##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934.
 For the quarterly period ended December 31, 2007
 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
(State or other jurisdiction of 
incorporation or organization)
    
    33-0314804
(I.R.S. Employer Identification No.)101 Enterprise Suite 300, Aliso Viejo, California
(Address of principal executive offices)
    
    92656
(Zip Code)
 (949) 389-6700
 þ o
  o o þ o
  o þ




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##### 



Table of Contents
 PagePART I. FINANCIAL INFORMATION
    
    
    
    3Item 1.
    
    Financial Statements
    
    
    
    3Condensed Consolidated Balance Sheets
    
    
    
    3Condensed Consolidated Statements of Operations
    
    
    
    4Condensed Consolidated Statements of Cash Flows
    
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    
    20Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    
    28Item 4.
    
    Controls and Procedures
    
    
    
    28PART II. OTHER INFORMATION
    
    
    
    29Item 1.
    
    Legal Proceedings
    
    
    
    29Item 1A.
    
    Risk Factors
    
    
    
    29Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    
    37Item 3.
    
    Defaults Upon Senior Securities
    
    
    
    37Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    
    37Item 5.
    
    Other Information
    
    
    
    37Item 6.
    
    Exhibits
    
    
    
    38SignaturesEXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. FINANCIAL STATEMENTS
 
 AVANIR PHARMACEUTICALS
CONDENSED CONSOLIDATED BALANCE SHEETS
 December 31,
    
    
    September 30,2007
    
    
    2007(unaudited)ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    28,315,460
    
    
    $
    30,487,962Short-term investments in marketable securities
    
    
    249,832
    
    
    
    1,747,761Receivables, net
    
    
    1,838,270
    
    
    
    988,450Inventories
    
    
    17,000
    
    
    
    17,000Prepaid expenses
    
    
    787,839
    
    
    
    1,479,992Current portion of restricted investments in marketable securities
    
    
    388,122
    
    
    
    688,122Total current assets
    
    
    31,596,523
    
    
    
    35,409,287Investments in marketable securities
    
    
    
    
    
    
    249,078Restricted investments in marketable securities, net of current portion
    
    
    468,475
    
    
    
    468,475Property and equipment, net
    
    
    1,115,582
    
    
    
    1,215,666Intangible assets, net
    
    
    21,005
    
    
    
    41,048Long-term inventories
    
    
    1,331,787
    
    
    
    1,337,991Other assets
    
    
    372,937
    
    
    
    374,348TOTAL ASSETS
    
    $
    34,906,309
    
    
    $
    39,095,893LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    1,136,260
    
    
    $
    307,700Accrued expenses and other liabilities
    
    
    2,630,570
    
    
    
    2,050,864Accrued compensation and payroll taxes
    
    
    659,972
    
    
    
    1,191,677Current portion of deferred revenues
    
    
    2,357,615
    
    
    
    2,267,594Current portion of notes payable
    
    
    183,278
    
    
    
    254,676Current liabilities of discontinued operations
    
    
    1,073,695
    
    
    
    Total current liabilities
    
    
    8,041,390
    
    
    
    6,072,511Accrued expenses and other liabilities, net of current portion
    
    
    1,092,736
    
    
    
    1,170,396Deferred revenues, net of current portion
    
    
    12,046,536
    
    
    
    13,052,836Notes payable, net of current portion
    
    
    11,783,395
    
    
    
    11,769,916Total liabilities
    
    
    32,964,057
    
    
    
    32,065,659COMMITMENTS AND CONTINGENCIES (NOTE 12)SHAREHOLDERS EQUITY:Preferred stock  no par value, 10,000,000 shares authorized, no
shares issued or outstanding as of December 31, 2007 and September
30, 2007
    
    
    
    
    
    
    Common stock  no par value, 200,000,000 shares authorized;
43,164,402 and 43,117,358 shares issued and outstanding as of
December 31, 2007 and September 30, 2007, respectively
    
    
    245,958,529
    
    
    
    245,531,712Accumulated deficit
    
    
    (244,017,367
    )
    
    
    (238,498,733
    )Accumulated other comprehensive income (loss)
    
    
    1,090
    
    
    
    (2,745
    )Total shareholders equity
    
    
    1,942,252
    
    
    
