##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 0-21185

AAIPHARMA INC.
(Exact name of Registrant as specified in its charter)

|                                |  |                    
|------------------------------- |  | -------------------
|DELAWARE                        |  | 04-2687849         
|(State or other jurisdiction of |  | (I.R.S. employer   
|incorporation or organization)  |  | identification no.)

2320 SCIENTIFIC PARK DRIVE, WILMINGTON, NC 28405
          
(Address of principal executive office)           
   (Zip code)

(910) 254-7000
(Registrants telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.   YES [X]     NO [  ]

The number of shares of the Registrants common stock outstanding, as of November 6, 2002 was 18,332,471 shares.





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aaiPharma Inc.
Table of Contents

The terms Company, Registrant or aaiPharma in this Form 10-Q include
aaiPharma Inc. and its subsidiaries, except where the context may indicate
otherwise. Any item which is not applicable or to which the answer is negative
has been omitted.

We own the U.S. rights to the following registered and unregistered trademarks:
M.V.I.®, Aquasol, Brethine®, Darvon®, Darvocet-N®, ProSorb®,
ProSorb-D, NeoSan and aaiPharma. We also reference trademarks
owned by other companies. Prilosec® is a registered trademark of AstraZeneca
AB and Prozac® is a registered trademark of Eli Lilly and Company. All
references in this Form 10-Q to any of these terms lacking the ® or 
symbols are defined terms that reference the products, technologies or
businesses bearing the trademarks with these symbols.

|                                                                                              |                                                 |  |          |   | 
|--------------------------------------------------------------------------------------------- | ----------------------------------------------- |  | -------- | - | 
|                                                                                              |                                                 |  | 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 |                                                 |  | 22       |  
|Item 3. Quantitative and Qualitative Disclosures About
Market Risk                            |                                                 |  | 30       |  
|Item 4. Controls and Procedures                                                               |                                                 |  | 30       |  
|PART II.OTHER INFORMATION                                                                     |                                                 |  |          |  
|Item 1. Legal Proceedings                                                                     |                                                 |  | 31       |  
|Item 6. Exhibits and Reports on Form 8-K                                                      |                                                 |  | 32       |  
|SIGNATURES                                                                                    |                                                 |  | 33       |  
|EXHIBIT INDEX                                                                                 |                                                 |  | 34       |  

2



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##### 



PART I. FINANCIAL INFORMATIONItem 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,    
|                                                   |                                      |   |                    |        |                  
|                                                   |                                      |   | 2002               |        | 2001              |   | 2002   |        | 2001
|                                                   |                                      |   |                    |        |                   |   |        |        |     
|Net revenues                                       |                                      | $ | 61,209             |        |                   | $ | 34,908 |        |      | $ | 168,276 |         |   | $ | 94,989 |       
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|Operating costs and expenses:                      |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|                                                   | Direct costs                         |   |                    | 20,731 |                   |   |        | 18,321 |      |   |         | 65,016  |   |   |        | 49,046 |  
|                                                   | Selling                              |   |                    | 6,085  |                   |   |        | 3,619  |      |   |         | 16,161  |   |   |        | 9,348  |  
|                                                   | General and administrative           |   |                    | 11,734 |                   |   |        | 7,879  |      |   |         | 32,980  |   |   |        | 22,004 |  
|                                                   | Research and development             |   |                    | 5,618  |                   |   |        | 2,655  |      |   |         | 15,691  |   |   |        | 6,763  |  
|                                                   | Direct pharmaceutical start-up costs |   |                    |       |                   |   |        | 442    |      |   |         |        |   |   |        | 2,123  |  
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|                                                   |                                      |   | 44,168             |        |                   |   | 32,916 |        |      |   | 129,848 |         |   |   | 89,284 |       
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|Income from operations                             |                                      |   | 17,041             |        |                   |   | 1,992  |        |      |   | 38,428  |         |   |   | 5,705  |       
|Other expense                                      |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|                                                   | Interest, net                        |   |                    | (5,506 | )                 |   |        | (890   | )    |   |         | (13,882 | ) |   |        | (1,600 | )
|                                                   | Other                                |   |                    | (77    | )                 |   |        | 84     |      |   |         | 126     |   |   |        | (603   | )
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|                                                   |                                      |   | (5,583             | )      |                   |   | (806   | )      |      |   | (13,756 | )       |   |   | (2,203 | )     
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|Income before income taxes and extraordinary loss  |                                      |   | 11,458             |        |                   |   | 1,186  |        |      |   | 24,672  |         |   |   | 3,502  |       
|Provision for income taxes                         |                                      |   | 4,354              |        |                   |   | 478    |        |      |   | 9,375   |         |   |   | 964    |       
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|Income before extraordinary loss                   |                                      |   | 7,104              |        |                   |   | 708    |        |      |   | 15,297  |         |   |   | 2,538  |       
|Extraordinary loss, net of a tax benefit of $2,714 |                                      |   |                   |        |                   |   |       |        |      |   | (5,339  | )       |   |   |       |       
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|Net income                                         |                                      | $ | 7,104              |        |                   | $ | 708    |        |      | $ | 9,958   |         |   | $ | 2,538  |       
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|Basic earnings (loss) per share:                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|                                                   | Income before extraordinary loss     |   | $                  | 0.39   |                   |   | $      | 0.04   |      |   | $       | 0.84    |   |   | $      | 0.14   |  
|                                                   | Extraordinary loss                   |   |                    |       |                   |   |        |       |      |   |         | (0.29   | ) |   |        |       |  
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|Net income                                         |                                      | $ | 0.39               |        |                   | $ | 0.04   |        |      | $ | 0.55    |         |   | $ | 0.14   |       
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|Weighted average shares outstanding                |                                      |   | 18,278             |        |                   |   | 17,945 |        |      |   | 18,198  |         |   |   | 17,774 |       
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|Diluted earnings (loss) per share:                 |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|                                                   | Income before extraordinary loss     |   | $                  | 0.38   |                   |   | $      | 0.04   |      |   | $       | 0.81    |   |   | $      | 0.14   |  
|                                                   | Extraordinary loss                   |   |                    |       |                   |   |        |       |      |   |         | (0.28   | ) |   |        |       |  
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|Net income                                         |                                      | $ | 0.38               |        |                   | $ | 0.04   |        |      | $ | 0.53    |         |   | $ | 0.14   |       
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       
|Weighted average shares outstanding                |                                      |   | 18,708             |        |                   |   | 18,571 |        |      |   | 18,947  |         |   |   | 18,152 |       
|                                                   |                                      |   |                    |        |                   |   |        |        |      |   |         |         |   |   |        |       

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,
|                                     |                                                          |                                            |         | 2002          |         | 2001        
|                                     |                                                          |                                            |         |               |         |             
|                                     |                                                          |                                            |         | (Unaudited)   |         |              |        |       
|ASSETS                               |                                                          |                                            |         |               |         |              |        |       
|Current assets:                      |                                                          |                                            |         |               |         |              |        |       
|                                     | Cash and cash equivalents                                |                                            | $       | 8,994         |         |              | $      | 6,371  |        
|                                     | Accounts receivable, net                                 |                                            |         | 33,841        |         |              |        | 26,594 |        
|                                     | Work-in-progress                                         |                                            |         | 10,715        |         |              |        | 10,464 |        
|                                     | Inventories                                              |                                            |         | 13,723        |         |              |        | 9,057  |        
|                                     | Prepaid and other current assets                         |                                            |         | 8,243         |         |              |        | 5,972  |        
|                                     |                                                          |                                            |         |               |         |              |        |       
|                                     |                                                          | Total current assets                       |         |               | 75,516  |              |        |        | 58,458  | 
|Property and equipment, net          |                                                          |                                            | 52,569  |               |         |              | 37,035 |       
|Goodwill and other intangibles, net  |                                                          |                                            | 300,023 |               |         |              | 88,504 |       
|Other assets                         |                                                          |                                            | 14,756  |               |         |              | 12,289 |       
|                                     |                                                          |                                            |         |               |         |              |        |       
|                                     |                                                          | Total assets                               |         | $             | 442,864 |              |        | $      | 196,286 | 
|                                     |                                                          |                                            |         |               |         |              |        |       
|LIABILITIES AND STOCKHOLDERS EQUITY |                                                          |                                            |         |               |         |              |        |       
|Current liabilities:                 |                                                          |                                            |         |               |         |              |        |       
|                                     | Current maturities of long-term debt and short-term debt |                                            | $       | 9,167         |         |              | $      |       |        
|                                     | Accounts payable                                         |                                            |         | 14,947        |         |              |        | 15,444 |        
|                                     | Customer advances                                        |                                            |         | 15,274        |         |              |        | 13,349 |        
|                                     | Accrued wages and benefits                               |                                            |         | 7,511         |         |              |        | 3,879  |        
|                                     | Interest payable                                         |                                            |         | 11,137        |         |              |        | 371    |        
|                                     | Other accrued liabilities                                |                                            |         | 4,078         |         |              |        | 4,922  |        
|                                     |                                                          |                                            |         |               |         |              |        |       
|                                     |                                                          | Total current liabilities                  |         |               | 62,114  |              |        |        | 37,965  | 
|Long-term debt, less current portion |                                                          |                                            | 285,530 |               |         |              | 78,878 |       
|Other liabilities                    |                                                          |                                            | 4,636   |               |         |              | 224    |       
|Commitments and contingencies        |                                                          |                                            |        |               |         |              |       |       
|Redeemable warrants                  |                                                          |                                            |        |               |         |              | 2,855  |       
|Stockholders equity:                |                                                          |                                            |         |               |         |              |        |       
|                                     | Common stock                                             |                                            |         | 18            |         |              |        | 18     |        
|                                     | Paid-in capital                                          |                                            |         | 78,427        |         |              |        | 75,233 |        
|                                     | Retained earnings                                        |                                            |         | 13,236        |         |              |        | 3,278  |        
|                                     | Accumulated other comprehensive losses                   |                                            |         | (1,097        | )       |              |        | (2,165 | )      
|                                     |                                                          |                                            |         |               |         |              |        |       
|                                     |                                                          | Total stockholders equity                 |         |               | 90,584  |              |        |        | 76,364  | 
|                                     |                                                          |                                            |         |               |         |              |        |       
|                                     |                                                          | Total liabilities and stockholders equity |         | $             | 442,864 |              |        | $      | 196,286 | 
|                                     |                                                          |                                            |         |               |         |              |        |       

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,    
|                                                    |                                                                                                                  |                                              |                                                          |          |                  
|                                                    |                                                                                                                  |                                              |                                                          |          | 2002              |         | 2001   
|                                                    |                                                                                                                  |                                              |                                                          |          |                   |         |        
|Cash flows from operating activities:               |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|                                                    | Income before extraordinary loss                                                                                 |                                              | $                                                        | 15,297   |                   |         | $       | 2,538   |      
|                                                    | Adjustments to reconcile income before extraordinary loss to
net cash provided by (used in) operating activities |                                              |                                                          |          |                   |         |         |         |      
|                                                    |                                                                                                                  | Depreciation and amortization                |                                                          |          | 6,965             |         |         |         | 5,600 |        
|                                                    |                                                                                                                  | Other                                        |                                                          |          | 476               |         |         |         | 1,067 |        
|                                                    |                                                                                                                  | Changes in operating assets and liabilities: |                                                          |          |                   |         |         |         |       |        
|                                                    |                                                                                                                  |                                              | Trade and other receivables                              |          |                   | (6,958  | )       |         |       | (16,665 | )
|                                                    |                                                                                                                  |                                              | Work-in-progress                                         |          |                   | 156     |         |         |       | (803    | )
|                                                    |                                                                                                                  |                                              | Inventories                                              |          |                   | (4,610  | )       |         |       | (2,699  | )
|                                                    |                                                                                                                  |                                              | Prepaid and other assets                                 |          |                   | (11,922 | )       |         |       | (1,116  | )
|                                                    |                                                                                                                  |                                              | Accounts payable                                         |          |                   | (667    | )       |         |       | (334    | )
|                                                    |                                                                                                                  |                                              | Customer advances                                        |          |                   | 1,646   |         |         |       | 814     |  
|                                                    |                                                                                                                  |                                              | Interest payable                                         |          |                   | 10,766  |         |         |       | (55     | )
|                                                    |                                                                                                                  |                                              | Accrued wages and benefits and other accrued liabilities |          |                   | 5,589   |         |         |       | 6,101   |  
|                                                    |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|Net cash provided by (used in) operating activities |                                                                                                                  |                                              | 16,738                                                   |          |                   |         | (5,552  | )      
|                                                    |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|Cash flows from investing activities:               |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|                                                    | Purchases of property and equipment                                                                              |                                              |                                                          | (6,659   | )                 |         |         | (3,519  | )    
|                                                    | Purchases of property and equipment previously leased                                                            |                                              |                                                          | (14,145  | )                 |         |         |        |      
|                                                    | Proceeds from sales of property and equipment                                                                    |                                              |                                                          | 13       |                   |         |         | 3,401   |      
|                                                    | Acquisitions                                                                                                     |                                              |                                                          | (211,997 | )                 |         |         | (52,163 | )    
|                                                    | Other                                                                                                            |                                              |                                                          | (529     | )                 |         |         | (104    | )    
|                                                    |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|Net cash used in investing activities               |                                                                                                                  |                                              | (233,317                                                 | )        |                   |         | (52,385 | )      
|                                                    |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|Cash flows from financing activities:               |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|                                                    | Net payments on short-term borrowings                                                                            |                                              |                                                          |         |                   |         |         | (3,216  | )    
|                                                    | Proceeds from long-term borrowings                                                                               |                                              |                                                          | 255,298  |                   |         |         | 60,859  |      
|                                                    | Payments on long-term borrowings                                                                                 |                                              |                                                          | (39,400  | )                 |         |         | (998    | )    
|                                                    | Issuance of common stock                                                                                         |                                              |                                                          | 3,193    |                   |         |         | 2,304   |      
|                                                    | Other                                                                                                            |                                              |                                                          | 16       |                   |         |         | (75     | )    
|                                                    |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|Net cash provided by financing activities           |                                                                                                                  |                                              | 219,107                                                  |          |                   |         | 58,874  |        
|                                                    |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|Net increase in cash and cash equivalents           |                                                                                                                  |                                              | 2,528                                                    |          |                   |         | 937     |        
|Effect of exchange rate changes on cash             |                                                                                                                  |                                              | 95                                                       |          |                   |         | (1      | )      
|Cash and cash equivalents, beginning of period      |                                                                                                                  |                                              | 6,371                                                    |          |                   |         | 1,225   |        
|                                                    |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|Cash and cash equivalents, end of period            |                                                                                                                  | $                                            | 8,994                                                    |          |                   | $       | 2,161   |        
|                                                    |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|Supplemental information, cash paid for:            |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|                                                    | Interest                                                                                                         |                                              | $                                                        | 4,759    |                   |         | $       | 890     |      
|                                                    |                                                                                                                  |                                              |                                                          |          |                   |         |         |        
|                                                    | Income taxes                                                                                                     |                                              | $                                                        | 2,405    |                   |         | $       | 67      |      
|                                                    |                                                                                                                  |                                              |                                                          |          |                   |         |         |        

