-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JBmrBxFgEjCMNzq2o+4UgDnzSRKi0C2iQNV3H3zAWqewCgQOXTHx15fe8okd5eoD jhsjxcdCfZRSCXPrlqHKrQ== 0000950144-02-008864.txt : 20020814 0000950144-02-008864.hdr.sgml : 20020814 20020814181054 ACCESSION NUMBER: 0000950144-02-008864 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AAIPHARMA INC CENTRAL INDEX KEY: 0001013243 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-TESTING LABORATORIES [8734] IRS NUMBER: 042687849 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-21185 FILM NUMBER: 02738149 BUSINESS ADDRESS: STREET 1: 2320 SCIENTIFIC PARK DRIVE CITY: WILMINGTON STATE: NC ZIP: 28405 BUSINESS PHONE: 9102547000 MAIL ADDRESS: STREET 1: 2320 SCIENTIFIC PARK DRIVE CITY: WILMINGTON STATE: NC ZIP: 28405 FORMER COMPANY: FORMER CONFORMED NAME: APPLIED ANALYTICAL INDUSTRIES INC DATE OF NAME CHANGE: 19960430 10-Q 1 g77946e10vq.txt AAIPHARMA INC. 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 June 30, 2002 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-21185 AAIPHARMA INC. (Exact name of Registrant as specified in its charter) DELAWARE 04-2687849 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 2320 SCIENTIFIC PARK DRIVE, WILMINGTON, NC 28405 (Address of principal executive office) (Zip code) (910) 254-7000 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] The number of shares of the Registrant's common stock outstanding, as of August 6, 2002 was 18,274,149 shares. AAIPHARMA INC. Table of Contents The terms "Company", "Registrant" or "aaiPharma" in this Form 10-Q include aaiPharma Inc. and its subsidiaries, except where the context may indicate otherwise. Any item which is not applicable or to which the answer is negative has been omitted. We own the U.S. rights to the following registered and unregistered trademarks: M.V.I.(R), Aquasol(TM), Brethine(R), Darvon(R), Darvocet-N(R), ProSorb(R), ProSorb-D(TM), NeoSan(TM) and aaiPharma(TM). We also reference trademarks owned by other companies. Prilosec(R) is a registered trademark of AstraZeneca AB and Prozac(R) is a registered trademark of Eli Lilly and Company. All references in this Form 10-Q 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.
Page No. -------- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS (unaudited) Consolidated Statements of Operations 3 Consolidated Balance Sheets 4 Consolidated Statements of Cash Flows 5 Consolidated Statements of Comprehensive Income 6 Notes to Consolidated Financial Statements 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 22 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 30 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 31 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 32 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 32 SIGNATURES 34 EXHIBIT INDEX 35
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 Six Months Ended June 30, June 30, ------------------------ ------------------------ 2002 2001 2002 2001 --------- --------- --------- --------- Net revenues $ 61,447 $ 29,884 $ 107,067 $ 60,081 --------- --------- --------- --------- Operating costs and expenses: Direct costs 22,061 15,276 44,285 30,725 Selling 5,759 2,891 10,076 5,729 General and administrative 11,703 6,382 21,246 14,125 Research and development 5,596 1,766 10,073 4,108 Direct pharmaceutical start-up costs -- 1,037 -- 1,681 --------- --------- --------- --------- 45,119 27,352 85,680 56,368 --------- --------- --------- --------- Income from operations 16,328 2,532 21,387 3,713 Other income (expense) Interest, net (6,553) (327) (8,376) (710) Other 69 (963) 203 (687) --------- --------- --------- --------- (6,484) (1,290) (8,173) (1,397) --------- --------- --------- --------- Income before income taxes and extraordinary loss 9,844 1,242 13,214 2,316 Provision for income taxes 3,740 228 5,021 486 --------- --------- --------- --------- Income before extraordinary loss 6,104 1,014 8,193 1,830 Extraordinary loss, net of a tax benefit of $2,714 -- -- (5,339) -- --------- --------- --------- --------- Net income $ 6,104 $ 1,014 $ 2,854 $ 1,830 ========= ========= ========= ========= Basic earnings (loss) per share Income before extraordinary loss $ 0.33 $ 0.06 $ 0.45 $ 0.10 Extraordinary loss -- -- (0.29) -- --------- --------- --------- --------- Net income $ 0.33 $ 0.06 $ 0.16 $ 0.10 ========= ========= ========= ========= Weighted average shares outstanding 18,243 17,721 18,157 17,687 ========= ========= ========= ========= Diluted earnings (loss) per share Income before extraordinary loss $ 0.32 $ 0.06 $ 0.43 $ 0.10 Extraordinary loss -- -- (0.28) -- --------- --------- --------- --------- Net income $ 0.32 $ 0.06 $ 0.15 $ 0.10 ========= ========= ========= ========= Weighted average shares outstanding 19,043 18,177 19,053 17,936 ========= ========= ========= =========
The accompanying notes are an integral part of these financial statements. 3 AAIPHARMA INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
June 30, December 31, 2002 2001 --------- ------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 4,212 $ 6,371 Accounts receivable, net 40,341 26,594 Work-in-progress 11,676 10,464 Inventories 9,393 9,057 Prepaid and other current assets 5,863 5,972 --------- --------- Total current assets 71,485 58,458 Property and equipment, net 52,425 37,035 Goodwill and other intangibles, net 300,525 88,504 Other assets 18,942 12,289 --------- --------- Total assets $ 443,377 $ 196,286 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt and short-term debt $ 5,417 $ -- Accounts payable 15,601 15,444 Customer advances 17,070 13,349 Accrued wages and benefits 4,315 3,879 Interest payable 6,616 371 Other accrued liabilities 4,936 4,922 --------- --------- Total current liabilities 53,955 37,965 Long-term debt, less current portion 304,492 78,878 Other liabilities 1,343 224 Commitments and contingencies -- -- Redeemable warrants -- 2,855 Stockholders' equity: Common stock 18 18 Paid-in capital 78,265 75,233 Retained earnings 6,132 3,278 Accumulated other comprehensive losses (828) (2,165) --------- --------- Total stockholders' equity 83,587 76,364 --------- --------- Total liabilities and stockholders' equity $ 443,377 $ 196,286 ========= =========
The accompanying notes are an integral part of these financial statements. 4 AAIPHARMA INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
Six Months Ended June 30, --------------------------- 2002 2001 --------- --------- Cash flows from operating activities: Income before extraordinary loss $ 8,193 $ 1,830 Adjustments to reconcile income before extraordinary loss to net cash (used in) provided by operating activities Depreciation and amortization 4,472 3,588 Other 117 869 Changes in operating assets and liabilities: Trade and other receivables (13,427) (4,758) Work-in-progress (761) (1,398) Inventories (275) 800 Prepaid and other assets (12,970) 386 Accounts payable (32) (1,116) Customer advances 3,413 285 Interest payable 6,245 (64) Accrued wages and benefits and other accrued liabilities (104) 279 --------- --------- Net cash (used in) provided by operating activities (5,129) 701 --------- --------- Cash flows from investing activities: Purchases of property and equipment (4,402) (2,561) Purchases of property and equipment previously leased (14,145) -- Proceeds from sales of property and equipment -- 3,050 Acquisitions -- (211,997) -- Other (151) (104) --------- --------- Net cash (used in) provided by investing activities (230,695) 385 --------- --------- Cash flows from financing activities: Net payments on short-term borrowings -- (1,102) Proceeds from long-term borrowings 248,755 -- Payments on long-term borrowings (18,400) (336) Issuance of common stock 3,031 1,115 Other 170 13 --------- --------- Net cash provided by (used in) financing activities 233,556 (310) --------- --------- Net (decrease) increase in cash and cash equivalents (2,268) 776 Effect of exchange rate changes on cash 109 (8) Cash and cash equivalents, beginning of period 6,371 1,225 --------- --------- Cash and cash equivalents, end of period $ 4,212 $ 1,993 ========= ========= Supplemental information, cash paid for: Interest $ 2,547 $ 562 ========= ========= Income taxes $ 1,947 $ 9 ========= =========
The accompanying notes are an integral part of these financial statements. 5 AAIPHARMA INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (IN THOUSANDS) (UNAUDITED)
Three Months Ended Six Months Ended June 30, June 30, ------- ----------- ------------------- 2002 2001 2002 2001 ------- ------- ------- ------- Net income $ 6,104 $ 1,014 $ 2,854 $ 1,830 Currency translation adjustments 1,512 (315) 1,337 (1,080) Reclassification adjustment of realized loss on available for sale securities -- 523 -- 591 ------- ------- ------- ------- Comprehensive income $ 7,616 $ 1,222 $ 4,191 $ 1,341 ======= ======= ======= =======
The accompanying notes are an integral part of these financial statements. 6 AAIPHARMA INC. Notes to Consolidated Financial Statements (Unaudited) 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and applicable Securities and Exchange Commission regulations for interim financial information. These financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for annual financial statements. The consolidated financial information as of December 31, 2001 has been derived from audited financial statements; certain amounts from the three and six months ended June 30, 2001 have been reclassified for consistent presentation with current year financial statements. It is presumed that users of this interim financial information have read or have access to the audited financial statements for the preceding fiscal year, which were included in the Company's Annual Report on Form 10-K. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included in these interim financial statements. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the full year. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from such estimates and changes in such estimates may affect amounts reported in future periods. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements". SAB 101 specifically addresses revenue recognition issues related to certain upfront payments or fees. In accordance with SAB 101, certain upfront fees and payments recognized as income in prior periods are required to be deferred and amortized into revenue over the terms of the relevant agreements or as the on-going services are performed. For the three and six months ended June 30, 2002, the Company recognized $83,000 and $167,000 of revenue related to the amortization of these deferred amounts, respectively. For the three and six months ended June 30, 2001, the Company recognized $105,000 and $333,000 of revenue related to the amortization of these deferred amounts, respectively. In July 2001, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). Under SFAS No. 142, goodwill and indefinite lived intangible assets are no longer amortized, but must be reviewed at least annually for impairment. In the second quarter of 2002, the Company identified reporting units and related goodwill, as defined by SFAS No. 142, and tested the goodwill for impairment, as of December 31, 2001, using the expected present value of future cash flows approach. As a result of this valuation process, as well as the application of the remaining provisions of SFAS No. 142, the Company concluded that there was no impairment of goodwill related to any of the Company's reporting units. SFAS No. 142 also states that goodwill and intangible assets acquired after June 30, 2001 should not be amortized. For acquisitions completed subsequent to June 30, 2001, the Company recorded $51.0 million of indefinite-lived intangible assets and $159.7 million of goodwill. These assets are not subject to amortization. The statement was effective for fiscal years beginning after December 7 15, 2001. Prior to the adoption of SFAS No. 142, the Company amortized goodwill related to acquisitions completed prior to June 30, 2001 over estimated useful lives ranging from 3 to 20 years. Amortization of goodwill totaled $166,000 and $340,000 for the three and six months ended June 30, 2001. In accordance with SFAS No. 142, the Company ceased amortization of goodwill related to such acquisitions. 2. EARNINGS PER SHARE The following table provides a reconciliation of the denominators for the basic and fully diluted earnings per share computations (in thousands):
Three Months Ended Six Months Ended June 30, June 30, ------------------- ------------------- 2002 2001 2002 2001 ------- ------- ------- ------- Basic earnings per share: Weighted average number of shares 18,243 17,721 18,157 17,687 Effect of dilutive securities: Stock options 800 456 896 249 ------- ------- ------- ------- Diluted earnings per share: Adjusted weighted average number of shares and assumed conversions 19,043 18,177 19,053 17,936 ======= ======= ======= =======
3. FINANCIAL INFORMATION BY BUSINESS SEGMENT AND GEOGRAPHIC AREA (IN THOUSANDS) The Company operates in three business segments consisting of a product sales business, primarily comprised of the pharmaceuticals business unit, a product development business, primarily the aaiResearch business unit, and a fee-for-service business, primarily the AAI International business unit. The product sales business provides for the sales of M.V.I., Aquasol, Brethine, Darvon, Darvocet-N and azathioprine product lines and for the commercial manufacturing of small quantity products outsourced by other pharmaceutical companies. In the product development segment, the Company internally develops drugs and technologies with the objective of licensing marketing rights to third parties in exchange for license fees and royalties. The core services provided on a fee-for-service basis to pharmaceutical and biotechnology industries worldwide include comprehensive formulation, testing and manufacturing expertise, in addition to the ability to take investigational products into and through human clinical trials. The majority of the Company's non-U.S. operations are located in Germany. 8 Corporate income (loss) from operations includes general corporate overhead costs and goodwill amortization, which are not directly attributable to a business segment. Financial data by segment and geographic region are as follows:
Three Months Ended Six Months Ended June 30, June 30, ------------------------ ------------------------ 2002 2001 2002 2001 --------- --------- --------- --------- NET REVENUES: Product sales $ 34,673 $ 2,143 $ 54,850 $ 4,597 Product development 6,469 4,952 8,604 8,683 --------- --------- --------- --------- 41,142 7,095 63,454 13,280 --------- --------- --------- --------- Research revenues: Non-clinical 14,518 15,832 31,395 33,076 Clinical 5,787 6,957 12,218 13,725 --------- --------- --------- --------- 20,305 22,789 43,613 46,801 --------- --------- --------- --------- $ 61,447 $ 29,884 $ 107,067 $ 60,081 ========= ========= ========= ========= United States $ 61,352 $ 26,581 $ 104,701 $ 53,445 Germany 3,290 4,332 6,914 8,094 Other 197 234 396 544 Less intercompany (3,392) (1,263) (4,944) (2,002) --------- --------- --------- --------- $ 61,447 $ 29,884 $ 107,067 $ 60,081 ========= ========= ========= ========= INCOME (LOSS) FROM OPERATIONS: Product sales $ 21,400 $ (363) $ 30,874 $ (486) Product development 933 3,226 (1,277) 4,678 --------- --------- --------- --------- 22,333 2,863 29,597 4,192 --------- --------- --------- --------- Research revenues: Non-clinical (1,621) 1,197 (813) 4,204 Clinical 430 399 862 516 --------- --------- --------- --------- (1,191) 1,596 49 4,720 --------- --------- --------- --------- Corporate (4,814) (1,927) (8,259) (5,199) --------- --------- --------- --------- $ 16,328 $ 2,532 $ 21,387 $ 3,713 ========= ========= ========= ========= United States $ 16,773 $ 1,996 $ 21,850 $ 2,959 Germany (288) 641 212 946 Other (157) (105) (251) (192) --------- --------- --------- --------- $ 16,328 $ 2,532 $ 21,387 $ 3,713 ========= ========= ========= =========
9
June 30, December 31, 2002 2001 --------- ------------ TOTAL ASSETS: Product sales $ 351,394 $ 105,541 Product development 6,692 7,832 Research revenues 52,060 55,555 Corporate 33,231 27,358 --------- --------- $ 443,377 $ 196,286 ========= ========= United States $ 422,186 $ 176,518 Germany 20,030 18,794 Other 1,161 974 --------- --------- $ 443,377 $ 196,286 ========= =========
4. TRANSACTIONS WITH RELATED PARTIES The Company has revenue, accounts receivable and work-in-progress with Aesgen, Inc. ("Aesgen") and Endeavor Pharmaceuticals, Inc. ("Endeavor"). Both Endeavor and Aesgen were organized by aaiPharma Inc. and its principal shareholders and continue to be related parties. Revenues recognized from Aesgen totaled $220,000 and $339,000 for the three and six months ended June 30, 2002. No revenues were recognized from Aesgen for the three and six months ended June 30, 2001. Revenues recognized from Endeavor totaled $667,000 and $966,000 for the three and six months ended June 30, 2002, and were $108,000 and $230,000 for the three and six months ended June 30, 2001. Services performed by the Company for Aesgen are covered by a Subscription Agreement, whereby the Company has agreed to receive Aesgen preferred stock in lieu of cash for the services performed. At June 30, 2002, we had no accounts receivable or work-in-progress related to Aesgen, and had approximately $220,000 of accounts receivable and work-in-progress related to Endeavor. 5. DEBT The following table presents the components of current maturities of long-term debt and short-term debt:
June 30, December 31, 2002 2001 --------- ------------ (In thousands) Current maturities of long-term debt and short-term debt $ 5,417 $ -- ========= =========
10 The following table presents the components of long-term debt:
June 30, December 31, 2002 2001 --------- ------------ (In thousands) U.S. bank term loan $ 92,000 $ 78,000 U.S. revolving credit facility 39,000 -- 11% senior subordinated notes due 2010, net of original issue discount 173,891 -- Interest rate swap monetization deferred income 3,428 -- Fair value of interest rate swap 676 -- Obligations under asset purchase agreement 914 878 Less current maturities of long-term debt (5,417) -- --------- --------- Total long-term debt due after one year $ 304,492 $ 78,878 ========= =========
On March 28, 2002, the Company entered into a $175 million senior secured credit facility consisting of a $75.0 million five-year revolving credit facility and a $100 million five-year term loan facility. The term loan facility amortizes over the full five-year term, with amortization of $5.0 million, $15.0 million, $20.0 million, $25.0 million and $35.0 million, respectively, in years one through five. As of June 30, 2002, the Company has paid $3.3 million of the first year's required payment plus $4.7 million of future required payments. The availability of borrowings under the revolving credit facility is not limited by a borrowing base. The senior credit facilities provide for variable interest rates based on LIBOR or an alternate base rate, at the Company's option. On June 30, 2002, 30-day LIBOR was 1.84%. Such facilities are guaranteed by all domestic subsidiaries and secured by a security interest on substantially all domestic assets, all of the stock of domestic subsidiaries and 65% of the stock of material foreign subsidiaries. The senior credit facilities require the payment of certain commitment fees based on the unused portion of the revolving credit facility. These senior credit facilities may be prepaid at any time without a premium. On March 28, 2002, the Company issued $175 million of senior subordinated notes due April 1, 2010. The proceeds from the issuance of these notes were $173.9 million, which was net of the original issue discount. This discount will be charged to interest expense over the term of the notes. These notes have a fixed interest rate of 11% per annum and are guaranteed on a subordinated basis by all existing domestic subsidiaries and all future domestic subsidiaries that are owned 80% or more by the Company. The notes are not secured. Prior to the third anniversary of the date of issuance of the notes, up to 35% of the notes are redeemable with the proceeds of qualified sales of equity at 111% of par value. The terms of the senior credit facilities first require repayment of all of the indebtedness under these facilities before repurchase of any of the notes. On or after the fourth anniversary of the date of issuance of the notes, all or any portion of the notes are redeemable at declining premiums to par value, beginning at 105.5%. On March 28, 2002, the Company entered into an interest rate swap agreement to effectively convert interest rate expense on $140 million of senior subordinated notes for the term of the notes from an 11% fixed annual rate to a floating annual rate equal to 6-month LIBOR plus 4.78%. On May 30, 2002, the Company sold this swap agreement and received $4.1 million. This amount, less the interest benefit earned through May 30, 2002, has been recorded as a premium to the carrying amount of the notes and will be amortized into interest income over their remaining life. Concurrent with the sale of the interest rate 11 swap, the Company entered into a new interest rate swap agreement which effectively converted $150 million of the notes from an 11% fixed annual rate to a floating rate equal to 6-month LIBOR plus 5.28%. On June 30, 2002, 6-month LIBOR was 1.96%. On August 5, 2002, the Company sold this new swap agreement for $5.6 million, which will also be recorded as a premium to the carrying amount of the notes and amortized into interest income over their remaining life, and entered into another interest rate swap agreement on similar terms as the May 30, 2002 agreement, at a floating rate of 6-month LIBOR plus 5.95%. Under the terms of the senior secured credit facility and the senior subordinated notes, the Company is required to comply with various covenants including, but not limited to, those pertaining to maintenance of certain financial ratios and incurring additional indebtedness. The Company was in compliance with the covenants at June 30, 2002. 6. ACQUISITIONS On March 28, 2002, the Company acquired the U.S. rights to the Darvon and Darvocet-N branded product lines, which treat mild to moderate pain, and existing inventory from Eli Lilly and Company, in a business combination accounted for as a purchase. The Company acquired these product lines and related intangible assets for $211.4 million. To finance this acquisition, which included $1.8 million of inventory, the Company used the proceeds from the senior secured credit facilities and senior subordinated notes, as described in note 5. The Darvon and Darvocet-N product lines did not have separable assets and liabilities associated with them, other than inventory, therefore the Company allocated the purchase price, including acquisition related expenses, to acquired identifiable assets, with the excess of the purchase price over the identifiable tangible and intangible assets recorded as goodwill. Based on this allocation, $51.2 million of intangible assets have been identified and will be amortized over 20 years. The excess of the purchase price over identifiable intangible assets has been classified as goodwill, which is not subject to amortization. 12 The following unaudited pro forma consolidated financial information reflects the results of operations for the three and six months ended June 30, 2002 and 2001, as if the above acquisition had occurred on January 1, 2001.
