Sarepta Therapeutics, Inc. - Quarter Report: 2011 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2011

OR

For the transition period from             to            

Commission file number 001-14895

AVI BIOPHARMA, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (425) 354-5038

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 Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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AVI BIOPHARMA, INC.

FORM 10-Q

INDEX

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

AVI BIOPHARMA, INC.

(A Development Stage Company)

BALANCE SHEETS

(unaudited)

(in thousands, except per share data)

See accompanying notes to financial statements.

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AVI BIOPHARMA, INC.

(A Development Stage Company)

STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share amounts)

See accompanying notes to financial statements.

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AVI BIOPHARMA, INC.

(A Development Stage Company)

STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

See accompanying notes to financial statements.

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AVI BIOPHARMA, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements reflect the accounts of AVI BioPharma, Inc. (the “Company”) and its consolidated subsidiaries. The accompanying unaudited condensed consolidated balance sheet data as of December 31, 2010 was derived from audited financial statements not included in this report. The accompanying unaudited condensed consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) pertaining to interim financial statements. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.

Management has determined that the Company operates in one segment: the development of pharmaceutical products on its own behalf or in collaboration with others.

The accompanying unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2010. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

Reclassifications

Certain prior year amounts have been reclassified to conform to current year presentation. These changes did not have a significant impact on the Company’s net loss, assets, liabilities, shareholders’ equity (deficit) or cash flows.

Estimates and Uncertainties

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Commitments and Contingencies

As of the date of this report, the Company is not a party to any material legal proceedings with respect to itself, its subsidiaries, or any of its material properties. In the normal course of business, the Company may from time to time be named as a party to various legal claims, actions and complaints, including matters involving employment, intellectual property, effects from the use of therapeutics utilizing its technology, professional services or others. It is impossible to predict with certainty whether any resulting liability would have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Note 2. Fair Value Measurements

The Company measures at fair value certain financial assets and liabilities in accordance with a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. There are three levels of inputs that may be used to measure fair-value:

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The Company’s assets and liabilities measured at fair value on a recurring basis consisted of the following as of the date indicated:

A reconciliation of the change in value of the Company’s warrants for the three months ended September 30, 2011 is as follows:

A reconciliation of the change in value of the Company’s warrants for the nine months ended September 30, 2011 is as follows:

See Note 7 — “Warrants” for additional information related to the determination of fair value of the warrants.

The carrying amounts reported in the balance sheets for accounts receivable, accounts payable, and other current monetary assets and liabilities approximate fair value because of the immediate or short-term maturity of these financial instruments.

Note 3. Accounts Receivable

Accounts receivable are stated at invoiced amount and do not bear interest. Because all accounts receivable are from the U.S. government and historically no amounts have been written off, an allowance for doubtful accounts receivable is not considered necessary. The accounts receivable balance included $2.2 million and $3.2 million of U.S. government receivables that were unbilled at September 30, 2011 and December 31, 2010, respectively.

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Note 4. Property Held for Sale

In 2009, the Company listed for sale the industrial property located in Corvallis, Oregon and recorded a $0.1 million impairment charge to reduce carrying value to fair value less estimated costs to sell. The Company recorded in general and administrative expenses additional impairment charges of $0.1 million and $0.4 million during the three months ending September 30, 2011 and 2010, respectively, to reduce its carrying value to the current appraised value. The Company has used a Level 3 fair value measure with the use of an independent appraisal to estimate the value of this property.

Note 5. U.S. Government Contracts

In the periods presented, substantially all of the revenue generated by the Company was derived from research contracts with the U.S. government. The Company recognizes revenues from U.S. government research contracts during the period in which the related expenditures are incurred and presents these revenues and related expenses gross in the consolidated financial statements. As of September 30, 2011, the Company had contracts with the U.S. government pursuant to which it is entitled to receive up to an aggregate of $198.5 million for development of its product candidates, of which $109.5 million had been billed or recognized as revenue and $89.0 million of which relates to development that has not yet been completed and has not been billed. The Company is potentially eligible for up to an additional $161.5 million if the U.S. government exercises its options for the Company to conduct additional activities under such contracts. The following is a description of such contracts.

