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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-K**

 

**x****      ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the fiscal year ended December 31,2009**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OF 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the transition periodfrom                        to                        **

 

**Commission File Number: 001-14895**

 

**AVI BioPharma, Inc.**

(Exact name of registrant as specified in its charter)

 

| **Oregon**                                                      | ** ** | **93-0797222**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

| **3450  Monte Villa Parkway, Suite 101, Bothell, Washington** | ** ** | **98021**  |
|--------------------------------------------------------------------|------------|------------|
| (Address of  principal executive offices)                          |       | (Zip Code) |

 

Registrant’s telephone number, including area code:  **(425) 354 5038**

 

Securities registered under Section 12(b) of the Act:**None**

 

Securities registered under Section 12(g) of the Act:

 

**Common Stock with $.0001 par value**

(Title of Class)

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.  Yes o  No x

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.  Yes o  No x

 

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes o  No o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  x

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large  accelerated filer o                |   | Accelerated  filer x         |
|------------------------------------------------|--------|-----------------------------------|
| Non-accelerated  filer o                  |   | Smaller Reporting  Company o |
| (Do not check if  a smaller reporting company) |   |                              |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o   No x

 

Theaggregate market value of the voting stock held by non-affiliates of theRegistrant as of June 30, 2009 was approximately $128,954,972. Thisdetermination of affiliate status is not necessarily a conclusive determinationfor other purposes. The number of outstanding shares of the Registrant’s CommonStock as of the close of business on March 15, 2010 was 110,395,587.

 

**Documents Incorporated by Reference**

 

Theissuer has incorporated into Part III of this annual report on Form 10-K,by reference, portions of its definitive Proxy Statement for its 2010 annualmeeting.

 

 

 

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**AVIBioPharma, Inc.**

**FORM 10-K INDEX**

 
| ** **        | ** ** | ** **                                                                                                          | ** ** | **Page**   |
|-------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **        | ** ** | ** **                                                                                                          | ** ** | ** ** |
| **PART I**   |
| ** **        |
| Item 1.           |       | Business                                                                                                            |       | 1          |
|              |       |                                                                                                                |       |       |
| Item 1A.          |       | Risk Factors                                                                                                        |       | 10         |
|              |       |                                                                                                                |       |       |
| Item 1B.          |       | Unresolved  Staff Comments                                                                                          |       | 15         |
|              |       |                                                                                                                |       |       |
| Item 2.           |       | Properties                                                                                                          |       | 15         |
|              |       |                                                                                                                |       |       |
| Item 3.           |       | Legal Proceedings                                                                                                   |       | 15         |
|              |       |                                                                                                                |       |       |
| Item 4.           |       | Submission  of Matters to a Vote of Security Holders                                                                |       | 15         |
|              |       |                                                                                                                |       |       |
| **PART II**  |
| ** **        |
| Item 5.           |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       | 16         |
|              |       |                                                                                                                |       |       |
| Item 6.           |       | Selected  Financial Data                                                                                            |       | 18         |
|              |       |                                                                                                                |       |       |
| Item 7.           |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       | 18         |
|              |       |                                                                                                                |       |       |
| Item 7A.          |       | Quantitative  and Qualitative Disclosures About Market Risk                                                         |       | 25         |
|              |       |                                                                                                                |       |       |
| Item 8.           |       | Financial  Statements and Supplementary Data                                                                        |       | 25         |
|              |       |                                                                                                                |       |       |
| Item 9.           |       | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure                               |       | 25         |
|              |       |                                                                                                                |       |       |
| Item 9A.          |       | Controls and  Procedures                                                                                            |       | 25         |
|              |       |                                                                                                                |       |       |
| Item 9B.          |       | Other Information                                                                                                   |       | 27         |
|              |       |                                                                                                                |       |       |
| **PART III** |
| ** **        |
| Item 10.          |       | Directors,  Executive Officers and Corporate Governance                                                             |       | 27         |
|              |       |                                                                                                                |       |       |
| Item 11.          |       | Executive  Compensation                                                                                             |       | 27         |
|              |       |                                                                                                                |       |       |
| Item 12.          |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    |       | 27         |
|              |       |                                                                                                                |       |       |
| Item 13.          |       | Certain  Relationships and Related Transactions, and Director Independence                                          |       | 27         |
|              |       |                                                                                                                |       |       |
| Item 14.          |       | Principal  Accountant Fees and Services                                                                             |       | 27         |
|              |       |                                                                                                                |       |       |
| Item 15.          |       | Exhibits  and Financial Statement Schedules                                                                         |       | 27         |
|              |       |                                                                                                                |       |       |
|              |       | Signatures                                                                                                          |       | 33         |

 

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**PART I**

 

**Item 1.  Business.**

 

# **General Overview**

# ** **

AVI BioPharma is abiopharmaceutical company specializing in the discovery and development ofnovel, RNA-based drugs targeting a range of diseases (in this report, “we,” “our,”“us,” “AVI,” and “Company” refers to AVI BioPharma, Inc.).

 

We are focused on thediscovery and development of RNA-based drugs utilizing antisense technologiesemploying proprietary chemistries developed and optimized by AVI.  These drugs can be designed to target diseasemechanisms through distinct mechanisms of action. Unlike other RNA-basedapproaches, AVI’s antisense technology has been used to directly target bothmessenger RNA (mRNA) and precursor messenger RNA (pre-mRNA) to eitherdown-regulate (inhibit) or up-regulate (promote)  targeted genes or proteins. We believe thatthese broad capabilities give the Company a highly competitive RNA-basedtechnology platform and a strong intellectual property position, both of whichare the result of advances across several areas of science, including over 20years of research and development work in chemistry and biology. Our patentestate includes 191 patents (foreign and domestic) issued to or licensed by usand 190 pending patent applications (domestic and foreign).

 

AVI is leveraging itsdiscovery and development capabilities to build a pipeline of RNA-based drugcandidates to develop in collaboration with larger pharmaceutical andbiotechnology partners. Current applications of AVI’s RNA technology platforminclude genetic diseases (Duchenne muscular dystrophy), infectious diseases(including Ebola, Marburg and H1N1 Influenza viruses), and other earlydiscovery targets.  Several of ourantiviral programs, including Ebola, Marburg, Junín and H1N1, have been or arecurrently funded by the U.S. government (see U.S. Department of DefenseAgreements below). Many of our other programs have received funding fromnon-government sources.

 

### **Business Strategy**

### ** **

We believe that ourRNA-based technology is applicable to the development of potentialpharmaceutical products in many therapeutic areas and we intend to usedata-driven decision making to exploit our core technology appropriately.

 

Our strategy is to:

 

focus on near-term opportunities in the geneticdisease, immunological and infectious diseases areas;

 

manage drug discovery, pre-clinical and clinicaldevelopment in-house;

 

utilize biodefense funding to advance our chemistryand its application to our antiviral programs;

 

bring products through early phase clinicaldevelopment;

 

enter into collaborative development agreements withstrategic partners for specific molecular targets or selected diseaseindications or commercialization and development of stockpiling inventories.

 

**AVIChemistries**

 

AVI’s core chemistry isbased on phosphordiamidate — linked morpholino oligomers or  “PMOs”.PMOs are synthetic molecules based on a fundamental redesign of the naturalnucleic acid structure of DNA and RNA. PMOs bind to complementary sequences ofRNA by standard nucleic acid base—pairing. Structurally, the difference betweenPMOs on the one hand and DNA and RNA on the other hand is that while PMOs havestandard nucleic acid bases, those bases are bound to morpholine rings insteadof deoxyribose (in DNA) or ribose (in RNA) rings, and they are linked throughphosphorodiamidate groups instead of phosphates. Replacement of anionicphosphates with the uncharged phosphorodiamidate groups eliminates ionizationin the usual physiological pH range, so PMOs in organisms or cells areuncharged molecules. The entire backbone of a PMO is made from these modifiedsubunits; they act in a drug-like manner as steric blockers and do not activatebiologic mechanisms — such as RNAse H — for their mode of action.

 

New synthetic analogs ofthis original chemistry differentiate AVI’s PMO-based drug candidates fromearlier-generation RNA antisense compounds and many current antisense drugcandidates. We believe that these key differences provide pharmaceuticalproperties that are preferable for advanced antisense technology to achievebroader drug characteristics and greater potential clinical utility than theother antisense compounds.

 

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AVI has advanced itsoriginal PMO chemistry through the addition of two new series of PMO analogues.The first is a peptide conjugated phosphorodiamidate morpholino oligomer, orPPMO, where cellular uptake of the active PMOs, as well as their potency andspecificity of tissue targeting, may be significantly enhanced by theconjugation of chemical moieties to a PMO, which broadly can be considered asarginine-rich cell-penetrating peptides (CPPs).

 

The second analogueseries includes the addition of positive charges to certain monomers in the PMObackbone. We believe that this new series, the PMO*plusTM*,may be effective in overcoming the viral mutations that make certain RNAviruses drug-resistant. We continue to advance additional discoveries tofurther optimize our core proprietary chemistry as well as to develop furthernovel analogues that we believe could provide benefit in the keycharacteristics for drug action, such as potency, bioavailability, therapeuticindex and tissue selectivity.

 

As a part of our newcorporate research and development, headquartered in Bothell, Washington, weestablished a dedicated research chemistry group to improve certain drug-likeproperties of our PMO chemistry.

 

## **TranslationSuppressing Oligomers (TSOs)**

## ** **

Translation SuppressingOligomers (TSOs) are PMO-based antisense compounds that interfere with geneexpression — and other RNA-dependent cellular processes — by binding to theirspecific target sequence in RNA. The primary application of TSOs is to stop orsuppress the translation of a specific protein through this binding process,thus inducing a desired therapeutic effect. TSOs demonstrate tight andselective RNA binding and act by a direct steric-blocking mechanism instead ofby RNAse H-mediated or RISC-mediated RNA degradation.

 

## **Splice SwitchingOligomers (SSOs)**

## ** **

Splice SwitchingOligomers (SSOs) are PMO-based compounds that can direct alternative splicingby forcing the cellular splicing machinery towards desired splicing outcomes,such as promoting the expression of a mRNA for desired protein. Sometimes thesedesired splicing pathways are entirely novel, i.e. they are not normally seenin the human body, and could produce important therapeutic outcomes. SSOsexploit pre-mRNA splicing to control gene function and are intended to producea therapeutic benefit in which a protein is inhibited, increased in its expressionlevel, changed in the overall profile of protein isoforms or results in theexpression of a unique novel protein. We believe this powerful mechanism mayprovide significant discrimination when used for intervention indisease-causing processes.

 

We believe that the fieldof directed alternative splicing is positioned at the crucial interface ofgenomes, regulatory networks and evolution, and represents a rapidly emergingmechanism for gene regulation. The genetic information stored in human DNA is dispersedin short DNA stretches, called exons that code for fragments of the protein andare separated by long non-coding pieces of DNA called introns. Duringprocessing of precursor or pre-mRNA, which is copied from the DNA template,introns are removed and exons spliced together to create the mature mRNA. InmRNA, the exons are brought together, the genetic information is madecontiguous and a functional protein can be translated. In alternative splicing,different pre-mRNA exons are combined, thus, creating multiple messenger RNAsand, hence, multiple proteins, all from the same gene. We believe our SSOs canbe used to manipulate splicing in a way that is distinct from conventionalantisense or siRNA or RNAi-based approaches.

 

By targeting elements inprecursor RNA that are essential for splicing, SSO compounds force the cellularmachinery to skip over targeted exons, creating an altered mRNA template. In adisease situation, SSOs can be designed to prevent formation of harmfulproteins and/or help to restore beneficial proteins. When the exon contains adisease-causing mutation, for example, forced skipping of the harmful exonproduces an altered protein which may have its function restored, partiallyrestored or neutralized. This approach may be used to overcome the devastatingconsequences of certain disease-causing mutations, which are known as geneticdiseases.

 

The Human Genome Projectrevealed that humans have far fewer genes than would have been predicted fromthe number of unique proteins that are expressed in the human proteome. Latestestimates indicate that approximately 90% of human genes are alternativelyspliced.  Thus, for the majority ofgenes, alternative splicing produces multiple proteins that can have slightlyor profoundly different functions. Some pairs of splice variants code forproteins that have exactly opposite effects. Alternative splicing pathways areaffected in many different diseases such that pathological protein isoforms areoverproduced and the physiological isoforms are decreased. AVI’s PMO-based SSOtechnology enables manipulation of splicing to restore production of desiredproteins, and, therefore, represents a novel therapeutic platform, withsignificant therapeutic potential in some previously untreatable diseases.

 

### **Therapeuticapplications of SSOs include:**

### ** **

·                  Inhibition of mRNA production through a kineticallyfavored process

 

·                  Functional repair of RNA mutations

 

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·                  Expression of novel proteins

 

·                  Alteration of protein compartmentalization

 

·                  The ability to flip an on/off control switch onspecific gene targets

 

·                  Alteration of the profile of protein isoforms

 

# **TheCompany believes that the field of directed alternative splicing represents anexciting opportunity and has emerged as a ubiquitous and dynamic mechanism forgene regulation. Supported by a growing stream of new insights and discoveriesderived from the fields of genomics, bioinformatics and molecular biology, webelieve that this area promises to be a rich source of therapeuticapplications.**

# ** **

This annual reportincludes our trademarks and registered trademarks, including NeuGene®,Avicine®, Resten-NG®, Resten-CPTM, Oncomyc-NGTM, and PMO*plus*TM.Each other trademark, trade name or service mark appearing in this annualreport belongs to its holder.

 

**DevelopmentPrograms**

 

Our RNA-based drugprograms are being clinically evaluated for the treatment of Duchenne MuscularDdystrophy and have demonstrated promising antiviral activity in Ebola, Marburgand H1N1 virus diseases and may prove applicable to other viral targets such asHCV, Junín and Dengue viruses.  Wecurrently have products at various stages of development including thosesummarized below.

 
| **Program**                                              | ** ** | **Mechanism** | ** ** | **Chemistry**   | ** ** | **Status**                                                                                                           | ** ** | **Developer /  Collaborator** |
|----------------------------------------------------------|------------|---------------|------------|-----------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|
| AVI-4658 Duchenne  muscular dystrophy DMD — Exon 51 |       | SSO           |       | PMO             |       | Phase 1 intramuscular  (IM) study complete. Phase 1/2 —IV study ongoing. Orphan status granted in  U.S. and EU. |       | Proprietary                   |
| AVI-5038 Duchenne  muscular dystrophy DMD — Exon 50 |       | SSO           |       | PPMO            |       | Preclinical  Development. Orphan status granted in U.S. and EU.                                                      |       | Proprietary                   |
| AVI — 6002 Ebola virus                              |       | TSO           |       | PMO*plusTM* |       | Open IND                                                                                                             |       | Proprietary/U.S.  Government  |
| AVI — 6003 Marburg virus                            |       | TSO           |       | PMO*plusTM* |       | Open IND                                                                                                             |       | Proprietary/U.S.  Government  |
| AVI — 7367 H1N1 virus                               |       | TSO           |       | PMO*plusTM* |       | Discovery                                                                                                            |       | Proprietary/U.S.  Government  |

 

**DuchenneMuscular Dystrophy (DMD) programs.**  We aredeveloping a series of drugs for the potential treatment of DMD.  We believe that a series of drugs skippingdifferent exons could treat the various genotypically distinct forms ofDMD.  Patients with DMD have a mutationin the DNA that codes for the production dystrophin, a critical muscle proteinlocalized beneath the sarcolemmal membrane of muscle cells. The absence ofdystrophin in muscle cells leads to cell damage, an abnormally permeable cellmembrane and ultimately causes muscle cell death and fibrotic replacement. Wecurrently have two programs underway with drugs that skip exon 51 (AVI-4658)and exon 50 (AVI-5038) and are identifying lead candidates for exons 44, 45 and53.

 

**AVI-4658**. A phase 1 human clinical trial inpatients with Duchenne Muscular Dystrophy (DMD) was completed by the MDEXconsortium in the United Kingdom. We announced the successful outcome of thattrial in January 2009.  Our SSOdrug, AVI-4658, targets the most frequent mutations resulting in DMD, forcesthe genetic machinery to skip over an adjacent contiguous piece (one or moreexons) of RNA, thus restoring the ability of the cell to express a newtruncated, but functional, dystrophin protein. We believe that this mayrestore, prevent or slow deterioration of muscle function. This was the firstclinical application of our SSO technology and entailed administration of thedrug directly into an affected muscle in DMD patients.   We have anongoing phase 1b/2 systemic clinical trial with this product at the Instituteof Child Health in London, UK and the University of Newcastle, UK. AVI-4658 hasbeen granted Orphan Status in the U.S. and the EU.   A set of Good Laboratory Practice (GLP)compliant preclinical studies has recently been completed and will be submittedto the FDA to support release from the full clinical hold imposed on the INDfor AVI-4658. No U. S. patients have yet been treated with AVI-4658.

 

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**AVI-5038**. We are conducting Good LaboratoryPractice (GLP) compliant preclinical evaluations with our SSO drug, AVI-5038,which is designed to skip exon 50 and potentially overcome the mutational blockand restore dystrophin expression.   Thisdrug utilizes our PPMO chemistry with the aim to enhance potency, tissueselectivity and bioavailability when compared to first generation PMO drugcandidates.

 

**AVI-5126Prevention of Restenosis.** AVI partnered with Global Therapeutics, a Cook Medical Company,to evaluate AVI’s cardiovascular restenosis drug candidate for use on achromium cobalt drug-eluting stent (DES) for the treatment of cardiovascularrestenosis. In November 2009, we announced that we believe Cookdiscontinued development of our drug candidate, AVI-5126, on itscobalt-chromium stent because of an unexpectedly high rate of restenosis.

 

**InfectiousDisease Programs.**Our infectious disease programs are currently focusing on single-stranded RNAviruses using our proprietary TSO technology with our PMO*plusTM*chemistry backbone to target the often fatal diseases such as Ebola and MarburgHemorrhagic Fevers, and H1N1 viruses, as well as other items included on theDepartment of Homeland Security’s list of bioterrorism agents, including Dengueand Junín viruses, anthrax and ricin. 

 

**AVI-6002Ebola virus program**,Ebola virus causes a highly lethal disease with no effective currenttherapy.  We have demonstratedsignificant survival in mice, guinea pigs and monkeys when they are treatedwith AVI-6002 post infection with Ebola virus. In November 2008, we filedan Investigational New Drug application (IND) with the United States Food andDrug Administration (FDA).  In December 2008,we received approval to move into the initial clinical study.  We plan to pursue development and approval ofAVI-6002 under the “Animal Rule.”  TheAnimal Rule states that in selected circumstances, when it is unethical orinfeasible to conduct human efficacy studies, the FDA may grant marketingapproval based on adequate and well-controlled animal studies when the resultsof those studies establish that the drug or biological product is reasonablylikely to produce clinical benefit in humans. Demonstration of the product’ssafety in humans is still necessary.  Wehave responded to a U.S. government request for proposal to develop AVI-6002through to NDA. Future development of AVI-6002 is dependent on continued U.S.government funding.

 

**AVI-6003Marburg virus program**, Marburg virus is a highly lethal virus with no effective currenttherapy.  We have demonstratedsignificant survival in mice, guinea pigs and monkeys when they are treatedwith AVI-6003 post-infection with Marburg virus.  In November 2008, we filed anInvestigational New Drug application (IND) with the FDA.  In December 2008, we received approvalto move into the initial clinical study. We plan to pursue development and approval of AVI-6003 under the AnimalRule.  Our development of AVI-6003 is currentlyfunded by the U.S. government.  Futuredevelopment of AVI-6003 is dependent on continued U.S. government funding.

 

**AVI-7367H1N1 virus program**,Pandemic H1N1 virus, also known as H1N1 or swine origin influenza virus, isoften treated with the standard of care drug oseltamivir, also known asTamiflu. AVI’s lead RNA-based candidate drug showed a statisticallysignificantly greater reduction in viral titer and clinical scores in infectedferrets than was seen with the scrambled sequence control, the saline controlor the positive control using oseltamivir. 

 

**StrategicAlliances and Other Material Agreements**

 

We believe that ourRNA-based technology could be broadly applicable for the potential developmentof pharmaceutical products in many therapeutic areas. To exploit our coretechnology as fully as possible, our strategy is to enter into strategicresearch and development alliances with larger pharmaceutical and biotechnologycompanies for specific AVI indentified molecular targets or selected diseaseindications, where these entities would partner in the research and commercial developmentof such targets and diseases. We also plan to pursue opportunities to accessintellectual property rights through license agreements or other arrangementsthat complement our portfolio of patents and patent applications.

 

## **We currently havestrategic alliances with the following companies and institutions**

## ** **

*Isis —Ercole Agreement*

 

In May of 2003,Ercole Biotech and Isis Pharmaceuticals entered into a collaboration andlicense agreement related to RNA splicing. This agreement established a cross-licensebetween the parties granting each party certain exclusive and nonexclusiverights under a selected set of the other parties’ patents and patentapplications for the research, development, and commercialization of antisensetherapeutics using RNA splicing.  The agreement also established thatcertain gene targets become exclusive to each party under and during the termof the agreement.

 

Subject to the satisfaction of certain milestonestriggering the obligation to make any such payments, AVI may be obligated tomake milestone payments of up to $23,450,000 in the aggregate for each productdeveloped under a licensed patent under this agreement.  

 

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As of December 31, 2009, AVI has not made, and isnot under any current obligation to make, any such milestone payments, as theconditions triggering any such milestone payment obligations have not beensatisfied.  The range of percentage royalty payments required to be madeby AVI under the terms of this agreement is in the single digits.

 

Subject to the satisfaction of certain milestonestriggering the obligation to make any such payments, Isis may be obligated tomake milestone payments of up to $21,050,000 in the aggregate for each productdeveloped under a licensed patent under this agreement.  As of December 31,2009, Isis has not made, and is not under any current obligation to make, anysuch milestone payments, as the conditions triggering any such milestonepayment obligations have not been satisfied.  The range of percentageroyalty payments required to be made by Isis under the terms of this agreementis in the single digits.

 

This agreement will terminate on the expiration dateof the last to expire patent licensed in the agreement, which expiration dateis in March, 2020. Researchcollaboration activity defined in the agreement expired in 2006. This agreementbecame an obligation of the Company as a part of the acquisition of ErcoleBiotech.

 

*ChironAgreement*

 

In January 2006, weentered into an agreement with Chiron Corporation that granted us anonexclusive license to Chiron’s patents and patent applications for research,development, and commercialization of antisense therapeutics against hepatitisC virus (HCV).  Chiron scientists were the first to clone HCV and Chironhas been granted more than 100 HCV-related patents.

 

The license agreementwith Chiron further strengthened our patent position on our HCV antisenseproduct candidates, which are already covered by issued U.S. patentclaims.  In conjunction with the license agreement, AVI issued Chironshares of AVI common stock as an initial license fee payment.

 

Subject to the satisfaction of certain milestonestriggering the obligation to make any such payments, AVI may be obligated tomake milestone payments of up to $5 million in the aggregate under thisagreement.  As of December 31, 2009,AVI has not made, and is not under any current obligation to make, any suchmilestone payments, as the conditions triggering any such milestone paymentobligations have not been satisfied.  Therange of percentage royalty payments required to be made by AVI under the termsof this agreement is in the single digits. Chiron is not obligated to make any milestone payments or royaltypayments under the agreement.    Thisagreement will terminate as of the later of (i) the 20th anniversary ofthe effective date of the agreement, or (ii) the expiration date of thelast to expire patent among certain patents issued to Chiron, which expirationdate is in 2016.

 

*CookGroup Agreement*

 

In March 2006, we* *entered into agreements with Cook Group Incorporated (“Cook”)for the development and commercialization of products for vascular diseases.Cook is the world’s largest privately-held manufacturer of medical devices andis a leading designer, manufacturer and global distributor of minimallyinvasive medical device technologies for diagnostic and therapeutic procedures.Pursuant to our agreements, Cook licensed AVI-5126 for down-regulating c-Mycexpression in the field of cardiovascular disease. Cook has taken over theclinical development of device-related programs for cardiovascular restenosis,including our AVI-5126 drug-eluting stent (DES) program, Resten-MPTMmicroparticle delivery program, and a program for catheter delivery ofResten-NG®.

 

Basedon the agreements, we expect Cook to fully fund the development, clinical andregulatory costs of licensed programs in the U.S. and Europe leading tocommercialization. The Company is not obligated to make any milestone paymentsunder the agreements with Cook.  Subjectto the satisfaction of a commercialization milestone relating to net sales ofproducts developed under the agreement, Cook is obligated to make a one-timemilestone payment of $10 million under the license and developmentagreement.  As of December 31, 2009,Cook has not made, and is not under any current obligation to make, any suchmilestone payment, as the condition triggering such milestone paymentobligation has not been satisfied.  Thelicense and development agreement also provides for payment to AVI of adouble-digit percentage royalty on net sales by Cook.  Cook has the right to terminate theagreements upon 90 days’ written notice to AVI. AVI has the right to terminate the agreements upon 60 days’ writtennotice to Cook if, following an assignment of Cook’s rights under theagreements in connection with a merger or sale of assets, the assigneeterminates its development efforts under the license and development agreement.In the absence of any such termination by Cook or AVI, the agreement terminatesby its own terms with the expiration of the last to expire patent among certainpatents.  AVI does not expect to beentitled to or receive any milestone payment from Cook under this agreement**.**InNovember 2009, we announced that we believe Cook discontinued developmentof our drug candidate, AVI-5126, on its cobalt-chromium stent because of anunexpectedly high rate of restenosis.

 

*ErcoleAgreement*

 

In December 2006, AVI and Ercole entered into acollaboration and license agreement for purposes of identifying and developingdrugs that direct the splicing of precursor messenger RNA (pre-mRNA) to treat avariety of genetic and acquired diseases. Under the collaboration and license agreement, each party selected genetargets for their research and development efforts.  Subject to the satisfaction of certaindevelopment-related milestones, Ercole was obligated to pay milestone paymentsto AVI of up to $2.2 million in the aggregate with respect to each therapeuticcandidate resulting from Ercole’s work on the gene targets selected byErcole.  AVI had a reciprocal obligationto Ercole with respect to each therapeutic candidate resulting from AVI’s workon the gene targets selected by AVI.

 

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Subject to the satisfaction of certaincommercialization milestones relating to net sales of drugs successfullydeveloped under the agreement, AVI was also obligated under the collaborationand license agreement to pay Ercole $20 million for each drug resulting fromAVI’s work on the gene targets selected by AVI, up to a maximum aggregateamount of $100 million in such payments. The parties also had reciprocal obligations to pay a single-digitpercentage royalty to one another on net sales of drugs developed from the genetargets they selected.  The collaborationand license agreement provided that it would terminate as of the later of (i) theexpiration date of the last to expire patent among certain patents, whichexpiration date is in 2020, or (ii) if all such patents were found to beinvalid or unenforceable, 10 years.  Theobligations of the parties to one another under this agreement were terminatedby operation of law when AVI acquired Ercole in March 2008.  At the time the acquisition was completed, nomilestone payments had been made by one party to the other, and no royaltieshad been paid under the agreement.

 

In May 2007,the parties entered into a second collaboration and license agreement forpurposes of expanding the collaboration between the parties to include thediscovery and development of drugs to treat muscular dystrophy and betathalassemia.  The parties agreed to sharecertain research and development costs under this agreement.  The second collaboration and licenseagreement provided that it would terminate as of the later of (i) theexpiration date of the last to expire patent among certain patents, whichexpiration date is in 2020, or (ii) if all such patents were found to beinvalid or unenforceable, 10 years.   Theobligations of the parties to one another under this agreement were likewiseterminated by operation of law when AVI acquired Ercole in March 2008.

