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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004.
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO
____________.
COMMISSION FILE NO. 0-9036
LANNETT COMPANY, INC.
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
STATE OF DELAWARE 23-0787-699
(STATE OF INCORPORATION) (I.R.S. EMPLOYER I.D. NO.)
9000 STATE ROAD
PHILADELPHIA, PA 19136
(215) 333-9000
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND TELEPHONE NUMBER)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [X] NO [ ]
As of May 6, 2004, there were 24,074,335 shares of the issuer's common stock,
$.001 par value, outstanding.
Page 1 of 41 pages
Exhibit Index on Page 26
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Balance Sheets as of
March 31, 2004 (unaudited) and
June 30, 2003.................................................... 3
Consolidated Statements of Income (unaudited)
for the three and nine months ended March 31, 2004
and 2003 ........................................................ 4
Consolidated Statements of Changes in Shareholders' Equity
for the nine months ended March 31, 2004......................... 5
Consolidated Statements of Cash Flows (unaudited)
for the nine months ended March 31, 2004
and 2003 ........................................................ 6
Notes to Consolidated Financial
Statements ...................................................... 7 - 15
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations......................................................... 15 - 23
ITEM 4. Controls and Procedures............................................ 23
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings.................................................. 23 - 24
ITEM 2. Changes in Securities and Use of Proceeds.......................... 25
ITEM 3. Defaults upon Senior Securities.................................... 25
ITEM 4. Submission of Matters to a Vote of Security Holders................ 25
ITEM 5. Other Information.................................................. 25
ITEM 6. Exhibits and Reports on Form 8-K................................... 25
2
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
3/31/04 06/30/03
------------ ------------
ASSETS
CURRENT ASSETS:
Cash $ 7,919,190 $ 3,528,511
Trade accounts receivable (net of allowance of $115,000 and $128,000) 12,344,190 8,516,481
Inventories 10,312,357 8,175,798
Prepaid expenses 801,745 367,400
Deferred tax asset 569,858 569,858
------------ ------------
Total current assets 31,947,340 21,158,048
------------ ------------
PROPERTY, PLANT AND EQUIPMENT 12,727,123 11,885,728
Less accumulated depreciation (5,292,995) (4,477,928)
------------ ------------
7,434,128 7,407,800
------------ ------------
CONSTRUCTION IN PROGRESS 5,783,094 -
------------ ------------
OTHER ASSETS 494,660 496,696
------------ ------------
Total assets $ 45,659,222 $ 29,062,544
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 1,511,000 $ 718,333
Accounts payable 1,895,213 2,664,616
Accrued expenses 1,807,482 526,430
Income taxes payable 654,115 63,617
------------ ------------
Total current liabilities 5,867,810 3,972,996
------------ ------------
LONG-TERM DEBT, LESS CURRENT PORTION 6,267,787 2,379,469
------------ ------------
DEFERRED TAX LIABILITY 1,112,369 1,112,369
------------ ------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock -
authorized 50,000,000 shares par value $.001;
issued and outstanding, 20,071,840 shares and 20,025,871 shares, respectively 20,072 20,026
Additional paid-in capital 2,884,247 2,526,077
Retained earnings 29,506,937 19,051,607
------------ ------------
Total shareholders' equity 32,411,256 21,597,710
------------ ------------
Total liabilities and shareholders' equity $ 45,659,222 $ 29,062,544
============ ============
The accompanying notes to consolidated financial statements are an
integral part of these statements.
NOTE: ALL SHARE AMOUNTS HAVE BEEN RESTATED TO REFLECT A 3 FOR 2 STOCK SPLIT,
EFFECTIVE FEBRUARY 14, 2003.
3
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
---------------------------- ----------------------------
3/31/04 3/31/03 3/31/04 3/31/03
------------ ------------ ------------ ------------
NET SALES $ 16,000,251 $ 11,019,906 $ 45,795,638 $ 30,329,723
COST OF SALES 6,947,195 3,976,519 18,405,293 11,778,104
------------ ------------ ------------ ------------
Gross profit 9,053,056 7,043,387 27,390,345 18,551,619
RESEARCH AND DEVELOPMENT EXPENSES 1,361,681 682,869 3,500,759 1,668,876
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 2,276,780 1,067,551 6,179,980 3,223,709
------------ ------------ ------------ ------------
Operating profit 5,414,595 5,292,967 17,709,606 13,659,034
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Loss on sale of assets - (119,275) - (119,275)
Net interest income (expense) 1,632 (3,978) 3,920 (41,239)
------------ ------------ ------------ ------------
1,632 (123,253) 3,920 (160,514)
------------ ------------ ------------ ------------
INCOME BEFORE TAXES 5,416,227 5,169,714 17,713,526 13,498,520
INCOME TAXES 2,217,829 1,914,081 7,258,196 4,928,322
------------ ------------ ------------ ------------
NET INCOME $ 3,198,398 $ 3,255,633 $ 10,455,330 $ 8,570,198
============ ============ ============ ============
BASIC INCOME PER SHARE $ 0.16 $ 0.16 $ 0.52 $ 0.43
DILUTED INCOME PER SHARE $ 0.16 $ 0.16 $ 0.52 $ 0.43
BASIC WEIGHTED AVERAGE
NUMBER OF SHARES 20,058,753 19,985,031 20,049,647 19,948,870
DILUTED WEIGHTED AVERAGE
NUMBER OF SHARES 20,265,833 20,117,795 20,263,146 20,081,634
The accompanying notes to consolidated financial statements are an
integral part of these statements.
NOTE: ALL SHARE AMOUNTS HAVE BEEN RESTATED TO REFLECT A 3 FOR 2 STOCK SPLIT,
EFFECTIVE FEBRUARY 14, 2003.
4
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
COMMON STOCK ADDITIONAL
------------------------- PAID-IN RETAINED SHAREHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS EQUITY
---------- ----------- ----------- ----------- -------------
BALANCE, JUNE 30, 2003 20,025,871 $ 20,026 $ 2,526,077 $19,051,607 $ 21,597,710
Exercise of stock options 36,492 37 231,797 231,834
Shares issued in connection
with employee stock purchase plan 9,477 9 126,373 126,382
Net Income 10,455,330 10,455,330
---------- ----------- ----------- ----------- -------------
BALANCE, MARCH 31, 2004 20,071,840 $ 20,072 $ 2,884,247 $29,506,937 $ 32,411,256
========== =========== =========== =========== =============
The accompanying notes to consolidated financial statements are an
integral part of these statements.
NOTE: ALL SHARE AMOUNTS HAVE BEEN RESTATED TO REFLECT A 3 FOR 2 STOCK SPLIT,
EFFECTIVE FEBRUARY 14, 2003.
5
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED
----------------------------
3/31/04 3/31/03
------------ ------------
OPERATING ACTIVITIES:
Net income $ 10,455,330 $ 8,570,198
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 815,067 742,449
Loss on sale/disposal of assets - 119,275
Changes in assets and liabilities which provided/(used) cash:
Trade accounts receivable (3,827,709) (4,002,378)
Inventories (2,136,559) (1,860,372)
Prepaid expenses and other assets (90,909) (269,679)
Accounts payable (769,403) 694,564
Accrued expenses 1,281,052 (283,136)
Income taxes payable 590,498 (171,740)
------------ ------------
Net cash provided by operating activities 6,317,367 3,539,181
------------ ------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (including construction in progress) (6,624,489) (1,704,102)
Deposits paid on machinery or building additions not placed in service (341,400) (456,872)
Proceeds from sale of property, plant and equipment - 375,003
------------ ------------
Net cash used in investing activities (6,965,889) (1,785,971)
------------ ------------
FINANCING ACTIVITIES:
Proceeds from debt financing 5,355,574 -
Net repayments under line of credit - (202,688)
Repayments of debt (674,589) (609,715)
Proceeds from issuance of stock 358,216 165,667
------------ ------------
Net cash provided by (used in) financing activities 5,039,201 (646,736)
------------ ------------
NET INCREASE IN CASH 4,390,679 1,106,474
CASH, BEGINNING OF YEAR 3,528,511 -
------------ ------------
CASH, END OF PERIOD $ 7,919,190 $ 1,106,474
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid during period $ 28,999 $ 41,239
Income taxes paid during period $ 6,667,698 $ 5,100,062
The accompanying notes to consolidated financial statements are an
integral part of these statements.
