Pharma Co. Investigating Unusual Sales

Standard & Poor's has changed its outlook on aaiPharma from stable to negative following the company's announcement that it is conducting an internal investigation into sales abnormalities in its Darvocet and Brethine product lines. The company also withdrew its 2004 earnings guidance and, depending on results of the investigation, may need to adjust the 2003 financial results.

The bank debt affected is a $156 million term loan and a $100 million revolver, rated BB- by S&P. The debt is led by Bank of America, Wachovia Securities and CIBC World Markets and backed aaiPharma's $100 million acquisition of a portfolio of pain management products from Elan Corp. (LMW, 1/5). The company acquired Darvocet, its main pharmaceutical product, in 2002 from Eli Lily for about $211 million. An aaiPharma spokeswoman did not return calls.

"There was talk swirling around about excess inventories of some of their products in the wholesaler channel. That's probably what the abnormalities are referring to," said Arthur Wong, an analyst with S&P. "The practice is commonly referred to as 'stuffing the channel,' where a pharmaceutical company gives wholesalers a good price on a drug and allows them to stock up or buy way in excess of normal levels," he said.

"The company is doing it in order to make a quarter's or year's sales and earnings number. However, going forward, wholesalers are going to buy less as they have so much inventory," Wong noted. "How steep the decline and how long it stays in depressed sales level depends on how much excess inventory."

It is unclear when the investigation will be completed, or how the inquiry will affect near-term earnings and cash flow generation, S&P says. "Right now they are saying this practice has been going on in the second half of last year. If it's just confined to this period and to these two products, then maybe it won't be so bad," Wong said. "However, they can expand the investigation to more than these two products or further back than second-half of last year. The more excess there is, the lower the sales are going forward and lower the EBITDA is going to be. They do have loan covenants of minimum EBITDA." EBITDA is going to be lower going forward, Wong noted. "How much lower is what everyone is asking at this point."