 

*EleosAgreement*

 

In January 2007, weannounced that we had entered into a cross-license agreement with Eleos Inc. (“Eleos”)for the development of antisense drugs targeting p53, a well-studied humanprotein that controls cellular response to genetic damage. Under the terms ofthe agreement, AVI granted Eleos an exclusive license to AVI’s NeuGene® third-generation antisense chemistry to treatcancer with p53-related drugs. In return, Eleos granted an exclusive license toits patents to AVI for treatment of most viral diseases with drugs that targetp53. The companies are sharing rights in other medical fields where targetingp53 may be therapeutically useful. Subject to the satisfaction of certaindevelopment and commercialization milestones, Eleos may be obligated to makemilestone payments of up to $19.5 million in the aggregate with respect todrugs resulting from Eleos’ use of AVI intellectual property licensed to Eleosunder the agreement.  AVI has areciprocal obligation to Eleos with respect to drugs resulting from AVI’s useof Eleos’ intellectual property licensed to AVI under the agreement. As of December 31,2009, neither Eleos nor AVI has made, and neither Eleos nor AVI is under anycurrent obligation to make, any such milestone payments, as the conditionstriggering any such milestone payment obligations have not been satisfied.  Percentage royalty payments required to bemade by Eleos to AVI under the terms of this agreement range from single digitsto low teens on net sales of drugs resulting from Eleos’ use of AVI’sintellectual property licensed to Eleos under the agreement.  AVI is required to pay to Eleos a low-teenspercentage royalty on net sales of drugs resulting from AVI’s use of Eleos’intellectual property.  For the fiscalyears ending December 31, 2009, 2008 and 2007, AVI recognized $125,000,$125,000, and $125,000, respectively, in revenue from this agreement.  This agreement will terminate as of the laterof (i) the expiration date of the last to expire patent among certainpatents licensed under the agreement having claims covering a product using AVIor Eleos intellectual property licensed under the agreement, which expirationdate is in 2024, or (ii) 10 years from the date of the first commercialsale of a product using AVI or Eleos intellectual property licensed under theagreement.

 

*Charley’sFund Agreement*

 

In October 2007, AVI and Charley’s Fund, Inc.,a nonprofit organization that funds drug development and discovery initiativesspecific to Duchenne muscular dystrophy (DMD), announced that AVI had beenawarded a $2.45 million research grant from Charley’s Fund for the purposes ofsupporting a new product development program using proprietary exon skipping technologiesdeveloped by AVI to overcome the effects of certain genetic errors in thedystrophin gene.  The parties enteredinto a sponsored research agreement in October 2007. The partiessubsequently entered into an amendment of the sponsored research agreement in May 2009.

 

At the time of the execution of the amendment by theparties, of the $2.45 million to be paid, $2 million had already been paid toAVI by Charley’s Fund, of which $1.35 million had been spent by AVI under theterms of the agreement.  The May 2009amendment allocated the remaining $650,000 already received by AVI, but not yetspent by AVI, toward a revised list of research and development tasks to beperformed by AVI.  Under the terms of theMay 2009 amendment, subject to the satisfaction of certain milestones,Charley’s Fund agreed that it would pay up to an additional $3 million to AVIin milestone payments over and above the $2 million it had already paid to AVIat the time of the execution of the amendment. As of December 31, 2009, Charley’s Fund has made an aggregate of$3.4 million in milestone payments to AVI, an amount which includes the $2million amount paid to AVI prior to the execution of the amendment to thesponsored research agreement. Revenue associated with this research anddevelopment arrangement is recognized based on proportional performance appliedto non-fundable payments received.  AVI recognized $0, $22,500 and$37,500, respectively, in revenue from Charley’s Fund for the years ended December 31,2009, 2008 and 2007.

 

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Under the terms of theSponsored Research Agreement, as amended, if AVI and any of its strategicpartner(s) elect to discontinue the development and commercialization of anyproduct containing any molecular candidate arising or derived from the researchsponsored by Charley’s Fund other than for safety or efficacy, AVI has grantedto Charley’s Fund an exclusive, royalty-bearing, fully-paid, worldwide license,with right of sublicense, to any such product. Depending on the timing of the obtainment of a license by Charley’s Fundto any such product, percentage royalty payments on net sales required to bemade by Charley’s Fund to AVI under the terms of the sponsored researchagreement, as amended, range from single digits to low teens.  Under the terms of the sponsored researchagreement, as amended, if the parties are able to successfully commercializeany molecular candidate arising or derived from the research sponsored byCharley’s Fund either through sales of products or through licensing orpartnership arrangements with a third party that include rights for such thirdparty to sell, distribute, promote or market such products or the underlyingintellectual property, then AVI is obligated to repay the research funds paidto AVI by Charley’s Fund, up to an amount equal to the total amount of fundsprovided by Charley’s Fund to AVI.  Inconnection with this repayment obligation, AVI agreed that it would pay asingle-digit percentage royalty on net sales of products containing anymolecular candidate arising or derived from the research sponsored by Charley’sFund (up to an amount equal to the total amount of funds provided by Charley’sFund to AVI).  This agreement willterminate by its own terms at the completion of the research being sponsored byCharley’s Fund.  The Company technologyupon which the agreement is based is covered by certain patents, the last of whichexpires following the termination of the agreement.

 

*U.S.Department of Defense Agreements*

 

The Company currently hasseveral contracts with the U.S. Department of Defense and its agencies fundingits programs, including the Company’s clinical stage programs for the Ebola,Marburg, and Junín and Swine Flu viruses. The continued funding of these programs from the U.S. government iscritical to the ongoing development of these programs.  Future funding of these programs is subjectto availability of budgeted funds from the U.S. Department of Defense.  As of December 31, 2009, the Company hadreceived an aggregate of $61.7 million in contract awards from the U.S.government, and an aggregate of $46.3 million in milestones payments had beenmade by the U.S. government to AVI under such awards.  AVI is not required to make any milestonepayments or royalty payments to the U.S. government under these contracts.  Unless terminated earlier by the U.S.government, these agreements terminate upon completion of the research fundedby the award.  The Company technologyupon which the agreements are based is covered by certain patents, all of whichexpire after the termination of the agreements.

 

**Manufacturing**

 

We believe we havedeveloped proprietary manufacturing techniques that could allow synthesis andpurification of our products to support up to Phase 2 clinical development. Weare in the process of establishing relationships with multiple third partiesthat have established Good Manufacturing Practices (“GMP”) that will facilitateproduction of our products at a greater scale. We believe that we will be successful at utilizing outsourced GMPmanufacturing facilities to provide sufficient manufacturing capacity tocontinue to meet our clinical trial requirements for the foreseeable future andallow us to produce products incorporating our technology.

 

**MarketingStrategy**

 

Initially, we plan tomarket products for which we obtain regulatory approval through marketingarrangements or other licensing arrangements with other pharmaceutical orbiotechnology companies. Implementation of this strategy will depend on manyfactors, including the market potential of any products we develop, and ourfinancial resources.  We do not expect to establish a direct sales capabilityfor therapeutic compounds for at least the next several years, if at all. Tomarket products that could serve a large, geographically diverse patientpopulation, we expect to enter into licensing, distribution, or partneringagreements with pharmaceutical companies that have, established salesorganizations. We believe that the timing of our entry into marketingarrangements or other licensing arrangements with pharmaceutical companies willdepend on many factors, including successful product development and regulatoryapproval within the regulatory framework established by the Federal Food, Drugand Cosmetics Act, as amended, and regulations promulgated thereunder and, tothe extent our products are distributed outside of the United States, withinthe regulatory framework established in other countries. Although theimplementation of initial aspects of our marketing strategy may be undertakenbefore this process is completed, the development and approval processtypically takes at least three to five years after the filing of an INDapplication  to complete and, thus,  our marketing strategy may not be implementedfor several years. See “Drug Approval Process and Other GovernmentalRegulation.”

 

**Patentsand Proprietary Rights**

 

We have developed oracquired a comprehensive body of intellectual property rights. The proprietarynature of, and protection for, our product candidates, processes and know-howare important to our business. We plan to prosecute and aggressively defend ourpatents and proprietary technology. Our policy is to patent the technology,inventions, and improvements that we believe are important to the developmentof our business. We also depend upon trade secrets, know-how, and continuingtechnological innovation to develop and maintain our competitive position.

 

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A patent estate including191 patents (domestic and foreign) issued or licensed to us, and 190 pendingpatent applications (domestic and foreign) has been developed for purposes ofprotecting our technologies.  We intend to protect our proprietarytechnology with additional filings as appropriate. Some of our patents on coretechnologies expired in 2008, including that for our basic PMO chemistry. Basedon patented improvements and additional support to such core patents, however,we believe our patent protection for those products and other products.

 

We have licensed certaintechnology to supplement and support certain of our core technologies. We havecertain obligations and minimum royalties under those agreements, which costsare not deemed material to our business.

 

**DrugApproval Process and Other Government Regulation**

 

The process for obtainingmarketing approval of a drug in the United States is highly regulated. In theU.S. the drug discovery, testing and regulatory process to successfully developa single product from research through market approval is estimated by thePharmaceutical Research and Manufacturers Association to cost approximately$1.2 to $1.3 billion and take between 10 and 15 years. (Pharmaceutical Researchand Manufacturers Association, Profile 2009 report)

 

#### ***DrugDiscovery***

#### ** **

Drug discovery is theprocess of discovering or designing compounds with potential therapeuticbenefit. The compounds are tested in cells or animal models of against adisease target, often a protein or gene, and modified to make them moreeffective. From this process lead drug candidates with desired drug propertiescan be identified.

 

#### ***PreclinicalDevelopment***

#### ** **

Using a lead candidatefrom the discovery process, the preclinical development stage employs a set ofextensive laboratory and animal studies to establish biological activity and togain insight into whether it might be safe and effective in humans.

 

#### ***InvestigationalNew Drug Application***

#### ** **

When a company intends toinitiate human clinical trials it submits an Investigation New Drug (IND)Application to the FDA containing all the preclinical data it generated alongwith a clinical trial plan. The Food and Drug Administration “FDA” may preventor delay the start of human clinical trials if not satisfied with the IND andrequest clarification or further data.

 

#### ***Phase****1I**Clinical Trials*

#### ** **

After an IND becomeseffective, Phase 1 human clinical trials in the U.S. may begin. These trialsusually involve small groups of healthy volunteers and are intended to providean initial assessment of safety and evaluate how the compound affects the body.

 

#### ***Phase****2**Clinical Trials*

#### ** **

Phase 2 clinical trialsare generally conducted with volunteer patients with the targeted disease. Thepurpose of these tests is to evaluate the safety and effectiveness of the drugon the volunteer patients, to determine an optimal dose at which the test drugis deemed safe and effective.

 

#### ***Phase****3**Clinical Trials*

#### ** **

Phase 3 clinical trialsare normally larger scale trials to further study efficacy and to observe andreport any reactions in a larger group of patients each of whom received theoptimal. It is customary to agree with the FDA on the data that needs to begenerated from these studies before they are started.

 

#### ***NewDrug Application***

#### ** **

After successfulcompletion of clinical trials a New Drug Application (NDA) is submitted to theFDA. The NDA is a comprehensive set of documents, including all informationobtained from each clinical trial, as well as all data pertaining to themanufacturing and testing of the product, as well as the results from allpreclinical toxicology testing. Based upon the NDA, the FDA will either approveor deny permission to market the compound as a drug.

 

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#### ***MarketingApproval***

#### ** **

If the FDA approves theNDA, the drug becomes available for physicians to prescribe. Periodic reportsmust be submitted to the FDA, including descriptions of any adverse reactionsreported. The FDA may request additional studies (Phase 4) to answer certainspecific questions or concerns.

 

#### ***Phase****4**Clinical Trials and Post Marketing Studies*

#### ** **

In addition to studiesrequested by the FDA after approval, these trials and studies are conducted toexplore new indications. The purpose of these trials and studies and relatedpublications may be to broaden the application and use of the drug and itsacceptance in the medical community. Sometimes an NDA is approved with the sponsoring company being requiredas a condition of approval to perform specific additional work, which should beprovided to the FDA in due course to maintain the product’s approval.

 

Many other countries andjurisdictions have similar drug development and regulatory review processes.

 

**Competition**

 

The biotechnology andpharmaceutical industries are highly competitive and subject to potentiallyrapid significant change. It can be expected that competing technologies willemerge and present a competitive challenge to us. We may also experiencesignificant competition for drug candidates we are developing, or that we maydecide to develop, because other companies may achieve significant competitiveadvantages over us. We may also compete against existing therapies that have anestablished history of safe and effective use.

 

We face competition fromorganizations pursuing the same or similar technologies that we are pursuing,as well as from organizations that are developing drugs that would compete withdrug candidates we are developing. We may not be able to compete successfullyagainst these other organizations, which include larger biotechnology andpharmaceutical companies that have substantial drug development capabilitiesand experience as well as greater financial, scientific and marketing resourcesthan we do.

 

We believe that otherbiotechnology and pharmaceutical companies share a focus on RNA-based drugdiscovery and development. Competitors with respect to our RNA-basedtechnologies include Alnylam Pharmaceuticals, Isis Pharmaceuticals, and Santaris.

 

Competitors with respectto our Duchenne muscular dystrophy (DMD) program include Prosensa andGlaxoSmithKline (“GSK), and BioMarin Pharmaceuticals. A European based clinicaltrial evaluating the systemic administration of the Prosensa/GSK lead DMD drugcandidate started several months before the start of our similar clinicaltrial. The Prosensa/GSK drug candidate may, or may not, prove to be safer andmore efficacious than our product candidate and it could gain marketingapproval before our product candidate.

 

**Researchand Development**

 

We expensed $24.4, $27.3and $31.1 million on research and development activities during the years endedDecember 31, 2009, 2008 and 2007, respectively. Research and development(R&D) expenses include related salaries, contractor fees, materials,utilities and allocations of corporate costs. R&D expenses consist ofindependent R&D costs and costs associated with collaborative developmentarrangements. In addition, the Company funded R&D at other companies andresearch institutions under agreements. Research and development costs areexpensed as incurred.

 

**Employees**

 

As of December 31,2009, we had 63 employees.  Of theseemployees, 23 hold advanced degrees. 45 are engaged directly in research anddevelopment activities, and 18 are in administration. None of our employees arecovered by collective bargaining agreements and we consider relations with ouremployees to be good.

 

#### **Where You Can FindAdditional Information**

#### ** **

We are a reportingcompany and file annual, quarterly and current reports, proxy statements andother information with the SEC. For further information with respect to us, youmay read and copy our reports, proxy statements and other information, at theSEC’s public reference room at Room 1580, 100 F Street, NE, Washington,D.C. 20549. You can request copies of these documents by writing to the SEC andpaying a fee for the copying cost. Please call the SEC at 1-800-SEC-0330 formore information about the operation of the public reference rooms. Our SECfilings are also available at the SEC’s web site at “http://www.sec.gov.”

 

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Copies of our AnnualReport on Form 10-K, Quarterly Reports on Form 10-Q, Current Reportson Form 8-K, our proxy statement and amendments to those reports filed orfurnished pursuant to Section 13(a) or 15(d) of the SecuritiesExchange Act of 1934 (the “Exchange Act”) as well as our corporate governanceguidelines, outline of directorship qualifications, code of business conductand ethics and the charters of our audit committee, compensation committee, andnominating and corporate governance committees are all available on our website(www.avibio.com) or by sending a request for a paper copy to: AVI BioPharma, Inc.,3450 Monte Villa Parkway, Suite 101, Bothell WA 98021, attn. InvestorRelations.

 

**Item 1A. Risk Factors.**

 

**RisksAffecting Future Operating Results**

 

The following factorsshould be considered in evaluating our business and prospects for the future.If risks described below actually occur, our operating results and financialcondition would likely suffer and the trading price of our common stock mayfall, causing a loss of some or all of an investment in our common stock. Inaddition, there may be additional risks not known to us or understood by uswhich may adversely affect our financial condition, results of operations, andthe price of our stock.

 

*We willneed additional funds to conduct our planned research and development efforts.If we fail to continue to attract significant capital, we may be unable tocontinue to successfully develop our products.*

 

Since we beganoperations, we have obtained operating funds primarily by selling shares of ourcommon stock. Based on our current plans, we believe that current cash balanceswill be sufficient to meet our operating needs for the next twelve months.Furthermore, the actual amount of funds that we will need will be determined bymany factors, some of which are beyond our control. These factors include thesuccess of our research and development efforts, the status of our pre-clinicaland clinical testing, costs relating to securing regulatory approvals and thecosts and timing of obtaining new patent rights, regulatory changes,competition and technological developments in the market. An unforeseen changein these factors might increase our need for additional capital. We may needfunds sooner than currently anticipated.

 

If necessary, potentialsources of additional funding could include strategic relationships, public orprivate sales of shares of our stock, debt, or other arrangements. We may notbe able to obtain additional funding when we need it on terms that will beacceptable to us or at all. If we raise funds by selling additional shares of ourcommon stock or securities convertible into our common stock, the ownershipinterest of our existing shareholders will be diluted. If we were unable toobtain financing when needed, our business and future prospects would bematerially adversely affected.

 

*Ourproducts are in an early stage of research and development and may not bedetermined to be safe or effective.*

 

We are in the earlystages of clinical development with respect to our RNA-based pharmaceuticalproducts. We have devoted almost all of our resources to research anddevelopment of our product candidates, protecting our proprietary rights andestablishing strategic alliances. Our potential products are in thepre-clinical or clinical stages of research and development and will require significantfurther research, development, clinical testing and regulatory approvals. Wehave no products available for sale and we do not expect to have any productsavailable for sale for several years. Our products could be found to beineffective or toxic, or could fail to receive necessary regulatory approvals.We have not received any significant revenues from the sale of products and wemay not successfully develop marketable products that will produce sales and,given adequate margins, make us profitable. Third parties may develop superioror equivalent, but less expensive, products.

 

*We relyon U.S. government contracts to support several important R&D programs*.

 

We rely on U.S.government contracts and awards to fund several of our development programs,including those for the Ebola, Marburg, Junín and H1N1 viruses.  The termination of one or more of thesecontracts, whether due to lack of funding, for convenience, or otherwise, orthe occurrence of delays or product failures in connection with one or more ofthese contracts, could negatively impact our financial condition. Furthermore,we can give no assurance that we would be able to procure new U.S. government contractsto offset the revenues lost as a result of any termination of our contracts.

 

The funding of U.S.government programs is subject to Congressional appropriations. Congressgenerally appropriates funds on a fiscal year basis even though a program mayextend over several fiscal years. Consequently, programs are often onlypartially funded initially and additional funds are committed only as Congressmakes further appropriations. In the event that appropriations for one of ourprograms become unavailable, or are reduced or delayed our contracts may beterminated or adjusted by the government, which could have a negative impact onour future sales under such a contract or subcontract. From time to time, whena formal appropriation bill has not been signed into law before the end of theU.S. government’s fiscal year, Congress may pass a continuing resolution thatauthorizes agencies of the U.S. government to continue to operate, generally atthe same funding levels from the prior year, but does not authorize newspending initiatives, during a certain period. During such a period (or untilthe regular appropriation bills are passed), delays can occur in governmentprocurement due to lack of funding and such delays can affect our operationsduring the period of delay.

 

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In addition, U.S.government contracts generally also permit the government to terminate thecontract, in whole or in part, without prior notice, at the government’sconvenience or for default based on performance. If one of our contracts isterminated for convenience, we would generally be entitled to payments for ourallowable costs and would receive some allowance for profit on the workperformed. If one of our contracts is terminated for default, we wouldgenerally be entitled to payments for our work that has been accepted by thegovernment. A termination arising out of our default could expose us toliability and have a negative impact on our ability to obtain future contracts.

 

*If wefail to receive or experience delays in receiving necessary regulatoryapprovals, we will be unable to develop and commercialize our product in atimely manner.*

 

All of our products aresubject to extensive regulation by the United States FDA, and by comparableagencies in other countries. The FDA and these agencies require newpharmaceutical products to undergo lengthy and detailed preclinical andclinical testing procedures and other costly and time-consuming complianceprocedures. We do not know when, or if, we will be able to submit our productsfor regulatory review. Even if we submit a new drug application, there may bedelays in obtaining regulatory approvals, if we are able to obtain them at all.Sales of our products outside the United States will also be subject toregulatory requirements governing clinical trials and product approval. Theserequirements vary from country to country and could delay introduction of ourproducts in those countries. We cannot guarantee that any of our products willreceive marketing approval from the FDA or comparable foreign agencies. Weexpect to develop the therapeutic product candidates to treat Ebola Virus andMarburg Virus under defined regulatory pathways using the Animal Rule mechanism. This mechanism has become available only relatively recently and has beeninfrequently used. This process has yet to be well tested and may presentchallenges for gaining final regulatory approval for these product candidates.

 

*If welose key personnel or are unable to attract and retain additional, highlyskilled personnel required for our activities, our business will suffer.*

 

The loss of key employeescould significantly delay the achievement of our goals. Competition forqualified personnel in our industry is intense, and our success will depend onour ability to attract and retain highly skilled personnel. To date, we havebeen successful in attracting and retaining key personnel. We now have addedemphasis on product development in our business plan. In addition, we arebuilding a new chemistry-led research capability in Bothell, Washington andhave outsourced our large scale manufacturing capability in Corvallis, Oregon.This short term transformation of our skill base has placed additional emphasison our ability to attract and retain skilled personnel.

 

*Asserting,defending and maintaining our intellectual property rights could be challengingand costly, and our failure to do so could harm our ability to compete andimpair the outcome of our operations. The pharmaceutical, biotechnology and academic environments are highlycompetitive and competing intellectual property could limit our ability toprotect our products.*

 

Our success will dependin significant part on our existing patents and licenses (191 patents (domesticand foreign) issued or licensed to us and 190 (domestic and foreign) pendingpatent applications) and our ability to obtain additional patents in thefuture. We license patents from other parties for certain complementarytechnologies.

 

Some of our patents oncore technologies expired in 2008, including for our general PMO chemistry.Based on patented improvements and inventive additions to such core patents,however, we believe the patent protection for our products in development extendsbeyond 2020.

 

We cannot be certain thatpending patent applications will result in patents being issued in the UnitedStates or foreign countries. In addition, the patents that have been or will beissued may not afford meaningful protection for our technology and products.Competitors may develop products similar to ours that do not conflict with ourpatents. Pharmaceutical research and development is highly competitive; othersmay file patents first.  We are aware ofa patent that was issued that may provide the basis for the patent holder toassert that our drug AVI-4658 infringes on such patent.  We intend to vigorously defend against anysuch claim if one should be asserted and believe that we may be able toinvalidate some or all of the claims covered by this patent.  In any case, we believe that we have freedomto operate and are moving forward with our ongoing clinical trials and drugdevelopment efforts for this drug candidate.

 

Others may challenge ourpatents and, as a result, our patents could be narrowed or invalidated. Thepatent position of pharmaceutical and biotechnology firms, as well as academia,is generally highly uncertain, involves complex legal and factual questions,and has recently been the subject of much litigation. No consistent policy hasemerged from the United States Patent and Trademark Office (USPTO) or thecourts regarding the breadth of claims allowed or the degree of protectionafforded under biotechnology patents. In addition, there is a substantialbacklog of pharmaceutical and biotechnology patent applications at the USPTOand the approval or rejection of patents may take several years.

 

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Our success will alsodepend partly on our ability to operate without infringing upon the proprietaryrights of others as well as our ability to prevent others from infringing onour proprietary rights. We may be required at times to take legal action toprotect our proprietary rights and, despite our best efforts, we may be suedfor infringing on the patent rights of others. We have not received anycommunications or other indications from owners of related patents or othersthat such persons believe our products or technology may infringe on theirpatents. Patent litigation is costly and, even if we prevail, the cost of suchlitigation could adversely affect our financial condition. If we do notprevail, in addition to any damages we might have to pay, we could be requiredto stop the infringing activity or obtain a license. Any required license maynot be available to us on acceptable terms, or at all. If we fail to obtain alicense, our business might be materially adversely affected.

 

To help protect ourproprietary rights in unpatented trade secrets, we require our employees,consultants and advisors to execute confidentiality agreements. However,such agreements may not provide us with adequate protection ifconfidential information is used or disclosed improperly. In addition, in somesituations these agreements may conflict with, or be subject to, the rights ofthird parties with whom our employees, consultants or advisors have prioremployment or consulting relationships. Further, others may independentlydevelop substantially equivalent proprietary information and techniques, orotherwise gain access to our trade secrets.

 

*Wedepend on our partners and contractors for critical functions. Therefore, ifour collaborations or strategic relationships are unsuccessful, our businesscould be harmed.*

 

Our strategicrelationships are important to our success. The discovery, development andmarketing of many of our key therapeutic products are or will be dependent inlarge part on the efforts of our strategic partners.  Our strategic partners may be unsuccessful intheir attempt to develop our potential products due to circumstances that arebeyond our control. The transactions contemplated by our agreements withstrategic partners, including the equity purchases and cash payments, aresubject to numerous risks and conditions. The occurrence of any of these eventscould severely harm our business.

 

We plan to enter intorelationships with pharmaceutical or biotechnology companies to conduct latestage clinical trials and to market our products. We also plan to use contractmanufacturing for late stage clinical and commercial quantities of ourproducts. We may be unable to enter into partnerships or other relationships atall or on favorable terms, which could impede our ability to bring our productsto market**.**Any such partnerships,if entered into at all, may be on less than favorable terms and may not resultin the successful development or marketing of our products. If we areunsuccessful in establishing advantageous clinical testing, manufacturing andmarketing relationships, we are not likely to generate significant revenues andbecome profitable.

 

To fully realize thepotential of our products, including development, production and marketing, wemay need to establish other strategic relationships.

 

*We mayget unexpected positive or negative results or outcomes during any stage ofproduct development.*

 

Clinical studies at allphases of clinical investigation, must be granted permission to proceed by theregulatory authorities and Institutional Review Boards (IRBs) or EthicsCommittees (ECs) before they may start and these agencies review progress andsafety information during the course of any study.  Clinical studies areexperiments designed to test a theory or hypothesis, and by their very nature,the result is unknown at the time the study is started, therefore, unexpectedresults or outcomes may occur that may provide positive or negative newinformation.  Examples of unexpected results or outcomes that may occurinclude results that are either better than or not as good as predicted duringhypothesis generation, including for example a result where the productperforms better than expected and as a result of the clinical benefit a longertime is taken to reach a predefined clinical endpoint that is based onworsening disease factors, or the product may not demonstrate the predictedlevel of effectiveness in a specific study, or an unexpected serious adverseevent may. These kinds of results or outcomes may result in the companyvoluntarily discussing the clinical study design, results and outcomes, andfuture development plans with the regulatory agencies, IRBs or ECs; any suchdiscussions, changes in study designs or changes to the overall developmentplans may either accelerate or delay development of the product. Similarly, unexpected results or outcomes may occur in nonclinical animalstudies or in manufacturing and quality control.  This might also lead to changes in thedevelopmental plan which could shorten or extend the time to a final studyresult.

 

*We haveincurred net losses since our inception and we may not achieve or sustainprofitability.*

 

We incurred a net loss of$25.2 million and $24.0 million for the years ended December 31, 2009 and2008, respectively. As of December 31, 2009, our accumulated deficit was$275.5 million. Our losses have resulted principally from expenses incurred inresearch and development of our technology and products and from general andadministrative expenses that we have incurred while building our businessinfrastructure. We expect to continue to incur significant operating losses inthe future as we continue our research and development efforts and seek toobtain regulatory approval of our products. Our ability to achieveprofitability depends on our ability to raise additional capital, completedevelopment of our products, obtain regulatory approvals and market ourproducts. It is uncertain when, if ever, we will become profitable.

 

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*Our ability to be successfulagainst our competitors cannot be assured.*

 

The biopharmaceuticalindustry is highly competitive, with a number of well-established firmsperforming leading-edge research for the development of new products to treat awide range of diseases. These companies generate patents for their intellectualproperty rights that could preclude other companies from using similartechnologies in their product development. Moreover, companies that are focusedon the treatment of similar diseases are in effect competing for the samefinite number of potential patients. Even if we are able to develop new products for market, there can be noassurance that we will be able to compete effectively or profitably against ourcompetitors.

 

*We maybe subject to clinical trial claims and our insurance may not be adequate tocover damages.*

 

We believe we carryadequate insurance for our current product development activities. In thefuture, commercial sale and use of our products might expose us to the risk of clinical trial claims. Although weintend to obtain product liability insurance coverage, product liabilityinsurance may not continue to be available to us on acceptable terms and ourcoverage may not be sufficient to cover all claims against us. A productliability claim, even one without merit or for which we have substantialcoverage, could result in significant legal defense costs, thereby increasingour expenses, lowering our earnings and, depending on revenues, potentiallyresulting in additional losses.

