AAIPHARMA INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 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)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(910) 254-7000

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK, $0.001 PAR VALUE PER SHARE
(Title of class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K of any
amendment to this Form 10-K. [ ]

The number of shares outstanding of the Registrant's common stock, as of
January 31, 2002 was 18,034,068 shares. The aggregate market value for the
voting stock held by non-affiliates of the Registrant on January 31, 2002 was
approximately $176,218,175.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for the 2002 annual meeting of
stockholders are incorporated by reference in Part III hereof.
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PART I

ITEM 1. BUSINESS

The terms "we", "us" or "our" in this Form 10-K 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. In 1999, we merged with Medical &
Technical Research Associates, Inc.

TRADEMARKS AND TRADE NAMES

We own the following registered and unregistered trademarks: M.V.I.(R),
M.V.I.-12(R), M.V.I.-Pediatric(TM), Aquasol A(R), Aquasol E(R), Aquasol D(TM),
Brethine(R), ProSorb(R), ProSLO(TM), ProSLO II(TM), ProCore(TM), ProSpher(TM),
ProLonic(TM), ProMelt(TM), NeoSan(TM), AzaSan(TM), aaiPharma(TM), and AAI(R). We
also reference trademarks owned by other companies. Darvon(R), Darvon-N(R) and
Darvocet-N(R) are registered trademarks of Eli Lilly and Company, and we
reference these trademarks in this report with its permission. References in
this document to Darvon are to Darvon(R) and Darvon-N(R) collectively and
references to Darvocet are to Darvocet-N(R). Following our pending acquisition
of these branded product lines from Eli Lilly, as described below, we will own
the Darvon(R), Darvon-N(R) and Darvocet-N(R) trademarks in the U.S. Cataflam(R)
is a registered trademark of Novartis Corporation, Infuvite(R) is a registered
trademark of Sabex Inc., Oxycontin(R) is a registered trademark of Purdue Pharma
L.P., Prilosec(R) is a registered trademark of AstraZeneca AB, Proventil(R) is a
registered trademark of Schering Corporation, Prozac(R) is a registered
trademark of Eli Lilly and Company, and Volmax(R) is a registered trademark of
GlaxoSmithKline. All references in this document to any of these terms lacking
the "(R)" or "(TM)" symbols are defined terms that reference the products,
technologies or businesses bearing the trademarks with these symbols.

OVERVIEW

We are a specialty pharmaceutical company focused on the acquisition,
development, enhancement and commercialization of branded pharmaceutical
products. We have over 20 years of pharmaceutical research and development
experience, with operations primarily in the United States and Europe.
Historically, we have generated our revenues by providing a comprehensive
spectrum of pharmaceutical research and development services on a
fee-for-service basis to a broad base of customers, including large
pharmaceutical companies such as AstraZeneca PLC, Bayer AG, Eli Lilly and
Company, and Novartis Corporation. In addition, we have dedicated a portion of
our resources to developing our own proprietary drug products and drug-delivery
technologies, with the goal of licensing or selling rights to these products and
technologies to our customers.

In recent years, the pharmaceutical industry has been characterized by
consolidation, which has increased the level of sales necessary for large
pharmaceutical companies to justify active marketing, promotion, and research
and development of an individual product. We believe that large pharmaceutical
companies have begun to focus their resources on existing drugs with annual
sales in excess of $500 million, new drugs with high-revenue potential, and
products that fit within core therapeutic classes or marketing priorities. These
large pharmaceutical companies are divesting smaller volume or non-strategic
branded pharmaceutical products. With our established relationships with many of
these large pharmaceutical companies, our product development expertise and
capabilities, and our existing proprietary drugs and drug-delivery technologies,
we believe that we are well positioned to acquire, revitalize and improve
established, branded pharmaceutical products.

In 2001, we began acquiring branded pharmaceutical products whose sales we
believe could be increased through enhanced promotion and marketing. We seek to
acquire established, branded products that we believe we can improve by applying
our significant research and development capabilities and that fall within
targeted therapeutic classes -- critical care, central nervous system, pain
management, oncology, immunosuppression and cardiology.

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We operate through the following businesses:

- NeoSan Pharmaceuticals. NeoSan acquires, markets and promotes
established branded pharmaceutical products in targeted therapeutic
classes that we believe will benefit from our sales promotion and product
improvement strategies.

- aaiResearch. aaiResearch uses its significant research and development
capabilities and a portfolio of proprietary drug-delivery technologies
and intellectual property rights to improve our acquired products and
internally develop new products. Additionally, we offer these
capabilities and technologies to our customers for royalties, milestone
payments and fees.

- AAI International. AAI International offers on a fee-for-service basis a
comprehensive range of pharmaceutical product development services to our
customers on an international basis.

NEOSAN PHARMACEUTICALS -- OUR PRODUCT SALES BUSINESS

NeoSan acquires established branded pharmaceutical products in targeted
therapeutic classes that we believe will benefit from our sales promotion and
product improvement strategies. Once acquired, we market and promote these
brands directly through our contract sales force to high-prescribing physicians.
We use data generated by third-parties to identify physicians who prescribe our
products and products in our targeted therapeutic classes. We seek to develop
improved products or line extensions to be sold under the acquired brands by
applying the significant expertise and scientific capabilities of AAI
International and aaiResearch. We also are employing these capabilities to
develop new products to be sold under our own brand names. NeoSan intends to
focus on the following therapeutic classes -- critical care, central nervous
system, pain management, oncology, immunosuppression and cardiology.

In August 2001, we acquired from AstraZeneca AB the U.S. rights to the
M.V.I. and Aquasol branded product lines of critical care injectable and oral
nutritional products, which provide nutrients to cancer, AIDS, post-operative
and nutritionally compromised patients. In December 2001, we acquired from
Novartis Pharmaceuticals Corporation and Novartis Corporation the U.S. rights to
the Brethine branded product line, which treats asthma. In February 2002, we
entered into a purchase agreement with Eli Lilly and Company to acquire the U.S.
rights to Darvon and Darvocet branded product lines, which treat mild to
moderate pain.

Through NeoSan, we seek commercially stable products within our targeted
therapeutic classes with strong brand recognition and high gross margins. We
also seek established pharmaceutical products that we believe have not been
actively marketed and promoted for at least several years prior to our acquiring
them. Our goal is to increase the value of the brands that we acquire by
promoting them to high-prescribing physicians, using one-on-one meetings, free
product samples, educational programs, advertising, direct mail, and website
promotion. We intend to acquire products that we can promote to our existing
customer base, thereby leveraging our sales force.

We also plan to apply the significant expertise and scientific capabilities
of AAI International and aaiResearch's portfolio of patents and proprietary and
in-licensed technologies to develop new formulations, delivery systems,
indications, dosage forms and line extensions for NeoSan's branded products that
will improve their safety, efficacy, convenience or cost effectiveness or reduce
their side effects. Once approved by the FDA, we intend to market these products
under the acquired brand names, thereby leveraging the value of the existing
brand for our product improvements and line extensions. Additionally, we will
seek renewed regulatory or patent exclusivity for these improved products. A new
indication for an existing product or changes in product composition, method of
use, formulation and process may provide three-year non-patent exclusivity or
longer-term patent protection.

Additionally, through the development expertise of aaiResearch, our NeoSan
business is continuing internal development efforts on our own branded
pharmaceutical products. Product candidates in the later stages of development
include three new dosage strengths of azathioprine tablets for treatment of
rheumatoid arthritis and post-transplant rejection, and an imidapril tablet,
which is an angiotensin converting enzyme (ACE)-inhibitor, for treatment of
cardiovascular disease. Earlier stage products include a quick-dissolving
omeprazole tablet for treatment of stomach and ulcer ailments, a microsphere
anticancer agent delivered by
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injection, and a controlled release mesalamine tablet for treatment of Crohn's
disease, a particular type of gastrointestinal disease. The details of NeoSan's
pipeline of product candidates from the development work of aaiResearch is
discussed in "-- aaiResearch -- Our Product Development Business." We do not
know, however, whether we will ever be able to successfully commercialize any of
these product candidates.

M.V.I. AND AQUASOL ACQUISITION

On August 17, 2001, we acquired the U.S. rights to a line of critical care
injectable and oral nutritional products from AstraZeneca for up to $100 million
in cash, of which we paid $52.5 million at closing of the acquisition. Future
guaranteed payments of $1.0 million each are due in August 2002 and 2003. Future
contingent payments of $2.0 million and $43.5 million are potentially due in
August 2003 and 2004, respectively. The acquired products are M.V.I.-12,
M.V.I.-Pediatric, Aquasol A and Aquasol E. The M.V.I.-12, M.V.I.-Pediatric and
Aquasol A products are administered by intravenous or injected solution to
provide nutrients to severely ill patients for whom oral nutrition is not
feasible. Aquasol E is administered by oral solution.

The M.V.I. and Aquasol brands had net sales of $24.6 million for the period
from January 1, 2001 to August 17, 2001, the audited period prior to their
acquisition. These brands had net revenues of $16.8 million for us during the
remaining portion of 2001. The initial M.V.I. product and Aquasol A were
approved for marketing over 45 years ago, and M.V.I.-Pediatric was approved in
1983. No FDA approval is necessary to market Aquasol E.

The M.V.I. products and Aquasol A are approved by the FDA for the following
uses:

- M.V.I.-12 is a multivitamin solution for intravenous use as a daily
multivitamin for adults and children over 11 years receiving parenteral
nutrition. It also is used in other situations where intravenous dosing
is required due to nutrient depletion, including in surgery, for
extensive burns, fractures and other trauma, for severe infectious
diseases, and for comatose states.

- M.V.I.-Pediatric is a sterile powder intended for reconstitution as a
solution for intravenous use as a daily multivitamin for infants and
children up to 11 years of age receiving parenteral nutrition. It also is
used in other situations where intravenous dosing is required due to
nutrient depletion, including in surgery, for extensive burns, fractures
and other trauma, for severe infectious diseases, and for comatose
states.

- Aquasol A (vitamin A) Parenteral is an injectable vitamin solution used
to provide vitamin A. Aquasol E (vitamin E) Drops, which do not require
FDA approval to be marketed, are nutritional supplements taken orally to
provide vitamin E.

On February 13, 2002, we acquired from Aesgen, Inc. the rights to a generic
injectable vitamin D nutritional product that we intend to market under our
Aquasol brand name as Aquasol D. We paid $1.0 million for this product at the
time of acquisition and agreed to make additional contingent milestone payments
of up to $1.5 million and certain royalty payments for the eight-year period
following the first commercial sale of this product. We are awaiting FDA
approval and are seeking as the approved indication of this drug the management
of hypocalcemia, or bone loss, in patients undergoing chronic kidney dialysis.

Product Market. According to IMS data, the U.S. market for injectable
nutritional products was approximately $310 million in annual sales in 2001, up
from $60 million of annual sales in 1996. Of this $310 million, the market for
injectable vitamin D products, where Aquasol D will compete, was approximately
$267 million in annual sales in 2001 and the market for injectable general
nutritional products, where M.V.I.-12 and M.V.I.-Pediatric compete, was $39
million in annual sales in 2001. Injectable nutrition products are used
primarily as part of total parenteral nutrition therapy for patients, both in
the hospital and for in-home health care. Many patients receiving this therapy
are recovering from malnutrition, burns, trauma and surgery.

