##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
 For the quarterly period ended June 30, 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
    
    92656(Address of principal executive offices)
    
    (Zip Code)
 (949) 389-6700
 þ o
  o þ o
 o þ




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##### Table of Contents



Table of Contents
 PagePART I. FINANCIAL INFORMATIONItem 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
    
    
    22Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    32Item 4.
    
    Controls and Procedures
    
    
    33PART II. OTHER INFORMATION
    
    
    33Item 1.
    
    Legal Proceedings
    
    
    33Item 1A.
    
    Risk Factors
    
    
    33Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    39Item 3.
    
    Defaults Upon Senior Securities
    
    
    40Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    40Item 5.
    
    Other Information
    
    
    40Item 6.
    
    Exhibits
    
    
    40Signatures
    
    
    
    
    41EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. FINANCIAL STATEMENTS
 AVANIR PHARMACEUTICALS
 
 CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 June 30,
    
    
    September 30,2007
    
    
    2006ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    7,538,570
    
    
    $
    4,898,214Short-term investments in securities
    
    
    1,982,957
    
    
    
    16,778,267Receivables, net
    
    
    3,356,157
    
    
    
    3,042,468Inventories
    
    
    2,561,555
    
    
    
    2,835,203Prepaid expenses
    
    
    684,905
    
    
    
    1,778,918Total current assets
    
    
    16,124,144
    
    
    
    29,333,070Investments in securities
    
    
    246,050
    
    
    
    2,216,995Restricted investments in securities
    
    
    1,156,597
    
    
    
    856,597Property and equipment, net
    
    
    2,001,140
    
    
    
    6,047,729Other intangible assets, net
    
    
    8,826,362
    
    
    
    10,113,329Goodwill
    
    
    22,042,439
    
    
    
    22,110,328Other assets
    
    
    426,191
    
    
    
    784,289TOTAL ASSETS
    
    $
    50,822,923
    
    
    $
    71,462,337LIABILITIES AND SHAREHOLDERS DEFICITCURRENT LIABILITIESAccounts payable
    
    $
    1,222,746
    
    
    $
    10,845,057Accrued expenses
    
    
    12,378,411
    
    
    
    12,983,501Assumed liabilities for returns and other discounts
    
    
    
    
    
    
    3,980,229Deferred revenues
    
    
    4,357,655
    
    
    
    7,592,563Notes payable
    
    
    324,410
    
    
    
    670,737Other current liabilities
    
    
    607,333
    
    
    
    Capital lease obligations
    
    
    
    
    
    
    230,760Total current liabilities
    
    
    18,890,555
    
    
    
    36,302,847Other non-current liabilities
    
    
    1,376,700
    
    
    
    230,450Deferred revenues, net of current portion
    
    
    13,720,637
    
    
    
    15,716,762Notes payable, net of current portion
    
    
    22,559,986
    
    
    
    24,715,905Capital lease obligations, net of current portion
    
    
    
    
    
    
    170,908Total liabilities
    
    
    56,547,878
    
    
    
    77,136,872COMMITMENTS AND CONTINGENCIES (Note 13)SHAREHOLDERS DEFICITPreferred stock  no par value, 10,000,000 shares
authorized, no shares issued and outstanding as of
June 30, 2007 and September 30, 2006
    
    
    
    
    
    
    Common stock  no par value, Class A, 200,000,000
shares authorized, 43,031,252 and 31,708,461
shares issued and outstanding as of June 30, 2007
and September 30, 2006, respectively
    
    
    242,535,904
    
    
    
    211,993,249Accumulated deficit
    
    
    (248,240,696
    )
    
    
    (217,565,280
    )Accumulated other comprehensive loss
    
    
    (20,163
    )
    
    
    (102,504
    )Total shareholders deficit
    
    
    (5,724,955
    )
    
    
    (5,674,535
    )TOTAL LIABILITIES AND SHAREHOLDERS DEFICIT
    
    $
    50,822,923
    
    
    $
    71,462,337
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AVANIR PHARMACEUTICALS
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 Three months ended
    
    
    Nine months endedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006PRODUCT SALESNet revenues
    
    $
    4,938,708
    
    
    $
    
    
    
    $
    15,038,523
    
    
    $
    Cost of revenues
    
    
    1,535,535
    
    
    
    260,164
    
    
    
    4,190,975
    
    
    
    260,164Product gross margin
    
    
    3,403,173
    
    
    
    (260,164
    )
    
    
    10,847,548
    
    
    
    (260,164
    )LICENSES, RESEARCH SERVICES AND GRANTSRevenues from non-government research services
    
    
    181,692
    
    
    
    1,746,581
    
    
    
