10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended June 30, 2005

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from_________to_________.

Commission File No. 1-15803

AVANIR PHARMACEUTICALS

(Exact name of registrant as specified in its charter)

California	33-0314804
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)
11388 Sorrento Valley Road, San Diego, California	92121
(Address of principal executive offices)	(Zip Code)

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES þ NO o

As of August 4, 2005, the registrant had 108,358,925 shares of Class A common stock issued and outstanding.

Table of Contents

	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Report of Independent Registered Public Accounting Firm		3
Condensed Consolidated Balance Sheets		4
Condensed Consolidated Statements of Operations		5
Condensed Consolidated Statements of Cash Flows		6
Notes to Condensed Consolidated Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		19
Item 3. Quantitative and Qualitative Disclosures about Market Risk		42
Item 4. Controls and Procedures		43
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		43
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		43
Item 3. Defaults Upon Senior Securities		43
Item 4. Submission of Matters to a Vote of Security Holders		43
Item 5. Other Information		43
Item 6. Exhibits		44
Signatures		45

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PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
Avanir Pharmaceuticals

We have reviewed the accompanying condensed consolidated balance sheet of Avanir Pharmaceuticals and subsidiaries (the “Company”) as of June 30, 2005, and the related condensed consolidated statements of operations for the three-month and nine-month periods ended June 30, 2005 and 2004, and of cash flows for the nine-month periods ended June 30, 2005 and 2004. These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Avanir Pharmaceuticals and subsidiary as of September 30, 2004, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated December 13, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of September 30, 2004 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

DELOITTE & TOUCHE LLP

San Diego, California
August 12, 2005

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Avanir Pharmaceuticals

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

	June 30,			September 30,
	2005			2004
ASSETS
Current assets:
Cash and cash equivalents	$	3,576,849		$	13,494,083
Short-term investments in securities		18,166,125			8,803,982
Receivables, net		123,341			239,879
Inventory		6,200			9,302
Prepaid expenses		1,998,616			1,526,282
Total current assets		23,871,131			24,073,528
Investments in securities		3,866,695			2,751,867
Restricted investments in securities		856,872			856,597
Property and equipment, net		6,051,182			6,390,964
Intangible assets, net		3,381,741			3,035,024
Long-term inventory		355,179			—
Other assets		281,066			295,973
TOTAL ASSETS	$	38,663,866		$	37,403,953
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	3,003,055		$	1,961,938
Accrued expenses and other liabilities		3,695,316			2,418,209
Accrued compensation and payroll taxes		1,091,199			710,368
Current portion of deferred revenue		1,976,871			1,961,530
Current portion of notes payable		302,817			211,092
Current portion of capital lease obligations		59,543			156,770
Total current liabilities		10,128,801			7,419,907
Deferred revenue, net of current portion		17,548,193			19,047,585
Notes payable, net of current portion		603,884			703,560
Capital lease obligations, net of current portion		16,165			35,642
Total liabilities		28,297,043			27,206,694
COMMITMENTS AND CONTINGENCIES (Note 14)
SHAREHOLDERS’ EQUITY:
Preferred stock – no par value, 10,000,000 shares authorized, no shares issued and outstanding as of June 30, 2005 and September 30, 2004		—			—
Common stock – no par value, Class A, 200,000,000 shares authorized, 108,344,660 and 95,305,757 shares issued and outstanding as of June 30, 2005 and September 30, 2004, respectively		164,250,777			134,687,535
Accumulated deficit		(153,752,982	)		(124,405,902	)
Accumulated other comprehensive loss		(130,972	)		(84,374	)
Total shareholders’ equity		10,366,823			10,197,259
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	38,663,866		$	37,403,953

See notes to consolidated financial statements.

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Avanir Pharmaceuticals

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

	Three months ended						Nine months ended
	June 30,						June 30,
	2005			2004			2005			2004
REVENUES:
Research contracts and licenses	$	2,763,014		$	—		$	3,063,014		$	270,500
Royalties and sale of royalty rights		455,937			351,517			1,386,067			1,237,029
Government research grants		114,887			222,437			400,455			661,968
Product sales		—			17,400			17,400			787,338
Total revenues		3,333,838			591,354			4,866,936			2,956,835
OPERATING EXPENSES:
Research and development		6,470,317			5,096,979			22,952,728			15,839,108
General and administrative		2,824,498			1,232,151			6,650,465			4,144,574
Sales and marketing		2,414,578			936,802			4,911,797			2,517,399
Cost of product sales		—			3,102			3,102			213,192
Total operating expenses		11,709,393			7,269,034			34,518,092			22,714,273
LOSS FROM OPERATIONS		(8,375,555	)		(6,677,680	)		(29,651,156	)		(19,757,438	)
Interest income		179,042			57,201			426,021			169,469
Interest expense		(22,513	)		(7,706	)		(69,458	)		(28,233	)
Other income (expense), net		11,496			11,116			(50,575	)		30,485
LOSS BEFORE INCOME TAXES		(8,207,530	)		(6,617,069	)		(29,345,168	)		(19,585,717	)
Provision for income taxes		(14	)		(424	)		(1,912	)		(2,544	)
NET LOSS	$	(8,207,544	)	$	(6,617,493	)	$	(29,347,080	)	$	(19,588,261	)
NET LOSS PER SHARE:
BASIC AND DILUTED	$	(0.08	)	$	(0.08	)	$	(0.29	)	$	(0.27	)
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
BASIC AND DILUTED		107,367,798			78,256,417			100,485,329			73,740,318

See notes to consolidated financial statements.

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Avanir Pharmaceuticals

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

	Nine Months Ended June 30,
	2005			2004
OPERATING ACTIVITIES:
Net loss	$	(29,347,080	)	$	(19,588,261	)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization		1,547,279			1,198,306
Compensation paid with stock options		8,103			32,170
Expense for issuance of common stock in connection with the acquisition of additional contractual rights to Neurodex™ (Note 12)		5,300,000			—
Other-than-temporary impairment of investment		84,252			—
Loss on disposal of assets		3,085			—
Intangible assets abandoned		234,232			—
Changes in operating assets and liabilities:
Receivables		116,538			51,686
Inventory		(352,077	)		201,552
Prepaid expenses and other assets		(467,365	)		534,981
Accounts payable		990,155			(616,513	)
Accrued expenses and other liabilities		1,126,957			1,269,157
Accrued compensation and payroll taxes		380,831			(4,445	)
Deferred revenue		(1,484,051	)		(1,281,145	)
Net cash used for operating activities		(21,859,141	)		(18,202,512	)
INVESTING ACTIVITIES:
Investments in securities		(18,438,209	)		(8,116,389	)
Proceeds from sales and maturities of investments in securities		7,830,113			700,000
Patent costs		(918,735	)		(873,111	)
Proceeds from sale of equipment		800			—
Purchases of property and equipment		(662,548	)		(89,780	)
Net cash used for investing activities		(12,188,579	)		(8,379,280	)
FINANCING ACTIVITIES:
Proceeds from issuance of common stock and warrants, net		24,255,141			34,406,139
Proceeds from issuance of notes payable		249,472			159,918
Payments on notes and capital lease obligations		(374,127	)		(474,193	)
Net cash provided by financing activities		24,130,486			34,091,864
Net (decrease) increase in cash and cash equivalents		(9,917,234	)		7,510,072
Cash and cash equivalents at beginning of period		13,494,083			12,198,408
Cash and cash equivalents at end of period	$	3,576,849		$	19,708,480
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid	$	69,458		$	28,233
Income taxes paid	$	1,912		$	2,368
NONCASH INVESTING ACTIVITIES:
Purchases of property and equipment which are included in accounts payable and accrued expenses	$	201,112		$	—

See notes to consolidated financial statements.

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Avanir Pharmaceuticals

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION

Avanir Pharmaceuticals (“Avanir,” “we,” or the “Company”) has prepared the unaudited condensed consolidated financial statements in this quarterly report in accordance with the instructions to Form 10-Q adopted under the Securities Exchange Act of 1934. Certain information and note disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. These unaudited condensed consolidated financial statements should be read with our audited consolidated financial statements and the accompanying notes included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2004. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary to present a fair statement of our financial position as of June 30, 2005 and September 30, 2004, and the results of operations for the three-month and nine-month periods ended June 30, 2005 and 2004, have been made. Operating results for the interim periods are not necessarily indicative of operating results for the entire fiscal year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and the disclosure of contingent amounts in the financial statements and accompanying notes. Actual results could differ from those estimates. Certain prior year amounts have been reclassified to conform to the current year presentation.

The unaudited condensed consolidated financial statements include the accounts of Avanir Pharmaceuticals and its wholly-owned subsidiaries, Xenerex Biosciences and Avanir Holding Company. All intercompany accounts and transactions have been eliminated.

2. STOCK-BASED COMPENSATION

In December 2004, the Financial Accounting Standards Board (“FASB”) revised Statement of Financial Accounting Standards No. 123 (“FAS 123R”), “Share-Based Payment.” FAS 123R will require us to measure the cost of all employee stock-based compensation awards based on the grant date fair value of those awards and to record that cost as compensation expense over the period during which the employee is required to perform service in exchange for the award (generally over the vesting period of the award). Excess tax benefits, as defined by FAS 123R, will be recognized as an addition to common stock. On April 14, 2005, the U.S. Securities and Exchange Commission (“SEC”) adopted a new rule amending the compliance dates for FAS 123R. In accordance with the new rule, the accounting provisions of FAS 123R will be effective for us in the fiscal year starting October 1, 2005. The SEC also issued Staff Accounting Bulleting No. 107 (“SAB 107”), which provides interpretive guidance to assist issuers in their initial implementation of FAS 123R. We are currently evaluating the effect of FAS 123R on our financial condition and results of operations.

Until FAS 123R becomes effective, we have chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in APB Opinion No. 25 and related interpretations for all periods presented. Accordingly, compensation costs for stock options granted to employees are measured as the excess, if any, of the fair value of our common stock at the date of the grant over the amount the employee must pay to acquire the stock. For the purpose of determining compensation expense for stock options granted to non-employees, all of our directors are considered to be employees.

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The following table summarizes the pro forma effect on our net loss if compensation costs had been determined based upon the fair value at the grant date for awards under the stock option plans consistent with the methodology prescribed under FAS 123.

	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2005			2004			2005			2004
Net loss, as reported	$	(8,207,544	)	$	(6,617,493	)	$	(29,347,080	)	$	(19,588,261	)
Add: Stock-based employee compensation expense		—			—			—			24,069
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(703,263	)		(258,127	)		(1,419,193	)		(832,626	)
Pro forma net loss	$	(8,910,807	)	$	(6,875,620	)	$	(30,766,273	)	$	(20,396,818	)
Net loss per share:
Basic and diluted – as reported	$	(0.08	)	$	(0.08	)	$	(0.29	)	$	(0.27	)
Basic and diluted – pro forma	$	(0.08	)	$	(0.09	)	$	(0.31	)	$	(0.28	)

We account for stock options granted to non-employees in accordance with Emerging Issues Task Force No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” (“EITF 96-18”). Under EITF 96-18, we determine the fair value of the stock options granted as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.

3. BALANCE SHEET DETAILS

The following tables provide details of selected balance sheet items.

Receivables, net. Receivables as of June 30, 2005 and September 30, 2004 consist of the following:

	June 30,			September 30,
	2005			2004
Total receivables	$	146,140		$	257,379
Allowance for doubtful accounts		(22,799	)		(17,500	)
Receivables, net	$	123,341		$	239,879

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     Property and equipment, net. Property and equipment consist of the following:

	June 30, 2005							September 30, 2004
	Gross							Gross
	Carrying		Accumulated					Carrying		Accumulated
	Value		Depreciation			Net		Value		Depreciation			Net
Research and development equipment	$	4,020,668	$	(2,558,291	)	$	1,462,377	$	3,701,461	$	(2,021,193	)	$	1,680,268
Computer equipment and related software		1,107,794		(661,677	)		446,117		999,073		(545,953	)		453,120
Leasehold improvements		5,034,679		(1,500,667	)		3,534,012		5,032,605		(1,048,184	)		3,984,421
Construction in progress		354,712		—			354,712		—		—			—
Office equipment, furniture, and fixtures		607,150		(353,186	)		253,964		558,970		(285,815	)		273,155
Total property and equipment	$	11,125,003	$	(5,073,821	)	$	6,051,182	$	10,292,109	$	(3,901,145	)	$	6,390,964

Depreciation expense related to property and equipment for the three-month and nine-month periods ended June 30, 2005 was approximately $393,000 and $1,200,000, respectively, as compared to $380,000 and $1,137,000 for the three-month and nine-month periods ended June 30, 2004, respectively.

Intangible assets. We account for intangible assets in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“FAS 142”). In accordance with FAS 142, goodwill and other intangible assets that have indefinite useful lives are not amortized; however, these assets must be reviewed at least annually for impairment. Intangible assets with finite lives are to be amortized over their useful lives and are evaluated for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable under FAS No. 144, “Accounting for Impairment or Disposal of Long-lived Assets.” If the review indicates that long-lived assets are not recoverable (i.e. the carrying amount is less than the future projected undiscounted cash flows), then their carrying value would be reduced to fair value.

Intangible assets with indefinite useful lives consist of costs of trademarks for Avanir™ and Xenerex™ and similar names.

Intangible assets with finite useful lives consist of capitalized legal costs incurred in connection with patents, patent applications pending, trademark applications and license agreements. We amortize costs of approved patents, patent applications pending, and license agreements over their useful lives, or terms of the agreements, whichever are shorter. For patents pending, we amortize the costs over the shorter of a period of twenty years from the date of filing the application or, if licensed, the term of the license agreement. For patent and trademark applications that we abandon, we charge the remaining unamortized accumulated costs to research and development expense.

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Intangible assets, consisting of both intangible assets with finite and indefinite useful lives as of June 30, 2005 and September 30, 2004, are as follows:

	June 30, 2005							September 30, 2004
	Gross							Gross
	Carrying		Accumulated					Carrying		Accumulated
	Value		Amortization			Net		Value		Amortization			Net
Intangible assets with finite lives:
Patent applications pending (1)	$	2,891,401	$	(336,485	)	$	2,554,916	$	2,462,704	$	(166,000	)	$	2,296,704
Patents (2)		1,245,508		(467,603	)		777,905		1,010,097		(339,552	)		670,545
Licenses		42,461		(17,339	)		25,122		42,461		(15,647	)		26,814
Total intangible assets with finite lives		4,179,370		(821,427	)		3,357,943		3,515,262		(521,199	)		2,994,063
Intangible assets with indefinite useful lives (3)		23,798		—			23,798		40,961		—			40,961
Total intangible assets	$	4,203,168	$	(821,427	)	$	3,381,741	$	3,556,223	$	(521,199	)	$	3,035,024

(1)	Patent applications pending include the net effect of $37,491 and $207,819 (net of accumulated amortization of $3,568 and $21,889) in intangible assets abandoned during the three-month and nine-month periods ended June 30, 2005, respectively. We abandoned certain therapeutic use patents pending in selected countries, because we were able to obtain superior claims in composition-of-matter patents.
(2)	Patents include the net effect of $0 and $2,944 (net of accumulated amortization of $0 and $68) in intangible assets abandoned during the three-month and nine-month periods ended June 30, 2005, respectively.
(3)	Intangible assets with indefinite useful lives include the net effect of $14,301 and $23,469 in trademarks abandoned during the three-month and nine-month periods ended June 30, 2005, respectively.

Amortization expense related to amortizable intangible assets for the three-month and nine–month periods ended June 30, 2005 was approximately $235,000 and $338,000, respectively, as compared to $24,000 and $62,000 for the three-month and nine-month periods ended June 30, 2004, respectively. Based solely on the amortizable intangible assets as of June 30, 2005, the estimated annual amortization expense of intangible assets for the fiscal years ending September 30 is shown in the following table. Actual amortization expense to be reported in future periods could differ from these estimates as a result of acquisitions, divestitures, and other relevant factors.

Amortization Expense
Fiscal year ending September 30:
2005 (remaining three months)	$	57,000
2006		228,000
2007		229,000
2008		228,000
2009		226,000
Thereafter		2,390,000
Total	$	3,358,000

4. INVENTORY

Inventory is stated at the lower of cost (first-in, first-out) or market. Inventory consists of the raw material docosanol, which is the active pharmaceutical ingredient in docosanol 10% cream. Docosanol in its present form as stored by us has a substantial shelf life, a relatively stable value and long-term use, and carries a low risk of becoming excess inventory or obsolete. We do not own or store any docosanol 10% cream in its finished product form. We and one of our licensees receive docosanol from a single supplier. We also supply several of our licensees with docosanol from the same supplier. Inventory is $361,379 as of June 30, 2005, of which $355,179 is in excess of management’s estimated 12-month usage and, accordingly, being classified as long-term.

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5. DEFERRED REVENUE

We have license agreements with additional or continuing obligations to perform under the agreements. In such arrangements, certain revenues have been deferred until the performance obligations have been met or ratably achieved (see also Note 6, “Revenue Recognition”). In December 2002, we sold to Drug Royalty USA, Inc. (“Drug Royalty USA”) an undivided interest in our rights to receive future Abreva® royalties under the license agreement with GlaxoSmithKline subsidiary, SB Pharmco Puerto Rico (“GlaxoSmithKline”), for $24.1 million (the “Drug Royalty USA Agreement” and “GlaxoSmithKline License Agreement”, respectively). Under the Drug Royalty USA Agreement, Drug Royalty USA has the right to receive royalties from GlaxoSmithKline on sales of Abreva until the later of December 2013 or the date of expiration of a certain Abreva patent in accordance with the GlaxoSmithKline License Agreement.

The terms of the Drug Royalty USA Agreement contain certain covenants under which we must perform in order to satisfy the continuing terms and conditions of the arrangement. In certain circumstances, nonperformance on our part could result in default of the arrangement, and could trigger a separate security agreement with Drug Royalty USA, which could result in loss of our rights to share in future Abreva royalties if wholesale sales by GlaxoSmithKline exceed $62 million in a year. The nature of these terms and covenants results in our continuing involvement and, accordingly, we recorded the net proceeds of the transaction as deferred revenue, to be recognized as revenue ratably over the expected life of the license agreement.

The following table sets forth as of June 30, 2005 the deferred revenue balances for the Drug Royalty USA Agreement and other agreements. The portion of deferred revenue classified as a current liability represents the amount Avanir expects to realize as revenue within the next 12 months.

	Drug Royalty			Other
	USA Agreement			Agreements			Total
Deferred revenue as of September 30, 2004	$	20,800,782		$	208,333		$	21,009,115
Changes during the period:
Recognized as revenue during period		(1,384,051	)		(100,000	)		(1,484,051	)
Deferred revenue as of June 30, 2005	$	19,416,731		$	108,333		$	19,525,064
Classified and reported as:
Current portion of deferred revenue	$	1,943,538		$	33,333		$	1,976,871
Deferred revenue, net of current portion		17,473,193			75,000			17,548,193
Total deferred revenue	$	19,416,731		$	108,333		$	19,525,064

6. REVENUE RECOGNITION

We recognize revenue in accordance with SEC Staff Accounting Bulletin Topic 13, “Revenue Recognition” and Emerging Issues Task Force No. 00-21 (“EITF 00-21”), “Accounting for Revenue Arrangements with Multiple Deliverables.” Revenue is recognized when the four basic criteria of revenue recognition are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed or determinable; and (4) collectibility is reasonably assured.

Contract Revenue from Collaborations. Collaborative arrangements typically consist of non-refundable and/or exclusive technology access fees, reimbursements for specific costs of research and development, and various milestone and product royalty payments. If the delivered technology does not have standalone value or if we do not have objective or reliable evidence of the fair value of the undelivered component, the amount of revenue allocable to the delivered technology is deferred. Nonrefundable, up-front license or technology access fees with standalone value that are not dependent on any future performance by us under the arrangements are recognized as revenue upon the earlier of when payments

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are received or collection is assured, but are deferred if we have continuing performance obligations. If we have continuing involvement through research and development collaborations or other contractual obligations, such up-front fees are deferred and recognized over the collaboration period or the period for which we continue to have a performance obligation, unless all of the following criteria exist: (1) the collaboration or contractual obligations have standalone value to the customer, (2) there is objective and reliable evidence of the fair value of the undelivered item(s), and (3) there is no general right to return the delivered item(s). Payments related to substantive, performance-based milestones are recognized as revenue upon the achievement of the milestones as specified in the underlying agreements, which represent the culmination of the earnings process. Revenue from research services is recognized during the period in which the services are performed and is based upon the number of full time equivalent (“FTE”) personnel working on the specific project at the agreed-upon rate. Payments received in advance are recorded as deferred revenue until the technology is transferred, services are performed, costs are incurred, or milestone is reached.

Royalty revenues. We recognize royalty revenues from licensed products when earned in accordance with the terms of the license agreements. Net sales figures used for calculating royalties include deductions for costs of unsaleable returns, managed care chargebacks, cash discounts, freight and warehousing, and miscellaneous write-offs, which may vary over the course of the license agreement.

Revenues from sale of royalty rights. In agreements where we have sold our rights to future royalties under license agreements and we maintain continuing involvement in earning such royalties, we defer revenues and recognize them over the life of the license agreement. For example, in the sale of an undivided interest of our Abreva® license agreement to Drug Royalty USA, revenue recognition is being determined under the units-of-revenue method. Under this method, the amount of deferred revenue to be recognized as revenue in each period is calculated by multiplying (i) the ratio of the royalty payments due to Drug Royalty USA for the period to the total remaining royalties that we expect GlaxoSmithKline will pay Drug Royalty USA over the term of the agreement, by (ii) the unamortized deferred revenue amount.

Revenue arrangements with multiple deliverables. We have revenue arrangements whereby we are obligated to deliver to the customer multiple products and/or services (multiple deliverables). Such arrangements may include antibody generation services agreements and other forms of research collaborations. In accordance with EITF 00-21, we analyze our multiple element arrangements to determine whether the elements can be separated and accounted for individually as separate units of accounting. The evaluation is performed at the inception of the arrangement. The delivered item(s) is considered a separate unit of accounting if all of the following criteria are met: (a) the delivered item(s) has value to the customer on a standalone basis; (b) there is objective and reliable evidence of the fair value of the undelivered item(s); and (c) if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially in our control.

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

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Product sales – Active Pharmaceutical Ingredient Docosanol. Revenue from product sales, which consist of sales of our active pharmaceutical ingredient docosanol, is recorded when the above criteria are met, generally when title and risk of loss have passed to the buyer upon delivery. We sell the active pharmaceutical ingredient docosanol to various licensees and ship only on written order for the materials. Total shipments generally occur fewer than five times a year. Our contracts for sales of the active pharmaceutical ingredient docosanol include buyer acceptance provisions that give our buyers the right of replacement if the delivered materials do not meet specified criteria, by giving notice within 30 days after receipt of such defective materials, and we have the option to refund or replace such defective materials. However, we have historically demonstrated that the materials shipped from the same pre-inspected lot have consistently met the specified criteria and no buyer has rejected any of our shipments from the same pre-inspected lot. Therefore, we recognize revenue from sales of the active pharmaceutical ingredient docosanol without providing for such contingency upon shipment.

7. INVESTMENTS

Investments are comprised of marketable securities consisting primarily of certificates of deposit, federal, state and municipal government obligations, and corporate bonds. All marketable securities are held in our name and primarily under the custodianship of two major financial institutions. Our policy is to protect the principal value of our investment portfolio and minimize principal risk. Short-term investments are marketable securities with maturities of less than one year from the balance sheet date.

Statement of Financial Accounting Standards No. 115 (“FAS 115”), “Accounting for Certain Investments in Debt and Equity Securities,” addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. Those investments are to be classified in three categories and accounted for as follows:

• Debt securities that we have the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost.

• Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in our Consolidated Statement of Operations.

• Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from the Consolidated Statement of Operations and reported in a separate component of shareholders’ equity.

FAS 115 also requires companies to determine whether a decline in fair value below the amortized cost basis is other-than-temporary. If a decline in fair value is determined to be other-than-temporary, FAS 115 requires the carrying value of the debt or equity security to be permanently written down to its fair value. In making an evaluation of whether or not an investment is impaired, we applied the effective paragraphs of EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” In evaluating whether or not the impairment is other-than-temporary, we consider the duration and severity of the impairment, as well as the intent and ability to hold the investment until recovery, among other factors.

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The following tables summarize our investments in securities, all of which are classified as available-for-sale except for restricted investments, which are classified as held-to-maturity.

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains (1)		Losses (1)			Value
As of June 30, 2005:
Certificates of deposit	$	956,872	$	255	$	—		$	957,127
Government debt securities		22,063,792		—		(131,227	)		21,932,565
Total	$	23,020,664	$	255	$	(131,227	)	$	22,889,692
Classified and reported as:
Short term investments:
Classified as available-for-sale	$	18,166,125
Long term investments:
Classified as available-for-sale		3,866,695
Restricted investments in securities (3)		856,872
Long-term investments		4,723,567
Total	$	22,889,692

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains (4)		Losses (4)			Value
As of September 30, 2004:
Certificates of deposit	$	1,356,597	$	3,558	$	—		$	1,360,155
Adjustable rate mutual fund (2)		3,014,365		—		(68,650	)		2,945,715
Government debt securities		8,125,858		6,186		(25,468	)		8,106,576
Total	$	12,496,820	$	9,744	$	(94,118	)	$	12,412,446
Classified and reported as:
Short term investments:
Classified as available-for-sale	$	8,803,982
Long term investments:
Classified as available-for-sale		2,751,867
Restricted investments in securities (3)		856,597
Long-term investments		3,608,464
Total	$	12,412,446

(1)	Gross unrealized gains of $255 on certificates of deposit and gross unrealized losses of $131,227 on government debt securities represent an accumulated net unrealized loss of $130,972, which is reported as “accumulated other comprehensive loss” on the consolidated balance sheet as of June 30, 2005.
(2)	Represents an investment in a mutual fund that invested primarily in adjustable rate mortgage-backed securities. We sold the investment in February 2005.
(3)	Represents amounts pledged to our bank as collateral for letters of credit issued in connection with our leases of office and laboratory space.
(4)	Gross unrealized gains of $9,744 and gross unrealized losses of $94,118 on government securities, the adjustable rate mutual fund, and certificates of deposit represent an accumulated net unrealized loss of $84,374, which is reported as “accumulated other comprehensive loss” on the consolidated balance sheet as of September 30, 2004.

