##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, DC 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2005
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period  to
 Commission File Number 0-21185
 AAIPHARMA INC.
  DELAWARE
    
    04-2687849(State or other jurisdiction of
    
    (I.R.S. employerincorporation or organization)
    
    identification no.)
 2320 SCIENTIFIC PARK DRIVE, WILMINGTON, NC 28405
 (910) 254-7000
 þ o
 þ o
 o þ




---



##### 



TM
  PART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements(unaudited)Consolidated Statements of OperationsConsolidated Balance SheetsConsolidated Statements of Cash FlowsConsolidated Statements of Comprehensive LossNotes to Consolidated Financial StatementsItem 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3.
    
    Quantitative and Qualitative Disclosures About Market RiskItem 4.
    
    Controls and ProceduresPART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal ProceedingsItem 2.
    
    Unregistered Sales of Equity Securities and Use of ProceedsItem 3.
    
    Defaults Upon Senior SecuritiesItem 6.
    
    ExhibitsSIGNATURESEXHIBIT INDEX
 2




---



##### 



PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
 AAIPharma Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net revenues:Product sales
    
    $
    3,263
    
    
    $
    13,520
    
    
    $
    34,316
    
    
    $
    59,734Product development (milestones and
royalties)
    
    
    282
    
    
    
    4,481
    
    
    
    8,326
    
    
    
    14,522Development services
    
    
    18,588
    
    
    
    23,054
    
    
    
    58,621
    
    
    
    72,529Reimbursed out-of-pocket
    
    
    1,823
    
    
    
    4,631
    
    
    
    6,866
    
    
    
    13,37223,956
    
    
    
    45,686
    
    
    
    108,129
    
    
    
    160,157Operating costs and expenses:Direct costs (excluding depreciation
and royalty expense):Product sales (includes product
rights amortization of $872, $3,972,
$6,110 and $11,916)
    
    
    2,286
    
    
    
    10,404
    
    
    
    17,620
    
    
    
    35,494Development services
    
    
    14,802
    
    
    
    12,749
    
    
    
    41,670
    
    
    
    42,248Reimbursable out-of-pocket
    
    
    1,823
    
    
    
    4,631
    
    
    
    6,866
    
    
    
    13,372Total direct costs
    
    
    18,911
    
    
    
    27,784
    
    
    
    66,156
    
    
    
    91,114Selling expenses
    
    
    1,204
    
    
    
    6,021
    
    
    
    4,406
    
    
    
    30,122General and administrative expenses
    
    
    7,379
    
    
    
    9,478
    
    
    
    26,240
    
    
    
    35,318Research and development
    
    
    444
    
    
    
    3,134
    
    
    
    3,278
    
    
    
    13,847Depreciation
    
    
    2,033
    
    
    
    2,367
    
    
    
    6,337
    
    
    
    6,404Professional fees  internal and
government investigations
    
    
    
    
    
    
    769
    
    
    
    299
    
    
    
    9,072Reorganization expenses
    
    
    4,018
    
    
    
    
    
    
    
    11,311
    
    
    
    Pharmaceutical assets gain on sale
    
    
    (29,046
    )
    
    
    
    
    
    
    (29,046
    )
    
    
    M.V.I. contingent payment/(gain on sale)
    
    
    
    
    
    
    (1,567
    )
    
    
    
    
    
    
    (8,112
    )Restructuring charges
    
    
    
    
    
    
    13,719
    
    
    
    
    
    
    
    17,119Royalty expenses
    
    
    22
    
    
    
    357
    
    
    
    247
    
    
    
    1,366Intangible asset impairment
    
    
    
    
    
    
    5,250
    
    
    
    1,190
    
    
    
    5,250Total operating costs and expenses
    
    
    4,965
    
    
    
    67,312
    
    
    
    90,418
    
    
    
    201,500Income (loss) from operations
    
    
    18,991
    
    
    
    (21,626
    )
    
    
    17,711
    
    
    
    (41,343
    )
 3




---



##### 



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Other income (expense):Interest, net
    
    
    (2,093
    )
    
    
    (9,469
    )
    
    
    (22,174
    )
    
    
    (23,866
    )Loss from extinguishment of debt
    
    
    (5,644
    )
    
    
    
    
    
    
    (12,432
    )
    
    
    (6,229
    )Other
    
    
    (438
    )
    
    
    (275
    )
    
    
    (1,190
    )
    
    
    (2,111
    )(8,175
    )
    
    
    (9,744
    )
    
    
    (35,796
    )
    
    
    (32,206
    )Income (loss) before taxes
    
    
    10,816
    
    
    
    (31,370
    )
    
    
    (18,085
    )
    
    
    (73,549
    )Provision for income taxes
    
    
    
    
    
    
    4,583
    
    
    
    219
    
    
    
    4,758Net income (loss)
    
    $
    10,816
    
    
    $
    (35,953
    )
    
    $
    (18,304
    )
    
    $
    (78,307
    )Basic earnings (loss) per share
    
    $
    0.38
    
    
    $
    (1.26
    )
    
    $
    (0.64
    )
    
    $
    (2.74
    )Weighted average shares outstanding
    
    
    28,586
    
    
    
    28,586
    
    
    
    28,586
    
    
    
    28,558Diluted earnings (loss) per share
    
    $
    0.38
    
    
    $
    (1.26
    )
    
    $
    (0.64
    )
    
    $
    (2.74
    )Weighted average shares outstanding
    
    
    28,586
    
    
    
    28,586
    
    
    
    28,586
    
    
    
    28,558
  4




---



##### 



AAIPharma Inc.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
 September 30,
    
    
    December 31,2005
    
    
    2004(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    4,471
    
    
    $
    7,130Restricted cash
    
    
    6,346
    
    
    
    Accounts receivable, net
    
    
    7,850
    
    
    
    12,756Work-in-progress
    
    
    10,513
    
    
    
    10,172Inventories, net
    
    
    3,122
    
    
    
    10,722Income tax recoverable
    
    
    
    
    
    
    11,110Prepaid and other current assets
    
    
    4,020
    
    
    
    7,751Total current assets
    
    
    36,322
    
    
    
    59,641Property and equipment, net
    
    
    44,254
    
    
    
    52,942Goodwill, net
    
    
    12,898
    
    
    
    14,350Intangible assets, net
    
    
    6,537
    
    
    
    190,099Other assets
    
    
    14,004
    
    
    
    22,038Total assets
    
    $
    114,015
    
    
    $
    339,070LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)Current liabilities:Current maturities of long-term debt
    
    $
    
    
    
    $
    351,645Accounts payable
    
    
    8,244
    
    
    
    22,031Customer advances
    
    
    10,658
    
    
    
    11,043Accrued wages and benefits
    
    
    3,686
    
    
    
    4,881Interest payable
    
    
    132
    
    
    
    5,738Deferred product revenue
    
    
    
    
    
    
    4,127Other accrued liabilities
    
    
    3,575
    
    
    
    51,481Liabilities subject to compromise
    
    
    219,771
    
    
    
    Total current liabilities
    
    
    246,066
    
    
    
    450,946Other liabilities
    
    
    9
    
    
    
    14Stockholders equity (deficit):Common stock
    
    
    29
    
    
    
    29Paid-in capital
    
    
    91,425
    
    
    
    91,425Accumulated deficit
    
    
    (225,782
    )
    
    
    (207,478
    )Accumulated other comprehensive income
    
    
    2,281
    
    
    
    4,398Deferred compensation
    
    
    (13
    )
    
    
    (264
    )Total stockholders equity (deficit)
    
    
    (132,060
    )
    
    
    (111,890
    )Total liabilities and stockholders equity (deficit)
    
    $
    114,015
    
    
    $
    339,070
  5




---



##### 



AAIPharma Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 Nine Months EndedSeptember 30,2005
    
    
    2004Cash flows from operating activities:Net loss
    
    $
    (18,304
    )
    
    $
    (78,307
    )Adjustments to reconcile net loss to
net cash used in operating activities:Depreciation and amortization
    
    
    12,730
    
    
    
    18,320Intangible asset impairment
    
    
    1,190
    
    
    
    5,250Write-off of deferred financing and related costs
    
    
    8,482
    
    
    
    6,229Net gain from asset sale
    
    
    (29,046
    )
    
    
    (39,113
    )Noncash stock based compensation
    
    
    251
    
    
    
    104Loss on disposal of assets and other
    
    
    221
    
    
    
