##### 



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
  o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
 Commission File Number 0-21185 AAIPHARMA INC.  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 o NO x Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes x No o The number of shares of the Registrants common stock outstanding, as of June
30, 2003 was 27,698,099 shares. 1




---



##### 



Explanatory Note: This Amendment No. 1 to aaiPharma Inc.s Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2003 includes unaudited restated consolidated
financial statements for the three and six months ended June 30, 2003 and 2002
and an audited restated consolidated balance sheet at December 31, 2002. The
accompanying restated consolidated financial statements and supplementary data,
including the notes to the accompanying restated consolidated financial
statements, have been revised to reflect the restatement occurring subsequent
to the filing of the original Quarterly Report on Form 10-Q for the period
ended June 30, 2003. The restatement impacts the first three quarters of 2003
and each quarter of 2002. The restated amounts for the first and third quarters
of 2003 and 2002 are presented in the Companys Quarterly Reports on Form
10-Q/A for the quarterly periods ended March 31, 2003 and September 30, 2003. This restatement:  
    
    corrects the recognition of revenue for certain
transactions in the first half of 2003 that did not satisfy all of
the conditions for revenue recognition contained in SFAS 48 and/or
SAB 101,
    
    increases reserves for product returns and makes other
adjustments to our revenue reserves in the first half of 2003, and
    
    with respect to 2002 and 2003, changes the accounting for
our major product line acquisitions which had been accounted for
as business combinations to treat such acquisitions as
acquisitions of assets that do not constitute a business. The restatement adjustments decreased our net revenues and diluted earnings per
share for the three and six months ended June 30, 2003 by approximately $4.7
million and $19.7 million or $0.16 per share and $0.49 per share, respectively.
The restatement adjustments decreased our diluted earnings per share for the
three and six months ended June 30, 2002 by approximately $0.04 and $0.05 per
share, respectively. For further discussion, see our Annual Report on Form
10-K for the year ended December 31, 2003 (the 2003 Form 10-K), Item 7, which
discloses the nature of the restatement adjustments and shows the impact of the
restatement adjustments. This Quarterly Report on Form 10-Q/A amends and restates Items 1, 2 and 4 of
Part I and Items 3 and 6 of Part II of the original Quarterly Report on Form
10-Q, and no other information included in the original Quarterly Report on
Form 10-Q is amended hereby. For a discussion of events and developments subsequent to June 30, 2003 through
the filing on June 15, 2004 of our 2003 Form 10-K, see our 2003 Form 10-K. This
Amendment No. 1 to our Quarterly Report on Form 10-Q for the quarterly period
ended June 30, 2003 has not been updated to reflect any events or developments
occurring subsequent to June 15, 2004. In accordance with Rule 12b-15 under
the Securities Exchange Act of 1934, this amendment includes only those items
of the Quarterly Report on Form 10-Q affected by our restatement. The terms we, us or our in this Quarterly Report on Form 10-Q/A 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. 2




---



##### 



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. On June 30, 2003 we
owned the following registered and unregistered trademarks referenced
herein:
Darvon®, Darvon-N®, Darvocet-N®, M.V.I.®,
M.V.I.-12®, M.V.I. Pediatric®, M.V.I. Adult, Aquasol®,
Aquasol A®, Aquasol E®, Brethine®, ProSorb-D, AzaSanTM,
aaiPharma®, and AAI®. Unless the context otherwise
requires, references in this
document to Darvon are to Darvon® and Darvon-N® collectively and references to
Darvocet are to Darvocet-N®. Unless the context otherwise
requires, references in this document to
M.V.I. are to M.V.I.-12®, M.V.I. Pediatric®, and M.V.I.
Adult, collectively, and references
in this document to Aquasol are to Aquasol A® and
Aquasol E®, collectively. All references in this document to any of these
terms lacking the ® or TM symbols are defined terms that reference the
products, technologies or businesses bearing the trademarks with these symbols. aaiPharma Inc. 
  Page No.PART I. FINANCIAL INFORMATIONItem 1. Financial Statements(unaudited)Restated Consolidated Statements of Operations
    
    
    4Restated Consolidated Balance Sheets
    
    
    5Restated Consolidated Statements of Cash Flows
    
    
    6Restated Consolidated Statements of Comprehensive Income
    
    
    7Notes to Restated Consolidated Financial Statements
    
    
    8Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    26Item 4. Controls and Procedures
    
    
    37PART II. OTHER INFORMATIONItem 3. Defaults Upon Senior Securities
    
    
    38Item 6. Exhibits and Reports on Form 8-K
    
    
    39SIGNATURES
    
    
    40EXHIBIT INDEX
    
    
    41
 3




---



##### 



PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements. The restated consolidated financial statements and supplementary data,
including the notes to the restated financial statements, set forth in this
Item 1, have been revised to reflect the restatement occurring subsequent to
the filing of the original Quarterly Report on Form 10-Q. aaiPharma Inc. 
 RESTATED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)

(Unaudited)
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2002
    
    2003
    
    2002Net revenues:Product sales
    
    $
    41,097
    
    
    $
    34,673
    
    
    $
    66,062
    
    
    $
    54,850Product development (royalties and fees)
    
    
    3,897
    
    
    
    6,469
    
    
    
    7,707
    
    
    
    8,604Development services
    
    
    21,102
    
    
    
    20,305
    
    
    
    41,314
    
    
    
    43,61366,096
    
    
    
    61,447
    
    
    
    115,083
    
    
    
    107,067Operating costs and expenses:Direct costs (excluding depreciation):Product sales (includes product
rights amortization of $2,969,
$2,968, $5,937 and $3,301)
    
    
    15,987
    
    
    
    11,303
    
    
    
    27,257
    
    
    
    19,441Development services
    
    
    12,377
    
    
    
    12,756
    
    
    
    24,381
    
    
    
    26,301Total direct costs
    
    
    28,364
    
    
    
    24,059
    
    
    
    51,638
    
    
    
    45,742Selling expenses
    
    
    8,201
    
    
    
    5,710
    
    
    
    15,935
    
    
    
    9,984General and administrative expenses
    
    
    11,289
    
    
    
    10,161
    
    
    
    21,319
    
    
    
    18,916Research and development
    
    
    5,588
    
    
    
    5,486
    
    
    
    10,074
    
    
    
    9,864Depreciation
    
    
    1,947
    
    
    
    1,908
    
    
    
    3,835
    
    
    
    3,585Royalty expense
    
    
    127
    
    
    
    
    
    
    
    127
    
    
    
    Total operating costs and expenses
    
    
    55,516
    
    
    
    47,324
    
    
    
    102,928
    
    
    
    88,091Income from operations
    
    
    10,580
    
    
    
    14,123
    
    
    
    12,155
    
    
    
    18,976Other income (expense):Interest, net
    
    
    (4,931
    )
    
    
    (6,553
    )
    
    
    (10,481
    )
    
    
    (8,376
    )Loss from extinguishment of debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,053
    )Other income (expense), net
    
    
    226
    
    
    
    69
    
    
    
    143
    
    
    
    203(4,705
    )
    
    
    (6,484
    )
    
    
    (10,338
    )
    
    
    (16,226
    )Income before income taxes
    
    
    5,875
    
    
    
    7,639
    
    
    
    1,817
    
    
    
    2,750Provision for income taxes
    
    
    2,383
    
    
    
    2,890
    
    
    
    793
    
    
    
    1,377Net income
    
    $
    3,492
    
    
    $
    4,749
    
    
    $
    1,024
    
    
    $
    1,373Basic earnings per share
    
    $
    0.13
    
    
    $
    0.17
    
    
    $
    0.04
    
    
    $
    0.05Weighted average shares outstanding
    
    
    27,621
    
    
    
    27,365
    
    
    
    27,590
    
    
    
    27,236Diluted earnings per share
    
    $
    0.12
    
    
    $
    0.17
    
    
    $
    0.04
    
    
    $
    0.05Weighted average shares outstanding
    
    
    28,682
    
    
    
    28,565
    
    
    
    28,643
    
    
    
    28,580
 The accompanying notes are an integral part of these financial statements. 4




---



##### 



aaiPharma Inc. 
 RESTATED CONSOLIDATED BALANCE SHEETS
(In thousands)
 June 30,
    
    December 31,2003
    
    2002(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    8,132
    
    
    $
    6,532Accounts receivable, net
    
    
    31,469
    
    
    
    29,467Work-in-progress
    
    
    12,249
    
    
    
    10,515Inventories, net
    
    
    16,974
    
    
    
    17,004Deferred tax assets
    
    
    1,271
    
    
    
    1,271Prepaid and other current assets
    
    
    6,342
    
    
    
    6,362Total current assets
    
    
    76,437
    
    
    
    71,151Property and equipment, net
    
    
    55,968
    
    
    
    53,125Goodwill, net
    
    
    12,345
    
    
    
    11,378Intangible assets, net
    
    
    276,348
    
    
    
    281,669Other assets
    
    
    13,318
    
    
    
    16,179Total assets
    
    $
    434,416
    
    
    $
    433,502LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current maturities of long-term debt
    
    $
    6,553
    
    
    $
    5,921Accounts payable
    
    
    17,229
    
    
    
    17,671Customer advances
    
    
    18,726
    
    
    
    15,051Accrued wages and benefits
    
    
    7,263
    
    
    
    6,718Interest payable
    
    
    5,026
    
    
    
    5,232Deferred product revenue
    
    
    11,729
    
    
    
    Other accrued liabilities
    
    
    4,629
    
    
    
    5,201Total current liabilities
    
    
    71,155
    
    
    
    55,794Long-term debt, less current portion
    
    
    259,271
    
    
    
    277,899Deferred tax liability
    
    
    2,316
    
    
    
    3,840Other liabilities
    
    
    2,281
    
    
    
    715Stockholders equity:Common stock
    
    
    28
    
    
    
    27Paid-in capital
    
    
    80,140
    
    
    
    79,049Retained earnings
    
    
    17,420
    
    
    
    16,396Accumulated other comprehensive income (loss)
    
    
    1,805
    
    
    
    (218
    )Total stockholders equity
    
    
    99,393
    
    
    
    95,254Total liabilities and stockholders equity
    
    $
    434,416
    
    
    $
    433,502
 The accompanying notes are an integral part of these financial statements. 5




---



##### 



aaiPharma Inc. 
 RESTATED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 Six Months Ended June 30,2003
    
    2002Cash flows from operating activities:Net income
    
    $
    1,024
    
    
    $
    1,373Adjustments to reconcile net income to
net cash provided by (used in) operating activities:Depreciation and amortization
    
    
    9,772
    
    
    
    6,886Write-off of deferred financing and other costs
    
    
    
    
    
    
    8,053Other
    
    
    (78
    )
    
    
    117Changes in operating assets and liabilities:Accounts receivable, net
    
    
    (1,766
    )
    
    
    (13,427
    )Work-in-progress
    
    
    (1,319
    )
    
    
    (761
    )Inventories, net
    
    
    94
    
    
    
    (275
    )Prepaid and other assets
    
    
    1,038
    
    
    
    (12,970
    )Accounts payable
    
    
    (607
    )
    
    
    (32
    )Customer advances
    
    
    3,437
    
    
    
    3,413Interest payable
    
    
    (206
    )
    
    
    6,245Deferred product revenue
    
    
    11,729
    
    
    
    Accrued wages and benefits and other accrued liabilities
    
    
    (2,385
    )
    
    
    (893
    )Net cash provided by (used in) operating activities
    
    
    20,733
    
    
    
    (2,271
    )Cash flows from investing activities:Purchases of property and equipment
    
    
    (6,482
    )
    
    
    (4,402
    )Purchase of property and equipment previously leased
    
    
    
    
    
    
    (14,145
    )Proceeds from sales of property and equipment
    
    
    389
    
    
    
    Acquisitions of product rights and other intangibles
    
    
    (600
    )
    
    
    (211,997
    )Other
    
    
    (287
    )
    
    
    (153
    )Net cash used in investing activities
    
    
    (6,980
    )
    
    
    (230,697
    )Cash flows from financing activities:Proceeds from long-term borrowings
    
    
    
    
    
    
    245,328Payments on long-term borrowings
    
    
    (17,000
    )
    
    
    (18,400
    )Proceeds from interest rate swaps, net
    
    
    2,678
    
    
    
    3,426Proceeds from stock option exercises
    
    
    1,091
    
    
    
    3,031Other
    
    
    1,018
    
    
    
    (2,685
    )Net cash (used in) provided by financing activities
    
    
    (12,213
    )
    
    
    230,700Net increase (decrease) in cash and cash equivalents
    
    
    1,540

    
    
    
    (2,268
    )Effect of exchange rate changes on cash
    
    
    60
    
    
    
    109Cash and cash equivalents, beginning of period
    
    
    6,532
    
    
    
    6,371Cash and cash equivalents, end of period
    
    $
    8,132
    
    
    $
    4,212Supplemental information, cash paid for:Interest
    
    $
    12,142
    
    
    $
    2,547Income taxes
    
    $
    2,979
    
    
    $
    1,947
 The accompanying notes are an integral part of these financial statements. 6




---



##### 



aaiPharma Inc. 
 RESTATED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2002
    
    2003
    
    2002Net income
    
    $
    3,492
    
    
    $
    4,749
    
    
    $
    1,024
    
    
    $
    1,373Currency translation adjustments
    
    
    1,292
    
    
    
    1,512
    
    
    
    2,023
    
    
    
    1,337Comprehensive income
    
    $
    4,784
    
    
    $
    6,261
    
    
    $
    3,047
    
    
    $
    2,710
 The accompanying notes are an integral part of these financial statements. 7




---



##### 



aaiPharma Inc. 
 