8. COMPUTATION OF NET LOSS PER COMMON SHARE

Basic net (loss) earnings per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period (“Basic EPS Method”). Diluted net (loss) earnings per common share is computed by dividing net loss by the weighted-average number of common and dilutive common equivalent shares outstanding during the period (“Diluted EPS Method”). In the loss periods, the shares of common stock issuable upon exercise of stock options and warrants are excluded from the computation of diluted net loss per share, as their effect is anti-dilutive. For the three-month and nine-month periods ended June 30, 2005 and 2004, options to purchase 5,921,897 and 5,264,246 shares of common stock, respectively, were excluded from the computation of diluted net loss

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per share. For the three-month and nine-month periods ended June 30, 2005 and 2004, warrants to purchase 4,488,211 and 5,442,911 shares of common stock, respectively, were excluded from the computation of diluted net loss per share.

9. COMPREHENSIVE LOSS

Comprehensive loss consists of the following:

	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2005			2004			2005			2004
Net loss	$	(8,207,544	)	$	(6,617,493	)	$	(29,347,080	)	$	(19,588,261	)
Other comprehensive loss, net of tax:
Unrealized gain (loss) on available-for-sale securities		(46,069	)		(74,781	)		(46,598	)		(105,542	)
Total comprehensive loss	$	(8,253,613	)	$	(6,692,274	)	$	(29,393,678	)	$	(19,693,803	)

10. SHAREHOLDERS’ EQUITY

Preferred stock. Preferred stock consists of Series C Junior Participating Preferred Stock, of which none is outstanding.

Class A common stock. In December 2004, we issued and sold to CDIB Capital Investment America Ltd., a wholly-owned subsidiary of China Development Industrial Bank, Inc., 2,333,333 shares of Class A common stock at a price of $3.00 per share, for aggregate offering proceeds of approximately $7 million. The offering was made pursuant to our shelf registration statement on Form S-3, filed with the SEC on April 9, 2004.

In March 2005, we issued 2,000,000 shares of Class A common stock, with a fair value of $5.3 million, to IriSys, Inc. (“IriSys”) in connection with the acquisition of additional contractual rights to Neurodex™, our late-stage drug candidate for the treatment of multiple central nervous system disorders. We valued these shares at $2.65 per share, based on the 5-day average closing price of our common stock, beginning two days before and ending two days after the close and announcement of the agreement on March 9, 2005. See Note 12, “Related Party Transactions,” for further discussions.

In April 2005, we issued and sold 7,770,000 shares of Class A common stock in a registered direct offering at a price of $2.20 per share, for aggregate offering proceeds of approximately $17.1 million and net offering proceeds of approximately $15.9 million, after deducting commissions and offering fees and expenses. The offering was made pursuant to our shelf registration statement on Form S-3, filed with the SEC on April 9, 2004.

During the three-month period ended June 30, 2005, we also issued an aggregate of 788,463 shares of Class A common stock in connection with the exercise of a Class G stock purchase warrant (757,050 shares at an exercise price of $1.45) and employee stock options (31,413 shares at an average exercise price of $1.19) for cash in the aggregate amount of approximately $1,135,174.

As of June 30, 2005 and 2004, warrants to purchase 4,488,211 and 5,442,911 shares of Class A common stock, respectively, at a weighted-average price per share of $1.89 and $1.83, respectively, remained outstanding, of which all are exercisable. As of June 30, 2005 and 2004, options to purchase 5,921,897 and 5,264,246 shares of Class A common stock, respectively, at a weighted-average price per share of $2.13 and $1.95, respectively, remained outstanding. 5,089,811 and 4,563,567 options are exercisable at June 30, 2005 and 2004, respectively.

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11. COLLABORATIVE AGREEMENT

On April 27, 2005, we entered into a research, development and commercialization agreement with Novartis International Pharmaceutical Ltd. (“Novartis”) for orally active small molecule therapeutics utilizing our novel macrophage migration inhibitory factor (“MIF”) technology as a potential treatment for inflammatory diseases. Under the terms of the agreement, we will be eligible to receive royalty payments assuming the product is successfully developed and approved for marketing by the U.S. Food and Drug Administration (“FDA”). In addition to ongoing royalty payments (that could be significant in the case of a successful drug as royalty is in the order of a high single digit to low double digit rate as a percentage of product revenue), we are also eligible to receive up to $169 million in milestone payments. These milestone payments are contingent upon achievement of certain development and regulatory milestones, which could take several years of further development, and on achievement of certain sales targets, if and when approved for marketing by the FDA. We received an up-front payment of $2.5 million in May 2005 for the license fee and transfer of data and know-how of the MIF technology to Novartis. We will also receive research funding of between $1.5 million and $2.5 million per year for providing contract development services to Novartis for two years from the date of the agreement or longer, upon mutual agreement of the parties. While both parties to the agreement will contribute expertise and intellectual property to the research and development collaboration, Novartis assumes responsibility for all pre-clinical and clinical expenses and an obligation to pursue the commercialization of the MIF technology to the degree feasible.

In accordance with EITF 00-21, we determined that the license fee and contract development services are separate units of accounting, because the license has value to Novartis on a standalone basis, there is objective and reliable evidence of the fair value of the undelivered research collaboration services and there is no right of return or refund relative to the license. We determined that the license fee has a standalone value because similar technology is sold separately by other vendors and Novartis has the ability to sell or transfer the license. Revenue from research services is recognized during the period in which the services are performed and is based upon the number of FTE personnel working on the project at the agreed-upon rates. Payments related to substantive, performance-based milestones are recognized as revenue upon the achievement of the milestones as specified in the agreement.

As of June 30, 2005, we have delivered the license and therefore, we recognized the $2.5 million up-front payment as revenue in the three-month and nine-month periods ended June 30, 2005. In addition, we have recorded research contract revenue of approximately $263,000 based on the number of full time equivalent employees that worked directly on the project at the agreed upon compensation rates in the three-month and nine-month periods ended June 30, 2005.

12. RELATED PARTY TRANSACTIONS

In March 2005, our wholly owned subsidiary, Avanir Holding Company, acquired certain contract rights to Neurodex™ from IriSys, Inc. At the time of that transaction, IriSys was an affiliate of Gerald J. Yakatan, Ph.D., our then current president and chief executive officer. Dr. Yakatan was also a member of our board of directors. For these rights to Neurodex, we paid IriSys total consideration of $7,225,000, which was comprised of $1,925,000 in cash and 2,000,000 shares of our Class A common stock with a fair value of $5,300,000. The fair value of the common stock was calculated at $2.65 per share using the 5-day average closing price of our common stock, beginning two days before and ending two days after the close and announcement of the agreement on March 9, 2005. Because of the uncertainty of receiving future economic benefits from the acquired contractual rights, particularly given that Neurodex had not been approved by the FDA for commercialization at the time of this transaction, the purchase price was immediately charged to research and development expense in accordance with United States generally accepted accounting principles.

In May 2005, Dr. Yakatan resigned as our president and chief executive officer and director. In connection with Dr. Yakatan’s resignation, we agreed to pay him severance payments in the aggregate amount of approximately $496,000, which included health benefits for a period of 12 months. We also agreed to pay him a bonus of $88,000 for fiscal 2005 which was paid in full as of June 30, 2005. The severance payment obligations were expensed during the quarter ended June 30, 2005 and are being paid in 26 installments over the period of one year from May 16, 2005. The balance of accrued but unpaid severance payment obligations for Dr. Yakatan is approximately $448,000 as of June 30, 2005. Dr. Yakatan has been retained by Avanir as a consultant at an agreed-upon hourly rate until May 15, 2006 to help advise us on FDA regulatory matters, if needed, with regard to our new drug application for Neurodex. Additionally, the

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vesting of options to purchase 227,580 shares of Class A common stock, held by Dr. Yakatan as of the resignation date, was accelerated to become immediately vested. According to the terms under which the options were granted, the grantee does not forfeit the options upon termination as an employee if the grantee continues to provide services as a consultant. No compensation charge has been recorded in the three-month and nine-month periods ended June 30, 2005 for the accelerated vesting, because the acceleration did not result in any of the in-the-money options vesting that otherwise would have expired unvested at the conclusion of the consulting agreement.

13. RECENT ACCOUNTING PRONOUNCEMENTS

In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151 (“FAS 151”), “Inventory Costs, an Amendment of ARB No. 43, Chapter 4,” that is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. FAS 151 requires that abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage), as well as unallocated overhead, be recognized as current period charges. We do not expect the adoption of FAS 151 to significantly affect our financial condition or results of operations.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (“FAS 154”), “Accounting Changes and Error Corrections.” FAS 154 establishes retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. FAS 154 also provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. FAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We do not expect the adoption of FAS 154 to significantly affect our financial condition or results of operations.

14. COMMITMENTS AND CONTINGENCIES

In the ordinary course of business, we may face various claims brought by third parties, including claims relating to the safety or efficacy of our products. Any of these claims could subject us to costly litigation and, while we generally believe that we have adequate insurance to cover many different types of liabilities, our insurance carriers may deny coverage or our policy limits may be inadequate to fully satisfy any damage awards or settlements. If this were to happen, the payment of any such awards could have a material adverse effect on our operations and financial position. Additionally, any such claims, whether or not successful, could damage our reputation and business. Management believes the outcome of currently identified claims and lawsuits will not have a material adverse effect on our operations or financial position.

15. SEGMENT INFORMATION

We operate in one segment, which is the business of discovery, development and commercialization of novel therapeutics for chronic diseases. Our chief operating decision-makers review our operating results on an aggregate basis and manage our operations as a single operating segment. We have developed one commercial product, docosanol 10% cream, known as Abreva® in the United States, and we have several other product candidates in various stages of development. We have licensed docosanol 10% cream to other companies that market the product and provide us royalties on product sales.

16. SUBSEQUENT EVENTS

On July 8, 2005, we entered into an exclusive licensing and research collaboration agreement with AstraZeneca PLC (“AstraZeneca”) to discover, develop and commercialize reverse cholesterol transport enhancing compounds for the treatment of cardiovascular disease. Under the terms of the agreement, we will be eligible to receive royalty payments, assuming the product is successfully developed and approved

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for marketing by the FDA. In addition to ongoing royalty payments (that could be significant in the case of a successful drug as royalty is in the order of a high single digit to low double digit rate as a percentage of product revenue), we are also eligible to receive up to $330 million in milestone payments. These milestone payments are contingent upon achievement of certain development and regulatory milestones, which could take several years of further development, and on achievement of certain sales targets, if and when approved for marketing by the FDA. Under this agreement, we received an up-front payment of $10 million on July 22, 2005 and will also receive research funding of between $2.5 million to $3.8 million per year for providing contract development services to AstraZeneca for three years. AstraZeneca will assume responsibility for overall development and for the development costs, with both parties contributing scientific expertise in the research collaboration.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q contains forward-looking statements concerning future events and performance of the Company. When used in this report, the words “intend,” “estimate,” “anticipate,” “believe,” “plan” or “expect” and similar expressions are included to identify forward-looking statements. These forward-looking statements are based on our current expectations and assumptions and many factors could cause our actual results to differ materially from those indicated in these forward-looking statements. You should review carefully the factors identified in this report under the caption, “Risk Factors” and in our most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission. We disclaim any obligation to update or announce revisions to any forward-looking statements to reflect actual events or developments. Except as otherwise indicated herein, all dates referred to in this report represent periods or dates fixed with reference to the calendar year, rather than our fiscal year ending September 30. The three-month and nine-month periods ended June 30, 2005, may also be referred to as the third quarter and first nine months, respectively, of fiscal 2005.

EXECUTIVE OVERVIEW

Avanir Pharmaceuticals is a pharmaceutical company focused on developing and commercializing novel therapeutic products for the treatment of chronic diseases. Our product candidates address therapeutic markets that include the central nervous system, atherosclerosis, inflammatory diseases and infectious diseases. Our first commercialized product, Abreva®, is marketed in North America by GlaxoSmithKline Consumer Healthcare and is one of the leading over-the-counter products for the treatment of cold sores. We recently submitted to the U.S. Food and Drug Administration (“FDA”) the final reviewable unit of our “rolling” new drug application (“NDA”) for Neurodex™ for the treatment of pseudobulbar affect. Additionally, we have initiated a Phase III clinical trial of Neurodex in patients with diabetic neuropathic pain.

We have licensed to Novartis International Pharmaceutical Ltd. our research and development program that targets macrophage migration inhibitory factor (“MIF”) as a potential treatment for inflammatory diseases. Also, we have licensed to AstraZeneca PLC our research and development program to discover, develop and commercialize reverse cholesterol transport (“RCT”) enhancing compounds for the treatment of cardiovascular disease. We also have a research and development program that targets immunoglobulin epsilon (“IgE”) as a potential treatment of inflammatory disorders such as asthma and other related diseases. Using our proprietary Xenerex™ technology, we are also conducting research to develop injectable human monoclonal antibody products for anthrax, cytomegalovirus, and other infectious diseases.

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The following chart illustrates the approximate status of research activities for our products, product candidates, and licensed technologies that are under development.

We strive to maintain a lean organizational structure while working on a diverse product development pipeline. We also strive to maintain flexibility in our cost structure by actively managing outsourced functions such as clinical trials, legal counsel, documentation and testing of internal controls, and portions of chemistry, rather than maintaining all of these functions in house. We believe the benefits of outsourcing, being flexible and being able to rapidly respond to program delays or successes far outweigh the higher costs often associated with outsourcing.

If Neurodex is assigned a priority review and approved by the FDA by the end of 2005, we plan to begin marketing and selling the product in the first half of 2006. Accordingly, we are in the process of transforming from a research and development organization into a commercially viable pharmaceutical company. In order to facilitate that transformation, we are investing in our infrastructure to support the planned commercial launch of Neurodex if it is approved by the FDA. In preparation for the commercial launch of Neurodex, we are in the process of developing our sales and marketing strategy and are recruiting sales and marketing personnel for key positions within the organization. We continue to evaluate the potential benefits of a co-promotion for Neurodex. The goal of a co-promotion arrangement would be to reach a broader target audience of physicians as well as to offset some of the previous and future development expenses associated with Neurodex.

In March 2005, we entered into an asset purchase agreement, pursuant to which our wholly owned subsidiary, Avanir Holding Company, acquired from IriSys, Inc. certain additional contractual rights to Neurodex. As a result, through our subsidiary we hold the exclusive worldwide marketing rights to Neurodex for five indications under a royalty-bearing license with the owner of the underlying technology, The Center for Neurologic Study. Going forward, we will be obligated, if we achieve certain contingent events, to pay CNS milestone payments, a patent royalty on product sales, and a share of

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revenues received if we sublicense Neurodex™ to a third party. We have no future financial obligation to IriSys. In the transaction, IriSys was paid $1,925,000 in cash and received 2,000,000 shares of our Class A common stock.

In April 2005, we entered into a research, development and commercialization agreement with Novartis International Pharmaceutical Ltd. for orally active small molecule therapeutics utilizing our novel MIF technology as a potential treatment for inflammatory diseases. Under the terms of the agreement, we will be eligible to receive royalty payments assuming the product is successfully developed and approved for marketing by the FDA. In addition to ongoing royalty payments (that could be significant in the case of a successful drug as royalty is in the order of a high single digit to low double digit rate as a percentage of product revenue), we are also eligible to receive up to $169 million in milestone payments. These milestone payments are contingent upon achievement of certain development and regulatory milestones, which could take several years of further development, and on achievement of certain sales targets, if and when approved for marketing by the FDA. We received an up-front payment of $2.5 million in May 2005 and will also receive research funding of between $1.5 million and $2.5 million per year for providing contract development services to Novartis for two years from the date of the agreement or longer, upon mutual agreement of the parties. While both parties to the agreement will contribute expertise and intellectual property to the research and development collaboration, Novartis assumes responsibility for all pre-clinical and clinical expenses and an obligation to pursue the commercialization of the MIF technology to the degree feasible.

Subsequent to the end of the third quarter of fiscal 2005, we entered into an exclusive licensing and research collaboration agreement with AstraZeneca PLC in July 2005 to discover, develop and commercialize RCT enhancing compounds for the treatment of cardiovascular disease. Under the terms of the agreement, we will be eligible to receive royalty payments, assuming the product is successfully developed and approved for marketing by the FDA. In addition to ongoing royalty payments (that could be significant in the case of a successful drug as royalty is in the order of a high single digit to low double digit rate as a percentage of product revenue), we are also eligible to receive up to $330 million in milestone payments. These milestone payments are contingent upon achievement of certain development and regulatory milestones, which could take several years of further development, and on achievement of certain sales targets, if and when approved for marketing by the FDA. Under the terms of the agreement, we received an upfront payment of $10 million on July 22, 2005 and will also receive research funding of between $2.5 million and $3.8 million per year for providing contract development services to AstraZeneca for three years. AstraZeneca has the responsibility for the overall development and for development costs, with both parties contributing scientific expertise in the research collaboration.

We intend to continue to seek partnerships with pharmaceutical companies to help fund other research and development programs in exchange for sharing in the rights to commercialize new drugs. In addition to the MIF development and the RCT development, we have licensed certain rights to docosanol 10% cream. We may also seek to develop other drug candidates through research collaborations with larger pharmaceutical companies, allowing us to share the risks and the opportunities that come from such development efforts.

We expect that our selling, marketing, development and other operational costs will continue to exceed revenues from existing sources through at least fiscal 2006. Trends in revenues and various types of expenses are discussed further in the “Results of Operations.” We expect that we will have to raise additional capital to prepare for and execute a product launch of Neurodex for PBA, if approved by the FDA for marketing, and to fund our ongoing clinical trials for Neurodex for neuropathic pain, as well as selected research and other operating activities. Our future capital needs will depend substantially on our ability to reach predetermined milestones under our existing collaboration agreements, as well as the economic terms and the timing of any new partnership or collaborative arrangements with pharmaceutical companies under which they will share the costs of such activities. If we are unable to raise capital as needed to fund our operations, or if we are unable to reach these milestones or enter into any such collaborative arrangements, then we may need to slow the rate of development of some of our programs or sell the rights to one or more of our drug candidates, and our commercialization plans for Neurodex

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may be adversely affected. For additional information about the risks and uncertainties that may affect our business and prospects, please see “Risk Factors.”

Our offices and research facilities are located at 11388 Sorrento Valley Road, San Diego, California 92121. Our telephone number is (858) 622-5200 and our e-mail address is info@avanir.com. Additional information about Avanir can be found on our website, at www.avanir.com, and in our periodic and current reports filed with the Securities and Exchange Commission (“SEC”). Copies of our current and periodic reports filed with the SEC are available at the SEC Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549, and online at www.sec.gov and our website at www.avanir.com.

RESULTS OF OPERATIONS

COMPARISON OF THREE MONTHS ENDED JUNE 30, 2005 AND 2004

Revenues

Revenues for the third quarter of fiscal 2005 amounted to $3.3 million, including $2.5 million and $263,000 from an upfront payment and research funding, respectively, in connection with the Novartis collaborative agreement, $456,000 from the recognition of deferred revenue relating to the sale of an undivided interest in our Abreva® license agreement to Drug Royalty USA (see Note 5, “Deferred Revenue,” in the Notes to Condensed Consolidated Financial Statements (Unaudited)), and $115,000 from a government research grant for preclinical research on a potential antibody to anthrax. Revenues for the third quarter of fiscal 2004 amounted to $591,000, including $351,000 from the recognition of deferred revenue relating to the sale of an undivided interest in our Abreva license agreement, $222,000 from government research grants, and $17,000 from product sales.

During fiscal 2005, we expect to recognize approximately $3.2 million in revenues from the Novartis agreement, approximately $1.9 million in revenues from the recognition of deferred revenue relating to the sale of an undivided interest in our Abreva license agreement, and $500,000 in revenues from research being performed under government research grants. We are currently evaluating revenue recognition for the $10 million upfront payment received in July 2005 in connection with the AstraZeneca agreement.

Revenue-generating Contracts

Revenue-generating contracts that remained active as of June 30, 2005 include seven docosanol 10% cream license agreements, one Neurodex™ sublicense and the recently completed Novartis license. Subsequent to the end of our third fiscal quarter, we entered into a new revenue-generating contract with AstraZeneca for our RCT program. Additionally, the licensees may pay or reimburse us for other work that we subcontract; however, the reimbursements, if any, cannot be reasonably predicted at this time. Under the agreements, our partners will absorb all costs of filing patents, and prosecutions and maintenance of such patents going forward in the respective collaboration. Many of our other product development programs could take years of additional development before they might be licensed, if ever, by other pharmaceutical companies.

We also have an active agreement, dated December 2003, for antibody research services that we performed for a third party which provides for up to $1.1 million in future milestones plus a royalty, if the product continues to be successfully developed, approved by the FDA, and marketed. No milestones are due at the present time or expected in fiscal 2006 for this license agreement.

Expenses

Operating expenses. Total operating expenses for the third quarter of fiscal 2005 were $11.7 million, compared to $7.3 million in the same period in fiscal 2004. The increase of $4.4 million in operating expenses was primarily caused by a $1.6 million increase in general and administrative expenses, a $1.5

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million increase in sales and marketing expenses as we prepare for the launch of Neurodex™ for PBA, if approved, and a $1.4 million increase in research and development expenses. These and other costs and trends are more fully described below.

	Three Months Ended						Nine Months Ended
	June 30						June 30
	2005			2004			2005			2004
Operating expenses:
Research and development		55	%		70	%		66	%		70	%
General and administrative		24	%		17	%		20	%		18	%
Sales and marketing		21	%		13	%		14	%		11	%
Costs of sales		—	%		—	%		—	%		1	%
Total operating expenses		100	%		100	%		100	%		100	%

Research and development (“R&D”) expenses. R&D expenses for the third quarter of fiscal 2005 were $6.5 million and included a $672,000 filing fee for our new drug application for Neurodex in the treatment of PBA. R&D expenses for the third quarter of fiscal 2004 were $5.1 million. In addition to the NDA filing fee, the increase is attributable to an $855,000 increase in clinical spending on Neurodex for the treatment of diabetic neuropathic pain and a $972,000 increase in preclinical research spending on the atherosclerosis program; offset in part by a $948,000 decrease in clinical spending on Neurodex for the treatment of PBA.

Clinical development and other research related to Neurodex in the treatment of PBA in the third quarter of fiscal 2005 amounted to $1.9 million. The open label study and costs associated with preparing the final reviewable unit of clinical data for submission of the NDA to the FDA for Neurodex amounted to $1.2 million, and the balance was for the NDA filing fee. Research related to Neurodex in the treatment of PBA amounted to $2.1 million in the third quarter of fiscal 2004. We expect that clinical and regulatory spending on Neurodex for the treatment of PBA will continue to decline in future quarters in 2005 as the program nears completion.

Clinical spending on Neurodex for diabetic neuropathic pain in the third quarter of fiscal 2005 was $1.3 million, compared to $465,000 in the third quarter of fiscal 2004, reflecting primarily the start of a Phase III clinical trial of Neurodex for the treatment of diabetic neuropathic pain. We expect to spend approximately $9.0 million in the next 18 months for continuation of clinical development, including continuation of a Phase III clinical trial of Neurodex for diabetic neuropathic pain.

R&D expenses in the third quarter of fiscal 2005 also included $1.3 million in preclinical research related to the development of potential compounds for the treatment of atherosclerosis, compared to $329,000 in the third quarter of fiscal 2004. The balance of R&D spending in the third quarter of fiscal 2005 was primarily for preclinical research related to the development of compounds for the treatment of asthma, inflammation and our antibody research programs.

We expect R&D spending levels for neuropathic pain, MIF and RCT will increase in the coming quarters, as we expand and advance those programs in the development pipeline. The R&D spending on MIF and RCT programs will be fully reimbursed by our collaborative partners. We expect that spending on a potential treatment for asthma and development of monoclonal antibodies will depend in part on our success in partnering these programs, or in obtaining additional government grants, so that we are able to defray part or all of these ongoing development costs.

Pharmaceutical R&D programs, by their very nature, require a substantial amount of financial and human resources and there is no assurance that any drug candidate will be approved for marketing by domestic and/or foreign regulatory agencies. The later stages of clinical development typically require substantially greater funds for development than the earlier stages. Thus, in order to defray part or all of our ongoing development costs, we have pursued a licensing strategy for several of these programs. We expect that our licensees will continue to develop and fund those products and pay us license fees,

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milestone payments, and royalties on product sales if those products are successfully developed and approved for marketing by the FDA and foreign regulatory agencies. We caution that we may not find licensees or partners for all of our programs and many of our development efforts could experience delays, setbacks and failures, with no assurance that any of our clinical research or our licensees or partners will ever reach the stage of submitting an NDA to the FDA or that any NDA will be approved.

The following table sets forth the status of, and costs attributable to, our proprietary research and clinical development programs.

