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Table of Contents

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2018

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM              TO            

 

Commission File No. 001-31298

 

LANNETT COMPANY, INC.

(Exact Name of Registrant as Specified in its Charter)

 

State of Delaware

 

23-0787699

(State of Incorporation)

 

(I.R.S. Employer I.D. No.)

 

9000 State Road

Philadelphia, PA 19136

(215) 333-9000

(Address of principal executive offices and telephone number)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

Emerging growth company o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12B-12 of the Exchange Act).  Yes o No x

 

Indicate the number of shares outstanding of each class of the registrant’s common stock, as of the latest practical date

 

Class

 

Outstanding as of April 30, 2018

Common stock, par value $0.001 per share

 

38,014,150

 

 

 



Table of Contents

 

Table of Contents

 

 

 

Page No.

PART I. FINANCIAL INFORMATION

 

 

 

 

 

 

 

ITEM 1.

 

FINANCIAL STATEMENTS

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets as of March 31, 2018 (unaudited) and June 30, 2017

 

3

 

 

 

 

 

 

 

Consolidated Statements of Operations (unaudited) for the three and nine months ended March 31, 2018 and 2017

 

4

 

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the three and nine months ended March 31, 2018 and 2017

 

5

 

 

 

 

 

 

 

Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the nine months ended March 31, 2018

 

6

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows (unaudited) for the nine months ended March 31, 2018 and 2017

 

7

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

 

8

 

 

 

 

 

ITEM 2.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

28

 

 

 

 

 

ITEM 3.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

39

 

 

 

 

 

ITEM 4.

 

CONTROLS AND PROCEDURES

 

39

 

 

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

 

 

ITEM 1.

 

LEGAL PROCEEDINGS

 

39

 

 

 

 

 

ITEM 1A.

 

RISK FACTORS

 

39

 

 

 

 

 

ITEM 6.

 

EXHIBITS

 

41

 

2



Table of Contents

 

PART I.  FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

LANNETT COMPANY, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

 

 

(Unaudited)
March 31, 2018

 

June 30, 2017

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

114,016

 

$

117,737

 

Investment securities

 

9,089

 

27,091

 

Accounts receivable, net

 

238,767

 

204,066

 

Inventories

 

133,290

 

122,604

 

Prepaid income taxes

 

16,563

 

16,703

 

Other current assets

 

10,045

 

6,592

 

Total current assets

 

521,770

 

494,793

 

Property, plant and equipment, net

 

267,398

 

243,148

 

Intangible assets, net

 

420,582

 

453,861

 

Goodwill

 

339,566

 

339,566

 

Deferred tax assets

 

18,713

 

52,753

 

Other assets

 

29,462

 

19,191

 

TOTAL ASSETS

 

$

1,597,491

 

$

1,603,312

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

67,501

 

$

44,720

 

Accrued expenses

 

5,832

 

12,499

 

Accrued payroll and payroll-related expenses

 

9,318

 

4,833

 

Rebates payable

 

41,267

 

44,593

 

Royalties payable

 

9,540

 

3,015

 

Restructuring liability

 

3,328

 

5,431

 

Settlement liability

 

 

17,000

 

Short-term borrowings and current portion of long-term debt

 

66,845

 

60,117

 

Total current liabilities

 

203,631

 

192,208

 

Long-term debt, net

 

784,689

 

843,530

 

Other liabilities

 

2,199

 

6,452

 

TOTAL LIABILITIES

 

990,519

 

1,042,190

 

Commitments and Contingencies (Note 12 and 13)

 

 

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

 

 

 

 

Common stock ($0.001 par value, 100,000,000 shares authorized; 38,176,302 and 37,528,450 shares issued; 37,305,266, and 36,919,296 shares outstanding at March 31, 2018 and June 30, 2017, respectively)

 

38

 

37

 

Additional paid-in capital

 

303,376

 

292,780

 

Retained earnings

 

317,823

 

277,774

 

Accumulated other comprehensive loss

 

(450

)

(222

)

Treasury stock (871,036 and 609,154 shares at March 31, 2018 and June 30, 2017, respectively)

 

(13,815

)

(9,247

)

Total stockholders’ equity

 

606,972

 

561,122

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

1,597,491

 

$

1,603,312

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

3



Table of Contents

 

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(In thousands, except share and per share data)

 

 

 

Three months ended
March 31,

 

Nine months ended
March 31,

 

 

 

2018

 

2017

 

2018

 

2017

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

174,386

 

$

165,720

 

$

513,652

 

$

498,223

 

Settlement agreement

 

 

(4,000

)

 

(4,000

)

Total net sales

 

174,386

 

161,720

 

513,652

 

494,223

 

Cost of sales

 

99,036

 

81,553

 

267,503

 

227,527

 

Amortization of intangibles

 

8,293

 

7,737

 

23,971

 

24,361

 

Gross profit

 

67,057

 

72,430

 

222,178

 

242,335

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development expenses

 

2,730

 

8,340

 

20,861

 

30,650

 

Selling, general and administrative expenses

 

14,112

 

17,629

 

61,643

 

56,958

 

Acquisition and integration-related expenses

 

 

1,256

 

83

 

3,674

 

Restructuring expenses

 

1,421

 

1,568

 

2,983

 

5,332

 

Loss on sale of intangible asset

 

15,514

 

 

15,514

 

 

Intangible asset impairment charges

 

 

 

 

88,084

 

Total operating expenses

 

33,777

 

28,793

 

101,084

 

184,698

 

Operating income

 

33,280

 

43,637

 

121,094

 

57,637

 

Other income (loss):

 

 

 

 

 

 

 

 

 

Investment income

 

719

 

1,037

 

4,208

 

3,085

 

Interest expense

 

(22,842

)

(22,373

)

(64,440

)

(68,700

)

Other

 

(662

)

(35

)

2,473

 

(298

)

Total other loss

 

(22,785

)

(21,371

)

(57,759

)

(65,913

)

Income (loss) before income tax

 

10,495

 

22,266

 

63,335

 

(8,276

)

Income tax expense (benefit)

 

(2,275

)

7,337

 

23,286

 

(2,003

)

Net income (loss)

 

12,770

 

14,929

 

40,049

 

(6,273

)

Less: Net income attributable to noncontrolling interest

 

 

 

 

34

 

Net income (loss) attributable to Lannett Company, Inc.

 

$

12,770

 

$

14,929

 

$

40,049

 

$

(6,307

)

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per common share attributable to Lannett Company, Inc.:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.34

 

$

0.41

 

$

1.08

 

$

(0.17

)

Diluted

 

$

0.33

 

$

0.40

 

$

1.05

 

$

(0.17

)

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

37,136,945

 

36,849,208

 

37,064,781

 

36,785,829

 

Diluted

 

38,287,005

 

37,752,304

 

38,112,193

 

36,785,829

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

4



Table of Contents

 

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

(In thousands)

 

 

 

Three months ended
March 31,

 

Nine months ended
March 31,

 

 

 

2018

 

2017

 

2018

 

2017

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

12,770

 

$

14,929

 

$

40,049

 

$

(6,273

)

Other comprehensive income (loss), before tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation gain (loss)

 

(103

)

76

 

(228

)

114

 

Total other comprehensive income (loss), before tax

 

(103

)

76

 

(228

)

114

 

Income tax related to items of other comprehensive income

 

 

 

 

 

Total other comprehensive income (loss), net of tax

 

(103

)

76

 

(228

)

114

 

Comprehensive income (loss)

 

12,667

 

15,005

 

39,821

 

(6,159

)

Less: Total comprehensive income attributable to noncontrolling interest

 

 

 

 

34

 

Comprehensive income (loss) attributable to Lannett Company, Inc.

 

$

12,667

 

$

15,005

 

$

39,821

 

$

(6,193

)

 

The accompanying notes are an integral part of the consolidated financial statements.

 

5



Table of Contents

 

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

(In thousands)

 

 

 

Common Stock

 

Additional

 

 

 

Accumulated
Other

 

 

 

Stockholders’
Equity

 

 

 

Shares
Issued

 

Amount

 

Paid-In
Capital

 

Retained
Earnings

 

Comprehensive
Loss

 

Treasury
Stock

 

Attributable to
Lannett Co., Inc

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, June 30, 2017

 

37,528

 

$

37

 

$

292,780

 

$

277,774

 

$

(222

)

$

(9,247

)

$

561,122

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares issued in connection with share-based compensation plans

 

648

 

1

 

3,578

 

 

 

 

3,579

 

Share-based compensation

 

 

 

7,018

 

 

 

 

7,018

 

Purchase of treasury stock

 

 

 

 

 

 

(4,568

)

(4,568

)

Other comprehensive loss, net of tax

 

 

 

 

 

(228

)

 

(228

)

Net income

 

 

 

 

40,049

 

 

 

40,049

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, March 31, 2018

 

38,176

 

$

38

 

$

303,376

 

$

317,823

 

$

(450

)

$

(13,815

)

$

606,972

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

6



Table of Contents

 

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)

 

 

 

Nine Months Ended
March 31,

 

 

 

2018

 

2017

 

OPERATING ACTIVITIES:

 

 

 

 

 

Net income (loss)

 

$

40,049

 

$

(6,273

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

40,638

 

41,556

 

Deferred income tax expense (benefit)

 

34,040

 

(11,217

)

Share-based compensation

 

7,018

 

5,962

 

Excess tax benefits on share-based compensation awards

 

 

(725

)

Intangible asset impairment charge

 

 

88,084

 

Loss on sale of assets

 

777

 

296

 

Loss on sale of intangible asset

 

15,514

 

 

Gain on investment securities

 

(3,201

)

(2,473

)

Amortization of debt discount and other debt issuance costs

 

17,294

 

15,548

 

Settlement agreement provision

 

 

4,000

 

Other noncash expenses

 

4

 

1,889

 

Changes in assets and liabilities which provided (used) cash:

 

 

 

 

 

Accounts receivable, net

 

(34,701

)

(9,470

)

Inventories

 

(10,686

)

(8,913

)

Prepaid income taxes/Income taxes payable

 

(77

)

(9,891

)

Other assets

 

(7,972

)

(6,480

)

Rebates payable

 

(3,326

)

12,773

 

Royalties payable

 

6,525

 

(1,196

)

Restructuring liability

 

(2,103

)

840

 

Settlement liability

 

 

(3,000

)

Accounts payable

 

5,781

 

11,567

 

Accrued expenses

 

(6,667

)

(1,785

)

Accrued payroll and payroll-related expenses

 

4,485

 

(633

)

Net cash provided by operating activities

 

103,392

 

120,459

 

INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of property, plant and equipment

 

(41,147

)

(32,116

)

Proceeds from sale of property, plant and equipment

 

35

 

38

 

Advance to variable interest entity

 

(9,955

)

 

Purchases of intangible assets

 

(7,038

)

 

Proceeds from sale of investment securities

 

83,833

 

44,571

 

Purchase of investment securities

 

(62,630

)

