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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 SEPTEMBER 30, 2004.
[ ] 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 REGISTRANT 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 October 26, 2004, there were 24,088,437 shares of the issuer's common
stock, $.001 par value, outstanding.
Page 1 of 39 pages
Exhibit Index on Page 34
INDEX
PAGE NO.
-------
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2004
(unaudited) and June 30, 2004.......................................... 3
Consolidated Statements of Income (unaudited) for the three
months ended September 30, 2004 and 2003............................... 4
Consolidated Statements of Changes in Shareholders' Equity
(unaudited) for the three months ended September 30, 2004.............. 5
Consolidated Statements of Cash Flows (unaudited) for the
three months ended September 30, 2004 and 2003......................... 6
Notes to Consolidated Financial Statements............................. 7 - 21
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations...................................................... 21 - 30
ITEM 4. Controls and Procedures.................................................... 31
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings.......................................................... 31-32
ITEM 6. Exhibits and Reports on Form 8-K........................................... 32
2
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
9/30/04 06/30/04
------------- -------------
ASSETS
CURRENT ASSETS:
Cash $ 9,043,956 $ 8,966,954
Trade accounts receivable (net of allowance for doubtful accounts of $280,000 8,041,568 15,355,887
and $260,000, respectively)
Inventories 18,207,995 12,813,250
Investments -- Available-for-sale 249,800 -
Prepaid taxes 104,456 882,613
Other current assets 747,032 1,016,050
Deferred tax assets 942,689 942,689
------------- -------------
Total current assets 37,337,496 39,977,443
------------- -------------
PROPERTY, PLANT AND EQUIPMENT 15,681,617 15,259,693
Less accumulated depreciation (6,051,270) (5,666,798)
------------- -------------
9,630,347 9,592,895
INVESTMENTS -- Available-for-sale 2,417,604 -
DEFERRED TAX ASSETS 167,146 166,332
INTANGIBLE ASSET, net of amortization 64,035,406 65,725,490
CONSTRUCTION IN PROGRESS 8,113,150 7,352,821
OTHER ASSETS 198,639 204,103
------------- -------------
TOTAL ASSETS $ 121,899,788 $ 123,019,084
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 2,399,162 $ 1,988,716
Accounts payable 2,545,093 5,640,054
Accrued expenses 2,385,115 3,424,859
------------- -------------
Total current liabilities 7,329,370 11,053,629
------------- -------------
LONG-TERM DEBT, LESS CURRENT PORTION 8,825,336 8,104,141
UNEARNED GRANT FUNDS 500,000 -
DEFERRED TAX LIABILITY 1,614,323 1,614,323
SHAREHOLDERS' EQUITY:
Common stock -authorized 50,000,000 shares par value $.001;
issued and outstanding, 24,083,847 shares and 24,074,710 shares, respectively 24,084 24,075
Additional paid-in capital 70,023,695 69,955,855
Retained earnings 33,584,202 32,267,061
Accumulated other comprehensive loss (1,222) -
------------- -------------
Total shareholders' equity 103,630,759 102,246,991
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 121,899,788 $ 123,019,084
============= =============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
3
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS ENDED
------------------------------
9/30/04 9/30/03
------------- -------------
NET SALES $ 15,011,496 $ 13,221,786
COST OF SALES 7,620,834 4,797,253
------------- -------------
Gross profit 7,390,662 8,424,533
RESEARCH AND DEVELOPMENT EXPENSES 1,348,217 886,440
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 2,110,889 1,726,592
AMORTIZATION EXPENSE OF INTANGIBLE ASSET 1,690,084 -
------------- -------------
Operating income 2,241,472 5,811,501
------------- -------------
OTHER INCOME/(EXPENSE):
Interest expense (61,053) (8,639)
Interest income 14,878 523
------------- -------------
(46,175) (8,116)
------------- -------------
INCOME BEFORE INCOME TAX EXPENSE 2,195,297 5,803,385
INCOME TAX EXPENSE 878,156 2,379,000
------------- -------------
NET INCOME $ 1,317,141 $ 3,424,385
============= =============
BASIC EARNINGS PER SHARE $ 0.05 $ 0.17
============= =============
DILUTED EARNINGS PER SHARE $ 0.05 $ 0.17
============= =============
BASIC WEIGHTED AVERAGE
NUMBER OF SHARES 24,082,401 20,040,102
DILUTED WEIGHTED AVERAGE
NUMBER OF SHARES 24,199,904 20,267,518
The accompanying notes to consolidated financial statements are an integral part
of these statements.
4
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
COMMON STOCK TOTAL
------------------------ ADDITIONAL RETAINED ACCUMULATED OTHER SHAREHOLDERS'
SHARES AMOUNT PAID-IN CAPITAL EARNINGS COMPREHENSIVE LOSS EQUITY
---------- ----------- --------------- ------------- ------------------ -------------
BALANCE, JUNE 30, 2004 24,074,710 $ 24,075 $ 69,955,855 $ 32,267,061 $ - $ 102,246,991
Exercise of stock options 6,000 6 27,793 27,799
Shares issued in connection
with employee stock purchase plan 3,137 3 40,047 40,050
Change in unrealized net gains/ (1,222) (1,222)
(losses) on marketable securities
Net Income 1,317,141 1,317,141
---------- ----------- --------------- ------------- ------------------ -------------
BALANCE, SEPTEMBER 30, 2004 24,083,847 $ 24,084 $ 70,023,695 $ 33,584,202 $ (1,222) $ 103,630,759
========== =========== =============== ============= ================== =============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
5
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE THREE MONTHS ENDED
----------------------------
9/30/04 9/30/03
------------ ------------
OPERATING ACTIVITIES:
Net income $ 1,317,141 $ 3,424,385
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,081,056 258,056
Changes in assets and liabilities which provided cash:
Trade accounts receivable 7,314,319 2,220,931
Inventories (5,394,745) (1,765,037)
Prepaid taxes 778,156 -
Other current assets 267,982 (87,615)
Accounts payable (3,094,961) (1,311,460)
Accrued expenses (1,039,744) 1,513,451
Income taxes payable - 2,376,791
------------ ------------
Net cash provided by operating activities 2,229,204 6,629,502
------------ ------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (including construction in progress) (1,182,253) (1,118,557)
Purchase of investments -- Available-for-sale (2,669,440) -
------------ ------------
Net cash used in investing activities (3,851,693) (1,118,557)
------------ ------------
FINANCING ACTIVITIES:
Proceeds from debt financing 1,602,610 -
Proceeds from grant funding 500,000 -
Repayments of debt (470,968) (203,007)
Proceeds from issuance of stock 67,849 115,239
------------ ------------
Net cash provided by (used in) financing activities 1,699,491 (87,768)
------------ ------------
NET INCREASE IN CASH 77,002 5,423,177
CASH, BEGINNING OF YEAR 8,966,954 3,528,511
------------ ------------
CASH, END OF PERIOD $ 9,043,956 $ 8,951,688
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid during period $ 61,053 $ 8,639
Income taxes paid during period $ 100,000 $ 2,209
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
Lannett Company, Inc. and subsidiaries (the "Company"), a Delaware corporation,
develops, manufactures, packages, markets and distributes pharmaceutical
products sold under generic chemical names.
