AVANIR PHARMACEUTICALS, PRE 14A, 1998-12-16

AVANIR PHARMACEUTICALS
PRE 14A, 1998-12-16
PHARMACEUTICAL PREPARATIONS

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<PAGE> 1

SCHEDULE 14A INFORMATION
(Rule 14a-101)

PROXY STATEMENT PURSUANT TO SECTION 14(A) OF
THE SECURITIES EXCHANGE ACT OF 1934 (Amendment No. )

Filed by the Registrant [X]

Filed by a Party other than the Registrant [ ]

Check the appropriate box:

[X] Preliminary Proxy Statement
[ ] Confidential, for Use of the Commission Only
(as permitted by Rule 14a-6(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to sec.240.14a-11(c) or sec.240.14a-12

AVANIR PHARMACEUTICALS
- --------------------------------------------------------------------------------
(Name of Registrant as Specified In Its Charter)

- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

Payment of Filing Fee (Check the appropriate box):

[X] No fee required.

[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.

(1) Title of each class of securities to which transaction applies:

(2) Aggregate number of securities to which transaction applies:

(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined):

(4) Proposed maximum aggregate value of transaction:

(5) Total fee paid:

[ ] Fee paid previously with preliminary materials.

[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.

(1) Amount Previously Paid:

(2) Form, Schedule or Registration Statement No.:

(3) Filing Party:

(4) Date Filed:
<PAGE> 2

AVANIR PHARMACEUTICALS
9393 TOWNE CENTRE DRIVE, SUITE 200
SAN DIEGO, CALIFORNIA 92121-3016
------------------------

NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD ON FEBRUARY 19, 1999

The Annual Meeting of Shareholders of AVANIR Pharmaceuticals will be held
at the Company's offices at 9393 Towne Centre Drive, Suite 200, San Diego,
California 92121 on February 19, 1999, at 9:00 a.m. for the following purposes:

1. To elect three (3) directors of the Company to hold office until the
2002 Annual Meeting of Shareholders.

2. To approve the 1998 Stock Option Plan of the Company pursuant to which
an aggregate 1,875,000 shares of Class A Common Stock will be reserved
for issuance.

3. To approve the grant of stock options exercisable into 25,000 shares of
Class A Common Stock to each of five directors newly elected on June 30,
1998 (for an aggregate total of 125,000 options).

4. To approve an amendment to the Company's Articles of Incorporation (the
"Articles") to reapportion the 100,000,000 authorized number of shares
of common stock to decrease the authorized number of Class A Common
Stock from 99,490,000 to 99,288,000 and to increase the authorized
number of shares of Class B Common Stock from 510,000 to 712,000.

5. To ratify the selection of Deloitte & Touche LLP as independent auditors
for the fiscal year ending September 30, 1999.

6. To transact such other business as may properly come before the meeting
or any adjournment or postponement of the meeting.

The foregoing items of business are more fully described in the Proxy
Statement accompanying this Notice.

Only shareholders of record at the close of business on December 22, 1998
will be entitled to notice of and to vote at the meeting or any adjournment
thereof. Each of these shareholders is cordially invited to be present and vote
at the meeting in person.

By Order of the Board of Directors,

/s/ Gregory P. Hanson
GREGORY P. HANSON
Secretary
San Diego, California
January , 1999

WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING, PLEASE SIGN AND DATE THE
ENCLOSED PROXY CARD AND RETURN IT PROMPTLY. THIS IS IMPORTANT BECAUSE A MAJORITY
OF THE SHARES MUST BE REPRESENTED, EITHER IN PERSON OR BY PROXY, TO CONSTITUTE A
QUORUM. IF YOU ATTEND THE MEETING, YOU MAY VOTE IN PERSON EVEN THOUGH YOU SEND
IN YOUR PROXY NOW.
<PAGE> 3

AVANIR PHARMACEUTICALS
------------------------

PROXY STATEMENT
FOR
ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD FEBRUARY 19, 1999
------------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
GENERAL INFORMATION......................................... 1
SHARES OUTSTANDING AND VOTING RIGHTS........................ 2
PROPOSAL ONE
ELECTION OF DIRECTORS..................................... 2
PROPOSAL TWO
APPROVAL OF THE 1998 STOCK OPTION PLAN.................... 6
PROPOSAL THREE
APPROVAL OF STOCK OPTIONS GRANTED TO
NEW DIRECTORS ELECTED JUNE 30, 1998....................... 11
PROPOSAL FOUR
APPROVAL OF AMENDMENT TO THE ARTICLES OF INCORPORATION.... 12
PROPOSAL FIVE
RATIFICATION OF INDEPENDENT AUDITORS...................... 14
OTHER BUSINESS.............................................. 25
ATTACHMENT A -- Text of Proposed 1998 Stock Option Plan..... A-1
</TABLE>

i
<PAGE> 4

AVANIR PHARMACEUTICALS
9393 TOWNE CENTRE DRIVE, SUITE 200
SAN DIEGO, CALIFORNIA 92121-3016

------------------------

PROXY STATEMENT FOR
ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD ON FEBRUARY 19, 1999

------------------------

GENERAL INFORMATION

Your proxy in the enclosed form is solicited by the Board of Directors (the
"Board") of AVANIR Pharmaceuticals, a California corporation (the "Company"),
for use at the annual meeting of the Company's shareholders (the "Shareholders")
to be held at the Company's offices at 9393 Towne Centre Drive, Suite 200, San
Diego, California 92121 on February 19, 1999 at 9:00 a.m. (the "Annual Meeting"
or the "1999 Annual Meeting") for the purposes set forth in the accompanying
notice and at any adjournment or postponement of the Annual Meeting. The mailing
of this Proxy Statement and the accompanying form of proxy to the Shareholders
is expected to commence on or about January 4, 1999.

The shares represented by any proxy in the enclosed form will be voted in
accordance with the instructions given on the proxy if the proxy is properly
executed and is received by the Company prior to the close of voting at the
Annual Meeting or any adjournment or postponement thereof. Proxies received by
the Company on which no contrary instruction has been given will be voted FOR
the election of directors to Class I, nominated by management to serve until the
2002 annual meeting; FOR the adoption of the 1998 Stock Option Plan (the "1998
Plan"); FOR the approval of stock option grants issued to new directors on June
30, 1998; FOR the Amendment to the Company's Articles of Incorporation (the
"Articles") to reapportion the authorized number of shares of common stock
between Class A Common Stock and Class B Common Stock; and FOR ratification of
the selection of independent auditors for the fiscal year ending September 30,
1999, and as recommended by the Board of Directors in its discretion, with
regard to all other matters which may properly come before the Annual Meeting. A
shareholder giving a proxy has the power to revoke it at any time before it is
exercised. A proxy may be revoked by filing with the Secretary of the Company an
instrument revoking it or a duly executed proxy bearing a later date. The powers
of the proxy holders will be suspended if the person executing the proxy is
present at the Annual Meeting and votes in person. In order for any Shareholder
to nominate a candidate or to submit a proposal for other business to be acted
upon at the 1999 Annual Meeting, he or she must provide the Secretary of the
Company with not less than sixty (60) days' advance written notice thereof in
the form prescribed by the Company's Bylaws.

Copies of solicitation material will be furnished to brokerage houses,
fiduciaries, and custodians holding shares in their names which are beneficially
owned by others ("record holders") to forward to such beneficial owners. In
addition, the Company may reimburse such persons for their cost of forwarding
the solicitation material to such beneficial owners. Original solicitation of
proxies by mail may be supplemented, if deemed desirable or necessary, by one or
more of telephone, telegram, facsimile, or personal solicitation by directors,
officers, or employees of the Company. No additional compensation will be paid
for any such services. The Company reserves the right, if deemed desirable or
necessary, to retain a proxy solicitation firm or other third parties to deliver
solicitation material to record holders for distribution by them to their
principals and to assist the Company in collecting or soliciting proxies from
such holders. The costs of these services, exclusive of out-of-pocket costs, is
not expected to exceed $10,000. Except as described above, the Company does not
intend to solicit proxies other than by mail.

1
<PAGE> 5

SHARES OUTSTANDING AND VOTING RIGHTS

Only holders of shares of Class A Common Stock ("Class A Shares") and Class
B Common Stock ("Class B Shares") of record as of the close of business on
December 22, 1998 are entitled to notice of and to vote at the Annual Meeting.
On the record date, there were issued and outstanding Class A Shares
and Class B Shares (collectively, the "Shares"). (There is currently a
dispute with Dr. David H. Katz, the former president and chief executive officer
and a director of the Company, as to the status of 234,000 Class A Shares. See
Footnote 4 to "Security Ownership of Certain Beneficial Owners and Management").
Each Class A Share is entitled to one vote and each Class B Share is entitled to
five votes on all matters to be voted upon at the Annual Meeting. The presence,
in person or by proxy duly authorized, of the holders of a majority of the
Shares will constitute a quorum for the transaction of business at the Annual
Meeting and any continuation or adjournment thereof. Shares that are voted "FOR"
or withheld authority for a nominee, or shares that are voted "FOR", "AGAINST",
or "ABSTAIN" on a proposal are treated as being present at the meeting for the
purposes of establishing a quorum and are also treated as shares entitled to
vote at the Annual Meeting ("Votes Cast"). Broker non-votes (i.e. shares held by
a broker or nominee which are represented at the Annual Meeting, but with
respect to which such broker or nominee is not empowered to vote on a particular
purpose) also will be counted in determining whether a quorum is present at the
Annual Meeting. Directors are elected by a plurality of votes of the Shares
present in person or represented by proxy at the Annual Meeting. Any shares not
voted (whether by abstention, broker non-votes or otherwise) will have no impact
on the election of directors, except to the extent that the failure to vote for
an individual results in another individual receiving a larger portion of votes.
The proposals to amend the Articles submitted to the Shareholders in the
enclosed proxy must be approved by the vote of a majority of the outstanding
Shares. Any shares not voted (whether by abstention, broker non-votes or
otherwise) will have the effect of a vote against the proposal. The proposals to
approve the 1998 Stock Option Plan, to approve the grant of stock options to
five directors, and to ratify the selection of the independent auditors must be
approved by a majority of Votes Cast. In determining whether such proposals have
been approved, abstentions are counted as a vote against the proposal and broker
non-votes are not counted as votes for or against the proposal.

Your execution of the enclosed proxy will not affect your right as a
shareholder to attend the Annual Meeting and to vote in person. Any shareholder
giving a proxy has a right to revoke it at any time by either (i) a later-dated
proxy, (ii) a written revocation sent to and received by the Secretary of the
Company prior to the Annual Meeting, or (iii) attendance at the Annual Meeting
and voting in person.

PROPOSAL ONE

ELECTION OF DIRECTORS
(ITEM 1 ON THE PROXY CARD)

The By-Laws of the Company provide that the Board of Directors shall be
divided into three classes as nearly equal in number as reasonably possible with
any overage allocated in the discretion of the Board of Driectors. The current
number of directors (which may vary between five and nine) has been fixed at
nine by action of the Board in accordance with the By-Laws. At the 1998 Annual
Meeting of Shareholders, three classes of directors were elected to serve in
terms expiring 1999, 2000, and 2001.

Three (the "Class I Directors") of the Company's nine directors are to be
elected at the Meeting.

The Board of Directors has nominated Messrs. Michael W. George, James B.
Glavin, and Dr. Gerald J. Yakatan to serve as Class I Directors of the Company
to hold office until the 2002 Annual Meeting of Shareholders. The remaining six
directors, the Class II and Class III Directors hold office until the 2000, and
2001 Annual Meetings, respectively. The current Class II Directors are Dr.
Dennis J. Carlo, and Messrs. Edward L. Hennessy, Jr., and Stuart A. Samuels. The
current Class III Directors are Messrs. George P. Rutland (Chairman of the
Board), Kenneth E. Olson and Joseph E. Smith.

Each Class I Director nominee elected at the Annual Meeting will hold
office until the 2002 Annual Meeting, and until his successor is elected and
qualified, unless he resigns or his seat on the Board of Directors becomes
vacant due to his death, removal or other cause in accordance with the By-Laws
of the Company.
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<PAGE> 6

Management knows of no reason why any of these nominees would be unable or
unwilling to serve; but if any nominee should be unable or unwilling to serve,
the proxies will be voted for the election of such other persons(s) for the
office of director as management may recommend in the place of such nominee.

THE BOARD RECOMMENDS VOTING "FOR" THE THREE NOMINEES
LISTED BELOW.

INFORMATION REGARDING CLASS I DIRECTOR NOMINEES FOR A THREE-YEAR TERM EXPIRING
AT THE 2002 ANNUAL MEETING

The following table sets forth the name, age, principal occupations for the
persons indicated and other directorships of the current Class I Director
nominees at the Annual Meeting.

<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION FOR THE PAST FIVE YEARS DIRECTOR CURRENT
NAME AGE AND OTHER DIRECTORSHIPS SINCE TERM ENDS
---- --- -------------------------------------------- -------- ---------
<S> <C> <C> <C> <C>
Michael W. George................. 50 President and Chief Operating Officer and a June 1999
member of the Board at UroCor, Inc. since 1998
August 1998. From August 1989 to August
1998, served in positions at Dupont Merck as
Executive Vice President, Administration,
Member of the Operating Group and Senior
Vice President, Cardiovasculars, at Dupont
(June 1997 to August 1998), President,
International & Europe (January 1994 to
December 1996); President, North America
(January 1992 to December 1993). Vice
President, Sales and Marketing (January 1991
to December 1991) and Director, Worldwide
Marketing (August 1989 to December 1990).
Prior to August 1989, held positions as a
Product Manager at Bristol-Myers Squibb and
Sandoz Pharmaceuticals.
James B. Glavin................... 63 Chairman of the Board of Directors of Immune N/A N/A
Response Corporation since May 1993. From
April 1987 to September 1997 served in
positions at Immune Response Corporation. as
Chief Executive Officer (April 1987 to
September 1994), President (October 1987 to
September 1994), and Treasurer (April 1987
to May 1991). Also held positions as
Chairman of the Board of Directors of Smith
Laboratories, Inc. ("Smith Labs"), a medical
products company, from September 1985 to May
1990 and Acting President and Chief
Executive Officer of Smith Labs from
September 1985 to August 1989; Director of
Gish Biomedical Inc., Inhale Therapeutic
Systems, Inc. and the Meridian Fund.
</TABLE>

3
<PAGE> 7

THE BOARD RECOMMENDS A VOTE "FOR" EACH NOMINEE LISTED ABOVE.

