ADOLOR CORP - FORM 10-Q - October 28, 2010

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EX-32.2 - SECTION 906 CFO CERTIFICATION - ADOLOR CORP	dex322.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - ADOLOR CORP	dex321.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - ADOLOR CORP	dex311.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - ADOLOR CORP	dex312.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2010

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

For the transition period from to

Commission File Number: 000-30039

ADOLOR CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Delaware

31-1429198

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification Number)

700 Pennsylvania Drive

Exton, Pennsylvania 19341

(Address of Principal Executive Offices and Zip Code)

484-595-1500

(Registrant’s Telephone Number, Including Area Code)

Not Applicable

(Former Name, Former Address and Former Fiscal Year, If Changed Since Last 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. x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

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

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

Indicate the number of shares outstanding of each class of the registrant’s common stock, as of the latest practicable date


Class		Outstanding as of October 15, 2010
Common Stock, par value $0.0001 per share		46,388,647 shares

ADOLOR CORPORATION AND SUBSIDIARY

FORM 10-Q

September 30, 2010

INDEX


		Page No.
	CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS		ii

PART I.	FINANCIAL INFORMATION

ITEM 1.	Consolidated Financial Statements (unaudited):

	Consolidated Balance Sheets at September 30, 2010 and December 31, 2009		1

	Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009		2

	Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2010		3

	Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009		4

	Notes to Consolidated Financial Statements		5

ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		10

ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk		16

ITEM 4.	Controls and Procedures		16

PART II.	OTHER INFORMATION

ITEM 1.	Legal Proceedings		17

ITEM 1A.	Risk Factors		17

ITEM 6.	Exhibits		27

	Signatures		28

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

In addition to historical facts or statements of current condition, this report and the documents into which this report is and will be incorporated contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements contained in this report or incorporated herein by reference constitute our expectations or forecasts of future events as of the date this report was filed with the Securities and Exchange Commission and are not statements of historical fact. You can identify these statements by the fact that they do not relate strictly to historical or current facts. Such statements may include words such as “anticipate,” “will,” “estimate,” “expect,” “project,” “intend,” “should,” “plan,” “believe,” “hope” and other words and terms of similar meaning in connection with any discussion of, among other things, sales, future operating or financial performance, strategic initiatives and business strategies, regulatory or competitive environments, our intellectual property and product development. In particular, these forward-looking statements include, among others, statements about:

•

our dependence on sales of ENTEREG^® (alvimopan) in the United States and the commercial prospects and future marketing efforts for this product;

•

our dependence on our current collaboration partners and our ability to attract future partners to finance development and commercialization of our product candidates;

•

our anticipated progress in our research and development of potential pharmaceutical products, including our ongoing or planned clinical trials, the status, timing, costs and results of such trials, the ability to secure regulatory approval for our product candidates and the likelihood or timing of revenues from these products, if any;

•

the scope and duration of our intellectual property protection for our products and product candidates, our ability to adequately protect our technologies and enforce our intellectual property rights and the future expiration of patent and/or regulatory exclusivity on alvimopan;

•

our anticipated operating losses and cash requirements, projections regarding the levels of our cash, cash equivalents and investments and our ability to raise additional funds in light of our current and projected level of operations; and

•

other statements regarding matters that are not historical facts or statements of current condition.

Any or all of our forward-looking statements in this report and in the documents that we have referred you to may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Therefore, you should not place undue reliance on any such forward-looking statements. The factors that could cause actual results to differ from those expressed or implied by our forward-looking statements include, among others:

•

the acceptance of ENTEREG by hospital formularies and pharmacies, physicians and patients in the marketplace;

•

setbacks with respect to research programs, clinical trials or manufacturing or commercial activities;

•

the timing and unpredictability of regulatory actions;

•

our ability to develop and launch new products effectively;

•

unanticipated cash requirements to support current operations, to expand our business or for capital expenditures;

•

the inability to adequately protect our key intellectual property rights;

•

the loss of key management or scientific personnel;

•

the activities of our competitors;

•

regulatory, legal or other setbacks with respect to our operations or business;

•

market conditions in the capital markets and the biopharmaceutical industry that make raising capital or consummating acquisitions difficult, expensive or both; and

•

enactment of new government laws, regulations, court decisions, regulatory interpretations or other initiatives that are adverse to us or our interests.

We do not intend to update publicly any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. We discuss in more detail the risks that we anticipate in Part II, Item 1A of this report. This discussion is permitted by the Private Securities Litigation Reform Act of 1995.

iii

ADOLOR CORPORATION AND SUBSIDIARY

Consolidated Balance Sheets

(Unaudited)


	September 30, 2010			December 31, 2009
Assets
Current assets:
Cash and cash equivalents	$	6,611,796		$	7,213,666
Short-term investments		46,979,700			75,992,310
Accounts receivable		3,004,602			3,816,205
Inventory		1,040,964			1,006,809
Prepaid expenses and other current assets		944,631			2,462,668

Total current assets		58,581,693			90,491,658
Equipment and leasehold improvements, net		558,714			860,776
Other assets		107,000			107,000

Total assets	$	59,247,407		$	91,459,434

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	580,495		$	1,742,362
Accrued expenses		9,135,691			8,421,570
Deferred revenue and rent – current		6,818,856			13,338,404

Total current liabilities		16,535,042			23,502,336
Deferred revenue and rent – non-current		20,418,970			23,903,425

Total liabilities		36,954,012			47,405,761

Commitments and contingencies

Stockholders’ equity:
Series A Junior Participating preferred stock, $0.01 par value; 35,000 shares authorized; none issued and outstanding		—			—
Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued and outstanding		—			—
Common stock, $0.0001 par value; 99,000,000 shares authorized; 46,400,336 and 46,333,735 shares issued; 46,388,647 and 46,333,735 outstanding at September 30, 2010 and December 31, 2009, respectively		4,639			4,633
Additional paid-in capital		549,210,531			546,995,528
Treasury stock, at cost, 11,689 shares at September 30, 2010		(17,931	)		—
Unrealized gains on available for sale securities		15,653			34,569
Accumulated deficit		(526,919,497	)		(502,981,057	)

Total stockholders’ equity		22,293,395			44,053,673

Total liabilities and stockholders’ equity	$	59,247,407		$	91,459,434

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

ADOLOR CORPORATION AND SUBSIDIARY

Consolidated Statements of Operations

(Unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Revenues:
Product sales, net	$	6,528,496		$	3,343,947		$	18,077,998		$	7,158,679
Contract revenues		4,145,113			5,318,994			14,209,991			17,247,860

Total revenues, net		10,673,609			8,662,941			32,287,989			24,406,539

Operating expenses incurred:
Cost of product sales		730,337			320,711			1,997,572			704,273
Research and development		6,425,667			11,105,662			26,539,299			35,400,476
Selling, general and administrative		7,750,777			8,673,482			25,980,032			26,056,422
Restructuring charge		1,918,701			(148,000	)		1,918,701			4,058,521

Total operating expenses		16,825,482			19,951,855			56,435,604			66,219,692

Loss from operations		(6,151,873	)		(11,288,914	)		(24,147,615	)		(41,813,153	)
Interest income		38,505			159,842			157,658			954,894
Other income		51,517			—			51,517			—

Net loss	$	(6,061,851	)	$	(11,129,072	)	$	(23,938,440	)	$	(40,858,259	)

Basic and diluted net loss per share	$	(0.13	)	$	(0.24	)	$	(0.52	)	$	(0.88	)

Shares used in computing basic and diluted net loss per share		46,351,148			46,296,235			46,332,662			46,296,235

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

ADOLOR CORPORATION AND SUBSIDIARY

Consolidated Statement of Stockholders’ Equity

(Unaudited)


	Common stock							Treasury stock					Unrealized gains			Accumulated deficit			Total stockholders’ equity
	Number of shares		Amount		Additional paid-in capital			Number of shares		Amount			on available for sale securities			Accumulated deficit			Total stockholders’ equity
Balance, January 1, 2010		46,333,735	$	4,633	$	546,995,528			—	$	—		$	34,569		$	(502,981,057	)	$	44,053,673
Vesting of deferred stock		54,912		6		(6	)		—		—			—			—			—
Stock-based compensation expense		—		—		2,215,009			—		—			—			—			2,215,009
Treasury stock acquired		—		—		—			11,689		(17,931	)		—			—			(17,931	)
Unrealized losses on available for sale securities, net		—		—		—			—		—			(18,916	)		—			(18,916	)
Net loss		—		—		—			—		—			—			(23,938,440	)		(23,938,440	)

Balance, September 30, 2010		46,388,647	$	4,639	$	549,210,531			11,689	$	(17,931	)	$	15,653		$	(526,919,497	)	$	22,293,395

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

ADOLOR CORPORATION AND SUBSIDIARY

Consolidated Statements of Cash Flows

(Unaudited)