    237Changes in operating assets and liabilities:Accounts receivable, net
    
    
    4,592
    
    
    
    27,895Work-in-progress
    
    
    (1,483
    )
    
    
    1,083Inventories
    
    
    3,892
    
    
    
    (1,824
    )Income taxes recoverable
    
    
    11,110
    
    
    
    8,728Prepaid and other assets
    
    
    1,773
    
    
    
    (5,889
    )Accounts payable
    
    
    (5,187
    )
    
    
    (318
    )Customer advances
    
    
    337
    
    
    
    (3,768
    )Accrued wages and benefits
    
    
    (463
    )
    
    
    1,542Interest payable
    
    
    7,205
    
    
    
    4,760Deferred product revenue
    
    
    (4,127
    )
    
    
    (35,032
    )Other accrued liabilities
    
    
    (18,204
    )
    
    
    24,525Net cash used in operating activities
    
    
    (25,031
    )
    
    
    (65,578
    )Cash flows from investing activities:Proceeds from sales of property and equipment
    
    
    19
    
    
    
    97Purchases of property and equipment
    
    
    (1,707
    )
    
    
    (5,475
    )Proceeds from disposition of pharmaceutical assets
    
    
    205,952
    
    
    
    92,944Funds deposited in restricted cash account
    
    
    (8,000
    )
    
    
    Payments from restricted cash account
    
    
    1,654
    
    
    
    Other
    
    
    35
    
    
    
    (199
    )Net cash provided by investing activities
    
    
    197,953
    
    
    
    87,367Cash flows from financing activities:Proceeds from long-term borrowings
    
    
    180,000
    
    
    
    147,500Payments on long-term borrowings
    
    
    (355,500
    )
    
    
    (164,000
    )Payments on interest rate swaps, net
    
    
    (129
    )
    
    
    (10,203
    )Proceeds from stock option exercises
    
    
    
    
    
    
    3,574Other
    
    
    68
    
    
    
    (292
    )Net cash used in financing activities
    
    
    (175,561
    )
    
    
    (23,421
    )
 6




---



##### 



Nine Months EndedSeptember 30,2005
    
    
    2004Net decrease in cash and cash equivalents
    
    
    (2,639
    )
    
    
    (1,632
    )Effect of exchange rate changes on cash
    
    
    (20
    )
    
    
    (10
    )Cash and cash equivalents, beginning of period
    
    
    7,130
    
    
    
    8,785Cash and cash equivalents, end of period
    
    $
    4,471
    
    
    $
    7,143Supplemental information, cash paid for:Interest
    
    $
    10,990
    
    
    $
    17,868Income taxes (refunds)
    
    $
    (11,060
    )
    
    $
    5,923
  7




---



##### 



AAIPharma Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income (loss)
    
    $
    10,816
    
    
    $
    (35,953
    )
    
    $
    (18,304
    )
    
    $
    (78,307
    )Currency translation
adjustments, net of tax
    
    
    42
    
    
    
    384
    
    
    
    (2,117
    )
    
    
    (664
    )Comprehensive income (loss)
    
    $
    10,858
    
    
    $
    (35,569
    )
    
    $
    (20,421
    )
    
    $
    (78,971
    )
  8




---



##### 



AAIPharma Inc.
 1. Basis of presentation and other matters
   ( )
 9




---



##### 



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(In thousands, except per share data)Net income (loss), as reported
    
    $
    10,816
    
    
    $
    (35,953
    )
    
    $
    (18,304
    )
    
    $
    (78,307
    )Add back deferred compensation
expense, net of tax
    
    
    18
    
    
    
    49
    
    
    
    151
    
    
    
    62Less pro forma stock-based
compensation cost, net of tax
    
    
    829
    
    
    
    1,088
    
    
    
    3,721
    
    
    
    4,635Pro forma net income (loss)
    
    $
    10,005
    
    
    $
    (36,992
    )
    
    $
    (21,874
    )
    
    $
    (82,880
    )Income (loss) per share:As reported Basic
    
    $
    0.38
    
    
    
    ($1.26
    )
    
    
    ($0.64
    )
    
    
    ($2.74
    )Diluted
    
    $
    0.38
    
    
    
    ($1.26
    )
    
    
    ($0.64
    )
    
    
    ($2.74
    )Pro forma Basic
    
    $
    0.35
    
    
    
    ($1.29
    )
    
    
    ($0.77
    )
    
    
    ($2.90
    )Diluted
    
    $
    0.35
    
    
    
    ($1.29
    )
    
    
    ($0.77
    )
    
    
    ($2.90
    )
 Going Concern and Bankruptcy Filing
    10




---



##### 



September 30,2005(In thousands)Current maturities of long-term debt
    
    $
    176,067Accounts payable
    
    
    7,746Accrued wages and benefits
    
    
    576Interest payable
    
    
    12,811Deferred product revenue
    
    
    Other accrued liabilities
    
    
    22,571$
    219,771
  Balance at June 30, 2005
    
    $
    235,015Settlement of minimum purchase commitment
    
    
    (11,695
    )Bankruptcy Court approved settlement
    
    
    (1,032
    )Other adjustments
    
    
    (2,517
    )Balance at September 30, 2005
    
    $
    219,771
  11




---



##### 



Asset Sale
     Reorganization Expenses
  12




---



##### 



Impact of Recently Issued Accounting Standards
    2. M.V.I. and Aquasol Product Line Sale and Contingent Payment
   13




---



##### 



3. Income taxes
  4. Income (loss) per share
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(in thousands)
    
    
    (in thousands)Basic income (loss) per share:Weighted average number of shares
    
    
    28,586
    
    
    
    28,586
    
    
    
    28,586
    
    
    
    28,558Effect of dilutive securities:Stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Diluted income (loss) per share:Adjusted weighted average number of
shares and assumed conversions
    
    
    28,586
    
    
    
    28,586
    
    
    
    28,586
    
    
    
    28,558
 5. Financial information by business segment and geographic area
  14




---



##### 



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(in thousands)Net revenues:Product sales
    
    $
    3,263
    
    
    $
    13,520
    
    
    $
    34,316
    
    
    $
    59,734Product development (milestones
and
royalties)
    
    
    282
    
    
    
    4,481
    
    
    
    8,326
    
    
    
    14,522Development services
    
    
    18,588
    
    
    
    23,054
    
    
    
    58,621
    
    
    
    72,529Reimbursed out-of-pockets
    
    
    1,823
    
    
    
    4,631
    
    
    
    6,866
    
    
    
    13,372$
    23,956
    
    
    $
    45,686
    
    
    $
    108,129
    
    
    $
    160,157United States
    
    $
    18,060
    
    
    $
    39,912
    
    
    $
    91,406
    
    
    $
    142,140Germany
    
    
    5,855
    
    
    
    5,755
    
    
    
    16,794
    
    
    
    18,253Other
    
    
    95
    
    
    
    191
    
    
    
    570
    
    
    
    1,095Less intercompany
    
    
    (54
    )
    
    
    (172
    )
    
    
    (641
    )
    
    
    (1,331
    )$
    23,956
    
    
    $
    45,686
    
    
    $
    108,129
    
    
    $
    160,157Income (loss) from operations:Product sales
    
    $
    28,671
    
    
    $
    (7,090
    )
    
    $
    37,915
    
    
    $
    (7,096
    )Product development (milestones
and
royalties)
    
    
    282
    
    
    
    4,481
    
    
    
    8,326
    
    
    
    14,522Development services
    
    
    (1,691
    )
    
    
    (5,004
    )
    
    
    (604
    )
    
    
    (4,168
    )27,262
    
    
    
    (7,613
    )
    
    
    45,637
    
    
    
    3,258Research and development expense
    
    
    (514
    )
    
    
    (3,748
    )
    
    
    (3,525
    )
    
    
    (14,663
    )Corporate
    
    
    (7,757
    )
    
    
    (10,265
    )
    
    
    (24,401
    )
    
    
    (29,938
    )$
    18,991
    
    
    $
    (21,626
    )
    
    $
    17,711
    
    
    $
    (41,343
    )United States
    
    $
    18,985
    
    
    $
    (21,963
    )
    
    $
    17,540
    
    
    $
    (43,110
    )Germany
    
    
    176
    
    
    
    493
    
    
    
    586
    
    
    
    1,850Other
    
    
    (170
    )
    
    
    (156
    )
    
    
    (415
    )
    
    
    (83
    )$
    18,991
    
    
    $
    (21,626
    )
    
