Quality
Manufacturing & Production
Customer Service
Teamwork
Integrity
Research & Development
Professionalism
Reliability & Trust
Lannett Company, Inc.
9000 State Road
Philadelphia, PA 19136
(215) 333-9000, (800) 325-9994
Fax (215) 333-9004
2 0 0 7 A N N U A L R E P O R T
Company Profile
Lannett Company, Inc. (AMEX: LCI) develops, manufactures
and distributes generic prescription pharmaceutical products in
tablet, capsule and oral liquid forms to customers throughout
the United States.
Drug Development Pipeline
FORMULATION
SCALE-UP
CLINICAL TESTING
FDA PENDING
42 Products
8 Products
3 Products
18 ANDAs*
*Abbreviated New Drug Application
BOARD OF DIRECTORS
CORPORATE INFORMATION
William Farber, R.Ph.
Chairman of the Board
Ronald West
Vice Chairman
Director, Beecher Associates
Arthur P. Bedrosian, J.D.
President and Chief Executive Officer, Lannett Company, Inc.
Jeffrey Farber
President, Auburn Pharmaceutical
Garnet Peck, Ph.D.
Professor Emeritus, Purdue University
Department of Industrial and Physical Pharmacy
Kenneth Sinclair, Ph.D.
Professor and Chair of the Accounting Department,
Lehigh University
Albert Wertheimer, Ph.D.
Professor, Temple University School of Pharmacy,
Director, Center for Pharmaceutical Health Services Research
Myron Winkelman, R.Ph.
President, Winkelman Management Consulting, Inc.
MANAGEMENT TEAM
Arthur P. Bedrosian, J.D.
President, Chief Executive Officer, Director
Brian Kearns
Chief Financial Officer,
Vice President—Finance, Treasurer, Secretary
Bernard Sandiford
Vice President—Operations
William Schreck
Vice President—Logistics
Kevin Smith
Vice President—Sales & Marketing
Corporate Headquarters
9000 State Road
Philadelphia, PA 19136
(215) 333-9000
Independent Registered Public Accounting Firm
Grant Thornton LLP
2001 Market Street
Two Commerce Square, Suite 3100
Philadelphia, PA 19103
Legal Counsel
Fox Rothschild LLP
2000 Market Street
Philadelphia, PA 19103
Investor Relations
PondelWilkinson Inc.
1880 Century Park East, Suite 700
Los Angeles, CA 90067
(310) 279-5980
Transfer Agent and Registrar
Registrar and Transfer Company
10 Commerce Drive
Cranford, NJ 07016
(800) 368-5948
Securities Listing
The common stock of Lannett Company, Inc. is traded on
the American Stock Exchange under the symbol “LCI.”
Annual Report and Form 10-K
Additional copies of this annual report
and the Company’s Form 10-K may be
obtained without charge and the exhibits
to the Form 10-K may be obtained for a
nominal fee by writing to:
Lannett Company, Inc.
Investor Relations
9000 State Road
Philadelphia, PA 19136
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements in “Item 1A – Risk Factors”, “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and in other statements located elsewhere in this Annual Report. Any statements made in this Annual Report that are not statements of historical fact or that refer to estimated
or anticipated future events are forward-looking statements. We have based our forward-looking statements on our management’s beliefs and assumptions based on information avail-
able to them at this time. Such forward-looking statements reflect our current perspective of our business, future performance, existing trends and information as of the date of this filing.
These include, but are not limited to, our beliefs about future revenue and expense levels and growth rates, prospects related to our strategic initiatives and business strategies,
express or implied assumptions about government regulatory action or inaction, anticipated product approvals and launches, business initiatives and product development activities,
assessments related to clinical trial results, product performance and competitive environment, and anticipated financial performance. Without limiting the generality of the forego-
ing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,” “estimate,” “continue,” or “pursue,” or the negative other variations thereof or
comparable terminology, are intended to identify forward-looking statements. The statements are not guarantees of future performance and involve certain risks, uncertainties
and assumptions that are difficult to predict. We caution the reader that certain important factors may affect our actual operating results and could cause such results to differ
materially from those expressed or implied by forward-looking statements. We believe the risks and uncertainties discussed under the “Item 1A - Risk Factors” and other risks
and uncertainties detailed herein and from time to time in our SEC filings, may affect our actual results.
We disclaim any obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. We also may make additional disclosures in
our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and in other filings that we may make from time to time with the SEC. Other factors besides those listed here could also
adversely affect us. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995, as amended.
Financial Highlights
Fiscal Year Ended June 30,
2007
2006
2005
2004
2003
Net Sales
Cost of Sales
Gross Profit
$ 82,577,591
$ 64,060,375 $ 44,901,645
$63,781,219
$42,486,758
57,394,751
33,900,045
31,416,908
26,856,875
16,257,794
25,182,840
30,160,330
13,484,737
36,924,344
26,228,964
Operating Expenses
31,147,249
21,706,412
67,124,395
16,093,375
7,168,858
Operating (Loss) Income
(5,964,409)
8,453,918
(53,639,658)
20,830,969
19,060,106
Net (Loss) Income
$ (6,929,008) $ 4,968,922 $ (32,779,596)
$13,215,454
$11,666,887
Total Current Assets
$ 44,285,190
$ 43,486,847
Property and Equipment, Net
27,443,161
19,645,549
Total Assets
Current Liabilities
104,656,100
105,992,064
22,250,243
20,040,608
Long-Term Debt, Less Current Portion
8,987,846
7,649,806
Total Liabilities and Shareholders’ Equity
$104,656,100
$105,992,064
Quarterly Net Sales Trend
(In Millions of Dollars)
Percentage of Net Sales
(By Customer Type)
$22.9
$22.0
$19.5
$20.3
$17.4
34%
6%
60%
$15.7
$15.2
$13.6
$9.4
$7.6
Q3-
FY05
Q4-
FY05
Q1-
FY06
Q2-
FY06
Q3-
FY06
Q4-
FY06
Q1-
FY07
Q2-
FY07
Q3-
FY07
Q4-
FY07
Distributors/Wholesalers
Chain Pharmacies
Mail Order Pharmacies
L A N N E T T C O M P A N Y ,
I N C . 1
,
p m e n t
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v
D e
,
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a
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a
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— A
L
A
B
ORATO R Y S E R V I C E S
Dear Shareholders:
In fiscal 2007, Lannett Company made
excellent progress laying the groundwork
for future growth. We successfully com-
pleted plans for plant expansion, signifi-
cantly added to our product pipeline,
established new strategic relationships and
acquired a bulk raw materials supplier. The
year also posed some challenges, most
notably a backlog at the U.S. Food and
Drug Administration (FDA) that has delayed
the approval of our Abbreviated New Drug
Applications (ANDAs). We are confident,
however, that these product applications
will ultimately be approved.
Net sales for fiscal 2007 were $82.6 million,
an increase of 29% over the prior year. Gross
profit was $25.2 million, compared with $30.2
million for the prior year. Our topline growth
was fueled by increased sales of distributed
products, which generally carry lower margins
than in-house manufactured products.
The Company reported a net loss for fiscal
2007 of $6.9 million, which included a $7.8
million impairment of a note receivable due
from a bulk raw materials supplier that we
acquired in April 2007. This compares with net
income of $5.0 million in fiscal 2006. Cash was
$5.2 million at June 30, 2007.
Room to Grow
In August of last year, we announced plans to
lease, with an option to purchase, a new 65,000
square-foot facility located on seven acres in the
City of Philadelphia. We added this facility to
broaden our manufacturing, product development
and warehousing capacity. The new space also
allows us to reconfigure existing facilities, as well
as more than double our manufacturing capacity.
Product Approvals and Distribution
In fiscal 2007, we received FDA approval and
commenced marketing several products, includ-
ing Danazol capsules 50mg and 100mg, a
drug used to treat endometriosis. The addition
of these two dosages to our already approved
200mg product allows us to market the full line
of oral Danazol. Lannett also received FDA
approval to market Baclofen 10mg tablets, bol-
stering our existing product offering of Baclofen
20mg tablets. Baclofen is used to help alleviate
signs and symptoms of spasticity resulting from
multiple sclerosis.
In addition to product approvals, Lannett com-
menced marketing and distribution of Meloxicam, a
drug indicated for the relief of signs and symptoms
of osteoarthritis and rheumatoid arthritis. We cur-
rently have more than 70 products in various stages
of development, including 18 product applications
pending at the FDA.
William Farber
Chairman
Arthur P. Bedrosian
President and
Chief Executive Officer
2 L A N N E T T C O M P A N Y ,
I N C .
S t a b i
i
l
t y , & P r o d u c t
I d e n t i f i c a t i o n
During the last few years, we have focused on
adding to our product offering by forming strate-
gic relationships as well as through an internal
product development program. Our pipeline is
now the largest in the Company’s history.
We are confident that our robust pipeline,
coupled with the progress we made in fiscal
2007, will help us reap solid returns and real-
ize the goals of our customers, employees
and shareholders.
Sincerely,
William Farber
Chairman
Arthur P. Bedrosian
President and
Chief Executive Officer
Research Agreement
In January 2007, we signed a research agreement
with Pharmaseed Bioservices to formulate a certain
topical pharmaceutical product, sales of which were
more than $400 million in the year ending June
2007, according to Wolters Kluwer. Under the terms
of the agreement, Lannett will assemble, submit and
own the ANDA for the product. We also acquired
the worldwide distribution rights to this product.
Supply Agreements and Acquisitions
We also signed a supply agreement in January
2007 with Banner Pharmacaps, Inc. for a certain
pharmaceutical product, sales of which were
approximately $54 million in 2005, according to
Wolters Kluwer. In April, we acquired a privately-
owned manufacturer/supplier of bulk active phar-
maceutical ingredients (API) to help facilitate the
Company’s growth and expand our product
offering. This acquisition provides access to raw
materials, including certain difficult-to-source
pharmaceutical ingredients, as well as the capa-
bility to manufacture a new dosage form, thereby
vertically integrating the Company.
Internal Efficiencies
Recently, we introduced a new Company-wide
program, called ”Savings for Success,” to help
manage costs. This new program encourages
and rewards employees to think creatively about
ways to reduce costs throughout the organiza-
tion. Since the program’s inception, we have
reduced costs by more than $1.5 million. We
expect additional savings in the future.
Lannett produces
and distributes
its own line of
high quality
pharmaceutical
products.
These products
are available to
chain drug stores,
wholesalers and
distributors under
Lannett's
name or as a
private label.
3
Butalbital, Aspirin and Caffeine Capsules
Migraine Headache
Butalbital, Aspirin, Caffeine with Codeine Phosphate Capsules
Migraine Headache
Fiorinal w/Codeine #3®
Products
NAME
Acetazolamide Tablets
Baclofen Tablets
Clindamycin HCl Capsules
Danazol Capsules
Dicyclomine Tablets/Capsules
Digoxin Tablets
Diphenoxylate with Atropine Sulfate Tablets
Doxycycline Tablets
Doxycycline Hyclate Tablets
Hydrochlorothiazide
Hydromorphone HCl Tablets
Levothyroxine Sodium Tablets
Meloxicam
Methocarbamol Tablets
MEDICAL INDICATION
EQUIVALENT BRAND
Glaucoma
Muscle Relaxer
Diamox®
Lioresal®
Fiorinal®
Antibiotic
Endometriosis
Irritable Bowels
Congestive Heart Failure
Diarrhea
Antibiotic
Antibiotic
Diuretic
Pain Management
Cleocin®
Danocrine®
Bentyl®
Lanoxin®
Lomotil®
Adoxa®
Periostat®
Hydrodiuril®
Dilaudid®
Thyroid Deficiency
Levoxyl®/Synthroid®
Arthritis
Muscle Relaxer
Mobic®
Robaxin®
Estratest ®
Roxanol®
Methyltestosterone/Esterified Estrogens Tablets
Hormone Replacement
Morphine Sulfate Oral Solution
Pain Management
Oxycodone HCl Oral Solution
Pain Management
Roxicodone®
Phentermine HCl Tablets
Pilocarpine HCl Tablets
Primidone Tablets
Probenecid Tablets
Sulfamethoxazole w/Trimethoprim
Terbutaline Sulfate Tablets
Unithroid® Tablets
4 L A N N E T T C O M P A N Y ,
I N C .
Weight Loss
Dryness of the Mouth
Epilepsy
Gout
Antibacterial
Bronchospasms
Thyroid Deficiency
Adipex-P®
Salagen®
Mysoline®
Benemid®
Bactrim®
Brethine®
N/A
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2007
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES 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
State of Incorporation
23-0787699
I.R.S. Employer I.D. No.
9000 State Road
Philadelphia, Pennsylvania 19136
(215) 333-9000
(Address of principal executive offices and telephone number)
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $.001 Par Value
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act
Yes No X
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes_ No X
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes X No __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. ___
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer __ Accelerated filer X Non-accelerated filer __
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12B-12 of the Exchange Act).
Yes __ No X
Aggregate market value of Common stock held by non-affiliates of the Registrant, as of December 31, 2006 was
$150,967,181, based on the closing price of the stock on the American Stock Exchange.
As of September 21, 2007, there were 24,177,118 shares of the issuer's common stock, $.001 par value, outstanding.
TABLE OF CONTENTS
PART I
PART II
ITEM 1. DESCRIPTION OF BUSINESS
ITEM 1A. RISK FACTORS
ITEM 1b. UNRESOLVED STAFF COMMENTS
ITEM 2. DESCRIPTION OF PROPERTY
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9B. OTHER INFORMATION
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
SIGNATURES
ANNUAL REPORT ON FORM 10-K
SUBSIDIARIES OF THE COMPANY, EXHIBIT 21
CONSENT OF GRANT THORNTON LLP, EXHIBIT 23.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER, EXHIBIT 31.1
CERTIFICATION OF CHIEF FINANCIAL OFFICER, EXHIBIT 31.2
CERTIFICATION OF CEO AND CFO PURSUANT TO SECTION 906, EXHIBIT 32
1
13
18
18
19
19
20
22
23
38
38
39
41
42
46
60
62
63
64
65
66
104
105
106
107
108
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements in “Item 1A – Risk Factors”, “Item 7
– Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other
statements located elsewhere in this Annual Report. Any statements made in this Annual Report that are not
statements of historical fact or that refer to estimated or anticipated future events are forward-looking
statements. We have based our forward-looking statements on our management’s beliefs and assumptions
based on information available to them at this time. Such forward-looking statements reflect our current
perspective of our business, future performance, existing trends and information as of the date of this filing.
These include, but are not limited to, our beliefs about future revenue and expense levels and growth rates,
prospects related to our strategic initiatives and business strategies, express or implied assumptions about
government regulatory action or inaction, anticipated product approvals and launches, business initiatives and
product development activities, assessments related to clinical trial results, product performance and
competitive environment, and anticipated financial performance. Without limiting the generality of the
foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,”
“estimate,” “continue,” or “pursue,” or the negative other variations thereof or comparable terminology, are
intended to identify forward-looking statements. The statements are not guarantees of future performance
and involve certain risks, uncertainties and assumptions that are difficult to predict. We caution the reader
that certain important factors may affect our actual operating results and could cause such results to differ
materially from those expressed or implied by forward-looking statements. We believe the risks and
uncertainties discussed under the “Item 1A - Risk Factors” and other risks and uncertainties detailed herein
and from time to time in our SEC filings, may affect our actual results.
We disclaim any obligation to publicly update any forward-looking statements, whether as a result of new
information, future events or otherwise. We also may make additional disclosures in our Quarterly Reports
on Form 10-Q, Current Reports on Form 8-K and in other filings that we may make from time to time with
the SEC. Other factors besides those listed here could also adversely affect us. This discussion is provided as
permitted by the Private Securities Litigation Reform Act of 1995, as amended.
PART I
ITEM 1.
DESCRIPTION OF BUSINESS
General
Lannett Company, Inc. (the “Company,” “Lannett,” “we,” or “us”) was incorporated in 1942 under the laws
of the Commonwealth of Pennsylvania, and reincorporated in 1991 as a Delaware corporation. We develop,
manufacture, market and distribute generic versions of pharmaceutical products. The Company reports
financial information on a quarterly and fiscal year basis, the most recent being the fiscal year ended June 30,
2007. All references herein to a fiscal year refer to the Company’s fiscal year ending June 30.
The Company is focused on increasing our share of the generic pharmaceutical market. We were able to
increase net sales during fiscal 2007 by adding new products, and by increasing sales under existing
distribution agreements. We plan to improve our financial performance by expanding our line of generic
products, increasing unit sales to current customers and reducing overhead and administrative costs. Some of
the new generic products sold by Lannett were developed and are manufactured by Lannett while other
products are manufactured by other companies. The products manufactured by Lannett and those
manufactured by others are identified in the section entitled “Products” in Item 1 of this Form 10-K.
Over the past several years, Lannett has consistently devoted resources to research and development (R&D)
projects, including new generic product offerings. The costs of these R&D efforts are expensed during the
periods incurred. The Company believes that such investments may be recovered in future years as it submits
1
applications to the Food and Drug Administration (FDA), and when it receives marketing approval from the
FDA to distribute such products. In addition to using cash generated from its operations, the Company has
entered into a number of financing agreements with third parties to provide additional cash when needed.
These financing agreements are more fully described in the section entitled “Liquidity and Capital
Resources” in Item 7 of this Form 10-K. The Company has embarked on a plan to grow in future years. In
addition to organic growth to be achieved through its own R&D efforts, the Company has also initiated
marketing projects with other companies in order to expand future revenue projections. The Company
expects that its growing list of generic drugs under development will drive future growth. The Company also
intends to use the infrastructure it has created, and to continually devote resources to additional R&D
projects. The following strategies highlight Lannett’s plan:
Research and Development Process
There are numerous stages in the generic drug development process:
1.) Formulation and Analytical Method Development: After a drug candidate is selected for future
sales, product development chemists perform various experiments on the incorporation of active
ingredients into a dosage form. These experiments will result in the creation of a number of
product formulations to determine which formula will be most suitable for the Company’s
subsequent development process. Various formulations are tested in the laboratory to measure
results against the innovator drug. During this time, the Company may use reverse engineering
methods on samples of the innovator drug to determine the type and quantity of inactive
ingredients. During the formulation phase, the Company’s research and development chemists
begin to develop an analytical, laboratory testing method. The successful development of this
test method will allow the Company to test developmental and commercial batches of the product
in the future. All of the information used in the final formulation, including the analytical test
methods adopted for the generic drug candidate, will be included as part of the Chemical,
Manufacturing and Controls section of the Abbreviated New Drug Application (ANDA)
submitted to the FDA in the generic drug application.
2.) Scale-up: After the product development scientists and the R&D chemists agree on a final
formulation to use in moving the drug candidate forward in the developmental process, the
Company will attempt to increase the batch size of the product. The batch size represents the
standard magnitude to be used in manufacturing a batch of the product. The determination of
batch size will affect the amount of raw material that is input into the manufacturing process and
the number of expected tablets or capsules to be created during the production cycle. The
Company attempts to determine batch size based on the amount of active ingredient in each
dosage, the available production equipment and unit sales projections. The scaled-up batch is
then generally produced in the Company’s commercial manufacturing facilities. During this
manufacturing process, the Company will document the equipment used, the amount of time in
each major processing step and any other steps needed to consistently produce a batch of that
product. This information, generally referred to as the validated manufacturing process, will be
included in the Company’s generic drug application submitted to the FDA.
3.) Clinical testing: After a successful scale-up of the generic drug batch, the Company then
schedules and performs clinical testing procedures on the product if required by the FDA. These
procedures, which are generally outsourced to third parties, include testing the absorption of the
generic product in the human bloodstream compared to the absorption of the innovator drug. The
results of this testing are then documented and reported to the Company to determine the
“success” of the generic drug product. Success, in this context, means the successful comparison
of the Company’s product related to the innovator product. Since bioequivalence and a stable
formula are the primary requirements for a generic drug approval (assuming the manufacturing
plant is in compliance with the FDA’s good manufacturing quality standards), lengthy and costly
clinical trials proving safety and efficacy, which are generally required by the FDA for innovator
2
drug approvals, are unnecessary for generic companies. If the results are successful, the
Company will continue the collection of documentation and information for assembly of the drug
application.
4.) Submission of the ANDA for FDA review and approval: The ANDA process became formalized
under The Drug Price Competition and Patent Term Restoration Act of 1984, also known as the
Hatch-Waxman Act (“Hatch-Waxman Act”). An ANDA represents a generic drug company’s
application to the FDA to manufacture and/or distribute a drug that is the generic equivalent to an
already-approved brand named (“innovator”) drug. Once bioequivalence studies are complete,
the generic drug company submits an ANDA to the FDA for marketing approval.
In a presentation entitled, “CDER Update,” given during the Windhover FDA/CMS Summit, Stephen K.
Galson, Director of the Center for Drug Evaluation and Research, cited the median approval time for a
new ANDA in fiscal 2006 at 16.6 months. This figure was slightly longer than the 2005 median approval
time of 16.3. However, there is no guarantee that the FDA will approve a company’s ANDA or that any
approval will be given within this time frame.
When a generic drug company files an ANDA with the FDA, it must certify that no patents are listed in
the Orange Book, the FDA’s reference listing of approved drugs, and listed patents. An ANDA filer must
certify, with respect to each application whether the filer is challenging a patent either that no patent was
filed for the listed drug (a "paragraph I" certification), that the patent has expired (a "paragraph II"
certification), that the patent will expire on a specified date and the ANDA filer will not market the drug
until that date (a "paragraph III" certification), or that the patent is invalid or would not be infringed by
the manufacture, use, or sale of the new drug (a "paragraph IV" certification). A paragraph IV
certification can trigger an automatic 30 month stay of the ANDA if the innovator company files a claim.
It will delay the approval of the generic company’s ANDA. Currently, Lannett has filed no Paragraph IV
certifications with its ANDAs.
Over the past several years, the Company has hired additional personnel in product development,
production, formulation and the R&D laboratory. Lannett believes that its ability to select appropriate
products for development, develop such products on a timely basis, obtain FDA approval, and achieve
economies in production will be critical for its success in the generic industry. The strategy involves a
combination of decisions focusing on long-term profitability and a secure market position with fewer
challenges from competitors.
Competition in generic pharmaceutical manufacturing will continue to grow as more pharmaceutical
products lose patent protection. However, the Company believes that with strong technical know-how,
low overhead expenses, and efficient product development, manufacturing and marketing, it can remain
competitive. It is the intention of the Company to reinvest as much capital as possible to develop new
products since the success of any generic pharmaceutical manufacturer depends on its ability to
continually introduce new generic products to the market. Over time, if a generic drug market for a
specific product remains stable and consumer demand remains consistent, it is likely that additional
generic manufacturing companies will pursue the generic product by developing it, submitting an ANDA,
and potentially receiving marketing approval from the FDA. If this occurs, the generic competition for
the drug increases, and a company’s market share may drop. In addition to reduced unit sales, the unit
selling price may also drop due to the product’s availability from additional suppliers. This may have the
effect of reducing a generic company’s future net sales of the product. Due to these factors that may
potentially affect a generic company’s future results of operations, the ability to properly assess the
competitive effect of new products, including market share, the number of competitors and the generic
unit price erosion, is critical to a generic company’s R&D plan. A generic company may be able to
reduce the potential exposure to competitive influences that negatively affect its sales and profits by
having several drug candidates in its R&D pipeline. As such, a generic company may be able to avoid
becoming materially dependent on the sales of one drug. Please refer to the following section entitled
“Products” for more descriptive information on the 23 products the Company currently produces or sells.
3
Unlike the branded, innovator companies, Lannett currently does not own proprietary drug patents.
However, the typical intellectual property in the generic drug industry are the ANDAs that generic drug
companies own.
Validated Pharmaceutical Capabilities
Lannett’s manufacturing facility consists of 31,000 square feet on 3.5 acres owned by the Company. In
addition, the Company owns a 63,000 square foot building located within 1 mile of the corporate office.
The second building contains packaging, warehouse and shipping functions, R&D and a number of
administrative functions.
The manufacturing facility of Lannett’s wholly-owned subsidiary, Cody Laboratories, Inc. (Cody)
consists of 73,000 square feet on 16.2 acres in Cody, Wyoming. Cody leases the facility from Cody LCI
Realty, LLC, a Limited Liability Company which is 50% owned by Lannett and 50% by an affiliate of
Cody Labs.
Many FDA regulations relating to current Good Manufacturing Practices (cGMP) have been adopted by
the Company in the last several years. In designing its facilities, full attention was given to material flow,
equipment and automation, quality control and inspection. A granulator, an automatic film coating
machine, high-speed tablet presses, blenders, encapsulators, fluid bed dryers, high shear mixers and high-
speed bottle filling are a few examples of the sophisticated product development, manufacturing and
packaging equipment the Company uses. In addition, the Company’s Quality Control laboratory facilities
are equipped with high precision instruments, like automated high-pressure liquid chromatographs, gas
chromatographs, robots and laser particle sizers.
Lannett continues to pursue its comprehensive plan for improving and maintaining quality control and
quality assurance programs for its pharmaceutical development and manufacturing facilities. The FDA
periodically inspects the Company’s production facilities to determine the Company’s compliance with
the FDA’s manufacturing standards. Typically, after the FDA completes its inspection, it will issue the
Company a report, entitled a Form 483, containing the FDA’s observations of possible violations of
cGMP. Such observations may be minor or severe in nature. The degree of severity of the observation is
generally determined by the time necessary to remediate the cGMP violation, any consequences upon the
consumer of the Company’s drug products, and whether the observation is subject to a Warning Letter
from the FDA. By strictly enforcing the various FDA guidelines, namely Good Laboratory Practices,
Standard Operating Procedures and cGMP, the Company has successfully kept the number of
observations in its FDA inspection at a minimal level. The Company believes that such observations are
minor in nature, and will be remediated in a timely fashion with no material effect on its results of
operations.
Sales and Customer Relationships
retailers, private
The Company sells its pharmaceutical products to generic pharmaceutical distributors, drug wholesalers,
chain drug
label distributors, mail-order pharmacies, other pharmaceutical
manufacturers, managed care organizations, hospital buying groups and health maintenance
organizations. It promotes its products through direct sales, trade shows, trade publications, and bids.
The Company also licenses the marketing of its products to other manufacturers and/or marketers in
private label agreements.
The Company continues to expand its sales to the major chain drug stores. Lannett is recognized by its
customers as a dependable supplier of high quality generic pharmaceuticals. The Company’s policy of
maintaining an adequate inventory and fulfilling orders in a timely manner has contributed to this
reputation.
4
Management
The Company has been focused on increasing the size and quality of its management team in anticipation
of continued growth. Managers from large, established, brand pharmaceutical companies as well as
competing generic companies have been brought in to complement the skills and knowledge of the
existing management team. As the Company continues to grow, additional managers may need to be
added to the team. We intend to hire the best people available to expand the knowledge and expertise
within the Company, in order to further accomplish specific Company goals.
Products
As of the date of this filing, the Company manufactured and/or distributed the following products:
Name of Product
Medical Indication
1 Acetazolamide Tablets
Glaucoma
Equivalent
Brand
Diamox®
2
3
4
Baclofen Tablets
Muscle Relaxer
Lioresal®
Butalbital, Aspirin and Caffeine Capsules
Migraine Headache
Fiorinal®
Butalbital, Aspirin, Caffeine with Codeine Phosphate
Capsules
Migraine Headache
Fiorinal w/
Codeine #3®
5
Clindamycin HCl Capsules
6 Danazol Capsules
Antibiotic
Cleocin®
Endometriosis
Danocrine®
7 Dicyclomine Tablets/Capsules
Irritable Bowels
Bentyl®
8 Digoxin Tablets
9 Diphenoxylate with Atropine Sulfate Tablets
10 Doxycycline Tablets
11 Doxycycline Hyclate Tablets
Congestive Heart
Failure
Diarrhea
Antibiotic
Antibiotic
Lanoxin®
Lomotil®
Adoxa®
Periostat®
12 Hydromorphone HCl Tablets
Pain Management
Dilaudid®
13 Levothyroxine Sodium Tablets
Thyroid Deficiency
Levoxyl®/
Synthroid®
14 Methyltestoterone/Esterified Estrogens Tablets
Hormone Replacement
Estratest®
15 Morphine Sulfate Oral Solution
Pain Management
Roxanol®
16 Oxycodone HCl Oral Solution
Pain Management
Roxicodone®
17 Phentermine HCl Tablets
18 Pilocarpine HCl Tablets
Weight Loss
Adipex-P®
Dryness of the Mouth
Salagen®
5
Name of Product
19 Primidone Tablets
20 Probenecid Tablets
Medical Indication
Equivalent
Brand
Epilepsy
Mysoline®
Gout
Benemid®
21 Sulfamethoxazole w/ Trimethoprim
Antibacterial
Bactrim®
22 Terbutaline Sulfate Tablets
Bronchospasms
Brethine®
23 Unithroid® Tablets
Thyroid Deficiency
N/A
Key Products
All of the products currently manufactured and/or sold by the Company are prescription products. Of the
products listed above, those containing Butalbital, Digoxin, Primidone and Levothyroxine Sodium were the
Company’s key products, contributing more than 70%, 80% and 93% of the Company’s total net sales in
Fiscal 2007, 2006 and 2005 respectively. In Fiscal 2006, the Company began selling Sulfamethoxazole w/
Trimethoprim (SMZ/TMP). Because of a market opportunity, sales of SMZ/TMP grew from 3% of sales
in 2006 to 19% of sales in 2007. This number is not included in the above key products because the
opportunity is no longer available to the Company after prices declined sharply. The decline in this
percentage of key products since 2005 is due to our focus on expanding the number of products sold.
The Company has two products containing Butalbital. One of the products, Butalbital with Aspirin and
Caffeine capsules, has been manufactured and sold by Lannett for more than nine years. The other Butalbital
product, Butalbital with Aspirin, Caffeine and Codeine Phosphate capsules is manufactured by Jerome
Stevens Pharmaceuticals, Inc. (JSP). Lannett began buying this product from JSP and selling it to its
customers in December 2001. Both products, which are in orally administered capsule dosage forms, are
prescribed to treat tension headaches caused by contractions of the muscles in the neck and shoulder area and
migraine. The drug is prescribed primarily for adults of various demographic backgrounds. Migraine
headache is an increasingly prevalent condition in the United States. As conditions continue to grow, the
demand for effective medical treatments will continue to grow. Common side effects of drugs which contain
Butalbital include dizziness and drowsiness. The Company notes that although new innovator drugs to treat
migraine headaches have been introduced by brand name drug companies, there is still a loyal following of
doctors and consumers who prefer to use Butalbital products for treatment. As the brand name companies
continue to promote products containing Butalbital, like Fiorinal®, the Company expects to continue to
produce and sell its generic Butalbital products.
