<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
================================================================================
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended JUNE 30, 1999 Commission File No. 0-18734
AVANIR PHARMACEUTICALS
(Exact name of registrant as specified in its charter)
CALIFORNIA 33-0314804
(State or other jurisdiction of (IRS Employer Identification No).
incorporation or organization)
9393 TOWNE CENTRE DRIVE, SUITE 200
SAN DIEGO, CALIFORNIA 92121
(Address of principal executive office) (Zip Code)
(858) 558-0364
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter periods that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [x] NO [ ]
The number of shares of Common Stock of the Registrant issued and outstanding as
of August 9, 1999:
<TABLE>
<S> <C>
Class A Common stock, no par value 43,155,139
Class B Common stock, no par value 440,000
</TABLE>
================================================================================
<PAGE> 2
AVANIR PHARMACEUTICALS
FORM 10-Q
For the quarter ended June 30, 1999
Index
<TABLE>
<CAPTION>
<S> <C> <C>
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Balance Sheets at September 30, 1998 and June 30, 1999.............. 3
Statements of Operations for the three and nine month periods
ended June 30, 1998 and 1999 and for the period from August 31, 1988
(inception) to June 30, 1999........................................ 4
Statements of Cash Flows for the nine month periods ended June
30, 1998 and 1999 and for the period from August 31, 1988 (inception)
to June 30, 1999.................................................... 5
Notes to Financial Statements....................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................... 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk ......... 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................... 29
Item 4. Submission of Matters to a Vote of Security Holders................. 30
Item 6. Exhibits and Reports on Form 8-K.................................... 30
SIGNATURES .................................................................... 33
</TABLE>
2
<PAGE> 3
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS (UNAUDITED)
<TABLE>
<CAPTION>
===================================================================================================================
SEPTEMBER 30, JUNE 30,
ASSETS 1998 1999
------------ ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 6,508,341 $ 1,437,351
Interest receivable 93,763
Inventory 111,901
Prepaid and other 282,211 116,386
------------ ------------
Total current assets 6,884,315 1,665,638
PROPERTY - at cost (less accumulated depreciation
of $400,719 and $468,599) 251,486 247,488
PATENT COSTS (less accumulated amortization
of $74,813 and $94,127) 450,038 542,327
DEFERRED COSTS 37,577 285,549
OTHER ASSETS 30,384 217,804
------------ ------------
TOTAL $ 7,653,800 $ 2,958,806
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Convertible notes payable $ 1,000,000
Accounts payable 528,471 $ 839,710
Accrued expenses and other liabilities 325,594 201,757
Accrued compensation and payroll taxes 210,420 266,936
------------ ------------
Total current liabilities 2,064,485 1,308,403
COMMITMENTS (Notes 7 and 8)
REDEEMABLE CONVERTIBLE PREFERRED STOCK
Series D - no par value, 500 shares authorized; 65.9 shares issued and 619,949
outstanding ------------
Total redeemable convertible preferred stock 619,949
SHAREHOLDERS' EQUITY:
Preferred stock - no par value, 9,999,500 shares authorized:
Series C Junior Participating - 1,000,000 shares
authorized, no shares issued or outstanding
Common stock - no par value:
Class A - 99,490,000 and 99,288,000 shares authorized;
39,814,017 and 43,003,767 issued and outstanding 59,179,721 61,570,350
Class B - 510,000 and 712,000 shares authorized;
49,000 and 440,000 shares issued and outstanding
(convertible into Class A Common Stock) 25,582 38,269
Deficit accumulated during development stage (53,615,988) (60,578,165)
------------ ------------
Total shareholders' equity 5,589,315 1,030,454
------------ ------------
TOTAL $ 7,653,800 $ 2,958,806
============ ============
</TABLE>
See notes to the unaudited financial statements.
3
<PAGE> 4
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
==============================================================================================================================
AUGUST 31,
1988
THREE MONTHS ENDED NINE MONTHS ENDED (INCEPTION)
JUNE 30, JUNE 30, TO
------------------------------- ------------------------------- JUNE 30,
1998 1999 1998 1999 1999
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
REVENUES:
License fees/contract services $ 4,507,625
Federal research grants 940,646
Interest and other $ 144,422 $ 25,879 $ 496,554 $ 135,268 4,826,295
------------ ------------ ------------ ------------ ------------
Total revenues 144,422 25,879 496,554 135,268 10,274,566
------------ ------------ ------------ ------------ ------------
EXPENSES:
Research and development 764,906 1,118,162 2,400,231 2,698,626 37,930,731
General and administrative 1,487,569 1,370,151 3,406,482 3,373,848 24,644,062
Sales and marketing 257,014 1,020,226 1,690,923
Litigation settlement 668,104 818,104 783,899
Interest 14,534 620 79,461 4,745 5,269,846
Cost of contract services 533,270
------------ ------------ ------------ ------------ ------------
Total expenses 2,935,113 2,745,947 6,704,278 7,097,445 70,852,731
------------ ------------ ------------ ------------ ------------
NET LOSS $ (2,790,691) $ (2,720,068) $ (6,207,724) $ (6,962,177) $(60,578,165)
============ ============ ============ ============ ============
NET LOSS ATTRIBUTABLE TO
COMMON SHAREHOLDERS $ (2,790,691) $ (2,742,726) $ (6,207,724) $ (6,984,835)
============ ============ ============ ============
NET LOSS PER SHARE $ (0.07) $ (0.07) $ (0.16) $ (0.17)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES OUTSTANDING 39,860,537 41,623,194 39,405,843 41,055,355
============ ============ ============ ============
</TABLE>
See notes to the unaudited financial statements.
4
<PAGE> 5
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
================================================================================================================
NINE MONTHS ENDED AUGUST 31, 1988
JUNE 30, (INCEPTION) TO
------------------------------- JUNE 30,
1998 1999 1999
------------ ------------ ---------------
<S> <C> <C> <C>
OPERATING ACTIVITIES: $ (6,207,724) $ (6,962,177) $(60,578,165)
Net loss
Adjustments to reconcile net loss to net cash
used for operating activities:
Depreciation and amortization 169,714 103,893 1,048,542
Non-cash interest expense 17,620 4,294,307
Technology license fee 3,545,713
Compensation paid with common stock and stock options 126,748 777,350
Compensation forgiven by stockholder 66,923
Imputed interest on technology license fee 82,613
Changes in assets and liabilities:
Interest receivable 50,826 93,763
Inventory (111,901) (111,901)
Prepaid and other 59,047 (21,595) (334,190)
Organizational costs (20,242)
Deferred costs (285,549) (285,549)
Accounts payable (169,998) 311,239 839,710
Accrued expenses and other liabilities 527,267 (123,837) 201,757
Accrued compensation and payroll taxes 25,246 56,516 266,936
------------ ------------ ------------
Net cash used for operating activities (5,545,622) (6,795,280) (50,206,196)
INVESTING ACTIVITIES:
Patent costs 102,304 (111,603) (636,454)
Capital expenditures (120,017) (80,578) (829,366)
------------ ------------ ------------
Net cash used for investing activities (17,713) (192,181) (1,465,820)
FINANCING ACTIVITIES:
Proceeds from issuance of common and preferred stock 40,939 2,060,206 41,312,483
Proceeds from issuance of convertible notes payable 19,500,000
Debt issue costs (1,067,410)
Repayment of convertible notes payable (2,673,217)
Stock issue costs (143,735) (3,057,438)
Advances for purchase of common stock 125,000
Collection of notes receivable for common stock 14,525
Proceeds from stockholder loans 322,788
Repayment of stockholder loans (322,788)
Proceeds from issuance of subordinated
notes payable - net of issue costs 538,750
Repayment of subordinated notes payable (625,000)
Payment on technology license fee (958,326)
------------ ------------ ------------
Net cash provided by financing activities 40,939 1,916,471 53,109,367
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (5,522,396) (5,070,990) 1,437,351
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 14,428,834 6,508,341
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD 8,906,438 $ 1,437,351 $ 1,437,351
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid $ 96,085 $ 4,745 $ 1,112,237
============ ============ ============
</TABLE>
See notes to the unaudited financial statements
5
<PAGE> 6
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO UNAUDITED FINANCIAL STATEMENTS
================================================================================
1. BASIS OF PRESENTATION
The unaudited financial statements presented in this quarterly report
have been prepared in accordance with the instructions to Form 10-Q under
Section 13 or 15(d) of the Securities Exchange Act of 1934. These statements
should be read with AVANIR Pharmaceuticals (the "Company") audited financial
statements and the accompanying notes included in the Company's Annual Report on
Form 10-K/A for the fiscal year ended September 30, 1998. In management's
opinion, the financial statements include all adjustments, consisting only of
normal recurring accruals that are necessary to summarize fairly the Company's
financial position as of June 30, 1999, and the results of operations for the
three and nine months ended June 30, 1999 and from August 31, 1988 (Inception)
to June 30, 1999. The results of operations for the three and nine months ended
June 30, 1999, may not be indicative of the results that may be expected for the
year ending September 30, 1999.
2. GOING CONCERN
The report from the Company's auditors for the fiscal year ended
September 30, 1998 contains an explanatory paragraph relating to the status of
the Company's ability to continue as a going concern. The Company has incurred
net losses since inception and has not yet received product approval from the
U.S. Food and Drug Administration ("FDA") on its new drug application for
docosanol cream. These factors and the lack of financing at September 30, 1998
raised substantial doubt about the ability of the Company to continue as a going
concern.
Status of Discussions With the FDA - On December 22, 1998, the Company
delayed product launch plans for docosanol cream a topical treatment for
oral-facial herpes (cold sores and fever blisters), when it received a "not
approvable" letter from the FDA following the FDA's review of the initial
information that the Company submitted with its new drug application. The letter
indicated that the FDA had completed its review of docosanol cream and stated
that additional evidence was needed to substantiate the efficacy findings of
studies that the Company submitted with the new drug application. In March 1999,
the Company amended its new drug application by providing additional evidence of
the effectiveness of docosanol cream, and in June 1999, held a meeting with the
FDA to discuss the additional evidence and other issues.
On August 4, 1999, the Company submitted what it believes to be the
final information on its new drug application for docosanol cream in response to
the FDA's request of July 21, 1999. In that letter, the FDA stated it had
reviewed the additional evidence of efficacy that the Company previously had
submitted and requested additional statistical analyses to assess the
consistency of the clinical data. The FDA has indicated that its review of that
material can be accomplished relatively quickly.