Three Months Ended June 30, Six Months Ended June 30, --------------------------- ------------------------- 2002 2001 2002 2001 ----------- ---------- ---------- --------- (In thousands, except per share data) Net revenues $ 61,447 $ 47,396 $ 116,799 $ 94,558 Income before extraordinary loss 6,104 4,027 7,879 7,423 Net income 6,104 4,027 2,540 7,423 Basic earnings per share: Income before extraordinary loss $ 0.33 $ 0.23 $ 0.43 $ 0.42 Net income $ 0.33 $ 0.23 $ 0.14 $ 0.42 Diluted earnings per share: Income before extraordinary loss $ 0.32 $ 0.22 $ 0.41 $ 0.41 Net income $ 0.32 $ 0.22 $ 0.13 $ 0.41
These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what operating results would have been had the acquisitions taken place on January 1, 2001. In addition, these results are not intended to be a projection of future results and do not reflect any synergies that might be achieved from the combined operations. As previously reported, the Company completed the acquisition of the M.V.I. and Aquasol branded product lines in August 2001, and the acquisition of the Brethine branded product line in December 2001. Revenues from the sales of these products are included in the Company's results of operations beginning on their acquisition dates. 7. EXTRAORDINARY LOSS In March 2002, the Company recorded a charge of $5.3 million, net of a tax benefit of $2.7 million, to record the write-off of deferred financing and other costs related to its prior debt facilities and redeemable warrants. 13 8. FINANCIAL INFORMATION FOR SUBSIDIARY GUARANTORS AND NON-GUARANTORS In the first quarter of 2002, the Company issued senior subordinated notes which are guaranteed by certain of the Company's subsidiaries. The following presents condensed consolidating financial information for the Company, segregating: (1) aaiPharma Inc., which issued the notes (the "Issuer"); (2) the domestic subsidiaries, which guarantee the notes (the "Guarantor Subsidiaries"); and (3) all other subsidiaries (the "Non-Guarantor Subsidiaries"). The guarantor subsidiaries are wholly owned direct subsidiaries of the Company and their guarantees are full, unconditional and joint and several. Wholly owned subsidiaries are presented on the equity basis of accounting. Certain reclassifications have been made to conform all of the financial information to the financial presentation on a consolidated basis. The principal eliminating entries eliminate investments in subsidiaries and inter-company balances and transactions. The following information presents consolidating statements of operations, balance sheets and cash flows for the periods and as of the dates indicated:
Three Months Ended June 30, 2002 ------------------------------------------------------------------------------- Non- Guarantor Guarantor Issuer Subsidiaries Subsidiaries Eliminations Consolidated ------------------------------------------------------------------------------- Net revenues $ 13,936 $ 47,416 $ 3,487 $ (3,392) $ 61,447 Equity earnings from subsidiaries 16,822 -- -- (16,822) -- -------- -------- -------- -------- -------- Total revenues 30,758 47,416 3,487 (20,214) 61,447 Operating costs and expenses: Direct costs 9,726 12,871 2,647 (3,183) 22,061 Selling 1,712 3,627 420 -- 5,759 General and administrative 8,001 2,837 865 -- 11,703 Research and development 169 5,427 -- -- 5,596 -------- -------- -------- -------- -------- 19,608 24,762 3,932 (3,183) 45,119 -------- -------- -------- -------- -------- Income (loss) from operations 11,150 22,654 (445) (17,031) 16,328 Other income (expense): Interest, net 566 (7,139) 20 -- (6,553) Net intercompany interest (584) 632 (48) -- -- Other (1,198) 1,266 1 -- 69 -------- -------- -------- -------- -------- (1,216) (5,241) (27) -- (6,484) -------- -------- -------- -------- -------- Income (loss) before income taxes 9,934 17,413 (472) (17,031) 9,844 Provision for income taxes 3,830 -- (90) -- 3,740 -------- -------- -------- -------- -------- Net income (loss) $ 6,104 $ 17,413 $ (382) $(17,031) $ 6,104 ======== ======== ======== ======== ========
14
Three Months Ended June 30, 2001 ----------------------------------------------------------------------------- Non- Guarantor Guarantor Issuer Subsidiaries Subsidiaries Eliminations Consolidated ----------------------------------------------------------------------------- Net revenues $ 13,717 $ 12,864 $ 4,565 $ (1,262) $ 29,884 Equity earnings from subsidiaries 4,994 -- -- (4,994) -- -------- -------- -------- -------- -------- Total revenues 18,711 12,864 4,565 (6,256) 29,884 Operating costs and expenses: Direct costs 8,354 5,573 2,611 (1,262) 15,276 Selling 1,935 676 280 -- 2,891 General and administrative 3,455 1,787 1,140 -- 6,382 Research and development 315 1,451 -- -- 1,766 Direct pharmaceutical start-up costs -- 1,037 -- -- 1,037 -------- -------- -------- -------- -------- 14,059 10,524 4,031 (1,262) 27,352 -------- -------- -------- -------- -------- Income (loss) from operations 4,652 2,340 534 (4,994) 2,532 Other income (expense): Interest, net (283) (3) (41) -- (327) Net intercompany interest (2,185) 2,203 (18) -- -- Other (942) (49) 28 -- (963) -------- -------- -------- -------- -------- (3,410) 2,151 (31) -- (1,290) -------- -------- -------- -------- -------- Income (loss) before income taxes 1,242 4,491 503 (4,994) 1,242 Provision for income taxes 228 -- -- -- 228 -------- -------- -------- -------- -------- Net income (loss) $ 1,014 $ 4,491 $ 503 $ (4,994) $ 1,014 ======== ======== ======== ======== ========
15
Six Months Ended June 30, 2002 ----------------------------------------------------------------------------- Non- Guarantor Guarantor Issuer Subsidiaries Subsidiaries Eliminations Consolidated ----------------------------------------------------------------------------- Net revenues $ 30,673 $ 74,028 $ 7,310 $ (4,944) $107,067 Equity earnings from subsidiaries 18,579 -- -- (18,579) -- -------- -------- -------- -------- -------- Total revenues 49,252 74,028 7,310 (23,523) 107,067 Operating costs and expenses: Direct costs 19,986 23,831 5,203 (4,735) 44,285 Selling 3,404 5,855 817 -- 10,076 General and administrative 14,046 5,447 1,753 -- 21,246 Research and development 416 9,657 -- -- 10,073 -------- -------- -------- -------- -------- 37,852 44,790 7,773 (4,735) 85,680 -------- -------- -------- -------- -------- Income (loss) from operations 11,400 29,238 (463) (18,788) 21,387 Other income (expense): Interest, net 453 (8,852) 23 -- (8,376) Net intercompany interest (1,148) 1,257 (109) -- -- Other (1,091) 1,254 40 -- 203 -------- -------- -------- -------- -------- (1,786) (6,341) (46) -- (8,173) -------- -------- -------- -------- -------- Income (loss) before income taxes and extraordinary loss 9,614 22,897 (509) (18,788) 13,214 Provision for income taxes 5,111 -- (90) -- 5,021 -------- -------- -------- -------- -------- Income (loss) before extraordinary loss 4,503 22,897 (419) (18,788) 8,193 Extraordinary loss (1,649) (3,690) -- -- (5,339) -------- -------- -------- -------- -------- Net income (loss) $ 2,854 $ 19,207 $ (419) $(18,788) $ 2,854 ======== ======== ======== ======== ========
16
Six Months Ended June 30, 2001 ----------------------------------------------------------------------------- Non- Guarantor Guarantor Issuer Subsidiaries Subsidiaries Eliminations Consolidated ----------------------------------------------------------------------------- Net revenues $ 28,775 $ 24,670 $ 8,637 $ (2,001) $ 60,081 Equity earnings from subsidiaries 7,223 -- -- (7,223) -- -------- -------- -------- -------- -------- Total revenues 35,998 24,670 8,637 (9,224) 60,081 Operating costs and expenses: Direct costs 16,817 10,672 5,237 (2,001) 30,725 Selling 3,796 1,372 561 -- 5,729 General and administrative 8,372 3,667 2,086 -- 14,125 Research and development 1,194 2,914 -- -- 4,108 Direct pharmaceutical start-up costs -- 1,681 -- -- 1,681 -------- -------- -------- -------- -------- 30,179 20,306 7,884 (2,001) 56,368 -------- -------- -------- -------- -------- Income (loss) from operations 5,819 4,364 753 (7,223) 3,713 Other income (expense): Interest, net (499) (2) (209) -- (710) Net intercompany interest (2,185) 2,203 (18) -- -- Other (819) (35) 167 -- (687) -------- -------- -------- -------- -------- (3,503) 2,166 (60) -- (1,397) -------- -------- -------- -------- -------- Income (loss) before income taxes 2,316 6,530 693 (7,223) 2,316 Provision for income taxes 486 -- -- -- 486 -------- -------- -------- -------- -------- Net income (loss) $ 1,830 $ 6,530 $ 693 $ (7,223) $ 1,830 ======== ======== ======== ======== ========
17
June 30, 2002 ----------------------------------------------------------------------------- Non- Guarantor Guarantor Issuer Subsidiaries Subsidiaries Eliminations Consolidated ----------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 4,014 $ 133 $ 65 $ -- $ 4,212 Accounts receivable, net 11,099 26,949 2,293 -- 40,341 Work-in-progress 4,634 5,608 4,978 (3,544) 11,676 Inventories 4,066 4,956 580 (209) 9,393 Prepaid and other current assets 1,736 3,907 220 -- 5,863 --------- --------- --------- --------- --------- Total current assets 25,549 41,553 8,136 (3,753) 71,485 Investments in and advances to subsidiaries 66,061 (46,202) -- (19,859) -- Property and equipment, net 42,366 6,102 3,957 -- 52,425 Goodwill and other intangibles, net 1,135 290,384 9,006 -- 300,525 Other assets 7,475 11,374 93 -- 18,942 --------- --------- --------- --------- --------- Total assets $ 142,586 $ 303,211 $ 21,192 $ (23,612) $ 443,377 ========= ========= ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt and short-term debt $ -- $ 5,417 $ -- $ -- $ 5,417 Accounts payable 4,282 9,626 1,693 -- 15,601 Customer advances 11,107 6,582 2,925 (3,544) 17,070 Accrued wages and benefits 1,984 1,034 1,297 -- 4,315 Interest payable 563 6,053 -- 6,616 Other accrued liabilities 1,183 3,510 114 129 4,936 --------- --------- --------- --------- --------- Total current liabilities 19,119 32,222 6,029 (3,415) 53,955 Long-term debt, less current portion 39,000 265,492 -- -- 304,492 Other liabilities 1,343 -- -- -- 1,343 Investments in and advances to subsidiaries 59,800 (63,698) 4,027 (129) -- Redeemable warrants -- -- -- -- -- Total stockholders' equity 23,324 69,195 11,136 (20,068) 83,587 --------- --------- --------- --------- --------- Total liabilities and stockholders' equity $ 142,586 $ 303,211 $ 21,192 $ (23,612) $ 443,377 ========= ========= ========= ========= =========
18
December 31, 2001 -------------------------------------------------------------------------- Non- Guarantor Guarantor Issuer Subsidiaries Subsidiaries Eliminations Consolidated -------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 5,301 $ 154 $ 916 $ -- $ 6,371 Accounts receivable, net 13,189 8,415 2,690 2,300 26,594 Work-in-progress 3,871 5,099 3,794 (2,300) 10,464 Inventories 2,955 5,584 518 -- 9,057 Prepaid and other current assets 3,081 2,640 251 -- 5,972 --------- --------- --------- --------- --------- Total current assets 28,397 21,892 8,169 -- 58,458 Investments in and advances to subsidiaries 66,061 (46,202) -- (19,859) -- Property and equipment, net 27,724 5,841 3,470 -- 37,035 Goodwill and other intangibles, net 1,071 79,383 8,050 -- 88,504 Other assets 7,372 4,836 81 -- 12,289 --------- --------- --------- --------- --------- Total assets $ 130,625 $ 65,750 $ 19,770 $ (19,859) $ 196,286 ========= ========= ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt and short-term debt $ -- $ 14 $ -- $ (14) $ -- Accounts payable 3,626 10,236 1,582 -- 15,444 Customer advances 3,883 6,874 2,592 -- 13,349 Accrued wages and benefits 2,040 958 881 -- 3,879 Other accrued liabilities 2,821 2,572 302 (402) 5,293 --------- --------- --------- --------- --------- Total current liabilities 12,370 20,654 5,357 (416) 37,965 Long-term debt, less current portion -- 78,878 -- -- 78,878 Other liabilities 224 -- -- -- 224 Investments in and advances to subsidiaries 79,157 (83,625) 4,052 416 -- Redeemable warrants 2,855 -- -- -- 2,855 Stockholders' equity 36,019 49,843 10,361 (19,859) 76,364 --------- --------- --------- --------- --------- Total liabilities and stockholders' equity $ 130,625 $ 65,750 $ 19,770 $ (19,859) $ 196,286 ========= ========= ========= ========= =========
19
Six Months Ended June 30, 2002 -------------------------------------------------------------------- Non- Guarantor Guarantor Issuer Subsidiaries Subsidiaries Eliminations Consolidated -------------------------------------------------------------------- Cash flows from operating activities: Income (loss) before extraordinary loss $ 4,503 $ 22,897 $(419) $ (18,788) $ 8,193 Adjustments to reconcile net income (loss) before extraordinary loss to net cash provided by (used in) operating activities: Depreciation and amortization 2,307 1,661 504 -- 4,472 Other 3 12 102 -- 117 Changes in operating assets and liabilities: Trade and other receivables 2,090 (18,533) 716 2,300 (13,427) Work-in-progress (764) (508) (733) 1,244 (761) Inventories (1,111) 627 -- 209 (275) Prepaid and other assets 1,242 (14,271) 59 -- (12,970) Accounts payable 655 (610) (77) -- (32) Customer advances 7,225 (292) 24 (3,544) 3,413 Interest payable 563 5,682 -- -- 6,245 Accrued wages and benefits and other accrued liabilities (3,429) 3,188 (394) 531 (104) Intercompany receivables and payables (39,586) 21,576 (24) 18,034 -- --------- --------- ----- --------- --------- Net cash (used in) provided by operating activities (26,302) 21,429 (242) (14) (5,129) --------- --------- ----- --------- --------- Cash flows from investing activities: Purchases of property and equipment (16,865) (937) (745) -- (18,547) Acquisitions -- (211,997) -- -- (211,997) Other (151) -- -- -- (151) --------- --------- ----- --------- --------- Net cash (used in) investing activities (17,016) (212,934) (745) -- (230,695) --------- --------- ----- --------- --------- Cash flows from financing activities: Proceeds from long-term borrowings 49,400 199,355 -- -- 248,755 Payments on long-term borrowings (10,400) (8,014) -- 14 (18,400) Issuance of common stock 3,031 -- -- -- 3,031 Other -- 143 27 -- 170 --------- --------- ----- --------- --------- Net cash provided by financing activities 42,031 191,484 27 14 233,556 --------- --------- ----- --------- --------- Net increase (decrease) in cash and cash equivalents (1,287) (21) (960) -- (2,268) Effect of exchange rate changes on cash -- -- 109 -- 109 Cash and cash equivalents, beginning of year 5,301 154 916 -- 6,371 --------- --------- ----- --------- --------- Cash and cash equivalents, end of period $ 4,014 $ 133 $ 65 $ -- $ 4,212 ========= ========= ===== ========= =========
20
Six Months Ended June 30, 2001 ---------------------------------------------------------------------- Non- Guarantor Guarantor Issuer Subsidiaries Subsidiaries Eliminations Consolidated ---------------------------------------------------------------------- Cash flows from operating activities: Net income (loss) $ 1,830 $ 6,530 $ 693 $ (7,223) $ 1,830 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 2,438 507 643 -- 3,588 Other 453 358 58 -- 869 Changes in operating assets and liabilities: Trade and other receivables (1,818) (3,114) 174 -- (4,758) Work-in-progress 1,475 (965) (1,908) -- (1,398) Inventories 702 (21) 119 -- 800 Prepaid and other assets 173 339 (126) -- 386 Accounts payable (769) (359) 12 -- (1,116) Customer advances 33 (494) 746 -- 285 Interest payable (64) -- -- -- (64) Accrued wages and benefits and other accrued liabilities (541) 118 702 -- 279 Intercompany receivables and payables (6,015) (3,056) 1,848 7,223 -- -------- -------- -------- -------- -------- Net cash (used in) provided by operating activities (2,103) (157) 2,961 -- 701 -------- -------- -------- -------- -------- Cash flows from investing activities: Purchases of property and equipment (1,471) (352) (738) -- (2,561) Proceeds from sales of property and equipment 2,757 293 -- -- 3,050 Other (104) -- -- -- (104) -------- -------- -------- -------- -------- Net cash provided by (used in) investing activities 1,182 (59) (738) -- 385 -------- -------- -------- -------- -------- Cash flows from financing activities: Net payments on short-term debt 450 -- (1,552) -- (1,102) Payments on long-term borrowings (304) (32) -- -- (336) Issuance of common stock 1,115 -- -- -- 1,115 Other 41 7 (35) -- 13 -------- -------- -------- -------- -------- Net cash (used in) provided by financing activities 1,302 (25) (1,587) -- (310) -------- -------- -------- -------- -------- Net increase in cash and cash equivalents 381 (241) 636 -- 776 Effect of exchange rate changes on cash -- -- (8) -- (8) Cash and cash equivalents, beginning of year 639 497 89 -- 1,225 -------- -------- -------- -------- -------- Cash and cash equivalents, end of period $ 1,020 $ 256 $ 717 $ -- $ 1,993 ======== ======== ======== ======== ========
21 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, the commencement, completion or cancellation of large contracts, demand for our pharmaceutical product lines, ability of contract manufacturers to supply conforming products on a timely basis, costs and results of ongoing and future litigation by and against us, progress of ongoing contracts, amounts recognized for licensing and royalty revenues, timing and amounts of start-up expenses for new facilities, timing and level of research and development expenditures, and changes in the mix of services. Because a large percentage of our operating costs are relatively fixed, variations in the timing and progress of large contracts, changes in the demand for our services and products, or the recognition of licensing and royalty revenues (on projects for which associated expense may have been recognized in prior periods) can materially affect our quarterly results. Accordingly, we believe that comparisons of our quarterly financial results may not be meaningful. RESULTS OF OPERATIONS: The following table presents the net revenues for each of our business units and our consolidated expenses and net income and each item expressed as a percentage of consolidated net revenues:
Three Months Ended June 30, Six Months Ended June 30, ------------------------------------------- ------------------------------------------ 2002 2001 2002 2001 ------------------- ------------------- -------------------- ----------------- (dollars in thousands) Net revenues: Product sales $ 34,673 56% $ 2,143 7% $ 54,850 52% $ 4,597 8% Product development 6,469 11% 4,952 17% 8,604 8% 8,683 14% -------- ------ -------- ------ --------- ------ -------- ---- 41,142 67% 7,095 24% 63,454 60% 13,280 22% -------- ------ -------- ------ --------- ------ -------- ---- Research revenues: Non-clinical 14,518 24% 15,832 53% 31,395 29% 33,076 55% Clinical 5,787 9% 6,957 23% 12,218 11% 13,725 23% -------- ------ -------- ------ --------- ------ -------- ---- 20,305 33% 22,789 76% 43,613 40% 46,801 78% -------- ------ -------- ------ --------- ------ -------- ---- $ 61,447 100% $ 29,884 100% $ 107,067 100% $ 60,081 100% ======== ====== ======== ====== ========= ====== ======== ==== Direct costs $ 22,061 36% $ 15,276 51% $ 44,285 41% $ 30,725 51% Selling 5,759 9% 2,891 10% 10,076 9% 5,729 10% General and administrative 11,703 19% 6,382 21% 21,246 20% 14,125 24% Research and development 5,596 9% 1,766 6% 10,073 9% 4,108 7% Direct pharmaceutical start-up costs -- -- 1,037 3% -- -- 1,681 3% Income from operations 16,328 27% 2,532 8% 21,387 20% 3,713 6% Interest expense, net (6,553) (11%) (327) (1%) (8,376) (8%) (710) (1%) Provision for income taxes 3,740 6% 228 1% 5,021 5% 486 1% Net income 6,104 10% 1,014 3% 2,854 3% 1,830 3%