    2,372,384
    
    
    
    6,181,164Cost of non-government research services
    
    
    (1,202,476
    )
    
    
    (1,488,363
    )
    
    
    (2,973,715
    )
    
    
    (5,302,796
    )Revenues from government research grant services
    
    
    122,398
    
    
    
    47,345
    
    
    
    475,474
    
    
    
    208,032Cost of government research grant services
    
    
    (201,178
    )
    
    
    (46,402
    )
    
    
    (666,166
    )
    
    
    (214,491
    )Revenues from license agreements
    
    
    1,443,543
    
    
    
    104,174
    
    
    
    1,556,827
    
    
    
    5,113,516Revenues from royalties and royalty rights
    
    
    453,091
    
    
    
    465,147
    
    
    
    1,955,804
    
    
    
    1,474,451License, research services, and grants gross margin
    
    
    797,070
    
    
    
    828,482
    
    
    
    2,720,608
    
    
    
    7,459,876Total gross margin
    
    
    4,200,243
    
    
    
    568,318
    
    
    
    13,568,156
    
    
    
    7,199,712OPERATING EXPENSESResearch and development
    
    
    3,906,024
    
    
    
    8,426,870
    
    
    
    16,057,310
    
    
    
    21,788,150Selling, general and administrative
    
    
    10,647,281
    
    
    
    10,105,474
    
    
    
    29,223,620
    
    
    
    23,366,332Loss from operations
    
    
    (10,353,062
    )
    
    
    (17,964,026
    )
    
    
    (31,712,774
    )
    
    
    (37,954,770
    )OTHER INCOME (EXPENSE)Interest expense
    
    
    (415,861
    )
    
    
    (191,302
    )
    
    
    (1,334,399
    )
    
    
    (236,143
    )Interest income
    
    
    88,916
    
    
    
    551,948
    
    
    
    425,254
    
    
    
    1,444,536Other
    
    
    1,537,725
    
    
    
    (15,029
    )
    
    
    1,968,004
    
    
    
    (10,009
    )Loss before income taxes
    
    
    (9,142,282
    )
    
    
    (17,618,409
    )
    
    
    (30,653,915
    )
    
    
    (36,756,386
    )Provision for income taxes
    
    
    (8,097
    )
    
    
    (809
    )
    
    
    (21,501
    )
    
    
    (3,230
    )NET LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE
    
    
    (9,150,379
    )
    
    
    (17,619,218
    )
    
    
    (30,675,416
    )
    
    
    (36,759,616
    )Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,616,058
    )NET LOSS
    
    $
    (9,150,379
    )
    
    $
    (17,619,218
    )
    
    $
    (30,675,416
    )
    
    $
    (40,375,674
    )Basic and diluted net loss per shareLoss before cumulative effect of change in accounting
principle
    
    $
    (0.23
    )
    
    $
    (0.56
    )
    
    $
    (0.86
    )
    
    $
    (1.21
    )Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.12
    )Net loss per share
    
    $
    (0.23
    )
    
    $
    (0.56
    )
    
    $
    (0.86
    )
    
    $
    (1.33
    )Basic and diluted weighted average number of common
shares outstanding
    
    
    40,580,326
    
    
    
    31,419,394
    
    
    
    35,546,976
    
    
    
    30,352,690
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AVANIR PHARMACEUTICALS
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 Nine Months EndedJune 30,2007
    
    
    2006OPERATING ACTIVITIESNet loss
    
    $
    (30,675,416
    )
    
    $
    (40,375,674
    )Adjustments to reconcile net loss to net cash used in operating activities:Cumulative effect of change in accounting principle
    
    
    
    
    
    
    3,616,058Depreciation and amortization
    
    
    4,719,632
    
    
    
    1,863,379Amortization of debt discount
    
    
    182,999
    
    
    
    Share-based compensation (income) expense
    
    
    (287,227
    )
    
    
    1,977,133Purchased in-process research and development
    
    
    
    
    
    
    2,600,000(Gain) loss on disposal of assets
    
    
    (229,829
    )
    
    
    17,339Changes in operating assets and liabilities:Receivables
    
    
    2,949
    
    
    
    (1,062,860
    )Inventories
    
    
    621,072
    
    
    
    (373,496
    )Prepaid expenses and other assets
    
    
    1,088,323
    
    
    
    815,521Accounts payable
    
    
    (9,622,311
    )
    
    
    (732,277
    )Accrued expenses and other liabilities
    
    
    1,148,493
    
    
    
    3,564,523Assumed liabilities, net of non-cash adjustment of purchase price
    
    
    87,660
    
    
    
