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:
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the status and anticipated timing of regulatory review and approval, if any, for our product candidates;
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our product development efforts, including results from clinical trials;
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anticipated dates of clinical trial initiation, completion and announcement of trial results by us and our collaborators;
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anticipated trial results and regulatory submission dates for our product candidates by us and our collaborators;
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analysis and interpretation of data by regulatory authorities;
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anticipated operating losses and capital expenditures;
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our intentions regarding the establishment of collaborations;
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anticipated efforts of our collaborators;
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estimates of the market opportunity and the commercialization plans for our product candidates;
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our intention to rely on third parties for manufacturing;
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the scope and duration of intellectual property protection for our products;
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the scope of third party patent rights;
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our ability to raise additional capital; and
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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 in Item 1A.
ITEM 1A. RISK FACTORS
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, Entereg®, 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 for any indication, the FDA would have to approve Entereg® for commercial sale. Drug development is a highly uncertain process. We received an approvable letter from FDA for Entereg® for POI in July 2005, however, there is no assurance that the FDA will approve Entereg® for POI in the future. Phase III clinical testing of Entereg® in OBD began in September 2005, however, there is no assurance that these studies will be successful or that Entereg® will be approved for OBD, 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.
Although we received an approvable letter from the FDA for Entereg® in POI, our NDA for Entereg® may not be approved. Study 314 results may not satisfy the FDA requirement for additional evidence of efficacy to support approval of our NDA.
In July 2005, we announced the receipt of an approvable letter from the FDA for Entereg® 12 mg capsules. Before the application for Entereg® may be approved, it will be necessary to provide additional proof of efficacy to the FDA to support the use of Entereg® following bowel resection surgery. The FDA indicated that this may be achieved
by demonstrating statistically significant results in at least one additional clinical study, and that this could potentially be addressed with positive results from Study 314. The FDA also indicated that we must provide justification that the median reduction in time to gastrointestinal recovery seen in bowel resection patients treated with Entereg® is clinically meaningful.
After a meeting with the FDA regarding the approvable letter, we reported that the Study 314 design represented an adequate and well-controlled study, the results of which could potentially provide the additional proof of efficacy requested by the FDA in the approvable letter. The FDA confirmed that the GI2 endpoint, representing time to recovery of GI function, and defined as the last to occur of upper GI recovery (solid food) and lower GI recovery (bowel movement), was acceptable as the primary endpoint of the study. As with our previous studies, the FDA confirmed that the hazard ratio will be the measure used to determine statistical significance.
Although we believe Study 314 yielded positive results, there is no assurance that the FDA will conclude that the results of Study 314 or the results obtained in our prior studies support the approval of Entereg® in POI. Further, there is no assurance that the FDA will conclude that any reduction in median time to GI recovery observed in the studies included in our NDA and in Study 314 is clinically meaningful. There is no assurance that the FDA will not raise additional issues, or that our NDA for Entereg® will be approved. FDA approval of our NDA is contingent on many factors, including a favorable review of all preclinical and clinical data, as well as information with respect to the manufacture of Entereg®. We have targeted submission of a Complete Response to the FDA by June 2006. We may not achieve that target.
With regard to any studies we may conduct, including Study 314, the FDA or other regulatory agencies may evaluate the results of such study by different methods or conclude that the clinical trial results are not statistically significant or clinically meaningful, or that there were human errors in the conduct of the clinical trials or otherwise. Even if we believe we have met the FDA guidelines for submission of data and information to the NDA, there is a risk that the FDA will require additional data and information that may require additional time to accumulate, or that we are unable to provide.
Certain results from Phase III clinical trials showed that the differences in the primary endpoint analyses between Entereg® and placebos were not statistically significant.
Our Entereg® POI Phase III program initially consisted of four studies, POI 14CL302, POI 14CL313, POI 14CL308 and POI 14CL306. Based on the results from these studies we submitted an NDA for Entereg® 12 mg capsules in June 2004. In study POI 14CL302, the difference from placebo in the primary endpoint, 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. Our NDA was amended in April 2005 to include data from Study 001. 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.
Unfavorable results or adverse safety findings from any clinical study will adversely affect our ability to obtain regulatory approval for Entereg®.
We and Glaxo expect to continue to clinically evaluate Entereg® in both acute and chronic conditions. Glaxo has initiated Phase III clinical testing in OBD. We are conducting, or planning to conduct, additional studies of Entereg® in the United States. 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 distension. 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. The most frequent adverse events in both placebo and treatment groups in study POI 14CL314 were nausea, vomiting and abdominal distention.
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®.
Entereg® may not be successfully developed for chronic use.
Results from the clinical studies conducted to date in OBD are not necessarily indicative of the results that may be obtained in further studies, or in clinical studies in the POI indication. Phase III clinical testing of Entereg® in OBD began in September 2005, and these studies may not be successful. The long-term animal toxicity studies necessary to support further development of Entereg® for chronic use are on-going. Adverse safety findings in these long-term animal toxicity studies could adversely affect our prospects for Entereg®, including its prospects for use in POI.
In the Phase IIa study in chronic constipation, there were no statistically significant differences from placebo for any dose of Entereg® in the primary or secondary endpoints, or in the key sub groups. There are currently no additional clinical studies of Entereg® in this indication in development.
If we are unable to commercialize Entereg®, 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 do so. If Entereg® is not approved by the FDA, 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:
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the breadth of the indication for which Entereg® may receive approval;
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the establishment and demonstration in the medical community of the safety and clinical efficacy of Entereg® and its potential advantages over competitive products; and
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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®.
Patient enrollment may be slow and patients may discontinue their participation in clinical studies, which may negatively impact the results of these studies, and extend the timeline for completion of our and our collaborator’s development programs for our product candidates.
The time required to complete clinical trials is dependent upon, among other factors, the rate of patient enrollment. Patient enrollment is a function of many factors, including:
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the size of the patient population;
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the nature of the clinical protocol requirements;
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the diversion of patients to other trials or marketed therapies;
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the ability to recruit and manage clinical centers and associated trials;
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the proximity of patients to clinical sites; and
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the patient eligibility criteria for the study.
We are subject to the risk that patients enrolled in our and our collaborator’s clinical studies for our product candidates may discontinue their participation at any time during the study as a result of a number of factors, including, withdrawing their consent or experiencing adverse clinical events which may or may not be related to our product candidates under evaluation. We are subject to the risk that if a large number of patients in any one of our studies discontinue their participation in the study, the results from that study may not be positive or may not support an NDA for regulatory approval of our product candidates.
In clinical study POI 14CL302, discontinuation rates were 21%, 16%, and 27% in the placebo group, 6 mg dose group and 12 mg dose group, respectively. This resulted in fewer efficacy evaluable patients in the placebo and 12 mg treatment groups compared to the 6 mg treatment group. Following the analysis of study POI 14CL302, we increased enrollment in studies POI 14CL313 and POI 14CL308, with the objective of potentially increasing the number of efficacy evaluable patients in each dose group in those studies. 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:
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researchers may find during later preclinical testing or clinical trials that the product candidate is ineffective or has harmful side effects;
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the number and types of patients available for extensive clinical trials may vary;
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new information about the mechanisms by which a drug candidate works may adversely affect its development;
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one or more competing products may be approved for the same or a similar disease condition, raising the hurdles to approval of the product candidate;
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the product candidate may fail to receive necessary regulatory approval or clearance; or
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competitors may market equivalent or superior products.
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, since January 1, 2005, the closing price of our common stock reached a low of $8.09 per share on February 17, 2005 and a high of $24.42 per share on February 9, 2006.
