which we currently operate will not change and that such change will not have a material adverse effect on our current and anticipated operations.

Whether or not FDA approval has been obtained, approval of a pharmaceutical product by comparable governmental regulatory authorities in foreign countries must be obtained prior to the commencement of clinical trials and subsequent sales and marketing efforts in those countries. The approval procedure varies in complexity from country to country, and the time required may be longer or shorter than that required for FDA approval.

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

We make available free of charge on or through our internet website at www.adolor.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

As of December 31, 2002, we had 122 full-time employees and 2 part-time employees, including 25 employees with Ph.D. or M.D. degrees. Eighty-two of our employees are engaged in research and development activities. Most of our senior management and professional employees have had prior experience in pharmaceutical or biotechnology companies. None of our employees are covered by collective bargaining agreements. We believe that our relations with our employees are good.

We currently occupy two suites with a combined 24,340 square feet of leased office and laboratory space in Malvern, Pennsylvania. The leases expire in May 2003 and October 2004. We also occupy approximately 20,000 square feet of additional office space in Exton, Pennsylvania, which accommodates our product development and administrative staff. The lease expires on December 31, 2003. In December 2002, we entered into a build to suit ten-year lease for a building in Exton, Pennsylvania. The building has approximately 80,000 square feet of space.

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We intend to build out and occupy approximately 30,000 square feet of office space and approximately 25,000 square feet of laboratory space. The remaining approximately 25,000 square feet of space will be unfinished and is available for potential future expansion. The build out of this space requires us to expend approximately $3.0 million in leasehold improvements. We are targeting moving to this facility in the second quarter of 2003.

In December 2002, a complaint entitled Tajrezaei et al. v. Principal Life Insurance Company and Adolor Corporation was filed in the Philadelphia County Court of Common Pleas. This complaint alleges, among other things, that we were negligent in failing to notify a former employee of his conversion rights under a certain group life insurance policy at the termination of his employment. The former employee died and the complaint was filed on behalf of members of his immediate family. The complaint seeks damages in excess of $50,000. We do not believe any judgment against us in this matter will have a material negative effect on our financial condition or results of operations.

From time to time we are party to various legal proceedings in the normal course of our business. We do not believe that resolution of any of these claims will have a material negative effect on our financial condition or results of operations.

No matters were submitted to a vote of our stockholders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended December 31, 2002.

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(a) Our common stock is traded on The Nasdaq National Market under the symbol “ADLR”. The initial public offering of our stock occurred on November 13, 2000 at an initial price of $15.00 per share. The price range per share reflected in the table below is the highest and lowest bid price for our stock as reported by The Nasdaq National Market during each quarter of the two most recent years that our common stock has been publicly traded.

In our initial public offering (the “Offering”), we sold 6,000,000 shares of our common stock on November 14, 2000. Upon the exercise of the underwriter’s over-allotment option, we sold an additional 900,000 shares of common stock. The effective date of the registration statement on Form S-1 for the 6,900,000 shares of common stock sold in our initial public offering was November 13, 2000 and the file number is 333-96333. The net proceeds to us after deducting discounts, commissions, fees and expenses, were $95,376,000.

As of December 31, 2002, we had used all of the Offering proceeds and applied them for general corporate purposes, including the continued development of existing product candidates, manufacturing, commercialization expenditures, research and development for additional product opportunities, hiring of sales, marketing, development, research and administrative personnel and expansion of our facilities.

(b) Holders. As of March 10, 2003, there were approximately 177 holders of record of our common stock. This does not reflect beneficial stockholders who hold their stock in nominee or “street” name through various brokerage firms.

(c) Dividends. We have never declared or paid cash dividends on our capital stock, and we do not intend to pay cash dividends in the foreseeable future. We plan to retain any earnings for use in the operation of our business and to fund future growth.

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The following selected financial data should be read in conjunction with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Report. The consolidated statements of operations data except as otherwise indicated below for the five years ended December 31, 2002, and our consolidated balance sheet data as of December 31, 2002 and 2001, are derived from our audited consolidated financial statements which are included elsewhere in this Report. The consolidated statements of operations data for the year ended December 31, 1998 and the consolidated balance sheet data as of December 31, 2000, 1999 and 1998 are derived from audited financial statements not included in this Report. Historical results are not necessarily indicative of the results to be expected in the future.

Please see Note 2 to our consolidated financial statements for an explanation of the method used to calculate the net loss allocable to common stockholders, net loss per share and the number of shares used in the computation of per share amounts.

Index to Financial Statements

Alvimopan is being evaluated in acute and chronic indications. We have completed three Phase II clinical trials and we are currently conducting Phase III clinical trials studying the use of alvimopan for the management of postoperative ileus (bowel dysfunction) that frequently follows abdominal surgery when opioids are used for pain relief. We have also completed several Phase II and one Phase III clinical trial studying the use of alvimopan for the reversal of the severe constipating effects associated with chronic use of opioids.

In April 2002, we entered into a collaboration agreement with Glaxo Group Limited (“Glaxo”) for the exclusive worldwide development and commercialization of alvimopan for certain indications. The companies have agreed to co-develop alvimopan for a number of indications, both acute and chronic, which would potentially involve the use of alvimopan in in-patient and out-patient settings. Under the terms of the collaboration agreement, Glaxo paid us a non-refundable and non-creditable signing fee of $50.0 million during the quarter ended June 30, 2002 and we may receive milestone payments of up to $220.0 million over the term of the agreement upon the successful achievement, if any, of certain clinical and regulatory objectives.

We have additional compounds in clinical development that are designed to elicit their effects by targeting peripheral opioid receptors, including kappa receptor. Our first kappa agonist compound, ADL 10-0101, is being studied in early clinical trials for the treatment of pain. Following positive results in two small exploratory clinical trials with ADL 10-0101, we commenced three additional exploratory clinical trials in visceral pain. These trials did not demonstrate adequate pain relief in patients. We have recently completed studies to identify the maximally tolerated dose in both males and females. Using this new information, we plan to initiate during 2003, Phase II studies of higher doses of ADL 10-0101 than previously studied.

Finally, we have been evaluating ADLR 2-1294, a peripheral mu opioid agonist, in pre-clinical development for treating a variety of pain conditions. The active ingredient of ADL 2-1294 is loperamide. We are currently in preclinical development exploring intra-articular administration of ADLR 2-1294 for relief of pain. We have previously maintained collaborative programs with corporate partners evaluating the use of ADL 2-1294 in dermal pain and itch as well as ophthalmic pain which were terminated by our collaboration partners. We are evaluating whether to seek another partner to continue to develop dermal ADL 2-1294 for pain or itch indications. We presently have no plans to continue the ophthalmic program.

Index to Financial Statements

received, along with Glaxo to surgeons, oncologists and pain management specialists in hospital-care settings. We intend to rely on Glaxo for sales and marketing of alvimopan outside the United States. 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.