    $
    17,711
    
    
    $
    (41,343
    )
 15




---



##### 



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(in thousands)Depreciation and amortization:Product sales
    
    $
    1,029
    
    
    $
    4,240
    
    
    $
    7,083
    
    
    $
    12,629Development services
    
    
    1,583
    
    
    
    1,322
    
    
    
    3,980
    
    
    
    3,703Research and development expense
    
    
    70
    
    
    
    145
    
    
    
    247
    
    
    
    347Corporate
    
    
    507
    
    
    
    632
    
    
    
    1,420
    
    
    
    1,641$
    3,189
    
    
    $
    6,339
    
    
    $
    12,730
    
    
    $
    18,320
 September 30,
    
    
    December 31,2005
    
    
    2004Total assets:Product sales
    
    $
    12,350
    
    
    $
    233,682Product development (milestones and royalties)
    
    
    1,380
    
    
    
    14,777Development services
    
    
    54,537
    
    
    
    51,939Corporate
    
    
    45,748
    
    
    
    38,672$
    114,015
    
    
    $
    339,070United States
    
    $
    87,093
    
    
    $
    308,018Germany
    
    
    26,312
    
    
    
    29,077Other
    
    
    610
    
    
    
    1,975$
    114,015
    
    
    $
    339,070Goodwill, net:Development services
    
    $
    12,898
    
    
    $
    14,350
 6. Accounts receivable, net
  September 30,
    
    
    December 31,2005
    
    
    2004(In thousands)Gross accounts receivable
    
    $
    20,156
    
    
    $
    39,885Allowance for uncollectible accounts
    
    
    (2,912
    )
    
    
    (2,564
    )Allowance for customer credits
    
    
    (9,394
    )
    
    
    (24,565
    )Total accounts receivable, net
    
    $
    7,850
    
    
    $
    12,756
 16




---



##### 



7. Inventories, net
  September 30,
    
    
    December 31,2005
    
    
    2004(In thousands)Finished goods
    
    $
    1,220
    
    
    $
    11,613Work-in-process
    
    
    83
    
    
    
    799Raw materials and supplies
    
    
    3,531
    
    
    
    5,747Inventory reserves
    
    
    (1,712
    )
    
    
    (7,437
    )Total inventories, net
    
    $
    3,122
    
    
    $
    10,722
 8. Debt
 September 30,
    
    
    December 31,2005
    
    
    2004(In thousands)Current maturities of long-term debt
    
    $
    
    
    
    $
    351,645
  September 30,
    
    
    December 31,2005
    
    
    2004(In thousands)Term loan
    
    $
    
    
    
    $
    165,000Revolving credit facility
    
    
    
    
    
    
    10,50011% senior subordinated notes due 2010, net of original issue
discount
    
    
    174,300
    
    
    
    174,249Interest rate swap monetization deferred income, net
    
    
    1,767
    
    
    
    1,896Fair value of interest rate swap
    
    
    
    
    
    
    Less liabilities subject to compromise
    
    
    (176,067
    )
    
    
    Less current maturities of long-term debt
    
    
    
    
    
    
    (351,645
    )Total long-term debt due after one year
    
    $
    
    
    
    $
    
    
    
    provide that the liens on assets that secure obligations under the senior subordinated
notes will continue if all senior debt is repaid, but will resume as junior liens if the
Company thereafter incurs any new senior debt; and
 17




---



##### 




    
    temporarily increase the interest rate on the senior subordinated notes by 0.5% per annum
(to 12% per annum), commencing to accrue on October 1, 2004 and ending on March 31, 2005.
      18




---



##### 




    
    100% of the capital stock of the Companys domestic subsidiaries;
    
    65% of the capital stock of the Companys first-tier foreign subsidiaries; and
    
    All of the Companys assets and the assets of the Companys existing and future
domestic subsidiaries.
  9. Other Accrued Liabilities and Restructuring Charges
  19




---



##### 



September 30,
    
    
    December 31,2005
    
    
    2004(In thousands)Reserve for restructuring
    
    $
    11,153
    
    
    $
    14,953Consignment inventory returns reserve
    
    
    8,524
    
    
    
    12,412Guaranteed purchase commitments
    
    
    
    
    
    
    11,695Advance royalty payments
    
    
    
    
    
    
    7,209Other
    
    
    6,469
    
    
    
    5,212Less liabilities subject to compromise
    
    
    (22,571
    )
    
    
    Total other accrued liabilities, net
    
    $
    3,575
    
    
    $
    51,481
    December 31,
    
    
    
    
    
    
    Less
    
    
    September 30,2004
    
    
    
    
    
    
    Payments/
    
    
    2005Balance
    
    
    Charges
    
    
    Write-downs
    
    
    BalanceLease costs, net of estimated sub-lease income
    
    $
    10,277
    
    
    $
    
    
    
    $
    (1,547
    )
    
    $
    8,730Severance costs
    
    
    4,082
    
    
    
    
    
    
    
    (1,834
    )
    
    
    2,248Other costs
    
    
    594
    
    
    
    
    
    
    
    (419
    )
    
    
    175Total
    
    $
    14,953
    
    
    $
    
    
    
    $
    (3,800
    )
    
    $
    11,153
 10. Intangible Asset Impairment
  11. Commitments and Contingencies
   20




---



##### 



21




---



##### 



22




---



##### 



23




---



##### 



24




---



##### 



25




---



##### 



26




---



##### 



12. Financial information for subsidiary guarantors and non-guarantors
    AAIPharma Inc.
CONSOLIDATING STATEMENT OF OPERATIONS
(In thousands)
 Three Months Ended September 30, 2005Non-DebtorDebtor Entities
    
    
    EntitiesGuarantor
    
    
    Non-GuarantorIssuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedNet revenues
    
    $
    10,416
    
    
    $
    7,644
    
    
    $
    5,950
    
    
    $
    (54
    )
    
    $
    23,956Equity earnings from subsidiaries
    
    
    21,196
    
    
    
    
    
    
    
    
    
    
    
    (21,196
    )
    
    
    Total revenues
    
    
    31,612
    
    
    
    7,644
    
    
    
    5,950
    
    
    
    (21,250
    )
    
    
    23,956Operating costs and expenses:Direct costs (excluding
depreciation and royalty
expense)
    
    
    8,621
    
    
    
    6,252
    
    
    
    4,091
    
    
    
    (53
    )
    
    
    18,911Selling expenses
    
    
    419
    
    
    
    367
    
    
    
    418
    
    
    
    
    
    
    
    1,204General and administrative
expenses
    
    
    8,943
    
    
    
    (2,760
    )
    
    
    1,196
    
    
    
    
    
    
    
    7,379Research and development
    
    
    
    
    
    
    444
    
    
    
    
    
    
    
    
    
    
    
    444Depreciation
    
    
    1,576
    
    
    
    219
    
    
    
    238
    
    
    
    
    
    
    
    2,033Reorganization expenses
    
    
    
    
    
    
    4,018
    
    
    
    
    
    
    
    
    
    
    
    4,018Pharmaceutical assets gain on
sale
    
    
    
    
    
    
    (29,046
    )
    
    
    
    
    
    
    
    
    
    
    (29,046
    )Royalty expenses
    
    
    
    
    
    
    22
    
    
    
    
    
    
    
    
    
    
    
    2219,559
    
    
    
    (20,484
    )
    
    
    5,943
    
    
    
    (53
    )
    
    
    4,965Income (loss) from operations
    
    
    12,053
    
    
    
    28,128
    
    
    
    7
    
    
    
    (21,197
    )
    
    
    18,991Other income (expense:)Interest, net
    
    
    (4,899
    )
    
    
    2,642
    
    
    
    164
    
    
    
    
    
    
    
    (2,093
    )Net intercompany interest
    
    
    4,036
    
    
    
    (3,868
    )
    
    
    (168
    )
    
    
    
    
    
    
    Other expense, net
    
    
    (374
    )
    
    
    (5,625
    )
    
    
    (83
    )
    
    
    
    
    
    
    (6,082
    )(1,237
    )
    
    
    (6,851
    )
    
    
    (87
    )
    
    
    
    
    
    
    (8,175
    )
 27




---



##### 



Three Months Ended September 30, 2005Non-DebtorDebtor Entities
    
    
    EntitiesGuarantor
    
    
    Non-GuarantorIssuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedIncome (loss) before income taxes
    
    
    10,816
    
    
    
    21,277
    
    
    
    (80
    )
    
    
    (21,197
    )
    
    
    10,816Provision for (benefit from)
income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    10,816
    
    
    $
    21,277
    
    
    $
    (80
    )
    
    $
    (21,197
    )
    
    $
    10,816
 28




---



##### 



AAIPharma Inc.
CONSOLIDATING STATEMENT OF OPERATIONS
(In thousands)
 Three Months Ended September 30, 2004Non-DebtorDebtor Entities
    
    
    EntitiesGuarantor
    
    
    Non-GuarantorIssuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedNet revenues
    
    $
    12,911
    
    
    $
    27,000
    
    
    $
    5,946
    
    
    $
    (171
    )
    
    $
    45,686Equity earnings from subsidiaries
    
    
    (12,824
    )
    
    
    
    
    
    
    
    
    
    
    12,824
    
    
    
    Total revenues
    
    
    87
    
    
    
    27,000
    
    
    
    5,946
    
    
    
    12,653
    
    
    
    45,686Operating costs and expenses:Direct costs (excluding
depreciation and royalty expense)
    
    
    8,057
    
    
    
    16,238
    
    
    
    3,612
    
    
    
    (123
    )
    
    
    27,784Selling expenses
    
    
    1,563
    
    
    
    3,924
    
    
    
    534
    
    
    
    
    
    
    
    6,021General and administrative expenses
    
    
    6,487
    
    
    
    1,832
    
    
    
    1,159
    
    
    
    
    
    
    
    9,478Research and development
    
    
    (1
    )
    
    
    3,135
    
    
    
    
    
    
    
    
    
    
    
    3,134Depreciation
    
    
    1,541
    
    
    
    522
    
    
    
    304
    
    
    
    
    
    
    
    2,367Professional fees  internal inquiry
    
    
    
    
    
    
    769
    
    
    
    
    
    
    
    
    
    
    
    769M.V.I. Contingent payment/(gain on
sale)
    
    
    
    
    
    
    (1,567
    )
    
    
    
    
    
    
    
    
    
    
    (1,567
    )Restructuring charges
    
    
    
    
    
    
    13,719
    
    
    
    
    
    
    
    
    
    
    
    13,719Royalty expenses
    
    
    
    
    
    
    357
    
    
    
    
    
    
    
    
    
    
    
    357Intangible asset impairment
    
    
    
    
    
    
    5,250
    
    
    
    
    
    
    
    
    
    
    
    5,25017,647
    
    
    
    44,179
    
    
    
    5,609
    
    
    
    (123
    )
    
    
    67,312(Loss) income from operations
    
    
    (17,560
    )
    
    
    (17,179
    )
    
    
    337
    
    
    
    12,776
    
    
    
    (21,626
    )Other expense:Interest, net
    
    
    (192
    )
    
    
    (9,355
    )
    
    
    78
    
    
    
    
    
    
    
    (9,469
    )Net intercompany interest
    
    
    (513
    )
    
    
    593
    
    
    
    (80
    )
    
    
    
    
    
    
    Other (expense) income, net
    
    
    (13,253
    )
    
    
    13,067
    
    
    
    (89
    )
    
    
    
    
    
    
    (275
    )(13,958
    )
    
    
    4,305
    
    
    
    (91
    )
    
    
    
    
    
    
    (9,744
    )(Loss) income before income taxes
    
    
    (31,518
    )
    
    
    (12,874
    )
    
    
    246
    
    
    
    12,776
    
    
    
    (31,370
    )Provision for income taxes
    
    
    4,435
    
    
    
    147
    
    
    
    1
    
    
    
    
    
    
    
    4,583Net (loss) income
    
    $
    (35,953
    )
    
    $
    (13,021
    )
    
    $
    245
    
    
    $
    12,776
    
    
    $
    (35,953
    )
 29




---



##### 



AAIPharma Inc.
CONSOLIDATING STATEMENT OF OPERATIONS
(In thousands)
 Nine Months Ended September 30, 2005Non-DebtorDebtor Entities
    
    
    EntitiesGuarantor
    
    
    Non-GuarantorIssuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedNet revenues
    
    $
    32,486
    
    
    $
    58,919
    
    
    $
    17,364
    
    
    $
    (640
    )
    
    $
    108,129Equity earnings from subsidiaries
    
    
    11,897
    
    
    
    
    
    
    
    
    
    
    
    (11,897
    )
    
    
    Total revenues
    
    
    44,383
    
    
    
    58,919
    
    
    
    17,364
    
    
    
    (12,537
    )
    
    
    108,129Operating costs and expenses:Direct costs (excluding
depreciation and royalty expense)
    
    
    24,695
    
    
    
    30,026
    
    
    
    11,881
    
    
    
    (446
    )
    
    
    66,156Selling expenses
    
    
    1,409
    
    
    
    1,608
    
    
    
    1,389
    
    
    
    
    
    
    
    4,406General and administrative
expenses
    
    
    29,352
    
    
    
    (6,270
    )
    
    
    3,158
    
    
    
    
    
    
    
    26,240Research and development
    
    
    
    
    
    
    3,278
    
    
    
    
    
    
    
    
    
    
    
    3,278Depreciation
    
    
    3,961
    
    
    
    1,613
    
    
    
    763
    
    
    
    
    
    
    
    6,337Professional fees  internal and
government investigations
    
    
    
    
    
    
    299
    
    
    
    
    
    
    
    
    
    
    
    299Reorganization expenses
    
    
    
    
    
    
    11,311
    
    
    
    
    
    
    
    
    
    
    
    11,311Pharmaceutical assets gain on sale
    
    
    
    
    
    
    (29,046
    )
    
    
    
    
    
    
    
    
    
    
    (29,046
    )Royalty expenses
    
    
    
    
    
    
    247
    
    
    
    
    
    
    
    
    
    
    
    247Intangible asset impairment
    
    
    
    
    
    
    1,190
    
    
    
    
    
    
    
    
    
    
    
    1,19059,417
    
    
    
    14,256
    
    
    
    17,191
    
    
    
    (446
    )
    
    
    90,418(Loss) income from operations
    
    
    (15,034
    )
    
    
    44,663
    
    
    
    173
    
    
    
    (12,091
    )
    
    
    17,711Other income (expense:)Interest, net
    
    
    (5,417
    )
    
    
    (16,998
    )
    
    
    241
    
    
    
    
    
    
    
    (22,174
    )Net intercompany interest
    
    
    2,617
    
    
    
    (2,366
    )
    
    
    (251
    )
    
    
    
    
    
    
    Other expense, net
    
    
    (470
    )
    
    
    (12,598
    )
    
    
    (554
    )
    
    
    
    
    
    
    (13,622
    )(3,270
    )
    
    
    (31,962
    )
    
    
    (564
    )
    
    
    
    
    
    
    (35,796
    )(Loss) income before income taxes
    
    
    (18,304
    )
    
    
    12,701
    
    
    
    (391
    )
    
    
    (12,091
    )
    
    
    (18,085
    )Provision for (benefit from) income
taxes
    
    
    
    
    
    
    254
    
    
    
    (35
    )
    
    
    
    
    
    
    219Net (loss) income
    
    $
    (18,304
    )
    
    $
    12,447
    
    
    $
    (356
    )
    
    $
    (12,091
    )
    
    $
    (18,304
    )
 30




---



##### 



AAIPharma Inc.
CONSOLIDATING STATEMENT OF OPERATIONS
(In thousands)
 Nine Months Ended September 30, 2004Non-DebtorDebtor Entities
    
    
    EntitiesGuarantor
    
    
    Non-GuarantorIssuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedNet revenues
    
    $
    41,852
    
    
    $
    100,286
    
    
    $
    19,349
    
    
    $
    (1,330
    )
    
    $
    160,157Equity earnings from subsidiaries
    
    
    (25,232
    )
    
    
    
    
    
    
    
    
    
    
    25,232
    
    
    
    Total revenues
    
    
    16,620
    
    
    
    100,286
    
    
    
    19,349
    
    
    
    23,902
    
    
    
    160,157Operating costs and expenses:Direct costs (excluding
depreciation and royalty
expense)
    
    
    28,653
    
    
    
    51,681
    
    
    
    11,607
    
    
    
    (827
    )
    
    
    91,114Selling expenses
    
    
    5,098
    
    
    
    23,226
    
    
    
    1,798
    
    
    
    
    
    
    
    30,122General and administrative
expenses
    
    
    32,529
    
    
    
    (496
    )
    
    
    3,285
    
    
    
    
    
    
    
    35,318Research and development
    
    
    5
    
    
    
    13,842
    
    
    
    
    
    
    
    
    
    
    
    13,847Depreciation
    
    
    4,165
    
    
    
    1,349
    
    
    
    890
    
    
    
    
    
    
    
    6,404Professional fees  internal
inquiry
    
    
    
    
    
    
    9,072
    
    
    
    
    
    
    
    
    
    
    
    9,072M.V.I. Contingent
payment/(gain on sale)
    
    
    
    
    
    
    (8,112
    )
    
    
    
    
    
    
    
    
    
    
    (8,112
    )Restructuring charges
    
    
    
    
    
    
    17,119
    
    
    
    
    
    
    
    
    
    
    
    17,119Royalty expenses
    
    
    
    
    
    
    1,366
    
    
    
    
    
    
    
    
    
    
    
    1,366Intangible asset impairment
    
    
    
    
    
    
    5,250
    
    
    
    
    
    
    
    
    
    
    
    5,25070,450
    
    
    
    114,297
    
    
    
    17,580
    
    
    
    (827
    )
    
    
    201,500(Loss) income from operations
    
    
    (53,830
    )
    
    
    (14,011
    )
    
    
    1,769
    
    
    
    24,729
    
    
    
    (41,343
    )Other expense:Interest, net
    
    
    (209
    )
    
    
    (23,838
    )
    
    
    181
    
    
    
    
    
    
    
    (23,866
    )Net intercompany interest
    
    
    (1,470
    )
    
    
    1,657
    
    
    
    (187
    )
    
    
    
    
    
    
    Other (expense) income, net
    
    
    (18,327
    )
    
    
    10,259
    
    
    
    (272
    )
    
    
    
    
    
    
    (8,340
    )(20,006
    )
    
    
    (11,922
    )
    
    
    (278
    )
    
    
    
    
    
    
    (32,206
    )(Loss) income before income taxes
    
    
    (73,836
    )
    
    
    (25,933
    )
    
    
    1,491
    
    
    
    24,729
    
    
    
    (73,549
    )Provision for income taxes
    
    
    4,471
    
    
    
    288
    
    
    
    (1
    )
    
    
    
    
    
    
    4,758Net (loss) income
    
    $
    (78,307
    )
    
    $
    (26,221
    )
    
    $
    1,492
    
    
    $
    24,729
    
    
    $
    (78,307
    )
 31




---



##### 



AAIPharma Inc.
CONSOLIDATING BALANCE SHEET
(In thousands)
 September 30, 2005Non-DebtorDebtor Entities
    
    
    EntitiesGuarantor
    
    
    Non-GuarantorIssuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCurrent assets:Cash and cash equivalents
    
    $
    4,131
    
    
    $
    47
    
    
    $
    293
    
    
    $
    
    
    
    $
    4,471Restricted cash
    
    
    6,346
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,346Accounts receivable, net
    
    
    8,890
    
    
    
    (3,771
    )
    
    
    2,731
    
    
    
    
    
    
    
    7,850Work-in-progress
    
    
    2,873
    
    
    
    4,974
    
    
    
    8,013
    
    
    
    (5,347
    )
    
    
    10,513Inventories, net
    
    
    1,787
    
    
    
    94
    
    
    
    1,241
    
    
    
    
    
    
    
    3,122Prepaid and other current assets
    
    
    2,210
    
    
    
    1,501
    
    
    
    309
    
    
    
    
    
    
    
    4,020Total current assets
    
    
    26,237
    
    
    
    2,845
    
    
    
    12,587
    
    
    
    (5,347
    )
    
    
    36,322Investments in and advances to subsidiaries
    
    
    66,099
    
    
    
    (46,240
    )
    
    
    
    
    
    
    (19,859
    )
    
    
    Property and equipment, net
    
    
    35,713
    
    
    
    5,290
    
    
    
    3,251
    
    
    
    
    
    
    
    44,254Goodwill, net
    
    
    726
    
    
    
    1,229
    
    
    
    10,943
    
    
    
    
    
    
    
    12,898Intangible assets, net
    
    
    6,537
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,537Other assets
    
    
    132
    
    
    
    13,730
    
    
    
    142
    
    
    
    
    
    
    
    14,004Total assets
    
    $
    135,444
    
    
    $
    (23,146
    )
    
    $
    26,923
    
    
    $
    (25,206
    )
    
    $
    114,015LIABILITIES AND STOCKHOLDERS EQUITY
(DEFICIT)Current liabilities:Accounts payable
    
    $
    6,678
    
    
    $
    934
    
    
    $
    632
    
    
    $
    
    
    
    $
    8,244Customer advances
    
    
    5,747
    
    
    
    3,133
    
    
    
    5,683
    
    
    
    (3,905
    )
    
    
    10,658Accrued wages and benefits
    
    
    1,515
    
    
    
    405
    
    
    
    1,766
    
    
    
    
    
    
    
    3,686Interest payable
    
    
    132
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    132Other accrued liabilities
    
    
    3,809
    
    
    
    1,298
    
    
    
    (588
    )
    
    
    (944
    )
    
    
    3,575Liabilities subject to compromise
    
    
    14,362
    
    
    
    205,409
    
    
    
    
    
    
    
    
    
    
    
    219,771Total current liabilities
    
    
    32,243
    
    
    
    211,179
    
    
    
    7,493
    
    
    
    (4,849
    )
    
    
    246,066Other liabilities
    
    
    9
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9Investments in and advances to subsidiaries
    
    
    198,830
    
    
    
    (203,265
    )
    
    
    3,289
    
    
    
    1,146
    
    
    
    Total stockholders equity (deficit)
    
    
    (95,638
    )
    
    
    (31,060
    )
    
    
    16,141
    
    
    
    (21,503
    )
    
    
    (132,060
    )Total liabilities and stockholders
equity (deficit)
    
    $
    135,444
    
    
    $
    (23,146
    )
    
    $
    26,923
    
    
    $
    (25,206
    )
    
    $
    114,015
 32




---



##### 



AAIPharma Inc.
CONSOLIDATING BALANCE SHEET
(In thousands)
 December 31, 2004Non-DebtorDebtor Entities
    
    
    EntitiesGuarantor
    
    
    Non-GuarantorIssuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedASSETSCurrent assets:Cash and cash equivalents
    
    $
    6,696
    
    
    $
    276
    
    
    $
    158
    
    
    $
    
    
    
    $
    7,130Accounts receivable, net
    
    
    10,831
    
    
    
    (756
    )
    
    
    2,681
    
    
    
    
    
    
    
    12,756Work-in-progress
    
    
    2,079
    
    
    
    4,830
    
    
    
    9,745
    
    
    
    (6,482
    )
    
    
    10,172Inventories, net
    
    
    1,871
    
    
    
    7,449
    
    
    
    1,402
    
    
    
    
    
    
    
    10,722Deferred tax assets
    
    
    11,110
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,110Prepaid and other current assets
    
    
    4,600
    
    
    
    2,940
    
    
    
    211
    
    
    
    
    
    
    
    7,751Total current assets
    
    
    37,187
    
    
    
    14,739
    
    
    
    14,197
    
    
    
    (6,482
    )
    
    
    59,641Investments in and advances to subsidiaries
    
    
    66,099
    
    
    
    (46,240
    )
    
    
    
    
    
    
    (19,859
    )
    
    
    Property and equipment, net
    
    
    36,108
    
    
    
    12,501
    
    
    
    4,333
    
    
    
    
    
    
    
    52,942Goodwill, net
    
    
    725
    
    
    
    1,229
    
    
    
    12,396
    
    
    
    
    
    
    
    14,350Intangibles assets, net
    
    
    1,159
    
    
    
    188,940
    
    
    
    
    
    
    
    
    
    
    
    190,099Other assets
    
    
    155
    
    
    
    21,757
    
    
    
    126
    
    
    
    
    
    
    
    22,038Total assets
    
    $
    141,433
    
    
    $
    192,926
    
    
    $
    31,052
    
    
    $
    (26,341
    )
    
    $
    339,070LIABILITIES AND STOCKHOLDERS EQUITY
(DEFICIT)Current liabilities:Current maturities of long-term debt
    
    $
    10,500
    
    
    $
    341,145
    
    
    $
    
    
    
    $
    
    
    
    $
    351,645Accounts payable
    
    
    7,057
    
    
    
    13,093
    
    
    
    1,881
    
    
    
    
    
    
    
    22,031Customer advances
    
    
    5,208
    
    
    