6
LANNETT COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the
accounts of the operating parent company, Lannett Company, Inc., its inactive
wholly owned subsidiary, Astrochem Corporation and its wholly owned subsidiary,
Lannett Holdings, Inc. All intercompany accounts and transactions have been
eliminated.
REVENUE RECOGNITION - The Company recognizes revenue when its products are
shipped. At this point, title and risk of loss have transferred to the customer,
and provisions for estimates, including rebates, promotional adjustments, price
adjustments, returns, chargebacks, and other potential adjustments are
reasonably determinable. Accruals for these provisions are presented in the
Consolidated Financial Statements as reductions to net sales and accounts
receivable. Accounts receivable are presented net of allowances relating to
these provisions, which were approximately $3,800,000 and $2,772,000 at March
31, 2004 and June 30, 2003, respectively. Provisions for estimated rebates,
promotional and other credits are estimated based on historical payment
experience, estimated customer inventory levels and contract terms. Provisions
for other customer credits, such as price adjustments, returns and chargebacks
require management to make subjective judgments. These provisions are discussed
in further detail below. If the historical data the Company uses, and the
assumptions management makes to calculate these estimates do not accurately
approximate future activity, its net sales, gross profit, net income and
earnings per share could change. However, management believes that these
estimates are reasonable based upon historical experience and current
conditions.
CHARGEBACKS - The provision for chargebacks is the most significant and complex
estimate used in the recognition of revenue. The Company sells its products
directly to wholesale distributors, generic distributors, retail pharmacy chains
and mail-order wholesalers. The Company also sells its products indirectly to
independent pharmacies, managed care organizations, hospitals, nursing homes and
group purchasing organizations, collectively referred to as "indirect
customers." Lannett enters into agreements with its indirect customers to
establish pricing for certain products. The indirect customers then
independently select a wholesaler from which to actually purchase the products
at these agreed-upon prices. Lannett will provide credit to the wholesaler for
the difference between the agreed-upon price with the indirect customer and the
wholesaler's invoice price. This credit is called a chargeback. The provision
for chargebacks is based on expected sell-through levels by the Company's
wholesale customers to the indirect customers, and estimated wholesaler
inventory levels. The Company continually monitors the reserve for chargebacks
and makes adjustments when it believes that actual chargebacks may differ from
estimated reserves.
REBATES - Rebates are offered to the Company's key customers to promote customer
loyalty and encourage greater product sales. These rebate programs provide
customers with rebate credits upon attainment of pre-established volumes or
attainment of net sales milestones for a specified period. Other promotional
programs are incentive programs offered to the customers. At the time of
shipment, the Company estimates reserves for rebates and other promotional
credit programs based on the specific terms in each agreement.
RETURNS - Consistent with industry practice, the Company has a product returns
policy that allows select customers to return product within a specified period
prior to and subsequent to the product's lot expiration date, in exchange for a
credit to be applied to future purchases. The Company's policy requires that the
customer obtain pre-approval from the Company for any qualifying return. The
Company estimates its provision for returns based on historical experience,
changes to business practices and credit terms. While such experience has
7
allowed for reasonable estimations in the past, history may not always be an
accurate indicator of future returns. The Company continually monitors the
provisions for returns, and makes adjustments when it believes that actual
product returns may differ from established reserves.
PRICE ADJUSTMENTS - Price adjustments, also known as "shelf stock adjustments,"
are credits issued to reflect decreases in the selling prices of the Company's
products that customers have remaining in their inventories at the time of the
price reduction. Decreases in selling prices are discretionary decisions made by
management to reflect competitive market conditions. Amounts recorded for
estimated shelf stock adjustments are based upon specified terms with direct
customers, estimated declines in market prices and estimates of inventory held
by customers. The Company regularly monitors these and other factors and
evaluates the reserve as additional information becomes available.
INVENTORIES - Inventories are valued at the lower of cost (determined under the
first-in, first-out method) or market.
PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment are stated at
cost. Depreciation and amortization are provided for by the straight-line and
accelerated methods over estimated useful lives of the assets. Depreciation
expense for the nine month periods ended March 31, 2004 and 2003 were
approximately $815,000 and $710,000, respectively.
DEFERRED DEBT ACQUISITION COSTS - Costs incurred in connection with obtaining
financing are amortized by the straight-line method over the term of the loan
arrangements. Amortization expense for the nine month periods ended March 31,
2004 and 2003 were approximately $8,000 and $32,000, respectively.
RESEARCH AND DEVELOPMENT - Research and development expenses are charged to
operations as incurred.
ADVERTISING COSTS - The Company charges advertising costs to operations as
incurred. Advertising expense for the nine month periods ended March 31, 2004
and 2003 were approximately $204,000 and $102,000, respectively.
INCOME TAXES - The Company uses the liability method specified by Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes.
Deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities as
measured by the enacted tax rates which will be in effect when these differences
reverse. Deferred tax expense/(benefit) is the result of changes in deferred tax
assets and liabilities.
SEGMENT INFORMATION - The Company reports segment information in accordance with
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information. The Company operates one business segment--generic pharmaceuticals.
In accordance with SFAS No. 131, the Company aggregates its financial
information for all products, and reports on one operating segment.
CONCENTRATION OF CREDIT RISK - Five of the Company's products, defined as
generics containing the same active ingredient or combination of ingredients,
accounted for approximately 30%, 25%, 17%, 14% and 11%, respectively, of net
sales for the nine month period ended March 31, 2004. The same five products
accounted for 35%, 0%, 34%, 13% and 12%, respectively, of net sales for the nine
month period ended March 31, 2003. The Company expects these percentages to
decrease as it continues to market additional products.
Credit terms are offered to customers based on evaluations of the customers'
financial condition. Generally, collateral is not required from customers.
Accounts receivable payment terms vary, and are stated in the financial
8
statements at amounts due from customers net of an allowance for doubtful
accounts. Accounts outstanding longer than the payment terms are considered past
due. The Company determines its allowance by considering a number of factors,
including the length of time trade accounts receivable are past due, the
Company's previous loss history, the customer's current ability to pay its
obligation to the Company, and the condition of the general economy and the
industry as a whole. The Company writes-off accounts receivable when they become
uncollectible, and payments subsequently received on such receivables are
credited to the allowance for doubtful accounts.
STOCK OPTIONS - At March 31, 2004, the Company had two stock-based employee
compensation plans. The Company accounts for stock options under SFAS No. 123,
"Accounting for Stock-Based Compensation," as amended by SFAS No. 148. Under
this statement, companies may use a fair value-based method for valuing
stock-based compensation, which measures compensation cost at the grant date,
based on the fair value of the award. Compensation is then recognized over the
service period, which is usually the vesting period. Alternatively, SFAS No. 123
permits entities to continue accounting for employee stock options and similar
equity instruments under Accounting Principles Board (APB) Opinion 25,
"Accounting for Stock Issued to Employees." Entities that continue to account
for stock options using APB Opinion 25 are required to make pro forma
disclosures of net income and earnings per share, as if the fair value-based
method of accounting defined in SFAS No.123 had been applied. The following
table illustrates the effect on net income and earnings per share if the Company
had applied the fair value recognition provisions of SFAS No. 123 to stock-based
employee compensation.