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,    
|                                                                                     |  |                    |       |                  
|                                                                                     |  | 2002               |       | 2001              |  | 2002 |       | 2001
|                                                                                     |  |                    |       |                   |  |      |       |     
|Net income                                                                           |  | $                  | 7,104 |                   |  | $    | 708   |      |  | $ | 9,958  |  |  | $ | 2,538 |  
|Currency translation adjustments                                                     |  |                    | (269  | )                 |  |      | 695   |      |  |   | 1,068  |  |  |   | (385  | )
|Reclassification adjustment of realized
(loss)/gain on available for sale securities |  |                    |      |                   |  |      | (44   | )    |  |   |       |  |  |   | 547   |  
|                                                                                     |  |                    |       |                   |  |      |       |      |  |   |        |  |  |   |       |  
|Comprehensive income                                                                 |  | $                  | 6,835 |                   |  | $    | 1,359 |      |  | $ | 11,026 |  |  | $ | 2,700 |  
|                                                                                     |  |                    |       |                   |  |      |       |      |  |   |        |  |  |   |       |  

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

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, 2001 has been derived
from audited financial statements; certain amounts from the three and nine
months ended September 30, 2001 have been reclassified for consistent
presentation with current year financial statements. 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 December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial
Statements. SAB 101 specifically addresses revenue recognition issues related
to certain upfront payments or fees. In accordance with SAB 101, certain
upfront fees and payments recognized as income in prior periods are required to
be deferred and amortized into revenue over the terms of the relevant
agreements or as the on-going services are performed. For the three and nine
months ended September 30, 2002, the Company recognized $56,000 and $222,000 of
revenue related to the amortization of these deferred amounts, respectively.
For the three and nine months ended September 30, 2001, the Company recognized
$83,000 and $417,000 of revenue related to the amortization of these deferred
amounts, respectively.

In July 2001, the Financial Accounting Standards Board (the FASB) issued
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets (SFAS No. 142). Under SFAS No. 142, goodwill and
indefinite-lived intangible assets are no longer amortized, but must be
reviewed at least annually for impairment. In the second quarter of 2002, the
Company identified reporting units and related goodwill, as defined by SFAS No.
142, and tested the goodwill for impairment, as of December 31, 2001, using the
expected present value of future cash flows approach. As a result of this
valuation process, as well as the application of the remaining provisions of
SFAS No. 142, the Company concluded that there was no impairment of goodwill
related to any of the Companys reporting units. SFAS No. 142 also states that
goodwill and indefinite-lived intangible assets acquired after June 30, 2001
should not be amortized. For acquisitions completed subsequent to June 30,
2001, the Company recorded $51.0 million of indefinite-lived intangible assets
and $159.7 million of goodwill. These assets are not subject to amortization.
The statement was effective for fiscal years

7



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##### 



beginning after December 15, 2001. Prior to the adoption of SFAS No. 142, the
Company amortized goodwill related to acquisitions completed prior to June 30,
2001 over estimated useful lives ranging from 3 to 20 years. Amortization of
goodwill totaled $293,000 and $633,000 for the three and nine months ended
September 30, 2001. In accordance with SFAS No. 142, the Company ceased
amortization of goodwill related to such acquisitions.

In April 2002, the FASB issued Statement of Financial Accounting Standards No.
145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections (SFAS No. 145). This statement
eliminates the automatic classification of gain or loss on early extinguishment
of debt as an extraordinary item and requires that any such gain or loss be
reviewed under the criteria of Accounting Principles Board No. 30 Reporting
Results of Operations. This statement also requires sale-leaseback accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions, and makes various other technical corrections to
existing pronouncements. The statement is effective for fiscal years beginning
after May 15, 2002. The Company does not expect that the adoption of SFAS No.
145 will have a significant impact on its consolidated results of operations,
financial position or cash flows.

2. Earnings per share

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

|                               |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |        |        | 
|------------------------------ | --------------------------------- | ------------------------------------------------------------------ |  | ------------------ | ------ | ----------------- |  | ------ | ------ | ---- |  | ------ | ------ |  |  | ------ | ------ | 
|                               |                                   |                                                                    |  | Three Months Ended |        | Nine Months Ended
|                               |                                   |                                                                    |  | September 30,      |        | September 30,    
|                               |                                   |                                                                    |  |                    |        |                  
|                               |                                   |                                                                    |  | 2002               |        | 2001              |  | 2002   |        | 2001
|                               |                                   |                                                                    |  |                    |        |                   |  |        |        |     
|Basic earnings per share:      |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |       
|                               | Weighted average number of shares |                                                                    |  | 18,278             |        |                   |  | 17,945 |        |      |  | 18,198 |        |  |  | 17,774 |       
|Effect of dilutive securities: |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |       
|                               | Stock options                     |                                                                    |  | 430                |        |                   |  | 626    |        |      |  | 749    |        |  |  | 378    |       
|                               |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |       
|Diluted earnings per share:    |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |       
|                               |                                   | Adjusted weighted average number of shares
and assumed conversions |  |                    | 18,708 |                   |  |        | 18,571 |      |  |        | 18,947 |  |  |        | 18,152 | 
|                               |                                   |                                                                    |  |                    |        |                   |  |        |        |      |  |        |        |  |  |       

8



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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 aaiResearch business unit, and a
fee-for-service business, primarily the AAI International business unit. The
product sales business provides for the sales of M.V.I., Aquasol, Brethine,
Darvon, Darvocet-N and azathioprine 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 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 and, in fiscal 2001, goodwill amortization, 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,    
|                    |  |              |        |                    |        |                  
|                    |  |              |        | 2002               |        | 2001              |        | 2002 |        | 2001
|                    |  |              |        |                    |        |                   |        |      |        |     
|Net revenues:       |  |              |        |                    |        |                   |        |      |        |      |         |   |        |   |        |  
|Product sales       |  | $            | 35,925 |                    |        | $                 | 6,653  |      |        | $    | 90,775  |   |        | $ | 11,250 |  
|Product development |  |              | 5,663  |                    |        |                   | 4,526  |      |        |      | 14,267  |   |        |   | 13,209 |  
|                    |  |              |        |                    |        |                   |        |      |        |      |         |   |        |   |        |  
|                    |  |              | 41,588 |                    |        |                   | 11,179 |      |        |      | 105,042 |   |        |   | 24,459 |  
|                    |  |              |        |                    |        |                   |        |      |        |      |         |   |        |   |        |  
|Research revenues:  |  |              |        |                    |        |                   |        |      |        |      |         |   |        |   |        |  
|                    |  | Non-clinical |        |                    | 14,748 |                   |        |      | 16,013 |      |         |   | 46,143 |   |        |   | 49,089 | 
|                    |  | Clinical     |        |                    | 4,873  |                   |        |      | 7,716  |      |         |   | 17,091 |   |        |   | 21,441 | 
|                    |  |              |        |                    |        |                   |        |      |        |      |         |   |        |   |        |  
|                    |  |              | 19,621 |                    |        |                   | 23,729 |      |        |      | 63,234  |   |        |   | 70,530 |  
|                    |  |              |        |                    |        |                   |        |      |        |      |         |   |        |   |        |  
|                    |  | $            | 61,209 |                    |        | $                 | 34,908 |      |        | $    | 168,276 |   |        | $ | 94,989 |  
|                    |  |              |        |                    |        |                   |        |      |        |      |         |   |        |   |        |  
|United States       |  | $            | 62,685 |                    |        | $                 | 31,726 |      |        | $    | 167,386 |   |        | $ | 85,171 |  
|Germany             |  |              | 4,526  |                    |        |                   | 3,757  |      |        |      | 11,440  |   |        |   | 11,851 |  
|Other               |  |              | 315    |                    |        |                   | 208    |      |        |      | 711     |   |        |   | 752    |  
|Less intercompany   |  |              | (6,317 | )                  |        |                   | (783   | )    |        |      | (11,261 | ) |        |   | (2,785 | )
|                    |  |              |        |                    |        |                   |        |      |        |      |         |   |        |   |        |  
|                    |  | $            | 61,209 |                    |        | $                 | 34,908 |      |        | $    | 168,276 |   |        | $ | 94,989 |  
|                    |  |              |        |                    |        |                   |        |      |        |      |         |   |        |   |        |  

9



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##### 



|                               |              |   |        |      |   |   |        |       |   |   |         |        |   |   |        |       |  | 
|------------------------------ | ------------ | - | ------ | ---- | - | - | ------ | ----- | - | - | ------- | ------ | - | - | ------ | ----- |  | 
|Income (loss) from operations: |              |   |        |      |   |   |        |       |   |   |         |        |   |   |        |      
|Product sales                  |              | $ | 22,137 |      |   | $ | 1,714  |       |   | $ | 53,011  |        |   | $ | 1,228  |      
|Product development            |              |   | 147    |      |   |   | 1,910  |       |   |   | (1,130  | )      |   |   | 6,588  |      
|                               |              |   |        |      |   |   |        |       |   |   |         |        |   |   |        |      
|                               |              |   | 22,284 |      |   |   | 3,624  |       |   |   | 51,881  |        |   |   | 7,816  |      
|                               |              |   |        |      |   |   |        |       |   |   |         |        |   |   |        |      
|Research revenues:             |              |   |        |      |   |   |        |       |   |   |         |        |   |   |        |      
|                               | Non-clinical |   |        | (519 | ) |   |        | (76   | ) |   |         | (1,332 | ) |   |        | 4,128 | 
|                               | Clinical     |   |        | 131  |   |   |        | 1,641 |   |   |         | 993    |   |   |        | 2,157 | 
|                               |              |   |        |      |   |   |        |       |   |   |         |        |   |   |        |      
|                               |              |   | (388   | )    |   |   | 1,565  |       |   |   | (339    | )      |   |   | 6,285  |      
|                               |              |   |        |      |   |   |        |       |   |   |         |        |   |   |        |      
|Corporate                      |              |   | (4,855 | )    |   |   | (3,197 | )     |   |   | (13,114 | )      |   |   | (8,396 | )    
|                               |              |   |        |      |   |   |        |       |   |   |         |        |   |   |        |      
|                               |              | $ | 17,041 |      |   | $ | 1,992  |       |   | $ | 38,428  |        |   | $ | 5,705  |      
|                               |              |   |        |      |   |   |        |       |   |   |         |        |   |   |        |      
|United States                  |              | $ | 16,619 |      |   | $ | 2,406  |       |   | $ | 38,469  |        |   | $ | 5,365  |      
|Germany                        |              |   | 439    |      |   |   | (302   | )     |   |   | 227     |        |   |   | 644    |      
|Other                          |              |   | (17    | )    |   |   | (112   | )     |   |   | (268    | )      |   |   | (304   | )    
|                               |              |   |        |      |   |   |        |       |   |   |         |        |   |   |        |      
|                               |              | $ | 17,041 |      |   | $ | 1,992  |       |   | $ | 38,428  |        |   | $ | 5,705  |      
|                               |              |   |        |      |   |   |        |       |   |   |         |        |   |   |        |      

|                    |  |  |               |         |              |  |   |         | 
|------------------- |  |  | ------------- | ------- | ------------ |  | - | ------- | 
|                    |  |  | September 30, |         | December 31,
|                    |  |  | 2002          |         | 2001        
|                    |  |  |               |         |             
|Total assets:       |  |  |               |         |              |  |   |         | 
|Product sales       |  |  | $             | 350,812 |              |  | $ | 105,541 | 
|Product development |  |  |               | 5,614   |              |  |   | 7,832   | 
|Research revenues   |  |  |               | 48,014  |              |  |   | 55,555  | 
|Corporate           |  |  |               | 38,424  |              |  |   | 27,358  | 
|                    |  |  |               |         |              |  |   |         | 
|                    |  |  | $             | 442,864 |              |  | $ | 196,286 | 
|                    |  |  |               |         |              |  |   |         | 
|United States       |  |  | $             | 421,665 |              |  | $ | 176,518 | 
|Germany             |  |  |               | 20,038  |              |  |   | 18,794  | 
|Other               |  |  |               | 1,161   |              |  |   | 974     | 
|                    |  |  |               |         |              |  |   |         | 
|                    |  |  | $             | 442,864 |              |  | $ | 196,286 | 
|                    |  |  |               |         |              |  |   |         | 

As discussed above, the Company is currently reporting its financial results
based on three operating segments. As a result of changes in the Companys
operations during the current year, including its transition into the specialty
pharmaceutical business, the segment structure and reporting will be reviewed
during the fourth quarter of 2002 and may be revised in light of ongoing
developments in the way the Company is being managed and operated. Any changes
in the reporting segments will be made in accordance with Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information and reported in the Companys Annual Report
on Form 10-K for the year ending December 31, 2002.