Research and Development Projects and Expenses

											Estimated
	Three Months Ended				Nine Months Ended				Inception		Cost to
	June 30,				June 30,				Through		License or
									June 30,		Complete
	2005 (1)		2004 (1)		2005 (1)		2004 (1)		2005 (1) (2)		Project (1)
Company-funded Projects:
Develop Neurodex™ for FDA marketing approval in treating PBA. Estimated cost and timing to reach NDA decision by the first half of 2006 (3)	$	1,869,968	$	2,145,760	$	11,571,736	$	6,343,674	$	29,594,451	$	5.3M	(4)
Develop Neurodex for neuropathic pain. Phase II open-label study completed. Estimated cost and timing to complete one Phase III trial and license the product: up to 2 years (5)		1,319,008		464,539		3,271,727		1,571,850		9,717,170	$	9M	(6)
Development program for asthma. Estimated timing to complete Phase I and license the product: up to 18 months		964,369		1,000,412		2,109,562		2,950,030		20,310,766	$	2M
Other projects involving monoclonal antibodies and docosanol		534,289		524,318		1,548,942		1,920,014		15,164,406		¾	(7)
Partner-funded Projects:
Preclinical atherosclerosis research program.		1,301,463		329,169		3,116,258		787,913		6,383,014		¾	(8)
Preclinical anti-inflammatory research program (MIF inhibitor)		353,706		369,991		929,886		1,439,583		11,071,974		¾	(9)
Government-funded Projects:
Preclinical research, primarily for potential treatments for genital herpes and anthrax. Estimated timing to complete the various projects up to 18 months		127,514		262,790		404,617		826,044		2,444,953	$	0.3 M	(10)
Total	$	6,470,317	$	5,096,979	$	22,952,728	$	15,839,108	$	94,686,734

(1)	Each project includes an allocation of laboratory occupancy costs. “M” refers to millions. Estimated costs and timing to complete the projects are subject to the availability of funds. For each of the projects set forth in the table, other than Neurodex for PBA, the atherosclerosis program and the MIF inhibitor, we are seeking development partners or licensees to defray part or all of the ongoing development costs.
(2)	Inception dates are on or after October 1, 1998, at which time we began identifying and tracking program costs.
(3)	The amount for the nine-month period ended June 30, 2005 includes $5.8 million which is 80% of the $1.9 million cash and non-cash charge of $5.3 million related to the acquisition of additional contractual rights to Neurodex (see Note 12, “Related Party Transactions,” in Notes to Condensed Consolidated Financial Statements (Unaudited)).

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(4)	Total expenditures of $5.3 million include plans for continuing the open label study until product launch in 2006 assuming the FDA approves Neurodex™ on a timely basis.
(5)	The amount for the nine-month period ended June 30, 2005 includes $1.4 million which is 20% of the $1.9 million cash and non-cash charge of $5.3 million related to the acquisition of additional contractual rights to Neurodex (see Note 12, “Related Party Transactions,” in Notes to Condensed Consolidated Financial Statements (Unaudited)).
(6)	Licensing and/or co-promotion alternatives are being explored whereby the partner would fund a portion of clinical development. See “Status of R&D Programs and Plans.” Program expenditures for Neurodex for the treatment of neuropathic pain during each of the listed periods include allocated costs of certain research programs that are shared with Neurodex for PBA. We expect that a second Phase III clinical trial will be required and we are exploring co-promotion opportunities in which our partner may fund the second trial, if the first trial is successful. There can be no assurances that we will choose to or be able to negotiate a licensing and/or co-promotion arrangement for Neurodex on attractive terms, if at all.
(7)	The costs and timing to complete projects involving development of antibodies to target antigens are unpredictable because of the uncertainty of outcomes of the research. Ongoing development of docosanol is limited to those efforts required to support due diligence performed by potential new licensees and our partners, as well as to support new drug applications in new territories.
(8)	Effective July 8, 2005, we entered into an exclusive licensing and research collaboration agreement with AstraZeneca, whereby AstraZeneca will be funding all future development of the project. We estimate our participation will represent $2.5 million to $3.8 million a year in expenses reimbursable by AstraZeneca for three years.
(9)	Effective April 27, 2005, we entered into a research, development and commercialization agreement with Novartis, whereby Novartis will be funding all future development of the project. We estimate we will provide research services in the range of $1.5 million to $2.5 million a year that will be paid by Novartis, for two years from the date of the agreement or longer, upon mutual agreement of the parties.
(10)	Represents the remaining balance of $264,000 for a Federal research grant award for research related to anthrax.

               Status of R&D Programs and Plans — Company-funded Projects

Neurodex for the treatment of PBA. We completed the submission of the final reviewable unit for an NDA to the FDA on June 30, 2005. We anticipate hearing from the FDA approximately 60 days from submission regarding the formal acceptance of the NDA for review and of the status of the review. If the FDA grants us priority review, we expect the FDA will take approximately six months to complete its review of the NDA. If we are assigned a standard review, we expect the FDA will take approximately ten months to complete its review of the NDA. We have been engaged in an open-label safety study for the treatment of PBA in a broad pool of patients who have PBA associated with their underlying neurodegenerative disease or condition. We expect this open-label study to continue through the first half of 2006.

Neurodex for the treatment of neuropathic pain. We have initiated one Phase III clinical trial of Neurodex in patients who have diabetic neuropathic pain and we are currently evaluating the balance of our development plan. Simultaneously, we are evaluating commercial development alternatives for this indication, including continuing development on our own (including conducting a second Phase III clinical trial) or co-promotion/licensing opportunities in which our partner may fund the second trial. There can be no assurances as to the timing of a license or co-promotion arrangement, if any.

Development program for asthma (IgE regulator). In 2004 we completed the first of at least two Phase I clinical trials of our asthma drug, AVP-13358, in 54 healthy volunteers. The placebo-controlled study was intended to assess safety, tolerability and pharmacokinetics following single rising oral doses. Results of the study suggest AVP-13358 was well tolerated at all doses up through 16 milligrams. The study also demonstrated AVP-13358 was detectable in the bloodstream at all doses administered and remains in circulation long enough to allow potentially once or twice daily dosing. We intend to continue to evaluate the safety of the drug by conducting a rising multi-dose study in healthy volunteers. Assuming the results of the multi-dose study are favorable, we will seek to license the drug to a larger pharmaceutical company for further development.

          Status of R&D Programs and Plans — Partner-funded Projects

Anti-inflammatory research program (MIF inhibitor). In April 2005, we entered into a research, development and commercialization agreement with Novartis International Pharmaceutical Ltd. for orally active small molecule therapeutics utilizing our novel MIF technology as a potential treatment for

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inflammatory diseases. Under the terms of the agreement, we will be eligible to receive royalty payments assuming the product is successfully developed and approved for marketing by the FDA. In addition to ongoing royalty payments (that could be significant in the case of a successful drug as royalty is in the order of a high single digit to low double digit rate as a percentage of product revenue), we are also eligible to receive up to $169 million in milestone payments. These milestone payments are contingent upon achievement of certain development and regulatory milestones, which could take several years of further development, and on achievement of certain sales targets, if and when approved for marketing by the FDA. We received an up-front payment of $2.5 million in May 2005 and will also receive research funding of between $1.5 million and $2.5 million per year for providing contract development services to Novartis for two years from the date of the agreement or longer, upon mutual agreement of the parties. While both parties to the agreement will contribute expertise and intellectual property to the research and development collaboration, Novartis assumes responsibility for all pre-clinical and clinical expenses and an obligation to pursue the commercialization of the MIF technology to the degree feasible.

Development program for atherosclerosis. We are engaged in preclinical research with our partner, AstraZeneca, investigating the use of small, orally active molecules as a potential treatment of atherosclerosis (the build-up of fatty plaques in blood vessel walls). Our research is focused on developing molecules that can enhance the naturally occurring process known as reverse cholesterol transport or RCT, whereby cholesterol is effluxed from the fatty-plaques in blood vessel walls and transported to the liver for elimination from the body. Preliminary studies in animal models suggest our compounds may reduce fatty plaques and increase fecal cholesterol excretion.

Consistent with our strategy of licensing our large research and development programs, in July 2005, we entered into an exclusive licensing and research collaboration agreement with AstraZeneca to discover, develop and commercialize RCT enhancing compounds for the treatment of cardiovascular disease. Under the terms of the agreement, we are eligible to receive royalty payments, assuming the product is successfully developed and approved for marketing by the FDA. In addition to ongoing royalty payments (that could be significant in the case of a successful drug as royalty is in the order of a high single digit to low double digit rate as a percentage of product revenue), we are eligible to receive up to $330 million in milestone payments. These milestone payments are contingent upon achievement of certain development and regulatory milestones, which could take several years of further development, and on achievement of certain sales targets, if and when approved for marketing by the FDA. Under the terms of the agreement, we received an upfront payment of $10.0 million on July 22, 2005 and will also receive research funding of between $2.5 million and $3.8 million per year for providing contract development services to AstraZeneca for three years. AstraZeneca has the responsibility for overall development and for the development costs, with both parties contributing scientific expertise to the research collaboration.

     Status of R&D programs and plans — government-funded projects

Government research grants have helped fund research on docosanol-based formulations for the treatment of genital herpes and the development of antibodies to anthrax toxins, among other research programs. Approximately $264,000 in aggregate funds remains to be spent in the 2005 and 2006 calendar years under the government research grant related to development of antibodies to anthrax toxins. The genital herpes project came to a formal end during the third quarter ended fiscal 2005 and no further work is anticipated to be performed by the Company on that project, unless funded by government research grants. We have no grant requests pending nor do we anticipate submitting in the future any grant requests for further research related to genital herpes.

Monoclonal antibodies to anthrax toxin. Two of our most potent anthrax antibodies, AVP-21D9 and AVP-22G12, appear unique both in mechanism of action and in terms of the binding site on an anthrax toxin. AVP-21D9 is currently in preclinical development for use as a prophylactic and therapeutic drug to treat anthrax infections and is being funded by a two-year $750,000 federal (SBIR) research grant. Much of the work has been funded by government research grants and we expect that ongoing development costs will be funded by government grants. Accordingly, our development plans and timing are currently partially dependent on the status of these grants. Because all of our monoclonal antibody

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research is at a very early preclinical stage of development and is unpredictable in terms of the outcome, we are unable to predict the cost and timing for development of any antibody or drug.

General and administrative expenses. Our general and administrative expenses for the third quarter of fiscal 2005 increased to $2.8 million, compared to $1.2 million for the same period a year ago. The increase of $1.6 million is primarily due to:

• a $584,000 severance expense related to the resignation of the CEO;

• a $537,000 increase related to professional services mainly associated with corporate governance, securities compliance and compliance with the Sarbanes-Oxley Act of 2002; and

• a $186,000 increase in recruiting fees and temporary labor costs.

We expect that costs related to professional services mainly associated with corporate governance, securities compliance and compliance with the Sarbanes-Oxley Act will continue at the present level for the next fiscal quarter.

Sales and marketing expenses. Sales and marketing expenses for the third quarter of fiscal 2005 increased to $2.4 million, compared to $937,000 during the same period in fiscal 2004. Higher expenses in the third quarter of fiscal 2005 were related to the continued expansion of our medical education and awareness programs for PBA, market research, and pre-launch activities for Neurodex™ and added sales and marketing personnel, including a new Senior Vice President, Sales and Marketing, and a new Senior Director, Marketing. We had a sales and marketing staff of 7 people at June 30, 2005 compared to 4 at June 30, 2004. Based on our current commercial development plans for Neurodex for the treatment of PBA, we expect sales and marketing expenses in fiscal 2005 will be at least double those in fiscal 2004.

Interest Income

For the third quarter of fiscal 2005, interest income increased to $179,000, compared to $57,000 for the same period in the prior year. The increase is primarily due to a 75% increase in average balance of investments in the quarter ended June 30, 2005 as compared to the same period in the prior year and a slightly higher weighted average interest rate in fiscal 2005.

Net Loss

For the third quarter of fiscal 2005, the net loss was $8.2 million, compared to $6.6 million for the same period a year ago. The net loss per share, basic and diluted, was $0.08 for the third quarter of fiscal 2005 and 2004. We expect to continue to pursue our drug development strategy focused on the commercial development of Neurodex, followed by other programs in earlier stages of development that are in larger therapeutic areas. Effective in April 2005, Novartis assumed all responsibility for product development expenses for our MIF technology. Effective July 2005, AstraZeneca assumed all responsibility for product development expenses for our atherosclerosis program. To help fund and develop our other products, we intend to seek licensees and partners to share the costs of development. These potential license arrangements could materially change our outlook for future revenues and costs. However, the certainty and timing of such additional potential arrangements are unpredictable.

COMPARISON OF NINE MONTHS ENDED JUNE 30, 2005 AND 2004

Revenues

Revenues for the first nine months of fiscal 2005 amounted to $4.9 million, compared to $3.0 million for the first nine months of fiscal 2004. Revenues for the first nine months of fiscal year 2005 included a $2.5 million license fee in connection with the transfer of data and know-how to Novartis, $1.4 million in revenue that we recognized from the sale of certain rights to future Abreva® royalties to Drug Royalty

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USA, $400,000 from government research grants, $300,000 relating to achievement of milestones under license agreements, $263,000 in connection with payments for research under the collaborative agreement with Novartis, and $17,000 in sales of the raw material docosanol. Revenues for the first nine months of fiscal year 2004 included $1.2 million in revenue that we recognized from the sale of certain rights to future Abreva® royalties to Drug Royalty USA, $787,000 in sales of the raw material docosanol, $662,000 from government research grants, and $271,000 from research contract and license revenues.

Expenses

Operating Expenses. Total operating expenses for the first nine months of fiscal 2005 increased to $34.5 million, compared to $22.7 million in the same period in fiscal 2004. The increase in operating expenses was primarily caused by a $7.2 million, or 46%, increase in research and development expenses, a $2.6 million, or 63%, increase in general and administrative expenses and a $2.4 million, or 96%, increase in sales and marketing expenses. Research and development programs accounted for 66% and 70% of total operating expenses for the first nine months of fiscal 2005 and 2004, respectively. General and administrative expenses accounted for 20% and 18% of total operating expenses for the first nine months of fiscal 2005 and 2004, respectively. Sales and marketing expenses accounted for 14% and 11% of total operating expenses for the first nine months of fiscal 2005 and 2004, respectively. These and other costs are more fully described below.

Research and Development Expenses. R&D expenses for the first nine months of fiscal 2005 were $23.0 million, compared to $15.8 million in the same period a year ago. The increase is primarily due to $7.2 million in expenses related to the acquisition of additional contractual rights to Neurodex™.

General and Administrative Expenses. General and administrative expenses for the first nine months of fiscal 2005 amounted to $6.7 million, compared to $4.1 million in the same period in the prior year. The increase of $2.6 million or 63% is primarily due to:

• a $584,000 severance expense related to the resignation of the CEO;

• a $923,000 increase related to professional services mainly associated with corporate governance, securities compliance and compliance with the Sarbanes-Oxley Act of 2002;

• a $231,000 increase in recruiting fees mainly due to hiring key marketing and sales positions; and

• a $161,000 increase in temporary labor expenses.

Sales and Marketing Expenses. Sales and marketing expenses for the first nine months of fiscal 2005 increased by $2.4 million or 96% to $4.9 million, compared to $2.5 million in the same period a year ago. Higher expenses in the first nine months of fiscal 2005 were primarily related to the addition of medical education and awareness programs for PBA, pre-launch planning activities for Neurodex, and an increase in sales and marketing personnel. As discussed above, we expect these expenses to continue to increase significantly over the next 12 months as we prepare for the commercial launch of Neurodex for PBA.

Net Loss

For the first nine months of fiscal 2005, the net loss was $29.3 million including a $7.2 million charge related to the acquisition of additional contractual rights to Neurodex. The net loss for the first nine months of fiscal 2004 was $19.6 million. The basic and diluted net loss per share was $0.29 and $0.27 for the first nine months of fiscal 2005 and 2004, respectively.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2005, we had cash, cash equivalents and investments in securities totaling $26.5 million, including cash and cash equivalents of $3.6 million, short- and long-term investments of $22.0 million and restricted investments in securities of approximately $857,000. Our net working capital balance as of

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June 30, 2005 was $13.7 million. As of September 30, 2004, we had cash, cash equivalents and investments in securities totaling $25.9 million, including cash and cash equivalents of $13.5 million, short- and long-term investments of $11.6 million, and restricted investments of approximately $857,000. Our net working capital balance as of September 30, 2004 was $16.7 million. Explanations of net cash provided by or used for operating, investing and financing activities are provided below.

			Increase
	June 30,		(Decrease)			September 30,
	2005		During Period			2004
Cash, cash equivalents and investment in securities	$	26,466,541	$	560,012		$	25,906,529
Cash and cash equivalents	$	3,576,849	$	(9,917,234	)	$	13,494,083
Net working capital	$	13,742,330	$	(2,911,291	)	$	16,653,621

	Nine Months						Nine Months
	Ended			Change			Ended
	June 30,			Between			June 30,
	2005			Periods			2004
Net cash used for operating activities	$	(21,859,141	)	$	(3,656,629	)	$	(18,202,512	)
Net cash used for investing activities		(12,188,579	)		(3,809,299	)		(8,379,280	)
Net cash provided by financing activities		24,130,486			(9,961,378	)		34,091,864
Net increase (decrease) in cash and cash equivalents	$	(9,917,234	)	$	(17,427,306	)	$	7,510,072

Operating activities.Net cash used for operating activities amounted to $21.9 million in the first nine months of fiscal 2005, $3.7 million higher than the same period a year ago. The net cash used for operating activities in the first nine months of fiscal 2004 amounted to $18.2 million. The increase in cash used is due to the continued expansion of our medical education and awareness programs for PBA, market research, and pre-launch activities for Neurodex™, assuming the drug is approved by the FDA for marketing. Based on our current commercial development plans for Neurodex for the treatment of PBA, we expect sales and marketing expenses by the end of fiscal 2005 will be approximately double those in fiscal 2004. We expect to spend approximately $9.0 million during the next 18 months on clinical development of Neurodex in the treatment of diabetic neuropathic pain, including continuation of a Phase III clinical trial. Additionally, we expect to increase spending on preclinical research related to the development of compounds for the MIF and RCT programs in fiscal 2006. However, both of these programs will be paid or funded by our collaborative partners.

Investing activities. Net cash used by investing activities during the first nine months of fiscal 2005 amounted to $12.2 million, including investments in securities totaling $18.4 million, partially offset by sales and maturities of investments totaling $7.8 million. Net cash used for investing activities during the first nine months of fiscal 2004 amounted to $8.4 million, including investments in securities totaling $8.1 million, capital expenditures related to purchases of capital equipment totaling $90,000, and patent costs of $873,000, partially offset by sales and maturities of investments totaling $700,000. We expect that capital expenditures for property and equipment will likely increase in the coming quarters as we make accommodations in our existing facilities for additional sales and marketing personnel that will be necessary to support commercialization of Neurodex, assuming the drug is approved by the FDA. (See Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Sales and Marketing Expenses.”)

Financing activities. Net cash provided by financing activities amounted to $24.1 million during the first nine months of fiscal 2005, consisting primarily of $24.3 million received from the sale of Class A

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common stock during the period. (See Note 10, “Shareholders’ Equity” in the Notes to Condensed Consolidated Financial Statements (Unaudited)). Net cash provided by financing activities amounted to $34.1 million in the first nine months of fiscal 2004, consisting primarily of $26.5 million received from the sale of Class A common stock in June 2004, and $7.6 million received from the sale of Class A common stock and warrants in December 2003.

In April 2004, we filed a shelf registration statement on Form S-3 with the SEC to sell an aggregate of up to $50 million in Class A common stock. In April 2005, we amended this registration statement to increase the dollar amount of securities registered under the registration statement to $52.9 million. Our sale of Class A common stock in June 2004, representing $28.8 million in gross proceeds ($26.5 million net of underwriting discount and costs of the financing transaction) was the first transaction for the sale of Class A common stock under the existing shelf registration. In December 2004, we sold an additional $7.0 million in Class A common stock to an institutional investor at $3.00 per share. In April 2005, we sold to certain investors $17.1 million in Class A common stock ($15.9 million net of offering expenses and commissions). No more shares of Class A common stock remained available for sale under the shelf registration as of May 12, 2005.

In September 2004, Avanir entered into an equipment line of credit with GE Healthcare Financial Services for financing of up to $1.4 million. As of June 30, 2005, the outstanding balance due under the line of credit was approximately $876,000.

In March 2005, we entered into an asset purchase agreement, pursuant to which our wholly owned subsidiary, Avanir Holding Company, acquired from IriSys certain additional contractual rights to Neurodex™. As a result, through our wholly owned subsidiary, we hold the exclusive worldwide marketing rights to Neurodex for certain indications as set forth under a license agreement with the Center for Neurologic Study (“CNS”). We will be obligated to pay CNS milestone payments upon achievement of certain future events relating to the FDA’s regulatory approval process for Neurodex and a royalty on commercial sales of Neurodex, if and when the drug is approved by the FDA for commercialization. Under certain circumstances, we may have the obligation to pay CNS a share of net revenues received if we sublicense Neurodex to a third party. Based on anticipated performance in 2005, we expect to pay an aggregate of $150,000 in milestones in calendar year 2005, including $75,000 paid in July 2005 and $75,000 if the FDA approves our NDA.

In connection with the asset purchase agreement, Avanir Holding Company paid IriSys a purchase price of $7,225,000 including $1,925,000 in cash and 2,000,000 shares of our Class A common stock with a fair value of $5,300,000. The fair value of the common stock was calculated at $2.65 per share using the 5-day average closing price of our common stock, beginning two days before and ending two days after the close and announcement of the agreement on March 9, 2005. (See Note 12, “Related Party Transactions,” in the Notes to Condensed Consolidated Financial Statements (Unaudited))

In June 2005, we filed shelf registration statement on Form S-3 with the SEC to sell an aggregate of up to $100 million in Class A common stock and preferred stock, depositary shares, debt securities and warrants. This shelf registration statement was declared effective on August 3, 2005.

MANAGEMENT OUTLOOK

We believe that cash, cash equivalents, and investments in securities of approximately $33.7 million at August 4, 2005, plus anticipated future cash from product sales (assuming that Neurodex is approved for marketing by the FDA) and licensed technologies, should be sufficient to sustain our planned level of operations for at least the next 12 months. However, to continue to fund the development of our new drug candidates and technology platforms and in anticipation of a product launch of Neurodex in 2006, we will need to raise additional capital and expect to continue to pursue various alternatives for raising capital during this period. Potential alternatives that we are considering for raising capital include, but are not limited to, partnering arrangements where partners share development costs, issuance of debt or equity securities, and licensing or sales of one or more of our platform technologies or new drug

30

candidates. If we are unable to raise capital as needed to fund our operations, or if we are unable to reach milestones in our license agreements or enter into any new collaborative arrangements, then we may need to slow the rate of development of some of our programs or sell the rights to one or more of our drug candidates. For information regarding the risks associated with our need to raise capital to fund our ongoing and planned operations, please see “Risk Factors.”

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires that management make a number of assumptions and estimates that affect the reported amounts of assets, liabilities, revenues and expenses in our consolidated financial statements and accompanying notes. Management bases its estimates on historical information and assumptions believed to be reasonable. Although these estimates are based on management’s best knowledge of current events and circumstances that may impact us in the future, actual results may differ from these estimates.

Our critical accounting policies are those that affect our financial statements materially and involve a significant level of judgment by management. Our critical accounting policies regarding revenue recognition are in the following areas: milestone payments in license agreements, royalties on licensed products, sale of rights to future royalties, and recognition of revenues in research contracts. Our critical accounting policies also include recognition of expenses in research contracts and research and development expenses and the valuation of long-lived and intangible assets.

Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin Topic 13, “Revenue Recognition” and Emerging Issues Task Force No. 00-21 (EITF 00-21), “Accounting for Revenue Arrangements with Multiple Deliverables.” Revenue is recognized when the four basic criteria of revenue recognition are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed or determinable; and (4) collectibility is reasonably assured.

Contract Revenue from Collaborations. Collaborative arrangements typically consist of non-refundable and/or exclusive technology access or data transfer fees, reimbursements for costs of specific research and development, and various milestone and future product royalty payments. If the delivered technology does not have standalone value or if we do not have objective or reliable evidence of the fair value of the undelivered component, the amount of revenue allocable to the delivered technology is deferred. Nonrefundable, up-front license or technology access fees with standalone value that are not dependent on any future performance by us under the arrangements are recognized as revenue upon the earlier of when payments are received or collection is assured, but are deferred if we have continuing performance obligations. If we have continuing involvement through research and development collaborations or other contractual obligations, such up-front fees are deferred and recognized over the collaboration period or the period for which we continue to have a performance obligation, unless all of the following criteria exist: (1) the collaboration or contractual obligations have standalone value to the customer, (2) there is objective and reliable evidence of the fair value of the undelivered item(s), and (3) there is no general right to return the delivered item(s). Payments related to substantive, performance-based milestones are recognized as revenue upon the achievement of the milestones as specified in the underlying agreements, which represent the culmination of the earnings process. Revenue from research services is recognized during the period in which the services are performed and is based upon the number of FTE personnel working on specific project at the agreed-upon rate. Payments received in advance are recorded as deferred revenue until the research is performed, costs are incurred, or milestone is reached.

Royalty revenues. We recognize royalty revenues from licensed products when earned in accordance with the terms of the license agreements. Net sales figures used for calculating royalties include deductions for costs of unsaleable returns, managed care chargebacks, cash discounts, freight and warehousing, and miscellaneous write-offs, which may vary over the course of the license agreement.

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Revenues from sale of royalty rights. In agreements where we have sold our rights to future royalties under license agreements and we maintain continuing involvement in earning such royalties, we defer revenues and recognize them over the life of the license agreement. For example, in the sale of an undivided interest of our Abreva® license agreement to Drug Royalty USA, revenue recognition is being determined under the units-of-revenue method. Under this method, the amount of deferred revenue to be recognized as revenue in each period is calculated by multiplying (i) the ratio of the royalty payments due to Drug Royalty USA for the period to the total remaining royalties that we expect GlaxoSmithKline will pay Drug Royalty USA over the term of the agreement, by (ii) the unamortized deferred revenue amount.

Revenue arrangements with multiple deliverables. We have revenue arrangements whereby we are obligated to deliver to the customer multiple products and/or services (multiple deliverables). Such arrangements may include antibody generation services agreements and other forms of research collaborations. In accordance with EITF 00-21, we analyze our multiple element arrangements to determine whether the elements can be separated and accounted for individually as separate units of accounting. The evaluation is performed at the inception of the arrangement. The delivered item(s) is considered a separate unit of accounting if all of the following criteria are met (a) the delivered item(s) has value to the customer on a standalone basis; (b) there is objective and reliable evidence of the fair value of the undelivered item(s); and (c) if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially in our control.