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------------- --------------------------------
3/31/04 3/31/03 3/31/04 3/31/03
-------------- -------------- -------------- --------------
Net income, as reported $ 3,198,398 $ 3,255,633 $ 10,455,330 $ 8,570,198
Deduct: Total compensation expense
determined under fair value based
method for all stock awards (307,847) (134,757) (842,186) (404,271)
Add: Tax savings at effective rate 126,091 49,894 345,120 147,600
-------------- -------------- -------------- --------------
Pro forma net income 3,016,642 3,170,770 9,958,264 8,313,527
============== ============== ============== ==============
Earnings per share:
Basic, as reported $ .16 $ .16 $ .52 $ .43
Basic, pro forma $ .15 $ .16 $ .50 $ .42
Diluted, as reported $ .16 $ .16 $ .52 $ .43
Diluted, pro forma $ .15 $ .16 $ .49 $ .41
NOTE: ALL SHARE AMOUNTS HAVE BEEN RESTATED TO REFLECT A 3 FOR 2 STOCK SPLIT,
EFFECTIVE FEBRUARY 14, 2003.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes options pricing model with the following weighted average
assumptions used for grants in 2004 and 2003: expected volatility of 53.1% and
79.5%; risk-free interest rates ranging between 4.47% and 4.52% for 2004 and
3.89% for 2003, and expected lives of 10 years.
USE OF ESTIMATES - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the
9
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
In the opinion of management, the accompanying unaudited consolidated financial
statements contain all adjustments (consisting of only normal recurring
adjustments) necessary to present fairly the financial position and the results
of operations and cash flows.
The results of operations for the three and nine months ended March 31, 2004 and
2003 are not necessarily indicative of results for the full year.
While the Company believes that the disclosures presented are adequate to make
the information not misleading, it is suggested that these consolidated
financial statements be read in conjunction with the consolidated financial
statements and the notes included in the Company's Annual Report on Form 10-KSB
for the year ended June 30, 2003.
NOTE 2. NEW ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). In general, a variable interest entity is a
corporation, partnership, trust or any other legal structure used for business
purposes that either (a) does not have equity investors with voting rights or
(b) has equity investors that do not provide sufficient financial resources for
the entity to support its activities. FIN 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if the
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
from other parties. The consolidation requirements of FIN 46 apply immediately
to variable interest entities created after January 31, 2003. The Company
adopted the provisions of FIN 46 effective February 1, 2003 and such adoption
did not have a material impact on the Company's consolidated financial
statements since the Company currently has no variable interest entities.
In December 2003, the FASB issued FIN 46R with respect to variable interest
entities created before January 31, 2003, which among other things , revised the
implementation date to the first fiscal year or interim period ending after
March 15, 2004, with the exception of Special Purpose Entities (SPE). The
consolidation requirements apply to all SPE's in the first fiscal year or
interim period ending after December 15, 2003. The Company adopted the
provisions of FIN 46R effective December 31, 2003 and such adoption did not have
a material impact on the Company's consolidated financial statements since the
Company currently has no SPE's.
On May 15, 2003, the FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. Most
of the guidance in SFAS 150 is effective for all financial instruments entered
into or modified after May, 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have a material effect on the Company's
consolidated financial position, results of operations or cash flows.
NOTE 3. INVENTORIES
Inventories consist of the following:
10
March 31, June 30,
2004 2003
----------- -----------
(unaudited)
Raw materials $ 4,342,128 $ 2,625,463
Work-in-process 777,510 992,330
Finished goods 4,999,655 4,363,432
Packaging supplies 193,064 194,573
----------- -----------
$10,312,357 $ 8,175,798
=========== ===========
The preceding amounts are net of inventory reserves of $494,731 and $235,246 at
March 31, 2004 and June 30, 2003 respectively.
NOTE 4. LONG-TERM DEBT
Long-Term debt consists of the following
March 31, June 30,
2004 2003
---------- ----------
unaudited)
Tax-exempt Bond Loan $2,487,287 $3,097,802
Mortgage Loan 2,700,000 -
Equipment Loan 1,641,500 -
Construction Loan 950,000 -
---------- ----------
$7,778,787 $3,097,802
Less current portion 1,511,000 718,333
---------- ----------
$6,267,787 $2,379,469
========== ==========
In April 1999, the Company entered into a loan agreement (the "Agreement")
with a governmental authority, the Philadelphia Authority for Industrial
Development (the "Authority") to finance future construction and growth projects
of the Company. The Authority issued $3,700,000 in tax-exempt variable rate
demand and fixed rate revenue bonds to provide the funds to finance such growth
projects pursuant to a trust indenture ("the "Trust indenture"). A portion of
the Company's proceeds from the bonds was used to pay for bond issuance costs of
approximately $170,000. The remainder of the proceeds was deposited into a money
market account, which was restricted for future plant and equipment needs of the
Company, as specified in the Agreement. The Trust Indenture requires that the
Company repay the Authority loan through installment payments beginning in May
2003 and continuing through May 2014, the year the bonds mature. The bonds bear
interest at the floating variable rate determined by the organization
responsible for selling the bonds (the "remarketing agent"). The interest rate
fluctuates on a weekly basis. The effective interest rate at March 31, 2004 was
1.21%. At March 31, 2004, the Company has $2,487,287 outstanding on the
Authority loan, of which $816,000 is classified as currently due. The remainder
is classified as a long-term liability. In April 1999, an irrevocable letter of
credit of $3,770,000 was issued by a bank, Wachovia Bank, National Association
(Wachovia), to secure payment of the Authority Loan and a portion of the related
accrued interest. At March 31, 2004, no portion of the letter of credit has been
utilized
On November 26, 2003, the Company exercised its option to purchase the
facility at 9001 Torresdale Avenue. The purchase price of the facility was
approximately $1.9 million. The Company has entered into agreements (the "2003
Loan Financing") with Wachovia to finance the purchase of the building, the
renovation and setup of the building, and the Company's other anticipated
capital expenditures for Fiscal 2004, including the implementation of its new
Enterprise Resource Planning (ERP) system, and a new fluid bed drying process
center at its current manufacturing plant at 9000 State Road. The 2003 Loan
Financing includes the following:
11
1) A Mortgage Loan of $2.7 million, used to finance the purchase of the
Torresdale Avenue facility, and certain renovations at the facility.
2) An Equipment Loan for up to $6 million, which will be used to
finance equipment, the ERP system implementation and other capital
expenditures.
3) A Construction Loan for $1 million, used to finance the construction
and fit up of the fluid bed drying process center, which is adjacent
to the Company's current manufacturing plant at 9000 State Road.
From November 26, 2003 to the earlier of November 26, 2004 or the date
that the Philadelphia Industrial Development Corporation lends the Company up to
$1,250,000 as reimbursement for a portion of the acquisition cost of the
facility (the "Conversion Date"), the Company is required to make interest only
payments on the Mortgage Loan. Commencing on the first day of the month
following the Conversion Date, the Company is required to make monthly payments
of principal and interest in amounts sufficient to fully amortize the principal
balance of the Mortgage Loan 15 years after the Conversion Date. The entire
outstanding principal amount of this mortgage loan, along with any accrued
interest, shall be due no later than 15 years from the date of the Conversion
Date. As of March 31, 2004, the Company has a principal balance of $2.7 million
under the Mortgage Loan.
The Equipment Loan is a non-revolving facility in which the Company will
borrow the funds necessary to finance its capital expenditures. Under the
Equipment Loan, the Company will request Wachovia to reimburse a portion of the
cost incurred to acquire and setup the equipment. The amount advanced to the
Company under the Equipment Loan is limited to no more than 80% of the cost of
such equipment. Each advance under the Equipment Loan will immediately convert
to a term loan with a maturity date of three to five years, depending on the
classification of the equipment acquired. During the term loan, the Company is
required to make equal payments of principal and interest. As of March 31, 2004,
the Company has outstanding $1,641,500 under the Equipment Loan of which
$495,000 is classified as currently due.