    4,327
    
    
    
    6,154
    
    
    
    (4,646
    )
    
    
    11,043Accrued wages and benefits
    
    
    2,553
    
    
    
    993
    
    
    
    1,335
    
    
    
    
    
    
    
    4,881Interest payable
    
    
    160
    
    
    
    5,578
    
    
    
    
    
    
    
    
    
    
    
    5,738Deferred product revenue
    
    
    
    
    
    
    4,127
    
    
    
    
    
    
    
    
    
    
    
    4,127Other accrued liabilities
    
    
    18,940
    
    
    
    33,698
    
    
    
    (408
    )
    
    
    (749
    )
    
    
    51,481Total current liabilities
    
    
    44,418
    
    
    
    402,961
    
    
    
    8,962
    
    
    
    (5,395
    )
    
    
    450,946Other liabilities
    
    
    14
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14Investments in and advances to subsidiaries
    
    
    162,690
    
    
    
    (166,510
    )
    
    
    3,457
    
    
    
    363
    
    
    
    Total stockholders equity (deficit)
    
    
    (65,689
    )
    
    
    (43,525
    )
    
    
    18,633
    
    
    
    (21,309
    )
    
    
    (111,890
    )Total liabilities and stockholders
equity (deficit)
    
    $
    141,433
    
    
    $
    192,926
    
    
    $
    31,052
    
    
    $
    (26,341
    )
    
    $
    339,070
 33




---



##### 



AAIPharma Inc.
CONSOLIDATING STATEMENT OF CASH FLOWS
(In thousands)
 Nine Months Ended September 30, 2005Non-DebtorDebtor Entities
    
    
    EntitiesNon-Guarantor
    
    
    GuarantorIssuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedCash flows from operating activities:Net (loss) income
    
    $
    (18,304
    )
    
    $
    12,447
    
    
    $
    (356
    )
    
    $
    (12,091
    )
    
    $
    (18,304
    )Adjustments to reconcile net (loss) income
to net cash provided by (used in)
operating activities:Depreciation and amortization
    
    
    3,962
    
    
    
    8,005
    
    
    
    763
    
    
    
    
    
    
    
    12,730Intangible asset impairment
    
    
    
    
    
    
    1,190
    
    
    
    
    
    
    
    
    
    
    
    1,190Write-off of deferred financing and other
costs
    
    
    
    
    
    
    8,482
    
    
    
    
    
    
    
    
    
    
    
    8,482Noncash stock based compensation
    
    
    251
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    251Net gain from asset sale
    
    
    (5,801
    )
    
    
    (23,245
    )
    
    
    
    
    
    
    
    
    
    
    (29,046
    )Loss on disposal of assets and other
    
    
    6
    
    
    
    14
    
    
    
    201
    
    
    
    
    
    
    
    221Changes in operating assets and liabilities:Accounts receivable, net
    
    
    1,941
    
    
    
    3,014
    
    
    
    (363
    )
    
    
    
    
    
    
    4,592Work-in-progress
    
    
    (794
    )
    
    
    (144
    )
    
    
    591
    
    
    
    (1,136
    )
    
    
    (1,483
    )Inventories
    
    
    84
    
    
    
    3,812
    
    
    
    (4
    )
    
    
    
    
    
    
    3,892Income taxes recoverable
    
    
    11,110
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,110Prepaid and other assets
    
    
    944
    
    
    
    983
    
    
    
    (154
    )
    
    
    
    
    
    
    1,773Accounts payable
    
    
    1,794
    
    
    
    (5,952
    )
    
    
    (1,029
    )
    
    
    
    
    
    
    (5,187
    )Customer advances
    
    
    539
    
    
    
    (1,193
    )
    
    
    250
    
    
    
    741
    
    
    
    337Accrued wages and benefits
    
    
    (462
    )
    
    
    (588
    )
    
    
    587
    
    
    
    
    
    
    
    (463
    )Interest payable
    
    
    (29
    )
    
    
    7,234
    
    
    
    
    
    
    
    
    
    
    
    7,205Deferred product revenue
    
    
    
    
    
    
    (4,127
    )
    
    
    
    
    
    
    
    
    
    
    (4,127
    )Other accrued liabilities
    
    
    (2,889
    )
    
    
    (15,297
    )
    
    
    177
    
    
    
    (195
    )
    
    
    (18,204
    )Intercompany receivables and payables
    
    
    25,078
    
    
    
    (37,591
    )
    
    
    (168
    )
    
    
    12,681
    
    
    
    Net cash provided by (used in) operating
activities
    
    
    17,430
    
    
    
    (42,956
    )
    
    
    495
    
    
    
    
    
    
    
    (25,031
    )Cash flows from investing activities:Proceeds from sales of property and equipment
    
    
    17
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    19Purchases of property and equipment
    
    
    (3,201
    )
    
    
    1,834
    
    
    
    (340
    )
    
    
    
    
    
    
    (1,707
    )Proceeds from disposition of pharmaceutical
assets
    
    
    
    
    
    
    205,952
    
    
    
    
    
    
    
    
    
    
    
    205,952Funds deposited in restricted cash account
    
    
    (8,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,000
    )Payments from restricted cash account
    
    
    1,654
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,654Other
    
    
    35
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35Net cash used in investing activities
    
    
    (9,495
    )
    
    
    207,788
    
    
    
    (340
    )
    
    
    
    
    
    
    197,953Cash flows from financing activities:Proceeds from long-term borrowings
    
    
    
    
    
    
    180,000
    
    
    
    
    
    
    
    
    
    
    
    180,000
 34




---



##### 



Nine Months Ended September 30, 2005Non-DebtorDebtor Entities
    
    
    EntitiesNon-Guarantor
    
    
    GuarantorIssuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedPayments on long-term borrowings
    
    
    (10,500
    )
    
    
    (345,000
    )
    
    
    
    
    
    
    
    
    
    
    (355,500
    )Payments on interest rate swaps, net
    
    
    
    
    
    
    (129
    )
    
    
    
    
    
    
    
    
    
    
    (129
    )Other
    
    
    
    
    
    
    68
    
    
    
    
    
    
    
    
    
    
    
    68Net cash (used in) provided by financing
activities
    
    
    (10,500
    )
    
    
    (165,061
    )
    
    
    
    
    
    
    
    
    
    
    (175,561
    )Net increase (decrease) in cash and cash
equivalents
    
    
    (2,565
    )
    
    
    (229
    )
    
    
    155
    
    
    
    
    
    
    
    (2,639
    )Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    (20
    )
    
    
    
    
    
    
    (20
    )Cash and cash equivalents, beginning of period
    
    
    6,696
    
    
    
    276
    
    
    
    158
    
    
    
    
    
    
    
    7,130Cash and cash equivalents, end of period
    
    $
    4,131
    
    
    $
    47
    
    
    $
    293
    
    
    $
    
    
    
    $
    4,471
 35




---



##### 



AAIPharma Inc.
CONSOLIDATING STATEMENT OF CASH FLOWS
(In thousands)
 Nine Months Ended September 30, 2004Non-DebtorDebtor Entities
    
    
    EntitiesNon-Guarantor
    
    
    GuarantorIssuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedCash flows from operating activities:Net (loss) income
    
    $
    (78,307
    )
    
    $
    (26,221
    )
    
    $
    1,492
    
    
    $
    24,729
    
    
    $
    (78,307
    )Adjustments to reconcile net (loss) income
to net cash (used in) provided by
operating activities:Depreciation and amortization
    
    
    3,917
    
    
    
    13,513
    
    
    
    890
    
    
    
    
    
    
    
    18,320Intangible asset impairment
    
    
    
    
    
    
    5,250
    
    
    
    
    
    
    
    
    
    
    
    5,250Write-off of deferred financing and other
costs
    
    
    
    
    
    
    6,229
    
    
    
    
    
    
    
    
    
    
    
    6,229Net gain from asset sale
    
    
    
    
    
    
    (39,113
    )
    
    
    
    
    
    
    
    
    
    
    (39,113
    )Non-cash stock based compensation
    
    
    104
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    104Other
    
    
    7
    
    
    
    12
    
    
    
    218
    
    
    
    
    
    
    
    237Changes in operating assets and liabilities:Accounts receivable, net
    
    
    (662
    )
    
    
    27,373
    
    
    
    1,184
    
    
    
    
    
    
    
    27,895Work-in-progress
    
    
    1,071
    
    
    
    200
    
    
    
    (920
    )
    
    
    732
    
    
    
