##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 FORM 10-Q
 
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
 For the quarterly period ended June 30, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 For the transition period
from_________to_________.
 Commission
File No. 1-15803
 AVANIR PHARMACEUTICALS
  California
    
    33-0314804(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)11388 Sorrento Valley Road, San Diego, California
    
    92121(Address of principal executive offices)
    
    (Zip Code)
 (858) 622-5200
 þ o
 þ o




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##### 



Table of Contents
 PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements (unaudited)Report of Independent Registered Public Accounting Firm
    
    
    3Condensed Consolidated Balance Sheets
    
    
    4Condensed Consolidated Statements of Operations
    
    
    5Condensed Consolidated Statements of Cash Flows
    
    
    6Notes to Condensed Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    19Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    42Item 4. Controls and Procedures
    
    
    43PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    43Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    43Item 3. Defaults Upon Senior Securities
    
    
    43Item 4. Submission of Matters to a Vote of Security Holders
    
    
    43Item 5. Other Information
    
    
    43Item 6. Exhibits
    
    
    44Signatures
    
    
    45
 2




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##### 



PART I. FINANCIAL INFORMATION
 
 Item 1. FINANCIAL STATEMENTS
 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 Avanir
 Avanir
   Avanir
  
 3




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##### 



A vanir Pharmaceuticals
 
 CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 
 June 30,
    
    September 30,2005
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    3,576,849
    
    
    $
    13,494,083Short-term investments in securities
    
    
    18,166,125
    
    
    
    8,803,982Receivables, net
    
    
    123,341
    
    
    
    239,879Inventory
    
    
    6,200
    
    
    
    9,302Prepaid expenses
    
    
    1,998,616
    
    
    
    1,526,282Total current assets
    
    
    23,871,131
    
    
    
    24,073,528Investments in securities
    
    
    3,866,695
    
    
    
    2,751,867Restricted investments in securities
    
    
    856,872
    
    
    
    856,597Property and equipment, net
    
    
    6,051,182
    
    
    
    6,390,964Intangible assets, net
    
    
    3,381,741
    
    
    
    3,035,024Long-term inventory
    
    
    355,179
    
    
    
    Other assets
    
    
    281,066
    
    
    
    295,973TOTAL ASSETS
    
    $
    38,663,866
    
    
    $
    37,403,953LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    3,003,055
    
    
    $
    1,961,938Accrued expenses and other liabilities
    
    
    3,695,316
    
    
    
    2,418,209Accrued compensation and payroll taxes
    
    
    1,091,199
    
    
    
    710,368Current portion of deferred revenue
    
    
    1,976,871
    
    
    
    1,961,530Current portion of notes payable
    
    
    302,817
    
    
    
    211,092Current portion of capital lease obligations
    
    
    59,543
    
    
    
    156,770Total current liabilities
    
    
    10,128,801
    
    
    
    7,419,907Deferred revenue, net of current portion
    
    
    17,548,193
    
    
    
    19,047,585Notes payable, net of current portion
    
    
    603,884
    
    
    
    703,560Capital lease obligations, net of current portion
    
    
    16,165
    
    
    
    35,642Total liabilities
    
    
    28,297,043
    
    
    
    27,206,694COMMITMENTS AND CONTINGENCIES(Note 14)SHAREHOLDERS EQUITY:Preferred stock  no par value, 10,000,000 shares
authorized, no shares issued and outstanding as of
June 30, 2005 and September 30, 2004
    
    
    
    
    
    
    Common stock  no par value, Class A, 200,000,000
shares authorized, 108,344,660 and 95,305,757
shares issued and outstanding as of June 30, 2005
and September 30, 2004, respectively
    
    
    164,250,777
    
    
    
    134,687,535Accumulated deficit
    
    
    (153,752,982
    )
    
    
    (124,405,902
    )Accumulated other comprehensive loss
    
    
    (130,972
    )
    
    
    (84,374
    )Total shareholders equity
    
    
    10,366,823
    
    
    
    10,197,259TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    38,663,866
    
    
    $
    37,403,953
  4




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##### 



A vanir Pharmaceuticals
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 
 Three months ended
    
    Nine months endedJune 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004REVENUES:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    

Research contracts and licenses
    
    $
    2,763,014
    
    
    $
    
    
    
    $
    3,063,014
    
    
    $
    270,500Royalties and sale of royalty rights
    
    
    455,937
    
    
    
    351,517
    
    
    
    1,386,067
    
    
    
    1,237,029Government research grants
    
    
    114,887
    
    
    
    222,437
    
    
    
    400,455
    
    
    
    661,968Product sales
    
    
    
    
    
    
    17,400
    
    
    
    17,400
    
    
    
    787,338
    

Total revenues
    
    
    3,333,838
    
    
    
    591,354
    
    
    
    4,866,936
    
    
    
    2,956,835OPERATING EXPENSES:Research and development
    
    
    6,470,317
    
    
    
    5,096,979
    
    
    
    22,952,728
    
    
    
    15,839,108General and administrative
    
    
    2,824,498
    
    
    
    1,232,151
    
    
    
    6,650,465
    
    
    
    4,144,574Sales and marketing
    
    
    2,414,578
    
    
    
    936,802
    
    
    
    4,911,797
    
    
    
