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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2003

OR

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

Commission File Number: 000-26929

ADOLOR CORPORATION

(Exact Name of Registrant as Specified in its Charter)

700 Pennsylvania Drive
Exton, Pennsylvania 19341
(Address of Principal Executive Offices and Zip Code)

484-595-1500
(Registrant’s Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
[X] Yes [_] No

Number of shares outstanding of the issuer’s Common Stock, par value $.0001 per share, as of April 28, 2003: 31,566,227 shares.

ADOLOR CORPORATION

INDEX

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ADOLOR CORPORATION
(A Development Stage Company)

Consolidated Balance Sheets
Unaudited
March 31, 2003 and December 31, 2002

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

ADOLOR CORPORATION
(A Development Stage Company)

Consolidated Statements of Operations
(Unaudited)
Three months ended March 31, 2003 and 2002
and the period from August 9, 1993
(inception) to March 31, 2003

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

ADOLOR CORPORATION
(A Development Stage Company)

Consolidated Statements of Cash Flows
(Unaudited)
Three months ended March 31, 2003 and 2002 and the
period from August 9, 1993 (inception) to March 31, 2003

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

Adolor Corporation
(A Development Stage Company)

Notes to Consolidated Financial Statements

March 31, 2003
(Unaudited)

1. ORGANIZATION AND BUSINESS ACTIVITIES

        Adolor Corporation (together with its subsidiary, “Adolor” or the “Company”) is a development stage biopharmaceutical corporation that was formed in 1993. The Company discovers, develops and plans to commercialize proprietary pharmaceutical products for the treatment of pain and the side effects that are caused by current pain treatments. The Company has a number of small molecule product candidates that are in various stages of development ranging from preclinical studies to Phase III clinical trials. In April 2002, the Company entered into a collaboration agreement with Glaxo Group Limited (“Glaxo”), an affiliate of GlaxoSmithKline plc, for the exclusive worldwide development and commercialization of its most advanced product candidate, alvimopan, for certain indications.

        The Company has not generated any product sales revenues and has not achieved profitable operations. The Company’s deficit accumulated during the development stage through March 31, 2003 aggregated approximately $166.5 million, and the Company expects to continue to incur substantial losses in future periods. A significant portion of our revenue recognized since inception 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. The Company’s future operations are heavily dependent on the success of the Company’s research, development and licensing efforts and, ultimately, upon regulatory approval and market acceptance of its proposed future products. There is no assurance that the Company will ever generate product sales or that profitable operations, if achieved, could be sustained on a continuing basis. The Company does 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, the Company will need to raise additional funds to finance our operating activities. There are no assurances that the Company will be successful in obtaining an adequate level of financing for the long-term development and commercialization of its product candidates.

 Principles of Consolidation

        The consolidated financial statements include the accounts of Adolor Corporation and its wholly owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation. The information at March 31, 2003 and for the three months ended March 31, 2003 and 2002, is unaudited but includes all adjustments (consisting only of normal recurring adjustments) which, in the opinion of management, are necessary to state fairly the financial information set forth in accordance with accounting principals generally accepted in the United States of America. The interim results are not necessarily indicative of results to be expected for the full fiscal year. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2002 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.

2.    COMPREHENSIVE LOSS

         In the Company’s annual consolidated financial statements, comprehensive loss is presented as a separate financial statement. For interim consolidated financial statements, the Company is permitted to disclose the information in the footnotes to the financial statements. The disclosures are required for comparative purposes.

        The following is the reconciliation of net loss to comprehensive loss for the three months ended March 31, 2003 and March 31, 2002:

 Adolor Corporation
(A Development Stage Company)

Notes to Consolidated Financial Statements

March 31, 2003
(Unaudited)

3. SHORT-TERM INVESTMENTS

        Short-term investments consist of investment-grade fixed income securities with original maturities of greater than three months including corporate securities and U.S. Treasury obligations. At March 31, 2003 and December 31, 2002, all short-term investments were carried as “available for sale” investments, and all matured within one year.

