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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, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period _______ to _______
Commission File Number 0-21185
AAIPHARMA INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 04-2687849
(State or other jurisdiction of (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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes [X] No [ ]
The number of shares of the registrant's common stock outstanding as of November
1, 2004 was 28,585,582 shares.
The terms "we", "us" or "our" in this Form 10-Q include aaiPharma Inc., its
corporate predecessors and its subsidiaries, except where the context may
indicate otherwise. Our corporation was incorporated in 1986, although its
corporate predecessor was founded in 1979. Our Internet address is
www.aaipharma.com. We make available through our Internet website our Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form
8-K, and amendments to those reports filed or furnished pursuant to Section
13(a) of the Securities Exchange Act of 1934 as soon as reasonably practicable
after we electronically file such material with, or furnish it to, the
Securities and Exchange Commission.
At September 30, 2004, we owned the following registered and unregistered
trademarks referenced herein: Darvocet(R), Darvon(R), Darvon-N(R),
Darvocet-N(R), Darvocet A500(TM), Brethine(R), ProSorb-D(TM), Lynxorb(TM),
Oramorph(R) SR, Roxicodone(R), AzaSan(R), aaiPharma(R) and AAI(R). AzaSan(R) is
a registered trademark owned by us and licensed to Salix Pharmaceuticals. Unless
the context otherwise requires, references in this document to Darvon are to
Darvon(R) and Darvon-N(R), collectively, and references to Darvocet are to
Darvocet-N(R) and Darvocet A500(TM), collectively. We also reference trademarks
owned by other companies. M.V.I.(R), M.V.I.-12(R), M.V.I. Pediatric(R), M.V.I.
Adult(TM), Aquasol(R), Aquasol A(R) and Aquasol E(R) are registered and
unregistered trademarks owned by Mayne Pharma (USA) Inc. Prilosec(R) is a
registered trademark owned by AstraZeneca. Unless the context otherwise
requires, references to M.V.I. are to M.V.I.-12(R), M.V.I. Pediatric(R) and
M.V.I. Adult(TM), collectively, and references to Aquasol are to Aquasol A(R)
and Aquasol E(R), collectively. Duraclon(R) is a registered trademark owned by
Fujisawa Healthcare, Inc. and licensed to us. All references in this document to
any of these terms lacking the "(R)" or "(TM)" symbols are defined terms that
reference the products, technologies or businesses bearing the trademarks with
these symbols.
AAIPHARMA INC.
Table of Contents
Page No.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (unaudited)
Consolidated Statements of Operations
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Consolidated Statements of Comprehensive Loss
Notes to Consolidated Financial Statements
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 6. EXHIBITS
SIGNATURES
EXHIBIT INDEX
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
AAIPHARMA INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net revenues:
Product sales $ 15,684 $ 13,664 $ 61,898 $ 78,428
Product development (royalties and fees) 4,481 3,524 14,522 11,231
Development services 23,054 22,512 72,529 65,124
--------- --------- --------- ---------
43,219 39,700 148,949 154,783
--------- --------- --------- ---------
Operating costs and expenses:
Direct costs (excluding depreciation and royalty expense):
Product sales (includes product rights amortization
of $3,972, $2,969, $11,916 and $8,906) 10,404 10,955 35,494 37,817
Development services 12,749 12,614 42,248 37,390
--------- --------- --------- ---------
Total direct costs 23,153 23,569 77,742 75,207
Selling expenses 6,021 9,071 30,122 25,006
General and administrative expenses 9,479 9,793 35,319 31,112
Research and development 3,134 5,367 13,847 15,441
Depreciation 2,367 1,912 6,404 5,747
Professional fees - internal inquiry 769 - 9,072 -
M.V.I. contingent payment/(gain on sale) (1,567) - (8,112) -
Restructuring charges 13,719 - 17,119 -
Royalty expense 357 325 1,366 452
Intangible asset impairment 5,250 - 5,250 -
--------- --------- --------- ---------
Total operating costs and expenses 62,682 50,037 188,129 152,965
--------- --------- --------- ---------
(Loss) income from operations (19,463) (10,337) (39,180) 1,818
Other income (expense):
Interest, net (9,469) (5,140) (23,866) (15,621)
Loss from extinguishment from debt - - (6,229) -
Other (275) (122) (2,111) 21
--------- --------- --------- ---------
(9,744) (5,262) (32,206) (15,600)
--------- --------- --------- ---------
Loss before income taxes (29,207) (15,599) (71,386) (13,782)
Provision for (benefit from) income taxes 4,583 (6,207) 4,758 (5,414)
--------- --------- --------- ---------
Net loss $ (33,790) $ (9,392) $ (76,144) $ (8,368)
========= ========= ========= =========
Basic loss per share: $ (1.18) $ (0.34) $ (2.67) $ (0.30)
========= ========= ========= =========
Weighted average shares outstanding 28,586 27,810 28,558 27,664
========= ========= ========= =========
Diluted loss per share: $ (1.18) $ (0.34) $ (2.67) $ (0.30)
========= ========= ========= =========
Weighted average shares outstanding 28,586 27,810 28,558 27,664
========= ========= ========= =========
The accompanying notes are an integral part of these financial statements.
3
AAIPHARMA INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
September 30, December 31,
2004 2003
------------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 7,143 $ 8,785
Accounts receivable, net 6,799 32,614
Work-in-progress 11,279 12,503
Inventories, net 13,509 14,693
Deferred tax assets 10,456 19,184
Prepaid and other current assets 10,335 10,398
--------- ---------
Total current assets 59,521 98,177
Property and equipment, net 56,126 57,236
Goodwill, net 13,154 13,361
Intangible assets, net 282,843 351,315
Other assets 14,225 14,508
--------- ---------
Total assets $ 425,869 $ 534,597
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ - $ 4,000
Accounts payable 21,515 21,879
Customer advances 13,775 17,630
Accrued wages and benefits 6,840 5,320
Interest payable 10,271 5,511
Deferred product revenue 10,632 45,664
Other accrued liabilities 37,524 11,133
--------- ---------
Total current liabilities 100,557 111,137
Long-term debt, less current portion 323,700 338,844
Deferred tax liability - 2,246
Other liabilities 18 7,647
Stockholders' equity:
Common stock 29 28
Paid-in capital 91,622 88,049
Accumulated deficit (92,451) (16,307)
Accumulated other comprehensive income 2,533 3,197
Deferred compensation (139) (244)
--------- ---------
Total stockholders' equity 1,594 74,723
--------- ---------
Total liabilities and stockholders' equity $ 425,869 $ 534,597
========= =========
The accompanying notes are an integral part of these financial statements.
4
AAIPHARMA INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
September 30,
------------------------
2004 2003
--------- ---------
Cash flows from operating activities:
Net loss $ (76,144) $ (8,368)
Adjustments to reconcile net loss to
net cash (used in) provided by operating activities:
Depreciation and amortization 18,320 14,653
Intangible asset impairment, net of tax 5,250 -
Write-off of deferred financing and other costs 6,229 -
Gain from asset sale (39,113) -
Other 237 138
Changes in operating assets and liabilities:
Accounts receivable, net 25,731 (1,570)
Work-in-progress 1,083 (4,520)
Inventories (1,824) (90)
Deferred tax assets 8,728 -
Prepaid and other assets (5,889) 273
Accounts payable (318) (1,420)
Customer advances (3,768) 4,158
Interest payable 4,760 4,566
Deferred product revenue (35,032) 45,198
Accrued wages and benefits and other accrued liabilities 26,067 (9,080)
--------- ---------
Net cash (used in) provided by operating activities (65,683) 43,938
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (5,475) (9,867)
Proceeds from sales of property and equipment 97 508
Product line disposals (acquisitions) 92,944 (6,050)
Other (199) (334)
--------- ---------
Net cash provided by (used in) investing activities 87,367 (15,743)
--------- ---------
Cash flows from financing activities:
Proceeds from long-term borrowings 147,500 -
Payments on long-term borrowings (164,000) (29,500)
(Payments on) proceeds from interest rate swaps, net (10,203) 2,191
Proceeds from stock option exercises 3,678 2,819
Other (292) 805
--------- ---------
Net cash used in financing activities (23,317) (23,685)
--------- ---------
Net (decrease) increase in cash and cash equivalents (1,633) 4,510
Effect of exchange rate changes on cash (9) 68
Cash and cash equivalents, beginning of period 8,785 6,532
--------- ---------
Cash and cash equivalents, end of period $ 7,143 $ 11,110
========= =========
Supplemental information, cash paid for:
Interest $ 17,868 $ 13,520
========= =========
Income taxes $ 5,923 $ 6,152
========= =========
The accompanying notes are an integral part of these financial statements.
5
AAIPHARMA INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(IN THOUSANDS)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net loss $(33,790) $ (9,392) $(76,144) $ (8,368)
Currency translation adjustments, net of tax 384 (42) (664) 1,981
-------- -------- -------- --------
Comprehensive loss $(33,406) $ (9,434) $(76,808) $ (6,387)
======== ======== ======== ========
The accompanying notes are an integral part of these financial statements.
6
AAIPHARMA INC.
Notes to Consolidated Financial Statements
(Unaudited)
1. BASIS OF PRESENTATION AND OTHER MATTERS
aaiPharma Inc. ("aaiPharma" or the "Company") is a science-based pharmaceutical
company focused on acquiring, improving and marketing well-known, branded
medicines in pain management and critical care. The Company also offers
comprehensive drug development services to the pharmaceutical, biotechnology,
generic and device industries through its development services division. The
accompanying unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
and applicable Securities and Exchange Commission (the "SEC") 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, 2003 has been derived from audited
financial statements; certain amounts from the three and nine months ended
September 30, 2003 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 for the year ended December 31, 2003 (the "2003 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.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25") and related interpretations in accounting
for its stock option plans; therefore, compensation expense has not been
recognized for options granted at fair value. Under APB 25, if the exercise
price of the Company's stock options is not less than the estimated fair market
value of the underlying stock on the date of grant, no compensation expense is
recognized. If compensation cost for the Company's plans had been determined
based on the fair value at the grant dates for awards under those plans
consistent with the fair value method of Statement of Financial Accounting
Standards No. 123 "Accounting for Stock Based Compensation", the Company's net
income (loss) and income (loss) per share would have been changed to the pro
forma amounts indicated below:
7
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
(In thousands, except per share data)
Net loss, as reported $ (33,790) $ (9,392) $ (76,144) $ (8,368)
Add back deferred compensation amortization, net of tax 21 21 62 62
Less pro forma stock-based compensation cost, net of tax 1,060 1,982 4,635 5,672
Pro forma net loss (34,829) (11,353) (80,717) (13,978)
Loss per share:
As reported -
Basic ($ 1.18) ($ 0.34) ($ 2.67) ($ 0.30)
Diluted ($ 1.18) ($ 0.34) ($ 2.67) ($ 0.30)
Pro forma -
Basic ($ 1.22) ($ 0.41) ($ 2.83) ($ 0.51)
Diluted ($ 1.22) ($ 0.41) ($ 2.83) ($ 0.51)
2. RECENT DEVELOPMENTS
MANAGEMENT CHANGES AND REDUCTION IN FORCE
On September 27, 2004, the Company's board of directors named Ludo Reynders,
Ph.D. as President and Chief Executive Officer and elected James G. Martin,
Ph.D., a non-employee member of the board of directors, to serve as
non-executive chairman of the board of directors. At that time, Frederick D.
Sancilio ceased to serve as Chairman, President, Chief Executive Officer and
Chief Scientific Officer, but continues to serve as a director of the Company.
On September 3, 2004, the Company announced that Vijay Aggarwal stepped down
from his position as President of AAI Development Services to accept the
position of Chief Executive Officer of another pharmaceutical company and that
Steve Cottrell, Executive Vice President of AAI Development Services' Sales,
Marketing and Project Management, had been assigned to the position of Interim
President of AAI Development Services. Mr. Cottrell left aaiPharma on October
15, 2004 to join a company providing training services to the pharmaceutical
industry. Dr. Ludo J. Reynders, President and Chief Executive Officer of
aaiPharma, was hospitalized with suspected pneumonia on November 7, 2004.
During Dr. Reynders' incapacity, Mr. Timothy R. Wright has been appointed to
the position of interim President and Chief Executive Officer.
In September 2004, the Company reduced the size of its workforce by
approximately 4%. The Company has estimated that the severance costs associated
with this reduction in workforce will be approximately $1.5 million. This amount
does not include separation payments to Dr. Sancilio of approximately $1.9
million. The Company also incurred additional restructuring charges of
approximately $10.3 million in the quarter ended September 30, 2004 in
connection with the closure of several leased facilities and the subleasing of
leased aircraft. This additional restructuring is consistent with the Company's
previously disclosed intentions to rationalize its expense base in relation to
its revenue. Payments under these severance and separation arrangements and
leases extend through 2006 and 2012, respectively.
The Company was late in filing its 2003 Form 10-K, which was filed on June 15,
2004. On June 21, 2004, NASDAQ notified the Company that the listing
qualifications panel had determined to continue the listing of the Company's
common stock if the Company met certain conditions, including providing NASDAQ
with additional information, filing the Quarterly Reports on Form 10-Q/A for
each of the first three quarters of 2003 and the Quarterly Report on Form 10-Q
for the first quarter of 2004 by the June 30, 2004 deadline, and filing on a
timely basis all periodic reports for reporting periods ending on or before June
30, 2005. The amended Quarterly Reports on Form 10-Q for 2003 were filed on June
24, 2004, the Quarterly Report on Form 10-Q for the period ended March 31, 2004
was filed on June 25, 2004 and the Company provided NASDAQ the required
additional information on June 30, 2004. As a result, NASDAQ notified the
Company that it was in compliance
8
and its common stock would continue to be listed subject to the conditions
identified in its June 21, 2004 notification. On July 9, 2004, the Company's
ticker symbol reverted to "AAII".
SENIOR CREDIT AGREEMENT AMENDMENTS AND INDENTURE CONSENT SOLICITATION
On August 9, 2004 and August 13, 2004, the Company entered into amendments to
its senior secured credit facilities to, among other things, increase the amount
of the term loans by up to $10 million, extend the maturity date of the
facilities by one year to April 21, 2007, increase the interest rate on the
loans by an additional 1.5% subject to potential incremental reduction based on
the Company's financial performance, adjust certain covenants under the
facilities and waive certain defaults and events of default. Under the amended
credit facility, the Company borrowed an additional $10 million in term loans on
August 13, 2004. The amendment adjusted both the percentages of proceeds of
certain transactions that are required to be applied to prepay the loans and the
fees to be paid upon optional reductions of the credit facility. As amended,
optional reductions in revolving credit commitments and optional prepayments of
term loans, as well as mandatory reductions in revolving credit commitments and
mandatory prepayments of term loans from the net cash proceeds of asset sales,
subject to defined exceptions, are subject to a prepayment fee equal to 3.5%
until August 9, 2005, 2.5% for the subsequent 12 months, and 1.5% for the next 6
months (with no prepayment penalty payable for the remainder of the term). The
August amendments also require the Company to retain FTI Consulting, Inc. during
the term of the senior credit facilities unless certain available cash and
annualized cost reduction thresholds are satisfied, at which time the retention
of FTI could be terminated.
On October 1, 2004, the Company failed to make the interest payment then due on
its senior subordinated notes. The failure to make the October 1, 2004 interest
payment constituted a default under the notes, subject to a 30-day cure period.
On October 29, 2004, the Company made the interest payment, curing the default
under the notes.
On October 29, 2004, the Company completed a solicitation seeking the consent
from the holders of its senior subordinated notes to certain amendments to, and
waivers under, the indenture (the "Indenture") governing the senior subordinated
notes to, among other things:
- - permit the Company to incur up to $30 million of additional indebtedness
under credit facilities;
- - permit the Company to incur additional senior debt in order to maintain
$40 million (subject to an increase up to $50 million in order to allow
the Company to make interest payments on the senior subordinated notes) in
senior debt under credit facilities in the event the Company is required
to pay down senior debt with the proceeds of asset sales;
- - require that debt permitted to be incurred under a fixed charge coverage
ratio test set forth in the Indenture must rank on parity with or be
subordinated in right of payment to the senior subordinated notes and any
liens granted to secure any such parity debt shall rank pari passu with
the liens securing the senior subordinated notes;
- - require proceeds of asset sales to be used to reduce senior debt under
credit facilities to $40 million;
- - provide that the liens on assets that secure obligations under the senior
subordinated notes will continue if all senior debt is repaid, but will
resume as junior liens if the Company thereafter incurs any new senior
debt;
- - prohibit the payment in cash in excess of an aggregate of $5 million to
settle pending litigation, excluding payments funded or reimbursed under
insurance policies, until the Company makes the interest payments due on
the senior subordinated notes on April 1, 2005 and October 1, 2005;
- - prohibit the payment of dividends on the Company's common stock and other
restricted payments (as defined in the Indenture) until the interest
payments due on the senior subordinated notes on April 1, 2005 and October
1, 2005 are paid; and
9
- - temporarily increase the interest rate on the senior subordinated notes by
0.5% per annum (to 12% per annum), beginning on October 1, 2004 and ending
on March 31, 2005.
The completion of the consent solicitation satisfied a condition of an amendment
to the Company's senior credit facilities (described below) that made available
a supplemental term loan under the senior credit facilities that was used on
October 29, 2004 to make the October 1, 2004 interest payment on the senior
subordinated notes, together with default interest thereon. This payment cured
the existing default under the senior subordinated notes.
Effective as of October 8, 2004, the Company amended its senior secured credit
facility to, among other things, adjust financial covenants. The senior secured
lenders also waived compliance with certain financial covenants in the senior
secured credit facility for the quarter ended September 30, 2004 and the quarter
ending December 31, 2004 provided that the Company meets minimum consolidated
EBITDA thresholds (as defined in the senior secured credit facility). The
amendment also added a minimum gross revenue requirement of $40 million for the
quarter ending December 31, 2004 and consented to certain asset disposition
transactions and receipt of a deferred purchase price payment pursuant to which
the Company would receive approximately $4.2 million in the aggregate. The
amendment also waived any requirement to prepay the senior secured loans with
the net proceeds of these transactions.