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

Product sales – Active Pharmaceutical Ingredient Docosanol. Revenue from product sales, which consist of sales of our active pharmaceutical ingredient docosanol, is recorded when the above criteria are met, generally when title and risk of loss have passed to the buyer upon delivery. We sell the active pharmaceutical ingredient docosanol to various licensees and ship only on written order for the materials. Total shipments generally occur fewer than five times a year. Our contracts for sales of the active pharmaceutical ingredient docosanol include buyer acceptance provisions that give our buyers the right of replacement if the delivered materials do not meet specified criteria, by giving notice within 30 days after receipt of such defective materials, and we have the option to refund or replace such defective materials. However, we have historically demonstrated that the materials shipped from the same pre-inspected lot have consistently met the specified criteria and no buyer has rejected any of our shipments from the same pre-inspected lot. Therefore, we recognize revenue from sales of the active pharmaceutical ingredient docosanol without providing for such contingency upon shipment.

Recognition of Expenses in Outsourced Contracts

Pursuant to management’s assessment of the progress that has been made on clinical trials and services provided in other contracts, we recognize expenses as the services are provided. Several of our contracts extend across multiple reporting periods, including our largest contract, representing an $8.5 million Phase III clinical trial contract as of June 30, 2005. A 3% variance in our estimate of the work completed in our largest contract could increase or decrease our operating expenses by $255,000. Such contracts require an assessment of the work that has been completed during the period, including measurement of progress, analysis of data that justifies the progress, and finally, management’s judgment.

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

• The technology is in the early stage of development and has no alternative uses;

• There is substantial uncertainty of the technology or product being successful;

• There will be difficulty in completing the remaining development; and

• There is substantial cost to complete the work.

Research and Development Expenses

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

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

Capitalization and Valuation of Long-Lived and Intangible Assets

Intangible assets with finite useful lives consist of capitalized legal costs incurred in connection with patents, patent applications pending, trademark applications and license agreements. We amortize costs of approved patents, patent applications pending and license agreements over their estimated useful lives, or terms of the agreements, whichever are shorter. For patents pending, we amortize the costs over the shorter of a period of twenty years from the date of filing the application or, if licensed, the term of the license agreement. We re-assess the useful lives of patents when they are issued, or whenever events or changes in circumstances indicate the useful lives may have changes. For patent and trademark applications that we abandon, we charge the remaining unamortized accumulated costs to expense. Our amortizable intangible assets consist of the costs of patents, patent applications pending and licenses.

Intangible assets are evaluated for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable. If the review indicates that long-lived assets are not recoverable (i.e. the carrying amount is less than the future projected undiscounted cash flows), their carrying amount would be reduced to fair value. Factors we consider important that could trigger an impairment review include the following:

• A significant underperformance relative to expected historical or projected future operating results;

• A significant change in the manner of our use of the acquired asset or the strategy for our overall business; and/or

• A significant negative industry or economic trend.

When we determine that the carrying value of intangible assets or long-lived assets are not recoverable based upon the existence of one or more of the above indicators of impairment, we may be required to record impairment charges for these assets that have not been previously recorded.

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As of June 30, 2005, our largest group of intangible assets with finite lives was patents and patents pending for our IgE down-regulation technology, having net intangible assets of approximately $1.1 million. Any setback or failure in our IgE technology, currently in Phase I clinical development for the treatment of asthma, could cause a re-assessment of the value of this technology and possible write-down of all or a portion of the costs of these assets.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 2, “Stock-based Compensation” and Note 13, “Recent Accounting Pronouncements” in the Notes to Condensed Consolidated Financial Statements (Unaudited) for a discussion of recent accounting pronouncements and their effect, if any, on our financial condition or results of operations.

RISK FACTORS

Risks Relating to Our Business

We have a history of losses and we may never achieve or maintain profitability.

To date, we have experienced significant operating losses in funding the research, development and clinical testing of our drug candidates and we expect to continue to incur substantial operating losses through at least fiscal 2006. As of June 30, 2005, our accumulated deficit was approximately $153.8 million. To achieve profitability, we would need to generate significant additional revenue with positive gross margins to offset our other operating expenses. Additionally, we intend to increase our pre-launch activities and sales and marketing efforts over the next several quarters as we await the FDA’s decision regarding the approval of Neurodex™ for the treatment of PBA.

We could also increase spending on our clinical and preclinical programs to the extent our progress in development is favorable. Although we have recently entered into attractive research collaborations with major pharmaceutical companies for two of our research programs, we continue to seek and to negotiate revenue-generating licenses and/or co-promotion arrangements for Neurodex and docosanol 10% cream, and for our other research programs for allergy/asthma and antibody technology. However, we may not find additional attractive arrangements, if at all, and any such arrangements may not provide adequate revenues to cover future operating expenses. Increases in expenditures may not be offset by new or adequate sources of revenues, and as a result, we may not achieve or maintain profitability.

We recently submitted our Neurodex clinical trial results to the FDA for review and approval. Any delay or adverse decisions in the regulatory review or approval process may harm our prospects and could harm our stock price.

We submitted the final reviewable unit that was part of a rolling submission of the NDA for Neurodex to the FDA in June 2005, and we must obtain FDA approval prior to commercialization in the United States. Any delays in the FDA’s review or approval could delay market launch and could affect the stock price and may result in additional operating losses, which would likely increase our cash requirements.

We anticipate hearing from the FDA approximately 60 days from submission regarding the formal acceptance of the NDA for review and of the status of the review (i.e., standard or priority review). Assuming that the FDA grants us priority review, we expect the FDA will take approximately six months to complete its review of the NDA. If we are assigned a standard review, we expect the FDA will take approximately ten months to complete its review of the NDA. The FDA’s official filing of an NDA is the action that begins the application’s substantive review. The FDA may refuse to file an NDA for review for many reasons, including if the submission contains insufficient data to demonstrate efficacy and/or safety. We cannot be certain that our NDA submission would be accepted for filing and reviewed by the FDA or that we would be able to respond to any requests during the review period in a timely manner without delaying potential action on our request for approval.

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We also cannot be certain that Neurodex™ will receive a favorable recommendation from any FDA advisory committees or be approved for marketing by the FDA. Even if the FDA grants marketing approval for Neurodex, we cannot be certain that we will be able to obtain the labeling claims necessary or desirable for the promotion of the product. In addition, delays in approvals or rejections of marketing applications may be based upon many factors, including regulatory requests for additional analyses, reports, data and/or studies, regulatory questions regarding data and results, changes in regulatory policy during the period of product development and/or the emergence of new information regarding our products or other products. Recent public announcements regarding safety problems with certain approved drugs may affect the FDA’s policies regarding safety data for new drug applications and may result in the FDA requiring additional safety data before accepting our planned NDA submission, as well as closer surveillance after commercialization if the drug is approved.

Changes in board and management composition could adversely affect our operations.

Our President and Chief Executive Officer resigned in May 2005 and we are currently in the process of recruiting a replacement. Additionally, since September 2004, four new directors have joined our board, we have recently appointed a new chairman and we recently recruited senior-level sales and marketing personnel, including a new Senior Vice President of Sales and Marketing. We continue to recruit other senior-level sales and marketing personnel to add to our management and we anticipate that we could experience other changes in management and infrastructure as we expand our organization, prepare for the commercialization of Neurodex, and effect our transition from a research and development company to a pharmaceutical company. These changes may be disruptive, and we may experience difficulties in retaining new directors, attracting and integrating new members of the management team, and in transitioning our operating activities.

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

The industry in which we compete has a high level of employee mobility and aggressive recruiting of skilled personnel. This type of environment creates intense competition for qualified personnel, particularly in product research and development, sales and marketing, and accounting and finance, and the loss of any of our executive officers or other key employees could adversely affect our operations.

In order to expand our company as planned and to effect our transition to a pharmaceutical company, we will need to hire, train, retain and motivate high quality personnel, including sales and marketing personnel for the commercialization of Neurodex. Any inability to hire qualified sales and marketing personnel would harm our commercialization plans. Additionally, if we were to lose one or more of our key scientists, then we would likely lose some portion of our institutional knowledge and technical know-how, potentially causing a substantial delay in one or more of our development programs until adequate replacement personnel could be hired and trained.

We have yet to market or sell Neurodex or any of our other potential products.

We have never before marketed or sold any pharmaceutical products. In order to market or co-market Neurodex, assuming it is approved by the FDA, or market any other drug candidates, we will need to hire a significant number of people with relevant pharmaceutical experience to staff our sales management team and marketing group, and possibly also to make appropriate arrangements with collaborative partners. If we cannot develop the required marketing and sales expertise internally or through our partnering arrangements, our ability to generate revenue from product sales will likely suffer. Additionally, we face additional challenges in that PBA is not a well known syndrome and it may be necessary to incur substantial expenditures to educate doctors and patients about the condition.

In international markets, we intend to rely on collaborative partners to obtain regulatory approvals, and to market and sell our products in those markets. We have not yet entered into any collaborative

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arrangement with respect to marketing or selling Neurodex™, with the exception of one such agreement relating to Israel. We cannot guarantee that we will be able to enter into any other arrangements on terms favorable to us, or at all. If we are able to enter into marketing and selling arrangements with collaborative partners, we cannot assure you that such marketing collaborators will apply adequate resources and skills to their responsibilities, or that their marketing efforts will be successful. If we are unable to enter into favorable collaborative arrangements with respect to marketing or selling Neurodex or docosanol 10% cream or our marketing collaborators’ efforts are not successful, our ability to generate revenue from product sales will suffer.

We expect that we will need to raise additional capital to fund ongoing operations through at least 2006. If we are unable to raise additional capital, we may be forced to curtail operations. If we succeed in raising additional capital through a licensing or financing transaction, it may affect our stock price and future revenues.

In order to maintain sufficient cash and investments to fund future operations and to prepare for the commercialization of Neurodex, we will need to raise additional capital. We expect to seek to raise up to $100 million of additional capital over the next 12 to 24 months through various alternatives, including licensing or sales of our technologies and drug candidates, selling shares of our Class A common stock, preferred stock, or through the issuance of one or more forms of senior or subordinated debt.

• If we raise capital through licensing or sales of one or more of our technologies or drug candidates, then we may not realize revenues from sales of any of our products that are successfully developed, approved by the FDA and marketed, or our share of such revenues may be substantially reduced. If we license any of our technologies or drug candidates, then the development of these products or technologies will no longer be in our control. A licensee might never reach any of the payment milestones in a license agreement. Further, if we sell any of our technologies or drug candidates, the sales price may not fully cover our investment in such technology or drug candidate.

• If we raise capital by issuing additional shares of Class A common stock at a price per share less than the then-current market price per share, or securities, such as preferred stock, convertible into our Class A common stock at a discount to our current market price, the value of the shares of Class A common stock then outstanding may be reduced. Further, even if we were to sell shares of common stock at prices equal to or higher than the current market price, the issuance of additional shares may depress the market price of our Class A common stock and will dilute voting rights of our other shareholders.

We may not be able to raise capital on terms that we find acceptable, or at all. If we are unable to raise additional capital to fund future operations, then we may not be able to execute our commercialization plans for Neurodex and may be required to reduce operations or defer or abandon one or more of our clinical or pre-clinical research programs. Any of these actions could decrease our stock price.

Developing and testing a drug candidate is a very expensive and time-consuming process that may not ultimately lead to a marketable product.

The drug development process is lengthy and capital-intensive. Since September 1998, we have spent approximately $94.7 million in preclinical and clinical studies researching the safety and efficacy of our drug candidates and potential drug candidates. If any of our drug candidates fail to demonstrate the desired safety and efficacy, we may abandon the development of the compound, in which event we would not recover our expenditures incurred to date for that compound. If a compound appears to be safe and effective in preclinical studies, we may decide to proceed with human clinical trials. The full complement of clinical trials required to obtain regulatory approval for many of our drug development programs exceeds our available capital. Because of our limited financial resources, we may be required to license

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the compound to a pharmaceutical company with greater financial resources in order to complete the development of the drug. We may be unable to find a large pharmaceutical company interested in licensing the drug or, if we do locate such a licensee, the proposed license terms may not be acceptable to us. In the event that we are unable to find a large pharmaceutical partner or licensee on acceptable terms, we may be forced to abandon one or more of our drug candidates.

We expect our quarterly operating results to fluctuate significantly from period-to-period for a number of reasons.

Historically, we have had only limited recurring revenue. As a result, operating results have been, and will continue to be, subject to significant quarterly fluctuations based on a variety of factors, including:

• New partnering arrangements — We are currently seeking co-promotion or licensing partners for docosanol 10% cream and our compound targeting IgE (allergy and asthma). We are also evaluating the potential benefits of a co-promotion for Neurodex™. It is difficult to predict whether any of these discussions will result in a partnering or license arrangement and what the financial terms of such an arrangement might be.

• Performance under partnering arrangements — The recognition of the revenue under our partnering arrangements, including our license agreements for our MIF and RCT programs, will partially depend on the efforts and performance of our licensees in reaching milestones that are outside our control. Such milestones may include specific events, such as regulatory approval, product launch, the passage of time, or reaching a sales threshold.

• Limited rights to future Abreva® royalties — In December 2002, we sold to Drug Royalty USA the rights to a substantial portion of our future royalty revenues from sales of Abreva by GlaxoSmithKline. We will not receive any future royalty payments unless and until annual Abreva wholesale sales exceed $62 million, at which time we will receive one-half of the stated royalty rate on any excess sales. We estimate that net sales for royalty calculation purposes reached approximately 89% of the $62 million threshold in 2004. We expect that any royalty payments on these excess sales, if any, would occur only once a year, after the end of each calendar year.

• Concentration of significant customers, suppliers and industries — Milestone payments, royalties earned, and revenues recognized from the sale of rights to royalties from a single licensee (GlaxoSmithKline) accounted for approximately 48%, 73% and 95% of our fiscal 2004, 2003 and 2002 revenues, respectively. We have now received all of the milestone payments from GlaxoSmithKline for North America. With the sale of our Abreva royalty rights to Drug Royalty USA, future royalty payments from GlaxoSmithKline will come exclusively from our remaining 50% share of Abreva royalties on contract sales in excess of $62 million a year. Additionally, we purchase the raw material docosanol from a sole foreign supplier that has been approved by the FDA for manufacturing. Any disturbances or delays in the manufacture of docosanol or other raw materials for our products and clinical research programs could seriously and adversely affect our business.

• Acquisitions/alliances — If, in the future, we acquire technologies, products, or businesses, or we form alliances with companies requiring technology investments or commitments, we will face a number of risks to our business. The risks that we may encounter include those associated with integrating operations, personnel, and technologies acquired or licensed, and the potential for unknown liabilities of the acquired business. Our business and operating results on a quarterly basis could be adversely affected if any or our acquisition or alliance activities, to the extent they exist in the future, are not successful.

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Our stock price has been highly volatile and investors may not be able to sell their shares at or above the price they pay for them.

The market price of our Class A common stock has been, and is likely to continue to be, highly volatile. The following factors, among others, could have a significant impact on the market price of our Class A common stock:

• Unfavorable announcements by us regarding Neurodex™, clinical trial results or results of operations;

• Our success or failure in entering into license and/or co-promotion arrangements for our products and product candidates;

• Delays in meeting goals or performance milestones by us or our partners;

• Comments made by securities analysts, including changes in their recommendations;

• Announcements of financing transactions and/or future sales of equity or debt securities;

• Announcements by us of significant acquisitions, strategic partnerships, joint ventures, or capital commitments;

• Sales of our Class A common stock by our directors, officers, or significant shareholders;

• Announcements by our competitors of clinical trial results or product approvals; and

• Market and economic conditions.

In addition, the market for biotechnology and pharmaceutical stocks has experienced significant price and volume fluctuations that are frequently unrelated to operating performance. This price volatility is often more pronounced for companies with a low stock price and a small market capitalization, such as ours. These broad market and industry factors might seriously harm the market price of our Class A common stock, regardless of our operating performance.

A significant decline in our stock price could also result in our Class A common stock being delisted from the American Stock Exchange and could lead to the filing of lawsuits, including securities class action lawsuits. Any such lawsuits against us would result in substantial costs, potential liabilities and the diversion of management’s attention and resources.

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

We rely substantially on the protection of our intellectual property through our ownership or control of 101 issued patents and 350 patent applications. Patents and patent applications owned or licensed by us include docosanol-related products and technologies, Neurodex, compounds capable of regulating the target IgE in controlling symptoms of allergy and asthma, compounds capable of regulating the target MIF in treatment of inflammatory diseases, compounds targeting apolipoprotein A1 for the treatment of atherosclerosis, and Xenerex technologies for developing monoclonal antibodies. Because of the competitive nature of the biopharmaceutical industry, we cannot assure you that:

• The claims in any pending patent applications will be allowed or that patents will be granted;

• 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 that may be not be available to us;

• Any of our 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.

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

We have utilized, and intend to continue utilizing, third parties to manufacture docosanol 10% cream, Neurodex™, active pharmaceutical ingredients, and supplies for our other drug candidates. We have no experience in manufacturing and do not have any manufacturing facilities. Currently, we have only a single supplier for the raw material docosanol and the finished product for Neurodex and we do not have any long-term agreements in place with either of these suppliers. Any delays or difficulties in obtaining Neurodex could delay our clinical trials for neuropathic pain and delay the commercialization of Neurodex for pseudobulbar affect. Additionally, although we and GlaxoSmithKline maintain a strategic reserve of docosanol to mitigate against a short-term supply disruption, any sustained disruption of our docosanol supply could harm our operations.

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

The nature of clinical trials and our business strategy of outsourcing a substantial portion of our research require that we rely on clinical research centers and other contractors to assist us with research and development and clinical testing activities. As a result, our success depends partially on the success of these third parties in performing their responsibilities. Although we pre-qualify our contractors and we believe that they will fully perform their contractual obligations, we cannot directly control the adequacy and timeliness of the resources and expertise that they apply to these activities. If our contractors do not perform their activities in an adequate or timely manner, the development and commercialization of our drug candidates could be delayed.

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

The testing, marketing, and sale of pharmaceutical products involves the risk of product liability claims by consumers and other third parties. We maintain product liability insurance coverage for our clinical trials in the amount of $5 million per incident and $5 million in the aggregate. We expect to increase this coverage if we receive a favorable marketing approval of Neurodex by the FDA. However, product liability claims can be high in the pharmaceutical industry and our insurance may not sufficiently cover our actual liabilities. Additionally, our insurance carriers may attempt to deny coverage in certain instances. If a suit against our business or proposed products is successful, then the lack of 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.

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

We have the opportunity to earn royalties on Abreva if wholesale sales by GlaxoSmithKline exceed $62 million a year. We estimate that net sales for royalty calculation purposes reached approximately 89% of the $62 million threshold in 2004. Abreva competes with several other products for oral-facial herpes currently on the market in the U.S., as well as other products or potential products that are or may be under development or undergoing FDA review. Many of these products are well established and are marketed by large pharmaceutical companies with substantial resources and significant marketing experience. As a result of this competition, annual wholesales sales of Abreva may never reach a level where we will participate in further royalty income from this product.

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Our future financial results will be affected by changes in the accounting rules governing the recognition of stock-based compensation expense.

We measure compensation expense for our employee stock compensation plans under the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” In addition, we provide pro forma disclosures of our operating results in our Notes to Consolidated Financial Statements as if the fair value method of accounting had been applied in accordance with FAS 123R, “Share-based Payment.” Had we accounted for our compensation expense under the fair value method accounting prescribed by FAS 123R, the charges would have been significantly higher, by approximately $1,003,000, $1,554,000 and $2,176,000 during fiscal 2004, 2003, and 2002, respectively. The planned effective date for proposed changes to accounting rules concerning the recognition of stock option compensation expense will be the fiscal year beginning October 1, 2005. We and other companies will be required to measure compensation expense using the fair value method, which will adversely affect our results of operations by reducing our income or increasing our losses.

Business interruptions could adversely affect our business.

Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, and other events beyond our control. For example, during 2001 and again in 2003, we experienced electrical power outages lasting several hours. The loss of electrical power for any significant periods of time could adversely affect our ability to conduct experiments and could also harm our vendors. Further, we could lose valuable data made to date in experiments currently underway. We have mitigated the severity of power losses by installing emergency power equipment, which we have used on several occasions to supply electricity to the areas that we consider to be the most critical to our operations. However, the emergency power units do not cover all of our electrical needs and, further, they might not operate properly in the event of a power loss.

The board of directors has the authority to effect a reverse stock split within a stated range until March 16, 2006. If implemented, the reverse stock split may negatively affect the price and liquidity of our Class A common stock.

At our 2005 Annual Meeting of Shareholders, the shareholders granted to the board of directors the authority to implement, within its discretion and for a period of one year, a reverse split of our Class A common stock within a range of 1:2 to 1:5. If the board of directors were to effect a reverse stock split, the bid price of the Class A common stock may not continue at a level in proportion to the reduction in the number of outstanding shares resulting from the reverse stock split. For example, if the board of directors decided to implement a reverse stock split at a ratio of 1-for-5, the post-split market price of our Class A common stock might not continue at a level at least five times greater than the pre-split price. Accordingly, the total market capitalization of our Class A common stock after a reverse stock split, if implemented, could be lower than the total market capitalization before the reverse stock split. Additionally, the liquidity of our Class A common stock could be affected adversely by the reduced number of shares outstanding after the reverse stock split.

Avanir and its licensees may not be successful in obtaining regulatory approval of docosanol 10% cream immediately as an OTC product in additional countries, or in licensing, marketing and selling the product in any other countries.

Currently, docosanol 10% cream is approved for sale in the United States, Canada, Korea, Israel, Sweden, Spain, Portugal, Denmark, Norway, Finland, Greece and Cyprus. We are currently seeking approval in various other countries in the European Union and intend to seek approval in Japan. Avanir and its licensees face a variety of risks in foreign countries in obtaining regulatory approval and in marketing and selling docosanol 10% cream, including:

• Regulatory approval requirements differ by country, and obtaining approvals to market the drug in foreign countries may be difficult to obtain, may require additional costly and time consuming

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	clinical trials, or may require being a prescription drug first before obtaining sufficient experience to warrant approval as an OTC product;
•	Building product awareness of a new drug, whether prescription or OTC, among customers or retail store decision makers may require a substantial amount of product promotion, which does not guarantee success;
•	Consumers may not perceive that docosanol 10% cream is superior to existing and potentially new OTC products for oral herpes;
•	Acceptance of docosanol 10% cream in the OTC consumer market may not be widespread; and
•	Potential price erosion could occur due to competitive products and responses to our product’s introduction.

Risks Relating to Our Industry

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

The pharmaceutical and biotechnology industries are highly competitive and subject to significant and rapid technological change. We compete with hundreds of companies that develop and market products and technologies in similar areas as our research. Additionally, many physicians prescribe medications for indications other than those for which a certain drug has been approved (so called “off-label” use). For example, if the FDA approves Neurodex™ for marketing as a treatment of PBA, physicians may continue prescribing other products in an off-label manner for the treatment of this condition, including:

• Antidepressants, such as ProzacÒ, CelexaÒ, ZoloftÒ, PaxilÒ, ElavilÒ and PamelorÒ and others;

• Atypical antipsychotics agents, such as ZyprexaÒ, ResperdalÒ, AbilifyÒ, GeodonÒ and others; and

• Other agents, such as SymmetrelÒ and Lithium

Our competitors may have specific expertise and technologies that are better than ours and many of these companies, either alone or together with their research partners, have substantially greater financial resources, larger research and development staffs and substantially greater experience than we do. Accordingly, our competitors may develop a competing product approved specifically for the treatment of PBA. If we commence commercial sales for Neurodex, we may potentially be competing with other companies and their products with respect to manufacturing efficiencies and marketing capabilities, areas where we have limited or no direct experience.

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

Government authorities in the U.S., including the FDA, and other countries highly regulate the development, production, testing, manufacturing and marketing of pharmaceutical products. The clinical testing and regulatory approval process can take many years and requires the expenditure of substantial resources. Failure to obtain, or delays in obtaining, these approvals will adversely affect our business operations, including our ability to commence marketing of any of the proposed products. We may find it necessary to use a significant portion of our financial resources for research and development and the clinical trials necessary to obtain these approvals for our proposed products. We will continue to incur costs of development without any assurance that we will ever obtain regulatory approvals for any of our products under development. Additionally, we cannot predict the extent to which adverse government regulations might arise from future U.S. or foreign legislative or administrative actions. Moreover, we cannot predict with accuracy the effects of any future changes in the regulatory approval process and in the domestic health care system for which we develop our products, or the costs of on-going compliance regulations after marketing approval has been obtained. Future changes could affect adversely the time

41

frame required for regulatory review, our financial resources, and the sales prices of our proposed products, if approved for sale.

Companies in our industry must protect their intellectual property rights and operate without infringing on or misappropriating the proprietary rights of others. Our inability to do so could be costly and could significantly affect our business prospects.

Pharmaceutical companies such as Avanir rely heavily on intellectual property rights to protect their innovations. Although we attempt to protect these rights by regularly filing patent applications and requiring all employees to sign confidentiality agreements, we cannot assure you that patents will be issued, that secrecy obligations will be honored, or that others will not independently develop similar or superior technology. Additionally, if our consultants, key employees or other third parties apply technological information independently developed by them or by others to our projects, then disputes may arise as to the ownership rights of these innovations.

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

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Interest rate sensitivity

Our investment portfolio consists primarily of fixed income instruments with an average duration of 1.2 years as of June 30, 2005 (1.2 years as of September 30, 2004). The primary objective of our investments in debt securities is to preserve principal while achieving attractive yields, without significantly increasing risk. We classify our investments in securities as of June 30, 2005 as available-for-sale and our restricted investments in securities as held-to-maturity. These available-for-sale securities are subject to interest rate risk. In general, we would expect that the volatility of this portfolio would decrease as its duration decreases. Based on the average duration of our investments as of June 30, 2005 and 2004, an increase of one percentage point in the interest rates would have resulted in increases in comprehensive losses of approximately $221,000 and $120,000, respectively.

