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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period _______ to _______
Commission File Number 0-21185
AAIPHARMA INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 04-2687849
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
2320 SCIENTIFIC PARK DRIVE, WILMINGTON, NC 28405
(Address of principal executive office) (Zip code)
(910) 254-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes [X] No [ ]
The number of shares of the registrant's common stock outstanding as of November
1, 2004 was 28,585,582 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.
At September 30, 2004, we owned the following registered and unregistered
trademarks referenced herein: Darvocet(R), Darvon(R), Darvon-N(R),
Darvocet-N(R), Darvocet A500(TM), Brethine(R), ProSorb-D(TM), Lynxorb(TM),
Oramorph(R) SR, Roxicodone(R), AzaSan(R), aaiPharma(R) and AAI(R). AzaSan(R) is
a registered trademark owned by us and licensed to Salix Pharmaceuticals. Unless
the context otherwise requires, references in this document to Darvon are to
Darvon(R) and Darvon-N(R), collectively, and references to Darvocet are to
Darvocet-N(R) and Darvocet A500(TM), collectively. We also reference trademarks
owned by other companies. M.V.I.(R), M.V.I.-12(R), M.V.I. Pediatric(R), M.V.I.
Adult(TM), Aquasol(R), Aquasol A(R) and Aquasol E(R) are registered and
unregistered trademarks owned by Mayne Pharma (USA) Inc. Prilosec(R) is a
registered trademark owned by AstraZeneca. Unless the context otherwise
requires, references to M.V.I. are to M.V.I.-12(R), M.V.I. Pediatric(R) and
M.V.I. Adult(TM), collectively, and references to Aquasol are to Aquasol A(R)
and Aquasol E(R), collectively. Duraclon(R) is a registered trademark owned by
Fujisawa Healthcare, Inc. and licensed to us. 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.
AAIPHARMA INC.
Table of Contents
Page No.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (unaudited)
Consolidated Statements of Operations
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Consolidated Statements of Comprehensive Loss
Notes to Consolidated Financial Statements
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 6. EXHIBITS
SIGNATURES
EXHIBIT INDEX
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
AAIPHARMA INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net revenues:
Product sales $ 15,684 $ 13,664 $ 61,898 $ 78,428
Product development (royalties and fees) 4,481 3,524 14,522 11,231
Development services 23,054 22,512 72,529 65,124
--------- --------- --------- ---------
43,219 39,700 148,949 154,783
--------- --------- --------- ---------
Operating costs and expenses:
Direct costs (excluding depreciation and royalty expense):
Product sales (includes product rights amortization
of $3,972, $2,969, $11,916 and $8,906) 10,404 10,955 35,494 37,817
Development services 12,749 12,614 42,248 37,390
--------- --------- --------- ---------
Total direct costs 23,153 23,569 77,742 75,207
Selling expenses 6,021 9,071 30,122 25,006
General and administrative expenses 9,479 9,793 35,319 31,112
Research and development 3,134 5,367 13,847 15,441
Depreciation 2,367 1,912 6,404 5,747
Professional fees - internal inquiry 769 - 9,072 -
M.V.I. contingent payment/(gain on sale) (1,567) - (8,112) -
Restructuring charges 13,719 - 17,119 -
Royalty expense 357 325 1,366 452
Intangible asset impairment 5,250 - 5,250 -
--------- --------- --------- ---------
Total operating costs and expenses 62,682 50,037 188,129 152,965
--------- --------- --------- ---------
(Loss) income from operations (19,463) (10,337) (39,180) 1,818
Other income (expense):
Interest, net (9,469) (5,140) (23,866) (15,621)
Loss from extinguishment from debt - - (6,229) -
Other (275) (122) (2,111) 21
--------- --------- --------- ---------
(9,744) (5,262) (32,206) (15,600)
--------- --------- --------- ---------
Loss before income taxes (29,207) (15,599) (71,386) (13,782)
Provision for (benefit from) income taxes 4,583 (6,207) 4,758 (5,414)
--------- --------- --------- ---------
Net loss $ (33,790) $ (9,392) $ (76,144) $ (8,368)
========= ========= ========= =========
Basic loss per share: $ (1.18) $ (0.34) $ (2.67) $ (0.30)
========= ========= ========= =========
Weighted average shares outstanding 28,586 27,810 28,558 27,664
========= ========= ========= =========
Diluted loss per share: $ (1.18) $ (0.34) $ (2.67) $ (0.30)
========= ========= ========= =========
Weighted average shares outstanding 28,586 27,810 28,558 27,664
========= ========= ========= =========
The accompanying notes are an integral part of these financial statements.
3
AAIPHARMA INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
September 30, December 31,
2004 2003
------------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 7,143 $ 8,785
Accounts receivable, net 6,799 32,614
Work-in-progress 11,279 12,503
Inventories, net 13,509 14,693
Deferred tax assets 10,456 19,184
Prepaid and other current assets 10,335 10,398
--------- ---------
Total current assets 59,521 98,177
Property and equipment, net 56,126 57,236
Goodwill, net 13,154 13,361
Intangible assets, net 282,843 351,315
Other assets 14,225 14,508
--------- ---------
Total assets $ 425,869 $ 534,597
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ - $ 4,000
Accounts payable 21,515 21,879
Customer advances 13,775 17,630
Accrued wages and benefits 6,840 5,320
Interest payable 10,271 5,511
Deferred product revenue 10,632 45,664
Other accrued liabilities 37,524 11,133
--------- ---------
Total current liabilities 100,557 111,137
Long-term debt, less current portion 323,700 338,844
Deferred tax liability - 2,246
Other liabilities 18 7,647
Stockholders' equity:
Common stock 29 28
Paid-in capital 91,622 88,049
Accumulated deficit (92,451) (16,307)
Accumulated other comprehensive income 2,533 3,197
Deferred compensation (139) (244)
--------- ---------
Total stockholders' equity 1,594 74,723
--------- ---------
Total liabilities and stockholders' equity $ 425,869 $ 534,597
========= =========
The accompanying notes are an integral part of these financial statements.
4
AAIPHARMA INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
September 30,
------------------------
2004 2003
--------- ---------
Cash flows from operating activities:
Net loss $ (76,144) $ (8,368)
Adjustments to reconcile net loss to
net cash (used in) provided by operating activities:
Depreciation and amortization 18,320 14,653
Intangible asset impairment, net of tax 5,250 -
Write-off of deferred financing and other costs 6,229 -
Gain from asset sale (39,113) -
Other 237 138
Changes in operating assets and liabilities:
Accounts receivable, net 25,731 (1,570)
Work-in-progress 1,083 (4,520)
Inventories (1,824) (90)
Deferred tax assets 8,728 -
Prepaid and other assets (5,889) 273
Accounts payable (318) (1,420)
Customer advances (3,768) 4,158
Interest payable 4,760 4,566
Deferred product revenue (35,032) 45,198
Accrued wages and benefits and other accrued liabilities 26,067 (9,080)
--------- ---------
Net cash (used in) provided by operating activities (65,683) 43,938
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (5,475) (9,867)
Proceeds from sales of property and equipment 97 508
Product line disposals (acquisitions) 92,944 (6,050)
Other (199) (334)
--------- ---------
Net cash provided by (used in) investing activities 87,367 (15,743)
--------- ---------
Cash flows from financing activities:
Proceeds from long-term borrowings 147,500 -
Payments on long-term borrowings (164,000) (29,500)
(Payments on) proceeds from interest rate swaps, net (10,203) 2,191
Proceeds from stock option exercises 3,678 2,819
Other (292) 805
--------- ---------
Net cash used in financing activities (23,317) (23,685)
--------- ---------
Net (decrease) increase in cash and cash equivalents (1,633) 4,510
Effect of exchange rate changes on cash (9) 68
Cash and cash equivalents, beginning of period 8,785 6,532
--------- ---------
Cash and cash equivalents, end of period $ 7,143 $ 11,110
========= =========
Supplemental information, cash paid for:
Interest $ 17,868 $ 13,520
========= =========
Income taxes $ 5,923 $ 6,152
========= =========
The accompanying notes are an integral part of these financial statements.
