Aaipharma 10Q/A 2003 Q2 Quarterly report (amended)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q/A

(Amendment No. 1)


x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2003


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

For the transition period to

Commission File Number 0-21185

AAIPHARMA INC.

(Exact name of Registrant as specified in its charter)


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

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

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YESo NOx

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yesx Noo

The number of shares of the Registrant’s common stock outstanding, as of June 30, 2003 was 27,698,099 shares.

Explanatory Note:

This Amendment No. 1 to aaiPharma Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003 includes unaudited restated consolidated financial statements for the three and six months ended June 30, 2003 and 2002 and an audited restated consolidated balance sheet at December 31, 2002. The accompanying restated consolidated financial statements and supplementary data, including the notes to the accompanying restated consolidated financial statements, have been revised to reflect the restatement occurring subsequent to the filing of the original Quarterly Report on Form 10-Q for the period ended June 30, 2003. The restatement impacts the first three quarters of 2003 and each quarter of 2002. The restated amounts for the first and third quarters of 2003 and 2002 are presented in the Company’s Quarterly Reports on Form 10-Q/A for the quarterly periods ended March 31, 2003 and September 30, 2003.

This restatement:

•		corrects the recognition of revenue for certain transactions in the first half of 2003 that did not satisfy all of the conditions for revenue recognition contained in SFAS 48 and/or SAB 101,

•		increases reserves for product returns and makes other adjustments to our revenue reserves in the first half of 2003, and

•		with respect to 2002 and 2003, changes the accounting for our major product line acquisitions which had been accounted for as business combinations to treat such acquisitions as acquisitions of assets that do not constitute a business.

The restatement adjustments decreased our net revenues and diluted earnings per share for the three and six months ended June 30, 2003 by approximately $4.7 million and $19.7 million or $0.16 per share and $0.49 per share, respectively. The restatement adjustments decreased our diluted earnings per share for the three and six months ended June 30, 2002 by approximately $0.04 and $0.05 per share, respectively. For further discussion, see our Annual Report on Form 10-K for the year ended December 31, 2003 (the “2003 Form 10-K”), Item 7, which discloses the nature of the restatement adjustments and shows the impact of the restatement adjustments.

This Quarterly Report on Form 10-Q/A amends and restates Items 1, 2 and 4 of Part I and Items 3 and 6 of Part II of the original Quarterly Report on Form 10-Q, and no other information included in the original Quarterly Report on Form 10-Q is amended hereby.

For a discussion of events and developments subsequent to June 30, 2003 through the filing on June 15, 2004 of our 2003 Form 10-K, see our 2003 Form 10-K. This Amendment No. 1 to our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003 has not been updated to reflect any events or developments occurring subsequent to June 15, 2004. In accordance with Rule 12b-15 under the Securities Exchange Act of 1934, this amendment includes only those items of the Quarterly Report on Form 10-Q affected by our restatement.

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

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

On June 30, 2003 we owned the following registered and unregistered trademarks referenced herein: Darvon®, Darvon-N®, Darvocet-N®, M.V.I.®, M.V.I.-12®, M.V.I. Pediatric®, M.V.I. Adult™, Aquasol®, Aquasol A®, Aquasol E®, Brethine®, ProSorb-D™, AzaSan^TM, aaiPharma®, and AAI®. Unless the context otherwise requires, references in this document to Darvon are to Darvon® and Darvon-N® collectively and references to Darvocet are to Darvocet-N®. Unless the context otherwise requires, references in this document to M.V.I. are to M.V.I.-12®, M.V.I. Pediatric®, and M.V.I. Adult™, collectively, and references in this document to Aquasol are to Aquasol A® and Aquasol E®, collectively. All references in this document to any of these terms lacking the “®” or “TM” symbols are defined terms that reference the products, technologies or businesses bearing the trademarks with these symbols.

aaiPharma Inc.

Table of Contents


	Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements(unaudited)
Restated Consolidated Statements of Operations		4
Restated Consolidated Balance Sheets		5
Restated Consolidated Statements of Cash Flows		6
Restated Consolidated Statements of Comprehensive Income		7
Notes to Restated Consolidated Financial Statements		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		26
Item 4. Controls and Procedures		37
PART II. OTHER INFORMATION
Item 3. Defaults Upon Senior Securities		38
Item 6. Exhibits and Reports on Form 8-K		39
SIGNATURES		40
EXHIBIT INDEX		41

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

The restated consolidated financial statements and supplementary data, including the notes to the restated financial statements, set forth in this Item 1, have been revised to reflect the restatement occurring subsequent to the filing of the original Quarterly Report on Form 10-Q.

aaiPharma Inc.

RESTATED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2003			2002			2003			2002
Net revenues:
Product sales	$	41,097		$	34,673		$	66,062		$	54,850
Product development (royalties and fees)		3,897			6,469			7,707			8,604
Development services		21,102			20,305			41,314			43,613

		66,096			61,447			115,083			107,067

Operating costs and expenses:
Direct costs (excluding depreciation):
Product sales (includes product rights amortization of $2,969, $2,968, $5,937 and $3,301)		15,987			11,303			27,257			19,441
Development services		12,377			12,756			24,381			26,301

Total direct costs		28,364			24,059			51,638			45,742
Selling expenses		8,201			5,710			15,935			9,984
General and administrative expenses		11,289			10,161			21,319			18,916
Research and development		5,588			5,486			10,074			9,864
Depreciation		1,947			1,908			3,835			3,585
Royalty expense		127			—			127			—

Total operating costs and expenses		55,516			47,324			102,928			88,091

Income from operations		10,580			14,123			12,155			18,976
Other income (expense):
Interest, net		(4,931	)		(6,553	)		(10,481	)		(8,376	)
Loss from extinguishment of debt		—			—			—			(8,053	)
Other income (expense), net		226			69			143			203

		(4,705	)		(6,484	)		(10,338	)		(16,226	)

Income before income taxes		5,875			7,639			1,817			2,750
Provision for income taxes		2,383			2,890			793			1,377

Net income	$	3,492		$	4,749		$	1,024		$	1,373

Basic earnings per share	$	0.13		$	0.17		$	0.04		$	0.05

Weighted average shares outstanding		27,621			27,365			27,590			27,236

Diluted earnings per share	$	0.12		$	0.17		$	0.04		$	0.05

Weighted average shares outstanding		28,682			28,565			28,643			28,580

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

aaiPharma Inc.

RESTATED CONSOLIDATED BALANCE SHEETS
(In thousands)


	June 30,		December 31,
	2003		2002
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	8,132	$	6,532
Accounts receivable, net		31,469		29,467
Work-in-progress		12,249		10,515
Inventories, net		16,974		17,004
Deferred tax assets		1,271		1,271
Prepaid and other current assets		6,342		6,362

Total current assets		76,437		71,151
Property and equipment, net		55,968		53,125
Goodwill, net		12,345		11,378
Intangible assets, net		276,348		281,669
Other assets		13,318		16,179

Total assets	$	434,416	$	433,502

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt	$	6,553	$	5,921
Accounts payable		17,229		17,671
Customer advances		18,726		15,051
Accrued wages and benefits		7,263		6,718
Interest payable		5,026		5,232
Deferred product revenue		11,729		—
Other accrued liabilities		4,629		5,201

Total current liabilities		71,155		55,794
Long-term debt, less current portion		259,271		277,899
Deferred tax liability		2,316		3,840
Other liabilities		2,281		715
Stockholders’ equity:
Common stock		28		27
Paid-in capital		80,140		79,049
Retained earnings		17,420		16,396
Accumulated other comprehensive income (loss)		1,805		(218	)

Total stockholders’ equity		99,393		95,254

Total liabilities and stockholders’ equity	$	434,416	$	433,502

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

aaiPharma Inc.

RESTATED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)


	Six Months Ended June 30,
	2003			2002
Cash flows from operating activities:
Net income	$	1,024		$	1,373
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		9,772			6,886
Write-off of deferred financing and other costs		—			8,053
Other		(78	)		117
Changes in operating assets and liabilities:
Accounts receivable, net		(1,766	)		(13,427	)
Work-in-progress		(1,319	)		(761	)
Inventories, net		94			(275	)
Prepaid and other assets		1,038			(12,970	)
Accounts payable		(607	)		(32	)
Customer advances		3,437			3,413
Interest payable		(206	)		6,245
Deferred product revenue		11,729			—
Accrued wages and benefits and other accrued liabilities		(2,385	)		(893	)

Net cash provided by (used in) operating activities		20,733			(2,271	)

Cash flows from investing activities:
Purchases of property and equipment		(6,482	)		(4,402	)
Purchase of property and equipment previously leased		—			(14,145	)
Proceeds from sales of property and equipment		389			—
Acquisitions of product rights and other intangibles		(600	)		(211,997	)
Other		(287	)		(153	)

Net cash used in investing activities		(6,980	)		(230,697	)

Cash flows from financing activities:
Proceeds from long-term borrowings		—			245,328
Payments on long-term borrowings		(17,000	)		(18,400	)
Proceeds from interest rate swaps, net		2,678			3,426
Proceeds from stock option exercises		1,091			3,031
Other		1,018			(2,685	)

Net cash (used in) provided by financing activities		(12,213	)		230,700

Net increase (decrease) in cash and cash equivalents		1,540			(2,268	)
Effect of exchange rate changes on cash		60			109
Cash and cash equivalents, beginning of period		6,532			6,371

Cash and cash equivalents, end of period	$	8,132		$	4,212

Supplemental information, cash paid for:
Interest	$	12,142		$	2,547

Income taxes	$	2,979		$	1,947

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

aaiPharma Inc.