    2,517,399Cost of product sales
    
    
    
    
    
    
    3,102
    
    
    
    3,102
    
    
    
    213,192Total operating expenses
    
    
    11,709,393
    
    
    
    7,269,034
    
    
    
    34,518,092
    
    
    
    22,714,273LOSS FROM OPERATIONS
    
    
    (8,375,555
    )
    
    
    (6,677,680
    )
    
    
    (29,651,156
    )
    
    
    (19,757,438
    )Interest income
    
    
    179,042
    
    
    
    57,201
    
    
    
    426,021
    
    
    
    169,469Interest expense
    
    
    (22,513
    )
    
    
    (7,706
    )
    
    
    (69,458
    )
    
    
    (28,233
    )

Other income (expense), net
    
    
    11,496
    
    
    
    11,116
    
    
    
    (50,575
    )
    
    
    30,485LOSS BEFORE INCOME TAXES
    
    
    (8,207,530
    )
    
    
    (6,617,069
    )
    
    
    (29,345,168
    )
    
    
    (19,585,717
    )Provision for income taxes
    
    
    (14
    )
    
    
    (424
    )
    
    
    (1,912
    )
    
    
    (2,544
    )NET LOSS
    
    $
    (8,207,544
    )
    
    $
    (6,617,493
    )
    
    $
    (29,347,080
    )
    
    $
    (19,588,261
    )NET LOSS PER SHARE:BASIC AND DILUTED
    
    $
    (0.08
    )
    
    $
    (0.08
    )
    
    $
    (0.29
    )
    
    $
    (0.27
    )WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING:BASIC AND DILUTED
    
    
    107,367,798
    
    
    
    78,256,417
    
    
    
    100,485,329
    
    
    
    73,740,318
  5




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##### 



A vanir Pharmaceuticals
 
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
 Nine Months Ended June 30,2005
    
    2004OPERATING ACTIVITIES:Net loss
    
    $
    (29,347,080
    )
    
    $
    (19,588,261
    )Adjustments to reconcile net loss to net cash used for
operating activities:Depreciation and amortization
    
    
    1,547,279
    
    
    
    1,198,306Compensation paid with stock options
    
    
    8,103
    
    
    
    32,170Expense for issuance of common stock in connection with
the acquisition of additional contractual rights to
Neurodex (Note 12)
    
    
    5,300,000
    
    
    
    Other-than-temporary impairment of investment
    
    
    84,252
    
    
    
    Loss on disposal of assets
    
    
    3,085
    
    
    
    Intangible assets abandoned
    
    
    234,232
    
    
    
    Changes in operating assets and liabilities:Receivables
    
    
    116,538
    
    
    
    51,686Inventory
    
    
    (352,077
    )
    
    
    201,552Prepaid expenses and other assets
    
    
    (467,365
    )
    
    
    534,981Accounts payable
    
    
    990,155
    
    
    
    (616,513
    )Accrued expenses and other liabilities
    
    
    1,126,957
    
    
    
    1,269,157Accrued compensation and payroll taxes
    
    
    380,831
    
    
    
    (4,445
    )Deferred revenue
    
    
    (1,484,051
    )
    
    
    (1,281,145
    )Net cash used for operating activities
    
    
    (21,859,141
    )
    
    
    (18,202,512
    )INVESTING ACTIVITIES:Investments in securities
    
    
    (18,438,209
    )
    
    
    (8,116,389
    )Proceeds from sales and maturities of investments in securities
    
    
    7,830,113
    
    
    
    700,000Patent costs
    
    
    (918,735
    )
    
    
    (873,111
    )Proceeds from sale of equipment
    
    
    800
    
    
    
    Purchases of property and equipment
    
    
    (662,548
    )
    
    
    (89,780
    )Net cash used for investing activities
    
    
    (12,188,579
    )
    
    
    (8,379,280
    )FINANCING ACTIVITIES:Proceeds from issuance of common stock and warrants, net
    
    
    24,255,141
    
    
    
    34,406,139Proceeds from issuance of notes payable
    
    
    249,472
    
    
    
    159,918Payments on notes and capital lease obligations
    
    
    (374,127
    )
    
    
    (474,193
    )Net cash provided by financing activities
    
    
    24,130,486
    
    
    
    34,091,864Net (decrease) increase in cash and cash equivalents
    
    
    (9,917,234
    )
    
    
    7,510,072Cash and cash equivalents at beginning of period
    
    
    13,494,083
    
    
    
    12,198,408Cash and cash equivalents at end of period
    
    $
    3,576,849
    
    
    $
    19,708,480SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Interest paid
    
    $
    69,458
    
    
    $
    28,233Income taxes paid
    
    $
    1,912
    
    
    $
    2,368NONCASH INVESTING ACTIVITIES:Purchases of property and equipment which are included in
accounts payable and accrued expenses
    
    $
    201,112
    
    
    $
    
  6




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##### 



A vanir Pharmaceuticals
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
 1. BASIS OF PRESENTATION
 Avanir Avanir
  Avanir
 2. STOCK-BASED COMPENSATION
   7




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##### 



Three Months Ended
    
    Nine Months EndedJune 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004Net loss, as reported
    
    $
    (8,207,544
    )
    
    $
    (6,617,493
    )
    
