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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT TO 1934
Commission File Number 0-21185
APPLIED ANALYTICAL INDUSTRIES, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 04-2687849
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
5051 NEW CENTRE DRIVE, WILMINGTON, NC 28403
(Address of principal executive office) (Zip code)
Registrant's telephone number, including area code: (910) 392-1606
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value per share
----------------------------------------
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K of any
amendment to this Form 10-K. [ ]
The number of shares outstanding of the Registrant's common stock, as of
February 28, 1997 was 16,287,256 shares. The aggregate market value for the
voting stock held by non-affiliates of the Registrant on February 28, 1997 was
approximately $142,267,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's 1996 Annual Report to Shareholders are incorporated
by reference in Part I, Part II, and Part IV hereof. Portions of the
Registrant's 1996 Proxy Statement dated approximately April 8, 1997 are
incorporated by reference in Part III hereof.
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PART I
ITEM 1. BUSINESS.
The terms "Company", "Registrant" or "AAI" in this Form 10-K include
Applied Analytical Industries, Inc., its corporate predecessors and its
subsidiaries, except where the context may indicate otherwise. The Company was
incorporated in 1986, although its corporate predecessor was founded in 1979.
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
significant 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 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 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.
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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
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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 investigational new drug
application and product license application 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
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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.
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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
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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.
In 1995 the Company entered into an agreement with Aesgen, Inc.
("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.
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
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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.
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.
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.
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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 contract research organization (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.
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.
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> 10
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.
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> 11
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.
<PAGE> 12
SPECIAL ITEM. EXECUTIVE OFFICERS OF THE COMPANY.
The following table sets forth the name, age, principal occupation and business
experience for the executive officers of the Company.
Frederick D. Sancilio, Ph.D., 47, 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, 49, 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, 49, 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.
<PAGE> 13
Mark P. Colonnese, 41, 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, 46, 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.
James Swarbrick, Ph.D., 63, 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, 34, 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.
ITEM 2. PROPERTIES.
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 renewable leases 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.
ITEM 3. LEGAL PROCEEDINGS.
The Company is party to lawsuits and administrative proceedings
incidental to the normal course of its business. In connection with the 1995
issuance of preferred stock, James L. Waters and Frederick D. Sancilio
(directors and significant stockholders of the Company) have agreed to indemnify
the Company for certain, then existing, claims if any losses are 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.
<PAGE> 14
The Company is currently appealing a judgment 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
statement. In January 1997, the North Carolina Court of Appeals denied the
Company's appeal of the judgment and overturned the trial court's denial of
pre-judgment interest on the award. The Company has requested the North Carolina
Supreme Court to hear arguments on both of these issues.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The information required by Item 5 is included on page 27 of the Annual Report
and is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA.
The information required by Item 6 is included on page 13 of the Annual Report
and is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The information required by Item 7 is included on pages 14 through 16 of the
Annual Report and is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by Item 8 is included on pages 17 through 27 of the
Annual Report and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The directors of the Company and their business experience are set forth on
pages 2 and 3 of the Company's Notice of Annual Meeting of Stockholders, dated
approximately April 8, 1997 (the "Proxy Statement") and are incorporated herein
by reference. The discussion of executive officers of the Company is included in
Part I under "Executive Officers of the Company."
<PAGE> 15
ITEM 11. EXECUTIVE COMPENSATION.
A description of the compensation of the Company's executive officers is set
forth on pages 6 through 8 of the Proxy Statement and is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
A description of the security ownership of certain beneficial owners and
management is set forth on pages 4 and 5 of the Proxy Statement and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Certain relationships and related transactions with management are described on
pages 12 and 14 of the Proxy Statement and in Items 11 and 12, and are
incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
EXHIBITS:
A list of the exhibits required to be filed as part of this Report on
Form 10-K is set forth in the "Exhibit Index", which immediately precedes such
exhibits, and is incorporated herein by reference.
FINANCIAL STATEMENT SCHEDULES:
The consolidated balance sheets as of December 31, 1996 and 1995, and
related consolidated statements of income, cash flows and stockholders' equity
for each of the three years in the period ended December 31, 1996 and the
related notes to financial statements, together with the report of independent
accountants thereon of Price Waterhouse LLP, dated February 21, 1997 appearing
on pages 17 through 26 of the Annual Report, are incorporated herein by
reference. With the exception of the aforementioned information and the
information incorporated by reference in Items 1 and 5 through 8, the Annual
Report is not to be deemed filed as part of this report. The additional
financial data listed below should be read in conjunction with the financial
statements in the Annual Report. Schedules not included with this additional
financial data have been omitted because they are not applicable or the required
information is shown in the financial statements or notes thereto.
REPORTS ON FORM 8-K:
The Company filed a report on Form 8-K, dated January 15, 1997, to
report the L.A.B. acquisition as of December 31, 1996. Such report, as amended
on March 17, 1997, included the financial statements of L.A.B. listed below.
<PAGE> 16
ADDITIONAL FINANCIAL DATA
Page
Applied Analytical Industries, Inc. for years ended
December 31, 1996, 1995 and 1994:
Report of Independent Accountants F-1
Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts F-2
L.A.B., financial statements for the years ended
December 31, 1996 and 1995:
Report of Independent Accountants F-3
Consolidated Balance Sheet F-4
Consolidated Statement of Operations F-5
Consolidated Statement of Cash Flows F-6
Notes to Financial Statements F-7 to F-10
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-11
Notes to Pro Forma Financial Information F-12
<PAGE> 17
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
/s/ FREDERICK D. SANCILIO President March 31, 1997
- ------------------------------- (Principal Executive Officer)
Frederick D. Sancilio, Ph.D.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons, or in their behalf by their duly
appointed attorney-in-fact, on behalf of the Registrant in the capacities and on
the date indicated.
<TABLE>
<CAPTION>
Signatures Title Date
---------- ----- ----
<S> <C> <C>
/s/ FREDERICK D. SANCILIO President and Director March 31, 1997
- ------------------------------------------ (Principal Executive Officer)
Frederick D. Sancilio, Ph.D.
/s/ MARK P. COLONNESE Vice President and Chief March 31, 1997
- ------------------------------------------ Financial Officer (Principal
Mark P. Colonnese Financial Officer)
/s/ STEPHEN F. RIZZO Vice President and March 31, 1997
- ------------------------------------------ Controller (Principal
Stephen F. Rizzo Accounting Officer)
/s/ WILLIAM H. UNDERWOOD Executive Vice President March 31, 1997
- ------------------------------------------ and Director
William H. Underwood
/s/ JOSEPH H. GLEBERMAN Director March 31, 1997
- ------------------------------------------
Joseph H. Gleberman
/s/ CHARLES D. MOSELEY, JR. Director March 31, 1997
- ------------------------------------------
Charles D. Moseley, Jr.
/s/ JOHN M. RYAN Director March 31, 1997
- ------------------------------------------
John M. Ryan
/s/ JAMES L. WATERS Director March 31, 1997
- ------------------------------------------
James L. Waters
</TABLE>
<PAGE> 18
REPORT OF INDEPENDENT ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE OF REGISTRANT
To the Board of Directors
of Applied Analytical Industries, Inc.
Our audits of the consolidated financial statements referred to in our report
dated February 21, 1997 appearing in the 1996 Annual Report to Shareholders of
Applied Analytical Industries, Inc. (which report and consolidated financial
statements are incorporated by reference in this Annual Report on Form 10-K)
also included an audit of the Financial Statement Schedule listed in Item 14 of
this Form 10-K. In our opinion, this Financial Statement Schedule presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.
PRICE WATERHOUSE LLP
Raleigh, North Carolina
February 21, 1997
F-1
<PAGE> 19
SCHEDULE II
APPLIED ANALYTICAL INDUSTRIES, INC.