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:
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developments concerning our collaborations, including our collaboration with Glaxo;
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announcements of technological innovations or new commercial products by our competitors or us;
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developments concerning proprietary rights, including patents;
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publicity regarding actual or potential medical results relating to products under development by our competitors or us;
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regulatory developments in the United States and foreign countries;
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litigation;
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economic and other external factors or other disasters or crises;
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period-to-period fluctuations in our financial results; and
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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 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) and section 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), in connection with the announcement of the results of certain studies in the our Phase III clinical trials for Entereg®, which allegedly had the effect of artificially inflating the price of the our common stock. This suit has been consolidated with three subsequent actions asserting similar claims under the caption: In re Adolor Corporation Securities Litigation, No. 2:04-cv-01728. On December 29, 2004, the district court issued an order appointing the Greater Pennsylvania Carpenters’ Pension Fund as Lead Plaintiff. The appointed Lead Plaintiff filed a consolidated amended complaint on February 28, 2005. The Complaint purported to extend the class period, so as to bring claims on behalf of a putative class of Adolor shareholders who purchased stock between September 23, 2003 and December 22, 2004. The Complaint also adds as defendants our Board of Directors asserting claims against them and the other defendants for violation of Section 11 and Section 15 of the Securities Act of 1933 in connection with our public offering of stock in November 2003. We and our management and director defendants moved to dismiss the Complaint on April 29, 2005. The plaintiffs responded to the motion to dismiss on June 28, 2005, and the defendants’ reply was filed on August 12, 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. On December 13, 2004, our directors and officers moved to dismiss the Complaint for failure to state a claim. Plaintiffs responded to the Company’s and our directors’ and officers’ motions on January 27, 2005. We and our 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, 2005 of approximately $103.1 million, together with the net proceeds of our public offering completed in February 2006 of approximately $135 million, will be sufficient to fund operations into 2008. 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, 2005, we have incurred a cumulative net loss of approximately $306.8 million. During the calendar years ended December 31, 2005 and 2004, we incurred operating losses of approximately $60.2 million and $46.1 million, respectively, and net losses of approximately $56.8 million and $43.6 million, respectively. We expect to incur substantial losses for at least the next several years and expect that these losses will increase as we expand our research and development and sales and marketing activities. If we fail to obtain the capital necessary to fund our operations, we will be forced to curtail our operations and we will be unable to develop products successfully. We do not know whether additional financing will be available when needed, or that, if available, we will obtain financing on terms favorable to our stockholders or to us. If adequate funds are not available on acceptable terms, our ability to fund our operations, products or technologies or otherwise respond to competitive pressures could be significantly delayed or limited, and we may have to reduce or cease our operations. If additional funds become available there can be no assurance that we can predict the time and costs required to complete development programs or that we will not substantially exceed our budgets.
We are dependent on our collaborators to perform their obligations under our collaboration agreements.
In April 2002, we and Glaxo entered into a collaboration agreement for the exclusive worldwide development and commercialization of Entereg® for certain indications. We and Glaxo agreed to develop Entereg® for a number of indications, both acute and chronic, which would potentially involve the use of Entereg® in in-patient and out-patient settings. In the United States, we have the right to co-develop and to co-promote Entereg® with Glaxo, and share development expenses and commercial returns, if any, pursuant to contractually agreed percentages. We have overall responsibility for the development of acute care indications such as POI, and Glaxo has overall responsibility for the development of chronic care indications such as OBD. We and Glaxo are required to use commercially reasonable efforts to develop the indications for which we and they are respectively responsible. We and Glaxo have established numerous joint committees to collaborate in the development of Entereg®. These committees meet at regularly scheduled intervals. We depend on Glaxo to provide us with substantial assistance and expertise in the development of Entereg®. Any failure of Glaxo to perform its obligations under our agreement could negatively impact our product candidate, Entereg®, and could lead to our loss of potential revenues from product sales and milestones that may otherwise become due under our collaboration agreement and would delay our achievement, if any, of profitability. Glaxo has extensive experience in the successful commercialization of product candidates which would be difficult for us to replace if the collaboration agreement was not in place. In the near term, our success will largely depend upon the success of our collaboration with Glaxo to further develop Entereg® and our success in obtaining regulatory approval to commercialize Entereg®.
The term of the collaboration agreement varies depending on the indication and the territory. The term of the collaboration agreement for the POI indication in the United States is ten years from the first commercial sale
of Entereg® in that indication, if any. Generally, the term for the OBD indication in the United States is fifteen years from the first commercial sale of Entereg® in that indication, if any. In the rest of the world, the term is generally fifteen years from the first commercial sale of Entereg®, if any, on a country-by-country and indication-by-indication basis.
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. For example, because the POI product has not been commercially sold as of December 31, 2005, Glaxo now possesses the right to terminate the collaboration agreement with respect to the POI product and the other products defined as the Adolor Products under the collaboration agreement. 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 are required to submit, in an NDA, information and data regarding chemistry, manufacturing and controls which satisfies the FDA that our contract manufacturers are able to make Entereg® in accordance with current Good Manufacturing Practices (“cGMP”). Under cGMPs, we and our manufacturers will be required to manufacture our products and maintain records in a prescribed manner with respect to manufacturing, testing and quality control activities. We are dependent on our third party manufacturers to comply with these regulations in the manufacture of our products and these parties may have difficulties complying with cGMPs. The failure of any third party manufacturer to comply with applicable government regulations could substantially harm and delay or prevent regulatory approval and marketing of Entereg®.
We maintain a relationship with Torcan Chemical Ltd. for the supply of the active pharmaceutical ingredient (“API”) in Entereg®. We also maintain a relationship with Girindus AG as an additional supplier of API for Entereg®. We maintain a relationship with Pharmaceutics International Inc. for the supply of Entereg®
finished capsules, and a relationship with Sharp Corporation for the packaging of Entereg® finished capsules. We also rely upon these parties for the performance of scale-up and other development activities, and for the maintenance and testing of product pursuant to applicable stability programs.
Clinical trials in our Phase III Entereg® program use drug product incorporating active pharmaceutical ingredient manufactured by two different contract manufacturing facilities, one of which is no longer in business. Our efforts to obtain regulatory approval for Entereg® may be impaired as a result of using material from two different contract manufacturing facilities.
We also expect to depend on third parties to manufacture product candidates we may acquire or in-license, including the sterile lidocaine patch product we in-licensed from EpiCept. We have no experience in manufacturing sterile lidocaine patch products and will need to develop our own internal capabilities and external relationships in that regard. We maintain a relationship with Corium International, Inc. under which Corium will engage in a development program to develop and scale up production of a sterile lidocaine patch product.
If we are unable to fully 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 fully 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, enrollment requirements, rate of enrollment, competition with other clinical trials for eligible patients and other factors. We are subject to the risk that subjects enrolled in our clinical studies may discontinue their participation at any time during the study as a result of a number of factors, including, withdrawing their consent or experiencing adverse clinical events which may or may not be judged related to our product candidates under evaluation.
We contract with third parties to conduct our clinical trials, and are subject to the risk that these third parties fail to perform their obligations properly and in compliance with applicable FDA and other governmental regulations. The failure of any third party to comply with any governmental regulations would substantially harm our development efforts and delay or prevent regulatory approval of our product candidates.
Our ability to enter into new collaborations and to achieve success under existing collaborations is uncertain.
We have entered into, and may in the future enter into, collaborative arrangements, including our arrangement with Glaxo, for the marketing, sale and distribution of our product candidates, which require, or may require, us to share profits or revenues. We may be unable to enter into additional collaborative licensing or other arrangements that we need to develop and commercialize our product candidates. Moreover, we may not
realize the contemplated benefits from such collaborative licensing or other arrangements. These arrangements may place responsibility on our collaborative partners for preclinical testing, human clinical trials, the preparation and submission of applications for regulatory approval, or for marketing, sales and distribution support for product commercialization. These arrangements may also require us to transfer certain material rights or issue our equity securities to corporate partners, licensees and others. Any license or sublicense of our commercial rights may reduce our product revenue. Moreover, we may not derive any revenues or profits from these arrangements.
We cannot be certain that any of these parties, including Glaxo, will fulfill their obligations in a manner consistent with our best interests. Collaborators may also pursue alternative technologies or drug candidates, either on their own or in collaboration with others, that are in direct competition with us.
Our quarterly operating results may fluctuate significantly depending on the initiation of new corporate collaboration agreements, the activities under current corporate collaboration agreements or the termination of existing corporate collaboration agreements.
We may not be able to successfully develop in-licensed product candidates, which could prevent us from commercializing any such candidates.
We intend to explore opportunities to expand our product portfolio by acquiring or in-licensing products and/or product development candidates. In July 2003, we entered into an agreement with EpiCept, under which we obtained exclusive rights to develop and commercialize in North America a sterile lidocaine patch which is being developed for the management of postoperative incisional pain. Although we conduct extensive evaluations of product candidate opportunities as part of our due diligence efforts, there can be no assurance that our product development efforts related thereto will be successful or that we will not become aware of issues or complications that will cause us to alter, delay or terminate our product development efforts.
Additionally, while we have built certain capabilities as an organization in executing the development plan for Entereg®, in-licensed products may require capabilities and expertise which we may not possess, and there is no assurance that we may 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.
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:
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perceptions by members of the health care community, including physicians, of the safety and efficacy of our product candidates;
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cost-effectiveness of our product candidates relative to competing products;
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the availability of government or third-party payor reimbursement for our product candidates; and
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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 Entereg®.
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 indications like those being targeted by us in both the acute and chronic settings. 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.
