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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, DC 20549


FORM 10-Q/A

(Amendment No. 1)


[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period _______ to _______

Commission File Number 0-21185

AAIPHARMA INC.

(Exact name of Registrant as specified in its charter)


|                                                                        |  |                                                
|----------------------------------------------------------------------- |  | -----------------------------------------------
|DELAWARE
(State or other jurisdiction of
incorporation or organization) |  | 04-2687849
(I.R.S. employer
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 x NO o

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

The number of shares of the Registrants common stock outstanding, as of May 5,
2003 was 27,609,100 shares.

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aaiPharma Inc.
Table of Contents

Explanatory Note:

This Amendment No. 1 on Form 10-Q/A amends the Registrants Quarterly Report on
Form 10-Q for the quarter ended March 31, 2003, as filed on May 15, 2003, but
has no effect on previously reported income from operations, net income (loss)
or net income (loss) per share. This amendment is being filed for the sole
purpose of reclassifying the presentation of the extraordinary item included in
the consolidated statement of operations for the three months ended March 31,
2002, and certain corresponding items in the consolidated statement of cash
flows for the three months ended March 31, 2002, in accordance with 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, and requires that any extraordinary gains or
losses on extinguishment of debt in prior periods presented be reclassified.
This report speaks as of the original filing date and, except as indicated, has
not been updated to reflect events occurring subsequent to the original filing
date. 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 the reclassification of these items.

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 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.

We own the following registered and unregistered trademarks: Darvon®,
Darvon-N®, Darvocet-N®, M.V.I.®, M.V.I.-12®,
M.V.I. Pediatric®, M.V.I. AdultTM,
Aquasol®, Aquasol A®, Aquasol E®, Brethine®, ProSorb®, ProSorb-D, ProSLOTM,
ProSLO IITM, ProCore®, ProSpher®, ProLonicTM, ProMelt®, NeoSanTM, AzaSanTM,
aaiPharmaTM, and AAI®. References in this document to Darvon are to Darvon®
and Darvon-N® collectively and references to Darvocet are to Darvocet-N®. We
also reference trademarks owned by other companies. Prilosec® is a registered
trademark of AstraZeneca AB and Prozac® is a registered trademark of Eli Lilly
and Company. All references in this document to any of these terms lacking the
® or TM symbols are defined terms that reference the products, technologies
or businesses bearing the trademarks with these symbols.

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|                                                                                              |                                                 |  |          |   |  |  |  |  | 
|--------------------------------------------------------------------------------------------- | ----------------------------------------------- |  | -------- | - |  |  |  |  | 
|                                                                                              |                                                 |  | Page No. |   |  |  | 
|                                                                                              |                                                 |  |          |   |  |  | 
|PART I. FINANCIAL INFORMATION                                                                
|                                                                                              |                                                 |  |          |   |  |  |  | 
|Item 1. Financial Statements(unaudited)                                                       |                                                 |  |          |   |  |  |  | 
|                                                                                              | Consolidated Statements of Operations           |  |          | 4 |  |  |  |  | 
|                                                                                              | Consolidated Balance Sheets                     |  |          | 5 |  |  |  |  | 
|                                                                                              | Consolidated Statements of Cash Flows           |  |          | 6 |  |  |  |  | 
|                                                                                              | Consolidated Statements of Comprehensive Income |  |          | 7 |  |  |  |  | 
|                                                                                              | Notes to Consolidated Financial Statements      |  |          | 8 |  |  |  |  | 
|                                                                                              |                                                 |  |          |   |  |  |  | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations |                                                 |  | 22       |   |  |  |  | 
|Item 4. Controls and Procedures                                                               |                                                 |  | 28       |   |  |  |  | 
|PART II. OTHER INFORMATION                                                                   
|                                                                                              |                                                 |  |          |   |  |  |  | 
|Item 6. Exhibits and Reports on Form 8-K                                                      |                                                 |  | 28       |   |  |  |  | 
|                                                                                              |                                                 |  |          |   |  |  |  | 
|SIGNATURES                                                                                    |                                                 |  | 29       |   |  |  |  | 
|CERTIFICATIONS                                                                                |                                                 |  | 30       |   |  |  |  | 
|EXHIBIT INDEX                                                                                 |                                                 |  | 33       |   |  |  |  | 

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

aaiPharma Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

|                                    |                                          |                      |                    |        |                    |        |        |        |        |        | 
|----------------------------------- | ---------------------------------------- | -------------------- | ------------------ | ------ | ------------------ | ------ | ------ | ------ | ------ | ------ | 
|                                    |                                          |                      |                    |        | Three Months Ended
|                                    |                                          |                      |                    |        | March 31,         
|                                    |                                          |                      |                    |        |                   
|                                    |                                          |                      |                    |        | 2003               |        | 2002  
|                                    |                                          |                      |                    |        |                    |        |       
|Net revenues:                       |                                          |                      |                    |        |                    |        |        |       
|                                    | Product sales                            |                      | $                  | 40,008 |                    |        | $      | 20,177 |       
|                                    | Product development (royalties and fees) |                      |                    | 3,810  |                    |        |        | 2,135  |       
|                                    | Development services                     |                      |                    | 20,212 |                    |        |        | 23,308 |       
|                                    |                                          |                      |                    |        |                    |        |        |       
|                                    |                                          |                      | 64,030             |        |                    |        | 45,620 |       
|                                    |                                          |                      |                    |        |                    |        |        |       
|Operating costs and expenses:       |                                          |                      |                    |        |                    |        |        |       
|                                    | Direct costs (excluding depreciation):   |                      |                    |        |                    |        |        |        |       
|                                    |                                          | Product sales        |                    |        | 9,951              |        |        |        | 7,805  |       
|                                    |                                          | Development services |                    |        | 12,004             |        |        |        | 13,545 |       
|                                    |                                          |                      |                    |        |                    |        |        |        |       
|                                    |                                          |                      | Total direct costs |        |                    | 21,955 |        |        |        | 21,350 | 
|                                    | Selling expenses                         |                      |                    | 7,734  |                    |        |        | 4,274  |       
|                                    | General and administrative expenses      |                      |                    | 10,029 |                    |        |        | 8,758  |       
|                                    | Depreciation and amortization            |                      |                    | 2,651  |                    |        |        | 1,801  |       
|                                    | Research and development                 |                      |                    | 4,486  |                    |        |        | 4,378  |       
|                                    |                                          |                      |                    |        |                    |        |        |        |       
|Total operating costs and expenses  |                                          |                      | 46,855             |        |                    |        | 40,561 |       
|                                    |                                          |                      |                    |        |                    |        |        |       
|Income from operations              |                                          |                      | 17,175             |        |                    |        | 5,059  |       
|Other income (expense):             |                                          |                      |                    |        |                    |        |        |       
|                                    | Interest, net                            |                      |                    | (5,550 | )                  |        |        | (1,823 | )     
|                                    | Loss from extinguishment of debt         |                      |                    |       |                    |        |        | (8,053 | )     
|                                    | Other                                    |                      |                    | (83    | )                  |        |        | 134    |       
|                                    |                                          |                      |                    |        |                    |        |        |        |       
|                                    |                                          |                      | (5,633             | )      |                    |        | (9,742 | )     
|                                    |                                          |                      |                    |        |                    |        |        |       
|Income before income taxes          |                                          |                      | 11,542             |        |                    |        | (4,683 | )     
|Provision for income taxes          |                                          |                      | 4,386              |        |                    |        | (1,433 | )     
|                                    |                                          |                      |                    |        |                    |        |        |       
|Net income (loss)                   |                                          | $                    | 7,156              |        |                    | $      | (3,250 | )     
|                                    |                                          |                      |                    |        |                    |        |        |       
|Basic earnings (loss) per share     |                                          | $                    | 0.26               |        |                    | $      | (0.12  | )     
|                                    |                                          |                      |                    |        |                    |        |        |       
|Weighted average shares outstanding |                                          |                      | 27,558             |        |                    |        | 27,107 |       
|                                    |                                          |                      |                    |        |                    |        |        |       
|Diluted earnings (loss) per share   |                                          | $                    | 0.25               |        |                    | $      | (0.11  | )     
|                                    |                                          |                      |                    |        |                    |        |        |       
|Weighted average shares outstanding |                                          |                      | 28,435             |        |                    |        | 28,589 |       
|                                    |                                          |                      |                    |        |                    |        |        |       

The accompanying notes are an integral part of these financial statements.

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aaiPharma Inc.
CONSOLIDATED BALANCE SHEETS
(In thousands)

|                                     |                                               |                                      |         |                                            |             |           |         |              |   |   |         | 
|------------------------------------ | --------------------------------------------- | ------------------------------------ | ------- | ------------------------------------------ | ----------- | --------- | ------- | ------------ | - | - | ------- | 
|                                     |                                               |                                      |         |                                            |             | March 31, |         | December 31,
|                                     |                                               |                                      |         |                                            |             | 2003      |         | 2002        
|                                     |                                               |                                      |         |                                            |             |           |         |             
|                                     |                                               |                                      | ASSETS  |                                            | (Unaudited) |           |         |              |  
|Current assets:                      |                                               |                                      |         |                                            |             |           |         |             
|                                     | Cash and cash equivalents                     |                                      | $       | 10,705                                     |             |           | $       | 6,532        |  
|                                     | Accounts receivable, net                      |                                      |         | 28,663                                     |             |           |         | 29,467       |  
|                                     | Work-in-progress                              |                                      |         | 12,292                                     |             |           |         | 10,515       |  
|                                     | Inventories                                   |                                      |         | 19,476                                     |             |           |         | 17,004       |  
|                                     | Prepaid and other current assets              |                                      |         | 7,312                                      |             |           |         | 7,633        |  
|                                     |                                               |                                      |         |                                            |             |           |         |             
|                                     |                                               |                                      |         | Total current assets                       |             |           | 78,448  |              |   |   | 71,151  | 
|Property and equipment, net          |                                               |                                      | 54,604  |                                            |             |           | 53,125  |             
|Goodwill, net                        |                                               |                                      | 211,178 |                                            |             |           | 210,792 |             
|Intangible assets, net               |                                               |                                      | 88,855  |                                            |             |           | 89,078  |             
|Other assets                         |                                               |                                      | 13,782  |                                            |             |           | 16,179  |             
|                                     |                                               |                                      |         |                                            |             |           |         |              |  
|                                     |                                               |                                      |         | Total assets                               |             | $         | 446,867 |              |   | $ | 440,325 | 
|                                     |                                               |                                      |         |                                            |             |           |         |             
|                                     |                                               | LIABILITIES AND STOCKHOLDERS EQUITY |         |                                            |             |           |         |              |   |  
|Current liabilities:                 |                                               |                                      |         |                                            |             |           |         |             
|                                     | Current maturities of long-term debt          |                                      | $       | 5,921                                      |             |           | $       | 5,921        |  
|                                     | Accounts payable                              |                                      |         | 17,929                                     |             |           |         | 17,671       |  
|                                     | Customer advances                             |                                      |         | 14,287                                     |             |           |         | 15,051       |  
|                                     | Accrued wages and benefits                    |                                      |         | 7,941                                      |             |           |         | 6,718        |  
|                                     | Interest payable                              |                                      |         | 9,940                                      |             |           |         | 5,232        |  
|                                     | Other accrued liabilities                     |                                      |         | 3,284                                      |             |           |         | 5,201        |  
|                                     |                                               |                                      |         |                                            |             |           |         |             
|                                     |                                               |                                      |         | Total current liabilities                  |             |           | 59,302  |              |   |   | 55,794  | 
|Long-term debt, less current portion |                                               |                                      | 266,487 |                                            |             |           | 277,899 |             
|Other liabilities                    |                                               |                                      | 13,313  |                                            |             |           | 7,182   |             
|Stockholders equity:                |                                               |                                      |         |                                            |             |           |         |             
|                                     | Common stock                                  |                                      |         | 28                                         |             |           |         | 27           |  
|                                     | Paid-in capital                               |                                      |         | 79,476                                     |             |           |         | 79,049       |  
|                                     | Retained earnings                             |                                      |         | 27,748                                     |             |           |         | 20,592       |  
|                                     | Accumulated other comprehensive income (loss) |                                      |         | 513                                        |             |           |         | (218         | )
|                                     |                                               |                                      |         |                                            |             |           |         |              |  
|                                     |                                               |                                      |         | Total stockholders equity                 |             |           | 107,765 |              |   |   | 99,450  | 
|                                     |                                               |                                      |         |                                            |             |           |         |             
|                                     |                                               |                                      |         | Total liabilities and stockholders equity |             | $         | 446,867 |              |   | $ | 440,325 | 
|                                     |                                               |                                      |         |                                            |             |           |         |             