    7,030,234TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    34,906,309
    
    
    $
    39,095,893
  3




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##### Table of Contents



AVANIR PHARMACEUTICALS
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 Three
Months Ended December 31,2007
    
    
    2006REVENUES FROM PRODUCT SALESNet revenues
    
    $
    36,000
    
    
    $
    Cost of revenues
    
    
    6,204
    
    
    
    Product gross margin
    
    
    29,796
    
    
    
    REVENUES AND COST OF RESEARCH SERVICES AND OTHERRevenues from research and development services
    
    
    
    
    
    
    1,270,244Revenues from government research grant services
    
    
    167,647
    
    
    
    86,348Revenues from license agreements
    
    
    57,265
    
    
    
    57,265Revenue from royalties and royalty rights
    
    
    1,837,853
    
    
    
    723,040Revenues from research services and other
    
    
    2,062,765
    
    
    
    2,136,897Cost of research and development services
    
    
    (49,991
    )
    
    
    (1,164,075
    )Cost of government research grant services
    
    
    (125,587
    )
    
    
    (95,727
    )Research services and other gross margin
    
    
    1,887,187
    
    
    
    877,095Total gross margin
    
    
    1,916,983
    
    
    
    877,095OPERATING EXPENSESResearch and development
    
    
    3,426,259
    
    
    
    5,197,253Selling, general and administrative
    
    
    3,128,120
    
    
    
    9,369,862Total operating expenses
    
    
    6,554,379
    
    
    
    14,567,115Loss from operations
    
    
    (4,637,396
    )
    
    
    (13,690,020
    )OTHER INCOME (EXPENSES)Interest income
    
    
    427,162
    
    
    
    191,476Interest expense
    
    
    (234,001
    )
    
    
    (418,095
    )Other (expense) income
    
    
    (704
    )
    
    
    145,345Loss from continuing operations before provision for income taxes
    
    
    (4,444,939
    )
    
    
    (13,771,294
    )Provision for income taxes
    
    
    
    
    
    
    Loss before discontinued operations
    
    
    (4,444,939
    )
    
    
    (13,771,294
    )(Loss) income from discontinued operations
    
    
    (1,073,695
    )
    
    
    153,767Net Loss
    
    $
    (5,518,634
    )
    
    $
    (13,617,527
    )BASIC AND DILUTED NET (LOSS) INCOME PER SHARE:Loss from continuing operations
    
    $
    (0.10
    )
    
    $
    (0.40
    )(Loss) income from discontinued operations
    
    
    (0.03
    )
    
    
    0.01Net Loss per share
    
    $
    (0.13
    )
    
    $
    (0.39
    )Basic and diluted weighted average number of common shares
outstanding
    
    
    43,106,369
    
    
    
    34,626,117
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AVANIR PHARMACEUTICALS
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 Three Months Ended December 31,2007
    
    
    2006OPERATING ACTIVITIES:Net Loss
    
    $
    (5,518,634
    )
    
    $
    (13,617,527
    )Loss (income) from discontinued operations
    
    
    1,073,695
    
    
    
    (153,767
    )Adjustments to reconcile loss before discontinued operations to net
cash used in operating activities:Depreciation and amortization
    
    
    137,480
    
    
    
    658,378Share-based compensation expense
    
    
    443,909
    
    
    
    844,517Amortization of debt discount
    
    
    34,917
    
    
    
    61,000Loss on disposal of assets
    
    
    3,464
    
    
    
    Changes in operating assets and liabilities (net of effects of
acquisition/disposition of FazaClo):Receivables
    
    
    (849,820
    )
    
    
    664,709Inventories
    
    
    6,204
    
    
    
    (1,071,251
    )Prepaid and other assets
    
    
    686,552
    
    
    
    63,403Accounts payable
    
    
    828,560
    
    
    
    (7,813,240
    )Accrued expenses and other liabilities
    
    
    502,047
    
    
    
    (265,666
    )Accrued compensation and payroll taxes
    
    
    (531,705
    )
    
    
    (1,015,239
    )Deferred revenue
    
    
    (916,279
    )
    
    
    (821,828
    )Net cash used in operating activities of continuing operations
    
    
    (4,099,610
    )
    
    
    (22,466,511
    )Net cash provided by operating activities of discontinued operations
    
    
    
