This Annual Report on Form 10-K contains forward-looking statements concerning future events and performance of our Company. When used in this report, the words “intend,” “estimate,” “anticipate,” “believe,” “plan,” “goal” and “expect” and similar expressions as they relate to Avanir PHARMACEUTICALS, INC. are included to identify forward-looking statements. These forward-looking statements are based on our current expectations and assumptions and many factors could cause our actual results to differ materially from those indicated in these forward-looking statements. You should review carefully the factors included in this report in Item 1A, “Risk Factors.” We disclaim any intent to update or announce revisions to any forward-looking statements to reflect actual events or developments.

 

Executive Overview

 

AVANIR is a pharmaceutical company focused on acquiring, developing and commercializing novel therapeutic products for the treatment of central nervous system disorders. Our lead product candidate, Zenvia^tm (dextromethorphan hydrobromide/quinidine sulfate), has successfully completed three Phase III clinical trials for the treatment of pseudobulbar affect (“PBA”) and has successfully completed a Phase III trial for the treatment of patients with diabetic peripheral neuropathic pain (“DPN pain”). In addition to our focus on products for the central nervous system, we also have a number of partnered programs in other therapeutic areas which may generate future income for the Company. Our first commercialized product, docosanol 10% cream, (sold in the United States and Canada as Abreva^® by our marketing partner GlaxoSmithKline Consumer Healthcare) is the only over-the-counter treatment for cold sores that has been approved by the U.S. Food and Drug Administration (“FDA”). In 2008, we licensed all of our monoclonal antibodies and we remain eligible to receive milestone payments and royalties related to the sale of these assets. Avanir was incorporated in California in August 1988 and was reincorporated in Delaware in March 2009.

 

Zenvia for the treatment of PBA

 

Zenvia has successfully completed three Phase III clinical trials in the treatment of patients with PBA, also known as emotional lability, and has successfully completed a Phase III trial for the treatment of patients with DPN pain.

 

In August 2009, we reported top line safety and efficacy data from the STAR trial. The STAR trial (Safety, Tolerability and Efficacy Results of AVP-923 in PBA) is a confirmatory Phase III trial of Zenvia in patients with PBA. The study results demonstrated that both doses of Zenvia met the primary efficacy endpoint in the treatment of PBA and were generally safe and well tolerated. Both doses of Zenvia provided a statistically significant reduction in episode rates over the course of the study when compared to placebo (p<0.0001). In an additional analysis of the primary endpoint, at week twelve (end of study), patients in the Zenvia 30/10 mg group reported a statistically significant mean reduction of 88% from baseline in PBA episode rates (p=0.01).

 

In November 2009, we reported safety, efficacy and tolerability data from the 12-week open-label extension phase of the STAR trial. The study results demonstrated that patients maintained on Zenvia 30/10 mg demonstrated statistically significant incremental improvement in their CNS-LS scores over the additional 12-week treatment period of the open-label study (p<0.0001). In addition, patients that were titrated from Zenvia 20/10 mg to Zenvia 30/10 mg demonstrated statistically significant improvement in their CNS-LS scores (p<0.0001) and patients originally on placebo that initiated Zenvia 30/10 mg demonstrated statistically significant improvement in their CNS-LS scores as well.

 

The STAR trial was conducted as a result of an approvable letter we received from the FDA for Zenvia in October of 2006. The approvable letter raised certain safety and efficacy concerns that have required additional clinical development to resolve. Based on discussions with the FDA, we were able to successfully resolve the outstanding efficacy concern relating to the original dose formulation that was tested in our earlier trials. However, to address the remaining safety concerns, we agreed to re-formulate Zenvia and conduct one additional

confirmatory Phase III clinical trial using lower quinidine dose formulations. The goal of this study was to demonstrate improved safety while maintaining significant efficacy at a lower quinidine exposure.

 

In October 2007, we reached agreement with the FDA under the Special Protocol Assessment (“SPA”) process on the design of the STAR trial. We enrolled our first patient in the STAR trial in December 2007 and in March 2009, we completed enrollment with a total of 326 patients.

 

In addition to conducting the STAR trial, we have conducted various pre-clinical and clinical safety studies to enhance our complete response to the 2006 approvable letter and to assist with planned label discussions with the FDA. We expect that the FDA’s approval decision for Zenvia will depend on the agency’s overall assessment of benefits versus potential risks. (See additional information included in this report in Item 1A, “Risk Factors.”)

 

After completion of the STAR trial and pre-clinical and clinical safety studies, we engaged in constructive written communication with the FDA. Based on the feedback we received, we will proceed with filing the full response with existing Zenvia data as planned, early in the second calendar quarter of 2010.

 

Zenvia for the treatment of neuropathic pain

 

In April 2007, we announced positive top-line data from our first Phase III clinical trial of Zenvia for DPN pain. Before discussing a second Phase III trial with the FDA, we made the decision to conduct a formal pharmacokinetic (“PK”) study to identify a lower quinidine dose formulation that may have similar efficacy to the doses tested in the Phase III study, anticipating that some of the concerns with the quinidine component that were raised in the PBA approvable letter could affect the clinical development of this indication as well.

 

In May 2008, we reported a positive outcome of the formal PK study and announced that we identified alternative lower quinidine dose formulations of Zenvia for the next DPN pain phase III clinical trial. The new dose is intended to deliver similar efficacy and improved safety/tolerability versus the formulations previously tested in DPN pain.

 

In September 2008, we submitted our Phase III protocol and related program questions for Zenvia in the treatment of patients with DPN pain to the FDA under the SPA process. In recent communications regarding the continued development of Zenvia for DPN pain, the FDA has expressed that the safety concerns and questions raised in the PBA approvable letter would be expected to necessitate the testing of a lower quinidine dose formulation in the DPN pain indication, as we had expected. Additionally, based on feedback we have received from the FDA on the proposed continued development of Zenvia for DPN pain, it is possible that two large well controlled Phase III trials utilizing a new lower quinidine dose formulation would be needed to support a New Drug Application (“NDA”) filing for this indication. Due to our limited capital resources and current focus on gaining approval for the PBA indication, we do not expect that we will be able to initiate the trials needed for this indication without additional capital or a development partner for Zenvia. Accordingly, we are evaluating our options to fund this program, including the potential for a development partner.

 

In September 2009, we reported on secondary efficacy endpoints from the double-blind phase of the Zenvia STAR trial in PBA, including an endpoint measuring reduction of pain in patients with underlying multiple sclerosis (“MS”). Zenvia 30/10 mg demonstrated statistically significant relief of MS-related pain compared to placebo in the subset of MS patients with moderate-to-severe pain. Based on these data and the previous proof of concept pain data in MS patients with PBA, we are conducting a strategic assessment of the optimal clinical development path for Zenvia to obtain a pain indication.

 

Drug Candidates and Marketed Products

 

Zenvia — Pseudobulbar Affect (PBA) Indication

 

PBA is a distinct neurologic syndrome that is characterized by a lack of control of emotional expression, typically involving episodes of involuntary or exaggerated motor expression of emotion such as laughing, crying or other emotional displays. PBA occurs secondary to progressive neurologic diseases such as amyotrophic lateral sclerosis (“ALS”), dementias including Alzheimer’s disease, multiple sclerosis, and Parkinson’s disease, as well as neurologic injuries such as stroke or traumatic brain injury. While the exact number of patients suffering from PBA

is unknown, based on our review of medical literature, independent surveys and our latest market research, we believe that there are an estimated two million patients in the U.S. suffering from the symptoms of moderate to severe PBA. In addition, our research also demonstrates that there are a significant number of patients who suffer from mild PBA and who would also be eligible for treatment. We believe that the availability of an FDA-approved treatment option for these patients may lead to the correct diagnosis of additional PBA patients. If the FDA approves Zenvia, it would be the first drug approved for the treatment of PBA. Zenvia is a patented, orally administered combination of two well-characterized compounds; the therapeutically active ingredient dextromethorphan (“DM”) and the enzyme inhibitor quinidine (“Q”), which serves to increase the bioavailability of dextromethorphan in the human body.

 

We received an approvable letter from the FDA in October 2006 for our NDA submission for Zenvia for the treatment of patients with PBA. In October 2007, we reached agreement with the FDA under the SPA process on the design, conduct and analysis of the STAR trial. For this trial, we developed two new lower dose formulations of Zenvia; the first contains 30 mg of DM and 10 mg of Q (Zenvia 30/10) and the second contains 20 mg of DM and 10 mg of Q (Zenvia 20/10). The new lower quinidine dose formulations of Zenvia were expected to improve the safety and tolerability profile while maintaining statistically significant and clinically meaningful efficacy.

 

At the conclusion of enrollment, we had enrolled a total of 326 patients (197 with underlying ALS and 129 with underlying MS) who exhibited signs and symptoms of PBA across 52 sites in the U.S. and Latin America. The primary efficacy analysis was based on the changes in crying/laughing episode rates recorded in patient diaries over the course of the study. Secondary endpoints for this clinical trial included other CNS relevant measures such as: 1) Center for Neurologic Study-Lability Scale (CNS-LS) score; 2) Neuropsychiatric Inventory Questionnaire (NPI-Q); 3) SF-36 Health Survey; 4) Beck Depression Inventory (BDI-II); and 5) Pain Rating Scale score (MS patients only).

 

Top Line Safety and Efficacy Data from STAR Trial

 

In August 2009, we reported top line safety and efficacy data from the 12-week double-blind phase of the STAR trial. The study results demonstrated that Zenvia met the primary efficacy endpoint in the treatment of PBA and were generally safe and well tolerated. Zenvia 30/10 mg provided a 47.2% incremental reduction in episode rates compared to placebo over the course of the study (p<0.0001). In an additional analysis of the primary endpoint, at week twelve (end of study), patients in the Zenvia 30/10 mg group reported a statistically significant mean reduction of 88% from baseline in PBA episode rates compared to placebo (p=0.01). Finally, in a secondary analysis of the primary endpoint, Zenvia 20/10 mg also provided a statistically significant incremental reduction of episode rates compared to placebo (p<0.0001). In addition, Zenvia demonstrated statistically significant improvement versus placebo on a number of secondary endpoints including CNS-LS score, SF-36 Mental Health Summary and Beck Depression Inventory.

 

Overall, in the STAR trial, both doses of Zenvia were generally safe and well tolerated. In the STAR trial, 90.9%, 82.2% and 86.2% of patients completed the 12-week double blind phase of the study in the Zenvia 30/10 mg, Zenvia 20/10 mg and placebo groups, respectively. The most common reason for early withdrawals was due to adverse events (AEs). Early withdrawal due to AEs occurred in 3.7%, 7.8% and 1.9% for the Zenvia 30/10 mg, Zenvia 20/10 mg and placebo groups, respectively. Reported AEs were generally mild to moderate in nature. The most commonly reported adverse events that appeared to be more frequent than placebo were dizziness, nausea and diarrhea.