        The following summarizes the “available for sale” investments at March 31, 2003 and December 31, 2002:

4. CONTRACT REVENUES

        The following summarizes revenues for the three months ended March 31, 2003 and 2002:  

Adolor Corporation
(A Development Stage Company)

Notes to Consolidated Financial Statements

March 31, 2003
(Unaudited)

        In April 2002, the Company entered into a collaboration agreement with Glaxo Group Limited for the exclusive worldwide development and commercialization of alvimopan for certain indications. The Company and Glaxo 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 agreement, Glaxo paid the Company a non-refundable and non-creditable signing fee of $50.0 million during the quarter ended June 30, 2002 and the Company 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 is expected to be recognized as revenue on a straight-line basis through April 2014, the estimated performance period. Revenue of $1,041,669 was recognized in the first quarter of 2003 related thereto. The milestone payments relate to substantive achievements in the development lifecycle and will be recognized as revenue if and when the milestones are achieved.

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

        Under the terms of the collaboration agreement with Glaxo for collaboration products being developed in the United States, external expenses for research and development and marketing activities incurred by each company will be shared on an indication by indication basis. Adolor is primarily responsible for the completion of the POI development program and receives reimbursement from Glaxo at a defined percentage of external expenses. Such contract reimbursement amounts paid to the Company will be recorded gross on its consolidated statements of operations pursuant to Emerging Issues Task Force (EITF) No. 99-19 and 01-14 as contract reimbursement revenue. Glaxo is primarily responsible for the completion of the opioid-induced bowel dysfunction development program and will receive reimbursement from Adolor at a defined percentage of external expenses. Any amounts owed to Glaxo by the Company will be recorded as research and development expense or marketing expense, as the case may be, on the Company’s consolidated statements of operations. Although the collaboration agreement was executed in April 2002, the cost sharing arrangement was retroactive to January 1, 2002. The Company recorded contract reimbursement revenues of $5,177,351 in the first quarter of 2003 under this arrangement.

        In April 2000, the Company entered into a license agreement with Santen Pharmaceutical Co., Ltd. granting Santen an exclusive royalty bearing license to develop and sell products in the field of ophthalmic pain in all countries other than South Korea and North Korea. A $500,000 non-refundable payment was paid to the Company upon execution of the agreement. Such amount was recorded as deferred revenue and was being recognized over the remaining patent life. In February 2003, Santen terminated this agreement and as a result, the Company recognized $418,046 as revenue in the three months ended March 31, 2003.

Adolor Corporation
(A Development Stage Company)

Notes to Consolidated Financial Statements

March 31, 2003
(Unaudited)

5. STOCK-BASED COMPENSATION

         The Company accounts for stock option issuances to employees and members of the Board of Directors in accordance with the provisions of Accounting Principals Board (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company does not record compensation expense on options granted to employees with exercise prices equal to market value at date of grant. Deferred compensation is recorded only to the extent that the current market value of the underlying stock exceeds the exercise price of the options on the date of grant. Such deferred compensation is amortized on a straight-line basis over the respective vesting periods of such option grants. The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards (“SFAS”) No. 123 “Accounting for Stock-Based Compensation” which allows entities to continue to apply the provisions of APB No. 25 for financial reporting purposes and provide pro forma net loss and pro forma net loss per share footnote disclosures for employee stock option grants. Transactions with non-employees, in which goods or services are the consideration received for the issuance of equity instruments, are accounted for on a fair-value basis.

        Had the Company determined compensation cost under SFAS No. 123 for options granted based on the fair value method the Company’s net loss and net loss per share would have been increased to the pro forma amounts indicated below:

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

Forward-Looking Statements 

        This Quarterly Report on Form 10-Q 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 Item 2 “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 at www.adolor.com. 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.

Our Company 

        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 studying the use of alvimopan for the management of postoperative ileus (“POI”) that frequently follows abdominal surgery when opioids are used for pain relief. Subsequently we initiated our alvimopan POI Phase III program consisting 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. 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). This study was designed to assess safety and will also assess efficacy in this patient population.

