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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-K



(Mark One)

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



For Fiscal Year Ended December 31, 2004



OR



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



For the Transition Period from
 to



Commission File 000-30039



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ADOLOR CORPORATION

(Exact name of registrant as specified in its charter)



|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Delaware                                                      |  | 31-1429198                         
|(State or other jurisdictionof incorporation or organization) |  | (IRS EmployerIdentification Number)



|                                            |  |           
|------------------------------------------- |  | ----------
|700 Pennsylvania Drive, Exton, Pennsylvania |  | 19341     
|(Address of principal executive offices)    |  | (Zip Code)



(484) 595-1500

(Registrants telephone number, including area code)



Securities registered pursuant to Section 12(b) of the Act:None



Securities registered pursuant to Section 12(g) of the Act:



|                                                             |  |                                            
|------------------------------------------------------------ |  | -------------------------------------------
|(Title of class)                                             |  | (Name of each exchange on which registered)
|Common Stock, $0.0001 par value                              |  | NASDAQ National Market                     
|Series A Junior Participating Preferred StockPurchase Rights |  | Not applicable                             



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



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



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



The approximate aggregate market value of Common Stock held by non-affiliates
of the registrant was $541,705,270 as of June 30, 2004, the last business day of the registrants most recently completed second fiscal quarter. (For purposes of determining this amount only, the registrant has defined affiliates as including
(a) the executive officers of the registrant as of June 30, 2004, (b) all directors of the registrant as of June 30, 2004 and (c) each stockholder that informed the registrant that as of June 30, 2004 it was the beneficial owner of 10% or more of
the outstanding common stock of the registrant.)



The number of
shares of the registrants Common Stock outstanding as of February 15, 2005 was 39,086,802 shares.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the definitive proxy statement (the Definitive Proxy Statement) to be filed with the Securities and Exchange Commission in
connection with the Companys Annual Meeting of Stockholders for the fiscal year ended December 31, 2004 are incorporated by reference into Part III of this Report.



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ADOLOR CORPORATION



FORM 10-K



December 31, 2004



TABLE OF CONTENTS



|         |  |                                                                                                              |  |         
|-------- |  | ------------------------------------------------------------------------------------------------------------ |  | --------
|         |  |                                                                                                              |  | Page No.
|         |  | PART I                                                                                                       |  |         
|         |  |                                                                                                             
|Item 1.  |  | Business                                                                                                     |  | 1       
|Item 2.  |  | Properties                                                                                                   |  | 11      
|Item 3.  |  | Legal Proceedings                                                                                            |  | 11      
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                          |  | 12      
|         |  |                                                                                                             
|         |  | PART II                                                                                                      |  |         
|         |  |                                                                                                             
|Item 5.  |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 13      
|Item 6.  |  | Selected Financial Data                                                                                      |  | 13      
|Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 14      
|         |  | Certain Risks Related to Our Business                                                                        |  | 26      
|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 41      
|Item 8.  |  | Financial Statements and Supplementary Data                                                                  |  | 41      
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 41      
|Item 9A. |  | Controls and Procedures                                                                                      |  | 41      
|Item 9B. |  | Other Information                                                                                            |  | 43      
|         |  |                                                                                                             
|         |  | PART III                                                                                                     |  |         
|         |  |                                                                                                             
|Item 10. |  | Directors and Executive Officers of the Registrant                                                           |  | 44      
|Item 11. |  | Executive Compensation                                                                                       |  | 44      
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 44      
|Item 13. |  | Certain Relationships and Related Transactions                                                               |  | 44      
|Item 14. |  | Principal Accountant Fees and Services                                                                       |  | 44      
|         |  |                                                                                                             
|         |  | PART IV                                                                                                      |  |         
|         |  |                                                                                                             
|Item 15. |  | Exhibits and Financial Statement Schedules                                                                   |  | 45      
|         |  | Signatures                                                                                                   |  | 46      
|         |  | Exhibit Index                                                                                                |  | 47      
|         |  | Index to Consolidated Financial Statements                                                                   |  | F-1     



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PART I



|ITEM 1. | BUSINESS
|------- | --------



Forward-Looking Statements



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



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



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



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



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



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



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



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



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



| |  |  | estimates of the market opportunity and the commercialization plans for our product candidates, 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 7 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.



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



Our Company



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 GlaxoSmithKline
(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 capsules to the U.S. Food and Drug Administration (FDA) in June 2004. Additionally, Glaxo has
completed a Phase III study evaluating Entereg in
POI conducted in Europe, Australia, and New Zealand, information from which has been requested by the FDA as part of its review of our NDA. Our NDA has a Prescription Drug User Fee Act (PDUFA) target action date of April 25, 2005. Our
goal is to deliver the information to FDA in a timeframe that would allow for an extension of the PDUFA target action date 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.



Entereg (alvimopan)



Background



Opioid analgesics produce pain relief by blocking pain signals through
stimulation of opioid receptors located on the surface of nerves that transmit pain signals. Because there are opioid receptors also present in the GI tract, opioid analgesics can disrupt normal GI function that allows for the passage, absorption
and expulsion of ingested solid materials through the GI tract and, consequently, can cause patients to experience significant discomfort and pain. Entereg is a small molecule, peripherally-acting mu opioid receptor antagonist designed to block the adverse side effects of opioid analgesics on the
GI tract without blocking their beneficial analgesic effects.



Glaxo Collaboration



In April 2002, we
entered into a collaboration agreement with Glaxo for the exclusive worldwide development and commercialization of Entereg for certain indications. The companies have agreed to co-develop Entereg for a number of indications, both acute and chronic, which would potentially involve the use



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of Entereg in in-patient and out-patient settings. 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 (OBD). In the United States, we and Glaxo intend to co-promote Entereg and share commercial returns, if any, pursuant to contractually agreed percentages. Outside the United States, Glaxo
has responsibility for the development and commercialization of Entereg for all indications, and we will receive royalties on sales revenues, if any. 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 of up to $210.0 million over the remaining term of the agreement based upon the successful achievement, if any, of certain clinical and regulatory objectives.



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 several secondary efficacy endpoints in this 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 each 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 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 in both the



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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 this 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 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 capsules to the FDA in June 2004. Subsequently, the FDA requested us to submit
data from Study SB767905/001.



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 November 2002, we announced top-line results of Study 304 of Entereg in OBD patients. This outpatient study enrolled 168 patients who were chronic users of opioids, such as morphine and codeine, primarily for pain relief, and whose bowel function had been
impaired as a result of opioid treatment. The patients received once daily dosing for 21 days of either a 0.5 mg or 1 mg dose of Entereg or placebo. The primary endpoint of the study was the proportion of patients having a bowel movement within 8 hours after each dose of study medication
during the 21-day treatment period. On average, the proportion of patients who had at least one bowel movement within 8 hours of each dose during the 21-day treatment period was 43% for the Entereg 0.5 mg group, 55% for the Entereg 1 mg group and 29% for the placebo group. In this study Entereg was generally well tolerated; the most frequently
occurring adverse events versus placebo included diarrhea, abdominal cramps, nausea and vomiting.



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Based on the results of this study, our development and commercialization partner for Entereg, Glaxo, is currently conducting two Phase IIb studies
evaluating the use of Entereg for the reversal of
the severe constipating effects associated with the chronic use of opioids. Results from the first study are targeted by the second quarter of 2005.



Glaxo is also conducting a Phase II study evaluating Entereg in chronic constipation, results from which are targeted by the second quarter of 2005.



Sterile Patch Program (ADL 8-7223)



In July 2003, we entered into an agreement with EpiCept Corporation
(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 recruiting 30 surgeon-focused sales representatives to collaborate with Glaxo representatives to co-promote Glaxos anti-thrombotic agent, Arixtra®. This sales force could also potentially focus on Entereg.



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



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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.



Our Strategy



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



Focusing our Discovery Efforts On Opioid Receptors in Pain Management.    We focus our discovery efforts principally on
clinical conditions that can be treated by either stimulating or blocking opioid receptors. These conditions include postoperative ileus and chronic opioid bowel dysfunction, as well as various pain conditions, including inflammatory pain, itch and
visceral pain. We have biological and chemical expertise to support drug discovery, including expertise in opioid receptors in analgesic pathways, cloned human opioid, orphan and chimeric receptors and the chemical synthesis of compounds that do not
readily cross the blood-brain barrier.



We also maintain
research efforts directed at the discovery and development of compounds that exert analgesic effects by targeting certain non opioid receptors.



Implementing a Strategy that will Combine Marketing and Product Development and Marketing Alliances with our Internal Product Development and Marketing
Efforts.    We have built certain capabilities in discovery, development and commercialization in advancing our product candidates. In addition, we have established and will continue selectively to establish collaborations
with pharmaceutical companies and leading academic institutions to enhance our internal capabilities.



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



Background On Opioid Analgesia



Pain Transmission Signals.    When tissues such
as the skin, muscles and joints become inflamed or are injured, pain receptors in those tissues are activated, and electrical pain signals are transmitted from the injured tissues through nerve fibers into the spinal cord. Within the spinal cord,
the electrical pain signals are received by a second set of nerve fibers that continue the transmission of the signal up the spinal cord and into the brain. Within the brain, additional nerve fibers transmit the electrical signals to the pain
centers of the brain where these signals are perceived as pain. Pain receptors are also present in internal, or visceral, organs such as the intestines, uterus, cervix and bladder. These pain receptors also send pain signals via similar
pathways to the brain when these organs are inflamed or distended.



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



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Our Approach To Pain Management



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



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



Peripheral Opioid Receptors in the GI Tract.    Just as there are opioid receptors on peripheral nerves that regulate the transmission of pain signals into the spinal cord, there are also opioid receptors in the
gastrointestinal tract that regulate functions such as motility and water secretion and absorption. Stimulation of these gastrointestinal mu opioid receptors by morphine or other opioid analgesics causes constipation associated with opioid
bowel dysfunction. Scientists have shown that blocking these receptors with opioid receptor antagonist drugs during administration of morphine or other opioid analgesics may prevent or reverse the effects of opioid bowel dysfunction. However,
currently marketed opioid receptor antagonist drugs also cross the blood-brain barrier and enter the brain where they can block the primary pain relieving effects of opioid analgesics such as morphine. These findings have created the opportunity to
develop a new class of opioid antagonists which, when taken with opioid analgesics, are designed to block the side effects of the opioid analgesics on the GI tract but not the desired analgesic activity of opioid drugs because they are designed not
to cross the blood-brain barrier.



Centrally Acting Receptor
Agonists.    Beyond our efforts in peripheral analgesia, we are focused also on the discovery of novel compounds which may act on the central nervous system, without the limiting side effects or abuse potential of opioid
agents, including compounds which act on non opioid receptor targets.



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 of up to $210.0 million over the remaining term of the agreement upon the successful achievement, if any, of certain clinical and regulatory objectives. 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



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for chronic care indications such as OBD. 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 terminates 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.



License Agreements



In November 1996, Roberts Laboratories Inc.
(Roberts) licensed from Eli Lilly certain intellectual property rights relating to Entereg. In June 1998, we entered into an Option and License Agreement with Roberts under which we licensed from Roberts the rights Roberts had licensed from Eli Lilly for Entereg. We have made license and milestone payments under
this agreement totaling $1.6 million. If Entereg
receives regulatory approval, we are obligated to make a milestone payment of $900,000 under this agreement, as well as royalties on commercial sales of Entereg. Our license to Entereg expires on the later of either the life of the last to expire of the licensed Eli Lilly patents or fifteen years from November 5, 1996,
following which we will have a fully paid up license.



In
August 2002, we entered into a separate exclusive license agreement with Eli Lilly under which we obtained an exclusive license to six issued U.S. patents and related foreign equivalents and know-how relating to peripherally selective opioid
antagonists. We paid Eli Lilly $4.0 million upon signing the agreement and are subject to additional clinical and regulatory milestone payments and royalty payments to Eli Lilly on sales, if any, of new products utilizing the licensed technology.
Under this license agreement, we also agreed to pay Eli Lilly $4.0 million upon acceptance for review of our NDA by the FDA, which payment was made in the third quarter of 2004.



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



Intellectual Property



We seek United States and international patent protection for important and strategic components of our technology. We also
rely on trade secret protection for certain of our confidential and proprietary information, and we use license agreements both to access external technologies and assets and to convey certain intellectual



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property rights to others. Our commercial success will be dependent in part on our ability to obtain commercially valuable patent claims and to protect our
intellectual property rights and to operate without infringing upon the proprietary rights of others.



We have rights to patents related to Entereg which expire between 2011 and 2020, including a U.S. patent claiming composition of matter which expires in 2011. We expect that the composition of
matter patent may be eligible for patent term extension. The scope of intellectual property protection provided during the period of patent term extension has been challenged in a number of legal cases. If we are granted patent term extensions for
an Entereg patent, we cannot be assured that any
such extension will provide meaningful proprietary protection during the period of extension. One of these Entereg related U.S. patents claims the use of Entereg in postoperative ileus and another claims the combination of Entereg plus an opioid agonist, both of these patents expire in 2020. These expiration dates are all based on the presumption
that the applicable maintenance fees are paid and the patents, if challenged, are not held to be invalid. We have licensed rights to patents and patent applications relating to the sterile lidocaine patch. There is no assurance that any patents we
have licensed will provide any meaningful proprietary protection for the sterile lidocaine patch.



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



| |  |  | the pending patent applications to which we have rights may not result in issued patents;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | the claims of any patents which are issued may not provide meaningful protection, may not provide a basis for commercially viable products or provide us with any competitive
advantages;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we may not be successful in developing additional proprietary technologies that are patentable;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | our patents may be challenged by third parties, and
| | - |  | ---------------------------------------------------



| |  |  | others may have patents that relate to our technology or business and that may prevent us from marketing our product candidates unless we are able to obtain a license to those
patents.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



With respect to proprietary
know-how that is not patentable and for processes for which patents are difficult to enforce, we rely on trade secret protection and confidentiality agreements to protect our interests. While we require all employees, consultants and potential
business partners to enter into confidentiality agreements, we may not be able to protect adequately our trade secrets or other proprietary information. Others may independently develop substantially equivalent proprietary information and techniques
or otherwise gain access to our trade secrets.



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Government Regulation



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



The drug approval process:



The process of drug development is complex and lengthy and the activities
undertaken before a new pharmaceutical product may be marketed in the United States include:



| |  |  | discovery research;
| | - |  | -------------------



| |  |  | preclinical studies;
| | - |  | --------------------



| |  |  | submission to the FDA of an Investigational New Drug application (IND), which must become effective before human clinical trials commence;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | adequate and well-controlled human clinical trials to establish the safety and efficacy of the product;
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | submission to the FDA of a NDA; and
| | - |  | -----------------------------------



| |  |  | FDA approval of the NDA prior to any commercial sale of the product.
| | - |  | --------------------------------------------------------------------



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



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



| |  |  | Phase I: The drug is initially introduced into healthy human subjects or patients and tested for safety, dosage tolerance, absorption, metabolism, distribution and excretion. In
addition, it is sometimes possible to assess efficacy in Phase I trials for analgesia.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Phase II: This phase involves studies in a limited patient population to identify possible adverse effects and safety risks, to determine the efficacy of the product for specific
targeted diseases and to determine optimal dosage and tolerance.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Phase III: When Phase II evaluations demonstrate that a dosage range of the product is effective and has an acceptable safety profile, Phase III trials are undertaken to further
evaluate dosage, clinical efficacy and to further test for safety in an expanded patient population at geographically dispersed clinical study sites.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Other regulatory requirements



The FDA mandates that drugs be manufactured in conformity with current Good Manufacturing Practices (cGMP)
regulations and at facilities approved to manufacture such drugs. If approval is granted, requirements for labeling, advertising, record keeping and adverse experience reporting will apply. In addition, if our products are approved for marketing by
the FDA, we will be required to comply with several other types of state and federal laws applicable to pharmaceutical marketing. These laws include healthcare antikickback statutes and false claims statutes. Additionally, we may also be subject to
regulations under other federal, state, and local laws, including the Occupational Safety and Health Act, the Environmental Protection Act, the Clean Air Act, national restrictions on technology transfer, import, export, and customs regulations.
Failure to comply with these requirements could result, among other things, in suspension of regulatory approval, recalls, injunctions or civil or criminal sanctions.



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



The Controlled Substances Act imposes various registration, record-keeping and reporting requirements, procurement and manufacturing quotas, labeling and packaging requirements, security controls and a restriction on prescription refills on
certain pharmaceutical products. A principal factor in determining the particular requirements, if any, applicable to a product is its actual or potential abuse profile. A pharmaceutical product may be scheduled as a Schedule I, II, III,
IV or V substance, with Schedule I substances considered to present the highest risk of substance abuse and Schedule V substances the lowest. Because of the potential to cause addiction, drugs that are able to activate muopioid receptors in
the brain (morphine-like opioid analgesics) are regulated, or scheduled, under the Controlled Substances Act. Any of our products that contain one of our product candidates in combination with narcotic analgesics will be subject to such regulation.



