##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



---



FORM 10-Q



---



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



For the quarterly period ended March 31, 2005



OR



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



Commission File Number: 000-30039



---



ADOLOR CORPORATION

(Exact Name of Registrant as Specified in its Charter)



---



|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|Delaware                                                       |  | 31-1429198                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)



700 Pennsylvania
Drive

Exton, Pennsylvania 19341

(Address of Principal Executive Offices and Zip Code)



484-595-1500

(Registrants Telephone Number, Including Area Code)



---



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



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



Number of shares outstanding of the issuers Common Stock, par value $0.0001 per share,
as of April 15, 2005: 39,086,902 shares.



---



---

##### Table of Contents

ADOLOR CORPORATION



INDEX



|         |  |                                                                                                                                                            |  |   
|-------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --
|PART I.  |  | FINANCIAL INFORMATION                                                                                                                                      |  |   
|         |  |                                                                                                                                                           
|ITEM 1.  |  | Financial Statements (Unaudited):                                                                                                                          |  |   
|         |  |                                                                                                                                                           
|         |  | Consolidated Balance Sheets at March 31, 2005 and December 31, 2004                                                                                        |  | 1 
|         |  |                                                                                                                                                           
|         |  | Consolidated Statements of Operations for the three months ended March 31, 2005 and 2004, and the period from August 9, 1993 (inception) to March 31, 2005 |  | 2 
|         |  |                                                                                                                                                           
|         |  | Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004, and the period from August 9, 1993 (inception) to March 31, 2005 |  | 3 
|         |  |                                                                                                                                                           
|         |  | Notes to Consolidated Financial Statements                                                                                                                 |  | 4 
|         |  |                                                                                                                                                           
|ITEM 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                                      |  | 9 
|         |  |                                                                                                                                                           
|         |  | Certain Risks Related to Our Business                                                                                                                      |  | 16
|         |  |                                                                                                                                                           
|ITEM 3.  |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                                 |  | 29
|         |  |                                                                                                                                                           
|ITEM 4.  |  | Controls and Procedures                                                                                                                                    |  | 29
|         |  |                                                                                                                                                           
|PART II. |  | OTHER INFORMATION                                                                                                                                          |  |   
|         |  |                                                                                                                                                           
|ITEM 1.  |  | Legal Proceedings                                                                                                                                          |  | 30
|         |  |                                                                                                                                                           
|ITEM 6.  |  | Exhibits                                                                                                                                                   |  | 31
|         |  |                                                                                                                                                           
|         |  | Signatures                                                                                                                                                 |  | 32



---

##### Table of Contents

PART I. FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS



ADOLOR CORPORATION

(A Development Stage Company)



Consolidated Balance Sheets

(Unaudited)



|                                                                                                                                                                             |  |                |              |   |                   |   |              |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------------ | - | ----------------- | - | ------------ | -
|                                                                                                                                                                             |  | March 31, 2005 |              |   | December 31, 2004 |  
|Assets                                                                                                                                                                       |  |                |              |   |                   |   |              |  
|Current assets:                                                                                                                                                              |  |                |              |   |                   |   |              |  
|Cash and cash equivalents                                                                                                                                                    |  | $              | 8,166,237    |   |                   | $ | 6,935,417    |  
|Short-term investments (Note 3)                                                                                                                                              |  |                | 138,851,305  |   |                   |   | 155,388,108  |  
|Accounts receivable from collaboration agreement (Note 4)                                                                                                                    |  |                | 1,874,650    |   |                   |   | 3,363,876    |  
|Prepaid expenses and other current assets                                                                                                                                    |  |                | 2,562,047    |   |                   |   | 2,542,693    |  
|                                                                                                                                                                             |  |                |              |   |                   |   |              |  
|Total current assets                                                                                                                                                         |  |                | 151,454,239  |   |                   |   | 168,230,094  |  
|                                                                                                                                                                             |  |               
|Equipment and leasehold improvements, net                                                                                                                                    |  |                | 9,586,157    |   |                   |   | 9,773,291    |  
|Other assets                                                                                                                                                                 |  |                | 220,662      |   |                   |   | 100,000      |  
|                                                                                                                                                                             |  |                |              |   |                   |   |              |  
|Total assets                                                                                                                                                                 |  | $              | 161,261,058  |   |                   | $ | 178,103,385  |  
|                                                                                                                                                                             |  |                |              |   |                   |   |              |  
|Liabilities and Stockholders Equity                                                                                                                                         |  |                |              |   |                   |   |              |  
|Current liabilities:                                                                                                                                                         |  |                |              |   |                   |   |              |  
|Accounts payable                                                                                                                                                             |  | $              | 1,014,142    |   |                   | $ | 3,103,409    |  
|Accrued expenses                                                                                                                                                             |  |                | 10,191,180   |   |                   |   | 11,716,232   |  
|Deferred licensing fees and rent current                                                                                                                                    |  |                | 4,329,192    |   |                   |   | 4,329,192    |  
|                                                                                                                                                                             |  |                |              |   |                   |   |              |  
|Total current liabilities                                                                                                                                                    |  |                | 15,534,514   |   |                   |   | 19,148,833   |  
|                                                                                                                                                                             |  |               
|Deferred licensing fees and rent non-current                                                                                                                                |  |                | 34,712,334   |   |                   |   | 35,794,635   |  
|                                                                                                                                                                             |  |                |              |   |                   |   |              |  
|Total liabilities                                                                                                                                                            |  |                | 50,246,848   |   |                   |   | 54,943,468   |  
|                                                                                                                                                                             |  |                |              |   |                   |   |              |  
|Commitments and Contingencies (Note 6)                                                                                                                                       |  |                |              |   |                   |   |              |  
|                                                                                                                                                                             |  |               
|Stockholders equity:                                                                                                                                                        |  |                |              |   |                   |   |              |  
|Series A Junior Participating preferred stock, par value $0.01; 35,000 shares authorized; none issued and outstanding                                                        |  |                |             |   |                   |   |             |  
|Preferred stock, par value $0.01; 1,000,000 shares authorized; none issued and outstanding                                                                                   |  |                |             |   |                   |   |             |  
|Common stock, par value $0.0001; 99,000,000 shares authorized; 39,086,902 and 39,080,345 shares issued and outstanding at March 31, 2005 and
December 31, 2004, respectively |  |                | 3,909        |   |                   |   | 3,908        |  
|Additional paid-in capital                                                                                                                                                   |  |                | 373,611,926  |   |                   |   | 373,605,431  |  
|Deferred compensation                                                                                                                                                        |  |                | (12,567      | ) |                   |   | (19,465      | )
|Unrealized losses on available for sale securities                                                                                                                           |  |                | (654,517     | ) |                   |   | (463,457     | )
|Deficit accumulated during the development stage                                                                                                                             |  |                | (261,934,541 | ) |                   |   | (249,966,500 | )
|                                                                                                                                                                             |  |                |              |   |                   |   |              |  
|Total stockholders equity                                                                                                                                                   |  |                | 111,014,210  |   |                   |   | 123,159,917  |  
|                                                                                                                                                                             |  |                |              |   |                   |   |              |  
|Total liabilities and stockholders equity                                                                                                                                   |  | $              | 161,261,058  |   |                   | $ | 178,103,385  |  
|                                                                                                                                                                             |  |                |              |   |                   |   |              |  



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



1



---

##### Table of Contents

ADOLOR CORPORATION

(A Development Stage Company)



Consolidated Statements of Operations

(Unaudited)

