Tyrannous Rx: a formula for making sluggish sales seem healthy created a monster that nearly destroyed aaiPharma.

• Author: Speizer, Irwin
• Position: Marketing strategy - Cover Story

The fortresslike office at 2320 Scientific Park Drive offers a foreboding front befitting its stature as a storehouse of trade secrets--and now as the home of a company under siege. Inside the Wilmington headquarters of aaiPharma Inc., Ph.D.s supervise Ph.D.s. For more than a quarter of a century, it has helped drug companies with the research needed to win federal approval for their products. Since 2001, it also has been buying and tweaking old drugs and putting improved versions back on the market.

Yet for all their smarts, the people who ran the company tripped over simple math. When revenue lagged Wall Street expectations, aaiPharma padded the bottom line with phony sales. And when the numbers didn't add up, federal investigators moved in, followed by lawyers brandishing shareholder lawsuits. The company ended up filing for Chapter 11 bankruptcy protection.

The top tier of management brought in to expand the company is gone, as is the grand ambition of building aaiPharma into a major drug company rather than just a contract-research organization. The company sold its drug business in July. In less than a year, aaiPharma had gone from its all-time-high share price to a penny stock attractive to only the most adventurous bottom feeders. "I think it's a tragedy," says Jim Waters, a former board member and an early investor. "It didn't have to be that way. But with the short-term thinking that went on, it became more and more inevitable."

Waters says aaiPharma fell because it focused on quarterly earnings reports. As he sees it, members of the management team feared missing Wall Street expectations so much that they dived deeper and deeper into fantasy accounting when sales slowed, then tried to hide the manipulations from investors and the board.

In June, former chief operating officer David Hurley pleaded guilty to fraud and conspiracy charges in a deal with federal prosecutors under which he agreed to cooperate in the continuing investigation, details of which have not been made public. What is known is that in 2003 sales of several of aaiPharma's key medicines such as the pain relievers Darvon and Darvocet began to slip. Instead of reporting lower sales and earnings, the company counted products stored with distributors as revenue. The tactic is called "channel stuffing," because products still in distribution channels are reported as sold.

A few Wall Street analysts caught on and began issuing reports critical of the company. Savvy traders began selling the stock short, betting its price would tumble. In August 2003, the U.S. Securities and Exchange Commission started questioning financial reports. After first insisting that the reports were accurate, the company backtracked and trimmed reported earnings and revenue. Caught in a downward spiral, it sank into insolvency.

Company officers declined to be interviewed for this story. In press releases, CEO Ludo Reynders talks about the new goal of becoming a CRO, which earns its money from fees charged to drug companies. That was the idea when aaiPharma was founded 26 years ago by an ambitious young scientist with an entrepreneurial bent. But he had wanted more, and in reaching for it, he lost control of his company, leaving it for others to pick up its pieces.

Frederick D. Sancilio now lives in Jupiter, Fla., where he has launched another CRO, Sancilio & Co. In an e-mail response to questions, he says he is eager to discuss what happened to aaiPharma but can't while it is tangled in lawsuits, a federal investigation and bankruptcy filings.

"There is," he writes, "so much to tell."

Sancilio, then 29, mortgaged most of what he owned to raise $175,000 to launch Applied Analytical Industries Inc. in 1979. He picked Wilmington because he liked the town and its location near the coast. He held master's and doctoral degrees in chemistry from Rutgers University in New Jersey and had worked as a research chemist for Nutley, N.J.-based Hoffmann-LaRoche. After supervising the chemical analysis of drugs at Kenilworth, N.J.-based Schering-Plough, he worked for London-based Burroughs Wellcome in Greenville, where he was responsible for quality control in research and development. He oversaw modernization of the company's labs and worked on regulatory issues.

Sancilio saw himself as more than a scientist. He was determined to use his knowledge and connections to start his own company. The idea was simple: Assemble experienced drug scientists in a lab, then lease the harnessed brainpower to companies that needed help with the complex work of perfecting and testing drugs and shepherding them through the U.S. Food and Drug Administration approval process. He struggled to nurture his shaky new business for about a year before he landed his first major outside investor: Waters.

Waters had founded a Milford, Mass.-based company called Waters Corp., which made scientific instruments such as spectrometers used to gather data about chemicals. Sancilio, a customer, had hired one of Waters' salesmen. Waters decided to invest in the new company, which had about a dozen employees, and...