5
AAIPHARMA INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(IN THOUSANDS)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net loss $(33,790) $ (9,392) $(76,144) $ (8,368)
Currency translation adjustments, net of tax 384 (42) (664) 1,981
-------- -------- -------- --------
Comprehensive loss $(33,406) $ (9,434) $(76,808) $ (6,387)
======== ======== ======== ========
The accompanying notes are an integral part of these financial statements.
6
AAIPHARMA INC.
Notes to Consolidated Financial Statements
(Unaudited)
1. BASIS OF PRESENTATION AND OTHER MATTERS
aaiPharma Inc. ("aaiPharma" or the "Company") is a science-based pharmaceutical
company focused on acquiring, improving and marketing well-known, branded
medicines in pain management and critical care. The Company also offers
comprehensive drug development services to the pharmaceutical, biotechnology,
generic and device industries through its development services division. 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 (the "SEC") 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, 2003 has been derived from audited
financial statements; certain amounts from the three and nine months ended
September 30, 2003 have been reclassified for consistent presentation with
current year financial statements. It is presumed that users of this interim
financial information have read or have access to the audited financial
statements for the preceding fiscal year, which were included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2003 (the "2003 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.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25") and related interpretations in accounting
for its stock option plans; therefore, compensation expense has not been
recognized for options granted at fair value. Under APB 25, if the exercise
price of the Company's stock options is not less than the estimated fair market
value of the underlying stock on the date of grant, no compensation expense is
recognized. If compensation cost for the Company's plans had been determined
based on the fair value at the grant dates for awards under those plans
consistent with the fair value method of Statement of Financial Accounting
Standards No. 123 "Accounting for Stock Based Compensation", the Company's net
income (loss) and income (loss) per share would have been changed to the pro
forma amounts indicated below:
7
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
(In thousands, except per share data)
Net loss, as reported $ (33,790) $ (9,392) $ (76,144) $ (8,368)
Add back deferred compensation amortization, net of tax 21 21 62 62
Less pro forma stock-based compensation cost, net of tax 1,060 1,982 4,635 5,672
Pro forma net loss (34,829) (11,353) (80,717) (13,978)
Loss per share:
As reported -
Basic ($ 1.18) ($ 0.34) ($ 2.67) ($ 0.30)
Diluted ($ 1.18) ($ 0.34) ($ 2.67) ($ 0.30)
Pro forma -
Basic ($ 1.22) ($ 0.41) ($ 2.83) ($ 0.51)
Diluted ($ 1.22) ($ 0.41) ($ 2.83) ($ 0.51)
2. RECENT DEVELOPMENTS
MANAGEMENT CHANGES AND REDUCTION IN FORCE
On September 27, 2004, the Company's board of directors named Ludo Reynders,
Ph.D. as President and Chief Executive Officer and elected James G. Martin,
Ph.D., a non-employee member of the board of directors, to serve as
non-executive chairman of the board of directors. At that time, Frederick D.
Sancilio ceased to serve as Chairman, President, Chief Executive Officer and
Chief Scientific Officer, but continues to serve as a director of the Company.
On September 3, 2004, the Company announced that Vijay Aggarwal stepped down
from his position as President of AAI Development Services to accept the
position of Chief Executive Officer of another pharmaceutical company and that
Steve Cottrell, Executive Vice President of AAI Development Services' Sales,
Marketing and Project Management, had been assigned to the position of Interim
President of AAI Development Services. Mr. Cottrell left aaiPharma on October
15, 2004 to join a company providing training services to the pharmaceutical
industry. Dr. Ludo J. Reynders, President and Chief Executive Officer of
aaiPharma, was hospitalized with suspected pneumonia on November 7, 2004.
During Dr. Reynders' incapacity, Mr. Timothy R. Wright has been appointed to
the position of interim President and Chief Executive Officer.
In September 2004, the Company reduced the size of its workforce by
approximately 4%. The Company has estimated that the severance costs associated
with this reduction in workforce will be approximately $1.5 million. This amount
does not include separation payments to Dr. Sancilio of approximately $1.9
million. The Company also incurred additional restructuring charges of
approximately $10.3 million in the quarter ended September 30, 2004 in
connection with the closure of several leased facilities and the subleasing of
leased aircraft. This additional restructuring is consistent with the Company's
previously disclosed intentions to rationalize its expense base in relation to
its revenue. Payments under these severance and separation arrangements and
leases extend through 2006 and 2012, respectively.
The Company was late in filing its 2003 Form 10-K, which was filed on June 15,
2004. On June 21, 2004, NASDAQ notified the Company that the listing
qualifications panel had determined to continue the listing of the Company's
common stock if the Company met certain conditions, including providing NASDAQ
with additional information, filing the Quarterly Reports on Form 10-Q/A for
each of the first three quarters of 2003 and the Quarterly Report on Form 10-Q
for the first quarter of 2004 by the June 30, 2004 deadline, and filing on a
timely basis all periodic reports for reporting periods ending on or before June
30, 2005. The amended Quarterly Reports on Form 10-Q for 2003 were filed on June
24, 2004, the Quarterly Report on Form 10-Q for the period ended March 31, 2004
was filed on June 25, 2004 and the Company provided NASDAQ the required
additional information on June 30, 2004. As a result, NASDAQ notified the
Company that it was in compliance
8
and its common stock would continue to be listed subject to the conditions
identified in its June 21, 2004 notification. On July 9, 2004, the Company's
ticker symbol reverted to "AAII".
SENIOR CREDIT AGREEMENT AMENDMENTS AND INDENTURE CONSENT SOLICITATION
On August 9, 2004 and August 13, 2004, the Company entered into amendments to
its senior secured credit facilities to, among other things, increase the amount
of the term loans by up to $10 million, extend the maturity date of the
facilities by one year to April 21, 2007, increase the interest rate on the
loans by an additional 1.5% subject to potential incremental reduction based on
the Company's financial performance, adjust certain covenants under the
facilities and waive certain defaults and events of default. Under the amended
credit facility, the Company borrowed an additional $10 million in term loans on
August 13, 2004. The amendment adjusted both the percentages of proceeds of
certain transactions that are required to be applied to prepay the loans and the
fees to be paid upon optional reductions of the credit facility. As amended,
optional reductions in revolving credit commitments and optional prepayments of
term loans, as well as mandatory reductions in revolving credit commitments and
mandatory prepayments of term loans from the net cash proceeds of asset sales,
subject to defined exceptions, are subject to a prepayment fee equal to 3.5%
until August 9, 2005, 2.5% for the subsequent 12 months, and 1.5% for the next 6
months (with no prepayment penalty payable for the remainder of the term). The
August amendments also require the Company to retain FTI Consulting, Inc. during
the term of the senior credit facilities unless certain available cash and
annualized cost reduction thresholds are satisfied, at which time the retention
of FTI could be terminated.
On October 1, 2004, the Company failed to make the interest payment then due on
its senior subordinated notes. The failure to make the October 1, 2004 interest
payment constituted a default under the notes, subject to a 30-day cure period.
On October 29, 2004, the Company made the interest payment, curing the default
under the notes.
On October 29, 2004, the Company completed a solicitation seeking the consent
from the holders of its senior subordinated notes to certain amendments to, and
waivers under, the indenture (the "Indenture") governing the senior subordinated
notes to, among other things:
- - permit the Company to incur up to $30 million of additional indebtedness
under credit facilities;
- - permit the Company to incur additional senior debt in order to maintain
$40 million (subject to an increase up to $50 million in order to allow
the Company to make interest payments on the senior subordinated notes) in
senior debt under credit facilities in the event the Company is required
to pay down senior debt with the proceeds of asset sales;
- - require that debt permitted to be incurred under a fixed charge coverage
ratio test set forth in the Indenture must rank on parity with or be
subordinated in right of payment to the senior subordinated notes and any
liens granted to secure any such parity debt shall rank pari passu with
the liens securing the senior subordinated notes;
- - require proceeds of asset sales to be used to reduce senior debt under
credit facilities to $40 million;
- - provide that the liens on assets that secure obligations under the senior
subordinated notes will continue if all senior debt is repaid, but will
resume as junior liens if the Company thereafter incurs any new senior
debt;
- - prohibit the payment in cash in excess of an aggregate of $5 million to
settle pending litigation, excluding payments funded or reimbursed under
insurance policies, until the Company makes the interest payments due on
the senior subordinated notes on April 1, 2005 and October 1, 2005;
- - prohibit the payment of dividends on the Company's common stock and other
restricted payments (as defined in the Indenture) until the interest
payments due on the senior subordinated notes on April 1, 2005 and October
1, 2005 are paid; and
9
- - temporarily increase the interest rate on the senior subordinated notes by
0.5% per annum (to 12% per annum), beginning on October 1, 2004 and ending
on March 31, 2005.
