**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-K/A**

**(Amendment No. 2)**

 

**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**

 

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

 

Securitiesregistered 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 any amendmentto 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. This determinationof affiliate status is not necessarily a conclusive determination for otherpurposes.

 

Thenumber of outstanding shares of the Registrant’s Common Stock as of the closeof business on May 21, 2010 was 110,384,820.

 

 

 

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** **

**Explanatory Note**

 

AVIBioPharma, Inc. is filing this Amendment No. 2 on Form 10-K/A (“AmendmentNo. 2”) to amend its Annual Report on Form 10-K for the fiscal yearended December 31, 2009 (the “Form 10-K”), which was filed with theSecurities and Exchange Commission (the “SEC”) on March 16, 2010 andpreviously amended by the Amendment No. 1 on Form 10-K/A filed withthe SEC on April 28, 2010. The purpose of this Amendment No. 2 is toamend footnote 12 (Subsequent Events (unaudited)) to the financial statementsin Part II. Except as described above, this Amendment No. 2 does notamend, update or change any other items or disclosures in the Form 10-K.

 

**PART II**

 

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

 

Theinformation required by this Item 8 begins on page F-1 in Item 15 of Part IVof this report on Form 10-K and is incorporated into this item byreference.

 

**PART IV**

 

**Item 15.  Exhibits, Financial StatementSchedules.**

 

(a)   The following documents are filed aspart of this Report:

 

(1) *Financial Statements*

 

The following financial statements of the Companyand the Report of KPMG LLP, Independent Auditors, are included in Part IVof 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 StatementSchedules*

 

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

 

(3) *Exhibits*

 

The following exhibits arefiled herewith and this list is intended to constitute the 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)                                                                                                 |
| 3.5                  |       | First  Amendment to First Restated Bylaws of AVI BioPharma, Inc. (53)                                                                                                                  |
| 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)                                                                                  |

 

2

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| 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)                                         |
| 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)                                                                                                         |

 

3

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| 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)                                                                   |
| 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 (filed with Form 10-K on  March 16, 2010)                          |
| 10.79        |   | Settlement  Agreement dated April 20, 2010 among AVI BioPharma, Inc. and the  Shareholder Group (54)                                                                                        |
| 10.80        |   | Separation  Agreement dated April 20, 2010 between AVI BioPharma, Inc. and  Leslie Hudson, Ph.D. (55)                                                                                       |
| 14.1         |   | Code  of Business Conduct and Ethics. (13)                                                                                                                                                            |
| 21.1         |   | Subsidiaries  of the Registrant. (filed with Form 10-K on March 16, 2010)                                                                                                                   |
| 23.1         |   | Consent  of Independent Registered Public Accounting Firm. (filed with Form 10-K  on March 16, 2010)                                                                                        |

 

4

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| 31.1 |   | Certification  of the Company’s Interim Chief Executive Officer and 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.                                     |

 

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| (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.                                          |
|   |                                                                                                                                                                                                                                                                   |
| (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.                                      |

 

5

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| (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 March 31, 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.                                                                |
|   |                                                                                                                                                                                                                            |
| (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. |

 

6

----

 
| (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. |
|   |                                                                                                                                                                                                                           |
| (53)   | Incorporated  by reference to Exhibit 3.1 to the Registrant’s Form 8-K filed with  the Securities and Exchange Commission on April 22, 2010.                                                               |
|   |                                                                                                                                                                                                                           |
| (54)   | Incorporated  by reference to Exhibit 10.1 to the Registrant’s Form 8-K filed  with the Securities and Exchange Commission on April 22, 2010.                                                              |
|   |                                                                                                                                                                                                                           |
| (55)   | Incorporated  by reference to Exhibit 10.2 to the Registrant’s Form 8-K filed  with the Securities and Exchange Commission on April 22, 2010.                                                              |

 

(b)  Exhibits.

 

Theexhibits listed under Item 15(a)(3) hereof are filed as part of this Form 10-K/Aother than Exhibit 32.1, which shall be deemed furnished.

 

(c)  FinancialStatement Schedules.

 

Allschedules are omitted because they are not applicable or the required informationis shown in the financial statements or the notes thereto.

 

----

*A Confidential Treatment Request for certain information in this document hasbeen filed with the Securities and Exchange Commission. The information forwhich treatment has been sought has been deleted from such exhibit and thedeleted text replaced by an asterisk (*).

 

†Indicates management contract or compensatory plan, contract or arrangement.

 

7

----

 

**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 
| Dated: | May 24,  2010 | AVI  BIOPHARMA, INC.                                                                           |
|--------|--------------------|-----------------------------------------------------------------------------------------------------|
|   |               |                                                                                                |
|   |               | By:                                                                                                 | /s/  J. David Boyle II |
|   |               | J.  David Boyle II                                                                                  |
|   |               | Interim  Chief Executive Officer and President, Senior Vice President, and Chief  Financial Officer |

 

8

----

 

**Report of Independent Registered Public AccountingFirm**

 

The Board of Directors andShareholders

AVI BioPharma, Inc:

 

We have audited theaccompanying balance sheets of AVI BioPharma, Inc. (a development stageenterprise) as of December 31, 2009 and 2008, and the related statementsof operations, shareholders’ equity and comprehensive income (loss), and cashflows for each of the years in the three-yearperiod ended December 31, 2009 and the information included in thecumulative from 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 inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the financial position of AVI BioPharma, Inc. (a developmentstage enterprise) as of December 31, 2009 and 2008, and the results of itsoperations and its cash flows for each of the 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, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of AVI BioPharma, Inc.’s internalcontrol over financial reporting as of December 31, 2009, based oncriteria established in *Internal Control -Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report, dated March 16,2010 expressed an unqualified opinion on the effectiveness of the Company’sinternal control over financial reporting.

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

 

F-1

----

 

***THIS REPORT IS A CONFORMED COPY OF THEREPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP AND HAS NOT BEEN REISSUED BYTHAT FIRM.***

 

**Report of Independent Public Accountants**

 

Tothe Board of Directors and Shareholders of

 

AVIBioPharma, Inc.

 

Wehave audited the accompanying balance sheet of AVI BioPharma, Inc. (anOregon corporation in the development stage) as of December 31, 2001, andthe related statements of operations, shareholders’ equity and cash flows foreach of the two years in the period ended December 31, 2001 and for theperiod from inception (July 22, 1980) to December 31, 2001. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

Weconducted our audits in accordance with auditing standards generally acceptedin the United States. Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, 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

----

** **

**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 |   |

 

See accompanying notes to financial statements.

 

F-3

----

 

**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     |       |                       |       |

 

See accompanying notes to financial statements.

 

F-4

----

 

**AVI BioPharma, Inc.**

**(A Development Stage Company)**

**Statements of Shareholders’Equity and Comprehensive 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 |   |

 

See accompanying notes to financial statements.

 

F-5

----

 

**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 |   |

 

See accompanying notes to financial statements.

 

F-6

----

 

**AVI BioPharma, Inc.**

**(A Development Stage Company)**

 

**NOTES TOFINANCIAL STATEMENTS**

 

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

 

AVIBioPharma, Inc. (the “Company” or “AVI”) was incorporated in the State ofOregon on July 22, 1980. The mission of the Company is to develop andcommercialize improved therapeutic products based upon antisense and cancerimmunotherapy technology.