Three months ended March
31, 2005 and 2004 and the period from August 9, 1993

(inception) to March 31, 2005



|                                                              |  |                              |             |   |                                                  |   |             |      |  |   |              |  
|------------------------------------------------------------- |  | ---------------------------- | ----------- | - | ------------------------------------------------ | - | ----------- | ---- |  | - | ------------ | -
|                                                              |  | Three months ended March 31, |             |   | Period fromAugust 9, 1993(inception) toMarch 31, |  
|                                                              |  | 2005                         |             |   | 2004                                             |   |             | 2005 | 
|Contract revenues (Note 4)                                    |  | $                            | 2,916,320   |   |                                                  | $ | 3,645,491   |      |  | $ | 79,185,612   |  
|                                                              |  |                              |             |   |                                                  |   |             |      |  |   |              |  
|Operating expenses incurred during the development stage:     |  |                              |             |   |                                                  |   |             |      |  |   |              |  
|Research and development                                      |  |                              | 10,063,240  |   |                                                  |   | 9,612,911   |      |  |   | 263,155,117  |  
|Marketing, general and administrative                         |  |                              | 5,607,674   |   |                                                  |   | 5,089,428   |      |  |   | 99,282,636   |  
|                                                              |  |                              |             |   |                                                  |   |             |      |  |   |              |  
|Total operating expenses                                      |  |                              | 15,670,914  |   |                                                  |   | 14,702,339  |      |  |   | 362,437,753  |  
|                                                              |  |                              |             |   |                                                  |   |             |      |  |   |              |  
|Loss from operations                                          |  |                              | (12,754,594 | ) |                                                  |   | (11,056,848 | )    |  |   | (283,252,141 | )
|                                                              |  |                              |            
|Interest income                                               |  |                              | 786,553     |   |                                                  |   | 780,732     |      |  |   | 21,673,497   |  
|Other expense                                                 |  |                              |            |   |                                                  |   | (993        | )    |  |   | (355,897     | )
|                                                              |  |                              |             |   |                                                  |   |             |      |  |   |              |  
|Net loss                                                      |  | $                            | (11,968,041 | ) |                                                  | $ | (10,277,109 | )    |  | $ | (261,934,541 | )
|                                                              |  |                              |             |   |                                                  |   |             |      |  |   |              |  
|Basic and diluted net loss per share                          |  | $                            | (0.31       | ) |                                                  | $ | (0.26       | )    |  |   |              |  
|                                                              |  |                              |             |   |                                                  |   |             |      |  |   |              |  
|Shares used in computing basic and diluted net loss per share |  |                              | 39,086,142  |   |                                                  |   | 38,796,526  |      |  |   |              |  
|                                                              |  |                              |             |   |                                                  |   |             |      |  |   |              |  



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



2



---

##### Table of Contents

ADOLOR CORPORATION

(A Development Stage Company)

Consolidated Statements of Cash Flows

(Unaudited)



|                                                                                                               |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|-------------------------------------------------------------------------------------------------------------- |  | ---------------------------- | ----------- | - | --------------------------------------------------- | - | ----------- | ---- |  | - | ------------ | -
|                                                                                                               |  | Three months ended March 31, |             |   | Period from August 9, 1993 (inception) to March 31, |  
|                                                                                                               |  | 2005                         |             |   | 2004                                                |   |             | 2005 | 
|Cash flows from operating activities:                                                                          |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Net loss                                                                                                       |  | $                            | (11,968,041 | ) |                                                     | $ | (10,277,109 | )    |  | $ | (261,934,541 | )
|Adjustments to reconcile net loss to net cash used in operating activities:                                    |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Non-cash compensation expense                                                                                  |  |                              | 6,898       |   |                                                     |   | 331,732     |      |  |   | 22,561,556   |  
|Non-cash warrant value                                                                                         |  |                              |            |   |                                                     |   |            |      |  |   | 60,000       |  
|Depreciation expense                                                                                           |  |                              | 671,238     |   |                                                     |   | 605,136     |      |  |   | 8,270,307    |  
|Non-cash proceeds from the trade of equipment                                                                  |  |                              |            |   |                                                     |   |            |      |  |   | 120,000      |  
|Loss on the disposal of equipment and leasehold improvements                                                   |  |                              |            |   |                                                     |   |            |      |  |   | (20,227      | )
|Changes in assets and liabilities:                                                                             |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Accounts receivable from collaboration agreements                                                              |  |                              | 1,489,226   |   |                                                     |   | 475,935     |      |  |   | (1,874,650   | )
|Prepaid expenses and other current assets                                                                      |  |                              | (19,354     | ) |                                                     |   | 886,223     |      |  |   | (2,562,047   | )
|Other assets                                                                                                   |  |                              | (120,662    | ) |                                                     |   | 64,537      |      |  |   | (220,662     | )
|Accounts payable                                                                                               |  |                              | (2,089,267  | ) |                                                     |   | (276,707    | )    |  |   | 1,014,142    |  
|Deferred licensing fees and rent                                                                               |  |                              | (1,082,301  | ) |                                                     |   | (1,041,669  | )    |  |   | 39,041,526   |  
|Accrued expenses                                                                                               |  |                              | (1,525,052  | ) |                                                     |   | (5,570,868  | )    |  |   | 10,191,180   |  
|                                                                                                               |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Net cash used in operating activities                                                                          |  |                              | (14,637,315 | ) |                                                     |   | (14,802,790 | )    |  |   | (185,353,416 | )
|                                                                                                               |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Cash flows from investing activities:                                                                          |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Purchase of equipment and leasehold improvements                                                               |  |                              | (484,104    | ) |                                                     |   | (386,613    | )    |  |   | (18,087,171  | )
|Proceeds from the sale of equipment and leasehold improvements                                                 |  |                              |            |   |                                                     |   |            |      |  |   | 144,273      |  
|Purchase of short-term investments                                                                             |  |                              | (29,195,585 | ) |                                                     |   | (53,792,519 | )    |  |   | (807,247,323 | )
|Maturities of short-term investments                                                                           |  |                              | 45,541,328  |   |                                                     |   | 68,174,074  |      |  |   | 667,741,501  |  
|                                                                                                               |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Net cash provided by / (used in) investing activities                                                          |  |                              | 15,861,639  |   |                                                     |   | 13,994,942  |      |  |   | (157,448,720 | )
|                                                                                                               |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Cash flows from financing activities:                                                                          |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Net proceeds from issuance of mandatorily redeemable convertible preferred stock and Series B warrants         |  |                              |            |   |                                                     |   |            |      |  |   | 78,501,909   |  
|Proceeds from Series D mandatorily redeemable convertible preferred stock subscription                         |  |                              |            |   |                                                     |   |            |      |  |   | 600,000      |  
|Net proceeds from issuance of restricted common stock and exercise of common stock options                     |  |                              | 9,519       |   |                                                     |   | 54,858      |      |  |   | 3,703,210    |  
|Proceeds from notes payable-related parties                                                                    |  |                              |            |   |                                                     |   |            |      |  |   | 1,000,000    |  
|Payment of notes payable                                                                                       |  |                              |            |   |                                                     |   |            |      |  |   | (1,832,474   | )
|Proceeds received on notes receivable                                                                          |  |                              | 112         |   |                                                     |   | 2,755       |      |  |   | 974,063      |  
|Interest receivable converted to principal on notes                                                            |  |                              | (3,135      | ) |                                                     |   | (2,936      | )    |  |   | (134,994     | )
|Proceeds from notes payable                                                                                    |  |                              |            |   |                                                     |   |            |      |  |   | 1,832,474    |  
|Net proceeds from issuance of common stock                                                                     |  |                              |            |   |                                                     |   |            |      |  |   | 266,324,185  |  
|                                                                                                               |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Net cash provided by financing activities                                                                      |  |                              | 6,496       |   |                                                     |   | 54,677      |      |  |   | 350,968,373  |  
|                                                                                                               |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Net increase (decrease) in cash and cash equivalents                                                           |  |                              | 1,230,820   |   |                                                     |   | (753,171    | )    |  |   | 8,166,237    |  
|Cash and cash equivalents at beginning of period                                                               |  |                              | 6,935,417   |   |                                                     |   | 5,339,202   |      |  |   |             |  
|                                                                                                               |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Cash and cash equivalents at end of period                                                                     |  | $                            | 8,166,237   |   |                                                     | $ | 4,586,031   |      |  | $ | 8,166,237    |  
|                                                                                                               |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Supplemental disclosure of cash flow information:                                                              |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Cash paid for interest                                                                                         |  | $                            |            |   |                                                     | $ | 993         |      |  | $ | 224,610      |  
|Supplemental disclosure of noncash transactions:                                                               |  |                              |             |   |                                                     |   |             |      |  |   |              |  
|Unrealized (losses) gains on available for sale securities                                                     |  |                              | (191,060    | ) |                                                     |   | 7,049       |      |  |   | (654,517     | )
|Deferred compensation from issuance of common stock, restricted common stock and common stock options          |  |                              |            |   |                                                     |   |            |      |  |   | 24,496,376   |  
|Issuance of common stock for technology license agreements or for services                                     |  |                              |            |   |                                                     |   |            |      |  |   | 19,589       |  
|Conversion of Series A through H preferred stock for common stock                                              |  |                              |            |   |                                                     |   |            |      |  |   | 80,383,703   |  
|Conversion of stock subscription to Series D mandatorily redeemable preferred stock                            |  |                              |            |   |                                                     |   |            |      |  |   | 600,000      |  
|Conversion of bridge financing, including accrued interest, to Series B mandatorily redeemable preferred stock |  |                              |            |   |                                                     |   |            |      |  |   | 1,019,787    |  



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



3



---

##### Table of Contents

Adolor Corporation

(A Development Stage Company)



Notes to Consolidated Financial Statements



March 31, 2005

(Unaudited)



1.
ORGANIZATION AND BUSINESS ACTIVITIES



Adolor Corporation
(together with its subsidiary, Adolor or the Company) is a development stage biopharmaceutical corporation that was formed in 1993. The Company specializes in the discovery, development and commercialization of prescription
pain management products. The Company has a number of small molecule product candidates that are in various stages of development ranging from preclinical studies to advanced stage clinical trials. The Companys lead product candidate,
Entereg(alvimopan), is designed to selectively block the unwanted effects of opioid
analgesics on the gastrointestinal tract. The Company is collaborating with Glaxo Group Limited (Glaxo) for the global development and commercialization of Enteregin multiple indications. The Companys next product candidate is a sterile lidocaine patch in clinical development for treating
postoperative incisional pain. The Companys other product candidates are analgesics in preclinical development for treating moderate-to-severe pain conditions.