INFORMATION REGARDING CLASS II DIRECTORS CONTINUING IN OFFICE UNTIL THE 2000
ANNUAL MEETING

<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION FOR THE CURRENT
PAST FIVE YEARS AND DIRECTOR TERM
NAME AGE OTHER DIRECTORSHIPS SINCE ENDS
---- --- ---------------------------------------- -------- ---------
<S> <C> <C> <C> <C>
Dennis J. Carlo, Ph.D. ........... 55 Co-founder and a Director of Immune June 2000
Response Corporation since 1987 and its 1998
President and Chief Executive Officer
since 1994. From 1987 to 1994, served as
its Chief Scientific Officer, Chief
Operating Officer and Executive Vice
President. From 1982 to 1987, served as
Vice President of Research and
Development and Therapeutic
Manufacturing at Hybritech, Inc., a
biotechnology company acquired in 1986
by Eli Lilly & Co. Serves as a Director
of Vyrex Corporation. From 1971 to 1981,
held various positions at Merck & Co.,
Inc.
Edward L. Hennessy, Jr. .......... 70 Retired. Formerly Chairman and Chief June 2000
Executive Officer of Allied-Signal, Inc. 1998
from 1979 to 1991. Serves as a Director
of The Wackenhut Corporation and NAI
Technologies.
Stuart A. Samuels................. 57 Pharmaceutical industry consultant since April 2000
1990. Affiliated with the Rorer Group 1992
from 1986 to 1990 where he held
positions of Senior Vice President,
Rorer Pharmaceuticals Corporation, and
General Manager of Rorer Pharmaceuticals
and President of Dermik Laboratories,
both divisions of Rorer Pharmaceuticals
Corporation.
</TABLE>

4
<PAGE> 8

INFORMATION REGARDING CLASS III DIRECTORS CONTINUING IN OFFICE UNTIL THE 2001
ANNUAL MEETING

<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION FOR THE CURRENT
PAST FIVE YEARS AND DIRECTOR TERM
NAME AGE OTHER DIRECTORSHIPS SINCE ENDS
---- --- ---------------------------------------- -------- ---------
<S> <C> <C> <C> <C>
Kenneth E. Olson.................. 62 Chairman of the Board (July 1984 to June August 2001
1994) and Chief Executive Officer 1988
(December 1990 to February 1996 and
March 1997 to June 1998) of Proxima
Corporation, a supplier of display
projection systems for professional
desktop computers. Also serves as a
Director of Laser Power Corporation and
Applied Digital Access Corporation.
George P. Rutland................. 66 Chairman of the Board of the Company June 2001
since June 1998. Also Chairman, Chief 1988
Executive Officer and a Director of
Taipan Corporation since 1995, a
management consulting and investing
company. Director of Hemet Federal Bank.
Retired Chairman, President and Chief
Executive Officer of Northeast Federal
Corp. and Northeast Savings Bank in
Hartford, Connecticut from 1988 until
1994. Chairman and Chief Executive
Officer and a Director of American
Custody Corp. from 1993 to 1994. Also
served as President and Chief Executive
Officer and a Director of CalFed, Inc.
(from 1982 to 1988) and Vice Chairman
and a Director of California Federal
Bank (from 1982 to 1988); as Senior
Executive Vice President of Crocker
National Bank (from 1975 to 1982); and
as Senior Vice President of Citibank
(from 1954 to 1975).
Joseph E. Smith................... 59 Retired. From March 1989 to September June 2001
1997, Mr. Smith served in various 1998
capacities at Warner-Lambert (including
President of Pharmaceuticals
(Parke-Davis) and President of Shaving
Products (Schick and Wilkinson Sword),
retiring in September 1997 as Corporate
Vice-President at Warner-Lambert, and a
member of the Office of the Chairman and
the firm's Management Committee). Mr.
Smith currently serves as a Director of
Boren, LePore, and Associates, Inc.,
Vivus, Inc. and Roberts Pharmaceutical
Corporation.
</TABLE>

There are no family relationships among any of the directors and officers.

BOARD MEETINGS AND COMMITTEES

During the fiscal year ended September 30, 1998 ("Fiscal 1998"), the Board
held seven regular meetings and eleven special meetings. Each director attended
at least 75% of the meetings held during Fiscal 1998 which occurred on or after
the initiation of his term as a director. Each director who served on the
Executive Compensation and Stock Option Committee also attended at least 75% of
such committee's meetings held during Fiscal 1998 which occurred on or after the
initiation of his term as a director.

During Fiscal 1998, the Board of the Company had an Executive Committee, an
Audit Committee, an Executive Compensation and Stock Option Committee and a
Technology Review Committee.

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<PAGE> 9

The Executive Committee has all of the authority of the Board to act on any
matter except with respect to: (i) the approval of any action for which
shareholder approval is required under the California General Corporation Law;
(ii) the filling of vacancies on the Board or on any committee thereof; (iii)
the fixing of compensation for directors; (iv) the adoption, amendment or repeal
of any bylaw; (v) the amendment or appeal of any resolution of the Board which
by its terms is not so amendable or repealable; (vi) any distribution to
Shareholders (as set forth under the California General Corporation Law) except
at a rate or within a price range determined by the Board; (vii) the appointment
of other committees of the Board or the members thereof; and (viii) the
termination of any officer. The Executive Committee currently consists of
Messrs. Rutland, as Committee Chairman, Kenneth E. Olson, Stuart A. Samuels,
Joseph E. Smith and Dr. Gerald J. Yakatan. There were 15 meetings of the
Executive Committee held during Fiscal 1998.

The Audit Committee oversees the Company's accounting and financial
reporting policies and internal controls, reviews annual audit reports and
management letters and makes recommendations to the Board regarding appointment
of independent auditors. The Audit Committee currently consists of Mr. Olson, as
Committee Chairman, and Messrs. Rutland and George. There was one meeting of the
Audit Committee during Fiscal 1998.

The Executive Compensation and Stock Option Committee currently consists of
Dr. Carlo, as Committee Chairman, and Messrs. Hennessy, Olson and Smith. The
principal functions of this committee are to recommend to the Board the
compensation of directors and officers of the Company, to oversee the
administration of the Company's stock option plans and to perform such other
duties regarding compensation for employees and consultants as the Board may
delegate from time to time. See also "Board Compensation Committee Report on
Executive Compensation." The Executive Compensation and Stock Option Committee
held one meeting during Fiscal 1998.

The Technology Review Committee was established to monitor the status of
the Company's research and product development efforts and to review the
commercial potential of existing and new product opportunities. During Fiscal
1998, no meetings of the Technology Review Committee were held and on December
9, 1998, the committee was abolished.

The Board of Directors formed the Nominating Committee on October 15, 1998.
The Nominating Committee currently consists of Mr. Rutland, as Committee
Chairman, Dr. Carlo and Mr. Olson. The principal function of the Nominating
Committee is to identify and recommend to the Board of Directors candidates to
fill vacancies on the Board due to resignation, term expiration or death. The
Company did not have a Nominating Committee during Fiscal 1998, nor did it have
a committee during that time that performed an equivalent function of a
nominating committee.

PROPOSAL TWO

APPROVAL OF THE 1998 STOCK OPTION PLAN
(ITEM 2 ON THE PROXY CARD)

On November 20, 1998, the Board of Directors approved the Company's 1998
Stock Option Plan (the "1998 Plan") pursuant to which an aggregate of 1,875,000
shares of Class A Common Stock are reserved for issuance. The 1998 Plan is being
presented to the shareholders for their approval.

The Board of Directors believes that stock options are an important and
valuable incentive and that the number of options currently available for future
option grants under the Company's existing stock option plan, the 1994 Stock
Option Plan (the "1994 Plan"), is insufficient. The 1994 Plan currently has
available for issuance only 229,029 options as of December 1, 1998, out of the
2,000,000 options authorized under the 1994 Plan. The primary purpose of the
1998 Plan is to increase the number of shares of Class A Common Stock available
for issuance under stock options plans and to ensure that the Company can
continue to grant stock options to employees, board members and consultants at
levels determined appropriate by the Board of Directors and the Executive
Compensation and Stock Option Committee.

6
<PAGE> 10

The 1998 Plan differs from the 1994 Plan, particularly with respect to the
ability for the Company to issue options to directors of the Company. (As
described under "Executive Compensation" below, the 1994 Plan provides for
automatic annual issuance of options to outside directors to purchase 10,000
shares of Class A Common Stock; whereas, the 1998 Plan contains no automatic
grant, and does not specify the number of options granted to outside directors.)
In the event that the shareholders do not approve the grants to the recently
elected outside directors described in "Proposal Three," below, the Board of
Directors intends to evaluate and act upon alternate ways of compensating the
newly elected directors for the services they render, including possible
issuance of options to such directors pursuant to the 1998 Plan, if approved,
and/or payment of cash.

The full text of the 1998 Plan, substantially in the form in which it will
take effect if approved by the shareholders, is set forth in Attachment A to
this Proxy Statement. The following description of the 1998 Plan is a summary
only. It is subject to, and qualified in its entirety by, Attachment A.

PURPOSE

The general purpose of the 1998 Plan, as with the 1994 Plan, is to assist
the Company in the recruitment, retention and motivation of employees, directors
and independent contractors who are in a position to make contributions to the
Company's progress. The 1998 Plan offers a significant incentive to the
employees, directors and independent contractors of the Company by enabling such
individuals to acquire the Company's common stock, thereby increasing their
proprietary interest in the growth and success of the Company. The 1998 Plan
also enables the Company to grant options to officers and directors under the
plan that qualify for exemption from application of the "short-swing" profit
provisions of Section 16 of the Exchange Act of 1934 as amended (the "Exchange
Act"). See "Exemption from Section 16 of the Exchange Act," below.

ADMINISTRATION

The 1998 Plan is administered by the Executive Compensation and Stock
Option Committee of the Board of Directors (the "Option Committee") composed of
at least two "Non-Employee Directors," as such term is defined in Rule 16b-3 and
further defined below. If no such committee is appointed the full Board serves
as the Option Committee. Subject to the limitations set forth in the 1998 Plan,
the Option Committee has broad authority to determine to whom options will be
granted (including initial grants to incoming directors), the term during which
an option may be exercised, and the rate at which the options may be exercised
(including acceleration of vesting). In general terms, a "Non-Employee Director"
within the meaning of Rule 16b-3 is a member of the Board who (i) is not
currently an officer or employee of the Company or a parent or subsidiary of the
Company, (ii) does not receive compensation, either directly or indirectly, from
the Company or a parent or subsidiary of the Company, for services rendered as a
consultant or in any other non-director capacity except for an amount that does
not exceed the dollar amount for which disclosure would be required pursuant to
Item 404(a) of Regulation S-K, (iii) does not possess an interest in any other
transaction for which disclosure would be required pursuant to Item 404(a) under
Regulation S-K, and (iv) is not engaged in a business relationship for which
disclosure would be required pursuant to Item 404(b) of Regulation S-K.

ELIGIBILITY AND SHARES SUBJECT TO THE 1998 PLAN

Under the 1998 Plan, 1,875,000 shares of Class A Common Stock have been
reserved for issuance upon exercise of options. The 1998 Plan provides for the
grant of both incentive stock options intended to qualify as such under section
422(b) of the Internal Revenue Code, as amended, and non-qualified stock options
(also known as nonstatutory stock options). Incentive stock options may be
granted only to employees (including officers and directors who are also
employees) of the Company. Non-qualified stock options may be granted to
employees (including officers and directors who are also employees), directors
and independent contractors of the Company. If any options granted under the
1998 Plan for any reason expire or are canceled or otherwise terminated without
having been exercised in full, the shares allocable to the unexercised portion
of such options again become available for the 1998 Plan. To date, no options
have been granted under the 1998 Plan.

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<PAGE> 11

The maximum term of each option granted under the 1998 Plan is 10 years.
Stock options granted under the 1998 Plan must be exercised by the optionee
during the earlier of their term or within 90 days after termination of the
optionee's employment, except that the period may be extended on certain events,
including death and termination due to disability.

The exercise price of shares of Class A Common Stock subject to options
under the 1998 Plan must not be less than the fair market value of the Class A
Common Stock on the date of the grant. With respect to an employee who owns more
than ten percent (10%) of the total combined voting power of all classes of
stock of the Company or any of its subsidiaries, the exercise price of any
option granted must be no less than 110% of the fair market value per share of
Class A Common Stock on the date of grant. In addition to payment in cash, the
1998 Stock Plan authorizes the Option Committee to permit an optionee to pay the
exercise price of an option (i) by delivery of shares of Class A Common Stock or
(on a form prescribed by the Company) of an irrevocable direction to a
securities broker approved by the Company to sell the optionee's shares and
deliver all or a part of the sale proceeds to the Company in payment of all or
part of the exercise price and any withholding taxes ("exercise/sale"
directions), or (ii) by delivery of an irrevocable direction to pledge the
optionee's shares to a securities broker or lender approved by the Company as
security for a loan and to deliver all or part of the loan proceeds to the
Company in payment of all or part of the exercise price and any withholding
taxes ("exercise/pledge" directions). Such Shares shall be valued at their fair
market value on the date when the new shares are purchased under the 1998 Plan.

Based upon the closing price of the Company's Class A Common Stock on the
NASDAQ National Market System on December 1, 1998 ($2.63), the maximum aggregate
value of the underlying securities to be issued under the 1998 Plan is
$4,931,250. The actual value of the securities to be issued will be determined
by the fair market value of the underlying securities on the date(s) such
securities are issued.

During an optionee's lifetime, such optionee's option(s) shall be
exercisable only by him or her and shall not be transferable. In the event of an
optionee's death, such optionee's option(s) shall not be transferable other than
by will or by the laws of descent and distribution.

DURATION, AMENDMENT AND TERMINATION

The Board may amend, suspend or terminate the 1998 Plan at any time, except
that any amendment, suspension or termination shall not affect any option
previously granted. Any amendment of the 1998 Plan, however, which increases the
number of shares available for issuance, materially changes the class of persons
who are eligible for the grant of Incentive stock options or, if required by
Rule 16b-3 (or any successor to such rule) under the Securities Exchange Act of
1934, as amended, would materially increase the benefits accruing to
participants under the 1998 Plan or would materially modify the requirement as
to eligibility for participation in the 1998 Plan, shall be subject to approval
of the Company's shareholders. Shareholder approval is not required for any
other amendment of the 1998 Plan. Unless sooner terminated by the Board of
Directors, the 1998 Plan will terminate on November 20, 2008, and no further
options may be granted or stock sold pursuant to the 1998 Plan following the
termination date.

