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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NO. 0-18734
AVANIR PHARMACEUTICALS
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C>
CALIFORNIA 33-0314804
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
<TABLE>
<S> <C>
9393 TOWNE CENTRE DRIVE, SUITE 200
SAN DIEGO, CALIFORNIA 92121
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
</TABLE>
(858) 558-0364
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Class A Common Stock, no par value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter periods that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to this
form 10-K. [X]
The aggregate market value of Registrant's voting stock held by
non-affiliates, as computed by reference to the average of the closing bid and
asked prices of the Class A Common Stock reported on the OTC Bulletin Board on
December 21, 1999: $103,000,000.
The number of shares of Common Stock of the Registrant issued and
outstanding as of December 21, 1999:
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Class A Common Stock, no par value....................... 46,060,314
Class B Common Stock, no par value....................... 440,000
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DOCUMENTS INCORPORATED BY REFERENCE
Registrant's definitive Proxy Statement which will be filed with the
Securities and Exchange Commission on or before January 28, 2000 in connection
with the Registrant's Annual Meeting of Shareholders to be held on March 23,
2000 is incorporated by reference into Part III of this Report.
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PART I
ITEM 1. BUSINESS
This Annual Report on Form 10-K contains forward-looking statements
concerning future events or performance of our company. 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 words like "estimate," "anticipate," "believe," "plan"
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 and those in our other SEC filings. We have no
obligation to update or announce revisions to any forward-looking statements to
reflect actual events or developments.
GENERAL
We are a development stage company organized to discover, develop and
market novel therapeutic products to treat human diseases. Since our inception
in 1988, we have operated in one business segment -- pharmaceutical product
development. Our executive offices are located at 9393 Towne Centre Drive, Suite
200, San Diego, California 92121. Our telephone number is (858) 558-0364; our
e-mail address is [email protected]; and our home page address is
http://www.avanir.com.
DOCOSANOL 10% CREAM
Potential FDA Approval as an OTC Product. Docosanol 10% cream is our lead
therapeutic product that we have been developing for over eight years. Docosanol
10% cream is a topical treatment for oral-facial herpes, which is more commonly
known as cold sores or fever blisters. In November 1999, the U.S. Food and Drug
Administration (FDA) informed us that our clinical data for docosanol 10% cream
would be sufficient for approval as an over-the-counter (OTC) product, provided
that the FDA finds no serious discrepancies from a site audit conducted at one
of our clinical study sites in The Netherlands. We currently are waiting for the
FDA's assessment of this site audit, which the Agency conducted during the
second week of December 1999. The site in The Netherlands was used by our former
European licensee to conduct one of the clinical studies submitted as part of
our new drug application for docosanol 10% cream. We also have submitted
proposed OTC product labeling for docosanol 10% cream, as requested by the FDA.
If our new drug application is approved by the FDA, then docosanol 10% cream
will be the first OTC product for cold sore treatment that will have an
FDA-approved new drug application to support claims made about the product's
performance.
Letter of Intent with SmithKline Beecham. We do not consider ourselves to
have sufficient experience or resources to market docosanol 10% cream as an OTC
product. For this reason, during the latter part of 1999, we began to hold
discussions with several pharmaceutical companies that have substantial consumer
products divisions about the opportunity to license the rights to market
docosanol 10% cream.
On December 20, 1999, we signed a letter of intent with SmithKline Beecham
(NYSE: SBH) for rights to market docosanol 10% cream in the North American OTC
market as a treatment for recurrent oral-facial herpes. SmithKline Beecham is
one of the world's leading health-care companies with over $13 billion in
revenues in 1998. We signed the letter of intent with SmithKline Beecham
because:
- SmithKline Beecham has a large, experienced and integrated sales and
marketing force capable of marketing and selling docosanol 10% cream as
an OTC product;
- SmithKline Beecham's unique experience in the topical antiviral
marketplace provides an advantage for effective marketing of docosanol
10% cream in the OTC market; and
- SmithKline Beecham Consumer Health has strong relationships with both the
retail trade and with physicians. We believe both types of relationships
are essential for marketing docosanol 10% cream successfully in the OTC
marketplace.
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The letter of intent provides that:
- we will negotiate exclusively with SmithKline Beecham until approximately
the end of February 2000 to finalize a license arrangement for docosanol
10% cream;
- assuming that these negotiations are successful and the FDA approves
docosanol 10% cream as an OTC product, we will receive an initial license
fee and other fees based upon our achievement of product milestones,
including product launch timing and sales levels, and royalties on sales
revenue; and
- we have the option to add selective foreign marketing rights to the
agreement if both companies agree to these terms.
At this time, we can provide no assurance that we will:
- Establish a license agreement with SmithKline Beecham or any major
pharmaceutical company on favorable terms;
- Obtain a successful site audit, as required by the FDA; or
- Agree with the FDA in a timely manner on labeling of the product.
Furthermore, we can give no assurance that the proceeds from a marketing
partnership will be sufficient to continue our other drug discovery and
development programs currently underway.
Licensing Agreements for Marketing Docosanol 10% Cream in Foreign
Countries.
We continue to maintain licensing agreements relating to the potential
marketing of docosanol 10% cream in several foreign countries. These agreements
are with:
Yamanouchi. In November 1991, we entered into a licensing agreement with
Yamanouchi for the clinical development, manufacturing, marketing and
distribution of docosanol 10% cream in selected European and other countries.
The agreement provides that, among other things, Yamanouchi may not sublicense
docosanol 10% cream without our approval. We anticipate licensing docosanol 10%
cream to another pharmaceutical partner in these areas because:
- we now have a right to select additional partners in the countries
covered by this agreement, because Yamanouchi's marketing right has
converted from an exclusive to a non-exclusive right;
- at this time, we do not anticipate a renewed development and registration
effort by Yamanouchi; and
- we prefer a pharmaceutical partner that has more consumer marketing
experience in the OTC market than Yamanouchi, whose marketing experience
lies more in the prescription drug marketing area.
CTS Chemical Industries, Ltd. In July 1993, we entered into a licensing
agreement with CTS Chemical Industries, Ltd., a subsidiary of CTS Ltd., located
in Kiryat Malachi, Israel, for the promotion of docosanol 10% cream in Israel,
including obtaining governmental approvals for its manufacture and distribution.
Although separate clinical trials in Israel are not required for marketing
approval, we expect that CTS Chemical Industries, Ltd. will keep its marketing
plans on hold until we make further progress with the FDA in obtaining marketing
approval for the U.S. market.
Boryung Pharmaceuticals Company, Ltd. In July 1994, we entered into a
licensing agreement with Boryung Pharmaceuticals Company, Ltd., located in
Seoul, Korea, for the promotion of docosanol 10% cream in the Republic of Korea,
including obtaining governmental approvals for its manufacture and distribution.
In Korea, selected local clinical trials, in addition to clinical data generated
in the U.S., Canada and Europe, are required to apply for marketing approval.
Boryung plans to initiate local clinical trials after docosanol 10% cream
receives U.S. FDA approval.
Under current circumstances, we must obtain the support and collaboration
of third parties in foreign countries to market and distribute docosanol 10%
cream or any of our other potential products outside the U.S. These third party
arrangements could include additional licensing or other collaborative
agreements with
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suitable outside parties that have sufficient financial resources and expertise
and/or additional financing to support the completion of any remaining
nonclinical and clinical development, regulatory marketing approval filings and,
if approved, eventual marketing of these products. We cannot assure you that we
will obtain the support of these third parties or commercialize successfully our
products in foreign countries even if we obtain applicable regulatory marketing
approvals for these products.
In the event that docosanol 10% cream is approved by the FDA, we believe
that our licensing partners will use the U.S. FDA approval in the regulatory
filings required for marketing and distribution in the specific territories. We
anticipate that these regulatory filings will be prepared on a timely basis.
However, we can provide no assurance that we will receive marketing approval for
docosanol 10% cream by the FDA in the U.S. or by comparable regulatory agencies
elsewhere in the world or that, if such approval is received, that our marketing
efforts will result in a level of sales sufficient to sustain our operations.
See "Business -- Risk Factors."
Potential Additional Uses of Docosanol 10% Cream. In addition to the
potential marketing and sale of docosanol 10% cream as an OTC product for cold
sores, other clinical studies indicate that docosanol 10% cream may have other
applications that could open other avenues for product development. Potential
indications for docosanol 10% cream include its use as a topical treatment for
Kaposi's sarcoma cutaneous lesions in HIV-positive patients, genital herpes,
wound healing and minor burns. However, at present, we do not intend to continue
development of any other potential topical indications, unless we obtain
substantial additional funding or a development partner to share in the product
development risks.
RESEARCH AND DEVELOPMENT -- OTHER PRODUCTS
We have been engaged in earlier stages of research and/or development of
several other potential therapeutic products, including new drugs for the
possible treatment of allergies, asthma, and inflammatory diseases. These
additional products will not be available for sale to the market for several
years, if at all.
The research and development efforts relating to many of our technologies
are at pre-clinical and early stages and these development efforts are, by their
nature, uncertain. We can provide no assurance that:
- our efforts to develop commercial applications of our current or future
in-licensed technologies will be successful or continued;
- any of our products currently under development will be available for
commercial sale even after several years of development, if at all; and
- preclinical and clinical testing of potential drugs under development
will demonstrate appropriate safety and efficacy to warrant further
development and/or to achieve the requirements of regulatory marketing
approvals in the U.S. or elsewhere.
In the event that we decide to proceed to develop these technologies for
commercial applications, then we likely will require additional financing. This
financing could come from collaborative arrangements with pharmaceutical or
biotechnology companies or from other sources. We can provide no assurance that:
- we will raise additional financing;
- we will enter into licensing or other collaborative arrangements on
favorable terms; or
- if funded, we will complete successfully the required development and
testing that will result in safe and effective products for human use.
New Therapies for Allergies and Asthma Through IgE Regulation. Our IgE
modulation program seeks to identify novel compounds that are useful in the
treatment of allergies and asthma. Allergy and asthma are respiratory diseases
affecting millions of people worldwide. After several decades of research,
scientists have established that allergies and asthma result from the fact that
allergic individuals commonly produce abnormally high levels of an antibody
known as IgE, the antibody responsible for triggering allergic responses. We
believe that the elevated IgE antibodies likely are due to a combination of
environmental and genetic influences. The end result is an unpleasant to
debilitating health condition.
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We use established techniques to screen for and identify novel small
molecule drugs that appear to selectively suppress IgE antibody production.
Using a combination of tissue culture, in vitro assays and in vivo models, we
have screened and identified several active candidate compounds that appear to
be significantly selective and specific in their inhibition of the IgE antibody
responses to allergens. We are attempting to identify therapeutic drug
candidates for allergic disease therapy that will be active when ingested. These
compounds are proprietary and we have filed several patent applications for them
with the United States Patent Office.
Our development of this technology and these small molecule drugs is
currently in the preclinical stage and will require many years and considerable
financial resources before we can develop, if at all, commercial products for
use in the field of allergy and asthma drug therapy. David H. Katz, M.D., a
former president, chief executive officer and member of the board of directors
of our company, and his wife, Lee R. Katz, have asserted a competing claim to
ownership of specific IgE technology. They contend that our pending patent
application constitutes a cloud on their title to this technology. This matter
is a subject of litigation between our company and Dr. and Mrs. Katz. See "Legal
Proceedings."
Human Immune System -- Reconstituted SCID Mouse Technology. By
reconstituting mice that have a genetic defect known as Severe Combined
ImmunoDeficiency (SCID) with human blood cells, our human immune system
reconstituted SCID mouse technology (hu-PBL-SCID) engrafts elements of the human
immune system in these mice. Various aspects of the human immune system thereby
function in laboratory animals. We have received the rights to both U.S. and
foreign patents for the hu-PBL-SCID technology in accordance with the settlement
agreement with a former development partner, Medical Biology Institute. See
"Business -- Patents and Proprietary Rights" and "Business -- Settlement
Agreement with Medical Biology Institute."
In the past, we completed work under 12 contract research agreements by
using hu-PBL-SCID mice infected with HIV to screen compounds developed by other
companies to test the potential therapeutic effect of these compounds in human
AIDS and other virus-induced diseases. We do not intend to perform this research
service for other pharmaceutical and biotechnology companies because we do not
expect that we would receive significant revenues from these contract research
agreements.
In August 1996, we entered into a five-year license agreement with Southern
Research Institute, under which we granted to Southern Research Institute a
non-exclusive license to use our hu-PBL-SCID technology in performing selected
contract research testing. We do not anticipate significant revenues under this
agreement. We have not signed any other license agreement for the use of this
technology.
Fully Human Antibody Generation Technology. Our scientists and outside
collaborators also have developed a technology that appears capable of
generating fully human monoclonal antibodies of high affinity. This technology
potentially eliminates the need to "humanize" mouse antibodies, which is a
process used to avoid natural rejection of foreign mouse proteins, by producing
entirely human antibodies. We believe that our technology could have advantages
over other technologies in the areas of rapid turnaround, production of diverse
antibody specificities with high affinity and reduced cost. We have joint patent
rights for this technology with IDEC Pharmaceuticals, San Diego, California, and
are exploring ways to commercialize it.
Protein Sequence Analysis Drug Discovery Method. Identifying potential
modulators that are capable of influencing the interaction among proteins
requires knowledge of the structures of proteins. In the past, scientists relied
on time-intensive three-dimensional techniques, including X-ray crystallography,
to determine structures and possible binding sites. Using a proprietary new drug
discovery method based on protein sequence analysis technology, our scientists
are attempting to discover active sites on a variety of clinically important
proteins. Although research efforts are at an early stage, our scientists
believe that this technology has the potential to shorten the drug discovery
process for particular types of drugs. We recognize that we will require
financing sources other than our current working capital before we can pursue
any additional development of this technology. We presently intend to actively
pursue outside partners from industry and/or the government to provide the
financial resources to pursue this area of therapeutic research.
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In-Licensing. In addition to our internal research and development
programs, we intend to pursue an in-licensing strategy to acquire new products
to develop internally, market or license to others. However, we will need
additional financial resources to pursue this strategy and to evaluate potential
products and technologies on a regular basis, to consider adding them to our
research and development pipeline. On February 5, 1999, we signed a letter of
intent with IriSys Research and Development, LLC to license the world-wide
rights to a product intended for use in a condition associated with
neurodegenerative diseases, chronic cough and neuropathic pain. Because of the
delays to obtain marketing approval for docosanol 10% cream and to obtain
additional financing, we have delayed negotiation of a final agreement with
IriSys. We cannot assure you that we will enter into a final agreement with
IriSys to in-license this product on favorable terms, or that we will have
sufficient funds to develop the product, if at all. Furthermore, we cannot
assure you that:
- any of the proposed products and technologies currently under
consideration will meet our expectations;
- we can complete negotiations with third parties;
- we will identify any other suitable products to in-license if we find
that the proposed products under consideration are unsuitable for our
purposes;
- once proposed products are identified, we will raise additional financing
or enter into licensing or other collaborative arrangements on favorable
terms, if at all;
- if funded, we will successfully complete the required development and
testing; or
- the required testing will prove the product safe and effective for human
use.
COMPETITION
The pharmaceutical industry is characterized by rapidly evolving technology
and intense competition. Many companies of all sizes, including major
pharmaceutical companies and specialized biotechnology companies, currently
engage in activities similar to our activities. Many of our competitors have
substantially greater financial and other resources and larger research and
development and clinical and regulatory affairs staffs. In addition, colleges,
universities, governmental agencies and other public and private research
organizations continue to conduct research and are becoming more active in
seeking patent protection and licensing arrangements to collect royalties for
use of technologies that they have developed, some of which may be in direct
competition with our proposed products. We also must compete with these
institutions in recruiting highly qualified scientific personnel. We do not have
the resources to compete with major pharmaceutical companies on a wide scale
basis in the areas of clinical testing, regulatory approvals, manufacturing and
marketing.
Docosanol 10% Cream. If ultimately marketed, docosanol 10% cream will face
intense worldwide competition from the following products:
- Zovirax(R) acyclovir (oral and topical) and Valtrex(R) valacyclovir
(oral) products marketed by Glaxo-Wellcome Corp;
- Famvir(R) famciclovir (oral) and Denavir(R) penciclovir (topical)
products marketed by SmithKline Beecham; and
- over-the-counter topical preparations, including well-known products such
as Blistex(R) and Carmex(R).
IgE Modulation Program. Our IgE modulation program competes with several
research approaches and numerous compounds under development by large
pharmaceutical and biotechnology companies, as well as very successful marketed
compounds, including:
- Claritin(R) loratadine from Schering-Plough;
- Hismanal(R) astemizole from Johnson & Johnson; and
- Anti-IgE antibody therapy under development at Genentech, Inc.
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We cannot assure you that our IgE modulation program will develop successfully a
safe and effective drug or, if developed, that we can obtain marketing approval
from the FDA for the drug.
We cannot predict what the competitive landscape will be for our proposed
products if they are introduced into the marketplace. In addition, we can
neither assure you that any of our proposed products and technologies will be
superior to our competitors' current or proposed products or technologies or
that our products and technologies will gain widespread acceptance in the
marketplace. See "Business -- Risk Factors -- Docosanol 10% cream, if ultimately
marketed, will face intense competition from a number of existing and well
established products."
PATENTS AND PROPRIETARY RIGHTS
Patents. We now have 19 worldwide patents and 24 additional patent
applications pending relating to the topical and systemic uses of docosanol 10%
cream. For example, we have received patents covering medical and veterinary
uses of the topical and systemic formulations of docosanol 10% cream in the U.S.
and Europe. We also have additional foreign patent applications pending that
cover topical and systemic uses of docosanol 10% cream and have been granted
rights under selected U.S. and foreign patents and patent applications relating
to docosanol 10% cream held by a third party. In addition, in connection with
the settlement agreement with Medical Biology Institute discussed below, we have
been granted rights to four U.S. and foreign patents and one patent application
is pending related to hu-PBL-SCID technologies. See "Business -- Research and
Development -- Other Products" and "Business -- Settlement Agreement with
Medical Biology Institute." Also, during the past year, we filed three U.S. and
three foreign patent applications related to IgE technology, which cover various
small molecules and related general structures or genus.
We cannot assure you that the claims in our pending patent applications
will be issued as patents, that any issued patents will provide us with
significant competitive advantages, or that the validity or enforceability of
any of our patents will not be challenged or, if instituted, that these
challenges will not be successful. The cost of litigation to uphold the validity
and prevent infringement of our patents could be substantial. Furthermore, we
cannot assure you that others will not independently develop similar
technologies or duplicate our technologies or design around the patented aspects
of our technologies. We can provide no assurance that our proposed technologies
will not infringe patents or other rights owned by others, the licenses to which
may not be available to us. In addition, the National Institute of Health
regulations provide that, if federally-funded institutions do not timely pursue
patent applications for patentable inventions, then the government can exercise
its right to own these inventions.
In addition, the approval process for patent applications in foreign
countries may differ significantly from the process in the U.S. The patent
authorities in each country administer that country's laws and regulations
relating to patents independently of the laws and regulations of any other
country and the patents must be sought and obtained separately. Therefore,
approval in one country does not necessarily indicate that approval can be
obtained in other countries.
Proprietary Rights. In some cases, we may rely on trade secrets and
confidentiality agreements to protect our innovations. We can provide no
assurance that:
- our trade secrets will be established;
- secrecy obligations will be honored; or
- others will not independently develop similar or superior technology. To
the extent that consultants, key employees or other third parties apply
technological information independently developed by them or by others to
our projects, we may be subject to disputes regarding the proprietary
rights to this information that may not be resolved in our favor.