	Nine Months Ended September 30,
	2010			2009
Net cash flows from operating activities:
Net loss	$	(23,938,440	)	$	(40,858,259	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock-based compensation expense		2,219,460			3,070,410
Amortization of premiums and discounts on short-term investments		(79,493	)		796,156
Amortization of deferred revenue and rent		(10,003,803	)		(10,127,519	)
Depreciation and amortization expense		276,125			1,039,135
Non-cash restructuring charge		—			1,876,479
Acquired in-process research and development		—			2,000,000
Changes in assets and liabilities:
Accounts receivable		811,603			1,742,300
Inventory		(38,806	)		(1,031,153	)
Prepaid expenses and other current assets		1,518,037			307,878
Other assets		—			(1,588	)
Accounts payable		(1,161,867	)		(1,343,080	)
Accrued expenses		714,121			(859,225	)
Customer deposits		—			915,157
Deferred revenue		—			8,425,000

Net cash used in operating activities		(29,683,063	)		(34,048,309	)

Net cash flows from investing activities:
Purchases of equipment and leasehold improvements		(37,521	)		(500,333	)
Proceeds from disposal of equipment		63,458			458,700
Purchase of in-process research and development		—			(2,000,000	)
Purchases of short-term investments		(38,926,813	)		(79,656,866	)
Maturities of short-term investments		68,000,000			112,000,000

Net cash provided by investing activities		29,099,124			30,301,501

Net cash flows from financing activities:
Payment of withholding taxes related to deferred stock		(17,931	)		—

Net cash used in financing activities		(17,931	)		—

Net decrease in cash and cash equivalents		(601,870	)		(3,746,808	)
Cash and cash equivalents at beginning of period		7,213,666			7,535,146

Cash and cash equivalents at end of period	$	6,611,796		$	3,788,338

Supplemental disclosure of cash flow information:
Unrealized losses on available for sale securities, net	$	(18,916	)	$	(585,913	)
Change in accrued expenses related to purchases of equipment		—			(179,663	)
Deposit received for sale of equipment		—			423,879

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

ADOLOR CORPORATION AND SUBSIDIARY

Notes to Consolidated Financial Statements

September 30, 2010

(Unaudited)

1.	ORGANIZATION AND BUSINESS ACTIVITIES

Adolor Corporation (the Company) is a biopharmaceutical company focused on the discovery, development and commercialization of novel prescription pain and pain-related products. In May 2008, the U.S. Food and Drug Administration (FDA) approved the Company’s first product, ENTEREG^® (alvimopan). ENTEREG is indicated to accelerate upper and lower gastrointestinal (GI) recovery following partial large or small bowel resection surgery with primary anastomosis. Delayed GI recovery causes significant complications for patients and results in increased expense to hospitals and healthcare providers. In June 2008, the Company launched ENTEREG in the United States in collaboration with Glaxo Group Limited (Glaxo).

The Company also has a number of product candidates in various stages of clinical and preclinical development. The Company is conducting a Phase 2 clinical trial of ADL5945 to treat opioid-induced constipation (OIC), a condition that often results from chronic use of opioid analgesics to treat persistent pain conditions. In addition, the Company is continuing development efforts on ADL7445, a second opioid antagonist compound. The Company also is collaborating with Pfizer Inc. (Pfizer) in the development of two delta opioid receptor agonist compounds, ADL5859 and ADL5747 (Pfizer compounds PF-04856880 and PF-04856881, respectively), for the treatment of pain. The Company has several earlier-stage product candidates under development for the management of pain and other central nervous system conditions.

Interim Financial Information

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. These consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission (SEC), which includes audited financial statements as of December 31, 2009 and 2008 and for each of the years in the three-year period ended December 31, 2009. The results of the Company’s operations for any interim period are not necessarily indicative of the results of operations for any other interim period or full year.

Basis of Presentation and Consolidation

The accompanying consolidated financial statements include the accounts of Adolor and its wholly-owned subsidiary. All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of assets and liabilities. The estimates made are principally in the areas of revenue recognition, research and development accruals and stock option expenses. Management bases its estimates on historical experience and various assumptions that are believed to be reasonable under the circumstances. Actual results may differ from those estimates.

Product Sales Recognition

Hospital orders for ENTEREG are processed through wholesalers; however, ENTEREG is drop-shipped by Glaxo directly to an ordering hospital registered under the ENTEREG Access Support and Education (E.A.S.E.®) Program. Wholesalers remit payment to Glaxo and, on a monthly basis, Glaxo remits the net proceeds to the Company. The Company recognizes revenue from product sales when the following four revenue recognition criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable and collectability is reasonably assured.

Prior to the fourth quarter of 2009, the Company deferred recognition of revenue associated with the first shipment of ENTEREG to each hospital customer as it was not able to reasonably estimate future returns. When an existing customer placed a new order, the Company recognized product sales on the previous shipment for an

amount equal to the lesser of (a) the previous shipment or (b) the new order. During the fourth quarter of 2009, the Company began to recognize net product sales upon the shipment of product to the registered hospital, as it had developed sufficient historical experience to reasonably estimate future returns of ENTEREG.

The Company records product sales net of prompt payment discounts, returns and other discounts as reported to it by Glaxo. Calculating these allowances requires significant estimates and judgments and while the Company undertakes certain procedures to review the reasonableness of the information, it cannot obtain absolute assurance over the accuracy of such information provided by Glaxo.

2.	RECENT ACCOUNTING PRONOUNCEMENTS

In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements (ASU 2010-06), which amends the existing fair value measurement and disclosure guidance currently included in Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures, to require additional disclosures regarding fair value measurements. Specifically, ASU 2010-06 requires entities to disclose the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers, the reasons for any transfer in or out of Level 3 and information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis. In addition, ASU 2010-06 also clarifies the requirement for entities to disclose information about both the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for additional disclosures related to Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010. The adoption of ASU 2010-06 did not impact the Company’s consolidated financial statements or results of operations.

In September 2009, the FASB issued ASU 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (ASU 2009-13), which requires companies to allocate revenue in arrangements involving multiple deliverables based on the estimated selling price of each deliverable when such deliverables are not sold separately either by the company or other vendors. ASU 2009-13 eliminates the requirement that all undelivered elements must have objective and reliable evidence of fair value before a company can recognize the portion of the overall arrangement fee that is attributable to items that already have been delivered. As a result, the new guidance may allow some companies to recognize revenue on transactions that involve multiple deliverables earlier than under current requirements. ASU 2009-13 is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted at the beginning of a company’s fiscal year. The Company expects to adopt ASU 2009-13 on January 1, 2011 and does not expect ASU 2009-13 to have a material impact on its consolidated financial statements.

3.	COMPREHENSIVE LOSS

The following is the reconciliation of net loss to comprehensive loss for the three and nine months ended September 30, 2010 and 2009:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Net loss	$	(6,061,851	)	$	(11,129,072	)	$	(23,938,440	)	$	(40,858,259	)
Unrealized losses on available for sale securities, net		(6,163	)		(3,815	)		(18,916	)		(585,913	)

Comprehensive loss	$	(6,068,014	)	$	(11,132,887	)	$	(23,957,356	)	$	(41,444,172	)

4.	SHORT-TERM INVESTMENTS

Short-term investments consist of investment grade, fixed income securities with original maturities of greater than three months. All investments are classified as available for sale and are considered current assets as the contractual maturities of the Company’s short-term investments are all less than one year.

The following summarizes the short-term investments at September 30, 2010 and December 31, 2009:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U.S. Government obligations at September 30, 2010	$	46,964,047	$	17,498	$	(1,845	)	$	46,979,700

U.S. Government obligations at December 31, 2009	$	75,957,741	$	40,944	$	(6,375	)	$	75,992,310

ASC 820, Fair Value Measurements and Disclosures, establishes a valuation hierarchy for disclosure of the inputs to valuations techniques used to measure fair value. This hierarchy prioritizes the inputs into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs include quoted prices for identical or similar assets and liabilities that are not active, quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on management’s own assumptions used to measure assets and liabilities at fair value. The classification of a financial asset or liability within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

The following table provides the Company’s assets and liabilities carried at fair value measured on a recurring basis as of September 30, 2010 and December 31, 2009:


			Fair Value Measurements Using
	Total Carrying Value		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Government obligations at September 30, 2010	$	46,979,700	$	46,979,700	$	—	$	—

U.S. Government obligations at December 31, 2009	$	75,992,310	$	75,992,310	$	—	$	—

5.	INVENTORY

As of September 30, 2010 and December 31, 2009, inventory consisted of the following:


	September 30, 2010		December 31, 2009
Raw materials	$	67,648	$	—
Work-in-process		156,931		527,036
Finished goods		816,385		479,773

Total inventory	$	1,040,964	$	1,006,809

Inventories are stated at the lower of cost or market, as determined on a first-in, first-out, or FIFO, basis. The above inventory was manufactured subsequent to the approval of ENTEREG by the FDA. Costs associated with the manufacture of alvimopan prior to the FDA approval of ENTEREG were expensed to research and development when incurred. As a result, at September 30, 2010 and December 31, 2009, the Company has inventory related to alvimopan, including raw material, which carries a zero-cost and is not reflected on the consolidated balance sheets at September 30, 2010 and December 31, 2009.

6.	STOCKHOLDERS’ EQUITY

During the nine months ended September 30, 2010, the Company granted options to purchase 207,400 shares of common stock to employees and non-employee directors. The employee stock options vest annually over a four-year period beginning from the date of grant and the non-employee director stock options vest in full on the first anniversary of the date of grant. All stock options were granted with an exercise price equal to the fair market value of the Company’s common stock on the date of grant. The average exercise price of options granted during the nine months ended September 30, 2010 was $1.63. The grant-date fair value of the options granted during the nine months ended September 30, 2010 was $0.2 million and such amount will be recognized over the vesting period.