Financing Arrangements. - As part of management's plan to secure
sufficient funds to support research and development activities and operations
in the current year, the Company entered into two financing arrangements in
early 1999 subject to various conditions. On January 22, 1999, the Company
entered into a two-year investment agreement for a $10 million equity
line. The investor may invest up to an additional 30% or $3 million at the
investor's option over the two-year period. The Company is unable to access the
equity line financing arrangements in the present form, because the Company does
not meet certain financing conditions. Further, the Securities and Exchange
Commission has changed its requirement for how equity lines are to be structured
the Company and the investor are evaluating
6
<PAGE> 7
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO UNAUDITED FINANCIAL STATEMENTS
================================================================================
potential changes to the equity line financing arrangement to determine whether
it is still financially attractive and viable for both parties
On March 22, 1999 the Company entered into an agreement to obtain up to
$5 million in financing through the sale of up to 500 shares of Series D
Redeemable Convertible Preferred Stock. See Notes 8 and 11 for further
discussions of the restrictions and assumptions that presently affect the
Company's ability to access the additional $3 million in financing that remain
under agreement.
On March 31, 1999 and April 1, 1999, the Company received cash proceeds
in the amount of $1.8 million and $200,000, respectively, from the sale of 200
shares of Series D Redeemable Convertible Preferred Stock. See Note 8. The
Company is in the process of seeking other financial arrangements to secure
sufficient funding to meet its needs for the upcoming year.
3. ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
4. RECLASSIFICATIONS
Certain amounts in the prior years' financial statements have been
reclassified to conform to current period presentation.
5. INVENTORY
In November 1998, the Company purchased the active ingredient in
docosanol cream at a cost of $223,800. The Company has estimated 50% of the raw
materials purchased as a current asset as it intends to manufacture and sell
this portion of the raw materials within the next year. The remaining 50% of the
raw materials inventory is classified on the Company's balance sheet as part of
other assets. The inventories are carried at the lower of cost (first-in,
first-out) or market.
6. DEFERRED COSTS
At June 30, 1999, deferred costs of $285,549 represent fees and expenses
related to the Series D Redeemable Convertible Preferred Stock Financing and
Equity Line Agreement as discussed in Notes 8 and 11. The amounts classified as
deferred costs will be offset against the proceeds from the remaining shares of
Series D Redeemable Convertible Preferred Stock and stock sold under the equity
line as appropriate.
7. RESEARCH & DEVELOPMENT COMMITMENTS
During fiscal 1999, the Company entered into several contractural
agreements totaling $671,000 with third party vendors for research and
development activities related to its allergy & asthma
7
<PAGE> 8
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO UNAUDITED FINANCIAL STATEMENTS
================================================================================
technology. For the three and nine month periods ended June 30, 1999, the
Company had recorded expense under these contracts of $260,000 and $437,000,
respectively. See Note 13.
8. REDEEMABLE CONVERTIBLE PREFERRED STOCK
Series D Redeemable Convertible Preferred Stock and Class J Stock
Purchase Warrants - On March 22, 1999, the Company entered into an agreement
with certain accredited investors to obtain up to $5 million in financing
through the issuance and sale of up to 500 shares of Series D Redeemable
Convertible Preferred Stock ("Series D Shares") and a corresponding number of
Class J Stock Purchase Warrants ("Class J Warrants"). The agreement requires
that the Company issue one Class J Warrant with each Series D Share for an
aggregate purchase price per unit of $10,000. Each Class J Warrant is
exercisable into 500 shares of Class A Common Stock, representing a maximum of
250,000 shares purchasable if all Class J Warrants are issued. The Class J
Warrants expire five years from the date of issuance.
On March 31, 1999, the investors made their initial investment in the
Company by purchasing 200 Series D Shares and the related Class J Warrants for
$2.0 million. In June 1999, the Company had the right to sell under certain
conditions 100 additional Series D Shares to the investors. However, this sale
did not occur, because the Company did not meet one of the conditions caused by
uncertainty of continued listing of the Company's Class A Common Stock on the
Nasdaq National Market. The investors in the Series D Shares have the option to
purchase the remaining 200 of Series D Shares for an additional investment of
$2.0 million. This purchase is subject to various conditions. See Note 2.
Each Series D Share bears an annual dividend of $500 that is payable on
a quarterly basis in cash or, at the Company's option, in stock at the
applicable conversion rate. The investors have the option to convert the Series
D Shares into shares of Class A Common Stock at a conversion rate equal to
$10,000 divided by a conversion price equal to the lesser of:
o the Fixed Conversion Price - an amount equal to $0.91488 per
share of Class A Common Stock, which represents 120% of the
five-day average of the closing bid prices per share of the
Class A Common Stock during the five trading days immediately
preceeding July 29, 1999; or
o the Variable Conversion Price - an amount equal to 86% of the
market price at the time when the Series D Shares are converted.
On the date of issuance, the exercise price of the Class J Warrants
issued in connection with the initial sale of 200 Series D Shares was equal to
$1.05 per share of Class A Common Stock, compared with the closing bid price of
$1.0313 per share on March 31, 1999, the date of the initial investment. The
Company estimated the value of the beneficial conversion feature at the time of
issuance to be immaterial and, therefore, did not allocate any portion of the
proceeds from the sale of the Series D Redeemable Convertible Preferred Stock to
the 200 Class J Stock Purchase Warrants. The Company reduced the exercise price
of the Class J Stock Purchase Warrants to $0.91488 per share of Class A Common
Stock on July 29, 1999 according to the reset provision of the agreement on the
120th day from the initial investment (as explained above as the Fixed
Conversion Price).
8
<PAGE> 9
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO UNAUDITED FINANCIAL STATEMENTS
================================================================================
Each of the selling shareholders and its affiliates may not convert the
Series D Shares and/or exercise the Class J Warrants if its beneficial ownership
would exceed 4.99% of the total outstanding shares of Class A Common Stock
following such conversion or exercise.
The Series D Redeemable Convertible Preferred Stock is redeemable at the
option of the holder in the event of a major corporate transaction, such as a
consolidation, merger or other business combination, and/or a triggering event
such as the Company's failure to meet certain conditions including, but not
limited to, the continued listing of the Company's Class A Common Stock on the
Nasdaq National Market System. In the event of a major transaction or triggering
event, the holder has the right to require the Company to redeem all or a
portion of the then currently outstanding shares of Series D Redeemable
Convertible Preferred Stock at a price per share determined by the type of event
triggering the redemption.
Between June 16, 1999 and June 30, 1999, the Company issued 2,062,475
shares of Class A Common Stock from the conversion of 134.1 shares of Series D
Redeemable Convertible Preferred Stock and the equivalent of $14,347 in accrued
dividends at an average conversion price of $0.66292 per share of Class A Common
Stock. Between July 1, 1999 and July 7, 1999, the Company issued an additional
151,372 shares of Class A Common Stock from the conversion of 10 shares of
Series D Redeemable Convertible Preferred Stock and the equivalent of $1,295
dividends at an average conversion price of $0.66919 per share.
As of August 9, 1999, there were 55.9 shares of Series D Redeemable
Convertible Preferred Stock outstanding, representing $559,000 in principal and
the equivalent of $10,031 in accrued dividends. Based on the conversion price as
of August 9, 1999, the outstanding shares of Series D Redeemable Convertible
Preferred Stock and accrued dividends were exercisable into 920,256 shares of
Class A Common Stock.
9. SHAREHOLDERS' EQUITY
Preferred Stock - The Company currently has two classes of preferred
stock authorized, Series C Junior Participating Preferred Stock and Series D
Redeemable Convertible Preferred Stock. See Note 8.
Series C Junior Participating Preferred - On March 2, 1999, the Board of
Directors of the Company approved a shareholder rights plan (the "Plan"). The
Plan features a dividend distribution of one Preferred Share Purchase Right (the
"Right") on each outstanding share of the Company's common stock, payable to
shareholders of record on March 25, 1999. Subject to limited exceptions, the
Rights will be exercisable if a person or group acquires 15% or more of the
Company's common stock or announces a tender offer for 15% or more of the common
stock (a "Trigger Event").
Under certain circumstances, each Right will entitle shareholders to buy
one one-hundredth of a share of newly created Series C Junior Participating
Preferred Stock of the Company at an exercise price of $10.00 per share. The
Company's Board of Directors will be entitled to redeem the Rights at $0.01 per
Right at any time before a person has acquired 15% or more of the outstanding
common stock. The Rights will expire on March 25, 2009. The Rights distribution
is not taxable to shareholders.
9
<PAGE> 10
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO UNAUDITED FINANCIAL STATEMENTS
================================================================================
If a Trigger Event occurs, each Right will entitle its owner, who is not
an acquiring person, to purchase at the Right's then current exercise price, a
number of shares of the Company's Class A Common Stock having a market value at
the time of twice the Right's exercise price. Rights held by the acquiring
person would become void and not be exercisable to purchase shares at the
bargain purchase price. An acquiring person is defined as a person who acquires
15% or more of the outstanding shares of common stock of the Company.
Class B Common Stock - Between October 1, 1998 and June 30, 1999, the
Company issued 391,000 shares of Class B Common Stock from the exercise of: i)
375,000 stock options at an exercise price of $0.0125 per share by a former
director, and ii) 16,000 options at an exercise price of $0.50 per share by
current director of the Company.
Class D Warrant - On June 30, 1999, the Company had 1,387,869 Class D
Warrants outstanding at an exercise price of $1.50 per share of Class A Common
Stock. On July 16, 1999, the Company's Board of Directors approved a repricing
of the exercise price of the currently outstanding Class D Warrants to $1.3750
per share. In connection with the repricing of the Class D Warrants, the Company
issued 126,166 additional Class D Warrants to purchase a like number of shares
of Class A Common Stock to the existing warrant holders. The Class D Warrants
expire on August 31, 1999.
Class I Stock Purchase Warrant - On March 4, 1999, the Company engaged
the services of a consultant to provide advice and counsel to the Company in
preparing various materials for submission to regulatory approval agencies and
in monitoring the progress of such submissions. The contract for consulting
services is for a period of 18 months. In connection with the consulting
services, the Company issued a Class I Stock Purchase Warrant for the purchase
of up to 500,000 shares of the Company's Class A Common Stock at an exercise
price of $0.78125 per share. The warrant vested fully upon issuance. The Class I
Stock Purchase Warrant expires on March 3, 2004.