EFFECT OF CERTAIN CORPORATE EVENTS

In the event of any of the following transactions (a "Corporate
Transaction"):

(i) a merger or acquisition involving the Company in which the Company
is not the surviving entity, except for a transaction the principal purpose
of which is to change the State of the Company's incorporation,

(ii) sale, transfer or other disposition of all or substantially all
of the assets of the Company or

(iii) any other corporate reorganization or business combination in
which fifty percent (50%) or more of the Company's outstanding voting stock
is transferred to different holders in a single transaction or a series of
related transactions,

8
<PAGE> 12

then the exercisability of each option outstanding under the 1998 Plan
shall be automatically accelerated so that each such Option shall
immediately prior to the specified effective date for the Corporate
Transaction, become fully exercisable with respect to the total number of
shares of Class A Common Stock purchasable under such Option and may be
exercised for all or any portion of such shares. However, an outstanding
Option under the Plan shall not be so accelerated if (i) such Option is, in
connection with the Corporate Transaction, either to be assumed by the
successor corporation or parent thereof or be replaced with a comparable
option to purchase shares of the capital stock of the successor corporation
or parent thereof, or (ii) the acceleration of such Option is subject to
other applicable limitations imposed by the Option Committee at the time of
the grant. The determination of comparability under clause (i) above shall
be made by the Option Committee and its determination shall be final,
binding and conclusive. In connection with any such Corporate Transaction,
the exercisability as an incentive stock option under the federal tax laws
of any accelerated Options under the Plan shall remain subject to any
applicable dollar limitation of the 1998 Plan. Except as otherwise provided
in the 1998 Plan, upon the consummation of the Corporate Transaction, all
outstanding Options under the 1998 Plan shall, to the extent not previously
exercised or assumed by the successor corporation or its parent company,
terminate and cease to be outstanding. If the Company is the surviving
entity in any Corporate Transaction or the outstanding Options are to be
assumed in connection with such Corporate Transaction, then each Option
shall, immediately after such Corporate Transaction, be appropriately
adjusted to apply and pertain to the number and class of securities which
would be issuable to the Optionee, upon consummation of such Corporate
Transaction if the Option were exercised immediately prior to such
Corporate Transaction. Appropriate adjustments shall also be made to the
exercise price payable per share, provided the aggregate exercise price
payable for such Option shall remain the same. In addition, the class and
number of securities available for issuance under the 1998 Plan following
the consummation of such Corporate Transaction shall be appropriately
adjusted.

FEDERAL INCOME TAX INFORMATION

Incentive Stock Options. Incentive stock options under the Option Plan are
intended to be eligible for the favorable federal income tax treatment accorded
"incentive stock options" under the Code.

There generally are no federal income tax consequences to the optionee or
the Company by reason of the grant or exercise of an incentive stock option
other than a disqualifying disposition as described below. However, the exercise
of an incentive stock option may increase the optionee's alternative minimum tax
liability, if any. If an optionee holds stock acquired through exercise of an
incentive stock option for at least two years from the date on which the option
is granted and at least one year from the date on which the shares are
transferred to the optionee upon exercise of the option, any gain or loss on a
disposition of such stock will be long-term capital gain or loss. Generally, if
the optionee disposes of the stock before the expiration of either of these
holding periods (a "disqualifying disposition"), at the time of disposition, the
optionee will realize taxable ordinary income equal to the lesser of (i) the
excess of the stock's fair market value on the date of exercise over the
exercise price or (ii) the optionee's actual gain, if any, on the purchase and
sale. The optionee's additional gain, or any loss upon the disqualifying
disposition will be a capital gain or loss which will be long-term or short-term
depending on whether the stock was held for more than one year.

To the extent the optionee recognizes ordinary income by reason of a
disqualifying disposition, the Company generally will be entitled (subject to
the requirement of reasonableness and the satisfaction of a tax reporting
obligation) to a corresponding business expense deduction in the tax year in
which the disqualifying disposition occurs.

Non-Qualified Stock Options. Non-qualified stock options granted under the
Option Plan generally have the following federal income tax consequences:

There are no tax consequences to the optionee or the Company by reason of
the grant of a non-qualified stock option. Upon exercise of a non-qualified
stock option, the optionee will recognize taxable ordinary income equal to the
excess of the stock's fair market value on the date of exercise over the option
exercise price. Generally, with respect to employees, the Company is required to
withhold taxes in an amount based on

9
<PAGE> 13

the ordinary income recognized. Subject to the requirement of reasonableness and
the satisfaction of any withholding obligation, the Company generally will be
entitled to a business expense deduction equal to the taxable ordinary income
realized by the optionee. Upon disposition of the stock, the optionee will
recognize a capital gain or loss equal to the difference between the selling
price and the sum of the amount paid for such stock plus any amount recognized
as ordinary income upon exercise of the option. Such gain or loss will be long
or short-term depending on whether the stock was held for more than one year.
Slightly different rules may apply to optionees who acquire stock subject to
certain repurchase options or who are subject to Section 16(b) of the Exchange
Act.

Potential Limitation on Company Deductions. As part of the Omnibus Budget
Reconciliation Act of 1993, the U.S. Congress amended the Code to add Section
162(m), which denies a deduction to any publicly held corporation for
compensation paid to certain employees in a taxable year to the extent that
compensation exceeds $1,000,000 for a covered employee. It is possible that
compensation attributable to stock options, when combined with all other types
of compensation received by a covered employee from the Company, may cause this
limitation to be exceeded in any particular year.

Certain kinds of compensation, including qualified "performance-based
compensation," are disregarded for purposes of the deduction limitation. In
accordance with proposed Treasury regulations issued under Section 162(m),
compensation attributable to stock options will qualify as performance-based
compensation, provided that: either (a)(i) the option plan contains a
per-employee limitation on the number of shares for which options may be granted
during a specified period, (ii) the per-employee limitation is approved by the
stockholders, (iii) the option is granted by a Compensation Committee comprised
solely of "outside directors" and (iv) the exercise price of the option is no
less than the fair market value of the stock on the date of grant; or (b) the
option is granted by a Compensation Committee comprised solely of "outside
directors" and is granted (or exercisable) only upon the achievement (as
certified in writing by the Compensation Committee) of an objective performance
goal established by the Compensation Committee while the outcome is
substantially uncertain and approved by the stockholders.

The 1998 Plan provides the flexibility for the Plan to be administered in a
manner which satisfies the conditions set forth above, but does not require it.
Accordingly, the Company may not be able to claim a tax deduction for certain
exercises of non-qualified stock options or disqualifying dispositions of
incentive stock options by any of the Company's top five (5) highest paid
executives to the extent that the income from such exercises or dispositions,
combined with such executive's other taxable compensation for the year, exceeds
$1 million. The Board of Directors will evaluate the desirability of compliance
from time to time in the future as it appears likely that such compliance would
materially benefit the Company.

OTHER TAX CONSEQUENCES

The foregoing discussion is intended to be a general summary only of the
federal income tax aspects of options granted under the 1998 Plan. Tax
consequences may vary depending on the particular circumstances at hand. In
addition, administrative and judicial interpretations of the application of the
federal income tax laws are subject to change. Furthermore, no information is
given with respect to state or local taxes that may be applicable. Participants
in the 1998 Plan who are residents of or are employed in a country other than
the United States may be subject to taxation in accordance with the tax laws of
that particular country in addition to or in lieu of United States federal
income taxes.

EXEMPTION FROM SECTION 16 OF THE EXCHANGE ACT

Section 16 of the Exchange Act ("Section 16") establishes insider liability
for profits realized from any "short-swing" trading transaction (i.e., purchase
and sale, or sale and purchase within less than six months). Grants of options
are generally viewed as purchases of the underlying securities for purposes of
Section 16. Rule 16b-3 of the Exchange Act provides that transactions by
officers and directors pursuant to an employee stock option plan, such as option
grants, are exempt from Section 16 liability provided that the plan meets
certain requirements. In general, such exemption from such rules require that
the transactions be: (i) approved by the Board, or a committee of the Board that
is composed solely of two or more non-employee

10
<PAGE> 14

directors; (ii) approved or ratified by either the affirmative votes of the
holders of a majority of the securities of the issuer present, or represented,
and entitled to vote at a meeting duly held in accordance with the applicable
laws of the state or other jurisdiction in which the Company is incorporated or
the written consent of the holders of a majority of the securities of the
Company entitled to vote, provided that such ratification occurs no later than
the date of the next annual meeting of shareholders; or (iii) equity securities
of the Company so acquired are held by the officer or director for a period of
at least six months following the date of such acquisition, provided that this
condition shall be satisfied with respect to a derivative security if at least
six months elapse from the date of acquisition of the derivative security to the
date of disposition of the derivative security (other than upon exercise or
conversion) or its underlying equity security.

The 1998 Plan is structured to comply with the above exemption requirements
of Rule 16b-3 under the Exchange Act.

VOTE REQUIRED

An affirmative vote by a majority of Votes Cast. THE BOARD OF DIRECTORS
RECOMMENDS A VOTE "FOR" THE APPROVAL OF THE 1998 PLAN.

PROPOSAL THREE

APPROVAL OF STOCK OPTIONS GRANTED TO NEW DIRECTORS
ON JUNE 30, 1998
(ITEM 3 ON THE PROXY CARD)

On June 30, 1998, the Company expanded its Board of Directors to nine
directors and five new directors (Dr. Carlo and Messrs. Rutland, Hennessy,
George and Smith) were elected to the Company's board. Upon election, these new
directors were each granted stock options to purchase 25,000 Class A Common
Stock at an exercise price of $1.50 per share, the fair market price on the date
of issuance (referred to below as the "New Director Option Grants"). The New
Director Option Grants vest over two years from the date of grant with 10,000
options vested as of June 30, 1998, 7,500 options vesting on June 30, 1999 and
the final 7,500 options vesting on June 30, 2000. The new directors also each
received stock options to purchase 10,000 shares of Class A Common Stock at the
same exercise price pursuant to the automatic grant provisions of the 1994
Option Plan (see "Executive Compensation -- Non-Employee Directors," below). The
10,000 option grants vest ratably over a three year period in thirds annually
commencing June 30, 1998 through June 30, 2001. The New Director Option Grants
were made by the prior Board of Directors of the Company in order to attract
what the prior Board of Directors felt were board members of excellent quality
who would make a significant contribution to the Company.

The New Director Option Grants were made subject to obtaining shareholder
approval of the grants pursuant to the rules of The NASDAQ Stock Market (the
market in which the Company's Class A Common Stock trades) which require that
the issuance of options to purchase 25,000 or more shares of stock be so
approved. In the event that shareholder approval is not obtained, the Board of
Directors intends to evaluate and act upon alternate ways of compensating these
directors for the services they have rendered, including, possibly, issuance of
options to such directors pursuant to the 1998 Plan, if approved (see "Proposal
Two," above), and/or payment of cash.

VOTE REQUIRED

An affirmative vote by a majority of Votes Cast is required for approval of
the New Director Option Grants. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR"
THE APPROVAL OF THE NEW DIRECTOR OPTION GRANTS.

11
<PAGE> 15

PROPOSAL FOUR

APPROVAL OF AMENDMENT OF ARTICLES TO REAPPORTION
AUTHORIZED NUMBER OF SHARES OF COMMON STOCK
(ITEM 4 ON THE PROXY CARD)

On November 20, 1998, the Board of Directors approved an amendment of the
Company's Articles of Incorporation ("Amended Articles") to reapportion the
allocation of the Company's authorized shares of common stock of 100,000,000
shares currently consisting of 99,490,000 shares of Class A Common Stock and
510,000 shares of Class B Common Stock to 99,288,000 shares of Class A Common
Stock and 712,000 shares of Class B Common Stock. This amendment is being
presented to shareholders for approval.

If the proposed amendment is approved, the first sentence of Section 3.2 of
Article 3 of the Company's Articles of Incorporation will read as follows
(changes marked in bold):

"3.2 The shares of Common Stock of this Corporation are divided into
99,288,000 shares of Class A Common Stock and 712,000 shares of Class B
Common Stock."

The full text of Section 3.2, if approved as proposed, is set forth below
(changes marked in bold):

"3.2 The shares of Common Stock of this Corporation are divided into
99,288,000 shares of Class A Common Stock and 712,000 shares of Class B
Common Stock. The rights, preferences, privileges and restrictions
including, but not limited to voting rights of the Class A Common Stock and
the Class B Common Stock shall be equal and identical in all respects
except that, unless otherwise provided by law, (i) each share of Class B
Common Stock shall entitle the holder thereof to five votes upon any and
all matters submitted to the shareholders of this Corporation for a vote,
(ii) each share of the Class B Common Stock will convert into one share of
the Class A Common Stock upon, and as of the date of, the delivery to this
Corporation of the written demand by the holder thereof for such
conversion, which demand may be delivered at any time, and (iii) each share
of Class B Common Stock will convert automatically into one share of Class
A Common Stock upon the sale or any other transfer thereof (including,
without limitation, conveyance into a trust and transfer by the operation
of any will or the laws of descent and distribution), except upon a sale or
any other transfer to a person who immediately prior to such sale or
transfer is a holder of a share or shares of Class B Common Stock."

PURPOSE AND EFFECT

The purpose of this amendment is to increase the authorized number of Class
B Common Stock ("Class B Common Stock" or "Class B Shares") to insure that all
currently outstanding options to purchase Class B Shares may be exercised. At
present there are 510,000 Class B Shares authorized, 49,000 Class B Shares
outstanding and options to purchase 429,000 Class B Shares outstanding. The
currently outstanding options (375,000 of which are held by Dr. Katz, a director
of the Company, and 10,000 are claimed to be held by his wife, as described in
Footnotes 4 and 5 to "Security Ownership of Certain Beneficial Owners and
Management," below) were issued to the optionees in 1988 and 1989.

There is currently a dispute between the Company and Dr. Katz regarding the
number of shares of Class B Common Stock he holds. Dr. Katz claims that 234,000
shares of common stock which the Company believes were converted according to
its Articles of Incorporation into Class A Common Stock in early 1998 have been
returned to a status of Class B Common Stock. The Company has informed Dr. Katz
that it disagrees with his claim. Dr. Katz is seeking a judicial determination
of his rights to these shares of common stock. (see Footnote 4 to "Security
Ownership of Certain Beneficial Owners and Management," and "Certain
Relationships and Transactions," below). On June 1, 1998, Dr. Katz gave notice
to the Company of his intent to exercise his options to purchase 375,000 shares
of Class B Common Stock. In the event Dr. Katz obtains a judicial determination
that the 234,000 shares he claims to be Class B Shares are so, the Company would
not have enough shares of Class B Common Stock to issue to all optionees
(including Dr. Katz) unless a sufficient number of other shares of Class B
Common Stock are converted to Class A Common Stock prior to exercise of the
option. The potential "deficiency" of Class B Common Stock is 202,000 shares
(the "Class B Deficiency"). As a result, the Company is unable to issue to Dr.
Katz all of the 375,000 shares of Class B
12
<PAGE> 16

Common Stock underlying the options to purchase Class B Shares which he has
attempted to exercise. In June 1996, Dr. Katz signed an agreement not to
exercise these options until such time as there was an adequate number of shares
of stock available to be issued to him after deducting the number of shares
underlying other outstanding options exercisable into Class B Common Stock. The
Board of Directors desires to increase the number of authorized shares of Class
B Common Stock to make those shares available for issuance to Dr. Katz. The
purpose of this amendment is to ensure that the Company has an adequate number
of shares of Class B Common Stock to issue to all optionees, including Dr. Katz,
regardless of the determination of the status of the above referenced 234,000
shares of common stock.

