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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549


FORM 10-Q

(Mark One)



|[X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934.
|--- | ---------------------------------------------------------------------------------------

For the quarterly period ended March 31, 2002

OR



|[   ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934.
|----- | ----------------------------------------------------------------------------------------

For the transition period from ________ to __________.

Commission File No. 0-18734

AVANIR PHARMACEUTICALS

(Exact name of registrant as specified in its charter)


|                                                                                                      |  |                                                
|----------------------------------------------------------------------------------------------------- |  | -----------------------------------------------
|California
(State or other jurisdiction of
incorporation or organization)                             |  | 33-0314804
(I.R.S. Employer
Identification No.)
|                                                                                                     
|11388 Sorrento Valley Road, Suite 200, San Diego, California
(Address of principal executive offices) |  | 92121
(Zip Code)                               

(858) 622-5200
(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
May 1, 2002:

|                                   |  |  |            | 
|---------------------------------- |  |  | ---------- | 
|Class A Common stock, no par value |  |  | 58,258,033 | 
|Class B Common stock, no par value |  |  | 18,500     | 



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TABLE OF CONTENTS



|                          |                                                                                               |                                                   |  |  |  |  |  | 
|------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------------- |  |  |  |  |  | 
|                          |                                                                                               | CONSOLIDATED BALANCE SHEETS (UNAUDITED)          
|                          |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
|                          |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
|                          |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|                          | Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                          | Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|PART II OTHER INFORMATION
|                          | Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                          | Item 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES               



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AVANIR PHARMACEUTICALS

FORM 10-QFor the Quarter Ended March 31, 2002

INDEX

|        |  |                                                                                       |  |     
|------- |  | ------------------------------------------------------------------------------------- |  | ----
|        |  |                                                                                       |  | Page
|       
|PART I  |  | FINANCIAL INFORMATION                                                                 |  |     
|       
|Item 1. |  | Financial Statements                                                                  |  |     
|       
|        |  | Consolidated Balance Sheets                                                           |  | 3   
|       
|        |  | Consolidated Statements of Operations                                                 |  | 4   
|       
|        |  | Consolidated Statements of Cash Flows                                                 |  | 5   
|       
|        |  | Notes to Consolidated 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                            |  | 28  
|       
|PART II |  | OTHER INFORMATION                                                                     |  |     
|       
|Item 4. |  | Submission of Matters to a Vote of Security Holders                                   |  | 29  
|       
|Item 6. |  | Exhibits and Reports on Form 8-K                                                      |  | 29  

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AVANIR PHARMACEUTICALS
CONSOLIDATED BALANCE SHEETS (UNAUDITED)

|                                       |                                                                                  |                                                                                                                              |                           |             |            |            |                |             |            |            | 
|-------------------------------------- | -------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------- | ------------------------- | ----------- | ---------- | ---------- | -------------- | ----------- | ---------- | ---------- | 
|                                       |                                                                                  |                                                                                                                              |                           |             | March 31,  |            | September 30,,
|                                       |                                                                                  |                                                                                                                              |                           |             | 2002       |            | 2001          
|                                       |                                                                                  |                                                                                                                              |                           |             |            |            |               
|ASSETS                                 |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|Current assets:                        |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|                                       | Cash and cash equivalents                                                        |                                                                                                                              | $                         | 8,850,681   |            |            | $              | 16,542,545  |           
|                                       | Short-term investments                                                           |                                                                                                                              |                           | 123,822     |            |            |                | 23,179      |           
|                                       | Receivables                                                                      |                                                                                                                              |                           | 931,634     |            |            |                | 898,676     |           
|                                       | Inventory                                                                        |                                                                                                                              |                           | 222,585     |            |            |                | 222,585     |           
|                                       | Prepaid expenses                                                                 |                                                                                                                              |                           | 635,174     |            |            |                | 581,298     |           
|                                       |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|                                       |                                                                                  |                                                                                                                              | Total current assets      |             |            | 10,763,896 |                |             |            | 18,268,283 | 
|                                       | Investments in securities (Note 6)                                               |                                                                                                                              |                           | 12,004,478  |            |            |                | 4,897,390   |           
|                                       | Restricted investment                                                            |                                                                                                                              |                           | 388,122     |            |            |                | 388,122     |           
|                                       | Property and equipment, net                                                      |                                                                                                                              |                           | 2,375,462   |            |            |                | 2,217,094   |           
|                                       | Intangible assets, net                                                           |                                                                                                                              |                           | 1,401,743   |            |            |                | 1,174,928   |           
|                                       | Other assets                                                                     |                                                                                                                              |                           | 105,162     |            |            |                | 108,136     |           
|                                       |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|                                       |                                                                                  |                                                                                                                              | TOTAL ASSETS              |             | $          | 27,038,863 |                |             | $          | 27,053,953 | 
|                                       |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|LIABILITIES AND SHAREHOLDERS EQUITY   |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|Current liabilities:                   |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|                                       | Accounts payable                                                                 |                                                                                                                              | $                         | 1,200,311   |            |            | $              | 734,701     |           
|                                       | Accrued expenses and other liabilities                                           |                                                                                                                              |                           | 1,200,199   |            |            |                | 858,991     |           
|                                       | Accrued compensation and payroll taxes                                           |                                                                                                                              |                           | 416,393     |            |            |                | 355,526     |           
|                                       | Loan payable                                                                     |                                                                                                                              |                           | 56,420      |            |            |                | 186,122     |           
|                                       | Current portion of capital lease obligations                                     |                                                                                                                              |                           | 118,569     |            |            |                | 105,366     |           
|                                       |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|                                       |                                                                                  |                                                                                                                              | Total current liabilities |             |            | 2,991,892  |                |             |            | 2,240,706  | 
|                                       | Capital lease obligations, net of current portion                                |                                                                                                                              |                           | 381,139     |            |            |                | 351,784     |           
|                                       |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|                                       |                                                                                  |                                                                                                                              | Total liabilities         |             |            | 3,373,031  |                |             |            | 2,592,490  | 
|                                      
|COMMITMENTS                            |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|                                      
|REDEEMABLE CONVERTIBLE PREFERRED STOCK |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|                                       | Series D  no par value, 500 shares authorized;
50 shares issued and outstanding |                                                                                                                              |                           | 512,021     |            |            |                | 502,903     |           
|SHAREHOLDERS EQUITY                   |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|                                       | Preferred stock  no par value, 9,999,500 shares authorized:                     |                                                                                                                              |                           |             |            |            |                |             |           
|                                       |                                                                                  | Series C Junior Participating  1,000,000 shares
authorized, no shares issued or outstanding                                 |                           |             |           |            |                |             |           |           
|                                       | Common stock  no par value:                                                     |                                                                                                                              |                           |             |            |            |                |             |           
|                                       |                                                                                  | Class A  99,288,000 shares authorized; 58,252,033 and
57,976,381 issued and outstanding                                     |                           |             | 86,967,208 |            |                |             | 86,626,355 |           
|                                       |                                                                                  | Class B  712,000 shares authorized; 18,500 and 36,500
shares issued and outstanding (convertible into Class A
Common Stock) |                           |             | 10,895     |            |                |             | 19,895     |           
|                                       | Accumulated deficit                                                              |                                                                                                                              |                           | (63,678,273 | )          |            |                | (62,735,080 | )         
|                                       | Accumulated other comprehensive income (loss)                                    |                                                                                                                              |                           | (146,019    | )          |            |                | 47,390      |           
|                                       |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|                                       |                                                                                  | Total shareholders equity                                                                                                   |                           |             | 23,153,811 |            |                |             | 23,958,560 |           
|                                       |                                                                                  |                                                                                                                              |                           |             |            |            |                |            
|                                       |                                                                                  | TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                   |                           | $           | 27,038,863 |            |                | $           | 27,053,953 |           
|                                       |                                                                                  |                                                                                                                              |                           |             |            |            |                |            

See notes to consolidated financial statements.

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AVANIR PHARMACEUTICALS
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |           |            | 
|----------------------------------------------------------------------- | ------------------------ | ------- | ---------- | ---------------------------- | ---------- | -------------------------- | ---------- | --------- | ---------- | ---- | ---------- | --------- | ---------- | - | --------- | --------- | ---------- | 
|                                                                        |                          |         |            | Three months ended March 31, |            | Six months ended March 31,
|                                                                        |                          |         |            |                              |            |                           
|                                                                        |                          |         |            | 2002                         |            | 2001                       |            | 2002      |            | 2001
|                                                                        |                          |         |            |                              |            |                            |            |           |            |     
|REVENUES:                                                               |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|Contract and license revenues                                           |                          | $       | 17,500     |                              |            | $                          | 2,350      |           |            | $    | 5,084,167  |           |            | $ | 5,012,350 |          
|Royalty revenues                                                        |                          |         | 719,752    |                              |            |                            | 1,253,051  |           |            |      | 1,783,300  |           |            |   | 1,253,051 |          
|Grant revenue                                                           |                          |         | 1,126      |                              |            |                            | 16,803     |           |            |      | 1,126      |           |            |   | 72,535    |          
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|                                                                        | Total revenues           |         |            | 738,378                      |            |                            |            | 1,272,204 |            |      |            | 6,868,593 |            |   |           | 6,337,936 |           
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|EXPENSES:                                                               |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|Product launch expenses                                                 |                          |         |           |                              |            |                            | 492,229    |           |            |      |           |           |            |   | 492,229   |          
|Research and development                                                |                          |         | 3,164,908  |                              |            |                            | 2,462,965  |           |            |      | 5,511,767  |           |            |   | 3,771,090 |          
|General and administrative                                              |                          |         | 1,078,971  |                              |            |                            | 1,048,916  |           |            |      | 2,033,039  |           |            |   | 1,821,611 |          
|Sales and marketing                                                     |                          |         | 360,765    |                              |            |                            | 291,975    |           |            |      | 680,797    |           |            |   | 506,294   |          
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|                                                                        | Total operating expenses |         |            | 4,604,644                    |            |                            |            | 4,296,085 |            |      |            | 8,225,603 |            |   |           | 6,591,224 |           
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|LOSS FROM OPERATIONS                                                    |                          | $       | (3,866,266 | )                            |            | $                          | (3,023,881 | )         |            | $    | (1,357,010 | )         |            | $ | (235,288  | )        
|Interest income                                                         |                          |         | 180,911    |                              |            |                            | 340,129    |           |            |      | 368,826    |           |            |   | 673,899   |          
|Other income                                                            |                          |         | 4,008      |                              |            |                            |           |           |            |      | 86,948     |           |            |   | 1,600     |          
|Interest expense                                                        |                          |         | (18,241    | )                            |            |                            | (1,579     | )         |            |      | (32,843    | )         |            |   | (4,438    | )        
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|NET INCOME (LOSS)                                                       |                          | $       | (3,699,588 | )                            |            | $                          | (2,685,331 | )         |            | $    | (934,079   | )         |            | $ | 417,773   |          
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|NET INCOME (LOSS)
ATTRIBUTABLE TO COMMON
SHAREHOLDERS:                  |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|Net income (loss)                                                       |                          | $       | (3,699,588 | )                            |            | $                          | (2,685,331 | )         |            | $    | (934,079   | )         |            | $ | 417,773   |          
|Dividends on redeemable
convertible preferred stock                     |                          |         | (6,250     | )                            |            |                            | (6,164     | )         |            |      | (12,500    | )         |            |   | (12,465   | )        
|Accretion of discount
related to redeemable
convertible preferred stock |                          |         | (4,509     | )                            |            |                            | (4,459     | )         |            |      | (9,118     | )         |            |   | (9,118    | )        
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|NET INCOME (LOSS)
ATTRIBUTABLE TO COMMON
SHAREHOLDERS                   |                          | $       | (3,710,347 | )                            |            | $                          | (2,695,954 | )         |            | $    | (955,697   | )         |            | $ | 396,190   |          
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|NET INCOME (LOSS) PER SHARE:                                            |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|                                                                        |                          | BASIC   |            | $                            | (0.06      | )                          |            | $         | (0.05      | )    |            | $         | (0.02      | ) |           | $         | 0.01       | 
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|                                                                        |                          | DILUTED |            | $                            | (0.06      | )                          |            | $         | (0.05      | )    |            | $         | (0.02      | ) |           | $         | 0.01       | 
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING:                   |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|                                                                        |                          | BASIC   |            |                              | 58,240,466 |                            |            |           | 57,346,992 |      |            |           | 58,133,775 |   |           |           | 57,281,146 | 
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          
|                                                                        |                          | DILUTED |            |                              | 58,240,466 |                            |            |           | 57,346,992 |      |            |           | 58,133,775 |   |           |           | 61,262,875 | 
|                                                                        |                          |         |            |                              |            |                            |            |           |            |      |            |           |            |   |           |          

See notes to the financial statements.