    
    
    
    3,364,627Net cash used in operating activities
    
    
    (4,099,610
    )
    
    
    (19,101,884
    )INVESTING ACTIVITIES:Investments in securities
    
    
    
    
    
    
    (50,440
    )Proceeds from sales and maturities of investments in securities
    
    
    2,050,841
    
    
    
    16,900,000Purchase of property and equipment
    
    
    (13,804
    )
    
    
    (86,193
    )Net cash provided by investing activities of continuing operations
    
    
    2,037,037
    
    
    
    16,763,367Net cash provided by investing activities
    
    
    2,037,037
    
    
    
    16,763,367FINANCING ACTIVITIES:Proceeds from issuances of common stock and warrants, net of
commissions
and offering costs
    
    
    
    
    
    
    14,992,979Tax withholding payments reimbursed by restricted stock
    
    
    (17,092
    )
    
    
    Payments on notes and capital lease obligations
    
    
    (92,837
    )
    
    
    (3,039,225
    )Net cash (used in) provided by financing activities of continuing
operations
    
    
    (109,929
    )
    
    
    11,953,754Net cash used in financing activities of discontinued operations
    
    
    
    
    
    
    (56,177
    )Net cash (used in) provided by financing activities
    
    
    (109,929
    )
    
    
    11,897,577Net
(decrease) increase in cash and cash equivalents
    
    
    (2,172,502
    )
    
    
    9,559,060Cash and cash equivalents at beginning of period
    
    
    30,487,962
    
    
    
    4,898,214Cash and cash equivalents at ending of period
    
    $
    28,315,460
    
    
    $
    14,457,274SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Interest paid
    
    $
    199,084
    
    
    $
    542,028Income taxes paid
    
    $
    15,050
    
    
    $
    SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:Stock subscription receivable
    
    $
    
    
    
    $
    238,365Purchase price adjustment of assumed liabilities
    
    $
    
    
    
    $
    3,067,889Accrued liabilities of discontinued operations in connection
with the Working Capital Adjustment
    
    $
    867,000
    
    
    $
    
  5




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AVANIR PHARMACEUTICALS
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 1. BASIS OF PRESENTATION
 Avanir Avanir
  ® Avanir
 2. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Nature of Business
 Avanir TM ®
 
 6




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Income Taxes
 Accounting for Uncertainty in Income Taxes  An Interpretation of FASB Statement
No. 109 Accounting for Income Taxes,
    Revenue Recognition
  Revenue Recognition. Revenue Recognition When Right of Return
Exists
 Accounting for Revenue Arrangements
with Multiple Deliverables.
 7




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##### Table of Contents



Product Sales
 Active Pharmaceutical Ingredient Docosanol (API Docosanol).
 FazaClo. (Sales from Discontinued Operations).
     8




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##### Table of Contents



Multiple Element Arrangements.
   License Arrangements.
   Research Services Arrangements. Reporting Revenue Gross as a Principal
versus Net as an Agent,
 Royalty Arrangements.
 ®
 9




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Government Research Grant Revenues.
 Cost of Revenues
  Recognition of Expenses in Outsourced Contracts
  Capitalization and Valuation of Long-Lived and Intangible Assets
 Business Combinations Goodwill and Other Intangible
Assets
 Accounting for the Impairment or Disposal of Long-Lived Assets
  
    
    A significant underperformance relative to expected historical or projected future
operating results;
    
    A significant change in the manner of our use of the acquired asset or the strategy for
our overall business; and/or
    
    A significant negative industry or economic trend.
  10




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Share-Based Compensation
    For the three months endedDecember 31,2007
    
    
    2006From Continuing Operations:Selling, general and administrative expense
    
    $
    289,364
    
    
    $
    708,605Research and development expense
    
    
    146,289
    
    
    
    122,807Share-based compensation expense related to continuing operations
    
    
    435,653
    
    
    
    831,412From Discontinued Operations:
    
    
    8,256
    
    
    
    13,105Total
    
    $
    443,909
    
    
    $
    844,517
 For the three months endedDecember 31,2007
    
    
    2006Share-based compensation expense from:Stock options
    
    $
    214,124
    
    
    $
    414,847Restricted stock units
    
    
    217,670
    
    
    