Valuation and Qualifying Accounts
(In thousands)
<TABLE>
<CAPTION>
Balance at Charged to Balance at
beginning costs and Deductions end of
Description of period expenses - describe period
----------- --------- -------- ---------- ------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts
1994 $ 92 114 81 (1) $125
1995 $125 23 78 (1) $ 70
1996 $ 70 4 1 (1) $ 73
</TABLE>
(1) Represents amounts written-off as uncollectible accounts receivable.
F-2
<PAGE> 20
Report of Independent Accountants
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-3
<PAGE> 21
L.A.B. Gesellschaft fur pharmakologische Untersuchungen mbH & Co.
Consolidated Balance Sheet
(In thousand Deutsche marks)
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<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-4
<PAGE> 22
L.A.B. Gesellschaft fur pharmakologische Untersuchungen mbH & Co.
Consolidated Statement of Operations
(In thousand Deutsche marks)
<TABLE>
<CAPTION>
For the years ended
December 31,
-----------------------
1996 1995
------ ------
<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-5
<PAGE> 23
L.A.B. Gesellschaft fur pharmakologische Untersuchungen mbH & Co.
Consolidated Statement of Cash Flows
(In thousand Deutsche marks)
<TABLE>
<CAPTION>
For the years ended
December 31,
------------
1996 1995
---- ----
<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-6
<PAGE> 24
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.
F-7
<PAGE> 25
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.
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
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.
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.
F-8
<PAGE> 26
4. Loan Obligations (in thousand Deutsche marks):
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<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 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.
F-9
<PAGE> 27
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-10
<PAGE> 28
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 occured 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
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Historical Historical Pro forma Pro forma
Year ended December 31, 1996 AAI L.A.B. adjustments combined
- ---------------------------- --- ------ ----------- --------
<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-11
<PAGE> 29
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-12
<PAGE> 30
APPLIED ANALYTICAL INDUSTRIES, INC.
Exhibit Index
Exhibit
No. Description
--- -----------
3.1 - Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1996)
3.2 - Restated By-laws of the Company (incorporated by reference to
Exhibit 3.2 to the Company's Registration Statement on Form S-1
(Registration No. 333-05535))
4.1 - Articles Fourth, Seventh, Eleventh and Twelfth of the form of
Amended and Restated Certificate of Incorporation of the Company
(included in Exhibit 3.1)
4.2 - Article II of the form of Restated By-laws of the Company
(included in Exhibit 3.2)
4.3 - Specimen Certificate for shares of Common Stock, $.001 par
value, of the Company (incorporated by reference to Exhibit 4.3 to
the Company's Registration Statement on Form S-1 (Registration No.
333-05535))
10.1 - Employment Agreement dated November 17, 1995 between the Company
and Frederick D. Sancilio (incorporated by reference to Exhibit
10.1 to the Company's Registration Statement on Form S-1
(Registration No. 333-05535))
10.2 - Applied Analytical Industries, Inc. 1995 Restricted Stock Award
Plan (incorporated by reference to Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (Registration No. 333-05535))
10.3 - Applied Analytical Industries, Inc. 1995 Stock Option Plan
(incorporated by reference to Exhibit 10.3 to the Company's
Registration Statement on Form S-1 (Registration No. 333-05535))
10.4 - Applied Analytical Industries, Inc. 1996 Stock Option Plan
(incorporated by reference to Exhibit 10.4 to the Company's
Registration Statement on Form S-1 (Registration No. 333-05535))
<PAGE> 31
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 (incorporated by reference to
Exhibit 10.5 to the Company's Registration Statement on Form S-1
(Registration No. 333-05535))
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 (incorporated by reference to
Exhibit 10.6 to the Company's Registration Statement on Form S-1
(Registration No. 333-05535))
10.7 - Loan Agreement dated as of December 21, 1992 between
NationsBank, N.A. and the Company, together with the First
Amendment and Second Amendment thereto and agreement extending the
term thereof (incorporated by reference to Exhibit 10.7 to the
Company's Registration Statement on Form S-1 (Registration No.
333-05535))
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 (incorporated by reference to Exhibit
10.8 to the Company's Registration Statement on Form S-1
(Registration No. 333-05535))
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 (incorporated by reference
to Exhibit 10.9 to the Company's Registration Statement on Form
S-1 (Registration No. 333-05535))
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
(incorporated by reference to Exhibit 10.10 to the Company's
Registration Statement on Form S-1 (Registration No. 333-05535))
10.11 - Lease Agreement dated as of December 23, 1993 between I-40
Properties, as landlord, and the Company, as tenant (incorporated
by reference to Exhibit 10.11 to the Company's Registration
Statement on Form S-1 (Registration No. 333-05535))
10.12 - Development Agreement dated as of April 25, 1994 between the
Company and Endeavor Pharmaceuticals, Inc. (formerly, GenerEst,
Inc.) (incorporated by reference to Exhibit 10.12 to the Company's
Registration Statement on Form S-1 (Registration No. 333-05535))
<PAGE> 32
10.13 - Development Agreement dated as of April 4, 1995 between the
Company and Aesgen, Inc. (incorporated by reference to Exhibit
10.13 to the Company's Registration Statement on Form S-1
(Registration No. 333-05535))
10.14 - Loan Agreement dated as of December 30, 1996 between
NationsBank, N.A. and the Company
10.15 - Letter dated August 22, 1996 from NationsBank, N.A. to the
Company extending the maturity of certain indebtedness
(incorporated by reference to Exhibit 10.15 to the Company's
Registration Statement on Form S-1 (Registration No. 333-05535))
10.16 - Registration Rights Agreement dated as of November 17, 1996
among the Company, GS Capital Partners II, L.P., Wakefield
Group Limited Partnership, James L. Waters, Frederick D. Sancilio
and the parties listed on Schedule 1 thereto (incorporated by
reference to Exhibit 10.16 to Post-effective Amendment No. 1 to
the Company's Registration Statement on Form S-1 (Registration No.
333-05535))
10.17 - Underwriting Agreement dated September 19, 1996 between the
Company and Goldman Sachs & Co., Cowen & Company and Lehman
Brothers, Inc., as representatives of the underwriters
listed on Schedule 1 thereto (incorporated by reference to
Exhibit 10.17 to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1996)
10.18 - 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)
10.19 - 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)
13 - 1996 Annual Report to Shareholders
21 - Subsidiaries of Applied Analytical Industries, Inc.
27 - Financial Data Schedule (for SEC use only)
<PAGE> 1
EXHIBIT 10.14
LOAN AGREEMENT
THIS LOAN AGREEMENT, dated as of December 30, 1996 (the "Loan
Agreement"), is by and between
APPLIED ANALYTICAL INDUSTRIES, INC., a corporation organized and
existing under the laws of the State of Delaware and having its principal place
of business in Wilmington, North Carolina (the "Borrower"); and
NATIONSBANK, N.A., a national banking association organized and
existing under the laws of the United States and having offices in Wilmington,
North Carolina (the "Bank").
RECITALS
A. The Borrower has requested that the Bank provide a revolving credit
facility of up to $20,000,000.00 for the purposes described herein.
B. The Bank has agreed to provide the requested revolving credit
facility to the Borrower on the terms and conditions hereinafter set forth.
NOW, THEREFORE, the Borrower and the Bank agree as follows:
ARTICLE I
Definitions
-----------
1.01 For the purposes hereof:
"Adjusted CD Rate" shall be equal to the sum of (1) the
quotient of (a) the CD Rate, divided by (b) the difference of (i) one
minus (ii) the appropriate reserve requirement imposed on the Bank by
the Federal Reserve System (expressed as a decimal), plus (2) the
appropriate assessment rate imposed on the Bank by the Federal Deposit
Insurance Corporation with regard to the applicable Rate Period. The
computation of the Adjusted CD Rate shall also include such adjustments
as may be necessary in the future with respect to impositions on the
Bank for insurance and other fees, assessments and surcharges which
occur because of the Bank's sale of the certificate of deposit which
established the CD Rate;
"Adjusted LIBOR Rate" means the rate as determined by the Bank
at which deposits in the requested amount and for three month interest
periods are offered to prime banks in the London Interbank Market, as
published weekly by the Federal Reserve Bank of New York in its H-15
Statistical Release, such rate being adjusted for the cost of reserve
requirements as prescribed by the Federal Reserve System.