    1,083Inventories
    
    
    (317
    )
    
    
    (1,490
    )
    
    
    (17
    )
    
    
    
    
    
    
    (1,824
    )Deferred tax assets
    
    
    8,728
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,728Prepaid and other assets
    
    
    1,242
    
    
    
    (7,125
    )
    
    
    (6
    )
    
    
    
    
    
    
    (5,889
    )Accounts payable
    
    
    1,412
    
    
    
    (222
    )
    
    
    (1,508
    )
    
    
    
    
    
    
    (318
    )Customer advances
    
    
    (2,393
    )
    
    
    (940
    )
    
    
    1,216
    
    
    
    (1,651
    )
    
    
    (3,768
    )Accrued wages and benefits
    
    
    768
    
    
    
    61
    
    
    
    713
    
    
    
    
    
    
    
    1,542Interest payable
    
    
    86
    
    
    
    4,674
    
    
    
    
    
    
    
    
    
    
    
    4,760Deferred product revenue
    
    
    
    
    
    
    (35,032
    )
    
    
    
    
    
    
    
    
    
    
    (35,032
    )Other accrued liabilities
    
    
    6,771
    
    
    
    17,198
    
    
    
    145
    
    
    
    411
    
    
    
    24,525Intercompany receivables and payables
    
    
    50,378
    
    
    
    (23,942
    )
    
    
    (2,215
    )
    
    
    (24,221
    )
    
    
    Net cash (used in) provided by operating
activities
    
    
    (7,195
    )
    
    
    (59,575
    )
    
    
    1,192
    
    
    
    
    
    
    
    (65,578
    )Cash flows from investing activities:Purchases of property and equipment
    
    
    (2,489
    )
    
    
    (1,887
    )
    
    
    (1,099
    )
    
    
    
    
    
    
    (5,475
    )Proceeds from sales of property and equipment
    
    
    9
    
    
    
    88
    
    
    
    
    
    
    
    
    
    
    
    97Proceeds from disposition of pharmaceutical
assets
    
    
    
    
    
    
    92,944
    
    
    
    
    
    
    
    
    
    
    
    92,944Other
    
    
    (237
    )
    
    
    38
    
    
    
    
    
    
    
    
    
    
    
    (199
    )Net cash used in (provided by) investing
activities
    
    
    (2,717
    )
    
    
    91,183
    
    
    
    (1,099
    )
    
    
    
    
    
    
    87,367Cash flows from financing activities:Proceeds from long-term borrowings
    
    
    12,500
    
    
    
    135,000
    
    
    
    
    
    
    
    
    
    
    
    147,500Payments on long-term borrowings
    
    
    (8,000
    )
    
    
    (156,000
    )
    
    
    
    
    
    
    
    
    
    
    (164,000
    )Proceeds from interest rate swaps, net
    
    
    
    
    
    
    (10,203
    )
    
    
    
    
    
    
    
    
    
    
    (10,203
    )Proceeds from stock option exercises
    
    
    3,574
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,574
 36




---



##### 



Nine Months Ended September 30, 2004Non-DebtorDebtor Entities
    
    
    EntitiesNon-Guarantor
    
    
    GuarantorIssuer
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Eliminations
    
    
    ConsolidatedOther
    
    
    
    
    
    
    (292
    )
    
    
    
    
    
    
    
    
    
    
    (292
    )Net cash provided by (used in) financing
activities
    
    
    8,074
    
    
    
    (31,495
    )
    
    
    
    
    
    
    
    
    
    
    (23,421
    )Net (decrease) increase in cash and cash
equivalents
    
    
    (1,838
    )
    
    
    113
    
    
    
    93
    
    
    
    
    
    
    
    (1,632
    )Effect of exchange rate changes on cash
    
    
    
    
    
    
    
    
    
    
    (10
    )
    
    
    
    
    
    
    (10
    )Cash and cash equivalents, beginning of period
    
    
    8,161
    
    
    
    192
    
    
    
    432
    
    
    
    
    
    
    
    8,785Cash and cash equivalents, end of period
    
    $
    6,323
    
    
    $
    305
    
    
    $
    515
    
    
    $
    
    
    
    $
    7,143
 37




---



##### 



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
  Summary
    38




---



##### 



39




---



##### 



Results of Operations
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(dollars in thousands)Net revenues:Product sales
    
    $
    3,263
    
    
    
    14
    %
    
    $
    13,520
    
    
    
    30
    %
    
    $
    34,316
    
    
    
    32
    %
    
    $
    59,734
    
    
    
    37
    %Product development (milestones and
royalties)
    
    
    282
    
    
    
    1
    %
    
    
    4,481
    
    
    
    10
    %
    
    
    8,326
    
    
    
    8
    %
    
    
    14,522
    
    
    
    9
    %Development services
    
    
    18,588
    
    
    
    77
    %
    
    
    23,054
    
    
    
    50
    %
    
    
    58,621
    
    
    
    54
    %
    
    
    72,529
    
    
    
    46
    %Reimbursed out-of-pocket
    
    
    1,823
    
    
    
    8
    %
    
    
    4,631
    
    
    
    10
    %
    
    
    6,866
    
    
    
    6
    %
    
    
    13,372
    
    
    
    8
    %$
    23,956
    
    
    
    100
    %
    
    $
    45,686
    
    
    
    100
    %
    
    $
    108,129
    
    
    
    100
    %
    
    $
    160,157
    
    
    
    100
    %
 40




---



##### 



Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(dollars in thousands)Direct costs (excluding depreciation
and royalty expense)
    
    $
    18,911
    
    
    
    79
    %
    
    $
    27,784
    
    
    
    61
    %
    
    $
    66,156
    
    
    
    61
    %
    
    $
    91,114
    
    
    
    57
    %Selling expenses
    
    
    1,204
    
    
    
    5
    
    
    
    6,021
    
    
    
    13
    
    
    
    4,406
    
    
    
    4
    
    
    
    30,122
    
    
    
    19General and administrative expenses
    
    
    7,379
    
    
    
    31
    
    
    
    9,478
    
    
    
    21
    
    
    
    26,240
    
    
    
    24
    
    
    
    35,318
    
    
    
    22Research and development
    
    
    444
    
    
    
    2
    
    
    
    3,134
    
    
    
    7
    
    
    
    3,278
    
    
    
    3
    
    
    
    13,847
    
    
    
    9Depreciation
    
    
    2,033
    
    
    
    8
    
    
    
    2,367
    
    
    
    5
    
    
    
    6,337
    
    
    
    6
    
    
    
    6,404
    
    
    
    4Professional fees  internal and
government investigations
    
    
    
    
    
    
    
    
    
    
    769
    
    
    
    2
    
    
    
    299
    
    
    
    
    
    
    
    9,072
    
    
    
    6Reorganization expenses
    
    
    4,018
    
    
    
    17
    
    
    
    
    
    
    
    
    
    
    
    11,311
    
    
    
    10
    
    
    
    
    
    
    
    Pharmaceutical assets gain on sale
    
    
    (29,046
    )
    
    
    (121
    )
    
    
    
    
    
    
    
    
    
    
    (29,046
    )
    
    
    (27
    )
    
    
    
    
    
    
    M.V.I. contingent payment (gain on sale)
    
    
    
    
    
    
    
    
    
    
    (1,567
    )
    
    
    (3
    )
    
    
    
    
    
    
    
    
    
    
    (8,112
    )
    
    
    (5
    )Restructuring charges
    
    
    
    
    
    
    
    
    
    
    13,719
    
    
    
    30
    
    
    
    
    
    
    
    
    
    
    
    17,119
    
    
    
    11Royalty expenses
    
    
    22
    
    
    
    
    
    
    
    357
    
    
    
    1
    
    
    
    247
    
    
    
    
    
    
    
    1,366
    
    
    
    1Intangible asset impairment
    
    
    
    
    
    
    
    
    
    
    5,250
    
    
    
    11
    
    
    
    1,190
    
    
    
    1
    
    
    
    5,250
    
    
    
    3Income (loss) from operations
    
    
    18,991
    
    
    
    79
    
    
    
    (21,626
    )
    
    
    (47
    )
    
    
    17,711
    
    
    
    16
    
    
    
    (41,343
    )
    
    
    (26
    )Interest expense, net
    
    
    2,093
    
    
    
    9
    
    
    
    9,469
    
    
    
    21
    
    
    
    22,174
    
    
    
    21
    
    
    
    23,866
    
    
    