We have not generated any product sales revenues and have not achieved profitable operations. Our deficit accumulated during the development stage through December 31, 2002 aggregated approximately $155.2 million, and we expect to continue to incur substantial losses in future periods. A significant portion of our revenue for 2002 was from reimbursement of expenses from Glaxo under our collaboration agreement and we expect such revenues to be substantially reduced in future periods as we expect the related reimbursable expenses to decrease. We are highly dependent on the success of our research, development and licensing efforts and, ultimately, upon regulatory approval and market acceptance of our proposed future products. We may never become profitable and even if we become profitable, we may not be able to sustain profitability on a continuing basis.

Excluding a non-refundable signing fee of $50.0 million in connection with the collaboration agreement we entered into with Glaxo, we reported an operating cash outflow of $51.8 million for the year ended December 31, 2002 and we do not expect to generate a positive cash flow from operations for the next several years, if ever. Prior to exhausting our current cash and short term investments, we will need to raise additional funds to finance our operating activities. There are no assurances that we will be successful in obtaining an adequate level of financing for the long-term development and commercialization of our product candidates.

In April 2002, we entered into a collaboration agreement with Glaxo Group Limited for the exclusive worldwide development and commercialization of alvimopan for certain indications. We and Glaxo have agreed to co-develop alvimopan for a number of indications, both acute and chronic, which would potentially involve the use of alvimopan in in-patient and out-patient settings. Under the terms of the collaboration agreement, Glaxo paid us a non-refundable and non-creditable signing fee of $50.0 million during the quarter ended June 30, 2002 and we may receive milestone payments of up to $220.0 million over the term of the agreement upon the successful achievement, if any, of certain clinical and regulatory objectives. As a result of the application of Staff Accounting Bulletin (SAB) 101, the $50.0 million signing fee is reflected in deferred licensing fees and are expected to be recognized on a straight-line basis over the estimated 12 year performance period. 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.

In the United States, we and Glaxo will co-develop and intend to co-promote alvimopan and share development expenses and commercial returns, if any. We have overall responsibility for development activities for acute-care indications such as postoperative ileus, and Glaxo has overall responsibility for development activities for chronic care indications such as opioid bowel dysfunction associated with the chronic use of opioids. Outside the United States, Glaxo will be responsible for the development and commercialization of alvimopan, and we will receive royalties on sales revenues, if any. Glaxo has certain rights to terminate the collaboration agreement as well as to terminate its rights and obligations with respect to the acute-care indications and/or chronic-care indications.

Under the terms of our collaboration agreement with Glaxo for collaboration products being developed in the United States, out-of-pocket costs and expenses from third parties for research and development and marketing activities incurred by each company will be combined on an indication by indication basis. We are primarily responsible for the completion of the POI development program and we receive reimbursement from Glaxo at a defined percentage of out-of-pocket costs and expenses from third parties subject to adjustment and netting, if any. Such contract reimbursement amounts paid to us will be recorded gross on our consolidated statements of operations pursuant to Emerging Issues Task Force (EITF) No. 99-19 and 01-14 as contract

Index to Financial Statements

reimbursement revenue. In addition, Glaxo is primarily responsible for the completion of the OBD development program and will receive reimbursement from us at a defined percentage of out-of-pocket costs and expenses from third parties subject to adjustment and netting, if any. Although the collaboration agreement was executed in April 2002, the cost sharing arrangement was retroactive to January 1, 2002. We recorded contract reimbursement revenue of $8,827,535 in the second quarter, which reflects reimbursement revenues of $3,427,102 and $5,400,433 related to the first and second quarters of 2002, respectively, $7,916,418 in the third quarter of 2002, and $7,502,379 in the fourth quarter of 2002, which is recorded as accounts receivable as of December 31, 2002. These revenues represent reimbursement of expenses incurred primarily in our POI development program. We expect contract reimbursement revenues to substantially decline in future periods as compared to 2002 as we expect the costs of the POI development program to decrease and also expect that we will incur expenses in connection with the OBD development program, including payments to Glaxo to reimburse them for our proportionate share of expenses they incur.

The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires management to adopt critical accounting policies and to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. The items in our consolidated financial statements reflecting critical accounting policies or requiring significant estimates and judgments are as follows:

Stock Compensation—We apply Accounting Principal Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”) and the related interpretations in accounting for our stock options granted to employees. Under APB 25, compensation cost related to stock options is computed based on the intrinsic value of the stock option at the date of grant, reflected by the difference between the exercise price and the fair market value of our Common Stock. Since our November 2000 public offering we have generally granted options to employees with exercise prices equal to fair market value on the date of grant and for such option grants we do not record compensation expense. Under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”, compensation cost related to stock options granted to employees and non-employees is computed based on the value of the stock options at the date of grant using an option valuation methodology, typically the Black-Scholes model. SFAS No. 123 can be applied either by recording the Black-Scholes model value of the options as compensation expense or by continuing to record the APB 25 value and by disclosing SFAS No. 123 compensation costs on a pro-forma basis. Had we adopted the Black-Scholes model value provisions of SFAS No. 123, our loss in 2002, 2001 and 2000 would have been increased by approximately $2.0 million, $0.08 million, and $0.03 million, respectively.

Collaborative Agreement Revenues—We defer upfront non-refundable fees received under collaboration agreements in which we have continuing involvement. We recognize such deferred amounts as revenue ratably over the estimated contract performance period. Such revenue recognition would be accelerated in the event of contract termination prior to completion of the expected performance period. Under the terms of the collaboration agreement with Glaxo we received a non-refundable and non-creditable upfront fee of $50.0 million. In 2002, approximately $3.0 million of the $50.0 million up-front fee was recognized as revenue and we expect to recognize $4.2 million per year as revenue through 2014, the estimated contract performance period.

Amounts reimbursable for costs incurred pursuant to the terms of collaboration agreements are recognized as revenue in the period in which the reimbursable costs are incurred. Such revenues are based on estimates of the reimbursable amount and are subject to verification by the collaborators. Of the $24.2 million recognized as revenue in 2002 pursuant to the cost reimbursement provisions of the Glaxo agreement, $16.7 million has been received from Glaxo as of December 31, 2002. The remaining $7.5 million is related to estimated reimbursable

Index to Financial Statements

expenses for the fourth quarter of 2002 and all of the cost reimbursement revenue is subject to verification by Glaxo.

Research and Development Expenses—We have entered into contracts with third parties to conduct substantial components of pre-clinical and clinical studies, and to manufacture the product candidates being studied in our trials. We accrue expenses related to such contracts based upon our estimate of the amounts due for work completed under the contracts. Factors considered in preparing such estimates include the number of subjects enrolled in studies compared to the number specified in the contract, quantities produced by the manufacturers compared to total contract quantities, and upon reviews of work progress with our vendors. We estimate that approximately $30.9 million will be payable under these agreements. Of this amount, approximately $15.9 million had been accrued for work estimated to have been completed as of December 31, 2002 and approximately $15.0 million relates to future performance under the agreements.

As we progress in our development and move closer to product approval and commercial operation, we may face additional issues that will require increased levels of management estimation and complex judgment.