 

*We usehazardous substances in our research activities.*

 

We use organic andinorganic solvents and reagents in our research and development efforts thatare customarily used in pharmaceutical research and development. Some of thesechemicals may be classified as hazardous substances, are flammable and, ifexposed to human skin, can cause anything from irritation to severe burns. Wereceive, store, use and dispose of such chemicals in compliance with allapplicable laws with containment storage facilities and contained handling anddisposal safeguards and procedures. We are routinely inspected by federal,state and local governmental and public safety agencies regarding our storage,use and disposal of such chemicals, including the federal Occupational, Safetyand Health Agency (“OSHA”), the Oregon Department of Environmental Quality (“DEQ”)and the Washington Department of Ecology (‘DOE”) and local fire departments,without any material noncompliance issues in such inspections to date. Based onour limited use of such chemicals, the nature of such chemicals and thesafeguards undertaken by the Company for storage, use and disposal, we believewe do not have any material exposure for toxic tort liability. Further, thecost of such compliance is not a material cost in our operating budget. Whilewe do not have toxic tort liability insurance at this time, we believe ourother insurance coverage is adequate to cover most liabilities that may arisefrom our use of such substances. If we are wrong in any of our beliefs, wecould incur a liability in certain circumstances that would be material to ourfinances and the value of an investment in our securities.

 

**RisksRelated to Share Ownership**

 

*Ourright to issue preferred stock, and our classified Board of Directors andOregon Anti-Takeover laws may delay a takeover attempt and prevent or frustrateany attempt to replace or remove the then current management and Board ofDirector’s.*

 

Our authorized capitalconsists of 200 million shares of common stock and 20 million shares ofpreferred stock. Our Board of Directors, without any further vote by theshareholders, has the authority to issue preferred shares and to determine theprice, preferences, rights and restrictions, including voting and dividendrights, of these shares. The rights of holders of any preferred shares that ourBoard of Directors may issue in the future may affect the rights of the holdersof shares of common stock. For example, our Board of Directors may allow theissuance of preferred shares with more voting rights, preferential dividendpayments or more favorable rights upon dissolution than the shares of commonstock or special rights to elect directors.

 

In addition, we have a “classified”Board of Directors, which means that approximately one-half of our directorsare eligible for election each year. Therefore, if shareholders wish to changethe composition of our Board of Directors, it could take at least two years toremove a majority of the existing directors or to change all directors. Havinga classified Board of Directors may, in some cases, delay mergers, tenderoffers or other possible transactions that may be favored by some or a majorityof our shareholders and may delay or frustrate action by shareholders to changethe then current Board of Directors and management.

 

The Oregon Control ShareAct and Business Combination Act may limit parties that acquire a significantamount of voting shares from exercising control over us for specific periods oftime. These acts may lengthen the period for a proxy contest or for a person tovote their shares to elect the majority of our Board and change management.

 

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*Ourstock price is volatile and may fluctuate due to factors beyond our control.*

 

Historically, the marketprice of our stock has been highly volatile. The following types ofannouncements could have a significant impact on the price of our common stock:positive or negative results of testing and clinical trials by ourselves,strategic partners, or competitors; delays in entering into corporatepartnerships; technological innovations or commercial product introductions byourselves or competitors; changes in government regulations; developmentsconcerning proprietary rights, including patents and litigation matters; publicconcern relating to the commercial value or safety of any of our products;financing or other corporate transactions; or general stock market conditions.

 

*Thesignificant number of our shares of common stock eligible for future sale maycause the price of our common stock to fall.*

 

We have outstanding110,495,587 shares of common stock as of December 31, 2009 and all areeligible for sale under Rule 144 or are otherwise freely tradable. Inaddition:

 

·                  Our employees and others hold options to buy a totalof 8,932,811 shares of common stock, of which 5,119,227 options wereexercisable at December 31, 2009. The options outstanding have exerciseprices between $0.60 and $7.35 per share. The shares of common stock to beissued upon exercise of these options have been registered, and, therefore, maybe freely sold when issued.

 

·                  There are outstanding warrants to buy 32,332,996 shares of common stockas of December 31, 2009 with exercise prices ranging from $.0003 to $35.63per share. Outstanding warrants to buy 30,203,466 shares of common stock areissuable upon exercise of outstanding warrants for common stock registered forresale and may be freely sold when issued, subject to the limitations imposedby applicable securities laws.

 

Warrants to purchase anaggregate of 2,129,530 shares of common stock are not registered for resale.These warrants include warrants to purchase an aggregate of shares of commonstock were issued to Isis Pharmaceuticals, Inc. (“ISIS”) in exchange forwarrants to purchase shares of Ercole capital stock previously issued by Ercoleto ISIS prior to the Company’s acquisition of Ercole. Warrants to purchase anaggregate of 1,683,545 shares of common stock issued in 2000 and prior wereissued as a part of a technology licensing agreement and to a former employee.

 

·                  We may issue options to purchase up to an additional681,955 shares of common stock as of December 31, 2009 under our stockoption plans, which also will be fully saleable when issued except to theextent limited under Rule 144 for resales by our officers and directors.

 

Sales of substantialamounts of shares into the public market could lower the market price of ourcommon stock.

 

*Our common stock is listed on TheNASDAQ Global Market and we may not be able to maintain that listing, which maymake it more difficult for investors to sell shares of our common stock.*

 

Our common stock is listed on The NASDAQ GlobalMarket. The NASDAQ Global Market has several quantitative and qualitativerequirements with which companies must comply in order to maintain thislisting, including a $1.00 minimum bid price per share and $50 million minimumvalue of listed securities. If a listed company fails to meet the $1.00 minimumbid price per share requirement for 30 consecutive days, it will receive anotice from NASDAQ mandating that the company achieve compliance with theminimum bid price per share listing requirement within 180 calendar days.  Our stock price is currently above $1.00;however, our stock price was priced at $0.99 as recently as May 11,2009.  There can be no assurance that wewill be able to maintain compliance with the minimum bid price per sharerequirement in the future.

 

In addition to the foregoing, if we are not listed onThe NASDAQ Stock Market and/or if our public float remains below $75 million,we may be limited in our ability to file new shelf registration statements onSEC Form S-3 and/or to fully use one or more registration statements onSEC Form S-3. We have relied significantly on shelf registrationstatements on SEC Form S-3 for most of our financings in recent years, soany such limitations might have a material adverse effect on our ability toraise any future capital we might need.

 

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*We donot expect to pay dividends in the foreseeable future.*

 

We have never paiddividends on our shares of common stock and do not intend to pay dividends inthe foreseeable future. Therefore, you should only invest in our common stockwith the expectation of realizing a return through capital appreciation on yourinvestment. You should not invest in our common stock if you are seekingdividend income.

 

**Item 1B. Unresolved Staff Comments.**

 

None.

 

**Item 2.  Properties.**

 

We occupy 53,000 squarefeet of leased laboratory and office space at 4575 SW Research Way, Suite 200,Corvallis, Oregon 97333. This lease expires in December 2020.  In March 2007, we purchased anadditional facility, totaling 34,000 square feet, in Corvallis, Oregon whichwas acquired with the intention of providing the Company with future expansionspace for the manufacture of potential products and components.  In September we engaged a commercialreal estate agent and have listed this property for sale.

 

In July 2009, weadded a second location and leased 19,000 square feet of laboratory and officespace at 3450 Monte Villa Parkway, Suite 101, Bothell, Washington. Webelieve that our facilities are suitable and adequate for our presentoperational requirements for the foreseeable future.

 

**Item 3. Legal Proceedings.**

 

As of March 6, 2010,there were no material, pending legal proceedings to which we are a party. Fromtime to time, we become involved in ordinary, routine or regulatory legalproceedings incidental to our business.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders.**

 

No matters were submittedto a vote of our shareholders during the quarter ended December 31, 2009.

 

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**PART II**

 

**Item 5.  Market for Registrant’s Common Equity, RelatedStockholder Matters and Issuer Purchases of Equity Securities.**

 

**MarketInformation**

 

Our Common Stock isquoted on the Nasdaq Global Market (“Nasdaq”) under the symbol “AVII.” The following table sets forth the high and low closing sales prices asreported by Nasdaq for each quarterly period in the two most recent years:

 
| ** ** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------|------------|----------|------------|---------|------------|
| 2008       |       |     |       |    |       |
| Quarter  1 |       | $        | 1.84       |    | $          | 1.07 |   |
| Quarter  2 |       | 1.88     |       | 1.12    |       |
| Quarter  3 |       | 1.26     |       | 0.96    |       |
| Quarter  4 |       | 1.11     |       | 0.48    |       |
|       |       |     |       |    |       |
| 2009       |       |     |       |    |       |
| Quarter  1 |       | $        | 1.41       |    | $          | 0.55 |   |
| Quarter  2 |       | 1.87     |       | 0.67    |       |
| Quarter  3 |       | 2.47     |       | 1.25    |       |
| Quarter  4 |       | 1.92     |       | 1.39    |       |

 

**Holders**

 

As of March 1, 2010,we had 602 shareholders of record.

 

**Dividends**

 

There were no cashdividends declared or paid in years 2009 or 2008. We do not anticipatedeclaring such dividends in the foreseeable future.

 

**SecuritiesAuthorized for Issuance under Equity Compensation Plans**

 

**Equity Compensation Plan Information**

 
| **Plan category**                                           | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights  (a)** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights  (b)** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))(1)  (c)** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders     |       | 8,932,811                                                                                               |       | $                                                                                       | 2.79       |                                                                                                                                                          | 681,955    |   |
|                                                        |       |                                                                                                    |       |                                                                                    |       |                                                                                                                                                          |       |
| Equity  compensation plans not approved by security holders |       | -0-                                                                                                     |       | —                                                                                  |       | -0-                                                                                                                                                           |       |
| **Total**                                                   |       | 8,932,811                                                                                               |       | $                                                                                       | 2.79       |                                                                                                                                                          | 681,955    |   |

 

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(1)          The number of securities remaining available forfuture issuance under equity compensation plans includes shares from theCompany’s 2002 Equity Incentive Plan (the “2002 Plan”). The number of sharesreserved for issuance is increased by an automatic annual share increasepursuant to which the number of shares available for issuance under the 2002Plan automatically increases on the first trading day of each year (the “FirstTrading Day”), beginning with the 2003 fiscal year and continuing through thefiscal year 2011, by an amount equal to two percent (2%) of the total number ofshares outstanding on the last trading day of the immediately preceding fiscalyear; such increases being subject to the limitation in the next sentence. The2002 Plan provides that, following any such adjustment, the number of thenoutstanding options under the Company’s stock option plans and stock purchaseplans, together with options in the reserve then available for future grantsunder the Company’s stock option plans, will not exceed twenty percent (20%) ofthe then outstanding voting shares of capital stock of the Company, and all theactually outstanding stock options under the Company’s stock option plans, togetherwith all shares in the reserve then available for future grants under theCompany’s stock option and stock purchase plans. This automatic share increasefeature is designed to assure that a sufficient reserve of Common Stock remainsavailable for the duration of the 2002 Plan to attract and retain the servicesof key individuals essential to the Company’s long-term growth and success.This feature is also designed to eliminate the uncertainty inherent in seekingan individual increase to the reserve each year as to what number of shareswill be available in the reserve for option grants. Creating a certain rate ofgrowth under the 2002 Plan assists the Company as it makes strategic personneldecisions in an effort to expand its growth, as the Company will know theapproximate number of shares that will become available for issuance under the2002 Plan. At the same time, the Company has attempted to minimize the dilutiveeffect that the issuance of Common Stock upon the exercise of options can haveon stockholders’ percentage of ownership in the Company by adopting only a 2%growth rate for the 2002 Plan. This rate, while it provides room for growth inthe 2002 Plan, is a rate which the Company believes it can reasonably sustain,minimizing the risk to stockholders that the option reserve grows faster thanthe Company itself. The twenty percent (20%) limitation discussed above furtherprotects shareholders by capping the size of the 2002 Plan in relation to theCompany’s other securities.

 

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**PerformanceGraph**

 

The following graphcompares the performance of the Company’s Common Stock for the periodsindicated with the performance of the NASDAQ Composite Index and the AmexBiotech Index. This graph assumes an investment of $100 on December 31,2004 in each of the Company’s common stock, the NASDAQ Composite Index and theAmex Biotech Index, and assumes reinvestment of dividends, if any. The stockprice performance shown on the graph below is not necessarily indicative offuture stock price performance.

 

 
| ** **          | ** ** | **AVII** | ** ** | **NASDAQ  Composite  Index** | ** ** | **Amex  Biotech  Index** | ** ** |
|---------------------|------------|----------|------------|------------------------------|------------|--------------------------|------------|
|                |       |     |       |                         |       |                     |       |
| End  of Fiscal 2004 |       | $        | 100.00     |                         | $          | 100.00                   |       | $ | 100.00 |   |
| End  of Fiscal 2005 |       | $        | 146.81     |                         | $          | 101.24                   |       | $ | 125.11 |   |
| End  of Fiscal 2006 |       | $        | 135.32     |                         | $          | 110.88                   |       | $ | 138.59 |   |
| End  of Fiscal 2007 |       | $        | 60.00      |                         | $          | 121.76                   |       | $ | 144.51 |   |
| End  of Fiscal 2008 |       | $        | 28.09      |                         | $          | 71.19                    |       | $ | 118.91 |   |
| End  of Fiscal 2009 |       | $        | 62.13      |                         | $          | 104.17                   |       | $ | 173.11 |   |

 

**RecentSales of Unregistered Securities.**

 

None.

 

**Purchasesof Equity Securities by the Issuer and Affiliated Purchasers.**

 

None.

 

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**Item 6. Selected Financial Data.**

 

The following selectedfinancial data is derived from our audited financial statements and should beread in conjunction with, and is qualified in its entirety by, Item 7. “Management’sDiscussion and Analysis or Plan of Operation” and Item 8. “FinancialStatements.”

 
| ** **                                    | ** ** | **YEAR ENDED DECEMBER 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|
| **(in thousands)**                            | ** ** | **2009**                    | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Operations  data:                             |       |                        |       |   |   |   |   |   |   |   |   |
| Revenues                                      |       | $                           | 17,585     |   | $ | 21,258 |   | $ | 10,985 |   | $ | 115 |   | $ | 4,784 |   |
| Research  and development                     |       | 24,396                      |       | 27,331 |   | 31,058 |   | 25,346 |   | 17,118 |   |
|                                          |       |                        |       |   |   |   |   |   |   |   |   |
| General  and administrative                   |       | 8,696                       |       | 11,469 |   | 13,035 |   | 7,753 |   | 5,182 |   |
| Acquired  in-process research and development |       | —                      |       | 9,916 |   | — |   | — |   | — |   |
| Operating  Loss                               |       | (15,507                     | )          | (27,458 | ) | (33,108 | ) | (32,984 | ) | (17,516 | ) |
|                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Interest  (expense) income, and other net     |       | (454                        | )          | 344 |   | 984 |   | 1,910 |   | 840 |   |
| Decrease  (increase) on warrant valuation     |       | (9,198                      | )          | 3,161 |   | 4,956 |   | 2,386 |   | (1,530 | ) |
| Net  loss                                     |       | (25,159                     | )          | (23,953 | ) | (27,168 | ) | (28,688 | ) | (18,206 | ) |
|                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Net  loss per share - basic and diluted       |       | $                           | (0.27      | ) | $ | (0.34 | ) | $ | (0.50 | ) | $ | (0.54 | ) | $ | (0.41 | ) |
|                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Balance  sheet data:                          |       |                        |       |   |   |   |   |   |   |   |   |
| Cash  and investments                         |       | $                           | 48,446     |   | $ | 11,474 |   | $ | 25,074 |   | $ | 33,152 |   | $ | 47,051 |   |
| Working  capital                              |       | 17,803                      |       | 9,756 |   | 18,959 |   | 25,596 |   | 38,327 |   |
| Total  assets                                 |       | 60,027                      |       | 25,536 |   | 38,638 |   | 40,863 |   | 56,408 |   |
| Shareholders’  equity                    |       | 23,630                      |       | 15,732 |   | 26,382 |   | 32,519 |   | 46,082 |   |

 

**Item 7.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operation**

 

**Forward-LookingInformation**

 

This report containsforward-looking statements regarding our plans, expectations, estimates andbeliefs. Our actual results could differ materially from those discussed in, orimplied by, these forward-looking statements. Forward-looking statements areidentified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,”“will,” “may,” and other similar expressions. In addition, any statements thatrefer to expectations, projections or other characterizations of future eventsor circumstances are forward-looking statements. We have based theseforward-looking statements largely on our expectations. Forward-lookingstatements in this report include, but are not necessarily limited to, thoserelating to:

 

·                  our intention to introduce new products,

 

·                  receipt of any required FDA or otherregulatory approval for our products,

 

·                  our expectations about the markets forour products,

 

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·                  acceptance of our products, whenintroduced, in the marketplace,

 

·                  our expectations about availability ofgovernment funding for certain projects,

 

·                  our future capital needs,

 

·                  results of our research and developmentefforts, and

 

·                  success of our patent applications.

 

Forward-lookingstatements are subject to risks and uncertainties, certain of which are beyondour control. Actual results could differ materially from those anticipated as aresult of the factors described in the “Risk Factors” and detailed herein andin our other Securities and Exchange Commission filings, including amongothers:

 

·                  the effect of regulation by the FDA andother governmental agencies,

 

·                  delays in obtaining, or our inability toobtain, approval by the FDA or other regulatory authorities for our products,

 

·                  research and development efforts,including delays in developing, or the failure to develop, our products,

 

·                  uncertainty of government funding forcertain projects,

 

·                  the development of competing or more effectiveproducts by other parties,

 

·                  the results of pre-clinical and clinicaltesting and our ability to conduct these tests,

 

·                  uncertainty of market acceptance of ourproducts,

 

·                  problems that we may face inmanufacturing, marketing, and distributing our products,

 

·                  our inability to raise additional capitalwhen needed,

 

·                  delays in the issuance of, or the failureto obtain, patents for certain of our products and technologies, and

 

·                  problems with important suppliers andbusiness partners.

 

Because of these risksand uncertainties, the forward-looking events and circumstances discussed inthis report or incorporated by reference might not occur. Factors that causeactual results or conditions to differ from those anticipated by these andother forward-looking statements include those more fully described in the “RiskFactors” section and elsewhere in this report.

 

**Overview**

 

From our inception in1980, we have devoted our resources primarily to fund our research anddevelopment efforts. We have been unprofitable since inception and we have hadno material revenues from the sale of products or from other sources other thanfrom government grants and research contracts; we do not expect materialrevenues for the foreseeable future. We expect to continue to incur losses forthe foreseeable future as we continue our research and development efforts andenter into additional collaborative efforts. As of December 31, 2009, ouraccumulated deficit was $275.5 million.

 

**Resultsof Operations**

 

**Summary of Results for FiscalYears 2009, 2008, and 2007**

 
| **(In****thousands****, except percentages and per share amounts)** | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Revenue**                                                         |       | $        | 17,585     |     | $          | 21,258   |       | $ | 10,985 |   |
| **Operating loss**                                                  |       | $        | (15,507    | )        | $          | (27,458  | )          | $ | (33,108 | ) |
| **Net loss**                                                        |       | $        | (25,159    | )        | $          | (23,953  | )          | $ | (27,168 | ) |
| **Diluted earnings per share**                                      |       | $        | (0.27      | )        | $          | (0.34    | )          | $ | (0.50 | ) |

 

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*YearEnded December 31, 2009 Compared with Year Ended December 31, 2008.*

 

Revenues decreased to$17.6 million in 2009 compared to $21.3 million in 2008. The decrease inresearch contracts revenues was the result of the decline in revenues fromgovernment research contracts, due to lower levels of project activitiesrelated to the DTRA Ebola, Marburg and Junín contract.

 

Operating loss decreasedto $15.5 million in 2009 compared to $27.5 million in 2008. In 2008, theoperating loss included a charge of $9.9 million for acquired in-processresearch and development associated with the acquisition of Ercole Biotech, Inc.The operating loss in 2009 also decreased compared to 2008 as a result of lowerresearch and development and general and administrative expenses.

 

Research and developmentexpenses decreased to $24.4 million in 2009 compared to $27.3 million 2008.Lower research and development expenses in 2009 compared to 2008 resultprimarily from less spending on government research projects.

 

General andadministrative expenses decreased to $8.7 million in 2009 compared to $11.5million in 2008. The decrease in general and administrative expenses was dueprimarily to non-cash costs recognized in 2008 primarily due to stock issued toErcole executives related to the prior year acquisition, 2008 severance and stockcompensation expenses related to the resignation of former executive officers,and relocation costs for new executive officers.

 

Interest income and otherexpense, net declined $0.8 million in 2009 as compared to 2008 primarily due todeclines in market rates of interest on the Company’s interest-earninginvestments and the write off of valuations for patents, property andequipment.

 

The increase on warrantliability valuation of $9.2 million in 2009 compared to the decrease on warrantliability valuation of $3.2 million, in 2008, is a non-cash expense and is theresult of the new warrants issued in 2009 and the increase in the Company’sstock price.  The decrease or increase onthe warrant liability valuation fluctuates as the market price of the Company’sstock fluctuates.

 

The net loss increased to$25.2 million in 2009 from $24.0 million in 2008.  The net loss increased primarily due to theincrease in the warrant valuation, a non-cash expense that resulted from thefluctuation in the Company’s stock price.

 

*YearEnded December 31, 2008 Compared with Year Ended December 31, 2007.*

 

Revenues, from licensefees, grants and research contracts, increased to $21.3 million 2008 from $11.0million in 2007. The increase in revenues for 2008 was primarily due to theincrease from government funding for work performed on viral disease researchprojects.

 

Operating loss decreasedto $27.5 million in 2008 compared to $33.1 million in 2007. In 2008, theoperating loss included a one-time charge of $9.9 million for acquiredin-process research and development associated with the acquisition of ErcoleBiotech, Inc. The operating loss in 2008 also decreased compared to 2007as a result of higher revenue and lower research and development expenses andlower general and administrative expenses.

 

Research and developmentexpenses decreased to $27.3 million in 2008 compared to $31.1 million 2007.Lower research and development expenses in 2008 compared to 2007 resultsprimarily from lower spending on manufacturing compounds for use in clinicaltrials.

 

General andadministrative expenses decreased to $11.5 million in 2008 compared to $13.0million in 2007. The decrease in general and administrative expenses was dueprimarily to decreases in compensation costs, legal and investor relationexpenses.

 

Net interest incomedeclined in 2008 as compared to 2007 primarily due to declines in the averagebalances in cash and cash equivalents, combined with lower market rates ofinterest on the Company’s interest-earning investments.

 

The decrease on thewarrant liability valuation of $3.2 million in 2008 compared to the decrease onwarrant liability valuation of $5.0 million in 2007 is a non-cash expense andis the result of the decrease in the Company’s stock price.  The decrease or increase on the warrantliability valuation fluctuates as the market price of the Company’s stockfluctuates.

 

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**Researchand Development Expenses**

 

Our research anddevelopment costs allocated by focus area for the year ended December 31,2009 were as follows:

 

(in thousands)

 
| **As of  December 31,**            | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|-----------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **(in  thousands)**                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Focus  areas:                           |       |       |       |       |       |       |       |
| Government  funded projects             |       | $          | 12,978     |       | $          | 17,581     |       | $ | 8,033 |   |
| Other  internal projects                |       | 11,418     |       | 9,750      |       | 23,025     |       |
|                                    |       |       |       |       |       |       |       |
| Total  research and development expense |       | $          | 24,396     |       | $          | 27,331     |       | $ | 31,058 |   |

 

Direct research anddevelopment costs associated with our programs include clinical trial sitecosts, clinical manufacturing costs, costs incurred for consultants and otheroutside services, such as data management and statistical analysis support, andmaterials and supplies used in support of the clinical programs, as well asother direct research. Indirect costs of our clinical program include wages,payroll taxes and other employee-related expenses including rent,restructuring, stock based compensation, utilities and other facilities-relatedmaintenance. Costs attributable to our discovery research programs representour efforts to develop and expand our product pipeline. The amount and timingof future research and development expense will depend on the Company’s abilityto obtain U.S. government awards to fund the advanced development of itsantiviral therapeutic candidates. Without future government awards, the Company would likely drasticallyreduce its spending in these areas.  Futureresearch and development costs may also increase if our internal projects, suchas Duchene Muscular Dystrophy, enter later stage clinical development.

 

While we believe ourprograms are promising, we do not know whether any commercially successful productswill result from our research and development efforts. Thus, we believe thatthe nature, timing, and estimated costs of the efforts necessary to completethe projects and the anticipated completion dates, are not estimable due tomany factors, including the following:

 

·                  Delivery strategies and potency enhancements of theCompany’s compounds are still being developed and explored;

 

·                  Variability among different disease categories resultin successful delivery strategies or potency enhancements not necessarily beingapplicable across different disease categories;

 

·                  Costs of clinical trials, like costs of all forms ofmedical care, are rapidly changing;

 

·                  Variability among different disease categories interms of such factors as dosages, duration of treatment, method ofadministration, and others exist;

 

·                  Rules surrounding filings and conduct of clinicaltrials are changing;

 

·                  Confidentiality surrounding commercialization isheightening; and

 

·                  Clinical endpoints are in a constant state of flux.

 

**Liquidityand Capital Resources**

 

Since its inception in1980 through December 31, 2009, the Company has incurred losses ofapproximately $275.5 million, substantially all of which resulted fromexpenditures related to research and development, general and administrativecharges and acquired in-process research and development resulting from twoacquisitions. The Company has not generated any material revenue from productsales to date, and there can be no assurance that revenues from product saleswill be achieved. Moreover, even if the Company does achieve revenues fromproduct sales, the Company expects to incur operating losses over the nextseveral years.

 

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Our cash, cashequivalents and short-term securities were $48.4 million at December 31,2009, compared with $11.5 million at December 31, 2008, respectively. Theincrease was due primarily to net proceeds of $47.8 million from the sale ofcommon stock and issuance of stock warrants from two separate equity financingtransactions that closed in January and August of 2009.  The cash from financing activities waspartially offset by cash used in operations of $8.8 million, costs of $2.0million related to acquisitions of patents and fixed assets and debt repaymentsof $0.1 million.

 

On January 30, 2009,the Company closed a registered equity financing for net proceeds of $15.5million with several institutional investors. The Company sold 14,224,202shares of common stock at $1.16 per share, and also issued warrants for thepurchase of 14,224,202 common shares at $1.16 per share. The  warrants had fair value at the date of issueof $8.2 million. These warrants are exercisable starting July 30, 2009 andexpire on July 30, 2014. In connection with the equity financing, theplacement agent received a warrant for the purchase of an additional 426,726common shares at $1.45 per share. This warrant is exercisable starting January 30,2009 and expires on January 30, 2014. All of these warrants have been classified as liabilities as theyrequire the issuance of registered shares. These warrants are non-cashliabilities; The Company does not expect to expend any cash to settle theseliabilities.

 

On August 25, 2009,the Company closed a registered equity financing for net proceeds of $32.3million with several institutional investors. The Company sold 24,295,775shares of common stock at $1.42 per share, and also issued warrants for thepurchase of 9,718,310 common shares at $1.78 per share. The warrants had fairvalue at the date of issue of $9.0 million. These warrants are exercisablestarting February 25, 2010 and expire on August 25, 2014.  All of these warrants have been classified asliabilities as, as they require the issuance of registered shares. Thesewarrants are non-cash liabilities; The Company does not expect to expend anycash to settle these liabilities.

 

The Company believes ithas sufficient cash to fund operations at least through the following twelvemonths, exclusive of future receipts from billings on existing governmentcontracts. For 2010, the Company expects expenditures for operations, net ofgovernment funding, including collaborative efforts and research anddevelopment activities to be approximately $23 to $27 million. The Companybelieves it will continue to receive funding from government and other sourcesto pursue the development of its product candidates, and has assumed certainrevenues from these awards in providing this guidance.  Should the Company not continue to receivefunding from its current contracts or receive additional funding, or should thetiming be delayed, it may have a significant negative impact on the Company’sguidance.

