##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 For the quarterly period ended June 30, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 For the transition period from  to  .
 Commission File No. 1-15803
 AVANIR PHARMACEUTICALS
  California
    
    33-0314804(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)11388 Sorrento Valley Road, San Diego, California
    
    92121(Address of principal executive offices)
    
    (Zip Code)
 (858) 622-5200
 þ o
  o þ o
 o þ




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##### 



Table of Contents
 PagePART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (Unaudited)Report of Independent Registered Public Accounting Firm
    
    
    3Condensed Consolidated Balance Sheets
    
    
    4Condensed Consolidated Statements of Operations
    
    
    5Condensed Consolidated Statements of Cash Flows
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    24Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    40Item 4.
    
    Controls and Procedures
    
    
    40PART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    42Item 1A.
    
    Risk Factors
    
    
    42Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    47Item 3.
    
    Defaults Upon Senior Securities
    
    
    47Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    47Item 5.
    
    Other Information
    
    
    48Item 6.
    
    Exhibits
    
    
    48Signatures
    
    
    49EXHIBIT 10.1EXHIBIT 10.2EXHIBIT 10.3EXHIBIT 10.4EXHIBIT 10.5EXHIBIT 10.6EXHIBIT 10.7EXHIBIT 15.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 31.3EXHIBIT 32.1EXHIBIT 32.2EXHIBIT 32.3
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. FINANCIAL STATEMENTS
 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 Avanir
 Avanir
   Avanir
  
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Avanir Pharmaceuticals
 
 CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 June 30,
    
    
    September 30,2006
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    2,158,872
    
    
    $
    8,620,143Short-term investments in securities
    
    
    32,766,262
    
    
    
    14,215,005Receivables, net
    
    
    3,577,925
    
    
    
    1,169,654Inventories
    
    
    2,560,766
    
    
    
    27,115Prepaid expenses
    
    
    1,866,488
    
    
    
    2,370,801Total current assets
    
    
    42,930,313
    
    
    
    26,402,718Investments in securities
    
    
    2,444,760
    
    
    
    3,845,566Restricted investments in securities
    
    
    856,597
    
    
    
    856,872Property and equipment, net
    
    
    7,770,659
    
    
    
    6,004,527Intangible assets, net
    
    
    35,866,642
    
    
    
    3,665,086Long-term inventories
    
    
    484,386
    
    
    
    347,424Other assets
    
    
    446,387
    
    
    
    279,797TOTAL ASSETS
    
    $
    90,799,744
    
    
    $
    41,401,990LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    6,891,171
    
    
    $
    6,751,781Accrued expenses and other liabilities
    
    
    9,611,046
    
    
    
    4,094,295Assumed liabilities for returns and other discounts (Note 11)
    
    
    6,384,089
    
    
    
    Accrued compensation and payroll taxes
    
    
    2,223,012
    
    
    
    1,272,231Deferred revenue, net
    
    
    3,483,694
    
    
    
    1,970,989Notes payable
    
    
    341,459
    
    
    
    317,667Capital lease obligations
    
    
    161,759
    
    
    
    26,305Total current liabilities
    
    
    29,096,230
    
    
    
    14,433,268Contingent consideration of the entity acquired
    
    
    625,103
    
    
    
    Deferred revenue, net of current portion
    
    
    16,088,043
    
    
    
    17,187,221Notes payable, net of current portion
    
    
    25,453,133
    
    
    
    637,285Capital lease obligations, net of current portion
    
    
    331,435
    
    
    
    9,337Total liabilities
    
    
    71,593,944
    
    
    
    32,267,111COMMITMENTS AND CONTINGENCIES(Note 18)SHAREHOLDERS EQUITY:Preferred stock  no par value, 10,000,000 shares authorized,
no shares issued and outstanding as of June 30, 2006 and
September 30, 2005
    
    
    
    
    
    
    Common stock  no par value, Class A, 200,000,000 shares
authorized, 31,732,269 and 27,341,732 shares issued and
outstanding as of June 30, 2006 and September 30, 2005,
respectively (Note 2)
    
    
    211,035,731
    
    
    
    167,738,303Unearned compensation
    
    
    
    
    
    
    (3,477,144
    )Accumulated deficit
    
    
    (191,584,615
    )
    
    
    (155,012,466
    )Accumulated other comprehensive loss
    
    
    (245,316
    )
    
    
    (113,814
    )Total shareholders equity
    
    
    19,205,800
    
    
    
    9,134,879TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    90,799,744
    
    
    $
    41,401,990
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Avanir Pharmaceuticals
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 Three Months Ended
    
    
    Nine Months EndedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005REVENUES:Research and development services
    
    $
    1,746,581
    
    
    $
    263,014
    
    
    $
    6,181,164
    
    
    $
    263,014Licenses
    
    
    104,174
    
    
    
    2,500,000
    
    
    
    5,113,516
    
    
    
    2,800,000Royalties and sales of royalty rights
    
    
    465,147
    
    
    
    455,937
    
    
    
    1,474,451
    
    
    
    1,386,067Government research grants
    
    
    47,345
    
    
    
    114,887
    
    
    
    208,032
    
    
    
    400,455Product sales
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,400Total revenues
    
    
    2,363,247
    
    
    
    3,333,838
    
    
    
    12,977,163
    
    
    
    4,866,936OPERATING EXPENSES:Research and development
    
    
    9,834,721
    
    
    
    6,470,317
    
    
    
    27,117,970
    
    
    
    22,952,728Selling, general and administrative
    
    
    10,105,474
    
    
    
    5,239,076
    
    
    
    23,366,332
    
    
    
    11,562,262Cost of product sales
    
    
    260,164
    
    
    
    
    
    
    
    260,164
    
    
    
    3,102Total operating expenses
    
    
    20,200,359
    
    
    
    11,709,393
    
    
    
    50,744,466
    
    
    
    34,518,092LOSS FROM OPERATIONS
    
    
    (17,837,112
    )
    
    
    (8,375,555
    )
    
    
    (37,767,303
    )
    
    
    (29,651,156
    )Interest income
    
    
    551,948
    
    
    
    179,042
    
    
    
    1,444,536
    
    
    
    426,021Interest expense
    
    
    (191,302
    )
    
    
    (22,513
    )
    
    
    (236,143
    )
    
    
    (69,458
    )Other income (expense), net
    
    
    (15,029
    )
    
    
    11,496
    
    
    
    (10,009
    )
    
    
    (50,575
    )LOSS BEFORE INCOME TAXES
    
    
    (17,491,495
    )
    
    
    (8,207,530
    )
    
    
    (36,568,919
    )
    
    
    (29,345,168
    )Provision for income taxes
    
    
    (809
    )
    
    
    (14
    )
    
    
    (3,230
    )
    
    
    (1,912
    )NET LOSS
    
    $
    (17,492,304
    )
    
    $
    (8,207,544
    )
    