Currently, the Companys revenues are derived from its collaboration agreement with Glaxo. The Company has not
generated any product sales revenues, has incurred operating losses since inception, and has not achieved profitable operations. The Companys deficit accumulated during the development stage through March 31, 2005 aggregated approximately
$261.9 million, and the Company expects to continue to incur substantial losses in future periods. The Company is highly dependent on the success of its research, development and licensing efforts and, ultimately, upon regulatory approval and market
acceptance of its products under development, particularly its lead product candidate, Entereg. There is no assurance that the Company will ever receive regulatory approval for any of its product candidates, generate product sales revenues, achieve profitable operations and generate positive cash flows from operations, or
that profitable operations, if achieved, could be sustained on a continuing basis. The Company will need to raise additional funds to finance its operating activities prior to exhausting its current cash, cash equivalents and short-term investments.
There are no assurances that the Company will be successful in obtaining an adequate level of financing for the long-term development and commercialization of its product candidates.



Interim Financial Information



The consolidated financial statements include the accounts of Adolor Corporation and its wholly owned subsidiary. All significant intercompany accounts
and transactions have been eliminated in consolidation. The information at March 31, 2005 and for periods ended March 31, 2005 and 2004, is unaudited but includes all adjustments (consisting only of normal recurring adjustments) which, in the
opinion of management, are necessary to state fairly the financial information set forth in accordance with U.S. generally accepted accounting principles. The interim results are not necessarily indicative of results to be expected for the full
fiscal year. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2004 included in the Companys Annual Report on Form 10-K filed with the
Securities and Exchange Commission.



2. COMPREHENSIVE LOSS



The following is the reconciliation of net loss to comprehensive loss for
the three months ended March 31, 2005 and 2004:



|                                                           |  |                              |             |   |      |   |             |  
|---------------------------------------------------------- |  | ---------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                           |  | Three months ended March 31, |            
|                                                           |  | 2005                         |             |   | 2004 |  
|Net loss                                                   |  | $                            | (11,968,041 | ) |      | $ | (10,277,109 | )
|Unrealized gains/(losses) on available for sale securities |  |                              | (191,060    | ) |      |   | 7,049       |  
|Realized gain on available for sale securities             |  |                              |            |   |      |   | (60,768     | )
|                                                           |  |                              |             |   |      |   |             |  
|Comprehensive loss                                         |  | $                            | (12,159,101 | ) |      | $ | (10,330,828 | )
|                                                           |  |                              |             |   |      |   |             |  



4



---

##### Table of Contents

Adolor Corporation

(A Development Stage Company)



Notes to Consolidated Financial Statements



March 31, 2005

(Unaudited)



3. SHORT-TERM INVESTMENTS



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



The following summarizes the short-term
investments at March 31, 2005 and December 31, 2004:



|                                                              |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|------------------------------------------------------------- |  | ---- | ----------- | -------------------- | - | --------------------- |  | - | ---------- | - |  | - | -----------
|                                                              |  | Cost |             | Grossunrealizedgains |   | Grossunrealizedlosses |  |   | Fair value
|U.S. Government obligations                                   |  | $    | 139,505,822 |                      | $ | 1,558                 |  | $ | (656,075   | ) |  | $ | 138,851,305
|                                                              |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|March 31, 2005                                                |  |      | 139,505,822 |                      |   | 1,558                 |  |   | (656,075   | ) |  |   | 138,851,305
|                                                              |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|Corporate bonds                                               |  | $    | 2,050,510   |                      | $ |                      |  | $ | (9,290     | ) |  | $ | 2,041,220  
|U.S. Government obligations                                   |  |      | 153,801,055 |                      |   |                      |  |   | (454,167   | ) |  |   | 153,346,888
|                                                              |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|December 31, 2004                                             |  | $    | 155,851,565 |                      | $ |                      |  | $ | (463,457   | ) |  | $ | 155,388,108
|                                                              |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|At March 31, 2005, maturities of investments were as follows: |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|Less than 1 year                                              |  | $    | 104,283,052 |                      | $ |                      |  | $ | (514,332   | ) |  | $ | 103,768,720
|1-2 years                                                     |  |      | 35,222,770  |                      |   | 1,558                 |  |   | (141,743   | ) |  |   | 35,082,585 
|                                                              |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|                                                              |  | $    | 139,505,822 |                      | $ | 1,558                 |  | $ | (656,075   | ) |  | $ | 138,851,305
|                                                              |  |      |             |                      |   |                       |  |   |            |   |  |   |            



5



---

##### Table of Contents

Adolor Corporation

(A Development Stage Company)



Notes to Consolidated Financial Statements



March 31, 2005

(Unaudited)



4. CONTRACT REVENUES



Contract revenues for the three months ended March 31, 2005 and 2004 consist of the following:



|                                           |  |                              |           |      |   |          
|------------------------------------------ |  | ---------------------------- | --------- | ---- | - | ---------
|                                           |  | Three months ended March 31,
|                                           |  | 2005                         |           | 2004
|Amortization of up-front license fees      |  | $                            | 1,041,669 |      | $ | 1,041,669
|Collaborative agreement cost reimbursement |  |                              | 1,619,651 |      |   | 2,603,822
|Co-promotion revenue                       |  |                              | 255,000   |      |   |         
|                                           |  |                              |           |      |   |          
|Total revenue                              |  | $                            | 2,916,320 |      | $ | 3,645,491
|                                           |  |                              |           |      |   |          



In April 2002, the
Company entered into a collaboration agreement with Glaxo for the exclusive worldwide development and commercialization of Enteregfor certain indications. Under the terms of the agreement, Glaxo paid the Company a non-refundable and non-creditable signing fee of $50.0 million during the quarter ended June 30, 2002. The $50.0
million signing fee is reflected in deferred licensing fees and is expected to be recognized as revenue on a straight-line basis through April 2014, the estimated performance period under the collaboration agreement. Revenue related thereto of
approximately $1.0 million was recognized in the three month period ended March 31, 2005 and 2004.



External expenses for research and development and marketing activities incurred by each company in the United States are reimbursed by the other party
pursuant to contractually agreed percentages. Contract reimbursement amounts owed to the Company by Glaxo are recorded gross on its consolidated statements of operations as collaborative agreement cost reimbursement revenue. The Company recorded
collaborative agreement cost reimbursement revenues of approximately $1.6 million and $2.6 million in the three months ended March 31, 2005 and 2004, respectively, under this arrangement. As of March 31, 2005 and December 31, 2004, approximately
$1.6 million and $3.4 million, respectively, were receivable from Glaxo for reimbursement of expenses incurred by the Company pursuant to the collaboration agreement.



The Company is currently establishing a 30 person, surgeon-focused sales force to collaborate with Glaxo representatives to
co-promote Glaxos anti-thrombotic agent, Arixtra®. Under the terms of the agreement,
Glaxo will provide certain cost reimbursement to Adolor for its promotion of Arixtra®. The
Company recognized revenues of $255,000 in the three months ended March 31, 2005 related thereto, which amount is receivable from Glaxo at March 31, 2005.



6



---

##### Table of Contents

Adolor Corporation

(A Development Stage Company)



Notes to Consolidated Financial Statements



March 31, 2005

(Unaudited)



5. STOCK-BASED COMPENSATION



The Company accounts for stock option issuances to employees and members of the Board of Directors in accordance with the provisions of Accounting
Principal Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations. The Company does not record compensation expense on options granted to employees with exercise prices equal to fair
market value at date of grant. Deferred compensation is recorded only to the extent that the current estimated fair value of the underlying stock exceeds the exercise price of the options on the date of grant. Such deferred compensation is amortized
on a straight-line basis over the respective vesting periods of such option grants.