    13,265Restricted stock awards
    
    
    12,115
    
    
    
    416,405Total
    
    $
    443,909
    
    
    $
    844,517
  Recently Issued Accounting Pronouncements
 Financial Accounting Standards No. 157 (FAS 157). Fair Value Measurements
 11




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Financial Accounting Standards No. 159 (FAS 159). The
Fair Value Option for Financial Assets and Financial Liabilities Including an amendment of FASB
Statement 115
 Financial Accounting Standards No. 141(R) (FAS 141R). Business Combinations: Applying the Acquisition Method
 Financial Accounting Standards No. 160 (FAS 160). Noncontrolling Interests in Consolidated Financials, an Amendment of ARB No. 51
 3. ACQUISITION OF ALAMO PHARMACEUTICALS, INC. / SALE OF FAZACLO
    12




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Sale of FazaClo, Presentation of Discontinued Operations, and Contingency for Working Capital
Adjustment
  Accounting for the Impairment or Disposal of Long-Lived Assets
  Accounting for
Contingencies
   For the threemonths endedDecember 31, 2006REVENUES FROM PRODUCT SALESNet revenues
    
    $
    6,270,704Cost of revenues
    
    
    1,347,184Product gross margin
    
    
    4,923,520OPERATING EXPENSESResearch and development
    
    
    708,748Selling, general and administrative
    
    
    3,876,072Income from operations
    
    
    338,700OTHER INCOME (EXPENSE)Interest expense
    
    
    (184,933
    )Income before provision for income taxes
    
    
    153,767Provision for income taxes
    
    
    NET INCOME
    
    $
    153,767
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4. RELOCATION OF COMMERCIAL AND GENERAL AND ADMINISTRATIVE OPERATIONS
   September 30,
    
    
    
    
    
    December 31,2007
    
    
    Payments
    
    
    2007AdjustmentsAccrued Restructuring:Employee severance and relocation benefits
    
    $
    75,790
    
    
    $
    (44,243
    )
    
    $
    31,547Lease restructuring liabilities
    
    
    2,223,802
    
    
    
    (370,334
    )
    
    
    1,853,468Subtotal
    
    
    2,299,592
    
    
    $
    (414,577
    )
    
    
    1,885,015Less: current portion
    
    
    (1,163,627
    )
    
    
    
    
    
    
    (830,956
    )Total
    
    $
    1,135,965
    
    
    
    
    
    
    $
    1,054,059
  5. INVENTORIES
  December 31,
    
    
    September 30,2007
    
    
    2007Raw materials
    
    $
    1,348,787
    
    
    $
    1,354,991Less: current portion
    
    
    (17,000
    )
    
    
    (17,000
    )Long-term portion
    
    $
    1,331,787
    
    
    $
    1,337,991
 TM TM
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6. ACCRUED EXPENSES AND OTHER LIABILITIES
  December 31, 2007
    
    
    September 30, 2007Accrued research and development expenses
    
    $
    872,520
    
    
    $
    419,989Accrued general and administrative expenses
    
    
    619,489
    
    
    
    287,517Deferred rent
    
    
    38,677
    
    
    
    34,432Lease restructuring liabilities
    
    
    1,853,468
    
    
    
    2,223,802Other
    
    
    339,152
    
    
    
    255,520Total accrued expenses and other liabilities
    
    
    3,723,306
    
    
    
    3,221,260Less: current portion
    
    
    (2,630,570
    )
    
    
    (2,050,864
    )Non-current total accrued expenses and other liabilities
    
    $
    1,092,736
    
    
    $
    1,170,396
  7. DEFERRED REVENUES
 ®
 Drug RoyaltyUSA
    
    
    OtherAgreement
    
    
    Agreements
    
    
    TotalDeferred revenues as of October 1, 2007
    
    $
    14,738,509
    
    
    $
    581,921
    
    
    $
    15,320,430Changes during the period:Additions
    
    
    
    
    
    
    50,000
    
    
    
    50,000Recognized as revenues during period
    
    
    (838,740
    )
    
    
    (127,539
    )
    
    
    (966,279
    )Deferred revenues as of December 31, 2007
    
    $
    13,899,769
    
    
    $
    504,382
    
    
    $
    14,404,151Classified and reported as:Current portion of deferred revenues
    
    $
    2,079,801
    
    
    $
    277,814
    
    
    $
    2,357,615Deferred revenues, net of current portion
    
    
    11,819,968
    
    
    
