##### 



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, 2003                                       
|  |  |                                                                                         
|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.

(Exact name of Registrant as specified in its charter)


|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|DELAWARE                                                       |  | 04-2687849                          
|(State or other jurisdiction of
incorporation or organization) |  | (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 þ       NO o

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

The number of shares of the Registrants common stock outstanding, as of
November 3, 2003 was 27,855,394 shares.





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##### 



aaiPharma Inc.
Table of Contents

The terms we, us or our in this Form 10-Q include aaiPharma Inc., its
corporate predecessors and its subsidiaries, except where the context may
indicate otherwise. Our corporation was incorporated in 1986, although its
corporate predecessor was founded in 1979.

Our Internet address is www.aaipharma.com. We make available through our
internet website our annual reports on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and amendments to those reports filed or
furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as
soon as reasonably practicable after we electronically file such material with,
or furnish it to, the Securities and Exchange Commission.

We own the following registered and unregistered trademarks: Darvon®,
Darvon-N®, Darvocet-N®, Darvocet A500TM, M.V.I.®, M.V.I.-12®, M.V.I.
Pediatric®, M.V.I. AdultTM, Aquasol®, Aquasol A®, Aquasol E®, Brethine®,
ProSorb®, ProSorb-D, AzaSanTM, aaiPharma®, and AAI®. References in this
document to Darvon are to Darvon® and Darvon-N® collectively, references to
Darvocet are to Darvocet-N® and references to Darvocet A500 are to Darvocet
A500TM. We also reference trademarks owned by other companies. Prilosec® is a
registered trademark of AstraZeneca AB. 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.

|                                                                   |                                                 |  |          |   | 
|------------------------------------------------------------------ | ----------------------------------------------- |  | -------- | - | 
|                                                                   |                                                 |  | Page No.
|                                                                   |                                                 |  |         
|PART I. FINANCIAL INFORMATION                                      |                                                 |  |          |  
|Item 1. Financial Statements(unaudited)                            |                                                 |  |          |  
|                                                                   | Consolidated Statements of Operations           |  |          | 3 | 
|                                                                   | Consolidated Balance Sheets                     |  |          | 4 | 
|                                                                   | Consolidated Statements of Cash Flows           |  |          | 5 | 
|                                                                   | Consolidated Statements of Comprehensive Income |  |          | 6 | 
|                                                                   | Notes to Consolidated Financial Statements      |  |          | 7 | 
|Item 2. Managements Discussion and Analysis of Financial          |                                                 |  |          |  
|Condition and Results of Operations                                |                                                 |  | 23       |  
|Item 3. Quantitative and Qualitative Disclosures About
Market Risk |                                                 |  | 31       |  
|Item 4. Controls and Procedures                                    |                                                 |  | 32       |  
|PART II. OTHER INFORMATION                                         |                                                 |  |          |  
|Item 1. Legal Proceedings                                          |                                                 |  | 32       |  
|Item 6. Exhibits and Reports on Form 8-K                           |                                                 |  | 33       |  
|SIGNATURES                                                         |                                                 |  | 34       |  
|EXHIBIT INDEX                                                      |                                                 |  | 35       |  

2



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##### 



PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

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

|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |         |        |        | 
|----------------------------------- | ---------------------------------------------------------- | -------------------- | ------------------ | ------ | ------------------ | ------ | ----------------- | ------ | ------ | ------ | ------- | ------- | ------ | ------ | ------- | ------- | ------ | ------ | 
|                                    |                                                            |                      |                    |        | Three Months Ended |        | Nine Months Ended
|                                    |                                                            |                      |                    |        | September 30,      |        | September 30,    
|                                    |                                                            |                      |                    |        |                    |        |                  
|                                    |                                                            |                      |                    |        | 2003               |        | 2002              |        | 2003   |        | 2002   
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |        
|Net revenues:                       |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|                                    | Product sales                                              |                      | $                  | 45,643 |                    |        | $                 | 35,925 |        |        | $       | 131,403 |        |        | $       | 90,775  |       
|                                    | Product development (royalties and fees)                   |                      |                    | 3,524  |                    |        |                   | 5,663  |        |        |         | 11,231  |        |        |         | 14,267  |       
|                                    | Development services                                       |                      |                    | 21,845 |                    |        |                   | 19,621 |        |        |         | 63,159  |        |        |         | 63,234  |       
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|                                    |                                                            |                      | 71,012             |        |                    |        | 61,209            |        |        |        | 205,793 |         |        |        | 168,276 |        
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|Operating costs and expenses:       |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|                                    | Direct costs (excluding depreciation
and royalty expense): |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |         |       
|                                    |                                                            | Product sales        |                    |        | 10,333             |        |                   |        | 8,155  |        |         |         | 32,410 |        |         |         | 24,295 |       
|                                    |                                                            | Development services |                    |        | 12,304             |        |                   |        | 11,620 |        |         |         | 36,685 |        |         |         | 37,921 |       
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|                                    |                                                            |                      | Total direct costs |        |                    | 22,637 |                   |        |        | 19,775 |         |         |        | 69,095 |         |         |        | 62,216 | 
|                                    | Selling expenses                                           |                      |                    | 9,071  |                    |        |                   | 6,044  |        |        |         | 25,006  |        |        |         | 16,028  |       
|                                    | General and administrative expenses                        |                      |                    | 9,795  |                    |        |                   | 10,345 |        |        |         | 31,113  |        |        |         | 29,264  |       
|                                    | Research and development                                   |                      |                    | 5,367  |                    |        |                   | 5,511  |        |        |         | 15,441  |        |        |         | 15,375  |       
|                                    | Depreciation and amortization                              |                      |                    | 2,676  |                    |        |                   | 2,493  |        |        |         | 8,038   |        |        |         | 6,965   |       
|                                    | Royalty expense                                            |                      |                    | 2,362  |                    |        |                   |       |        |        |         | 3,437   |        |        |         |        |       
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|Total operating costs and expenses  |                                                            |                      | 51,908             |        |                    |        | 44,168            |        |        |        | 152,130 |         |        |        | 129,848 |        
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|Income from operations              |                                                            |                      | 19,104             |        |                    |        | 17,041            |        |        |        | 53,663  |         |        |        | 38,428  |        
|Other income (expense):             |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|                                    | Interest, net                                              |                      |                    | (5,140 | )                  |        |                   | (5,506 | )      |        |         | (15,621 | )      |        |         | (13,882 | )     
|                                    | Loss from extinguishment of debt                           |                      |                    |       |                    |        |                   |       |        |        |         |        |        |        |         | (8,053  | )     
|                                    | Other                                                      |                      |                    | (122   | )                  |        |                   | (77    | )      |        |         | 21      |        |        |         | 126     |       
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|                                    |                                                            |                      | (5,262             | )      |                    |        | (5,583            | )      |        |        | (15,600 | )       |        |        | (21,809 | )      
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|Income before income taxes          |                                                            |                      | 13,842             |        |                    |        | 11,458            |        |        |        | 38,063  |         |        |        | 16,619  |        
|Provision for income taxes          |                                                            |                      | 4,914              |        |                    |        | 4,354             |        |        |        | 13,991  |         |        |        | 6,661   |        
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|Net income                          |                                                            | $                    | 8,928              |        |                    | $      | 7,104             |        |        | $      | 24,072  |         |        | $      | 9,958   |        
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|Basic earnings per share            |                                                            | $                    | 0.32               |        |                    | $      | 0.26              |        |        | $      | 0.87    |         |        | $      | 0.36    |        
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|Weighted average shares outstanding |                                                            |                      | 27,810             |        |                    |        | 27,417            |        |        |        | 27,664  |         |        |        | 27,297  |        
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|Diluted earnings per share          |                                                            | $                    | 0.31               |        |                    | $      | 0.25              |        |        | $      | 0.84    |         |        | $      | 0.35    |        
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        
|Weighted average shares outstanding |                                                            |                      | 29,072             |        |                    |        | 28,062            |        |        |        | 28,633  |         |        |        | 28,421  |        
|                                    |                                                            |                      |                    |        |                    |        |                   |        |        |        |         |         |        |        |         |        

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

3



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##### 



aaiPharma Inc.
CONSOLIDATED BALANCE SHEETS
(In thousands)

|                                     |                                               |                                      |         |                                            |  |               |         |              |   |   |         | 
|------------------------------------ | --------------------------------------------- | ------------------------------------ | ------- | ------------------------------------------ |  | ------------- | ------- | ------------ | - | - | ------- | 
|                                     |                                               |                                      |         |                                            |  | September 30, |         | December 31,
|                                     |                                               |                                      |         |                                            |  | 2003          |         | 2002        
|                                     |                                               |                                      |         |                                            |  |               |         |             
|                                     |                                               |                                      |         |                                            |  | (Unaudited)   |         |              |   |  
|                                     |                                               |                                      | ASSETS  |                                            |  |               |         |              |   |   |        
|Current assets:                      |                                               |                                      |         |                                            |  |               |         |             
|                                     | Cash and cash equivalents                     |                                      | $       | 11,110                                     |  |               | $       | 6,532        |  
|                                     | Accounts receivable, net                      |                                      |         | 37,122                                     |  |               |         | 29,467       |  
|                                     | Work-in-progress                              |                                      |         | 15,520                                     |  |               |         | 10,515       |  
|                                     | Inventories, net                              |                                      |         | 11,858                                     |  |               |         | 17,004       |  
|                                     | Prepaid and other current assets              |                                      |         | 9,723                                      |  |               |         | 7,633        |  
|                                     |                                               |                                      |         |                                            |  |               |         |             
|                                     |                                               |                                      |         | Total current assets                       |  |               | 85,333  |              |   |   | 71,151  | 
|Property and equipment, net          |                                               |                                      | 57,267  |                                            |  |               | 53,125  |             
|Goodwill, net                        |                                               |                                      | 211,904 |                                            |  |               | 210,792 |             
|Intangible assets, net               |                                               |                                      | 89,221  |                                            |  |               | 89,078  |             
|Other assets                         |                                               |                                      | 15,326  |                                            |  |               | 16,179  |             
|                                     |                                               |                                      |         |                                            |  |               |         |             
|                                     |                                               |                                      |         | Total assets                               |  | $             | 459,051 |              |   | $ | 440,325 | 
|                                     |                                               |                                      |         |                                            |  |               |         |             
|                                     |                                               | LIABILITIES AND STOCKHOLDERS EQUITY |         |                                            |  |               |         |              |   |  
|Current liabilities:                 |                                               |                                      |         |                                            |  |               |         |             
|                                     | Current maturities of long-term debt          |                                      | $       | 6,567                                      |  |               | $       | 5,921        |  
|                                     | Accounts payable                              |                                      |         | 16,912                                     |  |               |         | 17,671       |  
|                                     | Customer advances                             |                                      |         | 19,487                                     |  |               |         | 15,051       |  
|                                     | Accrued wages and benefits                    |                                      |         | 8,416                                      |  |               |         | 6,718        |  
|                                     | Interest payable                              |                                      |         | 9,798                                      |  |               |         | 5,232        |  
|                                     | Other accrued liabilities                     |                                      |         | 9,839                                      |  |               |         | 5,201        |  
|                                     |                                               |                                      |         |                                            |  |               |         |             
|                                     |                                               |                                      |         | Total current liabilities                  |  |               | 71,019  |              |   |   | 55,794  | 
|Long-term debt, less current portion |                                               |                                      | 243,092 |                                            |  |               | 277,899 |             
|Other liabilities                    |                                               |                                      | 16,618  |                                            |  |               | 7,182   |             
|Stockholders equity:                |                                               |                                      |         |                                            |  |               |         |             
|                                     | Common stock                                  |                                      |         | 28                                         |  |               |         | 27           |  
|                                     | Paid-in capital                               |                                      |         | 81,867                                     |  |               |         | 79,049       |  
|                                     | Retained earnings                             |                                      |         | 44,664                                     |  |               |         | 20,592       |  
|                                     | Accumulated other comprehensive income (loss) |                                      |         | 1,763                                      |  |               |         | (218         | )
|                                     |                                               |                                      |         |                                            |  |               |         |             
|                                     |                                               |                                      |         | Total stockholders equity                 |  |               | 128,322 |              |   |   | 99,450  | 
|                                     |                                               |                                      |         |                                            |  |               |         |             
|                                     |                                               |                                      |         | Total liabilities and stockholders equity |  | $             | 459,051 |              |   | $ | 440,325 | 
|                                     |                                               |                                      |         |                                            |  |               |         |             