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PRODUCT LIABILITY
The testing, marketing and sale of pharmaceutical products involve the risk
of product liability claims by consumers, end-users and other third parties. We
have obtained product liability insurance coverage in the amount of $2,000,000
per incident and in the aggregate for our clinical trials. Although we will
attempt to obtain additional product liability insurance before we market any of
our proposed products, we cannot assure you that we will obtain this insurance
or, if obtained, that we can acquire this insurance at a reasonable cost or in
amounts sufficient to cover all possible liabilities. In the event of a
successful suit against us, the lack or insufficiency of insurance coverage
could affect materially and adversely our business and financial condition.
Furthermore, various distributors of pharmaceutical products require minimum
product liability insurance coverage as a condition to purchase or accept
products for distribution. Failure to satisfy these insurance requirements could
impede our ability to achieve broad distribution of our proposed products, which
could affect materially and adversely our business and financial condition.
GOVERNMENT REGULATIONS
The FDA and comparable regulatory agencies in foreign countries regulate
extensively the manufacture and sale of the pharmaceutical products that we
currently are developing. The FDA has established guidelines and safety
standards that are applicable to the nonclinical evaluation and clinical
investigation of therapeutic products and stringent regulations that govern the
manufacture and sale of these products. The process of obtaining FDA approval
for a new therapeutic product, including docosanol 10% cream, usually requires a
significant amount of time and substantial resources. The steps typically
required before a product can be produced and marketed for human use include:
- nonclinical evaluation in vitro and in vivo including extensive
toxicology; and
- nonclinical pharmacological studies to obtain preliminary information on
the safety and efficacy of a drug.
The results of these nonclinical studies may be submitted to the FDA as
part of an investigational new drug application. The sponsor of an
investigational new drug application may not commence human testing of the
compound until being notified by the FDA, which usually occurs within 30 days of
submission of the application, that the FDA has activated the investigational
new drug application.
The clinical testing program for a drug may involve three phases:
- Phase 1 investigations are conducted in either healthy people or in
people or subjects often having a terminal disease, such as cancer, to
determine the maximum tolerated doses and any side effects of the
product;
- Phase 2 studies are conducted in limited numbers of subjects with the
disease or condition to be treated and are aimed at determining the most
effective doses and schedule of administration, evaluating safety and
whether the product demonstrates therapeutic effectiveness against the
disease; and
- Phase 3 studies involve large, well-controlled investigations in diseased
subjects and are aimed at verifying the safety and effectiveness of the
drug.
Data from all clinical studies, as well as all nonclinical studies and
evidence of good manufacturing processes, typically are submitted to the FDA in
a new drug application.
The FDA's Center for Drug Evaluation and Research or the Center for
Biologics Evaluation and Research must approve a new drug application or
biologics license application for a drug before the drug may be marketed in the
U.S. At the time, if ever, that we begin to market our proposed products for
commercial sale in the U.S., any manufacturing operations that may be
established in or outside the U.S. will be subject to rigorous regulation,
including compliance with current good manufacturing practices. We also may be
subject to regulation under the Occupational Safety and Health Act, the
Environmental Protection Act, the Toxic Substance Control Act, the Export
Control Act and other present and future laws of general application. In
addition, the handling, care and use of laboratory mice, including the
hu-PBL-SCID mice and rats, are
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subject to the Guidelines for the Humane Use and Care of Laboratory Animals
published by the National Institute of Health.
We currently intend to seek approval to market our proposed products in
foreign countries, which may have regulatory processes that differ materially
from those of the FDA. We anticipate that we will rely upon pharmaceutical or
biotechnology companies to license our proposed products or independent
consultants to seek approvals to market our proposed products in foreign
countries. We cannot assure you that approvals to market any of our proposed
products can be obtained in any country. Approval to market a product in any one
foreign country does not necessarily indicate that approval can be obtained in
other countries.
SETTLEMENT AGREEMENT WITH MEDICAL BIOLOGY INSTITUTE
In October 1988, we entered into an exclusive license agreement with
Medical Biology Institute, a non-profit research organization incorporated in
California in 1981, to conduct interdisciplinary basic research in biological
sciences. Medical Biology Institute was founded by David H. Katz, M.D., a former
president, chief executive officer and member of the board of directors of our
company until February 19, 1999. Dr. Katz also served as president, chief
executive officer and a director of Medical Biology Institute until May 14,
1998.
Since the date that we entered into the license agreement with Medical
Biology Institute, several technologies developed at Medical Biology Institute
have been transferred to us for further development and potential
commercialization. These technologies included:
- the SCID mouse model for creating reconstituted human immune systems;
- the protein sequence analysis drug discovery method, known as "indel"
technology;
- synthetic peptides and inhibitors and complement activation;
- large multivalent immunogen; and
- free fatty acid ADIFAB.
In 1998, Medical Biology Institute disputed our rights to docosanol 10%
cream and other products. These disputes led to the execution of a settlement
agreement and mutual general release on August 27, 1998, which provides that:
- we retain all rights to our lead therapeutic product, docosanol 10%
cream, other applications of the product and other technologies;
- Medical Biology Institute released any claims with respect to the IgE
program for creating therapies for allergies and asthma; and
- in return for obtaining full control of our technologies and avoidance of
potential future royalty payments, we loaned $500,000 to Medical Biology
Institute and returned other technologies that no longer fit our
long-term strategic plans. On February 23, 1999, we forgave the loan,
after determining that MBI had complied with specific loan covenants. See
Note 9 to the Financial Statements for additional information.
HUMAN RESOURCES
At December 21, 1999, we employed 15 persons, of whom nine were engaged in
research and development activities, clinical and regulatory affairs, and
business development, and six were engaged in finance, sales and marketing and
administrative functions. Our staff includes six employees with Ph.D. degrees.
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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.
Our auditors indicated that we will need to raise additional capital to
continue as a going concern in their Independent Auditors' Report on our
financial statements for fiscal year 1999. From our inception through September
30, 1999, we have generated only limited revenues and have incurred net losses
totaling approximately $62.2 million. Further, we expect to continue to incur
operating losses related to research and development and marketing activities,
unless we obtain the FDA's approval of our new drug application for docosanol
10% cream and we enter into a license agreement with SmithKline Beecham.
Docosanol 10% cream still requires regulatory approval before it can be sold in
the marketplace. In addition, during fiscal year 1999, the bulk of our financing
plans were either deferred or canceled because of the low market price of our
Class A Common Stock and our delisting from the Nasdaq National Market. With no
working capital at September 30, 1999, we need to successfully seek and complete
new licensing and financing arrangements to support future operations. Even if
the FDA approves our new drug application and we enter into a licensing
agreement with SmithKline Beecham for docosanol 10% cream, we cannot assure you
that these events or financing will occur in a timely manner to eliminate the
going concern issue.
Our ability to market and sell docosanol 10% cream is uncertain because we
have not reached a final agreement with SmithKline Beecham or any other
pharmaceutical company to market and sell the product in the OTC market.
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 10% cream or any other proposed products that we may develop. To
commercialize docosanol 10% cream, we have entered into collaborative
arrangements with manufacturing and distribution companies. These collaborative
arrangements likely will cause higher costs or the sharing of profits with third
parties. A potential marketing partner may not choose to use any of our
negotiated agreements, for which we might not have control. Due to the uncertain
nature of the market's acceptance of docosanol 10% cream as a topical treatment
for oral-facial herpes, we cannot assure you that any license fees and royalties
from licensing docosanol 10% cream will attain a level of revenue sufficient to
sustain our operations.
The timing of the product launch for docosanol 10% cream could be delayed
if our discussions and negotiations with SmithKline Beecham are delayed or
extended. For example, decisions involving the licensing of a pharmaceutical
product likely will involve a substantial amount of due diligence on the part of
both us and SmithKline Beecham. In addition, our ability to negotiate terms of
the amount of advertising and promotion expense on the part of SmithKline
Beecham may be limited. We cannot provide any assurance that, if a license
agreement is negotiated, we and SmithKline Beecham will develop effective
advertising or that consumers will select our product.
In addition, we have entered into several licensing agreements to cover the
clinical development, manufacturing and marketing of docosanol 10% 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 specific proposed products, which likely
would require substantial additional funds and personnel.
Our amended new drug application for docosanol 10% cream may not receive
FDA approval.
We can neither assure you that the FDA will approve docosanol 10% cream as
an OTC product, nor that the FDA will approve our proposed OTC labeling. On
October 29, 1999, we were informed by teleconference from Dr. Janet Woodcock,
Director, Center for Drug Evaluation and Research, that the clinical data on the
effectiveness of docosanol 10% cream in treating recurrent oral-facial herpes
would be sufficient for approval as an OTC product, pending and acceptable audit
of the data in one of the clinical studies presented in our new drug
application. Dr. Woodcock also stated that we should prepare and submit OTC
labeling for review
10
<PAGE> 11
by the FDA as a prerequisite to full marketing approval. A subsequent letter
from the FDA reiterated the FDA's decision. We are currently awaiting FDA
assessment of the site audit and evaluation of our proposed product labeling.
Failure to receive FDA marketing approval could affect materially and adversely
our business operations and financial condition.
We will face several risks to launch docosanol 10% cream as an
over-the-counter product.
If we pursue commercialization of docosanol 10% cream as an OTC product for
cold sores/fever blisters, we will face the following risks:
- potential delays to achieve timely compliance with FDA regulations for
marketing an OTC product;
- development of a professional marketing staff and sales communications
program in time for product launch;
- difficulty in building product awareness of a new OTC product among
customers or retail store decision makers;
- lack of consumer perception that docosanol 10% cream is superior to
existing and potentially new OTC products for oral herpes; and
- lack of widespread acceptance of docosanol 10% cream in the OTC consumer
market.
Docosanol 10% cream, if ultimately marketed, will face intense competition
from a number of existing and well-established products.
- If we or a marketing partner successfully launch docosanol 10% 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. 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. See
"Business -- Competition."
As a small emerging bio-pharmaceutical company, we have limited resources
to effectively mitigate potential risks relating to the foreign sales of
docosanol 10% cream and other potential products.
We are exposed to various foreign trade risks relating to the continued
development of docosanol 10% cream by foreign licensees. We also may arrange for
contracts in the future for the manufacture, marketing and distribution of
docosanol 10% cream overseas by foreign licensees, which will be substantially
out of our control. Specific risks that could impact significantly our ability
to deliver products include:
- changes in the regulatory and competitive environments in foreign
countries;
- changes in a specific country's or region's political or economic
conditions;
- shipping delays;
- difficulties in managing operations across disparate geographic areas;
- fluctuations in foreign currency exchange rates;
- difficulties associated with enforcing agreements through foreign legal
systems; and
- 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 10%
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
11
<PAGE> 12
testing and regulatory approval process can take a number of years and require
the expenditure of substantial resources. Although we have completed the
development of docosanol 10% cream and are 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 these approvals for our proposed products. We will continue to incur
costs of development without any assurance that we will ever obtain regulatory
approvals. Failure to obtain, or delays in obtaining, these approvals will
affect adversely our business operations, including our ability to commence
marketing of any proposed products. 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 exposed 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 preclinical 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.
We will face intense competition for these in-licensed products and
technologies. In addition, we might not locate suitable products and
technologies to fit our strengths or obtain them on acceptable terms, or have
the financial resources to develop products from the in-licensed technology. Our
business strategy is to in-license products and/or technologies at various
stages in the drug development pipeline. To achieve this objective, we must have
the financial resources to acquire and/or in-license new products and
technologies and develop and market the products, once approved. For example, we
signed a letter of intent with IriSys Research and Development, LLC in February
1999 to license world-wide rights to a product intended for use in a condition
associated with neurodegenerative diseases and pain. However, due to limited
financial resources in fiscal 1999, we deferred negotiations of a final
agreement with IriSys to in-license the product. We can provide no assurance
that we will in-license this or any other product or technology.
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 the history and
knowledge that they have which could substantially delay one or more of our
development programs until adequate replacement personnel could be hired and
trained. Our future success also depends on our continuing ability to identify,
hire, train and retain highly qualified, technical, sales, marketing and
customer service personnel. The employment and employee retention agreements
with several of our key employees are limited in scope and provide no real
assurance that any of these people will continue their employment with our
company. We do not have "key person" life insurance policies. The industry in
which we compete has a high level of employee mobility and aggressive
12
<PAGE> 13
recruiting of skilled personnel, which creates intense competition for qualified
personnel, particularly in product research, development, sales and marketing.
Our patents may be challenged and our pending patents may be denied, which
would seriously jeopardize our ability to compete in the intended markets
for our proposed products.
We rely substantially on the protection of our intellectual property, with
19 worldwide docosanol patents and 24 additional docosanol-related patent
applications pending. We also have ten patents issued or pending on other
products and technologies. Our patent applications involve compounds that 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:
- the claims in the pending patent applications will be allowed or that we
will even be issued patents;
- present and future competitors will not develop similar or superior
technologies independently, duplicate our technologies or design around
the patented aspects of our technologies;
- our proposed technologies will not infringe other patents or rights owned
by others, including licenses which may not be available to us;
- any issued patents will provide us with significant competitive
advantages; or
- challenges will not be instituted against the validity or enforceability
of any patent that we own or, if instituted, that these challenges will
not be successful.
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 10% 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 10% 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. In
addition, 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 this
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, various distributors of
pharmaceutical products require minimum product liability insurance coverage
before their purchase or acceptance of products for distribution. Failure to
satisfy these insurance requirements could impede our ability to achieve broad
distribution of our proposed products.
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<PAGE> 14
Our Class A Common Stock was delisted from the Nasdaq National Market
System and now trades on the OTC Bulletin Board.
Because our Class A Common Stock currently is traded on the OTC Bulletin
Board, shareholders are exposed to various risks, including:
- the liquidity of our Class A Common Stock is significantly lower as an
OTC Bulletin Board listed security than a Nasdaq National Market listed
security;
- the OTC Bulletin Board does not provide the same level of service or
information to our shareholders;
- various brokers may be restricted in being able to make recommendations
to their clients about our common stock.
Further, we can provide no assurance as to how quickly we can regain compliance
with the Nasdaq listing requirements, if ever.
If we issue additional shares of equity securities, which is likely, 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. For example, we potentially may issue and register
up to 8,137,388 shares of our Class A Common Stock under a two-year, $13 million
equity line agreement with Promethean Investment Group, L.L.C. that could result
in dilution to the present holders of Class A Common Stock. 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.
In addition, there will be a dilutive effect on the shares of our Class A
Common Stock from the conversion or exercise of other outstanding securities. As
of December 21, 1999, the following securities exercisable or convertible into
shares of Class A Common Stock were outstanding:
- stock options to purchase an aggregate of 7,561,142 shares of Class A
Common Stock (at exercise prices ranging from $0.30 to $6.44 per share)
and 28,000 shares of Class B Common Stock (at an exercise price of $0.50
per share);
- Class D Warrants exercisable into 1,455,853 shares of Class A Common
Stock (at an exercise price of $1.375 per share), which expired on
December 31, 1999;
- Class G Stock Purchase Warrants exercisable into 3,635,783 shares of
Class A Common Stock (at an exercise price of $1.375 per share);
- Class H Stock Purchase Warrants exercisable into 100,000 shares of Class
A Common Stock (at an exercise price of $2.40 per share);
- Class I Stock Purchase Warrant exercisable into 500,000 shares of Class A
Common Stock (at an exercise price of $0.78125 per share);
- Class J Stock Purchase Warrants exercisable into 50,000 shares of Class A
Common Stock (at exercise price of $0.9144 per share);
- Class K Stock Purchase Warrant exercisable into 375,000 shares of Class A
Common Stock (at an exercise price of $1.125 per share);
- Class L Stock Purchase Warrant exercisable into 55,000 shares of Class A
Common Stock at an exercise price of $1.1875 per share;
- Class M Stock Purchase Warrants exercisable into 700,934 shares of Class
A Common Stock at an exercise price of $1.284 per share; and
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<PAGE> 15
- 440,000 shares of Class B Common Stock (each convertible into one share
of Class A Common Stock).
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.
EXECUTIVE OFFICERS
The names of our executive officers and their ages as of December 21, 1999
are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Gerald J. Yakatan, Ph.D. ............ 57 President and Chief Executive Officer
Gregory P. Hanson.................... 53 Vice President, Finance; Chief Financial Officer
and Secretary
J. David Hansen...................... 48 Vice President, Sales and Marketing
James E. Berg........................ 48 Vice President, Clinical Affairs and Regulatory
Affairs
</TABLE>
Gerald J. Yakatan, Ph.D. Dr. Yakatan has served as president and chief
executive officer since March 1998. In addition, Dr. Yakatan:
- since July 1995, has served on a half-time basis as vice president of
Drug Development;
- has served as Chairman of IriSys Research & Development, LLC, a company
he founded in 1996 specializing in contract drug formulation development
services;
- from 1990 until 1995, served as president and chief executive officer of
San Diego based Tanabe Research Laboratories, USA, Inc., an inflammation
drug discovery research and development company;
- from 1987 until 1990, served as executive vice president for Research and
Development, and vice president of Pharmaceutical Development at
Immunetech Pharmaceuticals, the predecessor company to Tanabe Research;
- from 1980 to 1987, held various positions at Warner-Lambert Co.,
initially joining the Warner-Lambert/Parke-Davis Pharmaceutical Research
Division as Director, Pharmacokinetics/Drug Metabolism and later serving
as vice president of Product Development for the Pharmaceutical Research
Division; and
- from 1972 to 1980, was on the faculty of the University of Texas at
Austin and Assistant Director of the Drug Dynamics Institute at the
College of Pharmacy.
Dr. Yakatan has over 60 scientific and professional publications in the areas of
pharmacokinetics, biopharmaceutics, analysis of drugs in biological fluids and
drug stability. He is a Fellow of the American Association of Pharmaceutical
Scientists and the American College of Clinical Pharmacology. Dr. Yakatan
received his B.S. in Pharmacy in 1963 and M.S. in Pharmaceutical Chemistry in
1965 from Temple University. In 1971, Dr. Yakatan received his Ph.D. in
Pharmaceutical Sciences from the University of Florida.
Gregory P. Hanson. Mr. Hanson has served as vice president, Finance and
Chief Financial Officer (CFO) and Corporate Secretary since July 1998. In
addition, Mr. Hanson:
- from September 1995 to July 1998, served as CFO of XXsys Technologies
Inc., a composite materials technology company;
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<PAGE> 16
- from May 1993 to September 1995, held a number of financial positions
within The Titan Corporation, a diversified telecommunications and
information technology company, including acting CFO and acting
Controller for its subsidiary, Titan Information Systems;
- from January 1992 to May 1993, served as CFO of Onsite Energy, a contract
energy services company;
- from February 1990 to December 1991, was CFO for Catrel USA, a waste
resource recovery company; and
- prior to 1989, held management positions with Ford Motor Company and
Solar Turbines Incorporated, a subsidiary of Caterpillar.
Mr. Hanson has a B.S. degree in Mechanical Engineering from Kansas State
University and an M.B.A. degree with honors from the University of Michigan. He
is a Certified Management Accountant and has passed the examination for
Certified Public Accountants.
J. David Hansen. Mr. Hansen has served as vice president, Sales and
Marketing since September 1998. In addition, Mr. Hansen:
- from December 1989 to September 1998, held various management positions
at Dura Pharmaceuticals, San Diego, California, including Senior
Director, Strategic Sales Systems; National Sales Director, Director of
Business Development and Director of Marketing;
- from April 1988 to November 1989, was Marketing Manager for Immunetech
Pharmaceuticals, San Diego;
- from April 1981 to March 1988, held various managerial positions in sales
in Schering/Key Pharmaceuticals, Kennilworth, New Jersey; and
- from February 1976 to March 1981, was a territory representative for E.R.
Squibb & Sons, Princeton, New York.
Mr. Hansen graduated with honors from the University of Oregon, with a B.S.
degree in Chemistry in June 1974.