M.V.I.-12 and M.V.I.-Pediatric are market leaders in the U.S. for
injectable multi-vitamin drugs. According to IMS data, in 2001, M.V.I.-12 had
over a 90% share of the market for adult injectable multi-

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vitamins and M.V.I.-Pediatric had over a 90% share of the market for pediatric
injectable multi-vitamins. The main competition for M.V.I.-12 is Infuvite Adult,
which is marketed by Baxter Healthcare Corporation. The main competition of
M.V.I.-Pediatric is Infuvite Pediatric, which also is marketed by Baxter
Healthcare Corporation. Aquasol A is the only injectable Vitamin A product on
the market. Aquasol E competes with various other vitamin E products. If
approved by the FDA, the main competition of Aquasol D is expected to be
Calcijex and Zemplar, marketed by Abbott Laboratories, and Hectorol, marketed by
Bone Care International, Inc. Aquasol D has been submitted for approval by the
FDA as a generic substitute for Calcijex, although Aquasol D will be packaged in
a vial, rather than an ampoule, form.

The FDA has examined the product formulation and the current state of
medical thought on the vitamin levels needed in M.V.I.-12. After examining data
from a public workshop between the FDA and the American Medical Association as
to the appropriate dosage level of vitamins in parenteral multivitamin
preparations, the FDA increased the targeted dosage levels of vitamins B1, B6, C
and folic acid to be included in multivitamin injectable products to a level
greater than that included in any existing product and required the inclusion of
Vitamin K. Prior to our acquisition of the M.V.I. product line from AstraZeneca,
we had been working with AstraZeneca on a fee-for-service basis to reformulate
M.V.I.-12 to meet these guidelines. We anticipate that an application will be
submitted to the FDA for this reformulated product in the second half of this
year.

Product Line Strategy. We acquired the M.V.I. and Aquasol brands because
of their strong brand names and high market share. We believe that the M.V.I.
and Aquasol brands have significant growth opportunities that we can capture
through heightened promotional support and product line extensions.

We intend to enhance the sales of the M.V.I. and Aquasol products by
actively promoting them with our sales force. Our sales efforts have focused on
the supply of over 20 group purchasing organizations, or GPOs, for hospital and
outpatient settings, whose purchase contracts for M.V.I. were assigned to us by
AstraZeneca, and other wholesale customers, including managed care
organizations. We have actively marketed to GPOs, both to expand sales of M.V.I.
and to add Aquasol products to the contracts. Additionally, we are marketing to
pharmacy directors, nutritional staff and key physicians in the hospital and
institutional health care markets. The targeted physician groups are intensive
care specialists in hospitals, and oncologists and geriatricians active in-home
health care programs. We believe that significant marketing opportunities also
exist with providers in extended care, oncology, HIV, substance abuse and
outpatient surgery -- providers that deliver parenteral nutrition in markets
that have traditionally been underserved by M.V.I. Augmenting our sales force
activities are indirect marketing initiatives that revolve around our websites,
including www.neosan.com, www.mvi-us.com and www.TPNpro.com. The data on these
websites is not part of this report.

We are directing some of our marketing efforts at educating hospitals about
a change in the recommended dosage of injectable nutritional products. Due to
industry-wide shortages in the mid-1990s, we believe the dosage used at many
hospitals for total parenteral nutritional therapy was changed from once a day
to every other day. The American Society of Parenteral and Enteral Nutrition, or
ASPEN, has recently reaffirmed its recommended daily dosage of parenteral
nutritional products, which we intend to emphasize in our promotional efforts.
Also, we intend to work with ASPEN and leading physicians to have their
recommendations for nutritional products specifically address the benefits of
the M.V.I. and Aquasol product lines.

Our product line strategy for M.V.I. and Aquasol will also focus on
developing and marketing new replacement products, product improvements and
product line extensions, such as Aquasol D, as well as developing more efficient
packaging for our product line offerings. The reformulation of M.V.I.-12
described above to add vitamin K will create additional product line
opportunities within and outside the U.S. We also plan to reformulate M.V.I.-12
without vitamin K to be used for patients who cannot receive Vitamin K and are
developing a liquid injectable form of M.V.I.-Pediatric.

Since our acquisition of the M.V.I. and Aquasol product lines, we have
demonstrated success in increasing their sales and unit growth. We have
recruited a highly competent sales force and focused their promotional emphasis
on hospitals with the largest sales potential for these products. Additionally,
we have expanded the use of Aquasol A and Aquasol E in the marketplace by
including them within the scope of our
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contracts with group purchasing organizations. We have increased the average
monthly sales of the M.V.I. and Aquasol products sold in a month to $3.8 million
in the period September 2001 to December 2001, from an average of approximately
$3.3 million in the period January 1, 2001 to August 17, 2001 and $3.1 million
in 2000. We believe this increase reflects the focused promotional efforts of
our sales force on hospitals with the highest sales potential. Additionally, we
have expanded the use of Aquasol A and Aquasol E in the marketplace by including
these products in the scope of our contracts with group purchasing
organizations.

Acquisition Terms. We acquired the rights to M.V.I. and Aquasol in the
U.S. and its territories for payments of up to $100 million over three years,
with an initial payment of $52.5 million paid on August 17, 2001. Additional
payments of $1.0 million each are due in August 2002 and August 2003 (subject to
reduction in the event that product returns in each preceding period exceed
certain dollar minimums set forth in the purchase agreement). A contingent
payment of $2.0 million is due in August 2003 if the FDA approves by December
31, 2002 the reformulated M.V.I.-12 product with a minimum shelf life of 12
months. In addition, a contingent payment of up to $43.5 million is due in
August 2004 if the FDA approval of the reformulated M.V.I.-12 product is
received on or before December 31, 2003, with the $43.5 million payment being
reduced by $1.0 million for each month after December 31, 2002 during which FDA
approval is not obtained and with the contingent $43.5 million payment becoming
$0 in the event FDA approval is not obtained on or prior to December 31, 2003.
As indicated above, we believe that approval of this reformulation could be
obtained by the end of 2002 or early 2003.

Supply of Product. In connection with the M.V.I. and Aquasol acquisition,
we entered into an interim supply arrangement with AstraZeneca to supply us with
M.V.I.-12 in single-dose vials, multi-dose vials and bulk, Aquasol A and Aquasol
E. The initial term of this interim supply agreement is for two years through
August 17, 2003, but we have the option to extend the term for an additional
year. Under the interim supply agreement, we may purchase the products for a
fixed unit cost for the first two years equal to AstraZeneca's cost of goods
sold during 2000 for the relevant product, subject to full adjustment in August
2002 for changes in the cost of raw materials and an adjustment (limited to
changes in the Consumer Price Index) for changes in other manufacturing costs.
If the contract is extended to the third year, the price will increase to
AstraZeneca's full variable and fixed costs plus 20%. If we obtain FDA approval
for the reformulated M.V.I.-12 product, AstraZeneca will supply the reformulated
product to us at a price equal to AstraZeneca's costs, including materials,
labor and variable overhead. In addition, AstraZeneca assigned to us its
manufacturing agreement with a third-party supplier for the production of
M.V.I.-Pediatric for an indefinite period of time, provided that either party
can terminate this agreement upon at least four year's prior notice.

M.V.I. product line shortages existed in the mid-1990s due to third-party
manufacturing problems, which were resolved in 2000 when AstraZeneca brought
manufacturing of M.V.I.-12 in-house. Additionally, in September 2001 after an
FDA inspection of its facilities, our third party supplier of M.V.I.-Pediatric
halted production of M.V.I.-Pediatric at its manufacturing facility upon
discovery of microbial growth in other products manufactured in the section of
its facility used for the production of M.V.I.-Pediatric. This shutdown created
temporary shortages in marketplace. The manufacturer resumed production of
M.V.I.-Pediatric in February 2002 and experienced initial production problems.
We anticipate that these problems will be promptly resolved and that new
products will be shipped to our customers beginning early in the second quarter
of 2002. M.V.I.-Pediatric accounted for 31% of the M.V.I. product line sales in
2000 and 34% in 1999.

We expect to transfer the manufacture of the Aquasol products to our
Charleston and Wilmington manufacturing facilities, and to either bring the
manufacture of the M.V.I. product lines in-house or contract with third-party
manufacturers to ensure a continued, long-term supply on market terms.

BRETHINE ACQUISITION

On December 13, 2001, we acquired the U.S. rights to the Brethine branded
product line from Novartis Pharmaceuticals Corporation and Novartis Corporation
for $26.6 million in cash. Brethine is administered in oral and injectable forms
for the prevention and reversal of bronchospasm in patients age 12 and older
with asthma and reversible bronchospasm associated with bronchitis and
emphysema. Although physicians also

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prescribe Brethine to stop premature labor, this drug has not been approved by
the FDA for this indication and thus it cannot be marketed or promoted for this
use. Brethine had net sales of $15.2 million for the eleven and one-half months
ended December 13, 2001, the audited period prior to our acquisition. Brethine
was initially marketed beginning in 1975. We believe that Novartis ceased
actively promoting Brethine in the early 1990s, although Novartis selectively
marketed and promoted Brethine since then and a third party provided marketing
support for Brethine during 1999 and 2000.

Product Market. Brethine, or terbutaline sulfate, is a beta-adrenergic
agonist bronchodilator, meaning that it aids in the flow of air through the
bronchial tubes for people suffering from asthma, emphysema, chronic bronchitis,
and other lung diseases. According to Scott-Levin data, oral and injectable
drugs to treat these ailments generated sales of approximately $200 million in
2001. IMPAX Laboratories has been marketing a generic form of the oral form of
Brethine since July 2001. There are no approved generic forms of the injectable
form of this drug. Major branded products competing against Brethine to treat
these ailments include Volmax, Proventil, and branded and generic forms of
albuterol. Additionally, Brethine is prescribed to stop premature labor in
pregnant women. According to Scott-Levin data, this use is estimated to have
generated 42% of the total sales of Brethine in 2000.

Product Line Strategy. We acquired Brethine because of its strong brand
recognition, 25 years of clinical experience and well established safety record.
Our goal is to enhance the sales of Brethine by actively promoting the brand
name and using our existing relationships with hospitals and group purchasing
organizations to expand Brethine's distribution channels. We are initially
seeking to position Brethine as a preferred treatment of asthma, when a
short-acting agent is required. Our marketing efforts emphasize this product's
efficacy and its 25-year record of safety.

Historically, Brethine has been sold through wholesalers, and we are
considering the benefit of adding it to product lines carried by group
purchasing organizations that we already have as customers. Our existing sales
force also is targeting high-prescribing physicians in hospitals and private
practices and hospital and retail pharmacists to expand the use of Brethine. We
also are working with leading physician groups to have Brethine included in
their recommendations and guidelines for the treatment of asthma and related
ailments.

