##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 FORM 10-Q/A (Amendment No. 2)
 x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THESECURITIES EXCHANGE ACT OF 1934
   o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THESECURITIES EXCHANGE ACT OF 1934
 
 Commission File Number 0-21185 AAIPHARMA INC.  DELAWARE
    
    04-2687849(State or other jurisdiction of
    
    (I.R.S. employerincorporation or organization)
    
    identification no.)
 2320 SCIENTIFIC PARK DRIVE, WILMINGTON, NC 28405 (Address of principal executive office)
    
    (Zip code)
 (910) 254-7000
(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 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 o NO x Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes x No o The number of shares of the Registrants common stock outstanding, as of March
31, 2003 was 27,609,271 shares. 1




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Explanatory Note:
This Amendment No. 2 to aaiPharma Inc.s Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 2003 includes unaudited restated consolidated
financial statements for the three months ended March 31, 2003 and 2002 and an
audited restated consolidated balance sheet at December 31, 2002. The
accompanying restated consolidated financial statements and supplementary data,
including the notes to the accompanying restated consolidated financial
statements, have been revised to reflect the restatement occurring subsequent
to the filing of the original and Amendment No. 1 to Quarterly Report on Form
10-Q for the period ended March 31, 2003. The restatement impacts the first
three quarters of 2003 and each quarter of 2002. The restated amounts for the
second and third quarters of 2003 and 2002 are presented in the Companys
Quarterly Reports on Form 10-Q/A for the quarterly periods ended June 30, 2003
and September 30, 2003. This restatement:  
    
    corrects the recognition of revenue for certain transactions in
the first quarter of 2003 that did not satisfy all of the
conditions for revenue recognition contained in SFAS 48 and/or
SAB 101,  
    
    increases reserves for product returns and makes other
adjustments to our revenue reserves in the first quarter of
2003, and  
    
    with respect to 2002 and 2003, changes the accounting for our
major product line acquisitions which had been accounted for as
business combinations to treat such acquisitions as acquisitions
of assets that do not constitute a business. The restatement adjustments decreased our net revenues and diluted earnings per
share for the three months ended March 31, 2003 by approximately $15.0 million
and $0.34 per share, respectively. The restatement adjustments increased our
diluted loss per share for the three months ended March 31, 2002 by
approximately $(0.01) per share. For further discussion, see our Annual Report
on Form 10-K for the year ended December 31, 2003 (the 2003 Form 10-K), Item
7, which discloses the nature of the restatement adjustments and shows the
impact of the restatement adjustments. This Quarterly Report on Form 10-Q/A amends and restates Items 1, 2 and 4 of
Part I and Items 3 and 6 of Part II of the Quarterly Report on Form 10-Q, as
amended, and no other information included in the Quarterly Report on Form 10-Q
is amended hereby. For a discussion of events and developments subsequent to March 31, 2003
through the filing on June 15, 2004 of our 2003 Form 10-K, see our 2003 Form
10-K. This Amendment No. 2 to our Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 2003 has not been updated to reflect any
events or developments occurring subsequent to June 15, 2004. In accordance
with Rule 12b-15 under the Securities Exchange Act of 1934, this amendment
includes only those items of the Quarterly Report on Form 10-Q affected by our
restatement. The terms we, us or our in this amendment include aaiPharma Inc., its
corporate predecessors and its subsidiaries, except where the context may
indicate otherwise. Our corporation was incorporated in 1986, although its
corporate predecessor was founded in 1979. Our Internet address is www.aaipharma.com. We make available through our
internet website our annual reports on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and amendments to 2




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##### 



those reports filed or furnished pursuant to Section 13(a) of the Securities
Exchange Act of 1934 as soon as reasonably practicable after we electronically
file such material with, or furnish it to, the Securities and Exchange
Commission. On March 31, 2003, we owned the
following registered and unregistered trademarks referenced herein: Darvon®, Darvon-N®,
Darvocet-N®, M.V.I.®, M.V.I.-12®, M.V.I. Pediatric®, M.V.I. Adult,
Aquasol®, Aquasol A®, Aquasol E®, Brethine®, ProSorb-D,
AzaSan, aaiPharma®, and AAI®. Unless the context otherwise requires,
references in this document to Darvon are to Darvon® and Darvon-N® collectively and
references to Darvocet are to Darvocet-N®. Unless the context otherwise requires,
references in this document to M.V.I. are to M.V.I.-12®, M.V.I.
Pediatric® and M.V.I. Adult, collectively, and references in this
document to Aquasol are to Aquasol A® and Aquasol
E®, collectively. All references in this document
to any of these terms lacking the ® or  symbols are defined terms
that reference the products, technologies or businesses bearing the trademarks
with these symbols. aaiPharma Inc.
Table of Contents 
 Page No.PART I. FINANCIAL INFORMATIONItem 1. Financial Statements(unaudited)Restated Consolidated Statements of Operations
    
    
    4Restated Consolidated Balance Sheets
    
    
    5Restated Consolidated Statements of Cash Flows
    
    
    6Restated Consolidated Statements of Comprehensive Loss
    
    
    7Notes to Restated Consolidated Financial Statements
    
    
    8Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    24Item 4. Controls and Procedures
    
    
    33PART II. OTHER INFORMATIONItem 3. Defaults Upon Senior Securities
    
    
    34Item 6. Exhibits and Reports on Form 8-K
    
    
    35SIGNATURES
    
    
    36EXHIBIT INDEX
    
    
    37
 3




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##### 



PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements. The restated consolidated financial statements and supplementary data,
including the notes to the restated financial statements, set forth in this
Item 1, have been revised to reflect the restatement occurring subsequent to
the filing of the original Quarterly Report on Form 10-Q/A. aaiPharma Inc. 
 RESTATED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
 Three Months EndedMarch 31,2003
    
    2002Net revenues:Product sales
    
    $
    24,965
    
    
    $
    20,177Product development (royalties and fees)
    
    
    3,810
    
    
    
    2,135Development services
    
    
    20,212
    
    
    
    23,30848,987
    
    
    
    45,620Operating costs and expenses:Direct costs (excluding depreciation):Product sales (includes product rights amortization of $2,968 and $333)
    
    
    11,270
    
    
    
    8,138Development services
    
    
    12,004
    
    
    
    13,545Total direct costs
    
    
    23,274
    
    
    
    21,683Selling expenses
    
    
    7,734
    
    
    
    4,274General and administrative expenses
    
    
    10,030
    
    
    
    8,755Research and development
    
    
    4,486
    
    
    
    4,378Depreciation
    
    
    1,888
    
    
    
    1,677Total operating costs and expenses
    
    
    47,412
    
    
    
    40,767Income from operations
    
    
    1,575
    
    
    
    4,853Other income (expense):Interest, net
    
    
    (5,550
    )
    
    
    (1,823
    )Loss from extinguishment of debt
    
    
    
    
    
    
    (8,053
    )Other income (expense), net
    
    
    (83
    )
    
    
    134(5,633
    )
    
    
    (9,742
    )Loss before income taxes
    
    
    (4,058
    )
    
    
    (4,889
    )Benefit from income taxes
    
    
    (1,590
    )
    
    
    (1,513
    )Net loss
    
    $
    (2,468
    )
    
    $
    (3,376
    )Basic loss per share
    
    $
    (0.09
    )
    
    $
    (0.12
    )Weighted average shares outstanding
    
    
    27,558
    
    
    
    27,107Diluted loss per share
    
    $
    (0.09
    )
    
    $
    (0.12
    )Weighted average shares outstanding
    
    
    27,558
    
    
    
    27,107
 The accompanying notes are an integral part of these financial statements. 4




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aaiPharma Inc. 
 RESTATED CONSOLIDATED BALANCE SHEETS
(In thousands)
 March 31, 2003
    
    December 31, 2002(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,705
    
    
    $
    6,532Accounts receivable, net
    
    
    23,831
    
    
    
    29,467Work-in-progress
    
    
    12,292
    
    
    
    10,515Inventories, net
    
    
    21,058
    
    
    
    17,004Deferred tax assets
    
    
    1,271
    
    
    
    1,271Prepaid and other current assets
    
    
    6,041
    
    
    
    6,362Total current assets
    
    
    75,198
    
    
    
    71,151Property and equipment, net
    
    
    54,604
    
    
    
    53,125Goodwill, net
    
    
    11,764
    
    
    
    11,378Intangible assets, net
    
    
    279,240
    
    
    
    281,669Other assets
    
    
    13,782
    
    
    
    16,179Total assets
    
    $
    434,588
    
    
    $
    433,502LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current maturities of long-term debt
    
    $
    5,921
    
    
    $
    5,921Accounts payable
    
    
    17,862
    
    
    
    17,671Customer advances
    
    
    14,287
    
    
    
    15,051Accrued wages and benefits
    
    
    7,941
    
    
    
    6,718Interest payable
    
    
    9,940
    
    
    
    5,232Deferred product revenue
    
    
    10,211
    
    
    
    Other accrued liabilities
    
    
    2,748
    
    
    
    5,201Total current liabilities
    
    
    68,910
    
    
    
    55,794Long-term debt, less current portion
    
    
    266,487
    
    
    
    277,899Deferred tax liability
    
    
    3,165
    
    
    
    3,840Other liabilities
    
    
    2,081
    
    
    
    715Stockholders equity:Common stock
    
    
    28
    
    
    
    27Paid-in capital
    
    
    79,476
    
    
    
    79,049Retained earnings
    
    
    13,928
    
    
    
    16,396Accumulated other comprehensive income (loss)
    
    
    513
    
    
    
    (218
    )Total stockholders equity
    
    
    93,945
    
    
    
    95,254Total liabilities and stockholders equity
    
    $
    434,588
    
    
    $
    433,502
 The accompanying notes are an integral part of these financial statements. 5




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##### 



aaiPharma Inc. 
 RESTATED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 Three Months Ended March 31,2003
    
    2002Cash flows from operating activities:Net loss
    
    $
    (2,468
    )
    
    $
    (3,376
    )Adjustments to reconcile net loss to
net cash provided by (used in) operating activities:Depreciation and amortization
    
    
    4,856
    
    
    
    2,010Write-off of deferred financing and other costs
    
    
    
    
    
    
    8,053Other
    
    
    52
    
    
    
    78Changes in operating assets and liabilities:Accounts receivable, net
    
    
    5,713
    
    
    
    (3,951
    )Work-in-progress
    
    
    (1,640
    )
    
    
    (2,850
    )Inventories, net
    
    
    (4,033
    )
    
    
    1,082Prepaid and other assets
    
    
    856
    
    
    
    (14,118
    )Accounts payable
    
    
    137
    
    
    
    (1,991
    )Customer advances
    
    
    (843
    )
    
    
    (222
    )Interest payable
    
    
    4,708
    
    
    
    (175
    )Deferred product revenue
    
    
    10,211
    
    
    
    Accrued wages and benefits and other accrued liabilities
    
    
    (2,223
    )
    
    
    (1,288
    )Net cash provided by (used in) operating activities
    
    
    15,326
    
    
    
    (16,748
    )Cash flows from investing activities:Purchases of property and equipment
    
    
    (3,212
    )
    
    
    (1,549
    )Purchase of property and equipment previously leased
    
    
    
    
    
    
    (14,145
    )Acquisitions of product rights and other intangibles
    
    
    (500
    )
    
    
    (211,772
    )Other
    
    
    (232
    )
    
    
    2Net cash used in investing activities
    
    
    (3,944
    )
    
    
    (227,464
    )Cash flows from financing activities:Net payments on short-term debt
    
    
    
    
    
    
    5,000Proceeds from long-term borrowings
    
    
    
    
    
    
    240,274Payments on long-term borrowings
    
    
    (8,500
    )
    
    
    Proceeds from interest rate swaps, net
    
    
    435
    
    
    
    Proceeds from stock option exercises
    
    
    428
    
    
    
    1,980Other
    
    
    409
    
    
    
    (2,845
    )Net cash (used in) provided by financing activities
    
    
    (7,228
    )
    
    
    244,409Net increase in cash and cash equivalents
    
    
    4,154
    
    
    
    197Effect of exchange rate changes on cash
    
    
    19
    
    
    
    (17
    )Cash and cash equivalents, beginning of period
    
    
    6,532
    
    
    
    6,371Cash and cash equivalents, end of period
    
    $
    10,705
    
    
    $
    6,551Supplemental information, cash paid for:Interest
    
    $
    1,497
    
    
    $
    1,776Income taxes
    
    $
    2,202
    
    
    $
    1,687
 The accompanying notes are an integral part of these financial statements. 6




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aaiPharma Inc. 
 RESTATED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)
 Three Months EndedMarch 31,2003
    
    2002Net loss
    
    $
    (2,468
    )
    
    $
    (3,376
    )Currency translation adjustments
    
    
    731
    
    
    
    (175
    )Comprehensive loss
    
    $
    (1,737
    )
    
    $
    (3,551
    )
 The accompanying notes are an integral part of these financial statements. 7




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aaiPharma Inc. 
 
