APPLIED ANALYTICAL INDUSTRIES INC, POS AM, 1997-04-02

APPLIED ANALYTICAL INDUSTRIES INC
POS AM, 1997-04-02
MEDICAL LABORATORIES

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 2, 1997

REGISTRATION NO. 333-5535
================================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

---------------

POST-EFFECTIVE AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

---------------

APPLIED ANALYTICAL INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)

<TABLE>
<S> <C> <C>
DELAWARE 8731 04-2687849
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification Number)
</TABLE>

5051 NEW CENTRE DRIVE
WILMINGTON, NORTH CAROLINA 28403
TEL: (910) 392-1606
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)

---------------

R. FORREST WALDON
VICE PRESIDENT AND GENERAL COUNSEL
APPLIED ANALYTICAL INDUSTRIES, INC.
5051 NEW CENTRE DRIVE
WILMINGTON, NORTH CAROLINA 28403
TEL: (910) 392-1606
(Name, address, including zip code, and telephone number,
including area code, of agent for service)

---------------

COPIES TO:

STEPHEN M. LYNCH JEAN E. HANSON
JOHN M. HERRING FRIED, FRANK, HARRIS, SHRIVER & JACOBSON
ROBINSON, BRADSHAW & HINSON, P.A. One New York Plaza
1900 Independence Center New York, New York 10004
Charlotte, North Carolina 28246 Tel: (212) 859-8000
Tel: (704) 377-2536

<PAGE> 2

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As
soon as practicable after the Registration Statement becomes effective.
If any of the securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, check the following box: [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering: [ ]
If this Form is a post-effective amendment filed pursuant to Rule
462(e) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering: [ ]
If delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box: [ ]

---------------

CALCULATION OF REGISTRATION FEE

================================================================================
Proposed Maximum Amount of
Title of Each Class of Aggregate Registration
Securities to be Registered Offering Price(1)(2) Fee
- --------------------------------------------------------------------------------
Common Stock, $.001 par value.......... $43,470,000 $14,990(3)
================================================================================

(1) Includes (i) $43,470,000 aggregate offering price of shares of Common
Stock initially offered for sale in the initial public offering of the
Common Stock (including shares of Common Stock purchased to cover
overallotments in connection with such offering) which was completed on
September 25, 1996. An indeterminate number of shares of Common Stock
were registered for resale by a dealer in connection with market-making
transactions. See "Explanatory Note".

(2) Estimated pursuant to Rule 457(o) under the Securities Act of 1933
solely for the purpose of calculating the registration fee.
(3) Such amount was paid in connection with the initial filing on June 7,
1996.

---------------

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE
OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.

================================================================================

<PAGE> 3

EXPLANATORY NOTE

This Registration Statement covered the registration of $43,470,000
maximum aggregate offering price of shares of Common Stock, $.001 par value per
share, of Applied Analytical Industries, Inc. (the "Company") for sale in the
initial public offering of the Company's Common Stock which was completed on
September 25, 1996. This Registration Statement also covers the registration of
an indeterminate number of shares of Common Stock, $.001 par value per share,
for resale by Goldman, Sachs & Co., in connection with market-making
transactions. When initially effective, this Registration Statement included a
complete Prospectus relating to the initial public offering (the "IPO
Prospectus") and certain pages of the Prospectus relating solely to such
market-making transactions (together with the applicable portions of the
Prospectus, the "Market-making Prospectus"), including alternate front and back
cover pages and a section entitled "Plan of Distribution". This Post-effective
Amendment No. 2 (this "Amendment") is being filed to update the Market-making
Prospectus and delete portions of the IPO Prospectus relevant only to the
initial public offering.

<PAGE> 4

[AAI LOGO]

APPLIED ANALYTICAL INDUSTRIES, INC.

COMMON STOCK
(PAR VALUE $0.001 PER SHARE)

SEE "RISK FACTORS" BEGINNING ON PAGE 5 FOR CERTAIN CONSIDERATIONS
RELEVANT TO AN INVESTMENT IN THE COMMON STOCK.

The Common Stock is quoted on the Nasdaq National Market under the
symbol "AAII".

----------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION
OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.

----------

This Prospectus has been prepared for and is to be used by Goldman,
Sachs & Co. in connection with offers and sales of the shares of Common Stock
related to market-making transactions, at prevailing market prices, related
prices or negotiated prices. The Company will not receive any of the proceeds of
such sales. Goldman, Sachs & Co. may act as a principal or agent in such
transactions. The closing of the Offering referred to herein, which constituted
the initial public offering of the shares of Common Stock of the Company,
occurred on September 25, 1996. See "Plan of Distribution".

GOLDMAN, SACHS & CO.

----------

The date of this Prospectus is April 2, 1997

<PAGE> 5

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and consolidated financial statements and notes thereto appearing
elsewhere in this Prospectus. Unless otherwise indicated, all share and per
share data in this Prospectus have been adjusted to reflect (i) the conversion
of all outstanding shares of the Company's Series A Preferred Stock (the
"Preferred Stock") and Class B Non-voting Common Stock (the "Class B Common
Stock") into shares of the Company's Common Stock, $.001 par value per share
(the "Common Stock"), which occurred upon the completion of the initial public
offering of the Common Stock on September 25, 1996 (the "Offering"), (ii) a
200-for-one split of the Common Stock and Class B Common Stock effective May 31,
1996 and (iii) a one-for-.6325 reverse split of the Common Stock and Class B
Common Stock effective June 7, 1996.

THE COMPANY

Applied Analytical Industries, Inc. ("AAI" or the "Company") is a
leading provider of product development and support services to the worldwide
pharmaceutical and biotechnology industries, offering a broad range of
integrated, value-added services that span the drug life cycle, from new
compound characterization and synthesis to marketed-product compliance and
quality control testing. In addition, through its internal development program,
the Company leverages its expertise to generate additional revenue by licensing
internally developed drugs and drug technologies to third parties. AAI has
contributed to the submission, approval or continued marketing of client
products worldwide. As part of its internal development program, the Company has
licensed products to clients, including several products approved by the United
States Food and Drug Administration (the "FDA"), and has patented certain drug
technologies.

The Company competes in the contract research and development industry
(commonly referred to as the contract research organization, or CRO, industry)
which provides independent product development and marketed-product support
services to the drug industry. These research and development services include
compound synthesis/extraction, screening and pharmacological testing,
toxicology/safety testing, formulation development, laboratory testing, clinical
trial management, regulatory and compliance and quality control testing. The
Company provides a broad range of integrated, value-added services, including
chemical analysis, synthesis and other laboratory services; drug formulation
development; clinical trial services; clinical supply and niche manufacturing;
and regulatory and compliance consulting.

In addition to its core fee-for-service business, AAI leverages its
expertise by allocating a significant proportion of its technical resources and
operating capacity to internal drug and drug technology development, in which
the Company shares in the expense of development and participates in the
benefits of any potential commercial success through licensing arrangements.
Internal drug development is focused primarily on generic products. Certain of
these products have been licensed or sold. Licensing arrangements for these
products vary as to amounts of initial and milestone payments, as well as
methods and extent of revenue participation. The Company's proprietary
technology includes patents and pending patent applications on formulations and
methods, including liquid formulations for improved delivery of nonsteroidal
anti-inflammatory drugs or NSAIDs, such as ibuprofen, and chewable formulations
to mask the otherwise bitter taste of certain ulcer drugs. The Company licenses
certain of its proprietary technologies.

Since 1993, the Company has allocated a growing proportion of its
technical resources and operating capacity to its internal drug and technology
development program and because of the significant time required for development
and approval of pharmaceutical products, the Company has only recently begun to
recognize license revenue from its internal development efforts. In 1994, as
part of its internal development program, the Company organized Endeavor
Pharmaceuticals Inc. ("Endeavor") to develop certain generic hormone
pharmaceutical products, focusing initially on several such products then under
development by AAI. The Company owns approximately 40% of the fully diluted
common equity of Endeavor.

On December 31, 1996, the Company acquired L.A.B. Gesellschaft fur
pharmakologische Untersuchungen mbH & Co. ("L.A.B.") for an aggregate cost of
approximately $20.9 million. L.A.B. is a European contract research and
development organization headquartered in Neu-Ulm, Germany with principal
operating units in Neu-Ulm and Munich, Germany; and in Paris, France, as well as
smaller operating units in Stuttgart, Germany; London, England; Arnheim,

<PAGE> 6

Netherlands and Budapest, Hungary. L.A.B. also operates in China through a joint
venture. L.A.B. employs approximately 250 scientists, technicians and support
personnel, 40 or more with Ph.D. or M.D. degrees, or their U.S. equivalent.
L.A.B. focuses on both clinical and non-clinical pharmaceutical product
development and provides services that include drug formulation development;
chemical analysis; Phase I clinical trial studies; bioanalytical testing; and
European regulatory consulting. L.A.B. also provides controlled Phase II-A
clinical trial studies and multi-center clinical trials focused in niche
therapeutic areas including hepatic disease, chemotherapeutics, and hormone
replacement therapy. In connection with the acquisition of L.A.B., the Company
recognized an unusual item representing the write-off of certain in-process
research and development costs with an appraised value of approximately $6.6
million as of December 31, 1996.

The Company's principal executive offices are located in Wilmington,
North Carolina. In addition to its L.A.B. facilities, the Company maintains
operating facilities in Wilmington and Research Triangle Park, North Carolina
and sales offices in Raleigh, North Carolina; Chicago, Illinois; Boston,
Massachusetts; San Diego and San Francisco, California; Elmwood Park, New
Jersey; San Juan, Puerto Rico; Copenhagen, Denmark; London, England; Milan,
Italy; and Tokyo, Japan.

SUMMARY FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
1996 1995 1994 1993 1992
-------- ------- -------- ------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Net sales .................................. $ 42,162 $34,639 $ 32,882 $26,378 $21,846
Cost of sales .............................. 17,621 14,259 14,533 9,731 8,989
Selling expense ............................ 6,357 4,913 4,390 3,654 2,871
General and administrative expense ......... 8,908 8,171 8,485 8,738 7,329
Research and development expense ........... 4,216 3,326 2,394 1,273 207
Unusual item (a) ........................... 6,600
Other (income) expense, net ................ (494) 1,130 440 156 199
-------- ------- -------- ------- -------
Income (loss) before income taxes .......... (1,046) 2,840 2,640 2,826 2,251
Provision for income taxes ................. 2,102 39 -- -- --
Equity income (loss)(b) .................... -- 444 (444) -- --
-------- ------- -------- ------- -------
Net income (loss) .......................... $ (3,148) $ 3,245 $ 2,196 $ 2,826 $ 2,251
======== ======= ======== ======= =======
PRO FORMA DATA(UNAUDITED):
Pro forma earnings (loss) per share ........ $ (0.23)
Pro forma weighted average shares .......... 13,440
Pro forma income taxes(c) .................. $ 1,129 $ 1,118 $ 1,125 $ 878
Pro forma net income(c) .................... 2,116 1,078 1,701 1,373
Pro forma earnings per common share(c) ..... $ 0.18
</TABLE>

<TABLE>
<CAPTION>
As of
December 31, 1996
-----------------

<S> <C>
BALANCE SHEET DATA:
Working capital........................................................ $35,755
Property and equipment, net............................................ 19,216
Total assets........................................................... 104,478
Long-term debt, less current maturities................................ 6,671
Total stockholders' equity............................................. 63,995
</TABLE>

<PAGE> 7

YEAR ENDED DECEMBER 31,
------------------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
ADDITIONAL DATA:
Income before research and
development expense(d) . $9,770 $6,166 $5,034 $4,099 $2,458
</TABLE>
- -----------------

(b) Relates to equity accounting for the Company's investment in Endeavor.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Overview" and Note 6 of Notes to Consolidated
Financial Statements.

(c) Prior to November 17, 1995, the Company was treated as an S corporation
for federal and state income tax purposes. The pro forma data sets forth
the pro forma income taxes, pro forma net income and pro forma earnings
per common share of the Company as if the Company had been subject to
corporate income taxes as of the beginning of each year presented. The
pro forma earnings per common share data also reflects the capitalization
of the Company on a pro forma basis to give effect to the 200-for-one
split of the Common Stock and Class B Common Stock effected on May 31,
1996 and the one-for-.6325 split of the Common Stock and Class B Common
Stock effected on June 7, 1996 as if such events had occurred on the
first day of the period presented.

(d) Income before research and development expense represents net sales less
the cost of sales, selling expense, general and administrative expense
and other (income) expense, net. While this is not a measure of
performance under generally accepted accounting principles, the Company
has included income before research and development expense data because
such data may be used by certain investors and permit evaluation of the
profitability of the Company's operations throughout the period without
taking account of research and development expense. In 1993, the Company
began allocating a significant portion of its technical resources and
operating capacity to internal development of generic drugs and
proprietary technology. The Company has only recently begun to recognize
license revenue from these internal development efforts due to the
significant time required for development and approval of pharmaceutical
products. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview" and "Business --
Internal Drug and Technology Development".

<PAGE> 8

RISK FACTORS

In addition to the other information contained in this Prospectus, the
following risk factors should be carefully considered in evaluating the Company
and its business before purchasing the Common Stock offered hereby. This
Prospectus, including information incorporated by reference herein, contains
certain "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended (the "Securities Act"), which represent the
Company's expectations or beliefs, including, but not limited to, statements
concerning industry performance, the Company's operations, performance,
financial condition, growth and acquisition strategies, margins and growth in
net sales. For this purpose, any statements contained in this Prospectus that
are not statements of historical fact may be deemed to be forward-looking
statements. These statements by their nature involve substantial risks and
uncertainties, certain of which are beyond the Company's control, and actual
results may differ materially depending on a variety of important factors,
including those described in this "Risk Factors" section.

DEPENDENCE ON AND EFFECT OF GOVERNMENT REGULATION

The design, development, testing, manufacturing and marketing of
pharmaceutical compounds, biotechnology products, medical nutrition and
diagnostic products and medical devices are subject to regulation by
governmental authorities, including the FDA and comparable regulatory
authorities in other countries. The Company's business depends in part on strict
government regulation of the drug development process, especially in the United
States. In the recent past, legislation has been proposed in the U.S. Congress
to substantially modify regulations administered by the FDA governing the drug
approval process. Under such proposed legislation, applications for approval of
drugs could be made to private, accredited facilities in lieu of the FDA, the
number of clinical trials of new drugs would be reduced and other rules
administered by the FDA would be simplified. Any change in the scope of
regulatory requirements or the introduction of simplified drug approval
procedures could adversely affect the Company's business. See "Business
- --Government Regulation".

The drug approval process is generally lengthy, expensive and subject to
unanticipated delays. Currently, the Company is assisting in the development of
a number of products subject to regulatory approval for which it has the right
to receive license fees or otherwise participate in sales revenues, including
through its investment in Endeavor. Continued growth in AAI's revenues and
profits will depend, in part, on the successful introduction of some or all of
such products. There can be no assurance as to when or whether such approvals
from regulatory authorities will be received. In addition, the continued
development and manufacture of generic drug products is dependent upon the
availability of specific FDA-approved bulk drug ingredients, and accordingly the
Company's license revenue from such products depends upon the continued
availability of such ingredients. There can be no assurance that such
FDA-approved ingredients will be available in sufficient quantities. See
"Business -- Internal Drug and Technology Development" and "-- Endeavor".

All facilities and manufacturing techniques used in the manufacture of
products for clinical use or for sale in the United States must be operated in
conformity with current Good Manufacturing Practices ("GMP") regulations, FDA
regulations and guidelines governing the development and production of
pharmaceutical products. The Company's facilities are subject to scheduled
periodic regulatory inspections to ensure compliance with GMP requirements.
Failure on the part of the Company to comply with applicable requirements could
result in the termination of ongoing research or the disqualification of data
for submission to regulatory authorities. A finding that the Company had
materially violated GMP requirements could result in additional regulatory
sanctions and, in severe cases, could result in a mandated closing of the
Company's facilities which would materially and adversely affect the Company.
See "Business -- Industry Overview" and "-- Government Regulation".

MANAGEMENT OF GROWTH AND ACQUISITION RISKS

The Company has experienced rapid growth over the past ten years. The
Company believes that this growth may strain operational, human and financial
resources. In order to manage internal growth, AAI must continue to improve its
operating and administrative systems and to attract and retain qualified
management and professional, scientific and

<PAGE> 9

technical operating personnel. Failure to manage growth effectively could have a
material adverse effect on the Company's business.

The Company recently acquired L.A.B. and reviews acquisition
opportunities in the ordinary course of its business, although there can be no
assurance that the Company will complete any future acquisitions. Acquisitions
involve numerous risks, including difficulties in the assimilation of the
operations and services of the acquired companies, the expenses incurred in
connection with the acquisition and subsequent assimilation of operations and
services, the diversion of management's attention from other business concerns
and the potential loss of key employees of the acquired company. Acquisitions of
non-U.S. companies also may involve the additional risks of, among others,
assimilating differences in local business practices and regulations, overcoming
language barriers and managing currency exchange risk. There can be no assurance
that the Company's acquisitions will be successfully integrated into the
Company's operations. L.A.B. incurred losses before extraordinary items of
approximately DM3.7 million and DM9.2 million for 1995 and 1996 (or $2.6 million
and $6.1 million, applying published average monthly currency exchange rates for
such years), respectively, and had negative working capital of approximately
$17.6 million at the time of the acquisition. The Company anticipates that
L.A.B. will continue to incur losses for a portion of 1997. There can be no
assurance that acquisitions, including L.A.B., will contribute favorably to the
Company's operations and financial condition.

DEPENDENCE ON CERTAIN INDUSTRIES AND CLIENTS

The Company's revenues are highly dependent on research and development
expenditures and production-related compliance testing expenditures by the
pharmaceutical and biotechnology industries. AAI has benefited from the growing
tendency of pharmaceutical and biotechnology companies to engage independent
organizations to conduct development and testing projects. The Company's
business could be materially and adversely affected by a general economic
decline in these industries or by any reduction in the outsourcing of research,
development and testing activities.

The Company believes that concentration of business in its industry is
not uncommon. AAI has experienced such concentration in the past and may
experience such concentration in the future. During 1996, Endeavor (a venture
approximately 40% owned by the Company) and Aesgen, Inc. (an affiliate of the
Company) ("Aesgen") accounted for approximately 15% and 11%, respectively, of
the Company's net sales. There can be no assurance that the Company's business
will not continue to be dependent on certain clients or that annual results
would not be dependent upon performance of a few large projects for specific
clients. In addition, due to the project nature of the Company's business, there
can be no assurance that significant clients in any one period will continue to
be significant clients in other periods. Generally, the Company's
fee-for-service contracts are terminable by the client upon notice of 30 days or
less. Contracts may be terminated for a variety of reasons, including the
client's decision to forego a particular study, failure of products to satisfy
safety requirements and unexpected or undesired product results. The loss of
business from a significant client could have a material adverse effect on the
Company. Aesgen and Endeavor are early-stage development companies and their
revenues are dependent upon product approvals. Neither Aesgen nor Endeavor has
received any product approvals to date, and continued product development by
these firms is dependent upon their obtaining product approvals or additional
capital funding. See "Business -- Endeavor" and "-- Clients".

VARIATION IN QUARTERLY OPERATING RESULTS

The Company's results of operations historically have fluctuated on a
quarterly basis and can be expected to continue to be subject to quarterly
fluctuations. Quarterly results can fluctuate as a result of a number of
factors, including the commencement, completion or cancellation of large
contracts, progress of ongoing contracts, recognition of licensing revenue,
acquisitions, the timing of start-up expenses for new facilities and changes in
the mix of services. The Company believes that quarterly comparisons of its
financial results are not necessarily meaningful and should not be relied upon
as an indication of future performance. In addition, fluctuations in quarterly
results could affect the market price of the Common Stock in a manner unrelated
to the longer term operating performance of the Company.

DEPENDENCE ON KEY PERSONNEL

The Company relies on a number of key executives, including Frederick D.
Sancilio, Ph.D., its President and Chairman of the Board. In addition to his
duties at AAI, Dr. Sancilio serves as a senior management employee of Endeavor,
a company in which AAI owns approximately 40% of the common equity on a fully
diluted basis. Dr. Sancilio

<PAGE> 10

does not maintain an office or have day-to-day responsibilities at Endeavor and
devotes a substantial majority of his time to the management of AAI. The Company
maintains key man life insurance on Dr. Sancilio in the amount of $3.0 million.
The Company's performance depends on its ability to attract and retain qualified
management and professional, scientific and technical operating staff. The loss
of the services of any of AAI's key executives could have a material and adverse
effect on the Company. There also can be no assurance that AAI will be able to
continue to attract and retain qualified staff. See "Business -- Endeavor" and
"-- Employees".

POTENTIAL LIABILITY AND RISKS OF OPERATIONS

AAI develops, formulates, tests and, to a limited extent, manufactures
pharmaceutical products intended for use by the public. Such activities could
expose the Company to risk of liability for personal injury or death to persons
using such products, although the Company does not commercially market or sell
the products. The Company is currently involved in the commercial manufacture of
one pharmaceutical product and may manufacture pharmaceutical products for
third-party commercial distribution on a limited basis or as a service to its
clients transitioning to internal production. Such activities could increase the
Company's risk of personal injury liability. The Company seeks to reduce its
potential liability through measures such as contractual indemnification
provisions with clients (the scope of which may vary from client to client and
the performances of which are not secured) and insurance maintained by clients.
The Company could be materially and adversely affected if it were required to
pay damages or incur defense costs in connection with a claim that is outside
the scope of the indemnification agreements, if the indemnity, although
applicable, is not performed in accordance with its terms or if the Company's
liability exceeds the amount of applicable insurance or indemnity. In addition,
the Company could be held liable for errors and omissions in connection with the
services it performs. The Company currently maintains product liability and
errors and omissions insurance with respect to these risks. In addition, the
Company's expansion of services to include clinical trials of products in humans
and introduction of proprietary products in clinical trials may expose it to
additional risk of liability. In connection with providing clinical trial
services, the Company contracts with physicians to serve as investigators in
conducting clinical trials to test new drugs on human volunteers. Such testing
creates risk of liability for personal injury to or death of volunteers,
particularly to volunteers with life-threatening illnesses, resulting from
adverse reactions to the drugs administered. Although the Company does not
believe it is legally accountable for the medical care rendered by third party
investigators, it is possible that the Company could be held liable for the
claims and expenses arising from any professional malpractice of the
investigators with whom it contracts or in the event of personal injury to or
death of persons participating in clinical trials. The Company also could be
held liable for errors or omissions in connection with the services it performs.
In addition, as a result of its clinical trial facilities, the Company could be
liable for the general risks associated with a clinical trial facility
including, but not limited to, adverse events resulting from the administration
of drugs to clinical trial participants or the professional malpractice of
clinical trial medical care providers. The Company believes that its risks are
reduced by contractual indemnification provisions with clients and
investigators, insurance maintained by clients and investigators and by the
Company, various regulatory requirements, including the use of institutional or
ethical review boards and the procurement of each volunteer's informed consent
to participate in the study. Contractual indemnification generally does not
protect the Company against certain of its own actions such as negligence, and
contractual arrangements are subject to negotiation with clients and the terms
and scope of such indemnification vary from client to client and from trial to
trial. See "Business -- Potential Liability and Insurance".

COMPETITION

The Company competes primarily with the in-house research, development,
quality control and other support service departments of pharmaceutical and
biotechnology companies and with university research laboratories, many of which
have substantially greater resources than the Company. In addition, the CRO
industry is highly fragmented, consisting of several hundred small, limited
service providers and a few large, global firms. The Company competes against
these companies, some of which may have substantially greater resources than the
Company. As a result of competitive pressures, the CRO industry is
consolidating. This trend is likely to produce increased competition for both
clients and acquisition candidates. Increased competition may lead to increased
price and other forms of competition that may adversely affect the Company.
Competitive factors include reliability, turn-around time, reputation for
innovative and quality science, capacity to perform numerous required services,
financial viability and price. See "Business -- Competition".

<PAGE> 11

DEPENDENCE ON THIRD-PARTY MARKETING AND DISTRIBUTION

The Company has developed, and intends to continue internal development
of, drugs to be licensed to third parties for marketing and distribution. The
Company does not intend to market or commercially distribute such products.
Accordingly, the success of internal development activities depends upon the
Company's ability to enter into marketing arrangements with third parties. There
can be no assurance that such arrangements can be successfully negotiated or
that any such arrangements will be available on commercially reasonable terms.
Even if acceptable and timely marketing arrangements are available, there can be
no assurance that products developed by the Company will be accepted in the
marketplace. In addition, because the Company's marketing licensee will in many
cases make all or many material marketing and other commercialization decisions
regarding such products, a significant number of the variables that may affect
the Company's license fees and royalties, and therefore net income, will not be
within the Company's control.

UNCERTAINTY OF THIRD-PARTY REIMBURSEMENT; PRICING PRESSURE

The Company's license fees, royalties and other revenue may depend, in
part, on the availability of reimbursement from third-party payors, such as
government health administration authorities, private health insurers and other
organizations. Third-party payors are increasingly challenging the price and
cost-effectiveness of medical products and services. There can be no assurance
that adequate third-party reimbursement will be available to achieve or maintain
price levels sufficient to realize an appropriate return on the Company's
investment in product development.

In addition, global efforts to contain healthcare costs, particularly
among managed care organizations, continue to exert downward pressure on product
pricing. Further, a number of regulatory and legislative proposals aimed at
changing the healthcare industry in the United States and other countries have
been proposed. There can be no assurance that private sector reform or
governmental healthcare reform measures, if adopted, will not have a negative
impact upon the Company and its operations.

INTERNATIONAL OPERATIONS AND EXCHANGE RATE FLUCTUATIONS

As a result of the acquisition of L.A.B., the Company anticipates that a
significant portion of its revenues will be derived from the Company's
operations outside the United States. The Company's operations and financial
results could be significantly affected by factors associated with international
operations such as changes in currency exchange rates and uncertainties relative
to regional economic circumstances, as well as by other risks sometimes
associated with international operations. Since the revenue and expenses of the
Company's non-U.S. operations are generally denominated in local currencies,
exchange rate fluctuations between such local currencies and the U.S. dollar
will subject the Company to currency translation risks with respect to the
reported results of its non-U.S. operations. Also, the Company may be subject to
currency transaction risks when the Company's service contracts are denominated
in a currency other than the currency in which the Company incurs expenses
related to such contracts.

PROPRIETARY TECHNOLOGY; UNPREDICTABILITY OF PATENT PROTECTION

The Company's success will depend, in part, on its ability to obtain
patents in various jurisdictions on its current and future technologies and
products, to defend its patents and protect its trade secrets and to operate
without infringing on the proprietary rights of others. There can be no
assurance that the Company's patents will not be challenged by third parties
and, if challenged, will be held valid. In addition, there can be no assurance
that any technologies or products developed by AAI will not be challenged by
third parties owning patent rights and, if challenged, will be held to not
infringe such patent rights. The expense involved in any patent litigation can
be significant and cannot be estimated by the Company. Finally, if the Company
relies on unpatented, proprietary technology, there can be no assurance that
others will not independently develop or obtain similar products or
technologies.

<PAGE> 12

FUTURE CAPITAL REQUIREMENTS; UNCERTAINTY OF ADDITIONAL FUNDING

The Company has developed a substantial scientific and technical
infrastructure to provide a broad array of services to the pharmaceutical and
biotechnology industries. The Company expects capital and operating expenditures
to increase over the next several years as it continues to pursue its growth
strategy. Although the Company believes that existing cash and investment
securities and anticipated cash flow from operations will be sufficient to
support the Company's operations for the foreseeable future, the Company's
actual future capital requirements will depend on many factors, including
acquisitions made by the Company, the rate of internal growth and the amount and
timing of revenue from proprietary products and technology. The Company may
require significant additional financing in the future, which it may seek to
raise through public or private equity offerings or debt financings. No
assurance can be given that additional financing will be available when needed,
or that, if available, such financing will be obtained on terms favorable to the
Company or its stockholders. To the extent the Company raises additional capital
by issuing equity securities, ownership dilution to stockholders will result.

TRANSACTIONS WITH AFFILIATES; CONFLICTS OF INTEREST

The Company provides product development and other services to Aesgen,
which develops generic pharmaceutical products, and in June 1996 the Company
licensed to Aesgen marketing rights to a product being developed by the Company.
Approximately 30% of Aesgen's outstanding common stock is held by certain
holders of the Company's outstanding shares of capital stock. The Company holds
a $1.6 million non-convertible, non-voting preferred stock investment in Aesgen.
In addition, Frederick D. Sancilio, a director of the Company and its President,
and James L. Waters and Charles D. Moseley, Jr., non-employee directors of the
Company, serve as three of the ten directors of Aesgen. In addition, under the
development agreement between Aesgen and the Company, the Company has agreed in
certain circumstances not to develop a formulation for its own account or for
any other person of any generic pharmaceutical product that the Company has
agreed and agrees to develop for Aesgen. The Company also provides development
services to Endeavor. Approximately 44% of Endeavor's fully diluted common
equity is beneficially owned by certain holders of the Company's Common Stock.
The Company owns approximately 40% of the fully diluted common equity of
Endeavor. Dr. Sancilio and William H. Underwood, executive officers and
directors of the Company, serve on the six-member board of directors of
Endeavor. In addition, Mr. Moseley, an outside director of the Company, serves
on Endeavor's board of directors. The Company leases its headquarters facility
from a company in which each of Dr. Sancilio and Mr. Waters owns a one-third
interest. Rental fees under the lease are subject to adjustment for increases in
certain expenses in operating and insuring the facility. Various conflicts of
interest could arise between such related parties and the Company. The Company's
Restated Certificate of Incorporation includes certain provisions addressing
potential conflicts of interest between the Company and entities in which a
director or executive officer has a financial interest. See "Certain
Transactions" and "Description of Capital Stock -- Delaware Law and Certain
Provisions of the Company's Restated Certificate of Incorporation and By-laws".

CONCENTRATION OF OWNERSHIP

Certain of the Company's executive officers beneficially own in the
aggregate approximately 33.9% of the outstanding shares of Common Stock, and the
Company's non-employee directors beneficially own in the aggregate approximately
16.7% of the outstanding shares of Common Stock. Accordingly, such persons will
be in a position to influence the election of the Company's directors and the
outcome of corporate actions requiring stockholder approval. This concentration
of ownership may have the effect of delaying or preventing a change in control
of the Company. See "Management" and "Principal Stockholders".