Digoxin tablets are produced and marketed with two different potencies (0.125 and 0.25 milligrams per
tablet). This product is manufactured by JSP. Lannett began buying this product from JSP and selling it to
its customers in September 2002. Digoxin tablets are used to treat congestive heart failure in patients of
various ages and demographic backgrounds. The beneficial effects of Digoxin result from direct actions on
the cardiac muscle, as well as indirect actions on the cardiovascular system mediated by effects on the
autonomic nervous system. Side effects of Digoxin may include apathy, blurred vision, changes in heartbeat,
confusion, dizziness, headaches, loss of appetite, nausea, vomiting and weakness.
Primidone tablets are produced and marketed with two different potencies (50 and 250 milligrams per tablet).
This product was developed and is manufactured by Lannett. Lannett has been manufacturing and selling
Primidone 250-milligram tablets for more than seven years. Lannett began selling Primidone 50-milligram
tablets in June 2001. Both products, which are in orally administered tablet dosage forms, are prescribed to
treat convulsion and seizures in epileptic patients of all ages and demographic backgrounds. Common side
effects of Primidone include lack of muscle coordination, vertigo and severe dizziness.
6
The Company’s products containing Levothyroxine Sodium tablets are produced and marketed with
eleven different potencies. In addition to generic Levothyroxine Sodium tablets, the Company also
markets and distributes Unithroid tablets, a branded version of Levothyroxine Sodium tablets, which is
produced and marketed with eleven different potencies. Both Levothyroxine Sodium products are
manufactured by JSP. Lannett began buying generic Levothyroxine Sodium tablets from JSP and selling it
to its customers in April 2003. In September 2003, the Company began buying the branded Unithroid tablets
from JSP and selling it to its customers. Levothyroxine Sodium tablets are used to treat hypothyroidism
and other thyroid disorders. It remains one of the most prescribed drugs in the United States with over 13
million patients of various ages and demographic backgrounds. Side effects from Levothyroxine Sodium
are rare, but may include allergic reactions, such as rash or hives. In late June of 2004, JSP received a letter
from the FDA approving its supplemental application for generic bioequivalence to Levoxyl®. In December
2004, JSP received a letter from the FDA approving its supplemental application for generic bioequivalence
to Synthroid®. With its distribution of these products, Lannett competes in a market which is currently
controlled by two branded Levothyroxine Sodium tablet products—Abbott Laboratories’ Synthroid® and
Monarch Pharmaceutical’s Levoxyl® as well as generic competition from Mylan Laboratories and
Sandoz.
New Products
Lannett received 1 ANDA approval from the FDA and commenced marketing of 1 additional product
during Fiscal 2007. We received 10 approvals in Fiscal 2006. Following are more specific details
regarding our latest approvals. Market data is obtained from Wolters-Kluwer.
In January 2007, Lannett began distributing Meloxicam, the generic equivalent of Boehringer Ingelheim’s
Mobic®. Sales of Meloxicam, a non-steroidal anti-inflammatory drug (NSAID) indicated for the relief of
the signs and symptoms of osteoarthritis and rheumatoid arthritis, were approximately $1.4 billion for the
twelve months ended November 2006, according to Wolters Kluwer.
In April 2007, Lannett received a letter from the FDA with approval to market and launch Danazol 50mg
and 100mg capsules. Danazol is the generic version of Danocrine® and is used for the treatment of
endometriosis amenable to hormonal management. According to Wolters Kluwer, total sales of generic
Danazol Capsules were $15 million in 2006.
Additional products are currently under development. These products are either orally administered, solid-
dosage products (i.e. tablet/capsule) or oral solutions, topicals or parentarels designed to be generic
equivalents to brand named innovator drugs. The Company’s developmental drug products are intended to
treat a diverse range of indications. The products under development are at various stages in the development
cycle—formulation, scale-up, clinical testing and FDA review.
The cost associated with each product currently under development is dependent on numerous factors not
limited to the following: the complexity of the active ingredient’s chemical characteristics, the price of the
raw materials, the FDA-mandated requirement of bioequivalence studies—depending on the FDA’s Orange
Book classification and other developmental factors. The overall cost to develop a new generic product varies
in range from $100,000 to $1 million.
In addition, as one of the oldest generic drug manufacturers in the country, formed in 1942, Lannett currently
owns several ANDAs for products which it does not manufacture and market. These ANDAs are simply
dormant on the Company’s records. Occasionally, the Company reviews such ANDAs to determine if the
market potential for any of these older drugs has recently changed to make it attractive for Lannett to
reconsider manufacturing and selling them. If the Company makes the determination to introduce one of
these products into the consumer marketplace, it must review the ANDA and related documentation to ensure
that the approved product specifications, formulation and other factors meet current FDA requirements for
the marketing of that drug. Generally, in these situations, the Company must file a supplement to the FDA
for the applicable ANDA, informing the FDA of any significant changes in the manufacturing process, the
formulation, the raw material supplier or another major feature of the previously approved ANDA. The
7
Company would then redevelop the product and submit it to the FDA for supplemental approval. The FDA’s
approval process for ANDA supplements is similar to that of a new ANDA.
In addition to the efforts of its internal product development group, Lannett has contracted with several
outside firms for the formulation and development of several new generic drug products. These outsourced
R&D products are at various stages in the development cycle—formulation, analytical method development
and testing and manufacturing scale-up. These products are orally administered solid dosage products
intended to treat a diverse range of medical indications. It is the Company’s intention to ultimately transfer
the formulation technology and manufacturing process for all of these R&D products to the Company’s own
commercial manufacturing sites. The Company initiated these outsourced R&D efforts to complement the
progress of its own internal R&D efforts.
The majority of the Company’s R&D projects are being developed in-house under Lannett’s direct
supervision and with Company personnel. Hence, the Company does not believe that its outside contracts for
product development or manufacturing supply are material in nature, nor is the Company substantially
dependent on the services rendered by such outside firms. Since the Company has no control over the FDA
review process, management is unable to anticipate whether or when it will be able to begin producing and
shipping such additional products.
The following table summarizes key information related to the Company’s R&D products. The column
headings are defined as follows:
1.) Stage of R&D – Defines the current stage of the R&D product in the development process, as of
the date of this filing.
2.) Regulatory Requirement – Defines whether the R&D product is or is expected to be a new
ANDA submission, an ANDA supplement, or a grand-fathered product not requiring specific
FDA approval.
3.) Number of Products – Defines the number of products in R&D at the stage noted. In this
context, a product means any finished dosage form, including all potencies, containing the same
API or combination of APIs and which represents a generic version of the same Reference
Listed Drug (RLD) or innovator drug, identified in the FDA’s Orange Book.
Stage of R&D
FDA Review
FDA Review
Clinical Testing
Scale-Up
Scale-Up
Scale-Up
Formulation/Method Development
Regulatory Requirement
Number of Products
ANDA
ANDA supplement
ANDA
Grand-fathered
ANDA supplement
ANDA
ANDA
14
4
4
1
1
3
47
Raw Materials and Finished Goods Inventory Suppliers
The raw materials used by the Company in the production process consist of pharmaceutical chemicals in
various forms and are generally available from several sources. FDA approval is required in connection with
the process of using most active ingredient suppliers. In addition to the raw materials purchased for the
8
production process, the Company purchases certain finished dosage inventories, including capsule, tablet, and
oral liquid products. The Company then sells these finished dosage products directly to its customers along
with the finished dosage products internally manufactured. If suppliers of a certain material or finished
product are limited, the Company will generally take certain precautionary steps to avoid a disruption in
supply, such as finding a secondary supplier or ordering larger quantities.
The Company’s primary finished product inventory supplier is Jerome Stevens Pharmaceuticals, Inc. (JSP),
in Bohemia, New York. Purchases of finished goods inventory from JSP accounted for approximately 63%
of the Company’s inventory purchases in Fiscal 2007, 76% in Fiscal 2006 and 62% in Fiscal 2005. On
March 23, 2004, the Company entered into an agreement with JSP for the exclusive distribution rights in the
United States to the current line of JSP products in exchange for four million (4,000,000) shares of the
Company’s common stock. The JSP products covered under the agreement included Butalbital, Aspirin,
Caffeine with Codeine Phosphate capsules, Digoxin tablets and Levothyroxine Sodium tablets, sold
generically and under the brand name Unithroid®. The term of the agreement is ten years, beginning on
March 23, 2004 and continuing through March 22, 2014. Refer to the Materials Contract footnote to our
consolidated financial statements for more information on the terms, conditions, and financial impact of
this agreement.
During the term of the agreement, the Company is required to use commercially reasonable efforts to
purchase minimum dollar quantities of JSP’s products being distributed by the Company. The minimum
quantity to be purchased in the first year of the agreement was $15 million. Thereafter, the minimum
purchase quantity increases by $1 million per year up to $24 million for the last year of the ten-year
contract. The Company has met the minimum purchase requirement for the first three years of the
contract, but there is no guarantee that the Company will be able to continue to do so in the future. If the
Company does not meet the minimum purchase requirements, JSP’s sole remedy is to terminate the
agreement.
In August 2005, the Company signed an agreement with a finished goods provider to purchase, at fixed
prices, and distribute a certain generic pharmaceutical product in the United States. Purchases of finished
goods inventory from this provider accounted for approximately 23% of the Company’s costs of
purchased inventory in Fiscal 2007, and 11% in 2006. The term of the agreement is three years,
beginning on August 22, 2005 and continuing through August 21, 2008.
During the term of the agreement, the Company has committed to provide a rolling twelve month forecast
of the estimated Product requirements to this provider. The first three months of the rolling twelve month
forecast are binding and constitute a firm order.
The Company signed supply and development agreements with Olive Healthcare of India; Orion Pharma
of Finland; Azad Pharma AG of Switzerland, Pharmaseed in Israel and Banner Pharmacaps in the United
States. The Company is also in negotiations with companies in Israel for similar new product initiatives in
which Lannett will market and distribute products manufactured by third parties.
Customers and Marketing
The Company sells its products primarily to wholesale distributors, generic drug distributors, mail-order
pharmacies, group purchasing organizations, chain drug stores, and other pharmaceutical companies. The
industry’s largest wholesale distributors, McKesson, Cardinal Health, and Amerisource Bergen, accounted
for 24%, 12%, and 6%, respectively, of net sales in Fiscal 2007. The Company’s largest chain drug store
customer, Walgreens, accounted for 15% of net sales in Fiscal 2007. The Company performs ongoing
credit evaluations of its customers’ financial condition, and has experienced no significant collection
problems to date. Generally, the Company requires no collateral from its customers.
Sales to these wholesale customers include “indirect sales,” which represent sales to third-party entities,
such as independent pharmacies, managed care organizations, hospitals, nursing homes, and group
purchasing organizations, collectively referred to as “indirect customers.” Lannett enters into agreements
with its indirect customers to establish pricing for certain products. The indirect customers then
9
independently select a wholesaler from which to actually purchase the products at these agreed-upon
prices. Lannett will provide credit to the wholesaler for the difference between the agreed-upon price
with the indirect customer and the wholesaler’s invoice price. This credit is called a chargeback. For
more information on chargebacks, refer to the section entitled “Chargebacks” in Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K. These
indirect sale transactions are recorded on Lannett’s books as sales to the wholesale customers.
The Company believes that retail-level consumer demand dictates the total volume of sales for various
products. In the event that wholesale and retail customers adjust their purchasing volumes, the Company
believes that consumer demand will be fulfilled by other wholesale or retail sources of supply. As such,
Lannett attempts to obtain strong relationships with most of the major retail chains, wholesale
distributors, and mail-order pharmacies in order to facilitate the supply of the Company’s products
through whatever channel the consumer prefers. Although the Company has agreements with customers
governing the transaction terms of its sales, there are no minimum purchase quantities with these
agreements.
The Company promotes its products through direct sales, trade shows, trade publications, and bids. The
Company also markets its products through private label arrangements, whereby Lannett produces its
products with a label containing the name and logo of a customer. This practice is commonly referred to
as private label business. It allows the Company to expand on its own internal sales efforts by using the
marketing services from other well-respected pharmaceutical dosage suppliers. The focus of the
Company’s sales efforts is the relationships it creates with its customer accounts. Strong customer
relationships have created a positive platform for Lannett to increase its sales volumes. Advertising in the
generic pharmaceutical industry is generally limited to trade publications, read by retail pharmacists,
wholesale purchasing agents and other pharmaceutical decision-makers. Historically and in Fiscal 2007,
2006, and 2005, the Company’s advertising expenses were immaterial. When the customer and the
Company’s sales representatives make contact, the Company will generally offer to supply the customer
its products at fixed prices. If accepted, the customer’s purchasing department will coordinate the
purchase, receipt and distribution of the products throughout its distribution centers and retail outlets.
Once a customer accepts the Company’s supply of product, the customer generally expects a high
standard of service. This service standard includes shipping product in a timely manner on receipt of
customer purchase orders, maintaining convenient and effective customer service functions, and retaining
a mutually beneficial dialogue of communication. The Company believes that although the generic
pharmaceutical industry is a commodity industry, where price is the primary factor for sales success,
these additional service standards are equally important to the customers that rely on a consistent source
of supply.
Competition
The manufacture and distribution of generic pharmaceutical products is a highly competitive industry.
Competition is based primarily on price, service and quality. The Company competes primarily on this basis,
for example staying competitive, providing superior customer service (from fulfilling customer’s in critical
need of inventory, carrying excess finished goods inventory and providing added value) by insuring the
Company’s products are available from national suppliers as well as our own warehouse. The modernization
of its facilities, hiring of experienced staff, and implementation of inventory and quality control programs
have improved the Company’s competitive position over the past five years.
The Company competes with other manufacturers and marketers of generic and brand drugs. Each product
manufactured and/or sold by Lannett has a different set of competitors. The list below identifies the
companies with which Lannett primarily competes for each of its major products.
10
Product
Primary Competitors
Butalbital with Aspirin and Caffeine, with
and without Codeine Phosphate Capsules
Watson Pharmaceuticals, Breckenridge Pharmaceutical
(manufactured by Anabolic Laboratories)
Digoxin Tablets
GlaxoSmithKline, Actavis (marketed by Bertek
Pharmaceuticals), Caraco Pharmaceutical Laboratories
Doxycycline Tablets
Par Pharmaceuticals, Ranbaxy Laboratories
Levothyroxine Sodium Tablets
Primidone Tablets
Abbott Laboratories, Monarch Pharmaceuticals, Mylan
Laboratories, Sandoz, Forest Laboratories
Watson Pharmaceuticals, Qualitest Pharmaceuticals, URL,
Westward Pharmaceuticals
Sulfamethoxazole w/ Trimethoprim
URL/Mutual Pharmaceuticals, Sandoz, Vista, Teva
Unithroid Tablets
Government Regulation
Abbott Laboratories, Monarch Pharmaceuticals, Mylan
Laboratories, Sandoz
Pharmaceutical manufacturers are subject to extensive regulation by the federal government, principally by
the FDA and the Drug Enforcement Agency (DEA) and to a lesser extent, by other federal regulatory bodies
and state governments. The Federal Food, Drug and Cosmetic Act, the Controlled Substance Act, and other
federal statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, record
keeping, approval, pricing, advertising, and promotion of the Company's generic drug products.
Noncompliance with applicable regulations can result in fines, recall and seizure of products, total or partial
suspension of production, personal and/or corporate prosecution and debarment, and refusal of the
government to approve new drug applications. The FDA also has the authority to revoke previously
approved drug products.
Generally, FDA approval is required before a prescription drug can be marketed. A new drug is one not
generally recognized by qualified experts as safe and effective for its intended use. New drugs are typically
developed and submitted to the FDA by companies expecting to brand the product and sell it as a new
medical treatment. The FDA review process for new drugs is very extensive and requires a substantial
investment to research and test the drug candidate. However, less burdensome approval procedures may be
used for generic equivalents. Typically, the investment required to develop a generic drug is less costly than
the brand innovator drug.
There are currently three ways to obtain FDA approval of a drug:
• New Drug Applications (NDA): Unless one of the two procedures discussed in the following
paragraphs is available, a manufacturer must conduct and submit to the FDA complete clinical
studies to establish a drug's safety and efficacy.
• Abbreviated New Drug Applications (ANDA): An ANDA is similar to an NDA except that the
FDA generally waives the requirement of complete clinical studies of safety and efficacy. However,
it may require bioavailability and bioequivalence studies. Bioavailability indicates the rate of
absorption and levels of concentration of a drug in the bloodstream needed to produce a therapeutic
effect. Bioequivalence compares one drug product with another and indicates if the rate of
absorption and the levels of concentration of a generic drug in the body are within prescribed
11
statistical limits to those of a previously approved drug. Under the Hatch-Waxman Act, an ANDA
may be submitted for a drug on the basis that it is the equivalent of an approved drug regardless of
when such other drug was approved. In addition to establishing a new ANDA procedure, this act
created statutory protections for approved brand name drugs. Under the act, an ANDA for a generic
drug may not be made effective until all relevant product and use patents for the brand name drug
have expired or have been determined to be invalid. Prior to this act, the FDA gave no consideration
to the patent status of a previously approved drug. Additionally, the Hatch-Waxman Act extends for
up to five years the term of a product or use patent covering a drug to compensate the patent holder
for the reduction of the effective market life of a patent due to federal regulatory review. With
respect to certain drugs not covered by patents, the act sets specified time periods of two to ten years
during which ANDAs for generic drugs cannot become effective or, under certain circumstances,
cannot be filed if the branded drug was approved after December 31, 1981. Lannett, like most other
generic drug companies, uses the ANDA process for the submission of its developmental generic
drug candidates.
• Paper New Drug Applications (Paper NDA): For a drug that is identical to a drug first approved
after 1962, a prospective manufacturer need not go through the full NDA procedure. Instead, it may
demonstrate safety and efficacy by relying on published literature and reports. The manufacturer
must also submit, if the FDA so requires, bioavailability or bioequivalence data illustrating that the
generic drug formulation produces the same effects, within an acceptable range, as the previously
approved innovator drug. Because published literature to support the safety and efficacy of post-
1962 drugs may not be available, this procedure is of limited utility to generic drug manufacturers
and the resulting approved product will not be interchangeable with the innovator drug as an ANDA
drug would be unless bioeqivalency testing were undertaken and approved by FDA. Moreover, the
utility of Paper NDAs has been further diminished by the recently broadened availability of the
ANDA process, as described above.
Among the requirements for new drug approval is the requirement that the prospective manufacturer's
methods conform to the FDA's current Good Manufacturing Practice. The cGMP Regulations must be
followed at all times during which the approved drug is manufactured. In complying with the standards set
forth in the cGMP Regulations, the Company must continue to expend time, money, and effort in the areas of
production and quality control to ensure full technical compliance. Failure to comply with the cGMP
Regulations risks possible FDA action, including but not limited to, the seizure of noncomplying drug
products or, through the Department of Justice, enjoining the manufacture of such products.
The Company is also subject to federal, state, and local laws of general applicability, such as laws regulating
working conditions and the storage, transportation, or discharge of items that may be considered hazardous
substances, hazardous waste, or environmental contaminants. The Company monitors its compliance with all
environmental laws. The Company is in substantial compliance with all regulatory bodies.
Research and Development
The Company incurred research and development (R&D) expenses of approximately $7,459,000 in 2007,
$8,102,000 in 2006, and $6,266,000 in 2005. The R&D spending includes spending on bioequivalence
studies, internal development resources, as well as outsourced development. While the Company manages
all R&D from our offices in Philadelphia, we have also been taking advantage of favorable development
costs in other countries. In the current fiscal year, we have engaged Olive Healthcare, an India-based
manufacturer and exporter of pharmaceutical products. AZAD Pharma AG, a Switzerland-based developer of
Active Pharmaceutical Ingredients (APIs), has been contracted with to jointly develop and commercialize one
pharmaceutical product. This agreement also includes a supply agreement to provide us with five APIs that
we will develop into finished dosage forms for commercialization. The Company has contracted with
Banner Pharmacaps and with Pharmaseed of Israel to develop products in other dosage forms. Fixed
payment arrangements are established with these development partners, and can range from $150,000 to
12
$250,000 to develop a drug. Development payments are normally scheduled in advance, based on
milestones.
The following table shows the most common development arrangement for payments:
Milestone
Signing of Agreement
First delivery of test results
Second delivery of test results
Final Report
Payment
10%
40%
40%
10%
Employees
The Company currently has 198 employees.
Securities Exchange Act Reports
The Company maintains an Internet website at the following address: www.lannett.com. The Company
makes available on or through its Internet website certain reports and amendments to those reports that
are filed with the Securities and Exchange Commission (SEC) in accordance with the Securities
Exchange Act of 1934. These include annual reports on Form 10-K, quarterly reports on Form 10-Q and
current reports on Form 8-K. This information is available on the Company’s website free of charge as
soon as reasonably practicable after the Company electronically files the information with, or furnishes it
to, the SEC. The contents of the Company’s website are not incorporated by reference in this Form 10-K
and shall not be deemed “filed” under the Securities Exchange Act of 1934.
ITEM 1A.
RISK FACTORS
We operate in a rapidly changing environment that involves a number of risks, some of which are beyond
our control. The following discussion highlights some of these risks and others are discussed elsewhere
in this report. These and other risks could materially and adversely affect our business, financial
condition, operating results or cash flows.
If we are unable to successfully develop or commercialize new products, our operating results will
suffer.
Our future results of operations will depend to a significant extent upon our ability to successfully
commercialize new generic products in a timely manner. There are numerous difficulties in developing
and commercializing new products, including:
•
•
•
developing, testing and manufacturing products in compliance with regulatory standards in a timely
manner;
receiving requisite regulatory approvals for such products in a timely manner;
the availability, on commercially reasonable terms, of raw materials, including active pharmaceutical
ingredients and other key ingredients;
13
•
•
•
developing and commercializing a new product is time consuming, costly and subject to numerous
factors that may delay or prevent the successful commercialization of new products;
experiencing delays or unanticipated costs; and
commercializing generic products may be substantially delayed by the listing with the FDA of patents
that have the effect of potentially delaying approval of the off-patent product by up to 30 months, and
in some cases, such patents have issued and been listed with the FDA after the key chemical patent on
the branded drug product has expired or been litigated, causing additional delays in obtaining
approval.
As a result of these and other difficulties, products currently in development by Lannett may or may not
receive the regulatory approvals necessary for marketing. If any of our products, when developed and
approved, cannot be successfully or timely commercialized, our operating results could be adversely
affected. We cannot guarantee that any investment we make in developing products will be recouped,
even if we are successful in commercializing those products.
Our gross profit may fluctuate from period to period depending upon our product sales mix, our
product pricing, and our costs to manufacture or purchase products.
Our future results of operations, financial condition and cash flows depend to a significant extent upon
our product sales mix. Our sales of products that we manufacture tend to create higher gross margins
than do the products we purchase and resell. As a result, our sales mix will significantly impact our gross
profit from period to period. Factors that may cause our sales mix to vary include:
•
the amount of new product introductions;
• marketing exclusivity, if any, which may be obtained on certain new products;
•
•
•
the level of competition in the marketplace for certain products;
the availability of raw materials and finished products from our suppliers; and
the scope and outcome of governmental regulatory action that may involve us.
The profitability of our product sales is also dependent upon the prices we are able to charge for our
products, the costs to purchase products from third parties, and our ability to manufacture our products in
a cost effective manner.
If branded pharmaceutical companies are successful in limiting the use of generics through their
legislative and regulatory efforts, our sales of generic products may suffer.
Many branded pharmaceutical companies increasingly have used state and federal legislative and
regulatory means to delay generic competition. These efforts have included:
• pursuing new patents for existing products which may be granted just before the expiration of one
patent which could extend patent protection for additional years or otherwise delay the launch of
generics;
•
•
using the Citizen Petition process to request amendments to FDA standards;
seeking changes to U.S. Pharmacopoeia, an organization which publishes industry recognized
compendia of drug standards;
•
attaching patent extension amendments to non-related federal legislation; and
14
•
engaging in state-by-state initiatives to enact legislation that restricts the substitution of some generic
drugs, which could have an impact on products that we are developing.
If branded pharmaceutical companies are successful in limiting the use of generic products through these
or other means, our sales may decline. If we experience a material decline in product sales, our results of
operations, financial condition and cash flows will suffer.
Third parties may claim that we infringe their proprietary rights and may prevent us from
manufacturing and selling some of our products.
The manufacture, use and sale of new products that are the subject of conflicting patent rights have been
the subject of substantial litigation in the pharmaceutical industry. These lawsuits relate to the validity
and infringement of patents or proprietary rights of third parties. We may have to defend against charges
that we violated patents or proprietary rights of third parties. This is especially true in the case of generic
products on which the patent covering the branded product is expiring, an area where infringement
litigation is prevalent, and in the case of new branded products where a competitor has obtained patents
for similar products. Litigation may be costly and time-consuming, and could divert the attention of our
management and technical personnel. In addition, if we infringe on the rights of others, we could lose our
right to develop or manufacture products or could be required to pay monetary damages or royalties to
license proprietary rights from third parties. Although the parties to patent and intellectual property
disputes in the pharmaceutical industry have often settled their disputes through licensing or similar
arrangements, the costs associated with these arrangements may be substantial and could include ongoing
royalties. Furthermore, we cannot be certain that the necessary licenses would be available to us on terms
we believe to be acceptable. As a result, an adverse determination in a judicial or administrative
proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling a
number of our products, which could harm our business, financial condition, results of operations and
cash flows.
If we are unable to obtain sufficient supplies from key suppliers that in some cases may be the only
source of finished products or raw materials, our ability to deliver our products to the market may
be impeded.
We are required to identify the supplier(s) of all the raw materials for our products in our applications
with the FDA. To the extent practicable, we attempt to identify more than one supplier in each drug
application. However, some products and raw materials are available only from a single source and, in
some of our drug applications, only one supplier of products and raw materials has been identified, even
in instances where multiple sources exist. To the extent any difficulties experienced by our suppliers
cannot be resolved within a reasonable time, and at reasonable cost, or if raw materials for a particular
product become unavailable from an approved supplier and we are required to qualify a new supplier with
the FDA, our profit margins and market share for the affected product could decrease, as well as delay our
development and sales and marketing efforts.
Our policies regarding returns, allowances and chargebacks, and marketing programs adopted by
wholesalers, may reduce our revenues in future fiscal periods.
Based on industry practice, generic drug manufacturers have liberal return policies and have been willing
to give customers post-sale inventory allowances. Under these arrangements, from time to time, we give
our customers credits on our generic products that our customers hold in inventory after we have
decreased the market prices of the same generic products due to competitive pricing. Therefore, if new
competitors enter the marketplace and significantly lower the prices of any of their competing products,
we would likely reduce the price of our product. As a result, we would be obligated to provide credits to
15
our customers who are then holding inventories of such products, which could reduce sales revenue and
gross margin for the period the credit is provided. Like our competitors, we also give credits for
chargebacks to wholesalers that have contracts with us for their sales to hospitals, group purchasing
organizations, pharmacies or other customers. A chargeback is the difference between the price the
wholesaler pays and the price that the wholesaler’s end-customer pays for a product. Although we
establish reserves based on our prior experience and our best estimates of the impact that these policies
may have in subsequent periods, we cannot ensure that our reserves are adequate or that actual product
returns, allowances and chargebacks will not exceed our estimates.
The design, development, manufacture and sale of our products involves the risk of product
liability claims by consumers and other third parties, and insurance against such potential claims is
expensive and may be difficult to obtain.
The design, development, manufacture and sale of our products involve an inherent risk of product
liability claims and the associated adverse publicity. Insurance coverage is expensive and may be
difficult to obtain, and may not be available in the future on acceptable terms, or at all. Although we
currently maintain product liability insurance for our products in amounts we believe to be commercially
reasonable, if the coverage limits of these insurance policies are not adequate, a claim brought against
Lannett, whether covered by insurance or not, could have a material adverse effect on our business,
results of operations, financial condition and cash flows.
Rising insurance costs could negatively impact profitability.
The cost of insurance, including workers compensation, product liability and general liability insurance,
have risen in prior years and may increase in the future. In response, we may increase deductibles and/or
decrease certain coverages to mitigate these costs. These increases, and our increased risk due to
increased deductibles and reduced coverages, could have a negative impact on our results of operations,
financial condition and cash flows.
The loss of our key personnel could cause our business to suffer.
The success of our present and future operations will depend, to a significant extent, upon the experience,
abilities and continued services of key personnel. If the employment of any of our current key personnel
is terminated, we cannot assure you that we will be able to attract and replace the employee with the same
caliber of key personnel. As such, we have entered into employment agreements with all of our senior
executive officers.
Significant balances of intangible assets, including product rights acquired, are subject to
impairment testing and may result in impairment charges, which will adversely affect our results of
operations and financial condition.
Our acquired contractual rights to market and distribute products are stated at cost, less accumulated
amortization and related impairment charges identified to date. We determined the initial cost by
referring to the original fair value of the assets exchanged. Future amortization periods for product rights
are based on our assessment of various factors impacting estimated useful lives and cash flows of the
acquired products. Such factors include the product’s position in its life cycle, the existence or absence of
like products in the market, various other competitive and regulatory issues and contractual terms.
Significant changes to any of these factors would require us to perform an additional impairment test on
the affected asset and, if evidence of impairment exists, we would be required to take an impairment
charge with respect to the asset. Such a charge would adversely affect our results of operations and
financial condition.
16
Extensive industry regulation has had, and will continue to have, a significant impact on our
business, especially our product development, manufacturing and distribution capabilities.
All pharmaceutical companies, including Lannett, are subject to extensive, complex, costly and evolving
regulation by the federal government, principally the FDA and to a lesser extent by the DEA and state
government agencies. The Federal Food, Drug and Cosmetic Act, the Controlled Substances Act and
other federal statutes and regulations govern or influence the testing, manufacturing, packing, labeling,
storing, record keeping, safety, approval, advertising, promotion, sale and distribution of our products.
Under these regulations, we are subject to periodic inspection of our facilities, procedures and operations
and/or the testing of our products by the FDA, the DEA and other authorities, which conduct periodic
inspections to confirm that we are in compliance with all applicable regulations. In addition, the FDA
conducts pre-approval and post-approval reviews and plant inspections to determine whether our systems
and processes are in compliance with current Good Manufacturing Practice, or cGMP, and other FDA
regulations. Following such inspections, the FDA may issue notices on Form 483 that could cause us to
modify certain activities identified during the inspection. A Form 483 notice is generally issued at the
conclusion of a FDA inspection and lists conditions the FDA inspectors believe may violate cGMP or
other FDA regulations. FDA guidelines specify that a “Warning Letter” is issued only for violations of
“regulatory significance” for which the failure to adequately and promptly achieve correction may be
expected to result in an enforcement action. Any such sanctions, if imposed, could materially harm our
operating results and financial condition. Under certain circumstances, the FDA also has the authority to
revoke previously granted drug approvals. Similar sanctions as detailed above may be available to the
FDA under a consent decree, depending upon the actual terms of such decree. Although we have
instituted internal compliance programs, if these programs do not meet regulatory agency standards or if
compliance is deemed deficient in any significant way, it could materially harm our business. Certain of
our vendors are subject to similar regulation and periodic inspections.