    Deferred revenues
    
    
    (5,231,033
    )
    
    
    413,527Net cash used in operating activities
    
    
    (38,194,688
    )
    
    
    (27,676,827
    )INVESTING ACTIVITIESInvestments in securities
    
    
    (351,404
    )
    
    
    (59,231,954
    )Proceeds from sales and maturities of investments in securities
    
    
    16,900,000
    
    
    
    41,950,275Acquisition of businesses, net of cash acquired
    
    
    
    
    
    
    (4,617,694
    )Proceeds from the sale of property and equipment
    
    
    457,420
    
    
    
    Purchases of property and equipment
    
    
    (130,760
    )
    
    
    (1,391,987
    )Net cash provided by (used in) investing activities
    
    
    16,875,256
    
    
    
    (23,291,360
    )FINANCING ACTIVITIESProceeds from issuance of common stock, net
    
    
    30,829,882
    
    
    
    44,797,440Payments on notes and capital lease obligations
    
    
    (6,870,094
    )
    
    
    (290,524
    )Net cash provided by financing activities
    
    
    23,959,788
    
    
    
    44,506,916Net increase (decrease) in cash and cash equivalents
    
    
    2,640,356
    
    
    
    (6,461,271
    )Cash and cash equivalents at beginning of period
    
    
    4,898,214
    
    
    
    8,620,143Cash and cash equivalents at end of period
    
    $
    7,538,570
    
    
    $
    2,158,872SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATIONInterest paid
    
    $
    1,151,361
    
    
    $
    236,143Income taxes paid
    
    $
    21,501
    
    
    $
    3,230NON-CASH INVESTING AND FINANCING ACTIVITIES:Purchase price adjustment of assumed liabilities
    
    $
    4,067,889
    
    
    $
    Issuance of notes payable as additional consideration for the Alamo acquisition
    
    $
    4,000,000
    
    
    $
    Accounts payable and accrued expenses for purchases of property and equipment
    
    $
    
    
    
    $
    109,516Elimination of unearned compensation against common stock
    
    $
    
    
    
    $
    3,477,144Issuance of promissory notes as consideration for the Alamo acquisition
    
    $
    
    
    
    $
    25,075,000Accrued expenses for acquisition related transaction costs
    
    $
    
    
    
    $
    130,570
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AVANIR PHARMACEUTICALS
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 1. BASIS OF PRESENTATION
 Avanir Avanir
   2. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Nature of Business
  Revenue recognition
  Revenue Recognition.
 6




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Revenue Recognition When Right of Return Exists
 Accounting for Revenue Arrangements
with Multiple Deliverables.
 Product Sales
 Active Pharmaceutical Ingredient Docosanol (API Docosanol).
 FazaClo.
   7




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Multiple Element Arrangements.
   License Arrangements.
   8




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Research Services Arrangements. Reporting Revenue Gross as a Principal versus Net as an Agent,
 Royalty Arrangements.
 ®
 Government Research Grant Revenues.
 Cost of Revenues
  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
   9




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Share-Based Compensation
 Share-Based Payment, Accounting for Stock-Based Compensation
 Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards
     10




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For the three months ended
    
    
    For the nine months endedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Share-based compensation expense (income) from:Stock options
    
    $
    302,505
    
    
    $
    397,222
    
    
    $
    (481,249
    )
    
    $
    1,044,276Restricted stock awards
    
    
    35,430
    
    
    
    302,403
    
    
    
    900,641
    
    
    
    845,877Restricted stock units
    
    
    199,708
    
    
    
    57,775
    
    
    
    (706,619
    )
    
    
    86,980Total
    
    $
    537,643
    
    
    $
    757,400
    
    
    $
    (287,227
    )
    
    $
    1,977,133(Loss) income per share
    
    $
    (0.01
    )
    
    $
    (0.02
    )
    
    $
    (0.01
    )
    
    $
    (0.07
    )
  Change in Accounting for Patent-Related Costs
  Recently Issued Accounting Pronouncements
 Accounting for Uncertainty in Income Taxes-an interpretation
of FASB 109
 Fair Value Measurements
 The Fair Value Option for Financial Assets and Financial Liabilities- Including
an Amendment of FASB Statement No. 115
 11




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3. ALAMO PHARMACEUTICALS, INC.
    Purchase Price Allocation
   Purchase price:Cash paid at closing
    
    $
    4,040,000Estimated fair value of notes payable issued, net of imputed discount
    