DESCRIPTION OF EXISTING CAPITAL STOCK

Common Stock

The Company is authorized to issue 99,490,000 shares of Class A Common
Stock, no par value, 40,928,771 of which were issued and outstanding at December
1, 1998, and 510,000 shares of Class B Common Stock, no par value, 49,000 of
which were issued and outstanding at December 1, 1998. There is currently a
dispute between the Company and Dr. Katz regarding the number of shares of Class
B Common Stock he holds. (See Footnote 4 to "Security Ownership of Certain
Beneficial Owners and Management"). In the event it is ultimately decided that
the 234,000 shares Dr. Katz claims to be Class B Common Stock are so, the
outstanding shares of Class A Common Stock and Class B Common Stock would be
adjusted to 40,694,771 and 283,000, respectively.

Holders of Class A Common Stock and Class B Common Stock have equal rights
to receive dividends when, as and if declared by the Board of Directors out of
funds legally available therefor.

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

Holders of both classes of Common Stock are entitled upon liquidation of
the Company to share ratably in the net assets available for distribution
subject to the rights, if any, of holders of any preferred stock then
outstanding. Shares of both classes of Common Stock are not redeemable and have
no preemptive or similar rights. The Class B Common Stock may be converted into
Class A Common Stock on a share for share basis at any time at the election of
the holder and will automatically convert into Class A Common Stock upon sale or
transfer other than to another holder of Class B Common Stock.

The Company does not anticipate paying cash dividends on its common stock
in the foreseeable future.

Preferred Stock

The Company is authorized to issue up to 10,000,000 shares of preferred
stock containing such rights, preferences, privileges and restrictions as the
Company's Board of Directors may determine. As of December 1, 1998, there were
no shares of preferred stock outstanding.

13
<PAGE> 17

VOTE REQUIRED

An affirmative vote by the holders of a majority of the outstanding shares
of the Company is required for the approval of an amendment of the Company's
Articles of Incorporation. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE
APPROVAL OF AN AMENDMENT OF THE COMPANY'S ARTICLES OF INCORPORATION.

PROPOSAL FIVE

RATIFICATION OF INDEPENDENT AUDITORS
(ITEM 5 ON THE PROXY CARD)

The Board has selected Deloitte & Touche LLP as the Company's independent
auditors for the fiscal year ending September 30, 1999, and has further directed
that management submit the selection of independent auditors for ratification by
the Shareholders at the Annual Meeting. Deloitte & Touche LLP has audited the
Company's financial statements annually since the Company's inception. Its
representatives are expected to be present at the Annual Meeting. They will have
the opportunity to make a statement if they desire to do so and will be
available to respond to appropriate questions.

Shareholder ratification of the selection of Deloitte & Touche LLP as the
Company's independent auditors is not required by the Company's By-Laws or
otherwise. The Board is submitting the selection of Deloitte & Touche LLP to the
Shareholders for ratification as a matter of good corporate practice. In the
event the Shareholders fail to ratify the selection, the Board will reconsider
whether or not to retain that firm. Even if the selection is ratified, the Board
in its discretion may direct the appointment of a different independent
accounting firm at any time during the year if the Board determines that such a
change could be in the best interests of the Company and the Shareholders.

VOTE REQUIRED

An affirmative vote by a majority of Votes Cast is required for the
ratification of Deloitte & Touche LLP as the Company's independent auditors for
the fiscal year ending September 30, 1999. THE BOARD RECOMMENDS A VOTE "FOR" THE
RATIFICATION OF THE SELECTION OF DELOITTE & TOUCHE LLP TO SERVE AS THE COMPANY'S
INDEPENDENT AUDITORS FOR THE FISCAL YEAR ENDING SEPTEMBER 30, 1999.

14
<PAGE> 18

SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information regarding the beneficial
ownership (as defined by Rule 13d-3 under the Securities Exchange Act of 1934,
as amended (the "Exchange Act")) of the Company's voting shares (Class A Shares
and Class B Shares) as of December 1, 1998 by: (i) each director, nominee and
named executive officer of the Company; (ii) all current executive officers and
directors of the Company as a group; and (iii) each person or "group" of persons
(as defined under Section 13(d)(3) of the Exchange Act) known by the Company to
own beneficially 5% or more of the outstanding shares or voting power of the
Company's voting securities. The table is based upon information supplied by
directors, officers and principal shareholders. Unless otherwise indicated, each
of the listed persons has sole voting and sole investment power with respect to
the Shares beneficially owned, subject to community property laws where
applicable.

<TABLE>
<CAPTION>
AMOUNT AND PERCENT OF
NAME AND ADDRESS OF NATURE OF TOTAL
BENEFICIAL BENEFICIAL PERCENT OF VOTING
TITLE OF CLASS OWNER OR IDENTITY OF GROUP(1) OWNERSHIP(2) CLASS(2) POWER(3)
-------------- ----------------------------- ------------ ---------- ----------
<S> <C> <C> <C> <C>
Class A Common Stock David H. Katz(4)(5) 3,441,193 7.97% 11.74%
Class B Common Stock 375,000 88.44%
Class A Common Stock George P. Rutland(6) 232,500 *
Class B Common Stock -- -0-
Class A Common Stock Edward L. Hennessy, Jr.(7) 60,000 *
Class B Common Stock -- -0-
Class A Common Stock Kenneth E. Olson(8)(9) 223,400 * *
Class B Common Stock 16,000 24.62%
Class A Common Stock Stuart A. Samuels(10) 45,000 * *
Class B Common Stock -- -0-
Class A Common Stock Gerald J. Yakatan(11) 256,393 * *
Class B Common Stock -- -0-
Class A Common Stock Dennis J. Carlo(12) 10,000 * *
Class B Common Stock -- -0-
Class A Common Stock Michael W. George(13) 10,000 * *
Class B Common Stock -- -0-
Class A Common Stock Joseph E. Smith(14) 10,000 * *
Class B Common Stock -- -0-
Class A Common Stock Timothy R. Russell(15) 228,328 * *
Class B Common Stock -- -0-
Class A Common Stock James E. Berg(16) 105,658 * *
Class B Common Stock -- -0-
Class A Common Stock J. David Hansen(17) * *
Class B Common Stock -- -0-
Class A Common Stock Gregory P. Hanson(18) 4,000 * *
Class B Common Stock -- -0-
All officers and directors as a
Class A Common Stock group 4,626,472 10.51% 14.25%
Class B Common Stock (thirteen persons)(19)(20) 391,000 88.86%
</TABLE>

- ---------------
(1) The address for all persons shown, except Dr. Katz, is c/o AVANIR
Pharmaceuticals, 9393 Towne Centre Drive, Suite 200, San Diego, California
92121. The address for Dr. Katz is 1775 La Jolla Rancho Road, La Jolla,
California 92037.

(2) Based upon 40,928,771 shares of Class A Common Stock and 49,000 shares of
Class B Common Stock outstanding as of December 1, 1998. The percentage
ownership and voting power for each shareholder (or all directors and
executive officers as a group), is calculated by assuming the exercise or
conversion of all warrants, options and convertible securities exercisable
or convertible within 60 days of December 1, 1998 held by such shareholder
and the nonexercise and nonconversion of all other outstanding warrants,
options and convertible securities. See Footnote 5, below.

15
<PAGE> 19

(3) Percentage of total voting power is based upon total cumulative voting
power of Class A Common Stock and Class B Common Stock combined as of
December 1, 1998. Each share of Class A Common Stock entitles the holder to
one vote per share on matters to be voted on by shareholders; each share of
Class B Common Stock entitles the holder to five votes per share on matters
to be voted on by shareholders. The percentage ownership and voting power
for each shareholder (or all directors and executive officers as a group),
is calculated by assuming the exercise or conversion of all warrants,
options and convertible securities exercisable or convertible within 60
days of December 1, 1998 held by such shareholder and the nonexercise and
nonconversion of all other outstanding warrants, options and convertible
securities.

(4) Includes 1,196,003 shares of Class A Common Stock held by Dr. Katz and
2,000 shares held by his wife, options to purchase 1,827,000 shares of
Class A Common Stock and 386,190 shares of Class A Common Stock issuable
upon the exercise of Class D Warrants and options to purchase 30,000 shares
of Class A Common Stock held by his wife. Does not include options to
purchase 10,000 shares of Class A Common Stock which are not exercisable
within 60 days of December 1, 1998.

In Amendment No. 2 to Schedule 13D dated September 3, 1998 (the "Schedule
13D Amendment No. 2"), filed by Dr. Katz with the Securities and Exchange
Commission (the "SEC"), Dr. Katz stated that he and his wife (collectively,
the "Katz Parties") entered into a Settlement and Rescission Agreement to
settle certain litigation with Mitchell J. Stein, HealthMed, Inc.
("HealthMed"), National Trust Properties and the Trammel Trust
(collectively, the "HealthMed Parties") relating to the Stock Purchase
Agreement, the Purchase Rights Agreement, the Voting Trust Agreement, each
dated January 12, 1998, between Dr. Katz and HealthMed, and the Promissory
Note entered into between Dr. Katz and HealthMed on January 12, 1998
(collectively the "Katz Agreements") as described in Amendment No. 1 to
Schedule 13D filed by Dr. Katz, dated March 27, 1998. Pursuant to the terms
of the Settlement and Rescission Agreement ("Settlement Agreement") and
related court order, the Katz Agreements have been rescinded in their
entirety as between the parties. Dr. Katz has taken the position that one
effect of the Settlement Agreement is that 234,000 shares of Common Stock
(which had converted into Class A Common Stock at the date the Katz
Agreements were executed by operation of the Company's Articles of
Incorporation which require such conversion upon transfer of Class B Shares
into trust) should be reinstated to Class B Shares. The Company has
informed Dr. Katz that it disagrees with his claim that these Class A
Shares should be reclassified to Class B Shares based on its interpretation
of its Articles of Incorporation. (These shares are referred to below as
the "Disputed Class A Shares.") Dr Katz is seeking a judicial determination
of his rights to Class B Shares (in lieu of the Disputed Class A Shares)
under the Company's Articles of Incorporation. If Dr. Katz obtains a
determination in his favor in advance of the Annual Meeting, the Company
intends to provide to Dr. Katz the voting rights he would have enjoyed had
he held these Class B Shares on the Record Date of the Annual Meeting. The
effect of such a determination could increase Dr. Katz's voting rights by
as much as 936,000 votes and his beneficial ownership to as high as 14%.
Dr. Katz has further stated in his Amendment No. 3 to Schedule 13D dated
September 18, 1998 ("Schedule 13D Amendment No. 3") that he is the
beneficial owner of 3,264,096 Class A Shares and 619,000 Class B Shares. Of
that total, he states that he has the sole power to vote and dispose of
3,215,193 Class A Shares and 609,000 Class B Shares, and that his wife has
the sole power to vote and dispose of 46,903 Class A Shares and 10,000
Class B Shares. The Schedule 13D Amendment No. 3 reports the 234,000
Disputed Class A Shares as Class B Shares in the number of Class B Shares
Dr. Katz reports as beneficially owned. As discussed above, the Company
treats these shares as outstanding shares of Class A Common Stock.
Additionally, Dr. Katz's filing appears to include canceled options to
purchase 40,000 and 14,952 shares of Class A Common Stock issued to Dr.
Katz and his wife, respectively, and 10,000 canceled options to exercise
Class B Common Stock issued to his wife. It is the Company's position that
such options have been canceled because the options were not exercised
within the defined exercise period specified by the stock option plans
following the termination dates of employment.

(5) Includes options to purchase 375,000 Class B Shares granted under Dr.
Katz's employment agreement. On June 1, 1998, Dr. Katz gave notice to the
Company of his intent to exercise these options. However, Dr. Katz
previously signed a commitment letter to the Company in June 1996 in which
he agreed not to exercise these options until an adequate number of Class B
Shares were available. The Company has

16
<PAGE> 20

informed Dr. Katz that it is not in a position to issue Dr. Katz such shares at
the present time. The Company's ability to issue such shares in their entirety
depends, in part, upon a number of factors, including resolution of the
disagreement referenced in Footnote 4, above and the affirmative vote of
the shareholders on Proposal Four, above. See Proposal Four. The number set
forth in the table assumes that such shares are exercisable within 60 days
of December 1, 1998.

(6) Includes 222,500 shares of Class A Common Stock over which Mr. Rutland
exercises sole voting and investment power, and options to purchase 10,000
shares of Class A Common Stock. Does not include options to purchase 25,000
shares of Class A Common Stock which are not exercisable within 60 days of
December 1, 1998.

(7) Includes 50,000 shares of Class A Common Stock and options to purchase
10,000 shares of Class A Common Stock. Does not include options to purchase
25,000 shares of Class A Common Stock which are not exercisable within 60
days of December 1, 1998.

(8) Includes 36,400 shares of Class A Common Stock and options to purchase
187,000 shares of Class A Common Stock. Does not include options to
purchase 20,000 shares of Class A Common Stock which are not exercisable
within 60 days of December 1, 1998.

(9) Includes 16,000 options to purchase shares of Class B Common Stock.

(10) Includes options to purchase 45,000 shares of Class A Common Stock. Does
not include options to purchase 20,000 shares of Class A Common Stock which
are not exercisable within 60 days of December 1, 1998.

(11) Includes 20,000 shares of Class A Common Stock and options to purchase
236,393 shares of Class A Common Stock. Does not include options to
purchase 203,607 shares of Class A Common Stock which are not exercisable
within 60 days of December 1, 1998.

(12) Includes options to purchase 10,000 shares of Class A Common Stock. Does
not include options to purchase 25,000 shares of Class A Common Stock which
are not exercisable within 60 days of December 1, 1998.

(13) Includes options to purchase 10,000 shares of Class A Common Stock. Does
not include options to purchase 25,000 shares of Class A Common Stock which
are not exercisable within 60 days of December 1, 1998.

(14) Includes options to purchase 10,000 shares of Class A Common Stock. Does
not include options to purchase 25,000 shares of Class A Common Stock which
are not exercisable within 60 days of December 1, 1998.

(15) Includes 25,000 shares of Class A Common Stock and options to purchase
203,328 shares of Class A Common Stock. Does not include options to
purchase 16,672 shares of Class A Common Stock which are not exercisable
within 60 days of December 1, 1998.

(16) Includes options to purchase 105,658 shares of Class A Common Stock. Does
not include options to purchase 33,342 shares of Class A Common Stock which
are not exercisable within 60 days of December 1, 1998.

(17) Does not include options to purchase 100,000 shares of Class A Common Stock
which are not exercisable within 60 days of December 1, 1998.

(18) Includes 4,000 shares of Class A Common Stock. Does not include options to
purchase 100,000 shares of Class A Common Stock which are not exercisable
within 60 days of December 1, 1998.

(19) Includes 1,555,903 shares of Class A Common Stock, options to purchase
2,684,379 shares of Class A Common Stock and 386,190 shares issuable upon
the exercise of Class D Warrants. Does not include 628,621 options to
purchase Class A Common Stock not exercisable within 60 days of December 1,
1998.