    $
    (36,572,149
    )
    
    $
    (29,347,080
    )NET LOSS PER SHARE:BASIC AND DILUTED (Note 2)
    
    $
    (0.56
    )
    
    $
    (0.31
    )
    
    $
    (1.20
    )
    
    $
    (1.17
    )WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING:BASIC AND DILUTED (Note 2)
    
    
    31,419,394
    
    
    
    26,841,950
    
    
    
    30,352,690
    
    
    
    25,121,332
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Avanir Pharmaceuticals
 
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 Nine Months Ended June 30,2006
    
    
    2005OPERATING ACTIVITIES:Net loss
    
    $
    (36,572,149
    )
    
    $
    (29,347,080
    )Adjustments to reconcile net loss to net cash used for operating activities:Depreciation and amortization
    
    
    1,841,330
    
    
    
    1,547,279Share-based compensation expense
    
    
    1,977,133
    
    
    
    8,103Purchased in-process research and development
    
    
    2,600,000
    
    
    
    Issuance of common stock in connection with the acquisition of additional
contractual rights to Neurodex
    
    
    
    
    
    
    5,300,000Other-than-temporary impairment of investment
    
    
    
    
    
    
    84,252Loss on disposal of assets
    
    
    17,339
    
    
    
    3,085Intangible assets abandoned and impaired
    
    
    350,044
    
    
    
    234,232Changes in operating assets and liabilities:Receivables
    
    
    (1,062,860
    )
    
    
    116,538Inventories
    
    
    (373,496
    )
    
    
    (352,077
    )Prepaid expenses and other assets
    
    
    815,521
    
    
    
    (467,365
    )Accounts payable
    
    
    (732,277
    )
    
    
    990,155Accrued expenses and other liabilities
    
    
    3,133,706
    
    
    
    1,126,957Accrued compensation and payroll taxes
    
    
    430,817
    
    
    
    380,831Deferred revenue
    
    
    413,527
    
    
    
    (1,484,051
    )Net cash used for operating activities
    
    
    (27,161,365
    )
    
    
    (21,859,141
    )INVESTING ACTIVITIES:Investments in securities
    
    
    (59,231,954
    )
    
    
    (18,438,209
    )Proceeds from sales and maturities of investments in securities
    
    
    41,950,275
    
    
    
    7,830,113Acquisition of businesses, net of cash acquired
    
    
    (4,617,694
    )
    
    
    Patent costs
    
    
    (515,462
    )
    
    
    (918,735
    )Proceeds from sale of equipment
    
    
    
    
    
    
    800Purchases of property and equipment
    
    
    (1,391,987
    )
    
    
    (662,548
    )Net cash used for investing activities
    
    
    (23,806,822
    )
    
    
    (12,188,579
    )FINANCING ACTIVITIES:Proceeds from issuance of common stock, net
    
    
    44,797,440
    
    
    
    24,255,141Proceeds from issuance of notes payable
    
    
    
    
    
    
    249,472Payments on notes and capital lease obligations
    
    
    (290,524
    )
    
    
    (374,127
    )Net cash provided by financing activities
    
    
    44,506,916
    
    
    
    24,130,486Net decrease in cash and cash equivalents
    
    
    (6,461,271
    )
    
    
    (9,917,234
    )Cash and cash equivalents at beginning of period
    
    
    8,620,143
    
    
    
    13,494,083Cash and cash equivalents at end of period
    
    $
    2,158,872
    
    
    $
    3,576,849SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Interest paid
    
    $
    236,143
    
    
    $
    69,458Income taxes paid
    
    $
    3,230
    
    
    $
    1,912NONCASH INVESTING AND FINANCING ACTIVITIES:Accounts payable and accrued expenses for purchases of
property and equipment
    
    $
    109,516
    
    
    $
    201,112Elimination of unearned compensation against common stock
    
    $
    3,477,144
    
    
    $
    Issuance of promissory notes as consideration for the Alamo
acquisition
    
    $
    25,075,000
    
    
    $
    Accrued expenses for acquisition related transaction costs
    
    $
    130,570
    
    
    $
    
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Avanir Pharmaceuticals
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 1. BASIS OF PRESENTATION
 Avanir Avanir
  Avanir
 ®
 2. REVERSE STOCK SPLIT
  3. SIGNIFICANT ACCOUNTING POLICIES
 Change in Accounting Method for Share-Based Compensation
 Share-Based Payment,
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Accounting for Stock-Based
Compensation
 Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards
   Three Months Ended
    
    
    Nine Months EndedJune 30, 2006
    
    
    June 30, 2006Research and development expense
    
    $
    160,857
    
    
    $
    423,194Selling, general and administrative expense
    
    
    596,543
    
    
    
    1,553,939Share-based compensation expense before taxes
    
    
    757,400
    
    
    
    1,977,133Related income tax benefits
    
    
    
    
    
    
    Share-based compensation expense
    
    $
    757,400
    
    
    $
    1,977,133Net share-based compensation expense per common
Share  basic and diluted
    
    $
    (0.02
    )
    
    $
    (0.07
    )
 8




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Three Months Ended
    
    
    Nine Months EndedJune 30, 2006
    
    
    June 30, 2006Share-based compensation expense from:Stock options
    
    $
    397,222
    
    
    $
    1,044,276Restricted stock awards
    
    
    302,403
    
    
    
    845,877Restricted stock units
    
    
    57,775
    
    
    
    86,980Total
    
    $
    757,400
    
    
    $
    1,977,133
  Accounting for Stock
Issued to Employees
  Three Months Ended
    
    
    Nine Months EndedJune 30, 2005
    
    
    June 30, 2005Net loss, as reported
    
    $
    (8,207,544
    )
    
    $
    (29,347,080
    )Add: Share-based employee
compensation expense
    
    
    
    
    
    
    Deduct: Total share-based
employee compensation expense
determined under fair value based
method for all awards
    
    
    (703,263
    )
    
    
    (1,419,193
    )Pro forma net loss
    
    $
    (8,910,807
    )
    
    $
    (30,766,273
    )Net loss per share:Basic and diluted  as reported
    
    $
    (0.31
    )
    
    $
    (1.17
    )Basic and diluted  pro forma
    
    $
    (0.33
    )
    
    $
    (1.22
    )
  Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services
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Revenue Recognition
 General. Revenue Recognition
 Revenue Recognition When Right of Return Exists
 Accounting for Revenue Arrangements with Multiple Deliverables
 Revenue Arrangements with Multiple Deliverables
  License Arrangements.
  10




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Research and Development Services Reporting
Revenue Gross as a Principal versus Net as an Agent,
 Royalty Revenues.
 Revenues from Sale of Royalty Rights.
 Government Research Grant Revenue.
 Product Sales  Active Pharmaceutical Ingredient Docosanol (API Docosanol).
 Product Sales  FazaClo.
 11