    $
    (29,347,080
    )
    
    $
    (19,588,261
    )Add: Stock-based employee
compensation expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24,069Deduct: Total stock-based
employee compensation expense
determined under fair value based
method for all awards
    
    
    (703,263
    )
    
    
    (258,127
    )
    
    
    (1,419,193
    )
    
    
    (832,626
    )Pro forma net loss
    
    $
    (8,910,807
    )
    
    $
    (6,875,620
    )
    
    $
    (30,766,273
    )
    
    $
    (20,396,818
    )Net loss per share:Basic and diluted  as reported
    
    $
    (0.08
    )
    
    $
    (0.08
    )
    
    $
    (0.29
    )
    
    $
    (0.27
    )Basic and diluted  pro forma
    
    $
    (0.08
    )
    
    $
    (0.09
    )
    
    $
    (0.31
    )
    
    $
    (0.28
    )
  3. BALANCE SHEET DETAILS
  Receivables, net.
 June 30,
    
    September 30,2005
    
    2004Total receivables
    
    $
    146,140
    
    
    $
    257,379Allowance for doubtful accounts
    
    
    (22,799
    )
    
    
    (17,500
    )Receivables, net
    
    $
    123,341
    
    
    $
    239,879
 8




---



##### 



Property and equipment, net.
 June 30, 2005
    
    September 30, 2004Gross
    
    
    
    
    
    
    
    
    
    GrossCarrying
    
    Accumulated
    
    
    
    
    
    Carrying
    
    AccumulatedValue
    
    Depreciation
    
    Net
    
    Value
    
    Depreciation
    
    NetResearch and
development
equipment
    
    $
    4,020,668
    
    
    $
    (2,558,291
    )
    
    $
    1,462,377
    
    
    $
    3,701,461
    
    
    $
    (2,021,193
    )
    
    $
    1,680,268Computer equipment
and related
software
    
    
    1,107,794
    
    
    
    (661,677
    )
    
    
    446,117
    
    
    
    999,073
    
    
    
    (545,953
    )
    
    
    453,120Leasehold
improvements
    
    
    5,034,679
    
    
    
    (1,500,667
    )
    
    
    3,534,012
    
    
    
    5,032,605
    
    
    
    (1,048,184
    )
    
    
    3,984,421Construction in
progress
    
    
    354,712
    
    
    
    
    
    
    
    354,712
    
    
    
    
    
    
    
    
    
    
    
    Office equipment,
furniture, and
fixtures
    
    
    607,150
    
    
    
    (353,186
    )
    
    
    253,964
    
    
    
    558,970
    
    
    
    (285,815
    )
    
    
    273,155Total property
and equipment
    
    $
    11,125,003
    
    
    $
    (5,073,821
    )
    

    $
    6,051,182
    
    
    $
    10,292,109
    
    
    $
    (3,901,145
    )
    
    $
    6,390,964
  Intangible assets.
 Avanir
  9




---



##### 



June 30, 2005
    
    September 30, 2004Gross
    
    
    
    
    
    
    
    
    
    GrossCarrying
    
    Accumulated
    
    
    
    
    
    Carrying
    
    AccumulatedValue
    
    Amortization
    
    Net
    
    Value
    
    Amortization
    
    NetIntangible assets with
finite lives:Patent applications
pending (1)
    
    $
    2,891,401
    
    
    $
    (336,485
    )
    
    $
    2,554,916
    
    
    $
    2,462,704
    
    
    $
    (166,000
    )
    
    $
    2,296,704Patents (2)
    
    
    1,245,508
    
    
    
    (467,603
    )
    
    
    777,905
    
    
    
    1,010,097
    
    
    
    (339,552
    )
    
    
    670,545Licenses
    
    
    42,461
    
    
    
    (17,339
    )
    
    
    25,122
    
    
    
    42,461
    
    
    
    (15,647
    )
    
    
    26,814Total intangible
assets with finite
lives
    
    
    4,179,370
    
    
    
    (821,427
    )
    
    
    3,357,943
    
    
    
    3,515,262
    
    
    
    (521,199
    )
    
    
    2,994,063Intangible assets with
indefinite useful
lives (3)
    
    
    23,798
    
    
    
    
    
    
    
    23,798
    
    
    
    40,961
    
    
    
    
    
    
    
    40,961Total intangible assets
    
    $
    4,203,168
    
    
    $
    (821,427
    )
    
    $
    3,381,741
    
    
    $
    3,556,223
    
    
    $
    (521,199
    )
    
    $
    3,035,024
 
 (1)
    
    Patent applications pending include the net effect of $37,491 and $207,819 (net of
accumulated amortization of $3,568 and $21,889) in intangible assets abandoned during the
three-month and nine-month periods ended June 30, 2005, respectively. We abandoned certain
therapeutic use patents pending in selected countries, because we were able to obtain
superior claims in composition-of-matter patents.(2)
    
    Patents include the net effect of $0 and $2,944 (net of accumulated amortization of $0
and $68) in intangible assets abandoned during the three-month and nine-month periods ended
June 30, 2005, respectively.(3)
    
    Intangible assets with indefinite useful lives include the net effect of $14,301 and
$23,469 in trademarks abandoned during the three-month and nine-month periods ended June
30, 2005, respectively.  Amortization ExpenseFiscal year ending September 30:2005 (remaining three months)
    