 1. Basis of presentation and other matters The accompanying unaudited restated consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States and applicable Securities and Exchange Commission regulations for
interim financial information. These restated financial statements do not
include all of the information and footnotes required by accounting principles
generally accepted in the United States for annual financial statements. The
consolidated restated financial information as of December 31, 2002 has been
derived from audited financial statements; certain amounts for the three and
six months ended June 30, 2002 have been reclassified for consistent
presentation with current year financial statements. On January 30, 2003,
aaiPharmas Board of Directors approved a 3-for-2 stock split of the Companys
common shares. On March 10, 2003, each stockholder received one additional
share of common stock for every two shares they owned on the record date of
February 19, 2003. All share and per share amounts have been restated to
reflect the stock split for all periods presented. Users of this interim
financial information should read the audited financial statements for the
preceding fiscal year, which are included in the Companys Annual Report on
Form 10-K for the year ended December 31, 2003. In the opinion of management,
all adjustments (consisting of normal recurring adjustments) considered
necessary for fair presentation have been included in these interim restated
financial statements. Operating results for the interim periods presented are
not necessarily indicative of the results that may be expected for the full
year. The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported
in the consolidated financial statements and accompanying notes. Actual
results could differ from such estimates and changes in such estimates may
affect amounts reported in future periods. In 2003, the Company adopted Statement of Financial Accounting Standards No.
145, Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections (SFAS 145). SFAS 145 no longer requires
companies to report gains or losses associated with the extinguishment of debt
as a component of extraordinary gains or losses, net of tax. In addition, any
extraordinary gains or losses on extinguishment of debt in prior periods
presented would require reclassification. As required by SFAS 145, the
extraordinary loss recognized in the six months ended June 30, 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. The Company applies Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB 25) and related Interpretations in accounting
for its stock option plans; therefore, compensation expense has not been
recognized for options granted at fair value. Under APB 25, if the exercise
price of the Companys stock options is not less than the estimated fair market
value of the underlying stock on the date of grant, no compensation expense is
recognized. If compensation cost for the Companys plans had been determined
based on the fair value at the grant dates for awards under those 8




---



##### 



plans consistent with the fair value method of SFAS 123, the Companys net
income and earnings per share would have been changed to the pro forma amounts
indicated below: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2002
    
    2003
    
    2002(In thousands, except per share data)Net income, as reported
    
    $
    3,492
    
    
    $
    4,749
    
    
    $
    1,024
    
    
    $
    1,373Pro forma stock-based compensation cost, net of tax
    
    
    1,805
    
    
    
    1,376
    
    
    
    3,049
    
    
    
    2,483Pro forma net income (loss)
    
    
    1,687
    
    
    
    3,373
    
    
    
    (2,625
    )
    
    
    (1,110
    )Earnings (loss) per share:As reported -Basic
    
    $
    0.13
    
    
    $
    0.17
    
    
    $
    0.04
    
    
    $
    0.05Diluted
    
    $
    0.12
    
    
    $
    0.17
    
    
    $
    0.04
    
    
    $
    0.05Pro forma -Basic
    
    $
    0.06
    
    
    $
    0.12
    
    
    $
    (0.10
    )
    
    ($
    0.04
    )Diluted
    
    $
    0.06
    
    
    $
    0.12
    
    
    $
    (0.10
    )
    
    ($
    0.04
    )
 2. Restatement of Previously Issued Financial Statements The Company has restated its consolidated statements of operations, cash flows,
and comprehensive income for the three and six months ended June 30, 2003 and
2002 and its consolidated balance sheets as of June 30, 2003 and December 31,
2002. The restatement does not affect periods prior to 2002. The restatement,
among other things, corrects the Companys accounting treatment of certain
transactions that did not satisfy all of the conditions of FASB Statement No.
48 Revenue Recognition When Right of Return Exists (SFAS 48) and/or Staff
Accounting Bulletin No. 101 Revenue Recognition in Financial Statements (SAB
101) or were subsequently deemed to involve subjective determinations for
which the Company has determined alternative accounting treatments should be
used. Set forth below are the restatement adjustments included in the
restatement of the previously issued financial statements for the three and six
months ended June 30, 2003 and 2002. The following table presents the impact of the restatement adjustments
described below on net income for the three and six months ended June 30, 2003
and 2002: 9




---



##### 



Net Income for the
    
    Net Income for theThree Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2002
    
    2003
    
    2002(In thousands)As previously reported
    
    $
    7,988
    
    
    $
    6,104
    
    
    $
    15,144
    
    
    $
    2,854Consignment sale / reversal of
revenue (i)
    
    
    (779
    )
    
    
    
    
    
    
    (5,136
    )
    
    
    Returns reserves (ii)
    
    
    (1,981
    )
    
    
    
    
    
    
    (5,659
    )
    
    
    Intangible asset amortization (iii)
    
    
    (1,356
    )
    
    
    (1,371
    )
    
    
    (2,712
    )
    
    
    (1,577
    )Change in tax rate (iv)
    
    
    (380
    )
    
    
    16
    
    
    
    (613
    )
    
    
    96As restated
    
    $
    3,492
    
    
    $
    4,749
    
    
    $
    1,024
    
    
    $
    1,373
 The adjustments to restate the 2002 and 2003 quarterly periods relate to the
following:  (i)
    
    for 2003, the correction of the Companys revenue recognition of
certain transactions, including specific product sales in the first half
of 2003, that did not satisfy all of the conditions for recognition of
revenue under SFAS 48 and/or SAB 101,(ii)
    
    for 2003, significant increases in reserves for product returns and
other adjustments to the Companys revenue and product inventory
reserves,(iii)
    
    for 2002 and 2003, a change in the accounting treatment used with
respect to the Companys product line acquisitions from accounting for
the acquisitions as business combinations to recording such transactions
as asset acquisitions. Accordingly the Company adjusted the related
allocations to reverse the recording of goodwill and allocate all
amounts specifically to identifiable tangible and intangible assets, and(iv)
    
    for the change in effective tax rate resulting from the above
adjustments. The following table presents the impact of the restatement adjustments on the
Companys previously reported results for the three and six months ended June
30, 2003 and 2002 on a condensed basis: Three Months Ended
    
    Six Months EndedJune 30, 2003
    
    June 30, 2003As
    
    
    
    
    
    AsPreviously
    
    As
    
    Previously
    
    AsReported
    
    Restated
    
    Reported
    
    Restated(In thousands, except per share data)Statements of operations:Net revenues
    
    $
    70,751
    
    
    $
    66,096
    
    
    $
    134,781
    
    
    $
    115,083Total costs and expenses
    
    
    62,763
    
    
    
    62,604
    
    
    
    119,637
    
    
    
    114,059Net income
    
    $
    7,988
    
    
    $
    3,492
    
    
    $
    15,144
    
    
    $
    1,024Basic earnings per share
    
    $
    0.29
    
    
    $
    0.13
    
    
    $
    0.55
    
    
    $
    0.04Diluted earnings per share
    
    $
    0.28
    
    
    $
    0.12
    
    
    $
    0.53
    
    
    $
    0.04
 10




---



##### 



Three Months Ended
    
    Six Months EndedJune 30, 2002
    
    June 30, 2002As
    
    
    
    
    
    AsPreviously
    
    As
    
    Previously
    
    AsReported
    
    Restated
    
    Reported
    
    Restated(In thousands, except per share data)Statements of operations:Net revenues
    
    $
    61,447
    
    
    $
    61,447
    
    
    $
    107,067
    
    
    $
    107,067Total costs and expenses
    
    
    55,343
    
    
    
    56,698
    
    
    
    104,213
    
    
    
    105,694Net income
    
    $
    6,104
    
    
    $
    4,749
    
    
    $
    2,854
    
    
    $
    1,373Basic earnings per share
    
    $
    0.22
    
    
    $
    0.17
    
    
    $
    0.10
    
    
    $
    0.05Diluted earnings per share
    
    $
    0.21
    
    
    $
    0.17
    
    
    $
    0.10
    
    
    $
    0.05
 June 30, 2003
    
    December 31, 2002As Previously
    
    As
    
    As Previously
    
    AsReported
    
    Restated
    
    Reported
    
    Restated(In thousands)Balance sheets:ASSETSCurrent assets:Cash and cash equivalents
    
    $
    8,132
    
    
    $
    8,132
    
    
    $
    6,532
    
    
    $
    6,532Accounts receivable, net
    
    
    39,438
    
    
    
    31,469
    
    
    
    29,467
    
    
    
    29,467Inventory, net
    
    
    15,349
    
    
    
    16,974
    
    
    
    17,004
    
    
    
    17,004Other current assets
    
    
    19,862
    
    
    
    19,862
    
    
    
    18,148
    
    
    
    18,148Total current assets
    
    
    82,781
    
    
    
    76,437
    
    
    
    71,151
    
    
    
    71,151Goodwill, net
    
    
    211,759
    
    
    
    12,345
    
    
    
    210,792
    
    
    
    11,378Intangible assets, net
    
    
    88,168
    
    
    
    276,348
    
    
    
    89,078
    
    
    
    281,669Other assets
    
    
    69,286
    
    
    
    69,286
    
    
    
    69,304
    
    
    
    69,304Total assets
    
    $
    451,994
    
    
    $
    434,416
    
    
    $
    440,325
    
    
    $
    433,502LIABILITIES AND
STOCKHOLDERS EQUITYDeferred product revenue
    
    $
    
    
    
    $
    11,729
    
    
    $
    
    
    
    $
    Current liabilities
    
    
    61,502
    
    
    
    59,426
    
    
    
    55,794
    
    
    
    55,794Long-term debt, less current
portion
    
    
    259,271
    
    
    
    259,271
    
    
    
    277,899
    
    
    
    277,899Deferred tax liability
    
    
    11,231
    
    
    
    2,316
    
    
    
    6,467
    
    
    
    3,840Other liabilities
    
    
    2,281
    
    
    
    2,281
    
    
    
    715
    
    
    
    715Stockholders equity
    
    
    117,709
    
    
    
    99,393
    
    
    
    99,450
    
    
    
    95,254Total liabilities and
stockholders equity
    
    $
    451,994
    
    
    $
    434,416
    
    
    $
    440,325
    
    
    $
    433,502
 3. Earnings per share 11




---



##### 



Basic earnings per share are based on the weighted average number of common
shares outstanding during the year. Diluted earnings 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 and six months ended June 30, 2003 and 2002,
1,729,557, 1,587,487, 1,581,607 and 1,243,033 options, respectively, were
excluded as they were anti-dilutive. In each period presented, the net income
(the numerator) is the same for both basic and diluted per share
computations. The following table provides a reconciliation of the denominators for the basic
and diluted earnings per share computations (in thousands): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2002
    
    2003
    
    2002Basic earnings per share:Weighted average number of shares
    
    
    27,621
    
    
    
    27,365
    
    
    
    27,590
    
    
    
    27,236Effect of dilutive securities:Stock options
    
    
    1,061
    
    
    
    1,200
    
    
    
    1,053
    
    
    
    1,344Diluted earnings per share:Adjusted weighted average number of shares
and assumed conversions
    
    
    28,682
    
    
    
    28,565
    
    
    
    28,643
    
    
    
    28,580
 4. Financial information by business segment and geographic area The Company operates in three business segments, consisting of a product sales
business, primarily comprised of the pharmaceuticals business unit, a product
development business, primarily the research and development business unit, and
a development services business, primarily the AAI Development Services
business unit. The product sales business provides for the sales of the
Companys pharmaceutical product lines and for the commercial manufacturing of
small quantity products outsourced by other pharmaceutical companies. In the
product development segment, the Company internally develops drugs and
technologies for future sales by the product sales business or with the
objective of licensing marketing rights to third parties in exchange for
license fees and royalties. The core services provided by the development
services business on a fee-for-service basis to pharmaceutical and
biotechnology industries worldwide include comprehensive formulation, testing
and manufacturing expertise, in addition to the ability to take investigational
products into and through human clinical trials. The majority of the Companys
non-U.S. operations are located in Germany. 12




---



##### 



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
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2002
    
    2003
    
    2002Net revenues:Product sales
    
    $
    41,097
    
    
    $
    34,673
    
    
    $
    66,062
    
    
    $
    54,850Product development
    
    
    3,897
    
    
    