Available Information



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



Employees



As of
December 31, 2004, we had 141 full-time employees and 2 part-time employees, including 29 employees with Ph.D. or M.D. degrees. Ninety-three of our employees are engaged in research and development activities. Most of our senior management and
professional employees have had prior experience in pharmaceutical or biotechnology companies. None of our employees are covered by collective bargaining agreements. We believe that our relations with our employees are good.



|ITEM 2. | PROPERTIES
|------- | ----------



We conduct operations in a building in Exton, Pennsylvania, under a ten-year lease agreement expiring in July 2013. The building has approximately 80,000
square feet of space. We have built out and occupy approximately 30,000 square feet of office space and approximately 25,000 square feet of laboratory space. The remaining approximately 25,000 square feet of space is unfinished and is available for
potential future expansion.



|ITEM 3. | LEGAL PROCEEDINGS
|------- | -----------------



On April 21, 2004, a lawsuit was filed in the United States District Court for the Eastern District of Pennsylvania against us, one of our directors and
certain of our officers seeking unspecified damages on behalf of a putative class of persons who purchased our common stock between September 23, 2003 and January 14, 2004. The complaint alleges violations of Section 10(b) of the Securities Exchange
Act of 1934 (the Exchange Act), Rule 10b-5 under the Exchange Act and Section 20(a) of the Exchange Act in connection with the announcement of the results of certain studies in our Phase III clinical trials for Entereg, which allegedly had the effect of artificially
inflating the price of our common stock. Three additional complaints asserting similar claims were filed shortly after the initial complaint. These actions have been consolidated for filing purposes under the caption: In re Adolor Corporation
Securities Litigation,No. 2:04-cv-01728. Two parties separately moved to be appointed as Lead Plaintiff and to consolidate the actions for purposes of trial. One of those motions has subsequently been withdrawn. On December 29, 2004 the
district court issued an order appointing the remaining party, the Greater Pennsylvania Carpenters Pension Fund, as Lead Plaintiff. Pursuant to a schedule



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agreed to by the parties, we anticipate that the appointed Lead Plaintiff will file a consolidated amended complaint on February 28, 2005 to which we must
respond within sixty days or before April 28, 2005. We believe that the allegations are without merit and intend to vigorously defend the litigation.



On August 2, 2004, two shareholder derivative lawsuits were filed in the United States District Court for the Eastern District of Pennsylvania,
purportedly on behalf of us, against our directors and certain of our officers seeking unspecified damages for various alleged breaches of fiduciary duty and waste. The allegations are similar to those set forth in the class action complaints,
involving the announcement of the results of certain studies in our Phase III clinical trials for Entereg. On November 12, 2004, the Derivative Plaintiff filed an amended Complaint. On December 13, 2004, we filed a motion challenging the standing of the Derivative Plaintiff to file the
derivative litigation on its behalf. Our directors and officers moved to dismiss the Complaint for failure to state a claim. Pursuant to the Courts order dated October 13, 2004, Plaintiffs had 30 days to respond to our motions and the
directors and officers motions; that time has since been extended by agreement of the parties until January 27, 2005. We and the Directors and Officers filed our reply briefs on February 18, 2005.



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------



No matters were submitted to a vote of our stockholders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year
ended December 31, 2004.



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PART II



|ITEM 5. | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|------- | ------------------------------------------------------------------------------------------------------------



(a) Our common stock is traded on The Nasdaq National Market under the
symbol ADLR. The price range per share reflected in the table below is the highest and lowest bid price for our stock as reported by The Nasdaq National Market during each quarter of the two most recent years.



|               |  |      |       |     |   |      
|-------------- |  | ---- | ----- | --- | - | -----
|               |  | High |       | Low
|2003           |  |      |       |     |   |      
|First Quarter  |  | $    | 14.32 |     | $ | 9.53 
|Second Quarter |  |      | 20.50 |     |   | 9.61 
|Third Quarter  |  |      | 20.17 |     |   | 11.90
|Fourth Quarter |  |      | 21.71 |     |   | 17.11
|2004           |  |      |       |     |   |      
|First Quarter  |  | $    | 22.36 |     | $ | 13.26
|Second Quarter |  |      | 18.05 |     |   | 11.87
|Third Quarter  |  |      | 13.88 |     |   | 8.73 
|Fourth Quarter |  |      | 16.82 |     |   | 8.62 



(b) Holders. As
of February 15, 2005, there were approximately 171 holders of record of our common stock. This does not reflect beneficial stockholders who hold their stock in nominee or street name through various brokerage firms.



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



|ITEM 6. | SELECTED FINANCIAL DATA
|------- | -----------------------



The following selected financial data should be read in conjunction with our Consolidated Financial Statements and the related notes and
Managements Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Report. The Consolidated Statements of Operations data for the years ended December 31, 2004, 2003, and 2002, and our
Consolidated Balance Sheet data as of December 31, 2004 and 2003, are derived from our audited Consolidated Financial Statements which are included elsewhere in this Report. The Consolidated Statements of Operations data for the years ended December
31, 2001 and 2000 and the Consolidated Balance Sheet data as of December 31, 2002, 2001 and 2000 are derived from audited Consolidated Financial Statements not included in this Report. Historical results are not necessarily indicative of the results
to be expected in the future.



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



|                                                                                               |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|---------------------------------------------------------------------------------------------- |  | ------------------------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                                               |  | Years Ended December 31,              |         
|                                                                                               |  | 2004                                  |          |   | 2003 |   |          | 2002 |  |   | 2001     |   |  | 2000 |        
|                                                                                               |  | (In thousands, except per share data) |         
|Consolidated Statements of Operations                                                          |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|Contract revenues                                                                              |  | $                                     | 25,542   |   |      | $ | 20,727   |      |  | $ | 28,409   |   |  | $    | 1,387   |   |  | $ | 44      |  
|                                                                                               |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|Operating expenses incurred during the development stage:                                      |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|Research and development                                                                       |  |                                       | 48,766   |   |      |   | 56,654   |      |  |   | 71,705   |   |  |      | 36,005  |   |  |   | 15,884  |  
|Marketing, general and administrative                                                          |  |                                       | 22,870   |   |      |   | 17,648   |      |  |   | 21,693   |   |  |      | 15,229  |   |  |   | 7,626   |  
|                                                                                               |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|Total operating expenses                                                                       |  |                                       | 71,636   |   |      |   | 74,302   |      |  |   | 93,398   |   |  |      | 51,234  |   |  |   | 23,510  |  
|                                                                                               |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|Net other income                                                                               |  |                                       | 2,508    |   |      |   | 2,369    |      |  |   | 4,465    |   |  |      | 7,440   |   |  |   | 2,228   |  
|                                                                                               |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|Net loss                                                                                       |  |                                       | (43,586  | ) |      |   | (51,206  | )    |  |   | (60,524  | ) |  |      | (42,407 | ) |  |   | (21,238 | )
|Undeclared dividends attributable to mandatorily redeemable convertible preferred stock        |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   | 48,906  |  
|Beneficial conversion feature on mandatorily redeemable convertible preferred stock            |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   | 4,103   |  
|                                                                                               |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|Net loss allocable to common stockholders                                                      |  | $                                     | (43,586  | ) |      | $ | (51,206  | )    |  | $ | (60,524  | ) |  | $    | (42,407 | ) |  | $ | (74,247 | )
|                                                                                               |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|Basic and diluted net loss per share allocable to common stockholders                          |  | $                                     | (1.12    | ) |      | $ | (1.57    | )    |  | $ | (1.94    | ) |  | $    | (1.42   | ) |  | $ | (13.99  | )
|                                                                                               |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|Shares used in computing basic and diluted net loss per share allocable to common stockholders |  |                                       | 38,924   |   |      |   | 32,586   |      |  |   | 31,252   |   |  |      | 29,801  |   |  |   | 5,307   |  
|                                                                                               |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|                                                                                               | 
|                                                                                               |  | As of December 31,                    |         
|                                                                                               |  | 2004                                  |          |   | 2003 |   |          | 2002 |  |   | 2001     |   |  | 2000 |        
|                                                                                               |  | (In thousands)                        |         
|Consolidated Balance Sheet Data                                                                |  |                                       |          |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |         |  
|Cash, cash equivalents and short-term investments                                              |  | $                                     | 162,324  |   |      | $ | 210,174  |      |  | $ | 153,985  |   |  | $    | 156,444 |   |  | $ | 131,630 |  
|Working capital                                                                                |  |                                       | 149,081  |   |      |   | 195,531  |      |  |   | 140,290  |   |  |      | 149,708 |   |  |   | 128,671 |  
|Total assets                                                                                   |  |                                       | 178,103  |   |      |   | 224,664  |      |  |   | 168,271  |   |  |      | 164,182 |   |  |   | 135,610 |  
|Total long-term debt                                                                           |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   | 215     |  
|Deficit accumulated during the development stage                                               |  |                                       | (249,967 | ) |      |   | (206,380 | )    |  |   | (155,174 | ) |  |      | (94,649 | ) |  |   | (52,242 | )
|Total stockholders equity                                                                     |  |                                       | 123,160  |   |      |   | 165,279  |      |  |   | 100,728  |   |  |      | 152,781 |   |  |   | 129,040 |  



|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------



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 GI tract. We are collaborating with Glaxo for the global development and commercialization of Entereg in multiple indications. Our next product candidate is a sterile



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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 POI, and submitted an NDA for Entereg 12 mg capsules 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, information from which has been requested by the FDA as part of
its review of our NDA. Our NDA has a PDUFA target action date of April 25, 2005. Our goal is to deliver the information to the FDA in a timeframe that would allow for an extension of the PDUFA target action date 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 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 several secondary endpoints in this 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 each 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



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subjects receiving test drug are 50% more likely to 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 this 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 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 capsules to the FDA in June 2004. Subsequently, the FDA requested us to submit
date 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 November 2002, we announced top-line results of Study 304 of Entereg in OBD patients. This outpatient study enrolled 168 patients who were chronic users of opioids, such as morphine and codeine,



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primarily for pain relief, and whose bowel function had been impaired as a result of opioid treatment. The patients received once daily dosing for 21 days of
either a 0.5 mg or 1 mg dose of Entereg or
placebo. The primary endpoint of the study was the proportion of patients having a bowel movement within 8 hours after each dose of study medication during the 21-day treatment period. On average, the proportion of patients who had at least one
bowel movement within 8 hours of each dose during the 21-day treatment period was 43% for the Entereg 0.5 mg group, 55% for the Entereg 1 mg group and 29% for the placebo group. In this study Entereg was generally well tolerated; the most frequently occurring adverse events versus placebo included diarrhea, abdominal cramps, nausea and vomiting.



Based on the results of this study, our development and
commercialization partner for Entereg, Glaxo, is
currently conducting two Phase IIb studies evaluating the use of Entereg for the reversal of the severe constipating effects associated with the chronic use of opioids. Results from the first study are targeted by the second quarter of 2005.



Glaxo is also conducting a Phase II study evaluating Entereg in chronic constipation, results from which are
targeted by the second quarter of 2005.



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.



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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 recruiting 30 surgeon-focused sales representatives to collaborate with Glaxo representatives to co-promote Glaxos anti-thrombotic agent, Arixtra®. This sales force could also potentially focus on Entereg.



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 of up to
$210.0 million over the remaining term of the agreement upon the successful achievement, if any, of certain clinical and regulatory objectives. 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 OBD. 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 terminates 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.



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License Agreements



In November 1996, Roberts licensed from Eli Lilly certain intellectual property rights relating to Entereg. In June 1998, we entered into an Option and License Agreement with Roberts under
which we licensed from Roberts the rights Roberts had licensed from Eli Lilly for Entereg. We have made license and milestone payments under this agreement totaling $1.6 million. If Entereg receives regulatory approval, we are obligated to make a milestone payment of $900,000 under this agreement, as well as royalties on commercial sales
of Entereg. Our license to Entereg expires on the later of either the life of the last to
expire of the licensed Eli Lilly patents or fifteen years from November 5, 1996, following which we will have a fully paid up license.



In August 2002, we entered into a separate exclusive license agreement with Eli Lilly under which we obtained an exclusive license to six issued U.S.
patents and related foreign equivalents and know-how relating to peripherally selective opioid antagonists. We paid Eli Lilly $4.0 million upon signing the agreement and are subject to additional clinical and regulatory milestone payments and
royalty payments to Eli Lilly on sales, if any, of new products utilizing the licensed technology. Under this license agreement, we also agreed to pay Eli Lilly $4.0 million upon acceptance for review of our NDA by the FDA, which payment was
made in the third quarter of 2004.



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



Critical Accounting Policies
and Estimates



The preparation of our Consolidated
Financial Statements in conformity with accounting principles generally accepted in the United States requires management to adopt critical accounting policies and to make estimates and assumptions that affect the amounts reported in our
Consolidated Financial Statements and accompanying notes. These critical accounting policies and estimates have been reviewed by the Companys audit committee. The principal items in our Consolidated Financial Statements reflecting critical
accounting policies or requiring significant estimates and judgments are as follows:



Stock CompensationWe currently apply Accounting Principal Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, (APB 25), and related interpretations,
in accounting for stock options granted to employees. Under APB 25, compensation cost related to stock options is computed based on the intrinsic value of the stock option at the date of grant, reflected by the difference between the exercise price
and the fair market value of our common stock. Since our November 2000 public offering we have generally granted options to employees with exercise prices equal to fair market value on the date of grant, and for such option grants we do not record
compensation expense. Under Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, compensation cost related to stock options granted to employees and non-employees is computed
based on the value of the stock options at the date of grant using an option valuation methodology, (typically the Black-Scholes model). SFAS No. 123 can be applied either by recording the SFAS No. 123 value of the options as compensation expense or
by continuing to record the APB 25 value and by disclosing SFAS No. 123 compensation cost on a pro-forma basis in the notes to the Consolidated Financial Statements. Had we adopted the Black-Scholes model value provisions of SFAS No. 123, our loss
in 2004, 2003, and 2002 would have been increased by approximately $7.2 million, $5.3 million and $2.1 million, respectively. See Recently Issued Accounting Pronouncements and Note 2 to the Consolidated Financial Statements.



In December 2002, the Financial Accounting Standards Board
(FASB) issued Statement No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure. This statement amends FASB Statement No. 123, 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 SFAS No. 123 to require prominent disclosures in both annual and interim financial



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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, which were effective for financial statements issued after December 15, 2002, have been incorporated herein.



Collaborative Agreement RevenuesWe record deferred revenue for amounts received upfront under collaboration agreements in which we have
continuing involvement, and we recognize such deferred amounts as revenue ratably over the estimated contract performance period. Such revenue recognition may be accelerated in the event of contract termination prior to completion of the expected
performance period. Under the terms of the collaboration agreement with Glaxo we received a non-refundable and non-creditable upfront fee of $50.0 million and, in 2004, approximately $4.2 million of the $50.0 million up-front fee was recognized
as revenue. We expect to recognize approximately $4.2 million per year as revenue through 2014, the estimated contract performance period.



Milestone fees are recorded as revenue when the milestone event is achieved.



Amounts reimbursable for costs incurred pursuant to the terms of collaboration agreements are recognized as revenue in the
period in which the reimbursable costs are incurred. Such revenues are based on estimates of the reimbursable amount and are subject to verification by the collaborators. Accounts receivable from Glaxo of approximately $3.4 million at December 31,
2004 is related to estimated reimbursable expenses for the fourth quarter of 2004, and is subject to verification by Glaxo.



Research and Development ExpensesWe have entered into contracts with third parties to conduct certain research and development activities
including pre-clinical, clinical and manufacturing development activities. We accrue expenses related to such contracts based upon an estimate of the amounts due for work completed under the contracts. Factors considered in preparing such estimates
include the number of subjects enrolled in studies, materials produced by our manufacturers and other criteria relating to the progress of efforts by our vendors.



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 contract revenues. Cash, cash equivalents and short-term investments were approximately $162.3 million at December 31, 2004, and approximately $210.2 million at December 31, 2003, representing 91.1% and 93.6% of our
total assets, respectively. We invest excess cash in investment-grade fixed income securities, principally United States Treasury obligations.