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

In January 2006, the final version of the 2006 defense appropriations act was enacted, which act included an allocation of $11.0 million to fund the Company’s ongoing defense-related programs under four different contracts, all of which were executed in 2007, and the last of which expired in October 2010. Net of government administrative costs, it was anticipated that the Company would receive up to $9.8 million under this allocation. The Company’s technology is expected to be used to continue developing RNA-based drugs against Ebola and Marburg viruses. As of September 30, 2011, the Company had recognized revenue of $9.7 million with respect to these contracts and the Company does not expect to receive any additional significant funds under these contracts.

November 2006 Agreement (Ebola, Marburg and Junín Viruses)

In November 2006, the Company entered into a two-year research contract with the U.S. Defense Threat Reduction Agency (“DTRA”) pursuant to which the Company was entitled to $28.0 million to fund development of the Company’s antisense therapeutic candidates for Ebola, Marburg and Junín hemorrhagic viruses. In May 2009, this contract was amended to extend the term of the contract until November 2009 and to increase funding by $5.9 million to an aggregate of $33.9 million. In September 2009, the contract was amended again to extend the term of the contract to February 2011 and to increase funding by an additional $11.5 million to an aggregate of $45.4 million. In November 2010, the Company and DTRA agreed that the key activities under this contract had been completed and that further activities under this contract would cease and this contract would be deemed concluded. As of September 30, 2011, the Company had recognized revenue of $38.4 million with respect to this contract and the Company does not expect further significant revenue.

May 2009 Agreement (H1N1/Influenza)

In May 2009, the Company entered into a contract with DTRA to develop swine flu drugs. Under this contract, the Company was entitled to receive up to $4.1 million for work involving the application of the Company’s proprietary PMO and PMOplus^® antisense chemistry. The Company used the funds from this contract to conduct preclinical development activities, including animal testing. In March 2010, the contract was amended to include testing against additional influenza strains including H5N1 (avian flu), Tamiflu^®-resistant H1N1 (swine flu) and H3N2 (seasonal flu) and funding increased by $4.0 million to an aggregate of $8.1 million. As of September 30, 2011, the Company had recognized revenue of $7.0 million with respect to this contract and does not expect to receive additional significant revenue.

June 2010 Agreement (H1N1/Influenza)

On June 4, 2010, the Company entered into a contract with DTRA to advance the development of AVI-7100, which was previously designated AVI-7367 and which has been renumbered by the Company, as a medical countermeasure against the pandemic H1N1 influenza virus in cooperation with the Transformational Medical Technologies program (“TMT”) of the U.S. Department of

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Defense (“DoD”). The contract originally provided for funding of up to $18.0 million (which was reduced to $17.7 million in March 2011 when the contract was definitized) to advance the development of AVI-7100, including studies enabling an Investigational New Drug (“IND”) application with the U.S. Food and Drug Administration (“FDA”), the development of an intranasal delivery formulation, and the funding of the entry into a Phase I clinical trial to obtain human safety data to support potential use under an Emergency Use Authorization. In April 2011, the contract was amended to remove clinical studies from the scope of work and to add in vitro broad spectrum strain investigation, additional formulation work related to intranasal delivery and an intravenous compatibility study. As a result of this amendment, the amount of funding under the contract decreased to an aggregate of $13.1 million. The period of performance for this contract ended on June 3, 2011 and as of September 30, 2011, the Company had recognized revenue of $12.2 million with respect to this contract and does not expect to receive additional significant revenue.

July 2010 Agreement (Ebola and Marburg)

On July 14, 2010, the Company was 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 the Company’s hemorrhagic fever virus therapeutic candidates, AVI-6002 and AVI-6003, for Ebola and Marburg viruses, respectively. The contract is funded as part of the TMT program, which was established to develop innovative platform-based solutions countering biological threats. 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. Activity under the first segment began in July 2010 and includes 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 was extended by approximately 13 months to the second quarter of 2013. These activities include non-human primate studies to evaluate the typical viral time course of infection and the optimal doses, timing and pharmacokinetics and pharmacodynamics of each therapeutic candidate, as well as human safety studies of multiple ascending doses of AVI-6002 and AVI-6003. As a result of the amendment, the aggregate available funding for the current segments is approximately $126.5 million of which $39.6 million has been recognized 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, contract activities would include all clinical and licensure activities necessary to obtain FDA regulatory approval of each therapeutic candidate which could include aggregate potential funding up to approximately $288.0 million over six years, of which $161.5 million remains to be funded.