    6,469
    
    
    
    7,707
    
    
    
    8,604Development services
    
    
    21,102
    
    
    
    20,305
    
    
    
    41,314
    
    
    
    43,613$
    66,096
    
    
    $
    61,447
    
    
    $
    115,083
    
    
    $
    107,067United States
    
    $
    61,351
    
    
    $
    61,352
    
    
    $
    105,670
    
    
    $
    104,701Germany
    
    
    5,232
    
    
    
    3,290
    
    
    
    10,543
    
    
    
    6,914Other
    
    
    283
    
    
    
    197
    
    
    
    608
    
    
    
    396Less intercompany
    
    
    (770
    )
    
    
    (3,392
    )
    
    
    (1,738
    )
    
    
    (4,944
    )$
    66,096
    
    
    $
    61,447
    
    
    $
    115,083
    
    
    $
    107,067Income from operations:Product sales
    
    $
    17,883
    
    
    $
    18,589
    
    
    $
    25,202
    
    
    $
    27,374Product development
    
    
    3,897
    
    
    
    6,469
    
    
    
    7,707
    
    
    
    8,604Development services
    
    
    (208
    )
    
    
    (684
    )
    
    
    123
    
    
    
    1,10221,572
    
    
    
    24,374
    
    
    
    33,032
    
    
    
    37,080Research and development
    
    
    (5,698
    )
    
    
    (5,596
    )
    
    
    (10,284
    )
    
    
    (10,073
    )Corporate
    
    
    (5,294
    )
    
    
    (4,655
    )
    
    
    (10,593
    )
    
    
    (8,031
    )$
    10,580
    
    
    $
    14,123
    
    
    $
    12,155
    
    
    $
    18,976United States
    
    $
    10,401
    
    
    $
    14,568
    
    
    $
    11,268
    
    
    $
    19,439Germany
    
    
    291
    
    
    
    (288
    )
    
    
    1,020
    
    
    
    (212
    )Other
    
    
    (112
    )
    
    
    (157
    )
    
    
    (133
    )
    
    
    (251
    )$
    10,580
    
    
    $
    14,123
    
    
    $
    12,155
    
    
    $
    18,976Depreciation and amortization:Product sales
    
    $
    3,069
    
    
    $
    3,179
    
    
    $
    6,260
    
    
    $
    3,638Development services
    
    
    1,211
    
    
    
    1,000
    
    
    
    2,238
    
    
    
    1,941Product development
    
    
    109
    
    
    
    110
    
    
    
    209
    
    
    
    209Corporate
    
    
    527
    
    
    
    587
    
    
    
    1,065
    
    
    
    1,098$
    4,916
    
    
    $
    4,876
    
    
    $
    9,772
    
    
    $
    6,886
 13




---



##### 



June 30,
    
    December 31,2003
    
    2002Total assets:Product sales
    
    $
    338,833
    
    
    $
    340,773Product development
    
    
    7,931
    
    
    
    6,024Development services
    
    
    48,405
    
    
    
    49,952Corporate
    
    
    39,247
    
    
    
    36,753$
    434,416
    
    
    $
    433,502United States
    
    $
    408,791
    
    
    $
    411,174Germany
    
    
    23,935
    
    
    
    21,167Other
    
    
    1,690
    
    
    
    1,161$
    434,416
    
    
    $
    433,502Goodwill, net:Development services
    
    $
    12,345
    
    
    $
    11,378
 5. 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., its principal
shareholders and others, and
continued to be related parties at June 30, 2003. No revenues were recognized
from Aesgen for the three and six months ended June 30, 2003. Revenues
recognized from Aesgen totaled $0.2 million and $0.3 million for the three and
six months ended June 30, 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 expensed potential royalties of $0.1
million under that agreement in both the three and six months ended June 30,
2003. Revenues recognized from Endeavor totaled $0.3 million and $0.6 million
for the three and six months ended June 30, 2003, and were $0.7 million and
$1.0 million for the three and six months ended June 30, 2002, respectively.
Certain services performed by the Company for Endeavor are covered by a
Securities Payment Agreement between the Company and Endeavor, whereby the
Company receives Endeavor preferred stock in lieu of cash for services
performed. At June 30, 2003, we had no accounts receivable or work-in-progress
related to Aesgen, and had approximately $0.7 million of accounts receivable
and work-in-progress related to Endeavor. 6. Inventories, net The following table presents the components of inventories: June 30,
    
    December 31,2003
    
    2002(In thousands)Finished goods (including consigned inventory of $1,611 in 2003)
    
    $
    12,840
    
    
    $
    11,110Work-in-process
    
    
    448
    
    
    
    1,866Raw materials and supplies
    
    
    4,751
    
    
    
    4,749Inventory reserves
    
    
    (1,065
    )
    
    
    (721
    )Total inventories, net
    
    $
    16,974
    
    
    $
    17,004
 14




---



##### 



7. Debt The following table presents the components of current maturities of long-term debt: June 30,
    
    December 31,2003
    
    2002(In thousands)Current maturities of long-term debt
    
    $
    6,553
    
    
    $
    5,921
 The following table presents the components of long-term debt: June 30,
    
    December 31,2003
    
    2002(In thousands)U.S. bank term loan
    
    $
    46,000
    
    
    $
    50,000U.S. revolving credit facility
    
    
    34,500
    
    
    
    47,50011% senior subordinated notes due 2010, net of original issue discount
    
    
    174,035
    
    
    
    173,963Interest rate swap monetization deferred income
    
    
    13,164
    
    
    
    10,486Fair value of interest rate swap
    
    
    (1,875
    )
    
    
    1,871Less current maturities of long-term debt
    
    
    (6,553
    )
    
    
    (5,921
    )Total long-term debt due after one year
    
    $
    259,271
    
    
    $
    277,899
 In March 2002, the Company entered into a $175 million senior secured credit
facility consisting of a $75 million five-year revolving credit facility and a
$100 million five-year term loan facility. The term loan facility was
scheduled to be amortized over the full five-year term. The senior credit
facility was subsequently reduced due to early repayments made under the term
loan facility. The availability of borrowings under the revolving credit
facility was not limited by a borrowing base. At June 30, 2003, the Company
had unused availability under the revolving credit facility of $40.5 million.
The senior credit facility provided for variable interest rates based on LIBOR
or an alternate base rate, at the Companys option. On June 30, 2003, 30-day
LIBOR was 1.12%. Such facility was guaranteed by all domestic subsidiaries and
secured by a security interest on substantially all domestic assets, all of the
stock of domestic subsidiaries and 65% of the stock of material foreign
subsidiaries. The senior credit facility required the payment of certain
commitment fees based on the unused portion of the revolving credit facility
and 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 15




---



##### 



discount. This discount will be charged to interest expense over the term of
the notes. At June 30, 2003, these notes had a fixed interest rate of 11% per
annum and were guaranteed on a subordinated basis by all existing domestic
subsidiaries and all future domestic subsidiaries that are owned 80% or more by
the Company. At June 30, 2003, the notes were not secured. Prior to the third
anniversary of the date of issuance of the notes, up to 35% of the notes are
redeemable with the proceeds of qualified sales of equity at 111% of par value.
On or after the fourth anniversary of the date of issuance of the notes, all
or any portion of the notes are redeemable at declining premiums to par value,
beginning at 105.5%. Concurrent with the issuance of the senior subordinated notes, the Company
entered into an interest rate hedging agreement to effectively convert interest
expense on a portion of the senior subordinated notes for the term of the notes
from an 11% fixed annual rate to a floating annual rate equal to 6-month LIBOR
plus a base rate. On February 27, 2003, and again on June 23, 2003, the
Company sold the then outstanding interest rate hedging agreement for $2.3
million and $3.7 million, respectively, and replaced it with a similar interest
rate hedging agreement. The amounts received, less the interest benefits
earned through the dates of sale, have been recorded as premiums to the
carrying amount of the notes and are being amortized into interest income over
their remaining life. At June 30, 2003, the Company had an interest rate
hedging agreement in place covering $150 million of the notes, at a rate of
6-month LIBOR plus 7.41%. On June 30, 2003, 6-month LIBOR was 1.12%, giving
the Company an estimated all-in rate of 8.53%. The terms of the interest rate
hedging agreements, other than the base rate, were identical and were perfectly
matched with the terms of the related hedged instrument. Under the terms of the senior secured credit facility and the senior
subordinated notes, the Company was required to comply with various covenants
including, but not limited to, those pertaining to maintenance of certain
financial ratios and incurring additional indebtedness. After giving effect to
the restatement described in Note 2, the Company was not in compliance with the
covenants at June 30, 2003. The Company has since replaced its
senior secured credit facility and received waivers of any defaults
under its senior subordinated notes (see Notes 1 and 6 to the Companys Annual Report of Form
10-K for the year ended December 31, 2003 for additional
discussion). 8. Asset Acquisitions On March 28, 2002, the Company acquired the U.S. rights to the Darvon and
Darvocet branded product lines, which treat mild-to-moderate pain, and existing
inventory from Eli Lilly and Company, in an asset purchase. The Company
acquired these product lines and related intangible assets for $211.4 million,
exclusive of transactional costs. To finance this acquisition, which included
$1.8 million of inventory, the Company used the proceeds from the then existing
senior secured credit facility and senior subordinated notes, as described in
note 7. The Darvon and Darvocet product lines did not have separable assets
and liabilities associated with them, other than inventory, therefore the
Company allocated the purchase price, including acquisition related expenses,
to acquired identifiable tangible and intangible assets. The identified
intangible assets are being amortized over 20 years. In December 2001, the Company acquired from Novartis Pharmaceutical Corporation
and Novartis Corporation a line of asthma products used in the prevention and
reversal of bronchospasm in patients age 12 and older with asthma and
reversible bronchospasm associated with bronchitis and emphysema, in an asset
purchase. The product line acquired is marketed under the Brethine brand name.
The Company acquired this product line and related intangible assets for $26.6
million, exclusive of transactional costs. The Brethine product line did not
have separable assets and liabilities associated with it, therefore the 16




---



##### 



Company allocated the purchase price, including acquisition related expenses,
to acquired identifiable intangible assets, which are being amortized over 20
years. In August 2001, the Company completed the acquisition of a line of critical
care injectable and oral nutrition products from AstraZeneca AB, an affiliate
of AstraZeneca PLC, in an asset purchase. The product lines acquired are
marketed under the M.V.I. and Aquasol brand names. The Company acquired these
product lines and related intangible assets for $52.5 million, exclusive of
transactional costs, paid at closing, plus additional consideration
(see Note 2 to the Companys Annual Report on
Form 10-K for the year ended December 31, 2003 for
additional discussion). The M.V.I. and Aquasol product lines did
not have separable assets and liabilities associated with them, other than
inventory; therefore the Company allocated the purchase price, including
acquisition related expenses, to acquired identifiable tangible and intangible
assets. In connection with the M.V.I. and Aquasol acquisition, the Company
recorded intangible assets which meet the criteria for having an indefinite
life. In accordance with Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets, these intangible assets are not being
amortized but are evaluated for impairment on at least an annual basis. The
intangible assets recorded in connection with this acquisition represent the
trademarks, technology and know-how associated with the product lines. 9. Financial Information for Subsidiary Guarantors and Non-Guarantors In the first quarter of 2002, the Company issued senior subordinated notes
which are guaranteed by certain of the Companys subsidiaries. The following presents condensed consolidating financial information for the
Company, segregating: (1) aaiPharma Inc., which issued the notes (the
Issuer); (2) the domestic subsidiaries, which guarantee the notes (the
Guarantor Subsidiaries); and (3) all other subsidiaries (the Non-Guarantor
Subsidiaries). The Guarantor Subsidiaries are wholly-owned direct
subsidiaries of the Company and their guarantees are full, unconditional and
joint and several. Wholly-owned subsidiaries are presented on the equity basis
of accounting. Certain reclassifications have been made to conform all of the
financial information to the financial presentation on a consolidated basis.
The principal adjusting entries eliminate investments in subsidiaries and
intercompany balances and transactions. The following information presents consolidating statements of operations,
balance sheets and cash flows for the periods and as of the dates indicated: 17




---



##### 



aaiPharma Inc.
RESTATED CONSOLIDATING STATEMENT OF OPERATIONS
(In thousands) Three Months Ended June 30, 2003Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet revenues
    
    $
    11,631
    
    
    $
    49,721
    
    
    $
    5,514
    
    
    $
    (770
    )
    
    $
    66,096Equity earnings from subsidiaries
    
    
    12,444
    
    
    
    
    
    
    
    
    
    
    
    (12,444
    )
    
    
    Total revenues
    
    
    24,075
    
    
    
    49,721
    
    
    
    5,514
    
    
    
    (13,214
    )
    
    
    66,096Operating costs and expenses:Direct costs (excluding depreciation)
    
    
    6,528
    
    
    
    19,096
    
    
    