The accompanying notes are an integral part of these financial statements.

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aaiPharma Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |          |          |       |         |  
|--------------------------------------------------- | -------------------------------------------------------------------------------------------------- | ----------------------------------------------- | -------------------------------------------------------- | ------ | ---------------------------- | ------ | -------- | -------- | ----- | ------- | -
|                                                    |                                                                                                    |                                                 |                                                          |        | Three Months Ended March 31,
|                                                    |                                                                                                    |                                                 |                                                          |        |                             
|                                                    |                                                                                                    |                                                 |                                                          |        | 2003                         |        | 2002    
|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |         
|Cash flows from operating activities:               |                                                                                                    |                                                 |                                                          |        |                              |        |          |         
|                                                    | Net income (loss)                                                                                  |                                                 | $                                                        | 7,156  |                              |        | $        | (3,250   | )    
|                                                    | Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities: |                                                 |                                                          |        |                              |        |          |          |      
|                                                    |                                                                                                    | Depreciation and amortization                   |                                                          |        | 2,651                        |        |          |          | 1,801 |        
|                                                    |                                                                                                    | Write-off of deferred financing and other costs |                                                          |        |                             |        |          |          | 5,339 |        
|                                                    |                                                                                                    | Other                                           |                                                          |        | 52                           |        |          |          | 78    |        
|                                                    |                                                                                                    | Changes in operating assets and liabilities:    |                                                          |        |                              |        |          |          |       |        
|                                                    |                                                                                                    |                                                 | Accounts receivable, net                                 |        |                              | 882    |          |          |       | (3,951  | )
|                                                    |                                                                                                    |                                                 | Work-in-progress                                         |        |                              | (1,640 | )        |          |       | (2,850  | )
|                                                    |                                                                                                    |                                                 | Inventories                                              |        |                              | (2,451 | )        |          |       | 1,082   |  
|                                                    |                                                                                                    |                                                 | Prepaid and other assets                                 |        |                              | 856    |          |          |       | (14,118 | )
|                                                    |                                                                                                    |                                                 | Accounts payable                                         |        |                              | 204    |          |          |       | (1,991  | )
|                                                    |                                                                                                    |                                                 | Customer advances                                        |        |                              | (843   | )        |          |       | (222    | )
|                                                    |                                                                                                    |                                                 | Interest payable                                         |        |                              | 4,708  |          |          |       | (175    | )
|                                                    |                                                                                                    |                                                 | Accrued wages and benefits and other accrued liabilities |        |                              | 3,752  |          |          |       | 1,507   |  
|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |          |          |      
|Net cash provided by (used in) operating activities |                                                                                                    |                                                 | 15,327                                                   |        |                              |        | (16,750  | )       
|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |          |         
|Cash flows from investing activities:               |                                                                                                    |                                                 |                                                          |        |                              |        |          |         
|                                                    | Purchases of property and equipment                                                                |                                                 |                                                          | (3,212 | )                            |        |          | (1,549   | )    
|                                                    | Purchase of property and equipment previously leased                                               |                                                 |                                                          |       |                              |        |          | (14,145  | )    
|                                                    | Acquisitions                                                                                       |                                                 |                                                          | (500   | )                            |        |          | (211,772 | )    
|                                                    | Other                                                                                              |                                                 |                                                          | (232   | )                            |        |          | 2        |      
|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |          |          |      
|Net cash used in investing activities               |                                                                                                    |                                                 | (3,944                                                   | )      |                              |        | (227,464 | )       
|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |          |         
|Cash flows from financing activities:               |                                                                                                    |                                                 |                                                          |        |                              |        |          |         
|                                                    | Net payments on short-term debt                                                                    |                                                 |                                                          |       |                              |        |          | 5,000    |      
|                                                    | Proceeds from long-term borrowings                                                                 |                                                 |                                                          |       |                              |        |          | 240,274  |      
|                                                    | Payments on long-term borrowings                                                                   |                                                 |                                                          | (8,500 | )                            |        |          |         |      
|                                                    | Proceeds from interest rate swap, net                                                              |                                                 |                                                          | 435    |                              |        |          |         |      
|                                                    | Issuance of common stock                                                                           |                                                 |                                                          | 428    |                              |        |          | 1,980    |      
|                                                    | Other                                                                                              |                                                 |                                                          | 409    |                              |        |          | (2,845   | )    
|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |          |          |      
|Net cash (used in) provided by financing activities |                                                                                                    |                                                 | (7,228                                                   | )      |                              |        | 244,409  |         
|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |          |         
|Net increase in cash and cash equivalents           |                                                                                                    |                                                 | 4,155                                                    |        |                              |        | 195      |         
|Effect of exchange rate changes on cash             |                                                                                                    |                                                 | 18                                                       |        |                              |        | (15      | )       
|Cash and cash equivalents, beginning of period      |                                                                                                    |                                                 | 6,532                                                    |        |                              |        | 6,371    |         
|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |          |         
|Cash and cash equivalents, end of period            |                                                                                                    | $                                               | 10,705                                                   |        |                              | $      | 6,551    |         
|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |          |         
|Supplemental information, cash paid for:            |                                                                                                    |                                                 |                                                          |        |                              |        |          |         
|                                                    | Interest                                                                                           |                                                 | $                                                        | 1,497  |                              |        | $        | 1,776    |      
|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |          |         
|                                                    | Income taxes                                                                                       |                                                 | $                                                        | 2,202  |                              |        | $        | 1,687    |      
|                                                    |                                                                                                    |                                                 |                                                          |        |                              |        |          |         

The accompanying notes are an integral part of these financial statements.

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aaiPharma Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)

|                                 |  |                    |       |      |  |   |        |  
|-------------------------------- |  | ------------------ | ----- | ---- |  | - | ------ | -
|                                 |  | Three Months Ended
|                                 |  | March 31,         
|                                 |  |                   
|                                 |  | 2003               |       | 2002
|                                 |  |                    |       |     
|Net income (loss)                |  | $                  | 7,156 |      |  | $ | (3,250 | )
|Currency translation adjustments |  |                    | 731   |      |  |   | (175   | )
|                                 |  |                    |       |      |  |   |        |  
|Comprehensive income (loss)      |  | $                  | 7,887 |      |  | $ | (3,425 | )
|                                 |  |                    |       |      |  |   |        |  

The accompanying notes are an integral part of these financial statements.

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aaiPharma Inc.
Notes to Consolidated Financial Statements
(Unaudited)

1.     Basis of presentation and other matters

The accompanying unaudited 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 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 financial information as of December 31, 2002 has been derived
from audited financial statements; certain amounts from 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. It is presumed that users of this interim financial information have
read or have access to the audited financial statements for the preceding
fiscal year, which were included in the Companys Annual Report on Form 10-K.
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for fair presentation have been included in
these interim 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 No. 148). SFAS No. 148
amends Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS No. 123), to provide alternative methods of
transition to SFAS No. 123s fair value method of accounting for stock-based
employee compensation. SFAS No. 148 also amends the disclosure provisions in
SFAS No. 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 earnings per share
in annual and interim financial statements. The adoption of

8



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SFAS No. 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 No. 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 No. 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 No. 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 Ended                   
|                                                    |               |         |       | March 31,                            
|                                                    |               |         |       |                                      
|                                                    |               |         |       | 2003                                  |      | 2002
|                                                    |               |         |       |                                       |      |     
|                                                    |               |         |       | (In thousands, except per share data)
|Net income (loss), as reported                      |               | $       | 7,156 |                                       |      | $    | (3,250 | )
|Pro forma stock-based compensation cost, net of tax |               |         | 1,907 |                                       |      |      | 1,106  |  
|Pro forma net income (loss)                         |               |         | 5,249 |                                       |      |      | (4,356 | )
|Earnings (loss) per share:                          |               |         |       |                                       |      |      |        |  
|                                                    | As reported - |         |       |                                       |      |      |        |   |      
|                                                    |               | Basic   |       | $                                     | 0.26 |      |        | $ | (0.12 | )
|                                                    |               | Diluted |       | $                                     | 0.25 |      |        | $ | (0.11 | )
|                                                    | Pro forma -   |         |       |                                       |      |      |        |   |      
|                                                    |               | Basic   |       | $                                     | 0.19 |      |        | $ | (0.16 | )
|                                                    |               | Diluted |       | $                                     | 0.18 |      |        | $ | (0.15 | )

2.     Earnings 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,
3,250,053 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.