The following table sets forth the revenue for each of the contracts with the U.S. government for the three and nine months ended September 30, 2011 and 2010.

Note 6. Stock Compensation

Stock Options

The Company previously sponsored a 2002 Equity Incentive Plan (the “2002 Plan”) pursuant to which it issued options to purchase its common stock to the Company’s employees, directors and service providers. In June 2011, the 2002 Plan was replaced by the 2011 Equity Incentive Plan (the “2011 Plan” and, together with the 2002 Plan, the “Plans”) following approval by the Company’s shareholders. There will be no further grants under the 2002 Plan, but awards previously granted pursuant to the 2002 Plan will continue to be governed by its terms. The 2011 Plan allows for the grant of stock options, stock appreciation rights, restricted stock awards, restricted stock units, performance shares and performance units.

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In general, stock options granted under the 2002 Plan prior to December 31, 2010 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, stock options granted under the 2002 Plan vest over a four year period, with one-fourth of the underlying shares vesting on the first anniversary of the grant and 1/48^th of the underlying shares vesting monthly thereafter, such that the underlying shares will be fully vested on the fourth anniversary of the grant. As of September 30, 2011, no shares of common stock remain available for future grant under the 2002 Plan.

In general, stock options granted under the 2011 Plan 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. The maximum aggregate number of shares that may be issued under the 2011 Plan is 15,072,457, including 2,072,457 shares reserved but not issued under the 2002 Plan. In addition, shares subject to outstanding awards under the 2002 Plan that expire or otherwise terminate without having been exercised in full, or are forfeited to or repurchased by the Company, will be available for issuance under the 2011 Plan, up to a maximum of 11,086,073 shares. As of September 30, 2011, 11,213,246 shares of common stock remain available for future grant under the 2011 Plan.

A summary of the Company’s stock option activity with respect to the nine months ended September 30, 2011 follows:

The weighted-average fair value per share of stock-based awards, including stock options and restricted stock grants, granted to employees during the three months ended September 30, 2011 and 2010 was $0.79 and $1.36, respectively, and during the nine months ended September 30, 2011 and 2010 was $1.09 and $1.10, respectively. During the nine months ended September 30, 2011 and 2010, the total intrinsic value of stock options exercised was $82,000 and $955,000 respectively, and the total grant date fair value of stock options that vested was $2,300,000 and $2,555,000, respectively.

Valuation Assumptions

Stock-based compensation costs are based on the fair value calculated from the Black-Scholes option-pricing model on the date of grant for stock options. The fair value of stock grants is amortized as compensation expense on a straight-line basis over the vesting period of the grants.

The fair values of stock options granted during the periods presented were measured on the date of grant using the Black-Scholes option-pricing model, with the following assumptions:

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The risk-free interest rate is estimated using an average of treasury bill interest rates at the time of grant that correlate to the prevailing interest rates for a period commensurate with the expected life. The expected dividend yield is zero as the Company has not paid any dividends to date and does 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 historical calculated volatility of the Company’s common stock over a period commensurate with the expected life. 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 Company is required to estimate potential forfeiture of stock grants and adjust compensation cost recorded accordingly. The estimate of forfeitures is adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures are recognized through a cumulative catch-up in the period of change and impact the amount of stock compensation expense to be recognized in future periods.

Stock-based Compensation Expense

The amount of stock-based compensation expense recognized in the three months ended September 30, 2011 and 2010 was $592,000 and $509,000, respectively. For the nine months ended September 30, 2011 and 2010, stock-based compensation expense recognized was $2,454,000 and $2,540,000, respectively. A summary of the stock-based compensation expense recognized in the statements of operations is as follows:

As of September 30, 2011, there was $9.2 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted, including stock options and restricted stock. These costs are expected to be recognized over a weighted-average period of 3.2 years.