On October 22, 2004, the Company entered into another amendment to its senior
secured credit facilities that increased the existing term loan facility under
the senior secured credit facility by $30 million (the "Supplemental Term
Loan"), subject to certain specified conditions which were satisfied on October
29, 2004. The Supplemental Term Loan was made available in up to three draws to
be made on or prior to January 15, 2005, and the Company borrowed $20 million of
such term loans on October 29, 2004. Following effectiveness of the amendment,
the senior secured credit facility consisted of a term loan of up to $165
million and a revolving credit facility of up to $15 million.
The amendment also modified the interest rate on the entire senior secured
credit facility, including the Supplemental Term Loan, to equal a defined LIBOR
rate (with a floor of 2%) plus 8.25% per annum or a defined reference rate (with
a floor of 4%) plus 7.25% per annum. The amendment also provided for a
commitment fee equal to 0.75% per annum on any undrawn portion of the
Supplemental Term Loan, payable monthly in arrears. At October 29, the Company's
applicable LIBOR-based interest rate under the amended credit facilities was
10.25%.
The proceeds of the loans under the Supplemental Term Loan were and may be used
(i) to fund payment of the October 1, 2004 interest payment due on the senior
subordinated notes, (ii) to pay for fees, costs and expenses in connection with
the amendment and the October 2004 consent solicitation for the senior
subordinated notes, and (iii) for working capital and other general corporate
purposes.
The amendment added a covenant requiring the Company to retain Rothschild Inc.
or another financial advisor to assist with its exploration of the potential
sale of some or all of the assets comprising the Company's Pharmaceuticals
Division, but eliminated a minimum gross revenue covenant for the quarter ending
December 31, 2004. Compliance with the fixed charge coverage ratio and the
leverage ratio financial covenants was also waived through the first quarter of
2005 so long as defined minimum EBITDA thresholds are satisfied. In addition,
the amendment retained a covenant requiring certain levels of cash or revolver
availability and increased the level of cash or revolver availability required
for the period from March 31, 2005 through May 15, 2005 to $15.0 million.
The amendment also added an event of default if the Company fails to pursue in
good faith the exploration of the potential sale of some or all of the assets
comprising its Pharmaceutical Division or other non-core assets.
10
The Company has engaged Rothschild Inc. to assist it in evaluating potential
asset divestitures. The Company is exploring the potential sale of some or all
of the assets comprising the Pharmaceuticals Division, as well as other assets
that are no longer strategic to its long-term business plan. These asset sales,
above a minimum threshold, would require the consent of the senior secured
lenders.
GOVERNMENTAL INVESTIGATIONS AND LITIGATION
Beginning in April 2004, the Company received subpoenas for document production
and potential testimony issued by a grand jury of the United States District
Court for the Western District of North Carolina related primarily to 2002 and
2003 financial information, the terms, conditions of employment and compensation
arrangements of certain of the Company's senior management personnel,
compensation and incentive arrangements for employees responsible for the sale
of its Brethine, Darvocet, Calcitriol, Azasan and Darvon Compound products,
quantities of the foregoing products in distribution channels, financial
benefits with respect to specified corporate transactions to the Company's
senior management and others, certain loans obtained by the Company, extensions
of credit, if any, by the Company to its officers or directors, accounting for
sales and returns of the foregoing products, analysts' conference calls on
financial results, internal and external investigations of pharmaceutical
product sales activities, and related matters. The Company has also received a
subpoena from the SEC covering similar matters. In addition, the Company and
certain of its current and former officers and directors have been named as
defendants in purported stockholder class action lawsuits alleging violations of
federal securities laws and a stockholder derivative action, not yet served on
the Company, alleging violations of state law fiduciary responsibilities. The
Company is also a party to other litigation described in Part II, Item 1. "Legal
Proceedings" of this Quarterly Report on Form 10-Q. The Company has incurred,
and likely will continue to incur in the future, significant professional fees
in connection with these matters and other pending litigation. Professional fees
on a number of the matters described in this Form 10-Q, including these
litigation matters and governmental investigations, may extend for several
years.
3. M.V.I. AND AQUASOL PRODUCT LINE SALE AND CONTINGENT PAYMENT
On April 26, 2004, the Company sold its M.V.I. and Aquasol product lines to
Mayne Pharma (USA) Inc. for $105 million, subject to adjustments based on
inventory levels at closing and other post-closing obligations (the "M.V.I. and
Aquasol Sale"). A portion of the closing payment is held in escrow to satisfy
post-closing obligations under the agreement. The M.V.I. and Aquasol Sale
resulted in a preliminary gain of $37.5 million that the Company recorded in the
second quarter of 2004. The gain on the sale was based on the net cash received
from the sale less the book value of the intangible assets, inventories and
other items related to the product lines sold. In September 2004, the Company
received a cash distribution of $1.6 million related to a reduction in its
post-closing obligations under the purchase agreement, which was recorded as an
additional gain in the third quarter of 2004. The Company expects to receive a
final distribution of $0.2 million in the fourth quarter of 2004.
The Company's M.V.I. and Aquasol product line acquisition agreement with
AstraZeneca AB, as amended, provided for a future contingent payment of $43.5
million potentially due in August 2004, depending on the status of certain
reformulation activities being carried out by the seller and regulatory approval
of the reformulations by the U.S. Food and Drug Administration. The amount of
the $43.5 million contingent payment was to be reduced by $1 million per month
if the conditions for the contingent payment had not occurred by December 31,
2002. The amount of the contingent payment had decreased by $12.0 million by
December 31, 2003. Such conditions were satisfied in January and February 2004,
fixing the previously contingent liability under the amendment at $31.5 million.
The Company recorded this expense in the first quarter of 2004. As a result of
an amendment to the original acquisition agreement, the Company was precluded
from recognizing this obligation (the "M.V.I. Contingent Payment") as additional
purchase price for the M.V.I. and Aquasol product lines under Statement of
Financial Accounting Standards No. 142, "Goodwill
11
and Other Intangible Assets," and No. 141, "Business Combinations"; therefore,
this adjustment was expensed in the first quarter of 2004. As discussed above,
the Company sold its M.V.I. and Aquasol product lines on April 26, 2004. Because
the $31.5 million contingent payment was not included in the basis of the assets
sold, the gain from the sale transaction in the second quarter of 2004 offsets
the expense discussed in this Note in determining the net loss for the nine
months ended September 30, 2004. Concurrently with the closing of the M.V.I. and
Aquasol Sale on April 26, 2004, the Company paid to AstraZeneca AB the M.V.I.
Contingent Payment, which was discounted to approximately $31.0 million as a
result of the early payment.
4. INCOME TAXES
The Company recorded a net tax expense of approximately $4.6 million in the
third quarter of 2004. The Company recorded a tax benefit of approximately $12
million in the nine months ended September 30, 2004, primarily as a result of
current period net operating losses, offset by a valuation allowance for the
entire amount because it is more likely than not that the deferred tax asset
resulting from this benefit will not be realized. Included in this tax expense
is an additional valuation allowance of $4.4 million for previously unreserved
deferred tax assets for which it is now more likely than not that the benefit
will not be realized. The need for this additional valuation allowance resulted
from changes in the projected recoverability of these deferred tax assets.
5. EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share are based on the weighted average number of
common shares outstanding during the year. Diluted earnings (loss) per share are
computed assuming that the weighted average number of common shares was
increased by the conversion of stock options issued to employees and members of
the Company's Board of Directors. The diluted per share amounts reflect a change
in the number of shares outstanding (the "denominator") to include the options
as if they were converted to shares and issued, unless their inclusion would be
anti-dilutive. During the nine months ended September 30, 2004, approximately
360,000 options were exercised for aggregate proceeds to the Company of $3.6
million. In the three and nine months ended September 30, 2004, 5.1 million and
4.0 million options, respectively, were excluded as they were anti-dilutive. In
the three and nine months ended September 30, 2003, 2.2 million and 1.7 million
options, respectively, were excluded as they were anti-dilutive. In each period
presented, the net income (loss) (the "numerator") is the same for both basic
and diluted per share computations.
The following table provides a reconciliation of the denominator for the basic
and diluted earning per share computations (in thousands):
12
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- --------------------
2004 2003 2004 2003
------ ------ ------ ------
Basic earnings per share:
Weighted average number of shares 28,586 27,810 28,558 27,664
Effect of dilutive securities:
Stock options - - - -
------ ------ ------ ------
Diluted earnings per share:
Adjusted weighted average number of shares
and assumed conversions 28,586 27,810 28,558 27,664
====== ====== ====== ======
6. 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 division, a product
development business, primarily the research and development business unit, and
a development services business, primarily the AAI Development Services business
unit. The product sales business is engaged in the marketing and sale of the
Company's pharmaceutical product lines. In the product development segment, the
Company internally develops drugs and technologies for future sales by the
product sales business or with the objective of licensing marketing rights to
third parties in exchange for license fees and royalties. The core services
provided by the development services business on a fee-for-service basis to
pharmaceutical and biotechnology industries worldwide include comprehensive
formulation, testing and manufacturing expertise, in addition to the ability to
take investigational products into and through human clinical trials. The
majority of the Company's non-U.S. operations are located in Germany.
Corporate income (loss) from operations includes general corporate overhead
costs which are not directly attributable to a business segment. Financial data
by segment and geographic region are as follows (in thousands):
13
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ----------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
NET REVENUES:
Product sales $ 15,684 $ 13,664 $ 61,898 $ 78,428
Product development 4,481 3,524 14,522 11,231
Development services 23,054 22,512 72,529 65,124
---------- ---------- ---------- ----------
$ 43,219 $ 39,700 $ 148,949 $ 154,783
========== ========== ========== ==========
United States $ 37,462 $ 34,783 $ 130,965 $ 140,453
Germany 5,738 5,007 18,220 15,550
Other 191 458 1,095 1,066
Less intercompany (172) (548) (1,331) (2,286)
---------- ---------- ---------- ----------
$ 43,219 $ 39,700 $ 148,949 $ 154,783
========== ========== ========== ==========
(LOSS) INCOME FROM OPERATIONS:
Product sales $ (4,926) $ (5,244) $ (4,932) $ 19,448
Product development 4,481 3,524 14,522 11,231
Development services (5,004) 1,718 (4,168) 2,351
---------- ---------- ---------- ----------
(5,449) (2) 5,422 33,030
Research and development (3,748) (5,464) (14,663) (15,748)
Corporate (10,266) (4,871) (29,939) (15,464)
---------- ---------- ---------- ----------
$ (19,463) $ (10,337) $ (39,180) $ 1,818
========== ========== ========== ==========
United States $ (19,800) $ (10,766) $ (40,949) $ 502
Germany 493 376 1,852 1,396
Other (156) 53 (83) (80)
---------- ---------- ---------- ----------
$ (19,463) $ (10,337) $ (39,180) $ 1,818
========== ========== ========== ==========
DEPRECIATION AND AMORTIZATION:
Product sales $ 4,240 $ 3,093 $ 12,629 $ 9,199
Development services 1,322 1,187 3,703 3,579
Product development 145 98 347 307
Corporate 632 503 1,641 1,568
---------- ---------- ---------- ----------
$ 6,339 $ 4,881 $ 18,320 $ 14,653
========== ========== ========== ==========
September 30, December 31,
------------- ------------
2004 2003
---------- ----------
TOTAL ASSETS:
Product sales $ 315,503 $ 424,452
Product development 12,750 13,062
Development services 58,936 55,791
Corporate 38,680 41,292
---------- ----------
$ 425,869 $ 534,597
========== ==========
United States $ 396,531 $ 504,574
Germany 27,553 28,243
Other 1,785 1,780
---------- ----------
$ 425,869 $ 534,597
========== ==========
GOODWILL, NET:
Development services $ 13,154 $ 13,361
========== ==========
7. TRANSACTIONS WITH RELATED PARTIES
The Company had revenue, accounts receivable and work-in-progress with Aesgen,
Inc. ("Aesgen") and Endeavor Pharmaceuticals, Inc. ("Endeavor"). Both Endeavor
and Aesgen were organized by aaiPharma Inc., its principal shareholders and
others. Aesgen was a related party until the third quarter of 2004, when MGI
14
Pharma, Inc. acquired all the outstanding equity of Aesgen, including the equity
owned by the Company, for cash. This resulted in a $0.5 million gain to the
Company and is recorded as other income on the income statement. Endeavor was a
related party until the fourth quarter of 2003, when Endeavor filed articles of
dissolution and made a liquidating distribution to its stockholders, including
the Company. No revenues were recognized from Aesgen for the three and nine
months ended September 30, 2004 and 2003, respectively. At September 30, 2004,
the Company had no accounts receivable or work-in-progress related to Aesgen.
Services performed by the Company for Aesgen were covered by a Subscription
Agreement, whereby the Company had agreed to receive Aesgen preferred stock in
lieu of cash for the services performed. In February 2002, the Company acquired
a calcitriol product from Aesgen, under an agreement which included potential
royalty payments. The Company launched its calcitriol product in March 2003;
however, no revenues or royalty expenses were recorded for this product during
the first quarter of 2003. Calcitriol is shipped to wholesalers and revenues are
recorded under the consignment model; therefore no revenue or expenses were
recognized until the product is shipped by those wholesalers. The Company
expensed royalties of $0.1 million and $0.3 million under that agreement in the
three and nine months ended September 30, 2004 and expensed $0.2 million and
$0.3 million in the three and nine months ended September 30, 2003. Revenues
recognized from Endeavor totaled $0.1 million and $0.7 million for the three and
nine months ended September 30, 2003. Certain services performed by the Company
for Endeavor were covered by a Securities Payment Agreement between the Company
and Endeavor, whereby the Company would receive Endeavor preferred stock in lieu
of cash for services performed.
8. ACCOUNTS RECEIVABLE, NET
The following table presents the components of accounts receivable (in
thousands):
September 30, December 31,
2004 2003
------------- ------------
Gross accounts receivable $ 33,359 $ 85,726
Allowance for uncollectible accounts (2,055) (1,130)
Allowance for customer credits (24,505) (51,982)
-------- ---------
Total accounts receivable, net $ 6,799 $ 32,614
======== =========
Accounts receivable are presented net of an allowance for uncollectible accounts
and net of an allowance for customer credits, including discounts, rebates,
chargebacks, product returns and other allowances. The decrease in the allowance
for customer credits is due to decreases in product returns reserves primarily
related to decreases in wholesaler inventory levels and chargeback reserves
related to the M.V.I. and Aquasol product lines, which were sold in April 2004.
15
9. INVENTORIES, NET
The following table presents the components of inventories (in thousands):
September 30, December 31,
2004 2003
------------- ------------
Finished goods $ 13,160 $ 18,579
Work-in-process 1,672 1,865
Raw materials and supplies 6,339 5,007
Inventory reserves (7,662) (10,758)
-------- --------
Inventories, net $ 13,509 $ 14,693
======== ========
The decrease in inventory reserves is primarily related to reserves for certain
consignment inventories, which have subsequently been disposed of, and reserves
for the M.V.I. and Aquasol product lines, which were sold in April 2004.
10. DEBT
The following table presents the components of current maturities of long-term
debt (in thousands):
September 30, December 31,
2004 2003
------------- ------------
Current maturities of long-term debt $ - $ 4,000
======= ==========
The following table presents the components of long-term debt (in thousands):
September 30, December 31,
2004 2003
------------- ------------
Term loan $ 135,000 $ 156,000
Revolving credit facility 12,500 8,000
11.5% senior subordinated notes due 2010, net of original issue discount 174,213 174,106
Interest rate swap monetization deferred income, net 1,987 12,189
Fair value of interest rate swap - (7,451)
Less current maturities of long-term debt - (4,000)
---------- ----------
Total long-term debt due after one year $ 323,700 $ 338,844
========== ==========
In March 2002, the Company issued $175 million of senior subordinated notes due
April 1, 2010. The proceeds from the issuance of these notes were $173.9
million, which was net of the original issue discount. This discount will be
charged to interest expense over the term of the notes. These notes initially
had 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. When issued, the notes were not
secured. Prior to the third anniversary of the date of issuance of the notes, up
to 35% of the notes are
16
redeemable with the proceeds of qualified sales of equity at 111% of par value.
On or after the fourth anniversary of the date of issuance of the notes, all or
any portion of the notes are redeemable at declining premiums to par value,
beginning at 105.5%.
Concurrently with the issuance of the senior subordinated notes, the Company
entered into an interest rate hedging agreement to effectively convert interest
expense on a portion of the senior subordinated notes for the term of the notes
from an 11% fixed annual rate to a floating annual rate equal to 6-month LIBOR
plus a base rate. In 2003, the Company sold the then outstanding interest rate
hedging agreement and replaced it with a similar interest rate hedging
agreement. In April 2004, the Company paid $9.4 million to terminate the
interest rate hedging agreement. The amounts received, less the termination
payment and the interest benefits earned through the dates of sale, have been
recorded as premiums to the carrying amount of the notes and are being amortized
into interest income over their remaining life.
On March 31, 2004, the lenders under the Company's then-existing credit
agreement, which was then in default, exercised their right to block the Company
from making the interest payment due on April 1, 2004 to holders of the
Company's senior subordinated notes. Accordingly, aaiPharma did not make that
interest payment on April 1, 2004. In addition, the Company's failure to timely
file its Annual Report on Form 10-K for the year ended December 31, 2003
constituted a default under the indenture governing the senior subordinated
notes.