 

ThroughMay 1993, the financial statements included the combined accounts of theCompany and ANTI-GENE DEVELOPMENT GROUP, a limited partnership (AGDG or thePartnership) founded in 1981 and registered in the State of Oregon.Substantially all income generated and proceeds from the Partnership unit salesthrough that date have been paid to the Company under the terms of research anddevelopment contracts entered into by the Partnership and the Company.Significant transactions between the Company and the Partnership through thatdate have been eliminated.

 

InMarch 1993, the Company offered to all partners in the Partnership theopportunity to exchange their partnership units or warrants to purchasepartnership units (unit warrants) for common stock or warrants to purchasecommon stock. Under the terms of the offer, which was completed May 1,1993, each partner could elect to exchange each unit held or unit warrant heldfor 1,100 shares of common stock or warrants to purchase 1,100 shares of commonstock of the Company, respectively. Total shares and warrants to purchaseshares issued in the exchange offer were 1,632,950 and 381,700, respectively.

 

EffectiveMay 19, 1993, the Company and the Partnership entered into a TechnologyTransfer Agreement wherein the Partnership conveyed all intellectual propertythen within 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.

 

InMarch 2000, the Company and AGDG amended the Technology Transfer Agreementto give to AGDG and Gene Tools LLC, related organizations, exclusive, nonroyalty-bearing rights to in vitro diagnostic applications of the intellectualproperty. In consideration for this amendment, Gene Tools paid the Company $1million and reduced the royalty that the Company would pay to AGDG under theTechnology Transfer Agreement on future sales of therapeutic products from4.05% to 3.00%.

 

Theremaining net assets of the Partnership, $177,000 of cash, were no longercombined with those of the Company in May 1993. Under the terms of theTechnology Transfer Agreement, the Partnership ceased active sales ofpartnership units and income generating activities and no longer will enterinto research and development contracts with the Company. The Partnershipcurrently exists primarily for the purpose of collecting potential futurepayments from the Company as called for in the Technology Transfer Agreement.

 

*Acquisitionof Ercole*

 

OnMarch 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. Thetransaction included the assumption of approximately $1.8 million inliabilities of Ercole. The AVI common stock was valued at approximately $8.4million. AVI also issued warrants to purchase AVI stock to settle certainoutstanding warrants held in Ercole, which were valued at $437,000. Thesewarrants are classified as equity. The acquisition was aimed at consolidatingAVI’s position in directed alternative RNA splicing therapeutics. Ercole andthe Company had been collaborating since 2006 to develop drug candidates,including AVI-4658, currently in clinical testing in the United Kingdom for thetreatment of Duchenne muscular dystrophy. Ercole has other ongoing discoveryresearch programs.

 

Thetotal estimated purchase 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 |   |

 

F-7

----

 

Thepending patents acquired as part of the Ercole acquisition have an expectedexpiration date of 2026. Acquired in-process research and development consistsof other discovery research programs in areas including beta thalassemia andsoluble tumor necrosis factor receptor. As these programs were in developmentat the time of acquisition, there were significant risks associated withcompleting these projects, and there were no alternative future uses for theseprojects, the associated value has been considered acquired in-process researchand development.

 

Ercolehas been a development stage company since inception and does not have aproduct for sale. The Company has retained a limited number of Ercole employeesand plans on incorporating in-process technology of Ercole into the Company’sprocesses. The acquisition of Ercole did not meet the definition of a businessand it is therefore being accounted for as an asset acquisition.

 

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

 

*Basis of Accounting*

 

Thefinancial statements have been prepared in accordance with U.S. generallyaccepted accounting principles as outlined in the*FASB Accounting Standards Codification**TM**.*

 

*Use of Estimates*

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand assumptions 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 and liability classified warrants, long-lived asset impairment, andrevenue recognition.

 

*Reclassifications*

 

Certainprior year amounts have been reclassified to conform to current yearpresentation. These changes did not have a significant impact on Company’s netloss, assets, liabilities, shareholders’ equity or cash flows.

 

*Cashand Cash Equivalents*

 

TheCompany considers all highly liquid investments with an original maturity ofthree months or less from the date of purchase to be cash equivalents.

 

*Short-TermSecurities—Available-For-Sale*

 

Short-termsecurities include certificates of deposit, commercial paper and other highlyliquid investments 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.

 

*Accounts Receivable*

 

Accountsreceivable are stated at invoiced amount and do not bear interest as they aredue within twelve months. Because a majority of accounts receivable are fromthe U.S. government and historically no amounts have been written off, anallowance for doubtful accounts receivable is not considered necessary. Amountsincluded in accounts receivable are as follows:

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

 

F-8

----

 

*Property and Equipment*

 

Propertyand equipment is stated at cost and depreciated over the estimated useful livesof the assets, generally five years, using the straight-line method. Leaseholdimprovements are amortized over the shorter of the lease term or the estimateduseful life of 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.

 

Amountsincluded in property held for sale:

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

 

TheCompany has listed for sale an industrial property located in Corvallis Oregonfor a sales price of $2.5 million. Selling and closing expenses are estimatedto be $0.1 million.  The Company hasdecided to outsource its large scale manufacturing activities and has listedthis property for sale with a commercial real estate agent.

 

Amountsincluded in property 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 |   |

 

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

 

*PatentCosts*

 

Patentcosts consist primarily of legal and filing fees incurred to file patents onproprietary technology developed by the Company. Patent costs are amortized ona straight-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*

 

TheCompany records revenue from research contracts and grants as the services areperformed and payment is reasonably assured. In 2009, 2008 and 2007, theCompany recognized $17,585,000, $21,258,000 and $10,985,000, respectively, inresearch contracts revenues from government funding for work performed on viraldisease projects and other grants and contracts.  Revenue associated with research anddevelopment arrangements is recognized under the proportional performancemethod, using the payment received method. To date, revenue from research anddevelopment arrangements has not been material.

 

*Research and Development*

 

Researchand development (R&D) expenses include related salaries, contractor fees,materials, utilities and allocations of corporate costs. R&D expenses alsoconsist of independent R&D costs and costs associated with collaborativedevelopment arrangements. In addition, the Company funds R&D at othercompanies and research institutions under agreements. Research and developmentcosts are expensed as incurred.

 

F-9

----

 

*Other Current Assets*

 

Amountsincluded in other current 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 |   |

 

Startingin April 2006, the Company was required to pledge $150,000 as collateralfor company credit cards issued to certain employees. Starting in April 2007,the Company was required to pledge $125,000 as collateral for payments onlong-term debt. The Company 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*

 

TheCompany issues stock-based compensation to certain employees, officers anddirectors.  These principles requirecompanies to account for stock options using the fair value method, whichresults in the recognition of compensation expense over the vesting period ofthe options.  See Note 3.

 

*Income Taxes*

 

Incometaxes are accounted for under the asset and liability method. Deferred taxassets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases and operatingloss and tax credit carryforwards. Deferred tax assets and liabilities aremeasured using enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recovered andsettled. A valuation allowance is recorded to reduce the net deferred tax assetto zero because it is more likely than not that the deferred tax asset will notbe realized. The Company recognizes the effect of income tax positions only ifthose positions are more likely than not of being sustained upon anexamination.