 

The proportion of patients reporting at least one serious adverse event (SAE) was 6.5% in the Zenvia 30/10 mg group, 8.8% in the Zenvia 20/10 mg group and 10.4% in the placebo group. A total of 38 SAEs occurred in 27 patients over the course of the study. Of the 38 SAEs reported in the study, only two were deemed by the investigators to be possibly or probably treatment-related; zero in the Zenvia 30/10 mg group, two in the Zenvia 20/10 mg group and zero in the placebo group. In addition, there was a numerical difference in respiratory SAEs with five patients (4.7%) in the Zenvia 30/10 mg group, three patients (2.9%) in the Zenvia 20/10 mg group and two patients (1.9%) in the placebo group experiencing respiratory SAEs.

 

Overall, there were seven deaths in the study, all related to patients with underlying ALS. In total, three deaths occurred in the Zenvia 30/10 mg arm, three in the 20/10 mg arm and one in the placebo arm. Of the seven deaths that

were reported, five of the deaths (four in the Zenvia treatments arms and one in the placebo arm) occurred at least five days after study drug had been discontinued. There was one reported death in the Zenvia 20/10 mg group that was considered possibly treatment-related, which occurred five days after study drug had been discontinued. The ALS mortality rate in the Zenvia treatment groups was in line with historical norms and the rate in the placebo group was below historical norms.

 

Open Label Safety and Efficacy Data from STAR Trial

 

In November 2009, we reported safety, efficacy and tolerability data from the 12-week open-label extension phase of the STAR trial. The study results demonstrated that patients maintained on Zenvia 30/10 mg demonstrated statistically significant incremental improvement in their CNS-LS scores over the additional 12-week treatment period of the open-label study (p<0.0001). In addition, patients that were titrated from Zenvia 20/10 mg to Zenvia 30/10 mg demonstrated statistically significant improvement in their CNS-LS scores (p<0.0001) and patients originally on placebo that initiated Zenvia 30/10 mg demonstrated statistically significant improvement in their CNS-LS scores as well.

 

Overall, Zenvia 30/10 mg was generally safe and well tolerated, with 92.9% of patients completing the 12-week treatment period of the open-label study. Reported adverse events were low overall, mild to moderate in nature and consistent with the reported adverse events in the double-blind phase. The overall mortality rate observed in patients with ALS was consistent with historic norms.

 

Based on the results from the STAR trial, we intend to submit our complete response to the approvable letter early in the second quarter of calendar 2010. The complete response will include the results from the STAR trial, data from the pre-clinical and clinical safety studies we have conducted, and the data from the open-label safety study.

 

Zenvia — Neuropathic Pain Indications

 

Diabetic peripheral neuropathic pain (“DPN pain”), which arises from nerve injury, can result in a chronic and debilitating form of pain that has historically been poorly diagnosed and treated. It is often described as burning, tingling, stabbing, or pins and needles in the feet, legs, hands or arms. An estimated 3.5 million people in the United States experience diabetic peripheral neuropathic pain according to the American Diabetes Association. DPN pain currently is most commonly treated with antidepressants, anticonvulsants, opioid analgesics and local anesthetics. Most of these treatments have limited effectiveness or undesirable side effects resulting in a high degree of unmet medical need. The neuropathic pain market is continuing to grow rapidly, and in 2006, was estimated to be worth $2.6 billion in sales among the seven largest markets (i.e. the United States, Japan, France, Germany, Italy, Spain and the United Kingdom.)

 

In April 2007, we announced positive top-line data from our first Phase III clinical trial of Zenvia for the treatment of patients with DPN pain. The primary endpoint of the trial was based on the daily diary entries for the Pain Rating Scale as defined in the SPA with the FDA. In the trial, two doses of Zenvia, 45/30 mg DMQ dosed twice daily (“Zenvia 45/30”) and 30/30 mg DMQ dosed twice daily (“Zenvia 30/30”), were compared to placebo based on daily patient diary entries for the Pain Rating Scale. Both Zenvia treatment groups had lower pain ratings than placebo patients (p <0.0001 in both cases). In the Zenvia 45/30 patient group, average reductions were significantly greater than placebo patients at Days 30, 60, and 90 (p <0.0001 at each time point). In the Zenvia 30/30 patient group, average reductions were also significantly greater than placebo patients at Days 30 and 60 (p <0.0001) and Day 90 (p=0.007).

 

Zenvia also demonstrated statistically significant improvements in a number of key secondary endpoints including the Pain Relief Ratings Scale and the Pain Intensity Ratings Scale. The secondary endpoints compared the baseline value to the average rating values at each study visit after randomization. The average pain relief reductions, as measured on the Pain Relief Rating Scale, were greater for the Zenvia 45/30 patient group (p=0.0002) and for the Zenvia 30/30 patient group (p=0.0083), compared with placebo. In addition, the DMQ 45, but not the DMQ 30, patient group demonstrated statistically significant improvements in the Pain Intensity Rating Scale compared with placebo (p=0.029). Although not powered to detect differences in the secondary endpoint of the Peripheral Neuropathy Quality of Life Scale Composite score and thus not achieving statistical significance, the

Zenvia 45/30 patients showed a greater improvement than placebo patients (p=0.05) and the Zenvia 30/30 patients showed a trend towards greater improvement than placebo patients (p=0.08).

 

The most commonly reported adverse events from this Phase III study were dizziness, nausea, diarrhea, fatigue and somnolence, which were mild to moderate in nature. A higher number of patients in the Zenvia 45/30 and Zenvia 30/30 treatment groups (25.2% and 21.0%, respectively) discontinued due to an adverse event than compared to placebo (11.4%). There were no statistically significant differences in serious adverse event with 7.6%, 4.8% and 4.1% reported in the Zenvia 45/30, Zenvia 30/30 and placebo groups, respectively, and no deaths occurred during the study.

 

After receipt of these positive results, we conducted a formal pharmacokinetic (“PK”) study to identify a lower quinidine dose formulation that may have similar efficacy to the doses tested in the Phase III study. In May 2008, we reported a positive outcome of the formal PK study and announced that we identified an alternative lower quinidine dose formulation of Zenvia for DPN pain. The new dose is intended to deliver similar efficacy and improved safety/tolerability versus the formulations previously tested for this indication. In September 2008, we submitted our Phase III protocol and related questions for Zenvia for DPN pain to the FDA under a Special Protocol Assessment (“SPA”). We received the FDA’s initial response to the SPA and are evaluating our options to fund this program, including the potential for a development partner.

 

In September 2009, we reported on secondary efficacy endpoints from the double-blind phase of the Zenvia STAR trial in PBA, including an endpoint measuring reduction of pain in patients with underlying multiple sclerosis (“MS”). Zenvia 30/10 mg demonstrated statistically significant relief of MS-related pain compared to placebo in the subset of MS patients with moderate-to-severe pain. Based on these data and the previous proof of concept pain data in MS patients with PBA, we are conducting a strategic assessment of the optimal clinical development path for Zenvia to obtain a pain indication.

 

Other Programs

 

Docosanol 10% Cream — Cold Sores

 

Docosanol 10% cream is a topical treatment for cold sores. In 2000, we received FDA approval for marketing docosanol 10% cream as an over-the-counter product. Since that time, docosanol 10% cream has been approved by regulatory agencies in Canada, Denmark, Finland, Israel, Korea, Norway, Portugal, Spain, Poland, Germany, Greece and Sweden and is sold by our marketing partners in these territories. In 2000, we granted a subsidiary of GlaxoSmithKline, SB Pharmco Puerto Rico, Inc. (“GSK”) the exclusive rights to market docosanol 10% cream in the U.S. and Canada. GSK markets the product under the name Abreva^® in the United States and Canada. In fiscal 2003, we sold an undivided interest in our GSK license agreement for docosanol 10% cream to Drug Royalty USA, Inc. (“Drug Royalty USA”) for $24.1 million. We retained the right to receive 50% of all royalties (a net of 4%) under the GSK license agreement for annual net sales of Abreva in the U.S. and Canada in excess of $62 million. We also retained the rights to develop and license docosanol 10% cream outside the U.S. and Canada for the treatment of cold sores and other potential indications. We currently have several other collaborations for docosanol around the world. Two of these collaborations currently generate royalty revenue and the others may generate future royalty revenue for the Company depending on clinical and regulatory success outside of the United States.

 

Under the terms of our docosanol license agreements, our partners are generally responsible for all regulatory approvals, sales and marketing activities, and manufacturing and distribution of the product in the licensed territories. The terms of the license agreements typically provide for us to receive a data transfer fee, potential milestone payments and royalties on product sales. We purchase the active pharmaceutical ingredient (“API”), docosanol, from a large supplier in Western Europe and sell the material to our licensees for commercialization. We currently store our API in the United States. Any material disruption in manufacturing could cause a delay in shipments and possible loss of sales.

 

Xenerex Human Antibody Technology — Anthrax/Other Infectious Diseases

 

In March 2008, we entered into an Asset Purchase and License Agreement with Emergent Biosolutions for the sale of our anthrax antibodies and license to use our proprietary Xenerex Technology platform, which was used to

generate fully human antibodies to target antigens. Under the terms of the Agreement, we completed the remaining work under our NIH/NIAID grant (“NIH grant”) and transferred all materials to Emergent. Under the terms of the agreement, we are eligible to receive milestone payments and royalties on any product sales generated from this program. In connection with the sale of the anthrax antibody program, we also ceased all ongoing research and development work related to other infectious diseases on June 30, 2008.

 

In September 2008, we entered into an Asset Purchase Agreement with a San Diego based biotechnology company for the sale of our non-anthrax related antibodies as well as the remaining equipment and supplies associated with the Xenerex Technology platform. In connection with this sale, we received an upfront payment of $210,000 and are eligible to receive future royalties on potential product sales, if any.

 

Competition

 

The pharmaceutical industry is characterized by rapidly evolving technology and intense competition. A large number of companies of all sizes, including major pharmaceutical companies and specialized biotechnology companies, engage in activities similar to our activities. Many of our competitors have substantially greater financial and other resources available to them. 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 our competitors’ products and technologies are in direct competition with ours. We also must compete with these institutions in recruiting highly qualified personnel.

 

Zenvia for Pseudobulbar Affect.  Although we anticipate that Zenvia, if approved, could be the first product to be marketed for the treatment of PBA, we are aware that physicians may prescribe other products in an off-label manner for the treatment of this disorder. For example, Zenvia may face competition from the following products:

 

 

It is also possible that compounding pharmacies could produce Zenvia in an unauthorized fashion.

 

Zenvia for DPN pain.  We anticipate that Zenvia for the treatment of DPN pain, if further developed by us and approved by the FDA for marketing, would compete with other drug products that are currently prescribed by physicians, including these identified below. Additionally, many other companies are developing drug candidates for this indication and we expect competition for Zenvia, if approved to treat DPN pain, to be intense. Current approved competitors include:

 

 

Docosanol 10% cream.  Abreva faces intense competition in the U.S. and Canada from the following established products:

 

 

Manufacturing

 

We currently have no manufacturing or production facilities and, accordingly, rely on third parties for clinical production of our products and product candidates. We obtain the API for Zenvia from one of several available commercial suppliers. Further, we licensed to various pharmaceutical companies the exclusive rights to manufacture and distribute docosanol 10% cream.