During the nine months ended September 30, 2010, the Company granted 1,434,827 deferred stock awards to employees and non-employee directors. Of these awards, 277,500 shares were granted to the Company’s officers and vest upon the achievement of certain product sales and development targets within a specified period of time. The Company will begin recognizing compensation expense for these performance shares if and when it is probable the performance condition will be achieved. The remaining awards consisted of 1,120,350 employee deferred stock awards that vest in full in September 2012 and 36,977 non-employee director deferred stock awards that vest in full in May 2011. These deferred stock awards will be expensed over the applicable vesting period. The fair value of all deferred stock awards granted during the nine months ended September 30, 2010 was $1.6 million. During the nine months ended September 30, 2010, 66,601 deferred stock awards vested under the terms of employee and non-employee director grant agreements. In connection with the vesting of these restricted stock awards, 54,912 shares of the Company’s common stock were issued to employees and non-employee directors and 11,689 shares were surrendered to the Company in satisfaction of minimum tax withholding obligations. The surrendered shares were recorded as treasury stock on the Company’s consolidated balance sheet.

For the nine months ended September 30, 2010, compensation expense recognized related to outstanding stock options as well as deferred and restricted stock awards was $2.2 million.

7.	CONTRACT REVENUES

Contract revenues consist of the following:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Amortization of deferred revenue	$	3,291,670	$	3,291,669	$	9,875,008	$	9,998,725
Cost reimbursement under collaboration agreements		853,443		2,027,325		4,334,983		6,301,215
Other		—		—		—		947,920

Total contract revenues	$	4,145,113	$	5,318,994	$	14,209,991	$	17,247,860

In April 2002, the Company entered into a collaboration agreement with Glaxo for the exclusive worldwide development and commercialization of ENTEREG for certain indications. Under the terms of the agreement, Glaxo paid the Company a non-refundable and non-creditable signing fee of $50.0 million. The $50.0 million signing fee was recorded as deferred revenue and is being recognized as revenue on a straight-line basis over the estimated performance period under the collaboration agreement, which extends to March 2016. Revenue related to the Glaxo collaboration agreement of $0.8 million was recognized in each of the three months ended September 30, 2010 and 2009 and $2.5 million was recognized in each of the nine months ended September 30, 2010 and 2009.

During the first quarter of 2009, the Company and Glaxo entered into Amendment No. 4 to the collaboration agreement, under which Glaxo paid the Company $8.4 million. The $8.4 million was recorded as deferred revenue and is being recognized as revenue on a straight-line basis over the estimated remaining performance period under the collaboration agreement. Revenue related thereto of $0.3 million was recognized in each of the three months ended September 30, 2010 and 2009 and $0.9 million and $0.7 million was recognized in the nine months ended September 30, 2010 and 2009, respectively. Under the terms of Amendment No. 4, the Company also received a $0.9 million payment from Glaxo in 2009 that it recognized as revenue during the nine months ended September 30, 2009.

External expenses for research and development and certain marketing activities incurred in the United States by each party are reimbursed pursuant to contractually agreed percentages. Reimbursement amounts owed to the Company by Glaxo are recorded gross in the statements of operations as contract revenues. The Company recorded collaboration agreement cost reimbursements from Glaxo of $0.7 million and $0.8 million for the three months ended September 30, 2010 and 2009, respectively, and $1.2 million and $3.5 million for the nine months ended September 30, 2010 and 2009, respectively. As of September 30, 2010, $0.7 million was receivable from Glaxo for reimbursement of expenses incurred by the Company pursuant to the collaboration agreement.

In December 2007, the Company entered into a collaboration agreement with Pfizer for the exclusive worldwide development and commercialization of ADL5859 and ADL5747. Under the terms of the agreement, Pfizer paid the Company an up-front payment of $30.0 million and reimbursed $1.9 million of Phase 2a development costs incurred by the Company prior to entering into the collaboration agreement. The $31.9 million up-front fee was recorded as deferred revenue and is being recognized as revenue on a straight-line basis over the estimated performance period under the collaboration agreement. During the first quarter of 2009, the performance period was extended by four months to December 2010 based on the status of the development programs. The Company recorded revenue related to the deferred license fees under the collaboration agreement with Pfizer of $2.2 million for each of the three months ended September 30, 2010 and 2009 and $6.5 million and $6.8 million for the nine months ended September 30, 2010 and 2009, respectively.

External expenses for research and development and certain marketing activities incurred in the United States by each party are reimbursed pursuant to contractually agreed percentages. Reimbursement amounts owed to the Company by Pfizer are recorded gross on the statements of operations as contract revenues. The Company recorded collaboration cost reimbursement from Pfizer of $0.1 million and $1.2 million for the three months ended September 30, 2010 and 2009, respectively, and $3.1 million and $2.9 million for the nine months ended September 30, 2010 and 2009, respectively. As of September 30, 2010, $0.1 million was receivable from Pfizer for reimbursement of expenses incurred by the Company pursuant to the collaboration agreement.

8.	RESTRUCTURING

On July 15, 2010, the Company announced a restructuring plan to reduce costs and realign its workforce and operations based on its current business objectives. The restructuring resulted in the reduction of 30 positions, or approximately 27% of the Company’s workforce, as well as other cost saving initiatives. Terminated employees were provided with severance payments, continued benefits for a specified period of time and outplacement assistance. The Company recorded a restructuring charge of $1.9 million for the three and nine months ended September 30, 2010, which consisted of employee severance and benefits-related costs. The Company has completed all restructuring activities and recognized all anticipated restructuring charges as of September 30, 2010 in connection with this restructuring plan. The following table summarizes activity related to the Company’s restructuring:


	Employee Termination Costs
Balance at January 1, 2010	$	—
Restructuring charge		1,918,701
Cash payments		(1,733,854	)

Balance at September 30, 2010	$	184,847

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to provide information to assist you in better understanding and evaluating our financial condition and results of operations. We encourage you to read this MD&A in conjunction with our consolidated financial statements, included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

EXECUTIVE SUMMARY

We are a biopharmaceutical company focused on the discovery, development and commercialization of novel prescription pain and pain-related products. In May 2008, the U.S. Food and Drug Administration (FDA) approved our first product, ENTEREG^® (alvimopan). ENTEREG is specifically indicated to accelerate the time to upper and lower gastrointestinal (GI) recovery following partial large or small bowel resection surgery with primary anastomosis. Delayed GI recovery causes significant complications for patients and results in increased expense to hospitals and healthcare providers. We also have a number of product candidates in various stages of clinical and preclinical development.

For the nine months ended September 30, 2010, our total revenues and net loss were $32.3 million and $23.9 million, respectively. Net sales of ENTEREG for the three and nine months ended September 30, 2010 were $6.5 million and $18.1 million, respectively. We will need net sales of ENTEREG to increase significantly beyond current levels before we will be able to achieve profitability and positive cash flow from operations. Ultimately, we may never generate sufficient revenues from ENTEREG for us to reach profitability, generate positive cash flow or sustain, on an ongoing basis, our current or projected levels of operations.

On July 15, 2010, we announced a restructuring plan to reduce costs and realign our workforce and operations based on our current business objectives. We recorded a restructuring charge of $1.9 million for the three months ended September 30, 2010, which consisted of employee severance and benefits-related costs.

ENTEREG

Together with our partner, Glaxo Group Limited (Glaxo), we launched ENTEREG in the United States in mid-2008. ENTEREG is detailed primarily by Glaxo’s national hospital-based sales organization. In certain hospitals, we co-promote ENTEREG with a field force that numbers approximately 25 persons. ENTEREG was approved by the FDA subject to a Risk Evaluation and Mitigation Strategy under which the product is available only to hospitals that perform bowel resections and are enrolled in the ENTEREG Access Support and Education (E.A.S.E.®) Program.

Under our agreement with Glaxo, we have a profit-sharing arrangement under which we are allocated 45% of profits and losses, as defined, and Glaxo is allocated 55% of profits and losses. Profits and losses are calculated as net sales of ENTEREG less certain agreed-upon costs and are subject to certain adjustments. Beginning in mid-2011, the parties will share such profits and losses equally.

As required by our FDA approval letter for ENTEREG, we began a Phase 4 clinical trial in 2009 intended to evaluate the safety and efficacy of ENTEREG in patients undergoing radical cystectomy for bladder cancer.

Opioid-induced Constipation Program

Opioid receptors in the GI tract, or peripheral opioid receptors, regulate functions such as motility, water secretion and absorption. Stimulation of these GI mu opioid receptors by morphine, or other opioid analgesics, can slow gut motility and disrupt the normal GI function that allows for the passage, absorption and excretion of ingested solid materials resulting in a number of symptoms, including severe constipation. In patients who take opioid analgesics to treat chronic and persistent pain, this condition is known as opioid-induced constipation (OIC).