James E. Berg. Mr. Berg has served as vice president, Clinical Affairs and
Product Development since March 1997. From August 1992 to March 1997, Mr. Berg
was Director of Clinical Affairs and Product Development. In addition, Mr. Berg:
- from April 1984 to August 1992, was employed by QUIDEL Corporation, where
he held positions as Product Development Manager, Director of Materials;
- was National Accounts Manager for Allergy and IgE Products and Regional
Manager, Autoimmune Products; and
- from March 1979 to April 1984, was the Sales Manager, Eastern U.S. and
Canada, at Krupp Bilstein Corporation of America, Inc.
Mr. Berg received his B.A. degree from the University of Wisconsin in 1973.
ITEM 2. PROPERTIES
We currently sublease approximately 12,000 square feet of laboratory and
office space at 9393 Towne Centre Drive in San Diego, California for a base
annual rent of approximately $270,000. The current lease expires in June 2000.
We are evaluating our space requirements for mid-2000 and beyond at this time.
ITEM 3. LEGAL PROCEEDINGS
DAVID H. KATZ LITIGATION
On April 30, 1998, Dr. David H. Katz filed a complaint in the San Diego
Superior Court, making numerous claims related to the termination of his
employment as our president. Mrs. Lee Katz, Dr. Katz'
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<PAGE> 17
wife, later joined in the lawsuit and raised claims related to her stock
options. On October 30, 1998, we filed a cross-complaint against Dr. Katz and
Mrs. Katz for Dr. Katz' breach of his fiduciary duties as a director and officer
of our company, and the assignment by Dr. Katz and Mrs. Katz to our company of
any interest that they may possess in a pending patent application pertaining to
our proprietary IgE down-regulation technology. The following claims are still
pending before the court:
- Dr. Katz' request for the court to decide the voting rights for his
shares of our Class B Common Stock;
- Dr. Katz' claim that his termination as our president was not "for
cause";
- Dr. Katz' request for an accounting for allegedly deferred income and
money allegedly advanced to our company; and
- Our claim for specific performance of Dr. and Mrs. Katz' employment
contractual obligations to assign any interest in the pending IgE
technology patent application to us.
The jury in this litigation recently found in our favor on our claim that
Dr. Katz breached his fiduciary duty to us, and awarded us damages in the amount
of $9.0 million. The jury also returned a verdict against us on Dr. Katz'
defamation claim and awarded Dr. Katz' damages in the amount of $6.7 million.
The other original claims were either voluntarily dismissed by Dr. Katz, decided
in our favor by the court, or settled. However, the court has not set a date for
further proceedings to decide the remaining claims, and no judgment will be
entered in the overall case until trial is concluded on these claims. At that
point, we anticipate that both sides of the litigation will file post-trial
motions.
LEE KATZ AND LISA KATZ LITIGATION
On January 29, 1999, Lee Katz and Lisa Katz filed a separate lawsuit in the
San Diego Superior Court, making several claims related to our termination of
their employment and seeking monetary damages. The court has resolved several of
the claims in our favor, and we have reached a tentative settlement of the
remaining claims, although we have not agreed to the language of a written
settlement agreement. We intend to defend these claims vigorously until the
parties sign a settlement agreement or the case is resolved at trial.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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<PAGE> 18
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On November 30, 1998, shares of our Class A Common Stock began trading on
the NASDAQ National Market System under the symbol AVNR. Prior to November 30,
1998, our shares traded under the symbol LDAKA on the Nasdaq National Market
System. On September 20, 1999, our shares began trading on the OTC Bulletin
Board. The prices set forth below represent quotes between dealers and do not
include commissions, mark-ups or mark-downs, and may not necessarily represent
actual transactions.
<TABLE>
<CAPTION>
CLASS A
COMMON STOCK
--------------
HIGH LOW
----- -----
<S> <C> <C>
Fiscal 1998
First Quarter........................................ $2.94 $1.66
Second Quarter....................................... $2.19 $1.56
Third Quarter........................................ $1.81 $1.16
Fourth Quarter....................................... $1.47 $0.87
Fiscal 1999
First Quarter........................................ $2.91 $0.53
Second Quarter....................................... $1.09 $0.72
Third Quarter........................................ $1.13 $0.63
Fourth Quarter....................................... $0.78 $0.27
</TABLE>
On December 21, 1999, the closing bid and ask prices of Class A Common
Stock were $2.31 and $2.34, respectively.
As of December 21, 1999, we had 945 holders of record and approximately
14,400 beneficial owners of our Class A Common Stock. We have not paid any
dividends since our inception and do not contemplate payment of dividends in the
foreseeable future.
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<PAGE> 19
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below at September 30, 1998 and 1999,
for the years ended September 30, 1997, 1998 and 1999, and the period from
August 31, 1988, the date of our inception, through September 30, 1999 are
derived from and are qualified in their entirety by reference to our audited
financial statements included elsewhere in this report. These data should be
read in conjunction with those financial statements and notes and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." The selected financial data presented below at September 30, 1995,
1996 and 1997, and for the years ended September 30, 1995 and 1996, are derived
from audited financial statements that are contained in our previous SEC
reports.
SUMMARY FINANCIAL INFORMATION
<TABLE>
<CAPTION>
FROM
AUGUST 31,
1988
(INCEPTION)
THROUGH
YEARS ENDED SEPTEMBER 30,
---------------------------------------------------------------------
] SEPTEMBER 30,
1995 1996 1997 1998 1999 1999
------------ ----------- ------------ ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues................. $ 884,589 $ 4,158,038 $ 1,547,554 $ 590,728 $ 146,787 $ 10,286,085
Net loss................. (10,173,001) (6,130,241) (11,109,242) (8,210,548) (8,554,036) (62,170,024)
Net loss per common
shareholder............ (10,173,001) (6,130,241) (11,109,242) (8,210,548) (8,583,182) (62,199,170)
Net loss per share....... $ (0.35) $ (0.19) $ (0.30) $ (0.21) $ (0.21)
Weighted average number
of shares of common
stock outstanding...... 29,338,418 32,072,944 36,779,774 39,519,609 41,704,265
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------------------------------------------------------------
1995 1996 1997 1998 1999
------------ ----------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and
short-term investments... $ 10,035,727 $20,374,010 $ 14,428,834 $ 6,508,341 $ 122,674
Working capital............ 8,567,966 13,759,577 11,336,627 4,819,830 (1,068,091)
Total assets............... 10,954,043 22,846,879 15,727,495 7,653,800 1,765,215
Convertible notes
payable.................. 5,721,087 2,415,461 1,000,000
Total liabilities.......... 1,705,443 7,778,760 3,433,569 2,064,485 1,701,019
Shareholders' equity....... 9,248,600 15,068,119 12,293,926 5,589,315 64,196
</TABLE>
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<PAGE> 20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are a development stage company that was formed in August 1988.
Docosanol 10% cream is our lead therapeutic product that has been under
development since we filed our investigational new drug application in July
1991. In November 1999, the FDA informed us that our clinical data for docosanol
10% cream would be sufficient for approval as an over-the-counter (OTC) product,
if the FDA finds no serious discrepancies from the site audit that it conducted
at one of our clinical study sites in The Netherlands in mid-December 1999. We
currently are waiting for the FDA's assessment of the site audit.
On December 20, 1999, we entered into exclusive negotiations with
SmithKline Beecham regarding an acceptable partnership agreement for the
marketing and sale of docosanol 10% cream. If these negotiations are successful
and docosanol 10% cream is approved by the FDA, then SmithKline Beecham will
receive the right to market and sell docosanol 10% cream in the North American
market, in return for our receiving license fees based on the achievement of
product milestones, including product launch and sales levels, and royalties on
sales revenue.
If we obtain FDA approval for our new drug application for docosanol 10%
cream and we complete a license agreement with SmithKline Beecham, then we
intend to generate revenues from license fees and royalties from this license
agreement. Our revenues for the next several years will depend, perhaps
exclusively, on the license fees and royalties from this product.
We have incurred increasing annual operating expenses and, with the
potential commercialization of other products, we expect that this trend of
increased operating expenses will continue. Our business is exposed to
significant risks discussed in the section entitled "Risk Factors," which may
result in additional expenses, delays and lost opportunities that could have a
material adverse effect on our financial condition and results of operations.
RESULTS OF OPERATIONS
COMPARISON OF FISCAL YEARS 1999 AND 1998
NET LOSSES -- 1999 VS. 1998
Net losses for fiscal year 1999 were $8.6 million, or $0.21 per share,
compared with $8.2 million, or $0.21 per share, for fiscal year 1998. The higher
net loss in fiscal year 1999 resulted primarily from lower interest income in
1999 due to lower cash on hand for investment during the year. Other factors
contributing to the higher net loss in fiscal year 1999 compared with fiscal
year 1998 are discussed below.
REVENUES -- 1999 VS. 1998
Revenues decreased to $147,000 in fiscal year 1999 from $591,000 in fiscal
year 1998. This decrease in revenues resulted from lower interest earned on cash
and cash equivalents available for investment during fiscal year 1999.
EXPENSES -- 1999 VS. 1998
Operating Expenses. Our total operating expenses decreased to $8.7 million
in fiscal year 1999 compared to $8.8 million in fiscal year 1998. The net
decrease in operating expenses during fiscal year 1999 is described in the
following paragraphs.
Research and Development Expenses. Our research and development expenses
during fiscal year 1999 were $3.3 million, consistent with our research and
development expenses for fiscal year 1998. During fiscal year 1999, these
expenses related to the development of our allergy and asthma technology and the
phase 2 clinical trials of AVP-923. In the prior fiscal year, these expenses
related to several projects that we postponed or discontinued during fiscal year
1999 to allow us to focus on the development of our allergy and asthma
technology.
20
<PAGE> 21
General and Administrative Expenses. Our general and administrative
expenses during fiscal year 1999 decreased to $3.8 million from $4.0 million
during fiscal year 1998. These decreased expenses primarily relate to:
- lower proxy and shareholder solicitation costs due to the costs of
meetings held in fiscal year 1998;
- lower fees paid to the board of directors in fiscal year 1999;
- decreased facilities rent and related expenses due to the relocation of
our headquarters to a smaller and lower cost facility in June 1998; and
- lower consulting fees.
Partially offsetting the decreased expenses relative to fiscal year 1998 are
increased legal and related expenses in fiscal year 1999 associated with our
defense of claims asserted by Dr. David H. Katz, our former president and chief
executive officer and a former director.
Sales and Marketing Expenses. Sales and marketing expenses increased to
$1.6 million during fiscal year 1999 from $671,000 during fiscal year 1998. We
began our sales and marketing department in late fiscal year 1998. To date, we
have incurred costs related to the formation of a sales and marketing staff and
preparation for the launch of docosanol 10% cream. In fiscal year 1999, we
reduced our product launch support staff pending the outcome of the FDA's
decision relating to the marketing approval of docosanol 10% cream.
Interest Expense. Interest expense decreased to $8,000 in fiscal year 1999
compared to $95,000 in fiscal year 1998. The decrease in interest expense in
fiscal year 1999 resulted from the conversion of the balance of the convertible
note payable in October 1998.
Litigation Settlement. During fiscal year 1998, we recorded litigation
settlement expenses of $784,000 in connection with our settlement of various
technology disputes with Medical Biology Institute and our settlement with
HealthMed, Inc. There were no litigation settlement costs incurred during fiscal
year 1999.
COMPARISON OF FISCAL YEARS 1998 AND 1997
NET LOSSES -- 1998 VS. 1997
During fiscal year 1998, we incurred a net loss of $8.2 million compared to
a net loss of $11.1 million during fiscal year 1997. Factors contributing to the
lower net loss in fiscal year 1998 compared with fiscal year 1997 are discussed
below.
REVENUES -- 1998 VS. 1997
Our revenues totaled $591,000 for fiscal year 1998 compared to $1.5 million
for fiscal year 1997. Fiscal year 1998 revenues consisted of interest and other
income. The decrease in revenues during fiscal year 1998 compared to fiscal year
1997 resulted from discontinued license fees and federal research grant revenue
earned in fiscal year 1997 and lower interest income as a result of a lower
average cash balance during fiscal year 1998.
EXPENSES -- 1998 VS. 1997
Research and Development Expenses. Our research and development expenses
decreased by $4.4 million to $3.2 million during fiscal year 1998 from $7.6
million during fiscal year 1997. Research and development expenses decreased
during fiscal year 1998 due to the completion of U.S. Phase 3 clinical trials in
fiscal year 1997. Our research and development expense during fiscal year 1998
consisted of costs in preparing and filing the new drug application for
docosanol 10% cream in the first fiscal quarter of 1998 and costs related to our
other research and development activities.
21
<PAGE> 22
General and Administrative Expenses. Our general and administrative
expenses increased by $1.0 million to $4.0 million during fiscal year 1998 from
$3.0 million during fiscal year 1997. The increased expenses during fiscal year
1998 resulted primarily from higher legal expenses related to the following:
- evaluation of January 1998 financing proposal presented by HealthMed,
Inc.;
- settlement with Medical Biology Institute; and
- matters of litigation and potential litigation between us and Dr. Katz.
The increased general and administrative expenses in fiscal year 1998 also
resulted from: increased costs of legal and other expenses related to our annual
shareholders meeting held in June 1998; increased investor relations activities;
and increased board fees and related expenses due to an expanded board of
directors and higher number of meetings in fiscal year 1998.
Overall increases in general and administrative expenses during fiscal year
1998 were partially offset by lower expenses associated with license fees
relating to our reacquisition of the marketing rights to docosanol 10% cream
from Bristol-Myers Squibb Company.
Sales and Marketing Expenses. We incurred sales and marketing expenses of
$671,000 in fiscal year 1998 preparing for the product launch of docosanol 10%
cream.
Litigation Settlement. Our litigation settlement costs of $784,000 in
fiscal year 1998 related primarily to costs of the settlement agreement with
Medical Biology Institute.
Interest Expense. Our interest expense decreased by $2.0 million to $95,000
during fiscal year 1998. This decrease was due to lower interest expense
associated with the decrease in convertible debt outstanding in the period.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed operations primarily through the sale of
equity and convertible debt securities and shareholder loans. Net cash provided
by financing activities from inception through September 30, 1999 was $53
million.
At September 30, 1999, we had available $123,000 of cash, cash equivalents
and short-term investments and a negative working capital balance of $1.1
million 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 resulted from operating expenses that we incurred as discussed
above in "Results of Operations," which were offset only partially by cash
received from financing activities during fiscal year 1999.
Cash Used For Operating Activities. Net cash used for operating activities
of $7.9 million during fiscal year 1999 did not change significantly relative to
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 at least for the first half of fiscal year 2000. If we do not obtain
approval from the FDA for our new drug application for docosanol 10% cream and
negotiate a definitive licensing agreement with SmithKline Beecham for the North
American marketing rights to docosanol 10% cream, then we will have to cut
further our operating costs and obtain additional forms of financing not
currently contemplated to support our operations.
Cash Used For Investing Activities. Cash used for investing activities
totaled $275,000 in fiscal year 1999, including patent costs of $194,000 and
capital expenditures of $81,000. Cash used for investing activities in fiscal
year 1998 amounted to $5,000.
Cash Received from Financing Activities.
Fiscal Year 1999. On March 31, 1999, we issued and sold $2.0 million in
Series D Convertible Redeemable Preferred Stock to certain investors, resulting
in net cash receipts during fiscal year 1999 of $1.8 million. If various
conditions are met, then these investors have the right to purchase up to $3
million in additional shares of Series D Convertible Redeemable Preferred Stock
and shares of Class A Common Stock
22
<PAGE> 23
issuable upon the exercise of our Class J Stock Purchase Warrants. In addition,
on January 22, 1999, we entered into an equity line agreement with Promethean
Investment Group LLC. We have not received any cash proceeds from this equity
line because we have not met certain required milestones.
Financing Transactions Since September 30, 1999. The following events
occurred between October 1, 1999 to January 6, 2000 that have increased our
liquidity:
- $1,680,000 from the exercise of Class D Warrants into approximately 1.2
million shares of Class A Common Stock, at an average exercise price of
$1.38 per share. See Note 3 to the Financial Statements.
- $1,031,000 from the exercise of Class G Warrants into 750,000 shares of
Class A Common Stock, at an average exercise price of $1.38 per share.
- $46,000 from the exercise of Class J Warrants into 50,000 shares of Class
A Common Stock, at an average exercise price of $0.91 per share.
- $240,000 from the exercise of employee stock options into approximately
197,000 shares of Class A Common Stock, at an average exercise price of
$1.22 per share.
In addition, on November 23, 1999, we entered into a loan agreement with
two institutional investors for aggregate proceeds of $1.5 million. We also
intend to seek additional interim capital of up to $6 million during January
2000, which likely will require the sale and issuance of shares of our Class A
Common Stock and additional dilution to our current shareholder base.
If we do not receive FDA approval for docosanol 10% cream and enter into a
definitive license agreement with SmithKline Beecham or another pharmaceutical
company for the licensing of docosanol 10% cream, then our cash flow would be
materially adversely affected and we might not have sufficient cash flow to
sustain operations for the next 12 months without additional financing. 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 will obtain successfully this additional
capital or enter into the collaborative arrangements necessary to develop or
commercialize fully any of our drugs on acceptable terms. Failure to raise
additional capital, or enter into these collaborative arrangements in a timely
manner, could affect materially and adversely our business, financial condition
and results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
During June 1999, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 137, "Accounting for Derivative
Instruments and Hedging Activities-Deferral of the Effective Date of FASB
Statement 133." The statement defers the effective date of SFAS No. 133 to the
year ending September 30, 2001. Interim reporting for this standard will be
required. We have not yet assessed the effect of this standard on our current
reporting and disclosures.
IMPACT OF THE YEAR 2000 ISSUE AND COSTS
We did not have any disruption in our operations as we entered into year
2000. However, we took a number of precautions during fiscal year 1999 to
prepare our software and hardware for potential problems.
Evaluation, Testing and Remediation Program. We took several precautions
with regard to the transition from the year 1999 to year 2000, because most
computer systems were designed with date data using two digits of the year. For
example, 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 have resulted 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. In September 1998, we established a year 2000
program to analyze our internal systems and systems of third parties essential
to our operations.
23
<PAGE> 24
We conducted an evaluation of our internal systems, which included four
phases:
- implementation of our Y2K program,
- assessment, including prioritization and pre-testing,
- remediation, including modification, upgrading and replacement, and
- testing for year 2000 compliance.
We then evaluated our third-party vendors and service providers to determine the
extent to which we were vulnerable to any failure by these third parties to
remediate their respective year 2000 problems. Our vendors and service providers
reported that they were year 2000 compliant and many had contingency plans.
Costs. The total cost of our Y2K program, including the software upgrades
discussed above, was less than $20,000.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our market risk exposures relate to 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our financial statements are annexed to this Report as pages F-1 through
F-25
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ F-2
Balance Sheets at September 30, 1998 and 1999............... F-3
Statements of Operations for the years ended September 30,
1997, 1998 and 1999, and the period August 31, 1988
(inception) to September 30, 1999......................... F-4
Statements of Shareholders' Equity (Deficit) for the period
August 31, 1988 (inception) to September 30, 1999......... F-5
Statements of Cash Flows for the years ended September 30,
1997, 1998 and 1999, and the period August 31, 1988
(inception) to September 30, 1999......................... F-11
Notes to Financial Statements............................... F-12
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information relating to our directors that are required by this item is
incorporated by reference from the information under the caption "Election of
Directors" contained in our Definitive Proxy Statement which will be filed with
the Securities and Exchange Commission in connection with the solicitation of
proxies for our Annual Meeting of Shareholders to be held on March 23, 2000.
The required information concerning our executive officers is contained in
Part 1, Item 1, of this report under "Executive Officers."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
information under the caption "Executive Compensation" contained in the Proxy
Statement.
24
<PAGE> 25
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the
information under the caption "Security Ownership of Certain Beneficial Owners
and Management" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information under the caption "Certain Relationships and Transactions" contained
in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS AND SCHEDULE
(1) Index to financial statements appears on page F-1.