 

Patents and Proprietary Rights

 

As of November 1, 2009, we owned or had the rights to 207 issued patents (59 U.S. and 148 foreign) and 213 pending applications (25 U.S. and 188 foreign). Patents and patent applications owned or licensed by the Company include Zenvia and other technologies, including but not limited to docosanol-related products and technologies, MIF inhibitor technologies, and TNF-alpha inhibitor technologies.

 

 

In June 2008, the European Patent Office granted a new patent which extends the period of commercial exclusivity for Zenvia into 2023. The new European patent expands the available Zenvia dose ranges under prior patent protection and encompasses our current clinical development programs in PBA and DPN pain, as well as other neurologic conditions.

 

In October 2009, we received a “Notice of Allowance” from the United States Patent and Trademark Office (“USPTO”) announcing that the office intends to grant the Company a new patent, extending the period of commercial exclusivity for Zenvia into 2025. Upon issuance, the patent will provide Avanir with patent protection for low-dose quinidine formulations of Zenvia used to treat PBA.

 

In addition to this newly allowed U.S. patent, the Company has exclusive rights under a royalty-bearing license to a family of patents and patent applications that claim methods of treating PBA, chronic pain, as well as other neurologic conditions, using combinations of dextromethorphan and quinidine, the two active agents in Zenvia.

 

Information regarding the status of our various research and development programs, and the amounts spent on major programs through the last two fiscal years, can be found in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Government Regulations

 

The FDA and comparable regulatory agencies in foreign countries extensively regulate the manufacture and sale of the pharmaceutical products that we have developed or are currently 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 regulatory 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 tested in humans include:

 

 

The results of these nonclinical studies may be submitted to the FDA as part of an Investigational New Drug (“IND”) application. The sponsor of an IND application may commence human testing of the compound 30 days after submission of the IND, unless notified to the contrary by the FDA.

The clinical testing program for a new drug typically involves three phases:

 

 

Data from all clinical studies, as well as all nonclinical studies and evidence of product quality, typically are submitted to the FDA in a NDA. Although the FDA’s requirements for clinical trials are well established and we believe that we have planned and conducted our clinical trials in accordance with the FDA’s applicable regulations and guidelines, these requirements, including requirements relating to testing the safety of drug candidates, may be subject to change or new interpretation. Additionally, we could be required to conduct additional trials beyond what we had planned due to the FDA’s safety and/or efficacy concerns or due to differing interpretations of the meaning of our clinical data. (See Item 1A, “Risk Factors”).

 

The FDA’s Center for Drug Evaluation and Research must approve a NDA for a drug before it may be marketed in the U.S. If 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 also 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.

 

Regulatory obligations continue post-approval, and include the reporting of adverse events when a drug is utilized in the broader commercial population. Promotion and marketing of drugs is also strictly regulated, with penalties imposed for violations of FDA regulations, the Lanham Act (trademark statute), and other federal and state laws, including the federal anti-kickback statute.

 

We currently intend to continue to seek, directly or through our partners, approval to market our products and product candidates 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.

 

Product Liability Insurance

 

We maintain product liability insurance on our products and clinical trials that provides coverage in the amount of $10 million per incident and $10 million in the aggregate. We expect that we would increase our product liability insurance coverage if Zenvia is approved and we commence marketing the drug.

 

Executive Officers and Key Employees of the Registrant

 

Information concerning our executive officers and key employees, including their names, ages and certain biographical information can be found in Part III, Item 10 under the caption, “Executive Officers and Key Employees of the Registrant.” This information is incorporated by reference into Part I of this report.

 

Employees

 

As of November 18, 2009, we employed 20 persons, including 8 engaged in research and development activities, including clinical development, and regulatory affairs, and 12 in general and administrative functions such as human resources, finance, accounting, business development and investor relations.

Financial Information about Segments

 

We operate in a single accounting segment — the development and commercialization of novel treatments that target the central nervous system. Refer to Note 16, “Segment Information” in the Notes to the Consolidated Financial Statements.

 

General Information

 

Our principal executive offices are located at 101 Enterprise, Suite 300, Aliso Viejo, California 92656. Our telephone number is (949) 389-6700 and our e-mail address is info@avanir.com. Our Internet website address is www.avanir.com.

 

You are advised to read this Form 10-K in conjunction with other reports and documents that we file from time to time with the Securities and Exchange Commission (“SEC”). In particular, please read our Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K that we may file from time to time. You may obtain copies of these reports after the date of this annual report directly from us or from the SEC at the SEC’s Public Reference Room at 100 F Street, N.E. Washington, D.C. 20549. In addition, the SEC maintains information for electronic filers (including Avanir) at its website at www.sec.gov. The public may obtain information regarding the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. We make our periodic and current reports available on our internet website, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. No portion of our website is incorporated by reference into this Annual Report on Form 10-K.

 

 

Risks Relating to Our Business

 

There can be no assurance that the FDA will approve Zenvia for PBA or any other indication.

 

In October 2006, we received an “approvable letter” from the FDA for our NDA submission for Zenvia in the treatment of patients with PBA. The approvable letter raised certain safety and efficacy concerns. Based on discussions with the FDA, we were able to successfully resolve the outstanding efficacy concern of the original dose formulation that was tested in earlier clinical trials. However, the safety concerns require additional clinical development to resolve. To address the safety concerns, we re-formulated Zenvia and conducted one additional confirmatory Phase III clinical trial using new lower quinidine dose formulations. Although we believe that the data from the confirmatory trial, combined with additional clinical and pre-clinical data, should be sufficient to address the issues outlined in the FDA approvable letter, it is possible that the FDA will continue to have safety concerns that could prevent or delay approval. Accordingly, there can be no assurance that the FDA will approve Zenvia for commercialization.

 

Additionally, although we have a Special Protocol Assessment (“SPA”) from the FDA for our recently completed confirmatory Phase III trial for Zenvia in patients with PBA, there can be no assurance that the terms of the SPA will ultimately be binding on the FDA. An SPA is intended to serve as a binding agreement with the FDA on the adequacy of the planned design, conduct and analysis of a clinical trial. Even where an SPA has been granted, however, additional data may subsequently become available that causes the FDA to reconsider the previously agreed upon SPA and the FDA may have subsequent safety or efficacy concerns that override this agreement. As a result, even with positive data obtained under an SPA, we cannot be certain that the trial results will be found to be adequate to demonstrate a favorable risk-benefit profile required for product approval.

 

The FDA’s safety concerns regarding Zenvia for the treatment of PBA extend to other clinical indications that we have been pursuing, including DPN pain. Due to these concerns, any future development of Zenvia for other indications is expected to use an alternative lower-dose quinidine formulation, which may negatively affect efficacy.

 

We have successfully completed a single Phase III trial for Zenvia in the treatment of DPN pain. In communications regarding the continued development of Zenvia for this indication, the FDA has expressed that the safety concerns and questions raised in the PBA approvable letter necessitate the testing of a low-dose quinidine formulation in the DPN pain indication as well. Additionally, based on feedback we have received from the FDA on

the proposed continued development of Zenvia for this indication, it is possible that two large well-controlled Phase III trials would be needed to support an NDA filing for this indication. Due to our limited capital resources and current focus on gaining approval for the PBA indication, we do not expect that we will be able to conduct the trials needed for this indication without additional capital or a development partner for Zenvia. Moreover, although we achieved positive results in our initial Phase III trial, an alternative low-dose quinidine formulation may not yield the same levels of efficacy as seen in the earlier trials or as predicted based on our subsequent PK study. Any decrease in efficacy may be so great that the drug does not demonstrate a statistically significant improvement over placebo. Additionally, any alternative low-dose quinidine formulation that we develop may not sufficiently satisfy the FDA’s safety concerns. If this were to happen, we may not be able to pursue the development of Zenvia for other indications or may need to undertake significant additional clinical trials, which would be costly and cause potentially substantial delays.

 

Even if Zenvia receives marketing approval from the FDA, the approval may not be on the terms that we seek and could limit the marketability of the drug.

 

Even if the FDA approves Zenvia for marketing in one or more indications, approval could be granted on terms less favorable than those we are seeking. This may, in turn, limit our ability to commercialize Zenvia and generate substantial revenues from its sales. In addition to the confirmatory Phase III trial in PBA, we recently completed additional pre-clinical and clinical cardiac safety studies designed to enhance our response to the FDA’s approvable letter and to support planned label discussions with the FDA. Although we believe these studies showed an improvement in the margin of cardiac safety with the new lower dose of quinidine, it did show QTc prolongation of a duration that is above the FDA’s threshold of concern (5 ms mean increase) in approving new drugs. As a result, we could face one or more of the following risks:

 

 

Additionally, we experienced a total of seven deaths in the double-blind phase of the STAR trial, all among ALS patients. Although the overall mortality rate in the trial is consistent with published mortality rates, it is possible that these deaths may negatively affect the FDA decision on our PBA application. Any of these events could prevent us from achieving or maintaining market acceptance of our product, even if it receives marketing approval, or could substantially increase the cost of commercialization, which in turn could impair our ability to generate revenues from the product candidate.

 

We have limited capital resources and will need to raise additional funds to support our operations.

 

We have experienced significant operating losses in funding the research, development and clinical testing of our drug candidates, accumulating losses totaling $278.0 million as of September 30, 2009, and we expect to continue to incur substantial operating losses for the foreseeable future. As of September 30, 2009, we had approximately $32.0 million in cash and cash equivalents and restricted investments in marketable securities. Additionally, we currently do not have any meaningful sources of recurring revenue or cash flow from operations.

 

In light of our current capital resources, lack of near-term revenue opportunities and substantial long-term capital needs, we will need to raise additional capital in the future to finance our long-term operations, including the planned launch of Zenvia, until we expect to be able to generate meaningful amounts of revenue from product sales. Based on our current loss rate and existing capital resources as of the date of this filing, we estimate that we have

sufficient funds to sustain our operations at their current levels through calendar 2010, which includes the anticipated timing of the FDA approval decision for Zenvia in PBA in the second half of calendar year 2010. Although we expect to be able to raise additional capital, there can be no assurance that we will be able to do so or that the available terms of any financing would be acceptable to us. If we are unable to raise additional capital to fund future operations, then we may be unable to fully execute our development plans for Zenvia. This may result in significant delays in the development of Zenvia and may force us to further curtail our operations.

 

Any transactions that we may engage in to raise capital could dilute our stockholders and diminish certain commercial prospects.

 

Although we believe that we will have adequate capital reserves to fund operations beyond the anticipated timing of the FDA approval decision for Zenvia in PBA, we expect that we will need to raise additional capital in the future. We may do so through various financing alternatives, including licensing or sales of our technologies, drugs and/or drug candidates, selling shares of common or preferred stock, through the acquisition of other companies, or through the issuance of debt. Each of these financing alternatives carries certain risks. Raising capital through the issuance of common stock may depress the market price of our stock. Any such financing will dilute our existing stockholders and, if our stock price is relatively depressed at the time of any such offering, the levels of dilution would be greater. In addition, debt financing, to the extent available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as making capital expenditures or entering into licensing transactions. If we seek to raise capital through licensing transactions or sales of one or more of our technologies, drugs or drug candidates, as we have previously done with certain investigational compounds and docosanol 10% cream, then we will likely need to share a significant portion of future revenues from these drug candidates with our licensees. Additionally, the development of any drug candidates licensed or sold to third parties will no longer be in our control and thus we may not realize the full value of any such relationships.