LIMITED PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE

Prior to the Offering, there was no public market for the Common Stock.
The Common Stock is quoted on the Nasdaq National Market under the symbol
"AAII". There can be no assurance that an active public market for the Common
Stock can be sustained. The market price of the Company's Common Stock could be
subject to wide fluctuations in response to variations in operating results from
quarter to quarter, changes in earnings estimates by analysts, market conditions
in the industry and general economic conditions. Furthermore, the stock market
has experienced significant price and volume fluctuations

<PAGE> 13

unrelated to the operating performance of particular companies. These market
fluctuations may have an adverse effect on the market price of the Company's
Common Stock. The underwriters of the Offering (the "Underwriters") have
informed the Company that, subject to applicable laws and regulations, they
intend to make a market in the Common Stock. They are not obligated to do so,
however, and any such market-making may be discontinued at any time without
notice. Moreover, because of the affiliation of Goldman, Sachs & Co. with the
Company, Goldman, Sachs & Co. is required to deliver a current prospectus and
otherwise comply with the requirements of the Securities Act in connection with
any secondary market sale of the Common Stock, which may affect their ability
to continue market-making activities. See "Plan of Distribution".

SHARES ELIGIBLE FOR FUTURE SALE

Sales of a substantial number of shares of the Company's Common Stock in
the public market after this Offering could adversely affect the market price of
the shares of Common Stock. Of the approximately 16,300,000 shares of Common
Stock outstanding, 3,105,000 shares sold in the initial public offering of
Common Stock on September 25, 1996 are freely tradeable without restriction
unless held by affiliates of the Company, and as of March 19, 1997,
approximately 10,500,000 additional shares became eligible for sale, subject to
the provisions of Rule 144 under the Securities Act or Rule 701 under the
Securities Act. An additional 2,635,524 shares of Common Stock will become
eligible for sale under Rule 144 at various dates thereafter as the holding
period provisions of Rule 144 are satisfied. At December 31, 1996, the Company
had outstanding options to purchase a total of 442,755 shares of Common
Stock, which are subject to vesting in installments over 42 months. Certain
holders of the Company's capital stock are entitled to rights with respect to
the registration under the Securities Act of 13,076,206 shares of Common Stock.
See "Description of Capital Stock -- Registration Rights" and "Shares Eligible
for Future Sale".

CERTAIN ANTI-TAKEOVER PROVISIONS; POSSIBLE ISSUANCE OF PREFERRED STOCK

The Company's Restated Certificate of Incorporation and By-laws contain
certain provisions that may have the effect of deterring a future takeover of
the Company, including the classification of the Board of Directors into three
classes. These provisions could limit the price that certain investors might be
willing to pay in the future for shares of Common Stock. In addition, 5,000,000
shares of the Company's preferred stock may be issued in the future without
further stockholder approval and upon such terms and conditions, and having such
rights, privileges and preferences, as the Board of Directors of the Company may
determine. The issuance of preferred stock, while providing desirable
flexibility in connection with possible acquisitions and other corporate
purposes, could adversely affect the market price of shares of Common Stock and
could have the effect of making it more difficult for a third party to acquire,
or of discouraging a third party from acquiring, a majority of the outstanding
voting stock of the Company. AAI has no present plans to issue any shares of
preferred stock. In addition, Section 203 of the Delaware General Corporation
Law, to which the Company is subject, restricts certain business combinations
with any "interested stockholder" as defined by such statute. The statute may
delay, defer or prevent a change in control of the Company. See "Description of
Capital Stock".

<PAGE> 14

THE COMPANY

AAI is a leading integrated contract research and development resource to
the worldwide pharmaceutical and biotechnology industries, offering an
efficient, variable-cost alternative to its clients' internal drug development,
compliance and quality control programs. The Company provides a broad array of
value-added services, including chemical analysis, synthesis and other
laboratory services; drug formulation development; clinical trial services;
clinical supply and niche manufacturing; and regulatory and compliance
consulting. AAI has contributed to the submission, approval or continued
marketing of client products worldwide, encompassing a wide range of therapeutic
categories and technologies. The Company believes that its ability to offer an
extensive portfolio of high quality drug development and support services
enables it to effectively compete as pharmaceutical and biotechnology companies
look for integrated drug development solutions that offer cost-effective results
on an accelerated basis.

In addition to its core fee-for-service business, AAI leverages its
expertise by allocating a significant proportion of its technical resources and
operating capacity to internal drug and drug technology development, in which
the Company shares in the expense of development and participates in the
benefits of any potential commercial success through licensing arrangements.
Internal drug development is focused primarily on generic products. Certain of
these products have been licensed or sold. The Company's proprietary technology
includes patents and pending patent applications on formulations and methods,
including liquid formulations for improved delivery of nonsteroidal
anti-inflammatory drugs or NSAIDs, such as ibuprofen, and chewable formulations
to mask the otherwise bitter taste of certain ulcer drugs. Since 1993, the
Company has allocated a growing proportion of its technical resources and
operating capacity to its internal drug and drug technology development program,
and because of the significant time required for development and approval of
pharmaceutical products, the Company has only recently begun to recognize
license revenue from its internal development efforts.

In 1994, as part of its internal development program, the Company
organized Endeavor to develop certain hormone pharmaceutical products, focusing
initially on several such products then under development by AAI. The Company
owns approximately 40% of the fully diluted common equity of Endeavor.

On December 31, 1996, the Company acquired L.A.B. for an aggregate cost
of approximately $20.9 million. L.A.B. is a European contract research and
development organization headquartered in Neu-Ulm, Germany with principal
operating units in Neu-Ulm and Munich, Germany and in Paris, France, as well as
smaller operating units in Stuttgart, Germany; London, England; Arheim,
Netherlands and Budapest, Hungary. L.A. B. also operates in China through a
joint venture. L.A.B. employs approximately 250 scientists, technicians and
support personnel, 40 or more with Ph.D. or M.D. degrees, or their U.S.
equivalent. L.A.B. focuses on both clinical and non-clinical pharmaceutical
product development and provides services that include drug formulation
development; chemical analysis; Phase I clinical trial studies; bioanalytical
testing; and European regulatory consulting. L.A.B. also provides controlled
Phase II-A clinical trial studies and multi-center clinical trials focused in
niche therapeutic areas including hepatic disease, chemotherapeutics, and
hormone replacement therapy.

The Company was incorporated in 1986, although its corporate predecessor
was founded in 1979. The Company's principal executive offices are located at
5051 New Centre Drive, Wilmington, North Carolina 28403, and its telephone
number at that address is (910) 392-1606.

As used in this Prospectus, the terms "Company" and "AAI" include Applied
Analytical Industries, Inc., its corporate predecessors and its subsidiaries,
except where the context indicates otherwise.

<PAGE> 15

USE OF PROCEEDS

This Prospectus relates to the offer and sale of an indeterminate number
of shares of Common Stock by Goldman, Sachs & Co. in market-making transactions.
The Company will not receive any of the proceeds of such sales.

PRICE RANGE OF COMMON STOCK

The Common Stock is quoted on the Nasdaq National Market under the symbol
"AAII". The following table sets forth the high and low bid prices of the Common
Stock as reported on the Nasdaq National Market for the periods indicated below.
The Common Stock was first offered to the public at a price per share of $16.00
and was first quoted for trading on the Nasdaq National Market on September 20,
1996.

<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
Year ended December 31, 1996
Third quarter (from September 20, 1996)..... $25.125 $16.00
Fourth quarter.............................. 29.625 19.75
</TABLE>

As of February 28, 1997, there were approximately 249 record holders of
the Common Stock.

DIVIDEND POLICY

Prior to November 17, 1995, the Company was an S corporation for federal
income tax purposes and prior to such time periodically declared and paid cash
dividends to its stockholders in amounts approximately sufficient to permit its
stockholders to pay their income taxes on earnings of the Company that were
treated as having been earned by the Company's stockholders and in 1995 paid an
additional monthly dividend totaling $14,000 per month. In addition, in
connection with the termination of the Company's status as an S corporation, the
Company declared and paid in 1995 and 1996 a cash dividend in the aggregate
amount of approximately $6.9 million, approximating the Company's accumulated
adjustments account for federal income tax purposes as of such date.

The Company intends to retain future earnings, if any, to finance the
development and expansion of its business and, therefore, does not anticipate
paying any cash dividends on its Common Stock in the foreseeable future. The
decision whether to pay cash dividends will be made by the Board of Directors of
the Company in the light of conditions then existing, including the Company's
results of operations, financial condition and requirements, business conditions
and other factors.

<PAGE> 16

SELECTED FINANCIAL DATA

The selected financial data for the four years ended December 31, 1996
have been derived from the Company's consolidated financial statements, which
have been audited by Price Waterhouse LLP, independent accountants. The selected
historical financial data for the year ended December 31, 1992 have been derived
from the Company's financial statements, which have been audited by another
independent accounting firm. This information should be read in conjunction with
the Company's audited consolidated financial statements and notes thereto and
with Management's Discussion and Analysis of Financial Condition and Results of
Operations, which appear elsewhere in this Prospectus.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
1996 1995 1994 1993 1992
--------- ------- -------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Net sales ........................... $ 42,162 $34,639 $ 32,882 $26,378 $ 21,846
Cost of sales ....................... 17,621 14,259 14,533 9,731 8,989
Selling expense ..................... 6,357 4,913 4,390 3,654 2,871
General and administrative expense .. 8,908 8,171 8,485 8,738 7,329
Research and development expense .... 4,216 3,326 2,394 1,273 207
Unusual item (a) .................... 6,600
Other (income) expense, net ......... (494) 1,130 440 156 199
--------- ------- -------- ------- --------
Income (loss) before income taxes ... (1,046) 2,840 2,640 2,826 2,251
Provision for income taxes .......... 2,102 39 -- -- --
Equity income (loss) (b) ............ -- 444 (444) -- --
--------- ------- -------- ------- --------
Net income (loss) ................... $ (3,148) $ 3,245 $ 2,196 $ 2,826 2,251
========= ======= ======== ======= ========

PRO FORMA DATA (UNAUDITED):
Pro forma earnings (loss) per share . $ (0.23)
Pro forma weighted average shares ... 13,440
Pro forma income taxes(c) ........... $ 1,129 $ 1,118 $ 1,125 $ 878
Pro forma net income(c) ............. 2,116 1,078 1,701 1,373
Pro forma earnings per common
share(c) .......................... $ 0.18
Pro forma weighted average common
shares(c) ......................... 11,918
BALANCE SHEET DATA (AT PERIOD END)
Working capital ..................... $ 35,755 $12,374 $ (1,181) $ 601 $ (549)
Property and equipment, net ......... 19,216 10,904 10,782 9,121 8,477
Total assets ........................ 104,478 39,156 22,402 18,443 14,179
Long-term debt, less current
maturities ........................ 6,671 3,379 2,738 3,273 3,526
Total stockholders' equity .......... 63,995 21,990 5,856 5,549 3,649
ADDITIONAL DATA:
Income before research and
development expense (d) ........... $ 9,770 $ 6,166 $ 5,034 $ 4,099 $ 2,458
</TABLE>

- ----------

(a) In connection with the acquisition of L.A.B., the Company recognized an
unusual item representing the write-off of certain in-process research
and development costs with an appraised value of approximately $6.6
million as of December 31, 1996.
(b) Relates to equity accounting for the Company's investment in Endeavor.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Overview" and Note 6 of Notes to Consolidated
Financial Statements.
(c) Prior to November 17, 1995, the Company was treated as an S corporation
for federal and state income tax purposes. The pro forma data sets forth
the pro forma income taxes, pro forma net income and pro forma earnings
per common share of the Company as if the Company had been subject to
corporate income taxes as of the beginning of each year presented. The
pro forma earnings per common share data also reflects the capitalization

<PAGE> 17

of the Company on a pro forma basis to give effect to the 200-for-one
split of the Common Stock and Class B Common Stock effected on May 31,
1996 and the one-for-.6325 split of the Common Stock and Class B Common
Stock effected on June 7, 1996 as if such events had occurred on the
first day of the period presented.
(d) Income before research and development expense represents net sales less
the cost of sales, selling expense, general and administrative expense
and other (income) expense, net. While this is not a measure of
performance under generally accepted accounting principles, the Company
has included income before research and development expense data because
such data may be used by certain investors and permit evaluation of the
profitability of the Company's operations throughout the period without
taking account of research and development expense. In 1993, the Company
began allocating a significant portion of its technical resources and
operating capacity to internal development of generic drugs and
proprietary technology. The Company has only recently begun to recognize
license revenue from these internal development efforts due to the
significant time required for development and approval of pharmaceutical
products. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview" and "Business --
Internal Drug and Technology Development".

<PAGE> 18

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

OVERVIEW

The Company derives its revenue primarily from performing contract
product development and support services for the pharmaceutical and
biotechnology industries, including chemical analysis, synthesis and other
laboratory services; drug formulation development; clinical supply and niche
manufacturing; and regulatory and compliance consulting. In general, the Company
provides services to a client under an estimate that establishes the anticipated
price and scope of a project, although estimates may be adjusted during the term
of the project. The terms of the Company's engagements vary, ranging from less
than one month to several years, and generally may be terminated upon notice of
30 days or less by the client.

In addition to its core fee-for-service business, the Company has
allocated a growing proportion of its technical resources and operating capacity
to its internal drug and drug technology development projects. These projects
are either internally funded or shared-risk projects with development partners.
The Company has applied a portion of the net proceeds from its issuance of
convertible preferred stock in 1995 and a portion of the net proceeds
from its initial public offering of common stock in 1996 to expand its capacity
to enable growth in its internal development program, as well as its core
fee-for-service business. Internal development projects are undertaken to
develop targeted drugs and proprietary drug technologies with the intention of
licensing the marketing rights to third parties. The Company has also entered
into selective shared-risk development projects, reducing its fees for
development services in return for license fees, typically paid upon performance
of certain milestones, and royalties based on a percentage of product sales or
profit. Substantially all of the Company's research and development expenses are
the result of internal development and shared-risk projects.

The Company has only recently begun to recognize license revenue from its
internal development efforts due to the significant time required for
development and approval of pharmaceutical products. Historically, as the
Company expanded its internal development program, less capacity was available
for fee-for-service work to generate more immediate revenue. The Company
anticipates that licensing revenue, including royalties, from internal drug and
technology development will represent a larger proportion of its revenue,
although there can be no assurance that internal development projects will yield
products that will be approved by the appropriate regulatory authorities or will
be attractive to potential clients. The Company believes that the profit margins
from internal drug and technology development potentially exceed the margins on
its standard core fee-for-service engagements.

On December 31, 1996, the Company acquired all of the outstanding equity
in L.A.B. Gesellschaft fur pharmakologische Untersuchungen mbH & Co. ("L.A.B."),
a European contract research and development organization headquartered in
Neu-Ulm, Germany with operational units in Neu-Ulm, Stuttgart and Munich,
Germany as well as in France, Netherlands, England and Hungary. L.A.B. focuses
on both clinical and non-clinical pharmaceutical product development and
provides services that include drug formulation development; chemical analysis;
Phase I clinical studies; bioanalytical testing; and European regulatory
consulting. The firm also provides controlled Phase II-A studies and
multi-center trials focused in niche therapeutic areas including hepatic
disease, chemotherapeutics, and hormone replacement therapy. The acquisition of
L.A.B. significantly expands the Company's bioanalytical capabilities and allows
the Company to offer multi-center clinical testing services.

In 1994, the Company and private investors organized Endeavor to fund the
development of generic hormone pharmaceutical products, which initially focused
on certain products then under development by the Company. The Company owns
approximately 40% of the fully diluted common equity of Endeavor and continues
the development of these products under agreements with Endeavor. The Company's
net sales to Endeavor were approximately $6.2 million, $3.5 million and $2.0
million in 1996, 1995 and 1994, respectively. The Company also provides
development services

<PAGE> 19

to Aesgen, an affiliate, and recognized net sales to Aesgen of $4.7 million and
$5.6 million in 1996 and 1995, respectively.

The Company accounts for its investment in Endeavor under the equity
method which limits the recognition of losses to the amount invested or
committed for investment and financial support. The Company acquired its equity
interest in Endeavor in return for its contribution of existing formulations and
technology developed by the Company that had been fully expensed. Other
investors' cash contribution to Endeavor created a gain for AAI that was
deferred. In connection with its investment, the Company extended a $1.5 million
revolving credit facility to Endeavor. Because of this financial support
commitment under the credit facility, the Company recognized a liability during
1994 and the first three quarters of 1995 equal to its proportionate share of
Endeavor's operating losses, net of amortization of the deferred gain on the
original investment. Such amounts were reported as equity loss. In connection
with a cash investment in Endeavor by new investors in November 1995, loans
under this facility were repaid during the fourth quarter of 1995, and the
Company's obligation to make further loans was terminated. As a result of the
termination of the Company's obligation to make further loans to Endeavor under
the credit facility, the previously recorded liability was reversed in the
fourth quarter of 1995 and was reported as equity income.

Effective November 17, 1995, upon the issuance of the convertible
preferred stock the Company ceased to be treated as an S corporation for federal
and state income tax purposes, which had allowed all taxable income and expenses
to pass directly to the stockholders. Accordingly, the Company began to account
for income taxes.

This Prospectus contains certain forward-looking statements that involve
risks and uncertainties. The Company's actual results may differ significantly
from the results discussed in those forward-looking statements. Factors that
might cause such differences include, but are not limited to, the Company's
dependence on and effect of government regulation; its management of growth and
acquisition risks; the level of outsourcing of research, development and testing
activities in the pharmaceutical and biotechnology industries; its dependence on
key personnel, and its dependence on third-party marketing and distribution of
internally developed drugs.

RESULTS OF OPERATIONS

1996 COMPARED TO 1995

Net sales increased $7.5 million, or 22%, to $42.2 million in 1996
compared to 1995. The increase was principally due to the performance of a
greater number of laboratory service projects and increased licensing revenue.
Net sales from the core fee-for-service business increased 20% to $40.6 million
in 1996 from $33.9 million in 1995. Licensing revenues in 1996 increased 103% to
$1.5 million versus $738,000 in 1995.

Cost of sales increased by $3.4 million, or 24%, to $17.6 million for
1996 compared to 1995. Cost of sales increased slightly as a percentage of net
sales to 41.8% from 41.2%, reflecting the increased resources needed to perform
the greater inflow of work from fee-for-service clients.

Selling expense increased by $1.4 million, or 29%, to $6.4 million in
1996 compared to 1995. The increase was primarily attributable to the opening of
sales locations in Boston, Massachusetts; San Diego and San Francisco,
California; Copenhagen, Denmark; and London, England, as well as higher
commission expense associated with increased sales.

General and administrative expense increased by $737,000, or 9%, to $8.9
million in 1996 compared to 1995. The increase in general and administrative
expense is primarily a function of the Company's growth with no significant
change attributable to any specific items. As a percentage of sales, the
Company's general and administrative expense continued its downward trend,
decreasing to 21.1% for 1996 from 23.6% for 1995. Such trend may not continue in
the near term, as management anticipates selected increases in administrative
staffing and information technology spending to support the Company's continued
growth.

<PAGE> 20

Research and development expense increased by $890,000, or 27%, to $4.2
million in 1996 compared to 1995, and represented 10.0% of net sales for 1996
compared to 9.6% of net sales in 1995. The increase in research and development
expense reflects the Company's decision to allocate an increasing proportion of
its development capabilities to its internal development program. The Company
anticipates that, consistent with its business strategy, investments in research
and development will continue to increase over the next several years.

In connection with the acquisition of L.A.B. the Company recognized an
unusual item representing the write-off of certain in-process research and
development costs with an appraised value of approximately $6.6 million as of
December 31, 1996.

Other income (expense), net, which is primarily interest, was income of
$494,000 in 1996 compared to a net expense of $1.1 million in 1995. This change
is primarily due to the reduced borrowing levels during 1996 compared to 1995.
In addition, interest income from marketable securities, purchased with a
portion of the net proceeds of the issuance of the Preferred Stock in late 1995
and the initial public offering in September 1996, offset expense incurred with
respect to the Company's remaining interest-bearing liabilities.

As a result of the termination of the Company's obligations under the
credit facility to Endeavor during the fourth quarter of 1995, the Company
recognized no activity associated with its investment in Endeavor during 1996,
compared with income of $444,000 in 1995.

The provision for income taxes for 1996 was $2.1 million compared to
$39,000 in 1995. No income taxes were recognized for most of 1995 because the
Company was treated as an S corporation for federal and state income tax
purposes through November 17, 1995.

1995 COMPARED TO 1994

Net sales increased by $1.8 million, or 5%, to $34.6 million in 1995
compared to 1994. The increase in net sales was primarily attributable to a
greater number of fee-for-service projects undertaken by the Company. These
increases were partially offset by a $1.8 million reduction of net sales to a
single customer from the winding down of one project and by the Company's
decision to allocate an increasing proportion of its technical resources and
operating capacity to internal research and development projects.

Cost of sales declined by $274,000, or 2%, to $14.3 million in 1995
compared to 1994. Cost of sales as a percentage of net sales decreased to 41.2%
in 1995 from 44.2% in 1994. This decrease is primarily attributable to the high
level of cost of sales in 1994 associated with increases in professional
staffing in 1994 and with the opening of the Company's Research Triangle Park
facility in 1994.

Selling expense increased by $523,000, or 12%, to $4.9 million in 1995
compared to 1994. Such increase is primarily the result of the full-year impact
of increases in the sales and marketing personnel implemented in 1994. Selling
expense as a percent of net sales increased to 14.2% in 1995 compared to 13.4%
in 1994 reflecting the delay in productivity as new sales personnel were trained
and established relationships with prospective clients.

General and administrative expense decreased by $314,000, or 4%, to $8.2
million in 1995 compared to 1994 primarily as a result of reductions in the
level of executive compensation and the departure in 1995 of certain employees
to manage an affiliate. General and administrative expense as a percentage of
net sales continued its downward trend, decreasing to 23.6% in 1995 from 25.8%
in 1994. The Company believes that such trend reflects the compensation
reductions discussed above and the utilization of administrative leverage during
the period, with the expansion of operating facilities requiring no significant
increase in administrative staffing or management information systems.

Research and development expense increased $932,000, or 39%, to $3.3
million in 1995 compared to 1994. Research and development expense represented
9.6% of net sales in 1995 compared to 7.3% of net sales in 1994. The

<PAGE> 21

increase in research and development expense reflects the Company's decision to
allocate an increasing proportion of its development capabilities to proprietary
products.

Other expense increased by $690,000 to $1.1 million in 1995 compared to
1994, reflecting higher interest expense from increased borrowing levels during
1995 and a provision of $363,000 established in connection with litigation with
a former employee of the Company.

Equity income of $444,000 was recognized in 1995 with respect to the
Company's investment in Endeavor, reversing equity losses of $444,000 in 1994,
due to the termination in 1995 of the Company's obligation to provide Endeavor
funding under a credit facility.

LIQUIDITY AND CAPITAL RESOURCES

The Company has funded its business through operating cash flows,
proceeds from borrowings and the issuance of equity securities in September 1996
and November 1995. During 1996, 1995 and 1994, the Company generated $2.4
million, $3.8 million and $4.9 million, respectively, in cash flow from
operations and raised $44.8 million and $21.5 million in net proceeds in its
1996 and 1995 sales of equity securities, respectively.

Total capital expenditures were $7.6 million in 1996, $1.7 million in
1995 and $3.1 million in 1994. Capital expenditures were incurred predominantly
in connection with the opening of the Company's Research Triangle Park facility
and with improvements made to existing facilities. The Company anticipates
capital expenditures in 1997 to be approximately $10 million, to be used in part
for the expansion of facilities and the upgrading of certain information
systems.

Working capital was $35.8 million at December 31, 1996 compared to $12.4
million at December 31, 1995. The increase in working capital is primarily
attributable to the net proceeds from the September 1996 initial public offering
offset by approximately $17.6 million of negative working capital from the
L.A.B. acquisition. The Company has available a $20 million credit facility to
supplement its liquidity needs.

The Company expects to continue expanding its operations through internal
growth and strategic acquisitions. The Company expects such activities will be
funded from existing cash and cash equivalents, cash flow from operations and
borrowings under its credit facility. The Company believes that such sources of
cash will be sufficient to fund operations for the current and foreseeable
future and to pay existing debt as it becomes due and other capital obligations.
Although the Company has no present acquisition agreements or arrangements there
may be acquisition or other growth opportunities that require additional
external financing, and the Company may from time to time seek to obtain funds
from the public or private issuance of equity or debt securities. There can be
no assurances that such financing will be available on terms acceptable to the
Company.

INFLATION

The Company believes the effects of inflation generally do not have a
material adverse effect on its results of operations or financial condition.

<PAGE> 22

BUSINESS

In addition to its core fee-for-service business, AAI leverages its
expertise by allocating a significant proportion of its technical resources and
operating capacity to internal drug and drug technology development, in which
the Company shares in the expense of development and participates in the
benefits of any potential commercial success through licensing arrangements.
Internal drug development is focused primarily on generic products. Certain of
these products have been licensed or sold. The Company's proprietary technology
includes patents and pending patent applications on formulations and methods,
including liquid formulations for improved delivery of nonsteroidal
anti-inflammatory drugs or NSAIDs, such as ibuprofen, and chewable formulations
to mask the otherwise bitter taste of certain ulcer drugs. Since 1993, the
Company has allocated a growing proportion of its technical resources and
operating capacity to its internal drug and drug technology development program,
and because of the significant time required for development and approval of
pharmaceutical products, the Company has only recently begun to recognize
significant license revenue from its internal development efforts.

On December 31, 1996, the Company acquired L.A.B. for an aggregate cost
of approximately $20.9 million. L.A.B. is a European contract research and
development organization headquartered in Neu-Ulm, Germany with principal
operating units in Neu-Ulm and Munich, Germany; and in Paris, France, as well as
smaller operational units in Stuttgart, Germany; London, England; Arnheim,
Netherlands and Budapest, Hungary. L.A.B. also operates in China through a joint
venture. L.A.B. employs approximately 250 scientists, technicians and support
personnel, 40 or more with Ph.D. or M.D. degrees, or their U.S. equivalent.
L.A.B. focuses on both clinical and non-clinical pharmaceutical product
development and provides services that include drug formulation development;
chemical analysis; Phase I clinical trial studies; bioanalytical testing; and
European regulatory consulting. L.A.B. also provides controlled Phase II-A
clinical trial studies and multi-center clinical trials focused in niche
therapeutic areas including hepatic disease, chemotherapeutics, and hormone
replacement therapy.

INDUSTRY OVERVIEW

The contract research and development industry (commonly referred to as
the contract research organization, or CRO, industry) provides independent
product development and marketed-product support services to the pharmaceutical
and biotechnology industries. These research and development services include
compound synthesis/extraction, screening and pharmacological testing,
toxicology/safety testing, formulation development, laboratory testing, clinical
trial

<PAGE> 23

management, regulatory and compliance and quality control testing. The Company
estimates that in 1994 pharmaceutical and biotechnology companies spent
approximately $30 billion worldwide on research and development. These product
development and marketed-product support services, which are the primary focus
of AAI's fee-for-service business, require extensive technical expertise,
significant investment in capital equipment, and extensive experience in drug
development processes, GMP compliance and in regulatory affairs.

The CRO industry consists of several hundred service providers operating
in various portions of the market, with many of the larger companies focusing
primarily on managing clinical trials and only a few, such as AAI, offering a
broad array of services. There are significant barriers to entry to providing an
extensive portfolio of services, particularly in the portion of the CRO market
that does not focus primarily on clinical management. These barriers include the
capital investment required for state-of-the-art equipment and facilities, the
employment of skilled and experienced professionals and the development of
expertise in and reputation for performing critical development and support
services consistent with clients' time demands and regulatory requirements.

The Company also participates in the U.S. generic drug market through
licensing revenues on internally developed products and its partial ownership of
Endeavor. The U.S. generic drug market has expanded sales from approximately
$3.5 billion in 1990 to approximately $6.4 billion in 1994. Generic drugs
accounted for an estimated 38% of prescriptions dispensed in the United States
in 1994. The Company anticipates that the growth in the generic drug market will
continue as managed care organizations continue policies favoring generic
substitution and patents on many high dollar-volume products expire over the
next several years. In addition, L.A.B. has an active internal drug development
and licensing program and has licensed numerous drug dossiers to its clients in
Europe.

FACTORS INFLUENCING INCREASED OUTSOURCING

The Company estimates that approximately $33 billion was spent on drug
development, compliance and quality control worldwide in 1994 and that
approximately $3.5 billion was outsourced to independent contract service
providers. The Company believes that historically the majority of outsourcing
has been for clinical trial management and that pharmaceutical and biotechnology
companies are increasing outsourcing in non-clinical areas to control costs and
to leverage all aspects of internal development and product support
capabilities. The Company believes that the following factors will contribute to
a continuing increase in outsourcing activities:

COST CONTAINMENT PRESSURES. Market forces, including a shift toward
managed care, and governmental initiatives have placed significant pressure on
drug companies to limit and reduce drug prices. Pricing pressures have arisen
from increased competition as a result of "me too" drugs, patent expirations,
generic substitution and increased purchasing power of large buyer groups. The
Company believes that the pharmaceutical and biotechnology industries are
responding to these pressures by downsizing and rationalizing internal research
and development programs, favoring outsourcing as a variable-cost alternative.
Although these factors are driving drug companies to contain costs, drug
companies' needs for development capacity continue. In particular, the need for
additional capacity to increase the speed of new product development, maximizing
the period of marketing exclusivity, and to increase economic returns has driven
the need for outsourced services. In addition, market forces, including the
demand arising from an aging population and the incidence of chronic disorders
and life-threatening conditions such as infectious diseases, including AIDS,
have increased the pressure to develop new products. AAI believes that firms
with an extensive, integrated portfolio of drug development and support services
will have a competitive advantage in the market, as pharmaceutical and
biotechnology companies look for integrated drug development solutions offering
cost-effective results on an accelerated basis.

PATENT EXPIRATIONS. Patents for products representing $10.5 billion of
1994 U.S. drug sales are scheduled to expire by December 31, 2000. These patent
expirations are forcing drug companies to develop new products or modify
existing products to maintain market share against generic product competition.
The Company believes that the pressure to develop new products and modify
existing products, combined with internal capacity constraints, is leading
companies to outsource these activities. Further, the Company believes that
these patent expirations are providing generic drug companies with more product
opportunities than their internal development capacity can sustain, resulting in
increased outsourcing. AAI

<PAGE> 24

believes that firms offering integrated formulation development services and
expertise in a broad variety of dosage forms will benefit from this trend.