We are developing two molecules, ADL5945 and ADL7445, to treat OIC. These compounds are small molecule, mu opioid receptor antagonists intended to block the adverse effects of opioid analgesics on the GI tract without affecting analgesia. We licensed ADL5945 from Eli Lilly and Company (Lilly) in September 2009 and initiated clinical testing of this compound in February 2010. During the third quarter of 2010, we completed Phase 1

testing of both ADL5945 and ADL7445. The studies involved a single-ascending dose study in healthy volunteers followed by a multiple-ascending dose study in OIC patients with chronic non-cancer pain. Both compounds were well-tolerated in the studies and, in the patients with OIC, produced increases in weekly average spontaneous bowel movements compared to placebo.

In October 2010, we initiated a Phase 2 study of ADL5945 in patients suffering from OIC. The Phase 2 trial will evaluate two doses of ADL5945 (0.10mg and 0.25mg given twice daily) versus placebo in patients with OIC over a four week period. Approximately 120 patients will be enrolled. The primary endpoint of the study will be change from baseline in the weekly average of spontaneous bowel movements during treatment. Limited development efforts also continue on ADL7445.

Delta Opioid Receptor Agonists

We are collaborating with Pfizer Inc. (Pfizer) for the development and commercialization of the delta opioid receptor agonist compounds ADL5859 and ADL5747 (Pfizer compounds PF-04856880 and PF-04856881, respectively) for the treatment of pain. The delta receptor is one of three opioid receptors that are believed to modulate pain. Currently, all marketed opioid drugs interact primarily with only one such receptor, the mu receptor. We have identified a series of novel, orally-active delta agonists that selectively stimulate the delta opioid receptor. Our goal is to develop medications that produce pain relief similar to traditional mu opioids, while reducing or eliminating some typical side effects seen with currently available mu opioids, including dependence, sedation and respiratory depression.

During June 2010, we completed a Phase 2a clinical trial of ADL5859 and ADL5747 in patients with osteoarthritis (OA). The trial was a randomized, double-blind, placebo-controlled, multi-center trial designed to evaluate the safety, tolerability and clinical activity of ADL5859 and ADL5747 in patients with OA of the knee. The study enrolled over 400 patients. Top-line results of the study showed a high placebo response, with neither oxycodone CR nor ADL5859 nor ADL5747 demonstrating a statistically-significant improvement over placebo. Both ADL5859 and ADL5747 were well tolerated when given at 150 milligrams twice daily. Pfizer and we currently are further evaluating the results of the trial.

In January 2010, Pfizer and we initiated a Phase 2a proof-of-concept study of ADL5747 in post-herpetic neuralgia (PHN) patients. Results for this study are anticipated in early-2011.

LIQUIDITY AND CAPITAL RESOURCES

Cash, cash equivalents and short-term investments were $53.6 million at September 30, 2010 and $83.2 million at December 31, 2009, representing 90% and 91% of our total assets, respectively. We invest excess cash in U.S. Treasury obligations. Our working capital, which is calculated as current assets less current liabilities, was $42.0 million at September 30, 2010 compared to $67.0 million at December 31, 2009. The decrease in cash, cash equivalents, short-term investments and working capital was primarily from the use of cash to fund our operations during the nine months ended September 30, 2010.

The following is a summary of selected cash flow information for the nine months ended September 30, 2010 and 2009:


	Nine Months Ended September 30,
	2010			2009
Net loss	$	(23,938,440	)	$	(40,858,259	)
Adjustments for non-cash operating items		(7,587,711	)		(1,345,339	)

		(31,526,151	)		(42,203,598	)
Net change in assets and liabilities		1,843,088			8,155,289

Net cash used in operating activities	$	(29,683,063	)	$	(34,048,309	)

Net cash provided by investing activities	$	29,099,124		$	30,301,501

Net cash used in financing activities	$	(17,931	)	$	—

Net Cash Used in Operating Activities

Net operating cash outflows of $29.7 million and $34.0 million for the nine months ended September 30, 2010 and 2009, respectively, resulted primarily from research and development expenditures associated with our product candidates and selling, general and administrative expenses. For the nine months ended September 30,

2009, we also received $9.3 million related to the acceleration of payments owed by Glaxo to us under the terms of Amendment No. 4 of the Glaxo collaboration agreement.

Net Cash Provided by Investing Activities

Net cash provided by investing activities relates to purchases and maturities of investment securities, expenditures for property and equipment and proceeds from the sale of equipment. Capital expenditures are primarily for the purchase of laboratory equipment, furniture and fixtures, office equipment and leasehold improvements associated with our leased facility.

Net cash provided by investing activities was $29.1 million for the nine months ended September 30, 2010 as compared to $30.3 million for the nine months ended September 30, 2009. The decrease in cash provided by investing activities for the nine months ended September 30, 2010 as compared to the prior year period is primarily attributable to a decrease of $3.3 million in the net maturities of available-for-sale securities, offset partially by $2.0 million of payments made during the nine months ended September 30, 2009 related to the purchase of in-process research and development.

We expect to fund a significant portion of our future operations through the sale or maturities of investments in our portfolio, which consists of U.S. Treasury obligations.

Outlook

We expect to use our cash, cash equivalents and short-term investments to fund our operations. Since inception, we have experienced significant operating losses and negative operating cash flow and have funded our operations primarily from the proceeds received from the sale of our equity securities and amounts received under collaboration agreements. Our accumulated deficit at September 30, 2010 was $526.9 million and we expect to continue to incur substantial losses for at least the next several years.

We may never generate significant product sales, achieve profitable operations or generate positive cash flows from operations and, even if profitable operations are achieved, they may not be sustained on a continuing basis or sufficient to support our current or projected levels of investment in our research and development programs and our other operations. At this time, we cannot accurately assess a number of factors that will influence the levels of future product sales, such as the degree of market acceptance, patent protection and exclusivity of ENTEREG, the impact of competition, the effectiveness of our sales and marketing efforts and the outcome of our current efforts to develop, receive approval for and successfully launch other product candidates. However, at current expenditure levels, we will need ENTEREG sales to increase significantly beyond current levels before we will be able to achieve profitability and positive cash flows from operations.

We expect to continue to incur significant levels of research and development expenditures related to our clinical product candidates. During the remainder of 2010, we will be funding a number of clinical programs including, among others, our ongoing Phase 4 study of ENTEREG in patients undergoing radical cystectomy, the Phase 2 study of ADL5945 in OIC and the completion of the Phase 2a clinical trial of ADL5747 in PHN. We also expect to continue to conduct research, preclinical studies and process development activities on our other product candidates, although as a result of our restructurings in 2009 and 2010, the level of such expenditures will be significantly reduced compared to previous years. Should these programs advance to later stages of development, it is likely that expenses related to these efforts will increase over time.

We believe that our existing cash, cash equivalents and short-term investments are adequate to fund our operations through 2012 based upon the level of research and development and marketing and administrative activities we believe will be necessary to achieve our strategic objectives. We anticipate that we will need to obtain funding to support our operational needs in the future, and we cannot be certain that funding will be available on terms acceptable to us, or at all.

RESULTS OF OPERATIONS

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

Revenues

The following table sets forth revenues for the three and nine months ended September 30, 2010 and 2009:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Product sales, net	$	6,528,496	$	3,343,947	$	18,077,998	$	7,158,679
Contract revenues		4,145,113		5,318,994		14,209,991		17,247,860

Total revenues, net	$	10,673,609	$	8,662,941	$	32,287,989	$	24,406,539

Product Sales, net

Net product sales are derived solely from ENTEREG. ENTEREG was approved by the FDA in May 2008 and product shipments to hospitals began in June 2008. For a discussion of our revenue recognition policy, see Note 1, “ORGANIZATION AND BUSINESS ACTIVITIES – Product Sales Recognition,” in Part 1, Item 1 of this report.

Net sales of ENTEREG were $6.5 million and $3.3 million for the three months ended September 30, 2010 and 2009, respectively, and $18.1 million and $7.2 million for the nine months ended September 30, 2010 and 2009, respectively. The increase in net product sales during the three and nine months ended September 30, 2010 as compared to the prior year periods was driven primarily by an increase in the number of hospitals ordering ENTEREG and increased penetration within existing hospital customers. In addition, net product sales for the three and nine months ended September 30, 2010 were recognized at the time of shipment as compared to net product sales for the three and nine months ended September 30, 2009, which were recognized on a reorder basis under our previous revenue recognition policy. Net shipments of ENTEREG for the three and nine months ended September 30, 2009 were $4.0 million and $8.9 million, respectively.

Contract Revenues

Contract revenues are derived from our collaboration agreements with Glaxo and Pfizer and include milestone payments, cost reimbursement, amortization of up-front license fees and other revenue. Contract revenues were $4.1 million and $5.3 million in the three months ended September 30, 2010 and 2009, respectively, and $14.2 million and $17.2 million in the nine months ended September 30, 2010 and 2009, respectively. Contract revenues decreased for the three months ended September 30, 2010 compared to the same period in 2009 due primarily to decreased cost reimbursement under the Pfizer collaboration resulting from lower levels of clinical activity for ADL5859 and ADL5747 during the third quarter of 2010. Contract revenues decreased for the nine months ended September 30, 2010 compared to the same period in 2009 due primarily to lower Glaxo contract revenues as a result of reduced reimbursements under the collaboration agreement. In addition, we received a $0.9 million payment from Glaxo in the second quarter of 2009 under the terms of Amendment No. 4, which was recognized as revenue during the nine months ended September 30, 2009.