 

*Fair Value of Financial Instruments*

 

TheCompany measures at fair value certain financial assets and liabilities.Generally accepted accounting principles specify a hierarchy of valuationtechniques based on whether the inputs to those valuation techniques areobservable or unobservable. Observable inputs reflect market data obtained fromindependent sources, while unobservable inputs reflect the Company’s marketassumptions. These two types of inputs have created the following fair-valuehierarchy:

 

Level1—Quoted prices for identical instruments in active markets;

 

Level2—Quoted prices for similar instruments in active markets, quoted prices foridentical or similar instruments in markets that are not active, andmodel-derived valuations in which all significant inputs and significant valuedrivers are observable in active markets; and

 

Level3—Valuations derived from valuation techniques in which one or more significantvalue drivers are unobservable.

 

TheCompany’s assets measured at fair value on a recurring basis consisted of thefollowing 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 |   | $ | — |   |

 

F-10

----

 

TheCompany’s liabilities measured at fair value on a recurring basis consisted ofthe following as of the 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 |   |

 

TheCompany’s assets measured at fair value on a recurring basis consisted of thefollowing 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 |   | $ | — |   |

 

TheCompany’s liabilities measured at fair value on a recurring basis consisted ofthe following as of the 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 |   |

 

Areconciliation of the change in value of the Company’s warrants for the yearended 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     |   |

 

Areconciliation of the change in value of the Company’s warrants for the yearended 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      |   |

 

Thecarrying amounts reported in the balance sheets for cash and cash equivalents,accounts receivable, accounts payable, and other current monetary assets andliabilities approximate fair value because of the immediate or short-termmaturity of these financial instruments.

 

F-11

----

 

*Warrants*

 

Certainof the Company’s warrants issued in connection with financing arrangements areclassified as liabilities 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 |   |

 

Therisk-free interest rate is estimated using an average of treasury bill interestrates. The expected dividend yield is zero as the Company has not paid anydividends to date and does not expect to pay dividends in the future. Theexpected lives are based on the remaining contractual lives of the relatedwarrants. The expected volatility is estimated using historical calculatedvolatility and considers factors such as future events or circumstances thatcould impact volatility.

 

Forwarrants classified as permanent equity, the fair value of the warrants isrecorded as additional paid-in capital and no further adjustments are made.

 

*ComprehensiveIncome (Loss)*

 

Comprehensiveincome (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 operatinglease agreements for its Corvallis, Oregon facility and its Bothell, Washingtonfacility provide for scheduled annual rent increases throughout the lease’sterm.  In accordance with generallyaccepted accounting principles the Company recognizes the effects of thescheduled rent increases on a straight-line basis over the full term of theleases, which expires in 2020 and 2014.

 

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

 

*Commitments and Contingencies**.*

 

Inthe normal course of business, the Company may be named as a party to variouslegal claims, actions and complaints, including matters involving employment,intellectual property, effects from the use of drugs utilizing ourtechnology, or others. It is impossible to predict with certainty whether anyresulting liability would have a material adverse effect on the Company’sfinancial position, results of operations or cash flows.

 

*Financial Instruments**.*

 

Thecarrying amounts reported in the balance sheets for cash and cash equivalents,accounts receivable, accounts payable, and other current monetary assets andliabilities approximate fair value because of the immediate or short-term maturity of these financialinstruments.

 

F-12

----

 

*License Arrangements.*

 

Licensearrangements may consist of non-refundable upfront license fees, data transferfees, research reimbursement payments, exclusive licensed rights to patented orpatent pending compounds, technology access fees, various performance or salesmilestones and future product royalty payments. Some of these arrangements aremultiple element arrangements.

 

TheCompany defers recognition of non-refundable upfront fees if it has continuingperformance obligations without which the technology, right, product or serviceconveyed in conjunction with the non-refundable fee has no utility to thelicensee that is separate and independent of Company performance under theother elements of the arrangement. In addition, if the Company has continuinginvolvement through research and development services that are required becauseits know-how and expertise related to the technology is proprietary to theCompany, or can only be performed by the Company, then such up-front fees aredeferred and recognized over the period of continuing involvement.

 

Paymentsrelated to substantive, performance-based milestones in a research anddevelopment arrangement are recognized as revenue upon the achievement of themilestones as specified in the underlying agreements when they represent theculmination of the earnings process.

 

*Long-Lived Asset Impairment*

 

Long-livedassets held and used by us and intangible assets with determinable lives arereviewed for impairment whenever events or circumstances indicate that thecarrying amount of assets may not be recoverable in accordance with generallyaccepted accounting pronouncements. We evaluate recoverability of assets to beheld and used by comparing the carrying amount of an asset to future netundiscounted cash flows to be generated by the asset. If such assets areconsidered to be impaired, the impairment to be recognized is measured as theamount by which the carrying amount of the assets exceeds the fair value of theassets. Such reviews assess the fair value of the assets based upon estimatesof future cash flows that the assets are expected to generate.

 

AtDecember 31, 2008, the Company determined that the ongoing decline in thereal estate market had adversely impacted the fair value of a buildingpurchased by the Company for $3.3 million in 2007. Based on an independentthird-party appraisal, the Company estimated that the current fair value of thebuilding had declined to approximately $2.5 million. Accordingly, an impairmentcharge of $800,000 was recorded for the year ended December 31, 2008. TheCompany completed a second third party appraisal in November of 2009,based on this revised estimate the Company believes the property to have acurrent fair value, net of costs to sell of $2.4 million.  This property was listed for sale in November of2009. Selling and closing expenses are estimated to be $0.1 million.  The Company has decided to outsource itslarge scale manufacturing activities and has listed this property for sale witha commercial real estate agent.

 

Inaddition, at December 31, 2009, the Company conducted an evaluation of thestatus of its patents each quarter during 2009. Pursuant to these evaluations,the Company has recorded a write-off of $347,000, in 2009 for previouslycapitalized costs related to patents that have expired or were abandoned.

 

*Government Research Contract Revenue.*

 

TheCompany recognizes revenues from federal research contracts during the periodin which the related expenditures are incurred. The Company receivesreimbursement of costs incurred, overhead and, in some cases, a fixed fee. TheCompany presents these revenues and related expenses at gross in theconsolidated financial statements in accordance with the generally acceptedaccounting pronouncements.

 

*RecentAccounting Pronouncements*

 

Recentlyadopted accounting guidance:

 

Duringthe first fiscal quarter of 2009, the Financial Accounting Standards Boardissued Staff Positions ASC 820 10 65-65-4, “Determining Fair Value When theVolume and Level of Activity for the Asset or Liability has SignificantlyDecreased and the Identifying Transactions That Are Not Orderly”, ASC 320 1065-65-1, “Recognition and Presentation of Other-Than-Temporary Impairments”,and ASC 825 10 65 65-1, “Interim Disclosures about Fair Value of FinancialInstruments”. These Staff Positions were issued to clarify the application ofASC 820 10 65-65-4, “Fair Value Measurements” in the current economicenvironment, modify the recognition of other-than-temporary impairments of debtsecurities, and require companies to disclose the fair value of financialinstruments in interim periods. The Staff Positions are effective for interimand annual periods ending after September 15, 2009, with early adoptionpermitted for periods ending after March 15, 2009, if all three StaffPositions or both the fair-value measurement and other-than-temporaryimpairment Staff Positions are adopted simultaneously. The Company has adoptedthe Staff Positions in the third quarter of fiscal 2009, and there was nomaterial impact on the Company’s Financial Statements or related disclosures.