(b) CURRENT REPORTS ON FORM 8-K
(1) A Current Report on Form 8-K was filed on October 4, 1999, reporting
that:
- we received an action letter from the U.S. Food and Drug Administration
on September 24, 1999, confirming that our submissions of additional
analyses for our new drug application for docosanol 10% cream were not
adequate to establish effectiveness for the treatment of cold sores or
fever blisters; and
- we were notified by the Nasdaq Stock Market that our Class A Common Stock
would be de-listed from the Nasdaq National Market listing effective
before the opening of the market on Monday, September 20, 1999.
(2) A Current Report on Form 8-K was filed on December 3, 1999, reporting
that we had entered into a loan agreement with two financial lenders to obtain
$1.5 million in financing through the issuance of two 11% Convertible Debentures
and Class A Stock Purchase Warrants.
(c) EXHIBITS
<TABLE>
<S> <C>
3.1 Bylaws of the Registrant(1)
3.2 Restated Articles of Incorporation of the Registrant(2)
3.3 First and Second Amendment to Bylaws(2)
3.4 Fourth Amendment to Bylaws(3)
3.5 Sixth Amendment to Bylaws(4)
3.6 Certificate of Amendment of the Articles of Incorporation of
the Registrant(5)
4.1 Class D Warrant Agreement (including form of Class D Warrant
Certificate)(1)
4.2 Warrant Agreement (including form of Class E Warrant
Certificate)(1)
4.3 Form of Unit Purchase Option issued to D.H. Blair & Co.,
Inc. and its designees regarding Series B Preferred Stock
and Class D Warrants(1)
4.4 Registration Rights Agreement(1)
4.5 Certificate of Determination with respect to Series D
Convertible Preferred Stock of the Registrant(5)
4.6 Certificate of Determination with respect to Series C Junior
Participating Preferred Stock of the Registrant(5)
4.7 Rights Agreement, dated as of March 5, 1999, with American
Stock Transfer & Trust Company(5)
4.8 Form of Rights Certificate with respect to the Rights
Agreement, dated as of March 5, 1999(5)
</TABLE>
25
<PAGE> 26
<TABLE>
<S> <C>
4.9 Form of Series D Convertible Preferred Stock Certificate(5)
4.10 Amended and Restated Class I Stock Purchase Warrant, dated
as of March 4, 1999(5)
4.11 Form of Class J Stock Purchase Warrant(5)
4.12 Class K Stock Purchase Warrant, dated as of April 1, 1999(5)
4.13 Registration Rights Agreement with Promethean Investment
Group, LLC(5)
4.14 Class A Common Stock Investment Agreement with Promethean
Investment Group, LLC(5)
4.15 Amendment to the Class A Common Stock Investment Agreement
with Promethean Investment Group, LLC(5)
4.16 Securities Purchase Agreement for Series D Convertible
Preferred Stock(5)
4.17 Registration Rights Agreement for Series D Convertible
Preferred Stock(5)
4.18 Forms of Class A and Class B Common Stock Certificates(6)
4.19 Convertible Note issued to GFL Advantage Fund Limited(7)
4.20 Registration Rights Agreement with GFL Advantage Fund
Limited(7)
4.21 Convertible Note issued to Capital Ventures International(8)
4.22 Convertible Note, dated February 26, 1997, issued to RGC
International Investors LDC(9)
4.23 Form of Class G Stock Purchase Warrant(9)
4.24 Registration Rights Agreement, dated February 26, 1997, with
RGC International Investors, LDC(9)
4.25 Class L Stock Purchase Warrant, dated as of June 8, 1999(10)
4.26 Loan Agreement, dated as of November 23, 1999, with AMRO
International, S.A. and The Endeavour Capital Fund, S.A.(11)
4.27 Form of 11% Convertible Debenture(11)
4.28 Form of Stock Purchase Warrant(11)
4.29 Registration Rights Agreement, dated as of November 23,
1999, with AMRO International, S.A and The Endeavour Capital
Fund, S.A.(11)
4.30 Amendment No. 1 to Rights Agreement, dated November 30,
1999, with American Stock Transfer & Trust Company(11)
10.1 First, Second and Third Amendments to Sublease Agreement
with Medical Biology Institute(1)
10.2 Form of Employment Agreement, dated as of February 1999,
with certain executive officers and key employees of the
Registrant(5)
10.3 1998 Stock Option Plan(5)
10.4 1989 Stock Option Plan(6)
10.5 License Agreement with Medical Biology Institute(6)
10.6 Employment Agreement with David H. Katz, as amended(6)
10.7 Sublease Agreement with Medical Biology Institute(6)
10.8 Sixth Amendment to the Sublease Agreement with Medical
Biology Institute(7)
10.9 Subscription Agreement(7)
10.10 Note Purchase Agreement with GFL Advantage Fund Limited(7)
10.11 License and Development Agreement with Bristol-Myers Squibb
Company(8)
10.12 Registration Rights Agreement with Capital Ventures
International(8)
10.13 Note Purchase Agreement with Capital Ventures
International(8)
10.14 Seventh Amendment to the Sublease Agreement with Medical
Biology Institute(8)
10.15 Note Purchase Agreement, dated February 26, 1997, with RGC
International Investors, LDC(9)
</TABLE>
26
<PAGE> 27
<TABLE>
<S> <C>
10.16 Licensing Agreement with Yamanouchi Europe b.v.(12)
10.17 Amendment to License Agreement with Medical Biology
Institute, dated as of July 1993(13)
10.18 Amendment to Employment Agreement with David H. Katz, dated
as of April 1993(13)
10.19 Fourth and Fifth Amendments to the Sublease Agreement with
Medical Biology Institute(14)
10.20 1994 Stock Option Plan(14)
10.21 Supplemental Agreement with Yamanouchi Europe b.v.(14)
10.22 Licensing Agreement with Grelan Pharmaceutical Company
Limited(14)
10.23 Employment Agreement with Gerald J. Yakatan(15)
10.24 Form of Retention Agreement with certain Executive Officers
of the Registrant(15)
10.25 Form of Indemnification Agreement with certain Directors and
Executive Officers of the Registrant(15)
23.1 Independent Auditors' Consent
27.1 Financial Data Schedule
</TABLE>
- ---------------
(1) Incorporated by reference to the similarly described exhibit included with
the Registrant's Registration Statement on Form S-1, File No. 33-49082,
declared effective by the Commission on October 26, 1992.
(2) Incorporated by reference to the similarly described exhibit included 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.
(3) Incorporated by reference to the similarly described exhibit included with
the Registrant's Form 8-K, filed March 18, 1998.
(4) Incorporated by reference to the similarly described exhibit included with
the Registrant's Form 8-K, filed October 30, 1998.
(5) 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.
(6) Incorporated by reference to the similarly described exhibit included with
the Registrant's Registration Statement on Form S-1, File No. 33-32742,
declared effective by the Commission on May 8, 1990.
(7) 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, 1995, filed December 15, 1995.
(8) 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, 1996, filed May 15, 1996.
(9) Incorporated by reference to the similarly described exhibit included with
the Registrant's Form 8-K, filed March 10, 1997.
(10) 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, 1999, filed August 16, 1999.
(11) Incorporated by reference to the similarly described exhibit included with
the Registrant's Form 8-K, filed December 3, 1999.
(12) 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, 1991, filed January 11, 1992.
(13) 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, 1993, filed December 29, 1993.
(14) 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.
(15) 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.
27
<PAGE> 28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Date: January 6, 2000
AVANIR PHARMACEUTICALS
By:/s/ GERALD J. YAKATAN, PH.D.
--------------------------------------
Gerald J. Yakatan, Ph.D.
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ GERALD J. YAKATAN, PH.D. President and Chief Executive January 6, 2000
- ----------------------------------------------------- Officer (Principal Executive
Gerald J. Yakatan, Ph.D. Officer)
/s/ GREGORY P. HANSON Vice President, Finance and January 6, 2000
- ----------------------------------------------------- Chief Financial Officer
Gregory P. Hanson (Principal Financial and
Accounting Officer)
/s/ GEORGE P. RUTLAND Chairman of the Board January 6, 2000
- -----------------------------------------------------
George P. Rutland
/s/ DENNIS J. CARLO, PH.D. Director January 6, 2000
- -----------------------------------------------------
Dennis J. Carlo, Ph.D.
/s/ MICHAEL W. GEORGE Director January 6, 2000
- -----------------------------------------------------
Michael W. George
/s/ JAMES B. GLAVIN Director January 6, 2000
- -----------------------------------------------------
James B. Glavin
/s/ EDWARD L. HENNESSY, JR. Director January 6, 2000
- -----------------------------------------------------
Edward L. Hennessy, Jr.
/s/ KENNETH E. OLSON Director January 6, 2000
- -----------------------------------------------------
Kenneth E. Olson
/s/ JOSEPH E. SMITH Director January 6, 2000
- -----------------------------------------------------
Joseph E. Smith
</TABLE>
28
<PAGE> 29
AVANIR PHARMACEUTICALS
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
INDEPENDENT AUDITORS' REPORT................................ F-2
FINANCIAL STATEMENTS........................................
Balance Sheets at September 30, 1998 and 1999............... F-3
Statements of Operations for the years ended September 30, F-4
1997, 1998 and 1999, and the period August 31, 1988
(inception) to September 30, 1999.........................
Statements of Shareholders' Equity (Deficit) for the period F-5
August 31, 1988 (inception) to September 30, 1999.........
Statements of Cash Flows for the years ended September 30, F-11
1997, 1998 and 1999, and the period August 31, 1988
(inception) to September 30, 1999.........................
Notes to Financial Statements............................... F-12
</TABLE>
F-1
<PAGE> 30
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
AVANIR Pharmaceuticals:
We have audited the accompanying balance sheets of AVANIR Pharmaceuticals,
formerly LIDAK Pharmaceuticals, (a development stage enterprise) (the "Company")
as of September 30, 1998 and 1999, and the related statements of operations,
shareholders' equity (deficit) and cash flows for each of the three years in the
period ended September 30, 1999 and for the period August 31, 1988 (inception)
to September 30, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of AVANIR Pharmaceuticals at September 30, 1998
and 1999, and the results of its operations and its cash flows for each of the
three years in the period ended September 30, 1999 and the period August 31,
1988 (inception) to September 30, 1999 in conformity with generally accepted
accounting principles.
As discussed in Note 8 to the financial statements, the Company is a
defendant in certain lawsuits.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company is a development stage
enterprise as of September 30, 1999. As discussed in Note 1 to the financial
statements, the Company has incurred net losses since inception and has not yet
received regulatory approval for its product. These factors and the lack of
financing at September 30, 1999 raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans concerning these
matters are also described in Note 1. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
DELOITTE & TOUCHE LLP
San Diego, California
December 21, 1999
F-2
<PAGE> 31
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS
SEPTEMBER 30, 1998 AND 1999
ASSETS
<TABLE>
<CAPTION>
1998 1999
------------ ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................................... $ 6,508,341 $ 122,674
Receivable -- Insurance (net of allowance for non-payment
of $189,011)........................................... 76,499
Interest receivable....................................... 93,763
Inventory................................................. 111,901
Prepaid................................................... 274,616 263,004
Restricted cash........................................... 57,158
Other..................................................... 7,595 1,692
------------ ------------
Total current assets.............................. 6,884,315 632,928
PROPERTY -- at cost (less accumulated depreciation of
$400,719 and $496,726).................................... 251,486 219,361
PATENT COSTS (less accumulated amortization of $74,813 and
$101,473)................................................. 450,038 617,741
DEFERRED COSTS.............................................. 37,577 100,000
LONG-TERM INVENTORY......................................... 111,901
OTHER ASSETS................................................ 30,384 83,284
------------ ------------
TOTAL............................................. $ 7,653,800 $ 1,765,215
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Convertible notes payable................................. $ 1,000,000
Accounts payable.......................................... 528,471 $ 1,173,068
Accrued expenses and other liabilities.................... 325,594 221,207
Accrued compensation and payroll taxes.................... 210,420 123,068
Note payable.............................................. 183,676
------------ ------------
Total current liabilities......................... 2,064,485 1,701,019
COMMITMENTS (Notes 3, 5, 6, 7 and 11)
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 45,017,063 issued and outstanding..... 59,179,721 62,195,950
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 38,270
Deficit accumulated during development stage.............. (53,615,988) (62,170,024)
------------ ------------
Total shareholders' equity........................ 5,589,315 64,196
------------ ------------
TOTAL............................................. $ 7,653,800 $ 1,765,215
============ ============
</TABLE>
See notes to financial statements.
F-3
<PAGE> 32
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30, 1997, 1998 AND 1999 AND FOR THE PERIOD
AUGUST 31, 1988 (INCEPTION) TO SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
AUGUST 31,
1988
YEARS ENDED SEPTEMBER 30, (INCEPTION) TO
---------------------------------------- SEPTEMBER 30,
1997 1998 1999 1999
------------ ----------- ----------- --------------
<S> <C> <C> <C> <C>
REVENUES:
License fees/contract services............ $ 525,000 $ 4,507,625
Federal research grants................. 141,869 940,646
Interest and other...................... 880,685 $ 590,728 $ 146,787 4,837,814
------------ ----------- ----------- ------------
Total revenues.......................... 1,547,554 590,728 146,787 10,286,085
------------ ----------- ----------- ------------
EXPENSES:
Research and development................ 7,627,129 3,216,167 3,254,751 38,486,856
General and administrative.............. 2,958,535 4,035,337 3,842,008 25,112,222
Sales and marketing..................... 670,697 1,596,309 2,267,006
Litigation settlement................... 783,899 783,899
Interest................................ 2,071,132 95,176 7,755 5,272,856
Cost of contract services............... 533,270
------------ ----------- ----------- ------------
Total expenses.......................... 12,656,796 8,801,276 8,700,823 72,456,109
------------ ----------- ----------- ------------
NET LOSS.................................. $(11,109,242) $(8,210,548) $(8,554,036) $(62,170,024)
============ =========== =========== ============
NET LOSS ATTRIBUTABLE TO COMMON
SHAREHOLDERS............................ $(11,109,242) $(8,210,548) $(8,583,182) $(62,199,170)
============ =========== =========== ============
NET LOSS PER SHARE........................ $ (0.30) $ (0.21) $ (0.21)
============ =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING............................. 36,779,774 39,519,609 41,704,265
============ =========== ===========
</TABLE>
See notes to financial statements.
F-4
<PAGE> 33
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
AUGUST 31, 1988 (INCEPTION) TO SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK
-----------------------------------------------------------
SERIES A SERIES B SERIES D
------------------- ------------------------ ----------
SHARES AMOUNT SHARES AMOUNT SHARES
---------- ------ ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE, AUGUST 31, 1988 (INCEPTION)
Issuance of common stock for notes receivable
and cash in September 1988 at $0.0125 per
share........................................
Issuance of preferred stock in October 1988
for license and other rights................ 2,000,000 $ 1
Issuance of common stock for cash in October
1988 at $0.05 per share.....................
Issuance of common stock for cash in January
1989 at $0.05 per share.....................
Issuance of stock options effective in August
1989 to purchase 600,000 shares of Class B
Common Stock at $0.0125 per share (with an
estimated fair market value of $0.05 per
share)......................................
Issuance of common stock for cash in
September 1989 at $0.0125 per share (with an
estimated fair market value of $0.05 per
share)......................................
Collection on notes receivable...............
Net loss.....................................
---------- --- ---------- ----------- ----------
BALANCE, SEPTEMBER 30, 1989.................. 2,000,000 1
Conversion of advances to common stock in
October 1989 at $.50 per share..............
Issuance of common stock for cash in May 1990
at $1.00 per share (net of stock issue costs
totaling $1,033,280)........................
Issuance of common stock for cash in June
1990 at $1.00 per share (net of stock issue
costs totaling $97,500).....................
Exercise of stock options in July and August
1990 at $0.50 per share.....................
Forgiveness of compensation obligation.......
Collection on notes receivable...............
Net loss.....................................
---------- --- ---------- ----------- ----------
BALANCE, SEPTEMBER 30, 1990.................. 2,000,000 1
Exercise of stock options in November 1990 at
$0.50 per share.............................
<CAPTION>
CONVERTIBLE PREFERRED STOCK COMMON STOCK
----------- ------------------------
SERIES D CLASS A CLASS B
----------- ------------------------ -------------------------
AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- ---------- ----------- ---------- ------------
<S> <C> <C> <C> <C> <C>
BALANCE, AUGUST 31, 1988 (INCEPTION)
Issuance of common stock for notes receivable
and cash in September 1988 at $0.0125 per
share........................................ 4,235,000 $ 52,937
Issuance of preferred stock in October 1988
for license and other rights................
Issuance of common stock for cash in October
1988 at $0.05 per share..................... 80,000 4,000
Issuance of common stock for cash in January
1989 at $0.05 per share..................... 80,000 4,000
Issuance of stock options effective in August
1989 to purchase 600,000 shares of Class B
Common Stock at $0.0125 per share (with an
estimated fair market value of $0.05 per
share)...................................... 22,500
Issuance of common stock for cash in
September 1989 at $0.0125 per share (with an
estimated fair market value of $0.05 per
share)...................................... 400,000 20,000
Collection on notes receivable...............
Net loss.....................................
----------- ---------- ----------- ---------- ------------
BALANCE, SEPTEMBER 30, 1989.................. 4,795,000 103,437
Conversion of advances to common stock in
October 1989 at $.50 per share.............. 250,000 125,000
Issuance of common stock for cash in May 1990
at $1.00 per share (net of stock issue costs
totaling $1,033,280)........................ 5,000,000 $ 3,966,820
Issuance of common stock for cash in June
1990 at $1.00 per share (net of stock issue
costs totaling $97,500)..................... 750,000 652,500
Exercise of stock options in July and August
1990 at $0.50 per share..................... 21,500 10,750
Forgiveness of compensation obligation....... 66,923
Collection on notes receivable...............
Net loss.....................................
----------- ---------- ----------- ---------- ------------
BALANCE, SEPTEMBER 30, 1990.................. 5,750,000 4,619,320 5,066,500 306,110
Exercise of stock options in November 1990 at
$0.50 per share............................. 2,000 1,000
<CAPTION>
DEFICIT
ACCUMULATED NOTES
DURING THE RECEIVABLE
DEVELOPMENT FROM
STAGE SHAREHOLDERS TOTAL
------------ ------------ ------------
<S> <C> <C> <C>
BALANCE, AUGUST 31, 1988 (INCEPTION)
Issuance of common stock for notes receivable
and cash in September 1988 at $0.0125 per
share........................................ $ (14,525) $ 38,412
Issuance of preferred stock in October 1988
for license and other rights................ 1
Issuance of common stock for cash in October
1988 at $0.05 per share..................... 4,000
Issuance of common stock for cash in January
1989 at $0.05 per share..................... 4,000
Issuance of stock options effective in August
1989 to purchase 600,000 shares of Class B
Common Stock at $0.0125 per share (with an
estimated fair market value of $0.05 per
share)...................................... 22,500
Issuance of common stock for cash in
September 1989 at $0.0125 per share (with an
estimated fair market value of $0.05 per
share)...................................... 20,000
Collection on notes receivable............... 1,635 1,635
Net loss..................................... $ (409,718) (409,718)
------------ ----------- ------------
BALANCE, SEPTEMBER 30, 1989.................. (409,718) (12,890) (319,170)
Conversion of advances to common stock in
October 1989 at $.50 per share.............. 125,000
Issuance of common stock for cash in May 1990
at $1.00 per share (net of stock issue costs
totaling $1,033,280)........................ 3,966,820
Issuance of common stock for cash in June
1990 at $1.00 per share (net of stock issue
costs totaling $97,500)..................... 652,500
Exercise of stock options in July and August
1990 at $0.50 per share..................... 10,750
Forgiveness of compensation obligation....... 66,923
Collection on notes receivable............... 12,890 12,890
Net loss..................................... (2,319,231) (2,319,231)
------------ ----------- ------------
BALANCE, SEPTEMBER 30, 1990.................. (2,728,949) -- 2,196,482
Exercise of stock options in November 1990 at
$0.50 per share............................. 1,000
</TABLE>
F-5
<PAGE> 34
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
AUGUST 31, 1988 (INCEPTION) TO SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK
-----------------------------------------------------------
SERIES A SERIES B SERIES D
------------------- ------------------------ ----------
SHARES AMOUNT SHARES AMOUNT SHARES
---------- ------ ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Issuance of preferred stock in July 1991 for
cash (net of stock issue costs totaling
$130,339)................................... 960,003 $ 769,670
Conversion of common stock...................