RESTATED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2003		2002		2003		2002
Net income	$	3,492	$	4,749	$	1,024	$	1,373
Currency translation adjustments		1,292		1,512		2,023		1,337

Comprehensive income	$	4,784	$	6,261	$	3,047	$	2,710

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

aaiPharma Inc.

Notes to Restated Consolidated Financial Statements
(Unaudited)

1. Basis of presentation and other matters

The accompanying unaudited restated 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 restated 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 restated financial information as of December 31, 2002 has been derived from audited financial statements; certain amounts for the three and six months ended June 30, 2002 have been reclassified for consistent presentation with current year financial statements. On January 30, 2003, aaiPharma’s Board of Directors approved a 3-for-2 stock split of the Company’s common shares. On March 10, 2003, each stockholder received one additional share of common stock for every two shares they owned on the record date of February 19, 2003. All share and per share amounts have been restated to reflect the stock split for all periods presented. Users of this interim financial information should read the audited financial statements for the preceding fiscal year, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included in these interim restated financial statements. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the full year.

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

In 2003, the Company adopted Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS 145”). SFAS 145 no longer requires companies to report gains or losses associated with the extinguishment of debt as a component of extraordinary gains or losses, net of tax. In addition, any extraordinary gains or losses on extinguishment of debt in prior periods presented would require reclassification. As required by SFAS 145, the extraordinary loss recognized in the six months ended June 30, 2002 of approximately $8.1 million ($5.3 million net of tax) to record the write-off of deferred financing and other costs related to its prior debt facilities has been reclassified to other expense.

The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations in accounting for its stock option plans; therefore, compensation expense has not been recognized for options granted at fair value. Under APB 25, if the exercise price of the Company’s stock options is not less than the estimated fair market value of the underlying stock on the date of grant, no compensation expense is recognized. If compensation cost for the Company’s plans had been determined based on the fair value at the grant dates for awards under those

plans consistent with the fair value method of SFAS 123, the Company’s net income and earnings per share would have been changed to the pro forma amounts indicated below:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2003		2002		2003			2002
	(In thousands, except per share data)
Net income, as reported	$	3,492	$	4,749	$	1,024		$	1,373
Pro forma stock-based compensation cost, net of tax		1,805		1,376		3,049			2,483
Pro forma net income (loss)		1,687		3,373		(2,625	)		(1,110	)
Earnings (loss) per share:
As reported -
Basic	$	0.13	$	0.17	$	0.04		$	0.05
Diluted	$	0.12	$	0.17	$	0.04		$	0.05
Pro forma -
Basic	$	0.06	$	0.12	$	(0.10	)	($	0.04	)
Diluted	$	0.06	$	0.12	$	(0.10	)	($	0.04	)

2. Restatement of Previously Issued Financial Statements

The Company has restated its consolidated statements of operations, cash flows, and comprehensive income for the three and six months ended June 30, 2003 and 2002 and its consolidated balance sheets as of June 30, 2003 and December 31, 2002. The restatement does not affect periods prior to 2002. The restatement, among other things, corrects the Company’s accounting treatment of certain transactions that did not satisfy all of the conditions of FASB Statement No. 48 “Revenue Recognition When Right of Return Exists” (“SFAS 48”) and/or Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements” (“SAB 101”) or were subsequently deemed to involve subjective determinations for which the Company has determined alternative accounting treatments should be used. Set forth below are the restatement adjustments included in the restatement of the previously issued financial statements for the three and six months ended June 30, 2003 and 2002.

The following table presents the impact of the restatement adjustments described below on net income for the three and six months ended June 30, 2003 and 2002:


	Net Income for the						Net Income for the
	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2003			2002			2003			2002
	(In thousands)
As previously reported	$	7,988		$	6,104		$	15,144		$	2,854
Consignment sale / reversal of revenue (i)		(779	)		—			(5,136	)		—
Returns reserves (ii)		(1,981	)		—			(5,659	)		—
Intangible asset amortization (iii)		(1,356	)		(1,371	)		(2,712	)		(1,577	)
Change in tax rate (iv)		(380	)		16			(613	)		96

As restated	$	3,492		$	4,749		$	1,024		$	1,373

The adjustments to restate the 2002 and 2003 quarterly periods relate to the following:

(i)		for 2003, the correction of the Company’s revenue recognition of certain transactions, including specific product sales in the first half of 2003, that did not satisfy all of the conditions for recognition of revenue under SFAS 48 and/or SAB 101,

(ii)		for 2003, significant increases in reserves for product returns and other adjustments to the Company’s revenue and product inventory reserves,

(iii)		for 2002 and 2003, a change in the accounting treatment used with respect to the Company’s product line acquisitions from accounting for the acquisitions as business combinations to recording such transactions as asset acquisitions. Accordingly the Company adjusted the related allocations to reverse the recording of goodwill and allocate all amounts specifically to identifiable tangible and intangible assets, and

(iv)		for the change in effective tax rate resulting from the above adjustments.

The following table presents the impact of the restatement adjustments on the Company’s previously reported results for the three and six months ended June 30, 2003 and 2002 on a condensed basis:


	Three Months Ended				Six Months Ended
	June 30, 2003				June 30, 2003
	As				As
	Previously		As		Previously		As
	Reported		Restated		Reported		Restated
	(In thousands, except per share data)
Statements of operations:
Net revenues	$	70,751	$	66,096	$	134,781	$	115,083
Total costs and expenses		62,763		62,604		119,637		114,059

Net income	$	7,988	$	3,492	$	15,144	$	1,024

Basic earnings per share	$	0.29	$	0.13	$	0.55	$	0.04

Diluted earnings per share	$	0.28	$	0.12	$	0.53	$	0.04


	Three Months Ended				Six Months Ended
	June 30, 2002				June 30, 2002
	As				As
	Previously		As		Previously		As
	Reported		Restated		Reported		Restated
	(In thousands, except per share data)
Statements of operations:
Net revenues	$	61,447	$	61,447	$	107,067	$	107,067
Total costs and expenses		55,343		56,698		104,213		105,694

Net income	$	6,104	$	4,749	$	2,854	$	1,373

Basic earnings per share	$	0.22	$	0.17	$	0.10	$	0.05

Diluted earnings per share	$	0.21	$	0.17	$	0.10	$	0.05


	June 30, 2003				December 31, 2002
	As Previously		As		As Previously		As
	Reported		Restated		Reported		Restated
	(In thousands)
Balance sheets:
ASSETS
Current assets:
Cash and cash equivalents	$	8,132	$	8,132	$	6,532	$	6,532
Accounts receivable, net		39,438		31,469		29,467		29,467
Inventory, net		15,349		16,974		17,004		17,004
Other current assets		19,862		19,862		18,148		18,148

Total current assets		82,781		76,437		71,151		71,151
Goodwill, net		211,759		12,345		210,792		11,378
Intangible assets, net		88,168		276,348		89,078		281,669
Other assets		69,286		69,286		69,304		69,304

Total assets	$	451,994	$	434,416	$	440,325	$	433,502

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deferred product revenue	$	—	$	11,729	$	—	$	—
Current liabilities		61,502		59,426		55,794		55,794
Long-term debt, less current portion		259,271		259,271		277,899		277,899
Deferred tax liability		11,231		2,316		6,467		3,840
Other liabilities		2,281		2,281		715		715
Stockholders’ equity		117,709		99,393		99,450		95,254

Total liabilities and stockholders’ equity	$	451,994	$	434,416	$	440,325	$	433,502

3. Earnings per share

Basic earnings per share are based on the weighted average number of common shares outstanding during the year. Diluted earnings per share are computed assuming that the weighted average number of common shares was increased by the conversion of stock options issued to employees and members of the Company’s Board of Directors. The diluted per share amounts reflect a change in the number of shares outstanding (the “denominator”) to include the options as if they were converted to shares and issued, unless their inclusion would be anti-dilutive. In the three and six months ended June 30, 2003 and 2002, 1,729,557, 1,587,487, 1,581,607 and 1,243,033 options, respectively, were excluded as they were anti-dilutive. In each period presented, the net income (the “numerator”) is the same for both basic and diluted per share computations.