 

F-13

----

 

InApril 2009, the FASB issued FASB Staff Position ASC 320 10 65-65-1, “Recognitionand Presentation of Other-Than-Temporary Impairments”, which requires theCompany to disclose information for interim and annual periods that enablesusers of its financial statements to understand the types of available-for-saleand held-to-maturity debt and equity securities held, including informationabout investments in an unrealized loss position for which another-than-temporary impairment has or has not been recognized. The provisionsof this pronouncement were adopted in the second quarter of 2009. There was nomaterial impact on the Company’s financial statements.

 

InApril 2009, the FASB issued FSP  ASC825 10 65 65-1, “Interim Disclosures about Fair Value of Financial Instruments”, which requires publicly traded companies to include disclosures about thefair value of its financial instruments whenever it issues summarized financialinformation for interim reporting periods. The provisions of thesepronouncements were adopted in the second quarter of 2009. There was nomaterial impact on the Company’s financial statements.

 

**Recentaccounting guidance not yet adopted:**

 

InJanuary 2010, the FASB issued guidance to amend the disclosurerequirements related to recurring and nonrecurring fair value measurements. Theguidance requires new disclosures on the transfers of assets and liabilitiesbetween Level 1 (quoted prices in active market for identical assets orliabilities) and Level 2 (significant other observable inputs) of the fairvalue measurement hierarchy, including the reasons and the timing of thetransfers. The guidance will become effective for us with the reporting periodbeginning January 1, 2010, except for the disclosure on the roll forwardactivities for Level 3 fair value measurements, which will become effective forus with the reporting period beginning July 1, 2011. Other than requiringadditional disclosures, adoption of this new guidance will not have a materialimpact on our financial statements.

 

**3. STOCK-BASED COMPENSATION:**

 

Stock-basedcompensation costs are generally based on the fair value calculated from theBlack-Scholes option-pricing model on the date of grant for stock options andon the date of enrollment for the Plan. The fair value of stock grants isamortized as compensation expense on a straight-line basis over the vestingperiod of the grants. Stock options granted to employees are service-based andtypically vest over three years.

 

Thefair market values of stock options granted during 2009, 2008 and 2007 weremeasured on the date of grant using the Black-Scholes option-pricing model,with the following weighted average 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    | %          |

 

Therisk-free interest rate is estimated using an average of treasury bill interestrates. The expected dividend yield is zero as the Company has not paid anydividends to date and does not expect to pay dividends in the future. Theexpected lives are estimated using expected and historical exercise behavior.The expected volatility is estimated using historical calculated volatility.

 

TheCompany is required to estimate potential forfeiture of stock grants and adjustcompensation cost recorded accordingly. The estimate of forfeitures is adjustedover the requisite service period to the extent that actual forfeitures differ,or are expected to differ, from such estimates. Changes in estimatedforfeitures are recognized through a cumulative catch-up in the period ofchange and impact the amount of stock compensation expense to be recognized infuture periods.

 

F-14

----

 

Asummary of the Company’s stock 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       |       |       |   |   |   |   |   |   |   |

 

Thefollowing table summarizes 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 |   |

 

Theweighted average fair value per share of stock-based payments granted toemployees during 2009, 2008 and 2007 was $1.09, $1.04 and $2.27, respectively.During 2009, 2008 and 2007, the total intrinsic value of stock optionsexercised was $105,301, $1,831 and $4,937, and the total fair value of stockoptions that vested was $1,740,000, $3,040,000 and $3,661,000, respectively.

 

Asof December 31, 2009, there was $2,278,000 of total unrecognizedcompensation cost related to nonvested share-based compensation arrangementsgranted under the Plan. These costs are expected to be recognized over aweighted-average period of 2.3 years.

 

Duringthe year ended December 31, 2009, $76,000 was received for the exercise ofstock options. The Company is obligated to issue shares from the 2002 EquityIncentive Plan upon the exercise of stock options. The Company does notcurrently expect to repurchase shares from any source to satisfy itsobligations under the Plan. The Company may issue options to purchase up to anadditional 681,995 shares of Common Stock at December 31, 2009 under stockoption plans.

 

Thefollowing are the stock-based compensation costs recognized in the Company’sstatements of operations:

 

(inthousands)

 
| ** **                 | ** ** | **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 |   |

 

F-15

----

 

OnMarch 27, 2007, in connection with his resignation, the Companyentered into a Separation and Release Agreement with AVI’s former Chairman andChief Executive Officer. Pursuant to this agreement, he may exercise hispreviously granted options until the earlier of the termination date specifiedin the respective stock option grant agreements or March 28, 2010. Thismodification of these stock options in the first quarter of 2007 increasedcompensation costs by $1,057,000.

 

Inthe first quarter of 2008, the Company granted 333,000 shares of restrictedstock to its new Chief Executive Officer. These shares vest over a period offour years. The Company recognized compensation expense related to these sharesof for the years ended December 31, 2009 and 2008, of $63,000 and$166,000.

 

Inthe third quarter of 2008, the Company’s President and Chief Operating Officerresigned. In accordance with his existing employment agreement, he mayexercise his previously granted options until the earlier of thetermination date specified in the respective stock option grant agreements or March 18,2010.  This acceleration of the vestingof these stock options resulted in additional compensation costs of $382,000for the year ended December 31, 2008. As of December 31, 2009, theseoptions were outstanding.

 

Inthe second quarter of 2009, the Company granted a total of 25,000 shares ofrestricted stock to members of its Board of Directors. These shares vest over aperiod of one year.  During year ended December 31,2009, the Company recognized compensation expense related to these shares of$58,000.

 

Alsoin the second quarter of 2009, the Company granted 100,000 shares of restrictedstock to its Vice 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.

 

Inthe first quarter of 2009, the Company granted 60,000 shares of restrictedstock to its Chief Medical Officer. These shares vest over a period of 181days.  During the year ended December 31, 2009 the Company recognizedcompensation expense related to these shares of $82,000.

 

TheCompany records the fair value of stock options granted to non-employees inexchange for services in accordance with generally accepted accountingprinciples. The fair value of the options granted is expensed when themeasurement date is known. The performance for services was satisfied on thegrant date for stock options granted to non-employees.

 

Thetotal fair value of the options granted to non-employees during the years endedDecember 31, 2009, 2008 and 2007 was $141,000, $180,000 and $313,000respectively, which was expensed to general and administration.

 

**4.  NET LOSS PER SHARE:**

 

BasicEPS is calculated using the weighted average number of common sharesoutstanding for the period and diluted EPS is computed using the weightedaverage number of common shares and dilutive common equivalent sharesoutstanding. Given that the Company is in a loss position, there is nodifference between basic EPS and diluted EPS since the common stock equivalentswould 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 stock options to purchase 41,266,000, 17,665,000 and 20,161,000shares of common stock as of December 31, 2009, 2008 and 2007,respectively, were excluded from the earnings per share calculation as theireffect would have been antidilutive.