(20) Includes options to purchase 391,000 shares of Class B Common Stock.

17
<PAGE> 21

COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT ("SECTION 16(a)")

Section 16(a) of the Exchange Act of 1934 requires the Company's executive
officers and directors, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file reports of
beneficial ownership and changes in beneficial ownership with the SEC. Executive
officers, directors and greater than ten percent shareholders are required by
SEC regulations to furnish the Company with copies of all Section 16(a) forms
they file.

To the Company's knowledge, based solely on review of the copies of such
reports furnished to the Company and written representation that no other
reports were required, all Section 16(a) filing requirements applicable to its
executive officers, directors and greater than ten percent shareholders were
complied with in Fiscal 1998.

EXECUTIVE COMPENSATION

NON-EMPLOYEE DIRECTORS

Directors who are not otherwise employed by the Company ("Outside
Directors"), other than Mr. Rutland, are paid a retainer of $500 per month. Mr.
Rutland, Chairman of the Board, receives a monthly retainer of $2,500.
Additionally, all outside directors receive $1,500 for attendance at each
regular meeting of the Board, and $250 for attendance at each special meeting of
directors and meetings of committees of the directors. Committee chairpersons
for all committees receive $500 for attendance at the meeting.

In March 1994, the shareholders of the Company approved the Company's 1994
Stock Option Plan (the "1994 Option Plan"). The 1994 Option Plan provides that
non-employee directors are automatically granted options to purchase 10,000
Class A Shares of the Company's Common Stock on the date of the Company's annual
meeting each year. The options granted at such time have an exercise price equal
to the fair market value of the Class A Shares on the date of grant, vest
ratably over three years and have a term of ten years. Unless sooner terminated
by the Board, the 1994 Option Plan expires on January 14, 2004. The Board may
amend, suspend, modify or terminate the 1994 Option Plan, but may not without
the prior written approval of shareholders make any amendment which: (i)
materially increases the number of shares available for issuance under the 1994
Option Plan (except as expressly permitted); (ii) materially changes the class
of persons who are eligible for the grant of Incentive Stock Options ("ISO's");
or (iii) if required by Rule 16b-3 (or any successor) under the Exchange Act,
would materially increase the benefits accruing to participants under the 1994
Option Plan or would materially modify the requirements as to eligibility for
participation in the 1994 Option Plan.

On June 30 1998, Drs. Carlo and Katz, and Messrs. Rutland, Hennessy, Olson,
Samuels, George, and Smith each received stock options to purchase 10,000 shares
of Class A Common Stock at an exercise price of $1.50 per share pursuant to the
1994 Option Plan. In addition to the above referenced annual option grant under
the 1994 Stock Option Plan. Dr. Carlo, and Messrs. Rutland, Hennessy, George,
and Smith were granted additional stock options to purchase 25,000 shares of
Class A Common Stock on that date. Such grants are being put before the
shareholders for approval in this proxy (See Proposal Three, above).

On December 1, 1998, the Board of Directors adopted the 1998 Stock Option
Plan, which is being put before the shareholders for approval in this proxy.
(See Proposal Two, above).

COMPENSATION OF EXECUTIVE OFFICERS

In March 1998, the Company entered into an employment agreement with Dr.
Yakatan and Retention Agreements with certain other executive officers which are
described in more detail below under "Compensation of Executive Officers
Employment" and "Contracts, Retention Agreements and Termination of Employment
Arrangements."

18
<PAGE> 22

SUMMARY OF COMPENSATION

The following executive compensation disclosures reflect all compensation
awarded to, earned by or paid to the named executive officers of the Company for
the fiscal years ended September 30, 1998, 1997 and 1996. The named executive
officers (the "Named Executive Officers") are the Company's Chief Executive
Officer ("CEO"), regardless of compensation level, and the other executive
officers of the Company who received in excess of $100,000 in total annual
salary and bonus for Fiscal 1998. Gerald J. Yakatan was appointed President and
CEO of the Company on March 4, 1998, following the termination of David H. Katz
as the Company's President and CEO.

SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
---------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
----------------------------------------- -------------------------- ----------
SECURITIES
OTHER RESTRICTED UNDERLYING LTIP
ANNUAL STOCK OPTIONS/ PAYOUTS($)
NAME AND PRINCIPAL POSITION YEAR SALARY($)(2) BONUS($) COMPENSATION($) AWARDS($)(3) SAR'S(#)(4) (5)
--------------------------- ---- ------------ -------- --------------- ------------ ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Gerald J. Yakatan(1)............. 1998 222,461 -- -- -- 300,000 --
President and Chief 1997 111,693 -- -- -- 15,000 --
Executive Officer 1996 104,723 -- -- -- 25,000 --
Timothy R. Russell............... 1998 180,116 -- -- -- 10,000 --
Vice President of Business 1997 177,031 -- -- -- 15,000 --
Development and Licensing 1996 168,046 -- -- -- 25,000 --
James E. Berg.................... 1998 117,673 -- -- -- 25,000 --
Vice President of Clinical
Affairs 1997 110,792 -- -- -- 25,000 --
and Product Development 1996 99,705 -- -- -- 3,000 --
David H. Katz, M.D.(6)........... 1998 130,154 -- -- -- -- --
Former, President and 1997 232,200 -- -- -- 30,000 --
Chief Executive Officer 1996 228,000 -- -- -- -- --
Jeffery B. Weinress(7)........... 1998 110,640 -- -- -- 100,000 --
Former, Vice President 1997 -- -- -- -- -- --
Chief Financial Officer 1996 -- -- -- -- -- --

ALL OTHER
NAME AND PRINCIPAL POSITION COMPENSATION($)
--------------------------- ---------------
<S> <C>
Gerald J. Yakatan(1)............. --
President and Chief --
Executive Officer --
Timothy R. Russell............... --
Vice President of Business --
Development and Licensing --
James E. Berg.................... --
Vice President of Clinical
Affairs --
and Product Development --
David H. Katz, M.D.(6)........... --
Former, President and --
Chief Executive Officer --
Jeffery B. Weinress(7)........... --
Former, Vice President --
Chief Financial Officer --
</TABLE>

- ---------------
(1) Dr. Yakatan's salary for 1996, 1997 and until March 1998 was based on
allocating 50% of his time to the Company and 50% of his time to other
endeavors while he was employed as the Company's Vice President of Drug
Development. Commencing with his employment as President and Chief Executive
Officer on March 4, 1998, Dr. Yakatan's salary was raised to $300,000 for
full-time service.

(2) Amounts shown include compensation earned and received by Named Executive
Officers. No amounts were earned but deferred at the election of those
officers.

(3) The Company has not made Restricted Stock Awards.

(4) The Company has not made any grants of SAR's.

(5) The Company has not made any Long Term Incentive Plan ("LTIP") Payouts.

(6) Dr. Katz's employment with the Company terminated on March 4, 1998. For the
periods listed, his salary was based on allocating 75% of his time to the
Company. See "Employment Contracts, Retention Agreements and Termination of
Employment Agreements".

(7) Mr. Weinress served as Vice President, Chief Financial Officer from November
3, 1997 to July 10, 1998.

19
<PAGE> 23

STOCK OPTION GRANTS

The following table shows all individual grants of stock options to the
Named Executive Officers during Fiscal 1998.

<TABLE>
<CAPTION>
PERCENT OF POTENTIAL REALIZABLE
TOTAL VALUE AT ASSUMED
OPTIONS/ ANNUAL RATES OF
SARS EXERCISE APPRECIATION FOR
GRANTED TO OR BASE OPTION TERMS(3)
OPTIONS/SARS EMPLOYEES IN PRICE EXPIRATION --------------------
NAME GRANTED(#)(1) FISCAL YEAR ($/SH)(2) DATE 5% 10%
---- ------------- ------------ --------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Gerald J. Yakatan........... 300,000 44% $1.81 3/13/08 $341,961 $866,597
Timothy R. Russell.......... 10,000 1% $1.28 7/10/08 $ 8,050 $ 20,400
James E. Berg............... 25,000 4% $1.28 7/10/08 $ 20,125 $ 51,000
David H. Katz(4)............ -- -- -- -- --
Jeffery B. Weinress(5)...... 100,000 15% $2.28 5/31/99 $143,482 $363,612
</TABLE>

- ---------------
(1) These options vest over three years, with one-third vesting on the first
anniversary of the date of grant, and the remaining two-thirds vesting
during the next two years on a daily basis. Vesting may be accelerated and
the options may be repriced at the discretion of the Board. In the event of
a specified corporate transaction such as a dissolution, merger or other
reorganization of the Company in which more than 50% of the Company's stock
is exchanged, vesting on such options shall be accelerated unless the
surviving corporation assumes the options outstanding, substitutes similar
rights for outstanding options, or the options shall continue.

(2) Market price on date of grant.

(3) The potential realizable value is calculated by assuming that the stock
price on the date of grant appreciates at the indicated rate, compounded
annually, for the entire term of the option and that the option is exercised
and sold on the last day of its term at this appreciated stock price.

(4) Dr. Katz's employment with the Company terminated on March 4, 1998. During
Fiscal 1998, Dr. Katz was granted stock options as a director, See
"Executive Compensation" above.

(5) Mr. Weinress served as Vice President, Chief Financial Officer from November
3, 1997 to July 10, 1998. Of the 100,000 options noted above, 20,000 options
had vested as of the date of termination. Such options are exercisable
through May 31, 1999. The calculation above is based on the 100,000 options
granted in Fiscal 1998.

OPTION EXERCISES IN FISCAL 1998

Set forth below is information with respect to exercises of stock options
by the Named Executive Officers during Fiscal 98 and the fiscal year-end value
of all unexercised stock options held by such persons.

AGGREGATED OPTION EXERCISES IN FISCAL 1998 AND FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
NUMBER OF OPTIONS VALUE OF IN-THE-MONEY
HELD AT FISCAL OPTIONS
SHARES YEAR-END(#) AT FISCAL YEAR-END($)(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Gerald J. Yakatan........... -- -- 326,996 113,004 -- --
Timothy R. Russell.......... -- -- 198,909 21,091 -- --
James E. Berg............... -- -- 102,565 21,435 $ 1,500 --
David H. Katz............... -- -- 2,202,000 10,000 $417,188 --
Jeffery B. Weinress......... 20,000 -- -- --
</TABLE>

- ---------------
(1) Based upon the closing bid price of the Company's Common Stock of $1.125
quoted on the NASDAQ National Market System on September 30, 1998.

20
<PAGE> 24

EMPLOYMENT CONTRACTS, RETENTION AGREEMENTS AND TERMINATION OF EMPLOYMENT
ARRANGEMENTS

In March 1998, the Company entered into an employment agreement with Dr.
Gerald J. Yakatan, the Company's President and Chief Executive Officer. Dr.
Yakatan's employment agreement provides that Dr. Yakatan's employment with the
Company is "at-will," subject to the discretion of the Board, Dr. Yakatan's
annual base salary is $300,000, and he is eligible for a discretionary incentive
bonus. Dr. Yakatan received a grant of 300,000 stock options pursuant to the
1994 Option Plan, at an exercise price equal to $1.8125 (the fair market value
of the Company's Class A Common Stock on the date of the grant), of which
103,389 consisted of non-qualified stock options and 196,611 consisted of
incentive stock options. Stock options exercisable into 100,000 shares of Class
A Common Stock vest immediately, with the remainder of the stock options vesting
in four equal annual increments of 50,000 per year on the anniversary date of
Dr. Yakatan's employment, commencing on March 4, 1999.

In the event of a Change of Control Termination (as defined below) in the
first three years of Dr. Yakatan's employment, or in the event Dr. Yakatan is
otherwise terminated without cause as defined in the agreement, Dr. Yakatan is
eligible for severance in an amount equal to twelve (12) months of base salary
paid over a twelve (12) month period in exchange for his execution of a release
of all claims effective as of the termination date. In the event of a
termination without cause of the employment relationship or in the event of a
Change of Control Termination which occurs after the first year of employment,
vesting of the unvested options described above will be accelerated to include
options that would otherwise have vested had Dr. Yakatan remained an employee of
the Company for an additional twelve (12) months. In the event of a "Change of
Control Termination" of the employment relationship in the first year of
employment, vesting of the options described above will be accelerated to
include options that would otherwise have vested had Dr. Yakatan remained an
employee of the Company for an additional twenty four (24) months. In the event
of a Change of Control Termination within Dr. Yakatan's first year of
employment, upon Dr. Yakatan's request, he will have up to twelve (12) months
following the date of termination to exercise any vested options. In the event
of any other termination of Dr. Yakatan's employment, Dr Yakatan's vested
options will be exercisable in all respects in accordance with the terms of the
1994 Option Plan.

In April 1993, the Company entered into an employment agreement with David
H. Katz, M.D. (the "1993 Employment Agreement"), which replaced the prior
employment agreement between Dr. Katz and the Company dated September 9, 1988,
as amended on September 19, 1989 and October 8, 1989, respectively (the "1988
Employment Agreement"). On March 4, 1998, David H. Katz, M.D. was terminated for
cause as President and CEO of the Company. The 1993 Employment Agreement
provided that Dr. Katz's employment with the Company was on an "at will" basis,
subject to the discretion of the Board, for an annual base salary of $207,692.
Dr. Katz's salary was based on allocating 75% of his time to the Company and 25%
to the Medical Biology Institute. Dr. Katz's salary was reviewed by the
Compensation Committee of the Board of the Company from time to time to
determine, within the Board's discretion, whether an increase was appropriate.
In March 1994 and June 1997, the board increased Dr. Katz's annual base salary
to $228,000 and $240,000, respectively. Dr. Katz was also entitled to all
benefits generally available to the Company's employees. Under the 1993
Employment Agreement, in the event that Dr. Katz had been terminated for any
reason other than cause, Dr. Katz would have been entitled to receive a
severance payment in the amount of his annual base salary, payable over twelve
months. Dr. Katz has filed a lawsuit seeking a determination that his
termination was not "for cause." See "Certain Relationships and Transactions,"
below.

In April 1998, the Company entered into Retention Agreements (the
"Retention Agreements") with certain of its vice presidents and certain director
level employees, including Messrs. Berg and Russell. In the event of a
termination of the employee's employment within one (1) year of execution of the
agreement related to a "Change of Control Termination," as defined below, (1)
the employee is eligible for severance in an amount equal to twelve (12) months
of base salary, plus cost of health insurance, paid over a twelve (12) month
period in exchange for his execution of a release of all claims effective as of
the termination date.

For purposes of both Dr. Yakatan's employment agreement and the Retention
Agreements, "Change of Control Termination" of the employment relationship
occurs where the employee is (i) terminated without "Cause" or (ii) "Resigns for
Good Reason," within twelve (12) months following a "Change of Control."