In December 2002, the Financial Accounting Standards Board (FASB) issued Statement No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure, which amended FASB
Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this
statement amended the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method
used on reported results. The disclosure requirements of Statement No. 148 have been incorporated herein.



In December 2004, the FASB issued Statement No. 123R, Share-Based Payment, a revision to Statement No. 123, Accounting for Stock-Based
Compensation. This statement supercedes APB No.25, Accounting for Stock Issued to Employees, and its related implementation guidance. This statement establishes standards for the accounting for which an entity exchanges its equity
instruments for goods or services. This statement also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entitys equity instruments or that may be settled by
the issuance of those equity instruments. This statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost shall be
recognized over the period during which an employee is required to provide service in exchange for the award  the requisite service period (vesting period). The grant-date fair value of employee share options will be estimated using
option-pricing models adjusted for the unique characteristics of those instruments. This statement is effective as of the beginning of the next fiscal year that begins after June 15, 2005. The Company is currently evaluating various implementation
standards of Statement No. 123R, including adoption methods and option pricing methodology. The Company expects that adoption of this statement will have a material impact on the Consolidated Financial Statements.



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



|                                                                                                 |  |                              |             |   |      |   |             |  
|------------------------------------------------------------------------------------------------ |  | ---------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                                                                 |  | Three months ended March 31, |            
|                                                                                                 |  | 2005                         |             |   | 2004 |  
|Net loss, as reported                                                                            |  | $                            | (11,968,041 | ) |      | $ | (10,277,109 | )
|Add: Stock-based employee compensation expense included in reported net loss                     |  |                              | 3,130       |   |      |   | 264,698     |  
|Deduct: Total stock-based employee compensation expense determined under fair value based method |  |                              | (1,814,952  | ) |      |   | (2,145,201  | )
|                                                                                                 |  |                              |             |   |      |   |             |  
|Pro forma net loss                                                                               |  | $                            | (13,779,863 | ) |      | $ | (12,157,612 | )
|                                                                                                 |  |                              |             |   |      |   |             |  
|Net loss per share:                                                                              |  |                              |             |   |      |   |             |  
|Basic and diluted-as reported                                                                    |  | $                            | (0.31       | ) |      | $ | (0.26       | )
|Basic and diluted-pro forma                                                                      |  | $                            | (0.35       | ) |      | $ | (0.31       | )



7



---

##### Table of Contents

Adolor Corporation

(A Development Stage Company)



Notes to Consolidated Financial Statements



March 31, 2005

(Unaudited)



6. LEGAL PROCEEDINGS



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



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



8



---

##### Table of Contents

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



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



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



| |  |  | our product development efforts, including results from clinical trials;
| | - |  | ------------------------------------------------------------------------



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



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



| |  |  | analysis and interpretation of data by regulatory authorities;
| | - |  | --------------------------------------------------------------



| |  |  | anticipated operating losses and capital expenditures;
| | - |  | ------------------------------------------------------



| |  |  | our intentions regarding the establishment of collaborations;
| | - |  | -------------------------------------------------------------



| |  |  | anticipated efforts of our collaborators;
| | - |  | -----------------------------------------



| |  |  | estimates of the market opportunity and the commercialization plans for our product candidates, including our plans for the establishment of a sales force;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our intention to rely on third parties for manufacturing;
| | - |  | ---------------------------------------------------------



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



| |  |  | the scope of third party patent rights;
| | - |  | ---------------------------------------



| |  |  | our ability to raise additional capital; and
| | - |  | --------------------------------------------



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



In some cases, you can identify forward-looking statements by terminology such as may, will, should,
could, would, expect, plan, anticipate, believe, estimate, target, goal, continue, or the negative of such terms or other similar
expressions. Factors that might cause or contribute to differences include, but are not limited to, those discussed elsewhere in this Report in Item 2 Managements Discussion and Analysis of Financial Condition and Results of
Operations, (including a subsection thereof entitled Certain Risks Related to our Business) and discussed in our other Securities and Exchange Commission (SEC) filings.



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



9



---

##### Table of Contents

Company



Overview



We are a development stage biopharmaceutical corporation that was formed in 1993. We specialize in the discovery, development and commercialization of
prescription pain management products. We have a number of small molecule product candidates that are in various stages of development ranging from preclinical studies to advanced stage clinical trials. Our lead product candidate,
Entereg(alvimopan), is designed to selectively block the unwanted effects of opioid
analgesics on the gastrointestinal (GI) tract. We are collaborating with Glaxo Group Limited (Glaxo) for the global development and commercialization of Enteregin multiple indications. Our next product candidate is a sterile lidocaine patch in clinical development for treating postoperative
incisional pain. Our other product candidates are analgesics in preclinical development for treating moderate-to-severe pain conditions.



We have invested a significant portion of our time and financial resources since our inception in the development of Entereg, and our potential to achieve revenues from product sales in the foreseeable future is dependent
largely upon obtaining regulatory approval for and successfully commercializing Entereg,
especially in the United States. We have completed four Phase III clinical studies of Enteregfor the management of postoperative ileus (POI), and submitted a New Drug Application (NDA) for Entereg12 mg capsule to the FDA in June 2004. Additionally, Glaxo has completed a Phase III study evaluating Enteregin POI conducted in Europe, Australia and New Zealand, (Study 001). In January 2005, the
FDA requested that the Company provide information from Glaxo Study 001 and the Company indicated its goal was to deliver the information in a time frame that would allow for a Prescription Drug User Fee Act (PDUFA) target action date
extension. The final component of the requested information, the clinical study report from Study 001, was submitted to the FDA in April 2005. With that, the FDA has extended the PDUFA target action date from April 25, 2005 to July 25, 2005.



There is no assurance that the FDA will approve our NDA for
Entereg. FDA approval of our NDA is contingent on many factors, including a favorable
review of preclinical and clinical data, as well as information with respect to the manufacture of Entereg. Additionally, foreign country regulatory approvals are required prior to commercialization of Enteregoutside the United States. Even if Enteregis approved for sale, we will not be successful unless Entereggains
market acceptance. Enteregis also being clinically evaluated in chronic indications by
Glaxo, and there is no assurance that these studies will be successful. We may never receive regulatory approval for any of our product candidates, generate product sales revenues, achieve profitable operations, or generate positive cash flows from
operations, and even if profitable operations are achieved, these may not be sustained on a continuing basis.



POI Clinical Development Program



Enteregis being clinically evaluated in both acute and chronic indications. Our EnteregPOI Phase III clinical program included four studies which have been completed. Three of these studies (POI 14CL302, POI 14CL308 and POI 14CL313) were double-blind, placebo-controlled multi-center studies, each designed to enroll
patients scheduled to undergo certain types of major abdominal surgery and receiving opioids for pain relief. Under the protocols, patients were randomized into three arms to receive placebo, 6 mg or 12 mg doses of Entereg. The primary endpoint in these three efficacy studies was time to recovery of GI function
(GI3), a composite measure of the time to recovery of both upper and lower GI function, as defined by time to tolerability of solid foods, and time to first flatus or first bowel movement, whichever occurred last. The fourth POI clinical
study in our Phase III program, POI 14CL306, was a double-blind, placebo-controlled multi-center observational safety study under which patients were randomized to receive either Entereg12 mg (413 patients) or placebo (106 patients). GI3 was included as one of the secondary endpoints in the study. Glaxo has also
completed a Phase III study (Study SB-767905/001) evaluating Enteregin POI.



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



The hazard ratio measures the degree of difference between the study drug group and the placebo group. A hazard ratio of 1 would indicate no difference between the study drug group and the placebo group in achieving the endpoint. A hazard
ratio of 1.5 means that, on the average during the course of the data collection period, the subjects receiving test drug are 50% more likely to



10



---

##### Table of Contents

achieve the endpoint. Statistical analyses estimate the probability that a positive effect is actually produced by the
drug. This probability is expressed as a P value which refers to the likelihood that the difference measured between the drug group and the placebo group occurred just by chance. For example, when a P value is reported as
P<0.05, the probability that the drug produced an effect by chance is less than 5%.



Study 313.In September 2003, we announced top-line results of our second POI Phase III clinical study, POI 14CL313. Study POI 14CL313 enrolled 510
patients and was designed to include large bowel resection patients, small bowel resection patients and radical hysterectomy patients, and exclude simple hysterectomy patients. A statistically significant difference was achieved in the primary
endpoint of the study, time to recovery of GI function, in both the Entereg6 mg and 12
mg treatment groups compared to the placebo group (Cox proportional hazard model; for 6 mg group, hazard ratio = 1.28; P < 0.05; for 12 mg group, hazard ratio = 1.54; P < 0.01). A difference in favor of Enteregwas observed for all of the secondary endpoints in both the 6 mg and 12 mg treatment groups,
including time to hospital discharge order written. The most frequently observed adverse events in both the placebo and treatment groups were nausea, vomiting and hypotension.



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



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



Based on the results from these studies we submitted a NDA for Entereg12 mg capsule to the FDA in June 2004. Subsequently the FDA requested us to submit data from study SB 767905/001.



Study 001.In December 2004, we reported top line results from a Phase
III clinical study of Enteregin POI, SB-767905/001. Study 001 was conducted in Europe,
Australia and New Zealand by Glaxo and enrolled 741 bowel resection patients, and 170 radical hysterectomy patients. The prespecified primary analysis group only included the bowel resection patients. The primary endpoint results (GI3)
of the study were (Cox proportional hazard model) for the 6 mg group, hazard ratio = 1.22 (P=0.042); and for the 12 mg group, hazard ratio = 1.13 (P=0.20), each as compared to placebo. These results are not statistically significant; due to the
multiple dose comparison to a single placebo group, a P-value of less than 0.025 would be required in the 6 mg dose group to be considered statistically significant.



OBD and Chronic Constipation Clinical Development Programs



In March 2005, Glaxo and Adolor announced initial top-line results from two
Phase II studies of Enteregconducted by Glaxo. The Phase IIb study (SB-767905/011)
evaluated Enteregfor treatment of opioid-induced bowel dysfunction (OBD),
which results from the use of opioids in patients suffering from chronic pain. The Phase IIa study (SB-767905/007) investigated Enteregin patients with chronic idiopathic constipation (CIC) not associated with opioid use.



In the Phase IIb study, in 522 non cancer patients with OBD, all three oral Enteregdosage regimens achieved statistically significant effects on the primary and secondary endpoints compared with placebo. The primary
endpoint was the change from baseline in weekly frequency of spontaneous bowel movements (SBM) (defined as bowel movements with no laxative use in the previous 24 hours) over the first half of the 6-week treatment period. All groups
reported an SBM frequency of approximately 1 per week during the baseline period. The average weekly change from baseline over weeks 1-3 was 3.36 SBM for the Entereg0.5 mg, twice daily treatment group, 3.29 SBM for the Entereg1mg, once daily treatment group and 4.17 SBM for the Entereg1 mg, twice daily treatment group compared to 1.65 SBM for the placebo group. All Enteregtreatment groups were statistically significantly different from placebo at the P<0.001 level.



11



---

##### Table of Contents

In this Phase IIb study adverse events affecting the GI tract were the most common, occurring in 30%-43%
of Enteregtreated patients, compared to 36% on placebo. The most frequently reported
adverse events were abdominal pain, nausea and diarrhea and GI adverse events were also the most common reason for study withdrawal.



Further clinical evaluation of Enteregin OBD is planned. A Phase III clinical trial program is being developed, which under the collaboration agreement, Glaxo would lead.



In the Phase IIa study in chronic constipation, there were no statistically significant differences from placebo for any
dose of Enteregon the primary or secondary endpoints, or in key subgroups.



Sterile Patch Program (ADL 8-7223)



In July 2003, we entered into an agreement with EpiCept under which we
licensed exclusive rights to develop and commercialize in North America a sterile lidocaine patch which is being developed for the management of postoperative incisional pain. We made a $2.5 million payment to EpiCept upon execution of the
agreement, and may make up to $20.0 million in additional milestone payments if certain clinical and regulatory achievements are reached.



A clinical study of this sterile lidocaine patch was previously conducted by EpiCept in Germany and enrolled 215 hospitalized patients undergoing hernia
repair. Patients were randomized to receive a patch containing one of two doses of lidocaine or a placebo patch. The surgeons placed the sterile patch over the sutured incision at the end of the procedure and recorded pain scores from 2 to 48 hours.
A 27% reduction in post-incisional pain was observed in patients receiving the higher dose lidocaine patch vs. patients receiving a placebo patch. We are targeting further evaluation of this product in Phase II clinical trials in 2005.



Discovery



We maintain a research effort directed at the discovery of compounds that elicit potential analgesic effects by targeting
peripheral and central opioid receptors, as well as certain non opioid receptors. Additionally, we are exploring the development of an analgesic product candidate that would be a combination of Enteregand an opioid. This combination is intended to produce the pain relief of an opioid while reducing side effects, such as
constipation, nausea and vomiting.



Competitive Environment



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



Commercialization



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



We have a small marketing organization to support our development efforts. We
plan to co-promote Enteregalong with Glaxo in hospital-care settings, if regulatory
approval is received. We are currently establishing a 30 person, surgeon-focused sales force to collaborate with Glaxo representatives to co-promote Glaxos anti-thrombotic agent, Arixtra®. This sales force could also potentially focus on Entereg.



12



---

##### Table of Contents

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



Collaboration Agreement with Glaxo



In April 2002, we entered into a collaboration agreement with Glaxo for the exclusive worldwide development and
commercialization of Enteregfor certain indications. Under the terms of the
collaboration agreement, Glaxo paid us a non-refundable and non-creditable signing fee of $50.0 million during the quarter ended June 30, 2002. Additionally, in the third quarter of 2004, we recognized $10.0 million in revenue under this agreement
relating to achieving the milestone of acceptance for review of our NDA by the FDA. We may receive additional milestone payments over the remaining term of the agreement upon the successful achievement, if any, of certain clinical and regulatory
objectives. The milestone payments relate to substantive achievements in the development lifecycle and it is anticipated that these will be recognized as revenue if and when the milestones are achieved.



We and Glaxo have agreed to develop Enteregfor a number of acute and chronic indications which would potentially involve the use of
Enteregin in-patient and out-patient settings. In the United States, we and Glaxo
intend to co-develop and intend to co-promote Enteregand share development expenses and
commercial returns, if any, pursuant to contractually agreed percentages. We have overall responsibility for development activities for acute care indications such as POI, and Glaxo has overall responsibility for development activities for chronic
care indications such as opioid bowel dysfunction. Outside the United States, Glaxo will be responsible for the development and commercialization of Enteregfor all indications, and we will receive royalties on sales revenues, if any.



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



Glaxo
has certain rights to terminate the collaboration agreement. Glaxo also has the right to terminate its rights and obligations with respect to the acute-care indications, or its rights and obligations for the chronic-care indications. Glaxo has the
right to terminate the collaboration agreement for breach of the agreement by us or for safety related reasons as defined in the collaboration agreement. Glaxos rights to terminate the acute-care indications or the chronic-care indications are
generally triggered by failure to achieve certain milestones within certain timeframes, adverse product developments or adverse regulatory events. If Glaxo exercises its termination rights under the collaboration agreement, we may not be able to
find a new collaborator to replace Glaxo, and our business will be adversely affected.



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



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



We recorded
collaborative agreement cost reimbursement revenue of approximately $1.6 million in the three months ended March 31, 2005 under the Glaxo arrangement. These revenues represent reimbursement of expenses incurred by us primarily in our POI development
program. Additionally, we recorded research and development and marketing expenses of approximately $1.3 million in the three months ended March 31, 2005, representing reimbursement by us to Glaxo of expenses incurred by Glaxo primarily in the OBD
development program.



Liquidity and Capital Resources



We have experienced negative operating cash flows since
our inception, and have funded our operations primarily from the proceeds received from the sale of our equity securities, as well as from contract revenues. Cash, cash equivalents and short-term investments were approximately $147.0 million at
March 31, 2005, and approximately $162.3 million at December 31, 2004, representing 91.2% and 91.1% of our total assets, respectively. We invest excess cash in investment-grade fixed income securities, including United States Treasury obligations.



13



---

##### Table of Contents

We believe that our current financial resources and sources of liquidity are adequate to fund operations
into 2007 based upon our expectations of the level of research and development, marketing and administrative activities necessary to achieve our strategic objectives.



The following is a summary of selected cash flow information for the three months ended March 31, 2005 and 2004:



|                                          |  |                              |             |   |      |   |             |  
|----------------------------------------- |  | ---------------------------- | ----------- | - | ---- | - | ----------- | -
|                                          |  | Three Months Ended March 31, |            
|                                          |  | 2005                         |             |   | 2004 |  
|Net loss                                  |  | $                            | (11,968,041 | ) |      | $ | (10,277,109 | )
|Adjustments for non-cash operating items  |  |                              | 678,136     |   |      |   | 936,868     |  
|                                          |  |                              |             |   |      |   |             |  
|Net cash operating loss                   |  |                              | (11,289,905 | ) |      |   | (9,340,241  | )
|Net change in assets and liabilities      |  |                              | (3,347,410  | ) |      |   | (5,462,549  | )
|                                          |  |                              |             |   |      |   |             |  
|Net cash used in operating activities     |  | $                            | (14,637,315 | ) |      | $ | (14,802,790 | )
|                                          |  |                              |             |   |      |   |             |  
|Net cash provided by investing activities |  | $                            | 15,861,639  |   |      | $ | 13,994,942  |  
|                                          |  |                              |             |   |      |   |             |  
|Net cash provided by financing activities |  | $                            | 6,496       |   |      | $ | 54,677      |  
|                                          |  |                              |             |   |      |   |             |  



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



Net operating cash outflows for the three months ended March 31, 2005 have resulted primarily from research and development expenditures associated with our product candidates, including clinical development for Entereg, compensation costs, and marketing, general and administrative expenses. These outflows were
partially offset by cost reimbursement amounts received from Glaxo.



We expect to continue to use cash resources to fund operating losses. We expect that our operating losses in future quarters will increase as a result of continuing research and development expenses, as well as increased manufacturing
efforts and other costs incurred in preparation for the potential commercialization of Entereg, including marketing and sales force related expenses. We are currently establishing a 30 person sales force. We expect that as Glaxo incurs increasing expenses related to the OBD program in the United States, we will incur
substantial expenses relating to reimbursements owed to Glaxo. Further, we may in-license or acquire product candidates which will require additional cash outlays.



Net Cash Provided By Investing Activities and Investing Requirements Outlook



Net cash provided by investing activities for the three months ended March
31, 2005 relates primarily to maturities of investments, partially offset by expenditures for laboratory equipment and information technology to support our research and development activities.



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



Net Cash Provided By Financing Activities and Financing Requirements
Outlook



We may never receive regulatory approval for any
of our product candidates, generate product sales revenues, achieve profitable operations or generate positive cash flows from operations, and even if profitable operations are achieved, these may not be sustained on a continuing basis. We expect to
continue to use our cash and investments resources to fund operating and investing activities. We believe that our existing cash, cash equivalents and short-term investments of approximately $147.0 million as of March 31, 2005 will be sufficient to
fund operations into 2007. Prior to exhausting our current cash reserves, we will need to raise additional funds to finance our operating activities. If we do not raise additional cash, we may be required to curtail or limit certain marketing
support and research and development activities. A curtailment of certain activities would delay or possibly prevent development of certain of our products. We may seek to obtain additional funds through equity or debt financings or strategic
alliances with third parties. These financings could result in substantial dilution to the holders of our common stock. Any such required financing may not be available in amounts or on terms acceptable to us.



14



---

##### Table of Contents

Results of Operations



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



Contract revenues. Our contract revenues were approximately $2.9
million and $3.6 million for the three months ended March 31, 2005 and 2004, respectively. This decrease in revenue in 2005 compared to 2004 relates principally to a decrease in expenses incurred by us which are reimbursed by Glaxo under our
collaboration agreement.



Research and development expenses.Our research and development expenses consist primarily of salaries and other personnel-related expense, costs of clinical trials, costs to manufacture product candidates, technology licensing costs, laboratory supply costs and facility-related
costs. Research and development expenses increased to approximately $10.1 million for the three months ended March 31, 2005 from approximately $9.6 million for the three months ended March 31, 2004. This increase in 2005 is related to increases in
manufacturing development costs for product development candidates and general operating expenses.



Our research and development expenses can be identified as internal or external expenses. Internal expenses include expenses such as personnel, laboratory
operating and overhead related expenses. These expenses totaled approximately $5.4 million and $5.1 million in the three months ended March 31, 2005 and 2004, respectively, and are largely related to our Enteregdevelopment efforts. External expenses include expenses incurred with clinical research organizations,
contract manufacturers, and other third party vendors and can be allocated to significant research and development programs as follows:



|                      |  |                              |           |      |   |          
|--------------------- |  | ---------------------------- | --------- | ---- | - | ---------
|                      |  | Three months ended March 31,
|                      |  | 2005                         |           | 2004
|Entereg Program      |  | $                            | 3,792,641 |      | $ | 3,604,991
|Sterile Patch Program |  |                              | 102,672   |      |   | 402,750  
|Other Programs        |  |                              | 788,519   |      |   | 496,365  
|                      |  |                              |           |      |   |          
|Total                 |  | $                            | 4,683,832 |      | $ | 4,504,106
|                      |  |                              |           |      |   |          



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



Marketing, general and administrative expenses. Our marketing, general and administrative expenses increased to approximately $5.6 million for the three months ended March 31, 2005 from approximately $5.1
million in the three months ended March 31, 2004. These increases in 2005 are principally related to increased personnel expenses.



Net Loss Outlook



We have not generated any product sales revenues, have incurred operating losses since inception and have not achieved profitable operations. Our deficit
accumulated during the development stage through March 31, 2005 aggregated approximately $261.9 million, and we expect to continue to incur substantial losses in future periods. We expect that our operating losses in future periods will increase as
a result of continued research and development expenses, and increased manufacturing, marketing, sales and other costs incurred relating to the potential commercialization of Entereg, including marketing and sales force related expenses. We are currently establishing a 30 person sales force. We expect that as
Glaxo incurs increasing expenses related to the OBD program in the United States, we will incur substantial expenses relating to reimbursements owed to Glaxo. Further, we may in-license or acquire product candidates which will require additional
cash outlays.



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



15



---

##### Table of Contents

Certain Risks Related to Our Business



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



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



We have invested a
significant portion of our time and financial resources since our inception in the development of Entereg, and our potential to achieve revenues from product sales in the foreseeable future is dependent upon obtaining regulatory approval for and successfully commercializing Entereg, especially in the United States. Prior to commercialization of Enteregin the United States, the FDA would have to approve our NDA for Entereg. Drug development is a highly uncertain process. There is no assurance that the FDA will approve Enteregfor POI or any other indication. Additionally, foreign country regulatory approval is required prior
to commercialization of Enteregoutside of the United States. There is no assurance that
Glaxo will seek approval of Enteregin countries outside the United States, or that such
approval would be obtained.



Certain results from Phase
III clinical trials show that the differences in the primary endpoint analyses between EnteregTMand placebos are not
statistically significant.



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



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



These results may make it more difficult to achieve regulatory approval of Entereg.



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



Even if we conclude that the results from our preclinical studies and clinical trials of EnteregTMfor POI are positive, the FDA may not agree with us.



While we believe the results of studies POI 14CL302, POI 14CL313, POI 14CL306 and POI
14CL308, support our goal of obtaining approval for Enteregin the United States, there
can be no assurance that the FDA will concur with that assessment. The FDA may evaluate the results by different methods or conclude that the clinical trial results are not statistically significant or clinically meaningful, or that there were human
errors in the conduct of the clinical trials or otherwise. Even if we believe we have met the FDA guidelines for submission of data and information to the NDA, there is a risk that the FDA will require additional data and information that may
require additional time to accumulate, or that we are unable to provide.



We
have provided information from Study 001 to the FDA, as part of its review of our NDA for Entereg. The PDUFA target action date for our NDA has been extended to July 25, 2005 to allow for a review of data from Study 001. There can be no assurance that information from Study 001 will not negatively impact the consideration by the
FDA of the approval of the NDA.



16



---

##### Table of Contents

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



We and Glaxo expect to continue to clinically evaluate
Enteregin both acute and chronic conditions. Glaxo is targeting additional studies in
OBD. We are conducting, or planning to conduct, additional studies in the United States of Enteregincluding an on-going study evaluating quality of life, timing of pre-operative dosing, and GI recovery in POI. Unfavorable results in any study may adversely affect our ability to obtain FDA or other regulatory approval of
Entereg, and even if approved, may adversely affect market acceptance for
Entereg.



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



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



EnteregTMmay not be
successfully developed for chronic use.



Results from the clinical studies conducted to date in OBD are not necessarily indicative of the results that may be obtained in further studies, or in clinical studies
in the POI indication. Additional Phase III clinical studies in OBD are in development, and if conducted, may not be successful. The long-term animal toxicity studies necessary to support further development of Enteregfor chronic use are on-going. Adverse safety findings in these long-term animal toxicity studies
could adversely affect our prospects for Entereg, including its prospects for use in
POI.



In the Phase IIa study in chronic constipation, there were no
statistically significant differences from placebo for any dose of Enteregin the
primary or secondary endpoints, or in the key sub groups. There are currently no additional clinical studies of Enteregin this indication in development.