We have experienced negative operating annual cash flows since our inception and we have funded our operations primarily from the proceeds received from the sale of our equity securities, as well as license, milestone and contract revenues. Cash, cash equivalents and short-term investments were approximately $154.0 million at December 31, 2002, and approximately $156.4 million at December 31, 2001, representing 91.5% and 95.3% of our total assets, respectively. We invest excess cash in highly liquid investment-grade marketable securities, including corporate and United States government and agency securities.

We believe that our current financial resources and sources of liquidity are adequate to fund operations into early 2005 based on the level of research and development, marketing and administrative activities necessary to achieve our short-term objectives.

The following is a summary of selected cash flow information for the twelve months ended December 31, 2002 and 2001:

Our operating cash inflows for 2002 were derived from a non-recurring, non-refundable and non-creditable signing fee of $50.0 million received under the agreement with Glaxo, reimbursements of approximately $16.7 million for costs incurred as provided for in our collaboration with Glaxo, grant and license revenues, and interest income on cash equivalents and short-term investments.

Index to Financial Statements

Our operating cash outflows for 2002 have continued to be primarily used for research and development expenditures associated with our product candidates, including clinical development and manufacturing costs for alvimopan, and for the compensation of our employees.

Without the benefit of the Glaxo signing fee of $50.0 million, 2002 operating cash outflows would have been $51.8 million. We expect to continue to use cash, cash equivalents and short-term investments to fund operating losses. We expect that our revenue for contract reimbursement under our collaboration agreement with Glaxo will substantially decline in future periods as compared to 2002 as we expect expenses related to the POI program to decrease as we complete our Phase III trials. However, depending on the outcome of our clinical trials and the results of regulatory reviews, these expenditures may increase due to the possible need to perform additional development work. We expect that as Glaxo incurs increasing expenses under our collaboration related to the OBD program in the United States, we will incur substantial expenses relating to our reimbursements owed to Glaxo. We expect that other operating expenses will increase in future periods as a result of manufacturing scale-up efforts and in preparation for potential commercialization of our product candidates. Further, we may in-license or acquire product candidates which will require additional cash outlays.

The following summarizes our operating lease and debt obligations as of December 31, 2002:

In December 2002, we entered into a lease agreement for an office and laboratory facility which requires us to expend approximately $3.0 million in leasehold improvements.

Under the terms of the Glaxo agreement, we will partially reimburse Glaxo for third party expenses incurred by them in the development of alvimopan for certain indications in the United States, pursuant to an agreed upon development plan and budget. We also expect to incur certain expenses in the development of alvimopan, pursuant to an agreed upon development plan and budget, for certain other indications in the United States, a portion of which are reimbursable to us by Glaxo. We expect to record these expenses as incurred.

We have entered into various agreements for services with third party vendors, including agreements to conduct clinical trials and to manufacture the products being tested in our trials, for consulting and other contracted services. We accrue the costs of these agreements based on estimates of work completed to date. We estimate that approximately $30.9 million will be payable under these agreements. Of this amount, approximately $15.9 million had been accrued for work estimated to have been completed as of December 31, 2002 and approximately $15.0 million relates to future performance under these agreements.

With regard to our product, alvimopan, we have commitments to Roberts Laboratories, Inc. (Roberts) and Eli Lilly. In November 1996, Roberts licensed from Eli Lilly certain intellectual property rights relating to alvimopan. In June 1998, we entered into an Option and License Agreement with Roberts under which we

Index to Financial Statements

licensed from Roberts the rights Roberts had licensed from Eli Lilly for alvimopan. As of December 31, 2002, we have paid $600,000 to Roberts. We are obligated to pay milestone payments to Roberts and Eli Lilly upon the achievement of certain clinical and regulatory milestones that in the aggregate may total up to $1.9 million. We are also responsible for the costs to develop alvimopan. In addition, if alvimopan receives regulatory approval, we are obligated to pay royalties to Roberts and Eli Lilly on commercial sales of alvimopan. Under the terms of our arrangements, the license to alvimopan expires on the later of either the life of the last to expire of the licensed Eli Lilly patents or fifteen years from November 5, 1996, following which we will have a fully paid up license.

In August 2002, we entered into a separate exclusive license agreement with Eli Lilly under which we obtained an exclusive license to six issued U.S. patents, related foreign equivalents and know-how relating to peripherally selective opioid antagonists. We paid Eli Lilly $4.0 million upon signing the agreement and are subject to additional clinical and regulatory milestone payments and royalty payments to Eli Lilly on sales, if any, of new products utilizing the licensed technology. Under this license agreement, we agreed to pay Eli Lilly a $4.0 million dollar payment upon acceptance by a regulatory authority of the first application for marketing authorization for alvimopan.

With regard to our other product candidates, we have also entered into agreements in which we will be required to make milestone payments as the events occur and royalty payments if and when we have sales.

Our capital expenditures for the years ended December 31, 2002 and 2001, were $1,724,198 and $2,903,817, respectively, and were primarily for the purchase of laboratory equipment, furniture and fixtures, office equipment and leasehold improvements in order to further expand our product research and development capabilities.

In December 2002, we entered into a lease for an office and laboratory facility in which we plan to consolidate all operations. As a result, we are required to expend approximately $3.0 million for leasehold improvements. In addition, we expect to require additional investments in information technology, laboratory and office equipment to support the continued expansion of our research, development, administrative and potential commercialization activities.

During 2002 and 2001, we received $889,476 and $307,336, respectively, from stock option exercises and issuances of restricted common stock. We received additional financing for the payment of insurance premiums of $248,506 and $88,033 in the years ended December 31, 2002 and 2001, respectively. We used $427,769 and $609,086 to repay insurance premium loan obligations during the years ended December 31, 2002 and 2001, respectively. Payments on notes receivable for exercise of stock options was $267,677 and $156,839 for the twelve months ended December 31, 2002 and 2001, respectively. Additionally, interest converted to principal on these notes was $49,534 and $69,339 for the twelve months ended December 31, 2002 and 2001, respectively.

We do not expect to generate positive cash flows from operations for at least the next several years, if at all. We expect to continue to use our cash, cash equivalents and short-term investments to fund operating and investing activities. We believe that our existing cash, cash equivalents and short-term investments of approximately $154.0 million as of December 31, 2002 will be sufficient to meet our currently estimated operating and investing requirements into early 2005. Prior to exhausting our current cash reserve, we will 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 curtailment of

Index to Financial Statements

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.

The extent and timing of proceeds from future exercises of stock options, if any, are primarily dependent upon the market price of our common stock, as well as the exercise prices and expiration dates of the stock options.