On April 20, 2004, aaiPharma completed a solicitation seeking the consent from
holders of the Company's senior subordinated notes to approve a refinancing or
replacement of the Company's then-existing credit facilities with the Company's
senior credit facilities (described below) and certain amendments to, and
waivers under, the indenture governing the senior subordinated notes to, among
other things:
- - grant a lien to secure the Company's obligations under the senior
subordinated notes, which lien is junior to the liens securing the
Company's new senior credit facilities but covers the same collateral;
- - increase the interest rate of the senior subordinated notes from 11% per
annum to 11.5% per annum effective April 1, 2004;
- - suspend the Company's obligation under the indenture to file periodic
reports with the SEC until the earlier of the date that the Company's
2003 Form 10-K is filed with the SEC or September 30, 2004 and suspend
the Company's obligation to furnish annual written statements of the
Company's accountants until the fifth day after the earlier of the date
that the Company's 2003 Form 10-K is filed with the SEC and September 30,
2004;
- - further limit the Company's ability to grant liens to secure certain
obligations unless the liens are subordinate to the liens securing the
senior subordinated notes or are otherwise permitted under the indenture;
and
- - limit the Company's ability to incur up to $10 million of indebtedness,
and to grant liens to secure that amount of indebtedness, not otherwise
specifically permitted by the indenture, until the Company's 2003 Form
10-K is filed with the SEC or unless the indebtedness is incurred to fund
an interest payment with respect to the senior subordinated notes.
Following the completion of a consent solicitation, aaiPharma entered into a
supplemental indenture to effect these amendments and waivers and made the
interest payments that had been due on April 1, 2004, together with default
interest.
On October 1, 2004, the Company failed to make the interest payment then due on
its senior subordinated notes. The failure to make the October 1, 2004 interest
payment constituted a default under the notes, subject to a 30-day cure period.
On October 29, 2004, the Company made the interest payment, curing the default
under the notes.
17
On October 29, 2004, the Company completed a solicitation seeking the consent
from the holders of its senior subordinated notes to certain amendments to, and
waivers under, the indenture governing the senior subordinated notes to, among
other things:
- - permit the Company to incur up to $30 million of additional indebtedness
under credit facilities;
- - permit the Company to incur additional senior debt in order to maintain
$40 million (subject to an increase up to $50 million in order to allow
the Company to make interest payments on the senior subordinated notes) in
senior debt under credit facilities in the event the Company is required
to pay down senior debt with the proceeds of asset sales;
- - require that debt permitted to be incurred under a fixed charge coverage
ratio test set forth in the Indenture must rank on parity with or be
subordinated in right of payment to the senior subordinated notes and any
liens granted to secure any such parity debt shall rank pari passu with
the liens securing the senior subordinated notes;
- - require proceeds of asset sales to be used to reduce senior debt under
credit facilities to $40 million;
- - provide that the liens on assets that secure obligations under the senior
subordinated notes will continue if all senior debt is repaid, but will
resume as junior liens if the Company thereafter incurs any new senior
debt;
- - prohibit the payment in cash in excess of an aggregate of $5 million to
settle pending litigation, excluding payments funded or reimbursed under
insurance policies, until the Company makes the interest payments due on
the senior subordinated notes on April 1, 2005 and October 1, 2005;
- - prohibit the payment of dividends on the Company's common stock and other
restricted payments (as defined in the Indenture) until the interest
payments due on the senior subordinated notes on April 1, 2005 and October
1, 2005 are paid; and
- - temporarily increase the interest rate on the senior subordinated notes by
0.5% per annum (to 12% per annum), commencing to accrue on October 1, 2004
and ending on March 31, 2005.
The completion of the consent solicitation satisfied a condition of an amendment
to the Company's senior credit facilities (described below) that, among other
matters, made available a supplemental term loan under the senior credit
facilities. This supplemental term loan was used in part to make the October 1,
2004 interest payment on the senior subordinated notes, together with default
interest thereon, on October 29, 2004 and to pay a consent fee related to the
consent solicitation of $20 per $1,000 principal amount of the notes. The
interest payment made on October 29, 2004, cured the existing default under the
senior subordinated notes.
On April 23, 2004, aaiPharma entered into $140 million of senior credit
facilities with a syndicate of lenders, Silver Point Finance LLC ("Silver
Point") as collateral agent, and Bank of America, N.A., as administrative agent.
These senior credit facilities consisted of a two-year, $125 million senior
secured term loan facility (which was fully drawn at closing) and a two-year,
$15 million senior secured revolving credit facility, of which the entire amount
was available for borrowing at closing. The outstanding loans under the
Company's senior credit facilities were payable in full on the two-year
anniversary date of the closing of the facilities. The Company's senior credit
facilities are 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. As part of this transaction, the Company recorded
a $6.2 million loss for the early extinguishment of debt related to the
write-off of financing fees related to its previous senior credit facility.
Subject to exceptions set forth in the definitive documentation, loans under the
Company's senior credit facilities are also required to be prepaid with a
negotiated percentage of:
- - excess cash flow, as defined;
18
- - non-ordinary course assets sales;
- - net proceeds from the sale of subordinated indebtedness;
- - net proceeds from equity issuances; and
- - extraordinary receipts, as defined.
Optional reductions in revolving credit commitments and optional prepayments of
term loans were initially subject to a prepayment fee equal to 3% for the first
nine months of the term of the facilities, 1.5% for the subsequent nine months
of such term, and 0.75% for the next three months of such term (with no
prepayment penalty payable for the last three months of the term). Outstanding
loans under the facilities bore interest at a rate per annum equal to a defined
LIBOR rate (with a floor of 2%), plus 6.25%, or a defined reference rate (with a
floor of 4%), plus 5.25%, in each case payable monthly in arrears. An additional
1% per annum unused line fee is payable on unused revolving credit commitments,
payable quarterly in arrears.
The proceeds of the loans were used, together with the net cash proceeds from
the sale of the M.V.I. and Aquasol product lines, to (i) fund payment of
termination obligations with respect to the Company's interest rate hedging
agreement (discussed above), (ii) refinance the Company's then-existing senior
credit facility, (iii) fund the April 2004 interest payment due on the Company's
senior subordinated notes due 2010, (iv) provide for ongoing working capital and
general corporate needs, and (v) pay for fees, costs and expenses in connection
with the new senior credit facilities and other corporate transactions.
On August 9, 2004 and August 13, 2004, the Company entered into an amendment to
its senior secured credit facility to, among other things, increase the amount
of the term loans by up to $10 million, extend the maturity date of the
facilities by one year to April 21, 2007, increase the interest rate on the
loans by an additional 1.5% subject to potential incremental reduction based on
the Company's financial performance, adjust certain covenants under the
facilities and waive certain defaults and events of default. Under the amended
credit facility, the Company borrowed an additional $10 million in term loans on
August 13, 2004. The amendment adjusted both the percentages of proceeds of
certain transactions that are required to be applied to prepay the loans and the
fees to be paid upon optional reductions of the credit facility. As amended,
optional reductions in revolving credit commitments and optional prepayments of
term loans, as well as mandatory reductions in revolving credit commitments and
mandatory prepayments of term loans from the net cash proceeds of asset sales,
subject to defined exceptions, are subject to a prepayment fee equal to 3.5%
until August 9, 2005, 2.5% for the subsequent 12 months, and 1.5% for the next 6
months (with no prepayment penalty payable for the remainder of the term).
Effective as of October 8, 2004, the Company amended its senior secured credit
facility to, among other things, adjust financial covenants. The senior secured
lenders also waived compliance with certain financial covenants in the senior
secured credit facility for the quarter ended September 30, 2004 and the quarter
ending December 31, 2004 provided that the Company meets minimum consolidated
EBITDA thresholds (as defined in the senior secured credit facility). The
amendment also added a minimum gross revenue requirement of $40 million for the
quarter ending December 31, 2004 and consented to certain asset disposition
transactions and receipt of a deferred purchase price payment pursuant to which
the Company received approximately $4.2 million in the aggregate. These
transactions related to the sale of the Company's investment in Aesgen (see Note
7) and its M.V.I. and Aquasol product lines (see Note 3), respectively. The
amendment also waived any requirement to prepay the senior secured loans with
the net proceeds of these transactions.
On October 22, 2004, the Company entered into another amendment to its senior
secured credit facility that increased the existing term loan facility under the
senior secured credit facility by $30 million, subject to certain specified
conditions which were satisfied on October 29, 2004. The Supplemental Term Loan
was made available in up to three draws to be made on or prior to January 15,
2005, and the Company borrowed $20
19
million of such term loans on October 29, 2004. Following effectiveness of the
amendment, the senior secured credit facility consisted of a term loan of up to
$165 million and a revolving credit facility of up to $15 million.
The amendment also modified the interest rate on the entire senior secured
credit facility, including the Supplemental Term Loan, to equal a defined LIBOR
rate (with a floor of 2%) plus 8.25% per annum or a defined reference rate (with
a floor of 4%) plus 7.25% per annum. The amendment also provided for a
commitment fee equal to 0.75% per annum on any undrawn portion of the
Supplemental Term Loan, payable monthly in arrears.
The amendment retained the April 21, 2007 maturity date of the senior secured
credit facility and the optional and mandatory prepayment requirements and
premiums described above.
The proceeds of the loans under the Supplemental Term Loan were and may be used
(i) to fund payment of the October 1, 2004 interest payment due on the Company's
senior subordinated notes, (ii) to pay for fees, costs and expenses in
connection with the amendment and the October 2004 consent solicitation for the
Company's senior subordinated notes, and (iii) for working capital and other
general corporate purposes.
The amendment retained substantially the same representations, warranties and
affirmative and negative covenants as are provided in the existing senior
secured credit facility, including limitations on liens, indebtedness,
fundamental transactions, dispositions of assets, changes in the nature of the
Company's business, investments, acquisitions, capital and operating leases,
capital expenditures, dividends, redemptions or other acquisitions of capital
stock, redemptions or prepayments of other debt, transactions with affiliates,
issuances of capital stock, modifications of indebtedness, organizational
documents and other agreements, and retention of excess cash. The amendment also
added a covenant requiring the Company to retain Rothschild Inc. or another
financial advisor to assist with its exploration of the potential sale of some
or all of the assets comprising the Company's Pharmaceuticals Division.
The amendment also maintained the existing financial covenants under the senior
secured credit facilities, including a minimum fixed charge coverage ratio and a
maximum total debt to trailing twelve-month EBITDA leverage ratio, but
eliminated a minimum gross revenue covenant for the quarter ending December 31,
2004. Compliance with the fixed charge coverage ratio and the leverage ratio was
also waived through the first quarter of 2005 so long as defined minimum EBITDA
thresholds are satisfied. In addition, the amendment retained a covenant
requiring certain levels of cash or revolver availability and increased the
level of cash or revolver availability required for the period from March 31,
2005 through May 15, 2005 to $15.0 million. The amendment added a covenant
requiring the Company to retain Rothschild Inc. or another financial advisor to
assist with its exploration of the potential sale of some or all of the assets
of the Company's pharmaceutical division.
The amendment also substantially retained the existing events of default under
the senior secured credit facility, including, among others, nonpayment of
principal, interest or fees, violations of covenants, inaccuracy of
representations and warranties, a cross-default to the Company's senior
subordinated notes and other material indebtedness, bankruptcy events, and a
change in control and added an event of default if the Company fails to pursue
in good faith the exploration of the potential sale of some or all of the assets
comprising its Pharmaceutical Division or other non-core assets.
As of September 30, 2004, scheduled maturities of long-term debt for the years
ending December 31, 2004 through 2010 were as follows (in thousands):
20
2004 $ -
2005 -
2006 -
2007 147,500
2008 -
2009 -
2010 175,000
---------
Total $ 322,500
=========
11. RESTRUCTURING CHARGES
In June 2004, the Company announced and implemented a work force reduction
intended to rationalize its expense base in relation to its revenue. The Company
recorded a $3.4 million expense in the three months ended June 30, 2004,
representing severance costs and related employee-benefit expenses for those
affected by the reduction. In September 2004, the Company announced and
implemented a supplemental restructuring plan, which included an additional work
force reduction, separation payments to the former chief executive officer and a
facility closure plan. The Company recorded a $13.7 million expense in the three
months ended September 30, 2004, primarily representing severance costs and
related employee-benefit related expenses and costs for leased facilities and
aircraft which are no longer in use. The facilities included the Company's New
Jersey lab facility, along with smaller facilities in North Carolina and
California. These charges have been allocated to the related segments; $7.5
million to the development services business (including $6.1 million for the New
Jersey lab facility), $5.4 million to corporate operations, $0.4 million to
research and development and $0.4 million to the product sales business. The
liabilities are included in other current liabilities on the Company's
consolidated balance sheet.
The following table represents the components of the restructuring reserve (in
thousands):
June 30, Plus Less Sept. 30,
2004 Additional Payments/ 2004
Balance Charges Write-downs Balance
-------- ---------- ----------- ---------
Lease costs, net of estimated sub-lease income $ - $ 9,819 $ (314) $ 9,505
Severance costs 3,400 3,331 (1,563) 5,168
Other costs - 569 (569) -
-------- --------- ----------- ---------
Total $ 3,400 $ 13,719 $ (2,446) $ 14,673
======== ========= =========== =========
The Company is currently seeking to sub-lease all or a portion of these
facilities. In accordance with Statement of Financial Accounting Standard No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS
146"), the Company recorded facility closure costs at estimated fair value, net
of estimated sub-lease income.
12. INTANGIBLE ASSET IMPAIRMENT
As a result of the introduction of generic competition for our Brethine product,
which resulted in a significant decrease in projected product sales during the
third quarter of 2004, the Company performed a discounted cash flow analysis of
the carrying value of the intangible assets associated with the product line.
The Company determined that the intangible assets were impaired and recorded an
impairment charge of $5.3 million.
21
13. COMMITMENTS AND CONTINGENCIES
The Company may have to make contingent payments of $4.7 million over three
years in connection with the purchase of its Charleston, South Carolina
manufacturing facility, based on the level of manufacturing revenues at this
facility. At September 30, 2004, these contingent payment obligations are not
liabilities and have not been recorded on the Company's consolidated balance
sheet.
The Company made interest payments on the senior subordinated notes of $9.7
million in April 2004, and $10.2 million in October 2004 (see notes 2 and 10 for
additional information on this payment) and payments of $10.5 million and $10.1
million will be due on April 1 and October 1, 2005, respectively.
For additional information about other contingencies to which the Company is
subject, including litigation and governmental investigations, see Part II, Item
1, "Legal Proceedings," below, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital
Resources-Commitments and Contingencies" in the Company's 2003 Form 10-K.
14. FINANCIAL INFORMATION FOR SUBSIDIARY GUARANTORS AND NON-GUARANTORS
The Company's senior subordinated notes, due April 1, 2010, are guaranteed by
certain of the Company's subsidiaries.
The following presents condensed consolidating financial information for the
Company, segregating: (1) aaiPharma Inc., which issued the notes (the "Issuer");
(2) the domestic subsidiaries, which guarantee the notes (the "Guarantor
Subsidiaries"); and (3) all other subsidiaries (the "Non-Guarantor
Subsidiaries"). The Guarantor Subsidiaries are wholly-owned direct subsidiaries
of the Company and their guarantees are full, unconditional and joint and
several. Wholly-owned subsidiaries are presented on the equity basis of
accounting. Certain reclassifications have been made to conform all of the
financial information to the financial presentation on a consolidated basis. The
principal adjusting entries eliminate investments in subsidiaries and
inter-company balances and transactions.