(50,538

)

Net cash used in investing activities

 

(36,902

)

(38,045

)

FINANCING ACTIVITIES:

 

 

 

 

 

Repayments of short-term borrowings and long-term debt

 

(68,994

)

(139,927

)

Purchase of noncontrolling interest

 

 

(1,500

)

Acquisition-related contingent consideration

 

 

(35,000

)

Proceeds from issuance of stock

 

3,579

 

2,276

 

Excess tax benefits on share-based compensation awards

 

 

725

 

Purchase of treasury stock

 

(4,568

)

(1,840

)

Net cash used in financing activities

 

(69,983

)

(175,266

)

Effect on cash and cash equivalents of changes in foreign exchange rates

 

(228

)

114

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

 

(3,721

)

(92,738

)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

117,737

 

224,769

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

114,016

 

$

132,031

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

 

 

 

 

 

Interest paid (net of capitalized interest of $1.6 million and $1.1 million for the nine months ended March 31, 2018 and 2017, respectively)

 

$

46,740

 

$

51,422

 

Income taxes paid (received)

 

$

(6,760

)

$

19,116

 

Credits issued pursuant to a Settlement Agreement

 

$

17,000

 

$

2,500

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

7



Table of Contents

 

LANNETT COMPANY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 1.  Interim Financial Information

 

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for the presentation of interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, the unaudited financial statements do not include all the information and footnotes necessary for a comprehensive presentation of the financial position, results of operations and cash flows for the periods presented.  In the opinion of management, the unaudited financial statements include all the normal recurring adjustments that are necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented.  Operating results for the three and nine months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2018.  These unaudited financial statements should be read in combination with the other Notes in this section; “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in Item 2; and the Consolidated Financial Statements, including the Notes to the Consolidated Financial Statements, included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017.  The Consolidated Balance Sheet for the fiscal year ended June 30, 2017 was derived from audited financial statements.

 

Note 2.  The Business And Nature of Operations

 

Lannett Company, Inc. (a Delaware corporation) and its subsidiaries (collectively, the “Company” or “Lannett”) develop, manufacture, package, market and distribute solid oral and extended release (tablets and capsules), topical, nasal and oral solution finished dosage forms of drugs, that address a wide range of therapeutic areas.  Certain of these products are manufactured by others and distributed by the Company, most notably under the Jerome Stevens Distribution Agreement.  The Company also manufactures active pharmaceutical ingredients through its Cody Laboratories, Inc. (“Cody Labs”) subsidiary, providing a vertical integration benefit.

 

On November 25, 2015, the Company completed the acquisition of Kremers Urban Pharmaceuticals, Inc. (“KUPI”), the former U.S. specialty generic pharmaceuticals subsidiary of global biopharmaceuticals company UCB S.A (“UCB”).  KUPI is a specialty pharmaceuticals manufacturer focused on the development of products that are difficult to formulate or utilize specialized delivery technologies.  Strategic benefits of the acquisition include expanded manufacturing capacity, a diversified product portfolio and pipeline and complementary research and development expertise.

 

The Company operates pharmaceutical manufacturing plants in Philadelphia, Pennsylvania; Cody, Wyoming; Carmel, New York and Seymour, Indiana.  The Company’s customers include generic pharmaceutical distributors, drug wholesalers, chain drug stores, private label distributors, mail-order pharmacies, other pharmaceutical manufacturers, managed care organizations, hospital buying groups, governmental entities and health maintenance organizations.

 

Note 3.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

The Consolidated Financial Statements have been prepared in conformity with U.S. GAAP.

 

Principles of consolidation

 

The Consolidated Financial Statements include the accounts of Lannett Company, Inc. and its wholly-owned subsidiaries, as well as Cody LCI Realty, LLC (“Realty”), a former variable interest entity (“VIE”) in which the Company had a 50% ownership interest until November 30, 2016, when the Company acquired the remaining 50% interest.  Noncontrolling interest in Realty was recorded net of tax as net income attributable to the noncontrolling interest.  In December 2017, the Company legally dissolved Realty.  Additionally, all intercompany accounts and transactions have been eliminated.

 

8



Table of Contents

 

Business Combinations

 

Acquired businesses are accounted for using the acquisition method of accounting, which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective estimated fair values.  The fair values and useful lives assigned to each class of assets acquired and liabilities assumed are based on, among other factors, the expected future period of benefit of the asset, the various characteristics of the asset and projected future cash flows.  Significant judgment is employed in determining the assumptions utilized as of the acquisition date and for each subsequent measurement period.  Accordingly, changes in assumptions described above, could have a material impact on our consolidated results of operations.

 

Reclassifications

 

Certain prior year amounts have been reclassified to conform to the current year financial statement presentation.

 

Use of estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant estimates and assumptions are required in the determination of revenue recognition and sales deductions for estimated chargebacks, rebates, returns and other adjustments including a provision for the Company’s liability under the Medicare Part D program.  Additionally, significant estimates and assumptions are required when determining the fair value of long-lived assets, including goodwill and intangible assets, income taxes, contingencies and share-based compensation.  Because of the inherent subjectivity and complexity involved in these estimates and assumptions, actual results could differ from those estimates.

 

Foreign currency translation

 

The Consolidated Financial Statements are presented in U.S. Dollars, the reporting currency of the Company.  The financial statements of the Company’s foreign subsidiary are maintained in local currency and translated into U.S. dollars at the end of each reporting period.  Assets and liabilities are translated at period-end exchange rates, while revenues and expenses are translated at average exchange rates during the period.  The adjustments resulting from the use of differing exchange rates are recorded as part of stockholders’ equity in accumulated other comprehensive income (loss).  Gains and losses resulting from transactions denominated in foreign currencies are recognized in the Consolidated Statements of Operations under Other income (loss).  Amounts recorded due to foreign currency fluctuations are immaterial to the Consolidated Financial Statements.

 

Cash and cash equivalents

 

The Company considers all highly liquid investments with original maturities less than or equal to three months at the date of purchase to be cash and cash equivalents.  Cash and cash equivalents are stated at cost, which approximates fair value, and consist of bank deposits and certificates of deposit that are readily convertible into cash.  The Company maintains its cash deposits and cash equivalents at well-known, stable financial institutions.  Such amounts frequently exceed insured limits.

 

Investment securities

 

The Company’s investment securities consist of publicly-traded equity securities which are classified as trading investments.  Investment securities are recorded at fair value based on quoted market prices from broker or dealer quotations or transparent pricing sources at each reporting date.  Realized and unrealized gains and losses are included in the Consolidated Statements of Operations under Other income (loss).

 

Allowance for doubtful accounts

 

The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses.  The Company determines its allowance for doubtful accounts by considering a number of factors, including the length of time balances are past due, the Company’s previous loss history, the customer’s current ability to pay its obligations to the Company and the condition of the general economy and the industry as a whole.  The Company writes off accounts receivable when they are determined to be uncollectible.

 

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Table of Contents

 

Inventories

 

Inventories are stated at the lower of cost and net realizable value by the first-in, first-out method.  Inventories are regularly reviewed and provisions for excess and obsolete inventory are recorded based primarily on current inventory levels, expiration date and estimated sales forecasts.

 

Property, Plant and Equipment

 

Property, plant and equipment are stated at cost less accumulated depreciation.  Depreciation is computed on a straight-line basis over the assets’ estimated useful lives.

 

Intangible Assets

 

Definite-lived intangible assets are stated at cost less accumulated amortization.  Amortization of definite-lived intangible assets is computed on a straight-line basis over the assets’ estimated useful lives, generally for periods ranging from 10 to 15 years.  The Company continually evaluates the reasonableness of the useful lives of these assets.  Indefinite-lived intangible assets are not amortized, but instead are tested at least annually for impairment.  Costs to renew or extend the term of a recognized intangible asset are expensed as incurred.

 

Valuation of Long-Lived Assets, including Intangible Assets

 

The Company’s long-lived assets primarily consist of property, plant and equipment and definite and indefinite-lived intangible assets. Property, plant and equipment and definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances (“triggering events”) indicate that the carrying amount of the asset may not be recoverable.  If a triggering event is determined to have occurred, the asset’s carrying value is compared to the future undiscounted cash flows expected to be generated by the asset.  If the carrying value exceeds the undiscounted cash flow of the asset, then impairment exists.  Indefinite-lived intangible assets are tested for impairment at least annually during the fourth quarter of each fiscal year or more frequently if events or changes in circumstances indicate that the asset might be impaired.  An impairment loss is measured as the excess of the asset’s carrying value over its fair value, which in most cases is calculated using a discounted cash flow model.  Discounted cash flow models are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows.

 

In-Process Research and Development

 

Amounts allocated to in-process research and development (“IPR&D”) in connection with a business combination are recorded at fair value and are considered indefinite-lived intangible assets subject to impairment testing in accordance with the Company’s impairment testing policy for indefinite-lived intangible assets.  As products in development are approved for sale, amounts will be allocated to product rights and will be amortized over their estimated useful lives.  Definite-lived intangible assets are amortized over the expected lives of the related assets. The judgments made in determining the estimated fair value of in-process research and development, as well as asset lives, can materially impact our results of operations.  The Company’s fair value assessments are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows.

 

Goodwill

 

Goodwill, which represents the excess of purchase price over the fair value of net assets acquired, is carried at cost.  Goodwill is tested for impairment on an annual basis on the first day of the fourth quarter of each fiscal year or more frequently if events or changes in circumstances indicate that the asset might be impaired.  The Company first performs a qualitative assessment to determine if the quantitative impairment test is required.  If changes in circumstances indicate an asset may be impaired, the Company performs the quantitative impairment test.  The Company first determines the fair value of our reporting unit (generic pharmaceuticals).  If the net book value of our reporting unit exceeds its fair value, the difference will be recorded as a goodwill impairment, not to exceed the carrying amount of goodwill.  The Company’s fair value assessments are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows.  The judgments made in determining the estimated fair value of goodwill can materially impact our results of operations.