21
<PAGE> 25

"Change of Control" is defined to have occurred if, and only if, during the
applicable period: (1) any individual, partnership, firm, corporation,
association, trust, unincorporated organization or other entity or person, or
any syndicate or group deemed to be a person under Section 14(d)(2) of the
Exchange Act is or becomes the "Beneficial Owner" (as defined in Rule 13d-3 of
the General Rules and Regulations under the Exchange Act), directly or
indirectly, of securities of the Company representing 50% or more of the
combined voting power of the Company's then outstanding securities entitled to
vote in the election of directors of the Company; (2) the following persons
cease to constitute a majority of the Board: (a) individuals who constituted the
Board at the beginning of the Term (the "Incumbent Directors"); (b) individuals
(the "New Directors") who were elected by, or whose nomination for election by
the Company's shareholders was approved by a majority of the Incumbent
Directors; and (c) individuals who were elected by, or whose nomination for
election by the Company's shareholders was approved by, a majority of the
Incumbent Directors and the New Directors still serving as Board Members at the
time of such election; (3) there occurs a reorganization, merger, consolidation
or other corporate transaction involving the Company ("Transaction"), in each
case, with respect to which the stockholders of the Company immediately prior to
such Transaction do not, immediately after the Transaction, own more than fifty
percent (50%) of the combined voting power of the Company or other corporation
resulting from such Transaction; or (4) all or substantially all of the assets
of the Company are sold, liquidated or distributed. "Resignation for Good
Reason" is defined as resignation based on (1) a meaningful and detrimental
alteration in the employee's position or the nature or status of the employee's
responsibilities and reporting relationship from those in effect upon execution
of this Agreement; (2) the assignment to the employee of any duties inconsistent
with his status as an executive officer of Company; (3) a reduction by the
Company in the employee's Base Salary by greater than five percent (5%), except
to the extent the base salaries of other executive officers of the Company are
accordingly reduced; (4) a relocation of the employee's or the Company's
principal executive offices to a location outside San Diego County, if the
employee's principal office is at such offices, without reimbursement of
relocation costs; and (5) any other conduct which satisfies the requirements for
"constructive termination" as that term is defined under California law.

CERTAIN RELATIONSHIPS AND TRANSACTIONS

David H. Katz, who served as President and CEO until March 4, 1998 and
currently serves as a director of the Company, was also President and CEO of MBI
until May 14, 1998. (see "Employment Contracts, Retention Agreements and
Termination of Employment Arrangements, above). On April 30, 1998, Dr. Katz
filed a Complaint for Declaratory Relief (the "Katz Complaint") against the
Company seeking to overturn certain actions of the Company. The Katz Complaint
seeks various relief including (i) a declaration of the court that the action
taken by the Board of Directors to terminate his employment as President is null
and void; (ii) a declaration that the election of Gerald J. Yakatan, Ph.D., as a
Director and as the President and Chief Executive Officer is void; (iii) a
declaration that 234,000 shares of Class A Common Stock (returned to Dr. Katz
incident to a rescission of his personal transactions with HealthMed) is
restored to Class B Voting Rights, (see Footnote 4 to "Security Ownership of
Certain Beneficial Owners and Management"); (iv) a determination that the
termination of his employment was not "for cause," which would entitle him to
certain severance benefits, and (v) an accounting of personal funds he allegedly
advanced to the Company, and an award of unspecified money damages for emotional
distress and defamation.

On October 30, 1998, the Company filed a cross-complaint against Dr. Katz
seeking recovery of, among other things, compensatory and punitive damages for
his breach of fiduciary duties as a director and officer of the Company.

On August 27, 1998, the Company reached a Settlement Agreement and Mutual
General Release with Medical Biology Institute (the "MBI Settlement Agreement")
to settle all outstanding disputes between the two companies, specifically
including the disputed ownership to the Company's proprietary therapeutic
compound, docosanol cream as well as other technologies. The MBI Settlement
Agreement provides for the Company to retain all rights to docosanol cream and
certain other technologies. In return for obtaining full control of the
Company's technologies and avoidance of potential future royalty payments, the
Company loaned $500,000 to MBI and returned other technologies that no longer
fit the Company's long-term strategic

22
<PAGE> 26

plans. The loan will be forgiven by the Company, subject to certain loan
covenants to be maintained by MBI over a 180-day period.

BOARD COMPENSATION COMMITTEE
REPORT ON EXECUTIVE COMPENSATION

The Executive Compensation and Stock Option Committee (the "Committee")
recommends to the Board compensation for the Company's directors and officers
and oversees the administration of the Company's employee stock option plans.
All decisions of the Committee relating to compensation of the Company's
executive officers are reviewed and approved by the entire Board of Directors.

COMPENSATION POLICY

The Company's executive compensation policy is designed to establish an
appropriate relationship between executive pay and the Company's annual
performance, its long-term growth objectives and its ability to attract and
retain qualified executive officers. The Committee attempts to achieve these
goals by integrating on an individualized basis competitive annual base salaries
with stock options through the Company's stock option plans and otherwise. The
Committee believes that cash compensation in the form of salary and bonus
provides the Company's executives with short term rewards for success in
operations, and that long term compensation through the award of stock options
better coordinates the objectives of management with those of the shareholders
with respect to the long term performance and success of the Company. The
Committee generally takes into consideration a variety of subjective and
objective factors in determining the compensation package for executive
officers, including how compensation compares to that paid by competing
companies and the responsibilities and performance by each executive and the
Company as a whole. In making its determinations, the Committee attempts to
address the unique challenges which are present in the biotechnology industry in
which the Company competes against a number of public and private companies with
respect to attracting and retaining executives and other key employees.

The Committee has relied heavily on the equity/option position of
executives as an important mechanism to retain and motivate executives and key
employees while at the same time aligning the interests of the executives with
the interests of the shareholders generally. The Committee believes that option
grants are instrumental in motivating employees to meet the Company's future
goals. By working to increase the Company's value, one of the Company's primary
performance goals is met and the executives are likewise compensated through
option value.

COMPENSATION OF CHIEF EXECUTIVE OFFICER

As discussed above under "Employment Contracts, Retention Agreements and
Termination of Employment Agreements," the Company has entered into an
employment agreement with Dr. Yakatan which provides for an annual base salary
of $300,000 and the grant of 300,000 stock options, among other terms and
conditions.

Also as discussed above under "Employment Contracts and Termination of
Employment Agreements," the Company entered into an employment agreement with
Dr. Katz in April 1993, providing, among other things, for an annual base salary
of $207,692, based on Dr. Katz's allocating 75% of his time to the Company. In
June 1997, the Board increased this base salary to $240,000. Dr. Katz was
terminated as the President and CEO of the Company on March 4, 1998.

23
<PAGE> 27

COMPENSATION ARRANGEMENTS GENERALLY

Overall, the Committee believes that the compensation arrangements for the
Company's executives serve the long term interests of the Company and its
shareholders and that, in particular, the equity/option positions of executives
are an important factor in retaining and attracting key executives. Nonetheless,
the Committee intends to continue to review and analyze its policies in light of
the performance and development of the Company and the environment in which it
competes for executives and to retain outside compensation consultants from time
to time to assist the Committee in such review and analysis.

Executive Compensation and
Stock Option Committee

Dennis J. Carlo, Ph.D., Chairman
Edward L. Hennessy, Jr.
Kenneth E. Olson
Joseph E. Smith

November 20, 1998

The foregoing reports of the Committee shall not be deemed incorporated by
reference by any general statement incorporating by reference the Proxy
Statement into any filing under the Securities Act of 1933, as amended, or the
Exchange Act, except to the extent that the Company specifically incorporates
this information by reference, and shall not otherwise be deemed filed under
such acts.

24
<PAGE> 28

PERFORMANCE GRAPH

The graph below compares the cumulative total shareholder return on the
Company's Class A Common Stock from September 30, 1993 to September 30, 1998
with the cumulative total return of the NASDAQ U.S. Index and the NASDAQ
Pharmaceutical Index over the same period.

AVANIR PHARMACEUTICALS

COMPARISON OF FIVE YEAR CUMULATIVE SHAREHOLDER TOTAL RETURN*
AMONG AVANIR PHARMACEUTICALS(1), THE NASDAQ STOCK MARKET-US INDEX
AND THE NASDAQ PHARMACEUTICAL INDEX

<TABLE>
<CAPTION>
AVANIR NASDAQ STOCK MARKET
PHARMACEUTICALS(1) (U.S.) NASDAQ PHARMACEUTICAL
------------------ ------------------- ---------------------
<S> <C> <C> <C>
1993 100 100 100
1994 29.71 100.83 86.9
1995 56.52 139.28 128.33
1996 21.01 165.24 154.68
1997 28.62 226.81 172.59
1998 13.04 231.84 149.39
</TABLE>

- ---------------

(1) Prior to November 20, 1998, the Company operated under the name, LIDAK
Pharmaceuticals and traded on the Nasdaq National Market under the symbol
LDAKA. The Company's trading symbol is now AVNR.

* The graph assumes that $100.00 was invested in the Company's Class A Common
Stock and in each index on September 30, 1993.

** The total return for the Company's Class A Common Stock and the indices used
assumes the reinvestment of dividends. No dividends have been declared on
the Company's Class A Common Stock.

Pursuant to SEC regulations, this chart is not "soliciting material", is
not deemed filed with the SEC, and is not to be incorporated by reference in any
filing of the Company under the Securities Act of 1933, as amended, or the
Exchange Act.

OTHER BUSINESS

The Company knows of no other matters to be submitted at the Annual
Meeting. If any other matters are properly brought before the Annual Meeting or
any adjournment thereof, it is the intention of the persons named in the
enclosed proxy to vote the shares they represent in accordance with their
judgment. In order for any shareholder to nominate a candidate or to submit a
proposal for other business to be acted upon at the Annual Meeting, he or she
must provide the Secretary of the Company with not less than sixty (60) days'
advance written notice thereof in the form prescribed by the Company's Bylaws.

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SHAREHOLDER PROPOSALS TO BE PRESENTED
AT NEXT ANNUAL MEETING

Proposals of shareholders intended to be presented by such shareholders at
next year's Annual Meeting must be received by the Company at its principal
office no later than December 18, 1999, and must satisfy the conditions
established by the SEC for shareholder proposals to be included in the Company's
proxy statement for that meeting.

FORM 10-K

A copy of the Company's Annual Report for the fiscal year ended September
30, 1998 is being mailed with this proxy statement to shareholders entitled to
notice of the Annual Meeting. At any shareholder's written request, the Company
will provide without charge, a copy of the Company's Annual Report on Form 10-K
for the fiscal year ended September 30, 1998, as filed with the SEC, including
the financial statements and a list of exhibits. If copies of exhibits are
requested, a copying charge of $0.20 per page will be made. Requests should be
sent to Investor Relations, AVANIR Pharmaceuticals, 9393 Towne Centre Drive,
Suite 200, San Diego, California, 92121.

Each shareholder is urged to complete, date, sign and promptly return the
enclosed proxy card.

By Order of the Board of Directors

/s/ Gregory P. Hanson
GREGORY P. HANSON
Secretary

San Diego, California

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<PAGE> 30

ATTACHMENT A

AVANIR PHARMACEUTICALS
1998 STOCK OPTION PLAN

SECTION 1. Establishment And Purpose.

This Plan was established in 1998 to offer selected Employees, directors,
advisors and Consultants an opportunity to acquire a proprietary interest in the
success of AVANIR Pharmaceuticals, a California corporation (the "Company"), or
to increase such interest, by purchasing Shares of the Company's common stock.
This Plan provides for the grant of Options to purchase Shares. Options granted
under this Plan may include Nonstatutory Options as well as ISOs intended to
qualify under Section 422 of the Code. This Plan is intended to comply in all
respects with Rule 16b-3 (or its successor) under the Exchange Act.

SECTION 2. Definitions.

(a) "Board of Directors" shall mean the Board of Directors of the Company,
as constituted from time to time.

(b) "Code" shall mean the Internal Revenue Code of 1986, as amended.

(c) "Committee" shall mean a committee of the Board of Directors,
consisting of Nonemployee Directors as appointed by the Board of Directors from
time to time, or, if no such committee is appointed, all members of the Board of
Directors described in Section 3(a) of this Plan.

(d) "Company" shall mean AVANIR Pharmaceuticals, a California corporation.

(e) "Consultant" shall mean any individual who is (i) a member of the Board
of Directors but who is not an Employee, (ii) an affiliate of a member of the
Board of Directors, (iii) a member of the board of directors of a Subsidiary or
(iv) an independent contractor who performs services for the Company or a
Subsidiary.

(f) "Employee" shall include every individual performing Service to the
Company or its Subsidiaries if the relationship between such individual and the
Company or its Subsidiaries is the legal relationship of employer and employee.
This definition of "Employee" is qualified in its entirety and is subject to the
definition set forth in Section 3401(c) of the Code and the applicable
regulations thereunder.

(g) "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended.

(h) "Exercise Price" shall mean the amount for which one Share may be
purchased upon exercise of an Option, as specified by the Committee in the
applicable Stock Option Agreement.

(i) "Fair Market Value" shall mean the market price of Stock, determined by
the Committee as follows:

(1) If Stock was traded over-the-counter on the date in question but
was not classified as a national market issue, then the Fair Market Value
shall be equal to the mean between the last reported representative bid and
asked prices quoted by the NASDAQ system for such date;

(2) If Stock was traded over-the-counter on the date in question and
was classified as a national market issue, then the Fair Market Value shall
be equal to the last-transaction price quoted by the NASDAQ system for such
date;

(3) If Stock was traded on a stock exchange on the date in question,
then the Fair Market Value shall be equal to the closing price reported by
the applicable composite-transaction report for such date; and

(4) If none of the foregoing provisions is applicable, then the Fair
Market Value shall be determined by the Committee in good faith and in
accordance with Section 260.140.50, Title 10 of the California Code of
Regulations, or with respect to the determination of Fair Market Value in
connection

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with the exercise of any Options granted to Nonemployee Directors under
Section 4(b) of this Plan, by an independent appraiser selected by the
Committee in its sole discretion.

In all cases, the determination of Fair Market Value by the Committee shall
be conclusive and binding on all persons.

(j) "ISO" shall mean an incentive stock option described in Section 422(b)
of the Code.

(k) "Nonemployee Director" shall mean a member of the Board of Directors
who (i) is not currently an officer or Employee of the Company or a parent or
Subsidiary of the Company, (ii) has not received compensation for serving as a
Consultant or in any other non-director capacity or had an interest in any
transaction with the Company or a parent or Subsidiary of the Company that would
exceed the $60,000 threshold for which disclosure would be required under Item
404(a) of Regulation S-K, or (iii) has not been engaged through another party in
a business relationship with the Company which would be disclosable under Item
404(b) of Regulation S-K. If the Board of Directors determines that compliance
with Section 162(m) of the Code is desirable, then the term "Nonemployee
Director" shall also be interpreted to satisfy the definition of "outside
director" under Section 162(m) and applicable regulations issued pursuant
thereto.

(l) "Nonstatutory Option" shall mean a Stock Option not described in
Sections 422(b) or 423(b) of the Code.