Our competitors include fully integrated pharmaceutical companies and biotechnology companies, universities and public and private research institutions. Many of the organizations competing with us have substantially greater capital resources, larger research and development staffs and facilities, greater experience in drug development and in obtaining regulatory approvals, and greater manufacturing and marketing capabilities than we do. These organizations also compete with us to:
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attract qualified personnel;
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attract partners for acquisitions, joint ventures or other collaborations; and
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license proprietary technology.
Our Delta agonist IND has been put on clinical hold by the FDA.
We submitted an IND to the FDA in December 2005 for our novel Delta agonist product candidate, ADL5859. In January 2006 we announced the FDA requested additional preclinical safety studies and additional information regarding our proposed Phase 1 protocol. Until this data is compiled and submitted and the clinical hold removed by the FDA, we will be unable to initiate human clinical trials of this compound.
The additional preclinical studies and Phase 1 protocol data and information we are able to provide may not be adequate for the FDA to remove the clinical hold on the ADL 5859 IND. Even if we are able to provide adequate data to the FDA to remove the clinical hold, we may not be successful in our Delta agonist development program. To date there are no selective Delta agonists approved by the FDA. Development of Delta agonists may not lead to commercially successful drugs.
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. Our Chief Executive Officer is serving on an interim basis and we have commenced a search for a replacement CEO. We may not be successful in attracting a qualified individual to us. Our success also depends on our ability to develop and maintain important relationships with leading academic institutions and scientists. Competition for personnel and academic collaborations is intense. In particular, our product development programs depend on our ability to attract and retain highly skilled chemists, biologists and clinical development personnel. If we lose the services of any of these personnel it could impede significantly the achievement of our research and development objectives. In addition, we will need to hire additional personnel and develop additional academic collaborations as we continue to expand our research and development activities. We do not know if we will be able to attract, retain or motivate personnel or maintain relationships. We do not maintain key man life insurance on any of our employees.
Companies and universities that have licensed technology and product candidates to us are sophisticated entities that could develop similar products to compete with products we hope to develop.
Licensing product candidates from other companies, universities, or individuals does not prevent such parties from developing competitive products for their own commercial purposes, nor from pursuing patent protection in areas that are competitive with us. The individuals who created these technologies are sophisticated scientists and business people who may continue to do research and development and seek patent protection in the same areas that led to the discovery of the product candidates that they licensed to us. The development and commercialization by us of successful products is also likely to attract additional research by our licensors and by other investigators who have experience in developing products for the pain management market. By virtue of their previous research activities, these companies, universities, or individuals may be able to develop and market competitive products in less time than might be required to develop a product with which they have no prior experience.
If we breach our licensing agreements, we will lose significant benefits and may be exposed to liability for damages.
We may breach our license agreements and may thereby lose rights that are important. We are subject to various obligations with respect to license agreements, including development responsibilities, royalty and other payments and regulatory obligations. If we fail to comply with these requirements or otherwise breach a license agreement or contract, the licensor or other contracting party may have the right to terminate the license or
contract in whole or in part or change the exclusive nature of the arrangement. In such event we would not only lose all or part of the benefit of the arrangement but also may be exposed to potential liabilities for breach in the form of damages or other penalties.
Because we are not certain we will obtain necessary regulatory approvals to market our products in the United States and foreign jurisdictions, we cannot predict whether or when we will be permitted to commercialize any of our products.
The pharmaceutical industry is subject to stringent regulation by a wide range of authorities. We cannot predict whether we will obtain regulatory clearance for any product candidate we develop. We cannot market a pharmaceutical product in the United States until it has completed rigorous preclinical testing and clinical trials and the FDA’s extensive regulatory premarket approval 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 is intended to 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 governing manufacturing, promotion, labeling, and reporting of adverse events and other information, as well as other regulatory requirements. Failure to comply with applicable regulatory requirements could subject us to criminal penalties, civil penalties, recall or seizure of products, withdrawal of marketing approval, total or partial suspension of production or injunction, as well as other regulatory actions against our product or us.
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 to reduce liability for Medicaid Rebates. The majority of states also have statutes or regulations similar to the federal antikickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a manufacturer’s products from reimbursement under government programs, criminal fines, and imprisonment.
Because of the breadth of these laws and the narrowness of the safe harbors, it is possible that some of our business activities could be subject to challenge under one or more of such laws.
The federal Controlled Substances Act might impose significant restrictions, licensing and regulatory requirements on the manufacturing, distribution and dispensing of certain of our product candidates.
The federal Controlled Substances Act imposes significant restrictions, licensing and regulatory requirements on the manufacturing, distribution and dispensing of controlled substances. Therefore, we must determine whether the Drug Enforcement Administration (“DEA”) would consider any of our product candidates to be a controlled substance. We believe that it is unlikely that any of our product candidates, other than those which may act on the central nervous system, may be subject to regulation as controlled substances.
Facilities that conduct research, manufacture or distribute controlled substances must be registered to perform these activities and have the recordkeeping, reporting 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, including civil, administrative or criminal penalties. 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 are planning to develop products that contain alvimopan and an opioid. If we proceed with this development then we would be required to comply with the restrictions, licensing and regulatory requirements relating to 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:
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must conform with the FDA’s good clinical practice regulations;
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must meet requirements for institutional review board oversight;
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must meet requirements for informed consent;
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are subject to continuing FDA oversight; and
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may require large numbers of test subjects.
Before commencing clinical trials in humans, we must submit to the FDA an Investigational New Drug Application, or IND. The FDA may decide not to permit the clinical trial to go forward. In addition, we, or the FDA, may suspend ongoing clinical trials at any time if the subjects participating in the trials are exposed to unacceptable health risks, or if the FDA finds deficiencies in the IND application or the conduct of the trials.
It is difficult and costly to protect our intellectual property rights, and we cannot ensure the protection of these rights; we may be sued by others for infringing their intellectual property.
Our commercial success will depend in part on obtaining patent protection on our products and successfully defending these patents against third party challenges. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. Accordingly, we cannot predict the breadth of claims allowed in our patents or those of our collaborators.
Others have filed and in the future are likely to file patent applications covering products and technologies that are similar, identical or competitive to ours, or important to our business. We cannot be certain that any patent application owned by a third party will not have priority over patent applications filed or in-licensed by us, or that we or our licensors will not be involved in interference proceedings before the United States Patent and Trademark Office.
Although no third party has asserted a claim of infringement against us, others may hold proprietary rights that will prevent our product candidates from being marketed unless we can obtain a license to those proprietary rights. Any patent related legal action against our collaborators or us claiming damages and seeking to enjoin commercial activities relating to our products and processes could subject us to potential liability for damages and require our collaborators or us to obtain a license to continue to manufacture or market the affected products and processes. We cannot predict whether we or our collaborators would prevail in any of these actions or that any license required under any of these patents would be made available on commercially acceptable terms, if at all. There has been, and we believe that there will continue to be, significant litigation in the industry regarding patent and other intellectual property rights. If we become involved in litigation, it could consume substantial managerial and financial resources.
We rely on trade secrets to protect technology in cases when we believe patent protection is not appropriate or obtainable. However, trade secrets are difficult to protect. While we require employees, academic collaborators and consultants to enter into confidentiality agreements, we may not be able to protect adequately our trade secrets or other proprietary information. Our research collaborators and scientific advisors have rights to publish data and information in which we have rights. If we cannot maintain the confidentiality of our technology and other confidential information in connection with our collaborations, our ability to receive patent protection or protect our proprietary information may be imperiled.
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:
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government and health administration authorities; or
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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. Increasing emphasis on managed care in the United States will continue to put pressure on the pricing of pharmaceutical
products. Significant uncertainty exists as to the reimbursement status of newly approved health care products. Cost control initiatives could adversely affect our and our collaborator’s ability to commercialize our products, decrease the price that any of our collaborators or we would receive for any products in the future, and may impede patients’ ability to obtain reimbursement under their insurance programs 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:
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issue equity securities that would dilute our current stockholders’ percentage ownership;
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incur substantial debt that may place strains on our operations;
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spend substantial operational, financial and management resources in integrating new businesses, technologies and products;
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assume substantial actual or contingent liabilities; or
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merge with, or otherwise enter into a business combination with, another company in which our stockholders would receive cash or shares of the other company or a combination of both on terms that our stockholders may not deem desirable.
We are not in a position to predict what, if any, collaborations, alliances or other transactions may result or how, when or if these activities would have a material effect on us or the development of our business.
If product liability lawsuits are successfully brought against us, we may incur substantial liabilities and may have to limit or cease commercialization of our products.