- 1 -
<PAGE> 2
The Adjusted LIBOR rate for any Saturday or Sunday or any other day on
which the London Interbank Market is not open shall be the Adjusted
LIBOR rate for the immediately preceding day on which the London
Interbank Market is open.
"Applicable Percentage" means for the Revolving Loans, the
appropriate applicable percentages corresponding to the Leverage Ratio
in effect as of the most recent Calculation Date as shown below:
<TABLE>
<CAPTION>
Tier Leverage Ratio LIBOR Margin CD Margin
---- -------------- ------------ ---------
<S> <C> <C> <C>
One equal to or .75% .80%
less than .25
to 1.0
Two greater than 1.00% 1.05%
.25 but equal
to or less
than .50
Three greater than 1.25% 1.30%
.50
</TABLE>
The Applicable Percentage for Revolving Loans shall, in each case, be
determined and adjusted quarterly on each March 1, June 1, September 1
and December 1 (each a "Calculation Date"); provided that the initial
Applicable Percentage shall be based on Tier One and shall remain at
Tier One until the Calculation Date on March 1, 1997, and, thereafter,
the Applicable Percentage shall be determined by the then current
Leverage Ratio. Each Applicable Percentage shall be effective from one
Calculation Date until the next Calculation Date. On the Revolving Loan
Maturity Date, each of the margins set forth above shall be increased
by .10%.
"Business Day" means any day not a Saturday, Sunday or legal
holiday on which the Bank is open for business in Wilmington, North
Carolina;
"Cash Flow Coverage Ratio" means for any consecutive four
fiscal quarterly periods of the Borrower, the ratio of (x) EBITDA minus
cash dividends (each computed for such four consecutive fiscal
quarterly periods) to (y) current maturities of long term debt and
capitalized leases (each computed for such four consecutive fiscal
quarterly periods) plus 20% of the average outstanding principal
balance of the Revolving Loans for such four consecutive fiscal
quarterly periods plus interest expense plus current provision for
income taxes (each computed for such four consecutive fiscal quarterly
periods);
"CD Rate" shall be the interest rate which it would be
necessary for the Bank to pay in connection with a sale by the Bank, if
possible, of a certificate of deposit for a
- 2 -
<PAGE> 3
domestic deposit having a term approximately equivalent to a
given Rate Period;
"Closing Date" means the date as of which this
Loan Agreement is executed by the Borrower and the
Bank;
"Commitment" means the commitment by the Bank to
make Revolving Loans to the Borrower hereunder;
"Consistent Basis" in reference to the application of
Generally Accepted Accounting Principles, means that the accounting
principles observed in the period referred to are comparable in all
material respects to those applied in the most recent preceding period,
except for the impact of implementing new rules or regulations;
"Current Assets" means all items which, in accordance with
Generally Accepted Accounting Principles, would be classified as
current assets on a balance sheet of the Borrower;
"Current Liabilities" means all items which, in accordance
with Generally Accepted Accounting Principles, would be classified as
current liabilities on a balance sheet of the Borrower;
"Current Ratio" means the ratio of Current Assets to Current
Liabilities;
"EBITDA" means for any period of computation, earnings
before interest expense, provision for income taxes, depreciation and
amortization;
"Event of Default" shall have the meaning given to said term
in Section 8.01 hereof;
"Funded Debt" means all interest bearing obligations of the
Borrower including, without limitation, all obligations evidenced by
promissory notes or other similar contracts but excluding such items as
trade payables and accruals;
"Generally Accepted Accounting Principles" means those
principles of accounting set forth in pronouncements of the Financial
Accounting Standards Board, the American Institute of Certified Public
Accountants, or which have other substantial authoritative support and
are applicable in the circumstances as of the date of a report, as such
principles are from time to time supplemented and amended;
"Guarantors" means each of the Subsidiaries of the
Borrower;
- 3 -
<PAGE> 4
"Guaranty Agreement" means the guaranty agreement executed by
the Guarantors in favor of the Bank pursuant to which the Guarantors
guarantee the repayment of the Revolving Loans;
"Leverage Ratio" means as of any date of determination,
the ratio of Total Liabilities to Tangible Net Worth;
"Loan Documents" means this Loan Agreement, the Revolving
Note and the Guaranty Agreement;
"Person" means an individual, a corporation, a partnership, a
joint venture, an association, a joint stock company, a trust, an
unincorporated organization or a government or any agency or political
subdivision thereof;
"Prime Rate" means the rate of interest publicly announced by
the Bank in Charlotte, North Carolina from time to time as its "prime
rate." The Prime Rate is not necessarily the best or lowest rate of
interest offered by the Bank;
"Rate Period" shall be ninety (90) days. The last day in the
Rate Period shall be a Business Day; if not, such last day shall be
changed to the immediately preceding Business Day;
"Revolving Loan" means a Loan made pursuant to
Section 2.01 hereof;
"Revolving Note" means the promissory note of the Borrower
executed and delivered as provided in Section 2.02 hereof;
"Revolving Loan Committed Amount" means the maximum principal
amount of Revolving Loans permitted to be outstanding under Section
2.01;
"Revolving Loan Maturity Date" means May 31, 1998;
"Subsidiary" means any corporation more than 50% of the
outstanding voting stock of which at the time is owned directly or
indirectly by the Borrower and/or by one or more Subsidiaries; and
"Tangible Net Worth" means total stockholders' equity of the
Borrower determined in accordance with Generally Accepted Accounting
Principles on a Consistent Basis, with no upward adjustments due to a
revaluation of assets, minus the book value of assets which would be
treated as intangibles under Generally Accepted Accounting Principles,
including, but not limited to, goodwill, trade-names, trademarks,
copyrights, patents and unamortized debt discount and
- 4 -
<PAGE> 5
minus loans or advances to employees, stockholders, subsidiaries,
affiliates or related companies and minus investment in subsidiaries.
1.02 Accounting Terms. All accounting terms not specifically
defined herein shall be construed in accordance with then current
Generally Accepted Accounting Principles applied on a Consistent Basis.
ARTICLE II
Revolving Loans
---------------
2.01 Revolving Loans. Subject to the terms and conditions and relying
upon the representations and warranties herein set forth, the Bank agrees to
make Revolving Loans to the Borrower, at any time or from time to time on or
after the date hereof and until the Revolving Loan Maturity Date, in an
aggregate principal amount at any time outstanding not to exceed TWENTY MILLION
DOLLARS ($20,000,000.00) (the "Revolving Loan Committed Amount") for purposes of
financing the Borrower's capital expenditures, acquisitions and working capital
needs. The Borrower may borrow, repay and reborrow hereunder on or after the
date hereof and prior to the Revolving Loan Maturity Date, subject to the terms,
provisions and limitations set forth herein. The outstanding principal balance
of the Revolving Loans on the Revolving Loan Maturity Date (the "Outstanding
Balance") shall be repaid in 72 consecutive installments, the first 71 of which
shall be in an amount equal to 1/72nd of the Outstanding Balance and the 72nd of
which shall be in an amount equal to the then remaining portion of the
Outstanding Balance. Such principal installments shall commence on June 30, 1998
and shall continue thereafter through and including the final principal
installment due on May 31, 2004.
2.02 Revolving Note. The Revolving Loans by the Bank shall be evidenced
by the Revolving Note duly executed by the Borrower, dated the Closing Date, in
substantially the form of Exhibit 2.02 attached hereto, payable to the order of
the Bank in a principal amount equal to the Revolving Loan Committed Amount.
