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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-K

FOR ANNUAL AND TRANSITIONAL REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

|    |  |                                                                                     
|--- |  | ------------------------------------------------------------------------------------
|[X] |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2001
OR

|      |  |                                                                                         
|----- |  | ----------------------------------------------------------------------------------------
|[   ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________

Commission File No. 1-15803

AVANIR Pharmaceuticals

(Exact name of registrant as specified in its charter)


|                                                                          |  |                                                
|------------------------------------------------------------------------- |  | -----------------------------------------------
|California
(State or other jurisdiction of
incorporation or organization) |  | 33-0314804
(I.R.S. Employer Identification No.)

|                                                                                                     |  |                 
|---------------------------------------------------------------------------------------------------- |  | ----------------
|11388 Sorrento Valley Road, Suite 200, San Diego, California
(Address of principal executive office) |  | 92121
(Zip Code)

(858) 622-5200
(Registrants telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Class A Common Stock, no par value

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YESþ NO

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to
this form 10-K. [    ]

As of December 12, 2001, the issuer had outstanding 57,832,267 shares of Class
A and Class B common stock held by non-affiliates and the aggregate market
value of these shares on that date was $205,305,000.

The number of shares of Common Stock of the Registrant issued and outstanding
as of December 12, 2001:

|                                                                      |  |  |                   | 
|--------------------------------------------------------------------- |  |  | ----------------- | 
|Class A Common Stock, no par value
Class B Common Stock, no par value |  |  | 57,976,381
36,500 | 

DOCUMENTS INCORPORATED BY REFERENCE

Registrants definitive Proxy Statement, which will be filed with the
Securities and Exchange Commission on or before January 29, 2002, in connection
with the Registrants Annual Meeting of Shareholders to be held on March 14,
2002, is incorporated by reference into Part III of this Report.



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TABLE OF CONTENTS



|             |                                                                                               |                                                 |  |  |  |  |  | 
|------------ | --------------------------------------------------------------------------------------------- | ----------------------------------------------- |  |  |  |  |  | 
|PART I      
|             | Item 1. BUSINESS                                                                             
|             | Item 2. PROPERTIES                                                                           
|             | Item 3. LEGAL PROCEEDINGS                                                                    
|             | Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|             | Item 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                
|             | Item 6. SELECTED CONSOLIDATED FINANCIAL DATA                                                 
|             | Item 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|             | Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|             | Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                          
|             | Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 
|PART III    
|             | Item 10. DIRECTORS AND EXECUTIVE OFFICERS                                                    
|             | Item 11. EXECUTIVE COMPENSATION                                                              
|             | Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                      
|             | Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                      
|PART IV     
|             | Item 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES AND REPORTS ON FORM 8-K                
|             | INDEX TO CONSOLIDATED FINANCIAL STATEMENTS                                                   
|             | INDEPENDENT AUDITORS REPORT                                                                 
|             |                                                                                               | CONSOLIDATED BALANCE SHEETS                    
|             |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS          
|             |                                                                                               | CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
|             |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS          
|EXHIBIT 3.2 
|EXHIBIT 3.3 
|EXHIBIT 3.4 
|EXHIBIT 10.2
|EXHIBIT 10.4
|EXHIBIT 10.5
|EXHIBIT 21.1
|EXHIBIT 23.1



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PART I




Item 1. BUSINESS

This Annual Report on Form 10-K contains forward-looking statements concerning
future events and performance of our company. You should not rely exclusively
on these forward-looking statements, because they are only predictions based on
our current expectations and assumptions. Forward-looking statements often
contain words like estimate, anticipate, believe, plan or expect.
Many known and unknown risks and uncertainties may cause our actual results to
differ materially from those indicated in these forward-looking statements.
You should review carefully the risks and uncertainties identified in this
report. We have no obligation to update or announce revisions to any
forward-looking statements to reflect actual events or developments.

The Company

AVANIR Pharmaceuticals, based in San Diego and incorporated in California in
1988, is engaged in research, development, commercialization, licensing and
sales of innovative drug products and antibody generation services. AVANIRs
subsidiary, Xenerex Biosciences, is engaged in research collaborations with
partner companies for developing and commercializing completely human antibody
products to target antigens. AVANIR has a drug on the market that has been
approved by the United States Food and Drug Administration (FDA).

Marketed in North America by GlaxoSmithKline, Abreva (docosanol 10% cream) was
launched in the United States in late 2000. By March 2001, Abreva had become
the largest selling consumer healthcare product in the United States for the
treatment of cold sores. In September 2001, Abreva was ranked number five
among the top selling new consumer healthcare products introduced during the
prior twelve months. Under the license agreement with GlaxoSmithKline, AVANIR
has received milestone payments and royalties, which have helped fund other
product development programs in the Companys pipeline. Future docosanol 10%
cream royalties and milestone payments represent an important source of funds
for AVANIRs other development programs.

AVANIRs drug development pipeline consists of both clinical and pre-clinical
stage programs. Current clinical development programs are centered around
Neurodex, which could potentially provide a novel approach for the treatment
of several central nervous system disorders. AVANIR is currently developing
two of at least four potential indications for Neurodex. The leading
development program is for the treatment of emotional lability, a
neurodegenerative condition for which no FDA-approved drug exists. A Phase
II/III clinical trial for the treatment of emotional lability in patients with
Lou Gehrigs disease is underway. If the trial is successful, we plan to
follow with an additional Phase III clinical trial in patients with multiple
sclerosis. Positive results will be needed for both clinical trials for us to
file a new drug application with the FDA, possibly in 2003. We also intend to
enter Phase II clinical trials for Neurodex in the treatment of diabetic
neuropathic pain in 2002. Our drug discovery programs are at an earlier stage
of development and are directed toward large therapeutic areas, including
allergies and asthma, inflammatory diseases and cholesterol reduction.

Research collaborations are an important part of our development strategy and
we intend to partner with more companies that can help fund AVANIRs research
in exchange for rights to commercialize new drugs coming from this research.
We expect that Xenerex will play an important part in establishing new research
collaborations using our patented technology for developing fully human
monoclonal antibodies. We continue to seek other drug development opportunities
through acquisition or in-licensing, as part of our goal to expand our product
development pipeline.

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Abreva (docosanol 10% cream)  product licensing and regulatory approval status

AVANIR is in the process of expanding its docosanol franchise throughout the
world. We currently have license agreements with GlaxoSmithKline for the North
American market, Boryung Pharmaceuticals in South Korea and CTS Chemical
Industries in Israel. GlaxoSmithKline launched Abreva in the United States in
November 2000 and intends to begin marketing in Canada pending approval from
the Canadian regulatory agency. We have assisted Boryung and CTS in preparing
and filing for regulatory approvals to market and sell docosanol 10% cream in Korea and Israel and we anticipate decisions by these
agencies by mid-2002.

We are also making progress in developing other international license
agreements, including signing three letters of intent in 2001 with companies
capable of marketing and selling docosanol 10% cream in Southern Europe, China,
and parts of the Middle East. We are still holding discussions with a number
of other companies that are interested in licensing docosanol 10% cream in
Western Europe and Japan.

With the aid of our regulatory consultants in Europe and Japan, we intend to
file new drug applications for docosanol 10% cream in 2002. Our strategy is to
seek approval as an over-the-counter (OTC) product, which is the regulatory
status of docosanol 10% cream in the United States. We believe that the value
of license agreements for docosanol 10% cream in foreign countries will be
greater if the product is available for marketing as an OTC product. The
regulatory approval procedure we are using in Europe is intended for obtaining
mutual recognition by other European countries, provided we obtain approval by
the lead country. Although we successfully obtained FDA approval for docosanol
10% cream as an OTC product in the United States, we can provide no assurance
that we will be able to obtain similar regulatory approvals either as an OTC
product or as a prescription product in Japan or Europe, and if approved in
Europe, that mutual recognition by other countries will be achieved on a timely
basis, if at all.

Both AVANIRs and Xenerexs offices and research facilities are located at
11388 Sorrento Valley Road, Suite 200, San Diego, California 92121. Our
telephone number is (858) 622-5200 and our e-mail address is info@avanir.com.

Product development pipeline

AVANIR has the rights to develop at least four potential indications for
Neurodex, as treatments for emotional lability, neuropathic pain, weaning from
narcotics and anti-depressants, and chronic cough. We estimate the potential
combined market for all four indications to be $3 billion. Neurodex is
comprised of a new delivery system for the known drug dextromethorphan (DM).
The new delivery system includes an inhibitor of the human enzyme that
metabolizes DM, which we believe can provide additional therapeutic benefits if
unchanged DM can be present in the bloodstream for a longer time period.

We are currently engaged in clinical development for two indications for
Neurodex, emotional lability and neuropathic pain. We currently have a
100-patient Phase II/III clinical trial that is underway for the treatment of
emotional lability for patients who suffer from amyotrophic lateral sclerosis
(ALS or Lou Gehrigs disease). The trial has passed the midway point in terms of enrollment and
should be completed and its data available for publication by mid-2002. We
intend to follow with a second Phase III clinical trial for emotional lability
in 2002 in patients suffering from multiple sclerosis (MS). We also are
engaged in a number of toxicology studies for Neurodex as part of our
preparation for a Phase II clinical trial for the treatment of diabetic
neuropathic pain. If the toxicology studies are successful, we should be able
to begin the Phase II trial in early 2002.

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Our drug discovery programs are currently in the areas of developing novel
treatments for allergy and asthma, inflammation, and cholesterol reduction.
Our largest and most advanced efforts are focused on evaluating our lead
compound as a potential novel oral treatment for allergy and asthma. In
mid-2001, AVANIR scientists identified a small molecule found to be effective
in suppressing the synthesis of immunoglobulin epsilon (IgE) and other critical
mediators of the allergic response. We intend to evaluate the results of
current toxicology studies now under way to determine whether our lead compound
could be acceptable for filing with the FDA for an Investigational New Drug
(IND) application in 2002.

Xenerex Biosciences and antibody generation services

In a little more than a year of operation in our laboratory facility, Xenerex
Biosciences has been able to demonstrate several commercial capabilities of its
technology for generating fully human antibodies. In October 2001, Xenerex
scientists presented the results of a number of research projects that
confirmed the companys proprietary platform technology is capable of
generating fully human antibodies to multiple targets including human soluble
protein targets, human cell surface targets, and infectious disease targets.

During fiscal 2001, Xenerex began providing antibody generation services
through research collaborations with two companies. In May 2001 Xenerex
announced its first research collaboration agreement with Eos Biotechnology.
By December 2001 Xenerex had successfully generated antibodies to two
cancer-target antigens provided by Eos. Eos has asked Xenerex to proceed to
the next stage of the research agreement, which is intended to provide Eos with
more information on selected panels of the antibodies that meet the antibody
characteristics defined in the agreement. In June 2001, Xenerex entered into
an agreement with Peregrine Pharmaceuticals, Inc. (NASDAQ: PPHM), which
provides for Xenerex to generate fully human monoclonal antibodies for
Peregrine to evaluate for potential commercialization using Peregrines
therapeutic approach for the treatment of solid tumor cancers.

Xenerex differentiates its patented technology from other known methods used to
generate human antibodies by engrafting human immune system cells, which
include T-cells and B-cells, into severe combined immunodeficient (SCID) mice
to generate human antibodies following appropriate immunization. Through a
number of research projects conducted in fiscal 2001, Xenerex demonstrated an
ability to raise potentially commercializable antibody responses using its
proprietary technology. Xenerex has also shown that when antibodies of
interest are generated, its scientists can identify, isolate, and preserve
those valuable antibody-producing cells.

Xenerexs business model is to develop research collaborations with partners
who are able to provide attractive drug targets for Xenerex to develop human
antibodies using its proprietary technology. Xenerex offers low-cost services
to its partners during the initial stages of development, by charging modest
fees in exchange for generating human antibodies for its partners evaluation
and potential development into new drugs. If any of Xenerexs antibody
products are accepted by its partners for further development and those
partners are able to move forward successfully with clinical trials on drugs
using Xenerexs technology, then Xenerex has the opportunity to earn milestone
payments as drug development progresses. Long-term revenue would be derived
from royalties on sales if a drug reaches the market. In addition to providing
antibody generation services for others, Xenerex is also engaged in generating
antibodies to internally identified targets for internal development.

Raw materials supply for Abreva (docosanol 10% cream)

We purchase the raw material, docosanol, from a single supplier in Western
Europe that has been approved for manufacture by the FDA. Both AVANIR and
GlaxoSmithKline currently rely on the FDA-approved supplier for purchases of
the raw material. We believe GlaxoSmithKline maintains reserves of

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the raw material as a precautionary measure in the event of a delay or problem
in the manufacture of docosanol. We also maintain a small quantity of the
active ingredient, which may serve as a strategic reserve or for sales to our
licensees. We currently store our raw materials in the United States.

Business development and licensing

Our business development strategy is focused on expanding the docosanol
franchise worldwide, discovering and/or acquiring new drug technologies or
platforms, forming research collaborations through Xenerex Biosciences
antibody generation services business, and forming other research
collaborations to help support development efforts of our other technologies.
Our current license agreements for docosanol 10% cream cover sales in North
America, the Republic of Korea, and Israel. Through our subsidiary, Xenerex
Biosciences, we also have two research collaboration agreements for the
purposes of generating fully human antibodies for our partners (see Antibody
generation services and Xenerex Biosciences). Additionally, AVANIR has three
letters of intent with other companies to license docosanol 10% cream in China,
Southern Europe and parts of the Middle East. We intend to negotiate
definitive license agreements for docosanol 10% cream for these territories and
with companies who have access to other major markets in the rest of the world.

GlaxoSmithKline.Under our license agreement with GlaxoSmithKline for Abreva
for the North American market, AVANIR has earned milestone payments and
royalties totaling $22.5 million through September 30, 2001, including $10
million in milestone payments and $2.5 million in royalties on product sales in
fiscal 2001 and $10 million in milestone payments in fiscal 2000. A final
milestone payment of $5 million received in November 2001 will be part of our 2002
fiscal year. We expect to earn royalties on product sales under the existing
license agreement with GlaxoSmithKline for North America for at least the next
eight years. Thus, GlaxoSmithKline represents an important source of funds for
AVANIR to continue developing other drugs currently in the product development
pipeline or in the drug discovery stage. Royalties are based on a percentage
of all Abreva sales and could fluctuate substantially over the next eight
years, depending on such factors as unusually warm or cold weather conditions
and extent and severity of cold and flu seasons.

CTS Chemical Industries, Ltd (CTS). During fiscal 2001, we assisted our
licensee, CTS, in filing for regulatory approval to market docosanol 10% cream
in Israel. We also conducted a product education program for CTS personnel.
Initially signed in July 1993, the license agreement with CTS gives CTS the
rights to manufacture, market and sell docosanol 10% cream in Israel. The
agreement requires that CTS purchase its entire requirement of raw materials
from AVANIR and pay a royalty on product sales. CTS is currently awaiting a
decision on approval by Israeli regulatory authorities. We expect a decision
will be issued by mid-2002. At present, we cannot give any assurances that
docosanol 10% cream will be approved for sale in Israel, either as a
prescription product or as an OTC product.

Boryung Pharmaceuticals Company, Ltd (Boryung). During fiscal 2001, we
assisted Boryung in filing for regulatory approval to market docosanol 10%
cream in the Republic of Korea. The license agreement, initially signed in
July 1994, gives Boryung the rights to manufacture, market and sell docosanol
10% cream in that country. The agreement requires that Boryung purchase its
entire requirement of raw materials from AVANIR and pay us a royalty on product
sales. Boryung is currently awaiting a decision on approval by Korean
regulatory authorities. We expect a decision will be issued by mid-2002. At
present, we cannot give any assurances that docosanol 10% cream will be
approved for sale in the Republic of Korea, either as a prescription product or
as an OTC product.

Research collaborations.Xenerex Biosciences has entered into research
collaboration agreements with two other companies in order to provide antibody
generation services in exchange for fees for services, milestone payments upon
the Companys partners reaching clinical development milestones and royalties

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on sales if the Companys partner eventually sells the product. More
information about Xenerex business relationships can be found in Xenerex
Biosciences and antibody generation services.

In order to expand our existing product development pipeline, we continue to
seek the rights to develop other new drug candidates or drug development
platforms. We initiated this strategy in fiscal 2000 with the in-licensing of
Neurodex, potentially a new drug for the treatment of several central nervous
system disorders, and followed-up in 2001 with the acquisition of the MIF
inhibitor technology (described later).

Drug development programs and the therapeutic markets

AVANIR has actively engaged in (i) the research and development of several
potential therapeutic products, including two clinical trials of Neurodex
(formerly called AVP-923) as possible treatments for several central nervous
system disorders, (ii) advanced pre-clinical research around a lead compound
for the treatment of allergies and asthma, (iii) drug discovery programs
focused on inflammatory diseases and cholesterol reduction, and (iv) research
on other potential additional uses of our current product, docosanol 10% cream.
Highlights of these research activities are described below.

Neurodex.As of December 2001, we had reached 60% completion of enrollment in a
Phase II/III clinical study initiated earlier in fiscal 2001 to assess the
efficacy of Neurodex in reducing the loss of emotional control, clinically
known as emotional lability, in patients with Lou Gehrigs disease. Emotional lability is a condition of
pathological crying or laughing, frequently associated with neurological
diseases such as Lou Gehrig's disease, multiple sclerosis (MS), Alzheimers disease (AD) and
stroke. We expect to complete this study by mid-year 2002. We also intend to
proceed with a second, larger Phase III study of emotional lability in MS in
fiscal 2002, in order to demonstrate the effectiveness of the treatment across
a broad spectrum of neurological disorders.

Medical reports on the incidence of emotional lability estimate that up to 50%
of ALS patients and 10% to 25% of MS and AD patients are affected by the loss
of emotional control. In stroke patients the incidence is initially up to 20%
within the first year of stroke with one-half of those patients recovering
emotional control within the first year. Currently, there is no FDA-approved
product for the treatment of emotional lability. The FDA has requested that we
perform clinical studies for emotional lability in at least two of the
neurological diseases. If the studies demonstrate safety and efficacy, the FDA
may approve a general indication for emotional lability. We estimate the size
of the U.S. market population having emotional lability across all four
diseases is approximately one million patients per year.

Following completion of a number of toxicology studies currently underway or
planned for Neurodex, we expect to initiate clinical trials for a second
indication, neuropathic pain, in early 2002. One of the active ingredients,
dextromethorphan or DM, is a well-known NMDA receptor antagonist. It has been
reported in medical literature that DM is effective in reducing pain associated
with diabetic neuropathy. The medical literature indicates that, in the U.S.,
there are approximately ten million diabetics who suffer from diabetic
neuropathy, 40% of whom have moderate to severe disease. We estimate the
treatable patient pool is one and one-half million people.

Neurodex is comprised of DM and an enzyme inhibitor that significantly slows
the metabolism of DM. DM is already a widely known drug that is used as one of
the active ingredients in many over-the-counter cough medications. However, up
to now the therapeutic utility of dextromethorphan has been limited due to its
rapid metabolism. If clinical trials for Neurodex now under way for two
different indications prove successful, then we expect to continue development
of these and possibly other indications for the drug. We believe Neurodex
could find wide utility for the treatment of chronic cough typically caused by
smoking, post-nasal drip, asthma, gastro-esophageal reflux and chronic
bronchitis, as well as intractable cough, which is typically associated with
lung cancer. While we estimate that 30 million physician office visits
each year involve the treatment of chronic cough, and 40% of those involve

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moderate to severe cough, we expect the treatable patient pool for chronic and
intractable cough indication is much narrower., but still could be as high as
five hundred thousand patients.

Additional potential uses of docosanol 10% cream. In addition to the potential
marketing and sale of docosanol 10% cream as an OTC product for cold sores,
other preclinical studies indicate that docosanol 10% cream may have other
therapeutic properties that could open other avenues for product development.
Potential indications for docosanol 10% cream include its use as a topical
treatment for genital herpes, herpes zoster, wound healing and minor burns. We
are investigating several options to fund development of other potential
topical indications, which could include finding a development partner to share
in the product development risks and cost of clinical trials and government
funding. GlaxoSmithKline has the rights to manufacture and sell all OTC
products containing docosanol in the United States and Canada, provided the
products are approved for sale by the FDA as OTC products.

In August 2001, the San Diego Regional Technology Alliance (SDRTA) announced
that AVANIR was awarded a CalTIP grant to be used in the development of a
topical treatment for genital herpes. We are currently evaluating a new
formulation of docosanol designed for application to genital areas. The award
of $150,000 from the San Diego Regional Technology Alliance is a state-funded
matching funds grant that can be used in conjunction with federally funded
grants. We have applied for a $1 million SBIR Phase II grant from the National
Institutes of Health to complement the CalTIP award.

Advanced therapies for the treatment of allergies and asthma through IgE
regulation. Allergy and asthma are respiratory diseases affecting millions of
people worldwide. Prescription treatments and over-the-counter medications for
the treatment of both allergy and asthma account for over $6 billion per year
in worldwide sales. After several decades of research, scientists have
established that allergies and asthma result from the fact that allergic
individuals commonly produce abnormally high levels of an antibody known as
IgE, the antibody responsible for triggering allergic responses. The end
result is an unpleasant to debilitating health condition.

AVANIR scientists have identified a number of small molecules, exemplified by
the molecule internally code-named AVP-893, which have been found effective in
suppressing the synthesis of IgE and other critical mediators of the allergic
response. AVANIR intends to develop a safe, effective, oral formulation
capable of significantly inhibiting production of IgE and preventing or
reducing the signs and symptoms of allergy and asthma. AVP-893 is one of the
most potent of the lead compounds we have tested, and it has proven efficacious
in several laboratory and animal models. AVANIR scientists presented the
results of the AVP-893 investigation at the 2001 Annual Meeting of the American
College of Allergy, Asthma and Immunology (ACAAI) in November in Orlando,
Florida. We continue to advance our research on the series of compounds
represented by AVP-893 and intend to file an investigational new drug
application in mid-2002. Development of this technology and these small
molecule drugs is in an advanced pre-clinical stage. No human trials have yet
begun.

Allergies and asthma, a severe form of allergy, are caused by agents called
allergens. Allergens trigger the initial phase of an asthma or allergy attack,
and symptoms such as sneezing, coughing, stuffy noses, itching, chest
tightness, wheezing, tingling and shortness of breath soon develop. In
allergy-prone people, the presence of invading allergens triggers the immune
system to produce an extra amount of the antibody known as IgE. IgE binds to
mast cells, found in the mucosal lining of our airways. IgE and the allergen
team up to trigger the mast cell to degranulate and release histamine and other
chemical mediators that cause the symptoms of hay fever and asthma. In allergy
and asthma sufferers, IgE appears to be over-produced. We believe that if IgE
overproduction can be decreased, then the allergic response, which can range
from mild sneezing to a serious asthmatic attack, can be reduced or prevented.

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However, no small molecule drugs are currently available for the treatment of
excess IgE levels, either via neutralization or suppression of synthesis or
release. AVANIR anticipates that its new small molecule agents could become
very important first-line agents for the treatment of allergies and asthma.

MIF inhibitor technology.In August 2001 AVANIR acquired a macrophage
migration inhibitory factor (MIF) technology from Ciblex Corporation. The
asset acquisition provides AVANIR with various drug development opportunities
including the exclusive worldwide rights to develop and commercialize a series
of small molecule compounds that target MIF. Modulation of MIF activity may
offer a novel therapeutic intervention in rheumatoid arthritis, sepsis,
ulcerative colitis, Crohns disease, inflammatory neurological diseases,
glomerulonephritis and asthma. We believe these diseases still have unmet
therapeutic needs even though sales of current drugs for these diseases exceed
several billion dollars in the United States. Examples of successful
commercialization of injectable drugs that target pro-inflammatory proteins are
Enbrel® by Immunex Corporation and Remicade® by Johnson & Johnson, both of
which target TNF#. We intend to use the acquired technology to develop an
orally bioactive small molecule that targets an earlier stage of the
inflammatory pathway. Our research program is at an early stage of development
and will take several years of development effort to determine whether or not
it will be successful.

Xenerex Biosciences

In mid-2000, AVANIR created a subsidiary, Xenerex Biosciences, to exploit a
proprietary platform technology for producing antibodies indistinguishable from
antibodies isolated directly from humans. This technology can rapidly generate
many unique antibody products with potential applications in the diagnosis
and treatment of a wide array of human diseases. Xenerex Biosciences intends
to use this platform technology to build a human antibody generation service
company, as well as a diversified product portfolio, capable of being
commercialized through internal product development and corporate
collaborations.

Xenerex began providing antibody generation services in mid-2001 for two
biotechnology companies that have their own proprietary antigen targets.
Xenerex technology is able to use the entire human genetic library during the
generation effort. The goal is to provide the client with the greatest
diversity of antibodies that meet specific desired characteristics so that the
optimal antibody product candidate can be selected and moved forward into
development.

Xenerex has patent rights to a complementary set of proprietary technologies
that enable rapid generation of fully human antibodies of high affinity and
specificity to any antigenic disease target or human protein. The technology
combines the antigenic stimulation of human lymphoid cells with the grafting of
the cells into severe combined immunodeficient (SCID) mice. This technology
mimics the in vivohuman antibody response as it generates multiple antibodies
to an antigenic target with various combinations of affinities and
specificities characteristics. This allows for identification and selection of
the antibody or antibodies that most closely match the required criteria for
further development.

The technology being developed by Xenerex is different from other competitive
methods known to generate human antibodies by the fact that the Xenerex
technology utilizes human cells, which include T-cells and B-cells, along with
other supportive cells, to generate human antibodies following appropriate
immunization of the mice. Currently, two embodiments of the technology are
used by Xenerex: The hu-PBL-SCID technology uses human peripheral blood
lymphocytes for grafting while the hu-SPL-SCID technology uses human cells
capable of an immune response, such as human spleen cells or tonsil cells.
Each approach has unique advantages that can be exploited in the antibody
generation effort.

The Xenerex system is able to take advantage of the unique in vivocellular
interactions that occur in the human immune system that result in natural
affinity maturation. This is the process by which the

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immune system generates antibodies of high affinity and specificity. The
technology therefore is capable of duplicating many aspects of the human immune
system, resulting in the generation of human monoclonal antibodies.

Xenerex also has identified antigen targets of its own and intends to generate
antibodies to those targets that will be available for out-licensing or
developing jointly with a partner. In addition, Xenerex has identified certain
diagnostic applications of its technology that may also represent business
opportunities for use with potential research partners.

Competition

The pharmaceutical industry is characterized by rapidly evolving technology and
intense competition. Many companies of all sizes, including major
pharmaceutical companies and specialized biotechnology companies, currently
engage in activities similar to our activities. Many of our competitors have
substantially greater financial and other resources and larger research and
development and clinical and regulatory affairs staffs. In addition, colleges,
universities, governmental agencies and other public and private research
organizations continue to conduct research and are becoming more active in
seeking patent protection and licensing arrangements to collect royalties for
use of technologies that they have developed, some of which may be in direct
competition with our proposed products. We also must compete with these
institutions in recruiting highly qualified scientific personnel. We do not
have the resources to compete with major pharmaceutical companies on a wide
scale basis in the areas of clinical testing, regulatory approvals,
manufacturing and marketing.

Docosanol 10% cream. As the product launch for docosanol 10% cream (Abreva in
the United States) progresses, the drug will face intense worldwide competition
from the following products:



| |  |  | OTC topical preparations, including Blistex®, Carmex® and
Viractin®;                                                        
| | - |  | ----------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Zovirax® acyclovir (oral and topical) and Valtrex®
valacyclovir (oral) prescription products marketed by Glaxo
Wellcome; and
|
| |  |  | Famvir® famciclovir (oral) and Denavir® penciclovir (topical)
prescription products marketed by Novartis.                   

Neurodex.Assuming we are successful in our development program for Neurodex
in the treatment of neuropathic pain, it will compete with several drug
products in the marketplace today that are prescribed by physicians, including
a number of narcotic products, non-narcotic products, and off-label uses of
other drugs, such as the anticonvulsant, Neurontin®, marketed by Pfizer Inc.

IgE modulation program. Our preclinical IgE modulation program competes with
several research approaches and numerous compounds under development by large
pharmaceutical and biotechnology companies. One such example is the anti-IgE
therapy using rhuMAB-E25 (Zolair®), a recombinant humanized monoclonal antibody
developed in collaboration among Genentech, Tanox and Novartis Pharmaceuticals
Corporation. In June 2000 the collaborative team submitted a Biologic License
Application (BLA) to the FDA for their drug and they are currently developing
additional data requested by the FDA as a part of the BLA. Other competitive
and successful products already established in the marketplace include
non-sedative antihistamine products, such as Shering-Ploughs Claritin®
loratadine ($3 billion in annual sales) and Aventis Allegra®/Telfast® ($1
billion in annual sales). We cannot assure you that we will be able to develop
a safe and effective anti-IgE drug or, if developed, that we can obtain
marketing approval from the FDA for the drug on a timely basis, if at all.

Antibody generation services.The human antibody generation services business
is highly competitive. Several companies, including Abgenix, Medarex, Inc.,
and Cambridge Antibody Technology, have been

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in business longer and have substantially more financial resources and
personnel than we have at Xenerex.

We cannot predict what the competitive landscape will be for our proposed
products if they are introduced into the marketplace. In addition, we can
neither assure you that any of our proposed products and technologies will be
superior to our competitors current or proposed products or technologies or
that our products and technologies will gain widespread acceptance in the
marketplace.

Patents and proprietary rights

Patents. AVANIR presently has 38 issued patents (22 U.S. and 16 foreign) and
110 applications pending (six U.S. and 104 foreign). These include six issued
U.S. patents and four pending foreign applications, acquired from IriSys
Research and Development, as part of AVANIRs license agreement with respect to
dextromethorphan and an enzyme inhibitor. Patents and patent applications
owned by the Company are for docosanol in current approved drug applications
and other applications in preclinical and clinical stages of development,
Hu-PBL-SCID technologies for developing monoclonal antibodies and regulation of
IgE in controlling symptoms of allergy and asthma. The Companys in-licensed
patents are for several new uses of dextromethorphan.

Docosanol patents and patent applications.We now have 22 issued patents (11
U.S. and 11 foreign) and 39 applications pending (two U.S. and 37 foreign)
relating to the topical and systemic uses of docosanol 10% cream. The
expiration dates for these patents range from April 28, 2009, to December 17,
2016. We recently filed an application for patent term extension with the
Patent and Trademark Office for extension of the Companys use patent from
April 28, 2009, to April 28, 2014. These patents cover both medical and
veterinary uses of the topical and systemic formulations of docosanol 10% cream
in the U.S. and Europe. We also have additional foreign patent applications
pending that cover other topical and systemic uses of docosanol 10% cream and
have been granted rights under selected U.S. and foreign patents and patent
applications relating to docosanol 10% cream held by a third party.

Xenerex proprietary antibody generation technologies.We own the rights to
seven issued patents (three U.S. and four foreign) related to antibody
generation technologies. The expiration dates for these patents range from
December 19, 2012, to June 7, 2015. See Antibody Generation Services and
Xenerex Biosciences.

IgE regulation technology.We have received three issued patents (two U.S.
and one foreign). Additionally, we have 65 patent applications pending (three
U.S. and 62 foreign) related to IgE technology, which cover various small
molecules and related general structures currently under development or being
used in preclinical research.

Neurodex.We have in-licensed the worldwide rights to use a drug combination
of dextromethorphan and an enzyme inhibitor, which includes six issued patents
in the U.S. and four foreign patent applications pending. The expiration dates
for these patents range from June 30, 2010, to January 26, 2016.

MIF inhibitor technology.We have one provisional patent application regarding
the use of one or more of a series of small molecule compounds that target MIF
as a potential novel therapeutic intervention in rheumatoid arthritis, sepsis,
ulcerative colitis, Crohns disease, inflammatory neurological diseases,
glomerulonephritis and asthma.

We cannot assure you that the claims in our pending patent applications will be
issued as patents, that any issued patents will provide us with significant
competitive advantages, or that the validity or enforceability of any of our
patents will not be challenged or, if instituted, that these challenges will
not be successful. The cost of litigation to uphold the validity and prevent
infringement of our patents could

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be substantial. Furthermore, we cannot assure you that others will not
independently develop similar technologies or duplicate our technologies or
design around the patented aspects of our technologies. We can provide no
assurance that our proposed technologies will not infringe patents or other
rights owned by others, the licenses to which might not be available to us. In
addition, the National Institutes of Health regulations provide that, if
federally funded entities do not timely pursue patent applications for
patentable inventions, then the government may exercise its right to own these
inventions.

In addition, the approval process for patent applications in foreign countries
may differ significantly from the process in the U.S. The patent authorities in
each country administer that countrys laws and regulations relating to patents
independently of the laws and regulations of any other country and the patents
must be sought and obtained separately. Therefore, approval in one country
does not necessarily indicate that approval can be obtained in other countries.

Proprietary rights.In some cases, we may rely on trade secrets and
confidentiality agreements to protect our innovations. We can provide no
assurance that:



| |  |  | our trade secrets will be maintained;                                
| | - |  | ---------------------------------------------------------------------
|
| |  |  | secrecy obligations will be honored; or                              
|
| |  |  | others will not independently develop similar or superior technology.

To the extent that consultants, key employees or other third parties apply
technological information independently developed by them or by others to our
projects, we may be subject to disputes regarding the proprietary rights to
this information that may not be resolved in our favor.

Government regulations

The FDA and comparable regulatory agencies in foreign countries regulate
extensively the manufacture and sale of the pharmaceutical products that we
currently are developing. The FDA has established guidelines and safety
standards that are applicable to the nonclinical evaluation and clinical
investigation of therapeutic products and stringent regulations that govern the
manufacture and sale of these products. The process of obtaining FDA approval
for a new therapeutic product usually requires a significant amount of time and
substantial resources. The steps typically required before a product can be
produced and marketed for human use include:



| |  |  | nonclinical evaluation in vitro and in vivo including
extensive toxicology; and                            
| | - |  | -----------------------------------------------------------------------------------------------------------
|
| |  |  | nonclinical pharmacological studies to obtain preliminary
information on the safety and efficacy of a drug.

The results of these nonclinical studies may be submitted to the FDA as part of
an investigational new drug application. The sponsor of an investigational new
drug application may commence human testing of the compound only after being
notified by the FDA that the agency has activated the investigational new drug
application, which usually occurs within 30 days of submission of the
application.

The clinical testing program for a drug may involve three phases:



| |  |  | Phase 1investigations are conducted in either healthy people
or in people or subjects often having a terminal disease, such as
cancer, to determine the maximum tolerated doses and any side
effects of the product;                                                                                   
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Phase 2studies are conducted in limited numbers of subjects
with the disease or condition to be treated and are aimed at
determining the most effective doses and schedule of administration,
evaluating safety and whether the product demonstrates therapeutic
effectiveness against the disease; and

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| |  |  | Phase 3studies involve large, well-controlled investigations
in diseased subjects and are aimed at verifying the safety and
effectiveness of the drug.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------

Data from all clinical studies, as well as all nonclinical studies and evidence
of product quality, typically are submitted to the FDA in a new drug
application.

The FDAs Center for Drug Evaluation and Research or the Center for Biologics
Evaluation and Research must approve a new drug application or biologics
license application for a drug before the drug may be marketed in the U.S. At
the time, if ever, that we begin to market our proposed products for commercial
sale in the U.S., any manufacturing operations that may be established in or
outside the U.S. will be subject to rigorous regulation, including compliance
with current good manufacturing practices. We also may be subject to
regulation under the Occupational Safety and Health Act, the Environmental
Protection Act, the Toxic Substance Control Act, the Export Control Act and
other present and future laws of general application. In addition, the
handling, care and use of laboratory mice, including the hu-PBL-SCID mice and
rats, are subject to the Guidelines for the Humane Use and Care of Laboratory
Animals published by the National Institutes of Health.

We currently intend to seek approval to market docosanol 10% cream and other
proposed products in foreign countries, which may have regulatory processes
that differ materially from those of the FDA. We anticipate that we will rely
upon pharmaceutical or biotechnology companies to license our proposed products
or independent consultants to seek approvals to market our proposed products in
foreign countries. We cannot assure you that approvals to market any of our
proposed products can be obtained in any country. Approval to market a product
in any one foreign country does not necessarily indicate that approval can be
obtained in other countries.

Human resources

At December 5, 2001, we employed 44 persons, including 32 engaged in research
and development activities, clinical and regulatory affairs, and commercial
development, and 12 engaged in administrative functions such as human
resources, finance, accounting, purchasing and investor relations. Our staff
includes 15 employees with doctoral degrees. Of the total employment, nine
personnel are engaged in work at Xenerex Biosciences. We believe that our
relationship with our employees is good.

Risk factors that might affect future operations

If we experience any delays in obtaining regulatory approval for Abreva in
Canada or if GlaxoSmithKline experiences problems in manufacturing or reduces
promotion of the product, then our royalties from sales of Abreva will be
materially and adversely affected.

We have signed an exclusive license agreement with GlaxoSmithKline for
manufacturing and sales of Abreva in North America. Abreva is approved for
sale only in the United States at this time. We have completed the application
for regulatory approval for marketing in Canada and we are currently awaiting a
decision. We could experience problems or delays in obtaining regulatory
approval in Canada, which has a market size that is about 10% of the size of
the U.S. market. Further, our royalty revenues from sales of Abreva next year
will be substantially influenced by the level of GlaxoSmithKlines marketing
and promotion of the product. Any problem or delay in manufacturing, or any
material reduction in product promotion could affect materially and adversely
our business operations and financial condition.

AVANIR and its licensees may not be successful in obtaining regulatory approval
of docosanol 10% cream immediately as an OTC product in the rest of the world
or in licensing, marketing and selling the product in foreign countries.

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AVANIR and its licensees could face the following risks in our efforts to
obtain regulatory approval as an OTC product and to market and sell docosanol
10% cream in foreign countries:



| |  |  | Regulatory approval requirements differ by country, and
obtaining approvals to market the drug in foreign countries may be
difficult to obtain or may require prescription status first before
obtaining sufficient experience to warrant approval as an OTC
product;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | building product awareness of a new drug, whether
prescription or OTC, among customers or retail store decision makers
may require a substantial amount of product promotion, which does
not guarantee success;                                                      
|
| |  |  | consumers may not perceive that docosanol 10% cream is
superior to existing and potentially new OTC products for oral
herpes;                                                                                                                                        
|
| |  |  | acceptance of docosanol 10% cream in the OTC consumer market
may not be widespread; and                                                                                                                                                                              
|
| |  |  | potential price erosion could occur due to competitive
products and responses to our products introduction.                                                                                                                                                         

Abreva faces competition from a number of existing and well-established
products and the companies that market their products.

Abreva competes with several other products for oral-facial herpes currently
on the market in the U.S., as well as other products or potential products that
are or may be under development or undergoing FDA review. Most of our
competitors, including Blistex, Inc., Bayer Corp. and Schering Plough, have
substantial financial resources, research and development facilities and
manufacturing and marketing experience. Even with Abreva being marketed by
one of the worlds largest consumer healthcare companies, GlaxoSmithKline, not
all competitive responses and the impacts of those responses can be foreseen.

Foreign sales of docosanol 10% cream and other potential products are subject
to various foreign trade risks.

Our license agreement with GlaxoSmithKline is for the United States and Canada
only. We also have exclusive license agreements for docosanol 10% cream for
Israel and Korea. We are holding discussions with other potential licensees
for marketing and selling docosanol 10% cream in other countries not already
licensed. However, we may not finalize any license or distributorship
arrangements for territories on a timely basis or on favorable terms, if at
all. Further, we are exposed to various foreign trade risks relating to the
continued development and marketing of docosanol 10% cream by our foreign
licensees. Further, we may arrange for contracts in the future for the
manufacture, marketing and distribution of docosanol 10% cream overseas by
foreign licensees, which will be substantially outside our control. Even if we
are able to obtain experienced licensees in foreign markets, specific risks
that could impact significantly our ability to deliver products abroad include:



| |  |  | difficulties in obtaining regulatory approval of
docosanol 10% cream in Canada, Israel, Korea and other foreign
countries;
| | - |  | --------------------------------------------------------------------------------------------------------------------------
|
| |  |  | changes in the regulatory and competitive environments in foreign countries;                                              
|
| |  |  | changes in a specific countrys or regions political or economic conditions;                                             
|
| |  |  | difficulty in finding foreign partners with sufficient
capital to effectively launch, market and promote the product;     
|
| |  |  | shipping delays;                                                                                                          
|
| |  |  | difficulties in managing operations across disparate geographic areas;                                                    
|
| |  |  | fluctuations in foreign currency exchange rates;                                                                          
|
| |  |  | prices of competitive products;                                                                                           
|
| |  |  | difficulties associated with enforcing agreements through foreign legal systems; and                                      

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| |  |  | trade protection measures, including customs duties and export quotas.
| | - |  | ----------------------------------------------------------------------

Our failure or inability to comply with government regulations regarding the
development, production, testing, manufacturing and marketing of our other
products may adversely affect our operations.

Governmental authorities in the U.S., including the FDA, and other countries
regulate significantly the development, production, testing, manufacturing and
marketing of pharmaceutical products. The clinical testing and regulatory
approval process can take a number of years and require the expenditure of
substantial resources. Failure to obtain, or delays in obtaining, these
approvals will adversely affect our business operations, including our ability
to commence marketing of any proposed products. We may find it necessary to
use a significant portion of our financial resources for research and
development and the clinical trials necessary to obtain these approvals for our
proposed products. We will continue to incur costs of development without any
assurance that we will ever obtain regulatory approvals for any of our products
under development. In addition, we cannot predict the extent to which adverse
governmental regulation might arise from future U.S. or foreign legislative or
administrative action. Moreover, we cannot predict with accuracy the effect of
unspecified, but possible, future changes in the regulatory approval process
and in the domestic health care system for which we develop our products.
Future changes could affect adversely the time frame required for regulatory
review, our financial resources, and the sale prices of our proposed products,
if approved for sale.

Unsuccessful or lengthy research and development programs for proposed new
products could negatively affect our business.

We face substantial risks of failing to complete the development of our
research programs for the treatment of central nervous system disorders,
allergy and asthma, and other areas. Our Phase II/III clinical trials of
Neurodex for the treatment of emotional lability in ALS and MS patients may
experience setbacks or failures for reasons we have not anticipated. Our Phase
II clinical trial of Neurodex for the treatment of neuropathic pain may not
show proof of concept. Our observations during preclinical research of our
lead compound for treating allergy and asthma, while showing effectiveness in
several in-vitro and ex-vivo assays and in-vivo allergy models, may not be
relevant to the development of, indicate the efficacy of, or have the safety
profile necessary for a proposed product for human use. Unsuccessful clinical
trial results for our proposed products could affect materially and adversely
our future business operations and financial condition. The development process
for medical products is lengthy and capital intensive. Our drug development
programs are exposed to all of the risks inherent in product development based
on innovative technologies, including unanticipated development problems and
the possible lack of funding or collaborative partners, which could result in
the abandonment or substantial change in the development of a specific product.

We expect our quarterly revenues and operating results to fluctuate for a
number of reasons.

Future operating results will continue to be subject to quarterly fluctuations
based on a wide variety of factors, including:



| |  |  | Seasonality.Our sequential royalty revenues from sales of Abreva
by GlaxoSmithKline in the United States are expected to fluctuate
downward in the summer months based on
historical industry sales data for cold sores, which indicates some
seasonality.                                                                                                                                                                                                                                                                                                                                      
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Acquisitions/alliances.If, in the future, we acquire
technologies, products, or businesses, or we form alliances with
companies requiring technology investments or commitments, we will face
a number of risks to our business. The risks we may encounter include
those associated with integrating operations, personnel, and
technologies acquired or licensed, and the potential for unknown
liabilities of the acquired business. Our business and operating
results on a quarterly basis could be adversely affected if any of our
acquisition or alliance activities are not successful.

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| |  |  | Concentration of significant customers, suppliers and industries.
Milestone payments and royalties earned from a single licensee
(GlaxoSmithKline) accounted for approximately 91%, 93%, 0%, of our
fiscal 2001, 2000, and 1999 net revenues, respectively. Our business
could be adversely affected if GlaxoSmithKline or any other significant
licensee or customer terminated its business relationship with us or
significantly reduced the amount of business it did with us.
Additionally, we purchase our raw materials from a sole supplier that
has been approved for manufacture by the FDA. Any disturbances or
delays in the manufacture of the raw materials could seriously and
adversely affect our business.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Business interruptions could adversely affect our business.

Our operations are vulnerable to interruption by fire, earthquake, power loss,
telecommunications failure, terrorist attacks and other events beyond our
control. For example, during 2001, California experienced shortages in
adequate supply of electricity, resulting in rolling blackouts, where certain
areas are not provided with any electricity for periods of up to two hours.
The immediate impact was a significant increase in power rates for most users,
including us. Additionally, the loss of electrical power or blackouts for
any significant periods of time could harm either our vendors or our ability to
conduct our experiments or to provide antibody research services for others.
Further, we could lose valuable progress made to date in experiments currently
underway. We have attempted to mitigate the severity of power losses by
installing emergency power equipment, which we intend to use for those
electrical needs that we consider to be the most critical to operating our
business. However, the emergency power unit does not cover all of our
electrical needs.

Our acquisition and alliance activities could disrupt our ongoing business.

We intend to continue to make investments in products and technologies, acquire
or inlicense technologies, and, in the future, could acquire entire companies
to expand our product development pipeline and sales revenues. Acquisitions
and strategic alliances often involve risks, including: difficulty in
assimilating the acquired technologies, operations and employees, difficulty in
managing research collaborations, difficulty in retaining key employees of an
acquired operation, disruption of our ongoing business, inability to
successfully integrate the acquired technology and operations into our business
and lacking the experience to develop the acquired technology.

Difficulties in acquiring inlicensed technologies that we believe are necessary
to fill our product development pipeline may restrict our growth.

Our business strategy for growth is not only through internal development, but
also through inlicensing of products, potential products and/or technologies at
various stages in the drug development pipeline. We will face intense
competition in attempting to inlicense other products and technologies. In
addition, we may not be able to locate suitable products and technologies to
fit our strengths, be able to obtain them on acceptable terms, or have the
financial resources to develop products from the inlicensed technology. If we
are unable to add to our product development pipeline, our growth may be
limited and it may affect our business and stock price negatively. Also, we
must have the financial resources to acquire and/or inlicense new products and
technologies and develop and market the products, if approved. We can provide
no assurance that we will be successful in our inlicensing strategy or that it
will have the desired effect on our future growth or stock price.

Our failure to retain key management and scientific personnel could negatively
affect our business.

Our success depends on the performance of a small core staff of key management
and scientific employees with biotech experience. Given our small staff size
and programs currently under development, we depend substantially on our
ability to hire, train, retain and motivate high quality personnel, especially
our scientists and management team in this field. If we were to lose one or more of

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our key scientists, then we would lose the history and knowledge that they have
which could substantially delay one or more of our development programs until
adequate replacement personnel could be hired and trained.

Our future success also depends on our continuing ability to identify, hire,
train and retain highly qualified, technical, sales, marketing and customer
service personnel. We presently employ approximately 44 people in AVANIR and
our subsidiary, Xenerex Biosciences, and we expect to hire additional people
throughout the year. While we have employment and employee retention
agreements with certain key executives, they are limited in scope and provide
no real assurance that any of these people will continue their employment with
us. We do not have key person life insurance policies. The industry in
which we compete has a high level of employee mobility and aggressive
recruiting of skilled personnel, which creates intense competition for
qualified personnel, particularly in product research, development, sales and
marketing.

Our patents may be challenged and our pending patents may be denied. Either
result would seriously jeopardize our ability to compete in the intended
markets for our proposed products.

We rely substantially on the protection of our intellectual property for
docosanol, with 32 U.S. and foreign docosanol patents and 39 additional
docosanol-related patent applications pending. We also have patent
and patent applications
pending on other products and technologies, and have inlicensed the rights to
market a potential product that treats multiple central nervous system
disorders that has six issued patents. Because of the competitive nature of
the bio-pharmaceutical industry, we cannot assure you that:



| |  |  | the claims in the pending patent applications will be
allowed or that we will even be issued additional patents;                                                                     
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | present and future competitors will not develop similar
or superior technologies independently, duplicate our
technologies or design around the patented aspects of our
technologies;
|
| |  |  | our proposed technologies will not infringe other
patents or rights owned by others, including licenses which may
not be available to us;                                            
|
| |  |  | any issued patents will provide us with significant
competitive advantages; or                                                                                                       
|
| |  |  | challenges will not be instituted against the validity
or enforceability of any patent that we own or, if instituted,
that these challenges will not be successful.                  

Our inability to obtain or maintain patent protections for our products in
foreign markets may negatively affect our financial condition.

The process for the approval of patent applications in foreign countries may
differ significantly from the process in the U.S. These differences may delay
our plans to market and sell docosanol 10% cream and other products in the
international marketplace. Approval in one country does not necessarily
indicate that approval can be obtained in other countries. The patent
authorities in each country administer that countrys laws and regulations
relating to patents independently of the laws and regulations of any other
country and we must seek and obtain the patents separately. Our inability to
obtain or maintain patent protections for docosanol 10% cream and other
products in foreign markets would severely hamper our ability to generate
international sales from our first product and other products still under
development.

If we do not protect our technical innovations, then our business may be
negatively affected.

We rely substantially on confidentiality agreements to protect our innovations.
We cannot assure you that secrecy obligations will be honored, or that others
will not develop independently similar or superior technology. In addition, if
our consultants, key employees or other third parties apply technological

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information independently developed by them or by others to our projects, then
disputes may arise as to the proprietary rights to this information in which we
may not receive a favorable resolution.

Developing new pharmaceutical products for human use involves product liability
risks, for which we currently have limited insurance coverage.

The testing, marketing, and sale of pharmaceutical products involves the risk
of product liability claims by consumers and other third parties. We maintain
product liability insurance coverage for our clinical trials in the amount of
$2 million per incident and $2 million in the aggregate. However, product
liability claims can be high in the pharmaceutical industry and our insurance
may not cover sufficiently all of the possible liabilities. If a suit against
our business or proposed products is successful, then the lack or insufficiency
of insurance coverage could affect materially and adversely our business and
financial condition. Furthermore, various distributors of pharmaceutical
products require minimum product liability insurance coverage before their
purchase or acceptance of products for distribution. Failure to satisfy these
insurance requirements could impede our ability to achieve broad distribution
of our proposed products.

We may issue additional shares of our Class A common stock. These issuances may
dilute the value of our Class A common stock to current shareholders and may
adversely affect the market price of our Class A common stock.

If we raise additional capital by issuing additional shares of Class A common
stock at a price or a value per share less than the then-current price per
share of Class A common stock, then the value of the shares of Class A common
stock outstanding will be diluted or reduced. Further, even if we were to sell
shares of common stock at prices higher than todays price, sales of such
shares may depress our market price and dilute earnings per share.

The conversion or exercise of currently outstanding stock purchase warrants and
stock options, or conversion of redeemable convertible preferred stock
currently outstanding will have a dilutive effect on our Class A common stock.

As of December 5, 2001, the Company had outstanding stock options to purchase
an aggregate of 5,299,994 shares of Class A common stock at exercise prices
ranging from $0.30 to $6.44 per share and warrants to acquire up to 1,264,550
shares of Class A common stock at exercise prices ranging from $0.9144 to
$2.715 per share. The Company has other securities that may have a dilutive
effect, including 50 shares of Series D redeemable convertible preferred stock,
which at recent market prices may be converted into approximately
185,200
shares of Class A common stock at a fixed conversion price of $2.715 per share.

Sales in the public market of shares of Class A common stock acquired upon
exercise of stock options and warrants may affect adversely the prevailing
market prices for Class A common stock. Negative price movements in the shares
of Class A common stock likely would affect adversely our ability to obtain
additional equity capital on favorable terms, if at all.

We do not intend to declare or pay cash dividends in the foreseeable future.

We do not intend to declare or pay cash dividends on our Class A or Class B
common stock in the foreseeable future. We expect to retain any earnings, if
and when achieved, to finance our business.

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Item 2. PROPERTIES

We currently lease 27,047 square feet of laboratory and office space at 11388
Sorrento Valley Road, Suite 200, San Diego, California for an average base rent
of approximately $753,000 per year over the lease commitment period. The
current lease expires on August 31, 2008. See Note 6, Commitments, to our
financial statements annexed to this report.




Item 3. LEGAL PROCEEDINGS

None.




Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

PART II




Item 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our Class A common stock trades under the symbol AVN on The American Stock
Exchange (the AMEX), which has been the primary exchange for trading shares of
our common stock since April 6, 2000. For approximately a seven-month period
(from September 20, 1999 to April 5, 2000) our common stock traded on the
over-the-counter (OTC) bulletin board under the symbol AVNR. Prior to
that, our common stock traded on The Nasdaq Stock Market (Nasdaq) for
approximately nine years. Our stock symbol on the Nasdaq was initially
LDAKA, until our shareholders approved a change in the Companys name from
LIDAK Pharmaceuticals to AVANIR Pharmaceuticals on November 20, 1998, which
resulted in the Nasdaq changing our stock symbol to AVNR on November 30,
1998. The prices set forth below for the periods during which our stock traded
on the OTC market represent quotes between dealers and do not include
commissions, mark-ups or mark-downs, and may not necessarily represent actual
transactions.

|               |  |                      |      |     |  |   |      | 
|-------------- |  | -------------------- | ---- | --- |  | - | ---- | 
|               |  | Class A Common Stock
|               |  |                     
|               |  | High                 |      | Low
|               |  |                      |      |    
|Fiscal 2000    |  |                      |      |     |  |   |      | 
|First Quarter  |  | $                    | 2.88 |     |  | $ | 0.25 | 
|Second Quarter |  | $                    | 4.19 |     |  | $ | 1.75 | 
|Third Quarter  |  | $                    | 4.00 |     |  | $ | 1.81 | 
|Fourth Quarter |  | $                    | 9.00 |     |  | $ | 2.25 | 
|              
|Fiscal 2001    |  |                      |      |     |  |   |      | 
|First Quarter  |  | $                    | 9.50 |     |  | $ | 3.00 | 
|Second Quarter |  | $                    | 6.50 |     |  | $ | 3.75 | 
|Third Quarter  |  | $                    | 6.30 |     |  | $ | 3.03 | 
|Fourth Quarter |  | $                    | 6.25 |     |  | $ | 2.50 | 

On December 12, 2001, the closing sales price of Class A Common Stock was $3.55
per share.

As of December 12, 2001, we had 1,305 holders of record and approximately
23,750 beneficial owners of our Class A Common Stock. We have not paid any
dividends on our Class A or Class B common stock since our inception and do not
expect to pay dividends on our common stock in the foreseeable future.

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Item 6. SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data set forth below at September 30, 2001
and 2000, and for the years ended September 30, 2001, 2000 and 1999 are derived
from our audited consolidated financial statements included elsewhere in this
report. This information should be read in conjunction with those consolidated
financial statements, the notes thereto, and the independent auditors report
thereon, and with Managements Discussion and Analysis of Financial Condition
and Results of Operations. The selected consolidated financial data set forth
below at September 30, 1999, 1998 and 1997, and for the fiscal years ended
September 30, 1998 and 1997, are derived from audited financial statements that
are contained in our previous SEC reports.

Summary Financial Information

|                                                              |                                                       |         |            |                                  |            |      |            |          |            |      |            |            |            |   |            |            |            |   |             |             |            | 
|------------------------------------------------------------- | ----------------------------------------------------- | ------- | ---------- | -------------------------------- | ---------- | ---- | ---------- | -------- | ---------- | ---- | ---------- | ---------- | ---------- | - | ---------- | ---------- | ---------- | - | ----------- | ----------- | ---------- | 
|                                                              |                                                       |         |            | Fiscal Years Ended September 30,
|                                                              |                                                       |         |            |                                 
|                                                              |                                                       |         |            | 2001                             |            | 2000 |            | 1999     |            | 1998 |            | 1997      
|                                                              |                                                       |         |            |                                  |            |      |            |          |            |      |            |           
|Statement of operations data:                                 |                                                       |         |            |                                  |            |      |            |          |            |      |            |            |            |   |            |            |            |   |             |            
|Revenues                                                      |                                                       | $       | 13,828,741 |                                  |            | $    | 10,687,026 |          |            | $    | 146,787    |            |            | $ | 590,728    |            |            | $ | 1,547,554   |            
|Net income (loss)                                             |                                                       |         | 233,122    |                                  |            |      | (582,283   | )        |            |      | (8,554,036 | )          |            |   | (8,210,548 | )          |            |   | (11,109,242 | )          
|                                                              | Net income (loss) attributable to
common shareholders |         |            | 189,888                          |            |      |            | (801,806 | )          |      |            | (8,583,182 | )          |   |            | (8,210,548 | )          |   |             | (11,109,242 | )         
|Basic net income (loss) per share                             |                                                       | $       | 0.00       |                                  |            | $    | (0.02      | )        |            | $    | (0.21      | )          |            | $ | (0.21      | )          |            | $ | (0.30       | )          
|Diluted net income (loss) per share                           |                                                       | $       | 0.00       |                                  |            | $    | (0.02      | )        |            | $    | (0.21      | )          |            | $ | (0.21      | )          |            | $ | (0.30       | )          
|Weighted average number of shares of
common stock outstanding |                                                       |         |            |                                  |            |      |            |          |            |      |            |            |            |   |            |            |            |   |             |            
|                                                              |                                                       | Basic   |            |                                  | 57,475,748 |      |            |          | 51,784,214 |      |            |            | 41,704,265 |   |            |            | 39,519,609 |   |             |             | 36,779,774 | 
|                                                              |                                                       | Diluted |            |                                  | 63,980,738 |      |            |          | 51,784,214 |      |            |            | 41,704,265 |   |            |            | 39,519,609 |   |             |             | 36,779,774 | 

|                            |                                              |   |               |            |      |   |            |            |      |   |           |         |  |   |           |           |  |   |            |            | 
|--------------------------- | -------------------------------------------- | - | ------------- | ---------- | ---- | - | ---------- | ---------- | ---- | - | --------- | ------- |  | - | --------- | --------- |  | - | ---------- | ---------- | 
|                            |                                              |   | September 30,
|                            |                                              |   |              
|                            |                                              |   | 2001          |            | 2000 |   | 1999       |            | 1998 |   | 1997     
|                            |                                              |   |               |            |      |   |            |            |      |   |          
|Balance sheet data:         |                                              |   |               |            |      |   |            |            |      |   |           |         |  |   |           |           |  |   |            |           
|Cash and cash equivalents   |                                              | $ | 16,542,545    |            |      | $ | 19,699,768 |            |      | $ | 122,674   |         |  | $ | 6,508,341 |           |  | $ | 14,428,834 |           
|Investments                 |                                              |   | 5,308,691     |            |      |   | 1,568,474  |            |      |   |          |         |  |   |          |           |  |   |           |           
|                            |                                              |   |               |            |      |   |            |            |      |   |           |         |  |   |           |           |  |   |            |           
|                            | Total cash, cash equivalents and
investments |   |               | 21,851,236 |      |   |            | 21,268,242 |      |   |           | 122,674 |  |   |           | 6,508,341 |  |   |            | 14,428,834 | 
|Working capital             |                                              |   | 16,415,699    |            |      |   | 19,162,545 |            |      |   | (956,190  | )       |  |   | 4,819,830 |           |  |   | 11,336,627 |           
|Total assets                |                                              |   | 27,053,953    |            |      |   | 23,519,237 |            |      |   | 1,765,215 |         |  |   | 7,653,800 |           |  |   | 15,727,495 |           
|Convertible notes payable   |                                              |   |              |            |      |   |           |            |      |   |          |         |  |   | 1,000,000 |           |  |   | 2,415,461  |           
|Total liabilities           |                                              |   | 2,592,490     |            |      |   | 1,922,929  |            |      |   | 1,701,019 |         |  |   | 2,064,485 |           |  |   | 3,433,569  |           
|Convertible preferred stock |                                              |   | 502,903       |            |      |   | 465,920    |            |      |   |          |         |  |   |          |           |  |   |           |           
|Shareholders equity        |                                              |   | 23,958,560    |            |      |   | 21,130,388 |            |      |   | 64,196    |         |  |   | 5,589,315 |           |  |   | 12,293,926 |           

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|                                                              |                                     |         |           |                       |            |                |            |               |            |                    |            |       |            |   |           |      |            | 
|------------------------------------------------------------- | ----------------------------------- | ------- | --------- | --------------------- | ---------- | -------------- | ---------- | ------------- | ---------- | ------------------ | ---------- | ----- | ---------- | - | --------- | ---- | ---------- | 
|                                                              |                                     |         |           | Fiscal Quarters Ended
|                                                              |                                     |         |           |                      
|                                                              |                                     |         |           | December 31, 2000     |            | March 31, 2001 |            | June 30, 2001 |            | September 30, 2001
|                                                              |                                     |         |           |                       |            |                |            |               |            |                   
|Quarterly statement of operations
For fiscal year 2001:       |                                     |         |           |                       |            |                |            |               |            |                    |            |       |            |   |           |     
|Revenues                                                      |                                     | $       | 5,401,102 |                       |            | $              | 1,612,333  |               |            | $                  | 798,714    |       |            | $ | 6,016,592 |     
|Net income (loss)                                             |                                     |         | 3,103,104 |                       |            |                | (2,685,331 | )             |            |                    | (1,992,359 | )     |            |   | 1,807,708 |     
|Net income (loss) attributable to
common shareholders         |                                     |         | 3,092,144 |                       |            |                | (2,695,954 | )             |            |                    | (2,003,151 | )     |            |   | 1,796,849 |     
|                                                              | Basic net income (loss) per share   |         | $         | 0.05                  |            |                | $          | (0.05         | )          |                    | $          | (0.03 | )          |   | $         | 0.03 |           
|                                                              | Diluted net income (loss) per share |         | $         | 0.05                  |            |                | $          | (0.05         | )          |                    | $          | (0.03 | )          |   | $         | 0.03 |           
|Weighted average number of shares of
common stock outstanding |                                     |         |           |                       |            |                |            |               |            |                    |            |       |            |   |           |     
|                                                              |                                     | Basic   |           |                       | 57,216,732 |                |            |               | 57,346,992 |                    |            |       | 57,542,291 |   |           |      | 57,794,901 | 
|                                                              |                                     | Diluted |           |                       | 65,516,875 |                |            |               | 57,346,992 |                    |            |       | 57,542,291 |   |           |      | 62,017,795 | 

|                                                              |                                     |         |            |                       |            |                |            |               |            |                    |            |       |            |   |           |      |            | 
|------------------------------------------------------------- | ----------------------------------- | ------- | ---------- | --------------------- | ---------- | -------------- | ---------- | ------------- | ---------- | ------------------ | ---------- | ----- | ---------- | - | --------- | ---- | ---------- | 
|                                                              |                                     |         |            | Fiscal Quarters Ended
|                                                              |                                     |         |            |                      
|                                                              |                                     |         |            | December 31, 1999     |            | March 31, 2000 |            | June 30, 2000 |            | September 30, 2000
|                                                              |                                     |         |            |                       |            |                |            |               |            |                   
|Quarterly statement of operations
For fiscal year 2000:       |                                     |         |            |                       |            |                |            |               |            |                    |            |       |            |   |           |     
|Revenues                                                      |                                     | $       | 8,037      |                       |            | $              | 1,042,978  |               |            | $                  | 162,631    |       |            | $ | 9,473,380 |     
|Net income (loss)                                             |                                     |         | (1,837,127 | )                     |            |                | (4,674,746 | )             |            |                    | (1,449,937 | )     |            |   | 7,379,527 |     
|Net income (loss) attributable to
common shareholders         |                                     |         | (1,837,127 | )                     |            |                | (4,679,332 | )             |            |                    | (1,600,964 | )     |            |   | 7,315,617 |     
|                                                              | Basic net income (loss) per share   |         | $          | (0.04                 | )          |                | $          | (0.09         | )          |                    | $          | (0.03 | )          |   | $         | 0.13 |           
|                                                              | Diluted net income (loss) per share |         | $          | (0.04                 | )          |                | $          | (0.09         | )          |                    | $          | (0.03 | )          |   | $         | 0.11 |           
|Weighted average number of shares of
common stock outstanding |                                     |         |            |                       |            |                |            |               |            |                    |            |       |            |   |           |     
|                                                              |                                     | Basic   |            |                       | 45,683,119 |                |            |               | 50,438,776 |                    |            |       | 55,181,700 |   |           |      | 55,855,567 | 
|                                                              |                                     | Diluted |            |                       | 45,683,119 |                |            |               | 50,438,776 |                    |            |       | 55,181,700 |   |           |      | 64,205,372 | 

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Item 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

AVANIR Pharmaceuticals, based in San Diego, is a pharmaceutical
development company with an FDA-approved drug currently on the market. AVANIR
is engaged in research, development, commercialization, licensing and sales of
innovative drug products and antibody generation services. Founded in 1988,
AVANIRs first ten years were focused primarily on developing Abreva
(docosanol 10% cream), a topical treatment for cold sores. Since then, AVANIR
has developed a pipeline of products in both clinical and pre-clinical stages
of development. Two products in clinical development are focused on treatments
for emotional lability in patients with Lou Gehrigs disease and for
neuropathic pain. The Companys pre-clinical research programs are focused on
large therapeutic areas, including novel treatments for allergy and asthma,
inflammation, and cholesterol reduction.

In July 2000, the FDA formally approved our new
drug application for Abreva as an
over-the-counter (OTC) product. In October 2000, SmithKline Beecham (now
GlaxoSmithKline) began manufacturing and distributing Abreva in the United States under an exclusive license agreement for
the North American market. By March 2001, Abreva became the number one selling
cold sore medication in the OTC market place and by September 2001 was ranked
number five among the top selling new consumer healthcare products launched in
the last year.

Also in mid-2000, AVANIR formed a subsidiary, Xenerex Biosciences, for the
purposes of focusing on antibody generating services for other pharmaceutical
companies and to develop antibodies for our own disease targets. In a little
over a year since starting its operations in a newly designed facility in
September 2000, Xenerex has entered into research collaboration agreements with
two biotechnology companies for the purposes of developing antibodies to cancer
targets provided by both companies. Xenerex has made substantial progress in
commercializing its proprietary antibody technology while working with its
existing customers and intends to expand its marketing and sales of services to
more companies in fiscal year 2002.

Sources of revenues

Since obtaining approval by the FDA of Abreva in July 2000, AVANIR has been
able to earn revenues from milestone payments and royalties from sales of
Abreva by GlaxoSmithKline. These revenues, almost solely coming from
GlaxoSmithKline during that period, have been an important source of funds for
advancing our other programs in the development pipeline. We expect to
continue to receive royalties from Abreva sales in the United States and Canada
for at least the next eight years. We also have license agreements for
docosanol 10% cream in place in Korea and Israel and three letters of intent to
license the product in Southern Europe, China, and in certain countries in the
Middle East. Revenues from licensing the product in other countries are
subject to completion of milestones, are nonrecurring in nature, and depend
substantially on our progress in obtaining regulatory approvals for the product
in these and other countries.

Revenues earned from antibody generation services provided by our subsidiary,
Xenerex Biosciences, under research collaborations have been insignificant to
date because of the early stage of development under existing collaborations
and the revenue recognition process will not be complete until certain
milestones defined in the agreements have been achieved. Xenerex is working on
development of antibodies to six cancer target antigens specified by two
research collaborations. We also intend to develop additional research
collaborations for several of our other drug development programs, provided
they reach a stage that is attractive for partnering and can advance our
development efforts.

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Nature of operating expenses

AVANIRs operating expenses are influenced substantially by the amount of
spending devoted to our clinical development programs and drug discovery
research. During the past two years, we have substantially expanded our drug
development pipeline, which requires that we allocate significant amounts of
our operating costs to research and development expense. Our spending on new
business development and on general and administrative support staff tends to
follow trends in our spending for research, but to a lesser extent. Other
components of our operating costs include maintenance and operation of our
laboratory and office facilities, depreciation, professional and consulting
fees related to clinical trials and regulatory compliance, insurance, and
investor relations. We expect to incur increasing annual operating expenses
for the foreseeable future, in light of our expanded product development
pipeline. Our business is exposed to significant risks, as discussed in the
section entitled Risk factors that might affect future operations, which may
result in additional expenses, delays and lost opportunities that could have a
material adverse effect on our financial condition and results of operations.

Effects of inflation

We believe the impact of inflation and changing prices on net sales revenues
and on net income from continuing operations has been immaterial during the
past three years. Prices for electricity increased in early fiscal 2001,
however, our operations do not consume a substantial amount of electricity
other than for providing lighting and air conditioning for our offices and
laboratories.

RESULTS OF OPERATIONS

Comparison of fiscal years 2001 and 2000

Net income (loss) in 2001 vs. 2000

The net income attributable to common shareholders for fiscal 2001 was $190,000
or slightly better than breakeven on a per share basis, compared with a net
loss of $802,000, or $0.02 per share, for fiscal 2000. This represents an
improvement of $1 million or $0.02 per share in fiscal 2001 over the net loss in
fiscal 2000. Increased revenues from milestone payments and royalties on sales
of Abreva contributed to earning a profit in fiscal 2001 compared with a loss
in fiscal 2000, as further discussed below.

Revenues  2001 vs. 2000

Revenues in fiscal 2001 increased to $13.8 million, compared to $10.7 million
in fiscal 2000. The $3.1 million increase in revenues for fiscal 2001 resulted
primarily from the launch of our cold sore product, Abreva, in the United
States by our licensee, GlaxoSmithKline, in October 2000. AVANIR earned $10
million in milestone payments and $2.5 million in royalty revenues on sales of
Abreva in fiscal 2001, compared to $10 million in milestone payments under the
license agreement in the prior year. Other revenues in fiscal 2001 included
$1.1 million in interest income, $73,000 in federal grant revenues, and $70,000
in contract and license fees from other areas. Other revenues in fiscal 2000
included $225,000 in sales of the active ingredient, docosanol, and $434,000 in
interest income.

Expenses  2001 vs. 2000

Operating expenses. Our total operating expenses increased to $13.6 million in
fiscal 2001, compared to $11.3 million in fiscal 2000. Operating expenses in
fiscal 2001 were higher than fiscal 2000 by $6.4 million excluding litigation
settlement charges of $4.1 million in fiscal 2000. The net increase in
operating expenses during fiscal 2001 is described in the following paragraphs.

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Purchased in-process research and development expense.In fiscal 2001, we
charged $917,100 to in-process research and development expense, which
represents the cost of in-process technologies obtained in our acquisition of
certain technology and know-how from the Ciblex Corporation that could assist
us in discovering a drug capable of regulating macrophage migration inhibitory
factor, a protein thought to play a central role in the early stages of
development of several inflammatory diseases (MIF inhibitor technology) (See
Note 2 to the Financial Statements, Purchased in-process research and
development.)

Research and development (R&D) expenses. Our R&D expenses amounted to $7.2
million in fiscal 2001, compared to $2.4 million for fiscal year 2000. In
fiscal 2001, we spent $2.3 million or 32% of total R&D expenditures on a Phase
II/III clinical trial of Neurodex in the potential treatment of emotional
lability in ALS patients. We also spent $1.4 million or 19% of total R&D
expenditures on pre-clinical research focused on a novel treatment for allergy
and asthma, including development and scaled-up manufacture of a lead compound.
Within Xenerex, we spent $1.3 million or 18% of total R&D expenditures on
development of antibody generation technology. The balance of R&D spending was
primarily related to other pre-clinical programs addressing inflammation and
cholesterol reduction and operation of our laboratory facilities. In fiscal
2000, R&D expense was primarily related to drug discovery efforts in seeking
out a lead compound intended for the treatment of allergy and asthma and for
Phase II clinical trials of Neurodex as an intended treatment for emotional
lability in ALS and other neurodegenerative diseases.

General and administrative expenses. Our general and administrative expenses
increased to $3.5 million in fiscal 2001 from $3.3 million during fiscal 2000.
These increased expenses primarily relate to:



| |  |  | increased staff size and higher administrative support
costs for most of fiscal 2001 as the Company increased its level
of operating activity in drug discovery, clinical development,
and business development following approval of Abreva by the FDA;
partially offset by
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | lower legal expenses related to defense of claims
against the Company.                                                                                                                                                                                                      

Sales and marketing expenses. Sales and marketing expenses increased to $1.2
million in fiscal 2001 from $692,000 during fiscal 2000. In fiscal 2001,
business development activity, including travel, legal and overall staff costs
increased substantially as we pursued international licensing of docosanol 10%
cream. In fiscal 2000, we maintained a lower level of marketing and sales
staff while awaiting the FDAs approval of Abreva for marketing in the United
States.

Interest expense. Interest expense decreased to $6,500 in fiscal 2001 compared
to $516,000 in fiscal 2000. The high level of interest expense in fiscal 2000
related to the amortization of debt issue costs and interest expense incurred
on an aggregate of $1.5 million in redeemable convertible debt, portions of
which were outstanding for 66 and 71 days in fiscal 2000.

Comparison of fiscal years 2000 and 1999

Net loss  2000 vs. 1999

The net loss attributable to common shareholders for fiscal 2000 was $802,000
or $0.02 per share, compared with a net loss of $8.6 million, or $0.21 per
share, for fiscal 1999. The lower net loss in fiscal 2000 resulted primarily
from receipt of $10 million in milestone payments for Abreva, and lower sales
and marketing expenses, partially offset by $4.1 million in total charges for
litigation settlements completed during the year. Excluding the litigation
settlement charges in fiscal 2000, net earnings attributable to common
shareholders would have been $3.3 million in fiscal 2000. These and other
factors contributing to the lower net loss in fiscal 2000 compared with fiscal
1999 are discussed below.

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Revenues  2000 vs. 1999

Revenues increased to $10.7 million in fiscal 2000 from $147,000 in fiscal
1999. This increase in revenues resulted from earning $10 million upon
achieving several significant milestones under the Companys license agreement
with GlaxoSmithKline (formerly SmithKline Beecham), $225,000 in sales of the
active ingredient, docosanol, and higher levels of interest income from larger
cash balances available for investment during fiscal 2000.

Expenses  2000 vs. 1999

Operating expenses. Total operating expenses decreased to $7.2 million in
fiscal 2000, excluding litigation settlement charges of $4.1 million, compared
to $8.7 million in operating expenses in fiscal 1999. The net decrease in
operating expenses during fiscal 2000 is described in the following paragraphs.

Research and development expenses. Our R&D expenses during fiscal 2000 were
$2.4 million, compared to $3.3 million for fiscal year 1999. Research and
development expenses in fiscal 2000 related primarily to drug discovery efforts
in seeking out a lead compound intended for the treatment of allergy and
asthma. In the prior fiscal year, higher levels of R&D expense were being
incurred for allergy and asthma technology and for Phase II clinical trials of
Neurodex (formerly code-named AVP-923) as a potential treatment for central
nervous system disorders.

General and administrative expenses. Our general and administrative expenses
during fiscal 2000 decreased to $3.3 million from $3.8 million during fiscal
1999. These decreased expenses primarily relate to:



| |  |  | lower staff levels for most of fiscal 2000 while we
worked with the FDA on obtaining approval of our new drug
application for Abreva;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | lower legal expenses related to defense of claims
against the Company; and                                                           
|
| |  |  | lower proxy and shareholder solicitation costs of
meetings held in fiscal 2000 compared with the prior year.                         

Sales and marketing expenses. Sales and marketing expenses decreased to
$692,000 during fiscal 2000 from $1.6 million during fiscal year 1999. In
fiscal 2000, we maintained a lower level of marketing and sales staff, pending
the FDAs approval of our new drug application for Abreva. Also during fiscal
2000, we licensed the rights to market and sell Abreva in North America to
GlaxoSmithKline, which took over responsibility for marketing, sales and
promotion of the product, thus eliminating any need for a sales and marketing
staff to market Abreva in North America.

Interest expense. Interest expense increased to $516,000 in fiscal 2000
compared to $8,000 in fiscal 1999. The increase in interest expense in fiscal
2000 related to the amortization of debt issue costs and interest expense
incurred on an aggregate of $1.5 million in redeemable convertible debt,
portions of which were outstanding for 66 and 71 days in fiscal 2000.

Litigation settlement. During fiscal 2000, we recorded litigation settlement
expenses of $4.1 million in connection with settlements of litigation with the
former chief executive officer and director of the Company, and two other
related parties. There were no litigation settlement costs incurred during
fiscal year 1999.

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Liquidity and capital resources

At September 30, 2001, we had cash and cash equivalents of $16.5 million and a
net working capital balance of $16.4 million. At September 30, 2000, we had
cash and cash equivalents of $19.7 million and a net working capital balance of
$19.2 million. The $3.2 million decrease in cash and cash equivalents is
primarily the result of $5.2 million in cash used for investing
activities, partially offset by $634,000 in cash provided by operating
activities and $1.4 million in cash provided by financing activities. The $2.8
million decrease in net working capital is also primarily the result of $5.2
million in cash used for investing activities, which
includes a $4.2
million net increase in investments with maturities of longer than one year. See
also Results of Operations for a further discussion of operating activities
during fiscal 2001.

|                                          |                                                      |   |            |            |      |  |                 |   |  |   |            |            | 
|----------------------------------------- | ---------------------------------------------------- | - | ---------- | ---------- | ---- |  | --------------- | - |  | - | ---------- | ---------- | 
|                                          |                                                      |   |            |            |      |  | Increase        |   |  |   |           
|                                          |                                                      |   |            |            |      |  | (decrease) from |   |  |   |           
|                                          |                                                      |   | 2001       |            | 2000 |  | 2000           
|                                          |                                                      |   |            |            |      |  |                
|Cash and cash equivalents                 |                                                      | $ | 16,542,545 |            |      |  | ($3,157,223     | ) |  | $ | 19,699,768 |           
|Net working capital                       |                                                      |   | 16,415,699 |            |      |  | (2,763,046      | ) |  |   | 19,162,545 |           
|Net cash provided by operating activities |                                                      |   | 634,451    |            |      |  | (4,740,399      | ) |  |   | 5,374,850  |           
|Net cash used in investing activities     |                                                      |   | (5,240,378 | )          |      |  | (2,603,070      | ) |  |   | (2,637,308 | )         
|Net cash provided by financing activities |                                                      |   | 1,448,704  |            |      |  | (15,390,848     | ) |  |   | 16,839,552 |           
|                                          |                                                      |   |            |            |      |  |                 |   |  |   |            |           
|                                          | Net increase (decrease) in cash and cash
equivalents |   |            | (3,157,223 | )    |  |                 |   |  |   |            | 19,577,094 | 
|                                          |                                                      |   |            |            |      |  |                 |   |  |   |            |           

Operating activities. Net cash provided by operating activities amounted to
$634,000 in fiscal 2001, compared to $5.4 million in net cash provided by
operating activities in fiscal 2000. The net cash provided by operating
activities in fiscal 2000 included the effects of litigation settlements of
$4.1 million that were paid for in common stock.

Investing activities. Net cash used for investing activities totaled $5.2
million in fiscal 2001, including capital expenditures of $1 million and patent
costs of $538,000. Net cash used for investing activities in fiscal 2000
totaled $2.6 million, including capital expenditures of $951,000 and patent
costs of $118,000.

Financing activities. During fiscal 2001, we received $1.6 million from
financing activities, repaid $195,000 in outstanding debt and paid $6,000 in
dividends on preferred stock, yielding $1.4 million in net cash provided by
financing activities. The amount received from financing activities in fiscal
2001 represents funds received from exercises of stock options and stock
purchase warrants. During fiscal 2000, we received $18.6 million from
financing activities and repaid $1.7 million in outstanding debt. The amount
received from financing activities in fiscal 2000 included sales of common
stock relating to a $6 million private placement and exercises of stock options
and stock purchase warrants amounting to $10.5 million. AVANIR issued
redeemable convertible debentures to obtain interim financing in the amount of
$1.5 million in November 1999 and repaid the debentures in January 2000. Also,
on February 19, 2000, we issued and sold $1 million in Series D redeemable
convertible preferred stock and Class J Warrants to certain investors. The
balance of financing was related to annual financing of insurance premiums and
other financed purchase transactions in the ordinary course of business.

We believe that AVANIRs revenues, as well as cash flows from operations, for
fiscal 2002 will substantially depend upon royalties from sales of Abreva by
GlaxoSmithKline in North America, progress that we make in international
regulatory filings in Canada, Europe, Korea and Israel and in establishing
license agreements for docosanol 10% cream, including reaching milestones under
those agreements. Cash flow from operations in fiscal 2002 will also depend in
part on Xenerexs progress in

24



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##### Table of Contents



negotiating additional research collaboration agreements and in successfully
reaching milestones in its process of providing antibody generation services.

Recent Accounting Pronouncements

Effective October 1, 2000, we adopted Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities (SFAS 133), as amended by SFAS 138, Accounting for Certain
Derivative Instruments and Certain Hedging activities. SFAS No. 133, as
amended, establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires an entity to recognize all
derivatives as either assets or liabilities on the balance sheet and measure
those instruments at fair value. The adoption of this new standard did not
have a material impact on the Companys financial statements.

In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements. SAB 101, as amended, summarizes certain of the SECs views in
applying accounting principles generally accepted in the United States of
America to revenue recognition in financial statements, including revenues
earned from collaborations between companies. We adopted SAB 101 in the fourth
quarter of the fiscal year ended September 30, 2001. The adoption of SAB 101
did not have a material impact on the Companys earnings.

In July 2001, the Financial Accounting Standards Board (FASB) approved three
statements, SFAS 141, Business Combinations, SFAS 142, Goodwill and Other
Intangible Assets, and SFAS 143, Accounting for Asset Retirement
Obligations.

SFAS 141 supersedes APB Opinion No. 16, Business Combinations, and eliminates
the pooling-of-interests method of accounting for business combinations, thus
requiring all business combinations be accounted for using the purchase method.
In addition, in applying the purchase method, SFAS 141 changes the criteria
for recognizing intangible assets apart from goodwill and states the following
criteria should be considered in determining the recognition of the intangible
assets: (1) the intangible asset arises from contractual or other legal
rights, or (2) the intangible asset is separable or dividable from the acquired
entity and capable of being sold, transferred, licensed, rented, or exchanged.
The requirements of SFAS 141 are effective for all business combinations
completed after June 30, 2001. The adoption of this new standard did not have
a material impact on the Companys financial statements.

SFAS 142 supercedes APB Opinion No. 17, Intangible Assets, and requires
goodwill and other intangible assets that have an indefinite useful life to no
longer be amortized; however, these assets must be reviewed at least annually
for impairment. Application of SFAS 142 is required beginning
October 1, 2002. We do not believe the adoption of SFAS 142 will have a significant
impact on the Companys financial statements.

SFAS 143 requires entities to record the fair value of a liability for an asset
retirement obligation in the period in which it is incurred. When the
liability is initially recorded, the entity capitalizes a cost by increasing
the carrying amount of the related long-lived asset. Over time, the liability
is accreted to its present value each period, and the capitalized cost is
depreciated over the useful life of the related asset. Upon settlement of the
liability, an entity either settles the obligation for its recorded amount or
incurs a gain or loss upon settlement. Application of SFAS 143 became
effective for AVANIR on October 1, 2001. We do not believe that its adoption
will have a significant impact on the Companys financial statements.

In August 2001 the FASB issued SFAS 144 Accounting for the Impairment or
Disposal of Long-Lived Assets. This statement addresses financial accounting
and reporting for the impairment or disposal of long-lived Assets. This
statement supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of, and the accounting and
reporting provisions of APB Opinion No. 30, Reporting the Results of
Operations  Reporting the Effects of a Disposal of a Segment of a Business,
and Extraordinary, Unusual and infrequently Occurring Events and Transactions,
for the disposal of a segment of a business (as previously defined in that
Opinion). SFAS No. 144 is effective October 1, 2001. The effect of SFAS 144
on the Companys financial statements has not yet been determined.

25



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##### Table of Contents






Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk related to changes in interest rates. Because
substantially all our revenue, expense, and capital purchasing activities are
transacted in U.S. dollars, our exposure to foreign currency exchange rates is
immaterial. However, in the future we could face increasing exposure to
foreign currency exchange rates as we expand international distribution of
docosanol 10% cream. Until such time as we are faced with material amounts of
foreign currency exchange rate risks, we do not plan to use derivative
financial instruments, which can be used to hedge such risks. We will evaluate
the use of derivative financial instruments to hedge our exposures as the needs
and risks should arise.

Interest rate sensitivity

Our investment portfolio consists primarily of fixed income instruments with an
average duration of 2.8 years as of September 30, 2001 (nine-tenths of a year
as of September 30, 2000). The primary objective of our investments in debt
securities is to preserve principal while achieving attractive yields, without
significantly increasing risk. We carry some investments that we intend to
hold to maturity and others that we classify as available-for-sale. These
available-for-sale securities are subject to interest rate risk. In general,
we would expect that the volatility of this portfolio would increase as its
duration increases.




Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our financial statements are annexed to this report beginning on page F-1.




Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Inapplicable.

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##### Table of Contents






PART III




Item 10. DIRECTORS AND EXECUTIVE OFFICERS

The information relating to our directors that are required by this item is
incorporated by reference from the information under the caption Election of
Directors contained in our definitive proxy statement (the Proxy Statement),
which will be filed with the Securities and Exchange Commission in connection
our Annual Meeting of Shareholders to be held on March 14, 2002.

Executive officers of the Registrant

The names of our executive officers and their ages as of December 21, 2001
are set forth below. The Board of Directors annually elects the executive
officers of the Registrant.

|                         |  |     |    |          |  |                                                               
|------------------------ |  | --- | -- | -------- |  | --------------------------------------------------------------
|Name                     |  | Age |    | Position
|                         |  |     |    |         
|Gerald J. Yakatan, Ph.D. |  |     | 59 |          |  | President and Chief Executive Officer                         
|                        
|Gregory P. Hanson        |  |     | 55 |          |  | Vice President, Finance; Chief Financial
Officer and Secretary
|                        
|J. David Hansen          |  |     | 50 |          |  | Vice President, Commercial Development                        
|                        
|James E. Berg            |  |     | 50 |          |  | Vice President, Clinical and Regulatory Affairs               

Gerald J. Yakatan, Ph.D. Dr. Yakatan has served as president and chief
executive officer since March 1998. Dr. Yakatan also is a director and serves
as chairman of the board and chief executive officer of AVANIRs subsidiary,
Xenerex Biosciences. In addition, Dr. Yakatan serves or has served in the
following positions: from July 1995 to February 1998 has served on a half-time
basis as vice president of Drug Development at the Company; from 1996 to
present, Chairman of IriSys Research & Development, LLC, a company he founded
in 1996 specializing in contract drug formulation development services; from
1990 until 1995, president and chief executive officer of San Diego-based
Tanabe Research Laboratories, USA, Inc., an inflammation drug discovery
research and development company. Earlier in his career, Dr. Yakatan held
various positions over a seven-year span at Warner-Lambert Co., including vice
president of Product Development for the Pharmaceutical Research Division; and
for approximately eight years he was a faculty member of the University of
Texas at Austin and Assistant Director of the Drug Dynamics Institute at the
College of Pharmacy. Dr. Yakatan has over 60 scientific and professional
publications in the areas of pharmacokinetics, biopharmaceutics, analysis of
drugs in biological fluids and drug stability. He is a Fellow of the American
Association of Pharmaceutical Scientists and the American College of Clinical
Pharmacology. Dr. Yakatan received his B.S. in Pharmacy in 1963 and M.S. in
Pharmaceutical Chemistry in 1965 from Temple University. In 1971, Dr. Yakatan
received his Ph.D. in Pharmaceutical Sciences from the University of Florida.

Gregory P. Hanson. Mr. Hanson has served as vice president, Finance and chief
financial officer (CFO) and Corporate Secretary since July 1998. Mr. Hanson
also serves as CFO and corporate secretary for the companys subsidiary,
Xenerex Biosciences. From September 1995 to July 1998, he was the chief
financial officer of XXsys Technologies Inc., a composite materials technology
company; and from May 1993 to September 1995, he held a number of financial
positions within The Titan Corporation, a diversified telecommunications and
information technology company, including acting CFO and acting Controller for
its subsidiary, Titan Information Systems. Earlier in his career, Mr. Hanson
held various management positions at Ford Motor Company over a 14-year span and
at Solar Turbines Incorporated, a

27



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subsidiary of Caterpillar Inc., over a three-year span. Mr. Hanson has a B.S.
degree in Mechanical Engineering from Kansas State University and an M.B.A.
degree with honors from the University of Michigan. He is a Certified
Management Accountant and has passed the examination for Certified Public
Accountants.

J. David Hansen. Mr. Hansen is a vice president of the Company. Mr. Hansen is
also the president and chief operating officer of the Companys subsidiary,
Xenerex Biosciences. In addition, Mr. Hansen has served in the following
positions: from December 1989 to September 1998, various management positions
at Dura Pharmaceuticals, San Diego, California, including Senior Director,
Strategic Sales Systems; National Sales Director, Director of Business
Development and Director of Marketing. Earlier in his career, he held various
management positions at Immunetech Pharmaceuticals, San Diego, California;
Schering/Key Pharmaceuticals, Kennilworth, New Jersey; and E.R. Squibb & Sons,
Princeton, New York. Mr. Hansen graduated with honors from the University of
Oregon, with a B.S. degree in Chemistry in June 1974.

James E. Berg.Mr. Berg has served as vice president, Clinical and Regulatory
Affairs since March 1997. From August 1992 to March 1997, Mr. Berg was
Director of Clinical Affairs and Product Development at the Company. Earlier
in his career, Mr. Berg held various sales and management positions at QUIDEL
Corporation, San Diego, California, and at Krupp Bilstein Corporation of
America, Inc., San Diego, California. Mr. Berg received his B.A. degree from
the University of Wisconsin in 1973.




Item 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference to the
information under the caption Executive Compensation contained in the Proxy
Statement.




Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is incorporated by reference to the
information under the caption Security Ownership of Certain Beneficial Owners
and Management contained in the Proxy Statement.




Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is incorporated by reference to the
information under the caption Certain Relationships and Transactions
contained in our definitive proxy statement.




PART IV




Item 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES AND REPORTS ON FORM 8-K



|(a) |  | Financial Statements and Schedule
|--- |  | ---------------------------------



| | (1) |  | Index to financial statements appears on page F-1.
| | --- |  | --------------------------------------------------



|(b) |  | Current Reports on Form 8-K
|--- |  | ---------------------------
|   
|    |  | None                       

28



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|(c) |  | Exhibits
|--- |  | --------

|     |  |                                                                                                                                                                                   
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1  |  | Restated Articles of Incorporation of the Registrant, dated April 4, 1994 (1)                                                                                                     
|    
|3.2  |  | Certificate of Amendment of the Articles of Incorporation of the Registrant, dated
November 20, 1998                                                                              
|    
|3.3  |  | Certificate of Amendment of the Articles of Incorporation of the Registrant, dated
February 19, 1999                                                                              
|    
|3.4  |  | Amended and Restated Bylaws of the Registrant                                                                                                                                     
|    
|4.1  |  | Forms of Class A and Class B Common Stock Certificates (3)                                                                                                                        
|    
|4.2  |  | Form of Class G Stock Purchase Warrant issued in connection with Convertible Note,
dated February 26, 1997 (4)                                                                    
|    
|4.3  |  | Form of Class H Stock Purchase Warrant, issued in connection with Convertible Note
dated February 26, 1997 (4)                                                                    
|    
|4.4  |  | Registration Rights Agreement, dated February 26, 1997, with RGC International
Investors, LDC (4)                                                                                 
|    
|4.5  |  | Registration Rights Agreement with Promethean Investment Group, LLC (5)                                                                                                           
|    
|4.6  |  | Class A Common Stock Investment Agreement with Promethean Investment Group, LLC (5)                                                                                               
|    
|4.7  |  | Certificate of Determination with respect to Series C Junior Participating Preferred
Stock of the Registrant (6)                                                                  
|    
|4.8  |  | Rights Agreement, dated as of March 5, 1999, with American Stock Transfer & Trust
Company (6)                                                                                     
|    
|4.9  |  | Form of Rights Certificate with respect to the Rights Agreement, dated as of March 5,
1999 (6)                                                                                    
|    
|4.10 |  | Certificate of Determination, dated March 26, 1999, with respect to Series D redeemable
convertible preferred stock of the Registrant (7)                                         
|    
|4.11 |  | Form of Series D Convertible Preferred Stock Certificate (7)                                                                                                                      
|    
|4.12 |  | Form of Class J Stock Purchase Warrant issued in connection with Series D redeemable
convertible preferred stock (7)                                                              
|    
|4.13 |  | Securities Purchase Agreement for Series D Convertible Preferred Stock (7)                                                                                                        
|    
|4.14 |  | Registration Rights Agreement for Series D Convertible Preferred Stock (7)                                                                                                        
|    
|4.15 |  | Amendment to the Class A Common Stock Investment Agreement with Promethean Investment
Group, LLC (8)                                                                              
|    
|4.16 |  | Class K Stock Purchase Warrant, dated as of April 1, 1999, issued to Redington, Inc. (9)                                                                                          
|    
|4.17 |  | Amendment No. 1 to Registration Rights Agreement, dated as of November 23, 1999, with
AMRO International, S.A and The Endeavour Capital Fund, S.A. (10)                           
|    
|4.18 |  | Amendment No. 1 to Rights Agreement, dated November 30, 1999, with American Stock
Transfer & Trust Company (10)                                                                   
|    
|4.19 |  | Registration Rights Agreement, dated January 25, 2000, by and among (i) AVANIR
Pharmaceuticals and (ii) Bayview LLC, The Endeavour Capital Fund, S.A. and Roseworth
Group Ltd (12)
|    
|4.20 |  | Form of Class N Stock Purchase Warrant, issued in connection with Common Stock Purchase
Agreement dated January 25, 2000 (12)                                                     
|    
|10.1 |  | Form of Employment Agreement, dated as of February 1999, with certain executive officers and                                                                                      

29



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|      |  |                                                                                                                                                                                     
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     
|      |  | key employees of the Registrant (2)                                                                                                                                                 
|     
|10.2  |  | Amended and Restated 1998 Stock Option Plan                                                                                                                                         
|     
|10.3  |  | 1989 Stock Option Plan (3)                                                                                                                                                          
|     
|10.4  |  | Amended and Restated 1994 Stock Option Plan                                                                                                                                         
|     
|10.5  |  | Employment Agreement with Gerald J. Yakatan, dated November 29, 2001                                                                                                                
|     
|10.6  |  | Form of Retention Agreement with certain Executive Officers of the Registrant (11)                                                                                                  
|     
|10.7  |  | Form of Indemnification Agreement with certain Directors and Executive Officers of the
Registrant (11)                                                                              
|     
|10.8  |  | Common stock Purchase Agreement, dated January 25, 2000, by and among (i) AVANIR
Pharmaceuticals and (ii) Bayview LLC, The Endeavour Capital Fund, S.A. and Roseworth
Group Ltd (12)
|     
|10.9  |  | License Agreement, dated March 31, 2000, by and between AVANIR Pharmaceuticals and SB
Pharmco Puerto Rico, a Puerto Rico Corporation (13)                                           
|     
|10.10 |  | Standard Industrial Net Lease by and between AVANIR Pharmaceuticals and BC Sorrento,
LLC, effective September 1, 2000 (14)                                                          
|     
|10.11 |  | License Agreement, dated August 1, 2000, by and between AVANIR Pharmaceuticals
(Licensee) and Irisys Research and Development, LLC, a California limited liability
company (14)   
|     
|10.12 |  | Amended and Restated 2000 Stock Option Plan (15)                                                                                                                                    
|     
|21.1  |  | List of Subsidiaries                                                                                                                                                                
|     
|23.1  |  | Independent Auditors Consent                                                                                                                                                       





---

|(1) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Amendment
No. 4 to the Registration Statement on Form S-1, File No. 33-32742, declared effective by the
Commission on April 13, 1994.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Quarterly
Report on Form 10-Q for the quarter ended March 31, 1999, filed May 17, 1999.                                              
|   
|   
|   
|   
|(3) |  | Incorporated by reference to the similarly described exhibit included with the Registrants
Registration Statement on Form S-1, File No. 33-32742, declared effective by the Commission on May 8,
1990.                          
|   
|   
|   
|   
|(4) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Current
Report on Form 8-K, filed March 10, 1997.                                                                                    
|   
|   
|   
|   
|(5) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Current
Report on Form 8-K, filed January 25, 1999.                                                                                  
|   
|   
|   
|   
|(6) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Current
Report on Form 8-K, filed March 11, 1999.                                                                                    
|   
|   
|   
|   
|(7) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Current
Report on Form 8-K, filed April 1, 1999, at 16:31.                                                                           
|   
|   
|   
|   
|(8) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Current
Report on Form 8-K, filed April 1, 1999, at 16:37.                                                                           
|   
|   
|   
|   
|(9) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Current
Report on Form 8-K, filed April 20, 1999.                                                                                    

30



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##### Table of Contents



|(10) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Current
Report on Form 8-K, filed December 3, 1999.                   
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|    
|    
|    
|(11) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998.    
|    
|    
|    
|    
|(12) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Current
Report on Form 8-K, filed February 4, 2000.                   
|    
|    
|    
|    
|(13) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Current
Report on Form 8-K, filed May 4, 2000.                        
|    
|    
|    
|    
|(14) |  | Incorporated by reference to the similarly described exhibit included with the Registrants Quarterly
Report on Form 10-Q, filed August 14, 2000.                 
|    
|    
|    
|    
|(15) |  | Incorporated by reference from the Registrants definitive proxy statement to be filed on or before
January 29, 2002, for the 2002 Annual Meeting of Shareholders.

31



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##### Table of Contents



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

|                        |                                                                |                             
|----------------------- | -------------------------------------------------------------- | ----------------------------
|Date:  December 21,2001 | AVANIR PHARMACEUTICALS                                        
|                       
|                        | By:                                                            | /s/ Gerald J. Yakatan, Ph.D.
|                        |                                                               
|                        | Gerald J. Yakatan, Ph.D.
President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.

|                                                       |  |                                                                                                  |  |                  
|------------------------------------------------------ |  | ------------------------------------------------------------------------------------------------ |  | -----------------
|Signature                                              |  | Title                                                                                            |  | Date             
|                                                       |  |                                                                                                  |  |                  
|                                                      
|/s/ Gerald J. Yakatan, Ph.D.

Gerald J. Yakatan, Ph.D. |  | President and Chief
Executive Officer
(Principal Executive Officer)                              |  | December 21, 2001
|                                                      
|/s/ Gregory P. Hanson

Gregory P. Hanson               |  | Vice President, Finance and Chief
Financial Officer
(Principal Financial and Accounting Officer) |  | December 21, 2001
|                                                      
|/s/ James B. Glavin

James B. Glavin                   |  | Chairman of the Board                                                                            |  | December 21, 2001
|                                                      
|/s/ Dennis J. Carlo, Ph.D.

Dennis J. Carlo, Ph.D.     |  | Director                                                                                         |  | December 21, 2001
|                                                      
|/s/ Michael W. George

Michael W. George               |  | Director                                                                                         |  | December 21, 2001
|                                                      
|/s/ Susan Golding

Susan Golding                       |  | Director                                                                                         |  | December 21, 2001
|                                                      
|/s/ Edward L. Hennessy, Jr.

Edward L. Hennessy, Jr.   |  | Director                                                                                         |  | December 21, 2001
|                                                      
|/s/ Charles A. Mathews

Charles A. Mathews             |  | Director                                                                                         |  | December 21, 2001
|                                                      
|/s/ Kenneth E. Olson

Kenneth E. Olson                 |  | Director                                                                                         |  | December 21, 2001
|                                                      
|/s/ Harold F. Oberkfell

Harold F. Oberkfell           |  | Director                                                                                         |  | December 21, 2001

32



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Exhibits

|     |  |                                                                                                     
|---- |  | ----------------------------------------------------------------------------------------------------
|3.2  |  | Certificate of Amendment of the Articles of Incorporation of the Registrant, dated November 20, 1998
|    
|3.3  |  | Certificate of Amendment of the Articles of Incorporation of the Registrant, dated February 19, 1999
|    
|3.4  |  | Amended and Restated Bylaws of the Registrant                                                       
|    
|10.2 |  | Amended and Restated 1998 Stock Option Plan                                                         
|    
|10.4 |  | Amended and Restated 1994 Stock Option Plan                                                         
|    
|10.5 |  | Employment Agreement with Gerald J. Yakatan, dated November 29, 2001                                
|    
|21.1 |  | List of Subsidiaries                                                                                
|    
|23.1 |  | Independent Auditors Consent                                                                       

33



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##### Table of Contents



AVANIR Pharmaceuticals




INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

---



|                                                |  |      |     | 
|----------------------------------------------- |  | ---- | --- | 
|                                                |  | Page
|                                                |  |     
|INDEPENDENT AUDITORS REPORT                    |  |      | F-2 | 
|CONSOLIDATED FINANCIAL STATEMENTS               |  |      |     | 
|Consolidated Balance Sheets                     |  |      | F-3 | 
|Consolidated Statements of Operations           |  |      | F-4 | 
|Consolidated Statements of Shareholders Equity |  |      | F-5 | 
|Consolidated Statements of Cash Flows           |  |      | F-8 | 
|Notes to Consolidated Financial Statements      |  |      | F-9 | 

F-1



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##### Table of Contents






INDEPENDENT AUDITORS REPORT

To the Board of Directors and Shareholders of
AVANIR Pharmaceuticals:

We have audited the accompanying consolidated balance sheets of AVANIR
Pharmaceuticals as of September 30, 2001 and 2000, and the related consolidated
statements of operations, shareholders equity and cash flows for each of the
three years in the period ended September 30, 2001. These financial statements
are the responsibility of the Companys management. Our responsibility is to
express an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of AVANIR
Pharmaceuticals at September 30, 2001 and 2000, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended September 30, 2001, in conformity with accounting principles generally
accepted in the United States of America.

DELOITTE & TOUCHE LLP

San Diego, California
December 10, 2001

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##### Table of Contents






AVANIR Pharmaceuticals

CONSOLIDATED BALANCE SHEETS

---

|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |             |   |            |            | 
|-------------------------------------- | -------------------------------------------------------------------------------- | ------------------------------------------------ | ---------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------- | ------------- | ---------- | ----------- | - | ---------- | ---------- | 
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         | September 30,
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         |              
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         | 2001          |            | 2000       
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|ASSETS                                 |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|Current assets:                        |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|                                       | Cash and cash equivalents                                                        |                                                  | $                                                                                                                            | 16,542,545                 |         |               | $          | 19,699,768  |  
|                                       | Restricted investment                                                            |                                                  |                                                                                                                              | 388,122                    |         |               |            | 388,122     |  
|                                       | Short-term investments                                                           |                                                  |                                                                                                                              | 23,179                     |         |               |            | 480,352     |  
|                                       | Receivables, net                                                                 |                                                  |                                                                                                                              | 898,676                    |         |               |            | 95,429      |  
|                                       | Inventory                                                                        |                                                  |                                                                                                                              | 222,585                    |         |               |            | 9,804       |  
|                                       | Prepaid                                                                          |                                                  |                                                                                                                              | 581,298                    |         |               |            | 411,999     |  
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|                                       |                                                                                  |                                                  | Total current assets                                                                                                         |                            |         | 18,656,405    |            |             |   | 21,085,474 |           
|Property and equipment, net            |                                                                                  |                                                  | 2,217,094                                                                                                                    |                            |         |               | 1,050,703  |            
|Intangible costs, net                  |                                                                                  |                                                  | 1,174,928                                                                                                                    |                            |         |               | 614,816    |            
|Investments                            |                                                                                  |                                                  | 4,897,390                                                                                                                    |                            |         |               | 700,000    |            
|Other assets                           |                                                                                  |                                                  | 108,136                                                                                                                      |                            |         |               | 68,244     |            
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|                                       | TOTAL ASSETS                                                                     |                                                  | $                                                                                                                            | 27,053,953                 |         |               | $          | 23,519,237  |  
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|LIABILITIES AND SHAREHOLDERS EQUITY   |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|Current liabilities:                   |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|                                       | Accounts payable                                                                 |                                                  | $                                                                                                                            | 734,701                    |         |               | $          | 965,636     |  
|                                       | Accrued expenses and other liabilities                                           |                                                  |                                                                                                                              | 858,991                    |         |               |            | 537,027     |  
|                                       | Accrued compensation and payroll taxes                                           |                                                  |                                                                                                                              | 355,526                    |         |               |            | 248,599     |  
|                                       | Loan payable                                                                     |                                                  |                                                                                                                              | 186,122                    |         |               |            | 171,667     |  
|                                       | Current portion of capital lease obligation                                      |                                                  |                                                                                                                              | 105,366                    |         |               |            |            |  
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|                                       |                                                                                  |                                                  | Total current liabilities                                                                                                    |                            |         | 2,240,706     |            |             |   | 1,922,929  |           
|                                       |                                                                                  | Capital lease obligation, net of current portion |                                                                                                                              |                            | 351,784 |               |            |             |  |           
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|                                       |                                                                                  |                                                  |                                                                                                                              | Total liabilities          |         |               | 2,592,490  |             |   |            | 1,922,929  | 
|COMMITMENTS(Note 6)                    |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|REDEEMABLE CONVERTIBLE PREFERRED STOCK |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|                                       | Series D  no par value, 500 shares authorized;
50 shares issued and outstanding |                                                  |                                                                                                                              | 502,903                    |         |               |            | 465,920     |  
|SHAREHOLDERS EQUITY                   |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|                                       | Preferred stock  no par value, 9,999,500 shares authorized:                     |                                                  |                                                                                                                              |                            |         |               |            |             |  
|                                       |                                                                                  |                                                  | Series C Junior Participating  1,000,000 shares authorized,
no shares issued or outstanding
Common stock  no par value:    |                            |         |               |            |             |   |            |           
|                                       |                                                                                  |                                                  | Class A  99,288,000 shares authorized; 57,976,381 and
56,974,828 issued and outstanding                                     |                            |         | 86,626,355    |            |             |   | 84,695,590 |           
|                                       |                                                                                  |                                                  | Class B  712,000 shares authorized; 36,500 and 65,000
shares issued and outstanding (convertible into Class
A common stock) |                            |         | 19,895        |            |             |   | 34,145     |           
|                                       | Receivable for Class A common stock                                              |                                                  |                                                                                                                              |                           |         |               |            | (649,431    | )
|                                       | Accumulated deficit                                                              |                                                  |                                                                                                                              | (62,735,080                | )       |               |            | (62,949,916 | )
|                                       | Accumulated other comprehensive income                                           |                                                  |                                                                                                                              | 47,390                     |         |               |            |            |  
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|                                       |                                                                                  |                                                  |                                                                                                                              | Total shareholders equity |         |               | 23,958,560 |             |   |            | 21,130,388 | 
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            
|                                       | TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                       |                                                  | $                                                                                                                            | 27,053,953                 |         |               | $          | 23,519,237  |  
|                                       |                                                                                  |                                                  |                                                                                                                              |                            |         |               |            |            

See notes to consolidated financial statements.

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##### Table of Contents






AVANIR Pharmaceuticals

CONSOLIDATED STATEMENTS OF OPERATIONS

---

|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |           |            |           | 
|------------------------------------------------------ | --------------------------------------------- | ----------------------------------------------------------------------- | -------------- | ---------- | ------------------------- | ---------- | -------- | ---------- | ---------- | ---------- | ---------- | --------- | ---------- | --------- | 
|                                                       |                                               |                                                                         |                |            | Years Ended September 30,
|                                                       |                                               |                                                                         |                |            |                          
|                                                       |                                               |                                                                         |                |            | 2001                      |            | 2000     |            | 1999      
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |           
|REVENUES:                                              |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|                                                       | Contract and license revenues                 |                                                                         | $              | 10,070,350 |                           |            | $        | 10,000,000 |            |            |            |          |           
|                                                       | Grant revenue                                 |                                                                         |                | 72,535     |                           |            |          | 27,465     |            |            |            |          |           
|                                                       | Royalties                                     |                                                                         |                | 2,535,717  |                           |            |          |           |            |            |            |          |           
|                                                       | Other sales                                   |                                                                         |                | 2,700      |                           |            |          | 225,353    |            |            |            |          |           
|                                                       | Interest                                      |                                                                         |                | 1,147,439  |                           |            |          | 434,208    |            |            | $          | 146,787   |           
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|                                                       |                                               |                                                                         | Total revenues |            |                           | 13,828,741 |          |            |            | 10,687,026 |            |           |            | 146,787   | 
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|COSTS AND EXPENSES:                                    |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|                                                       | Cost of sales                                 |                                                                         |                |           |                           |            |          | 261,603    |            |            |            |          |           
|                                                       | Product launch expenses                       |                                                                         |                | 728,148    |                           |            |          |           |            |            |            |          |           
|                                                       | Purchased in-process research and development |                                                                         |                | 917,097    |                           |            |          |           |            |            |            |          |           
|                                                       | Research and development                      |                                                                         |                | 7,227,488  |                           |            |          | 2,373,951  |            |            |            | 3,254,751 |           
|                                                       | Sales and marketing                           |                                                                         |                | 1,234,604  |                           |            |          | 691,975    |            |            |            | 1,596,309 |           
|                                                       | General and administrative                    |                                                                         |                | 3,481,735  |                           |            |          | 3,327,988  |            |            |            | 3,842,008 |           
|                                                       | Litigation settlements                        |                                                                         |                |           |                           |            |          | 4,097,504  |            |            |            |          |           
|                                                       | Interest                                      |                                                                         |                | 6,547      |                           |            |          | 516,288    |            |            |            | 7,755     |           
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|                                                       |                                               |                                                                         | Total expenses |            |                           | 13,595,619 |          |            |            | 11,269,309 |            |           |            | 8,700,823 | 
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|NET INCOME (LOSS)                                      |                                               | $                                                                       | 233,122        |            |                           | $          | (582,283 | )          |            | $          | (8,554,036 | )        
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS: |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|                                                       |                                               | Net income (loss)                                                       |                | $          | 233,122                   |            |          | $          | (582,283   | )          |            | $         | (8,554,036 | )        
|                                                       |                                               | Dividends on redeemable convertible preferred
stock                     |                |            | (24,948                   | )          |          |            | (21,914    | )          |            |           | (29,146    | )        
|                                                       |                                               | Beneficial conversion feature of preferred stock                        |                |            |                          |            |          |            | (140,000   | )          |            |           |           |          
|                                                       |                                               | Accretion of discount related to redeemable
convertible preferred stock |                |            | (18,286                   | )          |          |            | (57,609    | )          |            |           |           |          
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS  |                                               | $                                                                       | 189,888        |            |                           | $          | (801,806 | )          |            | $          | (8,583,182 | )        
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|NET INCOME (LOSS) PER SHARE:                           |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|                                                       |                                               | BASIC                                                                   |                | $          | 0.00                      |            |          | $          | (0.02      | )          |            | $         | (0.21      | )        
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|                                                       |                                               | DILUTED                                                                 |                | $          | 0.00                      |            |          | $          | (0.02      | )          |            | $         | (0.21      | )        
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:  |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|                                                       |                                               | BASIC                                                                   |                |            | 57,475,748                |            |          |            | 51,784,214 |            |            |           | 41,704,265 |          
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          
|                                                       |                                               | DILUTED                                                                 |                |            | 63,980,738                |            |          |            | 51,784,214 |            |            |           | 41,704,265 |          
|                                                       |                                               |                                                                         |                |            |                           |            |          |            |            |            |            |          

See notes to consolidated financial statements.

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##### Table of Contents






AVANIR Pharmaceuticals

CONSOLIDATED STATEMENTS OF
SHAREHOLDERS EQUITY

---

|                                                                                                                       |                                                   |                                                                                                  |            |              |           |         |            |             |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   |            |           |           | 
|---------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------- | ------------------------------------------------------------------------------------------------ | ---------- | ------------ | --------- | ------- | ---------- | ----------- | --------- | ----------- | ------- | ------------- | ------- | ----------------- | ------ | ------ | ------ | ------ | -------- | - |  | - | ----------- | - |  |  |  |  |  | - | ---------- | --------- | --------- | 
|                                                                                                                       |                                                   |                                                                                                  |            | Common Stock |           |         |            |             |           |             |         |               |         |                   |        |        |        |        |          |  
|                                                                                                                       |                                                   |                                                                                                  |            |              |           |         |            |             |           |             |         |               |         |                   |        |        |        |        |          |  
|                                                                                                                       |                                                   |                                                                                                  |            | Class A      |           | Class B |            | Receivables |           |             |         |               |         | Accumulated Other |        | Total 
|                                                                                                                       |                                                   |                                                                                                  |            |              |           |         |            | For Common  |           | Accumulated |         | Comprehensive |         | Shareholders'    
|                                                                                                                       |                                                   |                                                                                                  |            | Shares       |           | Amount  |            | Shares      |           | Amount      |         | Stock         |         | Deficit           |        | Income |        | Equity
|                                                                                                                       |                                                   |                                                                                                  |            |              |           |         |            |             |           |             |         |               |         |                   |        |        |        |       
|BALANCE, OCTOBER 1, 1998                                                                                               |                                                   |                                                                                                  | 39,814,017 |              |           | $       | 59,179,721 |             |           |             | 49,000  |               |         | $                 | 25,582 |        |        |        |          |   |  | $ | (53,615,988 | ) |  |  |  |  |  | $ | 5,589,315  |          
|Net loss                                                                                                               |                                                   |                                                                                                  |            |              |           |         |            |             |           |             |         |               |         |                   |        |        |        |        |          |   |  |   | (8,554,036  | ) |  |  |  |  |  |   | (8,554,036 | )        
|Issuance of Class A common stock in
connection with:                                                                   |                                                   |                                                                                                  |            |              |           |         |            |             |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   |            |          
|                                                                                                                       |                                                   | Exercises of stock options                                                                       |            |              | 36,062    |         |            |             | 47,518    |             |         |               | 391,000 |                   |        |        | 12,688 |        |          |   |  |   |             |   |  |  |  |  |  |   |            |           | 60,206    | 
|                                                                                                                       |                                                   | Conversion of convertible note
(including interest of $17,620 and
net of issue costs of $37,577) |            |              | 1,091,213 |         |            |             | 980,049   |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   |            |           | 980,049   | 
|                                                                                                                       |                                                   | Conversion of Series D redeemable
convertible preferred stock                                    |            |              | 4,075,771 |         |            |             | 1,795,224 |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   |            |           | 1,795,224 | 
|Dividends on preferred stock                                                                                           |                                                   |                                                                                                  |            |              |           |         | (29,146    | )           |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   | (29,146    | )        
|Compensation expense related to
valuation of stock options and warrants
granted to non-employees for services
rendered |                                                   |                                                                                                  |            |              |           |         | 222,584    |             |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   | 222,584    |          
|                                                                                                                       |                                                   |                                                                                                  |            |              |           |         |            |             |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   |            |          
|BALANCE, SEPTEMBER 30, 1999                                                                                            |                                                   |                                                                                                  | 45,017,063 |              |           | $       | 62,195,950 |             |           |             | 440,000 |               |         | $                 | 38,270 |        |        |        |          |   |  | $ | (62,170,024 | ) |  |  |  |  |  | $ | 64,196     |          
|Net loss                                                                                                               |                                                   |                                                                                                  |            |              |           |         |            |             |           |             |         |               |         |                   |        |        |        |        |          |   |  |   | (582,283    | ) |  |  |  |  |  |   | (582,283   | )        
|Issuance of Class A common stock in
connection with:                                                                   |                                                   |                                                                                                  |            |              |           |         |            |             |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   |            |          
|                                                                                                                       | Private placement, net of issue
costs of $527,049 |                                                                                                  |            | 2,698,791    |           |         |            | 5,472,951   |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   |            | 5,472,951 |          
|                                                                                                                       | Exercise of warrants                              |                                                                                                  |            | 5,961,819    |           |         |            | 7,900,072   |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   |            | 7,900,072 |          
|                                                                                                                       | Exercise of stock options                         |                                                                                                  |            | 1,498,355    |           |         |            | 3,282,983   |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   |            | 3,282,983 |          
|                                                                                                                       | Litigation settlements                            |                                                                                                  |            | 1,135,000    |           |         |            | 4,097,504   |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   |            | 4,097,504 |          
|                                                                                                                       | Conversions from Class B common stock             |                                                                                                  |            | 375,000      |           |         |            | 4,125       |           |             |         | (375,000      | )       |                   |        | (4,125 | )      |        |          |   |  |   |             |   |  |  |  |  |  |   |            |          |          
|Receivable for Class A common stock                                                                                    |                                                   |                                                                                                  |            |              |           |         |            |             |           |             |         |               |         |                   |        |        |        |        | (649,431 | ) |  |   |             |   |  |  |  |  |  |   | (649,431   | )        
|Conversion of Series D redeemable
convertible preferred stock (including
dividends of $7,603)                          |                                                   |                                                                                                  | 288,800    |              |           |         | 507,603    |             |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   | 507,603    |          
|Dividends on preferred stock                                                                                           |                                                   |                                                                                                  |            |              |           |         | (21,914    | )           |           |             |         |               |         |                   |        |        |        |        |          |   |  |   |             |   |  |  |  |  |  |   | (21,914    | )        

F-5



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##### Table of Contents



AVANIR Pharmaceuticals

CONSOLIDATED STATEMENTS OF
SHAREHOLDERS EQUITY (Continued)

---

|                            |                                                                                                                        |                                                                                    |                                              |  |              |         |            |         |             |          |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            |         |         |          |  
|--------------------------- | ---------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------- | -------------------------------------------- |  | ------------ | ------- | ---------- | ------- | ----------- | -------- | ----------- |  | ------------- | ------- | ----------------- |  | ------ | ------- | -------- | ------- |  | - | ----------- | ------- | -------- | - |  |  |  | - | ---------- | ------- | ------- | -------- | -
|                            |                                                                                                                        |                                                                                    |                                              |  | Common Stock |         |            |         |             |          |             |  |               |         |                   |  |        |         |          |         | 
|                            |                                                                                                                        |                                                                                    |                                              |  |              |         |            |         |             |          |             |  |               |         |                   |  |        |         |          |         | 
|                            |                                                                                                                        |                                                                                    |                                              |  | Class A      |         | Class B    |         | Receivables |          |             |  |               |         | Accumulated Other |  | Total 
|                            |                                                                                                                        |                                                                                    |                                              |  |              |         |            |         | For Common  |          | Accumulated |  | Comprehensive |         | Shareholders'    
|                            |                                                                                                                        |                                                                                    |                                              |  | Shares       |         | Amount     |         | Shares      |          | Amount      |  | Stock         |         | Deficit           |  | Income |         | Equity  
|                            |                                                                                                                        |                                                                                    |                                              |  |              |         |            |         |             |          |             |  |               |         |                   |  |        |         |         
|                            | Valuations of:                                                                                                         |                                                                                    |                                              |  |              |         |            |         |             |          |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            |         |        
|                            |                                                                                                                        | Beneficial conversion feature of
redeemable convertible debentures                 |                                              |  |              |         |            | $       | 166,667     |          |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            | $       | 166,667 |         
|                            |                                                                                                                        | Warrants issued in connection with
redeemable convertible debentures               |                                              |  |              |         |            |         | 81,308      |          |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            |         | 81,308  |         
|                            |                                                                                                                        | Beneficial conversion feature of Series
D redeemable convertible preferred stock   |                                              |  |              |         |            |         | 140,000     |          |             |  |               |         |                   |  |        |         |          |         |  |   |             | $       | (140,000 | ) |  |  |  |   |            |         |        |         
|                            |                                                                                                                        | Warrants issued in connection with
Series D redeemable convertible
preferred stock |                                              |  |              |         |            |         | 106,000     |          |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            |         | 106,000 |         
|                            |                                                                                                                        | Accretion of discount related to Series
D redeemable convertible preferred stock   |                                              |  |              |         |            |         |             |          |             |  |               |         |                   |  |        |         |          |         |  |   |             |         | (57,609  | ) |  |  |  |   |            |         | (57,609 | )       
|                            | Compensation expense related to valuation
of stock options and warrants granted to
non-employees for services rendered |                                                                                    |                                              |  |              |         |            | 762,341 |             |          |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            | 762,341 |        
|                            |                                                                                                                        |                                                                                    |                                              |  |              |         |            |         |             |          |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            |        
|BALANCE, SEPTEMBER 30, 2000 |                                                                                                                        |                                                                                    | 56,974,828                                   |  |              | $       | 84,695,590 |         |             |          | 65,000      |  |               | $       | 34,145            |  |        | $       | (649,431 | )       |  | $ | (62,949,916 | )       |          |   |  |  |  | $ | 21,130,388 |        
|                            | Net income                                                                                                             |                                                                                    |                                              |  |              |         |            |         |             |          |             |  |               |         |                   |  |        |         |          |         |  |   |             | 233,122 |          |   |  |  |  |   |            | 233,122 |        
|                            | Issuance of Class A common stock in
connection with:                                                                   |                                                                                    |                                              |  |              |         |            |         |             |          |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            |         |        
|                            |                                                                                                                        |                                                                                    | Exercises of warrants                        |  |              | 254,716 |            |         |             | 304,697  |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            |         |         | 304,697  |  
|                            |                                                                                                                        |                                                                                    | Exercises of stock options, net of taxes     |  |              | 558,142 |            |         |             | 653,399  |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            |         |         | 653,399  |  
|                            |                                                                                                                        |                                                                                    | Acquisition of MIF technology                |  |              | 170,353 |            |         |             | 867,097  |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            |         |         | 867,097  |  
|                            |                                                                                                                        |                                                                                    | Acquisition of minority interests in
Xenerex |  |              | 25,000  |            |         |             | 97,250   |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            |         |         | 97,250   |  
|                            |                                                                                                                        |                                                                                    | Conversions from Class B common stock        |  |              | 28,500  |            |         |             | 14,250   |             |  |               | (28,500 | )                 |  |        | (14,250 | )        |         |  |   |             |         |          |   |  |  |  |   |            |         |         |         |  
|                            |                                                                                                                        |                                                                                    | Retired shares                               |  |              | (35,158 | )          |         |             | (129,031 | )           |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            |         |         | (129,031 | )
|                            | Receivable for Class A common stock                                                                                    |                                                                                    |                                              |  |              |         |            |         |             |          |             |  |               |         |                   |  |        |         |          | 649,431 |  |   |             |         |          |   |  |  |  |   |            | 649,431 |        
|                            | Dividends on preferred stock                                                                                           |                                                                                    |                                              |  |              |         |            | (24,948 | )           |          |             |  |               |         |                   |  |        |         |          |         |  |   |             |         |          |   |  |  |  |   |            | (24,948 | )      
|                            |                                                                                                                        | Accretion of discount related to Series
D redeemable convertible preferred stock   |                                              |  |              |         |            |         |             |          |             |  |               |         |                   |  |        |         |          |         |  |   |             |         | (18,286  | ) |  |  |  |   |            |         | (18,286 | )       

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AVANIR Pharmaceuticals

CONSOLIDATED STATEMENTS OF
SHAREHOLDERS EQUITY (Continued)

---

|                                                                                                                           |                             |                                |            |              |  |         |            |             |  |             |        |               |  |                   |        |        |  |        |   |  |  |   |             |   |  |   |        |   |        |   |            |  |        | 
|-------------------------------------------------------------------------------------------------------------------------- | --------------------------- | ------------------------------ | ---------- | ------------ |  | ------- | ---------- | ----------- |  | ----------- | ------ | ------------- |  | ----------------- | ------ | ------ |  | ------ | - |  |  | - | ----------- | - |  | - | ------ | - | ------ | - | ---------- |  | ------ | 
|                                                                                                                           |                             |                                |            | Common Stock |  |         |            |             |  |             |        |               |  |                   |        |        |  |        |   | 
|                                                                                                                           |                             |                                |            |              |  |         |            |             |  |             |        |               |  |                   |        |        |  |        |   | 
|                                                                                                                           |                             |                                |            | Class A      |  | Class B |            | Receivables |  |             |        |               |  | Accumulated Other |        | Total 
|                                                                                                                           |                             |                                |            |              |  |         |            | For Common  |  | Accumulated |        | Comprehensive |  | Shareholders'    
|                                                                                                                           |                             |                                |            | Shares       |  | Amount  |            | Shares      |  | Amount      |        | Stock         |  | Deficit           |        | Income |  | Equity
|                                                                                                                           |                             |                                |            |              |  |         |            |             |  |             |        |               |  |                   |        |        |  |       
|Net compensation expense related to
valuation of stock options and
warrants granted to non-employees for services rendered |                             |                                |            |              |  | $       | 148,051    |             |  |             |        |               |  |                   |        |        |  |        |   |  |  |   |             |   |  |   |        |   |        | $ | 148,051    | 
|Comprehensive Income:                                                                                                      |                             |                                |            |              |  |         |            |             |  |             |        |               |  |                   |        |        |  |        |   |  |  |   |             |   |  |   |        |   |        |   |            | 
|                                                                                                                           | Other comprehensive Income: |                                |            |              |  |         |            |             |  |             |        |               |  |                   |        |        |  |        |   |  |  |   |             |   |  |   |        |   |        |   |            |  |       
|                                                                                                                           |                             | Unrealized gains on securities |            |              |  |         |            |             |  |             |        |               |  |                   |        |        |  |        |   |  |  |   |             |   |  |   |        | $ | 47,390 |   |            |  | 47,390 | 
|                                                                                                                           |                             |                                |            |              |  |         |            |             |  |             |        |               |  |                   |        |        |  |        |   |  |  |   |             |   |  |   |        |   |        |   |            | 
|Total comprehensive income                                                                                                 |                             |                                |            |              |  |         |            |             |  |             |        |               |  |                   |        |        |  |        |   |  |  |   |             |   |  |   |        |   |        |   | 280,512    | 
|                                                                                                                           |                             |                                |            |              |  |         |            |             |  |             |        |               |  |                   |        |        |  |        |   |  |  |   |             |   |  |   |        |   |        |   |            | 
|BALANCE, SEPTEMBER 30, 2001                                                                                                |                             |                                | 57,976,381 |              |  | $       | 86,626,355 |             |  |             | 36,500 |               |  | $                 | 19,895 |        |  |        |  |  |  | $ | (62,735,080 | ) |  | $ | 47,390 |   |        | $ | 23,958,560 | 
|                                                                                                                           |                             |                                |            |              |  |         |            |             |  |             |        |               |  |                   |        |        |  |        |   |  |  |   |             |   |  |   |        |   |        |   |            | 

See notes to consolidated financial statements.

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AVANIR Pharmaceuticals

CONSOLIDATED STATEMENTS OF CASH FLOWS

---

|                                                                                                    |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |         |           |            |  
|--------------------------------------------------------------------------------------------------- | ----------------------------------------------------- | ------------------------------------------------------------------------------- | ---------------------------------------------------- | ------- | ------------------------- | ---------- | ---------- | --------- | ---------- | ---------- | ---------- | ------- | --------- | ---------- | -
|                                                                                                    |                                                       |                                                                                 |                                                      |         | Years ended September 30,
|                                                                                                    |                                                       |                                                                                 |                                                      |         |                          
|                                                                                                    |                                                       |                                                                                 |                                                      |         | 2001                      |            | 2000       |           | 1999      
|                                                                                                    |                                                       |                                                                                 |                                                      |         |                           |            |            |           |           
|OPERATING ACTIVITIES:                                                                               |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|Net income (loss)                                                                                   |                                                       | $                                                                               | 233,122                                              |         |                           | $          | (582,283   | )         |            | $          | (8,554,036 | )      
|Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities: |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|                                                                                                    | Depreciation and amortization                         |                                                                                 |                                                      | 373,290 |                           |            |            | 145,430   |            |            |            | 139,469 |          
|                                                                                                    | Non-cash interest expense                             |                                                                                 |                                                      |        |                           |            |            | 402,990   |            |            |            | 17,620  |          
|                                                                                                    | Compensation paid with common stock and stock options |                                                                                 |                                                      | 148,052 |                           |            |            | 762,341   |            |            |            | 222,584 |          
|                                                                                                    | Litigation settlements paid with common stock         |                                                                                 |                                                      |        |                           |            |            | 4,097,504 |            |            |            |        |          
|                                                                                                    | Purchased in-process R&D paid with common stock       |                                                                                 |                                                      | 867,097 |                           |            |            |          |            |            |            |        |          
|                                                                                                    | Loss on sales of assets                               |                                                                                 |                                                      | 3,187   |                           |            |            | 5,553     |            |            |            |        |          
|                                                                                                    | Patents abandoned                                     |                                                                                 |                                                      |        |                           |            |            | 89,433    |            |            |            |        |          
|Changes in assets and liabilities:                                                                  |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|                                                                                                    |                                                       | Accounts receivable                                                             |                                                      |         | (803,247                  | )          |            |           | (18,930    | )          |            |         | 17,264    |           
|                                                                                                    |                                                       | Inventory                                                                       |                                                      |         | (212,781                  | )          |            |           | 213,998    |            |            |         | (111,901  | )         
|                                                                                                    |                                                       | Prepaid and other                                                               |                                                      |         | (209,191                  | )          |            |           | (75,105    | )          |            |         | (204,444  | )         
|                                                                                                    |                                                       | Deferred costs                                                                  |                                                      |         |                          |            |            |           | 100,000    |            |            |         | (100,000  | )         
|                                                                                                    |                                                       | Accounts payable                                                                |                                                      |         | (230,935                  | )          |            |           | (207,432   | )          |            |         | 644,597   |           
|                                                                                                    |                                                       | Accrued expenses and other liabilities                                          |                                                      |         | 358,934                   |            |            |           | 315,820    |            |            |         | 79,289    |           
|                                                                                                    |                                                       | Accrued compensation and payroll taxes                                          |                                                      |         | 106,923                   |            |            |           | 125,531    |            |            |         | (87,352   | )         
|                                                                                                    |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|                                                                                                    |                                                       |                                                                                 | Net cash provided by (used for) operating activities |         |                           | 634,451    |            |           |            | 5,374,850  |            |         |           | (7,936,910 | )
|INVESTING ACTIVITIES:                                                                               |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|                                                                                                    |                                                       | Investments in securities                                                       |                                                      |         | (4,450,000                | )          |            |           | (1,568,474 | )          |            |         |          |           
|                                                                                                    |                                                       | Proceeds from sales and maturities of investments                               |                                                      |         | 757,173                   |            |            |           |           |            |            |         |          |           
|                                                                                                    |                                                       | Patent costs                                                                    |                                                      |         | (538,202                  | )          |            |           | (118,276   | )          |            |         | (194,363  | )         
|                                                                                                    |                                                       | Capital expenditures                                                            |                                                      |         | (1,009,349                | )          |            |           | (950,558   | )          |            |         | (80,678   | )         
|                                                                                                    |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|                                                                                                    |                                                       |                                                                                 | Net cash used for investing activities               |         |                           | (5,240,378 | )          |           |            | (2,637,308 | )          |         |           | (275,041   | )
|FINANCING ACTIVITIES:                                                                               |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|                                                                                                    |                                                       | Proceeds from issuance of common stock, net                                     |                                                      |         | 1,478,496                 |            |            |           | 16,006,576 |            |            |         | 60,206    |           
|                                                                                                    |                                                       | Proceeds from issuance of convertible preferred stock
and related warrants, net |                                                      |         |                          |            |            |           | 1,000,000  |            |            |         | 1,766,078 |           
|                                                                                                    |                                                       | Dividends paid on preferred stock                                               |                                                      |         | (6,250                    | )          |            |           |           |            |            |         |          |           
|                                                                                                    |                                                       | Proceeds from issuance of convertible notes payable,
net                        |                                                      |         |                          |            |            |           | 1,344,985  |            |            |         |          |           
|                                                                                                    |                                                       | Repayment of convertible notes payable                                          |                                                      |         |                          |            |            |           | (1,500,000 | )          |            |         |          |           
|                                                                                                    |                                                       | Proceeds from issuance of notes payable  net of issue
costs                    |                                                      |         | 171,750                   |            |            |           | 201,868    |            |            |         |          |           
|                                                                                                    |                                                       | Repayment of notes payable                                                      |                                                      |         | (195,292                  | )          |            |           | (213,877   | )          |            |         |          |           
|                                                                                                    |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|                                                                                                    |                                                       |                                                                                 | Net cash provided by financing activities            |         |                           | 1,448,704  |            |           |            | 16,839,552 |            |         |           | 1,826,284  |  
|                                                                                                    |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|Net increase (decrease) in cash and cash equivalents                                                |                                                       |                                                                                 | (3,157,223                                           | )       |                           |            | 19,577,094 |           |            |            | (6,385,667 | )      
|Cash and cash equivalents at beginning of period                                                    |                                                       |                                                                                 | 19,699,768                                           |         |                           |            | 122,674    |           |            |            | 6,508,341  |        
|                                                                                                    |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|Cash and cash equivalents at end of period                                                          |                                                       | $                                                                               | 16,542,545                                           |         |                           | $          | 19,699,768 |           |            | $          | 122,674    |        
|                                                                                                    |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:                                                  |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|                                                                                                    |                                                       | Interest paid                                                                   |                                                      | $       | 6,547                     |            |            | $         | 347,722    |            |            | $       | 7,755     |           
|                                                                                                    |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|SUPPLEMENTAL DISCLOSURES OF NON-CASH FINANCING ACTIVITIES:                                          |                                                       |                                                                                 |                                                      |         |                           |            |            |           |            |            |            |        
|                                                                                                    |                                                       | Patent purchased with Xenerex common stock                                      |                                                      | $       | 111,158                   |            |            | $         |           |            |            | $       |          |           
|                                                                                                    |                                                       | Acquisition of minority interests in Xenerex                                    |                                                      | $       | 97,250                    |            |            | $         |           |            |            | $       |          |           
|                                                                                                    |                                                       | Value of conversion discount for convertible
preferred stock                    |                                                      | $       |                          |            |            | $         | 140,000    |            |            | $       |          |           
|                                                                                                    |                                                       | Purchases of equipment with capital leases                                      |                                                      | $       | 495,147                   |            |            | $         |           |            |            | $       |          |           
|                                                                                                    |                                                       | Conversions into common stock from preferred stock                              |                                                      | $       |                          |            |            | $         | 507,603    |            |            | $       | 2,029,146 |           
|                                                                                                    |                                                       | Conversions into common stock from convertible notes                            |                                                      | $       |                          |            |            | $         |           |            |            | $       | 1,009,570 |           

See notes to consolidated financial statements.

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AVANIR Pharmaceuticals

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

---



|1. |  | DESCRIPTION OF BUSINESS
|-- |  | -----------------------

AVANIR Pharmaceuticals (AVANIR, we, or the Company) is engaged in
research, development, commercialization, licensing and sales of innovative
pharmaceutical products and in providing antibody generation services.
AVANIRs first product, Abreva (chemical name docosanol 10% cream), is the
number one selling cold sore medication in the U.S. over-the-counter market
(OTC) and the only OTC product in the cold sore category approved by the U.S.
Food and Drug Administration (FDA). AVANIR earns milestone payments and
royalties on product sales of Abreva under a license agreement with
GlaxoSmithKline for the North American market. AVANIR is engaged in various
stages of discussions and negotiations for licensing docosanol 10% cream to
companies in various other countries and in obtaining regulatory approvals in
those countries for marketing of the product. The Company is also engaged in
research and development of several drugs in various phases of clinical and
pre-clinical development. Through a wholly-owned subsidiary, Xenerex
Biosciences, the Company develops and commercializes completely human antibody
products for partner companies through research collaborations with those
companies and for AVANIR.

AVANIR is subject to various risks and uncertainties frequently encountered by
companies in the early stages of operations, particularly in the evolving
market for small biotech and specialty pharmaceuticals companies. Such risks
and uncertainties include, but are not limited to timing and uncertainty of
achieving milestones in clinical trials, and in obtaining approvals by the FDA
and regulatory agencies in other countries.

AVANIRs operating income and cash flow from operations depend substantially
upon royalties earned on sales of Abreva by GlaxoSmithKline in the North
American market. The Companys ability to generate revenues in the future will
depend substantially on sales of Abreva by GlaxoSmithKline, the timing and
success of filing and obtaining regulatory approvals and finding licensees for
docosanol 10% cream for the rest of the world, and in establishing research
collaborations and successfully providing antibody generation services at the
Companys subsidiary, Xenerex Biosciences. The Companys operating expenses
depend substantially on the level of expenditures for research and development
programs and the rate of progress being made on such programs.



|2. |  | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|-- |  | ------------------------------------------

Basis of presentation

The consolidated financial statements include the accounts of AVANIR
Pharmaceuticals and its subsidiary, Xenerex Biosciences. All significant
intercompany accounts and transactions have been eliminated. Certain amounts
from prior years have been reclassified to conform to the current year
presentation.

The Companys fiscal year ends on September 30 of each year. The years ended
September 30, 2001, 2000, and 1999, may be referred to as fiscal 2001, fiscal
2000, and fiscal 1999.

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.

Cash and cash equivalents

Cash and cash equivalents consist primarily of highly liquid investments with
original maturities of three months or less at the date of acquisition.
Substantially all cash and cash equivalents are under the custodianship of
three major financial institutions.

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Restricted investment

A restricted investment amounting to $388,122 for both of the periods ended
September 30, 2001, and September 30, 2000, represents an amount that we
pledged to our bank as collateral for a letter of credit that our bank issued
in connection with our office lease.

Investments

Investments (Note 4, Investments) are comprised of marketable securities
consisting primarily of certificates of deposit, U.S. state and municipal
government obligations, corporate bonds, and asset-backed and mortgage-backed
securities with original maturities beyond three months. All marketable
securities are held in the Companys name and primarily under the custodianship
of three major financial institutions. The Companys policy is to protect the
value of its investment portfolio and minimize principal risk by earning
returns based on current interest rates. Short-term investments are marketable
securities with maturities of less than one year from the balance sheet date.
At September 30, 2001, the Companys marketable securities were classified
either as available-for-sale or held-to-maturity. At September 30, 2000, the
Companys marketable securities were classified as held-to-maturity. The
marketable securities held to maturity are carried at amortized cost and the
marketable securities that are available for sale are carried at fair market
value. In addition, earnings related to marketable securities classified as
available for sale, including any gains or losses resulting from the sale of
these securities, are classified as interest income and included as part of
shareholders equity, as Accumulated other comprehensive income.

Unrealized gains and losses on available-for-sale securities are included as a
separate component of shareholders equity, net of any related tax effect.
Statement of Financial Accounting Standards No. 115 (SFAS 115), Accounting for
Certain Investments in Debt and Equity Securities, requires companies to
determine whether a decline in fair value below the amortized cost basis is
other than temporary. If a decline in fair value is determined to be other
than temporary, SFAS 115 requires the carrying value of the debt or equity
security to be written down to its fair value. The Company does not have any
investments that are impaired.

Carrying amounts of certain of the Companys financial instruments, including
cash and cash equivalents, approximate fair value because of their short
maturities. The fair values of investments are determined using quoted market
prices for those securities or similar financial instruments.

Inventory

Inventory is stated at the lower of cost (first-in, first-out) or market.
Inventory consists of the raw material, docosanol, which is the active
ingredient in docosanol 10% cream. Docosanol in its present form as stored by
the Company has a substantial shelf life, a relatively stable value and
long-term use, and carries a low risk of becoming excess inventory or obsolete.
AVANIR does not own or store any product in its final form, such as docosanol
10% cream.

Concentration of credit risk

The majority of cash and cash equivalents are maintained with three major
financial institutions in the United States. Deposits held with banks may
exceed the amount of insurance provided on such deposits. Generally, these
deposits may be redeemed upon demand and, therefore, bear minimal risk.

Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of marketable securities and interest rate
instruments. The counterparties to the agreements relating to the Companys
investment securities and interest rate instruments consist of various major
corporations and financial institutions of high credit standing. The Company
does not believe there is significant risk of non-performance by these
counterparties because the Company limits the amount of credit exposure to any
one financial institution and any one type of investment.

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The Company receives milestone payments and royalty income substantially from
one principal licensee, GlaxoSmithKline. The Company performs ongoing credit
evaluations of its customers financial conditions and would limit the amount
of credit extended if deemed necessary but usually requires no collateral.

The Company and one of its licensees receive raw materials and manufactured
products from sole suppliers. The inability of a sole supplier to fulfill
supply requirements of the Company or its licensees could materially impact
future operating results.

Intangibles and long-lived assets

The Companys policy regarding long-lived assets is to review such long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. If the review
indicates that long-lived assets are not recoverable (i.e. the carrying amount
is less than the future projected undiscounted cash flows), their carrying
amount would be reduced to fair value. The Company carries no goodwill on its
books at either September 30, 2001, or September 30, 2000. Further, during the
year ended September 30, 2001, the Company had no material impairments to
property, plant and equipment or intangible assets, which consist primarily of
cost of patents and trademarks.

We capitalize legal expenses incurred in connection with applications for
patents, trademark applications, and license agreements. We amortize the costs
of approved patents, trademarks and license agreements over their useful lives
or term of the agreements, whichever is less. For patent and trademark
applications that we abandon, we charge the remaining unamortized accumulated
costs to expense.

Redeemable convertible preferred
stock

At September 30, 2001 and 2000, the Company had an
obligation to redeem outstanding shares of Series D redeemable
convertible preferred stock at the option of the holder, therefore
the preferred stock has been reclassified from equity.

Revenue recognition

Performance-based license fees.We recognize revenues from license fees when
the performance requirements have been met, the fee is fixed or determinable,
and collection of fees is probable.

Royalty revenues.We recognize royalty revenues from our licensed products when
earned. Net sales figures used for calculating royalties due the Company can
often include deductions for costs of unsaleable returns, managed care
chargebacks, cash discounts, freight and warehousing, and miscellaneous
write-offs, which may vary over the course of the license agreement. Sales of
Abreva, if publicly reported by our licensee, GlaxoSmithKline, could differ
from net sales used for calculating royalties and in determining the royalties
earned in accordance with the license agreement.

Revenue arrangements with multiple deliverables.In certain circumstances, we
may enter into revenue arrangements whereby we are obligated to deliver to the
customer multiple products and/or services (multiple deliverables). Such
arrangements could include antibody generation services agreements and other
forms of research collaborations. In these transactions, we allocate the total
revenue to be earned under the arrangement among the various elements based on
their relative fair value. In the case of antibody generation services, the
allocation is based on customer specific objective evidence of fair value. In
the case of other forms of research collaborations, milestone payments are
deferred and recognized ratably over the period of the obligation. We
recognize revenue related to the delivered products or services only if: (i)
the above performance or service criteria are met; (ii) any undelivered
products or services are not essential to the functionality of the delivered
products or services; (iii) payment for the delivered products or services is
not contingent upon delivery of the remaining products or services; (iv) we
have an enforceable claim to receive the amount due in the event we do not
deliver the undelivered products or services; and (v) as discussed above, there
is evidence of the fair value for each of the undelivered products or services.

Federal research grant revenue.We recognize revenues from federal research
grants during the period in which the related expenditures are incurred.

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Depreciation and amortization

Property and equipment, net, is stated at cost less accumulated depreciation
and amortization. Depreciation and amortization is computed using the
straight-line method over the estimated useful lives of the assets. Estimated
useful lives of three years are used on computer equipment and related
software. Office equipment, furniture and fixtures are depreciated over five
years. Depreciation and amortization of leasehold improvements are computed
using the shorter of the remaining lease term or eight years.

Self-insurance

We self-insure for portions of our insurance policies based on a number of
factors, including historical loss experience, projected risk exposure, cost of
insurance, and AVANIRs ability to absorb potential losses that could arise
based on the amounts of the deductibles.

Research and development expenditures

Costs related to drug discovery and clinical development are charged to
research and development costs and expensed as they are incurred.

Purchased in-process research and development

In fiscal 2001, we charged $917,100 to in-process research and development
expense, representing the cost of in-process technologies that we acquired from
the Ciblex Corporation in fiscal 2001 that could assist us in discovering a
drug capable of regulating macrophage migration inhibitory factor, a protein
thought to play a central role in the early stages of development of several
inflammatory diseases (MIF inhibitor technology).

Technology acquired and valuation.AVANIR acquired all right, title and
interest in and to the MIF inhibitor technology, including a provisional patent
application, as well as any patent which may be issued upon AVANIRs filing of
a patent application regarding the use of certain compounds provided by Ciblex
or similar compounds, in the treatment of auto immune and inflammatory
diseases, all preclinical data related to those compounds, and all technology
and know-how relating to the foregoing, including laboratory data and previous
experimental results.

In return for receiving the rights to develop the MIF inhibitor technology,
AVANIR paid $50,000 in cash and issued 170,353 shares of the Companys Class A
common stock valued at $867,097, for a combined value of $917,097 in cash and
common stock. For the purposes of determining the fair market price for the
common stock at the time of the acquisition, we used the average closing sales
price of AVANIRs common stock during a period of time beginning two days
before and ending two days after the date of the acquisition, or $5.09 per
share.

Approach used for allocation of acquisition costs of technology.We used a
number of factors to determine the allocation of acquisition cost between
in-process research and development and other intangible assets, which might
have a useful live or indefinite life. Such determining factors included the
stage of completion of the technology, the complexity of the work completed to
date, the projected difficulty of completing the remaining development, and the
expected cost to complete the project. Because of the early stage of
development of the MIF inhibitor technology, lack of patented technology other
than a provisional patent application, uncertainty over obtaining patents, lack
of technological feasibility in its current stage of development, including
lack of lead compound for toxicology studies and clinical trials, which are
necessary to show evidence of safety and efficacy of the compounds among other
requirements, and no alternative future uses without further development, we
allocated 100% of the initial $917,097 cost of the acquisition as purchased
in-process research and development expense.

If and when we make progress in developing the MIF inhibitor technology to the
point of reaching certain milestones specified in the acquisition agreement
with Ciblex that may require additional payments to Ciblex,

F-12



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##### Table of Contents



we intend to re-assess the value of the technology using the same or similar
valuation methods and make a determination as to the allocation of costs of
those additional payments at the time those costs are incurred.

Computation of net income and net loss per common share

We computed basic income per share and basic loss per share by dividing the net
income and net loss by the weighted average number of common shares outstanding
during the period (Basic EPS method). We compute diluted earnings (loss) per
common share by dividing the net income and net loss by the weighted-average
number of common and dilutive common equivalent shares outstanding during the
period (Diluted EPS method). Dilutive common equivalent shares consist of
shares issuable upon exercise of stock options and warrants and conversion of
preferred stock. In the accompanying consolidated statements of operations, we
have presented our net income and net loss per share for fiscal 2001, fiscal
2000 and fiscal 1999, using both the Basic EPS method and the Diluted EPS
method.

Diluted weighted average number of shares

The following table is the reconciliation from the basic to the diluted EPS
computations for net income (loss) for fiscal 2001, 2000
and 1999:

|                                                                          |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |            |            |            |  
|------------------------------------------------------------------------- | ----------------------------------------------------------------------- | ------------------------------------- | ---------------------------------------------------------------------- | --------- | -------------------------------- | ------- | ---------- | -------- | ---------- | -------- | ---------- | ---------- | ---------- | ---------- | -
|                                                                          |                                                                         |                                       |                                                                        |           | Fiscal Years
Ended September 30,
|                                                                          |                                                                         |                                       |                                                                        |           |                                 
|                                                                          |                                                                         |                                       |                                                                        |           | 2001                             |         | 2000       |          | 1999      
|                                                                          |                                                                         |                                       |                                                                        |           |                                  |         |            |          |           
|Numerator:                                                                |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           
|                                                                          | Net income                                                              |                                       | $                                                                      | 233,122   |                                  |         | $          | (582,283 | )          |          | $          | (8,554,036 | )         
|Less:                                                                     |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           
|                                                                          | Dividends on redeemable convertible preferred stock                     |                                       |                                                                        | (24,948   | )                                |         |            | (21,914  | )          |          |            | (29,146    | )         
|                                                                          | Beneficial
conversion feature of preferred stock                        |                                       |                                                                        |          |                                  |         |            | (140,000 | )          |          |            |           |           
|                                                                          | Accretion of discount related to redeemable convertible
preferred stock |                                       |                                                                        | (18,286   | )                                |         |            | (57,609  | )          |          |            |           |           
|                                                                          |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           
|                                                                          |                                                                         |                                       | Income available to common shareholders for basic
earnings per share   |           |                                  | 189,888 |            |          |            | (801,806 | )          |            |            | (8,583,182 | )
|Effect of dilutive securities:                                            |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           
|                                                                          | Convertible preferred stock                                             |                                       |                                                                        | (5,157    | )                                |         |            |         |            |          |            |           |           
|                                                                          |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           
|                                                                          |                                                                         |                                       | Income available to common shareholders for diluted
earnings per share |           | $                                | 184,731 |            |          | $          | (801,806 | )          |            | $          | (8,583,182 | )
|                                                                          |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           
|Denominator:                                                              |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           
|Shares for basic earnings per share  weighted average
shares outstanding |                                                                         |                                       | 57,475,748                                                             |           |                                  |         | 51,784,214 |          |            |          | 41,704,265 |           
|Effect of dilutive securities:                                            |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           
|                                                                          | Stock options(1)                                                        |                                       |                                                                        | 5,410,192 |                                  |         |            |         |            |          |            |           |           
|                                                                          | Warrant shares(2)                                                       |                                       |                                                                        | 909,567   |                                  |         |            |         |            |          |            |           |           
|                                                                          | Convertible preferred stock(3)                                          |                                       |                                                                        | 185,231   |                                  |         |            |         |            |          |            |           |           
|                                                                          |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           
|                                                                          |                                                                         | Shares for diluted earnings per share |                                                                        |           | 63,980,738                       |         |            |          | 51,784,214 |          |            |            | 41,704,265 |           
|                                                                          |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           
|Basic earnings per share                                                  |                                                                         | $                                     | 0.00                                                                   |           |                                  | $       | (0.02      | )        |            | $        | (0.21      | )         
|                                                                          |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           
|Diluted earnings per share                                                |                                                                         | $                                     | 0.00                                                                   |           |                                  | $       | (0.02      | )        |            | $        | (0.21      | )         
|                                                                          |                                                                         |                                       |                                                                        |           |                                  |         |            |          |            |          |            |           



---

|(1) |  | For fiscal 2001, 2000 and 1999, options to purchase 66,500, 5,362,150 and 7,252,124 shares of common stock, respectively, were excluded from the computation of diluted earnings
per share as the inclusion of such shares would be antidilutive.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | For fiscal 2000 and 1999, warrants to purchase 1,619,578 and 7,029,818 shares of
 common stock, respectively, were excluded from the computation of diluted earnings
per share as the inclusion of such shares would be antidilutive.            
|   
|   
|   
|   
|(3) |  | For fiscal 2000, preferred
stock convertible into 171,610 shares of common stock
were excluded from the computation of diluted earnings per share as the inclusion of
such shares would be antidilutive.                                         

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Recent accounting pronouncements

Effective October 1, 2000, we adopted Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities (SFAS 133), as amended by SFAS 138, Accounting for Certain
Derivative Instruments and Certain Hedging activities. SFAS No. 133, as
amended, establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires an entity to recognize all
derivatives as either assets or liabilities on the balance sheet and measure
those instruments at fair value. The adoption of this new standard did not
have a material impact on the Companys financial statements.

In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements. SAB 101, as amended, summarizes certain of the SECs views in
applying accounting principles generally accepted in the United States of
America to revenue recognition in financial statements, including revenues
earned from collaborations between companies. We adopted SAB 101 in the fourth
quarter of the fiscal year ended September 30, 2001. The adoption of SAB 101
did not have a material impact on the Companys earnings.

In July 2001, the Financial Accounting Standards Board (FASB) approved three
statements, SFAS 141 Business Combinations, SFAS 142 Goodwill and Other
Intangible Assets, and SFAS 143, Accounting for Asset Retirement
Obligations.

SFAS 141 supersedes APB Opinion No. 16, Business Combinations, and eliminates
the pooling-of-interests method of accounting for business combinations, thus
requiring all business combinations be accounted for using the purchase method.
In addition, in applying the purchase method, SFAS 141 changes the criteria
for recognizing intangible assets apart from goodwill and states the following
criteria should be considered in determining the recognition of the intangible
assets: (1) the intangible asset arises from contractual or other legal
rights, or (2) the intangible asset is separable or dividable from the acquired
entity and capable of being sold, transferred, licensed, rented, or exchanged.
The requirements of SFAS 141 are effective for all business combinations
completed after June 30, 2001. The adoption of this new standard did not have
a material impact on the Companys financial statements.

SFAS 142 supercedes APB Opinion No. 17, Intangible Assets, and requires
goodwill and other intangible assets that have an indefinite useful life to no
longer be amortized; however, these assets must be reviewed at least annually
for impairment. Application of SFAS 142 is required beginning October 1, 2002.
We believe the adoption of SFAS 142 will not have a significant impact on the
Companys financial statements.

SFAS 143 requires entities to record the fair value of a liability for an asset
retirement obligation in the period in which it is incurred. When the
liability is initially recorded, the entity capitalizes a cost by increasing
the carrying amount of the related long-lived asset. Over time, the liability
is accreted to its present value each period, and the capitalized cost is
depreciated over the useful life of the related asset. Upon settlement of the
liability, an entity either settles the obligation for its recorded amount or
incurs a gain or loss upon settlement. Application of SFAS 143 became
effective on October 1, 2001. We do not believe that its adoption will have a
significant impact on the Companys financial statements.

In August 2001 the FASB issued SFAS 144 Accounting for the Impairment or
Disposal of Long-Lived Assets. This statement addresses financial accounting
and reporting for the impairment or disposal of long-lived Assets. This
statement supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of, and the accounting and
reporting provisions of APB Opinion No. 30, Reporting the Results of
Operations  Reporting the Effects of a Disposal of a Segment of a Business,
and Extraordinary, Unusual and infrequently Occurring Events and Transactions,
for the disposal of a segment of a business (as previously defined in that
Opinion). SFAS No. 144 is effective October 1, 2001. The effect of SFAS 144
on the Companys financial statements has not yet been determined.

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##### Table of Contents





|3. |  | BALANCE SHEET DETAIL
|-- |  | --------------------

The following tables provide details of selected balance sheet items.

|                             |                                                 |                             |           |               |           |               |           |          |           | 
|---------------------------- | ----------------------------------------------- | --------------------------- | --------- | ------------- | --------- | ------------- | --------- | -------- | --------- | 
|                             |                                                 |                             |           | September 30, |           | September 30,
|                             |                                                 |                             |           | 2001          |           | 2000         
|                             |                                                 |                             |           |               |           |              
|Receivables, net:            |                                                 |                             |           |               |           |               |           |         
|                             | Total receivables                               |                             | $         | 898,676       |           |               | $         | 109,970  |          
|                             | Allowance for doubtful accounts                 |                             |           |              |           |               |           | (14,541  | )        
|                             |                                                 |                             |           |               |           |               |           |         
|                             |                                                 | Receivables, net            |           | $             | 898,676   |               |           | $        | 95,429    | 
|                             |                                                 |                             |           |               |           |               |           |         
|Property and equipment, net: |                                                 |                             |           |               |           |               |           |         
|                             | Leasehold improvements                          |                             | $         | 753,824       |           |               | $         | 416,523  |          
|                             | Computer equipment and related software         |                             |           | 296,862       |           |               |           | 233,200  |          
|                             | Research and development equipment              |                             |           | 1,831,645     |           |               |           | 781,677  |          
|                             | Office equipment, furniture, and fixtures       |                             |           | 218,796       |           |               |           | 193,808  |          
|                             |                                                 |                             |           |               |           |               |           |         
|                             |                                                 |                             | 3,101,127 |               |           |               | 1,625,208 |         
|                             | Less, accumulated depreciation and amortization |                             |           | (884,033      | )         |               |           | (574,505 | )        
|                             |                                                 |                             |           |               |           |               |           |         
|                             |                                                 | Property and equipment, net |           | $             | 2,217,094 |               |           | $        | 1,050,703 | 
|                             |                                                 |                             |           |               |           |               |           |         
|Intangible costs, net:       |                                                 |                             |           |               |           |               |           |         
|                             | Intangible costs                                |                             | $         | 1,313,704     |           |               | $         | 715,222  |          
|                             | Less, accumulated amortization                  |                             |           | (138,776      | )         |               |           | (100,406 | )        
|                             |                                                 |                             |           |               |           |               |           |         
|                             |                                                 | Intangible costs, net       |           | $             | 1,174,928 |               |           | $        | 614,816   | 
|                             |                                                 |                             |           |               |           |               |           |         



|4. |  | INVESTMENTS
|-- |  | -----------

The following tables summarize the Companys investments in securities, which
are either held to maturity or available for sale. Available-for-sale
securities are those investments that the Company does not intend to sell in
the near term nor hold to maturity. The available-for-sale investments are
carried at fair value with unrealized gains or losses reported in shareholders
equity as a component of comprehensive income. Investments classified as held
to maturity are recorded at amortized cost.

|                          |                         |                                  |                        |       |           |           |           |            |        |            |        |       |   |  |   |   |           |   |           | 
|------------------------- | ----------------------- | -------------------------------- | ---------------------- | ----- | --------- | --------- | --------- | ---------- | ------ | ---------- | ------ | ----- | - |  | - | - | --------- | - | --------- | 
|                          |                         |                                  |                        |       |           |           |           |            |        | Gross      |        | Gross |   |  |   |  
|                          |                         |                                  |                        |       |           | Amortized |           | Unrealized |        | Unrealized |        | Fair 
|                          |                         |                                  |                        |       |           | Cost      |           | Gain       |        | Loss       |        | Value
|                          |                         |                                  |                        |       |           |           |           |            |        |            |        |      
|As of September 30, 2001: |                         |                                  |                        |       |           |           |           |            |        |            |        |       |   |  |   |  
|                          |                         | Certificates of deposit          |                        | $     | 411,301   |           |           |            |       |            |        |       |  |  |   | $ | 411,301   |  
|                          |                         | Government securities            |                        |       | 4,650,000 |           |           | $          | 48,952 |            |        |       |  |  |   |   | 4,698,952 |  
|                          |                         | Commercial paper                 |                        |       | 200,000   |           |           |            | 8,862  |            |        |       |  |  |   |   | 208,862   |  
|                          |                         |                                  |                        |       |           |           |           |            |        |            |        |       |   |  |   |  
|                          |                         |                                  |                        | Total |           | $         | 5,261,301 |            |        | $          | 57,814 |       |   |  |  |   |           | $ | 5,319,115 | 
|                          |                         |                                  |                        |       |           |           |           |            |        |            |        |       |   |  |   |  
|Reported as:              |                         |                                  |                        |       |           |           |           |            |        |            |        |       |   |  |   |  
|                          | Short-term investments: |                                  |                        |       |           |           |           |            |        |            |        |       |   |  |   |   |          
|                          |                         | Restricted investment            |                        | $     | 388,122   |           |           |            |        |            |        |       |   |  |   |   |           |  
|                          |                         | Classified as held to maturity   |                        |       | 23,179    |           |           |            |        |            |        |       |   |  |   |   |           |  
|                          |                         |                                  |                        |       |           |           |           |            |        |            |        |       |   |  |   |  
|                          |                         |                                  | Short-term investments |       |           | 411,301   |           |            |        |            |        |       |   |  |   |   |           |   |          
|                          | Long-term investments:  |                                  |                        |       |           |           |           |            |        |            |        |       |   |  |   |   |          
|                          |                         | Classified as available for sale |                        | $     | 4,497,390 |           |           |            |        |            |        |       |   |  |   |   |           |  
|                          |                         | Classified as held to maturity   |                        |       | 400,000   |           |           |            |        |            |        |       |   |  |   |   |           |  
|                          |                         |                                  |                        |       |           |           |           |            |        |            |        |       |   |  |   |  
|                          |                         |                                  | Long-term investments  |       |           | 4,897,390 |           |            |        |            |        |       |   |  |   |   |           |   |          
|                          |                         |                                  |                        |       |           |           |           |            |        |            |        |       |   |  |   |  
|                          |                         |                                  |                        | Total |           | $         | 5,308,691 |            |        |            |        |       |   |  |   |   |           |   |           | 
|                          |                         |                                  |                        |       |           |           |           |            |        |            |        |       |   |  |   |  

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##### Table of Contents



|                          |                         |                         |                                |         |         |           |           |            |   |            |   |       |       |   |       |   |         |   |           | 
|------------------------- | ----------------------- | ----------------------- | ------------------------------ | ------- | ------- | --------- | --------- | ---------- | - | ---------- | - | ----- | ----- | - | ----- | - | ------- | - | --------- | 
|                          |                         |                         |                                |         |         |           |           |            |   | Gross      |   | Gross |       |   |       |  
|                          |                         |                         |                                |         |         | Amortized |           | Unrealized |   | Unrealized |   | Fair 
|                          |                         |                         |                                |         |         | Cost      |           | Gain       |   | Loss       |   | Value
|                          |                         |                         |                                |         |         |           |           |            |   |            |   |      
|As of September 30, 2000: |                         |                         |                                |         |         |           |           |            |   |            |   |       |       |   |       |  
|                          |                         | Certificates of deposit |                                | $       | 588,122 |           |           |            |  |            |   |       |      |   |       | $ | 588,122 |  
|                          |                         | Government securities   |                                |         | 780,352 |           |           |            |  |            |   | $     | 1,517 |   |       |   | 778,835 |  
|                          |                         | Commercial paper        |                                |         | 200,000 |           |           |            |  |            |   |       | 336   |   |       |   | 199,664 |  
|                          |                         |                         |                                |         |         |           |           |            |   |            |   |       |       |   |       |  
|                          |                         |                         |                                | Total   |         | $         | 1,568,474 |            |   |            |  |       |       | $ | 1,853 |   |         | $ | 1,566,621 | 
|                          |                         |                         |                                |         |         |           |           |            |   |            |   |       |       |   |       |  
|Reported as:              |                         |                         |                                |         |         |           |           |            |   |            |   |       |       |   |       |  
|                          | Short-term investments: |                         |                                |         |         |           |           |            |   |            |   |       |       |   |       |   |        
|                          |                         |                         | Restricted investment          |         | $       | 388,122   |           |            |   |            |   |       |       |   |       |   |         |   |          
|                          |                         |                         | Classified as held to maturity |         |         | 480,352   |           |            |   |            |   |       |       |   |       |   |         |   |          
|                          | Long-term investments   |                         |                                | 700,000 |         |           |           |            |   |            |   |       |       |   |       |   |        
|                          |                         |                         |                                |         |         |           |           |            |   |            |   |       |       |   |       |  
|                          |                         |                         |                                | Total   |         | $         | 1,568,474 |            |   |            |   |       |       |   |       |   |         |   |           | 
|                          |                         |                         |                                |         |         |           |           |            |   |            |   |       |       |   |       |  



|5. |  | PRODUCT LAUNCH EXPENSES
|-- |  | -----------------------

AVANIR incurred certain costs related to the product launch phase for Abreva,
which were expensed in the fiscal year. Our obligation to share product launch
expenses with GlaxoSmithKline ceased after June 30, 2001.



|6. |  | COMMITMENTS
|-- |  | -----------

Lease commitments. On March 20, 2000, the Company signed an eight-year lease
with BC Sorrento LLC for use of 27,047 square feet of office space in a
building located at 11388 Sorrento Valley Road, Suite 200, San Diego,
California, commencing on September 1, 2000. Our total financial commitment to
the landlord for the term of the lease is $6,023,863. The lease has scheduled
rent increases each year. In connection with the lease, we have included
$91,790 of deferred rent in total accrued expenses and other liabilities in
fiscal 2001. In connection with this lease, we entered into an irrevocable
standby letter of credit, available through Bank of America, N.A. in the amount
of $388,122, which names the landlords lender as the beneficiary in the event
that we default on our payments to the landlord. Other lease commitments in
fiscal 2001 amounted to $22,840. Lease expense for fiscal 2001, fiscal 2000
and fiscal 1999 was $754,785, $401,281, and $315,523, respectively.

Future minimum payments under non-cancelable operating leases are as follows:

|                          |       |          |           |           | 
|------------------------- | ----- | -------- | --------- | --------- | 
|                          |       |          | Minimum  
|Year Ending September 30, |       | Payments
|                          |       |         
|2002                      |       | $        | 699,511   |          
|2003                      |       |          | 722,114   |          
|2004                      |       |          | 738,916   |          
|2005                      |       |          | 765,154   |          
|2006                      |       |          | 794,092   |          
|Thereafter                |       |          | 1,596,842 |          
|                          |       |          |           |          
|                          | Total |          | $         | 5,316,629 | 
|                          |       |          |           |          

Capital lease commitments.On September 21, 2001, the Company acquired several
pieces of equipment under four-year capital lease obligations. Each of these
capital leases provides the Company with the option at the expiration of the
lease term to purchase all the equipment leased for a price of one dollar
($1.00).

Future minimum payments under the capital leases are as follows:

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|                                    |       |                                    |         |         |         | 
|----------------------------------- | ----- | ---------------------------------- | ------- | ------- | ------- | 
|                                    |       |                                    |         | Minimum
|Year Ending September 30,           |       | Payments                          
|                                    |       |                                   
|2002                                |       | $                                  | 149,729 |        
|2003                                |       |                                    | 138,211 |        
|2004                                |       |                                    | 138,211 |        
|2005                                |       |                                    | 138,211 |        
|                                    |       |                                    |         |        
|                                    | Total |                                    |         | 564,362 |        
|                                    |       | Less: amount representing interest |         |         | 107,212 | 
|                                    |       |                                    |         |        
|Present value of net lease payments |       |                                    | 457,150 |        
|                                    |       | Less: current portion              |         |         | 105,366 | 
|                                    |       |                                    |         |        
|Long-term portion of obligation     |       | $                                  | 351,784 |        
|                                    |       |                                    |         |        



|7. |  | SHAREHOLDERS EQUITY
|-- |  | --------------------

Preferred stock

Preferred Stock consists of Series C Junior Participating Preferred Stock and
Series D Redeemable Convertible Preferred Stock.

Series C junior participating preferred stock

On March 2, 1999, our Board of Directors approved a shareholder rights plan
(the Plan). The Plan features a dividend distribution of one Preferred Share
Purchase Right (the Right) on each outstanding share of our Class A and Class
B Common Stock, payable to shareholders of record on March 25, 1999. Subject
to limited exceptions, the Rights will be exercisable if a person or group
acquires 15% or more of our common stock or announces a tender offer for 15% or
more of our common stock (a Trigger Event).

Under certain circumstances, each Right will entitle shareholders to buy one
one-hundredth of a share of newly created Series C Junior Participating
Preferred Stock of AVANIR at an exercise price of $10.00 per share. Our Board
of Directors will be entitled to redeem the Rights at $0.01 per Right at any
time before a person has acquired 15% or more of the outstanding common stock.
The Rights will expire on March 25, 2009.

If a Trigger Event occurs, each Right will entitle its owner, who is not an
acquiring person, to purchase at the Rights then current exercise price, a
number of shares of Class A Common Stock having a market value at the time of
twice the Rights exercise price. Rights held by the acquiring person would
become void and not be exercisable to purchase shares at the bargain purchase
price. An acquiring person is defined as a person who acquires 15% or more of
the outstanding shares of common stock.

Series D redeemable convertible preferred stock and Class J stock purchase warrants

At September 30, 2001, 50 shares of Series D redeemable convertible preferred
stock remained outstanding in connection with a securities purchase agreement
made with certain investors on March 22, 1999. In connection with the
issuances of preferred stock and warrants in fiscal 2000 and fiscal 1999,
Class J Warrants to purchase 50,000 shares of Class A common stock at $2.71
per share and 50,000 shares of Class A common stock at $0.944 per share also
remained outstanding on September 30, 2001. The expiration dates for the
warrants vary from March 31, 2004 to February 18, 2005.

The securities purchase agreement between the investors and the Company
provided for the sale of up to 500 shares of Series D Redeemable Convertible
Preferred Stock (Series D Shares) and a corresponding number of Class J Stock
Purchase Warrants (Class J Warrants). The agreement required that one Class
J Warrant be issued with each Series D Share for an aggregate purchase price
per unit of $10,000. Each Series D Share carried an annual dividend of $500
payable on a quarterly basis in cash or, at our option, in stock at the
applicable conversion rate. Each Class J Warrant that was issued as a part of
each $10,000 unit was

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exercisable into 500 shares of Class A Common Stock. The Class J Warrants had
an expiration date of five years from the date of issuance. (See Common Stock
for exercises of Class J Warrants in Fiscal 2000.)

As of September 30, 1999, none of the Series D Shares was outstanding; however,
Class J Warrants to purchase 100,000 shares of Class A common stock at $0.9144
per share were outstanding. On November 29, 1999, one of the investors
exercised its Class J Warrants to purchase 50,000 shares of Class A common
stock at $0.9144 per share, for cash in the amount of $45,720.

On February 18, 2000, we received $1,000,000 in exchange for issuing 100 Series
D Shares and Class J Warrants to purchase 50,000 shares of Class A common
stock. The Class J Stock Purchase Warrants issued in connection with the
financing have an exercise price equal to 120% of the market price for Class A
common stock, as defined in our Certificate of Determination or $2.715 per
share.

We estimated the value of the warrants issued on February 18, 2000, to be
$106,000, based on the Black Scholes method, which we credited (added) to Class
A common stock and reported the same amount as a discount to the Redeemable
Series D Convertible Preferred Stock, which we are accreting over the
three-year life of the Redeemable Series D Convertible Preferred Stock or
sooner if converted to Class A common stock. We estimated the value of the
beneficial conversion feature of the Redeemable Series D Convertible Preferred
Stock issued in February 2000 to be $140,000 based on the terms of the
conversion price in the agreement, which is the lesser of $2.715 per share or
86% of market price as defined in Certificate of Determination. In fiscal
2000, we recorded the effect of the beneficial conversion feature of $140,000
as a dividend paid, and charged the amount to the accumulated deficit and added
the same amount to Class A common stock.

On June 12, 2000, one of the holders of Series D Shares exercised its right to
convert 50 shares, representing $500,000 in redeemable convertible preferred
stock and $7,603 in accrued and unpaid dividends into 288,800 shares of Class A
common stock, for an average stock price of $1.7576 per share

The remaining Series D holders may convert any or all of the Series D Shares
into shares of Class A common stock at a conversion rate equal to $10,000
divided by a conversion price equal to the lesser of:



| |  |  | the fixed conversion price an amount equal to $2.715 per share of
Class A common stock; or                                    
| | - |  | -------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the variable conversion price an amount equal to 86% of the market
price of our Class A common stock, defined as the lower of:



| |  |  | the average of the five lowest trading prices per share of
Class A common stock on The American Stock Exchange during the 25
trading days immediately preceding a given date of determination,
where trading price is determined as the average of the high and low
trading prices of our Class A common stock on a particular trading
day; or
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the average of the high and low trading price per share of
Class A common stock on The American Stock Exchange on the date of
determination.                                                                                                                                                                                                  

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The following table summarizes the changes in Series D Shares and conversions
into Class A common stock from October 1, 1999 to September 30, 2001:

|                            |                                                                                         |  |                                 |     |        |   |         |           |  
|--------------------------- | --------------------------------------------------------------------------------------- |  | ------------------------------- | --- | ------ | - | ------- | --------- | -
|                            |                                                                                         |  | Series D Redeemable Convertible
|                            |                                                                                         |  | Preferred Stock                
|                            |                                                                                         |  |                                
|                            |                                                                                         |  | Shares                          |     | Amount
|                            |                                                                                         |  |                                 |     |       
|Balance, September 30, 1999 |                                                                                         |  | 0                               |     |        | $ | 0       |          
|                            | Issuance of Series D Shares in February 2000
for cash                                   |  |                                 | 100 |        |   |         | 1,000,000 |  
|                            | Valuation of warrants issued in connection
with redeemable convertible preferred stocks |  |                                 |     |        |   |         | (106,000  | )
|                            | Accretion of Series D redeemable
convertible preferred stock                            |  |                                 |     |        |   |         | 57,609    |  
|                            | Preferred stock dividends accrued between
February 2000 and September 2000              |  |                                 |     |        |   |         | 21,914    |  
|                            | Conversion into 288,800 shares of Class A
common stock                                  |  |                                 | (50 | )      |   |         | (507,603  | )
|                            |                                                                                         |  |                                 |     |        |   |         |          
|Balance, September 30, 2000 |                                                                                         |  | 50                              |     |        | $ | 465,920 |          
|                            | Accretion of Series D redeemable
convertible preferred stock                            |  |                                 |     |        |   |         | 18,286    |  
|                            | Preferred stock dividends accrued between
October 2000 and September 2001               |  |                                 |     |        |   |         | 18,697    |  
|                            |                                                                                         |  |                                 |     |        |   |         |          
|Balance, September 30, 2001 |                                                                                         |  | 50                              |     |        | $ | 502,903 |          
|                            |                                                                                         |  |                                 |     |        |   |         |          

Common stock

We have both Class A Common Stock and Class B Common Stock. Holders of Class A
Common Stock have one vote for each share held of record and holders of Class B
Common Stock have five votes for each share held of record on all matters to be
voted on by the shareholders. The Class A Common Stock and the Class B Common
Stock vote as one class on all matters requiring shareholder approval, except
that under California law the affirmative vote of a majority of the outstanding
shares of Class A Common Stock and a majority of the outstanding shares of
Class B Common Stock, each voting separately as a class, is required for any
amendment to our articles of incorporation that would alter or change the
powers, preferences or special right of, or increase or decrease the number of
shares of, or create a new class or series of shares having rights, preferences
or privileges prior to, each respective class of a Companys common stock.

Upon liquidation, holders of both classes of common stock would be entitled to
share ratably in the net assets available for distribution subject to the
rights, if any, of holders of any preferred stock then outstanding. Shares of
both classes of common stock are not redeemable and have no preemptive or
similar rights. The Class B Common Stock may be converted into Class A Common
Stock on a share-for-share basis at any time at the election of the holder and
will automatically convert into Class A Common Stock upon the sale or other
transfer to another holder of Class B Common Stock (including, without
limitation, conveyance into a trust or transfer by the operation of any will or
the laws of descent and distribution).

Issuances of Class A common stock.During fiscal year 2001 we issued an
aggregate of 973,053 shares of Class A common stock in connection with the exercise of stock purchase warrants
(254,716 shares), employee stock options (558,142 shares), acquisition of
technology (170,353 shares) and the acquisition of a minority shareholders
interest in Xenerex (25,000 shares) and we retired 35,158 shares of
Class A common stock in connection with the exercise of a stock
option held by a director of the Company. Details of the transactions are shown in
the tables that follow.

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|                                                                          |                 |       |                   |        |  |          |         |           |  |        |         |               |  |   |      |      | 
|------------------------------------------------------------------------- | --------------- | ----- | ----------------- | ------ |  | -------- | ------- | --------- |  | ------ | ------- | ------------- |  | - | ---- | ---- | 
|Warrants                                                                  |                 |       |                   |        |  |          |         |           |  | Amount |         | Average Price
|Exercised                                                                 |                 | Dates |                   | Shares |  | Received |         | Per Share
|                                                                          |                 |       |                   |        |  |          |         |          
|Class I warrants                                                          |                 |       | 01/02/01          |        |  |          | 2,135   |           |  |        |        |               |  |   |     |     
|Class K warrants                                                          |                 |       | 10/02/00-03/27/01 |        |  |          | 90,000  |           |  | $      | 101,250 |               |  | $ | 1.13 |     
|Class L warrants                                                          |                 |       | 11/06/00          |        |  |          | 55,000  |           |  |        | 65,313  |               |  | $ | 1.19 |     
|Class M warrants                                                          |                 |       | 07/23/01          |        |  |          | 107,581 |           |  |        | 138,134 |               |  | $ | 1.28 |     
|Stock options exercised in connection with retired shares of common stock |                 |       | 04/16/01          |        |  |          | 93,356  |           |  |        |        |               |  | $ | 1.38 |     
|Other stock options                                                       |                 |       | 10/01/01-09/30/01 |        |  |          | 464,786 |           |  |        | 524,368 |               |  | $ | 1.13 |     
|Retired shares in connection with stock options exercised                 |                 |       | 04/16/01          |        |  |          | (35,158 | )         |  |        |        |               |  | $ | 3.67 |     
|                                                                          |                 |       |                   |        |  |          |         |           |  |        |         |               |  |   |      |     
|                                                                          | Total / average |       |                   |        |  |          |         | 777,700   |  |        | $       | 829,065       |  |   | $    | 1.07 | 
|                                                                          |                 |       |                   |        |  |          |         |           |  |        |         |               |  |   |      |     

|                                                             |       |       |          |        |  |              |         |           |  |          |         |               |  |   |      |      | 
|------------------------------------------------------------ | ----- | ----- | -------- | ------ |  | ------------ | ------- | --------- |  | -------- | ------- | ------------- |  | - | ---- | ---- | 
|Acquisitions                                                 |       |       |          |        |  |              |         |           |  |          |         |               |  |   |      |     
|Made with                                                    |       |       |          |        |  |              |         |           |  | Value of |         | Average Price
|Common Stock                                                 |       | Dates |          | Shares |  | Common Stock |         | Per Share
|                                                             |       |       |          |        |  |              |         |          
|Purchased in-process
R&D related to MIF
inhibitor technology |       |       | 08/08/01 |        |  |              | 170,353 |           |  | $        | 867,097 |               |  | $ | 5.09 |     
|Purchased minority
Interest in Xenerex                       |       |       | 09/05/01 |        |  |              | 25,000  |           |  |          | 97,250  |               |  | $ | 3.89 |     
|                                                             |       |       |          |        |  |              |         |           |  |          |         |               |  |   |      |     
|                                                             | Total |       |          |        |  |              |         | 195,353   |  |          | $       | 964,347       |  |   | $    | 4.94 | 
|                                                             |       |       |          |        |  |              |         |           |  |          |         |               |  |   |      |     

Class B common stock conversion.During fiscal year 2001, 28,500 shares of
Class B common stock converted to 28,500 shares of Class A common stock.

Warrants

Class G warrants.As of September 30, 2001, a Class G Warrant to purchase
757,050 shares of Class A common stock at an exercise price of $1.375 per share
remained outstanding. The holder of the Class G Warrant did not exercise any
rights to purchase Class A common stock during the fiscal year ended September
30, 2001. The Class G Warrant was issued in connection with the conversion of
a convertible note payable issued on February 26, 1997, which is no longer
outstanding. The remaining Class G Warrant expires 60 days following the date
of effectiveness of a registration statement with the Securities and Exchange
Commission, which registers the resale of shares purchasable upon exercise of
the warrant.

Class H warrants. As of September 30, 2001, Class H Warrants to purchase
100,000 shares of Class A common stock at an exercise price of $2.40 per share
were outstanding. The holder of Class H Warrants did not exercise any rights
to purchase Class A common stock during the fiscal year ended September 30,
2001. The Class H Stock Purchase Warrant expires on February 26, 2002.

Class I warrant.As of September 30, 2001, none of the Class I Warrants to
purchase Class A common stock remained outstanding. On January 2, 2001, the
Class I warrant holder exercised its right to purchase 2,135 shares of Class A
common stock at $0.78125 per share using a cashless exercise option. The
market price on the date of exercise of the Class I warrant was $6.125 per
share. The gain in value per share purchasable under the warrant was $5.34375
per share. Therefore, the holder surrendered to us the remainder of the

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##### Table of Contents



warrant to purchase 312 shares that had an aggregate value of $1,667 based on
the difference in the market price on the tender date and the exercise price
of $0.78125 per share, times the portion of the warrant tendered.

Class J warrants. See Preferred
Stock  Series D Redeemable Convertible
Preferred Stock and Class J Stock Purchase Warrants above.

Class K warrant. On March 27, 2001, the Class K warrant holder exercised its
right to purchase 90,000 shares of Class A common stock at an exercise price
of $1.125 per share, for cash in the aggregate amount of $101,250. A warrant
to purchase 100,000 shares at $3.50 per share issued in fiscal 2000 was
canceled in fiscal 2001 because certain performance milestones related to
services to be provided by our consultant for investor relations in fiscal
2000 and fiscal 2001 were not achieved. Both warrants related to services
provided or milestones to be achieved by our consultant for investor
relations. We recorded compensation expense of $128,639 and $150,448 related
to the valuation of services rendered and milestones that were achieved under
the warrants in fiscal 2001 and fiscal 2000 respectively. As of September 30,
2001, a Class K Warrant to purchase 187,500 shares of Class A common stock at
$1.125 per share remained outstanding and fully vested. The expiration dates
of the warrants vary from June 14, 2003 to June 14, 2005.

Class L warrant.On October 2, 2000, the Class L warrant holder exercised its
right to purchase 55,000 shares of Class A common stock at an exercise price of
$1.1875 per share, for cash in the aggregate amount of $65,313. We recorded
compensation expense of $33,097 in fiscal 2000 and $16,548 in fiscal 1999 for
discounted advertising services rendered in connection with this warrant. None
of the Class L Warrant remained outstanding at September 30, 2001.

Class M warrants. As of September 30, 2001, Class M warrants to purchase
87,123 shares of Class A common stock remained outstanding in connection with
the issuance of $1.5 million in redeemable 11% convertible debentures in
November 1999. The cost of these warrants was fully amortized prior to fiscal
2001. During fiscal 2001, the holders exercised their rights to purchase
107,581 shares of Class A common stock at an exercise price of $1.284 per share
for cash in the aggregate amount of $138,134. The Class M warrants expire on
November 30, 2002. (See Note 8, Redemption of 11% Convertible Debentures. )

Class N warrants. At September 30, 2001, Class N warrants to purchase 32,877
shares of Class A common stock remained outstanding in connection with a $6
million private placement in January 2000. None of the Class N warrants were
exercised in fiscal 2001. The Class N warrants expire on January 31, 2004.

The following table summarizes all warrant activity for the period October 1,
1998, to September 30, 2001:

|                                  |           |  |                      |            |                  |   |                 |      |  |   |            |            | 
|--------------------------------- | --------- |  | -------------------- | ---------- | ---------------- | - | --------------- | ---- |  | - | ---------- | ---------- | 
|                                  |           |  | Shares of Class A    |            |                  |   |                 |      |  |   |           
|                                  |           |  | Common Stock         |            | Weighted Average |   |                 |      | 
|                                  |           |  | Purchasable Upon     |            | Exercise Price   |   | Range of       
|                                  |           |  | Exercise of Warrants |            | per Share        |   | Exercise Prices
|                                  |           |  |                      |            |                  |   |                
|Outstanding at October 1, 1998    |           |  | 2,972,717            |            |                  | $ | 2.27            |      |  | $ | 1.50$2.97 |           
|                                  | Issued    |  |                      | 6,087,556  |                  |   | $               | 1.45 |  |   | $          | 0.78$1.38 | 
|                                  | Cancelled |  |                      | (2,030,455 | )                |   | $               | 2.97 |  |   | $          | 2.97       | 
|                                  |           |  |                      |            |                  |   |                 |      |  |   |            |           
|Outstanding at September 30, 1999 |           |  | 7,029,818            |            |                  | $ | 1.33            |      |  | $ | 0.78$2.40 |           
|                                  | Issued    |  |                      | 1,113,948  |                  |   | $               | 1.53 |  |   | $          | 1.13$3.50 | 
|                                  | Cancelled |  |                      | (296,144   | )                |   | $               | 1.75 |  |   | $          | 1.13$1.28 | 
|                                  | Expired   |  |                      | (122,083   | )                |   | $               | 1.38 |  |   | $          | 1.38       | 
|                                  | Tendered  |  |                      | (144,142   | )                |   | $               | 0.78 |  |   | $          | 0.78       | 
|                                  | Exercised |  |                      | (5,961,819 | )                |   | $               | 1.37 |  |   | $          | 0.78$2.44 | 
|                                  |           |  |                      |            |                  |   |                 |      |  |   |            |           
|Outstanding at September 30, 2000 |           |  | 1,619,578            |            |                  | $ | 1.41            |      |  | $ | 0.78$3.50 |           
|                                  | Cancelled |  |                      | (100,000   | )                |   | $               | 3.50 |  |   | $          | 3.50       | 
|                                  | Tendered  |  |                      | (312       | )                |   | $               | 0.78 |  |   | $          | 0.78       | 
|                                  | Exercised |  |                      | (254,716   | )                |   | $               | 1.20 |  |   | $          | 0.78$1.28 | 
|                                  |           |  |                      |            |                  |   |                 |      |  |   |            |           
|Outstanding at September 30, 2001 |           |  | 1,264,550            |            |                  | $ | 1.48            |      |  |   |            |           
|                                  |           |  |                      |            |                  |   |                 |      |  |   |            |           

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Stock Options

Stock options to officers.On March 15, 2001, we issued nonqualified stock
options under our 2000 Stock Option Plan to the officers of the Company for the
purchase of 200,000 shares of Class A common stock at an exercise price of
$3.57 per share, 85% of the fair market value of the common stock at the date
of grant. We will record as compensation expense over the three-year vesting
period of the stock options the amount of $126,000, representing the aggregate
difference between the exercise price and the fair market value of the common
stock on the date granted.

Stock options to non-employee directors.On March 16, 2001, we issued to our
non-employee directors stock options to purchase an aggregate of 50,000 shares of Class A
common stock at an exercise price of $4.15 per share as part of a provision for
an annual formula grant under our 1994 Stock Option Plan. The option
price represents the closing market price for the common stock on the
date of grant.

2000 Stock Option Plan and proposed amendment.On March 23, 2000, our
shareholders approved the adoption of the 2000 Stock Option Plan (the 2000
Plan), pursuant to which an aggregate of 2,300,000 shares of our Class A
common stock have been reserved for issuance. The 2000 Plan allows us to grant
options to our officers, directors, employees and consultants. As of September
30, 2001, 843,256 shares of Class A common stock were available for grant under
the 2000 Plan. On November 29, 2001, our Board of Directors authorized an
amendment to the 2000 Plan to increase the number of shares purchasable under
the 2000 Plan by one million shares. The amended 2000 Plan is subject to
shareholders approval and will be presented to the shareholders in our proxy
statement for the 2002 Annual Meeting of Shareholders.

1998 Stock Option Plan. On February 19, 1999, our shareholders approved the
1998 Stock Option Plan (the 1998 Plan) under which options to purchase
1,875,000 shares of Class A Common Stock can be granted to our directors,
officers, employees and consultants. As of September 30, 2001, options to
purchase 47,303 shares of Class A Common Stock were available for grant under
the 1998 Plan.

1994 Stock Option Plan. In March 1994, our shareholders approved the adoption
of the 1994 Stock Option Plan (the 1994 Plan). The 1994 Plan as amended in
1995, 1996 and 1997 reserves for issuance an aggregate of 2,000,000 shares of
Class A Common Stock. The 1994 Plan allows us to grant options to our
officers, directors, employees and consultants. The 1994 Plan provides for an
automatic annual grant of an option to purchase 10,000 shares to each director
who is not also one of our employees. The 1994 Plan terminates on January 14,
2004. At September 30, 2001, 150,077 shares of Class A Common Stock were
available for grant under the 1994 Plan.

Other stock options. In July 1993, we granted options to purchase an aggregate
of 3,843,750 shares of Class A Common Stock to certain of our employees,
consultants, directors and original investors in the Company at an option price
of $3.56 per share. Recipients of these options waived all of their respective
rights to an aggregate of 3,843,750 shares of Class B Common Stock and options
to purchase Class B Common Stock held in an escrow account. These options were
fully exercisable when issued and they expire on July 17, 2003.

In September 1994, we reduced the exercise price on certain options granted to
several employees, officers and consultants to purchase an aggregate of
3,285,250 shares of Class A and Class B Common Stock, to $2.75 per share.

The following table summarizes all common stock option activity from October 1,
1998 to September 30, 2001:

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|                                  |           |  |                          |            |                |  |                 |          |   |   |      |      | 
|--------------------------------- | --------- |  | ------------------------ | ---------- | -------------- |  | --------------- | -------- | - | - | ---- | ---- | 
|                                  |           |  | Number of Shares         |            |                |  |                
|                                  |           |  | Underlying Stock Options |            | Weighted      
|                                  |           |  |                          |            | Average Option
|                                  |           |  | Class A                  |            | Class B        |  | Price Per Share
|                                  |           |  |                          |            |                |  |                
|Outstanding at October 1, 1998    |           |  | 5,859,910                |            |                |  | 419,000         |          |   | $ | 2.38 |     
|                                  | Granted   |  |                          | 1,720,000  |                |  |                 |          |   |   | $    | 0.76 | 
|                                  | Exercised |  |                          | (36,062    | )              |  |                 | (391,000 | ) |   | $    | 0.13 | 
|                                  | Canceled  |  |                          | (319,724   | )              |  |                 |          |   |   | $    | 1.55 | 
|                                  |           |  |                          |            |                |  |                 |          |   |   |      |     
|Outstanding at September 30, 1999 |           |  | 7,224,124                |            |                |  | 28,000          |          |   | $ | 2.16 |     
|                                  | Granted   |  |                          | 1,649,000  |                |  |                 |          |   |   | $    | 1.73 | 
|                                  | Exercised |  |                          | (1,482,355 | )              |  |                 | (16,000  | ) |   | $    | 2.19 | 
|                                  | Canceled  |  |                          | (2,028,619 | )              |  |                 | (12,000  | ) |   | $    | 2.71 | 
|                                  |           |  |                          |            |                |  |                 |          |   |   |      |     
|Outstanding at September 30, 2000 |           |  | 5,362,150                |            |                |  | 0               |          |   | $ | 1.81 |     
|                                  | Granted   |  |                          | 630,760    |                |  |                 |          |   |   | $    | 3.94 | 
|                                  | Exercised |  |                          | (558,142   | )              |  |                 |          |   |   | $    | 1.17 | 
|                                  | Canceled  |  |                          | (134,774   | )              |  |                 |          |   |   | $    | 2.10 | 
|                                  |           |  |                          |            |                |  |                 |          |   |   |      |     
|Outstanding at September 30, 2001 |           |  | 5,299,994                |            |                |  | 0               |          |   | $ | 2.13 |     
|                                  |           |  |                          |            |                |  |                 |          |   |   |      |     
|Exercisable at September 30, 2001 |           |  | 4,017,471                |            |                |  | 0               |          |   | $ | 1.95 |     
|                                  |           |  |                          |            |                |  |                 |          |   |   |      |     

We have applied APB Opinion No. 25 and related interpretations in accounting
for our employee stock options. Accordingly, we have not recognized any
compensation expense for stock options granted at the fair market value of our
Class A Common Stock. If compensation expense for stock options granted under
the stock option plans had been determined based on the fair value at the grant
date consistent with methodology prescribed under SFAS No. 123, then our pro
forma net income (loss) and net income (loss) per share would have been as
follows:

|                                                      |             |  |                                  |            |      |  |      |            |   |  |   |            |  
|----------------------------------------------------- | ----------- |  | -------------------------------- | ---------- | ---- |  | ---- | ---------- | - |  | - | ---------- | -
|                                                      |             |  | Fiscal Years Ended September 30,
|                                                      |             |  |                                 
|                                                      |             |  | 2001                             |            | 2000 |  | 1999
|                                                      |             |  |                                  |            |      |  |     
|Net income (loss)
attributable to common
shareholders |             |  |                                  |            |      |  |      |            |   |  |   |           
|                                                      | As reported |  | $                                | 189,888    |      |  | $    | (801,806   | ) |  | $ | (8,583,182 | )
|                                                      | Pro forma   |  | $                                | (1,478,488 | )    |  | $    | (2,210,593 | ) |  | $ | (9,273,260 | )
|Net income (loss) per
share basic and diluted         |             |  |                                  |            |      |  |      |            |   |  |   |           
|                                                      | As reported |  | $                                | 0.00       |      |  | $    | (0.02      | ) |  | $ | (0.21      | )
|                                                      | Pro forma   |  | $                                | (0.03      | )    |  | $    | (0.04      | ) |  | $ | (0.22      | )

We estimate the weighted average fair values per share of the options granted
during the fiscal years 2001, 2000 and 1999 to be $3.99, $1.73 and $0.76,
respectively, using the Black-Scholes option-pricing model and the following
assumptions:

|                        |  |                           |     |      |  |      |     |   |  |  |     |  
|----------------------- |  | ------------------------- | --- | ---- |  | ---- | --- | - |  |  | --- | -
|                        |  | Years Ended September 30,
|                        |  |                          
|                        |  | 2001                      |     | 2000 |  | 1999
|                        |  |                           |     |      |  |     
|Risk free interest rate |  |                           | 5.8 | %    |  |      | 6   | % |  |  | 5   | %
|Expected life (years)   |  |                           | 4.1 |      |  |      | 4.3 |   |  |  | 3.0 |  
|Expected volatility     |  |                           | 158 | %    |  |      | 153 | % |  |  | 151 | %
|Expected dividends      |  | None                      |     | None |  | None

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The following table summarizes information concerning outstanding and
exercisable Class A and Class B stock options at September 30, 2001:

|                |  |                     |           |                     |  |           |      |             |  |          |      |  |  |          |           |  |  |   |      | 
|--------------- |  | ------------------- | --------- | ------------------- |  | --------- | ---- | ----------- |  | -------- | ---- |  |  | -------- | --------- |  |  | - | ---- | 
|                |  | Options Outstanding |           | Options Exercisable
|                |  |                     |           |                    
|                |  |                     |           |                     |  | Weighted  |      |             |  |          |      |  |  |          |           |  |  |  
|                |  |                     |           |                     |  | Average   |      | Weighted    |  |          |      |  |  | Weighted
|                |  |                     |           |                     |  | Remaining |      | Average     |  |          |      |  |  | Average 
|Range of        |  | Number              |           | Contractual         |  | Exercise  |      | Number      |  | Exercise
|Exercise Prices |  | Outstanding         |           | Life in Years       |  | Price     |      | Exercisable |  | Price   
|                |  |                     |           |                     |  |           |      |             |  |         
|$0.30 - $0.72   |  |                     | 1,093,894 |                     |  |           | 7.47 |             |  | $        | 0.67 |  |  |          | 930,650   |  |  | $ | 0.66 | 
|$0.78 - $0.78   |  |                     | 15,000    |                     |  |           | 7.79 |             |  | $        | 0.78 |  |  |          | 15,000    |  |  | $ | 0.78 | 
|$1.00 - $1.06   |  |                     | 233,666   |                     |  |           | 6.06 |             |  | $        | 1.04 |  |  |          | 233,666   |  |  | $ | 1.04 | 
|$1.28 - $2.31   |  |                     | 1,473,914 |                     |  |           | 7.16 |             |  | $        | 1.66 |  |  |          | 1,140,110 |  |  | $ | 1.67 | 
|$2.47 - $2.50   |  |                     | 506,540   |                     |  |           | 7.11 |             |  | $        | 2.48 |  |  |          | 326,404   |  |  | $ | 2.48 | 
|$2.75 - $3.40   |  |                     | 1,165,220 |                     |  |           | 3.72 |             |  | $        | 2.88 |  |  |          | 965,685   |  |  | $ | 2.80 | 
|$3.56 - $6.44   |  |                     | 811,760   |                     |  |           | 6.27 |             |  | $        | 3.97 |  |  |          | 405,956   |  |  | $ | 3.80 | 
|                |  |                     |           |                     |  |           |      |             |  |          |      |  | 
|                |  |                     | 5,299,994 |                     |  |           |      |             |  |          |      |  |  |          | 4,017,471 |  |  |   |      | 
|                |  |                     |           |                     |  |           |      |             |  |          |      |  | 



|8. |  | REDEMPTION OF 11% CONVERTIBLE DEBENTURES
|-- |  | ----------------------------------------

Loan agreement. In November 1999, we entered into a loan agreement for $1.5
million in aggregate financing provided by two international financial lenders. We
issued an 18-month redeemable convertible debenture for $750,000 to each
lender, with an interest rate of 11% payable quarterly in arrears. On February
4, 2000 we redeemed the $1.5 million in outstanding convertible debentures plus
$28,151 in accrued and unpaid interest. We paid a 5% redemption premium in
connection with the redemption of these debentures. We were able to reduce the
interest rate from 11% to 10% according to the terms of the agreement, because
we redeemed the convertible debentures within the first 90 days of issuance.

Stock purchase warrants. In connection with the issuance and redemption of the
convertible debentures, the lenders and investment bankers retained
fully-vested Class M stock purchase warrants to purchase 467,289 shares of
Class A common stock at an exercise price of $1.284 per share. We valued the
warrants at $81,308, which was fully amortized during fiscal 2000. At
September 30, 2001, Class M stock purchase warrants to purchase 87,123 shares
of Class A common stock remained outstanding.

Debt issue costs. We fully amortized $155,015 in debt issue costs related to
the issuance of the 11% convertible debentures during fiscal 2000.



|9. |  | LICENSE AND OTHER AGREEMENTS
|-- |  | ----------------------------

GlaxoSmithKline. On March 31, 2000, we signed an exclusive license agreement
with GlaxoSmithKline (NYSE: GSK) for rights to manufacture and market Abreva
(docosanol 10% cream) as an over the counter (OTC) product in the United
States and Canada as a treatment for recurrent oral-facial herpes. Under the
terms of the license agreement, GlaxoSmithKline Consumer Healthcare is
responsible for all sales and marketing activities and the manufacturing and
distribution of Abreva in North America. The terms of the license agreement
provide for AVANIR to earn up to $25 million in milestone payments. We
received $10 million in milestone payments in fiscal 2001 and $10 million in
fiscal 2000. We received the remaining $5 million milestone
payment in November 2001.

CTS Chemical Industries. In July 1993, we entered into a license agreement
with CTS Chemical Industries, Ltd. (CTS), for the manufacturing, marketing
and distribution of docosanol 10% cream as a topical cold sore treatment in
Israel. The five-year period license begins upon CTS successfully obtaining
approval by the appropriate regulatory authorities in Israel. Under the terms
of the agreement, CTS will be responsible for obtaining the necessary
regulatory approvals and for the subsequent manufacturing, marketing and
distribution of docosanol 10% cream. The agreement includes a supply provision
under which CTS will purchase its entire

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##### Table of Contents



requirement of active ingredient for use in the manufacture of topical
docosanol 10% cream from us directly or from our designee. CTS is conducting
stability tests on docosanol 10% cream in preparation for filing with
regulatory authorities to obtain approval to market and sell docosanol 10%
cream in Israel. If approval is obtained, AVANIR will earn a royalty on
product sales under the license agreement.

Boryung Pharmaceuticals Company Ltd.In March 1994, we entered into a 12-year
exclusive license and supply agreement with Boryung Pharmaceuticals Company
Ltd. (Boryung), for the manufacture and sale of docosanol 10% cream in the
Republic of Korea (Korea). Under the terms of the agreement, Boryung will be
responsible for obtaining the necessary regulatory approvals and for the
subsequent manufacturing, marketing and distribution of docosanol 10% cream.
The agreement includes a supply provision under which Boryung will purchase its
entire requirement of active ingredient for use in the manufacture of topical
docosanol 10% cream from us directly. Boryung is in the process of preparing
for filing with regulatory authorities to obtain approval to market and sell
docosanol 10% cream in Korea. If approval is obtained, we will earn a royalty
on product sales under the license agreement.

Research collaboration agreements.Xenerex Biosciences, the Companys
subsidiary, currently is engaged in two research collaboration agreements
whereby Xenerex is responsible for generating fully human monoclonal antibodies
to antigen targets provided by its research partners. The agreements require
Xenerex to use commercially reasonable efforts to generate antibodies to the
antigen targets in exchange for an initial fee and do not guarantee that
efforts will be successful. Xenerex could earn additional fees based on
achieving milestones specified in the agreements and earn royalties on sales if
a partner commercializes the antibody. Milestones include a partners
selection of one or more antibodies of interest that Xenerex has generated, if
any, and a partners advancing the product through various stages of clinical
development. The clinical development process will likely take several years
to reach the stage of filing with the FDA for approval to market the product.
Xenerex has received an initial payment from each of its partners that is
intended to offset Xenerex costs of mounting efforts to generate antibodies to
the selected targets. Revenues to be earned on the research collaborations
after an antibody is selected, if any, are outside the control of Xenerex and
are dependent on the progress made by its research partners in the clinical
development process. There can be no assurance that Xenerex will generate
antibodies in sufficient quantities, that either partner will select an
antibody for further development, or that either partner will be successful in
developing and obtaining the necessary regulatory approvals for marketing the
product.



|10. |  | RELATED PARTY
|--- |  | -------------

IriSys Research and Development, LLC

License agreement.  On August 1, 2000, we entered into an agreement with
IriSys Research and Development, LLC (IriSys) to sublicense the exclusive
worldwide rights to a patented drug combination, Neurodex (formerly called
AVP-923), to treat multiple central nervous system disorders. Our license
agreement includes rights to the patented technology and know-how for the
development and potential marketing of products for treatments of:



| |  |  | emotional lability, which is a condition associated with
neurodegenerative diseases such as Amyotrophic Lateral Sclerosis (ALS or
Lou Gehrigs disease), multiple sclerosis (MS), Alzheimers Disease (AD)
and stroke;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | neuropathic pain, as occurs in diabetic neuropathy;                                                                                                                                                                   
|
| |  |  | symptoms of chronic and intractable cough; and                                                                                                                                                                        
|
| |  |  | weaning from narcotics.                                                                                                                                                                                               

The license agreement requires no upfront payments to be paid to IriSys for a
drugs indication before we complete all the clinical development phases to
confirm the drugs efficacy for that indication. We will be required to make
milestone payments to IriSys in the following two instances for each
indication:



| |  |  | if the FDA accepts the filing of a new drug application and
| | - |  | -----------------------------------------------------------
|
| |  |  | if the FDA approves the new drug application for marketing.

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##### Table of Contents



Further, if we successfully complete the clinical trials and the FDA accepts
our new drug application, we will be required to pay a royalty to IriSys based
on a percent of sales revenue if we market the product ourselves. If we
license the product to someone else, we are required to share equally any
royalties that we receive from third parties with IriSys. The agreement calls
for certain minimum sales levels to be achieved in order for AVANIR to maintain
exclusivity of the marketing rights in the licensed territories.

Dr. Yakatan, president and chief executive officer of AVANIR, is a founder,
chairman and a majority shareholder of IriSys. IriSys is the exclusive
licensee of certain patents and a patent application as set forth under an
Exclusive Patent License Agreement between IriSys and the Center for Neurologic
Study, dated as of April 2, 1997. The Company believes that the terms of the
license agreement with IriSys are no less favorable to the company than those
that could have been obtained from an unrelated party.

Research and development.On June 2, 1999, we entered into an agreement for
services with IriSys to develop formulations for a potential drug substance
candidate using our allergy and asthma technology. IriSys fees for services
compared favorably to competitive bids submitted to us at that time. During
fiscal 2001, 2000 and fiscal 1999, the Company paid IriSys $17,800, $101,197
and $81,400 respectively, for services rendered pursuant to this agreement.



|11. |  | INCOME TAXES
|--- |  | ------------

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of our net deferred tax assets were as follows:

|                                                |  |               |             |      |  |   |             |  
|----------------------------------------------- |  | ------------- | ----------- | ---- |  | - | ----------- | -
|                                                |  | September 30,
|                                                |  |              
|                                                |  | 2001          |             | 2000
|                                                |  |               |             |     
|Net operating loss carryforwards                |  | $             | 23,929,702  |      |  | $ | 23,534,919  |  
|Capitalized license fees                        |  |               | 876,353     |      |  |   | 943,764     |  
|Research credit carryforwards                   |  |               | 4,220,002   |      |  |   | 3,658,552   |  
|Capitalized research and development costs      |  |               | 1,343,792   |      |  |   | 1,342,513   |  
|Other                                           |  |               | (386,250    | )    |  |   | (229,870    | )
|Foreign tax credit                              |  |               | 253,572     |      |  |   |            |  
|                                                |  |               |             |      |  |   |             |  
|Net deferred tax assets                         |  |               | 30,237,171  |      |  |   | 29,249,878  |  
|Valuation allowance for net deferred tax assets |  |               | (30,237,171 | )    |  |   | (29,249,878 | )
|                                                |  |               |             |      |  |   |             |  
|                                                |  | $             |            |      |  | $ |            |  
|                                                |  |               |             |      |  |   |             |  

We have provided a valuation allowance against the net deferred tax assets
recorded as of September 30, 2001 and 2000 due to uncertainties as to their
ultimate realization. The net operating loss and research credit carryforwards
expire through 2021. In the event of certain ownership changes, the Tax Reform
Act of 1986 imposes certain restrictions on the amount of net operating loss
carryforwards, which we may use in any year. As of September 30, 2001, we had
$66,541,142 and $14,770,516 of federal and California net operating loss
carryforwards, respectively.



|12. |  | LITIGATION SETTLEMENTS
|--- |  | ----------------------

On March 24, 2000, the Company, David H. Katz,
M.D., (the Company's founder, former CEO, and a former director) and
Mrs. Lee R. Katz (the wife of Dr. Katz) jointly announced a
comprehensive settlement of all disputes, claims and litigation that
they had asserted against each other. Under the settlement terms, AVANIR conveyed to
Dr. Katz shares of Class A Common Stock, valued at $3.9
million, and an additional cash payment in the amount of $175,000.



|13. |  | EMPLOYEE SAVINGS PLAN
|--- |  | ---------------------

We have established an employee savings plan pursuant to Section 401(k) of the
Internal Revenue Code. The plan allows participating employees to deposit into
tax deferred investment accounts 2% to 20% of their salary, subject to annual
limits. We are not required to make matching contributions under the plan, and
we did not make any such contributions in fiscal years 2001, 2000 and 1999, nor
have we made any contributions since inception of the plan.

* * * * *

F-26