The Company has calculated the expense related to the services to be
performed under the Class I Stock Purchase Warrant as $225,900 using the
Black-Scholes pricing model. Given that the consultant's exercise the warrant is
subject to the consultant continuing to render consulting services during such
period, the Company will recognize the expense in the amount of $225,900
pro-rata over the 18-month period of the consulting agreement.
Class K Stock Purchase Warrant - On April 1, 1999, the Company engaged
the services of a consultant to provide investor relations services for the
period of one year. In connection with the consulting services, the Company
issued a Class K Stock Purchase Warrant for the purchase of up to 375,000 shares
of Class A Common Stock at an exercise price of $1.125 per share. The vesting
schedule of the warrant requires the consultant to achieve certain performance
milestones during the one-year consulting period, with the exception of the
right to purchase 62,500 shares of Class A Common Stock which vested on April 1,
1999. The Class K Stock Purchase Warrant expires on March 31, 2004. The Company
will record expense related to the valuation of the Class K Stock Purchase
Warrant as the milestones are met under the warrant agreement. In April 1999,
the Company recorded expense related to the initial vesting of 62,500 warrants
in the amount of $37,612.
10
<PAGE> 11
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO UNAUDITED FINANCIAL STATEMENTS
================================================================================
Class L Stock Purchase Warrant - On June 8, 1999, the Company engaged
the services of an advertising agency to assist in the promotion of docosanol
cream. In exchange for a reduction in the fees for services, the Company issued
a Class L Stock Purchase Warrant for the purchase of up to 55,000 shares of
Class A Common Stock at an exercise price of $1.1875 per share. The Class L
Stock Purchase Warrant vests on the earlier of December 8, 1999 or the date of
the first commercial sale of the Company's docosanol cream product. The Class L
Stock Purchase Warrant expires on June 7, 2002. Over the one-year term of the
contract, the Company will record expense related to the valuation of the Class
L Stock Purchase Warrant. The Class L Stock Purchase Warrant is valued at
$49,645, the value of the discounted fees from the advertising agency.
1998 Stock Option Plan - On February 19, 1999, the Company's
shareholders approved the 1998 Stock Option Plan under which options to purchase
1,875,000 shares of Class A Common Stock can be granted to the Company's
directors, officers, employees and consultants. Between February 19, 1999 and
July 16, 1999, the Company granted options exercisable into 1,427,590 shares to
its directors, officers and employees under the 1998 Stock Option Plan. Included
in the options granted are a options to purchase 135,000 shares of Class A
Common Stock granted on July 16, 1999 to the Company's directors. Such options
were granted at fair-market-value in lieu of cash compensation for their service
on the board of directors for the period of June 1999 through December 1999. The
Company has valued the issuance of these options at $89,500. The Company will
record a monthly expense in the amount of $12,786 for period of June 1999
through December 1999 for the services of the board of directors.
10. NET LOSS PER SHARE
Reconciliation of net loss attributable to common shareholders in
accordance with Statement of Financial Accounting Standards No. 128 is as
follows:
<TABLE>
<CAPTION>
Quarter ended Nine months ended
June 30, 1999 June 30, 1999
------------- -----------------
<S> <C> <C>
Net loss $(2,720,068) $(6,962,177)
Dividends on redeemable convertible
preferred stock (22,658) (22,658)
----------- -----------
Net loss attributable to common shareholders: $(2,742,726) $(6,984,835)
=========== ===========
</TABLE>
11. INVESTMENT AGREEMENT
On January 22, 1999, the Company entered into a Class A Common Stock
Investment Agreement (together with an amendment dated as of March 22, 1999, the
"Equity Line Agreement") with an investment fund (the "Equity Line Investor").
Pursuant to the Equity Line Agreement and under certain circumstances, the
Company may cause the Equity Line Investor to purchase up to $10,000,000 of the
Company's Class A Common Stock over approximately a two-year period subject to
certain stock price and trading volume conditions. The Company will sell the
shares at the higher of (i) a six percent (6%) discount from the market price of
the shares of Class A Common Stock or (ii) a designated fixed price set by the
Company. The Equity Line Agreement also gives to the Equity Line Investor the
option to purchase up to an additional $3,000,000 in shares of Class A Common
Stock by purchasing these shares in amounts equal to 30% of the respective
dollar amounts that the Company sets forth in its "put" notices to the Equity
Line Investor.
11
<PAGE> 12
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO UNAUDITED FINANCIAL STATEMENTS
================================================================================
The Company obtained shareholder approval for the issuance of more than 20%
of its Class A Common Stock in connection with both the Equity Line Agreement
and the Series D Redeemable Convertible Preferred Stock. See Note 8. The ability
to access the equity line depends on various conditions including, but not
limited to, the Company's Class A Common Stock trading at or above $1.00 per
share and the continued listing of the Company's Class A Common Stock on the
Nasdaq National Market System. As of August 9, 1999, the Company's Class A
Common Stock was trading below $1.00 per share. In addition, the Company is
required to file with the Securities and Exchange Commission ("SEC") a
registration statement to register the Class A Common Stock underlying the
equity line with the SEC. The Company has not filed such a registration
statement pending evaluation of a restructuring of the Equity Line Agreement by
the Company and the Equity Line Investor to meet current SEC registration
requirements for this type of financing. The registration of these shares is
necessary before the Company is able to access any of the funds under the Equity
Line Agreement.
12. LITIGATION
On April 30, 1998, Dr. David Katz (former president and chief executive
officer and a former director of the Company) filed a Complaint for Declaratory
Relief (the "Katz Complaint"). The Katz Complaint seeks a declaration that
certain shares of common stock (returned to Dr. Katz incident to a rescission of
his personal transactions with HealthMed) are restored in status from shares of
Class A to shares of Class B Common Stock with Class B Voting Rights.
Additionally, the Katz Complaint seeks a determination that the termination of
his employment was not "for cause," which would entitle him to certain severance
benefits. Finally, Dr. Katz seeks an accounting for personal funds that he
allegedly advanced to the Company.
A first amendment to the Katz Complaint was filed on December 21, 1998,
adding a claim for specific performance of an alleged option right to acquire
certain shares of Class B Common Stock, which the Company has since honored. See
Note 9. In this amended pleading, Dr. Katz's wife, Lee R. Katz, was added as a
plaintiff. Lee Katz, a former employee of the Company, alleges that the Company
breached her grant of options to acquire Class B Common Stock. A second
amendment was filed on January 21, 1999, adding a claim defamation. A third
amendment was filed on March 29, 1999, claiming that the Company intentionally
interfered with Dr. Katz's contract of employment as chief executive officer of
the Medical Biology Institute and certain promissory notes between the Medical
Biology Institute and Dr. Katz. This third amendment seeks unspecified general
and punitive damages allegedly caused by an allegedly tortious interference with
his contractual relations and his prospective economic advantage.
On October 30, 1998, the Company filed a cross-complaint against Dr. Katz
seeking recovery of compensatory and punitive damages for his breach of
fiduciary duties as a director and officer of the Company. Acting pursuant to
Dr. Katz' agreements with the Company, the cross-complaint also asks that the
court order Dr. and Mrs. Katz to assign any interest they may possess in a
pending patent application pertaining to the Company's proprietary IgE
down-regulation technology.
Trial on the Katz Complaint, as amended, and on the Company's
cross-complaint is set to begin on August 23, 1999.
Neither the Company nor its counsel can express an opinion on the likely
outcome of the lawsuits with Dr. Katz. However, the Company intends to defend
the claims from, and pursue claims against, Dr. Katz vigorously.
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AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO UNAUDITED FINANCIAL STATEMENTS
================================================================================
13. RELATED PARTY
IriSys Research and Development, LLC - The Company has entered into two
agreements with Irisys Research and Development Company, LLC ("Irisys") for
certain license rights and research and development activities. Dr. Gerald
Yakatan, the Company's president and chief executive officer, is the founder of
IriSys and the chairman and a majority shareholder. Based in San Diego, IriSys
is a privately held company formed by Dr. Yakatan in 1996 that engages in
contract formulation development. The Company's Board of Directors has approved
the following agreements with Irisys:
1. Letter of Intent - On February 5, 1999, the Company entered into
a letter of intent, subject to approval of a definitive
agreement, with IriSys to license the worldwide rights to
develop and market a new drug to treat a condition associated
with Amyotrophic Lateral Sclerosis ("ALS"). The terms of the
agreement, if approved, would require the Company to make
milestone payments in cash or stock to IriSys for successful
filings of new drug applications and subsequent marketing
approvals by the FDA, and pay royalties on revenues earned from
any sales if the product is ultimately approved for marketing by
the FDA.
2. Research and Development - On June 2, 1999, the Company entered
into an agreement for services with Irisys to develop
formulations for a potential drug substance candidate using the
Company's allergy and asthma technology. Irisys' fees for
services compared favorably to competitive bids. The total cost
of this agreement is $92,000. During the three and nine months
ended June 30, 1999 the Company had recorded expense of $47,125
related to this agreement and will record the remaining expense
in the amount of $44,875 in the fourth fiscal quarter of 1999.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Report contains forward-looking statements concerning future events
or performance of AVANIR. You should not rely excessively on these
forward-looking statements, because they are only predictions based on our
current expectations and assumptions. Forward-looking statements often contain
such words like "estimate," "anticipate," "believe" or "expect". Many known and
unknown risks and uncertainties could cause our actual results to differ
materially from those indicated in these forward-looking statements. You should
review carefully the risks and uncertainties identified in this report,
including those explained below and in our other filings with the Securities and
Exchange Commission. We have no obligation to update or announce revisions to
any forward-looking statements to reflect actual events or developments.
OVERVIEW
AVANIR Pharmaceuticals ("AVANIR or we") is a development stage company
organized to market novel therapeutic products to treat human diseases. Since
inception in August 1988, AVANIR has operated in one business segment -
pharmaceutical product development. For the period from inception to June 30,
1999, AVANIR had incurred a cumulative net loss of $60.6 million. The report
from the Company's auditors for the fiscal year ended September 30, 1998
contains an explanatory paragraph relating to the status of the Company's
ability to continue as a going concern. See "Liquidity and Capital Resources,"
Risk factor entitled "We are a development stage company with a history of
continuing losses and a small amount of capital reserves, which creates "going
concern" uncertainties," and Notes to the Financial Statement.