 

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Segment Information

 

The Company operates in one reportable segment, generic pharmaceuticals.  As such, the Company aggregates its financial information for all products.  The following table identifies the Company’s net sales by medical indication for the three and nine months ended March 31, 2018 and 2017:

 

(In thousands)

 

For the Three Months Ended
March 31,

 

For the Nine Months Ended
March 31,

 

Medical Indication

 

2018

 

2017

 

2018

 

2017

 

Antibiotic

 

$

3,801

 

$

4,474

 

$

10,701

 

$

13,047

 

Anti-Psychosis

 

9,336

 

14,433

 

47,127

 

47,119

 

Cardiovascular

 

18,514

 

14,815

 

39,955

 

39,484

 

Central Nervous System

 

8,395

 

11,124

 

24,137

 

32,028

 

Gallstone

 

3,828

 

11,157

 

15,674

 

37,465

 

Gastrointestinal

 

16,562

 

19,441

 

46,171

 

56,470

 

Glaucoma

 

875

 

4,868

 

5,706

 

15,962

 

Migraine

 

12,888

 

7,043

 

43,387

 

22,066

 

Muscle Relaxant

 

3,299

 

3,673

 

10,309

 

10,208

 

Pain Management

 

6,594

 

6,085

 

18,483

 

20,132

 

Respiratory

 

2,324

 

4,256

 

6,200

 

9,426

 

Thyroid Deficiency

 

69,975

 

44,999

 

185,983

 

130,267

 

Urinary

 

33

 

2,619

 

5,870

 

12,413

 

Other

 

12,376

 

14,555

 

38,178

 

36,870

 

Contract manufacturing revenue

 

5,586

 

2,178

 

15,771

 

15,266

 

Net sales

 

174,386

 

165,720

 

513,652

 

498,223

 

Settlement agreement

 

 

(4,000

)

 

(4,000

)

Total net sales

 

$

174,386

 

$

161,720

 

$

513,652

 

$

494,223

 

 

Customer, Supplier and Product Concentration

 

The following table presents the percentage of total net sales, for the three and nine months ended March 31, 2018 and 2017, for certain of the Company’s products, defined as products containing the same active ingredient or combination of ingredients, which accounted for at least 10% of total net sales in any of those periods:

 

 

 

For the Three Months Ended
March 31,

 

For the Nine Months Ended
March 31,

 

 

 

2018

 

2017

 

2018

 

2017

 

 

 

 

 

 

 

 

 

 

 

Product 1

 

40

%

28

%

36

%

26

%

 

The following table presents the percentage of total net sales, for the three and nine months ended March 31, 2018 and 2017, for certain of the Company’s customers which accounted for at least 10% of total net sales in any of those periods:

 

 

 

For the Three Months Ended
March 31,

 

For the Nine Months Ended
March 31,

 

 

 

2018

 

2017

 

2018

 

2017

 

 

 

 

 

 

 

 

 

 

 

Customer A

 

32

%

27

%

27

%

28

%

Customer B

 

15

%

23

%

18

%

21

%

 

The Company’s primary finished goods inventory supplier is Jerome Stevens Pharmaceuticals, Inc. (“JSP”), in Bohemia, New York.  Purchases of finished goods inventory from JSP accounted for approximately 37% and 33% of the Company’s inventory purchases during the three months ended March 31, 2018 and 2017, respectively.  Purchases of finished goods inventory from JSP accounted for approximately 36% and 37% of the Company’s inventory purchases during the nine months ended March 31, 2018 and 2017, respectively.  See Note 21 “Material Contracts with Suppliers” for more information.

 

Revenue Recognition

 

The Company recognizes revenue when title and risk of loss have transferred to the customer and provisions for rebates, promotional adjustments, price adjustments, returns, chargebacks and other potential adjustments are reasonably determinable and collection is reasonably assured.  The Company also considers all other relevant criteria specified in Securities and Exchange Commission Staff Accounting Bulletin No. 104, Topic No. 13, “Revenue Recognition”, in determining when to recognize revenue.

 

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Table of Contents

 

Net Sales Adjustments

 

When revenue is recognized, a simultaneous adjustment to gross sales is made for estimated chargebacks, rebates, returns, promotional adjustments and other potential adjustments.  These provisions are primarily estimated based on historical experience, future expectations, contractual arrangements with wholesalers and indirect customers and other factors known to management at the time of accrual.  Accruals for provisions are presented in the Consolidated Financial Statements as a reduction to gross sales with the corresponding reserve presented as a reduction of accounts receivable or included as rebates payable, depending on the nature of the reserve.  The reserves, presented as a reduction of accounts receivable, totaled $218.5 million and $175.8 million at March 31, 2018 and June 30, 2017, respectively.  Rebates payable at March 31, 2018 and June 30, 2017 totaled $41.3 million and $44.6 million, respectively, for certain rebate programs, primarily related to Medicare Part D and Medicaid and certain sales allowances and other adjustments paid to indirect customers.

 

Cost of Sales, including Amortization of Intangibles

 

Cost of sales includes all costs related to bringing products to their final selling destination, which includes direct and indirect costs, such as direct material, labor and overhead expenses.  Additionally, cost of sales includes product royalties, depreciation, amortization and costs to renew or extend recognized intangible assets, freight charges and other shipping and handling expenses.

 

Research and Development Expenses

 

Research and development costs are expensed as incurred, including all production costs until a drug candidate is approved by the Food and Drug Administration (“FDA”).  Research and development expenses include costs associated with internal projects as well as costs associated with third-party research and development contracts.

 

Contingencies

 

Loss contingencies, including litigation-related contingencies, are included in the Consolidated Statements of Operations when the Company concludes that a loss is both probable and reasonably estimable.  Legal fees related to litigation-related matters are expensed as incurred and included in the Consolidated Statements of Operations under the Selling, general and administrative expense line item.

 

Restructuring Costs

 

The Company records charges associated with approved restructuring plans to remove duplicative headcount and infrastructure associated with business acquisitions or to simplify business processes.  Restructuring charges can include severance costs to eliminate a specified number of employees, infrastructure charges to vacate facilities and consolidate operations and contract cancellation costs. The Company records restructuring charges based on estimated employee terminations, site closure and consolidation plans. The Company accrues severance and other employee separation costs under these actions when it is probable that a liability exists and the amount is reasonably estimable.

 

Share-Based Compensation

 

Share-based compensation costs are recognized over the vesting period, using a straight-line method, based on the fair value of the instrument on the date of grant less an estimate for expected forfeitures.  The Company uses the Black-Scholes valuation model to determine the fair value of stock options, the stock price on the grant date to value restricted stock and the Monte-Carlo simulation model to determine the fair value of performance-based shares.  The Black-Scholes valuation and Monte-Carlo simulation models include various assumptions, including the expected volatility, the expected life of the award, dividend yield and the risk-free interest rate as well as performance assumptions of peer companies.  These assumptions involve inherent uncertainties based on market conditions which are generally outside the Company’s control.  Changes in these assumptions could have a material impact on share-based compensation costs recognized in the consolidated financial statements.

 

Self-Insurance

 

Effective January 1, 2017, the Company self-insures for certain employee medical and prescription benefits.  The Company also maintains stop loss coverage with third party insurers to limit its total liability exposure.  The liability for self-insured risks is primarily calculated using independent third party actuarial valuations which take into account actual claims, claims growth and claims incurred but not yet reported.  Actual experience, including claim frequency and severity as well as health-care inflation, could result in different liabilities than the amounts currently recorded.  The liability for self-insured risks under this plan as of March 31, 2018 totaled $3.4 million and was not material to the consolidated financial position of the Company as of June 30, 2017.

 

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Table of Contents

 

Income Taxes

 

The Company uses the liability method to account for income taxes as prescribed by Accounting Standards Codification (“ASC”) 740, 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.  Deferred income tax assets and liabilities are adjusted to recognize the effects of changes in tax laws or enacted tax rates in the period during which they are signed into law.  The factors used to assess the likelihood of realization are the Company’s forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets.  Under ASC 740, Income Taxes, a valuation allowance is required when it is more likely than not that all or some portion of the deferred tax assets will not be realized through generating sufficient future taxable income.  Failure to achieve forecasted taxable income in applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings.

 

The Company may recognize the tax benefit from an uncertain tax position claimed on a tax return only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.  The authoritative accounting standards also provide guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.

 

On December 22, 2017, President Trump signed the Tax Cut and Jobs Act legislation (“2017 Tax Reform”) into law, which included a broad range of tax reform provisions affecting businesses, including corporate tax rates, business deductions and international tax provisions.  Many of these provisions significantly differ from current U.S. tax law, resulting in pervasive financial reporting implications.  As a result of the new law, the SEC issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain income tax effects of 2017 Tax Reform.  SAB 118 requires registrants to report the tax effects of 2017 Tax Reform, inclusive of provisional amounts for which the accounting is incomplete but a reasonable estimate can be determined.  SAB 118 also allows for a measurement period of up to one year in cases where a registrant reports a provisional amount or is unable to reasonably estimate the impact of 2017 Tax Reform.

 

Earnings (Loss) Per Common Share

 

Basic earnings (loss) per common share attributable to the Company is computed by dividing net income attributable to Lannett Company, Inc. common stockholders by the weighted average number of shares outstanding during the period.  Diluted earnings (loss) per common share attributable to the Company is computed by dividing net income attributable to Lannett Company, Inc. common stockholders by the weighted average number of shares outstanding during the period including additional shares that would have been outstanding related to potentially dilutive securities.  These potentially dilutive securities consist of stock options, unvested restricted stock, performance-based shares and an outstanding warrant.  Anti-dilutive securities are excluded from the calculation.  Dilutive shares are also excluded in the calculation in periods of net loss because the effect of including such securities would be anti-dilutive.

 

Comprehensive Income (Loss)

 

Comprehensive income (loss) includes all changes in equity during a period except those that resulted from investments by or distributions to the Company’s stockholders.  Other comprehensive income (loss) refers to gains and losses that are included in comprehensive income (loss), but excluded from net income as these amounts are recorded directly as an adjustment to stockholders’ equity.

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, Revenue from Contracts with Customers.  The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The authoritative guidance is effective for annual reporting periods beginning after December 15, 2017.  Based on a preliminary review of the contracts representing a substantial portion of our revenues, the Company does not expect the guidance to have a material impact on our disclosures or the timing and recognition of our revenues.  The majority of the Company’s revenues is generated from product sales and based on the Company’s initial assessment, it currently does not anticipate a significant impact to the revenue and disclosures related to these arrangements.

 

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Table of Contents

 

The Company is in the process of establishing and documenting key accounting policies, conducting training and education throughout the organization, and evaluating impacts on business processes, information technology, and controls resulting from the adoption of this new standard.  The Company also continues to accumulate the necessary information to determine the cumulative effects of the accounting change to be recorded upon adoption of the guidance.  The Company intends to use the modified retrospective approach upon implementation.

 

In November 2015, the FASB issued ASU 2015-17, Income Taxes — Balance Sheet Classification of Deferred Taxes.  ASU 2015-17 requires all deferred tax assets and liabilities to be classified as noncurrent on the balance sheet.  The guidance may be applied either prospectively or retrospectively.  The guidance became effective for the Company in the first quarter of Fiscal 2018.  Accordingly, the Company currently presents all deferred tax assets and liabilities as noncurrent on the balance sheet.  All prior period amounts have also been reclassified to conform with the current year presentation.

 

In February 2016, the FASB issued ASU 2016-02, Leases.  ASU 2016-02 requires an entity to recognize right-of-use assets and liabilities on its balance sheet for all leases with terms longer than 12 months.  Lessees and lessors are required to disclose quantitative and qualitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.  ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period and requires a modified retrospective application, with early adoption permitted.  The Company is currently in the process of assessing the impact this guidance will have on the consolidated financial statements.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows — Classification of Certain Cash Receipts and Cash Payments.  ASU 2016-15 addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows.  ASU 2016-15 is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2017.  The Company is currently in the process of assessing the impact this guidance will have on the consolidated financial statements.