    $
    57,0002006
    
    
    228,0002007
    
    
    229,0002008
    
    
    228,0002009
    
    
    226,000Thereafter
    
    
    2,390,000Total
    
    $
    3,358,000
 4. INVENTORY
  10




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##### 



5. DEFERRED REVENUE
   Avanir
 Drug Royalty
    
    OtherUSA Agreement
    
    Agreements
    
    TotalDeferred revenue as of September 30, 2004
    
    $
    20,800,782
    
    
    $
    208,333
    
    
    $
    21,009,115Changes during the period:Recognized as revenue during period
    
    
    (1,384,051
    )
    
    
    (100,000
    )
    
    
    (1,484,051
    )Deferred revenue as of June 30, 2005
    
    $
    19,416,731
    
    
    $
    108,333
    
    
    $
    19,525,064Classified
and reported as:Current portion of deferred revenue
    
    $
    1,943,538
    
    
    $
    33,333
    
    
    $
    1,976,871Deferred revenue, net of current portion
    
    
    17,473,193
    
    
    
    75,000
    
    
    
    17,548,193Total deferred revenue
    
    $
    19,416,731
    
    
    $
    108,333
    
    
    $
    19,525,064
 6. REVENUE RECOGNITION
  Contract Revenue from Collaborations
 11




---



##### 



Royalty revenues.
 Revenues from sale of royalty rights.
 Revenue arrangements with multiple deliverables.
 Government research grant revenue.
 12




---



##### 



Product sales  Active Pharmaceutical Ingredient Docosanol.
 7. INVESTMENTS
   
    
    Debt securities that we have the positive intent and ability to hold to maturity are
classified as held-to-maturity securitiesand reported at amortized cost.
    
    Debt and equity securities that are bought and held principally for the purpose of
selling them in the near term are classified as trading securitiesand reported at fair
value, with unrealized gains and losses included in our Consolidated Statement of
Operations.
    
    Debt and equity securities not classified as either held-to-maturity securities or
trading securities are classified as available-for-sale securitiesand reported at fair
value, with unrealized gains and losses excluded from the Consolidated Statement of
Operations and reported in a separate component of shareholders equity.
  13




---



##### 



Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains (1)
    
    Losses (1)
    
    ValueAs of June 30, 2005:Certificates of deposit
    
    $
    956,872
    
    
    $
    255
    
    
    $
    
    
    
    $
    957,127Government debt securities
    
    
    22,063,792
    
    
    
    
    
    
    
    (131,227
    )
    
    
    21,932,565Total
    
    $
    23,020,664
    
    
    $
    255
    
    
    $
    (131,227
    )
    
    $
    22,889,692Classified
and reported as:Short term investments:Classified as available-for-sale
    
    $
    18,166,125Long term investments:Classified as available-for-sale
    
    
    3,866,695Restricted investments in
securities (3)
    
    
    856,872Long-term investments
    
    
    4,723,567Total
    
    $
    22,889,692
 Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains (4)
    
    Losses (4)
    
    ValueAs of September 30, 2004:Certificates of deposit
    
    $
    1,356,597
    
    
    $
    3,558
    
    
    $
    
    
    
    $
    1,360,155Adjustable rate mutual fund (2)
    
    
    3,014,365
    
    
    
    
    
    
    
    (68,650
    )
    
    
    2,945,715Government debt securities
    
    
    8,125,858
    
    
    
    6,186
    
    
    
    (25,468
    )
    
    
    8,106,576Total
    
    $
    12,496,820
    
    
    $
    9,744
    
    
    $
    (94,118
    )
    
    $
    12,412,446Classified
and reported as:Short term investments:Classified as available-for-sale
    
    $
    8,803,982Long term investments:Classified as available-for-sale
    
    
    2,751,867Restricted investments in
securities (3)
    
    
    856,597Long-term investments
    
    
    3,608,464Total
    
    $
    12,412,446
 
 (1)
    
    Gross unrealized gains of $255 on certificates of deposit and gross unrealized losses of
$131,227 on government debt securities represent an accumulated net unrealized loss of
$130,972, which is reported as accumulated other comprehensive loss on the consolidated
balance sheet as of June 30, 2005.(2)
    
    Represents an investment in a mutual fund that invested primarily in adjustable rate
mortgage-backed securities. We sold the investment in February 2005.(3)
    
    Represents amounts pledged to our bank as collateral for letters of credit issued in
connection with our leases of office and laboratory space.(4)
    
    Gross unrealized gains of $9,744 and gross unrealized losses of $94,118 on government
securities, the adjustable rate mutual fund, and certificates of deposit represent an
accumulated net unrealized loss of $84,374, which is reported as accumulated other
comprehensive loss on the consolidated balance sheet as of September 30, 2004. 8. COMPUTATION OF NET LOSS PER COMMON SHARE
  14




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##### 



9. COMPREHENSIVE LOSS
  Three Months Ended
    
    Nine Months EndedJune 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004Net loss
    
    $
    (8,207,544
    )
    
    $
    (6,617,493
    )
    
    $
    (29,347,080
    )
    
    $
    (19,588,261
    )Other comprehensive
loss, net of tax:Unrealized gain
(loss) on
available-for-sale
securities
    