On June 9, 1999, we reduced our operating staff by 40%, which was
necessary given the extensive delay in obtaining a decision from the FDA on
marketing approval of docosanol cream and the difficulty of raising financing
at attractive rates while we await the FDA's decision. If we do not hear
favorably from the FDA by September 15, 1999, we will have to take additional
steps to improve liquidity, including further layoffs and possibly selling
rights to commercialize some or all of our technologies. Further, without FDA
approval or additional funds from the sale of common stock, preferred stock,
debt issuances, or sales of technology or rights to technology, we would not be
able to fund operating activities beyond September 30, 1999.
Docosanol Cream - Our primary product under development is docosanol
cream, a topical treatment for oral-facial herpes, more commonly known as cold
sores and fever blisters. On August 4, 1999, we submitted what we believe to be
the final information on our new drug application for docosanol cream in
response to the U.S. Food and Drug Administration's ( the "FDA") request of July
21, 1999. In that letter, the FDA stated it had reviewed the additional evidence
of efficacy we previously had submitted and requested additional statistical
analyses to assess the consistency of the clinical data. The FDA has indicated
that its review of that material can be accomplished relatively quickly.
We delayed product launch plans for docosanol cream when we received a
"not approvable" letter from the FDA in December 1998 following its review of
the initial information that we submitted with our new drug application for
docosanol cream. The FDA's letter stated that it required additional evidence to
substantiate the efficacy findings of studies that we submitted with the new
drug application. In March 1999, we amended our new drug application by
providing additional evidence of the effectiveness of docosanol cream. In June
1999, met with the FDA to discuss the additional statistical and scientific data
provided in our amended new drug application.
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If we do not receive FDA approval to distribute docosanol cream as a
prescription product or if we determine that the time and cost to obtain
approval is excessive, then we will likely be forced to pursue one of two
alternative strategies. One alternative is to find a development partner to
share in any further development costs to obtain prescription approval. Another
alternative is to develop and market a modified formulation of our product to
meet the FDA's guidelines for an over-the-counter product for cold sores. We
believe both of these alternatives will be more costly and will cause further
delays of any potential product launch for docosanol cream, when and if there is
a product launch.
To commercialize docosanol cream we will need to, among other things,
build a marketing and sales infrastructure that includes marketing staff, market
research capacity, a sales force, sales management structure and internal sales
support. Although our sales and marketing plans for docosanol cream have been on
hold since late December 1998, we intend to remain prepared to produce
advertising and promotional materials in the event of a possible future product
launch.
If we fail to implement an effective sales organization in a timely
manner, then our business and financial condition will be materially and
adversely affected. Because we cannot predict whether the marketplace will
accept our docosanol cream product as a topical treatment for oral-facial
herpes, we might not achieve a level of sales sufficient to sustain our
operations.
Other Research and Development- We also are engaged in much earlier
stages of research and/or development of several other potential therapeutic
products, including potential new drugs for the treatment of allergies and
asthma, and AVP-923, a treatment for symptoms associated with Amyotrophic
Lateral Sclerosis (ALS, or Lou Gehrig's disease). These additional products will
not be available for sale to the market for several years, if at all.
RESULTS OF OPERATIONS
NET LOSSES
Net losses for the quarter ended June 30, 1999 were consistent with net
losses for the quarter ended June 30, 1998 at $2.8 million or $0.07 per share.
Net losses for the nine months ended June 30, 1999 increased to $7.0 million or
$0.17 per share, compared to $6.2 million or $0.16 per share, for the same
period in 1998.
REVENUES
Revenues decreased to $26,000 in the third quarter of fiscal year 1999
from $144,000 in the same period in 1998. Revenues for the nine months ended
June 30, 1999 decreased to $135,000 from $497,000 in the same period in 1998.
The decrease in revenues during fiscal year 1999 was due to a decrease interest
earned due to lower cash and cash equivalents available for investment during
the periods.
EXPENSES
Operating Expenses - Total operating expenses decreased to $2.7 million
in the third quarter of fiscal year 1999 compared to $2.9 million in the same
period in 1998. For the nine months ended June 30, 1999, total operating
expenses increased to $7.1 million compared to $6.7 million in the same period
in 1998. The net increase in operating expenses in the 1999 periods is described
below in the discussions of research and development, general and
administrative, sales and marketing and interest expenses.
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Research and Development Expenses - During the third quarter of fiscal
year 1999, research and development expenses increased to $1.1 million compared
to $765,000 in the same period in 1998. Research and development expenses for
the nine months ended June 30, 1999 increased to $2.7 million from $2.4 million
in the same period in 1998.
The increased expenses in the 1999 periods are related to AVANIR's
efforts in developing its allergy & asthma technology and expenses related to
the phase 2 clinical trials of AVP-923 conducted during the quarter ended June
30, 1999. Partially offsetting increased expenses in the 1999 periods are
decreased expenses related to other research & development projects and
decreased laboratory occupancy costs due to the Company's facility relocation in
June 1998.
General and Administrative Expenses - During the third quarter of fiscal
year 1999, general and administrative expenses decreased to $1.4 million
compared to $1.5 million in the same period in 1998. The decreased expenses for
the third quarter of fiscal 1999 are primarily related to expenses from the
prior year relating to the 1998 Annual Shareholders meeting held in June 1998,
which include proxy and shareholder solicitation costs due to adjourning and
reconvening the meeting. Also contributing to the decreased expenses for the
1999 are lower fees paid to our board of directors for fewer meetings held
during the 1999 quarter and decreased facilities rent and related expenses due
to the relocation of our headquarters to a smaller and lower cost facility in
June 1998.
For the nine months ended June 30, 1999, general and administrative
expenses remained consistent with the 1998 period at $3.4 million. Compared to
the nine months ended June 30, 1998, expenses were favorably impacted by
decreased facilities rent and lower board of directors fees as discussed above,
and lower legal and consulting fees as a result of settlement in the HealthMed
and Medical Biology Institute matters. Partially offsetting the decreased
expenses from the 1998 period are increased legal and related expenses in the
1999 periods associated with our defense of claims asserted by Dr. David H.
Katz, our former president, chief executive and director, against AVANIR. (See
"Legal Proceedings" and Notes to the Financial Statements).
Sales and Marketing Expenses - During the third quarter of fiscal year
1999 and the nine months ended June 30, 1999, sales and marketing expenses were
$257,000 and $1.0 million, respectively. AVANIR did not have sales and marketing
staff nor any sales and marketing expenses in the prior fiscal year. These
expenses were related to formation of a sales and marketing staff and
preparation for the launch of docosanol cream. As discussed above, we have
delayed product launch until the FDA makes a decision as to the marketing
approval of docosanol cream.
Interest Expense - Interest expense decreased to $600 in the third
quarter of fiscal year 1999 compared to $14,500 for the same period in 1998.
Interest expense for the nine months ended June 30, 1999 decreased to $4,700
compared to $79,500 for the same period in 1998. The decrease in interest
expense in fiscal year 1999 was due to the conversion of the balance of the
convertible note payable in October 1998.
Litigation Settlement - During the quarter and nine months ended June
30, 1998, we recorded litigation settlement expenses of $668,000 and $818,000,
respectively, in connection with our settlement of certain technology disputes
with Medical Biology Institute and our settlement with HealthMed. There were no
litigation settlement costs incurred in the 1999 periods.
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LIQUIDITY AND CAPITAL RESOURCES
Since inception, AVANIR has financed operations primarily through the
sale of equity and convertible debt securities and stockholder loans. Net cash
provided by financing activities from inception through June 30, 1999 was $53.1
million.
At June 30, 1999, AVANIR had available cash, cash equivalents and
short-term investments of $1.4 million and working capital of $357,000, as
compared to $6.5 million and $4.8 million, respectively, at September 30, 1998.
The decreases in cash, cash equivalents and short-term investments and working
capital were due to operating expenses incurred by AVANIR as discussed above in
"Results of Operations" and partially offset by cash received from financing
activities.
Cash Used For Operating Activities
Net cash used to fund operating activities during the nine months ended
June 30, 1999 increased to $6.8 million from $5.5 million during the same period
in 1998. The increase is related primarily to net losses in the 1999 period as
discussed in "Results of Operations," funds used for the purchase of raw
materials inventory (see Note 5 to the Unaudited Financial Statements), and
deferred costs related to recent financing arrangements (see Notes 6,8 and 11 to
the Unaudited Financial Statements). Capital expenditures during the 1999 nine
month period totaled $81,000, compared with $120,000 during the same period in
1998.
Since inception, we have experienced negative cash flows from
operations. We believe that negative cash flows from operations will continue
for the foreseeable future, and that we will continue to require outside sources
of funding. We expect our cash requirements for the fiscal quarter ended
September 30, 1999 will be about the same as the average of the prior three
quarters in fiscal 1999. Our available funds will not be sufficient to:
o implement our marketing plan for docosanol cream, if ultimately
approved; or
o successfully complete development or commercialize successfully
any of our other proposed products or to in-license technologies
for further development.
Cash Received from Financing and Management's Financing Plan
As part of management's plan to secure sufficient funds to support
research and development activities and operations in the current year, we
entered into two financing arrangements in early 1999 for potentially up to $18
million in financing over the next two years subject to various conditions. As
of the nine months ended June 30, 1999, we had received $2.0 million from one of
these financing arrangements. We might not receive any of the remaining
funds from these two financing arrangements, depending on whether or not we
receive marketing approval for docosanol cream from the FDA and whether our
Class A Common Stock remains listed on the Nasdaq National Market System.
o On January 22, 1999, we entered into a Class A Common Stock
Investment Agreement for an equity line with Promethean
Investment Group LLC. We subsequently amended the investment
agreement effective March 22, 1999. We must meet certain
conditions to draw on the equity line including a trading price
of the Class A Common Stock of at least $1.06 per share and
continued listing on the Nasdaq National Market. See "Risk
Factors" and Notes to the Unaudited Financial Statements.
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o On March 22, 1999, we entered into an arrangement with certain
accredited investors to obtain up to $5 million in financing
through the issuance and sale of up to 500 shares of Series D
Redeemable Convertible Preferred Stock and a corresponding
number of Class J Stock Purchase Warrants. On March 31, 1999, we
received gross proceeds of $2 million from the sale of 200
shares of Series D Redeemable Convertible Preferred Stock. See
"Risk Factors" and Notes to the Unaudited Financial Statements.