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. Revenues recognized from Aesgen totaled
$149,000 and $488,000 for the three and nine months ended September 30, 2002.
No revenues were recognized from Aesgen for the three and nine months ended
September 30, 2001.

10



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Revenues recognized from Endeavor totaled $32,000 and
$998,000 for the three and nine months ended September 30, 2002, and were
$11,000 and $241,000 for the three and nine months ended September 30, 2001.
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.At September 30, 2002, we had no
accounts receivable or work-in-progress related to Aesgen, and had
approximately $145,000 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 and short-term debt:

|                                                         |  |                |       |              |  |   |   | 
|-------------------------------------------------------- |  | -------------- | ----- | ------------ |  | - | - | 
|                                                         |  | September 30,  |       | December 31,
|                                                         |  | 2002           |       | 2001        
|                                                         |  |                |       |             
|                                                         |  | (In thousands)
|Current maturities of long-term debt and short-term debt |  | $              | 9,167 |              |  | $ |  | 
|                                                         |  |                |       |              |  |   |   | 

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

|                                                                       |                                         |   |                |         |              |   |        |        | 
|---------------------------------------------------------------------- | --------------------------------------- | - | -------------- | ------- | ------------ | - | ------ | ------ | 
|                                                                       |                                         |   | September 30,  |         | December 31,
|                                                                       |                                         |   | 2002           |         | 2001        
|                                                                       |                                         |   |                |         |             
|                                                                       |                                         |   | (In thousands)
|U.S. bank term loan                                                    |                                         | $ | 88,000         |         |              | $ | 78,000 |       
|U.S. revolving credit facility                                         |                                         |   | 22,000         |         |              |   |       |       
|11% senior subordinated notes due 2010, net of original issue discount |                                         |   | 173,927        |         |              |   |       |       
|Interest rate swap monetization deferred income                        |                                         |   | 10,848         |         |              |   |       |       
|Fair value of interest rate swap                                       |                                         |   | (78            | )       |              |   |       |       
|Obligations under asset purchase agreement                             |                                         |   |               |         |              |   | 878    |       
|Less current maturities of long-term debt                              |                                         |   | (9,167         | )       |              |   |       |       
|                                                                       |                                         |   |                |         |              |   |        |       
|                                                                       | Total long-term debt due after one year |   | $              | 285,530 |              |   | $      | 78,878 | 
|                                                                       |                                         |   |                |         |              |   |        |       

On March 28, 2002, the Company entered into a $175 million senior secured
credit facility consisting of a $75.0 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, with amortization of $5.0
million, $15.0 million, $20.0 million, $25.0 million and $35.0 million,
respectively, in years one through five. As of September 30, 2002, the Company
has paid $3.3 million of the first years required payment plus $8.7 million of
future required payments. The availability of borrowings under the revolving
credit facility is not limited by a borrowing base. 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, 2002, 30-day LIBOR was
1.81%. 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.

11



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On March 28, 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 first 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 $140 million of 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 August 5, 2002, and again on September 19, 2002, the
Company sold the then outstanding swap agreement for $5.6 million and $3.7
million, respectively. The amounts received, less the interest benefit earned
through the dates of sale, have been recorded as a premium to the carrying
amount of the notes and will be amortized into interest income over their
remaining life. Currently, the Company has an interest rate swap agreement in
place covering $150 million of the notes, at a rate of 6-month LIBOR plus
6.54%. On September 30, 2002, 6-month LIBOR was 1.71%.

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, 2002.

6.     Acquisitions

On March 28, 2002, the Company acquired the U.S. rights to the Darvon and
Darvocet-N branded product lines, which treat mild to moderate pain, and
existing inventory from Eli Lilly and Company, in a business combination
accounted for as a purchase. The Company acquired these product lines and
related intangible assets for $211.4 million. To finance this acquisition,
which included $1.8 million of inventory, the Company used the proceeds from
the senior secured credit facilities and senior subordinated notes, as
described in note 5. The Darvon and Darvocet-N product lines did not have
separable assets and liabilities associated with them, other than inventory,
therefore the Company allocated the purchase price, including acquisition
related expenses, to acquired identifiable assets, with the excess of the
purchase price over the identifiable tangible and intangible assets recorded as
goodwill. Based on this allocation, $51.2 million of intangible assets have
been identified and will be amortized over 20 years. The excess of the
purchase price over identifiable intangible assets has been classified as
goodwill, which is not subject to amortization.

12



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The following unaudited pro forma consolidated financial information reflects
the results of operations for the three and nine months ended September 30,
2002 and 2001, as if the above acquisition had occurred at the beginning of the
period presented.

|                                 |                                  |   |                                       |      |                   |   |        |      |      |   |         |      |  |   |         |      | 
|-------------------------------- | -------------------------------- | - | ------------------------------------- | ---- | ----------------- | - | ------ | ---- | ---- | - | ------- | ---- |  | - | ------- | ---- | 
|                                 |                                  |   | Three Months Ended                    |      | Nine Months Ended
|                                 |                                  |   | September 30,                         |      | September 30,    
|                                 |                                  |   |                                       |      |                  
|                                 |                                  |   | 2002                                  |      | 2001              |   | 2002   |      | 2001
|                                 |                                  |   |                                       |      |                   |   |        |      |     
|                                 |                                  |   | (In thousands, except per share data)
|Net revenues                     |                                  | $ | 61,209                                |      |                   | $ | 51,135 |      |      | $ | 178,008 |      |  | $ | 145,693 |     
|Income before extraordinary loss |                                  |   | 7,104                                 |      |                   |   | 3,880  |      |      |   | 13,821  |      |  |   | 11,910  |     
|Net income                       |                                  |   | 7,104                                 |      |                   |   | 3,880  |      |      |   | 8,482   |      |  |   | 11,910  |     
|Basic earnings per share:        |                                  |   |                                       |      |                   |   |        |      |      |   |         |      |  |   |         |     
|                                 | Income before extraordinary loss |   | $                                     | 0.39 |                   |   | $      | 0.22 |      |   | $       | 0.76 |  |   | $       | 0.67 | 
|                                 | Net income                       |   | $                                     | 0.39 |                   |   | $      | 0.22 |      |   | $       | 0.47 |  |   | $       | 0.67 | 
|Diluted earnings per share:      |                                  |   |                                       |      |                   |   |        |      |      |   |         |      |  |   |         |     
|                                 | Income before extraordinary loss |   | $                                     | 0.38 |                   |   | $      | 0.21 |      |   | $       | 0.73 |  |   | $       | 0.66 | 
|                                 | Net income                       |   | $                                     | 0.38 |                   |   | $      | 0.21 |      |   | $       | 0.45 |  |   | $       | 0.66 | 

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
acquisitions 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.

As previously reported, the Company completed the acquisition of the M.V.I. and
Aquasol branded product lines in August 2001, and the acquisition of the
Brethine branded product line in December 2001. Revenues from the sales of
these products are included in the Companys results of operations beginning on
their acquisition dates.

7.     Extraordinary Loss

In March 2002, the Company recorded a charge of $5.3 million, net of a tax
benefit of $2.7 million, to record the write-off of deferred financing and
other costs related to its prior debt facilities and redeemable warrants.

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.

13



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##### 



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

|                                                         |                            |                |        |                                       |        |              |        |              |        |               |       |              |       |   |         |        |         |   |        |        |        | 
|-------------------------------------------------------- | -------------------------- | -------------- | ------ | ------------------------------------- | ------ | ------------ | ------ | ------------ | ------ | ------------- | ----- | ------------ | ----- | - | ------- | ------ | ------- | - | ------ | ------ | ------ | 
|                                                         |                            |                |        | Three Months Ended September 30, 2002
|                                                         |                            |                |        |                                      
|                                                         |                            |                |        |                                       |        |              |        | Guarantor    |        | Non-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               |                |        | 11,660                                |        |              |        | 12,032       |        |               |       | 2,953        |       |   |         | (5,914 | )       |   |        | 20,731 |       
|                                                         | Selling                    |                |        | 1,553                                 |        |              |        | 4,082        |        |               |       | 450          |       |   |         |       |         |   |        | 6,085  |       
|                                                         | General and administrative |                |        | 7,744                                 |        |              |        | 2,969        |        |               |       | 1,021        |       |   |         |       |         |   |        | 11,734 |       
|                                                         | Research and development   |                |        | 164                                   |        |              |        | 5,454        |        |               |       |             |       |   |         |       |         |   |        | 5,618  |       
|                                                         |                            |                |        |                                       |        |              |        |              |        |               |       |              |       |   |         |        |         |   |        |       
|                                                         |                            |                | 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 and
extraordinary loss |                            |                | 11,504 |                                       |        |              | 18,132 |              |        |               | 349   |              |       |   | (18,527 | )      |         |   | 11,458 |       
|Provision for income taxes                               |                            |                | 4,400  |                                       |        |              |       |              |        |               | (46   | )            |       |   |        |        |         |   | 4,354  |       
|                                                         |                            |                |        |                                       |        |              |        |              |        |               |       |              |       |   |         |        |         |   |        |       
|Income (loss) before extraordinary loss                  |                            |                | 7,104  |                                       |        |              | 18,132 |              |        |               | 395   |              |       |   | (18,527 | )      |         |   | 7,104  |       
|Extraordinary loss                                       |                            |                |       |                                       |        |              |       |              |        |               |      |              |       |   |        |        |         |   |       |       
|                                                         |                            |                |        |                                       |        |              |        |              |        |               |       |              |       |   |         |        |         |   |        |       
|Net income (loss)                                        |                            | $              | 7,104  |                                       |        | $            | 18,132 |              |        | $             | 395   |              |       | $ | (18,527 | )      |         | $ | 7,104  |       
|                                                         |                            |                |        |                                       |        |              |        |              |        |               |       |              |       |   |         |        |         |   |        |       

14



---



##### 



|                                  |                                      |                |        |                                       |        |              |        |              |        |               |       |              |       |   |        |      |        |   |        |        |        | 
|--------------------------------- | ------------------------------------ | -------------- | ------ | ------------------------------------- | ------ | ------------ | ------ | ------------ | ------ | ------------- | ----- | ------------ | ----- | - | ------ | ---- | ------ | - | ------ | ------ | ------ | 
|                                  |                                      |                |        | Three Months Ended September 30, 2001
|                                  |                                      |                |        |                                      
|                                  |                                      |                |        |                                       |        |              |        | Guarantor    |        | Non-Guarantor |       |              |       |   |        |      |        |  
|                                  |                                      |                |        | Issuer                                |        | Subsidiaries |        | Subsidiaries |        | Eliminations  |       | Consolidated
|                                  |                                      |                |        |                                       |        |              |        |              |        |               |       |             
|Net revenues                      |                                      | $              | 12,954 |                                       |        | $            | 18,772 |              |        | $             | 3,965 |              |       | $ | (783   | )    |        | $ | 34,908 |       
|Equity earnings from subsidiaries |                                      |                | 5,558  |                                       |        |              |       |              |        |               |      |              |       |   | (5,558 | )    |        |   |       |       
|                                  |                                      |                |        |                                       |        |              |        |              |        |               |       |              |       |   |        |      |        |   |        |       
|                                  |                                      | Total revenues |        |                                       | 18,512 |              |        |              | 18,772 |               |       |              | 3,965 |   |        |      | (6,341 | ) |        |        | 34,908 | 
|                                  |                                      |                |        |                                       |        |              |        |              |        |               |       |              |       |   |        |      |        |   |        |       
|Operating costs and expenses:     |                                      |                |        |                                       |        |              |        |              |        |               |       |              |       |   |        |      |        |   |        |       
|                                  | Direct costs                         |                |        | 9,230                                 |        |              |        | 7,116        |        |               |       | 2,758        |       |   |        | (783 | )      |   |        | 18,321 |       
|                                  | Selling                              |                |        | 1,895                                 |        |              |        | 1,288        |        |               |       | 436          |       |   |        |     |        |   |        | 3,619  |       
|                                  | General and administrative           |                |        | 5,213                                 |        |              |        | 1,481        |        |               |       | 1,185        |       |   |        |     |        |   |        | 7,879  |       
|                                  | Research and development             |                |        | 340                                   |        |              |        | 2,315        |        |               |       |             |       |   |        |     |        |   |        | 2,655  |       
|                                  | Direct pharmaceutical start-up costs |                |        |                                      |        |              |        | 442          |        |               |       |             |       |   |        |     |        |   |        | 442    |       
|                                  |                                      |                |        |                                       |        |              |        |              |        |               |       |              |       |   |        |      |        |   |        |       
|                                  |                                      |                | 16,678 |                                       |        |              | 12,642 |              |        |               | 4,379 |              |       |   | (783   | )    |        |   | 32,916 |       
|                                  |                                      |                |        |                                       |        |              |        |              |        |               |       |              |       |   |        |      |        |   |        |       
|Income (loss) from operations     |                                      |                | 1,834  |                                       |        |              | 6,130  |              |        |               | (414  | )            |       |   | (5,558 | )    |        |   | 1,992  |       
|Other income (expense):           |                                      |                |        |                                       |        |              |        |              |        |               |       |              |       |   |        |      |        |   |        |       
|                                  | Interest, net                        |                |        | (6,470                                | )      |              |        | 5,544        |        |               |       | 36           |       |   |        |     |        |   |        | (890   | )     
|                                  | Net intercompany interest            |                |        | 5,351                                 |        |              |        | (5,290       | )      |               |       | (61          | )     |   |        |     |        |   |        |       |       
|                                  | Other                                |                |        | 471                                   |        |              |        | (421         | )      |               |       | 34           |       |   |        |     |        |   |        | 84     |       
|                                  |                                      |                |        |                                       |        |              |        |              |        |               |       |              |       |   |        |      |        |   |        |       
|                                  |                                      |                | (648   | )                                     |        |              | (167   | )            |        |               | 9     |              |       |   |       |      |        |   | (806   | )     
|                                  |                                      |                |        |                                       |        |              |        |              |        |               |       |              |       |   |        |      |        |   |        |       
|Income (loss) before income taxes |                                      |                | 1,186  |                                       |        |              | 5,963  |              |        |               | (405  | )            |       |   | (5,558 | )    |        |   | 1,186  |       
|Provision for income taxes        |                                      |                | 478    |                                       |        |              |       |              |        |               |      |              |       |   |       |      |        |   | 478    |       
|                                  |                                      |                |        |                                       |        |              |        |              |        |               |       |              |       |   |        |      |        |   |        |       
|Net income (loss)                 |                                      | $              | 708    |                                       |        | $            | 5,963  |              |        | $             | (405  | )            |       | $ | (5,558 | )    |        | $ | 708    |       
|                                  |                                      |                |        |                                       |        |              |        |              |        |               |       |              |       |   |        |      |        |   |        |       