CONSOLIDATION IN THE PHARMACEUTICAL INDUSTRY. The pharmaceutical industry
is consolidating as companies seek to reduce costs and increase revenue through
business combinations. Once consolidated, many pharmaceutical companies
aggressively manage costs by eliminating jobs, decentralizing the research and
development process and outsourcing in an effort to reduce the fixed costs
associated with internal drug development and product support.

BIOTECHNOLOGY INDUSTRY AND "VIRTUAL" DRUG COMPANY GROWTH. The
biotechnology industry has grown rapidly over the last ten years and has
introduced a significant number of new compounds for development. Many
biotechnology companies do not have the necessary in-house resources to conduct
required development and testing. In addition, as a result of recent product
development setbacks encountered by some biotechnology companies, the Company
believes that many biotechnology companies are turning to experienced
development firms for analytical and regulatory expertise. Furthermore, the
number of "virtual" drug development companies with little or no internal
development or support resources have increased substantially over the past five
years. Accordingly, these companies must outsource development and support
services. The Company believes firms with formulation development and
biotechnology expertise will benefit from this trend.

INCREASING GENERIC PRODUCT DEVELOPMENT. Market opportunities arising with
the large number of impending patent expirations and market forces favoring
generic substitution have recently led many pharmaceutical companies to form
divisions focused exclusively on the development of generic products. These
generic product divisions are often allocated limited internal development
capabilities and must outsource some or all of their development and product
support needs. The Company believes that firms offering a broad array of
integrated development and support services will benefit the most from this
trend.

NEED FOR TECHNICAL EXPERTISE. Certain new compounds present complex
challenges in drug development, including acceptable profiles for stability,
delivery and other formulation parameters. Given the extensive expertise of
certain independent drug development firms, pharmaceutical and biotechnology
companies increasingly look to these firms for innovative solutions to complex
issues. AAI believes that firms with a reputation for high quality, innovative,
solution-driven contract work will have a key role in the area of difficult drug
development.

NEED FOR DATA MANAGEMENT EXPERTISE. Regulatory agencies are increasing
the volume of data required for regulatory filings, as well as requesting
increased access to these data. Furthermore, the FDA is encouraging the use of
computer-assisted filings in an effort to expedite the approval process.
Resource allocations and priorities may lead drug companies to outsource to
firms with automated data management capabilities. The Company believes that
firms that stay abreast of technological innovations and changing regulatory
requirements will have a competitive advantage.

GLOBALIZATION OF THE MARKETPLACE. Non-U.S. pharmaceutical companies,
particularly firms in Japan and Europe, are increasingly seeking to obtain
approval to market their existing products in the United States. Due to a lack
of familiarity with the complex U.S. regulatory system and the difficulty in
bringing their operating facilities into FDA-required GMP compliance, such firms
are increasingly relying on independent development companies with experience in
the United States to provide integrated services through all phases of product
development and to assist in preparing regulatory submissions. The Company
believes that domestic firms with established regulatory expertise and a broad
range of integrated development services will benefit from this trend. In
addition, L.A.B. offers the Company's U.S. and Asian clients the ability to
develop their drugs simultaneously in Europe through L.A.B.'s European
operations.

THE DRUG DEVELOPMENT PROCESS

Under the U.S. regulatory system, the development process for new
pharmaceutical products can be divided into three distinct phases. The
preclinical phase involves the discovery, characterization, product formulation
and animal testing necessary to prepare an Investigational New Drug ("IND")
exemption for submission to the FDA. The IND must

<PAGE> 25

be accepted by the FDA before the drug can be tested in humans. The second, or
clinical, phase of development follows a successful IND submission and involves
the activities necessary to demonstrate the safety, tolerability, efficacy and
dosage of the substance in humans, as well as the ability to produce the
substance in accordance with the FDA's GMP regulations. Data from these
activities are compiled in a New Drug Application ("NDA"), or for biotechnology
products, a Product License Application ("PLA"), for submission to the FDA
requesting approval to market the drug. The third phase, or post-approval phase,
follows FDA approval of the NDA, or PLA, and involves the production and
continued analytical and clinical monitoring of the drug. The post-approval
phase also involves the development and regulatory approval of product
modifications and line extensions, including improved dosage forms, of the
approved product, as well as for generic versions of the approved drug, as the
product approaches expiration of patent or other exclusivity protection.
Similar drug approval processes are required in many non-U.S. jurisdictions.

The following figure illustrates the drug development process and the
component activities involved in each of the three phases. The figure also
illustrates the areas of AAI's service offerings. The process is described in
more detail below.

[The figure is separated into three broad vertical fields, with each
field separated by a narrow column. The left hand field is entitled "The
Preclinical Phase" with three vertical columns of boxes. The left hand column
contains two vertically descending boxes, captioned "Discovery" and "Drug
Screening". The center column contains four vertically descending boxes,
captioned "Scale Up", "Chemistry", "Analysis" and "Formulation", with arrows
pointing in both horizontal directions from the "Analysis" and "Formulation"
boxes, spanning the entire field. The right hand column contains two vertically
descending boxes, captioned "Regulation" and "Stability". Below the boxes is a
row of three broad arrows, aligned under the three columns, captioned, from left
to right, "Discovery", "Animal Toxicology" and "Animal Pharmacology". To the
right of such field is a narrow column with the vertical caption, "IND
Submission and Review". To the right of such column is the broad center vertical
field with the caption, "The Clinical Phase", with three vertical columns of
boxes. The left hand column contains five vertically descending boxes with the
captions, "Phase I Clinical Trials", "Bulk Chemicals", "Dosage Development",
"Clinical Supplies" and "Bioanalytical and Metabolism". The center column
contains four vertically descending boxes with the captions, "Phase II Clinical
Trials", "Clinical Supplies", "Analytical" and "Stability", with arrows pointing
in both directions from the "Stability" box, spanning the entire field. The
right hand column contains four vertically descending boxes, captioned "Phase
III Clinical Trials", "Production Validation", "SOP's Generated" and
"Regulatory". Below the boxes is a row of three broad arrows, aligned under the
three columns, captioned, from left to right, "Human Toxicology", "Human
Pharmacology" and "Efficacy". To the right of such field is a narrow column with
the vertical caption, "NDA Submission and Review". To the right of such column
is the broad right hand vertical field with the caption, "The Post-Approval
Phase", with three vertical columns of boxes. The left hand column contains
three vertically descending boxes with the captions, "Phase IV Clinical Trials",
"Production" and "QA/QC". The center column contains three vertically descending
boxes with the captions, "Product Improvements", "Stability" and "Analytical",
with arrows pointing in both horizontal directions from the "Stability" and
"Analytical" boxes, spanning the entire field. The right hand column contains
four vertically descending boxes with the captions, "Production", "Formulation",
"Regulatory" and "Bioequivalence", with the "Bioequivalence" box shifted
one-half column to the left and arrows pointing in both horizontal directions
from the "Bioequivalence" box spanning to the center and right hand columns.
Below the boxes is a row of three broad arrows, aligned under the three columns,
captioned, from left to right, "Production Introduction", "Line Extensions" and
"Generic Competition". The following boxes are shaded to indicate areas of
services currently provided by AAI: left hand field "Chemistry", "Analysis",
"Formulation", "Regulatory" and "Stability"; center field, "Dosage Development",
"Bioanalytical and Metabolism", "Analytical", "Stability", "Production
Validation", "SOP's Generated", "Regulatory", "Phase I Clinical Trials", "Phase
II Clinical Trials", "Phase III Clinical Trials" and both "Clinical Supplies"
boxes; right hand field, "QA/QC", "Phase IV Clinical Trials", "Product
Improvement", "Stability", "Analytical", "Formulation", "Regulatory" and
"Bioequivalence".]

THE PRECLINICAL PHASE

The development of a new pharmaceutical agent begins with the discovery
or synthesis of a new molecule. These agents are screened for pharmacological
activity using various animal and tissue models, with the goal of selecting a
lead agent for further development. Additional studies are conducted to confirm
pharmacological activity, to generate safety

<PAGE> 26

data and to evaluate prototype dosage forms for appropriate release and activity
characteristics. Protocols for these studies are designed in anticipation of
fulfilling regulatory requirements. Once the pharmaceutically active molecule is
fully characterized, an initial purity profile of the agent is established.
During this and subsequent stages of development, the agent is analyzed to
confirm the integrity and quality of material produced. In addition, development
and optimization of the initial dosage forms to be used in clinical trials are
completed, together with analytical models to determine product stability and
degradation. Upon successful completion of preclinical safety and efficacy
studies in animals, an IND submission is prepared and provided to the FDA for
review prior to human clinical trials. The IND submission consists of the
initial chemistry, analytical, formulation and animal testing data generated
during the preclinical phase. The review period for an IND submission is 30
days, after which, if no comments are made by the FDA, the product candidate can
be studied in Phase I clinical trials.

The process for the development of biotechnology products parallels the
process outlined above. Biotechnology products frequently are large proteins,
with activity that is different from the activity of small, organic molecules.
Proteins may be coupled with other biologically active molecules, such as lipids
or sugars, for enhanced or modified biological activity. Biotechnology products
may be composed of the building blocks of DNA. Because of the diversity of the
nature of biotechnology products and their substantial molecular size (usually
hundreds of times larger than small, organic molecules), special technology is
required for their production, as well as their subsequent analysis. In
addition, highly sophisticated analytical techniques are required to
characterize the structure of these molecules.

Biotechnology products, especially proteins, may be produced with living
cells. Purity testing can be complex since living cells may harbor viruses and
other agents. The potential presence of these agents, and the requirement to
establish degradation profiles and identify impurities associated with
production and purification, further require establishing, validating and
conducting specialized tests and assays. Formulation development in this area is
often more complex than for small, organic drug substances. Generally, molecules
produced using recombinant DNA technology are inherently less stable than their
organic counterparts because structural integrity must be maintained through
administration and distribution of the product. Accordingly, certain aspects of
the development process for biotechnology products may be more challenging than
similar aspects encountered in the development of small, organic molecules.

THE CLINICAL PHASE

Following successful submission of an IND application, the sponsor is
permitted to conduct Phase I human clinical trials in a limited number of
healthy individuals to determine the drug's safety and tolerability which
analyses include bioanalytical assays to determine the availability and
metabolization of the active ingredient following administration. Prior to
conducting these early stage toxicology trials, the drug sponsor must secure
bulk supply of the active ingredient to support the necessary dosing of the
Phase I trials.

Phase II clinical trials involve administering the drug to individuals
who suffer from the target disease or condition to determine the drug's
potential effectiveness and ideal dose, and may involve Phase II-A clinical
trials in which drugs are administered to target patients housed at controlled
clinical facilities. These pharmacology trials require scale up for manufacture
of increasingly larger batches of bulk chemical. These batches require
validation analysis to confirm the consistent composition of the product. When
further safety (toxicology), tolerability and an ideal dosing regimen have been
established, Phase III clinical trials involving large numbers of patients are
conducted to verify the efficacy and long-term safety of the drug. Throughout
the clinical phase, samples of the product made in different batches are tested
for stability to establish shelf life constraints. In addition, large-scale
production protocols and written standard operating procedures ("SOPs") for each
aspect of commercial manufacture and testing must be developed.

After the successful completion of Phase III clinical trials, the sponsor
of the new drug submits an NDA, or PLA, to the FDA requesting that the product
be approved for marketing. An NDA, or PLA, is a comprehensive, multi-volume
application that includes, among other things, the results of all preclinical
and clinical studies, information about the drug's composition and the sponsor's
plans for producing, packaging and labeling the drug. The FDA's review may be
accelerated from a few months, for drugs related to life-threatening
circumstances, to many years, with the average review lasting two and one-half
years. Prior to granting approval, the FDA generally conducts an inspection of
the facilities, including outsourced facilities, that will be involved in the
manufacture, packaging, testing and control of the drug product for GMP
compliance. Drugs that successfully complete NDA or PLA review may be marketed
in the United States, subject to all conditions imposed by the FDA.

<PAGE> 27

THE POST-APPROVAL PHASE

Following NDA or PLA approval, the drug manufacturer must comply with
quality assurance and quality control requirements throughout production and
must continue chemical analytical and stability studies of the drug in
commercial production to continue to validate production processes and confirm
product shelf life. Raw materials must be analyzed prior to use in production,
and samples from each manufactured batch must be tested prior to release of the
batch for distribution to the public. Failure to comply with FDA regulations in
manufacturing or testing during this phase could result in severe sanctions,
including product recalls or closing of facilities.

PATENT EXPIRATION AND GENERIC DEVELOPMENT

Typically, a drug sponsor obtains patent protection for a new chemical
entity commencing upon initial discovery. Due to the length of the development
and regulatory review processes, a significant portion of the patent exclusivity
period expires prior to the initial marketing of the product. As patent
expiration ensues, the sponsor may extend the brand life of the product by
developing new formulations, including line extensions and improved or extended
dosage forms or strengths, improved taste of an orally administered product,
modifications to drug absorption to reduce the time of onset of therapeutic
activity and improvements to the stability of the product. The new product must
be tested for stability, and additional clinical toxicology studies may be
performed. Upon completion of all necessary studies, a supplemental NDA is filed
with the FDA requesting approval to market the modified product. In certain
circumstances, the sponsor may obtain three years of additional marketing
exclusivity for the modified product.

As a drug's patent expires, the drug is subject to generic competition.
Generic products must be approved by the FDA through the submission of an
Abbreviated New Drug Application ("ANDA"). In general, a generic product is
developed with the goal of being classified by the FDA as therapeutically
equivalent to an FDA-approved reference product (i.e., the innovator's product).
Such a rating would permit the substitution of the generic product by pharmacies
for the prescribed reference product. To establish therapeutic equivalence, the
generic product must contain the same active ingredients, be of the same dosage
form and provide the same strength and route of administration as the reference
product. In addition, the generic formulation must also satisfy prescribed
standards of strength, quality, purity and identity and must be shown in
bioequivalency studies with healthy individuals to produce a rate and extent of
absorption of active ingredients not significantly different from those of the
reference product. The FDA does not require the generic drug sponsor to
separately demonstrate the safety or efficacy of the generic form if it is shown
to be therapeutically equivalent to an existing FDA-approved product.
Accordingly, the development period for generic products is typically shorter
when compared to the development period for new drug products. In addition, the
regulatory review of an ANDA is generally considerably shorter than for an NDA.

As the foregoing figure and discussion illustrate, the drug development
process requires multiple services often conducted in parallel. Any capacity
constraints in any area of the process could severely limit the ability of a
drug company to develop a pipeline of products.

STRATEGY

The Company's objective is to be the leading provider of drug development
and support services to the worldwide pharmaceutical and biotechnology
industries and to continue to leverage its development expertise to expand its
internal development of drugs and drug technologies. The Company believes that
its customer-focused approach enables it to serve as a value-added partner in
solving complex product development problems, providing cost-effective results
on an accelerated basis. Further, its broad services assist clients with
virtually all aspects of product support and GMP compliance during commercial
manufacture. The Company believes that its reputation for high quality,
innovative, reliable and efficient services, its capital investment in
state-of-the-art equipment and facilities, skilled and experienced professional
staff, and expertise in performing critical development and support services
represent barriers to entry in its market. The Company believes that these
factors provide the Company with an opportunity to continue to compete
successfully in this growing market. The Company's strategy is to:

OFFER BREADTH OF HIGH QUALITY SERVICES

The Company consistently invests in personnel, facilities, technology and
information systems to provide its clients with a broad range of high quality
development and support services. AAI has built the internal technical expertise
to

<PAGE> 28

address difficult product challenges spanning the drug development process. For
each development project, the Company assigns a team of highly qualified
scientists and technicians that interacts with clients throughout a project's
duration. The Company intends to expand its development capabilities by adding
services that are complementary to its existing product development and support
services. The Company intends to cover most significant aspects of
pharmaceutical and biotechnology product development, offering clients a source
for seamless product development and support.

INVEST IN STATE-OF-THE-ART FACILITIES

The Company intends to continue to invest in state-of-the-art equipment
and facilities to further increase the quality and breadth of its services, as
well as to improve productivity. For example, during the third quarter of 1996
the Company added a containment suite to permit the development of potent
compounds. In addition, through its acquisition of L.A.B., the Company added
advanced analytical equipment, significantly enhancing its bioanalytical
capabilities and expanded the breadth of its clinical trials capabilities. The
Company also plans to expand its biotechnology expertise by adding virology
capabilities and to increase its clinical supply manufacturing capabilities by
adding facilities for manufacturing sterile injectable products. The Company
intends to invest on an ongoing basis in advanced and automated equipment and
facilities to improve productivity and quality and maintain its competitive
position.

EXPAND GEOGRAPHICALLY

The Company believes that establishing a presence in certain domestic and
international regions will enable the Company to more effectively compete for
services that require rapid turnaround and for certain biotechnology business.
In addition, the Company believes that geographic expansion will offer it access
to additional pools of talented professional and technical staff. Further,
adding facilities outside the United States also permits the Company to provide
services without certain regulatory restrictions applicable to delivery and
testing of substances in the United States. The addition of L.A.B's facilities
and expertise is a key step in implementing this strategy. The acquisition of
L.A.B. added operating facilities in Germany and other units in France, England,
Netherlands and Hungary, as well as access to China through a joint venture. In
addition, in acquiring L.A.B., the Company added approximately 250 scientists,
technicians and support personnel (more than 40 of which hold Ph.D. or M.D.
degrees, or their U.S. equivalent). The Company intends to add facilities in the
northeast and on the west coast, as well as in targeted international markets.
Further geographic expansion may be accomplished by internal growth,
acquisitions or joint ventures.

LEAD IN INFORMATION TECHNOLOGY

The Company believes that superior information technology is essential to
expand operations geographically and to provide innovative services to clients
to enable clients to better monitor their projects and expedite regulatory
review. Accordingly, the Company operates a customized data management system
which connects approximately 125 analytical instruments, permitting automated
data capture. In addition, the Company's proprietary laboratory tracking system
("LTS") tracks the status of each project being performed by the Company,
including the time expended by Company personnel for each step of the project,
permitting the Company to quantify capacity issues and schedule additional
projects.

The Company is currently operating a pilot-phase system providing certain
domestic and international clients secure access to in-progress laboratory data.
This system will allow a client to monitor directly the status of its project,
enabling the client to make immediate changes to the scope and format of the
project. The Company believes this system will allow development to be completed
more efficiently and, accordingly, at a lower cost to its clients. In addition,
the Company intends to offer its clients secure, on-line access through the
Internet to review all of the data generated through the development process on
their individual projects. The Company anticipates that this data management
system may lead to shortened regulatory-review periods for products submitted by
clients using the Company's system because the regulatory agencies will have
on-line access to client data in support of an application.

EXPAND INTERNAL DEVELOPMENT PROGRAM

The Company intends to dedicate a significant proportion of its
development capabilities to internal product and technology development with the
objective of licensing marketing rights to third parties. As part of this
strategy, the Company has entered into selected shared-risk development projects
providing for license payments and royalties following successful completion of
the project based upon net sales or profits. The Company does not intend to
independently

<PAGE> 29

commercialize products developed internally or otherwise directly compete with
its clients in the marketing or distribution of products and, accordingly,
believes that its internal development efforts are complementary to its clients'
development needs. Because of the significant time required for development and
approval of pharmaceutical products, the Company has only recently begun to
recognize significant license revenue from its internal drug and technology
development efforts.

SERVICES

The Company provides a broad array of drug development services,
including chemical analysis, synthesis and other laboratory services;
formulation development; clinical trial services; clinical supply and niche
manufacturing; and regulatory and compliance consulting. The Company assigns
project management teams consisting of customer service representatives and
technical employees that meet with clients at frequent intervals to monitor and
guide projects through the development process. Continual client interaction
allows the Company to efficiently manage the drug development process.

Historically, the Company's laboratory services account for approximately
one half of its fee-for-service revenue, although relative amounts vary from
year to year. Formulation development projects and clinical supply and niche
manufacturing generally have contributed the major portions of remaining annual
fee- for-service revenue. With the addition of L.A.B., the Company anticipates
that clinical trials services will contribute significantly to total revenues.

LABORATORY SERVICES

In support of drug development and compliance programs, the Company
offers laboratory services to characterize and measure drug components and
impurities. The Company has over 17 years' experience in providing analytical
testing services dedicated exclusively to the drug industry and has developed
the scientific expertise, state-of-the-art equipment and broad range of
scientific methods to accurately and quickly analyze almost any compound or
product. The Company's laboratory services include method development and
validation; stability studies; raw materials and release testing; biotechnology,
microbiology and bioanalytical testing; product characterization and organic
synthesis.

METHOD DEVELOPMENT AND VALIDATION. The Company develops and validates
methods used in a broad range of laboratory testing necessary to determine
physical or chemical characteristics of compounds. Analytical methods are
developed to demonstrate potency, purity, stability or physical attributes.
These methods are validated to ensure the data generated by these methods are
accurate, precise, reproducible and reliable and are used throughout the drug
development process and in product support testing.

STABILITY STUDIES. The Company provides stability testing and secure
storage facilities necessary to establish and confirm product purity, potency
and other shelf-life characteristics. Stability testing is required at all
phases of product development, from dosage form development through commercial
production, to confirm shelf life of each manufactured batch. The Company
maintains state-of-the-art controlled climate facilities in the United States
and Germany to determine the range of storage conditions the product can
withstand. FDA regulations and the regulations of European regulatory
authorities require that samples of clinical and commercial products placed in
stability chambers be analyzed in a timely fashion after scheduled "pull points"
occur, based on the date of manufacture. The Company's proprietary LTS systems
track client products maintained at the Company's stability storage facilities
and automatically schedules required testing as pull points occur.

RAW MATERIALS AND PRODUCT RELEASE TESTING. The Company offers testing
required by the FDA to confirm that raw materials used in production and
resulting finished products are consistent with established specifications. Due
to the incorporation of "just in time" inventory control systems and variations
in client production schedules, release testing for both raw materials and the
finished product often cannot be scheduled by clients in advance, yet must be
performed immediately. The Company believes that its internal scheduling
systems, analytical laboratory expertise and systems for prompt testing provide
it with a competitive advantage in providing both raw material and batch release
testing. The Company believes that this service enhances its client's confidence
in adopting cost-saving "just in time" inventory control systems.

BIOTECHNOLOGY ANALYSIS AND SYNTHESIS. Although the types of analytical
investigations of biotechnology products are similar to those required for more
traditional pharmaceutical products, the complex molecular structure of many

<PAGE> 30

biotechnology products requires different technology and expertise. The Company
provides a broad array of biotechnology services, including both analytical and
biological testing and method development and validation. AAI's breadth of
services allows the Company to rapidly deduce and characterize the complex
structure of the biotechnology product and measure the molecule or its
metabolites in human blood plasma to support clinical trial evaluation. The
Company has expertise in a broad spectrum of biochemical and immunochemical
methods for characterization and analysis of biotechnology drugs. These methods
include amino acid sequencing, amino acid analysis, peptide mapping,
carbohydrate and lipid analysis and electrophoresis. The Company also has
expertise in developing chromatographic methods that precisely evaluate the
purity and stability of biotechnology products. This service breadth and
diversity of analytical skills and technologies position the Company to assist
its clients from early product development through the IND and PLA stages and
commercial production.

MICROBIOLOGICAL TESTING. Microbiological testing is an essential
indicator to ensure that a drug product, whether raw material or finished
product, does not contain harmful micro-organisms. The Company has significant
experience conducting various microbial tests to identify and quantify micro-
organisms that may be present, including limulus amebocyte lysate (LAL) testing,
which measures toxic byproducts of micro-organisms, and particulate matter
testing to determine the presence of foreign matter in injectable drug products.
The Company also performs sterility testing to identify the genus and species of
any micro-organisms that are present. In addition, the Company performs tests to
determine the effectiveness of antibiotics against micro-organisms and the
minimum levels of preservatives necessary in product formulations.

The Company also assists clients with environmental monitoring, including
water and air systems testing, using an automated biochemical system to identify
micro-organisms present and determine whether such systems are within applicable
microbial limits. The Company assists clients in validating their environmental
control systems to ensure compliance with GMP regulations.

BIOANALYTICAL TESTING. The Company offers bioanalytical testing services
to support clinical trials, analyzing plasma samples to characterize the
metabolized forms of the drug and determine the rate of absorption.
Bioanalytical studies of new drugs often present challenging and complex issues,
with products being metabolized into multiple active and inactive forms, each of
which must be measured. The Company works with its clients to develop and
validate analytical methods to permit detection and measurement of the various
components to trace levels. The acquisition of L.A.B. significantly enhanced the
Company's bioanalytical capabilities.

PRODUCT CHARACTERIZATION. The Company has the expertise and instruments
required to identify and characterize a broad range of chemical entities.
Characterization analysis identifies the chemical composition, structure and
physical properties of a compound, and characterization data forms a significant
portion of a regulatory application. The Company uses numerous techniques to
characterize the compound, including spectroscopy, chromatographic analysis and
other physical chemistry techniques. Additionally, the Company uses such
information for control testing to be performed throughout development and
marketing to confirm consistent drug composition. Once appropriate test methods
are developed and validated, and appropriate reference standards (highly pure
samples) are characterized and certified, the Company can assist clients by
routinely testing compounds for clinical and commercial use.

ORGANIC SYNTHESIS. The Company develops synthesis methods for producing
experimental quantities of new compounds needed for analytical characterization,
toxicological studies, formulation development and clinical trials. Through
organic synthesis techniques, the Company can produce reference standards of the
active compound, specific impurities, degradation by-products, bioassay
reference standards or molecular analogs to permit sufficient quantities of such
compounds to be separately characterized and studied.

FORMULATION DEVELOPMENT SERVICES

The Company provides integrated formulation development services,
enabling the Company to take a client's compound and develop a safe and stable
product with desired characteristics. The Company believes its formulation
expertise and extensive analytical capabilities enable it to provide an
efficient, seamless development program, with a dedicated project team tracking
the product through all stages of formulation development. The Company provides
formulation development services to its clients during each phase of the drug
development process, from new compounds and modifications of existing products
to generic versions of branded products. The Company's formulation development

<PAGE> 31

projects may support a small segment of critical development activities or may
last for several years going from early formulation development to optimized and
validated production-scale, packaged product.

The Company's formulation development expertise spans a broad spectrum of
therapeutic areas. The Company works with clients to develop products with
desired characteristics, including dosage form, strength, release rate,
absorption properties, stability and appearance. The Company has developed
significant product and process "know-how" that enable it to more efficiently
solve the complex problems that arise in developing formulations with targeted
characteristics and has developed a range of proprietary product technologies
that allow it to better achieve desired results in product design and
development.

In providing formulation services, the Company works closely with clients
to design and conduct feasibility studies to chart the potential of formulating
a drug using a combination of active drug ingredients and inert "filler"
materials called excipients. Using experimental designs, initial prototype
formulations are prepared to identify potential problems in stability,
bioavailability and manufacturing. Generally, formulation development is an
iterative process, with numerous initial formulations being modified as problems
are encountered. The Company believes its experience and expertise in
formulation development, as well as certain proprietary technologies, permit it
to design efficient protocols for identifying and optimizing prototypes with the
greatest potential.

Upon selection of the final product prototypes, the Company develops
protocols to scale the product batch size from development stage (hundreds to
thousands of units) to clinical scale (thousands to millions of units). During
the clinical phase the Company refines the formulation in response to clinical,
bioanalytical and stability data. The manufacturing scale-up process involves
identifying and resolving manufacturing problems to facilitate an efficient
transfer to the full-scale production equipment of the Company's clients.
Throughout the development process, the Company develops and validates the
analytical methods necessary to test the product to establish and confirm
product specifications.

In addition to new drug development, the Company offers product
modification and line extension services to clients, generally for marketed
products facing patent expiration. Modifications of existing products offer the
Company's clients an opportunity to improve product characteristics, increasing
product market viability. Improved product characteristics include enhancement
of stability, absorption profiles (e.g., quick or sustained release), taste and
appearance. Product line extensions may include new dosage forms such as solids,
liquids and chewables, as well as new dosage strengths. Product modifications
and line extensions offer clients the opportunity to target new patient
subpopulations and improve patient compliance. The Company also offers
formulation services to clients seeking to develop generic products.

CLINICAL SUPPLY AND NICHE MANUFACTURING

The Company provides clinical trial materials for Phase I through IV
clinical trials, as well as bioequivalency studies of generic products. The
Company has expertise in manufacturing tablets, capsules, sachets, liquids and
suspensions, creams, gels, lotions and ointments. The Company believes that
outsourcing of clinical supply manufacturing is particularly attractive to
pharmaceutical companies that maintain large, commercial-quantity, batch
facilities, where clinical supply manufacturing would divert resources from
revenue-producing manufacturing. Similarly, pharmaceutical companies often seek
to outsource commercial manufacturing of small quantity products. In addition,
the Company provides its clients assistance in scaling up production of clinical
supply quantities to commercial quantity manufacturing, and manufactures
inventory on behalf of clients for commercial sale while client production
facilities are being built and validated.

The Company's manufacturing facilities and equipment are qualified and
validated to operate under GMP regulations.

REGULATORY AND COMPLIANCE CONSULTING

The Company assists in the preparation of regulatory submissions, audits
a client's vendors and client operations, conducts seminars, provides training
courses, and advises clients on applicable regulatory requirements. The Company
also assists clients in designing development programs for new or existing drugs
intended to be marketed in the United States and Europe. At the client's
request, the Company will either review client prepared submissions or draft
sections and assemble regulatory packages and attend FDA meetings with clients.

<PAGE> 32

The Company assists clients in preparation for FDA inspections and
assists them in correcting any deficiencies noted in FDA inspections. In
preparation for an FDA inspection, the Company's regulatory affairs specialists
conduct mock inspections to anticipate FDA observations and advise clients of
appropriate remedial actions. The Company also audits manufacturers of active
and excipient ingredients used in the drug product, as well as packaging
components, on behalf of clients to ensure that the manufacturers' facilities
are in compliance with GMP regulations. Such audits generally include review of
the vendor drug master files, analysis of standard operating procedures, review
of production records, and observation of operations to ensure SOPs are being
followed. Audit reports include recommendations to address any deficiencies. The
Company also advises clients on validation issues concerning their systems and
processes and audits client facilities to assist them in validating their
processes, cleaning, water and air handling systems.