The testing and marketing of medical products entail an inherent risk of product liability. If we cannot successfully defend ourselves against product liability claims, we may incur substantial liabilities or be required to limit or cease commercialization of our products. We currently carry clinical trial insurance at a level we believe is commercially reasonable but do not carry product liability insurance. Our corporate collaborators or we may not be able to obtain insurance at a reasonable cost, if at all. There is no assurance that our clinical trial insurance will be adequate to cover claims that may arise.
We enter into various agreements where we indemnify third parties such as manufacturers and investigators for certain product liability claims related to our products. These indemnification obligations may cause us to pay significant sums of money for claims that are covered by these indemnifications.
If we use biological and hazardous materials in a manner that causes injury or violates laws, we may be liable for damages.
Our research and development activities involve the controlled use of potentially harmful biological materials as well as hazardous materials, chemicals and various radioactive compounds. We use radioactivity in conducting biological assays and we use solvents that could be flammable in conducting our research and development activities. We cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of these materials. We do not maintain a separate insurance policy for these types of risks. In the event of contamination or injury, we could be held liable for damages that result, and any liability could exceed our resources. We are subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations could be significant.
Certain provisions of our charter documents and under Delaware law may make an acquisition of us, which may be beneficial to our stockholders, more difficult.
Provisions of our amended and restated certificate of incorporation and restated by-laws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders.
We have shares of our common stock and preferred stock available for future issuance without stockholder approval. The existence of unissued common stock and preferred stock may enable our board of directors to issue shares to persons friendly to current management or to issue preferred stock with terms that could render more difficult or discourage a third party attempt to obtain control of us by means of a merger, tender offer, proxy contest or otherwise, which would protect the continuity of our management.
Our amended and restated certificate of incorporation provides for our board of directors to be divided into three classes, with the term of one such class expiring each year, and we have eliminated the ability of our stockholders to consent in writing to the taking of any action pursuant to Section 228 of the Delaware General Corporation Law.
In addition, we adopted a shareholder rights plan, the effect of which may be to make an acquisition of the Company more difficult.
Under our collaboration agreement with Glaxo, there are certain limitations on Glaxo’s ability to acquire our securities. During and for one year after the term of the collaboration agreement, Glaxo and its affiliates will not, alone or with others, except as permitted under limited circumstances:
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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;
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make or participate in any solicitation of proxies to vote in connection with us;
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form, join or in any way participate in a group with respect to our voting securities;
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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
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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 do not prevent Glaxo, among other things, from acquiring our securities in certain circumstances following initiation by a third party of an unsolicited tender offer to purchase more than a certain percentage of any class of our publicly traded securities.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
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.
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 the Company, one of its directors and certain of its 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) and Section 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), in connection with the announcement of the results of certain studies in the Company’s Phase III clinical trials for Entereg®, which allegedly had the effect of artificially inflating the price of our common stock. This suit has been consolidated with three subsequent actions asserting similar claims under the caption: In re Adolor Corporation Securities Litigation, No. 2:04-cv-01728. On December 29, 2004, the district court issued an order appointing the Greater Pennsylvania Carpenters’ Pension Fund, as Lead Plaintiff. The appointed Lead Plaintiff filed a consolidated amended complaint on February 28, 2005. That Complaint purported to extend the class period, so as to bring claims on behalf of a putative class of Adolor shareholders who purchased stock between September 23, 2003 and December 22, 2004. The Complaint also adds as defendants our Board of Directors asserting claims against them and the other defendants for violation of Section 11 and Section 15 of the Securities Act of 1933 in connection with our public offering of stock in November 2003. The Company and the management and director defendants moved to dismiss the Complaint on April 29, 2005. The plaintiffs responded to the motion to dismiss on June 28, 2005, and the defendants’ reply was filed on August 12, 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 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, we filed a motion challenging the standing of the Derivative Plaintiff to file the derivative litigation on its behalf. On December 13, 2004, the Company’s directors and officers moved to dismiss the Complaint for the failure to state a claim. Plaintiffs responded to the Company’s and the directors’ and officers’ motions on January 27, 2005. The Company and the Directors and Officers filed reply briefs on February 18, 2005.
ITEM 4.
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, 2005.
PART II
ITEM 5.
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.
(b) Holders. As of February 9, 2006, there were approximately 155 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.
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 Annual Report. The Consolidated Statements of Operations data for the years ended December 31, 2005, 2004, and 2003, and our Consolidated Balance Sheet data as of December 31, 2005 and 2004, are derived from our audited Consolidated Financial Statements which are included elsewhere in this Annual Report. The Consolidated Statements of Operations data for the years ended December 31, 2002 and 2001 and the Consolidated Balance Sheet data as of December 31, 2003, 2002 and 2001 are derived from audited Consolidated Financial Statements not included in this Annual Report. Historical results are not necessarily indicative of the results to be expected in the future.
Please see Note 2 to our Consolidated Financial Statements for an explanation of the method used to calculate the net loss allocable to common stockholders, net loss per share and the number of shares used in the computation of per share amounts.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are a development stage biopharmaceutical corporation that was founded in 1993. Since our inception, we have specialized in the discovery and development of prescription pain management products and expect to commercialize products that we successfully develop. We have a number of product candidates in development, ranging from preclinical studies to pivotal clinical trials. Our most advanced product candidate, Entereg® (alvimopan), is intended to selectively block the unwanted effects of opioid analgesics on the gastrointestinal (“GI”) tract. For the global development and commercialization of Entereg® as a monotherapy, we are collaborating with Glaxo Group Limited (“Glaxo”) in multiple indications. Separately, we are also developing products that combine alvimopan with an opioid analgesic. In addition to products based on alvimopan, we are developing a sterile lidocaine patch, now in clinical development, for the treatment of postoperative incisional pain. Additional product candidates, including our Delta opioid agonist, are in preclinical development for the treatment of moderate-to-severe pain conditions.
Entereg® (alvimopan)
Opioid analgesics provide pain relief by stimulating opioid receptors located in the central nervous system. There are, however, opioid receptors throughout the body, including the GI tract. By binding to the receptors in
the GI tract, opioid analgesics can slow gut motility and disrupt normal GI function that allows for the passage, absorption and excretion of ingested solid materials. This disruption can cause patients to experience significant discomfort and abdominal pain and may result in their reducing or eliminating their pain medication.
Entereg® is a small molecule, mu-opioid receptor antagonist intended to block the adverse side effects of opioid analgesics on the GI tract without affecting analgesia. We are developing Entereg® for both acute and chronic conditions. The acute indication currently under development is the management of postoperative ileus (POI), a GI condition characterized by the slow return of gut function that can result from GI or other surgeries. Entereg® is also being developed to treat opioid-induced bowel dysfunction (OBD), which is a condition characterized by a number of GI symptoms, including constipation, that often results from chronic use of opioid analgesics to treat persistent pain conditions.
POI Clinical Development Program
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 FDA in June 2004. Additionally, Glaxo has completed a Phase III study evaluating Entereg® in POI conducted in Europe, Australia and New Zealand, (“Study 001”). Our NDA was amended in April 2005 to include data from Study 001.
In July 2005, we announced the receipt of an approvable letter from the FDA for Entereg® 12 mg capsules, under review for the management of POI by acceleration of GI function following bowel resection surgery. An approvable letter is a letter from the FDA to an NDA applicant indicating that the FDA may approve the NDA if specific additional information is submitted or specific conditions are agreed to. The approvable letter indicated that before the application for Entereg® may be approved, it will be necessary to provide additional proof of efficacy to the FDA to support the use of Entereg® following bowel resection surgery. The FDA indicated that this may be achieved by demonstrating statistically significant results in at least one additional clinical study, and that this could potentially be addressed with positive results from our Study 14CL314 (“Study 314”). The FDA also indicated that we must provide justification that the median reduction in time to gastrointestinal recovery seen in bowel resection patients treated with Entereg® is clinically meaningful.
After a meeting with the FDA regarding the approvable letter, we reported that the FDA confirmed that the Study 314 design represented an adequate and well controlled study, the results of which could potentially provide the additional proof of efficacy requested by the FDA in the approvable letter. The FDA confirmed that the “GI2” endpoint, representing time to recovery of GI function, and defined as the last to occur of upper GI recovery (solid food) and lower GI recovery (bowel movement), was acceptable as the primary endpoint of the study. As it was with our previous studies, the FDA confirmed that the hazard ratio will be the measure used to determine statistical significance.
In February 2006, we announced top line results of Study 314. The Phase III study enrolled 654 patients scheduled to undergo large or small bowel resection surgery. For the primary GI2 endpoint of Study 314, a statistically significant difference was achieved as compared to placebo (Cox proportional hazard model) hazard ratio = 1.53; P<0.001. A statistically significant difference in favor of Entereg® was achieved for each of the secondary time to event endpoints.