Net loss.....................................
---------- --- ---------- ----------- ----------
BALANCE, SEPTEMBER 30, 1991.................. 2,000,000 $ 1 960,003 769,670
Issuance of preferred stock in February 1992
for cash (net of stock issue costs totaling
$428,605)................................... 4,266,680 3,571,395
Exercise of stock options in March 1992 at
$0.50 per share.............................
Exercise of Class A Warrants in May 1992 at
$1.50 per share for cash (net of stock issue
costs totaling $317,930)....................
Conversion of common stock...................
Net loss.....................................
---------- --- ---------- ----------- ----------
BALANCE, SEPTEMBER 30, 1992.................. 2,000,000 1 5,226,683 4,341,065
Exercise of Unit Purchase Options between
October 1992 and September 1993 for cash....
Exercise of Class A Warrants between October
1992 and September 1993 at $0.9450 per share
for cash....................................
Exercise of Class B Warrants between October
1992 and September 1993 at $2.25 per share
for cash (net of stock issue costs totaling
$8,720).....................................
Exercise of Class C Warrants between October
1992 and September 1993 at $1.00 per share
for cash (net of stock issue costs totaling
$4,122).....................................
Exercise of Class D Warrants between October
1992 and September 1993 at $1.50 per share
for cash (net of stock issue costs totaling
$42,125)....................................
Exercise of Class E Warrants between October
1992 and September 1993 at $0.20 per share
for cash....................................
Exercise of Class F Warrants between October
1992 and September 1993 at $100,000 per
warrant for cash............................ 320,000 300,000
Exercise of Preferred Stock Units between
October 1992 and September 1993 for cash.... 96,000 90,000
<CAPTION>
CONVERTIBLE PREFERRED STOCK COMMON STOCK
----------- ------------------------
SERIES D CLASS A CLASS B
----------- ------------------------ -------------------------
AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- ---------- ----------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Issuance of preferred stock in July 1991 for
cash (net of stock issue costs totaling
$130,339)...................................
Conversion of common stock................... 115,000 $ 5,750 (115,000) $ (5,750)
Net loss.....................................
----------- ---------- ----------- ---------- ------------
BALANCE, SEPTEMBER 30, 1991.................. 5,865,000 4,625,070 4,953,500 301,360
Issuance of preferred stock in February 1992
for cash (net of stock issue costs totaling
$428,605)...................................
Exercise of stock options in March 1992 at
$0.50 per share............................. 119,000 59,500
Exercise of Class A Warrants in May 1992 at
$1.50 per share for cash (net of stock issue
costs totaling $317,930).................... 5,650,200 8,157,370
Conversion of common stock................... 395,000 6,250 (395,000) (6,250)
Net loss.....................................
----------- ---------- ----------- ---------- ------------
BALANCE, SEPTEMBER 30, 1992.................. 11,910,200 12,788,690 4,677,500 354,610
Exercise of Unit Purchase Options between
October 1992 and September 1993 for cash.... 793,645 600,010
Exercise of Class A Warrants between October
1992 and September 1993 at $0.9450 per share
for cash.................................... 793,645 749,995
Exercise of Class B Warrants between October
1992 and September 1993 at $2.25 per share
for cash (net of stock issue costs totaling
$8,720)..................................... 96,897 209,298
Exercise of Class C Warrants between October
1992 and September 1993 at $1.00 per share
for cash (net of stock issue costs totaling
$4,122)..................................... 103,050 98,928
Exercise of Class D Warrants between October
1992 and September 1993 at $1.50 per share
for cash (net of stock issue costs totaling
$42,125).................................... 836,335 1,212,376
Exercise of Class E Warrants between October
1992 and September 1993 at $0.20 per share
for cash.................................... 315,000 63,000
Exercise of Class F Warrants between October
1992 and September 1993 at $100,000 per
warrant for cash............................
Exercise of Preferred Stock Units between
October 1992 and September 1993 for cash....
<CAPTION>
DEFICIT
ACCUMULATED NOTES
DURING THE RECEIVABLE
DEVELOPMENT FROM
STAGE SHAREHOLDERS TOTAL
------------ ------------ ------------
<S> <C> <C> <C>
Issuance of preferred stock in July 1991 for
cash (net of stock issue costs totaling
$130,339)................................... $ 769,670
Conversion of common stock...................
Net loss..................................... $ (1,949,588) (1,949,588)
------------ ----------- ------------
BALANCE, SEPTEMBER 30, 1991.................. (4,678,537) 1,017,564
Issuance of preferred stock in February 1992
for cash (net of stock issue costs totaling
$428,605)................................... 3,571,395
Exercise of stock options in March 1992 at
$0.50 per share............................. 59,500
Exercise of Class A Warrants in May 1992 at
$1.50 per share for cash (net of stock issue
costs totaling $317,930).................... 8,157,370
Conversion of common stock...................
Net loss..................................... (2,361,855) (2,361,855)
------------ ----------- ------------
BALANCE, SEPTEMBER 30, 1992.................. (7,040,392) -- 10,443,974
Exercise of Unit Purchase Options between
October 1992 and September 1993 for cash.... 600,010
Exercise of Class A Warrants between October
1992 and September 1993 at $0.9450 per share
for cash.................................... 749,995
Exercise of Class B Warrants between October
1992 and September 1993 at $2.25 per share
for cash (net of stock issue costs totaling
$8,720)..................................... 209,298
Exercise of Class C Warrants between October
1992 and September 1993 at $1.00 per share
for cash (net of stock issue costs totaling
$4,122)..................................... 98,928
Exercise of Class D Warrants between October
1992 and September 1993 at $1.50 per share
for cash (net of stock issue costs totaling
$42,125).................................... 1,212,376
Exercise of Class E Warrants between October
1992 and September 1993 at $0.20 per share
for cash.................................... 63,000
Exercise of Class F Warrants between October
1992 and September 1993 at $100,000 per
warrant for cash............................ 300,000
Exercise of Preferred Stock Units between
October 1992 and September 1993 for cash.... 90,000
</TABLE>
F-6
<PAGE> 35
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
AUGUST 31, 1988 (INCEPTION) TO SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK
-----------------------------------------------------------
SERIES A SERIES B SERIES D
------------------- ------------------------ ----------
SHARES AMOUNT SHARES AMOUNT SHARES
---------- ------ ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Exercise of stock options in August 1993 and
September 1993 at exercise prices ranging
from $0.81 to $1.53 per share...............
Compensation expense related to stock options
granted at an exercise price below fair
market value.................................
Cancellation of Series A Preferred and Class
B Common Stock in July 1993................. (1,500,000)
Issuance of Class A Common Stock in July 1993
in connection with amendment to a license
agreement...................................
Conversion of preferred and common stock..... (100,000) (5,642,653) $(4,731,065)
Cancellation of partial shares............... (30)
Net loss.....................................
---------- --- ---------- ----------- ----------
BALANCE, SEPTEMBER 30, 1993.................. 400,000 $ 1 -- --
Exercise of non-redeemable Class B Warrants
in April 1994 at $1.4175 per share for
cash........................................
Exercise of redeemable Class B Warrants
between October 1993 and June 1994 at $2.25
per share for cash (net of stock issue costs
totaling $541,340)..........................
Exercise of Class C Warrants between October
1993 and September 1994 at $1.00 per share
for cash (net of commissions totaling
$4,414).....................................
Exercise of Class D Warrants between October
1993 and September 1994 at $1.50 per share
for cash (net of commissions totaling
$2,875).....................................
Exercise of Class F Warrants between October
1993 and November 1993 at $100,000 per
warrant for cash............................ 106,666 100,000
Exercise of stock options between October
1993 and September 1994 at exercise prices
ranging from $0.50 to $2.4375 per share.....
Compensation expense related to stock options
granted at an exercise price below fair
market value................................
Issuance of Class A Common Stock in
connection with Stock Purchase Agreement in
September 1994 (net of issue costs of
$192,215)...................................
<CAPTION>
CONVERTIBLE PREFERRED STOCK COMMON STOCK
----------- ------------------------
SERIES D CLASS A CLASS B
----------- ------------------------ -------------------------
AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- ---------- ----------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Exercise of stock options in August 1993 and
September 1993 at exercise prices ranging
from $0.81 to $1.53 per share............... 27,480 $ 37,480
Compensation expense related to stock options
granted at an exercise price below fair
market value................................. 163,333
Cancellation of Series A Preferred and Class
B Common Stock in July 1993................. 28,003 (2,240,250) $ (28,003)
Issuance of Class A Common Stock in July 1993
in connection with amendment to a license
agreement................................... 1,500,000 2,670,000
Conversion of preferred and common stock..... 6,040,653 4,790,121 (298,000) (59,056)
Cancellation of partial shares...............
Net loss.....................................
----------- ---------- ----------- ---------- ------------
BALANCE, SEPTEMBER 30, 1993.................. 22,416,905 23,411,234 2,139,250 267,551
Exercise of non-redeemable Class B Warrants
in April 1994 at $1.4175 per share for
cash........................................ 17,202 24,384
Exercise of redeemable Class B Warrants
between October 1993 and June 1994 at $2.25
per share for cash (net of stock issue costs
totaling $541,340).......................... 4,312,060 9,160,795
Exercise of Class C Warrants between October
1993 and September 1994 at $1.00 per share
for cash (net of commissions totaling
$4,414)..................................... 106,340 101,926
Exercise of Class D Warrants between October
1993 and September 1994 at $1.50 per share
for cash (net of commissions totaling
$2,875)..................................... 78,335 114,627
Exercise of Class F Warrants between October
1993 and November 1993 at $100,000 per
warrant for cash............................
Exercise of stock options between October
1993 and September 1994 at exercise prices
ranging from $0.50 to $2.4375 per share..... 113,267 156,048
Compensation expense related to stock options
granted at an exercise price below fair
market value................................ 245,000
Issuance of Class A Common Stock in
connection with Stock Purchase Agreement in
September 1994 (net of issue costs of
$192,215)................................... 522,449 1,807,785
<CAPTION>
DEFICIT
ACCUMULATED NOTES
DURING THE RECEIVABLE
DEVELOPMENT FROM
STAGE SHAREHOLDERS TOTAL
------------ ------------ ------------
<S> <C> <C> <C>
Exercise of stock options in August 1993 and
September 1993 at exercise prices ranging
from $0.81 to $1.53 per share............... $ 37,480
Compensation expense related to stock options
granted at an exercise price below fair
market value................................. 163,333
Cancellation of Series A Preferred and Class
B Common Stock in July 1993.................
Issuance of Class A Common Stock in July 1993
in connection with amendment to a license
agreement................................... 2,670,000
Conversion of preferred and common stock.....
Cancellation of partial shares...............
Net loss..................................... $ (6,139,223) (6,139,223)
------------ ----------- ------------
BALANCE, SEPTEMBER 30, 1993.................. (13,179,615) -- 10,499,171
Exercise of non-redeemable Class B Warrants
in April 1994 at $1.4175 per share for
cash........................................ 24,384
Exercise of redeemable Class B Warrants
between October 1993 and June 1994 at $2.25
per share for cash (net of stock issue costs
totaling $541,340).......................... 9,160,795
Exercise of Class C Warrants between October
1993 and September 1994 at $1.00 per share
for cash (net of commissions totaling
$4,414)..................................... 101,926
Exercise of Class D Warrants between October
1993 and September 1994 at $1.50 per share
for cash (net of commissions totaling
$2,875)..................................... 114,627
Exercise of Class F Warrants between October
1993 and November 1993 at $100,000 per
warrant for cash............................ 100,000
Exercise of stock options between October
1993 and September 1994 at exercise prices
ranging from $0.50 to $2.4375 per share..... 156,048
Compensation expense related to stock options
granted at an exercise price below fair
market value................................ 245,000
Issuance of Class A Common Stock in
connection with Stock Purchase Agreement in
September 1994 (net of issue costs of
$192,215)................................... 1,807,785
</TABLE>
F-7
<PAGE> 36
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
AUGUST 31, 1988 (INCEPTION) TO SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK
-----------------------------------------------------------
SERIES A SERIES B SERIES D
------------------- ------------------------ ----------
SHARES AMOUNT SHARES AMOUNT SHARES
---------- ------ ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Conversion of preferred and common stock..... (400,000) $(1) (106,666) $ (100,000)
Cancellation of Class A Common Stock and
Class B Common Stock between January 1994 and
May 1994.....................................
Cancellation of partial shares...............
Net loss.....................................
---------- --- ---------- ----------- ----------
BALANCE, SEPTEMBER 30, 1994.................. -- -- -- --
Exercise of non-redeemable Class B Warrants
in January and February, 1995 at $1.4175 per
share for cash..............................
Exercise of Class C Warrants between October,
1994 and June, 1995 at $1.00 per share for
cash (net of commissions totaling
$26,743)....................................
Exercise of Class D Warrants between April,
1995 and September, 1995 at $1.50 per share
for cash....................................
Exercise of Class E Warrants in April and
August, 1995 at $0.20 per share for cash....
Exercise of stock options between October,
1994 and September, 1995 at exercise prices
ranging from $0.50 per share to $3.56 per
share.......................................
Compensation expense related to stock options
granted at an exercise price below fair
market value................................
Conversion of Common Stock...................
Net loss.....................................
---------- --- ---------- ----------- ----------
BALANCE, SEPTEMBER 30, 1995.................. -- -- -- --
Exercise of Class D Warrants between October,
1995 and September, 1996 at $1.50 per share
for cash....................................
Exercise of Class E Warrants in March, 1996
at $0.20 per share for cash.................
Issuance of Class A Common Stock in
connection with Stock Purchase Agreement in
November, 1995 (net of issue costs of
$83,495)....................................
<CAPTION>
CONVERTIBLE PREFERRED STOCK COMMON STOCK
----------- ------------------------
SERIES D CLASS A CLASS B
----------- ------------------------ -------------------------
AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- ---------- ----------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Conversion of preferred and common stock..... 653,416 $ 113,911 (146,750) $ (13,910)
Cancellation of Class A Common Stock and
Class B Common Stock between January 1994 and
May 1994..................................... (70,000) 20,794 (1,546,500) (20,794)
Cancellation of partial shares............... (3)
Net loss.....................................
----------- ---------- ----------- ---------- ------------
BALANCE, SEPTEMBER 30, 1994.................. 28,149,971 35,156,504 446,000 232,847
Exercise of non-redeemable Class B Warrants
in January and February, 1995 at $1.4175 per
share for cash.............................. 97,202 137,783
Exercise of Class C Warrants between October,
1994 and June, 1995 at $1.00 per share for
cash (net of commissions totaling
$26,743).................................... 415,600 388,857
Exercise of Class D Warrants between April,
1995 and September, 1995 at $1.50 per share
for cash.................................... 153,335 230,003
Exercise of Class E Warrants in April and
August, 1995 at $0.20 per share for cash.... 85,000 17,000
Exercise of stock options between October,
1994 and September, 1995 at exercise prices
ranging from $0.50 per share to $3.56 per
share....................................... 842,956 1,121,771
Compensation expense related to stock options
granted at an exercise price below fair
market value................................ 129,792
Conversion of Common Stock................... 103,000 53,774 (103,000) (53,774)
Net loss.....................................
----------- ---------- ----------- ---------- ------------
BALANCE, SEPTEMBER 30, 1995.................. 29,847,064 37,235,484 343,000 179,073
Exercise of Class D Warrants between October,
1995 and September, 1996 at $1.50 per share
for cash.................................... 78,334 117,500
Exercise of Class E Warrants in March, 1996
at $0.20 per share for cash................. 25,000 5,000
Issuance of Class A Common Stock in
connection with Stock Purchase Agreement in
November, 1995 (net of issue costs of
$83,495).................................... 481,651 1,416,505
<CAPTION>
DEFICIT
ACCUMULATED NOTES
DURING THE RECEIVABLE
DEVELOPMENT FROM
STAGE SHAREHOLDERS TOTAL
------------ ------------ ------------
<S> <C> <C> <C>
Conversion of preferred and common stock.....
Cancellation of Class A Common Stock and
Class B Common Stock between January 1994 and
May 1994.....................................
Cancellation of partial shares...............
Net loss..................................... $ (4,813,341) $ (4,813,341)
------------ ----------- ------------
BALANCE, SEPTEMBER 30, 1994.................. (17,992,956) -- 17,396,395
Exercise of non-redeemable Class B Warrants
in January and February, 1995 at $1.4175 per
share for cash.............................. 137,783
Exercise of Class C Warrants between October,
1994 and June, 1995 at $1.00 per share for
cash (net of commissions totaling
$26,743).................................... 388,857
Exercise of Class D Warrants between April,
1995 and September, 1995 at $1.50 per share
for cash.................................... 230,003
Exercise of Class E Warrants in April and
August, 1995 at $0.20 per share for cash.... 17,000
Exercise of stock options between October,
1994 and September, 1995 at exercise prices
ranging from $0.50 per share to $3.56 per
share....................................... 1,121,771
Compensation expense related to stock options
granted at an exercise price below fair
market value................................ 129,792
Conversion of Common Stock...................
Net loss..................................... (10,173,001) (10,173,001)
------------ ----------- ------------
BALANCE, SEPTEMBER 30, 1995.................. (28,165,957) -- 9,248,600
Exercise of Class D Warrants between October,
1995 and September, 1996 at $1.50 per share
for cash.................................... 117,500
Exercise of Class E Warrants in March, 1996
at $0.20 per share for cash................. 5,000
Issuance of Class A Common Stock in
connection with Stock Purchase Agreement in
November, 1995 (net of issue costs of
$83,495).................................... 1,416,505
</TABLE>
F-8
<PAGE> 37
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
AUGUST 31, 1988 (INCEPTION) TO SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK
-----------------------------------------------------------
SERIES A SERIES B SERIES D
------------------- ------------------------ ----------
SHARES AMOUNT SHARES AMOUNT SHARES
---------- ------ ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Conversion of Convertible Notes to Class A
Common Stock between February and September,
1996 (including interest and discount applied
of $2,263,276 and net of issue costs of
$402,268)....................................
Exercise of stock options between October,
1995 and September, 1996 at exercise prices
ranging from $0.50 per share to $3.56 per
share.......................................
Conversion of common stock...................
Net loss.....................................
---------- --- ---------- ----------- ----------
BALANCE, SEPTEMBER 30, 1996.................. -- -- -- --
Exercise of Class D Warrants between January
and September, 1997 at $1.50 per share for
cash........................................
Exercise of Class E Warrants in October, 1996
at $0.20 per share for cash.................
Conversion of Convertible Notes to Class A
Common Stock between October, 1996 and
January, 1997 (including interest and
discount applied of $684,383 and net of
issue costs of $79,922).....................
Exercise of stock options between October,
1996 and September, 1997 at exercise prices
ranging from $0.9375 per share to $1.0625
per share...................................
Compensation expense related to valuation of
stock options granted to non-employees for
services rendered...........................
Discount on Convertible Notes issued in
February, 1997..............................
Conversion of Convertible Note to Class A
Common Stock between June, 1997 and
September, 1997 (including interest of
$86,345 and net of issue costs of
$156,593)...................................
Net loss.....................................
---------- --- ---------- ----------- ----------
BALANCE, SEPTEMBER 30, 1997.................. -- -- -- --
Exercise of stock options between October,
1997 and September, 1998 at exercise prices
ranging from $0.9375 per share to $1.4688
per share...................................