(m) "Option" shall mean an ISO or Nonstatutory Option granted under this
Plan and entitling the holder to purchase Shares.

(n) "Optionee" shall mean an individual who holds an Option.

(o) "Plan" shall mean the 1998 Stock Option Plan of the Company, as
amended.

(p) "Service" shall mean service as an Employee or Consultant.

(q) "Share" shall mean one share of Stock, as adjusted in accordance with
Section 8 of this Plan (if applicable).

(r) "Stock" shall mean the Common Stock of the Company.

(s) "Stock Option Agreement" shall mean the agreement between the Company
and an Optionee which contains the terms, conditions and restrictions pertaining
to his or her Option.

(t) "Stock Purchase Agreement" shall mean the Notice of Exercise and Stock
Purchase Agreement to be delivered by an Optionee to the Company upon exercise
of an Option.

(u) "Subsidiary" shall mean any corporation, if the Company and/or one or
more other Subsidiaries own not less than 50 percent of the total combined
voting power of all classes of outstanding Stock of such corporation. A
corporation that attains the status of a Subsidiary on a date after the adoption
of this Plan shall be considered a Subsidiary commencing as of such date.

(v) "Taxes" shall mean the term defined in Section 6(d)(1) of this Plan.

(w) "Total and Permanent Disability" shall mean that the Optionee is unable
to engage in any substantial gainful activity by reason of any medically
determinable physical or mental impairment which can be expected to result in
death or which has lasted, or can be expected to last, for a continuous period
of not less than one year.

SECTION 3. Administration.

(a) Committee Membership. This Plan shall be administered by the Committee.
The Committee shall be comprised either (i) solely of Nonemployee Directors of
the Company and shall have at least two members or (ii) of the entire Board of
Directors if no such committee is appointed. The Committee shall meet such other
requirements as may be established from time to time by the Securities and
Exchange Commission for plans intended to qualify for exemption under Rule 16b-3
(or its successor) under the Exchange Act. The Board of Directors may appoint a
separate committee of the Board of Directors, comprised of two or more
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<PAGE> 32

directors of the Company who need not be Nonemployee Directors, who may
administer this Plan with respect to Employees or Consultants who are not
officers or directors of the Company or incoming new directors of the Company,
may grant Options under this Plan to such persons and may determine the timing,
number of Shares subject to such Options and other terms of such grants.

(b) Committee Procedures. The Committee shall designate one of its members
as chairman. The Committee may hold meetings at such times and places as it
shall determine. The acts of a majority of the Committee's members present at
meetings at which a quorum exists, or acts reduced to or approved in writing by
all of the Committee's members, shall be valid acts of the Committee.

(c) Committee Responsibilities. Subject to the provisions of this Plan, and
without further approval of the Board of Directors, the Committee shall have
full authority and discretion to take the following actions:

(1) To interpret this Plan and to apply its provisions;

(2) To adopt, amend or rescind rules, procedures and forms relating to
this Plan;

(3) To authorize any person to execute, on behalf of the Company, any
instrument required to carry out the purposes of this Plan;

(4) To determine when Options are to be granted under this Plan;

(5) To select the Optionees;

(6) To determine the number of Shares to be made subject to each
Option;

(7) To prescribe the terms and conditions of each Option, including,
without limitation, the Exercise Price, to determine whether such Option is
to be classified as an ISO or as a Nonstatutory Option, and to specify the
provisions of the Stock Option Agreement relating to such Option;

(8) To amend any outstanding Stock Option Agreement, subject to
applicable legal restrictions and to the consent of the Optionee who
entered into such agreement;

(9) To accelerate or defer, with the consent of the Optionee, the
exercise date of any Option;

(10) With the consent of the Optionee, to reprice, cancel and regrant,
or otherwise adjust the Exercise Price of an Option previously granted by
the Committee;

(11) To prescribe the consideration for the grant of each Option or
other right under this Plan and to determine the sufficiency of such
consideration; and

(12) To take any other actions deemed necessary or advisable for the
administration of this Plan.

All decisions, interpretations and other actions of the Committee shall be
final and binding on all Optionees, and all persons deriving their rights from
an Optionee. No member of the Committee shall be liable for any action that he
or she has taken or has failed to take in good faith with respect to this Plan,
any Option, or any other right to acquire Shares under this Plan.

SECTION 4. Eligibility.

(a) General Rule. Employees and Consultants shall be eligible to receive
Options. However, only Employees shall be eligible for the grant of ISOs.

(b) Ten-Percent Stockholders. An Employee who owns more than 10 percent of
the total combined voting power of all classes of Outstanding Stock of the
Company or any of its Subsidiaries shall not be eligible for the grant of an
Option unless (i) the Exercise Price is at least 110 percent of the Fair Market
Value of the Shares underlying such Option on the date of grant of such Option
and (ii) if such Option is an ISO, such ISO is not exercisable after the
expiration of five years from the date of grant.

(c) Attribution Rules. For purposes of Subsection (b) above, in determining
Stock ownership, an Employee shall be deemed to own the Stock owned, directly or
indirectly, by or for such Employee's brothers, sisters, spouse, ancestors and
lineal descendants. Stock owned, directly or indirectly, by or for a
corporation,
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<PAGE> 33

partnership, estate or trust shall be deemed to be owned proportionately by or
for its stockholders, partners or beneficiaries. Stock with respect to which
such Employee holds an Option shall be counted in the determination of Stock
ownership for purposes of the above Subsection (b).

(d) Outstanding Stock. For purposes of Subsection (b) above, "Outstanding
Stock" shall include all Stock actually issued and outstanding immediately after
the grant. "Outstanding Stock" shall not include Shares authorized for issuance
under outstanding Options held by the Employee or by any other person.

SECTION 5. Stock Subject to this Plan.

(a) Basic Limitation. Shares subject to Options granted under this Plan
shall be authorized but unissued Shares. The aggregate number of Shares which
may be issued under this Plan (upon exercise of Options or other rights to
acquire Shares) shall not exceed 1,875,000 Shares, subject to adjustment
pursuant to Section 8 of this Plan. The number of Shares which is subject to
Options or other rights outstanding at any time under this Plan shall not exceed
the number of Shares which then remain available for issuance under this Plan.
The Company, during the term of this Plan, shall at all times reserve and keep
available sufficient Shares to satisfy the requirements of this Plan.

(b) Additional Shares. In the event that any outstanding Option or other
right for any reason expires or is canceled or otherwise terminated, the Shares
allocable to the unexercised portion of such Option or other right shall again
be available for the purpose of this Plan.

(c) Limitation on Grants. The maximum number of Shares as to which Options
shall be granted to any single Optionee shall not exceed 500,000 Shares.

SECTION 6. Terms and Conditions of Options.

(a) Stock Option Agreement. Each grant of an Option under this Plan shall
be evidenced by a Stock Option Agreement between the Optionee and the Company.
Such Option shall be subject to all applicable terms and conditions of this Plan
and may be subject to any other terms and conditions which are not inconsistent
with this Plan and which the Committee deems appropriate for inclusion in a
Stock Option Agreement. The provisions of the various Stock Option Agreements
entered into under this Plan need not be identical.

(b) Number of Shares. Each Stock Option Agreement shall specify the number
of Shares that are subject to the Option and shall provide for the adjustment of
such number in accordance with Section 8 of this Plan. The Stock Option
Agreement shall also specify whether the Option is an ISO or a Nonstatutory
Option.

(c) Exercise Price. Each Stock Option Agreement shall specify the Exercise
Price. The Exercise Price of an ISO shall not be less than 100 percent of the
Fair Market Value of a Share on the date of grant of the Option, except as
otherwise provided in Section 4(b) of this Plan. The Exercise Price of a
Nonstatutory Option shall not be less than 85 percent of the Fair Market Value
of a Share on the date of grant. Subject to the preceding two sentences, the
Exercise Price under any Option shall be determined by the Committee in its sole
discretion. The Exercise Price shall be payable in a form described in Section 7
of this Plan.

(d) Withholding Taxes. The Company's obligation to deliver Shares or cash
upon the exercise of Options shall be subject to the satisfaction of all
applicable Federal, State and local income tax and employment tax withholding
requirements.

(1) In the event that the Company or a Subsidiary determines that it
is required to withhold federal, state, foreign or local taxes or social
security/insurance amounts in connection with the grant or exercise of an
Option or the disposition of Shares pursuant to the exercise of an Option
(collectively, the "Taxes"), the Optionee or any person succeeding to the
rights of the Optionee, as a condition to such grant, exercise or
disposition, may be required to make arrangements satisfactory to the
Company or such Subsidiary to enable it to satisfy such withholding
requirements. Alternatively, at its discretion, the Company may issue or
transfer Shares net of the number of Shares sufficient to satisfy the
withholding requirements, with such Shares valued as of the date the
withholding obligation is incurred.

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<PAGE> 34

(2) The Committee may also, in its discretion and applying relevant
law in accordance with the provisions of this Section 6(d) and such
supplemental rules as the Committee may from time to time adopt, require as
a condition of delivery of the Shares upon exercise of Options, that the
Optionee remit to the Company an amount in cash or check sufficient to
satisfy the Taxes.

(3) The Committee may, in its discretion and in accordance with the
provisions of this Section 6(d) and such supplemental rules as the
Committee may from time to time adopt, provide any or all Optionees holding
Nonstatutory Options with the right to use Shares in satisfaction of all or
part of the Federal, State and local income tax and employment tax
liabilities incurred by such Optionees in connection with the exercise of
their Options (the "Taxes"). The Optionee holding a Nonstatutory Option may
be provided with the election to have the Company withhold, from the Shares
otherwise issuable upon the exercise of such Nonstatutory Option, a portion
of such Shares with an aggregate Fair Market Value equal to the designated
percentage (up to 100% as specified by the Optionee) of the applicable
Taxes. Any such withholding election shall be subject to the following
terms and conditions:

(i) The election must be made on or before the date the amount of
the Taxes incurred by the Optionee in connection with the exercise of
the Option is determined (the "Tax Determination Date").

(ii) The election shall be irrevocable.

(iii) The election shall be subject to the approval of the
Committee and none of the Shares for which the Option is exercised shall
be withheld in satisfaction of the Taxes incurred by the Optionee in
connection with such exercise, except to the extent the election is
approved by the Committee.

(iv) The Shares withheld pursuant to the election shall be valued
at Fair Market Value on the Tax Determination Date.

(v) In no event may the number of Shares requested to be withheld
exceed in value the dollar amount of Taxes incurred by the Optionee in
connection with the exercise of the Nonstatutory Option.

(vi) If the withholding election is to be made by an Optionee who
is at the time an officer or director of the Company subject to the
short-swing profit restrictions of Section 16(b) of the Exchange Act,
then the following limitations, in addition to the preceding provisions
of this Section 6(d), shall also be applicable:

(A) The election shall not become effective at any time prior to
the expiration of the six month period measured from the later of the
grant date of the Nonstatutory Option to which such election pertains
or the actual grant date of the withholding election, and no Shares
shall accordingly be withheld in connection with any Tax
Determination Date which occurs before the expiration of such six
month period.

(B) The election must be effected in accordance with either of
the following guidelines: (1) the election must be made six months or
more prior to the Tax Determination Date, and (2) the exercise of
such election and the exercise of the Nonstatutory Option to which
such election relates must occur concurrently within a quarterly
"window" period. Quarterly window periods shall begin on the third
business day following the date of public release of each quarterly
or annual summary statement of the Company's sales and earning and
end on the earlier of the 12th business day following such release
date or the Tax Determination Date.

(C) The six month period specified in clauses (A) and (B) shall
not be applicable in the event of the Optionee's death or disability.

(e) Exercisability and Term. Each Stock Option Agreement shall specify the
date when all or any installment of the Option is to become exercisable. The
vesting of any Option shall be determined by the Committee in its sole
discretion; provided, however, that the Optionee's right to exercise the Option
shall be at the rate of at least 20% per year over five years from the date when
the Option is granted. A Stock Option

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<PAGE> 35

Agreement may provide for accelerated exercisability in the event of the
Optionee's death, Total and Permanent Disability or retirement or other events
determined from time to time by the Committee. The Stock Option Agreement shall
also specify the term of the Option, which term shall not exceed ten years from
the date of grant. Subject to the preceding sentence, the Committee in its sole
discretion shall determine when an Option is to expire. An Option shall be
deemed exercised when the Company receives from the Optionee (i) an executed
Stock Purchase Agreement in accordance with the terms of the Option by the
person entitled to exercise the Option and (ii) full payment for the Shares with
respect to which the Option is exercised. Full payment may, as authorized by the
Committee, consist of any consideration and method of payment allowable under
Section 7 of this Plan. Until the issuance (as evidenced by the appropriate
entry on the books of the Company or of a duly authorized transfer agent of the
Company) of the stock certificate evidencing such Shares, no right to vote or
receive dividends or any other rights as a shareholder of the Company shall
exist with respect to the Shares, notwithstanding the exercise of the Option. No
adjustment will be made for a dividend or other right for which the record date
is prior to the date when the stock certificate is issued, except as provided in
Section 8 of this Plan. With respect to any ISOs granted under this Plan, the
aggregate Fair Market Value (determined as of the respective date or dates of
grant) of the Shares for which one or more Options granted to any Employee under
this Plan (or any other option plan of the Company or its parent or Subsidiary
corporations) may for the first time become exercisable as ISOs during any one
calendar year shall not exceed the sum of One Hundred Thousand Dollars
($100,000). To the extent the Employee holds two or more such Options which
become exercisable for the first time in the same calendar year, the foregoing
limitation on the exercisability thereof as ISOs shall be applied on the basis
of the order in which such Options are granted. To the extent such dollar
limitation is exceeded in any one calendar year, the Option shall nevertheless
be exercisable for the excess number of Shares as a Nonstatutory Option.

(f) Nontransferability. During an Optionee's lifetime, such Optionee's
Option(s) shall be exercisable only by him or her and shall not be transferable.
In the event of an Optionee's death, such Optionee's Option(s) shall not be
transferable other than by will or by the laws of descent and distribution.

(g) Termination of Service (Except by Death). If an Optionee's Service
terminates for any reason other than such Optionee's death, then such Optionee's
Option(s) shall expire on the earliest of the following occasions:

(1) The expiration date determined pursuant to Subsection (e) above;

(2) The date which is thirty (30) days after the termination of the
Optionee's Service for any reason other than Total and Permanent
Disability; or

(3) The date which is six (6) months after the termination of the
Optionee's Service by reason of Total and Permanent Disability.