The Company leverages its in-house laboratory training programs by
providing training to clients' employees. In addition, the Company organizes and
conducts seminars worldwide on a number of topical industry issues.

CLINICAL TRIAL STUDIES

The Company opened a 48-bed clinical trial facility at its Research
Triangle Park location in the third quarter of 1996. The clinical trial unit is
located in the same facility as the Company's bioanalytical laboratory and
permits time-sensitive and rapid-response analysis in clinical trials. The
clinical trial unit is initially intended for use in bioequivalency studies of
generic drug products and Phase I clinical trials. With the acquisition of
L.A.B., the Company has expanded its Phase I clinical trial capabilities and
added the ability to conduct Phase II-A studies and multi-center trials focused
in niche therapeutic areas, including hepatic disease, chemotherapeutics and
hormone replacement therapy. L.A.B.'s Neu-Ulm operations include a 120-bed
facility for conducting Phase I and II-A clinical trial studies, as well as
bioequivalency studies.

INTERNAL DRUG AND TECHNOLOGY DEVELOPMENT

The Company intends to dedicate a significant proportion of its technical
resources and operating capacity to internal drug and technology development
with the objective of licensing marketing rights to third parties. The Company
does not intend to independently commercialize products developed internally or
otherwise directly compete with its clients in the marketing or distribution of
products and, accordingly, believes that its internal development efforts are
complementary to its clients' development needs. The Company's internal product
and technology development program has resulted in multiple generic product
applications filed with the FDA. Certain of these products have been licensed or
sold. The internal development program has also resulted in patents covering
drug technology and pending patent applications. L.A.B. also engaged in an
internal product development program with goals similar to those of the Company.
At the time it was acquired by the Company, L.A.B. had numerous products then
licensed to clients and new products in development, targeted primarily for
regulatory approval and licensing in Europe.

Since 1993, the Company has significantly increased its investment in its
internal drug and technology development program. Because of the significant
time required for development and approval of pharmaceutical products, the
Company has only recently begun to recognize significant license revenue from
its internal drug and technology development efforts. The Company anticipates
that licensing revenue, including royalties and milestone payments, from
internal drug and technology development will represent a larger proportion of
its revenue, although there can be no assurance that internal development
projects will yield products that will be approved by the appropriate regulatory
authorities or will be attractive to potential clients. In 1996, the FDA
approved a generic product licensed by the Company to a client which is the
first approved generic version of a branded product that had over $100 million
in sales in 1995. The Company began to recognize royalties on this product in
the fourth quarter of 1996. Although there is a risk that any particular
development project may not produce revenues, the Company believes that the
profit margins from successful drug and technology development projects
potentially exceed the margins on standard fee-for-service engagements.

INTERNAL DRUG DEVELOPMENT

In 1993, the Company began allocating a significant portion of its
technical resources and operating capacity to internal development of generic
drugs. The U.S. generic drug market has expanded sales from approximately $3.5
billion in 1990 to approximately $6.4 billion in 1994. Generic drugs accounted
for an estimated 38% of prescriptions dispensed in the United States in 1994.
The Company anticipates that the growth in the generic drug market will continue
as

<PAGE> 33

managed care organizations pursue policies favoring generic substitution and as
patents on many high revenue products expire over the next several years.

The Company's research and development committee, composed of
representatives from the formulations development, finance, marketing and legal
departments, identifies potential generic drug development candidates for the
program. The committee selects development candidates after reviewing market
size and trends, current therapies and potential advances and patent and
formulation issues. In certain instances, the committee has also invited outside
consultants and medical panels to review selections.

The first group of products in the Company's internal product development
program involved generic versions of certain hormone products. In 1994, as part
of its internal development program, the Company organized Endeavor with certain
financial investors and an affiliate of Berlex Laboratories, Inc. to continue
the development of certain generic hormone products then under development by
AAI. The Company assigned its rights to such products to Endeavor in return for
approximately 47% of Endeavor's equity during a private placement of Endeavor
stock, and the Company entered into a development contract with Endeavor to
continue product development and clinical supply manufacture. AAI currently owns
approximately 40% of the fully diluted common equity of Endeavor, and the
Company's net sales to Endeavor were approximately $6.2 million, $3.5 million
and $2.0 million in 1996, 1995 and 1994, respectively. Endeavor is currently
developing two products in multiple dosage strengths, although there can be no
assurance that such products will ultimately be approved by the FDA. See
"Business -- Endeavor" and "Certain Transactions -- Transactions Involving
Management".

In 1995 the Company entered into an agreement with Aesgen, a company
organized by the Company with an affiliate of Mayo Clinic, MOVA Pharmaceutical
Corporation and certain financial investors, to develop certain generic
products. AAI recognized net sales to Aesgen of $4.7 million and $5.6 million in
1996 and 1995, respectively. In June 1996, the Company sold to Aesgen marketing
rights to a product being developed by the Company. Under the agreement, Aesgen
will pay license fees and additional royalties upon marketing the product,
although there can be no assurance that the product will be approved by the FDA
or marketed. AAI continues to hold a $1.6 million non-voting, non-convertible
preferred stock investment in Aesgen. See "Certain Transactions -- Transactions
Involving Management".

In addition to its development work for Endeavor and Aesgen, the Company
has continued its internal development of products to be licensed to third
parties that have marketing and distribution capabilities. The Company has
entered into numerous license agreements of products which are currently in
development. The terms of the license agreements vary as to amounts of initial
and milestone payments, as well as methods and extent of revenue participation.
While the Company anticipates that most of its product license agreements will
provide that prospective clients will sponsor the approved ANDA, the Company has
made ANDA submissions for internally developed products in its own name which
are currently under review at the FDA.

Continuing to leverage its development capabilities, the Company is
moving beyond generic drug development and has also begun reviewing new
compounds that are chemically similar to currently marketed products with proven
therapeutic and safety profiles, and that offer improved characteristics over
the marketed product. Such improved characteristics would include enhanced
therapeutic indices, reduced side effects, improved bioavailability and improved
pharmacokinetics. Because considerable toxicity data already exist for the
marketed product, the Company believes that new compound modifications or
pro-drugs generally could be developed with less risk of failure and in a
shorter time frame than new chemical entity development. The Company believes
that virtual and limited-resource drug companies provide opportunities to enter
into collaborative ventures to identify and develop this type of compound.

TECHNOLOGY DEVELOPMENT PROGRAM

As an adjunct to the internal development program, the Company has sought
to protect certain intellectual property it has developed relative to the drug
development process. The Company has established a patent committee which meets
quarterly to review employee-generated submissions of possible patentable
subject matter. The patent committee reviews the novelty and usefulness of the
submission and, with input from the marketing department as to commercial
viability, determines to either pursue a patent application or designate the
submission as a trade secret.

The Company's technology development program has yielded multiple issued
patents and has several pending applications. For example, the Company's
patented Pro-Sorb(TM) formulation technology has been shown to facilitate the

<PAGE> 34

oral absorption of a number of non-steroidal anti-inflammatory drugs or NSAIDs,
such as ibuprofen, to reduce gastric irritation and speed the onset of
therapeutic activity. In addition, the Company has patented a novel oral
delivery system for certain biotechnology compounds that may currently be
administered only by injection.

The Company has one licensing agreement for a patented technology for the
manufacture of low-dose products which are typically difficult to uniformly
blend and an additional licensing arrangement for its patented chewable
formulations to mask the otherwise bitter taste of certain ulcer drugs. In June
1996, the Company assigned to a third party certain of its patented technology
for the production of a high-purity active ingredient for a generic drug
product. The Company is seeking licensing partners for its other recently
developed technologies.

ENDEAVOR

The Company owns shares of convertible preferred stock of Endeavor,
representing approximately 40% of the fully diluted common equity. AAI also
provides development services to Endeavor at terms that the Company believes are
no less favorable than terms that would be obtained from an unrelated third
party.

As of the date of this Prospectus, Endeavor has submitted ANDAs for two
products in multiple dosage strengths and has received notice from the FDA
citing certain major deficiencies with the applications. Endeavor is pursuing
both ANDAs. Endeavor does not market any products, has not received approval of
any product and there can be no assurance that the FDA will approve any of its
products. Endeavor's revenues are dependent upon approval of its products, and
continued product development by Endeavor is dependent upon it obtaining product
approvals or additional capital funding. The Company believes that Endeavor
intends to market its products through licensing to third parties.

In addition to his duties at AAI, Frederick D. Sancilio, President of the
Company, serves as a senior management employee and director of Endeavor. Dr.
Sancilio does not maintain an office or have day-to-day responsibilities at
Endeavor and devotes a substantial majority of his time to the management of the
Company. In addition, one other executive officer of AAI serves on Endeavor's
six-member board of directors. See "Certain Transactions -- Transactions
Involving Management".

INFORMATION TECHNOLOGY

The Company has made significant investments in information technology.
The Company's LTS system tracks laboratory workflow and enables the Company to
effectively monitor and plan work through the Company's laboratories. The LTS
system monitors the progress of a client's project, records time expended by
laboratory personnel, tracks sample locations and controls document revisions.
The Company's customized data management system connects approximately 125
analytical instruments with multiple software architectures permitting automated
data capture. In addition, the Company is currently conducting a pilot test of a
system allowing certain domestic and international clients secured access to
review in-progress laboratory data. This system will allow a client to
efficiently monitor the immediate status of the project and make changes to the
scope and format of its project.

The Company believes that superior information technology will enable it
to expedite the development process by designing innovative services for
individual client needs, providing project execution, monitoring and control
capabilities that exceed a client's internal capabilities, streamlining and
enhancing data presentation to the FDA and enhancing its own internal
operational productivity while maintaining its quality. The Company has begun to
develop a database of client information integrating data, documents, electronic
messages, and reference services. The Company intends to make this database
available with secured on-line access through the Internet which would permit
client access to data on its projects at any location worldwide and facilitate
regulatory on-line access to the extensive data necessary to support the
chemistry, manufacturing and control section of a regulatory application. The
Company also believes that this service will allow clients to avoid delays
currently incurred in regulatory staff audits of paper-copy data stored at the
Company's or clients' facilities.

<PAGE> 35

CLIENTS

Over the past six years, the Company has provided services to 24 of the
top 25 pharmaceutical companies in the world as ranked by 1994 research and
development spending. In 1996, the Company provided services under contracts to
hundreds of clients, including some of the largest U.S., European and Japanese
drug companies.

The Company believes that concentration of business among certain large
clients is not uncommon in the CRO industry. The Company has experienced such
concentration in the past and may experience such concentration in the future.
During 1996, Endeavor and Aesgen accounted for 10% or more (approximately 15%
and 11% respectively) of the Company's net sales. Although AAI strives to reduce
its reliance on a limited number of major clients, there can be no assurance
that the Company's business will not be dependent upon certain major clients,
the loss of which could have a material adverse effect on the Company. In
addition, due to the project nature of the Company's business, there can be no
assurance that significant clients in any one period will continue to be
significant clients in other periods. See "Risk Factors -- Dependence on Certain
Industries and Clients".

MARKETING AND BUSINESS DEVELOPMENT

Since its inception, the Company has taken a customer-focused approach in
marketing its services, often placing the Company's technical personnel with its
clients' development teams to participate in planning meetings for the
development of a product. The Company assigns sales and technical personnel as
contacts for its larger clients, understanding that technical personnel may be
better able to identify the full scope of the client's needs and suggest
innovative approaches before the client formally develops the parameters of an
anticipated project. Generally, the Company also hosts more than ten technical
seminars per year for the pharmaceutical and biotechnology industries addressing
a variety of formulation development issues, stability testing and other topics.

CONTRACTUAL ARRANGEMENTS

The Company's fee-for-service contracts are typically evidenced by signed
service estimates establishing an estimated fee for identified services. During
the Company's performance of a project, clients often adjust the scope of
services to be provided by the Company in light of interim project results, at
which time the amount of fees is adjusted accordingly.

Generally, the Company's fee-for-service contracts are terminable by the
client upon notice of 30 days or less, although certain major formulation
development and manufacturing agreements are not unilaterally terminable by the
client. Although the contracts typically permit payment of certain fees for
winding down a project, the loss of a large contract or the loss of multiple
contracts could adversely affect the Company's future revenue and profitability.
Contracts may be terminated for a variety of reasons, including the client's
decision to forego a particular study, the failure of product prototypes to
satisfy safety requirements and unexpected or undesired results of product
testing. See "Risk Factors -- Dependence on Certain Industries and Clients".

BACKLOG

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

The Company believes that its backlog as of any date is not a meaningful
predictor of future results because backlog can be affected by a number of
factors, including variable size and duration of contracts and adjustments in
the scope of a contracted project as interim results become available.
Additionally, contracts generally are subject to termination by clients upon 30
days notice or less. Moreover, the scope of a contract can change over the
course of a project. At December 31, 1996, backlog was approximately $20.3
million, as compared to $19.7 million at December 31, 1995.

<PAGE> 36

COMPETITION

The Company competes primarily with in-house research, development,
quality control and other support service departments of pharmaceutical and
biotechnology companies, as well as university research laboratories. In
addition, the Company believes that although there are numerous competitors in
its industry, there are few competitors that offer the broad array of services
that it provides. The largest competitor offering these services is Covance Inc.
(formerly known as Corning Pharmaceutical Services, Inc., a subsidiary of
Corning, Inc.). Certain of the Company's competitors, including Covance Inc.,
may have significantly greater resources than the Company. Competitive
conditions for service areas vary.

Competitive factors include reliability, turn-around time, reputation for
innovative and quality science, capacity to perform numerous required services,
financial viability and price. The Company believes that it competes favorably
in these areas.

POTENTIAL LIABILITY AND INSURANCE

The Company maintains product liability and professional errors and
omissions liability insurance, providing $5 million in coverage on a claims-made
basis. In addition, in certain circumstances the Company seeks to manage its
liability risk through contractual provisions with clients requiring the Company
to be indemnified by the client or covered by clients' product liability
insurance policies. In addition, in certain types of engagements, the Company
seeks to limit contractual liability to its clients to the amount of fees
received by the Company. The contractual arrangements are subject to negotiation
with clients and the terms and scope of such indemnification, liability
limitation and insurance coverage vary from client to client and from project to
project. Although most of the Company's clients are large, well-capitalized
companies, the financial performance of these indemnities is not secured.
Therefore, AAI bears the risk that the indemnifying party may not have the
financial ability to fulfill its indemnification obligations or that liability
would exceed the amount of applicable insurance. In addition, the Company could
be held liable for errors and omissions in connection with the services it
performs. There can be no assurance that the Company's insurance coverage will
be adequate or that insurance coverage will continue to be available on terms
acceptable to the Company. In connection with providing clinical trial services,
the Company contracts with physicians to serve as investigators in conducting
clinical trials to test new drugs on human volunteers. Such testing creates risk
of liability for personal injury to or death of volunteers, particularly to
volunteers with life-threatening illnesses, resulting from adverse reactions to
the drugs administered. Although the Company does not believe it is legally
accountable for the medical care rendered by third party investigators, it is
possible that the Company could be held liable for the claims and expenses
arising from any professional malpractice of the investigators with whom it
contracts or in the event of personal injury to or death of persons
participating in clinical trials. The Company also could be held liable for
errors or omissions in connection with the services it performs. In addition, as
a result of its clinical trial facilities, the Company could be liable for the
general risks associated with a clinical trial facility including, but not
limited to, adverse events resulting from the administration of drugs to
clinical trial participants or the professional malpractice of clinical trial
medical care providers. The Company believes that its risks are reduced by
contractual indemnification provisions with clients and investigators, insurance
maintained by clients and investigators and by the Company, various regulatory
requirements, including the use of institutional or ethical review boards and
the procurement of each volunteer's informed consent to participate in the
study. Contractual indemnification generally does not protect the Company
against certain of its own actions such as negligence, and contractual
arrangements are subject to negotiation with clients and the terms and scope of
such indemnification vary from client to client and from trial to trial. See
"Risk Factors -- Potential Liability and Risks of Operations".

GOVERNMENT REGULATION

The services performed by the Company are subject to various regulatory
requirements designed to ensure the quality and integrity of pharmaceutical
products, primarily under the Federal Food, Drug and Cosmetic Act and associated
GMP regulations which are administered by the FDA in accordance with current
industry standards. Services being performed outside the United States or for
products intended to be substituted to non-U.S. jurisdictions may be subject to
additional regulatory requirements. U.S. regulations apply to all phases of drug
manufacture, testing and record keeping, including personnel, facilities,
equipment, control of materials, processes and laboratories, packaging,
labelling and distribution. Noncompliance with GMP by the Company in a project
could result in disqualification of data collected by the Company in the
project. Material violation of GMP requirements could result in additional
regulatory sanctions,

<PAGE> 37

and in severe cases could result in a mandated closing of the Company's
facilities which would materially and adversely affect the Company's business.

To help assure compliance with applicable regulations, the Company has
established quality assurance controls at its facilities that monitor ongoing
compliance by auditing test data and regularly inspecting facilities, procedures
and other GMP compliance parameters. In addition, FDA regulations and
guidelines, as well as applicable international standards, serve as a basis for
the Company's standard operating procedures. Certain of the Company's
development and testing activities are subject to the Controlled Substances Act,
administered by the Drug Enforcement Agency (the "DEA"), which regulates
strictly all narcotic and habit-forming substances. The Company maintains
separate, restricted-access facilities and heightened control procedures for
projects involving such substances due to the level of security and other
controls required by the DEA.

The Company's activities involve the controlled use of hazardous
materials and chemicals. The Company is subject to federal, state and local laws
and regulations governing the use, storage, handling and disposal of such
materials and certain waste products. Although the Company believes that its
safety procedures for handling and disposing of such materials comply with the
standards prescribed by federal, state and local laws and regulations, the risk
of accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an accident, the Company could be held liable
for any damages that result which could materially and adversely affect the
financial condition of the Company.

EMPLOYEES

At December 31, 1996, the Company, including L.A.B., had approximately
750 full-time equivalent employees, of which approximately 75 hold Ph.D. or M.D.
degrees, or their U.S. equivalent. The Company believes that its relations with
its employees are good. None of the Company's U.S.-based employees is
represented by a union. German law provides certain representative rights to
employees.

The Company's performance depends on its ability to attract and retain
qualified professional, scientific and technical staff. The level of competition
among employers for such skilled personnel is high. The Company believes that
its employee benefit plans, including its health benefit, profit-sharing and
employee stock option plans, enhance employee morale, professional commitment
and work productivity and provide an incentive for employees to remain with the
Company. In addition, the Company operates a 65-child, employee day-care
facility at its Wilmington, North Carolina campus as a benefit to its employees
and is expanding this facility. While the Company has not experienced any
significant problems in attracting or retaining qualified staff, there can be no
assurance that the Company will be able to avoid these problems in the future.

All employees enter into confidentiality agreements protecting the
Company's proprietary information, as well as client-confidential material. New
U.S.-based technical employees are generally required to sign non-competition
agreements, prohibiting the employee from engaging in activities in competition
with the Company for a period of one year after termination of employment.

LEGAL PROCEEDINGS

The Company is a party in an action, Kurtzman v. Applied Analytical
Industries, Inc., involving a claim by a former management employee for damages
arising from his termination of employment. In such matter, the former employee
alleged that a contract of employment existed between him and the Company for a
term of years. In 1995, a judgment for approximately $363,000 was entered
against the Company following a jury trial. The Company has recorded the full
amount of such judgment as an expense in its 1995 financial statements. In
February 1997, the North Carolina Court of Appeals affirmed the judgment and
overturned the trial court's decision not to award prejudgment interest. The
Company is seeking to appeal the case to the North Carolina Supreme Court. In
connection with the investment in November 1995 by the holders of the Preferred
Stock, James L. Waters and Frederick D. Sancilio (directors and significant
stockholders of the Company) have agreed to indemnify the Company for the
$363,000 judgment and prejudgment interest in the event that the Company is
ultimately required to pay such amount. See "Certain Transactions --
Transactions Involving Management".

<PAGE> 38

The Company is a party to a law suit commenced on December 19, 1996 in
U.S. District Court for the Eastern District of Pennsylvania by Maganin
Pharmaceutical, Inc. ("Maganin"). Maganin has alleged that the Company was
negligent in preparing a batch of clinical trial materials with an alleged value
of $450,000. The Company believes it has several defenses to the merits of such
allegations and plans to vigorously defend this litigation.

FACILITIES

The Company's principal executive offices are located in Wilmington,
North Carolina, in a 19,000-square foot leased facility. The Company's primary
U.S. facilities are located in Wilmington and Research Triangle Park, North
Carolina constituting approximately 150,000 square feet of operational and
administrative space. The Company's primary European facilities are located in
Neu-Ulm, Germany and include over 120,000 square feet of operational and
administrative space. This facility is leased under a renewable lease expiring
in 2001. The Company maintains other operating units at leased facilities in
Stuttgart and Munich, Germany; Paris, France; London, England; Arnheim,
Netherlands and Budapest, Hungary. The Company maintains sales offices in
Raleigh, North Carolina; Chicago, Illinois; Boston, Massachusetts; San Diego and
San Francisco, California; Elmwood Park, New Jersey; San Juan, Puerto Rico;
Copenhagen, Denmark; London, England; Milan, Italy and Tokyo, Japan. The Company
believes that its facilities are adequate for the Company's operations and that
suitable additional space will be available when needed.

<PAGE> 39

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth the names, ages and titles of the
individuals who are directors and executive officers of the Company:

<TABLE>
<CAPTION>
OFFICER OR DIRECTOR AGE POSITION
------------------- --- --------

<S> <C> <C>
Frederick D. Sancilio, Ph.D. 47 Chairman of the Board of Directors and President

William H. Underwood 49 Executive Vice President, Chief Operating Officer and Director

Anthony F. Arato 49 Vice President, Manufacturing and Engineering

Mark P. Colonnese 41 Vice President, Chief Financial Officer and Treasurer

Martin S. Hunicutt 46 Vice President, Marketing and Sales

James Swarbrick, Ph.D. 63 Vice President, Research and Development

R. Forrest Waldon 34 Vice President, General Counsel and Secretary

Joseph H. Gleberman 39 Director

Charles D. Moseley, Jr 54 Director

John M. Ryan 52 Director

James L. Waters 71 Director
</TABLE>

Frederick D. Sancilio, Ph.D., is Chairman of the Board of Directors and
President of the Company. With more than 20 years' experience in the
pharmaceutical industry, Dr. Sancilio worked with Burroughs-Wellcome Co.,
Schering-Plough Corporation, and Hoffmann-LaRoche, Inc. before founding the
Company in 1979. He has published more than 30 scientific articles discussing
various aspects of pharmaceutical chemistry and regularly makes scientific
presentations at pharmaceutical seminars and meetings worldwide.

William H. Underwood has served as Chief Operating Officer since 1995,
as Executive Vice President of the Company since 1992, as Vice President from
1986 to 1992, and as a director since January 1996. He has held positions in the
pharmaceutical and cosmetic industries for more than 17 years, in positions
including Director of Quality Assurance and Director of Manufacturing at Mary
Kay Cosmetics, Inc. and Group Leader of Bacteriological Quality Control at
Burroughs-Wellcome Co.

Anthony F. Arato joined AAI in 1981 and currently serves as Vice
President of Manufacturing and Engineering. Over the past decade he has served
in numerous capacities and management positions. Prior to joining AAI, Mr. Arato
was employed for eight years as a field engineer for Perkin-Elmer Corporation.

Mark P. Colonnese joined AAI in 1993 and currently serves as Vice
President, Chief Financial Officer and Treasurer. Prior to joining AAI, Mr.
Colonnese worked as a financial executive at Schering-Plough Corporation for ten
years, most recently as Senior Director of Planning and Business Analysis.

Martin S. Hunicutt joined AAI in 1994 as Vice President of Marketing
and Sales. Prior to joining AAI, Mr. Hunicutt worked for 19 years in a variety
of capacities for Burroughs-Wellcome Co. Mr. Hunicutt's experience includes
service as marketing project director for a major pharmaceutical product,
director of marketing with responsibilities for both marketed and pre-launch
products, and product manager with commercial management responsibilities.

<PAGE> 40

James Swarbrick, Ph.D., joined the Company in 1993 as Vice President of
Research and Development. Prior to joining the Company, Dr. Swarbrick was
Professor and Chairman of the Division of Pharmaceutics and Director of Graduate
Studies in the School of Pharmacy at the University of North Carolina at Chapel
Hill. Dr. Swarbrick serves on the FDA's Generic Drugs Advisory Committee and
serves as Chairman of the Pharmaceutical Research and Manufacturers Association
Foundation's Pharmaceutics Advisory Committee and is a member of that
organization's Scientific Advisory Committee. Dr. Swarbrick has published
extensively in areas of pharmaceutics and product development with more than 60
research publications to date and is co-author of Physical Pharmacy, a graduate
text, and senior co-author of the Encyclopedia of Pharmaceutical Technology,
which is used throughout the pharmaceutical industry.

R. Forrest Waldon has served as the Company's General Counsel and
Secretary since 1989 and as a Vice President since 1993. Prior to joining AAI,
Mr. Waldon was a corporate attorney with the Atlanta, Georgia law firm of
Thrasher & Whitley, P.C.

Joseph H. Gleberman joined the Company's Board of Directors in 1995.
Mr. Gleberman has been employed by Goldman, Sachs & Co. since 1982, where he has
been a Managing Director since 1997 and a Partner since 1990. Mr. Gleberman
serves as a director of Biofield Corporation and Diagnostic Holdings, Inc.

Charles D. Moseley, Jr. has served as a director of the Company since
January 1996. Since 1983, Mr. Moseley has been a partner of Noro-Moseley
Partners, a venture capital firm. Mr. Moseley is also a director of One Price
Clothing Stores, Inc. and several privately held companies.

John M. Ryan has served as a director of the Company since January
1996. Mr. Ryan serves as managing partner of Ryan Partners, a business advisory
and venture capital firm he founded in July 1996. Prior to founding Ryan
Partners, Mr. Ryan served as a partner of Coopers & Lybrand, L.L.P., an
accounting firm, with which he was associated from 1972 to 1996. Mr. Ryan has
served as a director of numerous private companies and as an officer and
director of several not-for-profit corporations.

James L. Waters has served as a director of the Company since 1981 and
as a non-employee officer from 1982 until 1996. Mr. Waters is a private investor
in numerous companies and was the founder of Waters Associates, Inc., now known
as Waters Corporation, a scientific instrumentation manufacturer.

The Board of Directors is classified, with directors serving staggered
three-year terms, with Messrs. Underwood and Sancilio serving terms expiring at
the 1997 annual meeting of stockholders, Messrs. Moseley and Waters serving
terms expiring at the 1998 annual meeting and Messrs. Ryan and Gleberman serving
terms expiring at the 1999 annual meeting. Pursuant to a Stockholder Agreement
among the Company and its stockholders entered into in November 1995 in
connection with the purchase by GS Capital Partners II, L.P., GS Capital
Partners II Offshore, L.P., Goldman, Sachs & Co. Verwaltungs GmbH, Stone Street
Fund 1995, L.P. and Bridge Street Fund 1995, L.P. (the "Goldman Investors") and
others of the Preferred Stock, the Goldman Investors have the right to designate
one member of the Board of Directors for so long as the Goldman Investors and
their affiliates (which includes Goldman, Sachs & Co.) beneficially own 10% or
more of the outstanding shares of the Common Stock. Mr. Gleberman currently
serves on the Board of Directors as the Goldman Investors' designee. Immediately
following the completion of this Offering, and assuming no additional shares of
Common Stock are acquired by the Goldman Investors or their affiliates in this
Offering, such persons would beneficially own 14.3% of the outstanding shares of
Common Stock. Pursuant to the employment agreement between the Company and Dr.
Sancilio, the Company is required to use its best efforts to cause Dr. Sancilio
to be re-elected to the Board of Directors during the term of his employment.
See "-- Employment and Compensation Agreements". In addition, certain
stockholders have entered into agreements under which certain of them have the
right to designate members of the Board of Directors, which agreements will
expire upon completion of this Offering.

The Board of Directors has established an Audit Committee and a
Compensation Committee. The Audit Committee is responsible for recommending to
the Board of Directors the engagement of the independent accountants of the
Company and reviewing with the independent accountants the scope and results of
the audits, the internal accounting controls of the Company, audit practices and
the professional services furnished by the independent accountants. Messrs.
Gleberman, Moseley and Ryan serve on the Audit Committee. The Compensation
Committee is responsible for reviewing and approving all compensation
arrangements for the officers of the Company and for administering the Company's
1995

<PAGE> 41

Restricted Stock Plan, the 1995 Stock Option Plan, the 1996 Stock Option Plan
and the 1997 Stock Option Plan (all as defined herein). Messrs. Moseley and Ryan
serve on the Compensation Committee.

In December 1996, the Company adopted a policy to compensate all
non-employee directors of the Company $1,500 for each meeting of the Board of
Directors and $1,000 for each meeting of a committee of the Board of Directors
not held in connection with a regular Board meeting attended by such
non-employee director or $200 for each board or committee meeting in which they
participate by telephone. All directors are reimbursed for expenses incurred in
connection with attending meetings of the Board of Directors and committees
thereof.

EXECUTIVE COMPENSATION

The following table sets forth all compensation awarded to, earned by
or paid for services rendered to the Company in all capacities in 1995 and 1996
by: (i) the Company's chief executive officer and (ii) the Company's next five
most highly compensated executive officers who were serving as executive
officers at the end of 1996 (collectively, the "Named Executive Officers"):

<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
AWARDS
-------------------------
SECURITIES
ANNUAL COMPENSATION RESTRICTED UNDERLYING
NAME AND ------------------------- STOCK OPTIONS/SARS ALL OTHER
PRINCIPAL POSITION YEAR SALARY($)(a) BONUS($) AWARDS($) (#) COMPENSATION($)(d)
- ------------------ ---- ------------ -------- ----------- ------------ ------------------
<S> <C> <C> <C> <C> <C> <C>
Frederick D. Sancilio, Ph.D. 1996 360,125(b) 0 0 0 3,082
President and 1995 306,580(c) 79,217 0 0 5,131
Chief Executive Officer

William H. Underwood 1996 159,993 0 0 7,680 3,082
Executive Vice President 1995 166,343 0 0 0 5,131

Mark P. Colonnese 1996 162,837 200,000(e) 0 88,093 3,082
Vice President and Chief 1995 121,448 0 0 0 35,691
Financial Officer

R. Forrest Waldon 1996 126,583 3,531 0 7,680 3,082
Vice President and 1995 114,064 0 272,000(f) 0 5,047
General Counsel

Martin S. Hunicutt 1996 130,000 0 0 101,376 2,025
Vice President 1995 130,000 0 0 0 0

James Swarbrick, Ph.D. 1996 130,000 0 0 79,871 2,697
Vice President 1995 130,000 0 0 0 3,323
</TABLE>
- ------

(a) Includes amounts deferred pursuant to the Company's 401(k) plan.
(b) Includes $100,000 in salary paid by Endeavor, a company 40% owned by
the Company.
(c) Includes $12,500 in salary paid by Endeavor.
(d) Such amounts represent the Company's contributions under its 401(k) and
profit sharing plans; and with respect to Mr. Colonnese, includes
$34,596 paid as relocation expense in 1995 in connection with Mr.
Colonnese's acceptance of employment in 1993.
(e) Of such amount, $50,000 was paid in 1996, $50,000 was paid in 1997,
$50,000 is payable in September 1997 and $50,000 is payable in December
1997.

<PAGE> 42

(f) Such amount represents the value of shares of restricted stock awarded
to Mr. Waldon net of consideration paid by Mr. Waldon for such shares.
Restrictions with respect to such shares lapsed upon the completion of
the Offering.

The following table sets forth certain information with respect to
options granted during 1996 to the executive officers named in the Summary
Compensation Table.

STOCK OPTION GRANTS IN 1996

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT
-------------------------------------- ASSUMED ANNUAL
PERCENT OF TOTAL RATES OF STOCK
OPTIONS/SARS PRICE APPRECIATION FOR
NUMBER OF SECURITIES GRANTED TO EXERCISE OPTION TERM (A)
UNDERLYING OPTIONS EMPLOYEES IN PRICE EXPIRATION ----------------------
NAME GRANTED (#)(B) FISCAL YEAR ($/SH) DATE 5%($) 10%($)
- ---- -------------- ----------- -------- ---- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Frederick D. Sancilio, Ph.D. .... 0 0 0 0 0 0
William H. Underwood............. 7,680 1.4% 8.35 4-26-06 40,330 102,204
Mark P. Colonnese................ 88,093 15.8% 8.35 4-26-06 462,600 1,172,320
R. Forrest Waldon................ 7,680 1.4% 8.35 4-26-06 40,330 102,204
Martin S. Hunicutt............... 101,376 18.2% 8.35 4-26-06 532,353 1,349,086
James Swarbrick, Ph.D. .......... 79,871 14.3% 8.35 4-26-06 419,424 1,062,903
</TABLE>

- ----------

(a) Potential realizable value is based on an assumption that the price of
the common stock appreciates at the annual rate shown (compounded
annually) from the date of grant until the end of the ten-year option
term. The numbers are calculated based on the requirements promulgated
by the Securities and Exchange Commission and do not reflect the
Company's estimate of future stock price growth.
(b) The options granted under the Company's 1995 Stock Plan and 1996 Stock
Plan vest in 25% increments at each of the sixth, eighteenth, thirtieth
and forty-second month anniversaries of the grant date.

The following table sets forth certain information with respect to the
value of options held at fiscal year end by the executive officers named in the
Summary Compensation Table.

AGGREGATED 1996 YEAR-END OPTION VALUES
<TABLE>
<CAPTION>

NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS/SARS IN-THE-MONEY OPTIONS
AT FISCAL YEAR-END AT FISCAL YEAR-END(A)
-------------------------------- ---------------------------------
NAME EXERCISABLE(#) UNEXERCISABLE(#) EXERCISABLE($) UNEXERCISABLE($)
- ---- -------------- ---------------- -------------- ----------------
<S> <C> <C> <C> <C>
Frederick D. Sancilio, Ph.D...... 0 0 0 0
William H. Underwood............. 1,920 5,760 22,012 66,038
Mark P. Colonnese................ 22,023 66,070 252,505 757,481
R. Forrest Waldon................ 1,920 5,760 22,012 66,038
Martin S. Hunicutt............... 25,344 76,032 290,569 871,707
James Swarbrick, Ph.D............ 19,968 59,903 228,933 686,788
</TABLE>

- ----------

(a) Market value of underlying securities at fiscal year end minus the
exercise price of "in-the-money" options.

<PAGE> 43

EMPLOYMENT AND COMPENSATION AGREEMENTS

On November 17, 1995 (the "Signing Date"), the Company and Frederick D.
Sancilio entered into an employment agreement (the "Employment Agreement") to
secure Dr. Sancilio's services as Chairman of the Board and President of the
Company. The Employment Agreement has an initial three-year term that is
automatically extended for an additional one-year period on each anniversary of
the Signing Date unless either party gives the other notice prior to the
anniversary date of its intention not to extend the term of the Employment
Agreement. Under the Employment Agreement, Dr. Sancilio will serve as the
Company's Chairman of the Board, President and chief executive officer, and the
Company is required to use its best efforts to cause Dr. Sancilio to be
re-elected to the Company's Board of Directors and to the boards of directors of
affiliates of the Company on which boards of directors Dr. Sancilio was serving
on the Signing Date and to be elected a director of any majority-owned
subsidiary of the Company acquired after the Signing Date.

The Employment Agreement provides that Dr. Sancilio will receive an
annual salary of $250,000, which amount may be increased by the Board of
Directors and once increased may not be reduced. The Employment Agreement
provides that Dr. Sancilio will be eligible to receive bonus compensation of up
to 50% of his annual salary if the Company attains certain performance
objectives set jointly by the Board of Directors and Dr. Sancilio. In addition,
Dr. Sancilio will be eligible to participate in employee benefit plans made
available generally to the Company's executive officers and any other Company
compensation or incentive plans of a long or short-term nature and to receive
other perquisites not to exceed, in the aggregate, $10,000 per year.

Under the Employment Agreement, the Company may terminate Dr. Sancilio's
employment at any time, with or without cause, as defined in the Employment
Agreement. In the event that the Company terminates Dr. Sancilio's employment
without cause or in the event that Dr. Sancilio terminates his employment within
90 days of an event of constructive discharge (defined in the Employment
Agreement to include, among other things, the removal of Dr. Sancilio from, or
the failure of Dr. Sancilio to be elected to, the positions of Chairman of the
Board or President, a reduction in Dr. Sancilio's responsibilities or relocation
of the Company's principal executive offices by more than 30 miles from its
current location), Dr. Sancilio would be entitled to receive payments
aggregating three times his then current annual salary to be paid in monthly
installments over two years, during which time Dr. Sancilio would continue to
receive medical and life insurance benefits. The Employment Agreement requires
Dr. Sancilio to refrain from certain activities in competition with the Company
for a period of two years after the termination of his employment for any
reason.

The Employment Agreement obligates the Company to use its reasonable
best efforts to cause Endeavor to employ Dr. Sancilio as a senior management
employee at an annual salary of at least $100,000 with bonus compensation of up
to 50% of annual salary to be paid if performance targets are attained and
greater amounts if targets are exceeded. Endeavor has employed Dr. Sancilio on
such terms, and should Endeavor fail to continue to employ him on such terms, it
is anticipated that Dr. Sancilio's annual salary and bonus paid by AAI would be
increased by similar amounts. See "Certain Transactions -- Transactions
Involving Management".

On November 20, 1995, the Company agreed to a cash bonus plan for Mr.
Colonnese pursuant to which he would receive a cash bonus of $50,000 upon the
closing of the initial public offering of the Common Stock and an additional
$50,000 one year later. In addition, the agreement provided in the event that
the trading price per share of the Common Stock exceeded $12.525 for 90
consecutive days (which has occurred), Mr. Colonnese would receive an additional
$50,000 bonus at that time and an additional $50,000 bonus one year thereafter.

STOCK OPTION AND RESTRICTED STOCK AWARD PLANS

Under the Company's 1995 Restricted Stock Award Plan (the "Restricted
Stock Plan") and the 1995 Stock Option Plan (the "1995 Option Plan"), the 1996
Stock Option Plan (the "1996 Option Plan") and the 1997 Stock Option Plan (the
"1997 Option Plan; collectively with the 1995 Option Plan and the 1996 Option
Plan, the "Option Plans"), the Company is authorized to award up to 105,453
restricted shares of Common Stock and options to purchase up to 1,224,165 shares
of Common Stock. The 1997 Option Plan was adopted by the Board of Directors on
March 21, 1997 and is subject to the approval of the stockholders at the 1997
annual meeting. The following summary descriptions of the principal terms of the
Restricted Stock Plan and Option Plans do not purport to be complete and are
qualified in their entirety by the full text of the Restricted Stock Plan and
Option Plans, which have been filed as an exhibit to the Registration Statement
of which this Prospectus is a part.

<PAGE> 44

RESTRICTED STOCK PLAN

The purpose of the Restricted Stock Plan is to promote the growth and
profitability of the Company by increasing the personal participation of certain
employees in the financial performance of the Company, to compensate such
employees for their contributions to the success of the Company and to assure
the continued participation of such employees in the growth of the Company
through the grant of restricted stock awards.

The Restricted Stock Plan is administered by a committee (the
"Committee") composed solely of members of the Board of Directors who are both
"disinterested persons" (as defined in Rule 16b-3 promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act") and "outside
directors" (as defined in Section 162(m) of the Internal Revenue Code of 1986,
as amended, and the regulations thereunder). The Committee has the authority to
interpret the terms and provisions of, and adopt, amend and rescind general and
special rules relating to, the Restricted Stock Plan.

The Restricted Stock Plan permits the award of shares of Common Stock to
long-term employees of the Company and other key employees as selected by the
Committee. Awards of shares under the Restricted Stock Plan vest over time, and
in the event of termination of a participant's employment with the Company other
than as a result of death, disability or retirement all unvested shares are
forfeited to the Company. Prior to the completion of this Offering such shares
would vest five years after the date of the award. However, pursuant to the
Restricted Stock Plan, upon completion of this Offering, 50% of the shares
awarded under the Restricted Stock Plan will vest on the first anniversary date
of completion of the Offering and the remaining shares will vest on the second
anniversary. Unvested shares will vest immediately upon completion of certain
transactions involving a change in control of the Company or a sale by the
Company of all or substantially all of its assets. Shares that have not vested
may not be transferred other than pursuant to certain domestic relations orders.

Of the 105,453 shares available under the Restricted Stock Plan, 104,696
shares (net of forfeitures) have been awarded and were outstanding as of
December 31, 1996. Such awards were made to 119 employees, including all
employees of the Company who had been with the Company for six years or more and
had maintained satisfactory job performance levels. Any shares forfeited by
participants under the Restricted Stock Plan are available for future awards. No
director or executive officer of the Company has been granted shares of Common
Stock under the Restricted Stock Plan.

OPTION PLANS

The purpose of the Option Plans is to promote the growth and
profitability of the Company and its subsidiaries by increasing the personal
participation of officers and key employees in the financial performance of the
Company. The Option Plans are administered by the Committee. The Committee has
the authority to interpret the terms and provisions of, and adopt, amend and
rescind general and special rules relating to the administration of, the Option
Plans and to make all other determinations necessary and advisable for the
administration of the Option Plans. All of the Company's employees are eligible
to receive stock options to purchase shares of Common Stock ("Options") pursuant
to the Option Plans.

Awards of Options may be made to officers and other key employees of the
Company or its subsidiaries ("Optionees"). The Option Plans permit awards of
Options intended to qualify as incentive stock options under Section 422 of the
Internal Revenue Code and nonqualified options. The Committee is authorized to
establish the exercise price of Options, although the per share exercise price
for Options intended to qualify as incentive stock options may not be less than
100% of the fair market value of a share of Common Stock on the date of grant
(110% for certain 10% stockholders). The exercise price per share of any Option
awarded under the Option Plans may not be less than 100% of the fair market
value of a share of Common Stock on the date of grant of the Option (the "Grant
Date") unless all members of the Committee agree, and in no event may it be less
than 75% of the fair market value on the Grant Date. In addition, pursuant to an
agreement among the Company and its stockholders entered into in connection with
the issuance of the Preferred Stock the exercise price for Options granted under
the 1996 Option Plan may be no less than the per Common Share equivalent price
paid by the purchasers of the Preferred Stock in November 1995 ($8.35). The
Committee is authorized to set the term of the Options, which may be no longer
than 10 years (5 years for certain Options intended to qualify as incentive
stock options).

<PAGE> 45

Options awarded under the 1995 and 1996 Option Plans become exercisable
with respect to 25% of the total shares under the option six months after the
grant date, 50% of the total shares 18 months after the grant date, 75% of the
total shares 30 months after the grant date and 100% of the total shares 42
months after the grant date. Options awarded under the 1997 Option Plan become
exercisable with respect to 50% of the total shares one year after the date of
grant and 100% of the total shares two years after the grant date. The Options
become immediately exercisable upon completion of certain transactions involving
a change in control of the Company or a sale by the Company of all or
substantially all of its assets. Unexercised Options expire upon termination of
the Optionee's employment, other than as a result of death, disability or
retirement, in which cases Options may be exercised for a specified period after
termination of employment. Options may not be transferred other than by will or
the laws of descent and distribution or pursuant to certain qualified domestic
relations orders. No person may be awarded Options to purchase more than 189,750
shares of Common Stock under the 1995 Option Plan, 253,000 shares of Common
Stock under the 1996 Option Plan and 200,000 shares of Common Stock in any
fiscal year under the 1997 Option Plan.

Of the 242,538 shares of Common Stock authorized under the 1995 Option
Plan, Options to purchase 235,681 shares had been issued to 12 employees and
were outstanding on December 31, 1996. The exercise price of such Options is
$8.35 per share, except for Options to acquire 2,214 shares granted in June 1996
at $9.10 per share. Under the terms of the plan, the Company will purchase from
Dr. Sancilio and Mr. Waters, upon the exercise of Options, a number of shares of
Common Stock equal to the number of shares subject to the exercised Options, at
an exercise price equal to the exercise price of such Options to provide the
shares for issuance. Options for the following numbers of shares have been
granted under the 1995 Option Plan to the following Named Executive Officers of
the Company at an exercise price per share equal to $8.35: Mr. Colonnese, 88,093
shares, Mr. Swarbrick, 79,871 shares and all executive officers as a group,
167,964 shares.

Of the 495,627 shares authorized under the 1996 Option Plan, Options to
purchase 208,744 shares had been issued to 83 employees and 207,074 options were
outstanding on December 31, 1996. The exercise price of such Options is $8.35
per share. Options for the following numbers of shares have been granted under
the 1996 Option Plan to the following Named Executive Officers of the Company at
an exercise price per share equal to $8.35: Mr. Hunicutt, 101,376 shares, Mr.
Underwood, 7,680 shares, Mr. Waldon, 7,680 shares, and all executive officers as
a group, 124,416 shares.

A total of 486,000 shares are authorized to be issued under the 1997
Option Plan. No options have been awarded under the 1997 Option Plan.

CERTAIN FEDERAL INCOME TAX CONSEQUENCES. The following discussion is a
brief summary of the principal United States federal income tax consequences
under current federal income tax laws relating to Options awarded under the
Option Plans. This summary is not intended to be exhaustive and, among other
things, does not describe state, local or non-U.S. income and other tax
consequences.

An Optionee will not recognize any taxable income upon the grant of a
nonqualified option, and the Company will not be entitled to a tax deduction
with respect to such grant. Upon exercise of a nonqualified option, the excess
of the fair market value of the shares on the exercise date over the exercise
price will be taxable as compensation income to the Optionee. Subject to the
Optionee including such excess amount in income or the Company satisfying
applicable reporting requirements, the Company should be entitled to a tax
deduction in the amount of such compensation income. The Optionee's tax basis
for the shares received pursuant to such exercise will equal the sum of the
compensation income recognized and the exercise price.

In the event of a sale of shares received upon the exercise of a
nonqualified option, any appreciation or depreciation after the exercise date
generally will be taxed as capital gain or loss and will be long-term gain or
loss if the holding period for such stock was more than one year.

Generally, an Optionee should not recognize taxable income at the time
of grant or exercise of an incentive stock option and the Company should not be
entitled to a tax deduction with respect to such grant or exercise. The exercise
of an incentive stock option generally will give rise to an item of tax
preference that may result in alternative minimum tax liability for the
Optionee.

<PAGE> 46

A sale or other disposition by an Optionee of shares acquired upon the
exercise of an incentive stock option more than one year after the transfer of
the shares to such Optionee and more than two years after the date of grant of
the incentive stock option should result in any difference between the net sale
proceeds and the exercise price being treated as long-term capital gain or loss
to the Optionee with no deduction being allowed to the Company. Upon a sale or
other disposition of shares acquired upon the exercise of an incentive stock
option within one year after the transfer of the shares to the Optionee or
within two years after the date of grant of the incentive stock option
(including the delivery of such shares in payment of the exercise price of
another incentive stock option within such period), any excess of (a) the lesser
of (i) the fair market value of the shares at the time of exercise of the Option
and (ii) the amount realized on such disqualifying sale or other disposition of
the shares over (b) the exercise price of such shares, should constitute
ordinary income to the Optionee and the Company should be entitled to a
deduction in the amount of such income. The excess, if any, of the amount
realized on a disqualifying sale over the fair market value of the shares at the
time of the exercise of the Option generally will constitute short-term or
long-term capital gain and will not be deductible by the Company. Special rules
may apply to Optionees who are subject to Section 16 of the Exchange Act.

Under certain circumstances the accelerated vesting or exercise of
Options in connection with a change of control of the Company might be deemed an
"excess parachute payment" for purposes of the golden parachute tax provisions
of section 280G of the Internal Revenue Code. To the extent it is so considered,
the Optionee may be subject to a 20% excise tax and the Company may be denied a
tax deduction.

SECTION 162(M). Section 162(m) of the Internal Revenue Code generally
disallows a federal income tax deduction to any publicly held corporation for
compensation paid in excess of $1 million in any taxable year to the chief
executive officer or any of the four other most highly compensated executive
officers who are employed by the Company on the last day of the taxable year.
Compensation attributable to Options granted under the Option Plans should not
be subject to such deduction limitations.

CERTAIN TRANSACTIONS

TRANSACTIONS INVOLVING MANAGEMENT

The Company leases its headquarters facility from 5051 New Centre Drive,
LLC ("New Centre"),an entity in which each of Mr. Waters and Dr. Sancilio owns a
one-third interest. Pursuant to the lease agreement between the Company and New
Centre, the Company pays rent at an annual base rate of $12.50 per square foot
of space leased, subject to adjustment for increases in the landlord's expense
in maintenance and insurance of the facility. The effective rate per square foot
was increased to the current rate of $13.30 commencing in June 1995 to reflect
such increased expenses. Under the agreement, the Company may lease portions of
the entire facility as needed and upon agreement of New Centre. At December 31,
1996, the Company leased approximately 19,000 square feet of space under the
agreement. The initial term of the lease agreement expires in March 1999, but
the agreement will extend for successive one-year periods unless either party
provides the other, at least 90 days prior to the scheduled expiration of the
agreement, notice of its intent not to renew the lease. The lease rate for any
renewal term is to be set by mutual agreement of the parties.

Approximately 40% of the capital stock of Endeavor on a fully diluted
basis is held by the Company, and certain directors of the Company serve as
directors and officers of Endeavor. Pursuant to an agreement among the Endeavor
stockholders, the Company has the right to designate two of the six members of
the Endeavor board of directors. AAI realized $6.2 million, $3.5 million and
$2.0 million in net sales to Endeavor in 1996, 1995 and 1994, respectively.

The Company provides product development services pursuant to an
agreement with Endeavor in connection with hormone pharmaceutical products that
Endeavor is developing. The Company has agreed to manufacture products developed
by Endeavor at the Company's manufacturing facility located at 1726 North 23rd
Street, Wilmington, North Carolina, until Endeavor achieves a specified
development milestone. The Company has agreed that at such time, it will grant
to Endeavor a lease/purchase option to either lease for 15 years or purchase the
portion of such facility intended for use by AAI in manufacturing Endeavor's
products. Upon achievement of the milestone by Endeavor, the Company will also
sell to Endeavor the equipment and inventory of raw materials, assign to
Endeavor its raw materials supply agreements relating to Endeavor's products and
make available certain personnel to Endeavor so that Endeavor can assume its
manufacturing operations. Upon exercise of either the option to lease or the
option to purchase, Endeavor is required

<PAGE> 47

to pay an exercise price of $2 million to the Company in addition to lease
payments or a purchase price based on the fair market value of the facility. If
Endeavor exercises the option to lease but does not subsequently exercise the
option to purchase and does not achieve certain development milestones by a
specified date, AAI must repay the option exercise price to Endeavor. The
facility subject to the option is currently used by the Company for clinical
supply and niche manufacturing operations. The Company is presently expanding
its clinical supply and niche manufacturing facilities which could be used to
manufacture Endeavor's products currently under development or, if Endeavor
exercises its option to manufacture such product itself, for other client work.
The Company has also agreed to permit Endeavor under certain circumstances the
first right to purchase additional proprietary hormone pharmaceutical products
developed by AAI at a price equal to the amount of development work expended by
AAI at its standard hourly rates and out-of-pocket expenses, and AAI would
continue the development work with respect to such product under the agreement
with Endeavor.

In addition to his duties at AAI, Dr. Sancilio is employed by Endeavor
as a senior management employee. Pursuant to his employment agreement with
Endeavor, Dr. Sancilio is to be based at AAI's principal executive offices and
does not have day-to-day responsibilities in the operation of Endeavor and is
assigned responsibilities from time to time by Endeavor's board of directors.
Dr. Sancilio receives an annual salary of $100,000 and is eligible for bonus
compensation of up to 50% of salary. Dr. Sancilio's employment agreement with
Endeavor has an initial two-year term expiring on November 17, 1997 and renews
for successive one-year periods unless either party elects not to renew the
agreement. Dr. Sancilio devotes the substantial majority of his time to the
management of AAI.

In addition, the Company provided management and administrative services
to Endeavor at an annual fee of $120,000 through April 1996 when this agreement
was terminated by Endeavor. The Company believes that the terms of each of the
foregoing agreements are no less favorable than terms that would be obtained in
an agreement with an unrelated third party.

The Company provides product development services to Aesgen, which
develops generic pharmaceutical products. Approximately 30% of Aesgen's
outstanding common stock is held by certain of the holders of AAI's currently
outstanding shares of capital stock. In addition, Mr. Waters and Dr. Sancilio
serve on the ten-member board of directors of Aesgen. AAI realized $4.7 million
and $5.6 million in net sales to Aesgen in 1996 and 1995, respectively. AAI has
the right under its development agreement with Aesgen to provide certain product
development and support services to Aesgen, provided that AAI's fees for such
services are comparable to those of a reasonably comparable firm. In addition,
under such development agreement, the Company has agreed, absent certain
circumstances, not to develop for its own account or for any other person, any
formulation of a product intended to be therapeutically equivalent to the same
reference product for any of the products currently under development by Aesgen
and any additional drugs that AAI agrees to develop for Aesgen under the
development agreement. The Company believes that the terms of such agreement are
no less favorable than terms that would be obtained in a transaction with an
unrelated third party.

In June 1996, the Company sold to Aesgen marketing rights to a product
being developed by the Company. Under the agreement, Aesgen will pay license
fees and additional royalties upon marketing of the product, although there can
be no assurance that the product will be approved by the FDA or marketed.

While incorporated in July 1994, Aesgen was formally organized and
funded in April 1995 via issuance of approximately $11 million of
nonconvertible, non-voting, mandatorily redeemable, preferred stock. As the
Company did not intend to hold an equity interest, the Company entered a series
of related transactions commencing in December 1995 in which the Company
transferred to a corporation ("Aesgen Holding"), owned by the holders of
substantially all of the then outstanding capital stock of the Company,
approximately 30% of the outstanding Aesgen common stock in return for $50,000
(the amount paid by AAI for such shares) and Aesgen Holding's assumption of and
AAI's release from an obligation to invest an additional $1.2 million in Aesgen.
The Company retains a $1.6 million nonconvertible, non-voting preferred stock
investment in Aesgen. Aesgen Holding has distributed all shares of Aesgen common
stock held by it to its stockholders. Accordingly, the Company's executive
officers beneficially own the following percentages of the fully diluted common
equity of Aesgen: Dr. Sancilio, 12.1%, Mr. Underwood, 0.7%, Mr. Arato, 0.2% and
Mr. Waldon, 0.2%.

In November 1995, in connection with the purchase by the Goldman
Investors and certain other investors of shares of Preferred Stock described
below, Mr. Waters purchased shares of Preferred Stock (convertible into 119,833
shares of Common Stock), on substantially the same terms and conditions,
including price, as other purchasers of shares of Preferred Stock. In connection
with such transaction, the Company granted certain stockholders, including Mr.
Waters

<PAGE> 48

and Dr. Sancilio, rights to cause the Company to register for sale shares of
Common Stock acquired upon conversion of the Preferred Stock. See "Description
of Capital Stock -- Registration Rights". In addition, in connection with the
Company's issuance of shares of Preferred Stock, Mr. Waters and Dr. Sancilio
agreed to indemnify the Company against certain matters including the imposition
of certain federal income tax liabilities, if any, in connection with the
Company's election to be treated as an S corporation, final resolution of
certain litigation brought by a former employee of AAI in which a judgment for
approximately $363,000 has been entered against the Company and which is
currently being appealed by the Company, and the payment of any amount due in
connection with the resolution of an assessment against the Company of a North
Carolina use tax deficiency of approximately $340,000 plus penalties and
interest assessed against the Company. In addition, and as part of the same
transaction, Mr. Waters and Dr. Sancilio have agreed to sell to AAI up to a
total of 242,539 shares of Common Stock to provide the shares for issuance
pursuant to the 1995 Stock Option Plan. Such shares are required to be sold by
Mr. Waters and Dr. Sancilio upon the exercise of options under the 1995 Plan at
the exercise price of such options. As of December 31, 1996, options to acquire
235,681 shares of Common Stock granted under the 1995 Stock Option Plan at an
exercise price per share of $8.35, except for options for 2,214 shares at an
exercise price of $9.10, were outstanding.

In 1988, the Company secured financing with variable rate North Carolina
industrial revenue bonds which are supported by a letter of credit issued by a
bank. Dr. Sancilio and Mr. Waters guaranteed the Company's obligation to repay
amounts drawn under such letter of credit. In March 1996, the bank released Dr.
Sancilio and Mr. Waters from such guarantees at which time the amount of the
letter of credit was approximately $1.7 million.

The Company loaned $82,775 to Mr. Underwood in 1993 in connection with a
purchase of shares of Common Stock. Such loan is evidenced by a promissory note,
which bears interest, payable biweekly, at an annual rate of 6.15% and is
payable, if not paid sooner, on March 30, 1998. At December 31, 1996, the
outstanding principal amount of such promissory note was $82,775.

The Company loaned $168,865 to Mr. Waldon in connection with his
purchase of 105,453 shares of Common Stock in November 1995 for $30,000 and with
the income tax liabilities arising in such transaction. Such loan is evidenced
by a promissory note that bears interest at an annual rate of 6.48%, with
principal and interest payable biweekly. Mr. Waldon's shares of Common Stock are
pledged to secure such loan, and Mr. Waldon granted the Company an option to
repurchase such shares at the initial purchase price plus a formula amount,
which option terminated upon the completion of the Offering. At December 31,
1996, the outstanding aggregate principal amount of such loan was $167,988.

CERTAIN BUSINESS RELATIONSHIPS

In November 1995, the Goldman Investors and certain other investors
purchased shares of Preferred Stock of the Company which were converted pursuant
to the terms thereof, and effective upon the closing of the Offering, into
2,276,832 shares of Common Stock. In connection with such transaction, the
Company granted the Goldman Investors certain rights to cause the Company to
register for sale shares of Common Stock acquired upon conversion of the
Preferred Stock. See "Description of Capital Stock -- Registration Rights".
Pursuant to a Stockholder Agreement entered into in November 1995 in connection
with the purchase of the Preferred Stock, the Goldman Investors have the right
to designate one member of the Board of Directors for so long as the Goldman
Investors and their affiliates (which include Goldman, Sachs & Co.) beneficially
own 10% or more of the outstanding shares of Common Stock. Pursuant to such
Agreement, Mr. Gleberman, a Managing Director of Goldman, Sachs & Co., serves as
one of the Company's directors. See "Management".

In connection with the purchase by the Goldman Investors and certain
other investors of shares of Preferred Stock in November 1995, the Company
agreed that so long as the Goldman Investors beneficially own 5% or more of the
outstanding shares of Common Stock, the Company will retain Goldman, Sachs & Co.
or an affiliate to perform all investment banking services for the Company for
which an investment banking firm is retained and to serve as managing
underwriter of any offering of the Company's capital stock, on customary terms,
consistent with an arm's-length transaction. In the event that the Company and
Goldman, Sachs & Co. or their affiliates cannot agree to the terms of such
engagement after good faith discussions, the agreement permits the Company to
engage any other investment banking firm, although Goldman, Sachs & Co. are
entitled to serve as co-managing underwriter in any underwritten offering of the
Company's capital stock. The Company has agreed to indemnify Goldman, Sachs &
Co. and their affiliates against certain liabilities, including liabilities
under the Securities Act.

<PAGE> 49

Goldman, Sachs & Co. acted as a manager of and received customary
discounts in the Offering. Pursuant to an agreement entered into in connection
with the Offering, the Company has agreed to maintain a current Prospectus in
connection with Goldman, Sachs & Co.'s market-making transactions and to pay
certain expenses relating to amendments or supplements to the Prospectus. See
"Plan of Distribution".

Approximately 14.2% of the capital stock of Endeavor on a fully diluted
basis and 4.1% of the common equity of Aesgen on a fully diluted basis is held
by the Goldman Investors.

In November 1995, Noro-Moseley Partners III, L.P. ("Noro-Moseley"), a
venture capital limited partnership, purchased shares of Preferred Stock which
were converted, pursuant to the terms thereof and effective upon the closing of
the Offering, into 119,833 shares of Common Stock. In connection with such
transaction, the Company granted Noro-Moseley certain rights to cause the
Company to register for sale shares of Common Stock acquired upon conversion of
the Preferred Stock. See "Description of Capital Stock -- Registration Rights".
The holders of Preferred Stock were granted the right to designate one director,
which right expires upon completion of the Offering. Such holders have agreed
that as long as the Goldman Investors beneficially own 10% or more of the
outstanding shares of Common Stock they will vote their shares in favor of the
Goldman Investors' designee. Noro-Moseley also currently owns 14.8% of the
capital stock of Endeavor on a fully diluted basis and 8.2% of the common equity
of Aesgen on a fully diluted basis. Charles D. Moseley, Jr., a member of the
limited liability company which is the general partner of Noro-Moseley, serves
as a director on the boards of directors of AAI, Endeavor and Aesgen.

PRINCIPAL STOCKHOLDERS

The following table sets forth certain information known to the Company
with respect to beneficial ownership of the Company's Common Stock as of
December 31, 1996 and as adjusted to give effect to the sale of shares of Common
Stock in the Offering by (i) each stockholder known by the Company to be the
beneficial owner of more than 5% of the Company's Common Stock, (ii) each
director, (iii) each Named Executive Officer (see "Management -- Executive
Compensation") and (iv) all executive officers and directors as a group.

<TABLE>
<CAPTION>
Number of Percentage of
Shares Shares
NAME OF BENEFICIAL OWNER Beneficially Beneficially
BENEFICIALLY OWNED(A) Owned(a) Owned
- --------------------- -------- -----
<S> <C> <C>
Frederick D. Sancilio, Ph.D.(b)....................... 5,053,044 30.9%
James L. Waters(c).................................... 2,617,703 16.0%
The Goldman Sachs Group, L.P.(d)...................... 2,276,832 13.9%
Joseph H. Gleberman(e)................................ -- --
Charles D. Moseley, Jr.(f)............................ 119,833 *
John M. Ryan.......................................... 1,000 *
William H. Underwood(g)............................... 233,834 1.4%
Anthony F. Arato(h)................................... 73,805 *
Mark P. Colonnese(i).................................. 23,023 *
Martin S. Hunicutt(j)................................. 26,594 *
James Swarbrick, Ph.D.(k)............................. 21,468 *
R. Forrest Waldon..................................... 107,373 *
All executive officers and directors as a
group (11 persons).................................. 8,277,677 50.7%
</TABLE>

- ----------

* Less than 1%
(a) Unless otherwise indicated below, the persons and entities named in the
table have sole voting and sole investment power with respect to all
shares beneficially owned, subject to community property laws where
applicable. Information in the table reflects options granted under the
1995 Option Plan and the 1996 Option Plan to the extent such options are
or become exercisable within 60 days. Accordingly, the totals for the
following executive officers

<PAGE> 50

and all executive officers and directors as a group includes the
following shares represented by options: Mr. Underwood, 1,920 shares; Mr.
Arato, 1,920 shares; Mr. Colonnese, 22,023 shares; Mr. Hunicutt, 25,344
shares; Dr. Swarbrick, 19,968 shares; Mr. Waldon, 1,920 shares; and all
executive officers and directors as a group, 73,095 shares.
(b) Dr. Sancilio's address is 5051 New Centre Drive, Wilmington, North
Carolina 28403.
(c) Includes 496,133 shares of Common Stock beneficially owned by Mr. Waters'
spouse. Mr. Waters' address is 47 New York Avenue, Framingham,
Massachusetts 01701.
(d) Represents 2,276,832 shares owned by certain investment partnerships, of
which affiliates of The Goldman Sachs Group, L.P. ("GS Group") are the
general partner, managing general partner or general manager. Includes
1,428,549 shares held of record by GS Capital Partners II, L.P.; 567,908
shares held of record by G.S. Capital Partners II Offshore, L.P.; 120,552
shares held of record by Bridge Street Fund 1995, L.P.; 107,132 shares
held of record by Stone Street Fund 1995, L.P.; and 52,691 shares held of
record by Goldman, Sachs & Co. Verwaltungs GmbH, as nominee for GS
Capital Partners II Germany Civil Law Partnership. GS Group disclaims
beneficial ownership of the shares owned by such investment partnerships
to the extent attributable to partnership interests therein held by
persons other than GS Group and its affiliates. Each of such investment
partnerships shares voting and investment power with certain of its
respective affiliates. The address of the GS Group is 85 Broad Street,
New York, New York 10004.
(e) Mr. Gleberman, a Managing Director of Goldman, Sachs & Co., disclaims
beneficial ownership of the 2,276,832 shares which may be deemed to be
beneficially owned by GS Group as described in note (d) above.
(f) Represents 119,833 shares beneficially owned by Noro-Moseley. Mr. Moseley
disclaims beneficial ownership of such shares.
(g) Includes 925 shares owned by Mr. Underwood's children.
(h) Includes 159 shares owned by Mr. Arato's children.
(i) Includes 1,000 shares owned by Mr. Colonnese's children.
(j) Includes 500 shares owned by Mr. Hunicutt's children.
(k) Includes 500 shares owned by Dr. Swarbrick's spouse.

DESCRIPTION OF CAPITAL STOCK

The authorized capital stock of the Company consists of 100 million shares
of Common Stock, $.001 par value per share, and 5 million shares of preferred
stock, $.001 par value per share. As of December 31, 1996, there were
outstanding 16,286,236 shares of Common Stock and 495,293 shares of Common Stock
reserved for issuance under the Option Plans (not including the 486,000 shares
reserved under the 1997 Option Plan which was adopted after December 31, 1996).

The following summary of certain provisions of the Common Stock and
preferred stock does not purport to be complete and is subject to, and qualified
in its entirety by, the provisions of the Company's Restated Certificate of
Incorporation and by the provisions of applicable law.

COMMON STOCK

The Company's Restated Certificate of Incorporation authorizes the
issuance of up to 100 million shares of Common Stock, $.001 par value per share.
Holders of Common Stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Accordingly, holders of a majority of the shares of Common Stock
entitled to vote in any election of directors may elect all of the directors
standing for election. Holders of Common Stock are entitled to receive ratably
such dividends, if any, as may be declared by the Company's Board of Directors
out of funds legally available therefor and subject to any preferential dividend
rights of any then outstanding preferred stock. Upon the liquidation,
dissolution or winding up of the Company, the holders of Common Stock are
entitled to receive ratably the net assets of the Company available after the
payment of all debts and other liabilities and subject to any preferential
dividend rights of any then outstanding preferred stock. Holders of Common Stock
have no preemptive, subscription, redemption or conversion rights. The
outstanding shares of Common Stock are fully paid and nonassessable.

<PAGE> 51

PREFERRED STOCK

The Board of Directors is authorized, subject to any limitations
prescribed by Delaware law, to provide for the issuance of additional shares of
preferred stock in one or more series, to establish from time to time the number
of shares to be included in each such series, to fix the powers, designations,
preferences and rights of the shares of each wholly unissued series and any
qualifications, limitations or restrictions thereon and to increase or decrease
the number of shares of any such series (but not below the number of shares of
such series then outstanding) without any further vote or action by the
stockholders. The Board of Directors may authorize the issuance of preferred
stock with voting or conversion rights that could adversely affect the voting
power or other rights of the holders of Common Stock. Such issuance could have
the effect of decreasing the market price of the Common Stock. Thus, the
issuance of preferred stock may have the effect of delaying, deferring or
preventing a change in control of the Company. As of December 31, 1996, no
series of preferred stock had been designated and no shares of preferred stock
were outstanding. The Company has no current plan to issue any shares of
preferred stock.

OPTIONS

As of December 31, 1996, there were outstanding options to purchase an
aggregate of 442,755 shares of Common Stock awarded under the Company's 1995
Stock Option Plan and 1996 Stock Option Plan, of which options for 440,541
shares are at an exercise price of $8.35 per share and options for 2,214 shares
are at an exercise price of $9.10 per share. See "Management -- Stock Option and
Restricted Stock Award Plans". Dr. Sancilio and Mr. Waters have granted the
Company an option to purchase shares of Common Stock to fund the purchase of the
242,538 shares under the 1995 Option Plan at the price per share for each option
under the 1995 Option Plan.

REGISTRATION RIGHTS

The holders (which include Dr. Sancilio, Mr. Waters and the Goldman
Investors) of 13,076,206 shares of Common Stock (the "Registrable Securities")
have certain rights with respect to the registration of those shares under the
Securities Act. If requested by any of such stockholders, including Dr.
Sancilio, Mr. Waters or the Goldman Investors, the Company must file a
registration statement under the Securities Act covering all Registrable
Securities requested to be included by such holders of Registrable Securities.
The Company may be required to effect up to three such registrations at its
expense (other than underwriting discounts and commissions) and thereafter may
be required to effect additional registrations upon reimbursement for expenses
by participating stockholders. The Company has the right to delay any such
registration for up to 180 days under certain circumstances. Such stockholders'
demand registration rights will expire when such stockholder, together with its
affiliates, cease to beneficially own Registrable Securities (i) equal to 10% of
the then outstanding shares of Common Stock or (ii) having an aggregate market
value of at least $30 million.

In addition, if the Company proposes to register any of its shares of
Common Stock under the Securities Act other than in connection with a Company
employee benefit plan or a corporate reorganization, the holders of Registrable
Securities may require the Company to include all or a portion of their shares
in such registration, subject to certain priorities among them, although a
co-managing underwriter of any such offering unaffiliated with any holder of
Registrable Securities may limit the number of shares in such registration. All
expenses incurred in connection with such registrations (other than underwriting
discounts and commissions) will be borne by the Company.

DELAWARE LAW AND CERTAIN PROVISIONS OF THE COMPANY'S RESTATED CERTIFICATE OF
INCORPORATION AND BY-LAWS

The Company is subject to the provisions of Section 203 of the General
Corporation Law of Delaware (the "Delaware General Corporation Law"). Section
203 prohibits a publicly held Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years after
the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in a prescribed manner.
A "business combination" includes mergers, asset sales and other transactions
resulting in a financial benefit to the interested stockholder. Subject to
certain exceptions, an "interested stockholder" is a person who, together with
affiliates and associates, owns, or within three years did own, 15% or more of
the corporation's voting stock.

The Restated Certificate of Incorporation provides for the division of the
Board of Directors into three classes as nearly equal in size as possible with
staggered three-year terms. In addition, the Restated Certificate of
Incorporation provides that directors may be removed only for cause by the
affirmative vote of the holders of two-thirds of the shares

<PAGE> 52

of capital stock of the Company entitled to vote. Under the Restated Certificate
of Incorporation, any vacancy on the Board of Directors, however occurring,
including a vacancy resulting from an enlargement of the Board of Directors, may
be filled only by vote of a majority of the directors then in office. The
classification of the Board of Directors and the limitations on the removal of
directors and filling of vacancies could have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
acquiring, control of the Company.

The Delaware General Corporation Law provides generally that the
affirmative vote of a majority of the shares entitled to vote on any matter is
required to amend a corporation's certificate of incorporation or by-laws,
unless the certificate of incorporation or by-laws, as the case may be, requires
a greater percentage. The Restated Certificate of Incorporation and the By-laws
require the affirmative vote of the holders of at least 75% of the shares of
capital stock of the Company issued and outstanding and entitled to vote to
amend or repeal any of the provisions described in the prior paragraph.

The Restated Certificate of Incorporation contains certain provisions
permitted under the Delaware General Corporation Law relating to the liability
of directors. The provisions eliminate a director's liability for monetary
damages for a breach of fiduciary duty, except in certain circumstances
involving wrongful acts, such as the breach of a director's duty of loyalty or
acts or omissions that involve intentional misconduct or a knowing violation of
law. The limitation of liability described above does not alter the liability of
directors and officers of the Company under federal securities laws.
Furthermore, the Restated Certificate of Incorporation contains provisions to
indemnify the Company's directors and officers to the fullest extent permitted
by the Delaware General Corporation Law. These provisions do not limit or
eliminate the right of the Company or any stockholder to seek non-monetary
relief such as an injunction or rescission in the event of a breach by a
director or an officer of a duty owed to the Company. The Company believes that
these provisions will assist the Company in attracting and retaining qualified
individuals to serve as directors.

In addition, the Restated Certificate of Incorporation contains certain
provisions addressing potential conflicts of interest between the Company and
any entity in which any directors of the Company have a financial interest (a
"Related Entity"). Under these provisions, any contract, agreement, arrangement
or transaction between the Company and a Related Entity (a "Related
Transaction") shall not be void or voidable solely for the reason that the
Company and a Related Entity are parties thereto, if: (i) the material facts of
the Related Transaction are disclosed or are known to the Board of Directors (or
a committee thereof) and the Board (or committee) in good faith authorizes,
approves or ratifies the Related Transaction by the affirmative vote of a
majority of the disinterested directors on the Board of Directors (or such
committee), even though the disinterested directors may be less than a quorum;
(ii) the material facts of the Related Transaction are disclosed or are known to
the holders of the then outstanding voting shares of the Company entitled to
vote thereon, and the Related Transaction is specifically approved or ratified
in good faith by the affirmative vote of the holders of a majority of the then
outstanding voting shares not owned by the interested directors or Related
Entity, as the case may be, even though such holders may be less than a quorum;
(iii) such Related Transaction is effected pursuant to and consistent with terms
and conditions specified in any arrangements, standards or guidelines that are
in good faith authorized, approved or ratified, after disclosure or knowledge of
the material facts related thereto, by the affirmative vote of a majority of the
disinterested directors on the Board of Directors (or committee thereof), or by
the affirmative vote of the holders of a majority of the then outstanding voting
shares of the Company not owned by the interested directors or Related Entity,
as the case may be, even though the disinterested directors or such holders may
be less than a quorum; or (iv) such Related Transaction was fair to the Company.

The Restated Certificate of Incorporation also provides that any such
contract, agreement, arrangement or transaction authorized, approved or
effected, and each of such arrangements, standards or guidelines so authorized
or approved, as described in (i), (ii) or (iii) above, shall be conclusively
deemed to be fair to the Company and its stockholders. If, however, such
authorization or approval is not obtained, or such contract, agreement,
arrangement or transaction is not so effected, no presumption shall arise that
such contract, agreement, arrangement or transaction, or such arrangements,
standards or guidelines, are not fair to the Company and its stockholders.

The By-laws of the Company establish an advance notice procedure for
stockholder proposals to be brought before a meeting of stockholders of the
Company and for nominations by stockholders of candidates for election as
directors at an annual meeting at which directors are to be elected. Subject to
any other applicable requirements, only such business may be conducted at a
meeting of stockholders as has been brought before the meeting by, or at the
direction of, the Board of Directors or by a stockholder who has given to the
Secretary of the Company timely written notice, in proper form, of the
stockholder's intention to bring that business before the meeting. The presiding
officer at such meeting has the

<PAGE> 53

authority to make such determinations. Only persons who are selected and
recommended by the Board of Directors or by a committee of the Board of
Directors designated to make nominations, or who are nominated by a stockholder
who has given timely written notice, in proper form, to the Secretary prior to a
meeting at which directors are to be elected, will be eligible for election as
directors of the Company.

To be timely, notice of nominations or other business to be brought before
any meeting must be received by the Secretary of the Company not later than 120
days in advance of the anniversary date of the Company's proxy statement for the
previous year's annual meeting or, in the case of special meetings, at the close
of business on the tenth day following the date on which notice of such meeting
is first given to stockholders.

The notice of any stockholder proposal or nomination for election as a
director must set forth the various information required under the By-laws. The
person submitting the notice of nomination and any person acting in concert with
such person must provide, among other things, the name and address under which
they appear on the Company's books (if they so appear) and the class and number
of shares of the Company's capital stock that are beneficially owned by them.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the Common Stock is First Union
National Bank of North Carolina.

SHARES ELIGIBLE FOR FUTURE SALE

As of December 31, 1996, 16,286,236 shares of Common Stock were
outstanding. Of these shares, the 3,105,000 shares sold in the Offering were
freely tradeable without restrictions or further registration under the
Securities Act, except for any shares purchased by "affiliates" of the Company,
as that term is defined in Rule 144 under the Securities Act ("Rule 144"), which
will be subject to the resale limitations imposed by Rule 144, as described
below. All of the remaining 13,181,236 shares of Common Stock outstanding are
"restricted securities" within the meaning of Rule 144. On March 19, 1997,
10,440,209 shares became eligible for sale, subject to the provisions of Rule
144 under the Securities Act or Rule 701 under the Securities Act ("Rule 701").
Of the remaining shares, 2,636,331 shares, all of which may be deemed to have
been issued in November 1995 for the purposes of Rule 144, will not be eligible
for resale under Rule 144 until after the expiration of the Rule 144 holding
period which commences on the date such restricted securities were acquired from
the Company or an affiliate, and may be resold in the public market only in
compliance with the registration requirements of the Securities Act or pursuant
to a valid exemption therefrom. Of such 13,181,236 restricted shares, 13,076,206
shares are beneficially owned by stockholders who have the right to have their
shares registered by the Company under the Securities Act. A total of 104,696
shares (net of forfeitures) were awarded pursuant to the Restricted Stock Plan
and, as discussed below, are subject to certain vesting requirements and may not
be transferred prior to vesting.

In general, under Rule 144 as currently in effect, a person (or persons
whose shares are required to be aggregated) whose restricted securities have
been outstanding for at least two years, including a person who may be deemed an
"affiliate" of the Company, may only sell a number of shares within any
three-month period that does not exceed the greater of (i) one percent of the
then outstanding shares of the Company's Common Stock or (ii) the average weekly
trading volume in the Company's Common Stock in the four calendar weeks
immediately preceding such sale. Sales under Rule 144 are also subject to
certain requirements as to the manner of sale, notice and the availability of
current public information about the Company. A person who is not an affiliate
of the issuer, has not been an affiliate within three months prior to the sale
and has owned the restricted securities for at least three years is entitled to
sell such shares under Rule 144(k) without regard to any of the limitations
described above. The Securities and Exchange Commission (the "Commission")
recently adopted amendments to Rule 144, reducing the initial holding period
from two years to one year and the holding period under Rule 144(k) from three
years to two years. These amendments become effective on April 29, 1997, at
which time the 2,636,331 shares not currently eligible for resale will be
eligible for resale under Rule 144.

Certain shares issued or issuable upon the exercise of options granted by
the Company or acquired pursuant to the Company's Restricted Stock Award Plan,
the Option Plans and other plans prior to the date of this Prospectus may be
eligible for sale in the public market pursuant to Rule 701 under the Securities
Act. In general, Rule 701 permits resales of shares issued pursuant to certain
compensatory benefit plans and contracts commencing 90 days after the issuer
becomes subject to the reporting requirements of the Exchange Act, in reliance
upon Rule 144, but without compliance with certain

<PAGE> 54

restrictions of Rule 144, including the holding period requirements. As of
December 31, 1996, the Company has granted outstanding options covering 442,755
shares of Common Stock, all of which become exercisable at various times in the
future and 104,696 restricted shares of Common Stock, a portion of which are
subject to forfeiture by the holder in certain events, do not vest until two
years after the completion of this Offering, subject to immediate vesting upon
certain change-in-control transactions, and may not be transferred prior to
vesting. Any shares of Common Stock issued upon the exercise of these options
and such restricted shares will be eligible for sale pursuant to Rule 701.

In addition to shares issuable pursuant to the exercise of outstanding
options, the Company has reserved 288,219 additional shares for issuance under
the 1996 Option Plan and 486,000 additional shares for issuance under the 1997
Option Plan. When issued, shares acquired under outstanding options issued under
the 1995 Option Plan and the 1996 Option Plan may only be sold within the
limitations of Rule 701 and Rule 144 or pursuant to registration under the
Securities Act. The Company intends to file registration statements covering
shares of Common Stock to be acquired upon the exercise of options granted after
the date of the Offering under the 1996 Option Plan and the 1997 Option Plan, if
it is approved by the stockholders. Once such registration statements become
effective, persons acquiring shares pursuant to the exercise of options granted
under such Option Plans, including affiliates, will be able to sell the shares
in the public market without regard to the holding period of Rule 144.

PLAN OF DISTRIBUTION

This Prospectus may be used by Goldman, Sachs & Co. in connection with
offers and sales related to market-making transactions in shares of Common Stock
effected from time to time after the commencement of the Offering. Goldman,
Sachs & Co. may act as principal or agent in such transactions, including as
agent for the counterparty when acting as principal or as agent for both
counterparties, and may receive compensation in the form of discounts and
commissions, including from both counterparties when it acts as agent for both.
Such sales will be made at prevailing market prices at the time of sale, at
prices related thereto or at negotiated prices.

The Company has agreed to indemnify Goldman, Sachs & Co. with respect to
certain liabilities in connection with this Prospectus, including liabilities
under the Securities Act.

For a description of certain relationships and transactions between
Goldman, Sachs & Co. and their affiliates and the Company, see "Management,"
"Certain Transactions" and "Principal Stockholders".

The Company has been advised by Goldman, Sachs & Co. that, subject to
applicable laws and regulations, Goldman, Sachs & Co. currently intend to make a
market in the Common Stock. However, they are not obligated to do so and any
market-making may be discontinued at any time without notice. In addition, such
market-making activity will be subject to the limits imposed by the Securities
Act and the Exchange Act. There can be no assurance that an active trading
market will develop or be sustained. See "Risk Factors -- Possible Volatility of
Stock Price".

Goldman, Sachs & Co. have informed the Company that they do not intend to
confirm sales to any accounts over which they exercise discretionary authority
without the prior specific written approval of such transactions by the
customer.

LEGAL MATTERS

The validity of the shares of Common Stock offered hereby has been passed
upon for the Company by Robinson, Bradshaw & Hinson, P.A., Charlotte, North
Carolina. Certain legal matters in connection with this Prospectus will be
passed upon for Goldman, Sachs & Co. by Fried, Frank, Harris, Shriver & Jacobson
(a partnership including professional corporations), New York, New York.

<PAGE> 55

EXPERTS

The financial statements of the Company as of December 31, 1996 and 1995
and for each of the three fiscal years in the period ended December 31, 1996
included in this Prospectus have been so included in reliance on the report of
Price Waterhouse LLP, independent accountants, given on the authority of said
firm as experts in auditing and accounting.

ADDITIONAL INFORMATION

The Company has filed with the Commission, Washington, D.C., a
Registration Statement on Form S-1 under the Securities Act that includes this
Prospectus. This Prospectus does not contain all of the information set forth in
the Registration Statement, certain portions of which have been omitted as
permitted by the rules and regulations of the Commission. For further
information with respect to the Company and the Common Stock, reference is made
to the Registration Statement, including the exhibits and schedules thereto.
Statements contained in this Prospectus as to the contents of any contract,
agreement or any other document referred to herein are not necessarily complete;
with respect to each such contract, agreement or document filed as an exhibit to
the Registration Statement, reference is made to such exhibit for a more
complete description of the matters involved, and each such statement shall be
deemed qualified in its entirety by such reference. The Registration Statement,
including the exhibits and schedules thereto, may be inspected without charge at
the Commission's principal office at 450 Fifth Street, N.W., Washington, D.C.
20549 and at the Commission's regional offices located at Northwestern Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and at 7
World Trade Center, New York, New York 10048. Copies of such material or any
part thereof may be obtained from such offices, upon payment of the fees
prescribed by the Commission. Such material may also be accessed electronically
by means of the Commission's home page on the Internet at http://www.sec.gov. In
addition, the Company files reports with the Commission, including annual
reports, quarterly reports and current reports on Form 8-K. These reports also
may be inspected, copied and accessed as described above. In addition, the
Company furnishes its stockholders with annual reports containing audited
consolidated financial statements and an opinion thereon expressed by its
independent accountants and with quarterly reports for the first three quarters
of each fiscal year containing unaudited summary condensed financial
information.

<PAGE> 56

INDEX TO FINANCIAL INFORMATION

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated financial statements of Applied Analytical
Industries, Inc.:
Report of Independent Accountants......................... F-2
Consolidated Statement of Income for the years ended
December 31, 1996, 1995 and 1994....................... F-3
Consolidated Balance Sheet as of December 31, 1996 and
1995................................................... F-4
Consolidated Statement of Cash Flows for the years ended
December 31, 1996, 1995 and 1994....................... F-5
Consolidated Statement of Stockholders' Equity for the
years ended December 31, 1996, 1995 and 1994........... F-6
Notes to Consolidated Financial Statements................ F-7
Consolidated financial statements of L.A.B. Gesellschaft fur
pharmakologische Untersuchungen mbH & Co.:
Report of Independent Accountants......................... F-17
Consolidated Balance Sheet as of December 31, 1996 and
1995................................................... F-18
Consolidated Statement of Operations for the years ended
December 31, 1996 and 1995............................. F-19
Consolidated Statement of Cash Flows for the years ended
December 31, 1996 and 1995............................. F-20
Notes to Consolidated Financial Statements................ F-21
Pro Forma Financial Information:
Pro Forma Condensed Statement of Operations, reflecting
the pro forma combination of AAI and L.A.B. for the
year ended December 31, 1996........................... F-24
Notes to Pro Forma Financial Information.................. F-25
</TABLE>

F-1
<PAGE> 57

REPORT OF INDEPENDENT ACCOUNTANTS ON

CONSOLIDATED FINANCIAL STATEMENTS OF

APPLIED ANALYTICAL INDUSTRIES, INC.

To the Board of Directors

and Stockholders of

Applied Analytical Industries, Inc.

In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of cash flows and of stockholders' equity
present fairly, in all material respects, the financial position of Applied
Analytical Industries, Inc. and subsidiaries at December 31, 1996 and 1995, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1996, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.

PRICE WATERHOUSE LLP

Raleigh, North Carolina

February 21, 1997

F-2
<PAGE> 58

APPLIED ANALYTICAL INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF INCOME

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995 1994
------- ------- -------
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
<S> <C> <C> <C>
Net sales (includes related party net sales of $10,916;
$9,088 and $1,991)........................................ $42,162 $34,639 $32,882
Operating costs and expenses:
Cost of sales............................................. 17,621 14,259 14,533
Selling................................................... 6,357 4,913 4,390
General and administrative................................ 8,908 8,171 8,485
Research and development.................................. 4,216 3,326 2,394
Unusual item.............................................. 6,600 -- --
------- ------- -------
43,702 30,669 29,802
------- ------- -------
Income (loss) from operations............................... (1,540) 3,970 3,080
Other income (expense):
Interest.................................................. (456) (1,004) (766)
Other..................................................... 950 (126) 326
------- ------- -------
494 (1,130) (440)
------- ------- -------
Income (loss) before income taxes........................... (1,046) 2,840 2,640
Provision for income taxes.................................. 2,102 39 --
Equity income (loss)........................................ -- 444 (444)
------- ------- -------
Net income (loss)........................................... $(3,148) $ 3,245 $ 2,196
======= ======= =======
Pro forma data (unaudited):
Pro forma earnings (loss) per share......................... $ (0.23)
=======
Pro forma weighted average shares........................... 13,440
=======
Net income, as reported................................... $ 3,245 $ 2,196
Pro forma income taxes.................................... 1,129 1,118
------- -------
Pro forma net income...................................... $ 2,116 $ 1,078
======= =======
Pro forma earnings per share.............................. $ 0.18
=======
Pro forma weighted average shares......................... 11,918
=======
</TABLE>

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

F-3
<PAGE> 59

APPLIED ANALYTICAL INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEET

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1995
-------- -------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................... $ 42,186 $13,081
Accounts receivable......................................... 10,033 7,375
Work-in-progress............................................ 9,462 4,134
Prepaid and other current assets............................ 6,357 1,238
-------- -------
Total current assets.............................. 68,038 25,828
-------- -------
Property and equipment, net................................. 19,216 10,904
Goodwill and other intangibles.............................. 14,953 576
Other assets................................................ 2,271 1,848
-------- -------
Total assets...................................... $104,478 $39,156
======== =======

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt and short-term debt.... $ 2,092 $ 4,726
Accounts payable............................................ 8,429 2,311
Customer advances........................................... 7,790 1,677
Accrued wages and benefits.................................. 5,127 1,530
Other accrued liabilities................................... 8,845 3,210
-------- -------
Total current liabilities......................... 32,283 13,454
-------- -------
Long-term debt.............................................. 6,671 3,379
Other liabilities........................................... 1,529 333
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, series A, $.01 par value,
none -- 1996; 1,000 shares authorized, 883 shares
outstanding -- 1995.................................... -- --
Common stock, voting, $.001 par value -- 1996, no
par -- 1995; 100 million shares authorized, 16,286,236
outstanding -- 1996; 446,799 shares
outstanding -- 1995.................................... 16 150
Common stock, Class B, non-voting, $.001 par
value -- 1996, no par -- 1995, none -- 1996; 9,993,076
shares outstanding -- 1995............................. -- 171
Paid-in capital............................................. 66,719 21,510
Retained earnings (deficit)................................. (2,591) 308
Stock subscriptions receivable.............................. (149) (149)
-------- -------
Total stockholders' equity........................ 63,995 21,990
-------- -------
Total liabilities and stockholders' equity........ $104,478 $39,156
======== =======
</TABLE>

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

F-4
<PAGE> 60

APPLIED ANALYTICAL INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1996 1995 1994
-------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss).......................................... $ (3,148) $ 3,245 $ 2,196
Adjustments to reconcile to net cash provided (used) by
operating activities:
Depreciation and amortization............................ 2,062 1,591 1,515
Deferred income taxes.................................... 25 (16) --
Unusual item............................................. 6,600 -- --
Equity (income) loss..................................... -- (444) 444
Other.................................................... 110 278 --
Changes in assets and liabilities:
Trade and other receivables........................... (1,073) 380 (1,763)
Work-in-progress...................................... (969) (1,827) (224)
Prepaid and other assets, net......................... (494) (385) (44)
Accounts payable...................................... 245 1,197 (61)
Customer advances..................................... (943) (509) 1,456
Other accrued liabilities............................. (48) 301 1,382
-------- ------- -------
Net cash provided (used) by operating activities........... 2,367 3,811 4,901
-------- ------- -------
Cash flows from investing activities:
Purchase of property and equipment......................... (7,609) (1,720) (3,091)
Investment in affiliate.................................... -- (1,593) --
Acquisition of L.A.B., net of cash acquired................ (2,206) -- --
Short-term investment...................................... (4,000) -- --
Other...................................................... 31 (249) (340)
-------- ------- -------
Net cash used by investing activities...................... (13,784) (3,562) (3,431)
-------- ------- -------
Cash flows from financing activities:
Net proceeds (payments) short-term debt.................... (2,656) (926) 1,260
Proceeds from long-term borrowings......................... -- 1,505 1,165
Payments on long-term borrowings........................... (565) (978) (1,996)
Payment of stockholder note................................ -- (1,159) --
Sale of preferred stock.................................... -- 21,510 --
Sale of common stock....................................... 44,794 -- --
Dividends.................................................. (1,051) (7,593) (1,889)
-------- ------- -------
Net cash provided (used) by financing activities........... 40,522 12,359 (1,460)
-------- ------- -------
Net increase in cash and cash equivalents.................. 29,105 12,608 10
Cash and cash equivalents, beginning of period............. 13,081 473 463
-------- ------- -------
Cash and cash equivalents, end of period................... $ 42,186 $13,081 $ 473
======== ======= =======
Supplemental information, cash paid for:
Interest................................................. $ 402 $ 938 $ 669
Income taxes............................................. $ 1,945 $ 146 $ --
</TABLE>

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

F-5
<PAGE> 61

APPLIED ANALYTICAL INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
COMMON STOCK CLASS B STOCK
--------------- ---------------- PAID-IN RETAINED
SHARES AMOUNT SHARES AMOUNT CAPITAL (1) EARNINGS
------ ------ ------- ------ ----------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1994............ 447 $ 322 9,784 $ 284 $ -- $ 5,026
Sale of stock to officer (2).......... -- -- 103 33 -- --
Dividends............................. -- -- -- -- -- (1,889)
Net income............................ -- -- -- -- -- 2,196
------ ----- ------- ----- ------- -------
Balance, December 31, 1994............ 447 $ 322 9,887 $ 317 $ -- $ 5,333
------ ----- ------- ----- ------- -------
Sale of stock to officer (2).......... -- -- 106 305 -- --
Sale of preferred stock, Series A,
(883 shares)........................ -- -- -- -- 21,510 --
Dividends............................. -- (172) -- (451) -- (8,270)
Net income............................ -- -- -- -- -- 3,245
------ ----- ------- ----- ------- -------
Balance, December 31, 1995............ 447 $ 150 9,993 $ 171 $21,510 $ 308
------ ----- ------- ----- ------- -------
Dividend adjustment................... -- -- -- -- -- 249
Stock award........................... -- -- 105 490 (490) --
Establish common stock par value of
$0.001 per share.................... -- (150) -- (651) 801 --
Sale of common stock.................. 3,105 3 -- -- 44,791 --
Conversion to common stock:
Preferred stock (883 shares)........ 2,636 3 -- -- (3) --
Class B common stock................ 10,098 10 (10,098) (10) -- --
Stock options exercised............... -- -- -- -- -- --
Deferred compensation earned.......... -- -- -- -- 110 --
Net income (loss)..................... -- -- -- -- -- (3,148)
------ ----- ------- ----- ------- -------
Balance, December 31, 1996............ 16,286 $ 16 -- $ -- $66,719 $(2,591)
====== ===== ======= ===== ======= =======
</TABLE>

- ---------------

(1) Paid-in capital includes deferred compensation of $(378) at December 31,
1996, with no amounts for 1995 and 1994, respectively.

(2) The sale of stock to officer in 1995 and 1994 each increased stock
subscription receivable by $(33) to $(149) at December 31, 1995 from $(116)
at December 31, 1994 and $(83) at January 1, 1994.

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

F-6
<PAGE> 62

APPLIED ANALYTICAL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation

The consolidated financial statements include the accounts of Applied
Analytical Industries, Inc. (the "Company" or "AAI") and its wholly-owned
subsidiaries. All material intercompany transactions have been eliminated. The
Company has ownership of approximately 40%, on a fully diluted basis, in
Endeavor Pharmaceuticals Inc. ("Endeavor") which is accounted for under the
equity method.

Revenue recognition

Licensing revenues from Company funded development projects are primarily
recognized as significant contract requirements are met. Royalty revenues are
recognized as earned in accordance with contract terms.

Income taxes

The financial statements of the Company prior to November 17, 1995 do not
include a provision for income taxes because, under an S corporation election,
all income and loss passed directly to the stockholders. The Company no longer
qualified as an S corporation as a result of the preferred stock issuance in
November 1995. At that time AAI was directly subject to federal and state income
taxes and, accordingly, began accounting for income taxes.

Unaudited pro forma data

For information purposes, the Consolidated Statement of Income includes a
pro forma income tax provision for financial reporting purposes using federal
and state tax rates that would have applied if the Company had been directly
subject to income taxes.

Pro forma earnings per share

The weighted average shares used in the calculation of pro forma earnings
per share include the effect of the conversion of convertible preferred stock
and Class B common stock as if they were converted at the beginning of the year.
Additionally, common stock or equivalent shares from stock options or awards
sold or issued at prices below $16.00 per share in the twelve months preceding
July 1996 have been included in the calculation as if outstanding as of the
beginning of the year.

Cash and cash equivalents

The Company considers all highly liquid debt investments purchased with an
original maturity of three months or less to be cash equivalents.

Accounts receivable

Unbilled accounts receivable represent specific invoices that, in keeping
with certain client billing arrangements, are mailed to clients approximately 15
days after the month during which the work was completed.

F-7
<PAGE> 63

APPLIED ANALYTICAL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Property and equipment

Property and equipment is recorded at cost. Depreciation is recognized
using the straight-line method over the estimated useful lives of the assets.
Depreciable lives are 31.5 years for buildings and improvements and 3 to 15
years for equipment.

Goodwill, intangibles and other assets

Goodwill, the excess of the purchase price over the fair value of the net
assets of acquired companies, is amortized over 20 years. Other identifiable
intangible assets are amortized, if applicable, on a straight-line basis over
their estimated useful lives which range from 3 to 17 years.

The Company has an investment in non-voting, mandatorily redeemable
preferred stock of a related party which is carried at original cost in other
assets. Management monitors this investment for impairment and will write-down
the carrying value below cost for any impairment considered to be other than
temporary.

Fair value of financial instruments

The carrying value of cash and cash equivalents, accounts receivable, the
preferred stock investment, current liabilities and long-term debt approximate
fair value. It is not practicable to estimate the fair value of the Company's
equity investment, which is recorded at zero, as no readily determinable market
exists for investments in such entities.

Use of estimates

The preparation of financial statements in conformity with generally
accepted accounting principles 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.

New Accounting Pronouncements

In 1996, the Company adopted the requirements of two new statements, issued
by the Financial Accounting Standards Board, related to accounting for
impairment of long-lived assets and accounting for stock compensation. The
effect of adoption of these statements has not resulted in a material impact to
the Company's financial position or results of operations.

Reclassifications

Certain amounts in prior year financial statements have been reclassified
to conform with the current year presentation.

2. ACQUISITION AND UNUSUAL ITEM

On December 31, 1996, the Company acquired all the outstanding equity in
L.A.B. Gesellschaft fur pharmakologische Untersuchungen mbH & Co. ("L.A.B."), a
European contract research and development organization headquartered in
Neu-Ulm, Germany with operational units in Neu-Ulm, Stuttgart and Munich,
Germany as well as in France, Netherlands, England and Hungary.

The aggregate purchase price for L.A.B. was approximately $20.9 million,
which includes current and future payments to former equity holders, L.A.B. debt
and other liabilities, and accrued AAI acquisition costs. The acquisition has
been accounted for using the purchase method of accounting. The consolidated
financial statements reflect the allocation of the purchase price to the fair
value of the assets

F-8
<PAGE> 64

APPLIED ANALYTICAL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

acquired, including goodwill of approximately $14.4 million. The results of
operations for L.A.B. will be included in the consolidated financial statements
of AAI beginning in 1997.

The following table reflects the unaudited pro forma combined results of
operations of AAI and L.A.B. as if the acquisition had occurred at the beginning
of each period. Such pro forma information is presented for informational
purposes only and is not necessarily indicative of the consolidated results that
would have been achieved had the acquisition been consummated as of that time.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1996 1995
--------- ---------
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C>
Net sales................................................... $60,385 $57,594
Net income (loss)........................................... $(8,473) $ (98)
Earnings (loss) per share................................... $ (0.63) $ (0.01)
</TABLE>

The identifiable assets of the Company as of December 31,1996 were located
in the United States ($82.5 million) and Europe ($22.0 million). Prior to the
acquisition of L.A.B., the Company's assets were predominantly located in the
United States.

3. INCOME TAXES

The following table presents the components for the provision for income
taxes.

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------
1996 1995
------ ----
(IN THOUSANDS)
<S> <C> <C>
Change in tax status........................................ $ -- $ 31
Current:
Federal................................................... 1,709 44
State..................................................... 368 11
------ ----
2,077 55
------ ----
Deferred:
Federal................................................... 18 (38)
State..................................................... 7 (9)
------ ----
25 (47)
------ ----
$2,102 $ 39
====== ====
</TABLE>

A table reconciliation of the provision for income taxes to the amount
computed by applying the federal statutory income tax rate is not presented.
Reconciling items are state income taxes for both 1996 and 1995 and the 1996
write-off of in-process research and development costs related to the L.A.B.
acquisition. This unusual item was excluded from taxable income in calculating
the provision for income taxes. This amount will result in the recognition of an
income tax benefit as L.A.B. has taxable income.

Deferred income taxes arise from temporary differences between the tax
bases of assets and liabilities and their reported amounts in the financial
statements. The following table presents the deferred tax assets and deferred
tax liability.

F-9
<PAGE> 65

APPLIED ANALYTICAL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
DECEMBER 31,
------------- NOVEMBER 17,
1996 1995 1995
----- ----- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Deferred tax assets, resulting from:
Accrued liabilities....................................... $ 308 $ 321 $ 227
Other items............................................... 49 28 41
----- ----- -----
357 349 268
Deferred tax liability, resulting from:
Property and equipment.................................... (366) (333) (299)
----- ----- -----
Net deferred tax (liability) asset........................ $ (9) $ 16 $ (31)
===== ===== =====
</TABLE>

Deferred tax assets of approximately $3.0 million have resulted from the
L.A.B. acquisition; however, a valuation allowance for the total asset amount
has been provided, since realization of such assets can not be predicted with
reasonable certainty.

4. DEBT

The following table presents the components of current maturities of
long-term debt and short-term debt.

<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1996 1995
------ ------
(IN THOUSANDS)
<S> <C> <C>
Industrial revenue bonds.................................... $1,425 $1,750
Bank debt................................................... -- 2,331
Current maturities of long-term debt........................ 667 645
------ ------
$2,092 $4,726
====== ======
</TABLE>

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

<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1996 1995
------ ------
(IN THOUSANDS)
<S> <C> <C>
Bank term loans............................................. $3,307 $3,867
L.A.B. bank debt............................................ 3,879 --
Other....................................................... 152 157
------ ------
7,338 4,024
Less current maturities..................................... (667) (645)
------ ------
$6,671 $3,379
====== ======
</TABLE>

The industrial revenue bonds were secured in 1988 to finance the
acquisition and construction of facilities in North Carolina. They have a
variable interest rate which is adjusted annually with a maximum allowable rate
of 15%. The rates at December 31, 1996 and 1995 were 4.45% and 5.45%,
respectively. The bonds are payable in monthly installments of $25,000, plus
interest, through November 2000, and are redeemable at the option of the
bondholders. The Company has entered into an agreement with a bank to pay any
bonds redeemed under a stand-by letter of credit covering the outstanding
principal of the bonds. The Company also has a bond remarketing agreement with
such bank to remarket any bonds presented for early redemption, on a best
efforts basis. These bonds have been classified as short-term debt because of
the early redemption feature.

F-10
<PAGE> 66

APPLIED ANALYTICAL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The bank term loans represent amounts outstanding under a credit facility
with a bank which expired in November 1996. The loans have variable interest
rates based on the 30-day LIBOR rate plus a margin based on the Company's debt
to equity ratio. The loans are payable in monthly installments including
interest. The average interest rate on these loans was 7.07% and 8.86% for 1996
and 1995, respectively.

In December 1996, the Company replaced the above credit facility with a new
revolving credit agreement with the same bank through May 1998. The agreement
provides for borrowings of up to $20 million at variable interest rates,
adjusted quarterly. The rates can be based , at the Company's option, on either
the 90-day LIBOR rate or an applicable CD rate. The rates can be reduced or
increased depending on the Company's ratio of total liabilities to tangible net
worth.

At the end of the revolving credit period any outstanding balances under
this facility convert to a term loan payable in monthly installments, including
interest, through the year 2004. The agreement requires the payment of a nominal
commitment fee based on the unused portion of the line of credit. There were no
amounts outstanding under this agreement at December 31, 1996.

The Company has classified the L.A.B. bank debt, which is approximately 6
million Deutsche marks, as long-term debt as of December 31, 1996, since it has
the intent and the ability to renew or convert these obligations through 1997
and future periods.

Under the terms of the revolving credit facility and the stand-by letter of
credit agreement, the Company is required to comply with various covenants
including, but not limited to, those pertaining to working capital, maintenance
of certain financial ratios, and incurring additional indebtedness outside the
agreement. The Company was in compliance with these covenants at December 31,
1996.

Scheduled maturities of long-term debt as of December 31, 1996 are
$667,000 -- 1997; $2,344,000 -- 1998; $200,000 -- 1999; $4,079,000 -- 2000; and
$48,000 -- 2001.

5. STOCKHOLDERS' EQUITY

The authorized capital stock of the Company at December 31, 1996 was 100
million shares of voting common stock, $.001 par value per share, and 5 million
shares of preferred stock, $.001 par value per share. The preferred stock is
issuable in one or more series by the Company's Board of Directors without
further stockholder approval. The Company has reserved 495,293 shares of common
stock for issuance under stock option plans.

AAI completed an initial public offering of 3,105,000 shares of common
stock, with net proceeds to the Company of approximately $44.8 million, on
September 25, 1996 (the "IPO"). Upon the completion of the IPO the Company's
then outstanding Class B common stock, $.001 par value per share, and Series A
convertible preferred stock, $.001 par value per share ("Series A Preferred"),
converted to a single class of common stock. Prior to the IPO, the Board of
Directors authorized two stock splits for all common stock, on May 31, 1996 a
stock split of 200 to 1 and on June 5, 1996 a reverse split of .6325 to 1,
resulting in a net increase to shares outstanding of 126.5 to 1. All numbers of
common shares and per share amounts in the accompanying financial statements
have been retroactively adjusted to reflect these stock splits.

Preferred Stock

On November 17, 1995, the Company issued 883 shares of Series A Preferred
resulting in net proceeds to the Company of approximately $21.5 million. This
stock was mandatorily converted into common stock of AAI upon the IPO. Pursuant
to a Stockholder Agreement among the Company and the holders of the Series A
Preferred, certain conditions remain in effect after the IPO regarding
transferability rights and the appointment of one board seat.

F-11
<PAGE> 67

APPLIED ANALYTICAL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Dividends

The Company elected to distribute its S corporation retained earnings
concurrent with the change to a C corporation tax status in November 1995. A
portion was paid in 1995 with the remainder paid in 1996 upon filing the final S
corporation tax returns for the period January 1, 1995 to November 17, 1995.

Stock Option and Award Plans

In 1996, the Board of Directors awarded 104,696 shares of Class B common
stock to certain employees and officers of the Company. The fair value at the
time of such award is recognized as deferred compensation in paid-in capital and
is being expensed over a two year period.

The Company has two stock option plans, the 1995 Stock Option Plan ("1995
Plan") and the 1996 Stock Option Plan ("1996 Plan"). Under the 1995 Plan, the
Board of Directors may grant options to purchase up to 242,538 shares of common
stock. However, the Company has no obligation to issue the shares upon exercise
of such options until it has purchased an equal number of shares from certain
existing stockholders. Under the 1996 Plan, the Board of Directors may grant
options to purchase up to 495,627 newly issued shares of common stock. Both
plans require that the exercise price of options cannot be less than 75% of the
estimated fair market value of the Company's shares of common stock on the date
of grant.

The combined activity from both plans is presented in the following table.

<TABLE>
<CAPTION>
WEIGHTED AVERAGE
SHARES PRICE PER SHARE
------- ----------------
<S> <C> <C>
Outstanding, January 1, 1996................................ --
Granted................................................... 452,658 $8.35
Exercised................................................. (334) $8.35
Forfeited................................................. (9,569) $8.35
-------
Outstanding, December 31, 1996.............................. 442,755 $8.35
=======
Exercisable, December 31, 1996.............................. 110,445 $8.35
=======
</TABLE>

The outstanding options have an exercise range of $8.35 to $9.10 per share
with a weighted average remaining life of 9.3 years. The weighted average fair
value at date of grant for options granted during 1996 was $2.20 per option. The
fair value of options at date of grant was estimated using the Black-Scholes
option pricing model with the following weighted average assumptions: expected
life (5 years); interest rate (6.3%); no volatility and no dividend yield.

The Company applies APB Opinion 25 and related interpretations in
accounting for its stock option plans; therefore, compensation expense has not
been recognized for all options granted. Had compensation cost for the Company's
plans been determined based on the fair value at the grant dates for awards
under those plans consistent with the method of FASB Statement 123, the
Company's net loss and loss per share would have been changed to the pro forma
amounts indicated below for the year ended December 31, 1996.

<TABLE>
<CAPTION>
EARNINGS (LOSS)
NET LOSS PER SHARE
----------- ---------------
<S> <C> <C>
As reported................................................. $(3,148,000) $(0.23)
Pro forma................................................... $(3,323,000) $(0.25)
</TABLE>

F-12
<PAGE> 68

APPLIED ANALYTICAL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. RELATED PARTY TRANSACTIONS AND MAJOR CUSTOMERS

Endeavor

In April 1994, AAI organized Endeavor with Berlex Laboratories, Inc. and
several other investors to fund the development of hormone pharmaceutical
products, initially focusing on several generic hormone products already under
development by the Company. AAI obtained a 47% equity interest in Endeavor
through the contribution of its accumulated product research and development and
technical know-how. The other investors contributed cash in exchange for their
interests which, for all investors, was in the form of convertible preferred
stock. Based on a subsequent cash infusion by a new investor in November 1995,
the Company's interest in Endeavor was diluted to approximately 40%, on a fully
diluted basis.

The Company's initial investment in Endeavor was recorded at zero. The gain
for its share of the cash contributed by the other investors was deferred over
the period the proceeds from such equity were expended by Endeavor. Due to a
commitment to provide financial support under a line of credit, AAI recognized a
liability for its proportionate share of Endeavor's losses, net of amortization
of the deferred gain, in 1994 and part of 1995. As a result of the November 1995
cash infusion from a third party, the Company was repaid all amounts outstanding
under the line of credit and terminated its obligation to provide any further
funding under such line of credit. Since AAI had no requirement to provide any
additional funding to Endeavor, the previously recorded liability was reversed
in the fourth quarter of 1995. During 1996, the remaining deferred gain offset
the Company's unrecorded share of Endeavor's net loss.

The Company had net sales to Endeavor for product development services of
approximately $6.2 million (15% of AAI net sales), $3.5 million (10% of AAI net
sales) and $2.0 million for the years ended December 31, 1996, 1995, and 1994,
respectively. These services are provided on terms and conditions management
believes are comparable to those afforded unrelated entities. Additionally, AAI
had approximately $967,000 and $21,000 in accounts receivable and approximately
$372,000 and $948,000 in work-in-progress related to Endeavor at December 31,
1996 and 1995, respectively.

The Company has agreed, upon the completion of a specified development
milestone, to grant Endeavor an option to lease certain production space
intended for use by AAI in manufacturing Endeavor's products or to purchase that
part of the facility. Upon exercise of the option to lease, Endeavor would be
required to pay $2 million to the Company and may purchase that portion of the
facility at its fair market value. If the option is exercised but AAI fails to
perform certain development milestones by a specified date, AAI must repay the
option exercise price to Endeavor. The facilities subject to the option are
currently used by the Company for its clinical supply and niche manufacturing
operations.

The Company is expanding its clinical supply and niche manufacturing
facilities to maintain necessary capacity in the event Endeavor exercises its
option. The Company has also agreed to permit Endeavor under certain
circumstances the first right to purchase additional proprietary hormone
pharmaceutical products developed by AAI.

F-13
<PAGE> 69

APPLIED ANALYTICAL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following tables present certain summary financial data for Endeavor.

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1995 1994
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Current assets.............................................. $ 1,330 $ 7,878 $ 1,525
Noncurrent assets........................................... 176 301 351
Current liabilities......................................... (726) (1,149) (532)
Noncurrent liabilities...................................... (3,458) (3,176) --
------- ------- -------
Stockholders' equity........................................ $(2,678) $ 3,854 $ 1,344
======= ======= =======
</TABLE>

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995 1994
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Net revenues................................................ $ 1,333 $ 250 $ 250
Net loss.................................................... $(6,532) $(4,217) $(2,767)
Excess of AAI's equity (deficit) in net assets over carrying
value..................................................... $(1,152) $ 1,652 $ 1,076
</TABLE>

Aesgen, Inc.

Aesgen, Inc. ("Aesgen") was formally organized with an affiliate of the
Mayo Clinic and MOVA Pharmaceutical Corporation and funded in April 1995 via
issuance of approximately $11 million of nonconvertible, non-voting, mandatorily
redeemable, preferred stock. The Company made a cash investment of $1.6 million
in such preferred stock, which is carried at cost, and is included in other
noncurrent assets on the balance sheet. As the Company did not intend to hold an
equity interest in Aesgen, the Company entered a series of related transactions
commencing in December 1995 to transfer to a corporation owned by the holders,
at that time, of substantially all of the outstanding capital stock of the
Company, all of its shares of Aesgen common stock in return for $50,000 (amount
paid by AAI for such shares) and such corporation's assumption of an obligation
to invest an additional $1.2 million in Aesgen.

The Company provides product development services to Aesgen at terms and
conditions that management believes are similar to those afforded unrelated
entities. In 1996, the Company sold to Aesgen marketing rights to a product
under development by the Company. Under the agreement, Aesgen paid a license fee
and will pay additional royalties upon marketing the product. AAI recognized net
sales of approximately $4.7 million (11% of AAI net sales) and $5.6 million (16%
of AAI net sales) from Aesgen for the years ended December 31, 1996 and 1995,
respectively. AAI also had accounts receivable of approximately $352,000 and
$51,000 from Aesgen and work-in-progress balances of approximately $345,000 and
$1.0 million at December 31, 1996 and 1995, respectively. AAI has the right
under its development agreement with Aesgen to provide certain product
development and support services to Aesgen with respect to some generic drugs
currently being developed by Aesgen, provided that AAI's fees for such services
are comparable to those of a competitor. In addition, under such development
agreement, the Company has agreed not to develop, for its own account or any
other person, a formulation of any of the generic products currently under
development for Aesgen and any additional drugs that AAI agrees to develop in
the future for Aesgen under the development agreement.

Pharmaceutical Seminars, Inc.

The Company purchased certain assets of Pharmaceutical Seminars, Inc.
("PSI") in 1994 and 1995 for a total of $374,000. PSI organized seminars
addressing various pharmaceutical industry topics and was wholly-owned by the
spouses of two of the Company's officers and directors.

F-14
<PAGE> 70

APPLIED ANALYTICAL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Other Major Customer

The Company had one unrelated customer which accounted for 12% and 19% of
net sales for the years ended December 31, 1995 and 1994, respectively. Due to
the nature of the Company's business, major customers may vary from year to
year.

7. SUPPLEMENTAL BALANCE SHEET INFORMATION

The following table presents the components of accounts receivable.

<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1996 1995
------- ------
(IN THOUSANDS)
<S> <C> <C>
Trade and other:
Billed.................................................... $ 7,235 $5,905
Unbilled.................................................. 1,552 1,467
Related parties............................................. 1,319 73
------- ------
10,106 7,445
Allowance for doubtful accounts............................. (73) (70)
------- ------
$10,033 $7,375
======= ======
</TABLE>

The following table presents the components of property and equipment.

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1995
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Land........................................................ $ 298 $ 298
Buildings and improvements.................................. 9,864 6,919
Machinery and equipment..................................... 17,388 12,468
Construction-in-progress.................................... 2,927 454
-------- --------
30,477 20,139
Less, accumulated depreciation.............................. (11,261) (9,235)
-------- --------
$ 19,216 $ 10,904
======== ========
</TABLE>

8. EMPLOYEE BENEFIT PLAN

The Company provides retirement benefits for all domestic AAI employees
with one year of service through a defined contribution plan qualified under
section 401(k) of the Internal Revenue Code of 1986, as amended. Participants
may elect to contribute a portion of their annual compensation, subject to
limitations. The Company makes matching contributions equal to 50% of a
participant's contribution up to a certain amount. Additionally, the Company
makes profit-sharing contributions at the discretion of the Board of Directors.
The discretionary contributions for the years ended December 31, 1996, 1995 and
1994 were $557,000, $226,000 and $322,000, respectively.

9. COMMITMENTS AND CONTINGENCIES

The Company leases land, buildings and equipment under renewable lease
agreements classified as operating leases. Rent expense under these agreements
for the years ended December 31, 1996, 1995 and 1994 was $1.3 million, $1.3
million and $1.1 million, respectively. Future minimum rentals due under lease
agreements as of December 31, 1996 are $2.8 million -- 1997; $2.2
million -- 1998; $1.7 million -- 1999; $1.7 million -- 2000; $1.5
million -- 2001 and $1.2 million -- thereafter.

F-15
<PAGE> 71

APPLIED ANALYTICAL INDUSTRIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company is party to lawsuits and administrative proceedings incidental
to the normal course of its business. In connection with the 1995 issuance of
the Series A Preferred, two of the Company's stockholders have agreed to
indemnify the Company for certain losses, if incurred. Management does not
believe that any liabilities related to such lawsuits or proceedings will have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.

10. SUBSEQUENT EVENT

In February 1997, one of the Company's investments in commercial paper for
$4 million was not redeemed because of a cancellation of the writer's credit
facility supporting their commercial paper. Such company has made public
statements that it will not make any debt payments while it tries to obtain new
credit facilities. In the interim, it has obtained a $50 million temporary
facility to fund its operations and continue its business. While management does
not believe that this situation will have a significant impact to the Company's
financial condition, it is unable to predict the outcome at this time. This
investment has been reclassified from cash and cash equivalents to prepaid and
other current assets as of December 31, 1996, since it is uncertain whether it
will be collected within three months.

11. FINANCIAL RESULTS BY QUARTER (UNAUDITED)

<TABLE>
<CAPTION>
QUARTER FIRST SECOND THIRD FOURTH
- ------- ------ ------- ------- -------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C> <C>
Year ended December 31, 1996
Net sales........................................... $9,925 $10,849 $10,396 $10,992
Gross profit........................................ $5,807 $ 6,152 $ 6,202 $ 6,380
Net income (loss) (1)............................... $ 655 $ 741 $ 799 $(5,343)
Pro forma earnings (loss) per share................. $ 0.06 $ 0.06 $ 0.06 $ (0.33)
Year ended December 31, 1995
Net sales........................................... $8,309 $ 8,292 $ 8,932 $ 9,106
Gross profit........................................ $4,683 $ 4,648 $ 5,456 $ 5,593
Net income.......................................... $ 32 $ 784 $ 1,088 $ 1,341
Pro forma net income (loss) (2)..................... $ (163) $ 475 $ 655 $ 1,149
Pro forma earnings (loss) per share (2)............. $(0.01) $ 0.04 $ 0.05 $ 0.10
</TABLE>

- ---------------

(1) In connection with the acquisition of L.A.B. the Company recognized an
unusual item representing the write-off of certain in-process research and
development costs with an appraised value of approximately $6.6 million as
of December 31, 1996. Without such write-off the net income in the fourth
quarter would have been approximately $1.3 million.

(2) Pro forma information is presented for 1995 to reflect a pro forma provision
for income taxes for the period prior to November 17, 1995, when the Company
was treated as an S corporation for income tax purposes.

F-16
<PAGE> 72

REPORT OF INDEPENDENT ACCOUNTANTS ON

CONSOLIDATED FINANCIAL STATEMENTS OF

L.A.B. GESELLSCHAFT FUR PHARMAKOLOGISCHE UNTERSUCHUNGEN MBH & CO.

To the Owners of

L.A.B. Gesellschaft fur pharmakologische Untersuchungen mbH & Co.

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations and of cash flows present fairly,
in all material respects, the financial position of L.A.B. Gesellschaft fur
pharmakologische Untersuchungen mbH & Co. and subsidiaries ("L.A.B.") at
December 31, 1996 and 1995 and the results of their operations and their cash
flows for each of the two years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.

Effective December 31, 1996, Applied Analytical Industries, Inc. acquired L.A.B.

PRICE WATERHOUSE GmbH

Stuttgart, Germany

February 21, 1997

F-17
<PAGE> 73

L.A.B. GESELLSCHAFT FUR PHARMAKOLOGISCHE UNTERSUCHUNGEN MBH & CO.

CONSOLIDATED BALANCE SHEET

<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1995
------- -------
(IN THOUSAND
DEUTSCHE MARKS)
<S> <C> <C>
ASSETS
Current assets:
Cash...................................................... 341 577
Accounts receivable....................................... 2,440 4,165
Work-in-progress.......................................... 6,711 9,364
Prepaid and other current assets.......................... 1,363 1,913
------- -------
Total current assets.............................. 10,855 16,019
------- -------
Property and equipment:
Buildings and improvements................................ 27 27
Machinery and equipment................................... 14,558 14,007
------- -------
14,585 14,034
Less, accumulated depreciation.............................. 11,221 10,256
------- -------
3,364 3,778
Other assets................................................ 559 258
------- -------
Total assets...................................... 14,778 20,055
======= =======

LIABILITIES AND OWNERS' EQUITY
Current liabilities:
Loan obligations.......................................... 5,972 5,570
Accounts payable.......................................... 5,675 6,204
Accrued wages and benefits................................ 2,710 2,221
Customer advances......................................... 10,862 13,489
AAI advance............................................... 1,364 --
Rent payable.............................................. 3,367 2,817
Other accrued liabilities................................. 8,849 6,519
------- -------
Total current liabilities......................... 38,799 36,820
------- -------
Long-term debt.............................................. -- 6,910
Commitments and contingencies
Owners' equity:
Stated capital............................................ 2,000 2,000
Contributed capital....................................... 2,890 --
Accumulated deficit....................................... (28,911) (25,675)
------- -------
Total owners' equity.............................. (24,021) (23,675)
------- -------
Total liabilities and owners' equity.............. 14,778 20,055
======= =======
</TABLE>

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

F-18
<PAGE> 74

L.A.B. GESELLSCHAFT FUR PHARMAKOLOGISCHE UNTERSUCHUNGEN MBH & CO.

CONSOLIDATED STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
--------------------
1996 1995
------- -------
(IN THOUSAND
DEUTSCHE MARKS)
<S> <C> <C>
Net sales................................................... 27,425 32,895
Operating costs and expenses:
Cost of sales............................................. 23,535 25,475
Selling................................................... 2,670 1,991
General and administrative................................ 6,263 5,905
Research and development.................................. 2,280 1,180
------ ------
34,748 34,551
------ ------
Loss from operations........................................ (7,323) (1,656)
Other (income) expense:
Interest.................................................. 1,245 1,499
Other..................................................... (275) (342)
------ ------
970 1,157
------ ------
Loss before income taxes and extraordinary item............. (8,293) (2,813)
Provision for income taxes.................................. 943 852
------ ------
Loss before extraordinary item.............................. (9,236) (3,665)
Extraordinary item -- gain on forgiveness of debt........... 6,000 --
------ ------
Net Loss.......................................... (3,236) (3,665)
====== ======
</TABLE>

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

F-19
<PAGE> 75

L.A.B. GESELLSCHAFT FUR PHARMAKOLOGISCHE UNTERSUCHUNGEN MBH & CO.

CONSOLIDATED STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
--------------------
1996 1995
-------- --------
(IN THOUSAND
DEUTSCHE MARKS)
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................... (3,236) (3,665)
Adjustments to reconcile net loss to net cash provided
(used) by operating activities:
Depreciation and amortization............................. 985 965
Extraordinary gain........................................ (6,000) --
Changes in assets and liabilities:
Accounts receivable.................................... 1,725 (325)
Work-in-progress....................................... 2,653 223
Prepaid and other assets............................... 550 468
Accounts payable....................................... (529) 1,704
Accrued wages and benefits............................. 489 512
Customer advances...................................... (2,627) (3,653)
AAI advance............................................ 1,364 --
Rent payable........................................... 3,440 794
Other accrued liabilities.............................. 2,330 (439)
------ ------
Net cash provided (used) by operating activities............ 1,144 (3,416)
------ ------
Cash flows from investing activities:
Proceeds from sale of property and equipment.............. 242 94
Purchase of property and equipment........................ (813) (2,564)
Other..................................................... (301) (24)
------ ------
Net cash used by investing activities....................... (872) (2,494)
------ ------
Cash flows from financing activities:
Proceeds from borrowings.................................. 402 6,848
Payments on borrowings.................................... (910) (2,541)
Capital contribution...................................... -- 1,500
------ ------
Net cash provided (used) by financing activities............ (508) 5,807
------ ------
Net increase (decrease) in cash............................. (236) (103)
Cash, beginning of period................................... 577 680
------ ------
Cash, end of period......................................... 341 577
------ ------
Supplemental information, cash paid for:
Interest.................................................. 197 125
Income taxes.............................................. 722 30
</TABLE>

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

F-20
<PAGE> 76

L.A.B. GESELLSCHAFT FUR PHARMAKOLOGISCHE UNTERSUCHUNGEN MBH & CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

Description of business

L.A.B. Gesellschaft fur pharmakologische Untersuchungen mbH & Co. (the
"Company" or "L.A.B."), is a limited partnership operating as a European
contract research and development organization headquartered in Neu-Ulm, Germany
with operational units in Neu-Ulm, Stuttgart and Munich, Germany as well as
limited liability subsidiaries in France, Netherlands, England and Hungary.

Basis of presentation

The consolidated financial statements include the accounts of L.A.B. and
its subsidiaries. All material intercompany transactions have been eliminated.

Revenue recognition

Revenues from contract pharmaceutical product development and support
services are recognized on a percentage of completion basis. Work-in-progress
represents revenues recognized prior to contract billing terms. Provisions for
losses on contracts, if any, are recognized when identified. Licensing revenues
from Company funded development projects are primarily recognized as significant
contract requirements are met.

Income taxes

The Company does not have the ability to consolidate its operations for
income tax purposes and is subject to income taxes separately by subsidiary.

Property and equipment

Property and equipment is recorded at cost. Depreciation is recognized
using the straight-line method over the estimated useful lives of the assets.
Depreciable lives are 12 years for building improvements and 3 to 10 years for
equipment.

Other assets

Other assets include a 50% joint venture in China entered into in November
1996. The investment is reported at original cost and is accounted for using the
equity method. There was no significant impact on 1996 operating results from
this investment.

Distributions

Distributions, under German law, are payable to the owners only when
retained earnings are not in a deficit position. Taxable income or loss passes
directly to the partners of L.A.B. since it is a limited partnership.

Translation of foreign currencies

The functional currency for the Company is the Deutsche mark. The financial
statements for international operations were translated into marks at year-end
exchange rates, including the statement of operations. Adjustments which would
have resulted from financial statement translations at average exchange rates
and be included in owners' equity as cumulative translation adjustments were not
material. Gains and losses resulting from foreign currency transactions are
included in operating results.

F-21
<PAGE> 77

L.A.B. GESELLSCHAFT FUR PHARMAKOLOGISCHE UNTERSUCHUNGEN MBH & CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Fair value of financial instruments

The carrying value of cash and cash equivalents, accounts receivable,
current liabilities and loans approximate fair value.

Use of estimates

2. CHANGE IN CONTROL OF L.A.B.

Applied Analytical Industries, Inc. ("AAI") exercised its option to acquire
L.A.B., effective as of December 31, 1996, through two wholly-owned German
subsidiaries. This change in control of L.A.B. is expected to have a significant
impact on the Company as described in the following footnotes.

3. EXTRAORDINARY ITEM

In contemplation of the acquisition of L.A.B. by AAI, certain creditors of
the Company have waived, as of December 30, 1996, their demands for DM6 million
in loan obligations prior to such acquisition. This forgiveness of liability has
been recognized in the consolidated financial statements as an extraordinary
item. There are no income taxes related to this transaction.

4. LOAN OBLIGATIONS:

<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1996 1995
----- ------
(IN THOUSAND
DEUTSCHE MARKS)
<S> <C> <C>
Banking institutions........................................ 5,972 11,632
Landlord loan............................................... -- 848
----- ------
5,972 12,480
Less current maturities..................................... 5,972 5,570
----- ------
Long-term debt.............................................. -- 6,910
===== ======
</TABLE>

The banking institutions' loan obligations represent interest bearing
lines-of-credit extended to the Company. The amounts at December 31, 1996 have
been reduced by the extraordinary item described above. Two of the three banking
institutions have withdrawn their credit lines for the Company and have
requested payment of their outstanding balances in January 1997. The remaining
bank has not requested immediate payment and has informally continued a
line-of-credit for DM1.3 million. The weighted average interest rate for the
loan obligations to banking institutions was 5.5% in 1996 and 8.7% in 1995.

The landlord loan represents unpaid rental payments, prior to 1994, related
to the Company's Neu-Ulm facility which were converted to a loan obligation at
the end of 1993. This loan has been paid through monthly installments of
approximately DM26,000, including interest at 8%.

5. RELATED PARTY TRANSACTIONS

In 1995, the owner of the Company's leased facility in Neu-Ulm acquired 75%
ownership of L.A.B. through a capital contribution of DM1.5 million. The Company
has not made rental payments related to this facility for 1995 and 1996. In
contemplation of the acquisition of L.A.B. by AAI, this majority-owner of

F-22
<PAGE> 78

L.A.B. GESELLSCHAFT FUR PHARMAKOLOGISCHE UNTERSUCHUNGEN MBH & CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the Company, as of December 30, 1996, has waived all claims against L.A.B.,
except for approximately DM2.9 million of the rental payments discussed above.
This forgiveness of liability of approximately DM2.9 million has been recognized
as a contribution of capital by this partner to owners' equity.

In 1996, AAI advanced DM1.5 million to L.A.B. as a prepayment for work to
be performed by the Company. As of December 31, 1996, there was approximately
DM1.4 million remaining in customer advances. L.A.B. performed approximately
DM100,000 of work for AAI in 1996.

6. INCOME TAXES

The provision for income taxes relates to taxable income of subsidiary
companies. The main operating company in Germany has had losses for both 1996
and 1995 which accrued to the existing partners; therefore, no tax loss
carryforwards will be available for AAI. Tax loss carryforwards available to AAI
at the non-German operations would have a 100% valuation allowance given the
historical operating losses at such operations.

7. COMMITMENTS AND CONTINGENCIES

The Company leases land, buildings and equipment under renewable lease
arrangements classified as operating leases. Lease expense recognized under such
agreements totaled DM5.1 million and DM4.0 million for the years ended December
31, 1996 and 1995, respectively. Included in both the 1996 and 1995 amounts was
approximately DM1.5 million which was ultimately forgiven.

Future minimum rentals due under lease agreements as of December 31, 1996
are DM2.2 million -- 1997; DM1.7 million -- 1998; DM1.5 million -- 1999; DM1.7
million -- 2000; DM1.5 million -- 2001 and none thereafter.

8. GOING CONCERN

L.A.B.'s current liabilities exceed its current assets at both December 31,
1996 and 1995, and given its financial resource availability described in
footnote 4, there would exist substantial doubt regarding the Company's ability
to continue as a going concern; however, this situation is alleviated by the AAI
acquisition and AAI's ability and intent to make financing available to fund
L.A.B.'s operations for the next year.

F-23
<PAGE> 79

APPLIED ANALYTICAL INDUSTRIES, INC.

PRO FORMA FINANCIAL INFORMATION

The following unaudited pro forma financial information is presented to
reflect the acquisition of L.A.B. Gesellschaft fur pharmakologische
Untersuchungen mbH & Co. ( "L.A.B.") by Applied Analytical Industries, Inc.
("AAI" or the "Company") as if it had occurred at the beginning of 1996. This
pro forma financial information is presented for informational purposes and is
not necessarily indicative of the consolidated results that would have been
achieved had the acquisition been consummated at the beginning of the period
presented. A pro forma balance sheet is not presented as of December 31, 1996,
since the L.A.B. transaction is reflected in such consolidated balance sheet of
AAI.

PRO FORMA CONDENSED STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
HISTORICAL HISTORICAL PRO FORMA PRO FORMA
YEAR ENDED DECEMBER 31, 1996 AAI L.A.B. ADJUSTMENTS COMBINED
- ---------------------------- ---------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
(UNAUDITED)

<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net sales..................................... $42,162 $18,223 $ -- $60,385
Operating costs and expenses:
Cost of sales............................... 17,621 15,638 (840) 32,419
Selling..................................... 6,357 1,774 (112) 8,019
General and administrative.................. 8,908 4,161 359 13,428
Research and development.................... 4,216 1,515 -- 5,731
Unusual item................................ 6,600 -- -- 6,600
------- ------- ------- -------
43,702 23,088 (593) 66,197
------- ------- ------- -------
Income (loss) from operations................. (1,540) (4,865) 593 (5,812)
Other income (expense), net................... 494 (645) 219 68
------- ------- ------- -------
Income (loss) before income taxes............. (1,046) (5,510) 812 (5,744)
Provision for income taxes.................... 2,102 627 -- 2,729
------- ------- ------- -------
Net income (loss)............................. $(3,148) $(6,137) $ 812 $(8,473)
======= ======= ======= =======
Earnings (loss) per share..................... $ (0.23) $ (0.63)
======= =======
Weighted average shares....................... 13,440 13,440
======= =======
</TABLE>

The accompanying notes are an integral part of this pro forma financial
information.

F-24
<PAGE> 80

APPLIED ANALYTICAL INDUSTRIES, INC.

NOTES TO PRO FORMA FINANCIAL INFORMATION

(UNAUDITED)

1. AAI HISTORICAL INFORMATION

The historical AAI information reflects the write-off of certain in-process
research and development costs with an appraised value of approximately $6.6
million, in connection with the L.A.B. acquisition on the unusual item line.

2. L.A.B. HISTORICAL INFORMATION

The historical L.A.B. information used in the pro forma statement of
operations does not include the extraordinary items reported in 1996.
Additionally, it has been translated from Deutsche marks to U.S. dollars using
an exchange rate of 1.505 marks per dollar, which was calculated using monthly
exchange rates for 1996 published by the Federal Reserve. The Company believes
this is a reasonable representation to what actual exchange rates may have been.

3. PRO FORMA ADJUSTMENTS

The pro forma adjustments include the following:

Amortization of intangibles ($737,000) and depreciation on assets
($56,000) where the allocated purchase price is greater than the historical
L.A.B. value.

A reduction in rental expense ($1,120,000) related to the Neu-Ulm
facility to reflect the accrued amounts forgiven by the landlord to be more
in-line with future rent.

A reduction in general and administrative expenses for L.A.B. merger
related costs ($266,000) incurred during 1996.

A reduction in interest expense ($219,000) related to L.A.B. forgiven
bank debt.

F-25
<PAGE> 81

================================================================================

NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.

------------------

TABLE OF CONTENTS
PAGE
----

PROSPECTUS SUMMARY.........................................................2
RISK FACTORS...............................................................5
THE COMPANY...............................................................11
USE OF PROCEEDS...........................................................12
PRICE RANGE OF COMMON STOCK...............................................12
DIVIDEND POLICY...........................................................12
SELECTED FINANCIAL DATA...................................................13
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................................15
BUSINESS..................................................................19
MANAGEMENT................................................................36
CERTAIN TRANSACTIONS......................................................43
PRINCIPAL STOCKHOLDERS....................................................46
DESCRIPTION OF CAPITAL STOCK..............................................47
SHARES ELIGIBLE FOR FUTURE SALE...........................................50
PLAN OF DISTRIBUTION......................................................51
LEGAL MATTERS.............................................................51
EXPERTS...................................................................52
ADDITIONAL INFORMATION....................................................52
INDEX TO FINANCIAL STATEMENTS............................................F-1

APPLIED ANALYTICAL
INDUSTRIES, INC.

COMMON STOCK
(PAR VALUE $0.001 PER SHARE)

------------------

[AAI LOGO]

------------------

GOLDMAN, SACHS & CO.

================================================================================

<PAGE> 82

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the Registrant's costs and expenses in connection
with the sale and distribution of the securities being registered. The
Commission registration fee was paid in connection with the registration of
shares of Common Stock in the Offering. All amounts shown are estimates except
for the Commission registration fee.

SEC registration fee............................................ $14,990
Accounting fees and expenses.................................... 5,000
Legal fees and expenses......................................... 5,000
Printing, engraving and mailing expenses........................ 2,000
Miscellaneous................................................... 2,000
-------
Total................................................. $28,990
=======

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

The Company's Restated Certificate of Incorporation provides that no
director of the Company shall be personally liable for any monetary damages for
any breach of fiduciary duty as a director, except to the extent that the
Delaware General Corporation Law prohibits elimination or limitation of
liability of directors for breach of fiduciary duty. The Restated Certificate of
Incorporation provides that a director or officer of the Company (a) shall be
indemnified by the Company against all expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement incurred in connection with any
litigation or other legal proceeding (other than an action by or in the right of
the Company) brought against him by virtue of his position as a director or
officer of the Company if he acted in good faith and in a manner he reasonably
believed to be in, or not opposed to, the best interests of the Company, and,
with respect to any criminal action or proceeding, had no reasonable cause to
believe his conduct was unlawful and (b) shall be indemnified by the Company
against all expenses (including attorneys' fees) and amounts paid in settlement
incurred in connection with any action by or in the right of the Company brought
against him by virtue of his position as a director or officer of the Company
brought against him by virtue of his position as a director or officer of the
Company if he acted in good faith and in a manner he reasonably believed to be
in, or not opposed to, the best interests of the Company, except that no
indemnification shall be made with respect to any matter as to which such person
shall have been adjudged to be liable to the Company, unless a court determines
that, despite such adjudication but in view of all of the circumstances, he is
entitled to indemnification of such expenses. Notwithstanding the foregoing, to
the extent that a director or officer has been successful, on the merits or
otherwise, including, without limitation, the dismissal of an action without
prejudice, he is required to be indemnified by the Company against all expenses
(including attorneys' fees) incurred in connection therewith. Expenses shall be
advanced to a director or officer at his request, provided that he undertakes to
repay the amount advanced if it is ultimately determined that he is not entitled
to indemnification for such expenses.

Indemnification is required to be made unless the Company determines
that the applicable standard of conduct required for indemnification has not
been met. In the event of a determination by the Company that the director or
officer did not meet the applicable standard of conduct required for
indemnification, or if the Company fails to make an indemnification payment
within 60 days after such payment is claimed by such person, such person is
permitted to petition the court to make an independent determination as to
whether such person is entitled to indemnification. As a condition precedent to
the right of indemnification, the director or officer must give the Company
notice of the action for which indemnity is sought and the Company has the right
to participate in such action or assume the defense thereof.

II-1

<PAGE> 83

Section 145 of the Delaware General Corporation Law provides that a
corporation has the power to indemnify a director, officer, employee or agent of
the corporation and certain other persons serving at the request of the
corporation in related capacities against amounts paid and expenses incurred in
connection with an action or proceeding to which he is or is threatened to be
made a party by reason of such position, if such person shall have acted in good
faith and in a manner he reasonably believed to be in or not opposed to the best
interests of the corporation, and in any criminal proceeding, if such person had
no reasonable cause to believe his conduct was unlawful; provided that, in the
case of actions brought by or in the right of the corporation, no
indemnification shall be made with respect to any matter as to which such person
shall have been adjudged to be liable to the corporation unless and only to the
extent that the adjudicating court determines that such indemnification is
proper under the circumstances.

Under Section 9 of the Underwriting Agreement for the Offering between
the Company and the Underwriters, the Underwriters will be obligated, under
certain circumstances, to indemnify directors and officers of the Company
against certain liabilities, including liabilities under the Securities Act.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

Set forth in chronological order below is information regarding the
number of shares of Common Stock, Class B Common Stock and Preferred Stock
issued, and the number of options granted, by the Company since June 1, 1993.
Further included is the consideration, if any, received by the Company for such
shares and options, and information relating to the section of the Securities
Act, or rule of the Securities and Exchange Commission under which exemption
from registration was claimed. All awards of options did not involve any sale
under the Securities Act and none of these securities was registered under the
Securities Act.

In February 1994, the Company issued 103,351 shares of Class B Common
Stock to an executive officer in consideration of a promissory note in the
initial principal amount of $32,860, payable March 31, 1999 and bearing interest
at an annual rate of 6.0%.

In November 1995, the Company issued 105,453 shares of Class B Common
Stock to an executive officer in consideration of a promissory note in the
initial principal amount of $166,865. The note matures in April 2001, bears
interest at an annual rate of 6.48% and requires bi-weekly payments of $484.34.
In connection with such issuance, the executive officer purchasing such shares
agreed to sell such shares to the Company at a price based on a formula, which
agreement expires upon completion of this Offering.
Such executive officer has pledged such shares to secure the note.

In November 1995, the Company issued 883 shares of Preferred Stock to
certain investors in return for cash payment of $21.5 million.

In March 1996, AAI awarded 105,453 shares of Class B Common Stock to
120 employees of the Company pursuant to the Company's 1995 Restricted Stock
Award Plan. Each such employee was required to pay $.001 per share in cash as
consideration for such award. Such shares vest over a period of time and
unvested shares are subject to forfeiture upon termination of employment, other
than upon the employee's death, disability or retirement.

In April 1996, the Company granted options to purchase an aggregate of
450,444 shares of Class B Common Stock to 95 employees pursuant to the Company's
1995 Stock Option Plan and 1996 Stock Option Plan at an exercise price per share
of $8.35.

In June 1996, the Company granted an option to purchase 2,214 shares of
Class B Common Stock to one employee pursuant to the Company's 1995 Option Plan
at an exercise price per share of $9.10.

II-2

<PAGE> 84

The shares of capital stock and securities issued in the above
transactions were offered and sold in reliance upon the exemption from
registration under Section 4(2) of the Securities Act or Regulation D or Rule
701 promulgated under the Securities Act, relative to sales by an issuer not
involving any public offering.

Upon the completion of the Offering on September 25, 1996, the Company
issued 12,734,103 shares of Common Stock upon the conversion of then outstanding
shares of Preferred Stock and Class B Common Stock. Options to purchase shares
of Class B Common Stock then outstanding automatically became options to
purchase the same number of shares of Common Stock, with no other changes to the
terms and conditions thereof. The securities issued in such transactions were
offered and sold in reliance upon the exemption from registration under Section
3(a)(9) of the Securities Act.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) Exhibits

EXHIBIT
NUMBER DESCRIPTION
------ -----------

<S> <C>
3.1 -- Amended and Restated Certificate of Incorporation of the Company (incorporated by
reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996)
3.2 * -- Restated By-laws of the Company
4.1 -- Articles Fourth, Seventh, Eleventh and Twelfth of the form of the Amended and
Restated Certificate of Incorporation of the Company (included in Exhibit 3.1)
4.2 * -- Article II of the Restated By-laws of the Company (included in Exhibit 3.2)
4.3 * -- Specimen Certificate for shares of Common Stock, $.001 par value, of the Company
5 * -- Opinion of Robinson, Bradshaw & Hinson, P.A. with respect to the validity of the
securities being offered
10.1 * -- Employment Agreement dated November 17, 1995 between the Company and
Frederick D. Sancilio
10.2 * -- Applied Analytical Industries, Inc. 1995 Restricted Stock Award Plan
10.3 * -- Applied Analytical Industries, Inc. 1995 Stock Option Plan
10.4 * -- Applied Analytical Industries, Inc. 1996 Stock Option Plan
10.5 * -- Stockholder Agreement dated as of November 17, 1995 among the Company, GS
Capital Partners II, L.P., GS Capital Partners II Offshore,
L.P., Goldman, Sachs & Co. Verwaltungs GmbH, Stone Street
Fund 1995, L.P., Bridge Street Fund 1995, L.P., Noro-Moseley
Partners III, L.P., Wakefield Group Limited Partnership,
James L. Waters, Frederick D. Sancilio and the parties
listed on Schedule 1 thereto
10.6 * -- Preferred Stock Purchase Agreement dated as of November 17, 1995 among the
Company, GS Capital Partners II, L.P., GS Capital Partners II Offshore, L.P.,
Goldman, Sachs & Co. Verwaltungs GmbH, Stone Street Fund 1995, L.P., Bridge
Street Fund 1995, L.P., Noro-Moseley Partners III, L.P., Wakefield Group Limited
Partnership and James L. Waters
10.7 -- Loan Agreement between NationsBank, N.A. and the Company dated December 30,
1996 (incorporated by reference to Exhibit 10.14 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1996)
10.8 * -- Loan Agreement dated as of November 1, 1988 between the Company and The New
Hanover County Industrial Facilities and Pollution Control Financing Authority
</TABLE>

II-3

<PAGE> 85

EXHIBIT
NUMBER DESCRIPTION
------ -----------

<S> <C>
10.9 * -- Letter of Credit Reimbursement Agreement dated November 1, 1988 between
NationsBank, N.A. (formerly, NCNB National Bank of North Carolina) and the
Company, as amended
10.10* -- Lease Agreement dated as of March 7, 1994 between 5051 New Centre Drive,
L.L.C., as landlord, and the Company, as tenant
10.11* -- Lease Agreement dated as of December 23, 1993 between I-40 Post Properties, as
landlord, and the Company, as tenant
10.12* -- Development Agreement dated as of April 25, 1994 between the Company and
Endeavor Pharmaceuticals, Inc. (formerly, GenerEst, Inc.)
10.13* -- Development Agreement dated as of April 4, 1995 between the Company and Aesgen,
Inc.
10.14 -- Option Agreement between Applied Analytical Industries, Inc. and My Asset
Management GmbH and Friedrich Herzog von Wurttemberg (incorporated by
reference to Exhibit 2.1 to the Company's Current Report on Form 8-K dated
December 31, 1996)
10.15 -- Purchase and Assignment Agreement between Friedrich Herzog von Wurttemberg and
My Asset Management GmbH (incorporated by reference to Exhibit 2.2 to the
Company's Current Report on Form 8-K dated December 31, 1996)
21 -- Subsidiaries of the Company (incorporated by reference to Exhibit 21 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1996
23.1 -- Consent of Robinson, Bradshaw & Hinson, P.A.
23.2 -- Consent of Price Waterhouse LLP
23.3 -- Consent of Price Waterhouse GmbH
* 24 -- Certain Powers of Attorney (included on signature page of Registration Statement as
initially filed)
27 -- Financial Data Schedule (for SEC use only) (incorporated by reference to Exhibit 27 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1996
</TABLE>

- ----------

* Previously filed.

(b) Financial Statement Schedules

Schedule Page
-------- ----
Schedule II valuation and qualifying accounts Following signature page

ITEM 17. UNDERTAKINGS

Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Company pursuant to the provisions contained in the Restated Certificate of
Incorporation and Restated By-laws of the Company and the laws of the State of
Delaware, or otherwise, the Company has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Securities Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than the
payment by the Company of expenses incurred or paid by a director, officer or
controlling person of the Company in the successful defense of any action, suit
or proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the

II-4

<PAGE> 86

Company will, unless in the opinion of its counsel the matter has been settled
by controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.

The undersigned Company hereby undertakes that:

(1) For purposes of determining any liability under the
Securities Act of 1933, the information omitted from the form of
prospectus filed as part of this Registration Statement in reliance
upon Rule 430A and contained in a form of prospectus filed by the
Company pursuant to Rule 424(b)(1) or (4) or 497(h) under the
Securities Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective.

(2) For the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment that contains a
form of prospectus shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide
offering thereof.

(3) It will file, during any period in which offers or sales
are being made, a post-effective amendment to this registration
statement:

(i) To include any prospectus required by section
10(a)(3) of the Securities Act of 1933;

(ii) To reflect in the prospectus any facts or events
arising after the effective date of the registration statement
(or the most recent post-effective amendment thereof) which,
individually or in the aggregate, represent a fundamental
change in the information set forth in the registration
statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar
value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form
of prospectus filed with the Securities and Exchange
Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20
percent change in the maximum aggregate offering price set
forth in the "Calculation of Registration Fee" table in the
effective registration statement; and

(iii) To include any material information with
respect to the plan of distribution not previously disclosed
in the registration statement or any material change to such
information in the registration statement.

(4) For the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be
deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall
be deemed to be the initial bona fide offering thereof.

(5) It will remove from registration by means of a
post-effective amendment any of the securities being registered which
remain unsold at the termination of the offering.

II-5

<PAGE> 87

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, as amended,
the Company has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Wilmington,
State of North Carolina, on this 1st day of April, 1997.

By: /s/ R. FORREST WALDON
-------------------------
R. Forrest Waldon
Vice President

Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed below by the following persons in the capacities and
on the dates indicated.

<TABLE>
<CAPTION>
SIGNATURE Title Date
--------- ----- ----
<S> <C> <C>

/s/ FREDERICK D. SANCILIO* President and Director April 1, 1997
- ---------------------------------- (Principal Executive
Frederick D. Sancilio, Ph.D. Officer)

/s/ MARK P. COLONNESE* Vice President and Chief April 1, 1997
- ---------------------------------- Financial Officer
Mark P. Colonnese (Principal Financial
Officer and Principal
Accounting Officer)

/s/ STEPHEN F. RIZZO Vice President and Controller April 1, 1997
- ---------------------------------- (Principal Accounting Officer)
Stephen F. Rizzo

/s/ WILLIAM H. UNDERWOOD* Executive Vice President April 1, 1997
- ---------------------------------- and Director
William H. Underwood

/s/ JOSEPH H. GLEBERMAN* Director April 1, 1997
- ----------------------------------
Joseph H. Gleberman

/s/ CHARLES D. MOSELEY, JR.* Director April 1, 1997
- ----------------------------------
Charles D. Moseley, Jr.
April 1, 1997
/s/ JOHN M. RYAN Director
- ----------------------------------
John M. Ryan

/s/ JAMES L. WATERS* Director April 1, 1997
- ----------------------------------
James L. Waters

- --------------

*By: /s/ R. FORREST WALDON
-------------------------------------
(R. Forrest Waldon, Attorney-in-Fact)

</TABLE>

II-6

<PAGE> 1

EXHIBIT 23.1

ROBINSON, BRADSHAW & HINSON, P.A.
ATTORNEYS AT LAW
ONE INDEPENDENCE CENTER
101 NORTH TRYON STREET, SUITE 1900
CHARLOTTE, NORTH CAROLINA 28246-1900
TELEPHONE (704) 377-2536
FAX (704) 378-4000

April 1, 1997

Applied Analytical Industries, Inc.
5051 New Centre Drive
Wilmington, North Carolina 28403

Re: Registration Statement on Form S-1
(Registration No. 333-05535)

Ladies and Gentlemen:

We hereby consent to be named in the above-captioned Registration
Statement and in the prospectus that constitutes Part I thereof as attorneys who
will pass upon legal matters in connection with the validity of the shares of
common stock, $.001 par value per share, offered thereby and to the continued
inclusion of our opinion dated August 8, 1996 as Exhibit 5.0 thereto.

Sincerely,

ROBINSON, BRADSHAW & HINSON, P.A.

/s/ Stephen M. Lynch

Stephen M. Lynch

<PAGE> 1

EXHIBIT 23.2

CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-2 of our report dated February 21, 1997,
relating to the financial statements of Applied Analytical Industries,
Incorporated, which appears in such Prospectus. We also consent to the
application of such report to the Financial Statement Schedule for the three
years ended December 31, 1996 listed under Item 16(b) of this Registration
Statement when such schedule is read in conjunction with the financial
statements referred to in our report. The audits referred to in such report
also included this schedule. We also consent to the references to us under the
headings "Experts" and "Selected Financial Data" in such Prospectus. However,
it should be noted that Price Waterhouse LLP has not prepared or certified such
"Selected Financial Data."

PRICE WATERHOUSE LLP
Raleigh, North Carolina
March 31, 1997

<PAGE> 1

EXHIBIT 23.3

CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-1 of our report dated February 21, 1997,
relating to the financial statements of L.A.B. Gesellschaft fur
pharmakologische Untersuchungen mbH & Co., which appears in such Prospectus.
We also consent to the references to us under the heading "Experts" in such
Prospectus.

PRICE WATERHOUSE GmbH
Stuttgart, Germany
March 31, 1997