 1. Basis of presentation
and other matters
The accompanying unaudited restated consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States and applicable Securities and Exchange Commission regulations for
interim financial information. These restated financial statements do not
include all of the information and footnotes required by accounting principles
generally accepted in the United States for annual financial statements. The
consolidated restated financial information as of December 31, 2002 has been
derived from audited financial statements; certain amounts for the three months
ended March 31, 2002 have been reclassified for consistent presentation with
current year financial statements. On January 30, 2003, aaiPharmas Board of
Directors approved a 3-for-2 stock split of the Companys common shares. On
March 10, 2003, each stockholder received one additional share of common stock
for every two shares they owned on the record date of February 19, 2003. All
share and per share amounts have been restated to reflect the stock split for
all periods presented. Users of this interim financial information should read
the audited financial statements for the preceding fiscal year, which are
included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2003. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for fair presentation
have been included in these interim restated financial statements. Operating
results for the interim periods presented are not necessarily indicative of the
results that may be expected for the full year. The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported
in the consolidated financial statements and accompanying notes. Actual
results could differ from such estimates and changes in such estimates may
affect amounts reported in future periods. In 2003, the Company adopted Statement of Financial Accounting Standards No.
145, Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections (SFAS 145). SFAS 145 no longer requires
companies to report gains or losses associated with the extinguishment of debt
as a component of extraordinary gains or losses, net of tax. In addition, any
extraordinary gains or losses on extinguishment of debt in prior periods
presented would require reclassification. As required by SFAS 145, the
extraordinary loss recognized in the three months ended March 31, 2002 of
approximately $8.1 million ($5.3 million net of tax) to record the write-off of
deferred financing and other costs related to its prior debt facilities has
been reclassified to other expense. In December 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure (SFAS 148). SFAS 148 amends
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS 123), to provide alternative methods of
transition to SFAS 123s fair value method of accounting for stock-based
employee compensation. SFAS 148 also amends the disclosure provisions in SFAS
123 and Accounting Principles Board Opinion No. 28, Interim Financial
Reporting, to require disclosure in the summary of significant accounting
policies of the effects of an entitys accounting policy with respect to
stock-based employee compensation on reported net income and 8




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earnings per share in annual and interim financial statements. The adoption of
SFAS 148 did not have a significant impact on the Companys consolidated
results of operations, financial position or cash flows. The Company applies Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB 25) and related Interpretations in accounting
for its stock option plans; therefore, compensation expense has not been
recognized for options granted at fair value. Under APB 25, if the exercise
price of the Companys stock options is not less than the estimated fair market
value of the underlying stock on the date of grant, no compensation expense is
recognized. If compensation cost for the Companys plans had been determined
based on the fair value at the grant dates for awards under those plans
consistent with the fair value method of SFAS 123, the Companys net income
(loss) and earnings (loss) per share would have been changed to the pro forma
amounts indicated below: Three Months EndedMarch 31,2003
    
    2002(In thousands, except per share data)Net loss, as reported
    
    $
    (2,468
    )
    
    $
    (3,376
    )Pro forma stock-based compensation cost, net of tax
    
    
    1,846
    
    
    
    1,106Pro forma net loss
    
    
    (4,314
    )
    
    
    (4,482
    )Loss per share:As reported -Basic
    
    ($
    0.09
    )
    
    ($
    0.12
    )Diluted
    
    ($
    0.09
    )
    
    ($
    0.12
    )Pro forma -Basic
    
    ($
    0.16
    )
    
    ($
    0.17
    )Diluted
    
    ($
    0.16
    )
    
    ($
    0.17
    )
 2. Restatement of
Previously Issued Financial Statements
The Company has restated its consolidated statements of operations, cash flows,
and comprehensive income for the three months ended March 31, 2003 and 2002 and
its consolidated balance sheets as of March 31, 2003 and December 31, 2002. The
restatement does not affect periods prior to 2002. The restatement, among
other things, corrects the Companys accounting treatment of certain
transactions that did not satisfy all of the conditions of FASB Statement No.
48 Revenue Recognition When Right of Return Exists (SFAS 48) and/or Staff
Accounting Bulletin No. 101 Revenue Recognition in Financial Statements (SAB
101) or were subsequently deemed to involve subjective determinations for
which the Company has determined alternative accounting treatments should be
used. Set forth below are the restatement adjustments included in the
restatement of the previously issued financial statements for the three months
ended March 31, 2003 and 2002. The following table presents the impact of the restatement adjustments
described below on net income for the three months ended March 31, 2003 and
2002: 9




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Net Income (Loss)For the Three Months EndedMarch 31,2003
    
    2002(In thousands)As previously reported
    
    $
    7,156
    
    
    $
    (3,250
    )Consignment sale / reversal of revenue (i)
    
    
    (4,357
    )
    
    
    Returns reserves (ii)
    
    
    (3,679
    )
    
    
    Intangible asset amortization (iii)
    
    
    (1,356
    )
    
    
    (206
    )Change in tax rate (iv)
    
    
    (232
    )
    
    
    80As restated
    
    $
    (2,468
    )
    
    $
    (3,376
    )
 The adjustments to restate the 2002 and 2003 quarterly periods relate to the
following:  (i)
    
    for 2003, the correction of the Companys revenue recognition of certain
transactions, including specific product sales in the first quarter of 2003,
that did not satisfy all of the conditions for recognition of revenue under
SFAS 48 and/or SAB 101,  (ii)
    
    for 2003, significant increases in reserves for product returns and other
adjustments to the Companys revenue and product inventory reserves,  (iii)
    
    for 2002 and 2003, a change in the accounting treatment used with respect
to the Companys product line acquisitions from accounting for the acquisitions
as business combinations to recording such transactions as asset acquisitions.
Accordingly the Company adjusted the related allocations to reverse the
recording of goodwill and allocate all amounts specifically to identifiable
tangible and intangible assets, and  (iv)
    
    for the change in effective tax rate resulting from the above adjustments. The following table presents the impact of the restatement adjustments on the
Companys previously reported results for the three months ended March 31, 2003
and 2002 on a condensed basis: Three Months Ended
    
    Three Months EndedMarch 31, 2003
    
    March 31, 2002As Previously
    
    As
    
    As Previously
    
    AsReported
    
    Restated
    
    Reported
    
    Restated(In thousands, except per share data)Statements of operations:Net revenues
    
    $
    64,030
    
    
    $
    48,987
    
    
    $
    45,620
    
    
    $
    45,620Total costs and expenses
    
    
    56,874
    
    
    
    51,455
    
    
    
    48,870
    
    
    
    48,996Net income (loss)
    
    $
    7,156
    
    
    $
    (2,468
    )
    
    $
    (3,250
    )
    
    $
    (3,376
    )
 10




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##### 



Three Months Ended
    
    Three Months EndedMarch 31, 2003
    
    March 31, 2002As Previously
    
    As
    
    As Previously
    
    AsReported
    
    Restated
    
    Reported
    
    Restated(In thousands, except per share data)Basic income (loss) per share
    
    $
    0.26
    
    
    $
    (0.09
    )
    
    $
    (0.12
    )
    
    $
    (0.12
    )Diluted income (loss) per
share
    
    $
    0.25
    
    
    $
    (0.09
    )
    
    $
    (0.11
    )
    
    $
    (0.12
    )
 March 31, 2003
    
    December 31, 2002AsPreviously
    
    As
    
    As Previously
    
    AsReported
    
    Restated
    
    Reported
    
    Restated(In thousands)Balance sheets:ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,705
    
    
    $
    10,705
    
    
    $
    6,532
    
    
    $
    6,532Accounts receivable, net
    
    
    28,663
    
    
    
    23,831
    
    
    
    29,467
    
    
    
    29,467Inventory, net
    
    
    19,476
    
    
    
    21,058
    
    
    
    17,004
    
    
    
    17,004Other current assets
    
    
    19,604
    
    
    
    19,604
    
    
    
    18,148
    
    
    
    18,148Total current assets
    
    
    78,448
    
    
    
    75,198
    
    
    
    71,151
    
    
    
    71,151Goodwill, net
    
    
    211,178
    
    
    
    11,764
    
    
    
    210,792
    
    
    
    11,378Intangible assets, net
    
    
    88,855
    
    
    
    279,240
    
    
    
    89,078
    
    
    
    281,669Other assets
    
    
    68,386
    
    
    
    68,386
    
    
    
    69,304
    
    
    
    69,304Total assets
    
    $
    446,867
    
    
    $
    434,588
    
    
    $
    440,325
    
    
    $
    433,502LIABILITIES AND STOCKHOLDERS EQUITYDeferred product revenue
    
    $
    
    
    
    $
    10,211
    
    
    $
    
    
    
    $
    Current liabilities
    
    
    59,302
    
    
    
    58,699
    
    
    
    55,794
    
    
    
    55,794Long-term debt, less current
portion
    
    
    266,487
    
    
    
    266,487
    
    
    
    277,899
    
    
    
    277,899Deferred tax liability
    
    
    11,232
    
    
    
    3,165
    
    
    
    6,467
    
    
    
    3,840Other liabilities
    
    
    2,081
    
    
    
    2,081
    
    
    
    715
    
    
    
    715Stockholders equity
    
    
    107,765
    
    
    
    93,945
    
    
    
    99,450
    
    
    