9



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##### 



The following table provides a reconciliation of the denominators for the basic
and diluted earnings (loss) per share computations (in thousands):



|                                   |                                   |                                                                    |  |                    |        |      |  |        |        | 
|---------------------------------- | --------------------------------- | ------------------------------------------------------------------ |  | ------------------ | ------ | ---- |  | ------ | ------ | 
|                                   |                                   |                                                                    |  | Three Months Ended
|                                   |                                   |                                                                    |  | March 31,         
|                                   |                                   |                                                                    |  |                   
|                                   |                                   |                                                                    |  | 2003               |        | 2002
|                                   |                                   |                                                                    |  |                    |        |     
|Basic earnings (loss) per share:   |                                   |                                                                    |  |                    |        |      |  |       
|                                   | Weighted average number of shares |                                                                    |  | 27,558             |        |      |  | 27,107 |       
|Effect of dilutive securities:     |                                   |                                                                    |  |                    |        |      |  |       
|                                   | Stock options                     |                                                                    |  | 877                |        |      |  | 1,482  |       
|                                   |                                   |                                                                    |  |                    |        |      |  |       
|Diluted earnings (loss) per share: |                                   |                                                                    |  |                    |        |      |  |       
|                                   |                                   | Adjusted weighted average number of shares
and assumed conversions |  |                    | 28,435 |      |  |        | 28,589 | 
|                                   |                                   |                                                                    |  |                    |        |      |  |       

3.     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 International business unit.
The product sales business provides for the sales of M.V.I., Aquasol,
Brethine, Darvon, Darvocet-N, Azasan and calcitriol 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 Ended
|                     |  |   | March 31,         
|                     |  |   |                   
|                     |  |   | 2003               |   | 2002
|                     |  |   |                    |   |     
|Net revenues:        |  |   |                    |   |      |   |        |  
|Product sales        |  | $ | 40,008             |   |      | $ | 20,177 |  
|Product development  |  |   | 3,810              |   |      |   | 2,135  |  
|Development services |  |   | 20,212             |   |      |   | 23,308 |  
|                     |  |   |                    |   |      |   |        |  
|                     |  | $ | 64,030             |   |      | $ | 45,620 |  
|                     |  |   |                    |   |      |   |        |  
|United States        |  | $ | 59,362             |   |      | $ | 43,349 |  
|Germany              |  |   | 5,311              |   |      |   | 3,624  |  
|Other                |  |   | 325                |   |      |   | 199    |  
|Less intercompany    |  |   | (968               | ) |      |   | (1,552 | )
|                     |  |   |                    |   |      |   |        |  
|                     |  | $ | 64,030             |   |      | $ | 45,620 |  
|                     |  |   |                    |   |      |   |        |  

10



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##### 



|                                       |                                                        |   |                    |        |      |   |        |        | 
|-------------------------------------- | ------------------------------------------------------ | - | ------------------ | ------ | ---- | - | ------ | ------ | 
|                                       |                                                        |   | Three Months Ended
|                                       |                                                        |   | March 31,         
|                                       |                                                        |   |                   
|                                       |                                                        |   | 2003               |        | 2002
|                                       |                                                        |   |                    |        |     
|Gross margin (excluding depreciation): |                                                        |   |                    |        |      |   |        |       
|Product sales                          |                                                        | $ | 30,057             |        |      | $ | 12,372 |       
|Product development                    |                                                        |   | 3,810              |        |      |   | 2,135  |       
|Development services                   |                                                        |   | 8,208              |        |      |   | 9,763  |       
|                                       |                                                        |   |                    |        |      |   |        |       
|                                       |                                                        | $ | 42,075             |        |      | $ | 24,270 |       
|                                       |                                                        |   |                    |        |      |   |        |       
|Income (loss) from operations:         |                                                        |   |                    |        |      |   |        |       
|Product sales                          |                                                        | $ | 22,918             |        |      | $ | 8,994  |       
|Product development                    |                                                        |   | 3,810              |        |      |   | 2,135  |       
|Development services                   |                                                        |   | 332                |        |      |   | 1,783  |       
|                                       |                                                        |   |                    |        |      |   |        |       
|                                       | Income from operations before research and development |   |                    | 27,060 |      |   |        | 12,912 | 
|Research and development               |                                                        |   | (4,586             | )      |      |   | (4,477 | )     
|Corporate                              |                                                        |   | (5,299             | )      |      |   | (3,376 | )     
|                                       |                                                        |   |                    |        |      |   |        |       
|                                       |                                                        | $ | 17,175             |        |      | $ | 5,059  |       
|                                       |                                                        |   |                    |        |      |   |        |       
|United States                          |                                                        | $ | 16,467             |        |      | $ | 5,077  |       
|Germany                                |                                                        |   | 729                |        |      |   | 76     |       
|Other                                  |                                                        |   | (21                | )      |      |   | (94    | )     
|                                       |                                                        |   |                    |        |      |   |        |       
|                                       |                                                        | $ | 17,175             |        |      | $ | 5,059  |       
|                                       |                                                        |   |                    |        |      |   |        |       
|Depreciation and amortization:         |                                                        |   |                    |        |      |   |        |       
|Product sales                          |                                                        | $ | 986                |        |      | $ | 250    |       
|Product development                    |                                                        |   | 100                |        |      |   | 99     |       
|Development services                   |                                                        |   | 1,027              |        |      |   | 941    |       
|Corporate                              |                                                        |   | 538                |        |      |   | 511    |       
|                                       |                                                        |   |                    |        |      |   |        |       
|                                       |                                                        | $ | 2,651              |        |      | $ | 1,801  |       
|                                       |                                                        |   |                    |        |      |   |        |       

|                     |  |           |         |              |  |   |         | 
|-------------------- |  | --------- | ------- | ------------ |  | - | ------- | 
|                     |  | March 31, |         | December 31,
|                     |  | 2003      |         | 2002        
|                     |  |           |         |             
|Total assets:        |  |           |         |              |  |   |         | 
|Product sales        |  | $         | 350,636 |              |  | $ | 347,596 | 
|Product development  |  |           | 6,134   |              |  |   | 6,024   | 
|Development services |  |           | 48,729  |              |  |   | 49,952  | 
|Corporate            |  |           | 41,368  |              |  |   | 36,753  | 
|                     |  |           |         |              |  |   |         | 
|                     |  | $         | 446,867 |              |  | $ | 440,325 | 
|                     |  |           |         |              |  |   |         | 
|United States        |  | $         | 423,231 |              |  | $ | 417,997 | 
|Germany              |  |           | 22,073  |              |  |   | 21,167  | 
|Other                |  |           | 1,563   |              |  |   | 1,161   | 
|                     |  |           |         |              |  |   |         | 
|                     |  | $         | 446,867 |              |  | $ | 440,325 | 
|                     |  |           |         |              |  |   |         | 
|Goodwill, net:       |  |           |         |              |  |   |         | 
|Product sales        |  | $         | 199,414 |              |  | $ | 199,414 | 
|Development services |  |           | 11,764  |              |  |   | 11,378  | 
|                     |  |           |         |              |  |   |         | 
|                     |  | $         | 211,178 |              |  | $ | 210,792 | 
|                     |  |           |         |              |  |   |         | 

11



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4.     Transactions with related parties

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. and its principal shareholders and
continue to be related parties. 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 and accrued potential
royalties of $0.4 million under that agreement 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.

12



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##### 



5.     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         |         |              | $ | 50,000  |        
|U.S. revolving credit facility                                         |                                         |   | 41,000         |         |              |   | 47,500  |        
|11% senior subordinated notes due 2010, net of original issue
discount |                                         |   | 173,999        |         |              |   | 173,963 |        
|Interest rate swap monetization deferred income                        |                                         |   | 10,921         |         |              |   | 10,486  |        
|Fair value of interest rate swap                                       |                                         |   | (1,512         | )       |              |   | 1,871   |        
|Less 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 $175 million of senior secured credit
facilities consisting of a $75 million five-year revolving credit facility and
a $100 million five-year term loan facility. The term loan facility amortizes
over the full five-year term. These senior credit facilities were subsequently
reduced to $123 million due to the $52 million of repayments made under the
term loan facility. The availability of borrowings under the revolving credit
facility is 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 facilities provide 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 facilities are 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 facilities require the payment of certain
commitment fees based on the unused portion of the revolving credit facility.
These senior credit facilities may 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. These notes
have a fixed interest rate of 11% per annum and are guaranteed on a
subordinated basis by all existing domestic subsidiaries and all future
domestic subsidiaries that are owned 80% or more by the Company. The notes are
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. The

13



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##### 



terms of the senior credit facilities require repayment of all of the
indebtedness under these facilities before repurchase of any of the notes. 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 swap 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
swap agreement for $2.3 million. The amount received, less the interest
benefit of $1.5 million 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 swap 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 swap 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 is required to comply with various covenants
including, but not limited to, those pertaining to maintenance of certain
financial ratios and incurring additional indebtedness. The Company was in
compliance with the covenants at March 31, 2003.

6.     Acquisition

On March 28, 2002, the Company acquired the U.S. rights to the Darvon and
Darvocet-N branded product lines, which treat mild to moderate pain, and
existing inventory from Eli Lilly and Company, in a business combination
accounted for as a purchase. The Company acquired these product lines and
related intangible assets for $211.4 million. To finance this acquisition,
which included $1.8 million of inventory, the Company used the proceeds from
the senior secured credit facilities and senior subordinated notes, as
described in note 5. The Darvon and Darvocet-N 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 assets, with the excess of the
purchase price over the identifiable tangible and intangible assets recorded as
goodwill. Based on this allocation, $51.2 million of intangible assets have
been identified and will be amortized over 20 years. In accordance with
Statement of Financial Accounting Standards No. 141 Business Combinations and
Statement of Financial Accounting Standards No. 142 Accounting for Goodwill
and Intangibles, the excess of the purchase price over identifiable intangible
assets in the amount of $159.7 million has been classified as goodwill, which
is not subject to amortization.

The following unaudited pro forma consolidated financial information reflects
the results of operations for the three months ended March 31, 2002, as if the
above acquisition had occurred at the beginning of the period presented (in
thousands, except per share data).

14



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##### 



|                       |  |                |        |  
|---------------------- |  | -------------- | ------ | -
|                       |  | Three Months  
|                       |  | Ended         
|                       |  | March 31, 2002
|                       |  |               
|Net revenues           |  | $              | 55,352 |  
|Net loss               |  |                | (2,722 | )
|Basic loss per share   |  | $              | (0.10  | )
|Diluted loss per share |  | $              | (0.10  | )

These pro forma results have been prepared for comparative purposes only and do
not purport to be indicative of what operating results would have been had the
acquisition taken place at the beginning of the period presented. In addition,
these results are not intended to be a projection of future results and do not
reflect any synergies that might be achieved from the combined operations.

7.     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 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 eliminating entries eliminate investments in subsidiaries and
inter-company balances and transactions.

