UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-21185
aaiPHARMA INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 04-2687849
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
2320 SCIENTIFIC PARK DRIVE, WILMINGTON, NC 28405
(Address of principal executive office) (Zip code)
(910) 254-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
The number of shares of the Registrant's common stock outstanding, as of
November 1, 2001, was 17,889,811 shares.
aaiPHARMA INC.
Table of Contents
The terms "Company", "Registrant" or "aaiPharma" in this Form 10-Q include
aaiPharma Inc. and its subsidiaries, except where the context may indicate
otherwise. Any item which is not applicable or to which the answer is negative
has been omitted.
Page No.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (unaudited)
Consolidated Statements of Operations 3
Consolidated Balance Sheets 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 16
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 17
SIGNATURES 18
EXHIBIT INDEX 19
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
aaiPHARMA INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2001 2000 2001 2000
-------- -------- -------- --------
Net revenues $ 34,908 $ 24,083 $ 94,989 $ 77,131
-------- -------- -------- --------
Operating costs and expenses:
Direct costs 17,947 12,344 48,556 37,323
Selling 3,620 2,967 9,348 8,984
General and administrative 7,879 6,507 22,004 20,010
Direct pharmaceutical start-up costs 442 -- 2,123 --
Research and development 3,028 2,774 7,253 8,112
-------- -------- -------- --------
32,916 24,592 89,284 74,429
-------- -------- -------- --------
Income (loss) from operations 1,992 (509) 5,705 2,702
Other income (expense):
Interest, net (893) (559) (1,600) (1,599)
Other 87 90 (603) 344
-------- -------- -------- --------
(806) (469) (2,203) (1,255)
-------- -------- -------- --------
Income (loss) before income taxes and cumulative
effect of accounting change 1,186 (978) 3,502 1,447
Provision for (benefit from) income taxes 478 (441) 964 (441)
-------- -------- -------- --------
Income (loss) before cumulative effect of
accounting change 708 (537) 2,538 1,888
Cumulative effect of a change in accounting principle,
net of a tax benefit of $495 -- -- -- (961)
-------- -------- -------- --------
Net income (loss) $ 708 $ (537) $ 2,538 $ 927
======== ======== ======== ========
Basic earnings (loss) per share
Income (loss) before cumulative effect $ 0.04 $ (0.03) $ 0.14 $ 0.11
Cumulative effect of accounting change -- -- -- (0.06)
-------- -------- -------- --------
Net income (loss) $ 0.04 $ (0.03) $ 0.14 $ 0.05
======== ======== ======== ========
Weighted average shares outstanding 17,945 17,556 17,774 17,439
======== ======== ======== ========
Diluted earnings (loss) per share
Income (loss) before cumulative effect $ 0.04 $ (0.03) $ 0.14 $ 0.11
Cumulative effect of accounting change -- -- -- (0.06)
-------- -------- -------- --------
Net income (loss) $ 0.04 $ (0.03) $ 0.14 $ 0.05
======== ======== ======== ========
Weighted average shares outstanding 18,571 17,556 18,152 17,756
======== ======== ======== ========
The accompanying notes are an integral part of these financial statements.
3
aaiPHARMA INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
September 30, December 31,
2001 2000
------------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 2,161 $ 1,225
Accounts receivable, net 41,954 29,447
Work-in-progress 16,176 11,459
Inventories 6,300 3,605
Prepaid and other current assets 9,676 9,141
--------- ---------
Total current assets 76,267 54,877
Property and equipment, net 36,711 42,161
Goodwill and other intangibles, net 62,230 11,266
Other assets 7,859 3,847
--------- ---------
Total assets $ 183,067 $ 112,151
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt and short-term debt $ 13,126 $ 16,884
Accounts payable 8,473 8,850
Customer advances 12,683 11,920
Accrued wages and benefits 4,383 2,710
Other accrued liabilities 8,722 3,955
--------- ---------
Total current liabilities 47,387 44,319
Long-term debt, less current portion 60,859 509
Other liabilities 1,009 1,602
Stockholders' equity:
Common stock 18 18
Paid-in capital 75,730 70,361
Accumulated deficit (124) (2,662)
Accumulated other comprehensive losses (1,812) (1,974)
Stock subscriptions receivable -- (22)
--------- ---------
Total stockholders' equity 73,812 65,721
--------- ---------
Total liabilities and stockholders' equity $ 183,067 $ 112,151
========= =========
The accompanying notes are an integral part of these financial statements.