 

Because of the cost (upto $1.318 billion) and timeframe (of 10 to 15 years) as published by WileyInterScience, ã2007 John Wiley and Sons, LTD, generallyassociated with developing a potential drug or pharmaceutical product to thepoint of approval by the FDA or other regulatory agencies for human use, ourgeneral business strategy is to develop our products up through human clinicaltrials and then look for third parties to fund further development of theproduct and to market the product through strategic partnerships, licenseagreements or other relationships. We also look for collaborative and otherefforts to utilize other technology to increase the potential variety andreduce the cost of identifying products. We believe that this strategy couldreduce the potential costs we would otherwise incur in developing a product andincrease the likelihood of getting a product to market. Our expected costsunder our various contracts and for various drug development products can beestimated for the next year or two, but not thereafter with much  certainty due to the uncertainty of clinicaltrial results, research results and the timing of securing one or more partnersto develop and market a potential drug.

 

Because of the variousfactors noted above and the expectation that, until we establish revenuesources, we will license or jointly develop our prospective products to or withstrategic partners, we review, at least annually, each research program andclinical trial based on results and progress during the prior year and estimateour needs for that program or trial for the coming year, making adjustmentsbased on the progress of the program during the year.

 

The Company currently hasa total of $61.7 million of contracted development studies.  As of December 31, 2009, $48.4 millionhas been billed to the government. The Company has $13.3 in developmentcontracts remaining that have not yet been completed and have not been billed.The Company expects to complete the remaining contract activity and receive thecontracted revenue in 2010 and early 2011.

 

**Summary of Material RevenueContracts**

 

In December 2006,the Company announced the execution of a two-year $28 million research contractwith the Defense Threat Reduction Agency (DTRA), an agency of the United StatesDepartment of Defense (DoD). The contract is directed toward funding theCompany’s development of antisense therapeutics to treat the effects of Ebola,Marburg and Junín hemorrhagic viruses, which are seen by DoD as potentialbiological warfare and bioterrorism agents. In May 2009, the Companyreceived an amendment from DTRA to extend the contract performance period to November 29,2009 and a cost modification of an additional $5.9 million, increasing thetotal contract amount to $33.9 million. In September 2009, the Companyreceived a second amendment from DTRA to extend the contract performance periodto February 28, 2011 and a cost modification of an additional $11.5million, increasing the total contract amount to $45.4 million.

 

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During the twelve monthperiod ended December 31, 2009, 2008 and 2007, the Company recognized$10.4 million, $16.8 million and $8.0 million, respectively, in researchcontract revenue from this contract. To date, the Company has recognizedrevenues of $35.2 million from this contract. Funding of the remainder of the contract is anticipated in 2010 and 2011.

 

In January 2006, theCompany announced that the final version of the 2006 defense appropriations acthad been approved, which included an allocation of $11.0 million to fund theCompany’s ongoing defense-related programs. Net of government administrativecosts, it is anticipated that the Company will receive up to $9.8 million underthis allocation. The Company’s technology is expected to be used to continuedeveloping RNA based drugs agents against Ebola and Marburg viruses. TheCompany has received signed contracts for all of these projects. The Companyexpects that funding under these signed contracts will be completed over thenext 12 months.  During the twelve monthperiod ended December 31, 2009, 2008 and 2007, the Company recognized $2.3million, $4.2 million and $2.7 million, respectively, in research contractrevenue from this contract. To date, the Company has recognized revenues of$9.2 million on these contracts. Funding of the remainder of these contracts isanticipated in 2010.

 

In May 2009, theCompany entered into a contract with DTRA to develop H1N1 drugs. Under thiscontract, DTRA will pay up to $4.1 million to the Company for the work to beperformed by the Company. The work will involve the application of analogsbased on the Company’s proprietary PMO chemistry and the Company plans toconduct preclinical development of at least one drug candidate and demonstrateit is effective by testing it in virus-infected animals. During the twelvemonth period ended December 31, 2009, the Company recognized $1.7 millionin revenue under this contract.

 

In September 2009,the Company and Charley’s Fund, Inc. (“Charley’s Fund”), a nonprofitorganization that funds drug discovery and development initiatives specific toDMD, entered into the First Amendment to an existing Sponsored ResearchAgreement (the “Amendment”). The Amendment pertains to certain provisions ofthe Sponsored Research Agreement by and between the Company and Charley’s Fundentered into effective October 12, 2007 (the “Agreement”). Under the termsof the Amendment, the Company was awarded up to an additional $3 million insponsored research funds, for a total of $5 million from Charley’s Fund tosupport a new product development program using proprietary exon skippingtechnologies developed by the Company to overcome the effects of certaingenetic errors in the dystrophin gene. In December 2009, the Companyreceived $1.4 million that was recorded as deferred revenue. Revenue associatedwith this research and development arrangement is recognized under theproportional performance method, using the payment received method.  TheCompany did not recognize any revenue under this contract in 2009.

 

We do not expect anymaterial revenues in 2010 from our business activities except for revenues fromU.S. government contracts and other agreements. We expect that our cashrequirements for the next twelve months will be satisfied by existing cashresources and these revenues. To fund our operations beyond the next twelvemonths, we may need to raise additional capital. We will continue to look foropportunities to finance our ongoing activities and operations throughaccessing corporate partners or the public equity markets, as we currently haveno credit facility and do not intend to seek one.

 

The likelihood of thelong-term success of the Company must be considered in light of the expenses,difficulties and delays frequently encountered in the development andcommercialization of new pharmaceutical products, competitive factors in themarketplace as well as the complex regulatory environment in which the Companyoperates. There can be no assurance that the Company will ever achievesignificant revenues or profitable operations.

 

**Off-BalanceSheet Arrangements**

 

The Company’s off-balancesheet arrangements are limited to operating leases and rents on certainfacilities and equipment and license agreements for which it is obligated topay the licensors a minimum annual royalty. These off-balance sheetarrangements are expensed as incurred. In 2009, these expenses totaled$1,467,000 for operating leases and $75,000 for royalty payments.

 

**ContractualPayment Obligations**

 

A summary of ourcontractual commitments and obligations as of December 31, 2009 is asfollows:

 
| ** **                                  | ** ** | **Payments Due By Period** | ** ** |
|---------------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations (in  thousands)** | ** ** | **Total**                  | ** ** | **2010** | ** ** | **2011 and 2012** | ** ** | **2013 and 2014** | ** ** | **2015 and  beyond** | ** ** |
| Operating  leases                           |       | $                          | 19,682     |   | $ | 2,073 |   | $ | 4,405 |   | $ | 4,069 |   | $ | 9,135 |   |
| Royalty  payments                           |       | 1,110                      |       | 100 |   | 160 |   | 135 |   | 715 |   |
|                                        |       | $                          | 20,792     |   | $ | 2,173 |   | $ | 4,565 |   | $ | 4,204 |   | $ | 9,850 |   |

 

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Our future expendituresand capital requirements depend on numerous factors, most of which aredifficult to project beyond the short term. These requirements include theprogress of our research and development programs and our pre-clinical andclinical trials, the time and costs involved in obtaining regulatory approvals,the cost of filing, prosecuting, defending and enforcing any patent claims andother intellectual property rights, competing technological and marketdevelopments, our ability to establish collaborative arrangements and the termsof any such arrangements, and the costs associated with commercialization ofour products. Our cash requirements are expected to increase as we advance ourresearch projects. There can be no assurance, however, that we will ever beable to generate product revenues or achieve or sustain profitability.

 

#### **New AccountingPronouncements**

#### ** **

#### **SeeNote 2 of Notes to Financial Statements with this report on Form 10-Kincluded under Part III, Item 15.**

#### ** **

#### **CriticalAccounting Policies and Estimates**

#### ** **

The discussion andanalysis of our financial condition and results of operations are based uponour financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses andrelated disclosure of contingent assets and liabilities. On an ongoing basis,we evaluate our estimates, including those related to stock-based compensation,valuation of investments, long-lived assets, and revenue recognition. We baseour estimates on historical experience and on various other assumptions. Actualresults may differ from these estimates under different assumptions orconditions. We believe the following critical accounting policies and therelated judgments and estimates affect the preparation of our financialstatements.

 

##### ***Revenue Recognition***

##### ** **

Revenue is recorded fromresearch contracts and grants as the services are performed and payment isreasonably assured. Upfront, nonrefundable fees and other fees associated withlicense and development arrangements are recognized as revenue ratably over theperformance period. Revenue associated with research and developmentarrangements is recognized under the proportional performance method, using thepayment received method.  To date, revenue from research and developmentarrangements has not been material.

 

*Long-LivedAsset Impairment*

 

Long-lived assets heldand used by us and intangible assets with determinable lives are reviewed forimpairment whenever events or circumstances indicate that the carrying amountof assets may not be recoverable in accordance with generally acceptedaccounting principles. We evaluate recoverability of assets to be held and usedby comparing the carrying amount of an asset to future net undiscounted cash flowsto be generated by the asset. If such assets are considered to be impaired, theimpairment to be recognized is measured as the amount by which the carryingamount of the assets exceeds the fair value of the assets. Such reviews assessthe fair value of the assets based upon estimates of future cash flows that theassets are expected to generate.

 

##### ***Stock-based Compensation Expense***

 

Stock-based compensationcosts are generally based on the fair value calculated from the Black-Scholesoption-pricing model on the date of grant for stock options and on the date ofenrollment for the Plan. The fair value of stock grants are amortized ascompensation expense on a straight-line basis over the vesting period of thegrants. Compensation expense recognized is shown in the operating activitiessection of the statements of cash flows. Stock options granted to employees areservice-based and typically vest over three years.

 

The fair market values ofstock options granted were measured on the date of grant using the Black-Scholesoption-pricing model, with weighted average assumptions for the risk-freeinterest rate, expected dividend yield, expected lives, and expectedvolatility. The Company is required to estimate potential forfeiture of stockgrants and adjust compensation cost recorded accordingly. The estimate offorfeitures will be adjusted over the requisite service period to the extentthat actual forfeitures differ, or are expected to differ, from such estimates.Changes in estimated forfeitures will be recognized through a cumulativecatch-up in the period of change and will also impact the amount of stockcompensation expense to be recognized in future periods.

 

The assumptions used in calculating the fair value of stock-basedcompensation expense represent management’s best estimates, but these estimatesinvolve inherent uncertainties and the application of management judgment. As aresult, if factors change and the Company uses different assumptions, itsstock-based compensation expense could be materially different in the future.See Note 3 to Notes to Financial Statements for a further discussion ofstock-based compensation.

 

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**Item 7A.  Quantitative and Qualitative Disclosures AboutMarket Risk.**

 

The primary objective ofour cash investment activities is to preserve principal and avoid significantmarket risk. As of December 31, 2009, we held more than 99% of our cash ina sweep money market account, with the remainder held in non-interest bearingchecking accounts or short-term certificates of deposit. We have no holdings ofderivative financial or commodity instruments. We do not anticipate makingsignificant changes in how we hold our cash. Accordingly, we believe our creditrisk is immaterial.

 

**Item 8.  Financial Statements and Supplementary Data.**

 

The information requiredby this Item 8 begins on page F-1 in Item 15 of Part III of thisreport on Form 10-K and is incorporated into this item by reference.

 

**Item 9.  Changes in and Disagreements with Accountantson Accounting and Financial Disclosure.**

 

None.

 

**Item 9A.  Controls and Procedures.**

 

**Disclosure Controls and Procedures**

 

We carried out anevaluation as of the end of period covered by this report, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and our Chief Financial Officer, of the effectiveness of ourdisclosure controls and procedures pursuant to paragraph (b) of Rule 13a-15and 15d-15 under the Exchange Act.  Basedon that review, the Chief Executive Officer and the Chief Financial Officerhave concluded that our disclosure controls and procedures are effective toensure that information required to be disclosed by the Company in the reportsit files or submits under the Exchange Act (1) is recorded, processed,summarized, and reported within the time periods specified in the Securitiesand Exchange Commission’s rules and forms, and (2) isaccumulated and communicated to our management, including our principalexecutive officer and principal financial officer, as appropriate to allowtimely decisions regarding required disclosure.

 

The Company does notexpect that its disclosure controls and procedures will prevent all error andall fraud. A control procedure, no matter how well conceived and operated, canprovide only reasonable, not absolute, assurance that the objectives of thecontrol procedure are met. Because of the inherent limitations in all control procedures,no evaluation of controls can provide absolute assurance that all controlissues and instances of fraud, if any, within the Company have been detected.These inherent limitations include the realities that judgments in decisionmaking can be faulty, and that breakdowns can occur because of simple error ormistake. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe control. The Company considered these limitations during the development ofit disclosure controls and procedures, and will continually reevaluate them toensure they provide reasonable assurance that such controls and procedures areeffective.

 

**InternalControl over Financial Reporting**

 

*Management’sAnnual Report on Internal Control over Financial Reporting*

 

The management of AVIBioPharma, Inc. (the Company or AVI) is responsible for establishing andmaintaining adequate internal control over financial reporting. The Company’sinternal control over financial reporting is a process designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles, and includes those policies andprocedures that:

 

·                  Pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the Company;

 

·                  Provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the Company are being made only in accordance withauthorizations of management and directors of the Company; and

 

·                  Provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use or disposition of the Company’sassets that could have a material effect on the financial statements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

The Company’s managementassessed the effectiveness of the Company’s internal control over financialreporting as of December 31, 2009. In making this assessment, the Company’smanagement used the criteria set forth by the Committee of SponsoringOrganizations of the Treadway Commission (COSO) in “Internal Control-IntegratedFramework.” Based on management’s assessment and those criteria, we believethat, as of December 31, 2009, the Company’s internal control overfinancial reporting is effective.

 

*Changesin Internal Control over Financial Reporting*

 

There have not been anychanges in the Company’s internal control over financial reporting (as suchterm is defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) during the Company’s fourth fiscal quarter that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

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**Report****of Independent****Registered Public Accounting Firm**

 

The Board of Directors and Shareholders

AVI BioPharma, Inc:

 

We have audited AVI BioPharma, Inc.’s (a developmentstage enterprise) internal control over financial reporting as of December 31,2009, based on criteria established in *lnternalControl -**Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). AVI BioPharma, Inc.’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting, included in the accompanying Managements‘ Annual Report on Internal Control over Financial Reporting.**Our responsibility is to expressan opinion on the Company’s internal control over financial reporting based onour audit.

 

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, assessing the riskthat a material weakness exists, and testing and evaluating the design andoperating effectiveness of internal control based on the assessed risk. Ouraudit also included performing such other procedures as we considered necessaryin the circumstances. We believe that our audit provides a reasonable basis forour opinion.

 

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

In our opinion, AVI BioPharma, Inc. maintained,in all material respects, effective internal control over financial reportingas of December 31, 2009, based on criteria established in *Internal Control*— *Integrated Framework*issued by theCommittee of Sponsoring Organizations of the Treadway Commission.

 

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), the balancesheets of AVI BioPharma, Inc. (a development stage enterprise) as of December 31,2009 and 2008, and the related statements of operations, shareholders’ equityand comprehensive income (loss), and cash flows for each of the years in thethree-year period ended December 31, 2009 and the information included inthe cumulative from inception presentations for the period January 1,2002to December 31,2009 (not separately presented herein). These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits. The financial statements of AVI BioPharma, Inc. for the periodJuly 22, 1980 (inception) to December 31, 2001 were audited by otherauditors who have ceased operations. Those auditors expressed an unqualifiedopinion on those financial statements in their report dated February 21,2002. Our report dated March 16, 2010 expressed an unqualified opinion onthose financial statements.

 
| /s/ KPMG LLP        |   |
|---------------------|--------|
|                |   |
| Portland, Oregon    |   |
| March 16, 2010 |   |

 

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**Item 9B.  Other Information.**

 

None.

 

**PART III**

 

**Item 10.  Directors, Executive Officers and CorporateGovernance.**

 

Information regarding ourdirectors and executive officers required by this item is included in ourdefinitive proxy statement for our 2010 annual meeting of shareholders to befiled with the Commission not later than 120 days after the end of the fiscalyear covered by this Annual Report and is incorporated herein by reference.

 

**Item 11.  Executive Compensation.**

 

The information requiredby this item is included in our definitive proxy statement for our 2010 annualmeeting of shareholders to be filed with the Commission not later than 120 daysafter the end of the fiscal year covered by this Annual Report and isincorporated herein by reference.

 

**Item 12.  Security Ownership of Certain BeneficialOwners and Management and Related Stockholder Matters.**

 

The information requiredby this item is included in our definitive proxy statement for our 2010 annualmeeting of shareholders to be filed with the Commission not later than 120 daysafter the end of the fiscal year covered by this Annual Report and isincorporated herein by reference.

 

**Item 13.  Certain Relationships and RelatedTransactions, and Director Independence.**

 

The information requiredby this item is included in our definitive proxy statement for our 2010 annualmeeting of shareholders to be filed with the Commission not later than 120 daysafter the end of the fiscal year covered by this Annual Report and isincorporated herein by reference.

 

**Item 14.  Principal Accountant Fees and Services.**

 

The information requiredby this item is included in our definitive proxy statement for our 2010 annualmeeting of shareholders to be filed with the Commission not later than 120 daysafter the end of the fiscal year covered by this Annual Report and is incorporatedherein by reference.

 

**Item 15.  Exhibits, Financial Statement Schedules.**

 

#### **(a)  The following documents are filed as part of this Report:**

#### ** **

(1) *Financial Statements*

 

#### **Thefollowing financial statements of the Company and the Report of KPMG LLP,Independent Auditors, are included in Part IV of this Report on the pages indicated:**

 
| Report of KPMG LLP, Independent Registered Public  Accounting Firm       |   | F-1 |
|--------------------------------------------------------------------------|--------|-----|
| Report of Arthur Andersen, Independent Auditors                          |   | F-2 |
| Balance  Sheets                                                          |   | F-3 |
| Statements  of Operations                                                |   | F-4 |
| Statements of Shareholders’ Equity and Comprehensive  Income (Loss) |   | F-5 |
| Statements  of Cash Flows                                                |   | F-6 |
| Notes to Financial Statements                                            |   | F-7 |

 

(2) *Financial Statement Schedules*

 

#### **Allschedules are omitted because they are not applicable or the requiredinformation is shown in the financial statements or the notes thereto.**

 

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(3) *Exhibits*

 

#### **Thefollowing exhibits are filed herewith and this list is intended to constitutethe exhibit index:**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                             |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 1.1                  |       | Underwriting Agreement  dated November 14, 2005. (15)                                                                                                                                  |
| 1.2                  |       | Placement Agency  Agreement between AVI BioPharma, Inc. and Citigroup Global Markets Inc.,  Oppenheimer & Co. Inc., and Maxim Group, LLC, dated  December 12, 2007. (22) |
| 1.3                  |       | Engagement Letter dated  January 28, 2009 between AVI BioPharma, Inc. and Rodman &  Renshaw, LLC. (41)                                                                   |
| 2.1                  |       | Agreement and Plan of  Merger dated March 12, 2008 by and among AVI BioPharma, Inc., EB  Acquisition Corp., Ercole Biotech, Inc. and the Stockholder  Representative. (35)   |
| 3.1                  |       | Third Restated Articles  of Incorporation of AntiVirals Inc. (1)                                                                                                                       |
| 3.2                  |       | First Restated Bylaws  of AVI BioPharma, Inc. (28)                                                                                                                                     |
| 3.3                  |       | First Amendment to  Third Restated Articles of Incorporation. (4)                                                                                                                           |
| 3.4                  |       | Amendment to  Article 2 of the Company Third Restated Articles of Incorporation. (11)                                                                                                  |
| 4.1                  |       | Form of Specimen  Certificate for Common Stock. (1)                                                                                                                                    |
| 4.2                  |       | Warrant to purchase  485,290 shares of the Company’s common stock dated November 14, 2005.  (16)                                                                                  |
| 4.3                  |       | Form of Warrant to  Purchase Common Stock, issued in connection with the Placement Agency  Agreement dated December 12, 2007. (23)                                                |
| 4.4                  |       | Form of Common  Stock Purchase Warrant. (42)                                                                                                                                           |
| 4.5                  |       | Form of Common  Stock Purchase Warrant. (51)                                                                                                                                           |
| 10.1†           |       | 1992 Stock Incentive  Plan (as amended through May 11, 2000). (1)                                                                                                                      |
| 10.2†           |       | Employment Agreement  with Denis R. Burger, Ph.D. dated November 4, 1996. (1)                                                                                                          |
| 10.3†           |       | Employment Agreement  with Alan P. Timmins dated November 4, 1996. (1)                                                                                                                 |
| 10.4†           |       | Employment Agreement  with Dwight Weller, Ph.D. dated November 4, 1996. (1)                                                                                                            |
| 10.5                 |       | Technology Transfer  Agreement between Anti-Gene Development Group and AntiVirals Inc., dated  February 9, 1992. (1)                                                              |
| 10.6                 |       | Amendment to Technology  Transfer Agreement between Anti-Gene Development Group and AntiVirals Inc.  dated January 20, 1996. (1)                                                       |
| 10.7                 |       | License and Option  Agreement between Anti-Gene Development Group and AntiVirals Inc., dated  February 9, 1993. (1)                                                               |
| 10.8                 |       | Commercial Lease  between Research Way Investments, Landlord, and AntiVirals Inc., Tenant,  dated June 15, 1992. (1)                                                              |
| 10.9                 |       | Lease between Benjamin  Franklin Plaza, Inc., Landlord, and AntiVirals Inc., Tenant, dated  June 17, 1992. (1)                                                                    |
| 10.10                |       | First Amendment to  Lease between Benjamin Franklin Plaza, Inc., Landlord, and AntiVirals  Inc., Tenant, dated July 24, 1995. (1)                                                 |
| 10.11†          |       | Employment Agreement  with Patrick L. Iversen, Ph.D. dated July 14, 1997. (2)                                                                                                          |
| 10.12†          |       | ImmunoTherapy  Corporation 1997 Stock Option Plan. (3)                                                                                                                                      |
| 10.13                |       | License Agreement  between ImmunoTherapy Corporation and Ohio State University, dated  March 12, 1996. (3)                                                                             |
| 10.14                |       | License Agreement  between ImmunoTherapy Corporation and Ohio State University, dated  December 26, 1996. (3)                                                                          |
| 10.15                |       | Amendment to License  Agreement between ImmunoTherapy Corporation and Ohio State University, dated  September 23, 1997. (3)                                                            |
| 10.16                |       | Purchase Agreement,  dated December 15, 1999, by and between AVI BioPharma, Inc. and  certain Investors. (5)                                                                      |
| 10.17                |       | Registration Rights  Agreement, dated December 15, 1999, by and between AVI  BioPharma, Inc. and certain Investors. (5)                                                           |
| 10.18                |       | Purchase Agreement,  dated December 16, 1999, by and between AVI BioPharma, Inc. and  certain Investors. (5)                                                                      |
| 10.19                |       | Registration Rights  Agreement, dated December 16, 1999, by and between AVI  BioPharma, Inc. and certain Investors. (5)                                                           |
| 10.20                |       | Subscription Agreement,  dated December 1, 1999, by and between SuperGen, Inc. and AVI  BioPharma, Inc. (5)                                                                  |

 

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| 10.21       |   | 2000 Amendment to  Technology Transfer Agreement between Anti-Gene Development Group and AVI  BioPharma, Inc. (6)                                                                                |
|-------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.22       |   | United States of  America Sales, Distribution, and Development Agreement, dated April 4,  2000, between SuperGen, Inc. and AVI BioPharma, Inc. (7)                                     |
| 10.23       |   | Common Stock and  Warrant Purchase Agreement, dated April 4, 2000, between  SuperGen, Inc. and AVI BioPharma, Inc. (7)                                                                 |
| 10.24       |   | Registration Rights  Agreement, dated April 14, 2000, between SuperGen, Inc. and AVI  BioPharma, Inc. (7)                                                                              |
| 10.25† |   | 2000 Employee Share  Purchase Plan. (8)                                                                                                                                                               |
| 10.26† |   | Employment Agreement  with Mark M. Webber dated May 11, 2000. (9)                                                                                                                                |
| 10.27       |   | Lease Agreement with  Spieker Partners, LP dated May 8, 2001. (9)                                                                                                                                |
| 10.28*      |   | Investment Agreement  dated May 22, 2001 between the Company and Medtronic Asset  Management, Inc. (9)                                                                                      |
| 10.29       |   | Warrant dated  June 20, 2001 issued to Medtronic Asset Management, Inc. (9)                                                                                                                 |
| 10.30       |   | Registration Rights  Agreement dated June 20, 2001 between the Company and Medtronic Asset  Management, Inc. (9)                                                                            |
| 10.31*      |   | License and Development  Agreement dated June 20, 2001 between the Company and Medtronic, Inc.  (9)                                                                                         |
| 10.32*      |   | Supply Agreement dated  June 20, 2001 between the Company and Medtronic, Inc. (9)                                                                                                           |
| 10.33       |   | Securities Purchase  Agreement dated March 25, 2002 between the Company and certain  purchasers (“2002 SPA”). (10)                                                                     |
| 10.34       |   | Form of Warrant  issued by the Company to certain purchasers under the 2002 SPA. (10)                                                                                                            |
| 10.35       |   | Registration Rights  Agreement dated March 25, 2002 between the Company and certain  purchasers. (10)                                                                                            |
| 10.36† |   | 2002 Equity Incentive  Plan. (11)                                                                                                                                                                     |
| 10.37       |   | Securities Purchase  Agreement dated January 19, 2005 between the Company and certain  purchasers (“2005 SPA”). (12)                                                                   |
| 10.38       |   | Form of Purchase  Warrant issued by the Company to certain purchasers under the 2005 SPA. (12)                                                                                                   |
| 10.39† |   | Amendment to employment  agreement of Denis R. Burger, Ph.D. (14)                                                                                                                                     |
| 10.40† |   | Amendment to employment  agreement of Alan P. Timmins. (14)                                                                                                                                           |
| 10.41† |   | Amendment to employment  agreement of Patrick L. Iversen, Ph.D. (14)                                                                                                                                  |
| 10.42† |   | Amendment to employment  agreement of Dwight D. Weller, Ph.D. (14)                                                                                                                                    |
| 10.43† |   | Amendment to employment  agreement of Peter D. O’Hanley, M.D., Ph.D. (14)                                                                                                                        |
| 10.44† |   | Amendment to employment  agreement of Mark M. Webber. (14)                                                                                                                                            |
| 10.45       |   | Securities Purchase  Agreement dated November 14, 2005 between the Company and certain  purchasers. (16)                                                                                         |
| 10.46*      |   | Supply Agreement, dated  March 10, 2006, by and between Cook Group Incorporated and AVI  BioPharma, Inc. (17)                                                                               |
| 10.47*      |   | License and Development  Agreement, dated March 10, 2006, by and between Cook Group Incorporated  and AVI BioPharma, Inc. (17)                                                              |
| 10.48*      |   | Investment Agreement,  dated March 10, 2006, by and between Cook Group Incorporated and AVI  BioPharma, Inc. (17)                                                                      |
| 10.49*      |   | License Agreement dated  January 26, 2006 by and between with Chiron Corporation and AVI  BioPharma, Inc. (18)                                                                              |
| 10.50       |   | Stock Purchase  Agreement dated January 26, 2006 by and between with Chiron Corporation  and AVI BioPharma, Inc. (18)                                                                  |
| 10.51       |   | Second Lease Extension  and Modification Agreement dated January 24, 2006 by and between  Research Way Investments and AVI BioPharma, Inc. (19)                                             |
| 10.52*      |   | Collaboration and  License Agreement, dated December 19, 2006, by and between Ercole  Biotech, Inc. and AVI BioPharma, Inc. (20)                                                       |
| 10.53       |   | Series A-2  Preferred Stock and Common Stock Purchase Agreement, dated December 19,  2006, by and between Ercole Biotech, Inc. and AVI BioPharma, Inc.  (21)                      |
| 10.54*      |   | Cross License Agreement  dated January 8, 2007 by and between Eleos, Inc. and AVI  BioPharma, Inc. (24)                                                                                |
| 10.55       |   | Separation and Release  Agreement dated March 27, 2007 by and between Denis R. Burger, Ph.D. and  AVI BioPharma, Inc. (25)                                                                  |
| 10.56*      |   | Second License and  Collaboration Agreement dated May 1, 2007 by and between Ercole Biotech.  Inc. and AVI BioPharma, Inc. (26)                                                             |
| 10.57       |   | Real Property Purchase  Agreement, dated April 19, 2007, by and between WKL Investments Airport,  LLC and AVI BioPharma, Inc. (27)                                                          |
| 10.58*      |   | Sponsored Research  Agreement between AVI BioPharma, Inc. and Charley’s Fund, Inc.,  effective October 12, 2007. (29)                                                             |
| 10.59       |   | Shareholder’s Trust  Agreement between and among AVI BioPharma, Inc., AVI Shareholder  Advocacy Trust, The Shareholder Advocate LLC, and Richard Macary, dated  October 29, 2007. (30) |
| 10.60† |   | Amended and Restated  Employment Agreement between Alan P. Timmins and AVI BioPharma, Inc.,  dated October 26, 2007. (31)                                                                   |
| 10.61       |   | Professional Services  Agreement between James B. Hicks Ph.D., LLC and AVI BioPharma, Inc.,  dated October 26, 2007. (32)                                                                   |