15



---



##### 



|                                                         |                            |                |        |                                      |        |              |         |              |         |               |        |              |        |   |         |         |         |   |         |         |         | 
|-------------------------------------------------------- | -------------------------- | -------------- | ------ | ------------------------------------ | ------ | ------------ | ------- | ------------ | ------- | ------------- | ------ | ------------ | ------ | - | ------- | ------- | ------- | - | ------- | ------- | ------- | 
|                                                         |                            |                |        | Nine Months Ended September 30, 2002
|                                                         |                            |                |        |                                     
|                                                         |                            |                |        |                                      |        |              |         | Guarantor    |         | Non-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               |                |        | 31,646                               |        |              |         | 35,863       |         |               |        | 8,156        |        |   |         | (10,649 | )       |   |         | 65,016  |        
|                                                         | Selling                    |                |        | 4,957                                |        |              |         | 9,937        |         |               |        | 1,267        |        |   |         |        |         |   |         | 16,161  |        
|                                                         | General and administrative |                |        | 21,790                               |        |              |         | 8,416        |         |               |        | 2,774        |        |   |         |        |         |   |         | 32,980  |        
|                                                         | Research and development   |                |        | 580                                  |        |              |         | 15,111       |         |               |        |             |        |   |         |        |         |   |         | 15,691  |        
|                                                         |                            |                |        |                                      |        |              |         |              |         |               |        |              |        |   |         |         |         |   |         |        
|                                                         |                            |                | 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                      |                |        | 97                                   |        |              |         | (3           | )       |               |        | 32           |        |   |         |        |         |   |         | 126     |        
|                                                         |                            |                |        |                                      |        |              |         |              |         |               |        |              |        |   |         |         |         |   |         |        
|                                                         |                            |                | (2,883 | )                                    |        |              | (10,757 | )            |         |               | (116   | )            |        |   |        |         |         |   | (13,756 | )      
|                                                         |                            |                |        |                                      |        |              |         |              |         |               |        |              |        |   |         |         |         |   |         |        
|Income (loss) before income taxes and
extraordinary loss |                            |                | 21,118 |                                      |        |              | 41,029  |              |         |               | (160   | )            |        |   | (37,315 | )       |         |   | 24,672  |        
|Provision for income taxes                               |                            |                | 9,511  |                                      |        |              |        |              |         |               | (136   | )            |        |   |        |         |         |   | 9,375   |        
|                                                         |                            |                |        |                                      |        |              |         |              |         |               |        |              |        |   |         |         |         |   |         |        
|Income (loss) before extraordinary loss                  |                            |                | 11,607 |                                      |        |              | 41,029  |              |         |               | (24    | )            |        |   | (37,315 | )       |         |   | 15,297  |        
|Extraordinary loss                                       |                            |                | (1,649 | )                                    |        |              | (3,690  | )            |         |               |       |              |        |   |        |         |         |   | (5,339  | )      
|                                                         |                            |                |        |                                      |        |              |         |              |         |               |        |              |        |   |         |         |         |   |         |        
|Net income (loss)                                        |                            | $              | 9,958  |                                      |        | $            | 37,339  |              |         | $             | (24    | )            |        | $ | (37,315 | )       |         | $ | 9,958   |        
|                                                         |                            |                |        |                                      |        |              |         |              |         |               |        |              |        |   |         |         |         |   |         |        

16



---



##### 



|                                  |                                      |                |        |                                      |        |              |        |              |        |               |        |              |        |   |         |        |         |   |        |        |        | 
|--------------------------------- | ------------------------------------ | -------------- | ------ | ------------------------------------ | ------ | ------------ | ------ | ------------ | ------ | ------------- | ------ | ------------ | ------ | - | ------- | ------ | ------- | - | ------ | ------ | ------ | 
|                                  |                                      |                |        | Nine Months Ended September 30, 2001
|                                  |                                      |                |        |                                     
|                                  |                                      |                |        |                                      |        |              |        | Guarantor    |        | Non-Guarantor |        |              |        |   |         |        |         |  
|                                  |                                      |                |        | Issuer                               |        | Subsidiaries |        | Subsidiaries |        | Eliminations  |        | Consolidated
|                                  |                                      |                |        |                                      |        |              |        |              |        |               |        |             
|Net revenues                      |                                      | $              | 41,729 |                                      |        | $            | 43,442 |              |        | $             | 12,602 |              |        | $ | (2,784  | )      |         | $ | 94,989 |       
|Equity earnings from subsidiaries |                                      |                | 12,781 |                                      |        |              |       |              |        |               |       |              |        |   | (12,781 | )      |         |   |       |       
|                                  |                                      |                |        |                                      |        |              |        |              |        |               |        |              |        |   |         |        |         |   |        |       
|                                  |                                      | Total revenues |        |                                      | 54,510 |              |        |              | 43,442 |               |        |              | 12,602 |   |         |        | (15,565 | ) |        |        | 94,989 | 
|                                  |                                      |                |        |                                      |        |              |        |              |        |               |        |              |        |   |         |        |         |   |        |       
|Operating costs and expenses:     |                                      |                |        |                                      |        |              |        |              |        |               |        |              |        |   |         |        |         |   |        |       
|                                  | Direct costs                         |                |        | 26,047                               |        |              |        | 17,788       |        |               |        | 7,995        |        |   |         | (2,784 | )       |   |        | 49,046 |       
|                                  | Selling                              |                |        | 5,691                                |        |              |        | 2,660        |        |               |        | 997          |        |   |         |       |         |   |        | 9,348  |       
|                                  | General and administrative           |                |        | 13,585                               |        |              |        | 5,148        |        |               |        | 3,271        |        |   |         |       |         |   |        | 22,004 |       
|                                  | Research and development             |                |        | 1,534                                |        |              |        | 5,229        |        |               |        |             |        |   |         |       |         |   |        | 6,763  |       
|                                  | Direct pharmaceutical start-up costs |                |        |                                     |        |              |        | 2,123        |        |               |        |             |        |   |         |       |         |   |        | 2,123  |       
|                                  |                                      |                |        |                                      |        |              |        |              |        |               |        |              |        |   |         |        |         |   |        |       
|                                  |                                      |                | 46,857 |                                      |        |              | 32,948 |              |        |               | 12,263 |              |        |   | (2,784  | )      |         |   | 89,284 |       
|                                  |                                      |                |        |                                      |        |              |        |              |        |               |        |              |        |   |         |        |         |   |        |       
|Income (loss) from operations     |                                      |                | 7,653  |                                      |        |              | 10,494 |              |        |               | 339    |              |        |   | (12,781 | )      |         |   | 5,705  |       
|Other income (expense):           |                                      |                |        |                                      |        |              |        |              |        |               |        |              |        |   |         |        |         |   |        |       
|                                  | Interest, net                        |                |        | (6,969                               | )      |              |        | 5,542        |        |               |        | (173         | )      |   |         |       |         |   |        | (1,600 | )     
|                                  | Net intercompany interest            |                |        | 3,166                                |        |              |        | (3,087       | )      |               |        | (79          | )      |   |         |       |         |   |        |       |       
|                                  | Other                                |                |        | (348                                 | )      |              |        | (456         | )      |               |        | 201          |        |   |         |       |         |   |        | (603   | )     
|                                  |                                      |                |        |                                      |        |              |        |              |        |               |        |              |        |   |         |        |         |   |        |       
|                                  |                                      |                | (4,151 | )                                    |        |              | 1,999  |              |        |               | (51    | )            |        |   |        |        |         |   | (2,203 | )     
|                                  |                                      |                |        |                                      |        |              |        |              |        |               |        |              |        |   |         |        |         |   |        |       
|Income (loss) before income taxes |                                      |                | 3,502  |                                      |        |              | 12,493 |              |        |               | 288    |              |        |   | (12,781 | )      |         |   | 3,502  |       
|Provision for income taxes        |                                      |                | 964    |                                      |        |              |       |              |        |               |       |              |        |   |        |        |         |   | 964    |       
|                                  |                                      |                |        |                                      |        |              |        |              |        |               |        |              |        |   |         |        |         |   |        |       
|Net income (loss)                 |                                      | $              | 2,538  |                                      |        | $            | 12,493 |              |        | $             | 288    |              |        | $ | (12,781 | )      |         | $ | 2,538  |       
|                                  |                                      |                |        |                                      |        |              |        |              |        |               |        |              |        |   |         |        |         |   |        |       