    
    (46,069
    )
    
    
    (74,781
    )
    
    
    (46,598
    )
    
    
    (105,542
    )Total comprehensive loss
    
    $
    (8,253,613
    )
    
    $
    (6,692,274
    )
    
    $
    (29,393,678
    )
    
    $
    (19,693,803
    )
 10. SHAREHOLDERS EQUITY
 Preferred stock.
 Class A common stock.
     15




---



##### 



11. COLLABORATIVE AGREEMENT
    12. RELATED PARTY TRANSACTIONS
  Avanir
 16




---



##### 



13. RECENT ACCOUNTING PRONOUNCEMENTS
   14. COMMITMENTS AND CONTINGENCIES
  15. SEGMENT INFORMATION
  16. SUBSEQUENT EVENTS
  17




---



##### 



18




---



##### 



Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  EXECUTIVE OVERVIEW
 Avanir
  19




---



##### 



20




---



##### 



21




---



##### 



info@avanir.com Avanir www.avanir.com www.sec.gov www.avanir.com.
 RESULTS OF OPERATIONS
 COMPARISON OF THREE MONTHS ENDED JUNE 30, 2005 AND 2004
 Revenues
   Revenue-generating Contracts
   Expenses
 Operating expenses.
 22




---



##### 



Three Months Ended
    
    Nine Months EndedJune 30
    
    June 302005
    
    2004
    
    2005
    
    2004Operating expenses:Research and development
    
    
    55
    %
    
    
    70
    %
    
    
    66
    %
    
    
    70
    %General and administrative
    
    
    24
    %
    
    
    17
    %
    
    
    20
    %
    
    
    18
    %Sales and marketing
    
    
    21
    %
    
    
    13
    %
    
    
    14
    %
    
    
    11
    %Costs of sales
    
    
    
    %
    
    
    
    %
    
    
    
    %
    
    
    1
    %Total operating expenses
    
    
    100
    %
    
    
    100

    %
    
    
    100
    %
    
    
    100
    %
 Research and development (R&D) expenses.
      23




---



##### 



Research and Development Projects and Expenses
 EstimatedThree Months Ended
    
    Nine Months Ended
    
    Inception
    
    Cost toJune 30,
    
    June 30,
    
    Through
    
    License orJune 30,
    
    Complete2005 (1)
    
    2004 (1)
    
    2005 (1)
    
    2004 (1)
    
    2005 (1) (2)
    
    Project (1)Company-funded Projects:Develop Neurodex for
FDA marketing approval in
treating PBA. Estimated
cost and timing to reach
NDA decision by the first
half of 2006 (3)
    
    $
    1,869,968
    
    
    $
    2,145,760
    
    
    $
    11,571,736
    
    
    $
    6,343,674
    
    
    $
    29,594,451
    
    
    $
    5.3M
    (4)Develop Neurodex for
neuropathic pain. Phase II
open-label study
completed. Estimated cost
and timing to complete one
Phase III trial and
license the product: up to
2 years (5)
    
    
    1,319,008
    
    
    
    464,539
    
    
    
    3,271,727
    
    
    
    1,571,850
    
    
    
    9,717,170
    
    
    $
    9M
    (6)Development program for
asthma. Estimated timing
to complete Phase I and
license the product: up to
18 months
    
    
    964,369
    
    
    
    1,000,412
    
    
    
    2,109,562
    
    
    
    2,950,030
    
    
    
    20,310,766
    
    
    $
    2MOther projects involving
monoclonal antibodies and
docosanol
    
    
    534,289
    
    
    
    524,318
    
    
    
    1,548,942
    
    
    
    1,920,014
    
    
    
    15,164,406
    
    
    
    3⁄4
    (7)Partner-funded Projects:Preclinical
atherosclerosis research
program.
    
    
    1,301,463
    
    
    
    329,169
    
    
    
    3,116,258
    
    
    
    787,913
    
    
    
    6,383,014
    
    
    
    3⁄4
    (8)Preclinical
anti-inflammatory research
program (MIF inhibitor)
    
    
    353,706
    
    
    
    369,991
    
    
    
    929,886
    
    
    
    1,439,583
    
    
    
    11,071,974
    
    
    
    3⁄4
    (9)Government-funded Projects:Preclinical research,
primarily for potential
treatments for genital
herpes and anthrax.
Estimated timing to
complete the various
projects up to 18 months
    
    
    127,514
    
    
    
    262,790
    
    
    
    404,617
    
    
    
    826,044
    
    
    
    2,444,953
    
    
    $
    0.3 M
    (10)Total
    
    $
    6,470,317
    
    
    $
    5,096,979
    
    
    $
    22,952,728
    
    
    $
    15,839,108
    
    
    $
    94,686,734
 
 (1)
    
    Each project includes an allocation of laboratory occupancy costs. M refers to
millions. Estimated costs and timing to complete the projects are subject to the
availability of funds. For each of the projects set forth in the table, other than
Neurodex for PBA, the atherosclerosis program and the MIF inhibitor, we are seeking
development partners or licensees to defray part or all of the ongoing development costs.(2)
    
    Inception dates are on or after October 1, 1998, at which time we began identifying
and tracking program costs.(3)
    