Operating Expenses

The following table sets forth operating expenses for the three and nine months ended September 30, 2010 and 2009:


	Three Months Ended September 30,					Nine Months Ended September 30,
	2010		2009			2010		2009
Cost of product sales	$	730,337	$	320,711		$	1,997,572	$	704,273
Research and development		6,425,667		11,105,662			26,539,299		35,400,476
Selling, general and administrative		7,750,777		8,673,482			25,980,032		26,056,422
Restructuring charge		1,918,701		(148,000	)		1,918,701		4,058,521

Total operating expenses	$	16,825,482	$	19,951,855		$	56,435,604	$	66,219,692

Cost of Product Sales

Cost of product sales was $0.7 million and $0.3 million for the three months ended September 30, 2010 and 2009, respectively, and $2.0 million and $0.7 million for the nine months ended September 30, 2010 and 2009, respectively, and consisted of royalty payments under certain alvimopan license agreements, FDA fees and manufacturing costs. The increases seen in 2010 compared to the same periods in 2009 were due to increased sales of ENTEREG. Cost of product sales as a percentage of net product sales were consistent during the three and nine months ended September 30, 2010 compared to the same periods in 2009.

Costs associated with the manufacture of alvimopan prior to FDA approval of ENTEREG in May 2008 were expensed to research and development. As a result, at September 30, 2010, we have inventory related to alvimopan that carries a zero-cost and is not reflected on the September 30, 2010 consolidated balance sheet. To the extent that this inventory is sold, our cost of product sales will not reflect all costs associated with such product manufacture, and our gross margins will be favorably impacted. We currently are unable to estimate the timing of the impact to future profitability resulting from the sell-through of any inventory manufactured after FDA approval of ENTEREG.

Research and Development Expenses

Our research and development expenses can be identified as external or internal expenses. External expenses include expenses incurred with clinical research organizations, contract manufacturers and other third-party vendors. Internal expenses include expenses such as personnel, laboratory and corresponding overhead expenses.

Research and development expenses were $6.4 million and $11.1 million for the three months ended September 30, 2010 and 2009, respectively, and $26.5 million and $35.4 million for the nine months ended September 30, 2010 and 2009, respectively, and consisted of the following:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
External research and development expenses:
ENTEREG	$	1,723,999	$	982,420	$	2,869,123	$	3,410,573
Delta agonist program		265,864		2,085,950		5,547,356		4,763,755
OIC program		1,605,774		3,117,978		5,733,777		6,075,127
Other programs		744,479		1,109,211		1,885,184		4,175,217

Total external research and development expenses		4,340,116		7,295,559		16,035,440		18,424,672
Total internal research and development expenses		2,085,551		3,810,103		10,503,859		16,975,804

Total research and development expenses	$	6,425,667	$	11,105,662	$	26,539,299	$	35,400,476

We report all expenses gross within our statements of operations and, as such, the above table and the research and development line item on our statements of operations do not reflect any cost reimbursements from our collaboration partners.

Total research and development expenses decreased for the three months ended September 30, 2010 as compared to the three months ended September 30, 2009 primarily due to lower expenses in our delta program resulting from lower levels of clinical activity for ADL5859 and ADL5747 during the third quarter of 2010 as well as reductions in expenses associated with our restructurings in June 2009 and July 2010. In addition, OIC program costs were lower period-over-period because of the $2.0 million of expense incurred during the third quarter of 2009 related to our purchase of the rights to ADL5945 from Lilly. These decreases were partially offset by higher costs for our ENTEREG Phase 4 cystectomy study during the three months ended September 30, 2010. Total research and development expenses decreased for the nine months ended September 30, 2010 as compared to the same period in 2009 primarily due to reductions in expenses associated with our restructurings in June 2009 and July 2010 and lower expenses in other programs.

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

Selling, General and Administrative Expenses

Our selling, general and administrative expenses were $7.8 million and $8.7 million for the three months ended September 30, 2010 and 2009, respectively, and $26.0 million and $26.1 million for the nine months ended September 30, 2010 and 2009, respectively. The decrease in the three and nine months ended September 30, 2010

compared to the same periods in 2009 was primarily driven by lower general and administrative expenses as a result of our June 2009 and July 2010 restructurings and lower marketing expenses, offset partially by higher ENTEREG profit-sharing expenses under the collaboration agreement with Glaxo.

Restructuring Charge

As a result of our July 2010 restructuring, we recorded a restructuring charge of $1.9 million for the three and nine months ended September 30, 2010, which consisted of employee severance and benefits-related costs. As a result of our June 2009 restructuring, we recorded a charge of $4.1 million for the nine months ended September 30, 2009. The reduction in expense of $0.1 million for the three months ended September 30, 2009 resulted from an increase in the estimated salvage value of certain impaired assets affected by the restructuring. The charge for the nine months ended September 30, 2009 consisted of $2.2 million of employee severance- and benefit-related costs and a $1.9 million non-cash impairment charge primarily related to leasehold improvements and laboratory equipment used for activities that were eliminated pursuant to our restructuring.

Interest and Other Income

The following table sets forth interest and other income for the three and nine months ended September 30, 2010 and 2009:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Interest income	$	38,505	$	159,842	$	157,658	$	954,894
Other income		51,517		—		51,517		—

Interest Income

Our interest income was approximately $39,000 and $0.2 million for the three months ended September 30, 2010 and 2009, respectively, and $0.2 million and $1.0 million for the nine months ended September 30, 2010 and 2009, respectively. The decrease period-over-period was primarily due to lower prevailing interest rates and lower investment balances resulting primarily from the use of cash in operating activities.

Other Income

Other income was $0.1 million for the three and nine months ended September 30, 2010 and consisted of sublease income related to laboratory space at our corporate office. There was no other income for the three or nine months ended September 30, 2009.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which we have prepared in accordance with U.S. generally accepted accounting principles. In preparing these consolidated financial statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We develop and periodically change these estimates and assumptions based on historical experience and various other factors that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in our Annual Report on Form 10-K for the year ended December 31, 2009 in the “Critical Accounting Policies and Estimates” section and the “Recently Issued Accounting Pronouncements” section of Part II, Item 7 and in Note 2 to the financial statements within Part II, Item 8.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our investment assets consist of U.S. Treasury obligations. The market value of such investments fluctuates with current market interest rates. In general, as rates increase, the market value of a debt instrument would be expected to decrease. The opposite also is true. To minimize such market risk, we have in the past held, 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 fair value of our investment portfolio at September 30, 2010 totaled $47.0 million, and the weighted-average yield-to-maturity was approximately 0.3% with maturities ranging up to 12 months.

ITEM 4.

CONTROLS AND PROCEDURES

(a)

Evaluation of Disclosure Controls and Procedures

For the quarterly period ended September 30, 2010, 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, Finance and Chief Financial Officer (the principal financial and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report.

Our management, including our President and Chief Executive Officer and our Senior Vice President, Finance and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all errors or fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met and our disclosure controls and procedures are designed to provide this reasonable assurance. Based upon the evaluation discussed above, our President and Chief Executive Officer and our Senior Vice President, Finance and Chief Financial Officer concluded that, as of September 30, 2010, our disclosure controls and procedures were effective at providing such reasonable assurance.

(b)

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the three-month period ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

None.

ITEM 1A.

RISK FACTORS

You should carefully consider the risks described below, in addition to the other information contained in this report, before making an investment decision. Our business, financial condition or results of operations could be harmed by any of these risks. The risks and uncertainties described below are not the only ones we face. Additional risks not presently known to us or other factors not perceived by us to present significant risks to our business at this time also may impair our business operations.

We are and will continue to be highly dependent on the commercial success of ENTEREG, and we may be unable to attain profitability and/or positive cash flow from operations based solely on product sales of ENTEREG.

In May 2008, the FDA approved ENTEREG for use in accelerating GI recovery following partial large or small bowel resection surgery with primary anastomosis. ENTEREG is indicated for in-hospital use only and is available only to hospitals that have been registered under our E.A.S.E. Program. The commercial success of ENTEREG depends on several factors, including the following:

•

the acceptance of ENTEREG in the medical community and the marketplace, particularly with respect to whether physicians, patients and hospitals view ENTEREG as safe and effective for its labeled indication, whether the product carries with it an acceptable benefit-to-risk profile and whether the product offers sufficient pharmacoeconomic benefit to hospitals in light of its cost;

•

the number of hospitals that register for the E.A.S.E. Program;

•

the ability to obtain formulary acceptance of ENTEREG at registered hospitals;

•

the effectiveness of Glaxo’s and our sales and marketing efforts;

•

the occurrence of any side effects, adverse reactions or misuse (or any unfavorable publicity relating thereto) stemming from the use of ENTEREG; and

•

the development of competing products or therapies that accelerate GI recovery following bowel resection surgery.

Ultimately, we may never generate sufficient revenues from ENTEREG for us to reach profitability, generate positive cash flow or sustain, on an ongoing basis, our current or projected levels of operations.

We expect to continue to incur significant operating losses over the next several years and without additional funding, we likely will be unable to continue our operations.

