<PAGE>   1
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                    FORM 10-Q
================================================================================
                  QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934


For the quarter ended DECEMBER 31, 1999             Commission File No. 0-18734




                             AVANIR PHARMACEUTICALS
             (Exact name of registrant as specified in its charter)

            CALIFORNIA                                   33-0314804
   (State or other jurisdiction of            (IRS Employer Identification No).
   incorporation or organization)


  9393 TOWNE CENTRE DRIVE, SUITE 200
        SAN DIEGO, CALIFORNIA                               92121
(Address of principal executive office)                  (Zip Code)


                                 (858) 410-2600
              (Registrant's telephone number, including area code)


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


The number of shares of Common Stock of the Registrant issued and outstanding as
of February 10, 2000:

<TABLE>
<S>                                                          <C>
         Class A Common stock, no par value                  50,248,653
         Class B Common stock, no par value                     440,000
</TABLE>



================================================================================


<PAGE>   2

                             AVANIR PHARMACEUTICALS

                                    FORM 10-Q

                     For the quarter ended December 31, 1999

                                      Index



<TABLE>
<CAPTION>
                                                                                                 Page
                                                                                                 ----
<S>        <C>                                                                                  <C>
  PART I.   FINANCIAL INFORMATION

 Item 1.    Financial Statements

            Balance Sheets at December 31, 1999 and September 30, 1999 .........................   3

            Statements of Operations for the three months ended December 31,
            1999 and 1998 and for the period from August 31, 1988 (Inception)
            to December 31, 1999................................................................   4

            Statements of Cash Flows for the three months ended December 31,
            1999 and December 31, 1998 and for the period from August 31, 1988
            (Inception) to December 31, 1999....................................................   5

            Notes to Financial Statements.......................................................   6

 Item 2.    Management's Discussion and Analysis of Financial Condition and
            Results of Operations...............................................................  11

 Item 3.    Quantitative and Qualitative Disclosures about Market Risk..........................  20

 PART II.   OTHER INFORMATION

 Item 1.    Legal Proceedings...................................................................  20

 Item 6.    Exhibits and Reports on Form 8-K....................................................  20
</TABLE>




                                       2

<PAGE>   3
                             AVANIR PHARMACEUTICALS
                        (A DEVELOPMENT STAGE ENTERPRISE)

                           BALANCE SHEETS (UNAUDITED)
================================================================================



<TABLE>
<CAPTION>
                                                                   DECEMBER 31,                SEPTEMBER 30,
ASSETS                                                                 1999                        1999
                                                                   ------------                ------------
<S>                                                                <C>                         <C>
CURRENT ASSETS:
    Cash and cash equivalents                                      $  3,454,104                $    122,674
    Receivable - Insurance (net of allowance for                                                     76,499
               non-payment of $214,827 and $189,011)
    Other receivables                                                    63,333
    Inventory                                                           111,901                     111,901
    Prepaid                                                             279,042                     263,004
    Restricted cash                                                       8,034                      57,158
    Other                                                                 2,070                       1,692
                                                                   ------------                ------------


         Total current assets                                         3,918,484                     632,928
PROPERTY - at cost (less accumulated depreciation of
               $524,006 and $496,726)                                   187,526                     219,361
PATENT COSTS (less accumulated amortization of
               $109,798 and $101,473)                                   622,376                     617,741
DEFERRED COSTS                                                          197,659                     100,000
LONG-TERM INVENTORY                                                     111,901                     111,901
OTHER ASSETS                                                             75,397                      83,284
                                                                   ------------                ------------

         TOTAL                                                     $  5,113,343                $  1,765,215
                                                                   ============                ============


LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
    Convertible debentures                                         $  1,352,313
    Accounts payable                                                  1,094,768                $  1,173,068
    Accrued expenses and other liabilities                              478,280                     221,207
    Accrued compensation and payroll taxes                              133,468                     123,068
    Note payable                                                        192,571                     183,676
                                                                   ------------                ------------


         Total current liabilities                                    3,251,400                   1,701,019

COMMITMENTS (Notes 7 and 9)

SHAREHOLDERS' EQUITY
    Preferred Stock - 10,000,000 shares authorized;
           no shares issued and outstanding
    Common stock - no par value:
      Class A - 99,288,000 shares authorized;
               47,274,541 and 45,017,063 issued and
               outstanding                                           65,767,490                  62,195,950
      Class B - 712,000 shares authorized; 440,000
               shares issued and outstanding
               (convertible into Class A common                          38,269                      38,270
               stock)
    Stock subscriptions                                                  63,333
    Deficit accumulated during development stage                    (64,007,149)                (62,170,024)
                                                                   ------------                ------------

         Total shareholders' equity                                   1,861,943                      64,196
                                                                   ------------                ------------

         TOTAL                                                     $  5,113,343                $  1,765,215
                                                                   ============                ============
</TABLE>


See notes to the financial statements



                                       3
<PAGE>   4

                             AVANIR PHARMACEUTICALS
                        (A DEVELOPMENT STAGE ENTERPRISE)

                      STATEMENTS OF OPERATIONS (UNAUDITED)
================================================================================



<TABLE>
<CAPTION>
                                                                                               AUGUST 31, 1988
                                                      THREE MONTHS ENDED                       (INCEPTION) TO
                                                          DECEMBER 31,                          DECEMBER 31,
                                              -------------------------------------            ---------------
                                                 1999                      1998                     1999
                                              ------------             ------------            --------------
<S>                                           <C>                      <C>                         <C>
REVENUES:
    License fees/contract services                                                              $  4,507,625
    Federal research grants                                                                          940,646
    Interest and other                        $      8,037             $     71,842                4,845,852
                                              ------------             ------------             ------------

        Total revenues                               8,037                   71,842               10,294,123
                                              ------------             ------------             ------------

EXPENSES:
    Research and development                       453,002                  594,670               38,939,857
    General and administrative                   1,004,365                  792,118               26,116,588
    Sales and marketing                             82,691                  687,580                2,349,697
    Litigation settlement                          197,504                                           981,403
    Interest                                       107,602                    2,616                5,380,457
    Cost of contract services                                                                        533,270
                                              ------------             ------------             ------------

        Total expenses                           1,845,164                2,076,984               74,301,272
                                              ------------             ------------             ------------

NET LOSS                                      $ (1,837,127)            $ (2,005,142)            $(64,007,149)
                                              ============             ============             ============
NET LOSS ATTRIBUTABLE TO COMMON
SHAREHOLDERS                                  $ (1,837,127)            $ (2,005,142)            $(64,036,295)
                                              ============             ============             ============

NET LOSS PER SHARE                            $      (0.04)            $      (0.05)
                                              ============             ============

WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING                              45,683,119               40,776,400
                                              ============             ============
</TABLE>

See notes to the financial statements.