<CAPTION>
CONVERTIBLE PREFERRED STOCK COMMON STOCK
----------- ------------------------
SERIES D CLASS A CLASS B
----------- ------------------------ -------------------------
AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- ---------- ----------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Conversion of Convertible Notes to Class A
Common Stock between February and September,
1996 (including interest and discount applied
of $2,263,276 and net of issue costs of
$402,268).................................... 3,419,166 $10,147,676
Exercise of stock options between October,
1995 and September, 1996 at exercise prices
ranging from $0.50 per share to $3.56 per
share....................................... 142,807 263,079
Conversion of common stock................... 60,000 31,325 (60,000) $ (31,325)
Net loss.....................................
----------- ---------- ----------- ---------- ------------
BALANCE, SEPTEMBER 30, 1996.................. 34,054,022 49,216,569 283,000 147,748
Exercise of Class D Warrants between January
and September, 1997 at $1.50 per share for
cash........................................ 321,085 481,628
Exercise of Class E Warrants in October, 1996
at $0.20 per share for cash................. 75,000 15,000
Conversion of Convertible Notes to Class A
Common Stock between October, 1996 and
January, 1997 (including interest and
discount applied of $684,383 and net of
issue costs of $79,922)..................... 2,093,852 3,144,577
Exercise of stock options between October,
1996 and September, 1997 at exercise prices
ranging from $0.9375 per share to $1.0625
per share................................... 33,800 34,564
Compensation expense related to valuation of
stock options granted to non-employees for
services rendered........................... 86,167
Discount on Convertible Notes issued in
February, 1997.............................. 1,058,823
Conversion of Convertible Note to Class A
Common Stock between June, 1997 and
September, 1997 (including interest of
$86,345 and net of issue costs of
$156,593)................................... 2,011,640 3,514,290
Net loss.....................................
----------- ---------- ----------- ---------- ------------
BALANCE, SEPTEMBER 30, 1997.................. 38,589,399 57,551,618 283,000 147,748
Exercise of stock options between October,
1997 and September, 1998 at exercise prices
ranging from $0.9375 per share to $1.4688
per share................................... 13,167 13,714
<CAPTION>
DEFICIT
ACCUMULATED NOTES
DURING THE RECEIVABLE
DEVELOPMENT FROM
STAGE SHAREHOLDERS TOTAL
------------ ------------ ------------
<S> <C> <C> <C>
Conversion of Convertible Notes to Class A
Common Stock between February and September,
1996 (including interest and discount applied
of $2,263,276 and net of issue costs of
$402,268).................................... $ 10,147,676
Exercise of stock options between October,
1995 and September, 1996 at exercise prices
ranging from $0.50 per share to $3.56 per
share....................................... 263,079
Conversion of common stock...................
Net loss..................................... $ (6,130,241) (6,130,241)
------------ ----------- ------------
BALANCE, SEPTEMBER 30, 1996.................. (34,296,198) -- 15,068,119
Exercise of Class D Warrants between January
and September, 1997 at $1.50 per share for
cash........................................ 481,628
Exercise of Class E Warrants in October, 1996
at $0.20 per share for cash................. 15,000
Conversion of Convertible Notes to Class A
Common Stock between October, 1996 and
January, 1997 (including interest and
discount applied of $684,383 and net of
issue costs of $79,922)..................... 3,144,577
Exercise of stock options between October,
1996 and September, 1997 at exercise prices
ranging from $0.9375 per share to $1.0625
per share................................... 34,564
Compensation expense related to valuation of
stock options granted to non-employees for
services rendered........................... 86,167
Discount on Convertible Notes issued in
February, 1997.............................. 1,058,823
Conversion of Convertible Note to Class A
Common Stock between June, 1997 and
September, 1997 (including interest of
$86,345 and net of issue costs of
$156,593)................................... 3,514,290
Net loss..................................... (11,109,242) (11,109,242)
------------ ----------- ------------
BALANCE, SEPTEMBER 30, 1997.................. (45,405,440) -- 12,293,926
Exercise of stock options between October,
1997 and September, 1998 at exercise prices
ranging from $0.9375 per share to $1.4688
per share................................... 13,714
</TABLE>
F-9
<PAGE> 38
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
AUGUST 31, 1988 (INCEPTION) TO SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK
-----------------------------------------------------------
SERIES A SERIES B SERIES D
------------------- ------------------------ ----------
SHARES AMOUNT SHARES AMOUNT SHARES
---------- ------ ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Exercise of Class D Warrants in November,
1997 at $1.50 per share for cash............
Conversion of Convertible Note to Class A
Common Stock between December, 1997 to
February, 1998 (including interest of $35,223
and net of issue costs of $200,119)..........
Net compensation expense related to valuation
of stock options and warrants granted to
non-employees for services rendered.........
Conversion of common stock...................
Net loss.....................................
---------- --- ---------- ----------- ----------
BALANCE, SEPTEMBER 30, 1998.................. -- -- -- --
Conversion of Convertible Note to Class A
Common Stock in October 1998 (including
interest of $17,620 and net of issue costs
of $37,577).................................
Exercise of stock options between October
1998 and September 30, 1999 at exercise
prices ranging from $0.0125 per share to
$1.625 per share for cash...................
Issuance of Series D Redeemable Convertible
Preferred Stock in March 1999 for cash (net
of issue costs of $233,922)................. 200
Preferred stock dividends accrued between
June 1999 and September 1999................
Conversion of Series D Redeemable Convertible
Preferred Stock into Class A Common Stock
between June 1999 and September 1999
(including dividends of $29,146)............ (200)
Net compensation expense related to valuation
of stock options and warrants granted to
non-employees for services rendered.........
Net loss.....................................
---------- --- ---------- ----------- ----------
BALANCE, SEPTEMBER 30, 1999.................. -- $-- -- $ -- --
========== === ========== =========== ==========
<CAPTION>
CONVERTIBLE PREFERRED STOCK COMMON STOCK
----------- ------------------------
SERIES D CLASS A CLASS B
----------- ------------------------ -------------------------
AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- ---------- ----------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Exercise of Class D Warrants in November,
1997 at $1.50 per share for cash............ 19,400 $ 29,100
Conversion of Convertible Note to Class A
Common Stock between December, 1997 to
February, 1998 (including interest of $35,223
and net of issue costs of $200,119).......... 958,051 1,250,563
Net compensation expense related to valuation
of stock options and warrants granted to
non-employees for services rendered......... 212,560
Conversion of common stock................... 234,000 122,166 (234,000) $ (122,166)
Net loss.....................................
----------- ---------- ----------- ---------- ------------
BALANCE, SEPTEMBER 30, 1998.................. 39,814,017 59,179,721 49,000 25,582
Conversion of Convertible Note to Class A
Common Stock in October 1998 (including
interest of $17,620 and net of issue costs
of $37,577)................................. 1,091,213 980,049
Exercise of stock options between October
1998 and September 30, 1999 at exercise
prices ranging from $0.0125 per share to
$1.625 per share for cash................... 36,062 47,518 391,000 12,688
Issuance of Series D Redeemable Convertible
Preferred Stock in March 1999 for cash (net
of issue costs of $233,922)................. $ 1,766,078
Preferred stock dividends accrued between
June 1999 and September 1999................ 29,146 (29,146)
Conversion of Series D Redeemable Convertible
Preferred Stock into Class A Common Stock
between June 1999 and September 1999
(including dividends of $29,146)............ (1,795,224) 4,075,771 1,795,224
Net compensation expense related to valuation
of stock options and warrants granted to
non-employees for services rendered......... 222,584
Net loss.....................................
----------- ---------- ----------- ---------- ------------
BALANCE, SEPTEMBER 30, 1999.................. $ -- 45,017,063 $62,195,950 440,000 $ 38,270
=========== ========== =========== ========== ============
<CAPTION>
DEFICIT
ACCUMULATED NOTES
DURING THE RECEIVABLE
DEVELOPMENT FROM
STAGE SHAREHOLDERS TOTAL
------------ ------------ ------------
<S> <C> <C> <C>
Exercise of Class D Warrants in November,
1997 at $1.50 per share for cash............ $ 29,100
Conversion of Convertible Note to Class A
Common Stock between December, 1997 to
February, 1998 (including interest of $35,223
and net of issue costs of $200,119).......... 1,250,563
Net compensation expense related to valuation
of stock options and warrants granted to
non-employees for services rendered......... 212,560
Conversion of common stock...................
Net loss..................................... $ (8,210,548) (8,210,548)
------------ ----------- ------------
BALANCE, SEPTEMBER 30, 1998.................. (53,615,988) -- 5,589,315
Conversion of Convertible Note to Class A
Common Stock in October 1998 (including
interest of $17,620 and net of issue costs
of $37,577)................................. 980,049
Exercise of stock options between October
1998 and September 30, 1999 at exercise
prices ranging from $0.0125 per share to
$1.625 per share for cash................... 60,206
Issuance of Series D Redeemable Convertible
Preferred Stock in March 1999 for cash (net
of issue costs of $233,922)................. 1,766,078
Preferred stock dividends accrued between
June 1999 and September 1999................
Conversion of Series D Redeemable Convertible
Preferred Stock into Class A Common Stock
between June 1999 and September 1999
(including dividends of $29,146)............
Net compensation expense related to valuation
of stock options and warrants granted to
non-employees for services rendered......... 222,584
Net loss..................................... (8,554,036) (8,554,036)
------------ ----------- ------------
BALANCE, SEPTEMBER 30, 1999.................. $(62,170,024) $ -- $ 64,196
============ =========== ============
</TABLE>
See notes to financial statements.
F-10
<PAGE> 39
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED SEPTEMBER 30, 1997, 1998 AND 1999 AND FOR THE PERIOD FROM
AUGUST 31, 1988 (INCEPTION) TO SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
AUGUST 31, 1988
YEARS ENDED SEPTEMBER 30, (INCEPTION) TO
------------------------------------------ SEPTEMBER 30
1997 1998 1999 1999
------------ ----------- ----------- ---------------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss.................................................... $(11,109,242) $(8,210,548) $(8,554,036) $(62,170,024)
Adjustments to reconcile net loss to net cash used for
operating activities:
Depreciation and amortization............................. 136,820 210,946 139,469 1,084,118
Non-cash interest expense................................. 1,470,434 35,223 17,620 4,294,307
Technology license fee.................................... 3,545,713
Compensation paid with common stock and stock options..... 86,167 (11,190) 222,584 873,186
Compensation forgiven by stockholder...................... 66,923
Imputed interest on technology license fee................ 82,613
Changes in assets and liabilities:
Accounts receivable....................................... 228,875 15,765 17,264 (76,499)
Inventory................................................. (111,901) (111,901)
Prepaid and other......................................... 823,923 (44,809) (204,444) (517,039)
Organizational costs...................................... (20,242)
Deferred costs............................................ (100,000) (100,000)
Deferred revenue.......................................... (500,000)
Accounts payable.......................................... (759,139) 155,111 644,597 1,173,068
Accrued expenses and other liabilities.................... 200,526 (93,661) 79,289 404,883
Accrued compensation and payroll taxes.................... 19,048 (15,073) (87,352) 123,068
------------ ----------- ----------- ------------
Net cash used for operating activities.................... (9,402,588) (7,958,236) (7,936,910) (51,347,826)
INVESTING ACTIVITIES:
Patent costs.............................................. (54,445) 151,018 (194,363) (719,214)
Capital expenditures...................................... (50,059) (156,089) (80,678) (829,466)
Short-term investments.................................... 7,026,502
------------ ----------- ----------- ------------
Net cash provided by (used for) investing activities.... 6,921,998 (5,071) (275,041) (1,548,680)
FINANCING ACTIVITIES:
Proceeds from issuance of common and preferred stock...... 531,192 42,814 2,060,206 41,312,483
Proceeds from issuance of convertible notes payable....... 6,000,000 19,500,000
Debt issue costs.......................................... (296,059) (1,067,410)
Repayment of convertible notes payable.................... (2,673,217) (2,673,217)
Stock issue costs......................................... (233,922) (3,147,625)
Advances for purchase of common stock..................... 125,000
Collection of notes receivable for common stock........... 14,525
Proceeds from shareholder loans........................... 322,788
Repayment of shareholder 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............... 3,561,916 42,814 1,826,284 53,019,180
------------ ----------- ----------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ 1,081,326 (7,920,493) (6,385,667) 122,674
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............ 13,347,508 14,428,834 6,508,341
------------ ----------- ----------- ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 14,428,834 $ 6,508,341 $ 122,674 $ 122,674
============ =========== =========== ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid............................................. $ 784,224 $ 113,729 $ 7,755 $ 1,115,247
============ =========== =========== ============
SUPPLEMENTAL DISCLOSURES OF NON-CASH FINANCING ACTIVITIES
Conversions into common stock from preferred stock........ 2,029,146
Conversions into common stock from convertible notes...... 6,124,656 1,434,678 1,009,570
============ =========== ===========
</TABLE>
See notes to financial statements.
F-11
<PAGE> 40
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations -- AVANIR Pharmaceuticals ("we" or the "Company") was
incorporated in the state of California on August 31, 1988. AVANIR
Pharmaceuticals is organized to engage in research, development, and
commercialization of innovative pharmaceutical products. From inception to
November 20, 1998, we operated under the name LIDAK Pharmaceuticals. On November
20, 1998, our shareholders approved a change in the name of the Company to
AVANIR Pharmaceuticals.
Basis of Accounting -- We have not yet completed product development,
obtained required regulatory approvals or verified the market acceptance and
demand for our products. We have completed clinical trials on our lead product,
docosanol 10% cream under an Investigational New Drug ("IND") application filed
with the United States Food & Drug Administration ("FDA"). We have filed an
amended New Drug Application ("NDA") with the FDA, and are awaiting the FDA's
decision on approval. We also are currently performing research in connection
with other technologies. Accordingly, our activities have been accounted for as
those of a "development stage enterprise" as set forth in Statement of Financial
Accounting Standards ("SFAS") No. 7. Among other disclosures, SFAS No. 7
requires that our financial statements be identified as those of a "development
stage enterprise" and that the statements of operations, shareholders' equity
(deficit) and cash flows disclose activities since the date of the Company's
inception.
Going Concern -- We have prepared the accompanying financial statements on
a going concern basis, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. We have incurred
net losses since our inception and have not yet received approval of our NDA for
docosanol from the FDA. As a result, we have neither generated any revenues from
our products nor obtained adequate financing to support future operations. We
are in the process of seeking financial arrangements to secure sufficient funds
to support our research and development activities in the coming year. We also
are working towards completion of a license agreement with SmithKline Beecham,
which would give them the rights to manufacture and sell docosanol 10% cream.
See Note 13. The uncertainty of our ability to complete either of these plans
raises substantial doubt about our ability to continue as a going concern.
Estimates -- The preparation of financial statements in conformity with
generally accepted accounting principles requires that we make estimates and
assumptions that affect the reported amounts of our 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.
Recent Accounting Pronouncements --
In June 1997, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes requirements for
disclosure of comprehensive income and became effective for us for the year
ended September 30, 1999. Comprehensive income includes such items as
foreign currency translation adjustments and unrealized holding gains and
losses on investments classified as available for sale securities. We
adopted this standard as of September 30, 1999. As we do not have any
comprehensive income, our total comprehensive loss is the same as total net
loss as of September 30, 1999 and September 30, 1998.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131
establishes standards for disclosure about operating segments in annual
financial statements and selected information in interim financial reports.
It also establishes standards for related disclosures about products and
services, geographic areas and major customers. We adopted this new
standard as of September 30, 1999. As we only have one operating segment,
this standard does not affect current reporting or disclosures.
F-12
<PAGE> 41
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting
and reporting standards for derivative instruments and for hedging
activities. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities -- Deferral of the Effective
Date of FASB Statement 133." The statement defers the effective date of
SFAS No. 133 and will become effective for us for the year ending September
30, 2001. We are currently in the process of reviewing the impact of this
standard on our current reporting and disclosures.
Cash Equivalents and Short-Term Investments -- Cash equivalents consist of
highly liquid investments purchased with original maturities of three months or
less, or other investments which provide for liquidity within three months.
Short-term investments represent certificates of deposit, U.S. government
securities, commercial paper, and other money market instruments with maturities
of approximately one year or less. Cash equivalents and short-term investments
are carried at cost, which approximates fair value. On October 1, 1995, we
adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities". In accordance with SFAS No. 115, our investments are classified as
"held-to-maturity." As of September 30, 1999, we had no investments.
Concentration of Credit Risk -- We invest our excess cash in certificates
of deposit, U.S. government securities, commercial paper, and other money market
instruments and have established guidelines relative to diversification and
maturities in an effort to maintain safety and liquidity. We periodically review
and modify these guidelines to take advantage of trends in yields and interest
rates. We have not experienced any significant losses on our cash equivalents or
short-term investments.
Inventory -- In November 1998, we purchased the active ingredient in
docosanol cream at a cost of $223,800. We estimated that 50% of the raw
materials purchased are current assets as we intend to manufacture and sell this
portion of raw materials within the next year. The remaining 50% of the raw
materials inventory is classified on our balance sheet as long-term inventory.
We carry our inventories at the lower of cost (first-in, first-out) or market.
Property -- Our property is primarily scientific equipment, and we record
the property at cost. We depreciate property over the estimated useful lives of
the property (generally five years) on the straight-line method. Depreciation
expense for the years ended September 30, 1997, 1998 and 1999 and the period
from August 31, 1988 (inception) to September 30, 1999 was $106,283, $122,221,
$111,992 and $607,164, respectively.
Impairment of Long-Lived Assets -- We evaluate our long-lived assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of such assets or intangibles may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of an asset to future undiscounted net cash flows expected to be
generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell.
Patent Costs -- We capitalize legal expenses incurred in connection with
applications for patents. We amortize the costs of approved patent applications
over the useful lives of the patents. For patent applications that we abandon,
we charge any remaining accumulated costs to expense.
Deferred Costs --
At September 30, 1998 -- Deferred costs at September 30, 1998
represented deferred debt issue costs related to the issuance of the
Convertible Note issued February 26, 1997 (the "1997 Note"). The deferred
debt issue costs were amortized over the life of the notes. We recorded
debt issuance costs in the
F-13
<PAGE> 42
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
amount of $519,809 in connection with the 1997 Note. Included in the total
debt issue costs in connection with the 1997 Note is a non-cash amount of
$223,750, which represents the issuance of the Class H Stock Purchase
Warrant in exchange for finder fee services. Through October 31, 1998,
$125,521 of debt issue costs were amortized and $394,288 were reclassified
to stock issue costs in connection with the conversion of the 1997 Note.
The debt issue costs related to the 1997 Note have been fully amortized or
reclassified to stock issue costs in connection with conversions of the
1997 Note. We have no further obligation under the 1997 Note.
At September 30, 1999 -- Deferred costs at September 30, 1999 totaling
$100,000 represent deferred costs related to an equity line investment
agreement dated January 22, 1999. The amounts classified as deferred costs
will be offset against the proceeds for stock sold under the equity line as
appropriate. We intend to sell shares of Class A Common Stock according to
the terms of the equity line agreement after we obtain listing of our
shares on one of the national stock market exchanges (See Notes 2 and 5).
Our policy is to record these costs as deferred assets when there is a
reasonable likelihood of the equity line being fulfilled and to expense
these costs immediately when the equity line will not be fulfilled. As we
are still pursuing this equity line and as the agreement has not expired,
we have recorded deferred costs at September 30, 1999.
Revenues -- Revenues from license fees are recognized when the performance
requirements of the license agreements are met. Revenues from federal research
grants and contracts are recognized during the period in which the related
expenditures are incurred. Revenues from research contracts are recognized on
the percentage of completion method. Under this method, revenues and costs are
recognized as the work is performed based on the ratio that incurred costs bear
to the estimated total costs. Provisions for anticipated losses on such
contracts would be made in the period in which they first become determinable.
