aaiPharma's Growing Tale of Woe

Troubled drugmaker aaiPharma ( AAIIE) has begun asking bondholders to approve the restructuring of corporate debt, giving them an April 16 deadline. The solicitation began last week.

Unless the company restructures its debt, creditors could declare the company in default, and aaiPharma might be forced to seek bankruptcy protection. The default could be triggered as early as April 30, when a $9.6 million interest payment -- whose initial deadline was April 1 -- comes due.

And in the latest in a series of recent setbacks, aaiPharma revealed that it received grand jury subpoenas on April 2 and April 6 for documents and potential testimony relating to 2002 and 2003 financial reports, sales of certain key products, corporate officers' public comments about the company's financial health, certain loans to the company and the "terms and conditions" of employment for some senior managers.

The subpoenas were issued by the U.S. District Court for the Western District of North Carolina. The company added that the U.S. Attorney's Office for the Western District of North Carolina has said aaiPharma may receive subpoenas from the Securities and Exchange Commission. The grand jury requests were reported by aaiPharma on Friday, when the markets were closed, in a document filed with the SEC.

Of all of aaiPharma's troubles, the need for debt restructuring has vaulted to the top of the list. The company is seeking help from investors who hold $175 million in bonds, just over half of the company's total debt of $342.8 million as of Dec. 31. At year's end, aaiPharma had only $8.8 million in cash and shareholders' equity of $145.9 million, according to CIBC World Markets.

The company's financial woes have prompted a drastic drop in its stock; it is down almost 80% since touching a 52-week high of $31.85 on Jan. 21. On Monday, shares fell 55 cents, or 6.6%, to $7.02.

Rating agencies recently lowered aaiPharma's credit ratings deeper into junk bond territory.

On March 31, Standard & Poor's cut the credit rating to CCC from B-plus, and Moody's Investor Services dropped the rating to Caa2 from B2. Any bond rating at or below BB for Standard & Poor's is speculative; anything at or below Ba for Moody's is speculative.

In addition, Moody's cut its rating of senior subordinated notes to Ca from Caa1. S&P lowered the company's senior secured debt rating to CCC-plus from BB-minus and its subordinated debt rating to CC from B-minus.

S&P says the ratings remain on its CreditWatch, with negative implications. Even the pending $100 million sale of nutrition products to another company or a possible financial restructuring announced Monday haven't changed S&P's negative view.

The proposed deals would remove the company's "immediate liquidity problems," S&P credit analyst Arthur Wong said Monday. But the company's earnings and cash-flow generation remain "highly uncertain." Cash flow from operations "will likely be negative for the first half of 2004 and possibly beyond," Wong said.

That $9.6 million interest payment is one of many reasons why aaiPharma is asking key bondholders -- investors in the company's 11% subordinate senior notes due in 2010 -- for their consent to restructure the debt. The proposal would give aaiPharma flexibility in dealing with the deadlines imposed by existing debt agreements. If the company can't restructure its debt, it could be in default.

The request requires approval by investors holding a majority amount of the notes. Bondholders who vote "yes" will receive a consent fee of $10 per $1,000 in principal as long as there are enough votes to restructure the debt, aaiPharma makes the $9.6 million interest payment and the company completes its debt restructuring plan.

The company told bondholders Monday that they will be voting on a different restructuring plan than the one that had been proposed last week. The former one was a $40 million, 15-month revolving credit facility with Bank of America. The current one is a $135 million, two-year credit facility underwritten by Silver Point Finance, a unit of Silver Point Capital, a Greenwich, Conn.-based provider of credit analysis and credit-related investments.

A yes vote by the bondholders will enable aaiPharma to sign the Silver Point deal. If bondholders vote "no," the credit agreement is off.

"This global financing solution will strengthen the company's capital structure and position aaiPharma to immediately resume executing its business plan," said Gregory F. Rayburn, aaiPharma's interim chief operating officer, in a prepared statement Monday.

The bond ballot comes as the Wilmington, N.C.-based maker of painkillers and other drugs reels from problems and management changes that have piled up in recent months.

Its CEO was replaced in late March by aaiPharma's founder and chairman. The chief operating officer left in February to run a startup drug company. He was replaced recently by Rayburn, a management consultant whose expertise is financial restructuring.

The company missed a March 15 deadline and a two-week extension for filing its 10-K annual report with the SEC. The delay was caused by an ongoing internal investigation of what the company called "unusual sales" for two product lines last year.

The investigation by a group of independent board members and an outside law firm has caused aaiPharma to warn that fourth-quarter 2003 results will be "materially adjusted" and that other quarterly returns for last year may need to be restated.

The company has withdrawn financial guidance for 2004. It disclosed Friday that it may be unable to prepare any quarterly reports this year until it files its 10-K for last year. The 2004 first quarter ended March 31.

The 10-K filing delay not only triggered a countdown that could lead to a bond default but also provoked the Nasdaq to warn that failure to make a prompt 10-K filing could cause aaiPharma's stock to be delisted. The company said it has scheduled a meeting with Nasdaq to discuss its filing. The stock symbol has been changed to AAIIE from its original AAII to reflect the 10-K filing delay.

Meanwhile, most equity analysts who follow the company have lowered their ratings recently. A week before the latest revelations, Susannah Grey, a credit quality specialist at CIBC World Markets, warned clients that "the risk of bankruptcy has increased substantially." Grey has an underperform rating on the company. (She doesn't own shares.)

Elliot Wilbur, the CIBC equities analyst covering aaiPharma, told clients at the same time that even if the company was forced to sell assets, the stock probably wouldn't fall below the $6 to $6.50 range, given the apparent sales strength of some products. He kept his sector underperform rating in his March 31 report to clients. (He doesn't own shares; his firm is a market maker in aaiPharma's stock and has had an investment banking relationship within the past 12 months.)

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