22 SECOND QUARTER 2002 COMPARED TO SECOND QUARTER 2001 Our consolidated net revenues for the quarter ended June 30, 2002 increased 106% to $61.4 million, from $29.9 million in the second quarter of 2001. Net revenues from product sales increased to $34.7 million in 2002, from $2.1 million in 2001, due to sales of our M.V.I., Aquasol and Brethine products, which we acquired in the second half of 2001 and sales of Darvon and Darvocet-N, which we acquired at the end of the first quarter of 2002. Because these acquired product lines will contribute revenues for the full year ending December 31, 2002, we have planned for significantly increased net revenues and expense from these product lines for 2002. Net revenues from commercial manufacturing of products marketed by other pharmaceutical companies, which is included in product sales, contributed $0.8 million and $2.1 million to net revenues from product sales in the second quarters of 2002 and 2001, respectively. Net revenues from product development increased 31% in the second quarter of 2002 to $6.5 million, from $5.0 million in 2001, primarily due to an increase in product development revenues under our significant development agreement, from $4.1 million in the second quarter of 2001 to $5.7 million in the second quarter of 2002. This development agreement is described in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of our Form 10-K for the fiscal year ended December 31, 2001. We expect product development revenues to be slightly lower on a quarterly basis over the remainder of the year. Net revenues from our research revenues business decreased 11% in the second quarter of 2002 to $20.3 million, from $22.8 million in 2001. Non-clinical research revenues decreased by 8% in 2002 to $14.5 million, a decrease of $1.3 million over the prior year, due primarily to a lower level of bioanalytical revenues in our U.S. operations and Phase I pre-clinical revenues in Europe. Clinical research revenues decreased by 17% in 2002 to $5.8 million, from $7.0 million in 2001. This decrease was primarily attributable to the re-deployment of a portion of our internal resources and capabilities from external revenue-producing projects to internal research and development projects. Gross margin dollars, or net revenues less direct costs, increased $24.8 million, or 170%, to $39.4 million, from $14.6 million in the second quarter of 2001, reflecting the benefit from our increased product sales revenues in 2002 over the prior year. As a percentage of net revenues, gross margin dollars increased to 64% in the second quarter of 2002 from 49% in the second quarter of 2001. The higher margins generated by our product sales business were partially offset by decreases in revenues and gross margin percentage from our research revenues business. Selling expenses increased 99% in the second quarter of 2002 to $5.8 million, from $2.9 million in 2001. This increase is primarily due to additional selling expenses incurred by our product sales business associated with marketing and promoting our new products, maintaining and enhancing distribution channels, and developing our product sales force. As a percentage of net revenues, selling expenses in the second quarter of 2002 decreased slightly from the second quarter of 2001. General and administrative costs increased 83% in the second quarter of 2002 to $11.7 million, from $6.4 million in 2001. This increase was primarily due to expenses related to the management build-up for our product sales business. As a percentage of net revenues, general and administrative expenses in the second quarter of 2002 decreased to 19%, from 21% in the second quarter of 2001, a trend that we expect to continue throughout the year. 23 Research and development expenses were approximately 9% of net revenues, or $5.6 million, in the second quarter of 2002, an increase from 6% of net revenues, or $1.8 million, in 2001. This increase resulted primarily from clinical trials we started in the first quarter of 2002 for our ProSorb-D pain management product. In general, we target annual research and development expenses to be approximately 8% to 10% of our estimated net revenues. There were no direct pharmaceutical start-up costs recorded in the second quarter of 2002, as compared to $1.0 million in the second quarter of 2001. These costs were incurred prior to our acquisition of any pharmaceutical product lines in 2001 and were expensed as incurred. Net interest expense increased to $6.6 million in the second quarter of 2002, from $0.3 million in 2001. This $6.3 million increase is primarily attributable to the borrowings that funded our product line acquisitions in the second half of 2001 and the first quarter of 2002. We have planned for significantly higher net interest expense in 2002, arising from the debt incurred to fund these acquisitions. Consolidated income from operations was $16.3 million in the second quarter of 2002, or $13.8 million higher than the prior year. This increase is primarily due to the expansion of our product sales business. This increase was partially offset by decreases in our research revenues business and our increased R&D spending. Income from operations for our product sales business was $21.4 million in the second quarter of 2002, compared to a loss from operations of ($0.4) million in the prior year. This increase is attributable to the revenues from our M.V.I., Aquasol, Brethine, Darvon and Darvocet-N product lines, which we acquired in the second half of 2001 and first quarter of 2002. Income from operations for our product development business was $0.9 million in the second quarter of 2002, compared to income from operations of $3.2 million in 2001. This change resulted from our increased research and development spending, as discussed above. We recorded a loss from operations for our research revenues business of ($1.2) million in the second quarter of 2002, compared to income from operations of $1.6 million in 2001. This decrease is primarily due to the decline in fee-for-service revenues, as described above. Unallocated corporate expenses increased in the second quarter of 2002 to $4.8 million, from $1.9 million in 2001. This higher level was due to additions to our corporate infrastructure to accommodate the expansion of our overall business, increased legal fees to support our intellectual property and lower reserve needs on customer balances reflected in the prior year results. As a percentage of net revenues, unallocated corporate expenses in the second quarter of 2002 increased to 8%, from 6% in the second quarter of 2001. We recorded a tax provision of $3.7 million in the second quarter of 2002, based on an effective tax rate of 38%. This rate is approximately equal to the statutory rate. Our effective tax rate for the second quarter of 2001 was 24%, which reflected the utilization of tax loss-carryforwards generated by our European operations. 24 SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001 Our consolidated net revenues for the six months ended June 30, 2002 increased 78% to $107.1 million, from $60.1 million in the first half of 2001. Net revenues from product sales increased to $54.9 million in 2002, from $4.6 million in 2001, due to sales of our M.V.I., Aquasol and Brethine products, which we acquired in the second half of 2001 and sales of Darvon and Darvocet-N, which we acquired at the end of the first quarter in 2002. Net revenues from commercial manufacturing of products marketed by other pharmaceutical companies, which is included in product sales, contributed $3.8 million and $4.6 million to net revenues from product sales in the first six months of 2002 and 2001, respectively. Net revenues from product development decreased 1% in the first half of 2002 to $8.6 million, from $8.7 million in the first half of 2001. Product development revenues under our significant development agreement increased from $6.7 million in the first half of 2001 to $7.1 million in the first half of 2002. Net revenues from our research revenues business decreased 7% in the first half of 2002 to $43.6 million, from $46.8 million in the first half of 2001. Non-clinical research revenues decreased by 5% in 2002 to $31.4 million, a decrease of $1.7 million over the prior year, due primarily to a lower level of bioanalytical revenues in our U.S. operations and Phase I pre-clinical revenues in Europe. Clinical research revenues decreased by 11% in 2002 to $12.2 million, from $13.7 million in 2001. This decrease was primarily attributable to the re-deployment of a portion of our internal resources and capabilities from external revenue-producing projects to internal research and development projects. Gross margin dollars increased $33.4 million to $62.8 million, from $29.4 million in the first half of 2001, reflecting the benefit from our increased product sales revenues. As a percentage of net revenues, gross margin dollars increased to 59% in the first half of 2002 from 49% in the first half of 2001. The higher margins generated by our product sales business were partially offset by decreases in revenues and gross margin percentage from our research revenues business. Selling expenses increased 76% in the first half of 2002 to $10.1 million, from $5.7 million in 2001. This increase is principally due to additional selling expenses incurred by our product sales business associated with marketing and promoting our new products, maintaining and enhancing distribution channels, and developing our product sales force. As a percentage of net revenues, selling expenses in the first half of 2002 remained consistent with the first half of 2001. General and administrative costs increased 50% in the first half of 2002 to $21.2 million, from $14.1 million in 2001. This increase was primarily due to expenses related to the management build-up for our product sales business. As a percentage of net revenues, general and administrative expenses in the first half of 2002 decreased to 20%, from 24% in the first half of 2001, a trend that we expect to continue throughout the year. Research and development expenses were approximately 9% of net revenues, or $10.1 million, in the first half of 2002, an increase from 7% of net revenues, or $4.1 million, in 2001. As previously discussed, this increase resulted primarily from clinical trials started in the first quarter of 2002 for our ProSorb-D pain management product. 25 There were no direct pharmaceutical start-up costs recorded in the first half of 2002, as compared to $1.7 million in the first half of 2001. These costs were incurred prior to our acquisition of any pharmaceutical product lines in 2001 and were expensed as incurred. Net interest expense increased to $8.4 million in the first half of 2002, from $0.7 million in 2001. This increase is primarily attributable to the borrowings that funded our product line acquisitions. Consolidated income from operations was $21.4 million in the first half 2002, or $17.7 million higher than the prior year, and is due to the expansion of our product sales business. Income from operations for our product sales business was $30.9 million in the first half of 2002, compared to a loss from operations of ($0.5) million in the prior year. This increase is attributable to the revenues from our product line acquisitions. The loss from operations for our product development business was ($1.3) million in the first half of 2002, compared to income from operations of $4.7 million in 2001. This change resulted from the increased research and development spending in the first half of 2002, as discussed above. We recorded income from operations for our research revenues business of $0.1 million in the first half of 2002, compared to $4.7 million in 2001. This decrease is primarily due to the decline in research revenues, as described above. Unallocated corporate expenses increased in the first half of 2002 to $8.3 million, from $5.2 million in 2001. This increase was due to additions to our corporate infrastructure to accommodate our expansion and increased legal fees to support our intellectual property. As a percentage of net revenues, unallocated corporate expenses in the first half of 2002 decreased to 8%, from 9% in the first half of 2001. We recorded a tax provision of $5.0 million in the first half of 2002, based on an effective tax rate of 38%. This rate is approximately equal to the statutory rate. Our effective tax rate for the first half of 2001 was 21%, which reflected the utilization of tax loss-carryforwards generated by our European operations. In March 2002, we recorded an extraordinary loss of $5.3 million, net of a tax benefit of $2.7 million, to record the write-off of deferred financing and other costs related to our prior debt facilities and redeemable warrants. LIQUIDITY AND CAPITAL RESOURCES Historically, we have funded our businesses with cash flows provided by operations and proceeds from borrowings. Cash flow used in operations in the first six months of 2002 was $5.1 million, compared to cash provided by operating activities of $0.7 million in the first six months of 2001. This change was primarily due to an increase in accounts receivable related to the product lines we acquired and prepaid financing fees related to the financing of our acquisitions, partially offset by the increase in income and interest payable on our senior subordinated notes. In the second quarter of 2002, we generated cash from operating activities of $14.5 million, which was provided by our net income and increases in interest payable and customer advances, partially offset by an increase in accounts receivable related to our product sales. 26 Cash used in investing activities was $230.7 million in the first half of 2002 compared to cash provided by investing activities of $0.4 million in the first half of 2001. This included $212.0 million related to our acquisition of the Darvon and Darvocet-N branded product lines as further described below, and $14.1 million for the purchase of assets formerly covered by our tax retention operating lease, including our corporate headquarters in Wilmington, N.C. and a laboratory and clinical facility in Chapel Hill, N.C. Cash provided by financing activities during the first half of 2002 was $233.6 million, primarily representing net proceeds of $248.8 million in additional borrowings under our new debt facilities, as described below, and $3.0 million of cash proceeds from the exercise of stock options, partially offset by the repayment of $18.4 million of these borrowings in the second quarter. In March 2001, we completed a sale/leaseback transaction on manufacturing equipment, which provided cash of $3.1 million. The lease has a five-year term and requires payments of approximately $0.6 million annually. On March 28, 2002, we acquired the U.S. rights to the Darvon and Darvocet-N branded product lines and existing inventory from Eli Lilly and Company for $211.4 million in cash, subject to potential reduction based on the net sales of these products after the closing of the acquisition. In connection with the acquisition, we entered into $175 million of senior credit facilities, issued $175 million of senior subordinated notes due 2010, repaid all $78 million of borrowings outstanding under our prior senior credit facilities, and terminated our tax retention operating lease and purchased the underlying properties. Our $175 million senior secured credit facilities consist of a $75 million five-year revolving credit facility and a $100 million five-year term loan facility. The term loan facility amortizes over the full five-year term, with amortization of $5 million, $15 million, $20 million, $25 million and $35 million, respectively, in years one through five. The availability of borrowings under our revolving credit facility is not limited by a borrowing base. Our senior credit facilities provide for variable interest rates based on LIBOR or an alternate base rate, at our option. Such facilities are guaranteed by all of our domestic subsidiaries and secured by a security interest on substantially all of our domestic assets, all of the stock of our domestic subsidiaries, and 65% of the stock of our material foreign subsidiaries. Our senior credit facilities require the payment of certain commitment fees based on the unused portion of the revolving credit facility. Under the terms of the credit agreement for our senior credit facilities, we are required to comply with various covenants including, but not limited to, those pertaining to maintenance of certain financial ratios and incurrence of additional indebtedness. These senior credit facilities may be prepaid at our option at any time without a premium. On March 28, 2002, we issued $175 million of senior subordinated unsecured notes due 2010. These notes have a fixed interest rate of 11% per annum and are guaranteed on a subordinated basis by all of our existing domestic subsidiaries and all of our future domestic subsidiaries of which we own 80% or more of the equity interests. Prior to March 28, 2005, up to 35% of the notes are redeemable with the proceeds of qualified sales of equity at 111% of par value. The terms of our senior credit facilities require us to first repay all of the indebtedness under these facilities before we could repurchase any of the notes. On or after March 28, 2006, all or any portion of the notes are redeemable at declining premiums to par value, beginning at 105.5%. Under the terms of the indenture for the notes, we are 27 required to comply with various covenants including, but not limited to, a covenant relating to incurrence of additional indebtedness. On March 28, 2002, we entered into an interest rate swap agreement to effectively convert interest rate expense on $140 million of our 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 4.78%. On May 30, 2002, we sold this swap agreement and received $4.1 million. This amount, less the interest benefit earned through May 30, 2002, has been recorded as a premium to the carrying amount of the notes and will be amortized into interest income over their remaining life. Concurrent with the sale of the interest rate swap, we entered into a new interest rate swap agreement, which effectively converted $150 million of the notes from an 11% fixed annual rate to a floating rate equal to 6-month LIBOR plus 5.28%. On June 30, 2002, 6-month LIBOR was 1.96%. On August 5, 2002, we sold this new swap agreement for $5.6 million, which will also be recorded as a premium to the carrying amount of the notes and amortized into interest income over their remaining life, and entered into another interest rate swap agreement on similar terms as the May 30, 2002 agreement at a floating rate of 6-month LIBOR plus 5.95%. Our liquidity needs increased significantly during the first half of 2002. After giving effect to our completed branded product line acquisitions, our annual net interest expense may exceed $25 million in 2002. We will make $2 million in payments in the next two years, including $1 million in August 2002, and may have to make contingent payments in the next several years of $47 million in connection with our product line acquisitions of M.V.I. and Aquasol, of which $43.5 million is potentially due in August 2004. In addition, we may have to make contingent payments of $5 million over five years in connection with the purchase of our Charleston, South Carolina manufacturing facility. We have $5.4 million of principal repayments due in the next twelve months under our senior credit facilities and will make an interest payment on the senior subordinated notes of $9.6 million in October 2002. This interest payment will be reduced by approximately $1.0 million to be received under our interest rate swap agreement. On April 5, 2002, we filed a Registration Statement on Form S-1, proposing to sell 1.5 million shares of our common stock to the public. An additional 1.1 million shares were proposed to be sold by other selling stockholders. On May 24, 2002, we withdrew the Registration Statement because the terms obtainable in the market place were not sufficiently attractive to warrant proceeding with the sale of the shares. We believe that our senior credit facilities and cash flow provided by operations will be sufficient to fund near-term growth and fund our guaranteed and contingent payment obligations arising from our acquisitions. We may require additional financing to pursue other acquisition opportunities or for other reasons. We may from time to time seek to obtain additional funds through the public or private issuance of equity or debt securities. While we remain confident that we can obtain additional financing, if necessary, we cannot assure you that additional financing will be available or that the terms will be acceptable to us. FORWARD LOOKING STATEMENTS, RISK FACTORS AND "SAFE HARBOR" LANGUAGE This report contains certain forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. 