Research and Development -- Research and development costs are expensed as
incurred.
Net Loss Per Share -- In February 1997, the Financial Accounting Standards
Board issued SFAS No. 128, "Earnings per Share" ("EPS"), which expands upon the
current standard, Accounting Principles Board ("APB") Opinion No. 15, "Earnings
Per Share."
In the accompanying statements of operations for the years ended September
30, 1997, 1998 and 1999, we have presented our net loss per share under SFAS No.
128. Net loss per share is computed using the Basic EPS method, as the inclusion
of common stock equivalents in the Diluted EPS calculation would be anti-
dilutive. Based on the our continuing net losses, implementing SFAS No. 128 has
not had a material impact on 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>
YEARS ENDED SEPTEMBER 30,
------------------------------------------
1997 1998 1999
------------ ----------- -----------
<S> <C> <C> <C>
Net loss................................... $(11,109,242) $(8,210,548) $(8,554,036)
Dividends on redeemable convertible
preferred stock............................ (29,146)
------------ ----------- -----------
Net loss attributable to common
shareholders............................. $(11,109,242) $(8,210,548) $(8,583,182)
============ =========== ===========
</TABLE>
Accounting for Stock-Based Compensation -- We apply APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations in
accounting for our employee stock option and purchase plans. We have opted under
SFAS No. 123, "Accounting for Stock-Based Compensation," to disclose the impact
of our stock-based compensation rather than recognize it in the financial
statements. The pro forma
F-14
<PAGE> 43
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
effects of applying SFAS No. 123 are not necessarily representative of the
effects on reported net income or loss for future years. See Note 3.
Reclassifications -- Certain amounts in the prior years' financial
statements have been reclassified to conform to current period presentation.
2. LISTING OF COMMON STOCK ON OTC BULLETIN BOARD
On September 17, 1999, we were notified by the Nasdaq Listing
Qualifications Panel that our Class A Common Stock was being delisted from the
Nasdaq National Stock Market. On September 20, 1999, our Class A Common Stock
began trading on the over-the-counter (OTC) bulletin board under the symbol
AVNR.
3. SHAREHOLDERS' EQUITY (DEFICIT)
Preferred Stock
Preferred Stock consists of Series C Junior Participating Preferred Stock
and Series D Redeemable Convertible Preferred Stock.
Series C Junior Participating Preferred -- On March 2, 1999, our board of
directors approved a shareholder rights plan (the "Plan"). The Plan features a
dividend distribution of one Preferred Share Purchase Right (the "Right") on
each outstanding share of our Class A and Class B Common Stock, payable to
shareholders of record on March 25, 1999. Subject to limited exceptions, the
Rights will be exercisable if a person or group acquires 15% or more of our
common stock or announces a tender offer for 15% or more of our common stock (a
"Trigger Event").
Under certain circumstances, each Right will entitle shareholders to buy
one one-hundredth of a share of newly created Series C Junior Participating
Preferred Stock of AVANIR at an exercise price of $10.00 per share. Our Board of
Directors will be entitled to redeem the Rights at $0.01 per Right at any time
before a person has acquired 15% or more of the outstanding common stock. The
Rights will expire on March 25, 2009. The Rights distribution is not taxable to
shareholders.
If a Trigger Event occurs, each Right will entitle its owner, who is not an
acquiring person, to purchase at the Right's then current exercise price, a
number of shares of Class A Common Stock having a market value at the time of
twice the Right's exercise price. Rights held by the acquiring person would
become void and not be exercisable to purchase shares at the bargain purchase
price. An acquiring person is defined as a person who acquires 15% or more of
the outstanding shares of common stock.
On November 23, 1999, we amended the Rights Agreement dated March 5, 1999
between American Stock Transfer & Trust Company and us. The Rights Agreement was
amended to exclude two financial institutions from being named as "acquiring
parties," as defined in the Rights Agreement, subject to certain conditions. In
a related transaction on November 24, 1999, we signed a financing arrangement
with the two "excluded" financial institutions and received $1.5 million in
bridge financing. See Note 13.
Series D Redeemable Convertible Preferred Stock and Class J Stock Purchase
Warrants -- On March 22, 1999, we 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 required that one Class J
Warrant be issued 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.
F-15
<PAGE> 44
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
On March 31, 1999, the investors made their initial investment by
purchasing 200 Series D Shares and the related Class J Warrants for $2.0
million. In June 1999, we had the right to sell under certain conditions 100
additional Series D Shares to the investors. However, this sale did not occur,
because we did not meet the closing conditions. The investors in the Series D
Shares have the option to purchase the remaining 200 Series D Shares for an
additional investment of $2.0 million.
Each Series D Share carried an annual dividend of $500 payable on a
quarterly basis in cash or, at our option, in stock at the applicable conversion
rate. The investors had 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:
- the Fixed Conversion Price -- an amount equal to $0.9144 per share of
Class A Common Stock, which represented 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 preceding July 29, 1999; or
- the Variable Conversion Price -- an amount equal to 86% of the market
price at the time when the Series D Shares were 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. We had
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 Shares to the 200 Class J Warrants. On July 29,
1999, we reduced the exercise price of the Class J Stock Purchase Warrants to
$0.9144 per share of Class A Common Stock, according to the reset provision of
the agreement on the 120th day following the initial investment (as explained
above as the Fixed Conversion Price).
Each of the selling shareholders and its affiliates could 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 outstanding Series D Shares were 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 our failure to
meet certain conditions including, but not limited to, the continued listing of
our Class A Common Stock on the Nasdaq National Market System. In the event of a
major transaction or triggering event, the holder had the right to require us to
redeem all or a portion of any outstanding Series D Shares at a price per share
determined by the type of event triggering the redemption.
Between June 16, 1999 and September 30, 1999, we issued 4,075,771 shares of
Class A Common Stock in connection with the conversion of all 200 Series D
Shares then outstanding and the equivalent of $29,146 in accrued dividends at an
average conversion price of $0.50 per share of Class A Common Stock. No Series D
Shares were outstanding as of the date of this report.
As of September 30, 1999, 100,000 Class J Warrants were outstanding. On
November 29, 1999, one of the investors exercised 50,000 Class J Warrants at
$0.9144 per share of Class A Common Stock, for cash in the amount of $45,720. As
of the date of this report, there are 50,000 Class J Warrants outstanding.
Common Stock
We have both Class A Common Stock and Class B Common Stock. Holders of
Class A Common Stock have one vote for each share held of record and holders of
Class B Common Stock have five votes for each share held of record on all
matters to be voted on by the shareholders. The Class A Common Stock and the
Class B Common Stock vote as one class on all matters requiring shareholder
approval, except that under
F-16
<PAGE> 45
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
California law the affirmative vote of a majority of the outstanding shares of
Class A Common Stock and a majority of the outstanding shares of Class B Common
Stock, each voting separately as a class, is required for any amendment to our
articles of incorporation that would alter or change the powers, preferences or
special right of, or increase or decrease the number of shares of, or create a
new class or series of shares having rights, preferences or privileges prior to,
each respective class of a company's common stock.
In describing further the rights of holders of Class A and Class B Common
Stock, if AVANIR Pharmaceuticals were to be a liquidated, the holders of both
classes of common stock would be entitled to share ratably in the net assets
available for distribution subject to the rights, if any, of holders of any
preferred stock then outstanding. Shares of both classes of common stock are not
redeemable and have no preemptive or similar rights. The Class B Common Stock
may be converted into Class A Common Stock on a share-for-share basis at any
time at the election of the holder and will automatically convert into Class A
Common Stock upon the sale or other transfer to another holder of Class B Common
Stock (including, without limitation, conveyance into a trust or transfer by the
operation of any will or the laws of descent and distribution).
Warrants
Class D Warrants -- Each Class D Warrant originally entitled the holder to
purchase one share of Class A Common Stock at an exercise price of $1.50 per
share. On July 16, 1999, our board of directors approved a repricing of the
exercise price of the 1,387,869 Class D Warrants then outstanding to $1.3750 per
share. In connection with the repricing of the Class D Warrants, we issued
126,166 additional Class D Warrants to purchase a like number of shares of Class
A Common Stock to the existing warrant holders. As of September 30, 1999,
1,514,035 Class D Warrants were outstanding. Between October 1, 1999 and
December 31, 1999, several Class D Warrant holders exercised their rights to
purchase an aggregate of 1,221,967 shares of Class A Common Stock for aggregate
exercise proceeds of $1,680,205. On December 31, 1999, the remaining unexercised
Class D Warrants expired.
Class E Warrants -- Each Class E Warrant entitled the holder to purchase
one share of Class A Common Stock at an exercise price of $0.20 per share. All
Class E Warrants had been exercised prior to fiscal year 1999.
Class G Stock Purchase Warrants -- Each of the Class G Stock Purchase
Warrants was issued in connection with the conversions of the 1997 Note. The
Class G Stock Purchase Warrants originally entitled the holder to purchase one
share of Class A Common Stock at an exercise price of $2.97 per share. On July
16, 1999, our board of directors approved a repricing of the exercise price of
the Class G Stock Purchase Warrant to $1.3750 per share. In connection with the
repricing, we cancelled the original 2,030,455 Class G Stock Purchase Warrants
and issued a replacement Class G Stock Purchase Warrant in the amount of
4,385,783 warrants to the existing warrant holders. The Class G Stock Purchase
Warrant expires on June 30, 2001. As of September 30, 1999, 4,385,783 Class G
Stock Purchase Warrants were outstanding. See Note 4.
Class H Stock Purchase Warrants -- Each Class H Stock Purchase Warrant
entitles the holder to purchase one share of Class A Common Stock at an exercise
price of $2.40 per share. The Class H Stock Purchase Warrant expires on February
26, 2002. As of September 30, 1999, 100,000 Class H Stock Purchase Warrants were
outstanding.
Class I Stock Purchase Warrant -- On March 4, 1999, we engaged the services
of a consultant to provide us with advice and counsel 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, we issued the
consultant a Class I Stock Purchase Warrant for the purchase of up to 500,000
shares of Class A Common Stock at an exercise price of $0.78125 per share. The
F-17
<PAGE> 46
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
warrant vested fully upon issuance. The Class I Stock Purchase Warrant expires
on March 3, 2004. As of September 30, 1999, the Class I Stock Purchase Warrant
had not been exercised.
We 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. The consultant's exercise of the warrant is subject to the consultant
continuing to render consulting services during the 18-month consulting period.
We will recognize the expense in the amount of $225,900 pro-rata over the
18-month period of the consulting agreement. As of September 30, 1999, we had
recorded expense in the amount of $87,850 representing seven months of services
under the consulting agreement.
Class J Stock Purchase Warrants -- See "Preferred Stock -- Series D
Redeemable Convertible Preferred Stock and Class J Stock Purchase Warrants"
above.
Class K Stock Purchase Warrant -- On April 1, 1999, we engaged the services
of a consultant to provide investor relations services for a period of one year.
In connection with the consulting services, we issued to the consultant 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. We will record
expense related to the valuation of the Class K Stock Purchase Warrant using the
Black-Scholes pricing model as the milestones are met under the warrant
agreement. In April 1999, we recorded expense related to the initial vesting of
62,500 warrants in the amount of $37,612. No other amounts had been expensed as
of September 30, 1999, as certain of the milestones had not been achieved. As of
September 30, 1999, the Class K Stock Purchase Warrant had not been exercised.
Class L Stock Purchase Warrant -- On June 8, 1999, we 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, we issued a Class L Stock
Purchase Warrant to the advertising agency 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 docosanol cream product. The Class L Stock
Purchase Warrant expires on June 7, 2002. Over the one-year term of the
contract, we will record expense related to the valuation of the Class L Stock
Purchase Warrant. We valued the Class L Stock Purchase Warrant at $49,645, which
represents the value of the discounted fees from the advertising agency. As of
September 30, 1999, we had recognized $16,548 as an expense associated with the
Class L Stock Purchase Warrant. As of September 30, 1999, the Class L Stock
Purchase warrant had not been exercised.
F-18
<PAGE> 47
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes all warrant activity for the period October
1, 1996 to September 30, 1999:
<TABLE>
<CAPTION>
CLASS D CLASS E CLASS G CLASS H CLASS I CLASS J CLASS K CLASS L
WARRANTS WARRANTS WARRANTS WARRANTS WARRANTS WARRANTS WARRANTS WARRANTS
---------- -------- ----------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at October 1, 1996......... 1,728,354 75,000
Issued............................. 1,005,822 100,000
Exercised.......................... (321,085) (75,000)
---------- -------- ----------- -------- -------- -------- -------- -------
Outstanding at September 30,
1997............................. 1,407,269 -- 1,005,822 100,000
Issued............................. 479,026
Exercised.......................... (19,400)
---------- -------- ----------- -------- -------- -------- -------- -------
Outstanding at September 30,
1998............................. 1,387,869 -- 1,484,848 100,000
Issued............................. 126,166 4,931,390 500,000 100,000 375,000 55,000
Cancelled.......................... (2,030,455)
Exercised..........................
---------- -------- ----------- -------- -------- -------- -------- -------
Outstanding at September 30,
1999............................. 1,514,035 4,385,783 100,000 500,000 100,000 375,000 55,000
========== ======== =========== ======== ======== ======== ======== =======
Exercise price per Share........... $ 1.375 $ -- $ 1.375 $ 2.40 $0.78125 $ 0.9144 $ 1.125 $1.1875
========== ======== =========== ======== ======== ======== ======== =======
</TABLE>
Stock Options
1998 Stock Option Plan -- On February 19, 1999, our 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 our directors, officers, employees and
consultants. The options are to be granted at an exercise price of at least fair
market value on the date of grant and generally vest over a three-year period.
Between February 19, 1999 and September 30, 1999, we granted options
exercisable into 1,427,590 shares to our directors, officers and employees under
the 1998 Stock Option Plan. Included in the options granted during the fiscal
year ended September 30, 1999 were options to purchase 135,000 shares of Class A
Common Stock granted on July 16, 1999 to our board of directors. These 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. We
valued the issuance of these options at $89,500. We are recording a monthly
expense in the amount of $12,786 for the period of June 1999 through December
1999 for the services of the board of directors. As of September 30, 1999,
453,210 shares of Class A Common Stock were available for grant under the 1998
Plan.
1994 Stock Option Plan -- In March 1994, our shareholders approved the
adoption of the 1994 Stock Option Plan (the "1994 Plan") pursuant to which an
aggregate of 750,000 shares of Class A Common Stock were reserved for issuance.
The 1994 Plan allows us to grant options to our officers, directors, employees
and consultants. The options are to be granted at an exercise price of at least
fair market value on the date of grant and generally vest over a three-year
period. The 1994 Plan provides for an automatic annual grant of an option to
purchase 10,000 shares to each director who is not also one of our employees.
The 1994 Plan terminates on January 14, 2004. In March, 1995, 1996 and 1997, our
shareholders voted to increase the shares reserved for issuance under the plan
to an aggregate of 1,100,000, 1,350,000, and 2,000,000 shares, respectively. At
September 30, 1999, 271,543 shares of Class A Common Stock were available for
grant under the 1994 Plan.
Proposed 2000 Stock Option Plan -- On December 2, 1999, our board of
directors authorized the 2000 Stock Option Plan (the "2000 Plan"), pursuant to
which an aggregate of 2,250,000 shares of our Class A Common Stock have been
reserved for issuance. The 2000 Plan is subject to shareholder approval and will
be presented to the shareholders in our proxy statement for the 2000 Annual
Meeting of Shareholders.
F-19
<PAGE> 48
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Other Stock Options
In July 1993, we granted options to purchase an aggregate of 3,843,750
shares of Class A Common Stock to certain of our employees, consultants,
directors and original investors in the Company at an option price of $3.56 per
share. Recipients of these options waived all of their respective rights to an
aggregate of 3,843,750 shares of Class B Common Stock and options to purchase
Class B Common Stock held in an escrow account. These options were fully
exercisable when issued and they expire on July 17, 2003.
In September 1994, we reduced the exercise price on certain options granted
to several employees, officers and consultants to purchase an aggregate of
3,285,250 shares of Class A and Class B Common Stock, to $2.75 per share.
The following table summarizes all common stock option activity for the
period October 1, 1996 to September 30, 1999:
<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERLYING STOCK OPTIONS WEIGHTED
------------------------- AVERAGE OPTION
CLASS A CLASS B PRICE PER SHARE
----------- ---------- ---------------
<S> <C> <C> <C>
Outstanding at October 1, 1996................. 5,120,022 429,000 $2.59
Granted........................................ 488,500 $1.85
Exercised.................................... (33,800) $1.02
Canceled..................................... (269,279) $3.19
--------- --------
Outstanding at September 30, 1997.............. 5,305,443 429,000 $2.51
Granted...................................... 954,000 $1.56
Exercised.................................... (13,167) $1.04
Canceled..................................... (386,366) (10,000) $2.33
--------- --------
Outstanding at September 30, 1998.............. 5,859,910 419,000 $2.38
Granted...................................... 1,720,000 $0.76
Exercised.................................... (36,062) (391,000) $0.13
Canceled..................................... (319,724) $1.55
--------- --------
Outstanding at September 30, 1999.............. 7,224,124 28,000 $2.16
========= ======== =====
Exercisable at September 30, 1999.............. 5,843,338 28,000 $2.43
========= ======== =====
</TABLE>
We have applied APB Opinion No. 25 and related interpretations in
accounting for our employee stock options (See Note 1). Accordingly, we have not
recognized any compensation expense for stock options granted at the fair market
value of our Class A Common Stock. If compensation expense for stock options
granted under the stock option plans had been determined based on the fair value
at the grant date consistent with methodology prescribed under SFAS No. 123,
then our pro forma net loss and net loss per share would have been as follows:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
------------------------------------------
1997 1998 1999
------------ ----------- -----------
<S> <C> <C> <C>
Net loss attributable to common
shareholders
As reported................................ $(11,109,242) $(8,210,548) $(8,583,182)
Pro forma................................ $(11,347,983) $(8,651,374) $(9,273,260)
Net loss per share
As reported.............................. $ (0.30) $ (0.21) $ (0.21)
Pro forma................................ $ (0.31) $ (0.22) $ (0.22)
</TABLE>
F-20
<PAGE> 49
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
We estimate the weighted average fair values per share of the options
granted during the fiscal years 1997, 1998 and 1999 to be $1.54, $1.56 and
$0.76, respectively, using the Black-Scholes option-pricing model and the
following assumptions:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
--------------------------
1997 1998 1999
------ ------ ------
<S> <C> <C> <C>
Risk free interest rate..................................... 5% 5% 5%
Expected life (years)....................................... 3.5 3.3 3.0
Expected volatility......................................... 161% 144% 151%
Expected dividends.......................................... None None None
</TABLE>
The following table summarizes information concerning outstanding and
exercisable Class A and Class B stock options at September 30, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------
WEIGHTED OPTIONS EXERCISABLE
AVERAGE ----------------------
REMAINING WEIGHTED WEIGHTED
CONTRACTUAL AVERAGE AVERAGE
RANGE OF NUMBER LIFE IN EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING YEARS PRICE EXERCISABLE PRICE
- --------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.50 - $0.50.. 28,000 0.86 $0.50 28,000 $0.50
$0.72 - $0.72.. 1,385,150 8.98 $0.72 507,910 $0.72
$0.78 - $0.78.. 135,000 9.79 $0.78 135,000 $0.78
$0.94 - $1.06.. 311,866 6.67 $1.03 185,921 $1.02
$1.28 - $1.31.. 199,000 5.55 $1.30 152,204 $1.30
$1.44 - $2.31.. 859,131 6.78 $1.76 528,326 $1.78
$2.50 - $2.94.. 3,801,977 3.88 $2.74 3,801,977 $2.74
$3.00 - $4.00.. 465,500 4.54 $3.58 465,500 $3.58
$5.75 - $6.44.. 66,500 3.47 $5.92 66,500 $5.92
--------- ---------
7,252,124 5,871,338
========= =========
</TABLE>
4. CONVERTIBLE NOTES PAYABLE
Note Issued in February 1997 -- On February 26, 1997, we issued a $6
million Convertible Note (the "1997 Note") as part of a private placement to an
institutional investor. The 1997 Note accrued interest at an annual rate of 7%,
beginning August 26, 1997 and was due and payable on February 26, 2000 if and to
the extent the 1997 Note was not previously converted pursuant to its terms. We
recognized the stated 7% annual interest ratably over the term of the 1997 Note.