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


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2003		2002		2003		2002
Basic earnings per share:
Weighted average number of shares		27,621		27,365		27,590		27,236
Effect of dilutive securities:
Stock options		1,061		1,200		1,053		1,344

Diluted earnings per share:
Adjusted weighted average number of shares and assumed conversions		28,682		28,565		28,643		28,580

4. Financial information by business segment and geographic area

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

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


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2003			2002			2003			2002
Net revenues:
Product sales	$	41,097		$	34,673		$	66,062		$	54,850
Product development		3,897			6,469			7,707			8,604
Development services		21,102			20,305			41,314			43,613

	$	66,096		$	61,447		$	115,083		$	107,067

United States	$	61,351		$	61,352		$	105,670		$	104,701
Germany		5,232			3,290			10,543			6,914
Other		283			197			608			396
Less intercompany		(770	)		(3,392	)		(1,738	)		(4,944	)

	$	66,096		$	61,447		$	115,083		$	107,067

Income from operations:
Product sales	$	17,883		$	18,589		$	25,202		$	27,374
Product development		3,897			6,469			7,707			8,604
Development services		(208	)		(684	)		123			1,102

		21,572			24,374			33,032			37,080
Research and development		(5,698	)		(5,596	)		(10,284	)		(10,073	)
Corporate		(5,294	)		(4,655	)		(10,593	)		(8,031	)

	$	10,580		$	14,123		$	12,155		$	18,976

United States	$	10,401		$	14,568		$	11,268		$	19,439
Germany		291			(288	)		1,020			(212	)
Other		(112	)		(157	)		(133	)		(251	)

	$	10,580		$	14,123		$	12,155		$	18,976

Depreciation and amortization:
Product sales	$	3,069		$	3,179		$	6,260		$	3,638
Development services		1,211			1,000			2,238			1,941
Product development		109			110			209			209
Corporate		527			587			1,065			1,098

	$	4,916		$	4,876		$	9,772		$	6,886


	June 30,		December 31,
	2003		2002
Total assets:
Product sales	$	338,833	$	340,773
Product development		7,931		6,024
Development services		48,405		49,952
Corporate		39,247		36,753

	$	434,416	$	433,502

United States	$	408,791	$	411,174
Germany		23,935		21,167
Other		1,690		1,161

	$	434,416	$	433,502

Goodwill, net:
Development services	$	12,345	$	11,378

5. 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., its principal shareholders and others, and continued to be related parties at June 30, 2003. No revenues were recognized from Aesgen for the three and six months ended June 30, 2003. Revenues recognized from Aesgen totaled $0.2 million and $0.3 million for the three and six months ended June 30, 2002. Services performed by the Company for Aesgen are covered by a Subscription Agreement, whereby the Company has agreed to receive Aesgen preferred stock in lieu of cash for the services performed.In February 2002, the Company acquired a calcitriol product from Aesgen, under an agreement which included potential royalty payments. The Company launched its calcitriol product in March 2003 and expensed potential royalties of $0.1 million under that agreement in both the three and six months ended June 30, 2003. Revenues recognized from Endeavor totaled $0.3 million and $0.6 million for the three and six months ended June 30, 2003, and were $0.7 million and $1.0 million for the three and six months ended June 30, 2002, respectively. Certain services performed by the Company for Endeavor are covered by a Securities Payment Agreement between the Company and Endeavor, whereby the Company receives Endeavor preferred stock in lieu of cash for services performed. At June 30, 2003, we had no accounts receivable or work-in-progress related to Aesgen, and had approximately $0.7 million of accounts receivable and work-in-progress related to Endeavor.

6. Inventories, net

The following table presents the components of inventories:


	June 30,			December 31,
	2003			2002
	(In thousands)
Finished goods (including consigned inventory of $1,611 in 2003)	$	12,840		$	11,110
Work-in-process		448			1,866
Raw materials and supplies		4,751			4,749
Inventory reserves		(1,065	)		(721	)

Total inventories, net	$	16,974		$	17,004

7. Debt

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


	June 30,		December 31,
	2003		2002
	(In thousands)
Current maturities of long-term debt	$	6,553	$	5,921

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


	June 30,			December 31,
	2003			2002
	(In thousands)
U.S. bank term loan	$	46,000		$	50,000
U.S. revolving credit facility		34,500			47,500
11% senior subordinated notes due 2010, net of original issue discount		174,035			173,963
Interest rate swap monetization deferred income		13,164			10,486
Fair value of interest rate swap		(1,875	)		1,871
Less current maturities of long-term debt		(6,553	)		(5,921	)

Total long-term debt due after one year	$	259,271		$	277,899

In March 2002, the Company entered into a $175 million senior secured credit facility consisting of a $75 million five-year revolving credit facility and a $100 million five-year term loan facility. The term loan facility was scheduled to be amortized over the full five-year term. The senior credit facility was subsequently reduced due to early repayments made under the term loan facility. The availability of borrowings under the revolving credit facility was not limited by a borrowing base. At June 30, 2003, the Company had unused availability under the revolving credit facility of $40.5 million. The senior credit facility provided for variable interest rates based on LIBOR or an alternate base rate, at the Company’s option. On June 30, 2003, 30-day LIBOR was 1.12%. Such facility was 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 facility required the payment of certain commitment fees based on the unused portion of the revolving credit facility and may be prepaid at any time without a premium.

Also in March 2002, the Company issued $175 million of senior subordinated notes due April 1, 2010. The proceeds from the issuance of these notes were $173.9 million, which was net of the original issue

discount. This discount will be charged to interest expense over the term of the notes. At June 30, 2003, these notes had a fixed interest rate of 11% per annum and were guaranteed on a subordinated basis by all existing domestic subsidiaries and all future domestic subsidiaries that are owned 80% or more by the Company. At June 30, 2003, the notes were not secured. Prior to the third anniversary of the date of issuance of the notes, up to 35% of the notes are redeemable with the proceeds of qualified sales of equity at 111% of par value. On or after the fourth anniversary of the date of issuance of the notes, all or any portion of the notes are redeemable at declining premiums to par value, beginning at 105.5%.

Concurrent with the issuance of the senior subordinated notes, the Company entered into an interest rate hedging agreement to effectively convert interest expense on a portion of the senior subordinated notes for the term of the notes from an 11% fixed annual rate to a floating annual rate equal to 6-month LIBOR plus a base rate. On February 27, 2003, and again on June 23, 2003, the Company sold the then outstanding interest rate hedging agreement for $2.3 million and $3.7 million, respectively, and replaced it with a similar interest rate hedging agreement. The amounts received, less the interest benefits earned through the dates of sale, have been recorded as premiums to the carrying amount of the notes and are being amortized into interest income over their remaining life. At June 30, 2003, the Company had an interest rate hedging agreement in place covering $150 million of the notes, at a rate of 6-month LIBOR plus 7.41%. On June 30, 2003, 6-month LIBOR was 1.12%, giving the Company an estimated all-in rate of 8.53%. The terms of the interest rate hedging agreements, other than the base rate, were identical and were perfectly matched with the terms of the related hedged instrument.

Under the terms of the senior secured credit facility and the senior subordinated notes, the Company was required to comply with various covenants including, but not limited to, those pertaining to maintenance of certain financial ratios and incurring additional indebtedness. After giving effect to the restatement described in Note 2, the Company was not in compliance with the covenants at June 30, 2003. The Company has since replaced its senior secured credit facility and received waivers of any defaults under its senior subordinated notes (see Notes 1 and 6 to the Company’s Annual Report of Form 10-K for the year ended December 31, 2003 for additional discussion).

8. Asset Acquisitions

On March 28, 2002, the Company acquired the U.S. rights to the Darvon and Darvocet branded product lines, which treat mild-to-moderate pain, and existing inventory from Eli Lilly and Company, in an asset purchase. The Company acquired these product lines and related intangible assets for $211.4 million, exclusive of transactional costs. To finance this acquisition, which included $1.8 million of inventory, the Company used the proceeds from the then existing senior secured credit facility and senior subordinated notes, as described in note 7. The Darvon and Darvocet 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 tangible and intangible assets. The identified intangible assets are being amortized over 20 years.

In December 2001, the Company acquired from Novartis Pharmaceutical Corporation and Novartis Corporation a line of asthma products used in the prevention and reversal of bronchospasm in patients age 12 and older with asthma and reversible bronchospasm associated with bronchitis and emphysema, in an asset purchase. The product line acquired is marketed under the Brethine brand name. The Company acquired this product line and related intangible assets for $26.6 million, exclusive of transactional costs. The Brethine product line did not have separable assets and liabilities associated with it, therefore the

Company allocated the purchase price, including acquisition related expenses, to acquired identifiable intangible assets, which are being amortized over 20 years.

In August 2001, the Company completed the acquisition of a line of critical care injectable and oral nutrition products from AstraZeneca AB, an affiliate of AstraZeneca PLC, in an asset purchase. The product lines acquired are marketed under the M.V.I. and Aquasol brand names. The Company acquired these product lines and related intangible assets for $52.5 million, exclusive of transactional costs, paid at closing, plus additional consideration (see Note 2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 for additional discussion). The M.V.I. and Aquasol 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 tangible and intangible assets. In connection with the M.V.I. and Aquasol acquisition, the Company recorded intangible assets which meet the criteria for having an indefinite life. In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” these intangible assets are not being amortized but are evaluated for impairment on at least an annual basis. The intangible assets recorded in connection with this acquisition represent the trademarks, technology and know-how associated with the product lines.