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Accounting for Consideration
Given by a Vendor to a Customer (Including a Reseller of the Vendors Products).
 Cost of Product Sales
  Recognition of Expenses in Outsourced Contracts
  Research and Development Expenses
  12




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
    
    The technology is in the early stage of development and has no alternative uses;
    
    There is substantial uncertainty regarding the future success of the technology or product;
    
    There will be difficulty in completing the remaining development; and
    
    There is substantial cost to complete the work.
 Purchased in-process research and development Business Combinations
 Acquired contractual rights
 Property and equipment
  Capitalization and Valuation of Long-Lived and Intangible Assets
 Goodwill and
Other Intangible Assets Accounting for the Impairment or Disposal of Long-Lived
Assets
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
    
    A significant underperformance relative to expected historical or projected future
operating results;
    
    A significant change in the manner of our use of the acquired asset or the strategy for
our overall business; and/or
    
    A significant negative industry or economic trend.
 4. ALAMO ACQUISITION
   
    
    A promissory note that would have been issuable in the principal amount of $4,000,000 if
FazaClo sales, as reported by IMS Health Incorporated, for each of the months of April and
May 2006 exceeded $1,266,539. Since the closing of the acquisition, we have determined that
FazaClo sales for the months April and May 2006 did not satisfy this condition and thus
this promissory note will not be issued pursuant to this contingency.
    
    If the preceding condition is not satisfied, then (A) a promissory note, in the
principal amount of $2,000,000, payable one time if monthly FazaClo net product sales, as
reported by us, exceed $1,000,000 for all three months in a given fiscal quarter during the
Contingent Payment Period, and (B) an additional promissory note in the principal amount of
$2,000,000, payable one time if monthly FazaClo net product sales, as reported by us,
exceed $1,500,000 for all three months in a given fiscal quarter during the Contingent
Payment Period.
    
    A one-time cash payment of $10,450,000 if FazaClo net product sales, as reported by us,
exceed $40.0 million over four consecutive fiscal quarters during the Contingent Payment
Period.
    
    A one-time cash payment of $25,000,000 if FazaClo net product sales, as reported by us,
exceed $50.0 million over four consecutive fiscal quarters during the Contingent Payment
Period.
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Purchase Price Allocation
  Accounting in a Business Combination for Deferred Revenue of an Acquiree
   15




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AmountNet tangible assets acquired:Cash
    
    $
    157,507Accounts receivables
    
    
    1,345,412Inventories
    
    
    2,297,117Property and equipment
    
    
    1,880,826Other assets
    
    
    498,621Identifiable intangible assets acquired:Purchased Intangible Assets
    
    
    32,500,000In-process research and development (to be expensed)
    
    
    2,600,000Total assets acquired
    
    
    41,279,483Liabilities assumed:Accounts payable and accrued expenses
    
    
    (3,440,899
    )Assumed liabilities for returns and other discounts
    
    
    (6,719,993
    )Contingent liability of the entity acquired
    
    
    (625,102
    )Capital lease obligations
    
    
    (512,717
    )Total liabilities assumed
    
    
    (11,298,711
    )Total purchase price
    
    $
    29,980,772
 Identifiable Intangible Assets
  In-Process Research and Development
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Pro Forma Results of Operations
  Three Months Ended June 30,
    
    Nine Months Ended June 30,2006
    
    2005
    
    2006
    
    2005Pro forma net revenues (1)
    
    $
    2,551,000
    
    
    $
    3,823,000
    
    
    $
    15,294,000
    
    
    $
    5,741,000Pro forma net loss (2)(3).
    
    $
    (9,974,000
    )
    
    $
    (14,448,000
    )
    
    $
    (39,643,000
    )
    
    $
    (50,737,000
    )Pro forma net loss per
basic and diluted share
    
    $
    (0.32
    )
    
    $
    (0.54
    )
    
    $
    (1.31
    )
    
    $
    (2.02
    )Shares used for basic and
diluted computation
    
    
    31,419,394
    
    
    
    26,841,950
    
    
    
    30,352,690
    
    
    
    25,121,332
 
 (1)
    
    
    In accordance
with the provisions of EITF 01-3 we did not assume Alamos reported deferred revenue
balance as of the acquisition date and accordingly will not record revenue associated
with such deferred revenue, resulting in lower net revenues in the periods following
the merger than Alamo would have achieved as a separate company.(2)
    
    
    Pro forma net loss for the periods presented included the following pro
forma adjustments:
 
    
    Amortization of Purchased Intangible Assets,
    
    Interest expense associated with the notes payable issued as part of purchase price,
    
    Elimination of interest expense associated with Alamos historical debt
that was assumed by us in the acquisition, and
    
    Reduction of interest income by an amount determined by applying the
average rate of return for the respective periods to the decrease in our cash
balance of $4.0 million used to fund the acquisition.
    
    The charge of $2.6 million purchased IPR&D is not
included in the pro forma results of operations. The purchased IPR&D
is a one-time charge directly related to the acquisition and does not
have a continuing impact on our future operations.
 5.
EXPANSION AND RELOCATION OF COMMERCIAL AND GENERAL AND ADMINISTRATIVE
OPERATIONS
  17




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Accounting for Costs Associated with Exit or Disposal Activities
 6. INVESTMENTS
  Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains (1)
    
    
    Losses (1)
    
    
    ValueAs of June 30, 2006:Certificates of deposit
    
    $
    856,597
    
    
    $
    
    
    
    $
    
    
    
    $
    856,597Government debt securities
    
    
    35,456,338
    
    
    
    
    
    
    
    (245,316
    )
    
    
    35,211,022Total
    
    $
    36,312,935
    
    
    $
    
    
    
    $
    (245,316
    )
    
    $
    36,067,619Classified and reported as:Short term investments:Classified as available-for-sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    32,766,262Long term investments:Classified as available-for-sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,444,760Restricted investments in
securities (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    856,597Long-term investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,301,357Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    36,067,619
 Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains (3)
    
    
    Losses (3)
    
    
    ValueAs of September 30, 2005:Certificates of deposit
    
    $
    956,872
    
    
    $
    48
    
    
    $
    
    
    
    $
    956,920Government debt securities
    
    
    18,074,385
    
    
    
    
    
    
    
    (113,862
    )
    
    
    17,960,523Total
    
    $
    19,031,257
    
    
    $
    48
    
    
    $
    (113,862
    )
    
    $
    18,917,443Classified and reported as:Short term investments:Classified as available-for-sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    14,215,005Long term investments:Classified as available-for-sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,845,566Restricted investments in
securities (2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    856,872Long-term investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,702,438Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    18,917,443
  Three Months
    
    
    Nine MonthsEnded
    
    
    EndedJune 30, 2006
    
    

June 30, 2006Balance, October 1, 2005
    
    $
    
    
    
    $
    Current period expense
    
    
    94,819
    
    
    
    94,819Payment
    
    
    
    
    