 

29

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| 10.62        |   | Letter Agreement  executed by George Haywood, dated October 29, 2007. (33)                                                                                               |
|--------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.63†  |   | Employment Agreement  dated February 8, 2008 by and between AVI BioPharma, Inc. and  Leslie Hudson, Ph.D. (34)                                                      |
| 10.64        |   | Ercole  Biotech, Inc. Convertible Promissory Note dated March 12, 2008.  (36)                                                                                       |
| 10.65†  |   | Employment Agreement  dated April 10, 2008 by and between AVI BioPharma, Inc. and  Dr. Ryszard Kole. (37)                                                      |
| 10.66*† |   | Employment Agreement  dated July 24, 2008 by and between AVI BioPharma, Inc. and J. David  Boyle II. (38)                                                           |
| 10.67*† |   | Amendment No. 1 to  Employment Agreement dated August 1, 2008 by and between AVI  BioPharma, Inc. and J. David Boyle II. (39)                                  |
| 10.68†  |   | Severance and Release  Agreement effective October 27, 2008 by and between AVI  BioPharma, Inc. and Peter O’Hanley. (40)                                       |
| 10.69†  |   | Employment Agreement  dated January 26, 2009 between AVI BioPharma, Inc. and Stephen  Bevan Shrewsbury, M.D. (43)                                                   |
| 10.70        |   | Securities Purchase  Agreement dated January 29, 2009 between AVI BioPharma, Inc. and  the Purchasers. (44)                                                         |
| 10.71†  |   | Letter Agreement  Regarding Board of Director Representation between AVI BioPharma, Inc.  and Eastbourne Capital Management, LLC. (45)                                   |
| 10.72        |   | Agreement between AVI  BioPharma, Inc. and the U.S. Defense Threat Reduction Agency dated  May 5, 2009. (46)                                                        |
| 10.73*† |   | Employment Agreement  dated May 19, 2009 between AVI BioPharma, Inc. and Paul Medeiros.  (47)                                                                       |
| 10.74        |   | Agreement between AVI  BioPharma, Inc. and the U.S. Defense Threat Reduction Agency dated  May 28, 2009. (48)                                                       |
| 10.75*       |   | First Amendment to  Sponsored Research Agreement between AVI BioPharma, Inc. and Charley’s  Fund, Inc. dated June 2, 2009. (49)                           |
| 10.76        |   | Lease dated  July 24, 2009 by and between BMR-3450 Monte Villa Parkway, LLC and AVI  BioPharma, Inc. (50)                                                           |
| 10.77        |   | Amendment of Contract  between AVI BioPharma, Inc. and the U.S. Defense Threat Reduction Agency  (contract no HDTRA 1-07-C0010), effective September 30, 2009. (52) |
| 10.78*       |   | Collaboration and License  Agreement between Isis Pharmaceuticals and Ercole Biotech, Inc. dated May 16,  2003                                                                |
| 14.1         |   | Code of Business  Conduct and Ethics. (13)                                                                                                                                    |
| 21.1         |   | Subsidiaries of the  Registrant.                                                                                                                                              |
| 23.1         |   | Consent of Independent  Registered Public Accounting Firm.                                                                                                                    |
| 31.1         |   | Certification of the  Company’s Chief Executive Officer, Leslie Hudson, Ph.D., pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                          |
| 31.2         |   | Certification of the  Company’s Chief Financial Officer, J. David Boyle II, pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                             |
| 32.1         |   | Certification of CEO  and CFO Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                            |

 

----

| (1)    | Incorporated by  reference to Exhibits to Registrant’s Registration Statement on  Form SB-2, as amended and filed with the Securities and Exchange  Commission on May 29, 1997 (Commission Registration No. 333-20513).                            |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                   |
| (2)    | Incorporated by  reference to Exhibits to Registrant’s Annual Report on Form 10-KSB for  the fiscal year ended December 31, 1997, and filed with the Securities  and Exchange Commission on March 30, 1998.                                        |
|   |                                                                                                                                                                                                                                                                   |
| (3)    | Incorporated by  reference to Exhibits to Registrant’s Registration Statement on Form S-4,  as amended, and filed with the Securities and Exchange Commission on  August 7, 1998 (Commission Registration No. 333-60849).                          |
|   |                                                                                                                                                                                                                                                                   |
| (4)    | Incorporated by  reference to Exhibits to Registrant’s current report on Form 8-K, as  filed with the Securities and Exchange Commission on September 30, 1998  (Commission Registration No. 000-22613).                                           |
|   |                                                                                                                                                                                                                                                                   |
| (5)    | Incorporated by  reference to Exhibits to Registrant’s Registration Statement on  Form S-3, as amended, and filed with the Securities and Exchange  Commission on December 21, 1999 (Commission Registration  No. 333-93135).                      |
|   |                                                                                                                                                                                                                                                                   |
| (6)    | Incorporated by  reference to Exhibits to Registrant’s Registration Statement on Form S-1  and filed with the Securities and Exchange Commission on June 16, 2000  (Commission Registration No. 333-39542).                                        |
|   |                                                                                                                                                                                                                                                                   |
| (7)    | Incorporated by  reference to Exhibits to Registrant’s Registrations Statement on  Form S-3, and filed with the Securities and Exchange Commission on  September 15, 2000 (Commission Registration No. 333-45888).                                 |
|   |                                                                                                                                                                                                                                                                   |
| (8)    | Incorporated by  reference to Appendix A to Registrant’s Definitive Proxy Statement on  Form 14-A, as amended, filed with the Securities and Exchange Commission  on April 12, 2000.                                                                    |
|   |                                                                                                                                                                                                                                                                   |
| (9)    | Incorporated by  reference to Exhibits to Registrant’s Quarterly Report on Form 10-Q for  the quarterly period ended June 30, 2001, and filed with the Securities  and Exchange Commission on August 14, 2001, as amended on April 23,  2002. |
|   |                                                                                                                                                                                                                                                                   |
| (10)   | Incorporated by  reference to Exhibits to Registrant’s current report on Form 8-K, as  filed with the Securities and Exchange Commission on April 2, 2002.                                                                                              |
|   |                                                                                                                                                                                                                                                                   |
| (11)   | Incorporated by  reference to appendixes to Registrant’s Definitive Proxy Statement on  Schedule 14-A, as filed with the Securities and Exchange Commission on  April 11, 2002.                                                                              |
|   |                                                                                                                                                                                                                                                                   |
| (12)   | Incorporated by  reference to registrants current report on Form 8-K, as filed with the  Securities and Exchange Commission on January 20, 2005.                                                                                                             |
|   |                                                                                                                                                                                                                                                                   |
| (13)   | Incorporated by  reference to Exhibits to Registrant’s Annual Report on Form 10-K for the  fiscal year ended December 31, 2003, and filed with the Securities and  Exchange Commission on March 15, 2004.                                          |

 

30

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| (14)   | Incorporated by  reference to Registrant’s current report on Form 8-K, as filed with the  Securities and Exchange Commission on February 28, 2005.                                                                   |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                |
| (15)   | Incorporated by  reference to Registrant’s current report on Form 8-K, as filed with the  Securities and Exchange Commission on November 21, 2005.                                                                   |
|   |                                                                                                                                                                                                                                |
| (16)   | Incorporated by  reference to Exhibits to Registrant’s Annual Report on Form 10-K for the  fiscal year ended December 31, 2005, and filed with the Securities and  Exchange Commission on March 16, 2006.       |
|   |                                                                                                                                                                                                                                |
| (17)   | Incorporated by  reference to Exhibits to Registrant’s Registrations Statement on  Form S-3, and filed with the Securities and Exchange Commission on  April 11, 2006 (Commission Registration No. 333-133211). |
|   |                                                                                                                                                                                                                                |
| (18)   | Incorporated by  reference to Exhibits to Registrant’s Quarterly Report on Form 10-Q for  the quarterly period ended March 31, 2006, and filed with the Securities  and Exchange Commission on May 10, 2006.    |
|   |                                                                                                                                                                                                                                |
| (19)   | Incorporated by  reference to Exhibits to Registrant’s Quarterly Report on Form 10-Q for  the quarterly period ended June 30, 2006, and filed with the Securities  and Exchange Commission on August 9, 2006.   |
|   |                                                                                                                                                                                                                                |
| (20)   | Incorporated by  reference to Exhibit 10.56 to the Registrant’s Form 10-K for the  fiscal year ended December 31, 2006, filed with the Securities and  Exchange Commission on March 16, 2007.              |
|   |                                                                                                                                                                                                                                |
| (21)   | Incorporated by  reference to Exhibit 10.57 to the Registrant’s Form 10-K for the  fiscal year ended December 31, 2006, filed with the Securities and  Exchange Commission on March 16, 2007.              |
|   |                                                                                                                                                                                                                                |
| (22)   | Incorporated by  reference to Exhibit 1.01 to the Registrant’s Form 8-K filed with  the Securities and Exchange Commission on December 13, 2007.                                                                |
|   |                                                                                                                                                                                                                                |
| (23)   | Incorporated by  reference to Exhibit 4.5 to the Registrant’s Form 8-K filed with  the Securities and Exchange Commission on December 13, 2007.                                                                 |
|   |                                                                                                                                                                                                                                |
| (24)   | Incorporated by  reference to Exhibit 10.58 to the Registrant’s Form 10-Q for the  quarterly period ended March 31, 2007, filed with the Securities and  Exchange Commission on May 10, 2007.              |
|   |                                                                                                                                                                                                                                |
| (25)   | Incorporated by  reference to Exhibit 10.59 to the Registrant’s Form 10-Q for the  quarterly period ended March 31, 2007, filed with the Securities and  Exchange Commission on May 10, 2007.              |
|   |                                                                                                                                                                                                                                |
| (26)   | Incorporated by  reference to Exhibit 10.60 to the Registrant’s Form 10-Q for the  quarterly period ended June 30, 2007, filed with the Securities and  Exchange Commission on August 9, 2007.             |
|   |                                                                                                                                                                                                                                |
| (27)   | Incorporated by  reference to Exhibit 10.61 to the Registrant’s Form 10-Q for the  quarterly period ended June 30, 2007, filed with the Securities and  Exchange Commission on August 9, 2007.             |
|   |                                                                                                                                                                                                                                |
| (28)   | Incorporated by  reference to Exhibit 3.5 to the Registrant’s Form 8-K filed with  the Securities and Exchange Commission on February 7, 2008.                                                                  |
|   |                                                                                                                                                                                                                                |
| (29)   | Incorporated by  reference to Exhibit 10.58 to the Registrant’s Form 10-K for the  fiscal year ended December 31, 2007, filed with the Securities and  Exchange Commission on March 17, 2008.              |
|   |                                                                                                                                                                                                                                |
| (30)   | Incorporated by  reference to Exhibit 10.59 to the Registrant’s Form 10-K for the  fiscal year ended December 31, 2007, filed with the Securities and  Exchange Commission on March 17, 2008.              |
|   |                                                                                                                                                                                                                                |
| (31)   | Incorporated by  reference to Exhibit 10.60 to the Registrant’s Form 10-K for the  fiscal year ended December 31, 2007, filed with the Securities and  Exchange Commission on March 17, 2008.              |
|   |                                                                                                                                                                                                                                |
| (32)   | Incorporated by  reference to Exhibit 10.61 to the Registrant’s Form 10-K for the  fiscal year ended December 31, 2007, filed with the Securities and  Exchange Commission on March 17, 2008.              |
|   |                                                                                                                                                                                                                                |
| (33)   | Incorporated by  reference to Exhibit 10.62 to the Registrant’s Form 10-K for the  fiscal year ended December 31, 2007, filed with the Securities and  Exchange Commission on March 17, 2008.              |
|   |                                                                                                                                                                                                                                |
| (34)   | Incorporated by  reference to Exhibit 10.63 to the Registrant’s Form 10-Q for the  quarterly period ended March31, 2008, filed with the Securities and  Exchange Commission on May 12, 2008.                    |
|   |                                                                                                                                                                                                                                |
| (35)   | Incorporated by  reference to Exhibit 2.1 to the Registrant’s Form 8-K filed with  the Securities and Exchange Commission on March 13, 2008.                                                                    |

 

31

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| (36)   | Incorporated by  reference to Exhibit 10.62 to the Registrant’s Form 8-K filed with  the Securities and Exchange Commission on March 13, 2008.                                                              |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                            |
| (37)   | Incorporated by  reference to Exhibit 10.64 to the Registrant’s Form 10-Q for the  quarterly period ended June 30, 2008, filed with the Securities and  Exchange Commission on August 11, 2008.        |
|   |                                                                                                                                                                                                                            |
| (38)   | Incorporated by  reference to Exhibit 10.65 to the Registrant’s Form 10-Q for the  quarterly period ended September 30, 2008, filed with the Securities and  Exchange Commission on November 10, 2008. |
|   |                                                                                                                                                                                                                            |
| (39)   | Incorporated by  reference to Exhibit 10.66 to the Registrant’s Form 10-Q for the  quarterly period ended September 30, 2008, filed with the Securities and  Exchange Commission on November 10, 2008. |
|   |                                                                                                                                                                                                                            |
| (40)   | Incorporated by  reference to Exhibit 10.68 to the Registrant’s Form 10-K for the  fiscal year ended December 31, 2008, filed with the Securities and  Exchange Commission on March 10, 2009.          |
|   |                                                                                                                                                                                                                            |
| (41)   | Incorporated by  reference to Exhibit 1.3 to the Registrant’s Form 8-K filed with  the Securities and Exchange Commission on January 30, 2009.                                                              |
|   |                                                                                                                                                                                                                            |
| (42)   | Incorporated by  reference to Exhibit 4.4 to the Registrant’s Form 8-K filed with  the Securities and Exchange Commission on January 30, 2009.                                                              |
|   |                                                                                                                                                                                                                            |
| (43)   | Incorporated by  reference to Exhibit 10.71 to the Registrant’s Form 10-Q for the  quarterly period ended March 31, 2009, filed with the Securities and  Exchange Commission on May 11, 2009.          |
|   |                                                                                                                                                                                                                            |
| (44)   | Incorporated by  reference to Exhibit 10.67 to the Registrant’s Form 8-K filed with  the Securities and Exchange Commission on January 30, 2009.                                                            |
|   |                                                                                                                                                                                                                            |
| (45)   | Incorporated by  reference to Exhibit 10.68 to the Registrant’s Form 8-K filed with  the Securities and Exchange Commission on January 30, 2009.                                                            |
|   |                                                                                                                                                                                                                            |
| (46)   | Incorporated by  reference to Exhibit 10.72 to the Registrant’s Form 10-Q for the  quarterly period ended June 30, 2009, filed with the Securities and  Exchange Commission on August 10, 2009.        |
|   |                                                                                                                                                                                                                            |
| (47)   | Incorporated by  reference to Exhibit 10.73 to the Registrant’s Form 10-Q for the  quarterly period ended June 30, 2009, filed with the Securities and  Exchange Commission on August 10, 2009.        |
|   |                                                                                                                                                                                                                            |
| (48)   | Incorporated by  reference to Exhibit 10.74 to the Registrant’s Form 10-Q for the  quarterly period ended June 30, 2009, filed with the Securities and  Exchange Commission on August 10, 2009.        |
|   |                                                                                                                                                                                                                            |
| (49)   | Incorporated by  reference to Exhibit 10.75 to the Registrant’s Form 10-Q for the  quarterly period ended June 30, 2009, filed with the Securities and  Exchange Commission on August 10, 2009.        |
|   |                                                                                                                                                                                                                            |
| (50)   | Incorporated by  reference to Exhibit 10.76 to the Registrant’s Form 10-Q for the  quarterly period ended September 30, 2009, filed with the Securities and  Exchange Commission on November 9, 2009.  |
|   |                                                                                                                                                                                                                            |
| (51)   | Incorporated by  reference to Exhibit 4.1 to the Registrant’s Form 8-K filed with  the Securities and Exchange Commission on August 24, 2009.                                                               |
|   |                                                                                                                                                                                                                            |
| (52)   | Incorporated by  reference to Exhibit 10.77 to the Registrant’s Form 10-Q for the  quarterly period ended September 30, 2009, filed with the Securities and  Exchange Commission on November 9, 2009.  |

 

(b)  Exhibits.

 

The exhibits listed underItem 15(a)(3) hereof are filed as part of this Form 10-K otherthan Exhibit 32.1, which shall be deemed furnished.

 

(c)  Financial Statement Schedules.

 

All schedules are omittedbecause they are not applicable or the required information is shown in thefinancial statements or the notes thereto.

 

* A ConfidentialTreatment Request for certain information in this document has been filed withthe Securities and Exchange Commission. The information for which treatment hasbeen sought has been deleted from such exhibit and the deleted text replaced byan asterisk (*).

 

† Indicates managementcontract or compensatory plan, contract or arrangement.

 

32

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| Dated: | March 16, 2010 | AVI  BIOPHARMA, INC.              |
|--------|---------------------|----------------------------------------|
|   |                |                                   |
|   |                | By:                                    | /s/ Leslie Hudson, Ph.D. |
|   |                | Leslie Hudson, Ph.D.                   |
|   |                | President and Chief  Executive Officer |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in theircapacities indicated on March 16, 2010:

 
| **Signature**                            | ** ** | **Title**                                        |
|------------------------------------------|------------|--------------------------------------------------|
|                                     |       |                                             |
| /s/ LESLIE HUDSON,  Ph.D.                |       | President and Chief  Executive Officer; Director |
| Leslie Hudson, Ph.D.                     |       | (Principal Executive  Officer)                   |
|                                     |       |                                             |
| /s/ J. DAVID BOYLE II                    |       | Chief Financial Officer                          |
| J. David Boyle II                        |       | (Principal Financial  and Accounting Officer)    |
|                                     |       |                                             |
| /s/ MICHAEL D. CASEY                     |       | Chairman of the Board                            |
| Michael D. Casey                         |       |                                             |
|                                     |       |                                             |
| /s/ M. KATHLEEN BEHRENS  Ph.D.           |       | Director                                         |
| M. Kathleen Behrens,  Ph.D.              |       |                                             |
|                                     |       |                                             |
| /s/ K. MICHAEL FORREST                   |       | Director                                         |
| K. Michael Forrest                       |       |                                             |
|                                     |       |                                             |
| /s/ WILLIAM A. GOOLSBEE                  |       | Director                                         |
| William A. Goolsbee                      |       |                                             |
|                                     |       |                                             |
| /s/ CHRISTOPHER S.  HENNEY, Ph.D., D.Sc. |       | Director                                         |
| Christopher S. Henney,  Ph.D., D.Sc.     |       |                                             |
|                                     |       |                                             |
| /s/ JOHN C. HODGMAN                      |       | Director                                         |
| John C. Hodgman                          |       |                                             |
|                                     |       |                                             |
| /s/ GIL PRICE, M.D.                      |       | Director                                         |
| Gil Price, M.D.                          |       |                                             |

 

33

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**Table ofContents**

** **

**PART IV**

** **

**Report of Independent Registered Public AccountingFirm**

 

The Board of Directors and Shareholders

AVI BioPharma, Inc:

 

We have audited the accompanying balance sheets of AVIBioPharma, Inc. (a development stage enterprise) as of December 31,2009 and 2008, and the related statements of operations, shareholders’ equityand comprehensive income (loss), and cash flows for each of the years in thethree-yearperiodended December 31, 2009 and the information included in the cumulativefrom inception presentations for the period January 1, 2002 to December 31,2009 (not separately presented herein). These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits. The financialstatements of AVI BioPharma, Inc. for the period July 22, 1980(inception) to December 31, 2001 were audited by other auditors who haveceased operations. Those auditors expressed an unqualified opinion on thosefinancial statements in their report dated February 21, 2002.

 

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position of AVIBioPharma, Inc. (a development stage enterprise) as of December 31,2009 and 2008, and the results of its operations and its cash flows for each ofthe years in the three-yearperiod ended December 31, 2009 and theinformation included in the cumulative from inception presentations for theperiod January I, 2002 to December 31, 2009 (not separately presentedherein), in conformity with U.S. generally accepted accounting principles.

 

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of AVI BioPharma, Inc.’s internal control over financialreporting as of December 31, 2009, based on criteria established in *Internal Control - Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission (COSO),and our report, dated March 16, 2010 expressed an unqualified opinion on theeffectiveness of the Company’s internal control over financial reporting.

 
| /s/ KPMG LLP        |   |
|---------------------|--------|
|                |   |
| Portland, Oregon    |   |
| March 16, 2010 |   |

 

F-1

----

Table of Contents

 

***THIS REPORT IS A CONFORMED COPY OF THE REPORT PREVIOUSLYISSUED BY ARTHUR ANDERSEN LLP AND HAS NOT BEEN REISSUED BY THAT FIRM.***

 

**Report of Independent Public Accountants**

 

To the Board of Directorsand Shareholders of

 

AVI BioPharma, Inc.

 

We have audited theaccompanying balance sheet of AVI BioPharma, Inc. (an Oregon corporationin the development stage) as of December 31, 2001, and the relatedstatements of operations, shareholders’ equity and cash flows for each of thetwo years in the period ended December 31, 2001 and for the period frominception (July 22, 1980) to December 31, 2001. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our auditsin accordance with auditing standards generally accepted in the United States.Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the financial position of AVI BioPharma, Inc. as of December 31,2001, and the results of its operations and its cash flows for each of the twoyears in the period ended December 31, 2001 and for the period frominception (July 22, 1980) to December 31, 2001, in conformity withaccounting principles generally accepted in the United States.

 
| /s/ Arthur Andersen LLP |   |
|-------------------------|--------|
|                    |   |
| Portland, Oregon        |   |
| February 21, 2002  |   |

 

F-2

----

Table ofContents

 

**AVI BioPharma, Inc.**

**(A Development Stage Company)**

**Balance Sheets**

 
| ** **                                                                                                        | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                        | ** ** | **2009**              | ** ** | **2008**              | ** ** |
| **Assets**                                                                                                        |       |                  |       |                  |       |
| Current Assets:                                                                                                   |       |                  |       |                  |       |
| Cash and cash equivalents                                                                                         |       | $                     | 48,275     |                  | $          | 11,192 |   |
| Short-term securities—available-for-sale                                                                     |       | 171                   |       | 282                   |       |
| Accounts receivable                                                                                               |       | 2,085                 |       | 4,971                 |       |
| Other current assets                                                                                              |       | 779                   |       | 599                   |       |
| Total Current Assets                                                                                              |       | 51,310                |       | 17,044                |       |
|                                                                                                              |       |                  |       |                  |       |
| Property held for sale                                                                                            |       | 2,372                 |       | _                     |       |
| Property and Equipment, net of accumulated depreciation  and amortization of $14,026 and $12,919                  |       | 2,466                 |       | 5,189                 |       |
| Patent Costs, net of accumulated amortization of $1,762  and $1,927                                               |       | 3,759                 |       | 3,268                 |       |
| Other assets                                                                                                      |       | 120                   |       | 35                    |       |
| Total Assets                                                                                                      |       | $                     | 60,027     |                  | $          | 25,536 |   |
|                                                                                                              |       |                  |       |                  |       |
|                                                                                                              |       |                  |       |                  |       |
| **Liabilities and Shareholders’  Equity**                                                                    |       |                  |       |                  |       |
| Current Liabilities:                                                                                              |       |                  |       |                  |       |
| Accounts payable                                                                                                  |       | $                     | 1,381      |                  | $          | 2,014 |   |
| Accrued employee compensation                                                                                     |       | 922                   |       | 1,306                 |       |
| Long-term debt, current portion                                                                                   |       | 77                    |       | 74                    |       |
| Warrant valuation                                                                                                 |       | 27,609                |       | 1,254                 |       |
| Deferred revenue                                                                                                  |       | 3,428                 |       | 2,190                 |       |
| Other liabilities                                                                                                 |       | 90                    |       | 450                   |       |
| Total Current Liabilities                                                                                         |       | 33,507                |       | 7,288                 |       |
|                                                                                                              |       |                  |       |                  |       |
| Commitments and Contingencies                                                                                     |       | —                |       | —                |       |
|                                                                                                              |       |                  |       |                  |       |
| Long-term debt, non-current portion                                                                               |       | 1,924                 |       | 2,001                 |       |
| Other long-term liabilities                                                                                       |       | 966                   |       | 515                   |       |
|                                                                                                              |       |                  |       |                  |       |
| Shareholders’ Equity:                                                                                        |       |                  |       |                  |       |
| Preferred stock, $.0001 par value, 20,000,000 shares  authorized; none issued and outstanding                     |       | —                |       | —                |       |
| Common stock, $.0001 par value, 200,000,000 shares  authorized; 110,495,587 and 71,101,738 issued and outstanding |       | 11                    |       | 7                     |       |
| Additional paid-in capital                                                                                        |       | 299,088               |       | 266,035               |       |
| Deficit accumulated during the development stage                                                                  |       | (275,469              | )          | (250,310              | )          |
| Total Shareholders’ Equity                                                                                   |       | 23,630                |       | 15,732                |       |
| Total Liabilities and Shareholders’ Equity                                                                   |       | $                     | 60,027     |                  | $          | 25,536 |   |

 

Seeaccompanying notes to financial statements.

 

F-3

----

Table ofContents

 

**AVI BioPharma, Inc.**

**(A Development Stage Company)**

**Statements of Operations**

** **
| ** **                                                                                           | ** ** | ** **                        | ** ** | ** **                   | ** ** | ** ** | ** ** | **July 22,  1980**     | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|------------------------------|------------|------------|------------|-----------------------------|------------|
| ** **                                                                                           | ** ** | **Year  ended December 31,** | ** ** | **(Inception) through** | ** ** |
| **(in thousands)**                                                                                   | ** ** | **2009**                          | ** ** | **2008**                     | ** ** | **2007**   | ** ** | **December 31,  2009** | ** ** |
|                                                                                                 |       |                              |       |                         |       |       |       |                        |       |
| Revenues from license fees, grants and research  contracts                                           |       | $                                 | 17,585     |                         | $          | 21,258     |       | $                           | 10,985     |   | $ | 59,809 |   |
|                                                                                                 |       |                              |       |                         |       |       |       |                        |       |
| Operating expenses:                                                                                  |       |                              |       |                         |       |       |       |                        |       |
| Research and development                                                                             |       | 24,396                            |       | 27,331                       |       | 31,058     |       | 230,432                     |       |
| General and administrative                                                                           |       | 8,696                             |       | 11,469                       |       | 13,035     |       | 74,020                      |       |
| Acquired in-process research and development                                                         |       | —                            |       | 9,916                        |       | —     |       | 29,461                      |       |
| Operating loss                                                                                       |       | (15,507                           | )          | (27,458                      | )          | (33,108    | )          | (274,104                    | )          |
|                                                                                                 |       |                              |       |                         |       |       |       |                        |       |
| Other non-operating (loss) income:                                                                   |       |                              |       |                         |       |       |       |                        |       |
| Interest (expense) income and other, net                                                             |       | (454                              | )          | 344                          |       | 984        |       | 8,323                       |       |
| (Increase) decrease on warrant valuation                                                             |       | (9,198                            | )          | 3,161                        |       | 4,956      |       | 3,450                       |       |
| Realized gain on sale of short-term securities— available-for-sale                              |       | —                            |       | —                       |       | —     |       | 3,863                       |       |
| Write-down of short-term securities— available-for-sale                                         |       | —                            |       | —                       |       | —     |       | (17,001                     | )          |
|                                                                                                 |       | (9,652                            | )          | 3,505                        |       | 5,940      |       | (1,365                      | )          |
|                                                                                                 |       |                              |       |                         |       |       |       |                        |       |
| Net loss                                                                                             |       | $                                 | (25,159    | )                            | $          | (23,953    | )          | $                           | (27,168    | ) | $ | (275,469 | ) |
|                                                                                                 |       |                              |       |                         |       |       |       |                        |       |
| Net loss per share - basic and diluted                                                               |       | $                                 | (0.27      | )                            | $          | (0.34      | )          | $                           | (0.50      | ) |   |   |
|                                                                                                 |       |                              |       |                         |       |       |       |                        |       |
| Weighted average number of common shares outstanding  for computing basic and diluted loss per share |       | 93,090                            |       | 69,491                       |       | 53,942     |       |                        |       |

 

Seeaccompanying notes to financial statements.