Additionally, on June 29, 1999, we extended the expiration date of the
Class D Warrants from June 30, 1999 to August 31, 1999, and on July 16, 1999,
reduced the exercise price of the Class D Warrants from $1.50 per share to
$1.3750 per share. These warrants, if exercised, could represent up to $2.1
million in financing for us and the issuance of potentially up to 1.5 million
shares of Class A Common Stock. At August 9, 1999, the closing sales price of
our Class A Common Stock was below $1.00 per share. Therefore, these warrants do
not represent an attractive investment to the holders at the present time. See
Notes to the Financial Statements.
On June 9, 1999, we reduced our operating staff by 40%, which was
necessary given the extensive delay in obtaining a decision from the FDA on
marketing approval of docosanol cream and the difficulty in raising financing at
attractive rates while we await the FDA's decision. If we do not hear favorably
from the FDA by September 15, 1999, we will have to take additional steps to
improve liquidity, including further layoffs and possibly selling rights to
commercialize some or all of our technologies. Further,without FDA approval or
any additional funds from the sale of common stock, preferred stock, debt
issuances, or sales of technology or rights to technology, we would not be able
to fund operating activities beyond September 30, 1999.
Our existence is substantially dependent upon receiving an FDA approval
for docosanol cream and additional financing from time-to-time until we begin to
generate positive cash flows from operations. We are currently evaluating other
financing alternatives for our research and development and operating
activities. We cannot assure you that we can negotiate or obtain favorable
terms, enter into final agreements with investors, or satisfy the conditions in
obtaining financing. Such financing activities could result in significant
dilution to stockholders. We also may have to enter into collaborative
arrangements with one or more other pharmaceutical or biotechnology companies to
commercialize our other proposed products. We cannot assure you that we can
obtain successfully such additional capital or enter into the collaborative
arrangements necessary to fully develop or commercialize any of our drugs on
acceptable terms. Failure to raise additional capital, or enter into such
collaborative arrangements in a timely manner could affect materially and
adversely our business, financial condition and results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities. The
new standard will become effective for AVANIR for the year ending September 30,
2000. Interim reporting of this standard will be required. We have not yet
assessed the effect of this standard on our current reporting and disclosures.
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IMPACT OF THE YEAR 2000 ISSUE
AVANIR'S YEAR 2000 PROGRAM
Historically, most computer systems were designed with date data using
two digits of the year. Most computer programs and computer hardware were
programmed to assume that all two digit dates were preceded with "19", causing
"00" to be interpreted as the year 1900. This formerly common practice could now
result in a computer system that fails to recognize properly a year that begins
with "20" rather than "19." This date recognition problem could result in
computer system miscalculations or failures, and is generally referred to as the
"year 2000 issue." In September 1998, we established a Year 2000 program ("Y2K
Program") to analyze our internal systems and systems of third parties essential
to our operations.
o Our evaluation of our internal systems includes four phases:
1. implementation of our Y2K Program,
2. assessment (including prioritization and pre-testing),
3. remediation (including modification, upgrading and replacement),
and
4. testing for year 2000 compliance.
o Our evaluation of third-parties is intended to determine the extent to
which we are vulnerable to any failure by such third-parties to
remediate their respective year 2000 problems.
INTERNAL BUSINESS SYSTEMS
State of Readiness - We have reviewed our internal business systems for
both hardware and software issues to determine if they are year 2000 compliant.
During the assessment phase of the evaluation, no material issues arose
concerning the hardware within the systems. As of the date of this report, we
have completed all of the testing and remediation of our business systems and
have verified that all of our internal business systems are year 2000 compliant,
including critical software that is utilized for our system network and
accounting systems. Additionally, we have determined that the software utilized
for payroll and the interface with our third party payroll vendor are year 2000
compliant. Although our business systems have been tested to be year 2000
compliant, we have identified that it is necessary to upgrade certain of the
software used in our operations to an updated edition of the software. We
anticipate completing these software upgrades in the upcoming calendar quarter.
Costs - We anticipate that the total cost of the Y2K Program, including
certain software upgrades discussed above, will be approximately $25,000 and
have allotted these funds in our budget for fiscal 1999. As of the date of this
report, we have incurred certain consulting and software expenses related to the
evaluation and remediation of our internal business systems. To date, these
costs have been minimal.
INTERFACES WITH THIRD PARTIES
State of readiness - Relationships with third parties are very important
to our business. We have initiated formal communications with our corporate
partners, vendors and service providers, including contract research
organizations that are critical to our research and development efforts. This
communication, in written form, requests a written assurance that the third
party is year 2000 compliant. As of August 9, 1999, we had received responses
from approximately 50 percent of our vendors who have assured us that their
systems are year 2000 compliant. The majority of the responses received to date
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from our vendors indicate that their systems are year 2000 compliant. However,
we are not able to determine the extent to which we may be vulnerable if those
third parties have failed to solve their year 2000 problems. In addition to the
potential risks we may face with third party vendors necessary for our
day-to-day operations, we may face year 2000 risks with our stock transfer
agent, banks, and the Nasdaq Stock Market. We have received written assurances
from these parties that they are year 2000 compliant. We plan to have completed
the assessment of the year 2000 risks of our third parties by September 30,
1999.
Costs - We do not anticipate the cost of communications with third
parties to be material, and have estimated the total cost of our Y2K Program to
be $25,000, as noted above.
Future risks with regard to third parties - As we move forward with a
potential launch of docosanol cream, we will face circumstances that may involve
significant year 2000 issues that we can not anticipate at this time. These
risks include potential year 2000 problems with the manufacturing, warehousing,
distribution, and marketing of docosanol cream. Currently, we have established
relationships for the manufacture of docosanol cream, and the warehousing and
distribution of the manufactured product. Additionally, we will establish
relationships with other parties in the marketing of docosanol cream. However,
we cannot determine at this time the extent to which we will be vulnerable to
year 2000 problems that these parties may encounter. As we initiate
communications with these parties, we intend to obtain assurances from them that
their systems are year 2000 compliant or that they have remediation plans.
CONTINGENCY PLANS
We are developing a business contingency plan to address both unforseen
and forseen but unavoidable year 2000 risks. The plan currently provides that we
have retained and will continue to retain hard copies and tape back-ups for our
accounting and payroll systems and laboratory and scientific data. Although we
have confidence in the assurances provided by software companies that the
upgrades to our systems are year 2000 compliant, we are developing a "worst
case" scenario in the event of internal and external system failures.
Additionally, we have purchased approximately a two-year supply of the active
ingredient in docosanol cream. This raw materials inventory is a key to the
success of the manufacturing and marketing efforts of docosanol cream. We
anticipate having a well-developed contingency plan by September 30, 1999.
Further, we intend to enhance and revise the contingency plan as additional
information becomes available and as we move forward with the marketing plans
for docosanol cream.
CONCLUSION
The above statements are based on our best estimates at the present
time, which are derived utilizing numerous assumptions of future events and
conditions and statements of assurance made by third parties. We can give no
assurance that these assumptions or third-party assurances will be accurate and
that these estimates will be achieved. Our evaluation and assessment is ongoing
and we expect that new or different information may become available as our
assessments and evaluations continue.
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RISK FACTORS
WE ARE A DEVELOPMENT STAGE COMPANY WITH A HISTORY OF CONTINUING LOSSES AND A
SMALL AMOUNT OF CAPITAL RESERVES, WHICH CREATES "GOING CONCERN" UNCERTAINTIES.
In the Independent Auditors' Report on our financial statements for the
fiscal year ended September 30, 1998, they indicated that we will need to raise
additional capital to continue as a going concern. From our inception through
June 30, 1999, we have generated only limited revenues and have incurred net
losses totaling approximately $60.6 million. Further, we expect to continue to
incur operating losses related to research and development and marketing
activities, until such time that we can generate significant revenues from our
proposed products. These proposed products are not fully developed and still
require regulatory approvals before we can offer them for sale in the
marketplace. We will need to successfully complete current financing
arrangements as well as seek additional financing for future operations which is
substantially dependent upon receiving marketing approval from the FDA for
docosanol cream and our Class A Common Stock remaining listed for trading on the
Nasdaq National Market System. Without favorable news from the FDA and
additional financing to support operations before September 30, 1999, there is a
significant risk that we will not be able to continue as a going concern.
IF WE DO NOT COMPLY WITH THE LISTING AND MAINTENANCE REQUIREMENTS OF THE NASDAQ
NATIONAL MARKET SYSTEM, THEN OUR CLASS A COMMON STOCK COULD BE DELISTED.
Our Class A Common Stock trades on the Nasdaq National Market System. On
February 8, 1999, we received notice from Nasdaq that the minimum bid price of
our Class A Common Stock had failed to maintain a closing bid price of greater
than or equal to $1.00 during the previous thirty (30) consecutive business
days. The letter indicated that the 90-day period to regain compliance had
begun. Our Class A Common Stock traded at or above $1.00 for thirteen (13)
consecutive trading days ended April 5, 1999 and for fourteen (14) additional
consecutive days ending June 11, 1999. However, as of August 9, 1999, the
closing bid price of our Class A Common Stock had been below $1.00 for 40
consecutive days. Although our stock price maintained a closing bid price at or
above $1.00 on several occasions since February 8, 1999, Nasdaq still considers
the bid price of our Class A Common Stock to be deficient and has never formally
deemed us to be back in compliance. Nasdaq also requires that we maintain net
tangible assets of at least $4 million. At June 30, 1999, our net tangible
assets were $1.7 million. If we do not complete additional financing
arrangements to support operations, we likely will not regain compliance with
Nasdaq's minimum listing requirement for net tangible assets, which would cause
the delisting of our Class A Common Stock. To comply with the listing and
maintenance requirements of the Nasdaq National Market System, one of the Nasdaq
rules provides that the minimum bid price of our Class A Common Stock must trade
at or above $1.00 per share. If the minimum bid price falls below $1.00 for
thirty (30) consecutive business days, then Nasdaq will notify us that we have
ninety (90) calendar days from the date of notification to comply with the
applicable continued inclusion standard. Nasdaq's minimum compliance standard
requires us to achieve a minimum bid price at or above $1.00 for a minimum of
ten (10) consecutive business days during the ninety-day compliance period.
Even if our stock price were to rise above $1.00 for any reason, the bid
price of our Class A Common Stock could still fall below $1.00 due to the resale
of shares of Class A Common Stock underlying our other outstanding securities,
warrants and stock options. Specifically, the resale of the shares underlying
our Series D Redeemable Convertible Preferred Stock and the resale of shares to
potentially be issued under our equity line arrangement could cause downward
pressure on the bid price of our Class A Common Stock. See the risk factor
entitled "If the Series D Preferred Redeemable Convertible Stock is converted or
we issue additional shares of equity securities, then the value of existing
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shares of Class A Common Stock currently outstanding may be diluted." See also
the risk factor entitled "There will be a dilutive effect on the shares of our
Class A Common Stock from the conversion or exercise of certain other
outstanding securities."