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

Contract, Grant, License and Milestone Revenues. Our contract, grant, license and milestone revenues were $28,409,417 and $1,386,803 for the years ended December 31, 2002 and 2001, respectively. Revenues recognized for the year ended December 31, 2002 consisted of: (a) $24,246,332 for the reimbursement of expenses from Glaxo in connection with a collaboration agreement executed in April 2002; (b) $2,951,394 which represents the amortization of the $50,000,000 signing fee received from Glaxo, which will be expected to be amortized into revenue on a straight-line basis over a twelve year period; (c) $26,316 which represents the amortization of the $500,000 license fee received from Santen on signing an agreement with Santen in April 2000; (d) $735,375 from a portion of the Small Business Innovation Research (SBIR) grants awarded to us by the National Institutes of Health (NIH) in September 2001; (e) a payment of $200,000 from Toray Industries, Inc., and (f) a milestone payment of $250,000 from Santen. Revenues recognized for the year ended December 31, 2001 consisted of: (a) a milestone payment of $500,000 received from an affiliate of GlaxoSmithKline; (b) $24,123 which represents the amortization of a deferred $500,000 license fee received from the same affiliate; (c) $438,596 which was the remaining balance of the deferred license fee received from the same affiliate in July 1999 as a non-refundable up-front payment upon signing the agreement, which was recorded as revenue upon termination of all continuing involvement; (d) a milestone payment of $250,000 from Santen; (e) $26,316 which is a portion of the $500,000 license fee received from Santen on signing that agreement in April 2000; (f) $80,071 from a portion of the SBIR grants awarded by NIH in September 2001 and (g) a patent cost reimbursement from Santen of $67,697. The license fee revenues related to Santen were being recognized over the remaining life of the patents that were licensed in those collaborations.

In connection with the collaboration agreement with Glaxo for the development of products in the United States, we recorded for the year ended December 31, 2002 as contract reimbursement revenue the reimbursement of the excess of the out-of-pocket research and development and marketing expenses that we incurred. The contract reimbursement revenue covered the period from January 1, 2002 to December 31, 2002. The amounts attributable to the year ended December 31, 2002 and the allocation of the amounts between research and development and marketing expenses are as follows:

Of the total contract reimbursement revenue of $24,246,332, $7,502,379 is recorded at December 31, 2002 as an account receivable from Glaxo under the collaboration agreement. Although we expect to collect this receivable, it is subject to review, verification and payment by Glaxo. In 2002, we received $16,743,953 from

Index to Financial Statements

Glaxo for reimbursement of shared research and development and marketing expenses through the third quarter of 2002.

Research and Development Expenses. Our research and development expenses consist primarily of salaries and other personnel-related expense, costs of clinical trials, costs to manufacture product candidates, stock-based compensation and other research expense. Research and development expenses increased to approximately $71.7 million for the year ended December 31, 2002 from approximately $36.0 million for the year ended December 31, 2001. This increase was primarily due to the higher costs of developing our product candidates, particularly alvimopan, as well as higher personnel costs and a license fee payment of $4.0 million to Eli Lilly and Company. In the year ended December 31, 2002, the costs of conducting Phase I and Phase III clinical trials and the costs of manufacturing the clinical trial materials for alvimopan increased by approximately $31.0 million compared to the same period in 2001. The costs of conducting Phase II clinical trials decreased by approximately $2.0 million as we moved into Phase III clinical trials for alvimopan. Personnel costs increased by approximately $2.8 million for the year ended December 31, 2002 compared to the same period in 2001.

Marketing, General and Administrative Expenses. Our marketing, general and administrative expenses increased to approximately $21.7 million for the year ended December 31, 2002 from approximately $15.2 million for the year ended December 31, 2001, an increase of approximately $6.5 million. The increase was due to approximately $2.5 million of higher payroll expenses of which approximately $0.8 million was a result of payments to be made under separation agreements; an increase in non-cash deferred compensation of approximately $1.6 million primarily related to the acceleration of the vesting of certain stock options under an employment agreement and a separation agreement; an increase of approximately $1.3 million for financial advisory fees associated with the execution of the collaboration agreement we entered into with Glaxo; a decrease of approximately $0.6 million in marketing expenses; an increase in consulting fees of approximately $0.4 million; an increase of approximately $0.8 in corporate legal fees due to costs related to the Glaxo collaboration and negotiations in the lease for the new facility.

Net Interest Income (Expense). Our interest income decreased to approximately $4.5 million for the year ended December 31, 2002 from approximately $7.5 million for the same period in 2001. Our interest income decreased because of a reduction in investment balance and lower interest rates for the year ended December 31, 2002. Our interest expense represents interest incurred on the financing of insurance premiums.

Net Loss. Our net loss for the years ended December 31, 2002 and 2001 was approximately $60.5 million and $42.4 million, respectively. The increase in net loss reflects higher costs associated with the expansion of Phase III clinical development for alvimopan, higher costs of clinical trial materials for alvimopan and non-cash charges in connection with the acceleration of the vesting of certain stock options.

We expect contract reimbursement revenues from Glaxo to substantially decline in future periods as compared to 2002 as we expect the costs of the POI development program to decrease and also expect that we will incur substantial expenses in connection with the OBD development program, including payments to Glaxo to reimburse them for our proportionate share of expenses they incur.

Index to Financial Statements

Contract, Grant, License and Milestone Revenues. Our contract, grant, license and milestone revenues were approximately $1.39 million and $43,860 for the years ended December 31, 2001 and 2000 respectively. Revenues recognized for the year ended December 31, 2001 consisted of: (a) a milestone payment of $500,000 from an affiliate of GlaxoSmithKline; (b) $24,123 which represents the amortization of a deferred $500,000 license fee from the same affiliate; (c) $438,596 which was the remaining balance of the deferred license fee received from the same affiliate in July 1999 as a non-refundable up-front payment upon signing the agreement, which was recorded as revenue upon termination of all continuing involvement; (d) a milestone payment of $250,000 from Santen; (e) $26,316 which is a portion of the $500,000 license fee received from Santen on signing an agreement in April 2000; (f) $80,071 from a portion of the SBIR grants awarded by the National Institutes of Health (NIH) in September 2001; and (g) a patent cost reimbursement from Santen of $67,697. Revenue recognized for the year ended December 31, 2000 consisted of (a) $26,316 which represents the amortization of the $500,000 license fee received from an affiliate of GlaxoSmithKline on signing an agreement in July 1999, and (b) $17,544 which is a portion of the deferred $500,000 license fee received from Santen on signing an agreement in April 2000. The license fee revenues related to Santen were being recognized over the remaining life of the patents that were licensed in those collaborations.