Our strategy for Brethine also involves product line extensions and
improvements. We plan to develop a glass vial form of the injectable Brethine
product, rather than the current glass ampoule formulation, to improve the
safety and convenience of administering this drug. We also are exploring the
development of an extended release tablet to be taken twice a day, rather than
three times a day as is the case under its current formulation. The
extended-release line extension is expected to use our patented drug-delivery
technologies that could provide us with patent exclusivity protection.

Acquisition Terms. We acquired the rights to Brethine in the U.S. and its
territories on December 13, 2001 for $26.6 million in cash from Novartis. In
connection with this acquisition, we agreed to pay Novartis royalties on our
sales in the U.S. and its territories of products developed by us that are
derivative of Brethine. Separately, we will be entitled to receive royalty
payments on sales outside of the U.S. and its territories of any of these future
derivative Brethine products, but not Brethine itself, if Novartis timely elects
to exercise its right to obtain an exclusive license from us to market any of
these derivative products outside the U.S.

Supply of Product. We entered into an interim supply agreement with
Novartis providing for its manufacture and packaging of the oral and injectable
form of Brethine for sale by us in the U.S. through December 13, 2004. We may
terminate the manufacturing component of the supply agreement on 12-months
notice and the packaging component on six months' notice. Under the supply
agreement, we may purchase the products for a fixed unit cost during the term of
the agreement, subject to an annual price adjustment on January 1, 2003 and
January 1, 2004 tied to the Consumer Price Index and to a downward adjustment in
the event product packaging is moved to a third party. We intend to transfer the
Brethine manufacturing processes to our own facilities prior to expiration of
the supply agreement. This move, however, is subject to FDA approval, and it is
possible that this approval will not be obtained on a timely basis, if at all.

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Novartis maintains an inventory of the active ingredient, terbutaline
sulfate, used to manufacture both the oral and injectable forms of the Brethine
products. The supplier of this existing inventory, however, has stopped
producing terbutaline sulfate. As a result, we have identified and are seeking
FDA approval of a new supplier and are responding to FDA requests regarding the
new supplier's material. We believe the current inventory of terbutaline sulfate
from the approved supplier is sufficient to continue to manufacture the oral
form of Brethine to supply anticipated orders until September 2002 for some
dosage strengths and several months later for other dosage strengths and to
manufacture the injectable form of Brethine to fill anticipated orders for
several years. Novartis has acquired an inventory of terbutaline sulfate from
the new supplier, but the Brethine products it manufactures for us with this
material may not be sold until the new supplier is approved by the FDA. We
believe that we will obtain approval of the new supplier prior to September
2002, but it is possible that we may not receive approval until much later, if
at all. If the FDA does not approve the new supplier, we will not be able to
supply one dosage strength of Brethine tablets to our customers after August
2002 and will not be able to supply the remaining oral dosage strength within
several months after that. Sales of the oral form of Brethine accounted for
approximately 65% of net sales of Brethine in 2001.

PENDING DARVON AND DARVOCET ACQUISITION

On February 18, 2002, we entered into an agreement with Eli Lilly to
acquire the U.S. rights to the Darvon and Darvocet branded product lines for
$211.4 million in cash, subject to reduction based on net sales of these
products before and after the closing of the acquisition. These products are
used to treat mild to moderate pain. The Darvon and Darvocet product lines had
net sales of $62.9 million in 2001, $56.5 million in 2000 and $49.5 million in
1999. Net sales of Darvon and Darvocet in November and December 2001 and January
2002, however, were less than their average monthly sales during each of 2001,
2000 and 1999. See "Additional Risk Factors -- Risks Relating to Our
Business -- Our acquisition strategy could have a material and adverse effect on
us; the product sales of Darvon and Darvocet have recently decreased" contained
elsewhere in this report. The Darvon and Darvocet product lines have been sold
in the U.S. for over 25 years. We believe that Eli Lilly ceased actively
marketing and promoting these products approximately nine years ago.

We are acquiring the Darvon and Darvocet brands because we believe they
have high customer recognition in the pain management therapeutic class, an area
where we currently have products under development. Our goal is to increase the
value of these brands by actively marketing and promoting them and repositioning
them through the development of line extensions. We believe that these brands
will respond positively to the marketing and promotional support that we intend
to provide. Specifically, we intend to enhance the value of the Darvon and
Darvocet brands by:

- actively promoting the Darvon and Darvocet brands with our sales force;

- increasing our sales force from 20 to 50 people;

- creating incentives for this sales force to generate new prescriptions
for Darvon and Darvocet;

- working with respected physicians at leading pain clinics to develop
pain-management guidelines that specify the use of the Darvon and
Darvocet products;

- targeting our brand promotion towards high-prescribing physicians; and

- developing, marketing and promoting improved products and line extensions
with improved product, delivery, and therapeutic characteristics and
potential regulatory and patent exclusivity.

In connection with this pending acquisition, we have entered into an
interim supply agreement with Eli Lilly for the manufacture of the Darvon and
Darvocet products through December 31, 2004. Upon the satisfaction of certain
conditions, we may extend the agreement for an additional six months, during
which Eli Lilly will use commercially reasonable efforts to supply NeoSan with a
calender year's supply of products during the extension period, subject to
certain maximum and minimum quantities. Prior to expiration of this agreement,
we intend to have FDA approval permitting the transfer of the manufacturing of
these products to our manufacturing facilities, one or more third-party
manufacturing facilities, or a combination of these

8

facilities. Darvon and Darvocet contains a controlled substance. Therefore, this
approval could take longer and will involve start up and transfer costs.

We have filed a Current Report on Form 8-K with the Securities and Exchange
Commission on March 11, 2002 with respect to our proposed acquisition of Darvon
and Darvocet. This current report includes our unaudited consolidated pro forma
financial statements giving effect to the acquisition and related financing
transactions.

SALES AND DISTRIBUTION OF BRANDED PRODUCTS

In connection with our acquisition of the M.V.I. and Aquasol product lines,
we engaged Ventiv Health U.S. Sales, Inc., a national pharmaceutical sales
organization, to provide us with a dedicated contract sales force of 20 sales
representatives and two sales managers. As we expand our branded product line
offerings, we intend to use Ventiv to assist us in expanding our field sales
organization. With the addition of the Darvon and Darvocet products, we plan to
expand the size of our dedicated sales force to 50 and the sales management team
to five. Ventiv provides over 2,500 sales representatives to pharmaceutical
clients, with each sales representative dedicated exclusively to one
pharmaceutical company pursuant to contract. Our relationship with Ventiv
enables us to ramp up our sales staff quickly and economically in connection
with the acquisition of a branded product and avoid incurring incremental sales
and marketing costs prior to an acquisition. The initial term on our contract
with Ventiv runs through December 31, 2003. However, either party may terminate
the agreement at any time upon 90 days prior written notice. If we decide to
employ any contract personnel provided by Ventiv under the agreement during the
term of the agreement or within one year of its termination, we must pay Ventiv
certain fees. Additionally, we have approximately 11 employees marketing and
promoting our branded products in support of our sales force.

Similarly, we have also contracted with Integrated Commercialization
Solutions, Inc., or ICS, to provide warehousing, distribution, inventory
tracking, customer service and financial administrative assistance related to
the distribution program (including management of applicable rebates,
chargebacks and accounts receivable collection).

SMALL VOLUME MANUFACTURING

We currently manufacture certain high-potency and high-toxicity drug
products, along with controlled substance products, for clients in our
manufacturing facility in Wilmington, North Carolina. Our manufacturing
generally covers small volume products. We also manufacture certain drugs
developed on behalf of clients for commercial sale while client production
facilities are being built and validated. We recently acquired a 48,000 square
foot sterile facility in Charleston, South Carolina where we manufacture sterile
products. Our manufacturing facilities and equipment are qualified and validated
to operate under current Good Manufacturing Practice regulations. We also
provide manufacturing, packaging and labeling of non-parenteral clinical trial
materials.

AAIRESEARCH -- OUR PRODUCT DEVELOPMENT BUSINESS

aaiResearch provides research and development expertise and a portfolio of
proprietary drug-delivery technologies and intellectual property rights, which
we use to enhance and develop products that are innovative, safer, more
effective, or more convenient or cost-efficient. This can result in renewed
regulatory or patent exclusivity, adding to the commercially valuable life of
the product. We offer these product improvement, or life cycle management,
activities to our customers for royalties, milestone payments and fees, and
apply this expertise to improve our acquired products and internally develop our
own new products. Net revenues for aaiResearch in 2001 were $20.4 million.

In addition to product development, aaiResearch seeks to develop
proprietary drug delivery technologies for licensing to our clients. We have
historically dedicated a portion of our technical resources and operating
capacity to internal drug and technology development with the objective of
licensing marketing rights to third parties. aaiResearch continues to pursue
this strategy today.

9

Our internal product and technology development program has resulted in
multiple product applications filed with the FDA and European regulatory
agencies. Many of these products have been licensed or sold. Others are still in
development. The internal development program has also resulted in patents
covering drugs and drug technology and numerous pending patent applications.
During 2001, we filed 15 new patent applications with the U.S. Patent and
Trademark Office, with international patent applications filed according to
applicable conventions.

We have significant experience in providing product life cycle management
services to our clients, which we leverage to develop our own proprietary
products. Product life cycle management offers product improvement and line
extension opportunities to clients, generally for marketed products facing
patent expiration and that could commercially benefit from improvements or line
extensions. Product improvements and line extensions offer clients an
opportunity to improve product or product delivery characteristics, thus
enhancing and extending the commercial value of a branded product line. Improved
product characteristics may include enhancement of product stability, creation
of additional absorption profiles (e.g., quick or sustained release), higher
drug absorption or bioavailability (permitting reduced drug loads per dose with
the potential for lower costs and side effects), improved taste, more attractive
appearance, or better dosage regimes (e.g., once a day versus multiple doses per
day). Product line extensions may include new dosage forms, such as solids,
liquids and chewables, to increase patient populations who can benefit from such
drugs (e.g., pediatric or geriatric patient populations), as well as new dosage
strengths that may be more convenient for doctors and patients under current
treatment regimens. Product modifications and line extensions offer clients the
opportunity to target new patient subpopulations and improve patient compliance
and convenience. Product life cycle management activities also can lead to new
inventions and discoveries in the course of the research and development work,
providing new opportunities for long-term patent protection for the modified
products and potential long-term value for licensees of our technologies.

OUR DRUG-DELIVERY TECHNOLOGIES

Our portfolio of internally developed and in-licensed drug-delivery
technologies provide us with some opportunities for the expansion of a drug
product's effective market life. Our currently available technologies include:

- ProCore -- a patented multiparticulate technology for controlled release
of a drug incorporated into a two-layered pellet. The first layer allows
for control of the lag time before an active agent begins its release
while the second layer controls the rate of release, and thus the duration
of the sustained release effect for the product.

