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SRPT > SEC Filings for SRPT > Form 10-K on 13-Mar-2012All Recent SEC Filings

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Form 10-K for AVI BIOPHARMA INC


13-Mar-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included elsewhere in this Annual Report on Form 10-K. Throughout this discussion, unless the context specifies or implies otherwise, the terms "AVI", "we", "us" and "our" refer to AVI BioPharma, Inc. and its subsidiaries.

Overview

We are a biopharmaceutical company focused on the discovery and development of unique RNA-based therapeutics for the treatment of rare and infectious diseases. Applying our proprietary, highly-differentiated and innovative platform technologies, we are able to target a broad range of diseases and disorders through distinct RNA-based mechanisms of action. We are primarily focused on rapidly advancing the development of our Duchenne muscular dystrophy drug candidates, including our lead product candidate, eteplirsen, which is currently in a Phase IIb trial. We are also focused on developing therapeutics for the treatment of infectious diseases and leveraging our RNA-based technology platforms to identify additional product candidates and explore various strategic opportunities.

Our lead program focuses on the development of disease-modifying therapeutic candidates for Duchenne muscular dystrophy, or DMD, a rare genetic muscle-wasting disease caused by the absence of dystrophin, a protein necessary for muscle function. Eteplirsen is our lead therapeutic candidate for DMD. If we are successful in our development efforts, eteplirsen will address a severe unmet medical need. Data from 17 of the 19 individuals enrolled in our Phase Ib/IIa trial in the United Kingdom who were treated systemically with eteplirsen demonstrated some generation of novel dystrophin, and one participant exhibited the first ever reported increase in dystrophin positive muscle fibers to 55% of normal. Restoration of dystrophin expression and dystrophin positive fibers is believed to be critical for successful disease-modifying treatment of individuals with DMD. We initiated a Phase IIb trial for eteplirsen in August 2011 with an objective of initiating a pivotal trial by the end of 2012. We anticipate releasing results from our current Phase IIb trial by the end of April 2012.

We are also leveraging the capabilities of our RNA-based technology platforms to develop therapeutics for the treatment of infectious diseases. The U.S. Department of Defense, or DoD, has provided significant financial support for the development of therapeutics against Ebola, Marburg, Dengue and influenza viruses, as described in greater detail below.

The basis for our novel RNA-based therapeutics is our phosphorodiamidate-linked morpholino oligomer, or PMO, chemistries. Unlike other RNA-based therapeutics, which are often used to down-regulate gene expression, our technologies can be used to selectively up-regulate or down-regulate the production of a target protein, or direct the expression of novel proteins involved in human diseases and disorders. We believe that these broad capabilities represent highly competitive RNA-based technology platforms and a strong intellectual property position, which we are leveraging to identify additional product candidates and explore various strategic opportunities. As of February 29, 2012, we owned or controlled approximately 276 U.S. and corresponding foreign patents and 191 U.S. and corresponding foreign patent applications.

Since our inception in 1980, we have incurred losses of approximately $310.0 million and substantially all of our revenue has been derived from research and development contracts with the U.S. government. We have not yet generated any material revenue from product sales and we have incurred expenses related to research and development, general and administrative charges and acquired in-process research and development resulting from two acquisitions. We expect to continue to incur losses in the future as we continue our research and development efforts and seek approval from various regulatory agencies for our product candidates, but there can be no assurance that we will obtain approval for our product candidates and achieve revenues from product sales.

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In March 2008, we acquired all of the stock of Ercole Biotechnology, Inc., or Ercole, in exchange for 5,811,721 shares of our common stock, which was valued at approximately $8.4 million, and the assumption of approximately $1.8 million in liabilities of Ercole. We also issued warrants to purchase our common stock (also classified as equity), which were valued at $437,000, in exchange for certain outstanding warrants issued by Ercole.