We believe that our current cash, cash equivalents and short-term investments 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 twelve months ended December 31, 2004 and 2003:



|                                                      |  |                                 |             |   |      |   |             |  
|----------------------------------------------------- |  | ------------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                      |  | Twelve Months EndedDecember 31, |            
|                                                      |  | 2004                            |             |   | 2003 |  
|Net loss                                              |  | $                               | (43,586,484 | ) |      | $ | (51,206,219 | )
|Adjustments for non-cash operating items              |  |                                 | 3,480,341   |   |      |   | 4,624,708   |  
|                                                      |  |                                 |             |   |      |   |             |  
|Net cash operating loss                               |  |                                 | (40,106,143 | ) |      |   | (46,581,511 | )
|Net change in assets and liabilities                  |  |                                 | (5,660,553  | ) |      |   | (3,579,014  | )
|                                                      |  |                                 |             |   |      |   |             |  
|Net cash used in operating activities                 |  |                                 | (45,766,696 | ) |      |   | (50,160,525 | )
|                                                      |  |                                 |             |   |      |   |             |  
|Net cash provided by / (used in) investing activities |  |                                 | 46,306,488  |   |      |   | (94,283,146 | )
|                                                      |  |                                 |             |   |      |   |             |  
|Net cash provided by financing activities             |  |                                 | 1,056,423   |   |      |   | 113,115,504 |  
|                                                      |  |                                 |             |   |      |   |             |  



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



Our operating cash outflows for 2004 and 2003 have resulted primarily from
research and development expenditures associated with our product candidates, including clinical development and manufacturing costs for Entereg, license fees and compensation costs, as well as marketing, general and administrative expenses. These outflows were partially offset by cost
reimbursement and milestone payments received from Glaxo.



We
expect to continue to use cash resources to fund operating losses. We expect that our operating losses in future years 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, as well as our co-promotion arrangement relating to Arixtra®. Under this co-promotion arrangement, we are currently recruiting a 30 person sales force. We expect contract revenues relating to cost reimbursement under our Glaxo agreement will be
lower in future periods. 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.



Contractual
Commitments



Lease Payments



Future minimum lease payments under non-cancelable operating leases for
equipment and office and laboratory space are as follows:



|                         |  |   |          
|------------------------ |  | - | ---------
|Year ending December 31, |  |  
|2005                     |  | $ | 1,275,000
|2006                     |  |   | 1,244,000
|2007                     |  |   | 1,220,000
|2008                     |  |   | 1,215,000
|2009                     |  |   | 1,215,000
|2010 and beyond          |  |   | 3,646,000
|                         |  |   |          
|                         |  | $ | 9,815,000
|                         |  |   |          



Glaxo Collaboration
Agreement



Under the terms of the Glaxo agreement, we will
partially reimburse Glaxo for certain third party expenses incurred by them relating to Entereg, pursuant to an agreed upon development plan and budget which is subject to annual review. We also expect to incur certain third party expenses ourselves relating to Entereg, pursuant to an agreed upon development plan and
budget, a portion of which are reimbursable to us by Glaxo. We expect to record these expenses as incurred.



Other Service Agreements



We have entered into various agreements for services with third party vendors, including agreements to conduct clinical trials, to manufacture product
candidates, and for consulting and other contracted services. We accrue the costs of these agreements based on estimates of work completed to date. We estimate that approximately $18.7 million will be payable in future periods under arrangements in
place at December 31, 2004. Of this amount, approximately $6.8 million has been accrued for work estimated to have been completed as of December 31, 2004 and approximately $11.9 million relates to future performance under these arrangements.



License and Research Agreements



With regard to our lead product, Entereg, we have commitments to Roberts and Eli Lilly. In November 1996, Roberts
licensed from Eli Lilly certain intellectual property rights relating to Entereg. In June 1998, we entered into an Option and License Agreement with Roberts under which we licensed from Roberts the rights



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Roberts had licensed from Eli Lilly for Entereg. We have made license and milestone payments under this agreement totaling $1.6 million. If Entereg receives regulatory approval, we are obligated to make an additional milestone payment
of $900,000 under this agreement, as well as royalties on commercial sales of Entereg. Our license to Entereg expires on the later of either the life of the last to expire of the licensed Eli Lilly patents or fifteen years from November 5, 1996, following which we will have a fully paid up license.



In August 2002, we entered into a separate exclusive license agreement with
Eli Lilly under which we obtained an exclusive license to six issued U.S. patents and related foreign equivalents and know-how relating to peripherally selective opioid antagonists. We paid Eli Lilly $4.0 million upon signing the agreement and are
subject to additional clinical and regulatory milestone payments and royalty payments to Eli Lilly on sales, if any, of new products utilizing the licensed technology. Under this license agreement, we also agreed to pay Eli Lilly $4.0 million
upon acceptance for review of our NDA by the FDA, which payment was made in the third quarter of 2004



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 development milestone payments if
certain clinical and regulatory achievements are reached.



Net Cash Provided
By / (Used In) Investing Activities and Investing Requirements Outlook



Net cash provided by investing activities for the year ended December 31, 2004 relates primarily to the maturities of investment securities. Net cash used in investing activities for the year ended December 31, 2003
related primarily to the purchase of investment securities. Capital expenditures in 2004 and 2003 were primarily for leasehold improvements associated with our leased facility, purchases of laboratory equipment, furniture and fixtures and office
equipment.



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



In November 2003 we completed the sale of 6.9
million shares of our common stock, which yielded proceeds of $111.6 million, net of offering costs. During 2004 and 2003, we received $1.1 million and $1.0 million, respectively, from stock option exercises.



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 to fund operating and investing activities. We believe that our existing cash, cash equivalents and short-term investments of approximately $162.3 million as of December 31, 2004 will be sufficient to fund operations into 2007. Prior
to exhausting our current cash and investment reserves, we will need to raise additional funds to finance our operating and investing activities. If we do not raise additional cash, we may be required to curtail or limit research and development and
marketing activities. A curtailment of certain activities would delay or possibly prevent development and commercialization 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.



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Results of Operations



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



Revenues.    Revenues increased in 2004 as
compared to 2003 primarily due to the recognition of $10.0 million in milestone revenue received from Glaxo in 2004. This increase was partially offset by a reduction in cost reimbursement revenues relating to a decrease in expenses incurred by
us which are reimbursable by Glaxo under the collaboration agreement. Revenues decreased in 2003 as compared to 2002 primarily due to a reduction in cost reimbursement revenues from Glaxo, partially offset by the recording in 2003 of a full
years amortization of the Glaxo signing fee.



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 decreased to approximately $48.8 million for the year ended December 31, 2004 from approximately $56.7 million for the year ended December 31, 2003 due
principally to a decrease of approximately $9.1 million in expenditures associated with clinical testing of Entereg, and a decrease of approximately $1.9 million in manufacturing development expenses, offset partially by an increase of approximately $2.4 million in
license fees.



Research and development expenses decreased to
approximately $56.7 million for the year ended December 31, 2003 from approximately $71.7 million for the year ended December 31, 2002 due principally to a decrease of approximately $14.6 million in expenditures associated with clinical testing
of Entereg, as well as a decrease in technology
license fees of approximately $1.5 million, offset partially by an increase of approximately $1.0 million for personnel-related expenses and laboratory supply and facility-related expenses.



Our research and development expenses can be identified as internal or
external expenses. Internal expenses include expenses such as personnel, laboratory, and overhead related expenses. These expenses totaled $21.1 million, $21.6 million, and $21.1 million in the years ended December 31, 2004, 2003, and 2002
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:



|                      |  |                          |            |      |   |            |  |   |           
|--------------------- |  | ------------------------ | ---------- | ---- | - | ---------- |  | - | ----------
|                      |  | Years Ended December 31,
|                      |  | 2004                     |            | 2003 |   | 2002      
|Entereg Program      |  | $                        | 24,893,900 |      | $ | 29,628,072 |  | $ | 44,222,837
|Sterile Patch Program |  |                          | 1,839,580  |      |   | 2,785,863  |  |   |          
|Other Programs        |  |                          | 1,001,391  |      |   | 2,728,202  |  |   | 6,351,956 
|                      |  |                          |            |      |   |            |  |   |           
|Total                 |  | $                        | 27,734,871 |      | $ | 35,142,137 |  | $ | 50,574,793
|                      |  |                          |            |      |   |            |  |   |           



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 significant programs are expected to commence, are not reasonably estimable.



Marketing, General and Administrative Expenses.    Our marketing, general and administrative expenses for the years ended December 31, 2004, 2003 and 2002 were approximately $22.9 million,
$17.6 million and $21.7 million, respectively. The increase in marketing, general and administrative expenses in 2004 as compared to 2003 are principally related to increased marketing-related expenses associated with a possible launch of



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Entereg, and increased personnel expenses and professional fees. The decrease in marketing, general and administrative expenses in 2003 as compared to 2002 are primarily due to non-cash charges
recorded in 2002 in connection with the acceleration of the vesting of certain stock options and compensation expenses recorded in 2002 in connection with payments to be made under separation agreements, as well as certain financial advisory and
legal fees incurred in conjunction with the execution of the Glaxo agreement.



Net Other Income.    Our other income increased in 2004 as compared to 2003 due to an increase in average investment balance and higher interest rates in 2004 as compared to 2003. Other
income decreased in 2003 as compared to 2002 due to a reduction in average investment balance and lower interest rates in 2003 as compared to 2002.



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 December 31, 2004 aggregated approximately $250.0 million, and we expect to continue to incur substantial losses in future periods. We expect that our operating losses in future years 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, as well as our co-promotion arrangement relating to Arixtra®. Under this co-promotion arrangement, we are currently
recruiting a 30 person sales force. We expect contract revenues relating to cost reimbursement under our Glaxo agreement will be lower in future periods. 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. Our net loss in 2005 will also be increased by the recording of
expense associated with employee stock options.



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.



Income Taxes



As of December 31, 2004, we had approximately $92,054,000 of Federal and $90,256,000 of state net operating loss
carryforwards potentially available to offset future taxable income. The Federal and state net operating loss carryforwards will begin expiring in 2009 and 2005, respectively, if not utilized. In addition, the utilization of the state net operating
loss carryforwards is subject to a $2.0 million annual limitation. At December 31, 2004, we also had approximately $5,569,000 of Federal and $789,000 of state research and development tax credit carryforwards, which begin expiring in 2011, and are
available to reduce Federal and state income taxes.



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



Recently Issued Accounting Pronouncements



In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment,a revision to SFAS No. 123, Accounting for Stock-Based Compensation.This statement supercedes APB No.25, Accounting for Stock Issued



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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 first interim or annual reporting period that begins after June 15, 2005. We are currently evaluating various
implementation standards of SFAS 123R, including adoption methods and option pricing methodology. We expect that adoption of this statement will have a material impact on our Consolidated Financial Statements. Our net loss for the years ended
December 31, 2004, 2003 and 2002 would have been increased by approximately $7.2 million, $5.3 million and $2.1 million, respectively, had we adopted the provisions of SFAS No. 123.



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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 our product candidates and 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



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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.



The FDA, as part of its review
of our NDA for Entereg, has requested that we
provide information from Study 001. We are working with Glaxo to provide this information to the FDA. Our goal is to deliver the information in a time frame that would allow for an extension of three months to the PDUFA target action date of April
25, 2005 to July 25, 2005. There can be no assurance that we will be able to provide requested information to the FDA on a timely basis, or that if provided, such information will not negatively impact the consideration by the FDA of the approval of
the NDA.



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 results from a chronic OBD Phase IIb study and a chronic constipation Phase II study by the second quarter of 2005. We are conducting, or planning to conduct, additional studies in the United States of Entereg. 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 use in treating chronic opioid bowel dysfunction and chronic constipation.



We have completed several clinical studies evaluating the use of
Entereg for the reversal of the severe
constipating effects associated with chronic use of opioids. Glaxo is currently conducting two Phase IIb studies in chronic OBD. Glaxo is also conducting a Phase II study evaluating Entereg in chronic constipation.



Results from the clinical studies conducted to date in OBD and chronic constipation are not necessarily indicative of the
results that may be obtained in further studies, or in clinical studies in the POI indication. Chronic OBD and chronic constipation Phase II clinical studies may not be successful, and even if successful, further Phase III clinical testing 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.



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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.



Patients may discontinue
their participation in our clinical studies, which may negatively impact the results of these studies, and extend the timeline for completion of our development programs.



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;
| | - |  | ----------------------------------------------------------------



| |  |  | our 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 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 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;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



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



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



The market price for our common stock has been highly volatile and may
continue to be highly volatile in the future. For example, 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) of the Securities Exchange Act of 1934 (the Exchange Act), Rule 10b-5 under the Exchange Act and Section 20(a) of 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. Three additional complaints asserting similar claims were filed shortly after the
initial complaint. These actions have been consolidated for filing purposes under the caption: In re Adolor Corporation Securities Litigation,No. 2:04-cv-01728. Two parties separately moved to be appointed as Lead Plaintiff and to
consolidate the actions for purposes of trial. One of those motions has subsequently been withdrawn. On December 29, 2004 the district



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court issued an order appointing the remaining party, the Greater Pennsylvania Carpenters Pension Fund, as Lead Plaintiff. Pursuant to a schedule
agreed to by the parties, the Company anticipates that the appointed Lead Plaintiff will file a consolidated amended complaint on February 28, 2005 to which the Company must respond within sixty days or before April 28, 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. Pursuant to the Courts order dated October 13, 2004, Plaintiffs had 30 days to respond to the Companys and the directors
and officers motions; that time has since been extended by agreement of the parties until January 27, 2005. 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 December 31, 2004 of approximately $162.3 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 December 31, 2004, we have incurred a cumulative net loss of approximately $250.0 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. 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



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they are respectively responsible. We and Glaxo have established numerous joint committees to collaborate in the development of Entereg. These committees meet at regularly scheduled
intervals. We depend on Glaxo to provide us with substantial assistance and expertise in the development of Entereg. Any failure of Glaxo to perform its obligations under our agreement could negatively impact our product candidate, Entereg, and could lead to our loss of potential revenues from product sales and
milestones that may otherwise become due under our collaboration agreement and would delay our achievement, if any, of profitability. Glaxo has extensive experience in the successful commercialization of product candidates which would be difficult
for us to replace if the collaboration agreement was not in place. In the near term, our success will largely depend upon the success of our collaboration with Glaxo to further develop Entereg and our success in obtaining regulatory approval to commercialize Entereg.



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



Glaxo has certain rights to terminate the collaboration agreement. Glaxo also has the right to terminate its rights and
obligations with respect to the acute-care indications, or its rights and obligations for the chronic-care indications. Glaxo has the right to terminate the collaboration agreement for breach of the agreement by us or for safety related reasons as
defined in the collaboration agreement. Glaxos rights to terminate the acute-care indications or the chronic-care indications are generally triggered by failure to achieve certain milestones within certain timeframes, adverse product
developments or adverse regulatory events. 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



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and controls which satisfies the FDA that our contract manufacturers are able to make Entereg in accordance with cGMPs. 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 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.



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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.



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.



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



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 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.



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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



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pharmaceutical product in the United States until it has completed rigorous preclinical testing and clinical trials and the FDAs extensive regulatory
clearance process. Satisfaction of regulatory requirements typically takes many years, is dependent upon the type, complexity and novelty of the product and requires the expenditure of substantial resources for research and development, testing,
manufacturing, quality control, labeling and promotion of drugs for human use. Since neither the FDA nor international regulatory authorities have approved peripherally restricted 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



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majority of states also have statutes or regulations similar to the federal antikickback law and false claims laws, which apply to items and services
reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a manufacturers products from
reimbursement under government programs, criminal fines, and imprisonment.



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



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



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



Facilities that conduct research, manufacture or distribute controlled substances must be registered to perform these activities and have the 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



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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.



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



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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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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.



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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;
| | - |  | --------------------------------------------------------------------------------------



| |  |  | 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.



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|ITEM 7A. | 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 December 31, 2004 totaled $155.4 million, and the weighted-average interest rate was approximately 2.18% with maturities of
investments ranging up to 17 months.



|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------



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



|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- | ------------------------------------------------------------------------------------



None.



|ITEM 9A. | CONTROLS AND PROCEDURES
|-------- | -----------------------



For the year ended December 31, 2004, we carried out an evaluation, under the supervision and with the participation of our management, including our
President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer (the principal finance and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to
Rules 13a-15(e) and 15d-15(e) under 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 and Chief Financial Officer concluded that,
as of December 31, 2004, our disclosure controls and procedures have been designed and are being operated in a manner that provides reasonable assurance that the information required to be disclosed by the Company in reports filed under the Exchange
Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Commission. A control system, no matter how well designed and operated, cannot provide assurance that the objectives of the control
system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.



The management of Adolor Corporation is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rule 13a  15(f) or 15d  15(f) promulgated under the Securities Exchange Act of 1934, as amended. Adolors internal control system was designed to provide reasonable assurance to the companys
management and board of directors regarding the preparation and fair presentation of published financial statements. There have not been any changes in our internal control over financial reporting during the quarter ended December 31, 2004 that
have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide
only reasonable assurance with respect to financial statement preparation and presentation.