9. 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 adjusting entries eliminate investments in subsidiaries and intercompany 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:

aaiPharma Inc.
RESTATED CONSOLIDATING STATEMENT OF OPERATIONS
(In thousands)


	Three Months Ended June 30, 2003
							Non-
				Guarantor			Guarantor
	Issuer			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Net revenues	$	11,631		$	49,721		$	5,514		$	(770	)	$	66,096
Equity earnings from subsidiaries		12,444			—			—			(12,444	)		—

Total revenues		24,075			49,721			5,514			(13,214	)		66,096

Operating costs and expenses:
Direct costs (excluding depreciation)		6,528			19,096			3,420			(680	)		28,364
Selling		1,637			5,955			609			—			8,201
General and administrative		8,070			2,210			1,009			—			11,289
Research and development		—			5,588			—			—			5,588
Depreciation		1,345			306			296			—			1,947
Royalty expense		—			127			—			—			127

		17,580			33,282			5,334			(680	)		55,516

Income (loss) from operations		6,495			16,439			180			(12,534	)		10,580
Other income (expense):
Interest, net		(352	)		(4,581	)		2			—			(4,931	)
Net intercompany interest		(520	)		564			(44	)		—			—
Other income (expense), net		220			13			(7	)		—			226

		(652	)		(4,004	)		(49	)		—			(4,705	)

Income (loss) before income taxes		5,843			12,435			131			(12,534	)		5,875
Provision for income taxes		2,351			32			—			—			2,383

Net income (loss)	$	3,492		$	12,403		$	131		$	(12,534	)	$	3,492

aaiPharma Inc.
RESTATED CONSOLIDATING STATEMENT OF OPERATIONS
(In thousands)


	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		14,617			—			—			(14,617	)		—

Total revenues		28,553			47,416			3,487			(18,009	)		61,447

Operating costs and expenses:
Direct costs (excluding depreciation)		8,974			15,753			2,515			(3,183	)		24,059
Selling		1,670			3,622			418			—			5,710
General and administrative		7,416			2,013			732			—			10,161
Research and development		169			5,317			—			—			5,486
Depreciation		1,379			260			269			—			1,908

		19,608			26,965			3,934			(3,183	)		47,324

Income (loss) from operations		8,945			20,451			(447	)		(14,826	)		14,123
Other income (expense):
Interest, net		566			(7,139	)		20			—			(6,553	)
Net intercompany interest		(584	)		632			(48	)		—			—
Other income (expense), net		(1,198	)		1,266			1			—			69

		(1,216	)		(5,241	)		(27	)		—			(6,484	)

Income (loss) before income taxes		7,729			15,210			(474	)		(14,826	)		7,639
Provision for (benefit from) income taxes		2,980			—			(90	)		—			2,890

Net income (loss)	$	4,749		$	15,210		$	(384	)	$	(14,826	)	$	4,749

aaiPharma Inc.

RESTATED CONSOLIDATING STATEMENT OF OPERATIONS

(In thousands)


	Six Months Ended June 30, 2003
							Non-
				Guarantor			Guarantor
	Issuer			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Net revenues	$	22,261		$	83,410		$	11,150		$	(1,738	)	$	115,083
Equity earnings from subsidiaries		15,987			—			—			(15,987	)		—

Total revenues		38,248			83,410			11,150			(17,725	)		115,083

Operating costs and expenses:
Direct costs (excluding depreciation)		13,049			33,420			6,592			(1,423	)		51,638
Selling		2,946			11,868			1,121			—			15,935
General and administrative		15,847			3,470			2,002			—			21,319
Research and development		—			10,074			—			—			10,074
Depreciation		2,701			585			549			—			3,835
Royalty expense		—			127			—			—			127

		34,543			59,544			10,264			(1,423	)		102,928

Income (loss) from operations		3,705			23,866			886			(16,302	)		12,155
Other income (expense):
Interest, net		(1,044	)		(9,440	)		3			—			(10,481	)
Net intercompany interest		(1,036	)		1,123			(87	)		—			—
Other		160			15			(32	)		—			143

		(1,920	)		(8,302	)		(116	)		—			(10,338	)

Income (loss) before income taxes		1,785			15,564			770			(16,302	)		1,817
Provision for income taxes		761			32			—			—			793

Net income (loss)	$	1,024		$	15,532		$	770		$	(16,302	)	$	1,024

aaiPharma Inc.

RESTATED CONSOLIDATING STATEMENT OF OPERATIONS

(In thousands)


	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		16,168			—			—			(16,168	)		—

Total revenues		46,841			74,028			7,310			(21,112	)		107,067

Operating costs and expenses:
Direct costs (excluding depreciation)		18,567			26,962			4,948			(4,735	)		45,742
Selling		3,322			5,849			813			—			9,984
General and administrative		13,005			4,403			1,508			—			18,916
Research and development		416			9,448			—			—			9,864
Depreciation		2,542			539			504			—			3,585

		37,852			47,201			7,773			(4,735	)		88,091

Income (loss) from operations		8,989			26,827			(463	)		(16,377	)		18,976
Other income (expense):
Interest, net		453			(8,852	)		23			—			(8,376	)
Net intercompany interest		(1,148	)		1,257			(109	)		—			—
Other		(5,454	)		(2,436	)		40			—			(7,850	)

		(6,149	)		(10,031	)		(46	)		—			(16,226	)

Income (loss) before income taxes		2,840			16,796			(509	)		(16,377	)		2,750
Provision for (benefit from) income taxes		1,467			—			(90	)		—			1,377

Net income (loss)	$	1,373		$	16,796		$	(419	)	$	(16,377	)	$	1,373

aaiPharma Inc.

RESTATED CONSOLIDATING BALANCE SHEET

(In thousands)


	June 30, 2003
							Non-
				Guarantor			Guarantor
	Issuer			Subsidiaries			Subsidiaries			Eliminations			Consolidated
ASSETS
Current assets:
Cash and cash equivalents	$	7,610		$	193		$	329		$	—		$	8,132
Accounts receivable, net		9,130			19,153			3,186			—			31,469
Work-in-progress		3,483			3,489			6,365			(1,088	)		12,249
Inventories		3,936			12,277			761			—			16,974
Deferred tax assets		1,271			—			—			—			1,271
Prepaid and other current assets		1,809			4,130			403			—			6,342

Total current assets		27,239			39,242			11,044			(1,088	)		76,437
Investments in and advances to subsidiaries		66,061			(46,202	)		—			(19,859	)		—
Property and equipment, net		41,125			10,755			4,088			—			55,968
Goodwill, net		725			1,230			10,390			—			12,345
Intangibles, net		1,067			275,281			—			—			276,348
Other assets		4,535			8,679			104			—			13,318

Total assets	$	140,752		$	288,985		$	25,626		$	(20,947	)	$	434,416

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt	$	—		$	6,553		$	—		$	—		$	6,553
Accounts payable		5,569			9,757			1,903			—			17,229
Customer advances		11,115			5,377			3,322			(1,088	)		18,726
Accrued wages and benefits		4,077			1,751			1,435			—			7,263
Interest payable		155			4,871			—			—			5,026
Deferred product revenue		—			11,729			—			—			11,729
Other accrued liabilities		1,572			2,975			(292	)		374			4,629

Total current liabilities		22,488			43,013			6,368			(714	)		71,155
Long-term debt, less current portion		34,500			224,771			—			—			259,271
Deferred tax liability		2,316			—			—			—			2,316
Other liabilities		406			1,875			—			—			2,281
Investments in and advances to subsidiaries		90,309			(95,852	)		5,290			253			—
Total stockholders’ equity		(9,267	)		115,178			13,968			(20,486	)		99,393

Total liabilities and stockholders’ equity	$	140,752		$	288,985		$	25,626		$	(20,947	)	$	434,416

aaiPharma Inc.

RESTATED CONSOLIDATING BALANCE SHEET

(In thousands)


	December 31, 2002
						Non-
			Guarantor			Guarantor
	Issuer		Subsidiaries			Subsidiaries			Eliminations			Consolidated
ASSETS
Current assets:
Cash and cash equivalents	$	5,725	$	180		$	627		$	—		$	6,532
Accounts receivable, net		10,104		16,758			2,605			—			29,467
Work-in-progress		4,135		2,951			4,568			(1,139	)		10,515
Inventories		5,504		11,114			697			(311	)		17,004
Deferred tax assets		1,271		—			—			—			1,271
Prepaid and other current assets		2,511		3,642			209			—			6,362

Total current assets		29,250		34,645			8,706			(1,450	)		71,151
Investments in and advances to subsidiaries		66,061		(46,202	)		—			(19,859	)		—
Property and equipment, net		42,055		7,070			4,000			—			53,125
Goodwill, net		624		1,230			9,524			—			11,378
Intangibles, net		952		280,717			—			—			281,669
Other assets		4,514		11,569			96			—			16,179

Total assets	$	143,456	$	289,029		$	22,326		$	(21,309	)	$	433,502

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt	$	—	$	5,921		$	—		$	—		$	5,921
Accounts payable		4,410		11,447			1,814			—			17,671
Customer advances		7,840		5,731			2,618			(1,138	)		15,051
Accrued wages and benefits		4,922		929			867			—			6,718
Interest payable		285		4,947			—			—			5,232
Other accrued liabilities		1,244		3,379			(77	)		655			5,201

Total current liabilities		18,701		32,354			5,222			(483	)		55,794
Long-term debt, less current portion		47,500		230,399			—			—			277,899
Deferred tax liability		3,840		—			—			—			3,840
Other liabilities		715		—			—			—			715
Investments in and advances to subsidiaries		68,094		(72,423	)		4,984			(655	)		—
Total stockholders’ equity		4,606		98,699			12,120			(20,171	)		95,254

Total liabilities and stockholders’ equity	$	143,456	$	289,029		$	22,326		$	(21,309	)	$	433,502

aaiPharma Inc.

RESTATED CONSOLIDATING STATEMENT OF CASH FLOWS

(In thousands)


	Six Months Ended June 30, 2003
							Non-
				Guarantor			Guarantor
	Issuer			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Cash flows from operating activities:
Net income (loss)	$	1,024		$	15,532		$	770		$	(16,302	)	$	1,024
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		2,470			6,754			548			—			9,772
Other		(163	)		1			84			—			(78	)
Changes in operating assets and liabilities:
Accounts receivable, net		974			(2,396	)		(344	)		—			(1,766	)
Work-in-progress		651			(538	)		(1,381	)		(51	)		(1,319	)
Inventories		1,569			(1,164	)		—			(311	)		94
Prepaid and other assets		681			531			(174	)		—			1,038
Accounts payable		1,159			(1,690	)		(76	)		—			(607	)
Customer advances		3,275			(352	)		464			50			3,437
Interest payable		(130	)		(76	)		—			—			(206	)
Deferred product revenue		—			11,729			—			—			11,729
Accrued wages and benefits and other accrued liabilities		(2,350	)		419			(173	)		(281	)		(2,385	)
Intercompany receivables and payables		6,228			(23,429	)		306			16,895			—

Net cash provided by operating activities		15,388			5,321			24			—			20,733

Cash flows from investing activities:
Purchases of property and equipment		(1,696	)		(4,404	)		(382	)		—			(6,482	)
Proceeds from sales of property and equipment		389			—			—			—			389
Acquisitions of product rights and other intangibles		—			(600	)		—			—			(600	)
Other		(287	)		—			—			—			(287	)

Net cash used in investing activities		(1,594	)		(5,004	)		(382	)		—			(6,980	)

Cash flows from financing activities:
Payments on long-term borrowings		(13,000	)		(4,000	)		—			—			(17,000	)
Proceeds from interest rate swaps, net		—			2,678			—			—			2,678
Proceeds from stock option exercises		1,091			—			—			—			1,091
Other		—			1,018			—			—			1,018

Net cash used in financing activities		(11,909	)		(304	)		—			—			(12,213	)

Net increase (decrease) in cash and cash equivalents		1,885			13			(358	)		—			1,540
Effect of exchange rate changes on cash		—			—			60			—			60
Cash and cash equivalents, beginning of period		5,725			180			627			—			6,532

Cash and cash equivalents, end of period	$	7,610		$	193		$	329		$	—		$	8,132

aaiPharma Inc.

RESTATED CONSOLIDATING STATEMENT OF CASH FLOWS

(In thousands)


	Six Months Ended June 30, 2002
							Non-
				Guarantor			Guarantor
	Issuer			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Cash flows from operating activities:
Net income (loss)	$	1,373		$	16,796		$	(419	)	$	(16,377	)	$	1,373
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Depreciation and amortization		2,307			4,074			504			—			6,885
Write-off of deferred financing and other costs		—			8,053			—			—			8,053
Other		3			12			102			—			117
Changes in operating assets and liabilities:
Accounts receivable, net		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		(1,504	)		475			(394	)		531			(892	)
Intercompany receivables and payables		(35,525	)		19,926			(24	)		15,623			—

Net cash (used in) provided by operating activities		(23,446	)		21,431			(242	)		(14	)		(2,271	)

Cash flows from investing activities:
Purchases of property and equipment		(2,720	)		(937	)		(745	)		—			(4,402	)
Purchases of property and equipment previously leased		(14,145	)		—			—			—			(14,145	)
Acquisitions of product rights and other intangibles		—			(211,997	)		—			—			(211,997	)
Other		(153	)		—			—			—			(153	)

Net cash used in investing activities		(17,018	)		(212,934	)		(745	)		—			(230,697	)

Cash flows from financing activities:
Proceeds from long-term borrowings		49,400			195,928			—			—			245,328
Payments on long-term borrowings		(10,400	)		(8,014	)		—			14			(18,400	)
Proceeds from interest rate swaps, net		—			3,426			—			—			3,426
Proceeds from stock option exercises		3,031			—			—			—			3,031
Other		(2,854	)		142			27			—			(2,685	)

Net cash provided by financing activities		39,177			191,482			27			14			230,700

Net 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 period		5,301			154			916			—			6,371

Cash and cash equivalents, end of period	$	4,014		$	133		$	65		$	—		$	4,212

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

The information set forth in this Item 2 has been revised to reflect the restatement occurring subsequent to the filing of the original Quarterly Report on Form 10-Q.

Restatement of Previously Issued Financial Statements

We have restated our consolidated statements of operations, cash flows, and comprehensive income for the three and six months ended June 30, 2003 and 2002 and our consolidated balance sheets as of June 30, 2003 and December 31, 2002. The restatement did not affect periods prior to 2002. The restatement is reported in our Annual Report on Form 10-K for the year ended December 31, 2003 and is reported in this Amendment No. 1 to our Quarterly Report for the quarterly period ended June 30, 2003 and in amendments to our Quarterly Reports on Form 10-Q/A for the quarterly periods ended March 31, 2003 and September 30, 2003. The restatement corrects our revenue recognition of certain transactions, including specific product sales in 2003, that did not satisfy all of the revenue recognition conditions under FASB Statement No. 48 “Revenue Recognition When Right of Return Exists” (“SFAS 48”), and/or Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”), increases reserves for product returns and records other adjustments to our revenue reserves for 2003, and reflects a different accounting treatment for our acquired products.

The following table summarizes the adjustments we have made to the financial information previously reported for the three months ended June 30, 2003.


	Revenue			Pre-Tax Income			Net Income
	($ in millions, except per share data)
Consignment Sale / Reversal of Revenue:
Calcitriol	$	(0.6	)	$	(0.6	)	$	(0.3	)
AzaSan 75mg and 100 mg		(0.8	)		(0.7	)		(0.4	)
Return Reserves:
Brethine (second-tier wholesaler)		(2.6	)		(2.6	)		(1.6	)
Other products		(0.7	)		(0.7	)		(0.4	)
Change in Accounting for Product Acquisitions					(2.2	)		(1.4	)
Change in Tax Rate								(0.4	)

Total Adjustments	$	(4.7	)	$	(6.8	)	$	(4.5	)

Diluted earnings per share							$	(0.16	)

The following table summarizes the adjustments we have made to the financial information previously reported for the six months ended June 30, 2003.


	Revenue			Pre-Tax Income			Net Income
	($ in millions, except per share data)
Consignment Sale:
Calcitriol	$	(3.7	)	$	(2.6	)	$	(1.5	)
AzaSan 75mg and 100 mg		(6.6	)		(6.0	)		(3.6	)
Return Reserves:
Brethine (second-tier wholesaler)		(5.9	)		(5.9	)		(3.6	)
Other products		(3.5	)		(3.5	)		(2.1	)
Change in Accounting for Product Acquisitions					(4.4	)		(2.7	)
Change in tax rate								(0.6	)

Total Adjustments	$	(19.7	)	$	(22.4	)	$	(14.1	)

Diluted earnings per share							$	(0.49	)

In connection with our new product launches in the first quarter of 2003 of calcitriol and AzaSan 75 mg and 100 mg, initial launch quantities of these products were sold pursuant to “guaranteed sale” conditions under which we agreed to accept returned product six months after the date of purchase, if not resold by then. Revenue was recognized for these sales upon shipment without the establishment of any special reserves to account for these return rights. Because these launches were into new markets or were products with which we did not have applicable or analogous historical experience, and because most of the sales for these products had returns provisions inconsistent with our normal returns provisions, we have concluded that we did not have the ability to reasonably estimate returns, and that revenue for these sales should not have been recognized until all of the conditions of SFAS 48 were met.

Since all of the conditions of SFAS 48 had not been met for these sales of calcitriol and AzaSan 75mg and 100mg in the second quarter of 2003, revenue has been recorded as if the sales were consignments. Calcitriol revenues have been reduced by $0.6 million and AzaSan revenues have been reduced by $0.8 million. Under the consignment model, upon shipment of product we invoice the wholesaler, record deferred revenue at gross invoice sales price and classify the inventory held by the wholesalers as consignment inventory at our cost of such inventory. We will recognize revenue (net of discounts, rebates, sales allowances and accruals for returns) when the consignment inventory is sold by the wholesalers, as quantified using data from the wholesalers and other third-party information sources. We will continue to recognize revenue on these products on this basis until such time as we develop sufficient historical experience on which to reasonably estimate returns and all other conditions under SFAS 48 are met. The build-up of inventory to support the initial launches of these products increased our inventory by $4.3 million in the first six months of 2003.

There were significant returns in the first quarter of 2004 from a second-tier wholesaler of our Brethine products that were inconsistent with our historical returns experience. The bulk of these products was initially sold by us during the first half of 2003 and was acquired by the second-tier wholesaler in purchases from us and from one of our principal wholesalers. Based on our knowledge regarding the

market factors affecting these requested returns, we now believe that this inventory was purchased by the wholesaler for a particular opportunity that did not materialize. A specific returns reserve of $2.6 million has been recorded in the second quarter of 2003 for these sales and for the related inventory in our restated financial statements.

At the time we recognize revenue from product sales, we record an adjustment, or decrease, to revenue for estimated chargebacks, rebates, discounts and returns. Revenue reserves are established on a product-by-product basis. These revenue reductions are established by management as its best estimate at the time of sale based on each product’s historical experience adjusted to reflect known changes in the factors that impact such reserves. Reserves for chargebacks, rebates and discounts are established based on the contractual terms with our customers; analysis of historical levels of discounts, chargebacks and rebates; communications with customers and purchased information about the rate of prescriptions being written and the levels of inventory remaining in the distribution channel as well as our expectations about the market for each product and anticipated introduction of competitive products. The reserve for chargebacks is the most significant estimate used in the recognition of our revenue from product sales. In brief, we have established contract prices for certain indirect customers that are supplied by our wholesale customers. A chargeback represents the difference between the current published wholesale acquisition cost and the indirect customers’ contract prices.

Prior to 2003, the amount of actual product returns experienced by the Company had not been significant. As a result, actual returns were charged against revenue in the period they occurred and aggregate revenue reserves were evaluated quarterly to determine if they were sufficient to cover estimated chargebacks, rebates and related allowances, as well as the expected rate of returns, and adjusted as deemed necessary. In 2003, we began segregating our products return reserve, which prior thereto we believed was adequately covered by our aggregate revenue reserves for chargebacks, rebates and related allowances. We increased the level of detail included in our analyses to include analyzing inventory in the channel to determine remaining shelf life. Our returns reserve needs are primarily related to the number of months of inventory estimated to be in the distribution channel. Levels of inventory in the distribution channel are monitored and estimated based on information we purchase from the wholesalers, combined with active discussions between our sales personnel and the wholesalers we supply. In addition, our actual sales, returns and chargeback history are used to assess the reasonableness of the estimated number of months of inventory on hand at our wholesalers. The shelf life of products remaining in the distribution channel is estimated based on an analysis of each lot sold. Each batch has a specific expiration date. A review of the actual returns history is performed and the run rate of sales out of the distribution channel is estimated. Estimated product returns reserves are adjusted based on these reviews. Reserves may also be adjusted to reflect any significant changes in trends or based upon new information that we believe may affect the reserve needs. Allowances for new product introductions are estimated based on our experiences for similar products that we currently market and are adjusted as deemed necessary based on our experience with each product. Our reserve analysis also includes a review for the potential introduction of generic competition and the resulting impact on pricing and returns reserves. Existing reserves may be adjusted accordingly to reflect our estimate for any impact these factors may have. We continually monitor our assumptions with respect to our revenue reserves for product sales and modify them if necessary. In addition to the consignment sales and other adjustments described above, we have adjusted our net revenues in the second quarter of 2003 by increasing our returns reserve for other products by $0.7 million based on a historical returns analysis.

In addition to the 2003 adjustments identified above, we are restating our consolidated financial statements for the three and six-month periods ended June 30, 2003 and 2002 to treat each of our major product line acquisitions as acquisitions of assets that do not constitute a business. We have changed the accounting treatment used from treating the acquisitions as business combinations to treating them as asset acquisitions. Accordingly, no portion of the purchase price for these acquisitions is allocated to goodwill, and the amount previously allocated to goodwill is instead allocated to the other identifiable acquired assets, including assets with definite lives. As a result, our direct costs in the three and six months ended June 30, 2002 are greater than the amount previously reported by $2.2 million and $2.4 million, respectively, due to the increase in amortization expense resulting from a greater amount of purchase price being allocated to assets with definite lives, and our directs costs in the three and six months ended June 30, 2003 are greater than the amount we previously reported by $2.2 million and $4.4 million, respectively.

Results of Operations

Our quarterly results have been, and we expect them to continue to be, subject to fluctuations. Quarterly results can fluctuate as a result of a number of factors, including without limitation, demand for our pharmaceutical product lines, the amount and timing of product returns, ability of contract manufacturers to supply conforming products on a timely basis, costs and results of ongoing and future litigation by and against us, progress of ongoing contracts, amounts recognized for licensing and royalty revenues, the commencement, completion or cancellation of large contracts, timing and amounts of start-up expenses for new facilities, timing and level of research and development expenditures, and changes in the mix of products and services. There have been no significant changes in our critical accounting policies previously disclosed in our 2003 Form 10-K. Because a large percentage of our development services operating costs are relatively fixed, variations in the timing and progress of large contracts, changes in the demand for our services and products, or the recognition of licensing and royalty revenues (on projects for which associated expense may have been recognized in prior periods) can materially affect our quarterly results. Accordingly, we believe that comparisons of our quarterly financial results may not be meaningful.

The following table sets forth our gross revenues and the amount of dilution to revenues resulting from allowances for customer credits, including discounts, rebates, chargebacks, product returns and other allowances.


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2003		2002		2003		2002
Gross revenues	$	97,758	$	76,331	$	165,033	$	128,514
Allowance for customer credits		31,662		14,884		49,950		21,447

Net revenues	$	66,096	$	61,447	$	115,083	$	107,067

In addition to changes in product mix, the increase in allowance for customer credits in the second quarter of 2003 relates primarily to a specific returns reserve of $2.6 million recorded in the second quarter of 2003 with respect to sales to a second-tier wholesaler of our Brethine products that resulted in returns that were inconsistent with

our historical returns experience, and to additional chargeback reserve requirements in the second quarter of 2003 for sales of our Brethine products. These chargeback reserves were required due to the inclusion of our Brethine products in our group purchasing organization contracts in the third quarter of 2002.

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


	Three Months Ended June 30,										Six Months Ended June 30,
	2003					2002					2003					2002
	(in thousands)
Net revenues:
Product sales	$	41,097		62	%	$	34,673		56	%	$	66,062		57	%	$	54,850		51	%
Product development		3,897		6			6,469		11			7,707		7			8,604		8
Development services		21,102		32			20,305		33			41,314		36			43,613		41

	$	66,096		100	%	$	61,447		100	%	$	115,083		100	%	$	107,067		100	%

Direct costs (excluding depreciation)	$	28,364		43	%	$	24,059		39	%	$	51,638		45	%	$	45,742		43	%
Selling		8,201		12			5,710		9			15,935		14			9,984		9
General and administrative		11,289		17			10,161		17			21,319		19			18,916		18
Research and development		5,588		8			5,486		9			10,074		9			9,864		9
Depreciation		1,947		3			1,908		3			3,835		3			3,585		3
Royalty expense		127		—			—		—			127		—			—		—
Income from operations		10,580		16			14,123		23			12,155		11			18,976		18
Loss from extinguishment of debt		—		—			—		—			—		—			(8,053	)	(8	)
Interest expense, net		(4,931	)	(7	)		(6,553	)	(11	)		(10,481	)	(9	)		(8,376	)	(8	)
Other income (expense), net		226		—			69		—			143		—			203		—
Provision for income taxes		2,383		4			2,890		5			793		1			1,377		1
Net income		3,492		5			4,749		8			1,024		1			1,373		1

Second Quarter 2003 Compared to Second Quarter 2002

Our consolidated net revenues for the quarter ended June 30, 2003 increased 8% to $66.1 million, from $61.4 million in the second quarter of 2002. Net revenues from product sales increased to $41.1 million in 2003, from $34.7 million in 2002, due to market share gains of our M.V.I. Pediatric product, a significant price increase in our injectable Brethine product that was implemented in June 2002, and contributions from our 50mg Azasan product, which was launched in June 2002. These increases in product sales were partially offset by lower sales of our Darvocet-N 100 500-count bottle product, which we believe to be due to lower purchases by repackagers of this product. Net revenues from commercial manufacturing of products marketed by other pharmaceutical companies, which is included in product sales, contributed $0.6 million and $0.2 million to net revenues from product sales in the second quarters of 2003 and 2002, respectively.

Net revenues from product development decreased 40% in the second quarter of 2003 to $3.9 million, or 6% of net revenues, from $6.5 million, or 11% of net revenues, in the 2002 period, primarily due to royalties under our significant development agreement, which decreased from $5.7 million in the second quarter of 2002 to $3.3 million in the second quarter of 2003. This development agreement is described in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our 2003 Form 10-K.

Net revenues from our development services business increased 4% in the second quarter of 2003 to $21.1 million, from $20.3 million in 2002. These increases were principally attributable to higher demand for our analytical, bioanalytical and clinical contract manufacturing capabilities, partially offset by lower clinical revenues related to the winding down of some large projects in the first half of 2002, and lower fee-for-service revenues under our significant development agreement.

Direct costs (excluding depreciation and royalty expense) increased $4.3 million, or 18%, to $28.4 million in the second quarter of 2003, from $24.1 million in the same period in 2002. This increase in direct cost dollars resulted from an increase of $4.7 million in product costs related to higher product sales. Direct costs as a percentage of net revenues were 43% for the second quarter of 2003, as compared to 39% in the second quarter of 2003. This percentage increase in direct costs reflected a product revenue mix change in the quarter towards revenues from lower margin components of our product portfolio.

Selling expenses increased 44% in the second quarter of 2003 to $8.2 million, or 12% of net revenues, from $5.7 million, or 9% of net revenues, in 2002. This increase was primarily due to expenses incurred by our product sales business associated with developing our product sales force and marketing and promoting our new products. As of June 30, 2003, our pharmaceutical sales force was approximately 80, as compared to 20 at June 30, 2002.

General and administrative costs increased 11% in the second quarter of 2003 to $11.3 million, or 17% of net revenues, from $10.2 million, or 17% of net revenues, in 2002. This increase was primarily due to expenses related to the management build-up for our product sales business.

Research and development expenses were $5.6 million, or 8% of net revenues, in the second quarter of 2003, a slight dollar increase from $5.5 million, or 9% of net revenues, in 2002. In the second quarter of 2003, significant project spending related to our ProSorb-D pain management product and development work on line extensions for our pain management and critical care products.

Consolidated income from operations was $10.6 million in the second quarter of 2003, or $3.5 million lower than the prior year. This decrease was primarily due to our increased selling, general and administrative spending to support our product sales business, increased returns reserves and our decreased product development revenues partially offset by the expansion of our product sales business and increases in revenues in our development services business.

Income from operations for our product sales business was $17.8 million in the second quarter of 2003, compared to $18.6 million in the second quarter of 2002. This decrease was attributable to the higher selling expenses, partially offset by the increased revenues and increase in direct costs, as discussed above.

Income from operations for our product development business was $3.9 million in the second quarter of 2003, compared to income from operations of $6.5 million in 2002. This change resulted from the decreased revenues from our significant development agreement, as discussed above.

Loss from operations for our development services business was ($0.2) million in the second quarter of 2003, compared to ($0.7) million in the second quarter of 2002. This improvement was primarily due to the increase in revenues, as described above.

Unallocated corporate expenses increased in the second quarter of 2003 to $5.3 million, from $4.7 million in 2002. This higher level was due to additions to our corporate infrastructure to accommodate the expansion of our overall business. As a percentage of net revenues, unallocated corporate expenses in the second quarter of 2003 and 2002 were both 8%.

Net interest expense decreased to $4.9 million in the second quarter of 2003, from $6.6 million in the second quarter of 2002. This $1.7 million decrease was primarily attributable to the lower LIBOR-based variable interest rates on our senior secured credit facility and a lower debt balance due to $50.5 million of debt repayments since June 30, 2002 on this facility.

Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002

Our consolidated net revenues for the six months ended June 30, 2003 increased 7% to $115.1 million, from $107.1 million in the first half of 2002. Net revenues from product sales increased to $66.1 million in 2003, from $54.9 million in 2002, due to contributions from our Darvon and Darvocet products, which we acquired at the end of the first quarter of 2002, and a significant price increase in our injectable Brethine product that was implemented in June 2002. Net revenues from commercial manufacturing of products marketed by other pharmaceutical companies, which are included in product sales, contributed $1.3 million and $3.2 million to net revenues from product sales in the first half of 2003 and 2002, respectively.

Net revenues from product development decreased 10% in the first half of 2003 to $7.7 million, or 7% of net revenues, from $8.6 million, or 8% of net revenues, in 2002, primarily due to lower revenues related to third-party licensing payments which we had previously deferred and were amortized into revenue in 2002 and prior years. No similar revenues were recognized in 2003.

Net revenues from our development services business decreased 5% in the first half of 2003 to $41.3 million, from $43.6 million in 2002. These decreases were principally attributable to lower clinical revenues related to the winding down of some large projects in the first half of 2002, lower fee-for-service revenues under our significant development agreement and the redeployment of a portion of our internal resources from external revenue-producing projects to research and development projects relating to our own pharmaceutical products.

Direct costs (excluding depreciation and royalty expense) increased $5.9 million, or 13%, to $51.6 million in the first six months of 2003, from $45.7 million in the same period in 2002. This increase in direct cost dollars resulted from an increased amortization expense of $2.6 million related to product rights for acquired products. Direct costs as a percentage of net revenues were 45% for the second quarter of 2003, as compared to 43% in the second quarter of 2003.

Selling expenses increased 60% in the first half of 2003 to $15.9 million, or 14% of net revenues, from $10.0 million, or 9% of net revenues, in 2002. This increase is primarily due to expenses incurred by our product sales business associated with developing our product sales force and marketing and promoting our new products.

General and administrative costs increased 13% in the first half of 2003 to $21.3 million, or 19% of net revenues, from $18.9 million, or 18% of net revenues, in 2002. This increase was primarily due to expenses related to the management build-up for our product sales business.

Research and development expenses were $10.1 million, or 9% of net revenues, in the first half of 2003, a slight increase from $9.9 million, or 9% of net revenues, in 2002. Consistent with the second quarter of 2003, significant project spending in the first half of 2003 related to our ProSorb-D pain management product and development work on line extensions for our pain management and critical care products.

Consolidated income from operations was $12.2 million in the first half of 2003, or $6.8 million lower than the first half of 2002. This decrease is primarily due to our increased selling, general and administrative spending to support our product sales business and decreases in revenues in our development services business, partially offset by the continued expansion of our product sales business.

Income from operations for our product sales business was $25.2 million in the first half of 2003, compared to $27.4 million in the first half of 2002. This decrease is attributable to the higher selling expense, offset by the increased operating income generated by the increased product sales and increased products rights amortization expense.

Income from operations for our product development business was $7.7 million in the first half of 2003, compared to income from operations of $8.6 million in 2002. This change resulted from the factors discussed above.

Income from operations for our development services business was $0.1 million in the first half of 2003, compared to $1.1 million in the first half of 2002. This decrease is primarily due to the decline in revenues and increase in direct costs, as described above.

Unallocated corporate expenses increased in the first half of 2003 to $10.6 million, from $8.0 million in 2002. This higher level was due to additions to our corporate infrastructure to accommodate the expansion of our overall business. As a percentage of net revenues, unallocated corporate expenses in the first half of 2003 was 9%, as compared to 8% in the first half of 2002.

Net interest expense increased to $10.5 million in the first half of 2003, from $8.4 million in 2002. This $2.1 million increase is primarily attributable to the borrowings that funded our product line acquisitions in March 2002.

A loss from the extinguishment of debt of $8.1 million was recorded in the first half of 2002. This loss was due to the write-off of deferred financing and other costs related to our prior debt facilities that were refinanced in March 2002.

Liquidity and Capital Resources

Historically, we have funded our businesses with cash flows provided by operations and proceeds from borrowings. Cash flow provided by operations in the first six months of 2003 was $20.7 million, compared to cash flow used in operations of $2.3 million in the first six months of 2002. This change was primarily due to an increase in net income and positive changes in working capital. In addition, the

first half of 2002 included $13.1 million of prepaid financing fees related to our senior credit facility and senior subordinated notes, which did not recur in the first half of 2003.

Cash used in investing activities was $7.0 million in the first six months of 2003 which included $6.5 million for capital spending. Cash used in investing activities was $230.7 million in the first six months of 2002, which included $211.4 million related to our 2002 acquisition of the Darvon and Darvocet branded product lines, and $14.1 million for the purchase of assets formerly covered by our tax retention operating lease, including our corporate headquarters in Wilmington, N.C. and a laboratory and clinical facility in Chapel Hill, N.C.

Net cash used in financing activities during the first six months of 2003 was $12.2 million, primarily representing debt payments of $17.0 million, partially offset by $2.7 million of interest rate swap proceeds and $1.1 million in proceeds from the issuance of common stock related to the exercise of stock options.

On March 28, 2002, we acquired the U.S. rights to the Darvon and Darvocet-N branded product lines and existing inventory from Eli Lilly and Company for $211.4 million in cash. In connection with the acquisition, we entered into a $175 million senior credit facility, 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.

At June 30, 2003, our $175 million senior secured credit facility consisted of a $75 million five-year revolving credit facility and a $100 million five-year term loan facility. The term loan facility was scheduled to be amortized over the full five-year term. The senior facility was subsequently reduced due to early repayments we made under the term loan facility. The availability of borrowings under our revolving credit facility was not limited by a borrowing base. At June 30, 2003, we had unused availability under the revolving credit facility of $40.5 million. Our senior credit facility provided for variable interest rates based on LIBOR or an alternate base rate, at our option. Such facility was 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 facility required the payment of certain commitment fees based on the unused portion of the revolving credit facility and could be prepaid at our option at any time without a premium.

Under the terms of the credit agreement for our senior credit facility, we were required to comply with various covenants including, but not limited to, those pertaining to maintenance of certain financial ratios and incurrence of additional indebtedness. After giving effect to the restatement described in this Quarterly Report on Form 10-Q/A, we were not in compliance with some of these financial covenants at June 30, 2003. See Notes 1 and 6 to our 2003 Form 10-K for additional discussion and a description of our new senior credit facility that has replaced the credit facility in effect at June 30, 2003.

On March 28, 2002, we issued $175 million of senior subordinated unsecured notes due 2010, which had a fixed interest rate of 11% per annum and are guaranteed on a subordinated basis by all of our existing domestic subsidiaries and all of our future domestic subsidiaries of which we own 80% or more of the equity interests. At June 30, 2003, these notes were not secured. 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. 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 our senior subordinated notes, we are required to comply with various covenants including, but not limited to, incurrence of additional indebtedness. After giving effect to the restatement described in this Quarterly Report on Form 10-Q/A, we were not in compliance withsome of these covenants at June 30, 2003. See Note 6 to our 2003 Form 10-K for additional discussion and a description of the consent solicitation approved in April 2004 that waived all then existing defaults under such indenture (including those in effect at June 30, 2003).

Concurrent with the issuance of our senior subordinated notes, we entered into an interest rate hedging agreement to effectively convert interest expense on a portion of the senior subordinated notes for the term of the notes from an 11% fixed annual rate to a floating annual rate equal to 6-month LIBOR plus a base rate. On February 27, 2003, and again on June 23, 2003, we sold the then outstanding hedging agreement for $2.3 million and $3.7 million, respectively and replaced it with a similar interest rate hedging agreement. The amounts we received, less the interest benefits earned through the dates of sale, have been recorded as premiums to the carrying amount of the notes and are being amortized into interest income over their remaining life. This amortization will be approximately $2.0 million annually. At June 30, 2003, we had an interest rate hedging agreement in place covering $150 million of the notes, at a rate of 6-month LIBOR plus 7.41%. On June 30, 2003, 6-month LIBOR was 1.12%, giving us an estimated all-in rate of 8.53%. The terms of the interest rate hedging agreements, other than the base rate, were identical and were perfectly matched with the terms of the related hedged instrument.

At June 30, 2003, our M.V.I. and Aquasol product line acquisition agreement provided for us to pay the second of two $1.0 million guaranteed payments in August 2003, a contingent payment of $2.0 million that was potentially due in August 2003 and a future contingent payment of $43.5 million potentially due in August 2004, depending on the status of certain reformulation activities being carried out by the seller and regulatory approval of the reformulation by the FDA. For information about a subsequent amendment to this agreement and subsequent developments related to our payment obligations thereunder, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our 2003 Form 10-K. In addition, we may have to make contingent payments of $4.7 million over four years in connection with the purchase of our Charleston, South Carolina manufacturing facility, based on the level of manufacturing revenues at this facility. At June 30, 2003, these contingent payment obligations, including the contingent payments potentially due in connection with the acquisition of the M.V.I. and Aquasol product lines, had not yet been recorded as a liability on our consolidated balance sheet. At June 30, 2003, we had $6.6 million of principal repayments due in the next twelve months under our senior credit facility. We made interest payments on the senior subordinated notes of $9.6 million in April 2003 and $9.6 million in October 2003. The October 2003 interest payment was offset by approximately $0.9 million received under our interest rate swap agreement.

Forward-Looking Statements, Risk Factors and “Safe Harbor” Language

This document contains forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Words such as “estimate,” “project,” “intend,” “anticipate,” “believe” and similar expressions are intended to identify forward-looking statements. The forward-looking statements contained in this document include statements about future financial and operating results, including the anticipated financial condition, results of operations, business strategies, operating efficiencies, competitive positions, growth opportunities for existing products, plans and objectives of management and markets for our common stock. These statements are based on the current expectations and beliefs of our management and are subject to a number of factors and uncertainties, including the matters noted above, that could cause actual results to differ materially from those described in the forward-looking statements. These statements are not guarantees of future performance, involve certain risks, uncertainties and assumptions that are difficult to predict, and are based upon assumptions as to future events that may not prove accurate. Therefore, actual outcomes and results may differ materially from what is expressed in the forward-looking statement. In any forward-looking statement in which we express an expectation or belief as to future results, that expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement or expectation or belief will result or be achieved or accomplished. Additional risks and uncertainties pertaining to the following factors, among others, could cause actual results to differ materially from those described in the forward-looking statements:

•		demand by consumers for our products and the products we produces for others;

•		the prices that we can obtain for such products;

•		the level of product and price competition;

•		competitive new product introductions, including generic competition;

•		distributors’ and wholesalers’ ordering patterns;

•		levels of our products in the distribution channels;

•		the outcome and costs of governmental investigations;

•		the outcome and costs of litigation brought by and against us;

•		timely success in product development and regulatory approvals for new products and line extensions;

•		actions by the FDA in connection with submissions related to our products or those of our competitors;

•		other governmental regulations and actions affecting our products or those of our competitors;

•		third-party payer decisions and actions affecting our products or those of our competitors; and

•		developments in patent or other proprietary rights owned by us or others.

Additional factors that may cause the actual results to differ materially are discussed in our recent filings with the SEC, including, but not limited to, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors and Forward Looking Statements” of our 2003 Form 10-K, our Current Reports on Form 8-K, 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 (and expressly disclaim any obligation to) update or alter our forward-looking statements, whether as a result of new information, future events or otherwise.

Item 4. Controls and Procedures

The Company has carried out an evaluation, under the supervision and with the participation of its newly appointed Chief Executive Officer and interim Chief Financial Officer, pursuant to Rule 13a-15 promulgated under the Securities Exchange Act of 1934, as amended, of the effectiveness of the design and operation of its disclosure controls and procedures as of December 31, 2003, which includes the period covered by this Quarterly Report on Form 10-Q/A. Disclosure controls and procedures are to be designed to ensure that material information the Company must disclose in its reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported on a timely basis. As a result of that review, our Chief Executive Officer and interim Chief Financial Officer have concluded that, as of December 31, 2003 and for the year then ended, including the period covered by this Quarterly Report on Form 10-Q/A, the Company’s disclosure controls and procedures were not adequate.

The internal control deficiencies related to, among other things, a lack of adequate policies with respect to revenue recognition, and a lack of sufficient control processes and procedures to effectively monitor and manage wholesaler inventory levels, to ensure adequate contract-approval oversight, and to ensure effective and timely communication among sales, marketing, finance and legal staff regarding the terms and conditions of certain transactions, including new product launches. Also, with respect to the sales of pharmaceutical products, the Company’s finance and accounting personnel lacked adequate training on the application of revenue recognition principles and the establishment of product return reserves.

In addition, in April 2004, in connection with their audit of the Company’s consolidated financial statements for the year ended December 31, 2003, the Company’s independent auditors identified and communicated to the Company and the Audit Committee two “material weaknesses” (as defined under standards established by the American Institute of Certified Public Accountants) relating to the Company’s accounting and public financial reporting of significant matters and to its initial recording and management review and oversight of certain accounting matters. The material weaknesses were with respect to the calculation and procedures for the analysis of revenue reserves for product sales and lack of procedures for timely communications from the Legal Department and operating divisions to the Finance Department impairing the ability to properly evaluate the accounting treatment for certain transactions the Company had entered into and assess the impact of such transactions in a timely manner. In addition, at that time, the Company’s independent auditors identified and communicated to the Company and the Audit Committee a “reportable condition” (as defined under standards established by the American Institute of Certified Public Accountants) relating to the Company’s internal controls over its financial reporting for investments. The reportable condition identified the Company’s failure to perform a formal review of its investments and failure to timely record patents or trademarks or to timely analyze the patents and trademarks for usefulness and possible impairment.

In view of the fact that the financial information presented in this Quarterly Report on Form 10-Q/A was prepared in the absence of adequate internal controls over financial reporting, the Company devoted a significant amount of time and resources to the analysis of the financial information and documentation underlying the financial statements contained in this Quarterly Report, resulting in the restatement of certain interim financial information. In particular, the Company reviewed significant product sales transactions to confirm the terms of the transaction and our accounting for the transaction, including whether all criteria for the recognition of revenue had been satisfied and whether we had properly

estimated allowances for returns and other customer credits. In addition, the Company reviewed in detail each of the matters identified by the Special Committee of the Company’s Board of Directors and its independent counsel and independent forensic accountants. The investigation of the Special Committee is discussed in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations–Special Committee Investigation” of the Company’s 2003 Form 10-K.

In light of the foregoing, the Company has taken the following actions, in addition to those described above, after the end of 2003 to address the deficiencies as described above:

•		reassigned all financial controllers from operating units into the Finance Department reporting to the Company’s Controller and Chief Accounting Officer who reports directly to the Chief Financial Officer;

•		commenced a company-wide education effort regarding our Code of Conduct and contract-approval policies;

•		implemented a more vigorous contract-approval process;

•		implemented formal revenue recognition protocols and training programs; and

•		contracted with a third-party consulting group, FTI Consulting, to provide transitional management services in the area of operations and finance.

In addition, since December 31, 2003, the Company’s then Chief Executive Officer, Chief Operating Officer and Chief Financial Officer have left the Company. In March of 2004, Dr. Sancilio, the Company’s Executive Chairman and Chief Scientific Officer, was appointed Chief Executive Officer, and Gregory F. Rayburn, a senior managing director with FTI Consulting, was appointed Interim Chief Operating Officer. In April 2004, Timothy R. Wright was appointed President of the Company’s Pharmaceuticals Products Division. Gina Gutzeit, a senior managing director with FTI Consulting, was appointed as interim Chief Financial Officer in May 2004.

The Company is fully committed to implementing controls identified by the Company’s independent auditors and the Special Committee. The Company’s efforts to strengthen its financial and internal controls continue, and the Company expects to complete remediation of the material weaknesses and reportable condition identified by its independent auditors by the end of 2004.

PART II. OTHER INFORMATION

Item 3. Defaults Upon Senior Securities.

Under the terms of the credit agreement for our senior credit facility in effect at June 30, 2003, we were required to comply with various covenants including, but not limited to, those pertaining to maintenance of certain financial ratios and incurrence of additional indebtedness. After giving effect to the restatement described in this Quarterly Report on Form 10-Q/A, we were not in compliance with some of these covenants at June 30, 2003. See Notes 1 and 6 to our 2003 Form 10-K for additional discussion and a description of our new senior credit facility that has replaced the credit facility in effect at June 30, 2003.

Under the terms of the indenture for our $175 million senior subordinated notes due 2010, we are required to comply with various covenants including, but not limited to a covenant relating to incurrence of additional indebtedness. After giving effect to the restatement described in this Quarterly Report on

Form 10-Q/A, we were not in compliance with some of these covenants at June 30, 2003. See Note 6 to our 2003 Form 10-K for additional discussion and a description of the consent solicitation approved in April 2004 that waived all then existing defaults under such indenture (including those in effect at June 30, 2003).

Item 6. Exhibits and Reports on Form 8-K

Exhibits:

A list of the exhibits required to be filed as part of this Quarterly Report on Form 10-Q/A is set forth in the “Exhibit Index”, which immediately precedes such exhibits, and is incorporated herein by reference.

Reports on Form 8-K:

During the second quarter of 2003, we furnished the following Form 8-K:

•

Dated April 23, 2003, to file a press release reporting our results of operations for the quarter ended March 31, 2003.

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.


Date:	June 24, 2004	By:	/s/	Frederick D. Sancilio

				Frederick D. Sancilio, Ph.D.
				Executive Chairman of the Board,
				Chief Executive Officer

Date:	June 24, 2004	By:	/s/	Gina Gutzeit

				Gina Gutzeit
				Interim Chief Financial Officer

aaiPharma Inc.

Exhibit Index


Exhibit
No.		Description
31.1		Certification pursuant to Exchange Act Rule 13a – 14(a) of Frederick D. Sancilio

31.2		Certification pursuant to Exchange Act Rule 13a – 14(a) of Gina Gutzeit

32.1		Certification pursuant to 18 U.S.C. Section 1350

Aaipharma Inactive 10-Q/A2003 Q2 Quarterly report (amended)