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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 FORM 10-Q (Mark One) [ X ]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
 For the quarterly period ended March 31, 2004 OR [   ]
    
    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. 0-18734 AVANIR PHARMACEUTICALS  California
    
    33-0314804(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)11388 Sorrento Valley Road, San Diego, California
    
    92121(Address of principal executive offices)
    
    (Zip Code)
 (858) 622-5200
(Registrants telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  YES [X] NO [   ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).  YES [X] NO [   ] As of May 5, 2004, the registrant had 71,494,608 shares of Class A common stock
issued and outstanding.




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Table of Contents PagePART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsIndependent Accountants Report
    
    
    3Consolidated Balance Sheets
    
    
    4Consolidated Statements of Operations
    
    
    5Consolidated Statements of Cash Flows
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    34Item 4.
    
    Controls and Procedures
    
    
    34PART II.
    
    OTHER INFORMATIONItem 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    35Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    35EXHIBIT 15EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I. FINANCIAL INFORMATION 
 Item 1. FINANCIAL STATEMENTS 
 INDEPENDENT ACCOUNTANTS REPORT Board of Directors and Shareholders
AVANIR Pharmaceuticals We have reviewed the accompanying consolidated balance sheet of AVANIR
Pharmaceuticals and subsidiary (the Company) as of March 31, 2004 and the
related consolidated statements of operations and cash flows for the
three-month and six-month periods ended March 31, 2004 and 2003. These interim
financial statements are the responsibility of the Companys management. We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and of making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with auditing standards generally accepted in the United States
of America, the objective of which is the expression of an opinion regarding
the financial statements taken as a whole. Accordingly, we do not express such
an opinion. Based on our review, we are not aware of any material modifications that should
be made to such consolidated interim financial statements for them to be in
conformity with accounting principles generally accepted in the United States
of America. We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of the
Company as of September 30, 2003 and the related consolidated statements of
operations, shareholders equity and cash flows for the year then ended (not
presented herein); and in our report dated December 19, 2003, we expressed an
unqualified opinion on those financial statements. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
September 30, 2003 is fairly stated, in all material respects, in relation to
the consolidated balance sheet from which it has been derived. DELOITTE & TOUCHE LLP San Diego, California
May 14, 2004 3




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AVANIR Pharmaceuticals 
 CONSOLIDATED BALANCE SHEETS (UNAUDITED) March 31,
    
    September 30,2004
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    7,910,493
    
    
    $
    12,198,408Short-term investments in securities
    
    
    4,565,121
    
    
    
    3,888,798Accounts receivable
    
    
    178,900
    
    
    
    271,681Inventory
    
    
    12,404
    
    
    
    210,854Prepaid expenses
    
    
    1,193,814
    
    
    
    1,564,315Total current assets
    
    
    13,860,732
    
    
    
    18,134,056Investments in securities
    
    
    103,514
    
    
    
    513,486Restricted investments in securities
    
    
    856,597
    
    
    
    856,597Property and equipment, net
    
    
    7,056,976
    
    
    
    7,742,005Intangible assets, net
    
    
    2,650,615
    
    
    
    2,131,209Other assets
    
    
    257,965
    
    
    
    267,904TOTAL ASSETS
    
    $
    24,786,399
    
    
    $
    29,645,257LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    2,969,819
    
    
    $
    2,853,604Accrued expenses and other liabilities
    
    
    3,045,386
    
    
    
    1,806,058Accrued compensation and payroll taxes
    
    
    697,781
    
    
    
    626,154Notes payable
    
    
    150,964
    
    
    
    244,805Current portion of deferred revenue
    
    
    1,755,768
    
    
    
    1,841,865Current portion of capital lease obligations
    
    
    150,348
    
    
    
    142,354Total current liabilities
    
    
    8,770,066
    
    
    
    7,514,840Deferred revenue, net of current portion
    
    
    19,906,368
    
    
    
    20,900,776Capital lease obligations, net of current portion
    
    
    115,113
    
    
    
    192,410Total liabilities
    
    
    28,791,547
    
    
    
    28,608,026Contingencies (Note 13)Shareholders equity (deficit):Preferred stock   no par value, 10,000,000
and 9,999,500 shares authorized as of March
31, 2004 and September 30, 2003, respectively:Series C Junior Participating -
1,000,000 shares authorized; no shares
issued or outstanding
    
    
    
    
    
    
    Common stock   no par value:Class A - 200,000,000 and 99,288,000
shares authorized as of March 31, 2004
and September 30, 2003, respectively;
71,494,608 and 65,816,434 shares issued
and outstanding as of March 31, 2004
and September 30, 2003, respectively
    
    
    105,253,977
    
    
    
    97,286,433Class B  None and 712,000 shares
authorized as of March 31, 2004 and
September 30, 2003, respectively; none
and 13,500 shares issued and
outstanding as of March 31, 2004 and
September 30, 2003, respectively
(convertible into Class A common stock)
    
    
    
    
    
    
    8,395Accumulated deficit
    
    
    (109,221,816
    )
    
    
    (96,251,049
    )Accumulated other comprehensive loss
    
    
    (37,309
    )
    
    
    (6,548
    )Total shareholders equity (deficit)
    
    
    (4,005,148
    )
    
    
    1,037,231TOTAL LIABILITIES AND SHAREHOLDERS
EQUITY (DEFICIT)
    
    $
    24,786,399
    
    
    $
    29,645,257
 See notes to consolidated financial statements. 4




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AVANIR Pharmaceuticals 
 CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) Three months ended
    
    Six months endedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003REVENUES:Research contracts and licenses
    
    $
    267,500
    
    
    $
    
    
    
    $
    270,500
    
    
    $
    50,000Royalties and sale of royalty
rights (Note 7)
    
    
    347,017
    
    
    
    481,450
    
    
    
    885,513
    
    
    
    1,074,745Government research grants
    
    
    241,320
    
    
    
    140,193
    
    
    
    439,531
    
    
    
    298,604Product sales
    
    
    
    
    
    
    
    
    
    
    769,938
    
    
    
    17,400Total revenues
    
    
    855,837
    
    
    
    621,643
    
    
    
    2,365,482
    
    
    
    1,440,749OPERATING EXPENSES:Research and development
    
    
    5,372,641
    
    
    
    4,860,280
    
    
    
    10,736,324
    
    
    
    8,471,902General and administrative
    
    
    1,510,332
    
    
    
    1,210,567
    
    
    
    2,918,228
    
    
    
    2,289,513Sales and marketing
    
    
    722,086
    
    
    
    606,339
    
    
    
    1,580,597
    
    
    
    1,031,468Cost of product sales
    
    
    
    
    
    
    
    
    
    
    210,090
    
    
    
    3,102Total operating expenses
    
    
    7,605,059
    
    
    
    6,677,186
    
    
    
    15,445,239
    
    
    
    11,795,985LOSS FROM OPERATIONS
    
    
    (6,749,222
    )
    
    
    (6,055,543
    )
    
    
    (13,079,757
    )
    
    
    (10,355,236
    )Interest income
    
    
    56,726
    
    
    
    85,128
    
    
    
    112,268
    
    
    
    153,150Other income
    
    
    11,722
    
    
    
    6,013
    
    
    
    19,369
    
    
    
    11,859Interest expense
    
    
    (9,719
    )
    
    
    (12,761
    )
    
    
    (20,527
    )
    
    
    (23,335
    )LOSS BEFORE INCOME TAXES
    
    
    (6,690,493
    )
    
    
    (5,977,163
    )
    
    
    (12,968,647
    )
    
    
    (10,213,562
    )Provision for income taxes
    
    
    (62
    )
    
    
    (771
    )
    
    
    (2,120
    )
    
    
    (2,371
    )NET LOSS
    
    $
    (6,690,555
    )
    
    $
    (5,977,934
    )
    
    $
    (12,970,767
    )
    
    $
    (10,215,933
    )NET LOSS ATTRIBUTABLE TO COMMON
SHAREHOLDERS:Net loss
    
    $
    (6,690,555
    )
    
    $
    (5,977,934
    )
    
    $
    (12,970,767
    )
    
    $
    (10,215,933
    )Dividends on redeemable
convertible preferred stock
    
    
    
    
    
    
    (6,250
    )
    
    
    
    
    
    
    (12,500
    )Accretion of discount related
to redeemable convertible
preferred stock
    
    
    
    
    
    
    (4,509
    )
    
    
    
    
    
    
    (9,118
    )NET LOSS ATTRIBUTABLE TO COMMON
SHAREHOLDERS
    
    $
    (6,690,555
    )
    
    $
    (5,988,693
    )
    
    $
    (12,970,767
    )
    
    $
    (10,237,551
    )NET LOSS PER SHARE:BASIC AND DILUTED
    
    $
    (0.09
    )
    
    $
    (0.10
    )
    
    $
    (0.18
    )
    
    $
    (0.18
    )WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING:BASIC AND DILUTED
    
    
    71,285,690
    
    
    
    58,352,406
    
    
    
    71,248,769
    
    
    
    58,324,174
 See notes to consolidated financial statements. 5




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AVANIR Pharmaceuticals 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months EndedMarch 31,2004
    
    2003OPERATING ACTIVITIES:Net loss
    
    $
    (12,970,767
    )
    
    $
    (10,215,933
    )Adjustments to reconcile net loss to net cash provided by (used
for) operating activities:Depreciation and amortization
    
    
    794,261
    
    
    
    383,954Compensation paid with stock options
    
    
    29,471
    
    
    
    181,706Loss on disposal of assets
    
    
    
    
    
    
    1,100Changes in assets and liabilities:Accounts receivable
    
    
    92,781
    
    
    
    880,429Inventory
    
    
    198,450
    
    
    
    3,102Prepaid expenses and other assets
    
    
    380,440
    
    
    
    (264,070
    )Accounts payable
    
    
    116,215
    
    
    
    230,861Accrued expenses and other liabilities
    
    
    1,239,328
    
    
    
    (61,438
    )Accrued compensation and payroll taxes
    
    
    71,627
    
    
    
    111,188Deferred revenue
    
    
    (1,080,505
    )
    
    
    19,588,555Net cash provided by (used for) operating activities
    
    
    (11,128,699
    )
    
    
    10,839,454INVESTING ACTIVITIES:Investments in securities
    
    
    (997,112
    )
    
    
    (706,382
    )Proceeds from sales and maturities of investments in securities
    
    
    700,000
    
    
    
    2,100,000Patent costs
    
    
    (556,852
    )
    
    
    (234,306
    )Construction in progress
    
    
    
    
    
    
    (2,986,803
    )Purchases of property and equipment
    
    
    (71,786
    )
    
    
    (782,525
    )Net cash used for investing activities
    
    
    (925,750
    )
    
    
    (2,610,016
    )FINANCING ACTIVITIES:Proceeds from issuance of common stock and warrants
    
    
    7,929,678
    
    
    
    85,350Dividends paid on preferred stock
    
    
    
    
    
    
    (12,500
    )Proceeds from issuance of notes payable
    
    
    159,918
    
    
    
    Payments on notes payable and capital lease obligations
    
    
    (323,062
    )
    
    
    (279,951
    )Net cash provided by (used for) financing activities
    
    
    7,766,534
    
    
    
    (207,101
    )Net increase (decrease) in cash and cash equivalents
    
    
    (4,287,915
    )
    
    
    8,022,337Cash and cash equivalents at beginning of period
    
    
    12,198,408
    
    
    
    8,630,547Cash and cash equivalents at end of period
    
    $
    7,910,493
    
    
    $
    16,652,884SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Interest paid
    
    $
    20,527
    
    
    $
    23,335Income taxes paid
    
    $
    2,120
    
    
    $
    2,371
 See notes to consolidated financial statements. 6




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AVANIR Pharmaceuticals 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION AVANIR Pharmaceuticals (AVANIR, we or the Company) has prepared the
unaudited consolidated financial statements in this quarterly report in
accordance with the instructions to Form 10-Q adopted under the Securities
Exchange Act of 1934. Certain information and note disclosures normally
included in consolidated financial statements prepared in accordance with
accounting principles generally accepted in the United States have been
condensed or omitted pursuant to such rules and regulations. These unaudited
consolidated financial statements should be read with our audited consolidated
financial statements and the accompanying notes included in our Annual Report
on Form 10-K for the fiscal year ended September 30, 2003. In our opinion, all
adjustments (consisting only of normal recurring adjustments) necessary to
present a fair statement of our financial position as of March 31, 2004, and
the results of operations for the three-month and six-month periods ended March
31, 2004 and 2003, have been made. The results of operations for the
three-month and six-month periods ended March 31, 2004 are not necessarily
indicative of the results for the fiscal year ending September 30, 2004 or any
future periods. 2. STOCK-BASED COMPENSATION Statement of Financial Accounting Standards No. 123 (SFAS No. 123)
encourages, but does not require, companies to record compensation cost for
stock-based employee compensation at fair value. The Company has chosen to
continue to account for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations for all
periods presented. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the fair value of the Companys stock at the
date of the grant over the amount an employee must pay to acquire the stock. If compensation cost had been determined based upon the fair value at the grant
date for awards under the stock option plans consistent with the methodology
prescribed under SFAS No. 123, the Companys net loss would have been higher by
approximately $262,000 and $552,000 for the three-month and six-month periods
ended March 31, 2004 and approximately $395,000 and $868,000 for the
three-month and six-month periods ended 2003, respectively, as summarized in
the following table. Three Months Ended March 31,
    
    Six Months Ended March 31,2004
    
    2003
    
    2004
    
    2003Net loss attributable to common
shareholders, as reported
    
    $
    (6,690,555
    )
    
    $
    (5,988,693
    )
    
    $
    (12,970,767
    )
    
    $
    (10,237,551
    )Add: Stock-based employee
compensation included in
reported net loss attributable
to common shareholders
    
    
    12,227
    
    
    
    132,570
    
    
    
    24,069
    
    
    
    175,743Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards
    
    
    (274,054
    )
    
    
    (527,883
    )
    
    
    (576,106
    )
    
    
    (1,043,735
    )Pro forma net loss
attributable to common
shareholders
    
    $
    (6,952,382
    )
    
    $
    (6,384,006
    )
    
    $
    (13,522,804
    )
    
    $
    (11,105,543
    )Net loss per share:Basic and diluted  as reported
    
    $
    (0.09
    )
    
    $
    (0.10
    )
    
    $
    (0.18
    )
    
    $
    (0.18
    )Basic and diluted  pro forma
    
    $
    (0.10
    )
    
    $
    (0.11
    )
    
    $
    (0.19
    )
    
    $
    (0.19
    )
 The Company accounts for stock options granted to non-employees using the fair
value method. Compensation expense for options granted to non-employees has
been determined in accordance with 7




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Emerging Issues Task Force (EITF) No. 96-18, Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services, as the fair value of the
consideration received or the fair value of the equity instruments issued,
whichever is more reliably measurable. For the purpose of determining
compensation expense for stock options granted to non-employees, all of the
Companys directors are considered to be employees. 3. RECLASSIFICATIONS Certain amounts from prior periods have been reclassified to conform to the
current period presentation. 4. BALANCE SHEET DETAILS The following tables provide details of selected balance sheet items. Property and equipment.Property and equipment consist of the following: March 31, 2004
    
    September 30, 2003Gross
    
    
    
    
    
    
    
    
    
    GrossCarrying
    
    Accumulated
    
    
    
    
    
    Carrying
    
    AccumulatedValue
    
    Depreciation
    
    Net
    
    Value
    
    Depreciation
    
    NetResearch and
development
equipment
    
    $
    3,597,372
    
    
    $
    (1,657,429
    )
    
    $
    1,939,943
    
    
    $
    3,544,343
    
    
    $
    (1,331,544
    )
    
    $
    2,212,799Computer equipment
and related
software
    
    
    997,979
    
    
    
    (466,569
    )
    
    
    531,410
    
    
    
    1,000,206
    
    
    
    (383,512
    )
    
    
    616,694Leasehold
improvements
    
    
    5,018,345
    
    
    
    (746,057
    )
    
    
    4,272,288
    
    
    
    5,000,147
    
    
    
    (445,435
    )
    
    
    4,554,712Office equipment,
furniture and
fixtures
    
    
    552,650
    
    
    
    (239,315
    )
    
    
    313,335
    
    
    
    549,864
    
    
    
    (192,064
    )
    
    
    357,800Total property
and equipment
    
    $
    10,166,346
    
    
    $
    (3,109,370
    )
    
    $
    7,056,976
    
    
    $
    10,094,560
    
    
    $
    (2,352,555
    )
    
    $
    7,742,005
 Depreciation expense related to property and equipment was approximately
$381,000 and $757,000 for the three-month and six-month periods ended March 31,
2004 and $171,000 and $342,000 for the same periods, respectively, in the prior
year. Intangible assets.Intangible assets with indefinite useful lives consist of
costs of trademarks for AVANIR and Xenerex and similar names intended for use
or potential use in the United States and the rest of the world. The Company
reviews intangible assets with indefinite useful lives at least annually for
impairment, following the guidelines established in Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS No.
142). There were no impairments to trademarks during the three-month and
six-month periods ended March 31, 2004 and 2003. Intangible assets with finite
lives are amortized over their useful lives and are evaluated for impairment
whenever events or changes in circumstances indicate that their carrying value
may not be recoverable under SFAS No. 144, Accounting for Impairment or
Disposal of Long-lived Assets. AVANIRs amortizable intangible assets consist
of the costs of patents, patent applications, and licenses. 8




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Intangible assets, consisting of both intangible assets with finite and
indefinite useful lives, are as follows: March 31, 2004
    
    September 30, 2003Gross
    
    
    
    
    
    
    
    
    
    GrossCarrying
    
    Accumulated
    
    
    
    
    
    Carrying
    
    AccumulatedValue
    
    Amortization
    
    Net
    
    Value
    
    Amortization
    
    NetIntangible assets with
finite lives:Patent applications
pending
    
    $
    1,966,276
    
    
    $
    
    
    
    $
    1,966,276
    
    
    $
    1,464,859
    
    
    $
    
    
    
    $
    1,464,859Patents
    
    
    908,633
    
    
    
    (290,970
    )
    
    
    617,663
    
    
    
    855,799
    
    
    
    (254,657
    )
    
    
    601,142Licenses
    
    
    42,461
    
    
    
    (14,515
    )
    
    
    27,946
    
    
    
    42,461
    
    
    
    (13,383
    )
    
    
    29,078Total intangible
assets with finite
lives
    
    
    2,917,370
    
    
    
    (305,485
    )
    
    
    2,611,885
    
    
    
    2,363,119
    
    
    
    (268,040
    )
    
    
    2,095,079Intangible assets with
indefinite useful
lives
    
    
    38,730
    
    
    
    
    
    
    
    38,730
    
    
    
    36,130
    
    
    
    
    
    
    
    36,130Total intangible assets
    
    $
    2,956,100
    
    
    $
    (305,485
    )
    
    $
    2,650,615
    
    
    $
    2,399,249
    
    
    $
    (268,040
    )
    
    $
    2,131,209
 Amortization expense related to amortizable intangible assets was approximately
$20,000 and $37,000 for the three-month and six-month periods ended March 31,
2004 and $20,000 and $36,000 for the same periods, respectively, in the prior
year. Based solely on the amortizable intangible assets as of March 31, 2004,
the estimated annual amortization expense of intangible assets for the fiscal
years ending September 30 is shown in the following table. Actual amortization
expense to be reported in future periods could differ from these estimates as a
result of acquisitions, divestitures, and other relevant factors. Amortization ExpenseFiscal year
ending September 30,2004 (Remaining six months)
    
    $
    37,1782005
    
    
    72,1822006
    
    
    72,1882007
    
    
    70,3602008
    
    
    70,515Thereafter
    
    
    323,186Subtotal
    
    
    645,609Patent applications pending
    
    
    1,966,276Total
    
    $
    2,611,885
 5. USE OF ESTIMATES The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates. 6. INVENTORY Inventory is stated at the lower of cost (first-in, first-out) or market.
Inventory consists of only the raw material docosanol, which is the active
ingredient in docosanol 10% cream. Docosanol in its present form as stored by
the Company has a substantial shelf life, a relatively stable value and
long-term use, and carries a low risk of becoming excess inventory or obsolete.
AVANIR does not own or store any docosanol 10% cream in its finished product
form. The Company and one of its licensees receive raw 9




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##### Table of Contents



materials from a single supplier. AVANIR also supplies several other licensees
with raw materials from the same supplier. The inability of a sole supplier to
fulfill supply requirements of the Company or its licensees could materially
impact future operating results. 7. DEFERRED REVENUE On December 24, 2002, AVANIR sold an undivided interest in its Abreva® license
agreement with SB Pharmco Puerto Rico, Inc. (SB or GlaxoSmithKline) to Drug
Royalty USA, Inc. (Drug Royalty USA) for $24.1 million. We recorded the net
proceeds of the transaction as deferred revenue, to be recognized as revenue
over the life of the license agreement, because of our ongoing involvement in
earning future revenues under our license agreement with SB. The following
table sets forth the deferred revenue balances for the Drug Royalty USA
agreement and other agreements as of March 31, 2004 and September 30, 2003. The
portion of deferred revenue classified as a current liability represents the
amount AVANIR expects to realize as revenue within the next 12 months. Drug Royalty
    
    OtherUSA Agreement
    
    Agreements
    
    TotalDeferred revenue as of September 30, 2003
    
    $
    22,509,308
    
    
    $
    233,333
    
    
    $
    22,742,641Changes during period:Additions to deferred revenue
    
    
    
    
    
    
    50,000
    
    
    
    50,000Recognized as revenue during period
    
    
    (880,505
    )
    
    
    (250,000
    )
    
    
    (1,130,505
    )Deferred revenue as of March 31, 2004
    
    $
    21,628,803
    
    
    $
    33,333
    
    
    $
    21,662,136Classified as:Current portion of deferred revenue
    
    $
    1,722,435
    
    
    $
    33,333
    
    
    $
    1,755,768Deferred revenue, net of current portion
    
    
    19,906,368
    
    
    
    
    
    
    
    19,906,368Total deferred revenue
    
    $
    21,628,803
    
    
    $
    33,333
    
    
    $
    21,662,136
 8. REVENUE RECOGNITION Performance-based license fees.We recognize revenues from license fees when
the performance requirements have been met, the fee is fixed or determinable,
and collection of fees is probable. We defer revenues and recognize them
ratably over the life of the agreement when we have continuing obligations to
perform under the agreement. Royalty revenues.We recognize royalty revenues from license agreements when
earned. Net sales figures used for calculating royalties due the Company can
often include deductions for costs of unsaleable returns, managed care
charge-backs, cash discounts, freight and warehousing, and miscellaneous
write-offs, which may vary over the course of the license agreement. Revenues from sale of royalty rights.In agreements where we have sold our
rights to future royalties under license agreements and we maintain continuing
involvement in earning such royalties, we defer revenues and recognize them
over the life of the license agreement. For example, in the sale of an
undivided interest of our Abreva license agreement to Drug Royalty USA, revenue
recognition is being determined under the units-of-revenue method. Under this
method, the amount of deferred revenue to be recognized as revenue in each
period is calculated by multiplying (i) the ratio of the royalty payments due
to Drug Royalty USA for the period to the total remaining royalties that we
expect SB will pay Drug Royalty USA over the term of the agreement, by (ii) the
unamortized deferred revenue amount. Revenue arrangements with multiple deliverables.In certain circumstances, we
enter into revenue arrangements whereby we are obligated to deliver to the
customer multiple products and/or services (multiple deliverables). Such
arrangements could include antibody generation services agreements and other
forms of research collaborations. In these transactions, we allocate the total
revenue to be earned under the arrangement among the various elements based on
their relative fair value. In the case of 10




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antibody generation services, the allocation is based on objective,
customer-specific evidence of fair value. We recognize revenue related to the
delivered products or services only if: (i) the above performance or service
criteria are met; (ii) any undelivered products or services are not essential
to the functionality of the delivered products or services; (iii) payment for
the delivered products or services is not contingent upon delivery of the
remaining products or services; (iv) we have an enforceable claim to receive
the amount due in the event we do not deliver the undelivered products or
services; and (v) as discussed above, there is evidence of the fair value for
each of the undelivered products or services. Government research grant revenues.We recognize revenues from government
research grants during the period in which the related expenditures are
incurred. 9. INVESTMENTS The following tables summarize the Companys investments in securities: Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains (1)
    
    Losses (1)
    
    ValueAs of March 31, 2004:Certificates of deposit
    
    $
    1,356,597
    
    
    $
    10,217
    
    
    $
    
    
    
    $
    1,366,814Adjustable rate mutual fund (2)
    
    
    3,014,365
    
    
    
    
    
    
    
    (40,566
    )
    
    
    2,973,799Government debt securities
    
    
    1,191,579
    
    
    
    
    
    
    
    (6,960
    )
    
    
    1,184,619Total
    
    $
    5,562,541
    
    
    $
    10,217
    
    
    $
    (47,526
    )
    
    $
    5,525,232Reported as:Short-term investments:Classified as available-for-sale
    
    $
    4,565,121Long-term investments:Classified as available-for-sale
    
    
    103,514Restricted investments (3)
    
    
    856,597Long-term investments
    
    
    960,111Total
    
    $
    5,525,232
 Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    FairCost
    
    Gains (4)
    
    Losses (4)
    
    ValueAs of September 30, 2003:Certificates of deposit
    
    $
    2,056,597
    
    
    $
    15,575
    
    
    $
    
    
    
    $
    2,072,172Adjustable rate mutual fund (2)
    
    
    3,014,365
    
    
    
    
    
    
    
    (18,723
    )
    
    
    2,995,642Government debt securities
    
    
    194,467
    
    
    
    
    
    
    
    (3,400
    )
    
    
    191,067Total
    
    $
    5,265,429
    
    
    $
    15,575
    
    
    $
    (22,123
    )
    
    $
    5,258,881Reported as:Short-term investments:Classified as available-for-sale
    
    $
    3,888,798Long-term investments:Classified as available-for-sale
    
    
    513,486Restricted investments (3)
    
    
    856,597Long-term investments
    
    
    1,370,083Total
    
    $
    5,258,881
   (1)
    
    Gross unrealized gains of $10,217 and gross unrealized losses of
$47,526 on government securities, the adjustable rate mutual fund, and
certificates of deposit represent an accumulated net unrealized loss of
$37,309, which is reported as accumulated other comprehensive loss on
the consolidated balance sheet as of March 31, 2004.(2)
    
    Represents an investment in a mutual fund that invests primarily in
adjustable rate mortgage-backed securities.(3)
    
    Restricted investments amounting to $856,597 as of both March 31,
2004 and September 30, 2003 represent amounts pledged to our bank as
collateral for letters of credit issued in connection with our leases
of office and laboratory space. 11




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(4)
    
    Gross unrealized gains of $15,575 and gross unrealized losses of
$22,123 on government securities, the adjustable rate mutual fund, and
certificates of deposit represent an accumulated net unrealized loss of
$6,548, which is reported as accumulated other comprehensive loss on
the consolidated balance sheet as of September 30, 2003. 10. COMPUTATION OF NET LOSS PER COMMON SHARE We compute basic net loss per common share by dividing the net loss
attributable to common shareholders by the weighted-average number of common
shares outstanding during the period (Basic EPS Method). We compute diluted
net loss per common share by dividing the net loss attributable to common
shareholders by the weighted-average number of common and dilutive common
equivalent shares outstanding during the period (Diluted EPS Method).
Dilutive common equivalent shares consist of shares issuable upon exercise of
stock options and warrants and conversion of preferred stock. In the
accompanying consolidated statements of operations, we have presented our net
loss per share for the three-month and six-month periods ended March 31, 2004
and 2003 using the Basic EPS Method and the Diluted EPS Method. The shares of
common stock issuable upon exercise of stock options and warrants and
conversion of preferred stock under the Diluted EPS Method were excluded from
the three-month and six-month periods ended March 31, 2004 and 2003, as the
inclusion of such shares would have been anti-dilutive. For the three-month and six-month periods ended March 31, 2004 and 2003,
options to purchase 5,250,357 and 6,450,676 shares of common stock,
respectively, were excluded from the computation of diluted net loss per share,
as the inclusion of such shares would be antidilutive. For the three-month and
six-month periods ended March 31, 2004 and 2003, warrants to purchase 5,442,911
and 1,031,350 shares of common stock, respectively, were excluded from the
computation of diluted net loss per share, as the inclusion of such shares
would be antidilutive. 11. SHAREHOLDERS EQUITY (DEFICIT) Preferred stock. Preferred stock consists of Series C Junior Participating
Preferred Stock, of which none is outstanding. Class A common stock.During the three-month period ended March 31, 2004, we
issued an aggregate of 263,239 shares of Class A common stock in connection
with the exercise of stock purchase warrants (154,971 shares) and employee
stock options (108,268 shares) for cash in the aggregate amount of $384,826,
representing a weighted average price per share of $1.46. Also during the
period the Class J warrant holder exercised its rights to acquire 19,119 shares
of Class A common stock using a cashless exercise option. The market price
on the date of exercise of the Class J warrant was $1.70 per share. The market
price was $0.65 per share greater than the $1.05 per share exercise price of
the warrant. Accordingly, the holder surrendered to us the warrant to purchase
30,881 shares that had an aggregate value of approximately $20,075 based on the
difference in the market price on the tender date and the exercise price, times
the number of shares purchasable under the warrant. On December 5, 2003, we sold and issued 5,382,316 shares of Class A common
stock and five-year warrants to purchase an additional 3,229,389 shares of
Class A common stock to several accredited investors and received $8,019,652 in
gross proceeds. The exercise price of the warrants is $1.75 per share. The
financing transaction was made pursuant to the terms of a securities purchase
agreement that provided each investor with a five-year warrant to purchase
six-tenths of a share of Class A common stock for every share of Class A common
stock purchased under the agreement. The effect of the financing transaction
was an increase in cash and shareholders equity in the amount of $7,544,852,
after taking into effect the costs of the transaction. The placement agent was
paid $415,000 in fees and expenses, and was issued a five-year warrant to
purchase 161,470 shares of the Companys Class A common stock at $1.75 per
share, in connection with this transaction. 12




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Class B common stock conversions.During the three-month period ended March
31, 2004, 3,500 shares of Class B common stock were converted to 3,500 shares
of Class A common stock. As of March 31, 2004 and September 30, 2003 there
were none and 13,500 shares of Class B common stock outstanding, respectively. 12. RECENT ACCOUNTING PRONOUNCEMENTS In January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities,
an Interpretation of ARB No. 51. FIN 46 requires the consolidation of certain
variable interest entities by the primary beneficiary of the entity if the
equity investment at risk is not sufficient to permit the entity to finance its
activities without additional subordinated financial support from other parties
or if the equity investors lack the characteristics of a controlling financial
interest. FIN 46 was effective immediately for variable interest entities
created or acquired after January 31, 2003. For variable interest entities
created or acquired prior to February 1, 2003, the provisions of FIN 46, as
amended, were applicable to entities deemed special purpose entities effective
on December 31, 2003 and were applicable to entities not deemed special purpose
entities effective on March 31, 2004. The application of the provisions of FIN
46 did not have a material impact on the Companys financial statements. 13. CONTINGENCIES In the ordinary course of business, we may face various claims brought by third
parties, including claims relating to the safety or efficacy of our products.
Any of these claims could subject us to costly litigation and, while we
generally believe that we have adequate insurance to cover many different types
of liabilities, our insurance carriers may deny coverage or our policy limits
may be inadequate to fully satisfy any damage awards or settlements. If this
were to happen, the payment of any such awards could have a material adverse
effect on our operations and financial position. Additionally, any such claims,
whether or not successful, could damage our reputation and business. Management
believes the outcome of currently identified claims and lawsuits will not have
a material adverse effect on the Companys operations or financial position. 
 Item 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 This quarterly report on Form 10-Q contains forward-looking statements
concerning future events and performance of our company. You should not rely
excessively on these forward-looking statements, because they are only
predictions based on our current expectations and assumptions. When used in
this report, the words intend, estimate, anticipate, believe, plan or
expect and similar expressions as they related to AVANIR are included to
identify forward-looking statements. Many factors could cause our actual
results to differ materially from those indicated in these forward-looking
statements. You should review carefully the factors identified in this report
under the caption, Risk Factors that Might Affect Future Results, and in our
most recent annual report on Form 10-K filed with the Securities and Exchange
Commission (SEC). We disclaim any obligation to update or announce revisions
to any forward-looking statements to reflect actual events or developments. EXECUTIVE OVERVIEW We are a drug discovery and development company focused primarily on novel
treatments for chronic diseases. We have one product that has been approved by
the U.S. Food and Drug Administration (FDA) for the treatment of cold sores,
docosanol 10% cream (sold as Abreva® by our marketing partner, GlaxoSmithKline
Consumer Healthcare, in North America), and have several product candidates in
clinical development. Our late-stage product candidate,
NeurodexTM, is in Phase
III clinical development for the treatment of pseudobulbar affect (PBA), also
known as pathological laughing or crying. Neurodex is also in Phase II clinical
development for the treatment of neuropathic pain. A 13




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##### Table of Contents



potential product for allergy and asthma, AVP-13358, is in Phase I clinical
development. We also have preclinical research programs targeting inflammatory
diseases, atherosclerosis and cancer. Our preclinical research and drug
discovery programs are focused primarily on small molecules that can be taken
orally as therapeutic treatments. Using our proprietary
XenerexTM technology,
we are also conducting research to develop injectable human monoclonal antibody
products for infectious diseases, such as anthrax and cytomegalovirus, and for
other therapeutic applications. The following graph illustrates the development status of our product
candidates. (GRAPH) The continued development of our product candidates, and the potential launch
of a new drug, will require substantial additional capital. We intend to
partner with pharmaceutical companies that can help fund our research and
potential product launch in exchange for sharing in the rights to commercialize
new drugs. We have licensed certain rights to docosanol 10% cream and continue
to seek licensees for that product and potential products in our pipeline.
Research collaborations also represent an important way to achieve our
development goals by sharing the risks and the opportunities that come from
such development efforts. We expect that our development and operational costs will continue to exceed
revenues from existing sources at least until the end of 2005. We will have to
raise significant amounts of additional capital to finance our research and
development activities and operations if we are unable to enter into
partnership or collaborative arrangements with pharmaceutical companies that
will share our drug development costs. If we are unable to raise capital as
needed to fund our operations, or if we are unable to enter into collaborative
arrangements, then we may need to slow the rate of development of some of our
programs or sell the rights to one or more our drug candidates. Our most significant product license to date is with GlaxoSmithKline for the
right to sell Abreva in North America for the treatment of cold sores. In
December 2002, we sold an undivided interest in our license with
GlaxoSmithKline to Drug Royalty USA for $24.1 million, under which we retained
one-half of all royalties from GlaxoSmithKline on annual Abreva sales in excess
of $62 million. Although we have received the $24.1 million in sale proceeds
under this contract, the revenues have been deferred in accordance with
accounting principles generally accepted in the United States and we are
recognizing a portion of the revenue each quarter through April 2014. We are seeking additional licensees for docosanol 10% cream in Europe and Japan
and, in November 2003, the Swedish Medical Products Agency approved docosanol
10% cream for marketing as a non-prescription, over-the-counter (OTC) topical
treatment for cold sores. Sweden is acting as the Reference Member State for
obtaining further regulatory approvals of docosanol 10% cream in the 14




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European Union. We expect that the Swedish approval should facilitate
regulatory approval in additional countries in the European Union through what
is known as the mutual recognition process. We also believe that European
regulatory approvals will make the drug more attractive for licensing. In March 2004, we completed enrollment in our Phase III clinical trial for
Neurodex in the treatment of PBA. If the results of the 90-day patient trials
are favorable, we expect to submit a new drug application (NDA) to the FDA
for the drug in the second half of the 2004 calendar year. We are in
the process of completing enrollment in an open-label safety study of
Neurodex in the treatment of PBA, which is expected to be
substantially complete by the time of our projected NDA submission. If the FDA approves
the product, we may license Neurodex for distribution in the United States and
other countries, or elect to market the drug directly with a co-promotion
partner. If we choose to market the drug directly, we will need to raise
additional capital to fund the creation of a sales force and provide working
capital related to manufacturing, promotion and sales of the product. If we
are able to obtain approval from the FDA in the second half of 2005 to market
Neurodex, and launch Neurodex shortly thereafter, we expect that revenues from
sales of the product will begin to contribute operating cash flows in
2006. See Risk Factors That Might Affect Future Operations
 Risks Relating to our Business. Regarding our other clinical and preclinical development programs, we intend to
develop those programs to Phase II proof of concept and then license those
programs to major pharmaceutical companies. We are pursuing this strategy for
these programs because we do not have sufficient human or capital resources to
carry out all phases of clinical development. Our offices and research facilities are located at 11388 Sorrento Valley Road,
San Diego, California 92121. Our telephone number is (858) 622-5200 and our
e-mail address is info@Avanir.com. Additional information about AVANIR can be
found on our website, at www.avanir.com,and in our periodic and current
reports filed with the Securities and Exchange Commission (SEC). Copies of
our current and periodic reports filed with the SEC are available at the SEC
Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549, and
online at www.sec.govand our website at www.avanir.com. RESULTS OF OPERATIONS 
COMPARISON OF THREE MONTHS ENDED MARCH 31, 2004 AND 2003 Revenues Revenues in the second quarter of fiscal 2004 amounted to $856,000 including
$268,000 from research contracts and licenses, $345,000 from the recognition of
deferred revenue relating to the sale of an undivided interest in our Abreva®
license agreement to Drug Royalty USA (see Note 7, Deferred Revenue, in the
accompanying consolidated financial statements), and $241,000 from government
research grants. Revenues from research contracts and licenses included
$200,000 from completion of antibody development work for DNAX Research, Inc.
Revenues in the second quarter of fiscal 2003 amounted to $622,000, including
$481,000 from the recognition of deferred revenue relating to the sale of an
undivided interest in our Abreva license agreement to Drug Royalty USA and
$140,000 from government research grants. During fiscal 2004, we expect
to recognize approximately $1.7 million in
revenues from the recognition of deferred revenue relating to the sale of an
undivided interest in our Abreva license agreement to Drug Royalty USA and the
DNAX Research contract, approximately $800,000 in sales of the active
ingredient docosanol to licensees, and approximately $800,000 in revenues from
government research grants. As of March 31, 2004, approximately one-half of
deferred revenues and revenues from government research grants had been
recognized out of projected amounts for fiscal 2004. Also, as of March 31,
2004, substantially all of projected fiscal 2004 revenues from the sales of
docosanol had been achieved. Projected fiscal 2004 revenues from new sources, such as license fees,
milestone payments, and royalties on foreign sales of licensed products, will
depend substantially on the timing of approval decisions for docosanol 10%
cream by foreign regulatory agencies and our ability to enter into additional
license arrangements and achieve milestones under those arrangements. Such
arrangements could be in the form 15




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of licensing or partnering agreements for docosanol 10% cream or for our other
product development programs for the treatment of PBA, neuropathic pain,
allergy and asthma, and cholesterol. Many of our product development programs
could take years of additional development before they reach the stage of
licensing, if ever, by other pharmaceutical companies. Revenue-generating Contracts Commercial contracts that remained active at the end of the second quarter of
fiscal 2004 include five docosanol 10% cream (e.g. Abreva) license agreements,
one antibody license and one Neurodex sublicense. The GlaxoSmithKline license
arrangement has been our most significant revenue source, representing
approximately 40% and 77% of total revenues for the three months ended March
31, 2004 and 2003, respectively. Expenses Operating expenses. Total operating expenses were $7.6 million in the second
quarter of fiscal 2004, compared to $6.7 million in the same period in fiscal
2003. The 14% increase in operating expenses was primarily caused by an
$899,000 increase in spending for Phase III clinical development and the open
label study of Neurodex for the treatment of PBA, reflecting substantially
higher rates of enrollment than during the same period a year ago. Research
and development programs accounted for 71% of total operating expenses for the
three months ended March 31, 2004. Sales and marketing expenses for the three
months ended March 31, 2004, increased by 19% over the same period a year ago,
representing additional medical education and awareness programs for PBA.
These and other costs are more fully described below. Three Months Ended
    
    Six Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Operating expenses:Research and development
    
    
    71
    %
    
    
    73
    %
    
    
    70
    %
    
    
    72
    %General and administrative
    
    
    20
    %
    
    
    18
    %
    
    
    19
    %
    
    
    19
    %Sales and marketing
    
    
    9
    %
    
    
    9
    %
    
    
    10
    %
    
    
    9
    %Cost of sales
    
    
    
    %
    
    
    
    %
    
    
    1
    %
    
    
    
    %Total operating expenses
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 Research and development (R&D) expenses. R&D expenses were $5.4 million in
the second fiscal quarter of 2004, compared to $4.9 million in the same period
a year ago. The Phase III clinical trial for Neurodex in the treatment of PBA
in patients with multiple sclerosis (MS) accounted for approximately 45% of all
R&D spending in the second quarter of fiscal 2004. Costs related to a Phase I
single rising dose study of AVANIRs lead compound for the treatment of
allergies and asthma accounted for approximately 16% of total R&D spending in
the second quarter of fiscal 2004. The balance of R&D spending was for other
programs, including preclinical research related to inflammation and
cholesterol-lowering compounds and antibody research programs. We expect R&D
spending will continue at the current rate through the next several quarters as
we proceed towards completion of the Phase III clinical trial and open label
study of Neurodex and continue the Phase I clinical trials of AVP-13358 and
preclinical research related to cholesterol reduction and inflammation. In the second quarter of fiscal 2003, approximately 31% of R&D expenses were
related to the Phase III clinical trial for Neurodex in the treatment of PBA in
patients with MS. Approximately 26% of R&D expenses were related to completion
of toxicology and other preclinical research related to treatments for
allergies and asthma. The balance of R&D spending was divided primarily among
research related to inflammation, cholesterol-lowering compounds, and antibody
research programs. Pharmaceutical R&D programs, by their very nature, require a substantial amount
of financial and human resources and there is no assurance that any drug
candidate will be approved for marketing by domestic and/or foreign regulatory
agencies. The later stages of clinical development typically require 16




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substantially greater funds for development than the earlier stages. Thus, for
many of our larger development programs, we intend to license our technology or
partner with other pharmaceutical companies that have substantially greater
financial resources. We expect that our licensees will continue to develop and
fund those projects and pay us up-front license fees, milestone payments, and
royalties on product sales if those products are successfully developed and
approved for marketing by the FDA and foreign regulatory agencies. We caution
that many of our development efforts could experience delays, setbacks and
failures, with no assurance that any of our clinical research or our potential
licensees or partners will ever reach the stage of submitting an NDA to the FDA
or that any NDA will be approved. The following table sets forth the status
of, and costs attributable to, our proprietary research and clinical
development programs. 17




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##### Table of Contents



Research and Development Projects and Expenses Three Months Ended
    
    Six Months EndedMarch 31,
    
    March 31,
    
    Inception Through
    
    Estimated Cost to License2004 (1)
    
    2003 (1)
    
    2004 (1)
    
    2003 (1)
    
    March 31, 2004 (1)(2)
    
    or Complete Project (1)Major Company-Funded
Projects:Develop Neurodex for FDA
marketing approval in
treating PBA. Estimated
timing to complete remaining
phases of project necessary
to submit an NDA to
FDA: 0.5 year
    
    $
    2,428,453
    
    
    $
    1,529,437
    
    
    $
    4,198,307
    
    
    $
    2,103,395
    
    
    $
    14,660,810
    
    
    $
    4MDevelop Neurodex for
neuropathic pain.
Phase II open-label study
completed
    
    
    510,298
    
    
    
    611,845
    
    
    
    1,105,660
    
    
    
    710,784
    
    
    
    5,862,833
    
    
    
    (3
    )Development program for
allergy and asthma (IgE
regulator). Estimated
timing to complete Phase IIa
and license the product: up
to 2 years
    
    
    882,574
    
    
    
    1,247,157
    
    
    
    1,949,868
    
    
    
    2,483,614
    
    
    
    16,452,869
    
    
    $
    15MPreclinical anti-inflammatory
research program (MIF
inhibitor). Estimated
timing to complete Phase
IIa and to license the
product: up to 4 years
    
    
    453,851
    
    
    
    391,256
    
    
    
    1,066,636
    
    
    
    1,017,831
    
    
    
    6,112,497
    
    
    $
    23MPreclinical cholesterol
reduction program.
Estimated timing to complete
proof of concept and license
product: up to 3.5 years
    
    
    237,059
    
    
    
    181,320
    
    
    
    460,424
    
    
    
    408,983
    
    
    
    2,361,203
    
    
    $
    27MGovernment-Funded Projects:Preclinical research,
primarily for potential
treatments for genital
herpes and anthrax.
Estimated timing to complete
the various projects varies
from one to two years
    
    
    337,039
    
    
    
    185,946
    
    
    
    562,872
    
    
    
    357,002
    
    
    
    1,645,926
    
    
    $
    1.0M
    (4)Other Research Projects:Other projects involving
monoclonal antibodies and
docosanol. The costs and
timing to complete these
projects are unpredictable
because of the uncertainty
of outcomes of our research
    
    
    523,367
    
    
    
    713,319
    
    
    
    1,392,557
    
    
    
    1,390,293
    
    
    
    12,790,146Total
    
    $
    5,372,641
    
    
    $
    4,860,280
    
    
    $
    10,736,324
    
    
    $
    8,471,902
    
    
    $
    59,886,284
   (1)
    
    Each project includes allocation of laboratory occupancy costs.
M refers to millions. Estimated costs and timing to complete the
projects are subject to the availability of funds.(2)
    
    Inception dates are on or after October 1, 1998, at which time we
began identifying and tracking program costs.(3)
    
    Licensing and/or co-promotion alternatives are being explored
whereby the partner would fund Phase III clinical trials. See
Research and Development Program Status 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.(4)
    
    Represents the remaining balance of State and Federal research
grant awards totaling $2.1 million for research related to genital
herpes, anthrax, cytomegalovirus (CMV) and a blood donor program. 18




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##### Table of Contents



Research and Development Program Status and Plans Neurodex for the treatment of PBA.On March 31, 2004, we completed enrollment
totaling 150 patients in a Phase III clinical trial of Neurodex for the
treatment of PBA in patients with MS and we closed the study to any further
enrollments. Given the 90-day study period, the last patient should complete
the clinical trial at the end of June 2004. We also recently surpassed
one-half the targeted enrollment in an open-label safety study for the treatment of
PBA in a broader pool of patients who could have any one of several
neurodegenerative diseases. Prior to engaging in these studies, we completed
the initial Phase III clinical trial of PBA in patients with amyotrophic
lateral sclerosis (ALS), in May 2002. Our goal is to submit an NDA to the FDA
in the second half of the 2004 calendar year. Neurodex for the treatment of neuropathic pain.This program is in the Phase
II stage of clinical development. At present, we are evaluating alternatives
for continued development of Neurodex in the treatment of neuropathic pain,
including continuing development on our own or with the funding of a potential
co-promotion partner or potential licensee. In mid-2003, we successfully
completed a four-week open-label dose escalation study of Neurodex in patients
with painful diabetic neuropathy. There can be no assurances as to the timing
of a license or co-promotion arrangement, if any. Development program for allergy and asthma (IgE regulator).We recently
completed a Phase I clinical trial of our asthma/allergy drug, AVP-13358, in 54
healthy volunteers. The placebo-controlled study was intended to assess
safety, tolerability and pharmacokinetics following a single oral
administration. Results of the study suggest AVP-13358 was well tolerated at
all doses. The study also demonstrated AVP-13358 was detectable in the
bloodstream at all doses administered and remains in circulation long enough to
allow potentially once or twice daily dosing. AVP-13358 is a novel drug
molecule discovered by AVANIR scientists that is intended to inhibit the
production of IgE, a well-known mediator of allergy and asthma. Phase I trials
are intended to establish safety of the drug in single rising doses in healthy
volunteers. These trials will be followed by Phase Ib clinical trials using
rising multi-doses in healthy patients. Assuming the successful completion of
Phase I clinical trials and adequate funds to continue development without a
partner, we intend to continue development of the drug through Phase IIa.
Assuming the results of such additional studies are favorable, we expect to
license the drug to a larger pharmaceutical company for further development. Cholesterol reduction. We are engaged in preclinical research focused on
certain types of small molecules that can be taken orally as a potential
treatment of hyper-cholesterolemia (high cholesterol). Cholesterol is
transported in the blood in large cholesterol-rich particles called
lipoproteins. Generally, low-density lipoproteins (LDL) deliver the
cholesterol to peripheral tissues including aorta and coronary arteries,
whereas high-density lipoproteins (HDL) remove excess cholesterol from
peripheral tissues, and transport it to the liver for elimination. The process
is also known as reverse cholesterol transport (RCT). We are evaluating a
series of compounds that, in animal modes, reduce the fatty deposits in the
blood vessel walls (commonly called plaque) typically associated with
atherosclerosis. We estimate the costs to develop selected compounds to the
stage of being able to demonstrate the proof of concept and to license the
compound to be $27 million. Anti-inflammatory research program (MIF inhibitor). We are currently
conducting research on several potential drug candidates capable of inhibiting
or blocking the activity of macrophage migration inhibitory factor (MIF).
Our research indicates that MIF may serve as a potential drug target in a
variety of diseases, including rheumatoid arthritis, Crohns disease, colitis
and asthma. Assuming we are successful in finding a lead compound and
submitting an investigational new drug application (IND) to the FDA, and
successfully completing some of the initial studies, we intend to license the
compound to another pharmaceutical company for further development. Any delays
to our product development 19




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##### Table of Contents



timeline or in submitting an IND could cause a
similar delay in the timing of when we expect that we could license our MIF
technology. Government research contracts.AVANIR has been engaged in research funded by
$2.1 million in government research grants. We recently completed two
government-funded research programs  the development of a blood donor program
intended to find high-affinity antibodies to infectious diseases and research
on potential antibodies to cytomegalovirus. Approximately $1.0 million in
funds remains to be spent throughout 2004 and 2005 under existing government
research grants for research on docosanol based formulations for the treatment of genital herpes and for the development
of antibodies to anthrax toxins. Monoclonal antibodies research. Two of AVANIRs most potent anthrax
antibodies, AVP 21D9 and AVP 22G12, appear unique both in mechanism of action
and in terms of the binding site on the anthrax toxin. AVP 21D9 is currently
in preclinical development for use as a prophylactic and therapeutic drug to
treat anthrax infections. Ultimately, AVANIR plans to submit an IND
application seeking clearance from the FDA to begin clinical trials to evaluate
the safety, tolerability, and pharmacology of AVP 21D9 in healthy human
subjects. Much of our work targeting infectious diseases has been funded by
government research grants. Because all of our research is at a very early
preclinical stage of development and is unpredictable in terms of the outcome,
we are unable to predict the cost and timing for development of any antibody or
drug. General and administrative expenses. General and administrative expenses
amounted to $1.5 million in the second quarter of fiscal 2004, representing a
25% increase over expenses of $1.2 million in the same period in the prior
year. Higher expenses were primarily attributable to a $257,000 increase in
expenses related to securities compliance and implementation of requirements
under the Sarbanes-Oxley Act of 2002 and a $102,000 increase in building
occupancy costs, including rent, utilities, maintenance and insurance resulting
from the utilization of additional office space in the current period,
partially offset by a $21,700 reduction in investor relations expenses due
primarily to discontinuation of certain contract services. The Company expects
that general and administrative expenses will remain at about the same level
over the next two quarters. Sales and marketing expenses. During the second quarter of fiscal 2004, sales
and marketing expenses were $722,000, compared to $606,000 in the same period a
year ago. Higher expenses in the second fiscal quarter of 2004 were related
primarily to the addition of approximately $203,000 in medical education and
awareness programs for PBA and pre-launch planning activities for Neurodex. We
expect that sales and marketing expenses will continue at the current rate for
at least the next quarter and increase thereafter if Phase III clinical trial
results for Neurodex are favorable. Net Loss For the second quarter of fiscal 2004, the net loss attributable to common
shareholders was $6.7 million, compared to $6.0 million for the same period a
year ago. The basic and diluted net loss per share was $0.09 for the second
quarter of fiscal 2004, compared to $0.10 for the same period a year ago. A
higher number of shares outstanding during the three months ended March 31,
2004 accounted for the lower per share loss compared to the same period in the
prior year. We expect to continue to pursue our drug development strategy
focused on the development of Neurodex, followed by other programs in earlier
stages of development that are in large therapeutic areas and that have
significant partnering and licensing potential. To help fund and develop our
products, we intend to seek licensees and partners to share the costs of
development. Some of these potential license arrangements could materially
change our outlook for future revenues and costs. However, the timing of such
potential arrangements is unpredictable. 20




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RESULTS OF OPERATIONS  Comparison of Six Months Ended March 31, 2004 and 2003 Revenues Revenues for the first six months of fiscal 2004 amounted to $2.4 million,
compared to $1.4 million for the same period last year. Revenues for the first
six months of fiscal year 2004 included $881,000 in revenue that the
Company recognized from the sale of certain rights to future Abreva royalties
to Drug Royalty USA, $770,000 in sales of the raw material docosanol, and
$440,000 from government research grants. Revenues for the first six months of
fiscal year 2003 included $1.1 million in revenue that the Company recognized
from the sale of certain rights to future Abreva royalties to Drug Royalty USA,
$299,000 from government research grants and $17,000 in sales of the raw
material docosanol. Expenses Operating Expenses. Total operating expenses were $15.4 million in the first
six months of fiscal 2004, compared to $11.8 million in the same period in
fiscal 2003. The 31% increase in operating expenses was primarily caused by a
27% increase in spending on research and development programs. Research and
development programs accounted for 70% and 72% of total operating expenses for
the first six months of fiscal 2004 and 2003, respectively. General and
administrative expenses accounted for 19% of total operating expenses for both
the first six months of fiscal 2004 and 2003. Sales and marketing expenses
accounted for 10% and 9% of total operating expenses for the first six months of
fiscal 2004 and 2003, respectively. These and other costs are more fully
described below. Research and Development Expenses. Research and development (R&D) expenses
were $10.7 million in the first six months of fiscal 2004, compared to $8.5
million in the same period a year ago. The clinical trials of Neurodex in the
treatment of pseudobulbar affect (PBA) in patients with multiple sclerosis
accounted for 39% of all R&D spending in the first six months of fiscal 2004.
Costs associated primarily with completion of toxicology, filing an IND and
initiating Phase I clinical trials of AVANIRs lead compound for the treatment
of allergies and asthma accounted for 18% of total R&D spending in the first
six months of fiscal 2004. The balance of R&D spending was for other programs,
including pre-clinical research related to inflammation and
cholesterol-lowering compounds and antibody research programs. In the first six months of fiscal 2003, costs associated with completion of
toxicology, filing an IND and initiating Phase I clinical trials of AVANIRs
lead compound for the treatment of allergies and asthma accounted for 29% of
total R&D spending. The clinical trials of Neurodex in the treatment of PBA in
patients with MS and in the treatment of neuropathic pain accounted for 25% and
8%, respectively, of all R&D spending in the first six months of fiscal 2003.
The balance of R&D spending was for other programs, including pre-clinical
research related to inflammation and cholesterol-lowering compounds and
antibody research programs. General and Administrative Expenses. General and administrative expenses
amounted to $2.9 million in the first six months of fiscal 2004, representing a
27% increase over expenses of $2.3 million in the same period in the prior
year. Higher expenses were attributable to a $321,000 increase related to
human resource programs, a $203,000 increase related to securities compliance
and the Sarbanes-Oxley Act of 2002, and a $190,000 increase in building
occupancy costs, including rent, utilities, maintenance and insurance,
resulting from the utilization of additional office space in the current
period, partially offset by a $70,000 reduction in outside services for
investor relations. 21




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##### Table of Contents



Sales and Marketing Expenses. During the first six months of fiscal 2004,
sales and marketing expenses were $1.6 million, compared to $1.0 million in the
same period a year ago. Higher expenses in the first six months of fiscal 2004
were primarily related to the addition of medical education and awareness
programs for PBA and pre-launch planning activities for Neurodex. Net Loss For the first six months of fiscal 2004, the net loss attributable to common
shareholders was $13.0 million, compared to $10.2 million for the same period a
year ago. The basic and diluted net loss per share was $0.18 for both the
first six months of fiscal 2004 and 2003. LIQUIDITY AND CAPITAL RESOURCES As of March 31, 2004, we had cash, cash equivalents, and investments in
securities totaling $13.4 million and a net working capital balance of $5.1
million. As of September 30, 2003, we had cash, cash equivalents and
investments in securities of $17.5 million and a net working capital balance of
$10.6 million. Explanations of net cash provided by or used for operating,
investing and financing activities are provided below. March 31,
    
    Decrease
    
    September 30,2004
    
    During Period
    
    2003Cash, cash equivalents and investments in securities
    
    $
    13,435,725
    
    
    $
    (4,021,564
    )
    
    $
    17,457,289Cash and cash equivalents
    
    $
    7,910,493
    
    
    $
    (4,287,915
    )
    
    $
    12,198,408Net working capital
    
    $
    5,090,666
    
    
    $
    (5,528,550
    )
    
    $
    10,619,216
 Six months ended
    
    Change
    
    Six months endedMarch 31,
    
    Between
    
    March 31,2004
    
    Periods
    
    2003Net cash provided by (used for) operating activities
    
    $
    (11,128,699
    )
    
    $
    (21,968,153
    )
    
    $
    10,839,454Net cash used for investing activities
    
    
    (925,750
    )
    
    
    1,684,266
    
    
    
    (2,610,016
    )Net cash provided by (used for) financing activities
    
    
    7,766,534
    
    
    
    7,973,635
    
    
    
    (207,101
    )Net increase (decrease) in cash and cash equivalents
    
    $
    (4,287,915
    )
    
    $
    (12,310,252
    )
    
    $
    8,022,337
 Operating activities. Net cash used for operating activities amounted to $11.1
million in the first six months of fiscal 2004, compared to $10.8 million in
cash provided by operating activities during the same period a year ago. For
the first six months of fiscal 2004, the net loss of $13.0 million primarily
accounted for the cash used for operating activities. Also during the period,
inventory declined by $198,000, representing the cost of docosanol sold to
various licensees, and accounts receivable increased by $93,000, representing
services provided under government grants for which payments were received
after the quarter ended. We intend to replenish our docosanol inventory later
in the fiscal year. The net cash provided by operating activities in the first
six months of fiscal 2003 includes $24.1 million in cash, net of transaction
costs, received from Drug Royalty USA on December 24, 2002, from the sale of an
undivided interest in our Abreva® license agreement with GlaxoSmithKline. The
sale of rights to future Abreva royalties was recorded as deferred revenue on
the date of sale. (See Note 7, Deferred Revenue in the accompanying notes to
the consolidated financial statements.) Investing activities. Net cash used for investing activities during the first
six months of fiscal 2004 amounted to $926,000, including investments in
securities totaling $997,000, purchases of property and equipment of $72,000
and patent costs of $557,000, partially offset by sales and maturities of
investments totaling $700,000. Net cash used for investing activities during
the first six months of fiscal 2003 amounted to $2.6 million, including
construction in progress totaling $3.0 million on additional leased occupancy
space, investments in securities totaling $706,000, purchases of property and
equipment of $783,000 and patent costs of $234,000, partially offset by sales
and maturities of investments totaling $2.1 million. Capital expenditures were
substantially lower in the second quarter of 22




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fiscal 2004, compared to the same
period a year ago when the Company was engaged in making leasehold improvements
to additional office and laboratory space. Financing activities. Net cash provided by financing activities amounted to
$7.8 million during the first six months of fiscal 2004, consisting primarily
of $7.5 million received from the sale of Class A common stock and warrants in
December 2003. Net cash used for financing activities amounted to $207,000 in
the first six months of fiscal 2003, consisting primarily of payments on notes
and capital lease obligations. To continue to fund the development of our new drug candidates and technology
platforms during at least the next two years, we expect to continue to pursue
various alternatives for raising capital. For example, in April 2004, we filed
a shelf registration statement on Form S-3 with the SEC that would enable the
Company, in one or more offerings, to sell an aggregate of up to $50 million in
Class A common stock from time to time over a period of up to two years. The
nature and terms of any offering will be established at the time of the
offering and set forth in a supplemental filing with the SEC. Other potential
alternatives that we are considering for raising capital include, but are not
limited to, partnering arrangements where partners share development costs,
issuance of debt or equity securities, and licensing or sales of any of our
platform technologies or new drug candidates. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America requires that
management make a number of assumptions and estimates that affect the reported
amounts of assets, liabilities, revenues and expenses in our consolidated
financial statements and accompanying notes. Management bases its estimates on
historical information and assumptions believed to be reasonable. Although
these estimates are based on managements best knowledge of current events and
circumstances that may impact the Company in the future, actual results may
differ from these estimates. Our critical accounting policies are those that affect our financial statements
materially and involve a significant level of judgment by management. Our
critical accounting policies regarding revenue recognition are in the following
areas: milestone payments in license agreements, royalties on licensed
products, sale of rights to future royalties, and recognition of revenues in
research contracts. Our critical accounting policies regarding expense
recognition are principally related to research contracts. Our critical
accounting policies also include the valuation of long-lived and intangible
assets. Milestone Payments in License Agreements We recognize revenues from license fees when the performance requirements have
been met, the fee is fixed or determinable, and collection of fees is probable.
We defer revenues and recognize them over the life of the agreement when we
have continuing obligations to perform under the agreement. Our largest and most significant license agreement is with SB Pharmco Puerto
Rico, Inc., a subsidiary of GlaxoSmithKline (GlaxoSmithKline). On March 31,
2000, we transferred the rights to manufacture, use, and sell Abreva in the
United States and Canada to GlaxoSmithKline and gave them full control,
authority and responsibility over research, development, regulatory compliance
activities (including actions required to obtain appropriate government
approvals), and commercialization of the product in those territories.
GlaxoSmithKline has achieved and paid all of the performance milestones under
the agreement. With regard to the milestones, we have no further performance
obligations. Future revenues, if any, to be earned under the GlaxoSmithKline
agreement will come solely from royalty revenues. We expect to enter into additional license agreements in the future. We expect
that each license agreement will have its own set of circumstances and terms of
performance. We will consider the 23




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##### Table of Contents



specific facts and circumstances of each
license agreement to determine the appropriate revenue recognition for such
items, including nonrefundable up-front fees and milestone payments and taking
into consideration when the earnings process is complete and collection is
reasonably assured. Royalties on Licensed Products We recognize royalty revenues from our licensed products based on the reported
sales by our licensees and computed in accordance with the specific terms of
the license agreements. Since the launch of Abreva in October 2000 through March 31, 2004, substantially all of our
royalties have come from GlaxoSmithKline. We have entered into additional
license agreements that contain royalties as a source of revenues, and we
expect to enter into additional similar license agreements with foreign-based
companies. Sales of Rights to Future Royalties In fiscal 2003, we sold an undivided interest in our license agreement with
GlaxoSmithKline to Drug Royalty USA for $24.1 million. Because of our ongoing
involvement with GlaxoSmithKline in earning future royalty revenues, we
recorded the amount received from Drug Royalty USA, net of costs of the
transaction and forgiveness of certain advances, as deferred revenue. The
amount recorded as deferred revenue is being recognized as revenue under the
units-of-revenue method over the period from October 2002 through April 2014.
The portion of deferred revenue classified as a current liability represents
the amount that we expect to realize as revenue within the next 12 months.
(See Note 7, Deferred Revenue, in the accompanying consolidated financial
statements.) Recognition of Revenues in Research Contracts In certain circumstances, we may enter into research contracts or
collaborations that have obligations to deliver to the customer multiple
products and/or services (multiple deliverables) in exchange for fees or
milestone payments. Such contracts could include antibody generation services
agreements and other forms of research collaborations, as discussed below. Antibody generation services.As of March 31, 2004, we were engaged in work on
one research collaboration agreement that had research initiation fees. In
this type of agreement, the customer provides us with the target antigens. We
then perform research services to develop potential antibodies for those
antigens. If we are able to estimate the period of service in the contract in
advance of beginning the work, then we recognize such research initiation fees
ratably as revenue over the estimated period of service. If we are unable to
identify the period of service in the contract in advance of beginning the
work, we defer research initiation fees and recognize such fees as revenue once
we have completed our efforts to create the antibodies. In the research phases
of the research collaboration agreement, we may receive payment either to start
a research phase or to complete a research phase (including receipt by the
customer of the deliverable). We recognize revenue once the product has been
delivered, because the earnings process is then complete and an exchange has
been made. Factors taken into consideration in recognizing revenues include
the following:  
    
    The performance criteria have been met;  
    
    Any undelivered products or services are not essential to the
functionality of the delivered products or services; and  
    
    Payment for the delivered products or services is not
contingent on delivery of the remaining products or services. Other research contracts.As with all our research contracts, including the
up-front initiation fee, we defer revenue recognition until services have been
rendered or products (e.g. developed antibodies) are 24




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delivered. The milestones
established within the contract are typically set to approximate the effort
associated with the completion of each phase. Recognition of Expenses in Research Contracts Pursuant to managements assessment of the progress that has been made on
clinical trials and services provided in other research contracts, we recognize
expenses as the services are provided. Several of our contracts extend across
multiple reporting periods. For example, contracts with organizations that
conduct our Phase III clinical trial of Neurodex for the treatment of PBA in
patients with multiple sclerosis and our Neurodex open label study, extend
beyond one year. Such contracts require an assessment of the work that has
been completed during the period, including measurement of progress, analysis
of data that justifies the progress, and finally, managements judgment. Valuation of Long-Lived and Intangible Assets We assess the impairment of identifiable intangible assets and long-lived
assets whenever events or changes in circumstances indicate that the carrying
value may not be recoverable. Factors we consider important that could trigger
an impairment review include the following:  
    
    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. When we determine that the carrying value of intangible assets or long-lived
assets are not recoverable based upon the existence of one or more of the above
indicators of impairment, we may be required to record impairment charges for
these assets that have not been previously recorded. RECENT ACCOUNTING PRONOUNCEMENTS See Note 12, Recent Accounting Pronouncements in the accompanying
consolidated financial statements for a discussion of recent accounting
pronouncements and their effect, if any, on the Company. RISK FACTORS THAT MIGHT AFFECT FUTURE OPERATIONS Risks Relating to Our Business We have a history of losses and we may never achieve or maintain profitability. To date, we have experienced significant operating losses in funding the
research, development and clinical testing of our drug candidates and we expect
to continue to incur substantial operating losses through at least 2005. As of
March 31, 2004, our accumulated deficit was approximately $109 million and our
shareholders deficit was $4.0 million. To achieve profitability, we would need
to generate significant additional revenue with positive gross margins.
Although we are seeking to negotiate revenue-generating licenses and/or
co-promotion arrangements for docosanol 10% cream, Neurodex and other product
candidates, we may not be successful in doing so, and any such arrangements may
not generate the anticipated revenue. Additionally, our sales and marketing and
general and administrative expenses are expected to increase over the next
several quarters. These increases in expenses may not be offset by new or
increased revenue, and, as a result, we may not achieve or maintain
profitability. 25




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##### Table of Contents



We expect to complete our Phase III clinical trial soon for Neurodex and any
negative results in this trial could harm our stock price. In March 2004, we announced that we had completed enrollment in our Phase III
clinical trial for Neurodex, our late-stage candidate for the treatment of
pseudobulbar affect. We expect to announce preliminary data from this trial
later in 2004. Neurodex is our most developed drug candidate and we believe it
represents the most immediate opportunity to produce significant revenue for
the Company. If the clinical trial data are negative or inconclusive, then we
may be required to conduct one or more
additional clinical trials and may not be able to seek regulatory approval to
market the compound. If this were to happen, we expect our stock price would be
negatively affected. Assuming favorable
results from our Phase III trial for Neurodex in Multiple
Sclerosis patients with PBA, we must submit our results to the FDA for review
and approval prior to U.S. commercialization. Any delay in the
regulatory review or approval process may harm our prospects and
could harm our stock price. Assuming positive results
from our Phase III trial of Neurodex in patients suffering from
PBA with Multiple Sclerosis, we will have to seek FDA approval prior to
commercialization in the United States. Any delays in our submission
or in the FDAs review or approval would delay market
launch and increase our cash requirements and could increase the
volatility of our stock price and result in additional operating
losses. The process of obtaining FDA
approval often takes many years and can vary substantially based upon
the type, complexity and novelty of the products involved. FDAs
review and approval of the actual NDA application is expensive and
uncertain. If we submit an NDA for Neurodex, the FDA must
decide whether to accept or reject the submission for filing. The
FDAs official filing of an NDA begins the
applications substantive review. The FDA may refuse to file
an NDA for review for many reasons, including if the submission
contains insufficient data to demonstrate efficacy and safety. We
cannot be certain that our NDA submission would be accepted for
filing and reviewed by the FDA or that we would be able to respond to
any requests during the review period in a timely manner without
delaying potential action on our request for approval. We also cannot
be certain that Neurodex will receive a favorable recommendation from
any FDA advisory committees or be approved for marketing by the FDA.
Even if the FDA grants us marketing approval for Neurodex, we cannot
be certain that we will be able to obtain the labeling claims
necessary or desirable for the promotion of the product. In
addition, delays in approvals or rejections of marketing applications
may be based upon many factors, including regulatory requests for
additional analyses, reports, data and/or studies, regulatory
questions regarding data and results, changes in regulatory policy
during the period of product development and/or the emergence of new
information regarding our products or other products. We expect that we will need to raise additional capital to fund ongoing
operations through at least 2005. 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. In order to maintain sufficient cash and investments to fund future operations,
we will need to raise additional capital. We expect to seek to raise
additional capital over the next 12 to 24 months through various alternatives,
including licensing or sales of our technologies and drug candidates and
through the sale of shares of our Class A common stock.  
    
    If we raise capital through licensing or sales of one or more
of our technologies and drug candidates, then we may lose an
opportunity for product sales if a product is successfully
developed, approved by the FDA and marketed. If we license
any of our technologies or drug candidates, then the
development of that product or technology may no longer be in
our control. A licensee might not ever reach any of the
milestones in a license agreement and we would not earn any
additional payments in such an event. Further, if we sell any
of our technologies or drug candidates, the sales price may
not 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, then the value of the shares of Class
A common stock outstanding may be diluted or 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 dilute your voting rights in the
Company.  
    
    We may not be able raise capital on terms that we find
acceptable, if at all. If we are unable to raise additional
capital to fund future operations, then we might have to
reduce operations or defer or abandon one or more of our
clinical or preclinical research programs. Any of these
actions could be expected to have an adverse effect on our
stock price. Our stock price is highly volatile and you may not be able to sell your shares
at or above the price you pay for them. The market price of our Class A common stock has been, and is likely to
continue to be, highly volatile. The following factors, among others, could
have a significant impact on the market price of our Class A common stock:  
    
    our success or failure in entering into license and/or co-promotion arrangements for our
products and product candidates; 26




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
    
    unfavorable or delayed announcements by us regarding clinical trial results or results
of operations, or favorable announcements by our competitors;  
    
    delays in meeting goals or performance milestones by us or our marketing partners;  
    
    comments made by securities analysts, including changes in, or failure to achieve,
financial estimates or milestones;
    
    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; and  
    
    market and economic conditions. In addition, the market for biotechnology and pharmaceutical stocks has
experienced significant price and volume fluctuations that are frequently
unrelated to operating performance. This price volatility is often more
pronounced for companies with a low stock price and a small market
capitalization, such as ours. These broad market and industry factors might
seriously harm the market price of our Class A common stock, regardless of our
operating performance. A significant decline in our stock price, or other factors, could also result
in our Class A common stock being delisted from the American Stock Exchange and
could initiate litigation, including a securities class action lawsuit. Such a
lawsuit against us could result in substantial costs, potential liabilities and
the diversion of managements attention and resources. Developing and testing a drug candidate is a very expensive and time-consuming
process that may not ultimately lead to a marketable product. The drug development process is lengthy and capital-intensive. Since September
1998, we have spent approximately $60 million in preclinical and clinical
studies researching the safety and efficacy of our drug candidates and
potential drug candidates. If any of our drug candidates fail to demonstrate
the desired safety and efficacy, we may abandon the development of the
compound, in which event we would not recover our expenditures incurred to date
for that compound. If a compound appears to be safe and effective in
preclinical studies, we may decide to proceed with human clinical trials. The
full complement of clinical trials required to obtain regulatory approval for a
new drug may involve tens-of-millions of dollars. Because of our limited
financial resources, we may be required to license the compound to a
pharmaceutical company with greater financial resources in order to complete
development of the drug. We may be unable to find a large pharmaceutical
company interested in licensing the drug or, if we do locate such a licensee,
that the proposed license terms will be acceptable to the Company. In the event
that we are unable to find a large pharmaceutical partner or licensee on
acceptable terms, we may be forced to abandon one or more of our drug
candidates. We expect our quarterly operating results to fluctuate significantly from
period-to-period for a number of reasons. Historically, we have had only limited recurring revenue. As a result,
operating results have been, and will continue to be, subject to significant
quarterly fluctuations based on a variety of factors, including:  
    
    Co-promotion or License Arrangements We are currently
seeking co-promotion or 27




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licensing partners for docosanol 10%
cream and Neurodex, as well as for our compounds targeting
IgE (allergy and asthma), MIF (inflammation) and
apolipoprotein A1 (cholesterol). 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. If we do enter into any such
arrangements, the recognition of revenue under that
arrangement may depend on the efforts and performance of our
licensees or partners in reaching milestones that are outside
of our control. Such milestones may include specific events,
such as regulatory approval, product launch, the passage of
time, or reaching a sales threshold.
    
    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 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 73% and 95% of our fiscal 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 our raw materials from a sole
foreign supplier that has been approved for manufacture by
the FDA. Any disturbances or delays in the manufacture of the
raw materials could seriously and adversely affect our
business.  
    
    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 of our
acquisition or alliance activities, to the extent they exist
in the future, are not successful. AVANIR and its licensees may not be successful in obtaining regulatory approval
of docosanol 10% cream immediately as an over-the-counter (OTC) product in
the rest of the world, or in licensing, marketing and selling the product in
foreign countries. Currently, docosanol 10% cream is approved for sale in the United States,
Canada, Korea, Israel and Sweden and we are currently seeking regulatory
approval in various other countries in the European Union and intend to seek
approval through a licensee in Japan. AVANIR and its licensees face a wide
variety of risks in foreign countries in obtaining regulatory approval and in
marketing and selling docosanol 10% cream, including:  
    
    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 clinical trials, or may require prescription
status first before obtaining sufficient experience to
warrant approval as an OTC product;  
    
    Building product awareness of a new drug, whether
prescription or OTC, among customers or retail store decision
makers may require a substantial amount of product promotion,
which 28




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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. Foreign sales of docosanol 10% cream and other potential products are subject
to various foreign trade risks. Our license agreement with GlaxoSmithKline is for the United States and Canada.
We also have exclusive license agreements for docosanol 10% cream for Israel,
South Korea, Italy and Egypt. We are holding discussions with other potential
licensees for marketing and selling docosanol 10% cream in other countries not
already licensed. However, we may not finalize any license or distribution
arrangements for other territories on a timely basis or on favorable terms, if
at all. Further, our foreign licensees expose us to various foreign trade risks
relating to development and marketing of docosanol 10% cream. We may arrange
for contracts in the future for the manufacture, marketing and distribution of
docosanol 10% cream overseas by foreign licensees, which will be substantially
outside our control. Even if we are able to obtain experienced licensees in
foreign markets, specific risks that could impact significantly our potential
revenues on foreign sales include:  
    
    difficulties in obtaining regulatory approval of docosanol 10% cream in foreign countries;  
    
    changes in the regulatory and competitive environments in foreign countries;  
    
    changes in a specific countrys or regions political or economic conditions, including
related to terrorism;  
    
    difficulty in finding foreign partners with sufficient capital to effectively launch,
market and promote the product;  
    
    shipping delays;  
    
    difficulties in managing operations across disparate geographic areas;  
    
    fluctuations in foreign currency exchange rates;  
    
    prices of competitive products;  
    
    difficulties associated with enforcing agreements through foreign legal systems;  
    
    trade protection measures, including customs duties and export quotas; and  
    
    foreign tax withholding laws. 29




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The Board of Directors has the authority to effect a reverse stock split within
a stated range until March 18, 2005. If implemented, the reverse stock split
may negatively affect the price and liquidity of our Class A common stock. At our 2004 Annual Meeting of Shareholders, the Board of Directors received the
authority to implement, within its discretion and for a period of one year, a
reverse split of our Class A common stock within a range of 1:2 to 1:12.5. If
the Board of Directors were to effect a reverse stock split, the bid price of
the Class A common stock may not continue at a level in proportion to the
reduction in the number of outstanding shares resulting from the reverse stock
split. For example, if the Board of Directors decided to implement a reverse
stock split at a ratio of 1-for-5, that the post-split market price of our
Class A common stock may not be at least five times the pre-split price. Accordingly,
the total market capitalization of our Class A common stock after a reverse
stock split, if implemented, could be lower than the total market
capitalization before the proposed reverse stock split. Additionally, the
liquidity of our Class A common stock could be affected adversely by the
reduced number of shares outstanding after the reverse stock split. Our inability to attract and retain key management and scientific personnel
could negatively affect our business. Our success depends on the performance of a small core staff of key management
and scientific employees with biotechnology experience. Given our small staff
size and programs currently under development, we depend substantially on our
ability to hire, train, retain and motivate high quality personnel, especially
our scientists and management team in this field. If we were to lose one or
more of our key scientists, then we would likely lose some portion of our
institutional knowledge and technical know-how, potentially causing a
substantial delay in one or more of our development programs until adequate
replacement personnel could be hired and trained. Other than our chief
executive officer, our executives do not have employment agreements. We do not
have key person life insurance policies for any of our executives. The
industry in which we compete has a high level of employee mobility and
aggressive recruiting of skilled personnel. This type of environment creates
intense competition for qualified personnel, particularly in product research
and development, sales and marketing, and accounting and finance. Our patents may be challenged and our pending patents may be denied. Either
result would seriously jeopardize our ability to compete in the intended
markets for our proposed products. We rely substantially on the protection of our intellectual property through
our ownership or control of 85 issued patents and 254 patent applications.
Patents and patent applications owned or controlled by the Company are for
docosanol-related products and technologies, Neurodex, compounds capable of
regulating the target IgE in controlling symptoms of allergy and asthma,
compounds capable of regulating the target MIF in the treatment of inflammatory
diseases, compounds targeting apolipoprotein A1 for the treatment of
cholesterol, and Xenerex technologies for developing monoclonal antibodies.
Because of the competitive nature of the biopharmaceutical industry, we cannot
assure you that:  
    
    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 not be available to us; 30




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
    
    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. Our inability to obtain or maintain patent protections for our products in
foreign markets may negatively affect our financial condition. The process for the approval of patent applications in foreign countries may
differ significantly from the process in the U.S. These differences may delay
our plans to market and sell docosanol 10% cream and
other products in the international marketplace. Approval in one country does
not indicate that approval will be obtained in other countries. The patent
authorities in each country administer that countrys laws and regulations
relating to patents independently of the laws and regulations of any other
country and we must seek and obtain the patents separately. Our inability to
obtain or maintain patent protections for docosanol 10% cream and other
products in foreign markets would severely hamper our ability to generate
international sales from our first product and other products still under
development. We are dependent on third parties to manufacture our drug and drug-candidate
compounds. The failure of these third parties to perform successfully could
harm our business. We have utilized, and intend to continue utilizing, third parties to
manufacture docosanol 10% cream, Neurodex and our other drug candidates. We
have no experience in manufacturing and do not have any manufacturing
facilities. Currently, we have only a single supplier for docosanol 10% cream
and we do not have any long-term supply agreements in place with this
manufacturer. Although we and GlaxoSmithKline maintain a strategic reserve of
docosanol 10% cream to mitigate against a short-term supply disruption, any
sustained disruption of our supply could result in shipping and sales delays
and additional costs that could harm our operations. Developing new pharmaceutical products for human use involves product liability
risks, for which we currently have limited insurance coverage. The testing, marketing, and sale of pharmaceutical products involves the risk
of product liability claims by consumers and other third parties. We maintain
product liability insurance coverage for our clinical trials in the amount of
$5 million per incident and $5 million in the aggregate. However, product
liability claims can be high in the pharmaceutical industry and our insurance
may not sufficiently cover our actual liabilities. If a suit against our
business or proposed products is successful, then the lack or insufficiency of
insurance coverage could affect materially and adversely our business and
financial condition. Furthermore, various distributors of pharmaceutical
products require minimum product liability insurance coverage before their
purchase or acceptance of products for distribution. Failure to satisfy these
insurance requirements could impede our ability to achieve broad distribution
of our proposed products. Abreva faces competition from a number of existing and well-established
products and the companies that market their products. We have the opportunity to earn royalties on Abreva product wholesale sales if
sales exceed $62 million a year. Abreva competes with several other products
for oral-facial herpes currently on the market in the U.S., as well as other
products or potential products that are or may be under development or
undergoing FDA review. Most of the competing products are manufactured by
companies having substantial financial resources, research and development
facilities and manufacturing and marketing experience. Even with Abreva being
marketed by one of the worlds largest consumer healthcare companies,
GlaxoSmithKline, not all competitive responses and the impacts of those
responses can be foreseen. 31




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Business interruptions could adversely affect our business. Our operations are vulnerable to interruption by fire, earthquake, power loss,
telecommunications failure, and other events beyond our control. For example,
during 2001 and again in 2003, we experienced electrical power outages lasting
several hours. The loss of electrical power for any significant periods of time
could adversely affect our ability to conduct experiments and could also harm
our vendors. Further, we could lose valuable data made to date in experiments
currently underway. We have mitigated the severity of power losses by
installing emergency power equipment, which we have used on several occasions
to supply electricity in the areas that we consider to be the most critical to
our operations. However, the emergency power units do not cover all of our electrical needs
and, further, they might not operate properly in the event of a power loss. Our financial results could be affected by potential changes in the accounting
rules governing the recognition of stock-based compensation expense. We measure compensation expense for our employee stock compensation plans under
the intrinsic value method of accounting prescribed by Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees. In addition,
we provide pro forma disclosures of our operating results in our Notes to
Consolidated Financial Statements as if the fair value method of accounting had
been applied in accordance with SFAS No. 123, Accounting for Stock-based
Compensation. Had we accounted for our compensation expense under the fair
value method of accounting prescribed by SFAS No. 123, the charges would have
been significantly higher, by approximately $1,554,000, $2,176,000, and
$1,540,000 during fiscal 2003, 2002, and 2001, respectively. Recently, the
Financial Accounting Standards Board proposed changes to accounting rules
concerning the recognition of stock option compensation expense. If these
proposals are implemented, we and other companies would be required to measure
compensation expense using the fair value method, which would adversely affect
our results of operations by reducing our income or increasing our losses by an
amount equal to the difference in the two measurement methods. Provisions in our charter documents and our shareholder rights plan could
prevent or delay a change of control in a transaction that offers our
shareholders a premium for their stock. Certain provisions of our charter documents may have an anti-takeover effect
and could discourage a third party from acquiring control of us without
approval of our board of directors. Additionally, we adopted a Shareholder
Rights Plan in 1999 for the purpose of requiring bidders to negotiate with our
Board of Directors before attempting a takeover of our company. Although the
Shareholder Rights Plan is intended to prevent coercive or low offers, it could
have the effect of discouraging, delaying or preventing a third party from
acquiring us in a transaction that may otherwise offer a premium over our
then-current stock price. 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. The pharmaceutical and biotechnology industries are highly competitive and
subject to significant and rapid technological change. We compete with hundreds
of companies that develop and market products and technologies in similar areas
as our research. For example, docosanol 10% cream faces worldwide competition
from the following products:  
    
    OTC monograph preparations, including Carmex®, Zilactin®,
Campho®, Orajel®, 32




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Herpecin® and others;  
    
    Zovirax® acyclovir (oral and topical) and Valtrex®
valacyclovir (oral) prescription products marketed by Biovail
Corporation and GlaxoSmithKline, respectively, and  
    
    Famvir® famciclovir (oral) and Denavir® penciclovir (topical)
prescription products marketed by Novartis. Our competitors may have specific expertise and technologies that are better
than ours and many of these companies, either alone or together with their
research partners, have substantially greater financial
resources, larger research and development staffs, and substantially greater
experience than we do. Accordingly, our competitors may develop superior
products or may develop competing products more rapidly. If we commence
commercial sales of our products, we will also be competing with respect to
manufacturing efficiencies and marketing capabilities, areas in which we have
limited or no direct experience. 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. Governmental authorities in the U.S., including the FDA, and other countries
highly regulate the development, production, testing, manufacturing and
marketing of pharmaceutical products. The clinical testing and regulatory
approval process can take a number of years and requires the expenditure of
substantial resources. Failure to obtain, or delays in obtaining, these
approvals will adversely affect our business operations, including our ability
to commence marketing of any of the proposed products. We may find it necessary
to use a significant portion of our financial resources for research and
development and the clinical trials necessary to obtain these approvals for our
proposed products. We will continue to incur costs of development without any
assurance that we will ever obtain regulatory approvals for any of our products
under development. Additionally, we cannot predict the extent to which adverse
governmental regulation might arise from future U.S. or foreign legislative or
administrative action. Moreover, we cannot predict with accuracy the effects of
any future changes in the regulatory approval process and in the domestic
health care system for which we develop our products, or the costs of on-going
compliance regulations after marketing approval has been obtained. Future
changes could affect adversely the time frame required for regulatory review,
our financial resources, and the sale prices of our proposed products, if
approved for sale. 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. Biotechnology companies such as AVANIR rely heavily on intellectual property
rights to protect their innovations. Although we attempt to protect these
rights by regularly filing patent applications and requiring all employees to
sign confidentiality agreements, we cannot assure you that patents will issue,
that secrecy obligations will be honored, or that others will not independently
develop similar or superior technology. Additionally, if our consultants, key
employees or other third parties apply to our projects technological
information independently developed by them or by others, then disputes may
arise as to the ownership rights of these innovations. Even if we successfully preserve our intellectual property rights, other
biotechnology or pharmaceutical companies may allege that our technology
infringes on their rights. Intellectual property litigation is costly, and,
even if we were to prevail in such a dispute, the cost of such litigation would
adversely affect our business, financial condition and results of operations.
Litigation is also time consuming and would 33




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divert managements attention and
resources away from our operations and other activities. If we were not to
prevail in any litigation, in addition to any damages we would have to pay, we
could be required to stop the infringing activity or obtain a license. Any
required license might not be available to us on acceptable terms. Some
licenses might be non-exclusive, and our competitors could have access to the
same technology licensed to us. If we were to fail to obtain a required license
or were unable to design around a competitors patent, we would be unable to
sell or continue to develop some of our products, which would have a material
adverse affect on our business, financial condition and results of operations. Companies in our industry are frequently subjected to product liability claims,
which can be very costly to defend against. In the ordinary course of business, biotechnology and pharmaceutical
companies face various claims brought by third parties, including claims
relating to the safety or efficacy of products. Any of these claims could
subject us to costly litigation and, while we generally believe that we have
adequate insurance to cover many different types of liabilities, our insurance
carriers may deny coverage or our policy limits may be inadequate to fully
satisfy any damage awards or settlements. If this were to happen, the payment
of any such awards could have a material adverse effect on our operations and
financial position. Additionally, any such claims, whether or not successful,
could damage our reputation and business. 
 Item 3.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 Interest rate sensitivity We are exposed to market risks related to changes in interest rates. Our
investment portfolio consists primarily of fixed income instruments with an
average duration of seven-tenths of a year as of March 31, 2004 (2.0 years as
of September 30, 2003). The primary objective of our investments in debt
securities is to preserve principal while achieving attractive yields, without
significantly increasing risk. We carry some investments that we intend to
hold to maturity and others that we classify as available-for-sale. These
available-for-sale securities are subject to interest rate risk. In general,
we would expect that the volatility of this portfolio would increase as its
duration increases. Foreign currency exchange rate sensitivity Because substantially all of our revenue, expense, and capital purchasing
activities are transacted in U.S. dollars, our exposure to foreign currency
exchange rates is immaterial. However, in the future we could face increasing
exposure to foreign currency exchange rates as we expand international
distribution of docosanol 10% cream. Until such time as we are faced with
material amounts of foreign currency exchange rate risks, we do not plan to use
derivative financial instruments, which can be used to hedge such risks. We
will evaluate the use of derivative financial instruments to hedge our
exposures as the needs and risks should arise. 
 Item 4. CONTROLS AND PROCEDURES The Companys Chief Executive Officer and Chief Financial Officer carried out
an evaluation of the effectiveness of the Companys disclosure controls and
procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e)
and 15(d)-15(e)), as of the end of the period covered by this report. Based on
that evaluation, these officers have concluded that the Companys disclosure
controls and procedures were adequate and designed to ensure that material
information relating to the Company and the Companys consolidated subsidiary
would be made known to them by others within those entities. 34




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PART II OTHER INFORMATION Items 1-3. NOT APPLICABLE 
 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Annual Meeting of Shareholders of AVANIR Pharmaceuticals was convened on
March 18, 2004, at 10:00 a.m. local time. There were issued and outstanding on
January 20, 2004, the record date, 71,266,550 shares of Class A common stock,
each share being entitled to one vote, constituting all of the outstanding
voting securities of the Company. There were present at the meeting in person
or by proxy, shareholders of the Company who were the holders of 67,078,172
votes of the Companys common stock entitled to vote thereat, constituting a
quorum. The following proposals received the number of votes set forth below: Directors
    
    
    
    For
    
    WithholdDennis J. Carlo, Ph.D.
    
    
    54,379,138
    
    
    
    12,670,389Kenneth E. Olson
    
    
    56,434,715
    
    
    
    10,614,812Gerald J. Yakatan, Ph.D.
    
    
    55,944,517
    
    
    
    11,105,010Proposals
    
    
    
    For
    
    Against
    
    Abstain2.
    
    Restate Articles of Incorporation
    
    
    57,907,905
    
    
    
    7,728,256
    
    
    
    1,442,0113.
    
    Increase Authorized Class ACommon Stock
    
    
    50,585,585
    
    
    
    15,913,111
    
    
    
    579,4754.
    
    Approve Reverse Stock SplitWithin Stated Range
    
    
    49,307,358
    
    
    
    17,225,442
    
    
    
    545,3725.
    
    Ratification of Deloitte &Touche LLP as Independent Auditors
    
    
    61,547,468
    
    
    
    4,279,960
    
    
    
    1,250,744
 
 Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits  15.0
    
    Letter on unaudited interim financial information31.1
    
    Certification pursuant to Section 302 of Sarbanes-Oxley Act of 200231.2
    
    Certification pursuant to Section 302 of Sarbanes-Oxley Act of 200232.1
    
    Certification pursuant to Section 906 of Sarbanes-Oxley Act of 200232.2
    
    Certification pursuant to Section 906 of Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K On February 12, 2004, the registrant filed a current report on Form 8-K
furnishing, under Items 7 and 12, a press release announcing the results of
operations for the quarter ended December 31, 2003. On April 5, 2004, the registrant filed a current report on Form 8-K disclosing,
under Item 5 that it had amended and restated its Articles of Incorporation for
the purposes of restating certain earlier amendments, eliminating certain
classes and series of stock no longer outstanding, and giving effect to an
increase in the authorized number of shares of Class A common stock, all of
which were approved at the Annual Meeting of Shareholders held on March 18,
2004. 35




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Signature
    
    Title
    
    Date/s/Gerald J. Yakatan, Ph.D.
Gerald J. Yakatan, Ph.D.
    
    President and Chief
Executive Officer
(Principal Executive Officer)
    
    May 14, 2004/s/Gregory P. Hanson, CMA
Gregory P. Hanson, CMA
    
    Vice President, Finance and Chief
Financial Officer
(Principal Financial and Accounting Officer)
    
    May 14, 2004
 36




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EXHIBIT INDEX Exhibit No.
    
    Description15.0
    
    Letter on unaudited interim financial information31.1
    
    Certification pursuant to Section 302 of Sarbanes-Oxley Act of 200231.2
    
    Certification pursuant to Section 302 of Sarbanes-Oxley Act of 200232.1
    
    Certification pursuant to Section 906 of Sarbanes-Oxley Act of 200232.2
    
    Certification pursuant to Section 906 of Sarbanes-Oxley Act of 2002
 37