4
aaiPHARMA INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
September 30,
----------------------
2001 2000
-------- -------
Cash flows from operating activities:
Net income $ 2,538 $ 927
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 5,600 5,424
Issuance of stock for services -- 225
Other 1,067 (74)
Changes in assets and liabilities:
Trade and other receivables (12,679) 4,609
Work-in-progress (4,789) 2,042
Inventories (2,699) (2,961)
Prepaid and other assets (1,116) 1,807
Accounts payable (334) (1,272)
Customer advances 814 (3,038)
Other accrued liabilities 6,046 (2,843)
-------- -------
Net cash provided by (used in) operating activities (5,552) 4,846
-------- -------
Cash flows from investing activities:
Proceeds from sales of property and equipment 3,401 290
Purchases of property and equipment (3,519) (3,320)
Product acquisitions (52,163) --
Other (104) 342
-------- -------
Net cash used in investing activities (52,385) (2,688)
-------- -------
Cash flows from financing activities:
Net payments on short-term debt (3,216) (2,585)
Proceeds from long-term borrowings 60,859 --
Payments on long-term borrowings (998) (506)
Issuance of common stock 2,304 344
Other (75) 1
-------- -------
Net cash provided by (used in) financing activities 58,874 (2,746)
-------- -------
Net increase (decrease) in cash and cash equivalents 937 (588)
Effect of exchange rate changes on cash (1) (36)
Cash and cash equivalents, beginning of period 1,225 1,988
-------- -------
Cash and cash equivalents, end of period $ 2,161 $ 1,364
======== =======
Supplemental information, cash paid for:
Interest $ 890 $ 1,318
Income taxes 67 20
The accompanying notes are an integral part of these financial statements.
5
aaiPHARMA INC.
Notes to Consolidated Financial Statements
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
and applicable Securities and Exchange Commission regulations for interim
financial information. These financial statements do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. The consolidated
financial information as of December 31, 2000 has been derived from audited
financial statements; certain amounts from the three and nine months ended
September 30, 2000 have been reclassified for consistent presentation with
current year financial statements. It is presumed that users of this interim
financial information have read or have access to the audited financial
statements for the preceding fiscal year. In the opinion of management, all
adjustments (consisting of normal recurring adjustments) considered necessary
for fair presentation have been included in these interim financial statements.
Operating results for the interim periods presented are not necessarily
indicative of the results that may be expected for the full year.
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from such estimates and changes in such estimates may affect
amounts reported in future periods.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements". SAB 101 specifically addresses revenue recognition issues related
to certain upfront payments or fees. Under SAB 101, certain upfront fees and
payments recognized as income in prior periods are required to be deferred and
are being amortized into revenue over the terms of the relevant agreements or as
the on-going services are performed. Although the Company implemented SAB 101 in
the fourth quarter of 2000, the cumulative effect of a change in accounting
principle has been retroactively adopted as of the beginning of the first
quarter of 2000. For the year 2000, the Company recorded a charge of $1,456,000
($961,000 after tax) for the cumulative effect of this change in accounting
principle. For the three and nine months ended September 30, 2001, the Company
recognized $83,000 and $417,000 of revenue related to the amortization of these
deferred amounts, respectively. For the three and nine months ended September
30, 2000, the Company recognized $183,000 and $550,000 of revenue, respectively.
In July 2001, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS No. 142"). Under SFAS No. 142, goodwill and indefinite
lived intangible assets will no longer be amortized, but must be reviewed at
least annually for impairment. SFAS No. 142 also states that goodwill and
intangible assets acquired after June 30, 2001 should not be amortized. The
statement is effective for fiscal years beginning after December 15, 2001, and
the Company is in the process of assessing the impact that SFAS No. 142 will
have on its results of operations and consolidated financial position.
In October 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No.
144"). SFAS No. 144 provides
6
guidance and addresses significant implementation questions on the accounting
for the impairment or disposal of long-lived assets. The statement is effective
for fiscal years beginning after December 15, 2001. The Company is in the
process of assessing the impact that SFAS No. 144 will have on its results of
operations and consolidated financial position.
2. EARNINGS PER SHARE
The following table sets forth the computation of basic and fully diluted
earnings per share (in thousands, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- --------------------
2001 2000 2001 2000
------- -------- ------- -------
Numerator:
Net income (1) $ 708 $ (537) $ 2,538 $ 927
======= ======== ======= =======
Denominator:
Denominator for basic earnings per share -
weighted average shares 17,945 17,556 17,774 17,439
Effect of dilutive securities:
Employee stock options 626 -- 378 317
------- -------- ------- -------
Denominator for fully diluted earnings per share -
weighted average shares 18,571 17,556 18,152 17,756
======= ======== ======= =======
Basic earnings per share $ 0.04 $ (0.03) $ 0.14 $ 0.05
Diluted earnings per share $ 0.04 $ (0.03) $ 0.14 $ 0.05
(1) Numerator for both basic and diluted earnings per share.