 

In July 2009, we entered into a financing facility with Cantor Fitzgerald & Co., providing for the sale of up to 12.5 million shares of our common stock from time to time into the open market at prevailing prices. As of November 1, 2009, we had sold a total of 4.7 million shares under this facility. We may or may not sell additional shares under this facility, depending on the volume and price of our common stock, as well as our capital needs and potential alternative sources of capital, such as a development partner for Zenvia. If we actively sell shares under this facility, a significant number of shares of common stock could be issued in a short period of time, although we would attempt to structure the volume and price thresholds in a way that minimizes market impact. Notwithstanding these control efforts, these sales, or the perceived risk of dilution from potential sales of stock through this facility, may depress our stock price or cause holders of our common stock to sell their shares, or it may encourage short selling by market participants, which could contribute to a decline in our stock price. A decline in our stock price might impede our ability to raise capital through the issuance of additional shares of common stock or other equity securities, and may cause our stockholders to lose part or all of the value of their investment in our stock.

 

We have licensed out or sold most of our non-core drug development programs and related assets and these and other possible future dispositions carry certain risks.

 

We have entered into agreements for the licensing out or sale of our non-core assets, including FazaClo, macrophage migration inhibitory factor (“MIF”), our anthrax antibody program, and other antibodies in our infectious disease program, as well as docosanol in major markets worldwide. From time to time, we have been and will continue to be engaged in discussions with potential licensing or development partners for Zenvia for PBA and/or other indications and we may choose to pursue a partnership or license involving Zenvia, if the terms are attractive. However, these transactions involve numerous risks, including:

 

 

Transactions such as these may result in disputes regarding representations and warranties, indemnities, earn-outs, and other provisions in the transaction agreements. If disputes are resolved unfavorably, our financial

condition and results of operations may be adversely affected and we may not realize the anticipated benefits from the transactions.

 

Disputes relating to these transactions can lead to expensive and time-consuming litigation and may subject us to unanticipated liabilities or risks, disrupt our operations, divert management’s attention from day-to-day operations, and increase our operating expenses.

 

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

 

We have invested in an extensive patent portfolio and we rely substantially on the protection of our intellectual property through our ownership or control of issued patents and patent applications. Because of the competitive nature of the biopharmaceutical industry, we cannot assure you that:

 

 

Even if we successfully secure our intellectual property rights, third parties, including other biotechnology or pharmaceutical companies, may allege that our technology infringes on their rights or that our patents are invalid. Intellectual property litigation is costly, and even if we were to prevail in such a dispute, the cost of litigation could adversely affect our business, financial condition, and results of operations. Litigation is also time-consuming and would divert management’s attention and resources away from our operations and other activities. If we were to lose any litigation, in addition to any damages we would have to pay, we could be required to stop the infringing activity or obtain a license. Any required license might not be available to us on acceptable terms, or at all. Some licenses might be non-exclusive, and our competitors could have access to the same technology licensed to us. If we were to fail to obtain a required license or were unable to design around a competitor’s patent, we would be unable to sell or continue to develop some of our products, which would have a material adverse effect on our business, financial condition and results of operations.

 

It is unclear whether we would be eligible for patent-term restoration in the U.S. under applicable law and we therefore do not know whether our patent-term can be extended.

 

Depending upon the timing, duration and specifics of FDA approval, if any, of Zenvia, some of our U.S. patents may be eligible for limited patent term extension under the Drug Price Competition and Patent Term Restoration Act of 1984, referred to as the Hatch-Waxman Amendments. If Zenvia is approved, the Hatch-Waxman Amendments may permit a patent restoration term of up to five years for one of our patents covering Zenvia as compensation for the patent term lost during product development and the regulatory review process. The patent term restoration period is generally one-half the time between the effective date of an IND and the submission date of an NDA, plus the time between the submission date of an NDA and the approval of that application. We intend to apply for patent term restoration. However, because Zenvia is not a new chemical entity, but is a combination of two previously approved products, it is uncertain whether Zenvia will be granted any patent term restoration under the U.S. Patent and Trademark Office guidelines. In addition, the patent term restoration cannot extend the remaining term of a patent beyond a total of 14 years after the product’s approval date.

 

Market exclusivity provisions under the Federal Food, Drug and Cosmetic Act, or the FDCA, also may delay the submission or the approval of certain applications for competing product candidates. The FDCA provides three

years of non-patent marketing exclusivity for an NDA if new clinical investigations, other than bioavailability studies, that were conducted or sponsored by the applicant are deemed by the FDA to be essential to the approval of the application. This three-year exclusivity covers only the conditions associated with the new clinical investigations and does not prohibit the FDA from approving abbreviated NDAs for drugs containing the original active agent.

 

Once the three-year FDCA exclusivity period has passed and after the patents (including the patent restoration term, if any) that cover Zenvia expire, generic drug companies would be able to introduce competing versions of the drug. If we are unsuccessful in defending our patents against generic competition, our long-term revenues from Zenvia sales may be less than expected and we may have greater difficulty finding a development partner or licensee for Zenvia.

 

If we fail to obtain regulatory approval in foreign jurisdictions, we would not be able to market our products abroad and our revenue prospects would be limited.

 

We may seek to have our products or product candidates marketed outside the United States. In order to market our products in the European Union and many other foreign jurisdictions, we must obtain separate regulatory approvals and comply with numerous and varying regulatory requirements. The approval procedure varies among countries and jurisdictions and can involve additional testing. The time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory approval processes may include all of the risks associated with obtaining FDA approval. We may not obtain foreign regulatory approvals on a timely basis, if at all. For example, our development partner in Japan encountered significant difficulty in seeking approval of docosanol in that country and was forced to abandon efforts to seek approval in that country. Approval by the FDA does not ensure approval by regulatory authorities in other countries or jurisdictions, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or jurisdictions or by the FDA. We may not be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products in any market. The failure to obtain these approvals could materially adversely affect our business, financial condition and results of operations.

 

We face challenges retaining members of management and other key personnel.

 

The industry in which we compete has a high level of employee mobility and aggressive recruiting of skilled employees. This type of environment creates intense competition for qualified personnel, particularly in clinical and regulatory affairs, research and development and accounting and finance. Because we have a relatively small organization, the loss of any executive officers, including the Chief Executive Officer, key members of senior management or other key employees, could adversely affect our operations. For example, if we were to lose one or more of the senior members of our clinical and regulatory affairs team, the pace of clinical development for Zenvia could be slowed significantly.

 

Risks Relating to Our Industry

 

There are a number of difficulties and risks associated with clinical trials and our trials may not yield the expected results.

 

There are a number of difficulties and risks associated with conducting clinical trials. For instance, we may discover that a product candidate does not exhibit the expected therapeutic results, may cause harmful side effects or have other unexpected characteristics that may delay or preclude regulatory approval or limit commercial use if approved. It typically takes several years to complete a late-stage clinical trial and a clinical trial can fail at any stage of testing. If clinical trial difficulties or failures arise, our product candidates may never be approved for sale or become commercially viable.

 

In addition, the possibility exists that:

 

 

 

It is possible that earlier clinical and pre-clinical trial results may not be predictive of the results of subsequent clinical trials. If earlier clinical and/or pre-clinical trial results cannot be replicated or are inconsistent with subsequent results, our development programs may be cancelled or deferred. In addition, the results of these prior clinical trials may not be acceptable to the FDA or similar foreign regulatory authorities because the data may be incomplete, outdated or not otherwise acceptable for inclusion in our submissions for regulatory approval.

 

Additionally, the FDA has substantial discretion in the approval process and may reject our data or disagree with our interpretations of regulations or draw different conclusions from our clinical trial data or ask for additional information at any time during their review. For example, the use of different statistical methods to analyze the efficacy data from our Phase III trial of Zenvia in DPN pain results in significantly different conclusions about the efficacy of the drug. Although we believe we have legitimate reasons to use the methods that we have adopted as outlined in our SPA with the FDA, the FDA may not agree with these reasons and may disagree with our conclusions regarding the results of these trials.

 

Although we would work to be able to fully address any such FDA concerns, we may not be able to resolve all such matters favorably, if at all. Disputes that are not resolved favorably could result in one or more of the following:

 

 

If we do not receive regulatory approval to sell our product candidates or cannot successfully commercialize our product candidates, we would not be able to generate meaningful levels of sustainable revenues.

 

The pharmaceutical industry is highly competitive and most of our competitors have larger operations and have greater resources. As a result, we face significant competitive hurdles.

 

The pharmaceutical and biotechnology industries are highly competitive and subject to significant and rapid technological change. We compete with hundreds of companies that develop and market products and technologies in areas similar to those in which we are performing our research. For example, we expect that Zenvia will face competition from antidepressants, atypical anti-psychotic agents and other agents in the treatment of PBA and from a variety of pain medications and narcotic agents for the treatment of DPN pain.

 

Our competitors may have specific expertise and development technologies that are better than ours and many of these companies, which include large pharmaceutical companies, either alone or together with their research partners, have substantially greater financial resources, larger research and development capabilities and substantially greater experience than we do. Accordingly, our competitors may successfully develop competing products.

We are also competing with other companies and their products with respect to manufacturing efficiencies and marketing capabilities, areas where we have limited or no direct experience.

 

If we fail to comply with regulatory requirements, regulatory agencies may take action against us, which could significantly harm our business.

 

Marketed products, along with the manufacturing processes, post-approval clinical data, labeling, advertising and promotional activities for these products, are subject to continual requirements and review by the FDA and other regulatory bodies. Even if we receive regulatory approval for one of our product candidates, the approval may be subject to limitations on the indicated uses for which the product may be marketed or to the conditions of approval or contain requirements for costly post-marketing testing and surveillance to monitor the safety or efficacy of the product.

 

In addition, regulatory authorities subject a marketed product, its manufacturer and the manufacturing facilities to ongoing review and periodic inspections. We will be subject to ongoing FDA requirements, including required submissions of safety and other post-market information and reports, registration requirements, current Good Manufacturing Practices (“cGMP”) regulations, requirements regarding the distribution of samples to physicians and recordkeeping requirements.

 

The cGMP regulations also include requirements relating to quality control and quality assurance, as well as the corresponding maintenance of records and documentation. We rely on the compliance by our contract manufacturers with cGMP regulations and other regulatory requirements relating to the manufacture of products. We are also subject to state laws and registration requirements covering the distribution of our products. Regulatory agencies may change existing requirements or adopt new requirements or policies. We may be slow to adapt or may not be able to adapt to these changes or new requirements.

 

We rely on insurance companies to mitigate our exposure for business activities, including developing and marketing pharmaceutical products for human use.

 

The conduct of our business, including the testing, marketing and sale of pharmaceutical products, involves the risk of liability claims by consumers stockholders and other third parties. Although we maintain various types of insurance, including product liability and director and officer liability, claims can be high and our insurance may not sufficiently cover our actual liabilities. If liability claims were made against us, it is possible that our insurance carriers may deny, or attempt to deny, coverage in certain instances. If a lawsuit against us 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 and the imposition of higher insurance requirements could impose additional costs on us. Additionally, we are potentially at risk if our insurance carriers become insolvent. Although we have historically obtained coverage through well rated and capitalized firms, the ongoing financial crisis may affect our ability to obtain coverage under existing policies or purchase insurance under new policies at reasonable rates.