    The amount for the nine-month period ended June 30, 2005 includes $5.8 million which is
80% of the $1.9 million cash and non-cash charge of $5.3 million related to the acquisition
of additional contractual rights to Neurodex (see Note 12, Related Party Transactions, in
Notes to Condensed Consolidated Financial Statements (Unaudited)). 24




---



##### 



(4)
    
    Total expenditures of $5.3 million include plans for continuing the open label study
until product launch in 2006 assuming the FDA approves Neurodex on a timely basis.(5)
    
    The amount for the nine-month period ended June 30, 2005 includes $1.4 million which is
20% of the $1.9 million cash and non-cash charge of $5.3 million related to the acquisition
of additional contractual rights to Neurodex (see Note 12, Related Party Transactions, in
Notes to Condensed Consolidated Financial Statements (Unaudited)).(6)
    
    Licensing and/or co-promotion alternatives are being explored whereby the partner
would fund a portion of clinical development. See Status of R&D Programs and Plans.
Program expenditures for Neurodex for the treatment of neuropathic pain during each of the
listed periods include allocated costs of certain research programs that are shared with
Neurodex for PBA. We expect that a second Phase III clinical trial will be required and we
are exploring co-promotion opportunities in which our partner may fund the second trial, if
the first trial is successful. There can be no assurances that we will choose to or be
able to negotiate a licensing and/or co-promotion arrangement for Neurodex on
attractive terms, if at all.(7)
    
    The costs and timing to complete projects involving development of antibodies to
target antigens are unpredictable because of the uncertainty of outcomes of the research.
Ongoing development of docosanol is limited to those efforts required to support due
diligence performed by potential new licensees and our partners, as well as to support new
drug applications in new territories.(8)
    
    Effective July 8, 2005, we entered into an exclusive licensing and research
collaboration agreement with AstraZeneca, whereby AstraZeneca will be funding all future
development of the project. We estimate our participation will
represent $2.5 million to $3.8 million a year in expenses reimbursable by AstraZeneca for three
years.(9)
    
    Effective April 27, 2005, we entered into a research, development and
commercialization agreement with Novartis, whereby Novartis will be funding all future
development of the project. We estimate we will provide research
services in the range of $1.5
million to $2.5 million a year that will be paid by Novartis,
for two years from the date of the agreement or longer, upon mutual
agreement of the parties.(10)
    
    Represents the remaining balance of $264,000 for a Federal research grant award for
research related to anthrax. Status of R&D Programs and Plans  Company-funded Projects
 Neurodex for the treatment of PBA.
 Neurodex for the treatment of neuropathic pain.
 Development program for asthma (IgE regulator).
 Status of R&D Programs and Plans  Partner-funded Projects
 Anti-inflammatory research program (MIF inhibitor).
 25




---



##### 



Development program for atherosclerosis.
  Status of R&D programs and plans  government-funded projects
 .
 Monoclonal antibodies to anthrax toxin.
 26




---



##### 



General and administrative expenses.
 
    
    a $584,000 severance expense related to the resignation of the CEO;
    
    a $537,000 increase related to professional services mainly associated with corporate
governance, securities compliance and compliance with the Sarbanes-Oxley Act of 2002; and
    
    a $186,000 increase in recruiting fees and temporary labor costs.
  Sales and marketing expenses.
 Interest Income
  Net Loss
  COMPARISON OF NINE MONTHS ENDED JUNE 30, 2005 AND 2004
 Revenues
  27




---



##### 



Expenses
 Operating Expenses
 Research and Development Expenses
 General and Administrative Expenses
 
    
    a $584,000 severance expense related to the resignation of the CEO;
    
    a $923,000 increase related to professional services mainly associated with corporate
governance, securities compliance and compliance with the Sarbanes-Oxley Act of 2002;
    
    a $231,000 increase in recruiting fees mainly due to hiring key marketing and sales
positions; and
    
    a $161,000 increase in temporary labor expenses.
 Sales and Marketing Expenses
 Net Loss
  LIQUIDITY AND CAPITAL RESOURCES
  28




---



##### 



IncreaseJune 30,
    
    (Decrease)
    
    September 30,2005
    
    During Period
    
    2004Cash, cash equivalents and investment in securities
    
    $
    26,466,541
    
    
    $
    560,012
    
    
    $
    25,906,529Cash and cash equivalents
    
    $
    3,576,849
    
    
    $
    (9,917,234
    )
    
    $
    13,494,083Net working capital
    
    $
    13,742,330
    
    
    $
    (2,911,291
    )
    
    $
    16,653,621
 Nine Months
    
    
    
    
    
    Nine MonthsEnded
    
    Change
    
    EndedJune 30,
    
    Between
    
    June 30,2005
    
    Periods
    
    2004Net cash used for operating activities
    
    $
    (21,859,141
    )
    
    $
    (3,656,629
    )
    
    $
    (18,202,512
    )Net cash used for investing activities
    
    
    (12,188,579
    )
    
    
    (3,809,299
    )
    
    
    (8,379,280
    )Net cash provided by financing activities
    
    
    24,130,486
    
    
    
    (9,961,378
    )
    
    
    34,091,864Net increase (decrease) in cash and cash equivalents
    
    $
    (9,917,234
    )
    