        In April 2003, we announced top-line results of our first Phase III clinical study POI 14CL302 for alvimopan in the management of postoperative ileus. A statistically significant difference was achieved in the primary endpoint of the study, time to recovery of gastrointestinal function, in patients in the alvimopan 6 mg treatment group compared to patients in the placebo group (Cox proportional hazard model hazard ratio = 1.47; P<0.01). Time to recovery of gastrointestinal function was a composite measure of the time to recovery of both lower and upper gastrointestinal function as defined by time to first flatus or first bowel movement and time to tolerability of solid foods, whichever occurred last. A difference in favor of the alvimopan 6 mg treatment group versus placebo was observed for all secondary endpoints, including time to hospital discharge order written. A positive trend was observed in the primary endpoint of the study for the alvimopan 12 mg treatment group; however, the difference from placebo was not statistically significant (Cox proportional hazard model, hazard ratio = 1.23; P = 0.11). The results of this study have not been submitted to or reviewed by the U.S. Food and Drug Administration (FDA) or any other regulatory agency. The results from this study are not necessarily indicative of the results that may be obtained in the other Phase III studies of alvimopan in postoperative ileus, studies POI 14CL313, POI 14CL308 and POI 14CL306, which have not yet been completed and analyzed.

         Enrollment in study POI 14CL313 is expected to be completed in the second quarter of 2003 and this study is expected to enroll approximately 500 patients. Enrollment in study POI 14CL308 is expected to be completed in the second half of 2003 and enrollment in this study is now expected to exceed 500 patients. Enrollment in study POI 14CL306 is complete.

        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 also have other compounds that are being designed to elicit potential analgesic effects by targeting peripheral opioid receptors, including the kappa receptor. In April, 2003, we initiated two Phase II clinical studies involving two of our kappa agonist compounds, ADL 10-0101 and ADL 10-0116, in standard pain models, third molar dental extraction and bunionectomy. These studies have now been terminated following an assessment of the data generated to date in the studies, which indicated that the balance between therapeutic effect and safety did not warrant continuing the studies. We plan to further review this data and evaluate whether to pursue these compounds in other clinical models, and also evaluate other kappa compounds in our portfolio for consideration of further study.

        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 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.

        We have not generated any product sales revenues and have not achieved profitable operations. Our deficit accumulated during the development stage aggregated approximately $166.5 million through March 31, 2003, and we expect to continue to incur substantial losses in future periods. A significant portion of our revenue recognized since inception 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. 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.

Collaboration Agreement with Glaxo 

        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 $50.0 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 is expected to be recognized on a straight-line basis through April, 2014, the estimated 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. We recognized revenue of $1,041,669 in the first quarter of 2003 related thereto.

        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 certain rights 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, external expenses for research and development and marketing activities incurred by each company will be shared 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 external expenses. 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. Glaxo is primarily responsible for the completion of the OBD development program and will receive reimbursement from us at a defined percentage of external expenses. We recorded contract reimbursement revenue of $5,177,351 in the first quarter of 2003 under this arrangement. 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 we expect the costs of the POI development program to decrease. We 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.

Liquidity and Capital Resources

        We have experienced negative operating cash flows since our inception, and we have funded our operations primarily from the proceeds received from the sale of our common stock and our mandatorily redeemable convertible preferred stock, as well as, license, milestone and contract revenues. Cash, cash equivalents and short-term investments were $136,733,803 at March 31, 2003, and $153,984,609 at December 31, 2002, representing 87.7% and 91.5% 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 three months ended March 31, 2003 and 2002:

Net Cash Used in Operating Activities

        Net operating cash outflows for the first quarter of 2003 have resulted primarily from research and development expenditures associated with our product candidates, including clinical development and manufacturing costs for alvimopan, and from the compensation of our employees.

        Accounts receivable from collaboration agreements increased by $5,177,351 in the three months ended March 31, 2003, relating to our collaboration agreement with Glaxo. In April 2003, we received $7,502,379 from Glaxo. All amounts billed to Glaxo are subject to review and verification before payment by Glaxo.

Operating Cash Flow Requirements Outlook

        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 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.

        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.

Net Cash Provided By Investing Activities

        Cash provided by investing activities in the first quarter of 2003 relates primarily to maturities of investments. Our capital expenditures for the three months ended March 31, 2003 were $1,006,856 and were primarily for the purchase of furniture and fixtures and leasehold improvements in order to further expand our product research and development capabilities.

Investing Requirements Outlook 

        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.

Net Cash Provided By Financing Activities

Financing Requirements Outlook

        We do not expect to generate sales and positive cash flows from operations for at least the next several years, if ever. 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 $136.7 million as of March 31, 2003 will be sufficient to meet our currently estimated operating and investing requirements into mid 2005. Prior to exhausting our current cash reserves, 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 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 our common stock’s market price, as well as the exercise prices and expiration dates of the stock options.