The Company is engaged in an industry which is subject to considerable
government regulation related to the development, manufacturing and marketing of
pharmaceutical products. In the normal course of business, the Company
periodically responds to inquiries or engages in administrative and judicial
proceedings involving regulatory authorities, particularly the Food and Drug
Administration (FDA) and the Drug Enforcement Agency (DEA).
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 $9,880,000 and $8,885,000 at
September 30, 2004 and June 30, 2004, respectively. The change in the reserves
for various sales adjustments was not proportionally equal to the change in
sales because of changes in the product mix and the customer mix. 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. Unlike branded
innovator companies, Lannett does not use information about product levels in
distribution channels from third-party sources, such as IMS Health and NDC
Health in estimating future returns and other credits.
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 pharmacies. 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. As sales to the large wholesale customers, such as Cardinal
Health, AmerisourceBergen and McKesson Corporation, increase, the reserve for
chargebacks will also generally increase. However, the size of the increase
depends on the product mix. The Company continually monitors the reserve for
chargebacks and makes adjustments when it believes that actual chargebacks may
differ from estimated reserves.
7
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. The reserve for
rebates increases as sales to certain wholesale and retail customers increase.
However, these rebate programs are tailored to the customers' individual
programs. Hence, the reserve will depend on the mix of customers that comprise
such rebate programs.
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
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. Generally, the reserve for
returns increases as net sales increase.
OTHER ADJUSTMENTS - Other adjustments consist primarily of price adjustments,
also known as "shelf stock adjustments," which 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.
The following tables identify the reserves for each major category of revenue
allowance and a summary of the activity for the three months ended September
2004 and 2003:
FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 2004
Reserve Category Chargebacks Rebates Returns Other Total
- ----------------------------------------- ------------ ------------ ------------ ------------ ------------
Reserve Balance as of June 30, 2004 $ 6,484,500 $ 1,864,200 $ 448,000 $ 88,300 $ 8,885,000
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2004 (3,236,300) (1,936,500) (408,400) (87,000) (5,668,200)
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2005 (662,800) (396,600) - - (1,059,400)
Additional Reserves Charged to
Net Sales During Fiscal 2005 4,828,900 2,609,400 284,000 300 7,722,600
------------ ------------ ------------ ------------ ------------
Reserve Balance as of September 30, 2004 $ 7,414,300 $ 2,140,500 $ 323,600 $ 1,600 $ 9,880,000
============ ============ ============ ============ ============
8
FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 2003
Reserve Category Chargebacks Rebates Returns Other Total
- ----------------------------------- ------------ ------------ ------------ ------------ ------------
Reserve Balance as of June 30, 2003 $ 1,638,100 $ 889,800 $ 210,000 $ 33,800 $ 2,771,700
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2003 (1,604,000) (799,800) (49,500) - (2,453,300)
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2004 (802,000) - - - (802,000)
Additional Reserves Charged to
Net Sales During Fiscal 2004 3,895,700 1,194,000 69,500 466,200 5,625,400
------------ ------------ ------------ ------------ ------------
Reserve Balance as of September
30, 2003 $ 3,127,800 $ 1,284,000 $ 230,000 $ 500,000 $ 5,141,800
============ ============ ============ ============ ============
The Company ships its products to the warehouses of its wholesale and
retail chain customers. When the Company and a customer come to an agreement for
the supply of a product, the customer will generally continue to purchase the
product, stock its warehouse(s) and resell the product to its own customers. The
Company's customer will continually reorder the product as its warehouse is
depleted. Lannett generally has no minimum size orders for its customers.
Additionally, most warehousing customers prefer not to stock excess inventory
levels due to the additional carrying costs and inefficiencies created by
holding extra inventory. As such, Lannett's customers continually reorder the
Company's products. It is common for Lannett's customers to order the same
products on a monthly basis. For generic pharmaceutical manufacturers, it is
critical to ensure that customers' warehouses are adequately stocked with its
products. This is important due to the fact that several generic competitors
compete for the consumer demand for a given product. Availability of inventory
ensures that a manufacturer's product is considered. Otherwise, retail
prescriptions would be filled with competitors' products. For this reason, the
Company periodically offers incentives to its customers to purchase its
products. These incentives are generally up-front discounts off its standard
prices at the beginning of a generic campaign launch for a newly-approved or
newly-introduced product, or when a customer purchases a Lannett product for the
first time. Customers generally inform the Company that such purchases represent
an estimate of expected resales for a period of time. This period of time is
generally up to three months. The Company records this revenue, net of any
discounts offered and accepted by its customers at the time of shipment. The
Company's products have either 24 months or 36 months shelf-life at the time of
manufacture. The Company monitors its customers' purchasing trends to attempt to
identify any significant lapses in purchasing activity. If the Company observes
a lack of recent activity, inquiries will be made to such customer regarding the
success of the customer's resale efforts. The Company attempts to minimize any
potential return (or shelf life issues) by maintaining an active dialogue with
the customers.