    $
    (17,427,306
    )
    
    $
    7,510,072
 Operating activities.
 Investing activities.
 Financing activities.
 29




---



##### 



Avanir
    MANAGEMENT OUTLOOK
  30




---



##### 



CRITICAL ACCOUNTING POLICIES AND ESTIMATES
   Revenue Recognition
  Contract Revenue from Collaborations
 Royalty
revenues .
 31




---



##### 



Revenues
from sale of royalty rights
 Revenue
arrangements with multiple deliverables
 Government
research grant revenue.
 Product
sales  Active Pharmaceutical Ingredient Docosanol.
 Recognition of Expenses in Outsourced Contracts
  32




---



##### 




    
    The technology is in the early stage of development and has no alternative uses;
    
    There is substantial uncertainty of the technology or product being successful;
    
    There will be difficulty in completing the remaining development; and
    
    There is substantial cost to complete the work.
 Research and Development Expenses
  Acquired contractual rights
 Capitalization and Valuation of Long-Lived and Intangible Assets
   
    
    A significant underperformance relative to expected historical or projected future
operating results;
    
    A significant change in the manner of our use of the acquired asset or the strategy for
our overall business; and/or
    
    A significant negative industry or economic trend.
  33




---



##### 



RECENT ACCOUNTING PRONOUNCEMENTS
  RISK FACTORS
 Risks Relating to Our Business
 We have a history of losses and we may never achieve or maintain profitability.
   We recently submitted our Neurodex clinical trial results to the FDA for review and approval. Any
delay or adverse decisions in the regulatory review or approval process may harm our prospects and
could harm our stock price.
   34




---



##### 



Changes in board and management composition could adversely affect our operations.
  Our inability to attract and retain key management and scientific personnel could negatively affect
our business.
   We have yet to market or sell Neurodex or any of our other potential products.
   35




---



##### 



We expect that we will need to raise additional capital to fund ongoing operations through at least
2006. If we are unable to raise additional capital, we may be forced to curtail operations. If we
succeed in raising additional capital through a licensing or financing transaction, it may affect
our stock price and future revenues.
  
    
    If we raise capital through licensing or sales of one or more of our technologies or
drug candidates, then we may not realize revenues from sales of any of our products that
are successfully developed, approved by the FDA and marketed, or our share of such revenues
may be substantially reduced. If we license any of our technologies or drug candidates,
then the development of these products or technologies will no longer be in our control. A
licensee might never reach any of the payment milestones in a license agreement. Further,
if we sell any of our technologies or drug candidates, the sales price may not fully cover
our investment in such technology or drug candidate.
    
    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, or securities, such as preferred
stock, convertible into our Class A common stock at a discount to our current market price,
the value of the shares of Class A common stock then outstanding may be reduced. Further,
even if we were to sell shares of common stock at prices equal to or higher than the
current market price, the issuance of additional shares may depress the market price of our
Class A common stock and will dilute voting rights of our other shareholders.
  Developing and testing a drug candidate is a very expensive and time-consuming process that may not
ultimately lead to a marketable product.
  36




---



##### 



We expect our quarterly operating results to fluctuate significantly from period-to-period for a
number of reasons.
  
    
    New partnering arrangements We are currently seeking co-promotion or licensing
partners for docosanol 10% cream and our compound targeting IgE (allergy and asthma). We
are also evaluating the potential benefits of a co-promotion for Neurodex. It is
difficult to predict whether any of these discussions will result in a partnering or
license arrangement and what the financial terms of such an arrangement might be.
    
    Performance under partnering arrangements The recognition of the revenue under our
partnering arrangements, including our license agreements for our MIF and RCT programs,
will partially depend on the efforts and performance of our licensees in reaching milestones
that are outside our control. Such milestones may include specific events, such as
regulatory approval, product launch, the passage of time, or reaching a sales threshold.
    
    Limited rights to future Abreva® royalties In December 2002, we sold to Drug Royalty
USA the rights to a substantial portion of our future royalty revenues from sales of Abreva
by GlaxoSmithKline. We will not receive any future royalty payments unless and until
annual Abreva wholesale sales exceed $62 million, at which time we will receive one-half of
the stated royalty rate on any excess sales. We estimate that net
sales for royalty calculation purposes reached
approximately 89% of the $62 million threshold in 2004. We expect that any royalty
payments on these excess sales, if any, would occur only once a year, after the end of each
calendar year.
    
    Concentration of significant customers, suppliers and
industries Milestone payments,
royalties earned, and revenues recognized from the sale of rights to royalties from a
single licensee (GlaxoSmithKline) accounted for approximately 48%, 73% and 95% of our
fiscal 2004, 2003 and 2002 revenues, respectively. We have now received all of the
milestone payments from GlaxoSmithKline for North America. With the sale of our Abreva
royalty rights to Drug Royalty USA, future royalty payments from GlaxoSmithKline will come
exclusively from our remaining 50% share of Abreva royalties on contract sales in excess of
$62 million a year. Additionally, we purchase the raw material docosanol from a sole
foreign supplier that has been approved by the FDA for manufacturing. Any disturbances or
delays in the manufacture of docosanol or other raw materials for our products and clinical
research programs could seriously and adversely affect our business.
    