(h) The Optionee may exercise all or part of his or her Option(s) at any
time before the expiration of such Option(s) under the preceding sentence, but
only to the extent that such Option(s) had become exercisable before the
Optionee's Service terminated or became exercisable as a result of the
termination. The balance of such Option(s) shall lapse when the Optionee's
Service terminates. In the event that the Optionee dies after the termination of
the Optionee's Service but before the expiration of the Optionee's Option(s),
all or part of such Option(s) may be exercised (prior to expiration) by the
executors or administrators of the Optionee's estate or by any person who has
acquired such Option(s) directly from the Optionee by bequest or inheritance,
but only to the extent that such Option(s) had become exercisable before the
Optionee's Service terminated or became exercisable as a result of the
termination. For purposes of the foregoing provisions of this Subsection 6(g),
the Optionee shall be deemed to be providing Service to the Company for so long
as the Optionee renders Service on a periodic basis to the Company or a
Subsidiary in the capacity of an Employee or Consultant. The Optionee shall be
considered to be an Employee for so long as the Optionee remains in the employ
of the Company or a Subsidiary.

(i) Leaves of Absence. For purposes of Subsection (g) above, Service shall
be deemed to continue while the Optionee is on military leave, sick leave or
other bona fide leave of absence (as determined by the Committee). The foregoing
notwithstanding, in the case of an ISO granted under this Plan, Service shall
not

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<PAGE> 36

be deemed to continue beyond the first 90 days of such leave, unless the
Optionee's reemployment rights are guaranteed by statute or by contract.

(j) Death of Optionee. If an Optionee dies while he or she is providing
Service to the Company, then such Optionee's Option(s) shall expire on the
earlier of the following dates:

(1) The expiration date determined pursuant to Subsection (e) above;
or

(2) The date which is six (6) months after the Optionee's death.

All or part of the Optionee's Option(s) may be exercised at any time before
the expiration of such Option(s) under the preceding sentence by the
executors or administrators of the Optionee's estate or by any person who
has acquired such Option(s) directly from the Optionee by bequest or
inheritance, but only to the extent that such Option(s) had become
exercisable before the Optionee's death or became exercisable as a result
of the Optionee's death. The balance of such Option(s) shall lapse when the
Optionee dies.

(k) No Rights as a Stockholder. An Optionee, or a transferee of an
Optionee, shall have no rights as a stockholder with respect to any Shares
covered by his or her Option until the date of the issuance of a stock
certificate for such Shares. No adjustments shall be made, except as provided in
Section 8 of this Plan.

(l) Modification, Extension and Renewal of Options. Within the limitations
of this Plan, the Committee may modify, extend or renew outstanding Options or
may accept the cancellation of outstanding Options (to the extent not previously
exercised) in return for the grant of new Options at the same or a different
Exercise Price. The foregoing notwithstanding, no modification of an Option
shall, without the consent of the Optionee, impair such Optionee's rights or
increase his or her obligations under such Option.

(m) Restrictions on Transfer of Shares. Any Shares issued upon exercise of
an Option shall be subject to such transfer restrictions as the Committee shall
determine so long as such restrictions do not unfairly prejudice the opportunity
of the Optionee to receive the fair value of the applicable Shares under
applicable law, in addition to any general restrictions that may apply to all
holders of Stock. Options may not be transferred or assigned in any manner other
than by will or by the laws of descent or distribution.

(n) Rule 16b-3. Options granted to persons who are subject to Section 16 of
the Exchange Act shall comply with the applicable provisions of Rule 16b-3
promulgated thereunder and shall contain such additional conditions or
restrictions as may be required thereunder to qualify for the maximum exemption
from Section 16 of the Exchange Act with respect to this Plan's transactions.

SECTION 7. Payment for Shares.

(a) General Rule. The entire Exercise Price of Shares issued under this
Plan shall be payable in lawful money of the United States of America at the
time when such Shares are purchased, except as follows:

(1) In the case of an ISO granted under this Plan, payment shall be
made only pursuant to the express provisions of the applicable Stock Option
Agreement. However, the Committee (in its sole discretion) may specify in
the Stock Option Agreement that payment may be made pursuant to Subsections
(b), (c) or (d) below; or

(2) In the case of a Nonstatutory Option granted under this Plan, the
Committee (in its sole discretion) may accept payment pursuant to
Subsections (b), (c) or (d) below.

(b) Surrender of Stock. To the extent that this Subsection (b) is
applicable, payment may be made all or in part with Shares which have already
been owned by the Optionee or his or her representative for more than 12 months
and which are surrendered to the Company in good form for transfer. Such Shares
shall be valued at their Fair Market Value on the date when the new Shares are
purchased under this Plan.

(c) Exercise/Sale. To the extent that this Subsection (c) is applicable,
payment may be made by the delivery (on a form prescribed by the Company) of an
irrevocable direction to a securities broker approved by

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the Company to sell Shares and to deliver all or part of the sales proceeds to
the Company in payment of all or part of the Exercise Price and any Taxes.

(d) Exercise/Pledge. To the extent that this Subsection (d) is applicable,
payment may be made by the delivery (on a form prescribed by the Company) of an
irrevocable direction to pledge Shares to a securities broker or lender approved
by the Company, as security for a loan, and to deliver all or part of the loan
proceeds to the Company in payment of all or part of the Exercise Price and any
Taxes.

SECTION 8. Adjustment of Shares.

(a) General. In the event of a subdivision of the outstanding Stock, a
declaration of a dividend payable in Shares, a declaration of a dividend payable
in a form other than Stock in an amount that has a material effect on the value
of Stock, a combination or consolidation of the outstanding Stock (by
reclassification or otherwise) into a lesser number of Shares, a
recapitalization, a spinoff or a similar occurrence, the Committee shall make
appropriate adjustments in one or more of (i) the number of Shares available for
future grants under Section 5 of this Plan, (ii) the number of Shares covered by
each outstanding Option or (iii) the Exercise Price under each outstanding
Option.

(b) Reorganizations. In the event of any of the following transactions (a
"Corporate Transaction"):

(1) a merger or acquisition involving the Company in which the Company
is not the surviving entity, except for a transaction the principal purpose
of which is to change the State of the Company's incorporation,

(2) sale, transfer or other disposition of all or substantially all of
the assets of the Company or

(3) any other corporate reorganization or business combination in
which fifty percent (50%) or more of the Company's outstanding voting stock
is transferred to different holders in a single transaction or a series of
related transactions,

then the exercisability of each Option outstanding under the Plan shall be
automatically accelerated so that each such Option shall immediately prior
to the specified effective date for the Corporate Transaction, become fully
exercisable with respect to the total number of Shares purchasable under
such Option and may be exercised for all or any portion of such Shares.
However, an outstanding Option under the Plan shall not be so accelerated
if (i) such Option is, in connection with the Corporate Transaction, either
to be assumed by the successor corporation or parent thereof or be replaced
with a comparable option to purchase shares of the capital stock of the
successor corporation or parent thereof, or (ii) such Option is to be
replaced by a comparable cash incentive program of the successor
corporation based on the value of the option at the time of the Corporate
Transaction, or (iii) the acceleration of such Option is subject to other
applicable limitations imposed by the Committee at the time of the grant.
The determination of comparability under clauses (i) or (ii) above shall be
made by the Committee and its determination shall be final, binding and
conclusive. In connection with any such Corporate Transaction, the
exercisability as an incentive stock option under the federal tax laws of
any accelerated Options under the Plan shall remain subject to any
applicable dollar limitation of Section 6(e). Except as provided below in
this Subsection (b), upon the consummation of the Corporate Transaction,
all outstanding Options under the Plan shall, to the extent not previously
exercised or assumed by the successor corporation or its parent company,
terminate and cease to be outstanding. If the Company is the surviving
entity in any Corporate Transaction or the outstanding Options are to be
assumed in connection with such Corporate Transaction, then each Option
shall, immediately after such Corporate Transaction, be appropriately
adjusted to apply and pertain to the number and class of securities which
would be issuable to the Optionee, upon consummation of such Corporate
Transaction if the Option were exercised immediately prior to such
Corporate Transaction. Appropriate adjustments shall also be made to the
Exercise Price payable per share, provided the aggregate Exercise Price
payable upon exercise of such Option shall remain the same. In addition,
the class and number of securities available for issuance under the Plan
following the consummation of such Corporate Transaction shall be
appropriately adjusted. The grant of Options under this Plan shall in no
way affect the right of the Company to adjust, reclassify,

A-8
<PAGE> 38

reorganize or otherwise change its capital or business structure or to
merge, consolidate, dissolve, liquidate or sell or transfer all or any part
of its business or assets.

(c) Reservation of Rights. Except as provided in this Section 8, an
Optionee shall have no rights by reason of any subdivision or consolidation of
Shares of Stock of any class, the payment of any dividend or any other increase
or decrease in the number of Shares of Stock of any class. Any issue by the
Company of Shares of Stock of any class, or securities convertible into Shares
of Stock of any class, shall not affect, and no adjustment by reason thereof
shall be made with respect to, the number or Exercise Price of Shares subject to
an Option. The grant of an Option pursuant to this Plan shall not affect in any
way the right or power of the Company to make adjustments, reclassification,
reorganizations or changes of its capital or business structure, to merge or
consolidate or to dissolve, liquidate, sell or transfer all or any part of its
business or assets.

SECTION 9. Securities Laws.

Shares shall not be issued under this Plan unless the issuance and delivery
of such Shares comply with (or are exempt from) all applicable requirements of
law, including, without limitation, the Securities Act of 1933, as amended, the
rules and regulations promulgated thereunder, state securities laws and
regulations, and the regulations of any stock exchange on which the Company's
securities may then be listed.

SECTION 10. No Employment Rights.

No provision of this Plan, nor any right or Option granted under this Plan,
shall be construed to give any person any right to become, to be treated as, or
to remain an Employee or Consultant or in any way to amend, modify, waive or
terminate the Company's (or any Subsidiary's) right to terminate any person's
Service at any time and for any reason.

SECTION 11. Duration and Amendments.

(a) Term of this Plan. This Plan, as set forth herein, shall become
effective December 1, 1998, the date when the Board of Directors adopted this
Plan. Notwithstanding the foregoing, no Option granted under this Plan shall
become exercisable unless and until this Plan shall have been approved by the
shareholders of the Company. This Plan shall terminate automatically on the date
which is ten (10) years after its initial adoption by the Board of Directors,
November 20, 2008, and may be terminated on any earlier date pursuant to
Subsection (b) below.

(b) Right to Amend or Terminate this Plan. The Board of Directors may
amend, suspend or terminate this Plan at any time and for any reason; provided,
however, that any amendment of this Plan which: (i) materially increases the
number of Shares available for issuance under this Plan (except as provided in
Section 8 of this Plan); (ii) materially changes the class of persons who are
eligible for the grant of ISOs; or (iii) if required by Rule 16b-3 (or any
successor thereto) under the Exchange Act, would materially increase the
benefits accruing to participants under this Plan or would materially modify the
requirements as to eligibility for participation in this Plan, shall be subject
to the approval of the Company's shareholders by the affirmative vote of the
holders of a majority of the securities of the Company present, or represented
and entitled to vote at a duly held shareholders' meeting. Shareholder approval
shall not be required for any other amendment of this Plan.

(c) Effect of Amendment or Termination. No Shares shall be issued or sold
under this Plan after the termination thereof, except upon exercise of an Option
granted prior to such termination. The termination of this Plan, or any
amendment thereof, shall not affect any Share previously issued or any Option
previously granted under this Plan.

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<PAGE> 39

SECTION 12. Execution.

To record the adoption of this Plan by the Board of Directors on as of
November 20, 1998, the Company has caused its authorized officer to execute the
same.

AVANIR PAHRMACEUTICALS
a California corporation

By:
------------------------------------
Gerald J. Yakatan, President and CEO

A-10
<PAGE> 40
AVANIR PHARMACEUTICALS

9393 Towne Centre Drive, Suite 200
San Diego, California 92121-3016

THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS

The undersigned hereby constitutes and appoints Gerald J. Yakatan and
Gregory P. Hanson, and each of them, his true and lawful agents and proxies with
full power of substitution in each, to represent the undersigned at the Annual
Meeting of Stockholders of AVANIR Pharmaceuticals to be held at the Company's
offices at 9393 Towne Centre Drive, Suite 200, San Diego, California 92121, on
February 19, 1999 at 9:00 a.m., local time, and at any adjournments thereof, and
to vote as designated.

THIS PROXY WHEN PROPERLY EXECUTED WILL BE VOTED IN THE MANNER DIRECTED HEREIN BY
THE UNDERSIGNED STOCKHOLDER. IF NO DIRECTION IS MADE, THIS PROXY WILL BE VOTED
"FOR" THE ELECTION OF THREE DIRECTORS TO HOLD OFFICE UNTIL THE 2002 ANNUAL
MEETING; "FOR" THE APPROVAL OF THE 1998 STOCK OPTION PLAN; "FOR" THE APPROVAL OF
THE GRANT OF STOCK OPTIONS TO NEW DIRECTORS ELECTED ON JUNE 30, 1998; "FOR" THE
AMENDMENT TO THE COMPANY'S ARTICLES OF INCORPORATION TO RE-APPORTION SHARES OF
COMMON STOCK BETWEEN CLASS A AND CLASS B; AND "FOR" THE RATIFICATION OF DELOITTE
& TOUCHE LLP, AS THE COMPANY'S AUDITORS FOR THE FISCAL YEAR ENDING SEPTEMBER 30,
1999.

PLEASE MARK, SIGN, DATE AND RETURN THIS PROXY CARD PROMPTLY USING THE ENCLOSED
ENVELOPE.

YOUR VOTE IS IMPORTANT! PLEASE VOTE.

(Continued on reverse side)

<PAGE> 41
BACK OF CARD

1. ____ FOR all nominees listed below except as marked to the contrary.

____ WITHHOLD AUTHORITY to vote for all nominees listed below.

Withhold Authority
For Specific Nominee

Nominees: 1. Michael W. George
2. James B. Glavin
3. Gerald J. Yakatan, Ph.D.

2. TO APPROVE THE 1998 STOCK OPTION PLAN

Vote For ____ Vote Against ____ Abstain ____

3. TO APPROVE THE GRANT OF STOCK OPTIONS EXERCISABLE INTO 25,000 SHARES OF
CLASS A COMMON STOCK TO EACH OF FIVE DIRECTORS ELECTED ON JUNE 30, 1998.

Vote For ____ Vote Against ____ Abstain ____

4. TO AMEND THE COMPANY'S ARTICLES OF INCORPORATION TO REAPPORTION THE
100,000,000 AUTHORIZED NUMBER OF COMMON STOCK AS 99,288,000 CLASS A
COMMON AND 712,000 CLASS B COMMON

Vote For ____ Vote Against ____ Abstain ____

5. RATIFICATION OF DELOITTE & TOUCHE LLP AS INDEPENDENT AUDITORS

Vote For ____ Vote Against ____ Abstain ____

and to vote on such other business as may properly come before the meeting

Dated: , 1999

Signature of Stockholder(s)

Please sign exactly as name appears hereon. When
shares are held by joint tenants, both should
sign. When signing as attorney, executor,
administrator, trustee or guardian, please give
full title as such. If a corporation, please
sign in full corporate name by president or
other authorized officer. If a partnership,
please sign in partnership name by authorized
person.

THANK YOU FOR VOTING