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

4



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##### 



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

|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |          |          |       |         |  
|--------------------------------------------------- | --------------------------------------------------------------------------------- | ----------------------------------------------------------- | -------------------------------------------------------- | ------- | ------------------------------- | ------ | -------- | -------- | ----- | ------- | -
|                                                    |                                                                                   |                                                             |                                                          |         | Nine Months Ended September 30,
|                                                    |                                                                                   |                                                             |                                                          |         |                                
|                                                    |                                                                                   |                                                             |                                                          |         | 2003                            |        | 2002    
|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |         
|Cash flows from operating activities:               |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|                                                    | Net income                                                                        |                                                             | $                                                        | 24,072  |                                 |        | $        | 9,958    |      
|                                                    | Adjustments to reconcile net income to
net cash provided by operating activities: |                                                             |                                                          |         |                                 |        |          |          |      
|                                                    |                                                                                   | Depreciation and amortization                               |                                                          |         | 8,038                           |        |          |          | 6,965 |        
|                                                    |                                                                                   | Write-off of deferred financing and other costs, net of tax |                                                          |         |                                |        |          |          | 5,339 |        
|                                                    |                                                                                   | Other                                                       |                                                          |         | 138                             |        |          |          | 476   |        
|                                                    |                                                                                   | Changes in operating assets and liabilities:                |                                                          |         |                                 |        |          |          |       |        
|                                                    |                                                                                   |                                                             | Accounts receivable, net                                 |         |                                 | (7,378 | )        |          |       | (6,958  | )
|                                                    |                                                                                   |                                                             | Work-in-progress                                         |         |                                 | (4,520 | )        |          |       | 156     |  
|                                                    |                                                                                   |                                                             | Inventories                                              |         |                                 | 5,220  |          |          |       | (4,610  | )
|                                                    |                                                                                   |                                                             | Prepaid and other assets                                 |         |                                 | (3,077 | )        |          |       | (11,922 | )
|                                                    |                                                                                   |                                                             | Accounts payable                                         |         |                                 | (952   | )        |          |       | (667    | )
|                                                    |                                                                                   |                                                             | Customer advances                                        |         |                                 | 4,158  |          |          |       | 1,646   |  
|                                                    |                                                                                   |                                                             | Interest payable                                         |         |                                 | 4,566  |          |          |       | 10,766  |  
|                                                    |                                                                                   |                                                             | Accrued wages and benefits and other accrued liabilities |         |                                 | 10,074 |          |          |       | 8,444   |  
|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|Net cash provided by operating activities           |                                                                                   |                                                             | 40,339                                                   |         |                                 |        | 19,593   |         
|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|Cash flows from investing activities:               |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|                                                    | Purchases of property and equipment                                               |                                                             |                                                          | (9,867  | )                               |        |          | (6,659   | )    
|                                                    | Purchase of property and equipment previously leased                              |                                                             |                                                          |        |                                 |        |          | (14,145  | )    
|                                                    | Proceeds from sales of property and equipment                                     |                                                             |                                                          | 508     |                                 |        |          | 13       |      
|                                                    | Acquisitions                                                                      |                                                             |                                                          | (2,450  | )                               |        |          | (211,997 | )    
|                                                    | Other                                                                             |                                                             |                                                          | (334    | )                               |        |          | (529     | )    
|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|Net cash used in investing activities               |                                                                                   |                                                             | (12,143                                                  | )       |                                 |        | (233,317 | )       
|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|Cash flows from financing activities:               |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|                                                    | Proceeds from long-term borrowings                                                |                                                             |                                                          |        |                                 |        |          | 244,450  |      
|                                                    | Payments on long-term borrowings                                                  |                                                             |                                                          | (29,500 | )                               |        |          | (39,400  | )    
|                                                    | Proceeds from interest rate swap, net                                             |                                                             |                                                          | 2,191   |                                 |        |          | 10,848   |      
|                                                    | Issuance of common stock                                                          |                                                             |                                                          | 2,819   |                                 |        |          | 3,193    |      
|                                                    | Other                                                                             |                                                             |                                                          | 805     |                                 |        |          | (2,839   | )    
|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|Net cash (used in) provided by financing activities |                                                                                   |                                                             | (23,685                                                  | )       |                                 |        | 216,252  |         
|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|Net increase in cash and cash equivalents           |                                                                                   |                                                             | 4,511                                                    |         |                                 |        | 2,528    |         
|Effect of exchange rate changes on cash             |                                                                                   |                                                             | 67                                                       |         |                                 |        | 95       |         
|Cash and cash equivalents, beginning of period      |                                                                                   |                                                             | 6,532                                                    |         |                                 |        | 6,371    |         
|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|Cash and cash equivalents, end of period            |                                                                                   | $                                                           | 11,110                                                   |         |                                 | $      | 8,994    |         
|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|Supplemental information, cash paid for:            |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|                                                    | Interest                                                                          |                                                             | $                                                        | 13,520  |                                 |        | $        | 4,759    |      
|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |          |         
|                                                    | Income taxes                                                                      |                                                             | $                                                        | 6,152   |                                 |        | $        | 2,405    |      
|                                                    |                                                                                   |                                                             |                                                          |         |                                 |        |          |         

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

5



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

|                                 |  |                    |       |                   |  |      |       |      |  |   |        |  |  |   |        | 
|-------------------------------- |  | ------------------ | ----- | ----------------- |  | ---- | ----- | ---- |  | - | ------ |  |  | - | ------ | 
|                                 |  | Three Months Ended |       | Nine Months Ended
|                                 |  | September 30,      |       | September 30,    
|                                 |  |                    |       |                  
|                                 |  | 2003               |       | 2002              |  | 2003 |       | 2002
|                                 |  |                    |       |                   |  |      |       |     
|Net income                       |  | $                  | 8,928 |                   |  | $    | 7,104 |      |  | $ | 24,072 |  |  | $ | 9,958  | 
|Currency translation adjustments |  |                    | (42   | )                 |  |      | (269  | )    |  |   | 1,981  |  |  |   | 1,068  | 
|                                 |  |                    |       |                   |  |      |       |      |  |   |        |  |  |   |        | 
|Comprehensive income             |  | $                  | 8,886 |                   |  | $    | 6,835 |      |  | $ | 26,053 |  |  | $ | 11,026 | 
|                                 |  |                    |       |                   |  |      |       |      |  |   |        |  |  |   |        | 

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

6



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##### 



aaiPharma Inc.
Notes to Consolidated Financial Statements
(Unaudited)

1. Basis of presentation and other matters

aaiPharma Inc. (aaiPharma or the Company) is a science-based, specialty
pharmaceutical company focused on acquiring, improving and marketing
well-known, branded medicines in pain management, critical care and
gastroenterology. The Company also offers comprehensive drug development
services to the pharmaceutical, biotechnology, generic and device industries
through its development services division. The accompanying unaudited
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States and applicable
Securities and Exchange Commission regulations for interim financial
information. These financial statements do not include all of the information
and footnotes required by accounting principles generally accepted in the
United States for annual financial statements. The consolidated financial
information as of December 31, 2002 has been derived from audited financial
statements; certain amounts from the three and nine months ended September 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. It is presumed that users of this interim financial information
have read or have access to the audited financial statements for the preceding
fiscal year, which were included in the Companys Annual Report on Form 10-K.
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for fair presentation have been included in
these interim financial statements. Operating results for the interim periods
presented are not necessarily indicative of the results that may be expected
for the full year.

The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported
in the consolidated financial statements and accompanying notes. Actual
results could differ from such estimates and changes in such estimates may
affect amounts reported in future periods.

In 2003, the Company adopted Statement of Financial Accounting Standards No.
145, Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections (SFAS 145). SFAS 145 no longer requires
companies to report gains or losses associated with the extinguishment of debt
as a component of extraordinary gains or losses, net of tax. In addition, any
extraordinary gains or losses on extinguishment of debt in prior periods
presented would require reclassification. As required by SFAS 145, the
extraordinary loss recognized in the nine months ended September 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.

In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, Consolidation of Variable Interest Entities (FIN
46). FIN 46, as amended, requires that variable interest entities be
consolidated by the primary beneficiary of the entity if certain criteria are
met. FIN 46 is effective immediately for all variable interest entities
created or acquired after January 31, 2003. For variable interest entities
created or acquired prior to February 1, 2003, the provisions of FIN 46 become
effective for the Company during the fourth quarter of 2003. The Company is
currently performing a

7



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##### 



review to determine if it is the primary beneficiary of any variable interest
entities. To date, the review has not identified any entity that would require
consolidation. Provided that the Company is not the primary beneficiary, the
maximum exposure to losses related to any entity that may be determined to be a
variable interest entity is limited to the carrying amount of the investment in
the entity.

The Company applies Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB No. 25) and related interpretations in
accounting for its stock option plans; therefore, compensation expense has not
been recognized for options granted at fair value. Under APB No. 25, if the
exercise price of the Companys stock options is not less than the estimated
fair market value of the underlying stock on the date of grant, no compensation
expense is recognized. If compensation cost for the Companys plans had been
determined based on the fair value at the grant dates for awards under those
plans consistent with the fair value method of SFAS No. 123, the Companys net
income and earnings per share would have been changed to the pro forma amounts
indicated below:

|                                                    |                     |         |       |                                       |      |                                 |       |      |      |      |        |      |      |   |       |      |      | 
|--------------------------------------------------- | ------------------- | ------- | ----- | ------------------------------------- | ---- | ------------------------------- | ----- | ---- | ---- | ---- | ------ | ---- | ---- | - | ----- | ---- | ---- | 
|                                                    |                     |         |       | Three Months Ended September 30,      |      | Nine Months Ended September 30,
|                                                    |                     |         |       |                                       |      |                                
|                                                    |                     |         |       | 2003                                  |      | 2002                            |       | 2003 |      | 2002
|                                                    |                     |         |       |                                       |      |                                 |       |      |      |     
|                                                    |                     |         |       | (In thousands, except per share data)
|Net income, as reported                             |                     | $       | 8,928 |                                       |      | $                               | 7,104 |      |      | $    | 24,072 |      |      | $ | 9,958 |     
|Pro forma stock-based
compensation cost,
net of tax |                     |         | 2,108 |                                       |      |                                 | 1,719 |      |      |      | 5,913  |      |      |   | 4,061 |     
|Pro forma net income                                |                     |         | 6,820 |                                       |      |                                 | 5,385 |      |      |      | 18,159 |      |      |   | 5,897 |     
|Earnings per share:                                 |                     |         |       |                                       |      |                                 |       |      |      |      |        |      |      |   |       |     
|                                                    | As
reported 
Basic |         | $     | 0.32                                  |      |                                 | $     | 0.26 |      |      | $      | 0.87 |      |   | $     | 0.36 |     
|                                                    |                     | Diluted |       | $                                     | 0.31 |                                 |       | $    | 0.25 |      |        | $    | 0.84 |   |       | $    | 0.35 | 
|                                                    | Pro
forma 
Basic   |         | $     | 0.25                                  |      |                                 | $     | 0.20 |      |      | $      | 0.66 |      |   | $     | 0.22 |     
|                                                    |                     | Diluted |       | $                                     | 0.23 |                                 |       | $    | 0.19 |      |        | $    | 0.63 |   |       | $    | 0.21 | 

2. Earnings per share

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 nine months ended September 30, 2003,
3,046,228 and 3,601,094 options, respectively, were excluded as they were
anti-dilutive. In the three and nine months ended September 30, 2002,
2,746,559 and 1,812,787 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):

8



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##### 



|                               |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |        |        | 
|------------------------------ | --------------------------------- | ------------------------------------------------------------------ |  | ------------------ | ------ | ----------------- |  | ------ | ------ | ---- |  | ------ | ------ |  |  | ------ | ------ | 
|                               |                                   |                                                                    |  | Three Months Ended |        | Nine Months Ended
|                               |                                   |                                                                    |  | September 30,      |        | September 30,    
|                               |                                   |                                                                    |  |                    |        |                  
|                               |                                   |                                                                    |  | 2003               |        | 2002              |  | 2003   |        | 2002
|                               |                                   |                                                                    |  |                    |        |                   |  |        |        |     
|Basic earnings per share:      |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |       
|                               | Weighted average number of shares |                                                                    |  | 27,810             |        |                   |  | 27,417 |        |      |  | 27,664 |        |  |  | 27,297 |       
|Effect of dilutive securities: |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |       
|                               | Stock options                     |                                                                    |  | 1,262              |        |                   |  | 645    |        |      |  | 969    |        |  |  | 1,124  |       
|                               |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |       
|Diluted earnings per share:    |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |       
|                               |                                   | Adjusted weighted average number of shares
and assumed conversions |  |                    | 29,072 |                   |  |        | 28,062 |      |  |        | 28,633 |  |  |        | 28,421 | 
|                               |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |       

3. Financial information by business segment and geographic area

The Company operates in three business segments, consisting of a product sales
business, primarily comprised of the pharmaceuticals business unit, a product
development business, primarily the research and development business unit, and
a development services business, primarily the AAI Development Services
business unit. The product sales business provides for the sales of the
Companys pharmaceutical product lines and for the commercial manufacturing of
small quantity products outsourced by other pharmaceutical companies. In the
product development segment, the Company internally develops drugs and
technologies for future sales by the product sales business or with the
objective of licensing marketing rights to third parties in exchange for
license fees and royalties. The core services provided by the development
services business on a fee-for-service basis to pharmaceutical and
biotechnology industries worldwide include comprehensive formulation, testing
and manufacturing expertise, in addition to the ability to take investigational
products into and through human clinical trials. The majority of the Companys
non-U.S. operations are located in Germany.

Corporate income (loss) from operations includes general corporate overhead
costs which are not directly attributable to a business segment. Financial
data by segment and geographic region are as follows (in thousands):

|                                                           |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|---------------------------------------------------------- |  | ------------------ | ------ | ----------------- |  | ---- | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                           |  | Three Months Ended |        | Nine Months Ended
|                                                           |  | September 30,      |        | September 30,    
|                                                           |  |                    |        |                  
|                                                           |  | 2003               |        | 2002              |  | 2003 |        | 2002
|                                                           |  |                    |        |                   |  |      |        |     
|Net revenues:                                              |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|Product sales                                              |  | $                  | 45,643 |                   |  | $    | 35,925 |      |  | $ | 131,403 |   |  | $ | 90,775  |  
|Product development                                        |  |                    | 3,524  |                   |  |      | 5,663  |      |  |   | 11,231  |   |  |   | 14,267  |  
|Development services                                       |  |                    | 21,845 |                   |  |      | 19,621 |      |  |   | 63,159  |   |  |   | 63,234  |  
|                                                           |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|                                                           |  | $                  | 71,012 |                   |  | $    | 61,209 |      |  | $ | 205,793 |   |  | $ | 168,276 |  
|                                                           |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|United States                                              |  | $                  | 66,095 |                   |  | $    | 62,684 |      |  | $ | 191,463 |   |  | $ | 167,385 |  
|Germany                                                    |  |                    | 5,007  |                   |  |      | 4,526  |      |  |   | 15,550  |   |  |   | 11,440  |  
|Other                                                      |  |                    | 458    |                   |  |      | 315    |      |  |   | 1,066   |   |  |   | 711     |  
|Less intercompany                                          |  |                    | (548   | )                 |  |      | (6,316 | )    |  |   | (2,286  | ) |  |   | (11,260 | )
|                                                           |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|                                                           |  | $                  | 71,012 |                   |  | $    | 61,209 |      |  | $ | 205,793 |   |  | $ | 168,276 |  
|                                                           |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|Gross margin (excluding
depreciation and royalty
expense): |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|Product sales                                              |  | $                  | 35,310 |                   |  | $    | 27,770 |      |  | $ | 98,993  |   |  | $ | 66,480  |  
|Product development                                        |  |                    | 3,524  |                   |  |      | 5,663  |      |  |   | 11,231  |   |  |   | 14,267  |  
|Development services                                       |  |                    | 9,541  |                   |  |      | 8,001  |      |  |   | 26,474  |   |  |   | 25,313  |  
|                                                           |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|                                                           |  | $                  | 48,375 |                   |  | $    | 41,434 |      |  | $ | 136,698 |   |  | $ | 106,060 |  
|                                                           |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  