During the nine months ended September 30, 2011, in connection with their appointments as officers of the Company, Ms. Effie Toshav, Dr. Peter Linsley and Dr. Edward Kaye were granted options to purchase 650,000, 800,000 and 850,000 shares, respectively, of the Company’s common stock at exercise prices of $2.58, $1.76, and $1.38, respectively. These options were granted outside of the Plans and have vesting schedules consistent with the customary schedule under the 2011 Plan. The shares underlying these options are included in the summary stock compensation table noted above in this Note 6.

Paul Medeiros, the Company’s former Senior Vice President of Business Development and Chief Business Officer, ceased to be an employee of the Company effective June 1, 2011. Pursuant to the terms of his employment agreement and a separation and release agreement that the Company entered into with Mr. Medeiros in connection with the termination of his employment, Mr. Medeiros received 12 months of his base compensation in a lump sum (an amount equal to $321,300) and all of his unvested stock options vested on June 1, 2011 and will be exercisable for a period of 180 days following June 1, 2011. During the nine months ending September 30, 2011, the Company paid his cash severance and recorded a charge of $288,000 for the stock compensation expense.

Dr. Stephen Shrewsbury, the Company’s former Senior Vice President and Chief Medical Officer, ceased to be an employee of the Company effective August 1, 2011. Pursuant to the terms of his employment agreement and a separation and release agreement that the Company entered into with Dr. Shrewsbury in connection with the termination of his employment, Dr. Shrewsbury received 12 months of his base compensation in a lump sum (an amount equal to $319,300) and all of his unvested stock options vested on August 1, 2011 and will be exercisable for a period of 180 days following August 1, 2011. During the nine months ending September 30, 2011, the Company paid his cash severance and recorded a charge of $288,000 for the stock compensation expense.

J. David Boyle II, the Company’s former Senior Vice President and Chief Financial Officer, ceased to be an employee of the Company effective July 24, 2011, the expiration date of his employment agreement. Pursuant to the terms of a separation agreement and release that the Company entered into with Mr. Boyle in connection with his separation from employment, Mr. Boyle received a lump sum payment equal to $113,507, the vesting of 116,666 shares subject to Mr. Boyle’s August 2008 option grant was accelerated and the post-separation exercise period for options to purchase up to 593,333 shares of the Company’s common stock was extended until December 30, 2011. During the nine months ending September 30, 2011, the Company paid his cash severance and recorded a decrease of $25,000 for the stock compensation expense.

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Note 7. Warrants

Warrants issued in connection with the Company’s December 2007, January 2009, and August 2009 financings are classified as liabilities due to their settlement terms. These warrants are non-cash liabilities; the Company is not required to expend any cash to settle these liabilities.

The fair value of these warrants was recorded on the balance sheet at issuance and the warrants are marked to market at each financial reporting period, with changes in the fair value recorded as a gain or loss in the 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 for the inputs used in the model. The following reflects the weighted-average assumptions for each of the periods indicated:

The risk-free interest rate is estimated using an average of treasury bill interest rates at the valuation date that correlate to the prevailing interest rates over a period commensurate with the expected lives. The expected dividend yield is zero as the Company has not paid any dividends to date and does not expect to pay dividends in the future. The expected lives are based on the remaining contractual lives of the related warrants at the valuation date. The expected volatility is estimated using historical volatility of the Company’s common stock, taking into account factors such as future events or circumstances that could impact volatility over a period commensurate with the expected lives. 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 warrants by the holders.

The Company also has warrants that are classified as permanent equity; the fair value of the warrants was recorded as additional paid-in capital at the time of issuance and no further adjustments are required. 255,895 shares were underlying such warrants for each of the three and nine months ended September 30, 2011 and 2010.

A summary of the Company’s warrant activity with respect to the nine months ended September 30, 2011 is as follows:

Note 8. Earnings Per Share

Basic net income (loss) per share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding. Diluted net income (loss) per share is computed by dividing net income (loss) by the weighted-average number of common shares and dilutive common stock equivalent shares outstanding.