 

Note 4.  Restructuring Charges

 

2016 Restructuring Program

 

On February 1, 2016, in connection with the acquisition of KUPI, the Company announced a plan related to the future integration of KUPI and the Company’s operations. The plan focuses on the closure of KUPI’s corporate functions and the consolidation of manufacturing, sales, research and development and distribution functions. The Company estimates that it will incur an aggregate of up to approximately $19.0 million in restructuring charges for actions that have been announced or communicated since the 2016 Restructuring Program began.  Of this amount, approximately $10.0 million relates to employee separation costs, approximately $1.0 million relates to contract termination costs and approximately $8.0 million relates to facility closure costs and other actions. The 2016 Restructuring Program is expected to be completed by the end of Fiscal 2019.  The expenses associated with the restructuring program included in restructuring expenses during the three and nine months ended March 31, 2018 and 2017 were as follows:

 

 

 

For the Three Months Ended
March 31,

 

For the Nine Months Ended
March 31,

 

(In thousands)

 

2018

 

2017

 

2018

 

2017

 

Employee separation costs (credits)

 

$

339

 

$

679

 

$

(41

)

$

2,840

 

Facility closure costs

 

1,082

 

889

 

3,024

 

2,492

 

Total

 

$

1,421

 

$

1,568

 

$

2,983

 

$

5,332

 

 

In the first quarter of Fiscal 2018, the Company decided to retain certain employees who were previously included in the 2016 Restructuring Program.  As a result, the Company reversed all previous charges incurred related to these employees.

 

A reconciliation of the changes in restructuring liabilities associated with the 2016 Restructuring Program from June 30, 2017 through March 31, 2018 is set forth in the following table:

 

(In thousands)

 

Employee
Separation Costs

 

Contract
Termination
Costs

 

Facility Closure
Costs

 

Total

 

Balance at June 30, 2017

 

$

5,431

 

$

 

$

 

$

5,431

 

Restructuring Charges (Credits)

 

(41

)

 

3,024

 

2,983

 

Payments

 

(2,062

)

 

(3,024

)

(5,086

)

Balance at March 31, 2018

 

$

3,328

 

$

 

$

 

$

3,328

 

 

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Note 5.  Accounts Receivable

 

Accounts receivable consisted of the following components at March 31, 2018 and June 30, 2017:

 

(In thousands)

 

March 31, 2018

 

June 30, 2017

 

Gross accounts receivable

 

$

458,878

 

$

380,653

 

Less Chargebacks reserve

 

(113,446

)

(79,537

)

Less Rebates reserve

 

(34,784

)

(43,023

)

Less Returns reserve

 

(47,253

)

(42,135

)

Less Other deductions

 

(23,026

)

(11,096

)

Less Allowance for doubtful accounts

 

(1,602

)

(796

)

Accounts receivable, net

 

$

238,767

 

$

204,066

 

 

For the three months ended March 31, 2018, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns and other deductions of $323.1 million, $72.0 million, $7.1 million, and $23.7 million, respectively.  For the three months ended March 31, 2017, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns and other deductions of $247.7 million, $75.9 million, $6.6 million, and $12.6 million, respectively.

 

For the nine months ended March 31, 2018, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns, and other deductions of $798.0 million, $228.1 million, $21.7 million, and $52.3 million, respectively.  For the nine months ended March 31, 2017, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns, and other deductions of $664.0 million, $218.9 million, $21.4 million, and $42.0 million, respectively.

 

Note 6.  Inventories

 

Inventories at March 31, 2018 and June 30, 2017 consisted of the following:

 

(In thousands)

 

March 31, 2018

 

June 30, 2017

 

Raw materials

 

$

63,325

 

$

57,442

 

Work-in-process

 

18,009

 

15,676

 

Finished goods

 

51,956

 

49,486

 

Total

 

$

133,290

 

$

122,604

 

 

Inventories were reduced by $6.1 million and $4.5 million at March 31, 2018 and June 30, 2017, respectively, for excess and obsolete inventory amounts.  During the three months ended March 31, 2018 and 2017, the Company recorded provisions for excess and obsolete inventory of $4.0 million and $2.3 million, respectively.  During the nine months ended March 31, 2018 and 2017, the Company recorded provisions for excess and obsolete inventory of $8.3 million and $7.7 million, respectively.

 

Note 7.  Property, Plant and Equipment

 

Property, plant and equipment, net at March 31, 2018 and June 30, 2017 consisted of the following:

 

(In thousands)

 

Useful Lives

 

March 31, 2018

 

June 30, 2017

 

Land

 

 

$

6,191

 

$

6,191

 

Building and improvements

 

10 - 39 years

 

108,035

 

108,730

 

Machinery and equipment

 

5 - 10 years

 

147,561

 

142,086

 

Furniture and fixtures

 

5 - 7 years

 

3,830

 

2,953

 

Less: accumulated depreciation

 

 

 

(85,565

)

(71,461

)

 

 

 

 

180,052

 

188,499

 

Construction in progress

 

 

 

87,346

 

54,649

 

Property, plant and equipment, net

 

 

 

$

267,398

 

$

243,148

 

 

Depreciation expense for the three months ended March 31, 2018 and 2017 was $5.0 million and $5.5 million, respectively.  Depreciation expense for the nine months ended March 31, 2018 and 2017 was $16.1 million.

 

Property, plant and equipment, net included amounts held in foreign countries in the amount of $1.1 million and $1.0 million at March 31, 2018 and June 30, 2017, respectively.

 

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Table of Contents

 

Note 8.  Fair Value Measurements

 

The Company’s financial instruments recorded in the Consolidated Balance Sheets include cash and cash equivalents, accounts receivable, investment securities, accounts payable, accrued expenses and debt obligations.  Included in cash and cash equivalents are certificates of deposit with maturities less than or equal to three months at the date of purchase and money market funds.  The carrying value of certain financial instruments, primarily cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, approximate their estimated fair values based upon the short-term nature of their maturity dates.  The carrying amount of the Company’s debt obligations approximates fair value based on current interest rates available to the Company on similar debt obligations.

 

The Company follows the authoritative guidance of ASC Topic 820 “Fair Value Measurements and Disclosures.”  Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  The authoritative guidance also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The Company’s financial assets and liabilities measured at fair value are entirely within Level 1 of the hierarchy as defined below:

 

Level 1 — Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

 

Level 2 — Directly or indirectly observable inputs, other than quoted prices, such as quoted prices for similar assets or liabilities; quoted prices for identical or similar instruments in markets that are not active; or model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 

Level 3 — Unobservable inputs that are supported by little or no market activity and that are material to the fair value of the asset or liability.  Financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation are examples of Level 3 assets and liabilities.

 

If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

 

The Company’s financial assets and liabilities measured at fair value at March 31, 2018 and June 30, 2017, were as follows:

 

 

 

March 31, 2018

 

(In thousands)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

Investment securities

 

$

9,089

 

$

 

$

 

$

9,089

 

Total Assets

 

$

9,089

 

$

 

$

 

$

9,089

 

 

 

 

June 30, 2017

 

(In thousands)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

Investment securities

 

$

27,091

 

$

 

$

 

$

27,091

 

Total Assets

 

$

27,091

 

$

 

$

 

$

27,091

 

 

Note 9.  Investment Securities

 

The Company uses the specific identification method to determine the cost of securities sold, which consisted entirely of equity securities classified as trading.

 

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The Company had a net gain on investment securities of $368 thousand during the three months ended March 31, 2018, which included an unrealized loss related to securities still held at March 31, 2018 of $1.6 million. The Company had a net gain on investment securities of $776 thousand during the three months ended March 31, 2017, which included an unrealized gain related to securities still held at March 31, 2017 of $103 thousand.

 

The Company had a net gain on investment securities of $3.2 million during the nine months ended March 31, 2018, which included an unrealized loss related to securities still held at March 31, 2018 of $421 thousand.  The Company had a net gain on investment securities of $2.5 million during the nine months ended March 31, 2017, which included an unrealized gain related to securities still held at March 31, 2017 of $660 thousand.

 

Note 10.  Intangible Assets

 

Intangible assets, net as of March 31, 2018 and June 30, 2017, consisted of the following:

 

 

 

Weighted

 

Gross Carrying Amount

 

Accumulated Amortization

 

Intangible Assets, Net

 

(In thousands)

 

Avg. Life
(Yrs.)

 

March 31,
2018

 

June 30,
2017

 

March 31,
2018

 

June 30,
2017

 

March 31,
2018

 

June 30,
2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Definite-lived:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cody Labs import license

 

15

 

$

582

 

$

582

 

$

(376

)

$

(347

)

$

206

 

$

235

 

KUPI product rights

 

15

 

416,154

 

434,000

 

(62,904

)

(43,286

)

353,250

 

390,714

 

KUPI trade name

 

2

 

2,920

 

2,920

 

(2,920

)

(2,338

)

 

582

 

KUPI other intangible assets

 

15

 

19,000

 

19,000

 

(2,978

)

(2,028

)

16,022

 

16,972

 

Silarx product rights

 

15

 

10,000

 

10,000

 

(1,889

)

(1,389

)

8,111

 

8,611

 

Other product rights

 

11

 

7,691

 

653

 

(1,147

)

(355

)

6,544

 

298

 

Total definite-lived

 

 

 

$

456,347

 

$

467,155

 

$

(72,214

)

$

(49,743

)

$

384,133

 

$

417,412

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Indefinite-lived:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

KUPI in-process research and development

 

 

$

18,000

 

$

18,000

 

$

 

$

 

$

18,000

 

$

18,000

 

Silarx in-process research and development

 

 

18,000

 

18,000

 

 

 

18,000

 

18,000

 

Other product rights

 

 

449

 

449

 

 

 

449

 

449

 

Total indefinite-lived

 

 

 

36,449

 

36,449

 

 

 

36,449

 

36,449

 

Total intangible assets, net

 

 

 

$

492,796

 

$

503,604

 

$

(72,214

)

$

(49,743

)

$

420,582

 

$

453,861

 

 

In the third quarter of Fiscal 2018, the Company sold an intangible asset related to a product right acquired as part of the KUPI acquisition.  In connection with the transaction, the Company recorded a $15.5 million loss on sale of the intangible asset, which had a carrying value of $15.8 million at the time of sale.

 

In February 2018, the Company completed the acquisition of five products from UCB for $5.0 million which is included within the “Other product rights” category of intangible assets.

 

For the three months ended March 31, 2018 and 2017, the Company recorded amortization expense of $8.3 million and $8.1 million, respectively.  For the nine months ended March 31, 2018 and 2017, the Company recorded amortization expense of $24.6 million and $25.5 million, respectively.