9



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##### 



|                               |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|------------------------------ |  | ------------------ | ------ | ----------------- |  | ---- | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                               |  | Three Months Ended |        | Nine Months Ended
|                               |  | September 30,      |        | September 30,    
|                               |  |                    |        |                  
|                               |  | 2003               |        | 2002              |  | 2003 |        | 2002
|                               |  |                    |        |                   |  |      |        |     
|Income (loss) from operations: |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|Product sales                  |  | $                  | 24,364 |                   |  | $    | 21,581 |      |  | $ | 71,969  |   |  | $ | 51,369  |  
|Product development            |  |                    | 3,524  |                   |  |      | 5,663  |      |  |   | 11,231  |   |  |   | 14,267  |  
|Development services           |  |                    | 1,551  |                   |  |      | 226    |      |  |   | 1,675   |   |  |   | 1,325   |  
|                               |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|                               |  |                    | 29,439 |                   |  |      | 27,470 |      |  |   | 84,875  |   |  |   | 66,961  |  
|Research and development       |  |                    | (5,464 | )                 |  |      | (5,618 | )    |  |   | (15,748 | ) |  |   | (15,691 | )
|Corporate                      |  |                    | (4,871 | )                 |  |      | (4,811 | )    |  |   | (15,464 | ) |  |   | (12,842 | )
|                               |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|                               |  | $                  | 19,104 |                   |  | $    | 17,041 |      |  | $ | 53,663  |   |  | $ | 38,428  |  
|                               |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|United States                  |  | $                  | 18,675 |                   |  | $    | 16,619 |      |  | $ | 52,347  |   |  | $ | 38,469  |  
|Germany                        |  |                    | 376    |                   |  |      | 439    |      |  |   | 1,396   |   |  |   | 227     |  
|Other                          |  |                    | 53     |                   |  |      | (17    | )    |  |   | (80     | ) |  |   | (268    | )
|                               |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|                               |  | $                  | 19,104 |                   |  | $    | 17,041 |      |  | $ | 53,663  |   |  | $ | 38,428  |  
|                               |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|Depreciation and amortization: |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|Product sales                  |  | $                  | 982    |                   |  | $    | 953    |      |  | $ | 2,832   |   |  | $ | 2,178   |  
|Development services           |  |                    | 1,093  |                   |  |      | 949    |      |  |   | 3,331   |   |  |   | 2,889   |  
|Product development            |  |                    | 98     |                   |  |      | 107    |      |  |   | 307     |   |  |   | 316     |  
|Corporate                      |  |                    | 503    |                   |  |      | 484    |      |  |   | 1,568   |   |  |   | 1,582   |  
|                               |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|                               |  | $                  | 2,676  |                   |  | $    | 2,493  |      |  | $ | 8,038   |   |  | $ | 6,965   |  
|                               |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  

|                     |  |               |         |              |  |   |         | 
|-------------------- |  | ------------- | ------- | ------------ |  | - | ------- | 
|                     |  | September 30, |         | December 31,
|                     |  | 2003          |         | 2002        
|                     |  |               |         |             
|Total assets:        |  |               |         |              |  |   |         | 
|Product sales        |  | $             | 357,225 |              |  | $ | 347,596 | 
|Product development  |  |               | 10,607  |              |  |   | 6,024   | 
|Development services |  |               | 48,309  |              |  |   | 49,952  | 
|Corporate            |  |               | 42,910  |              |  |   | 36,753  | 
|                     |  |               |         |              |  |   |         | 
|                     |  | $             | 459,051 |              |  | $ | 440,325 | 
|                     |  |               |         |              |  |   |         | 
|United States        |  | $             | 431,318 |              |  | $ | 417,997 | 
|Germany              |  |               | 26,170  |              |  |   | 21,167  | 
|Other                |  |               | 1,563   |              |  |   | 1,161   | 
|                     |  |               |         |              |  |   |         | 
|                     |  | $             | 459,051 |              |  | $ | 440,325 | 
|                     |  |               |         |              |  |   |         | 
|Goodwill, net:       |  |               |         |              |  |   |         | 
|Product sales        |  | $             | 199,414 |              |  | $ | 199,414 | 
|Development services |  |               | 12,490  |              |  |   | 11,378  | 
|                     |  |               |         |              |  |   |         | 
|                     |  | $             | 211,904 |              |  | $ | 210,792 | 
|                     |  |               |         |              |  |   |         | 

10



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##### 



4. Transactions with related parties

The Company has revenue, accounts receivable and work-in-progress with Aesgen,
Inc. (Aesgen) and Endeavor Pharmaceuticals, Inc. (Endeavor). Both Endeavor
and Aesgen were organized by aaiPharma Inc. and its principal shareholders and
continue to be related parties. No revenues were recognized from Aesgen for
the three and nine months ended September 30, 2003. Revenues recognized from
Aesgen totaled $149,000 and $488,000 for the three and nine months ended
September 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 royalties of $0.4 million and $1.1 million
under that agreement in the three and nine months ended September 30, 2003.
Revenues recognized from Endeavor totaled $0.1 million and $0.7 million for the
three and nine months ended September 30, 2003, and were $32,000 and $1.0
million for the three and nine months ended September 30, 2002. Certain
services performed by the Company for Endeavor are covered by a Securities
Payment Agreement between the Company and Endeavor, whereby the Company may
receive Endeavor preferred stock in lieu of cash for services performed. At
September 30, 2003, the Company had no accounts receivable or work-in-progress
related to Aesgen, and had approximately $0.8 million of accounts receivable
and work-in-progress related to Endeavor.

5. Debt

The following table presents the components of current maturities of long-term debt:

|                                     |  |                |       |              |  |   |       | 
|------------------------------------ |  | -------------- | ----- | ------------ |  | - | ----- | 
|                                     |  | September 30,  |       | December 31,
|                                     |  | 2003           |       | 2002        
|                                     |  |                |       |             
|                                     |  | (In thousands)
|Current maturities of long-term debt |  | $              | 6,567 |              |  | $ | 5,921 | 
|                                     |  |                |       |              |  |   |       | 

The following table presents the components of long-term debt:

|                                                                       |                                         |   |                |         |              |   |         |         | 
|---------------------------------------------------------------------- | --------------------------------------- | - | -------------- | ------- | ------------ | - | ------- | ------- | 
|                                                                       |                                         |   | September 30,  |         | December 31,
|                                                                       |                                         |   | 2003           |         | 2002        
|                                                                       |                                         |   |                |         |             
|                                                                       |                                         |   | (In thousands)
|U.S. bank term loan                                                    |                                         | $ | 40,000         |         |              | $ | 50,000  |        
|U.S. revolving credit facility                                         |                                         |   | 28,000         |         |              |   | 47,500  |        
|11% senior subordinated notes due 2010, net of original issue discount |                                         |   | 174,070        |         |              |   | 173,963 |        
|Interest rate swap monetization deferred income                        |                                         |   | 12,677         |         |              |   | 10,486  |        
|Fair value of interest rate swap                                       |                                         |   | (5,088         | )       |              |   | 1,871   |        
|Less current maturities of long-term debt                              |                                         |   | (6,567         | )       |              |   | (5,921  | )      
|                                                                       |                                         |   |                |         |              |   |         |        
|                                                                       | Total long-term debt due after one year |   | $              | 243,092 |              |   | $       | 277,899 | 
|                                                                       |                                         |   |                |         |              |   |         |        

In March 2002, the Company entered into $175 million of senior secured credit
facilities consisting of a $75 million five-year revolving credit facility and
a $100 million five-year term loan facility. The term

11



---



##### 



loan facility amortizes over the full five-year term. These senior credit
facilities were subsequently reduced to $115 million due to $60 million of
repayments made under the term loan facility. The availability of borrowings
under the revolving credit facility is not limited by a borrowing base. At
September 30, 2003, the Company had unused availability under the revolving
credit facility of $47.0 million. The senior credit facilities provide for
variable interest rates based on LIBOR or an alternate base rate, at the
Companys option. On September 30, 2003, 30-day LIBOR was 1.12%. Such
facilities are guaranteed by all domestic subsidiaries and secured by a
security interest on substantially all domestic assets, all of the stock of
domestic subsidiaries and 65% of the stock of material foreign subsidiaries.
The senior credit facilities require the payment of certain commitment fees
based on the unused portion of the revolving credit facility. These senior
credit facilities may be prepaid at any time without a premium.

Also in March 2002, the Company issued $175 million of senior subordinated
notes due April 1, 2010. The proceeds from the issuance of these notes were
$173.9 million, which was net of the original issue discount. This discount
will be charged to interest expense over the term of the notes. These notes
have a fixed interest rate of 11% per annum and are guaranteed on a
subordinated basis by all existing domestic subsidiaries and all future
domestic subsidiaries that are owned 80% or more by the Company. The notes are
not secured. Prior to the third anniversary of the date of issuance of the
notes, up to 35% of the notes are redeemable with the proceeds of qualified
sales of equity at 111% of par value. The terms of the senior credit
facilities require repayment of all of the indebtedness under these facilities
before repurchase of any of the notes. On or after the fourth anniversary of
the date of issuance of the notes, all or any portion of the notes are
redeemable at declining premiums to par value, beginning at 105.5%.

Concurrent with the issuance of the senior subordinated notes, the Company
entered into an interest rate swap agreement to effectively convert interest
expense on a portion of the senior subordinated notes for the term of the notes
from an 11% fixed annual rate to a floating annual rate equal to 6-month LIBOR
plus a base rate. On February 27, 2003, and again on June 23, 2003, the
Company sold the then outstanding swap agreement for $2.3 million and $3.7
million, respectively, and replaced it with a similar interest rate swap
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 September 30, 2003, the Company had an interest rate swap agreement in place
covering $150 million of the notes, at a rate of 6-month LIBOR plus 7.41%. On
September 30, 2003, 6-month LIBOR was 1.18%, giving the Company an estimated
all-in rate of 8.59%. The terms of the interest rate swap agreements, other
than the base rate, were identical and were perfectly matched with the terms of
the related hedged instrument.

Under the terms of the senior secured credit facility and the senior
subordinated notes, the Company is required to comply with various covenants
including, but not limited to, those pertaining to maintenance of certain
financial ratios and incurring additional indebtedness. The Company was in
compliance with the covenants at September 30, 2003.

6. Acquisition

On March 28, 2002, the Company acquired the U.S. rights to the Darvon and
Darvocet-N branded product lines, which treat mild to moderate pain, and
existing inventory from Eli Lilly and Company, in a business combination
accounted for as a purchase. The Company acquired these product lines and
related intangible assets for $211.4 million. To finance this acquisition,
which included $1.8 million of inventory, the Company used the proceeds from
the senior secured credit facilities and senior

12



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##### 



subordinated notes, as described in note 5. The Darvon and Darvocet-N product
lines did not have separable assets and liabilities associated with them, other
than inventory, therefore the Company allocated the purchase price, including
acquisition related expenses, to acquired identifiable assets, with the excess
of the purchase price over the identifiable tangible and intangible assets
recorded as goodwill. Based on this allocation, $51.2 million of intangible
assets have been identified and are being amortized over 20 years. In
accordance with Statement of Financial Accounting Standards No. 141 Business
Combinations and Statement of Financial Accounting Standards No. 142
Accounting for Goodwill and Intangibles, the excess of the purchase price
over identifiable intangible assets in the amount of $159.7 million has been
classified as goodwill, which is not subject to amortization.

The following unaudited pro forma consolidated financial information reflects
the results of operations for the nine months ended September 30, 2002, as if
the above acquisition had occurred at the beginning of the period presented (in
thousands, except per share data).

|                           |  |                    |         | 
|-------------------------- |  | ------------------ | ------- | 
|                           |  | Nine Months Ended 
|                           |  | September 30, 2002
|                           |  |                   
|Net revenues               |  | $                  | 178,008 | 
|Net income                 |  |                    | 8,482   | 
|Basic earnings per share   |  | $                  | 0.31    | 
|Diluted earnings per share |  | $                  | 0.30    | 

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

7. Subsequent Events

On August 5, 2003, aaiPharma, CIMA LABS INC., (CIMA), Scarlet Holding
Corporation, a direct, wholly owned subsidiary of aaiPharma (Holding
Company), Scarlet MergerCo, Inc., a direct, wholly owned subsidiary of Holding
Company (S MergerCo), and Crimson MergerCo, Inc., a direct, wholly owned
subsidiary of Holding Company (C MergerCo), entered into an Agreement and
Plan of Merger (the Merger Agreement). Pursuant to the Merger Agreement,
Holding Company would acquire all of the capital stock of each of CIMA and
aaiPharma through the merger of S MergerCo with and into aaiPharma and the
merger of C MergerCo with and into CIMA, with aaiPharma and CIMA surviving as
wholly owned subsidiaries of Holding Company (together, the Transaction).
The completion of the Transaction was subject to several conditions, including
the approval of the Transaction by the stockholders of CIMA and aaiPharma and
the expiration or termination of the applicable waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976.

On November 3, 2003, CIMA terminated the Merger Agreement and paid an $11.5
million termination fee to aaiPharma. This fee will used to offset
merger-related expenses.

On October 22, 2003, the Company entered into an agreement with certain
subsidiaries of Elan Corporation, plc to acquire a portfolio of pain management
products for $100 million in cash, subject to

13



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##### 



adjustment for the inventory to be acquired. The Company anticipates
completing this acquisition in the fourth quarter of 2003. The Company has
received a commitment from its current lenders to provide a term loan facility
in an amount necessary to fund the purchase of this product line, pay related
fees and expenses and repay indebtedness outstanding under the Companys
existing term loan facility. The completion of this transaction is subject to
clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 by the
Federal Trade Commission and the Department of Justice. In addition, in
connection with this acquisition, the Company anticipates revising and
increasing the amount of its existing revolving credit facility.

8. Financial Information for Subsidiary Guarantors and Non-Guarantors

In the first quarter of 2002, the Company issued senior subordinated notes
which are guaranteed by certain of the Companys subsidiaries.

The following presents condensed consolidating financial information for the
Company, segregating: (1) aaiPharma Inc., which issued the notes (the
Issuer); (2) the domestic subsidiaries, which guarantee the notes (the
Guarantor Subsidiaries); and (3) all other subsidiaries (the Non-Guarantor
Subsidiaries). The guarantor subsidiaries are wholly-owned direct
subsidiaries of the Company and their guarantees are full, unconditional and
joint and several. Wholly-owned subsidiaries are presented on the equity basis
of accounting. Certain reclassifications have been made to conform all of the
financial information to the financial presentation on a consolidated basis.
The principal eliminating entries eliminate investments in subsidiaries and
inter-company balances and transactions.

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

14



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aaiPharma Inc.
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands)

|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |        |        | 
|--------------------------------- | --------------------------------------------------------- | -------------- | ------ | ------------------------------------- | ------ | ------------ | ------ | ------------ | ------ | ------------ | ----- | ------------ | ----- | - | ------- | ---- | ------- | - | ------ | ------ | ------ | 
|                                  |                                                           |                |        | Three Months Ended September 30, 2003
|                                  |                                                           |                |        |                                      
|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       | Non-         |       |   |         |      |         |   |        |       
|                                  |                                                           |                |        |                                       |        |              |        | Guarantor    |        | Guarantor    |       |              |       |   |         |      |         |  
|                                  |                                                           |                |        | Issuer                                |        | Subsidiaries |        | Subsidiaries |        | Eliminations |       | Consolidated
|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       |             
|Net revenues                      |                                                           | $              | 11,134 |                                       |        | $            | 54,958 |              |        | $            | 5,468 |              |       | $ | (548    | )    |         | $ | 71,012 |       
|Equity earnings from subsidiaries |                                                           |                | 19,862 |                                       |        |              |       |              |        |              |      |              |       |   | (19,862 | )    |         |   |       |       
|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |       
|                                  |                                                           | Total revenues |        |                                       | 30,996 |              |        |              | 54,958 |              |       |              | 5,468 |   |         |      | (20,410 | ) |        |        | 71,012 | 
|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |       
|Operating costs and expenses:     |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |       
|                                  | Direct costs (excluding
depreciation and
royalty expense) |                |        | 6,478                                 |        |              |        | 13,323       |        |              |       | 3,294        |       |   |         | (458 | )       |   |        | 22,637 |       
|                                  | Selling                                                   |                |        | 1,548                                 |        |              |        | 7,059        |        |              |       | 464          |       |   |         |     |         |   |        | 9,071  |       
|                                  | General and administrative                                |                |        | 6,897                                 |        |              |        | 1,900        |        |              |       | 998          |       |   |         |     |         |   |        | 9,795  |       
|                                  | Research and development                                  |                |        |                                      |        |              |        | 5,367        |        |              |       |             |       |   |         |     |         |   |        | 5,367  |       
|                                  | Depreciation and amortization                             |                |        | 1,322                                 |        |              |        | 1,074        |        |              |       | 280          |       |   |         |     |         |   |        | 2,676  |       
|                                  | Royalty expense                                           |                |        |                                      |        |              |        | 2,362        |        |              |       |             |       |   |         |     |         |   |        | 2,362  |       
|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |       
|                                  |                                                           |                | 16,245 |                                       |        |              | 31,085 |              |        |              | 5,036 |              |       |   | (458    | )    |         |   | 51,908 |       
|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |       
|Income (loss) from operations     |                                                           |                | 14,751 |                                       |        |              | 23,873 |              |        |              | 432   |              |       |   | (19,952 | )    |         |   | 19,104 |       
|Other income (expense):           |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |       
|                                  | Interest, net                                             |                |        | (395                                  | )      |              |        | (4,874       | )      |              |       | 129          |       |   |         |     |         |   |        | (5,140 | )     
|                                  | Net intercompany interest                                 |                |        | (497                                  | )      |              |        | 538          |        |              |       | (41          | )     |   |         |     |         |   |        |       |       
|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |       
|                                  | Other                                                     |                |        | (15                                   | )      |              |        | 19           |        |              |       | (126         | )     |   |         |     |         |   |        | (122   | )     
|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |       
|                                  |                                                           |                | (907   | )                                     |        |              | (4,317 | )            |        |              | (38   | )            |       |   |        |      |         |   | (5,262 | )     
|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |       
|Income (loss) before income taxes |                                                           |                | 13,844 |                                       |        |              | 19,556 |              |        |              | 394   |              |       |   | (19,952 | )    |         |   | 13,842 |       
|Provision for income taxes        |                                                           |                | 4,916  |                                       |        |              | (1     | )            |        |              | (1    | )            |       |   |        |      |         |   | 4,914  |       
|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |       
|Net income (loss)                 |                                                           | $              | 8,928  |                                       |        | $            | 19,557 |              |        | $            | 395   |              |       | $ | (19,952 | )    |         | $ | 8,928  |       
|                                  |                                                           |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |      |         |   |        |       

15



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##### 



aaiPharma Inc.
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands)

|                                  |                                       |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |        |         |   |        |        |        | 
|--------------------------------- | ------------------------------------- | -------------- | ------ | ------------------------------------- | ------ | ------------ | ------ | ------------ | ------ | ------------ | ----- | ------------ | ----- | - | ------- | ------ | ------- | - | ------ | ------ | ------ | 
|                                  |                                       |                |        | Three Months Ended September 30, 2002
|                                  |                                       |                |        |                                      
|                                  |                                       |                |        |                                       |        |              |        |              |        |              |       | Non-         |       |   |         |        |         |   |        |       
|                                  |                                       |                |        |                                       |        |              |        | Guarantor    |        | Guarantor    |       |              |       |   |         |        |         |  
|                                  |                                       |                |        | Issuer                                |        | Subsidiaries |        | Subsidiaries |        | Eliminations |       | Consolidated
|                                  |                                       |                |        |                                       |        |              |        |              |        |              |       |             
|Net revenues                      |                                       | $              | 15,598 |                                       |        | $            | 47,085 |              |        | $            | 4,843 |              |       | $ | (6,317  | )      |         | $ | 61,209 |       
|Equity earnings from subsidiaries |                                       |                | 18,124 |                                       |        |              |       |              |        |              |      |              |       |   | (18,124 | )      |         |   |       |       
|                                  |                                       |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |        |         |   |        |       
|                                  |                                       | Total revenues |        |                                       | 33,722 |              |        |              | 47,085 |              |       |              | 4,843 |   |         |        | (24,441 | ) |        |        | 61,209 | 
|                                  |                                       |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |        |         |   |        |       
|Operating costs and expenses:     |                                       |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |        |         |   |        |       
|                                  | Direct costs (excluding depreciation) |                |        | 10,919                                |        |              |        | 11,957       |        |              |       | 2,813        |       |   |         | (5,914 | )       |   |        | 19,775 |       
|                                  | Selling                               |                |        | 1,523                                 |        |              |        | 4,074        |        |              |       | 447          |       |   |         |       |         |   |        | 6,044  |       
|                                  | General and administrative            |                |        | 7,255                                 |        |              |        | 2,158        |        |              |       | 932          |       |   |         |       |         |   |        | 10,345 |       
|                                  | Research and development              |                |        | 164                                   |        |              |        | 5,347        |        |              |       |             |       |   |         |       |         |   |        | 5,511  |       
|                                  | Depreciation and amortization         |                |        | 1,260                                 |        |              |        | 1,001        |        |              |       | 232          |       |   |         |       |         |   |        | 2,493  |       
|                                  |                                       |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |        |         |   |        |       
|                                  |                                       |                | 21,121 |                                       |        |              | 24,537 |              |        |              | 4,424 |              |       |   | (5,914  | )      |         |   | 44,168 |       
|                                  |                                       |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |        |         |   |        |       
|Income (loss) from operations     |                                       |                | 12,601 |                                       |        |              | 22,548 |              |        |              | 419   |              |       |   | (18,527 | )      |         |   | 17,041 |       
|Other income (expense):           |                                       |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |        |         |   |        |       
|                                  | Interest, net                         |                |        | (1,693                                | )      |              |        | (3,798       | )      |              |       | (15          | )     |   |         |       |         |   |        | (5,506 | )     
|                                  | Net intercompany interest             |                |        | (592                                  | )      |              |        | 639          |        |              |       | (47          | )     |   |         |       |         |   |        |       |       
|                                  | Other                                 |                |        | 1,188                                 |        |              |        | (1,257       | )      |              |       | (8           | )     |   |         |       |         |   |        | (77    | )     
|                                  |                                       |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |        |         |   |        |       
|                                  |                                       |                | (1,097 | )                                     |        |              | (4,416 | )            |        |              | (70   | )            |       |   |        |        |         |   | (5,583 | )     
|                                  |                                       |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |        |         |   |        |       
|Income (loss) before income taxes |                                       |                | 11,504 |                                       |        |              | 18,132 |              |        |              | 349   |              |       |   | (18,527 | )      |         |   | 11,458 |       
|Provision for income taxes        |                                       |                | 4,400  |                                       |        |              |       |              |        |              | (46   | )            |       |   |        |        |         |   | 4,354  |       
|                                  |                                       |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |        |         |   |        |       
|Net income (loss)                 |                                       | $              | 7,104  |                                       |        | $            | 18,132 |              |        | $            | 395   |              |       | $ | (18,527 | )      |         | $ | 7,104  |       
|                                  |                                       |                |        |                                       |        |              |        |              |        |              |       |              |       |   |         |        |         |   |        |       

16



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aaiPharma Inc.
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands)

|                                  |                                                           |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |        |         |   |         |         |         | 
|--------------------------------- | --------------------------------------------------------- | -------------- | ------ | ------------------------------------ | ------ | ------------ | ------- | ------------ | ------- | ------------ | ------ | ------------ | ------ | - | ------- | ------ | ------- | - | ------- | ------- | ------- | 
|                                  |                                                           |                |        | Nine Months Ended September 30, 2003
|                                  |                                                           |                |        |                                     
|                                  |                                                           |                |        |                                      |        |              |         |              |         |              |        | Non-         |        |   |         |        |         |   |         |        
|                                  |                                                           |                |        |                                      |        |              |         | Guarantor    |         | Guarantor    |        |              |        |   |         |        |         |  
|                                  |                                                           |                |        | Issuer                               |        | Subsidiaries |         | Subsidiaries |         | Eliminations |        | Consolidated
|                                  |                                                           |                |        |                                      |        |              |         |              |         |              |        |             
|Net revenues                      |                                                           | $              | 33,395 |                                      |        | $            | 158,065 |              |         | $            | 16,619 |              |        | $ | (2,286  | )      |         | $ | 205,793 |        
|Equity earnings from subsidiaries |                                                           |                | 58,253 |                                      |        |              |        |              |         |              |       |              |        |   | (58,253 | )      |         |   |        |        
|                                  |                                                           |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |        |         |   |         |        
|                                  |                                                           | Total revenues |        |                                      | 91,648 |              |         |              | 158,065 |              |        |              | 16,619 |   |         |        | (60,539 | ) |         |         | 205,793 | 
|                                  |                                                           |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |        |         |   |         |        
|Operating costs and expenses:     |                                                           |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |        |         |   |         |        
|                                  | Direct costs (excluding depreciation and
royalty expense) |                |        | 19,526                               |        |              |         | 41,563       |         |              |        | 9,887        |        |   |         | (1,881 | )       |   |         | 69,095  |        
|                                  | Selling                                                   |                |        | 4,466                                |        |              |         | 18,972       |         |              |        | 1,568        |        |   |         |       |         |   |         | 25,006  |        
|                                  | General and administrative                                |                |        | 22,773                               |        |              |         | 5,323        |         |              |        | 3,017        |        |   |         |       |         |   |         | 31,113  |        
|                                  | Research and development                                  |                |        |                                     |        |              |         | 15,441       |         |              |        |             |        |   |         |       |         |   |         | 15,441  |        
|                                  | Depreciation and amortization                             |                |        | 4,023                                |        |              |         | 3,187        |         |              |        | 828          |        |   |         |       |         |   |         | 8,038   |        
|                                  | Royalty expense                                           |                |        |                                     |        |              |         | 3,437        |         |              |        |             |        |   |         |       |         |   |         | 3,437   |        
|                                  |                                                           |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |        |         |   |         |        
|                                  |                                                           |                | 50,788 |                                      |        |              | 87,923  |              |         |              | 15,300 |              |        |   | (1,881  | )      |         |   | 152,130 |        
|                                  |                                                           |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |        |         |   |         |        
|Income (loss) from operations     |                                                           |                | 40,860 |                                      |        |              | 70,142  |              |         |              | 1,319  |              |        |   | (58,658 | )      |         |   | 53,663  |        
|Other income (expense):           |                                                           |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |        |         |   |         |        
|                                  | Interest, net                                             |                |        | (1,439                               | )      |              |         | (14,314      | )       |              |        | 132          |        |   |         |       |         |   |         | (15,621 | )      
|                                  | Net intercompany interest                                 |                |        | (1,533                               | )      |              |         | 1,661        |         |              |        | (128         | )      |   |         |       |         |   |         |        |        
|                                  | Other                                                     |                |        | 145                                  |        |              |         | 34           |         |              |        | (158         | )      |   |         |       |         |   |         | 21      |        
|                                  |                                                           |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |        |         |   |         |        
|                                  |                                                           |                | (2,827 | )                                    |        |              | (12,619 | )            |         |              | (154   | )            |        |   |        |        |         |   | (15,600 | )      
|                                  |                                                           |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |        |         |   |         |        
|Income (loss) before income taxes |                                                           |                | 38,033 |                                      |        |              | 57,523  |              |         |              | 1,165  |              |        |   | (58,658 | )      |         |   | 38,063  |        
|Provision for income taxes        |                                                           |                | 13,961 |                                      |        |              | 31      |              |         |              | (1     | )            |        |   |        |        |         |   | 13,991  |        
|                                  |                                                           |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |        |         |   |         |        
|Net income (loss)                 |                                                           | $              | 24,072 |                                      |        | $            | 57,492  |              |         | $            | 1,166  |              |        | $ | (58,658 | )      |         | $ | 24,072  |        
|                                  |                                                           |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |        |         |   |         |        

17



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aaiPharma Inc.
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands)

|                                  |                                       |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |         |         |   |         |         |         | 
|--------------------------------- | ------------------------------------- | -------------- | ------ | ------------------------------------ | ------ | ------------ | ------- | ------------ | ------- | ------------ | ------ | ------------ | ------ | - | ------- | ------- | ------- | - | ------- | ------- | ------- | 
|                                  |                                       |                |        | Nine Months Ended September 30, 2002
|                                  |                                       |                |        |                                     
|                                  |                                       |                |        |                                      |        |              |         |              |         |              |        | Non-         |        |   |         |         |         |   |         |        
|                                  |                                       |                |        |                                      |        |              |         | Guarantor    |         | Guarantor    |        |              |        |   |         |         |         |  
|                                  |                                       |                |        | Issuer                               |        | Subsidiaries |         | Subsidiaries |         | Eliminations |        | Consolidated
|                                  |                                       |                |        |                                      |        |              |         |              |         |              |        |             
|Net revenues                      |                                       | $              | 46,271 |                                      |        | $            | 121,113 |              |         | $            | 12,153 |              |        | $ | (11,261 | )       |         | $ | 168,276 |        
|Equity earnings from subsidiaries |                                       |                | 36,703 |                                      |        |              |        |              |         |              |       |              |        |   | (36,703 | )       |         |   |        |        
|                                  |                                       |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |         |         |   |         |        
|                                  |                                       | Total revenues |        |                                      | 82,974 |              |         |              | 121,113 |              |        |              | 12,153 |   |         |         | (47,964 | ) |         |         | 168,276 | 
|                                  |                                       |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |         |         |   |         |        
|Operating costs and expenses:     |                                       |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |         |         |   |         |        
|                                  | Direct costs (excluding depreciation) |                |        | 29,486                               |        |              |         | 35,618       |         |              |        | 7,761        |        |   |         | (10,649 | )       |   |         | 62,216  |        
|                                  | Selling                               |                |        | 4,845                                |        |              |         | 9,923        |         |              |        | 1,260        |        |   |         |        |         |   |         | 16,028  |        
|                                  | General and administrative            |                |        | 20,260                               |        |              |         | 6,564        |         |              |        | 2,440        |        |   |         |        |         |   |         | 29,264  |        
|                                  | Research and development              |                |        | 580                                  |        |              |         | 14,795       |         |              |        |             |        |   |         |        |         |   |         | 15,375  |        
|                                  | Depreciation and amortization         |                |        | 3,802                                |        |              |         | 2,427        |         |              |        | 736          |        |   |         |        |         |   |         | 6,965   |        
|                                  |                                       |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |         |         |   |         |        
|                                  |                                       |                | 58,973 |                                      |        |              | 69,327  |              |         |              | 12,197 |              |        |   | (10,649 | )       |         |   | 129,848 |        
|                                  |                                       |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |         |         |   |         |        
|Income (loss) from operations     |                                       |                | 24,001 |                                      |        |              | 51,786  |              |         |              | (44    | )            |        |   | (37,315 | )       |         |   | 38,428  |        
|Other income (expense):           |                                       |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |         |         |   |         |        
|                                  | Interest, net                         |                |        | (1,240                               | )      |              |         | (12,650      | )       |              |        | 8            |        |   |         |        |         |   |         | (13,882 | )      
|                                  | Net intercompany interest             |                |        | (1,740                               | )      |              |         | 1,896        |         |              |        | (156         | )      |   |         |        |         |   |         |        |        
|                                  | Other                                 |                |        | (4,266                               | )      |              |         | (3,693       | )       |              |        | 32           |        |   |         |        |         |   |         | (7,927  | )      
|                                  |                                       |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |         |         |   |         |        
|                                  |                                       |                | (7,246 | )                                    |        |              | (14,447 | )            |         |              | (116   | )            |        |   |        |         |         |   | (21,809 | )      
|                                  |                                       |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |         |         |   |         |        
|Income (loss) before income taxes |                                       |                | 16,755 |                                      |        |              | 37,339  |              |         |              | (160   | )            |        |   | (37,315 | )       |         |   | 16,619  |        
|Provision for income taxes        |                                       |                | 6,797  |                                      |        |              |        |              |         |              | (136   | )            |        |   |        |         |         |   | 6,661   |        
|                                  |                                       |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |         |         |   |         |        
|Net income (loss)                 |                                       | $              | 9,958  |                                      |        | $            | 37,339  |              |         | $            | (24    | )            |        | $ | (37,315 | )       |         | $ | 9,958   |        
|                                  |                                       |                |        |                                      |        |              |         |              |         |              |        |              |        |   |         |         |         |   |         |        

18



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##### 



aaiPharma Inc.
CONSOLIDATED BALANCE SHEET
(In thousands)

|                                            |                                      |                                            |         |                    |         |              |          |              |         |              |        |              |        |  |         |        |         |   |         |        |         | 
|------------------------------------------- | ------------------------------------ | ------------------------------------------ | ------- | ------------------ | ------- | ------------ | -------- | ------------ | ------- | ------------ | ------ | ------------ | ------ |  | ------- | ------ | ------- | - | ------- | ------ | ------- | 
|                                            |                                      |                                            |         | September 30, 2003
|                                            |                                      |                                            |         |                   
|                                            |                                      |                                            |         |                    |         |              |          |              |         |              |        | Non-         |        |  |         |        |         |   |         |       
|                                            |                                      |                                            |         |                    |         |              |          | Guarantor    |         | Guarantor    |        |              |        |  |         |        |         |  
|                                            |                                      |                                            |         | Issuer             |         | Subsidiaries |          | Subsidiaries |         | Eliminations |        | Consolidated
|                                            |                                      |                                            |         |                    |         |              |          |              |         |              |        |             
|                                            | ASSETS                               |                                            |         |                    |         |              |          |              |         |              |        |              |        |  |         |        |         |   |         |        |        
|Current assets:                             |                                      |                                            |         |                    |         |              |          |              |         |              |        |              |        |  |         |        |         |   |         |       
|                                            | Cash and cash equivalents            |                                            | $       | 10,279             |         |              | $        | 345          |         |              | $      | 486          |        |  | $       |       |         |   | $       | 11,110 |        
|                                            | Accounts receivable, net             |                                            |         | 8,725              |         |              |          | 24,888       |         |              |        | 3,509        |        |  |         |       |         |   |         | 37,122 |        
|                                            | Work-in-progress                     |                                            |         | 4,360              |         |              |          | 5,605        |         |              |        | 7,817        |        |  |         | (2,262 | )       |   |         | 15,520 |        
|                                            | Inventories                          |                                            |         | 4,140              |         |              |          | 6,946        |         |              |        | 772          |        |  |         |       |         |   |         | 11,858 |        
|                                            | Prepaid and other current assets     |                                            |         | 3,868              |         |              |          | 5,517        |         |              |        | 338          |        |  |         |       |         |   |         | 9,723  |        
|                                            |                                      |                                            |         |                    |         |              |          |              |         |              |        |              |        |  |         |        |         |   |         |        |        
|                                            |                                      | Total current assets                       |         |                    | 31,372  |              |          |              | 43,301  |              |        |              | 12,922 |  |         |        | (2,262  | ) |         |        | 85,333  | 
|Investments in and advances to subsidiaries |                                      |                                            | 66,061  |                    |         |              | (46,202  | )            |         |              |       |              |        |  | (19,859 | )      |         |   |        |       
|Property and equipment, net                 |                                      |                                            | 39,419  |                    |         |              | 13,675   |              |         |              | 4,173  |              |        |  |        |        |         |   | 57,267  |       
|Goodwill, net                               |                                      |                                            | 725     |                    |         |              | 200,643  |              |         |              | 10,536 |              |        |  |        |        |         |   | 211,904 |       
|Intangibles, net                            |                                      |                                            | 1,085   |                    |         |              | 88,136   |              |         |              |       |              |        |  |        |        |         |   | 89,221  |       
|Other assets                                |                                      |                                            | 4,529   |                    |         |              | 10,691   |              |         |              | 106    |              |        |  |        |        |         |   | 15,326  |       
|                                            |                                      |                                            |         |                    |         |              |          |              |         |              |        |              |        |  |         |        |         |   |         |        |        
|                                            |                                      | Total assets                               |         | $                  | 143,191 |              |          | $            | 310,244 |              |        | $            | 27,737 |  |         | $      | (22,121 | ) |         | $      | 459,051 | 
|                                            |                                      |                                            |         |                    |         |              |          |              |         |              |        |              |        |  |         |        |         |   |         |        |        
|                                            | LIABILITIES AND STOCKHOLDERS EQUITY |                                            |         |                    |         |              |          |              |         |              |        |              |        |  |         |        |         |   |         |        |        
|Current liabilities:                        |                                      |                                            |         |                    |         |              |          |              |         |              |        |              |        |  |         |        |         |   |         |       
|                                            | Current maturities of long-term debt |                                            | $       |                   |         |              | $        | 6,567        |         |              | $      |             |        |  | $       |       |         |   | $       | 6,567  |        
|                                            | Accounts payable                     |                                            |         | 3,573              |         |              |          | 11,480       |         |              |        | 1,859        |        |  |         |       |         |   |         | 16,912 |        
|                                            | Customer advances                    |                                            |         | 7,553              |         |              |          | 7,983        |         |              |        | 4,149        |        |  |         | (198   | )       |   |         | 19,487 |        
|                                            | Accrued wages and benefits           |                                            |         | 4,667              |         |              |          | 2,148        |         |              |        | 1,601        |        |  |         |       |         |   |         | 8,416  |        
|                                            | Interest payable                     |                                            |         | 19                 |         |              |          | 9,779        |         |              |        |             |        |  |         |       |         |   |         | 9,798  |        
|                                            | Other accrued liabilities            |                                            |         | 5,684              |         |              |          | 5,867        |         |              |        | (340         | )      |  |         | (1,372 | )       |   |         | 9,839  |        
|                                            |                                      |                                            |         |                    |         |              |          |              |         |              |        |              |        |  |         |        |         |   |         |        |        
|                                            |                                      | Total current liabilities                  |         |                    | 21,496  |              |          |              | 43,824  |              |        |              | 7,269  |  |         |        | (1,570  | ) |         |        | 71,019  | 
|Long-term debt, less current portion        |                                      |                                            | 28,000  |                    |         |              | 215,092  |              |         |              |       |              |        |  |        |        |         |   | 243,092 |       
|Other liabilities                           |                                      |                                            | 11,530  |                    |         |              | 5,088    |              |         |              |       |              |        |  |        |        |         |   | 16,618  |       
|Investments in and advances to subsidiaries |                                      |                                            | 111,547 |                    |         |              | (117,472 | )            |         |              | 5,901  |              |        |  | 24      |        |         |   |        |       
|Total stockholders equity                  |                                      |                                            | (29,382 | )                  |         |              | 163,712  |              |         |              | 14,567 |              |        |  | (20,575 | )      |         |   | 128,322 |       
|                                            |                                      |                                            |         |                    |         |              |          |              |         |              |        |              |        |  |         |        |         |   |         |        |        
|                                            |                                      | Total liabilities and stockholders equity |         | $                  | 143,191 |              |          | $            | 310,244 |              |        | $            | 27,737 |  |         | $      | (22,121 | ) |         | $      | 459,051 | 
|                                            |                                      |                                            |         |                    |         |              |          |              |         |              |        |              |        |  |         |        |         |   |         |        |        

19



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##### 



aaiPharma Inc.
CONSOLIDATED BALANCE SHEET
(In thousands)

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

20



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##### 



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

|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |         |       |        |  
|---------------------------------------------------- | ---------------------------------------------------------------------------------------- | -------------------------------------------- | -------------------------------------------------------- | ------- | ------------------------------------ | ------- | ------------ | ------- | ------------ | ------- | ------------ | ----- | ------------ | ------ | - | ------- | - | ------ | ------- | ------- | ----- | ------ | -
|                                                     |                                                                                          |                                              |                                                          |         | Nine Months Ended September 30, 2003
|                                                     |                                                                                          |                                              |                                                          |         |                                     
|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       | Non-         |        |   |         |   |        |         |         |      
|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         | Guarantor    |         | Guarantor    |       |              |        |   |         |   |        |        
|                                                     |                                                                                          |                                              |                                                          |         | Issuer                               |         | Subsidiaries |         | Subsidiaries |         | Eliminations |       | Consolidated
|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |             
|Cash flows from operating activities:                |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |        
|                                                     | Net income (loss)                                                                        |                                              | $                                                        | 24,072  |                                      |         | $            | 57,492  |              |         | $            | 1,166 |              |        | $ | (58,658 | ) |        | $       | 24,072  |      
|                                                     | Adjustments to reconcile net income (loss) to net cash
provided
by operating activities: |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |         |      
|                                                     |                                                                                          | Depreciation and amortization                |                                                          |         | 3,674                                |         |              |         | 3,535        |         |              |       | 829          |        |   |         |  |        |         |         | 8,038 |       
|                                                     |                                                                                          | Other                                        |                                                          |         | (65                                  | )       |              |         | (4           | )       |              |       | 207          |        |   |         |  |        |         |         | 138   |       
|                                                     |                                                                                          | Changes in operating assets and liabilities: |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |         |       |       
|                                                     |                                                                                          |                                              | Accounts receivable, net                                 |         |                                      | 1,379   |              |         |              | (8,130  | )            |       |              | (627   | ) |         |   |       |         |         |       | (7,378 | )
|                                                     |                                                                                          |                                              | Work-in-progress                                         |         |                                      | (226    | )            |         |              | (2,654  | )            |       |              | (2,764 | ) |         |   | 1,124  |         |         |       | (4,520 | )
|                                                     |                                                                                          |                                              | Inventories                                              |         |                                      | 1,364   |              |         |              | 4,167   |              |       |              |       |   |         |   | (311   | )       |         |       | 5,220  |  
|                                                     |                                                                                          |                                              | Prepaid and other assets                                 |         |                                      | (103    | )            |         |              | (2,869  | )            |       |              | (105   | ) |         |   |       |         |         |       | (3,077 | )
|                                                     |                                                                                          |                                              | Accounts payable                                         |         |                                      | (836    | )            |         |              | 33      |              |       |              | (149   | ) |         |   |       |         |         |       | (952   | )
|                                                     |                                                                                          |                                              | Customer advances                                        |         |                                      | (287    | )            |         |              | 2,252   |              |       |              | 1,252  |   |         |   | 941    |         |         |       | 4,158  |  
|                                                     |                                                                                          |                                              | Interest payable                                         |         |                                      | (265    | )            |         |              | 4,831   |              |       |              |       |   |         |   |       |         |         |       | 4,566  |  
|                                                     |                                                                                          |                                              | Accrued wages and benefits and other accrued liabilities |         |                                      | 8,613   |              |         |              | 3,631   |              |       |              | (143   | ) |         |   | (2,027 | )       |         |       | 10,074 |  
|                                                     |                                                                                          |                                              | Intercompany receivables and payables                    |         |                                      | (14,877 | )            |         |              | (44,970 | )            |       |              | 916    |   |         |   | 58,931 |         |         |       |       |  
|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |         |      
|Net cash provided by operating activities            |                                                                                          |                                              | 22,443                                                   |         |                                      |         | 17,314       |         |              |         | 582          |       |              |        |  |         |   |        | 40,339  |        
|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |         |      
|Cash flows from investing activities:                |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |        
|                                                     | Purchases of property and equipment                                                      |                                              |                                                          | (1,264  | )                                    |         |              | (7,813  | )            |         |              | (790  | )            |        |   |        |   |        |         | (9,867  | )    
|                                                     | Proceeds from sales of property and equipment                                            |                                              |                                                          | 390     |                                      |         |              | 118     |              |         |              |      |              |        |   |        |   |        |         | 508     |      
|                                                     | Acquisitions                                                                             |                                              |                                                          |        |                                      |         |              | (2,450  | )            |         |              |      |              |        |   |        |   |        |         | (2,450  | )    
|                                                     | Other                                                                                    |                                              |                                                          | (334    | )                                    |         |              |        |              |         |              |      |              |        |   |        |   |        |         | (334    | )    
|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |         |      
|Net cash used in investing activities                |                                                                                          |                                              | (1,208                                                   | )       |                                      |         | (10,145      | )       |              |         | (790         | )     |              |        |  |         |   |        | (12,143 | )      
|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |         |      
|Cash flows from financing activities:                |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |        
|                                                     | Payments on long-term borrowings                                                         |                                              |                                                          | (19,500 | )                                    |         |              | (10,000 | )            |         |              |      |              |        |   |        |   |        |         | (29,500 | )    
|                                                     | Proceeds from interest rate swap                                                         |                                              |                                                          |        |                                      |         |              | 2,191   |              |         |              |      |              |        |   |        |   |        |         | 2,191   |      
|                                                     | Issuance of common stock                                                                 |                                              |                                                          | 2,819   |                                      |         |              |        |              |         |              |      |              |        |   |        |   |        |         | 2,819   |      
|                                                     | Other                                                                                    |                                              |                                                          |        |                                      |         |              | 805     |              |         |              |      |              |        |   |        |   |        |         | 805     |      
|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |         |      
|Net cash used in financing activities                |                                                                                          |                                              | (16,681                                                  | )       |                                      |         | (7,004       | )       |              |         |             |       |              |        |  |         |   |        | (23,685 | )      
|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |         |      
|Net increase (decrease) in cash and cash equivalents |                                                                                          |                                              | 4,554                                                    |         |                                      |         | 165          |         |              |         | (208         | )     |              |        |  |         |   |        | 4,511   |        
|Effect of exchange rate changes on cash              |                                                                                          |                                              |                                                         |         |                                      |         |             |         |              |         | 67           |       |              |        |  |         |   |        | 67      |        
|Cash and cash equivalents, beginning of period       |                                                                                          |                                              | 5,725                                                    |         |                                      |         | 180          |         |              |         | 627          |       |              |        |  |         |   |        | 6,532   |        
|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |         |      
|Cash and cash equivalents, end of period             |                                                                                          | $                                            | 10,279                                                   |         |                                      | $       | 345          |         |              | $       | 486          |       |              | $      |  |         |   | $      | 11,110  |        
|                                                     |                                                                                          |                                              |                                                          |         |                                      |         |              |         |              |         |              |       |              |        |   |         |   |        |         |         |      

21



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##### 



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

|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |          |       |         |  
|---------------------------------------------------- | -------------------------------------------------------------------------------------------------- | ----------------------------------------------- | -------------------------------------------------------- | ------- | ------------------------------------ | ------- | ------------ | -------- | ------------ | ------- | ------------ | ------ | ------------ | ---- | --- | ------- | - | ------ | -------- | -------- | ----- | ------- | -
|                                                     |                                                                                                    |                                                 |                                                          |         | Nine Months Ended September 30, 2002
|                                                     |                                                                                                    |                                                 |                                                          |         |                                     
|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        | Non-         |      |     |         |   |        |          |          |      
|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          | Guarantor    |         | Guarantor    |        |              |      |     |         |   |        |         
|                                                     |                                                                                                    |                                                 |                                                          |         | Issuer                               |         | Subsidiaries |          | Subsidiaries |         | Eliminations |        | Consolidated
|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |             
|Cash flows from operating activities:                |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |         
|                                                     | Net income (loss)                                                                                  |                                                 | $                                                        | 9,958   |                                      |         | $            | 37,339   |              |         | $            | (24    | )            |      | $   | (37,315 | ) |        | $        | 9,958    |      
|                                                     | Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating activities: |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |          |      
|                                                     |                                                                                                    | Depreciation and amortization                   |                                                          |         | 3,499                                |         |              |          | 2,730        |         |              |        | 736          |      |     |         |  |        |          |          | 6,965 |        
|                                                     |                                                                                                    | Write-off of deferred financing and other costs |                                                          |         |                                     |         |              |          | 5,339        |         |              |        |             |      |     |         |  |        |          |          | 5,339 |        
|                                                     |                                                                                                    | Other                                           |                                                          |         | (5                                   | )       |              |          | 11           |         |              |        | 470          |      |     |         |  |        |          |          | 476   |        
|                                                     |                                                                                                    | Changes in operating assets and liabilities:    |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |          |       |        
|                                                     |                                                                                                    |                                                 | Accounts receivable, net                                 |         |                                      | 2,663   |              |          |              | (12,008 | )            |        |              | 87   |     |         |   | 2,300  |          |          |       | (6,958  | )
|                                                     |                                                                                                    |                                                 | Work-in-progress                                         |         |                                      | (146    | )            |          |              | 918     |              |        |              | 189  |     |         |   | (805   | )        |          |       | 156     |  
|                                                     |                                                                                                    |                                                 | Inventories                                              |         |                                      | (1,548  | )            |          |              | (3,675  | )            |        |              |     |     |         |   | 613    |          |          |       | (4,610  | )
|                                                     |                                                                                                    |                                                 | Prepaid and other assets                                 |         |                                      | 2,243   |              |          |              | (13,988 | )            |        |              | (177 | )   |         |   |       |          |          |       | (11,922 | )
|                                                     |                                                                                                    |                                                 | Accounts payable                                         |         |                                      | (607    | )            |          |              | 407     |              |        |              | (467 | )   |         |   |       |          |          |       | (667    | )
|                                                     |                                                                                                    |                                                 | Customer advances                                        |         |                                      | 3,915   |              |          |              | (120    | )            |        |              | (655 | )   |         |   | (1,494 | )        |          |       | 1,646   |  
|                                                     |                                                                                                    |                                                 | Interest payable                                         |         |                                      | 265     |              |          |              | 10,501  |              |        |              |     |     |         |   |       |          |          |       | 10,766  |  
|                                                     |                                                                                                    |                                                 | Accrued wages and benefits and other accrued liabilities |         |                                      | 3,593   |              |          |              | 4,554   |              |        |              | (53  | )   |         |   | 350    |          |          |       | 8,444   |  
|                                                     |                                                                                                    |                                                 | Intercompany receivables and payables                    |         |                                      | (24,365 | )            |          |              | (12,513 | )            |        |              | 541  |     |         |   | 36,337 |          |          |       |        |  
|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |          |      
|Net cash (used in) provided by operating activities  |                                                                                                    |                                                 | (535                                                     | )       |                                      |         | 19,495       |          |              |         | 647          |        |              |      | (14 | )       |   |        | 19,593   |         
|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |          |      
|Cash flows from investing activities:                |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |         
|                                                     | Purchases of property and equipment                                                                |                                                 |                                                          | (3,968  | )                                    |         |              | (1,423   | )            |         |              | (1,268 | )            |      |     |        |   |        |          | (6,659   | )    
|                                                     | Purchases of property and equipment previously leased                                              |                                                 |                                                          | (14,145 | )                                    |         |              |         |              |         |              |       |              |      |     |        |   |        |          | (14,145  | )    
|                                                     | Proceeds from sales of property and equipment                                                      |                                                 |                                                          | 13      |                                      |         |              |         |              |         |              |       |              |      |     |        |   |        |          | 13       |      
|                                                     | Acquisitions                                                                                       |                                                 |                                                          |        |                                      |         |              | (211,997 | )            |         |              |       |              |      |     |        |   |        |          | (211,997 | )    
|                                                     | Other                                                                                              |                                                 |                                                          | (578    | )                                    |         |              | 49       |              |         |              |       |              |      |     |        |   |        |          | (529     | )    
|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |          |      
|Net cash used in investing activities                |                                                                                                    |                                                 | (18,678                                                  | )       |                                      |         | (213,371     | )        |              |         | (1,268       | )      |              |      |    |         |   |        | (233,317 | )       
|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |          |      
|Cash flows from financing activities:                |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |         
|                                                     | Proceeds from long-term borrowings                                                                 |                                                 |                                                          | 49,401  |                                      |         |              | 195,049  |              |         |              |       |              |      |     |        |   |        |          | 244,450  |      
|                                                     | Payments on long-term borrowings                                                                   |                                                 |                                                          | (27,400 | )                                    |         |              | (12,014  | )            |         |              |       |              |      |     | 14      |   |        |          | (39,400  | )    
|                                                     | Proceeds from interest rate swap, net                                                              |                                                 |                                                          |        |                                      |         |              | 10,848   |              |         |              |       |              |      |     |        |   |        |          | 10,848   |      
|                                                     | Issuance of common stock                                                                           |                                                 |                                                          | 3,193   |                                      |         |              |         |              |         |              |       |              |      |     |        |   |        |          | 3,193    |      
|                                                     | Other                                                                                              |                                                 |                                                          | (2,855  | )                                    |         |              | (11      | )            |         |              | 27     |              |      |     |        |   |        |          | (2,839   | )    
|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |          |      
|Net cash provided by financing activities            |                                                                                                    |                                                 | 22,339                                                   |         |                                      |         | 193,872      |          |              |         | 27           |        |              |      | 14  |         |   |        | 216,252  |         
|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |          |      
|Net increase (decrease) in cash and cash equivalents |                                                                                                    |                                                 | 3,126                                                    |         |                                      |         | (4           | )        |              |         | (594         | )      |              |      |    |         |   |        | 2,528    |         
|Effect of exchange rate changes on cash              |                                                                                                    |                                                 |                                                         |         |                                      |         |             |          |              |         | 95           |        |              |      |    |         |   |        | 95       |         
|Cash and cash equivalents, beginning of period       |                                                                                                    |                                                 | 5,300                                                    |         |                                      |         | 154          |          |              |         | 917          |        |              |      |    |         |   |        | 6,371    |         
|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |          |      
|Cash and cash equivalents, end of period             |                                                                                                    | $                                               | 8,426                                                    |         |                                      | $       | 150          |          |              | $       | 418          |        |              | $    |    |         |   | $      | 8,994    |         
|                                                     |                                                                                                    |                                                 |                                                          |         |                                      |         |              |          |              |         |              |        |              |      |     |         |   |        |          |          |      

22



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##### 



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

Our quarterly results have been, and we expect them to continue to be, subject
to fluctuations. Quarterly results can fluctuate as a result of a number of
factors, including without limitation, demand for our pharmaceutical product
lines, ability of contract manufacturers to supply conforming products on a
timely basis, costs and results of ongoing and future litigation by and against
us, progress of ongoing contracts, amounts recognized for licensing and royalty
revenues, the commencement, completion or cancellation of large contracts,
timing and amounts of start-up expenses for new facilities, timing and level of
research and development expenditures, and changes in the mix of products and
services. There have been no significant changes in our critical accounting
policies, which have been previously disclosed in our Annual Report on Form
10-K for the year ended December 31, 2002. Because a large percentage of our
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.

Results of Operations:

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 September 30, |        | Nine Months Ended September 30,
|                                                          |                      |   |                                  |        |                                
|                                                          |                      |   | 2003                             |        | 2002                            |  | 2003 |    | 2002
|                                                          |                      |   |                                  |        |                                 |  |      |    |     
|                                                          |                      |   | (dollars in thousands)          
|Net revenues:                                             |                      |   |                                  |        |                                 |  |      |    |      |   |        |        |  |  |     |    |   |   |         |         |  |  |     |    |   |   |         |        |  |  |     |   
|                                                          | Product sales        |   | $                                | 45,643 |                                 |  |      | 64 | %    |   | $      | 35,925 |  |  |     | 59 | % |   | $       | 131,403 |  |  |     | 64 | % |   | $       | 90,775 |  |  |     | 54 | %
|                                                          | Product development  |   |                                  | 3,524  |                                 |  |      | 5  |      |   |        | 5,663  |  |  |     | 9  |   |   |         | 11,231  |  |  |     | 5  |   |   |         | 14,267 |  |  |     | 8  |  
|                                                          | Development services |   |                                  | 21,845 |                                 |  |      | 31 |      |   |        | 19,621 |  |  |     | 32 |   |   |         | 63,159  |  |  |     | 31 |   |   |         | 63,234 |  |  |     | 38 |  
|                                                          |                      |   |                                  |        |                                 |  |      |    |      |   |        |        |  |  |     |    |   |   |         |         |  |  |     |    |   |   |         |        |  |  |     |    |  
|                                                          |                      | $ | 71,012                           |        |                                 |  | 100  | %  |      | $ | 61,209 |        |  |  | 100 | %  |   | $ | 205,793 |         |  |  | 100 | %  |   | $ | 168,276 |        |  |  | 100 | % 
|                                                          |                      |   |                                  |        |                                 |  |      |    |      |   |        |        |  |  |     |    |   |   |         |         |  |  |     |    |   |   |         |        |  |  |     |    |  
|Direct costs (excluding depreciation
and royalty expense) |                      | $ | 22,637                           |        |                                 |  | 32   | %  |      | $ | 19,775 |        |  |  | 32  | %  |   | $ | 69,095  |         |  |  | 34  | %  |   | $ | 62,216  |        |  |  | 37  | % 
|Selling                                                   |                      |   | 9,071                            |        |                                 |  | 13   |    |      |   | 6,044  |        |  |  | 10  |    |   |   | 25,006  |         |  |  | 12  |    |   |   | 16,028  |        |  |  | 10  |   
|General and administrative                                |                      |   | 9,795                            |        |                                 |  | 14   |    |      |   | 10,345 |        |  |  | 17  |    |   |   | 31,113  |         |  |  | 15  |    |   |   | 29,264  |        |  |  | 17  |   
|Research and development                                  |                      |   | 5,367                            |        |                                 |  | 8    |    |      |   | 5,511  |        |  |  | 9   |    |   |   | 15,441  |         |  |  | 8   |    |   |   | 15,375  |        |  |  | 9   |   
|Depreciation and amortization                             |                      |   | 2,676                            |        |                                 |  | 4    |    |      |   | 2,493  |        |  |  | 4   |    |   |   | 8,038   |         |  |  | 4   |    |   |   | 6,965   |        |  |  | 4   |   
|Royalty expense                                           |                      |   | 2,362                            |        |                                 |  | 3    |    |      |   |       |        |  |  |    |    |   |   | 3,437   |         |  |  | 2   |    |   |   |        |        |  |  |    |   
|Income from operations                                    |                      |   | 19,104                           |        |                                 |  | 27   |    |      |   | 17,041 |        |  |  | 28  |    |   |   | 53,663  |         |  |  | 26  |    |   |   | 38,428  |        |  |  | 23  |   
|Interest expense, net                                     |                      |   | 5,140                            |        |                                 |  | 7    |    |      |   | 5,506  |        |  |  | 9   |    |   |   | 15,621  |         |  |  | 8   |    |   |   | 13,882  |        |  |  | 8   |   
|Loss from extinguishment of debt                          |                      |   |                                 |        |                                 |  |     |    |      |   |       |        |  |  |    |    |   |   |        |         |  |  |    |    |   |   | (8,053  | )      |  |  | (5  | ) 
|Other income (expense), net                               |                      |   | (122                             | )      |                                 |  |     |    |      |   | (77    | )      |  |  |    |    |   |   | 21      |         |  |  |    |    |   |   | 126     |        |  |  |    |   
|Provision for income taxes                                |                      |   | 4,914                            |        |                                 |  | 7    |    |      |   | 4,354  |        |  |  | 7   |    |   |   | 13,991  |         |  |  | 7   |    |   |   | 6,661   |        |  |  | 4   |   
|Net income                                                |                      |   | 8,928                            |        |                                 |  | 13   | %  |      |   | 7,104  |        |  |  | 12  | %  |   |   | 24,072  |         |  |  | 12  | %  |   |   | 9,958   |        |  |  | 6   | % 

23



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##### 



Third Quarter 2003 Compared to Third Quarter 2002

Our consolidated net revenues for the quarter ended September 30, 2003
increased 16% to $71.0 million, from $61.2 million in the third quarter of
2002. Net revenues from product sales increased to $45.6 million in 2003, from
$35.9 million in 2002, due to the product launch of our Darvocet A500 line
extension, increases in our Brethine injectable product, and the introduction
of our Calcitriol product, which was launched in March 2003, offset by
decreases in our M.V.I. and AzaSan product lines. Net revenues from commercial
manufacturing of products marketed by other pharmaceutical companies, which is
included in product sales, contributed $0.7 million and $0.3 million to net
revenues from product sales in the third quarters of 2003 and 2002,
respectively.

Net revenues from product development decreased 38% in the third quarter of
2003 to $3.5 million, or 5% of net revenues, from $5.7 million, or 9% of net
revenues, in the 2002 period, primarily due to product development revenues
under our significant development agreement, which decreased from $5.4 million
in the third quarter of 2002 to $3.4 million in the third quarter of 2003.
This development agreement is described in the Managements Discussion and
Analysis of Financial Condition and Results of Operations section of our
Annual Report on Form 10-K for the fiscal year ended December 31, 2002. We
expect product development revenues under this agreement to be in the range of
$12 million to $14 million in 2003.

Net revenues from our development services business increased 11% in the third
quarter of 2003 to $21.8 million, from $19.6 million in 2002. These increases
were principally attributable to higher demand for our analytical and clinical
capabilities, partially offset by lower fee-for-service revenues under our
significant development agreement.

Gross margin dollars, or net revenues less direct costs (excluding depreciation
and royalty expense), increased $6.9 million, or 17%, to $48.4 million in the
third quarter of 2003, from $41.4 million in the third quarter of 2002,
reflecting the benefit from our increased product sales and development
services revenues in 2003 over the prior year, partially offset by lower
product development revenues. As a percentage of net revenues, gross margin
dollars remained the same at 68% in the third quarter of 2003 and 2002.

Selling expenses increased 50% in the third quarter of 2003 to $9.1 million, or
13% of net revenues, from $6.0 million, or 10% 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. As of September 30, 2003, our pharmaceutical sales force was
approximately 85, as compared to 20 at September 30, 2002. We anticipate our
pharmaceutical sales force to increase to approximately 235 by the end of 2003,
including 150 outside sales professionals under an agreement with Athlon
Pharmaceuticals, from whom we acquired our Darvocet A500 product.

General and administrative costs decreased 5% in the third quarter of 2003 to
$9.8 million, or 14% of net revenues, from $10.3 million, or 17% of net
revenues, in 2002. This decrease was primarily due to decreases in employee
benefit related expenses.

Research and development expenses were $5.4 million, or 8% of net revenues, in
the third quarter of 2003, a slight dollar decrease from $5.5 million, or 9% of
net revenues, in 2002. In the third quarter of 2003,

24



---



##### 



significant project spending was related to our ProSorb-D pain management
product and development work on line extensions for our pain management and
critical care products. We target annual research and development expenses to
be approximately 8% to 10% of our estimated net revenues.

Royalty expenses for the third quarter of 2003 were $2.4 million. We accrue
royalties based on revenues generated by certain acquired products. No similar
royalty expenses were incurred in 2002.

Consolidated income from operations was $19.1 million in the third quarter of
2003, or $2.1 million higher than the prior year. This increase is primarily
due to the expansion of our product sales business and increases in revenues
and margins in our development services business, partially offset by our
increased selling expenses to support our product sales business and our
decreased product development revenues.

Income from operations for our product sales business was $24.4 million in the
third quarter of 2003, compared to $21.6 million in the third quarter of 2002.
This increase is attributable to the revenue increases from our Brethine and
Calcitriol product lines and our newly launched Darvocet A500 product,
partially offset by the increased selling expenses, as discussed above.

Income from operations for our product development business was $3.5 million in
the third quarter of 2003, compared to income from operations of $5.7 million
in 2002. This change resulted from the decreased revenues from our significant
development agreement, as discussed above.

Income from operations for our development services business was $1.6 million
in the third quarter of 2003, compared to $0.2 million in the third quarter of
2002. This improvement is primarily due to the increase in revenues and gross
margin, as described above.

Unallocated corporate expenses increased in the third quarter of 2003 to $4.9
million, from $4.8 million in 2002. As a percentage of net revenues,
unallocated corporate expenses in the third quarter of 2003 decreased to 7%,
from 8% in the third quarter of 2002.

Net interest expense decreased to $5.1 million in the third quarter of 2003,
from $5.5 million in the third quarter of 2002. This $0.4 million decrease is
primarily attributable to a lower debt balance due to debt repayments on these
facilities.

We recorded a tax provision of $4.9 million in the third quarter of 2003, based
on an effective tax rate of 35.5%. Our effective tax rate for the third
quarter of 2002 was 38%. This decrease in effective tax rate is due to the
benefit of ongoing tax initiatives we have implemented.

Nine Months Ended September 30, 2003 Compared to Nine Months Ended September 30, 2002

Our consolidated net revenues for the nine months ended September 30, 2003
increased 22% to $205.8 million, from $168.3 million in the first nine months
of 2002. Net revenues from product sales increased to $131.4 million in 2003,
from $90.8 million in 2002, due to sales of Darvon and Darvocet-N, which we
acquired at the end of the first quarter of 2002, including sales of our
Darvocet A500 line extension, which was introduced in September 2003, sales
increases for our Brethine injectable product and sales of our AzaSan 75
milligram and 100 milligram products and calcitriol injection products, which
were introduced in the first quarter of 2003. Net revenues from commercial
manufacturing of products

25



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marketed by other pharmaceutical companies, which are included in product
sales, contributed $2.0 million and $3.5 million to net revenues from product
sales in the first nine months of 2003 and 2002, respectively.

Net revenues from product development decreased 21% in the first nine months of
2003 to $11.2 million, or 5% of net revenues, from $14.3 million, or 8% of net
revenues, in 2002, primarily due to lower revenues related to our significant
development agreement in the third quarter of 2003 and to third-party licensing
payments which we had previously deferred and were amortized into revenue in
2002 and prior years. No previously deferred revenues were recognized in 2003.

Net revenues from our development services business were $63.2 million in both
the first nine months of 2003 and 2002.

Gross margin dollars, or net revenues less direct costs (excluding depreciation
and royalty expense), increased $30.6 million, or 29%, to $136.7 million in the
first nine months of 2003, from $106.1 million in the first nine months of
2002, reflecting the benefit from our increased product sales revenues in 2003
over the prior year. As a percentage of net revenues, gross margin dollars
increased to 66% in the first nine months of 2003 from 63% in the first nine
months of 2002.

Selling expenses increased 56% in the first nine months of 2003 to $25.0
million, or 12% of net revenues, from $16.0 million, or 10% 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.

General and administrative costs increased 6% in the first nine months of 2003
to $31.1 million, or 15% of net revenues, from $29.3 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 $15.4 million in both the first nine
months of 2003 and 2002. This represented 8% of net revenues in 2003 and 9% of
net revenues in 2002. Consistent with the third quarter of 2003, we incurred
significant project spending in the first nine months of 2003 related to our
ProSorb-D pain management product and development work on line extensions for
our pain management and critical care products.

Royalty expenses for the first nine months of 2003 were $3.4 million. We
accrue royalties based on revenues generated by certain acquired products. No
similar royalty expenses were incurred in 2002.

Consolidated income from operations was $53.7 million in the first nine months
of 2003, or $15.2 million higher than the first nine months of 2002. This
increase is primarily due to the continued expansion of our product sales
business, partially offset by our increased selling expenses to support our
product sales business and decreases in revenues and margins in our product
development services business.

Income from operations for our product sales business was $72.0 million in the
first nine months of 2003, compared to $51.4 million in the first nine months
of 2002. This increase is attributable to the revenues from our Darvon and
Darvocet-N product lines, which we acquired at the end of the first quarter of
2002

26



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and the introduction of our AzaSan line extensions, Darvocet A500 and
Calcitriol injection product in 2003.

Income from operations for our product development business was $11.2 million
in the first nine months of 2003, compared to income from operations of $14.3
million in 2002. This change resulted from the factors discussed above.

Income from operations for our development services business was $1.7 million
in the first nine months of 2003, compared to $1.3 million in the first nine
months of 2002. This increase is primarily due to increased margins in our
bioanalytical and analytical businesses in 2003.

Unallocated corporate expenses increased in the first nine months of 2003 to
$15.5 million, from $12.8 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 nine months of 2003 and 2002 were both 8%.

Net interest expense increased to $15.6 million in the first nine months of
2003, from $13.9 million in 2002. This $1.7 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 2002.
This loss was due to the write-off of deferred financing and other costs
related to our prior debt facilities that were refinanced in March 2002.

We recorded a tax provision of $14.0 million in the first nine months of 2003,
based on an effective tax rate of 37%. Our effective tax rate for the first
nine months of 2002 was 40%. This decrease in the effective tax rate is due to
benefits obtained from our ongoing tax initiatives.

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 nine months of 2003 was $40.3 million, compared to cash flow provided
by operations of $19.6 million in the first nine months of 2002. This change
was primarily due to an increase in net income and positive changes in working
capital. In addition, the first nine months of 2002 included $13.1 million of
prepaid financing fees related to our senior credit facilities and senior
subordinated notes, which did not recur in the first nine months of 2003.

Cash used in investing activities was $12.1 million in the first nine months of
2003 which included $9.9 million for capital spending. Cash used in investing
activities was $233.3 million in the first nine months of 2002, which included
$211.4 million related to our 2002 acquisition of the Darvon and Darvocet-N
branded product lines, and $14.1 million for the purchase of assets formerly
covered by our tax retention operating lease, including our corporate
headquarters in Wilmington, N.C. and a laboratory and clinical facility in
Chapel Hill, N.C.

Net cash used in financing activities during the first nine months of 2003 was
$23.7 million, primarily representing debt payments of $29.5 million, partially
offset by $2.2 million of interest rate swap proceeds and $2.8 million in proceeds
from the issuance of common stock related to the exercise of stock options.

27



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On March 28, 2002, we acquired the U.S. rights to the Darvon and Darvocet-N
branded product lines and existing inventory from Eli Lilly and Company for
$211.4 million in cash. In connection with the acquisition, we entered into
$175 million of senior credit facilities, issued $175 million of senior
subordinated notes due 2010, repaid all $78 million of borrowings outstanding
under our prior senior credit facilities, and terminated our tax retention
operating lease and purchased the underlying properties.

Our $175 million senior secured credit facilities consist of a $75 million
five-year revolving credit facility and a $100 million five-year term loan
facility. The term loan facility amortizes over the full five-year term. The
senior facilities were subsequently reduced to $115 million due to $60 million
of repayments we made under the term loan facility. The availability of
borrowings under our revolving credit facility is not limited by a borrowing
base. At September 30, 2003, we had unused availability under the revolving
credit facility of $47.0 million. Our senior credit facilities provide for
variable interest rates based on LIBOR or an alternate base rate, at our
option. Such facilities are guaranteed by all of our domestic subsidiaries and
secured by a security interest on substantially all of our domestic assets, all
of the stock of our domestic subsidiaries, and 65% of the stock of our material
foreign subsidiaries. Our senior credit facilities require the payment of
certain commitment fees based on the unused portion of the revolving credit
facility. Under the terms of the credit agreement for our senior credit
facilities, we are required to comply with various covenants including, but not
limited to, those pertaining to maintenance of certain financial ratios and
incurrence of additional indebtedness. We were in compliance with these
covenants at September 30, 2003. These senior credit facilities may be prepaid
at our option at any time without a premium.

On March 28, 2002, we issued $175 million of senior subordinated unsecured
notes due 2010. These notes have a fixed interest rate of 11% per annum and
are guaranteed on a subordinated basis by all of our existing domestic
subsidiaries and all of our future domestic subsidiaries of which we own 80% or
more of the equity interests. Prior to March 28, 2005, up to 35% of the notes
are redeemable with the proceeds of qualified sales of equity at 111% of par
value. The terms of our senior credit facilities require us to repay all of
the indebtedness under these facilities before we could repurchase any of the
notes. On or after March 28, 2006, all or any portion of the notes are
redeemable at declining premiums to par value, beginning at 105.5%.
Under the terms of the indenture for the notes, we are required to comply with
various covenants including, but not limited to, a covenant relating to incurrence
of additional indebtedness.We were in compliance with these covenants at September 30, 2003.

Concurrent with the issuance of our senior subordinated notes, we entered into
an interest rate swap agreement to effectively convert interest expense on a
portion of the senior subordinated notes for the term of the notes from an 11%
fixed annual rate to a floating annual rate equal to 6-month LIBOR plus a base
rate. On February 27, 2003, and again on June 23, 2003, we sold the then
outstanding swap agreement for $2.3 million and $3.7 million, respectively, and
replaced it with a similar interest rate swap 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 September 30, 2003, we had an
interest rate swap agreement in place covering $150

28



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million of the notes, at a rate of 6-month LIBOR plus 7.41%. On September 30,
2003, 6-month LIBOR was 1.18%, giving us an estimated all-in rate of 8.59%.
The terms of the interest rate swap agreements, other than the base rate, were
identical and were perfectly matched with the terms of the related hedged
instrument. Our annual net interest expense may exceed $20 million in 2003.

Our M.V.I. and Aquasol product line acquisition agreement was amended on July
22, 2003. As amended, it provided for a $1.0 million guaranteed payment, which
was made in August 2003, eliminated a contingent payment of $2.0 million that
was potentially due in August 2003 under the original agreement, and provides
future contingent payments of $43.5 million potentially due in August 2004,
depending on the status of certain reformulation activities being carried out
by the seller. As previously discussed in our Annual Report on Form 10-K for
the year ended December 31, 2002, the conditions for the contingent payment
were not met by the required date, so that the potential $43.5 million
contingent payment has decreased by $10.0 million by the end of October 2003
and is decreasing by $1.0 million for each full month thereafter that the
conditions continue to be unmet. Such conditions have not been met as of
October 31, 2003, and if such conditions are not satisfied by May 31, 2004
(subject to certain adjustments), the remaining contingent payment obligation
to the seller will decrease to zero. Also on July 22, 2003, the M.V.I. supply
agreement with the seller was extended through 2008. In addition, we may have
to make contingent payments of $4.7 million over four years in connection with
the purchase of our Charleston, South Carolina manufacturing facility, based on
the level of manufacturing revenues at this facility. These contingent payment
obligations, including the contingent payments potentially due in connection
with the acquisition of the M.V.I. and Aquasol product lines, have not yet been
recorded as a liability on our consolidated balance sheet. We have $6.6
million of principal repayments due in the next twelve months under our senior
credit facilities. We made an interest payment on the senior subordinated
notes of $9.6 million in October 2003 and a similar interest payment is due in
April 2004. At current estimated LIBOR rates, we anticipate that the April
2004 interest payment will be offset by approximately $1.6 million to be
received under our interest rate swap agreement.