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Note 9. Liquidity

Since its inception in 1980 through September 30, 2011 the Company has incurred losses of approximately $308.6 million, substantially all of which resulted from expenditures related to research and development, general and administrative charges and acquired in-process research and development resulting from two acquisitions. The Company has not generated any material revenue from product sales to date, and there can be no assurance that revenue from product sales will be achieved. The Company expects to incur operating losses over the next several years.

At September 30, 2011, cash and cash equivalents were $46.4 million, compared to $33.6 million at December 31, 2010. The Company’s principal sources of liquidity have been equity financings and revenue from its U.S. government research contracts. The Company’s principal uses of cash have been research and development expenses, general and administrative expenses and other working capital requirements.

In the periods presented, substantially all of the revenue generated by the Company was derived from research contracts with the U.S. government. As of September 30, 2011, the Company had ongoing contracts with the U.S. government pursuant to which it is entitled to receive up to an aggregate of $126.5 million for development of its product candidates, of which $39.6 million had been recognized as revenue and $86.9 million relates to development that has not yet been completed and has not been billed or recognized as revenue. Additionally, the Company is potentially eligible for an amount up to approximately $161.5 million of the potential aggregate total award of $288.0 million if the U.S. government exercises all its options on the July 2010 Ebola and Marburg agreement. See Note 5 — “U.S. Government Contracts” for additional information.

In January and August 2009, the Company sold shares of its common stock and also issued warrants to purchase shares of its common stock in offerings registered under the Securities Act of 1933 (the “Securities Act”). In April 2011, the Company sold 23.0 million shares of its common stock at the price of $1.50 per share in an offering registered under the Securities Act. The offering generated gross proceeds of $34.5 million. See Note 10 — “Equity Financings” for more information.

Note 10. Equity Financings

In December 2007, the Company closed a private equity financing for net proceeds of $14.4 million with several institutional investors. In the private equity financing, the Company sold units consisting of one share of common stock and a warrant to purchase one-half of a share of common stock for $1.90 per unit. A total of 10.7 million shares of common stock and warrants for the purchase of 5.3 million shares of common stock at $2.45 per share were sold. These warrants are currently exercisable and expire on December 19, 2012.

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In January 2009, the Company sold approximately 14.2 million shares of its common stock and also issued warrants to purchase approximately 14.2 million shares of its common stock in an offering registered under the Securities Act. The offering generated net proceeds of approximately $15.5 million. The warrants issued to the investors in the offering have an exercise price of $1.16 per share and are exercisable at any time on or before July 30, 2014. In connection with the offering, the Company also issued to the placement agent a warrant to purchase approximately 427,000 shares of the Company’s common stock at an exercise price of $1.45 per share. The warrant issued to the placement agent is exercisable on or before January 30, 2014.

In August 2009, the Company sold approximately 24.3 million shares of its common stock and also issued warrants to purchase approximately 9.7 million shares of its common stock in an offering registered under the Securities Act. The offering generated net proceeds of approximately $32.3 million. The warrants issued to the investors in the offering have an exercise price of $1.78 per share and are exercisable at any time on or before August 25, 2014.

The warrants issued in connection with the January and August 2009 offerings, as well as the warrants issued in the December 2007 financing, are classified as a liability due to their settlement terms. Accordingly, the fair value of the warrants is recorded on the 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 the consolidated statement of operations as described in greater detail in Note 7 — “Warrants.” These warrants are non-cash liabilities; the Company is not required to expend any cash to settle these liabilities.

In April 2011, the Company sold 23.0 million shares of its common stock at the price of $1.50 per share in an offering registered under the Securities Act. The offering generated gross proceeds of $34.5 million.

Note 11. Income Taxes

The Company has not recognized any liability for unrecognized tax benefits. There are no unrecognized tax benefits included in the balance sheet that would, if recognized, affect the effective tax rate.

The Company’s policy is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had no accrual for interest or penalties on its balance sheet at September 30, 2011 or December 31, 2010, and has not recognized interest and/or penalties in the statement of operations for the three and nine months ended September 30, 2011.