The process for obtaining governmental approval to manufacture and market pharmaceutical products is
rigorous, time-consuming and costly, and we cannot predict the extent to which we may be affected by
legislative and regulatory developments. We are dependent on receiving FDA and other governmental or
third-party approvals prior to manufacturing, marketing and shipping our products. Consequently, there
is always the chance that we will not obtain FDA or other necessary approvals, or that the rate, timing and
cost of such approvals, will adversely affect our product introduction plans or results of operations. We
carry inventories of certain product(s) in anticipation of launch, and if such product(s) are not
subsequently launched, we may be required to write-off the related inventory.
Federal regulation of arrangements between manufacturers of branded and generic products could
adversely affect our business.
As part of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, companies are
now required to file with the Federal Trade Commission and the Department of Justice certain types of
agreements entered into between brand and generic pharmaceutical companies related to the manufacture,
marketing and sale of generic versions of branded drugs. This new requirement could affect the manner
in which generic drug manufacturers resolve intellectual property litigation and other disputes with
branded pharmaceutical companies and could result generally in an increase in private-party litigation
against pharmaceutical companies or additional investigations or proceedings by the FTC or other
governmental authorities. The impact of this new requirement and the potential private-party lawsuits
associated with arrangements between brand name and generic drug manufacturers is uncertain, and could
adversely affect our business.
17
The pharmaceutical industry is highly competitive.
We face strong competition in our generic product business. Revenues and gross profit derived from the
sales of generic pharmaceutical products tend to follow a pattern based on certain regulatory and
competitive factors. As patents for brand name products and related exclusivity periods expire, the first
generic manufacturer to receive regulatory approval for generic equivalents of such products is generally
able to achieve significant market penetration. As competing off-patent manufacturers receive regulatory
approvals on similar products or as brand manufacturers launch generic versions of such products (for
which no separate regulatory approval is required), market share, revenues and gross profit typically
decline, in some cases dramatically. Accordingly, the level of market share, revenue and gross profit
attributable to a particular generic product is normally related to the number of competitors in that
product’s market and the timing of that product’s regulatory approval and launch, in relation to competing
approvals and launches. Consequently, we must continue to develop and introduce new products in a
timely and cost-effective manner to maintain our revenues and gross margins.
Sales of our products may continue to be adversely affected by the continuing consolidation of our
distribution network and the concentration of our customer base.
Our principal customers are wholesale drug distributors and major retail drug store chains. These
customers comprise a significant part of the distribution network for pharmaceutical products in the U.S.
This distribution network is continuing to undergo significant consolidation marked by mergers and
acquisitions among wholesale distributors and the growth of large retail drug store chains. As a result, a
small number of large wholesale distributors control a significant share of the market, and the number of
independent drug stores and small drug store chains has decreased. We expect that consolidation of drug
wholesalers and retailers will increase pricing and other competitive pressures on drug manufacturers,
including Lannett.
For the year ended June 30, 2007, our three largest customers accounted for 22%, 20% and 19%
respectively, of our net sales. The loss of any of these customers could materially adversely affect our
business, results of operations and financial condition and our cash flows. In addition, the Company has
no long-term supply agreements with its customers which would require them to purchase our products.
ITEM 1b.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
DESCRIPTION OF PROPERTY
Lannett owns two facilities in Philadelphia, Pennsylvania. The administrative offices, quality control
laboratory, and manufacturing and production facilities are located in a 38,000 square foot facility at 9000
State Road in Philadelphia. The second facility consists of 65,000 square feet, and is located within 1 mile of
the State Road location, 9001 Torresdale Avenue in Philadelphia. Our research laboratory, package,
warehousing and distribution operations, sales and accounting departments are located in the second building.
In June 2006, Lannett signed a lease agreement on a 66,000 square foot facility located on seven acres in
Philadelphia. An additional agreement which gives us the option to buy the facility was also signed. This
new facility is initially going to be used for warehouse space with the expectation of making this facility our
headquarters in addition to manufacturing and warehousing. The other Philadelphia locations will continue
to be utilized as manufacturing, packaging, and as a research laboratory. This gives Lannett the space to fit
its desire to expand.
18
Lannett’s subsidiary, Cody Laboratories, Inc. (“Cody”) leases a 73,000 square foot facility in Cody,
Wyoming. This location houses Cody’s manufacturing and production facilities. Cody leases the facility
from Cody LCI Realty, LLC, a Limited Liability Company which is 50% owned by Lannett and 50% by an
affiliate of Cody Labs.
ITEM 3.
LEGAL PROCEEDINGS
The Company monitors its compliance with all environmental laws. Any compliance costs which may be
incurred are contingent upon the results of future site monitoring and will be charged to operations when
incurred. No compliance costs were incurred during the years ended June 30, 2007, 2006 and 2005.
Pursuant to a Pennsylvania Department of Revenue (the “Department”) Sales and Use Tax audit, the
Department assessed Use Tax in the amount of $240,000, plus interest and penalties. The total due per the
audit is $347,000, although interest continues to accrue until paid. A Petition for Reassessment has been filed
with the Board of Appeals, an administrative board. At this point, management is waiting for a hearing to be
scheduled by the Board. Only certain audit issues have been raised in the Petition. Lannett is also contesting
the assessed penalties which total approximately $72,000. At this point, management has estimated the
minimum liability resulting from this audit will be $219,000, as has accrued this liability as of June 30, 2007.
The Company is currently engaged in several civil actions as a co-defendant with many other
manufacturers of Diethylstilbestrol (“DES”), a synthetic hormone. Prior litigation established that the
Company’s pro rata share of any liability is less than one-tenth of one percent. Due to the fact that prior
litigation established the “market share” method of prorating liability amongst the companies that
manufactured DES during the drug’s commercial distribution, which ended in 1971, management has
accepted this method as the most reasonably expected method of determining liability for future outcomes
of claims. The Company was represented in many of these actions by the insurance company with which
the Company maintained coverage (subject to limits of liability) during the time period that damages were
alleged to have occurred. The insurance company denies coverage for actions alleging involvement of the
Company filed after January 1, 1992. With respect to these actions, the Company paid nominal damages
or stipulated to its pro rata share of any liability. The Company has either settled or is currently defending
over 500 such claims. At this time, management is unable to estimate a range of loss, if any, related to
these actions. Management believes that the outcome of these cases will not have a material adverse
impact on the financial position or results of operations of the Company.
In addition to the matters reported herein, the Company is involved in litigation which arises in the
normal course of business. In the opinion of management, the resolution of these lawsuits will not have a
material adverse effect on the consolidated financial position or results of the Company.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters have been submitted to a vote of the Company's security holders during the quarter ended June
30, 2007.
19
PART II
ITEM 5.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market Information
On April 15, 2002, the Company’s common stock began trading on the American Stock Exchange. Prior to
this, the Company's common stock traded in the over-the-counter market through the use of the inter-dealer
"pink-sheets" published by Pink Sheets LLC. The following table sets forth certain information with respect
to the high and low daily closing prices of the Company's common stock during Fiscal 2007 and 2006, as
quoted by the American Stock Exchange. Such quotations reflect inter-dealer prices without retail mark-up,
markdown, or commission and may not represent actual transactions.
Fiscal Year Ended June 30, 2007
High
First quarter ........................................................................................
$6.38
Second quarter ...................................................................................
$6.94
Third quarter ......................................................................................
$6.83
Fourth quarter.....................................................................................
$7.15
Fiscal Year Ended June 30, 2006
High
First quarter ........................................................................................
$5.70
Second quarter ...................................................................................
$8.17
Third quarter ......................................................................................
$8.40
Fourth quarter.....................................................................................
$7.56
Low
$4.55
$5.28
$5.09
$5.08
Low
$4.24
$4.75
$7.06
$5.45
Holders
As of September 21, 2007, there were approximately 227 holders of record of the Company's common stock.
Dividends
The Company did not pay cash dividends in Fiscal 2007 or Fiscal 2006. The Company intends to use
available funds for working capital, plant and equipment additions, and various product extension ventures.
The Company does not expect to pay, nor should shareholders expect to receive, cash dividends in the
foreseeable future.
20
Equity Compensation Plan Information
The following table summarizes the equity compensation plans as of June 30, 2007:
Plan Category
Number of securities to be
issued upon exercise of
outstanding options, warrants
and rights
Weighted average exercise price of
outstanding options, warrants and
rights
Equity Compensation plans
approved by security holders
Equity Compensation plans not
approved by security holders
Total
(a)
1,119,331
-
1,119,331
(b)
$9.42
-
$9.42
Number of securities
remaining available for future
issuance under equity
compensation plans
(excluding securities reflected
in column (a))
(c)
3,746,234
-
3,746,234
21
ITEM 6.
SELECTED FINANCIAL DATA
The following financial information as of and for the five years ended June 30, 2007, has been derived
from the Company’s Consolidated Financial Statements. This information should be read in conjunction
with the Consolidated Financial Statements and related notes thereto included elsewhere herein.
The comparability of information is affected by the write-off of a portion of a note receivable due from
Cody Labs, and the subsequent acquisition of Cody Labs (a provider of active pharmaceutical ingredients
(“API”)) in Fiscal 2007. Approximately $7.8 million of notes were written-off prior to the Cody Labs
acquisition, representing the excess of the note receivable over the fair value of assets received of
approximately $4.4 million.
Statement of Financial Accounting Standards (SFAS) 123(R), “Share-Based Payment,” was adopted on
July 1, 2005 using the modified prospective transition method. Because the modified prospective
transition method was elected, results for prior periods have not been restated to include share-based
compensation expense for stock options or the Company’s Employee Stock Purchase Plan. See Note 1 to
the financial statements in Item 8 for more information.
In Fiscal 2005, the Company determined that an intangible asset related to acquired product rights was
impaired. At that time, the Company determined that this intangible was impaired and a $46.1 million
impairment charge was recorded.
Lannett Company, Inc. and Subsidiaries
Financial Highlights
2007
2006
2005
2004
2003
As of and for the Fiscal Year
Ended June 30,
Operating Highlights
Net Sales
Gross Profit
$82,577,591
$64,060,375
$44,901,645
$63,781,219
$42,486,758
$25,182,840
$30,160,330
$13,484,737
$36,924,344
$26,228,964
Operating (Loss)/Income
($5,964,409)
$8,453,918
($53,639,658)
$20,830,969
$19,060,106
Net (Loss)/Income
($6,929,008)
$4,968,922
($32,779,596)
$13,215,454
$11,666,887
Basic (Loss)/Earnings Per Share
($0.29)
$0.21
($1.36)
Diluted (Loss)/Earnings Per Share
($0.29)
$0.21
($1.36)
$0.63
$0.63
$0.58
$0.58
Weighted Average Shares
Outstanding, Basic
Weighted Average Shares
Outstanding, Diluted
Balance Sheet Highlights
Current Assets
Working Capital*
Total Assets
Total Debt
24,159,251
24,130,224
24,097,472
20,831,750
19,968,633
24,159,251
24,154,409
24,097,472
21,053,944
20,121,314
$44,285,190
$43,486,847
$33,938,115
$48,862,443
$23,930,048
$22,034,947
$22,862,419
$17,542,553
$28,923,814
$17,185,052
$104,656,100
$105,992,064
$94,917,060
$131,904,084
$31,834,544
$9,679,965
$8,196,692
$9,532,448
$10,092,857
$3,097,802
Deferred Tax Liabilities
$3,202,835
$2,545,734
$2,009,582
$1,614,323
$1,112,369
Total Stockholders’ Equity
$70,183,175
$75,755,916
$69,249,244
$102,246,991
$21,597,710
*Working capital equals current assets less current liabilities
22
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
In addition to historical information, this Form 10-K contains forward-looking information. The forward-
looking information is subject to certain risks and uncertainties that could cause actual results to differ
materially from those projected in the forward-looking statements. Important factors that might cause
such a difference include, but are not limited to, those discussed in the following section, entitled
“Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Readers are
cautioned not to place undue reliance on these forward-looking statements, which reflect management’s
analysis only as of the date of this Form 10-K. The Company undertakes no obligation to publicly revise
or update these forward-looking statements to reflect events or circumstances that may occur. Readers
should carefully review the risk factors described in other documents the Company files from time to time
with the SEC, including the quarterly reports on Form 10-Q to be filed by the Company in Fiscal 2008,
and any current reports on Form 8-K filed by the Company.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our
consolidated financial statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements.
Actual results may differ from these estimates under different assumptions or conditions.
Critical accounting policies are defined as those that are reflective of significant judgments and
uncertainties and potentially result in materially different results under different assumptions and
conditions. We believe that our critical accounting policies include those described below. For a detailed
discussion on the application of these and other accounting policies, refer to Note 1 in the Notes to the
Consolidated Financial Statements included herein.
Consolidation of Variable Interest Entity – The Company consolidates any Variable Interest Entity
(“VIE”) of which we are the primary beneficiary. The liabilities recognized as a result of consolidating a
VIE do not represent additional claims on our general assets; rather, they represent claims against the
specific assets of the consolidated VIE. Conversely, assets recognized as a result of consolidating a VIE
do not represent additional assets that could be used to satisfy claims against our general assets. Reflected
in the June 30, 2007 balance sheet are consolidated VIE assets of $1.8 million, which is comprised mainly
of land and building. There were no VIE assets at June 30, 2006. VIE liabilities consist of a mortgage on
that property in the amount of $1.8 million. This VIE was initially consolidated by Cody Labs, as Cody
has been the primary beneficiary. Cody has then been consolidated within Lannett’s financial statements,
due to the acquisition in April 2007 of Cody Labs by the Company.
Revenue Recognition – The Company recognizes revenue when its products are shipped. At this point,
an arrangement of sale exists by virtue of a customer purchase order. Delivery has transferred title and
risk of loss to the customer. The net sales price is determinable through a contracted sales price, less
provisions for rebates, promotional adjustments, price adjustments, returns, chargebacks, and other
potential adjustments that are reasonably determinable. Collectibility is reasonably assured. Accruals for
these provisions are presented in the consolidated financial statements as rebates and chargebacks payable
and reductions to net sales. The change in the reserves for various sales adjustments may not be
proportionally equal to the change in sales because of changes in both the product and the customer mix.
Increased sales to wholesalers will generally require additional accruals as they are the primary recipient
of chargebacks and rebates. Incentives offered to secure sales vary from product to product. Provisions
23
for estimated rebates and promotional credits are estimated based upon contractual terms. Provisions for
other customer credits, such as price adjustments, returns, and chargebacks, require management to make
subjective judgments on customer mix. Unlike branded innovator drug companies, Lannett does not use
information about product levels in distribution channels from third-party sources, such as IMS and NDC
Health, in estimating future returns and other credits. Lannett calculates a chargeback/rebate rate based on
contractual terms with its customers and applies this rate to customer sales. The only variable is customer
mix, and this is based on historical data and sales expectations. The chargeback/rebate reserve is
reviewed on a monthly basis by management using several ratio and calculated metrics. Lannett’s
methodology for estimating reserves has been consistent with previous periods.
Chargebacks – The provision for chargebacks is the most significant and complex estimate used in the
recognition of revenue. The Company sells its products directly to wholesale distributors, generic
distributors, retail pharmacy chains, and mail-order pharmacies. The Company also sells its products
indirectly to independent pharmacies, managed care organizations, hospitals, nursing homes, and group
purchasing organizations, collectively referred to as “indirect customers.” Lannett enters into agreements
with its indirect customers to establish pricing for certain products. The indirect customers then
independently select a wholesaler from which to actually purchase the products at these agreed-upon
prices. Lannett will provide credit to the wholesaler for the difference between the agreed-upon price
with the indirect customer and the wholesaler’s invoice price if the price sold to the indirect customer is
lower than the direct price to the wholesaler. This credit is called a chargeback. The provision for
chargebacks is based on expected sell-through levels by the Company’s wholesale customers to the
indirect customers and estimated wholesaler inventory levels. As sales to the large wholesale customers,
such as Cardinal Health, AmerisourceBergen, and McKesson, increase, the reserve for chargebacks will
also generally increase. However, the size of the increase depends on the product mix. The Company
continually monitors the reserve for chargebacks and makes adjustments when management believes that
actual chargebacks on actual shipments may differ from the actual chargeback reserves.
Rebates – Rebates are offered to the Company’s key customers to promote customer loyalty and increase
product sales. These rebate programs provide customers with rebate credits upon attainment of pre-
established volumes or attainment of net sales milestones for a specified period. Other promotional
programs are incentive programs offered to the customers. At the time of shipment, the Company
estimates reserves for rebates and other promotional credit programs based on the specific terms in each
agreement. The reserve for rebates increases as sales to certain wholesale and retail customers increase.
However, since these rebate programs are not identical for all customers, the size of the reserve will
depend on the mix of customers that eligible to receive rebates.
Returns – Consistent with industry practice, the Company has a product return policy that allows
customers to return products within a specified period prior to and subsequent to the product’s lot
expiration date in exchange for a credit to be applied to future purchases. The Company’s policy requires
that the customer obtain pre-approval from the Company for any qualifying return. The Company
estimates its provision for returns based on historical experience, changes to business practices, and credit
terms. While such experience has allowed for reasonable estimates in the past, historical returns may not
always be an accurate indicator of future returns. The Company continually monitors the provisions for
returns and makes adjustments when management believes that product returns on actual sales may differ
from established reserves. Generally, the reserve for returns increases as net sales increase. The reserve
for returns is included in the rebates and chargebacks payable account on the balance sheet. Return
periods will vary by customer and product.
In the fourth quarter of fiscal year 2005, the Company recorded a $1,500,000 reduction in sales to account
for expected returns from a major wholesaler who was having difficulty selling a significant amount of
Levothyroxine Sodium tablets that it had purchased a year earlier. The Company considered extending
the shelf-life of the product in March 2005, but decided against this extension. In May 2005, the
Company decided to reserve for all estimated returns of this unsold product on hand at the wholesaler.
24
All unsold products remaining from May 2005 were potentially returnable by December 2005, based on
expiration dates. The $1,500,000 reduction included the estimate of those expected returns through that
date. The product was returned to the Company in December 2005, and concurrently written off as slow
moving and short-dated inventory.
Other Adjustments – Other adjustments consist primarily of price adjustments, also known as “shelf
stock adjustments,” which are credits issued to reflect decreases in the selling prices of the Company’s
products that customers have remaining in their inventories at the time of a price reduction. Decreases in
selling prices are discretionary decisions made by management to reflect competitive market conditions.
Amounts recorded for estimated shelf stock adjustments are based upon specified terms with direct
customers, estimated declines in market prices, and estimates of inventory held by customers. The
Company regularly monitors these and other factors and evaluates the reserve as additional information
becomes available. Other adjustments are included in the rebates and chargebacks payable account on the
balance sheet. When competitors enter the market of existing products, shelf stock adjustments are issued
to maintain price competitiveness. Management foresaw this occurrence and appropriately reserved for it
as seen in the table below.
The following tables identify the reserves for each major category of revenue allowance and a summary
of the activity for the years ended June 30, 2007, 2006 and 2005:
For the Year Ended June 30, 2007
Reserve Category
Reserve Balance as of June 30, 2006
Actual credits issued related to sales recorded
in prior fiscal years
Reserves or (reversals) charged during Fiscal
2007 related to sales recorded in prior fiscal
years
Reserves charged to net sales in fiscal 2007
related to sales recorded in fiscal 2007
Actual credits issued related to sales in fiscal
2007
Chargebacks
Total
$ 10,137,400 $ 2,183,100 $ 416,000 $ 275,600 $ 13,012,100
Rebates
Returns
Other
(10,170,000) (1,800,000) (890,000) (250,000) (13,110,000)
- (300,000) 460,000
-
160,000
28,034,000 9,562,000 1,215,000 1,044,800
39,855,800
(23,351,922) (8,773,761) (1,087,687) (1,018,166) (34,231,536)
Reserve Balance as of June 30, 2007
$ 4,649,478 $ 871,339 $ 113,313 $ 52,234 $ 5,686,364
25
For the Year Ended June 30, 2006
Reserve Category
Reserve Balance as of June 30, 2005
Chargebacks
$ 7,999,700
Rebates
Total
$ 1,028,800 $ 1,692,000 $ 29,500 $ 10,750,000
Returns
Other
Actual credits issued related to sales recorded in
prior fiscal years
(7,920,500) (1,460,500) (1,272,400) (59,300) (10,712,700)
Reserves or (reversals) charged during Fiscal
2006 related to sales recorded in prior fiscal years
Reserves charged to net sales in fiscal 2006
related to sales recorded in fiscal 2006
Actual credits issued related to sales in fiscal
2006
-
500,000 (500,000)
-
-
28,237,000
5,688,500 497,300 1,298,200
36,221,000
(18,178,800) (3,573,700) (900) (992,800) (23,246,200)
Reserve Balance as of June 30, 2006
$ 10,137,400
$ 2,183,100 $ 416,000 $ 275,600 $ 13,012,100
For the Year Ended June 30, 2005
Reserve Category
Reserve balance as of June 30, 2004
Actual credits issued related to sales
recorded in prior fiscal years
Reserves or (reversals) charged during
Fiscal 2005 related to sales recorded in
prior fiscal years
Reserves charged to net sales in fiscal
2005 related to sales recorded in fiscal
2005
Actual credits issued related to sales in
fiscal 2005
Chargebacks
Total
$ 6,484,500 $ 1,864,200 $ 448,000 $ 88,300 $ 8,885,000
Rebates
Returns
Other
(4,978,300) (1,970,000) (523,100) (95,800) (7,567,200)
(1,420,000)
130,000 1,400,000
-
110,000
21,028,100 6,970,100 1,533,900 623,400
30,155,500
(13,114,600) (5,965,500) (1,166,800) (586,400) (20,833,300)
Reserve balance as of June 30, 2005
$ 7,999,700 $ 1,028,800 $ 1,692,000 $ 29,500 $ 10,750,000
Reserve Activity 2007 vs. 2006
The total reserves for chargebacks, rebates and returns decreased from $13,012,100 at June 30, 2006 to
$5,686,364 at June 30, 2007 due to a 50% decrease in sales to wholesale customers in the fourth quarter
of Fiscal 2007 as compared to prior year. Historically, the ratio of the reserve to overall gross sales has
been between 30% and 40%. The fiscal years ended June 30, 2007 and 2006 were 28% and 36%,
respectively. This decrease in Fiscal 2007 is due to the change in customer sales mix. The following
table shows the sales mix from Fiscal 2007 and Fiscal 2006, and the fourth quarter of each year.
26
Chain drug stores
Mail Order
Wholesalers
Private Label
Fiscal Year ended 6/30
2007
2006
Fiscal Fourth Quarter
2007
2006
24%
4%
72%
0%
100%
13%
7%
78%
2%
100%
34%
4%
62%
0%
100%
10%
6%
82%
2%
100%
Sales to chain drug stores have increased significantly over the prior year. The effect of those sales have
been to increase overall sales while at the same time reduce the rate of chargebacks and rebates overall.
The fourth quarter of each year is significant to show, because the majority of the reserve remaining on
the Company’s balance sheet at June 30 of each year has arisen from sales made in the fourth quarter.
The decline in reserves is due to this decrease in sales to wholesalers.
Fiscal Year Ended 6/30
Chargeback reserve
Rebate reserve
Return reserve
Other reserve
2007
4,649,478
871,339
113,313
52,234
5,686,364
%
82%
15%
2%
1%
100%
2006
10,137,400
2,183,100
416,000
275,600
13,012,100
$
$
%
78%
17%
3%
2%
100%
$
$
The decrease in the chargeback reserve to $4,649,478 at June 30, 2007 from $10,137,400 at June 30, 2006
is due to the decrease in sales to wholesalers. The decrease in rebate reserve to $871,339 from
$2,183,100 at June 30, 2006 is also due to the decrease in sales to wholesalers plus the decrease in overall
sales in the fourth quarter of Fiscal 2007. There was a large rebate reserve as of June 30, 2006 as direct
customers (those who receive the only rebates) were a larger than usual portion of sales in the month of
June – 58%, typically 50%.
During the year, the Company began to implement systematic improvements to separately calculate the
chargebacks and reserves. Management is continuing to make improvements to the calculation and
reconciliation of these amounts. Management performs several types of analysis to ensure reserves are
reasonable. This includes ratio analysis of: wholesaler versus direct (or retail) sales mix; revenue reserve
to gross sales; comparison of net receivables to net sales; comparison of gross receivables to gross sales;
and recalculation of wholesaler inventory levels. Through these steps, management is able to ensure that
all reserves are reasonably stated.
Because we are unable to independently verify product sales levels at the final customer, wholesaler
inventory reports are used to recalculate potential chargebacks and rebates based on known contracted
rebate and chargeback rates.
The return and other reserves have decreased since June 30, 2006, due to an unusually high level of shelf
stock adjustments required in the prior year. Changes in the competition in the Primidone 50 market
required Lannett to give more of this type of credit in the prior year.
Fluctuations in the amount of sales through the wholesaler channel will have an impact on the amount of
reserve being charged. Due to the fact that wholesale sales result in greater chargebacks, a change in
wholesale sales will directly correlate to change in the chargebacks required. For the first, second, third
and fourth quarters of Fiscal 2007, reserves recorded against sales amounted to $12.0 million, $10.5
million, $12.7 million and $4.7 million, respectively. Wholesaler sales were $16.2 million, $12.4 million,
$12.8 million and $8.7 million, respectively. The decrease in the dollar value of the reserves corresponds
27
to the increase in wholesale sales, most significantly in the fourth quarter. For the first, second, third and
fourth quarters of Fiscal 2006, reserves recorded against sales amounted to $7.1 million, $7.4 million,
$12.0 million and $9.7 million, respectively. Wholesaler sales were $9.3 million, $9.9 million, $16.7
million and $15.8 million, respectively. This third quarter increase in sales and reserves during Fiscal
2006 is a result of increased demand for Levothyroxine Sodium, for which the reserve rebate and
chargeback reserve remains consistent, but is higher than most other products. This drug’s reserves are
higher than other drugs because of the number of competitors in the market. This may change if the
number of competitors decline because low prices will force some competitors out of the market, which
in turn may lead to higher prices. Fourth quarter sales to wholesalers dropped off slightly from the third
quarter. The reserves in the fourth quarter also declined because of the product mix, but were consistent
with reserves in the first and second quarters.
Reserve Activity 2006 vs. 2005
The chargeback reserve increased from $10,750,000 at June 30, 2005 to $13,012,100 at June 30, 2006 due
to an increased level of sales in the months of May and June as compared to prior year. Historically, the
ratio of the reserve to gross sales is between 30% and 40%. The fiscal years ended June 30, 2006 and
2005 were 36% and 40%, respectively. In fiscal 2005, there were additional reserves taken for an
expected Levothyroxine return. This accounted for an additional $1.4 million or 1.8%. Additional rebate
reserves of $500,000 related to Fiscal 2005 were incurred during Fiscal 2006, and these were offset by
reduced return reserves of the same amount. This crossover of rebates and returns occurred because the
Company provided customer incentives to prevent any large returns. Rebates have decreased both in
amount and as a percentage of the reserve in the “additional credits issued-related to sales recorded in
Fiscal 2006” due to the classification of rebates from wholesale customers. When the reserve for
chargebacks and rebates is calculated for the wholesale/distribution customers, it is calculated in
aggregate, that is, on a combined basis, since they submit the amounts together. This is in part the reason
why the chargeback amount has increased. However there is a large rebate reserve as of June 30, 2006
as direct customers (those who receive the only rebates) were a larger than usual portion of sales in the
month of June – 58%, typically 50%. “Other” increased due to an increase in shelf stock adjustments.
Additional competitors in the Primidone 50 market have caused Lannett to give more of this type of
credit. Currently, the Company is in the process of developing systematic tracking of rebates and
chargebacks to improve the accuracy of estimating chargebacks and rebates. This will enable the
Company to separately analyze rebates and chargebacks, and will allow the Company to more accurately
estimate the required reserve on each category.
Fluctuations in the amount of sales through the wholesaler channel will have an impact on the amount of
reserve being charged. Due to the fact that wholesale sales result in greater chargebacks, an increase in
wholesale sales will result in a higher level of chargebacks. For the first, second, third and fourth quarters
of Fiscal 2006, reserves recorded against sales amounted to $7.5 million, $7.9 million, $12.5 million and
$10.0 million, respectively. Wholesaler sales were $9.3 million, $9.9 million, $16.7 million and $15.8
million, respectively. The increase in the dollar value of the reserves corresponds to the increase in
wholesale sales, most significantly in the third quarter. This third quarter increase in sales and reserves is
a result of increased demand for Levothyroxine Sodium, for which the reserve rebate and chargeback
reserve remains consistent, but is higher than most other products. This drug’s reserves are higher than
other drugs because of the number of competitors in the market. This may change if the number of
competitors decline, because low prices will force some competitors out of the market, which in turn may
lead to higher prices again. Fourth quarter sales to wholesalers dropped off slightly from the third
quarter. The reserves in the fourth quarter also declined because of the product mix, but were consistent
with reserves in the first and second quarters.
Management performs several types of analysis to ensure reserves are reasonable. This includes ratio
analysis of: wholesaler versus direct (or retail) sales mix; revenue reserve to gross sales; comparison of
28
net receivables to net sales; comparison of gross receivables to gross sales; and recalculation of
wholesaler inventory levels. Through these steps, management is able to ensure that all reserves are
reasonably stated.
Because we are unable to independently verify product sales levels at the final customer, wholesaler
inventory reports are used to recalculate potential chargebacks and rebates based on known contracted
rebate and chargeback rates.
Accounts Receivable - The Company performs ongoing credit evaluations of its customers and adjusts
credit limits based upon payment history and the customer's current credit worthiness, as determined by a
review of current credit information. The Company continuously monitors collections and payments from
its customers and maintains a provision for estimated credit losses based upon historical experience and
any specific customer collection issues that have been identified. While such credit losses have
historically been within both the Company’s expectations and the provisions established, the Company
cannot guarantee that it will continue to experience the same credit loss rates that it has in the past.
Inventories - The Company values its inventory at the lower of cost (determined by the first-in, first-out
method) or market, regularly reviews inventory quantities on hand, and records a provision for excess and
obsolete inventory based primarily on estimated forecasts of product demand and production
requirements. The Company’s estimates of future product demand may prove to be inaccurate, in which
case it may have understated or overstated the provision required for excess and obsolete inventory. In the
future, if the Company’s inventory is determined to be overvalued, the Company would be required to
recognize such costs in cost of goods sold at the time of such determination. Likewise, if inventory is
determined to be undervalued, the Company may have recognized excess cost of goods sold in previous
periods and would be required to recognize such additional operating income at the time of sale.