 

F-16

----

 

**5.  LIQUIDITY:**

 

Sinceits inception in 1980 through December 31, 2009, the Company has incurredlosses of approximately $275.5 million, substantially all of which resultedfrom expenditures related to research and development, general andadministrative charges and acquired in-process research and developmentresulting from two acquisitions. The Company has not generated any materialrevenue from product sales to date, and there can be no assurance that revenuesfrom product sales will be achieved. Moreover, even if the Company does achieverevenues from product sales, the Company expects to incur operating losses overthe next several years.

 

TheCompany believes it has sufficient cash to fund operations at least through thefollowing twelve months, exclusive of future receipts from billings on existinggovernment contracts. For 2010, the Company expects expenditures foroperations, net of government funding, including collaborative efforts andresearch and development activities to be approximately $23 to $27 million. TheCompany believes it will continue to receive funding from government and othersources to pursue the development of its product candidates, and has assumedcertain revenues 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.

 

Ourcash, cash equivalents 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.

 

InJanuary 2009, we raised net proceeds of $15.5 million in financing throughthe sale of 14,224,202 shares of common stock pursuant to a registered directoffering to a select group of institutional investors. The investors alsoreceived warrants to purchase 14,224,202 shares of the Company’s common stockat an exercise price of $1.16 per share. These warrants are exercisablestarting July 30, 2009 and expire on July 30, 2014. In addition, theplacement agent used for the equity financing received a warrant for thepurchase of an additional 426,726 common shares at $1.45 per share. This warrantis exercisable starting January 30, 2009 and expires on January 30,2014.  All of these warrants have beenclassified as liabilities as discussed in Note 7, as they require the issuanceof registered shares.  These warrants arenon-cash liabilities; the Company is not required to expend any cash to settlethese liabilities.

 

OnAugust 25, 2009, the Company closed a registered equity financing for netproceeds of $32.3 million with several institutional investors. The Companysold 24,295,775 shares of common stock at $1.42 per share, and also issuedwarrants for the purchase of 9,718,310 common shares at an exercise price of$1.78 per share. These warrants are exercisable starting February 25, 2010and expire on August 25, 2014.  Allof these warrants have been classified as liabilities as discussed in Note 7,as they require the issuance of registered shares. These warrants are non-cashliabilities; the Company is not required to expend any cash to settle theseliabilities.

 

TheCompany currently has a total of $61.7 million of contracted developmentstudies.  As of December 31, 2009,$48.4 million has been billed to the government.   The Company has $13.3 in developmentcontracts remaining that have not yet been completed and have not beenbilled.  The Company expects to completethe remaining contract activity and receive the contracted revenue in 2010 andearly 2011.

 

InDecember 2006, the Company announced the execution of a two-year $28million research contract with the Defense Threat Reduction Agency (DTRA), anagency of the United States Department of Defense (DoD). The contract isdirected toward funding the Company’s development of antisense therapeutics totreat the effects of Ebola, Marburg and Junín hemorrhagic viruses, which areseen by DoD as potential biological warfare and bioterrorism agents. In May 2009,the Company received an amendment from DTRA to extend the contract performanceperiod to November 29, 2009 and a cost modification of an additional $5.9million, increasing the total contract amount to $33.9 million. In September 2009,the Company received a second amendment from DTRA to extend the contractperformance period to February 28, 2011 and a cost modification of anadditional $11.5 million, increasing the total contract amount to $45.4million. During the twelve month period ended December 31, 2009, 2008 and2007, the Company recognized $10.4 million, $16.8 million and $8.0 million,respectively, in research contract revenue from this contract. To date, theCompany has recognized revenues of $35.2 million from this contract.  Funding of the remainder of the contract isanticipated in 2010 and 2011.

 

InJanuary 2006, the Company announced that the final version of the 2006defense appropriations act had been approved, which included an allocation of$11.0 million to fund the Company’s ongoing defense-related programs. Net ofgovernment administrative costs, it is anticipated that the Company willreceive up to $9.8 million under this allocation. The Company’s technology isexpected to be used to continue developing RNA based drugs against Ebola andMarburg viruses. The Company has received signed contracts for all of theseprojects. The Company expects that funding under these signed contracts will becompleted over the next 12 months. During the twelve month period ended December 31, 2009, 2008 and2007, the Company recognized $2.3 million, $4.2 million and $2.7 million,respectively, in research contract revenue from this contract. To date, theCompany has recognized revenues of $9.2 million on these contracts. Funding ofthe remainder of these contracts is anticipated in 2010.

 

F-17

----

 

InMay 2009, the Company entered into a contract with DTRA to develop H1N1drugs. Under this contract, DTRA will pay up to $4.1 million to the Company forthe work to be performed by the Company. The work will involve the applicationof analogs based 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.

 

InJuly 2009, the Company entered into a lease agreement with BMR-3450 MonteVilla Parkway LLC relating to the lease of 19,108 square feet of laboratory andoffice space in Bothell, 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%.

 

Thelikelihood of the long-term success of the Company must be considered in lightof the expenses, difficulties and delays frequently encountered in thedevelopment and commercialization of new pharmaceutical products, competitivefactors in the marketplace as well as the complex regulatory environment inwhich the Company operates. There can be no assurance that the Company willever achieve significant revenues or profitable operations.

 

**6.  LONG-TERM DEBT**

 

The Company has two loans outstanding which arecollateralized by a parcel of real property purchased in April 2007 inCorvallis, Oregon. These loans bear interest 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 a total indebtedness of $2,001,000.  The Company incurred interest expense onthese loans of $97,000, $104,000 and $104,000, respectively, for the yearsended December 31, 2009, 2008 and 2007.

 

The following table sets forth the expected futureprincipal payments on these loans:

 

(in thousands)

 
| **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:**

 

InDecember 2007, the Company closed a private equity financing for netproceeds of $14,448,250 with several institutional investors. The Company sold10,696,616 shares of common stock at $1.90 per share. These investors alsoreceived warrants for the purchase of 5,348,308 common shares at $2.45 pershare. These warrants are exercisable starting June 19, 2008 and expire onDecember 18, 2012.

 

OnJanuary 30, 2009, the Company closed a registered equity financing for netproceeds of $15.5 million with several institutional investors. The Companysold 14,224,202 shares of common stock at $1.16 per share, and also issuedwarrants for the purchase of 14,224,202 common shares at $1.16 per share and afair value at the date of issue of $8.2 million. These warrants are exercisablestarting July 30, 2009 and expire on July 30, 2014. In connectionwith the equity financing, the placement agent received a warrant for thepurchase of an additional 426,726 common shares at $1.45 per share. Thiswarrant is exercisable starting January 30, 2009 and expires on January 30,2014.  All of these warrants have beenclassified as liabilities as they require the issuance of registered shares.These warrants are non-cash liabilities; The Company does not expect to expendany cash to settle these liabilities.