    226,568
    
    
    
    12,046,536Total deferred revenues
    
    $
    13,899,769
    
    
    $
    504,382
    
    
    $
    14,404,151
 8. COMPUTATION OF NET LOSS PER COMMON SHARE
  15




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9. COMPREHENSIVE LOSS
  For the three monthsended December 31,2007
    
    
    2006Net loss
    
    $
    (5,518,634
    )
    
    $
    (13,617,527
    )Other comprehensive gain, net of tax:Unrealized gain on available-for-sale securities
    
    
    3,835
    
    
    
    68,001Total comprehensive loss
    
    $
    (5,514,799
    )
    
    $
    (13,549,526
    )
 10. SHAREHOLDERS EQUITY
   11. EMPLOYEE EQUITY INCENTIVE PLANS
   Stock Options
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WeightedWeighted
    
    averageaverage
    
    remainingexercise
    
    contractual
    
    Aggregateprice per
    
    term
    
    intrinsicNumber of shares
    
    share
    
    (in years)
    
    valueOutstanding, October 1, 2007
    
    
    1,040,581
    
    
    $
    7.69
    
    
    
    6.9
    
    
    $
    130,000Forfeited
    
    
    (172,791
    )
    
    $
    8.76Outstanding, December 31, 2007
    
    
    867,790
    
    
    $
    7.47
    
    
    
    7.2
    
    
    $
    1,200Vested and expected to vest in the future, December 31, 2007
    
    
    590,528
    
    
    $
    8.76
    
    
    
    6.6
    
    
    $
    580Exercisable, December 31, 2007
    
    
    430,630
    
    
    $
    10.26
    
    
    
    5.9
    
    
    $
    
    2006Expected volatility
    
    
    75
    %Weighted-average volatility
    
    
    75
    %Average expected term in years
    
    
    6.0Risk-fee interest rate (zero coupon U.S. Treasury Note)
    
    
    4.6
    %Expected dividend yield
    
    
    0
    %
   Options Outstanding
    
    Options ExercisableWeightedAverage
    
    Weighted
    
    
    
    
    
    WeightedRemaining
    
    Average
    
    
    
    
    
    AverageRange of
    
    Number
    
    Contractual
    
    Exercise
    
    Number
    
    ExerciseExercise Prices
    
    Outstanding
    
    Life in Years
    
    Price
    
    Exercisable
    
    Price$1.20 - $1.29
    
    
    150,960
    
    
    
    9.2
    
    
    $
    1.28
    
    
    
    
    
    
    $
    $2.30 - $2.28
    
    
    149,685
    
    
    
    7.9
    
    
    $
    2.42
    
    
    
    8,904
    
    
    $
    2.88$4.20 - $6.80
    
    
    128,804
    
    
    
    5.4
    
    
    $
    5.55
    
    
    
    106,304
    
    
    $
    5.45$6.92 - $9.92
    
    
    105,190
    
    
    
    7.4
    
    
    $
    8.17
    
    
    
    74,148
    
    
    $
    8.65$10.24 - $11.76
    
    
    171,396
    
    
    
    6.9
    
    
    $
    11.66
    
    
    
    110,610
    
    
    $
    11.63$12.12 - $16.60
    
    
    148,480
    
    
    
    6.8
    
    
    $
    14.14
    
    
    
    117,389
    
    
    $
    13.86$19.38 - $19.38
    
    
    13,275
    
    
    
    3.5
    
    
    $
    19.38
    
    
    
    13,275
    
    
    $
    19.38867,790
    
    
    
    7.2
    
    
    $
    7.47
    
    
    
    430,630
    
    
    $
    10.26
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Restricted stock units.
 WeightedNumber of
    
    average grantshares
    
    date fair valueUnvested, October 1, 2007
    
    
    1,914,988
    
    
    $
    2.17Granted
    
    
    525,285
    
    
    $
    1.65Vested
    
    
    (57,340
    )
    
    $
    2.79Forfeited
    
    
    (32,450
    )
    