 

Future annual amortization expense consisted of the following as of March 31, 2018:

 

(In thousands)
Fiscal Year Ending June 30,

 

Annual Amortization Expense

 

2018

 

$

14,307

 

2019

 

30,923

 

2020

 

30,082

 

2021

 

30,082

 

2022

 

30,082

 

Thereafter

 

248,657

 

 

 

$

384,133

 

 

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Note 11.  Long-Term Debt

 

Long-term debt, net consisted of the following:

 

 

 

March 31,

 

June 30,

 

(In thousands)

 

2018

 

2017

 

Term Loan A due 2020

 

$

234,151

 

$

254,375

 

Unamortized discount and other debt issuance costs

 

(11,457

)

(16,238

)

Term Loan A, net

 

222,694

 

238,137

 

Term Loan B due 2022

 

679,847

 

727,881

 

Unamortized discount and other debt issuance costs

 

(51,007

)

(63,106

)

Term Loan B, net

 

628,840

 

664,775

 

Revolving Credit Facility due 2020

 

 

 

Other

 

 

735

 

Total debt, net

 

851,534

 

903,647

 

Less short-term borrowings and current portion of long-term debt

 

(66,845

)

(60,117

)

Total long-term debt, net

 

$

784,689

 

$

843,530

 

 

During the third quarter of Fiscal 2018, the Company made a voluntary payment of $25.0 million against its outstanding Term Loan A and Term Loan B debt.  As a result of the prepayment, the Company wrote off a portion of the related debt issuance costs totaling $2.6 million which was included in interest expense.

 

Long-term debt amounts due, for the twelve month periods ending March 31 are as follows:

 

 

 

Amounts Payable

 

(In thousands)

 

to Institutions

 

2019

 

$

66,845

 

2020

 

66,845

 

2021

 

218,496

 

2022

 

39,345

 

2023

 

522,467

 

Total

 

$

913,998

 

 

Note 12.  Legal, Regulatory Matters and Contingencies

 

Connecticut Attorney General Inquiry

 

In July 2014, the Company received interrogatories and subpoena from the State of Connecticut Office of the Attorney General concerning its investigation into the pricing of digoxin.  According to the subpoena, the Connecticut Attorney General is investigating whether anyone engaged in any activities that resulted in (a) fixing, maintaining or controlling prices of digoxin or (b) allocating and dividing customers or territories relating to the sale of digoxin in violation of Connecticut antitrust law.  In June 2016, the Connecticut Attorney General issued interrogatories and a subpoena to an employee of the Company in order to gain access to documents and responses previously supplied to the Department of Justice.  In December 2016, the Connecticut Attorney General, joined by numerous other State Attorneys General, filed a civil complaint alleging that six pharmaceutical companies engaged in anti-competitive behavior related to doxycycline hyclate and gliburide.  The Company was not named in the action and does not compete on the products that formed the basis of the complaint.  The complaint was later transferred for pretrial purposes to the United States District Court for the Eastern District of Pennsylvania as part of a multidistrict litigation captioned In re: Generic Pharmaceuticals Pricing Antitrust Litigation.  On October 31, 2017, the state Attorneys General filed a motion in the District Court for leave to amend their complaint to add numerous additional defendants, including the Company, and claims relating to 13 additional drugs.  The claim relating to Lannett involves alleged price-fixing for one drug, doxycycline monohydrate, but does not involve the pricing for digoxin.  The state Attorneys General also allege that all defendants were part of an overarching, industry-wide conspiracy to allocate markets and fix prices generally.  All of the existing and proposed defendants, including the Company, have opposed the motion of the state Attorneys General.  The motion is pending.

 

The Company maintains that it acted in compliance with all applicable laws and regulations and continues to cooperate with the Connecticut Attorney General investigation.

 

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Federal Investigation into the Generic Pharmaceutical Industry

 

The Company and certain affiliated individuals and customers have been served with grand jury subpoenas relating to a federal investigation of the generic pharmaceutical industry into possible violations of the Sherman Act.  The subpoenas request corporate documents of the Company relating to corporate, financial and employee information, communications or correspondence with competitors regarding the sale of generic prescription medications and the marketing, sale, or pricing of certain products, generally for the period of 2005 through the dates of the subpoenas.

 

Based on reviews performed to date by outside counsel, the Company currently believes that it has acted in compliance with all applicable laws and regulations and continues to cooperate with the federal investigation.

 

Texas Medicaid Investigation

 

In August 2015, KUPI received a letter from the Texas Office of the Attorney General alleging that it had inaccurately reported certain price information in violation of the Texas Medicaid Fraud Prevention Act. UCB, KUPI’s previous parent company is handling the defense and is evaluating the allegations and cooperating with the Texas Attorney General’s Office.  Per the terms of the Stock Purchase Agreement between the Company and UCB (“Stock Purchase Agreement”) dated September 2, 2015, the Company is fully indemnified for any pre-acquisition amounts.  The Company is currently unable to estimate the timing or the outcome of this matter.

 

Government Pricing

 

During the quarter ended December 31, 2016, the Company completed a contract compliance review, for the period January 1, 2012 through June 30, 2016, for one of KUPI’s government-entity customers.  As a result of the review, the Company identified certain commercial customer prices and other terms that were not properly disclosed to the government-entity resulting in potential overcharges.  As of March 31, 2018 and June 30, 2017, the Company’s best estimate of the liability for potential overcharges was approximately $9.3 million.  For the period January 1, 2012 through November 24, 2015 (“the pre-acquisition period”), the Company is fully indemnified per the Stock Purchase Agreement.  Accordingly, the Company has recorded an indemnification asset and related liability of $8.3 million related to the pre-acquisition period.  The Company does not believe that the ultimate resolution of this matter will have a significant impact on our financial position, results of operations or cash flows.

 

AWP Litigation

 

The Company and some of our competitors have been named as defendants in two lawsuits filed in 2016 alleging that the Company and a number of other generic pharmaceutical manufacturers caused the Average Wholesale Prices (AWPs) of our and their products to be inflated, thereby injuring government programs, entities and persons who reimbursed prescription drugs based on AWPs.  The Company stopped using AWP as a basis for establishing prices in or around 2002 and the bulk of prescription drugs manufactured by the Company was sold under private label.  The first lawsuit, filed in the United States District Court for the Eastern of Pennsylvania, was dismissed on September 25, 2017 (the “Federal Action”).  The second lawsuit, pending in the Philadelphia (Pennsylvania) County Court of Common Pleas, remains stayed.  The Company disputes these allegations and does not believe that the ultimate resolution of these lawsuits will have a significant impact on our financial position, results of operations or cash flows.

 

EPA Violation Notice

 

On July 13, 2017, the United States Department of Environmental Protection Agency (“EPA”) sent a Finding of Violation to KUPI alleging several violations of national emissions standards for hazardous air pollutants at KUPI’s Seymour, Indiana facility.  The EPA is giving the company the opportunity to discuss the matter with the agency before filing a formal complaint or assessing fines with respect to the alleged violations.  The Company is conducting an investigation into the matter and cannot reasonably predict the outcome of any potential EPA action at this time.

 

Private Antitrust and Consumer Protection Litigation

 

The Company and certain competitors have been named as defendants in a number of lawsuits filed in 2016 and 2017 alleging that the Company and certain generic pharmaceutical manufacturers have conspired to fix prices of generic digoxin, levothyroxine, ursodiol and baclofen.  These cases are part of a larger group of more than 100 lawsuits generally alleging that over 30 generic pharmaceutical manufacturers and distributors conspired to fix prices for at least 18 different generic drugs in violation of the federal Sherman Act, various state antitrust laws, and various state consumer protection statutes.  The United States also has been granted leave to intervene in the cases.  On April 6, 2017, the Judicial Panel on Multidistrict Litigation (the “JPML”) ordered that all of the cases alleging price-fixing for generic drugs be consolidated for pretrial proceedings in the United States District Court for the Eastern District of Pennsylvania under the caption In re: Generic Pharmaceuticals Pricing Antitrust Litigation.  The various plaintiffs are grouped into three categories — Direct Purchaser Plaintiffs, End Payer Plaintiffs, and Indirect Reseller Purchasers — and filed Consolidated Amended Complaints (“CACs”) against the Company and the other defendants on August 15, 2017.

 

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The CACs naming the Company as a defendant involve generic digoxin, levothyroxine, ursodiol and baclofen.  Pursuant to a court-ordered schedule grouping the 18 different drug cases into three separate tranches, the Company and other generic pharmaceutical manufacturer defendants on October 6, 2017 filed joint and individual motions to dismiss the CACs involving the six drugs in the first tranche, including digoxin.  Those motions are pending.

 

On January 22, 2018, three opt-out direct purchasers filed a complaint alleging an overarching conspiracy and individual conspiracies on behalf of the Company and numerous other defendants to fix the prices of and allocate markets for at least 30 different drugs, including digoxin, doxycycline, levothyroxine, ursodiol and baclofen.  None of the defendants, including the Company, has responded yet to the complaint.

 

In addition to the lawsuits brought by private plaintiffs, the Attorneys General of 45 states, the District of Columbia and Puerto Rico have filed parens patriae lawsuits alleging price-fixing conspiracies by various generic pharmaceutical manufacturers.  The JPML has consolidated the suits by the state Attorneys General in the Eastern District of Pennsylvania as part of the multidistrict litigation. The original lawsuits did not name the Company, but the state Attorneys General on October 31, 2017 filed a motion with the District Court for leave to amend their complaint to add numerous additional defendants, including the Company, and claims relating to 13 additional drugs.  The claim relating to Lannett involves alleged price-fixing for one drug, doxycycline monohydrate, although the state Attorneys General allege that all defendants were part of an overarching, industry-wide conspiracy to allocate markets and fix prices generally.  All of the existing and proposed defendants, including the Company, have opposed the motion of the state Attorneys General.  The motion is pending.

 

The Company believes that it acted in compliance with all applicable laws and regulations.  Accordingly, the Company disputes the allegations set forth in these class actions.

 

Shareholder Litigation

 

In November 2016, a putative class action lawsuit was filed against the Company and two of its officers claiming that the Company damaged the purported class by including in its securities filings false and misleading statements regarding the Company’s drug pricing methodologies and internal controls.  A first amended complaint was filed in May 2017, and the Company filed a motion to dismiss the amended complaint in September 2017.  In December 2017, counsel for the putative class filed a second amended complaint, and the Court denied as moot the Company’s motion to dismiss the first amended complaint.  The Company filed a motion to dismiss the second amended complaint in February 2018.  The Company cannot reasonably predict the outcome of the suit at this time.

 

Patent Infringement (Paragraph IV Certification)

 

There is substantial litigation in the pharmaceutical industry with respect to the manufacture, use and sale of new products which are the subject of conflicting patent and intellectual property claims.  Certain of these claims relate to paragraph IV certifications, which allege that an innovator patent is invalid or would not be infringed upon by the manufacture, use, or sale of the new drug.

 

Zomig®

 

The Company filed with the Food and Drug Administration an ANDA No. 206350, along with a paragraph IV certification, alleging that the two patents associated with the Zomig® nasal spray product (U.S. Patent No. 6,750,237 and U.S. Patent No. 67,220,767) are invalid.