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AVANIR PHARMACEUTICALS
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

|                                                                         |                                                                                              |                                        |                                                       |            |                            |            |            |           |            |           |  
|------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------- | -------------------------------------- | ----------------------------------------------------- | ---------- | -------------------------- | ---------- | ---------- | --------- | ---------- | --------- | -
|                                                                         |                                                                                              |                                        |                                                       |            | Six Months Ended March 31,
|                                                                         |                                                                                              |                                        |                                                       |            |                           
|                                                                         |                                                                                              |                                        |                                                       |            | 2002                       |            | 2001      
|                                                                         |                                                                                              |                                        |                                                       |            |                            |            |           
|OPERATING ACTIVITIES:                                                    |                                                                                              |                                        |                                                       |            |                            |            |            |          
|                                                                         | Net income (loss)                                                                            |                                        | $                                                     | (934,079   | )                          |            | $          | 417,773   |           
|                                                                         | Adjustments to reconcile net income to net cash provided
by (used for) operating activities: |                                        |                                                       |            |                            |            |            |           |           
|                                                                         | Depreciation and amortization                                                                |                                        |                                                       | 275,654    |                            |            |            | 276,409   |           
|                                                                         | Compensation paid with common stock and stock options                                        |                                        |                                                       | 89,298     |                            |            |            | 31,828    |           
|                                                                         | Loss on sale or disposal of assets                                                           |                                        |                                                       | 485        |                            |            |            | 16,482    |           
|                                                                         | Changes in assets and liabilities:                                                           |                                        |                                                       |            |                            |            |            |           |           
|                                                                         |                                                                                              | Accounts receivable                    |                                                       |            | (32,958                    | )          |            |           | (1,310,486 | )        
|                                                                         |                                                                                              | Inventory                              |                                                       |            |                           |            |            |           | (212,781   | )        
|                                                                         |                                                                                              | Prepaid and other                      |                                                       |            | (50,902                    | )          |            |           | 135,945    |          
|                                                                         |                                                                                              | Deferred costs                         |                                                       |            |                           |            |            |           | (256,175   | )        
|                                                                         |                                                                                              | Accounts payable                       |                                                       |            | 465,610                    |            |            |           | (105,536   | )        
|                                                                         |                                                                                              | Accrued expenses and other liabilities |                                                       |            | 341,209                    |            |            |           | 700,959    |          
|                                                                         |                                                                                              | Accrued compensation and payroll taxes |                                                       |            | 60,867                     |            |            |           | 78,671     |          
|                                                                         |                                                                                              |                                        |                                                       |            |                            |            |            |          
|                                                                         |                                                                                              |                                        | Net cash provided by (used for) operating activities: |            |                            | 215,184    |            |           |            | (226,911  | )
|INVESTING ACTIVITIES:                                                    |                                                                                              |                                        |                                                       |            |                            |            |            |          
|                                                                         | Investments in securities                                                                    |                                        |                                                       | (8,601,136 | )                          |            |            |          |           
|                                                                         | Proceeds from sales and maturities of investments                                            |                                        |                                                       | 1,200,000  |                            |            |            | 389,102   |           
|                                                                         | Patent costs                                                                                 |                                        |                                                       | (250,570   | )                          |            |            | (355,214  | )         
|                                                                         | Capital expenditures                                                                         |                                        |                                                       | (300,111   | )                          |            |            | (793,167  | )         
|                                                                         |                                                                                              |                                        |                                                       |            |                            |            |            |          
|                                                                         |                                                                                              |                                        | Net cash used for investing activities                |            |                            | (7,951,817 | )          |           |            | (759,279  | )
|FINANCING ACTIVITIES:                                                    |                                                                                              |                                        |                                                       |            |                            |            |            |          
|                                                                         | Proceeds from issuance of common stock, net                                                  |                                        |                                                       | 255,054    |                            |            |            | 1,123,184 |           
|                                                                         | Dividends paid on preferred stock                                                            |                                        |                                                       | (12,500    | )                          |            |            |          |           
|                                                                         | Repayment of notes payable                                                                   |                                        |                                                       | (197,785   | )                          |            |            | (121,410  | )         
|                                                                         |                                                                                              |                                        |                                                       |            |                            |            |            |          
|                                                                         |                                                                                              |                                        | Net cash provided by financing activities             |            |                            | 44,769     |            |           |            | 1,001,774 |  
|                                                                         |                                                                                              |                                        |                                                       |            |                            |            |            |          
|Net increase (decrease) in cash and cash equivalents                     |                                                                                              |                                        | (7,691,864                                            | )          |                            |            | 15,584     |          
|Cash and cash equivalents at beginning of period                         |                                                                                              |                                        | 16,542,545                                            |            |                            |            | 19,699,768 |          
|                                                                         |                                                                                              |                                        |                                                       |            |                            |            |            |          
|Cash and cash equivalents at end of period                               |                                                                                              | $                                      | 8,850,681                                             |            |                            | $          | 19,715,352 |          
|                                                                         |                                                                                              |                                        |                                                       |            |                            |            |            |          
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:                       |                                                                                              |                                        |                                                       |            |                            |            |            |          
|Interest paid                                                            |                                                                                              | $                                      | 32,843                                                |            |                            | $          | 4,438      |          
|                                                                         |                                                                                              |                                        |                                                       |            |                            |            |            |          
|SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND
FINANCING ACTIVITIES: |                                                                                              |                                        |                                                       |            |                            |            |            |          
|Acquisition of equipment with capital leases                             |                                                                                              | $                                      | 110,641                                               |            |                            |            |           |          
|Patent purchased with common stock                                       |                                                                                              |                                        |                                                      |            |                            | $          | 111,158    |          

See notes to the financial statements.

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AVANIR PHARMACEUTICALS

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

We (also referred to as AVANIR or the Company) have prepared the unaudited
consolidated financial statements in this quarterly report in accordance with
the instructions to Form 10-Q adopted under the Securities Exchange Act of
1934. These statements should be read with our audited consolidated financial
statements and the accompanying notes included in our Annual Report
on Form 10-K for the fiscal year ended September 30, 2001. In our opinion, we have
presented the consolidated financial statements, including all adjustments
consisting only of normal recurring accruals that are necessary to summarize
fairly our financial position as of March 31, 2002, and the results of
operations for the three and six-month periods ended March 31,
2002, and March 31, 2001. The results of operations for the three and six-month periods ended
March 31, 2002, may not be indicative of the results that may be expected for
the fiscal year ending September 30, 2002.

2. RECLASSIFICATIONS

Certain amounts from the prior period have been reclassified to conform to the
current period presentation.

3. ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at 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. BALANCE SHEET DETAIL

The following tables provide details of selected balance sheet items.

|                             |                                                |                             |           |            |           |               |           |           |           | 
|---------------------------- | ---------------------------------------------- | --------------------------- | --------- | ---------- | --------- | ------------- | --------- | --------- | --------- | 
|                             |                                                |                             |           | March 31,  |           | September 30,
|                             |                                                |                             |           | 2002       |           | 2001         
|                             |                                                |                             |           |            |           |              
|Property and equipment, net: |                                                |                             |           |            |           |               |           |          
|                             | Leasehold improvements                         |                             | $         | 814,346    |           |               | $         | 753,824   |          
|                             | Computer equipment and related software        |                             |           | 363,506    |           |               |           | 296,862   |          
|                             | Research and development equipment             |                             |           | 2,104,071  |           |               |           | 1,831,645 |          
|                             | Office equipment, furniture, and fixtures      |                             |           | 225,286    |           |               |           | 218,796   |          
|                             |                                                |                             |           |            |           |               |           |          
|                             |                                                |                             | 3,507,209 |            |           |               | 3,101,127 |          
|                             | Less accumulated depreciation and amortization |                             |           | (1,131,747 | )         |               |           | (884,033  | )        
|                             |                                                |                             |           |            |           |               |           |          
|                             |                                                | Property and equipment, net |           | $          | 2,375,462 |               |           | $         | 2,217,094 | 
|                             |                                                |                             |           |            |           |               |           |          
|Intangible assets, net:      |                                                |                             |           |            |           |               |           |          
|                             | Intangible costs                               |                             | $         | 1,564,275  |           |               | $         | 1,313,704 |          
|                             | Less accumulated amortization                  |                             |           | (162,532   | )         |               |           | (138,776  | )        
|                             |                                                |                             |           |            |           |               |           |          
|                             |                                                | Intangible assets, net      |           | $          | 1,401,743 |               |           | $         | 1,174,928 | 
|                             |                                                |                             |           |            |           |               |           |          

6



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##### Table of Contents



5. INVENTORY

Inventory is stated at the lower of cost (first-in, first-out) or market.
Inventory consists of the raw material, docosanol, which is the active
ingredient in docosanol 10% cream. Docosanol in its present form as stored by
the Company has a substantial shelf life, a relatively stable value and
long-term use, and carries a low risk of becoming excess inventory or obsolete.
The Company does not own or store any product in its final form, such as
docosanol 10% cream.

6. INVESTMENTS

The following tables summarize the Companys investments in securities:

|                      |                         |                                  |                       |            |            |            |            |            |        |            |   |          |          |   |   |            |            |  |  | 
|--------------------- | ----------------------- | -------------------------------- | --------------------- | ---------- | ---------- | ---------- | ---------- | ---------- | ------ | ---------- | - | -------- | -------- | - | - | ---------- | ---------- |  |  | 
|                      |                         |                                  |                       |            |            |            |            |            |        | Gross      |   | Gross    |          |   |   |           
|                      |                         |                                  |                       |            |            | Amortized  |            | Unrealized |        | Unrealized |   | Fair    
|                      |                         |                                  |                       |            |            | Cost       |            | Gain(2)    |        | Loss(2)    |   | Value   
|                      |                         |                                  |                       |            |            |            |            |            |        |            |   |         
|As of March 31, 2002: |                         |                                  |                       |            |            |            |            |            |        |            |   |          |          |   |   |           
|                      | Certificates of deposit |                                  | $                     | 1,712,156  |            |            |            |           |        |            | $ | (16,450  | )        |   | $ | 1,695,706  |           
|                      | Government securities   |                                  |                       | 10,775,000 |            |            | $          | 7,148      |        |            |   | (136,717 | )        |   |   | 10,645,431 |           
|                      | Commercial paper        |                                  |                       | 200,000    |            |            |            | 5,144      |        |            |   |         |          |   |   | 205,144    |           
|                      |                         |                                  |                       |            |            |            |            |            |        |            |   |          |          |   |   |           
|                      |                         | Total                            |                       | $          | 12,687,156 |            |            | $          | 12,292 |            |   | $        | (153,167 | ) |   | $          | 12,546,281 | 
|                      |                         |                                  |                       |            |            |            |            |            |        |            |   |          |          |   |   |           
|Reported as:          |                         |                                  |                       |            |            |            |            |            |        |            |   |          |          |   |   |           
|                      | Short-term investments: |                                  |                       |            |            |            |            |            |        |            |   |          |          |   |   |            |           
|                      |                         | Classified as held to maturity   |                       | $          | 123,822    |            |            |            |        |            |   |          |          |   |   |            |            | 
|                      | Long-term investments:  |                                  |                       |            |            |            |            |            |        |            |   |          |          |   |   |            |           
|                      |                         | Classified as available for sale |                       | $          | 11,804,478 |            |            |            |        |            |   |          |          |   |   |            |            | 
|                      |                         | Classified as held to maturity   |                       |            | 200,000    |            |            |            |        |            |   |          |          |   |   |            |            | 
|                      |                         | Restricted investment (1)        |                       |            | 388,122    |            |            |            |        |            |   |          |          |   |   |            |            | 
|                      |                         |                                  |                       |            |            |            |            |            |        |            |   |          |          |   |   |           
|                      |                         |                                  | Long-term investments |            | $          | 12,392,600 |            |            |        |            |   |          |          |   |   |            |            |  | 
|                      |                         |                                  |                       |            |            |            |            |            |        |            |   |          |          |   |   |           
|                      |                         |                                  |                       | Total      |            | $          | 12,516,422 |            |        |            |   |          |          |   |   |            |            |  |  | 
|                      |                         |                                  |                       |            |            |            |            |            |        |            |   |          |          |   |   |           