Research and Development Expenses. Our research and development expenses consisted primarily of salaries and other personnel-related expenses, costs of clinical trials, costs to manufacture drug candidates, stock-based compensation, allocated and direct facility expenses and other research expenses. Research and development expenses increased to approximately $36.0 million for the year ended December 31, 2001 from $15.9 million for the year ended December 31, 2000. This increase is primarily due to the increased costs associated with developing our product candidates and additional product candidates being researched as well as higher personnel costs resulting from increased staffing levels. For the year ended December 31, 2001, the costs of conducting Phase I and Phase II clinical trials, the expansion in the Phase III clinical trials and the costs of manufacturing the clinical trial materials for alvimopan increased by approximately $10.7 million compared to the same period in 2000. Laboratory costs increased by approximately $1.4 million compared to the same period in 2000. In addition, we paid license fees of approximately $0.3 million to Arch Development Corporation and the National Institutes of Health in 2001. Database services increased by approximately $0.6 million in the twelve months ended December 31, 2001 compared to the same period in 2000. Personnel costs increased by approximately $4.3 million compared to the same period in 2000. Amortization of deferred stock-based compensation expenses increased by approximately $1.3 million in the year ended December 31, 2001 compared to the same period in 2000. An increase in other expenses, including office rent and office expense of approximately $0.9 million, compared to the same period in 2000 resulted from an increase in office space because of additional personnel.

Marketing, General and Administrative Expenses. Our marketing, general and administrative expenses increased to approximately $15.2 million for the year ended December 31, 2001 from approximately $7.6 million in the twelve months ended December 31, 2000, an increase of approximately $7.6 million. The increase is primarily due to approximately $1.0 million of higher payroll expenses related to additional personnel, approximately $0.9 million of higher amortization of deferred stock-based compensation expense, approximately $3.5 million of marketing expenses related to alvimopan, approximately $0.4 million of investor and public relations expenses, approximately $0.4 million of corporate legal fees, approximately $0.5 million in consulting fees, and increases of approximately $0.8 million for other expenses including insurance, office rent and office expense.

Net Interest Income (Expense). Our interest income increased from approximately $2.3 million for the year ended December 31, 2000 to approximately $7.5 million for the year ended December 31, 2001 due to the investment returns on the proceeds from our initial public offering in November 2000 and a follow-on round of financing in May 2001. Our interest expense represents interest incurred on the financing of insurance premiums.

Index to Financial Statements

Net Loss. Our net loss for the twelve months ended December 31, 2001 and 2000 was approximately $42.4 million and approximately $21.2 million, respectively. The increase in the net loss reflects higher costs associated with the expansion of Phase II and Phase III clinical development of our product candidates, higher manufacturing costs for the clinical trial materials for alvimopan and increased staffing levels partially offset by higher revenues.

Net Loss Allocable to Common Stockholders. For the year ended December 31, 2001, the net loss allocable to common stockholders was approximately $42.4 million, an amount equal to the net loss for the period. For the same period in 2000, the net loss allocable to common stockholders was approximately $74.2 million and included a net loss of approximately $21.2 million, a beneficial conversion feature on mandatorily redeemable convertible preferred stock of approximately $48.9 million and undeclared dividends attributable to mandatorily redeemable convertible preferred stock of approximately $4.1 million. Therefore, the net loss allocable to common stockholders decreased by approximately $31.8 million for the period ended December 31, 2001 compared to the same period in 2000 due to the non-recurring items in 2000.

As of December 31, 2002, we had approximately $41,872,000 of Federal and $42,971,000 of state net operating loss carryforwards potentially available to offset future taxable income. The Federal and state net operating loss carryforwards will begin expiring in 2009 and 2005, respectively, if not utilized. In addition, the utilization of the state net operating loss carryforwards is subject to a $2 million annual limitation. At December 31, 2002, we also had approximately $2,586,000 of Federal and $1,526,000 of state research and development tax credit carryforwards, which begin expiring in 2011, and are available to reduce Federal and state income taxes.

The Tax Reform Act of 1986 (the Act) provides for a limitation on the annual use of net operating loss and research and development tax credit carryforwards (following certain ownership changes, as defined by the Act) that could significantly limit our ability to utilize these carryforwards. We may have experienced various ownership changes, as defined by the Act, as a result of past financings. Additionally, because United States tax laws limit the time during which these carryforwards may be applied against future taxes, we may not be able to take full advantage of these attributes for Federal income tax purposes.

In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires the Company to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development, and/or normal use of the assets. The Company also records a corresponding asset that is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The Company is required to adopt SFAS No. 143 on January 1, 2003. The adoption of SFAS No. 143 is not expected to have a material effect on the Company’s financial position or results of operations.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 amends existing guidance on reporting gains and losses on the extinguishment of debt to prohibit the classification of the gain or loss as extraordinary, as the use of such extinguishments have become part of the risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of the Statement related to the rescission of Statement No. 4 is applied in fiscal years beginning after May 15, 2002. Earlier

Index to Financial Statements

application of these provisions is encouraged. The provisions of the Statement related to Statement No. 13 were effective for transactions occurring after May 15, 2002, with early application encouraged. The adoption of SFAS No. 145 is not expected to have a material effect on the Company’s financial position or results of operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of SFAS No. 146 is not expected to have a material effect on the Company’s financial position or results of operations.

In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2002 and are not expected to have a material effect on the Company’s financial position or results of operations. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123. This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002 and are included in the notes to the consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. The application of this Interpretation is not expected to have a material effect on the Company’s financial position or results of operations. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that the Company will consolidate or disclose information about variable interest entities when the Interpretation becomes effective.

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, alvimopan, which may never be approved for commercial use. If we are unable to commercialize alvimopan, our ability to generate revenues will be impaired and our business will be harmed.

We have invested a significant portion of our time and financial resources since our inception in the development of alvimopan, and we anticipate that for the foreseeable future our potential to achieve revenues

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from product sales will be dependent on its successful clinical testing, regulatory approval in the United States and commercialization. Drug development is a highly uncertain process. We or Glaxo, with whom we are collaborating to develop alvimopan, may suffer significant setbacks in advanced clinical trials of alvimopan, even after achieving potentially promising results in earlier clinical trials. Even if the clinical trials of alvimopan are successful, prior to commercialization of alvimopan in the United States, we will have to submit, and the United States Food and Drug Administration (“FDA”) will have to approve, a New Drug Application (“NDA”) for alvimopan. If our NDA, if any, for alvimopan is not approved by the FDA, or if approval is delayed, our ability to achieve revenues will be impaired and our stock price will be materially and adversely affected. FDA approval is contingent on many factors, including clinical test results and the evaluation of those results.

Our alvimopan postoperative ileus (“POI”) Phase III program consists of four studies. Three of these studies (POI 14CL302, POI 14CL308 and POI 14CL313) are double-blind, placebo-controlled multi-center studies each designed to enroll approximately 450 patients scheduled to undergo certain types of major abdominal surgery and receiving opioids for pain relief. Under the protocols, patients are randomized into three arms of approximately 150 patients each to receive placebo, 6 mg, or 12 mg doses of alvimopan. The primary endpoint in these three studies is a composite measure of the time to recovery of both the upper and lower gastrointestinal functions as defined by time to tolerability of solid foods and time to first flatus or first bowel movement. We have completed enrollment in study POI 14CL302 and are targeting completion of enrollment in studies POI 14CL308 and POI 14CL313 over the first half of 2003. The results of one or more of these clinical trials may be negative. The results of one or both of the dose comparisons in each study may be negative. Because the studies are intended to be confirmatory and each study involves multiple comparisons (i.e. two doses of alvimopan versus placebo), under statistical techniques, 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 significant level of P < 0.05, the other dose comparison in that study will need to reach a significance level of P < 0.025 to be considered statistically significant. We may not achieve positive statistical results in these studies.