Under the Construction Loan, the Company is required to make equal monthly
payments of principal and interest beginning on January 1, 2004 and ending on
November 30, 2008, the maturity date of the loan. As of March 31, 2004, the
Company has outstanding $950,000 under the Construction Loan of which $200,000
is classified as currently due.
The financing facilities under the 2003 Loan Financing bear interest at a
variable rate equal to the LIBOR Rate plus 150 basis points. The LIBOR Rate is
the rate per annum, based on a 30-day interest period, quoted two business days
prior to the first day of such interest period for the offering by leading banks
in the London interbank market of Dollar deposits. As of March 31, 2004, the
interest rate for the 2003 Loan Financing was 2.5962%.
The Company has executed a Security Agreement with Wachovia in which the
Company has agreed to use substantially all of its assets to collateralize the
amounts due to Wachovia under the 2003 Loan Financing.
The Company also has a $3,000,000 line of credit from Wachovia that bears
interest at the prime interest rate less 0.25%. The line of credit was renewed
and extended to November 30, 2004, at which time the Company expects to renew
and extend the due date. At March 31, 2004, the Company had $0 outstanding and
$3,000,000 available under the line of credit. The Company does not currently
expect to borrow cash under this line of credit in the future due to the
available cash on hand, and the cash expected to be provided by its results of
operations in the future. The line of credit is collateralized by substantially
all Company assets.
The terms of the line of credit, the Agreement, the related letter of
credit and the 2003 Loan Financing require that the Company meet certain
financial covenants and reporting standards, including the attainment of
standard financial liquidity and net worth ratios. As of March 31, 2004, the
Company has complied with such terms, and successfully met its financial
covenants. Additionally, it is the Company's opinion that such covenants are not
material in nature.
12
NOTE 5. INCOME TAXES
The provision for federal, state and local income taxes for the three months
ended March 31, 2004 and 2003 was $2,217,829 and $1,914,081, with effective tax
rates of 40.9% and 37.0%, respectively. The provision for federal, state and
local income taxes for the nine months ended March 31, 2004 and 2003 was
$7,258,196 and $4,928,322, with effective tax rates of 40.9% and 36.5%,
respectively.
NOTE 6. EARNINGS PER SHARE
SFAS No. 128, Earnings Per Share, requires a dual presentation of basic
and diluted earnings per share on the face of the Company's consolidated
statement of income and a reconciliation of the computation of basic earnings
per share to diluted earnings per share. Basic earnings per share excludes the
dilutive impact of common stock equivalents and is computed by dividing net
income by the weighted-average number of shares of common stock outstanding for
the period. Diluted earnings per share includes the effect of potential dilution
from the exercise of outstanding common stock equivalents into common stock
using the treasury stock method. Earnings per share amounts for all periods
presented have been calculated in accordance with the requirements of SFAS No.
128. A reconciliation of the Company's basic and diluted earnings per share
follows:
THREE MONTHS ENDED MARCH 31,
2004 2003
-------------------------- --------------------------
NET INCOME SHARES NET INCOME SHARES
(NUMERATOR) (DENOMINATOR) (NUMERATOR) (DENOMINATOR)
Basic earnings per share factors $ 3,198,398 20,058,753 $ 3,255,633 19,985,031
Effect of dilutive stock options 207,080 132,764
----------- ------------- ----------- -------------
Diluted earnings per share factors $ 3,198,398 20,265,833 $ 3,255,633 20,117,795
=========== ============= =========== =============
Basic earnings per share $ 0.16 $ 0.16
Diluted earnings per share $ 0.16 $ 0.16
The number of shares in the prior period have been adjusted for the Company's 3
for 2 stock split in February 2003.
13
NINE MONTHS ENDED MARCH 31,
2004 2003
-------------------------- --------------------------
NET INCOME SHARES NET INCOME SHARES
(NUMERATOR) (DENOMINATOR) (NUMERATOR) (DENOMINATOR)
Basic earnings per share factors $10,455,330 20,049,647 $ 8,570,198 19,948,870
Effect of dilutive stock options 213,499 132,764
----------- ------------- ----------- -------------
Diluted earnings per share factors $10,455,330 20,263,146 $ 8,570,198 20,081,634
=========== ============= =========== =============
Basic earnings per share $ 0.52 $ 0.43
Diluted earnings per share $ 0.52 $ 0.43
The number of shares in the prior period have been adjusted for the Company's 3
for 2 stock split in February 2003.
178,500 and 40,815 anti-dilutive weighted average shares have been excluded in
the computation of diluted earnings per share for the three months ended March
31, 2004 and 2003, respectively, because the options' exercise price is greater
than the average market price of the common stock. 7,500 and 40,815
anti-dilutive weighted average shares have been excluded in the computation of
diluted earnings per share for the nine months ended March 31, 2004 and 2003,
respectively, because the options' exercise price is greater than the average
market price of the common stock.
NOTE 7. RELATED PARTY TRANSACTIONS
The Company had sales of approximately $455,617 and $236,000 during the
nine months ended March 31, 2004 and 2003, respectively, to a distributor (the
"related party"), in which the owner, Jeffrey Farber, is the son of the Chairman
of the Board of Directors and principal shareholder of the Company, William
Farber. The Company also incurred sales commissions payable to the related party
of $0 and approximately $68,000 during the nine months ended March 31, 2004 and
2003, respectively. Accounts receivable includes amounts due from the related
party of approximately $99,840 and $95,000 at March 31, 2004 and June 30, 2003,
respectively. In the Company's opinion, the terms of these transactions were not
more favorable to the related party than would have been to a non-related party.
Stuart Novick, the son of Marvin Novick, a Director on the Company's Board
of Directors, was employed by two insurance brokerage companies (the "Insurance
Companies") that provide insurance agency services to the Company. The Company
paid approximately $344,000 and $224,000 during the nine months ended March 31,
2004 and 2003 to the Insurance Companies for various insurance coverage
policies. There were no amounts due to the Insurance Companies as of March 31,
2004 and June 30, 2003. In the Company's opinion, the terms of these
transactions were not more favorable to the related party than would have been
to a non-related party.
NOTE 8. MATERIAL CONTRACT WITH SUPPLIER
On March 23, 2004, the Company entered into an agreement with Jerome
Stevens Pharmaceuticals,, Inc. (JSP) for the exclusive distribution rights in
the United States to the current line of JSP products, in exchange for four
million (4,000,000) shares of the Company's common stock. According to the
agreement, which has a term of ten years, JSP will supply the Company with
Butalbital with Aspirin, Caffeine and Codeine Phosphate capsules ("BACC"),
Digoxin tablets ("Digoxin") and Levothyroxine Sodium tablets, sold under the
generic name and the brand name "Unithroid" ("Levothyroxine"). The Agreement was
included as an Exhibit in the Form 8-K filed by the Company on May 5, 2004. The
obligation of the Company to issue the four million (4,000,000) shares
14
was subject to the receipt of a fairness opinion issued by a recognized and
reputable investment banking firm in opining that the issuance of the four
million (4,000,000) shares and the resulting dilution of the ownership interest
of the Company's minority shareholders was fair to such shareholders in view of
JSP's products' contribution or potential contribution to the Company's
profitability. On April 20, 2004, the investment banker, which was selected by
the independent Directors of the Company's Board, opined that the issuance of
the four million (4,000,000) shares and the resulting dilution of the ownership
interest of the Company's minority shareholders was fair to such shareholders in
view of JSP's Products' contribution or potential contribution to the Company's
profitability. As such, subsequent to April 20, 2004, the Company issued four
million (4,000,000) shares to JSP's designees.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
INTRODUCTION
The following information should be read in conjunction with the
consolidated financial statements and notes in Part I, Item 1 of this Quarterly
Report and with Management's Discussion and Analysis of Financial Condition and
Results of Operations contained in the Company's Annual Report on Form 10-KSB
for the fiscal year ended June 30, 2003.