28 All statements that include the words "may," "will," "estimate," "intend," "project," "target," "objective," "goal," "should," "could," "might," "continue," "believe," "expect," "plan," "anticipate" and other similar words are intended to be forward-looking statements. We assume no obligation to update forward-looking statements, or any other statements, contained in this report. For purposes of illustration, these forward-looking statements include statements relating to the amount, timing, and use of proceeds of future issuance of equity; the sufficiency of our senior credit facilities and cash flow from operations to fund near-term growth and to fund guaranteed and contingent acquisition payment obligations; the availability of future financing, if necessary; the expected amounts owed under future contingent acquisition payment obligations; anticipated product development and research services net revenues and profitability levels and trends; expected levels of future net interest expenses; targeted research and development expenditures as a percentage of net revenues; anticipated levels of sales and general and administrative costs as a percentage of net revenues; and expected net revenues, expenses and profitability of our product sales. Although we believe that the expectations underlying any of our forward-looking statements are reasonable, these expectations may prove to be incorrect and all of these statements are subject to risks and uncertainties. Should one or more of these risks and uncertainties materialize, or should underlying assumptions, projections or expectations prove incorrect, actual results, performance or financial condition may vary materially and adversely from those anticipated, estimated or expected. We have identified below some important factors that could cause our forward-looking statements to differ materially from actual results, performance or financial condition: - We have recently transitioned our company to a specialty pharmaceutical company with challenges and risks that we have not historically faced in our fee-for-services and product development businesses; - We may devote significant operational and financial resources to develop products that we may never be able to successfully commercialize; - We have increased our sales and net income through a series of acquisitions of branded products, and we intend to seek more acquisition opportunities; we may have overpaid, or may overpay in the future, for a branded product line that may not produce sufficient cash flow to repay our debt, including indebtedness incurred in connection with that acquisition; - We are dependent on third parties for essential business functions and problems with these third-party arrangements could materially adversely affect our ability to manufacture and sell products and our financial condition and results of operations; - Competition from the sale of generic products and the development by other companies of new branded products could cause the revenues from our branded products to decrease significantly; - We may be unable to obtain government approval for our products or comply with government regulations relating to our business; and - Changes in government regulations may favor sales of generic products that compete with our branded products. Additional factors that may cause the actual results to differ materially are discussed in Exhibit 99.1 to this report hereto and incorporated herein by reference and in our recent filings with the SEC, including, but not limited to, our registration statements, as amended, our Annual Report on Form 10-K filed with the 29 SEC on March 11, 2002, including the exhibits attached or incorporated therein, our Form 10-Q filed with the SEC on May 15, 2002, including the exhibits thereof, our Form 8-K reports, and other periodic filings. Whenever you read or hear any subsequent written or oral forward-looking statements attributable to us or any person acting on our behalf, you should keep in mind the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a result of global operating activities, we are exposed to risks associated with changes in foreign exchange rates, principally exchange rates between the U.S. dollar and the euro. As foreign exchange rates change, the U. S. dollar equivalent of revenues and expenses denominated in foreign currencies change. If the exchange rate between the euro and the U.S. dollar were to change by 10%, year to date net income for June 30, 2002 would have changed by $35,000 due to the change in reported results from European operations. We are also exposed to fluctuations in interest rates on borrowings under our senior credit facilities and on $150 million of our senior subordinated notes, due to our entering into the interest rate swap agreement discussed above. The interest rates payable on these borrowings are based on LIBOR. If LIBOR rates were to increase by 1%, annual interest expense on variable rate debt would increase by approximately $3.2 million, or $800,000 per quarter. 30 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We are party to lawsuits and administrative proceedings incidental to the normal course of our business. We do not believe that any liabilities related to such lawsuits or proceedings will have a material adverse effect on our financial condition, results of operations or cash flows. While we cannot predict the outcomes of these suits, we intend to vigorously pursue all defenses available. In cases where we have initiated an action, we intend to prosecute our claims to the full extent of our rights under the law. We are a party to a number of legal actions with generic drug companies. We filed three cases in the United States District Court for the Eastern District of North Carolina claiming infringement of certain of our fluoxetine hydrochloride patents. Fluoxetine hydrochoride is an active ingredient in the drug marketed by Eli Lilly as Prozac. Each of the defendants in these three actions, Dr. Reddy's Laboratories Ltd., a pharmaceutical company based in India, and its U.S. affiliate, Dr. Reddy's Laboratories, Inc. (formerly Reddy-Cheminor, Inc.), Barr Laboratories, Inc., and PAR Pharmaceuticals, Inc. sells a generic fluoxetine hydrochloride product in the United States. In the first action, filed in August 2001, we alleged that the defendants are infringing our fluoxetine hydrochloride Form A patent (U.S. Patent No. 6,258,853) and are seeking an injunction to prevent the sale of products that infringe this patent, as well as compensatory and punitive damages and attorney's fees. In the second case, filed in October 2001, we alleged that the defendants are infringing three additional fluoxetine patents (U.S. Patent Nos. 6,310,250, 6,310,251 and 6,313,350) and are seeking an injunction to prevent the defendants from selling infringing fluoxetine products, and monetary damages. In the third action, filed in November 2001, we have brought similar claims against the defendants regarding a fifth fluoxetine patent (U.S. Patent No. 6,316,672). In each case, the defendants have filed counterclaims alleging patent invalidity, violations of the North Carolina Unfair Trade Practices Act and tortious interference with the defendants' distribution agreements. We have denied the substantive allegations of their claims. These cases are all in the initial stages and discovery is just beginning. It is possible that the patents subject to these lawsuits will be found invalid or unenforceable. We are also involved in three actions centered on our omeprazole-related patents. Omeprazole is the active ingredient found in Prilosec, a drug sold by AstraZeneca. Two cases have been filed against us by Dr. Reddy's Laboratories Ltd. and Dr. Reddy's Laboratories, Inc. in the United States District Court for the Southern District of New York in July 2001 and November 2001. These plaintiffs have sought but, as of March 1, 2002 have not obtained, approval from the FDA to market a generic form of Prilosec. The plaintiffs in these cases are challenging the validity of five patents that we have obtained relating to omeprazole (U.S. Patent Nos. 6,262,085, 6,262,086, 6,268,385, 6,312,712 and 6,312,723) and are seeking a declaratory judgment that their generic form of Prilosec does not infringe these patents. Additionally, they have alleged misappropriation of trade secrets, tortious interference, unfair competition and violations of the North Carolina Unfair Trade Practice Act. We have denied the substantive allegations made in these cases. Both cases are in the initial stages and discovery is just beginning. The third case involving our omeprazole patents was brought in August 2001 by Andrx Pharmaceuticals, Inc. in the United States District Court for the Southern District of New York. Andrx has received FDA approval for its generic omeprazole product. However, to our knowledge, it is not currently marketing this 31 drug in the U.S. Andrx is challenging the validity of three of our omeprazole patents (U.S. Patent Nos. 6,262,085, 6,262,086, and 6,268,385), and is also seeking a declaratory judgment that its generic omeprazole product does not infringe these patents. Furthermore, Andrx claims violations of federal and state antitrust laws with respect to the licensing of these omeprazole patents and is seeking injunctive relief and unspecified treble damages. We have denied the substantive allegations made by Andrx. This case is in the initial stages of discovery. It is possible that the patents subject to these lawsuits will be found invalid or unenforceable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 17, 2002, the Company held its annual meeting of stockholders. The total number of shares outstanding as of the record date, March 25, 2002, was 18,162,076. The matters voted on at the meeting and the results are as follows: Election of Directors:
John M. Ryan Joseph H. Gleberman Richard G. Morrision, Ph.D. ------------ ------------------- --------------------------- Votes For 17,264,411 17,239,766 17,264,526 Votes Withheld 223,227 247,872 223,112
Amend the 1997 Stock Option Plan authorizing the issuance of an additional 1,250,000 options: Votes For 10,335,405 Votes Against 4,611,614 Abstentions 409,094
Amend the 2000 Stock Option Plan for Non-employee Directors authorizing the issuance of an additional 250,000 options: Votes For 10,375,754 Votes Against 4,572,610 Abstentions 407,749
Amend the Company's Certificate of Incorporation increasing the size of the Board of Directors to ten members: Votes For 17,301,776 Votes Against 28,982 Abstentions 156,880
Ratify the appointment of Ernst & Young as independent auditors of the Company for the fiscal year ending December 21, 2002: Votes For 16,395,364 Votes Against 1,089,919 Abstentions 2,355
No other matters were voted on at the meeting. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K EXHIBITS: A list of the exhibits required to be filed as part of this Report on Form 10-Q is set forth in the "Exhibit Index", which immediately precedes such exhibits, and is incorporated herein by reference. 32 REPORTS ON FORM 8-K: During the second quarter of 2002, the Company filed the following Current Reports on Form 8-K: - Dated April 2, 2002, reporting the completion of the acquisition of the Darvon and Darvocet-N branded product lines from Eli Lilly and Company. - Dated April 12, 2002, to file an amendment to the March 7, 2002 Form 8-K, which announced the agreement to acquire the Darvon and Darvocet-N branded product lines. - Dated May 3, 2002, to file a press release reporting the Company's results of operations for the three months ended March 31, 2002 and announce the appointment of Dr. Phillip Tabbiner as the Company's Chief Executive Officer and Dr. Frederick Sancilio as Executive Chairman of the Board of Directors. - Dated May 23, 2002, to file an amendment to the January 24, 2002 Form 8-K to provide additional information regarding the acquisitions of the M.V.I. and Aquasol branded product lines. - Dated May 24, 2002, to file an amendment to the March 11, 2002 Form 8-K to provide audited special purpose financial statements related to the acquisition of the Darvon and Darvocet-N branded product lines. - Dated June 14, 2002, to file an amendment to the March 7, 2002 Form 8-K to provide additional information regarding the acquisition of the Darvon and Darvocet-N branded product lines. 33 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: August 13, 2002 By: /s/ PHILIP S. TABBINER --------------- ------------------------------------ Philip S. Tabbiner, D.B.A. President and Chief Executive Officer Date: August 13, 2002 By: /s/ WILLIAM L. GINNA, JR. --------------- ------------------------------------ William L. Ginna, Jr. Executive Vice President and Chief Financial Officer 34 AAIPHARMA INC. EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION 3.1 Amended and Restated Certificate of Incorporation of the Company and Amendment to Certificate of Incorporation dated May 24, 2000, and Amendment to Certificate of Incorporation dated November 15, 2000 and Amendment to Certificate of Incorporation dated June 27, 2002 3.2 Amended By-laws of the Company (incorporated by reference to Exhibit 3.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000) 4.1 Articles Fourth, Seventh, Eleventh and Twelfth of the form of the Amended and Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1) 4.2 Article II of the Amended By-laws of the Company (incorporated by reference to Exhibit 3.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000) 4.3 Specimen Certificate for shares of Common Stock, $0.001 par value, of the Company (incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-1 (Registration No. 333-5535)) 10.1 Indenture dated as of March 28, 2002 between the Company, certain of its subsidiaries and First Union National Bank, as Trustee (incorporated by reference to Exhibit 10.8 to the Company's Registration Statement on Form S-1 (Registration No. 333-85602)) 10.2 Registration Rights Agreement dated as of March 28, 2002 between the Company, certain of its subsidiaries, Banc of America Securities LLC, CIBC World Markets Corp. and First Union Securities, Inc. (incorporated by reference to Exhibit 10.9 to the Company's Registration Statement on Form S-1 (Registration No. 333-85602)) 10.3 Credit Agreement dated as of March 28, 2002 between the Company, certain of its subsidiaries, the lenders from time to time party thereto, and Bank of America, N.A., as administrative agent (incorporated by reference to Exhibit 10.11 to the Company's Registration Statement on Form S-1 (Registration No. 333-85602)) 10.4 Assignment, Transfer and Assumption Agreement dated as of February 18, 2002 between NeoSan Pharmaceuticals, Inc. and Eli Lilly and Company (incorporated by reference to Exhibit 2.1 to the Company's Amendment No. 1 to Current Report on Form 8-K/A dated April 12, 2002) 10.5 Manufacturing Agreement dated as of February 18, 2002 between NeoSan Pharmaceuticals, Inc. and Eli Lilly and Company (incorporated by reference to Exhibit 2.1 to the Company's Amendment No. 1 to Current Report on Form 8-K/A dated April 12, 2002)
35 10.6 aaiPharma Inc. 1997 Stock Option Plan, as amended (incorporated by reference to Exhibit 10.11 to the Company's Registration Statement on Form S-1 (Registration No. 333-85602)) 10.7 aaiPharma Inc. 2000 Stock Option Plan for Non-Employee Directors, as amended (incorporated by reference to Exhibit 10.6 to the Company's Registration Statement on Form S-1 (Registration No. 333-85602)) 99.1 Risk Factors 99.2. Statement Regarding Compliance with 18 U.S.C. Section 1350
36 EX-3.1 3 g77946exv3w1.txt RESTATED CERTIFICATE OF INCORPORATION Exhibit 3.1 RESTATED CERTIFICATE OF INCORPORATION OF APPLIED ANALYTICAL INDUSTRIES, INC. PURSUANT TO SECTIONS 242 AND 245 OF THE GENERAL CORPORATION LAW OF THE STATE OF DELAWARE APPLIED ANALYTICAL INDUSTRIES, INC., (the "Corporation"), a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware (the "General Corporation Law"), hereby certifies as follows: 1. The name of the Corporation is Applied Analytical Industries, Inc. The original Certificate of Incorporation was filed with the Secretary of State of Delaware on September 29, 1986. 2. Pursuant to Section 103(d) of the General Corporation Law, this Restated Certificate of Incorporation shall become effective at 10:00 a.m., Wilmington, Delaware time, on September 25, 1996. 3. This Restated Certificate of Incorporation: (a) restates and integrates and further amends the Restated Certificate of Incorporation of the Corporation that was filed on June 7, 1996, (b) was duly adopted in accordance with the provisions of Section 242 and 245 of the General Corporation Law and (c) was approved by written consent of the stockholders of the Corporation given in accordance with the provisions of Section 228 of the General Corporation Law (prompt notice of such action having been given to those stockholders who did not consent in writing). The text of the Corporation's Certificate of Incorporation as previously amended, supplemented or restated is hereby further restated and further amended to read in its entirety as follows: FIRST. The name of the Corporation is: Applied Analytical Industries, Inc. SECOND. The address of its registered office in the State of Delaware is Corporation Trust Center, 1209 Orange Street, in the City of Wilmington, County of New Castle. The name of its registered agent at such address is The Corporation Trust Company. THIRD. The nature of the business or purposes to be conducted or promoted by the Corporation is as follows: To engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware. FOURTH. The total number of shares of all classes of stock that the Corporation shall have authority to issue is 105,000,000 shares, consisting of (i) 100,000,000 shares of Common Stock, $.001 par value per share ("Common Stock"), and (ii) 5,000,000 shares of Preferred Stock, $.001 par value per share ("Preferred Stock"). The following is a statement of the designations and the powers, privileges and rights, and the qualifications, limitations or restrictions thereof in respect of each class of capital stock of the Corporation. A. COMMON STOCK 1. General. The voting, dividend and liquidation rights of the holders of the Common Stock are subject to and qualified by the rights of the holders of the Preferred Stock of any series as may be designated by the Board of Directors upon any issuance of the Preferred Stock of any series. 2. Voting. The holders of the Common Stock are entitled to one vote for each share held at all meetings of stockholders (and written actions in lieu of meetings). There shall be no cumulative voting. The number of authorized shares of Common Stock may be increased or decreased (but not below the number of shares thereof then outstanding) by the affirmative vote of the holders of a majority of the stock of the Corporation entitled to vote, irrespective of the provisions of Section 242(b)(2) of the General Corporation Law. 3. Dividends. Dividends may be declared and paid on the Common Stock from funds lawfully available therefor as and when determined by the Board of Directors and subject to any preferential dividend rights of any then outstanding Preferred Stock. 4. Liquidation. Upon the dissolution or liquidation of the Corporation, whether voluntary or involuntary, holders of Common Stock will be entitled to receive all assets of the Corporation available for distribution to its stockholders, subject to any preferential rights of any then outstanding Preferred Stock. B. PREFERRED STOCK. Preferred Stock may be issued from time to time in one or more series, each of such series to have such terms as stated or expressed herein and in the resolution or resolutions providing for the issue of such series adopted by the Board of Directors of the Corporation as hereinafter provided. Any shares of Preferred Stock that may be redeemed, purchased or acquired by the Corporation may be reissued except as otherwise provided by law or this Certificate of Incorporation. Different series of Preferred Stock shall not be construed to constitute different classes of shares for the purposes of voting by classes unless expressly provided. Authority is hereby expressly granted to the Board of Directors from time to time to issue the Preferred Stock in one or more series, and in connection with the creation of any such series, by resolution or resolutions providing for the issue of the shares thereof, to determine and fix such voting powers, full or limited, or no voting powers, and such designations, preferences and relative participating, optional or other special rights, and qualifications, limitations or restrictions thereof, including without limitation, dividend rights, conversion rights, redemption privileges and liquidation preferences, as shall be stated and expressed in such resolutions, all to the full extent now or hereafter permitted by the General Corporation Law. Without limiting the generality of the foregoing, the resolutions providing for issuance of any series of Preferred Stock may provide that such series shall be superior or rank equally or be junior to the Preferred Stock of any other series to the extent permitted by law and this Certificate of Incorporation. Except as otherwise provided in this Certificate of Incorporation, no vote of the holders of the Preferred Stock or Common Stock shall be a prerequisite to the designation or issuance of any shares of any series of the Preferred Stock authorized by and complying with the conditions of this Certificate of Incorporation, the right to have such vote being expressly waived by all present and future holders of the capital stock of the Corporation. FIFTH. The Corporation shall have a perpetual existence. SIXTH. In furtherance of and not in limitation of powers conferred by statute, the board of directors is expressly authorized to adopt, amend or repeal the by-laws of the Corporation. SEVENTH. Whenever a compromise or arrangement is proposed between this Corporation and its creditors or any class of them and/or between this Corporation and its stockholders or any class of them, any court of equitable jurisdiction within the State of Delaware may, on the application in a summary way of this Corporation or of any creditor or stockholder thereof, or on the application of any receiver or receivers appointed for this Corporation under the provisions of Section 291 of Title 8 of the Delaware Code or on the application of trustees in dissolution or of any receiver or receivers appointed for this Corporation under the provisions of section 279 of Title 8 of the Delaware Code order a meeting of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this Corporation, as the case may be, to be summoned in such manner as the said court directs. If a majority in number representing three-fourths in value of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this Corporation, as the case may be, agree to any compromise or arrangement and to any reorganization of this Corporation as a consequence of such compromise or arrangement, the said compromise or arrangement and the said reorganization shall, if sanctioned by the court to which the said application has been made, be binding on all the creditors or class of creditors, and/or on all the stockholders or class of stockholders, of this Corporation, as the case may be, and also on this Corporation. EIGHTH. Except to the extent that the General Corporation Law prohibits the elimination or limitation of liability of directors for breaches of fiduciary duty, no director of the Corporation shall be personally liable to the Corporation or its stockholders for monetary damages for any breach of fiduciary duty as a director, notwithstanding any other provision of law imposing such liability. No amendment to or repeal of this provision shall apply to or have any effect on the liability or alleged liability of any director of the Corporation for or with respect to any acts or omissions of such director occurring prior to such amendment. NINTH. The Corporation reserves the right to amend, alter, change or repeal any provision contained in this Restated Certificate of Incorporation, in the manner now or hereafter prescribed by statute and this Restated Certificate of Incorporation, and all rights conferred upon stockholders herein are granted subject to this reservation. TENTH: This Article is inserted for the management of the business and for the conduct of the affairs of the Corporation. 1. Number of Directors. The number of directors of the Corporation shall not be less than three (3) nor more than seven (7). The exact number of directors within the limitations specified in the preceding sentence shall be fixed from time to time by, or in the manner provided in, the Corporation's By-Laws. 2. Classes of Directors. The Board of Directors shall be and is divided into three classes: Class I, Class II and Class III. No one class shall have more than one director more than any other class. If a fraction is contained in the quotient arrived at by dividing the designated number of directors by three, then, if such fraction is one-third, the extra director shall be a member of Class I, and if such fraction is two-thirds, one of the extra directors shall be a member of Class I and one of the extra directors shall be a member of Class II, unless otherwise provided from time to time by resolution adopted by the Board of Directors. 3. Election of Directors. Elections of directors must be by written ballot. 4. Terms of Office. Each director shall serve for a term ending on the date of the third annual meeting following the annual meeting at which such director was elected; provided, that each initial director in Class I shall serve for a term ending on the date of the annual meeting in 1997; each initial director in Class II shall serve for a term ending on the date of the annual meeting in 1998; and each initial director in Class III shall serve for a term ending on the date of the annual meeting in 1999; and provided further, that the term of each director shall be subject to the election and qualification of his successor and to his earlier death, resignation or removal. 5. Allocation of Directors Among Classes in the Event of Increases or Decreases in the Number of Directors. In the event of any increase or decrease in the authorized number of directors, (i) each director then serving as such shall nevertheless continue as a director of the class of which he is a member and (ii) the newly created or eliminated directorships resulting from such increase or decrease shall be apportioned by the Board of Directors among the three classes of directors so as to ensure that no one class has more than one director more than any other class. To the extent possible, consistent with the foregoing rule, any newly created directorships shall be added to those classes whose terms of office are to expire at the latest dates following such allocation, and any newly eliminated directorships shall be subtracted from those classes whose terms of offices are to expire at the earliest dates following such allocation, unless otherwise provided from time to time by resolution adopted by the Board of Directors. 6. Quorum; Action at Meeting. A majority of the directors at any time in office shall constitute a quorum for the transaction of business. In the event one or more of the directors shall be disqualified to vote at any meeting, then the required quorum shall be reduced by one for each director so disqualified, provided that in no case shall less than one-third of the number of directors fixed pursuant to Section 1 above constitute a quorum. If at any meeting of the Board of Directors there shall be less than such a quorum, a majority of those present may adjourn the meeting from time to time. Every act or decision done or made by a majority of the directors present at a meeting duly held at which a quorum is present shall be regarded as the act of the Board of Directors unless a greater number is required by law, by the By-Laws of the Corporation or by this Restated Certificate of Incorporation. 7. Resignation; Removal. Any director may resign at any time upon written notice to the attention of the secretary of the corporation. Directors of the Corporation may be removed only for cause by the affirmative vote of the holders of at least two-thirds of the shares of the capital stock of the Corporation issued and outstanding and entitled to vote. 8. Vacancies. Any vacancy in the Board of Directors, however occurring, including a vacancy resulting from an enlargement of the board, shall be filled only by a vote of a majority of the directors then in office, although less than a quorum, or by a sole remaining director. A director elected to fill a vacancy shall be elected to hold office until the next election of the class for which such director shall have been chosen, subject to the election and qualification of his successor and to his earlier death, resignation or removal. 9. Amendments to Article. Notwithstanding any other provisions of law, this Restated Certificate of Incorporation or the By-Laws of the Corporation, each as amended, and notwithstanding the fact that a lesser percentage may be specified by law, the affirmative vote of the holders of at least seventy-five percent (75%) of the shares of capital stock of the Corporation issued and outstanding and entitled to vote shall be required to amend or repeal, or to adopt any provision inconsistent with, this Article TENTH. ELEVENTH. Stockholders of the Corporation may not take any action by written consent in lieu of a meeting. Notwithstanding any other provisions of law, this Restated Certificate of Incorporation or the By-Laws of the Corporation, each as amended, and notwithstanding the fact that a lesser percentage may be specified by law, the affirmative vote of the holders of at least seventy-five percent (75%) of the shares of capital stock of the Corporation issued and outstanding and entitled to vote shall be required to amend or repeal, or to adopt any provision inconsistent with, this Article ELEVENTH. TWELFTH. Special meetings of stockholders may be called at any time by (and only by) the Board of Directors. Business transacted at any special meeting of stockholders shall be limited to matters relating to the purpose or purposes stated in the notice of meeting. Notwithstanding any other provision of law, this Restated Certificate of Incorporation or the By-Laws of the Corporation, each as amended, and notwithstanding the fact that a lesser percentage may be specified by law, the affirmative vote of the holders of at least seventy-five percent (75%) of the shares of capital stock of the Corporation issued and outstanding and entitled to vote shall be required to amend or repeal, or to adopt any provisions inconsistent with, this Article TWELFTH. THIRTEENTH. In anticipation that the Corporation may enter into contracts or otherwise transact business with entities in which any directors of the Corporation own a financial interest ("Related Entities"), the provisions of this Article THIRTEENTH are set forth to regulate and guide such contracts or other business. These provisions are in addition to, and not in limitation of, the provisions of the General Corporation Law and the other provisions of this Restated Certificate of Incorporation. Any contract or other business that does not comply with the procedures set forth in this Article THIRTEENTH shall not by reason thereof be deemed void or voidable or result in any breach of any duty or the derivation of any improper personal benefit by any person but shall be governed by the provisions of this Restated Certificate of Incorporation, the By-laws of the Corporation, the General Corporation Law and other applicable law. No contract, agreement, arrangement or transaction between the Corporation and a Related Entity (a "Related Transaction") shall be void or voidable solely for the reason that such persons or entities are parties thereto, if: (i) the material facts of the Related Transaction are disclosed or are known to the Board of Directors of the Corporation (or a committee thereof) and such board (or committee) in good faith authorizes, approves or ratifies the Related Transaction by the affirmative vote of a majority of the disinterested directors on the Board of Directors (or such committee), even though the disinterested directors may be less than a quorum; (ii) the material facts of the Related Transaction are disclosed or are known to the holders of the then outstanding voting shares of the Corporation entitled to vote thereon, and the Related Transaction is specifically approved or ratified in good faith by the affirmative vote of the holders of a majority of the then outstanding voting shares not owned by the interested directors or Related Entity, as the case may be, even though such holders may be less than a quorum; (iii) such Related Transaction is effected pursuant to and consistent with terms and conditions specified in any arrangements, standards or guidelines that are in good faith authorized, approved or ratified, after disclosure or knowledge of the material facts related thereto, by the affirmative vote of a majority of the disinterested directors on the Board of Directors (or committee thereof), or by the affirmative vote of the holders of a majority of the then outstanding voting shares of the Corporation not owned by the interested directors or Related Entity, as the case may be, even though the disinterested directors or such holders may be less than a quorum; or (iv) The Related Transaction was fair to the Company. In addition, each Related Transaction authorized, approved or effected, and each of such arrangements, standards or guidelines so authorized or approved, as described in (i), (ii) or (iii) above, shall be conclusively deemed to be fair to the Corporation and its stockholders; provided, however, that if such authorization or approval is not obtained, or such Related Transaction is not so effected, no presumption shall arise that such Related Transaction, or such arrangements, standards or guidelines, are not fair to the Corporation and its stockholders. Any person or entity purchasing or otherwise acquiring any interest in any shares of the Corporation shall be deemed to have notice of and to have consented to the provisions of this Article THIRTEENTH. IN WITNESS WHEREOF, Applied Analytical Industries, Inc. has caused this Restated Certificate of Incorporation to be signed and attested by its duly authorized officers, this 20th day of September, 1996. APPLIED ANALYTICAL INDUSTRIES, INC. By: /s/ Frederick D. Sancilio -------------------------------- Frederick D. Sancilio, President ATTEST: /s/ R. Forrest Waldon - ---------------------------- R. Forrest Waldon, Secretary CERTIFICATE OF AMENDMENT OF CERTIFICATE OF INCORPORATION OF APPLIED ANALYTICAL INDUSTRIES, INC. Applied Analytical Industries, Inc., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, DOES HEREBY CERTIFY: FIRST: That the Board of Directors of said corporation, duly adopted a resolution setting forth a proposed amendment of the Certificate of Incorporation of said corporation, declaring said amendment to be advisable, and calling a meeting of the stockholders of said corporation for consideration thereof. The resolution setting forth the proposed amendment is as follows: RESOLVED, that the Certificate of Incorporation of Applied Analytical Industries, Inc. be amended to increase the maximum size of the Board of Directors from seven (7) to nine (9). SECOND: That thereafter, a meeting of the stockholders of said corporation was duly called and held, upon notice in accordance with Section 222 of the General Corporation Law of the State of Delaware at which meeting the holders of more than 75% of the outstanding shares of voting stock voted in favor of the amendment. THIRD: That the aforesaid amendments were duly adopted in accordance with the applicable provisions of Sections 242 and 222 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, said Applied Analytical Industries, Inc. has caused this certificate to be signed by Frederick D. Sancilio, Ph.D., its Chairman of the Board of Directors, this 24th day of May, 2000. APPLIED ANALYTICAL INDUSTRIES, INC. By:/s/ Frederick D. Sancilio --------------------------------- Frederick D. Sancilio, President CERTIFICATE OF AMENDMENT OF CERTIFICATE OF INCORPORATION OF APPLIED ANALYTICAL INDUSTRIES, INC. Applied Analytical Industries, Inc., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, DOES HEREBY CERTIFY: FIRST: That the Board of Directors of said corporation, duly adopted a resolution setting forth a proposed amendment of the Certificate of Incorporation of said corporation, declaring said amendment to be advisable, and calling a meeting of the stockholders of said corporation for consideration thereof. The resolution setting forth the proposed amendment is as follows: RESOLVED, that Article First of the Corporation's Certificate of Incorporation is hereby deleted in its entirety and replaced with the following new Article First: "First: The name of the Corporation is aaiPharma Inc." SECOND: That thereafter, a meeting of the stockholders of said corporation was duly called and held, upon notice in accordance with Section 222 of the General Corporation Law of the State of Delaware at which meeting the holders of a majority of the outstanding shares of voting stock voted in favor of the amendment. THIRD: That the aforesaid amendment was duly adopted in accordance with the applicable provisions of Sections 242 and 222 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, said Applied Analytical Industries, Inc. has caused this certificate to be signed by Frederick D. Sancilio, Ph.D., its Chairman of the Board of Directors, this 15th day of November, 2000. APPLIED ANALYTICAL INDUSTRIES, INC. By: /s/ Frederick D. Sancilio ---------------------------------- Frederick D. Sancilio, Ph.D. Chairman of the Board of Directors CERTIFICATE OF AMENDMENT OF CERTIFICATE OF INCORPORATION OF AAIPHARMA INC. aaiPharma Inc., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, DOES HEREBY CERTIFY: FIRST: That the Board of Directors of said corporation, duly adopted a resolution setting forth a proposed amendment of the Certificate of Incorporation of said corporation, declaring said amendment to be advisable, and calling a meeting of the stockholders of said corporation for consideration thereof. The resolution setting forth the proposed amendment is as follows: RESOLVED, that the Certificate of Incorporation of aaiPharma Inc. be amended to increase the maximum size of the Board of Directors from nine (9) to ten (10). SECOND: That thereafter, a meeting of the stockholders of said corporation was duly called and held, upon notice in accordance with Section 222 of the General Corporation Law of the State of Delaware at which meeting the holders of more than 75% of the outstanding shares of voting stock voted in favor of the amendment. THIRD: That the aforesaid amendments were duly adopted in accordance with the applicable provisions of Sections 242 and 222 of the General Corporation Law of the State of Delaware. FOURTH: That Section 1 of the Tenth Article of the corporation's Certificate of Incorporation is hereby amended and replaced in its entirety as follows: "1. Number of Directors. The number of directors of the Corporation shall not be less than three (3) nor more than ten (10)." IN WITNESS WHEREOF, said aaiPharma Inc. has caused this certificate to be signed by Frederick D. Sancilio, Ph.D., its Chairman of the Board of Directors, this 27th day of June, 2002. AAIPHARMA INC. By: /s/ Frederick D. Sancilio ---------------------------------- Frederick D. Sancilio, Ph.D. Chairman of the Board of Directors EX-99.1 4 g77946exv99w1.txt RISK FACTORS Exhibit 99.1 RISK FACTORS You should carefully consider the risks below before making a decision to invest in our common stock or senior subordinated notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occurs, our business, financial condition or results of future operations could be materially and adversely affected, the trading price of our securities could decline, and you may lose all or part of your investment. This report also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks faced by us described below and elsewhere in this report. RISKS RELATING TO OUR BUSINESS WE HAVE RECENTLY TRANSITIONED OUR COMPANY TO A SPECIALTY PHARMACEUTICAL COMPANY WITH CHALLENGES AND RISKS THAT WE HAVE NOT HISTORICALLY FACED. Our decision to commercialize branded products through our pharmaceutical products ("Pharmaceutical") business unit represents a change in our business with new challenges. We have only one years' experience in acquiring, marketing and promoting branded products. In the past, we generally partnered with customers in development projects, sharing the risk that the project would be unsuccessful. We anticipate that the integration of our acquired products will require significant management attention and expansion of our sales force. In order to effectively manage our acquisitions, we must maintain adequate operational, financial and management information systems and motivate and manage an increasing number of employees. In addition, our acquired branded products may generate lower-than-expected sales or need to be reformulated. They may be subject to manufacturing delays, product shortages or shut-downs due to FDA oversight and regulation, or product liability claims or recalls. In addition, although we have thus far relied on a contract sales force provided by a national pharmaceutical sales organization, we recently terminated this arrangement and have begun hiring and managing our sales force. Moreover, we plan to significantly expand our sales force during 2002. We have not previously managed a sales force of this size. Our business, financial condition and results of operations could be materially and adversely affected if we are unable to meet these challenges associated with our new specialty pharmaceutical business. WE MAY INCUR SUBSTANTIAL EXPENSE TO DEVELOP PRODUCTS THAT WE NEVER SUCCESSFULLY COMMERCIALIZE. We will incur substantial research and development expenses, and other expenses, attempting to develop new or improved products or product line extensions. These expenses will substantially exceed our prior research and development expenses. The products or line extensions to which we devote operational and financial resources could be commercial failures. Successful commercialization of products and product line extensions requires accurate anticipation of market and customer acceptance of particular products, customers' needs and emerging technological trends, among other things. Additionally, we must complete many complex formulation and analytical testing requirements and obtain regulatory approvals from the Food and Drug Administration, or FDA, and other regulatory agencies. When developed, new or reformulated drugs may not exhibit desired characteristics. Complications can also arise during production scale-up. Our products and line extensions may encounter unexpected, unresolvable patent conflicts or not have enforceable intellectual property rights. Delays or problems also may arise from internal conflicts for resource availability, personnel errors or equipment failures. In addition, our rights to use proprietary technologies of others in developing products may be terminated or limited prior to the completion of the development of a particular product, which could prevent us from commercializing that product. If we incur significant expenses for a product or line extension that we do not successfully commercialize, there could be a material adverse effect on our business, financial condition and results of operations. OUR ACQUISITION STRATEGY COULD HAVE A MATERIAL AND ADVERSE EFFECT ON US. We have increased our net revenues and net income through acquisitions of branded products, and we intend to pursue additional acquisition opportunities. The acquisition prices that we pay for branded products are based upon many factors, including our analysis of sales history, cost of goods sold, manufacturing and supply sources, marketing potential, brand strength, competition and product improvement opportunities. While we carefully analyze the prices that we pay, we may have overpaid, or may in the future overpay, for a branded product line that may not produce sufficient cash flow to repay our debt, including indebtedness incurred in connection with the acquisition, or provide an acceptable rate of return on our investment. Our growth strategy is dependent upon our ability to develop line extensions or improvements related to our acquired branded products and acquire branded products that can be promoted through our marketing and distribution channels. Despite our strong relationships with many large pharmaceutical companies which are our customers, other companies, including those with substantially greater financial, marketing and sales resources, are competing with us to acquire the same products. As a result, we may not be able to acquire rights to additional products or may pay too much when we acquire them. Additionally, our acquisitions will be dependent upon our ability to obtain necessary financing. Our senior credit facilities and senior subordinated notes limit our ability to obtain additional debt financing. Difficulties encountered in developing line extensions or improvements to acquired products may delay and increase the cost of a development project, requiring additional external funding. Events beyond our control, such as terrorist attacks and their aftermath, may adversely affect capital markets and limit our ability to obtain the equity or debt financing that we would need to pursue additional product line acquisitions. The inability to effect acquisitions of additional branded products could have a material adverse effect on our future business, financial condition and results of operations. 2 WE ARE DEPENDENT ON THIRD PARTIES FOR ESSENTIAL BUSINESS FUNCTIONS, AND PROBLEMS WITH THESE THIRD-PARTY ARRANGEMENTS COULD MATERIALLY ADVERSELY AFFECT OUR ABILITY TO MANUFACTURE AND SELL PRODUCTS AND OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. We are dependent on third parties for the manufacture of our products. We have entered into agreements with third parties for many of our product manufacturing requirements. Our manufacturing dependence upon third parties may adversely affect our profit margins and our ability to deliver our products on a timely and competitive basis. If we are unable to retain or replace third-party manufacturers on commercially acceptable terms, we may not be able to distribute our products as planned. If we encounter delays or difficulties with contract manufacturers in producing or packaging our products, the distribution, marketing and subsequent sales of these products would be adversely affected, and we may have to seek alternative sources of supply, lose sales or abandon or divest a product line on unsatisfactory terms. We may be unable to enter into alternative supply arrangements at commercially acceptable rates on a timely basis, if at all. The manufacturers that we utilize may not be able to provide us with sufficient quantities of our products, and the products supplied to us may not meet our specifications. Moreover, our contract manufacturers may not comply with regulatory requirements and keep their facilities validated and in good working order. Manufacturing at these facilities can be suspended and halted for lengthy periods of time by the FDA if these manufacturers do not comply with regulatory requirements. Additionally, modifications, enhancements or changes in manufacturing sites of approved products are subject to FDA approval that we may or may not be able to obtain and that may be subject to a lengthy application process. Our acquired products are subject to interim supply agreements, each with terms generally not exceeding three years. After expiration of these contracts, our manufacturing costs could be higher and the move of the manufacturing of any of our products will cause us to incur significant start-up costs associated with that move. Additionally, any move of the manufacturing site of any of these products would require FDA approval of the new manufacturing facility. FDA approval, however, is not within our control, and we may not receive it for a long time, if at all. We are dependent on third parties for the supply of critical raw materials. Sales of our products are dependent on our ability to obtain FDA-approved supplies of raw materials, including active and inactive pharmaceutical ingredients, and packaging materials, at commercially acceptable prices and terms, in time to satisfy critical product development, testing, analytical and manufacturing activities, customer contracts, or our development plans. Generally, there are limited suppliers, and in most cases only one supplier, of a critical raw material. The FDA must approve the supply source of many ingredients for our products. The qualification of a new supply source could delay the manufacture of the drug involved. Arrangements with our foreign suppliers are subject to certain additional risks, including the availability of governmental clearances, export duties, political instability, currency fluctuations and restrictions on the transfer of funds. Any constraints on the supply of raw materials could materially and adversely affect our business, financial condition and results of operations. 3 We use, and are dependent on, a contract distribution program. We have contracted with Integrated Commercialization Solutions, Inc., a national pharmaceutical product distribution company, to provide warehousing, product distribution, inventory tracking, customer service and financial administrative assistance related to our distribution program. The Integrated Commercialization Solutions contract may be terminated by either party with 180 days' written notice, and we provided notice of termination of this agreement in May with an effective date in November. We are in the process of negotiating a contract for the provision of warehousing, product distribution, inventory tracking, customer service and financial administrative assistance services. We are dependent on the capabilities of this third party to distribute our products effectively and interact with our customers. We do not have extensive experience performing these functions ourselves and may suffer significant disruption if we have to do so or find alternative providers. The failure to adequately support our distribution efforts or effectively manage our relationships with customers could have a material adverse effect on our business, financial condition and results of operations. WE ENCOUNTER AGGRESSIVE COMPETITION IN ALL AREAS OF OUR BUSINESS. The pharmaceutical industry is highly competitive and innovative. Our branded products are in competition with branded products marketed and promoted by many other pharmaceutical companies, including large, fully integrated companies with financial, marketing, legal and product development resources substantially greater than ours. Additional competitors may emerge to compete directly with us for acquisitions of branded product lines, any of which could materially adversely affect our ability to successfully make additional acquisitions of branded product lines or our ability to sell our products on a successful basis. We also compete with pharmaceutical companies in developing, marketing and promoting our own internally developed pharmaceutical products. Because the sales prices of pharmaceutical products typically decline as competition increases, this competition could materially adversely affect us. Our branded products are subject to generic competition. There is no proprietary protection for most of the branded pharmaceutical products that we sell, and as a result our branded pharmaceutical products are or may become subject to competition from generic substitutes. These generic substitutes for our branded products are sold by competitors at significantly lower prices than branded products, due to the significantly lower costs associated with them. These generic products may be precisely identical, in every respect, to the higher-priced branded drugs we sell. In addition, governmental and other pressures, including from third-party payers such as health maintenance organizations, or HMOs, and health insurers to reduce pharmaceutical costs may result in physicians or pharmacies increasingly using generic substitutes for our products. Further, Congress is currently considering legislation that would, if enacted, reduce regulatory obstacles to approval of generic products. Additional state and federal legislation may be considered in the future that would adversely affect sales of branded pharmaceutical products in favor of generic products, such as laws more broadly mandating substitution of generic products for prescriptions written for branded products. Competition from generic products or additional legislation or regulatory developments favoring generic products could cause the revenues from our branded products to decrease significantly and could have a material and adverse effect on our business, financial condition and results of operations. 4 In addition, consideration of legislative or regulatory changes that favor generic products or press reports of possible changes may adversely affect the trading price of our common stock. Newly developed branded products could adversely affect the commercially valuable life of our products. The rapid product development and technological changes occurring in the pharmaceutical industry could render our branded products obsolete or uneconomical. New drugs to treat the conditions addressed by our products could emerge. For example, we believe that sales of Darvon and Darvocet-N decreased significantly in the early and mid-1990s, due to the introduction of Oxycontin and the COX-2 class of drugs, which were thought to be superior to Darvon and Darvocet-N. In fact, companies that sell or have sold us a particular product line could be developing a competing product line to replace the line they are selling or have sold to us. Our competitors also may be able to complete the product regulatory approval process before us and, therefore, begin marketing their products in advance of our products. Additionally, technological advances, which could affect the efficacy, approval, cost, production or marketing of products, could benefit our competitors without similarly aiding us. Our business, financial condition and results of operations could be materially and adversely affected by any one or more of these developments. Our fee-for-service business is subject to increasing competitive pressures. We are also subject to the impact of marketplace actions of our competitors in our fee-for-service business. For example, in the event of business difficulties or changes in market supply and demand for products, a competitor may decide to slash its prices or take other pricing or market actions in order to obtain new business at any price. These actions could disrupt the entire marketplace, resulting in potential reduced revenues, either from responsive pricing reductions or a reduction in customer contracts. This could adversely affect our business, financial condition and results of operations. WE MAY BE UNABLE TO OBTAIN GOVERNMENT APPROVAL FOR OUR PRODUCTS OR COMPLY WITH GOVERNMENT REGULATIONS RELATING TO OUR BUSINESS. The commercialization of pharmaceutical products is subject to extensive federal, state and local regulation in the United States and similar foreign regulation. We do not know the extent to which we may be affected by legislative and other regulatory actions and developments concerning various aspects of our operations, our products and the health care field generally. We do not know what effect changes in governmental regulation and other actions or decisions by governmental agencies may have on our business in the future. Any changes could require changes to manufacturing methods or facilities, expanded or different labeling, new approvals, the recall, replacement or discontinuance of certain products, additional record keeping, and expanded documentation of the properties of certain products and scientific substantiation. Any regulatory changes could have a material adverse effect on our business, financial condition and results of operations or our competitive position. The manufacturing, processing, formulation, packaging, labeling, distribution, importation, pricing, reimbursement and advertising of our products, and disposal of waste products arising from these activities, are also subject to regulation by the Drug Enforcement Administration, the Federal Trade Commission, the Consumer Product Safety Commission, the U.S. Department of Agriculture, the Occupational Safety and Health Administration, the U.S. 5 Environmental Protection Agency, the U.S. Customs Service and the Centers for Medicare and Medicaid Services, as well as state, local and foreign governments. We are required to obtain approval from the FDA based upon pre-clinical testing, clinical trials showing safety and effectiveness, chemistry and manufacturing control data, and other data and information before marketing most drug products. The generation of the required data is regulated by the FDA and can be time-consuming and expensive, and the results might not justify approval. Our FDA product filings may not be approved in a timely manner, if at all, and we may be unable to meet other regulatory requirements for our products. Pharmaceutical products also must be distributed, sampled, advertised and promoted in accordance with FDA requirements. Even if we are successful in obtaining all required pre-marketing approvals, post-marketing requirements and our failure to comply with other regulations could result in suspension or limitation of approvals. The FDA could also require reformulation of products during the post-marketing stage. For example, prior to our acquisition of the M.V.I. and Aquasol product lines, the FDA determined that M.V.I.-12, an adult multivitamin injectable product, must be reformulated (along with other similar adult multivitamin products) to include higher doses of Vitamins B1, B6, C and folic acid and to add Vitamin K. Our formulation development laboratory has been working closely with AstraZeneca on this reformulation, and we are hopeful that FDA approval of the reformulation can be obtained by the end of this year or early next year, although this approval could take longer and may never be obtained. All of our drugs must be manufactured in conformity with current Good Manufacturing Practice regulations, as interpreted and enforced by the FDA, and drug products subject to an FDA-approved application must be manufactured, processed, packaged, held and labeled in accordance with information contained in the application. Additionally, modifications, enhancements or changes in manufacturing sites of approved products are, in many circumstances, subject to FDA approval, which may be subject to a lengthy application process or which we may be unable to obtain. Our facilities, including the facilities used in our fee-for-service business, and those of our third-party manufacturers are periodically subject to inspection by the FDA and other governmental agencies, and operations at these facilities could be interrupted or halted if such inspections are unsatisfactory. Failure to comply with FDA or other governmental regulations can result in fines, unanticipated compliance expenditures, recall or seizure of products, total or partial suspension of production or distribution, suspension of the FDA's review of our product applications, termination of ongoing research, disqualification of data for submission to regulatory authorities, enforcement actions, injunctions and criminal prosecution. Under certain circumstances, the FDA also has the authority to revoke previously granted drug approvals. Although we have instituted internal compliance programs, if our compliance is deficient in any significant way, it could have a material adverse effect on us. Most of our suppliers are subject to similar regulations and periodic inspections. The federal health care program antikickback statute makes it illegal for anyone to knowingly and willfully make or receive "kickbacks" in return for any health care item or service 6 reimbursed under any federally financed healthcare program. This statute applies to arrangements between pharmaceutical companies and the persons to whom they market, promote, sell and distribute their products. Federal false claims laws prohibit any person from knowingly making a false claim to the federal government for payment. Recently, several pharmaceutical companies have been prosecuted under these laws, even though they did not submit claims to government healthcare programs. The prosecutors alleged that they were inflating drug prices they report to pricing services, which are in turn used by the government to set Medicare and Medicaid reimbursement rates. Pharmaceutical companies also have been prosecuted under these laws for allegedly providing free products to customers with the expectation that the customers would bill federal programs for the products. Additionally, the majority of states have laws similar to the federal antikickback law and false claims laws. Sanctions under these federal and state laws include monetary penalties, exclusion from reimbursement for products under government programs, criminal fines and imprisonment. While we have internal policies and practices requiring and detailing compliance with the health care fraud and abuse laws and false claims laws, it is possible that some of our business practices could be subject to challenge under one or more of these laws, which could have a material adverse effect on our business, financial condition and results of operations. Additionally, our business involves the controlled storage, use and disposal of hazardous or highly potent materials and biological hazardous materials. We are subject to numerous environmental laws and regulations in the jurisdictions in which we operate. Although we believe that our safety procedures for handling and disposing of these hazardous materials comply in all material respects with the standards prescribed by law and regulation in each of our locations, the risk of accidental contamination or injury from hazardous materials cannot be completely eliminated. In the event of an accident, we could be held liable to governmental authorities or private parties for any damages that result, and the liability could exceed our resources. In addition, we may be held liable for costs associated with contamination of our currently or formerly occupied properties, or at other parties' disposal sites where we disposed of hazardous wastes, even though this contamination may have been caused by third parties or the disposal may have complied with the regulatory requirements then in place. Current or future environmental laws and regulations, or adverse changes in the way current laws and regulations are interpreted or enforced, may materially adversely affect our business, financial condition and results of operations. We maintain liability insurance for some environmental risks that our management believes to be appropriate and in accordance with industry practice. However, we may incur liabilities beyond the limits or outside the coverage of our insurance and may not be able to maintain insurance on acceptable terms. In connection with our activities outside the U.S., we are subject to foreign regulatory requirements governing the testing, approval, manufacture, labeling, marketing and sale of pharmaceutical products. These requirements vary from country to country. Even if FDA approval has been obtained for a product, approval by comparable regulatory authorities of foreign countries must be obtained prior to marketing the product in those countries. For example, some of our foreign operations are subject to regulations by the European Medicines Evaluations Agency and the U.K. Medicines Control Agency. The approval process may be more or less rigorous from country to country, and the time required for approval may be longer or shorter than that required in the U.S. Clinical studies conducted outside of any particular 7 country may not be accepted by that country, and the approval of a pharmaceutical product in one country does not assure that the product will be approved in another country. In addition, regulatory agency approval of pricing ixs required in many countries and may be required for our marketing of any drug in those countries. WE ARE VULNERABLE TO PRESSURES FROM THIRD-PARTY PAYERS. Our commercial success in product sales will depend on patients being reimbursed by third-party health care payers, such as government and private health insurers and managed care organizations. Third-party payers are increasingly challenging the pricing of medical products and services. For example, third-party payers strenuously discourage use of branded products such as ours when generic substitutes are available. As a result, reimbursement may not be available to enable us to maintain price levels sufficient to realize an appropriate return on our investment in product acquisition and development. If adequate reimbursement levels are not provided, our business, financial condition and results of operations could be materially and adversely affected. The market for our products may be limited by actions of third-party payers. For example, many managed health care organizations are now limiting the pharmaceutical products that are on their lists of approved drugs. The resulting competition among pharmaceutical companies to place their products on these formulary lists has created a trend of downward pricing pressure in the industry. In addition, many managed care organizations are pursuing various ways to reduce pharmaceutical costs and are considering formulary contracts primarily with those pharmaceutical companies that can offer a broad line of products for a given class of therapy or disease, which we cannot do. Our products may not be included on the approved drug list of managed care organizations, and downward pricing pressures in the industry generally could materially and adversely impact our business, financial condition and results of operations. Additionally, a number of legislative and regulatory proposals aimed at reducing the costs of medical products and services have been enacted or proposed. For example, President Bush's administration has recently proposed a program that would give Medicare beneficiaries the right to purchase a discount card for a nominal fee. The discount card would entitle the purchaser to receive pre-negotiated discounts on certain prescription drugs. Additionally, certain state governments have enacted legislation that seeks to reduce the price paid by Medicaid recipients for prescription drugs. In Florida, pharmaceutical companies that sell to state Medicaid programs are now required to offer rebates in addition to the already discounted prices mandated by federal law, and a new program in Michigan is designed to force pharmaceutical companies to reduce the prices of their prescription drugs to be placed on the state's preferred list of drugs eligible for Medicaid reimbursement. A number of states are considering additional legislation and other measures that would, if enacted, further adversely affect revenues from the sale of branded drugs, for example, through limits on the purchase of branded drugs by state institutions and restrictions on reimbursement for branded drugs in programs subject to state jurisdiction. Additionally, several large pharmaceutical companies have recently adopted discount plans for the elderly. Our business, financial condition and results of operations could be materially and adversely affected if recently established or future legislative or regulatory 8 programs that are designed to reduce the costs of medical products and services are effective or require consumers to use generic substitutes for our branded products. OUR SUCCESS IS DEPENDENT UPON A LIMITED NUMBER OF KEY PRODUCT LINES, WHICH MEANS THAT ANY UNFAVORABLE DEVELOPMENTS WITH RESPECT TO ANY ONE PRODUCT LINE COULD MATERIALLY AND ADVERSELY AFFECT US. We have a significant investment in a limited number of key product lines. Each of our branded product lines, and particularly Darvon and Darvocet-N, will represent a significant portion of our total product sales for the foreseeable future. On a pro forma basis as if we had completed the product line acquisition on January 1, 2001, sales of Darvon and Darvocet-N would have represented 26% of our net revenues and 37% of our gross margin dollars for 2001. Accordingly, any factor adversely affecting sales of any of our branded products, such as any problem with their safety or efficacy, could have a material adverse effect on our business, financial condition and results of operations. In addition, any perceived problems with our products could have a similar material adverse effect. We are aware of press and consumer advocate reports challenging the safety of Darvon and Darvocet-N, alleging that these products are addictive, not effective and have caused fatalities in the case of overdoses. Challenges to the safety and efficacy of Darvon and Darvocet-N could have a material adverse effect on our business, financial condition and results of operations. CONSOLIDATION OF OUR DISTRIBUTION NETWORK FOR PHARMACEUTICAL PRODUCTS COULD RESULT IN REDUCED PRODUCT PURCHASES AND INCREASED PRODUCT RETURNS BY OUR CUSTOMERS. The distribution network for pharmaceutical products has in recent years been subject to increasing consolidation. As a result, a few large wholesale distributors control a significant share of the market. These large, well-established distributors are our Pharmaceutical business unit's primary customers. We anticipate that as our Pharmaceutical business unit's business expands, some of these wholesalers and distributors may become significant customers accounting for 10% or more of our consolidated net revenues. We have experienced concentration of business in our other business units in the past, and in 2001 and 2000 the same customer and its affiliates accounted for approximately 15% of our consolidated net revenues. This consolidation trend could cause our distributors to stop carrying or reduce their inventory levels of our products, return our products or reduce our product offerings. For example, many pharmacies do not carry Darvon and Darvocet-N, instead carrying only generic substitutes. Additionally, there could be negative developments with any of these distributors or any of them could have financial difficulties. Any of these factors could have a material adverse effect on our business, financial condition and results of operations. 9 THE PRO FORMA INFORMATION INCLUDED IN THIS REPORT IS BASED ON ESTIMATES AND ASSUMPTIONS AND MAY NOT NECESSARILY BE INDICATIVE OF OUR ACTUAL REVENUES AND COSTS. The pro forma financial information included in this report is based upon the historical financial information for the Darvon and Darvocet-N product lines and on estimated costs to be incurred by our Pharmaceutical business unit for selling, general and administrative, and research and development expenses. While we believe that our assumptions are reasonable, our actual costs may not be the same. Additionally, we will probably move manufacturing of our products to new sites. This will involve costs and require FDA approval of the new manufacturing facilities. We may not receive this FDA approval for a long time, if at all. Our pro forma financial information, which use the prices in our supply agreements, do not include or estimate the possibility of these higher costs. Therefore, this pro forma financial information does not represent what our results of operations would actually have been if the events described therein had in fact occurred on the date indicated or project our results of operations for any future period. For all these reasons, investors should not place undue reliance on the pro forma financial data contained in this report. PRODUCT LIABILITY CLAIMS OR PRODUCT RECALLS COULD HARM OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. We face an inherent business risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in adverse effects. Such risks will exist even with respect to those products that receive regulatory approval for commercial sale. While we take what we believe are appropriate precautions, we may not be able to avoid significant product liability exposure. We currently have product liability insurance in the amount of $10 million for aggregate annual claims. This insurance is subject to significant limitations, including a $100,000 deductible per incident, among other things. This level of insurance coverage, however, may not be sufficient to cover all potential claims against us or involving our products. Also, adequate insurance coverage may not be available in the future at acceptable costs, if at all. When we acquire or develop new products, we cannot assure you that additional liability insurance coverage for these new products will be available on acceptable terms, if at all. Although we have yet to face a product liability claim, the assertion of this type of claim could have a material adverse affect on our business, financial condition and results of operations. Product recalls may be issued at our discretion or at the discretion of the FDA, other government agencies or others having regulatory authority for pharmaceutical product sales. Any product recall could materially adversely affect our business, financial condition and results of operations. WE MAY BE UNABLE TO SECURE OR ENFORCE ADEQUATE INTELLECTUAL PROPERTY RIGHTS TO PROTECT THE NEW PRODUCTS OR TECHNOLOGIES WE DEVELOP, AND OUR EXISTING INTELLECTUAL PROPERTY RIGHTS MAY NOT BE ADEQUATE TO PROTECT US OR PROVIDE US WITH A COMPETITIVE ADVANTAGE. Our ability to successfully commercialize new branded products or technologies is dependent upon our ability to secure and enforce strong intellectual property rights, generally 10 patents, and we may be unable to do so. To obtain patent protection we must be able to successfully persuade the U.S. Patent and Trademark Office and its foreign counterparts to issue patents on a timely basis and possibly in the face of third party challenges. Even if we are granted a patent, our rights may later be challenged or circumvented by third parties. The issuance of a patent is not conclusive as to its validity or enforceability. In addition, from time to time, we have received notices from third parties regarding patent claims against us. Any such claims, with or without merit, could be time-consuming to defend, result in costly litigation, divert management's attention and resources, and cause us to incur significant expenses. In addition, any potential intellectual property litigation could require that we stop selling our products, obtain a license from the owner to sell or use the relevant intellectual property, which we may not be able to obtain on favorable terms, if at all, or modify our products to avoid using the relevant intellectual property. In the event of a successful claim of infringement against us, our business, financial condition and results of operations could be materially and adversely affected. Additionally, we also rely on trade secrets and other unprotected proprietary knowledge, which we generally seek to protect by confidentiality, non-disclosure and assignment of invention agreements with our employees, consultants, licensees and other companies. These agreements, however, may be breached, may not be enforceable or we may not have adequate remedies for a breach by the other party. Additionally, our trade secrets may become known by our competitors. Parties to those agreements may claim rights to intellectual property arising out of their work. The disclosure or misappropriation of our intellectual property for any of these reasons could materially and adversely affect our business, financial condition or results of operations. WE DEPEND ON KEY PERSONNEL. We are highly dependent on key personnel, and the loss of any of them, particularly Frederick D. Sancilio, Ph.D., our Executive Chairman and Chief Scientific Officer, would be disruptive and could materially and adversely affect our business and prospects for success. Although we believe that we are adequately staffed in key positions and that we will be successful in retaining skilled and experienced management, operational and scientific personnel, we cannot assure you that we will be able to attract and retain such personnel on acceptable terms. The loss of the services of key scientific, technical and management personnel could have a material adverse effect on us, especially in light of our recent growth. We do not maintain key-person life insurance on, or have any employment agreements with, any of our executives other than Dr. Sancilio. A SIGNIFICANT PORTION OF OUR FACILITIES ARE LOCATED IN AREAS SUSCEPTIBLE TO HURRICANES AND MAJOR STORM DAMAGE. A significant portion of our research and development facilities, our corporate headquarters and other critical business operations and some of our key suppliers are located in geographic areas that have had, and are likely to continue to have, hurricanes and major storms. Although we maintain business interruption and other insurance coverage, this coverage is 11 subject to significant limitations and deductibles and may not be sufficient to offset the impact to our operations and infrastructure caused by future hurricanes and storms. RISKS RELATED TO OUR STOCK PRICE AND CORPORATE CONTROL OUR EXECUTIVE OFFICERS AND DIRECTORS AND ENTITIES AFFILIATED WITH THEM, WHOSE INTERESTS MAY DIFFER FROM OTHER STOCKHOLDERS, WILL HAVE THE ABILITY TO EXERCISE SIGNIFICANT CONTROL OVER US. Our executive officers, directors and entities affiliated with them will, as a group, beneficially owned more than 50% our common stock as of the date of June 30, 2002. Dr. Sancilio individually owned approximately 23% of our common stock. These stockholders, particularly Dr. Sancilio, will be able to exercise significant influence over all matters requiring approval by our stockholders, including the election of directors and the approval of significant corporate transactions, including a change of control of our company. The interests of these stockholders may differ from the interests of our other stockholders. FUTURE SALES OF COMMON STOCK BY OUR PRINCIPAL STOCKHOLDERS MAY CAUSE OUR STOCK PRICE TO DECLINE. These stockholders are free to sell these shares, subject to the volume limitations of Rule 144 under the Securities Act of 1933 and any lock-up agreement that they may enter into with the underwriters of our proposed equity offering. Some of these stockholders have registration rights under our investors' agreement. We cannot predict when any of these stockholders may sell their shares or in what volumes. However, the market price of our common stock could decline significantly if these stockholders sell a large number of shares into the public market or if the market believes that these sales may occur. OUR STOCK PRICE MAY BE VOLATILE AND MAY DECLINE. Our stock price has been volatile in the past, due, in part, to low trading volume and the small percentage of our outstanding common stock held by public investors. From January 1, 2000 through June 30, 2002, our stock price has ranged from a low trading price of $6.31 per share to a high trading price of $39.99 per share. Our stock price may continue to be volatile after this offering. The market price of our common stock may also be affected by our ability to meet analysts' and investors' expectations. Failure to meet these expectations, even slightly, could cause the market price of our common stock to fall significantly. IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE OUR COMPANY, WHICH COULD DEPRESS OUR STOCK PRICE. Delaware corporate law and our certificate of incorporation and bylaws contain provisions that could deter or prevent a change in control of our company or our management that stockholders may consider favorable or beneficial. These provisions could discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. These provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock. These provisions, which may be 12 amended only upon recommendation by our board of directors and approval by our stockholders include: - a staggered board of directors, so that it would take three successive annual meetings to replace all directors; - authorization of special meetings of stockholders only upon a call by the board of directors; - authorization to issue "blank check" preferred stock, which is preferred stock that can be created and issued by the board of directors without prior stockholder approval, with rights senior to our common stockholders; - prohibition on stockholder action by written consent; and - advance notice requirements for the submission by stockholders of nominations for election to the board of directors and for proposing matters that can be acted upon by stockholders at a meeting. In addition, our senior credit facilities and senior subordinated notes could deter a change of control that our stockholders consider favorable or beneficial. A change of control of our company constitutes an event of default under our senior credit facilities, and upon a change of control, we are required to offer to repay all of our outstanding senior subordinated notes. Our senior credit facilities, however, prevent us from repaying any of these notes prior to repaying all obligations under our senior credit facilities. As of June 30, 2002, we had approximately $310 million outstanding, including the current portion, under these debt agreements. RISKS RELATING TO OUR CAPITALIZATION OUR SUBSTANTIAL DEBT COULD ADVERSELY AFFECT OUR CASH FLOW AND PREVENT US FROM FULFILLING OUR OBLIGATIONS. We have a significant amount of debt and will continue to have a significant amount of debt following the completion of this offering and the use of the net proceeds to repay a portion of our debt. We may have more debt in the future. We have not had this level of debt in the past. Our substantial amount of debt could have important consequences to you. For example, it: - will make it more difficult for us to satisfy our obligations under our senior credit facilities and senior subordinated notes; - will increase our vulnerability to general adverse economic and industry conditions and adverse changes in governmental regulations; - will require us to dedicate a substantial portion of our cash flow from operations to make payments on our debt, reducing the availability of our cash flow to fund future capital expenditures, working capital, execution of our growth strategy, research and development costs and other general corporate requirements; 13 - could limit our flexibility in planning for, or reacting to, changes in our business and the pharmaceutical industry, which may place us at a competitive disadvantage compared with competitors that have less debt; and - could limit our ability to borrow additional funds, even when necessary to maintain adequate liquidity. The terms of our senior credit facilities and senior subordinated notes allow us to incur substantial amounts of additional debt, subject to certain limitations. We might incur additional debt for various reasons, particularly to pay for the additional product line acquisitions that we may make for our Pharmaceutical business unit. TO SERVICE OUR DEBT, WE WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH, WHICH MAY NOT BE AVAILABLE TO US. Our ability to make payments on or refinance our debt will depend largely upon our future operating performance. Our future operating performance is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We cannot assure you that our business will generate cash flow from operations in an amount sufficient to enable us to pay our debt or to fund our other liquidity needs. For example, in 1999 we had a loss from operations of $8.8 million and net cash used in operating activities of $12.7 million. If we are unable to generate sufficient cash flow to meet our debt service requirements, we may have to renegotiate the terms of our debt. We cannot assure you that we will be able to repay or refinance any of our debt, including our senior credit facilities or senior subordinated notes, on commercially reasonable terms or at all. If we were unable to refinance our debt or obtain new financing under these circumstances, we would have to consider other options, such as: - sales of certain assets to meet our debt service obligations; - sales of equity; and - negotiations with our lenders to restructure the applicable debt. However, these options may not be feasible or prove adequate. Our credit agreement and the indenture may restrict, or market or business conditions may limit, our ability to do some of these things. THE FINANCING AGREEMENTS GOVERNING OUR DEBT, INCLUDING OUR SENIOR CREDIT FACILITIES AND SENIOR SUBORDINATED NOTES, CONTAIN VARIOUS COVENANTS THAT LIMIT OUR DISCRETION IN THE OPERATION OF OUR BUSINESS AND COULD LEAD TO ACCELERATION OF DEBT. Our existing financing agreements impose operating and financial restrictions on our activities. These restrictions require us to comply with or maintain certain financial tests and ratios, and limit or prohibit our ability to, among other things: 14 - incur additional debt and issue preferred stock; - create liens; - redeem and/or prepay certain debt; - sell capital stock of subsidiaries or other assets; - make certain investments; - enter new lines of business; - engage in consolidations, mergers and acquisitions; - make certain capital expenditures; and - pay dividends and make other distributions. These restrictions on our ability to operate our business could seriously harm our business by, among other things, limiting our ability to take advantage of financing, merger and acquisition and other corporate opportunities. Various risks, uncertainties and events beyond our control could affect our ability to comply with these covenants and maintain the financial tests and ratios required by some of the instruments governing our financing arrangements. Failure to comply with any of the covenants in our financing agreements could result in a default under those agreements and under other agreements containing cross-default provisions. A default would permit lenders to accelerate the maturity of the debt under these agreements and to foreclose upon any collateral securing that debt. Under these circumstances, we might not have sufficient funds or other resources to satisfy all of our obligations, including our obligations under our senior credit facilities and senior subordinated notes. In addition, the limitations imposed by these financing agreements on our ability to incur additional debt and to take other actions might significantly impair our ability to obtain other financing. We may not be able to obtain future waivers or amendments, if necessary. RISKS RELATING TO OUR SENIOR SUBORDINATED NOTES PAYMENTS ON THE NOTES MAY BE ADVERSELY AFFECTED BY THE RIGHTS OF OUR SENIOR CREDITORS. Our senior subordinated notes and the related guarantees are general unsecured obligations, junior in right of payment to all existing and future senior debt. As a result, upon any distribution to our creditors in a bankruptcy, liquidation or reorganization or similar proceeding relating to us, the holders of our senior debt will be entitled to be paid in full in cash before any payment may be made on the notes. Our existing senior debt is also secured by virtually all of our assets except for the assets of our foreign subsidiaries and one-third of their capital stock. Therefore our senior lenders will also have priority with respect to the assets 15 securing their loans. The indenture governing our senior subordinated notes provides that all debt we may incur can be senior and secured. In the event of a bankruptcy or similar proceeding relating to us, holders of the notes will participate ratably with all of our general unsecured creditors. However, because the indenture requires that, until all of our senior debt is repaid, amounts otherwise payable to holders of the notes in a bankruptcy or similar proceeding be paid to holders of senior debt instead, holders of the notes may receive less, ratably, than our other general unsecured creditors in any such proceeding. In these cases, we may not have sufficient funds to pay all of our creditors, including the holders of the notes. The subordination provisions of the indenture also provide that, in most circumstances, we may not make payment to you during the continuance of payment defaults on our senior debt, and payments to you may be suspended for a period of up to 179 days if a nonpayment default exists under our senior debt. FEDERAL AND STATE LAWS PERMIT A COURT TO VOID THE SUBSIDIARY GUARANTEES UNDER CERTAIN CIRCUMSTANCES The guarantee of the notes by our domestic restricted subsidiaries will be subject to review under federal or state fraudulent transfer laws if the guarantors are called upon to pay under the guarantees. While the relevant laws vary from state to state, under such laws, generally the issuance of a guarantee will be a fraudulent conveyance if (1) any of our subsidiaries issued subsidiary guarantees with the intent of hindering, delaying or defrauding creditors, or (2) the subsidiary guarantors received less than reasonably equivalent value or fair consideration in return for issuing their respective guarantees, and, in the case of (2) only, one of the following is also true: - any of the subsidiary guarantors were insolvent, or became insolvent, when they paid the consideration; - issuing the guarantees left the applicable subsidiary guarantor with an unreasonably small amount of capital; or - the applicable subsidiary guarantor intended to, or believed that it would, be unable to pay debts as they matured. If the issuance of any guarantee were a fraudulent conveyance, a court could, among other things, void any of our subsidiary guarantor's obligations under its respective guarantee and require the repayment of any amounts paid under the guarantee. Generally, an entity will be considered insolvent if: - the sum of its debts is greater than the fair value of its property; - the present fair value of its assets is less than the amount that it will be required to pay on its existing debts as they become due; or - it cannot pay its debts as they become due. 16 Circumstance (2) identified above will be applicable to most of the guarantors because they will not receive anything in return for guaranteeing the notes. NOT ALL OF OUR SUBSIDIARIES GUARANTEE OUR OBLIGATIONS UNDER THE NOTES, AND THE ASSETS OF THE NON-GUARANTOR SUBSIDIARIES MAY NOT BE AVAILABLE TO MAKE PAYMENTS ON THE NOTES. Our foreign subsidiaries are not guarantors of the notes. Our present and future domestic restricted subsidiaries of which we own 80% or more of the diluted equity interests guarantee the notes. Payments on the notes are only required to be made by us and the subsidiary guarantors, but no payments are required to be made from assets of other subsidiaries. In addition, our consolidated financial statements included in this report are presented on a consolidated basis, including all of our foreign subsidiaries. Our non-guarantor subsidiaries had net revenues of $3.5 million in the second quarter of 2002, or 5.7% of our total net revenues. There is no specific limitation in the indenture on our ability to transfer assets to non-guarantor subsidiaries. In the event of a bankruptcy, liquidation or reorganization of any of our non-guarantor subsidiaries, their creditors, including trade creditors, will generally be entitled to payment of their claims from the assets of those subsidiaries before any assets are made available for distribution to us. As a result, the notes are effectively subordinated to the indebtedness of these non-guarantor subsidiaries. As of June 30, 2002, the total liabilities or our non-guarantor subsidiaries, excluding intercompany liabilities, were $6.0 million. 17 EX-99.2 5 g77946exv99w2.txt STMT RE COMPLIANCE WITH 18 USC SECTION 1350 Exhibit 99.2. Statement Regarding Compliance with 18 U.S.C. Section 1350. The certificates required by 18 U.S.C. section 1350 accompanied the filing of this Quarterly Report on Form 10-Q. -----END PRIVACY-ENHANCED MESSAGE-----