    3,420
    
    
    
    (680
    )
    
    
    28,364Selling
    
    
    1,637
    
    
    
    5,955
    
    
    
    609
    
    
    
    
    
    
    
    8,201General and administrative
    
    
    8,070
    
    
    
    2,210
    
    
    
    1,009
    
    
    
    
    
    
    
    11,289Research and development
    
    
    
    
    
    
    5,588
    
    
    
    
    
    
    
    
    
    
    
    5,588Depreciation
    
    
    1,345
    
    
    
    306
    
    
    
    296
    
    
    
    
    
    
    
    1,947Royalty expense
    
    
    
    
    
    
    127
    
    
    
    
    
    
    
    
    
    
    
    12717,580
    
    
    
    33,282
    
    
    
    5,334
    
    
    
    (680
    )
    
    
    55,516Income (loss) from operations
    
    
    6,495
    
    
    
    16,439
    
    
    
    180
    
    
    
    (12,534
    )
    
    
    10,580Other income (expense):Interest, net
    
    
    (352
    )
    
    
    (4,581
    )
    
    
    2
    
    
    
    
    
    
    
    (4,931
    )Net intercompany interest
    
    
    (520
    )
    
    
    564
    
    
    
    (44
    )
    
    
    
    
    
    
    Other income (expense), net
    
    
    220
    
    
    
    13
    
    
    
    (7
    )
    
    
    
    
    
    
    226(652
    )
    
    
    (4,004
    )
    
    
    (49
    )
    
    
    
    
    
    
    (4,705
    )Income (loss) before income taxes
    
    
    5,843
    
    
    
    12,435
    
    
    
    131
    
    
    
    (12,534
    )
    
    
    5,875Provision for income taxes
    
    
    2,351
    
    
    
    32
    
    
    
    
    
    
    
    
    
    
    
    2,383Net income (loss)
    
    $
    3,492
    
    
    $
    12,403
    
    
    $
    131
    
    
    $
    (12,534
    )
    
    $
    3,492
 18




---



##### 



aaiPharma Inc.
RESTATED CONSOLIDATING STATEMENT OF OPERATIONS
(In thousands) Three Months Ended June 30, 2002Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet revenues
    
    $
    13,936
    
    
    $
    47,416
    
    
    $
    3,487
    
    
    $
    (3,392
    )
    
    $
    61,447Equity earnings from subsidiaries
    
    
    14,617
    
    
    
    
    
    
    
    
    
    
    
    (14,617
    )
    
    
    Total revenues
    
    
    28,553
    
    
    
    47,416
    
    
    
    3,487
    
    
    
    (18,009
    )
    
    
    61,447Operating costs and expenses:Direct costs (excluding depreciation)
    
    
    8,974
    
    
    
    15,753
    
    
    
    2,515
    
    
    
    (3,183
    )
    
    
    24,059Selling
    
    
    1,670
    
    
    
    3,622
    
    
    
    418
    
    
    
    
    
    
    
    5,710General and administrative
    
    
    7,416
    
    
    
    2,013
    
    
    
    732
    
    
    
    
    
    
    
    10,161Research and development
    
    
    169
    
    
    
    5,317
    
    
    
    
    
    
    
    
    
    
    
    5,486Depreciation
    
    
    1,379
    
    
    
    260
    
    
    
    269
    
    
    
    
    
    
    
    1,90819,608
    
    
    
    26,965
    
    
    
    3,934
    
    
    
    (3,183
    )
    
    
    47,324Income (loss) from operations
    
    
    8,945
    
    
    
    20,451
    
    
    
    (447
    )
    
    
    (14,826
    )
    
    
    14,123Other income (expense):Interest, net
    
    
    566
    
    
    
    (7,139
    )
    
    
    20
    
    
    
    
    
    
    
    (6,553
    )Net intercompany interest
    
    
    (584
    )
    
    
    632
    
    
    
    (48
    )
    
    
    
    
    
    
    Other income (expense), net
    
    
    (1,198
    )
    
    
    1,266
    
    
    
    1
    
    
    
    
    
    
    
    69(1,216
    )
    
    
    (5,241
    )
    
    
    (27
    )
    
    
    
    
    
    
    (6,484
    )Income (loss) before income taxes
    
    
    7,729
    
    
    
    15,210
    
    
    
    (474
    )
    
    
    (14,826
    )
    
    
    7,639Provision for (benefit from) income taxes
    
    
    2,980
    
    
    
    
    
    
    
    (90
    )
    
    
    
    
    
    
    2,890Net income (loss)
    
    $
    4,749
    
    
    $
    15,210
    
    
    $
    (384
    )
    
    $
    (14,826
    )
    
    $
    4,749
 19




---



##### 



aaiPharma Inc. RESTATED CONSOLIDATING STATEMENT OF OPERATIONS
 (In thousands)
 Six Months Ended June 30, 2003Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet revenues
    
    $
    22,261
    
    
    $
    83,410
    
    
    $
    11,150
    
    
    $
    (1,738
    )
    
    $
    115,083Equity earnings from subsidiaries
    
    
    15,987
    
    
    
    
    
    
    
    
    
    
    
    (15,987
    )
    
    
    Total revenues
    
    
    38,248
    
    
    
    83,410
    
    
    
    11,150
    
    
    
    (17,725
    )
    
    
    115,083Operating costs and expenses:Direct costs (excluding depreciation)
    
    
    13,049
    
    
    
    33,420
    
    
    
    6,592
    
    
    
    (1,423
    )
    
    
    51,638Selling
    
    
    2,946
    
    
    
    11,868
    
    
    
    1,121
    
    
    
    
    
    
    
    15,935General and administrative
    
    
    15,847
    
    
    
    3,470
    
    
    
    2,002
    
    
    
    
    
    
    
    21,319Research and development
    
    
    
    
    
    
    10,074
    
    
    
    
    
    
    
    
    
    
    
    10,074Depreciation
    
    
    2,701
    
    
    
    585
    
    
    
    549
    
    
    
    
    
    
    
    3,835Royalty expense
    
    
    
    
    
    
    127
    
    
    
    
    
    
    
    
    
    
    
    12734,543
    
    
    
    59,544
    
    
    
    10,264
    
    
    
    (1,423
    )
    
    
    102,928Income (loss) from operations
    
    
    3,705
    
    
    
    23,866
    
    
    
    886
    
    
    
    (16,302
    )
    
    
    12,155Other income (expense):Interest, net
    
    
    (1,044
    )
    
    
    (9,440
    )
    
    
    3
    
    
    
    
    
    
    
    (10,481
    )Net intercompany interest
    
    
    (1,036
    )
    
    
    1,123
    
    
    
    (87
    )
    
    
    
    
    
    
    Other
    
    
    160
    
    
    
    15
    
    
    
    (32
    )
    
    
    
    
    
    
    143(1,920
    )
    
    
    (8,302
    )
    
    
    (116
    )
    
    
    
    
    
    
    (10,338
    )Income (loss) before income taxes
    
    
    1,785
    
    
    
    15,564
    
    
    
    770
    
    
    
    (16,302
    )
    
    
    1,817Provision for income taxes
    
    
    761
    
    
    
    32
    
    
    
    
    
    
    
    
    
    
    
    793Net income (loss)
    
    $
    1,024
    
    
    $
    15,532
    
    
    $
    770
    
    
    $
    (16,302
    )
    
    $
    1,024
 20




---



##### 



aaiPharma Inc. RESTATED CONSOLIDATING STATEMENT OF OPERATIONS
 (In thousands)
 Six Months Ended June 30, 2002Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedNet revenues
    
    $
    30,673
    
    
    $
    74,028
    
    
    $
    7,310
    
    
    $
    (4,944
    )
    
    $
    107,067Equity earnings from subsidiaries
    
    
    16,168
    
    
    
    
    
    
    
    
    
    
    
    (16,168
    )
    
    
    Total revenues
    
    
    46,841
    
    
    
    74,028
    
    
    
    7,310
    
    
    
    (21,112
    )
    
    
    107,067Operating costs and expenses:Direct costs (excluding depreciation)
    
    
    18,567
    
    
    
    26,962
    
    
    
    4,948
    
    
    
    (4,735
    )
    
    
    45,742Selling
    
    
    3,322
    
    
    
    5,849
    
    
    
    813
    
    
    
    
    
    
    
    9,984General and administrative
    
    
    13,005
    
    
    
    4,403
    
    
    
    1,508
    
    
    
    
    
    
    
    18,916Research and development
    
    
    416
    
    
    
    9,448
    
    
    
    
    
    
    
    
    
    
    
    9,864Depreciation
    
    
    2,542
    
    
    
    539
    
    
    
    504
    
    
    
    
    
    
    
    3,58537,852
    
    
    
    47,201
    
    
    
    7,773
    
    
    
    (4,735
    )
    
    
    88,091Income (loss) from operations
    
    
    8,989
    
    
    
    26,827
    
    
    
    (463
    )
    
    
    (16,377
    )
    
    
    18,976Other income (expense):Interest, net
    
    
    453
    
    
    
    (8,852
    )
    
    
    23
    
    
    
    
    
    
    
    (8,376
    )Net intercompany interest
    
    
    (1,148
    )
    
    
    1,257
    
    
    
    (109
    )
    
    
    
    
    
    
    Other
    
    
    (5,454
    )
    
    
    (2,436
    )
    
    
    40
    
    
    
    
    
    
    
    (7,850
    )(6,149
    )
    
    
    (10,031
    )
    
    
    (46
    )
    
    
    
    
    
    
    (16,226
    )Income (loss) before income taxes
    
    
    2,840
    
    
    
    16,796
    
    
    
    (509
    )
    
    
    (16,377
    )
    
    
    2,750Provision for (benefit from) income taxes
    
    
    1,467
    
    
    
    
    
    
    
    (90
    )
    
    
    
    
    
    
    1,377Net income (loss)
    
    $
    1,373
    
    
    $
    16,796
    
    
    $
    (419
    )
    
    $
    (16,377
    )
    
    $
    1,373
 21




---



##### 



aaiPharma Inc. RESTATED CONSOLIDATING BALANCE SHEET
 (In thousands)
 June 30, 2003Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedASSETSCurrent assets:Cash and cash equivalents
    
    $
    7,610
    
    
    $
    193
    
    
    $
    329
    
    
    $
    
    
    
    $
    8,132Accounts receivable, net
    
    
    9,130
    
    
    
    19,153
    
    
    
    3,186
    
    
    
    
    
    
    
    31,469Work-in-progress
    
    
    3,483
    
    
    
    3,489
    
    
    
    6,365
    
    
    
    (1,088
    )
    
    
    12,249Inventories
    
    
    3,936
    
    
    
    12,277
    
    
    
    761
    
    
    
    
    
    
    
    16,974Deferred tax assets
    
    
    1,271
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,271Prepaid and other current assets
    
    
    1,809
    
    
    
    4,130
    
    
    
    403
    
    
    
    
    
    
    
    6,342Total current assets
    
    
    27,239
    
    
    
    39,242
    
    
    
    11,044
    
    
    
    (1,088
    )
    
    
    76,437Investments in and advances to subsidiaries
    
    
    66,061
    
    
    
    (46,202
    )
    
    
    
    
    
    
    (19,859
    )
    
    
    Property and equipment, net
    
    
    41,125
    
    
    
    10,755
    
    
    
    4,088
    
    
    
    
    
    
    
    55,968Goodwill, net
    
    
    725
    
    
    
    1,230
    
    
    
    10,390
    
    
    
    
    
    
    
    12,345Intangibles, net
    
    
    1,067
    
    
    
    275,281
    
    
    
    
    
    
    
    
    
    
    
    276,348Other assets
    
    
    4,535
    
    
    
    8,679
    
    
    
    104
    
    
    
    
    
    
    
    13,318Total assets
    
    $
    140,752
    
    
    $
    288,985
    
    
    $
    25,626
    
    
    $
    (20,947
    )
    
    $
    434,416LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current maturities of long-term debt
    
    $
    
    
    
    $
    6,553
    
    
    $
    
    
    
    $
    
    
    
    $
    6,553Accounts payable
    
    
    5,569
    
    
    
    9,757
    
    
    
    1,903
    
    
    
    
    
    
    
    17,229Customer advances
    
    
    11,115
    
    
    
    5,377
    
    
    
    3,322
    
    
    
    (1,088
    )
    
    
    18,726Accrued wages and benefits
    
    
    4,077
    
    
    
    1,751
    
    
    
    1,435
    
    
    
    
    
    
    
    7,263Interest payable
    
    
    155
    
    
    
    4,871
    
    
    
    
    
    
    
    
    
    
    
    5,026Deferred product revenue
    
    
    
    
    
    
    11,729
    
    
    
    
    
    
    
    
    
    
    
    11,729Other accrued liabilities
    
    
    1,572
    
    
    
    2,975
    
    
    
    (292
    )
    
    
    374
    
    
    
    4,629Total current liabilities
    
    
    22,488
    
    
    