In the fourth quarter of fiscal year 2005, the Company recorded a $4,000,000 write-down of slow moving
and short dated inventory primarily related to Levothyroxine Sodium tablets, which had been returned by
a wholesaler during the quarter. During Fiscal 2006, approximately $400,000 of previously reserved
inventory had been sold to customers, and the related reserve reduced by that amount.
Intangible Asset – On March 23, 2004, the Company entered into an agreement with Jerome Stevens
Pharmaceuticals, Inc. (JSP) for the exclusive marketing and distribution rights in the United States to the
current line of JSP products in exchange for four million (4,000,000) shares of the Company’s common
stock. As a result of the JSP agreement, the Company recorded an intangible asset of $67,040,000 for the
exclusive marketing and distribution rights obtained from JSP. The intangible asset was recorded based
upon the fair value of the four million (4,000,000) shares at the time of issuance to JSP.
In June 2004, JSP’s Levothyroxine Sodium tablet product received from the FDA an AB rating to the
brand drug Levoxyl®. In December 2004, the product received from the FDA a second AB rating to the
brand drug Synthroid®. As a result of the dual AB ratings, the Company was required to pay JSP an
additional $1.5 million in cash to reimburse JSP for expenses related to obtaining the AB ratings. As of
March 31, 2005, the Company recorded an addition to the intangible asset of $1.5 million.
During Fiscal 2005, events occurred which indicated that the carrying value of the intangible asset was
not recoverable. In accordance with Statement of Financial Accounting Standards No. 144 (FAS 144),
Accounting for the Impairment or Disposal of Long-Lived Assets, the Company engaged a third party
valuation specialist to assist in the performance of an impairment test for the quarter ended March 31,
2005. The impairment test was performed by discounting forecasted future net cash flows for the JSP
products covered under the agreement and then comparing the discounted present value of those cash
flows to the carrying value of the asset (inclusive of the $1.5 million paid to JSP for the dual AB ratings).
As a result of the testing, the Company determined that the intangible asset was impaired as of March 31,
2005. In accordance with FAS 144, the Company recorded a non-cash impairment loss of approximately
$46,093,000 to write the asset down to its fair value of approximately $16,062,000 as of the date of the
29
impairment. This impairment loss is shown on the statement of operations as a component of operating
loss. Management concluded that, as of June 30, 2007, the intangible asset is correctly stated at fair value
and, therefore, no additional adjustment is required.
New Accounting Pronouncements - On September 13, 2006, the SEC staff issued Staff Accounting
Bulletin (SAB) Topic 1N, “Financial Statements — Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements” (SAB 108), SAB 108 addresses
how a registrant should evaluate whether an error in its financial statements is material. The SEC staff
concludes in SAB 108 that materiality should be evaluated using both the “rollover” and “iron curtain”
methods. Registrants are required to comply with the guidance in SAB 108 in financial statements for
fiscal years ending after November 15, 2006. The impact of applying SAB 108 is immaterial to the
operating results of the Company for the year ended June 30, 2007. Prior to application of SAB 108, the
Company had been using the “rollover” method to correct misstatements in the financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities (Including an amendment of FASB Statement No. 115)” (SFAS 159). This
Statement permits entities to choose to measure many financial instruments and certain other items at fair
value that are not currently required to be measured at fair value. The objective is to improve financial
reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply complex hedge accounting
provisions. SFAS 159 is expected to expand the use of fair value measurement, which is consistent with
the Financial Accounting Standards Board’s long-term measurement objective for accounting for
financial instruments. This statement also establishes presentation and disclosure requirements designed
to facilitate comparisons between entities that choose different measurement attributes for similar types of
assets and liabilities. SFAS 159 does not affect any existing accounting literature that requires certain
assets and liabilities to be carried at fair value. This statement does not establish requirements for
recognizing and measuring dividend income, interest income, or interest expense. SFAS 159 is effective
as of the beginning of an entity’s first fiscal year that begins after November 15, 2007, which, in the
Company’s case, is the fiscal year beginning July 1, 2008. This statement does not eliminate disclosure
requirements included in other accounting standards, including requirements for disclosure about fair
value measurements included in FASB Statement No. 157 “Fair Value Measurements,” and No. 107
“Disclosure about Fair Value of Financial Instruments.” The Company has not yet completed assessing
the impact this standard will have on its financial statements and results of operations.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157). This
Statement defines fair value, establishes a framework for measuring fair value in generally accepted
accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement
applies under other accounting pronouncements that require or permit fair value measurements, the Board
having previously concluded in those accounting pronouncements that fair value is the relevant
measurement attribute. Accordingly, this Statement does not require any new fair value measurements.
However, for some entities, the application of this Statement will change current practice. This Statement
is effective for financial statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. The Company will be required to adopt the guidance of SFAS
157 beginning July 1, 2008. The Company is currently evaluating the impact this standard will have on
its financial statements and will adopt this guidance beginning July 1, 2007.
On May 2, 2007, the Financial Accounting Standards Board (FASB) posted FASB Staff Position (FSP)
No. FIN 48-1, Definition of Settlement in FASB Interpretation No. 48. This FSP amended FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes, to provide guidance on how an
enterprise should determine whether a tax position is effectively settled for the purpose of recognizing
previously unrecognized tax benefits. This FASB Staff Position sets forth that certain conditions should
be evaluated when determining effective settlement. The guidance in this FSP shall be applied upon the
initial adoption of Interpretation 48.
30
In May 2005, the FASB issued FASB Statement No. 154, “Accounting Changes and Error Corrections, a
replacement of APB Opinion No. 20 and FASB Statement No. 3” (SFAS No. 154). Previously, APB
Opinion No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in
Interim Financial Statements” required the inclusion of the cumulative effect of changes in accounting
principle in net income of the period of the change. SFAS No. 154 requires companies to recognize a
change in accounting principle, including a change required by a new accounting pronouncement when
the pronouncement does not include specific transition provisions, retrospectively to prior period financial
statements. SFAS No. 154 was effective as of January 1, 2006. The adoption of this standard did not have
any impact on the Company in the current fiscal year.
In April 2006, the FASB issued FASB Staff Position No. FIN 46(R)—6, “Determining the Variability to
Be Considered in Applying FASB Interpretation No. 46(R)” (FSP No. 46(R)—6). This pronouncement
provides guidance on how a reporting enterprise should determine the variability to be considered in
applying FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest
Entities,” which could impact the assessment of whether certain variable interest entities are consolidated.
FSP No. 46(R)—6 was effective for the Company on July 1, 2006. See Note 13 for “Consolidation of
Variable Interest Entities”.
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes” (FIN 48), to clarify the accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with SFAS 109, “Accounting for Income Taxes.” Effective January 1,
2007, FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company
is currently evaluating the impact, that FIN 48 will have on its financial statements and will adopt this
guidance beginning July 1, 2007.
Results of Operations – Fiscal 2007 compared to Fiscal 2006
Net sales increased by 29% from $64,060,375 in Fiscal 2006 to $82,577,591 in Fiscal 2007. The increase
was due in part from continued improvement in sales of Levothyroxine Sodium (Levo), which increased
$18.1 million, or 121% over the prior year sales, and Sulfamethoxazole with Trimethoprim (SMZ) which
increased $14.9 million, a 570% increase. These increases were offset partially by decreases in other existing
products, most significantly Primidone tablets, of which sales declined $5,152,000. The Company is working
to offset continued declines in existing products through new product offerings. Currently, the Company has
over 18 ANDAs awaiting approval by the FDA. The increase in Levo sales is due entirely to an increase in
the quantity of bottles sold. The increase in SMZ is due to quantity increases of nearly 390% and price
increases of 180%.
Overall, product sales quantities increased 100% (including new products), leading to increased sales.
Greater pricing pressure, due to increased competition and new customer demands for lower prices offset the
volume increase, resulting in the 29% sales increase over Fiscal 2006. SMZ pricing benefited from the
departure of a competitor from the market. Such pricing changes due to competition are not predictable. For
that reason, the Company must maintain its focus on developing new products every year to expand the
number of product available to supply to customers. Net sales of new products are often impacted by greater
incentives to wholesalers. Excluding sales of SMZ in Fiscal 2007, the Company experienced a decline in new
product net sales in the year. This is due to the Company receiving fewer approvals from the FDA during the
year. At June 30, 2007, the Company had 18 products, as ANDA and ANDA supplements, awaiting
approval from the FDA. This increased from 10 as of June 30, 2006.
The Company sells its products to customers in various categories. The table below identifies the Company’s
net sales to each category.
31
Customer Category
Fiscal 2007 Net
Sales
Fiscal 2006 Net
Sales
Fiscal 2005 Net
Sales
Wholesaler/Distributor
$49.4 million
$44.0 million
$24.8 million
Retail Chain
$27.9 million
$10.6 million
$10.5 million
Mail-Order Pharmacy
$5.1 million
$7.0 million
$5.9 million
Private Label
$0.2 million
$2.5 million
$3.7 million
Total
$82.6 million
$64.1 million
$44.9 million
Wholesaler/Distributor sales increased due to a rebound in Levothyroxine Sodium sales and sales of new
products. Levo and SMZ sales increased as Wholesalers began to reorder the product in larger volumes in
Fiscal 2006. Retail Chain sales increased significantly due to a new significant customer agreement signed
during Fiscal 2007. Mail Order Pharmacy sales decreased slightly from the prior year. Private label sales
decreased due to our largest private label customer, Qualitest, receiving FDA approval in late November 05
to manufacture its own Primidone 50mg. As disclosed previously, sales to the Private Label category have
continued to decline, as Lannett does not actively pursue additional private label customers because of the
lower margins and product label inventories required to service the category.
Cost of sales (excluding amortization of intangible assets) increased 69%, from $33,900,045 in Fiscal 2006 to
$57,394,751 in Fiscal 2007. This increase is due in part to higher production volumes to meet increased sales
demand, and increased purchases of finished products for sale. Gross margins were 30% in 2007, a decline
from 47% in 2006. In spite of the significant increase in net sales, the Company has increasing sales of drugs
made by other companies, and distributed by Lannett. The margins on these drugs are typically lower than
margins on produced drugs. The Company also launched a greater amount of new drugs in the prior year,
and was able to take advantage of its new products and the higher margin on these products in 2006.
Depending on future market conditions for each of the Company’s products, changes in the future sales
product mix may occur. New drug approvals may increase in future years. Currently, there are 18 products
at the FDA review stage. These changes may affect the gross profit percentage in future periods.
Research and development (“R&D”) expenses decreased by $643,033 or 8%. The decrease in R&D is
primarily due to a decrease in raw material consumption for production of experimental batches.
Selling, general and administrative expenses increased $2,334,382, or 20%. A significant portion of the
increase is due to expenses incurred in Fiscal 2007 that relate to marketing agreements tied to sales of new
generic products.
The amortization expense relates to the March 23, 2004 exclusive marketing and distribution rights
agreement with JSP. For the remaining seven years of the contract, the Company will incur annual
amortization expense of approximately $1,785,000.
On March 31, 2007, the Company wrote down $7,775,890 of a note receivable owed by Cody Laboratories,
Inc. The Company determined that the value of the note receivable was impaired, and on April 10, 2007, it
was decided to complete the acquisition of Cody by forgiving a portion of the loan. At that point, Cody owed
Lannett approximately $11.7 million, in the form of notes receivable and prepayments on products and
services. The remaining value of the amounts owed, or $4.4 million was approximately the net asset value of
Cody at the time of the acquisition.
The Note was determined to be uncollectible due to FDA reviews and operational delays by Cody to return to
operation. In 2006, Cody received an FDA warning letter, and stopped operations to remediate their facility.
This remediation occurred from the months of August 2006 through February 2007. Upon completion of the
remediation, Cody requested a future FDA inspection. The timing of that inspection was, at that time,
unknown, and Cody management was unable to conclude as to the outcome of that inspection. With such a
limited outlook, Cody management suggested that the full note was not likely to be satisfied, and Lannett
32
management was not willing to loan further funds to Cody to keep it in operation. Both companies agreed to
complete the acquisition for the value of the Cody’s net assets. The uncollected portion of debt was
extinguished prior to the acquisition.
Upon acquisition, the fair value of Cody’s assets was added to the Company’s Consolidated Balance Sheets,
and the results of operations were included in the Consolidated Statements of Operations from the acquisition
date forward. Fair value was determined using an independent valuation firm. Due to the fact that most of
the value of Cody consisted of physical assets that were recently acquired as part of the remediation, the fair
value closely approximated the book value of net assets. In accordance with the Financial Accounting
Standards Board Statement No. 141, “Business Combinations,” measurement is based on the fair value of
the consideration given or the fair value of the asset (or net assets) acquired, whichever is more clearly
evident and, thus, more reliably measurable.
The Company's net loss for Fiscal 2007 includes an income tax expense of $1,007,929, as compared to an
expense of $3,561,175 in Fiscal 2006. The Company has set up a valuation allowance on the tax benefit
from the write-off of a portion of the Cody loan described above in Fiscal 2007. This has led to an
income tax expense despite of the net loss from operations.
The Company reported net loss of $6,929,008 for Fiscal 2007, or $.29 basic and diluted loss per share,
compared to net income of $4,968,922 for Fiscal 2006, or $.21 basic and diluted earnings per share.
Results of Operations – Fiscal 2006 compared to Fiscal 2005
Net sales increased by 43%, from $44,901,645 in Fiscal 2005 to $64,060,375 in Fiscal 2006. The increase
was due in part to a rebound in Levothyroxine sales which increased $6.4 million, or 75%. The Company
also had additional growth with the introduction of several new products which accounted for $12.6 million
in sales. Several other products besides Levothyroxine Sodium experienced increased sales over prior year –
including Digoxin 29%, Acetazolamide 8%, Unithroid 38%, and Hydromorphone 398%. Volume and price
increases attributed to increased sales – 33% due to increase in volume (new sales are included in volume
increases) and 11% increase in prices. Prices rebounded in the sales of Levothyroxine and Digoxin. Both
saw increased price pressure in the prior year as several competitors entered into the market. In addition,
net sales of new products are often impacted by greater incentives to wholesalers. New product net sales
of $12.6 million in Fiscal 2006 are net of reserves of $3.2 million. This is a significant increase over
Fiscal 2005 net sales of $500,000 and reserves of $100,000 that were associated with new product net
sales.
The Company sells its products to customers in various categories. The table below identifies the Company’s
net sales to each category.
Customer Category
Fiscal 2006 Net
Sales
Fiscal 2005 Net
Sales
Fiscal 2004 Net
Sales
Wholesaler/Distributor
$44.0 million
$24.8 million
$43.0 million
Retail Chain
$10.6 million
$10.5 million
$12.1 million
Mail-Order Pharmacy
$7.0 million
$5.9 million
$4.3 million
Private Label
$2.5 million
$3.7 million
$4.4 million
Total
$64.1 million
$44.9 million
$63.8 million
Wholesaler/Distributor sales increased due to a rebound in Levothyroxine Sodium sales and sales of new
products. Levothyroxine Sodium sales increased as Wholesalers reduced their inventories and began to
33
reorder the product in larger volumes in Fiscal 2006. Mail Order Pharmacy sales increased due to new
product sales and the fact that this area of the industry is growing at a faster rate than the other areas. Retail
Chain sales remained unchanged from the prior year, as new products sales replaced the loss of any existing
products. Private label sales decreased due to our largest private label customer, Qualitest, receiving FDA
approval in late November 05 to manufacture its own Primidone 50mg. Sales to the Private Label category
may continue to decline, as Lannett does not actively pursue additional private label customers because of the
lower margins and product label inventories required to service the category.
Cost of sales (excluding amortization of intangible assets) increased 8%, from $31,416,908 in Fiscal 2005 to
$33,900,045 in Fiscal 2006. This increase is due in part to higher production volumes to meet increased sales
demand. Gross margins were 47% in 2006, an improvement over 30% in 2005. Improvement was, in part,
affected by the prior year write-off of short-dated Levothyroxine Sodium. The prior year also experienced an
increased return accrual, taken in anticipation of an unusually large return of Levothyroxine. The
Levothyroxine related write-offs accounted for 10% of cost of sales in the prior year. Aside from the prior
year one-time incidents related to Levothyroxine, the margins increased due to additional product offerings
and higher effective pricing. Despite new entrants to the Primidone market, the Company was able to
maintain its market share and competitive price. The Company was also able to take advantage of its new
products and the higher margin on these products. Depending on future market conditions for each of the
Company’s products, changes in the future sales product mix may occur. These changes may affect the gross
profit percentage in future periods.
Research and development (“R&D”) expenses increased by $1,836,943, or 29%. The increase in R&D is
primarily due to an increase in raw material consumption for production of experimental batches.
Selling, general and administrative expenses increased $2.6 million, or 28%. The increase is primarily
due to the adoption of SFAS 123(R) which contributed stock compensation expense of $1.4 million.
Amortization expense decreased $3.7 million from $5.5 million to $1.8 million due to the write down of the
intangible asset that occurred in March 2005. Please see further description of this event in Note 1 of the
Notes to Consolidated Financial Statements, under the heading “Intangible Assets.”
As a result of the revaluation of the intangible asset, the Company’s financial results changed from an
operating loss of ($53,639,658) in Fiscal 2005 to an operating income of $8,453,918 in Fiscal 2006.
The Company’s income tax classification changed to an income tax expense of $3,561,175 from an income
tax benefit of ($21,045,902) in Fiscal 2005. The effective tax rate increased slightly from 39% in 2005 to
41% in 2006.
The Company reported net income of $4,968,922 for Fiscal 2006, or $.21 basic and diluted income per share,
compared to net loss of ($32,779,596) for Fiscal 2005, or ($1.36) basic and diluted loss per share.
Liquidity and Capital Resources
Net cash provided by operating activities of $12,675,320 for the year ended June 30, 2007 was attributable to
a net loss of $6,929,008 as adjusted for the effects of non-cash items of $14,927,897, of which $7,775,890
was an impairment charge related to the acquisition of Cody Laboratories, Inc., and net changes in operating
assets and liabilities totaling $4,676,431. Significant changes in operating assets and liabilities are described
below.
1. An increase in inventory of $2,716,610 due to an increase in the amount of distributed product
inventory on hand. Distributed products in general saw a significant increase in sales during
fiscal 2007, resulting in increased purchasing of those products by the Company in order to
maintain stock available for resale.
2. An increase in trade accounts receivable of $1,878,027 was due to changes in the sales mix at the
end of 2007, compared to the end of 2006. The Company sold significantly more product to
retail customers during 2007, and less as a percentage to wholesale customers. As a result, the
34
reserve for chargebacks and rebates, which are generally higher for wholesale customers,
decreased during the year more than gross trade accounts receivable, resulting in higher net trade
accounts receivable.
3. An increase in accounts payable of $5,991,581 resulted from favorable increases in payment
terms negotiated during the year as well as differences in the timing of payments at year end
2007 and 2006.
4. An increase in accrued expenses of $1,482,473 was due to a receiving accrual for materials
received at the end of the fiscal year related primarily to distributed products received, as well as
an increase in deferred revenue related to certain inventory for which payment has been received,
but which has not been shipped. This was partially offset by decreased personnel expenses.
These fluctuations are in the normal course of business.
5. An increase in deferred revenue of $1,637,993 was due to payments received in advance of
shipment of products. The Company will recognize revenue upon shipment of the drugs or upon
passage of their expiration date.
The Company monitors both Net DSO and Gross DSO as an overall check on collections and reasonableness
of reserves. In order to be effective indicators, both DSO measures are evaluated on a quarterly basis. The
Gross DSO calculation provides management with an understanding of the frequency of customer payments,
and the ability to process customer payments and deductions. The Net DSO calculation provides management
with an understanding of the relationship of the A/R balance net of the reserve liability compared to net sales
after reserves charged during the period. Standard payment terms offered to customers are consistent with
industry practice at 60 days. The following table shows the results of these calculations for the relevant
periods:
Fiscal Year Ended June 30,
Net DSO (in days)
Gross DSO (in days)
2006
56
77
2005
-1
50
2007
72
74
The increase in Net DSO is due to reduced reserves that offset receivables. This is a result of the increased
sales to chain drug stores, a result of new customers, and decreased sales to Wholesale customers. Issues in
the prior year related to customers’ reporting of credits had been resolved, lending to an improvement in the
Gross DSO calculation. In addition, the Company improved in the timeliness of processing credits. The
Company anticipates that Gross DSO will be in the 60 to 70 day range in future reports, as the payment terms
for most customers are 60 days.
The Net DSO Calculation provides us with an understanding of the relationship of the A/R balance net of the
reserve liability compared to net sales after reserves charged during the period. It eliminates the effect of
timing of processing, which is inherent in the Gross DSO calculation. A Net calculation greater than 60 days
may indicate under-reserved sales, while an amount less than 60 days may indicate over-reserved sales,
among other causes. This figure is expected to approximate 60 days. The fact that the amount is less than 60
days at June 30, 2006 and 2005 is primarily the result of wholesalers’ sell-through of our products being
extended past the expected 6 to 8 week timeframe. The increase to 72 days at June 30, 2007 indicates that
this sell through issue no longer exists.
The net cash used in investing activities of $7,501,076 for the twelve months ended June 30, 2007 was
mostly due to the purchase of property, plant and equipment of $2,465,075, as well as a $7,059,567 loan.
This was partially offset by the sale of $1,845,838 of the Company’s marketable securities.
On December 13, 2005 the Company refinanced $5,750,000 of its debt through the Philadelphia Industrial
Development Corporation (PIDC) and the Pennsylvania Industrial Development Authority (PIDA). With the
proceeds from the refinancing, the Company paid off its Mortgage and Construction Loan, as well as a
portion of the Equipment loan. These loans were with Wachovia Bank. The Company financed $4,500,000
through the Immigrant Investor Program (PIDC Regional Center, LP III). The Company will pay a bi-annual
interest payment at a rate equal to two and one-half percent per annum. The outstanding principal balance
shall be due and payable 5 years (60 months) from January 1, 2006. The remaining $1,250,000 is financed
35
through the PIDA Loan. The Company is required to make equal payments each month for 180 months
starting February 1, 2006 with interest of two and three-quarter percent per annum. The PIDA Loan has
$1,150,212 outstanding as of June 30, 2007 with $70,604 currently due. None of the PIDC Loan is currently
due.
An additional $500,000 was financed through the Pennsylvania Department of Community and Economic
Development Machinery and Equipment Loan Fund. The Company is required to make equal payments for
60 months starting May 1, 2006 with interest of two and three quarter percent per annum. As of June 30,
2007, $388,487 is outstanding and $97,001 is currently due.
In April 1999, the Company entered into a loan agreement (the “Agreement”) with a governmental authority,
the Philadelphia Authority for Industrial Development (the “Authority” or “PAID”), to finance future
construction and growth projects of the Company. The Authority issued $3,700,000 in tax-exempt variable
rate demand and fixed rate revenue bonds to provide the funds to finance such growth projects pursuant to a
trust indenture (“the Trust Indenture”). A portion of the Company’s proceeds from the bonds was used to pay
for bond issuance costs of approximately $170,000. The Trust Indenture requires that the Company repay the
Authority loan through installment payments beginning in May 2003 and continuing through May 2014, the
year the bonds mature. The bonds bear interest at the floating variable rate determined by the organization
responsible for selling the bonds (the “remarketing agent”). The interest rate fluctuates on a weekly basis.
The effective interest rate at June 30, 2007 was 3.89%. At June 30, 2007, the Company has $904,422
outstanding on the Authority loan, of which $109,164 is classified as currently due. The remainder is
classified as a long-term liability. In April 1999, an irrevocable letter of credit of $3,770,000 was issued by
Wachovia Bank, National Association (Wachovia) to secure payment of the Authority Loan and a portion of
the related accrued interest. At June 30, 2007, no portion of the letter of credit has been utilized.
The Equipment Loan consists of a term loan with a maturity date of five years. The Company, as part of the
2003 Loan Financing agreement with Wachovia, is required to make equal payments of principal and
interest. As of June 30, 2007, the Company has outstanding $722,266 under the Equipment Loan, of which
$320,520 is classified as currently due.
The financing facilities under the 2003 Loan Financing, of which only the Equipment Loan is left, bear
interest at a variable rate equal to the LIBOR rate plus 150 basis points. The LIBOR rate is the rate per
annum, based on a 30-day interest period, quoted two business days prior to the first day of such interest
period for the offering by leading banks in the London interbank market of dollar deposits. As of June 30,
2007, the interest rate for the 2003 Loan Financing (of which only the Equipment loan remains) was 6.82%.
The Company has executed Security Agreements with Wachovia, PIDA and PIDC in which the Company
has agreed to use substantially all of its assets to collateralize the amounts due.
The terms of the Equipment loan require that the Company meet certain financial covenants and reporting
standards, including the attainment of standard financial liquidity and net worth ratios. As of June 30, 2007,
the Company has complied with such terms, and successfully met its financial covenants.
As part of the acquisition of Cody, the Company assumed the debt owed to the Small Business
Administration (“SBA”). The loan requires fixed monthly payments through July 31, 2012. The
effective interest rate at June 30, 2007 was 8.75%. As of June 30, 2007, $231,812 is outstanding under
the SBA loan, of which $49,647 is classified as currently due.
Also part of the Cody acquisition is a variable interest entity (“VIE”), Cody LCI Realty, LLC, to which
Cody Labs is primary beneficiary. See Note 13 for “Consolidation of Variable Interest Entities.” The
VIE owns land and a building which is being leased to Cody. A mortgage loan with First National Bank
of Cody has been consolidated in the Company’s financial position. The mortgage has 19 years of
principal and interest payments remaining, with monthly payments of $14,782, at a fixed rate of 7.5%, to
be made on a monthly basis through June 2026. As of June 30, 2007, the Company has $1,782,766
outstanding under the mortgage loan, of which $45,183 is classified as currently due.
36
The following table represents annual contractual obligations as of June 30, 2007:
Total
Less than 1
year
1-3 years
3-5 years
more than 5
years
Long-Term Debt
Operating Leases
Purchase Obligations
Interest on Obligations
Total
$
9,679,965
1,658,836
147,000,000
1,510,391
159,849,192
$
$
692,119
401,395
18,000,000
374,515
19,468,029
$
$
1,208,951
783,807
39,000,000
639,566
41,632,324
$
$
5,196,028
473,634
43,000,000
383,820
49,053,482
$
$
2,582,867
-
47,000,000
112,490
49,695,357
$
Purchase obligations relate to the Company’s agreement with Jerome Stevens Pharmaceuticals, Inc. See
further description in the Notes to the Consolidated Financial Statements.
Prospects for the Future
The Company has several generic products under development. These products are all orally-administered,
topical and parenteral products designed to be generic equivalents to brand named innovator drugs. The
Company’s developmental drug products are intended to treat a diverse range of indications. As the oldest
generic drug manufacturer in the country, formed in 1942, Lannett currently owns several ANDAs for
products which it does not manufacture and market. These ANDAs are simply dormant on the Company’s
records. Occasionally, the Company reviews such ANDAs to determine if the market potential for any of
these older drugs has recently changed, so as to make it attractive for Lannett to reconsider manufacturing
and selling it. If the Company makes the determination to introduce one of these products into the consumer
marketplace, it must review the ANDA and related documentation to ensure that the approved product
specifications, formulation and other factors meet current FDA requirements for the marketing of that drug.
The Company would then redevelop the product and submit it to the FDA for supplemental approval. The
FDA’s approval process for ANDA supplements is similar to that of a new ANDA. Generally, in these
situations, the Company must file a supplement to the FDA for the applicable ANDA, informing the FDA of
any significant changes in the manufacturing process, the formulation, or the raw material supplier of the
previously-approved ANDA.
A majority of the products in development represent either previously approved ANDAs that the Company is
planning to reintroduce (ANDA supplements), or new formulations (new ANDAs). The products under
development are at various stages in the development cycle—formulation, scale-up, and/or clinical testing.
Depending on the complexity of the active ingredient’s chemical characteristics, the cost of the raw material,
the FDA-mandated requirement of bioequivalence studies, the cost of such studies and other developmental
factors, the cost to develop a new generic product varies. It can range from $100,000 to $1 million. Some of
Lannett’s developmental products will require bioequivalence studies, while others will not—depending on
the FDA’s Orange Book classification. Since the Company has no control over the FDA review process,
management is unable to anticipate whether or when it will be able to begin producing and shipping
additional products.
In addition to the efforts of its internal product development group, Lannett has contracted with several
outside firms for the formulation and development of several new generic drug products. These outsourced
R&D products are at various stages in the development cycle — formulation, analytical method development
and testing and manufacturing scale-up. These products are orally-administered solid dosage products
intended to treat a diverse range of medical indications. It is the Company’s intention to ultimately transfer
the formulation technology and manufacturing process for all of these R&D products to the Company’s own
commercial manufacturing sites. The Company initiated these outsourced R&D efforts to complement the
progress of its own internal R&D efforts.
37
Occasionally the Company will work on developing a drug product that does not require FDA approval.
The FDA allows generic manufacturers to manufacture and sell products which are chemically equivalent
to innovator drugs which are grand-fathered, under FDA rules, prior to the passage of the Hatch-Waxman
Act of 1984. The FDA allows generic manufacturers to produce and sell generic versions of such grand-
fathered products by simply performing and internally documenting the product’s stability over a period
of time. Under this scenario, a generic company can forego the time required for FDA ANDA approval.
The Company signed supply and development agreements with Olive Healthcare, of India; Orion Pharma,
of Finland; Azad Pharma AG, of Switzerland, Unichem Inc. of India, Wintac Limited of India,
Pharmaseed of Israel and Banner Pharmacaps of the United States, and is in negotiations with companies
in Israel and China for similar new product initiatives, in which Lannett will market and distribute
products manufactured by Lannett or by third parties. Lannett intends to use its strong customer
relationships to build its market share for such products, and increase future revenues and income.
The majority of the Company’s R&D projects are being developed in-house under Lannett’s direct
supervision and with Company personnel. Hence, the Company does not believe that its outside contracts for
product development and manufacturing supply are material in nature, nor is the Company substantially
dependent on the services rendered by such outside firms. Since the Company has no control over the FDA
review process, management is unable to anticipate whether or when it will be able to begin producing and
shipping such additional products.
Lannett may increase its focus on certain specialty markets in the generic pharmaceutical industry. Such a
focus is intended to provide Lannett customers with increased product alternatives in categories with
relatively few market participants. While there is no guarantee that Lannett has the market expertise or
financial resources necessary to succeed in such a market specialty, management is confident that such future
focus will be well received by Lannett customers and increase shareholder value in the long run.
The Company plans to enhance relationships with strategic business partners, including providers of product
development research, raw materials, active pharmaceutical ingredients as well as finished goods.