We have generated operating losses in each year since we began operations in November 1994, and as of September 30, 2010, our accumulated deficit was $526.9 million and our cash, cash equivalents and short-term investments were $53.6 million. Our losses have resulted principally from costs incurred in research and development, including clinical trials, and from selling, general and administrative expenses associated with our operations. Notwithstanding our restructurings in June 2009 and July 2010, we expect to continue to generate substantial losses and utilize substantial amounts of cash, cash equivalents and short-term investments for the foreseeable future, driven primarily by expenditures related to research and development and sales and marketing activities. We believe that our existing cash, cash equivalents and short-term investments are adequate to fund our operations through 2012 based upon the level of research and development and marketing and administrative activities we believe will be necessary to achieve our strategic objectives. We cannot be sure that we will ever achieve significant product revenue from ENTEREG or any of our other product candidates sufficient for us to generate positive cash flows from operations. Sales of ENTEREG will need to increase significantly beyond current levels before we will be able to achieve profitability and/or positive cash flows from operations. Even if we are able to achieve profitability, we may be unable to maintain profitability on a continuing basis or at a level sufficient to support our current or projected levels of continuing investment. We anticipate that we will need to obtain funding to support our operational needs in the future, and we cannot be certain that such funding will be available on terms

acceptable to us, if at all, particularly in light of current economic and capital market conditions. Any capital raising necessary to continue our operations may be through one or a combination of approaches, which could include public or private financing, issuances of equity or debt, sale or partnering of one or more of our development programs or other strategic initiatives. Any public or private financings involving issuances of common stock or other classes of our equity could further dilute existing stockholders’ percentage ownership. If we are unable to obtain funding to support operations, we will be forced to curtail our operations and we may be less likely to develop products successfully.

Restrictions on ENTEREG may have the effect of limiting the commercial prospects for the product.

In April 2007, Glaxo and we announced the results of Study 014, a Phase 3 long-term safety study of alvimopan in patients taking opioids for chronic non-cancer pain and experiencing OIC. Results from Study 014 showed numerically more myocardial infarctions and other serious adverse events reported by patients treated long-term with alvimopan in this study compared to placebo. As a result, ENTEREG was approved in its labeled indication by the FDA subject to a Risk Evaluation and Mitigation Strategy (REMS). The FDA has determined that a REMS is necessary to ensure that the benefits of ENTEREG outweigh the risks. The REMS is subject to modification by the FDA at anytime and it is possible that the FDA could require changes to the REMS or other restrictions that would make it even more difficult to market and sell ENTEREG.

Our ENTEREG product labeling carries a boxed warning that ENTEREG is available only for short-term (15 doses) use in hospitalized patients. The REMS and the boxed warning may make it more difficult to market and sell ENTEREG. We are not permitted to market and sell ENTEREG to hospitals that do not register in the E.A.S.E. Program. Hospitals may be unwilling or unable to comply with the requirements for registration in the E.A.S.E. Program. For example, hospitals may not have systems, order sets, protocols or other measures in place to limit the use of ENTEREG to no more than 15 doses per patient and to ensure in-hospital use only. Hospitals also may not have controls in place to ensure that ENTEREG will neither be dispensed for outpatient use nor be transferred to unregistered hospitals. In such cases, we will be unable to register these hospitals in the E.A.S.E. Program.

Selling a pharmaceutical product in the hospital setting presents certain challenges. Hospitals differ widely and each hospital’s or hospital group’s prescribing is influenced by a list of accepted drugs called a formulary. Most hospitals have a committee, often called a pharmacy and therapeutics (P&T) committee, which meets periodically to determine which pharmaceutical products to add to the formulary. Many factors are assessed by such committees, including the cost of the drug and its pharmacoeconomic profile. Once a pharmaceutical is on formulary, it is easier for a physician within a hospital or hospital group to prescribe the drug. Hospital formulary approval is critical to the commercial success of ENTEREG and we cannot assure you that a sufficient number of hospitals will include ENTEREG on their formulary.

Notwithstanding success in registering hospitals in the E.A.S.E. Program and having those registered hospitals include ENTEREG on their formulary, there can be no assurance that such hospitals will order ENTEREG in meaningful amounts, if at all.

Our OIC program and delta opioid receptor agonist program may not lead to successful drug candidates or commercially successful products.

Our future success is highly dependent on the results of our clinical development efforts, particularly with respect to our OIC program where we are testing ADL5945 in a Phase 2 study. While earlier studies of this compound supported initiation of the Phase 2 study, there is no assurance that the Phase 2 study will yield positive results. Even if the results are positive, it is unlikely that we will have sufficient available resources to fund a Phase 3 clinical program in OIC without either securing a partner for this program or raising proceeds in an equity or debt sale. We cannot be certain that such a partnership or capital raising transaction would be available on terms acceptable to us, if at all, particularly in light of current economic and capital market conditions. If we are able to successfully develop ADL5945, we still face significant commercial hurdles. There are a number of other products in various stages of clinical development for OIC that could have a material adverse impact on our ability to successfully market and sell ADL5945.

In addition to our OIC program, we are developing two delta agonists, ADL5859 and ADL5747, in collaboration with Pfizer. To date, no selective delta opioid receptor agonist compounds have been successfully developed and approved by the FDA or any other regulatory authority. We have completed four Phase 2a clinical studies of ADL5859 and one Phase 2a clinical study of ADL5747 and, in each case, the compounds have not achieved a statistically significant difference in efficacy versus placebo. Notwithstanding these results, we currently are conducting an additional Phase 2a study of ADL5747 in patients suffering from post-herpetic neuralgia.

Ultimately, drug development is a highly uncertain process; our OIC and delta agonist product candidates may not be safe or effective and we may not be successful in our clinical development programs. Development of ADL5945 and delta agonists may not lead to commercially successful products.

Our product sales revenues from ENTEREG and related financial results may fail to meet market expectations and will likely fluctuate, which may adversely affect our stock price.

Forecasting revenue is difficult, especially when there is little commercial history, the product is the first product approved for a particular indication and when the level of market acceptance of the product is uncertain. For ENTEREG, the registration process required under the E.A.S.E. Program, as well as the P&T committee and formulary approval process, has impacted uptake of the product. As a result of these factors, ENTEREG product sales may not meet either our expectations of those of the market and will likely fluctuate, which may adversely affect our stock price. In addition, there are other factors that may cause our financial results to fluctuate, including the achievement and timing of research and development milestones and other collaboration revenues, the cost and timing of clinical trials, marketing and other expenses and manufacturing or supply disruption.

Our stock price has been highly volatile, and your investment in our stock could decline significantly in value.

The market price for our common stock has been, and may continue to be in the future, highly volatile. For example, during the period January 1, 2007 through September 30, 2010, the price of our common stock reached a low of $1.00 per share on July 7, 2010 and a high of $9.45 per share on March 13, 2007.

The market price for our common stock is highly dependent on, among other things, the performance of ENTEREG in the market, the success of our product development efforts, the amount of our available cash and investments and our level of cash utilization. Negative announcements, including, among others:

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disappointing sales of ENTEREG;

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disappointing developments concerning our collaborations;

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negative clinical trial results or adverse regulatory decisions for our product candidates;

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adverse period-to-period fluctuations in our sales or operating results or financial results that fall below the market’s expectations; or

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legal challenges, disputes and/or other adverse developments impacting patents or other proprietary rights that protect our products,

could trigger a significant decline in the price of our common stock. In addition, external events, such as news concerning economic or market conditions in the general economy or within our industry, the activities of our competitors or our customers, changes in U.S. or foreign government regulations impacting our industry or the movement of capital into or out of our industry, also are likely to affect the price of our common stock, regardless of our operating performance. Further declines in our stock price or our failure to meet other conditions required by the NASDAQ Global Market could impact our continued listing on the NASDAQ Global Market.

Our success is highly dependent on the efforts of our collaborators and third-party contractors and on our ability to secure future partnerships.

Because we have limited resources, we seek to enter into, and in the past we have entered into, agreements with other pharmaceutical companies and third-party contractors. These agreements may call for our partner to control or play a significant role in, among other things:

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the development of a product candidate, including, among other things, toxicology, formulation and clinical research efforts;

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the design and execution of clinical studies;

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the process of obtaining regulatory approval to market the product; and

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the manufacturing, marketing and selling of any approved product.

In each of these areas, our partners may not support fully our research and commercial interests since our program may compete for time, attention and resources with the internal programs of our corporate collaborators.

As such, we cannot be sure that our corporate collaborators will share our perspectives on the relative importance of our program, that they will commit sufficient resources to our program to move it forward effectively or that the program will advance as rapidly as it might if we had retained complete control of all research, development, regulatory and commercialization decisions. For example, we are highly dependent on the efforts and expertise of Glaxo in the distribution, marketing and selling of ENTEREG. Presently, ENTEREG is detailed primarily by Glaxo’s national hospital-based sales organization. We are co-promoting ENTEREG in certain hospitals with a sales force that numbers approximately 25 persons. The ultimate commercial success of ENTEREG will depend, to a large degree, on the success of the efforts of Glaxo.