The following information presents consolidating statements of operations,
balance sheets and cash flows for the periods and as of the dates indicated:
22
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF OPERATIONS
(IN THOUSANDS)
Three Months Ended September 30, 2004
------------------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------- ------------ ------------
Net revenues $ 11,094 $ 26,367 $ 5,929 $ (171) $ 43,219
Equity earnings from subsidiaries (10,643) - - 10,643 -
--------- ---------- ------- ---------- ------------
Total revenues 451 26,367 5,929 10,472 43,219
--------- ---------- ------- ---------- ------------
Operating costs and expenses:
Direct costs 6,240 13,441 3,595 (123) 23,153
Selling 1,563 3,924 534 - 6,021
General and administrative 6,505 1,815 1,159 - 9,479
Research and development (1) 3,135 - - 3,134
Depreciation 1,541 522 304 - 2,367
Professional fees - internal inquiry - 769 - - 769
M.V.I. Contingent payment/(gain on
sale) - (1,567) - - (1,567)
Restructuring charges - 13,719 - - 13,719
Royalty expense - 357 - - 357
Intangible asset impairment - 5,250 - - 5,250
--------- ---------- ------- ---------- ------------
15,848 41,365 5,592 (123) 62,682
--------- ---------- ------- ---------- ------------
(Loss) income from operations (15,397) (14,998) 337 10,595 (19,463)
Other income (expense):
Interest, net (192) (9,355) 78 - (9,469)
Net intercompany interest (513) 593 (80) - -
Other expense, net (13,253) 13,067 (89) - (275)
--------- ---------- ------- ---------- ------------
(13,958) 4,305 (91) - (9,744)
--------- ---------- ------- ---------- ------------
(Loss) income before income taxes (29,355) (10,693) 246 10,595 (29,207)
Provision for income taxes 4,435 147 1 - 4,583
--------- ---------- ------- ---------- ------------
Net (loss) income $ (33,790) $ (10,840) $ 245 $ 10,595 $ (33,790)
========= ========== ======= ========== ============
23
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF OPERATIONS
(IN THOUSANDS)
Three Months Ended September 30, 2003
---------------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
---------- ------------ ------------- ------------ ------------
Net revenues $ 11,134 $ 23,649 $ 5,465 $ (548) $ 39,700
Equity earnings from subsidiaries (9,598) - - 9,598 -
---------- ---------- ---------- ---------- ----------
Total revenues 1,536 23,649 5,465 9,050 39,700
Operating costs and expenses:
Direct costs 6,478 14,255 3,294 (458) 23,569
Selling 1,557 7,039 475 - 9,071
General and administrative 6,870 1,939 984 - 9,793
Research and development - 5,367 - - 5,367
Depreciation 1,321 310 281 - 1,912
Royalty expense - 325 - - 325
---------- ---------- ---------- ---------- ----------
16,226 29,235 5,034 (458) 50,037
---------- ---------- ---------- ---------- ----------
(Loss) income from operations (14,690) (5,586) 431 9,508 (10,337)
Other income (expense):
Interest, net (395) (4,874) 129 - (5,140)
Net intercompany interest (497) 538 (41) - -
Other income (expense), net (15) 19 (126) - (122)
---------- ---------- ---------- ---------- ----------
(907) (4,317) (38) - (5,262)
---------- ---------- ---------- ---------- ----------
(Loss) income before income taxes (15,597) (9,903) 393 9,508 (15,599)
Benefit from income taxes (6,205) (1) (1) - (6,207)
---------- ---------- ---------- ---------- ----------
Net (loss) income $ (9,392) $ (9,902) $ 394 $ 9,508 $ (9,392)
========== ========== ========== ========== ==========
24
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF OPERATIONS
(IN THOUSANDS)
Nine Months Ended September 30, 2004
----------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------- ------------ ------------
Net revenues $ 35,152 $ 95,812 $ 19,315 $ (1,330) $ 148,949
Equity earnings from subsidiaries
(23,016) - - 23,016 -
--------- --------- -------- --------- ---------
Total revenues 12,136 95,812 19,315 21,686 148,949
--------- --------- -------- --------- ---------
Operating costs and expenses:
Direct costs (excluding depreciation) 21,953 45,043 11,573 (827) 77,742
Selling 5,098 23,226 1,798 - 30,122
General and administrative 32,582 (548) 3,285 - 35,319
Research and development 5 13,842 - - 13,847
Depreciation 4,165 1,349 890 - 6,404
Professional fees - internal inquiry - 9,072 - - 9,072
M.V.I. Contingent payment/(gain on sale) - (8,112) - - (8,112)
Restructuring charges - 17,119 - - 17,119
Royalty expense - 1,366 - - 1,366
Intangible asset impairment - 5,250 - - 5,250
--------- --------- -------- --------- ---------
63,803 107,607 17,546 (827) 188,129
--------- --------- -------- --------- ---------
(Loss) income from operations (51,667) (11,795) 1,769 22,513 (39,180)
Other expense:
Interest, net (209) (23,838) 181 - (23,866)
Net intercompany interest (1,470) 1,657 (187) - -
Other (expense) income, net (18,327) 10,259 (272) - (8,340)
--------- --------- -------- --------- ---------
(20,006) (11,922) (278) - (32,206)
--------- --------- -------- --------- ---------
(Loss) income before income taxes (71,673) (23,717) 1,491 22,513 (71,386)
Provision for (benefit from) income taxes 4,471 288 (1) - 4,758
--------- --------- -------- --------- ---------
Net (loss) income $ (76,144) $ (24,005) $ 1,492 $ 22,513 $ (76,144)
========= ========= ======== ========= =========
25
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF OPERATIONS
(IN THOUSANDS)
Nine Months Ended September 30, 2003
-------------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
-------- ------------ ------------- ------------ ------------
Net revenues $ 33,395 $ 107,059 $ 16,615 $ (2,286) $ 154,783
Equity earnings from subsidiaries 6,353 - - (6,353) -
-------- ------------ ------------- ------------ ------------
Total revenues 39,748 107,059 16,615 (8,639) 154,783
-------- ------------ ------------- ------------ ------------
Operating costs and expenses:
Direct costs (excluding depreciation) 19,527 47,675 9,886 (1,881) 75,207
Selling 4,503 18,907 1,596 - 25,006
General and administrative 22,681 5,445 2,986 - 31,112
Research and development - 15,441 - - 15,441
Depreciation 4,022 895 830 - 5,747
Royalty expense - 452 - - 452
-------- ------------ ------------- ------------ ------------
50,733 88,815 15,298 (1,881) 152,965
-------- ------------ ------------- ------------ ------------
(Loss) income from operations (10,985) 18,244 1,317 (6,758) 1,818
Other expense:
Interest, net (1,439) (14,314) 132 - (15,621)
Net intercompany interest (1,533) 1,661 (128) - -
Other income (expense), net 145 34 (158) - 21
-------- ------------ ------------- ------------ ------------
(2,827) (12,619) (154) - (15,600)
-------- ------------ ------------- ------------ ------------
(Loss) income before income taxes (13,812) 5,625 1,163 (6,758) (13,782)
(Benefit from) provision for income taxes (5,444) 31 (1) - (5,414)
-------- ------------ ------------- ------------ ------------
Net (loss) income $ (8,368) $ 5,594 $ 1,164 $ (6,758) $ (8,368)
======== ============ ============= ============ ============
26
AAIPHARMA INC.
CONSOLIDATING BALANCE SHEET
(IN THOUSANDS)
September 30, 2004
--------------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 6,323 $ 305 $ 515 $ - $ 7,143
Accounts receivable, net 11,904 (8,424) 3,319 - 6,799
Work-in-progress 2,617 5,137 8,571 (5,046) 11,279
Inventories 4,905 7,412 1,192 - 13,509
Deferred tax assets 10,456 - - - 10,456
Prepaid and other current assets 2,818 7,293 224 - 10,335
--------- --------- -------- -------- --------
Total current assets 39,023 11,723 13,821 (5,046) 59,521
Investments in and advances to subsidiaries 66,099 (46,240) - (19,859) -
Property and equipment, net 37,681 14,240 4,205 - 56,126
Goodwill, net 726 1,229 11,199 - 13,154
Intangibles, net 1,294 281,549 - - 282,843
Other assets 232 13,880 113 - 14,225
--------- --------- -------- -------- --------
Total assets $ 145,055 $ 276,381 $ 29,338 $(24,905) $425,869
========= ========= ======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ - $ - $ - $ - $ -
Accounts payable 6,495 14,069 951 - 21,515
Customer advances 4,048 7,161 5,936 (3,370) 13,775
Accrued wages and benefits 3,344 1,578 1,918 - 6,840
Interest payable 93 10,178 - - 10,271
Deferred product revenue - 10,632 - - 10,632
Other accrued liabilities 17,833 21,079 (408) (980) 37,524
--------- --------- -------- -------- --------
Total current liabilities 31,813 64,697 8,397 (4,350) 100,557
Long-term debt, less current portion 12,500 311,200 - - 323,700
Deferred tax liability - - - - -
Other liabilities 18 - - - 18
Investments in and advances to subsidiaries 152,430 (157,044) 3,995 619 -
Total stockholders' equity (51,706) 57,528 16,946 (21,174) 1,594
--------- --------- -------- -------- --------
Total liabilities and stockholders' equity $ 145,055 $ 276,381 $ 29,338 $(24,905) $425,869
========= ========= ======== ======== ========
27
AAIPHARMA INC.
CONSOLIDATING BALANCE SHEET
(IN THOUSANDS)
December 31, 2003
--------------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 8,161 $ 192 $ 432 $ - $ 8,785
Accounts receivable, net 11,242 16,785 4,587 - 32,614
Work-in-progress 3,688 5,337 7,793 (4,315) 12,503
Inventories 4,588 8,909 1,196 - 14,693
Deferred tax assets 19,184 - - - 19,184
Prepaid and other current assets 1,872 8,304 222 - 10,398
--------- --------- --------- --------- ---------
Total current assets 48,735 39,527 14,230 (4,315) 98,177
Investments in and advances to subsidiaries 66,061 (46,202) - (19,859) -
Property and equipment, net 39,011 13,954 4,271 - 57,236
Goodwill, net 725 1,229 11,407 - 13,361
Intangibles, net 1,209 350,106 - - 351,315
Other assets 2,419 11,974 115 - 14,508
--------- --------- --------- --------- ---------
Total assets $ 158,160 $ 370,588 $ 30,023 $ (24,174) $ 534,597
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ - $ 4,000 $ - $ - $ 4,000
Accounts payable 5,082 14,292 2,505 - 21,879
Customer advances 6,441 8,101 4,807 (1,719) 17,630
Accrued wages and benefits 2,575 1,517 1,228 - 5,320
Interest payable 7 5,504 - - 5,511
Deferred product revenue - 45,664 - - 45,664
Other accrued liabilities 8,640 4,332 (448) (1,391) 11,133
--------- --------- --------- --------- ---------
Total current liabilities 22,745 83,410 8,092 (3,110) 111,137
Long-term debt, less current portion 8,000 330,844 - - 338,844
Deferred tax liability 2,246 - - - 2,246
Other liabilities 196 7,451 - - 7,647
Investments in and advances to subsidiaries 127,232 (133,051) 6,212 (393) -
Total stockholders' equity (2,259) 81,934 15,719 (20,671) 74,723
--------- --------- --------- --------- ---------
Total liabilities and stockholders' equity $ 158,160 $ 370,588 $ 30,023 $ (24,174) $ 534,597
========= ========= ========= ========= =========
28
]
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF CASH FLOWS
(IN THOUSANDS)
Nine Months Ended September 30, 2004
------------------------------------------------------------------
Non-
Guarantor Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------ ------------ ------------
Cash flows from operating activities:
Net (loss) income $ (76,144) $ (24,005) $ 1,492 $ 22,513 $ (76,144)
Adjustments to reconcile net (loss) income
to net cash (used in) provided by operating activities:
Depreciation and amortization 3,917 13,513 890 - 18,320
Intangible asset impairment, net of tax - 5,250 - - 5,250
Write-off of deferred financing and other costs - 6,229 - - 6,229
Net gain from asset sale - (39,113) - - (39,113)
Other 7 12 218 - 237
Changes in operating assets and liabilities:
Accounts receivable, net (662) 25,209 1,184 - 25,731
Work-in-progress 1,071 200 (920) 732 1,083
Inventories (317) (1,490) (17) - (1,824)
Deferred tax assets 8,728 - - - 8,728
Prepaid and other assets 1,242 (7,125) (6) - (5,889)
Accounts payable 1,412 (222) (1,508) - (318)
Customer advances (2,392) (940) 1,215 (1,651) (3,768)
Interest payable 86 4,674 - - 4,760
Deferred product revenue - (35,032) - - (35,032)
Accrued wages & benefits & other accrued liabilities 7,540 17,257 859 411 26,067
Intercompany receivables and payables 48,215 (23,993) (2,217) (22,005) -
--------- --------- --------- --------- ---------
Net cash (used in) provided by operating activities (7,297) (59,576) 1,190 - (65,683)
--------- --------- --------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment (2,491) (1,886) (1,098) - (5,475)
Proceeds from sales of property and equipment 9 88 - - 97
Product line disposals (acquisitions) - 92,944 - - 92,944
Other (237) 38 - - (199)
--------- --------- --------- --------- ---------
Net cash (used in) provided by investing activities (2,719) 91,184 (1,098) - 87,367
--------- --------- --------- --------- ---------
Cash flows from financing activities:
Proceeds from long-term borrowings 12,500 135,000 - - 147,500
Payments on long-term borrowings (8,000) (156,000) - - (164,000)
Proceeds from interest rate swaps, net - (10,203) - - (10,203)
Proceeds from stock option exercises 3,678 - - - 3,678
Other - (292) - - (292)
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing activities 8,178 (31,495) - - (23,317)
--------- --------- --------- --------- ---------
Net (decrease) increase in cash and cash equivalents (1,838) 113 92 - (1,633)
Effect of exchange rate changes on cash - - (9) - (9)
Cash and cash equivalents, beginning of period 8,161 192 432 - 8,785
--------- --------- --------- --------- ---------
Cash and cash equivalents, end of period $ 6,323 $ 305 $ 515 $ - $ 7,143
========= ========= ========= ========= =========
29
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF CASH FLOWS
(IN THOUSANDS)
Nine Months Ended September 30, 2003
----------------------------------------------------------------------
Non-
Guarantor Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------ ------------ ------------
Cash flows from operating activities:
Net (loss) income $ (8,368) $ 5,594 $ 1,164 $ (6,758) $ (8,368)
Adjustments to reconcile net (loss) income
to net cash provided by operating activities:
Depreciation and amortization 3,675 10,149 829 - 14,653
Other (65) (4) 207 - 138
Changes in operating assets and liabilities:
Accounts receivable, net 1,378 (2,321) (627) - (1,570)
Work-in-progress (226) (2,654) (2,764) 1,124 (4,520)
Inventories 1,364 (1,143) - (311) (90)
Deferred tax assets - - - - -
Prepaid and other assets (103) 481 (105) - 273
Accounts payable (836) (435) (149) - (1,420)
Customer advances (287) 2,252 1,252 941 4,158
Interest payable (265) 4,831 - - 4,566
Deferred revenue - 45,198 - - 45,198
Accrued wages & benefits & other accrued liabilities (10,869) 3,959 (142) (2,028) (9,080)
Intercompany receivables and payables 37,045 (44,993) 916 7,032 -
--------- --------- --------- --------- ---------
Net cash provided by operating activities 22,443 20,914 581 - 43,938
--------- --------- --------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment (1,264) (7,813) (790) - (9,867)
Proceeds from sales of property and equipment 390 118 - - 508
Acquisitions of product rights and other intangibles - (6,050) - - (6,050)
Other (334) - - - (334)
--------- --------- --------- --------- ---------
Net cash used in investing activities (1,208) (13,745) (790) - (15,743)
--------- --------- --------- --------- ---------
Cash flows from financing activities:
Payments on long-term borrowings (19,500) (10,000) - - (29,500)
Proceeds from interest rate swaps, net - 2,191 - - 2,191
Proceeds from stock option exercises 2,819 - - - 2,819
Other - 805 - - 805
--------- --------- --------- --------- ---------
Net cash used in financing activities (16,681) (7,004) - - (23,685)
--------- --------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents 4,554 165 (209) - 4,510
Effect of exchange rate changes on cash - - 68 - 68
Cash and cash equivalents, beginning of period 5,725 180 627 - 6,532
--------- --------- --------- --------- ---------
Cash and cash equivalents, end of period $ 10,279 $ 345 $ 486 $ - $ 11,110
========= ========= ========= ========= =========
30
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 and product development services, the amount and timing of product
returns, ability of contract manufacturers to supply conforming products on a
timely basis, costs and results of ongoing and future litigation by and against
us, contractual disputes with customers, 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, changes
in the mix of products and services, restructuring charges, intangible asset
impairments and debt refinancing costs. Because a large percentage of our
development services operating costs are relatively fixed, variations in the
timing and progress of large contracts, changes in the demand for our services
and products, or the recognition of licensing and royalty revenues (on projects
for which associated expenses 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. There have
been no significant changes in our critical accounting policies previously
disclosed in our Annual Report on Form 10-K for the year ended December 31, 2003
(the "2003 Form 10-K").
SUMMARY
Liquidity continued to be a focus of management attention during the third
quarter of 2004. In addition to meeting working capital requirements, we also
faced a $10.1 million subordinated note interest payment due October 1, 2004. In
the third quarter of 2004, we amended our senior credit facilities and
implemented a reduction-in-force and facility closing plan. These efforts, and
further amendments to our senior credit facilities in October 2004, were
intended to stabilize our liquidity and cash flow position. We amended our
senior credit facilities to allow for an additional $10 million of borrowing
capacity in the third quarter. Although we expended significant efforts to
address liquidity needs during the third quarter of 2004, additional financing
was required in October 2004 to make our subordinated note interest payment,
which was paid on October 29, 2004, and to provide additional working capital.
In September 2004, we announced and implemented a supplemental restructuring
plan and recorded a $13.7 million expense in the third quarter of 2004,
primarily representing severance costs and related employee-benefit related
expenses, separation payments to our former chief executive officer and costs
for leased facilities and aircraft which are no longer in use. These charges
have been allocated to the related segment; $7.5 million to the development
services business, $5.4 million to corporate operations, $0.4 million to
research and development and $0.4 million to the product sales business. This
additional restructuring is consistent with our previously disclosed intentions
to rationalize our expense base in relation to our revenue.
In the third quarter, we recorded net revenues of $43.2 million and a loss per
share of $1.18. Several events occurred in the quarter which had a material
impact on our financial results. We recorded a $13.7 million restructuring
charge related to the additional work force reduction and facility closure plan
and a $5.3 million impairment charge for an intangible asset associated with our
Brethine product.
Operating results for our pharmaceutical business continued to be affected by
the amount of inventory previously sold into the wholesale channel. This
situation was further aggravated, we believe, as wholesalers limited their
purchases to minimize any exposure that could result from our liquidity
31
position. We recognized $15.7 million in pharmaceutical product revenues in the
third quarter. Of the $15.7 million in pharmaceutical product revenues, we
recognized $1.3 million in revenues recorded under the consignment method. For
these revenues, we had received cash for the products from the wholesalers,
principally in late 2003 or in the first quarter of 2004. Our revenues from
sales to wholesalers in the quarter were significantly reduced from prior
periods due to the levels of Brethine and Darvon/Darvocet products on hand at
wholesalers at the beginning of the quarter. During the first nine months of
2004, we reduced the aggregate amount of units of our products at the
wholesalers and chain pharmacies by approximately 74%. This inventory comparison
excludes M.V.I. and Aquasol product (which we sold in April 2004) at all
relevant times. The introduction of generic competition to our Brethine
injectable and Roxicodone products also had a negative impact on sales.
Our Development Services Division recorded $23.1 million in net sales during the
quarter. We continue to experience strong demand for Phase I services in both
the United States and Europe, as well as for analytical services. The
Development Services Division was able to dedicate more capacity to outside
clients during the quarter due to reduced utilization of resources on internally
driven Research and Development projects. The gross margin dollar contribution
from the Development Services Division in the third quarter of 2004 was higher
than the third quarter of 2003 due to increased clinical and analytical
contributions, partially offset by lower gross margins from our manufacturing
facility in Charleston. The manufacturing capacity for the Charleston facility
was planned to cover the manufacturing needs of our Brethine injectable product.
The introduction of a generic competitor eliminated the near-term need for
manufacturing additional Brethine injectable products and created for us an
excess in sterile manufacturing capacity which we were not able to sell to third
parties in the quarter. The gross margin provided by the non-manufacturing
services of the Development Services Division increased 2% percentage points in
the third quarter of 2004 when compared to the third quarter of 2003.
During the third quarter, we continued to advance our near-term pipeline.
Progress has been made on our Darvon/Darvocet extended release program, Lynxorb
(ProSorb-technology enhanced diclofenac, which we have previously publicly
referred to as ProSorb-D), a novel ulcerative colitis product and our proton
pump inhibitor development program. We continue to use the significant
scientific capabilities that our Company has developed over the past 24 years to
serve as the platform to develop and monetize enhancements to existing products.
In addition, we continued to train and deploy our pharmaceutical sales force,
while focusing our marketing efforts into the institutional settings and pain
clinics. We recorded $3.1 million in research and development expenses during
the quarter. We expect to file a NDA on Lynxorb in 2005.
We are exploring the potential sale of some or all of the assets comprising our
Pharmaceuticals Division, as well as other assets that are no longer strategic
to our long-term business plan. We have engaged Rothschild Inc. to assist us in
evaluating these potential asset divestitures.
RESULTS OF OPERATIONS
The following table presents the net revenues for each of our business units and
our consolidated expenses and net loss income for the three and nine months
ended September 30, 2004 and 2003, with each item expressed as a percentage of
consolidated net revenues:
32
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------- --------------------------------------
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
(dollars in thousands)
Net revenues:
Product sales $ 15,684 36% $ 13,664 34% $ 61,898 42% $ 78,428 51%
Product development 4,481 10% 3,524 9% 14,522 10% 11,231 7%
Development services 23,054 54% 22,512 57% 72,529 48% 65,124 42%
-------- --- -------- --- --------- --- --------- ----
$ 43,219 100% $ 39,700 100% $ 148,949 100% $ 154,783 100%
======== === ======== === ========= === ========= ====
Direct costs (excluding depreciation
and royalty expense) $ 23,153 54% $ 23,569 59% $ 77,742 52% $ 75,207 49%
Selling 6,021 14 9,071 23 30,122 20 25,006 16
General and administrative 9,479 22 9,793 25 35,319 24 31,112 20
Research and development 3,134 7 5,367 14 13,847 9 15,441 10
Depreciation 2,367 5 1,912 5 6,404 4 5,747 4
Professional fees - internal inquiry 769 2 - - 9,072 6 - -
M.V.I. contingent payment/(gain on sale) (1,567) (4) - - (8,112) (5) - -
Restructuring charges 13,719 32 - - 17,119 11 - -
Royalty expense 357 1 325 1 1,366 1 452 -
Intangible asset impairment 5,250 12 - - 5,250 4 - -
(Loss) income from operations (19,463) (45) (10,337) (26) (39,180) (26) 1,818 1
Interest expense, net (9,469) (22) (5,140) (13) (23,866) (16) (15,621) (10)
Loss from extinguishment of debt - - - - (6,229) (4) - -
Other (expense) income, net (275) (1) (122) - (2,111) (1) 21 -
Provision for (benefit from) income taxes 4,583 11 (6,207) (16) 4,758 3 (5,414) (3)
Net loss (33,790) (78) (9,392) (24) (76,144) (51) (8,368) (5)
As is customary in the pharmaceutical industry, we accept returns of products we
have sold as the products near their expiration date. At the time we recognize
revenue from product sales, we record an adjustment, or decrease, to revenue for
estimated chargebacks, rebates, discounts and returns. The following table sets
forth our gross revenues and the amount of dilution to revenues resulting from
allowances for customer credits, including discounts, rebates, chargebacks,
product returns and other allowances.
Three Months Ended Nine Months Ended
September 30, September 30,
----------------- -------------------
2004 2003 2004 2003
------- ------- -------- --------
(dollars in thousands)
Gross revenues $53,938 $54,502 $191,722 $219,536
Allowance for customer credits 10,719 14,802 42,773 64,753
------- ------- -------- --------
Net revenues $43,219 $39,700 $148,949 $154,783
======= ======= ======== ========
THIRD QUARTER 2004 COMPARED TO THIRD QUARTER 2003
Our consolidated net revenues for the quarter ended September 30, 2004 increased
9% to $43.2 million, from $39.7 million in the third quarter of 2003. Net
revenues from product sales increased in 2004, to
33
$15.7 million, from $13.7 million in 2003. The increase resulted from
contributions from our Roxicodone and Oramorph product lines, acquired in
December 2003, which was partially offset by decreased sales volumes in our
Darvon/Darvocet and Brethine product lines, as discussed above, as well as the
divestiture of our M.V.I. and Aquasol product lines in April 2004. The
introduction of generic versions of our Brethine product in the first six months
of 2004 also caused erosion in the demand and price for this product. Our net
revenues for the quarter ended September 30, 2004 included non-cash product
sales of $1.7 million, which included $1.3 million recognized under the
consignment sales method.
Net revenues from product development increased 27% in the third quarter of 2004
to $4.5 million, or 10% of net revenues, from $3.5 million, or 9% of net
revenues, in the 2003 period, primarily due to product development revenues
under our significant development agreement. This development agreement is
described in the "Management's Discussion and Analysis of Financial Condition
and Results of Operations" section of our 2003 Form 10-K. We expect product
development revenues under this agreement to be approximately $17 million in
2004. We received payment associated with this revenue during the quarter ended
June 30, 2004.
Net revenues from our development services business increased 2% in the third
quarter of 2004 to $23.1 million, from $22.5 million in 2003. The increase was
principally attributable to higher demand for our Phase I clinical capabilities
in both the United States and Europe, as well as for analytical services,
partially offset by lower fee-for-service revenues under our significant
development agreement.
Direct costs (excluding depreciation and royalty expense) decreased $0.4
million, or 2%, to $23.2 million in the third quarter of 2004 from $23.6 million
in the same period in 2003. This decrease in direct costs resulted from lower
product costs related to the revenue mix towards lower cost products, partially
offset by an increase in direct costs of our development services division,
primarily in our manufacturing capabilities, and an increase in amortization
expense related to product rights for products we acquired in December 2003.
Direct costs as a percentage of net revenues were 54% in the third quarter of
2004 as compared to 59% in the third quarter of 2003.
Selling expenses decreased 34% in the third quarter of 2004 to $6.0 million, or
14% of net revenues, from $9.1 million, or 23% of net revenues, in 2003. This
decrease is primarily due to decreased personnel costs as a result of a
workforce reduction implemented in the second quarter of 2004, as well as
significant cutbacks in promotional plans due to certain decreased product sales
levels in 2004.
General and administrative costs decreased $0.3 million in the third quarter of
2004 to $9.5 million, or 22% of net revenues, from $9.8 million, or 25% of net
revenues, in 2003. This decrease was primarily due to costs savings from lower
personnel costs as a result of the work force reduction implemented in the
second quarter of 2004, partially offset by additional product liability
insurance expense for the products we acquired in December 2003.
Research and development expenses were $3.1 million, or 7% of net revenues, in
the third quarter of 2004, compared to $5.4 million, or 14% of net revenues, in
2003. In the third quarter of 2004, significant project spending was related to
our Lynxorb pain management product and our proton pump inhibitor development
program.
34
In the third quarter of 2004, we recorded $0.8 million of legal, financial and
consulting professional fees associated with the investigation conducted by the
Special Committee.
In April 2004, we sold our M.V.I. and Aquasol product lines to Mayne Pharma
(USA) Inc. for $105 million, subject to adjustments based on inventory levels at
closing and other post-closing obligations. A portion of the closing payment is
held in escrow to satisfy post-closing obligations under the agreement. In
September 2004, we received a cash distribution of $1.6 million related to a
reduction in these post-closing obligations. This was recorded as a gain in the
third quarter of 2004. We expect to receive a final distribution of $0.2 million
in the fourth quarter of 2004.
In September 2004, we announced and implemented a supplemental restructuring
plan, which included an additional work force reduction and a facility closure
plan. We recorded a $13.7 million expense in the three months ended September
30, 2004, primarily representing severance costs and related employee-benefit
related expenses of $1.5 million, separation payments of $1.9 million to our
former chief executive officer and costs of $10.3 million for leased facilities
which are no longer in use. These leased facilities include our New Jersey lab
facility, smaller facilities in North Carolina and California, and aircraft
leased by us. We are currently seeking to sub-lease these facilities, and have
entered a short-term sublease for one aircraft and the California facility.
Royalty expenses for the third quarter of 2004 were $0.4 million. We accrue
royalties based on revenues generated by certain acquired products. Royalty
expenses were $0.3 million for the same period in 2003.
In September 2004, we recorded a $5.3 million charge due to the impairment of an
intangible asset associated with our acquired Brethine product. The introduction
of generic competition affected our future anticipated revenues, which
negatively impacted the carrying value of the acquired intangible assets.
Our consolidated loss from operations was $19.5 million in the third quarter of
2004, as compared to a loss from operations of $10.3 million in the third
quarter of 2003. This change is primarily attributable to the third quarter
restructuring expense and intangible asset impairment charge, partially offset
by the higher revenues and lower selling expenses discussed above.
The loss from operations for our product sales business was $4.9 million in the
third quarter of 2004, compared to $5.2 million in the third quarter of 2003.
This change is attributable to the increased product revenues, the gain on the
sale of our M.V.I. and Aquasol product lines and the decreased selling expenses,
as discussed above, partially offset by the intangible asset impairment charge
taken in the third quarter of 2004.
Income from operations for our product development business was $4.5 million in
the third quarter of 2004, compared to $3.5 million in 2003. This change
resulted from the increased revenues from our significant development agreement,
as discussed above.
The loss from operations for our development services business was $5.0 million
in the third quarter of 2004, compared to income from operations of $1.7 million
in the third quarter of 2003. This change is
35
primarily due to the restructuring charges related to work-force reductions and
facility closures recorded in the third quarter of 2004, as discussed above.
Unallocated corporate expenses increased in the third quarter of 2004 to $10.3
million, from $4.9 million in 2003. This increase is primarily related to
severance costs related to the work-force reduction, separation payments to our
former chief executive officer and facility closure expenses recorded in the
third quarter of 2004.
Net interest expense increased to $9.5 million in the third quarter of 2004 from
$5.1 million in 2003 due to charges related to the refinancing of our senior
credit facility. See "Liquidity and Capital Resources" for additional
information on subsequent changes to our debt.
Tax expense of $4.6 million was recorded for the third quarter of 2004. We
currently believe that it is more likely than not that any deferred tax assets
generated during 2004 will not be utilized; therefore no tax benefit was
recorded. Included in this tax expense is an additional valuation allowance of
$4.4 million for previously unreserved deferred tax assets for which it is now
more likely than not that the benefit will not be realized. The need for this
additional valuation allowance resulted from changes in the projected
recoverability of these deferred tax assets. Our effective tax rate for the
third quarter of 2004 was 16%. Our effective tax rate for the third quarter of
2003 was 40%.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
Our consolidated net revenues for the nine months ended September 30, 2004,
decreased 4% to $148.9 million, from $154.8 million in the same period of 2003.
Net revenues from product sales decreased in 2004, to $61.9 million, from $78.4
million in 2003. The decrease resulted from decreased sales volumes in our
Darvon/Darvocet and Brethine product lines, as discussed above, as well as the
divestiture of our M.V.I. and Aquasol product lines in the second quarter of
2004, which was partially offset by contributions from our Roxicodone and
Oramorph product lines. Roxicodone and Oramorph were acquired in December 2003.
In June 2004, we exchanged certain products at one wholesaler which reduced our
returns reserve by $3.9 million and is reflected in net revenue. Our net
revenues for the nine months ended September 30, 2004 included $10.4 million
recognized under the consignment sales method.
Net revenues from product development increased 29% in the first nine months of
2004 to $14.5 million, or 10% of net revenues, from $11.2 million, or 7% of net
revenues, in the 2003 period, primarily due to product development revenues
under our significant development agreement.
Net revenues from our development services business increased 11% in the first
nine months of 2004 to $72.5 million from $65.1 million in 2003. The increase
was principally attributable to higher demand for our Phase I clinical
capabilities in both the United States and Europe, as well as for Phase II-IV
and bioanalytical services, partially offset by lower fee-for-service revenues
under our significant development agreement.
Direct costs (excluding depreciation and royalty expense) increased $2.5
million, or 3%, to $77.7 million in the nine-month period ended September 30,
2004, from $75.2 million in the same period in 2003. This increase in direct
costs resulted from an increase in direct costs of our development services
division,
36
primarily in our manufacturing and clinical capabilities, and an increase in
amortization expense related to product rights for products we acquired in
December 2003, partially offset by the lower product costs resulting from the
decreased product revenue. Direct costs as a percentage of net revenues were 52%
in the first nine months of 2004 as compared to 49% in the same period of 2003.
Selling expenses increased 20% in the first nine months of 2004 to $30.1
million, or 20% of net revenues, from $25.0 million, or 16% of net revenues, in
2003. This increase is primarily due to expenses incurred by our product sales
business associated with sales force related expenses under an agreement with
Athlon Pharmaceuticals (which we terminated in the second quarter of 2004),
developing our product sales force and marketing and promoting our new products.
General and administrative costs increased $4.2 million in the first nine months
of 2004 to $35.3 million, or 24% of net revenues, from $31.1 million, or 20% of
net revenues, in 2003. This increase was primarily due to additional product
liability insurance expense for the products we acquired in December 2003 and
litigation-related expenses.
Research and development expenses were $13.8 million, or 9% of net revenues, in
the first nine months of 2004, compared to $15.4 million, or 10% of net
revenues, in 2003. In the first nine months of 2004, significant project
spending was related to our Lynxorb (formerly referred to as ProSorb-D) pain
management product and our proton pump inhibitor development program.
In the first nine months of 2004, we recorded $9.1 million of legal, financial
and consulting professional fees associated with the investigation conducted by
the Special Committee.
As discussed above, in April 2004, we sold our M.V.I. and Aquasol product lines
to Mayne Pharma (USA) Inc. for $105 million, subject to certain adjustments. The
sale resulted in a gain of $39.1 million that we recorded in the second and
third quarters of 2004. The gain was partially offset by a $31.0 million expense
we recorded in the first quarter of 2004 for a contingent payment to AstraZeneca
AB based on the status of the reformulation of our M.V.I.-12 product (the
"M.V.I. Contingent Payment"). The FDA's approval in the first quarter of the
reformulation of this product created an obligation under our product line
acquisition agreement for us to make the M.V.I. Contingent Payment.
In June and September 2004, we recorded restructuring charges of $3.4 million
and $13.7 million, respectively, related to work force reductions and facility
closing costs. These costs represent severance costs and related employee
benefit expenses for those affected by the reduction, separation payments to our
former chief executive officer and rent and other facility related costs through
lease terminations.
Royalty expenses for the nine-month period ended September 30, 2004 were $1.4
million. We accrue royalties based on revenues generated by certain acquired
products. Royalty expenses were $0.5 for the same period in 2003.
In September 2004, we recorded a $5.3 million charge due to the impairment of an
intangible asset associated with our acquired Brethine product, as discussed
above.
The consolidated loss from operations was $39.2 million in the first nine months
of 2004, as compared to income from operations of $1.8 million in the same
period of 2003. This decrease is primarily attributable
37
to the items discussed above, including the decrease in product sales revenue,
higher selling, general and administrative expenses, professional fees related
to the Special Committee investigation, the restructuring charges and the
intangible asset impairment, partially offset by the higher development services
and product development revenues and the gain on the sale of the M.V.I. and
Aquasol product lines, net of the expenses associated with the M.V.I. Contingent
Payment.
The loss from operations for our product sales business was $4.9 million in the
first nine months of 2004, compared to income from operations of $19.4 million
in the same period of 2003. This decrease is attributable to a decrease in
revenue due to the divestiture of our M.V.I. and Aquasol product lines, the
reduction in sales volumes of our Darvocet and Brethine products, the intangible
asset impairment and the increased selling expenses, as discussed above.
Income from operations for our product development business was $14.5 million in
the period ended September 30, 2004, compared to income from operations of $11.2
million in 2003. This change resulted from the increased revenues from our
significant development agreement, as discussed above.
The loss from operations for our development services business was $4.2 million
in the first nine months of 2004, compared to income from operations of $2.4
million in 2003. This change is primarily due to the restructuring charges
discussed above partially offset by the higher revenues.
Unallocated corporate expenses increased in the first nine months of 2004 to
$29.9 million, from $15.5 million in 2003. This increase is primarily related to
the restructuring charges and the professional fees related to the Special
Committee investigation.
Net interest expense increased to $23.9 million in the first nine months of 2004
from $15.6 million in 2003 due to charges related to the refinancing of our
senior credit facility (see "Liquidity and Capital Resources" for additional
information on subsequent changes to our debt). In addition, we recorded a $6.2
million expense for the extinguishment of debt related to our previous senior
credit facility.
Other expense includes $1.6 million representing the fee we paid to terminate an
asset purchase agreement for a product that we no longer believe is commercially
viable. Terminating the agreement eliminated a contingent payment obligation of
$13.8 million. No future obligations remain under this terminated agreement.
We recorded income tax expense of $4.8 million in the first nine months of 2004.
As discussed above, we currently believe that it is more likely than not that
any deferred tax assets generated during 2004 will not be utilized; therefore no
tax benefit was recorded. Our effective tax rate for the first nine months of
2004 was 7%. Our effective tax for the first nine months of 2003 was 39%.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have funded our businesses with cash flows provided by
operations and proceeds from borrowings. Cash flow used in operations in the
first nine months of 2004 was $65.7 million, compared to cash flow provided by
operations of $43.9 million in the first nine months of 2003. This decrease was
primarily due to the significant net loss and a decrease in deferred revenues on
products accounted for under the consignment model, partially offset by a
significant decrease in the gross amount of our
38
accounts receivable. In the third quarter of 2004, we also reclassified $7.7
million from deferred product revenue to other accrued liabilities, recognizing
the potential return of certain products accounted for under the consignment
model, resulting from reduced demand and related expiration issues.
The gross amount of our accounts receivable decreased by $52.4 million, or 61%,
in the first nine months of 2004 due to significant collections in 2004 for
pharmaceutical products shipped during the fourth quarter of 2003 and a
significant decrease in the amount of pharmaceutical products shipped during the
first nine months of 2004. Additionally, as of September 30, 2004, our $33.4
million in gross accounts receivable were offset by $26.6 million in allowances
for customer credits, which primarily consist of reserves we established to
cover estimated future chargebacks and estimated future product returns. These
reserves are necessary because we must either issue a credit on future sales or
make a cash payment when a chargeback is issued or when wholesalers exercise
their rights of return for our pharmaceutical products as the products near
expiration.
Cash provided by investing activities was $87.4 million in the first nine months
of 2004, primarily related to the cash proceeds from the M.V.I. and Aquasol
sale, partially offset by $5.5 million of capital spending. Cash used in
investing activities was $15.7 million in the first nine months of 2003, which
included $9.9 million related to capital spending.
Net cash used in financing activities during the first nine months of 2004 was
$23.3 million, primarily representing debt repayments of $164.0 million under
the previous debt agreements and a termination payment of $9.4 million under our
previous interest rate hedging agreement, partially offset by $147.5 million of
borrowings under our senior credit facilities and $3.7 million in proceeds from
the issuance of common stock primarily related to the exercise of stock options.
M.V.I. AND AQUASOL PRODUCT LINE SALE AND CONTINGENT PAYMENT
The agreement under which we acquired our M.V.I. and Aquasol product line was
amended in July 2003. As amended, it provided for two $1.0 million guaranteed
payments, which were made in August 2002 and 2003, eliminated a contingent
payment of $2.0 million that was potentially due in August 2003 under the
original agreement, and provided for a future contingent payment of $43.5
million, which we refer to as the M.V.I. Contingent Payment, potentially due in
August 2004, depending on the status of certain reformulation activities being
carried out by the seller and regulatory approval of the reformulations by the
U.S. Food and Drug Administration (FDA). The amount of the M.V.I. Contingent
Payment was to be reduced by $1 million per month if the conditions for the
contingent payment had not occurred by December 31, 2002. The amount of the
M.V.I. Contingent Payment had decreased by $12.0 million by December 31, 2003.
Such conditions were satisfied in January and February 2004, fixing the
previously contingent liability under the amendment at $31.5 million. As a
result of an amendment to the original acquisition agreement, we were precluded
from recognizing this obligation as additional purchase price for the M.V.I. and
Aquasol product line; therefore, we expensed this obligation in the first
quarter of 2004. We sold the M.V.I. and Aquasol product lines on April 26, 2004.
Because the $31.5 million contingent payment was not included in the basis of
the assets sold, we recorded a gain from the sale transaction in the second
quarter of 2004 of $37.5 million, which was partially offset by the expense for
the M.V.I. Contingent Payment in the first quarter of 2004. We made the M.V.I.
Contingent Payment, discounted to approximately $31.0 million, in April 2004. In
the third quarter of
39
2004, we recorded an additional gain of $1.6 million related to a reduction in
our post-closing obligations under the purchase agreement.
OTHER COMMITMENTS AND CONTINGENCIES
We may have to make contingent payments of $4.7 million over three years in
connection with the purchase of our Charleston, South Carolina manufacturing
facility, based on the level of future manufacturing revenues at this facility.
At September 30, 2004, these contingent payment obligations are not liabilities
and have not been recorded on our consolidated balance sheet. We made interest
payments on the senior subordinated notes of $9.7 million in April 2004 and
$10.2 million in October 2004, and payments of $10.5 million and $10.1 million
will be due on April 1 and October 1, 2005, respectively.
For additional information about other contingencies to which we are subject,
including litigation and governmental investigations, see Part II, Item 1,
"Legal Proceedings," below, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital
Resources-Commitments and Contingencies" in our 2003 Form 10-K.
We are currently working with one of our major pharmaceutical product customers
to resolve a payment issue. The customer has withheld payments to us and we, in
turn, have withheld payments due to the customer and its affiliates under a
separate agreement. At September 30, 2004, we believe the net amount due to us
to be approximately $2.0 million. We continue to conduct business with the
customer and its affiliates.
ANALYSIS OF LIQUIDITY
We have undergone two significant refinancings of our senior credit facilities
in 2004 to address liquidity issues. Our liquidity position was negatively
affected by inventory purchased and paid for by wholesalers in 2003, declining
sales of pharmaceutical products due to generic competition, increased payments
for the professional services of lawyers, accountants and other consultants, as
well as the costs of the two refinancings.
In addition to the two refinancings of our senior credit facilities, we have
undertaken other actions to address our liquidity position:
- - in June 2004, we announced and implemented a 10% workforce reduction,
including a reduction of our internal pharmaceutical sales force by
approximately 30%, and refocused our pharmaceutical sales and marketing
efforts to the hospital market;
- - in September 2004, we announced and implemented a supplemental
restructuring plan, which included an additional work force reduction and
facility closure plan. We recorded a $13.7 million expense in the three
months ended September 30, 2004, primarily representing severance costs
and related employee-benefit related expenses, separation payments to our
former chief executive officer and costs for leased facilities and
aircraft which are no longer in use. Payments under these
severance/separation arrangements and leases extend through 2006 and 2012,
respectively; and
- - we plan to sell non-revenue-generating assets in order to supplement our
cash flow and to facilitate the availability of cash to coincide with
anticipated cash needs. We are also exploring the potential sale of some
or all of the assets comprising our Pharmaceutical Division and have
40
engaged Rothschild Inc. to assist us. Sales of assets above specific
thresholds will require the consent of the lenders under our senior credit
facilities.
Our liquidity needs increased during 2003, and our annual net interest expense
will exceed $30 million in 2004, including the interest payment on our senior
subordinated notes of $10.2 million, which was paid in October 2004.
We believe, subject to the conditions and contingencies described above and in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources-Commitments and Contingencies," in
our 2003 Form 10-K, including that our results of operations meet our most
recent forecasts, that our cash flow from operations and borrowing capacity
under our senior credit facilities, as recently amended as described below, will
be adequate to meet our needs for working capital and anticipated capital
expenditures. At September 30, 2004, we had $12.5 million outstanding under our
revolving credit facility and additional borrowing capacity of $2.5 million.
If results of operations do not meet our forecasts, or if we are unable to sell
sufficient assets, our actual cash flow from operations may be less than we
anticipate. In the event cash flow from operations and borrowing capacity under
our senior credit facilities are not sufficient to fund our cash needs, we may
seek additional sources of financing, access to the capital markets or sale of
assets, although there can be no assurance that we would be able to effect any
such transaction on a timely basis on terms acceptable to us or at all. In
addition, in those circumstances covenant violations under our senior credit
facilities could occur. If we violate covenants under our senior credit
facilities, we would seek waivers and amendments from our lenders, but we can
give no assurance that any such necessary waivers and amendments would be
available at all or on acceptable terms. If we were unable to obtain a waiver of
future covenant violations, the lenders would be entitled to require immediate
repayment of all amounts outstanding under the senior credit facilities. An
acceleration of outstanding amounts under the senior credit facilities would
also cause a default under, and could permit acceleration of, our senior
subordinated notes due 2010. In the event of such an acceleration of
indebtedness under our senior credit facilities and senior subordinated notes,
we cannot assure you that we would be able to refinance such indebtedness or
effect other transactions, including asset sales, necessary to repay such
indebtedness, and may be required in those circumstances to seek a judicial
restructuring of our debt.
For additional information, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital
Resources-Impact of Recent Events on 2004 Results" in our 2003 Form 10-K.
SENIOR CREDIT FACILITIES
On April 23, 2004, we entered into $140 million of senior credit facilities with
a syndicate of lenders, Silver Point Finance LLC ("Silver Point") as collateral
agent, and Bank of America, N.A., as administrative agent. We entered into an
amendment to these credit facilities on August 9, 2004 and August 13, 2004 to,
among other things, increase the amount of the term loan by up to $10 million,
extend the maturity date of the facilities by one year, increase the interest
rate on the loans by an additional 1.5% subject to potential incremental
reduction, adjust certain covenants under the facilities and waive certain
defaults and events of default. As amended, our new senior credit facilities
consisted of a $135 million senior secured term loan facility (of which $125
million was fully drawn at the initial
41
closing in April and the remaining $10 million was drawn on August 13, 2004) and
a $15 million senior secured revolving credit facility. Our senior credit
facilities included a covenant requiring us to maintain combined availability
under the revolving credit facility and cash and cash equivalents in the
aggregate amount of $5.0 million plus certain other amounts related to payables,
bank overdrafts and interest payments on the loans paid in the form of
additional notes. The outstanding loans under our new senior credit facilities
are payable in full on April 21, 2007. The August amendments also require us to
retain FTI Consulting, Inc. during the term of the senior credit facilities
unless certain available cash and annualized cost reduction thresholds are
satisfied, at which time our retention of FTI could be terminated.
Our senior credit facilities are 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. As part of the initial borrowing under
these senior credit facilities, we recorded a $6.2 million loss for the early
extinguishment of debt related to the write-off of financing fees related to our
previous senior credit facility. Subject to exceptions set forth in the
definitive documentation, loans under our new senior credit facilities are also
required to be prepaid with a negotiated percentage of:
- - excess cash flow, as defined;
- - non-ordinary course assets sales;
- - net proceeds from the sale of subordinated indebtedness;
- - net proceeds from equity issuances; and
- - extraordinary receipts, as defined.
Optional reductions in revolving credit commitments and optional prepayments of
term loans, as well as mandatory reductions in revolving credit commitments and
mandatory prepayments of term loans from the net proceeds of asset sales,
subject to defined exceptions, are subject to a prepayment fee equal to 3.5%
until August 9, 2005, 2.5% for the subsequent 12 months, and 1.5% for the next 6
months (with no prepayment penalty payable for the remainder of the term). Prior
to the August 9, 2004 amendment, outstanding loans under the facilities bore
interest at a rate per annum equal to a defined LIBOR rate (with a floor of 2%),
plus 6.25%, or a defined reference rate (with a floor of 4%), plus 5.25%, in
each case payable monthly in arrears. As a result of, and effective with, the
August amendments to these credit facilities, the applicable interest rate on
outstanding loans was increased by an incremental amount, which was initially
1.5%, subject to incremental reductions based on our financial performance. An
additional 1% per annum unused line fee is payable on unused revolving credit
commitments, payable quarterly in arrears.
The proceeds of the initial borrowings under these facilities were used,
together with the net cash proceeds from the M.V.I. and Aquasol Sale, to (i)
fund payment of termination obligations with respect to our interest rate
hedging agreement (discussed below), (ii) refinance our then-existing senior
credit facility, (iii) fund the April 2004 interest payment due on our senior
subordinated notes due 2010, (iv) provide for ongoing working capital and
general corporate needs, and (v) pay for fees, costs and expenses in connection
with the new senior credit facilities and other corporate transactions. As a
result of changes to certain financial covenants effected by this amendment, we
were in compliance with the adjusted covenants under our senior credit
facilities at and for the applicable periods ended September 30, 2004.
42
Effective as of October 8, 2004, we amended our senior secured credit facilities
to, among other things, adjust financial covenants. The senior secured lenders
also waived compliance with certain financial covenants in the senior secured
credit facility for the quarter ended September 30, 2004 and the quarter ending
December 31, 2004 provided that we meet minimum consolidated EBITDA thresholds
(as defined in the senior secured credit facility). The amendment also added a
minimum gross revenue requirement of $40 million for the quarter ending December
31, 2004 and consented to certain asset disposition transactions and receipt of
a deferred purchase price payment pursuant to which we received approximately
$4.2 million in the aggregate. These transactions related to the sale of our
investment in Aesgen and our M.V.I. and Aquasol product lines. The amendment
also waived any requirement to prepay the senior secured loans with the net
proceeds of these transactions.
On October 22, 2004, we entered into another amendment to our senior secured
credit facility that increased the existing term loan facility under our senior
secured credit facility by $30 million (the "Supplemental Term Loan"), subject
to certain specified conditions which were satisfied on October 29, 2004. The
Supplemental Term Loan was made available in up to three draws to be made on or
prior to January 15, 2005, and we borrowed $20 million of such term loans on
October 29, 2004. Following effectiveness of the amendment, our senior secured
credit facility consisted of a term loan of up to $165 million and a revolving
credit facility of up to $15 million.
The amendment also modified the interest rate on the entire senior secured
credit facility, including the Supplemental Term Loan, to equal a defined LIBOR
rate (with a floor of 2%) plus 8.25% per annum or a defined reference rate (with
a floor of 4%) plus 7.25% per annum. The amendment also provided for a
commitment fee equal to 0.75% per annum on any undrawn portion of the
Supplemental Term Loan, payable monthly in arrears.
The amendment retained the April 21, 2007 maturity date of the senior secured
credit facility and the optional and mandatory prepayment requirements and
premiums described above.
The proceeds of the loans under the Supplemental Term Loan were and may be used
(i) to fund payment of the October 1, 2004 interest payment due on our senior
subordinated notes, (ii) to pay for fees, costs and expenses in connection with
the amendment and the October 2004 consent solicitation for our senior
subordinated notes, and (iii) for working capital and other general corporate
purposes.
The amendment retained substantially the same representations, warranties and
affirmative and negative covenants as are provided in the existing senior
secured credit facility, including limitations on liens, indebtedness,
fundamental transactions, dispositions of assets, changes in the nature of our
business, investments, acquisitions, capital and operating leases, capital
expenditures, dividends, redemptions or other acquisitions of capital stock,
redemptions or prepayments of other debt, transactions with affiliates,
issuances of capital stock, modifications of indebtedness, organizational
documents and other agreements, and retention of excess cash. The amendment also
added a covenant requiring us to retain Rothschild Inc. or another financial
advisor to assist with our exploration of the potential sale of some or all of
the assets comprising our Pharmaceuticals Division.
The amendment also maintained the existing financial covenants under the senior
secured credit facilities, including a minimum fixed charge coverage ratio, and
a maximum total debt to trailing twelve-month EBITDA leverage ratio, but
eliminated a minimum gross revenue covenant for the quarter ended December 31,
2004. Compliance with the fixed charge coverage ratio and the leverage ratio was
also waived through the first quarter of 2005 so long as defined minimum EBITDA
thresholds are
43
satisfied. In addition, the amendment retained a covenant requiring certain
levels of cash or revolver availability and increased the level of cash or
revolver availability required for the period from March 31, 2005 through May
15, 2005 to $15,000,000.
The amendment also substantially retained the existing events of default under
the senior secured credit facility, including, among others, nonpayment of
principal, interest or fees, violations of covenants, inaccuracy of
representations and warranties, a cross-default to our senior subordinated notes
and other material indebtedness, bankruptcy events, and a change in control and
added an event of default if we fail to pursue in good faith the exploration of
the potential sale of some or all of the assets comprising our Pharmaceutical
Division or other non-core assets.
SUBORDINATED NOTES DUE 2010
In March 2002, we issued $175 million of senior subordinated unsecured notes due
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 originally had a fixed
interest rate of 11% per annum and are guaranteed on a subordinated basis by all
of our existing domestic subsidiaries and all of our future domestic
subsidiaries of which we own 80% or more of the equity interests. Prior to March
28, 2005, up to 35% of the notes are redeemable with the proceeds of qualified
sales of equity at 111% of par value. The terms of our senior credit facilities
require us to repay all of the indebtedness under those facilities before we may
repurchase any of the notes. On or after March 28, 2006, all or any portion of
the notes are redeemable at declining premiums to par value, beginning at
105.5%. Under the terms of the indenture for the notes, we are required to
comply with various covenants including, but not limited to, a covenant relating
to incurrence of additional indebtedness. We were in compliance with these
covenants at September 30, 2004.
On March 31, 2004, the lenders under our then-existing credit agreement, which
was then in default, exercised their right to block us from making the interest
payment to holders of our senior subordinated notes due on April 1, 2004.
Accordingly, we did not make that interest payment on April 1, 2004. In
addition, our failure to timely file our 2003 Form 10-K constituted a default
under the indenture governing the senior subordinated notes.
On April 20, 2004, we completed a solicitation seeking the consent from holders
of our senior subordinated notes to approve a refinancing or replacement of our
then existing credit facilities with our senior credit facilities and certain
amendments to, and waivers under, the indenture governing the senior
subordinated notes to, among other things:
- - grant a lien to secure our obligations under the senior subordinated
notes, which lien is junior to the liens securing our new senior credit
facilities but covers the same collateral;
- - increase the interest rate of the senior subordinated from 11% per annum
to 11.5% per annum effective April 1, 2004;
- - suspend our obligation under the indenture to file periodic reports with
the SEC until the earlier of the date that our 2003 Form 10-K is filed
with the SEC or September 30, 2004, and suspend our obligation under the
indenture to furnish annual written statements of our accountants until
the fifth day after the earlier of the date that our 2003 Form 10-K is
filed with the SEC and September 30, 2004;
44
- - further limit our ability to grant liens to secure certain obligations
unless the liens are subordinate to the liens securing the senior
subordinated notes or are otherwise permitted under the indenture; and
- - limit our ability to incur up to $10 million of indebtedness, and to grant
liens to secure that amount of indebtedness, not otherwise specifically
permitted by the indenture, until our 2003 10-K is filed with the SEC or
unless the indebtedness is incurred to fund an interest payment with
respect to the senior subordinated debt.
Following the completion of this consent solicitation, we entered into a
supplemental indenture to effect these amendments and waivers and made the
interest payments that had been due on April 1, 2004, together with default
interest.
On October 1, 2004, we failed to make the interest payment then due on our
senior subordinated notes. The failure to make the October 1, 2004 interest
payment constituted a default under our notes, subject to a 30-day cure period.
On October 29, 2004, we made the interest payment, curing the default under the
notes.
On October 29, 2004, we completed a solicitation seeking the consent from the
holders of our senior subordinated notes to certain amendments to, and waivers
under, the indenture governing our senior subordinated notes to, among other
things:
- - permit us to incur up to $30 million of additional indebtedness under
credit facilities;
- - permit us to incur additional senior debt in order to maintain $40 million
(subject to an increase up to $50 million in order to allow us to make
interest payments on the senior subordinated notes) in senior debt under
credit facilities in the event we are required to pay down senior debt
with the proceeds of asset sales;
- - require that debt permitted to be incurred under a fixed charge coverage
ratio test set forth in the Indenture must rank on parity with or be
subordinated in right of payment to the senior subordinated notes and any
liens granted to secure any such parity debt shall rank pari passu with
the liens securing our senior subordinated notes;
- - require proceeds of asset sales to be used to reduce senior debt under
credit facilities to $40 million;
- - provide that the liens on assets that secure obligations under our senior
subordinated notes will continue if all senior debt is repaid, but will
resume as junior liens if we thereafter incur any new senior debt;
- - prohibit the payment in cash in excess of an aggregate of $5 million to
settle pending litigation, excluding payments funded or reimbursed under
insurance policies, until we make the interest payments due on our senior
subordinated notes on April 1, 2005 and October 1, 2005;
- - prohibit the payment of dividends on our common stock and other restricted
payments (as defined in the Indenture) until the interest payments due on
our senior subordinated notes on April 1, 2005 and October 1, 2005 are
paid; and
- - temporarily increase the interest rate on our senior subordinated notes by
0.5% per annum (to 12% per annum), beginning on October 1, 2004 and ending
on March 31, 2005.
The completion of the consent solicitation satisfied a condition of an amendment
to our senior credit facilities (described above) that, among other matters,
made available a supplemental term loan under
45
the senior credit facilities that was used in part to make the October 1, 2004
interest payment on our senior subordinated notes, together with default
interest thereon, on October 29, 2004 and to pay a consent fee related to the
consent solicitation of $20 per $1,000 principal amount of the notes for which
consents were validly tendered and not revoked in the consent solicitation. The
October 29, 2004 interest payment cured the existing default under the senior
subordinated notes.
INTEREST RATE HEDGING AGREEMENT
Concurrently with the issuance of our senior subordinated notes, we entered into
an interest rate hedging agreement to effectively convert interest expense on a
portion of the senior subordinated notes for the term of the notes from an 11%
fixed annual rate to a floating annual rate equal to 6-month LIBOR plus a base
rate. In 2003, we sold the then outstanding hedging agreement, and replaced it
with a similar interest rate hedging agreement. The amounts we received, less
the termination payment and the interest benefits earned through the dates of
sale, have been recorded as premiums to the carrying amount of the notes and are
being amortized into interest income over their remaining life.
As a condition to establishing our new senior credit facilities, we terminated
the interest rate hedging agreement in April 2004. Our termination obligations
under the interest rate hedging agreement were $9.4 million, which was paid upon
termination of that agreement.
FORWARD-LOOKING STATEMENTS, RISK FACTORS AND "SAFE HARBOR" LANGUAGE
This document contains forward-looking statements within the meaning of the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. Words such as "estimate," "project," "intend," "anticipate," "believe" and
similar expressions are intended to identify forward-looking statements. The
forward-looking statements contained in this document include statements about
future financial and operating results, including the anticipated financial
condition, results of operations, business strategies, operating efficiencies,
competitive positions, growth opportunities for existing products, plans and
objectives of management and markets for our common stock. These statements are
based on the current expectations and beliefs of our management and are subject
to a number of factors and uncertainties, including the matters noted above,
that could cause actual results to differ materially from those described in the
forward-looking statements. These statements are not guarantees of future
performance, involve certain risks, uncertainties and assumptions that are
difficult to predict, and are based upon assumptions as to future events that
may not prove accurate. Therefore, actual outcomes and results may differ
materially from what is expressed in the forward-looking statement. In any
forward-looking statement in which we express an expectation or belief as to
future results, that expectation or belief is expressed in good faith and
believed to have a reasonable basis, but there can be no assurance that the
statement or expectation or belief will result or be achieved or accomplished.
Additional risks and uncertainties pertaining to the following factors, among
others, could cause actual results to differ materially from those described in
the forward-looking statements:
- - our ability to comply with financial covenants under our senior credit
agreement or other indebtedness or receive waivers of prospective defaults
under such agreements,
- - our ability to generate sufficient cash from operations, asset sales or
other transactions to fund our cash needs, and an inability to do so could
result in our filing a voluntary petition for bankruptcy,
- - our ability to continue to operate in the ordinary course and manage our
relationships with our lenders, bondholders, vendors and suppliers and
employees,
46
- - our ability to effect the sale of some or all of the assets comprising our
Pharmaceutical Division and other assets, if we choose to do so, on
acceptable terms or at all,
- - the investigations by the U.S. Attorney's office and the SEC into our
financial reporting and related activity,
- - the outcome of pending litigation filed against us,
- - the outcome of pending litigations we have filed against others,
- - significant changes in our management team,
- - demand for our products and services and the products we produce for
others,
- - the prices that we can obtain for our products and services,
- - the level of competition we face,
- - our ability to attract and retain product development projects,
- - distributors' and wholesalers' inventory levels and ordering and payment
patterns,
- - timely success in product development and regulatory approvals for new
products and line extensions, both for our proprietary products and
products we develop for our customers,
- - market acceptance of new products and line extensions at levels that
justify our cost of developing or acquiring these products,
- - actions by the United States Food and Drug Administration ("FDA") in
connection with submissions related to our products or those of our
competitors or customers,
- - other governmental regulations and actions affecting our products and
services or those of our competitors,
- - third-party payer decisions and actions affecting our products or those of
our competitors or customers,
- - our ability to participate in federal health care programs, including the
Medicare and Medicaid programs,
- - developments in patent or other proprietary rights owned by us or others,
and
- - general conditions in the economy and capital markets.
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,
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations-Risk Factors and Forward Looking Statements" of our 2003 Form
10-K, our Current Reports on Form 8-K (including, without limitation, the
Current Reports we filed on October 22, 2004 and October 28, 2004), 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, and expressly disclaim, any obligation to update or alter
our forward-looking statements, whether as a result of new information, future
events or otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As a result of global operating activities, we are exposed to risks associated
with changes in foreign exchange rates, principally exchange rates between the
U.S. dollar and the euro. As foreign exchange rates change, the U. S. dollar
equivalent of revenues and expenses denominated in foreign currencies change. If
foreign exchange rates were to increase by 10%, our net loss would have been
higher by $0.1
47
million in the nine months ended September 30, 2004 due to the reduction in
reported results from European operations.
We are also exposed to fluctuations in interest rates on borrowings under our
senior credit facilities. The interest rates payable on these borrowings are
based on LIBOR. If LIBOR rates were to increase by 1%, annual interest expense
on our variable rate debt would increase by approximately $1.5 million.
ITEM 4. CONTROLS AND PROCEDURES.
The Company has carried out an evaluation, under the supervision and with the
participation of its Chief Executive Officer and interim Chief Financial
Officer, pursuant to Rule 13a-15 promulgated under the Securities Exchange Act
of 1934, as amended, of the effectiveness of the design and operation of its
disclosure controls and procedures as of September 30, 2004. Disclosure controls
and procedures are to be designed to ensure that material information the
Company must disclose in its reports filed or submitted under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported on a timely
basis. As a result of that review, our Chief Executive Officer and interim Chief
Financial Officer have concluded that, as of September 30, 2004, the Company's
disclosure controls and procedures were not adequate.
Internal control deficiencies were noted by the Special Committee's
investigation. The investigation of the Special Committee is discussed in Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Special Committee Investigation" of the Company's 2003 Form 10-K.
The internal control deficiencies related to, among other things, a lack of
adequate policies with respect to revenue recognition, and a lack of sufficient
control processes and procedures to effectively monitor and manage wholesaler
inventory levels, to ensure adequate contract-approval oversight, and to ensure
effective and timely communication among sales, marketing, finance and legal
staff regarding the terms and conditions of certain transactions, including new
product launches. Also, with respect to the sales of pharmaceutical products,
the Company's finance and accounting personnel lacked adequate training on the
application of revenue recognition principles and the establishment of product
return reserves.
In addition, in April 2004, in connection with their audit of the Company's
consolidated financial statements for the year ended December 31, 2003, the
Company's independent auditors identified and communicated to the Company and
the Audit Committee two "material weaknesses" (as defined under standards
established by the American Institute of Certified Public Accountants) relating
to the Company's accounting and public financial reporting of significant
matters and to its initial recording and management review and oversight of
certain accounting matters. The material weaknesses were with respect to the
calculation and procedures for the analysis of revenue reserves for product
sales and lack of procedures for timely communications from the Legal Department
and operating divisions to the Finance Department impairing the ability to
properly evaluate the accounting treatment for certain transactions the Company
had entered into and assess the impact of such transactions in a timely manner.
In addition, at that time, the Company's independent auditors identified and
communicated to the Company and the Audit Committee a "reportable condition" (as
defined under standards established by the American Institute of Certified
Public Accountants) relating to the Company's internal controls over its
financial reporting for investments. The reportable condition identified the
Company's failure to perform a formal review of its investments and its failure
to timely record patents or trademarks or to timely analyze the patents and
trademarks for usefulness and possible impairment.
48
In light of the foregoing, the Company has taken the following actions after the
end of 2003 to address the deficiencies described above:
- - During the first quarter of 2004, contracted with a third-party consulting
group, FTI Consulting, to provide transitional management services in the
area of operations and finance.
- - During the first quarter of 2004, reassigned all financial controllers
from operating units into the Finance Department reporting to the
Company's Controller and Chief Accounting Officer who reports directly to
the Chief Financial Officer.
- - Commenced a company-wide education effort regarding our Code of Conduct
and contract-approval policies, training 930 North American-based
employees during the second and third quarters of 2004. This included
dedicating significant resources towards ensuring compliance with Company
policies, procedures and applicable government regulations. We also
assigned a manager for compliance matters and created an active,
operational compliance committee of personnel across the Company's
functions and business units to reinforce compliance.
- - Implemented a more rigorous contract-approval process during the second
quarter of 2004 wherein all divisions affected by a contract covered by
such process must approve of the final draft prior to execution.
- - Implemented formal revenue recognition protocols and training programs. In
addition to a more rigorous examination of revenue recognition under
generally accepted accounting principles and applicable SEC regulations,
these protocols provide that the level of channel inventory and demand
trends for products be considered in the analysis of revenue reserves for
product sales. Key members of management and the finance department have
been involved in development of these protocols. The Company intends to
complete training of other employees during the fourth quarter of 2004.
- - Initiated process enhancements to the customer credit approval process,
which the Company began during the third quarter of 2004 and intends to
complete during the fourth quarter of 2004.
- - Initiated improvements to the budgeting and forecasting process, which the
Company began during the third quarter of 2004 and intends to complete
during the fourth quarter of 2004.
In addition, since December 31, 2003, the Company's then Executive Chairman and
Chief Scientific Officer, Chief Executive Officers, Chief Operating Officer and
Chief Financial Officer have left the Company. In March of 2004, Dr. Sancilio,
the Company's Executive Chairman and Chief Scientific Officer, was appointed
Chief Executive Officer and served in this position until September 27, 2004
when Dr. Ludo Reynders, a former executive at Quintiles Transnational
Corporation, replaced him. In March 2004, Gregory F. Rayburn, a senior managing
director with FTI Consulting, was appointed interim Chief Operating Officer. In
April 2004, Timothy R. Wright was appointed President of the Company's
Pharmaceuticals Products Division. Gina Gutzeit, a senior managing director with
FTI Consulting, was appointed as interim Chief Financial Officer in May 2004.
The Company is fully committed to remediating control deficiencies identified by
the Company's independent auditors and the Special Committee. The Company's
efforts to strengthen its financial and internal controls continue, and the
Company expects to complete remediation of the material weaknesses and
reportable condition identified by its independent auditors by the end of 2004.
49
In view of the fact that the above described remedial efforts had not been
completed by September 30, 2004, financial information presented in this
Quarterly Report on Form 10-Q was prepared in the absence of adequate internal
controls over financial reporting as of September 30, 2004, therefore, the
Company devoted a significant amount of time and resources to the analysis of
the financial information and documentation underlying the financial statements
contained in this Quarterly Report.
In addition to the above described remedial efforts, the Company is in the
process of documenting and testing our internal control procedures in order to
satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which
requires annual management assessments of the effectiveness of our internal
controls over financial reporting and a report by our independent auditors
addressing these assessments. The Company has expended significant internal and
external resources in this effort, and in remediating deficiencies identified,
in anticipation of the reporting on internal controls as of December 31, 2004.
Although the Company's management believes it has made significant progress in
this area, there is significant risk that remediation of deficiencies may not be
completed on a timely basis. On November 4, 2004, the Company's external
auditors notified the audit committee of the Company's board of directors that
they believed the Company is facing a significant risk of not completing its
assessment on a timely basis and that even if management is able to complete its
assessment, the independent auditors may not have sufficient time to complete
their assessment and report on internal control over financial reporting by the
filing deadline. The Company can provide no assurance at this time that
management will be able to report that the Company's internal controls over
financial reporting are effective as of December 31, 2004, or if management does
conclude that such internal controls are effective that the Company's
independent auditors will be able to attest that such internal controls are
effective.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are party to lawsuits and administrative proceedings incidental to the normal
course of our business. Our material legal proceedings are described below. We
cannot predict the outcomes of these matters. As noted below, we believe that
any liabilities related to such lawsuits or proceedings could have a material
adverse effect on our consolidated financial condition, results of operations
and cash flows, if adversely determined. Prosecuting and defending these
material legal proceedings, including responding to governmental inquiries, has
resulted, and is expected to continue to result, in a significant diversion of
management's attention and resources and an increase in professional fees.
GOVERNMENT INVESTIGATIONS
In April 2004, in connection with an investigation conducted by the United
States Attorney's Office for the Western District of North Carolina (the "U.S.
Attorney's Office"), we received five federal grand jury subpoenas for document
production and potential testimony related to, among other things, certain
transactions regarding our 2002 and 2003 financial information, the terms,
conditions of employment and compensation arrangements of certain of our senior
management personnel, compensation and incentive arrangements for employees
responsible for the sale of our Brethine, Darvocet, calcitriol, azathioprine and
Darvon Compound products, quantities of the foregoing products in distribution
channels, financial benefits with respect to specified corporate transactions to
our senior management and others, certain loans obtained by us, extensions of
credit, if any, by us to officers or directors,
50
accounting for sales and returns of our foregoing products, our analysts'
conference calls on financial results, internal and external investigations of
pharmaceutical product sales activities, and related matters. The SEC has also
commenced an investigation and we have received a subpoena from the SEC covering
similar matters. Certain of our current and former officers, directors and
employees have received subpoenas to appear before the federal grand jury or
requests to provide information to the U.S. Attorney's Office. A former officer
of the Company, David M. Hurley, has been advised by the U.S. Attorney's Office
that he is a target of its investigation. We and the Special Committee have
agreed to cooperate fully with the government investigations, and the Special
Committee has agreed to share all results of its investigation with the SEC and
the U.S. Attorney's Office. The U.S. Attorney's Office, SEC and other government
agencies that are investigating or might commence an investigation of aaiPharma
could impose, based on a claim of fraud, material misstatements, violation of
false claims law or otherwise, civil and/or criminal sanctions, including fines,
penalties, and/or administrative remedies. If any government sanctions are
imposed, which we cannot predict or reasonably estimate at this time, our
business, financial condition, results of operations or cash flows could be
materially adversely affected. These matters have resulted, and are expected to
continue to result, in a significant diversion of management's attention and
resources and in significant professional fees.
On January 2, 2004, we received separate letters from the Kentucky Office of
Attorney General and the Florida Office of Attorney General advising that each
was currently investigating allegations regarding our pricing practices related
to our average manufacturer price and best price calculations that are used by
the government to set Medicaid reimbursement rates. Neither letter requested
that we provide any information, and each letter merely requested that we retain
all documents with respect to these calculations pursuant to a newly adopted
federal regulation that would have permitted the destruction of these documents
three years after the applicable prices were reported, except to the extent we
were aware of an ongoing investigation. It is our understanding that many other
pharmaceutical companies received similar letters at that time from attorneys
general in a number of states and that such letters may have been in response to
the new federal regulation that would have otherwise allowed the destruction of
documents reflecting these pricing calculations. A number of attorneys general,
including the Florida and Kentucky attorneys general, petitioned the U.S.
Secretary of Health and Human Services to withdraw the new regulation. We are
not aware of any further developments in these investigations.
FEDERAL SECURITIES, DERIVATIVE AND ERISA LITIGATION
We and certain of our current and former officers and directors have been named
as defendants in purported stockholder class action lawsuits alleging violations
of federal securities laws and a stockholder derivative action alleging
violations of state law fiduciary responsibilities. The securities lawsuits were
filed beginning in February 2004 and are pending in the U.S. District Court for
the Eastern District of North Carolina. The securities lawsuits assert claims
arising under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934
and Rule 10b-5 there under on behalf of a class of purchasers of our common
stock during the period from January 31, 2002 through and including March 1,
2004. The securities complaints allege generally that the defendants knowingly
or recklessly made false or misleading statements during the Class Period
concerning our financial condition and that our financial statements did not
present our true financial condition and were not prepared in accordance with
generally accepted accounting principles. The securities complaints seek
certification as a class action, unspecified compensatory damages, attorneys'
fees and costs, and other relief. By order dated April 16, 2004, the district
court consolidated the securities lawsuits into one consolidated action. We
expect that these plaintiffs will file a consolidated, amended complaint in
December 2004, to which we
51
will respond in lieu of responding to the individual complaints. The stockholder
derivative suit asserts state law claims for breach of fiduciary duty, gross
negligence, breach of contract, and insider trading, and seeks unspecified
compensatory damages, attorneys' fees and costs, and other relief.
In addition, we, one of our former officers, certain of our employees and others
have been named in a purported class action brought by an aaiPharma pension plan
participant and beneficiary asserting claims under ERISA on behalf of a class of
all persons who are or were participants or beneficiaries of the aaiPharma Inc.
Retirement and Savings Plan during the period from April 24, 2002 to March 31,
2004. The complaint alleges generally that the defendants breached fiduciary
duties owed under ERISA with respect to the investment of Plan assets in
aaiPharma stock by misleading participants and beneficiaries of the Plan
regarding our earnings, prospects, and business condition. The complaint seeks
certification as a class action, unspecified compensatory damages, attorneys'
fees and costs, and other relief. This ERISA lawsuit is pending in U.S. District
Court for the Eastern District of North Carolina. We expect that the plaintiff
will file a consolidated, amended complaint in December 2004. The proceedings in
this matter are expected to be coordinated with the securities lawsuits
described above.
These lawsuits are at an early stage. A lead plaintiff was appointed in the
federal securities litigation on October 14, 2004, and a consolidated amended
complaint has not yet been served in the securities and ERISA litigation. The
derivative action has not yet been served on us. We are not required to file an
answer or motion to dismiss in the securities and ERISA lawsuits until after
service of a consolidated amended complaint on us in those actions and no
discovery has yet occurred in either the securities or derivative litigation.
By, and subject to, the terms of our bylaws, we have certain obligations to
indemnify our current and former officers, directors and employees who have been
named as defendants in these lawsuits. We have purchased directors and officers
liability insurance ("D&O insurance") that may provide coverage for some or all
of these lawsuits and governmental investigations. We have given notice to our
D&O insurance carriers of the securities and derivative suits described above,
and the insurers have responded by requesting additional information and by
reserving their rights under the policies, including the rights to deny coverage
under various policy exclusions or to rescind the policies. There is a risk,
however, that the D&O insurance carriers will rescind the policies or that some
or all of the claims or expenses will not be covered by such policies; or that,
even if covered, our ultimate liability will exceed the available insurance. Our
fiduciary liability insurance carrier has denied coverage of claims made in
connection with the ERISA litigation. Although we intend to vigorously pursue
all defenses available in these lawsuits, an adverse determination in these
lawsuits or an inability to obtain payment under our insurance policies for
litigation and indemnification costs and any damages ultimately borne by us as a
result of these lawsuits and investigations could have a material adverse effect
on our business, financial condition, results of operations or cash flows.
PATENT LITIGATION
We are a party to a number of legal actions with generic drug companies. We are
involved in four lawsuits centered on our omeprazole-related patents, including
one lawsuit brought by us against an alleged infringer of our patents and three
lawsuits which were brought by third parties against us and are currently
essentially inactive. Omeprazole is the active ingredient found in Prilosec, a
drug sold by AstraZeneca.
52
Two omeprazole-related cases have been filed against us by Dr. Reddy's
Laboratories Ltd. and Reddy-Cheminor Inc. in the U.S. District Court for the
Southern District of New York in July 2001 and November 2001. The plaintiffs in
these cases have challenged the validity of five patents that we have obtained
relating to omeprazole and are seeking a declaratory judgment that their generic
form of Prilosec does not infringe these patents. Additionally, in one of the
suits, 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 of these cases against us are in early stages of litigation. However, while
these plaintiffs have sought approval from the FDA to market a generic form of
Prilosec, to the best of our knowledge as of November 3, 2004, no such FDA
approval has been granted to them. In addition, these plaintiffs' omeprazole
product has been found in separate litigation to infringe certain patents of
AstraZeneca and the infringement findings have been upheld on appeal. These
lawsuits are essentially inactive at this time. Only limited discovery has
occurred in these lawsuits and no additional discovery is currently being
sought. No dates have been set for the trials. In the event that these lawsuits
again become active, we intend to vigorously defend the patents' validity and to
determine whether or not the plaintiffs' product infringes any of our relevant
patents.
The third case involving our omeprazole patents was brought against us in August
2001 by Andrx Pharmaceuticals, Inc. in the U.S. District Court for the Southern
District of New York. Andrx has challenged the validity of three of our
omeprazole patents and has also sought 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 has sought injunctive relief and unspecified treble
damages. We have denied the substantive allegations made by Andrx.
This case is in an early stage of litigation. While Andrx has received FDA
approval for its generic omeprazole product, to our knowledge, it is not
currently marketing this drug in the U.S. following judicial findings that
Andrx's omeprazole product infringed certain AstraZeneca patents. No date has
been set for trial. No discovery is currently being sought. We have filed a
motion to dismiss the litigation on various grounds and Andrx has objected to
our motion. The lawsuit is essentially inactive at this time. As of November 3,
2004, the judge has not decided our motion to dismiss the litigation.
The fourth case involving our omeprazole patents was brought in December 2002 by
us against Kremers Urban Development Co., Schwarz Pharma Inc. and Schwarz Pharma
AG (collectively, together with the other named defendants, "KUDCO") in the U.S.
District Court for the Southern District of New York. KUDCO has a generic
omeprazole product with final FDA marketing approval, was found not to infringe
the AstraZeneca patents in the separate AstraZeneca patent litigation, and is
currently selling its generic substitute for Prilosec in the U.S. marketplace.
We initially brought the lawsuit alleging infringement of our U.S. Patent No.
6,268,385. Following the collection of additional information concerning KUDCO's
commercially marketed product, we sought leave of the court to file an amended
complaint, adding additional claims of infringement and contributory
infringement under our U.S. Patent No. 6,326,384 and joining as defendants
Schwarz Pharma Manufacturing Inc. and Schwarz Pharma USA Holdings Inc. These two
patents include, among
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other claims, claims directed to compositions and methods wherein certain
characteristics of solid state omeprazole are essentially the same in formulated
drug product as in its active ingredient.
In September 2003, the judge granted us leave to file the first amended
complaint adding our second patent and the additional KUDCO affiliates to the
lawsuit. Following initial discovery, we sought leave of the court to file a
second amended complaint, adding Kremers Urban Inc., another KUDCO affiliate, to
the lawsuit. On February 26, 2004, the judge granted us leave to file the second
amended complaint, adding Kremers Urban Inc. to the lawsuit.
KUDCO has filed its answer to our complaint, denying our claims, asserting
various affirmative defenses to our claims (including patent invalidity and
product non-infringement), and asserting counterclaims and antitrust violations
under federal and state antitrust laws. KUDCO is also contesting the personal
jurisdiction of the court over all of the defendants in this lawsuit other than
Kremers Urban Development Co., Kremers Urban Inc. and Schwarz Pharma Inc.
Motions on the jurisdictional issues are pending before the court. We have
denied the substantive allegations made by KUDCO in its counterclaims, and the
court has granted our motion to stay antitrust discovery.
Substantial discovery of both sides' documents and of defendants' product
samples has occurred in the lawsuit, although both sides asserted numerous
discovery deficiencies against the other. On February 26, 2004, the judge
assigned the discovery disputes to a federal magistrate for resolution.
Discovery is continuing at this time. The parties previously had agreed to the
commencement of the trial in January 2005 but later moved the trial date to June
2005.
We have previously indicated to KUDCO a willingness to grant a license under our
omeprazole patents for an appropriate royalty. In the absence of KUDCO taking a
royalty-bearing license, we are seeking damages equal to a reasonable royalty on
all infringing sales by the KUDCO defendants since commercial launch of their
generic substitute for Prilosec on December 9, 2002 through the date of a
judicial decision in the litigation, and a permanent injunction on subsequent
sales thereafter (unless KUDCO takes a license), among other remedies, in the
event that we ultimately prevail in the litigation. The KUDCO defendants have
publicly confirmed sales of their generic omeprazole product during the first
twenty-two months after launch of their product of approximately $1.3 billion.
In the absence of a license or settlement, we intend to vigorously prosecute the
case, defend our patent rights and defend against the foregoing defenses and
counterclaims asserted by KUDCO. It is possible that the omeprazole-related
patents subject to the foregoing four lawsuits will be found invalid,
unenforceable or not infringed and, while currently stayed by the court, it is
possible that the defendants' antitrust counterclaims in the KUDCO litigation
will ultimately be allowed to proceed and be litigated. If adverse findings were
to occur, they could have a material adverse effect on our consolidated
financial statements, results of operations and cash flow.
In cases where we have initiated an action, we intend to prosecute our claims to
the full extent of our rights under the law. In cases where we are named
defendants, we intend to vigorously pursue all defenses available.
ATHLON LITIGATION
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On April 15, 2004, we filed a lawsuit against Athlon Pharmaceuticals, Inc. in
the U.S. District Court for the Northern District of Georgia seeking a
declaratory judgment that we were entitled to terminate the Service Agreement
(the "Athlon Service Agreement") dated July 16, 2003, as amended, between us and
Athlon as well as damages and injunctive relief for material breaches of the
Athlon Service Agreement by Athlon. The Athlon Service Agreement incorporated
the terms and conditions pursuant to which representatives of Athlon would
promote the sale of our Darvocet A500 product to physicians. We initially paid
Athlon $3,350,000 to build its sales force to promote the sale of our Darvocet
A500, and the terms of the Athlon Service Agreement would require us to pay
Athlon an additional $1,200,000 each month for such services for the contract
period of 36 months, commencing in October 2003, subject to Athlon's compliance
with certain representations, warranties and covenants, some of which are
described below.
The lawsuit asserts that Athlon has materially breached the Athlon Service
Agreement in several ways, including failure to: (i) provide the required number
of sales representatives during our launch of Darvocet A500 commencing in
October 2003, (ii) use its best efforts to promote Darvocet A500 at the targeted
levels of first and second pharmaceutical details to physicians, (iii) perform
the services to the best of its ability, as contractually required, and (iv)
require its sales representatives to perform the contracted services, as
required, in a professional manner consistent with industry standards and in
conformance with that level of care and skill ordinarily exercised by
professional contract sales organizations in similar circumstances. The lawsuit
also asserts that Athlon breached its representation and warranty that it would
perform, and would require its sales representatives to perform, the contracted
services in substantially the same manner that it would promote Athlon's own
products.
Athlon has asserted several counterclaims, including breach of an implied
covenant of good faith in fair dealing and anticipatory breach of the contract.
We have filed a reply denying these allegations.
In May 2004, we ceased making payments under the Athlon Service Agreement, and
on June 4, 2004, we sent a notice of termination of the agreement to Athlon. On
July 7, 2004, we amended the lawsuit to assert claims of fraud and breaches of
contract and implied covenants, seeking to recover compensatory and punitive
damages and attorneys' fees. Athlon has amended its counterclaim to assert fraud
claims and to seek punitive damages. The litigation is in its early stages and
discovery has commenced. No trial date has been set.
On August 11, 2004, Athlon filed a lawsuit against us, also in the U.S. District
Court for the Northern District of Georgia, alleging that we breached the Asset
Purchase Agreement (the "Purchase Agreement") dated July 16, 2003 pursuant to
which we acquired Darvocet A500 from Athlon. Athlon is seeking royalties it
alleges we failed properly to calculate and pay under the Purchase Agreement, as
well as attorneys' fees.
We have denied the substantive allegations in this case and have moved to have
the case consolidated with the contract sales force litigation described above.
Athlon is resisting consolidation. We have also filed counterclaims. This
litigation is also in its early stages, and discovery has recently begun. No
trial date has been set.
We intend to prosecute our claims and counterclaims, and defend against the
claims and counterclaims made by Athlon, in these lawsuits to the full extent
permitted by law.
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CIMA LITIGATION
In August 2004, CIMA Labs, Inc. initiated a lawsuit against us in Hennepin
County District Court in Minnesota alleging fraud and breach of contract
relating to the merger agreement that we had entered into with CIMA on August 5,
2003. In its complaint, CIMA seeks to recover the $11.5 million it paid to us
pursuant to that merger agreement upon CIMA's termination of that merger
agreement to permit it to accept a competing merger proposal, as well as $5
million in other costs. We have filed an answer to CIMA's complaint denying
liability and CIMA has initiated discovery requests. The Company intends to
continue to vigorously defend this litigation.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(d) MAXIMUM NUMBER (OR
(c) TOTAL NUMBER OF APPROXIMATE DOLLAR VALUE)
(a) (b) SHARES (OR UNITS) OF SHARES (OR UNITS) THAT
TOTAL NUMBER AVERAGE PRICE PURCHASED AS PART OF MAY YET BE PURCHASED
SHARES (OR UNITS) PAID PER SHARE PUBLICLY ANNOUNCED UNDER THE PLANS OR
PERIOD PURCHASED * (OR UNIT) PLANS OR PROGRAMS PROGRAMS
- ------ ----------- -------- ----------------- ---------
July 16,763 $ 5.43 - -
August - - - -
September 59,452 2.35 - -
--------------
Total 76,215 $ 3.03 - -
==============
* All of these shares were purchased on the open market by the trustee of
the Company's Retirement Savings Plan with amounts provided by the Company
as an employer match. These shares are held as assets of the plan. The
Company does not consider these purchases to be part of a publicly
announced plan or program.
ITEM 6. EXHIBITS
A list of the exhibits required to be filed as part of this Quarterly Report on
Form 10-Q is set forth in the "Exhibit Index," which immediately precedes such
exhibits, and is incorporated herein by reference.
56
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 9, 2004 By: /s/ Timothy R. Wright
-----------------------
Timothy R. Wright
Interim President and Chief Executive Officer
Date: November 9, 2004 By: /s/ Gina Gutzeit
--------------------------
Gina Gutzeit
Interim Chief Financial Officer
57
AAIPHARMA INC.
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
3.1 Amended and Restated Certificate of Incorporation of the Company, and
amendments thereto (incorporated by reference to Exhibit 3.1 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
2003)
3.2 Amended By-laws of the Company (incorporated by reference to Exhibit
3.3 to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000)
4.1 Indenture (which includes the form of 11% senior subordinated note due
2010) dated as of March 28, 2002 between the Company, certain of its
subsidiaries as guarantors and Wachovia Bank, National Association
(formerly, First Union National Bank), as Trustee (incorporated by
reference to Exhibit 4310.8 to the Company's Registration Statement on
Form S-1 (Registration No. 333-85602) filed with the SEC on April 5,
2002)
4.2 First Supplemental Indenture, dated as of April 20, 2004, among the
Company, certain of its subsidiaries as guarantor parties thereto and
Wachovia Bank, National Association (formerly, First Union National
Bank), as Trustee (incorporated by reference to Exhibit 99.4 to the
Company's Current Report on Form 8-K filed with the SEC on April 27,
2004)
4.3 Security Agreement, dated as of April 23, 2004, made by the Company
and certain subsidiaries of the Company as grantors in favor of
Wachovia Bank, National Association, in its capacity as collateral
agent for the holders of the Company's 11% Senior Subordinated Notes
due 2010 (incorporated by reference to Exhibit 99.5 to the Company's
Current Report on Form 8-K filed with the SEC on April 27, 2004)
4.4 Pledge and Security Agreement, dated as of April 23, 2004, made by the
Company and certain subsidiaries of the Company as pledgors in favor
of Wachovia Bank, National Association, in its capacity as collateral
agent for the holders of the Company's 11% Senior Subordinated Notes
due 2010 (incorporated by reference to Exhibit 99.6 to the Company's
Current Report on Form 8-K filed with the SEC on April 27, 2004)
4.5 Second Supplemental Indenture, dated as of October 29, 2004, among the
Company, certain of its subsidiaries as guarantor parties thereto and
Wachovia Bank, National Association (formerly, First Union National
Bank), as Trustee (incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K filed with the SEC on November 4,
2004)
10.1 First Amendment to Financing Agreement and Security Agreement dated as
of August 9, 2004 by and among aaiPharma Inc. and certain of its
subsidiaries, the financial institutions from time to time party
thereto, Silver Point Finance, LLC, as collateral agent, and Bank of
America, N.A., as administrative agent (incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K dated August
11, 2004)
58
10.2 Second Amendment to Financing Agreement, dated as of August 13, 2004,
among aaiPharma Inc., certain subsidiaries of aaiPharma Inc., the
financial institutions from time to time party thereto, Silver Point
Finance, LLC, as collateral agent and Bank of America, N.A. as
administrative agent
10.3 Third Amendment to Financing Agreement, dated as of October 8, 2004, among
aaiPharma Inc., certain subsidiaries of aaiPharma Inc., the financial
institutions from time to time party thereto, Silver Point Finance, LLC,
as collateral agent and Bank of America, N.A. as administrative agent
(incorporated by reference to Exhibit 10.1 to the Company's Current Report
on Form 8-K filed with the SEC on October 13, 2004)
10.4 Fourth Amendment to Financing Agreement, dated as of October 22, 2004,
among aaiPharma Inc., certain subsidiaries of aaiPharma Inc., the
financial institutions from time to time party thereto, Silver Point
Finance, LLC, as collateral agent and Bank of America, N.A. as
administrative agent (incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K dated October 22, 2004)
10.5 Amendment to Employment Agreement, dated as of September 27, 2004, between
aaiPharma Inc. and Frederick D. Sancilio, Ph.D. (incorporated by reference
to Exhibit 10.1 to the Company's Current Report on Form 8-K dated
September 29, 2004)
10.6 Employment Agreement, dated as of September 27, 2004, between aaiPharma
Inc. and Ludo Reynders (incorporated by reference to Exhibit 10.2 to the
Company's Current Report on Form 8-K dated September 29, 2004)
31.1 Certification pursuant to Exchange Act Rule 13a - 14(a) of Timothy R.
Wright
31.2 Certification pursuant to Exchange Act Rule 13a - 14(a) of Gina Gutzeit
32.1 Certification Pursuant to 18 U.S.C. Section 1350
99.1 Risk factors
59