 

F-4

----

Table ofContents

 

**AVI BioPharma, Inc.**

**(A Development Stage Company)**

**Statements of Shareholders’ Equity andComprehensive Income (Loss)**

** **
| ** **                                                                                           | ** ** | ** **      | ** ** | ** **        | ** ** | ** **  | ** ** | ** **     | ** ** | **Accumulated**   | ** ** | **Deficit**            | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------------|------------|-------------------|------------|-------------|------------|----------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                           | ** ** | ** **      | ** ** | ** **        | ** ** | ** **  | ** ** | ** **     | ** ** | **Other**         | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
| ** **                                                                                           | ** ** | ** **      | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional** | ** ** | **Comprehensive** | ** ** | **During  the**        | ** ** | **Total**  | ** ** |
| ** **                                                                                           | ** ** | **Partnership** | ** ** | **Common  Stock** | ** ** | **Paid-In** | ** ** | **Income**     | ** ** | **Development**   | ** ** | **Shareholders’** | ** ** |
| **(in thousands)**                                                                                   | ** ** | **Units**       | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **(Loss)**        | ** ** | **Stage**              | ** ** | **Equity** | ** ** |
|                                                                                                 |       |            |       |              |       |        |       |           |       |              |       |                   |       |       |       |
| BALANCE  AT JULY 22, 1980 (Inception)                                                                |       | —          |       | —            |       | —      |       | $              | —     |              | $          | —                 |       | $          | —     |   | $ | — |   |
| Issuance  of partnership units, warrants and common stock                                            |       | 3,615           |       | 8,273             |       | 1           |       | 33,733         |       | —            |       | —                 |       | 33,734     |       |
| Compensation  expense related to issuance of warrants for common stock and partnership  units        |       | —          |       | —            |       | —      |       | 537            |       | —            |       | —                 |       | 537        |       |
| Exercise  of warrants for partnership units and common stock                                         |       | 42              |       | 2,236             |       | —      |       | 4,152          |       | —            |       | —                 |       | 4,152      |       |
| Exercise  of options for common stock                                                                |       | —          |       | 990               |       | —      |       | 4,005          |       | —            |       | —                 |       | 4,005      |       |
| Issuance  of common stock for ESPP                                                                   |       | —          |       | 252               |       | —      |       | 810            |       | —            |       | —                 |       | 810        |       |
| Issuance  of common stock and warrants for cash and securities, net of offering costs                |       | —          |       | 37,185            |       | 4           |       | 162,348        |       | —            |       | —                 |       | 162,352    |       |
| Issuance  of common stock and warrants for the acquisition of ImmunoTherapy Corporation              |       | —          |       | 2,132             |       | —      |       | 17,167         |       | —            |       | —                 |       | 17,167     |       |
| Issuance  of common stock and warrants for services                                                  |       | —          |       | 536               |       | —      |       | 2,469          |       | —            |       | —                 |       | 2,469      |       |
| Compensation  expense related to issuance of options for common stock                                |       | —          |       | —            |       | —      |       | 6,842          |       | —            |       | —                 |       | 6,842      |       |
| Conversion  of debt into common stock and partnership units                                          |       | 9               |       | 10                |       | —      |       | 88             |       | —            |       | —                 |       | 88         |       |
| Issuance  of common stock in exchange for partnership units                                          |       | (1,810          | )          | 1,633             |       | —      |       | (0             | )          | —            |       | —                 |       | —     |       |
| Withdrawal  of partnership net assets upon conveyance of technology                                  |       | (1,856          | )          | —            |       | —      |       | (177           | )          | —            |       | —                 |       | (177       | )          |
| Common  stock subject to rescission, net                                                             |       | —          |       | (64               | )          | —      |       | (289           | )          | —            |       | —                 |       | (289       | )          |
| Comprehensive  income (loss):                                                                        |       |            |       |              |       |        |       |           |       |              |       |                   |       |       |       |
| Write-down  of short-term securities— available-for-sale                                        |       | —          |       | —            |       | —      |       | —         |       | 17,001            |       | —                 |       | 17,001     |       |
| Realized  gain on sale of short-term securities— available-for-sale                             |       | —          |       | —            |       | —      |       | —         |       | (3,766            | )          | —                 |       | (3,766     | )          |
| Unrealized  loss on short-term securities— available-for-sale                                   |       | —          |       | —            |       | —      |       | —         |       | (13,217           | )          | —                 |       | (13,217    | )          |
| Net  loss                                                                                            |       | —          |       | —            |       | —      |       | —         |       | —            |       | (199,189               | )          | (199,189   | )          |
| Comprehensive  loss                                                                                  |       |            |       |              |       |        |       |           |       |              |       |                   |       | (199,171   | )          |
| BALANCE  AT DECEMBER 31, 2006                                                                        |       | —          |       | 53,183            |       | 5           |       | $              | 231,685    |              | $          | 18                     |       | $          | (199,189   | ) | $ | 32,519 |   |
| Exercise  of warrants for common stock                                                               |       | —          |       | 12                |       | —      |       | 29             |       | —            |       | —                 |       | 29         |       |
| Exercise  of options for common stock                                                                |       | —          |       | 39                |       | —      |       | 90             |       | —            |       | —                 |       | 90         |       |
| Issuance  of common stock for ESPP                                                                   |       | —          |       | 518               |       | —      |       | 1,450          |       | —            |       | —                 |       | 1,450      |       |
| Issuance  of common stock to vendors                                                                 |       | —          |       |              |       |        |       |           |       | —            |       | —                 |       | —     |       |
| Compensation  expense related to issuance of options for common stock                                |       | —          |       | —            |       | —      |       | 313            |       | —            |       | —                 |       | 313        |       |
| Issuance  of common stock for cash and securities, net of offering costs                             |       | —          |       | 10,697            |       | 1           |       | 14,447         |       | —            |       | —                 |       | 14,448     |       |
| Stock-based  compensation                                                                            |       | —          |       | —            |       | —      |       | 4,719          |       | —            |       | —                 |       | 4,719      |       |
| Comprehensive  income (loss):                                                                        |       |            |       |              |       |        |       |           |       |              |       |                   |       |       |       |
| Unrealized  gain on short-term securities— available-for-sale, net                              |       | —          |       | —            |       | —      |       | —         |       | (18               | )          | —                 |       | (18        | )          |
| Net  loss                                                                                            |       | —          |       | —            |       | —      |       | —         |       | —            |       | (27,168                | )          | (27,168    | )          |
| Comprehensive  loss                                                                                  |       |            |       |              |       |        |       |           |       |              |       |                   |       | (27,186    | )          |
| BALANCE  AT DECEMBER 31, 2007                                                                        |       | —          |       | 64,449            |       | 6           |       | $              | 252,733    |              | $          | —                 |       | $          | (226,357   | ) | $ | 26,382 |   |
| Exercise  of options for common stock                                                                |       | —          |       | 7                 |       | —      |       | 9              |       | —            |       | —                 |       | 9          |       |
| Issuance  of common stock for ESPP                                                                   |       | —          |       | 84                |       | —      |       | 72             |       | —            |       | —                 |       | 72         |       |
| Issuance  of common stock and warrants to vendors                                                    |       | —          |       | 324               |       | —      |       | 828            |       | —            |       | —                 |       | 828        |       |
| Compensation  expense to non-employees on issuance of options and warrants to purchase  common stock |       | —          |       | —            |       | —      |       | 180            |       | —            |       | —                 |       | 180        |       |
| Compensation  expense on issuance of restricted stock                                                |       | —          |       | 100               |       | —      |       | 166            |       | —            |       | —                 |       | 166        |       |
| Stock-based  compensation                                                                            |       | —          |       | 326               |       | —      |       | 3,656          |       | —            |       | —                 |       | 3,656      |       |
| Issuance  of common stock for acquisition of Ercole                                                  |       | —          |       | 5,812             |       | 1           |       | 8,391          |       | —            |       | —                 |       | 8,392      |       |
| Comprehensive  income (loss):                                                                        |       |            |       |              |       |        |       |           |       |              |       |                   |       |       |       |
| Unrealized  gain on short-term securities— available-for-sale, net                              |       | —          |       | —            |       | —      |       | —         |       | —            |       | —                 |       | —     |       |
| Net  loss                                                                                            |       | —          |       | —            |       | —      |       | —         |       | —            |       | (23,953                | )          | (23,953    | )          |
| Comprehensive  loss                                                                                  |       |            |       |              |       |        |       |           |       |              |       |                   |       | (23,953    | )          |
| BALANCE  AT DECEMBER 31, 2008                                                                        |       | —          |       | 71,102            |       | 7           |       | $              | 266,035    |              | $          | —                 |       | $          | (250,310   | ) | $ | 15,732 |   |
| Exercise  of options for common stock                                                                |       | —          |       | 62                |       | —      |       | 76             |       | —            |       | —                 |       | 76         |       |
| Issuance  of common stock for ESPP                                                                   |       | —          |       | 124               |       | —      |       | 85             |       | —            |       | —                 |       | 85         |       |
| Issuance  of common stock for cash and securities, net of offering costs                             |       | —          |       | 38,520            |       | 4           |       | 30,518         |       | —            |       | —                 |       | 30,522     |       |
| Compensation  expense on issuance of restricted stock                                                |       | —          |       | 427               |       | —      |       | 203            |       | —            |       | —                 |       | 203        |       |
| Stock-based  compensation                                                                            |       | —          |       | 261               |       | —      |       | 2,171          |       | —            |       | —                 |       | 2,171      |       |
| Comprehensive  income (loss):                                                                        |       |            |       |              |       |        |       |           |       |              |       |                   |       |       |       |
| Unrealized  gain on short-term securities— available-for-sale, net                              |       | —          |       | —            |       | —      |       | —         |       | —            |       | —                 |       | —     |       |
| Net  loss                                                                                            |       | —          |       | —            |       | —      |       | —         |       | —            |       | (25,159                | )          | (25,159    | )          |
| Comprehensive  loss                                                                                  |       |            |       |              |       |        |       |           |       |              |       |                   |       | (25,159    | )          |
| BALANCE  AT DECEMBER 31, 2009                                                                        |       | —          |       | 110,496           |       | 11          |       | $              | 299,088    |              | $          | —                 |       | $          | (275,469   | ) | $ | 23,630 |   |

 

Seeaccompanying notes to financial statements.

 

F-5

----

Table of Contents

 

**AVI BioPharma, Inc.**

**(A Development Stage Company)**

**Statements of Cash Flows**

 
| ** **                                                                                                                       | ** ** | ** **                        | ** ** | ** **               | ** ** | ** ** | ** ** | **For the  Period**         | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|--------------------------|------------|------------|------------|-----------------------------|------------|
| ** **                                                                                                                       | ** ** | ** **                        | ** ** | ** **               | ** ** | ** ** | ** ** | **July 22,  1980**     | ** ** |
| ** **                                                                                                                       | ** ** | **Year  ended December 31,** | ** ** | **(Inception)  through** | ** ** |
| **(in thousands)**                                                                                                               | ** ** | **2009**                          | ** ** | **2008**                 | ** ** | **2007**   | ** ** | **December 31,  2009** | ** ** |
| Cash  flows from operating activities:                                                                                           |       |                              |       |                     |       |       |       |                        |       |
| Net loss                                                                                                                         |       | $                                 | (25,159    | )                        | $          | (23,953    | )          | $                           | (27,168    | ) | $ | (275,469 | ) |
| Adjustments to reconcile net loss to net cash flows  used in operating activities:                                               |       |                              |       |                     |       |       |       |                        |       |
| Depreciation and amortization                                                                                                    |       | 1,379                             |       | 1,469                    |       | 2,014      |       | 17,682                      |       |
| Loss on disposal of assets                                                                                                       |       | 347                               |       | 584                      |       | 59         |       | 1,305                       |       |
| Realized gain on sale of short-term securities—  available-for-sale                                                         |       | —                            |       | —                   |       | —     |       | (3,863                      | )          |
| Write-down of short-term  securities—available-for-sale                                                                     |       | —                            |       | —                   |       | —     |       | 17,001                      |       |
| Impairment charge on property held for sale                                                                                      |       | 128                               |       | 800                      |       |       |       | 928                         |       |
| Stock-based compensation                                                                                                         |       | 2,374                             |       | 4,830                    |       | 5,732      |       | 22,697                      |       |
| Conversion of interest accrued to common stock                                                                                   |       | —                            |       | —                   |       | —     |       | 8                           |       |
| Acquired in-process research and development                                                                                     |       | —                            |       | 9,916                    |       | —     |       | 29,461                      |       |
| Increase (decrease) on warrant valuation                                                                                         |       | 9,198                             |       | (3,161                   | )          | (4,956     | )          | (3,450                      | )          |
| (Increase) decrease in:                                                                                                          |       |                              |       |                     |       |       |       |                        |       |
| Accounts receivable and other assets                                                                                             |       | 2,621                             |       | (1,850                   | )          | (2,849     | )          | (2,900                      | )          |
| Net increase in accounts payable, accrued employee  compensation, and other liabilities                                          |       | 312                               |       | (975                     | )          | 2,491      |       | 5,274                       |       |
| Net cash used in operating activities                                                                                            |       | (8,800                            | )          | (12,340                  | )          | (24,677    | )          | (191,326                    | )          |
|                                                                                                                             |       |                              |       |                     |       |       |       |                        |       |
| Cash flows from investing activities:                                                                                            |       |                              |       |                     |       |       |       |                        |       |
| Purchase of property and equipment                                                                                               |       | (931                              | )          | (369                     | )          | (1,270     | )          | (17,869                     | )          |
| Patent costs                                                                                                                     |       | (1,063                            | )          | (848                     | )          | (857       | )          | (7,243                      | )          |
| Purchase of marketable securities                                                                                                |       | —                            |       | (11                      | )          | (110       | )          | (112,986                    | )          |
| Sale of marketable securities                                                                                                    |       | 111                               |       | —                   |       | 12,813     |       | 117,724                     |       |
| Acquisition costs                                                                                                                |       | —                            |       | (11                      | )          | —     |       | (2,389                      | )          |
| Net cash (used in) provided by investing activities                                                                              |       | (1,883                            | )          | (1,239                   | )          | 10,576     |       | (22,763                     | )          |
|                                                                                                                             |       |                              |       |                     |       |       |       |                        |       |
| Cash flows from financing activities:                                                                                            |       |                              |       |                     |       |       |       |                        |       |
| Proceeds from sale of common stock, warrants and partnership  units, net of offering costs, and exercise of options and warrants |       | 47,840                            |       | 81                       |       | 18,745     |       | 262,937                     |       |
| Repayments of long-term debt                                                                                                     |       | (74                               | )          | (113                     | )          | —     |       | (187                        | )          |
| Buyback of common stock pursuant to rescission  offering                                                                         |       | —                            |       | —                   |       | —     |       | (289                        | )          |
| Withdrawal of partnership net assets                                                                                             |       | —                            |       | —                   |       | —     |       | (177                        | )          |
| Issuance of convertible debt                                                                                                     |       | —                            |       | —                   |       | —     |       | 80                          |       |
| Net cash (used in) provided by financing activities                                                                              |       | 47,766                            |       | (32                      | )          | 18,745     |       | 262,364                     |       |
|                                                                                                                             |       |                              |       |                     |       |       |       |                        |       |
| Increase (decrease) in cash and cash equivalents                                                                                 |       | 37,083                            |       | (13,611                  | )          | 4,644      |       | 48,275                      |       |
|                                                                                                                             |       |                              |       |                     |       |       |       |                        |       |
| Cash and cash equivalents:                                                                                                       |       |                              |       |                     |       |       |       |                        |       |
| Beginning of period                                                                                                              |       | 11,192                            |       | 24,803                   |       | 20,159     |       | —                      |       |
| End of period                                                                                                                    |       | $                                 | 48,275     |                     | $          | 11,192     |       | $                           | 24,803     |   | $ | 48,275 |   |
|                                                                                                                             |       |                              |       |                     |       |       |       |                        |       |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                                                                |       |                              |       |                     |       |       |       |                        |       |
| Cash paid during the year for interest                                                                                           |       | $                                 | 97         |                     | $          | 104        |       | $                           | 104        |   | $ | 305 |   |
| SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES  AND FINANCING ACTIVITIES:                                                 |       |                              |       |                     |       |       |       |                        |       |
| Short-term securities—available-for-sale received  in connection with the private offering                                  |       | $                                 | —     |                     | $          | —     |       | $                           | —     |   | $ | 17,897 |   |
| Change in unrealized gain (loss) on short-term securities—available-for-sale                                                |       | $                                 | —     |                     | $          | —     |       | $                           | (18        | ) | $ | — |   |
| Issuance of common stock and warrants in satisfaction  of liabilities                                                            |       | $                                 | —     |                     | $          | —     |       | $                           | —     |   | $ | 545 |   |
| Issuance of common stock for building purchase                                                                                   |       | $                                 | —     |                     | $          | —     |       | $                           | 750        |   | $ | 750 |   |
| Assumption of long-term debt for building purchase                                                                               |       | $                                 | —     |                     | $          | —     |       | $                           | 2,200      |   | $ | 2,200 |   |
| Issuance of common stock for Ercole assets                                                                                       |       | $                                 | —     |                     | $          | 8,075      |       | $                           | —     |   | $ | 8,075 |   |
| Assumption of liabilities for Ercole assets                                                                                      |       | $                                 | —     |                     | $          | 2,124      |       | $                           | —     |   | $ | 2,124 |   |

 

Seeaccompanying notes to financial statements.

 

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**AVI BioPharma, Inc.**

**(A Development Stage Company)**

 

# **NOTES TO FINANCIAL STATEMENTS**

# ** **

**1. ORGANIZATION AND NATURE OF BUSINESS:**

 

AVI BioPharma, Inc.(the “Company” or “AVI”) was incorporated in the State of Oregon on July 22,1980. The mission of the Company is to develop and commercialize improvedtherapeutic products based upon antisense and cancer immunotherapy technology.

 

Through May 1993,the financial statements included the combined accounts of the Company andANTI-GENE DEVELOPMENT GROUP, a limited partnership (AGDG or the Partnership)founded in 1981 and registered in the State of Oregon. Substantially all incomegenerated and proceeds from the Partnership unit sales through that date havebeen paid to the Company under the terms of research and development contractsentered into by the Partnership and the Company. Significant transactionsbetween the Company and the Partnership through that date have been eliminated.

 

In March 1993, theCompany offered to all partners in the Partnership the opportunity to exchangetheir partnership units or warrants to purchase partnership units (unitwarrants) for common stock or warrants to purchase common stock. Under the termsof the offer, which was completed May 1, 1993, each partner could elect toexchange each unit held or unit warrant held for 1,100 shares of common stockor warrants to purchase 1,100 shares of common stock of the Company,respectively. Total shares and warrants to purchase shares issued in theexchange offer were 1,632,950 and 381,700, respectively.

 

Effective May 19,1993, the Company and the Partnership entered into a Technology TransferAgreement wherein the Partnership conveyed all intellectual property thenwithin its control to the Company. As part of the conveyance, the Companytendered to the Partnership for liquidation all partnership units receivedpursuant to the exchange offer and received a 49.37 percent undivided interestin the intellectual property. The Company then purchased the remainingundivided interest in the intellectual property for rights to payments of4.05 percent of gross revenues in excess of $200 million, from sales ofproducts, which would, in the absence of the Technology Transfer Agreement,infringe a valid claim under any patent transferred to the Company. The Companyalso granted to the Partnership a royalty-bearing license to make, use and sellsmall quantities of product derived from the intellectual property for researchpurposes only.

 

In March 2000, theCompany and AGDG amended the Technology Transfer Agreement to give to AGDG andGene Tools LLC, related organizations, exclusive, non royalty-bearing rights toin vitro diagnostic applications of the intellectual property. In considerationfor this amendment, Gene Tools paid the Company $1 million and reduced theroyalty that the Company would pay to AGDG under the Technology TransferAgreement on future sales of therapeutic products from 4.05% to 3.00%.

 

The remaining net assetsof the Partnership, $177,000 of cash, were no longer combined with those of theCompany in May 1993. Under the terms of the Technology Transfer Agreement,the Partnership ceased active sales of partnership units and income generatingactivities and no longer will enter into research and development contractswith the Company. The Partnership currently exists primarily for the purpose ofcollecting potential future payments from the Company as called for in theTechnology Transfer Agreement.

 

*Acquisition of Ercole*

 

On March 20, 2008,the Company acquired all of the stock of Ercole Biotechnology, Inc. (“Ercole”)in exchange for 5,811,721 shares of AVI common stock. The transaction includedthe assumption of approximately $1.8 million in liabilities of Ercole. The AVIcommon stock was valued at approximately $8.4 million. AVI also issued warrantsto purchase AVI stock to settle certain outstanding warrants held in Ercole,which were valued at $437,000. These warrants are classified as equity. Theacquisition was aimed at consolidating AVI’s position in directed alternativeRNA splicing therapeutics. Ercole and the Company had been collaborating since2006 to develop drug candidates, including AVI-4658, currently in clinicaltesting in the United Kingdom for the treatment of Duchenne muscular dystrophy.Ercole has other ongoing discovery research programs.

 

The total estimatedpurchase price of $10.2 million has been allocated as follows:

 
| Accounts  Receivable                          |   | $ | 76,000    |   |
|-----------------------------------------------|--------|---|-----------|--------|
| Prepaid  Expenses                             |   | $ | 7,000     |   |
| Fixed  Assets                                 |   | $ | 10,000    |   |
| Patents                                       |   | $ | 190,000   |   |
| Acquired  In-Process Research and Development |   | $ | 9,916,000 |   |

 

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The pending patentsacquired as part of the Ercole acquisition have an expected expiration date of2026. Acquired in-process research and development consists of other discoveryresearch programs in areas including beta thalassemia and soluble tumornecrosis factor receptor. As these programs were in development at the time ofacquisition, there were significant risks associated with completing theseprojects, and there were no alternative future uses for these projects, theassociated value has been considered acquired in-process research anddevelopment.

 

Ercole has been adevelopment stage company since inception and does not have a product for sale.The Company has retained a limited number of Ercole employees and plans onincorporating in-process technology of Ercole into the Company’s processes. Theacquisition of Ercole did not meet the definition of a business and it istherefore being accounted for as an asset acquisition.

 

**2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:**

 

*Basisof Accounting*

 

The financial statementshave been prepared in accordance with U.S. generally accepted accountingprinciples as outlined in the*FASBAccounting Standards Codification**TM**.*

 

*Use ofEstimates*

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates. Significantitems subject to such estimates and assumptions include the valuation ofinvestments andliability classified warrants, long-lived asset impairment, and revenuerecognition.

 

*Reclassifications*

 

Certain prior yearamounts have been reclassified to conform to current year presentation. Thesechanges did not have a significant impact on Company’s net loss, assets,liabilities, shareholders’ equity or cash flows.

 

*Cash and Cash Equivalents*

 

The Company considers allhighly liquid investments with an original maturity of three months or lessfrom the date of purchase to be cash equivalents.

 

*Short-TermSecurities—Available-For-Sale*

 

Short-term securitiesinclude certificates of deposit, commercial paper and other highly liquidinvestments with original maturities in excess of 90 days at the time ofpurchase and less than one year from the balance sheet date. The Companyclassifies its investment securities as available-for-sale and, accordingly,such investment securities are stated on the balance sheet at their fair marketvalue with unrealized gains (losses) recorded as a separate component ofshareholders’ equity and comprehensive income (loss).  There were no unrealized gains or losses onthe Company’s investments in marketable securities on its balance sheets as of December 31,2009 and 2008.

 

*AccountsReceivable*

 

Accounts receivable arestated at invoiced amount and do not bear interest as they are due withintwelve months. Because a majority of accounts receivable are from the U.S.government and historically no amounts have been written off, an allowance fordoubtful accounts receivable is not considered necessary. Amounts included inaccounts receivable are as follows:

 
| **As of December 31,** | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|-----------------------------|------------|------------|------------|------------|------------|
| **(in thousands)**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Research  contract          |       | $          | 2,085      |       | $          | 4,971 |   |
|                        |       |       |       |       |       |
| Accounts  receivable        |       | $          | 2,085      |       | $          | 4,971 |   |

 

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*Propertyand Equipment*

 

Property and equipment isstated at cost and depreciated over the estimated useful lives of the assets,generally five years, using the straight-line method. Leasehold improvementsare amortized over the shorter of the lease term or the estimated useful lifeof the asset, generally five years, using the straight-line method.Expenditures for repairs and maintenance are expensed as incurred. Expendituresthat increase the useful life or value are capitalized.

 

Amounts included inproperty held for sale:

 
| **As of December 31,** | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|-----------------------------|------------|------------|------------|------------|------------|
| **(in thousands)**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Property  held for sale     |       | $          | 2,372      |       | $          | — |   |
|                             |            |            |            |            |            |  |  |

 

The Company has listedfor sale an industrial property located in Corvallis Oregon for a sales priceof $2.5 million. Selling and closing expenses are estimated to be $0.1million.  The Company has decided tooutsource its large scale manufacturing activities and has listed this propertyfor sale with a commercial real estate agent.

 

Amounts included inproperty and equipment are as follows:

 
| **As of December 31,**    | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|--------------------------------|------------|------------|------------|------------|------------|
| **(in  thousands)**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Building                       |       | $          | —     |       | $          | 2,500 |   |
| Lab  equipment                 |       | 5,933      |       | 5,676      |       |
| Office  equipment              |       | 970        |       | 741        |       |
| Leasehold  improvements        |       | 9,589      |       | 9,191      |       |
|                           |       | 16,492     |       | 18,108     |       |
| Less  accumulated depreciation |       | (14,026    | )          | (12,919    | )          |
| Property  and equipment, net   |       | $          | 2,466      |       | $          | 5,189 |   |

 

Depreciation expense was$1,154,000, $1,212,000 and $1,718,000 for the years ended December 31,2009, 2008 and 2007, respectively.

 

*Patent Costs*

 

Patent costs consistprimarily of legal and filing fees incurred to file patents on proprietarytechnology developed by the Company. Patent costs are amortized on astraight-line basis over the shorter of the estimated economic lives or thelegal lives of the patents, generally 20 years. Patent amortization was$225,000, $257,000 and $296,000 for the years ended December 31, 2009,2008 and 2007, respectively.  The Companyalso expensed the remaining net book value of previously capitalized patentsthat were later abandoned of $347,000, $580,000 and $0, for 2009, 2008 and 2007respectively. The Company expects to incur amortization expense ofapproximately $146,000 per year over the following five fiscal years.

 

#### ***Revenue Recognition***

#### ** **

The Company recordsrevenue from research contracts and grants as the services are performed andpayment is reasonably assured. In 2009, 2008 and 2007, the Company recognized$17,585,000, $21,258,000 and $10,985,000, respectively, in research contractsrevenues from government funding for work performed on viral disease projectsand other grants and contracts.  Revenueassociated with research and development arrangements is recognized under theproportional performance method, using the payment received method. To date,revenue from research and development arrangements has not been material.

 

##### ***Research and Development***

##### ** **

Research and development(R&D) expenses include related salaries, contractor fees, materials,utilities and allocations of corporate costs. R&D expenses also consist ofindependent R&D costs and costs associated with collaborative developmentarrangements. In addition, the Company funds R&D at other companies andresearch institutions under agreements. Research and development costs areexpensed as incurred.