In December 2011, we restructured our operations by reducing our workforce by 35 employees, or 28%. Restructuring charges totaling $1.1 million were recorded in 2011 and included severance and related costs. The charge included approximately $0.5 million to research and development expense and approximately $0.6 million to general and administrative expense. The restructuring was completed by January 31, 2012 and all severance costs are expected to be paid by July 31, 2012.

As of December 31, 2011, we had cash and cash equivalents of $39.9 million and we anticipate receiving continued funding from the U.S. government to pursue the development of our therapeutics against Ebola and Marburg. Combined together, we believe these sources provide us with sufficient cash to fund operations at least through the following 12 months. In addition, we are likely to pursue additional funding through public or private financings and cash generated from establishing collaborations or licensing our technology to other companies. Should our funding from the U.S. government cease or be delayed, it would have a significant negative impact on our financial condition and on this guidance and we would likely be forced to significantly curtail our research and development efforts.

The likelihood of our long-term success must be considered in light of the expenses, difficulties and delays frequently encountered in the development and commercialization of new pharmaceutical products, competitive factors in the marketplace, the risks associated with U.S. government sponsored programs, and the complex regulatory environment in which we operate. There can be no assurance that we will ever achieve significant revenues or profitable operations.

U.S. Government Contracts

In the periods presented, nearly all of the revenue we generated was derived from research contracts with and grants from the U.S. government. As of December 31, 2011, we had substantially completed all of our contracts with the U.S. government except for the July 2010 agreement for the development of therapeutics against Ebola and Marburg. Pursuant to this agreement, as of December 31, 2011, we are currently entitled to receive up to $126.5 million of which $52.7 million has been recognized as revenue. In addition, if the U.S. government elects to exercise all its options under the agreement, an additional $161.5 million in funding is available.

The following table sets forth the revenue from each of our contracts with the U.S. government and other revenue for the years ended December 31, 2011, 2010 and 2009.

                                                               Year Ended December 31,
                                                           2011          2010          2009
                                                                    (in thousands)
January 2006 Agreements (Ebola and Marburg host
factor, Dengue, Anthrax and Ricin)                       $      9      $    519      $  2,288
November 2006 Agreement (Ebola, Marburg and Junín
Viruses)                                                       -          3,204        10,421
May 2009 Agreement (H1N1)                                     516         5,171         1,716
June 2010 Agreement (H1N1)                                  3,490         8,809            -
July 2010 Agreement (Ebola and Marburg)                    42,875         9,822            -
Grants                                                         -          1,622           725
Other Agreements                                              100           273         2,435

Total                                                    $ 46,990      $ 29,420      $ 17,585

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The following is a description of each of our significant U.S. government contracts and grants.

January 2006 Agreement (Ebola and Marburg Host Factors, Dengue, Anthrax and Ricin)

The 2006 defense appropriations included an allocation of $11.0 million to fund our ongoing defense-related programs under four different contracts, all of which were executed in 2007, and the last of which expired in October 2010. As of December 31, 2011, we have recognized revenue of $9.7 million with respect to these contracts and we do not expect to receive any additional revenue under these contracts.

November 2006 Agreement (Ebola, Marburg and Junín Viruses)

In November 2006, we entered into a two-year research contract with the U.S. Defense Threat Reduction Agency, or DTRA, which entitled us to $28.0 million to fund the development of our antisense therapeutic candidates against Ebola, Marburg and Junín hemorrhagic viruses. The contract was subsequently amended twice, which amendments extended the term of the contract to February 2011 and increased the award to an aggregate of $45.4 million. In November 2010, we and DTRA agreed that the key activities under this contract had been completed. As of December 31, 2011, we had recognized revenue of $38.4 million with respect to this contract and do not expect any further revenue.

May 2009 Agreement (H1N1/Influenza)

In May 2009, we entered into a contract with DTRA to develop swine flu drugs. Under this contract, DTRA was to pay us up to $4.1 million for the work involving the application of our proprietary PMO and PMOplus® antisense chemistry. In March 2010, the contract was amended to include testing against additional influenza strains and funding increased to an aggregate of $8.1 million. As of December 31, 2011, we have recognized revenue of $7.4 million with respect to this contract and we do not expect to receive additional revenue under this contract.

June 2010 Agreement (H1N1/Influenza)

On June 4, 2010, we entered into a contract with DTRA to advance the development of AVI-7100 as a medical countermeasure against the pandemic H1N1 influenza virus in cooperation with the Transformational Medical Technologies program, or TMT, of the U.S. Department of Defense, or DoD. The contract originally provided for funding of up to $18.0 million, but, pursuant to a subsequent modification, was decreased to $13.1 million. The period of performance for this contract ended on June 3, 2011 and, as of December 31, 2011, we have recognized revenue of $12.3 million and we do not expect to receive any additional revenue.

July 2010 Agreement (Ebola and Marburg)

On July 14, 2010, we were awarded a new contract with the DoD Chemical and Biological Defense Program through the U.S. Army Space and Missile Defense Command for the advanced development of our hemorrhagic fever virus therapeutic candidates, AVI-6002 and AVI-6003, against the Ebola and Marburg viruses, respectively. The contract is structured into four segments for each therapeutic candidate and has an aggregate period of performance spanning approximately six years if DoD exercises its options for all segments. Our activities under the first segment began in July 2010 and include Phase I studies in healthy volunteers as well as preclinical studies. In September 2011, the contract was amended to shift activities originally scheduled to occur during the second segment for each therapeutic candidate to the current funding period, which is scheduled to be completed in the second quarter of 2013. As a result of the amendment, the aggregate available funding for the current segments is approximately $126.5 million of which we have recognized $52.7 million to date.

After completion of the first segment, and each successive segment, DoD has the option to proceed to the next segment for either or both AVI-6002 and AVI-6003. If DoD exercises its options for all four segments for

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both AVI-6002 and AVI-6003, our contract activities would include all clinical and licensure activities necessary to obtain FDA regulatory approval for each therapeutic candidate and would provide for a total funding award to us of up to $288.0 million over a period of six years, of which $161.5 million remains to be funded.

In February 2012, we announced that we received approval from the FDA to proceed with a single oligomer from AVI-6003, AVI-7288, as the lead product candidate against Marburg virus infection.

2010 Qualifying Therapeutic Discovery Project

In October 2010, we were awarded five cash grants for our DMD program and infectious disease programs totaling approximately $1.2 million under the U.S. government's Qualifying Therapeutic Discovery Project, or QTDP, and recognized the entire amount as revenue in 2010. We will not receive any further funding under the QTDP grants.

Key Financial Metrics

Revenue

Government Research Contract and Grant Revenue. Substantially all of our revenue is generated from U.S. government research contracts and grants. See "Note 7-U.S. Government Contracts" of the financial statements included elsewhere in this Annual Report on Form 10-K. We recognize revenue from U.S. government research contracts and grants during the period in which the related expenses are incurred and present such revenues and related expenses gross in the consolidated financial statements.

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

We defer recognition of non-refundable upfront fees if we have continuing performance obligations when the technology, right, product or service conveyed in conjunction with the non-refundable fee has no utility to the licensee that is separate and independent of our performance under the other elements of the arrangement. In addition, if we have continuing involvement through research and development services that are required because of our know-how or because the services can only be performed by us, then such up-front fees are deferred and recognized over the period of continuing involvement. As of December 31, 2011, we had deferred revenue of $3.3 million, which represents up-front fees which we will recognize as revenue as we satisfy the outstanding performance obligations.

Expenses

Research and Development. Research and development expense consists of costs associated with research activities as well as costs associated with our product development efforts, conducting preclinical studies, and clinical trial and manufacturing costs.

Direct research and development expenses associated with our programs include clinical trial site costs, clinical manufacturing costs, costs incurred for consultants and other outside services, such as data management and statistical analysis support, and materials and supplies used in support of the clinical programs. Indirect costs of our clinical program include salaries, stock based compensation, and an allocation of our facility costs.

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The amount and timing of future research and development expense will depend on our ability to obtain U.S. government awards to fund the advanced development of our antiviral therapeutic candidates. Without such funding, we would likely drastically reduce our spending in these areas. Future research and development expenses may also increase if our internal projects, such as DMD, enter later stage clinical development. Our research and development programs are at an early stage and may not result in any approved products. Product candidates that appear promising at early stages of development may not reach the market for a variety of reasons. Similarly, any of our product candidates may be found to be ineffective during clinical trials, may take longer to complete clinical trials than we have anticipated, may fail to receive necessary regulatory approvals, or may prove impracticable to manufacture in commercial quantities at reasonable cost and with acceptable quality.

As a result of these uncertainties and the other risks inherent in the drug development process, we cannot determine the duration and completion costs of current or future clinical stages of any of our product candidates. Similarly, we cannot determine when, if, or to what extent we may generate revenue from the commercialization and sale of any product candidate. The timeframe for development of any product candidate, associated development costs, and the probability of regulatory and commercial success vary widely.

General and Administrative. General and administrative expense consists principally of salaries, benefits, stock-based compensation expense, and related costs for personnel in our executive, finance, legal, information technology, business development and human resource functions. Other general and administrative expenses include an allocation of our facility costs and professional fees for legal, consulting and accounting services.

Interest Income (Expense) and Other, Net. Interest income (expense) and other, net, consists of interest on our cash and cash equivalents, rental income and other income. Our cash equivalents consist of money market investments. Interest expense includes interest paid on our mortgage loan related to the Corvallis property, the substantial portion of which we leased in November 2011. Other income includes rental income from subleasing excess space in some of our facilities.

Change in Fair Value of Warrants. Warrants issued in connection with our December 2007 and January and August 2009 financings are classified as liabilities as opposed to equity due to their settlement terms. These warrants are non-cash liabilities; we are not required to expend any cash to settle these liabilities. The fair market value of these warrants was recorded on the balance sheet at issuance and the warrants are marked to market each financial reporting period, with changes in the fair value recorded as a gain or loss in our statement of operations. The fair value of the warrants is determined using the Black-Scholes option-pricing model, which requires the use of significant judgment and estimates related to the inputs used in the model and can result in significant swings in the fair market valuation primarily due to changes in our stock price. For more information, see "Note 9-Warrants" of the financial statements included elsewhere in this Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our financial statements included elsewhere in this Annual Report on Form 10-K. The preparation of our financial statements in accordance with accounting principles generally accepted in the United States, or GAAP, requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities for the periods presented. Some of these judgments can be subjective and complex, and, consequently, actual results may differ from these estimates. For any given individual estimate or assumption we make, there may also be other estimates or assumptions that are reasonable. We believe that the estimates and judgments upon which we rely are reasonable based upon historical experience and information available to us at the time that we make these estimates and judgments. To the extent there are material differences between these estimates and actual results, our financial statements will be affected. Although we believe that our judgments and estimates are appropriate, actual results may differ from these estimates.

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The policies that we believe are the most critical to aid the understanding of our financial results include:

• revenue recognition;

• stock-based compensation; and

• accounting for and valuation of warrants classified as liabilities.

Revenue Recognition

We have historically generated revenue from our U.S. government research contracts and grants and other license arrangements. For a more detailed description of our revenue recognition policies, see "-Key Financial Metrics" above and "Note 2-Summary of Significant Accounting Policies" of the financial statements included elsewhere in this Annual Report on Form 10-K.

Stock Compensation Expense

To determine stock-based compensation costs, we apply the provisions of Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, Topic 718, Share-Based Payments. We use the Black-Scholes option pricing model for determining the estimated fair value for stock-based awards on the date of grant, which requires the use of subjective and complex assumptions to determine the fair value of stock-based awards, including the option's expected term and the price volatility of the underlying stock. We recognize the value of the portion of the awards that is ultimately expected to vest as expense over the requisite vesting periods on a straight-line basis for the entire award. Stock options granted to employees are service-based and prior to December 31, 2010 typically vest over a three year period, with one-third of the underlying shares vesting on each anniversary of grant, and have a ten year term. Beginning in January 2011, newly granted stock options have a ten year term and typically vest over a four year period, with one fourth of the underlying shares vesting on the first anniversary of the grant and 1/48th of the underlying shares vesting monthly thereafter, such that the underlying shares will be fully vested on the fourth anniversary of the grant. Compensation expense of $3.1 million for the year ended December 31, 2011 is shown in the operating activities section of the statements of cash flows. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The following table summarizes the weighted average assumptions used in determining the fair value of stock options granted:

                                              Year Ended December 31,
                                 2011                  2010                  2009
 Risk-free interest rate         0.9% - 2.4%           1.4% - 3.8%           1.2% - 1.8%
 Expected dividend yield                  -%                    -%                    -%
 Expected lives              5.2 - 8.9 years       5.3 - 8.0 years       3.6 - 9.1 years
 Expected volatility           78.2% - 81.6%         82.5% - 90.3%         92.0% - 94.4%

The risk free interest rate is estimated using an average of treasury bill interest rates over a historical period commensurate with the expected life of the option that correlates to the prevailing interest rates at the time of grant. The expected dividend yield is zero as we have not paid any dividends to date and do not expect to pay dividends in the future. The expected lives are estimated using expected and historical exercise behavior. The expected volatility is estimated using calculated volatility of our common stock over a historical period commensurate with the expected life of the option. The amounts estimated according to the Black-Scholes option pricing model may not be indicative of the actual values realized upon the exercise of these options by the holders.

The assumptions used in calculating the fair value of stock-based compensation expense represent management's best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based

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compensation expense could be materially different in the future. See "Note 3-Stock Compensation" of the audited financial statements included elsewhere in this Annual Report on Form 10-K for a further discussion of stock-based compensation.

Warrant Liability

In December 2007 and January and August of 2009, we issued warrants to purchase an aggregate of 29.7 million shares of our common stock in connection with offerings of our common stock and warrants. These warrants are classified as a liability due to their settlement terms. These warrants are non-cash liabilities; we are not required to expend any cash to settle these liabilities.

The fair value of the warrants is recorded on our consolidated balance sheet as a liability, and such fair value is adjusted at each financial reporting period with the adjustment to fair value reflected in our consolidated statement of operations. The fair value of the warrants is determined using the Black-Scholes option pricing model, which requires the use of significant judgment and estimates related to the inputs used in the model. The following reflects the weighted-average assumptions for each of the periods indicated:

                                              Year Ended December 31,
                                 2011                  2010                  2009
 Risk-free interest rate         0.1% - 0.4%           0.6% - 1.0%           0.2% - 2.7%
 Expected dividend yield                  -%                    -%                    -%
 Expected lives              1.0 - 2.7 years       2.0 - 3.7 years       0.4 - 4.7 years
 Expected volatility           71.8% - 75.6%         84.7% - 90.1%        86.0% - 102.1%

Fluctuations in the assumptions and factors used in the Black-Scholes model can result in adjustments to the fair value of the warrants reflected on our balance sheet and, therefore, our statement of operations. If, for example, the market value of our common stock or its volatility at December 31, 2011 were 10% higher or lower than what we used in the valuation of the warrants, our valuation of the warrants would have increased by up to $1.0 million or decreased up to $1.0 million, respectively, with such difference reflected in our statement of operations. See "Note 9-Warrants" of the audited financial statements included elsewhere in this Annual Report on Form 10-K for a further discussion of warrants.

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