AAIPHARMA INC - 10-Q Quarterly Report

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003

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

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 o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes x No o

The number of shares of the Registrant’s common stock outstanding, as of May 5, 2003 was 27,609,100 shares.

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

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

We own the following registered and unregistered trademarks: Darvon®, Darvon-N®, Darvocet-N®, M.V.I.®, M.V.I.-12®, M.V.I. Pediatric®, M.V.I. Adult^TM, Aquasol®, Aquasol A®, Aquasol E®, Brethine®, ProSorb®, ProSorb-D™, ProSLO^TM, ProSLO II^TM, ProCore®, ProSpher®, ProLonic^TM, ProMelt®, NeoSan^TM, AzaSan^TM, aaiPharma^TM, and AAI®. References in this document to Darvon are to Darvon® and Darvon-N® collectively and references to Darvocet are to Darvocet-N®. We also reference trademarks owned by other companies. Prilosec® is a registered trademark of AstraZeneca AB and Prozac® is a registered trademark of Eli Lilly and Company. All references in this document to any of these terms lacking the “®” or “^TM” symbols are defined terms that reference the products, technologies or businesses bearing the trademarks with these symbols.


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PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Consolidated Statements of Operations		3
	Consolidated Balance Sheets		4
	Consolidated Statements of Cash Flows		5
	Consolidated Statements of Comprehensive Income		6
	Notes to Consolidated Financial Statements		7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		26
Item 4.	Controls and Procedures		26
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings		26
Item 6.	Exhibits and Reports on Form 8-K		28
SIGNATURES			29
CERTIFICATIONS			30
EXHIBIT INDEX			33

aaiPharma Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)


				Three Months Ended
				March 31,

				2003			2002

Net revenues:
	Product sales			$	40,008		$	20,177
	Product development (royalties and fees)				3,810			2,135
	Development services				20,212			23,308

					64,030			45,620

Operating costs and expenses:
	Direct costs (excluding depreciation):
		Product sales			9,951			7,805
		Development services			12,004			13,545

			Total direct costs		21,955			21,350
	Selling expenses				7,734			4,274
	General and administrative expenses				10,029			8,758
	Depreciation and amortization				2,651			1,801
	Research and development				4,486			4,378

Total operating costs and expenses					46,855			40,561

Income from operations					17,175			5,059
Other income (expense):
	Interest, net				(5,550	)		(1,823	)
	Other				(83	)		134

					(5,633	)		(1,689	)

Income before income taxes and extraordinary loss					11,542			3,370
Provision for income taxes					4,386			1,281

Income before extraordinary loss					7,156			2,089
Extraordinary loss, net of a tax benefit of $2,714					—			(5,339	)

Net income (loss)				$	7,156		$	(3,250	)

Basic earnings (loss) per share:
	Income before extraordinary loss			$	0.26		$	0.08
	Extraordinary loss				—			(0.20	)

Net income (loss)				$	0.26		$	(0.12	)

Weighted average shares outstanding					27,558			27,107

Diluted earnings (loss) per share:
	Income before extraordinary loss			$	0.25		$	0.07
	Extraordinary loss				—			(0.18	)

Net income (loss)				$	0.25		$	(0.11	)

Weighted average shares outstanding					28,435			28,589


			March 31,		December 31,
			2003		2002

			(Unaudited)
	ASSETS
Current assets:
	Cash and cash equivalents		$	10,705	$	6,532
	Accounts receivable, net			28,663		29,467
	Work-in-progress			12,292		10,515
	Inventories			19,476		17,004
	Prepaid and other current assets			7,312		7,633

		Total current assets		78,448		71,151
Property and equipment, net				54,604		53,125
Goodwill, net				211,178		210,792
Intangible assets, net				88,855		89,078
Other assets				13,782		16,179

		Total assets	$	446,867	$	440,325

	LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Current maturities of long-term debt		$	5,921	$	5,921
	Accounts payable			17,929		17,671
	Customer advances			14,287		15,051
	Accrued wages and benefits			7,941		6,718
	Interest payable			9,940		5,232
	Other accrued liabilities			3,284		5,201

		Total current liabilities		59,302		55,794
Long-term debt, less current portion				266,487		277,899
Other liabilities				13,313		7,182
Stockholders’ equity:
	Common stock			28		27
	Paid-in capital			79,476		79,049
	Retained earnings			27,748		20,592
	Accumulated other comprehensive income (loss)			513		(218	)

		Total stockholders’ equity		107,765		99,450

		Total liabilities and stockholders’ equity	$	446,867	$	440,325


				Three Months Ended March 31,

				2003			2002

Cash flows from operating activities:
	Income before extraordinary loss			$	7,156		$	2,089
	Adjustments to reconcile income before extraordinary loss to net cash provided by (used in) operating activities:
		Depreciation and amortization			2,651			1,801
		Other			52			78
		Changes in operating assets and liabilities:
			Accounts receivable, net		882			(3,951	)
			Work-in-progress		(1,640	)		(2,850	)
			Inventories		(2,451	)		1,082
			Prepaid and other assets		856			(14,118	)
			Accounts payable		204			(1,991	)
			Customer advances		(843	)		(222	)
			Interest payable		4,708			(175	)
			Accrued wages and benefits and other accrued liabilities		3,752			(1,348	)

Net cash provided by (used in) operating activities					15,327			(19,605	)

Cash flows from investing activities:
	Purchases of property and equipment				(3,212	)		(1,549	)
	Purchase of property and equipment previously leased				—			(14,145	)
	Acquisitions				(500	)		(211,772	)
	Other				(232	)		2

Net cash used in investing activities					(3,944	)		(227,464	)

Cash flows from financing activities:
	Net payments on short-term debt				—			5,000
	Proceeds from long-term borrowings				—			240,274
	Payments on long-term borrowings				(8,500	)		—
	Proceeds from interest rate swap, net				435			—
	Issuance of common stock				428			1,980
	Other				409			10

Net cash (used in) provided by financing activities					(7,228	)		247,264

Net increase in cash and cash equivalents					4,155			195
Effect of exchange rate changes on cash					18			(15	)
Cash and cash equivalents, beginning of period					6,532			6,371

Cash and cash equivalents, end of period				$	10,705		$	6,551

Supplemental information, cash paid for:
	Interest			$	1,497		$	1,776

	Income taxes			$	2,202		$	1,687

aaiPharma Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and applicable Securities and Exchange Commission regulations for interim financial information. These financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for annual financial statements. The consolidated financial information as of December 31, 2002 has been derived from audited financial statements; certain amounts from the three months ended March 31, 2002 have been reclassified for consistent presentation with current year financial statements. On January 30, 2003, aaiPharma’s Board of Directors approved a 3-for-2 stock split of the Company’s common shares. On March 10, 2003, each stockholder received one additional share of common stock for every two shares they owned on the record date of February 19, 2003. All share and per share amounts have been restated to reflect the stock split for all periods presented. It is presumed that users of this interim financial information have read or have access to the audited financial statements for the preceding fiscal year, which were included in the Company’s Annual Report on Form 10-K. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included in these interim financial statements. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the full year.

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

In December 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“SFAS No. 148”). SFAS No. 148 amends Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123), to provide alternative methods of transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions in SFAS No. 123 and Accounting Principles Board Opinion No. 28, “Interim Financial Reporting”, to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. The adoption of SFAS No. 148 did not have a significant impact on the Company’s consolidated results of operations, financial position or cash flows.

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

plans consistent with the fair value method of SFAS No. 123, the Company’s net income (loss) and earnings (loss) per share would have been changed to the pro forma amounts indicated below:


			Three Months Ended
			March 31,

			2003		2002

			(In thousands, except per share data)
Net income (loss), as reported			$	7,156	$	(3,250	)
Pro forma stock-based compensation cost, net of tax				1,907		1,106
Pro forma net income (loss)				5,249		(4,356	)
Earnings (loss) per share:
	As reported -
		Basic	$	0.26		($0.12	)
		Diluted	$	0.25		($0.11	)
	Pro forma -
		Basic	$	0.19		($0.16	)
		Diluted	$	0.18		($0.15	)

Masic earnings (loss) per share are based on the weighted average number of common shares outstanding during the year. Diluted earnings (loss) per share are computed assuming that the weighted average number of common shares was increased by the conversion of stock options issued to employees and members of the Company’s Board of Directors. The diluted per share amounts reflect a change in the number of shares outstanding (the “denominator”) to include the options as if they were converted to shares and issued, unless their inclusion would be anti-dilutive. In the three months ended March 31, 2003 and 2002, 3,250,053 and 868,210 options, respectively, were excluded as they were anti-dilutive. In each period presented, the net income (loss) (the “numerator”) is the same for both basic and diluted per share computations.

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

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

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


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

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