At December 31, 2010, the Company had net deferred tax assets of approximately $109 million. The deferred tax assets are primarily composed of U.S. federal and state tax net operating loss carryforwards, U.S. federal and state research and development credit carryforwards, share-based compensation expense and intangibles. Due to uncertainties surrounding its ability to generate future taxable income to realize these assets, a full valuation allowance has been established to offset its net deferred tax asset. Additionally, the Internal Revenue Code rules could limit the future use of its net operating loss and research and development credit carryforwards to offset future taxable income based on ownership changes and the value of the Company’s stock.

Note 12. Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”), issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. Other than requiring additional disclosures, adoption of this new guidance did not have a material impact on the Company’s financial statements.

In April 2010, the FASB issued guidance on applying the milestone method of revenue recognition for milestone payments for achieving specific performance measures when those payments are related to uncertain future events. The guidance is effective on a prospective basis to milestones achieved in fiscal years, and interim periods within those years, beginning January 1, 2011. The adoption of this new guidance did not have a material impact on the Company’s financial statements.

In April 2011, the FASB issued guidance to achieve common fair value measurement and disclosure requirements between GAAP and International Financial Reporting Standards. This guidance amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. The guidance is effective for fiscal years and interim periods beginning after December 15, 2011. The Company does not believe its adoption of this new guidance in the first quarter of 2012 will have a material impact on its financial statements.

In June 2011, the FASB issued guidance regarding presentation of other comprehensive income in the financial statements. This guidance will eliminate the option under GAAP to present other comprehensive income in the statement of changes in equity. Under the guidance, the Company will have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this new guidance is not expected to have a material impact on the Company’s financial statements.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This section should be read in conjunction with our condensed consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q and the section contained in our Annual Report on Form 10-K for the year ended December 31, 2010 under the caption “Part II-Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations”. This discussion contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act. All statements other than historical or current facts, including, without limitation, statements about our business strategy, plans and objectives of management, and our future prospects, are forward-looking statements and are sometimes identified by such words as “believe,” “expect,” “anticipate,” “may,” “will,” “should,” “could,” “would,” “plan,” “estimate,” “project,” “predict,” and “potential,” and words of similar import. These forward-looking statements include, but are not limited to, statements regarding:

These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in this Quarterly Report in Part II, Item 1A – “Risk Factors,” and elsewhere in this Quarterly Report. These statements, like all statements in this Quarterly Report, speak only as of their date, and we undertake no obligation to update or revise these statements in light of future developments. In this report, “we,” “our,” “us,” “AVI,” and “Company” refers to AVI BioPharma, Inc.

Overview

We are a biopharmaceutical company focused on the discovery and development of unique RNA-based therapeutics for the treatment of both 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 potentially disease-modifying Duchenne muscular dystrophy drug candidates with the intent to realize the product opportunities of such candidates and provide significant clinical benefits. We are also focused on developing therapeutics for the treatment of infectious diseases. By building on the research under our infectious disease programs funded by the U.S. government and leveraging our highly-differentiated, proprietary technology platforms, we are seeking to further develop our research and development competencies and capabilities and identify additional product candidates. We believe that our organizational capabilities will enable us to achieve these goals and become a leading developer and marketer of RNA-based therapeutics for the treatment of both rare and infectious diseases.

Our highly-differentiated RNA-based technologies work at the most fundamental level of biology and potentially could have a meaningful impact across a broad range of human diseases and disorders. 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 (the non-proprietary name assigned to AVI-4658) is our lead therapeutic candidate for DMD and is intended to target a substantial group of individuals with DMD. If we are successful in our

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development efforts, eteplirsen will address a severe unmet medical need. Data from 17 of the 19 individuals enrolled in our Phase Ib/II trial in the United Kingdom and 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 greater than 50% 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 II trial for eteplirsen in August 2011 with an objective of entering a pivotal trial in the second half of 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.

We employ our highly-differentiated and innovative RNA-based technology platforms in both our DMD and infectious disease programs. The basis for our novel RNA-based therapeutics is our phosphorodiamidate-linked morpholino oligomer, or PMO, chemistries. By applying our technologies, we are able to target a broad range of diseases and disorders through distinct RNA-based mechanisms of action. Unlike other RNA-based therapeutics, 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 September 30, 2011, we owned or controlled approximately 258 U.S. and corresponding foreign patents and 190 U.S. and corresponding foreign patent applications.