 

Risks Related to Reliance on Third Parties

 

Because we depend on clinical research centers and other contractors for clinical testing and for certain research and development activities, the results of our clinical trials and such research activities are, to a certain extent, beyond our control.

 

The nature of clinical trials and our business strategy of outsourcing a substantial portion of our research require that we rely on clinical research centers and other contractors to assist us with research and development, clinical testing activities, patient enrollment and regulatory submissions to the FDA. As a result, our success depends partially on the success of these third parties in performing their responsibilities. Although we pre-qualify our contractors and we believe that they are fully capable of performing their contractual obligations, we cannot directly control the adequacy and timeliness of the resources and expertise that they apply to these activities. Additionally, the current global economic slowdown may affect our development partners and vendors, which could adversely affect their ability to timely perform their tasks. If our contractors do not perform their obligations in an

adequate and timely manner, the pace of clinical development, regulatory approval and commercialization of our drug candidates could be significantly delayed and our prospects could be adversely affected.

 

We depend on third parties to manufacture, package and distribute compounds for our drugs and drug candidates. The failure of these third parties to perform successfully could harm our business.

 

We have utilized, and intend to continue utilizing, third parties to manufacture, package and distribute Zenvia and the Active Pharmaceutical Ingredient (“API”) for docosanol 10% cream and to provide clinical supplies of our drug candidates. We have no experience in manufacturing and do not have any manufacturing facilities. Currently, we have sole suppliers for the API for docosanol and Zenvia, and a sole manufacturer for the finished form of Zenvia. In addition, these materials are custom and available from only a limited number of sources. Any material disruption in manufacturing could cause a delay in shipments and possible loss of sales. We do not have any long-term agreements in place with our current docosanol supplier or Zenvia supplier. If we are required to change manufacturers, we may experience delays associated with finding an alternate manufacturer that is properly qualified to produce supplies of our products and product candidates in accordance with FDA requirements and our specifications. Any delays or difficulties in obtaining APIs or in manufacturing, packaging or distributing Zenvia could delay our clinical trials of this product candidate for DPN pain. The third parties we rely on for manufacturing and packaging are also subject to regulatory review, and any regulatory compliance problems with these third parties could significantly delay or disrupt our commercialization activities. Additionally, the ongoing economic crisis creates risk for us if any of these third parties suffer liquidity or operational problems. If a key third party vendor becomes insolvent or is forced to lay off workers assisting with our projects, our results and development timing could suffer.

 

We generally do not control the development of compounds licensed to third parties and, as a result, we may not realize a significant portion of the potential value of any such license arrangements.

 

Under our typical license arrangement, we have no direct control over the development of drug candidates and have only limited, if any, input on the direction of development efforts. These development efforts are made by our licensing partner and if the results of their development efforts are negative or inconclusive, it is possible that our licensing partner could elect to defer or abandon further development of these programs. We similarly rely on licensing partners to obtain regulatory approval for docosanol in foreign jurisdictions. Because much of the potential value of these license arrangements is contingent upon the successful development and commercialization of the licensed technology, the ultimate value of these licenses will depend on the efforts of licensing partners. If our licensing partners do not succeed in developing the licensed technology for whatever reason, or elect to discontinue the development of these programs, we may be unable to realize the potential value of these arrangements. If we were to license Zenvia to a third party or a development partner, it is likely that much of the long-term success of that drug will similarly depend on the efforts of the licensee.

 

We expect to rely entirely on third parties for international registration, sales and marketing efforts.

 

In the event that we attempt to enter into international markets, we expect to rely on collaborative partners to obtain regulatory approvals and to market and sell our product(s) in those markets. We have not yet entered into any collaborative arrangement with respect to marketing or selling Zenvia, with the exception of one such agreement relating to Israel. We may be unable to enter into any other arrangements on terms favorable to us, or at all, and even if we are able to enter into sales and marketing arrangements with collaborative partners, we cannot assure you that their sales and marketing efforts will be successful. If we are unable to enter into favorable collaborative arrangements with respect to marketing or selling Zenvia in international markets, or if our collaborators’ efforts are unsuccessful, our ability to generate revenues from international product sales will suffer.

Risks Relating to Our Stock

 

Our stock price has historically been volatile and we expect that this volatility will continue for the foreseeable future.

 

The market price of our common stock has been, and is likely to continue to be, highly volatile. This volatility can be attributed to many factors independent of our operating results, including the following:

 

 

If a substantial number of shares is sold into the market at any given time, particularly following any significant announcements or large swings in our stock price (whether sales are through the financing facility with Cantor Fitzgerald & Co. or from an existing stockholder), there may not be sufficient demand in the market to purchase the shares without a decline in the market price for our common stock. Moreover, continuous sales into the market of a number of shares in excess of the typical trading volume for our common stock, or even the availability of such a large number of shares, could depress the trading market for our common stock over an extended period of time.

 

Additionally, our stock price has been volatile as a result of announcements of regulatory actions and decisions relating to our product candidates, including Zenvia, and periodic variations in our operating results. We expect that our operating results will continue to vary from quarter-to-quarter. Our operating results and prospects may also vary depending on the status of our partnering arrangements.

 

As a result of these factors, we expect that our stock price may continue to be volatile and investors may be unable to sell their shares at a price equal to, or above, the price paid. Additionally, any significant drops in our stock price, such as the one we experienced following the announcement of the Zenvia approvable letter, could give rise to stockholder lawsuits, which are costly and time consuming to defend against and which may adversely affect our ability to raise capital while the suits are pending, even if the suits are ultimately resolved in favor of the Company. We have, from time to time, been a party to such suits and although none have been material to date, there can be no assurance that any such suit will not have an adverse effect on the Company.

 

 

None.

 

 

Our headquarters and commercial and administrative offices are located in Aliso Viejo, California, where we currently occupy 11,319 square feet. The Aliso Viejo office lease expires in June 2011. We lease approximately 30,370 square feet in two buildings in San Diego. The terms of the leases for the San Diego facilities end in January 2013. The San Diego buildings are sublet through January 2013.

 

 

In the ordinary course of business, we may face various claims brought by third parties and we may, from time to time, make claims or take legal actions to assert our rights, including intellectual property rights as well as claims relating to employment matters and the safety or efficacy of our products. Any of these claims could subject us to costly litigation and, while we generally believe that we have adequate insurance to cover many different types of

liabilities, our insurance carriers may deny coverage, may be inadequately capitalized to pay on valid claims, or our policy limits may be inadequate to fully satisfy any damage awards or settlements. If this were to happen, the payment of any such awards could have a material adverse effect on our consolidated operations, cash flows and financial position. Additionally, any such claims, whether or not successful, could damage our reputation and business. Management believes the outcome of currently pending claims or lawsuits will not likely have a material effect on our operations or financial position.

 

 

There were no matters submitted to a vote of our security holders during the fourth quarter of fiscal 2009.

 

 

The following table sets forth the high and low closing sales prices for our common stock in each of the quarters over the past two fiscal years, as quoted on the NASDAQ Global Market.

 

 

On November 18, 2009, the closing sales price of our Common Stock was $1.84 per share.

 

As of November 13, 2009, we had approximately 23,023 stockholders, including 366 holders of record and an estimated 22,657 beneficial owners. We have not paid any dividends on our common stock since our inception and do not expect to pay dividends on our common stock in the foreseeable future.

 

Information About Our Equity Compensation Plans

 

Information regarding our equity compensation plans is incorporated by reference in Item 12 of Part III of this annual report on Form 10-K.

 

 

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.

 

 

This Annual Report on Form 10-K contains forward-looking statements concerning future events and performance of the Company. When used in this report, the words “intend,” “estimate,” “anticipate,” “believe,” “plan” or “expect” and similar expressions are included to identify forward-looking statements. These forward-looking statements are based on our current expectations and assumptions and many factors could cause our actual results to differ materially from those indicated in these forward-looking statements. You should review carefully the factors identified in this report in Item 1A, “Risk Factors”. We disclaim any intent to update or announce revisions to any forward-looking statements to reflect actual events or developments. Except as otherwise indicated herein, all dates referred to in this report represent periods or dates fixed with reference to the calendar year, rather than our fiscal year ending September 30.

 

In August 2007, we sold our FazaClo business and related support operations to Azur Pharma, Inc. We have reflected the financial results of this business as discontinued operations in the consolidated statements of

operations for the year ended September 30, 2008. Unless otherwise noted, this Management’s Discussion and Analysis of Financial Condition and Results of Operations relates only to financial results from continuing operations.

 

Executive Overview

 

We are a pharmaceutical company focused on acquiring, developing and commercializing novel therapeutic products for the treatment of central nervous system disorders. Our lead product candidate, Zenvia^tm (dextromethorphan hydrobromide/quinidine sulfate), has successfully completed three Phase III clinical trials for the treatment of pseudobulbar affect (“PBA”) and has successfully completed a Phase III trial for the treatment of patients with diabetic peripheral neuropathic pain (“DPN pain”). In addition to our focus on products for the central nervous system, we also have a number of partnered programs in other therapeutic areas which may generate future income for the Company. Our first commercialized product, docosanol 10% cream, (sold in the United States and Canada as Abreva^® by our marketing partner GlaxoSmithKline Consumer Healthcare) is the only over-the-counter treatment for cold sores that has been approved by the U.S. Food and Drug Administration (“FDA”). In 2008, we licensed all of our monoclonal antibodies and we remain eligible to receive milestone payments and royalties related to the sale of these assets. Avanir was incorporated in California in August 1988 and was reincorporated in Delaware in March 2009.

 

The following is a summary of significant accomplishments in fiscal 2009 and subsequent to the end of fiscal 2009 through the date of this filing that have materially affected our operations, financial condition and prospects:

 

 

We have historically sought to maintain flexibility in our cost structure by actively managing several outsourced functions, such as clinical trials, legal counsel, documentation and testing of internal controls, pre-clinical development work, and manufacturing, warehousing and distribution services, rather than maintaining all of these functions in house. We believe that at this stage of our development the benefits of outsourcing, which include flexibility and rapid response to program delays or successes, far outweigh the higher costs often associated with outsourcing.

 

Our principal focus is currently on gaining regulatory approval for Zenvia for the PBA indication. We believe that cash and cash equivalents and restricted investments of approximately $32.0 million at September 30, 2009 will be sufficient to fund our operations for at least the next twelve months and through the date by which we expect that the FDA will render an approval decision with respect to Zenvia for PBA. For additional information about the risks and uncertainties that may affect our business and prospects, please see Item 1A, “Risk Factors.”

 

Critical Accounting Policies and Estimates for Continuing Operations

 

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make a number of assumptions and estimates that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported periods. Significant estimates and assumptions are required in the determination of revenue recognition in certain royalties. Significant estimates and assumptions are also required in the appropriateness of amounts recognized for inventories, income taxes, contingencies, estimates on the net working capital adjustment and stock-based compensation. We base our estimates on historical experience and various other assumptions that are available at that time and that we believe to be reasonable under the circumstances. Some of these judgments can be subjective and complex. For any given individual estimate or assumption made by us, there may also be other estimates or assumptions that are reasonable. These items are monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate.