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Adolors management assessed the effectiveness of the companys internal control over financial
reporting as of December 31, 2004. In making this assessment, it used the criteria set forth by the Committee on Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.Based on our
assessment we believe that, as of December 31, 2004, the Companys internal control over financial reporting is effective based on those criteria.



Adolors independent registered public accounting firm has issued an audit report on our assessment of the Companys internal control over
financial reporting. This report appears below.



REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and
Stockholders

Adolor Corporation.:



We have audited managements assessment, included in Managements Report on Internal Control over Financial Reporting appearing under Item 9A,
that Adolor Corporation (the Company) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal ControlIntegrated Frameworkissued bythe Committee
of Sponsoring Organizations of the Treadway Commission (COSO). Adolor Corporation Management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the Companys internal control over financial reporting based on our audit.



We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our
audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures
as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.



A companys internal control over financial reporting is a process designated to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.



Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.



In our
opinion, managements assessment that Adolor Corporation maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal
ControlIntegrated Framework issued by the COSO. Also, in our opinion, Adolor Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the criteria established
in Internal ControlIntegrated Framework issued by COSO.



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We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the consolidated balance sheets of Adolor Corporation and subsidiary as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive loss, stockholders equity, and cash flows for each of
the years in the three-year period ended December 31, 2004, and for the period from August 9, 1993 (inception) to December 31, 2004, and our report dated February 22, 2005 expressed an unqualified opinion on those consolidated financial statements.



/s/ KPMG LLP



Philadelphia, Pennsylvania

February 22, 2005



|ITEM 9B. | OTHER INFORMATION
|-------- | -----------------



None.



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PART III



|ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
|-------- | --------------------------------------------------



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



|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------



We incorporate by reference the information contained under the caption Compensation Tables in our Definitive Proxy Statement related to our
annual meeting of stockholders, to be filed within 120 days after the end of the year covered by this Report pursuant to Section 14(a) of the Exchange Act.



|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------



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



|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
|-------- | ----------------------------------------------



We incorporate by reference the information contained under the caption Certain Relationships and Related Transactions in our Definitive Proxy
Statement related to our annual meeting of stockholders, to be filed within 120 days after the end of the year covered by this Report pursuant to Section 14(a) of the Exchange Act.



|ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|-------- | --------------------------------------



We incorporate by reference the information contained under the caption Ratification of Appointment of Independent AccountantsReport of the
Audit CommitteeAudit Fees; Audit-Related Fees; Tax Fees; All Other Fees in our Definitive Proxy Statement related to our annual meeting of stockholders, to be filed within 120 days after the end of the year covered by this Report
pursuant to Section 14(a) of the Exchange Act.



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PART IV



|ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
|-------- | ------------------------------------------



| | (a) | 1. Financial Statements
| | --- | -----------------------



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



| |  | 2. Financial Statement Schedules
| |  | --------------------------------



None



| | (b) | Exhibits
| | --- | --------



Reference is made to the Exhibit Index on page 47 of this Report for a list of exhibits required by Item 601 of Regulation S-K to be filed as part of this Report.



45



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##### Table of Contents

SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Security Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.



Date: March 1, 2005



ADOLOR CORPORATIONBy:

/s/ BRUCE A. PEACOCKName:

Bruce A. PeacockTitle:

President, Chief Executive Officer and Director




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



|                                             |  |                                                                               |  |              
|-------------------------------------------- |  | ----------------------------------------------------------------------------- |  | -------------
|Signature                                    |  | Title                                                                         |  | Date         
|                                             |  |                                                                              
|/S/ BRUCE A. PEACOCKBruce A. Peacock         |  | President, Chief Executive Officer and Director (Principal Executive Officer) |  | March 1, 2005
|                                             |  |                                                                              
|/S/ MICHAEL R. DOUGHERTYMichael R. Dougherty |  | Senior Vice President, Chief Financial Officer (Principal Financial Officer)  |  | March 1, 2005
|                                             |  |                                                                              
|/S/ ARMANDO ANIDOArmando Anido               |  | Director                                                                      |  | March 1, 2005
|                                             |  |                                                                              
|/S/ PAUL GODDARDPaul Goddard                 |  | Director                                                                      |  | March 1, 2005
|                                             |  |                                                                              
|/S/ GEORGE V. HAGER, JR.George V. Hager, Jr. |  | Director                                                                      |  | March 1, 2005
|                                             |  |                                                                              
|/S/ DAVID M. MADDENDavid M. Madden           |  | Director                                                                      |  | March 1, 2005
|                                             |  |                                                                              
|/S/ CLAUDE H. NASHClaude H. Nash             |  | Director                                                                      |  | March 1, 2005
|                                             |  |                                                                              
|/S/ ROBERT T. NELSENRobert T. Nelsen         |  | Director                                                                      |  | March 1, 2005
|                                             |  |                                                                              
|/S/ DONALD E. NICKELSONDonald E. Nickelson   |  | Director                                                                      |  | March 1, 2005



46



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##### Table of Contents

EXHIBIT INDEX



|               |  |                                                                                                                                                                                                                                                                                                                                                                                                   
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                                                                                                                                                                                                                       
|3.1            |  | Amended and Restated Certificate of Incorporation of Adolor (incorporated by reference to Exhibit 3.1 to the Report on Form 10-Q filed by
the Company on August 14, 2001).                                                                                                                                                                                                                        
|               | 
|3.2            |  | Restated Bylaws of the Company as amended February 26, 2004 (incorporated by reference to Exhibit 3.2 to Report on Form 10-K filed by the
Company on March 4, 2004).                                                                                                                                                                                                                              
|               | 
|4.1            |  | Rights Agreement, dated as of February 20, 2001, between Adolor and StockTrans, Inc., as Rights Agent (incorporated by reference to Exhibit
4.1 to Form 8-K filed by the Company on February 23, 2001), which included as Exhibit B thereto the Form of Rights Certificate, incorporated by reference to Exhibit 1.1 to the Companys Registration Statement on Form 8-A, dated February 22,
2001.
|               | 
|4.2            |  | Form of Common Stock Certificate (incorporated by reference to Exhibit 4.14 to Amendment No. 3 to the Registration Statement filed by the
Company on March 21, 2000).                                                                                                                                                                                                                             
|               | 
|10.1           |  | Amended and Restated 1994 Equity Compensation Plan (incorporated by reference to Exhibit 10.1 on Form 10-Q filed by the Company on August
7, 2003).4                                                                                                                                                                                                                                              
|               | 
|10.2           |  | Adolor Corporation 2003 Stock-Based Incentive Compensation Plan (incorporated by reference to Exhibit 10.10 to the Report on Form 10-K
filed by the Company on March 4, 2004).4                                                                                                                                                                                                                   
|               | 
|10.3           |  | Option and License Agreement between Adolor and Roberts Laboratories, Inc., dated June 10, 1998 (incorporated by reference to Exhibit 10.2
to Amendment No. 1 to the Registration Statement filed by the Company on February 18, 2000).2                                                                                                                                                          
|               | 
|10.4           |  | Amended and Restated Build to Suit Lease between the Company and 700 Pennsylvania Drive Associates, dated February 27, 2003 (incorporated
by reference to Exhibit 10.4 to Form 10-K filed by the Company on March 18, 2003).                                                                                                                                                                      
|               | 
|10.5           |  | License Agreement between Adolor Corporation and Eli Lilly and Company, dated August 8, 2002 (incorporated by reference to Exhibit 10.1 to
Form 10-Q filed by the Company on November 1, 2002).2                                                                                                                                                                                                  
|               | 
|10.6           |  | Collaboration Agreement dated as of April 14, 2002, by and between the Company and Glaxo Group Limited (incorporated by reference to
Exhibit 10.1 to Form 8-K/A filed by the Company on October 10, 2003).2,3                                                                                                                                                                                     
|               | 
|10.7           |  | Amendment No. 1, dated as of June 22, 2004, to the Collaboration Agreement with Glaxo Group Limited (incorporated by reference to Exhibit
10.1 to Form 10-Q filed by the Company on August 4, 2004).                                                                                                                                                                                              
|               | 
|10.8           |  | Amendment No. 2, dated December 22, 2004, to Collaboration Agreement between Glaxo Group Limited and the Company (incorporated by reference
to Exhibit 10.1 to Form 8-K/A filed by the Company on February 25, 2005).3                                                                                                                                                                            
|               | 
|10.9           |  | Distribution Services Agreement between SmithKline Beecham Corporation and the Company, dated June 29, 2004 (incorporated by reference to
Exhibit 10.2 to Form 10-Q filed by the Company on August 4, 2004).2                                                                                                                                                                                     
|               | 
|10.10          |  | API Compound Supply Agreement Between the Company and Torcan Chemical Ltd., dated July 13, 2004 (incorporated by reference to Exhibit 10.3
to Form 10-Q filed by the Company on August 4, 2004).2                                                                                                                                                                                                 
|               | 
|10.11          |  | API Compound Supply Agreement Between the Company and Girindus AG, dated July 6, 2004 (incorporated by reference to Exhibit 10.4 to Form
10-Q filed by the Company on August 4, 2004).2                                                                                                                                                                                                           



47



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##### Table of Contents

|               |  |                                                                                                                                                                                                                           
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                                               
|               | 
|10.12          |  | Drug Product Supply Agreement between the Company and Pharmaceutics International, Inc., dated July 1, 2004 (incorporated by reference to
Exhibit 10.5 to Form 10-Q filed by the Company on August 4, 2004).2             
|               | 
|10.13          |  | ROW Supply Agreement dated September 13, 2004 between Glaxo Group Limited and the Company (incorporated by reference to Exhibit 10.1 to
Form 8-K filed by the Company on September 15, 2004).2                            
|               | 
|10.14          |  | Consulting Agreement between the Company and Paul Goddard dated as of July 28, 2003 (incorporated by reference to Exhibit 10.3 to Form 10-Q
filed by the Company on August 7, 2003).4                                     
|               | 
|10.15          |  | First Amendment to Consulting Agreement between the Company and Paul Goddard (incorporated by reference to Exhibit 10.7 to Form 10-Q filed
by the Company on August 4, 2004).4                                            
|               | 
|10.16          |  | Adolor Corporation Executive Severance Pay Program (incorporated by reference to Exhibit 10.2 to Form 10-Q filed by the Company on November
1, 2002).4                                                                    
|               | 
|10.17          |  | Letter Agreement between the Company and Bruce A. Peacock, dated April 22, 2002 (incorporated by reference to Exhibit 10.1 to Form 8-K
filed by the Company on April 25, 2002).4                                          
|               | 
|10.18          |  | Letter Agreement between the Company and Martha E. Manning, dated June 30, 2002 (incorporated by reference to Exhibit 10.2 to Form 10-Q
filed by the Company on August 13, 2002).4                                        
|               | 
|10.19          |  | Letter Agreement between the Company and Michael R. Dougherty, dated October 24, 2002 (incorporated by reference to Exhibit 10.15 to Form
10-K filed by the Company on March 18, 2003).4                                  
|               | 
|10.20          |  | Amendment dated January 26, 2004 to Letter Agreement between the Company and Michael R. Dougherty, dated October 24, 2002 (incorporated by
reference to Exhibit 10.6 to Form 10-K filed by the Company on March 4, 2004).4
|               | 
|10.21          |  | Letter Agreement between the Company and David Jackson, dated January 10, 2001 (incorporated by reference to Exhibit 10.16 to Form 10-K
filed by the Company on March 18, 2003).4                                         
|               | 
|10.22          |  | Agreement dated April 22, 2002 between the Company and Bruce A. Peacock (incorporated by reference to Exhibit 10.21 to Form 10-K filed by
the Company on March 18, 2003).4                                                
|               | 
|10.23          |  | Letter Agreement between the Company and James E. Barrett, Ph.D., dated June 23, 2004 (incorporated by reference to Exhibit 10.6 to Form
10-Q filed by the Company on August 4, 2004).4                                   
|               | 
|10.24          |  | Option Agreement between the Company and Bruce A. Peacock, dated as of April 22, 2002 (incorporated by reference to Exhibit 10.19 to Form
10-K filed by the Company on March 18, 2003).4                                  
|               | 
|10.25          |  | Option Agreement between the Company and Bruce A. Peacock, dated as of April 22, 2002 (incorporated by reference to Exhibit 10.20 to Form
10-K filed by the Company on March 18, 2003).4                                  
|               | 
|10.26          |  | Form of Stock Option Agreement.1 4                                                                                                                                                                                        
|               | 
|10.27          |  | Incentive Compensation Plan (incorporated by reference to Exhibit 10.1 to Form 8-K filed by the Company on January 10, 2005).4                                                                                            
|               | 
|21.1           |  | Adolor Finance LLC as Subsidiary.1                                                                                                                                                                                        
|               | 
|23.1           |  | Consent of KPMG LLP.1                                                                                                                                                                                                     
|               | 
|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                                                         



48



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##### Table of Contents

|               |  |                                                                                                                                                                  
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                      
|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.
|- | ---------------

|2 | Confidential treatment granted.
|- | -------------------------------

|3 | Confidential treatment has been requested with respect to portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange
Commission.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4 | Compensation plan or arrangement in which directors and executive officers are eligible to participate.
|- | -------------------------------------------------------------------------------------------------------



49



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##### Table of Contents

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



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



|                                                                                                                                                                              |  |     
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                                                                              |  | Page
|Report of Registered Public Accounting Firm                                                                                                                                   |  | F-2 
|Financial Statements:                                                                                                                                                         |  |     
|Consolidated Balance Sheets at December 31, 2004 and 2003                                                                                                                     |  | F-3 
|Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002, and for the period from August 9, 1993 (inception) to December 31, 2004           |  | F-4 
|Consolidated Statements of Comprehensive Loss for the years ended December 31, 2004, 2003 and 2002, and for the period from August 9, 1993 (inception) to December 31, 2004   |  | F-5 
|Consolidated Statements of Stockholders Equity for the period from August 9, 1993 (inception) to December 31, 2001, and for the years ended December 31, 2002, 2003 and 2004 |  | F-6 
|Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002, and for the period from August 9, 1993 (inception) to December 31, 2004           |  | F-9 
|Notes to Consolidated Financial Statements                                                                                                                                    |  | F-10



F-1



---

##### Table of Contents

Report of Independent Registered Public Accounting Firm



The Board of Directors and Stockholders

Adolor Corporation:



We have audited the accompanying consolidated balance sheets of Adolor Corporation (a development-stage company) and
subsidiary as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive loss, stockholders equity and cash flows for each of the years in the three-year period ended December 31, 2004, and for the
period from August 9, 1993 (inception) to December 31, 2004. These consolidated financial statements are the responsibility of the management of Adolor Corporation. Our responsibility is to express an opinion on these consolidated financial
statements based on our audits.



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



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Adolor
Corporation (a development-stage company) and subsidiary as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, and for the period from
August 9, 1993 (inception) to December 31, 2004, in conformity with accounting principles generally accepted in the United States of America.



We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the internal
control over financial reporting of Adolor Corporation and subsidiary as of December 31, 2004, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee on Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated February 22, 2005, expressed an unqualified opinion on managements assessment of, and the effective operation of, internal control over financial reporting.



/s/    KPMG LLP



Philadelphia, Pennsylvania

February 22, 2005



F-2



---

##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                     |  |                  |              |   |                  |   |              |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ---------------- | ------------ | - | ---------------- | - | ------------ | -
|                                                                                                                                                                                     |  | December 31,2004 |              |   | December 31,2003 |  
|Assets                                                                                                                                                                               |  |                  |              |   |                  |   |              |  
|Current assets:                                                                                                                                                                      |  |                  |              |   |                  |   |              |  
|Cash and cash equivalents                                                                                                                                                            |  | $                | 6,935,417    |   |                  | $ | 5,339,202    |  
|Short-term investments (Note 3)                                                                                                                                                      |  |                  | 155,388,108  |   |                  |   | 204,835,289  |  
|Accounts receivable from collaboration agreement (Note 4)                                                                                                                            |  |                  | 3,363,876    |   |                  |   | 3,079,757    |  
|Prepaid expenses and other current assets                                                                                                                                            |  |                  | 2,542,693    |   |                  |   | 2,946,254    |  
|                                                                                                                                                                                     |  |                  |              |   |                  |   |              |  
|Total current assets                                                                                                                                                                 |  |                  | 168,230,094  |   |                  |   | 216,200,502  |  
|Equipment and leasehold improvements, net (Note 5)                                                                                                                                   |  |                  | 9,773,291    |   |                  |   | 8,293,324    |  
|Other assets                                                                                                                                                                         |  |                  | 100,000      |   |                  |   | 169,915      |  
|                                                                                                                                                                                     |  |                  |              |   |                  |   |              |  
|Total assets                                                                                                                                                                         |  | $                | 178,103,385  |   |                  | $ | 224,663,741  |  
|                                                                                                                                                                                     |  |                  |              |   |                  |   |              |  
|Liabilities and Stockholders Equity                                                                                                                                                 |  |                  |              |   |                  |   |              |  
|Current liabilities:                                                                                                                                                                 |  |                  |              |   |                  |   |              |  
|Accounts payable                                                                                                                                                                     |  | $                | 3,103,409    |   |                  | $ | 1,542,699    |  
|Accrued expenses (Note 6)                                                                                                                                                            |  |                  | 11,716,232   |   |                  |   | 14,960,176   |  
|Deferred licensing fees and rentcurrent (Notes 4 & 5)                                                                                                                               |  |                  | 4,329,192    |   |                  |   | 4,166,676    |  
|                                                                                                                                                                                     |  |                  |              |   |                  |   |              |  
|Total current liabilities                                                                                                                                                            |  |                  | 19,148,833   |   |                  |   | 20,669,551   |  
|Deferred licensing fees and rentnon-current (Notes 4 & 5)                                                                                                                           |  |                  | 35,794,635   |   |                  |   | 38,715,256   |  
|                                                                                                                                                                                     |  |                  |              |   |                  |   |              |  
|Total liabilities                                                                                                                                                                    |  |                  | 54,943,468   |   |                  |   | 59,384,807   |  
|                                                                                                                                                                                     |  |                  |              |   |                  |   |              |  
|Commitments and contingencies (Note 10)                                                                                                                                              |  |                  |              |   |                  |   |              |  
|Stockholders equity:                                                                                                                                                                |  |                  |              |   |                  |   |              |  
|Series A Junior Participating preferred stock, $0.01 par value; 35,000 shares authorized; none issued and outstanding                                                                |  |                  |             |   |                  |   |             |  
|Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued and outstanding                                                                                           |  |                  |             |   |                  |   |             |  
|Common stock, par value $.0001 per share; 99,000,000 shares authorized; 39,080,345 and 38,793,122 shares issued and outstanding at December
31, 2004 and 2003, respectively (Note 7) |  |                  | 3,908        |   |                  |   | 3,879        |  
|Additional paid-in capital                                                                                                                                                           |  |                  | 373,605,431  |   |                  |   | 372,191,435  |  
|Deferred compensation                                                                                                                                                                |  |                  | (19,465      | ) |                  |   | (757,588     | )
|Unrealized (losses)/gains on available for sale securities                                                                                                                           |  |                  | (463,457     | ) |                  |   | 221,224      |  
|Deficit accumulated during the development stage                                                                                                                                     |  |                  | (249,966,500 | ) |                  |   | (206,380,016 | )
|                                                                                                                                                                                     |  |                  |              |   |                  |   |              |  
|Total stockholders equity                                                                                                                                                           |  |                  | 123,159,917  |   |                  |   | 165,278,934  |  
|                                                                                                                                                                                     |  |                  |              |   |                  |   |              |  
|Total liabilities and stockholders equity                                                                                                                                           |  | $                | 178,103,385  |   |                  | $ | 224,663,741  |  
|                                                                                                                                                                                     |  |                  |              |   |                  |   |              |  



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



F-3



---

##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



CONSOLIDATED STATEMENTS OF OPERATIONS



Years ended December 31, 2004, 2003 and 2002, and for the period from

August 9, 1993 (inception) to December 31, 2004



|                                                                                               |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  
|---------------------------------------------------------------------------------------------- |  | ----------------------- | ----------- | - | ------------------------------------------------------- | - | ----------- | ---- |  | - | ----------- | - |  | - | ------------ | -
|                                                                                               |  | Year ended December 31, |             |   | Period fromAugust 9, 1993(inception) toDecember 31,2004 |  
|                                                                                               |  | 2004                    |             |   | 2003                                                    |   |             | 2002 |  |  
|Contract revenues (Note 4)                                                                     |  | $                       | 25,541,627  |   |                                                         | $ | 20,726,637  |      |  | $ | 28,409,417  |   |  | $ | 76,269,292   |  
|                                                                                               |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  
|Operating expenses incurred during the development stage:                                      |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  
|Research and development                                                                       |  |                         | 48,765,515  |   |                                                         |   | 56,653,827  |      |  |   | 71,705,449  |   |  |   | 253,091,877  |  
|Marketing, general and administrative                                                          |  |                         | 22,870,535  |   |                                                         |   | 17,648,178  |      |  |   | 21,693,270  |   |  |   | 93,674,962   |  
|                                                                                               |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  
|Total operating expenses                                                                       |  |                         | 71,636,050  |   |                                                         |   | 74,302,005  |      |  |   | 93,398,719  |   |  |   | 346,766,839  |  
|                                                                                               |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  
|Other income (expense):                                                                        |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  
|Interest income                                                                                |  |                         | 2,509,519   |   |                                                         |   | 2,421,312   |      |  |   | 4,484,040   |   |  |   | 20,886,944   |  
|Other expense                                                                                  |  |                         | (1,580      | ) |                                                         |   | (52,163     | )    |  |   | (19,208     | ) |  |   | (355,897     | )
|                                                                                               |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  
|Total other income (expense)                                                                   |  |                         | 2,507,939   |   |                                                         |   | 2,369,149   |      |  |   | 4,464,832   |   |  |   | 20,531,047   |  
|                                                                                               |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  
|Net loss                                                                                       |  |                         | (43,586,484 | ) |                                                         |   | (51,206,219 | )    |  |   | (60,524,470 | ) |  |   | (249,966,500 | )
|Undeclared dividends attributable to mandatorily redeemable convertible preferred stock        |  |                         |            |   |                                                         |   |            |      |  |   |            |   |  |   | 10,546,314   |  
|Beneficial conversion feature on mandatorily redeemable convertible preferred stock            |  |                         |            |   |                                                         |   |            |      |  |   |            |   |  |   | 48,905,779   |  
|                                                                                               |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  
|Net loss allocable to common stockholders                                                      |  | $                       | (43,586,484 | ) |                                                         | $ | (51,206,219 | )    |  | $ | (60,524,470 | ) |  | $ | (309,418,593 | )
|                                                                                               |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  
|Basic and diluted net loss per share allocable to common stockholders                          |  | $                       | (1.12       | ) |                                                         | $ | (1.57       | )    |  | $ | (1.94       | ) |  |   |              |  
|                                                                                               |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  
|Shares used in computing basic and diluted net loss per share allocable to common stockholders |  |                         | 38,923,681  |   |                                                         |   | 32,585,928  |      |  |   | 31,252,004  |   |  |   |              |  
|                                                                                               |  |                         |             |   |                                                         |   |             |      |  |   |             |   |  |   |              |  



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



F-4



---

##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS



Years ended December 31, 2004, 2003 and 2002,

and the period August 9, 1993 (inception) to December 31, 2004



|                                                           |  |                          |             |   |                                                             |   |             |      |  |   |             |   |  |   |              |  
|---------------------------------------------------------- |  | ------------------------ | ----------- | - | ----------------------------------------------------------- | - | ----------- | ---- |  | - | ----------- | - |  | - | ------------ | -
|                                                           |  | Years ended December 31, |             |   | Period from August 9, 1993 (inception) to December 31, 2004 |  
|                                                           |  | 2004                     |             |   | 2003                                                        |   |             | 2002 |  |  
|Net loss                                                   |  | $                        | (43,586,484 | ) |                                                             | $ | (51,206,219 | )    |  | $ | (60,524,470 | ) |  | $ | (249,966,500 | )
|                                                           |  |                          |             |   |                                                             |   |             |      |  |   |             |   |  |   |              |  
|Other comprehensive income (loss):                         |  |                          |             |   |                                                             |   |             |      |  |   |             |   |  |   |              |  
|Unrealized gains (losses) on available for sale securities |  |                          | (684,681    | ) |                                                             |   | (122,723    | )    |  |   | (386,281    | ) |  |   | (463,457     | )
|Realized loss on available for sale securities             |  |                          | 114,086     |   |                                                             |   | 29,348      |      |  |   |            |   |  |   | 23,572       |  
|                                                           |  |                          |             |   |                                                             |   |             |      |  |   |             |   |  |   |              |  
|Comprehensive loss                                         |  | $                        | (44,157,079 | ) |                                                             | $ | (51,299,594 | )    |  | $ | (60,910,751 | ) |  | $ | (250,406,385 | )
|                                                           |  |                          |             |   |                                                             |   |             |      |  |   |             |   |  |   |              |  



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



F-5



---

##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY



For the period from August 9, 1993 (inception) to December 31, 2001, for
the years ended

December 31, 2002, 2003, and 2004



|                                                                                               |  |                 |   |  |                          |       |   |                      |   |             |                                                    |  |                                              |             |   |                          |   |         |  |   |             |   |  |   |             |  
|---------------------------------------------------------------------------------------------- |  | --------------- | - |  | ------------------------ | ----- | - | -------------------- | - | ----------- | -------------------------------------------------- |  | -------------------------------------------- | ----------- | - | ------------------------ | - | ------- |  | - | ----------- | - |  | - | ----------- | -
|                                                                                               |  | Common stock    |   |  | Additionalpaid-incapital |       |   | Deferredcompensation |   |             | Unrealizedgain (loss)onavailablefor salesecurities |  | DeficitAccumulatedduring thedevelopmentstage |             |   | Totalstockholdersequity |  
|                                                                                               |  | Numberof shares |   |  | Amount                   |       |   |                      |   |             |                                                   
|Inception, August 9, 1993                                                                      |  |                |   |  | $                        |      |   |                      | $ |            |                                                    |  | $                                            |            |   |                          | $ |        |  | $ |            |   |  | $ |            |  
|Issuance of common stock to founder in November 1994 at $.001 per share                        |  | 100,000         |   |  |                          | 10    |   |                      |   | 12,490      |                                                    |  |                                              | (12,400     | ) |                          |   |        |  |   |            |   |  |   | 100         |  
|Issuance of restricted stock in November 1994 and May 1996                                     |  | 565,411         |   |  |                          | 57    |   |                      |   | 72,355      |                                                    |  |                                              | (66,767     | ) |                          |   |        |  |   |            |   |  |   | 5,645       |  
|Issuance of common stock for technology license agreements in December 1995 at $.125 per share |  | 50,000          |   |  |                          | 5     |   |                      |   | 6,245       |                                                    |  |                                              |            |   |                          |   |        |  |   |            |   |  |   | 6,250       |  
|Issuance of common stock for services in April 1999 at $3.736 per share                        |  | 3,570           |   |  |                          |      |   |                      |   | 13,339      |                                                    |  |                                              |            |   |                          |   |        |  |   |            |   |  |   | 13,339      |  
|Value attributed to issuance of warrants                                                       |  |                |   |  |                          |      |   |                      |   | 60,000      |                                                    |  |                                              |            |   |                          |   |        |  |   |            |   |  |   | 60,000      |  
|Notes issued to employees for stock options exercised                                          |  |                |   |  |                          |      |   |                      |   | (1,056,488  | )                                                  |  |                                              |            |   |                          |   |        |  |   |            |   |  |   | (1,056,488  | )
|Payments on notes granted to employees for stock options                                       |  |                |   |  |                          |      |   |                      |   | 156,839     |                                                    |  |                                              |            |   |                          |   |        |  |   |            |   |  |   | 156,839     |  
|Interest receivable converted to principal on employee notes                                   |  |                |   |  |                          |      |   |                      |   | (69,339     | )                                                  |  |                                              |            |   |                          |   |        |  |   |            |   |  |   | (69,339     | )
|Accretion of Series H preferred stock issuance costs                                           |  |                |   |  |                          |      |   |                      |   | (281,794    | )                                                  |  |                                              |            |   |                          |   |        |  |   |            |   |  |   | (281,794    | )
|Forfeiture of stock options                                                                    |  | (67,303         | ) |  |                          | (7    | ) |                      |   | (973,718    | )                                                  |  |                                              | 973,725     |   |                          |   |        |  |   |            |   |  |   |            |  
|Exercise of stock options                                                                      |  | 1,734,205       |   |  |                          | 173   |   |                      |   | 1,768,821   |                                                    |  |                                              |            |   |                          |   |        |  |   |            |   |  |   | 1,768,994   |  
|Unrealized gain on investments                                                                 |  |                |   |  |                          |      |   |                      |   |            |                                                    |  |                                              |            |   |                          |   | 730,228 |  |   |            |   |  |   | 730,228     |  
|Conversion of preferred shares                                                                 |  | 18,818,421      |   |  |                          | 1,882 |   |                      |   | 80,381,821  |                                                    |  |                                              |            |   |                          |   |        |  |   |            |   |  |   | 80,383,703  |  
|Net proceeds from initial public offering                                                      |  | 6,900,000       |   |  |                          | 690   |   |                      |   | 95,375,779  |                                                    |  |                                              |            |   |                          |   |        |  |   |            |   |  |   | 95,376,469  |  
|Net proceeds from issuance of newly registered shares of common stock                          |  | 3,000,000       |   |  |                          | 300   |   |                      |   | 58,962,347  |                                                    |  |                                              |            |   |                          |   |        |  |   |            |   |  |   | 58,962,647  |  
|Deferred compensation resulting from grant of stock options                                    |  |                |   |  |                          |      |   |                      |   | 23,796,274  |                                                    |  |                                              | (23,796,274 | ) |                          |   |        |  |   |            |   |  |   |            |  
|Amortization of deferred compensation                                                          |  |                |   |  |                          |      |   |                      |   |            |                                                    |  |                                              | 11,374,019  |   |                          |   |        |  |   |            |   |  |   | 11,374,019  |  
|Net loss                                                                                       |  |                |   |  |                          |      |   |                      |   |            |                                                    |  |                                              |            |   |                          |   |        |  |   | (94,649,327 | ) |  |   | (94,649,327 | )
|                                                                                               |  |                 |   |  |                          |       |   |                      |   |             |                                                    |  |                                              |             |   |                          |   |         |  |   |             |   |  |   |             |  
|Balance, December 31, 2001                                                                     |  | 31,104,304      |   |  |                          | 3,110 |   |                      |   | 258,224,971 |                                                    |  |                                              | (11,527,697 | ) |                          |   | 730,228 |  |   | (94,649,327 | ) |  |   | 152,781,285 |  
|                                                                                               |  |                 |   |  |                          |       |   |                      |   |             |                                                    |  |                                              |             |   |                          |   |         |  |   |             |   |  |   |             |  



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



F-6



---

##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITYContinued



For the period from August 9, 1993 (inception) to December 31, 2001, for the years ended