We also have a development and commercialization agreement with Pfizer for ADL5859 and ADL5747, our proprietary delta opioid receptor agonist compounds, for the treatment of pain. Under the Pfizer agreement, we are responsible for IND filings and Phase 1 and Phase 2a clinical studies and Pfizer is responsible for subsequent worldwide development, securing regulatory approvals and commercialization of the products. In this program, we recently reported that neither ADL5859 nor ADL5747 achieved a statistically significant improvement versus placebo in a Phase 2a trial in patients with osteoarthritis. Depending on the results of the ongoing study of ADL5747 in PHN, Pfizer could decide to terminate the development and commercialization agreement.

Any failure by our collaborators to perform their obligations or any decision by our collaborators to terminate these agreements under the terms provided for in their respective agreements could negatively impact our ability to successfully develop, obtain regulatory approvals for and commercialize our product and product candidates, which would likely materially impact our financial condition, results of operations and outlook. In addition, any termination of our collaboration agreements will terminate the funding we may receive under the relevant collaboration agreement and may materially and adversely impact our ability to fund further development efforts and our progress in our development programs.

In the future, we may seek to enter into other collaborative arrangements for the development, marketing, sale and/or distribution of certain of our product candidates, including in our OIC program, which may require us to share profits or revenues. Despite our efforts, we may be unable to secure additional collaborative licensing or other arrangements that are necessary for us to further develop and commercialize our product candidates. Moreover, we may not realize the contemplated benefits from such collaborative licensing or other arrangements. These arrangements may place responsibility on our collaborative partners for preclinical testing, human clinical trials, the preparation and submission of applications for regulatory approval, or for marketing, sales and distribution support for product commercialization. These arrangements also may require us to transfer certain material rights or issue our equity securities to corporate partners, licensees or others. Moreover, we may not derive any revenues or profits from these arrangements.

The results and timing of future clinical trials cannot be predicted and future setbacks may materially and adversely affect our business.

We must demonstrate through preclinical testing and clinical trials that a product candidate is safe and efficacious. The results from preclinical testing and early clinical trials may not be predictive of results obtained in subsequent clinical trials, and we cannot be sure that these clinical trials will demonstrate the safety and efficacy necessary to obtain regulatory approval for any product candidates.

Many companies in the biotechnology and pharmaceutical industries have suffered significant setbacks in advanced clinical trials. Product candidates that appear to be promising at earlier stages of development may not reach the market or be marketed successfully for a number of reasons, including, but not limited to, the following:

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

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

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

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

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competitors may market equivalent or superior products.

The completion of clinical trials of our product candidates may be delayed by many factors, one of which is the rate of enrollment of patients. Neither we nor our collaborators can control the rate at which patients present themselves for enrollment, and we cannot be sure that the rate of patient enrollment will be consistent with our expectations or be sufficient to enable clinical trials of our product candidates to be completed in a timely manner. In addition, we contract with third parties to conduct our clinical trials, and are subject to the risk that these third parties fail to perform their obligations properly and in compliance with applicable FDA and other governmental regulations. Any significant delays in, or termination of, clinical trials of our product candidates may have a material adverse effect on our business and the price of our common stock.

We cannot be sure that we will be permitted by regulatory authorities to undertake additional clinical trials for any of our product candidates, or that if such trials are conducted, any of our product candidates will prove to be safe and efficacious or will receive regulatory approvals. In addition, we, or a regulatory authority, may suspend ongoing clinical trials at any time if the subjects participating in the trial are exposed to unacceptable health risks or if the regulatory agency finds deficiencies in the conduct of the trials. Any delays in or termination of these clinical trial efforts could have a material and adverse effect on our business.

We have no commercial manufacturing capability and infrastructure, and we rely on third parties to manufacture our product and product candidates in sufficient quantities, at an acceptable cost and in compliance with regulatory requirements.

We depend on Piramal Healthcare (Canada) Limited (formerly Torcan Chemical Ltd.) and Central Glass Germany GmbH (formerly Girindus AG) as the approved suppliers under our NDA of the active pharmaceutical ingredient in ENTEREG. We also depend on Pharmaceutics International, Inc. and Pharmaceutical Manufacturers Research Services Inc. as the approved manufacturers under our NDA of ENTEREG finished capsules. These suppliers have been inspected by the FDA but are subject to periodic re-inspection. In the event that these vendors cannot supply material for any reason, FDA approval is required to change or add new suppliers and manufacturers and obtaining such approval could result in delays that disrupt the supply of the product. While we seek to maintain inventories of the active pharmaceutical ingredient and finished products to protect against supply disruptions, if they were to occur they could materially and adversely affect the commercial success of ENTEREG.

Completion of our clinical trials and commercialization of our product candidates require access to, or development of, facilities to manufacture a sufficient supply of our product candidates. We have depended, and expect to continue to depend, on third parties for the manufacture of our product candidates for preclinical, clinical and commercial purposes. While we have established relationships with a number of different third-party manufacturing service providers, we may not be able to contract for the manufacture of sufficient quantities of the products we develop, or meet our needs for preclinical or clinical development. Our products may be in competition with other products for manufacturing capacity of third parties and suitable alternatives may be unavailable. Consequently, our products may be subject to manufacturing delays if outside contractors give their own or other products greater priority than ours. It is difficult, time consuming and expensive to change contract manufacturers for pharmaceutical products. Our dependence upon others for the manufacture of our products may adversely affect our future profit margin and our ability to commercialize products, if additional products are approved, on a timely and competitive basis.

To receive regulatory approval for any future product, contract manufacturers will need to be identified that can obtain FDA approval of their manufacturing facilities used to manufacture that product, and there is a risk that such approval may not be obtained. In an NDA, we are required to submit information and data regarding chemistry, manufacturing and controls which satisfy the FDA that our contract manufacturers are able to make that product in accordance with cGMPs. Under cGMPs, our manufacturers and we 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 and these parties may have difficulties complying with cGMPs. The failure of any third-party manufacturer to comply with applicable government regulations could cause us substantial harm by delaying or preventing regulatory approval and marketing of our products.

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

Our commercial success will depend, in part, on obtaining patent protection for new technologies, products and processes and successfully defending these patents against third-party challenges. To that end, we file applications for patents covering the compositions, uses and proprietary processes for the manufacture of our product and product candidates. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal, scientific and factual questions. Accordingly, we cannot predict the breadth of

claims allowed in our patents or those of our collaborators. The patents and patent applications relating to our products, product candidates and technologies may be challenged, invalidated or circumvented by third parties and might not protect us against competitors with similar products or technology. Patent disputes in our industry are frequent and can preclude commercialization of products. If we ultimately engage in and lose any such disputes, we could be subject to competition and/or significant liabilities, we could be required to enter into third-party licenses or we could be required to cease using the technology or product in dispute. In addition, even if such licenses are available, the terms of any license requested by a third party could be unacceptable to us.

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

Although no third party has asserted a claim of infringement against us, others may hold proprietary rights that could 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 our collaborators or we would prevail in any such 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. The results of patent litigation among third parties has caused, and may continue to cause, changes to the ways patents are interpreted, enforced and/or challenged. These changes may adversely affect our ability to protect our products. If we become involved in litigation, it could consume substantial managerial and financial resources.

We also 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, consultants and other contractors to enter into confidentiality agreements, we may not be able to adequately protect 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 collaborators and advisors, our ability to receive patent protection or protect our proprietary information may be imperiled.

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

Our long-term success depends upon our ability to discover, license and develop, receive regulatory approval for and commercialize our product candidates.

Our product candidates require governmental approvals prior to commercialization. Because these product candidates are in development, 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. There can be no assurance that these standards will remain consistent over time, further complicating our ability to obtain marketing approvals for our product candidates. To satisfy these standards, we will need to conduct significant additional research, preclinical testing and clinical trials.

Preclinical testing and clinical development are long, expensive and highly uncertain processes. Failure can occur at any stage of testing. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful. Based on results at any stage of clinical trials, we may decide to discontinue development of our product candidates. Even if we obtain approval and begin marketing a product, ongoing clinical trials, including for other indications, may result in additional information that could affect our ability or decision to continue marketing the product. Even if we receive regulatory approval for our product candidates, we must comply with applicable FDA post-marketing regulations governing manufacturing, promotion, labeling, risk management and reporting of adverse events and other information, as well as other regulatory requirements. Failure to comply with applicable regulatory requirements could subject us to criminal penalties, civil penalties, recall or seizure of

products, withdrawal of marketing approval, total or partial suspension of production or injunction, as well as other regulatory actions against our product or us.

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

If we market products in a manner that violates healthcare fraud and abuse laws, or if we violate government price reporting laws, we may be subject to civil or criminal penalties.

In addition to FDA restrictions on marketing of pharmaceutical products, several other types of state and federal healthcare fraud and abuse laws have been applied in recent years to restrict certain marketing practices in the pharmaceutical industry. These laws include false claims statutes and anti-kickback statutes. Because of the breadth of these laws and the narrowness of the safe harbors, it is possible that some of our business activities could be subject to challenge under one or more of these laws.

Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government or knowingly making, or causing to be made, a false statement to get a false claim paid. The federal healthcare program anti-kickback statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce, or in return for, purchasing, leasing, ordering or arranging for the purchase, lease or order of any healthcare item or service reimbursable under Medicare, Medicaid or other federally financed healthcare programs. This statute has been interpreted to apply to arrangements between pharmaceutical manufacturers on the one hand and prescribers, purchasers and formulary managers on the other. Although there are several statutory exemptions and regulatory safe harbors protecting certain common activities from prosecution, the exemptions and safe harbors are drawn narrowly, and practices that involve remuneration intended to induce prescribing, purchasing or recommending may be subject to scrutiny if they do not qualify for an exemption or safe harbor. Our practices may not in all cases meet all of the criteria for safe harbor protection from anti-kickback liability.