We are targeting June 2006 for submission of a Complete Response to the FDA Approvable Letter for the pending NDA, which submission will include the results of Study 314.
Our Entereg® POI Phase III clinical program in support of the NDA submitted in June 2004 included four studies. Three of these studies (POI 14CL302, POI 14CL308 and POI 14CL313) were double-blind, placebo-controlled multi-center studies, each designed to enroll patients scheduled to undergo certain types of major
abdominal surgery and receiving opioids for pain relief. Under the protocols, patients were randomized into three arms to receive placebo, 6 mg or 12 mg doses of Entereg®. The primary endpoint in these three efficacy studies was time to recovery of GI function (“GI3”), a composite measure of the time to recovery of both upper and lower GI function, as defined by time to tolerability of solid foods, and time to first flatus or first bowel movement, whichever occurred last. The fourth POI clinical study in our Phase III program, POI 14CL306, was a double-blind, placebo-controlled multi-center observational safety study under which patients were randomized to receive either Entereg® 12 mg (413 patients) or placebo (106 patients). GI3 was included as one of the secondary endpoints in the study. Glaxo also completed a Phase III study (Study SB-767905/001), Study 001, evaluating Entereg® in POI. We have conducted an additional study in support of our pending NDA, Study 314. The protocol for Study 314 provides that the initial dose of Entereg® should be administered 30 to 90 minutes prior to surgery, as compared to our previous Phase III studies where the first dose was required to be administered (at least) 120 minutes prior to surgery. The primary endpoint of Study 314 is time to recovery of GI function, GI2, 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 bowel movement, whichever occurred last. Study 314 has also been designed to evaluate certain secondary endpoints.
Study 302. In April 2003, we announced top-line results of our first POI Phase III clinical study, POI 14CL302. Study POI 14CL302 enrolled 451 patients and was designed to include large bowel resection patients and radical hysterectomy patients, as well as simple hysterectomy patients (22% of enrolled patients). A statistically significant difference was achieved in the primary endpoint of the study in patients in the Entereg® 6 mg treatment group compared to patients in the placebo group (Cox proportional hazard model, hazard ratio = 1.45; P<0.01). A positive trend was observed in the primary endpoint of the study for the Entereg® 12 mg treatment group; however, the difference from placebo was not statistically significant (Cox proportional hazard model, hazard ratio = 1.28; P = 0.059). A difference in favor of the Entereg® treatment groups versus placebo was observed for all secondary endpoints, including time to hospital discharge order written. The most frequently observed adverse events in both the placebo and treatment groups were nausea, vomiting and abdominal distension.
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 the probability of achieving the endpoint. A hazard ratio of 1.5 means that subjects receiving drug are 50% more likely to achieve the endpoint, on average, during the course of the data collection period. Statistical analyses estimate the probability that an effect is produced by the drug. This probability is generally expressed as a “P value” which is an estimate of the probability that any difference measured between the drug group and the placebo group occurred by chance. For example, when a P value is reported as P<0.05, the probability that the study demonstrated a drug 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 enroll only patients scheduled to undergo simple hysterectomy procedures. Study POI 14CL306 was the first study where dosing continued on an out-patient basis after patients were discharged from the hospital. Entereg® was generally well tolerated in this observational safety study with
93% of patients completing treatment in the Entereg® 12 mg treatment group and 92% of patients completing treatment in the placebo group. The most frequently observed adverse events in both the placebo and treatment groups were nausea, vomiting and constipation. The results in GI3, one of the secondary endpoints in the study, were not statistically significant as compared to placebo.
Study 308. In January 2004, we announced top-line results of our fourth POI Phase III clinical study, POI 14CL308. Study POI 14CL308 enrolled 666 patients, and was designed to include large bowel resection patients, small bowel resection patients and radical hysterectomy patients, as well as simple hysterectomy patients (14% of enrolled patients). A positive trend was observed in the primary endpoint of the study when each of the Entereg® 6 mg and 12 mg treatment groups was compared to the placebo group (Cox proportional hazard model; for 6 mg group, hazard ratio = 1.20, P=0.08; for 12 mg group, hazard ratio = 1.24, P=0.038). Due to the multiple dose comparison to a single placebo group, a P-value of less than 0.025 would have been 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.
Study 001. In December 2004, we reported top line results from a Phase III clinical study of Entereg® in POI, Study 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.
Study 314. In February 2006, we announced top-line results of our Phase III clinical study, POI 14CL314, which enrolled 654 patients scheduled to undergo large or small bowel resection. For the primary GI2 endpoint of Study 314, a statistically significant difference was achieved as compared to placebo (Cox proportional hazard model) hazard ratio = 1.53, P<0.001. A statistically significant difference in favor of Entereg® was achieved for each of the secondary time to event endpoints. Under the protocol patients were randomized to receive placebo or 12 mg of Entereg® twice daily. While GI3 was the primary endpoint for pivotal studies in the Company’s NDA, GI2 has been measured in each study. The data for the effect on time to GI2 recovery for bowel resection patients (MITT population) for the 12 mg dose of Entereg® as an additional analysis is as follows: in Study 302, the hazard ratio was 1.4 and the P-value 0.029; in Study 308, the hazard ratio was 1.365 and the P-value 0.017; in Study 313, the hazard ratio was 1.625 and the P-value <0.001; and in Study 001, the hazard ratio was 1.299 and the P-value 0.008.
OBD and Chronic Constipation Clinical Development Programs
Entereg® is being developed by Glaxo for the treatment of OBD in patients taking opioid analgesics for persistent pain conditions.
In September 2005, we and Glaxo announced the start of Phase III clinical testing to evaluate Entereg® for the treatment of opioid-induced bowel dysfunction (“OBD”). The Phase III clinical program, which is being led by Glaxo, is comprised of three studies with an expected enrollment of approximately 1,700 patients in North America, Europe and other parts of the world. Two of the three phase III OBD studies, Studies SB-767905/012 (“Study 012”) and SB-767905/013 (“Study 013”), are randomized, double-blind, placebo controlled, studies each designed to enroll approximately 480 adults who are taking opioid therapy for persistent non-cancer pain and have resulting OBD. Under the protocols, the patients are randomized to one of two Entereg® arms (0.5 mg. once daily or 0.5 mg. twice daily) or to placebo for twelve weeks of treatment. The primary objective of these confirmatory studies is to compare Entereg® with placebo for efficacy in the treatment of OBD. The primary
efficacy endpoint is based on frequency of bowel movements. The third Phase III OBD study, Study SB-767905/014 (“Study 014”), is a randomized, double-blind, placebo controlled study designed to enroll approximately 750 adults who are taking opioid therapy for persistent non-cancer pain and have OBD. Under the protocol, the patients are randomized to Entereg® (0.5 mg. twice daily) or placebo for twelve months of treatment. The primary objective of this phase III long-term safety study is to compare Entereg® with placebo for safety and tolerability in the treatment of OBD. The primary safety endpoint is based on the frequency of reported adverse events.
Enrollment in Study 012 and Study 014 is complete and enrollment in Study 013 is ongoing. Assuming the Phase III program is successful, we anticipate that an NDA and corresponding European filing will be made in mid-2007. The Phase III program follows a Phase IIb study of Entereg® conducted by Glaxo, for which topline results were announced in March 2005. The Phase IIb study (SB-767905/011) evaluated Entereg® for treatment of OBD which results from the use of opioids in patients suffering from chronic pain.
In the Phase IIb study, in 522 non-cancer patients with OBD, all three oral Entereg® dosage regimens achieved statistically significant effects on the primary and secondary endpoints compared with placebo. The primary endpoint was the change from baseline in weekly frequency of spontaneous bowel movements (“SBM”) (defined as bowel movements with no laxative use in the previous 24 hours) over the first half of the 6-week treatment period. All groups reported an SBM frequency of approximately 1 per week during the baseline period. The average weekly change from baseline over weeks 1-3 was 3.36 SBM for the Entereg® 0.5 mg, twice daily treatment group, 3.29 SBM for the Entereg® 1mg, once daily treatment group and 4.17 SBM for the Entereg® 1 mg, twice daily treatment group compared to 1.65 SBM for the placebo group. All Entereg® treatment groups were statistically significantly different from placebo at the P<0.001 level. In this Phase IIb study adverse events affecting the GI tract were the most common, occurring in 30%-43% of Entereg® treated patients, compared to 36% on placebo. The most frequently reported adverse events were abdominal pain, nausea and diarrhea and GI adverse events were also the most common reason for study withdrawal.