    43,013
    
    
    
    6,368
    
    
    
    (714
    )
    
    
    71,155Long-term debt, less current portion
    
    
    34,500
    
    
    
    224,771
    
    
    
    
    
    
    
    
    
    
    
    259,271Deferred tax liability
    
    
    2,316
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,316Other liabilities
    
    
    406
    
    
    
    1,875
    
    
    
    
    
    
    
    
    
    
    
    2,281Investments in and advances to subsidiaries
    
    
    90,309
    
    
    
    (95,852
    )
    
    
    5,290
    
    
    
    253
    
    
    
    Total stockholders equity
    
    
    (9,267
    )
    
    
    115,178
    
    
    
    13,968
    
    
    
    (20,486
    )
    
    
    99,393Total liabilities and stockholders equity
    
    $
    140,752
    
    
    $
    288,985
    
    
    $
    25,626
    
    
    $
    (20,947
    )
    
    $
    434,416
 22




---



##### 



aaiPharma Inc. RESTATED CONSOLIDATING BALANCE SHEET
 (In thousands)
 December 31, 2002Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedASSETSCurrent assets:Cash and cash equivalents
    
    $
    5,725
    
    
    $
    180
    
    
    $
    627
    
    
    $
    
    
    
    $
    6,532Accounts receivable, net
    
    
    10,104
    
    
    
    16,758
    
    
    
    2,605
    
    
    
    
    
    
    
    29,467Work-in-progress
    
    
    4,135
    
    
    
    2,951
    
    
    
    4,568
    
    
    
    (1,139
    )
    
    
    10,515Inventories
    
    
    5,504
    
    
    
    11,114
    
    
    
    697
    
    
    
    (311
    )
    
    
    17,004Deferred tax assets
    
    
    1,271
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,271Prepaid and other current assets
    
    
    2,511
    
    
    
    3,642
    
    
    
    209
    
    
    
    
    
    
    
    6,362Total current assets
    
    
    29,250
    
    
    
    34,645
    
    
    
    8,706
    
    
    
    (1,450
    )
    
    
    71,151Investments in and advances to subsidiaries
    
    
    66,061
    
    
    
    (46,202
    )
    
    
    
    
    
    
    (19,859
    )
    
    
    Property and equipment, net
    
    
    42,055
    
    
    
    7,070
    
    
    
    4,000
    
    
    
    
    
    
    
    53,125Goodwill, net
    
    
    624
    
    
    
    1,230
    
    
    
    9,524
    
    
    
    
    
    
    
    11,378Intangibles, net
    
    
    952
    
    
    
    280,717
    
    
    
    
    
    
    
    
    
    
    
    281,669Other assets
    
    
    4,514
    
    
    
    11,569
    
    
    
    96
    
    
    
    
    
    
    
    16,179Total assets
    
    $
    143,456
    
    
    $
    289,029
    
    
    $
    22,326
    
    
    $
    (21,309
    )
    
    $
    433,502LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current maturities of long-term debt
    
    $
    
    
    
    $
    5,921
    
    
    $
    
    
    
    $
    
    
    
    $
    5,921Accounts payable
    
    
    4,410
    
    
    
    11,447
    
    
    
    1,814
    
    
    
    
    
    
    
    17,671Customer advances
    
    
    7,840
    
    
    
    5,731
    
    
    
    2,618
    
    
    
    (1,138
    )
    
    
    15,051Accrued wages and benefits
    
    
    4,922
    
    
    
    929
    
    
    
    867
    
    
    
    
    
    
    
    6,718Interest payable
    
    
    285
    
    
    
    4,947
    
    
    
    
    
    
    
    
    
    
    
    5,232Other accrued liabilities
    
    
    1,244
    
    
    
    3,379
    
    
    
    (77
    )
    
    
    655
    
    
    
    5,201Total current liabilities
    
    
    18,701
    
    
    
    32,354
    
    
    
    5,222
    
    
    
    (483
    )
    
    
    55,794Long-term debt, less current portion
    
    
    47,500
    
    
    
    230,399
    
    
    
    
    
    
    
    
    
    
    
    277,899Deferred tax liability
    
    
    3,840
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,840Other liabilities
    
    
    715
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    715Investments in and advances to subsidiaries
    
    
    68,094
    
    
    
    (72,423
    )
    
    
    4,984
    
    
    
    (655
    )
    
    
    Total stockholders equity
    
    
    4,606
    
    
    
    98,699
    
    
    
    12,120
    
    
    
    (20,171
    )
    
    
    95,254Total liabilities and stockholders equity
    
    $
    143,456
    
    
    $
    289,029
    
    
    $
    22,326
    
    
    $
    (21,309
    )
    
    $
    433,502
 23




---



##### 



aaiPharma Inc. RESTATED CONSOLIDATING STATEMENT OF CASH FLOWS
 (In thousands)
 Six Months Ended June 30, 2003Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedCash flows from operating activities:Net income (loss)
    
    $
    1,024
    
    
    $
    15,532
    
    
    $
    770
    
    
    $
    (16,302
    )
    
    $
    1,024Adjustments to reconcile net income (loss) to net cash
provided
by operating activities:Depreciation and amortization
    
    
    2,470
    
    
    
    6,754
    
    
    
    548
    
    
    
    
    
    
    
    9,772Other
    
    
    (163
    )
    
    
    1
    
    
    
    84
    
    
    
    
    
    
    
    (78
    )Changes in operating assets and liabilities:Accounts receivable, net
    
    
    974
    
    
    
    (2,396
    )
    
    
    (344
    )
    
    
    
    
    
    
    (1,766
    )Work-in-progress
    
    
    651
    
    
    
    (538
    )
    
    
    (1,381
    )
    
    
    (51
    )
    
    
    (1,319
    )Inventories
    
    
    1,569
    
    
    
    (1,164
    )
    
    
    
    
    
    
    (311
    )
    
    
    94Prepaid and other assets
    
    
    681
    
    
    
    531
    
    
    
    (174
    )
    
    
    
    
    
    
    1,038Accounts payable
    
    
    1,159
    
    
    
    (1,690
    )
    
    
    (76
    )
    
    
    
    
    
    
    (607
    )Customer advances
    
    
    3,275
    
    
    
    (352
    )
    
    
    464
    
    
    
    50
    
    
    
    3,437Interest payable
    
    
    (130
    )
    
    
    (76
    )
    
    
    
    
    
    
    
    
    
    
    (206
    )Deferred product revenue
    
    
    
    
    
    
    11,729
    
    
    
    
    
    
    
    
    
    
    
    11,729Accrued wages and benefits and other accrued liabilities
    
    
    (2,350
    )
    
    
    419
    
    
    
    (173
    )
    
    
    (281
    )
    
    
    (2,385
    )Intercompany receivables and payables
    
    
    6,228
    
    
    
    (23,429
    )
    
    
    306
    
    
    
    16,895
    
    
    
    Net cash provided by operating activities
    
    
    15,388
    
    
    
    5,321
    
    
    
    24
    
    
    
    
    
    
    
    20,733Cash flows from investing activities:Purchases of property and equipment
    
    
    (1,696
    )
    
    
    (4,404
    )
    
    
    (382
    )
    
    
    
    
    
    
    (6,482
    )Proceeds from sales of property and equipment
    
    
    389
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    389Acquisitions of product rights and other intangibles
    
    
    
    
    
    
    (600
    )
    
    
    
    
    
    
    
    
    
    
    (600
    )Other
    
    
    (287
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (287
    )Net cash used in investing activities
    
    
    (1,594
    )
    
    
    (5,004
    )
    
    
    (382
    )
    
    
    
    
    
    
    (6,980
    )Cash flows from financing activities:Payments on long-term borrowings
    
    
    (13,000
    )
    
    
    (4,000
    )
    
    
    
    
    
    
    
    
    
    
    (17,000
    )Proceeds from interest rate swaps, net
    
    
    
    
    
    
    2,678
    
    
    
    
    
    
    
    
    
    
    
    2,678Proceeds from stock option exercises
    
    
    1,091
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,091Other
    
    
    
    
    
    
    1,018
    
    
    
    
    
    
    
    
    
    
    
    1,018Net cash used in financing activities
    
    
    (11,909
    )
    
    
    (304
    )
    
    
    
    
    
    
    
    
    
    
    (12,213
    )Net increase (decrease) in cash and cash equivalents
    
    
    1,885
    
    
    
    13
    
    
    
    (358
    )
    
    
    
    
    
    
    1,540Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    60
    
    
    
    
    
    
    
    60Cash and cash equivalents, beginning of period
    
    
    5,725
    
    
    
    180
    
    
    
    627
    
    
    
    
    
    
    
    6,532Cash and cash equivalents, end of period
    
    $
    7,610
    
    
    $
    193
    
    
    $
    329
    
    
    $
    
    
    
    $
    8,132
 24




---



##### 



aaiPharma Inc. RESTATED CONSOLIDATING STATEMENT OF CASH FLOWS
 (In thousands)
 Six Months Ended June 30, 2002Non-Guarantor
    
    GuarantorIssuer
    
    Subsidiaries
    
    Subsidiaries
    
    Eliminations
    
    ConsolidatedCash flows from operating activities:Net income (loss)
    
    $
    1,373
    
    
    $
    16,796
    
    
    $
    (419
    )
    
    $
    (16,377
    )
    
    $
    1,373Adjustments to reconcile net income (loss)
to net cash (used in) provided by operating activities:Depreciation and amortization
    
    
    2,307
    
    
    
    4,074
    
    
    
    504
    
    
    
    
    
    
    
    6,885Write-off of deferred financing and other costs
    
    
    
    
    
    
    8,053
    
    
    
    
    
    
    
    
    
    
    
    8,053Other
    
    
    3
    
    
    
    12
    
    
    
    102
    
    
    
    
    
    
    
    117Changes in operating assets and liabilities:Accounts receivable, net
    
    
    2,090
    
    
    
    (18,533
    )
    
    
    716
    
    
    
    2,300
    
    
    
    (13,427
    )Work-in-progress
    
    
    (764
    )
    
    
    (508
    )
    
    
    (733
    )
    
    
    1,244
    
    
    
    (761
    )Inventories
    
    
    (1,111
    )
    
    
    627
    
    
    
    
    
    
    
    209
    
    
    
    (275
    )Prepaid and other assets
    
    
    1,242
    
    
    
    (14,271
    )
    
    
    59
    
    
    
    
    
    
    
    (12,970
    )Accounts payable
    
    
    655
    
    
    
    (610
    )
    
    
    (77
    )
    
    
    
    
    
    
    (32
    )Customer advances
    
    
    7,225
    
    
    
    (292
    )
    
    
    24
    
    
    
    (3,544
    )
    
    
    3,413Interest payable
    
    
    563
    
    
    
    5,682
    
    
    
    
    
    
    
    
    
    
    
    6,245Accrued wages and benefits and other accrued liabilities
    
    
    (1,504
    )
    
    
    475
    
    
    
    (394
    )
    
    
    531
    
    
    
    (892
    )Intercompany receivables and payables
    
    
    (35,525
    )
    
    
    19,926
    
    
    
    (24
    )
    
    
    15,623
    
    
    
    Net cash (used in) provided by operating activities
    
    
    (23,446
    )
    
    
    21,431
    
    
    
    (242
    )
    
    
    (14
    )
    
    
    (2,271
    )Cash flows from investing activities:Purchases of property and equipment
    
    
    (2,720
    )
    
    
    (937
    )
    
    
    (745
    )
    
    
    
    
    
    
    (4,402
    )Purchases of property and equipment previously leased
    
    
    (14,145
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14,145
    )Acquisitions of product rights and other intangibles
    
    
    
    
    
    
    (211,997
    )
    
    
    
    
    
    
    
    
    
    
    (211,997
    )Other
    
    
    (153
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (153
    )Net cash used in investing activities
    
    
    (17,018
    )
    
    
    (212,934
    )
    
    
    (745
    )
    
    
    
    
    
    
    (230,697
    )Cash flows from financing activities:Proceeds from long-term borrowings
    
    
    49,400
    
    
    
    195,928
    
    
    
    
    
    
    
    
    
    
    
    245,328Payments on long-term borrowings
    
    
    (10,400
    )
    
    
    (8,014
    )
    
    
    
    
    
    
    14
    
    
    
    (18,400
    )Proceeds from interest rate swaps, net
    
    
    
    
    
    
    3,426
    
    
    
    
    
    
    
    
    
    
    
    3,426Proceeds from stock option exercises
    
    
    3,031
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,031Other
    
    
    (2,854
    )
    
    
    142
    
    
    
    27
    
    
    
    
    
    
    
    (2,685
    )Net cash provided by financing activities
    
    
    39,177
    
    
    
    191,482
    
    
    
    27
    
    
    
    14
    
    
    
    230,700Net decrease in cash and cash equivalents
    
    
    (1,287
    )
    
    
    (21
    )
    
    
    (960
    )
    
    
    
    
    
    
    (2,268
    )Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    109
    
    
    
    
    
    
    
    109Cash and cash equivalents, beginning of period
    
    
    5,301
    
    
    
    154
    
    
    
    916
    
    
    
    
    
    
    
    6,371Cash and cash equivalents, end of period
    
    $
    4,014
    
    
    $
    133
    
    
    $
    65
    
    
    $
    
    
    
    $
    4,212
 25




---



##### 



Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations. The information set forth in this Item 2 has been revised to reflect the
restatement occurring subsequent to the filing of the original Quarterly Report
on Form 10-Q. Restatement of Previously Issued Financial Statements We have restated our consolidated statements of operations, cash flows, and
comprehensive income for the three and six months ended June 30, 2003 and 2002
and our consolidated balance sheets as of June 30, 2003 and December 31, 2002.
The restatement did not affect periods prior to 2002. The restatement is
reported in our Annual Report on Form 10-K for the year ended December 31, 2003
and is reported in this Amendment No. 1 to our Quarterly Report for the
quarterly period ended June 30, 2003 and in amendments to our Quarterly Reports
on Form 10-Q/A for the quarterly periods ended March 31, 2003 and September 30,
2003. The restatement corrects our revenue recognition of certain
transactions, including specific product sales in 2003, that did not satisfy
all of the revenue recognition conditions under FASB Statement No. 48 Revenue
Recognition When Right of Return Exists (SFAS 48), and/or Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101),
increases reserves for product returns and records other adjustments to our
revenue reserves for 2003, and reflects a different accounting treatment for
our acquired products. The following table summarizes the adjustments we have made to the financial
information previously reported for the three months ended June 30, 2003. Revenue
    
    Pre-Tax Income
    
    Net Income($ in millions, except per share data)Consignment Sale / Reversal of Revenue:Calcitriol
    
    $
    (0.6
    )
    
    $
    (0.6
    )
    
    $
    (0.3
    )AzaSan 75mg and 100 mg
    
    
    (0.8
    )
    
    
    (0.7
    )
    
    
    (0.4
    )Return Reserves:Brethine (second-tier wholesaler)
    
    
    (2.6
    )
    
    
    (2.6
    )
    
    
    (1.6
    )Other products
    
    
    (0.7
    )
    
    
    (0.7
    )
    
    
    (0.4
    )Change in Accounting for Product
Acquisitions
    
    
    
    
    
    
    (2.2
    )
    
    
    (1.4
    )Change in Tax Rate
    
    
    
    
    
    
    
    
    
    
    (0.4
    )Total Adjustments
    
    $
    (4.7
    )
    
    $
    (6.8
    )
    
    $
    (4.5
    )Diluted earnings per share
    
    
    
    
    
    
    
    
    
    $
    (0.16
    )
 The following table summarizes the adjustments we have made to the financial
information previously reported for the six months ended June 30, 2003. 26




---



##### 



Revenue
    
    Pre-Tax Income
    
    Net Income($ in millions, except per share data)Consignment Sale:Calcitriol
    
    $
    (3.7
    )
    
    $
    (2.6
    )
    
    $
    (1.5
    )AzaSan 75mg and 100 mg
    
    
    (6.6
    )
    
    
    (6.0
    )
    
    
    (3.6
    )Return Reserves:Brethine (second-tier wholesaler)
    
    
    (5.9
    )
    
    
    (5.9
    )
    
    
    (3.6
    )Other products
    
    
    (3.5
    )
    
    
    (3.5
    )
    
    
    (2.1
    )Change in Accounting for Product
Acquisitions
    
    
    
    
    
    
    (4.4
    )
    
    
    (2.7
    )Change in tax rate
    
    
    
    
    
    
    
    
    
    
    (0.6
    )Total Adjustments
    
    $
    (19.7
    )
    
    $
    (22.4
    )
    
    $
    (14.1
    )Diluted earnings per share
    
    
    
    
    
    
    
    
    
    $
    (0.49
    )
 In connection with our new product launches in the first quarter of 2003 of
calcitriol and AzaSan 75 mg and 100 mg, initial launch quantities of these
products were sold pursuant to guaranteed sale conditions under which we
agreed to accept returned product six months after the date of purchase, if not
resold by then. Revenue was recognized for these sales upon shipment without
the establishment of any special reserves to account for these return rights.
Because these launches were into new markets or were products with which we did
not have applicable or analogous historical experience, and because most of the
sales for these products had returns provisions inconsistent with our normal
returns provisions, we have concluded that we did not have the ability to
reasonably estimate returns, and that revenue for these sales should not have
been recognized until all of the conditions of SFAS 48 were met. Since all of the conditions of SFAS 48 had not been met for these sales of
calcitriol and AzaSan 75mg and 100mg in the second quarter of 2003, revenue has
been recorded as if the sales were consignments. Calcitriol revenues have been
reduced by $0.6 million and AzaSan revenues have been reduced by $0.8 million.
Under the consignment model, upon shipment of product we invoice the
wholesaler, record deferred revenue at gross invoice sales price and classify
the inventory held by the wholesalers as consignment inventory at our cost of
such inventory. We will recognize revenue (net of discounts, rebates, sales
allowances and accruals for returns) when the consignment inventory is sold by
the wholesalers, as quantified using data from the wholesalers and other
third-party information sources. We will continue to recognize revenue on
these products on this basis until such time as we develop sufficient
historical experience on which to reasonably estimate returns and all other
conditions under SFAS 48 are met. The build-up of inventory to support the
initial launches of these products increased our inventory by $4.3 million in
the first six months of 2003. There were significant returns in the first quarter of 2004 from a second-tier
wholesaler of our Brethine products that were inconsistent with our historical
returns experience. The bulk of these products was initially sold by us during
the first half of 2003 and was acquired by the second-tier wholesaler in
purchases from us and from one of our principal wholesalers. Based on our
knowledge regarding the 27




---



##### 



market factors affecting these requested returns, we now believe that this
inventory was purchased by the wholesaler for a particular opportunity that did
not materialize. A specific returns reserve of $2.6 million has been recorded
in the second quarter of 2003 for these sales and for the related inventory in
our restated financial statements. At the time we recognize revenue from product sales, we record an adjustment,
or decrease, to revenue for estimated chargebacks, rebates, discounts and
returns. Revenue reserves are established on a product-by-product basis.
These revenue reductions are established by management as its best estimate at
the time of sale based on each products historical experience adjusted to
reflect known changes in the factors that impact such reserves. Reserves for
chargebacks, rebates and discounts are established based on the contractual
terms with our customers; analysis of historical levels of discounts,
chargebacks and rebates; communications with customers and purchased
information about the rate of prescriptions being written and the levels of
inventory remaining in the distribution channel as well as our expectations
about the market for each product and anticipated introduction of competitive
products. The reserve for chargebacks is the most significant estimate used in
the recognition of our revenue from product sales. In brief, we have
established contract prices for certain indirect customers that are supplied by
our wholesale customers. A chargeback represents the difference between the
current published wholesale acquisition cost and the indirect customers
contract prices. Prior to 2003, the amount of actual product returns experienced by the Company
had not been significant. As a result, actual returns were charged against
revenue in the period they occurred and aggregate revenue reserves were
evaluated quarterly to determine if they were sufficient to cover estimated
chargebacks, rebates and related allowances, as well as the expected rate of
returns, and adjusted as deemed necessary. In 2003, we began segregating our
products return reserve, which prior thereto we believed was adequately covered
by our aggregate revenue reserves for chargebacks, rebates and related
allowances. We increased the level of detail included in our analyses to
include analyzing inventory in the channel to determine remaining shelf life.
Our returns reserve needs are primarily related to the number of months of
inventory estimated to be in the distribution channel. Levels of inventory in
the distribution channel are monitored and estimated based on information we
purchase from the wholesalers, combined with active discussions between our
sales personnel and the wholesalers we supply. In addition, our actual sales,
returns and chargeback history are used to assess the reasonableness of the
estimated number of months of inventory on hand at our wholesalers. The shelf
life of products remaining in the distribution channel is estimated based on an
analysis of each lot sold. Each batch has a specific expiration date. A
review of the actual returns history is performed and the run rate of sales out
of the distribution channel is estimated. Estimated product returns reserves
are adjusted based on these reviews. Reserves may also be adjusted to reflect
any significant changes in trends or based upon new information that we believe
may affect the reserve needs. Allowances for new product introductions are
estimated based on our experiences for similar products that we currently
market and are adjusted as deemed necessary based on our experience with each
product. Our reserve analysis also includes a review for the potential
introduction of generic competition and the resulting impact on pricing and
returns reserves. Existing reserves may be adjusted accordingly to reflect our
estimate for any impact these factors may have. We continually monitor our
assumptions with respect to our revenue reserves for product sales and modify
them if necessary. In addition to the consignment sales and other adjustments
described above, we have adjusted our net revenues in the second quarter of
2003 by increasing our returns reserve for other products by $0.7 million based
on a historical returns analysis. 28




---



##### 



In addition to the 2003 adjustments identified above, we are restating our
consolidated financial statements for the three and six-month periods ended
June 30, 2003 and 2002 to treat each of our major product line acquisitions as
acquisitions of assets that do not constitute a business. We have changed the
accounting treatment used from treating the acquisitions as business
combinations to treating them as asset acquisitions. Accordingly, no portion
of the purchase price for these acquisitions is allocated to goodwill, and the
amount previously allocated to goodwill is instead allocated to the other
identifiable acquired assets, including assets with definite lives. As a
result, our direct costs in the three and six months ended June 30, 2002 are
greater than the amount previously reported by $2.2 million and $2.4 million,
respectively, due to the increase in amortization expense resulting from a
greater amount of purchase price being allocated to assets with definite lives,
and our directs costs in the three and six months ended June 30, 2003 are
greater than the amount we previously reported by $2.2 million and $4.4
million, respectively. Results of Operations Our quarterly results have been, and we expect them to continue to be, subject
to fluctuations. Quarterly results can fluctuate as a result of a number of
factors, including without limitation, demand for our pharmaceutical product
lines, the amount and timing of product returns, ability of contract
manufacturers to supply conforming products on a timely basis, costs and
results of ongoing and future litigation by and against us, progress of ongoing
contracts, amounts recognized for licensing and royalty 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 products and services.
There have been no significant changes in our critical accounting policies
previously disclosed in our 2003 Form 10-K. Because a large percentage of our
development services operating costs are relatively fixed, variations in the
timing and progress of large contracts, changes in the demand for our services
and products, or the recognition of licensing and royalty revenues (on projects
for which associated expense may have been recognized in prior periods) can
materially affect our quarterly results. Accordingly, we believe that
comparisons of our quarterly financial results may not be meaningful. The following table sets forth our gross revenues and the amount of dilution to
revenues resulting from allowances for customer credits, including discounts,
rebates, chargebacks, product returns and other allowances. Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2002
    
    2003
    
    2002Gross revenues
    
    $
    97,758
    
    
    $
    76,331
    
    
    $
    165,033
    
    
    $
    128,514Allowance for customer credits
    
    
    31,662
    
    
    
    14,884
    
    
    
    49,950
    
    
    
    21,447Net revenues
    
    $
    66,096
    
    
    $
    61,447
    
    
    $
    115,083
    
    
    $
    107,067
 In addition to changes in product mix, the increase in allowance for customer
credits in the second quarter of 2003 relates primarily to a specific returns
reserve of $2.6 million recorded in the second quarter of 2003
with respect to sales to a second-tier wholesaler of our Brethine
products that resulted in returns that were inconsistent with 29




---



##### 



our historical returns experience, and to additional chargeback reserve
requirements in the second quarter of 2003 for sales of our Brethine
products. These chargeback reserves were required due to the
inclusion of our Brethine products in our group purchasing organization contracts in the third
quarter of 2002. The following table presents the net revenues for each of our business units
and our consolidated expenses and net income, with each item expressed as a
percentage of consolidated net revenues: Three Months Ended June 30,
    
    Six Months Ended June 30,2003
    
    2002
    
    2003
    
    2002(in thousands)Net revenues:Product sales
    
    $
    41,097
    
    
    
    62
    %
    
    $
    34,673
    
    
    
    56
    %
    
    $
    66,062
    
    
    
    57
    %
    
    $
    54,850
    
    
    
    51
    %Product development
    
    
    3,897
    
    
    
    6
    
    
    
    6,469
    
    
    
    11
    
    
    
    7,707
    
    
    
    7
    
    
    
    8,604
    
    
    
    8Development services
    
    
    21,102
    
    
    
    32
    
    
    
    20,305
    
    
    
    33
    
    
    
    41,314
    
    
    
    36
    
    
    
    43,613
    
    
    
    41$
    66,096
    
    
    
    100
    %
    
    $
    61,447
    
    
    
    100
    %
    
    $
    115,083
    
    
    
    100
    %
    
    $
    107,067
    
    
    
    100
    %Direct costs (excluding depreciation)
    
    $
    28,364
    
    
    
    43
    %
    
    $
    24,059
    
    
    
    39
    %
    
    $
    51,638
    
    
    
    45
    %
    
    $
    45,742
    
    
    
    43
    %Selling
    
    
    8,201
    
    
    
    12
    
    
    
    5,710
    
    
    
    9
    
    
    
    15,935
    
    
    
    14
    
    
    
    9,984
    
    
    
    9General and administrative
    
    
    11,289
    
    
    
    17
    
    
    
    10,161
    
    
    
    17
    
    
    
    21,319
    
    
    
    19
    
    
    
    18,916
    
    
    
    18Research and development
    
    
    5,588
    
    
    
    8
    
    
    
    5,486
    
    
    
    9
    
    
    
    10,074
    
    
    
    9
    
    
    
    9,864
    
    
    
    9Depreciation
    
    
    1,947
    
    
    
    3
    
    
    
    1,908
    
    
    
    3
    
    
    
    3,835
    
    
    
    3
    
    
    
    3,585
    
    
    
    3Royalty expense
    
    
    127
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    127
    
    
    
    
    
    
    
    
    
    
    
    Income from operations
    
    
    10,580
    
    
    
    16
    
    
    
    14,123
    
    
    
    23
    
    
    
    12,155
    
    
    
    11
    
    
    
    18,976
    
    
    
    18Loss from extinguishment of debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,053
    )
    
    
    (8
    )Interest expense, net
    
    
    (4,931
    )
    
    
    (7
    )
    
    
    (6,553
    )
    
    
    (11
    )
    
    
    (10,481
    )
    
    
    (9
    )
    
    
    (8,376
    )
    
    
    (8
    )Other income (expense), net
    
    
    226
    
    
    
    
    
    
    
    69
    
    
    
    
    
    
    
    143
    
    
    
    
    
    
    
    203
    
    
    
    Provision for income taxes
    
    
    2,383
    
    
    
    4
    
    
    
    2,890
    
    
    
    5
    
    
    
    793
    
    
    
    1
    
    
    
    1,377
    
    
    
    1Net income
    
    
    3,492
    
    
    
    5
    
    
    
    4,749
    
    
    
    8
    
    
    
    1,024
    
    
    
    1
    
    
    
    1,373
    
    
    
    1
 Second Quarter 2003 Compared to Second Quarter 2002 Our consolidated net revenues for the quarter ended June 30, 2003 increased 8%
to $66.1 million, from $61.4 million in the second quarter of 2002. Net
revenues from product sales increased to $41.1 million in 2003, from $34.7
million in 2002, due to market share gains of our M.V.I. Pediatric product, a
significant price increase in our injectable Brethine product that was
implemented in June 2002, and contributions from our 50mg Azasan product, which
was launched in June 2002. These increases in product sales were partially
offset by lower sales of our Darvocet-N 100 500-count bottle product,
which we believe to be due to lower purchases by repackagers of this product. Net revenues from
commercial manufacturing of products marketed by other pharmaceutical
companies, which is included in product sales, contributed $0.6 million and
$0.2 million to net revenues from product sales in the second quarters of 2003
and 2002, respectively. Net revenues from product development decreased 40% in the second quarter of
2003 to $3.9 million, or 6% of net revenues, from $6.5 million, or 11% of net
revenues, in the 2002 period, primarily due to royalties under our significant
development agreement, which decreased from $5.7 million in the second quarter
of 2002 to $3.3 million in the second quarter of 2003. This development
agreement is described in the Managements Discussion and Analysis of
Financial Condition and Results of Operations section of our 2003 Form 10-K. 30




---



##### 



Net revenues from our development services business increased 4% in the second
quarter of 2003 to $21.1 million, from $20.3 million in 2002. These increases
were principally attributable to higher demand for our analytical,
bioanalytical and clinical contract manufacturing capabilities, partially
offset by lower clinical revenues related to the winding down of some large
projects in the first half of 2002, and lower fee-for-service revenues under
our significant development agreement. Direct costs (excluding depreciation and royalty expense) increased $4.3
million, or 18%, to $28.4 million in the second quarter of 2003, from $24.1
million in the same period in 2002. This increase in direct cost dollars
resulted from an increase of $4.7 million in product costs related to higher
product sales. Direct costs as a percentage of net revenues were 43% for the
second quarter of 2003, as compared to 39% in the second quarter of 2003. This
percentage increase in direct costs reflected a product revenue mix change in
the quarter towards revenues from lower margin components of our product
portfolio. Selling expenses increased 44% in the second quarter of 2003 to $8.2 million,
or 12% of net revenues, from $5.7 million, or 9% of net revenues, in 2002.
This increase was primarily due to expenses incurred by our product sales
business associated with developing our product sales force and marketing and
promoting our new products. As of June 30, 2003, our pharmaceutical sales
force was approximately 80, as compared to 20 at June 30, 2002. General and administrative costs increased 11% in the second quarter of 2003 to
$11.3 million, or 17% of net revenues, from $10.2 million, or 17% 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 $5.6 million, or 8% of net revenues, in
the second quarter of 2003, a slight dollar increase from $5.5 million, or 9%
of net revenues, in 2002. In the second quarter of 2003, significant project
spending related to our ProSorb-D pain management product and development work
on line extensions for our pain management and critical care products. Consolidated income from operations was $10.6 million in the second quarter of
2003, or $3.5 million lower than the prior year. This decrease was primarily
due to our increased selling, general and administrative spending to support
our product sales business, increased returns reserves and our decreased
product development revenues partially offset by the expansion of our product
sales business and increases in revenues in our development services business. Income from operations for our product sales business was $17.8 million in the
second quarter of 2003, compared to $18.6 million in the second quarter of
2002. This decrease was attributable to the higher selling expenses, partially
offset by the increased revenues and increase in direct costs, as discussed
above. Income from operations for our product development business was $3.9 million in
the second quarter of 2003, compared to income from operations of $6.5 million
in 2002. This change resulted from the decreased revenues from our significant
development agreement, as discussed above. Loss from operations for our development services business was ($0.2) million
in the second quarter of 2003, compared to ($0.7) million in the second quarter
of 2002. This improvement was primarily due to the increase in revenues, as
described above. 31




---



##### 



Unallocated corporate expenses increased in the second quarter of 2003 to $5.3
million, from $4.7 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 second quarter of 2003 and 2002 were both 8%. Net interest expense decreased to $4.9 million in the second quarter of 2003,
from $6.6 million in the second quarter of 2002. This $1.7 million decrease
was primarily attributable to the lower LIBOR-based variable interest rates on
our senior secured credit facility and a lower debt balance due to $50.5
million of debt repayments since June 30, 2002 on this facility. Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002 Our consolidated net revenues for the six months ended June 30, 2003 increased
7% to $115.1 million, from $107.1 million in the first half of 2002. Net
revenues from product sales increased to $66.1 million in 2003, from $54.9
million in 2002, due to contributions from our Darvon and Darvocet products,
which we acquired at the end of the first quarter of 2002, and a significant
price increase in our injectable Brethine product that was implemented in June
2002. Net revenues from commercial manufacturing of products marketed by other
pharmaceutical companies, which are included in product sales, contributed $1.3
million and $3.2 million to net revenues from product sales in the first half
of 2003 and 2002, respectively. Net revenues from product development decreased 10% in the first half of 2003
to $7.7 million, or 7% of net revenues, from $8.6 million, or 8% of net
revenues, in 2002, primarily due to lower revenues related to third-party
licensing payments which we had previously deferred and were amortized into
revenue in 2002 and prior years. No similar revenues were recognized in 2003. Net revenues from our development services business decreased 5% in the first
half of 2003 to $41.3 million, from $43.6 million in 2002. These decreases
were principally attributable to lower clinical revenues related to the winding
down of some large projects in the first half 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. Direct costs (excluding depreciation and royalty expense) increased $5.9
million, or 13%, to $51.6 million in the first six months of 2003, from $45.7
million in the same period in 2002. This increase in direct cost dollars
resulted from an increased amortization expense of $2.6 million related to
product rights for acquired products. Direct costs as a percentage of net
revenues were 45% for the second quarter of 2003, as compared to 43% in the
second quarter of 2003. Selling expenses increased 60% in the first half of 2003 to $15.9 million, or
14% of net revenues, from $10.0 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 and marketing and promoting
our new products. 32




---



##### 



General and administrative costs increased 13% in the first half of 2003 to
$21.3 million, or 19% of net revenues, from $18.9 million, or 18% 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 $10.1 million, or 9% of net revenues, in
the first half of 2003, a slight increase from $9.9 million, or 9% of net
revenues, in 2002. Consistent with the second quarter of 2003, significant
project spending in the first half of 2003 related to our ProSorb-D pain
management product and development work on line extensions for our pain
management and critical care products. Consolidated income from operations was $12.2 million in the first half of
2003, or $6.8 million lower than the first half of 2002. This decrease is
primarily due to our increased selling, general and administrative spending to
support our product sales business and decreases in revenues in our development
services business, partially offset by the continued expansion of our product
sales business. Income from operations for our product sales business was $25.2 million in the
first half of 2003, compared to $27.4 million in the first half of 2002. This
decrease is attributable to the higher selling expense, offset by the increased
operating income generated by the increased product sales and increased
products rights amortization expense. Income from operations for our product development business was $7.7 million in
the first half of 2003, compared to income from operations of $8.6 million in
2002. This change resulted from the factors discussed above. Income from operations for our development services business was $0.1 million
in the first half of 2003, compared to $1.1 million in the first half of 2002.
This decrease is primarily due to the decline in revenues and increase in
direct costs, as described above. Unallocated corporate expenses increased in the first half of 2003 to $10.6
million, from $8.0 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 half of 2003 was 9%, as compared to 8% in the first half of 2002. Net interest expense increased to $10.5 million in the first half of 2003, from
$8.4 million in 2002. This $2.1 million increase is primarily attributable to
the borrowings that funded our product line acquisitions in March 2002. A loss from the extinguishment of debt of $8.1 million was recorded in the
first half of 2002. This loss was due to the write-off of deferred financing
and other costs related to our prior debt facilities that were refinanced in
March 2002. Liquidity and Capital Resources Historically, we have funded our businesses with cash flows provided by
operations and proceeds from borrowings. Cash flow provided by operations in
the first six months of 2003 was $20.7 million, compared to cash flow used in
operations of $2.3 million in the first six months of 2002. This change was
primarily due to an increase in net income and positive changes in working
capital. In addition, the 33




---



##### 



first half of 2002 included $13.1 million of prepaid financing fees related to
our senior credit facility and senior subordinated notes, which did not recur
in the first half of 2003. Cash used in investing activities was $7.0 million in the first six months of
2003 which included $6.5 million for capital spending. Cash used in investing
activities was $230.7 million in the first six months of 2002, which included
$211.4 million related to our 2002 acquisition of the Darvon and Darvocet
branded product lines, and $14.1 million for the purchase of assets formerly
covered by our tax retention operating lease, including our corporate
headquarters in Wilmington, N.C. and a laboratory and clinical facility in
Chapel Hill, N.C. Net cash used in financing activities during the first six months of 2003 was
$12.2 million, primarily representing debt payments of $17.0 million, partially
offset by $2.7 million of interest rate swap proceeds and $1.1 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 a
$175 million senior credit facility, issued $175 million of senior subordinated
notes due 2010, repaid all $78 million of borrowings outstanding under our
prior senior credit facilities, and terminated our tax retention operating
lease and purchased the underlying properties. At June 30, 2003, our $175 million senior secured credit facility consisted of
a $75 million five-year revolving credit facility and a $100 million five-year
term loan facility. The term loan facility was scheduled to be amortized over
the full five-year term. The senior facility was subsequently reduced due to
early repayments we made under the term loan facility. The availability of
borrowings under our revolving credit facility was not limited by a borrowing
base. At June 30, 2003, we had unused availability under the revolving credit
facility of $40.5 million. Our senior credit facility provided for variable
interest rates based on LIBOR or an alternate base rate, at our option. Such
facility was guaranteed by all of our domestic subsidiaries and secured by a
security interest on substantially all of our domestic assets, all of the stock
of our domestic subsidiaries, and 65% of the stock of our material foreign
subsidiaries. Our senior credit facility required the payment of certain
commitment fees based on the unused portion of the revolving credit facility
and could be prepaid at our option at any time without a premium. Under the terms of the credit agreement for our senior credit facility, we were
required to comply with various covenants including, but not limited to, those
pertaining to maintenance of certain financial ratios and incurrence of
additional indebtedness. After giving effect to the restatement described in
this Quarterly Report on Form 10-Q/A, we were not in compliance with some of
these financial covenants at June 30, 2003. See Notes 1 and 6 to our 2003 Form
10-K for additional discussion and a description of our new senior credit
facility that has replaced the credit facility in effect at June 30, 2003. On March 28, 2002, we issued $175 million of senior subordinated unsecured
notes due 2010, which had a fixed interest rate of 11% per annum and are
guaranteed on a subordinated basis by all of our existing domestic subsidiaries
and all of our future domestic subsidiaries of which we own 80% or more of the
equity interests. At June 30, 2003, these notes were not secured. Prior to
March 28, 2005, up to 34