Our fourth POI clinical study in our Phase III program (POI 14CL306) is a double-blind placebo-controlled multi-center study designed to enroll approximately 500 patients scheduled to undergo total abdominal simple hysterectomy and receiving opioids for pain relief. Under this protocol, patients are randomized to receive either alvimopan 12 mg (approximately 400 patients) or placebo (approximately 100 patients). Enrollment in this study has been completed. This study was designed to assess safety and will also assess efficacy in this POI patient population.

The results from these clinical trials are expected to be analyzed over the next several quarters. The results from any one or all of these clinical trials may be negative. Negative results from one or more of these clinical trials will adversely affect our ability to obtain regulatory approval for alvimopan. Adverse safety finding from one or more of these studies will adversely affect our ability to obtain regulatory approval. Even if we conclude that the results from our preclinical studies and clinical trials are positive, the FDA may not agree with us because the FDA may evaluate the results by different methods or conclude that the clinical test results are not clinically meaningful or that there were human errors in the conduct of the clinical trials or otherwise. Clinical trials in our Phase III program use drug product manufactured by two different contract manufacturing facilities, one of which is no longer in business. Our efforts to obtain regulatory approval may be impaired as a result of using material from two different contract manufacturing facilities. To receive regulatory approval for alvimopan, our contract manufacturers will be required to obtain approval for their manufacturing facilities to manufacture alvimopan. To achieve this approval, we will also be 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 alvimopan in accordance with extensive regulatory requirements, commonly known as good manufacturing practices (cGMPs). FDA approval for our contract manufacturing facilities to manufacture alvimopan may not be obtained. We will be required to submit extensive preclinical data in our NDA, if any, which satisfies the FDA regulatory requirements. We may fail to meet the FDA’s standards on any one of these or other elements required in an NDA.

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Even if we believe we have met the FDA guidelines for submission of data and information to the NDA, if any, there is a risk that the FDA will require additional data and information that we are unable to provide.

We have completed a Phase III clinical trial of alvimopan in patients with opioid-induced bowel dysfunction (OBD) caused by chronic administration of opioids. Under our collaboration agreement with Glaxo, Glaxo has overall responsibility for development of alvimopan for OBD. We are conducting and plan to conduct additional long-term animal toxicity studies to support further development of alvimopan in OBD. Adverse safety findings in these long-term animal toxicity studies could adversely affect our prospects for alvimopan, including its prospects for use in postoperative ileus. Results from this study in OBD are not necessarily indicative of the results that may be reported from the clinical studies in the POI indication. The results of study OBD 13CL304 have not been submitted to, nor reviewed by, any regulatory agency. Additional studies for chronic OBD investigating longer duration of patient exposure and different dosing strategies, as well as preclinical toxicology studies will be required before any NDA could be filed for use of alvimopan in OBD.

Our alvimopan clinical trials are testing whether alvimopan is able to selectively block the effects of narcotic analgesics on the gastrointestinal tract. As combination clinical trials, they are subject to the risk that the use of alvimopan 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 alvimopan in combination with narcotic analgesics may add to the complexity of interpreting the study results.

Our stock price may be volatile, and your investment in our stock could decline in value. We may become involved in securities class action litigation.

The market price for our common stock has been highly volatile and may continue to be highly volatile in the future. The market price for our common stock is highly dependent on the results of our clinical trials, in particular our Phase III program clinical trials of alvimopan in post-operative ileus. Two of these clinical trials have completed accrual and the other clinical trials are expected to complete accrual, and these studies are expected to be analyzed and results announced over the next several quarters. There can be no assurance that accrual will be completed within the expected timeframe or that the results of any of these Phase III clinical trials will be positive. Failure of these results to be positive would adversely impact the market price of our common stock.

The following factors, in addition to the factors described in the alvimopan risk factor above and other risk factors contained in this document, may have a significant impact on the market price of our common stock:

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In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Litigation of this type is often extremely expensive 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 December 31, 2002 of approximately $154.0 million will be sufficient to meet our currently estimated operating and investing requirements into early 2005. We have generated operating losses since we began operations in November 1994 and we will need additional funds that may not be available in the future. We have no products that have generated any revenue, and as of December 31, 2002, we have incurred a cumulative net loss of approximately $155.2 million. Even if we succeed in developing a commercial product, 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.

We are dependent on our collaborators to perform their obligations under our collaboration agreements. If conflicts arise between our collaborators or advisors and us, they may act in their self-interest.

In April 2002, we and Glaxo entered into a collaboration agreement for the exclusive worldwide development and commercialization of alvimopan for certain indications. We and Glaxo agreed in the collaboration agreement to co-develop alvimopan for a number of indications, both acute and chronic, which would potentially involve the use of alvimopan in in-patient and out-patient settings. In the United States, we and Glaxo will co-develop and intend to co-promote alvimopan and share development expenses and commercial returns, if any. We have overall responsibility for the development of acute-care indications, such as postoperative ileus, and Glaxo has overall responsibility for the development of chronic-care indications, such as opioid bowel dysfunction associated with the chronic use of opioids. We and Glaxo are required to use commercially reasonable efforts to develop the indications for which we and they are respectively responsible. We depend on Glaxo to provide us with substantial assistance and expertise in the development of alvimopan. Any failure of Glaxo to perform its obligations under our agreement could negatively impact our product candidate, alvimopan, and could lead to our loss of potential revenues from product sales and milestones that may otherwise become due under our collaboration agreement with Glaxo and would delay our achievement, if any, of profitability. In the near term, our success will depend upon the success of our collaboration with Glaxo to further develop alvimopan and if we achieve regulatory approval to commercialize alvimopan.

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. If Glaxo terminates the collaboration agreement, our business will be adversely affected.

We have obtained, and intend to obtain in the future, licensed rights to certain proprietary technologies and compounds from other entities, individuals and research institutions, for which we may be obligated to pay

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license fees, make milestone payments and pay royalties. In addition, we have entered into, and may in the future enter into, collaborative arrangements, including our arrangement with Glaxo, for the marketing, sales 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. We cannot be certain that any of these parties, including Glaxo, will fulfill their obligations in a manner consistent with our best interests. 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. 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.

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.

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 alvimopan, 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.

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

We do not know whether our existing or any future clinical trials will demonstrate sufficient safety and efficacy necessary to obtain the requisite regulatory approvals or will result in marketable products. Our 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. Preclinical and clinical trials of our product candidates, including alvimopan, may not display the safety and efficacy necessary to obtain regulatory approvals. Drug development is a highly uncertain process. Pharmaceutical and biotechnology companies have suffered significant setbacks in advanced clinical trials, even after experiencing promising

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results in earlier trials. Data obtained from non-clinical and clinical tests are susceptible to varying interpretations which may delay, limit or prevent regulatory approval.