In particular, our Series D Redeemable Convertible Preferred Stock is a
"future-priced security," because its conversion price is linked to the future
market price of our Class A Common Stock at the time of conversion. Our Series D
Redeemable Convertible Preferred Stock will convert into more shares of Class A
Common Stock if the market price of our Class A Common Stock is lower at the
time of conversion. The conversion of the Series D Redeemable Convertible
Preferred Stock could dilute the ownership of holders of our Class A Common
Stock, causing downward pressure on the market price of our Class A Common
Stock. In turn, this lower market price would allow for still greater conversion
of the Series D Redeemable Convertible Preferred Stock and cause additional
downward pressure on the market price. If the bid price of our Class A Common
Stock is reduced to less than $1.00 per share, then Nasdaq could delist our
Class A Common Stock.
We attended an oral hearing with Nasdaq on July 1, 1999 and discussed
our financing plans and other plans for improving the trading price of our Class
A Common Stock to acceptable levels. As of August 9, 1999, we had not received a
report from the panel as to the outcome of the meeting. If Nasdaq delists our
Class A Common Stock, then we may face significant difficulties in raising
additional capital on favorable terms, if at all. Delisting also will negatively
affect shareholder liquidity.
OUR AMENDED NEW DRUG APPLICATION FOR DOCOSANOL CREAM MAY NOT RECEIVE FDA
APPROVAL.
On December 22, 1998, we received a letter from the FDA stating that the
new drug application for docosanol cream was "not-approvable." The letter
indicated that additional evidence was necessary to substantiate the drug's
effectiveness. In March 1999, we amended our new drug application to provide
additional evidence of the efficacy of docosanol cream and in June 1999, met
with the FDA to discuss the additional statistical and scientific data provided
in our amended new drug application. On July 21, 1999, we received a letter from
the FDA stating it had reviewed the additional evidence and requested additional
statistical analyses to "assess the consistency of the (clinical) data". We have
submitted these additional statistical results and are awaiting a decision from
the FDA on our new drug application. We can give no assurance as to the possible
outcome of our future discussions with the FDA. Failure to receive FDA approval
or a substantial delay in receiving FDA approval for docosanol cream would
affect materially and adversely our current business plan for docosanol cream as
a prescription product. The short-term effect likely would be a drop in the
market price of our Class A Common Stock, which would severely hinder our
ability to raise additional capital, if at all, to support continuing
operations, and would jeopardize our listing on the Nasdaq National Market
System. It also would cause us to delay other product development programs.
IF WE DO NOT RECEIVE FDA APPROVAL AS A PRESCRIPTION PRODUCT, WE WILL FACE
SEVERAL RISKS TO LAUNCH DOCOSANOL CREAM AS AN OVER-THE-COUNTER PRODUCT.
We have determined that, with a few minor changes made to the existing
formulation of docosanol cream, we could meet the FDA's regulations for
marketing an over-the-counter ("OTC") fever blister/cold sore product. We will
pursue this strategy only if we determine that the cost and timing of obtaining
FDA marketing approval of a prescription product are too onerous. If we pursue
commercialization of an OTC product for cold sores/fever blisters, then we will
face the following risks:
o identification of suitable ingredients to be used in the
reformulation;
o long term stability of the revised formulation;
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<PAGE> 23
o timely compliance with FDA regulations for marketing an OTC
product;
o timely execution of a professional marketing and sales
communications program for docosanol cream as an OTC product;
o the difficulty in building product awareness of a new OTC
product among customers or retail store decision makers;
o reduction in ability to price the product at a significant
premium to competing products in the market;
o consumers may not perceive docosanol cream as superior to the
existing and proposed OTC products for oral herpes; and
o that docosanol cream will gain widespread acceptance in the OTC
consumer market.
THE MARKET ACCEPTANCE OF DOCOSANOL CREAM IS UNCERTAIN BECAUSE OF THE NEWNESS OF
THE PRODUCT AND CHALLENGES OF BUILDING A NEW MARKETING AND SALES STAFF.
If we continue to develop and eventually launch docosanol cream, then we
will rely substantially on our own marketing and sales organization. We have not
yet hired a marketing and sales force and we expect to face difficulties in
hiring and training marketing and sales staff in a timely fashion, because of
intense competition for competent personnel in the bio-pharmaceutical area. Our
failure to implement an effective marketing and sales organization in a timely
manner would affect materially and adversely our business and financial
condition. Additionally, many people do not seek medical treatment for oral
herpes, cold sores or fever blisters. Although we have engaged an advertising
agency for advertising and promotional materials to prepare for a possible
product launch of docosanol cream, we might not develop effective advertising
in this particular market area or increase awareness of a new product. Further,
we might not attain a level of sales or profitability sufficient to sustain our
operations.
DOCOSANOL CREAM, IF ULTIMATELY MARKETED, WILL FACE INTENSE COMPETITION FROM A
NUMBER OF EXISTING AND WELL ESTABLISHED PRODUCTS.
If we launch successfully our first proposed product, docosanol cream,
then it will compete with several prescription products for oral-facial herpes
currently on the market in the U.S., as well as other products or potential
products that are or may be under development or undergoing the FDA regulatory
approval process. We will face intense competition from the following products:
o Zovirax(R) (acyclovir) and Valtrex(R) (valacyclovir) products
marketed by Glaxo-Wellcome Corp;
o Famvir(R) (famciclovir) and Denavir(R) (penciclovir) products
marketed by SmithKline Beecham; and
o over-the-counter preparations, including well known products
like Blistex(R) and Carmex(R).
Most of our competitors have greater financial resources, research and
development facilities and manufacturing and marketing experience than we do.
Our proposed products may not achieve commercial success in this intense
competitive environment, which would severely impact our revenues.
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<PAGE> 24
DUE TO THE SMALL SIZE OF OUR COMPANY, WE WILL DEPEND ON THIRD-PARTY ARRANGEMENTS
TO MANUFACTURE AND MARKET DOCOSANOL CREAM AND OUR OTHER PRODUCTS.
We do not have and do not expect to have in the foreseeable future the
resources to manufacture or market directly on a large commercial scale
docosanol cream or any other proposed products that we may develop. To
commercialize docosanol cream, we have entered into collaborative arrangements
with manufacturing and distribution companies. Such collaborative arrangements
likely will cause higher costs or the sharing of profits with third parties.
In addition, we have entered into several licensing agreements to cover
the clinical development, manufacturing and marketing of docosanol cream in
foreign markets. We might not finalize any licensing or distributorship
arrangements for territories not covered by existing agreements on favorable
terms, if at all. We ultimately may establish our own manufacturing and/or
marketing capabilities, at least for certain proposed products, which likely
would require substantial additional funds and personnel.
AS A SMALL EMERGING BIO-PHARMACEUTICAL COMPANY, WE HAVE LIMITED RESOURCES TO
EFFECTIVELY MITIGATE POTENTIAL RISKS RELATING TO THE FOREIGN SALES OF DOCOSANOL
CREAM AND OTHER POTENTIAL PRODUCTS.
We are subject to various foreign trade risks relating to the continued
development of docosanol cream by foreign licensees. We also may arrange for
contracts in the future, for the manufacture, marketing and distribution of
docosanol cream overseas by foreign licensees, which will be substantially out
of our control. Certain risks that could impact significantly our ability to
deliver products will include:
o changes in the regulatory and competitive environments in
foreign countries;
o changes in a specific country's or region's political or
economic conditions;
o shipping delays;
o difficulties in managing operations across disparate geographic
areas;
o fluctuations in foreign currency exchange rates;
o difficulties associated with enforcing agreements through
foreign legal systems; and
o trade protection measures such as customs duties and export
quotas.
AS A BIO-PHARMACEUTICAL COMPANY, WE NEED TO COMPLY WITH GOVERNMENT REGULATIONS
TO DEVELOP, PRODUCE, TEST, MANUFACTURE AND MARKET DOCOSANOL CREAM AND OUR OTHER
PRODUCTS.
Governmental authorities in the U.S. (including the FDA) and other
countries regulate significantly the development, production, testing,
manufacturing and marketing of pharmaceutical products. The clinical testing and
regulatory approval process can take a number of years and require the
expenditure of substantial resources. While development of docosanol as a
prescription product has been completed and is awaiting the FDA's decision on
approval, we may not obtain regulatory approval for it or any of our other
proposed products. We expect to use a significant portion of our financial
resources for research and development and the clinical trials necessary to
obtain such approvals for our proposed products. We will continue to incur costs
of development without any assurance that we will obtain regulatory approvals.
Failure to obtain (or delays in obtaining) such approvals will affect adversely
our business operations, including our ability to commence marketing of any
proposed products.
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<PAGE> 25
In addition, we cannot predict the extent to which adverse governmental
regulation might arise from future U.S. or foreign legislative or
administrative action. Moreover, we cannot predict with accuracy the effect of
unspecified, but possible, future changes in the regulatory approval process and
in the domestic health care system for which we develop our products. Future
changes could adversely affect the time frame required for regulatory review,
our financial resources, and the sale prices of our proposed products, if
approved for sale.
OUR RESEARCH AND DEVELOPMENT PROGRAMS FOR PROPOSED NEW PRODUCTS ARE IN THE EARLY
STAGE OF DEVELOPMENT, ARE UNPROVEN, AND MAY NEVER BE FULLY DEVELOPED.
The development process for medical products is lengthy and capital
intensive. Our drug development programs are subject to all of the risks
inherent in product development based on innovative technologies, including
unanticipated development problems and the possible lack of funding that could
result in the abandonment or substantial change in the development of a specific
product. For example, we face substantial risks of failing to complete the
development of our early-stage research and development programs in allergy and
asthma and other areas. The effectiveness of our pre-clinical allergy and asthma
research performed in vitro or in animal models may not be relevant to the
development of, or indicate the efficacy of, a proposed product for human use.
Unsuccessful clinical trial results for our proposed products could affect
materially and adversely our business operations and financial condition.
WE MAY NOT ACQUIRE IN-LICENSED TECHNOLOGIES THAT WE BELIEVE ARE NECESSARY TO
FILL OUR PRODUCT DEVELOPMENT PIPELINE.