- ProSorb -- technologies designed to accelerate absorption rates and thus
permit weakly acidic compounds to exhibit a longer duration and shorter
onset of action relative to conventional dosage forms. The concept of the
technology is that the acidic drugs incorporated into the technology form
a dispersion pattern upon release in the stomach that allows faster and
more complete absorption. ProSorb is a broad-based technology primarily
used with liquid or encapsulated drug products. Using this technology with
diclofenac, a non-steroidal anti-inflammatory drug, has resulted in our
proprietary ProSorb-D product candidate, which is discussed below.

- ProSLO I and ProSLO II -- an osmosis technology designed for combination
product therapy. Osmotic action is the natural movement of water through a
membrane and is used to make oral drug administration more accurate,
precise and convenient. Our technology has an immediate release component
in the outside layer of a laser drilled tablet. This tablet allows a
controlled release of multiple active ingredients. The advantages over
existing technologies are its easy scalability, the ability to use it with
numerous active ingredients, the ability to create both a long- and
short-acting drug combination, and its ability to handle what normally are
insoluble active ingredients.

- ProLonic -- a drug-delivery technology specifically designed to release
an active agent in the colon. This patented technology can be incorporated
into a tablet, a pellet, or a capsule dosage form and uses conventional
manufacturing equipment and processes. The advantage represented by this
technology is the ability to control the location and timing of release.
10

- ProMelt -- a fine particle, rapidly disintegrating technology that allows
for creation of a fast melt tablet dosage form while also permitting taste
masking, targeted delivery or controlled release of the active agent. The
technology is particularly applicable to pediatric and geriatric
treatments for patients who have difficulty swallowing more traditional
dosage forms such as tablets and capsules.

- ProSpher -- an injectable, depot formulation for controlled release of
active agents from days to months. It is capable of delivering
therapeutically important agents with reduced "burst effect," or immediate
release, upon administration, as compared to other depot technologies. The
technology is designed to allow the development of convenient single does
treatment for drug therapies lasting up to six months.

The ProSLO I and ProSLO II technologies are available for use by us and our
clients in the U.S. through an exclusive cooperative agreement with Osmotica
Corporation, provided that Osmotica Corporation must agree that the technology
is suitable for use with a particular drug product. Osmotica Corporation will
receive royalties from the use of these technologies. Additionally, the
ProLonic, ProMelt and ProSpher technologies are available to us pursuant to a
joint development agreement with Tanabe Seiyaku Co. Ltd. This agreement with
Tanabe provides for the joint development by us and Tanabe of certain mutually
agreeable drug technologies identified by Tanabe. Under this agreement, we have
an exclusive worldwide license to the developed technologies and we are required
to pay Tanabe a portion of all down payments and milestone payments, and all
royalties, received by us in connection with the commercialization of products
using these jointly developed technologies.

aaiResearch has continued our internal development of products to be
licensed to third parties that have additional marketing and distribution
capabilities or a therapeutic focus different than ours. We have entered into
multiple licensing agreements for products that are currently in development.
The terms of the agreements vary as to amounts of milestone payments and fees,
as well as methods and extent of revenue participation such as royalties. While
we anticipate that most of our product licensing agreements will provide that
prospective clients will ultimately sponsor the approved product, in certain
instances we have made submissions for internally developed products in our own
name.

Continuing to leverage our development capabilities, we have expanded into
product line extension development and have also begun developing new compounds
that are chemically similar to currently marketed products with proven
therapeutic and safety profiles, and that offer improved characteristics over
the marketed product. Examples of these efforts are found in the chart below and
include leuprolide and omeprazole. The anticipated improved product
characteristics that our work could create potentially include improved product
characteristics such as new therapeutic indications, reduced side effects,
improved bioavailability, and improved interaction characteristics within
patients. Because considerable toxicity data already exists for established
products, we believe that line extensions and improvements based on known active
ingredients generally can be developed with less risk of failure, less research
and development costs and in a shorter time frame than the development of new
chemical entities. We also believe that virtual and limited-resource drug
companies provide opportunities to enter into cooperative ventures to identify
and develop these types of compounds.

PROSORB-D

ProSorb-D is a softgel capsule that combines diclofenac, a proven pain
medication, with our ProSorb rapid-absorption technology. We are developing this
product for the management of pain and have recently begun Phase III clinical
trials. We have enrolled the first group of patients in our Phase III studies
and expect the Phase III clinical trials to be completed by the end of 2002,
with the filing of a New Drug Application, or NDA, with the FDA in early 2003.

Our completed Phase II clinical studies involving ProSorb-D examined the
reduction of pain in approximately 75 patients given either a single dose of
ProSorb-D, a single dose of Cataflam, which is an established diclofenac branded
product marketed by Novartis, or a placebo after the removal of three or more
impacted third molars. The results of the study indicated that 50% of the
subjects taking ProSorb-D reported the onset of meaningful analgesic activity,
or pain relief, within 18 minutes, with a median duration of
11

302 minutes. By comparison, 50% of those taking Cataflam reported an onset of
meaningful analgesic activity within 38 minutes, with a median duration of 272
minutes. After six hours from the time of molar removal, 72% of the patients
given ProSorb-D rated the medication as a very good or excellent pain reliever,
while only 45% of the subjects rated Cataflam with this mark.

In accordance with FDA requirements agreed upon at a pre-Phase III meeting
in 2001, our Phase III clinical studies will use two different pain models:
post-operative dental pain and knee pain. In each model we are conducting two
identical Phase III trials using separate groups of clinical investigators. The
dental pain studies will evaluate the safety and efficacy of a single dose of
ProSorb-D in the treatment of post-operative dental pain. We plan to study over
400 patients with full enrollment anticipated by the end of the second quarter
2002. The studies of knee pain will evaluate the safety and efficacy of
ProSorb-D in the treatment of arthroscopic knee surgery pain. We plan to study
over 300 patients. These clinical trials have only recently begun enrollment,
with full enrollment anticipated by the end of the third quarter 2002.

We also will undertake Phase III studies to evaluate the safety and
efficacy of diclofenac potassium softgel capsules to treat orthodontic
discomfort in patients eight to 16 years of age. This food-effects study will
evaluate the drug's interaction in healthy patients with and without food in
their stomachs.

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OUR INTERNAL PRODUCT PIPELINE

Our internal product development pipeline as of the date of this report is
described in the following chart, which identifies by product, the drug delivery
mechanism or technology, the therapeutic class, stage of development and whether
marketing rights are held by NeoSan or one of our customers:

- ---------------
(1) These products are undergoing stability testing. Under FDA regulations, we
believe that approval of these products will not require any clinical
studies.

AAI INTERNATIONAL -- OUR FEE-FOR-SERVICE BUSINESS

AAI International offers a comprehensive range of pharmaceutical product
development services to our customers on a worldwide basis. These services
include formulation development, analytical, bioanalytical and stability testing
services, production scale-up, human clinical trials, regulatory consulting, and
manufacturing. These services generally are provided on a fee-for-service basis.
Net revenues for AAI International were $93.2 million in 2001 and $87.0 million
in 2000.

Until our transition to a specialty pharmaceutical company, this
fee-for-service business was the core of our operations. AAI International
provides its services, both individually and in an integrated fashion, to

- pharmaceutical customers, to help them develop, control, and improve
their drug products;

- NeoSan, to improve its acquired drug products; and

13

- aaiResearch, to assist in its development of drugs and drug-delivery
technologies and product life cycle management activities.

We have a strong base of resources, expertise and ideas that allows us to
develop and improve drug products and carry out product life cycle management
activities both for our customers and ourselves. AAI International provides
analytical, clinical and manufacturing services and expertise to our other
business units, which do not have independent operations in these areas.

We focus on our customers' individual needs when marketing our services,
often placing our technical personnel with our clients' development teams to
participate in planning meetings for the development or improvement of a
product. We assign our sales and technical personnel as contacts for our larger
clients, understanding that technical personnel may be better able to identify
the full scope of our client's needs and suggest innovative approaches.
Additionally, we host several technical seminars each year to help our customers
stay abreast of the latest developments in their industries.

Our third-party product development contracts typically provide for upfront
fees and milestone payments. The commercialization of the products on which AAI
International works is the responsibility of our client. We typically provide
signed service estimates estimating fees for specified services. During our
performance of a project, clients often adjust the scope of services to be
provided by us, at which time the amount of fees is adjusted accordingly.
Generally, AAI International's fee-for-service contracts are terminable by the
client upon notice of 30 days or less. Although the contracts typically permit
payment of certain fees for winding down a project, the loss of a large contract
or the loss of multiple contracts could adversely affect our future revenue and
profitability in our research revenues business. Contracts may be terminated for
a variety of reasons, including the client's decision to stop a particular
study, the failure of product prototypes to satisfy safety requirements, and
unexpected or undesired results of product testing.

Since our founding in 1979, we have contributed to the submission, approval
or continued marketing of many client products, encompassing a wide range of
therapeutic categories and technologies. We believe that our ability to offer an
extensive portfolio of high quality drug development and support services
enables us to effectively compete as pharmaceutical and biotechnology companies
look for a mixture of standalone and integrated drug development solutions that
offer cost-effective results on an accelerated basis. AAI International's core
services are organized internally along pharmaceutical, analytical,
biopharmaceutical, clinical and regulatory affairs lines to best address the
product life cycle issues challenging a client.

PHARMACEUTICAL SERVICES

AAI International provides a variety of pharmaceutical services to its
customers, including drug formulation development, niche manufacturing, and
storage and distribution of clinical trial supplies. The services are organized
to help clients from the pre-clinical to post-marketing stages.

Formulation Development Services. AAI International provides integrated
formulation development services for its customers' pharmaceutical products, by
which it takes a compound and works to develop a safe and stable product with
desired characteristics. We believe that AAI International's formulation
expertise and significant analytical capabilities enable it to provide an
efficient development program, with a dedicated project team tracking the
product through all stages of formulation development. AAI International
provides formulation development services during each phase of the drug
development process, from new compounds to modifications of existing products.
AAI International's formulation development projects may support a small segment
of critical development activities for a short duration or may last for several
years, ranging from early formulation development to a validated,
production-scale, commercial product.

AAI International's formulation development group's expertise spans a broad
spectrum of therapeutic classes. It works with clients, and its own product
development personnel in the course of proprietary work, to develop products
with desired characteristics, including dosage form, strength, release rate,
absorption properties, stability and appearance. AAI International has developed
significant product and process capabilities that enhance its ability to
efficiently solve the complex problems that arise in developing

14

formulations with targeted characteristics and has developed a range of
proprietary product technologies that enhance its ability to efficiently achieve
desired results in product design and development.

In providing formulation services, AAI International works closely with
clients to design and conduct feasibility studies to chart the potential of
formulating a drug using a combination of active drug ingredients and inert
materials called excipients. Using experimental designs, initial prototype
formulations are prepared to identify potential problems in stability,
bioavailability and manufacturing. Generally, formulation development is an
iterative process, with numerous formulations being modified as problems are
encountered or to provide our clients with viable options.

We believe that AAI International's experience and expertise in formulation
development, as well as certain proprietary technologies, permit it to design
efficient protocols for identifying and enhancing formulation prototypes with
the greatest potential. Upon selection of the final product prototypes, AAI
International develops protocols to scale the product batch size from
development stage (e.g., hundreds or thousands of units) to clinical scale
(e.g., thousands or millions of units). During the clinical phase, AAI
International refines the formulation in response to clinical, bioanalytical and
stability data. The manufacturing scale-up process involves identifying and
resolving manufacturing problems to facilitate an efficient transfer to the
full-scale production equipment of AAI International's clients. Throughout the
development process, AAI International develops and validates the analytical
methods necessary to test the product to establish and confirm product
specifications.

In addition to new drug development, AAI International's formulations team
provides product modification and line extension services to clients through
product life cycle management contracts it enters into by us, generally for
marketed products facing patent expiration or that can benefit from formulation
improvements. Modifications of existing products offer clients an opportunity to
improve product characteristics, increasing product market viability. Improved
product characteristics include enhancement of stability, absorption profiles
(e.g., quick, controlled or sustained release), taste, and appearance. Product
line extensions may include new dosage forms, such as solids, liquids and
chewables, as well as new dosage strengths. Product modifications and line
extensions offer clients the opportunity to target new patient sub-populations
and improve patient acceptance of the product. AAI International's product
optimization services also cover investigation of impurities, contaminants and
degradation, the updating of mature products to meet current regulatory
standards and laboratory validation services.

Manufacture of Clinical Trial Supplies. AAI International manufactures
clinical trials materials for Phase I through Phase IV drug-product clinical
trials. It has expertise in manufacturing tablets, capsules, sachets, liquids
and suspensions, creams, gels, lotions and ointments. We believe that
outsourcing of clinical supply manufacturing is particularly attractive to
pharmaceutical companies that maintain large, commercial-quantity, batch
facilities, where clinical supply manufacturing would divert resources from
revenue-producing manufacturing. AAI International has a dedicated 25,000 square
foot facility in Wilmington, North Carolina and another facility in Neu-Ulm,
Germany to distribute and track clinical trial materials used in clinical
studies, with the capacity for controlled substance storage and handling. In
addition, AAI International provides its clients with assistance in scaling up
production of clinical supply quantities to commercial quantity manufacturing.

ANALYTICAL SERVICES

AAI International provides a wide variety of analytical services, as well
as services pertaining to method development and validation, drug product and
active pharmaceutical ingredient characterization and control, microbiological
support, stability storage and studies, and technical support and problem
solving with respect to pharmaceuticals. In support of the drug development and
compliance programs of its customers, AAI International offers laboratory
services to characterize and measure drug components and impurities. We have
more than two decades' of experience in providing analytical testing services
dedicated exclusively to the drug industry and have developed the scientific
expertise, technologically advanced equipment, and broad range of scientific
methods to accurately and quickly analyze almost any compound or product.

15

Method Development and Validation. AAI International develops and
validates methods used in a broad range of laboratory testing necessary to
determine physical or chemical characteristics of compounds. Over the last 20
years, we have developed over ten thousand methods on behalf of clients to be
applied to all types of dosage forms and drug substances. Analytical methods are
developed to demonstrate potency, purity, stability, or other physical or
chemical attributes. These methods are validated to ensure the data generated by
these methods are accurate, precise, reproducible and reliable, and are used
throughout the drug development process and in product support testing.

Product Characterization. AAI International has the expertise and
instruments required to identify and characterize a broad range of chemical
entities. Characterization analysis identifies the chemical composition,
structure, and physical properties of a compound, and characterization data
forms a significant portion of an application to seek regulatory approval to
market a new or modified drug. AAI International uses numerous techniques to
characterize a compound, including spectroscopy, chromatographic analyses and
other physical chemistry techniques. Additionally, it uses such information for
control testing to be performed throughout development and marketing to confirm
consistent drug composition. Once appropriate test methods are developed and
validated, and appropriate reference standards are characterized and certified,
AAI International can assist clients by routinely testing compounds for clinical
and commercial use.

Raw Materials and Product Release Testing. AAI International offers
testing required by the FDA and other regulatory agencies to confirm that raw
materials used in production of finished drug products, and the resulting
finished products themselves, are consistent with established specifications.
Due to the incorporation of "just-in-time" inventory control systems in client
production schedules, release testing for both raw materials and the finished
products often cannot be scheduled by clients in advance, yet must be performed
immediately. AAI International believes that its internal scheduling systems,
analytical laboratory expertise and systems for prompt testing provide it with a
competitive advantage in providing both raw material and batch release testing.
AAI International believes that this service enhances its clients' confidence in
adopting cost-saving "just-in-time" inventory control systems.

Microbiological Testing. Microbiological testing is an essential indicator
to ensure that a drug product, whether raw material or finished product, does
not contain harmful microorganisms. AAI International performs sterility testing
to ensure the absence of microorganisms from injection products. AAI
International has significant experience conducting various microbial tests to
identify and quantify micro-organisms that may be present, including limulus
amebocyte lysate testing, which measures endotoxins (toxic byproducts of
micro-organisms) and particulate matter testing, which determines the presence
of foreign matter in injectable drug products. In addition, it performs tests to
determine the effectiveness of antibiotics against microorganisms and the
minimum levels of preservatives necessary in product formulations to ensure that
they remain resistant to bacteria throughout their shelf life.

AAI International also assists clients with environmental monitoring,
including water and air systems testing, using an automated biochemical system
to identify microorganisms that are present and determine whether such systems
are within applicable microbial limits. It also assists clients in validating
their environmental control systems to ensure compliance with the FDA's current
Good Manufacturing Practice regulations.

Stability Studies. AAI International provides stability testing and secure
storage facilities necessary to establish and confirm product purity, potency
and other shelf-life characteristics. Stability testing is required at all
phases of product development, from dosage form development through commercial
production, to confirm the shelf life of each manufactured batch. AAI
International maintains technologically advanced climate-controlled facilities
in the United States and Germany to determine the impact of a range of storage
conditions on product integrity. FDA regulations and the regulations of European
regulatory authorities require that samples of clinical and commercial products
placed in stability chambers be analyzed in a timely fashion after scheduled
"pull points" occur, based on the date of manufacture.

16

BIOPHARMACEUTICAL SERVICES

AAI International integrates a Phase I clinical study capability with
strong bioanalytical and biotechnology expertise to provide biopharmaceutical
services to its customers. The analysis of drugs, metabolites and endogenous
compounds in biological samples is a core service of AAI International.

Phase I Clinical Services. AAI International has a 48-bed Phase I clinical
trial facility located in Research Triangle Park, North Carolina, and a 76-bed
facility in Neu-Ulm, Germany for conducting certain Phase I clinical trials. In
Phase I clinical trials, drugs are administered to human volunteers pursuant to
protocols approved by institutional review boards and blood samples are taken at
the times prescribed in the study protocols for subsequent bioanalytical testing
of the plasma samples.

Bioanalytical Testing. AAI International offers bioanalytical testing
services to support bioequivalence studies and Phase I through Phase IV clinical
trials for its clients' pharmaceutical product development needs, analyzing
plasma samples to characterize the metabolized forms of the drug and determine
the rate of absorption. Bioanalytical studies of new drugs often present
challenging and complex issues, with products being metabolized into multiple
active and inactive forms, each of which must be measured. AAI International
works with its clients to develop and validate analytical methods to permit
detection and measurement of the various components to trace levels.

Biotechnology Analysis and Synthesis. Although the types of analytical
investigations of biotechnology products are similar to those required for more
traditional pharmaceutical products, the complex molecular structure of many
biotechnology products require different technology and expertise. AAI
International provides a broad array of biotechnology services, including both
analytical and biological testing and method development and validation. AAI
International's breadth of services allows it to rapidly deduce and characterize
the complex structure of the biotechnology product and measure the molecule or
its metabolites in human blood plasma to support clinical trial evaluation. It
has expertise in a broad spectrum of biochemical and immunochemical methods for
characterization and analysis of biotechnology drugs. These methods include
amino acid sequencing, amino acid analysis, peptide mapping, carbohydrate and
lipid analysis and electrophoresis. AAI International also has expertise in
developing chromatographic methods that precisely evaluate the purity and
stability of biotechnology products. This breadth and diversity of analytical
skills and technologies enable AAI International to assist its clients from
early product development through the investigational new drug application and
product license application stages and commercial production.

PHASE I TO IV CLINICAL SERVICES

In the late 1990's, we expanded our Phase I clinical trial capabilities and
added the ability to conduct and monitor Phase II to Phase IV clinical studies
and multi-center trials focused in niche therapeutic classes, including hepatic
disease, chemotherapeutics and hormone replacement therapy.

AAI International can provide a broad range of Phase I through Phase IV
clinical services to customers in the pharmaceutical, biotechnology and medical
device industries for assistance in the drug development and regulatory approval
process in North America. The clinical services include clinical trial
management and monitoring, site selection, medical affairs (including safety
surveillance and serious adverse event management), data management and
statistics, with the core services focused on clinical monitoring and data
management.

REGULATORY AND OTHER CONSULTING SERVICES

AAI International provides consulting services with respect to regulatory
affairs, quality compliance, and process validations. It assists in the
preparation of regulatory submissions for drugs, devices and biologics, audits a
client's vendors and client operations, conducts seminars, provides training
courses, and advises clients on applicable regulatory requirements. AAI
International also assists clients in designing development programs for new or
existing drugs intended to be marketed in the United States and Europe.

17

At a client's request, AAI International will review client-prepared
submissions, draft and assemble regulatory submission packages, and attend FDA
meetings with clients. AAI International assists clients in preparation for FDA
inspections and in correcting any deficiencies noted in FDA inspections. In
preparation for an FDA inspection, AAI International's regulatory affairs
specialists conduct mock inspections to anticipate FDA observations and advise
clients of appropriate remedial actions.

AAI International also audits manufacturers of active and excipient
ingredients used in the drug product, as well as packaging components, on behalf
of clients to ensure that the manufacturers' facilities are in compliance with
GMP regulations. Such audits generally include review of the vendor's drug
master files, analysis of written standard operating procedures, or SOPs, review
of production records, and observation of operations to ensure that written SOPs
are being followed. Audit reports include recommendations to address any
deficiencies. In addition, AAI International advises clients on validation
issues concerning their systems and processes and audits client facilities to
assist them in validating their processes and their cleaning, water and air
handling systems.

AAI International organizes and conducts seminars worldwide on a number of
topical industry issues. AAI International also leverages its in-house
laboratory training programs by providing training to clients' employees.

COMPETITIVE STRENGTHS

We believe that our competitive position is attributable to our scientific
capabilities and a number of our other key strengths, including the following:

ESTABLISHED PHARMACEUTICAL PRODUCT DEVELOPMENT INFRASTRUCTURE. We have a
long history of assisting our customers in developing and commercializing
pharmaceutical products and have an established infrastructure to do so. Our
platform of businesses offers our customers a wide range of scientific
capabilities, including analytical services, biopharmaceutical services,
pharmaceutical product development services, Phase I to IV clinical services,
product manufacturing, and regulatory and other consulting services, in addition
to product life cycle management activities. We have approximately 700 employees
working on the development of drugs and have worked with over 2,000
pharmaceutical compounds in the past 20 years. We plan to use these capabilities
to enhance our internal proprietary product candidates.

STRONG BRANDS WITH ESTABLISHED CASH FLOWS. Each of the product lines we
have acquired has been sold in the U.S. for over 18 years, and the Darvon and
Darvocet products have been sold in the U.S. for over 25 years. These branded
product lines have generated sales and gross profits for many years despite
competition from generic and other competitive products. The product lines that
we have acquired, and Darvon and Darvocet, had gross margin percentages ranging
from 46% to 92% in the last audited period prior to their acquisition. We
believe that the cash flows that these products generate are sustainable, and,
moreover, we believe we can increase sales of these products by actively
promoting them.

ESTABLISHED CUSTOMER BASE ENHANCES PRODUCT ACQUISITION OPPORTUNITIES. We
have developed strong relationships with major pharmaceutical companies through
years of client service on research, product development, and product life cycle
management projects. For example, AAI International provided development
services to AstraZeneca for both M.V.I.-12 and M.V.I.-Pediatric for several
years prior to our acquisition of these products. We have, over the past 15
years, worked on some element of over 80% of the top 200 drug products in the
U.S., as ranked by IMS data for 2000. These relationships position us to acquire
established, branded products that are no longer the focus of our customers'
development, marketing and promotional efforts. We have more than 50
representatives in our research service business who regularly call on key
decision makers of the large pharmaceutical companies. These relationships
provide important insights into product portfolios and development pipelines and
may allow for more rapid identification and acquisition of attractive branded
pharmaceutical products.

EXPERTISE IN PRODUCT LIFE CYCLE MANAGEMENT. Through AAI International and
aaiResearch, we offer our customers a strong base of resources, expertise and
ideas to better understand and improve their existing products and develop new
products. Our portfolio of patents and proprietary and in-licensed technologies
may

18

provide our customers with new formulations, delivery systems, indications and
dosage forms to improve the safety, efficacy or cost effectiveness, or reduce
the side effects, of their drugs. This can result in renewed regulatory or
patent exclusivity, adding to the commercially valuable life of the product. For
example, we are currently working with a major pharmaceutical company to
reformulate their allergy product to be taken once a day instead of four times a
day. In the past, we also have worked with a major pharmaceutical company to
develop a long acting version of a cardiovascular product to be taken once a day
instead of twice a day and with another major pharmaceutical company to develop
a chewable tablet form of an antidepressant.

EXPERIENCED AND DEDICATED MANAGEMENT TEAM. We have an experienced
management team that is led by Frederick D. Sancilio, Ph.D., Chairman and Chief
Executive Officer, Philip S. Tabbiner, D.B.A., President and Chief Operating
Officer, William L. Ginna, Jr., Executive Vice President and Chief Financial
Officer, David Johnston, Ph.D., President of AAI International, George E. Van
Lear, Ph.D., President of aaiResearch, and David M. Hurley, President of NeoSan
Pharmaceuticals. These senior executives have an average of over 20 years of
experience in the pharmaceutical industry.

GROWTH STRATEGY

We believe that our ability to identify and acquire branded pharmaceutical
products, to apply our scientific capabilities to develop new and improved
products and product line extensions, and to leverage our marketing and
promotion organization and our strong relationships with many large
pharmaceutical companies, positions our company for continued growth.
Specifically, we intend to pursue the following growth strategies:

ENHANCE SALES THROUGH FOCUSED MARKETING AND PROMOTION. We seek to increase
sales of our branded pharmaceutical products through active marketing and
promotion directed at high-prescribing physicians, using one-on-one meetings,
free product samples, educational programs, advertising, direct mail and website
promotion. We also seek to acquire products that we believe have not been
actively marketed and promoted for at least a few years prior to our acquiring
them. For example, we believe that Eli Lilly stopped actively marketing and
promoting Darvon and Darvocet approximately nine years ago. We believe that we
can successfully increase sales by combining the strength of the brand name with
active promotion of the product.

STRENGTHEN BRANDS THROUGH PRODUCT LIFE CYCLE MANAGEMENT. We plan to
strengthen our branded product lines through product life cycle management
activities. We plan to use our research and development expertise and our
portfolio of patents and proprietary and in-licensed technologies to provide new
formulations, delivery systems, indications and dosage forms that will improve
the characteristics of our products, such as their safety, efficacy,
convenience, cost effectiveness or side effects. We will seek renewed regulatory
or patent exclusivity for our improved drugs, and we plan to market them as line
extensions to our acquired branded product lines. We intend to develop product
line extensions for each of our acquired product lines. For example, on February
13, 2002, we acquired the rights to a generic injectable vitamin D nutritional
product that we intend to market under the name Aquasol D as a line extension to
our Aquasol brand name.

LAUNCH INTERNALLY DEVELOPED BRANDED PRODUCTS. We plan to continue to
develop new drugs in our targeted therapeutic classes, with the view of
marketing these products under our own brand names. Although we have
successfully developed a number of products in the past, we did so with the
intention of licensing or selling the products to our customers. We are
currently developing several new drug products using our patented drug delivery
technologies that we intend to market under our own brand names. For example, we
recently concluded Phase II clinical studies for our ProSorb-D product to treat
pain. This internally developed product combines the proven pain drug diclofenac
with our patented ProSorb drug-delivery technology. ProSorb-D potentially offers
the strong pain relief associated with diclofenac, but could act faster, taste
better and cause less stomach irritation than other forms of this drug. We
recently began Phase III clinical trials for this drug.

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SEEK ATTRACTIVE ACQUISITION OPPORTUNITIES. We intend to continue to take
advantage of industry consolidation trends to identify and selectively acquire
branded pharmaceutical products. We generally will seek attractive branded
pharmaceutical products that:

- can benefit from focused sales and marketing efforts;

- lend themselves to product life cycle management opportunities such as
new formulations, delivery systems, indications and dosage forms;

- fall within our targeted therapeutic classes -- critical care, central
nervous system, pain management, oncology, immunosuppression and
cardiology;

- can be sold to our existing customer base, thereby leveraging our
sales-force capabilities; and

- have annual sales of less than $100 million with stable and high gross
margins.

INFORMATION TECHNOLOGY

We have made significant investments in information technology. Our
customized data management system connects analytical instruments with multiple
software architectures permitting automated data capture. We believe that
information technology will enable us to expedite the development process by
designing innovative services for individual client needs, providing project
execution, monitoring and control capabilities that exceed a client's internal
capabilities, streamlining and enhancing data presentation to the FDA and
enhancing our own internal operational productivity while maintaining quality.

We are continuing the implementation of an enterprise wide financial and
operational integrated management information system, including significant
systems licensed from SAP, which began in 1998. Initial financial components
became operational at year-end 1998, and other operational management systems
followed later in 1999 and 2000. We continue to implement these systems company
wide.

CUSTOMERS

Historically, our primary customers have been large and small
pharmaceutical and biotechnology companies serviced by aaiResearch and AAI
International. Significant research and development projects have a defined
cycle, and accordingly the composition of our customer group in these areas of
our business changes from year to year. In addition, because of the project
nature of engagements in these segments of our business, we may have a
concentration of business among some large customers in one period that we would
not expect to continue into subsequent periods. We have experienced
concentration in our business in the past, and we do not believe that this is
unusual for companies in the same markets as aaiResearch and AAI International.
During 2000 and 2001, net revenues from several product development agreements
with AstraZeneca and its affiliates accounted for approximately 15% of our
consolidated net revenues in each year. We cannot assure you that net revenues
from our agreements with AstraZeneca and its affiliates will continue at this
level in the future.

NeoSan's customers are primarily large well-established medical wholesalers
and distributors. We anticipate that as NeoSan's business expands as a result of
the addition of our acquired product lines, some of these wholesalers and
distributors may become significant customers accounting for 10% or more of our
consolidated net revenues. Correspondingly, we do not believe that revenues from
any large pharmaceutical company or other customer of aaiResearch or AAI
International is likely to exceed 10% of our consolidated net revenues in future
years.

BACKLOG

Backlog consists of anticipated net revenues from signed service estimates
and other fee-for-service contracts that have not been completed and provide for
a readily ascertainable price. Once contracted work begins, net revenues are
recognized as the service is performed. Occasionally, but infrequently, we begin
work for a client before a contract is signed. Accordingly, backlog does not
include anticipated net revenues for which we have begun work but for which we
do not have a signed service estimate, or for any variable-priced
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contracts. In addition, during the course of a project, the client may
substantially adjust the requested scope of services and corresponding
adjustments are made to the price of services under the contract.

We believe that our backlog as of any date is not a meaningful predictor of
future results because the backlog can be affected by a number of factors,
including variable size and duration of contracts and adjustments in the scope
of a contracted project as interim results become available. Additionally,
fee-for-service contracts generally are subject to termination by clients upon
30 days notice or less. Moreover, the scope of a contract can change over the
course of a project. At December 31, 2001 and 2000, backlog was approximately
$66 million and $91.4 million, respectively. Of the 2001 amount, approximately
$17.7 million is not expected to be filled within year 2002.

COMPETITION

We compete with companies and organizations in multiple segments of the
pharmaceutical industry. The branded drug products of our NeoSan business unit
are subject to competition from the branded and generic products of other
pharmaceutical companies, ranging from other small specialty pharmaceutical
companies to the large pharmaceutical companies who are among the customers of
the fee-for-service business of AAI International.

The main competition for M.V.I.-12 is Infuvite Adult, which is marketed by
Baxter Healthcare Corporation. The main competition of M.V.I.-Pediatric is
Infuvite Pediatric, which also is marketed by Baxter Healthcare Corporation.
Aquasol A is the only injectable Vitamin A product on the market. Aquasol E
competes with various other vitamin E products. If approved by the FDA, the main
competition of Aquasol D is expected to be Calcijex and Zemplar, marketed by
Abbott Laboratories, and Hectorol, marketed by Bone Care International, Inc.
Aquasol D has been submitted for approval by the FDA as a generic substitute for
Calcijex, although Aquasol D will be packaged in a vial, rather than an ampoule,
form. Brethine competes in the market for the treatment of asthma and related
bronchial ailments, which is a market led by Volmax, Proventil, and branded and
generic forms of albuterol sulfate.

Darvon and Darvocet compete primarily in the broad pain management market,
especially with products indicated for the management of mild to moderate pain.
Competitive products indicated for the management of mild to moderate pain
include Ultram and other non-steroidal anti-inflammatory drugs such as
ibuprofen. Additionally, major promotional efforts in the U.S. pain management
market today involve a relatively new class of drugs, the cyclo-oxygenase 2, or
the COX-2 enzyme, inhibitors. They are designed to work as effectively as Darvon
and Darvocet and NSAIDs, but without side effects such as ulcers and
gastrointestinal bleeding. These new inhibitors are more selective than
traditional NSAIDS. The non-selective inhibition of both COX-1 and COX-2 enzymes
in other NSAIDs is responsible for the toxicities and side effects.

The Darvon and Darvocet product lines no longer have patent exclusivity.
While precise data on generic substitution for these products is not available,
we believe a vast majority of the prescriptions written for Darvon and Darvocet
are filled with generic products. These generic substitutes are sold at
significantly lower prices, without the research, development and approval costs
associated with the branded Darvon and Darvocet products. Two of the world's
largest manufacturers of generic products, Teva Pharmaceutical Industries Ltd.
and Mylan Laboratories Inc., sell propoxyphene generic substitutes to Darvon and
Darvocet.

Sellers of generic products typically do not bear the related research and
development costs associated with branded products and, thus, are able to offer
their products at considerably lower prices. There are, however, a number of
factors that enable branded products to remain profitable once patent protection
has ceased. These include the establishment of a strong brand image with the
prescriber or the consumer, supported by the development of improved products
and line extensions to differentiate the branded products from the generic
competition.

Our AAI International and aaiResearch businesses compete primarily with
in-house research, development, quality control, and other support service
departments of pharmaceutical and biotechnology companies, as well as university
research laboratories and other contract research organizations. In addition,

21

we believe that although there are numerous fee-for-service competitors in our
industry, there are few competitors that offer the depth or breadth of
scientific capabilities that we provide. Some of our competitors, however, may
have significantly greater resources than we do. Competitive factors generally
include reliability, turn-around time, reputation for innovative and quality
science, capacity to perform numerous required services, financial viability,
and price. We believe that we compete favorably in each of these areas.

GOVERNMENT REGULATION

The services that we perform and the pharmaceutical products that we
develop and manufacture are subject to various rigorous regulatory requirements
designed to ensure the safety, effectiveness, quality and integrity of
pharmaceutical products, primarily under the Federal Food, Drug, and Cosmetic
Act, including current Good Manufacturing Practice regulations. These
regulations are commonly referred to as the cGMP regulations and are
administered by the FDA in accordance with current industry standards. Our
services and development efforts performed outside the U.S. and products
intended to be sold outside the U.S. are also subject to additional foreign
regulatory requirements and government agencies.

U.S. laws and regulations apply to all phases of the development,
manufacturing, testing, promotion and distribution of drugs, including with
respect to our personnel, record keeping, facilities, equipment, control of
materials, processes, laboratories, packaging, labeling, storage, pricing and
advertising. If we fail to comply with these laws and regulations, our drugs,
drug improvements, and product line extensions will not be approved by the FDA,
the data we collect may not be acceptable to the FDA, and we may not be
permitted to market our products. Additionally, we could be subject to
significant monetary fines, recalls and seizures of products, closing of our
facilities, revocation of drug approvals previously granted to us, and criminal
prosecution. Any of these regulatory actions could materially and adversely
affect our business, financial condition and results of operations.

To help assure our compliance with applicable laws and regulations, we have
quality assurance controls in place at our facilities and we use FDA regulations
and guidelines, as well as applicable international standards, as a basis for
our standard operating procedures. We regularly audit test data and inspect our
facilities and procedures. In addition, our facilities are inspected from time
to time by the FDA. We also have in place a system for monitoring
product-related complaints that we receive with respect to our products. Despite
our efforts, however, the rigorous nature and extensive scope of the applicable
regulatory requirements mean that the risk of regulatory citation or action by
the FDA cannot be completely eliminated. In the event of any such citation or
action of a material nature, the resulting restrictions on our business could
materially and adversely affect our business, financial condition and operating
results.

All of our drugs must be manufactured in conformity with the FDA's cGMP
regulations, and drug products subject to an approved FDA-application must be
manufactured, processed, packaged, held and labeled in accordance with
information contained in the application. Additionally, modifications,
enhancements, or changes in manufacturing sites of approved products are in many
circumstances subject to FDA inspections and approvals that we may not be able
to obtain and that may be subject to a lengthy application process. Our
facilities, including the facilities used in our fee-for-service business, and
those of our third-party manufacturers are periodically subject to inspection by
the FDA and other governmental agencies, and operations at these facilities
could be interrupted or halted for lengthy periods of time if such inspections
prove unsatisfactory.

Failure to comply with FDA or other governmental regulations can result in
fines, unanticipated compliance expenditures, recall or seizure of products,
total or partial suspension of production or distribution, suspension of the
FDA's review of our drug approval applications, termination of ongoing research,
disqualification of data for submission to regulatory authorities, enforcement
actions, injunctions and criminal prosecution. Under certain circumstances, the
FDA also has the authority to revoke previously granted drug approvals. Although
we have instituted internal compliance programs, if these programs do not meet
regulatory agency standards or if compliance is deemed deficient in any
significant way, it could have a material adverse effect on us. Most of our
vendors are subject to similar regulations and periodic inspections.

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Some of our development and testing activities (which will include the
manufacture, development and testing of the Darvon and Darvocet products) are
subject to the Controlled Substances Act, administered by the Drug Enforcement
Administration, or the DEA, which strictly regulates all narcotic and
habit-forming substances. We maintain separate, restricted-access facilities and
heightened control procedures for projects involving such substances due to the
level of security and other controls required by the DEA.

Additionally, our business involves the controlled storage, use and
disposal of hazardous materials and biological hazardous materials. We are
subject to numerous federal, state, local and foreign environmental regulations
governing the use, storage, handling and disposal of these materials. Although
we believe that our safety procedures for handling and disposing of these
hazardous materials comply in all material respects with the standards
prescribed by law and regulation in each of our locations, the risk of
accidental contamination or injury from hazardous materials cannot be completely
eliminated. We maintain liability insurance for some environmental risks that
our management believes to be appropriate and in accordance with industry
practice. However, we may not be able to maintain this insurance in the future
on acceptable terms. In the event of an accident, we could be held liable for
damages that are in excess or outside of the scope of our insurance coverage or
that deplete all or a significant portion of our resources.

We are also governed by federal, state and local laws of general
applicability, such as laws regulating intellectual property, including patents
and trademarks, working conditions, equal employment opportunity, and
environmental protection.

In connection with our activities outside the U.S., we also are subject to
foreign regulatory requirements governing the testing, approval, manufacture,
labeling, marketing and sale of pharmaceutical products, which requirements vary
from country to country. Whether or not FDA approval has been obtained for a
product, approval by comparable regulatory authorities of foreign countries must
be obtained prior to marketing the product in those countries. For example, some
of our foreign operations are subject to regulations by the European Medicines
Evaluations Agency and the U.K. Medicines Control Agency. The approval process
may be more or less rigorous from country to country, and the time required for
approval may be longer or shorter than that required in the U.S. No assurance
can be given that clinical studies conducted outside of any country will be
accepted by that particular country, and the approval of a pharmaceutical
product in one country does not assure that the product will be approved in
another country. In addition, regulatory agency approval of pricing is required
in many countries and may be required for the marketing in those countries of
any drug that we develop.

THE DRUG DEVELOPMENT REGULATORY PROCESS

New Drug Approval Process. FDA approval is required before any new drug
can be marketed and sold in the U.S. This approval is obtained through the new
drug application process, which involves the submission to the FDA of complete
pre-clinical data about new compounds and their characteristics and then
clinical data obtained from studies in humans showing the safety and
effectiveness of the drug for the proposed therapeutic use.

Before introducing a new drug into humans, stringent government
requirements for pre-clinical data must be satisfied. The pre-clinical data is
obtained from laboratory studies, and tests performed on animals, which are
submitted to the FDA in an investigational new drug application, or an IND. The
pre-clinical data must provide an adequate basis for evaluating both the safety
and the scientific rationale for the initiation of clinical trials of the new
drug in humans. Pursuant to the IND, the new drug is tested in humans for
safety, adverse effects, dosage, tolerance absorption, metabolism, excretion and
other elements of clinical pharmacology, and for effectiveness for the proposed
therapeutic use.

Clinical trials typically are conducted in three sequential phases,
although the phases may overlap. The process of completing clinical trials for a
new drug may take several years and require the expenditure of substantial
operational and financial resources.

- Phase I clinical trials frequently begin with the initial introduction of
the compound into healthy humans and test primarily for safety.

23

- Phase II clinical trials typically involve a small sample of the intended
patient population to assess the efficacy of the compound for a specific
indication, to determine dose tolerance and the optimal dose range and to
gather additional information relating to safety and potential adverse
effects.

- Phase III clinical trials are undertaken to further evaluate clinical
safety and efficacy in a much larger patient population at different
study sites to determine the overall risk-benefit ratio of the drug and
provide an adequate basis for product labeling.

Each clinical trial is conducted in accordance with rules, or protocols,
that are developed to detail the objectives of the study, including methods to
monitor safety and efficacy and the precise criteria to be evaluated. These
protocols must be submitted to the FDA as part of the IND. In some cases, the
FDA allows a company to rely on data developed in foreign countries, or
previously published data, which eliminates the need to independently repeat
some or all of the studies.

Once sufficient data have been developed pursuant to the IND, the new drug
application, or NDA, is submitted to the FDA to request approval to market the
new drug. Preparing an NDA involves substantial data collection, verification
and analysis, and there is no assurance that FDA approval of an NDA can be
obtained on a timely basis, if at all. The approval process is affected by a
number of factors, primarily the risks and benefits demonstrated in clinical
trials as well as the severity of the disease and the availability of
alternative treatments. The FDA will deny an NDA if the regulatory criteria are
not satisfied or, alternatively, may require additional testing or information
before approving an NDA.

With respect to the branded pharmaceutical products that we acquire, we are
often able to reference the original NDA that we acquired along with the
marketing rights to the products. As a result, when improving these products or
developing product line extensions, we are permitted to file a supplemental new
drug application, enabling us to begin our development process for these
improvements or line extensions generally in the Phase III or late-stage Phase
II clinical trials. Because we are referencing earlier work performed with the
acquired drug, our development process for improvements to and line extensions
of our acquired branded products may be shorter and less costly than with
respect to any new products that we may select to develop.

Abbreviated New Drug Application Process for Generic Products. A generic
drug contains the same active ingredient as a specified brand name drug and
usually can be substituted for the brand name drug by the pharmacist. FDA
approval is required before a generic drug can be marketed. Approval of a
generic drug is obtained through the filing of an abbreviated new drug
application, or an ANDA. Submission and approval of an ANDA is subject to
certain patent and non-patent exclusivity rights applicable to the brand name
drug. When processing an ANDA, the FDA waives the requirement of conducting full
clinical studies, although it normally requires bioequivalence studies.
Bioavailability relates to the rate and extent of absorption and levels of
concentration of a drug active ingredient in the blood stream needed to produce
a therapeutic effect. Bioequivalence compares the bioavailability of one drug
with another that contains the same active ingredient, and when established,
indicates that the rate and extent of absorption and levels of concentration of
a generic drug in the body are the same as the previously approved brand name
drug. An ANDA may be submitted for a drug on the basis that it is the equivalent
to a previously approved drug or, in the case of a new dosage form or other
close variant, is suitable for use under the conditions specified.

The timing of final FDA approval of ANDAs depends on a variety of factors,
including whether the applicant challenges any listed patents for the brand name
drug and whether the brand-name manufacturer is entitled to one or more
non-patent statutory exclusivity periods, during which the FDA is prohibited
from accepting or approving applications for generic drugs.

The FDA may impose debarment and other penalties on individuals and
companies that commit certain illegal acts relating to the generic drug approval
process. In some situations, the FDA is required not to accept or review ANDAs
for a period of time from a company or an individual that has committed certain
violations. The FDA may temporarily deny approval of ANDAs during the
investigation of certain violations that could lead to debarment and also, in
more limited circumstances, suspend the marketing of approved generic drugs by
the affected company. The FDA also may impose civil penalties and withdraw
previously approved ANDAs. Neither we nor any of our employees have ever been
subject to debarment.

24

Manufacturing Requirements. Before approving a drug, the FDA also requires
that our procedures and operations conform to the cGMP regulations. We must
follow the cGMP regulations at all times during the manufacture of our products.
To help insure compliance with the cGMP regulations, we must continue to spend
time, money and effort in the areas of production and quality control to ensure
full technical compliance. If the FDA believes a company is not in compliance
with cGMP, sanctions may be imposed upon that company including: withholding new
drug approvals as well as approvals for supplemental changes to existing
approvals, preventing the company from receiving the necessary export licenses
to export its products, and classifying the company as an unacceptable supplier
and thereby disqualifying the company from selling products to federal agencies.
We believe we are currently in compliance with the cGMP regulations.

Post-approval Requirements. After initial FDA approval for the marketing
of a drug has been obtained, further studies, including Phase IV post-marketing
studies, may be required to provide additional data on safety. Also, the FDA may
require post-marketing reporting to monitor the adverse effects of the drug.
Results of post-marketing programs may limit or expand the further marketing of
the drug. Further, if there are any modifications to the drug, including changes
in indication, manufacturing process, or manufacturing facility, an application
seeking approval of the modifications must be submitted to the FDA or other
regulatory authority. Additionally, the FDA regulates post-approval promotional
labeling and advertising activities to assure that such activities are being
conducted in conformity with statutory and regulatory requirements.

HEALTH CARE FRAUD AND ABUSE LAWS

Federal and state health care fraud and abuse laws have been applied to
restrict certain marketing practices in the pharmaceutical industry in recent
years. These laws include antikickback statutes and false claims statutes. The
federal health care program antikickback statute makes it illegal for anyone to
knowingly and willfully make or receive "kickbacks" in return for any health
care item or service reimbursed under any federally financed healthcare program.
This statute applies to arrangements between pharmaceutical companies and the
persons to whom they market, promote, sell and distribute their products. In
August 1994, the Office of the Inspector General of the Department of Health and
Human Services issued a "Special Fraud Alert" describing pharmaceutical
companies' activities that may violate the statute. There are a number of
exemptions and safe harbors protecting certain common marketing activities from
prosecution. These include exemptions or safe harbors for product discounts,
payments to employees, personal services contracts, warranties, and
administrative fees paid to group purchasing organizations. These exemptions and
safe harbors, however, are drawn narrowly.

Federal false claims laws prohibit any person from knowingly making a false
claim to the federal government for payment. Recently, several pharmaceutical
companies have been prosecuted under these laws, even though they did not submit
claims to government healthcare programs. The prosecutors alleged that they were
inflating drug prices they report to pricing services, which are in turn used by
the government to set Medicare and Medicaid reimbursement rates. Pharmaceutical
companies also have been prosecuted under these laws for allegedly providing
free products to customers with the expectation that the customers would seek
reimbursement under federal programs for the products.

Additionally, the majority of states have laws similar to the federal
antikickback law and false claims laws. Sanctions under these federal and state
laws include monetary penalties, exclusion from reimbursement for products under
government programs, criminal fines and imprisonment.

We have internal policies and practices requiring and detailing compliance
with the health care fraud and abuse laws and false claims laws. Because of the
breadth of these laws and the narrowness of the safe harbors, however, it is
possible that some of our business practices could be subject to challenge under
one or more of these laws, which could have a material adverse effect on our
business, financial condition and results of operations.

25

EMPLOYEES

At December 31, 2001, we had approximately 1,200 full-time equivalent
employees, of which 95 hold Ph.D. or M.D. degrees, or the foreign equivalent. We
believe that our relations with our employees are good. None of our employees in
the U.S. are represented by a union. German and French law provide certain
representative rights to our employees in those jurisdictions.

Our continued performance depends on our ability to attract and retain
qualified professional, scientific and technical staff. The level of competition
among employers for these skilled personnel is high. We believe that our
employee benefit plans enhance employee morale, professional commitment and work
productivity and provide an incentive for employees to remain with aaiPharma. We
have experienced difficulty in attracting and retaining qualified staff in our
Research Triangle Park and Natick, Massachusetts locations where competition for
trained personnel is particularly strong. It is possible that as competition for
these skilled employees increases at our other locations, we could experience
similar problems there as well.

INTELLECTUAL PROPERTY

Our ability to successfully commercialize new branded products or
technologies is significantly enhanced by our ability to secure strong
intellectual property rights -- generally patents -- covering these products and
technologies. We intend to seek patent protection in the United States and
selected foreign countries and to vigorously prosecute patent infringements, as
we deem appropriate. We currently own 23 patents issued by the U.S. Patent and
Trademark Office, and we currently have 14 patent applications filed and pending
with the Patent and Trademark Office. Additionally, we have assigned or
transferred an additional six of our patents to third parties for value.

Our patents cover proprietary processes and techniques, or formulation
technologies, that may be applied to both new and existing products and chemical
compounds. Our patents also cover new chemical entities or compounds,
pharmaceutical formulations, and methods of using certain compounds. We also
seek to patent discoveries of new structures of known compounds, new physical
and chemical characteristics of known compounds, and previously unknown
compounds.

We have two exclusive licenses in the U.S. and some other countries to use
the patents, patent applications, and know-how associated with four
pharmaceutical formulation technologies for mutually acceptable drug candidates.
The ProSLO I and ProSLO II technologies are licensed from Osmotica Corporation.
The other three technologies, ProLonic, ProMelt and ProSpher are licensed from
Tanabe Seiyaku. Like our own formulation technologies mentioned above, these
technologies may be used to develop mutually acceptable new drug products or
improve the physical characteristics of mutually acceptable existing products
and compounds.

In addition to our patents, we rely upon trade secrets and unpatented
proprietary know-how where we believe the public disclosures and limited patent
life associated with obtaining patent protection would not be in our best
strategic interest. We seek to protect these assets as permitted under state or
federal law and by requiring our employees, consultants, licensees, and other
companies to enter into confidentiality and nondisclosure agreements and, when
appropriate, assignment of invention agreements.

In the case of strategic partnerships or collaborative arrangements
requiring the sharing of data, our policy is to disclose to our partner only
such data as relevant to the partnership or arrangement during its term and so
long as our partner agrees to keep that data confidential.

SPECIAL ITEM. EXECUTIVE OFFICERS.

The following information sets forth the name, age, principal occupation
and business experience for our executive officers.

Frederick D. Sancilio, Ph.D., age 51, has been a Director since 1979, and
is currently Chairman of the Board of Directors and Chief Executive Officer of
aaiPharma. Before founding aaiPharma in 1979,

26

Dr. Sancilio's experience in the pharmaceutical industry included various
positions with Burroughs-Wellcome Co., Schering-Plough Corporation, and
Hoffmann-LaRoche, Inc.

Philip S. Tabbiner, D.B.A., age 46, has served as President and Chief
Operating Officer of aaiPharma since February 2002, having previously served as
Executive Vice President of aaiPharma and President of NeoSan Pharmaceuticals
from November 2000 to January 2002. Prior to joining aaiPharma, Dr. Tabbiner
held various positions in the pharmaceutical industry over a twenty year career.
Dr. Tabbiner served from December 1998 to November 2000 as a Senior Vice
President at Bayer Diagnostics, Bayer Corporation, and as President of
International at Chiron Diagnostics from 1997 until Bayer acquired Chiron
Diagnostics in 1998. Prior to joining Chiron Diagnostics, Dr. Tabbiner served
from 1995 to 1997 as Vice President of Worldwide Sales and Marketing at the
Dupont Merck Pharmaceutical Company -- Radiopharm Division.

Gregory S. Bentley, age 52, has served as Executive Vice President, General
Counsel and Secretary of aaiPharma since June 1999. Prior to joining aaiPharma,
Mr. Bentley served from 1994 to 1999 as Vice President, Regulatory and Quality
for Siemens Medical Systems, Inc., a leading medical device company and a
subsidiary of Siemens Corporation. Prior to joining Siemens Corporation as
Associate General Counsel in 1986, Mr. Bentley practiced law with Shearman &
Sterling in New York.

William L. Ginna, Jr., age 49, has served as Executive Vice President and
Chief Financial Officer of aaiPharma since February 2000. Prior to joining
aaiPharma, Mr. Ginna served from 1995 to 1999 as Vice President and Chief
Financial Officer for London International Group, a medical and consumer
products distributor. Mr. Ginna, a Certified Public Accountant, also spent ten
years with Athlone Industries, Inc., a listed New York Stock Exchange
manufacturer of specialty steels and consumer products, where he most recently
served as Vice President and Controller.

David M. Hurley, age 42, has served as Executive Vice President of
aaiPharma and President of NeoSan Pharmaceuticals since February 2002. Prior to
joining aaiPharma, Mr. Hurley served from June 2000 to January 2002 as Chief
Executive Officer of HealthNexis, a healthcare exchange company. Prior to
joining HealthNexis, Mr. Hurley held executive level positions from 1994 to 2000
at two subsidiary companies of Novartis Corporation, serving as President, Chief
Executive Officer, and as a Director of Geneva Pharmaceuticals, Inc., a
specialty pharmaceutical company, and as President, Chief Executive Officer, and
as a Director from December 1997 to December 1998 and as Executive Vice
President from November 1994 to December 1997 at Novartis Nutrition Corporation,
a medical nutrition company.

David Johnston, Ph.D., age 51, has served as Executive Vice President and
Chief Operating Officer, Non-clinical Operations, of aaiPharma and as President
of AAI International since January 2000. Prior to joining aaiPharma, Dr.
Johnston served from March 1997 to August 1999 as President of Oread
Laboratories and Executive Vice President of Drug Development of Oread, Inc., a
contract research organization located in Lawrence, Kansas. Prior to joining
Oread, Dr. Johnston served from October 1994 to March 1997 as Vice President of
Pharmaceutical Product Development of Sanofi, a pharmaceutical company,
directing more than 50 scientists in the area of drug development.

George E. Van Lear, Ph.D., age 61, has served as Executive Vice President
of aaiPharma and as President of aaiResearch since June 2000, having previously
worked for aaiPharma in the 1980's. Dr. Van Lear has over 30 years of experience
in the pharmaceutical industry, most recently serving as President of Senetek
PLC, a biotech company, from April 1999 to June 2000 and as Vice President of
Research and Development from 1996 to 1999 at DPT Technologies, Inc, a
healthcare company.

William H.