42

Item 4. CONTROLS AND PROCEDURES

With the participation of the principal executive officer and principal financial officer of Avanir Pharmaceuticals (“the Registrant”), the Registrant’s management has evaluated the effectiveness of our disclosure controls and procedures (as defined in the Securities Exchange Act of 1934, Rules 13a-15(e) and 15d-15(e), as of the end of the period covered by this report. Based on that evaluation, the Registrant’s principal executive officer and principal financial officer have concluded that:

• Information required to be disclosed by the Registrant in this Quarterly Report on Form 10-Q and the other reports that the Registrant files or submits under the Exchange Act would be accumulated and communicated to the Registrant’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure;

• Information required to be disclosed by the Registrant in this Quarterly Report on Form 10-Q and the other reports that the Registrant files or submits under the Exchange Act would be recorded, processed, summarized and reported within the time periods specific in the SEC’s rules and forms; and

• The Registrant’s disclosure controls and procedures are effective as of the end of the period covered by this Quarterly Report on Form 10-Q to ensure that material information relating to the Registrant and its consolidated subsidiaries is made known to them, particularly during the period in which the Registrant’s periodic reports, including this Quarterly Report on Form 10-Q, are being prepared.

Additionally, there were no changes in the Registrant’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the Registrant’s fiscal quarter ended June 30, 2005, that have materially affected, or are reasonably likely to materially affect the Registrant’s internal control over financial reporting.

PART II OTHER INFORMATION

Items 1. LEGAL PROCEEDINGS

In the ordinary course of business, we may face various claims brought by third parties. Any of these claims could subject us to costly litigation. Management believes the outcome of currently identified claims and lawsuits will not have a material adverse effect on our financial condition or results of operations.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

     Not applicable

Item 3. DEFAULTS UPON SENIOR SECURITIES

     Not applicable.

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

     Not applicable.

Item 5. OTHER INFORMATION

     None

43

Item 6. EXHIBITS

Exhibits
10.1	Research, Development and Commercialization Agreement, dated April 27, 2005, by and between AVANIRP harmaceuticals and Novartis International Pharmaceutical Ltd.*
15.1	Letter on unaudited interim financial information.
31.1	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

* Confidential treatment requested.

44

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.

Signature	Title	Date
/s/ Gregory P. Hanson, CMA	Vice President, Finance and Chief	August 12, 2005
Gregory P. Hanson, CMA	Financial Officer
	(Principal Executive, Financial and
	Accounting Officer)

45

EX-10.1

                                           *** Text omitted and filed separately
                                                Confidential Treatment Requested
                                         Under 17 C.F.R. Sections 200.80 (b) (4)
                                                                   and 240.24b-2

                                                                    EXHIBIT 10.1

================================================================================

                              RESEARCH, DEVELOPMENT

                         AND COMMERCIALIZATION AGREEMENT

                                 BY AND BETWEEN

                   NOVARTIS INTERNATIONAL PHARMACEUTICAL LTD.

                                       AND

                             AVANIR PHARMACEUTICALS

================================================================================

     This Research, Development and Commercialization Agreement (this
"Agreement") is made and entered into as of this 27th day of April, 2005 (the
"Effective Date") by and between Avanir Pharmaceuticals, a corporation organized
under the laws of the State of California with principal offices at 11388
Sorrento Valley Road, Suite 200, San Diego, California 92121 ("Avanir"), and
Novartis International Pharmaceutical Ltd., a Bermuda corporation with principal
offices at Hurst Holme, 12 Trott Road, Hamilton HM LX, Bermuda ("Novartis").

                                   WITNESSETH

     WHEREAS, Avanir has developed the MIF Program (as defined herein) and the
related Compounds (as defined herein);

     WHEREAS, Novartis and its Affiliates are engaged in the research,
development, marketing, manufacture and distribution of pharmaceutical compounds
used in treating, preventing or diagnosing human or animal diseases and
conditions;

     WHEREAS, both Parties desire to enter into a collaboration, the objective
of which will be to further research and develop the MIF Program and the related
Compounds; and

     WHEREAS, Avanir wishes to grant, and Novartis and its Affiliates wish to
obtain, an exclusive license to further research, develop and commercialize the
Compounds into Drug Products for the treatment, prevention or diagnosis of human
or animal diseases or conditions.

     NOW THEREFORE, in consideration of the foregoing premises, the Parties
agree as follows:

                                    ARTICLE I

                                   DEFINITIONS

     For the purpose of this Agreement, the following terms, whether used in
singular or plural form, shall have the respective meanings set forth below:

     1.1 "Accounting Standards" with respect to Avanir shall mean that Avanir
shall maintain records and books of accounts in accordance with United States
Generally


                                        2

Accepted Accounting Principles and with respect to Novartis shall mean that
Novartis shall maintain records and books of accounts in accordance with
International Financial Reporting Standards, in each case consistently applied.

     1.2 "Affiliate" shall mean any Person who directly or indirectly controls
or is controlled by or is under common control with a Party. For purposes of
this definition, "control" or "controlled" means ownership directly or through
one or more Affiliates, of fifty percent (50%) or more of the shares of stock
entitled to vote for the election of directors, in the case of a corporation, or
fifty percent (50%) or more of the equity interest in the case of any other type
of legal entity, status as a general partner in any partnership, or any other
arrangement whereby a Party controls or has the right to control the Board of
Directors or equivalent governing body of a corporation or other entity, or the
ability to cause the direction of the management or policies of a corporation or
other entity. The Parties acknowledge that in the case of certain entities
organized under the laws of certain countries outside of the United States, the
maximum percentage ownership permitted by law for a foreign investor may be less
than fifty percent (50%), and that in such case such lower maximum percentage
shall be substituted in the preceding sentence; provided that such foreign
investor has the power to direct the management and policies of such entity. In
the case of Novartis, "Affiliate" shall specifically exclude the Novartis
Institutes for Tropical Diseases, Idenix Pharmaceuticals Inc. and any Person
that becomes an Affiliate of Novartis after the Effective Date for all purposes
under this Agreement; provided that, for the purposes of determining Net Sales
only, such excluded parties shall be deemed to be Affiliates unless they are the
end users of the Drug Product.

     1.3 "Auditor" shall mean an independent reputable and certified auditor to
be engaged by Avanir to conduct a review of Novartis' books and records
regarding the sales of the Drug Products after such auditor's approval by
Novartis, which approval shall be neither unreasonably withheld or delayed.

     1.4 "Avanir Intellectual Property" shall mean all Avanir Patents and Avanir
Know-How and Avanir's right, title and interest in and to Joint Intellectual
Property.

     1.5 "Avanir Know-How" shall mean all Know-How Controlled by Avanir relating
to the MIF Program, the Compounds and the Drug Products.

     1.6 "Avanir Patents" shall mean all Patents Controlled by Avanir relating
to the MIF Program, the Compounds or the Drug Products necessary or useful to
Novartis in the


                                        3

development and/or commercialization of the Compounds or the Drug Products. A
list of Avanir Patents is appended hereto as Annex 1 and will be updated
periodically to reflect additions thereto during the term of this Agreement.

     1.7 "Business Day" shall mean any day other than a Saturday, Sunday or any
other day on which commercial banks in New York, New York, Basel, Switzerland or
Hamilton, Bermuda are authorized or required by law to remain closed.

     1.8 "Change In Control" shall mean any transaction which results in the
sale, merger, consolidation, transfer, or other reorganization of Avanir in
which substantially all of the assets of Avanir are transferred to a Third Party
with a market capitalization at the time in excess of $[***] or the resulting
entity with a market capitalization at the time in excess of $[***] which the
holders of Avanir's capital stock immediately prior to the transaction hold less
than a majority of the capital stock of the surviving entity after the
transaction.

     1.9 "Commercially Reasonable Efforts" shall mean the efforts and resources
normally used by Novartis and its Affiliates for a product with comparable sales
or sales potential, stage of development or development potential, and profit or
profit potential to the particular Compound or Drug Product.

     1.10 "Compound" shall mean any compound Controlled by Avanir that directly
interacts with macrophage migration inhibitory factor in vitro and/or in vivo,
including but not limited to that compound Controlled by Avanir known as [***].
The definition of Compound includes all its various chemical forms, including
derivatives, acids, bases, esters, salts, isomers, enantiomers, pro-drug forms,
metabolites, hydrates, solvates, polymorphs and degradants thereof in crystal,
powder or other form in existence as of the Effective Date or that arise during
the term of this Agreement.

     1.11 "Controlled" shall mean the legal authority or right of a Party hereto
to grant a license or sublicense of intellectual property rights to another
Party hereto, or to otherwise disclose proprietary or trade secret information
to such other Party, without breaching the terms of any agreement with a Third
Party, infringing upon the intellectual property rights of a Third Party, or
misappropriating the proprietary or trade secret information of a Third Party.

     1.12 "Data" shall mean any and all results, studies and information of any
type, including test results (including but not limited to pre-clinical and
human tests), and

                                              * Confidential Treatment Requested


                                        4

developmental, marketing, manufacturing and pharmaceutical information, whether
or not proprietary, and any related technical data or operating information,
regulatory dossier, submissions and translations with respect to any of the
foregoing, generated by or resulting or derived from the efforts of either Party
with respect to the Compounds or the Drug Products.

     1.13 "Development" or "Develop" shall mean activities associated with the
development of the Compounds and the Drug Products which are conducted by or at
the direction of Novartis and its Affiliates including but not limited to: (a)
manufacture, formulation and distribution of the Compounds and Drug Products for
clinical studies and commercial use; (b) planning, implementation, evaluation
and administration of preclinical research and development, animal studies,
human clinical trials, manufacturing process development and scale-up for the
commercial manufacture of the Compounds or the Drug Products; (c) preparation
and submission of Regulatory Filings; and (d) post-market surveillance of
approved drug indications, as required or agreed as part of a marketing approval
by any governmental regulatory authority.

     1.14 "Drug Product" shall mean any finished dosage form containing a
Compound as its active ingredient either alone or in combination with one or
more active or inactive ingredients and which is ready for human or animal
administration as a pharmaceutical.

     1.15 "FDA" shall mean the United States Food and Drug Administration, its
equivalent in another country in the Territory, or successor agencies thereto.

     1.16 "Field" shall mean all human and animal health-care applications
including, but not limited to, research, diagnosis, therapeutics, and
prophylaxis with respect to any Indication.

     1.17 "First Commercial Sale" shall mean the first sale of a Drug Product by
Novartis or an Affiliate or sublicensee of Novartis to a Third Party in a
country in the Territory following Regulatory Approval of such Drug Product in
that country or, if no such Regulatory Approval or similar marketing approval is
required, the date upon which such Drug Product is first commercially launched
in such country.

     1.18 "FTE" shall mean the equivalent of the work of one (1) scientist or
technical support person, full time for one (1) year, for or on behalf of
Avanir, which equates to a total of two thousand (2,000) hours per year of work,
directly related to the Research Program, excluding managerial activities. The
annual rate per FTE shall be $[***].

                                              * Confidential Treatment Requested


                                        5

     1.19 "Indication" shall mean a recognized disease or condition, sign or
symptom of a disease or condition, or symptom associated with a disease or
syndrome for which use of a Drug Product is approved, as would be identified for
example in the Drug Product's label under applicable FDA regulations or
equivalent thereof.

     1.20 "Initial Research Term" shall have the meaning set forth in Section
2.2.

     1.21 "Joint Intellectual Property" shall mean any and all: (i) Joint
Patents; and (ii) Know-How which are jointly made, conceived or reduced to
practice by Novartis, its Affiliates or others acting on its or their behalf on
the one hand, and Avanir, its Affiliates or others acting on its or their
behalf, on the other hand, in connection with any research, development or other
work relating to the Research Program, the Compounds or the Drug Products
performed under or in connection with this Agreement.

     1.22 "Joint Patents" shall have the meaning set forth in Section 8.3.

     1.23 "Joint Program Committee" or "JPC" shall have the meaning set forth in
Section 4.5.

     1.24 "Joint Research Committee" or "JRC" shall have the meaning set forth
in Section 2.4.

     1.25 "Know-How" shall mean all intellectual property, proprietary material
and information including but not limited to clinical and non-clinical data,
technical information, know-how, experience, inventions, discoveries, trade
secrets, compositions of matter and methods, whether currently existing or
developed or obtained during the course of this Agreement and whether or not
patentable or confidential, that are now or in the future become Controlled by a
Party or its Affiliates and that are necessary to use, research, develop, seek
Regulatory Approval, manufacture or sell, including, without limitation, various
chemical forms, formulations, combinations, back-ups, modes of delivery and
methods of use of the Compounds and/or the Drug Products.

     1.26 "Major Market Countries" shall mean the United States, France,
Germany, Italy, Spain, the United Kingdom and Japan.

     1.27 "MIF Program" shall mean Avanir's low molecular weight macrophage
migration inhibitory factor program composed of the Compounds, all assays and
biomarkers related to such Compounds which are Controlled by Avanir.

     1.28 "Net Sales" with respect to any Drug Product shall mean the gross
amount


                                        6

invoiced by or on behalf of Novartis and its Affiliates, licensees or
sublicensees for that Drug Product sold to Third Parties other than licensees or
sublicensees in bona fide, arm's-length transactions, [***], determined in
accordance with Novartis' standard accounting methods as generally and
consistently applied by Novartis and its Affiliates, but only to the extent they
actually pertain to the disposition of such Drug Product and are separately
billed:

     (i)    [***]

     (ii)   [***]

     (iii)  [***]

     (iv)   [***]

     (v)    [***]

     (vi)   [***]

     (vii)  [***]

     (viii) [***]

     (ix)   [***]

     (x)    [***];

     all as determined in accordance with Novartis' and its Affiliates' usual
and customary accounting methods, which are in accordance with International
Financial Reporting Standards as consistently applied at Novartis. Sales from
Novartis to its Affiliates shall be disregarded for purposes of calculating Net
Sales. Any of the items set forth above that would otherwise be deducted from
the invoice price in the calculation of Net Sales but which are separately
charged to Third Parties shall not be deducted from the invoice price in

                                              * Confidential Treatment Requested


                                        7

the calculation of Net Sales.

     Further:

     (a) In the case of any sale or other disposal of the Drug Product between
or among Novartis and its Affiliates, licensees and sublicensees, for resale,
Net Sales shall be calculated as above only on [***];

     (b) In the case of any sale which is not invoiced or is delivered before
invoice, Net Sales shall be calculated [***] or [***];

     (c) In the case of any sale or other disposal for value, such as barter or
counter-trade, of the Drug Product, or part thereof, other than in an
arm's-length transaction exclusively for money, Net Sales shall be calculated as
above on [***] or [***];

     (d) In the event the Drug Product is sold in a finished dosage form
containing a Compound in combination with one or more other active ingredients
(a "Combination Product"), the Net Sales of the Drug Product, for the purposes
of determining royalty payments, shall be determined by multiplying the Net
Sales (as defined above in this Section) of the Combination Product by the
fraction, A/(A+B) where A is [***] and B is [***]. In the event that such [***]
cannot be determined for both the Drug Product and the other product(s) in
combination, Net Sales for purposes of determining royalty payments shall be
agreed by the Parties based on the relative value contributed by each component,
such agreement shall not be unreasonably withheld.

     1.29 "Novartis Intellectual Property" shall mean all Novartis Patents and
Novartis Know-How made, developed or conceived by Novartis in the course of its
work pursuant to and during the term of this Agreement, and Novartis' and its
Affiliates' right, title and interest in and to Joint Intellectual Property.

                                               *Confidential Treatment Requested


                                        8

     1.30 "Novartis Know-How" shall mean all Know-How Controlled by Novartis or
its Affiliates (other than by virtue of the licenses granted to it and its
Affiliates hereunder) relating to the Compounds or the Drug Products.

     1.31 "Novartis Patents" shall mean all Patents Controlled by Novartis or
its Affiliates (other than by virtue of the licenses granted to it and its
Affiliates hereunder) relating to the Compounds or the Drug Products.

     1.32 "Novartis Submitted Compound" shall have the meaning set forth in
Section 2.8.

     1.33 "Parties" shall mean Avanir and Novartis and each individually shall
be a "Party".

     1.34 "Patents" shall mean all patent filings, utility model filings and
design filings, whether granted (issued), or not and all foreign counterparts of
any of the foregoing, including but not limited to patent applications,
continuations, continuations-in-part, additions, divisionals, provisionals or
any substitute applications, black box applications, registration applications,
supplementary protection certificate applications, and including granted
(issued) patents with respect to any of such application, including reissue
patents, re-examination patents, renewal patents, extensions including
supplementary protection certificates, confirmation patents or registration
patents and patents of addition.

     1.35 "Person" shall mean any individual, corporation, partnership,
association, joint-stock company, trust, unincorporated organization or
government or political subdivision thereof.

     1.36 "Phase I Clinical Trial" means the first clinical study of a Drug
Product in humans.

     1.37 "Phase II Clinical Trial" means a clinical study of a Drug Product in
patients intended to demonstrate efficacy, safety and tolerability, as well as
to define the dosage regimen and dose range required for a product in a
designated indication.

     1.38 "Phase III Clinical Trial" means a clinical study of a Drug Product in
patients which protocol is designed to establish efficacy and safety of such
Product for the purpose of preparing and submitting a Regulatory Filing in a
particular country.

     1.39 "Proprietary Party" shall have the meaning set forth in Section 10.1.

     1.40 "Regulatory Approval" shall mean all authorizations by the appropriate


                                        9

governmental entity or entities necessary for commercial sale of a Drug Product
in that country including, without limitation and where mandatory, approval of
labeling, price, reimbursement and manufacturing.

     1.41 "Receiving Party" shall have the meaning set forth in Section 10.1.

     1.42 "Regulatory Filing" shall mean with respect to each Drug Product the
submission to the relevant governmental regulatory authority of any appropriate
regulatory application, and shall include, without limitation, any submission to
a regulatory advisory board, marketing authorization application, supplementary
application or variation thereof, or any equivalent applications.

     1.43 "Research Plan" shall have the meaning set forth in Section 2.3(a).

     1.44 "Research Program" shall mean research activities and development
activities undertaken under this Agreement in connection with the Research Plan.

     1.45 "Research Term" shall have the meaning set forth in Section 2.2.

     1.46 "Research Year" shall mean a twelve (12) month period during the term
of the Research Program commencing on April 1st of a given year, and ending on
March 31st of the following year. The first Research Year hereunder shall be
deemed to have commenced on April 1, 2005.

     1.47 "Sales Report" shall mean a written report or reports showing each of:
(a) the Net Sales of each Drug Product in each country in the world during the
reporting period by Novartis and each Affiliate and sublicensee; (b) the number
of Drug Products sold in each country in the world during the reporting period
by Novartis and each Affiliate and sublicensee, and if applicable, the average
sale price during the reporting period for each Drug Product in any combination
product; (c) the royalties, payable in United States Dollars, which shall have
accrued under Section 7.5 in respect of such sales and the basis of calculating
those royalties; (d) withholding taxes, if any, required by law to be deducted
in respect of any such sales; (e) the US Dollar and local currency Net Sales by
country; and (f) dispositions of the Drug Products other than pursuant to sale
for cash, the value of such non-cash consideration and the method used to
calculate the value of the non-cash consideration.

     1.48 "sPOC" shall mean the selection for the clinical phase of Development
by Novartis in a given Indication. The specific criteria used to determine sPOC
are set forth in the Research Plan.


                                       10

     1.49 "Submitted Drug Product" shall have the meaning set forth in Section
2.8.

     1.50 "Territory" shall mean all the countries in the world.

     1.51 "Third Party" shall mean any Person or entity which is not a Party or
an Affiliate of any Party to this Agreement.

     1.52 "United States Dollars" shall mean the legal tender of the United
States of America.

     1.53 "Valid Claim" shall mean a claim of any granted, unexpired Patent that
has not been revoked or held unenforceable or invalid by a decision of a court
or governmental agency of competent jurisdiction from which no appeal can be
taken, or with respect to which an appeal is not taken within the time allowed
for appeal, and that has not been disclaimed, denied or admitted to be invalid
or unenforceable through reissue, disclaimer or otherwise, and that has not been
lost through interference proceedings or by intentional or unintentional
abandonment.

     1.54 "Wind-Down Period" shall have the meaning set forth in Section 12.4.

                                   ARTICLE II

                                RESEARCH PROGRAM

     2.1 COMMENCEMENT

     The Research Program shall commence pursuant to the Research Plan as soon
as practicable after the Effective Date. The Joint Research Committee, as
defined below, shall direct the conduct of the Research Program and the Parties
shall collaborate in the conduct of the Research Program with the roles and
responsibilities specified in the Research Plan. The Joint Research Committee
shall review and coordinate the efforts of the Parties with respect to the
Research Program.

     2.2 TERM

     The Research Program will conclude two (2) years from the Effective Date
(the "Initial Research Term"), unless earlier terminated in accordance with the
provisions hereof. The Research Program may be extended for up to two (2)
additional one- (1-) year periods (each of such periods, along with the Initial
Research Term, a "Research Term"), upon agreement of the Parties, upon the
provision of written notice to Avanir not later than ninety


                                       11

(90) calendar days prior to the end of the then current Research Term. Upon
mutual agreement of the Parties, the Research Term may be extended for
additional periods.

     2.3 RESEARCH PLAN; RESEARCH DILIGENCE; SUBMISSION OF REPORTS

     (a) Novartis and Avanir will agree upon an overall research plan, which
shall outline the overall objectives of the Research Program, including general
work flow and deliverables for each of the Parties (the "Research Plan"). An
initial outline of the Research Plan shall be attached to this Agreement as
Annex 2. The Parties will agree upon the final Research Plan within sixty (60)
calendar days after the Effective Date. Thereafter, the Research Plan shall be
reviewed by the JRC as necessary, and at any other time upon the request of
either Party, and shall be modified as appropriate to reflect material
scientific or commercial developments. Any disagreements between the Parties
with respect to any modification of the Research Plan will be resolved in
accordance with Section 2.7 of this Agreement.

     (b) Each of Avanir and Novartis and their respective Affiliates shall use
commercially reasonable efforts to fulfill their respective obligations under
the Research Plan.

     (c) Within at least ten (10) calendar days prior to each scheduled
quarterly meeting, each of the Parties shall provide a report to the JRC
detailing its progress with respect to the Research Program.

     2.4 JOINT RESEARCH COMMITTEE

     Upon execution of this Agreement, Avanir and Novartis will establish a
Joint Research Committee ("JRC"), which shall consist of an equal number of
executives or scientists as may be designated by each Party from time to time.
The JRC shall initially have six (6) members with each of Novartis and Avanir
having one (1) vote. If the JRC chooses to designate a Committee Chair, the
Parties shall alternate responsibility for chairing the meetings of the JRC,
beginning with Novartis. The JRC shall hold its first meeting within thirty (30)
calendar days after the Effective Date. Thereafter, the JRC shall meet
quarterly, or with such other frequency as may be established by the JRC (but in
no event less often than three (3) times per year), and at such time and
location as may be established by the JRC, for the following purposes:

     (a) Provide general oversight of the Research Program;


                                       12

     (b) Periodically review the overall goals and strategy of the Research
Program and consider changes to the Research Plan;

     (c) Prioritize the allocation of resources dedicated to the Research
Program, determine the number of FTEs required, and determine if Third Party
contractors should be engaged in connection with the Research Program; provided
that: (i) the foregoing rights of the JRC shall not be exercised to divest
Avanir of its rights to perform the services and conduct the activities set
forth in the Research Program; and (ii) the selection of Third Party contractors
and the terms of any engagement shall be in the sole discretion of [***];

     (d) Review for acceptance any compound(s) Controlled by Novartis to be
included in the Research Program pursuant to Section 2.8, if any; and

     (e) Resolve any disagreement between the Parties and discuss and resolve
any other relevant issues submitted to it, in accordance with the dispute
resolution procedure set forth in Section 2.7 below.

     The JRC may meet via telephone or video conference or in person; provided,
however, no less than one meeting each year shall be in person. In person
meetings shall, as a general matter, alternate between the Parties' (or, in the
case of Novartis, its Affiliates') sites in the United States. Each Party shall
be entitled to bring visitors to participate in meetings of the JRC; provided
that such visitors are reasonably acceptable to the other Party and subject to
obligations of confidentiality and non-use to the inviting Party no less
burdensome than as set forth in Article X. The Party providing the Chair of the
meeting shall prepare and circulate an agenda for comment and approval by the
other Party for the upcoming meeting and shall be responsible for taking minutes
at the meeting. Written minutes reflecting the conduct of each meeting of the
JRC shall be prepared and circulated among all members of the JRC promptly
following the meeting to which they relate. Minutes shall be reasonably detailed
and shall summarize all matters discussed by the JRC, state any conclusions or
determinations reached by the JRC and summarize the reasons for any such
conclusions or determinations. In addition, a Party may call a meeting of the
JRC upon reasonable notice to the other Party, such notice requirement being
deemed waived by a Party's attendance and participation. Conversations between
members of the JRC shall not be deemed to be meetings thereof absent a call for
a meeting, whether mutual or unilateral or such meeting being otherwise
scheduled. Minutes shall become official only upon their

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unanimous approval by the members of the JRC who attended the meeting reflected
in the minutes, and any dispute regarding the minutes shall not be subject to
resolution pursuant to Section 2.7.

     The JRC shall have the authority to create project teams for the Research
Program, each of which will meet (via telephone or video conference or in
person) no less frequently than monthly, and which will report to the JRC on its
progress on activities performed on the Research Program. The JRC shall also
have the authority to create additional subcommittees as needed. Notwithstanding
the foregoing, the JRC shall not have the authority to amend or modify the terms
of this Agreement.

     2.5 EXCHANGE OF INFORMATION; USE OF TECHNOLOGY

     (a) Avanir and Novartis and their respective Affiliates will share
information with the JRC necessary to facilitate mutual understanding of the
status of the Research Program and decision-making in connection therewith, as
soon as it is available.

     (b) Neither Avanir nor Novartis nor their respective Affiliates shall use
information disclosed by the other Party (excluding information which is no
longer subject to confidentiality restrictions under Article X by reason of the
exceptions set forth in Section 10.2(a), (b) and (c)) for any purpose, including
the filing of Patents containing such information without the other Party's
consent (which shall not be unreasonably withheld), other than for carrying out
the Research Program or discharging its responsibilities under this Agreement.

     (c) Except as otherwise set forth in this Agreement, neither Party shall be
entitled to information from the other Party concerning know-how, information or
technology discovered or developed by that Party outside the Research Program or
the Development; except that each Party must disclose to the JRC as soon as
practicable any and all know-how, information or technology which it discovers
or develops regarding any Joint Intellectual Property.

     (d) Neither Party will apply its rights in any information or technology or
the use thereof (and will use reasonable efforts to prevent its licensees, if
any, from applying similar rights acquired by license) to block or impede the
use of such information or technology as permitted hereunder by the other Party
or its assignees or licensees.


                                       14

     2.6 PRIMARY DATA ACCESS

     Each Party shall grant to the other and its Affiliates access to all data
(including, without limitation, all primary data and data contained in
laboratory notebooks) that directly relates to the MIF Program and/or is
generated as a result of performing its obligations under the Research Program.
Each Party and its Affiliates shall have the right, at reasonable intervals,
upon reasonable notice, and at its own expense, to have authenticated copies of
such data made to use and transfer as permitted hereunder.

     2.7 DECISIONS OF THE JRC; RESOLUTION OF DISPUTES

     The JRC shall make decisions unanimously where possible, but at least by
majority vote. If the JRC is unable to decide or resolve unanimously any matter
properly presented to it for action, then at the written request of either
Party, the issue shall be referred to the President of the Novartis Institutes
for BioMedical Research, Inc. (an Affiliate of Novartis) and the Chief Executive
Officer of Avanir. Such officers of the Parties, or their designees, will meet
promptly thereafter and shall negotiate in good faith to resolve such issue for
up to sixty (60) days. In the event of a deadlock, [***] shall have the deciding
vote. No such decisions shall obligate Avanir to spend money or devote resources
outside the previously agreed to in the Research Plan.

     2.8 POTENTIAL INCLUSION OF NOVARTIS COMPOUNDS TO THE RESEARCH PROGRAM

     From time to time during the Research Term, Novartis shall submit to the
JRC, for inclusion in the Research Program, any compound(s) Controlled by
Novartis (other than compounds licensed in or acquired by Novartis or its
Affiliates after the Effective Date) that (a) Novartis either has tested prior
to the Effective Date of this Agreement, or chooses, in its sole discretion, to
test using [***] and (b) [***]. Submission of such compound(s) to the JRC shall
be made in writing specifying in reasonable detail the compound(s) to be
included, and the acceptance by the JRC of such compound(s) shall be documented
in the minutes of the JRC. Each such compound that is accepted for inclusion by
the JRC (each a "Novartis Submitted Compound") and a drug product which contains
such Novartis Submitted Compound (each, a "Submitted Drug Product") shall be
treated as a Compound and a Drug Product, respectively, for the purposes of this
Agreement. For the avoidance of doubt: (i) the decision to submit any
compound(s) Controlled by Novartis for inclusion in the Research Program
pursuant to this Section 2.8 shall be in Novartis' sole and absolute discretion.

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                                   ARTICLE III

                                     LICENSE

     3.1 GRANT TO NOVARTIS

     Subject to the terms and conditions of this Agreement, Avanir hereby grants
to Novartis and its Affiliates a worldwide, exclusive license under the Avanir
Intellectual Property (with the right to sublicense) to research, develop, have
developed, make, have made, use, distribute, have distributed, export, have
exported, import, have imported, promote, have promoted, market, have marketed,
sell, have sold and offer to sell the Compounds and the Drug Products whether in
monotherapy or in combination with other pharmaceutical products, in the Field
in the Territory. Subject to the provisions of this Agreement, Avanir shall have
the right to use Avanir Intellectual Property and the Joint Intellectual
Property solely for research purposes and to comply with its obligations under
this Agreement. Novartis may subcontract its rights to manufacture the Compounds
or the Drug Products to a Third Party and may contract with Third Parties of its
choice to conduct or assist in the conduct of human clinical trials and the
evaluation of trials data or for any commercialization purposes. Novartis shall
be responsible to Avanir for the performance of any of its sublicensees or
subcontractors. Novartis shall not permit any subcontractors or sublicensees to
use Avanir Intellectual Property without provisions safeguarding confidentiality
at least equivalent to those provided in Article X (Confidentiality).

     3.2 INFORMATION TRANSFER

     From time to time after the Effective Date, and as determined by the JRC:
(i) Avanir shall deliver to Novartis free of charge material information
Controlled by it and possessed or readily available to Avanir relating to the
MIF Program and the Compounds and not previously provided to Novartis or its
Affiliates; and (ii) Novartis shall deliver to Avanir free of charge material
information Controlled by it and possessed or readily available to Novartis
relating to small molecule antagonists of macrophage migration inhibitory
factors not previously provided to Avanir. The information to be delivered shall
include copies of all Patents, Know-How, copyrights, copyright registrations,
and applications thereof, and all clinical or non-clinical data relating to the
MIF Program and macrophage migration inhibitory factors, as the case may be, and
the Compounds and all other manifestations of the intellectual property embodied
in the Compounds whether in human or machine readable form, all of which
delivered by Avanir shall be treated as confidential Avanir information pursuant
to Article X and all of which delivered by Novartis shall be treated as
confidential Novartis information pursuant to Article X.


                                       16

     3.3 COMPOUND SUBSTANCE TRANSFER

     As soon as practicable after the Effective Date, Avanir shall deliver to
Novartis free of charge such amounts of the Compounds, cell lines and other
material as are available to Avanir, and are not required otherwise for use by
or on behalf of Avanir in connection with the Research Plan or Development. Upon
the successful testing of a Compound in all of the in vivo models set forth in
the Research Plan, Avanir shall use commercially reasonable efforts to deliver
to Novartis approximately [***] of such Compound (at [***]). All such substances
described in this Section 3.3 shall be accompanied by appropriate certificates
of analysis to the extent they exist.

                                   ARTICLE IV

                                   DEVELOPMENT

     4.1 DEVELOPMENT RESPONSIBILITIES

     As soon as practicable after the achievement of the sPOC milestone
described in Section 7.4(a) and Annex 2 in connection with a particular
Compound, Novartis or its Affiliates shall commence the Development of such
Compound. Novartis or its Affiliates shall have sole authority and
responsibility for, and bear the cost of conducting, the Development with
respect to the Compound and the resulting Drug Product(s).

     4.2 REGULATORY MATTERS

     Novartis or its Affiliates shall have sole discretion concerning the
regulatory strategy and decision-making for all Compounds and Drug Products. All
Regulatory Filings shall be made by Novartis or its Affiliates. Novartis or its
Affiliates shall be responsible for all required Regulatory Approvals, including
formulary or marketing approvals. All Regulatory Approvals shall be held in the
name of Novartis or its Affiliates. Novartis or its Affiliates shall be the
principal interface with and shall otherwise handle all interactions with
regulatory agencies with respect to any Compounds and Drug Products. Novartis or
its Affiliates shall have the right to cross-reference information and
regulatory filings arising out of development work which previously has been
conducted by Avanir and its Affiliates and licensees, for the purpose of
Regulatory Filings hereunder. Avanir shall assist Novartis

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and its Affiliates and take all actions as reasonably requested by Novartis or
its Affiliates to enable Novartis or its Affiliates to comply with any law
applicable to the Compounds or the Drug Products, and Novartis or its Affiliates
shall reimburse Avanir for its out-of-pocket expenses incurred in connection
with such assistance.

     4.3 DEVELOPMENT OBLIGATIONS; DEVELOPMENT REPORTS

     Novartis or its Affiliates shall use Commercially Reasonable Efforts to
develop the Compounds into Drug Products. Novartis or its Affiliates shall
promptly notify Avanir in writing if it should determine that development of the
Compounds or the Drug Products is not technically feasible or commercially
justifiable, specifying in reasonable detail the reasons for that determination.
Novartis or its Affiliates shall prepare and submit to Avanir, on a semi-annual
basis, reports which set forth in reasonable detail: (a) the progress of the
Development and the results of work performed during the preceding semi-annual
period including a description of any key scientific discoveries as of the date
of the report; and (b) Development activities that are ongoing and planned for
the following semi-annual period, including a current schedule of anticipated
events or milestones, including those set forth in Section 7.2; (c) the
anticipated and actual market introduction dates for each Compound and Drug
Product; and (d) any sublicensing activity under this Agreement. Novartis or its
Affiliates will promptly report to Avanir the date of the first sale of a
Compound or Drug Product in each country. In the event of a Change In Control of
Avanir, Novartis and its Affiliates shall no longer be obligated to provide the
development reports set forth above to Avanir.

     4.4 INDICATIONS

     Novartis or its Affiliates shall have the sole discretion to determine the
Indication(s) for which it will develop the Compounds and the Drug Products.

     4.5 JOINT PROGRAM COMMITTEE

     (a) Within sixty (60) calendar days after the first achievement of the
[***] described in Section 7.4(a) and Annex 2, the Parties will establish a
Joint Program Committee ("JPC"), which shall consist of at least two (2)
representatives from each Party which may be designated by such Party from time
to time. Upon the establishment of the JPC with respect to a particular
Compound, the JRC shall have no further authority with respect to such Compound.
Each Party shall be entitled to bring visitors to participate in meetings of the
JPC; provided that such visitors are reasonably acceptable to the other Party

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and subject to obligations of confidentiality and non-use to the inviting Party
no less burdensome than as set forth in Article X. The JPC shall meet quarterly,
or with such other frequency as may be established by the JPC (but in no event
less often than two (2) times per year), and at such times and locations as may
be established by the JPC, for the sole purpose of providing a forum for
Novartis to seek input from, and provide updates to Avanir with respect to the
Development of Compounds and/or the commercialization of Drug Products, such
input to be given due consideration by Novartis. The JPC shall have no
decision-making authority with respect to the Development of Compounds and/or
the commercialization of Drug Products.

     (b) Each Party shall bear all expenses incurred by its delegates in
connection with their participation on the JPC. Meetings may be held in person,
by video conference or by teleconference, as the JPC may determine. In person
meetings shall, as a general matter, alternate between the Parties' (or, in the
case of Novartis, its Affiliates') sites in the United States. The JPC shall not
have the authority to amend or modify the terms of this Agreement. The JPC shall
be dissolved immediately upon provision of a written notice from Novartis to
Avanir in the event of a Change In Control of Avanir.

                                    ARTICLE V

                            MANUFACTURING AND SUPPLY

     5.1 COMPOUNDS AND DRUG PRODUCTS

     Novartis and its Affiliates shall have the exclusive worldwide right to
manufacture, distribute and supply (or have manufactured, distributed or
supplied) all Compounds and Drug Products as necessary for the conduct of the
Development and for all commercial purposes. Novartis and its Affiliates may
subcontract manufacturing in its sole discretion.

     5.2 FORMULATION AND PACKAGING

     In all events, Novartis and its Affiliates will be responsible for
formulation, packaging and labeling including but not limited to package inserts
and leaflets of the Drug Products.


                                       19

                                   ARTICLE VI

                                COMMERCIALIZATION

     6.1 MARKETING AND PROMOTION

     Consistent with Section 3.1, Novartis and its Affiliates shall have the
exclusive worldwide right to distribute, have distributed, export, have
exported, import, have imported, promote, have promoted, market, have marketed,
sell, have sold and offer to sell the Drug Products in the Territory.

     6.2 RECORDING OF SALES

     Novartis and its Affiliates shall record all sales of the Drug Products.
Pricing of the Drug Products will be determined by Novartis and its Affiliates
in their sole discretion.

     6.2 USE OF COMMERCIALLY REASONABLE EFFORTS

     Novartis and its Affiliates shall use Commercially Reasonable Efforts and
sound and reasonable business practices and judgment to effect the introduction
of Drug Products into the Major Market Countries as soon as reasonably
practicable. Novartis or its Affiliates shall promptly notify Avanir if it shall
determine that the marketing and sale of a Drug Product in any Major Market
Country is not commercially reasonable or economically profitable or if for
other unforeseen reasons further commercial support of a Drug Product in any
country is no longer prudent or practical.

                                   ARTICLE VII

                                    PAYMENTS

     7.1 UP-FRONT PAYMENT

     Upon the receipt by Novartis of a corresponding invoice from Avanir,
Novartis shall pay Avanir $2.5 million within ten (10) business days after the
Effective Date.

     7.2 STAFFING AND RESEARCH SUPPORT PAYMENTS

     Novartis or its Affiliates will fund between [***] and [***] Avanir FTEs in
each particular Research Year, with the exact number of FTEs to be determined by
the JRC. The JRC shall determine the manner in which such FTEs shall be
allocated under the Research Program. The annual rate per FTE shall be $[***].
The FTEs shall be funded in support of the Research Program under this
Agreement.

     Payments due for each Research Year shall be made by Novartis or its
Affiliates to Avanir quarterly in advance on or before April 1, July 1, October
1, and January 1 of each

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Research Year except that the quarterly payment due April 1, 2005 for the first
Research Year shall be made within thirty (30) calendar days after the Effective
Date. All payments shall be made without deduction for withholding or other
similar taxes, in United States Dollars to the credit of such bank account as
may be designated by Avanir in writing to Novartis. Any payments which fall due
on a date which is a legal holiday in Hamilton, Bermuda or Basel, Switzerland
may be made on the next following day which is not a legal holiday in Hamilton,
Bermuda or Basel, Switzerland.

     7.3 RECORDS

     Avanir shall keep accurate records and books of accounts, in accordance
with the Accounting Standards, containing all data reasonably required for the
calculation and verification of FTEs employed by, or equivalents supplied by,
Avanir in accordance with the Research Plan.

     At Novartis' reasonable advance written request, Avanir shall make those
records available, no more than once in a calendar year, during reasonable
working hours, for review by a recognized independent accounting firm acceptable
to both parties, at Novartis' expense, for the sole purpose of verifying the
accuracy of those records in the calculation of FTEs involved in the Research
Program. Novartis shall use commercially reasonable efforts to cause the
accounting firm to retain all such information in confidence.

     In the event of a negative difference between the average number of FTEs
stated to be involved in the Research Program and the number of FTEs actually
employed, the amount previously advanced to Avanir and attributable to any such
negative difference shall be due and payable to Novartis within thirty (30) days
of its receipt of the accounting firm's report. If the negative difference is
more than [***] in any Research Year, then Avanir shall also pay the reasonable
costs of the independent accountant employed by Novartis in the review.

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     7.4 MILESTONE PAYMENTS

     (a) Novartis or its Affiliates shall notify Avanir within thirty (30)
calendar days after the achievement of the milestone events set forth below with
respect to the Compounds or the Drug Products, and Novartis or its Affiliates
shall pay to Avanir the amounts set forth below in accordance with Section
16.18:

     
[***]   $[***]

[***]   $[***]

[***]   $[***]

[***]   $[***]

[***]   $[***]

[***]   $[***]

[***]   $[***]

[***]   $[***]

[***]   $[***]

[***]   $[***]

[***]   $[***]



*    In order to be considered as a second or third Regulatory Approval for the
     purposes of the milestones set forth above, a Regulatory Approval must be
     for an Indication in a different therapeutic area than the other Regulatory
     Approvals for such Drug Product. For the avoidance of doubt, the second
     Regulatory Approval for a Drug Product must be for an

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Indication in a different therapeutic area from the first Regulatory Approval
for such Drug Product, and the third Regulatory Approval must be for an
indication in a different therapeutic area from the first and second Regulatory
Approval for such Drug Product. By way of example, [***], [***] and [***] would
be considered separate therapeutic areas for the purposes of this Agreement, but
an Indication of combination therapy in [***] would not be considered as a
separate therapeutic area.

     (b) None of the payments listed above shall be payable more than once, and
each shall be payable at the first achievement of a milestone event for the
Compound or Drug Product and shall not be payable again if subsequently a
Combination Product, back-up or another Compound would achieve the same
milestone event.

     (c) All payments shall be made by wire transfer in United States Dollars to
the credit of such bank account as may be designated by Avanir in this Agreement
or in writing to Novartis. Any payment which falls due on a date which is not a
Business Day in Hamilton, Bermuda or Basel, Switzerland may be made on the next
succeeding Business Day in Hamilton, Bermuda or Basel, Switzerland. In the event
that any payment due hereunder is not received by Avanir when due, Novartis
shall pay to Avanir interest charges at a rate equal to the [***]. Such interest
shall be calculated from the date that payment was due until actually received
by Avanir.

     7.5 ROYALTY PAYMENTS

     (a) On a Drug Product by Drug Product basis, with respect to those
countries in which an Avanir Patent with a Valid Claim exists, Novartis or its
Affiliates shall pay to Avanir the following royalties in respect of such
countries:

[***] percent ([***]%) on annual Net Sales up to $[***]

[***] percent ([***]%) on that amount of annual Net Sales that is greater than
$[***] but less than or equal to $[***]

[***] percent ([***]%) on that amount of annual Net Sales greater than $[***]

     (b) In the event that Novartis or its Affiliates determines in its sole
discretion (but only after consultation with Avanir), that it would be necessary
or useful to acquire rights

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from one or more Third Parties in order to sell a Drug Product in a country,
then [***] percent ([***]%) of the royalty payable to such Third Party in such
country shall be deductible from the royalties payable to Avanir under this
Agreement. In no event shall this deduction cause the amounts to be paid to
Avanir to be less than [***] percent ([***]%) of the amount otherwise payable to
Avanir pursuant to Section 7.5(a) or Section 7.5(c), as the case may be. In the
event that the amount Novartis or its Affiliates is entitled to deduct hereunder
exceeds the amount of any individual royalty payment due to Avanir, Novartis or
its Affiliates shall be entitled to deduct amounts from any subsequent
payment(s) until the entire amount to which Novartis or its Affiliates is
entitled to deduct has been so deducted.

     (c) On a Drug Product by Drug Product basis, with respect to those
countries in which no Avanir Patents with a Valid Claim exist, Novartis shall
pay to Avanir royalties at [***] percent ([***]%) of the rates set forth in
Section 7.5(a), as reduced by Section 7.5(b), if applicable, in consideration of
Avanir Know-How; provided, however that, should a generic version of a Drug
Product be sold by a Third Party in the same country as a Drug Product, then the
royalty payments set forth in this Section 7.5 for such Drug Product shall
cease.

     (d) On a country-by-country basis, royalties as outlined in this Section
7.5 shall be payable for the term of this Agreement as set out in Article XII
(Term and Termination), on a quarterly basis, within sixty (60) calendar days
after the end of each calendar quarter, and in accordance with Section 16.18.

     7.6 SALES REPORTS

     (a) During the term of this Agreement and after the First Commercial Sale
of a Drug Product, Novartis or its Affiliates shall furnish or cause to be
furnished to Avanir on a quarterly basis a Sales Report covering each calendar
quarter (each such calendar quarter being sometimes referred to herein as a
"reporting period"). With respect to sales of Drug Products invoiced in United
States Dollars, the Net Sales amounts and the amounts due to Avanir hereunder
shall be expressed in United States Dollars. With respect to sales of Drug
Products invoiced in a currency other than United States Dollars, the Net Sales
and amounts due to Avanir hereunder shall be expressed in the domestic currency
of the Party making the sale, together with the United States Dollar equivalent
of the amount payable to Avanir, calculated using the then-current Novartis
standard exchange rate methodology applied in its external reporting (which is
ultimately based on official rates such as Reuters and the European Central
Bank) for the conversion of foreign currency sales into United States

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Dollars. Novartis shall furnish to Avanir appropriate evidence of payment of any
tax or other amount required by applicable laws or regulations to be deducted
from any royalty payment, including any tax or withholding levied by a foreign
taxing authority in respect of the payment or accrual of any royalty. Sales
Reports shall be due on the thirtieth (30th) Business Day following the close of
each reporting period. Novartis or its Affiliates shall keep accurate records in
sufficient detail to enable the amounts due hereunder to be determined and to be
verified by Avanir.

     (b) If at any time legal restrictions prevent the prompt remittance of any
payments with respect to any country of the Territory where a Drug Product is
sold, Novartis or its Affiliates or its sublicensees shall convert the amount
owed into US Dollars and remit payment from another source of funds.

     7.7 AUDIT

     (a) Avanir shall have the right for a period of three (3) years after
receiving any report or statement with respect to royalties due and payable to
appoint an Auditor to inspect the relevant records of Novartis or its Affiliates
to verify such reports, statements, records or books of accounts, as applicable.
Before beginning its audit, the auditor shall execute an undertaking reasonably
acceptable to Novartis by which the Auditor shall keep confidential all
information reviewed during such audit. The auditor shall have the right to
disclose to Avanir its conclusions regarding any payments owed to Avanir.

     (b) Novartis and its Affiliates shall keep complete and accurate books and
records regarding the sales of Drug Products in sufficient detail to enable the
payments due to Avanir hereunder to be determined. Novartis and its Affiliates
shall retain the books and records with respect to any annual accounting periods
for three (3) years after the date of the last entry for such annual accounting
period and during any extended period during the pendency of any controversy.
Novartis or its Affiliates shall make its records available for inspection by
the Auditor during regular business hours at such place or places where such
records are customarily kept, upon receipt of reasonable advance notice from
Avanir, solely to verify the accuracy of Novartis' or its Affiliates' sales
reports, payments records or books of accounts and Novartis' or its Affiliates'
compliance in other respects with this Agreement. Such inspection right shall
not be exercised more than once in any calendar year nor more frequently than
once with respect to records covering any specific period of time, except in the
event of accounting changes or restatements by Novartis or its Affiliates
directly related


                                       25

to a Drug Product and limited to any specific country changes or restatements.
Avanir agrees to hold in strict confidence all information received and all
information learned in the course of any audit or inspection, except to the
extent necessary for such Avanir to reveal such information in order to enforce
its rights under this Agreement or if disclosure is required by law, regulation
or judicial order.

     (c) [***] shall pay for such inspections, as well as its own legal expenses
associated with enforcing its rights with respect to any payments hereunder,
except that in the event there is any upward adjustment in aggregate amounts
payable for any year shown by such inspection of more than [***] percent
([***]%) of the amount paid, [***] shall pay for such inspection.

                                  ARTICLE VIII

                              INTELLECTUAL PROPERTY

     8.1 NOVARTIS INTELLECTUAL PROPERTY

     (a) All Novartis Intellectual Property shall be the property of Novartis or
its Affiliates, and Novartis or its Affiliates shall be the sole owner of such
Novartis Intellectual Property, other than that licensed hereunder from Avanir.

     (b) Novartis will be responsible for, and shall bear all expenses incurred
in, preparing, filing, prosecuting and maintaining all Novartis Patents.

     (c) Avanir undertakes at the reasonable request and the expense of Novartis
or its Affiliates to sign, or have signed, any and all documents necessary in
connection with the filing, prosecution, maintenance, extension and enforcement
of the Novartis Patents and to take such other necessary actions as Novartis or
its Affiliates may reasonably request from Avanir in connection with the
Novartis Patents.

     (d) Novartis or its Affiliates shall keep Avanir apprised of any activities
related to the Novartis Patent Rights by providing Avanir with copies of all
official actions, amendments and responses, which affect the scope of any
claims, with respect to the preparation, filing, prosecution and maintenance of
the Novartis Patents, and Novartis or its Affiliates shall take into account
Avanir's comments with respect to such activities. Other than reasonably
considering Avanir's comments, Novartis or its Affiliates shall have sole
discretion with respect to the preparation, filing, prosecution and maintenance
of the

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Novartis Patents.

     8.2 AVANIR INTELLECTUAL PROPERTY

     (a) All Avanir Intellectual Property whether or not patentable, will be the
property of Avanir, and Avanir shall be the sole owner of such Avanir
Intellectual Property.

     (b) Avanir shall be responsible for, and Novartis shall bear all reasonable
expenses incurred in, preparing, filing, prosecuting and maintaining the Avanir
Patents. For the purposes of this Section 8.2, Novartis shall only bear such
expenses in the event that: (i) in the case of a new patent application, the
Parties have agreed upon the filing of such new patent application and its
scope; (ii) the Parties have agreed, before filing, upon any country variant in
case of any foreign filing which is due during the term of this Agreement; (iii)
in the case of payments to patent agents employed by Avanir or its Affiliates,
Novartis has received the current fee sheet for such patent agent; and (iv)
Avanir has informed Novartis promptly upon becoming aware of any extraordinary
costs to be spent in patent prosecution or patent maintenance in any country,
including but not limited to costs in appeal proceedings, opposition
proceedings, costs for the filing of divisional applications, claim fees, and
the like, and Novartis has agreed to pay such costs in advance, which agreement
shall not be unreasonably withheld or delayed.

     (c) Novartis and its Affiliates undertake at the reasonable request of
Avanir to sign, or have signed, any and all documents necessary in connection
with the filing, prosecution, maintenance, extension and enforcement of the
Avanir Patents and to take such other necessary actions as Avanir may reasonably
request from Novartis or its Affiliates in connection with the Avanir Patents.

     (d) Avanir shall keep Novartis apprised of any activities related to the
Avanir Patent Rights by providing Novartis: (i) with a draft of new applications
and foreign filing texts at least ten (10) business days before the intended
filing; (ii) promptly with copies of all official actions, amendments and
responses, which affect the scope of any claims; (iii) with foreseen amendments
and responses to official actions which affect the scope of any claim at least
five (5) business days before the action due date. Avanir shall take into
account Novartis' or its Affiliates' comments with respect to such activities.

     (e) On each six-month anniversary of the Effective Date, Avanir shall
update Novartis on the status of all Patent filings indicated on Annex 1,
including information on the country particulars (filing date, filing number) of
each Patent, each foreign filing


                                       27

equivalent, and the corresponding Patent status (pending, granted, opposed,
under appeal, (un)intentionally abandoned, etc.). Additionally, Avanir shall
notify Novartis of any new Patent applications comprising Avanir Intellectual
Property filed in any country promptly after such Patent application is filed.

     8.3 JOINT INTELLECTUAL PROPERTY

     (a) Joint Intellectual Property and all Patents claiming joint inventions
shall be owned jointly by Novartis and Avanir, and such Patents shall constitute
"Joint Patents". Joint inventorship shall be determined in accordance with the
rules of inventorship under the patent laws of the United States.

     (b) The Parties shall determine by mutual agreement which Party shall be
responsible for the filing, prosecution and maintenance of Joint Patents on a
case-by-case basis.

     (c) In the event that a Party responsible for the filing, prosecution and
maintenance of any patent filing within Joint Patents (the "responsible Party")
desires to abandon such patent filing, or if the responsible Party declines
responsibility for such patent filing, the responsible Party shall notify
promptly the other Party (and in any event not less than sixty (60) calendar
days prior to the deadline for taking appropriate action with respect to such
Joint Patent). If the other Party believes that the Joint Patent in question
should be filed, prosecuted and/or maintained, it shall inform the responsible
Party of its belief and the Parties will negotiate in good faith to find a
mutually acceptable course of action.

     (d) Novartis shall bear all reasonable expenses incurred in preparing,
filing, prosecuting and maintaining the Joint Patents. In the event that Avanir
has been determined to be the Party responsible for the filing, prosecution and
maintenance of Joint Patents, for the purposes of this Section 8.3, Novartis
shall only bear such expenses in the event that: (i) in the case of a new patent
application the Parties have agreed upon the filing of a new patent application
and its scope; (ii) in the case of a foreign filing decision the Parties have
agreed upon any country variant in case of any foreign filing which is due
during the term of this Agreement; (iii) in the case of payments to patent
agents employed by Avanir or its Affiliates, Novartis has received the current
fee sheet for such patent agent; and (iv) in the case of extraordinary costs
Avanir has informed Novartis promptly upon becoming aware of any extraordinary
costs to be spent in patent prosecution or patent maintenance in any country,
including but not limited to costs in appeal proceedings, opposition
proceedings,


                                       28

costs for the filing of divisional applications, claim fees, and the like and
Novartis has agreed to pay such costs in advance, which agreement shall not be
unreasonably withheld or delayed.

     8.4 INFRINGEMENT

     (a) If either Party becomes aware of any activity that such Party believes
represents an infringement of the claims of the Avanir Intellectual Property or
the Novartis Intellectual Property, the Party obtaining such knowledge shall
promptly advise the other in writing of all relevant facts and circumstances
pertaining to the potential infringement. Novartis and Avanir shall thereafter
consult and cooperate fully to determine a course of action, including but not
limited to, the commencement of legal action to terminate any infringement of
the Avanir Intellectual Property or the Novartis Intellectual Property.

     (b) Novartis or its Affiliates shall have the first right, but not
obligation, to initiate and prosecute such legal proceedings related to Novartis
Intellectual Property, and Avanir shall have the first right, but not
obligation, to initiate and prosecute such legal proceedings related to Avanir
Intellectual Property, each at its own expense and in its own name, and to
control the defense of any declaratory judgment action relating to its
Intellectual Property; provided that no settlement shall be entered into by such
Party without the written consent of the other Party if such settlement would
materially affect the other Party's interests. Each Party shall cooperate with
the other Party in such effort, including being joined as a party to such action
if necessary.

     (c) If the Party which is entitled to firstly pursue the defense, does not
succeed, within ninety (90) calendar days after receiving notice from the other
Party of a potential infringement or within sixty (60) calendar days after
providing the other Party with notice of such infringement, either: (i) in
terminating such infringement; or (ii) in instituting an action to prevent
continuation thereof, or if the Party notifies the other Party that it does not
plan to defend against or terminate the infringement or to institute any such
action, then the other Party shall have the right to do so at its own cost and
expense. Each Party shall cooperate with the other Party in such effort,
including being joined as a party to such action if necessary.

     (d) In addition, each Party shall have the right to join in any action
against infringement brought in accordance with this Section 8.4 if necessary in
order to assert the damages incurred by such Party as a result of the alleged
infringement; provided that: (i) the


                                       29

foregoing shall not limit or restrict in any way the rights of the Party
controlling such action as determined in accordance with this Section 8.4 from
exercising such control in its discretion; (ii) in the event Avanir joins
Novartis in the defense of an infringement action, Avanir may elect to
participate up to [***] percent ([***]%) of the total out-of-pocket cost and
expense of Novartis and Avanir and consequently share to the same proportion in
any award; and (iii) in the event Novartis joins Avanir in the defense of an
infringement action, Novartis may elect to participate up to [***] percent
([***]%) of the total out-of-pocket cost and expense of Novartis and Avanir and
consequently share to the same proportion in any award. In the event that Avanir
decides not to join Novartis by way of participating in paying for out-of-pocket
costs and expenses, any recovery by Novartis (after reimbursement of its
out-of-pocket costs and expenses), which is intended as a reimbursement for
[***] as a result of such infringement shall be treated as [***] for purposes of
this Agreement. If Avanir pursues any such matter after Novartis declines to do
so, any recovery shall belong to Avanir alone.

     (e) The costs and expenses (including attorneys' fees) of any action
against an infringement brought in accordance with this Section shall be borne
by the Party controlling the infringement action, unless stated otherwise in
this Article VIII.

     8.5 UPDATING

     Each Party shall keep the other reasonably informed of developments in any
action or proceeding relating to the potential infringement of the claims of a
Patent relating to the Compounds or the Drug Products including, to the extent
permissible by law, the state of any settlement negotiations and the terms of
any offer related thereto.

     8.6 DEFENSE AND SETTLEMENT OF THIRD PARTY CLAIMS

     (a) If a Third Party asserts that a patent, trademark or other intellectual
properties owned by it is infringed by the importation, manufacture, use or sale
of any Compound or Drug Product, or if either Party learns of a claim or
assertion that the development, manufacture, use, marketing, promotion,
importation, exportation, offer for sale, sale or distribution of the Compounds
or the Drug Products infringes or otherwise violates the intellectual property
rights of any Third Party, then such Party will promptly notify the other Party
in writing. Novartis will have the sole right, but not the obligation, to
control such defense at its own expense. If Novartis does not assume control of
such defense, then Avanir shall have the right to control such defense at its
own expense. In any event, the

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                                       30

Party not controlling such defense will have the right to be represented in any
such action at its own expense. The Party controlling such defense shall keep
the other Party advised of the status of such action and shall consider
recommendations made by the other Party in respect thereto. The Party not
controlling such defense will assist and cooperate in any such infringement
litigation at the defending Party's reasonable request. If the Party controlling
such defense is not the Party against whom such action was originally brought,
then the Party controlling such defense will not agree to the settlement of any
such action without the prior written consent of the other Party.

     (b) If Novartis conducts the defense, Novartis will use Commercially
Reasonable Efforts to determine how and whether to defend against such charge of
infringement.

     (c) During the period in which such litigation is pending and following the
resolution thereof, Novartis shall bear all other costs incurred in connection
therewith (including litigation costs, attorneys fees, costs of settlement)
including damage awards and any other payment resulting therefrom in the event
Novartis is barred as a result of such litigation from further sales in the
country concerned.

     (d) Such application and deduction shall not apply to infringement caused
by Novartis' or its Affiliates' use of their respective name, trade name, logo
or the Novartis Patents or Novartis Know-How.

     8.7 TRADEMARKS

     Novartis or its Affiliates will be responsible for, and shall have sole
discretion in, selecting trademarks for the use on or in connection with the
Drug Products in the Territory. Novartis or its Affiliates will be responsible
for registration of such trademarks and will be the sole owner of such
trademarks. For the avoidance of doubt, trademarks, including those created
hereunder, are not included in the definition of Know-How.

     8.8 DRUG PRICE COMPETITION AND PATENT TERM RESTORATION ACT AND PEDIATRIC
EXCLUSIVITY

     (a) The Parties shall cooperate in an effort to avoid the loss of any
rights which may otherwise be available to the Parties under the provisions of
the Drug Price Competition and Patent Term Restoration Act of 1984 or comparable
laws outside of the United States and for pediatric exclusivity.


                                       31

     (b) Avanir shall provide any relevant Patent information to Novartis or its
Affiliates such that Novartis or its Affiliates, as an NDA applicant, may inform
the FDA or other applicable regulatory authority.

     (c) Avanir shall grant Novartis and its Affiliates cross-reference rights
to any relevant Drug Master Files and pre-clinical, clinical or regulatory
files.

     (d) The Parties shall cooperate with each other in obtaining patent term
restoration or supplemental protection certificates or their equivalents in any
country and region in the Territory where applicable. Avanir shall provide all
reasonable assistance to Novartis and its Affiliates, including permitting
Novartis or its Affiliates to proceed with applications for such in the name of
Avanir, if so required.

                                   ARTICLE IX

                         REPRESENTATIONS AND WARRANTIES

     9.1 REPRESENTATIONS AND WARRANTIES OF AVANIR

     Avanir represents and warrants to Novartis as follows:

     (a) Avanir is duly organized, validly existing and in good standing under
the laws of the State of California, with full power and authority to execute
and deliver this Agreement and to perform its obligations hereunder

     (b) This Agreement has been duly executed and delivered by Avanir and
constitutes the valid and binding obligation of Avanir, enforceable against
Avanir in accordance with its terms, subject to bankruptcy, insolvency or
similar laws of general application affecting the rights of creditors, and
subject to equitable principles limiting rights to specific performance or other
equitable remedies. The execution, delivery and performance of this Agreement
have been duly authorized by all necessary action on the part of Avanir, its
officers and directors on behalf of Avanir and no other corporate proceedings on
the part of Avanir are necessary to authorize such execution, delivery and
performance.

     (c) Except as disclosed in writing to Novartis: (i) Avanir, to its best
knowledge owns or possesses licenses or other such rights to use all Avanir
Intellectual Property, and to grant the licenses herein; and (ii) the granting
of the licenses to Novartis and its Affiliates hereunder does not violate any
right known to Avanir of any Third Party and, to its best knowledge, Avanir has
obtained all necessary consents from Third Parties in order to allow it to enter
into its obligations under this Agreement.


                                       32

     (d) Except as disclosed in writing by Avanir to Novartis or its agents, to
Avanir's knowledge, the development, manufacture, use or sale of any Compounds
or Drug Products pursuant to this Agreement insofar as the same is based upon
the practice of the licenses granted by Avanir to Novartis and its Affiliates
under this Agreement, will not infringe or conflict with any Third Party right
or patent, and Avanir is not aware of any issued patent or pending patent
application that, if issued, would be infringed by the development, manufacture,
use or sale of any Compounds or Drug Products by virtue of the practice of the
licenses granted by Avanir to Novartis and its Affiliates under this Agreement.

     (e) There is no action, suit, proceeding investigation, arbitration
proceedings or other proceedings pending or threatened against Avanir or
affecting, in whole or in part, the Avanir Intellectual Property at law, in
equity or otherwise, in, before, or by, any court or governmental authority, and
there is not currently outstanding any unsatisfied judgments or outstanding
orders, injunctions, decrees, stipulations or awards (whether rendered by a
court, an administrative agency or by an arbitrator) domestic or foreign, or
arbitrator relating, in whole or in part, against any of the Avanir Intellectual
Property which would have or reasonably be expected to have a material adverse
effect.

     (f) Execution of this Agreement and consummation of the transactions
contemplated hereby and thereby will not: (i) result in the violation of or
conflict with any of the terms and provisions of the articles of incorporation
or by-laws of Avanir; (ii) result in a material violation or breach of, or
constitute (with or without due notice or lapse of time or both) a material
default (or give rise to any right of termination, modification, cancellation or
acceleration or loss of material benefits) under, any of the terms, conditions
or provisions of any note, bond, mortgage, indenture, contract, agreement,
permit, license, lease, purchase order, sales order, arrangement or other
commitment or obligation to which Avanir is a Party; or (iii) violate any order,
writ, injunction, decree, statute, treaty, rule or regulation applicable to
Avanir, except such violations, breaches or defaults with respect to clauses
(ii) and (iii) above which would not have a material adverse effect.

     9.2 REPRESENTATIONS AND WARRANTIES OF NOVARTIS

     (a) Novartis is duly organized, validly existing and in good standing under
the laws of Bermuda with full power and authority to execute and deliver this
Agreement and to perform its obligations hereunder.


                                       33

     (b) Novartis represents and warrants to Avanir that this Agreement has been
duly executed and delivered by Novartis and constitutes the valid and binding
obligation of Novartis, enforceable against Novartis in accordance with its
terms. The execution, delivery and performance of this Agreement have been duly
authorized by all necessary action on the part of Novartis, its officers and
directors on behalf of Novartis.

                                    ARTICLE X

                                 CONFIDENTIALITY

     10.1 UNDERTAKING

     During the term of this Agreement, each Party (the "Receiving Party") shall
keep confidential, and other than as provided herein shall not use or disclose,
directly or indirectly, any trade secrets, confidential or proprietary
information, or any other knowledge, information, documents or materials, owned,
developed or possessed by the other Party (the "Proprietary Party"), whether in
tangible or intangible form, the confidentiality of which such other Party takes
commercially reasonable measures to protect, including but not limited to Avanir
Intellectual Property and Novartis Intellectual Property. The Affiliates of each
Party shall be entitled to possess such trade secrets, confidential or
proprietary information or any other knowledge, information, documents or
materials, owned, developed or possessed by the other Party to the same extent
that its affiliated Party is entitled to possess such items. Each Party shall
cause is Affiliates to comply with the terms and conditions of this Article X as
if such Affiliates were signatories to this Agreement.

     (a) Each Party shall take any and all lawful measures to prevent the
unauthorized use and disclosure of such information, and to prevent unauthorized
Persons or entities from obtaining or using such information.

     (b) Each Party further agrees to refrain from directly or indirectly taking
any action which would constitute or facilitate the unauthorized use or
disclosure of such information. Each Party may disclose such information to its
officers, employees and agents, to authorized licensees and sublicensees, and to
subcontractors in connection with the development or manufacture of the
Compounds or the Drug Products to the extent necessary to enable such parties to
perform their obligations hereunder or under the applicable license, sublicense
or subcontract, as the case may be; provided that such officers, employees,
agents, licensees, sublicensees and subcontractors have entered into appropriate
confidentiality agreements for secrecy and non-use of such information which by
their terms shall be enforceable by injunctive relief at the instance of the
disclosing Party.


                                       34

     (c) Each Party shall be liable for any unauthorized use and disclosure of
such information by its Affiliates, and its and its Affiliates', officers,
employees, agents, sublicensees and subcontractors.

     10.2 EXCEPTIONS

     Notwithstanding the foregoing, the provisions of Section 10.1 shall not
apply to knowledge, information, documents or materials which the Receiving
Party can conclusively establish:

     (a) have entered the public domain without the Receiving Party's breach of
any obligation owed to the Proprietary Party;

     (b) are permitted to be disclosed by the prior written consent of the
Proprietary Party;

     (c) have become known to the Receiving Party from a source other than the
Proprietary Party, other than by breach of an obligation of confidentiality owed
to the Proprietary Party;

     (d) are disclosed by the Proprietary Party to a Third Party without
restrictions on its disclosure;

     (e) are independently developed by the Receiving Party without breach of
this Agreement; or

     (f) are required to be disclosed by the Receiving Party to comply with
applicable laws or regulations, to defend or prosecute litigation or to comply
with governmental regulations; provided that the Receiving Party provides prior
written notice of such disclosure to the Proprietary Party and takes reasonable
and lawful actions to avoid or minimize the degree of such disclosure.

     10.3 PUBLICITY

     The Parties will agree upon the content of any press release or other
public communications relating to this Agreement and the transactions
contemplated herein.

     Except to the extent already disclosed in a press release or other public
communication, no public announcement concerning the existence or the terms of
this Agreement or concerning the transactions described herein shall be made,
either directly or


                                       35

indirectly, by Avanir or Novartis or their respective Affiliates, except as may
be legally required by applicable laws, regulations, or judicial order, without
first obtaining the approval of the other Party and agreement upon the nature,
text, and timing of such announcement, which approval and agreement shall not be
unreasonably withheld or delayed.

     The Party desiring to make any such public announcement shall provide the
other Party with a written copy of the proposed announcement in sufficient time
prior to public release to allow such other Party to comment upon such
announcement, prior to public release.

     Neither Avanir nor its Affiliates may publish or present any results, data,
or scientific findings related to the MIF Program or the Research Program
without the prior written consent of Novartis. Novartis and its Affiliates may
publish or presents any results, data, or scientific findings related to the MIF
Program or the Research Program without the consent of Avanir; provided that
Novartis or its Affiliates shall provide the Avanir with a written copy of the
results, data, or scientific findings to be published or presented in sufficient
time prior to public release to allow Avanir to comment prior to public release.
For the avoidance of doubt, Patents and Regulatory Filings are not regarded as
publications for the purposes of this Section 10.3.

     10.4 SURVIVAL

     The provisions of this Article X shall survive the termination of this
Agreement and shall extend for a period of [***] thereafter.

                                   ARTICLE XI

                               DISPUTE RESOLUTION

     11.1 GOVERNING LAW AND JURISDICTION

     This Agreement shall be governed and construed in accordance with the laws
of the State of Delaware. Both Parties agree to submit to personal jurisdiction
and venue in the State of Delaware.

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                                       36

     11.2 DISPUTE RESOLUTION PROCESS

     (a) Except as otherwise explicitly provided herein, in the event of any
claim arising out of or relating to any provision of this Agreement, failing
resolution of the controversy or claim, the matter shall be referred to the
chief executive officer of Avanir or his designee and the chief executive
officer of Novartis or his designee who shall, as soon as practicable, attempt
in good faith to resolve the controversy or claim. If such controversy or claim
is not resolved within sixty (60) calendar days of the date of initial referral
of the matter to the chief executive officers, either Party shall be free to
initiate the arbitration proceedings outlined in the following Section.

     (b) In the event of any controversy or claim arising out of or relating to
any provision of this Agreement, the Parties shall try to settle their
differences amicably between themselves. Any unresolved disputes arising between
the Parties relating to, arising out of or in any way connected with this
Agreement or any term or condition hereof, or the performance by either Party of
its obligations hereunder, whether before or after termination of this
Agreement, shall be resolved by final and binding arbitration. Whenever a Party
shall decide to institute arbitration proceedings, it shall give written notice
to that effect to the other Party. Except in the case of a determination to be
made where payments are to be made to by one Party to the other, the Party
giving such notice shall refrain from instituting the arbitration proceedings
for a period of sixty (60) calendar days referred to in Section 11.2(a) to allow
the Parties time to further attempt to come to an amicable resolution of the
dispute. Arbitration shall be held in New York, New York, according to the
commercial rules of the International Chamber of Commerce ("ICC"). The
arbitration will be conducted by a panel of three arbitrators appointed in
accordance with ICC rules; provided that each Party shall within thirty (30)
calendar days after the institution of the arbitration proceedings appoint a
Party arbitrator, and the Party-arbitrators shall select, if available, a
neutral arbitrator who shall have significant senior management experience in
the pharmaceutical or biotechnology businesses to be chairman of the arbitration
panel, within thirty (30) calendar days thereafter. If the Party-arbitrators are
unable to select a neutral arbitrator within such period, the neutral arbitrator
shall be appointed in accordance with ICC rules. All arbitrator(s) eligible to
conduct the arbitration must agree to render their opinion(s) within thirty (30)
calendar days of the final arbitration hearing. No arbitrator (nor the panel of
arbitrators) shall have the power to award punitive damages under this Agreement
and such award is expressly prohibited. Decisions of the arbitrator(s) shall be
final and binding on all of the Parties. Judgment on the award so rendered may
be entered in a court having jurisdiction thereof. In any arbitration pursuant
to this Agreement, the arbitrators shall


                                       37

interpret the express terms hereof and apply the laws of the State of Delaware.
The losing Party to the arbitration (if any) as determined by the arbitrators
shall pay the costs of arbitration. Notwithstanding the provisions of this
Section 11.2(b), either Party may seek preliminary or injunctive measures or
other equitable relief in any court of competent jurisdiction.

                                   ARTICLE XII

                              TERM AND TERMINATION

     12.1 TERM

     This Agreement shall become effective upon the Effective Date and the term
of this Agreement shall extend, subject to all applicable laws, with respect to
a Drug Product (or Submitted Drug Product, if applicable) in a particular
country until the later of:

     (a) the expiration of the last to expire of the Avanir Patents (or Novartis
Patents, solely with respect to a Submitted Drug Product) containing a Valid
Claim covering the Compound or the Drug Product (or Submitted Drug Product, if
applicable) or its use or manufacture in that country; or

     (b) [***] years from the date of First Commercial Sale of the Drug Product
(or Submitted Drug Product, if applicable) in that country.

     12.2 TERMINATION FOR CAUSE

     In addition to rights of termination which may be granted to either Party
under other provisions of this Agreement, either Party may terminate this
Agreement upon ninety (90) calendar days' prior written notice to the other
Party upon the material breach by such other Party of any of its
representations, warranties or obligations under this Agreement; provided that
such termination shall become effective only if the breaching Party shall fail
to remedy or cure the breach to the reasonable satisfaction of the other Party
within ninety (90) calendar days of receiving such notice.

     12.3 TERMINATION FOR BANKRUPTCY

     If at any time during the term of this Agreement, an Event of Bankruptcy
(as defined below) relating to either Party (the "Bankrupt Party") occurs, the
other Party (the "Other Party") shall have, in addition to all other legal and
equitable rights and remedies available

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                                       38

hereunder, the option to terminate this Agreement upon thirty (30) calendar
days' written notice to the Bankrupt Party. It is agreed and understood that if
the Other Party does not elect to terminate this Agreement upon the occurrence
of an Event of Bankruptcy, except as may otherwise be agreed with the trustee or
receiver appointed to manage the affairs of the Bankrupt Party, the Other Party
shall continue to make all payments required of it under this Agreement as if
the Event of Bankruptcy had not occurred, the Bankrupt Party shall not have the
right to terminate any license granted herein, and in the event that Avanir is
the Bankrupt Party, the operation of the Joint Research Committee and the Joint
Program Committee shall immediately cease. The term "Event of Bankruptcy" shall
mean: (a) filing in any court or agency pursuant to any statute or regulation of
any state or country, a petition in bankruptcy or insolvency or for
reorganization or for an arrangement or for the appointment of a receiver or
trustee of the Bankrupt Party or of its assets; (b) proposing a written
agreement of composition or extension of a Bankrupt Party's debts, (c) being
served with an involuntary petition against the Bankrupt Party, filed in any
insolvency proceeding, and such petition shall not be dismissed within sixty
(60) calendar days after the filing thereof, (d) proposing or being a party to
any dissolution or liquidation; or (e) making an assignment for the benefit of
creditors. Without limitation, the Bankrupt Party's rights under this Agreement
shall include those rights afforded by 11 U.S.C. Section 365(n) of the United
States Bankruptcy Code (the "USBC") and any successor thereto. If the bankruptcy
trustee of a Bankrupt Party as a debtor or debtor-in-possession rejects this
Agreement under 11 U.S.C. Section 365(o) of the USBC, the non-Bankrupt Party may
elect to retain its rights licensed from the Bankrupt Party hereunder (and any
other supplementary agreements hereto) for the duration of this Agreement and
avail itself of all rights and remedies to the full extent contemplated by this
Agreement and 11 U.S.C. Section 365(n) of the USBC, and any other relevant laws.

     12.4 TERMINATION BY NOVARTIS

     Following the [***] anniversary of the Effective Date, Novartis may
terminate this Agreement at any time upon the provision of sixty (60) calendar
days' prior written notice. In addition, Novartis may, in its sole discretion,
relinquish the licenses granted to it hereunder with respect to any particular
Compound or Drug Product without affecting the licenses granted to it hereunder
with respect to any other Compound or Drug Product. There shall be a wind-down
period (the "Wind-Down Period") of [***] subsequent to the effective termination
date during which Novartis or its Affiliates shall only continue to fund that
number of Avanir FTEs that were involved in the Research Plan immediately prior

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                                       39

to the termination notice. For the avoidance of doubt, only those activities in
which Avanir had been engaged at the time of termination shall continue during
the Wind-Down Period.

     12.5 EFFECT OF TERMINATION

     (a) Termination of this Agreement for any reason, or expiration of this
Agreement, will not affect: (i) obligations, including the payment of any
royalties and milestones which have accrued as of the date of termination or
expiration; and (ii) rights and obligations which, from the context thereof, are
intended to survive termination or expiration of this Agreement.

     (b) For each country, at the end of the term of this Agreement as provided
in Section 12.1 in respect of a Drug Product, Novartis and its Affiliates shall
have a perpetual, non-exclusive, transferable, paid-up, royalty-free license
with the right to sublicense in such country, to research, develop, have
developed, make, have made, use, distribute, have distributed, export, have
exported, import, have imported, promote, have promoted, market, have marketed,
sell, have sold and offer to sell the Compounds, the Drug Product in the Field
in the Territory under the Avanir Intellectual Property.

     (c) If Novartis terminates this entire Agreement pursuant to Section 12.4
or Avanir terminates this entire Agreement pursuant to Section 12.2, then all
licenses granted to Novartis and its Affiliates hereunder shall terminate and
revert to Avanir, and any sublicenses granted by Novartis or its Affiliates
hereunder shall be assigned to Avanir, and all copies of confidential
information of Avanir shall be returned to it.

     (i)  Novartis and its Affiliates shall grant to Avanir an exclusive,
          worldwide, paid-up license under Novartis Intellectual Property (with
          the right to sublicense with the consent of Novartis, which shall not
          be unreasonably withheld or delayed) to research, develop, have
          developed, make, have made, use, distribute, have distributed, export,
          have exported, import, have imported, promote, have promoted, market,
          have marketed, sell, have sold and offer to sell the Compounds (except
          Novartis Submitted Compounds) and the Drug Products (except Submitted
          Drug Products) whether in monotherapy or in combination with other
          pharmaceutical products, in the Field in the Territory.
          Notwithstanding the foregoing, in the event that Avanir commercializes
          any such Drug Product that Novartis has progressed through Development
          to the end of [***], then Avanir shall pay to Novartis a [***] percent
          ([***]%) royalty

                                              * Confidential Treatment Requested


                                       40

          on any future sales of such Drug Product sold directly by Avanir or
          its Affiliates, and in the case where Avanir does not sell such Drug
          Product directly, Avanir shall pay to Novartis a [***] percent
          ([***]%) royalty on any future sales of such Drug Product sold
          indirectly by Avanir or its Affiliates.