Results of Operations

Three Months Ended March 31, 2003 and 2002

        Contract revenues.   Our contract revenues were $6,637,066 and $317,339 for the three months ended March 31, 2003 and 2002, respectively. Revenues recognized for the three months ended March 31, 2003 consisted of: (a) $5,177,351 for the reimbursement of expenses from Glaxo in connection with a collaboration agreement executed in April 2002; (b) $1,041,669 which represents the amortization of the $50,000,000 signing fee received from Glaxo, which is expected to be amortized into revenue on a straight-line basis through April 2014; and (c) $418,046 which was recorded as revenue primarily related to the termination of a license agreement we had with Santen Pharmaceutical Co., Ltd. Revenues recognized for the three months ended March 31, 2002 consisted of: (a) $200,000, relating to a patent agreement fee from Toray Industries, Inc.; (b) $6,579, which represents the amortization of the Santen license fee; and (c) $110,760, relating to Small Business Innovation Research (SBIR) grants awarded by the National Institutes of Health (NIH) in September 2001.

        In connection with the collaboration agreement with Glaxo for the development of products in the United States, we recorded for the three months ended March 31, 2003 as contract reimbursement revenue the reimbursement of external research and development and marketing expenses that we incurred. The allocation of the amounts between research and development and marketing expenses are as follows:

        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 decreased to approximately $15.1 million for the three months ended March 31, 2003 from approximately $17.1 million for the three months ended March 31, 2002. This decrease principally relates to a decrease in the costs of conducting clinical trials of approximately $4.2 million, offset by an increase in manufacturing development costs for alvimopan of approximately $1.8 million. Personnel costs increased by approximately $0.4 million in the three months ended March 31, 2003 compared to the same period in 2002.

        Marketing, general and administrative expenses.  Our marketing, general and administrative expenses decreased to approximately $3.6 million for the three months ended March 31, 2003 from approximately $4.1 million in the three months ended March 31, 2002. The decrease was primarily due to a decrease in corporate legal and patent fees.

        Net interest income (expense).  Our interest income decreased to approximately $0.8 million for the three months ended March 31, 2003 from approximately $1.3 million for the same period in 2002 due to a reduction in investments balances and lower interest rates in 2003. Our interest expense represents interest incurred on the financing of insurance premiums.

        Net loss.   Our net loss for the three months ended March 31, 2003 and 2002 was approximately $11.3 million and $19.6 million, respectively. The reduction in the net loss principally reflects an increase of revenue due to cost reimbursements from Glaxo and a decrease in costs of our clinical trials programs.

Net Loss Outlook 

        We have not generated any product sales revenues and have not achieved profitable operations. Our deficit accumulated during the development stage through March 31, 2003 aggregated approximately $166.5 million, and we expect to continue to incur substantial losses in future periods. 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.

        We expect contract reimbursement revenues from Glaxo to substantially decline in future periods as we expect the costs of the POI development program to decrease. We 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.

Certain Risks Related to Our Business

        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 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 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 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.

        In April 2003, we announced top-line results of our first Phase III clinical study (POI 14CL302) for alvimopan in the management of postoperative ileus. A statistically significant difference was achieved in the primary endpoint of the study, time to recovery of gastrointestinal function, in patients in the alvimopan 6 mg treatment group compared to patients in the placebo group (Cox proportional hazard model hazard ratio = 1.47; P<0.01). Time to recovery of gastrointestinal function was a composite measure of the time to recovery of both lower and upper gastrointestinal function as defined by time to first flatus or first bowel movement and time to tolerability of solid foods, whichever occurred last. A difference in favor of the alvimopan 6 mg treatment group versus placebo was observed for all secondary endpoints, including time to hospital discharge order written. A positive trend was observed in the primary endpoint of the study for the alvimopan 12 mg treatment group; however, the difference from placebo was not statistically significant (Cox proportional hazard model, hazard ratio = 1.23; P = 0.11).