December 31, 2002, 2003 and 2004



|                                                                                                                                |  |                  |   |                          |        |       |                      |   |             |                                                    |  |   |                                              |   |  |                          |          |   |  |   |              |   |  |   |             |  
|------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | - | ------------------------ | ------ | ----- | -------------------- | - | ----------- | -------------------------------------------------- |  | - | -------------------------------------------- | - |  | ------------------------ | -------- | - |  | - | ------------ | - |  | - | ----------- | -
|                                                                                                                                |  | Common stock     |   | Additionalpaid-incapital |        |       | Deferredcompensation |   |             | Unrealizedgain (loss)onavailablefor salesecurities |  |   | DeficitAccumulatedduring thedevelopmentstage |   |  | Totalstockholdersequity |         
|                                                                                                                                |  | Number of shares |   |                          | Amount |       |                      |   |             |                                                   
|Payments on notes granted to employees for stock options                                                                        |  |                 |   |                          |        |      |                      |   | 267,677     |                                                    |  |   |                                             |   |  |                          |         |   |  |   |             |   |  |   | 267,677     |  
|Interest receivable converted to principal on employee notes                                                                    |  |                 |   |                          |        |      |                      |   | (49,534     | )                                                  |  |   |                                             |   |  |                          |         |   |  |   |             |   |  |   | (49,534     | )
|Forfeiture of stock and stock options                                                                                           |  | (2,943           | ) |                          |        |      |                      |   | (732,578    | )                                                  |  |   | 732,578                                      |   |  |                          |         |   |  |   |             |   |  |   |            |  
|Reduction of estimated offering costs                                                                                           |  |                 |   |                          |        |      |                      |   | 400,000     |                                                    |  |   |                                             |   |  |                          |         |   |  |   |             |   |  |   | 400,000     |  
|Exercise of stock options                                                                                                       |  | 385,526          |   |                          |        | 39    |                      |   | 889,437     |                                                    |  |   |                                             |   |  |                          |         |   |  |   |             |   |  |   | 889,476     |  
|Issuance of common stock for bonus awards and under an employment agreement                                                     |  | 7,350            |   |                          |        |      |                      |   | 320,307     |                                                    |  |   | (2,172                                       | ) |  |                          |         |   |  |   |             |   |  |   | 318,135     |  
|Unrealized loss on investments                                                                                                  |  |                 |   |                          |        |      |                      |   |            |                                                    |  |   |                                             |   |  |                          | (386,281 | ) |  |   |             |   |  |   | (386,281    | )
|Deferred compensation resulting from grant of stock options adjustment                                                          |  |                 |   |                          |        |      |                      |   | (30,270     | )                                                  |  |   | 30,270                                       |   |  |                          |         |   |  |   |             |   |  |   |            |  
|Accelerated amortization and cancellation of deferred compensation resulting from the acceleration of vesting of
stockoptions   |  |                 |   |                          |        |      |                      |   | (28,555     | )                                                  |  |   | 2,884,232                                    |   |  |                          |         |   |  |   |             |   |  |   | 2,855,677   |  
|Amortization of deferred compensation                                                                                           |  |                 |   |                          |        |      |                      |   |            |                                                    |  |   | 4,175,751                                    |   |  |                          |         |   |  |   |             |   |  |   | 4,175,751   |  
|Net loss                                                                                                                        |  |                 |   |                          |        |      |                      |   |            |                                                    |  |   |                                             |   |  |                          |         |   |  |   | (60,524,470  | ) |  |   | (60,524,470 | )
|                                                                                                                                |  |                  |   |                          |        |       |                      |   |             |                                                    |  |   |                                              |   |  |                          |          |   |  |   |              |   |  |   |             |  
|Balance, December 31, 2002                                                                                                      |  | 31,494,237       |   |                          |        | 3,149 |                      |   | 259,261,455 |                                                    |  |   | (3,707,038                                   | ) |  |                          | 343,947  |   |  |   | (155,173,797 | ) |  |   | 100,727,716 |  
|Payments on notes granted to employees for stock options                                                                        |  |                 |   |                          |        |      |                      |   | 546,681     |                                                    |  |   |                                             |   |  |                          |         |   |  |   |             |   |  |   | 546,681     |  
|Interest receivable converted to principal on employee notes                                                                    |  |                 |   |                          |        |      |                      |   | (10,051     | )                                                  |  |   |                                             |   |  |                          |         |   |  |   |             |   |  |   | (10,051     | )
|Forfeiture of stock and stock options                                                                                           |  | (1,001           | ) |                          |        |      |                      |   |             |                                                    |  |   |                                             |   |  |                          |         |   |  |   |             |   |  |   |            |  
|Exercise of stock options                                                                                                       |  | 386,798          |   |                          |        | 39    |                      |   | 1,029,322   |                                                    |  |   |                                             |   |  |                          |         |   |  |   |             |   |  |   | 1,029,361   |  
|Issuance of common stock for bonus awards and under an employment agreement                                                     |  | 9,259            |   |                          |        | 1     |                      |   | (96,537     | )                                                  |  |   |                                             |   |  |                          |         |   |  |   |             |   |  |   | (96,536     | )
|Issuance of common stock for technology license agreements                                                                      |  | 3,829            |   |                          |        |      |                      |   | 50,006      |                                                    |  |   |                                             |   |  |                          |         |   |  |   |             |   |  |   | 50,006      |  
|Unrealized loss on investments                                                                                                  |  |                 |   |                          |        |      |                      |   |            |                                                    |  |   |                                             |   |  |                          | (122,723 | ) |  |   |             |   |  |   | (122,723    | )
|Net proceeds from issuance of newly registered shares of common stock                                                           |  | 6,900,000        |   |                          |        | 690   |                      |   | 111,584,379 |                                                    |  |   |                                             |   |  |                          |         |   |  |   |             |   |  |   | 111,585,069 |  
|Deferred compensation resulting from grant of stock options adjustment                                                          |  |                 |   |                          |        |      |                      |   | 145,007     |                                                    |  |   | (145,007                                     | ) |  |                          |         |   |  |   |             |   |  |   |            |  
|Cancellations and accelerated amortization of deferred compensation resulting from the acceleration of vesting of stock
options |  |                 |   |                          |        |      |                      |   | (318,827    | )                                                  |  |   | 567,482                                      |   |  |                          |         |   |  |   |             |   |  |   | 248,655     |  
|Amortization of deferred compensation                                                                                           |  |                 |   |                          |        |      |                      |   |            |                                                    |  |   | 2,526,975                                    |   |  |                          |         |   |  |   |             |   |  |   | 2,526,975   |  
|Net loss                                                                                                                        |  |                 |   |                          |        |      |                      |   |            |                                                    |  |   |                                             |   |  |                          |         |   |  |   | (51,206,219  | ) |  |   | (51,206,219 | )
|                                                                                                                                |  |                  |   |                          |        |       |                      |   |             |                                                    |  |   |                                              |   |  |                          |          |   |  |   |              |   |  |   |             |  
|Balance, December 31, 2003                                                                                                      |  | 38,793,122       |   |                          | $      | 3,879 |                      | $ | 372,191,435 |                                                    |  | $ | (757,588                                     | ) |  | $                        | 221,224  |   |  | $ | (206,380,016 | ) |  | $ | 165,278,934 |  
|                                                                                                                                |  |                  |   |                          |        |       |                      |   |             |                                                    |  |   |                                              |   |  |                          |          |   |  |   |              |   |  |   |             |  



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



F-7



---

##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITYContinued



For the period from August 9, 1993 (inception) to December 31, 2001, for the years ended

December 31, 2002, 2003 and 2004



|                                                                       |  |                 |  |                          |       |  |                      |             |   |                                                    |   |           |                                              |  |   |                          |   |  |   |              |   |  |   |             |  
|---------------------------------------------------------------------- |  | --------------- |  | ------------------------ | ----- |  | -------------------- | ----------- | - | -------------------------------------------------- | - | --------- | -------------------------------------------- |  | - | ------------------------ | - |  | - | ------------ | - |  | - | ----------- | -
|                                                                       |  | Common stock    |  | Additionalpaid-incapital |       |  | Deferredcompensation |             |   | Unrealizedgain (loss)onavailablefor salesecurities |   |           | DeficitAccumulatedduring thedevelopmentstage |  |   | Totalstockholdersequity |  
|                                                                       |  | Numberof shares |  | Amount                   |       |  |                      |             |  
|Payments on notes granted to employees for stock options               |  |                |  |                          |      |  |                      | 2,754       |   |                                                    |   |          |                                              |  |   |                         |   |  |   |             |   |  |   | 2,754       |  
|Interest receivable converted to principal on employee notes           |  |                |  |                          |      |  |                      | (2,935      | ) |                                                    |   |          |                                              |  |   |                         |   |  |   |             |   |  |   | (2,935      | )
|Exercise of stock options                                              |  | 287,223         |  |                          | 29    |  |                      | 1,056,575   |   |                                                    |   |          |                                              |  |   |                         |   |  |   |             |   |  |   | 1,056,604   |  
|Unrealized loss on investments                                         |  |                |  |                          |      |  |                      |            |   |                                                    |   |          |                                              |  |   | (684,681                 | ) |  |   |             |   |  |   | (684,681    | )
|Deferred compensation resulting from grant of stock options adjustment |  |                |  |                          |      |  |                      | 357,602     |   |                                                    |   | (357,602  | )                                            |  |   |                         |   |  |   |             |   |  |   |            |  
|Amortization of deferred compensation                                  |  |                |  |                          |      |  |                      |            |   |                                                    |   | 1,095,725 |                                              |  |   |                         |   |  |   |             |   |  |   | 1,095,725   |  
|Net loss                                                               |  |                |  |                          |      |  |                      |            |   |                                                    |   |          |                                              |  |   |                         |   |  |   | (43,586,484  | ) |  |   | (43,586,484 | )
|                                                                       |  |                 |  |                          |       |  |                      |             |   |                                                    |   |           |                                              |  |   |                          |   |  |   |              |   |  |   |             |  
|Balance, December 31, 2004                                             |  | 39,080,345      |  | $                        | 3,908 |  | $                    | 373,605,431 |   |                                                    | $ | (19,465   | )                                            |  | $ | (463,457                 | ) |  | $ | (249,966,500 | ) |  | $ | 123,159,917 |  
|                                                                       |  |                 |  |                          |       |  |                      |             |   |                                                    |   |           |                                              |  |   |                          |   |  |   |              |   |  |   |             |  



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



F-8



---

##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



CONSOLIDATED STATEMENTS OF CASH FLOWS



Years ended December 31, 2004, 2003 and 2002, and for the period from

August 9, 1993 (inception) to December 31, 2004



|                                                                                                               |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|-------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------------ | - | ---------------------------------------------------------- | - | ------------ | ---- |  | - | ------------ | - |  | - | ------------ | -
|                                                                                                               |  | Year ended December 31, |              |   | Period from August 9, 1993 (inception) to December 31,2004 |  
|                                                                                                               |  | 2004                    |              |   | 2003                                                       |   |              | 2002 |  |  
|Net cash flows from operating activities:                                                                      |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Net loss                                                                                                       |  | $                       | (43,586,484  | ) |                                                            | $ | (51,206,219  | )    |  | $ | (60,524,470  | ) |  | $ | (249,966,500 | )
|Adjustments to reconcile net loss to net cash used in operating activities:                                    |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Non-cash compensation expense                                                                                  |  |                         | 1,095,725    |   |                                                            |   | 2,679,095    |      |  |   | 7,349,563    |   |  |   | 22,498,402   |  
|Non-cash warrant value                                                                                         |  |                         |             |   |                                                            |   |             |      |  |   |             |   |  |   | 60,000       |  
|Depreciation expense                                                                                           |  |                         | 2,384,616    |   |                                                            |   | 1,854,195    |      |  |   | 1,395,582    |   |  |   | 7,599,069    |  
|Non-cash benefit from the trade of equipment                                                                   |  |                         |             |   |                                                            |   |             |      |  |   | 120,000      |   |  |   | 120,000      |  
|Gain on the sale of equipment                                                                                  |  |                         |             |   |                                                            |   | 41,412       |      |  |   | (61,639      | ) |  |   | (20,227      | )
|Issuance of common stock for technology license agreements                                                     |  |                         |             |   |                                                            |   | 50,006       |      |  |   |             |   |  |   | 56,256       |  
|Changes in assets and liabilities:                                                                             |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Accounts receivable from collaboration agreements                                                              |  |                         | (284,119     | ) |                                                            |   | 4,422,622    |      |  |   | (7,502,379   | ) |  |   | (3,363,876   | )
|Prepaid expenses and other current assets                                                                      |  |                         | 403,561      |   |                                                            |   | 114,916      |      |  |   | 1,173,339    |   |  |   | (2,542,693   | )
|Other assets                                                                                                   |  |                         | 69,915       |   |                                                            |   | 6,650        |      |  |   | (94,530      | ) |  |   | (100,000     | )
|Accounts payable                                                                                               |  |                         | 1,560,710    |   |                                                            |   | (63,066      | )    |  |   | (724,336     | ) |  |   | 3,103,409    |  
|Accrued expenses                                                                                               |  |                         | (3,243,944   | ) |                                                            |   | (3,463,637   | )    |  |   | 10,024,622   |   |  |   | 11,716,232   |  
|Deferred licensing fees and rent                                                                               |  |                         | (4,166,676   | ) |                                                            |   | (4,596,499   | )    |  |   | 47,022,291   |   |  |   | 40,123,827   |  
|                                                                                                               |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Net cash used in operating activities                                                                          |  |                         | (45,766,696  | ) |                                                            |   | (50,160,525  | )    |  |   | (1,821,957   | ) |  |   | (170,716,101 | )
|                                                                                                               |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Net cash flows from investing activities:                                                                      |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Purchases of equipment and leasehold improvements                                                              |  |                         | (2,456,012   | ) |                                                            |   | (6,642,373   | )    |  |   | (1,724,198   | ) |  |   | (17,603,067  | )
|Proceeds from the sale of equipment                                                                            |  |                         |             |   |                                                            |   |              |      |  |   | 144,273      |   |  |   | 144,273      |  
|Purchases of short-term investments                                                                            |  |                         | (204,047,348 | ) |                                                            |   | (260,410,834 | )    |  |   | (101,681,763 | ) |  |   | (778,051,738 | )
|Maturities of short-term investments                                                                           |  |                         | 252,809,848  |   |                                                            |   | 172,770,061  |      |  |   | 90,405,159   |   |  |   | 622,200,173  |  
|                                                                                                               |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Net cash provided by / (used in) investing activities                                                          |  |                         | 46,306,488   |   |                                                            |   | (94,283,146  | )    |  |   | (12,856,529  | ) |  |   | (173,310,359 | )
|                                                                                                               |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Net 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                     |  |                         | 1,056,604    |   |                                                            |   | 1,029,361    |      |  |   | 889,476      |   |  |   | 3,693,691    |  
|Proceeds from notes payablerelated parties                                                                    |  |                         |             |   |                                                            |   |             |      |  |   |             |   |  |   | 1,000,000    |  
|Proceeds from notes payable                                                                                    |  |                         |             |   |                                                            |   | 93,824       |      |  |   | 248,506      |   |  |   | 1,832,474    |  
|Payment of notes payable                                                                                       |  |                         |             |   |                                                            |   | (129,380     | )    |  |   | (427,769     | ) |  |   | (1,832,474   | )
|Proceeds received on notes receivable                                                                          |  |                         | 2,754        |   |                                                            |   | 546,681      |      |  |   | 267,677      |   |  |   | 973,951      |  
|Interest receivable converted to principal on notes                                                            |  |                         | (2,935       | ) |                                                            |   | (10,051      | )    |  |   | (49,534      | ) |  |   | (131,859     | )
|Net proceeds from issuance of common stock                                                                     |  |                         |             |   |                                                            |   | 111,585,069  |      |  |   | 400,000      |   |  |   | 266,324,185  |  
|                                                                                                               |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Net cash provided by financing activities                                                                      |  |                         | 1,056,423    |   |                                                            |   | 113,115,504  |      |  |   | 1,328,356    |   |  |   | 350,961,877  |  
|                                                                                                               |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Net increase (decrease) in cash and cash equivalents                                                           |  |                         | 1,596,215    |   |                                                            |   | (31,328,167  | )    |  |   | (13,350,130  | ) |  |   | 6,935,417    |  
|Cash and cash equivalents at beginning of period                                                               |  |                         | 5,339,202    |   |                                                            |   | 36,667,369   |      |  |   | 50,017,499   |   |  |   |             |  
|                                                                                                               |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Cash and cash equivalents at end of period                                                                     |  | $                       | 6,935,417    |   |                                                            | $ | 5,339,202    |      |  | $ | 36,667,369   |   |  | $ | 6,935,417    |  
|                                                                                                               |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Supplemental disclosure of cash flow information:                                                              |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Cash paid for interest                                                                                         |  | $                       | 1,580        |   |                                                            | $ | 10,751       |      |  | $ | 19,208       |   |  | $ | 224,610      |  
|                                                                                                               |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Supplemental disclosure of non-cash financing activities:                                                      |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  
|Unrealized gains (losses) on available for sale securities                                                     |  | $                       | (684,681     | ) |                                                            | $ | (122,723     | )    |  | $ | (386,281     | ) |  | $ | (463,457     | )
|Deferred compensation from issuance of common stock, restricted common stock and common stock options          |  |                         | 357,602      |   |                                                            |   | 145,007      |      |  |   | 118,326      |   |  |   | 24,496,376   |  
|Issuance of common stock for technology license agreements or for services                                     |  |                         |             |   |                                                            |   |             |      |  |   |             |   |  |   | 19,589       |  
|Conversion of Series A through H (excluding D) preferred stock for common stock                                |  |                         |             |   |                                                            |   |             |      |  |   |             |   |  |   | 80,383,703   |  
|Conversion of stock subscription to Series D mandatorily redeemable preferred stock                            |  |                         |             |   |                                                            |   |             |      |  |   |             |   |  |   | 600,000      |  
|Conversion of bridge financing, including accrued interest, to Series B mandatorily redeemable preferred stock |  |                         |             |   |                                                            |   |             |      |  |   |             |   |  |   | 1,019,787    |  
|                                                                                                               |  |                         |              |   |                                                            |   |              |      |  |   |              |   |  |   |              |  



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



F-9



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##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



|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 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 December 31, 2004 aggregated approximately $250.0 million, and the Company expects to continue to incur substantial losses in future periods. The Company is highly dependent on the success of
the Companys 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.



|2. | BASIS OF ACCOUNTING AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|-- | ------------------------------------------------------------------



Principles of Consolidation



The Consolidated Financial Statements include the accounts of Adolor Corporation and its wholly owned subsidiary. All significant intercompany accounts
and transactions have been eliminated in consolidation.



Cash and Cash
Equivalents



The Company considers all highly liquid
investments with an original maturity of three months or less when purchased to be cash equivalents. Cash equivalents are held in investment grade fixed income securities including United States Treasury obligations and corporate securities. The
carrying amount of cash and cash equivalents approximates its fair value due to its short-term nature.



Short-term Investments



The Companys entire portfolio of short-term investments is currently classified as available for sale and is stated at fair value as determined by quoted market values. All investments are considered short-term and are classified as
current assets, including securities with maturities in excess of one year, as management has the option to sell them at any time. Changes in net unrealized gains and losses are included as a separate component of stockholders equity and
comprehensive loss. For purposes of determining realized gains and losses, the cost of short-term investments sold is based upon specific identification.



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##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued)



Concentration of Credit Risk



The Company invests its excess cash in accordance with a policy objective that seeks to ensure both liquidity and safety of
principal. The policy limits investments to instruments issued by the U.S. government and commercial institutions with strong investment grade credit ratings and places restrictions on maturity terms and concentrations by type and issuer.



Equipment and Leasehold Improvements



Purchases of equipment (consisting of computer, office and laboratory
equipment), furniture and fixtures and leasehold improvements are recorded at cost. Depreciation and amortization is provided using the straight-line method over the estimated useful lives of the assets or lease term, whichever is shorter, generally
three to seven years. Expenditures for repairs and maintenance are charged to expense as incurred.



Revenue Recognition



The Company records a liability for deferred revenue for amounts received as upfront payments under collaboration agreements in which the Company has continuing involvement. The Company recognizes such deferred amounts as revenue ratably
over the estimated contract performance period. Such revenue recognition may be accelerated in the event of contract termination prior to completion of the expected performance period. Milestone amounts are recorded as revenue when the milestone
event is achieved. Amounts reimbursable for costs incurred pursuant to the terms of collaboration agreements are recorded as revenue in the period in which the reimbursable cost is incurred. Such revenues are determined based on estimates of the
reimbursable amount and are subject to verification by the collaborators.



Research and Development Expenses



Research
and product development costs are charged to expense as incurred. Costs incurred under agreements with third parties are charged to expense as incurred in accordance with the specific contractual performance terms of such agreements. Research and
development expenses include, among other costs, salaries and other personnel-related costs, costs to conduct clinical trials, costs to manufacture drug candidates and clinical supplies, laboratory supplies costs and facility related costs.



Accounting for Income Taxes



Deferred income tax assets and liabilities are determined based on
differences between the financial statement reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred income tax assets are
reduced, as necessary, by a valuation allowance when management determines it is more likely than not that some or all of the tax benefits will not be realized. The effect on deferred income tax assets and liabilities of a change in tax rates is
recognized in the period that such tax rate changes are enacted.



Segment
Information



The Company is managed and operated as one
business. The Company is managed by a single management team that reports to the chief executive officer. The Company does not operate separate lines of business or separate business entities with respect to any of its product candidates.
Accordingly, the Company does not prepare discrete financial information with respect to separate product areas, or by location, and does not have separately reportable segments.



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##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued)



Net Loss per Share



Net loss per share is computed by dividing the net loss allocable to common stockholders by the weighted average number of shares of common stock
outstanding. Net loss allocable to common stockholders is calculated as the net loss plus preferred dividends accrued for the respective period, whether or not declared, plus the beneficial conversion feature, if any, on mandatorily redeemable
convertible preferred stock. In computing the basic and diluted net loss per share allocable to common stockholders the weighted average number of shares remains the same for both calculations due to the fact that when a net loss exists, dilutive
shares are not included in the calculation.



Use of Estimates



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



Reclassifications



Certain prior year amounts have been reclassified to conform with the current year presentation.



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 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 FASB issued SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure, which amended SFAS
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 SFAS 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 SFAS No. 148 have been incorporated herein.



In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment,a revision to SFAS 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



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##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued)



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 first interim or annual reporting period that begins
after June 15, 2005. The Company is currently evaluating various implementation standards of SFAS 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 SFAS No. 123 for options granted based on the fair value method the Companys net loss and net loss per share would have been increased to the pro forma amounts indicated below:



|                                                                                                               |  |                          |             |   |      |   |             |      |  |   |             |  
|-------------------------------------------------------------------------------------------------------------- |  | ------------------------ | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                                                               |  | Years Ended December 31, |            
|                                                                                                               |  | 2004                     |             |   | 2003 |   |             | 2002 | 
|Net loss, as reported                                                                                          |  | $                        | (43,586,484 | ) |      | $ | (51,206,219 | )    |  | $ | (60,524,470 | )
|Add: Stock-based employee compensation expense included in reported net income                                 |  |                          | 598,223     |   |      |   | 2,461,017   |      |  |   | 6,884,428   |  
|Deduct: Total stock-based employee compensation expense determined under fair value based method of all awards |  |                          | (7,763,839  | ) |      |   | (7,740,796  | )    |  |   | (9,031,775  | )
|                                                                                                               |  |                          |             |   |      |   |             |      |  |   |             |  
|Pro forma net loss                                                                                             |  | $                        | (50,752,100 | ) |      | $ | (56,485,998 | )    |  | $ | (62,671,817 | )
|                                                                                                               |  |                          |             |   |      |   |             |      |  |   |             |  
|Loss per share:                                                                                                |  |                          |             |   |      |   |             |      |  |   |             |  
|Basic and dilutedas reported                                                                                  |  | $                        | (1.12       | ) |      | $ | (1.57       | )    |  | $ | (1.94       | )
|Basic and diluted pro forma                                                                                   |  | $                        | (1.30       | ) |      | $ | (1.73       | )    |  | $ | (2.01       | )



The weighted average
fair value of the options granted during 2004, 2003 and 2002, is estimated at $6.86, $5.60, and $6.07 per share, respectively, using the Black-Scholes option pricing model with the following assumptions: dividend yield of zero; volatility of 48
percent, 50 percent, and 47 percent, respectively; weighted average risk-free interest rate of between 2.81 and 4.01 percent, between 2.10 and 3.52 percent, and between 2.67 and 4.76 percent, respectively; and an expected life of 4.0, 4.0, and 4.0
years, respectively.



|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 December 31, 2004 and 2003:



|                                     |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|------------------------------------ |  | ---- | ----------- | -------------------- | - | --------------------- |  | - | ---------- | - |  | - | -----------
|                                     |  | Cost |             | Grossunrealizedgains |   | Grossunrealizedlosses |  |   | Fair value
|Corporate bonds                      |  | $    | 2,050,510   |                      | $ |                      |  | $ | (9,290     | ) |  | $ | 2,041,220  
|US Government obligations & agencies |  |      | 153,801,055 |                      |   |                      |  |   | (454,167   | ) |  |   | 153,346,888
|                                     |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|December 31, 2004                    |  | $    | 155,851,565 |                      | $ |                      |  | $ | (463,457   | ) |  | $ | 155,388,108
|                                     |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|Corporate bonds                      |  | $    | 32,067,478  |                      | $ | 106,799               |  | $ | (8,090     | ) |  | $ | 32,166,187 
|US Government obligations & agencies |  |      | 172,546,587 |                      |   | 130,514               |  |   | (7,999     | ) |  |   | 172,669,102
|                                     |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|December 31, 2003                    |  | $    | 204,614,065 |                      | $ | 237,313               |  | $ | (16,089    | ) |  | $ | 204,835,289
|                                     |  |      |             |                      |   |                       |  |   |            |   |  |   |            



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##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued)



At December 31, 2004, maturities of investments were as follows:



|                  |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|----------------- |  | ---- | ----------- | -------------------- | - | --------------------- |  | - | ---------- | - |  | - | -----------
|                  |  | Cost |             | Grossunrealizedgains |   | Grossunrealizedlosses |  |   | Fair value
|Less than 1 year  |  | $    | 127,090,572 |                      | $ |                      |  | $ | (383,494   | ) |  | $ | 126,707,078
|Due in 1-5 years  |  |      | 28,760,993  |                      |   |                      |  |   | (79,963    | ) |  |   | 28,681,030 
|                  |  |      |             |                      |   |                       |  |   |            |   |  |   |            
|December 31, 2004 |  | $    | 155,851,565 |                      | $ |                      |  | $ | (463,457   | ) |  | $ | 155,388,108
|                  |  |      |             |                      |   |                       |  |   |            |   |  |   |            



|4. | CONTRACT REVENUES
|-- | -----------------



Contract revenues for the year ended December 31, 2004, 2003 and 2002 consist of the following:



|                                                 |  |              |            |      |   |            |  |   |           
|------------------------------------------------ |  | ------------ | ---------- | ---- | - | ---------- |  | - | ----------
|                                                 |  | December 31,
|                                                 |  | 2004         |            | 2003 |   | 2002      
|Cost reimbursement under collaborative agreement |  | $            | 11,374,951 |      | $ | 16,141,916 |  | $ | 24,246,332
|Amortization of up-front license fees            |  |              | 4,166,676  |      |   | 4,584,721  |  |   | 2,977,710 
|License and milestone payments                   |  |              | 10,000,000 |      |   |           |  |   | 450,000   
|Grant revenue                                    |  |              |           |      |   |           |  |   | 735,375   
|                                                 |  |              |            |      |   |            |  |   |           
|Total revenue                                    |  | $            | 25,541,627 |      | $ | 20,726,637 |  | $ | 28,409,417
|                                                 |  |              |            |      |   |            |  |   |           



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 $4.2 million was recognized in each of the years ended December 31, 2004 and 2003. In the third quarter of 2004, upon acceptance for review of the Companys NDA by the FDA, and
under the terms of the collaboration agreement, the Company recognized $10.0 million in milestone revenue received from Glaxo.



External expenses for research and development and marketing activities incurred by each company in the United States are reimbursed by the other party
pursuant to contractually agreed percentages. Reimbursement amounts owed to the Company by Glaxo are recorded gross on the Consolidated Statements of Operations as contract reimbursement revenue. The Company recorded contract reimbursement revenues
of approximately $11.4 million and $16.1 million, respectively, in the years ended December 31, 2004 and 2003 under this arrangement. As of December 31, 2004 and 2003, approximately $3.4 million and $3.1 million, respectively, were receivable from
Glaxo for reimbursement of expenses incurred by the Company pursuant to the collaboration agreement.



In April 2000, the Company entered into a license agreement with Santen Pharmaceutical Co., Ltd. granting Santen an exclusive royalty bearing license to
develop and sell products in the field of ophthalmic pain in all countries other than South Korea and North Korea. A $500,000 non-refundable payment was paid to the Company upon execution of the agreement. Such amount was recorded as deferred
revenue and was being recognized over the remaining patent life. In February 2003 Santen terminated this agreement and, as a result, the Company recognized $0.4 million as revenue in the first quarter of 2003.



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##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued)



|5. | EQUIPMENT AND LEASEHOLD IMPROVEMENTS
|-- | ------------------------------------



Equipment and leasehold improvements consist of the following:



|                                               |  |              |            |   |      |   |            |  
|---------------------------------------------- |  | ------------ | ---------- | - | ---- | - | ---------- | -
|                                               |  | December 31, |           
|                                               |  | 2004         |            |   | 2003 |  
|Laboratory, computer and office equipment      |  | $            | 9,469,351  |   |      | $ | 7,511,064  |  
|Furniture, fixtures and leasehold improvements |  |              | 6,885,017  |   |      |   | 5,041,250  |  
|                                               |  |              |            |   |      |   |            |  
|                                               |  |              | 16,354,368 |   |      |   | 12,552,314 |  
|Less accumulated depreciation and amortization |  |              | (6,581,077 | ) |      |   | (4,258,990 | )
|                                               |  |              |            |   |      |   |            |  
|                                               |  | $            | 9,773,291  |   |      | $ | 8,293,324  |  
|                                               |  |              |            |   |      |   |            |  



Management has
conducted a review of its accounting for the lease of its corporate headquarters, which was entered into in 2003. The Company did not account for a tenant improvement allowance provided by the landlord on the consolidated balance sheets or on the
consolidated statements of cash flows. Management determined that the appropriate accounting under generally accepted accounting principles requires that the allowance be recorded as a deferred rent liability on the consolidated balance sheets and
as a component of operating activities on the consolidated cash flow statements. As a result, the Company recorded a leasehold improvement of approximately $1.4 million relating to a tenant allowance and a corresponding deferred rent liability at
December 31, 2004. The deferred rent liability will be amortized over the lease term as a reduction of rent expense and the addition to leasehold improvements will be amortized over the useful life of the improvement. The cash flow statement for the
period from August 9, 1993 (inception) to December 31, 2004 has also been corrected to reflect the tenant allowance as both a cash flow from operations and an investing activity. The Company has corrected the lease accounting as of December 31, 2004
as management has determined that the amounts are immaterial to financial statements of prior periods.



|6. | ACCRUED EXPENSES
|-- | ----------------



Accrued expenses consist of the following:



|                                 |  |              |            |      |   |           
|-------------------------------- |  | ------------ | ---------- | ---- | - | ----------
|                                 |  | December 31,
|                                 |  | 2004         |            | 2003
|Clinical development costs       |  | $            | 2,047,411  |      | $ | 2,995,095 
|Manufacturing costs              |  |              | 3,051,055  |      |   | 4,522,001 
|Consulting and other costs       |  |              | 1,736,045  |      |   | 2,744,098 
|Collaboration agreement expenses |  |              | 1,814,721  |      |   | 1,479,474 
|Professional fees                |  |              | 535,100    |      |   | 288,214   
|Personnel related costs          |  |              | 2,531,900  |      |   | 2,931,294 
|                                 |  |              |            |      |   |           
|                                 |  | $            | 11,716,232 |      | $ | 14,960,176
|                                 |  |              |            |      |   |           



|7. | COMMON STOCK AND COMMON STOCK OPTIONS
|-- | -------------------------------------



In November 2003 the Company sold 6 million shares of common stock. Upon the exercise of the underwriters over-allotment option, the Company sold an
additional 900,000 shares of common stock. The price to the public of the 6.9 million shares of common stock sold was $17.25 per share. The proceeds of the offering were approximately $111,585,000, net of offering costs.



Shareholder Rights Plan



The Companys Board of Directors adopted a Shareholder Rights Plan (the
Plan) in February 2001. Under the Plan, preferred stock purchase rights (each, a Right) were distributed as a dividend at the rate of one Right



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##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued)



for each share of common stock outstanding as of the close of business on February 20, 2001 and automatically attach to shares issued thereafter. Each Right
entitles the holder to purchase one ten-thousandth of a share of newly created Series A Junior Participating Preferred Stock of the Company at an exercise price of $155.00 (the Exercise Price) per Right. In general, the Rights will be
exercisable if a person or group (Acquiring Person) becomes the beneficial owner of 15% or more of the outstanding common stock of the Company or announces a tender offer for 15% or more of the common stock of the Company. When the
Rights become exercisable, a holder, other than the Acquiring Person, will have the right to receive, upon exercise, common stock having a value equal to two times the Exercise Price of the Right. The Board of Directors will in general be entitled
to redeem the Rights for $.0001 per Right at any time prior to the occurrence of the stock acquisition events described above. If not redeemed, the Rights will expire on February 19, 2011.



Standstill Arrangement



The Glaxo collaboration agreement generally provides that during its term,
Glaxo will not, directly or indirectly, alone or in concert with others, (i) acquire, or agree to acquire any shares of the Companys common stock or any securities exercisable for or convertible into the Companys common stock, (ii) make,
or in any way participate in, any solicitation of proxies to vote the Companys common stock or (iii) acquire or agree to acquire any of the Companys tangible or intangible assets not offered for sale by the Company. However, Glaxo may
under certain circumstances acquire equity securities of the Company set forth in the agreement including following the initiation by a third party of an unsolicited tender offer to purchase the Company or in connection with stock splits or
recapitalizations or on exercise of pre-emptive rights afforded to the Companys stockholders generally.



Stock Options



The Companys 1994 Amended and Restated Equity Compensation Plan, as amended (the 1994 Plan) and 2003 Stock-Based Incentive Compensation
Plan (the 2003 Plan), together known as the Plans, allow for the granting of incentive and nonqualified stock options to employees, directors, consultants and contractors to purchase an aggregate of 8,850,000 shares of the Companys
common stock. The options are exercisable generally for a period of seven to ten years from the date of grant and vest over terms ranging from immediately to four years. Additionally, in 2002, the Company granted its Chief Executive Officer options
to purchase 540,000 shares of common stock outside of the Plans.



A summary of option activity from January 1, 2002 to December 31, 2004, is as follows:



|                           |  |                  |   |  |                         |            
|-------------------------- |  | ---------------- | - |  | ----------------------- | -----------
|                           |  | Number ofoptions |   |  | Exercise Priceper share
|Balance, January 1, 2002   |  | 1,926,221        |   |  | $                       |            
|Granted                    |  | 1,599,754        |   |  |                         | 9.85-17.33 
|Exercised                  |  | (385,526         | ) |  |                         | .21-16.11  
|Cancelled                  |  | (207,060         | ) |  |                         | .13-21.30  
|                           |  |                  |   |  |                         |            
|Balance, December 31, 2002 |  | 2,933,389        |   |  |                         |            
|Granted                    |  | 1,021,790        |   |  |                         | 11.26-20.14
|Exercised                  |  | (386,798         | ) |  |                         | .21-17.59  
|Cancelled                  |  | (140,583         | ) |  |                         | .21-27.99  
|                           |  |                  |   |  |                         |            
|Balance, December 31, 2003 |  | 3,427,798        |   |  |                         |            
|Granted                    |  | 1,305,915        |   |  |                         | 10.65-22.24
|Exercised                  |  | (287,223         | ) |  |                         | .35-16.73  
|Cancelled                  |  | (443,830         | ) |  |                         | 3.50-22.24 
|                           |  |                  |   |  |                         |            
|Balance, December 31, 2004 |  | 4,002,660        |   |  |                         |            
|                           |  |                  |   |  |                         |            



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##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued)



A summary of options outstanding and exercisable by price range at December 31, 2004, is as follows:



|                         |  |                     |  |                                        |  |                                           |       |                 |           |                                           |   |      
|------------------------ |  | ------------------- |  | -------------------------------------- |  | ----------------------------------------- | ----- | --------------- | --------- | ----------------------------------------- | - | -----
|                         |  | Options Outstanding |  | Options Exercisable                   
|Range of exercise prices |  | Number ofoptions    |  | Weighted average remaining option life |  | Weighted averageexercise price(per share) |       | Number ofshares |           | Weighted averageexercise price(per share)
|$0.002.79               |  | 122,674             |  | 5.0                                    |  | $                                         | 2.20  |                 | 122,674   |                                           | $ | 2.20 
|$2.805.59               |  | 114,605             |  | 5.6                                    |  |                                           | 3.50  |                 | 114,605   |                                           |   | 3.50 
|$5.608.39               |  |                    |  |                                       |  |                                           |      |                 |          |                                           |   |     
|$8.4011.19              |  | 232,250             |  | 8.4                                    |  |                                           | 10.35 |                 | 88,481    |                                           |   | 10.16
|$11.2013.99             |  | 970,282             |  | 8.2                                    |  |                                           | 12.79 |                 | 448,383   |                                           |   | 13.18
|$14.0016.79             |  | 1,384,118           |  | 7.6                                    |  |                                           | 15.08 |                 | 752,177   |                                           |   | 15.11
|$16.8019.59             |  | 317,933             |  | 8.1                                    |  |                                           | 18.30 |                 | 133,612   |                                           |   | 18.20
|$19.6022.39             |  | 850,798             |  | 8.4                                    |  |                                           | 21.10 |                 | 313,161   |                                           |   | 21.06
|$22.4025.19             |  |                    |  |                                       |  |                                           |      |                 |          |                                           |   |     
|$25.2027.99             |  | 10,000              |  | 6.4                                    |  |                                           | 27.99 |                 | 8,749     |                                           |   | 27.99
|                         |  |                     |  |                                        |  |                                           |       |                 |           |                                           |   |      
|                         |  | 4,002,660           |  |                                        |  | $                                         | 15.09 |                 | 1,981,842 |                                           | $ | 14.19
|                         |  |                     |  |                                        |  |                                           |       |                 |           |                                           |   |      



During the year ended
December 31, 2000, the Company granted options to certain employees to acquire 1,657,035 shares of the Companys common stock at exercise prices ranging from $2.25 to $3.50 per share for which deferred compensation, based on a fair value of
$14.40 per share on the grant date, amounting to approximately $18.7 million was recorded and was amortized to compensation expense over the respective vesting periods of the options.



During the years ended December 31, 2004, 2003 and 2001, the Company granted options to non-employees to acquire 59,966,
4,000 and 20,000 shares of common stock, respectively, for which deferred compensation of $365,000, $24,627 and $294,000 was recorded in 2004, 2003 and 2001, respectively, based on fair value as determined using a Black-Scholes option pricing model
and is being amortized to expense over the vesting periods of the options. The amount of amortization for option grants to non-employees is subject to change each reporting period based upon changes in the fair value of the Companys common
stock, estimated volatility and the risk free interest rate until the non-employee completes his or her performance under the option agreement.



Compensation expense during the years ended December 31, 2004, 2003 and 2002, relating to option grants was approximately $1.1 million, $2.8 million and
$7.0 million, respectively. During the years ended December 31, 2003 and 2002 approximately $0.3 million and $2.6 million of such expense was recorded in connection with the acceleration of the vesting of certain stock options under an
employment agreement and separation agreements. Future compensation expense relating to such option grants is expected to be approximately $20,000 for the year ending December 31, 2005. The expense amortization of deferred compensation may change
subject to termination or acceleration of vesting of the related stock options.



|8. | LICENSE AND RESEARCH AGREEMENTS
|-- | -------------------------------



In November 1996, Roberts licensed from Eli Lilly certain intellectual property rights relating to Entereg. In June 1998, the Company entered into an Option and License Agreement with Roberts
under which the Company licensed from Roberts the rights Roberts had licensed from Eli Lilly for Entereg. The Company has made license and milestone payments under this agreement totaling $1.6 million. If Entereg receives regulatory approval, the Company is obligated to make an additional milestone payment of $900,000 under this
agreement,



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##### Table of Contents

ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued)



as well as royalties on commercial sales of Entereg. The license to Entereg expires on the later of either the life of the last to expire of the licensed Eli Lilly patents or fifteen years from November 5, 1996, following which
the Company will have a fully paid up license.



In August 2002,
the Company expanded its intellectual property rights related to Entereg by entering into a separate exclusive license agreement with Eli Lilly under which the Company obtained an exclusive license to six issued U.S. patents and related foreign equivalents and know-how relating to
peripherally selective opioid antagonists. The Company paid Eli Lilly $4.0 million upon signing the agreement and owes additional clinical and regulatory milestone payments and royalty payments to Eli Lilly on sales, if any, of new products
utilizing the licensed technology. Under this license agreement, the Company also agreed to pay Eli Lilly $4.0 million upon acceptance for review of the Companys NDA by the FDA, which payment was made in the third quarter of 2004 and included
in research and development expense in the Consolidated Statement of Operations at December 31, 2004.



In July 2003, the Company entered into an agreement with EpiCept Corporation under which the Company 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. The Company made a $2.5 million payment to EpiCept upon execution of the agreement and may make up to $20.0
million in additional development milestone payments if certain clinical and regulatory achievements are reached. The $2.5 million payment was recorded as research and development expense in 2003 as the underlying technology licensed has not reached
technological feasibility and has no alternative uses.



The
Company intends to charge to expense research and development milestone payments that are required to be made upon the occurrence of future events prior to receipt of applicable regulatory approval.



|9. | INCOME TAXES
|-- | ------------



No federal and state taxes are payable as of December 31, 2004 and 2003.



As of December 31, 2004, the Company had approximately $92,054,000 of Federal and $90,256,000 of state net operating loss
carryforwards potentially available to offset future taxable income. The Federal and Pennsylvania net operating loss carryforwards will expire as follows:



|           |  |       |            |         |   |           
|---------- |  | ----- | ---------- | ------- | - | ----------
|           |  | State |            | Federal
|2005       |  | $     | 450,000    |         | $ |          
|2006       |  |       | 1,232,000  |         |   |          
|2007       |  |       | 2,063,000  |         |   |          
|2008       |  |       | 3,519,000  |         |   |          
|2009       |  |       | 3,938,000  |         |   | 33,000    
|2010       |  |       | 6,780,000  |         |   | 482,000   
|2011       |  |       | 12,151,000 |         |   | 1,078,000 
|2012       |  |       | 20,032,000 |         |   | 1,867,000 
|Thereafter |  |       | 40,091,000 |         |   | 88,594,000
|           |  |       |            |         |   |           
|           |  | $     | 90,256,000 |         | $ | 92,054,000
|           |  |       |            |         |   |           



The utilization of the
state net operating loss carryforwards is subject to a $2.0 million annual limitation. At December 31, 2004, the Company also has approximately $5,569,000 of Federal and $789,000 of state research and development tax credit carryforwards, which
begin expiring in 2011, and are available to reduce Federal and state income taxes.



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ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued)



The Tax Reform Act of 1986 (the Act) provides for a limitation on the annual use of net
operating loss and research and development tax credit carryforwards following certain ownership changes (as defined by the Act) that could significantly limit the Companys ability to utilize these carryforwards. The Company may have
experienced various ownership changes, as defined by the Act, as a result of past financings and the initial public offering. Accordingly, the Companys ability to utilize the aforementioned carryforwards may be limited.



Significant components of the Companys deferred tax assets and
liabilities are shown below. At December 31, 2004, a valuation allowance of $103,361,000 has been recognized to fully offset the deferred tax asset balance. A valuation allowance to reduce the deferred tax assets is required if, based on weight of
the evidence, it is more likely than not that some, or all, of the deferred tax assets will not be realized. Realization of the Companys deferred tax assets is dependent upon generating future taxable income and given the uncertainty of future
profitability, management has determined that a valuation allowance is necessary to reduce net deferred tax assets to zero. The change in the deferred tax asset account before application of the valuation allowance in 2004 and 2003 were
approximately $19,943,000 and $21,730,000, respectively, related primarily to additional net operating losses and research and development costs incurred by the Company that are capitalized for income tax purposes.



|                                           |  |      |              |   |      |   |             |  
|------------------------------------------ |  | ---- | ------------ | - | ---- | - | ----------- | -
|                                           |  | 2004 |              |   | 2003 |  
|Deferred tax assets:                       |  |      |              |   |      |   |             |  
|Net operating losses                       |  | $    | 37,922,000   |   |      | $ | 25,159,000  |  
|Capitalized research and development costs |  |      | 44,486,000   |   |      |   | 36,711,000  |  
|Tax credit carryforwards                   |  |      | 6,082,000    |   |      |   | 4,886,000   |  
|Deferred revenue                           |  |      | 16,064,000   |   |      |   | 17,793,000  |  
|Accrued expenses and other                 |  |      | 107,000      |   |      |   | 169,000     |  
|                                           |  |      |              |   |      |   |             |  
|Total deferred tax assets                  |  |      | 104,661,000  |   |      |   | 84,718,000  |  
|Less valuation allowance                   |  |      | (103,361,000 | ) |      |   | (84,408,000 | )
|                                           |  |      |              |   |      |   |             |  
|Net deferred tax assets                    |  |      | 1,300,000    |   |      |   | 310,000     |  
|Deferred tax liability                     |  |      | (1,300,000   | ) |      |   | (310,000    | )
|                                           |  |      |              |   |      |   |             |  
|Net deferred tax                           |  | $    |             |   |      | $ |            |  
|                                           |  |      |              |   |      |   |             |  



|10. | COMMITMENTS AND CONTINGENCIES
|--- | -----------------------------



Future minimum lease payments under non-cancelable operating leases for equipment and office and laboratory space are as follows:



|                         |  |   |          
|------------------------ |  | - | ---------
|Year ending December 31, |  |  
|2005                     |  | $ | 1,275,000
|2006                     |  |   | 1,244,000
|2007                     |  |   | 1,220,000
|2008                     |  |   | 1,215,000
|2009                     |  |   | 1,215,000
|2010 and beyond          |  |   | 3,646,000
|                         |  |   |          
|                         |  | $ | 9,815,000
|                         |  |   |          



Rent expense was
approximately $1,103,000, $1,063,000, and $977,000 for the years ended December 31, 2004, 2003 and 2002, respectively. In December 2002, the Company signed a ten-year lease agreement for office and laboratory space with minimum rental payments of
approximately $1,110,000 for 2005 through 2008, and $1,170,000 for 2009 through 2013. The lease includes a renewal option for two consecutive additional five year periods and the Company has a purchase option exercisable at the fifth or tenth year
of the lease term.



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ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued)



Glaxo Collaboration Agreement



Under the terms of the Glaxo agreement, the Company will partially reimburse Glaxo for third party expenses incurred by
Glaxo in the development of Entereg for certain
indications in the United States, pursuant to an agreed upon development plan and budget. The Company also expects to incur certain expenses in the development of Entereg, pursuant to an agreed upon development plan and budget, for certain other indications in the United States, a portion
of which are reimbursable to the Company by Glaxo. The Company expects to record these expenses as incurred.



Other Service Agreements



The Company has entered into various agreements for services with third party vendors, including agreements to conduct clinical trials, to manufacture
product candidates, and for consulting and other contracted services. The Company accrues the costs of these agreements based on estimates of work completed to date. The Company estimates that approximately $18.7 million will be payable in future
periods under arrangements in place at December 31, 2004. Of this amount, approximately $6.8 million has been accrued for work estimated to have been completed as of December 31, 2004, and approximately $11.9 million relates to future performance
under these arrangements.



|11. | 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) of the
Securities Exchange Act of 1934 (the Exchange Act), Rule 10b-5 under the Exchange Act and Section 20(a) of 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. Three additional complaints asserting similar claims were filed shortly after the initial complaint. These actions have been consolidated for filing purposes under the
caption: In re Adolor Corporation Securities Litigation,No. 2:04-cv-01728. Two parties separately moved to be appointed as Lead Plaintiff and to consolidate the actions for purposes of trial. One of those motions has subsequently been
withdrawn. On December 29, 2004, the district court issued an order appointing the remaining party, the Greater Pennsylvania Carpenters Pension Fund, as Lead Plaintiff. Pursuant to a schedule agreed to by the parties, the Company anticipates
that the appointed Lead Plaintiff will file a consolidated amended complaint on February 28, 2005 to which the Company must respond within sixty days or before April 28, 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. Pursuant to the Courts order dated October 13, 2004, Plaintiffs had 30 days to respond to the Companys and the directors and officers motions; that time has since been extended by
agreement of the parties until January 27, 2005. The Company and the Directors and Officers filed reply briefs on February 18, 2005.



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ADOLOR CORPORATION AND SUBSIDIARY

(A Development Stage Company)



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(continued)



|12. | 401(k) PROFIT SHARING PLAN
|--- | --------------------------



In 1995, the Company adopted a 401(k) Profit Sharing Plan (the 401(k) Plan) available to all employees meeting certain eligibility criteria.
The 401(k) Plan permits participants to contribute up to 100% of their salary, not to exceed the limits established by the Internal Revenue Code. All contributions made by participants vest immediately into the participants account. In 2004,
2003 and 2002, the Company made contributions to the 401(k) Plan of approximately $225,000, $174,000 and $143,000, respectively. The Companys common stock is not and never has been an investment option for 401(k) Plan participants.



|13. | QUARTERLY INFORMATION (UNAUDITED)
|--- | ---------------------------------



This table summarizes the unaudited results of operations for each quarter of 2004 and 2003:



|                                 |  |                                          |         |   |         |   |         |              |  |   |             |   |  |   |         |  
|-------------------------------- |  | ---------------------------------------- | ------- | - | ------- | - | ------- | ------------ |  | - | ----------- | - |  | - | ------- | -
|                                 |  | Quarter Ended                            |        
|                                 |  | March 31                                 |         |   | June 30 |   |         | September 30 |  |   | December 31 |  
|                                 |  | (In thousands, except per share amounts) |        
|Fiscal 2004                      |  |                                          |         |   |         |   |         |              |  |   |             |   |  |   |         |  
|Revenue                          |  | $                                        | 3,645   |   |         | $ | 3,707   |              |  | $ | 13,784      |   |  | $ | 4,406   |  
|Net loss                         |  |                                          | (10,277 | ) |         |   | (13,016 | )            |  |   | (8,709      | ) |  |   | (11,584 | )
|Basic and diluted loss per share |  |                                          | (0.26   | ) |         |   | (0.34   | )            |  |   | (0.22       | ) |  |   | (0.30   | )
|Fiscal 2003                      |  |                                          |         |   |         |   |         |              |  |   |             |   |  |   |         |  
|Revenue                          |  | $                                        | 6,637   |   |         | $ | 5,120   |              |  | $ | 4,848       |   |  | $ | 4,122   |  
|Net loss                         |  |                                          | (11,329 | ) |         |   | (11,491 | )            |  |   | (13,838     | ) |  |   | (14,548 | )
|Basic and diluted loss per share |  |                                          | (0.36   | ) |         |   | (0.36   | )            |  |   | (0.44       | ) |  |   | (0.41   | )



F-21