 

In July 2014, AstraZeneca AB, AstraZeneca UK Limited and Impax Laboratories, Inc. filed two patent infringement lawsuits in the United States District Court for the District of Delaware, alleging that the Company’s filing of ANDA No. 206350 constitutes an act of patent infringement and seeking a declaration that the two patents at issue are valid and infringed.

 

In September 2014, the Company filed a motion to dismiss one patent infringement lawsuit for lack of standing and responded to the second lawsuit by denying that any valid patent claim would be infringed.  In the second lawsuit, the Company also counterclaimed for a declaratory judgment that the patent claims are invalid and not infringed.  The Court has consolidated the two actions and denied the motion to dismiss the first action without prejudice.

 

In July 2015, the Company filed with the United States Patent and Trademark Office (“USPTO”) a Petition for Inter Partes Review of each of the patents in suit seeking to reject as invalid all claims of the patents in suit.  The USPTO has issued a decision denying initiation of the Inter Partes Review.

 

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A trial was conducted in September 2016.  The Court issued its decision on March 29, 2017, finding that Lannett did not prove that the patents at issue are invalid.  The Company has appealed the decision. All briefing to the appellate court has been submitted, and oral argument before the appellate court was conducted on April 5, 2018. A final decision of the appellate court is expected in 2018.

 

Thalomid®

 

The Company filed with the Food and Drug Administration an ANDA No. 206601, along with a paragraph IV certification, alleging that the fifteen patents associated with the Thalomid drug product (U.S. Patent Nos. 6,045,501; 6,315,720; 6,561,976; 6,561,977; 6,755,784; 6,869,399; 6,908,432; 7,141,018; 7,230,012; 7,435,745; 7,874,984; 7,959,566; 8,204,763;  8,315,886; 8,589,188 and 8,626,53) are invalid, unenforceable and/or not infringed.  On January 30, 2015, Celgene Corporation and Children’s Medical Center Corporation filed a patent infringement lawsuit in the United States District Court for the District of New Jersey, alleging that the Company’s filing of ANDA No. 206601 constitutes an act of patent infringement and seeking a declaration that the patents at issue are valid and infringed.  The Company filed an answer and affirmative defenses, and an amended answer to the complaint.

 

A settlement agreement was reached and the Court dismissed the lawsuit in October 2017.  Pursuant to the settlement agreement, the Company entered into a license agreement that permits Lannett to manufacture and market in the U.S. its generic thalidomide product as of August 1, 2019 or earlier under certain circumstances.

 

SUPREP®

 

The Company filed ANDA No. 209941 with the Food and Drug Administration seeking approval to sell a bowel preparation oral solution (the “Company’s Oral Solution”), along with a paragraph IV certification, alleging that US Patent 6,946,149 associated with the Suprep® bowel preparation kit would not be infringed by the Company’s Oral Solution and/or that the patent is invalid.

 

In March 2017, Braintree Laboratories, Inc. (“Braintree”) filed a patent infringement lawsuit in the United States District Court for the District of Delaware (C.A. No. 1:17-cv-00293-GMS), alleging that the Company’s filing of ANDA No. 209941 constitutes an act of patent infringement and seeking a declaration that the patent at issue was infringed by the submission of ANDA No. 209941.  The Company answered the complaint denying infringement and raising invalidity as a defense, and has filed counterclaims seeking a declaration of non-infringement and invalidity.  On July 28, 2017, the Company filed a motion for judgment on the pleadings, seeking a ruling that its ANDA product does not infringe the Braintree patent and seeking judgment as a matter of law.  Braintree opposed the motion and has alternatively requested that the Court delay its decision on the motion until discovery is taken.  The Company opposed Braintree’s request to delay the decision.  While the motions were pending, the parties agreed to resolve this dispute.  The parties signed a confidential settlement agreement and filed a Stipulation of Dismissal Without Prejudice on December 13, 2017.  On December 17, 2017, the Court granted the parties’ Stipulation of Dismissal Without Prejudice.  In connection with the settlement agreement, the Company received $3.5 million, which is included in Other Income within the Consolidated Statements of Operations.

 

Although the Company cannot currently predict the length or outcome of paragraph IV litigation, legal expenses associated with these lawsuits could have a significant impact on the financial position, results of operations and cash flows of the Company.

 

Other Litigation Matters

 

The Company is also subject to various legal proceedings arising out of the normal course of its business including, but not limited to, product liability, intellectual property, patent infringement claims and antitrust matters.  It is not possible to predict the outcome of these various proceedings.  An adverse determination in any of these proceedings in the future could have a significant impact on the financial position, results of operations and cash flows of the Company.

 

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Table of Contents

 

Note 13.  Commitments

 

Leases

 

The Company leases certain manufacturing and office equipment, in the ordinary course of business.  These leases are typically renewed annually.  Rental and lease expense was not material for all periods presented.

 

Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) for the remainder of Fiscal 2018 and the twelve month periods ending June 30 thereafter are as follows:

 

(In thousands)

 

Amounts Due

 

Remainder of 2018

 

$

437

 

2019

 

1,835

 

2020

 

1,855

 

2021

 

1,406

 

2022

 

1,080

 

Thereafter

 

5,238

 

Total

 

$

11,851

 

 

Other Commitment

 

During the third quarter of Fiscal 2017, the Company signed an agreement with a company operating in the pharmaceutical business, under which the Company agreed to provide up to $15.0 million in revolving loans for the purpose of expansion and other business needs.  The decision to provide any portion of the revolving loan is at the Company’s sole discretion.  At any time after the outstanding revolving loan balance is equal to or greater than $7.5 million, the Company has the option to convert the first $7.5 million into a 50% ownership interest in the entity.  As of March 31, 2018, $10.9 million was outstanding under the revolving loan. The board of the entity is comprised of five members, two of which are employees of the Company.  Based on the guidance set forth in ASC 810-10 Consolidation, the Company has concluded that it has a variable interest in the entity.  However, the Company is not the primary beneficiary to the entity and as such, is not required to consolidate the entity’s results of operations.

 

Note 14.  Accumulated Other Comprehensive Loss

 

The Company’s Accumulated Other Comprehensive Loss was comprised of the following components as of March 31, 2018 and 2017:

 

(In thousands)

 

March 31,
2018

 

March 31,
2017

 

Foreign Currency Translation

 

 

 

 

 

Beginning Balance, June 30

 

$

(222

)

$

(295

)

Net gain (loss) on foreign currency translation (net of tax of $0 and $0)

 

(228

)

114

 

Reclassifications to net income (net of tax of $0 and $0)

 

 

 

Other comprehensive income (loss), net of tax

 

(228

)

114

 

Ending Balance, March 31

 

(450

)

(181

)

Total Accumulated Other Comprehensive Loss

 

$

(450

)

$

(181

)

 

Note 15.  Earnings (Loss) Per Common Share

 

A dual presentation of basic and diluted earnings (loss) per common share is required on the face of the Company’s Consolidated Statement of Operations as well as a reconciliation of the computation of basic earnings per common share to diluted earnings per common share.  Basic earnings (loss) per common share excludes the dilutive impact of potentially dilutive securities and is computed by dividing net income (loss) attributable to Lannett Company, Inc. by the weighted average number of common shares outstanding for the period.  Diluted earnings (loss) per common share is computed using the treasury stock method and includes the effect of potential dilution from the exercise of outstanding stock options, a warrant and treats unvested restricted stock and performance-based shares as if they were vested.  Potentially dilutive securities have been excluded in the weighted average number of common shares used for the calculation of earnings per share in periods of net loss because the effect of including such securities would be anti-dilutive.  A reconciliation of the Company’s basic and diluted earnings (loss) per common share was as follows:

 

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Table of Contents

 

 

 

Three Months Ended
March 31,

 

(In thousands, except share and per share data)

 

2018

 

2017

 

 

 

 

 

 

 

Net income attributable to Lannett Company, Inc.

 

$

12,770

 

$

14,929

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

37,136,945

 

36,849,208

 

Effect of potentially dilutive stock options, warrants and restricted stock awards

 

1,150,060

 

903,096

 

Diluted weighted average common shares outstanding

 

38,287,005

 

37,752,304

 

 

 

 

 

 

 

Earnings per common share attributable to Lannett Company, Inc.:

 

 

 

 

 

Basic

 

$

0.34

 

$

0.41

 

Diluted

 

$

0.33

 

$

0.40

 

 

 

 

Nine Months Ended
March 31,

 

(In thousands, except share and per share data)

 

2018

 

2017

 

 

 

 

 

 

 

Net income (loss) attributable to Lannett Company, Inc.

 

$

40,049

 

$

(6,307

)

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

37,064,781

 

36,785,829

 

Effect of potentially dilutive stock options, warrants and restricted stock awards

 

1,047,412

 

 

Diluted weighted average common shares outstanding

 

38,112,193

 

36,785,829

 

 

 

 

 

 

 

Earnings (loss) per common share attributable to Lannett Company, Inc.:

 

 

 

 

 

Basic

 

$

1.08

 

$

(0.17

)

Diluted

 

$

1.05

 

$

(0.17

)

 

The number of anti-dilutive shares that have been excluded in the computation of diluted earnings per share for the three months ended March 31, 2018 and 2017 was 3.0 million.  The number of anti-dilutive shares that have been excluded in the computation of diluted earnings per share for the nine months ended March 31, 2018 and 2017 was 3.0 million and 4.4 million, respectively.

 

Note 16.  Warrant

 

In connection with the KUPI acquisition on November 25, 2015, Lannett issued to UCB Manufacturing a warrant to purchase up to a total of 2.5 million shares of Lannett’s common stock (the “Warrant”).

 

The Warrant has a term of three years (expiring November 25, 2018) and an exercise price of $48.90 per share, subject to customary adjustments, including for stock splits, dividends and combinations. The Warrant also has a “weighted average” anti-dilution adjustment provision.  The fair value included as part of the total consideration transferred to UCB at the acquisition date was $29.9 million.  The fair value assigned to the Warrant was determined using the Black-Scholes valuation model.  The Company concluded that the warrant was indexed to its own stock and therefore the Warrant has been classified as an equity instrument.

 

Note 17.  Share-Based Compensation

 

At March 31, 2018, the Company had two share-based employee compensation plans (the 2011 Long-Term Incentive Plan “LTIP” and the 2014 “LTIP”).  Together these plans authorized an aggregate total of 4.5 million shares to be issued.  The plans have a total of 1.5 million shares available for future issuances.

 

The Company issues share-based compensation awards with a vesting period ranging up to 3 years and a maximum contractual term of 10 years.  The Company issues new shares of stock when stock options are exercised.  As of March 31, 2018, there was $10.6 million of total unrecognized compensation cost related to non-vested share-based compensation awards.  That cost is expected to be recognized over a weighted average period of 2.0 years.