Our business strategy is to in-license products at various stages in the
drug development pipeline. We plan to seek additional products through
in-licensing and co-promotion arrangements. To achieve this objective, we must
acquire and/or in-license new products and technologies to further develop,
market and/or sublicense them from others. We will face intense competition for
these in-licensed products and technologies and we might not locate suitable
products and technologies to fit our strengths or obtain them on acceptable
terms. For example, we have signed a letter of intent with IriSys Research and
Development, LLC to license world-wide rights to a product intended for use in
a condition associated with neurodegenerative diseases and pain. We cannot
assure you that we will enter into a final agreement with IriSys Research and
Development, LLC to in-license this product on favorable terms, if at all.
AS A SMALL, EMERGING, BIO-PHARMACEUTICAL COMPANY, WE DEPEND ON KEY MANAGEMENT
AND SCIENTIFIC PERSONNEL.
Our success depends on the performance of a small core staff of key
management and scientific employees. Given our early stage of development, we
depend substantially on our ability to hire, train, retain and motivate high
quality personnel, especially our scientists and management team. If we were to
lose one or more of our key scientists, then we would lose a certain amount of
history and knowledge that they have which could substantially delay one or more
of our development programs until adequate replacement personnel could be hired
and trained. Our future success also depends on our continuing ability to
identify, hire, train and retain highly qualified, technical, sales, marketing
and customer service personnel. We do not have employment agreements for fixed
terms with any of our employees, except with Dr. Gerald J. Yakatan, our
president and chief executive officer, nor do we have "key person" life
insurance policies. The industry in which we compete has a high level of
employee mobility and aggressive recruiting of skilled personnel, which creates
intense competition for qualified personnel, particularly in product research,
development, sales and marketing.
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<PAGE> 26
OUR PATENTS MAY BE CHALLENGED AND OUR PENDING PATENTS MAY BE DENIED, WHICH WOULD
SERIOUSLY JEOPARDIZE OUR ABILITY TO COMPETE IN THE INTENDED MARKETS FOR OUR
PROPOSED PRODUCTS.
We own or have rights to eleven U.S. and eight foreign patents on our
products or technologies. We also have pending U.S. and foreign patent
applications. These patents and patent applications cover medical uses of
docosanol and related compounds, compounds which may be helpful in the treatment
of conditions associated with allergy and asthma and other technologies. Because
of the competitive nature of the bio-pharmaceutical industry, we cannot assure
you that:
o the claims in the pending patent applications will be issued as
patents;
o present and future competitors will not develop similar or
superior technologies independently, duplicate our technologies
or design around the patented aspects of our technologies;
o our proposed technologies will not infringe other patents or
rights owned by others, including licenses which may not be
available to us;
o any issued patents will provide us with significant competitive
advantages; or
o challenges will not be instituted against the validity or
enforceability of any patent that we own or, if instituted, that
such challenges will not be successful.
Even if we overcome any patent infringement challenges, we likely could
incur substantial costs of litigation to uphold the validity and prevent
infringement of our patents.
In addition, the process for the approval of patent applications in
foreign countries may differ significantly from the process in the U.S., which
may delay our plans to market and sell docosanol cream in the international
market place. Approval in one country does not necessarily indicate that
approval can be obtained in other countries. The patent authorities in each
country administer that country's laws and regulations relating to patents
independently of the laws and regulations of any other country and we must seek
and obtain the patents separately. Our ability to obtain or maintain patent
protections for docosanol cream in foreign markets would hamper severely our
ability to generate international sales from our first proposed product.
We also rely substantially on confidentiality agreements to protect our
innovations. We cannot assure you that secrecy obligations will be honored, or
that others will not develop independently similar or superior technology.
Additionally, if our consultants, key employees or other third parties apply
technological information independently developed by them or by others to our
projects, then disputes may arise as to the proprietary rights to such
information in which we do not receive a favorable resolution.
DEVELOPING NEW PHARMACEUTICAL PRODUCTS FOR HUMAN USE INVOLVES PRODUCT LIABILITY
RISKS, FOR WHICH WE CURRENTLY HAVE LIMITED INSURANCE COVERAGE.
The testing, marketing and sale of pharmaceutical products involve the
risk of product liability claims by consumers and other third parties. We have
maintained product liability insurance coverage for our clinical trials in the
amount of $2 million per incident and in the aggregate. However, product
liability claims can be high in the pharmaceutical industry and our insurance
may not cover sufficiently all possible liabilities or the size of the claim. If
a suit against our business or proposed products is successful, then the lack or
insufficiency of insurance coverage could affect materially and adversely our
business and financial condition. Furthermore, certain distributors of
pharmaceutical products require
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<PAGE> 27
minimum product liability insurance coverage prior to their purchase or
acceptance of products for distribution. Failure to satisfy such insurance
requirements could impede our ability to achieve broad distribution of our
proposed products.
IF THE SERIES D REDEEMABLE CONVERTIBLE PREFERRED STOCK IS CONVERTED OR WE ISSUE
ADDITIONAL SHARES OF EQUITY SECURITIES, THEN THE VALUE OF EXISTING SHARES OF
CLASS A COMMON STOCK CURRENTLY OUTSTANDING MAY BE DILUTED.
If we raise additional capital by issuing equity securities at a price
or a value per share less than the then current price per share of Class A
Common Stock, then the value of the shares of Class A Common Stock then
outstanding will be diluted or reduced. At present we have the following two
arrangements to issue additional equity securities that could result in dilution
to the present holders of Class A Common Stock:
o Our Series D Redeemable Convertible Preferred Stock is
convertible into shares of Class A Common Stock upon
conversion by the selling shareholders. On March 31, 1999, we
sold 200 shares of Series D Redeemable Convertible Preferred
Stock in exchange for a $2 million investment. Between June
16, 1999 and August 9, 1999, 144.1 shares of Series D Redeemable
Convertible Preferred Stock and the equivalent of $15,642 in
accrued dividends were converted into 2,213,847 shares of
Class A Common Stock. At August 9, 1999, there were 55.9
shares of Series D Redeemable Convertible Preferred Stock
issued and outstanding and accrued dividends of $10,031.
The applicable conversion price for these shares and
dividends as of August 9, 1999 would require us to issue
920,256 shares of Class A Common Stock at a price per share
that is approximately $0.10 per share less than the last sale
price of the Class A Common Stock on that date. We may issue
all 300 shares of Series D Preferred Stock for an
additional $3 million in financing upon meeting certain
conditions, thereby creating a similar dilutive situation. In
expectation of the additional financing and assuming price
fluctuations, either of which could reduce the conversion price,
we have registered for resale up to 8,137,388 shares of Class A
Common Stock. The number of shares issuable upon conversion
could be more or less than the shares currently registered,
depending on market conditions.
o We potentially may issue shares of our Class A Common Stock
under a two-year, $13 million equity line agreement with
Promethean Investment Group L.L.C, and intend to register
8,137,388 shares of Class A Common Stock in connection with this
arrangement. Depending on the price per share of our Class A
Common Stock during the next two years, we may need to register
additional shares for resale to access the full amount of
financing available. Our ability to access the equity line
depends on various conditions including, but not limited to, our
Class A Common Stock trading at or above $1.00 per share and the
continued listing of our Class A Common Stock on the Nasdaq
National Market System. In addition, we are required to file
with the SEC a registration statement to register the Class
A Common Stock underlying the equity line with the SEC. We have
not yet filed this registration statement pending our review of
recent SEC interpretations regarding rules governing the use of
equity lines as a form of financing.
THERE WILL BE A DILUTIVE EFFECT ON THE SHARES OF OUR CLASS A COMMON
STOCK FROM THE CONVERSION OR EXERCISE OF CERTAIN OTHER OUTSTANDING SECURITIES.
As of the date of this report, the following securities exercisable or
convertible into shares of Class A Common Stock were outstanding:
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o stock options to purchase an aggregate of 7,249,889 shares of
Class A Common Stock (at exercise prices ranging from $0.72 to
$6.4375 per share) and 28,000 shares of Class B Common Stock (at
an exercise price of $0.50 per share);
o Class D Warrants exercisable into 1,514,035 shares of Class A
Common Stock (at an exercise price of $1.3750 per share);
o Class G Stock Purchase Warrants exercisable into 2,030,455
shares of Class A Common Stock (at an exercise price of $2.97
per share);
o Class H Stock Purchase Warrants exercisable into 100,000 shares
of Class A Common Stock (at an exercise price of $2.40 per
share);
o Class I Stock Purchase Warrant exercisable into 500,000 shares
of Class A Common Stock (at an exercise price of $0.78125 per
share);
o Class J Stock Purchase Warrants exercisable into 100,000 shares
of Class A Common Stock (at an exercise price of $0.91488 per
share);
o Class K Stock Purchase Warrant exercisable into 375,000 shares
of Class A Common Stock (at an exercise price of $1.125 per
share);
o Class L Stock Purchase Warrant exercisable into 55,000 shares of
Class A Common Stock (at an exercise price of $1.1875 per
share);
o 440,000 shares of Class B Common Stock (each convertible into
one share of Class A Common Stock); and
o 55.9 shares of Series D Redeemable Convertible Preferred Stock
convertible into 912,392 shares of Class A Common Stock as of
August 9, 1999.
To the extent that our other outstanding securities are exercised or
converted, our shareholders will experience dilution of their ownership
percentages. Sales in the public market of shares of Class A Common Stock that
underlie stock options and warrants may affect adversely the prevailing market
prices for shares of Class A Common Stock. Accordingly, negative price movements
in the shares of Class A Common Stock likely would have adverse effects on our
ability to obtain additional equity capital on favorable terms, if at all.
OUR COMPUTER SYSTEMS AND SYSTEMS OF THIRD-PARTIES IMPORTANT TO OUR BUSINESS
COULD FAIL WHEN THE YEAR CHANGES TO 2000.
Many computer systems may not recognize properly date-sensitive
information when the year changes to 2000. Computers which refer to years in
terms of their final two digits only may interpret the year 2000 to mean the
year 1900. If our internal business systems or software licensed from third
parties do not properly recognize such information, then our systems could fail.
We have established a year 2000 program to evaluate our internal business
systems and the systems of third parties essential to our operations. We have
completed the review, implementation and remediation phases of our internal
business systems for both hardware and software issues, and believe that the
critical software used in our business is year 2000 compliant. We are working
with our external suppliers and third parties important to our business to
obtain assurances that their systems are year 2000 compliant. We plan to have
completed the assessment of the year 2000 risks of our third parties by August
31, 1999.