(2) Options to purchase 244,000 weighted average shares in the third quarter of
2000 were not included in diluted earnings per share since their inclusion
would be anti-dilutive
7
3. COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity during a period from
transactions and other events and circumstances from non-owner sources. The
following table presents the components of the Company's comprehensive income
(in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2001 2000 2001 2000
------- -------- ------- -------
Net income (loss) $ 708 $ (537) $ 2,538 $ 927
Currency translation adjustments 695 (775) (385) (1,103)
Unrealized gain (loss) on investments (44) -- 547 --
------- ------- ------- -------
Comprehensive income (loss) $ 1,359 $(1,312) $ 2,700 $ (176)
======= ======= ======= =======
4. FINANCIAL INFORMATION BY BUSINESS SEGMENT AND GEOGRAPHIC AREA
(IN THOUSANDS):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2001 2000 2001 2000
-------- -------- -------- --------
NET REVENUES:
Research revenues:
Non-clinical $ 16,013 $ 15,869 $ 49,089 $ 47,022
Clinical 7,716 6,412 21,441 18,133
-------- -------- -------- --------
23,729 22,281 70,530 65,155
Product sales 6,653 1,100 11,250 4,391
Product development 4,526 702 13,209 7,585
-------- -------- -------- --------
$ 34,908 $ 24,083 $ 94,989 $ 77,131
======== ======== ======== ========
United States $ 31,726 $ 20,976 $ 85,171 $ 64,067
Non-U.S. 3,965 3,926 12,603 15,714
Less intercompany (783) (819) (2,785) (2,650)
-------- -------- -------- --------
$ 34,908 $ 24,083 $ 94,989 $ 77,131
======== ======== ======== ========
8
INCOME FROM OPERATIONS:
Research revenues:
Non-clinical $ 297 $ 4,281 $ 4,618 $ 12,298
Clinical 1,641 294 2,157 669
------- ------- -------- --------
1,938 4,575 6,775 12,967
Product sales 1,714 (210) 1,228 (278)
Product development 1,536 (2,244) 6,097 (1,460)
Corporate (3,196) (2,630) (8,395) (8,527)
------- ------- -------- --------
$ 1,992 $ (509) $ 5,705 $ 2,702
======= ======= ======== ========
United States $ 2,406 $ (567) $ 5,365 $ (2,081)
Non-U.S. (414) 58 340 4,783
------- ------- -------- --------
$ 1,992 $ (509) $ 5,705 $ 2,702
======= ======= ======== ========
5. TRANSACTIONS WITH RELATED PARTIES
The Company has work-in-progress and receivables due from Aesgen, Inc.
("Aesgen") and Endeavor Pharmaceuticals, Inc. ("Endeavor"). Both Endeavor and
Aesgen were organized by aaiPharma Inc. and its principal shareholders, and
continue to be related parties. The total amount of work-in-progress and
receivables at September 30, 2001 related to Aesgen was approximately $625,000
and the amount related to Endeavor was approximately $133,000. Revenues
recognized from Aesgen and Endeavor totaled $11,000 and $241,000 for the three
and nine months ended September 30, 2001, and were $223,000 and $715,000 for the
three and nine months ended September 30, 2000.
6. DEBT
The following table presents the components of current maturities of long-term
and short-term debt (in thousands):
September 30, December 31,
2001 2000
------------- ------------
U.S. revolving credit facility $13,100 $ 9,403
U.S. bank debt -- 5,250
German revolving credit facility -- 1,716
Current maturities of long-term debt 26 515
------- -------
Current maturities of long-term debt and
short-term debt $13,126 $16,884
======= =======
9
September 30, December 31,
2001 2000
------------- ------------
U.S. bank term loans $60,000 $ 1,024
Obligations under asset purchase agreement 859 --
Less current maturities of long-term debt -- (515)
------- -------
Total long-term debt due after one year $60,859 $ 509
======= =======
In August 2001, the Company entered into the Second Amended and Restated Loan
Agreement, which expires in September 2002. The agreement provides for
borrowings of up to $85 million, consisting of a term loan of $60 million and a
revolving credit facility of up to $25 million. The revolving credit amount is
based upon a borrowing base consisting of portions of accounts receivable and
inventories. The agreement provides for variable interest rates based on LIBOR
and is secured by a security interest on substantially all assets of the
Company. At the end of the credit period, any outstanding balances under this
facility must be repaid. Subject to certain financial conditions, the agreement
may be extended to December 31, 2006. If the agreement is extended, quarterly
principal payments on the term loan will begin in March 2003. The agreement
requires the payment of certain commitment fees based on the unused portion of
the line of credit. At September 30, 2001, the Company qualified for the entire
$25.0 million borrowing base of the revolving credit facility; actual borrowings
totaled $13.1 million.
Under the terms of the credit agreement, the Company is required to comply with
various covenants including, but not limited to, those pertaining to maintenance
of certain financial ratios, and incurring additional indebtedness. The Company
was in compliance with the financial covenants at September 30, 2001.
7. CONTINGENCIES
The Company currently leases a facility adjacent to the Company's laboratories
from two banks. The facility was built in 1999 in Wilmington, North Carolina.
The Company also leases a laboratory in Durham, North Carolina from the same two
banks. The Company's operating leases for these facilities covered an initial
period of three years, which expired in October 2001, with two one-year renewal
periods. At the end of the initial term, the Company elected to extend the
leases under the first renewal period. At the end of the first renewal period,
the Company may elect to purchase the facilities at fair market value, extend
the leases again or the properties may be sold.
8. ACQUISITION
In the third quarter of 2001, the Company completed the acquisition of a line of
critical care injectable nutritional products from AstraZeneca AB, an affiliate
of AstraZeneca PLC. The Company acquired these products for payments of up to
$100 million over three years. Revenues from the sales of these products are
included in the Company's results of operations beginning on the acquisition
date. To finance the initial payment for this acquisition, the Company used the
proceeds from the term loan, as described in Note 6. Future guaranteed payments
are due in September 2002 and 2003. Future contingent payments for the
acquisition are potentially due in September 2003 and 2004, but are contingent
upon certain obligations being completed by AstraZeneca, and have not yet been
recorded as a liability on the Company's balance sheet.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The Company's quarterly results have been, and are expected to continue to be,
subject to fluctuations. Quarterly results can fluctuate as a result of a number
of factors, including without limitation, the commencement, completion or
cancellation of large contracts, demand for the Company's pharmaceutical product
line, ability of contract manufacturers to supply products on a timely basis,
costs and results of ongoing and future litigation by and against the Company,
progress of ongoing contracts, achieving expected levels of licensing and
royalty revenues, the timing of start-up expenses for new facilities, timing and
level of research and development expenditures and changes in the mix of
services. Since a large percentage of the Company's operating costs are
relatively fixed, variations in the timing and progress of large contracts or
the recognition of licensing and royalty revenues (on projects for which
associated expense may have been recognized in prior periods) can materially
affect quarterly results. Accordingly, the Company believes that comparisons of
its quarterly financial results may not be meaningful.
RESULTS OF OPERATIONS:
THIRD QUARTER 2001 COMPARED TO THIRD QUARTER 2000
Overall net revenues for the third quarter of 2001 grew 45% to $34.9 million,
compared to $24.1 million in the third quarter of 2000. Research revenues
(non-clinical and clinical) were $23.7 million in the third quarter of 2001
compared to $22.3 million in the same period of 2000. Non-clinical research
revenues were up 1% to $16.0 million in the third quarter of 2001, from $15.9
million in the same period of 2000. Clinical research revenues were up 20% to
$7.7 million in the third quarter of 2001, from $6.4 million in the same period
of 2000. Clinical research revenues were higher primarily related to revenue
generated from significant new contracts entered into in the last half of 2000,
including amendments to those contracts, which occurred in 2001.
Product development revenues (royalties & fees) were $4.5 million in the third
quarter of 2001 compared to $0.7 million in the prior year period. This positive
change reflects an increase in royalties earned and milestones achieved. The
Company anticipates that product development revenues will increase in future
quarters as additional agreements are signed, and royalties and milestones are
earned. However, there can be no assurance that the Company will be successful
in executing additional product development agreements and increase its future
revenue, that the products developed will be commercially successful or that
product development projects will not be cancelled by innovator companies. In
addition, under certain product development contracts, royalties are based on
sales of customer products or other circumstances beyond our control, and
royalties under these agreements may be reduced or terminated on the occurrence
of events beyond our control.
Pharmaceutical product sales were $6.7 million in the third quarter of 2001
compared to $1.1 million in the third quarter of 2000. This increase is
attributable primarily to sales generated by the recently acquired M.V.I.(R) and
Aquasol(TM) critical care injectable nutritional product lines (the "M.V.I.(R)
Product line"), along with continued growth in azathioprine and other
pharmaceutical products. The M.V.I.(R) product line was acquired from
AstraZeneca AB in the third quarter of 2001, and is marketed by one of our
business units, NeoSan Pharmaceuticals.
11
Gross margin dollars were $17.0 million in the third quarter of 2001 compared to
$11.7 million in the third quarter of 2000, due principally to the higher
revenue levels. Gross margin as a percentage of revenues was approximately 49%
for both the third quarters of 2001 and 2000. Increases in gross margin
percentage generated by the initial sales of the M.V.I.(R) product line were
offset by the lower gross margin percentage from the changing mix of research
revenues, with lower margin clinical revenues up significantly, and higher
margin Product Life Cycle Management revenues lower due to the winding down of a
significant project as it nears completion.
Selling, general and administrative costs as a percentage of net revenues were
approximately 33% in the third quarter of 2001, compared to 39% for the same
quarter in 2000. This trend is expected to continue, as pharmaceutical product
sales become a more significant component of overall revenues and require little
incremental G&A expenses. Selling expenses will increase in the fourth quarter
as the NeoSan Pharmaceuticals sales force is fully implemented.
The third quarter of 2001 included $0.4 million of start-up costs, related to
the build-out of the NeoSan Pharmaceuticals product marketing organization,
which were recorded until the acquisition date of the critical care brands.
There were no corresponding costs in the third quarter of 2000.
Research and development expenses were approximately 9% of net revenues in the
third quarter of 2001, compared with approximately 12% of revenues for the same
period in 2000. The Company believes R&D expense will continue to be
approximately 8-10% of revenues.
The Company recorded a tax provision of $0.5 million in the third quarter of
2001. The effective tax rate of 40% resulted from a higher mix of U.S. based
income in the quarter.
Based on the above factors, the net income for the third quarter of 2001 was
$0.7 million, or $0.04 per diluted share, compared with a net loss of $0.5
million, or ($0.03) per diluted share in the same period of 2000.
NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2000
Overall net revenues for the nine months ended September 30, 2001 grew 23% to
$95.0 million, compared to $77.1 million in same period of 2000. Research
revenues (non-clinical and clinical) were $70.5 million, an increase of 8% over
the $65.2 million recorded in 2000. Non-clinical research revenues were up 4% to
$49.1 million in the nine months ended September 30, 2001, from $47.0 million in
the same period of 2000. Clinical research revenues were $21.4 million in the
nine months ended September 30, 2001, an increase from the $18.1 million in the
same period of 2000.
Product development revenues were $13.2 million in the nine months ended
September 30, 2001 compared to $7.6 million in the prior year period. Sales of
pharmaceutical products were $11.3 million compared to $4.4 million in the first
nine months of 2000, reflecting the M.V.I.(R) product line acquisition in the
third quarter of 2001 and the continued growth of other product sales.
Gross margin dollars were $46.4 million or $6.6 million higher than the nine
months ended September 30, 2000, primarily resulting from the increased revenue
in the current period. Gross margin as a percentage of revenues was
approximately 49% for the first nine months of 2001, compared to 52% for
12
the same period of 2000. The lower overall gross margin percentage reflects the
mix of revenues, with lower margin clinical revenues up significantly, and
higher margin Product Life Cycle Management revenues lower, partially offset by
the initial sales of higher margin M.V.I.(R) products.
Selling, general and administrative costs as a percentage of net revenues
decreased to approximately 33% in 2001 compared to 38% for the same period in
2000, reflecting the decreases experienced in the third quarter.
The nine months ended September 30, 2001 included $2.1 million of start-up costs
related to the build-out of the NeoSan Pharmaceuticals product marketing
organization. There were no corresponding costs in 2000.
Research and development expenses were approximately 8% of net revenues in the
nine months ended September 30, 2001, compared with approximately 11% of
revenues for the same period in 2000. As previously reported, the Company has
taken several steps to utilize R&D spending more efficiently.
Income from operations was $5.7 million for the nine months ended September 30,
2001 as compared to income from operations of $2.7 million for the same period
of 2000. This increase was largely due to higher product development revenues,
initial sales of the M.V.I.(R) product line, higher research revenues and lower
R&D spending, partially offset by the direct pharmaceutical start-up costs.
In the first quarter of 2000, the Company recorded $1.0 million in expense (net
of tax) for the cumulative effect adjustment due to the change in accounting
principle related to the implementation of Staff Accounting Bulletin No. 101
("SAB 101"), "Revenue Recognition in Financial Statements". SAB 101 required
certain revenues to be deferred and amortized into revenue in future periods.
Based on the above factors, net income for the nine months ended September 30,
2001 was $2.5 million, or $0.14 per diluted share, compared to $0.9 million, or
$0.05 per diluted share after the cumulative effect of a change in accounting
principle (SAB 101).
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically funded its business through operating cash flows
and proceeds from borrowings. Cash used by operations in the first nine months
of 2001 was $5.6 million, which included $4.6 million for working capital needs
to establish the M.V.I.(R) product line, primarily for accounts receivable and
inventories. Cash provided by operating activities was $4.8 million in the first
nine months of 2000. Excluding the cash used for M.V.I.(R) operating activities,
the change primarily resulted from an increase in accounts receivable,
work-in-progress and accounts payable, which are all strongly influenced by the
timing of transactions. Cash payments on borrowings during the first nine months
of 2001 were approximately $4.2 million.
In March 2001, the Company concluded a sale/leaseback transaction on certain
manufacturing assets, which provided cash of $3.1 million. Capital expenditures
were $3.5 million during the first nine months of 2001 compared to $3.3 million
during the same period last year. The Company anticipates total capital
expenditures for 2001 to be less than depreciation expense for the year.
13
In August 2001, the Company entered into the Second Amended and Restated Loan
Agreement, which expires in September 2002. The agreement provides for
borrowings of up to $85 million, consisting of a term loan of $60 million and a
revolving credit facility of up to $25 million. The revolving credit amount is
based upon a borrowing base consisting of portions of accounts receivable and
inventories. The agreement provides for variable interest rates based on LIBOR
and is secured by a security interest on substantially all assets of the
Company. At the end of the credit period, any outstanding balances under this
facility must be repaid. Subject to certain financial conditions, the agreement
may be extended to December 31, 2006. If the agreement is extended, quarterly
principal payments on the term loan will begin in March 2003. The agreement
requires the payment of certain commitment fees based on the unused portion of
the line of credit. At September 30, 2001, the Company qualified for the entire
$25.0 million borrowing base of the revolving credit facility; actual borrowings
totaled $13.1 million.
Under the terms of the credit agreement, the Company is required to comply with
various covenants including, but not limited to, those pertaining to maintenance
of certain financial ratios, and incurring additional indebtedness. The Company
was in compliance with the financial covenants at September 30, 2001.
In the third quarter of 2001, the Company completed the acquisition of a line of
critical care injectable nutrition products from AstraZeneca AB, an affiliate of
AstraZeneca PLC. The Company acquired these products for payments of up to $100
million over three years. Revenues from the sales of these products are included
in the Company's results of operations beginning on the acquisition date. To
finance the initial payment for this acquisition, the Company used the proceeds
from the term loan, as described above. Future guaranteed payments are due in
September 2002 and 2003. Future contingent payments for the acquisition are
potentially due in September 2003 and 2004, but are contingent upon certain
obligations being completed by AstraZeneca, and have not yet been recorded as a
liability on the Company's balance sheet.
aaiPharma expects that near term growth can be accommodated utilizing the
current credit facility. The Company may seek to supplement cash flow from
operations with the issuance of equity securities and additional borrowings. At
some point in the future there may be other opportunities that require
additional external financing, and the Company may from time-to-time seek to
obtain funds through the public or private issuance of equity or debt
securities. While the Company remains confident that it can secure additional
financing if necessary, there can be no assurances that such financing will be
available or that the terms will be acceptable to the Company.
In July 2001, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS No. 142"). Under SFAS No. 142, goodwill and indefinite
lived intangible assets will no longer be amortized, but must be reviewed at
least annually for impairment. SFAS No. 142 also states that goodwill and
intangible assets acquired after June 30, 2001 should not be amortized. The
statement is effective for fiscal years beginning after December 15, 2001, and
the Company is in the process of assessing the impact that SFAS No. 142 will
have on the results of its operations and consolidated financial position.
In October 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No.
144"). SFAS No. 144 provides guidance and addresses significant implementation
questions on the accounting for the impairment or
14
disposal of long-lived assets. The statement is effective for fiscal years
beginning after December 15, 2001. The Company is in the process of assessing
the impact that SFAS No. 144 will have on its results of operations and
consolidated financial position.
FORWARD LOOKING STATEMENTS, RISK FACTORS AND "SAFE HARBOR" LANGUAGE
This quarterly report contains certain forward-looking statements, within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, including the statements
pertaining to future product applications of the licensed technology, the
publication and issuance of valuable and enforceable patents, and anticipated
future revenues and commercial success of aaiPharma. These statements involve
risks and uncertainties that could cause actual results to differ materially,
including, without limitation, risks and uncertainties pertaining to aaiPharma's
ability to successfully apply its new technologies to new products; obtain,
enforce and license valid and commercially valuable patents; obtain additional
profitable contracts with respect to major pharmaceutical products; and achieve
commercial success of the contemplated products.
These forward-looking statements include, among others:
o all statements discussing liquidity; future, planned or targeted
operational or financial expectations, goals or objectives; future, planned
or targeted cost reductions and capital expenditures; litigation;
royalties; and continued access to financing; and
o all statements using the words "expect", "may", "believe", "anticipate",
"estimate", "project", "intend", "will", "plan", "target", "objective",
"goal", "should" and similar expressions are intended to identify
forward-looking statements.
Although the Company believes that the expectations reflected in any such
forward-looking statements are reasonable, there can be no assurance that such
expectations will prove to be correct. Any such statements are subject to
certain risks and uncertainties. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions or projections prove
incorrect, actual results, performance or financial condition may vary
materially from those anticipated, estimated or expected.
The Company assumes no obligation to update its forward-looking statements, or
other statements, contained herein. Additional factors that may cause the actual
results to differ materially are discussed in Exhibit 99.1 attached hereto and
incorporated herein by reference, and in the Company's recent filings with the
SEC, including, but not limited to, the Company's registration statement, as
amended, its Annual Report on Form 10-K filed with the SEC on April 2, 2001, its
Quarterly Report on Form 10-Q filed with the SEC on August 14, 2001, including
the exhibits thereof, its Form 8-K's, and its other periodic filings.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company, as a result of global operating activities, is exposed to risks
associated with changes in foreign exchange rates. As foreign exchange rates
change, the U. S. dollar equivalent of revenues and expenses denominated in
foreign currencies change and can have an adverse impact on the Company's
15
operating results. If foreign exchange rates were to increase by 10%, year to
date operating results would have been lower by $28,000 due to the reduction in
reported results from European operations.
The Company is also exposed to fluctuations in interest rates on its variable
rate debt instruments and leases tied to LIBOR. If interest rates were to
increase by 1%, annual interest expense on variable rate debt and leases tied to
interest rates would increase by approximately $457,000, or $114,000 per
quarter.
16
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
There have been no material developments in the litigation described in the
Company's Form 10-Q for the period ended June 30, 2001. In addition to the
previously described litigation, legal action initiated by the Company after
September 30, 2001 is summarized below.
On October 30, 2001, the Company initiated patent infringement litigation
against several companies selling, or seeking to sell, generic versions of
Prozac(R), including Barr Laboratories, Inc., Dr. Reddy's Laboratories Ltd.,
Reddy-Cheminor Inc., and PAR Pharmaceuticals Inc., in United States District
Court for the Eastern District of North Carolina, seeking a declaratory judgment
that the named generic drug manufacturers are infringing on the Company's two
recently issued fluoxetine hydrochloride Form A patents, an injunction to
prevent any sale of products infringing on the patents, and compensatory and
punitive monetary damages and attorneys fees. These patents were issued to the
Company by the United States Patent and Trademark Office on October 30, 2001.
The complaint was amended on November 6, 2001 to include one additional patent
that was issued to the Company on November 6, 2001. The Company is vigorously
prosecuting this action.
The Company may be party to other lawsuits and administrative proceedings
incidental to the normal course of its business which are not considered
material.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
EXHIBITS:
A list of the exhibits required to be filed as part of this Report on Form 10-Q
is set forth in the "Exhibit Index", which immediately precedes such exhibits,
and is incorporated herein by reference.
REPORTS ON FORM 8-K:
During the third quarter of 2001, the Company filed no Form 8-K's.
17
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
aaiPHARMA INC.
Date: November 12, 2001 By: /s/ FREDERICK D. SANCILIO
------------------- -----------------------------------------
Frederick D. Sancilio, Ph.D.
Chairman of the Board and Chief Executive
Officer (Principal Executive Officer)
Date: November 12, 2001 By: /s/ WILLIAM L. GINNA, JR.
------------------- -----------------------------------------
William L. Ginna, Jr.
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
18
aaiPHARMA INC.
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1996)
3.2 Amendment to Certificate of Incorporation dated May 24, 2000
(incorporated by reference to Exhibit 3.2 to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2000)
3.3 Amended By-laws of the Company (incorporated by reference to Exhibit
3.3 to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000)
4.1 Articles Fourth, Seventh, Eleventh and Twelfth of the form of Amended
and Restated Certificate of Incorporation of the Company (included in
Exhibit 3.1)
4.2 Article II of the form of Restated By-laws of the Company (included in
Exhibit 3.2)
4.3 Specimen Certificate for shares of Common Stock, $.001 par value, of
the Company (incorporated by reference to Exhibit 4.3 to the Company's
Registration Statement on Form S-1 (Registration No. 333-5535))
10.1 Employment Agreement dated November 17, 1995 between the Company and
Frederick D. Sancilio (incorporated by reference to Exhibit 10.1 to the
Company's Registration Statement on Form S-1 (Registration No.
333-5535))
10.2 Applied Analytical Industries, Inc. 1995 Stock Option Plan
(incorporated by reference to Exhibit 10.3 to the Company's
Registration Statement on Form S-1 (Registration No. 333-5535))
10.3 Applied Analytical Industries, Inc. 1997 Stock Option Plan, as amended
on May 8, 1998, (incorporated by reference to Exhibit 10.4 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
1998)
10.4 Stockholder Agreement dated as of November 17, 1995 among the Company,
GS Capital Partners II, L.P., GS Capital Partners II Offshore, L.P.,
Goldman, Sachs & Co. Verwaltungs GmbH, Stone Street Fund 1995, L.P.,
Bridge Street Fund 1995, L.P., Noro-Moseley Partners III, L.P.,
Wakefield Group Limited Partnership, James L. Waters, Frederick D.
Sancilio and the parties listed on Schedule 1 thereto (incorporated by
reference to Exhibit 10.5 to the Company's Registration Statement on
Form S-1 (Registration No. 333-5535))
10.5 Development Agreement dated as of April 25, 1994 between the Company
and Endeavor Pharmaceuticals Inc. (formerly, GenerEst, Inc.)
(incorporated by reference to Exhibit 10.12 to the Company's
Registration Statement on Form S-1 (Registration No. 333-5535))
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10.6 Development Agreement dated as of April 4, 1995 between the Company and
Aesgen, Inc. (incorporated by reference to Exhibit 10.13 to the
Company's Registration Statement on Form S-1 (Registration No.
333-5535))
10.7 Underwriting Agreement dated September 19, 1996 between the Company and
Goldman Sachs & Co., Cowen & Company and Lehman Brothers, Inc., as
representatives of the underwriters listed on Schedule 1 thereto
(incorporated by reference to Exhibit 10.17 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1996)
10.8 Partnership Agreement dated as of October 2, 1998 between the Company,
First Security Bank, N. A. and the Various Banks and Other Lending
Institutions Which are Parties Hereto from time to time, as the Holders
and as the Lenders and NationsBank, N. A. (incorporated by reference to
Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998)
10.9 Security Agreement dated as of October 2, 1998 between First Security
Bank, N. A., and NationsBank, N. A. (incorporated by reference to
Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998)
10.10 Amendment No. 1 to the Employment Agreement dated November 17, 1995
between the Company and Frederick D. Sancilio (incorporated by
reference to Exhibit 10.14 to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1999)
10.11 Amendment and Forbearance Agreement dated August 26, 1999 between the
Company and the Bank of America, N.A. (incorporated by reference to
Exhibit 10.15 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1999)
10.12 Pledge Agreement dated August 26, 1999 between the Company and the Bank
of America, N.A. (incorporated by reference to Exhibit 10.16 to the
Company's Quarterly Report on Form 10-Q for the quarter ended September
30, 1999)
10.13 Security Agreement dated August 26, 1999 between the Company and the
Bank of America, N.A. (incorporated by reference to Exhibit 10.17 to
the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1999)
10.14 Applied Analytical Industries, Inc. 1996 Stock Option Plan, as amended
on March 27, 2000 (incorporated by reference to exhibit to the
Company's Annual Report on Form 10-K filed for the year ended December
31, 1999)
10.15 Second Amended and Restated Loan Agreement dated as of August 17, 2001
between the Company, AAI Applied Analytical Industries Deutschland GmbH
& Co. KG, certain subsidiaries of the Company and Bank of America, N.A.
10.16 Asset Purchase Agreement by and between AstraZeneca AB and NeoSan
Pharmaceuticals Inc. dated as of July 25, 2001
10.17 Applied Analytical Industries, Inc. 2000 Stock Option Plan for
Non-Employee Directors (incorporated by reference to Exhibit 10.18 to
the Company's Quarterly Report on Form 10-Q for the quarter ended June
30, 2001)
99.1 Risk Factors
20