    $
    2.15Unvested, December 31, 2007
    
    
    2,350,483
    
    
    $
    2.04
   Restricted stock awards
 WeightedNumber of
    
    average grantshares
    
    date fair valueUnvested, October 1, 2007
    
    
    22,500
    
    
    $
    11.87Forfeited
    
    
    (2,000
    )
    
    $
    6.91Unvested, December 31, 2007
    
    
    20,500
    
    
    $
    12.35
   12. COMMITMENTS AND CONTINGENCIES
  Center for Neurologic Study (CNS) 
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Eurand, Inc TM TM
 Contingencies.
   Guarantees and Indemnities.
  13. SEGMENT INFORMATION
    19




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##### Table of Contents



14. SUBSEQUENT EVENTS
   
 Item 2.
 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  EXECUTIVE OVERVIEW
 ®
 Zenvia Status
 
 
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Docosanol 10% Cream
 ®
 Inflammation Program
  Xenerex Human Antibody Technology  Anthrax/Other Infectious Diseases
   21




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##### Table of Contents



Restructuring Activities
 ®  TM
  TM
 info@avanir.com www.avanir.com.
 CRITICAL ACCOUNTING POLICIES AND ESTIMATES
  22




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RESULTS OF OPERATIONS
 COMPARISON OF THREE MONTHS ENDED DECEMBER 31, 2007 AND 2006
 Three months endedDecember 312007
    
    
    2006
    
    
    $ Change
    
    
    % ChangePRODUCT SALESNet revenues
    
    $
    36,000
    
    
    $
    
    
    
    $
    36,000
    
    
    
    100
    %Cost of revenues
    
    
    6,204
    
    
    
    
    
    
    
    6,204
    
    
    
    100
    %Gross margin
    
    $
    29,796
    
    
    $
    
    
    
    $
    29,796
    
    
    
    100
    %LICENSES, RESEARCH SERVICES AND GRANTSRevenues:License agreements
    
    $
    57,265
    
    
    $
    57,265
    
    
    $
    
    
    
    
    0
    %Research services
    
    
    
    
    
    
    1,270,244
    
    
    
    (1,270,244
    )
    
    
    -100
    %Government research grant
    
    
    167,647
    
    
    
    86,348
    
    
    
    81,299
    
    
    
    94
    %Royalty and sale of royalty rights
    
    
    1,837,853
    
    
    
    723,040
    
    
    
    1,114,813
    
    
    
    154
    %Revenues from licenses, research services and grants
    
    
    2,062,765
    
    
    
    2,136,897
    
    
    
    (74,132
    )
    
    
    -3
    %Costs:Research services
    
    
    49,991
    
    
    
    1,164,075
    
    
    
    (1,114,084
    )
    
    
    -96
    %Government research grant
    
    
    125,587
    
    
    
    95,727
    
    
    
    29,860
    
    
    
    31
    %Costs from licenses, research services and grants
    
    
    175,578
    
    
    
    1,259,802
    
    
    
    (1,084,224
    )
    
    
    -86
    %Total revenues
    
    $
    2,098,765
    
    
    $
    2,136,897
    
    
    $
    (38,132
    )
    
    
    -2
    %Total gross margin
    
    $
    1,916,983
    
    
    $
    877,095
    
    
    $
    1,039,888
    
    
    
    119
    %
 Revenues
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Cost of Revenues
  Three Months endedDecember 312007
    
    
    2006
    
    
    $ Change
    
    
    % ChangeOPERATING EXPENSESResearch and development
    
    $
    3,426,259
    
    
    $
    5,197,253
    
    
    $
    (1,770,994
    )
    
    
    
    
    
    
    -34
    %Selling, general and administrative
    
    
    3,128,120
    
    
    
    9,369,862
    
    
    
    (6,241,742
    )
    
    
    
    
    
    
    -67
    %Total Operating Expenses
    
    $
    6,554,379
    
    
    $
    14,567,115
    
    
    $
    (8,012,736
    )
    
    
    
    
    
    
    -55
    %
 Research and Development Expenses
   Selling, General and Administrative Expenses
   Share-Based Compensation
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Interest Expense and Interest Income
   (Loss) income from Discontinued Operations
  Net Loss
  LIQUIDITY AND CAPITAL RESOURCES
   IncreaseDecember 31,
    
    (Decrease)
    