The holder of the 1997 Note had the right to convert the 1997 Note (subject to
certain maximum share limitations discussed below) into shares of Class A Common
Stock at a price equal to 85% of the market price per share (as defined in the
1997 Note) on the date of conversion. Pursuant to the terms of the 1997 Note,
the holder was entitled to receive (i) a Class G Stock Purchase Warrant for each
two shares of Class A Common Stock issued to the holder upon conversion of the
1997 Note, and (ii) a certain number of Class G Stock Purchase Warrants in the
event that we prepaid the 1997 Note. Each Class G Stock Purchase Warrant was
initially exercisable five years from the date of issue into one share of Class
A Common Stock at an exercise price of $2.97 per share.
The option to convert the 1997 Note at 85% of the average closing bid price
of the Class A Common Stock effectively resulted in the issuance of the 1997
Note at an 18% discount. We recorded the discount on the 1997 Note, totaling
$1,058,823, as equity in connection with the issuance of the 1997 Note. We
amortized
F-21
<PAGE> 50
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
the discount as non-cash interest expense over the 90 days from the date of
issuance with a corresponding increase to the principal amount of the 1997 Note.
Through October 30, 1998, we issued 4,060,904 shares of Class A Common
Stock and 2,030,455 Class G Stock Purchase Warrants in connection with the
conversion of the total $6,000,000 in principal amount of the 1997 Note. We have
no further obligation under the 1997 Note.
On July 16, 1999, we cancelled 2,030,455 Class G Stock Purchase Warrants
and replaced them with 4,385,783 Class G Stock Purchase Warrants at an exercise
price of $1.375 per share in connection with a repricing associated with
anti-dilution provisions of the warrant agreement and shortened expiration
dates. See Note 3, Shareholders' Equity for additional information on the Class
G Stock Purchase Warrants.
5. INVESTMENT AGREEMENT
On January 22, 1999, we entered into a Class A Common Stock Investment
Agreement as amended on 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, we may cause the Equity Line Investor
to purchase up to $10,000,000 of Class A Common Stock over approximately a
two-year period subject to certain stock price, marketing listing and trading
volume conditions. We will sell the shares to the Equity Line Investor at the
higher of:
- a designated fixed price set by the Company; or
- a six percent (6%) discount from the market price of the shares of Class
A Common Stock.
The Equity Line Investor also has 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 we set
forth in our "put" notices to the Equity Line Investor.
On May 11, 1999, we obtained shareholder approval for the issuance of more
than 20% of Class A Common Stock in connection with both the Equity Line
Agreement and the Series D Redeemable Convertible Preferred Stock.
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, listing of our Class A Common Stock on a national market
exchange, and registration of the shares underlying the Equity Line with the
Securities and Exchange Commission ("SEC") for resale in the public marketplace.
On September 17, 1999, following approximately eight months of our Class A
Common Stock trading below $1.00 per share, a Nasdaq review panel delisted our
Class A Common Stock from the Nasdaq National Market System. Because of our
delisting and the Equity Line Investor's pending evaluation of a restructuring
of the Equity Line Agreement to meet SEC registration requirements, we have not
filed a registration statement for the Class A Common Stock with the SEC. We
will need to register these shares and obtain a re-listing on one of the
national exchanges before we will be able to access any of the funds under the
Equity Line Agreement.
6. LICENSE AND DISTRIBUTION AGREEMENTS
Yamanouchi Europe, b.v. (formerly Brocades Pharma, b.v.) -- In November
1991, we entered into a licensing agreement with Yamanouchi Europe, b.v. of the
Netherlands ("Yamanouchi") for clinical development, manufacturing, marketing
and distribution of docosanol cream, as a prescription topical anti-herpes
compound in certain European and other countries. On December 31, 1998, the
license agreement became non-exclusive. Under the agreement, we may receive
payments based on the attainment of certain milestones by Yamanouchi and may
receive royalties on sales in the subject territories after market introduction.
These milestones include Yamanouchi obtaining the necessary regulatory approvals
and for the
F-22
<PAGE> 51
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
subsequent manufacturing, marketing and distribution of docosanol in certain
European and other countries. As of December 21,1999, Yamanouchi had not
initiated any actions that would entitle us to receive payments or royalties,
nor do we expect Yamanouchi to take any action now that docosanol is being
considered an OTC product.
CTS -- In July 1993, we entered into a five-year license/supply and
distribution agreement with CTS Chemical Industries, Ltd. ("CTS"), for the
manufacturing, marketing and distribution of docosanol cream as a topical
anti-herpes compound in Israel. The five-year period of the license begins upon
CTS successfully obtaining approval by the appropriate regulatory authorities in
Israel. Under the terms of the agreement, CTS will be responsible for obtaining
the necessary regulatory approvals and for the subsequent manufacturing,
marketing and distribution of docosanol cream in Israel. The agreement includes
a supply provision under which CTS will purchase its entire requirement of
active ingredients for use in the manufacture of topical docosanol cream from us
directly or from our designee.
Boryung -- In July 1994, we entered into a 12-year exclusive license and
supply agreement with Boryung Pharmaceuticals Company Ltd. ("Boryung"), for the
manufacture and sale of docosanol cream in the Republic of Korea ("Korea").
Under the terms of the agreement, Boryung will be responsible for obtaining the
necessary regulatory approvals and for the subsequent manufacturing, marketing
and distribution of docosanol cream in Korea. The agreement includes a supply
provision under which Boryung will purchase its entire requirement of active
ingredient for use in the manufacture of topical docosanol cream from us
directly or from our designee, and after market introduction we will receive
royalties on sales in the subject territory. We have the right to terminate the
agreement if market introduction in Korea has not occurred by December 31, 1998.
As of December 21, 1999, we had not taken any action to terminate the agreement.
Grelan -- In October 1994, we entered into an exclusive license agreement
with Grelan Pharmaceutical Co., Ltd. ("Grelan") for the manufacturing, marketing
and distribution of docosanol cream in Japan. Under the terms of the agreement,
Grelan would be responsible for obtaining the necessary regulatory approvals and
for the subsequent manufacturing, marketing and distribution of docosanol cream
in Japan. Under the agreement, we received payments on the attainment of certain
milestones. After Grelan was acquired by another company in 1997, Grelan and we
agreed to terminate the license, and on June 30, 1998, all rights were returned
to us.
Bristol-Myers Squibb -- In February 1996, we entered into a license
agreement with Bristol-Myers Squibb Company ("BMS") for the manufacture,
marketing and distribution of docosanol cream as a topical treatment for oral
herpes exclusively in the U.S., Canada and all remaining major territories
throughout the world which were not licensed to other parties at the time. In
connection with this agreement, we received an initial license fee with a
portion recorded as revenue in the year ended September 30, 1996 and the
remainder recorded as deferred revenue at September 30, 1996. In the fiscal year
ended September 30, 1997, we recognized the deferred revenue due to achievement
of certain milestones. In November 1996, we reacquired from BMS the rights to
market docosanol cream in all territories covered in the license agreement,
except the United States, Canada and Mexico. On December 29, 1997, BMS canceled
the license agreement.
Livingston Healthcare Services -- In October 1998, we signed a warehousing,
distribution and logistical support agreement with Livingston Healthcare
Services, Inc. ("LHSI"). The agreement provides the terms for LHSI's Decatur,
Georgia facility to warehouse and distribute docosanol cream. As of September
30, 1999, we were using LHSI's facility to warehouse only a certain quantity of
the active ingredient, docosanol. We have not yet engaged in the manufacture of
docosanol cream, until such time that a decision is made by the FDA regarding
our new drug application.
Bausch & Lomb -- In November 1998, we entered into a Contract Manufacturing
and Supply Agreement with Bausch & Lomb Pharmaceuticals, Inc. ("Bausch & Lomb").
The agreement provides the terms
F-23
<PAGE> 52
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
under which Bausch & Lomb would manufacture, package and supply docosanol cream.
As of December 20, 1999, we had not yet arranged for the manufacture of
docosanol cream, because we are still awaiting the FDA's decision to approve
docosanol cream for marketing in the United States.
7. RELATED PARTY
IriSys Research and Development, LLC -- During the fiscal year ended
September 30, 1999, we entered into two agreements with IriSys Research and
Development Company, LLC ("IriSys") for certain license rights and research and
development activities. Dr. Gerald Yakatan, our 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. Our board of directors
has approved the following agreements with IriSys:
- Letter of Intent -- On February 5, 1999, we 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 us 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.
- Research and Development -- On June 2, 1999, we entered into an agreement
for services with IriSys to develop formulations for a potential drug
substance candidate using our allergy and asthma technology. IriSys' fees
for services compared favorably to competitive bids. The total cost of
this agreement is $92,000. Expense was recorded in the amount of $81,400
related to this agreement as of September 30, 1999.
Board of Directors -- On October 21, 1999, several members of our board of
directors loaned an aggregate of $75,000 to AVANIR, for the purposes of
providing working capital. The terms of the loan agreements provide for an
interest rate at the Prime Rate, as regularly reported in the Wall Street
Journal. The prime rate increased from 8.25 % to 8.5 % on November 17, 1999. The
term of each of these loans is for a period of the earlier to occur of our
raising an aggregate of $2 million in financing or 90 days. As of December 21,
1999, we had not paid back these loans.
8. LEGAL PROCEEDINGS
David H. Katz Litigation -- On April 30, 1998, Dr. David H. Katz filed a
complaint in the San Diego Superior Court, making numerous claims related to the
termination of his employment as our president. Mrs. Lee Katz, Dr. Katz' wife,
later joined in the lawsuit and raised claims related to her stock options. On
October 30, 1998, we filed a cross-complaint against Dr. Katz and Mrs. Katz for
Dr. Katz' breach of his fiduciary duties as a director and officer of our
company, and the assignment by Dr. Katz and Mrs. Katz to our company of any
interest that they may possess in a pending patent application pertaining to our
proprietary IgE down regulation technology. The following claims are still
pending before the court:
- Dr. Katz' request for the court to decide the voting rights for his
shares of our Class B Common Stock;
- Dr. Katz' claim that his termination as our president was not "for
cause";
- Dr. Katz' request for an accounting for allegedly deferred income and
money allegedly advanced to our company; and
- Our claim for specific performance of Dr. and Mrs. Katz' employment
contractual obligations to assign any interest in the pending IgE
technology patent application to us.
F-24
<PAGE> 53
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The jury in this litigation recently found in our favor on our claim that
Dr. Katz breached his fiduciary duty to us, and awarded us damages in the amount
of $9.0 million. The jury also returned a verdict against us on Dr. Katz'
defamation claim and awarded Dr. Katz' damages in the amount of $6.7 million.
The other original claims were either voluntarily dismissed by Dr. Katz, decided
in our favor by the court, or settled. However, the court has not set a date for
further proceedings to decide the remaining claims, and no judgment will be
entered in the overall case until trial is concluded on these claims. At that
point, we anticipate that both sides of the litigation will file post-trial
motions. We have not recorded any asset or liability associated with this case,
as the ultimate outcome is still unknown.
Lee Katz and Lisa Katz Litigation -- On January 29, 1999, Lee Katz and Lisa
Katz filed a separate lawsuit in the San Diego Superior Court, making several
claims related to our termination of their employment and seeking monetary
damages. The court has resolved several of the claims in our favor, and we have
reached a tentative settlement of the remaining claims, although we have not
agreed to the language of a written settlement agreement. We intend to defend
these claims vigorously until the parties sign a settlement agreement or the
case is resolved at trial.
9. LITIGATION SETTLEMENT
On August 27, 1998, we entered into a settlement agreement and mutual
general release with Medical Biology Institute ("MBI") to settle all outstanding
disputes between the two companies, specifically including the disputed
ownership of our proprietary therapeutic compound, docosanol, as well as other
technologies. The settlement agreement provides for us to retain all rights to
docosanol and certain other technologies. In return for obtaining full control
of our technologies and avoidance of potential future royalty payments, we
loaned $500,000 to MBI and returned other technologies that no longer fit our
long-term strategic plans. We forgave the loan effective February 23, 1999,
following MBI's meeting certain loan covenants over the 180-day period of the
loan. In the fiscal year ended September 30, 1998, we recorded litigation
settlement costs in our statement of operations of $783,899, which includes the
write down of the loan to MBI of $500,000 and certain other costs that were
previously capitalized by us related to those patents which were returned to
MBI. Also included in the litigation settlement costs for the fiscal year ended
September 30, 1998 is $150,000 paid to HealthMed, Inc. in connection with a
settlement agreement with HealthMed, Inc. dated March 24, 1998. We have no
further obligation to MBI or to HealthMed, Inc.
10. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
our net deferred tax assets were as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------------
1998 1999
------------ ------------
<S> <C> <C>
Net operating loss carryforwards........................ $ 18,544,270 $ 22,206,023
Capitalized license fees................................ 1,010,559 1,011,176
Research credit carryforwards........................... 2,570,352 3,590,161
Capitalized research and development costs.............. 926,955 1,344,814
Other................................................... (184,750) (195,954)
------------ ------------
Net deferred tax assets................................. 22,867,386 27,956,220
Valuation allowance for net deferred tax assets......... (22,867,386) (27,956,220)
------------ ------------
$ -- $ --
============ ============
</TABLE>
F-25
<PAGE> 54
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
We have provided a valuation allowance against the net deferred tax assets
recorded as of September 30, 1998 and 1999 due to uncertainties as to their
ultimate realization. The net operating loss and research credit carryforwards
expire through 2014. In the event of certain ownership changes, the Tax Reform
Act of 1986 imposes certain restrictions on the amount of net operating loss
carryforwards, which we may use in any year. As of September 30, 1999, we had
$60,244,253 and $19,490,686 of federal and California net operating loss
carryforwards, respectively.
11. COMMITMENTS
Operating Leases -- Prior to June 1998, our facilities were leased from MBI
under a month-to-month operating lease. Beginning June 16, 1998, we entered into
a facilities lease for two years with another company. Lease expense for the
years ended September 30, 1997, 1998 and 1999 and the period from inception to
September 30, 1999 was $448,251, $325,781, $315,523 and $3,066,030 respectively.
Future minimum payments under non-cancelable operating leases are as
follows:
<TABLE>
<CAPTION>
YEAR ENDING SEPTEMBER 30,
-------------------------
<S> <C>
2000.............................................. $244,262
2001.............................................. 23,318
2002.............................................. 9,277
2003.............................................. 6,185
--------
Total................................... $283,042
========
</TABLE>
12. EMPLOYEE SAVINGS PLAN
We have established an employee savings plan pursuant to Section 401(k) of
the Internal Revenue Code. The plan allows participating employees to deposit
into tax deferred investment accounts 2% to 20% of their salary, subject to
annual limits. We are not required to make matching contributions under the
plan, and we did not make any such contributions in fiscal years 1997, 1998 and
1999, nor have we made any contributions since inception of the plan.
13. SUBSEQUENT EVENTS
On November 24, 1999, we entered into a loan agreement for an aggregate of
$1.5 million in financing with two international financial institutions. On
November 24, 1999 and November 29, 1999, we issued to each lender an 18-month
convertible debenture with an interest rate of 11% payable quarterly in arrears.
Under the loan agreement, we must pay back the outstanding principal and accrued
interest on each convertible debenture within the first 100 days from its
issuance date before the lender is entitled to convert the convertible debenture
into shares of Class A Common Stock. After this 100-day period, the lender will
have a right to convert the outstanding principal and accrued interest into
shares of Class A Common Stock at a conversion rate of 90% of the market price,
as defined in the loan agreement, per share of Class A Common Stock.
In connection with this financing, we issued to each lender 292,056 Class M
Stock Purchase Warrants to purchase Class A Common Stock at a purchase price of
$1.284 per share. Two-thirds of the warrants vested on November 24, 1999. The
remaining one-third will vest only if we have not repaid in full the outstanding
principal and accrued interest on the convertible debentures within the first
100 days from the issuance date of the convertible debentures. In addition, we
paid two investment banks an aggregate finder's fee of $120,000 and issued to
them 116,822 fully vested Class M Stock Purchase Warrants.
F-26
<PAGE> 55
AVANIR PHARMACEUTICALS
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
On December 2, 1999, our board of directors approved the 2000 Stock Option
Plan and a proposal to amend our Articles of Incorporation (the "Articles") to
conform the Articles with our bylaws regarding the definition of a quorum for a
meeting of shareholders. Each proposal above is subject to approval by our
shareholders and will be described and presented to the shareholders in our
proxy statement for the 2000 Annual Meeting of Shareholders.
On December 21, 1999, we signed a letter of intent with SmithKline Beecham
(NYSE: SBH) for rights to market docosanol 10% cream in the OTC market as a
treatment for recurrent oral-facial herpes. SmithKline Beecham is one of the
world's leading healthcare companies, which discovers, develops, manufactures
and markets pharmaceuticals, vaccines, OTC medicines and health-related consumer
products. We intend to negotiate a more definitive agreement with SmithKline
Beecham while we simultaneously wait for the FDA's assessment of a site audit
and approval of labeling claims for docosanol in the OTC market. If we do not
obtain FDA approval, then the value of any agreement to be established between
us and our licensing partner would be affected materially and adversely. We can
give no assurances that we will reach a definitive agreement with SmithKline
Beecham or any other company to license the rights to market docosanol in the
OTC market.
* * * * *
F-27
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
AVANIR PHARMACEUTICALS
We consent to the incorporation by reference in Registration Statement
No. 33-49082 on Form S-l, Registration Statement Nos. 33-71276, 33-94370,
333-83089 and 333-84183 on Form S-8, and Registration Statement Nos. 33-76094,
33-90048, 33-64983, 333-24549, 333-76641 and 333-77925 on Form S-3 of AVANIR
Pharmaceuticals, formerly LIDAK Pharmaceuticals, (a development stage
enterprise) of our report dated December 21, 1999 (which expresses an
unqualified opinion and includes explanatory paragraphs relating to the status
of the Company as a development stage enterprise, the Company's ability to
continue as a going concern, and the Company as a defendant in certain lawsuits)
appearing in this Annual Report on Form 10-K of AVANIR Pharmaceuticals for the
year ended September 30, 1999.
DELOITTE & TOUCHE LLP
San Diego, California
January 11, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-K FOR THE TWELVE MONTHS ENDED SEPTEMBER 30, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> SEP-30-1999
<CASH> 122,674
<SECURITIES> 0
<RECEIVABLES> 76,499<F1>
<ALLOWANCES> 0
<INVENTORY> 111,901
<CURRENT-ASSETS> 632,928
<PP&E> 716,087
<DEPRECIATION> (496,726)
<TOTAL-ASSETS> 1,765,215
<CURRENT-LIABILITIES> 1,701,019
<BONDS> 0
0
0
<COMMON> 62,195,950
<OTHER-SE> (62,170,024)
<TOTAL-LIABILITY-AND-EQUITY> 1,765,215
<SALES> 0
<TOTAL-REVENUES> 146,787
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 8,693,068
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7,755
<INCOME-PRETAX> (8,554,036)
<INCOME-TAX> 0
<INCOME-CONTINUING> (8,554,036)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,554,036)
<EPS-BASIC> (0.21)
<EPS-DILUTED> (0.21)
<FN>
<F1>NET OF ALLOWANCE FOR NONPAYMENT OF $189,011.
</FN>
</TABLE>