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



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



| |  |  | the breadth of the indication for which Enteregmay receive approval;
| | - |  | ---------------------------------------------------------------------



| |  |  | the establishment and demonstration in the medical community of the safety and clinical efficacy of Enteregand its potential advantages over competitive products; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



17



---

##### Table of Contents

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



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



| |  |  | the size of the patient population;
| | - |  | -----------------------------------



| |  |  | the nature of the clinical protocol requirements;
| | - |  | -------------------------------------------------



| |  |  | the diversion of patients to other trials or marketed therapies;
| | - |  | ----------------------------------------------------------------



| |  |  | the ability to recruit and manage clinical centers and associated trials;
| | - |  | -------------------------------------------------------------------------



| |  |  | The proximity of patients to clinical sites; and
| | - |  | ------------------------------------------------



| |  |  | The patient eligibility criteria for the study.
| | - |  | -----------------------------------------------



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



In clinical study POI 14CL302, discontinuation rates were 21%, 16%, and 27% in the placebo
group, 6 mg dose group and 12 mg dose group, respectively. This resulted in fewer efficacy evaluable patients in the placebo and 12 mg treatment groups compared to the 6 mg treatment group. Following the analysis of study POI 14CL302, we increased
enrollment in studies POI 14CL313 and POI 14CL308, with the objective of potentially increasing the number of efficacy evaluable patients in each dose group in our ongoing studies. These enrollment increases have extended the timeline for completion
of our POI development program. In study POI 14CL313 discontinuation rates were 30%, 23% and 19% in the placebo, 6 mg and 12 mg dose groups, respectively. In study POI 14CL308 discontinuation rates were 13%, 14% and 14% in the placebo, 6 mg and 12
mg treatment groups, respectively.



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



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



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



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



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



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



18



---

##### Table of Contents

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



| |  |  | competitors may market equivalent or superior products.
| | - |  | -------------------------------------------------------



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



The market price for our common stock has been highly volatile and may continue to be highly
volatile in the future. For example, in the calendar year ended December 31, 2004, the closing price of our common stock reached a low of $8.78 per share in December 2004 and a high of $22.24 per share in January 2004.



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



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



| |  |  | developments concerning our collaborations, including our collaboration with Glaxo;
| | - |  | -----------------------------------------------------------------------------------



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



| |  |  | developments concerning proprietary rights, including patents;
| | - |  | --------------------------------------------------------------



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



| |  |  | regulatory developments in the United States and foreign countries;
| | - |  | -------------------------------------------------------------------



| |  |  | litigation;
| | - |  | -----------



| |  |  | economic and other external factors or other disasters or crises;
| | - |  | -----------------------------------------------------------------



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



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



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



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



On April 21, 2004, a lawsuit was filed in the United States District Court for the Eastern
District of Pennsylvania against the Company, one of its directors and certain of its officers seeking unspecified damages on behalf of a putative class of persons who purchased Company common stock between September 23, 2003 and January 14, 2004.
The complaint alleges violations of Section 10(b) and section 20(a) of the Securities Exchange Act of 1934 (the Exchange Act), in connection with the announcement of the results of certain studies in the Companys Phase III clinical
trials for Entereg, which allegedly had the effect of artificially inflating the price
of the Companys common stock. This suit has been consolidated with three subsequent actions asserting similar claims under the caption:In re Adolor Corporation Securities Litigation, No. 2:04-cv-01728. On December 29, 2004, the
district court issued an order appointing the Greater Pennsylvania Carpenters Pension Fund as Lead



19



---

##### Table of Contents

Plaintiff. The appointed Lead Plaintiff filed a consolidated amended complaint on February 28, 2005. The Complaint
purported to extend the class period, so as to bring claims on behalf of a putative class of Adolor shareholders who purchased stock between September 23, 2003 and December 22, 2004. The Complaint also adds as defendants the Companys Board of
Directors asserting claims against them and the other defendants for violation of Section 11 and Section 15 of the Securities Act of 1933 in connection with the Companys public offering of stock in November 2003. The Company and the management
and director defendants responded to the Complaint on April 29, 2005. The Company believes that the allegations are without merit and intends to vigorously defend the litigation.



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



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



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



We believe our existing cash, cash equivalents and
short-term investments as of March 31, 2005 of approximately $147.0 million will be sufficient to fund operations into 2007. We have generated operating losses since we began operations in November 1994. We expect to continue to generate such losses
and will need additional funds that may not be available in the future. We have no products that have generated any revenue, and as of March 31, 2005, we have incurred a cumulative net loss of approximately $261.9 million. During the calendar years
ended December 31, 2004 and 2003, we incurred operating losses of approximately $46.1 million and $53.6 million, respectively, and net losses of approximately $43.6 million and $51.2 million, respectively. During the three month period ended March
31, 2005 we incurred operating losses of approximately $12.8 million and net losses of approximately $12.0 million. Even if we succeed in securing regulatory approval of Entereg, we expect to incur substantial losses for at least the next several years and expect that these losses will increase as we expand
our research and development and sales and marketing activities. If we fail to obtain the capital necessary to fund our operations, we will be forced to curtail our operations and we will be unable to develop products successfully. We do not know
whether additional financing will be available when needed, or that, if available, we will obtain financing on terms favorable to our stockholders or to us. If adequate funds are not available on acceptable terms, our ability to fund our operations,
products or technologies or otherwise respond to competitive pressures could be significantly delayed or limited, and we may have to reduce or cease our operations. If additional funds become available there can be no assurance that we can predict
the time and costs required to complete development programs or that we will not substantially exceed our budgets.



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



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



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



20



---

##### Table of Contents

Glaxo has certain rights to terminate the collaboration agreement. Glaxo also has the right to terminate its rights and
obligations with respect to the acute-care indications, or its rights and obligations for the chronic-care indications. Glaxo has the right to terminate the collaboration agreement for breach of the agreement by us or for safety related reasons as
defined in the collaboration agreement. Glaxos rights to terminate the acute-care indications or the chronic-care indications are generally triggered by failure to achieve certain milestones within certain timeframes, adverse product
developments or adverse regulatory events. If Glaxo terminates the collaboration agreement, we may not be able to find a new collaborator to replace Glaxo, and our business will be adversely affected.



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



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



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



To receive regulatory approval for Entereg, our contract manufacturers will be required to obtain approval for their manufacturing facilities to manufacture
Entereg, and there is a risk that such approval may not be obtained. We will be required
to submit, in an NDA, information and data regarding chemistry, manufacturing and controls which satisfies the FDA that our contract manufacturers are able to make Enteregin accordance with current Good Manufacturing Practices (cGMP). Under cGMPs, we and our manufacturers will be required
to manufacture our products and maintain records in a prescribed manner with respect to manufacturing, testing and quality control activities. We are dependent on our third party manufacturers to comply with these regulations in the manufacture of
our products and these parties may have difficulties complying with cGMPs. The failure of any third party manufacturer to comply with applicable government regulations could substantially harm and delay or prevent regulatory approval and marketing
of Entereg.



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



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



We also expect to depend on third
parties to manufacture product candidates we may acquire or in-license, including the sterile patch product we in-licensed from EpiCept. We have no experience in manufacturing sterile patch products and will need to develop our own internal
capabilities and external relationships in that regard.



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



We currently have no distribution capability and limited sales and marketing capabilities. In
order to commercialize products, if any are approved, we must internally develop sales, marketing and distribution capabilities or make arrangements with third



21



---

##### Table of Contents

parties to perform these services. If we obtain regulatory approval, we intend to sell some products directly in certain markets and rely on relationships
with established pharmaceutical companies to sell products in certain markets. To sell any of our products directly, we must develop a marketing and field force with technical expertise, as well as supporting distribution capabilities. We may not be
able to establish in-house sales and distribution capabilities or relationships with third parties. To the extent that we enter into co-promotion or other licensing arrangements, our product revenues may be lower than if we directly marketed and
sold our products, and any revenues we receive will depend upon the efforts of third parties, which efforts may not be successful.



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



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



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



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



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



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



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



We may not be able to successfully develop in-licensed product
candidates, which could prevent us from commercializing any such candidates.



We intend to explore opportunities to expand our product portfolio by acquiring or in-licensing products and/or product development candidates. In July 2003, we entered into an agreement with EpiCept, under which we obtained exclusive
rights to develop and commercialize in North America a sterile lidocaine patch which is being developed for the management of postoperative incisional pain. Although we conduct extensive evaluations of product candidate opportunities as part of our
due diligence efforts, there can be no assurance that our product development efforts related thereto will be successful or that we will not become aware of issues or complications that will cause us to alter, delay or terminate our product
development efforts.