|                          |                        |                         |                                  |                       |           |           |           |            |        |            |        |       |   |  |   |   |           |   |           | 
|------------------------- | ---------------------- | ----------------------- | -------------------------------- | --------------------- | --------- | --------- | --------- | ---------- | ------ | ---------- | ------ | ----- | - |  | - | - | --------- | - | --------- | 
|                          |                        |                         |                                  |                       |           |           |           |            |        | Gross      |        | Gross |   |  |   |  
|                          |                        |                         |                                  |                       |           | Amortized |           | Unrealized |        | Unrealized |        | Fair 
|                          |                        |                         |                                  |                       |           | Cost      |           | Gain(3)    |        | Loss       |        | Value
|                          |                        |                         |                                  |                       |           |           |           |            |        |            |        |      
|As of September 30, 2001: |                        |                         |                                  |                       |           |           |           |            |        |            |        |       |   |  |   |  
|                          |                        | Certificates of deposit |                                  | $                     | 411,301   |           |           |            |       |            |        |       |  |  |   | $ | 411,301   |  
|                          |                        | Government securities   |                                  |                       | 4,650,000 |           |           | $          | 48,952 |            |        |       |  |  |   |   | 4,698,952 |  
|                          |                        | Commercial paper        |                                  |                       | 200,000   |           |           |            | 8,862  |            |        |       |  |  |   |   | 208,862   |  
|                          |                        |                         |                                  |                       |           |           |           |            |        |            |        |       |   |  |   |  
|                          |                        |                         |                                  | Total                 |           | $         | 5,261,301 |            |        | $          | 57,814 |       |   |  |  |   |           | $ | 5,319,115 | 
|                          |                        |                         |                                  |                       |           |           |           |            |        |            |        |       |   |  |   |  
|Reported as:              |                        |                         |                                  |                       |           |           |           |            |        |            |        |       |   |  |   |  
|                          |                        | Short-term investments: |                                  |                       |           |           |           |            |        |            |        |       |   |  |   |   |           |  
|                          |                        |                         | Classified as held to maturity   |                       | $         | 23,179    |           |            |        |            |        |       |   |  |   |   |           |   |          
|                          | Long-term investments: |                         |                                  |                       |           |           |           |            |        |            |        |       |   |  |   |   |          
|                          |                        |                         | Classified as available for sale |                       | $         | 4,497,390 |           |            |        |            |        |       |   |  |   |   |           |   |          
|                          |                        |                         | Classified as held to maturity   |                       |           | 400,000   |           |            |        |            |        |       |   |  |   |   |           |   |          
|                          |                        |                         | Restricted investment (1)        |                       |           | 388,122   |           |            |        |            |        |       |   |  |   |   |           |   |          
|                          |                        |                         |                                  |                       |           |           |           |            |        |            |        |       |   |  |   |  
|                          |                        |                         |                                  | Long-term investments |           | $         | 5,285,512 |            |        |            |        |       |   |  |   |   |           |   |           | 
|                          |                        |                         |                                  |                       |           |           |           |            |        |            |        |       |   |  |   |  
|                          |                        |                         |                                  | Total                 |           | $         | 5,308,691 |            |        |            |        |       |   |  |   |   |           |   |           | 
|                          |                        |                         |                                  |                       |           |           |           |            |        |            |        |       |   |  |   |  



---

|(1) |  | A restricted investment amounting to $388,122 as of March 31, 2002,
and September 30, 2001, represents an amount that we pledged to our
bank as collateral for a letter of credit that our bank issued in
connection with our lease of office and laboratory space.                                 
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | Gross unrealized gains of $7,148 on government securities and gross
unrealized losses of $153,167 on other investments represent an
accumulated net unrealized loss of $146,019, which is reported as
Accumulated other comprehensive loss on the consolidated balance
sheet as of March 31, 2002.

7



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##### Table of Contents



|(3) |  | Includes government securities with maturities in excess of 90 days
and having gross unrealized gains totaling $47,390, which has been
reported as Accumulated other comprehensive income on the
consolidated balance sheet as of September 30, 2001.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

7. COMPUTATION OF NET INCOME (LOSS) PER COMMON SHARE

We computed basic income per share and basic loss per share by dividing the net
income and net loss by the weighted average number of common shares outstanding
during the period (Basic EPS method). We compute diluted earnings (loss) per
common share by dividing the net income and net loss by the weighted-average
number of common and dilutive common equivalent shares outstanding during the
period (Diluted EPS method). Dilutive common equivalent shares consist of
shares issuable upon exercise of stock options and warrants and conversion of
preferred stock. In the accompanying consolidated statements of operations, we
have presented our net income and net loss per share for the three and
six-month periods ended March 31, 2002 and March 31, 2001, using both the Basic
EPS method and the Diluted EPS method.

8. DILUTED WEIGHTED AVERAGE NUMBER OF SHARES

The following table is the reconciliation from the basic to the diluted
earnings (loss) per share computations for net income (loss) for the three
and six-month periods ended March 31, 2002 and March 31, 2001:

|                                                                          |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |           |         |            |         | 
|------------------------------------------------------------------------- | ------------------------------ | ----------------------------------------------------------------------- | ------------------------------------- | ----------------------------------------------------------------------------- | ---------- | ------------------ | ---------- | ---------------- | ---------- | ---------- | ---------- | ---- | -------- | ---------- | ---------- | --------- | ------- | ---------- | ------- | 
|                                                                          |                                |                                                                         |                                       |                                                                               |            | Three Months Ended |            | Six Months Ended
|                                                                          |                                |                                                                         |                                       |                                                                               |            | March 31,          |            | March 31,       
|                                                                          |                                |                                                                         |                                       |                                                                               |            |                    |            |                 
|                                                                          |                                |                                                                         |                                       |                                                                               |            | 2002               |            | 2001             |            | 2002       |            | 2001
|                                                                          |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |     
|Numerator:                                                                |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          
|                                                                          |                                | Net income (loss)                                                       |                                       | $                                                                             | (3,699,588 | )                  |            | $                | (2,685,331 | )          |            | $    | (934,079 | )          |            | $         | 417,773 |           
|Less:                                                                     |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          
|                                                                          |                                | Dividends on redeemable
convertible preferred stock                     |                                       |                                                                               | (6,250     | )                  |            |                  | (6,164     | )          |            |      | (12,500  | )          |            |           | (12,465 | )         
|                                                                          |                                | Accretion of discount
related to redeemable
convertible preferred stock |                                       |                                                                               | (4,509     | )                  |            |                  | (4,459     | )          |            |      | (9,118   | )          |            |           | (9,118  | )         
|                                                                          |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          
|                                                                          |                                |                                                                         |                                       | Income (loss) available
to common shareholders
for basic earnings per
share   |            |                    | (3,710,347 | )                |            |            | (2,695,954 | )    |          |            | (955,697   | )         |         |            | 396,190 | 
|Effect of dilutive securities:                                            |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          
|                                                                          |                                | Convertible preferred stock                                             |                                       |                                                                               |           |                    |            |                  |           |            |            |      |         |            |            |           | (35,926 | )         
|                                                                          |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          
|                                                                          |                                |                                                                         |                                       | Income (loss) available
to common shareholders
for diluted earnings per
share |            | $                  | (3,710,347 | )                |            | $          | (2,695,954 | )    |          | $          | (955,697   | )         |         | $          | 360,264 | 
|                                                                          |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          
|Denominator:                                                              |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          
|Shares for basic earnings per
share  weighted average
shares outstanding |                                |                                                                         | 58,240,466                            |                                                                               |            |                    | 57,346,992 |                  |            |            | 58,133,775 |      |          |            | 57,281,146 |          
|Effect of dilutive securities:                                            |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          
|                                                                          | Stock options(1)               |                                                                         |                                       |                                                                              |            |                    |            |                 |            |            |            |     |          |            |            | 2,759,608 |        
|                                                                          | Warrant
shares(2)              |                                                                         |                                       |                                                                              |            |                    |            |                 |            |            |            |     |          |            |            | 1,042,562 |        
|                                                                          | Convertible
preferred stock(3) |                                                                         |                                       |                                                                              |            |                    |            |                 |            |            |            |     |          |            |            | 179,559   |        
|                                                                          |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          
|                                                                          |                                |                                                                         | Shares for diluted
earnings per share |                                                                               |            | 58,240,466         |            |                  |            | 57,346,992 |            |      |          | 58,133,775 |            |           |         | 61,262,875 |        
|                                                                          |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          
|Basic earnings (loss) per share                                           |                                | $                                                                       | (0.06                                 | )                                                                             |            | $                  | (0.05      | )                |            | $          | (0.02      | )    |          | $          | 0.01       |          
|                                                                          |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          
|Diluted earnings (loss) per
share                                         |                                | $                                                                       | (0.06                                 | )                                                                             |            | $                  | (0.05      | )                |            | $          | (0.02      | )    |          | $          | 0.01       |          
|                                                                          |                                |                                                                         |                                       |                                                                               |            |                    |            |                  |            |            |            |      |          |            |            |          



---

|(1) |  | For the three-month periods ended March 31, 2002 and March 31, 2001,
options to purchase 5,617,342 and 5,198,595 shares of common stock,
respectively, were excluded from the computation of diluted earnings per
share, as the inclusion
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|    |  | of such shares would be antidilutive. For the
six-month periods ended March 31, 2002 and March 31, 2001, options to
purchase 5,617,342 and 4,500 shares of common stock, respectively, were
excluded from the computation of diluted earnings per share, as the
inclusion of such shares would be antidilutive.                                                                                                                                                                                                                
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | For the three-month periods ended March 31, 2002 and March 31, 2001,
warrants to purchase 1,184,550 and 1,372,131 shares of common stock,
respectively, were excluded from the computation of diluted earnings per
share as the inclusion of such shares would be antidilutive. For the
six-month period ended March 31, 2002, warrants to purchase 1,184,550
shares of common stock were excluded from the computation of diluted
earnings per share, as the inclusion of such shares would be antidilutive.                  
|   
|   
|   
|   
|(3) |  | For the three-month periods ended March 31, 2002 and March 31, 2001,
preferred stock convertible into 218,646 and 179,559 shares of common
stock, respectively, were excluded from the computation of diluted
earnings per share as the inclusion of such shares would be antidilutive.
For the six-month period ended March 31, 2002, preferred stock convertible
into 218,646 shares of common stock were excluded from the computation of
diluted earnings per share, as the inclusion of such shares would be
antidilutive.