 

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*OtherCurrent Assets*

 

Amounts included in othercurrent assets are as follows:

 
| **As of December 31,** | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|-----------------------------|------------|------------|------------|------------|------------|
| **(in  thousands)**         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Prepaid  expenses           |       | $          | 337        |       | $          | 316 |   |
| Prepaid  rents              |       | 158        |       | —     |       |
| Restricted  cash            |       | 284        |       | 283        |       |
|                        |       |       |       |       |       |
| Other  current assets       |       | $          | 779        |       | $          | 599 |   |

 

Starting in April 2006,the Company was required to pledge $150,000 as collateral for company creditcards issued to certain employees. Starting in April 2007, the Company wasrequired to pledge $125,000 as collateral for payments on long-term debt. TheCompany classifies these amounts as restricted cash. As of December 31,2009, restricted cash including accrued interest was $284,000. The remainingcomponents of other current assets include normally occurring prepaid expensesand rents.

 

*Stock-basedCompensation*

 

The Company issuesstock-based compensation to certain employees, officers and directors.  These principles require companies to accountfor stock options using the fair value method, which results in the recognitionof compensation expense over the vesting period of the options.  See Note 3.

 

*IncomeTaxes*

 

Income taxes areaccounted for under the asset and liability method. Deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases and operating loss and taxcredit carryforwards. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered and settled. Avaluation allowance is recorded to reduce the net deferred tax asset to zerobecause it is more likely than not that the deferred tax asset will not berealized. The Company recognizes the effect of income tax positions only ifthose positions are more likely than not of being sustained upon anexamination.

 

*FairValue of Financial Instruments*

 

The Company measures atfair value certain financial assets and liabilities. Generally acceptedaccounting principles specify a hierarchy of valuation techniques based onwhether the inputs to those valuation techniques are observable orunobservable. Observable inputs reflect market data obtained from independentsources, while unobservable inputs reflect the Company’s market assumptions.These two types of inputs have created the following fair-value hierarchy:

 

Level 1—Quoted prices foridentical instruments in active markets;

 

Level 2—Quoted prices forsimilar instruments in active markets, quoted prices for identical or similarinstruments in markets that are not active, and model-derived valuations inwhich all significant inputs and significant value drivers are observable inactive markets; and

 

Level 3—Valuationsderived from valuation techniques in which one or more significant valuedrivers are unobservable.

 

The Company’s assetsmeasured at fair value on a recurring basis consisted of the following as of December 31,2009:

 
| ** **                                                     | ** ** | **Fair Value Measurement as of December 31, 2009** |       |
|----------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(in  thousands)**                                            | ** ** | **Total**                                               | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Short-term  securities-available- for-sale and restricted cash |       | $                                                       | 48,730     |   | $ | 48,275 |   | $ | 455 |   | $ | — |   |
| Total                                                          |       | $                                                       | 48,730     |   | $ | 48,275 |   | $ | 455 |   | $ | — |   |

 

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The Company’s liabilitiesmeasured at fair value on a recurring basis consisted of the following as ofthe date indicated:

 
| ** **          | ** ** | **Fair Value Measurement as of December 31, 2009** | ** ** |
|---------------------|------------|---------------------------------------------------------|------------|
| **(in  thousands)** | ** ** | **Total**                                               | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Warrants            |       | $                                                       | 27,609     |   | $ | — |   | $ | — |   | $ | 27,609 |   |
| Total               |       | $                                                       | 27,609     |   | $ | — |   | $ | — |   | $ | 27,609 |   |

 

The Company’s assetsmeasured at fair value on a recurring basis consisted of the following as of December 31,2008:

 
| ** **                                                     | ** ** | **Fair Value Measurement as of December 31, 2008** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(in  thousands)**                                            | ** ** | **Total**                                               | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Short-term  securities-available- for-sale and restricted cash |       | $                                                       | 11,757     |   | $ | 11,192 |   | $ | 565 |   | $ | — |   |
| Total                                                          |       | $                                                       | 11,757     |   | $ | 11,192 |   | $ | 565 |   | $ | — |   |

 

The Company’s liabilitiesmeasured at fair value on a recurring basis consisted of the following as ofthe date indicated:

 
| ** **          | ** ** | **Fair Value Measurement as of December 31, 2008** | ** ** |
|---------------------|------------|---------------------------------------------------------|------------|
| **(in  thousands)** | ** ** | **Total**                                               | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Warrants            |       | $                                                       | 1,254      |   | $ | — |   | $ | — |   | $ | 1,254 |   |
| Total               |       | $                                                       | 1,254      |   | $ | — |   | $ | — |   | $ | 1,254 |   |

 

A reconciliation of thechange in value of the Company’s warrants for the year ended December 31,2009 is as follows:

 
| ** **                         | ** ** | **Fair Value Measurements  Using Significant  Unobservable Inputs** | ** ** |
|------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(in  thousands)**                | ** ** | **(Level 3)**                                                       | ** ** |
|                               |       |                                                                |       |
| Balance  at January 1, 2009   |       | $                                                                   | 1,254      |   |
| Change  in value of warrants       |       | 9,198                                                               |       |
| Issuances                          |       | 17,157                                                              |       |
| Balance  at December 31, 2009 |       | $                                                                   | 27,609     |   |

 

A reconciliation of thechange in value of the Company’s warrants for the year ended December 31,2008 is as follows:

 
| ** **                         | ** ** | **Fair Value Measurements  Using Significant  Unobservable Inputs** | ** ** |
|------------------------------------|------------|---------------------------------------------------------------------|------------|
| **(in  thousands)**                | ** ** | **(Level 3)**                                                       | ** ** |
|                               |       |                                                                |       |
| Balance  at January 1, 2008   |       | $                                                                   | 4,415      |   |
| Change  in value of warrants       |       | (3,161                                                              | )          |
|                               |       |                                                                |       |
| Balance  at December 31, 2008 |       | $                                                                   | 1,254      |   |

 

The carrying amountsreported in the balance sheets for cash and cash equivalents, accountsreceivable, accounts payable, and other current monetary assets and liabilitiesapproximate fair value because of the immediate or short-term maturity of thesefinancial instruments.

 

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*Warrants*

 

Certain of the Company’swarrants issued in connection with financing arrangements are classified asliabilities in accordance with the generally accepted accountingpronouncements, whereby, the fair market value of these warrants is recorded onthe balance sheet at issuance and marked to market at each financial reportingperiod. The change in the fair value of the warrants is recorded in theStatement of Operations as a non-cash gain (loss) and is estimated using theBlack-Scholes option-pricing model with the following assumptions:

 
| **Year  Ended December 31,**           | ** ** | **2009**      | ** ** | **2008**      | ** ** | **2007**      | ** ** |
|---------------------------------------------|------------|---------------|------------|---------------|------------|---------------|------------|
| Risk-free  interest rate                    |       | 0.2%-2.69     | %          | 0.3%-3.0      | %          | 3.1%-3.5      | %          |
| Expected  dividend yield                    |       | 0             | %          | 0             | %          | 0             | %          |
| Expected  lives                             |       | 0.4-4.7 years |       | 0.2-4.2 years |       | 0.9-5.0 years |       |
| Expected  volatility                        |       | 86.0%-102.1   | %          | 63.6%-104.8   | %          | 58.2%-80.7    | %          |
| Warrants  classified as liabilities         |       | 30,203,466    |       | 7,994,229     |       | 9,607,866     |       |
| Warrants  classified as equity              |       | 2,129,530     |       | 2,129,530     |       | 4,248,545     |       |
| Market  value of stock at beginning of year |       | $             | 0.66       |          | $          | 1.41          |       | $ | 3.18 |   |
| Market  value of stock at end of year       |       | $             | 1.46       |          | $          | 0.66          |       | $ | 1.41 |   |

 

The risk-free interestrate is estimated using an average of treasury bill interest rates. The expecteddividend yield is zero as the Company has not paid any dividends to date anddoes not expect to pay dividends in the future. The expected lives are based onthe remaining contractual lives of the related warrants. The expectedvolatility is estimated using historical calculated volatility and considersfactors such as future events or circumstances that could impact volatility.

 

For warrants classifiedas permanent equity, the fair value of the warrants is recorded as additionalpaid-in capital and no further adjustments are made.

 

*ComprehensiveIncome (Loss)*

 

Comprehensive income(loss) includes charges or credits to equity that did not result fromtransactions with shareholders. The Company’s only component of “othercomprehensive income (loss)” is unrealized gain (loss) on cash equivalents andshort-term securities—available-for-sale.

 

*Rent Expense*

 

The Company’s operating lease agreements for itsCorvallis, Oregon facility and its Bothell, Washington facility provide forscheduled annual rent increases throughout the lease’s term.  In accordance with generally acceptedaccounting principles the Company recognizes the effects of the scheduled rentincreases on a straight-line basis over the full term of the leases, whichexpires in 2020 and 2014.

 

During the years ended December 31, 2009, 2008and 2007, the Company recognized $230,000, $133,000 and $155,000, respectively,in additional rent expense from the amortization of future scheduled rentincreases.

 

*Commitmentsand Contingencies**.*

 

In the normal course ofbusiness, the Company may be named as a party to various legal claims, actionsand complaints, including matters involving employment, intellectual property,effects from the use of drugs utilizing our technology, or others. Itis impossible to predict with certainty whether any resultingliability would have a material adverse effect on the Company’s financialposition, results of operations or cash flows.

 

*Financial Instruments**.*

 

The carrying amountsreported in the balance sheets for cash and cash equivalents, accountsreceivable, accounts payable, and other current monetary assets and liabilitiesapproximate fair value because of the immediate or short-term maturity of these financial instruments.

 

*LicenseArrangements.*

 

License arrangements mayconsist of non-refundable upfront license fees, data transfer fees, researchreimbursement payments, exclusive licensed rights to patented or patent pendingcompounds, technology access fees, various performance or sales milestones andfuture product royalty payments. Some of these arrangements are multipleelement arrangements.

 

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The Company defersrecognition of non-refundable upfront fees if it has continuing performanceobligations without which the technology, right, product or service conveyed inconjunction with the non-refundable fee has no utility to the licensee that isseparate and independent of Company performance under the other elements of thearrangement. In addition, if the Company has continuing involvement throughresearch and development services that are required because its know-how andexpertise related to the technology is proprietary to the Company, or can onlybe performed by the Company, then such up-front fees are deferred andrecognized over the period of continuing involvement.

 

Payments related tosubstantive, performance-based milestones in a research and developmentarrangement are recognized as revenue upon the achievement of the milestones asspecified in the underlying agreements when they represent the culmination ofthe earnings process.

 

*Long-LivedAsset Impairment*

 

Long-lived assets heldand used by us and intangible assets with determinable lives are reviewed forimpairment whenever events or circumstances indicate that the carrying amountof assets may not be recoverable in accordance with generally acceptedaccounting pronouncements. We evaluate recoverability of assets to be held andused by comparing the carrying amount of an asset to future net undiscountedcash flows to be generated by the asset. If such assets are considered to beimpaired, the impairment to be recognized is measured as the amount by whichthe carrying amount of the assets exceeds the fair value of the assets. Suchreviews assess the fair value of the assets based upon estimates of future cashflows that the assets are expected to generate.

 

At December 31,2008, the Company determined that the ongoing decline in the real estate markethad adversely impacted the fair value of a building purchased by the Companyfor $3.3 million in 2007. Based on an independent third-party appraisal, theCompany estimated that the current fair value of the building had declined toapproximately $2.5 million. Accordingly, an impairment charge of $800,000 wasrecorded for the year ended December 31, 2008. The Company completed asecond third party appraisal in November of 2009, based on this revisedestimate the Company believes the property to have a current fair value, net ofcosts to sell of $2.4 million.  Thisproperty was listed for sale in November of 2009. Selling and closingexpenses are estimated to be $0.1 million. The Company has decided to outsource its large scale manufacturingactivities and has listed this property for sale with a commercial real estateagent.

 

In addition, at December 31,2009, the Company conducted an evaluation of the status of its patents eachquarter during 2009. Pursuant to these evaluations, the Company has recorded awrite-off of $347,000, in 2009 for previously capitalized costs related topatents that have expired or were abandoned.

 

*GovernmentResearch Contract Revenue.*

 

The Company recognizesrevenues from federal research contracts during the period in which the relatedexpenditures are incurred. The Company receives reimbursement of costsincurred, overhead and, in some cases, a fixed fee. The Company presents theserevenues and related expenses at gross in the consolidated financial statementsin accordance with the generally accepted accounting pronouncements.

 

*Recent Accounting Pronouncements*

 

Recently adoptedaccounting guidance:

 

During the first fiscalquarter of 2009, the Financial Accounting Standards Board issued Staff PositionsASC 820 10 65-65-4, “Determining Fair Value When the Volume and Level ofActivity for the Asset or Liability has Significantly Decreased and theIdentifying Transactions That Are Not Orderly”, ASC 320 10 65-65-1, “Recognitionand Presentation of Other-Than-Temporary Impairments”, and ASC 825 10 65 65-1, “InterimDisclosures about Fair Value of Financial Instruments”. These Staff Positionswere issued to clarify the application of ASC 820 10 65-65-4, “Fair ValueMeasurements” in the current economic environment, modify the recognition ofother-than-temporary impairments of debt securities, and require companies todisclose the fair value of financial instruments in interim periods. The StaffPositions are effective for interim and annual periods ending after September 15,2009, with early adoption permitted for periods ending after March 15,2009, if all three Staff Positions or both the fair-value measurement andother-than-temporary impairment Staff Positions are adopted simultaneously. TheCompany has adopted the Staff Positions in the third quarter of fiscal 2009,and there was no material impact on the Company’s Financial Statements orrelated disclosures.

 

In April 2009, theFASB issued FASB Staff Position ASC 320 10 65-65-1, “Recognition and Presentationof Other-Than-Temporary Impairments”, which requires the Company to discloseinformation for interim and annual periods that enables users of its financialstatements to understand the types of available-for-sale and held-to-maturitydebt and equity securities held, including information about investments in anunrealized loss position for which an other-than-temporary impairment has orhas not been recognized. The provisions of this pronouncement were adopted inthe second quarter of 2009. There was no material impact on the Company’sfinancial statements.

 

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In April 2009, theFASB issued FSP  ASC 825 10 65 65-1, “InterimDisclosures about Fair Value of Financial Instruments” , which requirespublicly traded companies to include disclosures about the fair value of itsfinancial instruments whenever it issues summarized financial information forinterim reporting periods. The provisions of these pronouncements were adoptedin the second quarter of 2009. There was no material impact on the Company’sfinancial statements.

 

**Recent accounting guidance notyet adopted:**

 

In January 2010, theFASB issued guidance to amend the disclosure requirements related to recurringand nonrecurring fair value measurements. The guidance requires new disclosureson the transfers of assets and liabilities between Level 1 (quoted prices inactive market for identical assets or liabilities) and Level 2 (significantother observable inputs) of the fair value measurement hierarchy, including thereasons and the timing of the transfers. The guidance will become effective forus with the reporting period beginning January 1, 2010, except for thedisclosure on the roll forward activities for Level 3 fair value measurements,which will become effective for us with the reporting period beginning July 1,2011. Other than requiring additional disclosures, adoption of this newguidance will not have a material impact on our financial statements.

 

**3. STOCK-BASEDCOMPENSATION:**

 

Stock-based compensationcosts are generally based on the fair value calculated from the Black-Scholesoption-pricing model on the date of grant for stock options and on the date ofenrollment for the Plan. The fair value of stock grants is amortized ascompensation expense on a straight-line basis over the vesting period of thegrants. Stock options granted to employees are service-based and typically vestover three years.

 

The fair market values ofstock options granted during 2009, 2008 and 2007 were measured on the date ofgrant using the Black-Scholes option-pricing model, with the following weightedaverage assumptions:

 
| **Year Ended December 31,** | ** ** | **2009**      | ** ** | **2008**      | ** ** | **2007**      | ** ** |
|----------------------------------|------------|---------------|------------|---------------|------------|---------------|------------|
| Risk-free  interest rate         |       | 1.2%-1.8      | %          | 1.1%-3.4      | %          | 4.4%-5.1      | %          |
| Expected  dividend yield         |       | 0             | %          | 0             | %          | 0             | %          |
| Expected  lives                  |       | 3.6-9.1 Years |       | 3.6-9.1 Years |       | 3.7-9.1 Years |       |
| Expected  volatility             |       | 92.0%-94.4    | %          | 81.0%-90.7    | %          | 84.1%-90.6    | %          |

 

The risk-free interestrate is estimated using an average of treasury bill interest rates. Theexpected dividend yield is zero as the Company has not paid any dividends todate and does not expect to pay dividends in the future. The expected lives areestimated using expected and historical exercise behavior. The expectedvolatility is estimated using historical calculated volatility.

 

The Company is requiredto estimate potential forfeiture of stock grants and adjust compensation costrecorded accordingly. The estimate of forfeitures is adjusted over therequisite service period to the extent that actual forfeitures differ, or areexpected to differ, from such estimates. Changes in estimated forfeitures arerecognized through a cumulative catch-up in the period of change and impact theamount of stock compensation expense to be recognized in future periods.

 

A summary of the Company’sstock option activity with respect to the years ended December 31, 2009,2008 and 2007 is presented in the following table:

 
| ** **                                             | ** ** | **2009**   | ** ** | **2008**                               | ** ** | **2007**   | ** ** |
|--------------------------------------------------------|------------|------------|------------|----------------------------------------|------------|------------|------------|
| **For the Year Ended  December 31,**              | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise**

**Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Options  outstanding at beginning of year              |       | 7,540,873  |       | $                                      | 3.34       |       | 6,304,453  |   | $ | 4.60 |   | 5,571,470 |   | $ | 5.12 |   |
| Granted                                                |       | 2,727,000  |       | 1.10                                   |       | 2,743,607  |       | 1.27 |   | 1,263,548 |   | 2.80 |   |
| Exercised                                              |       | (62,711    | )          | 1.68                                   |       | (6,761     | )          | 1.31 |   | (11,639 | ) | 2.49 |   |
| Canceled                                               |       | (1,272,351 | )          | 2.72                                   |       | (1,500,426 | )          | 4.82 |   | (518,926 | ) | 5.88 |   |
| Options  outstanding at end of year                    |       | 8,932,811  |       | 2.79                                   |       | 7,540,873  |       | 3.34 |   | 6,304,453 |   | 4.60 |   |
|                                                   |       |       |       |                                   |       |       |       |   |   |   |   |   |   |
| Exercisable  at end of year                            |       | 5,119,227  |       | $                                      | 3.94       |       | 4,779,603  |   | $ | 4.18 |   | 4,497,526 |   | $ | 4.76 |   |
| Vested  at December 31, 2009 and expected to vest |       | 8,856,539  |       | $                                      | 2.80       |       |       |   |   |   |   |   |   |   |

 

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The following tablesummarizes information about stock options outstanding at December 31,2009:

 
| ** **                    | ** ** | **Outstanding Options** | ** ** | **Exercisable Options**              | ** ** |
|-------------------------------|------------|-------------------------|------------|--------------------------------------|------------|
| **Range  of Exercise Prices** | ** ** | **Number of Shares**    | ** ** | **Weighted Average Exercise  Price** | ** ** | **Weighted Average  Remaining Contractual********Life (Years)** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise**

**Price** | ** ** |
| $0.60-$1.09                   |       | 2,013,950               |       | $                                    | 0.96       |   | 8.54 |   | 200,617 |   | $ | 1.06 |   |
| $1.10-$1.39                   |       | 1,895,430               |       | $                                    | 1.24       |   | 8.64 |   | 447,181 |   | $ | 1.28 |   |
| $1.42-$2.53                   |       | 1,969,357               |       | $                                    | 2.18       |   | 6.29 |   | 1,569,524 |   | $ | 2.30 |   |
| $2.55-$5.75                   |       | 2,106,291               |       | $                                    | 4.49       |   | 3.08 |   | 1,954,122 |   | $ | 4.60 |   |
| $5.88-$7.35                   |       | 947,783                 |       | $                                    | 7.21       |   | 4.26 |   | 947,783 |   | $ | 7.21 |   |
| Total                         |       | 8,932,811               |       | $                                    | 2.79       |   | 6.33 |   | 5,119,227 |   | $ | 3.94 |   |

 

The weighted average fairvalue per share of stock-based payments granted to employees during 2009, 2008and 2007 was $1.09, $1.04 and $2.27, respectively. During 2009, 2008 and 2007,the total intrinsic value of stock options exercised was $105,301, $1,831 and$4,937, and the total fair value of stock options that vested was $1,740,000,$3,040,000 and $3,661,000, respectively.

 

As of December 31,2009, there was $2,278,000 of total unrecognized compensation cost related tononvested share-based compensation arrangements granted under the Plan. Thesecosts are expected to be recognized over a weighted-average period of 2.3years.

 

During the year ended December 31,2009, $76,000 was received for the exercise of stock options. The Company isobligated to issue shares from the 2002 Equity Incentive Plan upon the exerciseof stock options. The Company does not currently expect to repurchase sharesfrom any source to satisfy its obligations under the Plan. The Company mayissue options to purchase up to an additional 681,995 shares of Common Stock atDecember 31, 2009 under stock option plans.

 

The following are thestock-based compensation costs recognized in the Company’s statements ofoperations:

 

(in thousands)

 
| ** **                  | ** ** | **Year Ended  December 31, 2009** | ** ** | **Year Ended  December 31, 2008** | ** ** | **Year Ended  December 31, 2007** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| Research  and development   |       | $                                      | 1,192      |                                   | $          | 1,689                                  |       | $ | 1,878 |   |
| General  and administrative |       | 1,182                                  |       | 3,141                                  |       | 3,854                                  |       |
| Total                       |       | $                                      | 2,374      |                                   | $          | 4,830                                  |       | $ | 5,732 |   |

 

On March 27, 2007,in connection with his resignation, the Company entered into a Separationand Release Agreement with AVI’s former Chairman and Chief Executive Officer.Pursuant to this agreement, he may exercise his previously granted optionsuntil the earlier of the termination date specified in the respective stockoption grant agreements or March 28, 2010. This modification of thesestock options in the first quarter of 2007 increased compensation costs by$1,057,000.

 

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In the first quarter of2008, the Company granted 333,000 shares of restricted stock to its new ChiefExecutive Officer. These shares vest over a period of four years. The Companyrecognized compensation expense related to these shares of for the years ended December 31,2009 and 2008, of $63,000 and $166,000.

 

In the third quarter of2008, the Company’s President and Chief Operating Officer resigned. Inaccordance with his existing employment agreement, he may exercise hispreviously granted options until the earlier of the termination date specifiedin the respective stock option grant agreements or March 18, 2010.  This acceleration of the vesting of thesestock options resulted in additional compensation costs of $382,000 for theyear ended December 31, 2008. As of December 31, 2009, these optionswere outstanding.

 

In the second quarter of2009, the Company granted a total of 25,000 shares of restricted stock tomembers of its Board of Directors. These shares vest over a period of oneyear.  During year ended December 31,2009, the Company recognized compensation expense related to these shares of$58,000.

 

Also in the secondquarter of 2009, the Company granted 100,000 shares of restricted stock to itsVice President of Business Development. These shares vest******upon the achievementof certain performance milestones. During the year ended December 31,2009, the Company did not recognize any compensation expense related to theseshares since the performance milestones was not achieved and these shares werecanceled.

 

In the first quarter of2009, the Company granted 60,000 shares of restricted stock to its ChiefMedical Officer. These shares vest over a period of 181 days.  During theyear ended December 31, 2009 the Company recognized compensation expenserelated to these shares of $82,000.

 

The Company records thefair value of stock options granted to non-employees in exchange for servicesin accordance with generally accepted accounting principles. The fair value ofthe options granted is expensed when the measurement date is known. Theperformance for services was satisfied on the grant date for stock optionsgranted to non-employees.

 

The total fair value ofthe options granted to non-employees during the years ended December 31,2009, 2008 and 2007 was $141,000, $180,000 and $313,000 respectively, which wasexpensed to general and administration.

 

**4. NET LOSS PER SHARE:**

 

Basic EPS is calculatedusing the weighted average number of common shares outstanding for the periodand diluted EPS is computed using the weighted average number of common sharesand dilutive common equivalent shares outstanding. Given that the Company is ina loss position, there is no difference between basic EPS and diluted EPS sincethe common stock equivalents would be antidilutive.

 
| **Year Ended December 31,**                                                                | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|-------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **(in  thousands)**                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net  loss                                                                                       |       | $          | (25,159    | )          | $          | (23,953    | )          | $ | (27,168 | ) |
| Weighted  average number of shares of common stock and common stock equivalents  outstanding:   |       |       |       |       |       |       |       |
| Weighted  average number of common shares outstanding for computing basic earnings per  share   |       | 93,090     |       | 69,491     |       | 53,942     |       |
| Dilutive  effect of warrants and stock options after application of the treasury stock  method  |       | *          |       | *          |       | *          |       |
| Weighted  average number of common shares outstanding for computing diluted earnings  per share |       | 93,090     |       | 69,491     |       | 53,942     |       |
| Net  loss per share - basic and diluted                                                         |       | $          | (0.27      | )          | $          | (0. 34)    |       | $ | (0. 50) |   |

 

----

* Warrants and stockoptions to purchase 41,266,000, 17,665,000 and 20,161,000 shares of commonstock as of December 31, 2009, 2008 and 2007, respectively, were excludedfrom the earnings per share calculation as their effect would have beenantidilutive.

 

**5. LIQUIDITY:**

 

Since its inception in1980 through December 31, 2009, the Company has incurred losses ofapproximately $275.5 million, substantially all of which resulted fromexpenditures related to research and development, general and administrativecharges and acquired in-process research and development resulting from twoacquisitions. The Company has not generated any material revenue from productsales to date, and there can be no assurance that revenues from product saleswill be achieved. Moreover, even if the Company does achieve revenues fromproduct sales, the Company expects to incur operating losses over the next severalyears.

 

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The Company believes ithas sufficient cash to fund operations at least through the following twelvemonths, exclusive of future receipts from billings on existing governmentcontracts. For 2010, the Company expects expenditures for operations, net ofgovernment funding, including collaborative efforts and research anddevelopment activities to be approximately $23 to $27 million. The Companybelieves it will continue to receive funding from government and other sourcesto pursue the development of its product candidates, and has assumed certainrevenues from these awards in providing this guidance.  Should the Company not continue to receivefunding from its current contracts or receive additional funding, or should thetiming be delayed, it may have a significant negative impact on the Company’sguidance.

 

Our cash, cashequivalents and short-term securities were $48.4 million at December 31,2009, compared with $11.5 million at December 31, 2008, respectively. Theincrease of $36.9 million was due primarily to net proceeds of $47.8 millionfrom the sale of common stock and issuance of stock warrants from two separateequity financing transactions that closed in January and August of2009.  The cash from financing activitieswas partially offset by cash used in operations of $8.8 million, costs of $2.0million related to acquisitions of patents and fixed assets and debt repaymentsof $0.1 million.

 

In January 2009, weraised net proceeds of $15.5 million in financing through the sale of14,224,202 shares of common stock pursuant to a registered direct offering to aselect group of institutional investors. The investors also received warrantsto purchase 14,224,202 shares of the Company’s common stock at an exerciseprice of $1.16 per share. These warrants are exercisable starting July 30,2009 and expire on July 30, 2014. In addition, the placement agent usedfor the equity financing received a warrant for the purchase of an additional426,726 common shares at $1.45 per share. This warrant is exercisable starting January 30,2009 and expires on January 30, 2014. All of these warrants have been classified as liabilities as discussedin Note 7, as they require the issuance of registered shares.  These warrants are non-cash liabilities; theCompany is not required to expend any cash to settle these liabilities.

 

On August 25, 2009,the Company closed a registered equity financing for net proceeds of $32.3million with several institutional investors. The Company sold 24,295,775shares of common stock at $1.42 per share, and also issued warrants for thepurchase of 9,718,310 common shares at an exercise price of $1.78 per share.These warrants are exercisable starting February 25, 2010 and expire on August 25,2014.  All of these warrants have beenclassified as liabilities as discussed in Note 7, as they require the issuanceof registered shares. These warrants are non-cash liabilities; the Company isnot required to expend any cash to settle these liabilities.