    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 that 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 or our acquisition or alliance
activities, to the extent they exist in the future, are not successful.
 37




---



##### 



Our stock price has been highly volatile and investors may not be able to sell their shares at or
above the price they pay for them.
  
    
    Unfavorable announcements by us regarding Neurodex, clinical trial results or results of
operations;
    
    Our success or failure in entering into license and/or co-promotion arrangements for our
products and product candidates;
    
    Delays in meeting goals or performance milestones by us or our partners;
    
    Comments made by securities analysts, including changes in their recommendations;
    
    Announcements of financing transactions and/or future sales of equity or debt securities;
    
    Announcements by us of significant acquisitions, strategic partnerships, joint ventures,
or capital commitments;
    
    Sales of our Class A common stock by our directors, officers, or significant shareholders;
    
    Announcements by our competitors of clinical trial results or product approvals; and
    
    Market and economic conditions.
   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.
  
    
    The claims in any pending patent applications will be allowed or that patents will be
granted;
    
    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 be not be available to us;
    
    Any of our issued patents will provide us with significant competitive advantages; or
    
    Challenges will not be instituted against the validity or enforceability of any patent
that we own or, if instituted, that these challenges will not be successful.
 38




---



##### 



We depend on third parties to manufacture compounds for our drugs and drug candidates. The failure
of these third parties to perform successfully could harm our business.
  Because we depend on clinical research centers and other contractors for clinical testing and for
certain research and development activities, the results of our clinical trials and such research
activities are, to a certain extent, beyond our control.
  Developing new pharmaceutical products for human use involves product liability risks, for which we
currently have limited insurance coverage.
  Abreva® faces competition from a number of existing and well-established products and the
companies that market these products.
  39




---



##### 



Our future financial results will be affected by changes in the accounting rules governing the
recognition of stock-based compensation expense.
  Business interruptions could adversely affect our business.
  The board of directors has the authority to effect a reverse stock split within a stated range
until March 16, 2006. If implemented, the reverse stock split may negatively affect the price and
liquidity of our Class A common stock.
  Avanir and its licensees may not be successful in obtaining regulatory approval of
docosanol 10% cream immediately as an OTC product in additional countries, or in licensing,
marketing and selling the product in any other countries.
 Avanir
 
    
    Regulatory approval requirements differ by country, and obtaining approvals to market
the drug in foreign countries may be difficult to obtain, may require additional costly and
time consuming
 40




---



##### 



clinical trials, or may require being a prescription drug 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.
 Risks Relating to Our Industry
 The pharmaceutical industry is highly competitive and most of our competitors are larger and have
greater resources. As a result, we face significant competitive hurdles.
  
    
    Antidepressants, such as ProzacÒ, CelexaÒ, ZoloftÒ, PaxilÒ,
ElavilÒ and PamelorÒ and others;
    
    Atypical antipsychotics agents, such as ZyprexaÒ, ResperdalÒ,
AbilifyÒ, GeodonÒ and others; and
    
    Other agents, such as SymmetrelÒ and Lithium
  Our industry is highly regulated and our failure or inability to comply with government regulations
regarding the development, production, testing, manufacturing and marketing of our products may
adversely affect our operations.
  41




---



##### 



Companies in our industry must protect their intellectual property rights and operate without
infringing on or misappropriating the proprietary rights of others. Our inability to do so could
be costly and could significantly affect our business prospects.
 Avanir
  
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  Interest rate sensitivity
  
 42




---



##### 



Item 4.
CONTROLS AND PROCEDURES
 Avanir
 
    
    Information required to be disclosed by the Registrant in this Quarterly Report on Form
10-Q and the other reports that the Registrant files or submits under the Exchange Act
would be accumulated and communicated to the Registrants management, including its
principal executive officer and principal financial officer, as appropriate to allow timely
decisions regarding required disclosure;
    
    Information required to be disclosed by the Registrant in this Quarterly Report on Form
10-Q and the other reports that the Registrant files or submits under the Exchange Act
would be recorded, processed, summarized and reported within the time periods specific in
the SECs rules and forms; and
    
    The Registrants disclosure controls and procedures are effective as of the end of the
period covered by this Quarterly Report on Form 10-Q to ensure that material information
relating to the Registrant and its consolidated subsidiaries is made known to them,
particularly during the period in which the Registrants periodic reports, including this
Quarterly Report on Form 10-Q, are being prepared.
  
 PART II OTHER INFORMATION
 
 Items 1. LEGAL PROCEEDINGS
  
 Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 Item 3. DEFAULTS UPON SENIOR SECURITIES
  
 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 Item 5. OTHER INFORMATION
  
 43




---



##### 



Item 6. EXHIBITS
 Exhibits10.1
    
    Research, Development and Commercialization Agreement, dated April 27,
2005, by and between AVANIRP harmaceuticals and
Novartis International Pharmaceutical Ltd.*15.1
    
    Letter on unaudited interim financial information.31.1
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 *
    
    Confidential treatment requested. 44




---



##### 



SIGNATURES
  Signature
    
    Title
    
    Date/s/ Gregory P. Hanson, CMA
    
    Vice President, Finance and Chief
    
    August 12, 2005Gregory P. Hanson, CMA
    
    Financial Officer(Principal Executive, Financial andAccounting Officer)
 45