2.03 Interest. The outstanding principal balance of the Revolving Loans
shall bear interest at a rate equal to the Adjusted CD Rate plus the Applicable
Margin or the Adjusted LIBOR Rate plus the Applicable Margin. The Borrower shall
select either of the foregoing rates as of the first day of each March, June,
September and December and once selected, the selected rate shall be applicable
for the quarterly period commencing on each of such dates. Notwithstanding the
foregoing, the rate at which interest is calculated on the outstanding principal
balance of the Revolving Loans shall not exceed the Prime Rate at any time.
Interest calculated at the foregoing rates shall be due and payable monthly in
arrears on the last day of each month.
- 5 -
<PAGE> 6
2.04 Commitment Fee. The Borrower agrees to pay the Bank a commitment
fee in an amount equal to 0.15% per annum of the average daily unused portion of
the Commitment, such fee to be paid quarterly in arrears on the last day of each
calendar quarter.
ARTICLE III
Additional Provisions Regarding Revolving Loans
-----------------------------------------------
3.01 Default Rate. If the Borrower shall default in the payment when
due (subject to applicable grace periods, if any) of the principal of or
interest on any Loan or any other amount becoming due hereunder, the Borrower
shall on demand from time to time pay interest on any overdue payment of
principal and, to the extent permitted by law, on overdue payments of interest
up to the date of actual payment (after as well as before judgment):
(i) in the case of principal of or interest on a Loan at a
rate equal to 2% per annum above the rate which would otherwise be
payable hereunder; and
(ii) in the case of any other amount payable hereunder or
under any of the other Loan Documents (other than principal of or
interest on any Loan referred to in clause (i) above), at a rate 2% per
annum above the Prime Rate.
3.02 Voluntary Prepayments. The Borrower shall have the right at any
time and from time to time to prepay any Loan in whole or in part, without
premium or penalty, upon at least one Business Day's notice to the Bank;
provided, however, partial prepayments of any Loan shall be applied to principal
installments thereunder in the inverse order of maturities.
3.03 Capital Adequacy.
(a) In the event that the Bank shall have determined
that the adoption or implementation on or after the Closing Date
of any applicable law, rule, regulation or guideline regarding capital
adequacy, or any change therein, or any change in the interpretation or
administration thereof by any governmental authority, central bank or
comparable agency charged with the interpretation or administration
thereof or by any court, or compliance by the Bank (or any lending
office of the Bank) with any request or directive made or issued after
the Closing Date regarding capital adequacy (whether or not having the
force of law) of any such authority, central bank or comparable agency,
has or would have the effect of reducing the rate of return on the
Bank's capital as a consequence of its obligations hereunder to a level
below that which the
- 6 -
<PAGE> 7
Bank could have achieved but for such adoption, change or compliance
(taking into consideration the Bank's policies as the case may be, with
respect to capital adequacy) by an amount deemed by the Bank to be
material, then from time to time the Borrower shall pay to the Bank
such additional amount or amounts as will compensate the Bank for any
such reduction suffered; provided, however, that no such amounts shall
be payable with respect to a reduction in rate of return incurred more
than 90 days before the Bank demands compensation under this Section.
(b) Failure on the part of the Bank to demand compensation for
any reduction in return on capital with respect to any period shall not
constitute a waiver of the Bank's rights to demand compensation for any
reduction in return on capital in such period or in any other period.
The protection of this Section shall be available to the Bank
regardless of any possible contention of invalidity or inapplicability
of the law, regulation or condition which shall have been imposed.
ARTICLE IV
Conditions of Lending
---------------------
4.01 Conditions. The Bank shall not be obligated to make any Revolving
Loan hereunder unless the representations and warranties contained in Article V
hereof are true and correct as of the date of the making of such Revolving Loan
and unless immediately after the making of such Revolving Loan no Event of
Default nor any event which upon notice or lapse of time or both would
constitute such an Event of Default shall have occurred and be continuing.
ARTICLE V
Representations and Warranties
------------------------------
The Borrower hereby represents and warrants to the Bank that:
5.01 Corporate Existence and Power. The Borrower is a corporation duly
incorporated, validly existing and in good standing under the laws of the State
of Delaware and is duly qualified and in good standing as a foreign corporation
authorized to do business in every jurisdiction where the failure to so qualify
would have a material adverse effect on the Borrower. Further, the Borrower has
all power and authority to own and operate its properties and to carry on its
business as now conducted.
- 7 -
<PAGE> 8
5.02 Authorization of Loan Agreement. The Borrower has the power and
authority to enter into this Loan Agreement and to perform its obligations under
and consummate the transactions contemplated by this Loan Agreement and has by
proper corporate action duly authorized the execution and delivery of this Loan
Agreement. When executed and delivered, this Loan Agreement and the other Loan
Documents will be valid and binding obligations of the Borrower enforceable in
accordance with their respective terms.
5.03 No Violation of Corporate Restrictions. Neither the execution and
delivery of this Loan Agreement, nor the performance of the obligations under or
consummation of the transactions contemplated by this Loan Agreement, violates
or will violate any law or governmental order, conflicts or will conflict with
any provision of any charter document or by-law of the Borrower or any material
term or provision of any agreement or instrument to which the Borrower is a
party or by which the Borrower is bound, or constitutes or will constitute a
breach of or a default under any such agreement or instrument (unless
appropriate written waivers have been received and delivered to the Bank).
5.04 Governmental Consents. No consent, approval or authorization of,
or filing, registration or qualification with, any governmental authority on the
part of the Borrower is required as a condition to the execution, delivery or
performance of this Loan Agreement or any of the other Loan Documents by the
Borrower.
5.05 Litigation. Except as set forth on Exhibit 5.05 attached hereto,
there are no material pending, or to the best knowledge of Borrower, threatened,
legal proceedings to which the Borrower is a party or of which any of its
properties are the subject.
5.06 Other Agreements. The Borrower is not in default in the
performance, observance or fulfillment of any of the obligations, covenants or
conditions contained in any material agreement or instrument to which it is a
party.
5.07 Taxes. The Borrower has filed or caused to be filed all federal,
state and local tax returns which are required to be filed by the Borrower and
has paid or caused to be paid all taxes as shown on said returns or on any
assessment to the extent such taxes have become due, except for taxes which are
being contested in good faith and against which reserves in accordance with
Generally Accepted Accounting Principles will be established. The Borrower does
not know of any proposed material tax assessments against it. No extension of
time for assessment or payment of any federal, state or local tax by the
Borrower is in effect.
- 8 -
<PAGE> 9
5.08 Liens. None of the assets of the Borrower is subject to any
mortgage, pledge, title retention lien or other lien, encumbrance or security
interest, except (i) for current taxes not delinquent or taxes being contested
in good faith and by appropriate proceedings, (ii) liens arising in the ordinary
course of business for sums not due or sums being contested in good faith and by
appropriate proceedings, but not involving any borrowed money or the deferred
purchase price of property or services, (iii) mechanics' and materialmen's
liens, reservations, exceptions, encroachments, easements, rights of way,
covenants, conditions, restrictions, leases and other similar title exceptions
or encumbrances affecting real property which do not in the aggregate materially
detract from the value of said properties or materially interfere with their use
in the ordinary conduct of the Borrower's business and (iv) to the extent shown
in Exhibit 5.08.
5.09 ERISA. The Borrower has not incurred any accumulated unfunded
deficiency within the meaning of the Employee Retirement Income Security Act of
1974 ("ERISA") nor has incurred any material liability to the Pension Benefit
Guaranty Corporation ("PBGC") established under such Act (or any successor
thereto under such Act) in connection with the employee benefit plans
established or maintained by the Borrower. The Borrower is in compliance in all
material respects with those provisions of ERISA and the regulations and public
interpretations thereunder which are applicable to the Borrower and its
Subsidiaries. No Reportable Event (as defined in ERISA) has occurred with
respect to any Plan.
5.10 Subsidiaries. The Borrower has no Subsidiaries as of the date
hereof except as set forth on Exhibit 5.10 attached hereto.
5.11 Regulation U. The Borrower is not engaged principally, or as one
of its important activities, in the business of extending credit for the purpose
of purchasing or carrying margin stock (within the meaning of Regulation U of
the Board of Governors of the Federal Reserve System).
5.12 Patents and Trademarks. The Borrower possesses all of the
necessary patents, licenses, trademarks, trademark rights, tradenames, tradename
rights and copyrights material to conduct its business as now conducted, without
known conflict with any patent, license, trademark, tradename or copyright of
any other Person.
5.13 Financial Information Provided. The Borrower represents that the
financial information it has heretofore furnished to the Bank dated September
30, 1996 with regard to its operations is true and correct, and presents fairly
the financial position of the Borrower, and there have been no material adverse
changes since that date.
- 9 -
<PAGE> 10
5.14 Environmental Compliance. The Borrower has fully complied with all
laws, ordinances, regulations and orders, including without limitation all
zoning, safety and environmental laws, ordinances, regulations and orders,
applicable to its business or properties and the present uses by the Borrower of
its properties do not violate any such laws, ordinances, regulations or orders.
There is not currently and in the past there has not been (i) any use,
treatment, storage or disposal of any hazardous substance or material or
pollutant on any of the Borrower's properties, except as of the date hereof as
disclosed on Exhibit 5.14 attached hereto, (ii) any spill, leakage, discharge or
release of any hazardous substance or material or pollutant thereon or
therefrom, or (iii) any off-site disposal by the Borrower of any hazardous
substance or material or pollutant in any location, except as disclosed on
Exhibit 5.14 attached hereto.
ARTICLE VI
Affirmative Covenants
---------------------
6.01 The Borrower agrees that as long as its obligations hereunder
remain outstanding and until the Commitment hereunder is terminated (unless the
Bank shall otherwise consent in writing), the Borrower will, and will cause its
Subsidiaries to with respect to the subsections (e) through (o) below:
(a) within ninety (90) days of the end of each fiscal year,
deliver to the Bank either (i) the Borrower's Annual Report on Form
10-K for such fiscal year or (ii) a detailed consolidated financial
report of the Borrower and its Subsidiaries as of the end of such
fiscal year (including a balance sheet, income statement and statements
of cash flows and stockholders' equity) based on Generally Accepted
Accounting Principles applied on a Consistent Basis containing an
unqualified opinion of nationally recognized independent certified
public accountants;
(b) within forty-five (45) days after the end of each fiscal
quarter of each fiscal year, deliver either (i) the copy of Form 10-Q
for such quarter as filed with the Securities and Exchange Commission
or (ii) financial information and reports as of the end of such fiscal
quarter (including a balance sheet and income statement) of the
Borrower and its Subsidiaries (in consolidated form) certified by the
chief financial officer of the Borrower to be correct and accurate;
(c) together with each delivery of financial reports required
by Section 6.01(a) and (b) hereof, deliver to the Bank a statement
signed by the chief
- 10 -
<PAGE> 11
financial officer of the Borrower substantially in the form of Exhibit
6.01(c) hereto, setting forth that the Borrower has kept, observed,
performed and fulfilled each and every agreement binding on it
contained in this Loan Agreement and the Loan Documents and is not at
the time in default in the keeping, observance, performance or
fulfillment of any of the terms, provisions and conditions of this Loan
Agreement or any of the Loan Documents and that no Event of Default
specified in Article VIII hereof, nor any event, which, upon notice or
lapse of time or both, would constitute such an Event of Default, has
occurred, or if such Event of Default exists or would occur as the case
may be, stating the nature thereof, the period of existence thereof and
what action the Borrower proposes to take with respect thereto;
(d) promptly, from time to time, deliver to the Bank a copy of
all filings made under the Securities and Exchange Act of 1934 and such
other information regarding the Borrower's operations, business affairs
and financial condition as the Bank may reasonably request. The Bank is
hereby authorized to deliver a copy of any such financial information
delivered hereunder to the Bank to any regulatory authority having
jurisdiction over the Bank with appropriate confidential restrictions
being noted on any submissions of such information;
(e) maintain or cause to be maintained all personal property
material to its business in good working order and condition and make
all needed repairs, replacements and renewals as are necessary to
conduct its business in accordance with prudent business practices;
(f) do or cause to be done all things necessary to preserve
and keep in full force and effect its corporate existence, rights and
franchises;
(g) (i) comply with or contest in good faith all statutes and
governmental regulations of which the Borrower has knowledge and the
noncompliance of which would have a material adverse effect on the
financial condition of the Borrower; and (ii) pay all taxes,
assessments, governmental charges, claims for labor, supplies, rent and
any other obligation which, if unpaid, might become a lien against any
of its properties except liabilities being contested in good faith and
against which adequate reserves have been established;
(h) at all times keep its insurable properties insured to such
extent and against such risks, including, without limitation, public
liability
- 11 -
<PAGE> 12
insurance, hazard insurance, worker's compensation and other insurance
required by law and is customary with companies of comparable size in
the same or similar business but at all times of the type and at least
in the amount of the present coverage of the Borrower;
(i) preserve and protect its patents, licenses trademarks,
trademark rights, tradenames, tradename rights and copyrights and
maintain all of its other material properties and assets used or useful
in the conduct of its business in good repair, working order and
condition and from time to time cause to be made all proper
replacements, betterments and improvements thereto;
(j) keep true books of records and accounts in accordance with
Generally Accepted Accounting Principles applied on a Consistent Basis,
and in which full, true and correct entries will be made of the
Borrower's dealings and transactions;
(k) permit any officer of the Bank designated by the Bank to
visit and inspect any of the Borrower's properties, books and financial
records at such times as the Bank may reasonably request upon
reasonable notice and during ordinary business hours;
(l) upon the request of the Bank, authorize any officer of the
Bank to discuss its financial statements and financial affairs at any
time and from time to time with the Borrower's independent certified
public accountants upon reasonable notice and during ordinary business
hours with a representative of the Borrower present;
(m) deliver to the Bank forthwith, upon any officer of the
Borrower obtaining knowledge of an Event of Default or an event which
would constitute such an Event of Default but for the requirement that
notice be given or time elapse or both, a certificate signed by the
chief executive officer of the Borrower specifying the nature and
period of existence thereof and what action the Borrower proposes to
take with respect thereto;
(n) within ten (10) days of the event becoming known to any
officer of the Borrower, notify the Bank in writing of the occurrence
of any of the following events:
(i) the pendency or commencement of any action, suit
or proceeding at law or in equity under which a party or
parties seek an amount equal to or exceeding $250,000.00;
- 12 -
<PAGE> 13
(ii) any event or condition which shall constitute an
event of default under any other agreement for borrowed money
or any known or potential materially adverse change in any
other material contractual agreement;
(iii) any levy of an attachment, execution or other
process against its assets; and
(iv) any change in any existing agreement or contract
which may materially adversely affect any of its businesses or
affairs, financial or otherwise;
(o) the Borrower shall (i) at all times, make prompt payment
of all contributions required under all employee benefit plans
("Plans") to meet the minimum funding standard set forth in ERISA
(defined herein) with respect to its Plans; (ii) within thirty (30)
days after the filing thereof, furnish to the Bank copies of each
annual report/return (Form 5500 Series), as well as all schedules and
attachments required to be filed with the Department of Labor and/or
the Internal Revenue Service pursuant to ERISA, and the regulations
promulgated thereunder, in connection with each of its Plans for each
Plan Year; (iii) notify the Bank immediately of any fact, including,
but not limited to, any Reportable Event (as defined in ERISA) arising
in connection with any of its Plans, which might constitute grounds for
termination thereof by the PBGC or for, the appointment by the
appropriate United States District Court of a trustee to administer
such Plan, together with a statement, if requested by the Bank, as to
the reason therefor and the action, if any, proposed to be taken with
respect thereof; and (iv) furnish to the Bank, upon its request, such
additional information concerning any of the Borrower's Plans as may be
reasonably requested;
(p) satisfy the following financial tests:
(i) the Borrower will maintain as of the end of each
fiscal quarter (commencing with the fiscal quarter ending
December 31, 1996) Tangible Net Worth of not less than
$40,000,000.00;
(ii) the Borrower shall maintain as of the end of
each fiscal quarter (commencing with the fiscal quarter ending
December 31, 1996) a Current Ratio of not less than 2.0 to
1.0;
(iii) the Borrower shall maintain a Cash Flow
Coverage Ratio of not less than 1.25 to 1.0 computed as of the
last day of each fiscal quarter
- 13 -
<PAGE> 14
commencing with the fiscal quarter ending December 31, 1996;
(iv) the Borrower shall maintain a Leverage Ratio of
not greater than 1.00 to 1.0 computed on the last day of each
fiscal quarter commencing with the fiscal quarter ending
December 31, 1996; and
(v) the Borrower shall maintain a ratio of Funded
Debt to EBITDA of not greater than 2.5 to 1.0 computed on the
last day of each fiscal quarter commencing with the fiscal
quarter ending December 31, 1996.
ARTICLE VII
Negative Covenants
------------------
7.01 The Borrower agrees that as long as its obligations hereunder
remain outstanding and until the Commitment is terminated (unless the Bank shall
otherwise consent in writing), the Borrower shall not:
(a) incur, create, assume or permit to exist any indebtedness
for borrowed money, howsoever evidenced, or its equivalent (including
but not limited to leases required to be capitalized under Generally
Accepted Accounting Principles), except
(i) indebtedness set forth in the financial
statements referred to in Section 5.13 hereof and as set forth
in Exhibit 7.01(a)(i);
(ii) additional indebtedness extended by the Bank;
and
(iii) purchase money indebtedness incurred to finance
the acquisition of equipment on installment contracts with
terms not to exceed 6 months;
(b) incur, create or permit to exist any pledge, lien, charge
or other encumbrance of any nature whatsoever on the property of the
Borrower or any of its Subsidiaries, whether now owned or hereafter
acquired, other than
(i) liens as disclosed in Exhibit 5.08 hereto;
(ii) any unfiled lien of materialmen, mechanics,
workmen, warehousemen, carriers, landlords or repairmen;
provided that if such a
- 14 -
<PAGE> 15
lien shall be perfected and shall not be contested in good
faith, it shall be discharged of record immediately by
payment, bond or otherwise;
(iii) tax liens which are being contested in good
faith, or which constitute liens for taxes the payment of
which is not yet required;
(iv) liens in favor of the Bank;
(v) liens incurred in connection with the purchase
money indebtedness permitted under Section 1.01(a)(iii); and
(vi) liens on assets securing indebtedness or
obligations in amounts less than $10,000.00;
(c) sell, lease, transfer or otherwise dispose of any of the
properties and assets of the Borrower or any of its Subsidiaries to any
Person other than (i) sales in the ordinary course of business and (ii)
other sales so long as the aggregate net book value of the assets sold
pursuant to such sales shall not exceed $2,000,000.00;
(d) seek or permit dissolution or liquidation of the Borrower
in whole or in part;
(e) guaranty, or become liable for, the obligations of any
other Person (provided, however, (i) this shall not prevent the
Borrower or any of its Subsidiaries from endorsing negotiable
instruments for collections in the ordinary course of business and (ii)
this shall not prevent the Borrower from entering into guarantees,
endorsements or debt assumptions for related, affiliate or subsidiary
entities of the Borrower so long as the aggregate amount of such
guaranties, endorsements or debt assumptions shall not exceed
$4,000,000.00 at any time);
(f) make any loans or advances in excess of $2,000,000.00 in
the aggregate; provided, however, the Borrower may make loans or
advances to related, affiliate or subsidiary entities of the Borrower
so long as the aggregate amount of such guaranties, endorsements or
debt assumptions shall not exceed $4,000,000.00 at any time;
(g) consolidate with, merge into or be acquired by any Person;
provided, however, the Borrower shall be permitted to enter into merger
and/or consolidation transactions so long as the Borrower is the
surviving entity;
- 15 -
<PAGE> 16
(h) change the general character of business of the Borrower
or any of its Subsidiaries or engage in any type of business not
reasonably related to the business of the Borrower or any of its
Subsidiaries as presently conducted;
(i) (1) pay any cash dividends to the shareholders of the
Borrower, (2) make any distribution on any shares of any class of the
capital stock of the Borrower which results in a reduction to
stockholders' equity, (3) apply any of the Borrower's property or
assets to the purchase, redemption or other retirement of any shares of
any class of capital stock resulting in a reduction to stockholders'
equity in excess of $1,000,000.00 in the aggregate, except as set forth
in the existing stock option and award plans or (4) amend in any way
the capital structure of the Borrower;
(j) create or permit to exist or become effective, directly or
indirectly, any prohibition or restriction on the creation or existence
of any lien upon the assets of the Borrower or any of its Subsidiaries
other than as set forth herein; or
(k) create or permit to exist any Subsidiary unless such
Subsidiary guarantees the obligations of the Borrower hereunder
pursuant to the Guaranty Agreement.
ARTICLE VIII
Events of Default and Acceleration
----------------------------------
8.01 Any of the following shall constitute an "Event of Default" under
this Loan Agreement:
(a) Nonpayment. Nonpayment when and as due of any principal,
interest or other payment hereunder or under the Revolving Notes and
the continuation of such nonpayment for a period of five (5) days.
(b) Breach of Covenants. Other than as set forth in Section
8.01(a) hereof, the failure to perform and observe any covenant or
other obligation contained herein or in any other Loan Documents and
the continuation of such failure for a period of thirty (30) days after
receipt of written notice from the Bank thereof.
(c) False Statements. If any representation or warranty made
by the Borrower or any Guarantor in this Loan Agreement, any other Loan
Document or in any document, certificate, statement or report
- 16 -
<PAGE> 17
heretofore or hereafter made shall be untrue in any material respect.
(d) Bankruptcy. In the event that the Borrower or any
Guarantor
(1) shall make an assignment for the benefit of
creditors; or
(2) has a petition initiating a proceeding under any
section or chapter of the Bankruptcy Code or its amendments,
filed by or against the Borrower or any Guarantor and, if
against the Borrower or any Guarantor, such petition is not
set aside within ninety (90) days after such filing; or
(3) shall file any proceedings for dissolution or
liquidation; or
(4) has a receiver, trustee or custodian appointed
for all or part of its or his assets; or
(5) seeks to make an adjustment, settlement or
extension of its or his debts with its or his creditors
generally; or
(6) has a notice of an action for enforcement of a
lien filed or recorded or a judgment lien or execution
obtained against it or him in excess of an aggregate of
$50,000.00 which notice of lien is not removed, insured,
reserved for (in amounts satisfactory to the Bank), satisfied,
bonded or contested in good faith within thirty (30) days
after any officer of the Borrower or the applicable Guarantor,
as the case may be, becomes aware of such lien;
(e) if an event of default occurs under any agreement for
Funded Debt by and between the Borrower and the Bank which is in
existence as of the date hereof or which is entered into subsequent to
the date hereof;
(f) if the Borrower in the performance of any other agreement
for Funded Debt between it and any other lender defaults and such
default permits such other lender to accelerate such other indebtedness
of the Borrower for borrowed money;
(g) any change shall occur with respect to the chief executive
officer management position of the Borrower; or
- 17 -
<PAGE> 18
(h) any Guarantor shall default in the performance of any
obligation under the Guaranty Agreement.
8.02 Remedies. Upon the occurrence of any such Event of Default and
after the applicable grace period, if any, and unless the Bank agrees to waive
in writing such an Event of Default:
(a) Termination of Commitment. The Bank, in its sole
discretion, may terminate the Commitment.
(b) Acceleration of Indebtedness. All of the indebtedness of
any and every kind owing by the Borrower to the Bank, howsoever
evidenced, now existing or hereafter arising, shall become due and
payable upon written notice to the Borrower (other than an Event of
Default described in Section 8.01(d) in which case such indebtedness
shall become due and payable immediately without necessity of written
demand) without the necessity of any other demand, presentment, protest
or notice upon the Borrower, all of which are hereby expressly waived
by the Borrower.
(c) Acceleration of Obligations. All of the obligations of the
Borrower under the Loan Documents shall thereupon be immediately due
and payable without the necessity of any other demand, presentment,
protest or notice upon the Borrower, all of which are hereby expressly
waived by the Borrower.
(d) Right of Set-Off. Regardless of the adequacy of the
collateral, the Bank shall have the right, immediately and without
further action by it, to set-off against the Revolving Note, all money
owed by the Bank in any capacity to the Borrower, whether or not due,
and the Bank shall be deemed to have exercised such right of set-off
and to have made a charge against any such money immediately upon the
occurrence of such event of default even though such charge is made or
entered on the books of the Bank subsequent thereto. If the Bank
exercises its right of set-off described in this paragraph, it will
provide the Borrower, in adequate detail, a description of all amounts
set-off against the Revolving Note.
- 18 -
<PAGE> 19
ARTICLE IX
Miscellaneous
-------------
9.01 Notices. All notices and other communications hereunder shall be
sufficiently given and shall be deemed given when delivered or when mailed by
registered or certified mail, postage prepaid, addressed as follows:
(a) if to the Borrower:
Applied Analytical Industries, Inc.
5051 New Centre Drive
Wilmington, North Carolina 28403
Attention: Mark P. Colonnese
(b) if to the Bank
NationsBank, N.A.
155 North Front Street
Wilmington, North Carolina 28401
Attention: David Houston
9.02 Waiver. No failure or delay on the part of the Bank in the
exercise of any right, power or privilege hereunder or under any other Loan
Document shall operate as a waiver of any such right, power or privilege nor
shall any such failure or delay preclude any other or further exercise thereof.
The rights and remedies herein provided are cumulative and not exclusive of any
rights or remedies provided by law.
9.03 Survival. All covenants, agreements, representations and
warranties made herein and in the other Loan Documents shall survive the making
by the Bank of the Revolving Loans and the execution and delivery to the Bank of
the Loan Documents and shall continue in full force and effect so long as any of
the indebtedness of the Borrower to the Bank evidenced by the Notes or any
obligations under the Commitment remain outstanding.
9.04 Successors and Assigns. This Loan Agreement and the Loan Documents
shall inure to the benefit of and be binding upon successors and assigns of the
Bank; provided, however, the Borrower shall not assign any of its rights or
obligations hereunder without the prior written consent of the Bank.
9.05 Costs. The Borrower agrees to pay all reasonable costs and
expenses in connection with the preparation, execution and delivery of the Loan
Documents, including, without limitation, the reasonable fees and out-of-pocket
- 19 -
<PAGE> 20
expenses of special counsel to the Bank (not to exceed $10,000.00), and, after
the occurrence of an Event of Default, costs and expenses of the Bank in
connection with the enforcement of this Loan Agreement or the other Loan
Documents (including without limitation reasonable attorneys fees) and to hold
the Bank harmless from any and all such costs, expenses and liabilities.
9.06 Amendment; Waiver; Consents. No approval, decision, option or
action required of the Bank ("Approval") hereunder nor any modification,
amendment or waiver ("Waiver") of any provision of this Loan Agreement or any
other Loan Document nor any consent to any departure by the Borrower therefrom
("Consent") shall in any event be effective unless the same shall be in writing
signed by the Bank and delivered in accordance with the provisions of Section
9.01 hereof, and then such Approval, Waiver or Consent shall be effective only
in the specific instance and for the purpose for which given but any such
Approval, Waiver or Consent when signed shall be effective and binding upon the
Bank. No notice to or demand on the Borrower in any case shall entitle the
Borrower to any other or further notice or demand in the same, similar or other
circumstances.
9.07 Year. Interest, fees and premiums hereunder shall be computed on
the basis of a three hundred sixty (360) day year for the actual number of days
in the billing period.
9.08 Payment on Business Day. Should any installment or other payment
of the principal of or interest on the Notes become due and payable on other
than a Business Day, the maturity thereof shall be extended to the next
succeeding Business Day thereafter and in the case of an installment of
principal, interest shall be payable thereon at the rate per annum herein
specified during such extension.
9.09 Counterparts. This Loan Agreement may be executed in any number of
counterparts, each of which when so executed and delivered shall be deemed an
original, and it shall not be necessary in making proof of this Loan Agreement
to produce or account for more than one such counterpart.
9.10 Assignment. The Bank may, at any time, transfer or assign all or
any portion of the indebtedness evidenced by the Revolving Note held by the Bank
and the terms hereof shall extend to any subsequent holder of the Revolving
Note.
9.11 Term. The term of this Loan Agreement shall be until the Bank is
no longer obligated to lend under the Commitment and the Bank has received
payment in full of the unpaid principal and interest of the Revolving Note.
- 20 -
<PAGE> 21
9.12 Captions. The captions herein are inserted only as a matter of
convenience and for reference and in no way define, limit or describe the scope
of this Loan Agreement nor the interest of any provisions hereof.
9.13 Governing Law. This Loan Agreement and the other Loan Documents
and all matters relating thereto shall be governed by and construed and
interpreted in accordance with the laws of the State of North Carolina. The
Borrower hereby submits to the jurisdiction and venue of the state and federal
courts of North Carolina and agrees that the Bank may, at its option, enforce
its rights under the Loan Documents in such courts. The Borrower hereby agrees
that both the federal and state courts in Mecklenburg County, North Carolina are
a convenient forum and agrees not to raise as a defense that such courts are not
a convenient forum.
9.14 ARBITRATION. ANY CONTROVERSY OR CLAIM BETWEEN OR AMONG THE PARTIES
HERETO INCLUDING BUT NOT LIMITED TO THOSE ARISING OUT OF OR RELATING TO THIS
INSTRUMENT, AGREEMENT OR DOCUMENT OR ANY RELATED INSTRUMENTS, AGREEMENTS OR
DOCUMENTS, INCLUDING ANY CLAIM BASED ON OR ARISING FROM AN ALLEGED TORT, SHALL
BE DETERMINED BY BINDING ARBITRATION IN ACCORDANCE WITH THE FEDERAL ARBITRATION
ACT (OR IF NOT APPLICABLE, THE APPLICABLE STATE LAW), THE RULES OF PRACTICE AND
PROCEDURE FOR THE ARBITRATION OF COMMERCIAL DISPUTES OF J.A.M.S./ENDISPUTE OR
ANY SUCCESSOR THEREOF ("J.A.M.S."), AND THE "SPECIAL RULES" SET FORTH BELOW. IN
THE EVENT OF ANY INCONSISTENCY, THE SPECIAL RULES SHALL CONTROL. JUDGMENT UPON
ANY ARBITRATION AWARD MAY BE ENTERED IN ANY COURT HAVING JURISDICTION. ANY PARTY
TO THIS LOAN AGREEMENT MAY BRING AN ACTION, INCLUDING A SUMMARY OR EXPEDITED
PROCEEDING, TO COMPEL ARBITRATION OF ANY CONTROVERSY OR CLAIM TO WHICH THIS LOAN
AGREEMENT APPLIES IN ANY COURT HAVING JURISDICTION OVER SUCH ACTION.
A. SPECIAL RULES. THE ARBITRATION SHALL BE CONDUCTED IN THE CITY OF THE
BORROWER'S DOMICILE AT TIME OF THE EXECUTION OF THIS INSTRUMENT, AGREEMENT OR
DOCUMENT AND ADMINISTERED BY J.A.M.S. WHO WILL APPOINT AN ARBITRATOR; IF
J.A.M.S. IS UNABLE OR LEGALLY PRECLUDED FROM ADMINISTERING THE ARBITRATION, THEN
THE AMERICAN ARBITRATION ASSOCIATION WILL SERVE. ALL ARBITRATION HEARINGS WILL
BE COMMENCED WITHIN 90 DAYS OF THE DEMAND FOR ARBITRATION; FURTHER, THE
ARBITRATOR SHALL ONLY, UPON A SHOWING OR CAUSE, BE PERMITTED TO EXTEND THE
COMMENCEMENT OF SUCH HEARING FOR UP TO AN ADDITIONAL 60 DAYS.
B. RESERVATION OF RIGHTS. NOTHING IN THIS ARBITRATION PROVISION SHALL
BE DEEMED TO (I) LIMIT THE APPLICABILITY OF ANY OTHERWISE APPLICABLE STATUTES OF
LIMITATION OR REPOSE AND ANY WAIVERS CONTAINED IN THIS ARBITRATION PROVISION; OR
(II) BE A WAIVER BY THE BANK OF THE PROTECTION AFFORDED TO IT BY 12 U.S.C. SEC.
91 OR ANY
- 21 -
<PAGE> 22
SUBSTANTIALLY EQUIVALENT STATE LAW; OR (III) LIMIT THE RIGHT OF THE BANK HERETO
(A) TO EXERCISE SELF HELP REMEDIES SUCH AS (BUT NOT LIMITED TO) SETOFF, OR (B)
TO FORECLOSE AGAINST ANY REAL OR PERSONAL PROPERTY COLLATERAL, OR (C) TO OBTAIN
FROM A COURT PROVISIONAL OR ANCILLARY REMEDIES SUCH AS (BUT NOT LIMITED TO)
INJUNCTIVE RELIEF, WRIT OF POSSESSION OR THE APPOINTMENT OF A RECEIVER. THE BANK
MAY EXERCISE SUCH SELF HELP RIGHTS, FORECLOSE UPON SUCH PROPERTY, OR OBTAIN SUCH
PROVISIONAL OR ANCILLARY REMEDIES BEFORE, DURING OR AFTER THE PENDENCY OF ANY
ARBITRATION PROCEEDING BROUGHT PURSUANT TO THIS INSTRUMENT, AGREEMENT OR
DOCUMENT. NEITHER THIS EXERCISE OF SELF HELP REMEDIES NOR THE INSTITUTION OR
MAINTENANCE OF AN ACTION FOR FORECLOSURE OR PROVISIONAL OR ANCILLARY REMEDIES
SHALL CONSTITUTE A WAIVER OF THE RIGHT OF ANY PARTY, INCLUDING THE CLAIMANT IN
ANY SUCH ACTION, TO ARBITRATE THE MERITS OF THE CONTROVERSY OR CLAIM
OCCASSIONING RESORT TO SUCH REMEDIES.
9.15 Loan Documents. The Bank agrees to provide the Borrower with
copies of all of the Loan Documents in acceptable electronic format.
- 22 -
<PAGE> 23
IN WITNESS WHEREOF, the parties hereto have executed or caused this
instrument to be executed under seal as of the day and year first above written.
APPLIED ANALYTICAL INDUSTRIES, INC.
ATTEST:
By /s/ By /s/
------------------------------ ------------------------------
Title Title Vice-President
---------------------------- ------------------------------
(Corporate Seal)
NATIONSBANK, N.A.
By /s/
------------------------------
Title Vice President
------------------------------
- 23 -
<PAGE> 1
EXHIBIT 13
1996 ANNUAL REPORT TO SHAREHOLDERS
(PORTIONS INCORPORATED BY REFERENCE)
SELECTED FINANCIAL DATA
<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 (1) .................... 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)(2):
Pro forma earnings (loss) per share . $ (0.23)
Pro forma weighted average shares.... 13,440
Pro forma income taxes .............. $ 1,129 $ 1,118 $ 1,125 $ 878
Pro forma net income ................ 2,116 1,078 1,701 1,373
Pro forma earnings per common share . $ 0.18
Pro forma weighted average common
shares ............................ 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(3) ....... 63,995 21,990 5,856 5,549 3,649
</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.
(2) Pro forma information is presented prior to 1996 to reflect pro forma
provisions for income taxes for the periods prior to November 17, 1995,
when the Company was treated as an S corporation for income tax purposes.
(3) The Company completed an initial public offering of its common stock on
September 25, 1996.
APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES 13
<PAGE> 2
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 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.
14 APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES
<PAGE> 3
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.
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.
APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES 15
<PAGE> 4
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 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.
16 APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES
<PAGE> 5
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.
APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES 17
<PAGE> 6
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.
18 APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES
<PAGE> 7
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.
APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES 19
<PAGE> 8
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.
20 APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES
<PAGE> 9
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
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. 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.
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.
APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES 21
<PAGE> 10
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 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.
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 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.
<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.
22 APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES
<PAGE> 11
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.
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
APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES 23
<PAGE> 12
of the Series A Preferred, certain conditions remain in effect after the IPO
regarding transferability rights and the appointment of one board seat.
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>
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
24 APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES
<PAGE> 13
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.
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-process 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.
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>
APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES 25
<PAGE> 14
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.
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.
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
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
26 APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES
<PAGE> 15
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)
Price range of common stock, traded on the NASDAQ
market under the symbol "AAII"(2)
High -- -- $25 1/8 $29 5/8
Low -- -- $16 $19 3/4
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) (3)..................... $ (163) $ 475 $ 655 $ 1,149
Pro forma earnings (loss) per share (3)............. $(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) The Company completed an initial public offering of its common stock on
September 25, 1996 at $16.00 per share. There were approximately 249
holders of record for the common stock as of February 28, 1997.
(3) 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.
APPLIED ANALYTICAL INDUSTRIES INC. AND SUBSIDIARIES 27
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF APPLIED ANALYTICAL INDUSTRIES, INC.
1. Applied Analytical Industries Italy, S.r.l.
2. L.A.B. Gesellschaft fur pharmakologische Untersuchungen mbH & Co.
3. AAI UK Limited
4. AAI Japan, Inc.
5. AAI Technologies, Inc.
6. AAI Properties, Inc.
7. Applied Analytical Industries Learning Center, Inc.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFOMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF APPLIED ANALYTICAL INDUSTRIES, INC. AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 42,186
<SECURITIES> 0
<RECEIVABLES> 10,106
<ALLOWANCES> 73
<INVENTORY> 0
<CURRENT-ASSETS> 68,038
<PP&E> 30,477
<DEPRECIATION> 11,261
<TOTAL-ASSETS> 104,478
<CURRENT-LIABILITIES> 32,283
<BONDS> 0
0
0
<COMMON> 16
<OTHER-SE> 63,979
<TOTAL-LIABILITY-AND-EQUITY> 104,478
<SALES> 42,162
<TOTAL-REVENUES> 42,162
<CGS> 17,621
<TOTAL-COSTS> 17,621
<OTHER-EXPENSES> 26,083
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 402
<INCOME-PRETAX> (1,046)
<INCOME-TAX> 2,102
<INCOME-CONTINUING> (3,148)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,148)
<EPS-PRIMARY> (0.23)
<EPS-DILUTED> (0.23)
</TABLE>