                                       4
<PAGE>   5
                             AVANIR PHARMACEUTICALS
                        (A DEVELOPMENT STAGE ENTERPRISE)

                      STATEMENTS OF CASH FLOWS (UNAUDITED)
================================================================================




<TABLE>
<CAPTION>
                                                                                                              AUGUST 31, 1988
                                                                      THREE MONTHS ENDED                      (INCEPTION) TO
                                                                          DECEMBER 31,                          DECEMBER 31,
                                                              -------------------------------------           ---------------
                                                                  1999                     1998                     1999
                                                              ------------             ------------           ---------------
<S>                                                           <C>                      <C>                      <C>
OPERATING ACTIVITIES:
  Net loss                                                    $ (1,837,127)            $ (2,005,142)            $(64,007,149)
  Adjustments to reconcile net loss to
    net cash used for operating activities:
  Depreciation and amortization                                     35,604                   34,689                1,119,722
  Non-cash interest expense                                        157,644                   17,620                4,451,951
  Technology license fee                                                                                           3,545,713
  Compensation paid with common
   stock and stock options                                         274,033                    7,418                1,147,219
  Common stock subscriptions                                        63,333                                            63,333
  Compensation forgiven by shareholder                                                                                66,923
  Imputed interest on technology license fee                                                                          82,613
  Changes in assets and liabilities:
    Accounts receivable                                             13,167                   76,397                  (63,332)
    Inventory                                                                              (111,901)                (111,901)
    Prepaid and other                                               40,594                 (117,623)                (476,445)
    Organizational costs                                                                                             (20,242)
    Deferred costs                                                                         (106,877)                (100,000)
    Accounts payable                                               (78,300)                  20,935                1,094,768
    Accrued expenses and other liabilities                         273,912                  163,466                  678,793
    Accrued compensation and payroll taxes                          10,401                  (25,226)                 133,469
                                                              ------------             ------------             ------------
      Net cash used for operating activities:                   (1,046,739)              (2,046,244)             (52,394,565)
INVESTING ACTIVITIES:
  Patent costs                                                     (12,960)                  (5,097)                (732,174)
  Investment in fixed assets                                         4,556                  (34,846)                (824,910)
                                                              ------------             ------------             ------------
      Net cash used for investing activities                        (8,404)                 (39,943)              (1,557,084)
FINANCING ACTIVITIES:
  Proceeds from issuance of common and preferred                 3,049,532                   47,518               44,362,015
    stock
  Proceeds from issuance of convertible notes                    1,500,000                                        21,000,000
    payable
  Debt issue costs                                                (155,015)                                       (1,222,425)
  Repayment of convertible notes payable                                                                          (2,673,217)
  Stock issue costs                                                                                               (3,147,625)
  Advances for purchase of common stock                                                                              125,000
  Collection of notes receivable for common stock                                                                     14,525
  Proceeds from shareholders loans                                                                                   322,788
  Repayment of shareholder loans                                                                                    (322,788)
  Proceeds from issuance of  notes payable - net                    75,000                                           613,750
    of issue costs
  Repayment of  notes payable                                      (82,944)                                         (707,944)
  Payment on technology license fee                                                                                 (958,326)
                                                              ------------             ------------             ------------
      Net cash provided by financing activities                  4,386,573                   47,518               57,405,753
                                                              ------------             ------------             ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS             3,331,430               (2,038,669)               3,454,104
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                   122,674                6,508,341
                                                              ------------             ------------             ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD                    $  3,454,104             $  4,469,672             $  3,454,104
                                                              ------------             ------------             ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid                                                        3,922                                      $  1,119,169
                                                              ============             ============             ============
SUPPLEMENTAL DISCLOSURES OF NON-CASH FINANCING ACTIVITIES:
Conversions into common stock from Series D preferred stock                                                     $  2,029,146
</TABLE>


See notes to the financial statements.



                                       5
<PAGE>   6
AVANIR PHARMACEUTICALS
 (A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------



1.       BASIS OF PRESENTATION

         We have prepared the unaudited financial statements in this quarterly
report in accordance with the instructions to Form 10-Q under Section 13 or
15(d) of the Securities Exchange Act of 1934. These statements should be read
with our audited financial statements and the accompanying notes included in our
Annual Report on Form 10-K for the fiscal year ended September 30, 1999. In our
opinion, we have presented the financial statements, including all adjustments
consisting only of normal recurring accruals, that are necessary to summarize
fairly our financial position as of December 31, 1999, and the results of
operations for the three months ended December 31, 1999 and from our inception
on August 31, 1988 to December 31, 1999. The results of operations for the three
months ended December 31, 1999 may not be indicative of the results that may be
expected for the year ending September 30, 1999.

2.       GOING CONCERN

         We have prepared the accompanying financial statements on a going
concern basis, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. We have incurred net losses since
our inception and have not yet received approval of our new drug application for
docosanol 10% cream from the FDA. As a result, we have not generated any
revenues from our products. We also are working towards completion of a license
agreement with SmithKline Beecham, which would give it the rights to manufacture
and sell docosanol 10% cream in the North American market. See Note 14. The
report from our auditors for fiscal year 1999 contains an explanatory paragraph
referring to the status of our ability to continue as a going concern. During
the first quarter of fiscal year 1999, we received approximately $3.0 million
from the exercise of stock purchase warrants and stock options. In addition, on
January 31, 2000, we completed a $6 million private placement financing which
will be used for working capital purposes to support operations in the event of
any delays in decisions from the FDA or the failure to enter into a license
agreement with SmithKline Beecham.

3.       ESTIMATES

         The preparation of financial statements in conformity with generally
accepted accounting principles requires that we make estimates and assumptions
that affect the reported amounts of our assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

4.       RECLASSIFICATIONS

         Certain amounts in the prior years' financial statements have been
reclassified to conform to current period presentation.

5.       INVENTORY

         In November 1998, we purchased the active ingredient in docosanol 10%
cream at a cost of $223,800. We estimated that 50% of the raw materials
purchased are current assets because we intend for at least one-half of the raw
materials to be used in manufacturing and sold within the next year. We
classified the remaining 50% of the raw materials inventory on our balance sheet
as part of other assets. We record the value our inventories at the lower of
cost (first-in, first-out) or market price.



                                       6
<PAGE>   7

6.       DEFERRED COSTS

         Deferred costs at December 31, 1999 totaling $197,659 represent
$100,000 in costs related to an equity line investment agreement dated January
22, 1999, and $97,659 in costs related to our issuance of a $1.5 million
convertible debenture (See Note 7). The amounts classified as deferred costs for
the equity line agreement will be offset against the proceeds for stock sold
under the equity line as appropriate. We intend to sell shares of Class A common
stock according to the terms of the equity line agreement after we obtain
listing of our shares on one of the national stock market exchanges. Our policy
is to record these costs as deferred assets when there is a reasonable
likelihood of the equity line being fulfilled and to expense these costs
immediately when the equity line will not be fulfilled. As we are still pursuing
this equity line and as the agreement has not expired, we have recorded deferred
costs at December 31, 1999. Deferred costs associated with the 11% convertible
debenture are discussed in Note 8, "Debt Issue Costs".