 

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Table of Contents

 

Stock Options

 

The Company measures share-based compensation cost for options using the Black-Scholes option pricing model.  The following table presents the weighted average assumptions used to estimate fair values of the stock options granted during the nine months ended March 31, 2018 and 2017:

 

 

 

Nine Months Ended

 

 

 

March 31, 2018

 

March 31, 2017

 

Risk-free interest rate

 

2.12

%

1.1

%

Expected volatility

 

57.6

%

55.6

%

Expected dividend yield

 

%

%

Forfeiture rate

 

6.5

%

6.5

%

Expected term (in years)

 

5.4 years

 

5.2 years

 

Weighted average fair value

 

$

11.25

 

$

15.33

 

 

Expected volatility is based on the historical volatility of the price of our common shares during the historical period equal to the expected term of the option.  The Company uses historical information to estimate the expected term, which represents the period of time that options granted are expected to be outstanding.  The risk-free rate for the period equal to the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.  The forfeiture rate assumption is the estimated annual rate at which unvested awards are expected to be forfeited during the vesting period.  This assumption is based on our actual forfeiture rate on historical awards.  Periodically, management will assess whether it is necessary to adjust the estimated rate to reflect changes in actual forfeitures or changes in expectations.  Additionally, the expected dividend yield is equal to zero, as the Company has not historically issued and has no immediate plans to issue a dividend.

 

A stock option roll-forward as of March 31, 2018 and changes during the nine months then ended, is presented below:

 

(In thousands, except for weighted average price and life data)

 

Awards

 

Weighted-
Average
Exercise
Price

 

Aggregate
Intrinsic
Value

 

Weighted
Average
Remaining
Contractual
Life (yrs.)

 

 

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2017

 

1,475

 

$

18.02

 

$

12,212

 

5.7

 

Granted

 

50

 

$

21.43

 

 

 

 

 

Exercised

 

(404

)

$

7.13

 

$

3,897

 

 

 

Forfeited, expired or repurchased

 

(20

)

$

32.31

 

 

 

 

 

Outstanding at March 31, 2018

 

1,101

 

$

21.93

 

$

4,205

 

5.6

 

 

 

 

 

 

 

 

 

 

 

Vested and expected to vest at March 31, 2018

 

1,096

 

$

21.92

 

$

4,205

 

5.6

 

Exercisable at March 31, 2018

 

1,044

 

$

21.60

 

$

4,205

 

5.4

 

 

Restricted Stock

 

The Company measures restricted stock compensation costs based on the stock price at the grant date less an estimate for expected forfeitures.  The annual forfeiture rate used to calculate compensation expense was 5.6% and 6.5% for the nine months ended March 31, 2018 and 2017, respectively.

 

A summary of restricted stock awards as of March 31, 2018 and changes during the nine months then ended, is presented below:

 

(In thousands, except for weighted average price and life data)

 

Awards

 

Weighted
Average Grant -
date Fair Value

 

Aggregate
Intrinsic Value

 

 

 

 

 

 

 

 

 

Non-vested at June 30, 2017

 

334

 

$

30.71

 

 

 

Granted

 

588

 

$

18.24

 

 

 

Vested

 

(177

)

$

31.30

 

$

3,901

 

Forfeited

 

(57

)

$

21.70

 

 

 

Non-vested at March 31, 2018

 

688

 

$

20.63

 

 

 

 

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Performance-Based Shares

 

On September 22, 2017, the Company approved and granted performance-based awards to certain key executives.  The stock-settled awards will cliff vest based on relative Total Shareholder Return (“TSR”) over a three-year period.  The Company measures share-based compensation cost for TSR awards using a Monte-Carlo simulation model.

 

A summary of performance-based share awards as of March 31, 2018 and changes during the nine months then ended, is presented below:

 

(In thousands, except for weighted average price and life data)

 

Awards

 

Weighted
Average Grant -
date Fair Value

 

Aggregate
Intrinsic Value

 

 

 

 

 

 

 

 

 

Non-vested at June 30, 2017

 

 

$

 

 

 

Granted

 

47

 

$

25.58

 

 

 

Vested

 

(21

)

$

25.58

 

$

500

 

Forfeited

 

 

$

 

 

 

Non-vested at March 31, 2018

 

26

 

$

25.58

 

 

 

 

In connection with the termination of the employment of Arthur P. Bedrosian, the Company’s former Chief Executive Officer, the Company entered into a separation agreement pursuant to which he received certain benefits including, among others, accelerated vesting of his outstanding equity awards.

 

Employee Stock Purchase Plan

 

In February 2003, the Company’s stockholders approved an Employee Stock Purchase Plan (“ESPP”).  Employees eligible to participate in the ESPP may purchase shares of the Company’s stock at 85% of the lower of the fair market value of the common stock on the first day of the calendar quarter or the last day of the calendar quarter.  Under the ESPP, employees can authorize the Company to withhold up to 10% of their compensation during any quarterly offering period, subject to certain limitations.  The ESPP was implemented on April 1, 2003 and is qualified under Section 423 of the Internal Revenue Code.  The Board of Directors authorized an aggregate total of 1.1 million shares of the Company’s common stock for issuance under the ESPP.  During the nine months ended March 31, 2018 and 2017, 46 thousand shares and 43 thousand shares were issued under the ESPP, respectively.  As of March 31, 2018, 588 thousand total cumulative shares have been issued under the ESPP.

 

The following table presents the allocation of share-based compensation costs recognized in the Consolidated Statements of Operations by financial statement line item:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

March 31,

 

March 31,

 

(In thousands)

 

2018

 

2017

 

2018

 

2017

 

Selling, general and administrative expenses

 

$

1,638

 

$

1,345

 

$

5,350

 

$

4,568

 

Research and development expenses

 

149

 

175

 

477

 

500

 

Cost of sales

 

478

 

269

 

1,191

 

894

 

Total

 

$

2,265

 

$

1,789

 

$

7,018

 

$

5,962

 

 

 

 

 

 

 

 

 

 

 

Tax benefit at statutory rate

 

$

668

 

$

653

 

$

2,070

 

$

2,176

 

 

Note 18.  Employee Benefit Plan

 

The Company has a 401k defined contribution plan (the “Plan”) covering substantially all employees.  Pursuant to the Plan provisions, the Company is required to make matching contributions equal to 50% of each employee’s contribution, not to exceed 4% of the employee’s compensation for the Plan year.  Contributions to the Plan during the three months ended March 31, 2018 and 2017 were $675 thousand and $527 thousand, respectively.  Contributions to the Plan during the nine months ended March 31, 2018 and 2017 were $1.7 million and $1.6 million, respectively.

 

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Note 19.  Income Taxes

 

The Company uses the liability method to account 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.

 

The federal, state and local income tax benefit for the three months ended March 31, 2018 was $2.3 million compared to income tax expense of $7.3 million for the three months ended March 31, 2017.  The effective tax rates for the three months ended March 31, 2018 and 2017 were (21.7)% and 33.0%, respectively.  The federal, state and local income tax expense for the nine months ended March 31, 2018 was $23.3 million compared to income tax benefit of $2.0 million for the nine months ended March 31, 2017.  The effective tax rates were 36.8% and 24.2%, respectively.

 

The effective tax rate for the nine months ended March 31, 2018 was higher compared to the same prior-year period primarily due to 2017 Tax Reform which was signed into law on December 22, 2017.  Among numerous provisions included in the new law was the reduction of the statutory corporate federal income tax rate from 35% to 21%.  In the second quarter of Fiscal 2018, the Company applied the newly enacted corporate federal income tax rate of 21% resulting in an approximately $11.1 million revaluation of the Company’s net long term deferred tax assets which are expected to reverse in future periods.  During the third quarter of Fiscal 2018, the Company revised its provisional calculation for timing items related to the filing of its Fiscal 2017 tax return.  As a result, the Company reduced the previously recorded revaluation amount to $8.1 million in the third quarter of Fiscal 2018.  The increase in the effective tax rate as a result of the revaluation was partially offset by a lower blended federal statutory tax rate of approximately 28.0% as compared to 35.0% in the same prior-year period.  This resulted in an approximately $4.6 million income tax benefit for the nine months ended March 31, 2018.

 

The effective tax rate for the three months ended March 31, 2018 was lower compared to the same prior-year period primarily due to the impact for timing items related to the filing of the Company’s Fiscal 2017 tax return discussed above.  The lower blended federal statutory tax rate of approximately 28.0% due to 2017 Tax Reform also contributed to a lower effective tax rate.  This resulted in an approximately $763 thousand income tax benefit for the three months ended March 31, 2018.

 

Overall, the Company anticipates the decrease in the U.S. federal statutory rate resulting from the enactment of the 2017 Tax Reform will have a favorable impact on future U.S. tax expense and operating cash flows.  The Company initially recorded the impact of 2017 Tax Reform in the second quarter of Fiscal 2018, inclusive of provisional amounts based on reasonable estimates.  However, the final impact of 2017 Tax Reform may differ due to and among other things, changes in interpretations, assumptions made by the Company, the issuance of additional guidance, and actions the Company may take as a result of 2017 Tax Reform.  Adjustments, if any, will be made in accordance with SAB 118.

 

The Company may recognize the tax benefit from an uncertain tax position claimed on a tax return only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.

 

As of March 31, 2018 and June 30, 2017, the Company has total unrecognized tax benefits of $1.7 million and $5.9 million, respectively.  The decrease was primarily the result of an expiration in the statute of limitations related to several state-related unrecognized tax benefits.  As a result of the positions taken during the period, the Company has not recorded any interest and penalties for the period ended March 31, 2018 in the statement of operations and no cumulative interest and penalties have been recorded in the Company’s statement of financial position as of March 31, 2018 and June 30, 2017.  The Company will recognize interest accrued on unrecognized tax benefits in interest expense and any related penalties in operating expenses.

 

The Company files income tax returns in the United States federal jurisdiction and various states.  The Company’s tax returns for Fiscal Year 2014 and prior generally are no longer subject to review as such years generally are closed.  The Company’s Fiscal Year 2016 federal return is currently under examination by the Internal Revenue Service (“IRS”).  The Company cannot reasonably predict the outcome of the examination at this time.

 

Note 20.  Related Party Transactions

 

The Company had sales of $962 thousand and $823 thousand during the three months ended March 31, 2018 and 2017, respectively, to a generic distributor, Auburn Pharmaceutical Company (“Auburn”).  Sales to Auburn for the nine months ended March 31, 2018 and 2017 were $3.0 million and $2.8 million, respectively.  Jeffrey Farber, Chairman of the Board, is the owner of Auburn.  Accounts receivable includes amounts due from Auburn of $583 thousand and $751 thousand at March 31, 2018 and June 30, 2017, respectively.