    
    28,343,000Transaction costs
    
    
    911,536$
    33,294,536Allocation:Net tangible assets acquired
    
    $
    5,749,898Identifiable intangible assets acquired
    
    
    11,960,000Goodwill
    
    
    22,042,439Total assets acquired
    
    
    39,752,337Liabilities assumed
    
    
    (6,457,801
    )$
    33,294,536
 Accounting in a Business Combination for Deferred Revenue of an Acquiree,
 12




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In-Process Research and Development
  Pro Forma Results of Operations for Acquisition
  For the
    
    For thethree months ended
    
    nine months endedJune 30, 2006
    
    June 30, 2006Pro forma net revenues(1)
    
    $
    2,551,218
    
    
    $
    15,294,299Pro forma net loss(2)
    
    $
    (12,651,297
    )
    
    $
    (45,681,343
    )Pro forma loss per basic and diluted share
    
    $
    (0.40
    )
    
    $
    (1.51
    )Shares used for basic and diluted computation
    
    
    31,419,394
    
    
    
    30,352,690
 
 (1)
    
    In accordance with the provisions of EITF 01-3, we will not recognize deferred revenues
recorded as of the acquisition date, resulting in lower net revenues in the periods following
the merger than Alamo would likely have achieved as a separate company.(2)
    
    Pro forma net loss for the periods presented includes the amortization of identifiable
intangible assets, interest expense associated with the notes payable issued as part of the
purchase price, elimination of interest expense associated with Alamos historical debt that
was not assumed by us in the acquisition, reduction of interest income by an amount determined
by applying the average rate of return for the respective periods to the decrease in our cash
balance of $4.0 million used to fund the acquisition, and amortization of discount associated
with the notes payable. The charge of $1.3 million for purchased IPR&D is not included in the
pro forma results of operations because it reflects a one-time charge directly related to the
acquisition and does not have a continuing impact on our future operations. 13




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Sale of FazaClo/Subsequent Event
   As ofAugust 3, 2007ASSETSCURRENT ASSETS:Receivables, net
    
    $
    2,606,463Inventory
    
    
    1,267,460Prepaids
    
    
    45,251TOTAL CURRENT ASSETS
    
    
    3,919,174Property and equipment
    
    
    611,727Intangible assets
    
    
    8,916,091Goodwill
    
    
    20,042,439TOTAL ASSETS
    
    $
    33,489,431LIABILITIESCURRENT LIABILITIES:Accounts payable
    
    $
    47,307Accrued expenses
    
    
    326,739Accrued chargebacks and rebates
    
    
    1,660,902Deferred revenue
    
    
    2,000,000TOTAL CURRENT LIABILITIES
    
    $
    4,034,948NET ASSETS INCLUDED IN DISPOSAL GROUP
    
    $
    29,454,483
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4. RELOCATION OF COMMERCIAL AND GENERAL AND ADMINISTRATIVE OPERATIONS
   September 30,
    
    
    
    
    
    
    
    
    
    
    June 30,2006
    
    
    Additions
    
    
    Payments
    
    
    2007Accrued Restructuring:Employee severance and relocation benefits
    
    $
    237,050
    
    
    $
    771,852
    
    
    $
    (1,008,902
    )
    
    $
    Lease restructuring liability fiscal year 2006
    
    
    273,998
    
    
    
    
    
    
    
    (32,661
    )
    
    
    241,337Lease restructuring liability fiscal year 2007
    
    
    
    
    
    
    1,742,696
    
    
    
    
    
    
    
    1,742,696Total
    
    $
    511,048
    
    
    $
    2,514,548
    
    
    $
    (1,041,563
    )
    
    $
    1,984,033
  5. INVENTORIES
  June 30,
    
    
    September 30,2007
    
    
    2006Raw materials
    
    $
    1,599,254
    
    
    $
    923,822Work in progress
    
    
    225,463
    
    
    
    80,580Finished goods
    
    
    535,384
    
    
    
    1,642,208Finished goods  FazaClo inventories subject to return
    
    
    201,454
    
    
    
    536,017Total inventories
    
    $
    2,561,555
    
    
    $
    3,182,627
  15




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6. ACCRUED EXPENSES
  June 30,
    
    
    September 30,2007
    
    
    2006Accrued compensation and payroll taxes
    
    $
    2,570,821
    
    
    $
    3,125,862Accrued returns, rebates and other
discounts
    
    
    2,692,486
    
    
    
    2,371,703Accrued research and development
expenses
    
    
    3,960,371
    
    
    
    3,947,191Accrued sales and marketing expenses
    
    
    1,171,836
    
    
    
    2,354,344Deferred rent
    
    
    664,399
    
    
    
    680,730Other
    
    
    1,318,498
    
    
    