In the Phase IIa study in chronic constipation, there were no statistically significant differences from placebo for any dose of Entereg® in the primary or secondary endpoints, or in key subgroups.
Combination Product
We are developing an analgesic product candidate that combines Entereg® and an opioid analgesic. This combination is intended to produce the pain relief of an opioid while reducing constipating side effects.
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, a $0.5 million payment to EpiCept in September 2005 and may make up to approximately $20.0 million in additional milestone payments if certain clinical and regulatory achievements are reached.
We are developing a sterile lidocaine patch intended for the management of postoperative incisional pain. In September 2005, we announced the initiation of Study 29CL227. Study 29CL227 is a Phase II, double-blind, placebo-controlled, randomized, multicenter study of the sterile lidocaine patch enrolling 30 patients undergoing hernia repair surgery. The study’s primary objective is to evaluate the pharmacokinetics of the sterile lidocaine patch. Safety and tolerability will be evaluated for up to 72 hours, and preliminary efficacy data will be obtained to assess the analgesic effect during the 72-hour treatment period, as demonstrated by a reduction in pain scores measured by the 11-point Numeric Pain Rating Scale (“NPRS”).
Delta Agonist Program
We submitted an Investigational New Drug Application (IND) to the FDA for ADL5859, our novel oral compound, which was designed by our researchers to target the Delta opioid receptor. The Delta receptor is one of three opioid receptors that modulate pain. On January 30, 2006, we announced that the FDA requested additional preclinical safety studies and additional information regarding our proposed Phase 1 protocol. Until this data is compiled and submitted and the clinical hold removed by the FDA, we will be unable to initiate human clinical trials on this compound.
Discovery / In-Licensing
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.
We believe there are opportunities to expand our product portfolio through the acquisition or in-licensing of products and/or product development candidates and intend to continue to explore and evaluate such opportunities.
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 maintain a marketing organization to support our development efforts. We have also established a surgeon-focused sales force who are currently engaged in the detailing of Glaxo’s anti-thrombotic agent, Arixtra®, under our co-promotion arrangement with Glaxo. This sales force could also potentially focus on Entereg® if FDA approval is received.
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.
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 and Other Agreements 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 including up to $40 million related to the POI indication and up to $25 million related to the chronic OBD indication. 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 profits that result from the sale of product. For commercial sales of Entereg® for POI in the United States, Adolor would receive forty-five percent (45%) and GSK would receive fifty-five percent (55%) of the net sales less certain agreed upon costs, and subject to certain adjustments. After the first three years each party’s share would become fifty percent (50%). For commercial sales of Entereg® for OBD in the United States, we would receive thirty-five percent (35%) and GSK would receive sixty-five percent (65%) of the net sales less certain agreed upon costs, and subject to certain adjustments. Under the collaboration agreement, we have the right to convert our right to receive a profit share for OBD in the United States to a royalty on net sales of twenty percent (20%). 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 is responsible for the development and commercialization of Entereg® for all indications, and we would receive royalties on net sales, 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.
In June 2004 we entered into a Distribution Agreement with Glaxo under which, upon our receipt of regulatory approvals, Glaxo will perform certain distribution and contracting services for Entereg® on our behalf for a fee. Outside of the United States we intend to rely on Glaxo for sales and marketing of Entereg®, and expect to supply Glaxo with bulk capsules for sale under a Supply Agreement we entered into with Glaxo in September 2004.
External expenses for research and development and marketing activities incurred by each company in the United States are reimbursed by the other party pursuant to contractually agreed percentages. Contract reimbursement amounts owed to us by Glaxo are recorded gross on our Consolidated Statements of Operations as cost reimbursement under collaborative agreement revenue. Amounts reimbursable to Glaxo by us are recorded as research and development or marketing expense, as appropriate, on our Consolidated Statements of Operations.
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.
In July 2003, we entered into a license agreement with EpiCept Corporation under which we licensed exclusive rights to develop and commercialize in North America a sterile lidocaine patch which is being developed for management of postoperative incisional pain. We made a $2.5 million payment to EpiCept upon execution of the agreement, a $0.5 million payment to EpiCept in September 2005 and may make up to $20 million in additional milestone payments if certain clinical and regulatory goals are achieved. This license requires us to pay royalties on commercial sales, if any, of the sterile lidocaine patch.
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 U. S. generally accepted accounting principles 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 our 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-Through December 31, 2005 we applied 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 losses in 2005, 2004, and 2003 would have been increased by approximately $7.0 million, $7.2 million and $5.3 million, respectively.
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 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. See Recently Issued Accounting Pronouncements for a discussion of SFAS No. 123R.
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 2005, 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 $1.9 million at December 31, 2005 is related to estimated reimbursable expenses for the fourth quarter of 2005, 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 $103.1 million at December 31, 2005, and approximately $162.3 million at December 31, 2004, representing 87.9% and 91.1% 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, together with the net proceeds of our public offering completed in February 2006 of approximately $135 million, are adequate to fund operations into 2008 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, 2005 and 2004:
Net Cash Used In Operating Activities and Operating Cash Flow Requirements Outlook
Our operating cash outflows for 2005 and 2004 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 2006 and future periods will increase as a result of substantially increased research and development expenses relating to Entereg® and increased spending relating to other product development programs, as well as increased costs incurred in preparation for the potential commercialization of Entereg®. We maintain a surgeon-focused sales force that is currently engaged in the detailing of Arixtra® in support of our co-promotion agreement with Glaxo. We receive certain payments from Glaxo under this agreement at an FTE contract rate for the Adolor sales representatives deployed on Arixtra®. Payments from Glaxo are scheduled to be reduced by half in 2006 and will cease thereafter, unless the agreement is reviewed or extended. Additionally, 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 license or acquire product candidates from others which would require additional cash outlays.
Contractual Commitments
Lease Payments
Future minimum lease payments under non-cancelable operating leases are as follows:
Glaxo Collaboration Agreement
Under the terms of the Glaxo agreement, we will reimburse Glaxo for a portion of 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 $11.9 million will be payable in future periods under arrangements in place at December 31, 2005. Of this amount, approximately $3.1 million has been accrued for work estimated to have been completed as of December 31, 2005 and approximately $8.8 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 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 a license agreement with EpiCept Corporation under which we licensed exclusive rights to develop and commercialize in North America a sterile lidocaine patch which is being developed for management of postoperative incisional pain. We made a $2.5 million payment to EpiCept upon execution of the agreement, a $0.5 million payment to EpiCept in September 2005 and may make up to $20 million in additional milestone payments if certain clinical and regulatory achievements are reached. We are also obligated to make ongoing payments to EpiCept on commercial sales of the sterile lidocaine patch.
Net Cash Provided By Investing Activities and Investing Requirements Outlook
Net cash provided by investing activities for the year ended December 31, 2005 and 2004 relates primarily to the maturities of investment securities. Capital expenditures in 2005 and 2004 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
Net cash provided by financing activities for the year ended December 31, 2005 and 2004 relates primarily to the exercise of stock options.
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 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. Although we received an approvable letter from the FDA for Entereg® in July 2005, there is no assurance that the FDA will approve Entereg® in the future. We expect to continue to use our cash and investments resources to fund operating and investing activities. We believe that our existing cash, cash equivalents and short-term investments of approximately $103.1 million as of December 31, 2005, together with the net proceeds of our public offering completed in February 2006 of approximately $135 million, will be sufficient to fund operations into 2008.
Results of Operations
This section should be read in conjunction with the discussion above under “Liquidity and Capital Resources”.
Revenues. Revenues decreased in 2005 as compared to 2004 primarily due to the recognition in 2004 of $10.0 million in milestone revenue received from Glaxo. Additionally, cost reimbursement revenues decreased as a result of a decrease in expenses incurred by us which are reimbursable by Glaxo under our collaboration agreement. These decreases were partially offset by a revenue increase in 2005 as compared to 2004 of $4.2 under our co-promotion arrangement with Glaxo relating to Arixtra®.
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.
Research and Development Expenses. Our research and development expenses consist primarily of salaries and other personnel-related expense, costs of clinical trials, costs to manufacture product candidates, technology licensing costs, laboratory supply costs and facility-related costs. Research and development expenses increased to approximately $49.6 million for the year ended December 31, 2005 from approximately $48.8 million for the year ended December 31, 2004. This increase was due to increased expense for reimbursements owed Glaxo relating to the OBD program, an increase in expenses related to Study 314, increased expenses associated with other development programs and increased personnel costs. These increases were partially offset by the recognition of $4.5 million in license fee expense related to Entereg® in 2004.
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.
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 $21.8 million, $21.1 million and $21.6 million in the years ended December 31, 2005, 2004, and 2003, 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:
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, 2005, 2004 and 2003 were approximately $26.3 million, $22.9 million and $17.6 million, respectively.
The increase in 2005 is principally related to increased personnel expenses, including expenses associated with our sales force. The increase was partially offset by decreased legal fees. The increase in marketing, general and administrative expenses in 2004 as compared to 2003 is principally related to increased marketing-related expenses associated with a possible launch of Entereg®, and increased personnel expenses and professional fees.
Net Other Income. Our other income increased in 2005 due to higher net returns on cash balances and short term investments. 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.
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, 2005 aggregated approximately $306.8 million, and we expect to continue to incur substantial losses in future periods. We expect that our operating losses in 2006 will increase as a result of substantially increased research and development expenses relating to Entereg® and increased expenses relating to other product development programs, as well as increased costs incurred in preparation for the potential commercialization of Entereg®.
We maintain a surgeon-focused sales force that is currently engaged in the detailing of Arixtra® under our co-promotion agreement with Glaxo. We receive certain payments from Glaxo under this agreement at an FTE contract rate for the Adolor sales representatives deployed on Arixtra®. Payments from Glaxo will be reduced in half in 2006. Additionally, we expect that as Glaxo incurs increasing expenses related to the OBD program in the United States, we will incur substantial expenses relating to reimbursements owed to Glaxo. Further, we may in-license or acquire product candidates which will require additional cash outlays.
We are highly dependent on the success of our research, development and licensing efforts and, ultimately, upon regulatory approval and market acceptance of our products under development, particularly our lead product candidate, Entereg®. We may never receive regulatory approval for any of our product candidates, generate product sales revenues, achieve profitable operations or generate positive cash flows from operations, and even if profitable operations are achieved, these may not be sustained on a continuing basis.
Income Taxes
As of December 31, 2005, we had approximately $196.9 million of Federal and $194.4 million 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 2006, 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, 2005, we also had approximately $6.9 million of Federal and $836,000 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
The FASB issued SFAS No. 123R, “Share-Based Payment”, in December 2004. This statement requires that the cost of all forms of equity-based compensation granted to employees, excluding employee stock ownership plans, be recognized in a company’s income statement and that such cost be measured at the fair value of the equity-based compensation as of the date of grant. This statement replaces the guidance in SFAS No. 123, “Accounting for Stock-Based Compensation”, and APB No. 25, “Accounting for Stock Issued to Employees”. This statement will be effective for financial statements relating to fiscal periods beginning after June 15, 2005. In addition, the SEC issued SAB No. 107, “Share-Based Payment” in March 2005, which provides supplemental SFAS No. 123R application guidance based on the views of the SEC. The Company will adopt SFAS 123(R) in the first quarter of fiscal 2006 using the modified prospective basis transition method. Under this method, compensation cost is recognized for share-based payments to employees based on their grant date fair value from the beginning of the fiscal period in which the recognition provisions are first applied. Measurement and recognition of compensation cost for awards that were granted prior to, but not vested as of the date of adoption are based on the same estimate of grant-date fair value and the same recognition method used previously under SFAS 123. The value of each option is estimated as of the grant date using the Black-Scholes option pricing model. The Company will recognize the compensation cost for stock-based awards issued after December 31, 2005 on a straight-line basis over the requisite service period. We expect that the adoption of SFAS 123(R) will have a material impact on our results of operations. The financial statement impact will be dependent on the future stock-based awards and any unvested stock options outstanding at the date of adoption. Our net loss for the years ended December 31, 2005, 2004 and 2003 would have been increased by approximately $7.0 million, $7.2 million and $5.3 million, respectively, had we adopted SFAS No. 123.
ITEM 7A.
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, 2005 totaled $101.3 million, and the weighted-average interest rate was approximately 3.25% with maturities of investments ranging up to 9 months.
ITEM 8.
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.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
For the year ended December 31, 2005, we carried out an evaluation, under the supervision and with the participation of our management, including our Interim President and Chief Executive Officer and our 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 Interim President and Chief Executive Officer and our Vice President and Chief Financial Officer concluded that, as of December 31, 2005, 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, 2005 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.
Adolor’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. 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, 2005, 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, 2005, based on criteria established in Internal Control-Integrated Framework issued by The 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 designed 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, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by COSO. Also, in our opinion, Adolor Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control-Integrated Framework issued by COSO.
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, 2005 and 2004, 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, 2005, and for the period from August 9, 1993 (inception) to December 31, 2005, and our report dated March 2, 2006 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Philadelphia, Pennsylvania
March 2, 2006
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
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 Annual Report pursuant to Section 14(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
ITEM 11.
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 Annual Report pursuant to Section 14(a) of the Exchange Act.
ITEM 12.
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 Annual Report pursuant to Section 14(a) of the Exchange Act.
ITEM 13.
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 Annual Report pursuant to Section 14(a) of the Exchange Act.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING 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 Annual Report pursuant to Section 14(a) of the Exchange Act.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements
Reference is made to the Index to Consolidated Financial Statements on page of this Annual Report.
2. Financial Statement Schedules
None
(b) Exhibits
Reference is made to the Exhibit Index on page 47 of this Annual Report for a list of exhibits required by Item 601 of Regulation S-K to be filed as part of this Annual Report.
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 3, 2006
ADOLOR CORPORATION
By:
/s/ DAVID M. MADDEN
Name:
David M. Madden
Title:
Interim 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 and on the dates indicated.
EXHIBIT INDEX
Filed herewith.
Confidential treatment granted.
Confidential treatment has been requested with respect to portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.
Compensation plan or arrangement in which directors and executive officers are eligible to participate.
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 Registered Public Accounting Firm are filed as a part of this Annual Report on Form 10-K.
Page
Report of Independent Registered Public Accounting Firm
Financial Statements:
Consolidated Balance Sheets at December 31, 2005 and 2004
Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003, and for the period from August 9, 1993 (inception) to December 31, 2005
Consolidated Statements of Comprehensive Loss for the years ended December 31, 2005, 2004 and 2003, and for the period from August 9, 1993 (inception) to December 31, 2005
Consolidated Statements of Stockholders’ Equity for the period from August 9, 1993 (inception) to December 31, 2002, and for the years ended December 31, 2003, 2004 and 2005
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003, and for the period from August 9, 1993 (inception) to December 31, 2005
Notes to Consolidated Financial Statements
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, 2005 and 2004, 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, 2005, and for the period from August 9, 1993 (inception) to December 31, 2005. 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, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, and for the period from August 9, 1993 (inception) to December 31, 2005, in conformity with U.S. generally accepted accounting principles.
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, 2005, 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 March 2, 2006, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Philadelphia, Pennsylvania
March 2, 2006
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of the consolidated financial statements.
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 2005, 2004 and 2003, and for the period from
August 9, 1993 (inception) to December 31, 2005
The accompanying notes are an integral part of the consolidated financial statements.
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
Years ended December 31, 2005, 2004 and 2003,
and the period August 9, 1993 (inception) to December 31, 2005
The accompanying notes are an integral part of the consolidated financial statements.
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the period from August 9, 1993 (inception) to December 31, 2002, for the years ended
December 31, 2003, 2004, and 2005
The accompanying notes are an integral part of the consolidated financial statements.
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, 2002, for the years ended
December 31, 2003, 2004 and 2005
The accompanying notes are an integral part of the consolidated financial statements.
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2005, 2004 and 2003, and for the period from
August 9, 1993 (inception) to December 31, 2005
The accompanying notes are an integral part of the consolidated financial statements.
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BUSINESS ACTIVITIES
Adolor (“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 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 (“GI”) tract. The Company is collaborating with Glaxo Group Limited (“Glaxo”) for the global development and commercialization of Entereg® in multiple indications. The Company is also planning the development of a product that combines alvimopan with an opioid analgesic. Another product candidate is a sterile lidocaine patch, which is in clinical development for treating postoperative incisional pain. The Company’s other product candidates are in preclinical development for treating moderate-to-severe pain conditions.
Currently, the Company’s revenues are derived from its collaboration and co-promotion agreements 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, 2005 aggregated approximately $306.8 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®.
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. The wholly owned subsidiary was dissolved in June 2005.
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. 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. Investments are held in investment grade fixed income securities including United States Treasury obligations and corporate securities. 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. The Company has not experienced any other-than-temporary losses.
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.
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
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 and co-promotion 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.
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
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
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 U. S. generally accepted accounting principles require 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.
Stock-Based Compensation
Through December 31, 2005, the Company accounted 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. Accordingly, 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.