---



##### 



35% of the notes are redeemable with the proceeds of qualified sales of equity
at 111% of par value. On or after March 28, 2006, all or any portion of the
notes are redeemable at declining premiums to par value, beginning at 105.5%. Under the terms of the indenture for our senior subordinated notes, we are
required to comply with various covenants including, but not limited to,
incurrence of additional indebtedness. After giving effect to the restatement
described in this Quarterly Report on Form 10-Q/A, we were not in compliance
withsome of these covenants at June 30, 2003. See Note 6 to our 2003 Form 10-K
for additional discussion and a description of the consent solicitation
approved in April 2004 that waived all then existing defaults under such
indenture (including those in effect at June 30, 2003). Concurrent with the issuance of our senior subordinated notes, we entered into
an interest rate hedging agreement to effectively convert interest expense on a
portion of the senior subordinated notes for the term of the notes from an 11%
fixed annual rate to a floating annual rate equal to 6-month LIBOR plus a base
rate. On February 27, 2003, and again on June 23, 2003, we sold the then
outstanding hedging agreement for $2.3 million and $3.7 million, respectively
and replaced it with a similar interest rate hedging agreement. The amounts we
received, less the interest benefits earned through the dates of sale, have
been recorded as premiums to the carrying amount of the notes and are being
amortized into interest income over their remaining life. This amortization
will be approximately $2.0 million annually. At June 30, 2003, we had an
interest rate hedging agreement in place covering $150 million of the notes, at
a rate of 6-month LIBOR plus 7.41%. On June 30, 2003, 6-month LIBOR was 1.12%,
giving us an estimated all-in rate of 8.53%. The terms of the interest rate
hedging agreements, other than the base rate, were identical and were perfectly
matched with the terms of the related hedged instrument. At June 30, 2003, our M.V.I. and Aquasol product line acquisition agreement
provided for us to pay the second of two $1.0 million guaranteed payments in
August 2003, a contingent payment of $2.0 million that was potentially due in
August 2003 and a future contingent payment of $43.5 million potentially due in
August 2004, depending on the status of certain reformulation activities being
carried out by the seller and regulatory approval of the reformulation by the
FDA. For information about a subsequent amendment to this agreement and
subsequent developments related to our payment obligations thereunder, see Item
7, Managements Discussion and Analysis of Financial Condition and Results of
Operations of our 2003 Form 10-K. In addition, we may have to make contingent
payments of $4.7 million over four years in connection with the purchase of our
Charleston, South Carolina manufacturing facility, based on the level of
manufacturing revenues at this facility. At June 30, 2003, these contingent
payment obligations, including the contingent payments potentially due in
connection with the acquisition of the M.V.I. and Aquasol product lines, had
not yet been recorded as a liability on our consolidated balance sheet. At
June 30, 2003, we had $6.6 million of principal repayments due in the next
twelve months under our senior credit facility. We made interest payments on
the senior subordinated notes of $9.6 million in April 2003 and $9.6 million in
October 2003. The October 2003 interest payment was offset by approximately
$0.9 million received under our interest rate swap agreement. 35




---



##### 



Forward-Looking Statements, Risk Factors and Safe Harbor Language This document contains forward-looking statements within the meaning of the
safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Words such as estimate, project, intend, anticipate, believe
and similar expressions are intended to identify forward-looking statements.
The forward-looking statements contained in this document include statements
about future financial and operating results, including the anticipated
financial condition, results of operations, business strategies, operating
efficiencies, competitive positions, growth opportunities for existing
products, plans and objectives of management and markets for our common stock.
These statements are based on the current expectations and beliefs of our
management and are subject to a number of factors and uncertainties, including
the matters noted above, that could cause actual results to differ materially
from those described in the forward-looking statements. These statements are
not guarantees of future performance, involve certain risks, uncertainties and
assumptions that are difficult to predict, and are based upon assumptions as to
future events that may not prove accurate. Therefore, actual outcomes and
results may differ materially from what is expressed in the forward-looking
statement. In any forward-looking statement in which we express an expectation
or belief as to future results, that expectation or belief is expressed in good
faith and believed to have a reasonable basis, but there can be no assurance
that the statement or expectation or belief will result or be achieved or
accomplished. Additional risks and uncertainties pertaining to the following
factors, among others, could cause actual results to differ materially from
those described in the forward-looking statements:  
    
    demand by consumers for our products and the products we produces for others;
    
    the prices that we can obtain for such products;
    
    the level of product and price competition;
    
    competitive new product introductions, including generic competition;
    
    distributors and wholesalers ordering patterns;
    
    levels of our products in the distribution channels;
    
    the outcome and costs of governmental investigations;
    
    the outcome and costs of litigation brought by and against us;
    
    timely success in product development and regulatory approvals for
new products and line extensions;
    
    actions by the FDA in connection with submissions related to our
products or those of our competitors;
    
    other governmental regulations and actions affecting our products or
those of our competitors;
    
    third-party payer decisions and actions affecting our products or those of our competitors; and
    
    developments in patent or other proprietary rights owned by us or others. Additional factors that may cause the actual results to differ materially are
discussed in our recent filings with the SEC, including, but not limited to,
Item 7, Managements Discussion and Analysis of Financial Condition and
Results of OperationsRisk Factors and Forward Looking Statements of our 2003
Form 10-K, our Current Reports on Form 8-K, and other periodic filings.
Whenever you read or hear any subsequent written or oral forward-looking
statements attributable to us or any person acting on our behalf, you should
keep in mind the cautionary statements contained or referred to in this
section. We do not undertake any obligation to (and expressly disclaim any obligation
to) update or alter our forward-looking statements, whether as a result of new
information, future events or otherwise. 36




---



##### 



Item 4. Controls and Procedures The Company has carried out an evaluation, under the supervision and with the
participation of its newly appointed Chief Executive Officer and interim Chief
Financial Officer, pursuant to Rule 13a-15 promulgated under the Securities
Exchange Act of 1934, as amended, of the effectiveness of the design and
operation of its disclosure controls and procedures as of December 31, 2003,
which includes the period covered by this Quarterly Report on Form 10-Q/A.
Disclosure controls and procedures are to be designed to ensure that material
information the Company must disclose in its reports filed or submitted under
the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported on a timely basis. As a result of that review, our Chief Executive
Officer and interim Chief Financial Officer have concluded that, as of December
31, 2003 and for the year then ended, including the period covered by this
Quarterly Report on Form 10-Q/A, the Companys disclosure controls and
procedures were not adequate. The internal control deficiencies related to, among other things, a lack of
adequate policies with respect to revenue recognition, and a lack of sufficient
control processes and procedures to effectively monitor and manage wholesaler
inventory levels, to ensure adequate contract-approval oversight, and to ensure
effective and timely communication among sales, marketing, finance and legal
staff regarding the terms and conditions of certain transactions, including new
product launches. Also, with respect to the sales of pharmaceutical products,
the Companys finance and accounting personnel lacked adequate training on the
application of revenue recognition principles and the establishment of product
return reserves. In addition, in April 2004, in connection with their audit of the Companys
consolidated financial statements for the year ended December 31, 2003, the
Companys independent auditors identified and communicated to the Company and
the Audit Committee two material weaknesses (as defined under standards
established by the American Institute of Certified Public Accountants) relating
to the Companys accounting and public financial reporting of significant
matters and to its initial recording and management review and oversight of
certain accounting matters. The material weaknesses were with respect to the
calculation and procedures for the analysis of revenue reserves for product
sales and lack of procedures for timely communications from the Legal
Department and operating divisions to the Finance Department impairing the
ability to properly evaluate the accounting treatment for certain transactions
the Company had entered into and assess the impact of such transactions in a
timely manner. In addition, at that time, the Companys independent auditors
identified and communicated to the Company and the Audit Committee a
reportable condition (as defined under standards established by the American
Institute of Certified Public Accountants) relating to the Companys internal
controls over its financial reporting for investments. The reportable
condition identified the Companys failure to perform a formal review of its
investments and failure to timely record patents or trademarks or to timely
analyze the patents and trademarks for usefulness and possible impairment. In view of the fact that the financial information presented in this Quarterly
Report on Form 10-Q/A was prepared in the absence of adequate internal controls
over financial reporting, the Company devoted a significant amount of time and
resources to the analysis of the financial information and documentation
underlying the financial statements contained in this Quarterly Report,
resulting in the restatement of certain interim financial information. In
particular, the Company reviewed significant product sales transactions to
confirm the terms of the transaction and our accounting for the transaction,
including whether all criteria for the recognition of revenue had been
satisfied and whether we had properly 37




---



##### 



estimated allowances for returns and other customer credits. In addition, the
Company reviewed in detail each of the matters identified by the Special
Committee of the Companys Board of Directors and its independent counsel and
independent forensic accountants. The investigation of the Special Committee
is discussed in Item 7, Managements Discussion and Analysis of Financial
Condition and Results of OperationsSpecial Committee Investigation of the
Companys 2003 Form 10-K. In light of the foregoing, the Company has taken the following actions, in
addition to those described above, after the end of 2003 to address the
deficiencies as described above:  
    
    reassigned all financial controllers from operating units into
the Finance Department reporting to the Companys Controller and
Chief Accounting Officer who reports directly to the Chief Financial
Officer;
    
    commenced a company-wide education effort regarding our Code of
Conduct and contract-approval policies;
    
    implemented a more vigorous contract-approval process;
    
    implemented formal revenue recognition protocols and training programs; and
    
    contracted with a third-party consulting group, FTI Consulting,
to provide transitional management services in the area of operations
and finance. In addition, since December 31, 2003, the Companys then Chief Executive
Officer, Chief Operating Officer and Chief Financial Officer have left the
Company. In March of 2004, Dr. Sancilio, the Companys Executive Chairman and
Chief Scientific Officer, was appointed Chief Executive Officer, and Gregory F.
Rayburn, a senior managing director with FTI Consulting, was appointed Interim
Chief Operating Officer. In April 2004, Timothy R. Wright was appointed
President of the Companys Pharmaceuticals Products Division. Gina Gutzeit, a
senior managing director with FTI Consulting, was appointed as interim Chief
Financial Officer in May 2004. The Company is fully committed to implementing controls identified by the
Companys independent auditors and the Special Committee. The Companys
efforts to strengthen its financial and internal controls continue, and the
Company expects to complete remediation of the material weaknesses and
reportable condition identified by its independent auditors by the end of 2004. 
 PART II. OTHER INFORMATION 
 Item 3. Defaults Upon Senior Securities. Under the terms of the credit agreement for our senior credit facility in
effect at June 30, 2003, we were required to comply with various covenants
including, but not limited to, those pertaining to maintenance of certain
financial ratios and incurrence of additional indebtedness. After giving
effect to the restatement described in this Quarterly Report on Form 10-Q/A, we
were not in compliance with some of these covenants at June 30, 2003. See
Notes 1 and 6 to our 2003 Form 10-K for additional discussion and a description
of our new senior credit facility that has replaced the credit facility in
effect at June 30, 2003. Under the terms of the
indenture for our $175 million senior subordinated notes due
2010, we are required to comply with various covenants including, but not
limited to a covenant relating to incurrence of additional indebtedness. After
giving effect to the restatement described in this Quarterly Report on 38




---



##### 



Form 10-Q/A, we were not in compliance with some of these covenants at June 30,
2003. See Note 6 to our 2003 Form 10-K for additional discussion and a
description of the consent solicitation approved in April 2004 that waived all
then existing defaults under such indenture (including those in effect at June
30, 2003). 
 Item 6. Exhibits and Reports on Form 8-K Exhibits:
 A list of the exhibits required to be filed as part of this Quarterly Report on
Form 10-Q/A is set forth in the Exhibit Index, which immediately precedes
such exhibits, and is incorporated herein by reference. Reports on Form 8-K: During the second quarter of 2003, we furnished the following Form 8-K:  
    
    Dated April 23, 2003, to file a press release reporting our results
of operations for the quarter ended March 31, 2003. 39




---



##### 



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. Date:
    
    June 24, 2004
    
    By:
    
    /s/
    
    Frederick D. SancilioFrederick D. Sancilio, Ph.D.Executive Chairman of the Board,Chief Executive OfficerDate:
    
    June 24, 2004
    
    By:
    
    /s/
    
    Gina GutzeitGina GutzeitInterim Chief Financial Officer
 40




---



##### 



aaiPharma Inc. 
 Exhibit Index
 ExhibitNo.
    
    Description31.1
    
    Certification pursuant to Exchange Act Rule 13a  14(a) of Frederick D. Sancilio31.2
    
    Certification pursuant to Exchange Act Rule 13a  14(a) of Gina Gutzeit32.1
    
    Certification pursuant to 18 U.S.C. Section 1350
 41