The products that the Company sells are generic versions of brand named
drugs. The consumer markets for such drugs are well-established markets with
many years of historically-confirmed consumer demand. Such consumer demand may
be affected by several factors, including alternative treatments, cost, etc.
However, the effects of changes in such consumer demand for Lannett's products,
like generic products manufactured by other
9
generic companies, are gradual in nature. Any overall decrease in consumer
demand for generic products generally occurs over an extended period of time.
This is because there are thousands of doctors, prescribers, third-party payers,
institutional formularies and other buyers of drugs that must change prescribing
habits, and medicinal practices before such a decrease would affect a generic
drug market. If the historical data the Company uses, and the assumptions
management makes to calculate its estimates of future returns, chargebacks and
other credits 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.
ACCOUNTS RECEIVABLE - The Company performs ongoing credit evaluations of its
customers and adjusts credit limits based upon payment history and the
customer's current credit worthiness, as determined by a review of their current
credit information. The Company continuously monitors collections and payments
from its customers and maintains a provision for estimated credit losses based
upon historical experience and any specific customer collection issues that have
been identified. While such credit losses have historically been within the
Company's expectations and the provisions established, the Company cannot
guarantee that it will continue to experience the same credit loss rates that it
has in the past.
INVENTORIES - The Company values its inventory at the lower of cost or market
and regularly reviews inventory quantities on hand and records a provision for
excess and obsolete inventory based primarily on estimated forecasts of product
demand and production requirements. The Company's estimates of future product
demand may prove to be inaccurate, in which case it may have understated or
overstated the provision required for excess and obsolete inventory. In the
future, if the Company's inventory is determined to be overvalued, the Company
would be required to recognize such costs in cost of goods sold at the time of
such determination. Likewise, if inventory is determined to be undervalued, the
Company may have recognized excess cost of goods sold in previous periods and
would be required to recognize such additional operating income at the time of
sale.
PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment are stated at
cost. Depreciation is provided for by the straight-line and accelerated methods
over estimated useful lives of the assets. Depreciation expense for the three
month period ended September 30, 2004 and 2003 was approximately $384,500 and
$256,000, respectively.
INVESTMENTS - The Company's investments consist primarily of marketable debt
securities, in government and agency obligations. All of the Company's
marketable securities are classified as available-for-sale and recorded at fair
value, based on quoted market prices. Unrealized holding gains and losses are
recorded, net of any tax effect, as a separate component of accumulated other
comprehensive income. No gains or losses on marketable debt securities are
realized until they are sold or a decline in fair value is determined to be
other-than-temporary. If a decline in fair value is determined to be other than
temporary, an impairment charge is recorded and a new cost basis in the
investment is established. See Note 5 Investments (Marketable Debt Securities)
for a summary of available-for-sale debt securities as of September 30, 2004.
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 debt acquisition costs for the three
month period ended September 30, 2004 and 2003 was approximately $6,500 and
$2,800, respectively.
SHIPPING AND HANDLING COSTS - The cost of shipping products to customers is
recognized at the time the products are shipped, and is included in COST OF
SALES.
RESEARCH AND DEVELOPMENT - Research and development expenses are charged to
operations as incurred.
10
INTANGIBLE ASSETS - 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. As a result of
the JSP agreement, the Company recorded an intangible asset of $67,040,000 for
the exclusive marketing and distribution rights obtained from JSP. The
intangible asset was recorded based upon the fair value of the (4,000,000)
shares at the time of issuance to JSP. The Company will incur annual
amortization expense of approximately $6,760,000 for the intangible asset over
the term of the contract (10 years). Amortization expense for the three month
period ended September 30, 2004 and 2003, was approximately $1,690,084 and $0,
respectively. In accordance with SFAS 142, Goodwill and Other Intangible Assets,
the Company performs an impairment test on its intangible asset each reporting
period. The impairment test consists of discounting future cash flows in order
to compare the carrying amount of the intangible asset to its fair value. As a
result of the testing, there was no impairment of the intangible asset as of
September 30, 2004.
ADVERTISING COSTS - The Company charges advertising costs to operations as
incurred. Advertising expense for the three month period ended September 30,
2004 and 2003 was approximately $74,200 and $62,000, 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. The
Company's products contain various active pharmaceutical ingredients aimed at
treating a diverse range of medical indications. The following table identifies
the Company's approximate net product sales by medical indication for the three
month period ended September 30, 2004 and 2003.
FOR THE THREE MONTHS ENDED
---------------------------
MEDICAL INDICATION 9/30/2004 9/30/2003
- ------------------ ------------ ------------
Migraine Headache $ 3,294,000 $ 3,474,000
Epilepsy 4,314,000 3,949,000
Heart Failure 1,445,000 2,684,000
Thyroid Deficiency 5,338,000 2,574,000
Other 620,000 541,000
------------ ------------
Total $ 15,011,000 $ 13,222,000
============ ============
11
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 31%, 24%, 10%, 34% and 4%, respectively, of net
sales for the three month period ended September 30, 2004. The same five
products accounted for 31%, 27%, 21%, 17% and 3%, respectively, of net sales for
the three month period ended September 30, 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
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 September 30, 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
------------------------------
9/30/04 9/30/03
------------- -------------
Net income, as reported $ 1,317,141 $ 3,424,385
Deduct: Total compensation expense
determined under fair value based
method for all stock awards (448,028) (211,197)
Add: Tax savings at effective rate 179,218 86,591
------------- -------------
Pro forma net income $ 1,048,331 $ 3,299,779
============= =============
Earnings per share:
Basic, as reported $ .05 $ .17
Basic, pro forma $ .04 $ .16
Diluted, as reported $ .05 $ .17
Diluted, pro forma $ .04 $ .16
12
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 Fiscal 2004: expected volatility ranging between
31.2% and 96.2%; risk-free interest rates ranging between 4.33% and 4.79% for
2004, and expected lives of 10 years.
UNEARNED GRANT FUNDS - The Company records all grant funds received as a
liability until the Company fulfills all the requirements of the grant funding
program. See Note 7 Unearned Grant Funds for a detailed description of unearned
grant funds as of September 30, 2004.
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 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 months ended September 30, 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-K
for the year ended June 30, 2004.
NOTE 2. NEW ACCOUNTING STANDARDS
The Company adopted EITF 03-1, "The Meaning of Other than Temporary Impairment
and Its Application to Certain Investments" as of June 30, 2004. EITF 03-1
includes certain disclosures regarding quantitative and qualitative disclosures
for investment securities accounted for under FAS 115, Accounting for Certain
Investments in Debt and Equity Securities that are impaired at the balance sheet
date, but an other-than temporary impairment has not been recognized . The
disclosures under EITF 03-1 are required for financial statements for years
ending after December 15, 2003 and are included in these financial statements.
13
NOTE 3. INVENTORIES
Inventories consist of the following:
September 30, June 30,
2004 2004
------------- -------------
(unaudited)
Raw materials $ 4,349,687 $ 4,195,255
Work-in-process 513,463 626,647
Finished goods 13,054,458 7,854,975
Packaging supplies 290,387 136,373
------------- -------------
$ 18,207,995 $ 12,813,250
============= =============
The preceding amounts are net of inventory reserves of $610,000 and $515,000 at
September 30, 2004 and June 30, 2004 respectively.
NOTE 4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
Useful Lives 2004 2004
-------------- ------------- -------------
Land - $ 33,414 $ 33,414
Building and improvements 10 - 39 years 3,526,003 3,526,003
Machinery and equipment 5 - 10 years 11,926,801 11,504,877
Furniture and fixtures 5 - 7 years 195,399 195,399
------------- -------------
$ 15,681,617 $ 15,259,693
============= =============
NOTE 5. INVESTMENTS (SECURITIES AVAILABLE-FOR-SALE)
The amortized cost, gross unrealized gains and losses, and fair value of the
Company's available-for-sale securities as of September 30, 2004 are summarized
as follows: (there were no investments as of September 30, 2003)
2004
Available-for-Sale
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
U.S. Government Treasury $ 249,377 $ 423 $ - $ 249,800
U.S. Government Agency 677,157 733 (209) 677,681
Mortgage-Backed Securities 1,319,670 2,570 (2,521) 1,319,719
Asset-Back Securities 423,236 422 (3,454) 420,204
------------ ------------ ------------ ------------
$ 2,669,440 $ 4,148 $ (6,184) $ 2,667,404
============ ============ ============ ============
14
NOTE 5. INVESTMENTS (SECURITIES AVAILABLE-FOR-SALE)-CONTINUED
The amortized cost and fair value of the Company's available-for - sale
securities by contractual maturity as of September 30, 2004 are summarized as
follows:
2004
Available for Sale
-----------------------
Amortized Fair
Cost Value
---------- ----------
Due in one year or less $ 249,377 $ 249,800
Due after one year through
five years 526,857 526,698
Due after five years through ten years 150,300 150,983
Due after ten years - -
---------- ----------
$ 926,534 $ 927,481
Mortgage-Back Securities 1,319,670 1,319,719
Asset-Back Securities 423,236 420,204
---------- ----------
$2,669,440 $2,667,404
========== ==========
The Company uses the specific identification method to determine the cost of
securities sold. There were no realized gains or losses on the sales of
securities as of September 30, 2004. There were no securities held from a single
issuer that represented more than 10% of stockholders' equity.
The table below indicates the length of time individual securities have been in
a continuous unrealized loss position as of September 30, 2004:
Less than 12 months 12 months or longer Total
----------------------- ----------------------- -----------------------
Description of Number of Fair Unrealized Fair Unrealized Fair Unrealized
Securities Securities Value Loss Value Loss Value Loss
- -------------------------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
U.S. Government Agency 1 $ 149,792 $ (209) $ - $ - $ 149,792 $ (209)
Mortgage-Backed Securities 7 874,590 (2,521) - - 874,590 (2,521)
Asset-Back Securities 2 269,079 (3,454) - - 269,079 (3,454)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total temporarily
impaired Investment
securities 10 $1,293,461 $ (6,184) $ - $ - $1,293,461 $ (6,184)
========== ========== ========== ========== ========== ========== ==========
15
NOTE 6. BANK LINE OF CREDIT
The Company has a $3,000,000 line of credit from Wachovia Bank, N.A. that bears
interest at the prime interest rate less 0.25% (4.50% at September 30, 2004).
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 September 30, 2004 and
2003, the Company had $0 outstanding and $3,000,000 available under the line of
credit. The line of credit is collateralized by substantially all of the
Company's assets.
NOTE 7. UNEARNED GRANT FUNDS
In July 2004, the Company received $500,000 of grant funding from the
Commonwealth of Pennsylvania, acting through the Department of Community and
Economic Development. The grant funding program requires the Company to use the
funds for machinery and equipment located at their Pennsylvania locations, hire
an additional 100 full-time employees by June 30, 2006, operate its Pennsylvania
locations a minimum of five years and meet certain matching investment
requirements. If the Company fails to comply with any of the requirements above,
the Company would be liable to the full amount of the grant funding ($500,000).
The Company records the unearned grant funds as a liability until the Company
complies with all of the requirements of the grant funding program. On a
quarterly basis, the Company will monitor its progress in fulfilling the
requirements of the grant funding program and will determine the status of the
liability. As of September 30, 2004, the Company has recognized the grant
funding as a long term liability under the caption of Unearned Grant Funds.
NOTE 8. LONG-TERM DEBT
Long-Term debt consists of the following
September 30, June 30,
2004 2004
------------- -------------
(unaudited)
Tax-exempt Bond Loan $ 2,136,969 $ 2,287,802
Mortgage Loan 2,700,000 2,700,000
Equipment Loan 5,537,529 4,205,055
Construction Loan 850,000 900,000
------------- -------------
$ 11,224,498 $ 10,092,857
Less current portion 2,399,162 1,988,716
------------- -------------
$ 8,825,336 $ 8,104,141
============= =============
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 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 September 30, 2004 was 1.86%. At September
16
30, 2004, the Company has $2,136,969 outstanding on the Authority loan, of which
$655,000 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 September 30, 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. The 2003 Loan Financing includes the following:
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 was 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 September 30, 2004, the Company has outstanding $2.7 million under
the Mortgage Loan of which $143,098 is classified as currently due.
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 September 30,
2004, the Company has outstanding $5,537,529 under the Equipment Loan of which
$1,401,060 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 September 30, 2004, the
Company has outstanding $850,000 under the Construction Loan of which $200,004
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 September 30, 2004, the
interest rate for the 2003 Loan Financing was 3.15%.
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.
17
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 September 30, 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 loan 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 September 30, 2004, the
Company has complied with such terms, and successfully met its financial
covenants.
NOTE 9. INCOME TAXES
The provision for federal, state and local income taxes for the three months
ended September 30, 2004 and 2003 was $878,156 and $2,379,000, with effective
tax rates of 40.0% and 40.9%, respectively.
NOTE 10. 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 SEPTEMBER 30,
----------------------------------------------------------
2004 2003
--------------------------- ----------------------------
NET INCOME SHARES NET INCOME SHARES
(NUMERATOR) (DENOMINATOR) (NUMERATOR) (DENOMINATOR)
------------ ------------- ------------ -------------
Basic earnings per share factors $ 1,317,141 24,082,401 $ 3,424,385 20,040,102
Effect of dilutive stock options 117,503 227,416
------------ ------------- ------------ -------------
Diluted earnings per share factors $ 1,317,141 24,199,904 $ 3,424,385 20,267,518
============ ============= ============ =============
Basic earnings per share $ 0.05 $ 0.17
Diluted earnings per share $ 0.05 $ 0.17
18
The number of anti-dilutive weighted average shares that have been excluded in
the computation of diluted earnings per share for the three months ended
September 30, 2004 and 2003 were 461,495 and 7,500 respectively. These shares
have been excluded because the options' exercise price was greater than the
average market price of the common stock.
NOTE 11. COMPREHENSIVE INCOME
The Company's other comprehensive loss is comprised of unrealized losses
on its holdings of marketable debt securities. The components of comprehensive
income and related taxes consisted of the following as of September 30, 2004 and
2003:
FOR THE THREE MONTHS ENDED
----------------------------
9/30/2004 9/30/2003
------------ ------------
COMPREHENSIVE INCOME:
Other Comprehensive Loss:
Unrealized Holding Loss on Securities $ (2,036) -
Add: Tax savings at effective rate 814 -
------------ ------------
Total Unrealized Loss on Securities, Net $ (1,222) -
------------ ------------
Total Other Comprehensive Loss -
Net Income $ 1,317,141 $ 3,424,385
------------ ------------
Total Comprehensive Income $ 1,315,919 $ 3,424,385
============ ============
NOTE 12. RELATED PARTY TRANSACTIONS
The Company had sales of approximately $133,000 and $138,000 during the
three months ended September 30, 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. Accounts receivable includes amounts due from the related party
of approximately $116,000 and $114,000 at September 30, 2004 and 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.
19
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 $24,000 and $0 during the three months ended September 30,
2004 and 2003 to the Insurance Companies for various insurance coverage
policies. There was $1,800 and $0 due to the Insurance Companies as of September
30, 2004 and June 30, 2004. 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 13. MATERIAL CONTRACT WITH SUPPLIER
Currently, the Company's only finished product inventory supplier is
Jerome Stevens Pharmaceuticals, Inc. (JSP), in Bohemia, New York. On March 23,
2004, the Company entered into an agreement with 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. The
JSP products covered under the agreement included Butalbital, Aspirin, Caffeine
with Codeine Phosphate capsules, Digoxin tablets and Levothyroxine Sodium
tablets, sold generically and under the brand name Unithroid(R). The term of the
agreement is ten years, beginning on March 23, 2004 and continuing through March
22, 2014. Both Lannett and JSP have the right to terminate the contract if one
of the parties does not cure a material breach of the contract within thirty
(30) days of notice from the non-breaching party. During the term of the
agreement, the Company is required to use commercially reasonable efforts to
purchase minimum dollar quantities of JSP's products being distributed by the
Company. The minimum quantity to be purchased in the first year of the agreement
is $15 million. Thereafter, the minimum quantity to be purchased increases by $1
million per year of the contract -- up to $24 million for the last year of the
ten-year contract. The Company projects that it will be able to meet the minimum
purchase requirements, but there is no guarantee that the Company will be able
to do so. If the Company does not meet the minimum purchase requirements, JSP's
sole remedy is to terminate the agreement. Under the agreement, JSP is entitled
to nominate one person to serve on the Company's Board of Directors (the
"Board"); provided, however, that the Board shall have the right to reasonably
approve any such nominee in order to fulfill its fiduciary duty by ascertaining
that such person is suitable for membership on the board of a publicly traded
corporation including, but not limited to, complying with the requirements of
the Securities and Exchange Commission, the American Stock Exchange and
applicable law including the Sarbanes-Oxley Act of 2002. The Agreement was
included as an Exhibit in the Current Report on Form 8-K filed by the Company on
May 5, 2004, as subsequently amended. The obligation of the Company to issue the
four million (4,000,000) shares 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,
Donnelly Penman and Partners, 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 from a financial point of
view. As such, subsequent to April 20, 2004, the Company issued four million
(4,000,000) shares to JSP's designees. As a result of the transaction, the
Company recorded an intangible asset related to the contract in the amount of
$67,040,000. The intangible asset was recorded based upon the fair value of the
(4,000,000) shares at the time of issuance to JSP.
The Company has also contracted with Spectrum Pharmaceuticals, based in
California, to purchase and distribute ciproflaxin tablets which are
manufactured by Spectrum and/or its partners. Ciproflaxin tablets are the
generic version of the brand Cipro(R), an anti-bacterial drug, marketed by Bayer
Corporation, prescribed to treat infections. As of September 30, 2004, the
Company has not purchased any ciproflaxin tablets from Spectrum Pharmaceuticals.
20
NOTE 14. CONTINGENCIES
The Company monitors its compliance with all environmental laws. Any
compliance costs which may be incurred are contingent upon the results of future
site monitoring and will be charged to operations when incurred. No monitoring
costs were incurred during the three months ended September 30, 2004 and 2003.
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. Due to the fact
that prior litigation established the "market share" method of prorating
liability amongst the companies that manufactured DES during the drug's
commercial distribution, which ended in 1971, management has accepted this
method as the most reasonably expected method of determining liability for
future outcomes of claims. The Company was represented in many of these actions
by the insurance company with which the Company maintained coverage (subject to
limits of liability) during the time period that damages were alleged to have
occurred. The Company has either settled or had dismissed approximately 250
claims. An additional 283 claims are currently being defended. Prior settlements
have been in the range of $500 to $3,500. Management believes that the outcome
will not have a material adverse impact on the consolidated financial position
or results of operations of the Company.
In addition to the matters reported herein, the Company is involved in
litigation which arises in the normal course of business. In the opinion of
management, the resolution of these lawsuits will not have a material adverse
effect on the consolidated financial position or results of operations.
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-K for
the fiscal year ended June 30, 2004.
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-K filed by the Company in
Fiscal 2004, and any Current Reports on Form 8-K filed by the Company.
21
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
- 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 discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amount of assets and
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities at the date of our financial statements. Actual results may
differ from these estimates under different assumptions or conditions.
Critical accounting policies are defined as those that are reflective
of significant judgments and uncertainties, and potentially result in materially
different results under different assumptions and conditions. We believe that
our critical accounting policies include those described below. For a detailed
discussion on the application of these and other accounting policies, see Note 1
in the Notes to the Consolidated Financial Statements included herein.
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 $9,880,000 and $8,885,000 at
September 30, 2004 and June 30, 2004, respectively. The change in the reserves
for various sales adjustments was not proportionally equal to the change in
sales because of changes in the product mix and the customer mix. Provisions for
estimated rebates,
22
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. Unlike branded innovator
companies, Lannett does not use information about product levels in distribution
channels from third-party sources, such as IMS Health and NDC Health in
estimating future returns and other credits.
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 pharmacies. 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. As sales to the large wholesale customers, such as Cardinal
Health, AmerisourceBergen and McKesson Corporation, increase, the reserve for
chargebacks will also generally increase. However, the size of the increase
depends on the product mix. 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. The reserve for
rebates increases as sales to certain wholesale and retail customers increase.
However, these rebate programs are tailored to the customers' individual
programs. Hence, the reserve will depend on the mix of customers that comprise
such rebate programs.
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
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. Generally, the reserve for
returns increases as net sales increase.
OTHER ADJUSTMENTS - Other adjustments consist primarily of price adjustments,
also known as "shelf stock adjustments," which 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.
23
The following tables identify the reserves for each major category of revenue
allowance and a summary of the activity for the three months ended September
2004 and 2003:
FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 2004
Reserve Category Chargebacks Rebates Returns Other Total
- -------------------------------- ------------- ------------- ------------- ------------- -------------
Reserve Balance as of June 30, $ 6,484,500 $ 1,864,200 $ 448,000 $ 88,300 $ 8,885,000
2004
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2004 (3,236,300) (1,936,500) (408,400) (87,000) (5,668,200)
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2005 (662,800) (396,600) - - (1,059,400)
Additional Reserves Charged to
Net Sales During Fiscal 2005 4,828,900 2,609,400 284,000 300 7,722,600
------------- ------------- ------------- ------------- -------------
Reserve Balance as of September
30, 2004 $ 7,414,300 $ 2,140,500 $ 323,600 $ 1,600 $ 9,880,000
============= ============= ============= ============= =============
FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 2003
Reserve Category Chargebacks Rebates Returns Other Total
- -------------------------------- ------------- ------------- ------------- ------------- -------------
Reserve Balance as of June 30, $ 1,638,100 $ 889,800 $ 210,000 $ 33,800 $ 2,771,700
2003
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2003 (1,604,000) (799,800) (49,500) - (2,453,300)
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2004 (802,000) - - - (802,000)
Additional Reserves Charged to
Net Sales During Fiscal 2004 3,895,700 1,194,000 69,500 466,200 5,625,400
------------- ------------- ------------- ------------- -------------
Reserve Balance as of September
30, 2003 $ 3,127,800 $ 1,284,000 $ 230,000 $ 500,000 $ 5,141,800
============= ============= ============= ============= =============
The Company ships its products to the warehouses of its wholesale and
retail chain customers. When the Company and a customer come to an agreement for
the supply of a product, the customer will generally continue to purchase the
product, stock its warehouse(s) and resell the product to its own customers. The
Company's customer will continually reorder the product as its warehouse is
depleted. Lannett generally has no minimum
24
size orders for its customers. Additionally, most warehousing customers prefer
not to stock excess inventory levels due to the additional carrying costs and
inefficiencies created by holding extra inventory. As such, Lannett's customers
continually reorder the Company's products. It is common for Lannett's customers
to order the same products on a monthly basis. For generic pharmaceutical
manufacturers, it is critical to ensure that customers' warehouses are
adequately stocked with its products. This is important due to the fact that
several generic competitors compete for the consumer demand for a given product.
Availability of inventory ensures that a manufacturer's product is considered.
Otherwise, retail prescriptions would be filled with competitors' products. For
this reason, the Company periodically offers incentives to its customers to
purchase its products. These incentives are generally up-front discounts off its
standard prices at the beginning of a generic campaign launch for a
newly-approved or newly-introduced product, or when a customer purchases a
Lannett product for the first time. Customers generally inform the Company that
such purchases represent an estimate of expected resales for a period of time.
This period of time is generally up to three months. The Company records this
revenue, net of any discounts offered and accepted by its customers at the time
of shipment. The Company's products have either 24 months or 36 months
shelf-life at the time of manufacture. The Company monitors its customers'
purchasing trends to attempt to identify any significant lapses in purchasing
activity. If the Company observes a lack of recent activity, inquiries will be
made to such customer regarding the success of the customer's resale efforts.
The Company attempts to minimize any potential return (or shelf life issues) by
maintaining an active dialogue with the customers.
The products that the Company sells are generic versions of brand named
drugs. The consumer markets for such drugs are well-established markets with
many years of historically-confirmed consumer demand. Such consumer demand may
be affected by several factors, including alternative treatments, cost, etc.
However, the effects of changes in such consumer demand for Lannett's products,
like generic products manufactured by other generic companies, are gradual in
nature. Any overall decrease in consumer demand for generic products generally
occurs over an extended period of time. This is because there are thousands of
doctors, prescribers, third-party payers, institutional formularies and other
buyers of drugs that must change prescribing habits, and medicinal practices
before such a decrease would affect a generic drug market. If the historical
data the Company uses, and the assumptions management makes to calculate its
estimates of future returns, chargebacks and other credits 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.
ACCOUNTS RECEIVABLE - The Company performs ongoing credit evaluations of its
customers and adjusts credit limits based upon payment history and the
customer's current credit worthiness, as determined by a review of their current
credit information. The Company continuously monitors collections and payments
from its customers and maintains a provision for estimated credit losses based
upon historical experience and any specific customer collection issues that have
been identified. While such credit losses have historically been within the
Company's expectations and the provisions established, the Company cannot
guarantee that it will continue to experience the same credit loss rates that it
has in the past.
INVENTORIES - The Company values its inventory at the lower of cost or market
and regularly reviews inventory quantities on hand and records a provision for
excess and obsolete inventory based primarily on estimated forecasts of product
demand and production requirements. The Company's estimates of future product
demand may prove to be inaccurate, in which case it may have understated or
overstated the provision required for excess and obsolete inventory. In the
future, if the Company's inventory is determined to be overvalued, the Company
would be required to recognize such costs in cost of goods sold at the time of
such determination. Likewise, if inventory is determined to be undervalued, the
Company may have recognized excess cost of goods sold in previous periods and
would be required to recognize such additional operating income at the time of
sale.
25
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED
WITH THREE MONTHS ENDED SEPTEMBER 30, 2003.
Net sales increased by 13.5% from $13,221,786 for the three months
ended September 30, 2003 ("First Quarter Fiscal 2004") to $15,011,496 for the
three months ended September 30, 2004 ("First Quarter Fiscal 2005"). The
increase was primarily attributable to a $2.5 million sales increase in
Levothyroxine Sodium tablets. In late June of 2004, the Company received a
letter from the FDA approving the bioequivalence of the Company's Levothyroxine
Sodium tablet product to Monarch Pharmaceutical's branded product Levoxyl(R).
This approval increased the overall market size in which the Company's product
competes by allowing it to be substituted by third-party formularies and retail
pharmacy outlets in lieu of the branded product. Additional products such as
Primidone, Dicyclomine, Acetazolmide, and Unithroid had a total sales increase
of approximately $700,000 as a result of increased unit sales. The increase in
sales of a portion of the Company's products was offset by a decrease in sales
of certain other products, including Butalbital with Aspirin and Caffeine
capsules and Digoxin tablets, which in total decreased by approximately $1.4
million due to increased competition and sales price reductions.
The Company sells its products to customers in various categories. The
table below identifies the Company's approximate net sales to each category for
the three months ended September 30, 2004 and 2003:
FOR THE THREE MONTHS ENDED
---------------------------
CUSTOMER CATEGORY 9/30/2004 9/30/2003
- ---------------------- ------------ ------------
Wholesaler/Distributor $ 10,071,000 $ 7,879,000
Retail Chain 2,839,000 2,507,000
Mail-Order Pharmacy 1,348,000 1,322,000
Private Label 753,000 1,514,000
------------ ------------
Total $ 15,011,000 $ 13,222,000
============ ============
Cost of sales increased by 59% from $4,797,253 for the First Quarter
Fiscal 2004 to $7,620,834 for the First Quarter Fiscal 2005. The cost of sales
increase is due to an increase in direct variable costs such as raw materials
and costs of finished goods as a result of the increase in sales volume as well
as an increase in a portion of the Company's inventory purchase prices. The
additional costs associated with raw materials and costs of finished goods
inventory increased the cost of sales by approximately $3.3 million. The
increase in cost of sales was offset by a decrease in labor expenses of
approximately $380,000 and other miscellaneous production related expenses of
approximately $120,000. The decreased in labor and production expenses reflect
the change in sales product mix between manufactured and purchased finished
goods. Gross profit margins for the First Quarter Fiscal 2005 and the First
Quarter Fiscal 2004 were 49% and 64%, respectively. The decrease in the gross
profit percentage is due to increased competition, lower sales prices, higher
inventory purchase prices and product sales mix. During the First Quarter Fiscal
2005, a larger percentage of the Company's total net sales were from products
supplied by JSP, as compared to the First Quarter Fiscal 2004. 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 First Quarter
Fiscal 2005. 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.
26
Research and development ("R&D") expenses increased by 52% from
$886,440 for the First Quarter Fiscal 2004 to $1,348,217 for the First Quarter
Fiscal 2005. This increase is primarily due to an increase in product
development costs and an increase in the costs of generic bioequivalence tests
which are commonly required for ANDA submissions. The costs associated with
product development and generic bioequivalence tests increased approximately
$500,000 in the First Quarter of Fiscal 2005 as compared to the First Quarter of
2004.
Selling, general and administrative expenses increased by 22% from
$1,726,592 for the First Quarter Fiscal 2004 to $2,110,889 for the First Quarter
Fiscal 2005. This increase is a result of an increase in the following expenses:
insurance expenses, which increased by approximately $194,000, consulting
expenses, which increased by approximately $80,000, depreciation of computer and
office equipment, which increased by approximately $95,000 and travel expenses,
which increased by approximately $27,000.
Amortization expense for the intangible asset for the three month
period ended September 30, 2004 and 2003 was approximately $1,690,084 and $0,
respectively. 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. As a result of the JSP
agreement, the Company recorded an intangible asset of $67,040,000 for the
exclusive marketing and distribution rights obtained from JSP. The intangible
asset was recorded based upon the fair value of the (4,000,000) shares at the
time of issuance to JSP. The Company will incur annual amortization expense of
approximately $6,760,000 for the intangible asset over the term of the contract
(10 years).
As a result of the items discussed above, the Company's operating
income decreased from $5,811,501 in the First Quarter Fiscal 2004 to $2,241,472
in the First Quarter Fiscal 2005.
The Company's interest expense increased from approximately $8,600 in
the First Quarter Fiscal 2004 to approximately $61,000 in the First Quarter
Fiscal 2005 as a result of the borrowing under the "2003 Loan Financing" which
included a mortgage loan, equipment loan and construction loan. See Liquidity
and Capital Resources below. Interest income increased from approximately $500
in the First Quarter Fiscal 2004 to approximately $15,000 in the First Quarter
Fiscal 2005, as a result of investment interest and a higher cash balance.
The Company's income tax expense decreased from $2,379,000 in the First
Quarter Fiscal 2004 to $878,156 in the First Quarter Fiscal 2005 as a result of
the decrease in income before taxes. The effective tax rate decreased slightly
from 40.9% in the First Quarter Fiscal 2004 to 40.0% in the First Quarter of
2005. The decrease is due to the company's decreased activities in some higher
statutory jurisdictions.
The Company reported net income of $1,317,141 in the First Quarter
Fiscal 2005, or $0.05 basic and diluted income per share, compared to net income
of $3,424,385 in the First Quarter Fiscal 2004, or $0.17 basic and diluted
income per share.
LIQUIDITY AND CAPITAL RESOURCES -
Net cash provided by operating activities of $2,229,204 for the three
months ended September 30, 2004 was attributable to net income of $1,317,141, as
adjusted for the effects of non-cash items of $2,074,556 and net changes in
operating assets and liabilities totaling ($1,162,493). Significant changes in
operating assets and liabilities are comprised of:
27
1. A decrease in trade accounts receivable of $7,314,319 due to
cash payments received by the Company in the first quarter of
Fiscal 2005, including the collection of receivables from
customers who had extended payment terms in the fourth quarter
of Fiscal 2004 offered by the Company as a result of
compatibility issues related to the Company's exchange of
Electronic Data Interchange (EDI) documents. The decrease in
trade accounts receivable was also caused by decreased sales
in the First Quarter of Fiscal 2005 compared to the Fourth
Quarter of Fiscal 2004.
2. An increase in inventories of $5,394,745 due to an increase in
raw materials and finished goods inventory. Due to the
Company's anticipated 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 prepaid taxes of $778,156 was a result of the
tax expense of $878,156 for the First Quarter of 2005 less
taxes paid during the First Quarter of Fiscal 2005.
4. A decrease in accounts payable of $3,094,961 due to the
payments for the Company's purchases of raw materials and
finished goods inventory in the last quarter of Fiscal 2004 as
well as the First Quarter of 2005.
5. A decrease in accrued expenses of $1,039,744 due to the
payments of accrued construction costs and bio-study
equivalence testing fess that totaled approximately $1.2
million at the Fiscal 2004 year-end.
The net cash used in investing activities of $3,851,693 for the three
months ended September 30, 2004 was attributable to the Company's renovation of
its new facility on Torresdale Avenue, the purchase and installation of new
equipment and payments for building additions which in total accounted for
approximately $1,182,253. The remaining $2,669,440 was used to purchase
investments which consisted primarily of marketable debt securities, in
government and agency obligations.
The following table summarizes the remaining repayments of debt,
including sinking fund requirements as of September 30, 2004:
Amounts Payable
Fiscal Year Ending to Institutions
- -------------------- ---------------
2005 $ 1,758,138
2006 2,422,958
2007 1,738,317
2008 1,352,434
2009 1,287,697
Thereafter 2,664,954
---------------
$ 11,224,498
===============
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 September 30, 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
28
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 loan 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 September 30, 2004, the
Company has complied with such terms, and successfully met its financial
covenants.
In July 2004, the Company received $500,000 of grant funding from the
Commonwealth of Pennsylvania, acting through the Department of Community and
Economic Development. The grant funding program requires the Company to use the
funds for machinery and equipment located at their Pennsylvania locations, hire
an additional 100 full-time employees by June 30, 2006, operate its Pennsylvania
locations a minimum of five years and meet certain matching investment
requirements. If the Company fails to comply with any of the requirements above,
the Company would be liable to the full amount of the grant funding ($500,000).
The Company records the unearned grant funds as a liability until the Company
complies with all of the requirements of the grant funding program. On a
quarterly basis, the Company will monitor its progress in fulfilling the
requirements of the grant funding program and will determine the status of the
liability. As of September 30, 2004, the Company has recognized the grant
funding as a long term liability under the caption of Unearned Grant Funds.
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
September 30, 2004, are sufficient to finance its level of operations and
currently anticipated capital expenditures.
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 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 any
significant changes 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, also an orally-administered obesity
product, is a new ANDA submitted to the FDA in July 2003 for approval. The FDA
has recently disclosed that the average amount of time to review and approve a
new ANDA is approximately seventeen months. Since the Company has no control
over the FDA review
29
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 will
require bioequivalence studies, while others will not -- depending on the FDA's
Orange Book classification. 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 an outside firm (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 which 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, prescription solid
dosage 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 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 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.
30
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
three months ended September 30, 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 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
31
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. As of September 30, 2004, the EEOC also has closed its file on
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.
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.
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 August 23, 2004, the Company filed a Form 8-K disclosing in Item
2.02 and Item 9.01 thereof and including as an exhibit the press
release announcing its results of operations for the quarter ended
and fiscal year ended June 30, 2004.
(c) On August 27, 2004, the Company filed a Form 8-K/A disclosing in
Item 1.01, 2.01 and Item 9.01 thereof and including as an exhibit
the agreement and the press release disclosing the details of the
agreement between Lannett Company, Inc. and Jerome Stevens
Pharmaceuticals, Inc.
32
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: November 4, 2004 By: /s/ Larry Dalesandro
-------------------------------------
Larry Dalesandro
Chief Financial Officer
By: /s/ William Farber
-------------------------------------
William Farber
Chairman of the Board and Chief
Executive Officer
33
EXHIBIT INDEX
31.1 Certification of Chief Executive Officer Filed Herewith
Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
31.2 Certification of Chief Financial Officer Filed Herewith
Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
32 Certifications of Chief Executive Officer and Filed Herewith
Chief Financial Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
34