From our inception in 1980, we have devoted our resources primarily to fund our research and development efforts. We have been unprofitable since inception and, other than government research contracts, limited interest, license fees, and grants, we have had no material revenue. We expect to continue to incur losses for the foreseeable future as we continue our research and development efforts and seek to enter additional collaborative efforts. As of September 30, 2011, our accumulated deficit was $308.6 million.

Government Contracts

In the periods presented, substantially all of the revenue generated by our company was derived from research contracts with the U.S. government. We recognize revenues from U.S. government research contracts during the period in which the related expenditures are incurred and present these revenues and related expenses gross in the consolidated financial statements. As of September 30, 2011, we had contracts with the U.S. government pursuant to which we are entitled to receive up to an aggregate of $198.5 million for development of our product candidates, of which $109.5 million had been billed or recognized as revenue and $89.0 million of which relates to development that has not yet been completed and has not been billed. We are potentially eligible for up to approximately $161.5 million if the U.S. government exercises its options for the Company to conduct additional activities under such contracts. The following is a description of such contracts.

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

In January 2006, the final version of the 2006 defense appropriations act was enacted, which act 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. Net of government administrative costs, it was anticipated that we would receive up to $9.8 million under this allocation. Our technology is expected to be used to continue developing RNA-based drugs against Ebola and Marburg viruses. As of September 30, 2011, we had recognized revenue of $9.7 million with respect to these contracts and do not expect to receive any additional significant funds 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, pursuant to which we were entitled to $28.0 million to fund development of our antisense therapeutic candidates for Ebola, Marburg and Junín hemorrhagic viruses. In May 2009, this contract was amended to extend the term of the contract until November 2009 and to increase funding by $5.9 million to an aggregate of $33.9 million. In September 2009, the contract was amended again to extend the term of the contract to February 2011 and to increase funding by an additional $11.5 million to an aggregate of $45.4 million. In November 2010, we and DTRA agreed that the key activities under this contract had been completed and that further activities under this contract would cease and this contract would be deemed concluded. As of September 30, 2011, we had recognized revenue of $38.4 million with respect to this contract and do not expect further significant revenue.

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May 2009 Agreement (H1N1/Influenza)

In May 2009, we entered into a contract with DTRA to develop swine flu drugs. Under this contract, we were entitled to receive up to $4.1 million for work involving the application of our proprietary PMO and PMOplus^® antisense chemistry. We used the funds from this contract to conduct preclinical development activities, including animal testing. In March 2010, the contract was amended to include testing against additional influenza strains including H5N1 (avian flu), Tamiflu^®-resistant H1N1 (swine flu) and H3N2 (seasonal flu) and funding increased by $4.0 million to an aggregate of $8.1 million. As of September 30, 2011, we had recognized revenue of $7.0 million with respect to this contract and do not expect to receive additional significant revenue.

June 2010 Agreement (H1N1/Influenza)

On June 4, 2010, we entered into a contract with DTRA to advance the development of AVI-7100, which was previously designated AVI-7367 and which has been renumbered by us, 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 (which was reduced to $17.7 million in March 2011 when the contract was definitized) to advance the development of AVI-7100, including studies enabling an Investigational New Drug, or IND, application with the U.S. Food and Drug Administration, or FDA, the development of an intranasal delivery formulation, and the funding of the entry into a Phase I clinical trial to obtain human safety data to support potential use under an Emergency Use Authorization. In April 2011, the contract was amended to remove clinical studies from the scope of work and to add in vitro broad spectrum strain investigation, additional formulation work related to intranasal delivery and an intravenous compatibility study. As a result of this amendment, the amount of funding under the contract decreased to an aggregate of $13.1 million. The period of performance for this contract ended on June 3, 2011 and as of September 30, 2011, we had recognized revenue of $12.2 million with respect to this contract and do not expect to receive additional significant 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, for Ebola and Marburg viruses, respectively. The contract is funded as part of the TMT program, which was established to develop innovative platform-based solutions countering biological threats. 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. Activity under the first segment began in July 2010 and includes 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 was extended by approximately 13 months to the second quarter of 2013. These activities include non-human primate studies to evaluate the typical viral time course of infection and the optimal doses, timing and pharmacokinetics and pharmacodynamics of each therapeutic candidate, as well as human safety studies of multiple ascending doses of AVI-6002 and AVI-6003. As a result of the amendment, the aggregate available funding for the current segments is approximately $126.5 million of which $39.6 million has been recognized 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, contract activities would include all clinical and licensure activities necessary to obtain FDA regulatory approval of each therapeutic candidate which could include aggregate potential funding up to $288.0 million over six years, of which $161.5 million remains to be funded.