    503,671Total
    
    $
    12,378,411
    
    
    $
    12,983,501
 7. DEFERRED REVENUES
 ®
 Drug Royalty
    
    
    FazaCloUSA
    
    
    Net
    
    
    OtherAgreement
    
    
    Shipments
    
    
    Agreements
    
    
    TotalDeferred revenues as of October 1, 2006
    
    $
    17,111,913
    
    
    $
    3,955,150
    
    
    $
    2,242,262
    
    
    $
    23,309,325Changes during the period:Shipments, net
    
    
    
    
    
    
    13,111,375
    
    
    
    244,587
    
    
    
    13,355,962Recognized as revenues during period
    
    
    (1,741,485
    )
    
    
    (15,038,523
    )
    
    
    (1,806,987
    )
    
    
    (18,586,995
    )Deferred revenues as of June 30, 2007
    
    $
    15,370,428
    
    
    $
    2,028,002
    
    
    $
    679,862
    
    
    $
    18,078,292Classified and reported as:Current portion of deferred revenues
    
    $
    2,065,890
    
    
    $
    2,028,002
    
    
    $
    263,763
    
    
    $
    4,357,655Deferred revenues, net of current portion
    
    
    13,304,538
    
    
    
    
    
    
    
    416,099
    
    
    
    13,720,637Total deferred revenues
    
    $
    15,370,428
    
    
    $
    2,028,002
    
    
    $
    679,862
    
    
    $
    18,078,292
  8. NET PRODUCT REVENUES
  For the three
    
    
    For the ninemonths ended
    
    
    months endedJune 30, 2007
    
    
    June 30, 2007Gross product revenues
    
    $
    6,545,786
    
    
    $
    20,802,601Less product sales allowances :Prompt payment discount
    
    
    (56,635
    )
    
    
    (341,771
    )Medicaid and managed care rebates
    
    
    (811,678
    )
    
    
    (2,775,494
    )Chargebacks and other fees
    
    
    (738,765
    )
    
    
    (2,646,813
    )Net product revenues
    
    $
    4,938,708
    
    
    $
    15,038,523
  16




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##### Table of Contents



9. COMPUTATION OF NET LOSS PER COMMON SHARE
  10. COMPREHENSIVE LOSS
  For the three months
    
    
    For the nine monthsended June 30,
    
    
    Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net loss
    
    $
    (9,150,379
    )
    
    $
    (17,619,218
    )
    
    $
    (30,675,416
    )
    
    $
    (40,375,674
    )Other comprehensive loss, net of tax:Unrealized (loss) gain on available-for-sale securities
    
    
    3,042
    
    
    
    59,829
    
    
    
    82,341
    
    
    
    (131,502
    )Total comprehensive loss
    
    $
    (9,147,337
    )
    
    $
    (17,559,389
    )
    
    $
    (30,593,075
    )
    
    $
    (40,507,176
    )
 11. SHAREHOLDERS EQUITY
    12. EMPLOYEE EQUITY INCENTIVE PLANS
   17




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##### Table of Contents



Stock Options
  WeightedWeighted
    
    averageaverage
    
    remainingexercise
    
    contractual
    
    Aggregateprice per
    
    term
    
    intrinsicNumber of shares
    
    share
    
    (in years)
    
    valueOutstanding, October 1, 2006
    
    
    1,587,070
    
    
    $
    10.07
    
    
    
    7.2
    
    
    $
    817,000Granted
    
    
    369,380
    
    
    $
    5.14Exercised
    
    
    (67,758
    )
    
    $
    4.33Forfeited
    
    
    (869,023
    )
    
    $
    10.16Expired
    
    
    (8,125
    )
    
    $
    7.89Outstanding, June 30, 2007
    
    
    1,011,544
    
    
    $
    8.59
    
    
    
    8.3
    
    
    $
    169,656Vested and expected to vest in the future, June 30, 2007
    
    
    763,365
    
    
    $
    9.34
    
    
    
    .6
    
    
    $
    68,169Exercisable, June 30, 2007
    
    
    341,118
    
    
    $
    10.40
    
    
    
    6.6
    
    
    $
    
    2007
    
    2006Expected volatility
    
    
    75%-103
    %
    
    
    77.5% - 80.4
    %Weighted-average volatility
    
    
    88
    %
    
    
    78.6
    %Average expected term in years
    
    
    6.0
    
    
    
    4.5Risk-fee interest rate (zero coupon U.S. Treasury Note)
    
    
    4.7
    %
    
    
    4.5
    %Expected dividend yield
    
    
    0
    %
    
    
    0
    %
 18




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##### Table of Contents



Options Outstanding
    
    Options ExercisableWeightedAverage
    
    Weighted
    
    
    
    
    