    September 30,2007
    
    During Period
    
    2007Cash, cash equivalents and investment in securities
    
    $
    29,421,889
    
    
    $
    (4,219,509
    )
    
    $
    33,641,398Cash and cash equivalents
    
    $
    28,315,460
    
    
    $
    (2,172,502
    )
    
    $
    30,487,962Net working capital
    
    $
    23,555,133
    
    
    $
    (5,781,643
    )
    
    $
    29,336,776
 Three Months
    
    
    
    
    
    
    Three MonthsEnded
    
    
    Change
    
    
    EndedDecember 31,
    
    
    Between
    
    
    December 31,2007
    
    
    Periods
    
    
    2006Net cash used in operating activities
    
    $
    (4,099,610
    )
    
    $
    (15,002,274
    )
    
    $
    (19,101,884
    )Net cash provided by investing activities
    
    
    2,037,037
    
    
    
    14,726,330
    
    
    
    16,763,367Net cash (used in) provided by financing activities
    
    
    (109,929
    )
    
    
    12,007,506
    
    
    
    11,897,577Net (decrease) increase in cash and cash equivalents
    
    $
    (2,172,502
    )
    
    $
    11,731,562
    
    
    $
    9,559,060
 Operating activities.
 Investing activities.
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Financing activities.
    Payments Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    1 Year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    5 YearsLong-term debt (principal and interest)
    
    $
    13,062,958
    
    
    $
    965,342
    
    
    $
    12,097,616
    
    
    $
    
    
    
    $
    Operating lease obligations
    
    
    7,708,467
    
    
    
    2,012,862
    
    
    
    3,033,334
    
    
    
    2,616,249
    
    
    
    46,022Purchase obligations (1)
    
    
    14,012,788
    
    
    
    6,625,532
    
    
    
    7,387,256
    
    
    
    
    
    
    
    Total
    
    $
    34,784,213
    
    
    $
    9,603,736
    
    
    $
    22,518,206
    
    
    $
    2616,249
    
    
    $
    46,022
 
 (1)
    
    Purchase obligations consist of the total of trade accounts payable and trade related accrued
expenses at December 31, 2007 which approximates our contractual commitments for goods and
services in the normal course of our business.   Contingency on Working Capital Adjustment.
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Accounting for Contingencies
 Alamo Earn-Out Payments.
 Eurand Milestone and Royalty Payments.
 Zenvia License Milestone Payments.
  27




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Management Outlook
   
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  Interest rate sensitivity
  
 Item 4. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls over Financial Reporting
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PART II OTHER INFORMATION
 
 Item 1. LEGAL PROCEEDINGS
  
 Item 1A. RISK FACTORS
  Risks Relating to Our Business
 We must conduct additional clinical trials for Zenvia and there can be no assurance that the FDA
will approve Zenvia or that an approval, if granted, will be on terms we may seek.
    The FDAs safety concerns regarding Zenvia for the treatment of PBA may extend to other clinical
indications that we are pursuing, including DPN pain. Due to these concerns, we expect to develop
Zenvia for other indications using alternative doses, which may negatively affect efficacy.
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We have limited capital resources and will need to raise additional funds to support our
operations.
   Any transactions that we may engage in to raise capital could dilute our shareholders and diminish
certain commercial prospects.
  We have licensed out or sold many of our non-core drug development programs and related assets and
these dispositions carry certain risks.
  
    
    Diversion of managements attention from normal daily operations of the business;
    
    Disputes over earn-outs, working capital adjustments or contingent payment obligations;
    
    Insufficient proceeds to offset expenses associated with the transactions; and
    
    The potential loss of key employees following such a transaction.
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Our patents may be challenged and our patent applications may be denied. Either result would
seriously jeopardize our ability to compete in the intended markets for our proposed products.
  