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:

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 meet demand for our products and lose potential revenues.

To receive regulatory approval for alvimopan, our contract manufacturers will be required to obtain approval for their manufacturing facilities to manufacture alvimopan. To achieve this approval, we will also be 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 alvimopan in accordance with extensive regulatory requirements, commonly known as good manufacturing practices (cGMPs). FDA approval for our contract manufacturing facilities to manufacture alvimopan may not be obtained. We are highly dependent on our current contract manufacturers because we have developed our manufacturing processes and controls with them. It is difficult and expensive to change contract manufacturers for pharmaceutical products, particularly when the products are under regulatory review in an NDA process. 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 we continue to depend on our collaborators or third parties for the manufacture of compounds for preclinical, clinical and commercial purposes in their manufacturing facilities. These manufacturers are required to adhere to FDA cGMP requirements. Under cGMPs, 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 manufacturers to comply with these regulations in the manufacture of our products, 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 alvimopan. If these third party manufacturers fail to perform in compliance with these regulations, we may be compelled to delay our development efforts. Our products may be in competition with other products for access to facilities of third parties and our collaborators and suitable alternatives may be unavailable. Consequently, our products may be subject to delays in manufacture if collaborators or outside contractors give other products greater priority than our products. For this and other reasons, our collaborators or third parties may not be able to manufacture these products in a cost-effective or timely manner. If the manufacture of these products does not occur in a timely manner, the clinical trial development of our product candidates or their submission for regulatory approval could be delayed, and our ability to deliver products, if any are approved, on a timely basis could be impaired or precluded. We may not be able to enter into necessary third-party manufacturing arrangements on acceptable terms, if at all. 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. We do not intend to develop or acquire facilities for the manufacture of product candidates for clinical trials or commercial purposes in the foreseeable future.

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We have limited experience in conducting and managing the clinical trials necessary to obtain regulatory approval.

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, stringent enrollment requirements, slow rate of enrollment, size of patient population, competition with other clinical trials for eligible patients, geographical considerations and others. We contract with third parties to conduct our clinical trials including our clinical trials in our Phase III POI program. We are subject to the risk that these third parties fail to perform their obligations properly and in compliance with applicable FDA regulations.

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

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 restricted opioid analgesic or peripherally acting narcotic antagonist drugs will achieve commercial success in the marketplace. Market acceptance of our product candidates will depend on a number of factors, including:

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.

Our product candidate alvimopan is under investigation in POI and OBD for use in patients taking opioid analgesics and reduction in the use of opioid analgesics would reduce the potential market for alvimopan

If the use of drugs or techniques which reduce the requirement for mu-opioids increases, the demand for alvimopan would be decreased. Various techniques to reduce the use of opioids are used in an attempt to reduce the impact of opioid side effects. These techniques have variable impact on the incidence of side effects because some opioid effects, such as changes in gastrointestinal function, happen even with a single dose of opioid. Other opioid effects, such as nausea and vomiting, appear to be related to total opioid dose and so opioid sparing techniques may have more impact. 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. These catheters are limited to use in certain types of procedures, are contraindicated in patients on blood thinning agents, have a higher requirement for maintenance and generally cannot be continued for more than 3 days, thus limiting their wide adoption. Non-steroidal inflammatory agents may reduce the total opioid requirement but cannot entirely replace the use of opioids in moderate to severe pain and are associated with side effects such as bleeding, decreased bone healing, and adverse renal effects. 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 to provide pain relief or to enhance opioid analgesia are under development but have not yet demonstrated wide clinical applicability in humans.

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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 that will reduce our commercial opportunities.

Other companies have product candidates in clinical trials to treat the conditions for which we are seeking to discover and develop product candidates. These competing potential drugs may result in effective, commercially successful products. Even if our collaborators or we are successful in developing effective drugs, our products may not compete effectively with these products or other successful products. Our competitors may succeed in developing products either that are more effective than those that we may develop, alone or with our collaborators, or that they market before we market any products we develop.

Our competitors include fully integrated pharmaceutical companies and biotechnology companies that currently have substantial research and development efforts and universities and public and private research institutions. In addition, companies pursuing research in different but related fields represent substantial competition. 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:

The successful entrance by our competitors into partnering arrangements or license agreements with academic research institutions will preclude us from pursuing those specific opportunities. Since each of these opportunities is unique, we may not be able to find an acceptable substitute.

Third parties are conducting or will conduct many of our product development activities and almost all of our manufacturing and marketing activities. If these third parties fail to perform these functions satisfactorily and in compliance with regulatory requirements, our product development could be delayed.

We rely, to a significant extent, on third parties to jointly conduct some research and preclinical testing functions and to manufacture certain of our product candidates. If any of these third parties breaches or terminates their agreement with us or otherwise fails to conduct their activities successfully and in a timely manner, their actions could delay or terminate the preclinical or clinical development or potential commercialization of the affected product candidates or research programs. We cannot control the amount and timing of resources these third parties devote to our programs or product candidates. The failure of any third party to comply with any governmental regulations would substantially harm our development and marketing efforts and delay or prevent regulatory approval of our product candidates. If these third parties fail to perform their obligations properly and in compliance with applicable regulations, we may be compelled to delay our development efforts, and our business could be harmed.

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 clearance 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

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promotion of drugs for human use. Since neither the FDA nor international regulatory authorities have approved peripherally restricted opioid analgesics or peripherally restricted narcotic antagonist drugs for marketing, we do not know 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 will be treated. Outside the United States, our ability to market a product is contingent upon receiving a marketing authorization from the appropriate regulatory authorities. This foreign regulatory approval process includes all of the risks associated with FDA clearance described above.

If we receive regulatory approval for our product candidates and if we fail to comply with applicable FDA post marketing regulations or other regulatory requirements, we could be subject to criminal prosecution, civil penalties, recall or seizure of products, total or partial suspension of production or injunction, as well as other regulatory actions against our product or us. In addition, 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 DEA would consider any product to be a controlled substance. We believe that it is unlikely that any of our product candidates other than those acting on the central nervous system will be subject to regulation as 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:

Before commencing clinical trials in humans, we must submit and receive approval from the FDA of an Investigational New Drug, or IND, application. We, or the FDA, may suspend 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.

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 and 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. Failure to negotiate additional acceptable collaborations with academic institutions and scientists, or lack of success with respect to our existing academic collaborations, may delay our product development programs. 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.

If we do not realize value from our retained commercialization rights, we may not achieve our commercial objectives or profitability.

If we do not effectively exploit the commercialization rights we have retained, we will not achieve profitability. In our corporate collaborations, we intend to retain various commercialization rights for our

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pharmaceutical products, including rights for specific pharmaceutical indications or in specified geographical regions. We may take advantage of these currently retained rights directly or through collaborations with others. The value of these rights, if any, will largely derive from our ability, directly or with collaborators, to develop and commercialize drugs, the success of which is also uncertain. The exploitation of retained commercialization rights requires:

We may not be able to develop or obtain these resources in sufficient quantity or at a sufficient quality level to achieve our objectives. We will need to rely on third parties for many of these resources. Our failure to establish and maintain relationships to obtain these services cost-effectively could materially reduce or eliminate our ability to realize value from our retained commercialization rights.