    
    Balance, June 30, 2006
    
    $
    94,819
    
    
    $
    94,819
 18




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##### Table of Contents



(1)
    
    Gross unrealized losses of $245,316 on government debt securities are reported as
accumulated other comprehensive loss on the consolidated balance sheet as of June 30, 2006.(2)
    
    Represents amounts pledged to our bank as collateral for letters of credit issued in
connection with our leases of office and laboratory space.(3)
    
    Gross unrealized gains of $48 and gross unrealized losses of $113,862 on government
securities and certificates of deposit represent an accumulated net unrealized loss of
$113,814, which is reported as accumulated other comprehensive loss on the consolidated
balance sheet as of September 30, 2005.
 7. RECEIVABLES, NET
  June 30,
    
    
    September 30,2006
    
    
    2005Accounts receivable (1)
    
    $
    2,185,371
    
    
    $
    31,599Unbilled receivables
    
    
    1,222,734
    
    
    
    1,010,902Receivables
    
    
    197,919
    
    
    
    155,2523,606,024
    
    
    
    1,197,753Allowance for doubtful accounts
    
    
    (28,099
    )
    
    
    (28,099
    )Receivables, net
    
    $
    3,577,925
    
    
    $
    1,169,654
 
 (1)
    
    Accounts receivable at June 30, 2006 included those purchased
as part of the Alamo acquisition. 8. INVENTORIES
  June 30,
    
    
    September 30,2006
    
    
    2005Finished goods
    
    $
    1,747,483
    
    
    $
    Raw materials
    
    
    929,918
    
    
    
    374,539Work in progress
    
    
    173,420
    
    
    
    Inventories subject to return
    
    
    194,331
    
    
    
    Total inventories
    
    
    3,045,152
    
    
    
    374,539Less: current portion
    
    
    (2,560,766
    )
    
    
    (27,115
    )Long-term portion
    
    $
    484,386
    
    
    $
    347,424
  19




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9. PROPERTY AND EQUIPMENT
  June 30, 2006
    
    
    September 30, 2005Gross
    
    
    
    
    
    
    
    
    
    
    GrossCarrying
    
    
    Accumulated
    
    
    
    
    
    
    Carrying
    
    
    AccumulatedValue
    
    
    Depreciation
    
    
    Net
    
    
    Value
    
    
    Depreciation
    
    
    NetResearch and
development
equipment
    
    $
    4,123,355
    
    
    $
    (2,994,129
    )
    
    $
    1,129,226
    
    
    $
    3,903,735
    
    
    $
    (2,567,843
    )
    
    $
    1,335,892Computer equipment
and related
software
    
    
    2,132,716
    
    
    
    (728,885
    )
    
    
    1,403,831
    
    
    
    1,038,390
    
    
    
    (565,137
    )
    
    
    473,253Leasehold
improvements
    
    
    5,844,984
    
    
    
    (2,195,366
    )
    
    
    3,649,618
    
    
    
    5,583,177
    
    
    
    (1,641,485
    )
    
    
    3,941,692Office equipment,
furniture and
fixtures
    
    
    1,230,940
    
    
    
    (392,186
    )
    
    
    838,754
    
    
    
    558,911
    
    
    
    (305,221
    )
    
    
    253,690Automobiles
    
    
    524,675
    
    
    
    (37,164
    )
    
    
    487,511
    
    
    
    
    
    
    
    
    
    
    
    Manufacturing
equipment
    
    
    261,719
    
    
    
    
    
    
    
    261,719
    
    
    
    
    
    
    
    
    
    
    
    Total property
and equipment
    
    $
    14,118,389
    
    
    $
    (6,347,730
    )
    
    $
    7,770,659
    
    
    $
    11,084,213
    
    
    $
    (5,079,686
    )
    
    $
    6,004,527
   20




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10. INTANGIBLE ASSETS
  June 30, 2006
    
    
    September 30, 2005Gross
    
    
    
    
    
    
    
    
    
    
    GrossCarrying
    
    
    Accumulated
    
    
    
    
    
    
    Carrying
    
    
    AccumulatedValue
    
    
    Amortization
    
    
    Net
    
    
    Value
    
    
    Amortization
    
    
    NetAmortizable intangible
assets:Purchased Intangible
Assets
    
    $
    32,500,000
    
    
    $
    (260,164
    )
    
    $
    32,239,836
    
    
    $
    
    
    
    $
    
    
    
    $
    Patent applications
pending (1)
    
    
    3,205,857
    
    
    
    (576,310
    )
    
    
    2,629,547
    
    
    
    3,029,127
    
    
    
    (336,457
    )
    
    
    2,692,670Patents (1)
    
    
    1,682,942
    
    
    
    (735,415
    )
    
    
    947,527
    
    
    
    1,429,532
    
    
    
    (506,144
    )
    
    
    923,388Licenses
    
    
    42,461
    
    
    
    (19,595
    )
    
    
    22,866
    
    
    
    42,461
    
    
    
    (17,904
    )
    
    
    24,557Total intangible
assets with finite
lives
    
    
    37,431,260
    
    
    
    (1,591,484
    )
    
    
    35,839,776
    
    
    
    4,501,120
    
    
    
    (860,505
    )
    
    
    3,640,615Intangible assets with
indefinite lives:Trademarks (2)
    
    
    26,866
    
    
    
    
    
    
    
    26,866
    
    
    
    24,471
    
    
    
    
    
    
    
    24,471Total intangible assets
    
    $
    37,458,126
    
    
    $
    (1,591,484
    )
    
    $
    35,866,642
    
    
    $
    4,525,591
    
    
    $
    (860,505
    )
    
    $
    3,665,086
 
 (1)
    
    Patent applications pending and patents include the net effect of $19,000 and $60,000
(net of accumulated amortization of $4,000 and $7,000) in intangible assets abandoned
during the three-month and nine-month periods ended June 30, 2006, respectively. Patent
applications pending include the net effect of $37,000 and $208,000 (net of accumulated
amortization of $4,000 and $22,000) in intangible assets abandoned during the three-month
and nine-month periods ended June 30, 2005, respectively. We abandoned certain patents and
patent applications pending related to docosanol 10% cream in selected countries where we
determined there are no viable markets.(2)
    
    Intangible assets with indefinite useful lives include the net effect of $14,000 and
$23,000 in trademarks abandoned during the three-month and nine-month periods ended June
30, 2005.
   21




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Amortization Expense
 Fiscal year ending September 30:2006 (remaining three months)
    
    $
    700,0002007
    
    
    2,768,0002008
    
    
    2,775,0002009
    
    
    2,759,0002010
    
    
    2,732,0002011
    
    
    2,716,000Thereafter
    
    
    21,390,000Total
    
    $
    35,840,000
 11. ASSUMED LIABILITIES FOR RETURNS AND OTHER DISCOUNTS
  Balance, at acquisition date
    
    $
    6,719,993Payments for returns and other discounts
    
    
    (335,904
    )Balance, at June 30, 2006
    
    $
    6,384,089
 12. NET DEFERRED REVENUE
  Drug Royalty
    
    
    FazaCloUSA
    
    
    Product
    
    
    OtherAgreement
    
    
    Shipments
    
    
    Agreements
    
    
    TotalNet deferred revenue as of September
30, 2005
    
    $
    19,049,877
    
    
    $
    
    
    
    $
    108,333
    
    
    $
    19,158,210Changes during the period:Shipments, net
    
    
    
    
    
    
    1,141,040
    
    
    
    
    
    
    
    1,141,040License fee
    
    
    
    
    
    
    
    
    
    
    860,215
    
    
    
    860,215Recognized as revenue during period
    
    
    (1,474,212
    )
    
    
    
    
    
    
    (113,516
    )
    
    
    (1,587,728
    )Net deferred revenue as of June 30, 2006
    
    $
    17,575,665
    
    
    $
    1,141,040
    
    
    $
    855,032
    
    
    $
    19,571,737Classified and reported as:Current portion of deferred revenue,
    
    $
    2,058,508
    
    
    $
    1,141,040
    
    
    $
    284,146
    
    
    $
    3,483,694Deferred revenue, net of current
portion
    
    
    15,517,157
    
    
    
    
    
    
    
    570,886
    
    
    
    16,088,043Total deferred revenue
    
    $
    17,575,665
    
    
    $
    1,141,040
    
    
    $
    855,032
    
    
    $
    19,571,737
 FazaClo Product 
 22




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Drug Royalty Agreement
  Docosanol License Agreement
   23




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13. NOTES PAYABLE
    14. COMPUTATION OF NET LOSS PER COMMON SHARE
  24




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15. COMPREHENSIVE LOSS
  Three Months Ended June 30,
    
    
    Nine Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net loss
    
    $
    (17,492,304
    )
    
    $
    (8,207,544
    )
    
    $
    (36,572,149
    )
    
    $
    (29,347,080
    )Other comprehensive income (loss):Unrealized income (loss) on
available-for-sale
securities
    
    
    59,829
    
    
    
    (46,069
    )
    
    
    (131,502
    )
    
    
    (46,598
    )Total comprehensive loss
    
    $
    (17,432,475
    )
    
    $
    (8,253,613
    )
    
    $
    (36,703,651
    )
    
    $
    (29,393,678
    )
 16. SHAREHOLDERS EQUITY
 Unearned compensation
 Common stock
    25




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17. EQUITY INCENTIVE PLANS
   Stock Options
 a.
    
    25% of the option shares vest and become exercisable on the first anniversary of the
grant date and the remaining 75% of the option shares vest and become exercisable quarterly
in equal installments thereafter over three years;b.
    
    One-third of the option shares vest and become exercisable on the first anniversary of
the grant date and the remaining two-thirds of the option shares vest and become
exercisable daily or quarterly in equal installments thereafter over two years; orc.
    
    Options fully vest and become exercisable at the date of grant.
   WeightedWeighted
    
    
    averageaverage
    
    
    remainingexercise
    
    
    contractual
    
    
    Aggregateprice per
    
    
    term
    
    
    intrinsicNumber of shares
    
    
    share
    
    
    (in years)
    
    
    valueOutstanding, September 30, 2005
    
    
    1,600,034
    
    
    $
    8.76Granted
    
    
    540,312
    
    
    $
    11.68Exercised
    
    
    (521,837
    )
    
    $
    6.23Forfeited or expired
    
    
    (84,680
    )
    
    $
    11.97Outstanding, June 30, 2006
    
    
    1,533,829
    
    
    $
    10.44
    
    
    
    7.3
    
    
    $
    742,000Exercisable, June 30, 2006
    
    
    757,066
    
    
    $
    9.05
    
    
    
    5.1
    
    
    $
    713,000
 26




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Expected volatility
    
    
    77.5%-80.4
    %Weighted-average volatility
    
    
    78.6
    %Average expected term in years
    
    
    4.5Risk-fee interest rate (zero coupon U.S. Treasury Note)
    
    
    4.5
    %Expected dividend yield
    
    
    0
    %
 Restricted stock units.
 WeightedNumber of
    
    
    average grantshares
    
    
    date fair valueUnvested, September 30, 2005
    
    
    
    
    
    $
    Granted
    
    
    51,480
    
    
    $
    15.54Unvested, June 30, 2006
    
    
    51,480
    
    
    $
    15.54
  Restricted stock awards
 WeightedNumber of
    
    
    average grantshares
    
    

date fair valueUnvested, September 30, 2005
    
    
    250,000
    
    
    $
    14.22Granted
    
    
    50,250
    
    
    $
    12.73Unvested, June 30, 2006
    
    
    300,250
    
    
    $
    13.97
 27




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18. COMMITMENTS AND CONTINGENCIES
  19. LICENSE AGREEMENTS
 AstraZeneca UK Limited (AstraZeneca)
 Novartis International Pharmaceutical Ltd. (Novartis)
 28




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##### Table of Contents



Three Months Ended June 30,
    
    
    Nine Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenues:Licenses
    
    $
    
    
    
    $
    2,500,000
    
    
    $
    5,000,000
    
    
    $
    2,500,000Research and
development
services and
reimbursements
    
    
    1,746,581
    
    
    
    263,014
    
    
    
    6,181,614
    
    
    
    263,014Total
    
    $
    1,746,581
    
    
    $
    2,763,014
    
    
    $
    11,181,614
    
    
    $
    2,763,014
 20. MANUFACTURING SERVICE AGREEMENTS
 Patheon
 CIMA Labs Inc
 Twelve-month period ending December 31:2006
    
    $
    250,0002007
    
    
    300,0002008 and each year thereafter and
    
    
    400,000
  21. SEGMENT INFORMATION
  29




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22. RECENT ACCOUNTING PRONOUNCEMENTS
 Financial Accounting Standards No. 154 (FAS 154). Accounting Changes and Error Corrections
 Financial Accounting Standards No. 155 (FAS 155). Accounting for Certain Hybrid Financial Instruments Accounting for Derivative Instruments and Hedging Activities Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities Application of Statement 133 to Beneficial Interests in Securitized Financial Assets
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FASB Interpretation No. 48 (FIN 48 Accounting for
Uncertainty in Income Taxes
 23. SUBSEQUENT EVENTS
   31




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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  EXECUTIVE OVERVIEW
 Avanir
  
    
    On July 6, 2006, we entered into an exclusive agreement with Healthcare Brands
International (HBI) to develop and market our docosanol 10% cream as a treatment for cold
sores in the European Union, (with the exception of Denmark, Finland, Greece, Italy, and
Sweden, all of which are covered by previous license grants from us) Russia and Ukraine.
The agreement provides for us to receive an upfront fee of
£750,000 (approximately $1.4 million, based on the exchange
rate on July 6, 2006) at signing, plus aggregate milestone
payments of up to £1,500,000 if 10% docosanol cream receives certain regulatory approvals in the licensed territory.
Additionally, if there is any subsequent divestiture or sublicense of 10% docosanol cream
by HBI (including through a sale of HBI), or any initial public offering of HBIs
securities, we will receive a payment calculated based on a percentage of the assigned
value of 10% docosanol cream to the overall value of the transaction. HBI will be
responsible for all expenses related to the regulatory approval and commercialization of
10% docosanol cream in the territory.
    
    On June 29, 2006, we were notified that we had been awarded a $2.0 million research
grant from the National Institutes of Health/National Institute of Allergy and Infectious
Disease (NIH) for ongoing research and development related to our fully human monoclonal
antibody for the treatment of post-exposure anthrax infection (the Anthrax Antibody).
Under the terms of the grant, the NIH will reimburse us for up to $2.0 million in certain
expenses (including expenses incurred in the 90 days preceding the grant award date)
related to the establishment of a cGMP manufacturing process and the testing of efficacy of
the Anthrax Antibody in non-human primate animal models.
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
    
    On June 19, 2006, we were advised that the FDA extended the review period for our NDA
for Neurodex for the treatment of IEED/PB. Accordingly, we expect the FDA to take action
on October 30, 2006 (the PDUFA date), based on our estimates of the timing for the
priority review. However, the action may be delayed if there are questions from the FDA
about our NDA.
    
    On May 24, 2006, we acquired Alamo Pharmaceuticals, LLC (Alamo) as an indirect wholly
owned subsidiary. Because the acquisition occurred about the middle of the third quarter of
fiscal 2006, the full impact on operating expenses and interest expense associated with the
acquisition will not be reflected until the fourth quarter of fiscal 2006. See Note 4,
Alamo Acquisition, in the Notes to Condensed Consolidated Financial Statements
(Unaudited) for further discussion.
    
    On May 4, 2006, our Board of Directors authorized a space restructuring plan and the
relocation of our commercial and general and administrative operations. We currently occupy
three laboratory buildings in San Diego, California. We are in the process of relocating
all operations other than research and development to Orange County, California and expect
to sublease two of the San Diego buildings after our relocation is complete. On May 5,
2006, we entered into a lease for the new Orange County facilities, which consists
initially of approximately 11,000 square feet of office space, increasing to 17,000 square
feet in the second quarter of 2007, leased for an initial term of five years. The aggregate
minimum payments over the initial term of the lease are expected to be approximately $2.8
million.
    
    On April 3, 2006, The NASDAQ Stock Market approved our application for listing our
common stock for trading on the NASDAQ Global Market (formerly the NASDAQ National Market
System). On April 11, 2006, our stock began trading on the NASDAQ under the stock symbol
AVNR simultaneously with the discontinuation of trading on the American Stock Exchange.
    33




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##### Table of Contents



info@avanir.com Avanir www.avanir.com www.sec.gov .
 CRITICAL ACCOUNTING POLICIES AND ESTIMATES
  35




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Share-based compensation expense
 Share-Based Payment
   36




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Revenue Recognition
 General. Revenue Recognition
 37




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Revenue Recognition When Right of Return Exists
 Accounting for Revenue Arrangements with Multiple Deliverables
 Revenue Arrangements with Multiple Deliverables .
  License Arrangements.
  Research and Development Services
 38




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Reporting Revenue Gross as a
Principal versus Net as an Agent,
 Royalty Revenues.
 Revenues from Sale of Royalty Rights .
 Government Research Grant Revenue.
 Product Sales  Active Pharmaceutical Ingredient Docosanol (API Docosanol).
 Product Sales  FazaClo.
  39




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Accounting for Consideration
Given by a Vendor to a Customer (Including a Reseller of the Vendors Products).
 Cost of Product Sales
  Recognition of Expenses in Outsourced Contracts
  Research and Development Expenses
   
    
    The technology is in the early stage of development and has no alternative uses;
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##### Table of Contents




    
    There is substantial uncertainty regarding the future success of the technology or product;
    
    There will be difficulty in completing the remaining development; and
    
    There is substantial cost to complete the work.
 Acquired in-process research and development Business Combinations
 Acquired contractual rights
 Capitalization and Valuation of Long-Lived and Intangible Assets
 Goodwill and
Other Intangible Assets Accounting for the Impairment or Disposal of Long-Lived
Assets
   
    
    A significant underperformance relative to expected historical or projected future
operating results;
    
    A significant change in the manner of our use of the acquired asset or the strategy for
our overall business; and/or
    
    A significant negative industry or economic trend.
 41




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RESULTS OF OPERATIONS
 COMPARISON OF THREE MONTHS ENDED JUNE 30, 2006 AND 2005
 Revenues
   Operating Expenses
  Three Months Ended
    
    Nine Months EndedJune 30,
    
    June 30,2006
    
    2005
    
    2006
    
    2005Operating expenses:Research and development
    
    
    49
    %
    
    
    55
    %
    
    
    53
    %
    
    
    66
    %Selling, general and administrative
    
    
    50
    %
    
    
    45
    %
    
    
    46
    %
    
    
    34
    %Costs of sales
    
    
    1
    %
    
    
    
    %
    
    
    1
    %
    
    
    
    %Total operating expenses
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 Research and development (R&D) expenses .
 42




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Research and Development Projects and Expenses
 Inception
    
    
    Estimated CostThree Months Ended
    
    
    Nine Months Ended
    
    
    Through
    
    
    to License orJune 30,
    
    
    June 30,
    
    
    June 30,
    
    
    Complete2006 (1)
    
    
    2005 (1)(4)
    
    
    2006 (1)
    
    
    2005 (1)(4)
    
    
    2006 (1)(2)(4)
    
    
    Project (1)(3)Company-funded Projects:Development programs for
Neurodex, selective
cytokine inhibitor and
other programs projected
through fiscal 2007 (3)
    
    $
    5,699,956
    
    
    $
    4,687,634
    
    
    $
    19,000,765
    
    
    $
    18,501,967
    
    
    $
    96,770,258
    
    
    $30M to $40MPartner-funded Projects:Reverse cholesterol
transport and MIF
inhibitor research
programs (4)
    
    
    1,488,363
    
    
    
    1,655,169
    
    
    
    5,303,597
    
    
    
    4,046,144
    
    
    
    24,486,399
    
    
    Funded by PartnersGovernment-funded Projects:Preclinical research on
various projects.
Funding for the anthrax
research project has been
completed
    
    
    46,402
    
    
    
    127,514
    
    
    
    213,608
    
    
    
    404,617
    
    
    
    2,699,394
    
    
    $
    Purchased in-process R&D (5)
    
    
    2,600,000
    
    
    
    
    
    
    
    2,600,000
    
    
    
    
    
    
    
    2,600,000Total
    
    $
    9,834,721
    
    
    $
    6,470,317
    
    
    $
    27,117,970
    
    
    $
    22,952,728
    
    
    $
    126,556,051
 
 (1)
    
    Each project includes an allocation of laboratory occupancy costs. M refers to
millions. Estimated costs and timing to complete the projects are subject to the
availability of funds. For each of the projects set forth in the table, other than
Neurodex for IEED/PBA (which we intend to market ourselves), the reverse cholesterol
transport and the MIF inhibitor programs (both of which we have partnered), we may seek
development partners or licensees to defray part or all of the ongoing development costs.(2)
    
    Inception dates are on or after October 1, 1998, at which time we began identifying
and tracking program costs.(3)
    
    Assumes completion of development of Neurodex in the treatment of IEED/PBA and for
one Phase III clinical trial in the treatment of painful diabetic neuropathy and
continuation of Phase I studies of our selective cytokine inhibitor program. Projected
spending thereafter will be subject to progress made in research that is currently
underway.(4)
    
    Includes expenses funded by us prior to partnering these projects in the amounts of
$1.3 million and $3.7 million for the three-month and nine-month periods ended June 30,
2005, respectively, and $16.8 million since inception through June 30, 2006 .(5)
    
    See Note 4, Alamo Acquisition.  Status of R&D Programs and Plans  Company-funded Projects
 Neurodex for the treatment of Involuntary Emotional Expression Disorder/Pseudobulbar Affect.
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Neurodex for the treatment of painful diabetic neuropathy.
 Development program for selective cytokine inhibitor.
 Status of R&D Programs and Plans  Partner-funded Projects
 AstraZeneca
UK Limited ("AstraZeneca")
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Novartis
International Pharmaceutical Ltd. ("Novartis").
 Status of R&D Programs and Plans  Government-Funded Projects
 .
    Selling, general and administrative expenses .
  Cost of product sales.
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Share-Based Compensation
  Interest Income
  Net Loss
  COMPARISON OF NINE-MONTH PERIODS ENDED JUNE 30, 2006 AND 2005
 Revenues
  Operating Expenses
  Research and development (R&D) expenses .
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Selling, general and administrative expenses .
 Cost of product sales.
 Share-Based Compensation
  Interest Income
  Net Loss
  LIQUIDITY AND CAPITAL RESOURCES
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Increase(Decrease)
    
    September 30,June 30, 2006
    
    During Period
    
    2005Cash, cash
equivalents, investment
in securities and
restricted investments
    
    $
    38,226,491
    
    
    $
    10,688,905
    
    
    $
    27,537,586Cash and cash equivalents
    
    $
    2,158,872
    
    
    $
    (6,461,271
    )
    
    $
    8,620,143Net working capital
    
    $
    13,834,083
    
    
    $
    1,864,633
    
    
    $
    11,969,450
 Nine Months
    
    
    Change
    
    
    Nine MonthsEnded
    
    
    Between
    
    
    EndedJune 30, 2006
    
    
    Periods
    
    
    June 30, 2005Net cash used for operating activities
    
    $
    (27,161,365
    )
    
    $
    (5,302,224
    )
    
    $
    (21,859,141
    )Net cash (used for) provided by investing activities
    
    
    (23,806,822
    )
    
    
    (11,618,243
    )
    
    
    (12,188,579
    )Net cash provided by financing activities
    
    
    44,506,916
    
    
    
    20,376,430
    
    
    
    24,130,486Net increase (decrease) in cash and cash equivalents
    
    $
    (6,461,271
    )
    
    $
    3,455,963
    
    
    $
    (9,917,234
    )
 Operating activities.
  Investing activities.
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Financing activities.
    
    
    A promissory note that would have been issuable in the principal amount of $4,000,000 if
FazaClo sales, as reported by IMS Health Incorporated, for each of the months of April and
May 2006 exceeded $1,266,539. Since the closing of the acquisition, we have determined that
FazaClo sales for the months April and May 2006 did not satisfy this condition and thus
this promissory note will not be issued pursuant to this contingency.
    
    If the preceding condition is not satisfied, then (A) a promissory note, in the
principal amount of $2,000,000, payable one time if monthly FazaClo net product sales, as
reported by us, exceed $1,000,000 for all three months in a given fiscal quarter during the
Contingent Payment Period, and (B) an additional promissory note in the principal amount of
$2,000,000, payable one time if monthly FazaClo net product sales, as reported by us,
exceed $1,500,000 for all three months in a given fiscal quarter during the Contingent
Payment Period.
    
    A one-time cash payment of $10,450,000 if FazaClo net product sales, as reported by us,
exceed $40.0 million over four consecutive fiscal quarters during the Contingent Payment
Period.
    
    A one-time cash payment of $25,000,000 if FazaClo net product sales, as reported by us,
exceed $50.0 million over four consecutive fiscal quarters during the Contingent Payment
Period.
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Twelve-month period ending December 31:2006
    
    $
    250,0002007
    
    
    300,0002008 and each year thereafter
    
    
    400,000
  50




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MANAGEMENT OUTLOOK
    RECENT ACCOUNTING PRONOUNCEMENTS
  
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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Interest rate sensitivity
   
 Item 4. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls over Financial Reporting
  
 PART II OTHER INFORMATION
 
 Item 1. LEGAL PROCEEDINGS
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Item 1A. RISK FACTORS
 Risks Relating to Our Business
 We have a history of losses and we may never achieve or maintain profitability.
   We will need to raise additional capital to fund ongoing operations and support our planned product
launch. If we are unable to raise additional capital, we may be forced to curtail operations. If
we succeed in raising additional capital through a licensing or financing transaction, it may
affect our stock price and future revenues.
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Any adverse decisions or delays in the regulatory review or approval process may harm our prospects
and could harm our stock price.
   We have only limited sales and marketing experience and capabilities and we expect to rely entirely
on third parties for international sales and marketing efforts. .
   We
are dependent on a small number of physicians for a substantial of FazaClo sales.
  It is difficult to integrate acquired companies, products, technologies and personnel into our
operations and our inability to do so could greatly lessen the value of any such acquisitions.
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Changes in board and management composition that are intended to strengthen the board and
management team could adversely disrupt our operations.
  Our inability to attract and retain key management and scientific personnel could negatively affect
our business.
   We generally do not control the development of compounds licensed to third parties and, as a
result, we may not realize a significant portion of the potential value of any such license
arrangements.
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Our patents may be challenged and our patent applications may be denied. Either result would
seriously jeopardize our ability to compete in the intended markets for our proposed products.
  
    
    The claims in any pending patent applications will be allowed or that patents will be
granted;
    
    Competitors will not develop similar or superior technologies independently, duplicate
our technologies, or design around the patented aspects of our technologies;
    
    Our proposed technologies will not infringe other patents or rights owned by others,
including licenses that may be not be available to us;
    
    Any of our issued patents will provide us with significant competitive advantages; or
    
    Challenges will not be instituted against the validity or enforceability of any patent
that we own or, if instituted, that these challenges will not be successful.
  We depend on third parties to manufacture, package and distribute compounds for our drugs and drug
candidates. The failure of these third parties to perform successfully could harm our business.
  Because we depend on clinical research centers and other contractors for clinical testing and for
certain research and development activities, the results of our clinical trials and such research
activities are, to a certain extent, beyond our control.
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Accounting for material transactions can be very complex and we face risks if regulators disagree
with our accounting treatment for any of these transactions.
   Developing and marketing pharmaceutical products for human use involves product liability risks,
for which we currently have limited insurance coverage.
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Risks Relating to Our Stock
 Our stock price has historically been volatile and we expect that this volatility will continue for
the foreseeable future.
  
    
    Comments made by securities analysts, including changes in their recommendations;
    
    Short selling activity by certain investors, including any failures to timely settle
short sale transactions;
    
    Announcements by us of financing transactions and/or future sales of equity or debt securities;
    
    Sales of our Class A common stock by our directors, officers, or significant shareholders;
    
    Announcements by our competitors of clinical trial results or product approvals; and
    
    Market and economic conditions.
  
    
    Timing and outcome of FDA regulatory decisions We are in the process of building a
sales force for the planned commercialization of Neurodex. The timing and extent of these
development expenditures will vary depending on the FDAs review and decision on approval
of our NDA for Neurodex. As a result, our expenses could vary significantly from
quarter-to-quarter while we await regulatory decisions and complete this building process
and our stock price could vary significantly depending on the outcome of the FDAs
regulatory review.
    
    Performance under partnering arrangements The recognition of the revenue under our
partnering arrangements, including our license agreements for our MIF and RCT technologies,
will largely depend on the efforts and performance of our licensees in reaching milestones
that are outside of our control, such as regulatory approval, product launch, or reaching a
sales threshold.
    
    Acquisitions Our acquisition of Alamo Pharmaceuticals in the third quarter of fiscal
2006 resulted in charges of approximately $2.6 million. We may acquire other companies or
technologies, and if we do so, we will incur potentially significant charges in connection
with such acquisitions and may have ongoing charges after the closing of any such
transaction. Any such acquisitions could also be disruptive to our operations and may
adversely affect our results of operations.
  Risks Relating to Our Industry
 The pharmaceutical industry is highly competitive and most of our competitors are larger and have
greater resources. As a result, we face significant competitive hurdles.
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Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 Item 3. DEFAULTS UPON SENIOR SECURITIES
  
 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 Item 5. OTHER INFORMATION
  
 Item 6. EXHIBITS
 Exhibits
 10.1
    
    Unit Purchase Agreement by and among Avanir Pharmaceuticals, the
Sellers and Alamo Pharmaceuticals, LLC, dated May 22, 2006.10.2
    
    Senior Note for $14.4 million payable to Neal R. Cutler, dated May 24, 2006.10.3
    
    Senior Note for $6,675,000 payable to Neal R. Cutler, dated May 24, 2006.10.4
    
    Senior Note for $4.0 million payable to Neal R. Cutler, dated May 24. 2006.10.5
    
    Amended and Restated Development, License and Supply Agreement by and
between CIMA Labs Inc. and Alamo Pharmaceuticals, LLC, dated August 22,
2005.*10.6
    
    Amendment #1 to Amended and Restated Development, License and Supply
Agreement by and between CIMA Labs Inc. and Alamo Pharmaceuticals, LLC,
dated October 19, 2005.*10.7
    
    Registration Rights Agreement between
Avanir Pharmaceuticals and
Neal Cutler, dated May 24, 2006.15.1
    
    Letter on unaudited interim financial information.31.1
    
    Certification of Principal Executive Officer Required Under Rule 13a-14(a)
of the Securities Exchange Act of 1934, as amended.
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31.2
    
    Certification of Principal Financial Officer Required Under Rule 13a-14(a)
of the Securities Exchange Act of 1934, as amended.31.3
    
    Certification of Principal Accounting Officer Required Under
Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.32.1
    
    Certification of Principal Executive Officer Required Under Rule 13a-14(b)
of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. 1350.32.2
    
    Certification of Principal Financial Officer Required Under Rule 13a-14(b)
of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. 1350.32.3
    
    Certification of Principal Accounting Officer Required Under
Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended,
and 18 U.S.C. 1350.
 
 *
    
    Confidential treatment requested. 60




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SIGNATURES
  Signature
    
    Title
    
    Date/s/ Eric K. Brandt

Eric K. Brandt
    
    President and Chief Executive Officer
(Principal Executive Officer)
    
    August 9, 2006/s/ Michael J. Puntoriero

Michael J. Puntoriero
    
    Senior Vice President, Finance and
Chief Financial Officer
(Principal Financial Officer)
    
    August 9, 2006/s/ Gregory P. Hanson, CMA

Gregory P. Hanson, CMA
    
    Vice President and Chief Accounting
Officer
(Principal Accounting Officer)
    
    August 9, 2006
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EXHIBITS INDEX
 Exhibits
 10.1
    
    Unit Purchase Agreement by and among Avanir Pharmaceuticals, the
Sellers and Alamo Pharmaceuticals, LLC, dated May 22, 2006.10.2
    
    Senior Note for $14.4 million payable to Neal R. Cutler, dated May 24, 2006.10.3
    
    Senior Note for $6,675,000 payable to Neal R. Cutler, dated May 24, 2006.10.4
    
    Senior Note for $4.0 million payable to Neal R. Cutler, dated May 24. 2006.10.5
    
    Amended and Restated Development, License and Supply Agreement by and
between CIMA Labs Inc. and Alamo Pharmaceuticals, LLC, dated August 22,
2005.*10.6
    
    Amendment #1 to Amended and Restated Development, License and Supply
Agreement by and between CIMA Labs Inc. and Alamo Pharmaceuticals, LLC,
dated October 19, 2005.*10.7
    
    Registration Rights Agreement between Avanir Pharmaceuticals and
Neal Cutler, dated May 24, 2006.15.1
    
    Letter on unaudited interim financial information.31.1
    
    Certification of Principal Executive Officer Required Under Rule 13a-14(a)
of the Securities Exchange Act of 1934, as amended.31.2
    
    Certification of Principal Financial Officer Required Under Rule 13a-14(a)
of the Securities Exchange Act of 1934, as amended.31.3
    
    Certification of Principal Accounting Officer Required Under
Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.32.1
    
    Certification of Principal Executive Officer Required Under Rule 13a-14(b)
of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. 1350.32.2
    
    Certification of Principal Financial Officer Required Under Rule 13a-14(b)
of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. 1350.32.3
    
    Certification of Principal Accounting Officer Required Under
Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended,
and 18 U.S.C. 1350.
 
 *
    
    Confidential treatment requested. 62