    
    The claims in any pending patent applications will be allowed or that patents will be
granted;
    
    Competitors will not develop similar or superior technologies independently, duplicate our
technologies, or design around the patented aspects of our technologies;
    
    Our technologies will not infringe on other patents or rights owned by others, including
licenses that may not be available to us;
    
    Any of our issued patents will provide us with significant competitive advantages; or
    
    Challenges will not be instituted against the validity or enforceability of any patent that
we own or, if instituted, that these challenges will not be successful.
  We currently have only a limited term of patent coverage for Zenvia in the U.S., which could result
in the introduction of generic competition within in a few years of product launch.
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If we fail to obtain regulatory approval in foreign jurisdictions, we would not be able to market
our products abroad and our revenue prospects would be limited.
  We have recently experienced significant turnover in senior management.
  We face challenges retaining members of management and other key personnel.
  Risks Relating to Our Industry
 There are a number of difficulties and risks associated with clinical trials and our trials may not
yield the expected results.
   
    
    the results from earlier clinical trials may not be statistically significant or predictive
of results that will be obtained from subsequent clinical trials, particularly larger trials;
    
    institutional review boards or regulators, including the FDA, may hold, suspend or terminate
our clinical research or the clinical trials of our product candidates for various reasons,
including noncompliance with regulatory requirements or if, in their opinion, the participating
subjects are being exposed to unacceptable health risks;
    
    subjects may drop out of our clinical trials;
    
    our preclinical studies or clinical trials may produce negative, inconsistent or
inconclusive results, and we may decide, or regulators may require us, to conduct additional
preclinical studies or clinical trials; and
    
    the cost of our clinical trials may be greater than we currently anticipate.
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
    
    delays in our ability to submit a New Drug Application (NDA);
    
    the refusal by the FDA to accept for file any NDA we may submit;
    
    requests for additional studies or data;
    
    delays of an approval; or
    
    the rejection of an application.
  Clinical trials can be delayed for a variety of reasons. If we experience any such delays, we would
be unable to commercialize our product candidates on a timely basis, which would materially harm
our business.
  
    
    identifying and engaging a sufficient number of clinical trial sites;
    
    negotiating acceptable clinical trial agreement terms with prospective trial sites;
    
    obtaining institutional review board approval to conduct a clinical trial at a prospective
site;
    
    recruiting eligible subjects to participate in clinical trials;
    
    competition in recruiting clinical investigators;
    
    shortage or lack of availability of supplies of drugs for clinical trials;
    
    the need to repeat clinical trials as a result of inconclusive results or poorly executed
testing;
    
    the placement of a clinical hold on a study;
    
    the failure of third parties conducting and overseeing the operations of our clinical trials
to perform their contractual or regulatory obligations in a timely fashion; and
    
    exposure of clinical trial subjects to unexpected and unacceptable health risks or
noncompliance with regulatory requirements, which may result in suspension of the trial.
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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.
   If we fail to comply with regulatory requirements, regulatory agencies may take action against us,
which could significantly harm our business.
    Developing and marketing pharmaceutical products for human use involves product liability risks,
for which we currently have limited insurance coverage.
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Risks Related to Reliance on Third Parties
 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.
  We depend on third parties to manufacture, package and distribute compounds for our drugs and drug
candidates. The failure of these third parties to perform successfully could harm our business.
  We generally do not control the development of compounds licensed to third parties and, as a
result, we may not realize a significant portion of the potential value of any such license
arrangements.
  We expect to rely entirely on third parties for international sales and marketing efforts.
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Risks Relating to Our Stock
 Our stock price has historically been volatile and we expect that this volatility will continue for
the foreseeable future.
  
    
    Comments made by securities analysts, including changes in their recommendations;
    
    Short selling activity by certain investors, including any failures to timely settle short
sale transactions;
    
    Announcements by us of financing transactions and/or future sales of equity or debt
securities;
    
    Sales of our Class A common stock by our directors, officers, or significant shareholders;
    
    Announcements by our competitors of clinical trial results or product approvals; and
    
    Market and economic conditions.
   Our common stock could be delisted from The NASDAQ Global Market, which could negatively impact the
price of our common stock and our ability to access the capital markets.
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Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 Item 3. DEFAULTS UPON SENIOR SECURITIES
  
 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 Item 5. OTHER INFORMATION
  
 Item 6. EXHIBITS
 Exhibits
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SIGNATURES
  Signature
    
    Title
    
    Date/s/ Keith A. Katkin

Keith A. Katkin
    
    President and Chief Executive Officer
(Principal Executive Officer)
    
    February 8, 2008/s/ Christine G. Ocampo

Christine G. Ocampo
    
    Corporate Controller
(Principal Financial and Accounting Officer)
    
    February 8, 2008
 38