    WeightedRemaining
    
    Average
    
    
    
    
    
    AverageRange of
    
    Number
    
    Contractual
    
    Exercise
    
    Number
    
    ExerciseExercise Prices
    
    Outstanding
    
    Life in Years
    
    Price
    
    Exercisable
    
    Price$1.20 - $4.64
    
    
    228,931
    
    
    
    8.9
    
    
    $
    2.09
    
    
    
    38,471
    
    
    $
    4.19$5.12  -  $6.92
    
    
    168,054
    
    
    
    7.8
    
    
    $
    6.34
    
    
    
    42,679
    
    
    $
    6.07$7.12  -  $9.92
    
    
    120,440
    
    
    
    8.4
    
    
    $
    8.69
    
    
    
    42,855
    
    
    $
    8.92$10.10 - $10.70
    
    
    146,250
    
    
    
    8.8
    
    
    $
    10.68
    
    
    
    42,189
    
    
    $
    10.65$11.08 - $11.76
    
    
    184,572
    
    
    
    8.0
    
    
    $
    11.71
    
    
    
    94,050
    
    
    $
    11.70$12.12 - $13.84
    
    
    90,022
    
    
    
    7.5
    
    
    $
    13.18
    
    
    
    50,567
    
    
    $
    13.17$14.28 - $19.38
    
    
    73,275
    
    
    
    7.7
    
    
    $
    16.24
    
    
    
    30,307
    
    
    $
    17.451,011,544
    
    
    
    8.3
    
    
    $
    8.59
    
    
    
    341,118
    
    
    $
    10.40
 Restricted stock units.
 WeightedNumber of
    
    average grantshares
    
    date fair valueUnvested, October 1, 2006
    
    
    51,480
    
    
    $
    15.54Granted
    
    
    2,320,143
    
    
    $
    1.74Vested
    
    
    
    
    
    $
    Forfeited
    
    
    (263,920
    )
    
    $
    2.79Unvested, June 30, 2007
    
    
    2,107,703
    
    
    $
    1.94
  Restricted stock awards
 WeightedNumber of
    
    average grantshares
    
    date fair valueUnvested, October 1, 2006
    
    
    223,915
    
    
    $
    13.48Granted
    
    
    15,000
    
    
    $
    7.34Vested
    
    
    (44,999
    )
    
    $
    13.96Forfeited
    
    
    (150,999
    )
    
    $
    13.54Unvested, June 30, 2007
    
    
    42,917
    
    
    $
    10.62
   19




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##### Table of Contents



13. COMMITMENTS AND CONTINGENCIES
 Center for Neurologic Study (CNS) 
 Eurand Agreement for Zenvia
 CIMA Agreement for FazaClo 
   20




---



##### Table of Contents



14. SEGMENT INFORMATION
     15. SUBSEQUENT EVENTS
     21




---



##### Table of Contents



Item 2.
 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  EXECUTIVE OVERVIEW
 Avanir ®
 Zenvia Status
    Restructuring Activities
  22




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info@avanir.com www.avanir.com.
 CRITICAL ACCOUNTING POLICIES AND ESTIMATES
   23




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##### Table of Contents



Share-Based Compensation
  RESULTS OF OPERATIONS
 COMPARISON OF THREE MONTHS ENDED JUNE 30, 2007 AND 2006
 Three Months endedJune 302007
    
    
    2006
    
    
    $ Change
    
    
    % ChangePRODUCT SALESNet revenues
    
    $
    4,938,708
    
    
    $
    
    
    
    $
    4,938,708
    
    
    
    100
    %Cost of revenues
    
    
    1,535,535
    
    
    
    260,164
    
    
    
    1,275,371
    
    
    
    490
    %Gross margin
    
    $
    3,403,173
    
    
    $
    (260,164
    )
    
    $
    3,663,337
    
    
    
    -1,408
    %LICENSES, RESEARCH SERVICES AND GRANTSRevenues:License agreements
    
    $
    1,443,543
    
    
    $
    104,174
    
    
    $
    1,339,369
    
    
    
    1,286
    %Research services
    
    
    181,692
    
    
    
    1,746,581
    
    
    
    (1,564,889
    )
    
    
    -90
    %Government research grant
    
    
    122,398
    
    
    
    47,345
    
    
    
    75,053
    
    
    
    159
    %Royalty and sale of royalty rights
    
    
    453,091
    
    
    
    465,147
    
    
    
    (12,056
    )
    
    
    -3
    %2,200,724
    
    
    
    2,363,247
    
    
    
    (162,523
    )
    
    
    -7
    %Costs:Research services
    
    
    1,202,476
    
    
    
    1,488,363
    
    
    
    (285,887
    )
    
    
    -19
    %Government research grant
    
    
    201,178
    
    
    
    46,402
    
    
    
    154,776
    
    
    
    334
    %1,403,654
    
    
    
    1,534,765
    
    
    
    (131,111
    )
    
    
    -9
    %Gross margin
    
    $
    4,200,243
    
    
    $
    568,318
    
    
    $
    3,631,925
    
    
    
    639
    %
 Revenues
   24




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Cost of Revenues
   Three Months endedJune 302007
    
    
    2006
    
    
    $ Change
    
    
    % ChangeOPERATING EXPENSESResearch and development
    
    $
    3,906,024
    
    
    $
    8,426,870
    
    
    $
    (4,520,846
    )
    
    
    -54
    %Selling, general and administrative
    
    
    10,647,281
    
    
    
    10,105,474
    
    
    
    541,807
    
    
    
    -5
    %Total Operating Expenses
    
    $
    14,553,305
    
    
    $
    18,532,344
    
    
    $
    (3,979,039
    )
    
    
    -21
    %
 Research and Development Expenses
    25




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Selling, General and Administrative Expenses
   Share-Based Compensation
   Interest Expense and Interest Income
   Net Loss
  26




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COMPARISON OF NINE MONTHS ENDED JUNE 30, 2007 AND 2006
 Nine Months endedJune 302007
    
    
    2006
    
    
    $ Change
    
    
    % ChangePRODUCT SALESNet revenues
    
    $
    15,038,523
    
    
    $
    
    
    
    $
    15,038,523
    
    
    
    100
    %Cost of revenues
    
    
    4,190,975
    
    
    
    260,164
    
    
    
    3,930,811
    
    
    
    1,511
    %Gross margin
    
    $
    10,847,548
    
    
    $
    (260,164
    )
    
    $
    11,107,712
    
    
    
    -4,270
    %LICENSES, RESEARCH SERVICES AND GRANTSRevenues:License agreements
    
    $
    1,556,827
    
    
    $
    5,113,516
    
    
    $
    (3,556,689
    )
    
    
    -70
    %Research services
    
    
    2,372,384
    
    
    
    6,181,164
    
    
    
    (3,808,780
    )
    
    
    -62
    %Government research grant
    
    
    475,474
    
    
    
    208,032
    
    
    
    267,442
    
    
    
    129
    %Royalty and sale of royalty rights
    
    
    1,955,804
    
    
    
    1,474,451
    
    
    
    481,353
    
    
    
    33
    %6,360,489
    
    
    
    12,977,163
    
    
    
    (6,616,674
    )
    
    
    -51
    %Costs:Research services
    
    
    2,973,715
    
    
    
    5,302,796
    
    
    
    (2,329,081
    )
    
    
    -44
    %Government research grant
    
    
    666,166
    
    
    
    214,491
    
    
    
    451,675
    
    
    
    211
    %3,639,881
    
    
    
    5,517,287
    
    
    
    (1,877,406
    )
    
    
    -34
    %Gross margin
    
    $
    13,568,156
    
    
    $
    7,199,712
    
    
    $
    6,368,444
    
    
    
    88
    %
 Revenues
   Cost of Revenues
   27




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Nine Months endedJune 302007
    
    
    2006
    
    
    $ Change
    
    
    % ChangeOPERATING EXPENSESResearch and development
    
    $
    16,057,310
    
    
    $
    21,788,150
    
    
    $
    (5,730,840
    )
    
    
    -26
    %Selling, general and administrative
    
    
    29,223,620
    
    
    
    23,366,332
    
    
    
    5,857,288
    
    
    
    25
    %Total Operating Expenses
    
    $
    45,280,930
    
    
    $
    45,154,482
    
    
    $
    126,448
    
    
    
    0
    %
 Research and Development Expenses
     Selling, General and Administrative Expenses
   Share-Based Compensation
  28




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Interest Expense and Interest Income
   Net Loss
  LIQUIDITY AND CAPITAL RESOURCES
   IncreaseJune 30,
    
    (Decrease)
    
    September 30,2007
    
    During Period
    
    2006Cash, cash equivalents and investment in securities
    
    $
    10,924,174
    
    
    $
    (13,825,899
    )
    
    $
    24,750,073Cash and cash equivalents
    
    $
    7,538,570
    
    
    $
    2,640,356
    
    
    $
    4,898,214Net working capital
    
    $
    (2,766,411
    )
    
    $
    4,203,366
    
    
    $
    (6,969,777
    )
 Nine Months
    
    
    
    
    