In addition to historical information, this Form 10-Q contains
forward-looking information. The forward-looking information contained herein is
subject to certain risks and uncertainties that could cause actual results to
differ materially from those projected in the forward-looking statements.
Important factors that might cause such a difference include, but are not
limited to, those discussed in the following section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's analysis only as of the date of this Form
10-Q. The Company undertakes no obligation to publicly revise or update these
forward-looking statements to reflect events or circumstances which arise later.
Readers should carefully review the risk factors described in other documents
the Corporation files from time to time with the Securities and Exchange
Commission, including the Annual report on Form 10-KSB filed by the Company in
Fiscal 2003, and any Current Reports on Form 8-K filed by the Company.
In addition to the risks and uncertainties posed generally by the
generic drug industry, the Company faces the following risks and uncertainties:
- competition from other manufacturers of generic drugs;
- potential declines in revenues and profits from individual generic
pharmaceutical products due to competitors' introductions of their
own generic equivalents;
- new products or treatments by other manufacturers that could render
the Company's products obsolete;
- the value of the Company's common stock has fluctuated widely in the
past, which could lead to investment losses for shareholders;
- intense regulation by government agencies may delay the Company's
efforts to commercialize new drug products; and
15
- dependence on third parties to supply raw materials and certain
finished goods inventory; any failure to obtain a sufficient supply
of raw materials from these suppliers could materially and adversely
affect the Company's business.
Because of the foregoing and other factors, the Company may
experience material fluctuations in future operating results on a quarterly or
annual basis which could materially adversely affect the business, financial
condition, operating results and the Company's stock price.
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are more fully
described in Note 1 to the consolidated financial statements included in this
Quarterly Report and in Note 1 to the consolidated financial statements included
in the Company's Annual Report on Form 10-KSB for the year ended June 30, 2003,
filed with the Securities and Exchange Commission. Certain accounting policies
are particularly important to the portrayal of the Company's financial position
and results of operations and require the application of significant judgment by
management. As a result, these policies are subject to an inherent degree of
uncertainty. In applying these policies, management makes estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosures. The Company bases its estimates and judgments
on historical experience, terms of existing contracts, observance of trends in
the industry, information received from customers and outside sources, and on
various other assumptions that management believes to be reasonable and
appropriate under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
Our critical accounting policies, including inventory valuation,
revenue recognition, accounts receivable allowances for chargebacks, rebates,
and similar items, and income taxes are each discussed in more detail in our
Annual Report on Form 10-KSB for the year ended June 30, 2003. The Company has
reviewed and determined that those policies remain the Company's critical
accounting policies as of and for the nine months ended March 31, 2004. The
Company did not make any changes in those policies during the period.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2004 COMPARED
WITH THREE MONTHS ENDED MARCH 31, 2003.
Net sales increased by 45% from $11,019,906 for the three months
ended March 31, 2003 ("Third Quarter Fiscal 2003") to $16,000,251 for the three
months ended March 31, 2004 ("Third Quarter Fiscal 2004"). Sales increased as a
result of additions to the Company's prescription line of products, including,
Levothyroxine Sodium tablets, first marketed in April 2003 and Unithroid
tablets, first marketed in August 2003. These product additions had the effect
of increasing the total net sales in the Third Quarter Fiscal 2004, compared to
the Third Quarter Fiscal 2003, due to the fact that the Company sold the
products for longer periods of time in the Third Quarter Fiscal 2004, compared
to the Third Quarter Fiscal 2003. These product additions accounted for
approximately $3.4 million of the increase in net sales from the Third Quarter
Fiscal 2003 to the Third Quarter Fiscal 2004. Additionally, sales of a portion
of the Company's previously marketed products, including Butalbital with
Aspirin, Caffeine and Codeine Phosphate capsules and Digoxin tablets increased
due to new customer accounts and increased unit sales.
Cost of sales increased by 75% from $3,976,519 for the Third Quarter
Fiscal 2003 to $6,947,195 for the Third Quarter Fiscal 2004. The cost of sales
increase is due to an increase in direct variable costs and certain
16
indirect overhead costs as a result of the increase in sales volume, and related
production activities. These costs include raw materials/cost of finished goods
purchased and resold, which increased by approximately $2,305,000, labor and
benefit expenses, which increased by approximately $333,000 and other
miscellaneous production expenses, which comprised the remainder of the increase
in cost of sales. Gross profit margins for the Third Quarter Fiscal 2004 and the
Third Quarter Fiscal 2003 were 57% and 64%, respectively. The decrease in the
gross profit percentage is due to product sales mix and decreased absorption of
fixed overhead costs. During the Third Quarter Fiscal 2004, a larger percentage
of the Company's total net sales were of JSP-manufactured products, as compared
to the Third Quarter Fiscal 2003. The Company's average gross profit margin for
the JSP products are less than the average gross profit margin for products
internally manufactured. As such, the change in product sales mix reduced the
gross profit percentage in the Third Quarter Fiscal 2004. Depending on future
market conditions for each of the Company's products, changes in the future
sales product mix may occur. These changes may affect the gross profit
percentage in future periods.
Research and development ("R&D") expenses increased by 99% from
$682,869 for the Third Quarter Fiscal 2003 to $1,361,681 for the Third Quarter
Fiscal 2004. This increase is a result of an increase in the number of chemists
in the R&D laboratory and the related payroll and benefits expenses, which
increased by approximately $325,000 and an increase in raw materials (of
$150,000) and clinical testing fees (of $205,000) for products not yet approved
by the FDA.
Selling, general and administrative expenses increased by 113% from
$1,067,551 for the Third Quarter Fiscal 2003 to $2,276,780 for the Third Quarter
Fiscal 2004. This increase is a result of an increase in the following expenses:
payroll/incentive compensation and benefits, which increased by approximately
$763,000, consulting expenses, which increased by approximately $120,000, legal
expenses, which increased by approximately $85,000 and miscellaneous other
expenses, including computer support costs, travel and entertainment expenses,
investor relations expenses, employee recruitment fees and advertising. Such
miscellaneous expenses comprised the remainder of the increase in selling,
general and administrative expenses. The increases were due to the hiring of
additional administrative employees and a general increase in administrative
expenses due to the growth of the Company in terms of employees, production
volume and sales.
As a result of the foregoing, the Company increased its operating
profit from $5,292,967 in Third Quarter Fiscal 2003 to $5,414,595 in Third
Quarter Fiscal 2004.
The Company's net interest decreased from net interest expense of
$3,978 for the Third Quarter Fiscal 2003 to net interest income of $1,632 for
the Third Quarter Fiscal 2004 as a result of principal repayments, reduced
interest rates and increased interest income due to higher cash balances. See
Liquidity and Capital Resources below.
The Company's income tax expense increased from $1,914,081 in the
Third Quarter Fiscal 2003 to $2,217,829 in the Third Quarter Fiscal 2004 as a
result of the increase in income before taxes and an increase in the effective
tax rates. The effective tax rate increased from 37.0% to 40.9% due to the
company's increased activities in higher statutory jurisdictions.
The Company reported net income of $3,198,398 in the Third Quarter
Fiscal 2004, or $0.16 basic and diluted income per share, compared to net income
of $3,255,633 in the Third Quarter Fiscal 2003, or $0.16 basic and diluted
income per share.
RESULTS OF OPERATIONS - NINE MONTHS ENDED MARCH 31, 2004 COMPARED
WITH NINE MONTHS ENDED MARCH 31, 2003.
17
Net sales increased by 51% from $30,329,723 for the nine months
ended March 31, 2003 to $45,795,638 for the nine months ended March 31, 2004.
Sales increased as a result of additions to the Company's prescription line of
products, including Digoxin tablets, first marketed in September 2002,
Levothyroxine Sodium tablets, first marketed in April 2003 and Unithroid
tablets, first marketed in August 2003. These product additions had the effect
of increasing the total net sales in the nine months ended March 31, 2004,
compared to the nine months ended March 31, 2003, due to the fact that the
Company sold the products for longer periods of time in the nine months ended
March 31, 2004, compared to the nine months ended March 31, 2003. These product
additions accounted for approximately $14.0 million of the increase in net sales
from the nine months ended March 31, 2003 to the nine months ended March 31,
2004. Additionally, sales of a portion of the Company's previously marketed
products, including Primidone tablets, increased due to new customer accounts,
increased unit sales, and increased unit sales prices. The Company raised its
sales prices for Primidone 50 milligram tablets in Fiscal 2004 subsequent to an
increase in the price of the brand named drug. Generally, the Company sells its
products at the accepted market prices for such products. If the competitive
environment changes, the Company monitors such changes to determine the effect
on the market prices for its products. Such changes may include new competitors,
fewer competitors, or an increase in the price of the innovator drug. The
increase in sales of a portion of the Company's products was partially offset by
a decrease in sales of certain other products, including butalbital, aspirin and
caffeine capsules (which decreased by $2.4 million) due to increased competition
and a discontinuation of pseudoephedrine hydrochloride tablets (which decreased
by $681,000).
Cost of sales increased by 56% from $11,778,104 for the nine months
ended March 31, 2003 to $18,405,293 for the nine months ended March 31, 2004.
The cost of sales increase is due to an increase in direct variable costs and
certain indirect overhead costs as a result of the increase in sales volume, and
related production activities. These costs include raw materials/cost of
finished goods purchased and resold, which increased by approximately
$5,096,000, labor and benefits expenses, which increased by approximately
$1,126,000, depreciation expense, which increased by approximately $728,000 and
other miscellaneous production-related expenses, which increased in total by
approximately $803,000. Gross profit margins for the nine months ended March 31,
2004 and 2003 were 60% and 61%, respectively. The decrease in the gross profit
percentage is due to product sales mix and decreased absorption of fixed
overhead costs.
Research and development ("R&D") expenses increased by 110% from
$1,668,876 for the nine months ended March 31, 2003 to $3,500,759 for the nine
months ended March 31, 2004. This increase is a result of an increase in the
number of chemists in the R&D laboratory and the related payroll and benefits
expenses, which increased by approximately $949,000 and an increase in raw
materials (of $194,000) and clinical testing fees (of $727,000) for products not
yet approved by the FDA. These increases were partially offset by a decrease in
miscellaneous other R&D expenses of approximately $38,000.
Selling, general and administrative expenses increased by 92% from
$3,223,709 for the nine months ended March 31, 2003 to $6,179,980 for the nine
months ended March 31, 2004. This increase is a result of an increase in the
following expenses: payroll/incentive compensation and benefits, which increased
by approximately $2.1 million, consulting services, which increased by
approximately $165,000, legal expenses, which increased by approximately
$109,000, computer support costs, which increased by approximately $147,000,
advertising expenses, which increased by approximately $104,000 and
miscellaneous other expenses, including travel and entertainment expenses,
investor relations expenses, employee recruitment fees. Such miscellaneous
expenses comprised the remainder of the increase in selling, general and
administrative expenses. The increases were due to the hiring of additional
administrative employees and a general increase in administrative expenses due
to the growth of the Company in terms of employees, production volume and sales.
As a result of the foregoing, the Company increased its operating
profit from $13,659,034 for the nine months ended March 31, 2003 to $17,709,606
for the nine months ended March 31, 2004.
18
The Company's net interest decreased from net interest expense of
$41,239 for the nine months ended March 31, 2003 to net interest income of
$3,920 for the nine months ended March 31, 2004 as a result of principal
repayments, reduced interest rates and increased interest income due to higher
cash balances. See Liquidity and Capital Resources below.
The Company's income tax expense increased from $4,928,322 for the
nine months ended March 31, 2003 to $7,258,196 for the nine months ended March
31, 2004 as a result of the increase in income before taxes and an increase in
the effective tax rate. The effective tax rate increased from 36.5% to 40.9% due
to the company's increased activities in higher statutory jurisdictions.
The Company reported net income of $10,455,330 for the nine months
ended March 31, 2004, or $0.52 basic and diluted income per share, compared to
net income of $8,570,198 for the nine months ended March 31, 2003, or $0.43
basic and diluted income per share.
LIQUIDITY AND CAPITAL RESOURCES -
Net cash provided by operating activities of $6,317,367 for the nine
months ended March 31, 2004 was attributable to net income of $10,455,330, as
adjusted for the effects of non-cash items of $815,067 and net changes in
operating assets and liabilities totaling ($4,953,030). Significant changes in
operating assets and liabilities are comprised of:
1. An increase in trade accounts receivable of $3,827,709 due to
the increase in sales for the nine months ended March 31,
2004. The Company generally offers credit payment terms to its
current and prospective customers.
2. An increase in inventories of $2,136,559 due to an increase in
raw materials and finished goods inventory. Due to the
Company's sales growth and the increase in the quantity of new
products under development, additional investments were made
in raw material and finished goods inventory. It is the
Company's goal to stock an adequate inventory of finished
goods and raw materials. Such a strategy will allow the
Company to minimize stock-outs and back-orders, and to provide
a high level of customer order fulfillment. Additionally, the
Company has increased its inventory carrying amounts of
certain raw materials and finished products to ensure supply
continuity;
3. A decrease in accounts payable of $769,403 due to timing of
the receipts and the related payments for finished goods
inventory shipments. In April 2003, the Company launched its
sales campaign for Levothyroxine Sodium tablets. Due to the
timing of the Company's launch, the receipt of significant
inventory quantities and beneficial supplier payment terms,
the accounts payable balance as of June 30, 2003 included
significant amounts due to the supplier of the Levothyroxine
Sodium tablets. Subsequent to June 20, 2003, these invoices
have been paid, thereby decreasing the overall accounts
payable balance.
4. An increase in accrued expenses of $1,281,052 due to an
increase in accrued employee incentive compensation costs and
an increase in the accrual for the cost of inventory received,
but not yet billed by the supplier.
5. An increase in income taxes payable of $590,498 due to higher
taxable income and the accrual of related state and local
income taxes.
The net cash used in investing activities of $6,965,889 for the nine
months ended March 31, 2004 was attributable to the Company's acquisition of its
new facility on Torresdale Avenue, purchases and deposits for equipment and
payments for building additions. The Company's anticipated budget for capital
expenditures in Fiscal 2004 is approximately $10 million. The anticipated
capital expenditure requirements will support the
19
Company's growth related to new product introductions and increased production
output due to expected higher sales levels.
In April 1999, the Company entered into a loan agreement (the
"Agreement") with a governmental authority, the Philadelphia Authority for
Industrial Development (the "Authority") to finance future construction and
growth projects of the Company. The Authority issued $3,700,000 in tax-exempt
variable rate demand and fixed rate revenue bonds to provide the funds to
finance such growth projects pursuant to a trust indenture ("the "Trust
indenture"). A portion of the Company's proceeds from the bonds was used to pay
for bond issuance costs of approximately $170,000. The remainder of the proceeds
was deposited into a money market account, which was restricted for future plant
and equipment needs of the Company, as specified in the Agreement. The Trust
Indenture requires that the Company repay the Authority loan through installment
payments beginning in May 2003 and continuing through May 2014, the year the
bonds mature. The bonds bear interest at the floating variable rate determined
by the organization responsible for selling the bonds (the "remarketing agent").