 

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Table of Contents

 

The Company also had sales of $406 thousand and $617 thousand during the three months ended March 31, 2018 and 2017, respectively, to a generic distributor, KeySource.  Sales to KeySource for the nine months ended March 31, 2018 and 2017 were $1.4 million and $946 thousand, respectively.  Albert Paonessa, a current board member, was appointed the CEO of KeySource in May 2017.  Accounts receivable includes amounts due from KeySource of $340 thousand and $606 thousand as of March 31, 2018 and June 30, 2017, respectively.

 

In connection with the termination of the employment of Arthur P. Bedrosian, the Company’s former Chief Executive Officer, effective as of December 31, 2017, the Company entered into a separation agreement pursuant to which he will receive certain benefits including, among others, 36 months base salary, a pro-rated Fiscal 2018 cash bonus as well as accelerated vesting of his outstanding equity awards.  The total benefits resulted in an approximately $3.4 million charge to the Company’s consolidated statements of operations in the second quarter of Fiscal 2018.  On January 20, 2018, the Company also entered into a consulting agreement with Mr. Bedrosian to work on several important projects, primarily involving existing and new partnering efforts to expand and diversify opportunities, including but not limited to spearheading the effort to transition and strengthen the Company’s existing contractual relationships with its key partners.

 

Note 21.  Material Contracts with Suppliers

 

Jerome Stevens Pharmaceuticals Distribution Agreement:

 

The Company’s primary finished goods inventory supplier is JSP, in Bohemia, New York.  Purchases of finished goods inventory from JSP accounted for approximately 37% and 33% of the Company’s inventory purchases in the three months ended March 31, 2018 and 2017, respectively.  Purchases of finished goods inventory from JSP accounted for 36% and 37% of the Company’s inventory purchases in the nine months ended March 31, 2018 and 2017, respectively.

 

On August 19, 2013, the Company entered into an agreement with JSP to extend its initial contract to continue as the exclusive distributor in the United States of three JSP products: Butalbital, Aspirin, Caffeine with Codeine Phosphate Capsules USP; Digoxin Tablets USP; and Levothyroxine Sodium Tablets USP.  The amendment to the original agreement extends the initial contract, which was due to expire on March 22, 2014, for five years through March 2019.  In connection with the amendment, the Company issued a total of 1.5 million shares of the Company’s common stock to JSP and JSP’s designees.  In accordance with its policy related to renewal and extension costs for recognized intangible assets, the Company recorded a $20.1 million expense in cost of sales, which represents the fair value of the shares on August 19, 2013.  If the parties agree to a second five-year extension from March 23, 2019 to March 23, 2024, the Company is required to issue to JSP or its designees an additional 1.5 million shares of the Company’s common stock.  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 renewal term of the JSP Distribution Agreement, the Company is required to use commercially reasonable efforts to purchase minimum dollar quantities of JSP products.  There is no guarantee that the Company will be able to meet the minimum purchase requirements.  If the Company does not meet the minimum purchase requirements, JSP’s sole remedy is to terminate the JSP Distribution Agreement.

 

Note 22.  Subsequent Events

 

On May 4, 2018, the Company entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”) by and between the Company and a subsidiary of Endo International plc (“Endo”), pursuant to which the Company acquired a portfolio of 23 U.S. FDA-approved ANDAs, one ANDA that is pending FDA approval, and manufacturing and other information related to the products (the “Assets”).  The purchase of the Assets closed simultaneously with the execution of the Asset Purchase Agreement.  Pursuant to the Asset Purchase Agreement, the purchase price for the Assets was $12 million, $10 million of which was paid in cash at closing, $1 million of which is due within five days after the filing of transfer of ownership letters with the FDA for the ANDAs and $1 million of which is due within five days after the Company first supplies or distributes any products relating to any of the purchased ANDAs to a third party.

 

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Table of Contents

 

ITEM 2.                        MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Cautionary Statement About Forward-Looking Statements

 

This Report on Form 10-Q and certain information incorporated herein by reference contains forward-looking statements which are not historical facts made pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements are not promises or guarantees and investors are cautioned that all forward-looking statements involve risks and uncertainties, including but not limited to the impact of competitive products and pricing, product demand and market acceptance, new product development, acquisition-related challenges, the regulatory environment, interest rate fluctuations, reliance on key strategic alliances, availability of raw materials, fluctuations in operating results and other risks detailed from time to time in our filings with the Securities and Exchange Commission (the “SEC”). These statements are based on management’s current expectations and are naturally subject to uncertainty and changes in circumstances.  We caution you not to place undue reliance upon any such forward-looking statements which speak only as of the date made.  Lannett is under no obligation to, and expressly disclaims any such obligation to, update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.

 

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, 2017.  All references to “Fiscal 2018” or “Fiscal Year 2018” shall mean the fiscal year ending June 30, 2018 and all references to “Fiscal 2017” or “Fiscal Year 2017” shall mean the fiscal year ended June 30, 2017.

 

Company Overview

 

Lannett Company, Inc. (a Delaware corporation) and its subsidiaries (collectively, the “Company”, “Lannett”, “we” or “us”) develop, manufacture, package, market and distribute solid oral and extended release (tablets and capsules), topical, nasal and oral solution finished dosage forms of drugs, that address a wide range of therapeutic areas.  Certain of these products are manufactured by others and distributed by the Company.  The Company also manufactures active pharmaceutical ingredients through its Cody Labs subsidiary, providing a vertical integration benefit.  Additionally, the Company is pursuing partnerships, research contracts and internal expansion for the development and production of other dosage forms including: ophthalmic, nasal, patch, foam, buccal, sublingual, soft gel, injectable and oral dosages.

 

On November 25, 2015, the Company completed the acquisition of Kremers Urban Pharmaceutical, Inc. (“KUPI”), the former subsidiary of global biopharmaceuticals company UCB S.A.  KUPI is a specialty pharmaceuticals manufacturer focused on the development of products that are difficult to formulate or utilize specialized delivery technologies.  Strategic benefits of the acquisition include expanded manufacturing capacity, a diversified product portfolio and pipeline and complementary research and development expertise.

 

The Company operates pharmaceutical manufacturing plants in Philadelphia, Pennsylvania; Cody, Wyoming; Carmel, New York and Seymour, Indiana.  The Company’s customers include generic pharmaceutical distributors, drug wholesalers, chain drug stores, private label distributors, mail-order pharmacies, other pharmaceutical manufacturers, managed care organizations, hospital buying groups, governmental entities and health maintenance organizations.

 

2016 Restructuring Plan

 

On February 1, 2016, in connection with the acquisition of KUPI, the Company announced a plan related to the future integration of KUPI and the Company’s operations (the “2016 Restructuring Program”). The plan focuses on the closure of KUPI’s corporate functions and the consolidation of manufacturing, sales, research and development and distribution functions. The Company estimates that it will incur an aggregate of up to approximately $19.0 million in restructuring charges for actions that have been announced or communicated since the 2016 Restructuring Program began.  Of this amount, approximately $10.0 million relates to employee separation costs, approximately $1.0 million relates to contract termination costs and approximately $8.0 million relates to facility closures costs and other actions.

 

The plan is currently estimated to generate annualized synergies of approximately $50.0 million by the end of Fiscal 2018 and is expected to achieve an ultimate annual run rate of synergies totaling approximately $65.0 million by the end of Fiscal 2020.

 

These amounts are estimates based on the information currently available to management. It is possible that additional charges and future cash payments could occur in relation to the restructuring actions.

 

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Table of Contents

 

Financial Summary

 

For the third quarter of Fiscal Year 2018, net sales increased to $174.4 million compared to $165.7 million in the same prior-year period.  Total net sales increased to $174.4 million compared to $161.7 million in the prior-year period, which included a $4.0 million settlement agreement adjustment.  Gross profit decreased to $67.1 million compared to $72.4 million in the prior-year period and gross profit percentage decreased to 38% compared to 45% in the prior-year period.  Excluding the impact of the settlement agreement adjustment, gross profit as a percentage of net sales decreased to 38% from 46% in the prior-year period.  R&D expenses decreased 67% to $2.7 million compared to $8.3 million in the third quarter of Fiscal Year 2017 while SG&A expenses decreased 20% to $14.1 million from $17.6 million in the prior-year period.  Acquisition and integration-related expenses were $1.3 million in the prior-year period.  Restructuring expenses decreased to $1.4 million from $1.6 million in the prior-year period.  Operating income for the third quarter of Fiscal Year 2018 was $33.3 million, which included a $15.5 million loss on sale of an intangible asset, compared to $43.6 million in the third quarter of Fiscal Year 2017.  Net income attributable to the Company for the third quarter of Fiscal Year 2018 was $12.8 million, or $0.33 per diluted share compared to $14.9 million, or $0.40 per diluted share in the third quarter of Fiscal Year 2017.

 

For the first nine months of Fiscal 2018, net sales increased to $513.7 million compared to $498.2 million in the same prior-year period.  Total net sales increased to $513.7 million compared to $494.2 million in the prior-year period, which included a $4.0 million settlement agreement adjustment.  Gross profit decreased $20.2 million to $222.2 million, compared to $242.3 million in the prior-year period and gross profit percentage decreased to 43% compared to 49% in the prior-year period.  Excluding the impact of the settlement agreement adjustment, gross profit as a percentage of net sales decreased to 43% from 49% in the prior-year period.  R&D expenses decreased 32% to $20.9 million compared to $30.7 million in the first nine months of Fiscal 2018 while SG&A expenses increased 8% to $61.6 million from $57.0 million in the prior-year period.  Acquisition and integration-related expenses decreased to $83 thousand from $3.7 million in the prior-year period.  Restructuring expenses decreased to $3.0 million from $5.3 million in the prior-year period.  Operating income for the first nine months of Fiscal 2018, which included a $15.5 million loss on sale of an intangible asset, was $121.1 million compared to $57.6 million in the prior-year period, which included an $88.1 million intangible assets impairment charge.  Net income attributable to the Company for the first nine months of Fiscal 2018 was $40.0 million, or $1.05 per diluted share compared to net loss attributable to the Company of $6.3 million, or $0.17 per diluted share in the prior-year period.

 

A more detailed discussion of the Company’s financial results can be found below.

 

Results of Operations - Three months ended March 31, 2018 compared with the three months ended March 31, 2017

 

Total net sales increased to $174.4 million compared to $161.7 million in the prior-year period, which included a $4.0 million reduction for a settlement agreement adjustment.

 

Net sales increased 5% to $174.4 million for the three months ended March 31, 2018.  The following table identifies the Company’s net product sales by medical indication for the three months ended March 31, 2018 and 2017:

 

(In thousands) 

 

Three Months Ended March 31,

 

Medical Indication

 

2018

 

2017

 

Antibiotic

 

$

3,801

 

$

4,474

 

Anti-Psychosis

 

9,336

 

14,433

 

Cardiovascular

 

18,514

 

14,815

 

Central Nervous System

 

8,395

 

11,124

 

Gallstone

 

3,828

 

11,157

 

Gastrointestinal

 

16,562

 

19,441

 

Glaucoma

 

875

 

4,868

 

Migraine

 

12,888

 

7,043

 

Muscle Relaxant