Management believes that mutually beneficial strategic relationships in such areas, including potential
financing arrangements, partnerships, joint ventures or acquisitions, could allow for potential competitive
advantages in the generic pharmaceutical market. The Company plans to continue to explore such areas for
potential opportunities to enhance shareholder value.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements and Report of the Independent Registered Public Accounting Firm
filed as a part of this Form 10-K are listed in the Exhibit Index filed herewith.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
38
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Annual Report, management performed, with the participation
of our Chief Executive Officer and Chief Financial Officer, an evaluation of the effectiveness of our
disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Our
disclosure controls and procedures are designed to ensure that information required to be disclosed in the
report we file or submit under the Exchange Act is recorded, processed, summarized, and reported within
the time periods specified in the SEC’s forms, and that such information is accumulated and
communicated to our management including our Chief Executive Officer and our Chief Financial Officer,
to allow timely decisions regarding required disclosures. Based on the evaluation and the identification of
the material weaknesses in internal control over financial reporting described below, our Chief Executive
Officer and our Chief Financial Officer concluded that, as of June 30, 2007, the Company’s disclosure
controls and procedures were not effective.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial
reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Internal control over
financial reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements in accordance with GAAP. Because of its
inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Also, projection of any evaluation of effectiveness to future periods is subject to the risks that controls
may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Management has conducted, with the participation of our Chief Executive Officer and our Chief Financial
Officer, an assessment, including testing of the effectiveness of our internal control over financial
reporting as of June 30, 2007. Management’s assessment of internal controls over financial reporting was
conducted using the criteria in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial
reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual
or interim financial statements will not be prevented or detected on a timely basis. In connection with
management’s assessment of our internal control over financial reporting, we identified the following
material weaknesses in our internal control over financial reporting as of June 30, 2007.
During the fourth quarter of fiscal 2007, we identified a number of production orders that were completed
and removed from production in our information system during fiscal 2007, however, such activity was
not properly reflected in the corresponding quarterly financial statements. The result was that work in
process inventory was overstated and cost of goods sold was understated by $840,000 as of and for the
year ended June 30, 2007, with the following quarterly pre-tax accounting effect of the misstatement as
follows: three months ended September 30, 2006 was $394,000; three months ended December 31, 2006
was $158,000; and three months ended March 31, 2007 was $95,000.
Additionally during the fourth quarter, we identified another material weakness related to non-routine
transactions. Management determined that the loans to Cody Labs were impaired as of March 31, 2007.
However, this impairment was not properly reflected before the end of the quarter ended March 31, 2007.
Lack of documentation of a non-routine transaction resulted in the Company not properly recording an
impairment of $7,776,000 on the loans during the interim period ended March 31, 2007. At the end of
the period management has assessed the controls to not be effective.
39
The control deficiencies discussed above resulted in adjustments to our consolidated financial statements
as of and for the year ended June 30, 2007. Additionally, these control deficiencies resulted in material
misstatements in the aforementioned financial statement accounts and disclosures in our interim fiscal
2007 consolidated financial statements and required us to restate amounts previously reported for interim
periods in 2007. Accordingly, management has determined that the control deficiencies described above
constitute material weaknesses.
Because of the material weaknesses noted above, management has concluded that we did not maintain
effective internal control over financial reporting as of June 30, 2007, based on the Internal Control—
Integrated Framework.
The scope of management’s assessment of the effectiveness of internal control over financial reporting
includes all of the Company’s businesses except for Cody Laboratories, Inc., an acquisition consummated
on April 10, 2007.
Remediation of Material Weakness in Internal Control Over Financial Reporting
We have engaged in, and continue to engage in, substantial efforts to address the material weakness in our
internal control over financial reporting and the ineffectiveness of our disclosure controls and procedures.
The Company is in the process of remediating its material weakness associated with the misstatement of
costs of goods sold through the following actions:
(cid:131)
Including WIP in cycle counting and quarterly count procedures. The proper execution of
inventory cycle counts and period-end inventory counts will add a level of assurance that the
balance is correctly stated.
(cid:131) Reconciliation of systems transactions to be performed and reviewed on a monthly basis to
ensure that WIP value in inventory systems agrees to WIP value in general ledger accounts.
(cid:131) Revision of monthly closing checklist to include each trial balance account, and identify a
specific person responsible for reconciling and reviewing each account as appropriate.
(cid:131) Analysis of detailed WIP inventory, and review of such analysis, to ensure the balance is
reasonable in comparison to actual production activities.
(cid:131) Engage SAP consulting experts to review processes that are used to close WIP batches.
The Company is in the process of remediating its material weakness associated with the impairment of
notes receivable as of March 31, 2007 through the following actions:
(cid:131) Formalize and enforce company policy to require either CEO or CFO signature on all material
company contracts.
(cid:131) Formalize and enforce company policy to require legal review of all material Lannett contracts
prior to execution.
(cid:131) Formalize and enforce company policy to require all material Lannett contracts are provided to
Lannett’s Corporate Controller and CFO in a timely manner to allow for appropriate accounting
review and analysis.
(cid:131) Request that Lannett’s outside attorney provide management with a quarterly report identifying
all Lannett contracts reviewed during that quarter.
(cid:131) Lannett’s Disclosure Committee will review the outside attorney provided quarterly report to
determine materiality and appropriate disclosure.
The foregoing initiatives have enabled us to improve our internal controls over financial reporting.
Management is committed to continuing efforts aimed at fully achieving an operationally effective system
of internal controls. The remediation efforts noted above are subject to the Company’s internal control
assessment, testing and evaluation process.
40
Changes in Internal Control Over Financial Reporting
Our management carried out an evaluation, with the participation of our Chief Executive Officer and our
Chief Financial Officer, of changes in internal control over financial reporting, as defined in Rule 13a-
15(f). Based on this evaluation, our management determined that no change in our internal control over
financial reporting occurred during the fourth quarter of fiscal 2007 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial reporting. The identified
improvements to our internal control over financial reporting necessary to remedy the material
weaknesses identified above were implemented prior to the filing of this report.
ITEM 9B. OTHER INFORMATION
None.
41
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERANCE
PART III
Directors and Executive Officers
The directors and executive officers of the Company are set forth below:
Age
Position
Directors:
William Farber
Ronald A. West
Arthur P. Bedrosian
Jeffrey Farber
Garnet Peck
Kenneth Sinclair
Albert Wertheimer
Myron Winkelman
Officers:
Arthur P. Bedrosian
Brian J. Kearns
Bernard Sandiford
William Schreck
Kevin Smith
75
73
61
47
77
61
64
69
61
41
78
58
47
Chairman of the Board
Vice Chairman of the Board, Director
Director
Director
Director
Director
Director
Director
President and Chief Executive Officer
Vice President of Finance, Treasurer, Secretary and Chief
Financial Officer
Vice President of Operations
Vice President of Logistics
Vice President of Sales and Marketing
William Farber R. Ph.D was elected as Chairman of the Board of Directors in August 1991. From April
1993 to the end of 1993, Mr. Farber was the President and a director of Auburn Pharmaceutical Company.
From 1990 through March 1993, Mr. Farber served as Director of Purchasing for Major Pharmaceutical
Corporation. From 1965 through 1990, Mr. Farber was the Chief Executive Officer of Michigan Pharmacal
Corporation. Mr. Farber is a registered pharmacist in the State of Michigan.
Ronald A. West was elected a Director of the Company in January 2002. In September 2004, Mr. West was
elected Vice Chairman of the Board of Directors. Mr. West is currently a Director of Beecher Associates, an
industrial real estate investment company, R&M Resources, an investment and consulting services company
and North East Staffing, Inc., an employee services company. Prior to this, from 1983 to 1987, Mr. West,
financial expert for the audit committee at Lannett, served as Chairman and Chief Executive Officer of Dura
Corporation, an original equipment manufacturer of automotive products and other engineered equipment
components. In 1987, Mr. West sold his ownership position in Dura Corporation, at which time he retired
42
from active management positions. Mr. West was employed at Dura Corporation since 1969. Prior to this,
he served in various financial management positions with TRW, Inc., Marlin Rockwell Corporation and
National Machine Products Group, a division of Standard Pressed Steel Company. Mr. West studied
Business Administration at Michigan State University and the University of Detroit.
Jeffrey Farber was elected director of the Company, Inc in May 2006. Jeffrey Farber joined the Company in
August 2003 as Secretary. For the past 13 years, Mr. Farber has been President and the owner of Auburn
Pharmaceutical (“Auburn”), a national generic pharmaceutical distributor. Prior to starting Auburn,
Mr. Farber served in various positions at Major Pharmaceutical (“Major”), where he was employed for over
15 years. At Major, Mr. Farber was involved in sales, purchasing and eventually served as President of the
mid-west division. Mr. Farber also spent time working at Major’s manufacturing division – Vitarine
Pharmaceuticals – where he served on its Board of Directors. Mr. Farber graduated from Western Michigan
University with a Bachelors of Science Degree in Business Administration and participated in the Pharmacy
Management Graduate Program at Long Island University. Mr. Farber is the son of William Farber, the
Chairman of the Board of Directors and the principal shareholder of the Company.
Garnet Peck, Ph.D., was elected a director of the Company in September 2005. Dr. Peck is Professor
Emeritus of the Industrial and Physical Pharmacy department at Purdue University, where he has held
numerous positions since 1967. Earlier in his career, Dr. Peck served as senior scientist and group leader at
Mead Johnson Research Center and as a Pharmacist in the United States Army. Dr. Peck has also consulted
for some of the largest pharmaceutical companies in the world and served on several committees of the
United States Food and Drug Administration. Dr. Peck has chaired numerous pharmaceutical conferences
and is a published author and frequent lecturer. He earned his Bachelor of Science Degree in Pharmacy, with
distinction, from Ohio Northern University, and a Master of Science degree and Doctorate Degree in
Industrial Pharmacy from Purdue University.
Kenneth Sinclair, Ph.D., was elected director of the Company in September 2005. Dr. Sinclair is currently
Professor and Chair of the Accounting Department at Lehigh University, where he began his academic career
in 1972. Dr. Sinclair has been recognized for his teaching innovation, held leadership positions with
professional accounting organizations and served on numerous academic and advisory committees. He has
received a number of awards and honors for teaching and service, and has researched and written on a myriad
of subjects related to accounting. Dr. Sinclair earned a Bachelor of Business Administration degree in
Accounting, a Master of Science degree in accounting and a Doctorate Degree in Business Administration
from the University of Massachusetts.
Albert I. Wertheimer was elected a Director of the Company in September 2004. Dr. Wertheimer has a
long and distinguished career in various aspects of pharmacy, health care, education and pharmaceutical
research. Since 2000, Dr. Wertheimer has been a professor at the School of Pharmacy at Temple
University, and director of its Center for Pharmaceutical Health Services Research. From 1997 to 2000,
Dr. Wertheimer was Director of Outcomes Research and Management at Merck & Co., Inc. In addition
to his academic responsibilities, he is the author of 22 books and more than 360 journal articles. Dr.
Wertheimer also provides consulting services to institutions in the pharmaceutical industry. Dr.
Wertheimer's academic experience includes professorships and other faculty and administrative positions
at several educational institutions, including the Medical College of Virginia, St. Joseph's University,
Philadelphia College of Pharmacy and Science and the University of Minnesota. Dr. Wertheimer's
previous professional experience includes pharmacy services in commercial and non-profit environments.
Professor Wertheimer is a licensed pharmacist in five states, and is a member of several health
associations, including the American Pharmacists Association and the American Public Health
Association. Dr. Wertheimer is the editor of the “Journal of Pharmaceutical Finance and Economic
Policy”; and he has been on the editorial board of the Journal of Managed Pharmaceutical Care, Medical
Care, and other healthcare journals. Dr. Wertheimer has a Bachelor of Science Degree in Pharmacy from
the University of Buffalo, a Master of Business Administration from the State University of New York at
43
Buffalo, a Physical Science Doctorate from Purdue University and a Post Doctoral Fellowship from the
University of London, St. Thomas' Medical School.
Myron Winkelman, R. Ph. was elected a Director of the Company in June 2003. Mr. Winkelman has
significant career experience in various aspects of pharmacy and health care. He is currently President of
Winkelman Management Consulting (WMC), which provides consulting services to both commercial and
governmental clients. He has served in this position since 1994. Mr. Winkelman has recently managed
multi-state drug purchasing initiatives for both Medicaid and state entities. Prior to creating WMC, he
was a senior executive with ValueRx, a large pharmacy benefits manager, and served for many years as a
senior executive for the Revco, Rite Aid and Perry Drug chains. While at ValueRx, Mr. Winkelman
served on the Board of Directors of the Pharmaceutical Care Management Association. He belongs to a
number of pharmacy organizations, including the Academy of Managed Care Pharmacy and the Michigan
Pharmacy Association. Mr. Winkelman is a registered pharmacist and holds a Bachelor of Science Degree
in Pharmacy from Wayne State University.
Arthur P. Bedrosian, J.D. was promoted to President of the Company in May 2002 and CEO in January of
2006. Prior to this, he served as the Company’s Vice President of Business Development from January 2002
to April 2002. Mr. Bedrosian was elected as a Director in February 2000 and served to January 2002. Mr.
Bedrosian was re-elected to the board in January 2006. Mr. Bedrosian has operated generic drug
manufacturing, sales, and marketing businesses in the healthcare industry for many years. Prior to joining the
Company, from 1999 to 2001, Mr. Bedrosian served as President and Chief Executive Officer of Trinity
Laboratories, Inc., a medical device and drug manufacturer. Mr. Bedrosian also operated Pharmaceutical
Ventures Ltd, a healthcare consultancy and Interal Corporation, a computer consultancy to Fortune 100
companies. Mr. Bedrosian holds a Bachelor of Arts Degree in Political Science from Queens College of the
City University of New York and a Juris Doctorate from Newport University in California.
Brian J. Kearns joined the Company in March 2005 as Vice President of Finance, Treasurer and Chief
Financial Officer of the Company and was appointed Secretary in May 2005. Prior to joining the
Company, Mr. Kearns served as the Executive Vice President, Treasurer and Chief Financial Officer of
MedQuist Inc., a healthcare information management company, from 2000 through 2004. Prior to joining
MedQuist, Mr. Kearns was Vice President and Senior Health Care IT analyst at Banc of America
Securities from 1999 trough 2000. Mr. Kearns also held various positions with Salomon Smith Barney
from 1994 through 1998, including Senior Analyst of Business Services Equity Research. Prior to that,
Mr. Kearns held several financial management positions during his seven years at Johnson & Johnson.
Mr. Kearns holds a Bachelor of Science degree in Finance from Lehigh University and a Master of
Business Administration degree from Rider University, where he matriculated with distinction.
Bernard Sandiford joined the Company in November 2002 as Vice President of Operations. Prior to this,
from 1998 to 2002, he was the President of Sandiford Consultants, a firm specializing in providing consulting
services to drug manufacturers for Good Manufacturing Practices and process validations. His previous
employment included senior operating positions with Halsey Drug Company, Barr Laboratories, Inc.,
Duramed Pharmaceuticals, Inc., and Revlon Health Care Group. In addition to these positions, Mr. Sandiford
performed various consulting assignments regarding Good Manufacturing Practices for several companies in
the pharmaceutical industry. Mr. Sandiford has a Bachelor of Science Degree in Chemistry from Long Island
University.
William Schreck joined the Company in January 2003 as Materials Manager. In May 2004, he was
promoted to Vice President of Logistics. Prior to this, from 1999 to 2001, he served as Vice President of
Operations at Nature’s Products, Inc., an international nutritional and over-the-counter drug product
manufacturing and distribution company; from 2001 to 2002 he served as an independent consultant for
various companies. Mr. Schreck’s prior experience also includes executive management positions at Ivax
Pharmaceuticals, Inc., a division of Ivax Corporation, Zenith-Goldline Laboratories and Rugby-Darby Group
Companies, Inc. Mr. Schreck has a Bachelor of Arts Degree from Hofstra University.
44
Kevin Smith joined the Company in January 2002 as Vice President of Sales and Marketing. Prior to this,
from 2000 to 2001, he served as Director of National Accounts for Bi-Coastal Pharmaceutical, Inc., a
pharmaceutical sales representation company. Prior to this, from 1999 to 2000, he served as National
Accounts Manager for Mova Laboratories Inc., a pharmaceutical manufacturer. Prior to this, from 1991 to
1999, Mr. Smith served as National Sales Manager at Sidmak Laboratories, a pharmaceutical manufacturer.
Mr. Smith has extensive experience in the generic sales market, and brings to the Company a vast network of
customers, including retail chain pharmacies, wholesale distributors, mail-order wholesalers and generic
distributors. Mr. Smith has a Bachelor of Science Degree in Business Administration from Gettysburg
College.
To the best of the Company's knowledge, there have been no events under any bankruptcy act, no criminal
proceedings and no judgments or injunctions that are material to the evaluation of the ability or integrity of
any director, executive officer, or significant employee during the past five years.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Company’s directors, officers, and persons
who own more than 10% of a registered class of the Company’s equity securities to file with the SEC reports
of ownership and changes in ownership of common stock and other equity securities of the Company.
Officers, directors and greater-than-10% stockholders are required by SEC regulations to furnish the
Company with copies of all Section 16(a) forms they file.
Based solely on review of the copies of such reports furnished to the Company or written representations that
no other reports were required, the Company believes that during Fiscal 2007, all filing requirements
applicable to its officers, directors and greater-than-10% beneficial owners were complied with.
Code of Ethics and Financial Expert
The Company has adopted the Code of Professional Conduct (the “code of ethics”), a code of ethics that
applies to the Company’s Chief Executive Officer, Chief Financial Officer, and Corporate Controller, and
other finance organization employees. The code of ethics is publicly available on our website at
www.lannett.com. If the Company makes any substantive amendments to the finance code of ethics or
grant any waiver, including any implicit waiver, from a provision of the code to our Chief Executive
Officer, Chief Financial Officer, or Corporate Controller, we will disclose the nature of such amendment
or waiver on our website or in a report on Form 8-K.
The Board of Directors has determined that Mr. West, current director of Lannett as well as director of
Beecher Associates, an industrial real estate investment company, R&M Resources, an investment and
consulting services company and North East Staffing, Inc., an employee services company and previously
the Chief Executive Officer of Dura Corporation, is the audit committee financial expert as defined in
section 3(a)(58) of the Exchange Act and the related rules of the Commission.
45
ITEM 11.
EXECUTIVE COMPENSATION
Summary Compensation Table
The following table summarizes all compensation paid to or earned by the named executive officers of the
Company for Fiscal 2007, Fiscal 2006 and Fiscal 2005.
Name and Principal
Position
(a)
Arthur P. Bedrosian 1
President and Chief
Executive Officer
Brian Kearns 2
Chief Financial Officer,
Treasurer
Bernard Sandiford
Vice President of
Operations
William Schreck
Vice President of
Logistics
Kevin Smith
Vice President of Sales
and Marketing
Fiscal Year
(b)
Salary
(c)
Stock Awards
(e)
Option
Awards
(f)
Non-equity
incentive plan
compensation
(g)
All Other
Compensation
(i)
Total
(j)
2007
2006
2005
2007
2006
2005
2007
2006
2005
2007
2006
2005
2007
2006
2005
$301,016
$122,234
$158,303
$43,358
$34,159
$659,070
264,267
-
222,465
338,880
233,628
-
-
92,970
17,834
18,132
843,446
344,730
202,678
83,021
161,830
27,719
22,841
$498,089
185,480
- -
240,000
47,115
-
351,470
20,712
154,525
64,799
161,830
16,628
143,016
-
34,877
145,000
133,779
-
-
54,898
162,871
68,021
161,830
16,724
157,192
-
34,877
160,000
137,026
-
-
183,230
61,490
161,830
60,000
18,814
175,853
-
34,877
180,000
162,821
-
-
66,895
9,685
1,815
41,888
41,014
34,522
25,334
18,819
10,009
24,076
22,269
20,836
435,165
421,112
$439,670
363,907
223,199
$434,780
370,888
207,035
$449,440
412,999
250,552
1
Mr. Bedrosian was promoted to President and Chief Executive Officer on January
3, 2006.
2
Brian Kearns was hired March 14, 2005 as Chief Financial Officer.
46
(i) Supplemental All Other Compensation Table
The following table summarizes the components of column (i) of the Summary Compensation Table:
Name and Principal
Position
Fiscal
Year
Company
Matched
Contributions to
401(k) Plan
Auto
Allowance
Pay in Lieu
of Vacation
Housing
Allowance
Excess Life
Insurance
Total
Arthur P. Bedrosian
President and Chief
Executive Officer
Brian Kearns
Chief Financial
Officer, Treasurer
Bernard Sandiford
Vice President of
Operations
William Schreck
Vice President of
Logistics
Kevin Smith
Vice President of
Sales and Marketing
2007
2006
2005
2007
2006
2005
2007
2006
2005
2007
2006
2005
2007
2006
2005
$
10,935
$
13,265
$
9,540
$
-
$
419
$
34,159
3,003
4,786
12,222
1,526
-
9,212
5,146
5,768
9,382
6,604
5,760
9,309
6,212
7,126
10,888
7,200
10,559
8,091
1,800
3,486
5,971
-
-
-
10,601
11,258
10,214
7,200
10,589
9,000
2,400
13,188
13,062
9,000
5,226
7,154
5,095
2,942
1,730
1,486
2,895
4,670
-
-
-
-
-
10,817
20,428
14,400
-
-
-
-
-
-
457
175
60
68
15
-
-
-
268
273
119
93
100
40
17,834
18,132
22,841
9,685
1,815
41,888
41,014
34,522
25,334
18,819
10,009
24,076
22,269
20,836
47
Aggregated Options/SAR Exercises and Fiscal Year-end Options/SAR Values
(a)
(b)
(c)
(d)
Shares
Acquired
On
Value
Name
Exercise
Realized
Number of Securities
Underlying Unexercised
Options at FY-End
Exercisable/
Unexercisable
0
0
0
0
0
186,233/
46,667
66,666/
48,334
41,881/
22,999
21,745/
23,000
75,759/
23,000
0
0
0
0
0
Arthur P. Bedrosian
President and Chief
Executive Officer
Brian Kearns
Chief Financial
Officer, Treasurer
Bernard Sandiford
Vice President of
Operations
William Schreck
Vice President of
Logistics
Kevin Smith
Vice President of Sales
and Marketing
Employment Agreements
(e)
Value of
Unexercised
In-the-Money
Options at
FY-End
Exercisable/
Unexercisable
$26,280/
0
$0/
0
$3,640/
7,280
$3,640/
7,280
$3,640/
7,280
The Company has entered into employment agreements with Arthur P. Bedrosian, Brian Kearns, Kevin
Smith, William Schreck, and Bernard Sandiford (the “Named Executives”). Each of the agreements provide
for an annual base salary and eligibility to receive a bonus. The salary and bonus amounts of the Named
Executives are reviewed and approved by the Board of Directors. Additionally, the Named Executives are
eligible to receive long term incentive awards, including stock options and restricted shares of stock, which
are granted at the discretion of the Board of Directors, and in accordance with the Company’s policy
regarding long term incentive awards.
Under the agreements, the Named Executive employees may be terminated at any time with or without cause,
or by reason of death or disability. In certain termination situations, the Company is liable to pay severance
compensation to the Named Executive of between eighteen months and three years.
48
Compensation of Directors
Non-employee directors received a retainer of $2,600 per month as compensation for their services during
Fiscal 2007. They also were compensated $1,000 per Board meeting. There were seven Board meetings
held during Fiscal 2007. Additional committees of the Board of Directors include the Audit Committee, the
Compensation Committee and the Strategic Planning Committee. Committee members received $1,000 and
the Chairman received $1,500 per Committee meeting attended. There were nine Audit Committee
meetings, seven Strategic Planning Committee meetings and seven Compensation Committee meetings held
during Fiscal 2007. Directors are also reimbursed for expenses incurred in attending Board and Committee
meetings. There were no stock options granted to directors in Fiscal 2007.
COMPENSATION DISCUSSION AND ANALYSIS
Overview of Our Compensation Program
A fundamental goal of our compensation program is to maximize stockholder value. In order to
accomplish this goal, we must attract and retain talented and capable executives, and we must provide
those executives with incentives that motivate and reward them for achieving Lannett’s short and longer-
term goals. To this end, our executive compensation is guided by the following key principles:
•
that executive compensation should depend upon group and individual performance factors;
that the interests of executives should be closely aligned with those of stockholders through
•
equity-based compensation; and
that compensation should be appropriate and fair in comparison to the compensation provided to
•
similarly situated executives within the pharmaceutical industry and within other publicly-traded
companies similar in market capitalization to Lannett’s.
Important to our compensation program are the decisions of, and guidance from, the Compensation
Committee of our Board of Directors. This Committee (which we refer to, for purposes of this analysis, as
“the Committee”) is composed entirely of directors who are independent of Lannett under the
independence standards established by the American Stock Exchange, the securities exchange where our
common stock is traded. The Committee operates pursuant to a written charter adopted by the Board. If
you would like to review the Committee’s charter, it is available to any stockholder who requests a copy
from our Chief Financial Officer, at 9000 State Road, Philadelphia, Pennsylvania 19136.
The Committee has the authority and responsibility to establish and periodically review our executive
compensation principles, described above. Importantly, the Committee also has sole responsibility for
approving the corporate goals and objectives upon which the compensation of the chief executive officer
(the “CEO”) is based, for evaluating the CEO’s performance in light of these goals and objectives, and for
determining the CEO’s compensation, including his equity-based compensation.
The Committee also reviews and approves the recommendations of the CEO with regard to the
compensation and benefits of other executive officers. In accomplishing this responsibility, the
Committee meets regularly with the CEO, approves cash and equity incentive objectives of the executive
officers, reviews with the CEO the accomplishment of these objectives and approves the base salary and
other elements of compensation for the executive officers. The Committee has full discretion to modify
the recommendations of the CEO in the course of its approval of executive officer compensation.
The Committee also annually
reviews
recommendations to the Board about, the compensation of non-employee directors.
recommendations
from
their consultant, and makes
During Fiscal 2007, the Committee recommended the adoption of a new Incentive Plan to supplement our
existing stock option plans. The Incentive Plan was approved by our stockholders in January 2007. The
Incentive Plan provides for the grant of various equity awards, including stock options and restricted
49
stock, to Lannett employees and directors. The Committee is responsible for administering this Plan and it
has sole authority to make grants to the CEO or any other executive officer.
In conjunction with its responsibilities related to executive compensation, the Committee also oversees
the management development process, reviews plans for executive officer succession and performs
various other functions.
The Committee consults as needed with an outside compensation consulting firm retained by the
Committee. As it makes decisions about executive compensation, the Committee obtains data from its
consultant regarding current compensation practices and trends among United States companies in
general and pharmaceutical companies in particular, and reviews this information with its consultant.
During Fiscal 2007, the Committee was advised by Mercer Human Resources Consulting, a global human
resources consulting firm. For Fiscal 2008, the Committee is expected to continue to use Mercer as a
consultant as needed. In addition, the Chairman of the Committee is in contact with management outside
of Committee meetings regarding matters being considered or expected to be considered by the
Committee.
The individuals who served as Chief Executive Officer and Chief Financial Officer during Fiscal 2007, as
well as the other individuals included in the Summary Compensation Table on page 48, are referred to as
the “named executive officers.”
Our Fiscal 2007 Compensation Program
In Fiscal 2007, the Committee’s approach to compensation was intended to focus our executives on
accomplishing our short and longer-term objectives, and it had as its ultimate object sustained growth in
stockholder value. This approach was intended to compensate executives at levels at or near the median
levels of compensation offered by other pharmaceutical companies similar in size to Lannett and with
whom we compete.
In making decisions about the elements of Fiscal 2007 compensation, the Committee not only considered
available market information about each element but also considered aggregate compensation for each
executive. Base salary provided core compensation to executives, but it was accompanied by:
the potential for incentive-based cash compensation based upon our attainment of Fiscal 2007
•
operating income, R&D and individual or departmental objectives,
various forms of equity compensation, including some grants based upon Fiscal 2007 sales
•
growth results and upon our return on invested capital results,
•
•
various benefits and perquisites, and
the potential for post-termination compensation under certain circumstances.
Summary of Fiscal 2007 Compensation Elements
The table below provides detailed information regarding each element of the Fiscal 2007
compensation program.
Compensation Element Overview
Purpose of the Compensation Element
Base
Salary
Base salary pays for competence in the executive
role. An executive’s salary level depends on the
decision making responsibilities, experience,
work performance, achievement of key goals and
team building skills of each position, and the
relationship to amounts paid to other executives
at peer companies.
To provide competitive fixed
compensation based on sustained
performance in the executive’s role and
competitive market practice.
50
Short-
Term
Incentives
Annual Incentive Bonus Plan (AIBP)
The AIBP program rewards with cash awards for
annual achievement of overall corporate
objectives, and specific individual or
departmental operational objectives. In Fiscal
2007, objectives for the Officers were tied to
Lannett’s achievement of operating income
targets, R&D targets and individual objectives.
To motivate and focus our executive
team on the achievement of our annual
performance goals.
Compensation Element Overview
Purpose of the Compensation Element
Long-
Term
Incentives
Stock Options
Stock options reward sustained stock price
appreciation and encourage executive retention
during a three-year vesting term and a ten-year
option life.
We strive to deliver a balanced long-
term incentive portfolio to executives,
focusing on (a) share price appreciation,
(b) retention, and (c) internal financial
objectives.
Restricted Stock
Restricted stock rewards sustained stock price
appreciation and encourages executive
retention during its three-year vesting term.
The value of participants’ restricted stock
increases and decreases according to Lannett’s
stock price performance during the vesting
period and thereafter.
The primary objectives of the overall
design are:
• to align management interests with
those of stockholders,
• to increase management’s potential for
stock ownership opportunities (all
awards are earned in shares),
• to attract and retain excellent
management talent, and
• to reward growth of the business,
increased profitability, and sustained
stockholder value.
Compensation Element Overview
Purpose of the Compensation Element
Benefits
In General
Executives participate in employee benefit
plans available to all employees of Lannett,
including health, life insurance and disability
plans. The cost of these benefits is partially
borne by the employee, but mostly paid by the
Company.
These benefits are designed to attract
and retain employees and provide
security for their health and welfare
needs. We believe that these benefits are
reasonable, competitive and consistent
with Lannett’s overall executive
compensation program.
51
401(k) Plan
Executives may participate in Lannett’s 401(k)
retirement savings plan, which is available to
all employees. In calendar 2006, the Company
matched employees’ contributions to the plan,
on a dollar for dollar basis, up to 3% of their
base salary, subject to regulatory limits.
Beginning in calendar 2007, Lannett began
matching contributions, at a rate of $.50 on the
dollar up to 8% of base salary.