Companies and universities that have licensed product candidates to us for clinical development and marketing are sophisticated competitors 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 them from developing non-identical but 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 of successful new drugs from our research program is 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 the previous research that led to the discovery of the drugs or product candidates that they licensed to us, 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.

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

We may breach the agreements under which we license commercialization or development rights and may thereby lose license rights that are important. We license rights to products and technology that are relevant to our business, including among others our exclusive worldwide license to alvimopan from Roberts Laboratories, Inc. and our license agreement with Eli Lilly to license intellectual property rights relating to peripherally selective opioid antagonists. We are subject to various obligations with respect to these 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.

It is difficult and costly to protect our intellectual property rights, and we cannot ensure their protection; 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.

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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. Others may have patent applications that may overlap with a patent application that we have in-licensed covering certain receptors. We cannot assure that any patent application owned by a third party will not have priority over patent applications filed or in-licensed by us, nor that we or our licensor will not be involved in interference proceedings before the United States Patent and Trademark Office.

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. We are aware of an issued patent that has expired for non-payment of a maintenance fee and that relates to methods of treatment of symptoms associated with the cold and flu. It is possible that the patent could be reinstated and that a claim could be asserted that certain ophthalmic uses of our ADL 2-1294 product candidate infringe this issued patent. If this patent is reinstated and is found to contain claims infringed by the use of our ADL 2-1294 product candidate and such claim is are ultimately found valid and enforceable, we may not be able to obtain a license at a reasonable cost, or at all. 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 a substantial portion of our 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.

Others may hold proprietary rights that will prevent our product candidates from being marketed unless we are able to obtain a license to those proprietary rights. 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 this technology on commercially reasonable terms, our product development and research may be delayed. In addition, we generally do not control the prosecution of 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. For example, the University of California, San Diego is prosecuting the patent for additional claims regarding the use of ADL 2-1294 for the treatment of inflammatory pain.

If we are unable to 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 sales or distribution capability and limited 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 FDA approval, we intend to market some products directly and rely on relationships with one or more pharmaceutical companies with established distribution systems and direct sales forces to market other products. To market any of our products directly, we must develop a marketing and sales force with technical expertise and with 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.

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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:

The continuing efforts of government and third-party payors to contain or reduce the costs of health care through various means will 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. In addition, 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 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 for our products. Further, cost control initiatives could adversely affect our collaborators’ ability to commercialize our products, and our ability to realize royalties from this commercialization.

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:

We are not in a position to predict what, if any, collaborations, alliances or transactions may result or how, when or if they will 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 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. If we cannot obtain sufficient product liability insurance at an acceptable cost to protect against potential product liability claims we may be prevented from commercializing our products. We enter into indemnification agreements where we indemnify third parties such as investigators for certain product liability

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claims related to our products under investigation. 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 cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of these materials. 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.

Anti-takeover provisions in 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.

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 designed to encourage parties seeking to acquire us to negotiate with and seek the approval of our Board of Directors.

Under our collaboration agreement with Glaxo, Glaxo has certain limitations on its ability to acquire our securities.

A substantial portion of our assets are investment grade debt instruments such as direct obligations of the U.S. Treasury and corporate securities, including commercial paper and corporate debt instruments. 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 December 31, 2002 was $117.3 million and the weighted-average interest rate was approximately 2.90% with maturities from one to fifteen months.

The financial statements required to be filed pursuant to this Item 8 are appended to this Annual Report on Form 10-K. A list of the financial statements filed herewith can be found at “Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.”

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The Company incorporates by reference the information contained under the captions “Election of Directors, Item 1 on Proxy Card”, “Executive Officers of the Registrant” and “Section 16(a) Beneficial Ownership Reporting Compliance” in its Definitive Proxy Statement related to its annual meeting of stockholders, to be filed within 120 days after the end of the year covered by this Report pursuant to Section 14(a) of the Securities Exchange Act of 1934, as amended (the Exchange Act).

The Company incorporates by reference the information contained under the caption “Compensation Tables” in its Definitive Proxy Statement related to its annual meeting of stockholders, to be filed within 120 days after the end of the year covered by this Report pursuant to Section 14(a) of the Exchange Act.

The Company incorporates by reference the information contained under the captions “Security Ownership of Certain Beneficial Owners and Directors and Officers” and “Other Forms of Compensation” in its Definitive Proxy Statement related to its annual meeting of stockholders, to be filed within 120 days after the end of the year covered by this Report pursuant to Section 14(a) the Exchange Act.

The Company incorporates by reference the information contained under the caption “Certain Relationships and Related Transactions” in its Definitive Proxy Statement related to its annual meeting of stockholders, to be filed within 120 days after the end of the year covered by this Report pursuant to Section 14(a) of the Securities Exchange Act.

Within the ninety days prior to the date of this Annual Report, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Senior Vice President 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-14 and 15d-14 under the Exchange Act. Based upon this evaluation, our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer concluded that, as of December 31, 2002, our disclosure controls and procedures have been designed and are being operated in a manner that provides reasonable assurance that the information required to be disclosed by the Company in reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Commission. A control system, no matter how well designed and operated, cannot provide assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

Additionally, our President and Chief Executive Officer and Senior Vice President and Chief Financial Officer determined, as of December 31, 2002, that there were no significant changes in our internal controls or in other factors that could significantly affect our internal controls subsequent to the date of their evaluation.

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Reference is made to the Index to Consolidated Financial Statements on page F-1 of this Report.

On October 16, 2002, the Company filed a Current Report on Form 8-K which reported the resignation of the former Senior Vice President of Commercial Operations and Chief Operating Officer of the Company and compensation expenses and non-cash charges to be recorded by the Company in the third quarter of 2002 in connection with agreements between the Company and the former President and Chief Executive Officer of the Company and the former Senior Vice President of Commercial Operations and Chief Operating Officer of the Company.

Reference is made to the Exhibit Index on page 52 of this Report for a list of exhibits required by Item 601 of Regulation S-K to be filed as part of this Report.

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Pursuant to the requirements of Section 13 or 15(d) of the Security 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

By:		/s/ BRUCE A. PEACOCK
Name:		Bruce A. Peacock
Title:		President, Chief Executive Officer and Director

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

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The following Consolidated Financial Statements, and the related Notes thereto, of Adolor Corporation and subsidiary and the Report of Independent Auditors are filed as a part of this annual report on Form 10-K.

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We have audited the accompanying consolidated balance sheets of Adolor Corporation (a development-stage company) and subsidiary as of December 31, 2002 and 2001, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity (deficit) and cash flows for each of the years in the three-year period ended December 31, 2002 and for the period from August 9, 1993 (inception) to December 31, 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Adolor Corporation (a development-stage company) and subsidiary as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, and for the period from August 9, 1993 (inception) to December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.

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