On August 5, 2003, aaiPharma, CIMA LABS INC., (CIMA), Scarlet Holding
Corporation, a direct, wholly owned subsidiary of aaiPharma (Holding
Company), Scarlet MergerCo, Inc., a direct, wholly owned subsidiary of Holding
Company (S MergerCo), and Crimson MergerCo, Inc.,
a direct, wholly owned subsidiary of Holding Company (C MergerCo), entered
into an Agreement and Plan of Merger (the Merger Agreement). Pursuant to the
Merger Agreement, Holding Company would acquire all of the capital stock of
each of CIMA and aaiPharma through the merger of S MergerCo with and into
aaiPharma and the merger of C MergerCo with and into CIMA, with aaiPharma and
CIMA surviving as wholly owned subsidiaries of Holding Company (together, the
Transaction). The completion of the Transaction was subject to several
conditions, including the approval of the Transaction by the stockholders of
CIMA and aaiPharma and the expiration or termination of the applicable waiting
period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.

On November 3, 2003, CIMA terminated the Merger Agreement and paid an $11.5
million termination fee to us. This fee will used to offset merger-related
expenses.

On October 22, 2003, we entered into an agreement with certain subsidiaries of
Elan Corporation, plc to acquire a portfolio of pain management products for
$100 million in cash, subject to adjustment for the inventory to be acquired.
We anticipate completing this acquisition in the fourth quarter of 2003. We

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have received a commitment from our current lenders to provide a term loan
facility in an amount necessary to fund the purchase of this product line, pay
related fees and expenses and repay indebtedness under our existing term loan
facility. The completion of this transaction is subject to clearance under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976 by the Federal Trade
Commission and the Department of Justice. In addition, in connection with this
acquisition, we anticipate revising and increasing the amount of our existing
revolving credit facility.

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

In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, Consolidation of Variable Interest Entities (FIN
46). FIN 46, as amended, requires that variable interest entities be
consolidated by the primary beneficiary of the entity if certain criteria are
met. FIN 46 is effective immediately for all variable interest entities
created or acquired after January 31, 2003. For variable interest entities
created or acquired prior to February 1, 2003, the provisions of FIN 46 become
effective for us during the fourth quarter of 2003. We are currently
performing a review to determine if we are the primary beneficiary of any
variable interest entities. To date, the review has not identified any entity
that would require consolidation. Provided that we are not the primary
beneficiary, the maximum exposure to losses related to any entity that may be
determined to be a variable interest entity is limited to the carrying amount
of our investment in the entity.

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

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

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

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



| |  |  | We have transitioned our company to a specialty pharmaceutical company
with different challenges and risks;                                                                                                                                                                                                                                                            
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We may devote significant operational and financial resources to develop
products that we may never be able to successfully commercialize;                                                                                                                                                                                                                             
|
| |  |  | We have increased our sales and net income through a series of
acquisitions of branded products, and we intend to seek more acquisition
opportunities; we may have overpaid, or may overpay in the future, for a
branded product line that may not produce sufficient cash flow to repay
our debt, including indebtedness incurred in connection with that
acquisition;
|
| |  |  | We are dependent on third parties for essential business functions and
problems with these third-party arrangements could materially adversely
affect our ability to manufacture and sell products and our financial
condition and results of operations;                                                                                                              
|
| |  |  | Competition from the introduction and sale of generic products and the
development by other companies of new branded products could cause the
revenues from our branded products to decrease significantly;                                                                                                                                                            
|
| |  |  | We may be unable to obtain government approval for our products or comply
with government regulations relating to our business; and                                                                                                                                                                                                                                    
|
| |  |  | Changes in government regulations may further favor sales of generic
products that compete with our branded products.                                                                                                                                                                                                                                                  

Additional factors that may cause the actual results to differ materially are
discussed in our recent filings with the SEC, including, but not limited to,
Exhibit 99.1, attached hereto, our Annual Report on Form 10-K filed with the
SEC on March 28, 2003, including the exhibits attached or incorporated therein,
our Form 10-Q, filed with the SEC on August 15, 2003, our Form 8-K reports, and
other periodic filings. Whenever you read or hear any subsequent written or
oral forward-looking statements attributable to us or any person acting on our
behalf, you should keep in mind the cautionary statements contained or referred
to in this section. We do not undertake any obligation to release publicly any
revisions to these forward-looking statements to reflect events or
circumstances after the date of this document or to reflect the occurrence of
unanticipated events.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As a result of global operating activities, we are exposed to risks associated
with changes in foreign exchange rates, principally exchange rates between the
U.S. dollar and the euro. As foreign exchange rates change, the U. S. dollar
equivalent of revenues and expenses denominated in foreign currencies change.
If foreign exchange rates were to increase by 10%, our net income would have
been lower by $101,000 in the nine months ended September 30, 2003 due to the
reduction in reported results from European operations.

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We are also exposed to fluctuations in interest rates on borrowings under our
senior credit facilities and on $150 million of our senior subordinated notes,
due to our entering into the interest rate swap agreement discussed in Item 1.
Liquidity and Capital Resources. The interest rates payable on these
borrowings are based on LIBOR. If LIBOR rates were to increase by 1%, annual
interest expense on variable rate debt would increase by approximately $0.8
million, or $200,000 per quarter.

Item 4. Controls and Procedures

(a)     Evaluation of Disclosure Controls and Procedures  aaiPharma Inc.s
Executive Chairman, Chief Executive Officer and Chief Financial Officer have
evaluated the Companys disclosure controls and procedures as of September 30,
2003, and they concluded that these controls and procedures are effective.

(b)     Changes in Internal Controls  There was no change in internal controls
over financial reporting during or subsequent to the most recent fiscal quarter
that has materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are party to lawsuits and administrative proceedings incidental to the
normal course of our business, including a number of legal actions with generic
drug companies. While we cannot predict the outcomes of these suits, we do not
believe that any liabilities related to such lawsuits or proceedings will have
a material adverse effect on our consolidated financial condition, results of
operations or cash flows and we intend to vigorously pursue all defenses
available. In cases where we have initiated an
action, we intend to prosecute our claims to the full extent of our rights
under the law.

We are involved in four actions centered on our omeprazole-related patents.
Omeprazole is the active ingredient found in Prilosec, a drug sold by
AstraZeneca.

Two omeprazole-related cases have been filed against us by Dr. Reddys
Laboratories Ltd. and Dr. Reddys Laboratories, Inc. in the United States
District Court for the Southern District of New York in July 2001 and November
2001. These plaintiffs have sought but, as of November 5, 2003 have not
obtained, approval from the FDA to market a generic form of Prilosec. In
addition, these plaintiffs omeprazole product has been found in separate
litigation to infringe certain patents of AstraZeneca. The plaintiffs in these
cases are challenging the validity of five patents that we have obtained
relating to omeprazole and are seeking a declaratory judgment that their
generic form of Prilosec does not infringe these patents. Additionally, they
have alleged misappropriation of trade secrets, tortious interference, unfair
competition and violations of the North Carolina Unfair Trade Practice Act. We
have denied the substantive allegations made in these cases. Both cases are in
the initial stages and discovery is just beginning. No date has been set for
trial. We intend to vigorously defend the patents validity and to determine
whether or not Dr. Reddys product infringes any of our relevant patents.

The third case involving our omeprazole patents was brought in August 2001 by
Andrx Pharmaceuticals, Inc. in the United States District Court for the
Southern District of New York. Andrx has received FDA approval for its generic
omeprazole product. However, to our knowledge, it is not currently marketing
this drug in the U.S. following a judicial finding that Andrxs omeprazole
product

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infringed certain AstraZeneca patents. Andrx is challenging the validity of
three of our omeprazole patents and is also seeking a declaratory judgment that
its generic omeprazole product does not infringe these patents. Furthermore,
Andrx claims violations of federal and state antitrust laws with respect to the
licensing of these omeprazole patents and is seeking injunctive relief and
unspecified treble damages. We have denied the substantive allegations made by
Andrx. This case is in the initial stages of discovery. No date has been set
for trial. aaiPharma has filed a motion to dismiss the litigation (or,
alternatively, with respect to the antitrust claims, to stay them pending the
appellate decision in the Andrx litigation with AstraZeneca). Andrxs papers
in opposition to our motion to dismiss have been filed, and a decision by the
court on the motion is pending.

The fourth case involving our omeprazole patents was brought in December 2002
by us against Kremers Urban Development Co., Schwarz Pharma Inc. and Schwarz
Pharma AG (collectively, KUDCO) in the United States District Court for the
Southern District of New York. The case involves claims of infringement of our
omeprazole patent dealing with a dry-blend process of manufacturing omeprazole
products. KUDCO has a generic omeprazole product with final FDA marketing
approval, was found not to infringe the AstraZeneca patents in the separate
AstraZeneca patent litigation, and is currently selling its generic substitute
for Prilosec in the U.S. marketplace. KUDCO has filed its answer to the
Companys original complaint, denying the Companys claims, asserting various
affirmative defenses to our claims, and asserting counterclaims of patent
invalidity, product non-infringement and antitrust violations under federal and
state antitrust laws. We have denied the substantive counterclaims made by
KUDCO. In September 2003, an amended complaint was filed, asserting
infringement of a second aaiPharma patent and naming two additional KUDCO
affiliates as defendants. Two of the defendants have answered the amended
complaint, while three of the defendants are contesting jurisdiction in the New
York court. We intend to vigorously defend our patent rights and defend
against the foregoing defenses and counterclaims asserted by KUDCO. It is possible that the
omeprazole-related patents subject to the foregoing four lawsuits will be found
invalid, unenforceable or not infringed.

Item 6. Exhibits and Reports on Form 8-K

Exhibits:

A list of the exhibits required to be filed as part of this Report on Form 10-Q
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 third quarter of 2003, we furnished the following Form 8-Ks:



| |  |  | Dated July 25, 2003, reporting our results of operations for the quarter ended June 30, 2003.                                                                                                   
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Dated August 5, 2003, reporting our Merger Agreement for a potential
merger with CIMA LABS INC.                                                                                                 
|
| |  |  | Dated August 6, 2003, to file as an exhibit the Merger Agreement to
include the annexes and exhibits attached to the Merger Agreement and
incorporated therein.                                 
|
| |  |  | Dated August 21, 2003, reporting our receipt of notification from
CIMA LABS INC. that CIMA has an unsolicited proposal from Cephalon,
Inc., concerning its potential interest in acquiring CIMA.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

|                        |  |                |  |                                      
|----------------------- |  | -------------- |  | -------------------------------------
|                        |  | aaiPharma Inc.
|                        |  |                |  |                                      
|Date: November 13, 2003 |  | By:            |  | /s/ PHILIP S. TABBINER               
|                        |  |                |  |                                      
|                        |  |                |  | Philip S. Tabbiner, D.B.A.           
|                        |  |                |  | President and Chief Executive Officer
|                        |  |                |  |                                      
|Date: November 13, 2003 |  | By:            |  | /s/ WILLIAM L. GINNA, JR.            
|                        |  |                |  |                                      
|                        |  |                |  | William L. Ginna, Jr.                
|                        |  |                |  | Executive Vice President and         
|                        |  |                |  | Chief Financial Officer              

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aaiPharma Inc.
Exhibit Index

|        |       |             |  |                                                                                                                                                                                                                      
|------- | ----- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |            
|No.     |       | Description
|        |       |            
|        | 3.1   |             |  | Amended and Restated
Certificate of Incorporation of the Company, and amendments thereto
(incorporated by reference to Exhibit 3.1 to the Companys Quarterly Report on Form 10-Q for the quarter ended June 30,2003)
|        |       |             |  |                                                                                                                                                                                                                      
|        | 3.2   |             |  | Amended By-laws of
the Company (incorporated by reference to Exhibit 3.3 to the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 2000)                                                         
|        |       |             |  |                                                                                                                                                                                                                      
|        | 4.1   |             |  | Articles Fourth,
Seventh, Eleventh and Twelfth of the form of Amended and Restated Certificate of Incorporation of the Company (included in Exhibit 3.1)                                                             
|        |       |             |  |                                                                                                                                                                                                                      
|        | 4.2   |             |  | Article II of
the form of Restated By-laws of the Company (included in Exhibit 3.2)                                                                                                                                  
|        |       |             |  |                                                                                                                                                                                                                      
|        | 4.3   |             |  | Specimen Certificate
for shares of Common Stock, $.001 par value, of the Company
(incorporated by reference to Exhibit 4.3 to the Companys Registration Statement on Form S-1 (Registration No. 333-5535))          
|        |       |             |  |                                                                                                                                                                                                                      
|        | 10.1* |             |  | First Amendment to
Interim Supply Agreement between aaiPharma LLC and AstraZeneca LP,
dated July 22, 2003                                                                                                            
|        |       |             |  |                                                                                                                                                                                                                      
|        | 10.2  |             |  | First Amendment to
Asset Purchase Agreement between aaiPharma LLC and AstraZeneca AB, dated July 22, 2003                                                                                                            
|        |       |             |  |                                                                                                                                                                                                                      
|        | 31.1  |             |  | Certification pursuant to Rule 13a  14(a) of Frederick D. Sancilio                                                                                                                                                  
|        |       |             |  |                                                                                                                                                                                                                      
|        | 31.2  |             |  | Certification pursuant to Rule 13a  14(a) of Philip S. Tabbiner                                                                                                                                                     
|        |       |             |  |                                                                                                                                                                                                                      
|        | 31.3  |             |  | Certification pursuant to Rule 13a  14(a) of William L. Ginna, Jr.                                                                                                                                                  
|        |       |             |  |                                                                                                                                                                                                                      
|        | 32.1  |             |  | Certification Pursuant to 18 U.S.C. Section 1350                                                                                                                                                                     
|        |       |             |  |                                                                                                                                                                                                                      
|        | 99.1  |             |  | Risk Factors
(incorporated by reference to Exhibit 99.1 to the Companys Quarterly Report on Form 10-Q for
the quarter ended June 30, 2003)                                                                          



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|* |  | Certain information in this document has been omitted pursuant to a request
for confidential treatment dated November 13, 2003 submitted to the Secretary
of the Securities and Exchange Commission.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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