 

OnAugust 25, 2009, the Company closed a registered equity financing for netproceeds of $32.3 million with several institutional investors. The Companysold 24,295,775 shares of common stock at $1.42 per share, and also issuedwarrants for the purchase of 9,718,310 common shares at $1.78 per share and afair value 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.

 

F-18

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TheCompany has two stock option plans, the 2002 Equity Incentive Plan and the 1997Stock Option Plan (the Plans). The 2002 Plan provides for the issuance ofincentive stock options to employees and nonqualified stock options, stockappreciation rights and bonus rights to employees, directors of the Company andconsultants. The 1997 Plan provides for the assumption of the ImmunoTherapyOptions under the Merger Agreement. The Company has reserved11,828,111 shares of common stock for issuance under the Plans. Optionsissued under the Plans generally vest ratably over three years and expire fiveto ten years from the date of grant. At December 31, 2009, 8,932,811options were outstanding at a weighted-average exercise price of $2.79 underequity 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.

 

TheCompany has also issued warrants for the purchase of common stock inconjunction with financing and compensation arrangements. A summary of thestatus and activity with respect to the Company’s warrants is presented in thefollowing 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 |   |

 

Thefollowing table summarizes 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               |       |
|                     |              |                                                     |            |                                                           |                    |                          |            |  |

 

Thewarrants issued in 2009 and 2007 do not require net cash settlement. However,because the warrants require settlement in registered shares, the Company hasrecorded the warrants as liabilities on the accompanying balance sheet. Thereis no effect on cash flows from these warrants, as the mark-to-marketadjustment is reflected as a non-cash charge within the Company’s Statements ofOperations. There were 30,203,466, 9,607,866, and 4,259,558 outstandingwarrants classified as liabilities at December 31, 2009, 2008, and 2007,respectively.

 

**8.  SIGNIFICANT AGREEMENTS:**

 

OnJanuary 27, 2007, the Company announced that it had entered into adefinitive License Agreement with Chiron Corporation (“Chiron”) granting theCompany a nonexclusive license to Chiron’s patents and patent applications forthe research, development, and commercialization of antisense therapeuticsagainst hepatitis C virus, in exchange for the payment of certain milestone androyalty payments to Chiron. In lieu of the first milestone payment due underthe License Agreement, the Company and Chiron also entered into a separateagreement under which the Company issued to Chiron 89,012 shares of the Company’scommon stock with a market 

 

F-19

----

 

valueof $500,000 and which was expensed to research and development. There may befuture payments made to Chiron by the Company based on milestones in theLicense Agreement.

 

OnMarch 13, 2007, the Company announced that it had entered into agreementswith Cook Group Inc. (“Cook”) for Cook’s development and commercialization ofproducts for vascular and cardiovascular diseases. In November 2009, weannounced that we believe Cook discontinued development of our drug candidate,AVI-5126, on its cobalt-chromium stent because of an unexpectedly high rate ofrestenosis.

 

EffectiveJanuary 1, 2006, the Company extended the lease on its facility located at4575 SW Research Way, Suite 200, Corvallis, OR 97333. This lease nowexpires on December 31, 2020. As of December 31, 2005, the Companyhad an accrued rent payable of $615,163 related to back rent payments. Duringthe first half of 2006 the Company issued 31,154 shares of the Company’s commonstock with a market value of $175,000, paid cash and sold fixed assets toResearch Way Investments to pay off the accrued rent payable related to backrent payments.

 

InJanuary 2006, the Company issued 30,000 shares of the Company’s commonstock with a market value of $200,000 to the Oregon State University Foundationto secure access to certain university research facilities, which was expensedto research and development.

 

OnJanuary 8, 2007, the Company announced that it had entered into across-license agreement with Eleos Inc. for the development of antisense drugstargeting p53, a well-studied human protein that controls cellular response togenetic damage. Under the terms of the agreement, the Company granted EleosInc. an exclusive license to the 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 makemilestone payments and royalty payments to the other on development and salesof products that utilize technology licensed under the agreement. In addition,Eleos Inc. made an upfront payment of $500,000 to the Company. The Companyrecognized $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 deferredrevenue.

 

OnMarch 27, 2007, in connection with the resignation of AVI’s formerChairman and Chief Executive Officer, the Company entered into aSeparation and Release Agreement, pursuant to which the former Chairman and CEOis entitled to receive his base compensation for 18 months ($562,500 inthe aggregate) and medical insurance for the same 18 month period andmay exercise 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.

 

OnApril 19, 2007, the Company entered into a real property purchaseagreement with WKL Investments Airport, LLC (“WKL”) to purchase a parcel ofreal property, including improvements situated on the land and intangiblesrelated to the land, for $3,300,000. The Company paid the purchase price asfollows: $350,000 in cash, assumption of two loans secured by the property inthe amount of $2,200,000, and issuance of 270,758 shares of AVI common stock(at $2.77 per share or $750,000 in the aggregate).

 

OnOctober 15, 2007, the Company and Charley’s Fund, Inc. announced thatthe Company had been awarded a $2.45 million research grant from Charley’sFund, a nonprofit organization that funds drug development and discoveryinitiatives specific to Duchenne muscular dystrophy (DMD). This award willsupport a new product development program using proprietary exon skippingtechnologies developed by the Company to overcome the effects of certaingenetic errors in the dystrophin gene. The award will allow AVI to accelerateits development of new therapeutics for DMD. Through December 31, 2009,the Company had received $2.0 million from Charley’s Fund, and recorded theadvances as Deferred Revenue, to be recognized upon the attainment of certainmilestones as specified in the agreement. In September 2009, the Company amended the agreement with Charley’sFund. The Amendment pertains to certain provisions of the Sponsored ResearchAgreement by and between the Company and Charley’s Fund entered into effective October 12,2007 (the “Agreement”). Under the terms of the Amendment, the Company wasawarded up to an additional $3 million in sponsored research funds, for a totalof $5 million from Charley’s Fund to support a new product development programusing proprietary exon skipping technologies developed by the Company toovercome the effects of certain genetic errors in the dystrophin gene. Revenueassociated with this research and development arrangement is recognized underthe proportional performance 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.

 

OnSeptember 18, 2008, the Company’s President and Chief Operating Officerresigned. In accordance with his employment agreement, he is entitled toreceive severance payments totaling $630,000. Of this amount, one-third ($210,000) was paid on the effective date ofhis termination, and the remaining $420,000 was paid in monthly installments of$35,000 over the following 12 months. The Company recognized compensation expense of $630,000 in 2008 pursuantto his resignation, of which $280,000 was classified as a deferred liability asof December 31, 2008. In 2009 the Company recognized $315,000 ofcompensation expense.   In addition, inaccordance with his employment agreement, he may exercise his previouslygranted stock options until the earlier of the 

 

F-20

----

 

terminationdate specified in the respective stock option grant agreements or March 18,2010. This acceleration of the vesting of these stock options resulted inadditional compensation costs of $382,419 for the year ended December 31,2008.

 

InJuly 2009, the Company entered into a lease agreement with BMR-3450 MonteVilla Parkway LLC relating to the lease of 19,108 square feet of laboratory andoffice space in Bothell, 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%.

 

**9.  INCOME TAXES:**

 

Asof December 31, 2009 the Company has federal and state net operating losscarryforwards of approximately $211,108,000 and $225,611,000, respectively,available to reduce future taxable income, which expire 2009 through 2028. Ofthese amounts, approximately $2,007,000 and $2,046,000, respectively, relate tofederal and state net operating losses assumed as part of the Ercoleacquisition. Utilization of the Ercole net operating losses is limited toapproximately $425,000 per year. In addition, the Internal Revenue Code rules underSection 382 and related state laws could limit the future use of theremaining net operating losses based on ownership changes and the value of theCompany’s stock. Approximately $3,930,000 of the Company’s carryforwards weregenerated as a result of deductions related to exercises of stock options. Whenutilized, this portion of the Company’s carryforwards, as tax affected, will beaccounted for as a direct increase to contributed capital rather than as areduction of the year’s provision for income taxes. The principal differencesbetween net operating loss carryforwards for tax purposes and the accumulateddeficit result from depreciation, amortization, investment write-downs,treatment of research and development costs, limitations on the length of timethat net operating losses may be carried forward, and differences in therecognition of stock-based compensation.

 

TheCompany had net deferred tax assets of $110,539,000 and $102,881,000 at December 31,2009 and 2008, respectively, primarily from net operating loss carryforwardsand research 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.

 

Deferredtax assets assumed as part of the Ercole acquisition total approximately$1,407,000 and primarily relate to accrual to cash adjustment, net operatinglosses, and research & development credits.  A valuation allowance was recorded to reducethe net deferred tax assets to zero because it is more likely than not that thedeferred tax asset will not be realized. When such deferred tax assets areutilized or at such time when the valuation allowance is lifted, this portionof the Company’s deferred tax assets, as tax affected, will be accounted for asa direct increase to equity rather than as a reduction of that year’s provisionfor income taxes.

 

Ananalysis of the deferred 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   | )          |
|                                        |       |       |       |       |       |
|                                        |       | $          | —     |       | $          | — |   |

 

F-21

----

 

TheCompany’s policy is to recognize interest and/or penalties related to incometax matters in income tax expense. The Company had no accrual for interest orpenalties on its balance sheet at December 31, 2009 and at December 31,2008, and has not recognized interest and/or penalties in the statement ofoperations for the years ended December 31, 2009, 2008 or 2007.

 

**10.  COMMITMENTS AND CONTINGENCIES:**

 

*Lease Obligations*

 

TheCompany leases office and laboratory facilities under various noncancelableoperating leases through December 2020. Rent expense under these leaseswas $1,467,000, $1,429,000 and $1,388,000 for the years ended December 31,2009, 2008 and 2007, respectively, and $12,837,000 for the period from July 22,1980 through December 31, 2009.

 

AtDecember 31, 2009, the aggregate non-cancelable future minimum paymentsunder these leases are as follows:

 

(inthousands)

 
| **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*

 

TheCompany has license agreements for which it is obligated to pay the licensors aminimum annual royalty. 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.

 

AtDecember 31, 2009, the aggregate future minimum royalty payments under theseagreements are as 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*

 

Inthe ordinary course of business, the Company defends its patents as deemednecessary. There are no material asserted claims as of 12/31/09.

 

F-22

----

 

**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            |       |

 
| **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****(UNAUDITED):**

 

·                  On March 18, 2010,Michael Casey announced to the Board of Directors his decision to not stand forre-election at the end of his term as a director of the Company. On March 24,2010, Dr. Christopher Henney announced to the Board of Directors hisdecision to not stand for re-election at the end of his term as a director ofthe Company  Both decisions were based solely on personal reasons, and wasnot the result of any disagreement with the Company on any matter relating tothe Company’s operations, policies, or practices. Both will remain a directorthrough the end of his current term which ends following the 2010 AnnualMeeting of the Company’s shareholders.

 

·                  On March 25, 2010, AVIBioPharma, Inc. (“AVI” or the “Company”) entered into an amendment to itscontract with the U.S. Defense Threat Reduction Agency (“DTRA”) to develop, incooperation with the Transformational Medical Technologies Initiative (“TMTI”)of the U.S. Department of Defense, one or more of AVI’s nucleotide-based drugcandidates targeting the pandemic H1N1 influenza virus (swine flu) anddemonstrate efficacy in an appropriate preclinical model. The materialterms of the original contract between DTRA and the Company were previouslydisclosed by the Company in the Company’s Current Report on Form 8-K filedwith the U.S. Securities and Exchange Commission on May 11, 2009.

 

F-23

----

 

Underthe contract entered into by the Company in May 2009, DTRA agreed to payup to $5.1 million to the Company for the work to be performed by the Company,which amount was ultimately finalized at $4.1 million.  The amendmententered into on March 25, 2010 provides up to $4.0 million in additionalDTRA funding to support continued preclinical development of AVI’s leadinfluenza drug candidate, AVI-7367, against H1N1 as well as its expandedpreclinical evaluation against H5N1 (avian flu) and drug resistant H1N1 andH3N2 flu strains. AVI’s lead influenza drug candidate utilizes AVI’sproprietary PMO*plusTM*  chemistry.

 

·                  On April 14, 2010, atthe 2010 American Academy of Neurology Annual Meeting, AVI BioPharma, Inc.(“AVI” or the “Company”) presented the poster entitled*  AVI-5038:Initial Efficacy and Safety Evaluation in Cynomolgus Monkeys.*

 

AVI-5038is AVI’s lead pre-clinical PPMO, or peptide-conjugated phosphorodiamidatemorpholino oligomer, drug candidate for the potential treatment of Duchennemuscular dystrophy (DMD) and is intended to cause a skip of exon 50 in the genecoding for the protein dystrophin. PPMOs are one of a series of differentchemical analogs being developed from AVI’s core PMO, or phosphorodiamidatemorpholino oligomer, chemistry.

 

TheAmerican Academy of Neurology poster includes previously reported data of apreclinical study in which cynomolgus monkeys were dosed intravenously for fourweeks with AVI-5038 given up to 9mg/kg.  In that study, the candidate drugappeared to be well tolerated with findings generally limited to the kidney,and included basophilic granule accumulation and evidence of tubulardegeneration/regeneration that was dose dependent.  Clinical chemistry andurinalysis did not detect a change in kidney function.  Significant levelsof exon skipping were detected by RT-PCR in the diaphragm, heart and quadricepsafter four weeks of dosing at 9mg/kg.

 

Apreliminary summary of the findings from an ongoing 12-week preclinical studyin which cynomolgus monkeys were dosed intravenously with AVI-5038 at doses of1.5, 6 and 15mg/kg was also presented. Significant toxicological findings wereobserved following bolus intravenous administration at 6 and 15mg/kg.  Thepreliminary results suggest that the toxicities seen in this study are alsodose dependent and primarily involve the kidney. The in life portion of thestudy is complete, but the collection and analysis of data from the study isstill ongoing.  The Company believes that the data set is not yetsufficient to determine the ultimate impact these findings might have on thefuture development of AVI-5038.

 

PPMOsare chemically distinct from PMOs.  AVI-4658 is AVI’s lead PMO drugcandidate for the potential treatment of DMD by skipping exon 51. AVI-4658 is currently being evaluated in an ongoing Phase 1b/2 clinical trialat two sites in the United Kingdom and has been generally well tolerated todate in all patients dosed up to 20mg/kg for 12 weeks.

 

·                  On April 20, 2010, theCompany entered into a Settlement Agreement with George W. Haywood (“Mr. Haywood”),Cheryl Haywood (“Ms. Haywood”), Rockall Emerging Markets Master FundLimited (the “Fund”), Meldrum Asset Management, LLC (“Meldrum”), Con Egan (“Mr. Egan”)and Conor O’Driscoll (“Mr. O’Driscoll”) (“Mr. Haywood”, “Ms. Haywood”,the “Fund”, “Meldrum”, “Mr. Egan” and “Mr. O’Driscoll” each a “ShareholderParty” and, collectively, the “Shareholder Group”). The Shareholder Group hadpreviously requested that the Company call a special shareholders’ meeting to (1) removecertain members of the Company’s board of directors (“Board”) and (2) electnew directors to the Board to fill vacancies left by removal of directors.  The Settlement Agreement memorializes certainactions taken by the Board of Directors, including, among other things, (i) requestingthe resignation of Leslie Hudson as the Company’s Chief Executive Officer andPresident, and as a director, (ii) amending the Company’s Bylaws to reducethe size of the Board and to clarify that a nominee appointed by the Board tofill a vacancy would serve the remainder of the term of such seat, (iii) appointingJ. David Boyle II, the Company’s current Senior Vice President and ChiefFinancial Officer, as the Company’s Interim Chief Executive Officer andPresident, (iv) appointing Anthony R. Chase to serve as a director of theCompany to fill the vacancy created by Dr. Hudson’s resignation from theBoard, (v) appointing Mr. Chase to the Nominating and CorporateGovernance Committee and (vi) accepting the resignation of one of theCompany’s directors, K. Michael Forrest, to facilitate the reduction in Boardsize as a result of the Bylaw amendment.

 

·                  As the Board of Directorsrequested that Leslie Hudson, PhD, the Company’s Chief Executive Officerand President, tender his resignation as the Company’s Chief Executive Officerand President, such resignation is being treated as an involuntary terminationof his employment without “Cause” for purposes of Section 13(d) ofthe Employment Agreement dated February 8, 2008 between the Company and Dr. Hudson(the “Employment Agreement”). In connection with his resignation, on April 20,2010, the Company entered into a separation agreement with Dr. Hudson (the“Separation Agreement”), the terms of which were previously negotiated pursuantto the Employment Agreement.  Pursuant tothe terms of the Separation Agreement, Dr. Hudson will receive total cashseverance payments of $1,412,170.00 (the “Cash Severance Payments”), calculatedby reference to two (2) times the sum of: (i) his annual base salaryin effect as of the Separation Date ($494,400), (ii) the average of hislast two annual bonuses ($188,669), and (iii) the annual cost of Pfizerretiree healthcare coverage for him and his spouse ($23,016).  The Cash Severance Payments will be made to Dr. Hudsonin twenty-four (24) equal monthly 

 

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installments, less required deductions andwithholdings, over the twenty-four (24) month period following the effectivedate of the Separation Agreement.  Inaddition, as of the effective date of the Separation Agreement, all previouslygranted options to Dr. Hudson became fully vested and exercisable until October 20,2010 and all shares of restricted stock granted to Dr. Hudson not releasedfor the Company’s repurchase option were released from such repurchaseoption.  The aggregate number of unvestedshares subject to previously granted options that became fully vested andexercisable as of April 20, 2010 was one million one hundred sixty-sixthousand eight hundred thirty-three (1,166,833).  The following table identifies the optionsheld by Dr. Hudson as of April 20, 2010, and how many shares werevested and unvested under each option granted to Dr. Hudson immediatelyprior to the acceleration of all unvested options provided for in Dr. Hudson’sEmployment Agreement and Separation Agreement:

 
| **Date  of Option Grant** | ** ** | **Number of   Shares Subject   to the Option** | ** ** | **Exercise   Price** | ** ** | **Number of   Options Vested   as of April 20,   2010** | ** ** | **Number of   Unvested Options   Accelerated as of  April, 20, 2010** | ** ** | **Termination of   Exercise Period** | ** **            |
|---------------------------|------------|------------------------------------------------|------------|----------------------|------------|--------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|--------------------------------------|-----------------------|
| February 8, 2008     |       | 667,000                                        |       | $                    | 1.09       |                                                         | 333,500    |                                                                  | 333,500    |                                 | October 20, 2010 |   |
| February 10, 2009    |       | 350,000                                        |       | $                    | 0.92       |                                                         | 116,667    |                                                                  | 233,333    |                                 | October 20, 2010 |   |
| February 9, 2010     |       | 600,000                                        |       | $                    | 1.45       |                                                         | 0          |                                                                  | 600,000    |                                 | October 20, 2010 |   |
|                      |       |                                           |       |                 |       |                                                         |       |                                                                  |       |                                 |                  |
| Total                     |       | 1,617,000                                      |       |                 |       | 450,167                                                      |       | 1,166,833                                                             |       | October 20,1010                 |                  |

 

An additional one hundred sixteen thousand fivehundred (116,500) shares of restricted stock were released from the Company’srepurchase option as of April 20, 2010.

 

·                  On April 20, 2010, the Boardof Directors appointed J. David Boyle II, 56, the Company’s current Senior VicePresident and Chief Financial Officer as its Interim Chief Executive Officerand President, to serve at the pleasure of the Board of Directors.  Mr. Boyle will continue in his positionas Chief Financial Officer.  As a resultof this interim appointment, Mr. Boyle’s salary has been increased by$3,000 per month while serving as the Interim Chief Executive Officer andPresident, his bonus target percentage for 2010 has been increased to fortypercent (40%), and he has been granted a fully vested option on April 20,2010 to acquire 50,000 shares of the Company’s common stock at an exerciseprice of $1.24.

 

·                  On April 20, 2010, theBoard of Directors appointed Anthony R. Chase as a Group II Director to fillthe vacancy on the Board left by the resignation of Leslie Hudson.  The Board also designated Mr. Chase asan independent member of the Board.  TheShareholder Group submitted Mr. Chase’s name for consideration by theCompany’s Nominating and Corporate Governance Committee and the Board.  Mr. Chase was granted an option pursuantto the Company’s 2002 Equity Incentive Plan to acquire 60,000 shares of theCompany’s Common Stock, at an exercise price of $1.24, with a four-year vestingperiod commencing on the grant date of April 20, 2010 (the “Grant Date”),1/4th of the shares vest and become exercisable on the earlier of one yearafter the Grant Date or the commencement of the next succeeding annual meetingof shareholders; 1/4th of the shares vest and become exercisable on the earlierof two years after the Grant Date or the commencement of the next succeedingannual meeting of shareholders, 1/4th of the shares vest and become exercisableon the earlier of three years after the Grant Date or the commencement of thenext succeeding annual meeting of shareholders and 1/4th of the shares vest andbecome exercisable on the earlier of four years after the Grant Date or thecommencement of the next succeeding annual meeting of shareholders.  Mr. Chase will hold office for theremainder of the term of a Group II director and until such director’ssuccessor shall have been elected and qualified.

 

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