Over the past several years, numerous pharmaceutical and other healthcare companies have been prosecuted under these laws for a variety of alleged promotional and marketing activities, such as: allegedly providing free trips, free goods, sham consulting fees and grants and other monetary benefits to prescribers; reporting to pricing services inflated average wholesale prices that were then used by federal programs to set reimbursement rates; engaging in off-label promotion that caused claims to be submitted to Medicaid for non-covered, off-label uses; and submitting inflated best price information to the Medicaid Rebate Program to reduce liability for Medicaid rebates. Most states also have statutes or regulations similar to the federal anti-kickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a manufacturer’s products from reimbursement under government programs, criminal fines and imprisonment.

We are required to submit pricing data to the federal government as a condition of selling ENTEREG to healthcare facilities of the VA, Department of Defense (DoD), Public Health Service and U.S. Coast Guard (the VA Network). These price reports are used to determine the amount of discount that must be provided to the VA Network. Pharmaceutical manufacturers have been prosecuted under false claims laws for knowingly submitting inaccurate pricing information to the government to reduce their liability for providing discounts. The rules governing the calculation of these reported prices are complex. We depend upon Glaxo to calculate these prices for ENTEREG, and it is possible that Glaxo’s methodologies for calculating these prices could be challenged under false claims laws or other laws. If this were to occur, we could face substantial liability.

We face product liability risks, which may have a negative effect on our financial performance.

The administration of drugs to humans, whether in clinical trials or commercially, can result in product liability claims regardless of whether or not the drugs are actually at fault for causing an injury. The product labeling for ENTEREG includes a boxed warning that ENTEREG is available only for short-term (15 doses) use in hospitalized patients. The product label informs physicians that there were more reports of myocardial infarctions in patients treated with alvimopan 0.5 milligrams twice daily compared with placebo-treated patients in a 12-month study of patients treated with opioids for chronic pain. ENTEREG also is marketed and sold under a REMS.

If ENTEREG is used more widely or if physicians prescribe the product for conditions other than its labeled indication, the likelihood of an adverse drug reaction, unintended side effect or incident of misuse may

increase. Product liability claims can be expensive to defend and may result in large judgments or settlements against us, which could have a negative effect on our financial performance or condition. The cost of product liability insurance has increased in recent years, and the availability of coverage has decreased. We maintain product liability insurance and self-insurance retentions in amounts we believe to be commercially reasonable, but which may not cover the potential liability associated with significant product liability claims. Even if a product liability claim is not successful, the adverse publicity and time and expense of defending such a claim may harm the commercial prospects for the product or otherwise interfere with our business. Regardless of whether we face product liability lawsuits, we may be required to disclose adverse events associated with ENTEREG. Although ENTEREG may not be the cause of these adverse events, these disclosures could nevertheless have a materially adverse effect on our sales of ENTEREG and our financial condition.

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

Our ability to generate product sales could diminish if we fail to obtain acceptable prices or an adequate level of reimbursement for our products from third-party payors.

Our ability to successfully commercialize pharmaceutical products, alone or with collaborators, may depend in part on the extent to which reimbursement is available from government and health administration authorities or private health insurers and third-party payors.

The continuing efforts of government and third-party payors to contain or reduce the costs of healthcare through various means may limit our commercial opportunity. Increasing emphasis on managed care in the United States will continue to put pressure on the pricing of in-patient hospital procedures and pharmaceutical products. Significant uncertainty exists as to the reimbursement status of newly approved healthcare products. Cost control initiatives could adversely affect the commercialization of our products, decrease the price received for any products in the future and may impede patients’ ability to obtain reimbursement under their insurance programs for our products.

In the case of partial large or small bowel resection surgery, a hospital typically will be reimbursed a fixed fee for the procedure by a private health insurer or Medicare. Pharmaceutical products such as ENTEREG that may be used in connection with the surgery are not separately reimbursed and, therefore, a hospital must assess the cost of ENTEREG relative to its benefits. Current and future efforts to limit the level of reimbursement for in-patient hospital procedures could cause a hospital to decide to not use ENTEREG or to discontinue use of the product.

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

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

We are aware of other products in various stages of clinical development for the acceleration of GI recovery following bowel resection surgery, OIC and other manifestations of opioid bowel dysfunction. For example, we are aware of molecules in development by Progenics Pharmaceuticals, Inc., Tranzyme Pharma, Helsinn Therapeutics, AstraZeneca in collaboration with Nektar Therapeutics, Theravance Inc. and Alkermes, Inc. that could compete with our existing product or our product candidates. In addition, there are products already on the market for use in treating other GI conditions that also are being developed for use in OIC. There are additional competitive products being developed that could have a material adverse effect on our ability to successfully market and sell our product and product candidates.

There are numerous classes of pharmaceuticals that address the pain market, including non-steroidal, anti-inflammatory drugs (NSAIDs), opioids, COX-2 inhibitors, dual-action analgesics, as well as over-the-counter medication like aspirin and acetaminophen. New entrants into this area will need to be substantially improved, either in terms of increased analgesia or reduced side effects, in order to be competitive. Numerous companies have new pain drugs under development.

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:

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attract partners for acquisitions, joint ventures or other collaborations;

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license proprietary technology; and

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attract qualified personnel.

Reductions in the number of bowel resection surgeries or in the use of opioid analgesics would reduce the potential market for ENTEREG and any products developed to treat OIC.

ENTEREG is indicated for the acceleration of gastrointestinal recovery following partial small or large bowel resection surgery with primary anastomosis. If medical advances or surgical techniques are developed that reduce the need for these surgeries, the potential market for ENTEREG would be similarly reduced. Moreover, if the use of drugs or techniques that reduce the requirement for mu opioid analgesics becomes more widespread, the market for ENTEREG and our OIC product candidates would decrease. Various techniques to reduce the use of opioids are being utilized in an attempt to reduce the impact of opioid side effects. The use of local anesthetics in epidural catheters during and after surgery with the continuation of the epidural into the postoperative period can reduce or eliminate the use of opioids. Non-steroidal anti-inflammatory agents also may reduce total opioid requirements. Continuous infusion of local anesthetic into a wound or near major nerves can reduce the use of opioids in limited types of procedures and pain states. Novel analgesics that act at receptors other than mu opioid receptors also are under development. Many companies have developed and are developing analgesic products that compete with opioids or which, if approved, would compete with opioids. If these analgesics reduce the use of opioids, it would have a negative impact on the potential market for ENTEREG and our OIC product candidates.

We are or may become involved in legal proceedings that, if adversely adjudicated or settled, could materially impact our financial condition.

As a public biopharmaceutical company, we are or may become a party to litigation in the ordinary course of our business, including, among others, matters alleging product liability, patent or other intellectual property rights infringement, patent invalidity, violations of securities laws, employment discrimination or breach of commercial contract. In general, litigation claims can be expensive and time consuming to bring or defend against and could result in settlements or damages that could significantly impact our results of operations and financial condition.

Our business could suffer if we are unable to 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. We may not be successful in attracting or retaining qualified individuals. Our success also depends on our ability to develop and maintain important relationships with leading academic institutions and scientists. Competition for personnel and academic collaborations is intense. In particular, our product development programs depend on our ability to attract and retain highly-skilled chemists, biologists and clinical development personnel. If we lose the services of any of these personnel, it could impede significantly the achievement of our research and development objectives. In addition, we will need to hire additional personnel and develop additional academic collaborations if we determine to expand our research and development activities. We do not know if we will be able to attract, retain or motivate personnel or maintain relationships. We do not maintain key man life insurance on any of our employees.

If we engage in an acquisition, reorganization 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, 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:

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

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incur substantial debt that may place strains on our operations;

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

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assume substantial actual or contingent liabilities; or

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

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

Certain provisions of both our charter documents and Delaware law, our adoption of a stockholder rights plan and certain limitations within our collaboration agreements 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 bylaws, 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.

Authorized shares of our common stock and preferred stock are available for future issuance without stockholder approval. The existence of unissued common stock and preferred stock may enable our Board of Directors to issue shares to persons friendly to current management or to issue preferred stock with terms that could render more difficult or discourage a third-party attempt to obtain control of us by means of a merger, tender offer, proxy contest or otherwise, which would protect the continuity of our management. In addition, we adopted a stockholder rights plan, the effect of which may be to make an acquisition of us more difficult.

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.

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

ITEM 6.

EXHIBITS


Exhibit No.		Description
31.1*		Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2*		Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1#		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2#		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*	Filed herewith.

This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section. Further, this exhibit shall not be deemed to be incorporated by reference in any document filed under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

SIGNATURES

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


	ADOLOR CORPORATION

Date: October 28, 2010	By:	/s/ Michael R. Dougherty
		Michael R. Dougherty
		President and Chief Executive Officer (Principal executive officer)

	By:	/s/ Stephen W. Webster
		Stephen W. Webster
		Senior Vice President, Finance and Chief Financial Officer (Principal financial and accounting officer)

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company