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As we move forward with a potential product launch of docosanol cream,
we will face circumstances that may involve significant year 2000 issues that we
cannot anticipate at this time. These risks include potential year 2000 problems
with manufacturing, warehousing, distribution and marketing of the product.
Although we have established contracts for the manufacture, warehousing and
distribution of docosanol cream, we cannot determine at this time the extent to
which we will be vulnerable to year 2000 problems that these parties may
encounter.
Our evaluation and assessment of our year 2000 issues is on-going and we
expect that new or different information may become available as our assessments
and evaluations continue.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
AVANIR's market risk exposures are related to its cash and cash
equivalents. We invest our excess cash in highly liquid short-term investments
with maturities of less than one-year, which we do not believe is a significant
market risk.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are currently in trial preparation for the case between AVANIR and
Dr. David H. Katz, (former president and chief executive officer and a former
director of AVANIR). The trial is set to begin on August 23, 1999 on the
following causes of action:
1. Dr. Katz's claim for reinstatement of voting rights with respect
to the shares of Class B Common Stock that he sold to HealthMed,
Inc.;
2. A determination whether Dr. Katz was fired for "cause" and
therefore is entitled to severance pay;
3. Whether the exercise date for Mrs. Katz's options to exercise
10,000 shares of Class B Common Stock should be extended;
4. Whether Dr. Katz was "defamed" by statements that he was fired
for "cause";
5. Whether AVANIR interfered with any contractual relations between
Dr. Katz and Medical Biology Institute; and
6. An accounting for unreimbursed expenses allegedly advanced to
AVANIR by Dr. Katz.
The above causes of action are remaining from the fifteen causes of
action included in Dr. Katz's original Complaint for Declaratory Relief filed
against AVANIR on April 30, 1998, and further amended on December 21, 1998,
January 21, March 29 and May 3, 1999. The reduction in claims against AVANIR is
the result of Dr. Katz withdrawing certain claims or rulings by the court by
summary adjudication in AVANIR's favor.
On October 30, 1998, AVANIR filed a cross-complaint against Dr. Katz
seeking recovery of compensatory and punitive damages for his breach of
fiduciary duties as a director and officer of AVANIR. Acting pursuant to Dr.
Katz' agreements with AVANIR, the cross-complaint also asks that the court order
Dr. and Mrs. Katz to assign any interest they may possess in a pending patent
application pertaining to AVANIR's proprietary IgE down-regulation technology.
These claims also are scheduled for trial beginning August 23, 1999.
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Neither our counsel nor AVANIR can express an opinion on the likely
outcome of the lawsuits with Dr. Katz. However, we intend to defend the claims
from, and pursue claims against, Dr. Katz vigorously. See Notes to the Unaudited
Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 11, 1999 we convened a Special Meeting of Shareholders to approve
the potential issuance of more than 20% of our outstanding shares of Class A
Common Stock in connection with the potential issuance of Class A Common Stock
associated with our financing arrangements for Series D Redeemable Convertible
Preferred Stock and the Equity Line Agreement discussed above. See "Risk
Factors" and Notes to the Unaudited Financial Statements.
On May 11, 1999 there were not a sufficient number of votes returned to
constitute a quorum. The meeting was reconvened on May 21, 1999 and the proposal
obtained shareholder approval with 17,663,232 votes in favor, 4,922,594 votes
against and 325,690 votes abstained.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Current Reports on Form 8-K
A Current Report on Form 8-K was filed on April 1, 1999, reporting that
we had entered into a letter amendment to the Class A Common Stock
Investment Agreement dated January 22, 1999, previously reported in our
Current Report on Form 8-K filed January 25, 1999 as noted above.
A Current Report on Form 8-K filed on April 1, 1999, reporting that we
had entered into an agreement with several accredited investors to
obtain up to $5 million in financing through the sale of up to 500
shares of Series D Redeemable Convertible Preferred Stock and related
Class J Stock Purchase Warrants.
A Current Report on Form 8-K was filed on April 20, 1999, reporting that
the we had issued a Class I Stock Purchase Warrant exercisable into
500,000 shares of Class A Common Stock at an exercise price of $0.78125
per share and a Class K Stock Purchase Warrant exercisable into 375,000
shares of Class A Common Stock at an exercise price of $1.125 per share.
Each of these warrants were issued to consultants in exchange for their
services to AVANIR.
(b) Exhibits
<TABLE>
<CAPTION>
<S> <C>
3.1 - Restated Articles of Incorporation of the Registrant(4)
3.2 - Certificate of Amendment of the Articles of
Incorporation of the Registrant(11)
3.3 - Certificate of Determination with respect to Series D
Redeemable Convertible Preferred Stock of the
registrant(12)
3.4 - Certificate of Determination with respect to Series C
Junior Participating Preferred Stock of the
registrant(10)
3.5 - Amended and Restated By-laws of the Registrant(8)
4.1 - Forms of Class A and Class B Common Stock
Certificates(2)
4.2 - Class D Warrant Agreement (including form of Class D
Warrant Certificate)(3)
4.3 - Convertible Note, dated February 26, 1997, issued to RGC
International Investors LDC(8)
4.4 - Form of Class G Stock Purchase Warrant(6)
</TABLE>
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4.5 - Rights Agreement dated as of March 5, 1999, between
AVANIR Pharmaceuticals and American Stock Transfer &
Trust Company(10)
4.6 - Form of Rights Certificate with respect to the Rights
Agreement dated as of March 5, 1999(10)
4.7 - Form of Series D Redeemable Convertible Preferred Stock
Certificate(11)
4.8 - Amended and Restated Class I Stock Purchase Warrant
dated March 4, 1999(13)
4.9 - Form of Class J Stock Purchase Warrant(11)
4.10 - Class K Stock Purchase Warrant dated April 1, 1999(13)
4.11 - Class L Stock Purchase Warrant dated June 8, 1999(15)
10.1 - 1989 Stock Option Plan(2)
10.3 - Licensing Agreement with Yamanouchi Europe b.v.(1)
10.4 - 1994 Stock Option Plan(5)
10.5 - Supplemental Agreement with Yamanouchi Europe b.v.(5)
10.6 - Licensing Agreement with Grelan Pharmaceutical Company
Limited6
10.7 - Employment Agreement with Gerald J. Yakatan(7)
10.8 - Form of Indemnification Agreement with certain Directors
and Executive Officers of the Company(7)
10.9 - Registration Rights Agreement with Promethean Investment
Group, LLC(9)
10.10 - Class A Common Stock Investment Agreement the Promethean
Investment Group, L.L.C(9)
10.11 - Amendment to the Class A Common Investment Agreement(12)
10.12 - Securities Purchase Agreement for Series D Redeemable
Convertible Preferred Stock(11)
10.13 - Registration Rights Agreement for Series D Redeemable
Convertible Preferred Stock(11)
10.14 - Form of Employment Retention Agreement dated February
1999 with certain executive officers and key employees
of AVANIR(14)
10.15 - 1998 Stock Option Plan(14)
27.1 - Financial Data Schedule
(1) Incorporated by reference to the similarly described exhibits included
with the Registrant's Annual Report on Form 10-K for the fiscal year
ended September 30, 1991, filed January 11, 1992.
(2) Incorporated by reference to the similarly described exhibit filed in
connection with the Registrant's Registration Statement on Form S-1,
File No. 33-32742, declared effective by the Commission on May 8, 1990.
(3) Incorporated by reference to the similarly described exhibit filed in
connection with the Registrant's Registration Statement on Form S-1,
File No. 33-49082, declared effective by the Commission on October 26,
1992.
(4) Incorporated by reference to the similarly described exhibit filed in
connection with the Registrant's Amendment #4 to the Registration
Statement on Form S-1, File No. 33-32742, declared effective by the
Commission on April 13, 1994.
(5) Incorporated by reference to the similarly described exhibit included
with the Registrant's Annual Report on Form 10-K for the fiscal year
ended September 30, 1994, filed December 29, 1994.
(6) Incorporated by reference to the similarly described exhibit included
with the registrant's Current Report on Form 8-K filed March 10, 1997.
(7) Incorporated by reference to the similarly described exhibit included
with the Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998.
(8) Incorporated by reference to the similarly described exhibit included
with the Registrants Form 8-K filed on October 30, 1998.
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<PAGE> 32
(9) Incorporated by reference to the similarly described exhibit included
with the Registrant's Form 8-K filed on January 25, 1999.
(10) Incorporated by reference to the similarly described exhibit included
with the registrant's Current Report on Form 8-K filed March 11, 1999.
(11) Incorporated by reference to the similarly described exhibit included
with the registrant's Current Report on Form 8-K filed on April 1, 1999.
(12) Incorporated by reference to the similarly described exhibit included
with the registrant's Current Report on Form 8-K filed on April 1, 1999.
(13) Incorporated by reference to the similarly described exhibit included
with the registrant's Current Report on Form 8-K filed on April 20,
1999.
(14) Incorporated by reference to the similarly described exhibit included
with the registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1999, filed May 17, 1999.
(15) Incorporated by reference to the similarly described exhibit included
with the registrant's Registration Statement on Form S-3, filed July 15,
1999.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the date indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Gerald J. Yakatan, Ph.D. President and Chief August 14, 1999
- ----------------------------- Executive Officer
Gerald J. Yakatan, Ph.D. (Principal Executive Officer)
/s/Gregory P. Hanson Vice President, Finance and Chief August 14, 1999
- ----------------------------- Financial Officer (Principal
Gregory P. Hanson Financial and Accounting Officer)
</TABLE>
32
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-Q FOR THE NINE MONTHS ENDED JUNE 30, 1999 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> JUN-30-1999
<CASH> 1,437,351
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 111,901
<CURRENT-ASSETS> 1,665,638
<PP&E> 829,366
<DEPRECIATION> (468,599)
<TOTAL-ASSETS> 2,958,806
<CURRENT-LIABILITIES> 1,308,403
<BONDS> 0
619,949
0
<COMMON> 61,608,619
<OTHER-SE> (60,578,165)
<TOTAL-LIABILITY-AND-EQUITY> 2,958,806
<SALES> 0
<TOTAL-REVENUES> 135,268
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 7,092,700
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,745
<INCOME-PRETAX> (6,962,177)
<INCOME-TAX> 0
<INCOME-CONTINUING> (6,962,177)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,962,177)
<EPS-BASIC> (0.17)
<EPS-DILUTED> (0.17)
</TABLE>