    95,254Total liabilities and
stockholders equity
    
    $
    446,867
    
    
    $
    434,588
    
    
    $
    440,325
    
    
    $
    433,502
 3. Earnings
(loss) per share
Basic earnings (loss) per share are based on the weighted average number of
common shares outstanding during the year. Diluted earnings (loss) per share
are computed assuming that the weighted average number of common shares was
increased by the conversion of stock options issued to employees and members of
the Companys Board of Directors. The diluted per share amounts reflect a
change in the number of shares outstanding (the denominator) to include the
options as if they were converted to shares and issued, unless their inclusion
would be anti-dilutive. In the three months ended March 31, 2003 and 2002,
2,493,573 and 868,210 options, respectively, were excluded as they were
anti-dilutive. In each period presented, the net income (loss) (the
numerator) is the same for both basic and diluted per share computations. 11




---



##### 



The following table provides a reconciliation of the denominators for the basic
and diluted earnings (loss) per share computations (in thousands): Three Months EndedMarch 31,2003
    
    2002Basic loss per share:Weighted average number of shares
    
    
    27,558
    
    
    
    27,107Effect of dilutive securities:Stock options
    
    
    
    
    
    
    Diluted loss per share:Adjusted weighted average number of shares
and assumed conversions
    
    
    27,558
    
    
    
    27,107
 4. Financial information
by business segment and geographic area
The Company operates in three business segments, consisting of a product sales
business, primarily comprised of the pharmaceuticals business unit, a product
development business, primarily the research and development business unit, and
a development services business, primarily the AAI Development Services
business unit. The product sales business provides for the sales of the
Companys pharmaceutical product lines and for the commercial manufacturing of
small quantity products outsourced by other pharmaceutical companies. In the
product development segment, the Company internally develops drugs and
technologies for future sales by the product sales business or with the
objective of licensing marketing rights to third parties in exchange for
license fees and royalties. The core services provided by the development
services business on a fee-for-service basis to pharmaceutical and
biotechnology industries worldwide include comprehensive formulation, testing
and manufacturing expertise, in addition to the ability to take investigational
products into and through human clinical trials. The majority of the Companys
non-U.S. operations are located in Germany. Corporate income (loss) from operations includes general corporate overhead
costs which are not directly attributable to a business segment. Financial
data by segment and geographic region are as follows (in thousands): Three Months EndedMarch 31,2003
    
    2002Net revenues:Product sales
    
    $
    24,965
    
    
    $
    20,177Product development
    
    
    3,810
    
    
    
    2,135Development services
    
    
    20,212
    
    
    
    23,308$
    48,987
    
    
    $
    45,620United States
    
    $
    44,319
    
    
    $
    43,349
 12




---



##### 



Three Months EndedMarch 31,2003
    
    2002Germany
    
    
    5,311
    
    
    
    3,624Other
    
    
    325
    
    
    
    199Less intercompany
    
    
    (968
    )
    
    
    (1,552
    )$
    48,987
    
    
    $
    45,620Income from operations:Product sales
    
    $
    7,319
    
    
    $
    8,785Product development
    
    
    3,810
    
    
    
    2,135Development services
    
    
    331
    
    
    
    1,78611,460
    
    
    
    12,706Research and development
    
    
    (4,586
    )
    
    
    (4,477
    )Corporate
    
    
    (5,299
    )
    
    
    (3,376
    )$
    1,575
    
    
    $
    4,853United States
    
    $
    867
    
    
    $
    4,871Germany
    
    
    729
    
    
    
    76Other
    
    
    (21
    )
    
    
    (94
    )$
    1,575
    
    
    $
    4,853Depreciation and amortization:Product sales
    
    $
    3,191
    
    
    $
    459Product development
    
    
    100
    
    
    
    99Development services
    
    
    1,027
    
    
    
    941Corporate
    
    
    538
    
    
    
    511$
    4,856
    
    
    $
    2,010
 March 31,
    
    December 31,2003
    
    2002Total assets:Product sales
    
    $
    333,649
    
    
    $
    340,773Product development
    
    
    6,898
    
    
    
    6,024Development services
    
    
    52,673
    
    
    
    49,952Corporate
    
    
    41,368
    
    
    
    36,753$
    434,588
    
    
    $
    433,502United States
    
    $
    410,952
    
    
    $
    411,174Germany
    
    
    22,075
    
    
    
    21,167Other
    
    
    1,561
    
    
    
    1,161$
    434,588
    
    
    $
    433,502Goodwill, net:Development services
    
    $
    11,764
    
    
    $
    11,378
 5. Transactions with related parties 13




---



##### 



The Company has revenue, accounts receivable and work-in-progress with Aesgen,
Inc. (Aesgen) and Endeavor Pharmaceuticals, Inc. (Endeavor). Both Endeavor
and Aesgen were organized by aaiPharma Inc., its principal
shareholders and others, and
continued to be related parties at March 31, 2003. No revenues were recognized
from Aesgen for the three months ended March 31, 2003. Revenues recognized
from Aesgen totaled $119,000 for the three months ended March 31, 2002.
Services performed by the Company for Aesgen are covered by a Subscription
Agreement, whereby the Company has agreed to receive Aesgen preferred stock in
lieu of cash for the services performed.In February 2002, the Company
acquired a calcitriol product from Aesgen, under an agreement which included
potential royalty payments. The Company launched its calcitriol product in
March 2003; however, no revenues or royalty expenses were recorded for this
product in the first quarter of 2003. Revenues recognized from Endeavor
totaled $269,000 for the three months ended March 31, 2003, and were $299,000
for the three months ended March 31, 2002. At March 31, 2003, we had no
accounts receivable or work-in-progress related to Aesgen, and had
approximately $0.4 million of accounts receivable and work-in-progress related
to Endeavor. 6. Inventories, Net The following table presents the components of inventory: March 31,
    
    December 31,2003
    
    2002(In thousands)Finished goods (including consigned inventory of $1,569 in 2003)
    
    $
    16,039
    
    
    $
    11,110Work-in-process
    
    
    2,160
    
    
    
    1,866Raw materials and supplies
    
    
    3,696
    
    
    
    4,749Inventory reserves
    
    
    (837
    )
    
    
    (721
    )Total inventories, net
    
    $
    21,058
    
    
    $
    17,004
 7. Debt The following table presents the components of current maturities of long-term debt: March 31,
    
    December 31,2003
    
    2002(In thousands)Current maturities of long-term debt
    
    $
    5,921
    
    
    $
    5,921
 The following table presents the components of long-term debt: March 31,
    
    December 31,2003
    
    2002(In thousands)U.S. bank term loan
    
    $
    48,000
    
    
    $
    50,000U.S. revolving credit facility
    
    
    41,000
    
    
    
    47,500
 14




---



##### 



March 31,
    
    December 31,2003
    
    2002(In thousands)11% senior subordinated notes due 2010, net of original issue
discount
    
    
    173,999
    
    
    
    173,963Interest rate swap monetization deferred income
    
    
    10,921
    
    
    
    10,486Fair value of interest rate swap
    
    
    (1,512
    )
    
    
    1,871Less current maturities of long-term debt
    
    
    (5,921
    )
    
    
    (5,921
    )Total long-term debt due after one year
    
    $
    266,487
    
    
    $
    277,899
 In March 2002, the Company entered into a $175 million senior secured credit
facility consisting of a $75 million five-year revolving credit facility and a
$100 million five-year term loan facility. The term loan facility was
scheduled to be amortized over the full five-year term. The senior facility
was subsequently reduced due to early repayments made under the term loan
facility. The availability of borrowings under the revolving credit facility
was not limited by a borrowing base. At March 31, 2003, the Company had unused
availability under the revolving credit facility of $34.0 million. The senior
credit facility provided for variable interest rates based on LIBOR or an
alternate base rate, at the Companys option. On March 31, 2003, 30-day LIBOR
was 1.30%. Such facility was guaranteed by all domestic subsidiaries and
secured by a security interest on substantially all domestic assets, all of the
stock of domestic subsidiaries and 65% of the stock of material foreign
subsidiaries. The senior credit facility required the payment of certain
commitment fees based on the unused portion of the revolving credit facility
and could be prepaid at any time without a premium. Also in March 2002, the Company issued $175 million of senior subordinated
notes due April 1, 2010. The proceeds from the issuance of these notes were
$173.9 million, which was net of the original issue discount. This discount
will be charged to interest expense over the term of the notes. At March 31,
2003, these notes had a fixed interest rate of 11% per annum and were
guaranteed on a subordinated basis by all existing domestic subsidiaries and
all future domestic subsidiaries that are owned 80% or more by the Company. At
March 31, 2003, the notes were not secured. Prior to the third anniversary of
the date of issuance of the notes, up to 35% of the notes are redeemable with
the proceeds of qualified sales of equity at 111% of par value. On or after
the fourth anniversary of the date of issuance of the notes, all or any portion
of the notes are redeemable at declining premiums to par value, beginning at
105.5%. Concurrent with the issuance of the senior subordinated notes, the Company
entered into an interest rate hedging agreement to effectively convert interest
expense on a portion of the senior subordinated notes for the term of the notes
from an 11% fixed annual rate to a floating annual rate equal to 6-month LIBOR
plus a base rate. On February 27, 2003, the Company sold the then outstanding
interest rate hedging agreement for $2.3 million and replaced it with a similar
interest rate hedging agreement. The amount received, less the interest
benefits earned through the date of sale, has been recorded as a premium to the
carrying amount of the notes and is being amortized into interest income over
their remaining life. At March 31, 2003, the Company had an interest rate
hedging agreement in place covering $150 million of the notes, at a rate of
6-month LIBOR plus 6.94%. On March 31, 2003, 6-month LIBOR was 1.23%, giving
the Company an estimated all-in rate of 8.17%. The terms of the interest rate
hedging agreements, other than the base rate, were identical and were perfectly
matched with the terms of the related hedged instrument. Under the terms of the senior secured credit facility and the senior
subordinated notes, the Company was required to comply with various covenants
including, but not limited to, those pertaining to maintenance 15




---



##### 



of certain financial ratios and incurring additional indebtedness. After
giving effect to the restatement described in this Quarterly Report on Form
10-Q/A, the Company was not in compliance with these covenants at March 31,
2003. The Company has since replaced its senior secured credit
facility and received waivers of any defaults under its senior
subordinated notes (see Notes 1 and 6 to the Companys Annual Report on Form 10-K for the year ended
December 31, 2003 for additional discussion). 8. Asset
Acquisitions
On March 28, 2002, the Company acquired the U.S. rights to the Darvon and
Darvocet branded product lines, which treat mild-to-moderate pain and existing
inventory from Eli Lilly and Company, in an asset purchase. The Company
acquired these product lines and related intangible assets for $211.4 million,
exclusive of transactional costs. To finance this acquisition, which included
$1.8 million of inventory, the Company used the proceeds from the then existing
senior secured credit facility and senior subordinated notes, as described in
note 7. The Darvon and Darvocet product lines did not have separable assets
and liabilities associated with them, other than inventory, therefore the
Company allocated the purchase price, including acquisition related expenses,
to acquired identifiable tangible and intangible assets. The identified
intangible assets are being amortized over 20 years. In December 2001, the Company acquired from Novartis Pharmaceutical Corporation
and Novartis Corporation a line of asthma products used in the prevention and
reversal of bronchospasm in patients age 12 and older with asthma and
reversible bronchospasm associated with bronchitis and emphysema, in an asset
purchase. The product line acquired is marketed under the Brethine brand name.
The Company acquired this product line and related intangible assets for $26.6
million, exclusive of transactional costs. The Brethine product line did not
have separable assets and liabilities associated with it, therefore the Company
allocated the purchase price, including acquisition related expenses, to
acquired identifiable intangible assets, which are being amortized over 20
years. In August 2001, the Company completed the acquisition of a line of critical
care injectable and oral nutrition products from AstraZeneca AB, an affiliate
of AstraZeneca PLC, in an asset purchase. The product lines acquired are
marketed under the M.V.I. and Aquasol brand names. The Company acquired these
product lines and related intangible assets for $52.5 million, exclusive of
transactional costs, paid at closing, plus additional consideration
(see Note 2 to the Companys Annual Report on
Form 10-K for the year ended December 31, 2003 for
additional discussion). The M.V.I. and Aquasol product lines did
not have separable assets and liabilities associated with them, other than
inventory; therefore the Company allocated the purchase price, including
acquisition related expenses, to acquired identifiable tangible and intangible
assets. In connection with the M.V.I. and Aquasol acquisition, the Company
recorded intangible assets which meet the criteria for having an indefinite
life. In accordance with Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets, these intangible assets are not being
amortized but are evaluated for impairment on at least an annual basis. The
intangible assets recorded in connection with this acquisition represent the
trademarks, technology and know-how associated with the product lines. 9. Financial Information
for Subsidiary Guarantors and Non-Guarantors
In the first quarter of 2002, the Company issued senior subordinated notes,
which are guaranteed by certain of the Companys subsidiaries. The following presents condensed consolidating financial information for the
Company, segregating: (1) aaiPharma Inc., which issued the notes (the
Issuer); (2) the domestic subsidiaries, which guarantee the notes (the
Guarantor Subsidiaries); and (3) all other subsidiaries (the Non-Guarantor
Subsidiaries). The Guarantor Subsidiaries are wholly-owned direct
subsidiaries of the Company and 16




---



##### 



their guarantees are full, unconditional and joint and several. Wholly-owned
subsidiaries are presented on the equity basis of accounting. Certain
reclassifications have been made to conform all of the financial information to
the financial presentation on a consolidated basis. The principal adjusting
entries eliminate investments in subsidiaries and intercompany balances and
transactions. 17




---



##### 



The following information presents consolidating statements of operations,
balance sheets and cash flows for the periods and as of the dates indicated: aaiPharma Inc.
RESTATED CONSOLIDATING STATEMENT OF OPERATIONS
(In thousands) Three Months Ended March 31, 2003Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet revenues
    
    $
    10,630
    
    
    $
    33,689
    
    
    $
    5,636
    
    
    $
    (968
    )
    
    $
    48,987Equity earnings from subsidiaries
    
    
    3,543
    
    
    
    
    
    
    
    
    
    
    
    (3,543
    )
    
    
    Total revenues
    
    
    14,173
    
    
    
    33,689
    
    
    
    5,636
    
    
    
    (4,511
    )
    
    
    48,987Operating costs and expenses:Direct costs (excluding depreciation)
    
    
    6,521
    
    
    
    14,324
    
    
    
    3,172
    
    
    
    (743
    )
    
    
    23,274Selling
    
    
    1,309
    
    
    
    5,913
    
    
    
    512
    
    
    
    
    
    
    
    7,734General and administrative
    
    
    7,777
    
    
    
    1,260
    
    
    
    993
    
    
    
    
    
    
    
    10,030Research and development
    
    
    
    
    
    
    4,486
    
    
    
    
    
    
    
    
    
    
    
    4,486Depreciation
    
    
    1,356
    
    
    
    279
    
    
    
    253
    
    
    
    
    
    
    
    1,88816,963
    
    
    
    26,262
    
    
    
    4,930
    
    
    
    (743
    )
    
    
    47,412(Loss) income from operations
    
    
    (2,790
    )
    
    
    7,427
    
    
    
    706
    
    
    
    (3,768
    )
    
    
    1,575Other income (expense):Interest, net
    
    
    (692
    )
    
    
    (4,859
    )
    
    
    1
    
    
    
    
    
    
    
    (5,550
    )Net intercompany interest
    
    
    (516
    )
    
    
    559
    
    
    
    (43
    )
    
    
    
    
    
    
    Other income (expense), net
    
    
    (60
    )
    
    
    2
    
    
    
    (25
    )
    
    
    
    
    
    
    (83
    )(1,268
    )
    
    
    (4,298
    )
    
    
    (67
    )
    
    
    
    
    
    
    (5,633
    )(Loss) income before income taxes
    
    
    (4,058
    )
    
    
    3,129
    
    
    
    639
    
    
    
    (3,768
    )
    
    
    (4,058
    )Benefit from income taxes
    
    
    (1,590
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,590
    )Net (loss) income
    
    $
    (2,468
    )
    
    $
    3,129
    
    
    $
    639
    
    
    $
    (3,768
    )
    
    $
    (2,468
    )
 18




---



##### 



aaiPharma Inc.
RESTATED CONSOLIDATING STATEMENT OF OPERATIONS
(In thousands) Three Months Ended March 31, 2002Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet revenues
    
    $
    16,737
    
    
    $
    26,610
    
    
    $
    3,825
    
    
    $
    (1,552
    )
    
    $
    45,620Equity earnings from subsidiaries
    
    
    1,551
    
    
    
    
    
    
    
    
    
    
    
    (1,551
    )
    
    
    Total revenues
    
    
    18,288
    
    
    
    26,610
    
    
    
    3,825
    
    
    
    (3,103
    )
    
    
    45,620Operating costs and expenses:Direct costs (excluding depreciation)
    
    
    9,593
    
    
    
    11,209
    
    
    
    2,433
    
    
    
    (1,552
    )
    
    
    21,683Selling
    
    
    1,652
    
    
    
    2,228
    
    
    
    394
    
    
    
    
    
    
    
    4,274General and administrative
    
    
    5,589
    
    
    
    2,385
    
    
    
    781
    
    
    
    
    
    
    
    8,755Research and development
    
    
    247
    
    
    
    4,131
    
    
    
    
    
    
    
    
    
    
    
    4,378Depreciation
    
    
    1,163
    
    
    
    279
    
    
    
    235
    
    
    
    
    
    
    
    1,67718,244
    
    
    
    20,232
    
    
    
    3,843
    
    
    
    (1,552
    )
    
    
    40,767Income (loss) from operations
    
    
    44
    
    
    
    6,378
    
    
    
    (18
    )
    
    
    (1,551
    )
    
    
    4,853Other income (expense):Interest, net
    
    
    (113
    )
    
    
    (1,713
    )
    
    
    3
    
    
    
    
    
    
    
    (1,823
    )Net intercompany interest
    
    
    (564
    )
    
    
    625
    
    
    
    (61
    )
    
    
    
    
    
    
    Other income (expense), net
    
    
    (4,256
    )
    
    
    (3,702
    )
    
    
    39
    
    
    
    
    
    
    
    (7,919
    )(4,933
    )
    
    
    (4,790
    )
    
    
    (19
    )
    
    
    
    
    
    
    (9,742
    )(Loss) income before income taxes
    
    
    (4,889
    )
    
    
    1,588
    
    
    
    (37
    )
    
    
    (1,551
    )
    
    
    (4,889
    )Benefit from income taxes
    
    
    (1,513
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,513
    )Net (loss) income
    
    $
    (3,376
    )
    
    $
    1,588
    
    
    $
    (37
    )
    
    $
    (1,551
    )
    
    $
    (3,376
    )
 19




---



##### 



aaiPharma Inc.
RESTATED CONSOLIDATING BALANCE SHEET
(In thousands) March 31, 2003Guarantor
    
    Non-GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedASSETSCurrent assets:Cash and cash equivalents
    
    $
    9,920
    
    
    $
    170
    
    
    $
    615
    
    
    $
    
    
    
    $
    10,705Accounts receivable, net
    
    
    9,054
    
    
    
    11,413
    
    
    
    3,364
    
    
    
    
    
    
    
    23,831Work-in-progress
    
    
    4,618
    
    
    
    3,977
    
    
    
    4,623
    
    
    
    (926
    )
    
    
    12,292Inventories
    
    
    4,675
    
    
    
    15,665
    
    
    
    718
    
    
    
    
    
    
    
    21,058Deferred tax assets
    
    
    1,271
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,271Prepaid and other current assets
    
    
    1,966
    
    
    
    3,663
    
    
    
    412
    
    
    
    
    
    
    
    6,041Total current assets
    
    
    31,504
    
    
    
    34,888
    
    
    
    9,732
    
    
    
    (926
    )
    
    
    75,198Investments in and advances to subsidiaries
    
    
    66,061
    
    
    
    (46,202
    )
    
    
    
    
    
    
    (19,859
    )
    
    
    Property and equipment, net
    
    
    41,919
    
    
    
    8,688
    
    
    
    3,997
    
    
    
    
    
    
    
    54,604Goodwill, net
    
    
    725
    
    
    
    1,230
    
    
    
    9,809
    
    
    
    
    
    
    
    11,764Intangibles, net
    
    
    1,039
    
    
    
    278,201
    
    
    
    
    
    
    
    
    
    
    
    279,240Other assets
    
    
    4,486
    
    
    
    9,198
    
    
    
    98
    
    
    
    
    
    
    
    13,782Total assets
    
    $
    145,734
    
    
    $
    286,003
    
    
    $
    23,636
    
    
    $
    (20,785
    )
    
    $
    434,588LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current maturities of long-term debt
    
    $
    
    
    
    $
    5,921
    
    
    $
    
    
    
    $
    
    
    
    $
    5,921Accounts payable
    
    
    4,181
    
    
    
    12,159
    
    
    
    1,522
    
    
    
    
    
    
    
    17,862Customer advances
    
    
    7,510
    
    
    
    5,298
    
    
    
    2,405
    
    
    
    (926
    )
    
    
    14,287Accrued wages and benefits
    
    
    5,072
    
    
    
    1,713
    
    
    
    1,156
    
    
    
    
    
    
    
    7,941Interest payable
    
    
    281
    
    
    
    9,659
    
    
    
    
    
    
    
    
    
    
    
    9,940Deferred product revenue
    
    
    
    
    
    
    10,211
    
    
    
    
    
    
    
    
    
    
    
    10,211Other accrued liabilities
    
    
    (1,635
    )
    
    
    3,954
    
    
    
    (5
    )
    
    
    434
    
    
    
    2,748Total current liabilities
    
    
    15,409
    
    
    
    48,915
    
    
    
    5,078
    
    
    
    (492
    )
    
    
    68,910Long-term debt, less current portion
    
    
    41,000
    
    
    
    225,487
    
    
    
    
    
    
    
    
    
    
    
    266,487Other liabilities
    
    
    3,734
    
    
    
    1,512
    
    
    
    
    
    
    
    
    
    
    
    5,246Investments in and advances to subsidiaries
    
    
    86,567
    
    
    
    (92,109
    )
    
    
    5,439
    
    
    
    103
    
    
    
    Total stockholders equity
    
    
    (976
    )
    
    
    102,198
    
    
    
    13,119
    
    
    
    (20,396
    )
    
    
    93,945Total liabilities and stockholders equity
    
    $
    145,734
    
    
    $
    286,003
    
    
    $
    23,636
    
    
    $
    (20,785
    )
    
    $
    434,588
 20




---



##### 



aaiPharma Inc.
RESTATED CONSOLIDATING BALANCE SHEET
(In thousands) December 31, 2002Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedASSETSCurrent assets:Cash and cash equivalents
    
    $
    5,725
    
    
    $
    180
    
    
    $
    627
    
    
    $
    
    
    
    $
    6,532Accounts receivable, net
    
    
    10,104
    
    
    
    16,758
    
    
    
    2,605
    
    
    
    
    
    
    
    29,467Work-in-progress
    
    
    4,135
    
    
    
    2,951
    
    
    
    4,568
    
    
    
    (1,139
    )
    
    
    10,515Inventories
    
    
    5,504
    
    
    
    11,114
    
    
    
    697
    
    
    
    (311
    )
    
    
    17,004Deferred tax assets
    
    
    1,271
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,271Prepaid and other current assets
    
    
    2,511
    
    
    
    3,642
    
    
    
    209
    
    
    
    
    
    
    
    6,362Total current assets
    
    
    29,250
    
    
    
    34,645
    
    
    
    8,706
    
    
    
    (1,450
    )
    
    
    71,151Investments in and advances to subsidiaries
    
    
    66,061
    
    
    
    (46,202
    )
    
    
    
    
    
    
    (19,859
    )
    
    
    Property and equipment, net
    
    
    42,055
    
    
    
    7,070
    
    
    
    4,000
    
    
    
    
    
    
    
    53,125Goodwill, net
    
    
    624
    
    
    
    1,230
    
    
    
    9,524
    
    
    
    
    
    
    
    11,378Intangibles, net
    
    
    952
    
    
    
    280,717
    
    
    
    
    
    
    
    
    
    
    
    281,669Other assets
    
    
    4,514
    
    
    
    11,569
    
    
    
    96
    
    
    
    
    
    
    
    16,179Total assets
    
    $
    143,456
    
    
    $
    289,029
    
    
    $
    22,326
    
    
    $
    (21,309
    )
    
    $
    433,502LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current maturities of long-term debt
    
    $
    
    
    
    $
    5,921
    
    
    $
    
    
    
    $
    
    
    
    $
    5,921Accounts payable
    
    
    4,410
    
    
    
    11,447
    
    
    
    1,814
    
    
    
    
    
    
    
    17,671Customer advances
    
    
    7,840
    
    
    
    5,731
    
    
    
    2,618
    
    
    
    (1,138
    )
    
    
    15,051Accrued wages and benefits
    
    
    4,922
    
    
    
    929
    
    
    
    867
    
    
    
    
    
    
    
    6,718Interest payable
    
    
    285
    
    
    
    4,947
    
    
    
    
    
    
    
    
    
    
    
    5,232Other accrued liabilities
    
    
    1,244
    
    
    
    3,379
    
    
    
    (77
    )
    
    
    655
    
    
    
    5,201Total current liabilities
    
    
    18,701
    
    
    
    32,354
    
    
    
    5,222
    
    
    
    (483
    )
    
    
    55,794Long-term debt, less current portion
    
    
    47,500
    
    
    
    230,399
    
    
    
    
    
    
    
    
    
    
    
    277,899Other liabilities
    
    
    4,555
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,555Investments in and advances to subsidiaries
    
    
    68,094
    
    
    
    (72,423
    )
    
    
    4,984
    
    
    
    (655
    )
    
    
    Total stockholders equity
    
    
    4,606
    
    
    
    98,699
    
    
    
    12,120
    
    
    
    (20,171
    )
    
    
    95,254Total liabilities and stockholders equity
    
    $
    143,456
    
    
    $
    289,029
    
    
    $
    22,326
    
    
    $
    (21,309
    )
    
    $
    433,502
 21




---



##### 



aaiPharma Inc.
RESTATED CONSOLIDATING STATEMENT OF CASH FLOWS
(In thousands) Three Months Ended March 31, 2003Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedCash flows from operating activities:Net (loss) income
    
    $
    (2,468
    )
    
    $
    3,129
    
    
    $
    639
    
    
    $
    (3,768
    )
    
    $
    (2,468
    )Adjustments to reconcile net (loss) income
to net cash provided by operating activities:Depreciation and amortization
    
    
    1,241
    
    
    
    3,362
    
    
    
    253
    
    
    
    
    
    
    
    4,856Other
    
    
    
    
    
    
    
    
    
    
    52
    
    
    
    
    
    
    
    52Changes in operating assets and liabilities:Accounts receivable, net
    
    
    1,050
    
    
    
    5,345
    
    
    
    (682
    )
    
    
    
    
    
    
    5,713Work-in-progress
    
    
    (483
    )
    
    
    (1,026
    )
    
    
    82
    
    
    
    (213
    )
    
    
    (1,640
    )Inventories
    
    
    829
    
    
    
    (4,551
    )
    
    
    
    
    
    
    (311
    )
    
    
    (4,033
    )Prepaid and other assets
    
    
    573
    
    
    
    478
    
    
    
    (195
    )
    
    
    
    
    
    
    856Accounts payable
    
    
    (229
    )
    
    
    712
    
    
    
    (346
    )
    
    
    
    
    
    
    137Customer advances
    
    
    (331
    )
    
    
    (433
    )
    
    
    (292
    )
    
    
    213
    
    
    
    (843
    )Interest payable
    
    
    (4
    )
    
    
    4,712
    
    
    
    
    
    
    
    
    
    
    
    4,708Deferred product revenue
    
    
    
    
    
    
    10,211
    
    
    
    
    
    
    
    
    
    
    
    10,211Accrued wages and benefits and other accrued liabilities
    
    
    (3,548
    )
    
    
    1,357
    
    
    
    190
    
    
    
    (222
    )
    
    
    (2,223
    )Intercompany receivables and payables
    
    
    14,930
    
    
    
    (19,685
    )
    
    
    454
    
    
    
    4,301
    
    
    
    Net cash provided by operating activities
    
    
    11,560
    
    
    
    3,611
    
    
    
    155
    
    
    
    
    
    
    
    15,326Cash flows from investing activities:Purchases of property and equipment
    
    
    (1,061
    )
    
    
    (1,965
    )
    
    
    (186
    )
    
    
    
    
    
    
    (3,212
    )Acquisitions of product rights and other intangibles
    
    
    
    
    
    
    (500
    )
    
    
    
    
    
    
    
    
    
    
    (500
    )Other
    
    
    (232
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (232
    )Net cash used in investing activities
    
    
    (1,293
    )
    
    
    (2,465
    )
    
    
    (186
    )
    
    
    
    
    
    
    (3,944
    )Cash flows from financing activities:Payments on long-term borrowings
    
    
    (6,500
    )
    
    
    (2,000
    )
    
    
    
    
    
    
    
    
    
    
    (8,500
    )Proceeds from interest rate swaps, net
    
    
    
    
    
    
    435
    
    
    
    
    
    
    
    
    
    
    
    435Proceeds from stock option exercises
    
    
    428
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    428Other
    
    
    
    
    
    
    409
    
    
    
    
    
    
    
    
    
    
    
    409Net cash used in financing activities
    
    
    (6,072
    )
    
    
    (1,156
    )
    
    
    
    
    
    
    
    
    
    
    (7,228
    )Net increase (decrease) in cash and cash equivalents
    
    
    4,195
    
    
    
    (10
    )
    
    
    (31
    )
    
    
    
    
    
    
    4,154Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    19
    
    
    
    
    
    
    
    19Cash and cash equivalents, beginning of period
    
    
    5,725
    
    
    
    180
    
    
    
    627
    
    
    
    
    
    
    
    6,532Cash and cash equivalents, end of period
    
    $
    9,920
    
    
    $
    170
    
    
    $
    615
    
    
    $
    
    
    
    $
    10,705
 22




---



##### 



aaiPharma Inc.
RESTATED CONSOLIDATING STATEMENT OF CASH FLOWS
(In thousands) Three Months Ended March 31, 2002Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedCash flows from operating activities:Net (loss) income
    
    $
    (3,376
    )
    
    $
    1,588
    
    
    $
    (37
    )
    
    $
    (1,551
    )
    
    $
    (3,376
    )Adjustments to reconcile net (loss) income
to net cash (used in) provided by operating activities:Depreciation and amortization
    
    
    1,047
    
    
    
    728
    
    
    
    235
    
    
    
    
    
    
    
    2,010Write-off of deferred financing and other costs
    
    
    
    
    
    
    8,053
    
    
    
    
    
    
    
    
    
    
    
    8,053Other
    
    
    2
    
    
    
    11
    
    
    
    65
    
    
    
    
    
    
    
    78Changes in operating assets and liabilities:Accounts receivable, net
    
    
    (2,995
    )
    
    
    (1,606
    )
    
    
    650
    
    
    
    
    
    
    
    (3,951
    )Work-in-progress
    
    
    (619
    )
    
    
    (1,772
    )
    
    
    (459
    )
    
    
    
    
    
    
    (2,850
    )Inventories
    
    
    420
    
    
    
    662
    
    
    
    
    
    
    
    
    
    
    
    1,082Prepaid and other assets
    
    
    1,019
    
    
    
    (15,159
    )
    
    
    22
    
    
    
    
    
    
    
    (14,118
    )Accounts payable
    
    
    1,001
    
    
    
    (2,777
    )
    
    
    (215
    )
    
    
    
    
    
    
    (1,991
    )Customer advances
    
    
    (284
    )
    
    
    70
    
    
    
    (8
    )
    
    
    
    
    
    
    (222
    )Interest payable
    
    
    24
    
    
    
    (199
    )
    
    
    
    
    
    
    
    
    
    
    (175
    )Accrued wages and benefits and other accrued liabilities
    
    
    (2,610
    )
    
    
    1,318
    
    
    
    111
    
    
    
    (107
    )
    
    
    (1,288
    )Intercompany receivables and payables
    
    
    (26,532
    )
    
    
    25,347
    
    
    
    (459
    )
    
    
    1,644
    
    
    
    Net cash (used in) provided by operating activities
    
    
    (32,903
    )
    
    
    16,264
    
    
    
    (95
    )
    
    
    (14
    )
    
    
    (16,748
    )Cash flows from investing activities:Purchases of property and equipment
    
    
    (798
    )
    
    
    (345
    )
    
    
    (406
    )
    
    
    
    
    
    
    (1,549
    )Purchases of property and equipment previously leased
    
    
    (14,145
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14,145
    )Acquisitions of product rights and other intangibles
    
    
    
    
    
    
    (211,772
    )
    
    
    
    
    
    
    
    
    
    
    (211,772
    )Other
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Net cash used in investing activities
    
    
    (14,941
    )
    
    
    (212,117
    )
    
    
    (406
    )
    
    
    
    
    
    
    (227,464
    )Cash flows from financing activities:Net payments on short-term debt
    
    
    
    
    
    
    5,000
    
    
    
    
    
    
    
    
    
    
    
    5,000Proceeds from long-term borrowings
    
    
    49,400
    
    
    
    190,874
    
    
    
    
    
    
    
    
    
    
    
    240,274Payments on long-term borrowings
    
    
    
    
    
    
    (14
    )
    
    
    
    
    
    
    14
    
    
    
    Proceeds from stock option exercises
    
    
    1,980
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,980Other
    
    
    (2,855
    )
    
    
    (14
    )
    
    
    24
    
    
    
    
    
    
    
    (2,845
    )Net cash provided by financing activities
    
    
    48,525
    
    
    
    195,846
    
    
    
    24
    
    
    
    14
    
    
    
    244,409Net increase (decrease) in cash and cash equivalents
    
    
    681
    
    
    
    (7
    )
    
    
    (477
    )
    
    
    
    
    
    
    197Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    (17
    )
    
    
    
    
    
    
    (17
    )Cash and cash equivalents, beginning of period
    
    
    5,301
    
    
    
    154
    
    
    
    916
    
    
    
    
    
    
    
    6,371Cash and cash equivalents, end of period
    
    $
    5,982
    
    
    $
    147
    
    
    $
    422
    
    
    $
    
    
    
    $
    6,551
 23




---



##### 



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations. The information set forth in this Item 2 has been revised to reflect the
restatement occurring subsequent to the filing of the original Quarterly Report
on Form 10-Q/A. Restatement of Previously Issued Financial Statements We have restated our consolidated statements of operations, cash flows, and
comprehensive loss for the three months ended March 31, 2003 and 2002 and our
consolidated balance sheets as of March 31, 2003 and December 31, 2002. The
restatement did not affect periods prior to 2002. The restatement is reported
in our Annual Report on Form 10-K for the year ended December 31, 2003 (the
2003 Form 10-K) and is reported in this Amendment No. 2 to our Quarterly
Report for the quarterly period ended March 31, 2003 and in amendments to our
Quarterly Reports on Form 10-Q/A for the quarterly periods ended June 30, 2003
and September 30, 2003. The restatement corrects our revenue recognition of
certain transactions, including specific product sales in 2003, that did not
satisfy all of the revenue recognition conditions under FASB Statement No. 48
Revenue Recognition When Right of Return Exists (SFAS 48), and/or Staff
Accounting Bulletin No. 101 Revenue Recognition in Financial Statements (SAB
101), increases reserves for product returns and records other adjustments to
our revenue reserves for 2003, and reflects a different accounting treatment
for our acquired products. The following table summarizes the adjustments we have made to the financial
information previously reported for the period ended March 31, 2003. Revenue
    
    Pre-Tax Income
    
    Net Income($ in millions, except per share data)Consignment Sale / Reversal of Revenue:Calcitriol
    
    $
    (3.1
    )
    
    $
    (2.0
    )
    
    $
    (1.2
    )AzaSan 75mg and 100 mg
    
    
    (5.8
    )
    
    
    (5.3
    )
    
    
    (3.2
    )Return Reserves:Brethine (second-tier wholesaler)
    
    
    (3.3
    )
    
    
    (3.3
    )
    
    
    (2.0
    )Other products
    
    
    (2.8
    )
    
    
    (2.8
    )
    
    
    (1.7
    )Change in Accounting for Product
Acquisitions
    
    
    
    
    
    
    (2.2
    )
    
    
    (1.4
    )Change in Tax Rate (adjusted for
rounding)
    
    
    
    
    
    
    
    
    
    
    (0.1
    )Total Adjustments
    
    $
    (15.0
    )
    
    $
    (15.6
    )
    
    $
    (9.6
    )Diluted loss per share
    
    
    
    
    
    
    
    
    
    $
    (0.34
    )
 24




---



##### 



In connection with our new product launches in the first quarter of 2003 of
calcitriol and AzaSan 75 mg and 100 mg, initial launch quantities of these
products were sold pursuant to guaranteed sale conditions under which we
agreed to accept returned product six months after the date of purchase, if not
resold by then. Revenue was recognized for these sales upon shipment without
the establishment of any special reserves to account for these return rights.
Because these launches were into new markets or were products with which we did
not have applicable or analogous historical experience, and because most of the
sales for these products had returns provisions inconsistent with our normal
returns provisions, we have concluded that we did not have the ability to
reasonably estimate returns, and that revenue for these sales should not have
been recognized until all of the conditions of SFAS 48 were met. Since all of the conditions of SFAS 48 had not been met for these sales of
calcitriol and AzaSan 75mg and 100mg in the first quarter of 2003, revenue has
been recorded as if the sales were consignments. Calcitriol revenues have been
reduced by $3.1 million and AzaSan revenues have been reduced by $5.8 million.
Under the consignment model, upon shipment of product we invoice the
wholesaler, record deferred revenue at gross invoice sales price and classify
the inventory held by the wholesalers as consignment inventory at our cost of
such inventory. We will recognize revenue (net of discounts, rebates, sales
allowances and accruals for returns) when the consignment inventory is sold by
the wholesalers, as quantified using data from the wholesalers and other
third-party information sources. We will continue to recognize revenue on
these products on this basis until such time as we develop sufficient
historical experience on which to reasonably estimate returns and all other
conditions under SFAS 48 are met. The build-up of inventory to support the
initial launches of these products increased our inventory by $2.6 million in
the first quarter of 2003. There were significant returns in the first quarter of 2004 from a second-tier
wholesaler of our Brethine products that were inconsistent with our historical
returns experience. A significant amount of these products was initially sold
by us in the first quarter of 2003 and was acquired by the second-tier
wholesaler in purchases from us and from one of our principal wholesalers.
Based on our knowledge regarding the market factors affecting these requested
returns, we now believe that this inventory was purchased by the wholesaler for
a particular opportunity that did not materialize. A specific returns reserve
of $3.3 million has been recorded in the first quarter of 2003 for these sales
and for the related inventory in our restated financial statements. At the time we recognize revenue from product sales, we record an adjustment,
or decrease, to revenue for estimated chargebacks, rebates, discounts and
returns. Revenue reserves are established on a product-by-product basis.
These revenue reductions are established by management as its best estimate at
the time of sale based on each products historical experience adjusted to
reflect known changes in the factors that impact such reserves. Reserves for
chargebacks, rebates and discounts are established based on the contractual
terms with our customers; analysis of historical levels of discounts,
chargebacks and rebates; communications with customers and purchased
information about the rate of prescriptions being written and the levels of
inventory remaining in the distribution channel as well as our expectations
about the market for each product and anticipated introduction of competitive
products. The reserve for chargebacks is the most significant estimate used in
the recognition of our revenue from product sales. In brief, we have
established contract prices for certain indirect customers that are supplied by
our wholesale customers. A chargeback represents the difference between the
current published wholesale acquisition cost and the indirect customers
contract prices. 25




---



##### 



Prior to 2003, the amount of actual product returns experienced by the Company
had not been significant. As a result, actual returns were charged against
revenue in the period they occurred and aggregate revenue reserves were
evaluated quarterly to determine if they were sufficient to cover estimated
chargebacks, rebates and related allowances, as well as the expected rate of
returns, and adjusted as deemed necessary. In 2003, we began segregating our
products return reserve, which prior thereto we believed was adequately covered
by our aggregate revenue reserves for chargebacks, rebates and related
allowances. We increased the level of detail included in our analyses to
include analyzing inventory in the channel to determine remaining shelf life.
Our returns reserve needs are primarily related to the number of months of
inventory estimated to be in the distribution channel. Levels of inventory in
the distribution channel are monitored and estimated based on information we
purchase from the wholesalers, combined with active discussions between our
sales personnel and the wholesalers we supply. In addition, our actual sales,
returns and chargeback history are used to assess the reasonableness of the
estimated number of months of inventory on hand at our wholesalers. The shelf
life of products remaining in the distribution channel is estimated based on an
analysis of each lot sold. Each batch has a specific expiration date. A
review of the actual returns history is performed and the run rate of sales out
of the distribution channel is estimated. Estimated product returns reserves
are adjusted based on these reviews. Reserves may also be adjusted to reflect
any significant changes in trends or based upon new information that we believe
may affect the reserve needs. Allowances for new product introductions are
estimated based on our experiences for similar products that we currently
market and are adjusted as deemed necessary based on our experience with each
product. Our reserve analysis also includes a review for the potential
introduction of generic competition and the resulting impact on pricing and
returns reserves. Existing reserves may be adjusted accordingly to reflect our
estimate for any impact these factors may have. We continually monitor our
assumptions with respect to our revenue reserves for product sales and modify
them if necessary. In addition to the consignment sales described above, we
have adjusted our net revenues in the first quarter of 2003 by increasing our
returns reserve for other products by $2.8 million based on a historical
returns analysis. In addition to the 2003 adjustments identified above, we are restating our
consolidated financial statements for the three-month periods ended March 31,
2003 and 2002 to treat each of our major product line acquisitions as
acquisitions of assets that do not constitute a business. We have changed the
accounting treatment used from treating the acquisitions as business
combinations to treating them as asset acquisitions. Accordingly, no portion
of the purchase price for these acquisitions is allocated to goodwill, and the
amount previously allocated to goodwill is instead allocated to the other
identifiable acquired assets, including assets with definite lives. As a
result, our direct costs in the first quarter of 2002 are greater than the
amount previously reported by $0.2 million due to the increase in amortization
expense resulting from a greater amount of purchase price being allocated to
assets with definite lives, and our directs costs in the first quarter of 2003
are greater than the amount we previously reported by $2.2 million. Results of Operations Our quarterly results have been, and we expect them to continue to be, subject
to fluctuations. Quarterly results can fluctuate as a result of a number of
factors, including without limitation, demand for our pharmaceutical product
lines, the amount and timing of product returns, ability of contract
manufacturers to supply conforming products on a timely basis, costs and
results of ongoing and future litigation by and against us, progress of ongoing
contracts, amounts recognized for licensing and royalty 26




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revenues, the commencement, completion or cancellation of large contracts,
timing and amounts of start-up expenses for new facilities, timing and level of
research and development expenditures, and changes in the mix of services.
There have been no significant changes in our critical accounting policies
previously disclosed in our 2003 Form 10-K. Because a large percentage of our
fee-for-service operating costs are relatively fixed, variations in the timing
and progress of large contracts, changes in the demand for our services and
products, or the recognition of licensing and royalty revenues (on projects for
which associated expense may have been recognized in prior periods) can
materially affect our quarterly results. Accordingly, we believe that
comparisons of our quarterly financial results may not be meaningful. The following table presents the net revenues for each of our business units
and our consolidated expenses and net income (loss), with each item expressed
as a percentage of consolidated net revenues: Three Months Ended March 31,2003
    
    2002(dollars in thousands)Net revenues:Product sales
    
    $
    24,965
    
    
    
    51
    %
    
    $
    20,177
    
    
    
    44
    %Product development
    
    
    3,810
    
    
    
    8
    
    
    
    2,135
    
    
    
    5Development services
    
    
    20,212
    
    
    
    41
    
    
    
    23,308
    
    
    
    51$
    48,987
    
    
    
    100
    %
    
    $
    45,620
    
    
    
    100
    %Direct costs (excluding depreciation)
    
    $
    23,274
    
    
    
    48
    %
    
    $
    21,683
    
    
    
    48
    %Selling
    
    
    7,734
    
    
    
    16
    
    
    
    4,274
    
    
    
    9General and administrative
    
    
    10,030
    
    
    
    20
    
    
    
    8,755
    
    
    
    19Research and development
    
    
    4,486
    
    
    
    9
    
    
    
    4,378
    
    
    
    10Depreciation
    
    
    1,888
    
    
    
    4
    
    
    
    1,677
    
    
    
    4Income from operations
    
    
    1,575
    
    
    
    3
    
    
    
    4,853
    
    
    
    11Loss from extinguishment of debt
    
    
    
    
    
    
    
    
    
    
    (8,053
    )
    
    
    (18
    )Interest expense, net
    
    
    (5,550
    )
    
    
    (11
    )
    
    
    (1,823
    )
    
    
    (4
    )Other income (expense), net
    
    
    (83
    )
    
    
    
    
    
    
    134
    
    
    
    Benefit from income taxes
    
    
    (1,590
    )
    
    
    (3
    )
    
    
    (1,513
    )
    
    
    (3
    )Net loss
    
    
    (2,468
    )
    
    
    (5
    )
    
    
    (3,376
    )
    
    
    (7
    )
 First Quarter 2003 Compared to First Quarter 2002 Our consolidated net revenues for the quarter ended March 31, 2003 increased 7%
to $49.0 million, from $45.6 million in the first quarter of 2002. Net
revenues from product sales increased to $25.0 million in 2003, from $20.2
million in 2002, primarily due to contributions from our Darvon and Darvocet
products, which we acquired at the end of the first quarter of 2002, and a
significant price increase in our injectable Brethine product that was
implemented in June 2002. Net revenues from commercial manufacturing of
products marketed by other pharmaceutical companies, which is included in
product sales, contributed $0.7 million and $3.0 million to net revenues from
product sales in the first quarters of 2003 and 2002, respectively. 27




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Net revenues from product development increased 78% in the first quarter of
2003 to $3.8 million, or 8% of net revenues, from $2.1 million, or 5% of net
revenues, in 2002, primarily due to royalties under our significant development
agreement, which increased from $1.3 million in the first quarter of 2002 to
$3.5 million in the first quarter of 2003. This development agreement is
described in the Managements Discussion and Analysis of Financial Condition
and Results of Operations section of our 2003 Form 10-K. Net revenues from our development services business decreased 13% in the first
quarter of 2003 to $20.2 million, from $23.3 million in 2002. These decreases
were principally attributable to lower clinical revenues related to the winding
down of some large projects in the first quarter of 2002, lower fee-for-service
revenues under our significant development agreement and the redeployment of a
portion of our internal resources from external revenue-producing projects to
research and development projects relating to our own pharmaceutical products. The following table sets forth our gross revenues and the amount of dilution to
revenues resulting from allowances for customer credits, including discounts,
rebates, chargebacks, product returns and other allowances. Three Months EndedMarch 31,2003
    
    2002Gross revenues
    
    $
    67,275
    
    
    $
    52,184Allowance for customer credits
    
    
    18,288
    
    
    
    6,564Net revenues
    
    $
    48,987
    
    
    $
    45,620
 The increase in allowance for customer credits in the first quarter of 2003
relates primarily to a specific returns reserve of $3.3 million recorded in the
first quarter of 2003 with respect to sales to a second-tier wholesaler of our Brethine
products that resulted in returns that were inconsistent with our historical returns experience, and to
additional chargeback reserve requirements in the first quarter of 2003 for
sales of our Brethine products. These chargeback reserves were
required due to the inclusion of our Brethine products in our group purchasing
organization contracts in the third quarter of 2002. Direct costs (excluding depreciation and royalty expense) increased $1.6
million, or 7%, to $23.3 million in the first quarter of 2003, from $21.7
million in the same period in 2002. This increase in direct cost dollars
resulted from an increase in amortization expense of $2.6 million related to
product rights for acquired products, which was partially offset by a $1.5
million decrease in direct costs of our development services division. Direct
costs as a percentage of net revenues were 48%, the same for the first quarters
of both 2002 and 2003. Selling expenses increased 81% in the first quarter of 2003 to $7.7 million, or
16% of net revenues, from $4.3 million, or 9% of net revenues, in 2002. This
increase is primarily due to expenses incurred by our product sales business
associated with developing our product sales force, marketing and promoting our
new products and maintaining and enhancing distribution channels. As of March
31, 2003, our pharmaceutical sales force was approximately 80, as compared to
20 at March 31, 2002. 28




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General and administrative costs increased 15% in the first quarter of 2003 to
$10.0 million, or 20% of net revenues, from $8.8 million, or 19% of net
revenues, in 2002. This increase was primarily due to expenses related to the
management build-up for our product sales business. Research and development expenses were approximately $4.5 million, or 9% of net
revenues, in the first quarter of 2003, a slight increase from $4.4 million, or
10% of net revenues, in 2002. In the first quarter of 2003, the significant
project spending related to our ProSorb-D pain management product and
development work on line extensions for our pain management and critical care
products. Consolidated income from operations was $1.6 million in the first quarter of
2003, or $3.3 million lower than the prior year. This decrease was primarily
due to our increased selling, general and administrative spending to support
our product sales business, product rights amortization and decreases in
revenues in our development services business, partially offset by increases in
our product sales and product development revenues. Income from operations for our product sales business was $7.3 million in the
first quarter of 2003, compared to $8.8 million in the first quarter of 2002.
This decrease was attributable to the increased selling expenses discussed
above and the increased product rights amortization expense, partially offset
by the revenues from our Darvon and Darvocet product lines, which we acquired
at the end of the first quarter of 2002. Income from operations for our product development business was $3.8 million in
the first quarter of 2003, compared to income from operations of $2.1 million
in 2002. This change resulted from the increased revenues from our significant
development agreement, as discussed above. Income from operations for our development services revenues business was $0.3
million in the first quarter of 2003, compared to $1.8 million in the first
quarter of 2002. This decrease is primarily due to the decline in revenues and
increase in direct costs, as described above. Unallocated corporate expenses increased in the first quarter of 2003 to $5.3
million, from $3.4 million in 2002. This higher level was due to additions to
our corporate infrastructure to accommodate the expansion of our overall
business. As a percentage of net revenues, unallocated corporate expenses in
the first quarter of 2003 increased to 11%, from 7% in the first quarter of
2002. Net interest expense increased to $5.6 million in the first quarter of 2003,
from $1.8 million in 2002. This $3.8 million increase was primarily
attributable to the borrowings that funded our product line acquisitions in the
first quarter of 2002. A loss from the extinguishment of debt of $8.1 million was recorded in the
first quarter of 2002. This loss was due to the write-off of deferred
financing and other costs related to our prior debt facilities that were
refinanced in March 2002. Liquidity and Capital Resources Historically, we have funded our businesses with cash flows provided by
operations and proceeds from borrowings. Cash flow provided by operations in
the first quarter of 2003 was $15.3 million, compared 29




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to cash flow used in operations of $16.8 million in the first quarter of 2002.
This change was primarily due to positive changes in working capital. In
addition, the first quarter of 2002 included $13.1 million of prepaid financing
fees related to our senior credit facility and senior subordinated notes, which
did not recur in the first quarter of 2003. Cash used in investing activities was $3.9 million in the first quarter of
2003, which included $3.2 million for capital spending. Cash used in investing
activities was $227.5 million in the first quarter of 2002, which included
$211.4 million related to our 2002 acquisition of the Darvon and Darvocet
branded product lines, and $14.1 million for the purchase of assets formerly
covered by our tax retention operating lease, including our corporate
headquarters in Wilmington, N.C. and a laboratory and clinical facility in
Chapel Hill, N.C. Net cash used in financing activities during the first quarter of 2003 was $7.2
million, primarily representing debt payments of $8.5 million partially offset
by $0.4 million of interest rate swap proceeds and $0.4 million in proceeds
from the issuance of common stock related to the exercise of stock options. On March 28, 2002, we acquired the U.S. rights to the Darvon and Darvocet
branded product lines and existing inventory from Eli Lilly and Company for
$211.4 million in cash. In connection with the acquisition, we entered into a
$175 million senior credit facility, issued $175 million of senior subordinated
notes due 2010, repaid all $78 million of borrowings outstanding under our
prior senior credit facilities, and terminated our tax retention operating
lease and purchased the underlying properties. At March 31, 2003, our $175 million senior secured credit facility consisted of
a $75 million five-year revolving credit facility and a $100 million five-year
term loan facility. The term loan facility was scheduled to be amortized over
the full five-year term. The senior facility was subsequently reduced due to
the early repayments we made under the term loan facility. The availability of
borrowings under our revolving credit facility is not limited by a borrowing
base. Our senior credit facility provided for variable interest rates based on
LIBOR or an alternate base rate, at our option. Such facility was guaranteed
by all of our domestic subsidiaries and secured by a security interest on
substantially all of our domestic assets, all of the stock of our domestic
subsidiaries, and 65% of the stock of our material foreign subsidiaries. Our
senior credit facility required the payment of certain commitment fees based on
the unused portion of the revolving credit facility and could be prepaid at our
option at any time without a premium. Under the terms of the credit agreement for our senior credit facility, we were
required to comply with various covenants including, but not limited to, those
pertaining to maintenance of certain financial ratios and incurrence of
additional indebtedness. After giving effect to the restatement described in
this Quarterly Report on Form 10-Q/A, we were not in compliance with some of
these covenants at March 31, 2003. See Notes 1 and 6 to our 2003 Form 10-K for
additional discussion and a description of our new senior credit facility that
has replaced the credit facility in effect at March 31, 2003. On March 28, 2002, we issued $175 million of senior subordinated unsecured
notes due 2010, which had a fixed interest rate of 11% per annum and are
guaranteed on a subordinated basis by all of our existing domestic subsidiaries
and all of our future domestic subsidiaries of which we own 80% or more of the
equity interests. At March 31, 2003, these notes were not secured. Prior to
March 28, 2005, up to 30




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35% of the notes are redeemable with the proceeds of qualified sales of equity
at 111% of par value. On or after March 28, 2006, all or any portion of the
notes are redeemable at declining premiums to par value, beginning at 105.5%.
Under the terms of the indenture for the notes, we are required to comply with
various covenants including, but not limited to a covenant relating to
incurrence of additional indebtedness. After giving effect to the restatement
described in this Quarterly Report on Form 10-Q/A, we were not in compliance
with some of these covenants at March 31, 2003. See Note 6 to our 2003 Form
10-K for additional discussion and a description of the consent solicitation
approved in April 2004 that waived all then existing defaults under such
indenture (including those in effect at March 31, 2003). Concurrent with the issuance of our senior subordinated notes, we entered into
an interest rate hedging agreement to effectively convert interest expense on a
portion of the senior subordinated notes for the term of the notes from an 11%
fixed annual rate to a floating annual rate equal to 6-month LIBOR plus a base
rate. On February 27, 2003, we sold the then outstanding interest rate hedging
agreement for $2.3 million and replaced it with a similar interest rate hedging
agreement. The amount we received, less the interest benefits earned through
the date of sale, has been recorded as a premium to the carrying amount of the
notes and is being amortized into interest income over their remaining life.
At March 31, 2003, we had an interest rate hedging agreement in place covering
$150 million of the notes, at a rate of 6-month LIBOR plus 6.94%. On March 31,
2003, 6-month LIBOR was 1.23%, giving us an estimated all-in rate of 8.17%.
The terms of the interest rate hedging agreements, other than the base rate,
were identical and were perfectly matched with the terms of the related hedged
instrument. At March 31, 2003, our M.V.I. and Aquasol product line acquisition agreement
provided for us to pay the second of two $1.0 million guaranteed payments in
August 2003, a contingent payment of $2.0 million that was potentially due in
August 2003 and a future contingent payment of $43.5 million potentially due in
August 2004, depending on the status of certain reformulation activities being
carried out by the seller and regulatory approval of the reformulation by the
FDA. For information about a subsequent amendment to this agreement and
subsequent developments related to our payment obligations thereunder, see Item
7, Managements Discussion and Analysis of Financial Condition and Results of
Operations of our 2003 Form 10-K. In addition, we may have to make contingent
payments of $4.7 million over four years in connection with the purchase of our
Charleston, South Carolina manufacturing facility, based on the level of
manufacturing revenues at this facility. At March 31, 2003, these contingent
payment obligations, including the contingent payments potentially due in
connection with the acquisition of the M.V.I. and Aquasol product lines, had
not yet been recorded as a liability on our consolidated balance sheet. At
March 31, 2003, we had $5.9 million of principal repayments due in the next
twelve months under our senior credit facility. We made interest payments on
the senior subordinated notes of $9.6 million in April 2003 and $9.6 million in
October 2003. The April interest payment was reduced by approximately $0.3
million received under our interest rate hedging agreement. The October 2003
interest payment was offset by approximately $1.9 million received under our
interest rate hedging agreement. In 2003, we adopted Statement of Financial Accounting Standards No. 145,
Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement No.
13, and Technical Corrections (SFAS 145). SFAS 145 no longer requires
companies to report gains or losses associated with the extinguishment of debt
as a component of extraordinary gains or losses, net of tax. In addition, any
extraordinary gains or losses on extinguishment of debt in prior periods
presented would require reclassification. As required by SFAS 145, the
extraordinary loss recognized in the three months ended 31




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March 31, 2002 of approximately $8.1 million ($5.3 million net of tax) to
record the write-off of deferred financing and other costs related to our prior
debt facilities has been reclassified to other expense. Forward-Looking Statements, Risk Factors and Safe Harbor Language This document contains forward-looking statements within the meaning of the
safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Words such as estimate, project, intend, anticipate, believe
and similar expressions are intended to identify forward-looking statements.
The forward-looking statements contained in this document include statements
about future financial and operating results, including the anticipated
financial condition, results of operations, business strategies, operating
efficiencies, competitive positions, growth opportunities for existing
products, plans and objectives of management and markets for our common stock.
These statements are based on the current expectations and beliefs of our
management and are subject to a number of factors and uncertainties, including
the matters noted above, that could cause actual results to differ materially
from those described in the forward-looking statements. These statements are
not guarantees of future performance, involve certain risks, uncertainties and
assumptions that are difficult to predict, and are based upon assumptions as to
future events that may not prove accurate. Therefore, actual outcomes and
results may differ materially from what is expressed in the forward-looking
statement. In any forward-looking statement in which we express an expectation
or belief as to future results, that expectation or belief is expressed in good
faith and believed to have a reasonable basis, but there can be no assurance
that the statement or expectation or belief will result or be achieved or
accomplished. Additional risks and uncertainties pertaining to the following
factors, among others, could cause actual results to differ materially from
those described in the forward-looking statements:  
    
    demand by consumers for our products and the products we produces for others;  
    
    the prices that we can obtain for such products;  
    
    the level of product and price competition;  
    
    competitive new product introductions, including generic competition;  
    
    distributors and wholesalers ordering patterns;  
    
    levels of our products in the distribution channels;  
    
    the outcome and costs of governmental investigations;  
    
    the outcome and costs of litigation brought by and against us;  
    
    timely success in product development and regulatory approvals for
new products and line extensions;  
    
    actions by the FDA in connection with submissions related to our
products or those of our competitors;  
    
    other governmental regulations and actions affecting our products or
those of our competitors;  
    
    third-party payer decisions and actions affecting our products or those of our competitors; and  
    
    developments in patent or other proprietary rights owned by us or others. Additional factors that may cause the actual results to differ materially are
discussed in our recent filings with the SEC, including, but not limited to,
Item 7, Managements Discussion and Analysis of Financial Condition and
Results of OperationsRisk Factors and Forward Looking Statements of our 2003
Form 10-K, our Current Reports on Form 8-K, and other periodic filings.
Whenever you read or hear any subsequent written or oral forward-looking
statements attributable to us or any person acting on our behalf, you should
keep in mind the cautionary statements contained or referred to in this
section. 32




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##### 



We do not undertake any obligation to (and expressly disclaim any obligation
to) update or alter our forward-looking statements, whether as a result of new
information, future events or otherwise. 
 Item 4. Controls and Procedures The Company has carried out an evaluation, under the supervision and with the
participation of its newly appointed Chief Executive Officer and interim Chief
Financial Officer, pursuant to Rule 13a-15 promulgated under the Securities
Exchange Act of 1934, as amended, of the effectiveness of the design and
operation of its disclosure controls and procedures as of December 31, 2003,
which includes the period covered by this Quarterly Report on Form 10-Q/A.
Disclosure controls and procedures are to be designed to ensure that material
information the Company must disclose in its reports filed or submitted under
the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported on a timely basis. As a result of that review, our Chief Executive
Officer and interim Chief Financial Officer have concluded that, as of December
31, 2003 and for the year then ended, including the period covered by this
Quarterly Report on Form 10-Q/A, the Companys disclosure controls and
procedures were not adequate. The internal control deficiencies related to, among other things, a lack of
adequate policies with respect to revenue recognition, and a lack of sufficient
control processes and procedures to effectively monitor and manage wholesaler
inventory levels, to ensure adequate contract-approval oversight, and to ensure
effective and timely communication among sales, marketing, finance and legal
staff regarding the terms and conditions of certain transactions, including new
product launches. Also, with respect to the sales of pharmaceutical products,
the Companys finance and accounting personnel lacked adequate training on the
application of revenue recognition principles and the establishment of product
return reserves. In addition, in April 2004, in connection with their audit of the Companys
consolidated financial statements for the year ended December 31, 2003, the
Companys independent auditors identified and communicated to the Company and
the Audit Committee two material weaknesses (as defined under standards
established by the American Institute of Certified Public Accountants) relating
to the Companys accounting and public financial reporting of significant
matters and to its initial recording and management review and oversight of
certain accounting matters. The material weaknesses were with respect to the
calculation and procedures for the analysis of revenue reserves for product
sales and lack of procedures for timely communications from the Legal
Department and operating divisions to the Finance Department impairing the
ability to properly evaluate the accounting treatment for certain transactions
the Company had entered into and assess the impact of such transactions in a
timely manner. In addition, at that time, the Companys independent auditors
identified and communicated to the Company and the Audit Committee a
reportable condition (as defined under standards established by the American
Institute of Certified Public Accountants) relating to the Companys internal
controls over its financial reporting for investments. The reportable
condition identified the Companys failure to perform a formal review of its
investments and its failure to timely record patents or trademarks or to timely
analyze the patents and trademarks for usefulness and possible impairment. In view of the fact that the financial information presented in this Quarterly
Report on Form 10-Q/A was prepared in the absence of adequate internal controls
over financial reporting, the Company devoted a significant amount of time and
resources to the analysis of the financial information and documentation 33




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##### 



underlying the financial statements contained in this Quarterly Report,
resulting in the restatement of certain interim financial information. In
particular, the Company reviewed significant product sales transactions to
confirm the terms of the transaction and our accounting for the transaction,
including whether all criteria for the recognition of revenue had been
satisfied and whether we had properly estimated allowances for returns and
other customer credits. In addition, the Company reviewed in detail each of
the matters identified by the Special Committee of the Companys Board of
Directors and its independent counsel and independent forensic accountants.
The investigation of the Special Committee is discussed in Item 7,
Managements Discussion and Analysis of Financial Condition and Results of
OperationsSpecial Committee Investigation of the Companys 2003 Form 10-K. In light of the foregoing, the Company has taken the following actions, in
addition to those described above, after the end of 2003 to address the
deficiencies as described above:  
    
    reassigned all financial controllers from operating units into
the Finance Department reporting to the Companys Controller and
Chief Accounting Officer who reports directly to the Chief Financial
Officer;  
    
    commenced a company-wide education effort regarding our Code of
Conduct and contract-approval policies;  
    
    implemented a more vigorous contract-approval process;  
    
    implemented formal revenue recognition protocols and training programs; and  
    
    contracted with a third-party consulting group, FTI Consulting,
to provide transitional management services in the area of operations
and finance. In addition, since December 31, 2003, the Companys then Chief Executive
Officer, Chief Operating Officer and Chief Financial Officer have left the
Company. In March of 2004, Dr. Sancilio, the Companys Executive Chairman and
Chief Scientific Officer, was appointed Chief Executive Officer, and Gregory F.
Rayburn, a senior managing director with FTI Consulting, was appointed Interim
Chief Operating Officer. In April 2004, Timothy R. Wright was appointed
President of the Companys Pharmaceuticals Products Division. Gina Gutzeit, a
senior managing director with FTI Consulting, was appointed as interim Chief
Financial Officer in May 2004. The Company is fully committed to implementing controls identified by the
Companys independent auditors and the Special Committee. The Companys
efforts to strengthen its financial and internal controls continue, and the
Company expects to complete remediation of the material weaknesses and
reportable condition identified by its independent auditors by the end of 2004. 
 PART II. OTHER INFORMATION 
 Item 3. Defaults Upon Senior Securities. Under the terms of the credit agreement for our senior credit facility in
effect at March 31, 2003, we were required to comply with various covenants
including, but not limited to, those pertaining to maintenance of certain
financial ratios and incurrence of additional indebtedness. After giving
effect to the restatement described in this Quarterly Report on Form 10-Q/A, we
were not in compliance with some of these covenants at March 31, 2003. See
Notes 1 and 6 to our 2003 Form 10-K for additional discussion and a description
of our new senior credit facility that has replaced the credit facility in
effect at March 31, 2003. 34




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##### 



Under the terms of the
indenture for our $175 million senior subordinated notes due
2010, we are required to comply with various covenants including, but not
limited to a covenant relating to incurrence of additional indebtedness. After
giving effect to the restatement described in this Quarterly Report on Form
10-Q/A, we were not in compliance with some of these covenants at March 31,
2003. See Note 6 to our 2003 Form 10-K for additional discussion and a
description of the consent solicitation approved in April 2004 that waived all
then existing defaults under such indenture (including those in
effect at March 31, 2003). 
 Item 6. Exhibits and Reports on Form 8-K Exhibits: A list of the exhibits required to be filed as part of this Quarterly Report on
Form 10-Q/A is set forth in the Exhibit Index, which immediately precedes
such exhibits, and is incorporated herein by reference. Reports on Form 8-K: During the first quarter of 2003, we furnished the following Form 8-K:  
    
    Dated January 28, 2003, to file a press release reporting our results
of operations for the quarter and fiscal year ended December 31, 2002. 35




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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. aaiPharma Inc.Date:
    
    June 24, 2004
    
    By:
    
    /s/ Frederick D. SancilioFrederick D. Sancilio, Ph.D.Executive Chairman of the Board,Chief Executive OfficerDate:
    
    June 24, 2004
    
    By:
    
    /s/ Gina GutzeitGina GutzeitInterim Chief Financial Officer
 36




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##### 



aaiPharma Inc. 
 Exhibit Index
 ExhibitNo.
    
    Description31.1
    
    Certification pursuant to Exchange Act Rule 13a  14(a) of Frederick D. Sancilio31.2
    
    Certification pursuant to Exchange Act Rule 13a  14(a) of Gina Gutzeit32.1
    
    Certification pursuant to 18 U.S.C. Section 1350
 37