9. SHAREHOLDERS EQUITY

Series C Junior Participating Preferred Stock

None of the Series C Junior Participating Preferred Stock is outstanding.

Series D Redeemable Convertible Preferred Stock

At March 31, 2002 and September 30, 2001, 50 shares of Series D redeemable
convertible preferred stock (Series D Shares) remained outstanding in
connection with a securities purchase agreement made with certain investors on
March 22, 1999. The Series D holders may convert any or all of the remaining
Series D Shares into shares of Class A common stock at a conversion rate equal
to $10,000 divided by a conversion price equal to the lesser of:



| |  | the Fixed Conversion Price an amount equal to $2.715 per share of Class A common stock; or                                    
|- |  | -------------------------------------------------------------------------------------------------------------------------------
| 
| |  | the Variable Conversion Price an amount equal to 86% of the market price of our Class A common stock, defined as the lower
of:



| |  |  | the average of the five lowest trading prices per share of Class A
common stock on The American Stock Exchange during the 25 trading days
immediately preceding a given date of determination, where trading
price is determined as the average of the high and low trading prices
of our Class A common stock on a particular trading day; or
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the average of the high and low trading price per share of Class A
common stock on The American Stock Exchange on the date of
determination.                                                                                                                                                                                                  

Class A Common Stock

On December 12, 2001, the holder of Class K Warrants exercised its right to
purchase 80,000 shares of Class A common stock at an exercise price of $1.125
per share, for cash in the aggregate amount of $90,000.

Class B Common Stock Conversion

On February 4, 2002, 18,000 shares of Class B common stock converted to 18,000
shares of Class A common stock.

9



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10. RECENT ACCOUNTING PRONOUNCEMENTS

In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements. SAB 101, as amended, summarizes certain of the SECs views in
applying accounting principles generally accepted in the United States of
America to revenue recognition in financial statements, including revenues
earned from collaborations between companies. We adopted SAB 101 in the fourth
quarter of the fiscal year ended September 30, 2001. The adoption of SAB 101
did not have a material impact on the Companys earnings.

In July 2001, the Financial Accounting Standards Board (FASB) approved three
statements, Statement of Financial Accounting Standards No. 141 (SFAS 141),
Business Combinations, SFAS 142, Goodwill and Other Intangible Assets, and
SFAS 143, Accounting for Asset Retirement Obligations.

SFAS 141 supersedes APB Opinion No. 16, Business Combinations, and eliminates
the pooling-of-interests method of accounting for business combinations, thus
requiring all business combinations be accounted for using the purchase method.
In addition, in applying the purchase method, SFAS 141 changes the criteria
for recognizing intangible assets apart from goodwill and states the following
criteria should be considered in determining the recognition of the intangible
assets: (1) the intangible asset arises from contractual or other legal
rights, or (2) the intangible asset is separable or dividable from the acquired
entity and capable of being sold, transferred, licensed, rented, or exchanged.
The requirements of SFAS 141 are effective for all business combinations
completed after June 30, 2001. The adoption of this new standard did not have
a material impact on the Companys financial statements.

SFAS 142 supercedes APB Opinion No. 17, Intangible Assets, and requires
goodwill and other intangible assets that have an indefinite useful life to no
longer be amortized; however, these assets must be reviewed at least annually
for impairment. Application of SFAS 142 is required for the Company on October
1, 2002. We do not believe the adoption of SFAS 142 will have a significant
impact on the Companys financial statements.

In August 2001 the FASB issued SFAS 144 Accounting for the Impairment or
Disposal of Long-Lived Assets. This statement addresses financial accounting
and reporting for the impairment or disposal of long-lived Assets. This
statement supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of, and the accounting and
reporting provisions of APB Opinion No. 30, Reporting the Results of
Operations  Reporting the Effects of a Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,
for the disposal of a segment of a business (as previously defined in that
Opinion). SFAS No. 144 becomes effective for the Company on October 1, 2002.
The effect, if any, of SFAS 144 on the Companys financial statements has not
yet been determined.

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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

This quarterly report on Form 10-Q contains forward-looking statements
concerning future events and performance of our company. You should not rely
excessively on these forward-looking statements, because they are only
predictions based on our current expectations and assumptions. When used in
this report, the words intend, estimate, anticipate, believe, plan
and expect and similar expressions as they relate to AVANIR are included to
identify forward-looking statements. Many factors could cause our actual
results to differ materially from those indicated in these forward-looking
statements. You should review carefully the factors identified in this report
as set forth below and under Additional Factors that Might Affect Future
Results and in our most recent annual report on Form 10-K filed with the
Securities and Exchange Commission. We disclaim any obligation to update or
announce revisions to any forward-looking statements to reflect actual events
or developments.

Overview

AVANIR Pharmaceuticals, based in San Diego and incorporated in California in
1988, is a biopharmaceutical drug discovery and development company. AVANIR is
engaged in research, discovery, development and licensing of innovative drug
products, and through its subsidiary, Xenerex Biosciences (Xenerex), sales of
antibody generation services and antibody product development. AVANIR
currently has the first over-the-counter drug that has been approved by the
United States Food and Drug Administration (FDA) for the treatment of cold
sores.

Marketed in North America by GlaxoSmithKline, Abreva (docosanol 10% cream) was
launched in the United States in late 2000. According to AC Nielson, Abreva is
the largest selling consumer healthcare product in the United States for the
treatment of cold sores. The consumer research group also ranked Abreva among
the ten top selling new consumer healthcare products introduced in the
twelve-month period ended December 2001. Under the license agreement with
GlaxoSmithKline, AVANIR has received $25 million in milestone payments and will
continue to receive royalties on Abreva product sales until at least 2014.

AVANIR has completed other license agreements for docosanol 10% cream in
Canada, South Korea, Israel, Egypt and other countries in the Middle East and
is assisting those companies in their efforts to obtain regulatory approvals
for manufacturing and marketing the drug in those markets.

In May 2002, AVANIR filed for marketing approval of docosanol 10% cream with
the Medical Products Agency (MPA) in Sweden. In seeking regulatory approvals
in the European Union (EU), AVANIR chose to make its first submission to the
Swedish MPA because it is a mutual recognition country held in high regard by
the other EU regulatory agencies. If docosanol 10% cream is approved for
marketing in Sweden by the MPA, we intend to ask the MPA to prepare a mutual
recognition package for consideration by regulatory agencies in other European
countries that we have selected.

AVANIRs drug development pipeline consists of clinical, pre-clinical and drug
discovery programs. Current clinical development programs are centered around
Neurodex (formerly AVP-923), which could potentially provide a novel approach
for the treatment of several central nervous system disorders. The leading
clinical development program is for the treatment of pseudobulbar affect, a
symptom of Lou Gehrigs disease (amyotrophic lateral sclerosis or ALS) for
which no FDA-approved drug is indicated. Enrollment in a Phase II/III clinical
trial for the treatment of pseudobulbar affect in patients with ALS was
completed in April 2002. We expect to complete the trial and report the
results in calendar year 2002. If the trial is successful, we plan to follow
it with a Phase III clinical trial in patients suffering from pseudobulbar
affect and who have multiple sclerosis. If the clinical trials show positive
results, we

11



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plan to file a New Drug Application (NDA) with the FDA in 2004. We
also intend to initiate a Phase II dosing trial for Neurodex in the
treatment of diabetic neuropathic pain later
in 2002. Our preclinical research and drug discovery programs are directed
primarily toward large therapeutic areas, including allergies and asthma,
inflammatory diseases and cholesterol reduction.

Partnering represents an important source of funds to us to pursue development
of all of our potential drugs and technology platforms. We intend to fund our
current preclinical development programs, if successful, at least until we are
able to obtain Investigational New Drug (IND) status and begin clinical trials.
Thereafter, we intend to seek partners for co-development or issue licenses to
develop and market our potential new drugs. Co-development would allow us to
share development costs. Licensing would provide an opportunity to receive
license fees and milestone payments as the product is developed and royalties
on product sales if a product is successfully launched.

We also expect that Xenerex will help establish new research collaborations as
it produces human monoclonal antibodies to selected targets. In January 2002,
Xenerex entered into its third collaborative research agreement for generating
fully human monoclonal antibodies to target antigens provided by research
partners. Xenerex now has contracts to generate antibodies to eight target
antigens provided by its partners. Xenerex is also producing antibodies to
targets identified internally for future research and development by the
Company.

Revenue-generating Contracts

As of May 1, 2002, we had entered into seven contracts that are generating or
could generate important revenues in the future to help fund our research and
development programs. Four of the contracts are in the form of Abreva or
docosanol 10% cream license agreements. Three other contracts are through
Xenerex and are in the form of antibody research service agreements. We expect
that substantially all of our revenues for the next two quarters will be earned
from license fees, milestone payments, raw materials supply, research fees and
royalties under these contracts. GlaxoSmithKline continues to be our most
significant revenue source. A list of our contractual arrangements is set
forth below.

|                                 |  |                                             |  |                   |  |                             
|-------------------------------- |  | ------------------------------------------- |  | ----------------- |  | ----------------------------
|REVENUE-GENERATING CONTRACTS    
|                                
|                                 |  | Type of                                     |  | Date of           |  | Product License             
|Company                          |  | Agreement                                   |  | Agreement         |  | Or Service                  
|                                 |  |                                             |  |                   |  |                             
|GlaxoSmithKline                  |  | License of Abreva
(U.S. and Canada)        |  | March 31, 2000    |  | Cold sore
product license   
|CTS Chemical Industries, LTD     |  | Docosanol license(Israel)                   |  | July 6, 1993      |  | Cold soreproduct license    
|Boryung Pharmaceuticals Co., LTD |  | Docosanol license(South Korea)              |  | March 11, 1994    |  | Cold soreproduct license    
|BioPharm Group                   |  | Docosanol license
(Egypt/Other Middle East) |  | January 11, 2002  |  | Cold soreproduct license    
|Eos Biotechnology, Inc.          |  | Antibody research by Xenerex                |  | December 21, 2001 |  | Antibody generationServices 
|Peregrine Pharmaceuticals        |  | Antibody research by Xenerex                |  | June 7, 2001      |  | Antibody generation
Services
|DNAX Research, Inc.              |  | Antibody research by Xenerex                |  | January 21, 2002  |  | Antibody generationServices 

Research and Development Programs and Products in Clinical Development

We are currently conducting research on a number of potential therapeutic
products and technology platforms that are in various phases of clinical and
pre-clinical development. Pharmaceutical research

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and development (R&D)
programs, by their very nature, require a substantial amount of financial and
human resources and there is no assurance that they will be approved for
marketing by domestic and/or
foreign regulatory agencies. Development of drugs
through all clinical phases for large therapeutic areas would cost
substantially in excess of funds currently available to the Company.
As a result, we do not intend to fund all clinical development
stages ourselves. Assuming we make successful progress in our development
programs, we intend to pursue our development programs using our own funds in
the early clinical stages and then partner or license our technology
when our research has been validated by Phase I or Phase II clinical
data. Later stages of development will require that we
license our technology or partner with other pharmaceutical companies that have
substantially greater financial resources. We caution that many of our
development efforts could experience delays, setbacks and failures, with no
assurance that any of our clinical research will ever reach the stage of a new
drug application (NDA) with the FDA or that the NDA will be approved. The
table below sets forth the status of our proprietary products in clinical
development, our research programs and the estimated cost to
complete the next milestone.