Life Insurance
Lannett provides life insurance benefits to all
employees. The coverage amount for
executives is one times base compensation up
to a limit of $115,000 and premiums paid for
coverage above $50,000 are treated as imputed
income to the executive.
Disability Insurance
Lannett provides short-term and long-term
disability insurance to employees which would,
in the event of disability, pay an employee 60%
of his or her base salary with limits.
Compensation Element Overview
Purpose of the Compensation Element
Perquisites Lannett does not utilize perquisites or personal
benefits extensively. The few perquisites that
are provided complement other compensation
vehicles and enable the Company to attract and
retain key executives. These perquisites
include:
We believe these benefits better allow us
to attract and retain superior employees
for key positions.
•
• automobile allowances in various amounts to
key executives.
Compensation Element Overview
Purpose of the Compensation Element
Post-
Termination
Pay
Severance Plan
Lannett’s Severance Pay Plan is designed
to pay severance benefits to an executive
for a qualifying separation. For the Chief
Executive Officer, the Severance Pay
Plan provides for a payment of three
times the sum of base salary plus a pro
rated annual cash bonus for the current
The Severance Pay Plan is intended (1) to
allow executives to concentrate on making
decisions in the best interests of Lannett (or
any successor organization in the event that
a change of control is to occur), and (2)
generally alleviate an executive’s concerns
about the loss of his or her position without
cause.
52
year calculated as if all targets and goals
are achieved. For the other named
executive officers, the Severance Pay
Plan provides for a payment of eighteen
months of base salary plus a pro rated
annual cash bonus for the current year
calculated as if all targets and goals are
achieved.
The use of the above compensation tools enables Lannett to reinforce its pay for performance philosophy
as well as to strengthen its ability to attract and retain high-performing executive officers. The Committee
believes that this combination of programs provides an appropriate mix of fixed and variable pay,
balances short-term operational performance with long-term stockholder value creation, and encourages
executive recruitment and retention in a high-performance culture.
Market Data and Our Peer Group
In determining 2007 compensation for the named executive officers, the Committee relied on market data
provided by its consultant. This information was principally related to a group of 13 peer companies
similar in size to Lannett with median revenues of $40 million to $133 million (we refer to this group of
companies as the “Peer Group”). Information on these companies was derived from two sources: (1) the
consultant and broader market survey data analysis, and (2) publicly-available information appearing in
the proxy statements of these companies. The members of the Peer Group were:
Bradley Pharmaceutical
Viropharma Inc.
Savient Pharm. Inc.
Balchem Corp.
Able Laboratories Inc
Caraco Pharm. Labs
Hi Tech Pharm. Co. Inc.
Orasure Technologies Inc.
Neogen Corp.
Quigley Corp.
Interpharm Holdings Inc
Akorn Inc.
Noven Pharmaceuticals Inc.
The Committee plans to evaluate the Peer Group annually and revise it as necessary to ensure that it
continues to be appropriate for benchmarking our executive compensation program.
Base Salary
Base salaries for the named executive officers are intended, in general, to approach median salaries for
similarly situated executives among Peer Group companies. A number of additional factors are
considered, however, in determining base salary, such as the executive’s individual performance, his or
her experience, competencies, skills, abilities, contribution and tenure, internal compensation consistency,
the need to attract new, talented executives, and the Company’s overall annual budget. Base salaries are
generally reviewed on an annual basis.
The 2007 salaries for Arthur Bedrosian, Lannett’s CEO, and for Brian Kearns, Lannett’s CFO, were
lower than the median for comparable positions among members of the Peer Group and the survey data.
Base salaries for all remaining named executive officers were lower than the median for comparable
positions among members of the Peer Group, but higher than the median for the survey data.
Base salary increases were granted to Mr. Bedrosian for $29,357 effective on January 1, 2007, Mr.
Kearns for $3,300 effective on September 1, 2006, Mr. Smith for $3,980 effective on September 1, 2006,
Mr. Schreck for $3,537 effective on September 1, 2006, and Mr. Sandiford for $3,206 effective on
53
September 1, 2006, based on their performance. Mr. Sandiford also received a base pay increase in the
amount of $14,400 effective on January 1, 2007. This increase was to eliminate a housing allowance he
was receiving in the same amount prior to the effective date.
Fiscal 2007 Annual Incentive Bonus Plan
Design
In November 2006, the Committee approved the 2007 Annual Incentive Bonus Plan (or “AIBP”)
program. This program allowed executive officers the opportunity to earn cash awards upon the
accomplishment of the Fiscal 2007 operating income goal, R&D objectives and a number of individual
objectives. The relative weighting of these objectives for each executive was fifty percent (50%) for
operating income, twenty-five percent (25%) for R&D targets, twenty percent (20%) for individual
objectives and five percent (5%) based on CEO and Committee discretion. For the CEO, the five percent
(5%) discretionary portion will be determined by the Committee.
Based on market data provided by its consultant, and considering the relatively low base salaries of the
named executive officers, the Committee formulated potential AIBP awards which exceeded the 50th
percentile among Peer Group companies, expressed as percentages of base salary. Actual payouts
depended upon the degree to which objectives were accomplished as well as the weight accorded to each
objective, as described above. The table below shows the potential payout amounts for each of the named
executive officers, expressed as percentages of base salary.
Performance
Level
Arthur
Bedrosian
Superior Level
Goal Level
Threshold
120-150%
100-120%
50-100%
Brian
Kearns
120-150%
100-120%
50-100%
Bernard
Sandiford
100-125%
75-100%
30-75%
William
Schreck
100-125%
75-100%
30-75%
Kevin
Smith
100-125%
75-100%
30-75%
The Committee also determined that, if results for any objectives were between the minimum and
maximum of the ranges, the Committee would determine appropriate payout percentage.
As discussed above, each named executive officer’s objectives for Fiscal 2007 included Company
operating income targets and R&D targets. The Committee reviewed and approved these targets
following discussions with management, a review of our historical results, consideration of the various
circumstances facing the Company during Fiscal 2007 and taking into account the expectations of our
annual plan. The Fiscal 2007 operating income and R&D AIBP targets approved by the Committee are
detailed in the table below.
Objective
Superior Goal
Operating Income*
$11.5 M $10.5 M
R&D Submissions
R&D Acceptances
R&D Launches
11
9
8
10
8
7
Target
$8.9 M
9
7
6
*
For purposes of determining achievement of the AIBP targets, these measures exclude certain
categories of non-recurring items that the Committee believes do not reflect the performance of
Lannett’s core continuing operations.
54
Operational objectives for Mr. Bedrosian related to finalizing an acquisition. Mr. Kearns’s objectives
related to controlling SG&A costs, implementing SAP and achieving budgeted cash targets. Objectives
for Mr. Smith included achieving sales targets and margin targets. For Mr. Schreck the objectives
included improvements in inventory turns and cycle counts along with the warehouse relocation. Mr.
Sandiford’s objectives related to achieving SOX goals, reducing rejections and internal audits.
All payouts to executive officers under the 2007 AIBP were contingent upon the Committee’s review and
certification of the degree to which Lannett achieved the 2007 AIBP objectives, and upon the
Committee’s certification of the degree to which individual objectives had been achieved. The program
provided that payout for any objective would be limited to 20% of the actual operating income attained by
Lannett.
The 2007 AIBP program provided that the Committee could, in its discretion: modify, amend, suspend or
terminate the Plan at any time. The Committee did not take any of these actions in connection with the
2007 AIBP program.
Results
In September 2007, the Committee reviewed and certified Lannett’s Fiscal 2007 results for purposes of
the AIBP program, determining that the objectives for operating income, R&D acceptances and launches
were not met, and the R&D objective for submissions was met at the goal level. The Committee also
reviewed and certified the performance of the executive officer individual objectives, determining that
these objectives were achieved to varying degrees. The named executive officers received the following
payments in connection with the 2007 AIBP program:
2007 AIBP
2007 AIBP
2007
AIBP
Percentage
Cash
Restricted
Shares ($) (1)
Total
Award ($) of Base Salary
Officer
Arthur Bedrosian
$ 43,358
$ 55,336
$ 98,694
31 %
President and Chief
Executive Officer
Brian Kearns
Chief Financial
Officer
$ 27,719
$ 45,542
$ 73,261
36 %
Bernard Sandiford
$ 16,628
$ 27,320
$ 43,948
27 %
Vice President of
Operations
William Schreck
Vice President of
Logistics
$ 16,724
$ 30,542
$ 47,266
29 %
Kevin Smith
$ 18,814
$ 24,011
$ 42,825
23 %
Vice President, Sales
& Marketing
55
(1) Restricted shares issued on 9/18/07 with vesting on 1/1/08 at $4.03/share. In an effort to increase
equity ownership by officers a portion sixty percent (60%) of the 2007 AIBP cash award was distributed
in restricted stock instead of cash.
Awards made to named executive officers under the 2007 AIBP program are also reflected in column (d)
of the Summary Compensation Table on page 48.
2007 Long Term Incentive Awards (LTIA)
Design
The Committee believes that long-term equity incentives are an important part of a complete
compensation package because they focus executives on: increasing the value of the assets that are
entrusted to them by the stockholders, achieving Lannett’s long-term goals, aligning the interests of
executives with those of stockholders, encouraging sustained stock performance and helping to retain
executives.
Prior to the approval of the Incentive Plan by stockholders in 2007, Lannett’s equity grants consisted only
of stock options. The Incentive Plan expanded the types of equity vehicles which the Committee could
grant to executives by including restricted stock. In September 2007, the Committee granted both stock
options and restricted stock to executives, each designed to emphasize particular elements of the
Company’s immediate and long-term objectives and to retain key executives. We refer to these grants
collectively as the 2007 Long Term Incentive Awards (LTIA). The types of grants were:
stock options, becoming exercisable over three years (33%, 33% and 34% on each anniversary)
•
from the date of the grant and having a total term of ten years,
shares of restricted stock, vesting over three years (33%, 33% and 34% on each anniversary)
•
from the date of grant,
The Committee assessed the appropriate overall value of these equity grants to executives by reviewing
survey results and other market data provided by its consultant. This information included the value of
equity grants made to similarly situated executives among the Peer Group. The overall value of LTIA
grants for each executive was determined by the Committee with assistance from their consultant.
In determining the overall value of LTIA grants, the Committee also considered the potential value of
equity compensation relative to other elements of compensation for each named executive officer. It
likewise assessed the appropriate distribution of equity value among the grant types, as well as the
corporate objectives each type of grant was intended to encourage.
Stock Options and Restricted Stock
The stock options and restricted stock granted as part of the 2007 LTIA were designed to reward
sustained stock price appreciation and to encourage executive retention during a three-year vesting term
and, in the case of stock options, a ten-year option life. Stock option and restricted stock awards are
intended to align executives’ motivation with stockholders’ best interests. Grants of stock options were
not contingent upon any conditions. They are to be granted independent of organizational performance.
Stock options become exercisable approximately in one-third increments on the first three anniversaries
of the date of grant. Restricted stock was contingent upon Lannett achieving annual sales growth and
return on invested capital goals. Restricted stock will vest in one-third increments on the first three
anniversaries of the date of the grant. The Committee determined for each executive officer a target
number of options and restricted shares and those targets appear in the tables below.
56
Restricted Stock Targets:
Performance Level Bedrosian Kearns Sandiford Schreck Smith
Superior
Goal
Threshold
16,600
8,300
12,500
6,600
8,300
5,000
8,300
6,600
5,000
8,300
6,600
5,000
8,300
6,600
5,000
Stock Option Targets:
Range
High
Medium
Low
Results
Bedrosian Kearns Sandiford Schreck Smith
50,000 25,000
25,000
25,000
37,500 20,000
20,000
20,000
25,000 15,000
15,000
15,000
25,000
20,000
15,000
In September 2007, the Committee reviewed and certified the Fiscal 2007 results for purposes of the
Restricted Share Grants and determined that the superior level had been met for the sales growth objective
and the threshold level was met for the return on invested capital objective associated with those grants.
The number of restricted shares granted to each executive officer was then determined. The Committee
decided to grant stock options at the high level, and, in addition, the Committee granted an additional
25,000 special option grant to each named officer. This was done to bring total direct compensation more
in line with the marketplace data provided by the consultant. Restricted shares, options and special
options are detailed in the chart below.
Stock Option Awards:
Awards
Options
Bedrosian Kearns Sandiford Schreck Smith
50,000 25,000
25,000
25,000
25,000
Special Options
25,000 25,000
25,000
25,000
25,000
Restricted Shares
16,600
9,300
9,300
9,300
9,300
Perquisites and Other Benefits
We provide named executive officers with perquisites and other personal benefits that we believe are
reasonable and consistent with our overall compensation program to better enable us to attract and retain
superior employees for key positions. The Committee periodically reviews the levels of perquisites and
other personal benefits provided to named executive officers.
During calendar year 2006, Lannett matched employees’ contributions to the Lannett Company, Inc.
401(k) Retirement Savings Plan on a dollar for dollar basis up to 3% of an employee’s base salary,
subject to regulatory limits. Contributions by the named executive officers were matched in this way,
subject to the limitations of the Plan and applicable law. Beginning in calendar year 2007, Lannett
matched contributions to the 401(k) plan on a fifty cents on the dollar basis up to 8% of the contributing
employee’s base salary. The named executive officers are also provided with car allowances, for which
the taxes are also paid by the Company.
57
Lannett provides life insurance for executive officers which would, in the event of death, pay $115,000 to
designated beneficiaries. Premiums paid for coverage above $50,000 are treated as imputed income to the
executive. Lannett also provides short-term and long-term disability insurance which would, in the event
of disability, pay the executive officer sixty percent (60%) of his base salary up to the plan limits of
$1250/week for short term disability and $6000/month for long term disability. Executive officers
participate in other qualified benefit plans, such as medical insurance plans, in the same manner as all
other employees.
Attributed costs of the personal benefits available to the named executive officers for the fiscal year ended
June 30, 2007, are included in column (i) of the Summary Compensation Table on page 48.
Severance and Change of Control Benefits
We believe that reasonable severance and change in control benefits are necessary in order to recruit and
retain qualified senior executives and are generally required by the competitive recruiting environment
within our industry and the marketplace in general. These severance benefits reflect the fact that it may be
difficult for such executives to find comparable employment within a short period of time, and are
designed to alleviate an executive’s concerns about the loss of his or her position without cause. We also
believe that a change in control arrangement will provide an executive security that will likely reduce the
reluctance of an executive to pursue a change in control transaction that could be in the best interests of
our stockholders. Lannett’s Severance Pay Plan is designed to pay severance benefits to an executive for a
qualifying separation. For the Chief Executive Officer, the Severance Pay Plan provides for a payment of
three times the sum of base salary plus a pro rated annual cash bonus for the current year calculated as if
all targets and goals are achieved. For the other named executive officers, the Severance Pay Plan
provides for a payment of eighteen months of base salary plus a pro rated annual cash bonus for the
current year calculated as if all targets and goals are achieved.
Timing of Committee Meetings and Grants; Option and Share Pricing
The Committee typically holds four regular meetings each year, and the timing of these meetings is
generally established during the year. The Committee holds special meetings from time to time as its
workload requires. Historically, annual grants of equity awards have typically been accomplished at a
meeting of the Committee in September of each year. Individual grants (for example, associated with the
hiring of a new executive officer or promotion to an executive officer position) may occur at any time of
year. We expect to coordinate the timing of equity award grants to be made within thirty (30) days of
Lannett’s earnings release announcement following the completion of the fiscal year. The exercise price
of each stock option and restricted share awarded to our executive officers is the closing price of our
common stock on the date of grant.
Tax and Accounting Implications
Deductibility of Executive Compensation
Section 162(m) of the Internal Revenue Code of 1986, as amended, precludes the deductibility of an
executive officer’s compensation that exceeds $1.0 million per year unless the compensation is paid under
a performance-based plan that has been approved by stockholders. The Committee believes that it is
generally preferable to comply with the requirements of Section 162(m) through, for example, the use of
our Incentive Plan. However, to maintain flexibility in compensating executive officers in a manner that
attracts, rewards and retains high quality individuals, the Committee may elect to provide compensation
outside of those requirements when it deems appropriate. The Committee believes that stockholder
interests are best served by not restricting the Committee’s discretion in this regard, even though such
compensation may result in non-deductible compensation expenses to the Company.
58
REPORT OF THE COMPENSATION COMMITTEE
The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis set forth
above with management. Taking this review and discussion into account, the undersigned Committee members
recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this annual
report on Form 10-K.
The Compensation Committee
Ronald West (Chair)
Albert Wertheimer
Myron Winkelman
59
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth, as of June 30, 2007, information regarding the security ownership of the
directors and certain executive officers of the Company and persons known to the Company to be beneficial
owners of more than five (5%) percent of the Company's common stock:
Name and Address of
Benefical Owner
Directors/Executive Officers:
Office
Excluding Options
and Debentures
Number of
Shares
Percent of
Class
Including Options (*)
Number of
Shares
Percent of
Class
William Farber
9000 State Road
Philadelphia, PA 19136
Ronald A. West
9000 State Road
Philadelphia, PA 19136
Jeffrey Farber
9000 State Road
Philadelphia, PA 19136
Albert Wertheimer
9000 State Road
Philadelphia, PA 19136
Myron Winkelman
9000 State Road
Philadelphia, PA 19136
Arthur Bedrosian
9000 State Road
Philadelphia, PA 19136
Brian Kearns
9000 State Road
Philadelphia, PA 19136
Bernard Sandiford
9000 State Road
Philadelphia, PA 19136
William Schreck
9000 State Road
Philadelphia, PA 19136
Kevin Smith
9000 State Road
Philadelphia, PA 19136
All directors and
executive officers as a
group (10 persons)
Chairman of the Board
13,619,129 1
56.34% 13,706,629 2
55.33%
Vice Chairman of the
Board, Director
7,310
0.03%
57,258 3
0.23%
Director
147,120
0.61%
169,620 4
0.68%
Director
1,000
0.00%
14,333 5
0.06%
Director
1,000
0.00%
36,000 6
0.15%
President and Chief
Executive Officer
458,750 7
1.91%
644,983 8
2.61%
Chief Financial Officer
0
0.00%
66,666 9
0.27%
Vice President of
Operations
Vice President of
Logistics
287
0.00%
42,167 10
0.17%
0
0.00%
21,745 11
0.09%
Vice President of Sales
and Marketing
336
0.00%
76,096 12
0.31%
14,237,179
58.90% 14,837,744
59.90%
60
1
Includes 300,000 shares owned jointly by William Farber and his spouse Audrey Farber.
2
Includes 37,500 vested options to purchase common stock at an exercise price of $7.97 per share.
25,000 vested options to purchase common stock at an exercise price of $17.36. 25,000 vested options to
purchase common stock at an exercise price of $16.04.
3
Includes 9,948 vested options to purchase common stock at an exercise price of $7.97 per share,
15,000 vested options to purchase common stock at an exercise price of $17.36 per share, and 25,000
vested options to purchase common stock at an exercise price of $16.04.
4
and 12,500 vested options to purchase common stock at an exercise price of $16.04.
Includes 10,000 vested options to purchase common stock at an exercise price of $17.36 per share
5
Includes 13,333 vested options to purchase common stock at an exercise price of $9.02 per share.
6
vested options to purchase common stock at an exercise price of $16.04.
Includes 15,000 vested options to purchase common stock at an exercise price of $17.36. 20,000
7
beneficial ownership of these shares.
Includes 27,450 shares owned by Arthur Bedrosian’s wife, Shari. Mr. Bedrosian disclaims
8
Includes 18,000 vested options to purchase common stock at an exercise price of $4.63 per share,
96,900 vested options to purchase common stock at an exercise price of $7.97 per share, 33,000 vested
options to purchase common stock at an exercise price of $17.36, 30,000 vested options to purchase
common stock at an exercise price of $16.04 and 8,333 vested options to purchase common stock at an
exercise price of $8.00 per share.
9
Includes 66,666 vested options to purchase common stock at an exercise price of $6.75 per share.
10
Includes 15,380 vested options to purchase common stock at an exercise price of $11.27 per
share, 10,000 vested options to purchase common stock at an exercise price of $17.36 per share, 12,500
vested options to purchase common stock at an exercise price of $16.04 per share, and 4,000 vested
options to purchase common stock at an exercise price of $5.18 per share.
11
and 4,000 vested options to purchase common stock at an exercise price of $5.18 per share.
Includes 17,745 vested options to purchase common stock at an exercise price of $11.27 per share
12
Includes 38,760 vested options to purchase common stock at an exercise price of $7.97 per share,
13,000 vested options to purchase common stock at an exercise price of $17.36 per share, 20,000 vested
options to purchase common stock at an exercise price of $16.04 per share and 4,000 vested options to
purchase common stock at an exercise price of $5.18 per share.
.
* Assumes that all options exercisable within sixty days have been exercised, which results in
24,771,782 shares outstanding.
61
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND
DIRECTOR INDEPENDENCE
The Company had sales of approximately $763,000, $1,143,000, and $590,000 during the fiscal years ended
June 30, 2007, 2006 and 2005, respectively, to a generic distributor, Auburn Pharmaceutical Company.
Jeffrey Farber (the “related party”), a board member and the son of the Chairman of the Board of Directors
and principal shareholder of the Company, William Farber, is the owner of Auburn Pharmaceutical
Company. Accounts receivable includes amounts due from the related party of approximately $109,000 and
$191,000 at June 30, 2007 and 2006, respectively. In the Company’s opinion, the terms of these transactions
were not more favorable to the related party than would have been to a non-related party.
In January 2005, Lannett Holdings, Inc. entered into an agreement pursuant to which it purchased for
$100,000 and future royalty payments the proprietary rights to manufacture and distribute a product for
which Pharmeral, Inc. owns the ANDA. This agreement is subject to Lannett Holdings, Inc.’s ability to
obtain FDA approval to use the proprietary rights. Subsequently the submission has been approved by
the FDA and the marketing has begun. The Company has treated this payment as a prepaid asset, which
will be amortized over the term of the agreement. Arthur Bedrosian, President of Lannett, was formerly
the President and Chief Executive Officer and currently owns 100% of Pharmeral, Inc. This transaction
was approved by the Board of Directors of Lannett and, in its opinion; the terms were not more favorable
to the related party than they would have been to a non-related party.
The Company has approximately $1,683,000 of deferred revenue as a result of prepayments on inventory
received from Provell Pharmaceuticals, LLC (“Provell”). Provell is a joint venture to distribute
pharmaceutical products through mail order outlets. Lannett was given 33% ownership of this venture in
exchange for access to Lannett’s drug providers. The investment is valued at zero, due to losses incurred
to date by Provell.
62
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Grant Thornton LLP served as the independent auditors of the Company during Fiscal 2007, 2006 and
2005. No relationship exists other than the usual relationship between independent public accountant and
client. The following table identifies the fees paid to Grant Thornton LLP in Fiscal 2007, 2006 and 2005.
Audit Fees
Audit-Related (1)
Tax Fees (2)
All Other Fees (3)
Total Fees
Fiscal 2007:
Fiscal 2006:
$338,660
$180,418
$ -
$ -
$36,528
$52,942
$70,300
$135,248
$445,460
$368,608
(1) Audit-related fees include fees paid for preparation and participation in Board of Director meetings, and
Audit Committee meetings.
(2) Tax fees include fees paid for preparation of annual federal, state and local income tax returns, quarterly
estimated income tax payments, and various tax planning services. Fiscal 2006 and 2005 include fees paid to
Grant Thornton for services rendered during an IRS audit.
(3) Other fees include:
Fiscal 2007 – Fees paid for review of various SEC correspondence, disclosures, and fixed asset
review.
Fiscal 2006 – Fees paid for services rendered in connection with quarterly reviews of the Company’s
SEC filings, fixed asset review, a cost segregation study and review of various SEC correspondence.
The non-audit services provided to the Company by Grant Thornton LLP were pre-approved by the
Company's audit committee. Prior to engaging its auditor to perform non-audit services, the Company's
audit committee reviews the particular service to be provided and the fee to be paid by the Company for
such service and assesses the impact of the service on the auditor's independence.
63
PART IV
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K
(a)
A list of the exhibits required by Item 601 of Regulation S-K to be filed as of this Form 10-K is
shown on the Exhibit Index filed herewith
(b)
Consolidated Financial Statements and Supplementary Data
The following are included herein:
• Report of Independent Registered Public Accounting Firm
• Consolidated Balance Sheets as of June 30, 2007 and 2006
• Consolidated Statements of Operations for each of the three years in the period ended June 30,
2007
• Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the
period ended June 30, 2007
• Consolidated Statements of Cash Flows for each of the three years in the period ended June 30,
2007
• Notes to Consolidated Financial Statements
• Supplementary Data
(c)
On September 13, 2006, the Company filed a Form 8-K disclosing Item 2 and Item 9 thereof and
including as an exhibit the press release announcing the Company’s results of operations for the
fiscal 2006 fourth quarter and full year ended June 30, 2006.
On November 8, 2006, the Company filed a Form 8-K disclosing Item 2 and Item 9 thereof and
including as an exhibit the press release announcing the Company’s results of operations for the
fiscal year 2007 first quarter ended September 30, 2006.
On February 7, 2007, the Company filed a Form 8-K disclosing Item 2 and Item 9 thereof and
including as an exhibit the press release announcing the Company’s results of operations for the
fiscal year 2007 second quarter and six months ended December 31, 2006.
On April 12, 2007, the Company filed a Form 8-K disclosing Item 8 and Item 9 thereof and
including as an exhibit the press release announcing the Company has acquired a bulk raw
material supplier.
On May 7, 2007, the Company filed a Form 8-K disclosing Item 2 and Item 9 thereof and
including as an exhibit the press release announcing the Company’s results of operations for the
fiscal year 2007 third quarter and nine months ended March 31, 2007.
On September 25, 2007, the Company filed a Form 8-K disclosing Item 4.02, Non-Reliance on
Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review,
relating to a restatement of previously filed Forms 10-Q from the three month and fiscal year-to-
date periods ended September 30, 2006, December 31, 2006 and March 31, 2007.
On October 2, 2007, the Company filed a Form 8-K disclosing Item 2.02, Results of Operations,
and Item 9 thereof and including as an exhibit the press release announcing the Company’s
preliminary unaudited results of operations for the fiscal year ended June 30, 2007.
64
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Date: October 9, 2007
Date: October 9, 2007
LANNETT COMPANY, INC.
By: / s / Arthur P. Bedrosian
Arthur P. Bedrosian,
President and
Chief Executive Officer
By: / s / Brian Kearns
Brian Kearns,
Vice President of Finance, Treasurer, and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the
following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date: October 9, 2007
Date: October 9, 2007
Date: October 9, 2007
Date: October 9, 2007
Date: October 9, 2007
Date: October 9, 2007
Date: October 9, 2007
Date: October 9, 2007
By: / s / William Farber
William Farber,
Chairman of the Board of Directors
By: / s / Ronald West
Ronald West,
Director, Vice Chairman of the Board,
Chairman of Compensation Committee
By: / s / Arthur P Bedrosian
Arthur P. Bedrosian,
Director, President and Chief Executive Officer
By: / s / Jeffrey Farber
Jeffrey Farber,
Director
By: / s / Garnet Peck
Garnet Peck,
Director
By: / s / Kenneth Sinclair
Kenneth Sinclair,
Director, Chairman of Audit Committee
By: / s / Albert Wertheimer
Albert Wertheimer,
Director
By: / s / Myron Winkelman
Myron Winkelman,
Director, Chairman of Strategic Plan Committee
65
Exhibit 13
Annual Report on Form 10-K
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Lannett Company, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Lannett Company, Inc. (a
Delaware corporation) and Subsidiaries as of June 30, 2007 and 2006, and the related consolidated statements
of operations, shareholders’ equity, and cash flows for each of the three years in the period ended June 30,
2007. These consolidated financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements, assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Lannett Company, Inc. and Subsidiaries as of June 30, 2007
and 2006, and the consolidated results of their operations and their cash flows for each of the three years in
the period ended June 30, 2007 in conformity with accounting principles generally accepted in the United
States of America.
We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Lannett Company, Inc. and Subsidiaries’ internal
control over financial reporting as of June 30, 2007, based on criteria established in Internal Control—
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) and our report dated October 8, 2007 expressed an adverse opinion on the effectiveness of
internal controls over financial reporting.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
October 8, 2007
66
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Lannett Company, Inc. and Subsidiaries
We have audited Lannett Company, Inc. (a Delaware corporation) and Subsidiaries’ (collectively, “the
Company”) internal control over financial reporting as of June 30, 2007 based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company’s management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the effectiveness of internal control over
financial reporting, included in the accompanying management’s report on internal control over financial
reporting. Our responsibility is to express an opinion on the Company’s internal control over financial
reporting based on our audits.
We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal controls over financial reporting,
assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness
of internal control based on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. The
scope of management’s assessment of the effectiveness of internal control over financial reporting includes all
of the Company’s business except for Cody Laboratories, Inc., an acquisition consummated on April 10,
2007.
A company’s internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A company’s internal control
over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation
of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.
67
A material weakness is a deficiency, or combination of control deficiencies, in internal control over
financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s
annual or interim financial statements will not be prevented or detected on a timely basis. The following
material weaknesses have been identified and included in management’s assessment. There were ineffective
controls in place over closing work-in-process to finished goods, which further resulted in a material
adjustment to interim financial statements. There were also ineffective controls in place over documentation
of a non-routine transaction, which resulted in recording an impairment in the improper period.
In our opinion, because of the effect of the material weaknesses described above on the achievement
of objectives of the control criteria, Lannett Company, Inc. and Subsidiaries have not maintained effective
internal control over financial reporting as of June 30, 2007, based on criteria established in Internal Control -
Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Lannett Company, Inc. and Subsidiaries
as of June 30, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity, and
cash flows for each of the three years in the period ended June 30, 2007. The material weakness identified
above was considered in the nature, timing, and extent of audit tests applied in our audit of the 2007
consolidated financial statements, and this report does not affect our report dated October 8, 2007, which
expressed an unqualified opinion on those financial statements.