The completion of the consent solicitation satisfied a condition of an amendment
to the Company's senior credit facilities (described below) that made available
a supplemental term loan under the senior credit facilities that was used on
October 29, 2004 to make the October 1, 2004 interest payment on the senior
subordinated notes, together with default interest thereon. This payment cured
the existing default under the senior subordinated notes.
Effective as of October 8, 2004, the Company amended its senior secured credit
facility to, among other things, adjust financial covenants. The senior secured
lenders also waived compliance with certain financial covenants in the senior
secured credit facility for the quarter ended September 30, 2004 and the quarter
ending December 31, 2004 provided that the Company meets minimum consolidated
EBITDA thresholds (as defined in the senior secured credit facility). The
amendment also added a minimum gross revenue requirement of $40 million for the
quarter ending December 31, 2004 and consented to certain asset disposition
transactions and receipt of a deferred purchase price payment pursuant to which
the Company would receive approximately $4.2 million in the aggregate. The
amendment also waived any requirement to prepay the senior secured loans with
the net proceeds of these transactions.
On October 22, 2004, the Company entered into another amendment to its senior
secured credit facilities that increased the existing term loan facility under
the senior secured credit facility by $30 million (the "Supplemental Term
Loan"), subject to certain specified conditions which were satisfied on October
29, 2004. The Supplemental Term Loan was made available in up to three draws to
be made on or prior to January 15, 2005, and the Company borrowed $20 million of
such term loans on October 29, 2004. Following effectiveness of the amendment,
the senior secured credit facility consisted of a term loan of up to $165
million and a revolving credit facility of up to $15 million.
The amendment also modified the interest rate on the entire senior secured
credit facility, including the Supplemental Term Loan, to equal a defined LIBOR
rate (with a floor of 2%) plus 8.25% per annum or a defined reference rate (with
a floor of 4%) plus 7.25% per annum. The amendment also provided for a
commitment fee equal to 0.75% per annum on any undrawn portion of the
Supplemental Term Loan, payable monthly in arrears. At October 29, the Company's
applicable LIBOR-based interest rate under the amended credit facilities was
10.25%.
The proceeds of the loans under the Supplemental Term Loan were and may be used
(i) to fund payment of the October 1, 2004 interest payment due on the senior
subordinated notes, (ii) to pay for fees, costs and expenses in connection with
the amendment and the October 2004 consent solicitation for the senior
subordinated notes, and (iii) for working capital and other general corporate
purposes.
The amendment added a covenant requiring the Company to retain Rothschild Inc.
or another financial advisor to assist with its exploration of the potential
sale of some or all of the assets comprising the Company's Pharmaceuticals
Division, but eliminated a minimum gross revenue covenant for the quarter ending
December 31, 2004. Compliance with the fixed charge coverage ratio and the
leverage ratio financial covenants was also waived through the first quarter of
2005 so long as defined minimum EBITDA thresholds are satisfied. In addition,
the amendment retained a covenant requiring certain levels of cash or revolver
availability and increased the level of cash or revolver availability required
for the period from March 31, 2005 through May 15, 2005 to $15.0 million.
The amendment also added an event of default if the Company fails to pursue in
good faith the exploration of the potential sale of some or all of the assets
comprising its Pharmaceutical Division or other non-core assets.
10
The Company has engaged Rothschild Inc. to assist it in evaluating potential
asset divestitures. The Company is exploring the potential sale of some or all
of the assets comprising the Pharmaceuticals Division, as well as other assets
that are no longer strategic to its long-term business plan. These asset sales,
above a minimum threshold, would require the consent of the senior secured
lenders.
GOVERNMENTAL INVESTIGATIONS AND LITIGATION
Beginning in April 2004, the Company received subpoenas for document production
and potential testimony issued by a grand jury of the United States District
Court for the Western District of North Carolina related primarily to 2002 and
2003 financial information, the terms, conditions of employment and compensation
arrangements of certain of the Company's senior management personnel,
compensation and incentive arrangements for employees responsible for the sale
of its Brethine, Darvocet, Calcitriol, Azasan and Darvon Compound products,
quantities of the foregoing products in distribution channels, financial
benefits with respect to specified corporate transactions to the Company's
senior management and others, certain loans obtained by the Company, extensions
of credit, if any, by the Company to its officers or directors, accounting for
sales and returns of the foregoing products, analysts' conference calls on
financial results, internal and external investigations of pharmaceutical
product sales activities, and related matters. The Company has also received a
subpoena from the SEC covering similar matters. In addition, the Company and
certain of its current and former officers and directors have been named as
defendants in purported stockholder class action lawsuits alleging violations of
federal securities laws and a stockholder derivative action, not yet served on
the Company, alleging violations of state law fiduciary responsibilities. The
Company is also a party to other litigation described in Part II, Item 1. "Legal
Proceedings" of this Quarterly Report on Form 10-Q. The Company has incurred,
and likely will continue to incur in the future, significant professional fees
in connection with these matters and other pending litigation. Professional fees
on a number of the matters described in this Form 10-Q, including these
litigation matters and governmental investigations, may extend for several
years.
3. M.V.I. AND AQUASOL PRODUCT LINE SALE AND CONTINGENT PAYMENT
On April 26, 2004, the Company sold its M.V.I. and Aquasol product lines to
Mayne Pharma (USA) Inc. for $105 million, subject to adjustments based on
inventory levels at closing and other post-closing obligations (the "M.V.I. and
Aquasol Sale"). A portion of the closing payment is held in escrow to satisfy
post-closing obligations under the agreement. The M.V.I. and Aquasol Sale
resulted in a preliminary gain of $37.5 million that the Company recorded in the
second quarter of 2004. The gain on the sale was based on the net cash received
from the sale less the book value of the intangible assets, inventories and
other items related to the product lines sold. In September 2004, the Company
received a cash distribution of $1.6 million related to a reduction in its
post-closing obligations under the purchase agreement, which was recorded as an
additional gain in the third quarter of 2004. The Company expects to receive a
final distribution of $0.2 million in the fourth quarter of 2004.
The Company's M.V.I. and Aquasol product line acquisition agreement with
AstraZeneca AB, as amended, provided for a future contingent payment of $43.5
million potentially due in August 2004, depending on the status of certain
reformulation activities being carried out by the seller and regulatory approval
of the reformulations by the U.S. Food and Drug Administration. The amount of
the $43.5 million contingent payment was to be reduced by $1 million per month
if the conditions for the contingent payment had not occurred by December 31,
2002. The amount of the contingent payment had decreased by $12.0 million by
December 31, 2003. Such conditions were satisfied in January and February 2004,
fixing the previously contingent liability under the amendment at $31.5 million.
The Company recorded this expense in the first quarter of 2004. As a result of
an amendment to the original acquisition agreement, the Company was precluded
from recognizing this obligation (the "M.V.I. Contingent Payment") as additional
purchase price for the M.V.I. and Aquasol product lines under Statement of
Financial Accounting Standards No. 142, "Goodwill
11
and Other Intangible Assets," and No. 141, "Business Combinations"; therefore,
this adjustment was expensed in the first quarter of 2004. As discussed above,
the Company sold its M.V.I. and Aquasol product lines on April 26, 2004. Because
the $31.5 million contingent payment was not included in the basis of the assets
sold, the gain from the sale transaction in the second quarter of 2004 offsets
the expense discussed in this Note in determining the net loss for the nine
months ended September 30, 2004. Concurrently with the closing of the M.V.I. and
Aquasol Sale on April 26, 2004, the Company paid to AstraZeneca AB the M.V.I.
Contingent Payment, which was discounted to approximately $31.0 million as a
result of the early payment.