17



---



##### 



|                                            |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |              |         |        |   |   |         |        |  |   |         | 
|------------------------------------------- | -------------------------------------------------------- |  | ------ | ------------------------------------------ | - | ------------------ | ------- | ------------ |  | ------------ | ------- | ------------- |  | ------------ | ------- | ------ | - | - | ------- | ------ |  | - | ------- | 
|                                            |                                                          |  |        |                                            |   | September 30, 2002
|                                            |                                                          |  |        |                                            |   |                   
|                                            |                                                          |  |        |                                            |   |                    |         |              |  | Guarantor    |         | Non-Guarantor |  |              |         |        |   |   |         |       
|                                            |                                                          |  |        |                                            |   | Issuer             |         | Subsidiaries |  | Subsidiaries |         | Eliminations  |  | Consolidated
|                                            |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |             
|ASSETS                                      |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |              |         |        |   |   |         |       
|Current assets:                             |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |              |         |        |   |   |         |       
|                                            | Cash and cash equivalents                                |  | $      | 8,426                                      |   |                    | $       | 151          |  |              | $       | 417           |  |              | $       |       |   |   | $       | 8,994  | 
|                                            | Accounts receivable, net                                 |  |        | 10,526                                     |   |                    |         | 20,423       |  |              |         | 2,892         |  |              |         |       |   |   |         | 33,841 | 
|                                            | Work-in-progress                                         |  |        | 4,016                                      |   |                    |         | 4,182        |  |              |         | 4,011         |  |              |         | (1,494 | ) |   |         | 10,715 | 
|                                            | Inventories                                              |  |        | 4,503                                      |   |                    |         | 9,259        |  |              |         | 574           |  |              |         | (613   | ) |   |         | 13,723 | 
|                                            | Prepaid and other current assets                         |  |        | 3,664                                      |   |                    |         | 4,124        |  |              |         | 455           |  |              |         |       |   |   |         | 8,243  | 
|                                            |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |              |         |        |   |   |         |        | 
|                                            |                                                          |  |        | Total current assets                       |   |                    | 31,135  |              |  |              | 38,139  |               |  |              | 8,349   |        |   |   | (2,107  | )      |  |   | 75,516  | 
|Investments in and advances to subsidiaries |                                                          |  | 66,061 |                                            |   |                    | (46,202 | )            |  |              |        |               |  |              | (19,859 | )      |   |   |        |       
|Property and equipment, net                 |                                                          |  | 42,442 |                                            |   |                    | 6,282   |              |  |              | 3,845   |               |  |              |        |        |   |   | 52,569  |       
|Goodwill and other intangibles, net         |                                                          |  | 1,537  |                                            |   |                    | 289,571 |              |  |              | 8,915   |               |  |              |        |        |   |   | 300,023 |       
|Other assets                                |                                                          |  | 4,547  |                                            |   |                    | 10,120  |              |  |              | 89      |               |  |              |        |        |   |   | 14,756  |       
|                                            |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |              |         |        |   |   |         |        | 
|                                            |                                                          |  |        | Total assets                               |   | $                  | 145,722 |              |  | $            | 297,910 |               |  | $            | 21,198  |        |   | $ | (21,966 | )      |  | $ | 442,864 | 
|                                            |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |              |         |        |   |   |         |        | 
|LIABILITIES AND STOCKHOLDERS EQUITY        |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |              |         |        |   |   |         |       
|Current liabilities:                        |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |              |         |        |   |   |         |       
|                                            | Current maturities of long-term debt and
short-term debt |  | $      |                                           |   |                    | $       | 9,167        |  |              | $       |              |  |              | $       |       |   |   | $       | 9,167  | 
|                                            | Accounts payable                                         |  |        | 3,019                                      |   |                    |         | 10,643       |  |              |         | 1,285         |  |              |         |       |   |   |         | 14,947 | 
|                                            | Customer advances                                        |  |        | 7,797                                      |   |                    |         | 6,755        |  |              |         | 2,216         |  |              |         | (1,494 | ) |   |         | 15,274 | 
|                                            | Accrued wages and benefits                               |  |        | 4,798                                      |   |                    |         | 1,338        |  |              |         | 1,375         |  |              |         |       |   |   |         | 7,511  | 
|                                            | Interest Payable                                         |  |        | 265                                        |   |                    |         | 10,872       |  |              |         |              |  |              |         |       |   |   |         | 11,137 | 
|                                            | Other accrued liabilities                                |  |        | (757                                       | ) |                    |         | 4,571        |  |              |         | 315           |  |              |         | (51    | ) |   |         | 4,078  | 
|                                            |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |              |         |        |   |   |         |        | 
|                                            |                                                          |  |        | Total current liabilities                  |   |                    | 15,122  |              |  |              | 43,346  |               |  |              | 5,191   |        |   |   | (1,545  | )      |  |   | 62,114  | 
|Long-term debt, less current portion        |                                                          |  | 22,000 |                                            |   |                    | 263,530 |              |  |              |        |               |  |              |        |        |   |   | 285,530 |       
|Other liabilities                           |                                                          |  | 4,636  |                                            |   |                    |        |              |  |              |        |               |  |              |        |        |   |   | 4,636   |       
|Investments in and advances to subsidiaries |                                                          |  | 91,496 |                                            |   |                    | (96,136 | )            |  |              | 4,589   |               |  |              | 51      |        |   |   |        |       
|Redeemable warrants                         |                                                          |  |       |                                            |   |                    |        |              |  |              |        |               |  |              |        |        |   |   |        |       
|Total stockholders equity                  |                                                          |  | 12,468 |                                            |   |                    | 87,170  |              |  |              | 11,418  |               |  |              | (20,472 | )      |   |   | 90,584  |       
|                                            |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |              |         |        |   |   |         |        | 
|                                            |                                                          |  |        | Total liabilities and stockholders equity |   | $                  | 145,722 |              |  | $            | 297,910 |               |  | $            | 21,198  |        |   | $ | (21,966 | )      |  | $ | 442,864 | 
|                                            |                                                          |  |        |                                            |   |                    |         |              |  |              |         |               |  |              |         |        |   |   |         |        | 

18



---



##### 



|                                            |                                                          |                                      |        |                                            |  |                   |         |              |  |              |        |               |  |              |         |        |   |   |         |        |  |   |         | 
|------------------------------------------- | -------------------------------------------------------- | ------------------------------------ | ------ | ------------------------------------------ |  | ----------------- | ------- | ------------ |  | ------------ | ------ | ------------- |  | ------------ | ------- | ------ | - | - | ------- | ------ |  | - | ------- | 
|                                            |                                                          |                                      |        |                                            |  | December 30, 2001
|                                            |                                                          |                                      |        |                                            |  |                  
|                                            |                                                          |                                      |        |                                            |  |                   |         |              |  | Guarantor    |        | Non-Guarantor |  |              |         |        |   |   |         |       
|                                            |                                                          |                                      |        |                                            |  | Issuer            |         | Subsidiaries |  | Subsidiaries |        | Eliminations  |  | Consolidated
|                                            |                                                          |                                      |        |                                            |  |                   |         |              |  |              |        |               |  |             
|                                            |                                                          |                                      | ASSETS |                                            |  |                   |         |              |  |              |        |               |  |              |         |        |   |   |         |        |  |   |        
|Current assets:                             |                                                          |                                      |        |                                            |  |                   |         |              |  |              |        |               |  |              |         |        |   |   |         |       
|                                            | Cash and cash equivalents                                |                                      | $      | 5,301                                      |  |                   | $       | 154          |  |              | $      | 916           |  |              | $       |       |   |   | $       | 6,371  | 
|                                            | Accounts receivable, net                                 |                                      |        | 13,189                                     |  |                   |         | 8,415        |  |              |        | 2,690         |  |              |         | 2,300  |   |   |         | 26,594 | 
|                                            | Work-in-progress                                         |                                      |        | 3,871                                      |  |                   |         | 5,099        |  |              |        | 3,794         |  |              |         | (2,300 | ) |   |         | 10,464 | 
|                                            | Inventories                                              |                                      |        | 2,955                                      |  |                   |         | 5,584        |  |              |        | 518           |  |              |         |       |   |   |         | 9,057  | 
|                                            | Prepaid and other current assets                         |                                      |        | 3,081                                      |  |                   |         | 2,640        |  |              |        | 251           |  |              |         |       |   |   |         | 5,972  | 
|                                            |                                                          |                                      |        |                                            |  |                   |         |              |  |              |        |               |  |              |         |        |   |   |         |        | 
|                                            |                                                          |                                      |        | Total current assets                       |  |                   | 28,397  |              |  |              | 21,892 |               |  |              | 8,169   |        |   |   |        |        |  |   | 58,458  | 
|Investments in and advances to subsidiaries |                                                          |                                      | 66,061 |                                            |  |                   | (46,202 | )            |  |              |       |               |  |              | (19,859 | )      |   |   |        |       
|Property and equipment, net                 |                                                          |                                      | 27,724 |                                            |  |                   | 5,841   |              |  |              | 3,470  |               |  |              |        |        |   |   | 37,035  |       
|Goodwill and other intangibles, net         |                                                          |                                      | 1,071  |                                            |  |                   | 79,383  |              |  |              | 8,050  |               |  |              |        |        |   |   | 88,504  |       
|Other assets                                |                                                          |                                      | 7,372  |                                            |  |                   | 4,836   |              |  |              | 81     |               |  |              |        |        |   |   | 12,289  |       
|                                            |                                                          |                                      |        |                                            |  |                   |         |              |  |              |        |               |  |              |         |        |   |   |         |        | 
|                                            |                                                          |                                      |        | Total assets                               |  | $                 | 130,625 |              |  | $            | 65,750 |               |  | $            | 19,770  |        |   | $ | (19,859 | )      |  | $ | 196,286 | 
|                                            |                                                          |                                      |        |                                            |  |                   |         |              |  |              |        |               |  |              |         |        |   |   |         |        | 
|                                            |                                                          | LIABILITIES AND STOCKHOLDERS EQUITY |        |                                            |  |                   |         |              |  |              |        |               |  |              |         |        |   |   |         |        |  |  
|Current liabilities:                        |                                                          |                                      |        |                                            |  |                   |         |              |  |              |        |               |  |              |         |        |   |   |         |       
|                                            | Current maturities of long-term debt and
short-term debt |                                      | $      |                                           |  |                   | $       | 14           |  |              | $      |              |  |              | $       | (14    | ) |   | $       |       | 
|                                            | Accounts payable                                         |                                      |        | 3,626                                      |  |                   |         | 10,236       |  |              |        | 1,582         |  |              |         |       |   |   |         | 15,444 | 
|                                            | Customer advances                                        |                                      |        | 3,883                                      |  |                   |         | 6,874        |  |              |        | 2,592         |  |              |         |       |   |   |         | 13,349 | 
|                                            | Accrued wages and benefits                               |                                      |        | 2,040                                      |  |                   |         | 958          |  |              |        | 881           |  |              |         |       |   |   |         | 3,879  | 
|                                            | Interest payable                                         |                                      |        |                                           |  |                   |         | 371          |  |              |        |              |  |              |         |       |   |   |         | 371    | 
|                                            | Other accrued liabilities                                |                                      |        | 2,821                                      |  |                   |         | 2,201        |  |              |        | 302           |  |              |         | (402   | ) |   |         | 4,922  | 
|                                            |                                                          |                                      |        |                                            |  |                   |         |              |  |              |        |               |  |              |         |        |   |   |         |        | 
|                                            |                                                          |                                      |        | Total current liabilities                  |  |                   | 12,370  |              |  |              | 20,654 |               |  |              | 5,357   |        |   |   | (416    | )      |  |   | 37,965  | 
|Long-term debt, less current portion        |                                                          |                                      |       |                                            |  |                   | 78,878  |              |  |              |       |               |  |              |        |        |   |   | 78,878  |       
|Other liabilities                           |                                                          |                                      | 224    |                                            |  |                   |        |              |  |              |       |               |  |              |        |        |   |   | 224     |       
|Investments in and advances to subsidiaries |                                                          |                                      | 79,157 |                                            |  |                   | (83,625 | )            |  |              | 4,052  |               |  |              | 416     |        |   |   |        |       
|Redeemable warrants                         |                                                          |                                      | 2,855  |                                            |  |                   |        |              |  |              |       |               |  |              |        |        |   |   | 2,855   |       
|Total stockholders equity                  |                                                          |                                      | 36,019 |                                            |  |                   | 49,843  |              |  |              | 10,361 |               |  |              | (19,859 | )      |   |   | 76,364  |       
|                                            |                                                          |                                      |        |                                            |  |                   |         |              |  |              |        |               |  |              |         |        |   |   |         |        | 
|                                            |                                                          |                                      |        | Total liabilities and stockholders equity |  | $                 | 130,625 |              |  | $            | 65,750 |               |  | $            | 19,770  |        |   | $ | (19,859 | )      |  | $ | 196,286 | 
|                                            |                                                          |                                      |        |                                            |  |                   |         |              |  |              |        |               |  |              |         |        |   |   |         |        | 

19



---



##### 



|                                                     |                                                                                                                              |                                              |                                                          |         |                                      |         |              |          |              |         |               |        |              |      |     |         |   |        |          |          |       |         |  
|---------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------- | -------------------------------------------------------- | ------- | ------------------------------------ | ------- | ------------ | -------- | ------------ | ------- | ------------- | ------ | ------------ | ---- | --- | ------- | - | ------ | -------- | -------- | ----- | ------- | -
|                                                     |                                                                                                                              |                                              |                                                          |         | Nine Months Ended September 30, 2002
|                                                     |                                                                                                                              |                                              |                                                          |         |                                     
|                                                     |                                                                                                                              |                                              |                                                          |         |                                      |         |              |          | Guarantor    |         | Non-Guarantor |        |              |      |     |         |   |        |         
|                                                     |                                                                                                                              |                                              |                                                          |         | Issuer                               |         | Subsidiaries |          | Subsidiaries |         | Eliminations  |        | Consolidated
|                                                     |                                                                                                                              |                                              |                                                          |         |                                      |         |              |          |              |         |               |        |             
|Cash flows from operating activities:                |                                                                                                                              |                                              |                                                          |         |                                      |         |              |          |              |         |               |        |              |      |     |         |   |        |          |         
|                                                     | Income (loss) before extraordinary loss                                                                                      |                                              | $                                                        | 11,607  |                                      |         | $            | 41,029   |              |         | $             | (24    | )            |      | $   | (37,315 | ) |        | $        | 15,297   |      
|                                                     | Adjustments to reconcile net income (loss) before extraordinary
loss to net cash (used in) provided by operating activities: |                                              |                                                          |         |                                      |         |              |          |              |         |               |        |              |      |     |         |   |        |          |          |      
|                                                     |                                                                                                                              | Depreciation and amortization                |                                                          |         | 3,499                                |         |              |          | 2,730        |         |               |        | 736          |      |     |         |  |        |          |          | 6,965 |        
|                                                     |                                                                                                                              | Other                                        |                                                          |         | (5                                   | )       |              |          | 11           |         |               |        | 470          |      |     |         |  |        |          |          | 476   |        
|                                                     |                                                                                                                              | Changes in operating assets and liabilities: |                                                          |         |                                      |         |              |          |              |         |               |        |              |      |     |         |   |        |          |          |       |        
|                                                     |                                                                                                                              |                                              | Trade and other receivables                              |         |                                      | 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 |         |                                      | 738     |              |          |              | 4,554   |               |        |              | (53  | )   |         |   | 350    |          |          |       | 5,589   |  
|                                                     |                                                                                                                              |                                              | Intercompany receivables and payables                    |         |                                      | (26,014 | )            |          |              | (10,863 | )             |        |              | 540  |     |         |   | 36,337 |          |          |       |        |  
|                                                     |                                                                                                                              |                                              |                                                          |         |                                      |         |              |          |              |         |               |        |              |      |     |         |   |        |          |          |      
|Net cash (used in) provided by operating activities  |                                                                                                                              |                                              | (3,390                                                   | )       |                                      |         | 19,496       |          |              |         | 646           |        |              |      | (14 | )       |   |        | 16,738   |         
|                                                     |                                                                                                                              |                                              |                                                          |         |                                      |         |              |          |              |         |               |        |              |      |     |         |   |        |          |          |      
|Cash flows from investing activities:                |                                                                                                                              |                                              |                                                          |         |                                      |         |              |          |              |         |               |        |              |      |     |         |   |        |          |         
|                                                     | Purchases of property and equipment                                                                                          |                                              |                                                          | (18,113 | )                                    |         |              | (1,423   | )            |         |               | (1,268 | )            |      |     |        |   |        |          | (20,804  | )    
|                                                     | 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  |                                      |         |              | 205,897  |              |         |               |       |              |      |     |        |   |        |          | 255,298  |      
|                                                     | Payments on long-term borrowings                                                                                             |                                              |                                                          | (27,400 | )                                    |         |              | (12,014  | )            |         |               |       |              |      |     | 14      |   |        |          | (39,400  | )    
|                                                     | Issuance of common stock                                                                                                     |                                              |                                                          | 3,193   |                                      |         |              |         |              |         |               |       |              |      |     |        |   |        |          | 3,193    |      
|                                                     | Other                                                                                                                        |                                              |                                                          |        |                                      |         |              | (11      | )            |         |               | 27     |              |      |     |        |   |        |          | 16       |      
|                                                     |                                                                                                                              |                                              |                                                          |         |                                      |         |              |          |              |         |               |        |              |      |     |         |   |        |          |          |      
|Net cash provided by financing activities            |                                                                                                                              |                                              | 25,194                                                   |         |                                      |         | 193,872      |          |              |         | 27            |        |              |      | 14  |         |   |        | 219,107  |         
|                                                     |                                                                                                                              |                                              |                                                          |         |                                      |         |              |          |              |         |               |        |              |      |     |         |   |        |          |          |      
|Net increase (decrease) in cash and cash equivalents |                                                                                                                              |                                              | 3,126                                                    |         |                                      |         | (3           | )        |              |         | (595          | )      |              |      |    |         |   |        | 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                                                    |         |                                      | $       | 151          |          |              | $       | 417           |        |              | $    |    |         |   | $      | 8,994    |         
|                                                     |                                                                                                                              |                                              |                                                          |         |                                      |         |              |          |              |         |               |        |              |      |     |         |   |        |          |          |      

20



---



##### 



|                                                    |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |         |       |         |  
|--------------------------------------------------- | -------------------------------------------------------------------------------------------------- | -------------------------------------------- | -------------------------------------------------------- | ------ | ------------------------------------ | ------ | ------------ | ------- | ------------ | ------- | ------------- | ------ | ------------ | ------ | - | ------- | - | ------ | ------- | ------- | ----- | ------- | -
|                                                    |                                                                                                    |                                              |                                                          |        | Nine Months Ended September 30, 2001
|                                                    |                                                                                                    |                                              |                                                          |        |                                     
|                                                    |                                                                                                    |                                              |                                                          |        |                                      |        |              |         | Guarantor    |         | Non-Guarantor |        |              |        |   |         |   |        |        
|                                                    |                                                                                                    |                                              |                                                          |        | Issuer                               |        | Subsidiaries |         | Subsidiaries |         | Eliminations  |        | Consolidated
|                                                    |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |             
|Cash flows from operating activities:               |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |        
|                                                    | Net income (loss)                                                                                  |                                              | $                                                        | 2,538  |                                      |        | $            | 12,493  |              |         | $             | 288    |              |        | $ | (12,781 | ) |        | $       | 2,538   |      
|                                                    | Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities: |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |         |      
|                                                    |                                                                                                    | Depreciation and amortization                |                                                          |        | 3,761                                |        |              |         | 789          |         |               |        | 1,050        |        |   |         |  |        |         |         | 5,600 |        
|                                                    |                                                                                                    | Other                                        |                                                          |        | 453                                  |        |              |         | 407          |         |               |        | 207          |        |   |         |  |        |         |         | 1,067 |        
|                                                    |                                                                                                    | Changes in operating assets and liabilities: |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |         |       |        
|                                                    |                                                                                                    |                                              | Trade and other receivables                              |        |                                      | (6,061 | )            |         |              | (10,546 | )             |        |              | (58    | ) |         |   |       |         |         |       | (16,665 | )
|                                                    |                                                                                                    |                                              | Work-in-progress                                         |        |                                      | 2,415  |              |         |              | (945    | )             |        |              | (2,273 | ) |         |   |       |         |         |       | (803    | )
|                                                    |                                                                                                    |                                              | Inventories                                              |        |                                      | 816    |              |         |              | (3,594  | )             |        |              | 79     |   |         |   |       |         |         |       | (2,699  | )
|                                                    |                                                                                                    |                                              | Prepaid and other assets                                 |        |                                      | 3,444  |              |         |              | (4,573  | )             |        |              | 13     |   |         |   |       |         |         |       | (1,116  | )
|                                                    |                                                                                                    |                                              | Accounts payable                                         |        |                                      | (315   | )            |         |              | 14      |               |        |              | (33    | ) |         |   |       |         |         |       | (334    | )
|                                                    |                                                                                                    |                                              | Customer advances                                        |        |                                      | 1,144  |              |         |              | (1,121  | )             |        |              | 791    |   |         |   |       |         |         |       | 814     |  
|                                                    |                                                                                                    |                                              | Interest Payable                                         |        |                                      | (129   | )            |         |              | 74      |               |        |              |       |   |         |   |       |         |         |       | (55     | )
|                                                    |                                                                                                    |                                              | Accrued wages and benefits and other accrued liabilities |        |                                      | 1,274  |              |         |              | 4,369   |               |        |              | 458    |   |         |   |       |         |         |       | 6,101   |  
|                                                    |                                                                                                    |                                              | Intercompany receivables and payables                    |        |                                      | (7,845 | )            |         |              | (7,407  | )             |        |              | 2,471  |   |         |   | 12,781 |         |         |       |        |  
|                                                    |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |         |      
|Net cash provided by (used in) operating activities |                                                                                                    |                                              | 1,495                                                    |        |                                      |        | (10,040      | )       |              |         | 2,993         |        |              |        |  |         |   |        | (5,552  | )      
|                                                    |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |         |      
|Cash flows from investing activities:               |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |        
|                                                    | Purchases of property and equipment                                                                |                                              |                                                          | (1,925 | )                                    |        |              | (593    | )            |         |               | (1,001 | )            |        |   |        |   |        |         | (3,519  | )    
|                                                    | Proceeds from sales of property and equipment                                                      |                                              |                                                          | 2,757  |                                      |        |              | 644     |              |         |               |       |              |        |   |        |   |        |         | 3,401   |      
|                                                    | Product acquisitions                                                                               |                                              |                                                          | (983   | )                                    |        |              | (51,180 | )            |         |               |       |              |        |   |        |   |        |         | (52,163 | )    
|                                                    | Other                                                                                              |                                              |                                                          | (104   | )                                    |        |              |        |              |         |               |       |              |        |   |        |   |        |         | (104    | )    
|                                                    |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |         |      
|Net cash used in investing activities               |                                                                                                    |                                              | (255                                                     | )      |                                      |        | (51,129      | )       |              |         | (1,001        | )      |              |        |  |         |   |        | (52,385 | )      
|                                                    |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |         |      
|Cash flows from financing activities:               |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |        
|                                                    | Net payments on short-term debt                                                                    |                                              |                                                          | (1,553 | )                                    |        |              |        |              |         |               | (1,663 | )            |        |   |        |   |        |         | (3,216  | )    
|                                                    | Proceeds from long-term borrowings                                                                 |                                              |                                                          |       |                                      |        |              | 60,859  |              |         |               |       |              |        |   |        |   |        |         | 60,859  |      
|                                                    | Payments on long-term borrowings                                                                   |                                              |                                                          | (952   | )                                    |        |              | (46     | )            |         |               |       |              |        |   |        |   |        |         | (998    | )    
|                                                    | Issuance of common stock                                                                           |                                              |                                                          | 2,304  |                                      |        |              |        |              |         |               |       |              |        |   |        |   |        |         | 2,304   |      
|                                                    | Other                                                                                              |                                              |                                                          | (3     | )                                    |        |              | (35     | )            |         |               | (37    | )            |        |   |        |   |        |         | (75     | )    
|                                                    |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |         |      
|Net cash (used in) provided by financing activities |                                                                                                    |                                              | (204                                                     | )      |                                      |        | 60,778       |         |              |         | (1,700        | )      |              |        |  |         |   |        | 58,874  |        
|                                                    |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |         |      
|Net increase in cash and cash equivalents           |                                                                                                    |                                              | 1,036                                                    |        |                                      |        | (391         | )       |              |         | 292           |        |              |        |  |         |   |        | 937     |        
|Effect of exchange rate changes on cash             |                                                                                                    |                                              |                                                         |        |                                      |        |             |         |              |         | (1            | )      |              |        |  |         |   |        | (1      | )      
|Cash and cash equivalents, beginning of period      |                                                                                                    |                                              | 639                                                      |        |                                      |        | 497          |         |              |         | 89            |        |              |        |  |         |   |        | 1,225   |        
|                                                    |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |         |      
|Cash and cash equivalents, end of period            |                                                                                                    | $                                            | 1,675                                                    |        |                                      | $      | 106          |         |              | $       | 380           |        |              | $      |  |         |   | $      | 2,161   |        
|                                                    |                                                                                                    |                                              |                                                          |        |                                      |        |              |         |              |         |               |        |              |        |   |         |   |        |         |         |      

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

Our quarterly results have been, and we expect them to continue to be, subject
to fluctuations. Quarterly results can fluctuate as a result of a number of
factors, including without limitation, demand for our pharmaceutical product
lines, ability of contract manufacturers to supply conforming products on a
timely basis, costs and results of ongoing and future litigation by and against
us, progress of ongoing contracts, amounts recognized for licensing and royalty
revenues, the commencement, completion or cancellation of large contracts,
timing and amounts of start-up expenses for new facilities, timing and level of
research and development expenditures, and changes in the mix of services.
Because a large percentage of our fee-for-service operating costs are
relatively fixed, variations in the timing and progress of large contracts,
changes in the demand for our services and products, or the recognition of
licensing and royalty revenues (on projects for which associated expense may
have been recognized in prior periods) can materially affect our quarterly
results. Accordingly, we believe that comparisons of our quarterly financial
results may not be meaningful.

Results of Operations:

The following table presents the net revenues for each of our business units
and our consolidated expenses and net income, with each item expressed as a
percentage of consolidated net revenues:

|                                     |                     |              |        |                                  |        |                                 |     |      |    |      |        |       |        |  |     |    |    |   |         |        |        |  |     |    |    |   |        |        |        |  |     |    |    |  
|------------------------------------ | ------------------- | ------------ | ------ | -------------------------------- | ------ | ------------------------------- | --- | ---- | -- | ---- | ------ | ----- | ------ |  | --- | -- | -- | - | ------- | ------ | ------ |  | --- | -- | -- | - | ------ | ------ | ------ |  | --- | -- | -- | -
|                                     |                     |              |        | Three Months Ended September 30, |        | Nine Months Ended September 30,
|                                     |                     |              |        |                                  |        |                                
|                                     |                     |              |        | 2002                             |        | 2001                            |     | 2002 |    | 2001
|                                     |                     |              |        |                                  |        |                                 |     |      |    |     
|                                     |                     |              |        | (dollars in thousands)          
|Net revenues:                        |                     |              |        |                                  |        |                                 |     |      |    |      |        |       |        |  |     |    |    |   |         |        |        |  |     |    |    |   |        |        |        |  |     |   
|                                     | Product sales       |              | $      | 35,925                           |        |                                 |     | 59   | %  |      | $      | 6,653 |        |  |     | 19 | %  |   | $       | 90,775 |        |  |     | 55 | %  |   | $      | 11,250 |        |  |     | 11 | % 
|                                     | Product development |              |        | 5,663                            |        |                                 |     | 9    | %  |      |        | 4,526 |        |  |     | 13 | %  |   |         | 14,267 |        |  |     | 8  | %  |   |        | 13,209 |        |  |     | 14 | % 
|                                     |                     |              |        |                                  |        |                                 |     |      |    |      |        |       |        |  |     |    |    |   |         |        |        |  |     |    |    |   |        |        |        |  |     |    |   
|                                     |                     |              | 41,588 |                                  |        |                                 | 68  | %    |    |      | 11,179 |       |        |  | 32  | %  |    |   | 105,042 |        |        |  | 63  | %  |    |   | 24,459 |        |        |  | 25  | % 
|                                     |                     |              |        |                                  |        |                                 |     |      |    |      |        |       |        |  |     |    |    |   |         |        |        |  |     |    |    |   |        |        |        |  |     |    |   
|                                     | Research revenues:  |              |        |                                  |        |                                 |     |      |    |      |        |       |        |  |     |    |    |   |         |        |        |  |     |    |    |   |        |        |        |  |     |    |   
|                                     |                     | Non-clinical |        |                                  | 14,748 |                                 |     |      | 24 | %    |        |       | 16,013 |  |     |    | 46 | % |         |        | 46,143 |  |     |    | 27 | % |        |        | 49,089 |  |     |    | 52 | %
|                                     |                     | Clinical     |        |                                  | 4,873  |                                 |     |      | 8  | %    |        |       | 7,716  |  |     |    | 22 | % |         |        | 17,091 |  |     |    | 10 | % |        |        | 21,441 |  |     |    | 23 | %
|                                     |                     |              |        |                                  |        |                                 |     |      |    |      |        |       |        |  |     |    |    |   |         |        |        |  |     |    |    |   |        |        |        |  |     |    |   
|                                     |                     |              | 19,621 |                                  |        |                                 | 32  | %    |    |      | 23,729 |       |        |  | 68  | %  |    |   | 63,234  |        |        |  | 37  | %  |    |   | 70,530 |        |        |  | 75  | % 
|                                     |                     |              |        |                                  |        |                                 |     |      |    |      |        |       |        |  |     |    |    |   |         |        |        |  |     |    |    |   |        |        |        |  |     |    |   
|                                     |                     | $            | 61,209 |                                  |        |                                 | 100 | %    |    | $    | 34,908 |       |        |  | 100 | %  |    | $ | 168,276 |        |        |  | 100 | %  |    | $ | 94,989 |        |        |  | 100 | % 
|                                     |                     |              |        |                                  |        |                                 |     |      |    |      |        |       |        |  |     |    |    |   |         |        |        |  |     |    |    |   |        |        |        |  |     |    |   
|Direct costs                         |                     | $            | 20,731 |                                  |        |                                 | 34  | %    |    | $    | 18,321 |       |        |  | 52  | %  |    | $ | 65,016  |        |        |  | 39  | %  |    | $ | 49,046 |        |        |  | 52  | % 
|Selling                              |                     |              | 6,085  |                                  |        |                                 | 10  | %    |    |      | 3,619  |       |        |  | 10  | %  |    |   | 16,161  |        |        |  | 10  | %  |    |   | 9,348  |        |        |  | 10  | % 
|General and administrative           |                     |              | 11,734 |                                  |        |                                 | 19  | %    |    |      | 7,879  |       |        |  | 23  | %  |    |   | 32,980  |        |        |  | 20  | %  |    |   | 22,004 |        |        |  | 23  | % 
|Research and development             |                     |              | 5,618  |                                  |        |                                 | 9   | %    |    |      | 2,655  |       |        |  | 8   | %  |    |   | 15,691  |        |        |  | 9   | %  |    |   | 6,763  |        |        |  | 7   | % 
|Direct pharmaceutical
start-up costs |                     |              |       |                                  |        |                                 |    |      |    |      | 442    |       |        |  | 1   | %  |    |   |        |        |        |  |    |    |    |   | 2,123  |        |        |  | 2   | % 
|Income from operations               |                     |              | 17,041 |                                  |        |                                 | 28  | %    |    |      | 1,992  |       |        |  | 6   | %  |    |   | 38,428  |        |        |  | 23  | %  |    |   | 5,705  |        |        |  | 6   | % 
|Interest expense, net                |                     |              | 5,506  |                                  |        |                                 | 9   | %    |    |      | 890    |       |        |  | 3   | %  |    |   | 13,882  |        |        |  | 8   | %  |    |   | 1,600  |        |        |  | 2   | % 
|Provision for income taxes           |                     |              | 4,354  |                                  |        |                                 | 7   | %    |    |      | 478    |       |        |  | 1   | %  |    |   | 9,375   |        |        |  | 6   | %  |    |   | 964    |        |        |  | 1   | % 
|Net income                           |                     |              | 7,104  |                                  |        |                                 | 12  | %    |    |      | 708    |       |        |  | 2   | %  |    |   | 9,958   |        |        |  | 6   | %  |    |   | 2,538  |        |        |  | 3   | % 

22



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Third Quarter 2002 Compared to Third Quarter 2001

Our consolidated net revenues for the quarter ended September 30, 2002
increased 75% to $61.2 million, from $34.9 million in the third quarter of
2001. Net revenues from product sales increased to $35.9 million in 2002, from
$6.7 million in 2001, due to sales of our M.V.I. and Aquasol products, which we
acquired in mid-August 2001, our Brethine products, which we acquired in
December of 2001, and sales of Darvon and Darvocet-N, which we acquired at the
end of the first quarter of 2002. Because these acquired product lines will
contribute revenues for the full year ending December 31, 2002, we have planned
for significantly increased net revenues and expense from these product lines
for 2002. Net revenues from commercial manufacturing of products marketed by
other pharmaceutical companies, which is included in product sales, contributed
$0.3 million and $1.6 million to net revenues from product sales in the third
quarters of 2002 and 2001, respectively.

Net revenues from product development increased 25% in the third quarter of
2002 to $5.7 million, from $4.5 million in 2001, primarily due to an increase
in product development revenues under our significant development agreement,
from $2.3 million in the third quarter of 2001 to $5.2 million in the third
quarter of 2002. This development agreement is described in the Managements
Discussion and Analysis of Financial Condition and Results of Operations
section of our Form 10-K for the fiscal year ended December 31, 2001. We
expect product development revenues to be slightly lower in the fourth quarter
of 2002.

Net revenues from our research revenues business decreased 17% in the third
quarter of 2002 to $19.6 million, from $23.7 million in 2001. Non-clinical
research revenues decreased by 8% in 2002 to $14.7 million, a decrease of $1.3
million over the prior year. Clinical research revenues decreased by 37% in
2002 to $4.9 million, from $7.7 million in 2001. These decreases were
principally attributable to the redeployment of a portion of our internal
resources from external revenue-producing projects to research and development
projects relating to our own pharmaceutical products, both current and future,
as well as other market factors.

This redeployment of resources is a strategic decision we have made to expand
our proprietary product development pipeline through the increased use of our
research revenue (fee-for-service) segments core competencies. Overall, about
15% of our fee-for-service resources were utilized in the third quarter to
support our own products, especially in clinical research work on ProSorb-D.
This strategy allows us to better control project flow, at lower costs, and
accordingly, we believe this trend will continue into the fourth quarter of
2002 and future years, reflecting the development of our proprietary product
pipeline.

Gross margin dollars, or net revenues less direct costs, increased $23.9
million, or 144%, to $40.5 million, from $16.6 million in the third quarter of
2001, reflecting the benefit from our increased product sales revenues in 2002
over the prior year. As a percentage of net revenues, gross margin dollars
increased to 66% in the third quarter of 2002 from 48% in the third quarter of
2001. The higher margins generated by our product sales business were
partially offset by decreases in external revenues and gross margin percentage
from our research revenues business.

Selling expenses increased 68% in the third quarter of 2002 to $6.1 million,
from $3.6 million in 2001. This increase is primarily due to additional
selling expenses incurred by our product sales business associated with
marketing and promoting our new products, maintaining and enhancing
distribution channels, and developing our product sales force. As a percentage
of net revenues, selling expenses in the third quarter of 2002 decreased
slightly from the third quarter of 2001.

23



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##### 



General and administrative costs increased 49% in the third quarter of 2002 to
$11.7 million, from $7.9 million in 2001. This increase was primarily due to
expenses related to the management build-up for our product sales business. As
a percentage of net revenues, general and administrative expenses in the third
quarter of 2002 decreased to 19%, from 23% in the third quarter of 2001, a
trend that we expect to continue throughout the year.

Research and development expenses were approximately 9% of net revenues, or
$5.6 million, in the third quarter of 2002, an increase from 8% of net
revenues, or $2.7 million, in 2001. This increase resulted primarily from
clinical trials for our ProSorb-D pain management product, for which we plan to
file a New Drug Application with the United States Food and Drug Administration
in the first quarter of 2003, and development work on line extensions for our
critical care and Brethine products, for which we plan filings in the first and
second quarters of 2003, respectively. In general, we target annual research
and development expenses to be approximately 8% to 10% of our estimated net
revenues.

There were no direct pharmaceutical start-up costs recorded in the third
quarter of 2002, as compared to $0.4 million in the third quarter of 2001.
These costs were incurred prior to our acquisition of any pharmaceutical
product lines in 2001 and were expensed as incurred.

Net interest expense increased to $5.5 million in the third quarter of 2002,
from $0.9 million in 2001. This $4.6 million increase is primarily
attributable to the borrowings that funded our product line acquisitions in the
second half of 2001 and the first quarter of 2002. We have planned for
significantly higher net interest expense in 2002, arising from the debt
incurred to fund these acquisitions.

Consolidated income from operations was $17.0 million in the third quarter of
2002, or $15.0 million higher than the prior year. This increase is primarily
due to the expansion of our product sales business, partially offset by
decreases in our research revenues business and our increased R&D spending.

Income from operations for our product sales business was $22.1 million in the
third quarter of 2002, compared to a $1.7 million in the prior year. This
increase is attributable to the revenues from our M.V.I., Aquasol, Brethine,
Darvon and Darvocet-N product lines, which we acquired in the second half of
2001 and first quarter of 2002.

Income from operations for our product development business was $0.1 million in
the third quarter of 2002, compared to income from operations of $1.9 million
in 2001. This change resulted from our increased research and development
spending, as discussed above.

We recorded a loss from operations for our research revenues business of ($0.4)
million in the third quarter of 2002, compared to income from operations of
$1.6 million in 2001. This decrease is primarily due to the decline in
fee-for-service revenues, as described above.

Unallocated corporate expenses increased in the third quarter of 2002 to $4.9
million, from $3.2 million in 2001. This higher level was due to additions to
our corporate infrastructure to accommodate the expansion of our overall
business, increased legal fees to support our intellectual property and
increased employee benefit expenses. As a percentage of net revenues,
unallocated corporate expenses in the third quarter of 2002 decreased to 8%,
from 9% in the third quarter of 2001. For comparative purposes, unallocated
corporate expenses in the second quarter of 2002 were $4.8 million, which also
represented 8% of net revenues.

24



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##### 



We recorded a tax provision of $4.4 million in the third quarter of 2002, based
on an effective tax rate of 38%. This rate is approximately equal to the
statutory rate. Our effective tax rate for the third quarter of 2001 was 40%,
which reflected a higher mix of U.S. based taxable income in that period.

Nine Months Ended September 30, 2002 Compared to Nine Months Ended September
30, 2001

Our consolidated net revenues for the nine months ended September 30, 2002
increased 77% to $168.3 million, from $95.0 million in the same period of 2001.
Net revenues from product sales increased to $90.8 million in 2002, from $11.3
million in 2001, due to sales of our M.V.I., Aquasol and Brethine products,
which we acquired in the second half of 2001, and sales of Darvon and
Darvocet-N, which we acquired at the end of the first quarter in 2002. Net
revenues from commercial manufacturing of products marketed by other
pharmaceutical companies, which is included in product sales, contributed $3.5
million and $6.2 million to net revenues from product sales in the first nine
months of 2002 and 2001, respectively.

Net revenues from product development increased 8% in the first nine months of
2002 to $14.3 million, from $13.2 million in the same period of 2001. Product
development revenues under our significant development agreement increased from
$8.9 million in the first nine months of 2001 to $12.3 million in the first
nine months of 2002.

Net revenues from our research revenues business decreased 10% in the first
nine months of 2002 to $63.2 million, from $70.5 million in the first nine
months of 2001. Non-clinical research revenues decreased by 6% in 2002 to
$46.1 million, from $49.1 million in the prior year. Clinical research
revenues decreased by 20% in 2002 to $17.1 million, from $21.4 million in 2001.
As discussed above, these decreases were principally attributable to the
redeployment of a portion of our internal resources from external
revenue-producing projects to research and development projects relating to our
own pharmaceutical products, as well as other market factors.

Gross margin dollars increased $57.4 million to $103.3 million, from $45.9
million in the first nine months of 2001, reflecting the benefit from our
increased product sales revenues. As a percentage of net revenues, gross
margin dollars increased to 61% in the first nine months of 2002 from 48% in
the first nine months of 2001. The higher margins generated by our product
sales business were partially offset by decreases in revenues and gross margin
percentage from our research revenues business.

Selling expenses increased 73% in the first nine months of 2002 to $16.2
million, from $9.3 million in 2001. This increase is principally due to
additional selling expenses incurred by our product sales business associated
with marketing and promoting our new products, maintaining and enhancing
distribution channels, and developing our product sales force. As a percentage
of net revenues, selling expenses in the first nine months of 2002 decreased
slightly from the first nine months of 2001.

25



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##### 



General and administrative costs increased 50% in the first nine months of 2002
to $33.0 million, from $22.0 million in 2001. This increase was primarily due
to expenses related to the management build-up for our product sales business.
As a percentage of net revenues, general and administrative expenses in the
first nine months of 2002 decreased to 20%, from 23% in the first nine months
of 2001, a trend that we expect to continue throughout the year.

Research and development expenses were approximately 9% of net revenues, or
$15.7 million, in the first nine months of 2002, an increase from 7% of net
revenues, or $6.8 million, in 2001. As previously discussed, this increase
resulted primarily from clinical trials started in the first quarter of 2002
for our ProSorb-D pain management product and line extension development of our
critical care products.

There were no direct pharmaceutical start-up costs recorded in the first nine
months of 2002, as compared to $2.1 million in the first nine months of 2001.
These costs were incurred prior to our acquisition of any pharmaceutical
product lines in 2001 and were expensed as incurred.

Net interest expense increased to $13.9 million in the first nine months of
2002, from $1.6 million in 2001. This increase is primarily attributable to
the borrowings that funded our product line acquisitions.

Consolidated income from operations was $38.4 million in the first nine months
of 2002, or $32.7 million higher than the prior year, and is due to the
expansion of our product sales business.

Income from operations for our product sales business was $53.0 million in the
first nine months of 2002, compared to $1.2 million in the prior year. This
increase is attributable to the revenues and gross margin generated from our
product line acquisitions.

The loss from operations for our product development business was ($1.1)
million in the first nine months of 2002, compared to income from operations of
$6.6 million in 2001. This change resulted from the increased research and
development spending in the first nine months of 2002, as discussed above.

We recorded a loss from operations for our research revenues business of ($0.3)
million in the first nine months of 2002, compared to income from operations of
$6.3 million in 2001. This decrease is primarily due to the decline in
research revenues, as described above.

Unallocated corporate expenses increased in the first nine months of 2002 to
$13.1 million, from $8.4 million in 2001. This increase was due to additions
to our corporate infrastructure to accommodate our expansion and increased
legal fees to support our intellectual property. As a percentage of net
revenues, unallocated corporate expenses in the first nine months of 2002
decreased to 8%, from 9% in the first nine months of 2001.

We recorded a tax provision of $9.4 million in the first nine months of 2002,
based on an effective tax rate of 38%. This rate is approximately equal to the
statutory rate. Our effective tax rate for the first nine months of 2001 was
28%, which reflected the utilization of tax loss-carryforwards generated by our
European operations.

26



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##### 



In March 2002, we recorded an extraordinary loss of $5.3 million, net of a tax
benefit of $2.7 million, to record the write-off of deferred financing and
other costs related to our prior debt facilities and redeemable warrants.

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 2002 was $16.7 million, compared to cash flow used in
operations of $5.6 million in the first nine months of 2001. This change was
primarily due to an increase in net income and accrued interest payable on our
senior subordinated notes, partially offset by increases in accounts receivable
and inventories related to the product lines we acquired and prepaid financing
fees related to the financing of our acquisitions. In the third quarter of
2002, we generated cash from operating activities of $21.9 million, which was
provided by our net income and increases in interest payable and accrued
liabilities and a decrease in accounts receivable, partially offset by an
increase in inventories related to our product sales.

Cash used in investing activities was $233.3 million in the first nine months
of 2002 compared to cash used in investing activities of $52.4 million in the
first nine months of 2001. This change included $211.4 million related to our
acquisition of the Darvon and Darvocet-N branded product lines as further
described below, 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.
In March 2001, we completed a sale/leaseback transaction on manufacturing
equipment, which provided cash of $3.1 million. The lease has a five-year term
and requires payments of approximately $0.6 million annually.

Cash provided by financing activities during the first nine months of 2002 was
$219.1 million, primarily representing net proceeds of $255.3 million in
additional borrowings under our new debt facilities, as described below, and
$3.2 million of cash proceeds from the exercise of stock options, partially
offset by the repayment of $39.4 million of these borrowings in the second and
third quarters of 2002.

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, subject to potential reduction based on the net sales
of these products after the closing of the acquisition. 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, with
amortization of $5 million, $15 million, $20 million, $25 million and $35
million, respectively, in years one through five. The availability of
borrowings under our revolving credit facility is not limited by a borrowing
base. Our senior credit facilities provide for variable interest rates based
on LIBOR or an alternate base rate, at our option. Such facilities are
guaranteed by all of our domestic subsidiaries and secured by a security
interest on substantially all of our domestic assets, all of the stock of our
domestic subsidiaries, and 65% of the stock of our material foreign
subsidiaries. Our senior credit facilities require the payment of certain
commitment fees based on the unused portion of the revolving credit facility.
Under the terms of the credit agreement for our senior credit facilities, we
are required to comply with various covenants including, but not limited to,
those pertaining to maintenance of certain financial ratios and incurrence of
additional indebtedness. These senior credit facilities may be prepaid at our
option at any time without a premium.

27



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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 first 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.

Concurrent with the issuance of our senior subordinated notes, we entered into
an interest rate swap agreement to effectively convert interest expense on $140
million of 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 August 5, 2002, and again on September 19, 2002, we sold the then
outstanding swap agreement for $5.6 million and $3.7 million, respectively.
The amounts we received, less the interest benefit earned through the dates of
sale, have been recorded as a premium to the carrying amount of the notes and
will be amortized into interest income over their remaining life. Currently,
we have an interest rate swap agreement in place covering $150 million of the
notes, at a rate of 6-month LIBOR plus 6.54%. On September 30, 2002, 6-month
LIBOR was 1.71%.

Our liquidity needs increased significantly during the first nine months of
2002. After giving effect to our completed branded product line acquisitions,
our annual net interest expense may exceed $19 million in 2002. We will make a
$1 million payment in August 2003, and may have to make contingent payments in
the next several years of $47 million in connection with our product line
acquisitions of M.V.I. and Aquasol, of which $43.5 million is potentially due
in August 2004. In addition, we may have to make contingent payments of $4.8
million over four years in connection with the purchase of our Charleston,
South Carolina manufacturing facility. We have $9.2 million of principal
repayments due in the next twelve months under our senior credit facilities and
will make an interest payment on the senior subordinated notes of $9.6 million
in April 2003. This interest payment will be reduced by approximately $1.7
million to be received under our interest rate swap agreement.

We believe that our senior credit facilities and cash flow provided by
operations will be sufficient to fund near-term growth and fund our guaranteed
and 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.

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In April 2002, the Financial Accounting Standards Board (the FASB) issued
Statement of Financial Accounting Standards No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections (SFAS No. 145). This statement eliminates the automatic
classification of gain or loss on early extinguishment of debt as an
extraordinary item and requires that any such gain or loss be reviewed under
the criteria of Accounting Principles Board No. 30 Reporting Results of
Operations. This statement also requires sale-leaseback accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions, and makes various other technical corrections to
existing pronouncements. The statement is effective for fiscal years beginning
after May 15, 2002. We do not expect that the adoption of SFAS No. 145 will
have a significant impact on our results of operations, consolidated financial
position or cash flows.

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 guaranteed and
contingent acquisition payment obligations; 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 research services net revenues and profitability levels
and trends; expected levels of future net interest expenses; targeted research
and development expenditures as a percentage of net revenues; anticipated
levels of sales and general and administrative costs as a percentage of net
revenues; and expected net revenues, expenses and profitability of our product
sales.

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



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

29



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| |  |  | We are dependent on third parties for essential business functions and
problems with these third-party arrangements could materially
adversely affect our ability to manufacture and sell products and our
financial condition and results of operations;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | Competition from the sale of generic products and the development by
other companies of new branded products could cause the revenues from
our branded products to decrease significantly;                                                               
| |  |  | We may be unable to obtain government approval for our products or
comply with government regulations relating to our business; and                                                                                                                      
| |  |  | Changes in government regulations may favor sales of generic products
that compete with our branded products.                                                                                                                                            

Additional factors that may cause the actual results to differ materially are
discussed in Exhibit 99.1 to this report hereto and incorporated herein by
reference and in our recent filings with the SEC, including, but not limited
to, our registration statements, as amended, our Annual Report on Form 10-K
filed with the SEC on March 11, 2002, including the exhibits attached or
incorporated therein, our Form 10-Q filed with the SEC on August 14, 2002,
including the exhibits thereof, 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 the exchange rate between the euro and the U.S. dollar were to change by
10%, net income for the nine months ended September 30, 2002 would have changed
by $2,000 due to the change in reported results from European operations.

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 above. 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 $1.2 million, or $300,000 per quarter.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures  aaiPharma Inc.s Chief
Executive Officer and Chief Financial Officer have evaluated the companys
disclosure controls and procedures as of November 11, 2002, and they concluded
that these controls and procedures are effective.
(b) Changes in Internal Controls  There are no significant changes in internal
controls or in other factors that could significantly affect these controls
subsequent to November 11, 2002.

30



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PART II.       OTHER INFORMATION

Item 1. Legal Proceedings

We are party to lawsuits and administrative proceedings incidental to the
normal course of our business. We do not believe that any liabilities related
to such lawsuits or proceedings will have a material adverse effect on our
financial condition, results of operations or cash flows. While we cannot
predict the outcomes of these suits, 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 a party to a number of legal actions with generic drug companies. We
filed three cases in the United States District Court for the Eastern District
of North Carolina claiming infringement of certain of our fluoxetine
hydrochloride patents. Fluoxetine hydrochoride is an active ingredient in the
drug marketed by Eli Lilly as Prozac. Each of the defendants in these three
actions, Dr. Reddys Laboratories Ltd., a pharmaceutical company based in
India, and its U.S. affiliate, Dr. Reddys Laboratories, Inc. (formerly
Reddy-Cheminor, Inc.), Barr Laboratories, Inc., and PAR Pharmaceuticals, Inc.
sells a generic fluoxetine hydrochloride product in the United States.

In the first action, filed in August 2001, we alleged that the defendants are
infringing our fluoxetine hydrochloride Form A patent (U.S. Patent No.
6,258,853) and are seeking an injunction to prevent the sale of products that
infringe this patent, as well as compensatory and punitive damages and
attorneys fees. In the second case, filed in October 2001, we alleged that
the defendants are infringing three additional fluoxetine patents (U.S. Patent
Nos. 6,310,250, 6,310,251 and 6,313,350) and are seeking an injunction to
prevent the defendants from selling infringing fluoxetine products, and
monetary damages. In the third action, filed in November 2001, we have brought
similar claims against the defendants regarding a fifth fluoxetine patent (U.S.
Patent No. 6,316,672). In each case, the defendants have filed counterclaims
alleging patent invalidity, violations of the North Carolina Unfair Trade
Practices Act and tortious interference with the defendants distribution
agreements. We have denied the substantive allegations of their claims. These
cases are all in the initial stages and discovery is just beginning, other than
the cases involving Barr Laboratories, Inc., which have been settled and a
non-exclusive license entered into with respect to our fluoxetine patents. As
part of the settlement, a pre-existing agreement between us and Barr with
respect to an unidentified product has been terminated by mutual consent, each
party retains ownership of all of their respective confidential information
provided under such agreement, and each party is free to continue to pursue its
own products related to such termination agreement without further obligation
to each other. It is possible that the patents subject to these lawsuits will
be found invalid or unenforceable.

We are also involved in three actions centered on our omeprazole-related
patents. Omeprazole is the active ingredient found in Prilosec, a drug sold by
AstraZeneca. Two 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 1, 2002 have not obtained, approval
from the FDA to market a generic form of Prilosec. The plaintiffs in these
cases are challenging the validity of five patents that we have obtained
relating to omeprazole (U.S. Patent Nos. 6,262,085, 6,262,086, 6,268,385,
6,312,712 and 6,312,723) 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.

31



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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. Andrx is challenging the validity of three of our
omeprazole patents (U.S. Patent Nos. 6,262,085, 6,262,086, and 6,268,385), 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. It is possible that the patents subject to these
lawsuits will be found invalid or unenforceable.

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 2002, the Company did not file any current reports
on Form 8-K.

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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, 2002 |  | By:                                                                        |  | /s/ PHILIP S. TABBINER   
|      |  |                   |  |                                                                            |  |                          
|      |  |                   |  | Philip S. Tabbiner, D.B.A.
President and Chief
Executive Officer          
|      |  |                   |  |                                                                            |  |                          
|Date: |  | November 13, 2002 |  | By:                                                                        |  | /s/ WILLIAM L. GINNA, JR.
|      |  |                   |  |                                                                            |  |                          
|      |  |                   |  | William L. Ginna, Jr.
Executive Vice President and
Chief Financial Officer

33



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CERTIFICATION

Each of the undersigned officers of the registrant certifies that:



|1. |  | I have reviewed the quarterly report on Form 10-Q of aaiPharma Inc. (the Company or the registrant) for the quarter ending on September 30, 2002
(the Quarterly Report);                                                                                                                                              
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, the Quarterly Report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by the Quarterly Report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in the Quarterly Report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Company as of, and for, the periods presented in the
Quarterly Report;                      
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:                                                                                                   



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



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



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





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|6. |  | The registrants other certifying officers and I have indicated in this
Quarterly Report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                        |  |                                                                                                      | 
|----------------------- |  | ---------------------------------------------------------------------------------------------------- | 
|Date: November 12, 2002 |  | /s/ PHILIP S. TABBINER
Philip S. Tabbiner
President and Chief Executive Officer                     
|                       
|                       
|Date: November 12, 2002 |  | /s/ WILLIAM L. GINNA, JR.
William L. Ginna, Jr.
Executive Vice President and
Chief Financial Officer
|                       
|                       
|Date: November 12, 2002 |  | /s/ FREDERICK D. SANCILIO
Frederick D. Sancilio
Executive Chairman                                  





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aaiPharma Inc.
Exhibit Index

|        |  |                                                                                                                                                                                                                                                                                                                                                                                                         
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                                                                                                                                                                                                                                                         
|No.     |  | Description                                                                                                                                                                                                                                                                                                                                                                                             
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                         
|3.1     |  | Amended and Restated Certificate of Incorporation of the Company and
Amendment to Certificate of Incorporation dated May 24, 2000, and
Amendment to Certificate of Incorporation dated November 15, 2000 and
Amendment to Certificate of Incorporation dated June 27, 2002
(incorporated by reference to Exhibit 3.1 to the Companys Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002)
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                         
|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 the Amended
and Restated Certificate of Incorporation of the Company (incorporated by
reference to Exhibit 3.1)                                                                                                                                                                                                                           
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                         
|4.2     |  | Article II of the 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)                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                         
|4.3     |  | Specimen Certificate for shares of Common Stock, $0.001 par value, of the
Company (incorporated by reference to Exhibit 4.3 to the Companys
Registration Statement on Form S-1 (Registration No. 333-5535))                                                                                                                                                                                            
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                         
|99.1    |  | 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,
2002)