    15Loss from extinguishment of debt
    
    
    (5,644
    )
    
    
    (24
    )
    
    
    
    
    
    
    
    
    
    
    (12,432
    )
    
    
    (11
    )
    
    
    (6,229
    )
    
    
    (4
    )Other (expense) income, net
    
    
    (438
    )
    
    
    (2
    )
    
    
    (275
    )
    
    
    (1
    )
    
    
    (1,190
    )
    
    
    (1
    )
    
    
    (2,111
    )
    
    
    (1
    )Provision for income taxes
    
    
    
    
    
    
    
    
    
    
    4,583
    
    
    
    10
    
    
    
    219
    
    
    
    
    
    
    
    4,758
    
    
    
    3Net income (loss)
    
    
    10,816
    
    
    
    45
    
    
    
    (35,953
    )
    
    
    (79
    )
    
    
    (18,304
    )
    
    
    (17
    )
    
    
    (78,307
    )
    
    
    (49
    )
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(dollars in thousands)Gross revenues
    
    $
    26,871
    
    
    $
    58,569
    
    
    $
    129,516
    
    
    $
    205,093Less allowance for customer credits
    
    
    2,915
    
    
    
    12,883
    
    
    
    21,387
    
    
    
    44,936Net revenues
    
    $
    23,956
    
    
    $
    45,686
    
    
    $
    108,129
    
    
    $
    160,157
  Three Months Ended September 30, 2005 Compared to Three Months Ended September 30, 2004
  41




---



##### 



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(in thousands)Darvon/Darvocet
    
    $
    1,026
    
    
    $
    2,685
    
    
    $
    15,518
    
    
    $
    12,676Brethine
    
    
    (275
    )
    
    
    (1,169
    )
    
    
    (1,156
    )
    
    
    4,380MVI/Aquasol
    
    
    
    
    
    
    1,351
    
    
    
    
    
    
    
    7,075CII Pain Products
    
    
    1,727
    
    
    
    8,287
    
    
    
    16,151
    
    
    
    27,488All Other
    
    
    785
    
    
    
    2,366
    
    
    
    3,803
    
    
    
    8,115Total net revenues
    
    $
    3,263
    
    
    $
    13,520
    
    
    $
    34,316
    
    
    $
    59,734
     42




---



##### 



43




---



##### 



44




---



##### 



Nine Months Ended September 30, 2005 Compared to Nine Months Ended September 30, 2004
     45




---



##### 



46




---



##### 



47




---



##### 



Liquidity and Capital Resources
    Other Commitments and Contingencies
  48




---



##### 



Analysis of Liquidity
       49




---



##### 




    
    provide that the liens on assets that secure obligations under the senior subordinated
notes will continue if all senior debt is repaid, but will resume as junior liens if we
thereafter incur any new senior debt; and
    
    temporarily increase the interest rate on our senior subordinated notes by 0.5% per annum
(to 12% per annum), commencing to accrue on October 1, 2004 and ending on March 31, 2005.
     50




---



##### 




    
    100% of the capital stock of our domestic subsidiaries;
    
    65% of the capital stock of our first-tier foreign subsidiaries; and
    
    All of our assets and the assets our existing and future domestic subsidiaries.
 51




---



##### 



New Accounting Standards
    52




---



##### 



Potential Applicability of Fresh Start Accounting
  Risk Factors and Forward Looking Statements
 Forward-Looking Statements and Safe Harbor Language
  
    
    our ability to obtain requisite approval of the Plan or any other Chapter 11
plan that would permit AAIPharma to emerge from bankruptcy proceedings as a going
concern,
    
    the uncertainty whether a Chapter 11 plan, as approved in the bankruptcy
proceedings, would provide for any continuing ownership interest in the Company for the
current holders of our common stock,
    
    our ability to continue to operate our business effectively in light of the
significant diversion of resources, including management attention, in connection with
our pending bankruptcy proceedings,
    
    the uncertainty of the timing of any approval of a Chapter 11 plan and the
consequent continuation of our bankruptcy proceedings until such approval is obtained,
including the impact of heightened legal fees and other expenses during the pendency of
these proceedings,
 53




---



##### 




    
    our ability to attract, retain and complete product development projects and
other customer relationships, which ability has been significantly adversely affected
by the uncertainties regarding our financial condition and our bankruptcy proceedings,
    
    our ability to comply with the DIP Facilities,
    
    our ability to obtain sufficient sources of capital to fund operating needs
upon termination or expiration of the DIP Facilities,
    
    our ability to generate sufficient cash from operations for our cash needs,
    
    our ability to continue to operate in the ordinary course and to manage our
relationships with our lenders, noteholders, customers, vendors and suppliers and
employees,
    
    our ability to obtain critical supplies,
    
    the impact of material weaknesses in internal control over financial reporting
on our ability to timely prepare accurate financial statements and to avoid material
adverse effects on our financial and operational results,
    
    our ability to timely remediate identified material weaknesses in internal
control over financial reporting,
    
    the investigations by the U.S. Attorneys office and the SEC into our financial
reporting and related activity,
    
    the outcome of pending litigation filed against us, if not included within the
Plan,
    
    the outcome of pending litigation we have filed against others, if not included
within the Plan,
    
    significant changes in our management team and the loss of critical personnel,
    
    our ability to attract critical personnel,
    
    demand for our services,
    
    the prices that we can obtain for our services,
    
    the level of competition we face,
    
    the amounts and timing of product returns and chargebacks and their impact on
our ability to receive the portion of the purchase price for assets of the
Pharmaceuticals Division held in escrow,
    
    timely success in product development and regulatory approvals for new products
and line extensions for which we may be entitled to receive royalty payments,
 54




---



##### 




    
    actions by the United States Food and Drug Administration (FDA) in connection
with submissions related to products with respect to which we may be entitled to
receive royalties,
    
    activities of third parties to successfully commercialize products to which we
may be entitled to royalties,
    
    other governmental regulations and actions affecting our services or the
products with respect to which we may be entitled to receive royalties,
    
    developments in patent or other proprietary rights owned by us or others, and
    
    general conditions in the economy and capital markets.
    Item 3. Quantitative and Qualitative Disclosures About Market Risk.
  55




---



##### 



Item 4. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures
        56




---



##### 



Changes in Internal Controls
   
    
    Management is currently reviewing the invoicing processes for our Development Services
Division and determining areas where more control and review processes should be added. We
are currently in the process of developing these new procedures; however, we do not expect
these to be in place until the fourth quarter of 2005. To provide assurance on the
financials as they relate to the invoicing function, management is performing quarterly
internal audits of the Development Services invoicing function.
    
    While new procedures were implemented during the second quarter of 2005 for the
accounting for the issuance of certain inventory used in the non-clinical portion of our
Development Services business, management is continuing to review the processes used in
this area and determining where additional controls may be implemented.
  PART II. OTHER INFORMATION
 Item 1. Legal Proceedings.
  57




---



##### 



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  Item 3. Defaults Upon Senior Securities
   Item 6. Exhibits
  58




---



##### 



SIGNATURES
  AAIPharma Inc.Date: November 9, 2005
    By:

/s/ Ludo J. ReyndersLudo J. ReyndersChief Executive Officer Date: November 9, 2005
    By:
    /s/ Matthew E. CzajkowskiMatthew E. CzajkowskiChief Financial Officer 59




---



##### 



AAIPharma Inc.
Exhibit Index
 ExhibitNo.
    
    Description10.1
    
    Second Amendment to Asset Purchase Agreement between Xanodyne Pharmaceuticals, Inc.,
AAIPharma Inc. and AAIPharma LLC dated as of July 18, 2005, incorporated by reference to
Exhibit 10.1 to the Current Report on Form 8-K of AAIPharma Inc. dated July 22, 200510.2
    
    Master Services Agreement between Xanodyne Pharmaceuticals, Inc. and AAIPharma Inc. dated as
of June 25, 2005, incorporated by reference to Exhibit 10.4 to the Current Report on Form 8-K
of AAIPharma Inc. dated July 29, 200510.3
    
    AAIPharma Inc. Key Employee Retention Plan and Severance Plan, incorporated by reference to
Exhibit 10.1 to the Current Report on Form 8-K of AAIPharma Inc. dated August 9, 200531.1
    
    Certification pursuant to Exchange Act Rule 13a  14(a) of Dr. Ludo J. Reynders31.2
    
    Certification pursuant to Exchange Act Rule 13a  14(a) of Matthew E. Czajkowski32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350
 60