We do not express an opinion or any other form of assurance on the remediation plan of material
weaknesses in internal control over financial reporting included in management’s report on internal control
over financial reporting.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
October 8, 2007
68
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
Current Assets
Cash
Trade accounts receivable (net of allowance of $250,000 for both periods)
Inventories
Interest receivable
Prepaid taxes
Deferred tax assets - current portion
Other current assets
Total Current Assets
Property, plant and equipment
Less accumulated depreciation
Construction in progress
Investment securities - available for sale
Note receivable
Intangible asset (product rights) - net of accumulated amortization
Deferred tax asset
Other assets
Total Assets
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Current Liabilities
Accounts payable
Accrued expenses
Deferred Revenue
Unearned grant funds
Current portion of long term debt
Rebates and chargebacks payable
Total Current Liabilities
Long term debt, less current portion
Deferred tax liabilities
Other long term liabilities
Total Liabilities
COMMITMENTS AND CONTINGENCIES - SEE NOTES 9 AND 10
SHAREHOLDERS' EQUITY
Common stock - authorized 50,000,000 shares, par value $0.001;
issued and outstanding, 24,171,217 and 24,141,325 shares, respectively
Additional paid in capital
Retained earnings
Accumulated other comprehensive loss
Less: Treasury stock at cost - 50,900 shares
TOTAL SHAREHOLDERS' EQUITY
June 30,2007
June 30,2006
$
5,192,341
19,473,978
14,518,484
36,260
3,193,685
1,258,930
611,512
44,285,190
39,260,689
(11,817,528)
27,443,161
176,003
3,320,632
-
12,046,502
17,150,174
234,438
104,656,100
$
$
468,359
24,921,671
11,476,503
193,549
3,212,511
1,461,172
1,753,082
43,486,847
28,782,350
(9,136,801)
19,645,549
1,955,508
5,621,609
3,182,498
13,831,168
18,070,674
198,211
105,992,064
$
$
7,013,985
6,719,782
1,637,993
500,000
692,119
5,686,364
22,250,243
8,987,846
3,202,835
32,001
34,472,925
$
763,744
5,217,894
-
500,000
546,886
13,012,084
20,040,608
7,649,806
2,545,734
-
30,236,148
24,171
73,053,778
(2,472,621)
(27,583)
70,577,745
(394,570)
70,183,175
24,141
71,742,402
4,456,387
(72,444)
76,150,486
(394,570)
75,755,916
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$
104,656,100
$
105,992,064
The accompanying notes to consolidated financial statements are an integral part of these statements.
69
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FISCAL YEARS ENDED JUNE 30,
Net sales
Cost of sales (excluding amortization of
intangible asset)
2007
$ 82,577,591
57,394,751
2006
$ 64,060,375
33,900,045
2005
$ 44,901,645
31,416,908
Gross profit
25,182,840
30,160,330
13,484,737
Research and development expense
Selling, general, and administrative expense
Amortization of intangible assets
(Gain) loss on sale of assets
Loss on impairment/abandonment of assets
7,459,432
14,134,376
1,784,664
(7,113)
7,775,890
8,102,465
11,799,994
1,784,665
19,288
-
6,265,522
9,194,377
5,516,417
1,466
46,146,613
Operating (loss) income
(5,964,409)
8,453,918
(53,639,658)
OTHER INCOME(EXPENSE):
Interest income
Interest expense
(Loss) income before income tax
expense(benefit)
316,963
(273,633)
43,330
437,470
(361,291)
76,179
165,622
(351,462)
(185,840)
(5,921,079)
8,530,097
(53,825,498)
Income tax expense (benefit)
1,007,929
3,561,175
(21,045,902)
Net (loss) income
$ (6,929,008)
$ 4,968,922
$ (32,779,596)
Basic (loss) earnings per common share
$ (0.29)
$ 0.21
$ (1.36)
Diluted (loss) earnings per common share
$ (0.29)
$ 0.21
$ (1.36)
The accompanying notes to consolidated financial statements are an integral part of these statements.
70
LANNETT COMPANY, INC. AND SUBSIDIAIRIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FISCAL YEARS ENDED JUNE 30, 2007, 2006 AND 2005
Common Stock
Shares
Issued
Amount
Additional
Paid-in
Capital
Retained
Earnings
(Deficit)
Treasury
Stock
Accum. Other
Comp. Loss
Shareholders'
Equity
BALANCE, JUNE 30, 2004 24,074,710 $ 24,075 $ 69,955,855 $ 32,267,061 $ - $ - $ 102,246,991
Exercise of stock options
Shares issued in connection with
employee stock purchase plan
Other comprehensive loss
Cost of treasury stock
Net loss
19,126 19 60,892 - - -
60,911
17,304 17 140,684 - - -
- - - - -
- - - -
- - -
140,701
(25,193) (25,193)
(394,570) - (394,570)
(32,779,596) - - (32,779,596)
BALANCE, JUNE 30, 2005 24,111,140 $ 24,111 $ 70,157,431 $ (512,535) $ (394,570) $ (25,193)
$ 69,249,244
Exercise of stock options
Shares issued in connection with
employee stock purchase plan
Stock compensation expense
Other comprehensive loss
Net income
1,000 1 4,632 - - -
4,633
29,185 29 139,628 - - -
1,440,711 - - -
- -
- - - - -
- - -
139,657
1,440,711
(47,251) (47,251)
4,968,922
4,968,922 - -
BALANCE, JUNE 30, 2006 24,141,325 $ 24,141 $ 71,742,402 $ 4,456,387 $ (394,570) $ (72,444)
$ 75,755,916
Exercise of stock options
Shares issued in connection with
employee stock purchase plan
Stock compensation expense
Other comprehensive income
Net loss
375 -
281 - - -
281
29,517 30 134,860 - - -
1,176,235 - - -
- -
- - - - -
44,861
- - -
134,890
1,176,235
44,861
(6,929,008) - - (6,929,008)
BALANCE, JUNE 30, 2007 24,171,217 $ 24,171 $ 73,053,778 $ (2,472,621) $ (394,570) $ (27,583)
$ 70,183,175
The accompanying notes to consolidated financial statements are an integral part of these statements.
71
CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEARS ENDED JUNE 30,
OPERATING ACTIVITIES:
Net (loss) income
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Depreciation and amortization
Loss (gain) on disposal/impairment of assets
Deferred tax
Stock compensation expense
Interest income accrued on note
Changes in assets and liabilities which provided cash:
Trade accounts receivable
Inventories
Prepaid taxes
Prepaid expenses and other current assets
Accounts payable
Accrued expenses
Deferred revenue
2007
2006
2005
$ (6,929,008)
$ 4,968,922
$ (32,779,596)
4,465,393
7,774,098
1,779,843
1,176,235
(267,672)
(1,878,027)
(2,716,610)
18,826
140,195
5,991,581
1,482,473
1,637,993
3,967,128
(5,945)
2,738,418
1,440,711
-
(11,924,058)
(1,487,734)
745,482
(18,827)
(444,404)
3,550,257
-
6,970,932
46,093,236
(20,229,832)
-
-
15,370,358
2,824,481
(3,075,380)
(905,862)
(4,431,906)
(1,757,219)
-
Net cash provided by operating activities
12,675,320
3,529,949
8,079,212
INVESTING ACTIVITIES:
Cash paid for acquisition of business, net cash received
Purchases of property, plant and equipment
Proceed from sale of fixed assets
Note receivable
Purchase of intangible asset
Sales (purchases) of available for sale investment securities
167,728
(2,465,075)
10,000
(7,059,567)
-
1,845,838
-
(5,073,076)
-
(3,182,498)
-
2,219,848
-
(3,213,297)
-
-
(1,500,000)
(7,913,901)
Net cash used in investing activities
(7,501,076)
(6,035,726)
(12,627,198)
FINANCING ACTIVITIES:
Repayments of debt
Proceeds from grant funding
Proceeds from debt, net of restricted cash released in 2004
Proceeds from issuance of stock
Treasury stock transactions
(585,433)
(7,585,755)
-
-
135,171
-
-
6,250,000
144,290
-
(2,163,015)
500,000
1,602,606
201,612
(394,570)
Net cash used in financing activities
(450,262)
(1,191,465)
(253,367)
NET INCREASE (DECREASE) IN CASH
4,723,982
(3,697,242)
(4,801,353)
CASH, BEGINNING OF YEAR
468,359
4,165,601
8,966,954
CASH, END OF YEAR
$ 5,192,341
$ 468,359
$ 4,165,601
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION -
Interest paid
Income taxes paid
$ 154,713
$ 321,277
$ 351,462
$ 684,670
$ 50,000
$ 3,149,620
The accompanying notes to consolidated financial statements are an integral part of these statements.
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Lannett Company, Inc. and subsidiaries (the "Company"), a Delaware corporation, develops, manufactures,
packages, markets and distributes pharmaceutical products sold under generic chemical names.
The Company is engaged in an industry which is subject to considerable government regulation related to the
development, manufacturing and marketing of pharmaceutical products. In the normal course of business,
the Company periodically responds to inquiries or engages in administrative and judicial proceedings
involving regulatory authorities, particularly the Food and Drug Administration (FDA) and the Drug
Enforcement Agency (DEA).
Use of Estimates - The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Principles of Consolidation - The consolidated financial statements include the accounts of the operating
parent company, Lannett Company, Inc., its wholly owned subsidiaries, Lannett Holdings, Inc. and Cody
Laboratories, Inc. Cody Laboratories, Inc includes the consolidation of Cody LCI Realty, LLC, a variable
interest entity, as a result of the acquisition of Cody Laboratories, Inc. See note 13 about the
consolidation of this variable interest entity. All intercompany accounts and transactions have been
eliminated.
Revenue Recognition – The Company recognizes revenue when its products are shipped. At this point,
title and risk of loss have transferred to the customer and provisions for estimates, including rebates,
promotional adjustments, price adjustments, returns, chargebacks, and other potential adjustments are
reasonably determinable. Accruals for these provisions are presented in the consolidated financial
statements as rebates and chargebacks payable and reductions to net sales. The change in the reserves for
various sales adjustments may not be proportionally equal to the change in sales because of changes in
both the product and the customer mix. Increased sales to wholesalers will generally require additional
accruals as they are the primary recipient of chargebacks and rebates. Incentives offered to secure sales
vary from product to product. Provisions for estimated rebates and promotional credits are estimated
based upon contractual terms. Provisions for other customer credits, such as price adjustments, returns,
and chargebacks, require management to make subjective judgments on customer mix. Unlike branded
innovator drug companies, Lannett does not use information about product levels in distribution channels
from third-party sources, such as IMS and NDC Health, in estimating future returns and other credits.
Lannett calculates a chargeback/rebate rate based on contractual terms with its customers and applies this
rate to customer sales. The only variable is customer mix, and this assumption is based on historical data
and sales expectations. The chargeback/rebate reserve is reviewed on a monthly basis by management
using several ratios and calculated metrics. Lannett’s methodology for estimating reserves has been
consistent with previous periods.
Chargebacks – The provision for chargebacks is the most significant and complex estimate used in the
recognition of revenue. The Company sells its products directly to wholesale distributors, generic
distributors, retail pharmacy chains, and mail-order pharmacies. The Company also sells its products
indirectly to independent pharmacies, managed care organizations, hospitals, nursing homes, and group
purchasing organizations, collectively referred to as “indirect customers.” Lannett enters into agreements
with its indirect customers to establish pricing for certain products. The indirect customers then
73
independently select a wholesaler from which to actually purchase the products at these agreed-upon
prices. Lannett will provide credit to the wholesaler for the difference between the agreed-upon price
with the indirect customer and the wholesaler’s invoice price if the price sold to the indirect customer is
lower than the direct price to the wholesaler. This credit is called a chargeback. The provision for
chargebacks is based on expected sell-through levels by the Company’s wholesale customers to the
indirect customers and estimated wholesaler inventory levels. As sales to the large wholesale customers,
such as Cardinal Health, AmerisourceBergen, and McKesson, increase, the reserve for chargebacks will
also generally increase. However, the size of the increase depends on the product mix. The Company
continually monitors the reserve for chargebacks and makes adjustments when management believes that
expected chargebacks on actual sales may differ from actual chargeback reserves.
Rebates – Rebates are offered to the Company’s key chain drug store and wholesaler customers to
promote customer loyalty and increase product sales. These rebate programs provide customers with
rebate credits upon attainment of pre-established volumes or attainment of net sales milestones for a
specified period. Other promotional programs are incentive programs offered to the customers. At the
time of shipment, the Company estimates reserves for rebates and other promotional credit programs
based on the specific terms in each agreement. The reserve for rebates increases as sales to certain
wholesale and retail customers increase. However, since these rebate programs are not identical for all
customers, the size of the reserve will depend on the mix of customers that are eligible to receive rebates.
Returns – Consistent with industry practice, the Company has a product returns policy that allows select
customers to return product within a specified period prior to and subsequent to the product’s lot
expiration date in exchange for a credit to be applied to future purchases. The Company’s policy requires
that the customer obtain pre-approval from the Company for any qualifying return. The Company
estimates its provision for returns based on historical experience, changes to business practices, and credit
terms. While such experience has allowed for reasonable estimations in the past, history may not always
be an accurate indicator of future returns. The Company continually monitors the provisions for returns
and makes adjustments when management believes that actual product returns may differ from
established reserves. Generally, the reserve for returns increases as net sales increase. The reserve for
returns is included in the rebates and chargebacks payable account on the balance sheet.
Other Adjustments – Other adjustments consist primarily of price adjustments, also known as “shelf
stock adjustments,” which are credits issued to reflect decreases in the selling prices of the Company’s
products that customers have remaining in their inventories at the time of the price reduction. Decreases
in selling prices are discretionary decisions made by management to reflect competitive market
conditions. Amounts recorded for estimated shelf stock adjustments are based upon specified terms with
direct customers, estimated declines in market prices, and estimates of inventory held by customers. The
Company regularly monitors these and other factors and evaluates the reserve as additional information
becomes available. Other adjustments are included in the rebates and chargebacks payable account on the
balance sheet.
74
The following tables identify the reserves for each major category of revenue allowance and a summary
of the activity for the fiscal years ended June 30, 2007, 2006 and 2005:
For the Year Ended June 30, 2007
Reserve Category
Reserve Balance as of June 30, 2006
Actual credits issued related to sales recorded
in prior fiscal years
Reserves or (reversals) charged during Fiscal
2007 related to sales recorded in prior fiscal
years
Reserves charged to net sales in fiscal 2007
related to sales recorded in fiscal 2007
Actual credits issued related to sales in fiscal
2007
Chargebacks
Total
$ 10,137,400 $ 2,183,100 $ 416,000 $ 275,600 $13,012,100
Rebates
Returns
Other
(10,170,000) (1,800,000) (890,000) (250,000) (13,110,000)
- (300,000) 460,000 - 160,000
28,034,000 9,562,000 1,215,000 1,044,800 39,855,800
(23,351,922) (8,773,761) (1,087,687) (1,018,166) (34,231,536)
Reserve Balance as of June 30, 2007
$ 4,649,478 $ 871,339 $ 113,313 $ 52,234 $ 5,686,364
For the Year Ended June 30, 2006
Reserve Category
Chargebacks
Rebates
Returns
Other
Total
Reserve Balance as of June 30, 2005
$ 7,999,700 $ 1,028,800 $ 1,692,000 $ 29,500 $10,750,000
Actual credits issued related to sales recorded
in prior fiscal years
2006 related to sales recorded in prior fiscal
years
Reserves charged to net sales in fiscal 2006
related to sales recorded in fiscal 2006
Actual credits issued related to sales in fiscal
2006
(7,920,500) (1,460,500) (1,272,400) (59,300) (10,712,700)
- 500,000 (500,000)
-
-
28,237,000 5,688,500 497,300 1,298,200
36,221,000
(18,178,800) (3,573,700) (900) (992,800) (23,246,200)
Reserve Balance as of June 30, 2006
$ 10,137,400 $ 2,183,100 $ 416,000 $ 275,600 $13,012,100
75
For the Year Ended June 30, 2005
Reserve Category
Chargebacks
Rebates
Returns
Other
Total
Reserve balance as of June 30, 2004
$ 6,484,500 $ 1,864,200 $ 448,000 $ 88,300 $ 8,885,000
Actual credits issued related to sales recorded
in prior fiscal years
Reserves or (reversals) charged during Fiscal
2005 related to sales recorded in prior fiscal
years
Reserves charged to net sales in fiscal 2005
related to sales recorded in fiscal 2005
Actual credits issued related to sales in fiscal
2005
(4,978,300) (1,970,000) (523,100) (95,800) (7,567,200)
(1,420,000) 130,000 1,400,000
-
110,000
21,028,100 6,970,100 1,533,900 623,400
30,155,500
(13,114,600) (5,965,500) (1,166,800) (586,400) (20,833,300)
Reserve balance as of June 30, 2005
$ 7,999,700 $ 1,028,800 $ 1,692,000 $ 29,500 $ 10,750,000
The Company ships its products to the warehouses of its wholesale and retail chain customers. When the
Company and a customer come to an agreement for the supply of a product, the customer will generally
continue to purchase the product, stock its warehouse(s), and resell the product to its own customers. The
Company’s customer will reorder the product as its warehouse is depleted. The Company generally has
no minimum size orders for its customers. Additionally, most warehousing customers prefer not to stock
excess inventory levels due to the additional carrying costs and inefficiencies created by holding excess
inventory. As such, the Company’s customers continually reorder the Company’s products. It is
common for the Company’s customers to order the same products on a monthly basis. For generic
pharmaceutical manufacturers, it is critical to ensure that customers’ warehouses are adequately stocked
with its products. This is important due to the fact that several generic competitors compete for the
consumer demand for a given product. Availability of inventory ensures that a manufacturer’s product is
considered. Otherwise, retail prescriptions would be filled with competitors’ products. For this reason,
the Company periodically offers incentives to its customers to purchase its products. These incentives are
generally up-front discounts off its standard prices at the beginning of a generic campaign launch for a
newly-approved or newly-introduced product, or when a customer purchases a Lannett product for the
first time. Customers generally inform the Company that such purchases represent an estimate of
expected resale for a period of time. This period of time is generally up to three months. The Company
records this revenue, net of any discounts offered and accepted by its customers at the time of shipment.
The Company’s products have either 24 months or 36 months of shelf-life at the time of manufacture.
The Company monitors its customers’ purchasing trends to attempt to identify any significant lapses in
purchasing activity. If the Company observes a lack of recent activity, inquiries will be made to such
customer regarding the success of the customer’s resale efforts. The Company attempts to minimize any
potential return (or shelf life issues) by maintaining an active dialogue with the customers.
The products that the Company sells are generic versions of brand named drugs. The consumer markets
for such drugs are well-established markets with many years of historically-confirmed consumer demand.
Such consumer demand may be affected by several factors, including alternative treatments and costs, etc.
However, the effects of changes in such consumer demand for the Company’s products, like generic
products manufactured by other generic companies, are gradual in nature. Any overall decrease in
consumer demand for generic products generally occurs over an extended period of time. This is because
there are thousands of doctors, prescribers, third-party payers, institutional formularies and other buyers
of drugs that must change prescribing habits and medicinal practices before such a decrease would affect
a generic drug market. If the historical data the Company uses and the assumptions management makes
76
to calculate its estimates of future returns, chargebacks, and other credits do not accurately approximate
future activity, its net sales, gross profit, net income and earnings per share could change. However,
management believes that these estimates are reasonable based upon historical experience and current
conditions.
Accounts Receivable - The Company performs ongoing credit evaluations of its customers and adjusts
credit limits based upon payment history and the customer's current credit worthiness, as determined by a
review of current credit information. The Company continuously monitors collections and payments from
its customers and maintains a provision for estimated credit losses based upon historical experience and
any specific customer collection issues that have been identified. While such credit losses have
historically been within both the Company’s expectations and the provisions established, the Company
cannot guarantee that it will continue to experience the same credit loss rates that it has in the past.
Inventories - The Company values its inventory at the lower of cost (determined by the first-in, first-out
method) or market, regularly reviews inventory quantities on hand, and records a provision for excess and
obsolete inventory based primarily on estimated forecasts of product demand and production
requirements. The Company’s estimates of future product demand may fluctuate, in which case estimates
required reserves for excess and obsolete inventory may increase or decrease. If the Company’s
inventory is determined to be overvalued, the Company recognizes such costs in cost of goods sold at the
time of such determination. Likewise, if inventory is determined to be undervalued, the Company may
have recognized excess cost of goods sold in previous periods and would be required to recognize such
additional operating income at the time of sale.
Property, Plant and Equipment - Property, plant and equipment are stated at cost. Depreciation is
provided for by the straight-line and accelerated methods over the estimated useful lives of the assets.
Depreciation expense for the fiscal years ended June 30, 2007, 2006, and 2005 was approximately
$2,765,000, $2,182,000 and $1,799,000, respectively.
Investment Securities – The Company’s investment securities consist of marketable debt securities,
primarily in U.S. government and agency obligations. All of the Company’s marketable debt securities
are classified as available-for-sale and recorded at fair value, based on quoted market prices. Unrealized
holding gains and losses are recorded, net of any tax effect, as a separate component of accumulated other
comprehensive loss. No gains or losses on marketable debt securities are realized until they are sold or a
decline in fair value is determined to be other-than-temporary. If a decline in fair value is determined to
be other-than-temporary, an impairment charge is recorded and a new cost basis in the investment is
established. There were no securities determined by management to be other-than-temporarily impaired
for the twelve month period ended June 30, 2007
Shipping and Handling Costs – The cost of shipping products to customers is recognized at the time the
products are shipped, and is included in Cost of Sales.
Research and Development – Research and development expenses are charged to operations as incurred.
Intangible Assets – On March 23, 2004, the Company entered into an agreement with Jerome Stevens
Pharmaceuticals, Inc. (JSP) for the exclusive marketing and distribution rights in the United States to the
current line of JSP products in exchange for four million (4,000,000) shares of the Company’s common
stock. As a result of the JSP agreement, the Company recorded an intangible asset of $67,040,000 for the
exclusive marketing and distribution rights obtained from JSP. The intangible asset was recorded based
upon the fair value of the four million (4,000,000) shares at the time of issuance to JSP.
In June 2004, JSP’s Levothyroxine Sodium tablet product received from the FDA an AB rating to the
brand drug Levoxyl®. In December 2004, the product received from the FDA a second AB rating to the
brand drug Synthroid®. As a result of the dual AB ratings, the Company was required to pay JSP an
77
additional $1.5 million in cash to reimburse JSP for expenses related to obtaining the AB ratings. As of
June 30, 2005, the Company had recorded an addition to the intangible asset of $1.5 million.
During Fiscal 2005, events occurred (as described in subsequent paragraphs) which indicated that the
carrying value of the intangible asset was not recoverable. In accordance with Statement of Financial
Accounting Standards No. 144 (FAS 144), Accounting for the Impairment or Disposal of Long-Lived
Assets, the Company engaged a third party valuation specialist to assist in the performance of an
impairment test for the quarter ended March 31, 2005. The impairment test was performed by discounting
forecasted future net cash flows for the JSP products covered under the agreement and then comparing the
discounted present value of those cash flows to the carrying value of the asset (inclusive of the $1.5
million payable to JSP for the second AB rating). As a result of the testing, the Company had determined
that the intangible asset was impaired as of March 31, 2005. In accordance with FAS 144, the Company
recorded a non-cash impairment loss of approximately $46,093,000 to write the asset down to its fair
value of approximately $16,062,000 as of the date of the impairment. This impairment loss is shown on
the statement of operations as a component of operating loss. Management concluded that, as of June 30,
2007, the intangible asset was correctly stated at fair value and, therefore, no adjustment was required.
Several factors contributed to the impairment of this asset. In December 2004, the Levothyroxine Sodium
tablet product received the AB rating to Synthroid®. The expected sales increase as a result of the AB
rating did not occur in the third quarter of 2005. The delay in receiving the AB rating to Synthroid®
caused the Company to be competitively disadvantaged with its Levothyroxine Sodium tablet product and
to lose market share to competitors whose products had already received AB ratings to both major brand
thyroid deficiency drugs. Additionally, the generic market for thyroid deficiency drugs turned out to be
smaller than it was anticipated to be as a result of a lower brand-to-generic substitution rate. Increased
competition in the generic drug market, both from existing competitors and new entrants, has resulted in
significant pricing pressure on other products supplied by JSP. The combination of these factors resulted
in diminished forecasted future net cash flow which, when discounted, yield a lower present value than
the carrying value of the asset before impairment.
The Company will incur annual amortization expense of approximately $1,785,000 for the intangible
asset over the remaining term of the contract. For the periods ending June 30, 2007, 2006 and 2005, the
Company incurred amortization expense of $1,785,000, $1,785,000, and $5,516,000, respectively.
Future annual amortization expense of the JSP intangible asset consists of the following:
Fiscal Year Ending June 30,
2008
2009
2010
2011
2012
Thereafter
Annual Amortization Expense
$1,785,000
1,785,000
1,785,000
1,785,000
1,785,000
3,122,000
$12,047,000
Advertising Costs - The Company charges advertising costs to operations as incurred. Advertising
expense for the fiscal years ended June 30, 2007, 2006 and 2005 was approximately $75,000, $165,000,
and $157,000, respectively.
Income Taxes - The Company uses the liability method specified by Statement of Financial Accounting
Standards No. 109 (FAS), Accounting for Income Taxes. Deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax bases of assets and liabilities
as measured by the enacted tax rates which will be in effect when these differences reverse. Deferred tax
expense/(benefit) is the result of changes in deferred tax assets and liabilities.
Segment Information – The Company reports segment information in accordance with Statement of
Financial Accounting Standard No. 131 (FAS 131), Disclosures about Segments of an Enterprise and
78
Related Information. The Company operates one business segment - generic pharmaceuticals,
accordingly the Company has one reporting segment. In accordance with FAS 131, the Company
aggregates its financial information for all products and reports as one operating segment. The following
table identifies the Company’s approximate net product sales by medical indication for the fiscal years
ended June 30, 2007, 2006 and 2005:
Medical Indication
Migraine Headache
Epilepsy
Heart Failure
Thyroid Deficiency
Other
Total
For the Fiscal Year Ended June 30,
2007
2006
2005
$10,738,109
7,593,547
4,728,907
35,350,388
24,166,640
$ 11,667,330
12,815,637
7,214,182
17,931,743
14,431,483
$ 11,808,286
14,019,832
5,608,899
10,700,868
2,763,760
$82,577,591
$ 64,060,375
$ 44,901,645
Concentration of Market and Credit Risk – Five of the Company’s products, defined as generics
containing the same active ingredient or combination of ingredients, accounted for approximately 43%,
21%, 9%, 7%, and 6% of net sales for the fiscal year ended June 30, 2007. Those same products
accounted for 28%, 4%, 20%, 10%, and 7%, respectively, of net sales for the fiscal year ended June 30,
2006, and 24%, 0%, 31%, 16%, and 10%, respectively, for the fiscal year ended June 30, 2005.
Four of the Company’s customers accounted for 24%, 15%, 12%, and 6%, respectively, of net sales for
the fiscal year ended June 30, 2007; 17%, 4%, 15%, and 5%, respectively, of net sales for the fiscal year
ended June 30, 2006 and 17%, 7%, 14%, and 9%, respectively, of net sales for the fiscal year ended June
30, 2005.
Credit terms are offered to customers based on evaluations of the customers’ financial condition.
Generally, collateral is not required from customers. Accounts receivable payment terms vary and are
stated in the financial statements at amounts due from customers net of an allowance for doubtful
accounts. Accounts remaining outstanding longer than the payment terms are considered past due. The
Company determines its allowance by considering a number of factors, including the length of time trade
accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to
pay its obligation to the Company, and the condition of the general economy and the industry as a whole.
The Company writes-off accounts receivable when they become uncollectible, and payments
subsequently received on such receivables are credited to the allowance for doubtful accounts.
Stock Options - In December 2004, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 123 (R), “Share-Based Payment” (SFAS 123(R)). This
standard is a revision of SFAS 123, “Accounting for Stock-Based Compensation” and supersedes
Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees.”
SFAS 123(R) addresses the accounting for share-based compensation in which we receive employee
services in exchange for our equity instruments. Under the standard, we are required to recognize
compensation cost for share-based compensation issued to or purchased by employees, net of estimated
forfeitures, under share-based compensation plans using a fair value method.
At June 30, 2007, the Company had two stock-based employee compensation plans (the “New Plan” and
the “Old Plan”). Prior to July 1, 2005, the Company accounted for the plan under the recognition and
measurement provisions of APB 25, and related Interpretations, as permitted by SFAS 123. Effective
July 1, 2005, the Company adopted the fair value recognition provisions of SFAS 123(R), using the
modified-prospective-transition method.
79
Under this method, the Company is required to record compensation expense for all awards granted after
the date of adoption and for the unvested portion of previously granted awards that remain outstanding as
of the beginning of the period of adoption. The Company measures share-based compensation cost 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 years ended June 30:
Risk-free interest rate
Expected volatility
Expected dividend yield
Expected term (in years)
Weighted average fair value
2007
4.74%
59%
0.0%
5.00
$3.30
2006
4.47%
61%
0.0%
5.00
$3.25
2005
4.09%
55%
0.0%
5.00
$3.70
Approximately 354,000 options were issued during the year ended June 30, 2007. This compares to
approximately 109,000 options issued during the year ended June 30, 2006 and approximately 131,000
options issued during the year ended June 30. 2005. There were 375 shares under option that were
exercised in the year ended June 30, 2007, resulting in proceeds of $281 to the Company. There were
1,000 shares under option that were exercised in the year ended June 30, 2006, resulting in proceeds of
$4,633 to the Company. There were 19,126 shares exercised in the year ended June 30, 2005, resulting in
proceeds of $60,913. At June 30, 2007, there were 1,119,331 options outstanding. Of those, 908,098
were options issued under the New Plan and 211,233 under the Old Plan. There are no further shares
authorized to be issued under the Old Plan. 1,125,000 shares were authorized to be issued under the New
Plan, with 7,690 shares under option having already been exercised under that plan.
Expected volatility is based on the historical volatility of the price of our common shares since the date
we commenced trading on the AMEX, April 2002. We use historical information to estimate expected
term within the valuation model. The expected term of awards represents the period of time that options
granted are expected to be outstanding. The risk-free rate for periods within the expected life of the
option is based on the U.S. Treasury yield curve in effect at the time of grant. Compensation cost is
recognized using a straight-line method over the vesting or service period and is net of estimated
forfeitures.
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 historical forfeiture rate. Periodically,
management will assess whether it is necessary to adjust the estimated rate to reflect changes in actual
forfeitures or changes in expectations. For example, adjustments may be needed if, historically,
forfeitures were affected mainly by turnover that resulted from a business restructuring that is not
expected to recur. The increase in the forfeiture rate from 3% at June 30, 2006 to 5% at June 30, 2007 is
an adjustment made to account for recent turnover at manager levels. As the Company continues to grow,
this rate is likely to change to match such changes in turnover and hiring rates. Under the provisions of
FAS 123R, the Company will incur additional expense if the actual forfeiture rate is lower than originally
estimated. A recovery of prior expense will be recorded if the actual rate is higher than originally
estimated.