|                                                                                           |  |                                                          |  |                       |  |        |         |           |  |                    |           |                  |  |           |           |      |  |   |           |  |  |   |           |  |  |           |  | 
|------------------------------------------------------------------------------------------ |  | -------------------------------------------------------- |  | --------------------- |  | ------ | ------- | --------- |  | ------------------ | --------- | ---------------- |  | --------- | --------- | ---- |  | - | --------- |  |  | - | --------- |  |  | --------- |  | 
|Research and Development Program Expenses                                                 
|                                                                                          
|                                                                                           |  |                                                          |  |                       |  |        |         |           |  | Three Months Ended |           | Six Months Ended |  | Inception
|                                                                                           |  |                                                          |  |                       |  |        |         |           |  |                    |           |                  |  | through  
|                                                                                           |  |                                                          |  |                       |  |        |         |           |  |                    |           |                  |  |           |           |      |  |   |           |  |  |   |           |  |  | March 31,
|Product                                                                                    |  |                                                          |  |                       |  | Status |         | March 31, |  | March 31,          |           | March 31,        |  | March 31, |           | 2002
|Candidate or Program                                                                       |  | Indication                                               |  | (2)                   |  | 2002   |         | 2001      |  | 2002               |           | 2001             |  | (3)      
|                                                                                           |  |                                                          |  |                       |  |        |         |           |  |                    |           |                  |  |          
|Product Candidates                                                                        
|Neurodex                                                                                   |  | Emotional lability                                       |  | Clinical Phase
II/III |  | $      | 663,632 |           |  | $                  | 578,110   |                  |  | $         | 1,097,899 |      |  | $ | 743,068   |  |  | $ | 3,088,334 | 
|Neurodex                                                                                   |  | Neuropathic pain                                         |  | Clinical Phase II     |  |        | 260,175 |           |  |                    | 485,085   |                  |  |           | 494,590   |      |  |   | 590,719   |  |  |   | 1,576,228 | 
|IgE Regulator                                                                              |  | Allergy and Asthma                                       |  | Pre-clinical          |  |        | 716,344 |           |  |                    | 372,957   |                  |  |           | 1,201,382 |      |  |   | 765,438   |  |  |   | 5,199,015 | 
|                                                                                          
|Funded Research                                                                           
|Grant
Program Research                                                                     |  | Genital Herpes                                           |  | Pre-clinical          |  |        | 1,126   |           |  |                    | 24,835    |                  |  |           | 1,126     |      |  |   | 80,567    |  |  |   | 115,808   | 
|                                                                                          
|Other Preclinical Research
Programs                                                       
|Drug Discovery
through technology
platforms (CCM, MIF and Monoclonal Antibody Technology) |  | Anti-Inflammation,
cholesterol reduction and anti-cancer |  | Pre-clinical          |  |        | 966,952 |           |  |                    | 559,478   |                  |  |           | 1,671,949 |      |  |   | 832,964   |  |  |   | 4,641,102 | 
|                                                                                          
|Other
(1)                                                                                  |  |                                                          |  |                       |  |        |         |           |  |                    | 556,679   |                  |  |           | 442,500   |      |  |   | 1,044,821 |  |  |   | 758,334   |  |  |           |  | 
|                                                                                           |  |                                                          |  |                       |  |        |         |           |  |                    |           |                  |  |           |           |      |  |   |           |  |  |   |           |  |  |           |  | 
|Total                                                                                      |  |                                                          |  |                       |  |        |         |           |  | $                  | 3,164,908 |                  |  | $         | 2,462,965 |      |  | $ | 5,511,767 |  |  | $ | 3,771,090 |  |  |           |  | 
|                                                                                           |  |                                                          |  |                       |  |        |         |           |  |                    |           |                  |  |           |           |      |  |   |           |  |  |   |           |  |  |           |  | 



|1. |  | Other includes primarily laboratory occupancy costs and scientific
management.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|  
|  
|  
|2. |  | At March 31, 2002, we held the worldwide rights to manufacture, market and
sell all of the products in clinical development and any of the products that
might come from our R&D programs. Estimated costs and timing to
complete certain milestones for each of our product candidates or
research programs are as follows: complete Phase II/III clinical
trial and one additional Phase III clinical trial for emotional
liability ($4 - 6 million over next two years); one Phase
II clinical trial for
neuropathic pain ($1 - 2 million over next 12 months); completion of
work on IgE regulator and file IND ($2 - 3 million by
December 2002); completion of genital herpes research grants
($1.2 million spread over two
years); and other research ($2 - 4 million a year).
|  
|  
|  
|  
|3. |  | Inception dates are on or after October 1, 1998, at which time we began
identifying and tracking costs for these research programs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

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Neurodex

Neurodex is a patented, orally administered combination of dextromethorphan
(DM) and an enzyme inhibitor that sustains elevated levels of dextromethorphan
on a proposed twelve-hour dosing schedule. AVANIR is developing Neurodex for
use in multiple indications including pseudobulbar affect (also known as
emotional lability) and neuropathic pain. AVANIR has an investigational new
drug application (IND) in place for Neurodex and has completed Phase I clinical
trials to establish the safety of the drug combination of dextromethorphan and
an enzyme inhibitor. Enrollment in a Phase II/III clinical trial to examine
the efficacy of Neurodex as a treatment for emotional lability began in
February 2001 and closed in April 2002. Results from this clinical trial
should be available shortly after mid-year. Pending positive results from this
clinical trial, AVANIR plans to initiate a second pivotal Phase III trial that
will be conducted in multiple sclerosis (MS) patients in 2002. An open-label
safety study will also be conducted starting in 2002. The open-label study
will include patients with symptoms of emotional lability occurring in stroke,
Alzheimers disease, ALS or MS.

The neuropathic pain indication is also in clinical development and we intend
to begin a Phase II, open-label dose-ranging trial in patients with diabetic
neuropathy by the third quarter of 2002.

Allergy and Asthma Research (IgE Regulator)

A key component in the pathophysiology of both allergy and asthma is the
overproduction of immunoglobulin epsilon (IgE) antibodies. We have identified
a family of orally active small molecules that selectively inhibit or prevent
the production of IgE antibodies. As of March 31, 2002, we were engaged in
toxicology studies of our lead compound. We intend to file for an IND
application for our lead compound with the FDA before December 31, 2002.
Thereafter, we intend to continue to develop the lead compound to a clinical
stage that could be attractive for partnering. Assuming we are successful in
filing an IND for the product, we intend to begin shortly thereafter the
process of seeking a partner to help fund further development. We expect to
require a partner at least before Phase III clinical development because the
cost of Phase III clinical trials in this large therapeutic area would require
substantially more financial resources than we anticipate will be available at
that time. AVANIRs allergy and asthma research is currently in the
preclinical stage of development.

Genital Herpes Research (Grant Programs)

We have completed studies that showed the effectiveness of a docosanol-based
product in an animal model of herpes simplex infections. Recently, we received
a Phase II Small Business Innovative Research (SBIR) grant and a California
Technology Investment Partnership (CalTIP) grant to be used in the development
of a topical treatment for genital herpes (HSV-2). The SBIR grant is being
used to fund the pre-clinical research. The CalTIP funds will be used for
defining and assessing the market including assessment of competitive
landscape, product opportunities, brand identification and possible brand names
for a potential genital herpes product. Our SBIR grant, together with the
CalTIP grant, brings total funds awarded to AVANIR for further research and
development of a potential new treatment of genital herpes to $1,159,000. The
SBIR grant represents a two-year period of funding of approximately $500,000
each year for the Companys research project.

Other Preclinical Research

Anti-Inflammatory Research (MIF Inhibitor) We recently acquired a proprietary
series of compounds that inhibit or block the activity of macrophage migration
inhibitory factor (MIF). MIF is a protein that plays a central role in
inflammation pathways. Our research indicates that MIF may serve as a
potential drug target in a variety of diseases, including rheumatoid arthritis,
Crohns disease, colitis, asthma and

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sepsis. Our goal is to identify and develop an orally administered
compound that can be developed as an
innovative therapy for the treatment of inflammatory diseases. We expect to
require a partner to help develop this product through clinical trials. Our
MIF technology platform is currently in the early preclinical stage of
development.

Cholesterol Reduction (CCM Technology) Our research on cholesterol lowering
agents is a very early stage drug discovery program that has been implemented
to discover agents that will be valuable in the treatment and prevention of
hyper-cholesterolemia (high cholesterol). Cholesterol is transported in the
blood in large cholesterol-rich particles called lipoproteins. Generally,
low-density lipoproteins (LDL) deliver the cholesterol to peripheral tissues
including aorta and coronary arteries, whereas high-density lipoproteins (HDL)
remove excess cholesterol from peripheral tissues, and transport it to the
liver for elimination. We have a proprietary technology, code named CCM, that
we are using to identify peptides that may be capable of accelerating the
removal of excess cholesterol from peripheral tissues and transporting it to
the liver for elimination.

Monoclonal Antibodies Research As of March 31, 2002, we have established
research collaborations with three companies to use our proprietary technology
to produce fully human monoclonal antibodies to potential disease targets.
These research collaborations typically provide us with advance payments to
conduct research and provide for milestone payments in the event that we are
successful in meeting certain predetermined stages of development. Xenerex is
also conducting research on developing antibodies to targets identified by
AVANIR and itself for possible addition to the Companys own drug discovery and
development programs.

RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2002

Revenues

Revenue for the second quarter of fiscal 2002 was $738,000, compared to revenue
of $1.3 million for the same period last year. Revenue in both periods
consisted primarily of royalties on sales of Abreva from GlaxoSmithKline.
Royalties in the prior year included payments resulting from initial Abreva
sales to fill the product distribution pipeline by stocking shelves in
wholesale and retail outlets during product launch. From a consumer
standpoint, retail sales of Abreva for
the second quarter of fiscal 2002 increased by 60% from the same period a year
ago. Retail sales are not the basis for calculating Abreva royalties,
as our royalties are based on wholesale sales, but we believe retail
sales represents a good indicator of Abreva product performance. The Company reached completion of its milestone payments from
GlaxoSmithKline during the first quarter of fiscal 2002.

Our revenues for the next several quarters will depend substantially on the
amount of royalties earned from Abreva product sales, the amount of potential
license fees, royalties and milestone payments from international licensees of
docosanol 10% cream, and new business at Xenerex, including milestones in
providing human antibodies.

We believe GlaxoSmithKlines launch of Abreva has been very successful to
date, as demonstrated by achieving market leadership in the first year of
introduction. We expect that sales of Abreva will generate royalties to AVANIR
in the range of $3.3 million to $4.5 million during fiscal 2002, depending on
GlaxoSmithKlines level of product promotion and the timing of regulatory
approval for marketing the product in Canada. We believe that future royalties
on sales of Abreva will provide an important source of funds for pursuing our
development programs.

We continue to make progress in outlicensing docosanol 10% cream in
international markets, which represent potential new sources of revenues for us
in the future. Our ability to earn license fees and milestone payments from
international sources will depend substantially on the timing of foreign

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regulatory approvals and the timing of product launch by our licensees, which
are substantially outside of our control.

We expect that our subsidiary, Xenerex Biosciences, will gradually become a
significant source of revenues through its antibody generation services
business. Revenues from research collaborations should help fund Xenerexs
research, but the larger milestone payments that typically accompany these
collaborations will depend on the progress made by our partners in evaluating,
selecting and advancing our antibodies through the development pipeline.
Progress by our research partners is largely unpredictable and will take years
of development before an antibody reaches the market, if ever, assuming it is
selected for further development.

Expenses

Operating Expenses Total operating expenses amounted to $4.6 million in the
second quarter of fiscal 2002, compared to $4.3 million in the same period in
fiscal 2001. The 7% increase in operating expenses was primarily caused by a
28% increase in spending on research and development programs. The second
fiscal quarter 2001 included product launch costs of $492,000. Research and
development programs accounted for 69% and 57% of total operating expenses for
the fiscal quarters ended March 31, 2002 and 2001, respectively. General and
administrative expenses accounted for 23% and 24% of total operating expenses
for the fiscal quarters ended March 31, 2002 and 2001, respectively. Sales and
marketing expenses accounted for 8% and 7% of total operating expenses for the
fiscal quarters ended March 31, 2002 and 2001, respectively. These and other
costs are more fully described below.