     (ii) In the event that Novartis determines in its sole discretion that it
          wishes to license out, sell, or transfer rights to develop any
          Submitted Drug Product(s), Avanir shall have a first right of
          negotiation to acquire exclusive rights to such Submitted Drug
          Product(s) on commercially reasonable terms. In such event, Novartis
          shall give written notice to Avanir that it wishes to license out,
          sell, or transfer rights to develop such Submitted Drug Product(s) and
          Avanir shall have thirty (30) days from the date on which it is deemed
          pursuant to Section 16.14 to have received such notice from Novartis
          to inform Novartis in writing of whether it wishes to act on its right
          of first negotiation. If Avanir does not notify Novartis in writing of
          its desire to act on its right of first negotiation within this thirty
          (30) day period, Novartis shall be free to grant rights to such
          Submitted Drug Products(s) to Third Parties. If Avanir does notify
          Novartis in writing of its desire to act on its right of first
          negotiation within this thirty (30) day period, the Parties shall
          enter into good faith negotiations regarding the terms and conditions
          for the proposed license, sale, or transfer rights to develop such
          Submitted Drug Product(s). In the event that the Parties fail to
          conclude such good faith negotiations and execute the agreements
          documenting such transaction within one hundred and twenty (120) days
          of the date on which Avanir notifies Novartis of its desire to act on
          its right of first negotiation, Novartis shall be free grant rights to
          such Submitted Drug Products(s) to Third Parties; provided that,
          Novartis shall not license, sell, or transfer such rights to a Third
          Party on terms more favorable to such Third Party than those last
          offered to Avanir without notifying Avanir in writing and affording
          Avanir the opportunity to enter into the proposed transaction on the
          same terms and conditions. In such event, Avanir shall have ten (10)
          business days in which to notify Novartis in writing that it wishes to
          enter into such transaction on the proposed terms and conditions.

                                              * Confidential Treatment Requested


                                       41

     (iii) In the event that termination occurs during the Development but prior
          to the First Commercial Sale of a Drug Product, Avanir may elect, but
          solely for Compounds and Drug Products that originated as Avanir
          Intellectual Property, and give, within sixty (60) calendar days of
          the date of termination notice, written notice to Novartis requesting
          the transfer of Data and Know-How as it pertains to the manufacturing
          processes of the relevant Compound and/or Drug Product, and to
          purchase remaining stocks and inventory of the relevant Compound
          and/or Drug Product that Novartis may have in its possession. The
          purchase price for such stocks shall be based on direct labor and
          out-of-pocket costs that Novartis may have incurred for such stock.
          The purchase shall be EX WORKS (Incoterms 2000) with [***]. Novartis
          shall make no representations or warranties as to the suitability of
          such stocks for any use and will be sold as-is. Novartis shall not be
          obligated to conduct any further testing on such stocks. Novartis
          shall not be required to dedicate more than [***] FTEs to such efforts
          and in any case shall not be required to provide further efforts
          towards the transfer of such manufacturing Data and Know-How beyond
          ninety (90) calendar days of the actual termination date of this
          Agreement. Avanir may request and Novartis, in its sole discretion,
          may provide further assistance towards the Data and Know-How transfer,
          however such assistance by Novartis shall be reimbursed by Avanir at
          the then prevailing Novartis FTE compensation rate. The Parties shall
          also agree to transfer any Regulatory Filings regarding such Compound
          and Drug Product from Novartis to Avanir, and Avanir shall bear any
          costs that may be incurred during such transfer. In the event that
          termination occurs after the First Commercial Sale of a Drug Product
          that originated as Avanir Intellectual Property, the Parties agree to
          enter into good faith negotiations to conclude a commercially
          reasonable supply agreement which, at a minimum, will provide for
          Novartis to supply and Avanir to purchase, commercially acceptable
          Drug Product for a period of [***]. The Parties shall also agree to
          transfer affected Regulatory Filings pursuant to such Compounds and
          Drug Products from Novartis to Avanir, and Avanir shall bear any costs
          that may be incurred during such transfer.

                                              * Confidential Treatment Requested


                                       42

     (d) If Novartis terminates this entire Agreement pursuant to Section 12.2,
then Novartis and its Affiliates shall be entitled to convert the license
granted herein to an exclusive, worldwide license, with the right to sublicense,
to research, develop, have developed, make, have made, use, distribute, have
distributed, export, have exported, import, have imported, promote, have
promoted, market, have marketed, sell, have sold and offer to sell the
Compounds, the Drug Products in the Field in the Territory under the Avanir
Intellectual Property, subject only to the obligation to pay to Avanir the
amounts due under Sections 7.4 and 7.5 as they become due; provided, however, in
the event that such termination was due to (i) the purported grant to a Third
Party of license rights granted exclusively to Novartis under this Agreement,
(ii) the disclosure by Avanir of material confidential information of Novartis
in violation of Article X of this Agreement, (iii) Avanir ceasing to perform its
funded obligations during the Research Term or (iv) the material breach by
Avanir of any of the representations or warranties set out in Section 9.1,
Novartis shall only be obligated to pay to Avanir [***] percent ([***]%) of the
amounts otherwise due under Sections 7.4 and 7.5 as they become due.

                                  ARTICLE XIII

                                 INDEMNIFICATION

     13.1 INDEMNIFICATION BY AVANIR

     Avanir will indemnify and hold Novartis and its Affiliates, and their
employees, officers and directors harmless against any Third Party loss,
damages, action, suit, claim, demand, liability, expense, bodily injury, death
or property damage (a "Loss"), that may be brought, instituted or arise against
or be incurred by such Persons to the extent such Loss is based on or arises out
of:

     (a) negligence or willful misconduct concerning the Research Program, a
Compound or a Drug Product by Avanir or its Affiliates; or

     (b) the breach by Avanir of any of its material obligations, covenants,
representations or warranties set forth in this Agreement; and

     (c) provided that the foregoing indemnification shall not apply to any Loss
to the extent such Loss is caused by the breach of this Agreement, negligent or
willful misconduct of Novartis or its Affiliates and their employees, officers
and directors.

                                              * Confidential Treatment Requested


                                       43

     13.2 INDEMNIFICATION BY NOVARTIS

     Novartis will indemnify and hold Avanir, and its Affiliates, and their
employees, officers and directors harmless against any Third Party Loss that may
be brought, instituted or arise against or be incurred by such Persons to the
extent such Loss is based on or arises out of:

     (a) the development, manufacture, use, sale, storage or handling of a
Compound or a Drug Product by Novartis or its Affiliates or their
representatives, agents, licensees, sublicensees or subcontractors under this
Agreement, or any actual or alleged violation of law resulting therefrom (with
the exception of Losses based on infringement or misappropriation of
intellectual property rights); or

     (b) the breach by Novartis of any of its material obligations, covenants,
representations or warranties set forth in this Agreement;

     (c) the breach by any of Novartis' or its Affiliates or sublicensees of any
obligations relating to manufacture and whether through willful default or
negligence, giving rise to a Loss by Avanir; and

     (d) provided that the foregoing indemnification shall not apply to any Loss
to the extent such Loss is caused by the breach of this Agreement, negligent or
willful misconduct of Avanir or its Affiliates and their employees, officers and
directors.

     13.3 CLAIMS PROCEDURES

     Each Party entitled to be indemnified by the other Party (an "Indemnified
Party") pursuant to Section 13.1 or 13.2 shall give notice to the other Party
(an "Indemnifying Party") promptly after such Indemnified Party has actual
knowledge of any threatened or asserted claim as to which indemnity may be
sought, and shall permit the Indemnifying Party to assume the defense of any
such claim or any litigation resulting therefrom; provided:

     (a) that counsel for the Indemnifying Party, who shall conduct the defense
of such claim or any litigation resulting therefrom, shall be approved by the
Indemnified Party (whose approval shall not unreasonably be withheld or delayed)
and the Indemnified Party may participate in such defense at such Party's
expense (unless: (i) the employment of counsel by such Indemnified Party has
been authorized by the Indemnifying Party; or (ii) the Indemnified Party shall
have reasonably concluded that there may be a conflict of interest between the
Indemnifying Party and the Indemnified Party in the defense of such action, in


                                       44

each of which cases the Indemnifying Party shall pay the reasonable fees and
expenses of one law firm serving as counsel for the Indemnified Party, which law
firm shall be subject to approval, not to be unreasonably withheld, by the
Indemnifying Party); and

     (b) the failure of any Indemnified Party to give notice as provided herein
shall not relieve the Indemnifying Party of its obligations under this Agreement
to the extent that the failure to give notice did not result in harm to the
Indemnifying Party.

     (c) No Indemnifying Party, in the defense of any such claim or litigation,
shall, except with the approval of each Indemnified Party which approval shall
not be unreasonably withheld, consent to entry of any judgment or enter into any
settlement which: (i) would result in injunctive or other relief being imposed
against the Indemnified Party; or (ii) does not include as an unconditional term
thereof the giving by the claimant or plaintiff to such Indemnified Party of a
release from all liability in respect to such claim or litigation.

     (d) Each Indemnified Party shall furnish such information regarding itself
or the claim in question as an Indemnifying Party may reasonably request in
writing and shall be reasonably required in connection with the defense of such
claim and litigation resulting therefrom.

     13.4 LIMITATION OF LIABILITY

     Neither Party shall be liable to the other for consequential, indirect or
punitive damages. For the avoidance of doubt, no Party can recover from the
other Party more than once for a single cause of action under an indemnity
granted by an indemnifying Party pursuant to this Agreement. The foregoing
sentence shall not be construed to preclude recovery in respect of multiple
claims arising from a single event or series of events. Neither Party shall have
liability with respect to any breach of any of the other Party's representations
and warranties under this Agreement: (a) for any individual item where the Loss
relating thereto is less than $[***]; and (b) in respect of each individual item
where the Loss relating thereto is equal to or greater than $[***], unless and
until the aggregate amount of such Losses exceeds [***] percent ([***]%) of the
amounts which Novartis or its Affiliates has paid under this Agreement and then
the liable Party shall be liable for the entire amount of the Losses described
in this Article XIII. The foregoing shall not be construed to limit liability
pursuant to Section 13.1 or Section 13.2. Each Party shall take and shall cause
its Affiliates to take all reasonable steps to mitigate any Loss upon becoming
aware of any event which would reasonably be expected to, or does, give rise
thereto,

                                              * Confidential Treatment Requested


                                       45

including incurring costs only to the minimum extent necessary to remedy a
breach that gives rise to the Loss.

     13.5 COMPLIANCE

     The Parties shall comply fully with all applicable laws and regulations in
connection with their respective activities under this Agreement.

     13.6 INSURANCE

     Each Party shall use all commercially reasonable efforts to maintain
insurance and/or self-insurance including product liability insurance, with
respect to its activities hereunder and, in that event, shall claim upon such
insurance policy before relying upon the Indemnity set forth in Article XIII.

                                   ARTICLE XIV

                                  PIRATE GOODS

     Novartis and its Affiliates shall exercise commercially reasonable efforts
to monitor the sales in the Territory and take action to prevent trade in goods
by a Third Party that violate Novartis' or its Affiliates' exclusive legal
rights to market, price and sell a Drug Product in such a market. In the event
that Avanir first becomes aware of such a trade in goods by a Third Party which
violates Novartis' or its Affiliates' exclusive legal rights, Avanir shall
notify Novartis within seven (7) calendar days of first becoming aware of such
trading by a Third Party.

                                   ARTICLE XV

                                   EXCLUSIVITY

     During the term of this Agreement and except as otherwise set forth in this
Agreement, Avanir will work exclusively with Novartis and its Affiliates on the
MIF Program and the development of the Compounds and the Drug Products in the
Field and in the Territory.


                                       46

                                   ARTICLE XVI

                            MISCELLANEOUS PROVISIONS

     16.1 OFFICIAL LANGUAGE

     English shall be the official language of this Agreement, and all
communications between the Parties hereto shall be conducted in that language.

     16.2 EXPORT CONTROLS

     This Agreement is made subject to any restrictions concerning the export of
materials and intellectual property from the United States which may be imposed
upon or related to either Party to this Agreement from time to time by the
Government of the United States. Furthermore, Novartis and its Affiliates will
not export, directly or indirectly, any Avanir Intellectual Property or any
Compound or Drug Product utilizing such Avanir Intellectual Property to any
countries for which the United States Government or any agency thereof at the
time of export requires an export license or other governmental approval,
without first obtaining the written consent to do so from the Department of
Commerce or other agency of the United States Government when required by
applicable statute or regulation.

     16.3 PHARMACOVIGILANCE

     Novartis shall be fully responsible for ensuring compliance with all
pharmacovigilance obligations, including the holding and maintaining of the
global safety database for the Drug Products. Prior to the first Regulatory
Approval of the first Drug Product, the Parties shall agree and implement a
procedure for the mutual exchange of adverse event reports and safety
information associated with the Drug Product. Details of the operating procedure
respecting such adverse event reports and safety information exchange shall be
the subject of a mutually acceptable pharmacovigilance agreement between the
Parties which shall at that time be made an addendum to this Agreement. Such
pharmacovigilance agreement shall be implemented at a time sufficient to permit
compliance with applicable guidelines and regulations of regulatory authorities.

     16.4 WAIVER

     No provision of the Agreement may be waived except in writing by both
Parties hereto. No failure or delay by either Party hereto in exercising any
right or remedy hereunder or under applicable law will operate as a waiver
thereof, or a waiver of a particular right or waiver of any right or remedy on
any subsequent occasion.


                                       47

     16.5 FORCE MAJEURE

     Neither Party shall be held liable or responsible to the other Party nor be
deemed to have defaulted under or breached this Agreement for failure or delay
in fulfilling or performing any term of this Agreement, other than an obligation
to make a payment, when such failure or delay is caused by or results from fire,
floods, embargoes, government regulations, prohibitions or interventions, war,
acts of war (whether war be declared or not), insurrections, riots, civil
commotions, strikes, lockouts, acts of God, or any other cause beyond the
reasonable control of the affected Party.

     16.6 REGISTRATION OF LICENSE

     Novartis or its Affiliates may, at its or their expense, register the
license granted under this Agreement in any country where the use, sale or
manufacture of a Drug Product in such country would be covered by a Valid Claim.
Upon request by Novartis or its Affiliates, Avanir agrees promptly to execute
any "short form" licenses submitted to it by Novartis or its Affiliates in order
to effect the foregoing registration in such country, but such licenses shall in
no way alter or affect the obligations of the Parties hereunder.

     16.7 SEVERABILITY

     It is the intention of the Parties to comply with all applicable laws
domestic or foreign in connection with the performance of its obligations
hereunder. In the event that any provision of this Agreement, or any part
hereof, is found invalid or unenforceable, the remainder of this Agreement will
be binding on the Parties hereto, and will be construed as if the invalid or
unenforceable provision or part thereof had been deleted, and the Agreement
shall be deemed modified to the extent necessary to render the surviving
provisions enforceable to the fullest extent permitted by law.

     16.8 GOVERNMENT ACTS

     In the event that any act, regulation, directive, or law of a government,
including its departments, agencies or courts, should make impossible or
prohibit, restrain, modify or limit any material act or obligation of Novartis,
Avanir and their respective Affiliates under this Agreement, the Party, if any,
not so affected shall have the right, at its option, to suspend or terminate
this Agreement as to such country, if good faith negotiations between the
Parties to make such modifications to this Agreement as may be necessary to
fairly address the impact thereof, are not successful after a reasonable period
of time in producing mutually acceptable modifications to this Agreement.

     16.9 GOVERNMENT APPROVALS


                                       48

     Novartis will use reasonable efforts to obtain any government approval
required to enable this Agreement to become effective, or to enable any payment
hereunder to be made, or any other obligation hereunder to be observed or
performed. Each Party will keep the other informed of progress in obtaining any
such approvals.

     16.10 ASSIGNMENT

     Novartis may assign its rights and obligations under this Agreement without
the prior written consent of Avanir to an Affiliate or in connection with the
transfer or sale of all or substantially all of its assets or business or in the
event of its merger or consolidation with a Third Party. Novartis may also
assign its rights and obligations under this Agreement to any of the [***], with
the prior written consent of Avanir. Avanir may not assign its rights and
obligations under this Agreement during the Research Term without the prior
written consent of Novartis. Thereafter, but prior to receipt of the first
Regulatory Approval for a Drug Product, Avanir may assign its right to receive
payments under this Agreement only to a Third Party which has a market
capitalization prior to the assignment (including its affiliates) of less than
$[***]. Following the receipt of the first Regulatory Approval for a Drug
Product, Avanir may assign its right to receive payments under this Agreement
without the prior written consent of Novartis. Any other proposed assignment by
Avanir of its rights and obligations under this Agreement shall require the
prior written consent of Novartis. Any request for consent to assignment shall
not be unreasonably withheld or delayed. In addition, Avanir shall be entitled
to assign all or any part of its right to receive payments under this Agreement.
Any purported assignment in contravention of this Section 16.10 shall, at the
option of the non-assigning Party, be null and void and of no effect. No
assignment shall release either Party from responsibility for the performance of
any accrued obligation of such Party hereunder. This Agreement shall be binding
upon and enforceable against the successor to or any permitted assignee from
either of the Parties hereto.

     16.11 AFFILIATES

     Each Party may perform its obligations hereunder personally or through one
or more Affiliates, although each Party shall nonetheless be solely responsible
for the performance of its Affiliates. Neither Party shall permit any of its
Affiliates to commit any act (including any act of omission) which such Party is
prohibited hereunder from committing directly. The use of subcontractors by
either Party shall not increase the financial obligations of the other Party
hereunder in any respect.

                                              * Confidential Treatment Requested


                                       49

     16.12 COUNTERPARTS

     This Agreement may be executed in duplicate both of which shall be deemed
to be originals, and both of which shall constitute one and the same Agreement.

     16.13 NO AGENCY

     Nothing herein contained shall be deemed to create an agency, joint
venture, amalgamation, partnership or similar relationship between Novartis and
Avanir. Notwithstanding any of the provisions of this Agreement, neither Party
shall at any time enter into, incur, or hold itself out to third Parties as
having authority to enter into or incur, on behalf of the other Party, any
commitment, expense, or liability whatsoever, and all contracts, expenses and
liabilities undertaken or incurred by one Party in connection with or relating
to the development, manufacture or sale of the Compounds or the Drug Products
shall be undertaken, incurred or paid exclusively by that Party, and not as an
agent or representative of the other Party.

     16.14 NOTICE

     All communications between the Parties with respect to any of the
provisions of this Agreement will be sent to the addresses set out below, or to
other addresses as designated by one Party to the other by notice pursuant
hereto, by prepaid certified, air mail (which shall be deemed received by the
other Party on the seventh (7th) Business Day following deposit in the mails),
or by cable, telex, facsimile transmission, or other electronic means of
communication (which shall be deemed received when transmitted), with
confirmation by letter given by the close of business on or before the next
following Business Day:

     If to Novartis, at:

     Novartis International Pharmaceutical Ltd.
     Hurst Holme, 12 Trott Road
     P.O. Box HM 2899
     Hamilton HM LX
     Bermuda
     Fax: + [***]
     Attention: Emil Bock

     with a copy to:

     Novartis Institutes for BioMedical Research, Inc.
     400 Technology Square
     Cambridge, Massachusetts 02139
     Fax: + [***]
     Attention: Robert L. Thompson, Vice President and General Counsel

                                              * Confidential Treatment Requested


                                       50

     and

     Novartis Pharma AG
     Lichstrasse, 35
     CH-4056 Basel, Switzerland
     Fax: +[***]
     Attention: General Counsel Pharma Legal

     If to Avanir, at:

     Avanir Pharmaceuticals
     11388 Sorrento Valley Road
     Suite 200
     San Diego, California 92121
     Fax: + [__________]
     Attention: ___________________________

     with a copy to:

     Heller Ehrman White & McAuliffe LLP
     4350 La Jolla Village Drive
     San Diego, California 92122-1246
     Fax: +858.450.8499
     Attention: Richard A. Kaufman, Esq.

     16.15 HEADINGS

     The paragraph headings are for convenience only and will not be deemed to
affect in any way the language of the provisions to which they refer.

     16.16 AUTHORITY

     The undersigned represent that they are authorized to sign this Agreement
on behalf of the Parties hereto. The Parties each represent that no provision of
this Agreement will violate any other agreement that such Party may have with
any other Person. Each Party has relied on that representation in entering into
this Agreement.

     16.17 ENTIRE AGREEMENT

     This Agreement, including the Annexes appended hereto, contains the entire
understanding of the Parties relating to the matters referred to herein, and may
only be amended by a written document, duly executed on behalf of the respective
Parties.

     16.18 INVOICE REQUIREMENT

                                              * Confidential Treatment Requested


                                       51

     Except as otherwise set forth in this Agreement, any amounts payable to
Avanir hereunder shall be made within thirty (30) calendar days after receipt by
Novartis, or its nominee designated for that purpose in advance by Novartis in
writing to Avanir, of an invoice covering such payment, which invoice shall
conform to the extent reasonably practicable to the form of invoice contained in
Annex 3.

                            [Signature page follows]


                                       52

     IN WITNESS WHEREOF, the Parties hereto have caused this Agreement to be
executed by their duly authorized representatives in duplicates as of the day,
month and year first above written.

AVANIR PHARMACEUTICALS


By: /s/ Gerald J. Yakatan
    ----------------------------
Title: President & CEO


NOVARTIS INTERNATIONAL PHARMACEUTICAL LTD.


By: /s/ Emil Bock
    ----------------------------
Title: Emil Bock, Member of the Board of Directors


By: /s/ Michael Jones
    ----------------------------
Title: Michael Jones, Member of the Board of Directors


                                  53

                            ANNEX 1 - PATENT SCHEDULE

                             AVANIR PHARMACEUTICALS

                          MIF PATENTS AND APPLICATIONS

                                      [***]

                                              * Confidential Treatment Requested

                             ANNEX 2 - RESEARCH PLAN

                                      [***]

                                              * Confidential Treatment Requested

EX-15.1

                                                                    EXHIBIT 15.1

August 12, 2005

AVANIR Pharmaceuticals
San Diego, California

We have made a review, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), of the unaudited interim financial
information of AVANIR Pharmaceuticals and subsidiaries as of June 30, 2005 and
for the periods ended June 30, 2005 and 2004, as indicated in our report dated
August 12, 2005; because we did not perform an audit, we expressed no opinion on
that information.

We are aware that our report referred to above, which is included in your
Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, is
incorporated by reference in Registration Statement Nos. 33-71276, 33-94370,
333-83089, 333-84183, 333-38094, 333-108716 and 333-125743 on Form S-8 and
Registration Statement Nos. 33-49082, 33-76094, 333-24549, 333-76641, 333-77925,
333-31442, 333-32776, 333-34958, 333-35934, 333-107820, 333-111680, 333-114389,
333-123867, 333-124230 and 333-125979 on Form S-3.

We also are aware that the aforementioned report, pursuant to Rule 436(c) under
the Securities Act of 1933, is not considered a part of the Registration
Statement prepared or certified by an accountant or a report prepared or
certified by an accountant within the meaning of Sections 7 and 11 of that Act.

Yours truly,

/s/ DELOITTE & TOUCHE LLP

EX-31.1

                                                                    EXHIBIT 31.1

CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Gregory P. Hanson, certify that:

     1.   I have reviewed this quarterly report on Form 10-Q of AVANIR
          Pharmaceuticals;

     2.   Based on my knowledge, this report does not contain any untrue
          statement of a material fact or omit to state a material fact
          necessary to make the statements made, in light of the circumstances
          under which such statements were made, not misleading with respect to
          the period covered by this report;

     3.   Based on my knowledge, the financial statements, and other financial
          information included in this report, fairly present in all material
          respects the financial condition, results of operations and cash flows
          of the registrant as of, and for, the periods presented in this
          report;

     4.   The registrant's other certifying officer and I are responsible for
          establishing and maintaining disclosure controls and procedures (as
          defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
          registrant and have:

               a) designed such disclosure controls and procedures, or caused
               such disclosure controls and procedures to be designed under our
               supervision, to ensure that material information relating to the
               registrant, including its consolidated subsidiaries, is made
               known to us by others within those entities, particularly during
               the period in which this report is being prepared;

               b) evaluated the effectiveness of the registrant's disclosure
               controls and procedures and presented in this report our
               conclusions about the effectiveness of the disclosure controls
               and procedures, as of the end of the period covered by this
               report based on such evaluation; and

               c) disclosed in this report any change in the registrant's
               internal control over financial reporting that occurred during
               the registrant's most recent fiscal quarter (the registrant's
               fourth fiscal quarter in the case of an annual report) that has
               materially affected, or is reasonably likely to materially
               affect, the registrant's internal control over financial
               reporting; and

     5.   The registrant's other certifying officer and I have disclosed, based
          on our most recent evaluation of internal control over financial
          reporting, to the registrant's auditors and the audit committee of
          registrant's Board of Directors (or persons performing the equivalent
          functions):

               a) all significant deficiencies and material weaknesses in the
               design or operation of internal control over financial reporting
               which are reasonably likely to adversely affect the registrant's
               ability to record, process, summarize and report financial
               information; and

               b) any fraud, whether or not material, that involves management
               or other employees who have a significant role in the
               registrant's internal control over financial reporting.

Dated: August 12, 2005


                                        /s/ GREGORY P. HANSON, CMA
                                        ----------------------------------------
                                        Gregory P. Hanson, CMA
                                        Chief Financial Officer

EX-32.1

                                                                    EXHIBIT 32.1

   CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (18
                              U.S.C. SECTION 1350)

In connection with the accompanying Quarterly Report of AVANIR Pharmaceuticals
(the "Company") on Form 10-Q for the fiscal quarter ended June 30, 2005 (the
"Report"), I, Gregory P. Hanson, Chief Financial Officer of the Company,
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, that:

     (1) The Report fully complies with the requirements of Section 13(a) of the
     Securities Exchange Act of 1934; and

     (2) The information contained in the Report fairly presents, in all
     material respects, the financial condition and results of operations of the
     Company.

Dated: August 12, 2005


                                        /s/ GREGORY P. HANSON, CMA
                                        ----------------------------------------
                                        Gregory P. Hanson, CMA
                                        Chief Financial Officer