        The results of study POI 14CL302 have not been submitted to or reviewed by the FDA or any other regulatory agency. The results from this study are not necessarily indicative of the results that may be obtained in the phase III studies of alvimopan in postoperative ileus which have not yet been completed and analyzed. While the Company believes the results of study POI 14CL302 support our goal of submitting a New Drug Application for alvimopan, there can be no assurance that the FDA will concur with that assessment. The difference from placebo was not statistically significant in the 12 mg treatment group, and there can be no assurance that this outcome will not occur again in our further clinical testing, or that the 6 mg treatment group will again achieve a statistically significant difference. There can also be no assurance that the outcome of study POI 14 CL302 or further studies will be considered clinically meaningful, and this determination is necessary for approval of alvimopan for commercial sale.

          Enrollment in study POI 14CL313 is expected to be completed in the second quarter of 2003 and this study is expected to enroll approximately 500 patients. Enrollment in study POI 14CL308 is expected to be completed in the second half of 2003 and enrollment in this study is now expected to exceed 500 patients. Enrollment in study POI 14CL306 is complete.

        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 any one or all of our 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 findings 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.

        The results of one or both of the dose comparisons in each study that includes multiple dose comparisons 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 significance level of P < 0.05, as was the case in Study POI 14CL302, 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.

        Clinical trials in our Phase III program use drug product incorporating active pharmaceutical ingredient manufactured by two different contract manufacturing facilities, one of which is no longer in business. Our efforts to obtain regulatory approval 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 current 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.

        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 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 prior to initiating the confirming clinical studies required to be successfully completed 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.

        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 over the remainder of 2003. 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:  

        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.

        We believe our existing cash, cash equivalents and short-term investments as of March 31, 2003 of approximately $136.7 million will be sufficient to meet our currently estimated operating and investing requirements into mid 2005. We have generated operating losses since we began operations in November 1994. We expect to continue to generate such losses and will need additional funds that may not be available in the future. We have no products that have generated any revenue, and as of March 31, 2003, we have incurred a cumulative net loss of approximately $166.5 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.

        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 obtaining 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, license rights to certain proprietary technologies and compounds from other entities, individuals and research institutions, for which we may be obligated to pay 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.

        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 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 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:  

        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 suitable alternatives may be unavailable. Consequently, our products may be subject to delays in manufacture if outside contractors give other products greater priority than our products. For this and other reasons, 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.

        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.

        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.

        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.

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

        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.

        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 program. 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.

        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 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.

        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 Application, or IND. 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.

        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 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 pharmaceutical products, including rights for specific pharmaceutical indications or in specified geographical regions. 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.

        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.

        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 from 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.

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

        Others have filed and in the future are likely to file patent applications covering products and technologies that are similar, identical or competitive to ours. 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. 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 fully 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.

        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.

        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 program for our products. Further, cost control initiatives could adversely affect our collaborators’ ability to commercialize our products, and our ability to realize royalties from such commercialization.

        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.

        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 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.

        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.

        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, the effect of which may be to make an acquisition of the company more difficult.

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

Recently Issued Accounting Pronouncements

        In December 2002, the Financial Accounting Standards Board (“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 Note 5.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        A substantial portion of our assets are investment grade debt instruments such as corporate securities and direct obligations of the U.S. Treasury. 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 March 31, 2003 was approximately $83.2 million and the weighted-average interest rate was approximately 2.48% with maturities from 1 to 12 months.

ITEM 4. CONTROLS AND PROCEDURES

        For the quarterly period ending March 31, 2003 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, Chief Operating Officer 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, Chief Operating Officer and Chief Financial Officer concluded that, as of March 31, 2003, 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, Chief Operating Officer and Chief Financial Officer determined, as of March 31, 2003, 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.

PART II. OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:

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

¹ Filed herewith.

(b)     We filed the following Current Reports on Form 8-K during the quarter ended March 31, 2003:

SIGNATURES

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

ADOLOR CORPORATION

CERTIFICATION

I, Bruce A. Peacock, certify that:

Date: May 14, 2003

/s/ Bruce A. Peacock
Bruce A. Peacock
President, Chief Executive Officer and Director

CERTIFICATION

I, Michael R. Dougherty, certify that:

Date: May 14, 2003

/s/ Michael R. Dougherty
Michael R. Dougherty
Senior Vice President, Chief Operating Officer and Chief Financial Officer