The interest rate fluctuates on a weekly basis. The effective interest rate at
March 31, 2004 was 1.21%. At March 31, 2004, the Company has $2,487,287
outstanding on the Authority loan, of which $816,000 is classified as currently
due. The remainder is classified as a long-term liability. In April 1999, an
irrevocable letter of credit of $3,770,000 was issued by a bank, Wachovia Bank,
National Association (Wachovia), to secure payment of the Authority Loan and a
portion of the related accrued interest. At March 31, 2004 no portion of the
letter of credit has been utilized.
On November 26, 2003, the Company exercised its option to purchase
the facility at 9001 Torresdale Avenue. The purchase price of the facility was
approximately $1.9 million. The Company has entered into agreements (the "2003
Loan Financing") with Wachovia to finance the purchase of the building, the
renovation and setup of the building, and the Company's other anticipated
capital expenditures for Fiscal 2004, including the implementation of its new
Enterprise Resource Planning (ERP) system, and a new fluid bed drying process
center at its current manufacturing plant at 9000 State Road. The 2003 Loan
Financing includes the following:
1) A Mortgage Loan for $2.7 million, used to finance the purchase of
the Torresdale Avenue facility, and certain renovations at the
facility.
2) An Equipment Loan for up to $6 million, which will be used to
finance equipment, the ERP system implementation and other capital
expenditures.
3) A Construction Loan for $1 million, used to finance the construction
and fit up of the fluid bed drying process center, which is adjacent
to the Company's current manufacturing plant at 9000 State Road.
From November 26, 2003 to the earlier of November 26, 2004 or the date
that the Philadelphia Industrial Development Corporation lends the Company up to
$1,250,000 as reimbursement for a portion of the acquisition cost of the
facility (the "Conversion Date"), the Company is required to make interest only
payments on the Mortgage Loan. Commencing on the first day of the month
following the Conversion Date, the Company is required to make monthly payments
of principal and interest in amounts sufficient to fully amortize the principal
balance of the Mortgage Loan 15 years after the Conversion Date. The entire
outstanding principal amount of this mortgage loan, along with any accrued
interest, shall be due no later than 15 years from the date of the Conversion
Date. As of March 31, 2004, the Company has a principal balance of $2.7 million
under the Mortgage Loan.
The Equipment Loan is a non-revolving facility in which the Company will
borrow the funds necessary to finance its capital expenditures. Under the
Equipment Loan, the Company will request Wachovia to reimburse a portion of the
cost incurred to acquire and setup the equipment. The amount advanced to the
Company under the Equipment Loan is limited to no more than 80% of the cost of
such equipment. Each advance under the Equipment Loan will immediately convert
to a term loan with a maturity date of three to five years, depending on the
classification of the equipment acquired. During the term loan, the Company is
required to make equal
20
payments of principal and interest. As of March 31, 2004, the Company has
outstanding $1,641,500 under the Equipment Loan of which $495,000 is classified
as currently due.
Under the Construction Loan, the Company is required to make equal monthly
payments of principal and interest beginning on January 1, 2004 and ending on
November 30, 2008, the maturity date of the loan. As of March 31, 2004, the
Company has outstanding $950,000 under the Construction Loan of which $200,000
is classified as currently due.
The financing facilities under the 2003 Loan Financing bear interest at a
rate equal to the LIBOR Rate plus 150 basis points. The LIBOR Rate is the rate
per annum, based on a 30-day interest period, quoted two business days prior to
the first day of such interest period for the offering by leading banks in the
London interbank market of Dollar deposits. As of March 31, 2004, the interest
rate for the 2003 Loan Financing was 2.5962%.
The Company has executed a Security Agreement with Wachovia in which the
Company has agreed to use substantially all of its assets to collateralize the
amounts due to Wachovia under the 2003 Loan Financing.
The Company also has a $3,000,000 line of credit from Wachovia that bears
interest at the prime interest rate less 0.25%. The line of credit was renewed
and extended to November 30, 2004, at which time the Company expects to renew
and extend the due date. At March 31, 2004, the Company had $0 outstanding and
$3,000,000 available under the line of credit. The Company does not currently
expect to borrow cash under this line of credit in the future due to the
available cash on hand, and the cash expected to be provided by its results of
operations in the future. The line of credit is collateralized by substantially
all Company assets.
The terms of the line of credit, the Agreement, the related letter of
credit and the 2003 Loan Financing require that the Company meet certain
financial covenants and reporting standards, including the attainment of
standard financial liquidity and net worth ratios. As of March 31, 2004, the
Company has complied with such terms, and successfully met its financial
covenants. Additionally, it is the Company's opinion that such covenants are not
material in nature.
The Company believes that cash generated from its operations and the
balances available under the Company's existing loans and line of credit as of
March 31, 2004, are sufficient to finance its level of operations and currently
anticipated capital expenditures. However, to benefit from the low interest
rates in the current financial markets, the Company is planning to finance some
or all of the capital expenditures in Fiscal 2004.
Except as set forth in this report, the Company is not aware of any
trends, events or uncertainties that have or are reasonably likely to have a
material adverse impact on the Company's short-term or long-term liquidity or
financial condition.
PROSPECTS FOR THE FUTURE
The Company has several generic products under development. These
products are all orally-administered, solid-dosage (i.e. tablet/capsule)
products designed to be generic equivalents to brand named innovator drugs. The
Company's developmental drug products are intended to treat a diverse range of
indications. One of these developmental products, an orally-administered obesity
product, represents a generic ANDA currently owned by the Company, but not
currently manufactured and distributed for commercial consumption. As one of the
oldest generic drug manufacturers in the country, formed in 1942, Lannett
currently owns several ANDAs for products which it
21
does not manufacture and market. These ANDAs are simply dormant on the Company's
records. Occasionally, the Company reviews such ANDAs to determine if the market
potential for any of these older drugs has recently changed, so as to make it
attractive for Lannett to reconsider manufacturing and selling it. If the
Company makes the determination to introduce one of these products into the
consumer marketplace, it must review the ANDA and related documentation to
ensure that the approved product specifications, formulation and other features
are feasible in the Company's current environment. Generally, in these
situations, the Company must file a supplement to the FDA for the applicable
ANDA, informing the FDA of a significant change in the manufacturing process,
the formulation, the raw material supplier or another major feature of the
previously-approved ANDA. The Company would then redevelop the product and
submit it to the FDA for supplemental approval. The FDA's approval process for
ANDA supplements is similar to that of a new ANDA.
Another developmental product is a new ANDA submitted to the FDA in
July 2003 for approval. This ANDA is for an orally-administered prescription
capsule product to treat obesity. The FDA has recently disclosed that the
average amount of time to review and approve a new ANDA is approximately
eighteen months. Since the Company has no control over the FDA review process,
management is unable to anticipate whether or when it will be able to begin
commercially producing and shipping this product.
The remainder of the products in development represent either
previously approved ANDAs that the Company is planning to reintroduce (ANDA
supplements), or new formulations (new ANDAs). The products under development
are at various stages in the development cycle -- formulation, scale-up, and/or
clinical testing. Depending on the complexity of the active ingredient's
chemical characteristics, the cost of the raw material, the FDA-mandated
requirement of bioequivalence studies, the cost of such studies and other
developmental factors, the cost to develop a new generic product varies. It can
range from $100,000 to $1 million. Some of Lannett's developmental products
require bioequivalence studies, while others do not -- depending on the FDA's
Orange Book classification. The Orange Book is the FDA's reference list for drug
products. Since the Company has no control over the FDA review process,
management is unable to anticipate whether or when it will be able to begin
producing and shipping additional products.
In addition to the efforts of its internal product development
group, Lannett has contracted with two outside firms (Pharmatek Laboratories
Inc. in California and The PharmaNetwork LLC in New Jersey) for the formulation
and development of several new generic drug products. These outsourced R&D
products are at various stages in the development cycle -- formulation,
analytical method development and testing and manufacturing scale-up. These
products are orally-administered solid dosage products intended to treat a
diverse range of medical indications. It is the Company's intention to
ultimately transfer the formulation technology and manufacturing process for all
of these R&D products to the Company's own commercial manufacturing sites. The
Company initiated these outsourced R&D efforts to compliment the progress of its
own internal R&D efforts.
The Company is also developing a drug product that does not require
FDA approval. The FDA allows generic manufacturers to manufacture and sell
products which are equivalent to innovator drugs that are grand-fathered, under
FDA rules, prior to the passage of the Hatch-Waxman Act of 1984. The FDA allows
generic manufacturers to produce and sell generic versions of such
grand-fathered products by simply performing and internally documenting the
product's stability over a period of time. Under this scenario, a generic
company can forego the time and costs related to a FDA-mandated ANDA approval
process. The Company currently has one product under development in this
category. The developmental drug is an orally-administered solid dosage
prescription product.
The Company has also contracted with Spectrum Pharmaceuticals Inc.,
based in California, to market generic products developed and manufactured by
Spectrum and/or its partners. The first applicable product under this agreement
is ciprofloxacin tablets, the generic version of Cipro(R), an anti-bacterial
drug marketed by Bayer Corporation prescribed to treat infections. The Company
has also initiated discussions with other firms for
22
similar new product initiatives, in which Lannett will market and distribute
products manufactured by third parties. Lannett intends to use its strong
customer relationships to build its market share for such products, and increase
future revenues and income.
The majority of the Company's R&D projects are being developed
in-house under Lannett's direct supervision and with Company personnel. Hence,
the Company does not believe that its outside contracts for product development,
including those for Pharmatek Laboratories Inc. and The PharmaNetwork LLC, or
manufacturing supply, including Spectrum Pharmaceuticals Inc., are material in
nature, nor is the Company substantially dependent on the services rendered by
such outside firms. Since the Company has no control over the FDA review
process, management is unable to anticipate whether or when it will be able to
begin producing and shipping such additional products.
ITEM 4 CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in its Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms, and that such
information is accumulated and communicated to management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. Management necessarily applies its
judgment in assessing the costs and benefits of such controls and procedures,
which, by their nature, can provide only reasonable assurance regarding
management's control objectives.
With the participation of management, the Company's Chief Executive Officer and
Chief Financial Officer evaluated the effectiveness of the design and operation
of the Company's disclosure controls and procedures at the conclusion of the
nine months ended March 31, 2004. Based upon this evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were effective in ensuring that material
information required to be disclosed is included in the reports that it files
with the Securities and Exchange Commission.
CHANGES IN INTERNAL CONTROLS
There were no significant changes in the Company's internal controls or, to the
knowledge of management of the Company, in other factors that could
significantly affect internal controls subsequent to the date of the Company's
most recent evaluation of its disclosure controls and procedures utilized to
compile information included in this filing.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Regulatory Proceedings
The Company is engaged in an industry which is subject to considerable
government regulation relating to the development, manufacturing and marketing
of pharmaceutical products. Accordingly, incidental to its business, the
23
Company periodically responds to inquiries or engages in administrative and
judicial proceedings involving regulatory authorities, particularly the FDA and
the Drug Enforcement Agency.
Employee Claims
A claim of retaliatory discrimination has been filed by a former
employee with the Pennsylvania Human Relations Commission ("PHRC") and the Equal
Employment Opportunity Commission ("EEOC"). The Company was notified of the
complaint in March 1997. The Company has denied liability in this matter. The
PHRC has made a determination that the complaint against the Company should be
dismissed because the facts do not establish probable cause of the allegations
of discrimination. The matter is still pending before the EEOC. At this time,
management is unable to estimate a range of loss, if any, related to this
action. Management believes that the outcome of this claim will not have a
material adverse impact on the financial position or results of operations of
the Company.
A claim of discrimination has been filed against the Company with
the EEOC and the PHRC. The Company was notified of the complaint in June 2001.
The Company has filed an answer with the EEOC denying the allegations. The EEOC
has made a determination that the complaint against the Company should be
dismissed because the facts do not establish probable cause of the allegations
of discrimination. The PHRC has also closed its file in this matter. At this
time, management is unable to estimate a range of loss, if any, related to this
action. Management believes that the outcome of this claim will not have a
material adverse impact on the financial position or results of operations of
the Company.
A claim of discrimination has been filed against the Company with
the PHRC and the EEOC. The Company was notified of the complaint in July 2001.
The Company has filed an answer with the PHRC denying the allegations. The PHRC
has made a determination that the complaint against the Company should be
dismissed because the facts do not establish probable cause of the allegations
of discrimination. The matter is still pending before the EEOC. At this time,
management is unable to estimate a range of loss, if any, related to this
action. Management believes that the outcome of this claim will not have a
material adverse impact on the financial position or results of operations of
the Company.
DES Cases.
The Company is currently engaged in several civil actions as a co-defendant with
many other manufacturers of Diethylstilbestrol ("DES"), a synthetic hormone.
Prior litigation established that the Company's pro rata share of any liability
is less than one-tenth of one percent. The Company was represented in many of
these actions by the insurance company with which the Company maintained
coverage during the time period that damages were alleged to have occurred. The
insurance company denies coverage for actions alleging involvement of the
Company filed after January 1, 1992. With respect to these actions, the Company
paid nominal damages or stipulated to its pro rata share of any liability. The
Company has either settled or is currently defending over 500 such claims. At
this time, management is unable to estimate a range of loss, if any, related to
these actions. Management believes that the outcome of these cases will not have
a material adverse impact on the financial position or results of operations of
the Company.
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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) A list of the exhibits required by Item 601 of Regulation S-K to be
filed as a part of this Form 10-Q is shown on the Exhibit Index
filed herewith.
(b) On January 20, 2004, the Company filed a Form 8-K disclosing in Item
7 and Item 12 thereof and including as an exhibit the press release
announcing its results of operations for the quarter ended and the
six months ended December 31, 2003.
(c) On February 17, 2004, the Company filed a Form 8-K disclosing in
Item 1 that William Farber, the Chief Executive Officer and Chairman
of the Board of Lannett Company, Inc has granted an irrevocable
option to Perrigo Company to purchase all of his shares (13,306,129
shares which represents 66.27% of the outstanding Common Stock of
the Company) of Lannett Company, Inc. for $14.56 per share plus
contingent additional consideration. In addition the Form 8-K,
disclosed in Item 7 thereof and included as an exhibit the Stock
Purchase Option Agreement dated as of February 4, 2004 by and among
William Farber, Audrey Farber and Perrigo Company.
SIGNATURE
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
LANNETT COMPANY, INC.
Dated: May 10, 2004 By: /s/ Larry Dalesandro
------------------------------------
Larry Dalesandro
Chief Financial Officer
By: /s/ William Farber
------------------------------------
William Farber
Chairman of the Board and Chief Executive Officer
25
EXHIBIT INDEX
2.1 Agreement between Lannett Company, Incorporated by reference to Exhibit 2.1 -
Inc. and Jerome Stevens Pharmaceuticals to Form 8-K dated April 20, 2004
10 Employment Agreement between Lannett Filed Herewith 27-34
Company, Inc. and Arthur Bedrosian
11 Computation of Per Share Earnings Filed Herewith 35-36
31.1 Certification of Chief Executive Officer Filed Herewith 37-38
Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer Filed Herewith 39-40
Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
32 Certifications of Chief Executive Officer Filed Herewith 41
and Chief Financial Officer Pursuant
to Section 906 of the Sarbanes-Oxley Act of
2002
26