15



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##### 



The following information presents consolidating statements of operations,
balance sheets and cash flows for the periods and as of the dates indicated:

aaiPharma Inc.
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands)

|                                  |                                       |                |        |                                   |        |              |        |              |        |                |       |              |       |   |         |      |         |   |        |        |        | 
|--------------------------------- | ------------------------------------- | -------------- | ------ | --------------------------------- | ------ | ------------ | ------ | ------------ | ------ | -------------- | ----- | ------------ | ----- | - | ------- | ---- | ------- | - | ------ | ------ | ------ | 
|                                  |                                       |                |        | Three Months Ended March 31, 2003
|                                  |                                       |                |        |                                  
|                                  |                                       |                |        |                                   |        |              |        | Guarantor    |        | Non- Guarantor |       |              |       |   |         |      |         |  
|                                  |                                       |                |        | Issuer                            |        | Subsidiaries |        | Subsidiaries |        | Eliminations   |       | Consolidated
|                                  |                                       |                |        |                                   |        |              |        |              |        |                |       |             
|Net revenues                      |                                       | $              | 10,630 |                                   |        | $            | 48,732 |              |        | $              | 5,636 |              |       | $ | (968    | )    |         | $ | 64,030 |       
|Equity earnings from subsidiaries |                                       |                | 19,143 |                                   |        |              |       |              |        |                |      |              |       |   | (19,143 | )    |         |   |       |       
|                                  |                                       |                |        |                                   |        |              |        |              |        |                |       |              |       |   |         |      |         |   |        |       
|                                  |                                       | Total revenues |        |                                   | 29,773 |              |        |              | 48,732 |                |       |              | 5,636 |   |         |      | (20,111 | ) |        |        | 64,030 | 
|                                  |                                       |                |        |                                   |        |              |        |              |        |                |       |              |       |   |         |      |         |   |        |       
|Operating costs and expenses:     |                                       |                |        |                                   |        |              |        |              |        |                |       |              |       |   |         |      |         |   |        |       
|                                  | Direct costs (excluding depreciation) |                |        | 6,521                             |        |              |        | 13,005       |        |                |       | 3,172        |       |   |         | (743 | )       |   |        | 21,955 |       
|                                  | Selling                               |                |        | 1,289                             |        |              |        | 5,933        |        |                |       | 512          |       |   |         |     |         |   |        | 7,734  |       
|                                  | General and administrative            |                |        | 7,797                             |        |              |        | 1,240        |        |                |       | 992          |       |   |         |     |         |   |        | 10,029 |       
|                                  | Depreciation and amortization         |                |        | 1,356                             |        |              |        | 1,042        |        |                |       | 253          |       |   |         |     |         |   |        | 2,651  |       
|                                  | Research and development              |                |        |                                  |        |              |        | 4,486        |        |                |       |             |       |   |         |     |         |   |        | 4,486  |       
|                                  |                                       |                |        |                                   |        |              |        |              |        |                |       |              |       |   |         |      |         |   |        |       
|                                  |                                       |                | 16,963 |                                   |        |              | 25,706 |              |        |                | 4,929 |              |       |   | (743    | )    |         |   | 46,855 |       
|                                  |                                       |                |        |                                   |        |              |        |              |        |                |       |              |       |   |         |      |         |   |        |       
|Income (loss) from operations     |                                       |                | 12,810 |                                   |        |              | 23,026 |              |        |                | 707   |              |       |   | (19,368 | )    |         |   | 17,175 |       
|Other expense:                    |                                       |                |        |                                   |        |              |        |              |        |                |       |              |       |   |         |      |         |   |        |       
|                                  | Interest, net                         |                |        | (692                              | )      |              |        | (4,859       | )      |                |       | 1            |       |   |         |     |         |   |        | (5,550 | )     
|                                  | Net intercompany interest             |                |        | (516                              | )      |              |        | 559          |        |                |       | (43          | )     |   |         |     |         |   |        |       |       
|                                  | Other                                 |                |        | (60                               | )      |              |        | 2            |        |                |       | (25          | )     |   |         |     |         |   |        | (83    | )     
|                                  |                                       |                |        |                                   |        |              |        |              |        |                |       |              |       |   |         |      |         |   |        |       
|                                  |                                       |                | (1,268 | )                                 |        |              | (4,298 | )            |        |                | (67   | )            |       |   |        |      |         |   | (5,633 | )     
|                                  |                                       |                |        |                                   |        |              |        |              |        |                |       |              |       |   |         |      |         |   |        |       
|Income (loss) before income taxes |                                       |                | 11,542 |                                   |        |              | 18,728 |              |        |                | 640   |              |       |   | (19,368 | )    |         |   | 11,542 |       
|Provision for income taxes        |                                       |                | 4,386  |                                   |        |              |       |              |        |                |      |              |       |   |        |      |         |   | 4,386  |       
|                                  |                                       |                |        |                                   |        |              |        |              |        |                |       |              |       |   |         |      |         |   |        |       
|Net income (loss)                 |                                       | $              | 7,156  |                                   |        | $            | 18,728 |              |        | $              | 640   |              |       | $ | (19,368 | )    |         | $ | 7,156  |       
|                                  |                                       |                |        |                                   |        |              |        |              |        |                |       |              |       |   |         |      |         |   |        |       

16



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##### 



aaiPharma Inc.
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands)

|                                      |  |                                       |                |   |                                   |        |              |   |              |        |              |   |              |       |        |   |        |        |        |   |        |        | 
|------------------------------------- |  | ------------------------------------- | -------------- | - | --------------------------------- | ------ | ------------ | - | ------------ | ------ | ------------ | - | ------------ | ----- | ------ | - | ------ | ------ | ------ | - | ------ | ------ | 
|                                      |  |                                       |                |   | Three Months Ended March 31, 2002
|                                      |  |                                       |                |   |                                  
|                                      |  |                                       |                |   |                                   |        |              |   |              |        |              |   | Non-         |       |        |   |        |        |        |   |       
|                                      |  |                                       |                |   |                                   |        |              |   | Guarantor    |        | Guarantor    |   |              |       |        |   |        |        |       
|                                      |  |                                       |                |   | Issuer                            |        | Subsidiaries |   | Subsidiaries |        | Eliminations |   | Consolidated
|                                      |  |                                       |                |   |                                   |        |              |   |              |        |              |   |             
|Net revenues                          |  | $                                     | 16,737         |   |                                   | $      | 26,610       |   |              | $      | 3,825        |   |              | $     | (1,552 | ) |        | $      | 45,620 |  
|Equity earnings from subsidiaries     |  |                                       | 1,757          |   |                                   |        |             |   |              |        |             |   |              |       | (1,757 | ) |        |        |       |  
|                                      |  |                                       |                |   |                                   |        |              |   |              |        |              |   |              |       |        |   |        |        |        |  
|                                      |  |                                       | Total revenues |   |                                   | 18,494 |              |   |              | 26,610 |              |   |              | 3,825 |        |   |        | (3,309 | )      |   |        | 45,620 | 
|                                      |  |                                       |                |   |                                   |        |              |   |              |        |              |   |              |       |        |   |        |        |        |  
|Operating costs and expenses:         |  |                                       |                |   |                                   |        |              |   |              |        |              |   |              |       |        |   |        |        |        |  
|                                      |  | Direct costs (excluding depreciation) |                |   | 9,593                             |        |              |   | 10,876       |        |              |   | 2,433        |       |        |   | (1,552 | )      |        |   | 21,350 |       
|                                      |  | Selling                               |                |   | 1,652                             |        |              |   | 2,228        |        |              |   | 394          |       |        |   |       |        |        |   | 4,274  |       
|                                      |  | General and administrative            |                |   | 5,589                             |        |              |   | 2,386        |        |              |   | 783          |       |        |   |       |        |        |   | 8,758  |       
|                                      |  | Depreciation and amortization         |                |   | 1,163                             |        |              |   | 403          |        |              |   | 235          |       |        |   |       |        |        |   | 1,801  |       
|                                      |  | Research and development              |                |   | 247                               |        |              |   | 4,131        |        |              |   |             |       |        |   |       |        |        |   | 4,378  |       
|                                      |  |                                       |                |   |                                   |        |              |   |              |        |              |   |              |       |        |   |        |        |        |  
|                                      |  |                                       | 18,244         |   |                                   |        | 20,024       |   |              |        | 3,845        |   |              |       | (1,552 | ) |        |        | 40,561 |  
|                                      |  |                                       |                |   |                                   |        |              |   |              |        |              |   |              |       |        |   |        |        |        |  
|Income (loss) from operations         |  |                                       | 250            |   |                                   |        | 6,586        |   |              |        | (20          | ) |              |       | (1,757 | ) |        |        | 5,059  |  
|Other expense:                        |  |                                       |                |   |                                   |        |              |   |              |        |              |   |              |       |        |   |        |        |        |  
|                                      |  | Interest, net                         |                |   | (113                              | )      |              |   | (1,713       | )      |              |   | 3            |       |        |   |       |        |        |   | (1,823 | )     
|                                      |  | Net intercompany interest             |                |   | (564                              | )      |              |   | 625          |        |              |   | (61          | )     |        |   |       |        |        |   |       |       
|                                      |  | Other                                 |                |   | (4,256                            | )      |              |   | (3,702       | )      |              |   | 39           |       |        |   |       |        |        |   | (7,919 | )     
|                                      |  |                                       |                |   |                                   |        |              |   |              |        |              |   |              |       |        |   |        |        |        |  
|                                      |  |                                       | (4,933         | ) |                                   |        | (4,790       | ) |              |        | (19          | ) |              |       |       |   |        |        | (9,742 | )
|                                      |  |                                       |                |   |                                   |        |              |   |              |        |              |   |              |       |        |   |        |        |        |  
|Net (loss) income before income taxes |  |                                       | (4,683         | ) |                                   |        | 1,796        |   |              |        | (39          | ) |              |       | (1,757 | ) |        |        | (4,683 | )
|Provision for income taxes            |  |                                       | (1,433         | ) |                                   |        |             |   |              |        |             |   |              |       |       |   |        |        | (1,433 | )
|                                      |  |                                       |                |   |                                   |        |              |   |              |        |              |   |              |       |        |   |        |        |        |  
|Net (loss) income                     |  | $                                     | (3,250         | ) |                                   | $      | 1,796        |   |              | $      | (39          | ) |              | $     | (1,757 | ) |        | $      | (3,250 | )
|                                      |  |                                       |                |   |                                   |        |              |   |              |        |              |   |              |       |        |   |        |        |        |  

17



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##### 



aaiPharma Inc.
CONSOLIDATED BALANCE SHEET
(In thousands)

|                                            |                                      |                                      |        |                                            |   |                |         |              |  |              |         |               |   |              |         |      |   |   |         |        |  |   |         | 
|------------------------------------------- | ------------------------------------ | ------------------------------------ | ------ | ------------------------------------------ | - | -------------- | ------- | ------------ |  | ------------ | ------- | ------------- | - | ------------ | ------- | ---- | - | - | ------- | ------ |  | - | ------- | 
|                                            |                                      |                                      |        |                                            |   | March 31, 2003
|                                            |                                      |                                      |        |                                            |   |               
|                                            |                                      |                                      |        |                                            |   |                |         |              |  | Guarantor    |         | Non-Guarantor |   |              |         |      |   |   |         |       
|                                            |                                      |                                      |        |                                            |   | Issuer         |         | Subsidiaries |  | Subsidiaries |         | Eliminations  |   | Consolidated
|                                            |                                      |                                      |        |                                            |   |                |         |              |  |              |         |               |   |             
|                                            |                                      |                                      | ASSETS |                                            |   |                |         |              |  |              |         |               |   |              |         |      |   |   |         |        |  |   |        
|Current assets:                             |                                      |                                      |        |                                            |   |                |         |              |  |              |         |               |   |              |         |      |   |   |         |       
|                                            | Cash and cash equivalents            |                                      | $      | 9,920                                      |   |                | $       | 170          |  |              | $       | 615           |   |              | $       |     |   |   | $       | 10,705 | 
|                                            | Accounts receivable, net             |                                      |        | 9,054                                      |   |                |         | 16,245       |  |              |         | 3,364         |   |              |         |     |   |   |         | 28,663 | 
|                                            | Work-in-progress                     |                                      |        | 4,618                                      |   |                |         | 3,977        |  |              |         | 4,623         |   |              |         | (926 | ) |   |         | 12,292 | 
|                                            | Inventories                          |                                      |        | 4,675                                      |   |                |         | 14,083       |  |              |         | 718           |   |              |         |     |   |   |         | 19,476 | 
|                                            | Prepaid and other current assets     |                                      |        | 3,237                                      |   |                |         | 3,663        |  |              |         | 412           |   |              |         |     |   |   |         | 7,312  | 
|                                            |                                      |                                      |        |                                            |   |                |         |              |  |              |         |               |   |              |         |      |   |   |         |        | 
|                                            |                                      |                                      |        | Total current assets                       |   |                | 31,504  |              |  |              | 38,138  |               |   |              | 9,732   |      |   |   | (926    | )      |  |   | 78,448  | 
|Investments in and advances to subsidiaries |                                      |                                      | 66,061 |                                            |   |                | (46,202 | )            |  |              |        |               |   |              | (19,859 | )    |   |   |        |       
|Property and equipment, net                 |                                      |                                      | 41,919 |                                            |   |                | 8,688   |              |  |              | 3,997   |               |   |              |        |      |   |   | 54,604  |       
|Goodwill, net                               |                                      |                                      | 725    |                                            |   |                | 200,644 |              |  |              | 9,809   |               |   |              |        |      |   |   | 211,178 |       
|Intangibles, net                            |                                      |                                      | 1,039  |                                            |   |                | 87,816  |              |  |              |        |               |   |              |        |      |   |   | 88,855  |       
|Other assets                                |                                      |                                      | 4,486  |                                            |   |                | 9,198   |              |  |              | 98      |               |   |              |        |      |   |   | 13,782  |       
|                                            |                                      |                                      |        |                                            |   |                |         |              |  |              |         |               |   |              |         |      |   |   |         |        | 
|                                            |                                      |                                      |        | Total assets                               |   | $              | 145,734 |              |  | $            | 298,282 |               |   | $            | 23,636  |      |   | $ | (20,785 | )      |  | $ | 446,867 | 
|                                            |                                      |                                      |        |                                            |   |                |         |              |  |              |         |               |   |              |         |      |   |   |         |       
|                                            |                                      | LIABILITIES AND STOCKHOLDERS EQUITY |        |                                            |   |                |         |              |  |              |         |               |   |              |         |      |   |   |         |        |  |  
|Current liabilities:                        |                                      |                                      |        |                                            |   |                |         |              |  |              |         |               |   |              |         |      |   |   |         |       
|                                            | Current maturities of long-term debt |                                      | $      |                                           |   |                | $       | 5,921        |  |              | $       |              |   |              | $       |     |   |   | $       | 5,921  | 
|                                            | Accounts payable                     |                                      |        | 4,181                                      |   |                |         | 12,226       |  |              |         | 1,522         |   |              |         |     |   |   |         | 17,929 | 
|                                            | Customer advances                    |                                      |        | 7,510                                      |   |                |         | 5,298        |  |              |         | 2,405         |   |              |         | (926 | ) |   |         | 14,287 | 
|                                            | Accrued wages and benefits           |                                      |        | 5,072                                      |   |                |         | 1,713        |  |              |         | 1,156         |   |              |         |     |   |   |         | 7,941  | 
|                                            | Interest payable                     |                                      |        | 281                                        |   |                |         | 9,659        |  |              |         |              |   |              |         |     |   |   |         | 9,940  | 
|                                            | Other accrued liabilities            |                                      |        | (1,098                                     | ) |                |         | 3,953        |  |              |         | (5            | ) |              |         | 434  |   |   |         | 3,284  | 
|                                            |                                      |                                      |        |                                            |   |                |         |              |  |              |         |               |   |              |         |      |   |   |         |        | 
|                                            |                                      |                                      |        | Total current liabilities                  |   |                | 15,946  |              |  |              | 38,770  |               |   |              | 5,078   |      |   |   | (492    | )      |  |   | 59,302  | 
|Long-term debt, less current portion        |                                      |                                      | 41,000 |                                            |   |                | 225,487 |              |  |              |        |               |   |              |        |      |   |   | 266,487 |       
|Other liabilities                           |                                      |                                      | 11,801 |                                            |   |                | 1,512   |              |  |              |        |               |   |              |        |      |   |   | 13,313  |       
|Investments in and advances to subsidiaries |                                      |                                      | 86,644 |                                            |   |                | (92,186 | )            |  |              | 5,439   |               |   |              | 103     |      |   |   |        |       
|Total stockholders equity                  |                                      |                                      | (9,657 | )                                          |   |                | 124,699 |              |  |              | 13,119  |               |   |              | (20,396 | )    |   |   | 107,765 |       
|                                            |                                      |                                      |        |                                            |   |                |         |              |  |              |         |               |   |              |         |      |   |   |         |       
|                                            |                                      |                                      |        | Total liabilities and stockholders equity |   | $              | 145,734 |              |  | $            | 298,282 |               |   | $            | 23,636  |      |   | $ | (20,785 | )      |  | $ | 446,867 | 
|                                            |                                      |                                      |        |                                            |   |                |         |              |  |              |         |               |   |              |         |      |   |   |         |       

18



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##### 



aaiPharma Inc.
CONSOLIDATED BALANCE SHEET
(In thousands)

|                                            |                                      |                                      |        |                                            |  |                   |         |              |  |              |         |               |   |              |         |        |   |   |         |        |  |   |         | 
|------------------------------------------- | ------------------------------------ | ------------------------------------ | ------ | ------------------------------------------ |  | ----------------- | ------- | ------------ |  | ------------ | ------- | ------------- | - | ------------ | ------- | ------ | - | - | ------- | ------ |  | - | ------- | 
|                                            |                                      |                                      |        |                                            |  | December 31, 2002
|                                            |                                      |                                      |        |                                            |  |                  
|                                            |                                      |                                      |        |                                            |  |                   |         |              |  | Guarantor    |         | Non-Guarantor |   |              |         |        |   |   |         |       
|                                            |                                      |                                      |        |                                            |  | Issuer            |         | Subsidiaries |  | Subsidiaries |         | Eliminations  |   | Consolidated
|                                            |                                      |                                      |        |                                            |  |                   |         |              |  |              |         |               |   |             
|                                            |                                      |                                      | ASSETS |                                            |  |                   |         |              |  |              |         |               |   |              |         |        |   |   |         |        |  |   |        
|Current assets:                             |                                      |                                      |        |                                            |  |                   |         |              |  |              |         |               |   |              |         |        |   |   |         |       
|                                            | Cash and cash equivalents            |                                      | $      | 5,725                                      |  |                   | $       | 180          |  |              | $       | 627           |   |              | $       |       |   |   | $       | 6,532  | 
|                                            | Accounts receivable, net             |                                      |        | 10,104                                     |  |                   |         | 16,758       |  |              |         | 2,605         |   |              |         |       |   |   |         | 29,467 | 
|                                            | Work-in-progress                     |                                      |        | 4,135                                      |  |                   |         | 2,951        |  |              |         | 4,568         |   |              |         | (1,139 | ) |   |         | 10,515 | 
|                                            | Inventories                          |                                      |        | 5,504                                      |  |                   |         | 11,114       |  |              |         | 697           |   |              |         | (311   | ) |   |         | 17,004 | 
|                                            | Prepaid and other current assets     |                                      |        | 3,782                                      |  |                   |         | 3,642        |  |              |         | 209           |   |              |         |       |   |   |         | 7,633  | 
|                                            |                                      |                                      |        |                                            |  |                   |         |              |  |              |         |               |   |              |         |        |   |   |         |       
|                                            |                                      |                                      |        | Total current assets                       |  |                   | 29,250  |              |  |              | 34,645  |               |   |              | 8,706   |        |   |   | (1,450  | )      |  |   | 71,151  | 
|Investments in and advances to subsidiaries |                                      |                                      | 66,061 |                                            |  |                   | (46,202 | )            |  |              |        |               |   |              | (19,859 | )      |   |   |        |       
|Property and equipment, net                 |                                      |                                      | 42,055 |                                            |  |                   | 7,070   |              |  |              | 4,000   |               |   |              |        |        |   |   | 53,125  |       
|Goodwill, net                               |                                      |                                      | 624    |                                            |  |                   | 200,644 |              |  |              | 9,524   |               |   |              |        |        |   |   | 210,792 |       
|Intangibles, net                            |                                      |                                      | 952    |                                            |  |                   | 88,126  |              |  |              |        |               |   |              |        |        |   |   | 89,078  |       
|Other assets                                |                                      |                                      | 4,514  |                                            |  |                   | 11,569  |              |  |              | 96      |               |   |              |        |        |   |   | 16,179  |       
|                                            |                                      |                                      |        |                                            |  |                   |         |              |  |              |         |               |   |              |         |        |   |   |         |        | 
|                                            |                                      |                                      |        | Total assets                               |  | $                 | 143,456 |              |  | $            | 295,852 |               |   | $            | 22,326  |        |   | $ | (21,309 | )      |  | $ | 440,325 | 
|                                            |                                      |                                      |        |                                            |  |                   |         |              |  |              |         |               |   |              |         |        |   |   |         |       
|                                            |                                      | LIABILITIES AND STOCKHOLDERS EQUITY |        |                                            |  |                   |         |              |  |              |         |               |   |              |         |        |   |   |         |        |  |  
|Current liabilities:                        |                                      |                                      |        |                                            |  |                   |         |              |  |              |         |               |   |              |         |        |   |   |         |       
|                                            | Current maturities of long-term debt |                                      | $      |                                           |  |                   | $       | 5,921        |  |              | $       |              |   |              | $       |       |   |   | $       | 5,921  | 
|                                            | Accounts payable                     |                                      |        | 4,410                                      |  |                   |         | 11,447       |  |              |         | 1,814         |   |              |         |       |   |   |         | 17,671 | 
|                                            | Customer advances                    |                                      |        | 7,840                                      |  |                   |         | 5,731        |  |              |         | 2,618         |   |              |         | (1,138 | ) |   |         | 15,051 | 
|                                            | Accrued wages and benefits           |                                      |        | 4,922                                      |  |                   |         | 929          |  |              |         | 867           |   |              |         |       |   |   |         | 6,718  | 
|                                            | Interest payable                     |                                      |        | 285                                        |  |                   |         | 4,947        |  |              |         |              |   |              |         |       |   |   |         | 5,232  | 
|                                            | Other accrued liabilities            |                                      |        | 1,244                                      |  |                   |         | 3,379        |  |              |         | (77           | ) |              |         | 655    |   |   |         | 5,201  | 
|                                            |                                      |                                      |        |                                            |  |                   |         |              |  |              |         |               |   |              |         |        |   |   |         |        | 
|                                            |                                      |                                      |        | Total current liabilities                  |  |                   | 18,701  |              |  |              | 32,354  |               |   |              | 5,222   |        |   |   | (483    | )      |  |   | 55,794  | 
|Long-term debt, less current portion        |                                      |                                      | 47,500 |                                            |  |                   | 230,399 |              |  |              |        |               |   |              |        |        |   |   | 277,899 |       
|Other liabilities                           |                                      |                                      | 7,182  |                                            |  |                   |        |              |  |              |        |               |   |              |        |        |   |   | 7,182   |       
|Investments in and advances to subsidiaries |                                      |                                      | 68,171 |                                            |  |                   | (72,500 | )            |  |              | 4,984   |               |   |              | (655    | )      |   |   |        |       
|Total stockholders equity                  |                                      |                                      | 1,902  |                                            |  |                   | 105,599 |              |  |              | 12,120  |               |   |              | (20,171 | )      |   |   | 99,450  |       
|                                            |                                      |                                      |        |                                            |  |                   |         |              |  |              |         |               |   |              |         |        |   |   |         |       
|                                            |                                      |                                      |        | Total liabilities and stockholders equity |  | $                 | 143,456 |              |  | $            | 295,852 |               |   | $            | 22,326  |        |   | $ | (21,309 | )      |  | $ | 440,325 | 
|                                            |                                      |                                      |        |                                            |  |                   |         |              |  |              |         |               |   |              |         |        |   |   |         |       

19



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##### 



aaiPharma Inc.
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)

|                                                     |                                                                                          |                                              |                                                          |        |                                   |       |              |        |              |         |              |      |              |      |   |         |   |        |        |        |       |        |  
|---------------------------------------------------- | ---------------------------------------------------------------------------------------- | -------------------------------------------- | -------------------------------------------------------- | ------ | --------------------------------- | ----- | ------------ | ------ | ------------ | ------- | ------------ | ---- | ------------ | ---- | - | ------- | - | ------ | ------ | ------ | ----- | ------ | -
|                                                     |                                                                                          |                                              |                                                          |        | Three Months Ended March 31, 2003
|                                                     |                                                                                          |                                              |                                                          |        |                                  
|                                                     |                                                                                          |                                              |                                                          |        |                                   |       |              |        |              |         |              |      | Non-         |      |   |         |   |        |        |        |      
|                                                     |                                                                                          |                                              |                                                          |        |                                   |       |              |        | Guarantor    |         | Guarantor    |      |              |      |   |         |   |        |       
|                                                     |                                                                                          |                                              |                                                          |        | Issuer                            |       | Subsidiaries |        | Subsidiaries |         | Eliminations |      | Consolidated
|                                                     |                                                                                          |                                              |                                                          |        |                                   |       |              |        |              |         |              |      |             
|Cash flows from operating activities:                |                                                                                          |                                              |                                                          |        |                                   |       |              |        |              |         |              |      |              |      |   |         |   |        |        |       
|                                                     | Net income (loss)                                                                        |                                              | $                                                        | 7,156  |                                   |       | $            | 18,728 |              |         | $            | 640  |              |      | $ | (19,368 | ) |        | $      | 7,156  |      
|                                                     | Adjustments to reconcile net income (loss)
to net cash provided by operating activities: |                                              |                                                          |        |                                   |       |              |        |              |         |              |      |              |      |   |         |   |        |        |        |      
|                                                     |                                                                                          | Depreciation and amortization                |                                                          |        | 1,241                             |       |              |        | 1,157        |         |              |      | 253          |      |   |         |  |        |        |        | 2,651 |       
|                                                     |                                                                                          | Other                                        |                                                          |        |                                  |       |              |        |             |         |              |      | 52           |      |   |         |  |        |        |        | 52    |       
|                                                     |                                                                                          | Changes in operating assets and liabilities: |                                                          |        |                                   |       |              |        |              |         |              |      |              |      |   |         |   |        |        |        |       |       
|                                                     |                                                                                          |                                              | Accounts receivable, net                                 |        |                                   | 1,050 |              |        |              | 514     |              |      |              | (682 | ) |         |   |       |        |        |       | 882    |  
|                                                     |                                                                                          |                                              | Work-in-progress                                         |        |                                   | (483  | )            |        |              | (1,026  | )            |      |              | 82   |   |         |   | (213   | )      |        |       | (1,640 | )
|                                                     |                                                                                          |                                              | Inventories                                              |        |                                   | 829   |              |        |              | (2,969  | )            |      |              |     |   |         |   | (311   | )      |        |       | (2,451 | )
|                                                     |                                                                                          |                                              | Prepaid and other assets                                 |        |                                   | 573   |              |        |              | 478     |              |      |              | (195 | ) |         |   |       |        |        |       | 856    |  
|                                                     |                                                                                          |                                              | Accounts payable                                         |        |                                   | (229  | )            |        |              | 779     |              |      |              | (346 | ) |         |   |       |        |        |       | 204    |  
|                                                     |                                                                                          |                                              | Customer advances                                        |        |                                   | (331  | )            |        |              | (433    | )            |      |              | (292 | ) |         |   | 213    |        |        |       | (843   | )
|                                                     |                                                                                          |                                              | Interest payable                                         |        |                                   | (4    | )            |        |              | 4,712   |              |      |              |     |   |         |   |       |        |        |       | 4,708  |  
|                                                     |                                                                                          |                                              | Accrued wages and benefits and other accrued liabilities |        |                                   | 2,428 |              |        |              | 1,356   |              |      |              | 190  |   |         |   | (222   | )      |        |       | 3,752  |  
|                                                     |                                                                                          |                                              | Intercompany receivables and payables                    |        |                                   | (670  | )            |        |              | (19,685 | )            |      |              | 454  |   |         |   | 19,901 |        |        |       |       |  
|                                                     |                                                                                          |                                              |                                                          |        |                                   |       |              |        |              |         |              |      |              |      |   |         |   |        |        |        |      
|Net cash provided by operating activities            |                                                                                          |                                              | 11,560                                                   |        |                                   |       | 3,611        |        |              |         | 156          |      |              |      |  |         |   |        | 15,327 |       
|                                                     |                                                                                          |                                              |                                                          |        |                                   |       |              |        |              |         |              |      |              |      |   |         |   |        |        |       
|Cash flows from investing activities:                |                                                                                          |                                              |                                                          |        |                                   |       |              |        |              |         |              |      |              |      |   |         |   |        |        |       
|                                                     | Purchases of property and equipment                                                      |                                              |                                                          | (1,061 | )                                 |       |              | (1,965 | )            |         |              | (186 | )            |      |   |        |   |        |        | (3,212 | )    
|                                                     | Acquisitions                                                                             |                                              |                                                          |       |                                   |       |              | (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 swap                                                         |                                              |                                                          |       |                                   |       |              | 435    |              |         |              |     |              |      |   |        |   |        |        | 435    |      
|                                                     | Issuance of common stock                                                                 |                                              |                                                          | 428    |                                   |       |              |       |              |         |              |     |              |      |   |        |   |        |        | 428    |      
|                                                     | Other                                                                                    |                                              |                                                          |       |                                   |       |              | 409    |              |         |              |     |              |      |   |        |   |        |        | 409    |      
|                                                     |                                                                                          |                                              |                                                          |        |                                   |       |              |        |              |         |              |      |              |      |   |         |   |        |        |        |      
|Net cash used in financing activities                |                                                                                          |                                              | (6,072                                                   | )      |                                   |       | (1,156       | )      |              |         |             |      |              |      |  |         |   |        | (7,228 | )     
|                                                     |                                                                                          |                                              |                                                          |        |                                   |       |              |        |              |         |              |      |              |      |   |         |   |        |        |       
|Net increase (decrease) in cash and cash equivalents |                                                                                          |                                              | 4,195                                                    |        |                                   |       | (10          | )      |              |         | (30          | )    |              |      |  |         |   |        | 4,155  |       
|Effect of exchange rate changes on cash              |                                                                                          |                                              |                                                         |        |                                   |       |             |        |              |         | 18           |      |              |      |  |         |   |        | 18     |       
|Cash and cash equivalents, beginning of period       |                                                                                          |                                              | 5,725                                                    |        |                                   |       | 180          |        |              |         | 627          |      |              |      |  |         |   |        | 6,532  |       
|                                                     |                                                                                          |                                              |                                                          |        |                                   |       |              |        |              |         |              |      |              |      |   |         |   |        |        |        |      
|Cash and cash equivalents, end of period             |                                                                                          | $                                            | 9,920                                                    |        |                                   | $     | 170          |        |              | $       | 615          |      |              | $    |  |         |   | $      | 10,705 |       
|                                                     |                                                                                          |                                              |                                                          |        |                                   |       |              |        |              |         |              |      |              |      |   |         |   |        |        |       

20



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##### 



aaiPharma Inc.
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)

|                                                     |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      |              |      |     |        |   |       |          |          |       |         |  
|---------------------------------------------------- | -------------------------------------------------------------------------------------------------- | ----------------------------------------------- | -------------------------------------------------------- | ------- | --------------------------------- | ------- | ------------ | -------- | ------------ | ------- | ------------ | ---- | ------------ | ---- | --- | ------ | - | ----- | -------- | -------- | ----- | ------- | -
|                                                     |                                                                                                    |                                                 |                                                          |         | Three Months Ended March 31, 2002
|                                                     |                                                                                                    |                                                 |                                                          |         |                                  
|                                                     |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      | Non-         |      |     |        |   |       |          |          |      
|                                                     |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          | Guarantor    |         | Guarantor    |      |              |      |     |        |   |       |         
|                                                     |                                                                                                    |                                                 |                                                          |         | Issuer                            |         | Subsidiaries |          | Subsidiaries |         | Eliminations |      | Consolidated
|                                                     |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      |             
|Cash flows from operating activities:                |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      |              |      |     |        |   |       |          |         
|                                                     | Net (loss) income                                                                                  |                                                 | $                                                        | (3,250  | )                                 |         | $            | 1,796    |              |         | $            | (39  | )            |      | $   | (1,757 | ) |       | $        | (3,250   | )    
|                                                     | Adjustments to reconcile net (loss) income
to net cash (used in) provided by operating activities: |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      |              |      |     |        |   |       |          |          |      
|                                                     |                                                                                                    | Depreciation and amortization                   |                                                          |         | 1,047                             |         |              |          | 519          |         |              |      | 235          |      |     |        |  |       |          |          | 1,801 |        
|                                                     |                                                                                                    | Write-off of deferred financing and other costs |                                                          |         |                                  |         |              |          | 5,339        |         |              |      |             |      |     |        |  |       |          |          | 5,339 |        
|                                                     |                                                                                                    | Other                                           |                                                          |         | 2                                 |         |              |          | 11           |         |              |      | 65           |      |     |        |  |       |          |          | 78    |        
|                                                     |                                                                                                    | Changes 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     |              |      |              |     |     |        |   |      |          |          |       | 1,082   |  
|                                                     |                                                                                                    |                                                 | Prepaid 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 |         |                                   | (2,530  | )            |          |              | 4,033   |              |      |              | 111  |     |        |   | (107  | )        |          |       | 1,507   |  
|                                                     |                                                                                                    |                                                 | Intercompany receivables and payables                    |         |                                   | (26,738 | )            |          |              | 25,347  |              |      |              | (459 | )   |        |   | 1,850 |          |          |       |        |  
|                                                     |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      |              |      |     |        |   |       |          |          |      
|Net cash (used in) provided by operating activities  |                                                                                                    |                                                 | (32,903                                                  | )       |                                   |         | 16,264       |          |              |         | (97          | )    |              |      | (14 | )      |   |       | (16,750  | )       
|                                                     |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      |              |      |     |        |   |       |          |         
|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                                                                                       |                                                 |                                                          |        |                                   |         |              | (211,772 | )            |         |              |     |              |      |     |       |   |       |          | (211,772 | )    
|                                                     | Other                                                                                              |                                                 |                                                          | 2       |                                   |         |              |         |              |         |              |     |              |      |     |       |   |       |          | 2        |      
|                                                     |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      |              |      |     |        |   |       |          |          |      
|Net 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    |              |         |              |     |              |      |     |       |   |       |          | 5,000    |      
|                                                     | Proceeds from long-term borrowings                                                                 |                                                 |                                                          | 49,400  |                                   |         |              | 190,874  |              |         |              |     |              |      |     |       |   |       |          | 240,274  |      
|                                                     | Payments on long-term borrowings                                                                   |                                                 |                                                          |        |                                   |         |              | (14      | )            |         |              |     |              |      |     | 14     |   |       |          |         |      
|                                                     | Issuance of common stock                                                                           |                                                 |                                                          | 1,980   |                                   |         |              |         |              |         |              |     |              |      |     |       |   |       |          | 1,980    |      
|                                                     | Other                                                                                              |                                                 |                                                          | (2,855  | )                                 |         |              | (14      | )            |         |              | 24   |              |      |     |       |   |       |          | (2,845   | )    
|                                                     |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      |              |      |     |        |   |       |          |          |      
|Net cash provided by financing activities            |                                                                                                    |                                                 | 48,525                                                   |         |                                   |         | 195,846      |          |              |         | 24           |      |              |      | 14  |        |   |       | 244,409  |         
|                                                     |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      |              |      |     |        |   |       |          |         
|Net increase (decrease) in cash and cash equivalents |                                                                                                    |                                                 | 681                                                      |         |                                   |         | (7           | )        |              |         | (479         | )    |              |      |    |        |   |       | 195      |         
|Effect of exchange rate changes on cash              |                                                                                                    |                                                 |                                                         |         |                                   |         |             |          |              |         | (15          | )    |              |      |    |        |   |       | (15      | )       
|Cash and cash equivalents, beginning of period       |                                                                                                    |                                                 | 5,301                                                    |         |                                   |         | 154          |          |              |         | 916          |      |              |      |    |        |   |       | 6,371    |         
|                                                     |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      |              |      |     |        |   |       |          |          |      
|Cash and cash equivalents, end of period             |                                                                                                    | $                                               | 5,982                                                    |         |                                   | $       | 147          |          |              | $       | 422          |      |              | $    |    |        |   | $     | 6,551    |         
|                                                     |                                                                                                    |                                                 |                                                          |         |                                   |         |              |          |              |         |              |      |              |      |     |        |   |       |          |         

21



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Item 2. Managements Discussion and Analysis of Financial Condition and 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, 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
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,
which have been previously disclosed in our Annual Report on Form 10-K for the
year ended December 31, 2002. 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.

Results of Operations:

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        |   | $                            | 40,008 |      |  |     | 62 | % |   | $      | 20,177 |  |  |     | 44 | %
|                                      | Product development  |   |                              | 3,810  |      |  |     | 6  |   |   |        | 2,135  |  |  |     | 5  |  
|                                      | Development services |   |                              | 20,212 |      |  |     | 32 |   |   |        | 23,308 |  |  |     | 51 |  
|                                      |                      |   |                              |        |      |  |     |    |   |   |        |        |  |  |     |   
|                                      |                      | $ | 64,030                       |        |      |  | 100 | %  |   | $ | 45,620 |        |  |  | 100 | % 
|                                      |                      |   |                              |        |      |  |     |    |   |   |        |        |  |  |     |   
|Direct costs (excluding depreciation) |                      | $ | 21,955                       |        |      |  | 34  | %  |   | $ | 21,350 |        |  |  | 47  | % 
|Selling                               |                      |   | 7,734                        |        |      |  | 12  |    |   |   | 4,274  |        |  |  | 9   |   
|General and administrative            |                      |   | 10,029                       |        |      |  | 16  |    |   |   | 8,758  |        |  |  | 19  |   
|Depreciation and amortization         |                      |   | 2,651                        |        |      |  | 4   |    |   |   | 1,801  |        |  |  | 4   |   
|Research and development              |                      |   | 4,486                        |        |      |  | 7   |    |   |   | 4,378  |        |  |  | 10  |   
|Income from operations                |                      |   | 17,175                       |        |      |  | 27  |    |   |   | 5,059  |        |  |  | 11  |   
|Interest expense, net                 |                      |   | 5,550                        |        |      |  | 9   |    |   |   | 1,823  |        |  |  | 4   |   
|Loss from extinguishment of debt      |                      |   |                             |        |      |  |    |    |   |   | (8,053 | )      |  |  | (17 | ) 
|Provision for income taxes            |                      |   | 4,386                        |        |      |  | 7   |    |   |   | 1,433  |        |  |  | 3   |   
|Net income (loss)                     |                      |   | 7,156                        |        |      |  | 11  |    |   |   | (3,250 | )      |  |  | (7  | ) 

22



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##### 



First Quarter 2003 Compared to First Quarter 2002

Our consolidated net revenues for the quarter ended March 31, 2003 increased
40% to $64.0 million, from $45.6 million in the first quarter of 2002. Net
revenues from product sales increased to $40.0 million in 2003, from $20.2
million in 2002, due to sales of Darvon and Darvocet-N, which we acquired at
the end of the first quarter of 2002, and sales of our recently approved Azasan
75 milligram and 100 milligram, and calcitriol injection products, which were
introduced in the first quarter of 2003. 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.

Net revenues from product development increased 78% in the first quarter of
2003 to $3.8 million, or 6% of net revenues, from $2.1 million, or 5% of net
revenues, in 2002, primarily due to product development revenues 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 Annual Report
on Form 10-K for the fiscal year ended December 31, 2002. We expect product
development revenues under this agreement to be in the range of $12 million to
$14 million in 2003.

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.

Gross margin dollars, or net revenues less direct costs (excluding
depreciation), increased $17.8 million, or 73%, to $42.1 million in the first
quarter of 2003, from $24.3 million in the first quarter of 2002, reflecting
the benefit from our increased product sales revenues in 2003 over the prior
year. As a percentage of net revenues, gross margin dollars increased to 66%
in the first quarter of 2003 from 53% in the first quarter of 2002. The higher
gross margin dollars generated by our product sales business were partially
offset by decreases in external revenues and gross margin dollars from our
development services business.

Selling expenses increased 81% in the first quarter of 2003 to $7.7 million, or
12% 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. We anticipate our pharmaceutical sales force to increase
to approximately 150 by the end of 2003.

General and administrative costs increased 15% in the first quarter of 2003 to
$10.0 million, or 16% 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 7% 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

23



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##### 



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. We target annual research and
development expenses to be approximately 8% to 10% of our estimated net
revenues.

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 is primarily
attributable to the borrowings that funded our product line acquisitions in the
first quarter of 2002.

Consolidated income from operations was $17.2 million in the first quarter of
2003, or $12.1 million higher than the prior year. This increase is primarily
due to the expansion of our product sales business and our increased product
development revenues, partially offset by our increased selling, general and
administrative spending to support our product sales business and decreases in
revenues and margins in our development services business.

Income from operations for our product sales business was $22.9 million in the
first quarter of 2003, compared to $9.0 million in the first quarter of 2002.
This increase is attributable to the revenues from our Darvon and Darvocet-N
product lines, which we acquired at the end of the first quarter of 2002 and
the introduction of our Azasan line extensions and calcitriol injection in the
first quarter of 2003.

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
gross margin, 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 8%, from 7% 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.

We recorded a tax provision of $4.4 million in the first quarter of 2003, based
on an effective tax rate of 38%. This rate is approximately equal to the
statutory rate. Our effective tax rate for the first quarter of 2002 was also
38%.

24



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##### 



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 to cash flow used in
operations of $16.8 million in the first quarter of 2002. This change was
primarily due to an increase in net income and 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 facilities 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-N
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-N
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
$175 million of senior credit facilities, 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.

Our $175 million senior secured credit facilities consist of a $75 million
five-year revolving credit facility and a $100 million five-year term loan
facility. The term loan facility amortizes over the full five-year term. The
senior facilities were subsequently reduced to $123 million due to the $52
million of 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 facilities provide for variable interest rates based
on LIBOR or an alternate base rate, at our option. Such facilities are
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 facilities require the payment of certain
commitment fees based on the unused portion of the revolving credit facility.
Under the terms of the credit agreement for our senior credit facilities, we
are required to comply with various covenants including, but not limited to,
those pertaining to maintenance of certain financial ratios and incurrence of
additional indebtedness. We were in compliance with these covenants at March
31, 2003. These senior credit facilities may be prepaid at our option at any
time without a premium.

On March 28, 2002, we issued $175 million of senior subordinated unsecured
notes due 2010. These notes have 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. Prior to March 28, 2005, up to 35% of the notes
are redeemable with the

25



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##### 



proceeds of qualified sales of equity at 111% of par value. The terms of our
senior credit facilities require us to repay all of the indebtedness under
these facilities before we could repurchase any of the notes. 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.
We were in compliance with these covenants at March 31, 2003.

Concurrent with the issuance of our senior subordinated notes, we entered into
an interest rate swap 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 swap agreement for
$2.3 million. The amount we received, less the interest benefit of $1.5
million 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 swap
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 swap
agreements, other than the base rate, were identical and were perfectly matched
with the terms of the related hedged instrument. Our annual net interest
expense may exceed $21 million in 2003.

Our M.V.I. and Aquasol product line acquisition agreement provided for a $1.0
million guaranteed payment in August 2003, and future contingent payments of
$2.0 million and $43.5 million potentially due in August 2003 and August 2004,
respectively, depending on the status of certain reformulation activities being
carried out by the seller. As previously discussed in our Annual Report on
Form 10-K for the year ended December 31, 2002, the conditions for the
contingent payments were not met by the required date, so that the $2.0 million
amount is no longer a contingent obligation of ours and the potential $43.5
million contingent payment is decreasing by $1.0 million for each full month
that the conditions continue to be unmet. Such conditions have not been met as
of March 31, 2003, and if such conditions are not satisfied by December 31,
2003, the remaining contingent payment obligation to the seller will decrease
to zero. 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. These contingent payment obligations, including the
contingent payments potentially due in connection with the acquisition of the
M.V.I. and Aquasol product lines, have not yet been recorded as a liability on
our consolidated balance sheet. We have $5.9 million of principal repayments
due in the next twelve months under our senior credit facilities. We made an
interest payment on the senior subordinated notes of $9.6 million in April 2003
and a similar interest payment is due in October 2003. The April interest
payment was reduced by approximately $0.3 million received under our interest
rate swap agreement. At current estimated LIBOR rates, we anticipate that the
October 2003 interest payment will be offset by approximately $1.9 million to
be received under our interest rate swap 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

26



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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.

We believe that our senior credit facilities and cash flow provided by
operations will be sufficient to fund near-term growth and fund our existing
contractual payment obligations and our contingent payment obligations arising
from our acquisitions. We may require additional financing to pursue other
acquisition opportunities or for other reasons. We may from time to time seek
to obtain additional funds through the public or private issuance of equity or
debt securities. While we remain confident that we can obtain additional
financing, if necessary, we cannot assure you that additional financing will be
available or that the terms will be acceptable to us.

Forward Looking Statements, Risk Factors and Safe Harbor Language

This report contains certain forward-looking statements, within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. All statements that include the
words may, will, estimate, intend, project, target, objective,
goal, should, could, might, continue, believe, expect, plan,
anticipate and other similar words are intended to be forward-looking
statements. We assume no obligation to update forward-looking statements, or
any other statements, contained in this report.

For purposes of illustration, these forward-looking statements include
statements relating to the amount, timing, and use of proceeds of future
issuance of equity; the sufficiency of our senior credit facilities and cash
flow from operations to fund near-term growth and to fund existing contractual
and contingent acquisition payment obligations; amounts we will receive under
our interest rate swap arrangements; the availability of future financing, if
necessary; the expected amounts owed under future contingent acquisition
payment obligations; our R&D activities, funding and trends and the expected
use of our fee-for-service resources in support thereof; anticipated product
development and development services net revenues and profitability levels and
trends; expected levels of future net interest expenses; targeted research and
development expenditures as a percentage of net revenues; anticipated levels of
sales and general and administrative costs as a percentage of net revenues;
and expected net revenues, expenses and profitability of our product sales.

Although we believe that the expectations underlying any of our forward-looking
statements are reasonable, these expectations may prove to be incorrect and all
of these statements are subject to risks and uncertainties. Should one or more
of these risks and uncertainties materialize, or should underlying assumptions,
projections or expectations prove incorrect, actual results, performance or
financial condition may vary materially and adversely from those anticipated,
estimated or expected. We have identified below some important factors that
could cause our forward-looking statements to differ materially from actual
results, performance or financial condition:



| |  |  | We have transitioned our company to a specialty pharmaceutical company
with different challenges and risks;                                                                    
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We may devote significant operational and financial resources to develop
products that we may never be able to successfully commercialize;                                     
|
| |  |  | We have increased our sales and net income through a series of
acquisitions of branded products, and we intend to seek more acquisition
opportunities; we may have overpaid, or

27



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##### 





| |   |  | may overpay in the future, for a branded product line that may not produce
sufficient cash flow to repay our debt, including indebtedness incurred in
connection with that acquisition;                                                                  
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We are dependent on third parties for essential business
functions and problems with these third-party
arrangements could materially adversely affect our
ability to manufacture and sell products and our
financial condition and results of operations;
|
| |  |  | Competition from the sale of generic products and the
development by other companies of new branded products
could cause the revenues from our branded products to
decrease significantly;                                                               
|
| |  |  | We may be unable to obtain government approval for our
products or comply with government regulations relating
to our business; and                                                                                                                      
|
| |  |  | Changes in government regulations may favor sales of
generic products that compete with our branded products.                                                                                                                                            

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,
Exhibit 99.1 to our Annual Report on Form 10-K filed with the SEC on March 28,
2003, including the exhibits attached or incorporated therein, our Form 8-K
reports, 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. We do not undertake any obligation
to release publicly any revisions to these forward-looking statements to
reflect events or circumstances after the date of this document or to reflect
the occurrence of unanticipated events.

Item 4. Controls and Procedures

(a)  Evaluation of Disclosure Controls and Procedures  aaiPharma Inc.s
Executive Chairman, Chief Executive Officer and Chief Financial Officer have
evaluated the Companys disclosure controls and procedures as of March 31,
2003, and they concluded that these controls and procedures are effective.

(b)  Changes in Internal Controls  There were no significant changes in
internal controls or in other factors that could significantly affect these
controls subsequent to March 31, 2003.

PART II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

Exhibits:

A list of the exhibits required to be filed as part of this 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------

28



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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: |  | October 16, 2003 |  | By: /s/ PHILIP S. TABBINERPhilip S. Tabbiner, D.B.A.
President and
Chief Executive Officer             
|     
|      |  |                  |  |                                                                                                        
|     
|Date: |  | October 16, 2003 |  | By: /s/ WILLIAM L. GINNA, JR.William L. Ginna, Jr.
Executive Vice President and
Chief Financial Officer

29



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##### 



I, Frederick D. Sancilio, certify that:

1.     I have reviewed this Amendment No.1 on Form 10-Q/A of aaiPharma Inc.;

2.     Based on my knowledge, this Amendment No. 1 on Form 10-Q/A of aaiPharma
Inc. does not contain any untrue statement of a material fact or omit to state
a material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading with
respect to the period covered by this quarterly report;

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

4.     The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



| | a) |  | designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this quarterly report (the Evaluation
Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;                                                                                                                        

5.     The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):



| | a) |  | all significant deficiencies in the design or operation
of internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data
and have identified for the registrants auditors any material
weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrants internal controls; and                                                                                                                                        

6.     The registrants other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.

|                 |  |                                                              |  |                                                                       
|---------------- |  | ------------------------------------------------------------ |  | ----------------------------------------------------------------------
|October 16, 2003 |  | /s/ Frederick D. Sancilio, Ph.D.Frederick D. Sancilio, Ph.D. |  | Executive Chairman of the Board,
Chief Scientific Officer and Director

30



---



##### 



I, Philip S. Tabbiner, certify that:

1.     I have reviewed this Amendment No. 1 on Form 10-Q/A of aaiPharma Inc.;

2.     Based on my knowledge, this Amendment No. 1 on Form 10-Q/A of aaiPharma
Inc. does not contain any untrue statement of a material fact or omit to state
a material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading with
respect to the period covered by this quarterly report;

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

4.     The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



| | a) |  | designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this quarterly report (the Evaluation
Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;                                                                                                                        

5.     The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):



| | a) |  | all significant deficiencies in the design or operation
of internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data
and have identified for the registrants auditors any material
weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrants internal controls; and                                                                                                                                        

6.     The registrants other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.

|                 |  |                                                           |  |                                                                              
|---------------- |  | --------------------------------------------------------- |  | -----------------------------------------------------------------------------
|October 16, 2003 |  | /s/ Phillip S. Tabbiner, D.B.A.Philip S. Tabbiner, D.B.A. |  | President, Chief Executive Officer and
Director (Principal Executive Officer)

31



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##### 



I, William L. Ginna, Jr. certify that:

1.     I have reviewed this Amendment No. 1 on Form 10-Q/A of aaiPharma Inc.;

2.     Based on my knowledge, this Amendment No. 1 on Form 10-Q/A of aaiPharma
Inc. does not contain any untrue statement of a material fact or omit to state
a material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading with
respect to the period covered by this quarterly report;

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

4.     The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



| | a) |  | designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this quarterly report (the Evaluation
Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;                                                                                                                        

5.     The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):



| | a) |  | all significant deficiencies in the design or operation
of internal controls which could adversely affect the registrants
ability to record, process, summarize and report financial data
and have identified for the registrants auditors any material
weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrants internal controls; and                                                                                                                                        

6.     The registrants other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.

|                 |  |                                                |  |                                                     
|---------------- |  | ---------------------------------------------- |  | ----------------------------------------------------
|October 16, 2003 |  | /s/ William L. Ginna, Jr.William L. Ginna, Jr. |  | Executive Vice President and Chief
Financial Officer

32



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##### 



aaiPharma Inc.
Exhibit Index

|        |  |                                                                                                                                                                                                                                                                                                                                                             
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                                                                                                                                                                                                             
|No.     |  | Description                                                                                                                                                                                                                                                                                                                                                 
|        |  |                                                                                                                                                                                                                                                                                                                                                             
|3.1     |  | Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Companys Quarterly
Report on Form 10-Q for the quarter ended September 30, 1996)                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                             
|3.2     |  | Amendment to Certificate of Incorporation dated May 24, 2000
(incorporated by reference to Exhibit 3.2 to the Companys Quarterly
Report on Form 10-Q for the quarter ended June 30, 2000)                                                                                                                                                                  
|        |  |                                                                                                                                                                                                                                                                                                                                                             
|3.3     |  | Amended By-laws of the Company (incorporated by reference to Exhibit 3.3
to the Companys Quarterly Report on Form 10-Q for the quarter ended June
30, 2000)                                                                                                                                                                                                
|        |  |                                                                                                                                                                                                                                                                                                                                                             
|4.1     |  | Articles Fourth, Seventh, Eleventh and Twelfth of the form of Amended and
Restated Certificate of Incorporation of the Company (included in Exhibit
3.1)                                                                                                                                                                                                    
|        |  |                                                                                                                                                                                                                                                                                                                                                             
|4.2     |  | Article II of the form of Restated By-laws of the Company (included in
Exhibit 3.2)                                                                                                                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                             
|4.3     |  | Specimen Certificate for shares of Common Stock, $.001 par value, of the
Company (incorporated by reference to Exhibit 4.3 to the Companys
Registration Statement on Form S-1 (Registration No. 333-5535))                                                                                                                                                 
|        |  |                                                                                                                                                                                                                                                                                                                                                             
|99.1    |  | Certification Pursuant to 18 U.S.C. Section 1350, signed by Frederick D.
Sancilio, Ph.D., Executive Chairman of the Board, Chief Scientific Officer and
Director, Philip S. Tabbiner, D.B.A., President, Chief Executive Officer and
Director (Principal Executive Officer), and William L. Ginna, Jr., Executive
Vice President and Chief Financial Officer

33