 

Share-Based Compensation

 

We grant options, restricted stock units and restricted stock awards to purchase our common stock to our employees, directors and consultants under our stock option plans. The benefits provided under these plans are share-based payments that we account for using the fair value method.

 

The fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option pricing model (“Black-Scholes model”) that uses assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. Expected volatilities are based on historical volatility of our common stock and other factors. The expected terms of options granted are based on analyses of historical employee termination rates and option exercises. The risk-free interest rates are based on the U.S. Treasury yield in effect at the time of the grant. Since we do not expect to pay dividends on our common stock in the foreseeable future, we estimated the dividend yield to be 0%.

 

If factors change and we employ different assumptions in calculating the fair value in future periods, the compensation expense that we record may differ significantly from what we have recorded in the current period. There is a high degree of subjectivity involved when using option pricing models to estimate share-based compensation. Because changes in the subjective input assumptions can materially affect our estimates of fair values of our share-based compensation, in our opinion, existing valuation models, including the Black-Scholes and lattice binomial models, may not provide reliable measures of the fair values of our share-based compensation. Consequently, there is a risk that our estimates of the fair values of our share-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, early termination or

forfeiture of those share-based payments in the future. Certain share-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. For awards with a longer vesting period, such as the three-year cliff vesting awards issued to certain officers, the actual forfeiture rate and related expense may not be known for a longer period of time, which can result in more significant accounting adjustments once the awards are either vested or forfeited.

 

Alternatively, values may be realized from these instruments that are significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. There is no current market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values. Although the fair value of employee share-based awards is determined using an option-pricing model, the value derived from that model may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

 

The application of the fair value method of accounting for share-based compensation may be subject to further interpretation and refinement over time. There are significant differences among valuation models, and there is a possibility that we will adopt different valuation models in the future. This may result in a lack of consistency in future periods and materially affect the fair value estimate of share-based payments. It may also result in a lack of comparability with other companies that use different models, methods and assumptions.

 

Theoretical valuation models and market-based methods are evolving and may result in lower or higher fair value estimates for share-based compensation. The timing, readiness, adoption, general acceptance, reliability and testing of these methods is uncertain. Sophisticated mathematical models may require voluminous historical information, modeling expertise, financial analyses, correlation analyses, integrated software and databases, consulting fees, customization and testing for adequacy of internal controls. Market-based methods are emerging that, if employed by us, may dilute our earnings per share and involve significant transaction fees and ongoing administrative expenses. The uncertainties and costs of these extensive valuation efforts may outweigh the benefits to investors.

 

Share-based compensation expense recognized during a period is based on the value of the portion of share-based payment awards that is ultimately expected to vest amortized under the straight-line attribution method. As share-based compensation expense recognized in the consolidated statements of operations for fiscal 2009 and 2008 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. The fair value method requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We estimate forfeitures based on our historical experience. Changes to the estimated forfeiture rate are accounted for as a cumulative effect of change in the period the change occurred. In the fourth quarter of fiscal 2009, we reviewed our estimated forfeiture rate considering recent actual data resulting in a reduction to our estimated forfeiture rate from 30.0% to 12.6%. Additionally, we reduced our estimated forfeiture rate on certain restricted stock unit awards from 30.0% to zero percent, as we expect all the awards to vest. These changes in the estimated forfeiture rates resulted in an increase in share-based compensation expense of $935,000 and an increase to the diluted loss per share of $0.01 for fiscal 2009.

 

Revenue Recognition

 

General.  We recognize revenue when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) our price to the buyer is fixed and determinable; and (4) collectability is reasonably assured.

 

Certain product sales are subject to rights of return. For products sold where the buyer has the right to return the product, we recognize revenue at the time of sale only if (1) our price to the buyer is fixed and determinable; (2) the buyer has paid us, or the buyer is obligated to pay us and the obligation is not contingent on the resale of the product; (3) the buyer’s obligation to us would not be changed in the event of theft or physical destruction or damage of the product; (4) the buyer has economic substance apart form that provided by us; (5) we do not have significant obligations for future performance to directly bring about resale of the product by the buyer; and (6) the amount of future returns can be reasonably estimated.

Revenue Arrangements with Multiple Deliverables.  We have revenue arrangements whereby we deliver to the customer multiple products and/or services. Such arrangements have generally included some combination of the following: antibody generation services; licensed rights to technology, patented products, compounds, data and other intellectual property; and research and development services. We analyze our multiple element arrangements to determine whether the elements can be separated. We perform our analysis at the inception of the arrangement and as each product or service is delivered. If a product or service is not separable, the combined deliverables will be accounted for as a single unit of accounting.

 

A delivered product or service (or group of delivered products or services) can be separated from other elements when it meets all of the following criteria: (1) the delivered item has value to the customer on a standalone basis; (2) there is objective and reliable evidence of the fair value of the undelivered item; and (3) if the arrangement includes a general right of return relative to the delivered item, delivery, or performance of the undelivered item is considered probable and substantially in our control. If an element can be separated, we allocate revenue based upon the relative fair values of each element. We determine the fair value of a separate deliverable using the price we charge other customers when we sell that product or service separately; however if we do not sell the product or service separately, we use third-party evidence of fair value. We consider licensed rights or technology to have standalone value to our customers if we or others have sold such rights or technology separately or our customers can sell such rights or technology separately without the need for our continuing involvement.

 

License Arrangements.  License arrangements may consist of non-refundable upfront license fees, data transfer fees, or research reimbursement payments and/or exclusive licensed rights to patented or patent pending compounds, technology access fees, various performance or sales milestones and future product royalty payments. Some of these arrangements are multiple element arrangements.

 

Non-refundable, up-front fees that are not contingent on any future performance by us, and require no consequential continuing involvement on our part, are recognized as revenue when the license term commences and the licensed data, technology and/or compound is delivered. Such deliverables may include physical quantities of compounds, design of the compounds and structure-activity relationships, the conceptual framework and mechanism of action, and rights to the patents or patents pending for such compounds. We defer recognition of non-refundable upfront fees if we have continuing performance obligations without which the technology, right, product or service conveyed in conjunction with the non-refundable fee has no utility to the licensee that is separate and independent of our performance under the other elements of the arrangement. In addition, if we have continuing involvement through research and development services that are required because our know-how and expertise related to the technology is proprietary to us, or can only be performed by us, then such up-front fees are deferred and recognized over the period of continuing involvement.

 

Payments related to substantive, performance-based milestones in a research and development arrangement are recognized as revenue upon the achievement of the milestones as specified in the underlying agreements when they represent the culmination of the earnings process.

 

Royalty Revenues.  We recognize royalty revenues from licensed products when earned in accordance with the terms of the license agreements. Net sales figures used for calculating royalties include deductions for returned product, pricing allowances, managed care charge backs, cash discounts, freight/warehousing, and miscellaneous write-offs.

 

Certain royalty agreements require that royalties are earned only if a sales threshold is exceeded. Under these types of arrangements, the threshold is typically based on annual sales. The company recognizes royalty revenue in the period in which the threshold is exceeded.

 

Revenues from Sale of Royalty Rights.  When we sell our rights to future royalties under license agreements and also maintain continuing involvement in earning such royalties, we defer recognition of any upfront payments and recognize them as revenue over the life of the license agreement. We recognize revenue for the sale of an undivided interest of our Abreva license agreement to Drug Royalty USA under the “units-of-revenue method.” Under this method, the amount of deferred revenue to be recognized as revenue in each period is calculated by multiplying the following: (1) the ratio of the royalty payments due to Drug Royalty USA for the period to the total

remaining royalties that we expect GSK will pay Drug Royalty USA over the term of the agreement by (2) the unamortized deferred revenue amount.

 

Research Services Arrangements.  Revenue from research services is recognized during the period in which the services are performed and is based upon the number of full-time-equivalent personnel working on the specific project at the agreed-upon rate. Reimbursements from collaborative partners for agreed upon direct costs including direct materials and outsourced, or subcontracted, pre-clinical studies are classified as revenue and recognized in the period the reimbursable expenses are incurred. Payments received in advance are recorded as deferred revenue until the research and development services are performed or costs are incurred. These arrangements are often multiple element arrangements.

 

Government Research Grant Revenue.  We recognize revenues from federal research grants during the period in which the related expenditures are incurred.

 

Product Sales — Active Pharmaceutical Ingredient Docosanol (“API Docosanol”).  Revenue from sales of our API Docosanol is recorded when title and risk of loss have passed to the buyer and provided the criteria for revenue recognition are met. We sell the API Docosanol to various licensees upon receipt of a written order for the materials. Shipments generally occur fewer than three times a year. Our contracts for sales of the API Docosanol include buyer acceptance provisions that give our buyers the right of replacement if the delivered product does not meet specified criteria. That right requires that they give us notice within 30 days after receipt of the product.

 

We have the option to refund or replace any such defective materials; however, we have historically demonstrated that the materials shipped from the same pre-inspected lot have consistently met the specified criteria and no buyer has rejected any of our shipments from the same pre-inspected lot to date. Therefore, we recognize revenue at the time of delivery without providing any returns reserve.

 

Cost of Revenues

 

Cost of revenues includes direct and indirect costs to manufacture product sold, including the write-off of obsolete inventory, reserves against inventory and to provide research and development services.

 

Recognition of Expenses in Outsourced Contracts

 

Pursuant to management’s assessment of the services that have been performed on clinical trials and other contracts, we recognize expenses as the services are provided. Such management assessments include, but are not limited to: (1) an evaluation by the project manager of the work that has been completed during the period, (2) measurement of progress prepared internally and/or provided by the third-party service provider, (3) analyses of data that justify the progress, and (4) management’s judgment. Several of our contracts extend across multiple reporting periods, including our largest contract, representing a $7.1 million Phase III clinical trial contract that was entered into in the first fiscal quarter of fiscal 2008. Management bases its assessments on estimates that it considers reasonable in the circumstances. Other estimates could result in different assessments and different expense recognition.

 

Research and Development Expenses

 

Research and development expenses consist of expenses incurred in performing research and development activities including salaries and benefits, facilities and other overhead expenses, clinical trials, contract services and other outside expenses. Research and development expenses are charged to operations as they are incurred. Up-front payments to collaborators made in exchange for the avoidance of potential future milestone and royalty payments on licensed technology are also charged to research and development expense when the drug is still in the development stage, has not been approved by the FDA for commercialization and concurrently has no alternative uses.

We assess our obligations to make milestone payments that may become due under licensed or acquired technology to determine whether the payments should be expensed or capitalized. We charge milestone payments to research and development expense when:

 

 

Acquired contractual rights.  Payments to acquire contractual rights to a licensed technology or drug candidate are expensed as incurred when there is uncertainty in receiving future economic benefits from the acquired contractual rights. We consider the future economic benefits from the acquired contractual rights to a drug candidate to be uncertain until such drug candidate is approved by the FDA or when other significant risk factors are abated.

 

Effects of Inflation

 

We believe the impact of inflation and changing prices on net revenues and on operations has been minimal during the past two years.

 

Results of Operations

 

We operate our business on the basis of a single reportable segment, which is the business of development, acquisition and commercialization of novel therapeutics for chronic diseases. Our chief operating decision-maker is the Chief Executive Officer, who evaluates our company as a single operating segment.

 

We categorize revenues by type of revenue in five different categories: 1) royalties and royalty rights, 2) licensing, 3) government research grant services, 4) research and development services and 5) product sales.

 

All long-lived assets for fiscal 2009 and 2008 are located in the United States.

Comparison of Fiscal 2009 and 2008

 

Revenues and Cost of Revenues

 

 

Revenues

 

For the fiscal year ended September 30, 2009, we generated no product revenues. In fiscal 2008, we received net product revenues of $130,000. Product revenues for that period were generated from the sale of the active pharmaceutical ingredient docosanol.

 

Revenues from research services and other were $4.2 million for the fiscal year ended September 30, 2009 compared to $6.8 million for the fiscal year ended September 30, 2008. The decrease in revenues is attributed to a one-time milestone payment received from HBI of $1.5 million in fiscal 2008 that was not repeated in 2009 and a decline in grant revenue received from the NIH grant of $1.0 million due to the termination of the anthrax antibody program which ended in 2008, and accordingly, there are no comparable revenues in fiscal 2009.

 

Potential revenue-generating contracts that remained active as of September 30, 2009 include licensing revenue from our agreement with GSK, potential royalties from our agreements with Azur Pharma and Emergent Biosolutions, Inc. and modest revenue generated from various other licensing agreements. Partnering, licensing and research collaborations have been, and may continue to be, an important part of our business development strategy. We may continue to seek partnerships with pharmaceutical companies that can help fund our operations in exchange for sharing in the success of any licensed compounds or technologies. See Note 13 “Research, License, Supply and other Agreements” and Note 16 “Segment Information” in Notes to Consolidated Financial Statements.

 

Cost of Revenues

 

In fiscal 2009, cost of product revenues was $73,000 compared to $22,000 in fiscal 2008. Cost of product revenues in fiscal 2009 was primarily attributed to an inventory reserve amount of $69,000 established for docosanol.

Cost of research services and grants was $10,000 for the fiscal year ended September 30, 2009 compared to $1.2 million for the fiscal year ended September 30, 2008. The decline in cost of revenues is primarily attributable to the completion of the remaining work under the NIH grant and the termination of all future research and development work related to other infectious diseases in June 2008.

 

 

Research and Development Expenses

 

Research and development expenses increased by approximately $1.8 million or 12% for the fiscal year ended September 30, 2009 compared to the fiscal year ended September 30, 2008. The increase is primarily due to costs incurred for the confirmatory Phase III trial for the PBA indication of Zenvia. Following the completion of the STAR trial, we expect these expenses to decrease in fiscal 2010.

 

General and Administrative Expenses

 

General and administrative expenses decreased by approximately $448,000 or 4% for the fiscal year ended September 30, 2009, compared to the fiscal year ended September 30, 2008. The decrease is primarily attributed to a decrease in our overall general and administrative expenses as a result of the restructuring and the significant organizational changes that we made to our infrastructure. In addition, our general and administrative costs have decreased as a result of our focused efforts to contain costs and negotiate discounts with our principal vendors.

 

Share-Based Compensation

 

The Company re-examines forfeiture rates as they apply to stock-based compensation on an annual basis. We estimate forfeitures based on our historical experience. Changes to the estimated forfeiture rate are accounted for as a cumulative effect of change in the period the change occurred. In the fourth quarter of fiscal 2009, we reviewed our estimated forfeiture rate considering recent actual data resulting in a reduction to our estimated forfeiture rate from 30.0% to 12.6%. Additionally, we reduced our estimated forfeiture rate on certain restricted stock unit awards from 30.0% to zero percent, as we expect all the awards to vest. These changes in the estimated forfeiture rates resulted in an increase in share-based compensation expense of approximately $935,000 and an increase to the diluted loss per share of $0.01 for fiscal 2009. Future estimates may differ substantially from the Company’s current estimates.

 

Total compensation expense for our share-based payments in the fiscal year ended September 30, 2009 and 2008 was approximately $2.9 million and $1.6 million (excluding $14,000 included in discontinued operations), respectively. General and administrative expense in the fiscal years ended September 30, 2009 and 2008 includes share-based compensation expense of approximately $2.2 million and $1.1 million, respectively. Research and development expense in the fiscal years ended September 30, 2009 and 2008 includes share-based compensation expense of approximately $664,000 and $491,000, respectively. As of September 30, 2009, approximately $3.0 million of total unrecognized compensation costs related to unvested awards is expected to be recognized over a weighted average period of 2.4 years. See Note 12, “Stockholders’ Equity — Employee Equity Incentive Plans” in the Notes to Consolidated Financial Statements for further discussion.

 

Interest Expense and Interest Income

 

For the fiscal year ended September 30, 2009, interest expense was $517, compared to approximately $541,000 for the prior fiscal year. The decrease in interest expense in 2009 is primarily due to a decrease in the balance on notes payable as compared to the prior year, mostly attributed to the accelerated repayment of the remaining outstanding principal in June 2008. The notes payable were issued in connection with the purchase of Alamo Pharmaceuticals, Inc.

For the fiscal year ended September 30, 2009, interest income was approximately $204,000, compared to approximately $1.3 million for the prior fiscal year. The decrease is due to an 18% decrease in the average cash balance of our investment accounts in fiscal 2009 as compared to the prior fiscal year, coupled with a lower investment yield in fiscal 2009.

 

Other, net

 

Other, net expense was approximately $272,000 in fiscal 2009 compared to income of approximately $1.2 million in fiscal 2008. In fiscal 2009, the company recognized a loss on disposal of fixed assets of approximately $268,000. In fiscal 2008, the Company received approximately $1.25 million in proceeds resulting from a settlement agreement with a former employee. The proceeds represented court awarded reimbursement of attorney’s fees incurred in connection with the Company’s defense. The proceeds were recorded as other income in the third fiscal quarter of 2008.

 

Loss from Discontinued Operations

 

There was no loss from discontinued operations for the fiscal year ended September 30, 2009. For the fiscal year ended September 30, 2008, approximately a $1.6 million loss from discontinued operations was recorded as a result of the final net working capital adjustment of approximately $1.4 million under our FazaClo asset purchase agreement with Azur, as well as additional trailing costs related to the operations of FazaClo.

 

Net Loss

 

Net loss was approximately $22.0 million, or $0.28 per share, for the fiscal year ended September 30, 2009, compared to a net loss of approximately $17.5 million, or $0.30 per share for the fiscal year ended September 30, 2008. The increase in net loss is primarily attributed to the following: 1) non-cash expenses of approximately $1.9 million related to share-based compensation expense and other non-cash expenses, 2) increased spending in research and development 3) the presence of two non-recurring revenue sources in 2008 totaling $2.5 million. In addition, in fiscal 2008, we recorded a gain on early extinguishment of debt and other income which together totaled approximately $2.2 million.

 

Liquidity and Capital Resources

 

We assess our liquidity based on our ability to generate cash to fund future operations. Key factors in the management of our liquidity are: cash required to fund operating activities including expected operating losses and the levels of inventories, accounts payable and capital expenditures; the timing and extent of cash received from milestone payments under license agreements; adequate credit facilities; and financial flexibility to attract long-term equity capital on favorable terms. Historically, cash required to fund on-going business operations has been provided by financing activities and used to fund operations, working capital requirements and investing activities.

 

Cash, cash equivalents and restricted investments, as well as, net cash provided by or used in operating, investing and financing activities, are summarized in the table below.

 

 

 

Operating activities.  Net cash used in operating activities was approximately $20.3 million in fiscal year 2009 compared to approximately $16.7 million in fiscal year 2008. The increase is primarily due to expenses related to the confirmatory Phase III trial and additional pre-clinical and clinical studies in support of the response to the approvable letter.

 

Investing activities.  Net cash provided by investing activities was approximately $357,000 in fiscal year 2009, compared to approximately $1.0 million in fiscal year 2008. In fiscal year 2009, cash provided by investing activities arose primarily from sales and maturities of investments. In fiscal year 2008, proceeds from sales and maturities of investments of approximately $2.3 million were partially offset by payments of approximately $1.4 million related to the net working capital adjustment from our sale of FazaClo.

 

Financing activities.  Net cash provided by financing activities was approximately $10.0 million in fiscal year 2009 compared to approximately $26.5 million in fiscal year 2008. In fiscal 2009, we raised approximately $10.8 million in gross proceeds (approximately $10.2 million net of offering costs and commissions) from an open market offering. In fiscal 2008, we raised gross proceeds of approximately $40.0 million from sales of our common stock through a registered common stock offering in April 2008 (approximately $38.0 million net of offering costs and commissions), offset by $11.3 million to reduce long-term debt.

 

In April 2009, we filed a shelf registration statement on Form S-3 with the SEC to sell an aggregate of up to $35.0 million in common stock, preferred stock, debt securities and warrants. On May 6, 2009, the registration statement was declared effective. On July 30, 2009 we entered into a financing facility with Cantor Fitzgerald & Co., providing for the sale of up to 12,500,000 shares of our common stock from time to time into the open market at prevailing prices. As of November 1, 2009, 4.7 million shares of common stock had been sold for total gross proceeds of $11.0 million through this facility under our registration statement. We may or may not sell additional shares under this facility, depending on the volume and price of our common stock, as well as our capital needs and potential alternative sources of capital, such as a development partner for Zenvia.

 

In September 2009, we filed a shelf registration statement on Form S-3 with the SEC to sell an aggregate of up to $75.0 million in common stock, preferred stock, debt securities and warrants. On September 23, 2009, the registration statement was declared effective. No offerings have been made pursuant to this registration statement to date.

 

As of September 30, 2009, we have contractual obligations for long-term debt and operating lease obligations, as summarized in the table that follows. We have no off-balance sheet arrangements.

 

 

 

 

In connection with the Alamo acquisition, we agreed to pay up to an additional $39,450,000 in revenue-based earn-out payments, based on future sales of FazaClo. These earn-out payments are based on FazaClo sales in the U.S. from the closing date of the acquisition through December 31, 2018 (the “Contingent Payment Period”). As previously discussed in this filing, we sold the FazaClo product line to Azur in August 2007. Our future earn-out obligations that would have been payable to the prior owner of Alamo Pharmaceuticals upon the achievement of certain milestones were assumed by Azur, although we may remain liable for these payments if Azur defaults on these obligations.

 

Zenvia License Milestone Payments.  We hold the exclusive worldwide marketing rights to Zenvia for certain indications pursuant to an exclusive royalty-bearing license agreement with the Center for Neurologic Study (“CNS”). We will be obligated to pay CNS up to $400,000 in the aggregate in milestones to continue to develop Zenvia for both PBA and DPN pain, assuming they are both approved for marketing by the FDA. We are not currently developing, nor do we have an obligation to develop, any other indications under the CNS license agreement. The Company will pay a $75,000 milestone if the FDA approves Zenvia for the treatment of PBA. In addition, the Company is obligated to pay CNS a royalty on commercial sales of Zenvia with respect to each indication, if the drug is approved by the FDA for commercialization. Under certain circumstances, the Company may have the obligation to pay CNS a portion of net revenues received if it sublicenses Zenvia to a third party. Under the agreement with CNS, the Company is required to make payments on achievements of up to a maximum of ten milestones, based upon five specific clinical indications. Maximum payments for these milestone payments could total approximately $2.1 million if the Company pursued the development of Zenvia for all of the licensed indications. Of the clinical indications that the Company currently plans to pursue, expected milestone payments could total $800,000. In general, individual milestones range from $150,000 to $250,000 for each accepted new drug application (“NDA”) and a similar amount for each approved NDA. In addition the Company is obligated to pay CNS a royalty ranging from approximately 5% to 8% of net revenues.

 

Management Outlook

 

We believe that cash, cash equivalents and restricted investments of approximately $32.0 million at September 30, 2009 will be sufficient to sustain our planned level of operations for at least the next twelve months and through the anticipated FDA approval decision for Zenvia for PBA. However, we cannot provide assurances that our plans will not change, or that changed circumstances or delays in clinical development will not result in the depletion of capital resources more rapidly than anticipated.

 

For information regarding the risks associated with our need to raise capital to fund our ongoing and planned operations, please see Item 1A, “Risk Factors.”

 

Recent Authoritative Guidance

 

See Note 2, “Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements for a discussion of recently issued authoritative guidance and its effect, if any, on the Company.

 

 

As described below, we are exposed to market risks related to changes in interest rates. Because substantially all of our revenue, expenses, 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 if we expand international distribution of docosanol 10% cream and purchase additional services from outside the U.S. 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 exposure as the needs and risks should arise.

 

Interest Rate Sensitivity

 

Our investment portfolio consists primarily of cash equivalent fixed income instruments invested in government money market funds. The primary objective of our investments in these securities is to preserve principal. We classify our restricted investments, which are primarily certificates of deposit, as of September 30, 2009 as

held-to-maturity. These held-to-maturity securities are subject to interest rate risk. Based on the average duration of our investments as of September 30, 2009 and 2008, an increase of one percentage point in the interest rates would have resulted in increases in interest income of approximately $343,000 and $409,000, respectively.

 

As of September 30, 2009, $31.1 million of our cash and cash equivalents were maintained in six separate money market mutual funds, and approximately $379,000 of our cash and cash equivalents were maintained at two major financial institutions in the United States. At times, deposits held with the financial institution may exceed the amount of insurance provided on such deposits, and at September 30, 2009, such uninsured deposits totaled $31.1 million. Generally, these deposits may be redeemed upon demand and, therefore, bear minimal risk. Effective October 3, 2008, the Emergency Economic Stabilization Act of 2008 raised the Federal Deposit Insurance Corporation deposit coverage limits to $250,000 per owner from $100,000 per owner. This program is currently available through December 31, 2009.

 

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and cash. Our cash and cash equivalents are placed at various money market mutual funds and financial institutions of high credit standing.

 

We perform ongoing credit evaluations of our customers’ financial conditions and would limit the amount of credit extended if deemed necessary but usually we have required no collateral.

 

 

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

 

 

None.

 

 

Evaluation of Disclosure Controls and Procedures

 

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Vice President, Finance, of the effectiveness of our “disclosure controls and procedures” as of the end of the period covered by this report, pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended.

 

In connection with that evaluation, our CEO and Vice President, Finance concluded that our disclosure controls and procedures were effective and designed to provide reasonable assurance that the information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms as of September 30, 2009. For the purpose of this review, disclosure controls and procedures means controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that we file or submit is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that we file or submit is accumulated and communicated to management, including our principal executive officer, principal financial officer and principal accounting officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

Management’s Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we

conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and related COSO guidance. Based on our evaluation under this framework, our management concluded that our internal control over financial reporting was effective as of September 30, 2009.

 

This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

 

Changes in Internal Control over Financial Reporting

 

There has been no change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the Company’s fourth fiscal quarter ended September 30, 2009, that has materially affected, or is reasonably likely to materially affect the Company’s internal control over financial reporting.

 

 

None.

 

 

The information relating to our directors that is required by this item is incorporated by reference from the information under the captions “Election of Directors,” “Corporate Governance,” and “Board of Directors and Committees” contained in our definitive proxy statement (the “Proxy Statement”), which will be filed with the Securities and Exchange Commission in connection with our 2010 Annual Meeting of Stockholders.

 

Additionally, information relating to reporting of insider transactions in Company securities is incorporated by reference from the information under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement.

 

Executive Officers and Key Employees of the Registrant

 

The names of our executive officers and key employees and their ages as of November 1, 2009 are set forth below. Officers are elected annually by the Board of Directors and hold office until their respective successors are qualified and appointed or until their resignation, removal or disqualification.

 

 

Executive Officers

 

Keith Katkin.  Mr. Katkin joined Avanir in July of 2005 as Senior Vice President of Sales and Marketing. In March 2007, Mr. Katkin was appointed President and Chief Executive Officer and was elected as a member of the Board of Directors. Prior to joining Avanir, Mr. Katkin previously served as Vice President, Commercial Development for Peninsula Pharmaceuticals, playing a key role in the management and ultimate sale of the

company to Johnson & Johnson in 2005. Additionally, Mr. Katkin’s employment experience includes leadership roles at InterMune, Amgen and Abbott Laboratories. Mr. Katkin also served as strategic advisor to Cerexa, a pharmaceutical company that was sold to Forest Laboratories in 2007. Mr. Katkin received a B.S. degree in Business and Accounting from Indiana University and an M.B.A. degree in Finance from the Anderson School of Management at UCLA, graduating with honors. Mr. Katkin became a licensed Certified Public Accountant in 1995.

 

Randall E. Kaye, M.D.  Dr. Kaye joined Avanir in January 2006 as Vice President of Clinical and Medical Affairs and assumed the role of Senior Vice President Clinical Research and Medical Affairs and Chief Medical Officer in February 2007. Immediately prior to joining Avanir, from 2004 to 2006, Dr. Kaye was the Vice President of Medical Affairs for Scios Inc., a division of Johnson & Johnson. From 2002 to 2004, Dr. Kaye recruited and managed the Medical Affairs department for InterMune Inc. Previously, Dr. Kaye served for nearly a decade in a variety of Medical Affairs and Marketing positions for Pfizer Inc. Dr. Kaye earned his Doctor of Medicine, Masters in Public Health and Bachelor of Science degrees at George Washington University in Washington, D.C. and was a Research Fellow in Allergy and Immunology at Harvard Medical School.

 

Christine G. Ocampo.  Ms. Ocampo joined Avanir in March 2007 as Corporate Controller and was promoted to Vice President, Finance in February 2008. Prior to joining Avanir, Ms. Ocampo served as Senior Vice President, Chief Financial Officer, Chief Accounting Officer, Treasurer and Secretary of Cardiogenesis Corporation from November 2003 until April 2006. From 2001 to November 2003, Ms. Ocampo served in the role of Vice President and Corporate Controller at Cardiogenesis. Prior to first joining Cardiogenesis in April 1997, Ms. Ocampo held a management position in Finance at Mills-Peninsula Health Systems in Burlingame, CA, and spent three years as an auditor for Ernst & Young LLP. Ms. Ocampo graduated with a Bachelors of Science in Accounting from Seattle University and became a licensed Certified Public Accountant in 1996.

 

Key Employees

 

Eric S. Benevich.  Mr. Benevich joined Avanir Pharmaceuticals, Inc. in July 2005 as Senior Director of Marketing. In August 2007, he was promoted to Vice President of Communications. Prior to joining Avanir, Mr. Benevich previously served as the Senior Director of Marketing for Peninsula Pharmaceuticals. Prior to his tenure at Peninsula Pharmaceuticals, Mr. Benevich held several Marketing positions with Amgen Inc., a global biotechnology company. In addition, Mr. Benevich held several commercial roles at Astra Merck in Sales, Market Research and Brand Marketing. Mr. Benevich graduated from Washington State University with a degree in International Business and has completed several MBA courses at Villanova University.

 

Gregory J. Flesher.  Mr. Flesher joined Avanir Pharmaceuticals, Inc. in June 2006 as Senior Director of Commercial Strategy and in November 2006 assumed the additional responsibility for Business Development and Portfolio Planning. In August 2007 he was promoted to Vice President of Business Development. Prior to joining Avanir, he served as a Sales Director from 2004 to 2006 and as Director of Pulmonary & Infectious Disease Marketing from 2002 to 2004 at InterMune, Inc., a biopharmaceutical company. Prior to his tenure at InterMune, Mr. Flesher held Oncology and Nephrology marketing positions with Amgen Inc., a global biotechnology company. Mr. Flesher also held roles in global marketing and clinical development at Eli Lilly and Company. Mr. Flesher graduated from Purdue University with a degree in Biology and has completed his doctorate coursework in Biochemistry and Molecular Biology at Indiana University School of Medicine.

 

Code of Ethics

 

We have adopted a code of ethics for directors, officers (including our principal executive officer, principal financial officer, and principal accounting officer and controller), and employees. This code of ethics is available on our website at www.avanir.com. Any waivers from or amendments to the code of ethics will be filed with the SEC on Form 8-K. You may also request a printed copy of our Code of Ethics, without charge, by writing to us at 101 Enterprise, Suite 300, Aliso Viejo, California 92656, Attn. Investor Relations.

 

The information required by this item is incorporated by reference to the information under the captions “Executive Compensation” and “Compensation Committee Interlocks and Insider Participation” contained in the Proxy Statement.

 

 

The information required by this item is incorporated by reference to the information under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” contained in the Proxy Statement.

 

 

The information required by this item is incorporated by reference to the information under the captions “Certain Relationships and Related Party Transactions,” “Director Independence” and “Board Committees” contained in the Proxy Statement.

 

 

The information required by this item is incorporated by reference to the information under the caption “Fees for Independent Registered Public Accounting Firm” contained in the Proxy Statement.

 

 

(a) Financial Statements and Schedules

 

Financial statements for the two years ended September 30, 2009 and 2008 are attached. The index to these financial statements appears on page F-1.

 

(b) Exhibits

 

The following exhibits are incorporated by reference or filed as part of this report.

 

 

 

 

Pursuant to the requirements of Section 13 or 15(d) 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.

 

Avanir Pharmaceuticals, INC.

 

Keith A. Katkin

President and Chief Executive Officer

 

Date: November 25, 2009

 

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.

 

Avanir Pharmaceuticals, Inc.

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

To the Board of Directors and Stockholders of

Avanir Pharmaceuticals, Inc.

 

We have audited the accompanying consolidated balance sheets of Avanir Pharmaceuticals, Inc. and subsidiaries (the “Company”) as of September 30, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity and comprehensive loss, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Avanir Pharmaceuticals, Inc. and subsidiaries as of September 30, 2009 and 2008, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ KMJ Corbin & Company LLP

 

Costa Mesa, California

November 25, 2009

Avanir Pharmaceuticals, Inc.

 

CONSOLIDATED BALANCE SHEETS

 

 

See notes to consolidated financial statements.

Avanir Pharmaceuticals, Inc.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See notes to consolidated financial statements.

Avanir Pharmaceuticals, Inc.

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE LOSS