    
    Nine MonthsEnded
    
    
    Change
    
    
    EndedJune 30,
    
    
    Between
    
    
    June 30,2007
    
    
    Periods
    
    
    2006Net cash used for operating activities
    
    $
    (38,194,688
    )
    
    $
    (10,517,861
    )
    
    $
    (27,676,827
    )Net cash provided by (used for) investing activities
    
    
    16,875,256
    
    
    
    40,166,616
    
    
    
    (23,291,360
    )Net cash provided by financing activities
    
    
    23,959,788
    
    
    
    (20,547,128
    )
    
    
    44,506,916Net increase (decrease) in cash and cash equivalents
    
    $
    2,640,356
    
    
    $
    9,101,627
    
    
    $
    (6,461,271
    )
 Operating activities.
 29




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##### Table of Contents



Investing activities.
 Financing activities.
    Payments Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    1 Year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    5 YearsLong-term debt (principal and interest)
    
    $
    26,298,538
    
    
    $
    1,872,741
    
    
    $
    24,425,797
    
    
    $
    
    
    
    $
    Operating lease obligations
    
    
    9,869,528
    
    
    
    2,331,891
    
    
    
    3,633,158
    
    
    
    3,247,180
    
    
    
    657,299Purchase obligations (1)
    
    
    6,135,857
    
    
    
    5,522,271
    
    
    
    613,586
    
    
    
    
    
    
    
    Total
    
    $
    42,303,923
    
    
    $
    9,726,903
    
    
    $
    28,672,541
    
    
    $
    3,247,180
    
    
    $
    657,299
 
 (1)
    
    Purchase obligations consist of the total of trade accounts payable and trade related accrued
expenses at June 30, 2007 which approximates our contractual commitments for goods and
services in the normal course of our business.  30




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##### Table of Contents



Alamo Earn-Out Payments.
  CIMA Royalty payments.
 Twelve-month period ended June 30:2007
    
    $
    250,0002008
    
    $
    300,0002009 and each year thereafter
    
    $
    400,000
  Eurand Milestone and Royalty Payments.
 31




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##### Table of Contents



Zenvia License Milestone Payments.
  Management Outlook
   
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  32




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##### Table of Contents



Interest rate sensitivity
  
 Item 4. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls over Financial Reporting
  
 PART II OTHER INFORMATION
 
 Item 1. LEGAL PROCEEDINGS
  
 Item 1A. RISK FACTORS
  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.
  33




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##### Table of Contents



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.
  The FDAs safety concerns regarding Zenvia for the treatment of IEED/PBA may extend to other
clinical indications that we are pursuing, including DPN pain. Due to these concerns, we may not be
able to develop Zenvia for these other indications.
  34




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We have recently experienced significant turnover in senior management.
  We face challenges retaining members of management and other key personnel.
  If we fail to comply with regulatory requirements, regulatory agencies may take action against us,
which could significantly harm our business.
      35




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##### Table of Contents




    
    restrictions on our products or manufacturing processes;
    
    warning letters;
    
    withdrawal of the products from the market;
    
    voluntary or mandatory recall;
    
    fines;
    
    suspension or withdrawal of regulatory approvals;
    
    suspension or termination of any of our ongoing clinical trials;
    
    refusal to permit the import or export of our products;
    
    refusal to approve pending applications or supplements to approved applications that we submit;
    
    product seizure; and
    
    injunctions or the imposition of civil or criminal penalties.
 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.
  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.
  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.
  36




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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.
    
    
    delays in our ability to submit an NDA;
    
    the refusal by the FDA to file any NDA we may submit;
    
    requests for additional studies or data;
    
    delays of an approval; or
    
    the rejection of an application.
 37




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##### Table of Contents



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.
  
    
    obtaining an effective investigational new drug application, or IND, or regulatory approval to commence a clinical trial;
    
    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 qualified 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.
  Developing and marketing pharmaceutical products for human use involves product liability risks,
for which we currently have limited insurance coverage.
  38




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##### Table of Contents



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.
    The preparation of our financial statements requires the use of certain assumptions and estimates.
If the facts underlying these assumptions or estimates change, or if our analysis and conclusions
change, our financial position and operating results could vary significantly from period to
period.
  
 Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  39




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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
    40




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##### Table of Contents



SIGNATURES
  Signature
    
    Title
    
    Date/s/ Keith A. Katkin

Keith A. Katkin
    
    President and Chief Executive Officer (Principal
Executive Officer)
    
    August 9, 2007/s/ Martin J. Sturgeon

Martin J. Sturgeon
    
    Vice President, Interim Chief Financial Officer (Principal
Financial and Accounting Officer)
    
    August 9, 2007
 41