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:
The weighted average fair value of the options granted during 2005, 2004 and 2003, is estimated at $5.19, $6.86, and $5.60, per share, respectively, using the Black-Scholes option pricing model with the following assumptions: dividend yield of zero; volatility of 68 percent, 48 percent, and 50 percent, respectively; weighted average risk-free interest rate of between 3.64 and 4.55 percent, between 2.81 and 4.01 percent, and between 2.10 and 3.52 percent, respectively; and an expected life of 4.0 years.
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
Recently Issued Accounting Pronouncements
The FASB issued SFAS No. 123R, “Share-Based Payment”, in December 2004. This statement requires that the cost of all forms of equity-based compensation granted to employees, excluding employee stock ownership plans, be recognized in a company’s income statement and that such cost be measured at the fair value of the equity-based compensation as of the date of grant. This statement replaces the guidance in SFAS No. 123, “Accounting for Stock-Based Compensation”, and APB No. 25, “Accounting for Stock Issued to Employees”. This statement will be effective for financial statements relating to fiscal periods beginning after June 15, 2005. In addition, the SEC issued SAB No. 107, “Share-Based Payment” in March 2005, which provides supplemental SFAS No. 123R application guidance based on the views of the SEC. The Company will adopt SFAS 123(R) in the first quarter of fiscal 2006 using the modified prospective basis transition method. Under this method, compensation cost is recognized for share-based payments to employees based on their grant date fair value from the beginning of the fiscal period in which the recognition provisions are first applied. Measurement and recognition of compensation cost for awards that were granted prior to, but not vested as of the date of adoption are based on the same estimate of grant-date fair value and the same recognition method used previously under SFAS 123. The value of each option is estimated as of the grant date using the Black-Scholes option pricing model. The Company will recognize the compensation cost for stock-based awards issued after December 31, 2005 on a straight-line basis over the requisite service period. Management expects that the adoption of SFAS 123(R) will have a material impact on our results of operations. The financial statement impact will be dependent on the future stock-based awards and any unvested stock options outstanding at the date of adoption.
The Company’s net loss for the years ended December 31, 2005, 2004 and 2003 would have been increased by approximately $7.0 million, $7.2 million and $5.3 million, respectively had the Company adopted SFAS No. 123.
3. SHORT-TERM INVESTMENTS
Short-term investments consist of investment grade fixed income securities with original maturities of greater than three months at December 31, 2005, and all such investments have maturities of less than one year. All investments are classified as “available for sale” and are considered current assets as management has the ability and intent to sell them at any time.
The following summarizes the short-term investments at December 31, 2005 and 2004:
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
4. CONTRACT REVENUES
Contract revenues consist of the following:
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, 2005, 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 revenues. The Company recorded contract revenues of approximately $7.3 million, $11.4 million and $16.1 million, respectively, in the years ended December 31, 2005, 2004 and 2003 under this arrangement. As of December 31, 2005 and 2004, approximately $1.9 million and $3.4 million, respectively, were receivable from Glaxo for reimbursement of expenses incurred by the Company pursuant to the collaboration agreement. The Company also had a $1.3 million receivable from Glaxo at December 31, 2005 related to co-promotion activities.
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. For example, because the postoperative ileus (“POI”) product has not been commercially sold as of December 31, 2005, Glaxo now possesses the right to terminate the collaboration agreement with respect to the POI product and the other products defined as the Adolor products under the collaboration agreement.
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:
In 2004, management 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 required 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 Statements of Cash Flow. 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 is amortized over the lease term as a reduction of rent expense and the addition to leasehold improvements is amortized over the useful life of the improvement. The Company corrected the lease accounting as of December 31, 2004 as management determined that the amounts are immaterial to the financial statements of prior periods.
6. ACCRUED EXPENSES
Accrued expenses consist of the following:
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
7. COMMON STOCK AND COMMON STOCK OPTIONS
In 2003 the Company sold 6.9 million shares of common stock at $17.25 per share. The proceeds of the offering were approximately $111.6 million, 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 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 former Chief Executive Officer options to purchase 540,000 shares of common stock outside of the Plans.
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
A summary of option activity from January 1, 2003 to December 31, 2005, is as follows:
A summary of options outstanding and exercisable by price range at December 31, 2005, is as follows:
There were 478,881 and 1,201,248 options available for future grant under the 1994 Plan and the 2003 Plan, respectively, as of December 31, 2005. The Company has reserved 6,030,903 shares of common stock for the exercise of stock options.
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. The deferred compensation 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
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
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, 2005, 2004 and 2003, relating to option grants was approximately $18,000, $1.1 million, and $2.8 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 $1,000 for the year ending December 31, 2006. 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 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.
In July 2003, we entered into a license agreement with EpiCept Corporation under which we licensed exclusive rights to develop and commercialize in North America a sterile lidocaine patch which is being developed for management of postoperative incisional pain. We made a $2.5 million payment to EpiCept upon execution of the agreement, a $0.5 million payment to EpiCept in September 2005 and may make up to $20 million in additional milestone payments if certain clinical and regulatory achievements are reached.
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.
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
9. INCOME TAXES
No federal and state taxes are payable as of December 31, 2005 and 2004.
As of December 31, 2005, the Company had approximately $196,935,000 of Federal and $194,352,000 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:
The utilization of the state net operating loss carryforwards is subject to a $2.0 million annual limitation. At December 31, 2005, the Company also has approximately $6,900,000 of Federal and $836,000 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 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.
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
Significant components of the Company’s deferred tax assets and liabilities are shown below. At December 31, 2005, a valuation allowance of $128,083,000 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. The change in the deferred tax asset account before application of the valuation allowance in 2005 and 2004 were approximately $24,605,000 and $19,943,000, respectively, related primarily to additional net operating losses and research and development costs incurred by the Company that are capitalized for income tax purposes.
10. COMMITMENTS
Future minimum lease payments under non-cancelable operating leases for equipment and office and laboratory space are as follows:
Rent expense was approximately $1,027,000, $1,103,000, and $1,063,000, for the years ended December 31, 2005, 2004 and 2003, respectively. In December 2002, the Company signed a ten-year lease agreement for office and laboratory space with minimum rental payments of approximately $1,156,000 for 2006 through 2008, and $1,216,000 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.
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 $11.9 million will be payable in future periods under arrangements in place at December 31, 2005. Of this amount, approximately $3.1 million has been accrued for work estimated to have been completed as of December 31, 2005, and approximately $8.8 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) and Section 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), in connection with the announcement of the results of certain studies in the Company’s Phase III clinical trials for Entereg®, which allegedly had the effect of artificially inflating the price of the Company’s common stock. This suit has been consolidated with three subsequent actions asserting similar claims under the caption: In re Adolor Corporation Securities Litigation, No. 2:04-cv-01728. On December 29, 2004, the district court issued an order appointing the Greater Pennsylvania Carpenters’ Pension Fund, as Lead Plaintiff. The appointed Lead Plaintiff filed a consolidated amended complaint on February 28, 2005. That Complaint purported to extend the class period, so as to bring claims on behalf of a putative class of Adolor shareholders who purchased stock between September 23, 2003 and December 22, 2004. The Complaint also adds as defendants the Company’s Board of Directors asserting claims against them and the other defendants for violation of Section 11 and Section 15 of the Securities Act of 1933 in connection with the Company’s public offering of stock in November 2003. The Company and the management and director defendants moved to dismiss the Complaint on April 29, 2005. The plaintiffs responded to the motion to dismiss on June 28, 2005, and the defendants’ reply was filed on August 12, 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. On December 13, 2004, the Company’s directors and officers moved to dismiss the Complaint for the failure to state a claim. Plaintiffs responded to the Company’s and the directors’ and officers’ motions on January 27, 2005. The Company and the Directors and Officers filed reply briefs on February 18, 2005.
ADOLOR CORPORATION AND SUBSIDIARY
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(continued)
12. 401(k) PROFIT SHARING PLAN
The Company maintains 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 2005, 2004 and 2003, the Company made contributions to the 401(k) Plan of approximately $278,000, $225,000, and $174,000, respectively. The Company’s common stock is not and never has been an investment option for 401(k) Plan participants.
13. SUBSEQUENT EVENT
On February 10, 2006, the Company filed a shelf registration statement on Form S-3, which will allow it to offer up to 6,000,000 shares of common stock from time to time in one or more public offerings. On February 22, 2006, the Company closed a public offering of 5,750,000 shares (including the underwriters’ over allotment) of common stock at $25.00 per share. The Company received net proceeds from the offering and the over allotment of approximately $135 million.
14. QUARTERLY INFORMATION (UNAUDITED)
This table summarizes the unaudited results of operations for each quarter of 2005 and 2004: