##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
 For the quarterly period ended March 31, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
 For the transition period from
to .
 Commission File No. 1-15803
 AVANIR PHARMACEUTICALS
  California(State or other jurisdiction of
    
    33-0314804incorporation or organization)
    
    (I.R.S. Employer Identification No.)101 Enterprise Suite 300, Aliso Viejo, California
    
    92656(Address of principal executive offices)
    
    (Zip Code)
 (949) 389-6700
 þ o
  o þ o
 o þ




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##### 



Table of Contents
 PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements
    
    
    3Condensed Consolidated Balance Sheets
    
    
    3Condensed Consolidated Statements of Operations
    
    
    4Condensed Consolidated Statements of Cash Flows
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    20Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    31Item 4. Controls and Procedures
    
    
    31PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    31Item 1A. Risk factors
    
    
    31Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    37Item 3. Defaults Upon Senior Securities
    
    
    37Item 4. Submission of Matters to a Vote of Security Holders
    
    
    38Item 5. Other Information
    
    
    38Item 6. Exhibits
    
    
    39Signatures
    
    
    40EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
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PART I. FINANCIAL INFORMATION
 
 Item 1. FINANCIAL STATEMENTS
 AVANIR PHARMACEUTICALS
 
 CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 March 31,
    
    
    September 30,2007
    
    
    2006ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    5,286,799
    
    
    $
    4,898,214Short-term investments in securities
    
    
    1,979,305
    
    
    
    16,778,267Receivables, net
    
    
    3,410,745
    
    
    
    3,042,468Inventories
    
    
    3,019,237
    
    
    
    2,835,203Prepaid expenses
    
    
    1,306,092
    
    
    
    1,778,918Total current assets
    
    
    15,002,178
    
    
    
    29,333,070Investments in securities
    
    
    246,178
    
    
    
    2,216,995Restricted investments in securities
    
    
    1,156,597
    
    
    
    856,597Property and equipment, net
    
    
    4,355,454
    
    
    
    6,047,729Other intangible assets, net
    
    
    9,244,151
    
    
    
    10,113,329Goodwill
    
    
    20,042,439
    
    
    
    22,110,328Other assets
    
    
    472,481
    
    
    
    784,289TOTAL ASSETS
    
    $
    50,519,478
    
    
    $
    71,462,337LIABILITIES AND SHAREHOLDERS DEFICITCURRENT LIABILITIESAccounts payable
    
    $
    2,344,285
    
    
    $
    10,845,057Accrued expenses
    
    
    11,082,946
    
    
    
    12,983,501Assumed liabilities for returns and other discounts
    
    
    
    
    
    
    3,980,229Deferred revenues
    
    
    5,404,921
    
    
    
    7,592,563Notes payable
    
    
    489,398
    
    
    
    670,737Capital lease obligations
    
    
    166,494
    
    
    
    230,760Total current liabilities
    
    
    19,488,044
    
    
    
    36,302,847Other liabilities
    
    
    208,676
    
    
    
    230,450Deferred revenues, net of current portion
    
    
    14,261,512
    
    
    
    15,716,762Notes payable, net of current portion
    
    
    22,292,851
    
    
    
    24,715,905Capital lease obligations, net of current portion
    
    
    117,150
    
    
    
    170,908Total liabilities
    
    
    56,368,233
    
    
    
    77,136,872COMMITMENTS AND CONTINGENCIES (Note 12)SHAREHOLDERS DEFICITPreferred stock  no par value, 10,000,000 shares
authorized, no shares issued and outstanding as of
March 31, 2007 and September 30, 2006
    
    
    
    
    
    
    Common stock  no par value, Class A, 200,000,000
shares authorized, 40,384,035 and 31,708,461
shares issued and outstanding as of March 31, 2007
and September 30, 2006, respectively
    
    
    233,264,767
    
    
    
    211,993,249Accumulated deficit
    
    
    (239,090,317
    )
    
    
    (217,565,280
    )Accumulated other comprehensive loss
    
    
    (23,205
    )
    
    
    (102,504
    )Total shareholders deficit
    
    
    (5,848,755
    )
    
    
    (5,674,535
    )TOTAL LIABILITIES AND SHAREHOLDERS DEFICIT
    
    $
    50,519,478
    
    
    $
    71,462,337
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AVANIR PHARMACEUTICALS
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 Three months ended
    
    
    Six months endedMarch 31,
    
    
    March 31,2007
    
    
    2006
    
    
    2007
    
    
    2006PRODUCT SALESNet revenues
    
    $
    3,829,111
    
    
    $
    
    
    
    $
    10,099,815
    
    
    $
    Cost of revenues
    
    
    1,308,256
    
    
    
    
    
    
    
    2,655,440
    
    
    
    Product gross margin
    
    
    2,520,855
    
    
    
    
    
    
    
    7,444,375
    
    
    
    LICENSES, RESEARCH SERVICES AND GRANTSRevenues from non-government research services
    
    
    920,448
    
    
    
    1,956,565
    
    
    
    2,190,692
    
    
    
    4,434,583Cost of non-government research services
    
    
    (607,164
    )
    
    
    (1,795,634
    )
    
    
    (1,771,239
    )
    
    
    (3,811,719
    )Revenues from government research grant services
    
    
    266,728
    
    
    
    75,862
    
    
    
    353,076
    
    
    
    160,687Cost of government research grant services
    
    
    (369,261
    )
    
    
    (96,966
    )
    
    
    (464,988
    )
    
    
    (166,955
    )Revenues from license agreements
    
    
    56,019
    
    
    
    9,342
    
    
    
    113,284
    
    
    
    5,009,342Revenues from royalties and royalty rights
    
    
    779,673
    
    
    
    427,259
    
    
    
    1,502,713
    
    
    
    1,009,304License, research services, and grants gross margin
    
    
    1,046,443
    
    
    
    576,428
    
    
    
    1,923,538
    
    
    
    6,635,242Total gross margin
    
    
    3,567,298
    
    
    
    576,428
    
    
    
    9,367,913
    
    
    
    6,635,242OPERATING EXPENSESResearch and development
    
    
    6,245,285
    
    
    
    6,162,322
    
    
    
    12,151,286
    
    
    
    13,365,128Selling, general and administrative
    
    
    5,330,405
    
    
    
    8,492,115
    
    
    
    18,576,339
    
    
    
    13,260,858Loss from operations
    
    
    (8,008,392
    )
    
    
    (14,078,009
    )
    
    
    (21,359,712
    )
    
    
    (19,990,744
    )OTHER INCOME (EXPENSE)Interest expense
    
    
    (315,510
    )
    
    
    (21,403
    )
    
    
    (918,538
    )
    
    
    (44,841
    )Interest income
    
    
    144,862
    
    
    
    564,422
    
    
    
    336,338
    
    
    
    892,588Other
    
    
    284,934
    
    
    
    (5,492
    )
    
    
    430,279
    
    
    
    5,020Loss before income taxes
    
    
    (7,894,106
    )
    
    
    (13,540,482
    )
    
    
    (21,511,633
    )
    
    
    (19,137,977
    )Provision for income taxes
    
    
    (13,404
    )
    
    
    (4
    )
    
    
    (13,404
    )
    
    
    (2,421
    )NET LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE
    
    
    (7,907,510
    )
    
    
    (13,540,486
    )
    
    
    (21,525,037
    )
    
    
    (19,140,398
    )Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,616,058
    )NET LOSS
    
    $
    (7,907,510
    )
    
    $
    (13,540,486
    )
    
    $
    (21,525,037
    )
    
    $
    (22,756,456
    )Basic and diluted net loss per shareLoss before cumulative effect of change in accounting
principle
    
    $
    (0.20
    )
    
    $
    (0.44
    )
    
    $
    (0.58
    )
    
    $
    (0.64
    )Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.12
    )Net loss per share
    
    $
    (0.20
    )
    
    $
    (0.44
    )
    
    $
    (0.58
    )
    
    $
    (0.76
    )Basic and diluted weighted average number of common
shares outstanding
    
    
    39,047,597
    
    
    
    31,086,874
    
    
    
    36,797,202
    
    
    
    29,819,338
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AVANIR PHARMACEUTICALS
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 Six Months EndedMarch 31,2007
    
    
    2006OPERATING ACTIVITIESNet loss
    
    $
    (21,525,037
    )
    
    $
    (22,756,456
    )Adjustments to reconcile net loss to net cash used in operating activities:Cumulative effect of change in accounting principle
    
    
    
    
    
    
    3,616,058Depreciation and amortization
    
    
    2,787,297
    
    
    
    831,965Share-based
compensation expense (income)
    
    
    (824,871
    )
    
    
    1,219,733Loss on disposal of assets
    
    
    
    
    
    
    8,994Changes in operating assets and liabilities:Receivables
    
    
    (368,277
    )
    
    
    (313,020
    )Inventories
    
    
    163,390
    
    
    
    (419,344
    )Prepaid expenses and other assets
    
    
    423,184
    
    
    
    723,863Accounts payable
    
    
    (8,500,772
    )
    
    
    (3,476,650
    )Accrued expenses and other liabilities
    
    
    (1,922,329
    )
    
    
    3,068,318Assumed liabilities, net of non-cash
adjustment of purchase price
    
    
    87,660
    
    
    
    Deferred revenues
    
    
    (3,642,892
    )
    
    
    (158,249
    )Net cash used in operating activities
    
    
    (33,322,647
    )
    
    
    (17,654,788
    )INVESTING ACTIVITIESInvestments in securities
    
    
    (350,922
    )
    
    
    (46,165,564
    )Proceeds from sales and maturities of investments in securities
    
    
    16,900,000
    
    
    
    22,850,000Purchases of property and equipment
    
    
    (89,818
    )
    
    
    (951,362
    )Net cash provided by (used in) investing activities
    
    
    16,459,260
    
    
    
    (24,266,926
    )FINANCING ACTIVITIESProceeds from issuance of common stock, net
    
    
    22,096,389
    
    
    
    44,381,987Payments on notes and capital lease obligations
    
    
    (4,844,417
    )
    
    
    (167,836
    )Net cash provided by financing activities
    
    
    17,251,972
    
    
    
    44,214,151Net increase in cash and cash equivalents
    
    
    388,585
    
    
    
    2,292,437Cash and cash equivalents at beginning of period
    
    
    4,898,214
    
    
    
    8,620,143Cash and cash equivalents at end of period
    
    $
    5,286,799
    
    
    $
    10,912,580SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATIONInterest paid
    
    $
    795,973
    
    
    $
    44,841Income taxes paid
    
    $
    13,404
    
    
    $
    2,421NON-CASH INVESTING AND FINANCING ACTIVITIES:Purchase price adjustment of assumed liabilities
    
    $
    4,067,889
    
    
    $
    Issuance of note payable
    
    $
    2,000,000
    
    
    $
    Purchases of property and equipment which are included in accounts
payable and accrued expenses
    
    $
    
    
    
    $
    229,319Elimination of unearned compensation against common stock
    
    $
    
    
    
    $
    3,477,144
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AVANIR PHARMACEUTICALS
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 1. BASIS OF PRESENTATION
 Avanir Avanir
  2. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Nature of Business
  Revenue recognition
  Revenue Recognition. Revenue Recognition When Right of Return
Exists
 6




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Accounting for Revenue Arrangements
with Multiple Deliverables.
 Product Sales
 Active Pharmaceutical Ingredient Docosanol (API Docosanol).
 FazaClo.
    7




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Multiple Element Arrangements.
   License Arrangements.
   Research Services Arrangements. Reporting Revenue Gross as a Principal versus Net as an Agent,
 8




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Royalty Arrangements.
 ®
 Government Research Grant Revenues.
 Cost of Revenues
  Capitalization and Valuation of Long-Lived and Intangible Assets
 Business Combinations Goodwill and Other Intangible
Assets
 Accounting for the Impairment or Disposal of Long-Lived Assets
   Share-Based Compensation
 Share-Based Payment,
 9




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Accounting for Stock-Based Compensation
 Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards
     For the three months ended
    
    
    For the six months endedMarch 31,
    
    
    March 31,2007
    
    
    2006
    
    
    2007
    
    
    2006Share-based
compensation expense (income) from:Stock options
    
    $
    (1,198,602
    )
    
    $
    400,356
    
    
    $
    (783,755
    )
    
    $
    647,054Restricted stock awards
    
    
    448,806
    
    
    
    328,159
    
    
    
    865,211
    
    
    
    543,474Restricted stock units
    
    
    (919,592
    )
    
    
    29,205
    
    
    
    (906,327
    )
    
    
    29,205Total
    
    $
    (1,669,388
    )
    
    $
    757,720
    
    
    $
    (824,871
    )
    
    $
    1,219,733Income (loss) per share
    
    $
    0.04
    
    
    $
    (0.02
    )
    
    $
    0.02
    
    
    $
    (0.04
    )
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Change in Accounting for Patent-Related Costs
  Recently Issued Accounting Pronouncements
 The Fair Value Option for Financial Assets and Financial Liabilities- Including
an Amendment of FASB Statement No. 115
 3. ALAMO ACQUISITION
  §
    
    As part of the transaction, a highly trained and skilled workforce with an established
commercial organization was acquired, which will provide Avanir with the opportunity to
cross-sell future Avanir products.§
    
    The transaction places Avanir in a position of market recognition as a provider of
treatment for schizophrenia. This positioning will afford Avanir the opportunity to acquire
new customers in the future that it would not otherwise acquire.§
    
    The market position achieved through the transaction will also provide Avanir with the
ability to license and/or acquire and sell new products into the market as older products
are phased out and/or replaced.
  11




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
    
    A promissory note in the principal amount of $2,000,000, generally payable on the third
anniversary date if monthly FazaClo net product sales, as recognized in the statement of
operations, exceed $1,500,000 for each of the three months in a given fiscal quarter during
the Contingent Payment Period.
    
    A one-time cash payment of $10,450,000 if FazaClo net product sales, as recorded by the
Company in the statement of operations, exceed $40.0 million over four consecutive fiscal
quarters during the Contingent Payment Period.
    
    An additional one-time cash payment of $25,000,000 if FazaClo net product sales, as
recorded by the Company in the statement of operations, exceed $50.0 million over four
consecutive fiscal quarters during the Contingent Payment Period.
   Purchase Price Allocation
   Purchase price:Cash paid at closing
    
    $
    4,040,000Estimated fair value of notes payable issued, net of imputed discount
    
    
    26,343,000Transaction costs
    
    
    911,536$
    31,294,536Allocation:Net tangible assets acquired
    
    $
    5,749,898Identifiable intangible assets acquired
    
    
    11,960,000Goodwill
    
    
    20,042,439Total assets acquired
    
    
    37,752,337Liabilities assumed
    
    
    (6,457,801
    )$
    31,294,536
 Accounting in a Business Combination for Deferred Revenue of an Acquiree,
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Identifiable Intangible Assets
    Product
    
    Customer
    
    Trade
    
    Non-CompeteYear
    
    Rights
    
    Relationships
    
    Name
    
    Agreements1
    
    
    14
    %
    
    
    15
    %
    
    
    8
    %
    
    
    100
    %2
    
    
    15
    %
    
    
    22
    %
    
    
    9
    %
    
    
    3
    
    
    15
    %
    
    
    18
    %
    
    
    8
    %
    
    
    4
    
    
    14
    %
    
    
    13
    %
    
    
    9
    %
    
    
    5
    
    
    14
    %
    
    
    9
    %
    
    
    8
    %
    
    
    6
    
    
    14
    %
    
    
    8
    %
    
    
    9
    %
    
    
    7
    
    
    14
    %
    
    
    8
    %
    
    
    8
    %
    
    
    8
    
    
    
    
    
    
    7
    %
    
    
    9
    %
    
    
    9
    
    
    
    
    
    
    
    
    
    
    8
    %
    
    
    10
    
    
    
    
    
    
    
    
    
    
    9
    %
    
    
    11
    
    
    
    
    
    
    
    
    
    
    8
    %
    
    
    12
    
    
    
    
    
    
    
    
    
    
    8
    %
    
    
    
 In-Process Research and Development
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Pro Forma Results of Operations
  For the
    
    For thethree months ended
    
    six months endedMarch 31, 2006
    
    March 31, 2006Pro forma net revenues(1)
    
    $
    3,374,032
    
    
    $
    12,743,081Pro forma net loss(2)
    
    $
    (18,330,150
    )
    
    $
    (33,035,091
    )Pro forma loss per basic and diluted share
    
    $
    (0.59
    )
    
    $
    (1.11
    )Shares used for basic and diluted computation
    
    
    31,086,874
    
    
    
    29,819,338
 
 (1)
    
    In accordance with the provisions of EITF 01-3, we will not recognize deferred revenues
recorded as of the acquisition date, resulting in lower net revenues in the periods following
the merger than Alamo would likely have achieved as a separate company.(2)
    
    Pro forma net loss for the periods presented includes the amortization of identifiable
intangible assets, interest expense associated with the notes payable issued as part of the
purchase price, elimination of interest expense associated with Alamos historical debt that
was not assumed by us in the acquisition, reduction of interest income by an amount determined
by applying the average rate of return for the respective periods to the decrease in our cash
balance of $4.0 million used to fund the acquisition, and amortization of discount associated
with the notes payable. The charge of $1.3 million for purchased IPR&D is not included in the
pro forma results of operations because it reflects a one-time charge directly related to the
acquisition and does not have a continuing impact on our future operations. 4. RELOCATION OF COMMERCIAL AND GENERAL AND ADMINISTRATIVE OPERATIONS
   September 30,
    
    
    
    
    
    
    
    
    
    
    March 31,2006
    
    
    Additions
    
    
    Payments
    
    
    2007Accrued Restructuring:Employee severance and relocation benefits
    
    $
    237,050
    
    
    $
    771,852
    
    
    $
    (926,037
    )
    
    $
    82,865Lease restructuring liability
    
    
    273,998
    
    
    
    
    
    
    
    (21,774
    )
    
    
    252,224Total
    
    $
    511,048
    
    
    $
    771,852
    
    
    $
    (947,811
    )
    
    $
    335,089
 5. INVENTORIES
  March 31,
    
    
    September 30,2007
    
    
    2006Raw materials
    
    $
    1,833,556
    
    
    $
    923,822Work in progress
    
    
    161,500
    
    
    
    80,580Finished goods
    
    
    846,832
    
    
    
    1,642,208Finished goods FazaClo Inventories subject to return
    
    
    177,349
    
    
    
    536,017Total inventories
    
    $
    3,019,237
    
    
    $
    3,182,627
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6. NET DEFERRED REVENUES
  Drug Royalty
    
    
    FazaCloUSA
    
    
    Net
    
    
    OtherAgreement
    
    
    Shipments
    
    
    Agreements
    
    
    TotalNet deferred revenues as of October 1, 2006
    
    $
    17,111,913
    
    
    $
    3,955,150
    
    
    $
    2,242,262
    
    
    $
    23,309,325Changes during the period:Shipments, net
    
    
    
    
    
    
    7,671,712
    
    
    
    208,637
    
    
    
    7,880,349Recognized as revenues during period
    
    
    (1,268,620
    )
    
    
    (10,099,815
    )
    
    
    (154,806
    )
    
    
    (11,523,241
    )Net deferred revenues as of March 31, 2007
    
    $
    15,843,293
    
    
    $
    1,527,047
    
    
    $
    2,296,093
    
    
    $
    19,666,433Classified and reported as:Current portion of deferred revenues
    
    $
    2,054,521
    
    
    $
    1,527,047
    
    
    $
    1,823,353
    
    
    $
    5,404,921Deferred revenues, net of current portion
    
    
    13,788,772
    
    
    
    
    
    
    
    472,740
    
    
    
    14,261,512Total deferred revenues
    
    $
    15,843,293
    
    
    $
    1,527,047
    
    
    $
    2,296,093
    
    
    $
    19,666,433
 7. NET PRODUCT REVENUES
  For the three
    
    
    For the sixmonths ended
    
    
    months endedMarch 31, 2007
    
    
    March 31, 2007Gross product revenues
    
    $
    5,403,558
    
    
    $
    14,256,815Less product sales allowances :Prompt payment discount
    
    
    (108,071
    )
    
    
    (285,136
    )Medicaid and managed care rebates
    
    
    (604,783
    )
    
    
    (1,963,816
    )Chargebacks
    
    
    (861,593
    )
    
    
    (1,908,048
    )Net product
revenues
    
    $
    3,829,111
    
    
    $
    10,099,815
 8. COMPUTATION OF NET LOSS PER COMMON SHARE
  15




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##### Table of Contents



9. COMPREHENSIVE LOSS
  For the three months
    
    
    For the six monthsended March 31,
    
    
    ended March 31,2007
    
    
    2006
    
    
    2007
    
    
    2006Net loss
    
    $
    (7,907,510
    )
    
    $
    (13,540,486
    )
    
    $
    (21,525,037
    )
    
    $
    (22,756,456
    )Other comprehensive loss, net of tax:Unrealized (loss) gain on available-for-sale securities
    
    
    11,298
    
    
    
    (131,994
    )
    
    
    79,299
    
    
    
    (191,331
    )Total comprehensive loss
    
    $
    (7,896,212
    )
    
    $
    (13,672,480
    )
    
    $
    (21,445,738
    )
    
    $
    (22,947,787
    )
 10. SHAREHOLDERS EQUITY
    11. EMPLOYEE EQUITY INCENTIVE PLANS
   Stock Options
 16




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##### Table of Contents



WeightedWeighted
    
    averageaverage
    
    remainingexercise
    
    contractual
    
    Aggregateprice per
    
    term
    
    intrinsicNumber of shares
    
    share
    
    (in years)
    
    valueOutstanding, October 1, 2006
    
    
    1,587,070
    
    
    $
    10.07
    
    
    
    7.2
    
    
    $
    817,000Granted
    
    
    369,380
    
    
    $
    5.14Exercised
    
    
    (66,758
    )
    
    $
    4.33Forfeited
    
    
    (783,602
    )
    
    $
    9.96Expired
    
    
    (8,125
    )
    
    $
    7.89Outstanding, March 31, 2007
    
    
    1,097,965
    
    
    $
    8.85
    
    
    
    8.4
    
    
    
    400Vested and expected to vest in
the future, March 31, 2007
    
    
    1,027,235Exercisable, March 31, 2007
    
    
    345,566
    2007
    
    2006Expected volatility
    
    
    75%-103
    %
    
    
    78.4% - 80.4
    %Weighted-average volatility
    
    
    88
    %
    
    
    79.0
    %Average expected term in years
    
    
    6.0
    
    
    
    4.5Risk-fee interest rate (zero coupon U.S. Treasury Note)
    
    
    4.7
    %
    
    
    4.4
    %Expected dividend yield
    
    
    0
    %
    
    
    0
    %
  Options Outstanding
    
    Options ExercisableWeightedAverage
    
    Weighted
    
    
    
    
    
    WeightedRemaining
    
    Average
    
    
    
    
    
    AverageRange of
    
    Number
    
    Contractual
    
    Exercise
    
    Number
    
    ExerciseExercise Prices
    
    Outstanding
    
    Life in Years
    
    Price
    
    Exercisable
    
    Price$1.20 - $4.64
    
    
    236,681
    
    
    
    9.0
    
    
    $
    2.17
    
    
    
    45,211
    
    
    $
    4.26$5.12 - $6.92
    
    
    169,054
    
    
    
    8.0
    
    
    $
    6.35
    
    
    
    33,304
    
    
    $
    6.07$7.12 - $9.92
    
    
    129,579
    
    
    
    8.7
    
    
    $
    8.63
    
    
    
    45,016
    
    
    $
    8.70$10.10 - $10.70
    
    
    146,250
    
    
    
    9.0
    
    
    $
    10.68
    
    
    
    14,167
    
    
    $
    10.56$11.08 - $11.76
    
    
    211,221
    
    
    
    8.2
    
    
    $
    11.70
    
    
    
    93,786
    
    
    $
    11.70$12.12 - $13.84
    
    
    113,105
    
    
    
    7.4
    
    
    $
    13.17
    
    
    
    67,787
    
    
    $
    13.18$14.28 - $19.38
    
    
    92,075
    
    
    
    8.0
    
    
    $
    16.23
    
    
    
    46,295
    
    
    $
    17.041,097,965
    
    
    
    8.4
    
    
    $
    8.85
    
    
    
    345,566
    
    
    $
    10.75
 17




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##### Table of Contents



Restricted stock units.
 WeightedNumber of
    average grantshares
    date fair valueUnvested, October 1, 2006
    
    
    51,480
    
    
    $
    15.54Granted
    
    
    2,310,543
    
    
    $
    1.73Vested
    
    
    
    
    
    $
    Forfeited
    
    
    (224,900
    )
    
    $
    Unvested, March 31, 2007
    
    
    2,137,123
    
    
    $
    2.25
  Restricted stock awards
 WeightedNumber of
    
    average grantshares
    
    date fair valueUnvested, October 1, 2006
    
    
    223,915
    
    
    $
    13.48Granted
    
    
    15,000
    
    
    $
    7.35Vested
    
    
    (41,666
    )
    
    $
    2.90Forfeited
    
    
    (131,999
    )
    
    $
    Unvested, March 31, 2007
    
    
    65,250
    
    
    $
    47.03
   12. COMMITMENTS AND CONTINGENCIES
 Center for Neurologic Study (CNS) 
 18




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##### Table of Contents



Eurand Agreement for Zenvia
 CIMA Agreement for FazaClo 
   13. SEGMENT INFORMATION
     19




---



##### Table of Contents



14. SUBSEQUENT EVENTS
   
 Item 2.
 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  EXECUTIVE OVERVIEW
 Avanir ®
   20




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info@avanir.com www.avanir.com.
 21




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##### Table of Contents



CRITICAL ACCOUNTING POLICIES AND ESTIMATES
   Share-Based Compensation
  RESULTS OF OPERATIONS
 COMPARISON OF THREE MONTHS ENDED MARCH 31, 2007 AND 2006
 Three Months endedMarch 312007
    
    
    2006
    
    
    $ Change
    
    
    % ChangePRODUCT SALESNet revenues
    
    $
    3,829,111
    
    
    $
    
    
    
    $
    3,829,111
    
    
    
    100
    %Cost of revenues
    
    
    1,308,256
    
    
    
    
    
    
    
    1,308,256
    
    
    
    100
    %Gross margin
    
    $
    2,520,855
    
    
    $
    
    
    
    $
    2,520,855
    
    
    
    100
    %LICENSES, RESEARCH SERVICES AND GRANTSRevenues:License agreements
    
    $
    56,019
    
    
    $
    9,342
    
    
    $
    46,677
    
    
    
    499.6
    %Research services
    
    
    920,448
    
    
    
    1,956,565
    
    
    
    (1,036,117
    )
    
    
    -53.0
    %Government research grant
    
    
    266,728
    
    
    
    75,862
    
    
    
    190,866
    
    
    
    251.6
    %Royalty and sale of royalty rights
    
    
    779,673
    
    
    
    427,259
    
    
    
    352,414
    
    
    
    82.5
    %2,022,868
    
    
    
    2,469,028
    
    
    
    (446,160
    )
    
    
    -18.1
    %Costs:Research services
    
    
    607,164
    
    
    
    1,795,634
    
    
    
    (1,188,470
    )
    
    
    -66.2
    %Government research grant
    
    
    369,261
    
    
    
    96,966
    
    
    
    272,295
    
    
    
    281.1
    %976,425
    
    
    
    1,892,600
    
    
    
    (916,175
    )
    
    
    -48.4
    %Gross margin
    
    $
    1,046,443
    
    
    $
    576,428
    
    
    $
    470,015
    
    
    
    81.5
    %
 22




---



##### Table of Contents



Revenues
     Cost of Revenues
   Three Months endedMarch 312007
    
    
    2006
    
    
    $ Change
    
    
    % ChangeOPERATING EXPENSESResearch and development
    
    $
    6,245,285
    
    
    $
    6,162,322
    
    
    $
    82,963
    
    
    
    1.3
    %Selling, general and administrative
    
    
    5,330,405
    
    
    
    8,492,115
    
    
    
    (3,161,710
    )
    
    
    -37.2
    %Total Operating Expenses
    
    $
    11,575,690
    
    
    $
    14,654,437
    
    
    $
    (3,078,747
    )
    
    
    -21.0
    %
 Research and Development Expenses
  23




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##### Table of Contents



Selling, General and Administrative expenses
  Share-Based Compensation
   Interest Expense and Interest Income
   Net Loss
  24




---



##### Table of Contents



COMPARISON OF SIX MONTHS ENDED MARCH 31, 2007 AND 2006
 Six Months endedMarch 312007
    
    
    2006
    
    
    $ Change
    
    
    % ChangePRODUCT SALESNet revenues
    
    $
    10,099,815
    
    
    $
    
    
    
    $
    10,099,815
    
    
    
    100
    %Cost of revenues
    
    
    2,655,440
    
    
    
    
    
    
    
    2,655,440
    
    
    
    100
    %Gross margin
    
    $
    7,444,375
    
    
    $
    
    
    
    $
    7,444,375
    
    
    
    100
    %LICENSES, RESEARCH SERVICES AND GRANTSRevenues:License agreements
    
    $
    113,284
    
    
    $
    5,009,342
    
    
    $
    (4,896,058
    )
    
    
    -97.7
    %Research services
    
    
    2,190,692
    
    
    
    4,434,583
    
    
    
    (2,243,891
    )
    
    
    -50.6
    %Government research grant
    
    
    353,076
    
    
    
    160,687
    
    
    
    192,389
    
    
    
    119.7
    %Royalty and sale of royalty rights
    
    
    1,502,713
    
    
    
    1,009,304
    
    
    
    493,409
    
    
    
    48.9
    %4,159,765
    
    
    
    10,613,916
    
    
    
    (6,454,151
    )
    
    
    -60.8
    %Costs:Research services
    
    
    1,771,239
    
    
    
    3,811,719
    
    
    
    (2,040,480
    )
    
    
    -53.5
    %Government research grant
    
    
    464,988
    
    
    
    166,955
    
    
    
    298,033
    
    
    
    178.5
    %2,236,227
    
    
    
    3,978,674
    
    
    
    (1,742,447
    )
    
    
    43.8
    %Gross margin
    
    $
    1,923,538
    
    
    $
    6,635,242
    
    
    $
    (4,711,704
    )
    
    
    -71.0
    %
 Revenues
     25




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##### Table of Contents



Cost of Revenues
   Six Months endedMarch 31,2007
    
    
    2006
    
    
    $ Change
    
    
    % ChangeOPERATING EXPENSESResearch and development
    
    $
    12,151,286
    
    
    $
    13,365,128
    
    
    $
    (1,213,842
    )
    
    
    -9.1
    %Selling, general and administrative
    
    
    18,576,339
    
    
    
    13,260,858
    
    
    
    5,315,481
    
    
    
    40.1
    %Total Operating Expenses
    
    $
    30,727,625
    
    
    $
    26,625,986
    
    
    $
    4,101,639
    
    
    
    15.4
    %
 Research and Development Expenses
   Selling, General and Administrative expenses
  Share-Based Compensation
   26




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##### Table of Contents



Interest Expense and Interest Income
   Net Loss
  LIQUIDITY AND CAPITAL RESOURCES
   IncreaseMarch 31,
    
    
    (Decrease)
    
    
    September 30,2007
    
    
    During Period
    
    
    2006Cash, cash equivalents and investment in securities
    
    $
    8,668,879
    
    
    $
    (16,081,194
    )
    
    $
    24,750,073Cash and cash equivalents
    
    $
    5,286,799
    
    
    $
    388,585
    
    
    $
    4,898,214Net working capital
    
    $
    (4,485,866
    )
    
    $
    2,483,911
    
    
    $
    (6,969,777
    )
 Six Months
    
    
    
    
    
    
    Six MonthsEnded
    
    
    Change
    
    
    EndedMarch 31,
    
    
    Between
    
    
    March 31,2007
    
    
    Periods
    
    
    2006Net cash used for operating activities
    
    $
    (33,322,647
    )
    
    $
    (15,667,859
    )
    
    $
    (17,654,788
    )Net cash provided by (used for) investing activities
    
    
    16,459,260
    
    
    
    40,726,186
    
    
    
    (24,266,926
    )Net cash provided by financing activities
    
    
    17,251,972
    
    
    
    (26,962,179
    )
    
    
    44,214,151Net increase in cash and cash equivalents
    
    $
    388,585
    
    
    $
    (1,903,852
    )
    
    $
    2,292,437
 Operating activities.
 27




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##### Table of Contents



Investing activities.
 Financing activities.
     Payments Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    1 Year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    5 YearsLong-term debt (principal and interest)
    
    $
    26,615,242
    
    
    $
    2,031,316
    
    
    $
    24,583,926
    
    
    $
    
    
    
    $
    Capital (finance) lease obligations
    
    
    293,531
    
    
    
    176,381
    
    
    
    117,150
    
    
    
    
    
    
    
    Operating lease obligations
    
    
    10,434,392
    
    
    
    2,514,900
    
    
    
    3,877,794
    
    
    
    3,078,762
    
    
    
    962,936Purchase obligations (1)
    
    
    4,801,549
    
    
    
    4,321,394
    
    
    
    480,155
    
    
    
    
    
    
    
    Total
    
    $
    42,144,714
    
    
    $
    9,043,991
    
    
    $
    29,059,025
    
    
    $
    3,078,762
    
    
    $
    962,936
 
 (1)
    
    Purchase obligations consist of the total of trade accounts payable and trade related accrued
expenses at March 31, 2007 which approximates our contractual commitments for goods and
services in the normal course of our business.  28




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##### Table of Contents



Alamo Earn-Out Payments.
 
    
    A promissory note, in the principal amount of $2,000,000, generally payable on the
third anniversary date if monthly FazaClo net product sales, as recognized in the statement
of operations, exceed $1,500,000 for each of the three months in a given fiscal quarter
during the Contingent Payment Period (Additional Run-Rate Note).
    
    A one-time cash payment of $10,450,000 if FazaClo net product sales, as recorded by the
Company in the statement of operations, exceed $40.0 million over four consecutive fiscal
quarters during the Contingent Payment Period.
    
    An additional one-time cash payment of $25,000,000 if FazaClo net product sales, as
recorded by the Company in the statement of operations, exceed $50.0 million over four
consecutive fiscal quarters during the Contingent Payment Period.
  CIMA Royalty payments.
 Twelve-month period ended March 31:2007
    
    $
    250,0002008
    
    $
    300,0002009 and each year thereafter
    
    $
    400,000
  Eurand Milestone and Royalty Payments.
 29




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##### Table of Contents



Zenvia License Milestone Payments.
  Management Outlook
   30




---



##### Table of Contents



Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  Interest rate sensitivity
  
 Item 4. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls over Financial Reporting
  
 PART II OTHER INFORMATION
 
 Item 1. LEGAL PROCEEDINGS
  
 Item 1A. RISK FACTORS
  31




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We must conduct additional clinical trials for Zenvia and there can be no assurance that the FDA
will approve Zenvia or that an approval, if granted, will be on terms we may seek.
   We have limited capital resources and will need to raise additional funds to support our
operations.
   Any transactions that we may engage in to raise capital could dilute our shareholders and diminish
certain commercial prospects.
  The FDAs safety concerns regarding Zenvia for the treatment of IEED/PBA may extend to other
clinical indications that we are pursuing, including DPNP.
  32




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We have recently experienced significant turnover in senior management.
  We face challenges retaining members of management and other key personnel.
  If we fail to comply with regulatory requirements, regulatory agencies may take action against us,
which could significantly harm our business.
      33




---



##### Table of Contents




    
    restrictions on our products or manufacturing processes;
    
    warning letters;
    
    withdrawal of the products from the market;
    
    voluntary or mandatory recall;
    
    fines;
    
    suspension or withdrawal of regulatory approvals;
    
    suspension or termination of any of our ongoing clinical trials;
    
    refusal to permit the import or export of our products;
    
    refusal to approve pending applications or supplements to approved applications that we submit;
    
    product seizure; and
    
    injunctions or the imposition of civil or criminal penalties.
 We generally do not control the development of compounds licensed to third parties and, as a
result, we may not realize a significant portion of the potential value of any such license
arrangements.
  If we fail to obtain regulatory approval in foreign jurisdictions, we would not be able to market
our products abroad and our revenue prospects would be limited.
  Because we depend on clinical research centers and other contractors for clinical testing and for
certain research and development activities, the results of our clinical trials and such research
activities are, to a certain extent, beyond our control.
  34




---



##### Table of Contents



Risks Relating to Our Industry
 There are a number of difficulties and risks associated with clinical trials and our trials may not
yield the expected results.
   
    
    the results from earlier clinical trials may not be statistically
significant or predictive of results that will be obtained from subsequent
clinical trials, particularly larger trials;
    
    institutional review boards or regulators, including the FDA, may hold,
suspend or terminate our clinical research or the clinical trials of our
product candidates for various reasons, including noncompliance with
regulatory requirements or if, in their opinion, the participating subjects
are being exposed to unacceptable health risks;
    
    subjects may drop out of our clinical trials;
    
    our preclinical studies or clinical trials may produce negative,
inconsistent or inconclusive results, and we may decide, or regulators may
require us, to conduct additional preclinical studies or clinical trials;
and
    
    the cost of our clinical trials may be greater than we currently anticipate.
    
    
    delays in our ability to submit an NDA;
    
    the refusal by the FDA to file any NDA we may submit;
    
    requests for additional studies or data;
    
    delays of an approval; or
    
    the rejection of an application.
 35




---



##### Table of Contents



Clinical trials can be delayed for a variety of reasons. If we experience any such delays, we would
be unable to commercialize our product candidates on a timely basis, which would materially harm
our business.
  
    
    obtaining an effective investigational new drug application, or IND, or regulatory approval to commence a clinical trial;
    
    identifying and engaging a sufficient number of clinical trial sites;
    
    negotiating acceptable clinical trial agreement terms with prospective trial sites;
    
    obtaining institutional review board approval to conduct a clinical trial at a prospective site;
    
    recruiting qualified subjects to participate in clinical trials;
    
    competition in recruiting clinical investigators;
    
    shortage or lack of availability of supplies of drugs for clinical trials;
    
    the need to repeat clinical trials as a result of inconclusive results or poorly executed testing;
    
    the placement of a clinical hold on a study;
    
    the failure of third parties conducting and overseeing the operations of our clinical trials to perform their contractual
or regulatory obligations in a timely fashion; and
    
    exposure of clinical trial subjects to unexpected and unacceptable health risks or noncompliance with regulatory
requirements, which may result in suspension of the trial.
  Developing and marketing pharmaceutical products for human use involves product liability risks,
for which we currently have limited insurance coverage.
  36




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##### Table of Contents



Risks Relating to Our Stock
 Our stock price has historically been volatile and we expect that this volatility will continue for
the foreseeable future.
  
    
    Comments made by securities analysts, including changes in their recommendations;
    
    Short selling activity by certain investors, including any failures to timely settle short sale transactions;
    
    Announcements by us of financing transactions and/or future sales of equity or debt securities;
    
    Sales of our Class A common stock by our directors, officers, or significant shareholders;
    
    Announcements by our competitors of clinical trial results or product approvals; and
    
    Market and economic conditions.
    The
preparation of our financial statements requires the use of certain
assumptions and estimates. If the facts underlying these assumptions
or estimates change, or if our analysis and conclusions change, our
financial position and operating results could vary significantly
from period to period.
  
 Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 Item 3. DEFAULTS UPON SENIOR SECURITIES
  37




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##### Table of Contents



Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  Proposal No. 1: Election of Directors
 Director Nominee
    
    For
    
    WithholdDavid Mazzo
    
    
    32,871,983
    
    
    
    1,860,654Craig Wheeler
    
    
    32,921,171
    
    
    
    1,811,466Scott Whitcup
    
    
    32,921,382
    
    
    
    1,811,255
 Proposal No. 2: Ratification of Selection of Deloitte & Touche LLP as Independent Registered Public
Accounting Firm
 For
    
    Against
    
    Abstain33,919,757
    
    
    656,826
    
    
    
    156,052
 
 Item 5.
OTHER INFORMATION
   38




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Item 6. EXHIBITS
 Exhibits
     39




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##### Table of Contents



SIGNATURES
  Signature
    
    Title
    
    Date/s/ Keith Katkin

Keith Katkin
    
    President and Chief Executive
Officer (Principal
Executive Officer)
    
    May 10, 2007/s/ Michael J. Puntoriero

Michael J. Puntoriero
    
    Vice President, Finance and Chief
Financial Officer (Principal
Financial and Accounting Officer)
    
    May 10, 2007/s/ Martin J. Sturgeon

Martin J. Sturgeon
    
    Vice President, Chief Accounting Officer
    
    May 10, 2007
 40