Outsourcing Outlook

Seeking a Fresh Start

Jim Miller is the president of PharmSource Information Services, Inc. and publisher of Bio/Pharmaceutical Outsourcing Report, tel.703.914.1203, fax 703.914.1205, info@pharmsource.com, www.pharmsource.com

The Chapter 11 bankruptcy filing of aaiPharma (Wilmington, NC, www.aaipharma.com), parent of AAI Development Services, was the culmination of an agonizing year-long odyssey. It also was a first step in restoring one of the best-known brands in the CRO industry. The filing was triggered by aaiPharma's inability to service the $350 million debt it took on in 2002–2003 in an effort to remake itself from a CRO into a specialty pharmaceutical company. The company used the debt to acquire a product line, only to find it was unable to maintain the sales of those products in the face of generic competition. Efforts by some former executives to cover the sales' shortfalls ultimately led to a massive restatement of financial reports, government investigations, default on the debt, and the resignation of key executives. As the products business went bad, aaiPharma fell back on its CRO business, AAI Development Services, an industry leader in nonclinical drug development services, including analytical and bioanalytical chemistry, microbiology, and formulation. Underscoring the return to its CRO roots, the company brought in Ludo Reynders, a respected former Quintiles executive, as its new CEO. AAI Development Services generated $95 million in revenue in 2004, up 6% from its 2003 performance. The financial problems sparked by the products side of the company have taken their toll on the CRO business, however. CRO revenues for the first quarter of 2005 were down 20% from the year before. In its 10-Q filing, the company admitted that "customer concerns with respect to our uncertain financial condition have adversely affected our ability to obtain new development service projects, particularly long-term projects." The Chapter 11 filing gives the company some breathing room to restructure its operations and finances. It appears the process will move relatively quickly because the filing was preceded by two major developments: the securing of $210 million in debtor-in-possession (DIP) financing and the signing of an agreement to sell the pharmaceutical products line. The DIP financing includes $180 million to replace the company's senior credit facility plus a $30-million revolving credit facility, which will help fund its ongoing operations. The agreement to sell the pharmaceutical products line is with Xanodyne Pharmaceuticals (Florence, KY, www.xanodyne.com), a privately held specialty pharmaceutical company that focuses on the women's health, pain management, and urology markets. The deal calls for Xanodyne to pay aaiPharma $170 million plus potential royalties for its currently marketed products, plus rights to some products under development by aaiPharma. Documents filed by aaiPharma with the Securities and Exchange Commission (SEC) indicated that the pharmaceutical products sale could be completed as soon as the end of June, with emergence from bankruptcy following shortly thereafter. It is in the interest of the company's subordinated debt holders, who will own the company after its emergence from bankruptcy, to normalize the situation as soon as possible to preserve the CRO business. Those debt holders will effectively have two choices. The first is to hold on to the company in hopes that the CRO business can grow to a point where it can be sold at a price that will recover the debt. The second choice is to cut their losses by selling the CRO business now for whatever price it can command. In an SEC filing made just before the bankruptcy filing, aaiPharma presented projections indicating that the CRO business could generate revenues of $142 million by 2007, up 40% from $102 million in 2005, with operating profit of $31 million. The company could reach a valuation of at least $200 million at the profitability level, but achieving it will require that the company salvage its market reputation quickly and make some smart moves to build its business. It also will require that company management not be distracted by the lingering investigations and lawsuits that surround it. For that reason, a sale of the CRO business to a third party (leaving the corporate aaiPharma shell intact to handle the legal issues) could be the best option. (continued)