 

The Company currently hasa total of $61.7 million of contracted development studies.  As of December 31, 2009, $48.4 millionhas been billed to the government.   TheCompany has $13.3 in development contracts remaining that have not yet beencompleted and have not been billed.  TheCompany expects to complete the remaining contract activity and receive thecontracted revenue in 2010 and early 2011.

 

In December 2006,the Company announced the execution of a two-year $28 million research contractwith the Defense Threat Reduction Agency (DTRA), an agency of the United StatesDepartment of Defense (DoD). The contract is directed toward funding theCompany’s development of antisense therapeutics to treat the effects of Ebola,Marburg and Junín hemorrhagic viruses, which are seen by DoD as potentialbiological warfare and bioterrorism agents. In May 2009, the Companyreceived an amendment from DTRA to extend the contract performance period to November 29,2009 and a cost modification of an additional $5.9 million, increasing thetotal contract amount to $33.9 million. In September 2009, the Companyreceived a second amendment from DTRA to extend the contract performance periodto February 28, 2011 and a cost modification of an additional $11.5million, increasing the total contract amount to $45.4 million. During thetwelve month period ended December 31, 2009, 2008 and 2007, the Companyrecognized $10.4 million, $16.8 million and $8.0 million, respectively, inresearch contract revenue from this contract. To date, the Company hasrecognized revenues of $35.2 million from this contract.  Funding of the remainder of the contract isanticipated in 2010 and 2011.

 

In January 2006, theCompany announced that the final version of the 2006 defense appropriations acthad been approved, which included an allocation of $11.0 million to fund theCompany’s ongoing defense-related programs. Net of government administrativecosts, it is anticipated that the Company will receive up to $9.8 million underthis allocation. The Company’s technology is expected to be used to continuedeveloping RNA based drugs against Ebola and Marburg viruses. The Company hasreceived signed contracts for all of these projects. The Company expects thatfunding under these signed contracts will be completed over the next 12months.  During the twelve month periodended December 31, 2009, 2008 and 2007, the Company recognized $2.3million, $4.2 million and $2.7 million, respectively, in research contractrevenue from this contract. To date, the Company has recognized revenues of$9.2 million on these contracts. Funding of the remainder of these contracts isanticipated in 2010.

 

In May 2009, theCompany entered into a contract with DTRA to develop H1N1 drugs. Under thiscontract, DTRA will pay up to $4.1 million to the Company for the work to beperformed by the Company. The work will involve the application of analogsbased on the Company’s proprietary PMO and PMO*plu*santisense chemistry and the Company plans to conduct preclinical development ofat least one drug candidate and demonstrate it is effective by testing it invirus infected animals. During the twelve month period ended December 31,2009, the Company recognized $1.7 million in revenue under this contract.

 

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In July 2009, theCompany entered into a lease agreement with BMR-3450 Monte Villa Parkway LLCrelating to the lease of 19,108 square feet of laboratory and office space inBothell, Washington. The Company began occupying this space in August 2009,and has moved its headquarters and R&D functions to this new location.  The term of the lease is approximately 63months, although the Company has a one-time option to terminate the lease after3 years’ time upon payment of a termination fee. The Company will commencepaying base rent of approximately $43,000 per month after approximately 3months. The amount of base rent is subject to an annual increase of 3%.

 

The likelihood of thelong-term success of the Company must be considered in light of the expenses,difficulties and delays frequently encountered in the development andcommercialization of new pharmaceutical products, competitive factors in themarketplace as well as the complex regulatory environment in which the Companyoperates. There can be no assurance that the Company will ever achievesignificant revenues or profitable operations.

 

**6.  LONG-TERM DEBT**

 

TheCompany has two loans outstanding which are collateralized by a parcel of realproperty purchased in April 2007 in Corvallis, Oregon. These loans bearinterest at 4.75% and mature in February 2027. At December 31, 2009,these loans had unpaid principal balances of $1,275,000 and $726,000, for atotal indebtedness of $2,001,000.  TheCompany incurred interest expense on these loans of $97,000, $104,000 and$104,000, respectively, for the years ended December 31, 2009, 2008 and2007.

 

Thefollowing table sets forth the expected future principal payments on theseloans:

 

(inthousands)

 
| **Year ending December 31,**   |   |   |   |
|------------------------------------------|--------|--------|--------|
| 2010                                     |   | $      | 77     |   |
| 2011                                     |   | 81     |   |
| 2012                                     |   | 85     |   |
| 2013                                     |   | 90     |   |
| 2014                                     |   | 92     |   |
| Thereafter                               |   | 1,576  |   |
| Total  scheduled loan principal payments |   | $      | 2,001  |   |

 

**7. SHAREHOLDERS’ EQUITY AND WARRANT LIABILITY:**

 

In December 2007,the Company closed a private equity financing for net proceeds of $14,448,250with several institutional investors. The Company sold 10,696,616 shares ofcommon stock at $1.90 per share. These investors also received warrants for thepurchase of 5,348,308 common shares at $2.45 per share. These warrants areexercisable starting June 19, 2008 and expire on December 18, 2012.

 

On January 30, 2009,the Company closed a registered equity financing for net proceeds of $15.5million with several institutional investors. The Company sold 14,224,202shares of common stock at $1.16 per share, and also issued warrants for thepurchase of 14,224,202 common shares at $1.16 per share and a fair value at thedate of issue of $8.2 million. These warrants are exercisable starting July 30,2009 and expire on July 30, 2014. In connection with the equity financing,the placement agent received a warrant for the purchase of an additional426,726 common shares at $1.45 per share. This warrant is exercisable starting January 30,2009 and expires on January 30, 2014. All of these warrants have been classified as liabilities as theyrequire the issuance of registered shares. These warrants are non-cashliabilities; The Company does not expect to expend any cash to settle theseliabilities.

 

On August 25, 2009,the Company closed a registered equity financing for net proceeds of $32.3million with several institutional investors. The Company sold 24,295,775shares of common stock at $1.42 per share, and also issued warrants for thepurchase of 9,718,310 common shares at $1.78 per share and a fair value at thedate of issue of $9.0 million. These warrants are exercisable starting February 25,2010 and expire on August 25, 2014. All of these warrants have been classified as liabilities as, as theyrequire the issuance of registered shares. These warrants are non-cashliabilities; The Company does not expect to expend any cash to settle theseliabilities.

 

The Company has two stockoption plans, the 2002 Equity Incentive Plan and the 1997 Stock Option Plan(the Plans). The 2002 Plan provides for the issuance of incentive stock optionsto employees and nonqualified stock options, stock appreciation rights andbonus rights to employees, directors of the Company and consultants. The 1997Plan provides for the assumption of the ImmunoTherapy Options under the MergerAgreement. The Company has reserved 11,828,111 shares of common stock forissuance under the Plans. Options issued under the Plans generally vest ratablyover three years and expire five to ten years from the date of grant. At December 31,2009, 8,932,811 options were outstanding at a weighted-average exercise priceof $2.79 under equity compensations plans approved by security holders. At December 31,2009, 681,955 options were available for issuance under equity compensationplans approved by security holders.  SeeNote 3—“Stock-Based Compensation” for a summary of the status of the Company’sstock option plans and changes for the years ended December 31, 2009, 2008and 2007.

 

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The Company has alsoissued warrants for the purchase of common stock in conjunction with financingand compensation arrangements. A summary of the status and activity withrespect to the Company’s warrants is presented in the following table:

 
| ** **                                 | ** ** | **2009**   | ** ** | **2008**                               | ** ** | **2007**   | ** ** |
|--------------------------------------------|------------|------------|------------|----------------------------------------|------------|------------|------------|
| **For the Year Ended  December 31,**  | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Warrants  outstanding at beginning of year |       | 10,123,759 |       | $                                      | 8.54       |       | 13,856,411 |   | $ | 8.12 |   | 8,508,103 |   | $ | 11.68 |   |
| Granted                                    |       | 24,369,238 |       | 1.41                                   |       | 445,985    |       | 1.77 |   | 5,348,308 |   | 2.45 |   |
| Exercised                                  |       | —     |       | —                                 |       | —     |       | — |   | — |   | — |   |
| Expired                                    |       | (2,160,001 | )          | 5.00                                   |       | (4,178,637 | )          | 6.42 |   | — |   | — |   |
| Warrants  outstanding at end of year       |       | 32,332,996 |       | 3.40                                   |       | 10,123,759 |       | 8.54 |   | 13,856,411 |   | 8.12 |   |
|                                       |       |       |       |                                   |       |       |       |   |   |   |   |   |   |
| Exercisable  at end of year                |       | 20,948,808 |       | $                                      | 1.60       |       | 8,457,881  |   | $ | 3.21 |   | 6,842,225 |   | $ | 5.85 |   |

 

The following tablesummarizes information about warrants outstanding at December 31, 2009:

 
| **Exercise  Price** | ** ** | **Outstanding Warrants at  December 31, 2009** | ** ** | **Weighted Average  Remaining Contractual  Life (Years)** | ** **          | **Exercisable Warrants** | ** ** |
|---------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------------|---------------------|--------------------------|------------|
| $                   | 0.0003     |                                                | 16,667     |                                                      | No expiration  date |                     | 16,667     |   |
| 0.1679              |       | 238,228                                             |       | 2.87                                                      |                | 238,228                  |       |
| 1.14                |       | 1,000                                               |       | No expiration  date                                       |                | 1,000                    |       |
| 1.16                |       | 14,224,202                                          |       | 4.58                                                      |                | 14,224,202               |       |
| 1.45                |       | 426,726                                             |       | 4.08                                                      |                | 426,726                  |       |
| 1.78                |       | 9,718,310                                           |       | 4.67                                                      |                | 0                        |       |
| 2.45                |       | 5,348,308                                           |       | 2.97                                                      |                | 5,348,308                |       |
| 3.61                |       | 207,757                                             |       | 0.37                                                      |                | 207,757                  |       |
| 5.00                |       | 485,920                                             |       | 0.37                                                      |                | 485,920                  |       |
| 35.63               |       | 1,665,878                                           |       | 0.25                                                      |                | —                   |       |
|                |       | 32,332,996                                          |       |                                                      |                | 20,948,808               |       |
|                     |            |                                                     |            |                                                           |                     |                          |            |  |

 

The warrants issued in2009 and 2007 do not require net cash settlement. However, because the warrantsrequire settlement in registered shares, the Company has recorded the warrantsas liabilities on the accompanying balance sheet. There is no effect on cashflows from these warrants, as the mark-to-market adjustment is reflected as anon-cash charge within the Company’s Statements of Operations. There were30,203,466, 9,607,866, and 4,259,558 outstanding warrants classified asliabilities at December 31, 2009, 2008, and 2007, respectively.

 

**8. SIGNIFICANT AGREEMENTS:**

 

On January 27, 2007,the Company announced that it had entered into a definitive License Agreementwith Chiron Corporation (“Chiron”) granting the Company a nonexclusive licenseto Chiron’s patents and patent applications for the research, development, andcommercialization of antisense therapeutics against hepatitis C virus, inexchange for the payment of certain milestone and royalty payments to Chiron.In lieu of the first milestone payment due under the License Agreement, theCompany and Chiron also entered into a separate agreement under which theCompany issued to Chiron 89,012 shares of the Company’s common stock with amarket value of $500,000 and which was expensed to research and development.There may be future payments made to Chiron by the Company based on milestonesin the License Agreement.

 

On March 13, 2007,the Company announced that it had entered into agreements with Cook Group Inc.(“Cook”) for Cook’s development and commercialization of products for vascularand cardiovascular diseases. In November 2009, we announced that webelieve Cook discontinued development of our drug candidate, AVI-5126, on itscobalt-chromium stent because of an unexpectedly high rate of restenosis.

 

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Effective January 1,2006, the Company extended the lease on its facility located at 4575 SWResearch Way, Suite 200, Corvallis, OR 97333. This lease now expires on December 31,2020. As of December 31, 2005, the Company had an accrued rent payable of$615,163 related to back rent payments. During the first half of 2006 theCompany issued 31,154 shares of the Company’s common stock with a market valueof $175,000, paid cash and sold fixed assets to Research Way Investments to payoff the accrued rent payable related to back rent payments.

 

In January 2006, theCompany issued 30,000 shares of the Company’s common stock with a market valueof $200,000 to the Oregon State University Foundation to secure access tocertain university research facilities, which was expensed to research anddevelopment.

 

On January 8, 2007,the Company announced that it had entered into a cross-license agreement withEleos Inc. for the development of antisense drugs targeting p53, a well-studiedhuman protein that controls cellular response to genetic damage. Under theterms of the agreement, the Company granted Eleos Inc. an exclusive license tothe Company’s NEUGENE® third-generation antisense chemistry to treatcancer with p53-related drugs. In return, Eleos Inc. granted an exclusivelicense to its patents to the Company for treatment of most viral diseases withdrugs that target p53. The companies are sharing rights in other medical fieldswhere targeting p53 may be therapeutically useful. Each company will make milestonepayments and royalty payments to the other on development and sales of productsthat utilize technology licensed under the agreement. In addition, Eleos Inc.made an upfront payment of $500,000 to the Company. The Company recognized$125,000 in license fees for each of the years ended December 31, 2009,2008 and 2007; the remaining $125,000 has been classified as deferred revenue.

 

On March 27, 2007,in connection with the resignation of AVI’s former Chairman and ChiefExecutive Officer, the Company entered into a Separation and ReleaseAgreement, pursuant to which the former Chairman and CEO is entitled to receivehis base compensation for 18 months ($562,500 in the aggregate)and medical insurance for the same 18 month period and mayexercise his previously granted options until the earlier of thetermination date of the respective stock option grant agreements or March 28,2010. The Company recognized $1,619,872 in total compensation expense togeneral and administrative in 2007, including $562,500 in cash compensation and$1,057,372 in stock-based compensation.

 

On April 19, 2007,the Company entered into a real property purchase agreement with WKLInvestments Airport, LLC (“WKL”) to purchase a parcel of real property,including improvements situated on the land and intangibles related to theland, for $3,300,000. The Company paid the purchase price as follows: $350,000in cash, assumption of two loans secured by the property in the amount of$2,200,000, and issuance of 270,758 shares of AVI common stock (at $2.77 pershare or $750,000 in the aggregate).

 

On October 15, 2007,the Company and Charley’s Fund, Inc. announced that the Company had beenawarded a $2.45 million research grant from Charley’s Fund, a nonprofitorganization that funds drug development and discovery initiatives specific toDuchenne muscular dystrophy (DMD). This award will support a new productdevelopment program using proprietary exon skipping technologies developed bythe Company to overcome the effects of certain genetic errors in the dystrophingene. The award will allow AVI to accelerate its development of newtherapeutics for DMD. Through December 31, 2009, the Company had received$2.0 million from Charley’s Fund, and recorded the advances as DeferredRevenue, to be recognized upon the attainment of certain milestones asspecified in the agreement.  In September 2009,the Company amended the agreement with Charley’s Fund. The Amendment pertainsto certain provisions of the Sponsored Research Agreement by and between the Companyand Charley’s Fund entered into effective October 12, 2007 (the “Agreement”).Under the terms of the Amendment, the Company was awarded up to an additional$3 million in sponsored research funds, for a total of $5 million from Charley’sFund to support a new product development program using proprietary exonskipping technologies developed by the Company to overcome the effects ofcertain genetic errors in the dystrophin gene. Revenue associated with thisresearch and development arrangement is recognized under the proportionalperformance method, using the payment received method.   For the years ended December 31, 2009,2008 and 2007, the Company recognized $ 0, $23,000 and $38,000, respectively,in revenues from Charley’s Fund.

 

On September 18, 2008,the Company’s President and Chief Operating Officer resigned. In accordancewith his employment agreement, he is entitled to receive severance paymentstotaling $630,000.  Of this amount,one-third ($210,000) was paid on the effective date of his termination, and theremaining $420,000 was paid in monthly installments of $35,000 over thefollowing 12 months.  The Companyrecognized compensation expense of $630,000 in 2008 pursuant to hisresignation, of which $280,000 was classified as a deferred liability as of December 31,2008. In 2009 the Company recognized $315,000 of compensation expense.   In addition, in accordance with hisemployment agreement, he may exercise his previously granted stock optionsuntil the earlier of the termination date specified in the respective stockoption grant agreements or March 18, 2010. This acceleration of thevesting of these stock options resulted in additional compensation costs of$382,419 for the year ended December 31, 2008.

 

In July 2009, theCompany entered into a lease agreement with BMR-3450 Monte Villa Parkway LLCrelating to the lease of 19,108 square feet of laboratory and office space inBothell, Washington. The Company began occupying this space in August 2009,and has moved its headquarters and R&D functions to this new location.  The term of the lease is approximately 63months, although the Company has a one-time option to terminate the lease after3 years’ time upon payment of a termination fee. The Company will commencepaying base rent of approximately $43,000 per month after approximately 3months. The amount of base rent is subject to an annual increase of 3%.

 

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**9. INCOME TAXES:**

 

As of December 31,2009 the Company has federal and state net operating loss carryforwards ofapproximately $211,108,000 and $225,611,000, respectively, available to reducefuture taxable income, which expire 2009 through 2028. Of these amounts,approximately $2,007,000 and $2,046,000, respectively, relate to federal andstate net operating losses assumed as part of the Ercole acquisition.Utilization of the Ercole net operating losses is limited to approximately$425,000 per year. In addition, the Internal Revenue Code rules under Section 382and related state laws could limit the future use of the remaining netoperating losses based on ownership changes and the value of the Company’sstock. Approximately $3,930,000 of the Company’s carryforwards were generatedas a result of deductions related to exercises of stock options. When utilized,this portion of the Company’s carryforwards, as tax affected, will be accountedfor as a direct increase to contributed capital rather than as a reduction ofthe year’s provision for income taxes. The principal differences between netoperating loss carryforwards for tax purposes and the accumulated deficitresult from depreciation, amortization, investment write-downs, treatment ofresearch and development costs, limitations on the length of time that netoperating losses may be carried forward, and differences in the recognition ofstock-based compensation.

 

The Company had netdeferred tax assets of $110,539,000 and $102,881,000 at December 31, 2009and 2008, respectively, primarily from net operating loss carryforwards andresearch and development credit carryforwards. A valuation allowance wasrecorded to reduce the net deferred tax asset to zero because it is more likelythan not that the deferred tax asset will not be realized. The net change inthe valuation allowance for deferred tax assets was an increase ofapproximately $7,658,000 and $8,250,000 for the years ended December 31,2009 and 2008, respectively, mainly due to the increase in the net operatingloss carryforwards, research and development tax credits, and a decrease in theasset related to short term securities due to the expiration of the capitalloss carryforward period as of December 31, 2009.

 

Deferred tax assetsassumed as part of the Ercole acquisition total approximately $1,407,000 andprimarily relate to accrual to cash adjustment, net operating losses, andresearch & development credits. A valuation allowance was recorded to reduce the net deferred tax assetsto zero because it is more likely than not that the deferred tax asset will notbe realized. When such deferred tax assets are utilized or at such time whenthe valuation allowance is lifted, this portion of the Company’s deferred taxassets, as tax affected, will be accounted for as a direct increase to equityrather than as a reduction of that year’s provision for income taxes.

 

An analysis of thedeferred tax assets (liabilities) is as follows:

 
| **December 31,**                        | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|
| **(in thousands)**                      | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                         |       |       |       |       |       |
| Net  operating loss carryforwards            |       | $          | 83,057     |       | $          | 75,509 |   |
| Difference  in depreciation and amortization |       | 2,544      |       | 2,276      |       |
| Capital  loss carryforward                   |       | 8          |       | 8          |       |
| Research  and development tax credits        |       | 18,436     |       | 20,404     |       |
| stock  compensation                          |       | 4,197      |       | 3,326      |       |
| Stock  options for consulting services       |       | 1,012      |       | 957        |       |
| Deferred  Rent                               |       | 378        |       | 244        |       |
| Deferred  Revenue                            |       | 805        |       | —     |       |
| Other                                        |       | 102        |       | 157        |       |
|                                         |       | 110,539    |       | 102,881    |       |
|                                         |       |       |       |       |       |
| Valuation  allowance                         |       | (110,539   | )          | (102,881   | )          |
|                                         |       |       |       |       |       |
|                                         |       | $          | —     |       | $          | — |   |

 

The Company’s policy isto recognize interest and/or penalties related to income tax matters in incometax expense. The Company had no accrual for interest or penalties on itsbalance sheet at December 31, 2009 and at December 31, 2008, and hasnot recognized interest and/or penalties in the statement of operations for theyears ended December 31, 2009, 2008 or 2007.

 

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**10. COMMITMENTS AND CONTINGENCIES:**

 

##### ***Lease Obligations***

##### ** **

The Company leases officeand laboratory facilities under various noncancelable operating leases through December 2020.Rent expense under these leases was $1,467,000, $1,429,000 and $1,388,000 forthe years ended December 31, 2009, 2008 and 2007, respectively, and $12,837,000for the period from July 22, 1980 through December 31, 2009.

 

At December 31,2009, the aggregate non-cancelable future minimum payments under these leasesare as follows:

 

(in thousands)

 
| **Year ending December 31,** |   |   |   |
|----------------------------------------|--------|--------|--------|
| 2010                                   |   | $      | 2,073  |   |
| 2011                                   |   | 2,175  |   |
| 2012                                   |   | 2,230  |   |
| 2013                                   |   | 2,036  |   |
| 2014                                   |   | 2,033  |   |
| Thereafter                             |   | 9,135  |   |
| Total  minimum lease payments          |   | $      | 19,682 |   |

##### ** **

##### ***Royalty Obligations***

##### ** **

The Company has licenseagreements for which it is obligated to pay the licensors a minimum annualroyalty. Royalty payments under these agreements were $75,000, $75,000 and$125,000 for the years ended December 31, 2009, 2008 and 2007,respectively, and $1,259,000 for the period from July 22, 1980 through December 31,2009.

 

At December 31,2009, the aggregate future minimum royalty payments under these agreements areas follows:

 

( in thousands)

 
| **Year ending December 31,** |   |   |   |
|-----------------------------------|--------|--------|--------|
| 2010                              |   | $      | 100    |   |
| 2011                              |   | 80     |   |
| 2012                              |   | 80     |   |
| 2013                              |   | 80     |   |
| 2014                              |   | 55     |   |
| Thereafter                        |   | 715    |   |
| Total  minimum royalty payments   |   | $      | 1,110  |   |

 

##### ***Litigation***

 

In the ordinary course of business, theCompany defends its patents as deemed necessary. There are no material assertedclaims as of 12/31/09.

 

**11. FINANCIAL INFORMATION BY QUARTER (UNAUDITED):**

** **
| **2009 for quarter ended (in thousands)**             | ** ** | **December 31** | ** ** | **September 30** | ** ** | **June 30** | ** ** | **March 31** | ** ** |
|-------------------------------------------------------|------------|----------------------|------------|-----------------------|------------|------------------|------------|-------------------|------------|
| Revenues  from grants and research contracts          |       | $                    | 5,141      |                  | $          | 6,349            |       | $                 | 2,945      |   | $ | 3,150 |   |
|                                                  |       |                 |       |                  |       |             |       |              |       |
| Operating  expenses:                                  |       |                 |       |                  |       |             |       |              |       |
| Research  and development                             |       | 6,624                |       | 7,473                 |       | 5,804            |       | 4,495             |       |
| General  and administrative                           |       | 2,470                |       | 1,800                 |       | 2,206            |       | 2,220             |       |
| Operating  loss                                       |       | (3,953               | )          | (2,924                | )          | (5,065           | )          | (3,565            | )          |
|                                                  |       |                 |       |                  |       |             |       |              |       |
| Other  income (loss):                                 |       |                 |       |                  |       |             |       |              |       |
| Interest  income, net                                 |       | (312                 | )          | (127                  | )          | (31              | )          | 16                |       |
| Increase  (decrease) on warrant valuation             |       | 7,791                |       | (5,039                | )          | (14,572          | )          | 2,622             |       |
|                                                  |       |                 |       |                  |       |             |       |              |       |
| Net  income (loss)                                    |       | $                    | 3,526      |                  | $          | (8,090           | )          | $                 | (19,668    | ) | $ | (927 | ) |
| Net  income (loss) per share — basic             |       | $                    | 0.03       |                  | $          | (0.08            | )          | $                 | (0.23      | ) | $ | (0.01 | ) |
| Net  income (loss) per share — diluted           |       | $                    | 0.03       |                  | $          | (0.08            | )          | $                 | (0.23      | ) | $ | (0.01 | ) |
| Shares  used in per share calculations — basic   |       | 110,266              |       | 95,261                |       | 85,664           |       | 80,759            |       |
| Shares  used in per share calculations — diluted |       | 125,647              |       | 95,261                |       | 85,664           |       | 80,759            |       |

 

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| **2008 for quarter ended (in thousands)**             | ** ** | **December 31** | ** ** | **September 30** | ** ** | **June 30** | ** ** | **March 31** | ** ** |
|-------------------------------------------------------|------------|----------------------|------------|-----------------------|------------|------------------|------------|-------------------|------------|
| Revenues  from grants and research contracts          |       | $                    | 5,479      |                  | $          | 5,171            |       | $                 | 4,983      |   | $ | 5,625 |   |
|                                                  |       |                 |       |                  |       |             |       |              |       |
| Operating  expenses:                                  |       |                 |       |                  |       |             |       |              |       |
| Research  and development                             |       | 5,070                |       | 7,680                 |       | 7,678            |       | 6,903             |       |
| General  and administrative                           |       | 3,303                |       | 3,429                 |       | 2,184            |       | 2,553             |       |
| Acquired  in process research and development         |       | —               |       | —                |       | —           |       | 9,916             |       |
| Operating  loss                                       |       | (2,894               | )          | (5,938                | )          | (4,879           | )          | (13,747           | )          |
|                                                  |       |                 |       |                  |       |             |       |              |       |
| Other  income (loss):                                 |       |                 |       |                  |       |             |       |              |       |
| Interest  income, net                                 |       | 36                   |       | 60                    |       | 81               |       | 167               |       |
| Increase  (decrease) on warrant valuation             |       | 1,718                |       | (169                  | )          | 3,047            |       | (1,435            | )          |
|                                                  |       |                 |       |                  |       |             |       |              |       |
| Net  income (loss)                                    |       | $                    | (1,140     | )                     | $          | (6,047           | )          | $                 | (1,751     | ) | $ | (15,015 | ) |
| Net  income (loss) per share — basic             |       | $                    | (0.01      | )                     | $          | (0.08            | )          | $                 | (0.02      | ) | $ | (0.23 | ) |
| Net  income (loss) per share — diluted           |       | $                    | (0.01      | )                     | $          | (0.08            | )          | $                 | (0.02      | ) | $ | (0.23 | ) |
| Shares  used in per share calculations — basic   |       | 71,074               |       | 71,151                |       | 70,986           |       | 65,189            |       |
| Shares  used in per share calculations — diluted |       | 71,074               |       | 71,151                |       | 70,986           |       | 65,189            |       |

 

**12. SUBSEQUENT EVENTS:**

 

During the first quarterof 2010, the independent directors of the Company’s Board of Directorscompleted a voluntary reviewregarding prior disclosures made by the Companyconcerning the status of the clinical development of a drug-eluting stent usingAVI-5126, licensed to Global Therapeutics, a Cook Medical Company (the “CookTrial”). The independent directors initiated the review following questionsfrom a shareholder with respect to the Cook Trial. The independent directorsasked the Company’s regular outside general counsel to identify one of hispartners with expertise in commercial, business and securities issues, who hadnot previously preformed any work on behalf of the Company, to interviewemployees, review documents and emails and prepare a report to the independentdirectors.  The Company’s outside general counsel was supportive inthese activities. Following the delivery of counsels’ report to the independentdirectors, the independent directors concluded that no further disclosures wererequired with respect to the Cook Trial. Following that conclusion of but priorto communicating it to the shareholder, on March 15, 2009 the Companyreceived a letter from the shareholder’s counsel making similar demands. Basedon the review undertaken prior to receipt of this letter, the Company believesthat this matter will not have a material impact on the Company's statements oroperations.

 

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