Additionally, while we have built certain capabilities as
an organization in executing the development plan for Entereg, in-licensed products such
as this sterile patch product will require capabilities and expertise which we do not currently possess, and there is no assurance that we will be able to develop or acquire these capabilities. If we do not develop or acquire these capabilities, we
may not be able to commercialize our in-licensed products and technologies.



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



22



---

##### Table of Contents

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



Preclinical testing and clinical development are long, expensive and uncertain processes. Failure can occur at any stage of testing. Success in preclinical testing and
early clinical trials does not ensure that later clinical trials will be successful. Based on results at any stage of clinical trials, we may decide to discontinue development of our product candidates.



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



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



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



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



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



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



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



Reduction in the use of opioid analgesics would therefore reduce the
potential market for EnteregTM.



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



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



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



We believe that Progenics Pharmaceuticals, Inc. is
developing methylnaltrexone for the treatment of opioid bowel dysfunction and POI. There are products already on the market for use in treating irritable bowel syndrome which may be evaluated for utility



23



---

##### Table of Contents

in opioid induced bowel dysfunction. There may be additional competitive products about which we are not aware. If our
competitors are able to reach the commercial market before we are, this could have a material adverse effect on our ability to reach the commercial market and sell our products.



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



| |  |  | attract qualified personnel;
| | - |  | ----------------------------



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



| |  |  | license proprietary technology.
| | - |  | -------------------------------



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



We are a small company, and our success depends on our continued ability to attract,
retain and motivate highly qualified management and scientific personnel, including our president and chief executive officer, Bruce A. Peacock. Our success also depends on our ability to develop and maintain important relationships with leading
academic institutions and scientists. Competition for personnel and academic collaborations is intense. In particular, our product development programs depend on our ability to attract and retain highly skilled chemists, biologists and clinical
development personnel. If we lose the services of any of these personnel it could impede significantly the achievement of our research and development objectives. In addition, we will need to hire additional personnel and develop additional academic
collaborations as we continue to expand our research and development activities. We do not know if we will be able to attract, retain or motivate personnel or maintain relationships. We do not maintain key man life insurance on any of our employees.



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



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



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



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



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



The pharmaceutical industry is subject to stringent regulation by a wide range of authorities. We cannot predict whether we will obtain regulatory clearance for any product candidate we develop. We cannot market a
pharmaceutical product in the United States until it has completed rigorous preclinical testing and clinical trials and the FDAs extensive regulatory clearance process. Satisfaction of regulatory requirements typically takes many years, is
dependent upon the type, complexity and novelty of the product and requires the expenditure of substantial resources for research and development, testing, manufacturing, quality



24



---

##### Table of Contents

control, labeling and promotion of drugs for human use. Since neither the FDA nor international regulatory authorities
have approved peripherally restricted narcotic antagonist drugs for marketing, there is additional uncertainty as to whether our research and clinical approaches to developing new products for the pain management market will lead to drugs that the
FDA will consider safe and effective for indicated uses. Before receiving FDA approval to market a product, we must demonstrate that the product candidate is safe and effective in the patient population that will be treated. Outside the United
States, our ability to market a product is also contingent upon receiving a marketing authorization from the appropriate regulatory authorities, and is subject to similar risks and uncertainties.



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



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



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



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



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



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



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



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



25



---

##### Table of Contents

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



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



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



| |  |  | must conform with the FDAs good clinical practice regulations;
| | - |  | ---------------------------------------------------------------



| |  |  | must meet requirements for institutional review board oversight;
| | - |  | ----------------------------------------------------------------



| |  |  | must meet requirements for informed consent;
| | - |  | --------------------------------------------



| |  |  | are subject to continuing FDA oversight; and
| | - |  | --------------------------------------------



| |  |  | may require large numbers of test subjects.
| | - |  | -------------------------------------------



Before commencing clinical trials in humans, we must submit and receive approval from the FDA of an Investigational New Drug Application, or IND. We, or the FDA, may
suspend clinical trials at any time if the subjects participating in the trials are exposed to unacceptable health risks, or if the FDA finds deficiencies in the IND application or the conduct of the trials.



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



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



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



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



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



26



---

##### Table of Contents

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



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



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



| |  |  | government and health administration authorities; or
| | - |  | ----------------------------------------------------



| |  |  | private health insurers and third party payors.
| | - |  | -----------------------------------------------



The continuing efforts of government and third-party payors to contain or reduce the costs of health care through various means may limit our commercial opportunity. For
example, in some foreign markets, pricing and profitability of prescription pharmaceuticals are subject to government control. In the United States, we expect that there will continue to be a number of federal and state proposals to implement
pharmaceutical pricing and cost control measures under government health care programs such as Medicare and Medicaid. For example, federal legislation was enacted on December 8, 2003, which provides a new Medicare prescription drug benefit beginning
in 2006 and mandates other reforms. Although we cannot predict the full effects on our business of the implementation of this new legislation, it is possible that the new Medicare benefit, which will be managed by private health insurers, pharmacy
benefit managers, and other managed care organizations, will result in decreased reimbursement for prescription drugs, which may further exacerbate industry-wide pressure to reduce the prices charged for prescription drugs. This could have an
adverse effect on our business. In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical products. Significant uncertainty exists as to the reimbursement status of newly
approved health care products. Cost control initiatives could adversely affect our and our collaborators ability to commercialize our products, decrease the price that any of our collaborators or we would receive for any products in the
future, and may impede patients ability to obtain reimbursement under their insurance program for our products.



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



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



| |  |  | issue equity securities that would dilute our current stockholders percentage ownership;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | incur substantial debt that may place strains on our operations;
| | - |  | ----------------------------------------------------------------



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



| |  |  | assume substantial actual or contingent liabilities; or
| | - |  | -------------------------------------------------------



| |  |  | 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



27



---

##### Table of Contents

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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



28



---

##### Table of Contents

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



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



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



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



A substantial portion of our assets are investment grade fixed income securities, principally U.S. Treasury obligations. The market value of such
investments fluctuates with current market interest rates. In general, as rates increase, the market value of a debt instrument would be expected to decrease. The opposite is also true. To minimize such market risk, we have in the past and, to the
extent possible, will continue in the future to hold such debt instruments to maturity at which time the debt instrument will be redeemed at its stated or face value. Due to the short duration and nature of these instruments, we do not believe that
we have a material exposure to interest rate risk related to our investment portfolio. The investment portfolio at March 31, 2005 was approximately $138.9 million, and the weighted-average interest rate return on the portfolio was approximately
2.30%, with maturities of investments ranging up to 16 months.



ITEM 4. CONTROLS AND PROCEDURES



Evaluation
of Disclosure Controls and Procedures



For the quarterly
period ended March 31, 2005, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Senior Vice President, Chief Operating Officer and Chief
Financial Officer (the principal finance and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, or the
Exchange Act, as of the end of the period covered by this report. Based upon this evaluation, our President and Chief Executive Officer and our Senior Vice President, Chief Operating Officer and Chief Financial Officer concluded that as of March 31,
2005, our disclosure controls and procedures were effective.



Our management, including our President and Chief Executive Officer and our Senior Vice President 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 and Chief Financial Officer concluded that, as of March 31, 2005, our disclosure controls and procedures were effective at providing such
reasonable assurance. Because of inherent limitations, in all control systems, no evaluation of control can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.



Changes in Internal Control Over Financial Reporting



There were no changes in our internal control over financial reporting
during the quarterly period ended March 31, 2005, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



29



---

##### Table of Contents

PART II. OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



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



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



30



---

##### Table of Contents

ITEM 6. EXHIBITS:



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



|     |  |                                                                                                                                                                  
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1 |  | Summary of 2005 Executive Officer Base Salaries1                                                                                                                 
|     | 
|31.1 |  | Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.1
|     | 
|31.2 |  | Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.1
|     | 
|32.1 |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.1                                         
|     | 
|32.2 |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.1                                         

---

|1 | Filed herewith.
|- | ---------------



31



---

##### Table of Contents

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: May 5, 2005 |  | By:                |  | /s/    Bruce A. Peacock              
|                  |  |                    |  | Bruce A. Peacock                     
|                  |  |                    |  | President and Chief Executive Officer
|                  |  |                   
|                  |  | By:                |  | /s/    Michael R. Dougherty          
|                  |  |                    |  | Michael R. Dougherty                 
|                  |  |                    |  | Senior Vice President,               
|                  |  |                    |  | Chief Operating Officer and          
|                  |  |                    |  | Chief Financial Officer              



32