4. INCOME TAXES
The Company recorded a net tax expense of approximately $4.6 million in the
third quarter of 2004. The Company recorded a tax benefit of approximately $12
million in the nine months ended September 30, 2004, primarily as a result of
current period net operating losses, offset by a valuation allowance for the
entire amount because it is more likely than not that the deferred tax asset
resulting from this benefit will not be realized. Included in this tax expense
is an additional valuation allowance of $4.4 million for previously unreserved
deferred tax assets for which it is now more likely than not that the benefit
will not be realized. The need for this additional valuation allowance resulted
from changes in the projected recoverability of these deferred tax assets.
5. EARNINGS (LOSS) PER SHARE
Basic 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. During the nine months ended September 30, 2004, approximately
360,000 options were exercised for aggregate proceeds to the Company of $3.6
million. In the three and nine months ended September 30, 2004, 5.1 million and
4.0 million options, respectively, were excluded as they were anti-dilutive. In
the three and nine months ended September 30, 2003, 2.2 million and 1.7 million
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 denominator for the basic
and diluted earning per share computations (in thousands):
12
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- --------------------
2004 2003 2004 2003
------ ------ ------ ------
Basic earnings per share:
Weighted average number of shares 28,586 27,810 28,558 27,664
Effect of dilutive securities:
Stock options - - - -
------ ------ ------ ------
Diluted earnings per share:
Adjusted weighted average number of shares
and assumed conversions 28,586 27,810 28,558 27,664
====== ====== ====== ======
6. FINANCIAL INFORMATION BY BUSINESS SEGMENT AND GEOGRAPHIC AREA
The Company operates in three business segments consisting of a product sales
business, primarily comprised of the pharmaceuticals division, a product
development business, primarily the research and development business unit, and
a development services business, primarily the AAI Development Services business
unit. The product sales business is engaged in the marketing and sale of the
Company's pharmaceutical product lines. 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):
13
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ----------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
NET REVENUES:
Product sales $ 15,684 $ 13,664 $ 61,898 $ 78,428
Product development 4,481 3,524 14,522 11,231
Development services 23,054 22,512 72,529 65,124
---------- ---------- ---------- ----------
$ 43,219 $ 39,700 $ 148,949 $ 154,783
========== ========== ========== ==========
United States $ 37,462 $ 34,783 $ 130,965 $ 140,453
Germany 5,738 5,007 18,220 15,550
Other 191 458 1,095 1,066
Less intercompany (172) (548) (1,331) (2,286)
---------- ---------- ---------- ----------
$ 43,219 $ 39,700 $ 148,949 $ 154,783
========== ========== ========== ==========
(LOSS) INCOME FROM OPERATIONS:
Product sales $ (4,926) $ (5,244) $ (4,932) $ 19,448
Product development 4,481 3,524 14,522 11,231
Development services (5,004) 1,718 (4,168) 2,351
---------- ---------- ---------- ----------
(5,449) (2) 5,422 33,030
Research and development (3,748) (5,464) (14,663) (15,748)
Corporate (10,266) (4,871) (29,939) (15,464)
---------- ---------- ---------- ----------
$ (19,463) $ (10,337) $ (39,180) $ 1,818
========== ========== ========== ==========
United States $ (19,800) $ (10,766) $ (40,949) $ 502
Germany 493 376 1,852 1,396
Other (156) 53 (83) (80)
---------- ---------- ---------- ----------
$ (19,463) $ (10,337) $ (39,180) $ 1,818
========== ========== ========== ==========
DEPRECIATION AND AMORTIZATION:
Product sales $ 4,240 $ 3,093 $ 12,629 $ 9,199
Development services 1,322 1,187 3,703 3,579
Product development 145 98 347 307
Corporate 632 503 1,641 1,568
---------- ---------- ---------- ----------
$ 6,339 $ 4,881 $ 18,320 $ 14,653
========== ========== ========== ==========
September 30, December 31,
------------- ------------
2004 2003
---------- ----------
TOTAL ASSETS:
Product sales $ 315,503 $ 424,452
Product development 12,750 13,062
Development services 58,936 55,791
Corporate 38,680 41,292
---------- ----------
$ 425,869 $ 534,597
========== ==========
United States $ 396,531 $ 504,574
Germany 27,553 28,243
Other 1,785 1,780
---------- ----------
$ 425,869 $ 534,597
========== ==========
GOODWILL, NET:
Development services $ 13,154 $ 13,361
========== ==========
7. TRANSACTIONS WITH RELATED PARTIES
The Company had revenue, accounts receivable and work-in-progress with Aesgen,
Inc. ("Aesgen") and Endeavor Pharmaceuticals, Inc. ("Endeavor"). Both Endeavor
and Aesgen were organized by aaiPharma Inc., its principal shareholders and
others. Aesgen was a related party until the third quarter of 2004, when MGI
14
Pharma, Inc. acquired all the outstanding equity of Aesgen, including the equity
owned by the Company, for cash. This resulted in a $0.5 million gain to the
Company and is recorded as other income on the income statement. Endeavor was a
related party until the fourth quarter of 2003, when Endeavor filed articles of
dissolution and made a liquidating distribution to its stockholders, including
the Company. No revenues were recognized from Aesgen for the three and nine
months ended September 30, 2004 and 2003, respectively. At September 30, 2004,
the Company had no accounts receivable or work-in-progress related to Aesgen.
Services performed by the Company for Aesgen were covered by a Subscription
Agreement, whereby the Company had agreed to receive Aesgen preferred stock in
lieu of cash for the services performed. In February 2002, the Company acquired
a calcitriol product from Aesgen, under an agreement which included potential
royalty payments. The Company launched its calcitriol product in March 2003;
however, no revenues or royalty expenses were recorded for this product during
the first quarter of 2003. Calcitriol is shipped to wholesalers and revenues are
recorded under the consignment model; therefore no revenue or expenses were
recognized until the product is shipped by those wholesalers. The Company
expensed royalties of $0.1 million and $0.3 million under that agreement in the
three and nine months ended September 30, 2004 and expensed $0.2 million and
$0.3 million in the three and nine months ended September 30, 2003. Revenues
recognized from Endeavor totaled $0.1 million and $0.7 million for the three and
nine months ended September 30, 2003. Certain services performed by the Company
for Endeavor were covered by a Securities Payment Agreement between the Company
and Endeavor, whereby the Company would receive Endeavor preferred stock in lieu
of cash for services performed.
8. ACCOUNTS RECEIVABLE, NET
The following table presents the components of accounts receivable (in
thousands):
September 30, December 31,
2004 2003
------------- ------------
Gross accounts receivable $ 33,359 $ 85,726
Allowance for uncollectible accounts (2,055) (1,130)
Allowance for customer credits (24,505) (51,982)
-------- ---------
Total accounts receivable, net $ 6,799 $ 32,614
======== =========
Accounts receivable are presented net of an allowance for uncollectible accounts
and net of an allowance for customer credits, including discounts, rebates,
chargebacks, product returns and other allowances. The decrease in the allowance
for customer credits is due to decreases in product returns reserves primarily
related to decreases in wholesaler inventory levels and chargeback reserves
related to the M.V.I. and Aquasol product lines, which were sold in April 2004.
15
9. INVENTORIES, NET
The following table presents the components of inventories (in thousands):
September 30, December 31,
2004 2003
------------- ------------
Finished goods $ 13,160 $ 18,579
Work-in-process 1,672 1,865
Raw materials and supplies 6,339 5,007
Inventory reserves (7,662) (10,758)
-------- --------
Inventories, net $ 13,509 $ 14,693
======== ========
The decrease in inventory reserves is primarily related to reserves for certain
consignment inventories, which have subsequently been disposed of, and reserves
for the M.V.I. and Aquasol product lines, which were sold in April 2004.
10. DEBT
The following table presents the components of current maturities of long-term
debt (in thousands):
September 30, December 31,
2004 2003
------------- ------------
Current maturities of long-term debt $ - $ 4,000
======= ==========
The following table presents the components of long-term debt (in thousands):
September 30, December 31,
2004 2003
------------- ------------
Term loan $ 135,000 $ 156,000
Revolving credit facility 12,500 8,000
11.5% senior subordinated notes due 2010, net of original issue discount 174,213 174,106
Interest rate swap monetization deferred income, net 1,987 12,189
Fair value of interest rate swap - (7,451)
Less current maturities of long-term debt - (4,000)
---------- ----------
Total long-term debt due after one year $ 323,700 $ 338,844
========== ==========
In March 2002, the Company issued $175 million of senior subordinated notes due
April 1, 2010. The proceeds from the issuance of these notes were $173.9
million, which was net of the original issue discount. This discount will be
charged to interest expense over the term of the notes. These notes initially
had a fixed interest rate of 11% per annum and are guaranteed on a subordinated
basis by all existing domestic subsidiaries and all future domestic subsidiaries
that are owned 80% or more by the Company. When issued, the notes were not
secured. Prior to the third anniversary of the date of issuance of the notes, up
to 35% of the notes are
16
redeemable with the proceeds of qualified sales of equity at 111% of par value.
On or after the fourth anniversary of the date of issuance of the notes, all or
any portion of the notes are redeemable at declining premiums to par value,
beginning at 105.5%.
Concurrently with the issuance of the senior subordinated notes, the Company
entered into an interest rate hedging agreement to effectively convert interest
expense on a portion of the senior subordinated notes for the term of the notes
from an 11% fixed annual rate to a floating annual rate equal to 6-month LIBOR
plus a base rate. In 2003, the Company sold the then outstanding interest rate
hedging agreement and replaced it with a similar interest rate hedging
agreement. In April 2004, the Company paid $9.4 million to terminate the
interest rate hedging agreement. The amounts received, less the termination
payment and the interest benefits earned through the dates of sale, have been
recorded as premiums to the carrying amount of the notes and are being amortized
into interest income over their remaining life.
On March 31, 2004, the lenders under the Company's then-existing credit
agreement, which was then in default, exercised their right to block the Company
from making the interest payment due on April 1, 2004 to holders of the
Company's senior subordinated notes. Accordingly, aaiPharma did not make that
interest payment on April 1, 2004. In addition, the Company's failure to timely
file its Annual Report on Form 10-K for the year ended December 31, 2003
constituted a default under the indenture governing the senior subordinated
notes.
On April 20, 2004, aaiPharma completed a solicitation seeking the consent from
holders of the Company's senior subordinated notes to approve a refinancing or
replacement of the Company's then-existing credit facilities with the Company's
senior credit facilities (described below) and certain amendments to, and
waivers under, the indenture governing the senior subordinated notes to, among
other things:
- - grant a lien to secure the Company's obligations under the senior
subordinated notes, which lien is junior to the liens securing the
Company's new senior credit facilities but covers the same collateral;
- - increase the interest rate of the senior subordinated notes from 11% per
annum to 11.5% per annum effective April 1, 2004;
- - suspend the Company's obligation under the indenture to file periodic
reports with the SEC until the earlier of the date that the Company's
2003 Form 10-K is filed with the SEC or September 30, 2004 and suspend
the Company's obligation to furnish annual written statements of the
Company's accountants until the fifth day after the earlier of the date
that the Company's 2003 Form 10-K is filed with the SEC and September 30,
2004;
- - further limit the Company's ability to grant liens to secure certain
obligations unless the liens are subordinate to the liens securing the
senior subordinated notes or are otherwise permitted under the indenture;
and
- - limit the Company's ability to incur up to $10 million of indebtedness,
and to grant liens to secure that amount of indebtedness, not otherwise
specifically permitted by the indenture, until the Company's 2003 Form
10-K is filed with the SEC or unless the indebtedness is incurred to fund
an interest payment with respect to the senior subordinated notes.
Following the completion of a consent solicitation, aaiPharma entered into a
supplemental indenture to effect these amendments and waivers and made the
interest payments that had been due on April 1, 2004, together with default
interest.
On October 1, 2004, the Company failed to make the interest payment then due on
its senior subordinated notes. The failure to make the October 1, 2004 interest
payment constituted a default under the notes, subject to a 30-day cure period.
On October 29, 2004, the Company made the interest payment, curing the default
under the notes.
17
On October 29, 2004, the Company completed a solicitation seeking the consent
from the holders of its senior subordinated notes to certain amendments to, and
waivers under, the indenture governing the senior subordinated notes to, among
other things:
- - permit the Company to incur up to $30 million of additional indebtedness
under credit facilities;
- - permit the Company to incur additional senior debt in order to maintain
$40 million (subject to an increase up to $50 million in order to allow
the Company to make interest payments on the senior subordinated notes) in
senior debt under credit facilities in the event the Company is required
to pay down senior debt with the proceeds of asset sales;
- - require that debt permitted to be incurred under a fixed charge coverage
ratio test set forth in the Indenture must rank on parity with or be
subordinated in right of payment to the senior subordinated notes and any
liens granted to secure any such parity debt shall rank pari passu with
the liens securing the senior subordinated notes;
- - require proceeds of asset sales to be used to reduce senior debt under
credit facilities to $40 million;
- - provide that the liens on assets that secure obligations under the senior
subordinated notes will continue if all senior debt is repaid, but will
resume as junior liens if the Company thereafter incurs any new senior
debt;
- - prohibit the payment in cash in excess of an aggregate of $5 million to
settle pending litigation, excluding payments funded or reimbursed under
insurance policies, until the Company makes the interest payments due on
the senior subordinated notes on April 1, 2005 and October 1, 2005;
- - prohibit the payment of dividends on the Company's common stock and other
restricted payments (as defined in the Indenture) until the interest
payments due on the senior subordinated notes on April 1, 2005 and October
1, 2005 are paid; and
- - temporarily increase the interest rate on the senior subordinated notes by
0.5% per annum (to 12% per annum), commencing to accrue on October 1, 2004
and ending on March 31, 2005.
The completion of the consent solicitation satisfied a condition of an amendment
to the Company's senior credit facilities (described below) that, among other
matters, made available a supplemental term loan under the senior credit
facilities. This supplemental term loan was used in part to make the October 1,
2004 interest payment on the senior subordinated notes, together with default
interest thereon, on October 29, 2004 and to pay a consent fee related to the
consent solicitation of $20 per $1,000 principal amount of the notes. The
interest payment made on October 29, 2004, cured the existing default under the
senior subordinated notes.
On April 23, 2004, aaiPharma entered into $140 million of senior credit
facilities with a syndicate of lenders, Silver Point Finance LLC ("Silver
Point") as collateral agent, and Bank of America, N.A., as administrative agent.
These senior credit facilities consisted of a two-year, $125 million senior
secured term loan facility (which was fully drawn at closing) and a two-year,
$15 million senior secured revolving credit facility, of which the entire amount
was available for borrowing at closing. The outstanding loans under the
Company's senior credit facilities were payable in full on the two-year
anniversary date of the closing of the facilities. The Company's senior credit
facilities are secured by a security interest on substantially all domestic
assets, all of the stock of domestic subsidiaries and 65% of the stock of
material foreign subsidiaries. As part of this transaction, the Company recorded
a $6.2 million loss for the early extinguishment of debt related to the
write-off of financing fees related to its previous senior credit facility.
Subject to exceptions set forth in the definitive documentation, loans under the
Company's senior credit facilities are also required to be prepaid with a
negotiated percentage of:
- - excess cash flow, as defined;
18
- - non-ordinary course assets sales;
- - net proceeds from the sale of subordinated indebtedness;
- - net proceeds from equity issuances; and
- - extraordinary receipts, as defined.
Optional reductions in revolving credit commitments and optional prepayments of
term loans were initially subject to a prepayment fee equal to 3% for the first
nine months of the term of the facilities, 1.5% for the subsequent nine months
of such term, and 0.75% for the next three months of such term (with no
prepayment penalty payable for the last three months of the term). Outstanding
loans under the facilities bore interest at a rate per annum equal to a defined
LIBOR rate (with a floor of 2%), plus 6.25%, or a defined reference rate (with a
floor of 4%), plus 5.25%, in each case payable monthly in arrears. An additional
1% per annum unused line fee is payable on unused revolving credit commitments,
payable quarterly in arrears.
The proceeds of the loans were used, together with the net cash proceeds from
the sale of the M.V.I. and Aquasol product lines, to (i) fund payment of
termination obligations with respect to the Company's interest rate hedging
agreement (discussed above), (ii) refinance the Company's then-existing senior
credit facility, (iii) fund the April 2004 interest payment due on the Company's
senior subordinated notes due 2010, (iv) provide for ongoing working capital and
general corporate needs, and (v) pay for fees, costs and expenses in connection
with the new senior credit facilities and other corporate transactions.
On August 9, 2004 and August 13, 2004, the Company entered into an amendment to
its senior secured credit facility to, among other things, increase the amount
of the term loans by up to $10 million, extend the maturity date of the
facilities by one year to April 21, 2007, increase the interest rate on the
loans by an additional 1.5% subject to potential incremental reduction based on
the Company's financial performance, adjust certain covenants under the
facilities and waive certain defaults and events of default. Under the amended
credit facility, the Company borrowed an additional $10 million in term loans on
August 13, 2004. The amendment adjusted both the percentages of proceeds of
certain transactions that are required to be applied to prepay the loans and the
fees to be paid upon optional reductions of the credit facility. As amended,
optional reductions in revolving credit commitments and optional prepayments of
term loans, as well as mandatory reductions in revolving credit commitments and
mandatory prepayments of term loans from the net cash proceeds of asset sales,
subject to defined exceptions, are subject to a prepayment fee equal to 3.5%
until August 9, 2005, 2.5% for the subsequent 12 months, and 1.5% for the next 6
months (with no prepayment penalty payable for the remainder of the term).
Effective as of October 8, 2004, the Company amended its senior secured credit
facility to, among other things, adjust financial covenants. The senior secured
lenders also waived compliance with certain financial covenants in the senior
secured credit facility for the quarter ended September 30, 2004 and the quarter
ending December 31, 2004 provided that the Company meets minimum consolidated
EBITDA thresholds (as defined in the senior secured credit facility). The
amendment also added a minimum gross revenue requirement of $40 million for the
quarter ending December 31, 2004 and consented to certain asset disposition
transactions and receipt of a deferred purchase price payment pursuant to which
the Company received approximately $4.2 million in the aggregate. These
transactions related to the sale of the Company's investment in Aesgen (see Note
7) and its M.V.I. and Aquasol product lines (see Note 3), respectively. The
amendment also waived any requirement to prepay the senior secured loans with
the net proceeds of these transactions.
On October 22, 2004, the Company entered into another amendment to its senior
secured credit facility that increased the existing term loan facility under the
senior secured credit facility by $30 million, subject to certain specified
conditions which were satisfied on October 29, 2004. The Supplemental Term Loan
was made available in up to three draws to be made on or prior to January 15,
2005, and the Company borrowed $20
19
million of such term loans on October 29, 2004. Following effectiveness of the
amendment, the senior secured credit facility consisted of a term loan of up to
$165 million and a revolving credit facility of up to $15 million.
The amendment also modified the interest rate on the entire senior secured
credit facility, including the Supplemental Term Loan, to equal a defined LIBOR
rate (with a floor of 2%) plus 8.25% per annum or a defined reference rate (with
a floor of 4%) plus 7.25% per annum. The amendment also provided for a
commitment fee equal to 0.75% per annum on any undrawn portion of the
Supplemental Term Loan, payable monthly in arrears.
The amendment retained the April 21, 2007 maturity date of the senior secured
credit facility and the optional and mandatory prepayment requirements and
premiums described above.
The proceeds of the loans under the Supplemental Term Loan were and may be used
(i) to fund payment of the October 1, 2004 interest payment due on the Company's
senior subordinated notes, (ii) to pay for fees, costs and expenses in
connection with the amendment and the October 2004 consent solicitation for the
Company's senior subordinated notes, and (iii) for working capital and other
general corporate purposes.
The amendment retained substantially the same representations, warranties and
affirmative and negative covenants as are provided in the existing senior
secured credit facility, including limitations on liens, indebtedness,
fundamental transactions, dispositions of assets, changes in the nature of the
Company's business, investments, acquisitions, capital and operating leases,
capital expenditures, dividends, redemptions or other acquisitions of capital
stock, redemptions or prepayments of other debt, transactions with affiliates,
issuances of capital stock, modifications of indebtedness, organizational
documents and other agreements, and retention of excess cash. The amendment also
added a covenant requiring the Company to retain Rothschild Inc. or another
financial advisor to assist with its exploration of the potential sale of some
or all of the assets comprising the Company's Pharmaceuticals Division.
The amendment also maintained the existing financial covenants under the senior
secured credit facilities, including a minimum fixed charge coverage ratio and a
maximum total debt to trailing twelve-month EBITDA leverage ratio, but
eliminated a minimum gross revenue covenant for the quarter ending December 31,
2004. Compliance with the fixed charge coverage ratio and the leverage ratio was
also waived through the first quarter of 2005 so long as defined minimum EBITDA
thresholds are satisfied. In addition, the amendment retained a covenant
requiring certain levels of cash or revolver availability and increased the
level of cash or revolver availability required for the period from March 31,
2005 through May 15, 2005 to $15.0 million. The amendment added a covenant
requiring the Company to retain Rothschild Inc. or another financial advisor to
assist with its exploration of the potential sale of some or all of the assets
of the Company's pharmaceutical division.
The amendment also substantially retained the existing events of default under
the senior secured credit facility, including, among others, nonpayment of
principal, interest or fees, violations of covenants, inaccuracy of
representations and warranties, a cross-default to the Company's senior
subordinated notes and other material indebtedness, bankruptcy events, and a
change in control and added an event of default if the Company fails to pursue
in good faith the exploration of the potential sale of some or all of the assets
comprising its Pharmaceutical Division or other non-core assets.
As of September 30, 2004, scheduled maturities of long-term debt for the years
ending December 31, 2004 through 2010 were as follows (in thousands):
20
2004 $ -
2005 -
2006 -
2007 147,500
2008 -
2009 -
2010 175,000
---------
Total $ 322,500
=========
11. RESTRUCTURING CHARGES
In June 2004, the Company announced and implemented a work force reduction
intended to rationalize its expense base in relation to its revenue. The Company
recorded a $3.4 million expense in the three months ended June 30, 2004,
representing severance costs and related employee-benefit expenses for those
affected by the reduction. In September 2004, the Company announced and
implemented a supplemental restructuring plan, which included an additional work
force reduction, separation payments to the former chief executive officer and a
facility closure plan. The Company recorded a $13.7 million expense in the three
months ended September 30, 2004, primarily representing severance costs and
related employee-benefit related expenses and costs for leased facilities and
aircraft which are no longer in use. The facilities included the Company's New
Jersey lab facility, along with smaller facilities in North Carolina and
California. These charges have been allocated to the related segments; $7.5
million to the development services business (including $6.1 million for the New
Jersey lab facility), $5.4 million to corporate operations, $0.4 million to
research and development and $0.4 million to the product sales business. The
liabilities are included in other current liabilities on the Company's
consolidated balance sheet.
The following table represents the components of the restructuring reserve (in
thousands):
June 30, Plus Less Sept. 30,
2004 Additional Payments/ 2004
Balance Charges Write-downs Balance
-------- ---------- ----------- ---------
Lease costs, net of estimated sub-lease income $ - $ 9,819 $ (314) $ 9,505
Severance costs 3,400 3,331 (1,563) 5,168
Other costs - 569 (569) -
-------- --------- ----------- ---------
Total $ 3,400 $ 13,719 $ (2,446) $ 14,673
======== ========= =========== =========
The Company is currently seeking to sub-lease all or a portion of these
facilities. In accordance with Statement of Financial Accounting Standard No.
146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS
146"), the Company recorded facility closure costs at estimated fair value, net
of estimated sub-lease income.
12. INTANGIBLE ASSET IMPAIRMENT
As a result of the introduction of generic competition for our Brethine product,
which resulted in a significant decrease in projected product sales during the
third quarter of 2004, the Company performed a discounted cash flow analysis of
the carrying value of the intangible assets associated with the product line.
The Company determined that the intangible assets were impaired and recorded an
impairment charge of $5.3 million.
21
13. COMMITMENTS AND CONTINGENCIES
The Company may have to make contingent payments of $4.7 million over three
years in connection with the purchase of its Charleston, South Carolina
manufacturing facility, based on the level of manufacturing revenues at this
facility. At September 30, 2004, these contingent payment obligations are not
liabilities and have not been recorded on the Company's consolidated balance
sheet.
The Company made interest payments on the senior subordinated notes of $9.7
million in April 2004, and $10.2 million in October 2004 (see notes 2 and 10 for
additional information on this payment) and payments of $10.5 million and $10.1
million will be due on April 1 and October 1, 2005, respectively.
For additional information about other contingencies to which the Company is
subject, including litigation and governmental investigations, see Part II, Item
1, "Legal Proceedings," below, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital
Resources-Commitments and Contingencies" in the Company's 2003 Form 10-K.
14. FINANCIAL INFORMATION FOR SUBSIDIARY GUARANTORS AND NON-GUARANTORS
The Company's senior subordinated notes, due April 1, 2010, are guaranteed by
certain of the Company's subsidiaries.
The following presents condensed consolidating financial information for the
Company, segregating: (1) aaiPharma Inc., which issued the notes (the "Issuer");
(2) the domestic subsidiaries, which guarantee the notes (the "Guarantor
Subsidiaries"); and (3) all other subsidiaries (the "Non-Guarantor
Subsidiaries"). The Guarantor Subsidiaries are wholly-owned direct subsidiaries
of the Company and their guarantees are full, unconditional and joint and
several. Wholly-owned subsidiaries are presented on the equity basis of
accounting. Certain reclassifications have been made to conform all of the
financial information to the financial presentation on a consolidated basis. The
principal adjusting entries eliminate investments in subsidiaries and
inter-company balances and transactions.
The following information presents consolidating statements of operations,
balance sheets and cash flows for the periods and as of the dates indicated:
22
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF OPERATIONS
(IN THOUSANDS)
Three Months Ended September 30, 2004
------------------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------- ------------ ------------
Net revenues $ 11,094 $ 26,367 $ 5,929 $ (171) $ 43,219
Equity earnings from subsidiaries (10,643) - - 10,643 -
--------- ---------- ------- ---------- ------------
Total revenues 451 26,367 5,929 10,472 43,219
--------- ---------- ------- ---------- ------------
Operating costs and expenses:
Direct costs 6,240 13,441 3,595 (123) 23,153
Selling 1,563 3,924 534 - 6,021
General and administrative 6,505 1,815 1,159 - 9,479
Research and development (1) 3,135 - - 3,134
Depreciation 1,541 522 304 - 2,367
Professional fees - internal inquiry - 769 - - 769
M.V.I. Contingent payment/(gain on
sale) - (1,567) - - (1,567)
Restructuring charges - 13,719 - - 13,719
Royalty expense - 357 - - 357
Intangible asset impairment - 5,250 - - 5,250
--------- ---------- ------- ---------- ------------
15,848 41,365 5,592 (123) 62,682
--------- ---------- ------- ---------- ------------
(Loss) income from operations (15,397) (14,998) 337 10,595 (19,463)
Other income (expense):
Interest, net (192) (9,355) 78 - (9,469)
Net intercompany interest (513) 593 (80) - -
Other expense, net (13,253) 13,067 (89) - (275)
--------- ---------- ------- ---------- ------------
(13,958) 4,305 (91) - (9,744)
--------- ---------- ------- ---------- ------------
(Loss) income before income taxes (29,355) (10,693) 246 10,595 (29,207)
Provision for income taxes 4,435 147 1 - 4,583
--------- ---------- ------- ---------- ------------
Net (loss) income $ (33,790) $ (10,840) $ 245 $ 10,595 $ (33,790)
========= ========== ======= ========== ============
23
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF OPERATIONS
(IN THOUSANDS)
Three Months Ended September 30, 2003
---------------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
---------- ------------ ------------- ------------ ------------
Net revenues $ 11,134 $ 23,649 $ 5,465 $ (548) $ 39,700
Equity earnings from subsidiaries (9,598) - - 9,598 -
---------- ---------- ---------- ---------- ----------
Total revenues 1,536 23,649 5,465 9,050 39,700
Operating costs and expenses:
Direct costs 6,478 14,255 3,294 (458) 23,569
Selling 1,557 7,039 475 - 9,071
General and administrative 6,870 1,939 984 - 9,793
Research and development - 5,367 - - 5,367
Depreciation 1,321 310 281 - 1,912
Royalty expense - 325 - - 325
---------- ---------- ---------- ---------- ----------
16,226 29,235 5,034 (458) 50,037
---------- ---------- ---------- ---------- ----------
(Loss) income from operations (14,690) (5,586) 431 9,508 (10,337)
Other income (expense):
Interest, net (395) (4,874) 129 - (5,140)
Net intercompany interest (497) 538 (41) - -
Other income (expense), net (15) 19 (126) - (122)
---------- ---------- ---------- ---------- ----------
(907) (4,317) (38) - (5,262)
---------- ---------- ---------- ---------- ----------
(Loss) income before income taxes (15,597) (9,903) 393 9,508 (15,599)
Benefit from income taxes (6,205) (1) (1) - (6,207)
---------- ---------- ---------- ---------- ----------
Net (loss) income $ (9,392) $ (9,902) $ 394 $ 9,508 $ (9,392)
========== ========== ========== ========== ==========
24
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF OPERATIONS
(IN THOUSANDS)
Nine Months Ended September 30, 2004
----------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------- ------------ ------------
Net revenues $ 35,152 $ 95,812 $ 19,315 $ (1,330) $ 148,949
Equity earnings from subsidiaries
(23,016) - - 23,016 -
--------- --------- -------- --------- ---------
Total revenues 12,136 95,812 19,315 21,686 148,949
--------- --------- -------- --------- ---------
Operating costs and expenses:
Direct costs (excluding depreciation) 21,953 45,043 11,573 (827) 77,742
Selling 5,098 23,226 1,798 - 30,122
General and administrative 32,582 (548) 3,285 - 35,319
Research and development 5 13,842 - - 13,847
Depreciation 4,165 1,349 890 - 6,404
Professional fees - internal inquiry - 9,072 - - 9,072
M.V.I. Contingent payment/(gain on sale) - (8,112) - - (8,112)
Restructuring charges - 17,119 - - 17,119
Royalty expense - 1,366 - - 1,366
Intangible asset impairment - 5,250 - - 5,250
--------- --------- -------- --------- ---------
63,803 107,607 17,546 (827) 188,129
--------- --------- -------- --------- ---------
(Loss) income from operations (51,667) (11,795) 1,769 22,513 (39,180)
Other expense:
Interest, net (209) (23,838) 181 - (23,866)
Net intercompany interest (1,470) 1,657 (187) - -
Other (expense) income, net (18,327) 10,259 (272) - (8,340)
--------- --------- -------- --------- ---------
(20,006) (11,922) (278) - (32,206)
--------- --------- -------- --------- ---------
(Loss) income before income taxes (71,673) (23,717) 1,491 22,513 (71,386)
Provision for (benefit from) income taxes 4,471 288 (1) - 4,758
--------- --------- -------- --------- ---------
Net (loss) income $ (76,144) $ (24,005) $ 1,492 $ 22,513 $ (76,144)
========= ========= ======== ========= =========
25
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF OPERATIONS
(IN THOUSANDS)
Nine Months Ended September 30, 2003
-------------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
-------- ------------ ------------- ------------ ------------
Net revenues $ 33,395 $ 107,059 $ 16,615 $ (2,286) $ 154,783
Equity earnings from subsidiaries 6,353 - - (6,353) -
-------- ------------ ------------- ------------ ------------
Total revenues 39,748 107,059 16,615 (8,639) 154,783
-------- ------------ ------------- ------------ ------------
Operating costs and expenses:
Direct costs (excluding depreciation) 19,527 47,675 9,886 (1,881) 75,207
Selling 4,503 18,907 1,596 - 25,006
General and administrative 22,681 5,445 2,986 - 31,112
Research and development - 15,441 - - 15,441
Depreciation 4,022 895 830 - 5,747
Royalty expense - 452 - - 452
-------- ------------ ------------- ------------ ------------
50,733 88,815 15,298 (1,881) 152,965
-------- ------------ ------------- ------------ ------------
(Loss) income from operations (10,985) 18,244 1,317 (6,758) 1,818
Other expense:
Interest, net (1,439) (14,314) 132 - (15,621)
Net intercompany interest (1,533) 1,661 (128) - -
Other income (expense), net 145 34 (158) - 21
-------- ------------ ------------- ------------ ------------
(2,827) (12,619) (154) - (15,600)
-------- ------------ ------------- ------------ ------------
(Loss) income before income taxes (13,812) 5,625 1,163 (6,758) (13,782)
(Benefit from) provision for income taxes (5,444) 31 (1) - (5,414)
-------- ------------ ------------- ------------ ------------
Net (loss) income $ (8,368) $ 5,594 $ 1,164 $ (6,758) $ (8,368)
======== ============ ============= ============ ============
26
AAIPHARMA INC.
CONSOLIDATING BALANCE SHEET
(IN THOUSANDS)
September 30, 2004
--------------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 6,323 $ 305 $ 515 $ - $ 7,143
Accounts receivable, net 11,904 (8,424) 3,319 - 6,799
Work-in-progress 2,617 5,137 8,571 (5,046) 11,279
Inventories 4,905 7,412 1,192 - 13,509
Deferred tax assets 10,456 - - - 10,456
Prepaid and other current assets 2,818 7,293 224 - 10,335
--------- --------- -------- -------- --------
Total current assets 39,023 11,723 13,821 (5,046) 59,521
Investments in and advances to subsidiaries 66,099 (46,240) - (19,859) -
Property and equipment, net 37,681 14,240 4,205 - 56,126
Goodwill, net 726 1,229 11,199 - 13,154
Intangibles, net 1,294 281,549 - - 282,843
Other assets 232 13,880 113 - 14,225
--------- --------- -------- -------- --------
Total assets $ 145,055 $ 276,381 $ 29,338 $(24,905) $425,869
========= ========= ======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ - $ - $ - $ - $ -
Accounts payable 6,495 14,069 951 - 21,515
Customer advances 4,048 7,161 5,936 (3,370) 13,775
Accrued wages and benefits 3,344 1,578 1,918 - 6,840
Interest payable 93 10,178 - - 10,271
Deferred product revenue - 10,632 - - 10,632
Other accrued liabilities 17,833 21,079 (408) (980) 37,524
--------- --------- -------- -------- --------
Total current liabilities 31,813 64,697 8,397 (4,350) 100,557
Long-term debt, less current portion 12,500 311,200 - - 323,700
Deferred tax liability - - - - -
Other liabilities 18 - - - 18
Investments in and advances to subsidiaries 152,430 (157,044) 3,995 619 -
Total stockholders' equity (51,706) 57,528 16,946 (21,174) 1,594
--------- --------- -------- -------- --------
Total liabilities and stockholders' equity $ 145,055 $ 276,381 $ 29,338 $(24,905) $425,869
========= ========= ======== ======== ========
27
AAIPHARMA INC.
CONSOLIDATING BALANCE SHEET
(IN THOUSANDS)
December 31, 2003
--------------------------------------------------------------------------
Guarantor Non-Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 8,161 $ 192 $ 432 $ - $ 8,785
Accounts receivable, net 11,242 16,785 4,587 - 32,614
Work-in-progress 3,688 5,337 7,793 (4,315) 12,503
Inventories 4,588 8,909 1,196 - 14,693
Deferred tax assets 19,184 - - - 19,184
Prepaid and other current assets 1,872 8,304 222 - 10,398
--------- --------- --------- --------- ---------
Total current assets 48,735 39,527 14,230 (4,315) 98,177
Investments in and advances to subsidiaries 66,061 (46,202) - (19,859) -
Property and equipment, net 39,011 13,954 4,271 - 57,236
Goodwill, net 725 1,229 11,407 - 13,361
Intangibles, net 1,209 350,106 - - 351,315
Other assets 2,419 11,974 115 - 14,508
--------- --------- --------- --------- ---------
Total assets $ 158,160 $ 370,588 $ 30,023 $ (24,174) $ 534,597
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ - $ 4,000 $ - $ - $ 4,000
Accounts payable 5,082 14,292 2,505 - 21,879
Customer advances 6,441 8,101 4,807 (1,719) 17,630
Accrued wages and benefits 2,575 1,517 1,228 - 5,320
Interest payable 7 5,504 - - 5,511
Deferred product revenue - 45,664 - - 45,664
Other accrued liabilities 8,640 4,332 (448) (1,391) 11,133
--------- --------- --------- --------- ---------
Total current liabilities 22,745 83,410 8,092 (3,110) 111,137
Long-term debt, less current portion 8,000 330,844 - - 338,844
Deferred tax liability 2,246 - - - 2,246
Other liabilities 196 7,451 - - 7,647
Investments in and advances to subsidiaries 127,232 (133,051) 6,212 (393) -
Total stockholders' equity (2,259) 81,934 15,719 (20,671) 74,723
--------- --------- --------- --------- ---------
Total liabilities and stockholders' equity $ 158,160 $ 370,588 $ 30,023 $ (24,174) $ 534,597
========= ========= ========= ========= =========
28
]
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF CASH FLOWS
(IN THOUSANDS)
Nine Months Ended September 30, 2004
------------------------------------------------------------------
Non-
Guarantor Guarantor
Issuer Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------ ------------ ------------
Cash flows from operating activities:
Net (loss) income $ (76,144) $ (24,005) $ 1,492 $ 22,513 $ (76,144)
Adjustments to reconcile net (loss) income
to net cash (used in) provided by operating activities:
Depreciation and amortization 3,917 13,513 890 - 18,320
Intangible asset impairment, net of tax - 5,250 - - 5,250
Write-off of deferred financing and other costs - 6,229 - - 6,229
Net gain from asset sale - (39,113) - - (39,113)
Other 7 12 218 - 237
Changes in operating assets and liabilities:
Accounts receivable, net (662) 25,209 1,184 - 25,731
Work-in-progress 1,071 200 (920) 732 1,083
Inventories (317) (1,490) (17) - (1,824)
Deferred tax assets 8,728 - - - 8,728
Prepaid and other assets 1,242 (7,125) (6) - (5,889)
Accounts payable 1,412 (222) (1,508) - (318)
Customer advances (2,392) (940) 1,215 (1,651) (3,768)
Interest payable 86 4,674 - - 4,760
Deferred product revenue - (35,032) - - (35,032)
Accrued wages & benefits & other accrued liabilities 7,540 17,257 859 411 26,067
Intercompany receivables and payables 48,215 (23,993) (2,217) (22,005) -
--------- --------- --------- --------- ---------
Net cash (used in) provided by operating activities (7,297) (59,576) 1,190 - (65,683)
--------- --------- --------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment (2,491) (1,886) (1,098) - (5,475)
Proceeds from sales of property and equipment 9 88 - - 97
Product line disposals (acquisitions) - 92,944 - - 92,944
Other (237) 38 - - (199)
--------- --------- --------- --------- ---------
Net cash (used in) provided by investing activities (2,719) 91,184 (1,098) - 87,367
--------- --------- --------- --------- ---------
Cash flows from financing activities:
Proceeds from long-term borrowings 12,500 135,000 - - 147,500
Payments on long-term borrowings (8,000) (156,000) - - (164,000)
Proceeds from interest rate swaps, net - (10,203) - - (10,203)
Proceeds from stock option exercises 3,678 - - - 3,678
Other - (292) - - (292)
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing activities 8,178 (31,495) - - (23,317)
--------- --------- --------- --------- ---------
Net (decrease) increase in cash and cash equivalents (1,838) 113 92 - (1,633)
Effect of exchange rate changes on cash - - (9) - (9)
Cash and cash equivalents, beginning of period 8,161 192 432 - 8,785
--------- --------- --------- --------- ---------
Cash and cash equivalents, end of period $ 6,323 $ 305 $ 515 $ - $ 7,143
========= ========= ========= ========= =========
29
AAIPHARMA INC.
CONSOLIDATING STATEMENT OF CASH FLOWS