7.       11% CONVERTIBLE DEBENTURES

         Loan Agreement - On November 23, 1999, we entered into a loan agreement
for $1.5 million in financing from two international financial lenders. On
November 24, 1999 and November 29, 1999, respectively, we issued to each lender
an 18-month convertible debenture, with an interest rate of 11% payable
quarterly in arrears. Under the loan agreement, we may pay back the outstanding
principal and accrued interest on each convertible debenture within the first
100 days from its issuance date before the lender is entitled to convert the
convertible debenture into shares of Class A common stock. After this 100-day
period and assuming we have not redeemed the convertible debentures, each lender
has a right to convert the outstanding principal and accrued interest into
shares of Class A common stock at a conversion rate of 90% of the market price
per share of Class A common stock, as defined in the loan agreement. The
interest rate is reduced from 11% to 10% if we redeem the convertible debentures
within the first 90 days of issuance.

         The option to convert the convertible debentures at 90% of the market
price of the Class A common stock effectively results in the issuance of the
convertible debentures at an 11% discount. We recorded this discount, totaling
$166,667, as equity in connection with the issuance of the convertible
debentures (See Note 9). The discount will be amortized as non-cash interest
expense during the 100 days prior to the period in which the discount on
conversion applies, with a corresponding increase to the principal amount of the
convertible debentures.

         The convertible debentures are redeemable at various premiums over the
principal amount, beginning with a 105% redemption price if within the first 90
days of issuance. During February 2000, we redeemed all of the convertible
debentures outstanding and paid the 5% redemption premium.

         Stock Purchase Warrant - In connection with issuing the convertible
debentures, we issued to each lender a Class M stock purchase warrant to
purchase 292,056 shares of Class A common stock at an exercise price of $1.284
per share. Two-thirds of the shares of Class A common stock underlying the Class
M stock purchase warrants vested on November 24, 1999. The remaining one-third
would have become exercisable if we had not repaid in full the outstanding
principal and accrued interest on the convertible debentures within the first
100 days from the issuance date of the convertible debentures. Because we
redeemed the convertible debentures within the first 100 days from their
respective issuance dates, each lender may only exercise 194,704 shares under
the Class M stock purchase warrants. In addition, we paid two investment banks
an aggregate finder's fee of $120,000 and issued Class M stock purchase warrants
to purchase an aggregate of 116,822 shares of Class A common stock at an
exercise price of $1.284 per share. The vesting of the investment banks' Class M
stock purchase warrants also stopped at 77,881 shares. See Note 9 for the
valuation of the Class M stock purchase warrants.



                                       7
<PAGE>   8

         Amendment to Rights Agreement - Pursuant to the terms and conditions of
the loan agreement, we amended our Rights Agreement, dated as of March 5, 1999,
between our company and American Stock Transfer & Trust Company, as rights
agent, to exclude each of the lenders from triggering the Rights Agreement in
the event of a conversion of the convertible debentures and/or exercise of the
Class M stock purchase warrants.

         Under the Rights Agreement, either lender will be deemed to be an
"Acquiring Person" if it becomes the beneficial owner of 15% or more of our
Class A common stock and Class B common stock. Because the beneficial ownership
of each lender could exceed this 15% threshold in the event of the conversion of
the convertible debentures at a price per share that is lower than the current
market price per share for Class A common stock and/or with the exercise of the
Class M stock purchase warrants, we amended the Rights Agreement to exclude each
lender from the definition of "Acquiring Person," unless the lender beneficially
owns or will beneficially own any shares of Class A common stock and Class B
common stock, other than:

         -        the lender's ownership of convertible debentures or Class M
                  stock purchase warrants or any Class A common stock and Class
                  B common stock issuable upon the conversion or exercise
                  thereof; and

         -        any stock dividend or distribution paid or made on the
                  outstanding Class A common stock and Class B common stock or
                  pursuant to a split or subdivision of the outstanding Class A
                  common stock and Class B common stock.

See Item 6 - "Exhibits and Reports on Form 8-K" for additional information.

8.       DEBT ISSUE COSTS

         We incurred $155,015 in debt issue costs related to the issuance of the
Convertible Debentures (See Note 7). The debt issue costs are amortized over the
first 100 days from issuance, based on our intent to redeem the Convertible
Debentures as soon as we have completed sufficient equity financing to replace
outstanding debt. We have amortized $57,356 in debt issue costs through December
31, 1999.

9.       SHAREHOLDERS' EQUITY

         Preferred Stock - Preferred stock consists of Series C Junior
Participating Preferred Stock and Series D Redeemable Convertible Preferred
Stock. At December 31, 1999 and September 30, 1999, there were no shares of
preferred stock issued and outstanding.

         Class A Common Stock - Between October 1, 1999 and December 31, 1999,
we issued an aggregate of 2,065,892 shares of Class A common stock in connection
with the exercise of $2,817,572 in stock purchase warrants and 191,587 shares of
Class A common stock in connection with the exercise of $231,960 in employee
stock options. Details of the transactions are shown in the table below.


<TABLE>
<CAPTION>
   WARRANTS                                                 AMOUNT           AVERAGE PRICE
   EXERCISED                      DATES                     SHARES              RECEIVED              PER SHARE
----------------            -----------------             ---------          --------------          ------------
<S>                         <C>                          <C>                   <C>                   <C>
Class D warrants            12/16/99-12/31/99             1,265,891            $1,740,602            $     1.3750
Class G warrants            12/08/99-12/21/99               750,000            $1,031,250            $     1.3750
Class J warrants                11/30/99                     50,000            $   45,720            $     0.9144
                                                          ---------            ----------            ------------
    Total                                                 2,065,891            $2,817,572            $     1.3639
</TABLE>




                                       8
<PAGE>   9


<TABLE>
<CAPTION>
 STOCK OPTIONS                                                                  AMOUNT               AVERAGE PRICE
   EXERCISED                  DATES                       SHARES               RECEIVED                PER SHARE
                        -----------------                -------               --------              -------------
<S>                     <C>                              <C>                   <C>                    <C>
Employees               11/08/99-12/24/99                191,587               $231,960               $     1.2107
</TABLE>

         Class D Warrants. As of September 30, 1999, there were 1,514,035 Class
D warrants outstanding. The Class D warrant holders exercised $1,803,935 in
warrants to purchase a total of 1,311,952 shares of Class A common stock at an
exercise price of $1.375 per share prior to the December 31, 1999 expiration
date. However, our transfer agent had processed only $1,740,602 of the Class D
warrant exercises for the purchase of 1,265,891 shares of Class A common stock
as of December 31, 1999. Therefore, we recognized the balance of the exercises
of $63,333 in Class D warrants to purchase 46,060 shares of Class A common stock
processed after December 31, 1999 as subscriptions receivable at December 31,
1999.

         Class G Warrants. As of September 30, 1999, 4,385,783 Class G warrants
were outstanding. In December 1999, the Class G warrant holders exercised an
aggregate of $1,031,250 in warrants to purchase a total of 750,000 shares of
Class A common stock at an exercise price of $1.375 per share. As of December
31, 1999, 3,635,783 Class G warrants were outstanding.

         Class J Warrants. As of September 30, 1999, 100,000 Class J warrants
were outstanding. On November 29, 1999, one of the investors exercised 50,000
Class J warrants at an exercise price of $0.9144 per share, for cash in the
aggregate amount of $45,720. As of the date of this report, there are 50,000
Class J warrants outstanding.

         Class M Warrants. We issued Class M stock purchase warrants to certain
lenders and investment bankers to purchase an aggregate of 700,934 shares of
Class A common stock at an exercise price of $1.284 per share in connection with
the $1.5 million in convertible debentures that we issued in November 1999. We
valued the warrants at $81,308 based on the difference in the warrant price and
the market price on the date of issuance. See Note 7.

         In December 1999, we recorded equity in the amount of $166,667
representing the discount related to the conversion feature on the convertible
debentures. See Note 7.

         On December 3, 1999, we issued stock options to employees for the
purchase of 694,000 shares of Class A common stock at an exercise price of $1.55
per share. The closing sales price for our Class A common stock on December 3,
1999 was $1.8125 per share. In connection with such issuance of stock options at
a discount, we recorded compensation expense and equity in the amount of
$182,175, representing the difference in the market price on the date of
issuance and the discounted price of the stock options on the date granted.

10.      NET LOSS PER SHARE

         Net Loss Per Share - In the accompanying statements of operations for
the quarters ended December 31, 1999 and 1998, we have presented our net loss
per share under SFAS No. 128. Net loss per share is computed using the Basic EPS
method, as the inclusion of common stock equivalents in the Diluted EPS
calculation would be anti-dilutive. Based on the our continuing net losses,
implementing SFAS No. 128 has not had a material impact on net loss per share.


11.      LITIGATION



                                       9
<PAGE>   10

         David H. Katz Litigation - On April 30, 1998, Dr. David H. Katz filed a
complaint in the San Diego Superior Court, making numerous claims related to the
termination of his employment as our president. Mrs. Lee Katz, Dr. Katz' wife,
later joined in the lawsuit and raised claims related to her stock options. On
October 30, 1998, we filed a cross-complaint against Dr. Katz and Mrs. Katz for
Dr. Katz' breach of his fiduciary duties as a director and officer of our
company, and the assignment by Dr. Katz and Mrs. Katz to our company of any
interest that they may possess in a pending patent application pertaining to our
proprietary IgE down regulation technology. The following claims are still
pending before the court:

-        Dr. Katz' request for the court to decide the voting rights for his
         shares of our Class B common stock;

-        Dr. Katz' claim that his termination as our president was not "for
         cause";

-        Dr. Katz' request for an accounting for allegedly deferred income and
         money allegedly advanced to our company; and

-        Our claim for specific performance of Dr. and Mrs. Katz' employment
         contractual obligations to assign any interest in the pending IgE
         technology patent application to us.

         The jury in this litigation recently found in our favor on our claim
that Dr. Katz breached his fiduciary duty to us, and awarded us damages in the
amount of $9.0 million. The jury also returned a verdict against us on Dr. Katz'
defamation claim and awarded Dr. Katz' damages in the amount of $6.7 million.
The other original claims were either voluntarily dismissed by Dr. Katz, decided
in our favor by the court, or settled. However, the court has not set a date for
further proceedings to decide the remaining claims, and no judgment will be
entered in the overall case until trial is concluded on these claims. At that
point, we anticipate that both sides of the litigation will file post-trial
motions. We have not recorded any asset or liability associated with this case,
as the ultimate outcome is still unknown.

12.      LITIGATION SETTLEMENT

         On January 29, 1999, two former employees filed a lawsuit in San Diego
Superior Court, making several claims related to our termination of their
employment and seeking monetary damages. On November 12, 1999 we reached a
settlement before a settlement judge, which included a commitment to issue an
aggregate of 160,000 shares of Class A common stock to these former employees.
On January 28, 2000, we executed a written settlement agreement and mutual
general release with the former employees to settle all outstanding disputes
between the parties; the lawsuit was dismissed on January 28, 2000. We have
reserved for issuance 160,000 shares of Class A common stock and recorded
litigation settlement expense in the amount of $197,504, with a corresponding
increase to accrued expenses and other liabilities related to this transaction,
based on a closing price per share of $1.234 for our Class A common stock on
November 12, 1999.

13.      FDA REVIEW OF DOCOSANOL 10% CREAM

         In November 1999, the U.S. Food and Drug Administration (FDA) informed
us that our clinical data for docosanol 10% cream would be sufficient for
approval as an over-the-counter (OTC) product, provided that the FDA finds no
serious discrepancies from a site audit conducted at one of our clinical study
sites in The Netherlands. We currently are waiting for the FDA's assessment of
this site audit, which the FDA conducted during the second week of December
1999. Our former European licensee used the site in The Netherlands to conduct
one of the clinical studies submitted as part of our new drug application for
docosanol 10% cream. We also have submitted proposed OTC product labeling for
docosanol 10% cream, as requested by the FDA. If our new drug application is
approved by the FDA, then docosanol 10% cream will be the first OTC product for
cold sore treatment that will have an FDA-approved new drug application to
support claims made about the product's performance.

14.      LETTER OF INTENT WITH SMITHKLINE BEECHAM



                                       10
<PAGE>   11

         On December 20, 1999, we signed a letter of intent with SmithKline
Beecham (NYSE: SBH) for rights to market docosanol 10% cream in the North
American OTC market as a treatment for recurrent oral-facial herpes. SmithKline
Beecham is one of the world's leading health-care companies with over $13
billion in revenues in 1998.

The letter of intent provides that:

-        we will negotiate exclusively with SmithKline Beecham until
         approximately the end of February 2000 to finalize a license
         arrangement for docosanol 10% cream;

-        assuming that these negotiations are successful and the FDA approves
         docosanol 10% cream as an OTC product, we will receive an initial
         license fee and other fees based upon our achievement of product
         milestones, including product launch timing and sales levels, and
         royalties on sales revenue; and

-        we have the option to add selective foreign marketing rights to the
         agreement if both companies agree to these terms.

At this time, we can provide no assurance that we will:

-        Establish a license agreement with SmithKline Beecham or any major
         pharmaceutical company on favorable terms;

-        Obtain a successful site audit, as required by the FDA; or

-        Agree with the FDA in a timely manner on labeling of the product.

         Furthermore, we can give no assurance that the proceeds from a
marketing partnership will be sufficient to continue our other drug discovery
and development programs currently underway.

15.      SUBSEQUENT EVENTS

         $6 Million Private Placement - On January 31, 2000, we closed a $6
million private placement financing with three accredited financial
institutions, in which we issued 2,630,137 shares of Class A common stock and
warrants to purchase an aggregate of 263,014 shares of Class A common stock at
an exercise price of $2.44 per share. We paid financial advisory and finders'
fees of $480,000 in connection with this financing arrangement. We used
approximately $1.6 million of the proceeds from this financing to redeem the
$1.5 million in convertible debentures that we issued in November 1999. See Item
6 - "Exhibits and Reports on Form 8-K."

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

         This report contains forward-looking statements concerning our future
events or performance. You should not rely excessively on these forward-looking
statements, because they are only predictions based on our current expectations
and assumptions. Forward-looking statements often contain words like "estimate,"
"anticipate," "believe" or "expect". Many known and unknown risks and
uncertainties could cause our actual results to differ materially from those
indicated in these forward-looking statements. You should review carefully the
risks and uncertainties identified in this report, including those explained
below and in our other filings with the Securities and Exchange Commission. We
have no obligation to update or announce revisions to any forward-looking
statements to reflect actual events or developments.

OVERVIEW

         We are a development stage company organized to discover, develop and
market novel therapeutic products to treat human diseases. Since inception in
August 1988, we have operated in one



                                       11
<PAGE>   12

business segment - pharmaceutical product development. Docosanol 10% cream is
our lead therapeutic product that has been under development since we filed our
investigational new drug application in July 1991. In November 1999, the FDA
informed us that our clinical data for docosanol 10% cream would be sufficient
for approval as an over-the-counter (OTC) product, if the FDA finds no serious
discrepancies from the site audit that it conducted at one of our clinical study
sites in The Netherlands in mid-December 1999. Additionally, we have submitted
proposed product labeling for docosanol 10% cream as an OTC product. We
currently are waiting for the FDA's assessment of the site audit and evaluation
of our proposed product labeling.

         On December 20, 1999, we entered into exclusive negotiations with
SmithKline Beecham regarding an acceptable partnership agreement for the
marketing and sale of docosanol 10% cream. If these negotiations are successful
and docosanol 10% cream is approved by the FDA, then SmithKline Beecham will
receive the right to market and sell docosanol 10% cream in the North American
market, in return for our receiving license fees based on the achievement of
product milestones, including product launch and sales levels, and royalties on
sales revenue.

         If we obtain FDA approval for our new drug application for docosanol
10% cream and we complete a license agreement with SmithKline Beecham, then we
intend to generate revenues from license fees and royalties from this license
agreement. Our revenues for the next several years will depend, perhaps
exclusively, on the license fees and royalties from this product.

         We have incurred increasing annual operating expenses and, with the
potential commercialization of other products, we expect that this trend of
increased operating expenses will continue. Our business is exposed to
significant risks discussed in the section entitled "Risk Factors," which may
result in additional expenses, delays and lost opportunities that could have a
material adverse effect on our financial condition and results of operations.

RESULTS OF OPERATIONS

NET LOSSES

         Net losses for the first quarter of fiscal year 2000 were $1.8 million,
compared to a loss of $2.0 million for the first quarter of fiscal year 1999.

REVENUES

         Revenues decreased to $8,000 in the first quarter of fiscal year 2000
from $72,000 in the same period in 1999. The decrease in revenues during the
first quarter of fiscal year 2000 was due to a decrease in interest earned due
to lower cash and cash equivalents available for investment during the period.

EXPENSES

         Operating Expenses - Total operating expenses decreased to $1.8 million
in the first quarter of fiscal year 2000 compared to $2.1 million in the same
period in 1999. The net decrease in operating expenses in the first quarter of
fiscal year 2000 is described below.

         Research and Development Expenses - During the first quarter of fiscal
year 2000, research and development expenses decreased to $453,000 compared to
$595,000 in the same period in 1999.

         The decreased expenses in the first quarter of fiscal year 2000 relate
to reduced development activity relating primarily to our allergy & asthma
technology, as we decreased spending on all of our development programs due to
limited financial resources. Since July 1999, we substantially cut our
development efforts, primarily in the areas of third-party contract research, as
we await the FDA's



                                       12
<PAGE>   13

decision on our new drug application for docosanol 10% cream. As the decision by
the FDA currently is pending, we have continued to conserve our cash resources
through the first quarter of fiscal year 2000.

         General and Administrative Expenses - During the first quarter of
fiscal year 2000, general and administrative expenses increased to $1.0 million
compared to $792,000 in the same period in fiscal year 1999. The increased
expenses for the first quarter of fiscal year 2000 primarily relate to
litigation expenses, in which we were engaged in a six-week jury trial regarding
matters of litigation with David H. Katz. (See Note 11.)

         Sales and Marketing Expenses - During the first quarter of fiscal year
2000, sales and marketing expenses were $83,000, compared with $688,000 in the
same period in fiscal year 1999. Expenses in the first quarter of fiscal year
1999 were related to formation of a sales and marketing staff and preparation
for the potential launch of docosanol 10% cream. However, because of the delays
in obtaining FDA approval of our new drug application for docosanol 10% cream
and our change in strategy to out-license docosanol 10% cream to SmithKline
Beecham, we reduced substantially our marketing staff and marketing development
efforts in the first quarter of fiscal year 2000.

         Interest Expense - Interest expense increased to $108,000 in the first
quarter of fiscal year 2000 compared to $2,600 for the same period in fiscal
year 1999. The increased interest expense in the first quarter of fiscal year
2000 was due to the addition of the Convertible Debenture in November 1999.

         Litigation Settlement - During the first quarter of fiscal year 2000,
we recorded litigation settlement expenses of $197,504 in connection with our
settlement with two former employees over their termination of employment and
seeking monetary damages. (See Note 12.) There were no litigation settlement
costs incurred in the same period in 1999.

LIQUIDITY AND CAPITAL RESOURCES

         Since inception, we have financed operations primarily through the sale
of equity and convertible debt securities and shareholder loans. Net cash
provided by financing activities from inception through December 31, 1999 was
$57.4 million.

         At December 31, 1999, we had available $3.5 million of cash, cash
equivalents and short-term investments and a working capital balance of
$667,000, compared to cash and cash equivalents of $123,000 and a negative
working capital balance of $1.1 million at September 30, 1999. The increases in
cash, cash equivalents and short-term investments and working capital resulted
from financing activities accomplished during the first quarter of fiscal year
2000, partially offset by operating expenses, which are discussed in "Results of
Operations."

         Cash Used For Operating Activities. Net cash used for operating
activities were $1.0 million during the first quarter of fiscal year 2000,
compared with $2.0 million in the same period in the prior year. The reduction
in the use of cash for operations was primarily due to a lower net loss for the
first quarter of fiscal year 2000, use of stock options as a form of
compensation to employees who had reduced salaries during the period in which we
were short of cash, and the avoidance of any further purchases of raw materials
inventory.

         We still are awaiting a decision by the FDA regarding our new drug
application for docosanol 10% cream. If we do not obtain approval from the FDA
for our new drug application for docosanol 10% cream and do not negotiate a
definitive licensing agreement with SmithKline Beecham for marketing rights to
docosanol 10% cream, then we expect to continue to use cash to support
operations for the foreseeable future.



                                       13
<PAGE>   14

         Cash Used For Investing Activities. Cash for investing activities
totaled $8,000 in the first quarter of fiscal year 2000, representing patent
costs, partially offset by reimbursement from a vendor for returned capital
equipment. Cash used for investing activities totaled $40,000 in the same period
a year ago, representing patent costs of $5,000 and capital expenditures of
$35,000. We maintained a low level of capital expenditures in the first quarter
of fiscal year 2000, while we worked to obtain additional cash resources to
support operations and investing activities.

         Cash Received from Financing Activities.

         First Quarter of Fiscal Year 2000. During the first quarter of fiscal
year 2000, we completed the following financing transactions (See Note 9):

-        $1,740,000 from the exercise of Class D warrants into approximately 1.3
         million shares of Class A common stock, at an average exercise price of
         $1.38 per share;

-        $1,031,000 from the exercise of Class G warrants into 750,000 shares of
         Class A common stock, at an average exercise price of $1.38 per share;

-        $46,000 from the exercise of Class J warrants into 50,000 shares of
         Class A common stock, at an average exercise price of $0.91 per share;
         and

-        $232,000 from the exercise of employee stock options into approximately
         192,000 shares of Class A common stock, at an average exercise price of
         $1.21 per share.

         Financing Transactions After December 31, 1999. On January 31, 2000, we
completed a $6 million private placement financing transaction in exchange for
2,630,137 shares of Class A common stock, for an average of $2.28 per share. We
also issued warrants to acquire up to 263,014 shares of Class A common stock at
an exercise price of $2.44 per share. The shares of Class A common stock are
restricted until registered for resale with the SEC. Under the terms of the
agreement, our stock price must achieve certain performance milestones during
the next twelve months. See Item 6, "Exhibits and Reports on Form 8-K."

RECENT ACCOUNTING PRONOUNCEMENTS

         During June 1999, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 137, "Accounting for Derivative
Instruments and Hedging Activities-Deferral of the Effective Date of FASB
Statement 133." The statement defers the effective date of SFAS No. 133 to the
year ending September 30, 2001. Interim reporting for this standard will be
required. We have not yet assessed the effect of this standard on our current
reporting and disclosures.

RISK FACTORS

We are a development stage company with a history of continuing losses and a
limited amount of capital reserves, which created "going concern" uncertainties
for our fiscal year ended September 30, 1999.

         Our auditors indicated that we needed to raise additional capital to
continue as a going concern in their Independent Auditors' Report on our
financial statements for fiscal year 1999. From our inception through December
31, 1999, we have generated only limited revenues and have incurred net losses
totaling approximately $64 million.

         Since the Independent Auditors' Report was issued, we have raised an
additional $6 million in equity capital to support operations for the next year.
However, our business plan for future spending on research and development
depends substantially upon receiving a favorable decision from the FDA regarding
our new drug application for docosanol 10% cream and completion of a licensing
agreement with SmithKline Beecham. If we do not obtain approval from the FDA of
our new drug application for docosanol 10% cream and we do not enter into a
license agreement with SmithKline Beecham, then we



                                       14
<PAGE>   15

expect to continue to incur operating losses related to research and development
and marketing activities for the foreseeable future.

Our ability to market and sell docosanol 10% cream is uncertain because we have
not reached a final agreement with SmithKline Beecham or any other
pharmaceutical company to market and sell the product in the OTC market.

         We do not have and do not expect to have in the foreseeable future the
resources to manufacture or market directly on a large commercial scale
docosanol 10% cream or any other proposed products that we may develop. We have
entered into collaborative arrangements with manufacturing and distribution
companies in our efforts to commercialize docosanol 10% cream. These
collaborative arrangements likely will cause higher costs or the sharing of
profits with third parties. A potential marketing partner may choose not to use
any of our negotiated agreements. Due to the uncertain nature of the market's
acceptance of docosanol 10% cream as a topical treatment for oral-facial herpes,
we cannot assure you that any license fees and royalties from licensing
docosanol 10% cream will attain a level of revenue sufficient to sustain our
operations.

         The timing of the product launch for docosanol 10% cream could be
delayed if our discussions and negotiations with SmithKline Beecham are delayed
or extended. For example, decisions involving the licensing of a pharmaceutical
product likely will involve a substantial amount of due diligence on the part of
both us and SmithKline Beecham. In addition, our ability to negotiate terms of
the amount of advertising and promotion expense by SmithKline Beecham may be
limited. We cannot provide any assurance that, if a license agreement is
negotiated, we and SmithKline Beecham will develop effective advertising or that
consumers will select our product.

         We have entered into several licensing agreements to cover the clinical
development, manufacturing and marketing of docosanol 10% cream in foreign
markets. We might not finalize any licensing or distributorship arrangements for
territories not covered by existing agreements on favorable terms, if at all. We
ultimately may establish our own manufacturing and/or marketing capabilities, at
least for specific proposed products, which likely would require substantial
additional funds and personnel.

Our amended new drug application for docosanol 10% cream may not receive FDA
approval.

         We cannot assure you that the FDA will approve docosanol 10% cream as
an OTC product or that the FDA will approve our proposed OTC labeling. Failure
to receive FDA marketing approval could affect materially and adversely our
business operations and financial condition.

         On October 29, 1999, the Center for Drug Evaluation and Research
informed us that the clinical data on the effectiveness of docosanol 10% cream
in treating recurrent oral-facial herpes would be sufficient for approval as an
OTC product, pending an acceptable audit of the data in one of the clinical
studies presented in our new drug application. The FDA asked that we submit
proposed product labeling for an OTC product, which we have completed. We are
currently awaiting FDA assessment of the site audit and evaluation of our
proposed product labeling.

Neither we nor our licensees may successfully sell docosanol 10% cream as an OTC
product.

         If we and/or our licensees pursue commercialization of docosanol 10%
cream as an OTC product for cold sores/fever blisters, then we will face the
following risks in our efforts to market this product:

-        potential delays in achieving timely compliance with FDA regulations
         for marketing an OTC product;

-        development in a timely manner of a professional marketing staff and
         sales communications program to launch the product;



                                       15
<PAGE>   16

-        difficulty in building product awareness of a new OTC product among
         customers or retail store decision makers;

-        lack of consumer perception that docosanol 10% cream is superior to
         existing and potentially new OTC products for oral herpes; and

-        lack of widespread acceptance of docosanol 10% cream in the OTC
         consumer market.

Docosanol 10% cream, if ultimately marketed, will face intense competition from
a number of existing and well-established products.

         If successfully launched by us or a marketing partner, then docosanol
10% cream will compete with several prescription products for oral-facial herpes
currently on the market in the U.S., as well as other products or potential
products that are or may be under development or undergoing the FDA regulatory
approval process. Most of our competitors, including Glaxo-Wellcome Inc., have
greater financial resources, research and development facilities and
manufacturing and marketing experience than we do. Docosanol 10% cream may not
achieve commercial success in this intense competitive environment, which would
severely impact our revenues.

Foreign sales of docosanol 10% cream and other potential products are subject to
various foreign trade risks.

         We are exposed to various foreign trade risks relating to the continued
development of docosanol 10% cream by foreign licensees. We also may arrange for
contracts in the future for the manufacture, marketing and distribution of
docosanol 10% cream overseas by foreign licensees, which will be substantially
out of our control. Specific risks that could impact significantly our ability
to deliver products abroad include:

-        changes in the regulatory and competitive environments in foreign
         countries;

-        changes in a specific country's or region's political or economic
         conditions;

-        difficulty in finding foreign partners with sufficient capital to
         effectively launch the product;

-        shipping delays;

-        difficulties in managing operations across disparate geographic areas;

-        fluctuations in foreign currency exchange rates;

-        difficulties associated with enforcing agreements through foreign legal
         systems; and

-        trade protection measures such as customs duties and export quotas.

Our failure to comply with government regulations regarding the development,
production, testing, manufacturing and marketing of docosanol 10% cream and our
other products may affect adversely our operations.

         Governmental authorities in the U.S., including the FDA, and other
countries regulate significantly the development, production, testing,
manufacturing and marketing of pharmaceutical products. The clinical testing and
regulatory approval process can take a number of years and require the
expenditure of substantial resources. Although we have completed the development
of docosanol 10% cream and are waiting for the FDA's approval, we may not obtain
regulatory approval for it or any of our other proposed products.

         Failure to obtain, or delays in obtaining, these approvals will affect
adversely our business operations, including our ability to commence marketing
of any proposed products. We expect to use a significant portion of our
financial resources for research and development and the clinical trials
necessary to obtain these approvals for our proposed products. We will continue
to incur costs of development without any assurance that we will ever obtain
regulatory approvals. In addition, we cannot predict the extent to which adverse
governmental regulation might arise from future U.S. or foreign



                                       16
<PAGE>   17

legislative or administrative action. Moreover, we cannot predict with accuracy
the effect of unspecified, but possible, future changes in the regulatory
approval process and in the domestic health care system for which we develop our
products. Future changes could affect adversely the time frame required for
regulatory review, our financial resources, and the sale prices of our proposed
products, if approved for sale.

Unsuccessful research and development programs for proposed new products could
affect negatively our business.

         We face substantial risks of failing to complete the development of our
early-stage research and development programs in allergy and asthma and other
areas. The effectiveness of our preclinical allergy and asthma research
performed in vitro or in animal models may not be relevant to the development
of, or indicate the efficacy of, a proposed product for human use. Unsuccessful
clinical trial results for our proposed products could affect materially and
adversely our business operations and financial condition. The development
process for medical products is lengthy and capital intensive. Our drug
development programs are exposed to all of the risks inherent in product
development based on innovative technologies, including unanticipated
development problems and the possible lack of funding that could result in the
abandonment or substantial change in the development of a specific product.

Difficulties in acquiring in-licensed technologies that we believe are necessary
to fill our product development pipeline may negatively affect our stock price
and restrict our growth.

         We will face intense competition for these in-licensed products and
technologies. In addition, we might not locate suitable products and
technologies to fit our strengths or obtain them on acceptable terms, or have
the financial resources to develop products from the in-licensed technology. Our
inability to add these technologies and products to our product development
pipeline will hinder our growth and may affect negatively our business.

         Our business strategy is to in-license products and/or technologies at
various stages in the drug development pipeline. To achieve this objective, we
must have the financial resources to acquire and/or in-license new products and
technologies and develop and market the products, once approved. For example, we
signed a letter of intent with IriSys Research and Development, LLC in February
1999 to license world-wide rights to a product intended for use in a condition
associated with neurodegenerative diseases and pain. However, due to limited
financial resources in fiscal year 1999, we deferred negotiations of a final
agreement with IriSys to in-license the product. We can provide no assurance
that we will in-license this or any other product or technology.

Our failure to retain key management and scientific personnel could affect
negatively our business.

         Our success depends on the performance of a small core staff of key
management and scientific employees. Given our early stage of development, we
depend substantially on our ability to hire, train, retain and motivate high
quality personnel, especially our scientists and management team. If we were to
lose one or more of our key scientists, then we would lose the history and
knowledge that they have which could substantially delay one or more of our
development programs until adequate replacement personnel could be hired and
trained.

         Our future success also depends on our continuing ability to identify,
hire, train and retain highly qualified, technical, sales, marketing and
customer service personnel. The employment and employee retention agreements
with several of our key employees are limited in scope and provide no real
assurance that any of these people will continue their employment with our
company. We do not have "key person" life insurance policies. The industry in
which we compete has a high level of employee mobility and aggressive recruiting
of skilled personnel, which creates intense competition for qualified personnel,
particularly in product research, development, sales and marketing.



                                       17
<PAGE>   18

Our patents may be challenged and our pending patents may be denied, which would
seriously jeopardize our ability to compete in the intended markets for our
proposed products.

         We rely substantially on the protection of our intellectual property,
with 19 worldwide docosanol patents and 24 additional docosanol-related patent
applications pending. We also have ten patents issued or pending on other
products and technologies. Because of the competitive nature of the
bio-pharmaceutical industry, we cannot assure you that:

-        the claims in the pending patent applications will be allowed or that
         we will even be issued patents;

-        present and future 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 which may not be available to us;

-        any 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.

Our inability to obtain or maintain patent protections for our products in
foreign markets may affect negatively our financial condition.

         The process for the approval of patent applications in foreign
countries may differ significantly from the process in the U.S., which may delay
our plans to market and sell docosanol 10% cream in the international market
place. Approval in one country does not necessarily indicate that approval can
be obtained in other countries. The patent authorities in each country
administer that country's laws and regulations relating to patents independently
of the laws and regulations of any other country and we must seek and obtain the
patents separately. Our inability to obtain or maintain patent protections for
docosanol 10% cream in foreign markets would hamper severely our ability to
generate international sales from our first proposed product.

If we do not protect our technical innovations, then our business may be
negatively affected.

         We rely substantially on confidentiality agreements to protect our
innovations. We cannot assure you that secrecy obligations will be honored, or
that others will not develop independently similar or superior technology. In
addition, if our consultants, key employees or other third parties apply
technological information independently developed by them or by others to our
projects, then disputes may arise as to the proprietary rights to this
information in which we may not receive a favorable resolution.

Developing new pharmaceutical products for human use involves product liability
risks, for which we currently have limited insurance coverage.

         The testing, marketing and sale of pharmaceutical products involve the
risk of product liability claims by consumers and other third parties. We have
maintained product liability insurance coverage for our clinical trials in the
amount of $2 million per incident and in the aggregate. However, product
liability claims can be high in the pharmaceutical industry and our insurance
may not cover sufficiently all possible liabilities. If a suit against our
business or proposed products is successful, then the lack or insufficiency of
insurance coverage could affect materially and adversely our business and
financial condition. Furthermore, various distributors of pharmaceutical
products require minimum product liability insurance coverage before their
purchase or acceptance of products for distribution. Failure to satisfy these
insurance requirements could impede our ability to achieve broad distribution of
our proposed products.



                                       18
<PAGE>   19

Our Class A common stock was delisted from the Nasdaq National Market System and
now trades on the OTC Bulletin Board.

         Because our Class A common stock currently trades on the OTC Bulletin
Board, shareholders are exposed to various risks, including:

-        the liquidity of our Class A common stock is significantly lower as an
         OTC Bulletin Board traded security;

-        the OTC Bulletin Board does not provide the same level of service or
         information to our shareholders; and

-        various brokers may be restricted in making recommendations to their
         clients about our Class A common stock.

         We can provide no assurance as to how quickly we can regain compliance
with the Nasdaq listing requirements, if ever.

We may issue additional shares of our Class A common stock that may dilute the
value of our common stock to current shareholders and may affect adversely the
market price of our common stock.

         If we raise additional capital by issuing equity securities at a price
or a value per share less than the then current price per share of Class A
common stock, then the value of the shares of Class A common stock then
outstanding will be diluted or reduced. For example, we potentially may issue
and register up to 8,137,388 shares of our Class A common stock under a
two-year, $13 million equity line agreement with Promethean Investment Group,
L.L.C. that could result in dilution in your ownership position in the company.
Depending on the price per share of our Class A common stock during the next two
years, we may need to register additional shares for resale to access the full
amount of financing available.

         In addition, there will be a dilutive effect on the shares of our Class
A common stock from the conversion or exercise of other outstanding securities.
As of February 9, 2000, the following securities exercisable or convertible into
shares of Class A common stock were outstanding:

-        stock options to purchase an aggregate of 7,387,553 shares of Class A
         common stock (at exercise prices ranging from $0.30 to $6.44 per share)
         and 28,000 shares of Class B common stock (at an exercise price of
         $0.50 per share);

-        Class G stock purchase warrants exercisable into 3,635,783 shares of
         Class A common stock (at an exercise price of $1.375 per share);

-        Class H stock purchase warrants exercisable into 100,000 shares of
         Class A common stock (at an exercise price of $2.40 per share);

-        The remaining portion of the Class I stock purchase warrant exercisable
         into 368,000 shares of Class A common stock (at an exercise price of
         $0.78125 per share);

-        Class J stock purchase warrants exercisable into 50,000 shares of Class
         A common stock (at exercise price of $0.9144 per share);

-        Class K stock purchase warrant exercisable into 375,000 shares of Class
         A common stock (at an exercise price of $1.125 per share);

-        Class L stock purchase warrant exercisable into 55,000 shares of Class
         A common stock at an exercise price of $1.1875 per share;

-        Class M stock purchase warrants exercisable into 467,288 shares of
         Class A common stock at an exercise price of $1.284 per share;

-        Class N stock purchase warrants exercisable into 263,014 shares of
         Class A common stock at an exercise price of $2.44 per share; and

-        440,000 shares of Class B common stock (each convertible into one share
         of Class A common stock).



                                       19
<PAGE>   20

Sales in the public market of shares of Class A common stock that underlie stock
options and warrants may affect adversely the prevailing market prices for
shares of Class A common stock. Negative price movements in the shares of Class
A common stock likely would have adverse effects on our ability to obtain
additional equity capital on favorable terms, if at all.


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         The Company's market risk exposures are related to its cash and cash
equivalents. We invest our excess cash in highly liquid short-term investments
with maturities of less than one-year, which we do not believe is a significant
market risk.

                            PART II OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         David H. Katz Litigation - On April 30, 1998, Dr. David H. Katz filed a
complaint in the San Diego Superior Court, making numerous claims related to the
termination of his employment as our president. Mrs. Lee Katz, Dr. Katz' wife,
later joined in the lawsuit and raised claims related to her stock options. On
October 30, 1998, we filed a cross-complaint against Dr. Katz and Mrs. Katz for
Dr. Katz' breach of his fiduciary duties as a director and officer of our
company, and the assignment by Dr. Katz and Mrs. Katz to our company of any
interest that they may possess in a pending patent application pertaining to our
proprietary IgE down regulation technology. The following claims are still
pending before the court:

-        Dr. Katz' request for the court to decide the voting rights for his
         shares of our Class B common stock;

-        Dr. Katz' claim that his termination as our president was not "for
         cause";

-        Dr. Katz' request for an accounting for allegedly deferred income and
         money allegedly advanced to our company; and

-        Our claim for specific performance of Dr. and Mrs. Katz' employment
         contractual obligations to assign any interest in the pending IgE
         technology patent application to us.

         The jury in this litigation recently found in our favor on our claim
that Dr. Katz breached his fiduciary duty to us, and awarded us damages in the
amount of $9.0 million. The jury also returned a verdict against us on Dr. Katz'
defamation claim and awarded Dr. Katz' damages in the amount of $6.7 million.
The other original claims were either voluntarily dismissed by Dr. Katz, decided
in our favor by the court, or settled. However, the court has not set a date for
further proceedings to decide the remaining claims, and no judgment will be
entered in the overall case until trial is concluded on these claims. At that
point, we anticipate that both sides of the litigation will file post-trial
motions. We have not recorded any asset or liability associated with this case,
as the ultimate outcome is still unknown.

         Other Litigation - On January 29, 1999, two former employees filed a
lawsuit in San Diego Superior Court, making several claims related to our
termination of their employment and seeking monetary damages. On November 12,
1999 we reached a settlement before a settlement judge, which included a
commitment to issue an aggregate of 160,000 shares of Class A common stock to
these former employees. On January 28, 2000, we executed a written settlement
agreement and mutual general release with the former employees to settle all
outstanding disputes between the parties; the lawsuit was dismissed on January
28, 2000.

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

         None.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)      Current Reports on Form 8-K

        On October 4, 1999, we filed a Current Report on Form 8-K, reporting
        that we had received an action letter from the FDA on September 24,
        1999, which confirmed an earlier request by the



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<PAGE>   21

         FDA for additional clinical data to support of our new drug application
         for docosanol 10% cream. We also reported that The Nasdaq Stock Market
         had delisted our Class A common stock from trading on the Nasdaq
         National market effective September 17, 1999. Further, we reported that
         on Monday, September 20, 1999, our Class A common stock began trading
         on the over-the-counter Bulletin Board under the symbol AVNR.OB.

         On December 3, 1999, we filed a Current Report on Form 8-K, reporting
         that we had entered into a loan agreement for $1.5 million in financing
         from two international financial lenders.

         On February 4, 2000, we filed a Current Report on Form 8-K, reporting
         that we had completed a $6 million private placement financing with
         three accredited investors.


(b)      Exhibits

4.1     --       Loan Agreement, dated as of November 23, 1999, with AMRO
                 International, S.A. and Endeavour Capital Fund, S.A. (1)

4.2     --       Form of 11% Convertible Debenture (1)

4.3     --       Form of Stock Purchase Warrant (1)

4.4     --       Registration Rights Agreement, dated as of November 23, 1999,
                 with AMRO International, S.A and Endeavour Capital Fund, S.A.
                 (1)

4.5     --       Amendment No. 1 to Rights Agreement, dated November 30, 1999,
                 with American Stock Transfer & Trust Company (1)

27.1    --       Financial Data Schedule


--------------------

(1)      Incorporated by reference to the similarly described exhibit included
         with the Registrant's Form 8-K, filed December 3, 1999.






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<PAGE>   22

                                   SIGNATURES


         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 date indicated.




<TABLE>
<CAPTION>
Signature                                     Title                                 Date
---------                                     -----                                 ----
<S>                                   <C>                                          <C>
/s/ Gerald J. Yakatan, Ph.D.           President and Chief                          February 14, 2000
-----------------------------          Executive Officer
Gerald J. Yakatan, Ph.D.              (Principal Executive Officer)


/s/ Gregory P. Hanson                  Vice President, Finance and Chief            February 14, 2000
-----------------------------          Financial Officer
Gregory P. Hanson                      (Principal Financial and
                                       Accounting Officer)
</TABLE>





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