Research and Development (R&D) Expenses R&D expenses increased to $3.2
million in the second fiscal quarter 2002, compared to $2.5 million in the same
period a year ago. The growth in R&D expenses reflected the Companys expanded
product development pipeline and advances in clinical and preclinical
development, including accelerated patient enrollments in the Phase II/III
clinical trial for Neurodex (formerly AVP-923) for the treatment of emotional
lability. Also during fiscal 2002, AVANIR initiated toxicology work on its
novel lead compound for treating allergy and asthma.

Total R&D spending by major program for the second quarter of fiscal 2002
included Neurodex clinical development (29%), allergy and asthma research
(23%), Xenerex antibody generation research (12%) and other preclinical
research related to anti-inflammation and cholesterol reduction (19%). The
balance of R&D spending was primarily for routine costs associated with
operation and maintenance of laboratory facilities. In the second quarter of
fiscal 2001, R&D expenses were related primarily to the early stages of
enrollment in the Neurodex Phase II/III clinical trial and in the development
of the antibody generation technology.

We plan to continue increasing our spending on established R&D programs in the
product development pipeline. We intend to expand our clinical development
programs for Neurodex through the next several quarters. This expansion will
include both a Phase II clinical trial for the treatment of neuropathic pain
and a Phase III clinical trial of emotional lability in patients with multiple
sclerosis. We also intend to continue toxicology work and other advanced
preclinical research on our lead compound for treating allergy and allergic
asthma and other preclinical research in the areas of anti-inflammation,
cholesterol reduction and drug discovery through antibody generation research.

General and Administrative Expenses General and administrative expenses
amounted to $1.1 million in the second fiscal quarter 2002, representing a 3%
increase over expenses of $1.0 million in the same period in the prior year. General and administrative

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expenses grew at a slower
rate than R&D and sales and marketing expenses as the Company concentrated its
efforts on expanding its R&D programs and outlicensing of docosanol 10% cream.

Sales and Marketing Expenses During the second fiscal quarter 2002, sales and
marketing expenses were $361,000, compared with $292,000 in the same period a
year ago. The increase in expenses was due primarily to the legal and
consulting costs of
outlicensing docosanol 10% cream, establishing a research collaboration in the Peoples Republic of China and
increasing commercial development activity at Xenerex. Sales and marketing
activity in fiscal year 2001 was relatively lower while we directed our efforts
toward out-licensing rights to manufacture and sell docosanol 10% cream outside
North America.

Other Income and Expenses

Interest Income In the second fiscal quarter 2002, interest income amounted
to $181,000, compared to $340,000 for the same period a year ago. The decrease
in interest income during the second fiscal quarter 2002 was primarily due to
lower interest rates on investments compared with the same period a year ago.

Other Income Other income for the second fiscal quarter 2002 primarily
consists of one-time fees charged by the Company to potential licensees for
exclusive rights to negotiate license agreements for docosanol 10% cream and
rental income for use of the Companys conference center and emergency standby
power generating equipment.

Interest Expense In the second fiscal quarter 2002, interest expense amounted
to $18,000, compared to $1,500 for the same period a year ago. Increased
levels of interest expense will continue for the foreseeable future. Increased
interest expense for the second fiscal quarter 2002 was primarily related to
$556,000 in new capital equipment lease financing transactions for an emergency
power generator and various new pieces of laboratory equipment purchased since
September 21, 2001.

Net Loss Attributable To Common Shareholders

For the second fiscal quarter 2002, the net loss attributable to common
shareholders was $3.7 million, compared to $2.7 million for the same period a
year ago. Basic and diluted net loss per share was $0.06, compared to a basic
and diluted net loss per share of $0.05 for the same period a year ago. We
expect to incur losses at least through the next two quarters as we pursue our
drug development strategy focused on large market therapeutic areas with
significant partnering and licensing potential. Thereafter, for a period of at
least two years, we expect to have some quarterly periods of profitability and
some quarterly periods of losses, depending on the amounts and timing of
license fees and milestone payments and through partnering arrangements for our
R&D programs.

RESULTS OF OPERATIONS
SIX MONTHS ENDED MARCH 31, 2002

Revenues

Revenue for the first six months of fiscal 2002 amounted to $6.9 million,
compared to $6.3 million for the same period a year ago. The 8% increase in
revenue was due primarily to increased royalties earned by AVANIR from sales of
Abreva generated by GlaxoSmithKline, reflecting increased market penetration
since product launch began in October 2000. Revenue for the first six months
of fiscal 2002 included a $5 million milestone when Abreva reached the one-year
anniversary after product launch and $1.8 million in royalties on Abreva
product sales. Revenue for the first six months of fiscal

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2001 included a $5
million milestone earned on the Abreva product launch and $1.3 million in
royalties on Abreva product sales.

AVANIRs revenues for the next several quarters will depend primarily on the
amount of royalties earned from Abreva product sales, the amount of potential
license fees, royalties and milestone payments
from international licensees of docosanol 10% cream, and the achievement of
milestones in providing human antibodies at Xenerex.

Expenses

Operating Expenses Total operating expenses amounted to $8.2 million for the
first six months of fiscal 2002, compared to $6.6 million for the same period
of fiscal 2001. The 25 % increase in operating expenses was primarily due to a
$1.7 million or 46% increase in spending on R&D programs, including increases
associated with allergy and asthma research, clinical trials of Neurodex, and
the addition of MIF research. Expenditures on R&D programs accounted for 67%
and 57% of total operating expenses for the first six months of fiscal 2002 and
2001, respectively. General and administrative expenses accounted for 25% and
28% of total operating expenses for the first six months of fiscal 2002 and
2001, respectively. Sales and marketing expenses accounted for 8% of total
operating expenses for the first six months of fiscal 2002 and 2001. These and
other costs are more fully described below.

Research and Development Expenses Total R&D expenses amounted to $5.5 million
for the first six months of fiscal 2002, compared to $3.8 million for the same
period a year ago. A breakdown of major R&D spending for the first six months
of the current fiscal year included Neurodex research (29%), allergy and asthma
research (22%), antibody generation research within Xenerex (13%) and other
preclinical research related to inflammation and cholesterol reduction (17%).
The balance of R&D spending primarily reflected routine costs associated with
operation and maintenance of laboratory facilities.

General and Administrative Expenses General and administrative expenses
amounted to $2 million in the first six months of fiscal 2002, representing a
12% increase over expenses of $1.8 million in the same period in the prior
year. Compared with the same period a year ago, higher expenses were
attributable to an increase in administrative staff size to support growing R&D and
commercial development operations, a 172% increase in utilities expense and a 77%
increase in depreciation expense. General and administrative expenses grew at
a slower rate than R&D and sales and marketing expenses as the Company
concentrated its efforts on R&D programs.

Sales and Marketing Expenses Sales and marketing expenses during the first
six months of fiscal 2002 were $681,000, compared with $506,000 in the same
period a year ago. Increased expenses in the first six months of fiscal 2002
were related to legal and consulting costs to out-license docosanol 10% cream in Europe
and the Middle East, establishing a research collaboration in the Peoples
Republic of China, and increasing commercial development activity at Xenerex
Biosciences. Sales and marketing activity for the same period in fiscal year
2001 was relatively low while we directed most of our efforts toward
GlaxoSmithKlines launch of Abreva.

Other Income and Expenses

Interest Income In the first six months of fiscal 2002, interest income
amounted to $369,000, compared to $674,000 for the same period a year ago. The
decrease in interest income during the first six months of fiscal 2002 was
primarily due to lower interest rates on investments compared with the same
period a year ago.

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Other Income Other income for the first six-months of fiscal 2002 primarily
consists of one-time fees charged by the Company to potential licensees for
exclusive rights to negotiate license agreements for docosanol 10% cream and
rental income for use of the Companys conference center and emergency standby
power generating equipment.

Interest Expense In the first six months of fiscal 2002, interest expense
amounted to $33,000, compared to $4,000 for the same period a year ago.
Increased levels of interest expense will continue for the foreseeable future.
Increased interest expense for the first six months of fiscal 2002 was
primarily related to the addition of $556,000 in new capital equipment lease
financing transactions, primarily for an emergency power generator and various
new pieces of laboratory equipment since September 21, 2001.

Net Income (Loss) Attributable To Common Shareholders

The net loss attributable to common shareholders for the first six months of
fiscal 2002 was $956,000, compared to net income attributable to common
shareholders of $396,000 for the same period a year ago. Basic and diluted net
loss per share was $0.02 for the first six months of fiscal 2002, compared to
basic and diluted net income per share of $0.01 for the same period a year ago.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 2002, we had cash and investments of
$21.4 million, including $8.9 million in cash and cash
equivalents. At September 30, 2001, we had cash and
investments of $21.9 million, including $16.5 million in cash and cash
equivalents. Explanations of the changes in net cash
provided by or used for operating and financing activities and net cash used
for investing activities are provided below.

Operating Activities Net cash provided by operating activities in the first
six months of fiscal 2002 amounted to $215,000, compared to net cash used for
operating activities of $227,000 during the comparable period in fiscal year
2001. Net cash provided by operating activities for the first six months of
fiscal 2002 is attributable primarily to increases in accounts payable
($466,000) and accrued compensation and other accrued expenses ($402,000) and
depreciation and amortization ($276,000), which more than offset the net loss
of $934,000. Net cash used in operating activities for the first six months of
fiscal 2001 is attributable primarily to increases in accounts receivable ($1.3
million) and inventory ($213,000), partially offset by net income of $418,000,
increases in accrued compensation and other expenses ($780,000) and reduced
prepaid expenses ($136,000).

Investing Activities Net cash used for investing activities during the first
six months of fiscal 2002 amounted to $8 million, including investments in
securities totaling $8.6 million, capital expenditures of $300,000 and patent
costs of $251,000, partially offset by maturities of securities of $1.2
million. As short-term interest rates came down through most of 2002, we
sought to achieve higher yields on our available cash by investing in
securities that had maturities longer than one year. Our investment strategy
of seeking higher yields through longer maturities of government securities and
bank CDs primarily resulted in a $7.2 million net increase in short and
long-term investments for the first six months of fiscal 2002. Net cash used
for investing activities in the first six months of fiscal 2001 amounted to
$760,000, including capital expenditures of $793,000 and patent costs of
$355,000.

Financing Activities Net cash provided by financing activities during the
first six months of fiscal 2002 amounted to $45,000 and reflected
funds received from issuances of common stock partially offset by
repayment of short-term
financing of insurance premiums and payments of dividends on preferred stock.
During the same period a year ago, net cash provided by financing activities
amounted to $1 million,

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primarily from issuances of Class A common stock on
exercises of stock options and stock purchase warrants, partially offset by
repayment of notes payable.

We believe that cash and short and long-term investments totaling $21.4 million
at March 31, 2002, provide us with sufficient liquidity to
sustain our present level of operations for one and
one-half to two years based only on Abreva royalty revenues and
not taking into consideration other sources of revenue or additional
capital. To enhance our capital base and liquidity and to fund the
development of a greater number of drug candidates and technology
platforms now available to us, we intend to pursue several
alternatives for raising additional funds during the next twelve
months. Potential alternatives that we are considering for raising capital include, but are not
limited to, partnering arrangements where partners share development costs,
issuance of debt or equity securities, and licensing or sales of any of our
platform technologies or new drug candidates.

CRITICAL ACCOUNTING POLICIES

Because of the significance of our revenue recognition policies to our
financial statements, we believe it is appropriate to include our revenue
recognition policies as critical accounting policies.

Milestone Payments in License Agreements

We recognize revenues from license fees when the performance requirements have
been met, the fee is fixed or determinable, and collection of fees is probable.

Our largest and most significant license agreement is with GlaxoSmithKline. On
March 31, 2000, we transferred the rights to GlaxoSmithKline to manufacture,
use, and sell Abreva in the United States and Canada and gave them full
control, authority and responsibility over research, development, registration
including actions required to obtain appropriate government approvals, and
commercialization of the product in that territory. As of December 31, 2001,
GlaxoSmithKline had achieved all of the performance milestones under the
agreement and we had earned all of the $25 million in license fees and
milestone payments. We have no further obligations to perform any future
services, deliver any product, or perform any marketing or sales of the
product. Future revenues to be earned under the GlaxoSmithKline agreement will
come solely from royalty revenues.

We expect to enter into additional license agreements in the future. We expect
that each license agreement will have its own set of circumstances and terms of
performance. We will consider the specific facts and circumstances of each
license agreement to determine the appropriate accounting and revenue
recognition for such items, including nonrefundable up-front fees and milestone
payments and taking into consideration when the earnings process is complete
and collection is reasonable assured.

Royalties on Licensed Products

We recognize royalty revenues from our licensed products based on the reported
sales by our licensee and computed in accordance with the specific terms of the
license agreement. Since the launch of Abreva in October 2000, all of our
royalties have come from GlaxoSmithKline. We intend to enter into additional
license agreements that will contain royalties as a source of revenues. We
expect that many of these additional license agreements will be with
foreign-based companies.

Research Contracts

In certain circumstances, we may enter into research contracts or
collaborations where we are obligated to deliver to the customer multiple
products and/or services (multiple deliverables) in exchange for fees

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or milestone payments. Such contracts could include antibody generation services
agreements and other forms of research collaborations.

As of March 31, 2002, Xenerex had entered into three research collaboration
arrangements, all of which have research initiation fees. In these agreements,
the customer provides antigens to Xenerex. Xenerex performs research to
develop potential antibodies for those antigens (initial phase). If, after a
reasonable commercial effort is made to develop an antibody, it is determined
that none exists, the contract is complete and the initiation fee is
recognized. If antibodies are developed, they are provided to the
customer and a determination is made by the customer to have Xenerex perform
further research or terminate the remaining contract. If the customer decides
to have Xenerex continue research on the developed antibodies, there exists in
the contract milestones that are tied to the completion of the different phases
of effort such as when the customer files the Biologics License Application and
when the customer obtains regulatory approval.

The research collaboration agreements also define the amount of royalties on
product sales by the licensee, if the licensee successfully develops and
obtains approval for marketing a product. The license fees and royalty rates,
while defined as part of the research collaboration agreement, would still be
subject to completion of a definitive license agreement with the customer.

Xenerex Research Initiation Fees Xenerex defers research initiation fees and
recognizes the revenue once Xenerex has completed its efforts to create
antibodies. Under the three agreements at March 31, 2002, if Xenerex fails to
create antibodies, then the remaining contract may be terminated and the
research initiation fees are not refundable, indicating that the earnings
process is complete, provided Xenerex has made a commercially reasonable effort
to create antibodies. The status of Xenerex three existing collaborative
agreements are as follows:



| |  |  | Peregrine Pharmaceuticals The Peregrine contract provides
for the creation of antibodies to three target antigens provided by
Peregrine. As of March 31, 2002, Xenerex had advanced to the second
stage of the research collaboration agreement for one of the three
target antigens. The second stage is intended to provide Peregrine
with more information on selected panels of the antibodies that meet
the antibody characteristics desired by Peregrine. We earned and
recognized a pro-rata portion of the research initiation fee as
revenue associated with our efforts and included the amount in our
contract and license fee revenues for the six months ended March 31,
2002. We have not completed the performance associated with stage
two or other milestones in the agreement and have not earned or
recognized any other revenues in the six months ended March 31,
2002.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Eos Biotechnology, Inc. The Eos contract provides for the
creation of antibodies to three target antigens provided by Eos. As
of March 31, 2002, Xenerex had advanced to the second stage of the
research collaboration agreement for two of the three target
antigens. The second stage is intended to provide Eos with more
information on selected panels of the antibodies that meet the
antibody characteristics desired by Eos. We earned and recognized
the research initiation fee as revenue associated with our
commercial efforts on all three antigens and included the amount in
our contract and license fee revenues in the prior fiscal year ended
September 30, 2001. We have not completed the performance
associated with stage two or other milestones in the agreement and
have not earned or recognized any revenues in the six months ended
March 31, 2002.           
|
| |  |  | DNAX Research, Inc. The DNAX contract provides for the
creation of antibodies to two target antigens provided by DNAX. We
have not completed the commercial efforts associated with the
research initiation fees or achieved any of the milestones in the
agreement. Therefore, as of March 31, 2002, we had not earned or
recognized any revenues in the agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

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Xenerex Receipt of Milestone Payments In the research phases of the research
collaboration agreement, Xenerex may receive payment either to start a research
phase or to complete a research phase (including receipt by the customer of the
deliverable). Xenerex recognizes revenue once the product has been delivered,
because the earning process would be complete and an exchange has been made.
Factors taken into consideration in recognizing revenues include the following:



| |  |  | The performance criteria have been met;                                                                                              
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Any undelivered products or services are not essential to the
functionality of the delivered products or services;                   
|
| |  |  | Payment for the delivered products or services is not contingent on
delivery of the remaining products or services; and              
|
| |  |  | We have an enforceable claim to receive the amount due in the event
we do not deliver the remaining undelivered products or services.

Commercial Phase of Xenerex Research Contracts Xenerex research collaboration
agreements provide that a final license agreement will be executed to
incorporate the terms and conditions for the commercial phase of the contract.
We will evaluate revenue recognition in the commercial phase once a license
agreement is executed and the commercial phase has commenced.

Other Research Contracts As with all our research contracts, including the
up-front initiation fee, we defer revenue recognition until services have been
rendered or products (e.g. developed antibodies) are delivered. The
milestones established within the contract are set to approximate the effort
associated with the completion of each phase. Regardless of when we receive
the payment associated with a research phase, we defer the revenue recognition
until the service is completed or product is delivered.

Federal research grants

We recognize revenues from federal research grants over the period in which the
related expenditures are incurred.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 10, Recent Accounting Pronouncements for a discussion of recent
accounting pronouncements and their effect, if any, on the Company.

ADDITIONAL FACTORS THAT MIGHT AFFECT FUTURE RESULTS

We expect our quarterly revenues and operating results to fluctuate for a
number of reasons.

Future operating results will continue to be subject to quarterly fluctuations
based on a wide variety of factors, including:



| |  |  | Seasonality Our sequential royalty revenues from sales of Abreva
by GlaxoSmithKline in the United States are expected to fluctuate
downward in the summer months based on historical industry sales data
for cold sore treatments, which indicates some seasonality.                                                                                                                                                                                                     
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Concentration of Significant Customers, Suppliers and Industries 
Milestone payments and royalties earned from a single licensee
(GlaxoSmithKline) accounted for approximately 91% and 93% of our fiscal
2001 and 2000 net revenues, respectively. We have now received all of
the milestone payments from GlaxoSmithKline. Future revenues from
GlaxoSmithKline will come exclusively from Abreva royalties. Our
business could be adversely affected if GlaxoSmithKline

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| |   |  | terminated its
business relationship with us or significantly reduced the amount of
marketing and promotion of Abreva. Additionally, we purchase our raw
materials from a sole foreign supplier that has been approved for
manufacture by the FDA. Any disturbances or delays in the manufacture
of the raw materials could seriously and adversely affect our business.                                                                                                                                                                                                                         
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Achievement of Milestones Under License Agreements May Be Outside
Our Control Recognition of revenue under several of our license
agreements may depend solely on the efforts and performance of our
licensees in reaching milestones outside of our control. Such
milestones
may include specific events, such as regulatory approval, product launch,
the passage of time, or reaching a sales threshold.                                                                                                                                                                                     
|
| |  |  | Acquisitions/Alliances If, in the future, we acquire
technologies, products, or businesses, or we form alliances with
companies requiring technology investments or commitments, we will face
a number of risks to our business. The risks we may encounter include
those associated with integrating operations, personnel, and
technologies acquired or licensed, and the potential for unknown
liabilities of the acquired business. Our business and operating
results on a quarterly basis could be adversely affected if any of our
acquisition or alliance activities are not successful.

If we experience any delays in obtaining regulatory approval for Abreva in
Canada or if GlaxoSmithKline experiences problems in manufacturing or reduces
promotion of the product, then our royalties from sales of Abreva will be
materially and adversely affected.

We have signed an exclusive license agreement with GlaxoSmithKline for
manufacturing and sales of Abreva in North America. Abreva is approved for
sale only in the United States at this time. We have completed the application
for regulatory approval for marketing in Canada and we are currently awaiting a
decision. We could experience problems or delays in obtaining regulatory
approval in Canada, which has a market size that is about 10% of the size of
the U.S. market. Further, our royalty revenues from sales of Abreva next year
will be substantially influenced by the level of GlaxoSmithKlines marketing
and promotion of the product. Any problem or delay in manufacturing, or any
material reduction in product promotion could affect materially and adversely
our business operations and financial condition.

AVANIR and its licensees may not be successful in obtaining regulatory approval
of docosanol 10% cream immediately as an OTC product in the rest of the world
or in licensing, marketing and selling the product in foreign countries.

AVANIR and its licensees could face the following risks in our efforts to
obtain regulatory approval as an over-the-counter (OTC) product and to market
and sell docosanol 10% cream in foreign countries:



| |  |  | Regulatory approval requirements differ by country, and
obtaining approvals to market the drug in foreign countries may be
difficult to obtain or may require prescription status first before
obtaining sufficient experience to warrant approval as an OTC
product;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | building product awareness of a new drug, whether
prescription or OTC, among customers or retail store decision makers
may require a substantial amount of product promotion, which does
not guarantee success;                                                      
|
| |  |  | consumers may not perceive that docosanol 10% cream is
superior to existing and potentially new OTC products for oral
herpes;                                                                                                                                        
|
| |  |  | acceptance of docosanol 10% cream in the OTC consumer market
may not be widespread; and                                                                                                                                                                              
|
| |  |  | potential price erosion could occur due to competitive
products and responses to our products introduction.                                                                                                                                                         

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Developing and testing a drug candidate is a very expensive and time-consuming
process that may not ultimately lead to a marketable product.

We may spend millions of dollars in pre-clinical studies researching the
potential safety and efficacy of our drug candidates. If any such drug
candidate fails to demonstrate the desired safety and efficacy, we may abandon
the development of those compounds, in which event we will be forced to
write-off the research costs incurred for that compound. If a compound appears
to be safe and effective in pre-clinical studies, we may decide to proceed with
human clinical trials. The full complement of clinical trials required to
obtain regulatory approval for a new drug may involve millions of dollars.
Because of the
Companys limited financial resources, we may be required to license the
compound to a pharmaceutical company with greater financial resources in order
to complete development of the drug. There is no assurance that we will be
able to find a large pharmaceutical company interested in licensing the drug
or, if we do locate a potential licensee, that the proposed license terms will
be acceptable to the Company. In the event that we are unable to find a large
pharmaceutical partner or licensee on acceptable terms, we may be forced to
abandon one or more of our drug candidates.

Abreva faces competition from a number of existing and well-established
products and the companies that market their products.

Abreva competes with several other 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 FDA review. Most of our
competitors, including Blistex, Inc., Bayer Corp. and Schering Plough, have
substantial financial resources, research and development facilities and
manufacturing and marketing experience. Even with Abreva being marketed by one
of the worlds largest consumer healthcare companies, GlaxoSmithKline, not all
competitive responses and the impacts of those responses can be foreseen.