The following table sets forth the revenue for each of the contracts with the U.S. government for the three and nine months ended September 30, 2011 and 2010.

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Key Financial Metrics

Revenue

Government Research Contract Revenue. In the periods presented, we have generated substantially all of our revenue from U.S. government research contracts. We recognize revenue from U.S. government research contracts during the period in which the related expenditures are incurred and present such revenue and related expense gross in the consolidated financial statements.

We defer recognition of non-refundable upfront fees if we have continuing performance obligations without which 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 our know-how and expertise related to the technology is proprietary to us, or can only be performed by us, then such up-front fees are deferred and recognized over the period of continuing involvement. As of September 30, 2011, we had deferred revenue of $3.3 million, which represents up-front fees received from third parties pursuant to certain contractual arrangements and will be recognized as performance obligations are satisfied.

Substantially all of our revenue is derived from research contracts with the U.S. government. Government contract revenue is highly dependent on the timing of various activities performed by us and our third party vendors, in particular, with respect to our July 2010 Ebola and Marburg agreement. Changes in the timing of activities performed in support of this contract have, and may in the future, resulted in unexpected fluctuations in our revenue from period to period. For example, certain activities originally scheduled for the third and fourth quarters of 2011 were deferred pending finalization of the amendment to the July 2010 Ebola and Marburg Agreement in September 2011. As a result, the revenue associated with these activities was also deferred. We expect that future revenue under our government contracts will continue to be variable as a result of the foregoing factors.

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. Our research and development expenses are impacted by our activities in support of both our U.S. government research contracts and our DMD and other proprietary development programs. Research and development expenses linked to our U.S. government programs are highly dependent on the timing of various activities performed by us and our third party vendors, in particular, with respect to our July 2010 Ebola and Marburg agreement. Changes in the timing of activities performed in support of this contract have, and may in the future, resulted in unexpected fluctuations in our research and development expenses from period to period. As we prepare for the initiation of a pivotal trial in eteplirsen in the second half of 2012, we anticipate that research and development expenses linked to our DMD program will increase. However, because it is difficult to predict the relative contribution of research and development expenses related to our U.S. government research contracts and those related to our DMD and other proprietary development programs, we expect that total future research and development expenses will continue to be variable.

The amount and timing of future research and development expense will depend, in part, 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, and 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 or from the contractual funding for our infectious disease research by the U.S. government. 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 professional fees for legal, consulting and accounting services and an allocation of our facility costs.

Interest Income (Expense) and Other, Net. Interest income (expense) and other, net, consists of interest on our cash equivalents and short-term investments and 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 held for sale. Other income includes rental income on sublease facilities.

Change in Fair Value of Warrants. Warrants issued in connection with our December 2007 and January and August 2009 equity financings are classified as liabilities 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

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the warrants are marked to market each financial reporting period, with changes in the fair value recorded as non-operating income 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 for the inputs used in the model. For more information, see Note 7—“Warrants” of the unaudited condensed consolidated financial statements included elsewhere in this report.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements included elsewhere in this report. 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, revenue 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 consolidated financial statements will be affected. Although we believe that our judgments and estimates are appropriate, actual results may differ from these estimates.

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

Our critical accounting policies and significant estimates are detailed in our annual report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 15, 2011.

Results of Operations for the Three and Nine Months Ended September 30, 2011 and 2010

The following table sets forth selected consolidated statements of operations data for each of the periods indicated: