Back to GetFilings.com
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 DECEMBER 31, 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
90days.
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 January 31, 2005, there were 24,104,256 shares of the issuer's common
stock, $.001 par value, outstanding.
Page 1 of 40 pages
Exhibit Index on Page 40
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of December 31, 2004 (unaudited) and
June 30, 2004.............................................................. 3
Consolidated Statements of Income (unaudited)
for the three and six months ended December 31, 2004 and 2003.............. 4
Consolidated Statement of Changes in Shareholders' Equity (unaudited)
for the six months ended December 31, 2004................................. 5
Consolidated Statements of Cash Flows (unaudited)
for the six months ended December 31, 2004 and 2003........................ 6
Notes to Consolidated Financial Statements................................. 7 - 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................ 21 - 32
ITEM 4. CONTROLS AND PROCEDURES.................................................. 33
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS........................................................ 34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K......................................... 35
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS 12/31/04 06/30/04
- ------ ------------- --------------
CURRENT ASSETS:
Cash $ 9,588,231 $ 8,966,954
Trade accounts receivable (net of allowance for doubtful accounts of $397,000
and $260,000, respectively) 6,679,464 15,355,887
Inventories 16,085,993 12,813,250
Prepaid taxes 679,535 882,613
Other currentassets 1,154,543 1,016,050
Deferred tax assets 941,069 942,689
------------- --------------
Total current assets 35,128,835 39,977,443
------------- --------------
PROPERTY, PLANT AND EQUIPMENT 23,099,895 15,259,693
Less accumulated depreciation (6,501,134) (5,666,798)
------------- --------------
16,598,761 9,592,895
INVESTMENT SECURITIES - Available-for-sale 2,883,277 -
DEFERRED TAX ASSETS 170,151 166,332
INTANGIBLE ASSET, net of accumulated amortization 62,345,322 65,725,490
CONSTRUCTION IN PROGRESS 1,549,954 7,352,821
OTHER ASSETS 193,175 204,103
------------- --------------
TOTAL ASSETS $ 118,869,475 $ 123,019,084
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 2,436,066 $ 1,988,716
Accounts payable 861,117 5,640,054
Accrued expenses 726,816 3,424,859
------------- --------------
Total current liabilities 4,023,999 11,053,629
------------- --------------
LONG-TERM DEBT, LESS CURRENT PORTION 8,224,416 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, 24,099,255 shares and 24,074,710 shares, respectively 24,099 24,075
Additional paid-in capital 70,114,257 69,955,855
Retained earnings 34,371,679 32,267,061
Accumulated other comprehensive loss (3,298) -
------------- --------------
Total shareholders' equity 104,506,737 102,246,991
------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 118,869,475 $ 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 FOR THE SIX MONTHS ENDED
------------------------------- ------------------------------
12/31/04 12/31/03 12/31/04 12/31/03
------------- ------------- ------------- ------------
NET SALES $ 12,918,521 $ 16,573,601 $ 27,930,017 $ 29,795,387
COST OF SALES 7,085,479 6,660,845 14,706,313 11,458,098
------------- ------------- ------------- ------------
Gross profit 5,833,042 9,912,756 13,223,704 18,337,289
RESEARCH AND DEVELOPMENT EXPENSES 1,000,437 1,252,638 2,348,654 2,139,078
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 1,775,797 2,176,608 3,886,686 3,903,200
AMORTIZATION EXPENSE 1,690,084 - 3,380,168 -
------------- ------------- ------------- ------------
Operating income 1,366,724 6,483,510 3,608,196 12,295,011
------------- ------------- ------------- ------------
OTHER INCOME (EXPENSE):
Realized loss on sale of investment securities (595) - (595) -
Interest expense (87,630) (5,871) (148,683) (14,510)
Interest income 33,899 16,275 48,777 16,798
------------- ------------- ------------- ------------
(54,326) 10,404 (100,501) 2,288
------------- ------------- ------------- ------------
INCOME BEFORE TAXES $ 1,312,398 $ 6,493,914 $ 3,507,695 $ 12,297,299
INCOME TAX EXPENSE $ 524,921 $ 2,661,367 $ 1,403,077 $ 5,040,367
------------- ------------- ------------- ------------
NET INCOME $ 787,477 $ 3,832,547 $ 2,104,618 $ 7,256,932
============= ============= ============= ============
BASIC EARNINGS PER SHARE $ 0.03 $ 0.19 $ 0.09 $ 0.36
DILUTED EARNINGS PER SHARE $ 0.03 $ 0.19 $ 0.09 $ 0.36
BASIC WEIGHTED AVERAGE
NUMBER OF SHARES 24,093,609 20,050,145 24,088,038 20,045,113
DILUTED WEIGHTED AVERAGE
NUMBER OF SHARES 24,185,378 20,275,985 24,192,686 20,272,425
The accompanying notes to consolidated financial statements
are an integral part of these statements.
4
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
COMMON STOCK ADDITIONAL TOTAL
---------------------- PAID-IN RETAINED ACCUMULATED OTHER SHAREHOLDERS'
SHARES AMOUNT 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 13,000 13 48,552 48,565
Shares issued in connection 11,545 11 109,850 109,861
with employee stock purchase
plan
Unrealized net losses (3,298) (3,298)
Net Income 2,104,618 2,104,618
---------- -------- ------------ ----------- ------------------ -------------
BALANCE, DECEMBER 31, 2004 24,099,255 $ 24,099 $ 70,114,257 $34,371,679 $ (3,298) $ 104,506,737
========== ======== ============ =========== ================== =============
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 SIX MONTHS ENDED
-------------------------------
12/31/04 12/31/03
------------- -------------
OPERATING ACTIVITIES:
Net income $ 2,104,618 $ 7,256,932
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 834,336 543,101
Amortization 3,380,168 -
Decrease in trade accounts receivable 8,676,423 168,085
Increase in inventories (3,272,743) (2,601,292)
Decrease in prepaid taxes 203,078 -
Increase in other current assets (129,764) (370,360)
Decrease in accounts payable (4,778,937) (859,622)
(Decrease) and increase in accrued expenses (2,698,043) 124,756
Increase in income taxes payable - 448,355
------------- -------------
Net cash provided by operating activities 4,319,136 4,709,955
------------- -------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (including construction in progress) (2,037,335) (4,463,213)
Purchase of investment securities - available-for-sale (2,886,575) -
------------- -------------
Net cash used in investing activities (4,923,910) (4,463,213)
------------- -------------
FINANCING ACTIVITIES:
Proceeds from debt financing 1,602,610 4,445,574
Proceeds from grant funding 500,000 -
Repayments of debt (1,034,985) (370,758)
Proceeds from issuance of stock 158,426 176,114
------------- -------------
Net cash provided by financing activities 1,226,051 4,250,930
------------- -------------
NET INCREASE IN CASH 621,277 4,497,672
CASH, BEGINNING OF YEAR 8,966,954 3,528,511
------------- -------------
CASH, END OF PERIOD $ 9,588,231 $ 8,026,183
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid during period $ 148,683 $ 14,510
Income taxes paid during period $ 1,200,000 $ 4,592,012
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 - UNAUDITED
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 wholly
owned subsidiary, Lannett Holdings, Inc., and its inactive wholly owned
subsidiary, Astrochem Corporation. 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 $10,665,000 and $8,885,000 at
December 31, 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 both the product and the customer mix. Increased
sales to wholesalers will generally require additional rebates. Incentives
offered to secure sales vary from product to product. Provisions for estimated
rebates and 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 management 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 management 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 six months ended December 2004
and 2003:
FOR THE SIX MONTHS ENDED
DECEMBER 31, 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 (4,478,700) (1,936,500) (408,400) (87,000) (6,910,600)
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2005 (4,128,600) (3,100,200) (467,500) (274,500) (7,970,800)
Additional Reserves Charged to
Net Sales During Fiscal 2005 9,808,000 5,642,700 737,900 472,800 16,661,400
------------ ------------ ---------- --------- ------------
Reserve Balance as of December 31
31, 2004 $ 7,685,200 $ 2,470,200 $ 310,000 $ 199,600 $ 10,665,000
============ ============ ========== ========= ============
8
FOR THE SIX MONTHS ENDED
DECEMBER 31, 2003
Reserve Category Chargebacks Rebates Returns Other Total
- ------------------ ------------ ------------ ---------- --------- ------------
Reserve Balance as of June 30, 2003 $ 1,638,000 $ 889,900 $ 210,200 $ 33,900 $ 2,772,000
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2003 (1,604,000) (1,166,400) (98,300) - (2,868,700)
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2004 (3,477,700) (493,300) - (310,000) (4,281,000)
Additional Reserves Charged to
Net Sales During Fiscal 2004 5,680,100 2,064,100 148,200 426,200 8,318,600
------------ ------------ ---------- --------- ------------
Reserve Balance as of December
31, 2003 $ 2,236,400 $ 1,294,300 $ 260,100 $ 150,100 $ 3,940,900
============ ============ ========== ========= ============
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. The Company 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 excess inventory. As such, the Company's customers continually reorder
the Company's products. It is common for the Company'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 of 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 the Company'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,
9
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 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 both
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 (determined
by the first-in, first-out method) or market, 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
months ended December 31, 2004 and 2003 was approximately $450,000 and $282,000,
respectively. Depreciation expense for the six months ended December 31, 2004
and 2003 was approximately $834,000 and $537,000, respectively.
INVESTMENT SECURITIES - The Company's investment securities consist of
marketable debt securities, primarily in U.S. government and agency obligations.
All of the Company's marketable debt 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. There were no securities
determined by management to be other-than-temporarily impaired for the six month
period ended December 31, 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
months ended December 31, 2004 and 2003 was approximately $5,500 and $2,800,
respectively. Amortization expense for debt acquisition costs for the six months
ended December 31, 2004 and 2003 was approximately $11,000 and $5,600,
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.
10
RESEARCH AND DEVELOPMENT - Research and development expenses are charged to
operations as incurred.
11
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 months
ended December 31, 2004 and 2003 was approximately $1,690,000 and $0,
respectively. Amortization expense for the six months ended December 31, 2004
and 2003 was approximately $3,380,000 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 net present value. As a result of the
testing, management determined that there was no impairment of the intangible
asset as of December 31, 2004.
ADVERTISING COSTS - The Company charges advertising costs to operations as
incurred. Advertising expense for the three months ended December 31, 2004 and
2003 was approximately $33,000 and $74,000, respectively. Advertising expense
for the six months ended December 31, 2004 and 2003 was approximately $107,000
and $136,000, 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 and six months ended December 31, 2004 and 2003:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
MEDICAL INDICATION 12/31/2004 12/31/2003 12/31/2004 12/31/2003
- ------------------ ---------- ---------- ---------- ----------
Migraine Headache $ 3,181,000 $ 4,425,000 $ 6,470,000 $ 7,899,000
Epilepsy 4,573,000 4,799,000 8,874,000 8,749,000
Heart Failure 1,771,000 1,491,000 3,208,000 4,176,000
Thyroid Deficiency 2,736,000 5,365,000 8,101,000 7,937,000
Other 658,000 494,000 1,277,000 1,034,000
----------- ----------- ----------- -----------
Total $12,919,000 $16,574,000 $27,930,000 $29,795,000
=========== =========== =========== ===========
12
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 37%, 26%, 14%, 16%, and 6%, respectively, of net
sales for the three months ended December 31, 2004. The same five products
accounted for 30%, 27%, 9%, 24%, and 9%, respectively, of net sales for the
three months ended December 31, 2003; 34%, 24%, 12%, 26% and 5%, respectively,
of net sales for the six months ended December 31, 2004; and 30%, 27%, 14%, 21%,
and 6%, respectively, of net sales for the six months ended December 31, 2003.
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 December 31, 2004, the Company had two stock-based employee
compensation plans. The Company accounts for stock options under FAS 123,
Accounting for Stock-Based Compensation, as amended by FAS 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, FAS 123 permits
entities to continue accounting for employee stock options and similar equity
instruments under Accounting Principles Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees. Entities that continue to account for stock
options using APB 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 FAS 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 FAS 123 to stock-based employee compensation:
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------- --------------------------
12/31/04 12/31/03 12/31/04 12/31/03
----------- ----------- ----------- -----------
Net income, as reported $ 787,477 $ 3,832,547 $ 2,104,618 $ 7,256,932
Deduct: Total compensation expense
determined under fair value based
method for all stock awards (1,375,621)* (323,142) (1,823,649)* (534,339)
Add: Tax savings at effective rate 550,208 132,488 729,459 219,079
----------- ----------- ----------- -----------
Pro forma net (loss) income $ (37,936) $ 3,641,893 $ 1,010,428 $ 6,941,672
=========== =========== =========== ===========
Earnings per share:
Basic, as reported $ .03 $ .19 $ .09 $ .36
Basic, pro forma $ .00 $ .18 $ .04 $ .35
Diluted, as reported $ .03 $ .19 $ .09 $ .36
Diluted, pro forma $ .00 $ .18 $ .04 $ .34
*Options compensation expense increased by $996,862 in the three months ended
December 31, 2004 due to the accelerated vesting of options resulting from the
separation agreement of Larry Dalesandro, the former Chief Financial Officer.
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 2005 and 2004: expected volatility of
37.5% for 2005 and ranging between 31.2% and 96.2% for 2004; risk-free interest
rate of 4.19% for 2005 and ranging between 4.33% and 4.79% for 2004; and
expected lives of 10 years.
13
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.
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 and six month periods ended December 31,
2004 and 2003 are not necessarily indicative of results for the full year.
While management 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 Emerging Issues Task Force (EITF) Issue No. 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.
In November 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 151, Inventory Costs - an
amendment of ARB No. 43, Chapter 4 (FAS 151). Paragraph 5 of ARB 43, Chapter 4
previously stated that "...under some circumstances, items such as idle facility
expense, excessive spoilage, double freight, and rehandling costs may be so
abnormal as to require treatment as current period charges..." FAS 151 requires
that those items be recognized as current period charges regardless of whether
they meet the criterion of "so abnormal." The adoption of FAS 151 did not have a
material effect on the Company's consolidated financial position, results of
operations, or cash flows.
In December 2004, the FASB revised FAS 123, Accounting for Stock-Based
Compensation. This Statement supersedes APB 25, Accounting for Stock Issued to
Employees and its related implementation guidance and eliminates the alternative
to use APB 25's intrinsic value method of accounting that was provided in FAS
123 as originally issued. Under APB 25, issuing stock options to employees
generally resulted in recognition of no compensation cost. FAS 123 (revised)
requires entities to recognize the cost of employee services received in
exchange for awards of equity instruments based on the grant-date fair value of
those awards. That cost will be recognized over the period during which an
employee is required to provide service in exchange for the award - the
requisite service period (usually the vesting period). The Company plans to
adopt FAS 123 for the quarter ended September 30, 2005.
14
NOTE 3. INVENTORIES
Inventories consist of the following:
December 31, June 30,
2004 2004
----------- -----------
(unaudited)
Raw materials $ 5,033,187 $ 4,195,255
Work-in-process 1,000,082 626,647
Finished goods 9,904,146 7,854,975
Packaging supplies 148,578 136,373
----------- -----------
$16,085,993 $12,813,250
=========== ===========
The preceding amounts are net of inventory reserves of $1,200,000 and $515,000
at December 31, 2004 and June 30, 2004, respectively.
NOTE 4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
December 31, June 30,
Useful Lives 2004 2004
------------ -----------
Land - $ 233,414 $ 33,414
Building and improvements 10 - 39 years 9,631,070 3,526,003
Machinery and equipment 5 - 10 years 12,421,245 11,504,877
Furniture and fixtures 5 - 7 years 814,166 195,399
----------- -----------
$23,099,895 $15,259,693
=========== ===========
NOTE 5. INVESTMENT 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 December 31, 2004 are summarized
as follows (there were no investments as of December 31, 2003):
December 31, 2004
Available-for-Sale
------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ------------------ ----------- ----------
U.S. Government Agency $2,084,934 $ 885 $ (10,745) $2,075,074
Mortgage-Backed Securities 402,580 5,582 - 408,162
Asset-Backed Securities 401,261 82 (1,302) 400,041
---------- ------------------ ----------- ----------
$2,888,775 $ 6,549 $ (12,047) $2,883,277
========== ================== =========== ==========
15
NOTE 5. INVESTMENT SECURITIES - AVAILABLE-FOR-SALE
The amortized cost and fair value of the Company's current available-for-sale
securities by contractual maturity at December 31, 2004 are summarized as
follows:
December 31, 2004
Available for Sale
-----------------------
Amortized Fair
Cost Value
---------- ---------
Due in one year or less $ - $ -
Due after one year through five years 1,131,923 1,129,362
Due after five years through ten years 322,552 319,791
Due after ten years 1,434,300 1,434,124
---------- ----------
$2,888,775 $2,883,277
========== ==========
The Company uses the specific identification method to determine the cost of
securities sold. For the three months ended December 31, 2004, the Company had
realized losses of $595. For the six months ended December 31, 2004, the Company
had realized losses of $595. There were no realized losses for the three or six
months ended December 31, 2003.
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 December 31, 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 13 $ 1,645,212 $ (10,745) - - $ 1,645,212 $ (10,745)
Asset-Backed Securities 2 249,995 (1,302) - - 249,995 (1,302)
------ ----------- ----------- ----- ----------- ----------- ----------
Total temporarily
impaired investment
securities 15 $ 1,895,207 $ (12,047) $ - $ - $ 1,895,207 $ (12,047)
====== =========== ========== ===== =========== =========== ==========
There were no securities determined by management to be other-than-temporarily
impaired for the six month period ended December 31, 2004.
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% (5.00% at December 31, 2004). The
line of credit was renewed and extended to October 30, 2005. At December 31,
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. The Company currently has no plans to borrow under this line
of credit due to the sufficiency of cash on hand and the cash expected to be
provided by the results of operations in the future.
16
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 repay 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 December 31, 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:
December 31, June 30,
2004 2004
----------- -----------
(unaudited)
Tax-exempt Bond Loan $ 1,973,220 $ 2,287,802
Mortgage Loan 2,700,000 2,700,000
Equipment Loan 5,187,264 4,205,055
Construction Loan 799,998 900,000
----------- -----------
$10,660,482 $10,092,857
Less current portion 2,436,066 1,988,716
----------- -----------
$ 8,224,416 $ 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 December 31, 2004 was 2.14%. At December
31, 2004, the Company has $1,973,220 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 Wachovia Bank, National Association (Wachovia) to
secure payment of the Authority Loan and a portion of the related accrued
interest. At December 31, 2004, no portion of the letter of credit has been
utilized.
As part of the 2003 Loan Financing Agreement, the Philadelphia Industrial
Development Corporation will lend the Company up to $1,250,000 as reimbursement
for a portion of the Mortgage Loan from Wachovia. Until that Conversion Date
occurs, 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 loan Mortgage
Loan 15 years after the Conversion Date. The entire outstanding principal amount
of this
17
Mortgage Loan, along with any accrued interest, shall be due no later
than 15 years from the Conversion Date. As of December 31, 2004, the Conversion
date has not taken place and the Company continues to make interest only
payments. As of December 31, 2004, the Company has outstanding $2.7 million
under the Mortgage Loan, of which $180,000 is classified as currently due.
The Equipment Loan consists of various term loans with maturity dates ranging
from three to five years. The Company as part of the 2003 Loan Financing
agreement is required to make equal payments of principal and interest. As of
December 31, 2004, the Company has outstanding $5,187,264 under the Equipment
Loan, of which $1,401,066 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 December 31, 2004, the
Company has outstanding $799,998 under the Construction Loan, of which $200,000
is classified as currently due.
The financing facilities under the 2003 Loan Financing bear interest at a
variable rate equal to the LIBOR Rate plus 150 basis points. The LIBOR Rate is
the rate per annum, based on a 30-day interest period, quoted two business days
prior to the first day of such interest period for the offering by leading banks
in the London interbank market of Dollar deposits. As of December 31, 2004, the
interest rate for the 2003 Loan Financing was 3.78%.
The Company has executed a Security Agreement with Wachovia in which the Company
has agreed to use substantially all of its assets to collateralize the amounts
due to Wachovia under the 2003 Loan Financing.
The 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 December 31, 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 month
period ended December 31, 2004 and 2003 was $524,921 and $2,661,367,
respectively, with effective tax rates of 39.9% and 40.9%, respectively. The
provision for federal, state and local income taxes for the six month period
ended December 31, 2004 and 2003 was $1,403,077 and $5,040,367, respectively,
with effective tax rates of 39.9% and 40.9%, respectively.
NOTE 10. EARNINGS PER SHARE
SFAS No. 128, Earnings Per Share, requires the 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:
18
THREE MONTHS ENDED DECEMBER 31,
2004 2003
-------------------------- -------------------------
NET INCOME SHARES NET INCOME SHARES
(NUMERATOR) (DENOMINATOR) (NUMERATOR) (DENOMINATOR)
Basic earnings per share factors $ 784,477 24,093,609 $ 3,832,547 20,050,145
Effect of dilutive stock options 91,769 225,840
---------- ----------- ------------ -----------
Diluted earnings per share factors $ 784,477 24,185,378 $ 3,832,547 20,275,985
========== =========== ============ ===========
Basic earnings per share $ 0.03 $ 0.19
Diluted earnings per share $ 0.03 $ 0.19
SIX MONTHS ENDED DECEMBER 31,
2004 2003
------------------------- -------------------------
NET INCOME SHARES NET INCOME SHARES
(NUMERATOR) (DENOMINATOR) (NUMERATOR) (DENOMINATOR)
Basic earnings per share factors $2,104,618 24,088,038 $ 7,256,932 20,045,113
Effect of dilutive stock options 104,648 227,312
---------- ----------- ------------- ----------
Diluted earnings per share factors $2,104,618 24,192,686 $ 7,256,932 20,272,425
========== =========== ============= ==========
Basic earnings per share $ 0.09 $ 0.36
Diluted earnings per share $ 0.09 $ 0.36
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
December 31, 2004 and 2003 were 461,695 and 7,500, respectively. The number of
anti-dilutive weighted average shares that have been excluded in the computation
of diluted earnings per share for the six months ended December 31, 2004 and
2003 were 461,695 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.
19
NOTE 11. COMPREHENSIVE INCOME
The Company's other comprehensive loss is comprised of unrealized losses on
investment securities classified as available-for-sale. The components of
comprehensive income and related taxes consisted of the following as of December
31, 2004 and 2003:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
COMPREHENSIVE INCOME 12/31/2004 12/31/2003 12/31/2004 12/31/2003
---------- ---------- ---------- ----------
Other Comprehensive Loss:
Unrealized Holding Loss on Securities (3,461) - (5,498) -
Add: Tax savings at effective rate 1,385 - 2,200 -
-------- ---------- ---------- ----------
Total Unrealized Loss on Securities, Net (2,076) - (3,298) -
-------- ---------- ---------- ----------
Total Other Comprehensive Loss (2,076) - (3,298) -
Net Income 787,477 3,832,547 2,104,618 7,256,932
-------- ---------- ---------- ----------
Total Comprehensive Income 785,401 3,832,547 2,101,320 7,256,932
======== ========== ========== ==========
NOTE 12. RELATED PARTY TRANSACTIONS
The Company had sales of approximately $278,900 and $325,800 during the six
months ended December 31, 2004 and 2003, respectively, to a distributor (the
"related party") owned by Jeffrey Farber, 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 $105,000
(currently due) and $117,000 at December 31, 2004 and June 30, 2004,
respectively. In management's opinion, the terms of these transactions were not
more favorable to the related party than they would have been to a non-related
party.
Stuart Novick, the son of Marvin Novick, a Director on the Company's Board of
Directors through January 13, 2005, was employed by two insurance brokerage
companies (the "Insurance Brokers") that provide insurance agency services to
the Company. The Company paid approximately $381,497 and $286,843 during the six
months ended December 31, 2004 and 2003 to the Insurance Brokers for various
insurance policies. There was $37,700 and $9,400 due to the Insurance Brokers as
of December 31, 2004 and June 30, 2004. In management's opinion, the terms of
these transactions were not more favorable to the related party than they would
have been to a non-related party.
NOTE 13. MATERIAL CONTRACT WITH SUPPLIER
The Company's primary 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
20
purchased in the first year of the agreement is $15 million. Thereafter, the
minimum quantity to be purchased increases by $1 million per year up to $24
million for the last year of the ten-year contract. Management believes 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. Suitability is determined by, but
not limited to, the requirements of the Securities and Exchange Commission, the
American Stock Exchange, and other applicable laws, 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 Company has also contracted with Spectrum Pharmaceuticals, based in
California, to purchase and distribute ciprofloxacin tablets which are
manufactured by Spectrum and/or its partners. Ciprofloxacin tablets are the
generic version of the brand Cipro(R), an anti-bacterial drug, marketed by Bayer
Corporation, prescribed to treat infections. As of December 31, 2004, the
Company has purchased ciprofloxacin tablets but has not yet begun selling them.
In October of 2004, the Company signed an agreement with Orion Pharma (Orion),
based in Finland to purchase and distribute three drug products. Under the terms
of the agreement, Orion will supply Lannett with the finished products and all
laboratory documentation and Lannett will coordinate the completion of the
clinical biostudies necessary to submit Abbreviated New Drug Applications
(ANDAs) to the Food and Drug Administration.
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 and six months ended December 31, 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 among the companies
that manufactured DES during the drug's commercial distribution, which ended in
1971, management has accepted this as the most reasonable 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.
21
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.
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
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.
22
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 $10,665,000 and $8,885,000 at
December 31, 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 both the product and the customer mix. Increased
sales to wholesalers will generally require additional rebates. Incentives
offered to secure sales vary from product to product. Provisions for estimated
rebates and 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
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
23
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 six months ended December 2004
and 2003:
FOR THE SIX MONTHS ENDED
DECEMBER 31, 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 (4,478,700) (1,936,500) (408,400) (87,000) (6,910,600)
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2005 (4,128,600) (3,100,200) (467,500) (274,500) (7,970,800)
Additional Reserves Charged to
Net Sales During Fiscal 2005 9,808,000 5,642,700 737,900 472,800 16,661,400
----------- ----------- --------- --------- ------------
Reserve Balance as of December
31, 2004 $ 7,685,200 $ 2,470,200 $ 310,000 $ 199,600 $ 10,665,000
=========== =========== ========= ========= ============
24
FOR THE SIX MONTHS ENDED
DECEMBER 31, 2003
Reserve Category Chargebacks Rebates Returns Other Total
- ---------------- ------------ ------------ ---------- --------- ------------
Reserve Balance as of June 30, $ 1,638,000 $ 889,900 $ 210,200 $ 33,900 $ 2,772,000
2003
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2003 (1,604,000) (1,166,400) (98,300) - (2,868,700)
Actual Credits Issued-Related
To Sales Recorded in Fiscal 2004 (3,477,700) (493,300) - (310,000) (4,281,000)
Additional Reserves Charged to
Net Sales During Fiscal 2004 5,680,100 2,064,100 148,200 426,200 8,318,600
------------ ------------ ---------- --------- ------------
Reserve Balance as of December
31, 2003 $ 2,236,400 $ 1,294,300 $ 260,100 $ 150,100 $ 3,940,900
============ ============ ========== ========= ============
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 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,
25
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 (determined
by the first-in, first-out method) 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.
RESULTS OF OPERATIONS - THREE MONTHS ENDED DECEMBER 31, 2004 COMPARED WITH
THREE MONTHS ENDED DECEMBER 31, 2003
Net sales decreased by 22% from $16,573,601 for the three months ended
December 31, 2003 ("Second Quarter Fiscal 2004") to $12,918,521 for the three
months ended December 31, 2004 ("Second Quarter Fiscal 2005"). The decrease was
primarily attributable to a $1.8 million sales decrease in Levothyroxine Sodium
tablets. The decrease was due to increased competition and the fact that the
Levothyroxine Sodium tablets only had the bioequivalence status of the branded
product Levoxyl(R) and not for Synthroid(R) for most of the quarter thus
limiting the sales opportunity because of the lack of substitution for both of
the branded products. In December 2004, the Company received FDA approval for
bioequivalence of the Company's Levothyroixine Sodium tablet product to the
branded product Synthroid (R). Additionally, sales of the Butalbital with
Aspirin and Caffeine capsules declined approximately $1.2 million as a result of
increased competition. Finally, the sales of Unithroid decreased $800K due to
the increased competition in the generic market for thyroid drugs. The decrease
in sales of a portion of the Company's products was offset by an increase in
sales of Digoxin tablets which increased approximately $260K.
26
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 December 31, 2004 and 2003:
FOR THE THREE MONTHS ENDED
CUSTOMER CATEGORY 12/31/2004 12/31/2003
- ---------------------- ---------------- --------------
Wholesaler/Distributor $ 8,668,000 $ 10,654,000
Retail Chain 2,442,000 3,154,000
Mail-Order Pharmacy 1,163,000 1,330,000
Private Label 646,000 1,436,000
---------------- --------------
Total $ 12,919,000 $ 16,574,000
================ ==============
Cost of sales increased by 6% from $6,660,845 for the Second Quarter
Fiscal 2004 to $7,085,479 for the Second 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 unit volume.
The increase in the raw material costs of approximately $156,000 and
labor/production costs of approximately $260,000 were a direct result and
proportionally related to the increase in sales unit volume for the quarter.
Gross profit margins for the Second Quarter Fiscal 2005 and the Second Quarter
Fiscal 2004 were 45% and 60%, respectively. The decrease in the gross profit
percentage is due to increased competition, lower sales prices, and product
sales mix. Depending on future market conditions for each of the Company's
products, changes in the future sales product mix may occur. These changes may
affect the gross profit percentage in future periods.
Research and development ("R&D") expenses decreased by 20% from $1,252,638
for the Second Quarter Fiscal 2004 to $1,000,437 for the Second Quarter Fiscal
2005. The decrease is primarily due to a decrease of approximately $430,000 in
the costs of generic bioequivalence tests which are commonly required for ANDA
submissions. The decrease in bioequivalence costs were offset by increases in
consulting of approximately $104,000 and $63,000 in outside contract laboratory
expenses.
Selling, general and administrative expenses decreased by 18% from
$2,176,608 for the Second Quarter Fiscal 2004 to $1,775,797 for the Second
Quarter Fiscal 2005. The decrease is primarily due to a decline in the incentive
compensation expense of approximately $554,000. Incentive compensation is
contingent upon the results of operations. The decrease in incentive
compensation expense was offset by increases in consulting of approximately
$86,000 and depreciation of computer and office equipment of approximately
$94,000.
Amortization expense for the intangible asset for the three months ended
December 31, 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 $6,483,510 in the Second Quarter Fiscal 2004 to $1,366,724 in the
Second Quarter Fiscal 2005.
27
The Company's interest expense increased from approximately $5,871 in the
Second Quarter Fiscal 2004 to approximately $87,630 in the Second Quarter Fiscal
2005 as a result of the borrowing under the "2003 Loan Financing" which included
a mortgage loan, equipment loan and construction loan. Interest income increased
from approximately $16,275 in the Second Quarter Fiscal 2004 to approximately
$33,899 in the Second Quarter Fiscal 2005, as a result of investment of excess
cash in marketable securities and a higher cash balance.
The Company's income tax expense decreased from $2,661,367 in the Second
Quarter Fiscal 2004 to $524,921 in the Second Quarter Fiscal 2005 as a result of
the decrease in income before taxes. The effective tax rate decreased slightly
from 40.9% in the Second Quarter Fiscal 2004 to 39.9% in the Second Quarter of
2005. The decrease is due to the company's decreased activities in some higher
statutory jurisdictions.
The Company reported net income of $787,477 in the Second Quarter Fiscal
2005, or $0.03 basic and diluted income per share, compared to net income of
$3,832,547 in the Second Quarter Fiscal 2004, or $0.19 basic and diluted income
per share.
RESULTS OF OPERATIONS - SIX MONTHS ENDED DECEMBER 31, 2004 COMPARED WITH
SIX MONTHS ENDED DECEMBER 31, 2003
Net sales decreased by 6% from $29,795,387 for the six months ended
December 31, 2003 to $27,930,017 for the six months ended December 31, 2004. The
decrease was primarily attributable to an approximately $1.4 million decline in
sales of Butalbital with Aspirin and Caffiene capsules. Additionally, sales of
Digoxin declined by $968,000, and sales of Unithroid declined by $535,000. These
declines came as a result of increased competition. These declines were
partially offset by increased sales of Levothyroxine Sodium tablets of $699,000.
While sales of Levothyroxine were up overall for the six month period, there was
a significant decline that occurred during the Second Quarter Fiscal 2005. This
decline was due to increased competition and the fact that the Levothyroxine
Sodium tablets only had the bioequivalence status of the branded product
Levoxyl(R) and not for Synthroid(R) for most of the quarter thus limiting the
sales opportunity because of the lack of substitution for both of the branded
products. In December 2004, the Company received FDA approval for bioequivalence
of the Company's Levothyroixine Sodium tablet product to the branded product
Synthroid(R). Also, sales of Primidone increased by $124,000 and accompanied
modest increases in sales of various other products totaling approximately
$257,000.
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
six months ended December 31, 2004 and 2003:
FOR THE SIX MONTHS ENDED
CUSTOMER CATEGORY 12/31/2004 12/31/2003
- ---------------------- --------------- -------------
Wholesaler/Distributor $ 18,741,000 $ 18,532,000
Retail Chain 5,279,000 5,661,000
Mail-Order Pharmacy 2,514,000 2,652,000
Private Label 1,396,000 2,950,000
--------------- -------------
Total $ 27,930,000 $ 29,795,000
=============== =============
28
Cost of sales increased by 28% from $11,458,098 for the six months ended
December 31, 2003 to $14,706,313 for the six months ended December 31, 2004. 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
unit volume. The increase in the raw material costs of approximately $3.4
million were partially offset by a decrease in labor/production costs of
approximately $150,000. The decreased labor/production expenses reflect the
change in sales product mix. Gross profit margins for the six months ended
December 31, 2004 and 2003 were 47% and 62%, respectively. The decrease in the
gross profit percentage is due to increased competition, lower sales prices, and
product sales mix. Depending on future market conditions for each of the
Company's products, changes in the future sales product mix may occur. These
changes may affect the gross profit percentage in future periods.
Research and development ("R&D") expenses increased by 10% from $2,139,078
for the six months ended December 31, 2003 to $2,348,654 for the six months
ended December 31, 2004. This is primarily due to an increase of approximately
$331,000 in consulting expenses, partially offset by a $125,000 decline in
generic bioequivalence testing costs.
Selling, general and administrative expenses decreased less than 1% from
$3,903,200 for the six months ended December 31, 2003 to $3,886,686 for the six
months ended December 31, 2004. While the overall expense remained basically
unchanged, the components did fluctuate. Incentive compensation declined by
approximately $742,000, while the following items increased: consulting expenses
increased by approximately $165,000; depreciation of computer and office
equipment increased by approximately $182,000; and insurance expense increased
by approximately $399,000. Product liability insurance premiums are based on
previously achieved sales levels.
Amortization expense for the intangible asset for the six months ended
December 31, 2004 and 2003 was approximately $3,380,168 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 $12,295,011 for the six months ended December 31, 2003 to
$3,608,196 for the six months ended December 31, 2004.
The Company's interest expense increased from approximately $14,510 for
the six months ended December 31, 2003 to $148,683 for the six months ended
December 31, 2004 as a result of the borrowing under the "2003 Loan Financing"
which included a mortgage loan, equipment loan and construction loan. Interest
income increased from $16,798 for the six months ended December 31, 2003 to
$48,777 for the six months ended December 31, 2004 as a result of investment of
excess cash in marketable securities and a higher cash balance.
The Company's income tax expense decreased from $5,040,367 for the six
months ended December 31, 2003 to $1,403,077 for the six months ended December
31, 2004 as a result of the decrease in income before taxes. The effective tax
rate decreased slightly from 40.9% for the six months ended December 31, 2003 to
39.9% for the six months ended December 31, 2004. The decrease is due to the
company's decreased activities in some higher statutory jurisdictions.
29
The Company reported net income of $2,104,618 for the six months ended
December 31, 2004, or $0.09 basic and diluted income per share, compared to net
income of $7,256,932 for the six months ended December 31, 2003, or $0.36 basic
and diluted income per share.
30
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities of $4,319,136 for the six months
ended December 31, 2004 was attributable to net income of $2,104,618, as
adjusted for the effects of non-cash items of $4,214,504 and net changes in
operating assets and liabilities totaling ($1,999,986). Significant changes in
operating assets and liabilities are comprised of:
1. A decrease in trade accounts receivable of $8,676,423 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 the trade accounts receivable was also due to lower
sales dollars.
2. An increase in inventories of $3,272,743 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 accounts payable of $4,778,937 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.
4. A decrease in accrued expenses of $2,698,043 due to the payments of
accrued construction costs of approximately $811,000, generic
bio-study equivalence testing fees of approximately $570,000 and
incentive compensation of approximately $1.2 million.
The net cash used in investing activities of $4,923,910 for the six months
ended December 31, 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
$2,037,335. The remaining $2,886,575 was used to purchase investment securities,
which consist primarily of U. S. government and agency marketable debt
securities.
The following table summarizes the remaining repayments of debt, including
sinking fund requirements as of December 31, 2004:
Amounts Payable
Fiscal Year Ending to Institutions
- ------------------ ---------------
2005 $ 1,194,123
2006 2,422,958
2007 1,738,317
2008 1,352,434
2009 1,287,697
Thereafter 2,664,953
---------------
$ 10,660,482
===============
31
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% (5.00% at December 31,
2004). The line of credit was renewed and extended to October 30, 2005. At
December 31, 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. The Company currently has no plans to
borrow under this line of credit due to the sufficiency of cash on hand and the
cash expected to be provided by the results of operations in the future.
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 December 31, 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 December 31, 2004, the Company has recognized the grant funding
as a long term liability under the caption of Unearned Grant Funds.
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
32
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.
In October of 2004, the Company signed an agreement with Orion Pharma
(Orion), based in Finland to purchase and distribute three drug products. Under
the terms of the agreement, Orion will supply Lannett with the finished products
and all laboratory documentation and Lannett will coordinate the completion of
the clinical biostudies necessary to submit Abbreviated New Drug Applications
(ANDAs) to the Food and Drug Administration.
The majority of the Company's R&D projects are being developed in-house
under Lannett's direct supervision and with Company personnel. Hence, management
does not believe that its' outside contracts for product development, including
The PharmaNetwork LLC, or manufacturing supply, including Spectrum
Pharmaceuticals Inc. and Orion Pharma, 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,
33
management is unable to anticipate whether or when it will be able to begin
producing and shipping such additional products.
In December 2004, the FDA approved bioequivalence of Jerome Stevens
Pharmaceutical, Inc.'s Levothyroxine Sodium Tablet, to which the Company has
exclusive distribution rights, to Synthroid(R), which is marketed by Abbott
Laboratories, Inc. In June 2004, the FDA approved bioequivalence of
Levothyroxine Sodium Tablets to Levoxyl, which is marketed by King
Pharmaceuticals. This dual approval will now allow pharmacists to substitute
Levothyroxine Sodium Tablets for both dominant brands.
34
PART I. FINANCIAL INFORMATION
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 Interim 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
Interim Chief Financial Officer evaluated the effectiveness of the design and
operation of the Company's disclosure controls and procedures at the conclusion
of the six months ended December 31, 2004. Based upon this evaluation, the Chief
Executive Officer and Interim 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.
35
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 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
36
outcome of these cases will not have a material adverse impact on the financial
position or results of operations of the Company.
37
PART II. OTHER INFORMATION
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 December 1, 2004, the Company filed a Form 8-K disclosing in Item
1.01, Item 5.02, and Item 9.01 thereof, and including as exhibits
the separation agreement and general release and press release, the
departure of Larry Dalesandro as Chief Financial Officer and the
appointment of Michael Tuterice as Interim Chief Financial Officer
effective December 1, 2004.
38
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: February 7, 2005 By: /s/ Michael Tuterice
----------------------
Michael Tuterice
Interim Chief Financial Officer
By: /s/ William Farber
--------------------
William Farber
Chairman of the Board and Chief Executive Officer
39
EXHIBIT INDEX
31.1 Certification of Chief Executive Filed Herewith
Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of Interim Chief Filed Herewith
Financial Officer Pursuant to
Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certifications of Chief Filed Herewith
Executive Officer and Interim
Chief Financial Officer Pursuant
to Section 906 of the
Sarbanes-Oxley Act of 2002
40