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

We anticipate that we may raise additional capital in the next twelve months
through the sale of shares of our Class A Common Stock. If we raise capital by
issuing additional shares of Class A common stock at a price per share less
than the then-current market price per share, then the value of the shares of
Class A common stock outstanding will be diluted or reduced. Further, even if
we were to sell shares of common stock at prices higher than todays price, the
issuance of additional shares may depress our market price and dilute earnings
per share.

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

Our license agreement with GlaxoSmithKline is for the United States and Canada
only. We also have exclusive license agreements for docosanol 10% cream for
Israel, Korea, Egypt and other parts of the Middle East. We are holding
discussions with other potential licensees for marketing and selling docosanol
10% cream in other countries not already licensed. However, we may not
finalize any license or distribution arrangements for territories on a timely
basis or on favorable terms, if at all. Further, our foreign licensees expose
us to various foreign trade risks relating to development and marketing of
docosanol 10% cream. Further, we 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 outside our control. Even if we
are able to obtain experienced licensees in foreign markets, specific risks
that could impact significantly our ability to deliver products abroad include:

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| |  |  | difficulties in obtaining regulatory approval of
docosanol 10% cream in Canada, Israel, Korea and other foreign
countries;
| | - |  | --------------------------------------------------------------------------------------------------------------------------
|
| |  |  | 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, market and promote the product;     
|
| |  |  | shipping delays;                                                                                                          
|
| |  |  | difficulties in managing operations across disparate geographic areas;                                                    
|
| |  |  | fluctuations in foreign currency exchange rates;                                                                          
|
| |  |  | prices of competitive products;                                                                                           
|
| |  |  | difficulties associated with enforcing agreements through foreign legal systems; and                                      
|
| |  |  | trade protection measures, including customs duties and export quotas.                                                    

Our antibody generation services subsidiary, Xenerex Biosciences, faces intense
competition and rapid technological change, and if we fail to provide services
that keep pace with new technologies and gain market acceptance, our services
and technologies could become obsolete.

The biotechnology industry is highly competitive and subject to significant and
rapid technological change. We compete with several companies that offer
antibody generation services to companies that have antigens. These
competitors have specific expertise or technology related to antibody
development and introduce new or modified technologies from time to time.
These companies include Abgenix, Inc, Medarex, GenPharm, Kirin Brewing Co.,
Genmab, Cambridge Antibody Technology Group, Protein Design Labs, and
MorphoSys. Many of these companies either alone or together with their
customers, have substantially greater financial resources, larger research and
development staffs, and substantially greater experience than we do.

Our failure or inability to comply with government regulations regarding the
development, production, testing, manufacturing and marketing of our other
products may adversely affect 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. Failure to obtain, or delays in obtaining, these
approvals will adversely affect our business operations, including our ability
to commence marketing of any proposed products. We may find it necessary 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 for any of our products
under development. In addition, we cannot predict the extent to which adverse
governmental regulation might arise from future U.S. or foreign 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 or lengthy research and development programs for proposed new
products could negatively affect our business.

We face substantial risks of failing to complete the development of our
research programs for the treatment of central nervous system disorders,
allergy and asthma, and other areas. Our Phase II/III clinical trials of
Neurodex for the treatment of emotional lability in ALS and MS patients may
experience setbacks or failures for reasons we have not anticipated. Our Phase
II clinical trial of Neurodex for the treatment of neuropathic pain may not
show proof of concept. Our observations during

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preclinical research of our
lead compound for treating allergy and asthma, while showing effectiveness in
several in-vitroand ex-vivoassays and in-vivoallergy models, may not be
relevant to the development of, indicate the efficacy of, or have the safety
profile necessary for a proposed product for human use. Unsuccessful clinical
trial results for our proposed products could affect materially and adversely
our future 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 or collaborative partners, which could result in
the abandonment or substantial change in the development of a specific product.

Business interruptions could adversely affect our business.

Our operations are vulnerable to interruption by fire, earthquake, power loss,
telecommunications failure, terrorist attacks and other events beyond our
control. For example, during 2001, California experienced shortages in
adequate supply of electricity, resulting in rolling blackouts, where certain
areas are not provided with any electricity for periods of up to two hours.
The immediate impact was a significant increase in power rates for most users,
including us. Additionally, the loss of electrical power or blackouts for
any significant periods of time could harm either our vendors or our ability to
conduct our experiments or to provide antibody research services for others.
Further, we could lose valuable progress made to date in experiments currently
underway. We have attempted to mitigate the severity of power losses by
installing emergency power equipment, which we intend to use for those
electrical needs that we consider to be the most critical to operating our
business. However, the emergency power unit does not cover all of our
electrical needs.

Our acquisition and alliance activities could disrupt our ongoing business.

We intend to continue to make investments in products and technologies, acquire
or inlicense technologies, and, in the future, could acquire entire companies
to expand our product development pipeline and sales revenues. Acquisitions
and strategic alliances often involve risks, including: difficulty in
assimilating the acquired technologies, operations and employees, difficulty in
managing research collaborations, difficulty in retaining key employees of an
acquired operation, disruption of our ongoing business, inability to
successfully integrate the acquired technology and operations into our business
and lack of experience in developing the acquired technology.

Difficulties in acquiring inlicensed technologies that we believe are necessary
to fill our product development pipeline may restrict our growth.

Our business strategy for growth is not only through internal development, but
also through inlicensing of products, potential products and/or technologies at
various stages in the drug development pipeline. We will face intense
competition in attempting to inlicense other products and technologies. In
addition, we may not be able to locate suitable products and technologies to
fit our strengths, obtain rights to these products and technologies on
acceptable terms, or have the financial resources to develop products from the
inlicensed technology. If we are unable to add to our product development
pipeline, our growth may be limited and it may affect our business and stock
price negatively. Also, we must have the financial resources to acquire and/or
inlicense new products and technologies and develop and market the products, if
approved. We can provide no assurance that we will be successful in our
inlicensing strategy or that it will have the desired effect on our future
growth or stock price.

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

Our success depends on the performance of a small core staff of key management
and scientific employees with biotech experience. Given our small staff size
and programs currently under

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development, we depend substantially on our
ability to hire, train, retain and motivate high quality personnel, especially
our scientists and management team in this field. If we were to lose one or
more of our key scientists, then we would lose the history and their knowledge,
potentially causing a substantial delay in 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. We presently employ approximately 50 people in AVANIR and
our subsidiary, Xenerex Biosciences, and we expect to hire additional people
over the next twelve months. While we have employment and employee retention
agreements with certain key executives, they are limited in scope and provide
no real assurance that any
of these people will continue their employment with us. 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.

Our patents may be challenged and our pending patents may be denied. Either
result 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 for
docosanol, with 22 U.S. and foreign docosanol patents and 39 additional
docosanol-related patent applications pending. We also have patents and patent
applications pending on other products and technologies, and have in-licensed
the rights to market a potential product that treats multiple central nervous
system disorders that has six issued patents. 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 additional 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 that 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 negatively affect our financial condition.

The process for the approval of patent applications in foreign countries may
differ significantly from the process in the U.S. These differences may delay
our plans to market and sell docosanol 10% cream and other products in the
international marketplace. 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 and other
products in foreign markets would severely hamper our ability to generate
international sales from our first product and other products still under
development.

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

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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 involves the risk
of product liability claims by consumers and other third parties. We maintain
product liability insurance coverage for our clinical trials in the amount of
$2 million per incident and $2 million in the aggregate. However, product
liability claims can be high in the pharmaceutical industry and our insurance
may not sufficiently cover our actual
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.

We could incur significant liabilities as a result of material litigation.

In the ordinary course of business, we may face various claims brought by third
parties, including claims relating to the safety or efficacy of our products.
Any of these claims could subject us to costly litigation and, while we
generally believe that we have adequate insurance to cover any resulting
liabilities, our insurance carriers may deny coverage or our policy limits may
be inadequate to fully satisfy any damage awards or settlements. If this were
to happen, the payment of any such awards could have a material adverse effect
on our operations and financial position. Additionally, any such claims,
whether or not successful, could damage our reputation and business.




Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK

We are exposed to market risk related to changes in interest rates. Because
substantially all our revenue, expense, and capital purchasing activities are
transacted in U.S. dollars, our exposure to foreign currency exchange rates is
immaterial. However, in the future we could face increasing exposure to
foreign currency exchange rates as we expand international distribution of
docosanol 10% cream. Until such time as we are faced with material amounts of
foreign currency exchange rate risks, we do not plan to use derivative
financial instruments, which can be used to hedge such risks. We will evaluate
the use of derivative financial instruments to hedge our exposures as the needs
and risks should arise.

Interest Rate Sensitivity

Our investment portfolio consists primarily of fixed income instruments with an
average duration of 3 years as of March 31, 2002 (2.8 years as of September 30,
2001). The primary objective of our investments in debt securities is to
preserve principal while achieving attractive yields, without significantly
increasing risk. We carry some investments that we intend to hold to maturity
and others that we classify as available-for-sale. These available-for-sale
securities are subject to interest rate risk. In general, we would expect that
the volatility of this portfolio would increase as its duration increases.

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PART II OTHER INFORMATION




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

The Annual Meeting of Shareholders of AVANIR Pharmaceuticals was convened on
March 14, 2002, at 10:00 a.m. local time. There were issued and outstanding on
January 17, 2002, the record date, 58,195,381 shares of Class A common stock,
each share being entitled to one vote, and 36,500 shares of the Companys Class
B common stock, each share being entitled to five votes, constituting all of
the outstanding voting securities of the Company. There were present at the
meeting in person or by proxy, shareholders of the Company who were the holders
of 55,815,641 votes of the Companys common stock entitled to vote thereat,
constituting a quorum. The following votes were cast for each nominee for
election to the Board of Directors:

|                  |  |     |            |          |  |  |           | 
|----------------- |  | --- | ---------- | -------- |  |  | --------- | 
|                  |  | For |            | Withhold
|                  |  |     |            |         
|Michael W. George |  |     | 53,628,649 |          |  |  | 2,186,992 | 
|James B. Glavin   |  |     | 51,909,442 |          |  |  | 3,906,199 | 
|Susan Golding     |  |     | 53,088,515 |          |  |  | 2,727,126 | 

The proposal to amend the 2000 Stock Option Plan (the Plan) to increase the
number of shares of Class A common stock issuable under the Plan by 1,000,000
shares, to a total of 3,3000,000 shares received the following votes:

|           |  |         |            |         |  |  |         | 
|---------- |  | ------- | ---------- | ------- |  |  | ------- | 
|For        |  | Against |            | Abstain
|           |  |         |            |        
|43,387,901 |  |         | 12,051,121 |         |  |  | 376,619 | 

The proposal to ratify the selection of Deloitte & Touche LLP as the Companys
independent auditors for the fiscal year ending September 30, 2002, received
the following votes:

|           |  |         |           |         |  |  |         | 
|---------- |  | ------- | --------- | ------- |  |  | ------- | 
|For        |  | Against |           | Abstain
|           |  |         |           |        
|54,155,717 |  |         | 1,347,016 |         |  |  | 312,908 | 

Each of the nominees was elected as Class I directors, and each of the other
proposals was accordingly approved by the shareholders of the Company.




Item 6. EXHIBITS AND REPORTS ON FORM 8-K

None.




SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

|                                                      |  |                                                                                                  |  |             
|----------------------------------------------------- |  | ------------------------------------------------------------------------------------------------ |  | ------------
|Signature                                             |  | Title                                                                                            |  | Date        
|                                                      |  |                                                                                                  |  |             
|                                                     
|/s/Gerald J. Yakatan, Ph.D.

Gerald J. Yakatan, Ph.D. |  | President and Chief Executive Officer
(Principal Executive Officer)                              |  | May 15, 2002
|                                                     
|/s/Gregory P. Hanson

Gregory P. Hanson               |  | Vice President, Finance and Chief Financial Officer
(Principal Financial and Accounting Officer) |  | May 15, 2002

29