The following table presents all share-based compensation costs recognized in our statements of income
as part of selling, general and administrative expenses:
Twelve months ended June 30,
2007
2006
2005
Method used to account for share-based compensation
Fair Value
Fair Value
Intrinsic
Share-based compensation under SFAS 123(R)
Tax benefit at effective rate
$
$
1,176,236
187,762
$
$
1,440,711 $ -
317,400 $ -
80
The following table illustrates the pro forma effect on net income and earnings per share if we had
recorded compensation expense based on the fair value method for all share-based compensation awards:
Net loss - as reported
Deduct: total share-based compensation, determined under fair value based method
Add: tax benefit at effective rate
Net loss – pro forma
Basic loss per share - as reported
Basic loss per share – pro forma
Diluted loss per share - as reported
Diluted loss per share - pro forma
2005
$ (32,779,597)
(2,616,888)
1,023,203
$ (34,373,282)
$
$
$
$
(1.36)
(1.43)
(1.36)
(1.43)
Options outstanding that have vested and are expected to vest as of June 30, 2007 are as follows:
Options vested
Options expected to vest
Total vested and expected to vest
Awards
665,291
431,338
1,096,629
Weighted -
Average
Exercise
Price
$
$
$
11.67
6.13
9.47
Aggregate
Intrinsic
Value
$
$
$
72,028
221,403
293,431
Weighted
Average
Remaining
Contractual
Life
6.4
9.0
7.4
A summary of award activity under the Plans as of June 30, 2007, 2006 and 2005 and changes during the
twelve months then ended, is presented below:
Weighted -
Average
Exercise
Price
Aggregate
Intrinsic
Value
Weighted
Average
Contractual
Life
$
$
$
$
$
$
$
11.47
6.02
0.75
7.84
9.42
6.13
11.67
$
$
$
$
2,063
305,083
233,055
72,028
7.4
9.0
6.4
Outstanding at July 1, 2006
Granted
Exercised
Forfeited or expired
Outstanding at June 30, 2007
Outstanding at June 30, 2007 and
not yet vested
Exercisable at June 30, 2007
Awards
792,003
353,783
375
26,080
1,119,331
454,040
665,291
81
Weighted -
Average
Exercise
Price
Aggregate
Intrinsic
Value
Weighted
Average
Contractual
Life
$
$
$
$
$
$
$
13.72
6.07
4.63
-
10.89
9.92
11.47
$
$
$
$
2,537
84,130
42,585
41,545
7.3
7.8
7.1
Weighted -
Average
Exercise
Price
Aggregate
Intrinsic
Value
Weighted
Average
Contractual
Life
$
$
$
$
$
$
$
12.45
7.42
3.70
14.02
13.72
14.43
12.85
$
146,409
$
$
$
27,703
5,696
22,007
8.3
8.7
8.7
Awards
857,108
108,500
1,000
172,605
792,003
297,780
494,223
Awards
801,424
131,070
19,126
56,260
857,108
491,045
366,063
Outstanding at July 1, 2005
Granted
Exercised
Forfeited or expired
Outstanding at June 30, 2006
Outstanding at June 30, 2006 and not
yet vested
Exercisable at June 30, 2006
Outstanding at July 1, 2004
Granted
Exercised
Forfeited or expired
Outstanding at June 30, 2005
Outstanding at June 30, 2005 and not
yet vested
Exercisable at June 30, 2005
Options with a fair value of approximately $1,124,000 completed vesting during 2007. As of June 30,
2007, there was approximately $1,114,000 of total unrecognized compensation cost related to nonvested
share-based compensation awards granted under the Plans. That cost is expected to be recognized over a
weighted average period of 1.6 years. As of June 30, 2006 there was approximately $1,210,000 of total
unrecognized compensation cost related to nonvested share-based compensation awards granted under the
Plans.
Unearned Grant Funds – The Company records all grant funds received as a liability until the Company
fulfills all the requirements of the grant funding program.
Earnings per Common Share – SFAS No. 128, Earnings per Share, requires a dual presentation of basic
and diluted earnings per share on the face of the Company's consolidated statement of income and a
reconciliation of the computation of basic earnings per share to diluted earnings per share. Basic earnings
per share excludes the dilutive impact of common stock equivalents and is computed by dividing net
income by the weighted-average number of shares of common stock outstanding for the period. Diluted
earnings per share include the effect of potential dilution from the exercise of outstanding common stock
equivalents into common stock using the treasury stock method. Earnings per share amounts for all
periods presented have been calculated in accordance with the requirements of SFAS No. 128. A
reconciliation of the Company's basic and diluted earnings per share follows:
82
2007
2006
2005
Net Loss
(Numerator)
Shares
(Denominator)
Net Income
(Numerator)
Shares
(Denominator)
Net Loss
(Numerator)
Shares
(Denominator)
Basic (loss)/earnings per
share factors
Effect of potentially
dilutive option plans
Diluted (loss)/earnings
per share factors
$
(6,929,008)
24,159,251
$
4,968,922
24,130,224
$
(32,779,596)
24,097,472
-
-
-
26,665
-
-
(6,929,008)
24,159,251
4,968,922
24,156,889
(32,779,596)
24,097,472
share
per share
$
$
(0.29)
(0.29)
$
$
0.21
0.21
$
$
(1.36)
(1.36)
Dilutive shares have been excluded in the weighted average shares used for the calculation of earnings per
share in periods of net loss because the effect of such securities would be anti-dilutive. The number of
anti-dilutive shares that have been excluded in the computation of diluted earnings per share for the fiscal
years ended June 30, 2007, 2006 and 2005 were 1,119,331, 726,833, and 857,108, respectively.
Subsequent to the year end, 53,800 restricted shares were issued.
Note 2. New Accounting Standards
On September 13, 2006, the SEC staff issued Staff Accounting Bulletin (SAB) Topic 1N, “Financial
Statements — Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements” (SAB 108), SAB 108 addresses how a registrant should evaluate
whether an error in its financial statements is material. The SEC staff concludes in SAB 108 that
materiality should be evaluated using both the “rollover” and “iron curtain” methods. Registrants are
required to comply with the guidance in SAB 108 in financial statements for fiscal years ending after
November 15, 2006. The impact of applying SAB 108 is immaterial to the operating results of the
Company for the year ended June 30, 2007. Prior to application of SAB 108, the Company had been
using the “rollover” method to correct misstatements in the financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities (Including an amendment of FASB Statement No. 115)” (SFAS 159). This
Statement permits entities to choose to measure many financial instruments and certain other items at fair
value that are not currently required to be measured at fair value. The objective is to improve financial
reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply complex hedge accounting
provisions. SFAS 159 is expected to expand the use of fair value measurement, which is consistent with
the Financial Accounting Standards Board’s long-term measurement objective for accounting for
financial instruments. This statement also establishes presentation and disclosure requirements designed
to facilitate comparisons between entities that choose different measurement attributes for similar types of
assets and liabilities. SFAS 159 does not affect any existing accounting literature that requires certain
assets and liabilities to be carried at fair value. This statement does not establish requirements for
recognizing and measuring dividend income, interest income, or interest expense. SFAS 159 is effective
as of the beginning of an entity’s first fiscal year that begins after November 15, 2007, which, in the
Company’s case, is the fiscal year beginning July 1, 2008. This statement does not eliminate disclosure
requirements included in other accounting standards, including requirements for disclosure about fair
value measurements included in FASB Statement No. 157 “Fair Value Measurements,” and No. 107
83
“Disclosure about Fair Value of Financial Instruments.” The Company has not yet completed assessing
the impact this standard will have on its financial statements and results of operations.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157). This
Statement defines fair value, establishes a framework for measuring fair value in generally accepted
accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement
applies under other accounting pronouncements that require or permit fair value measurements, the Board
having previously concluded in those accounting pronouncements that fair value is the relevant
measurement attribute. Accordingly, this Statement does not require any new fair value measurements.
However, for some entities, the application of this Statement will change current practice. This Statement
is effective for financial statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. The Company will be required to adopt the guidance of SFAS
157 beginning July 1, 2008. The Company has not completed its study of the effects of adopting this
standard.
On May 2, 2007, the Financial Accounting Standards Board (FASB) posted FASB Staff Position (FSP)
No. FIN 48-1, Definition of Settlement in FASB Interpretation No. 48. This FSP amended FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes, to provide guidance on how an
enterprise should determine whether a tax position is effectively settled for the purpose of recognizing
previously unrecognized tax benefits. This FASB Staff Position sets forth that certain conditions should
be evaluated when determining effective settlement. The guidance in this FSP shall be applied upon the
initial adoption of Interpretation 48.
In May 2005, the FASB issued FASB Statement No. 154, “Accounting Changes and Error Corrections, a
replacement of APB Opinion No. 20 and FASB Statement No. 3” (SFAS No. 154). Previously, APB
Opinion No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in
Interim Financial Statements” required the inclusion of the cumulative effect of changes in accounting
principle in net income of the period of the change. SFAS No. 154 requires companies to recognize a
change in accounting principle, including a change required by a new accounting pronouncement when
the pronouncement does not include specific transition provisions, retrospectively to prior period financial
statements. SFAS No. 154 was effective as of January 1, 2006. The adoption of this standard did not have
any impact on the Company in the current fiscal year.
In April 2006, the FASB issued FASB Staff Position No. FIN 46(R)—6, “Determining the Variability to
Be Considered in Applying FASB Interpretation No. 46(R)” (FSP No. 46(R)—6). This pronouncement
provides guidance on how a reporting enterprise should determine the variability to be considered in
applying FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest
Entities,” which could impact the assessment of whether certain variable interest entities are consolidated.
FSP No. 46(R)—6 was effective for the Company on July 1, 2006. See Note 13 for “Consolidation of
Variable Interest Entities”.
In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes” (FIN 48), to clarify the accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with SFAS 109, “Accounting for Income Taxes.” Effective January 1,
2007, FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company
is currently evaluating the impact, if any, that FIN 48 will have on its financial statements and will adopt
this guidance beginning July 1, 2007.
84
Note 3. Inventories
Inventories at June 30, 2007 and 2006 consist of the following:
Raw Materials
Work-in-process
Finished Goods
Packaging Supplies
2007
$ 3,631,780
1,008,195
9,640,106
238,403
$ 14,518,484
2006
$ 5,143,714
1,438,794
4,511,274
382,721
$ 11,476,503
The preceding amounts are net of inventory obsolescence reserves of $923,920 and $1,054,498 at June
30, 2007 and 2006, respectively.
Note 4. Property, Plant and Equipment
Property, plant and equipment at June 30, 2007 and 2006 consist of the following:
Land
Building and improvements
Machinery and equipment
Furniture and fixtures
Less accumulated depreciation
Total
Useful Lives
2007
2006
-
10 - 39 years
5 - 10 years
5 - 7 years
$
918,314
16,229,427
21,275,686
837,262
$
233,414
10,612,954
17,109,279
826,703
$
39,260,689
(11,817,528)
$
28,782,350
(9,136,801)
$
27,443,161
$
19,645,549
As of June 30, 2007, $1,777,630 of property, plant and equipment ($1,805,158, net of $27,528 of
accumulated depreciation) was pledged as collateral for a mortgage by the Company, the balance of
which was $1,782,766 as of June 30, 2007.
Note 5. Investment Securities - Available-for-Sale
The amortized cost, gross unrealized gains and losses, and fair value of the Company’s available-for-sale
securities as of June 30, 2007 and June 30, 2006:
85
Available for Sale Securities
June 30, 2007
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
U.S. Government Agency
Asset-Backed Securities
$
$
2,474,435
892,168
3,366,603
$
$
8,302
18
8,320
$
(5,525)
(48,766)
(54,291)
$
$
$
2,477,212
843,420
3,320,632
Available for Sale Securities
June 30, 2006
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
U.S. Government Agency
Asset-Backed Securities
$
$
3,593,368
2,148,981
5,742,349
$
$
15
63
78
(67,510)
(53,308)
(120,818)
$
$
3,525,873
2,095,736
5,621,609
$
$
The amortized cost and fair value of the Company’s current available-for-sale securities by contractual
maturity at June, 30, 2007 and June 30, 2006 are summarized as follows:
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
June 30, 2007
Available for Sale
Amortized
Cost
Fair
Value
$
$
201,540
2,491,286
216,182
457,595
3,366,603
198,750
2,493,953
208,602
419,327
3,320,632
$
$
June 30, 2006
Available for Sale
Amortized
Cost
$
-
3,944,872
804,965
992,512
5,742,349
$
Fair
Value
$
-
3,881,558
797,517
942,534
5,621,609
$
The Company uses the specific identification method to determine the cost of securities sold. For the fiscal
years ended June 30, 2007, 2006 and 2005, the Company had realized losses of $1,095, $25,233 and $1,466,
respectively.
There were no securities held from a single issuer that represented more than 10% of shareholders’ equity.
The Company adopted Emerging Issues Task Force (EITF) Issue No. 03-1, The Meaning of Other than
Temporary Impairment and Its Application to Certain Investments as of June 30, 2004. EITF 03-1 includes
certain disclosures regarding quantitative and qualitative disclosures for investment securities accounted for
under Statement of Financial Accounting Standards No. 115 (FAS 115), Accounting for Certain Investments
in Debt and Equity Securities, that are impaired at the balance sheet date, but an other-than temporary
impairment has not been recognized. The disclosures under EITF 03-1 are required for financial statements
for years ending after December 15, 2003 and are included in these financial statements.
The table below indicates the length of time individual securities have been in a continuous unrealized loss
position as of June 30, 2007:
86
Description of
Securities
Number of
Securities
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Less than 12 months
12 months or longer
Total
Fair
Value
Unrealized
Loss
U.S. Government Agency
Asset-Backed Securities
9
12
$
776,822
-
$
(2,735)
-
$
198,750
798,345
$
(2,790)
(48,766)
$
975,572
798,345
$
(5,525)
(48,766)
Total temporarily
impaired investment
securities
21
$
776,822
$
(2,735)
$
997,095
$
(51,556)
$
1,773,917
$
(54,291)
There were no securities determined by management to be other-than-temporarily impaired for the year
ended June 30, 2007.
Note 6. Bank Line of Credit
The Company has a $3,000,000 line of credit from Wachovia Bank, N.A. that bears interest at the prime
interest rate less 0.25% (8.00% at June 30, 2007). The line of credit was renewed and extended to
November 30, 2007. At June 30, 2007 and 2006, the Company had $0 outstanding and $3,000,000
available under the line of credit. The line of credit is collateralized by substantially all of the Company’s
assets. The Company currently has no plans to borrow under this line of credit.
Note 7. Unearned Grant Funds
In July 2004, the Company received $500,000 of grant funding from the Commonwealth of Pennsylvania,
acting through the Department of Community and Economic Development. The grant funding program
requires the Company to use the funds for machinery and equipment located at their Pennsylvania locations,
hire an additional 100 full-time employees by June 30, 2006, operate its Pennsylvania locations a minimum
of five years and meet certain matching investment requirements. If the Company fails to comply with any of
the requirements above, the Company would be liable to repay the full amount of the grant funding
($500,000). The Company has recorded the unearned grant funds as a liability until the Company complies
with all of the requirements of the grant funding program. On a quarterly basis, the Company will monitor its
progress in fulfilling the requirements of the grant funding program and will determine the status of the
liability. As of June 30, 2007, the Company is in the process of renegotiation the funding arrangement with
the Commonwealth of Pennsylvania, and thus continues to record the grant funding as a short term liability
under the caption of Unearned Grant Funds.
87
Note 8. Long-Term Debt
Long-term debt at June 30, 2007 and 2006 consists of the following:
PIDC Regional Center, LP III loan
Pennsylvania Industrial Development
Authority loan
Pennsylvania Department of Community &
Economic Development loan
Tax-exempt bond loan (PAID)
Equipment loan
SBA Loan
First National Bank of Cody
Total debt
Less current portion
June 30,
2007
June 30,
2006
$ 4,500,000
$ 4,500,000
1,150,212
1,221,780
388,487
904,422
722,266
231,812
1,782,766
9,679,965
692,119
476,560
955,566
1,042,786
-
-
8,196,692
546,886
Long term debt
$ 8,987,846
$ 7,649,806
On December 13, 2005, the Company refinanced $5,750,000 of its debt through the Philadelphia
Industrial Development Corporation (PIDC) and the Pennsylvania Industrial Development Authority
(PIDA). With the proceeds from the refinancing, the Company paid off its Mortgage and Construction
Loan, as well as a portion of the Equipment loan. These loans were with Wachovia Bank. The Company
financed $4,500,000 through the Immigrant Investor Program (PIDC Regional Center, LP III). The
Company will pay a bi-annual interest payment at a rate equal to two and one-half percent per annum.
The outstanding principal balance shall be due and payable 5 years (60 months) from January 1, 2006.
The remaining $1,250,000 is financed through the PIDA Loan. The Company is required to make equal
payments each month for 180 months starting February 1, 2006 with interest of two and three-quarter
percent per annum. The PIDA Loan has $1,150,212 outstanding as of June 30, 2007, and $70,604 is
currently due; none of the PIDC Loan is currently due.
An additional $500,000 was financed through the Pennsylvania Department of Community and Economic
Development Machinery and Equipment Loan Fund. The Company is required to make equal payments
for 60 months starting May 1, 2006 with interest of two and three quarter percent per annum. As of June
30, 2007, $388,487 is outstanding, and $97,001 is currently due.
In April 1999, the Company entered into a loan agreement (the “Agreement”) with a governmental
authority, the Philadelphia Authority for Industrial Development (the “Authority” or “PAID”), to finance
future construction and growth projects of the Company. The Authority issued $3,700,000 in tax-exempt
variable rate demand and fixed rate revenue bonds to provide the funds to finance such growth projects
pursuant to a trust indenture (“the Trust Indenture”). A portion of the Company’s proceeds from the
bonds was used to pay for bond issuance costs of approximately $170,000. The Trust Indenture requires
that the Company repay the Authority loan through installment payments beginning in May 2003 and
continuing through May 2014, the year the bonds mature. The bonds bear interest at the floating variable
rate determined by the organization responsible for selling the bonds (the “remarketing agent”). The
interest rate fluctuates on a weekly basis. The effective interest rate at June 30, 2007 was 3.89%. At June
88
30, 2007, the Company has $904,422 outstanding on the Authority loan, of which $109,164 is classified
as currently due. The remainder is classified as a long-term liability. In April 1999, an irrevocable letter
of credit of $3,770,000 was issued by Wachovia Bank, National Association (Wachovia) to secure
payment of the Authority Loan and a portion of the related accrued interest. At June 30, 2007, no portion
of the letter of credit has been utilized.
The Equipment Loan consists of a term loan with a maturity date of five years. The Company, as part of
the 2003 Loan Financing agreement with Wachovia, is required to make equal payments of principal and
interest. As of June 30, 2007, the Company has outstanding $722,266 under the Equipment Loan, of
which $320,520 is classified as currently due.
The financing facilities under the 2003 Loan Financing, of which only the Equipment Loan is left, bear
interest at a variable rate equal to the LIBOR rate plus 150 basis points. The LIBOR rate is the rate per
annum, based on a 30-day interest period, quoted two business days prior to the first day of such interest
period for the offering by leading banks in the London interbank market of dollar deposits. As of June
30, 2007, the interest rate for the 2003 Loan Financing (of which only the Equipment loan remains) was
6.82%.
The Company has executed Security Agreements with Wachovia, PIDA and PIDC in which the Company
has agreed to pledge substantially all of its assets to collateralize the amounts due.
The terms of the Equipment loan require that the Company meet certain financial covenants and reporting
standards, including the attainment of standard financial liquidity and net worth ratios. As of June 30,
2007, the Company has complied with such terms, and successfully met its financial covenants.
As part of the acquisition of Cody, the Company assumed the debt owed to the Small Business
Administration (“SBA”). The loan requires fixed monthly payments, with an effective interest rate of
8.75%, through July 31, 2012. As of June 30, 2007, $231,812 is outstanding under the SBA loan, of
which $49,647 is classified as currently due. Cody has pledged inventory, accounts receivable and
equipment as collateral.
Also part of the Cody acquisition, the Company became primary beneficiary to a variable interest entity
(“VIE”) called Cody LCI Realty, LLC. See Note 13, Consolidation of Variable Interest Entity for
additional description. The VIE owns land and a building which is being leased to Cody. A mortgage
loan with First National Bank of Cody has been consolidated in the Company’s financial position, along
with the related land and building. The mortgage has 19 years remaining. Principal and interest
payments of $14,782, at an effective interest rate of 7.5% are being made on a monthly basis through June
2026. As of June 30, 2007, the Company has $1,782,766 outstanding under the mortgage loan,
collateralized by the land and building, of which $45,183 is classified as currently due.
Long-term debt amounts are due as follows:
Fiscal Year Ending
June 30,
2008
2009
2010
2011
2012
Thereafter
Amounts Payable
to Institutions
$
692,119
712,560
496,391
4,908,897
287,131
2,582,867
$
9,679,965
89
Some of the Company’s debt instruments are fixed rate, with a lower interest rate than the prevailing
market rates. The Company has been able to obtain favorable rates through Philadelphia and
Pennsylvania Industrial Development Authorities. Management estimates the fair value of this debt at the
remaining principal balance on debt.
Note 9. Contingencies
The Company monitors its compliance with all environmental laws. Any compliance costs which may be
incurred are contingent upon the results of future site monitoring and will be charged to operations when
incurred. No compliance costs were incurred during the years ended June 30, 2007, 2006 and 2005.
Pursuant to a Pennsylvania Department of Revenue (the “Department”) Sales and Use Tax audit, the
Department assessed Use Tax in the amount of $240,000, plus interest and penalties. The total due per the
audit is $347,000, although interest continues to accrue until paid. A Petition for Reassessment has been filed
with the Board of Appeals, an administrative board. At this point, management is waiting for a hearing to be
scheduled by the Board. Only certain audit issues have been raised in the Petition. Lannett is also contesting
the assessed penalties which total approximately $72,000. At this point, management has estimated the
minimum liability resulting from this audit will be $219,000, as has accrued this liability as of June 30, 2007.
The Company is currently engaged in several civil actions as a co-defendant with many other
manufacturers of Diethylstilbestrol (“DES”), a synthetic hormone. Prior litigation established that the
Company’s pro rata share of any liability is less than one-tenth of one percent. Due to the fact that prior
litigation established the “market share” method of prorating liability amongst the companies that
manufactured DES during the drug’s commercial distribution, which ended in 1971, the Company has
accepted this method as the most reasonably expected method of determining liability for future outcomes
of claims. The Company was represented in many of these actions by the insurance company with which
the Company maintained coverage (subject to limits of liability) during the time period that damages were
alleged to have occurred. The insurance company denies coverage for actions alleging involvement of the
Company filed after January 1, 1992. With respect to these actions, the Company paid nominal damages
or stipulated to its pro rata share of any liability. The Company has either settled or is currently defending
over 500 such claims. At this time, management is unable to estimate a range of loss, if any, related to
these actions. Management believes that the outcome of these cases will not have a material adverse
impact on the financial position or results of operations of the Company.
In addition to the matters reported herein, the Company is involved in litigation which arises in the
normal course of business. In the opinion of management, the resolution of these lawsuits will not have a
material adverse effect on the consolidated financial position or results of the Company.
Note 10. Commitments
Leases
In June 2006, Lannett signed a lease agreement on a 66,000 square foot facility located on seven acres in
Philadelphia. An additional agreement which gives the Company the option to buy the facility was also
signed. This new facility is initially going to be used for warehouse space with the expectation of making this
facility the Company’s headquarters in addition to manufacturing and warehousing. The other Philadelphia
locations will continue to be utilized as manufacturing, packaging, and as a research laboratory. This gives
Lannett the space to fit its desire to expand.
Lannett’s subsidiary, Cody Laboratories, Inc. (“Cody”) leases a 73,000 square foot facility in Cody,
Wyoming. This location houses Cody’s manufacturing and production facilities. Cody leases the facility
from Cody LCI Realty, LLC, a Limited Liability Company which is 50% owned by Lannett. See Note 13.
In addition to the above, the Company has operating leases, expiring in 2008, for office equipment.
90
Rental and lease expense for the years ended June 30, 2007, 2006 and 2005 was approximately $380,000,
$47,000, and $50,000, respectively.
Contractual Obligations
The following table represents annual contractual purchase obligations as of June 30, 2007:
Total
Less than 1
year
1-3 years
3-5 years
more than 5
years
Long-Term Debt
Operating Leases
Purchase Obligations
Interest on Obligations
Total
$
9,679,965
1,658,836
147,000,000
1,510,391
159,849,192
$
$
692,119
401,395
18,000,000
374,515
19,468,029
$
$
1,208,951
783,807
39,000,000
639,566
41,632,324
$
$
5,196,028
473,634
43,000,000
383,820
49,053,482
$
$
2,582,867
-
47,000,000
112,490
49,695,357
$
The purchase obligations above are due to the agreement with Jerome Stevens Pharmaceuticals, Inc. If the
minimum purchase requirement is not met, Jerome Stevens has the right to terminate the contract within 60
days of Lannett’s failure to meet the requirement. If Jerome Stevens terminates the contract, Lannett does not
pay any fee, but could lose its exclusive distribution rights in the United States. If Lannett’s management
believes that it is not in the Company’s best interest to fulfill the minimum purchase requirements, it can also
terminate the contract without any penalty. No matter which party terminates the purchase agreement, there
would be minimal impact on the operating cash flows of the Company from the termination.
Employment Agreements
The Company has entered into employment agreements with Arthur P. Bedrosian, President and Chief
Executive Officer, Brian Kearns, Chief Financial Officer, Treasurer, Kevin Smith, Vice President of Sales
and Markerting, Bernard Sandiford, Vice President of Operations, and William Schreck, Vice President of
Logistics, (the “Named Executives”). Each of the agreements provide for an annual base salary and
eligibility to receive a bonus. The salary and bonus amounts of the Named Executives are determined by the
Board of Directors. Additionally, the Named Executives are eligible to receive stock options, which are
granted at the discretion of the Board of Directors, and in accordance with the Company’s policies regarding
stock option grants.
Under the agreements, the Named Executive employees may be terminated at any time with or without cause,
or by reason of death or disability. In certain termination situations, the Company is liable to pay severance
compensation to the Named Executive of between one year and three years.
91
Note 11. Other Comprehensive (Loss) Income
The Company’s other comprehensive loss is comprised of unrealized losses on investment securities
classified as available-for-sale. The components of comprehensive income and related taxes consisted of the
following as of June 30, 2007, 2006 and 2005:
OTHER COMPREHENSIVE (LOSS) INCOME
For Fiscal Year Ended June 30,
2006
2005
2007
Other Comprehensive Loss:
Unrealized Holding Gain (Loss) on Securities
Add: Tax savings at effective rate
$
74,769
(29,908)
$
(78,751)
31,500
$
(41,989)
16,796
Total Unrealized Gain (Loss) on Securities, Net
44,861
(47,251)
(25,193)
Total Other Comprehensive Income (Loss)
Net (Loss) Income
44,861
(6,929,008)
(47,251)
4,968,922
(25,193)
(32,779,596)
Total Comprehensive (Loss) Income
$
(6,884,147)
$
4,921,671
$
(32,804,789)
Note 12. Acquisition of Cody Laboratories, Inc.
On April 10, 2007, the Company entered into a Stock Purchase Agreement to acquire Cody Laboratories,
Inc. (“Cody Labs”) by purchasing all of the remaining shares of common stock of Cody Labs. The
Company initially acquired a 12.5% direct interest in Cody Labs in July 2005. The consideration for the
April 10, 2007 acquisition was approximately $4,438,000, which represents the fair value of the tangible
net assets acquired. Cody Labs was a privately owned manufacturer and supplier of bulk active
pharmaceutical ingredients (API). The Company acquired all outstanding stock in this supplier in order
to expand the breadth of its product offerings, and to maximize the profit margin on these products being
offered.
A condensed balance sheet of Cody Labs at the date of acquisition, April 10, 2007, is as follows:
Cash
Inventory
Other current assets
Total current assets
Property, plant and equipment, net
Total assets
Accounts payable
Current portion of long-term debt
Accrued expenses
Total current liabilities
Long term debt, less current portion
Total shareholders' equity
$
157,962
325,372
89,445
572,779
4,457,455
5,030,234
$
$
258,660
48,524
91,476
398,660
193,417
4,438,157
Total liabilities and shareholders' equity
$
5,030,234
In accordance with the agreement, the closing date consideration was $4,438,000 which was offset
against the impaired loans and payables which totaled $11,730,000, plus 120,000 shares of unregistered
92
common stock of the Company. Issuance of the unregistered shares is contingent upon the receipt of a
license from a regulatory agency. As a result of the net assets of Cody Labs being below the balance of
the outstanding note receivable, the Company recognized a loss on the impaired loans of $7,775,890 as of
March 31, 2007. The remaining balance due from Cody Labs, including a previous year investment of
$500,000, was $4,438,000. A valuation of $4,438,000 was obtained by an independent valuation
specialist.
The Company accounted for the transaction by following the guidance under SFAS 15, Accounting by
Debtors and Creditors for Troubled Debt Restructuring and under the purchase method of accounting as
provided in SFAS 141, Business Combinations.
The acquisition was accounted for under the purchase method of accounting. The operating results of the
acquired business have been included in the consolidated statements of operations, financial condition and
cash flows from April 10, 2007 (the acquisition date) through June 30, 2007.
The following pro forma historical results of operations for the years ended June 30, 2007 and 2006 are
presented as if the Company had acquired Cody Labs on July 1, 2005.
Statements of Operations
UNAUDITED
Net Sales
Net (loss) income
Year Ended
June 30,
2007
2006
$ 82,578,000
$ (3,197,000)
$ 64,803,000
$ 2,068,000
(Loss) earnings per common share - basic and diluted
$ (0.13)
$ 0.09
Weighted average common shares outstanding - basic
Weighted average common shares outstanding - diluted
24,159,251
24,159,251
24,130,224
24,156,889
The unaudited pro forma financial information is presented for informational purposes only and does not
purport to represent what the operating results actually would have been had the acquisition occurred on
that date.
Note 13. Consolidation of Variable Interest Entity
Lannett consolidates any Variable Interest Entity (“VIE”) of which we are the primary beneficiary. The
liabilities recognized as a result of consolidating a VIE do not represent additional claims on our general
assets; rather, they represent claims against the specific assets of the consolidated VIE. Conversely, assets
recognized as a result of consolidating a VIE do not represent additional assets that could be used to
satisfy claims against our general assets. Reflected in the June 30, 2007 balance sheet are consolidated
VIE assets of $1.8 million, which is comprised mainly of land and building. There were no VIE assets at
June 30, 2006. VIE liabilities consist of a mortgage on that property in the amount of $1.8 million. There
were no VIE liabilities at June 30, 2006.
Cody LCI Realty LLC (“Realty”) is the only VIE that is consolidated. Realty has been consolidated by
Cody prior to its acquisition by Lannett. Realty is a 50/50 joint venture with a former shareholder of
Cody Labs. Its purpose was to acquire the facility used by Cody. Until the acquisition of Cody in April
2007, Lannett had not consolidated the VIE because Cody Labs had been the primary beneficiary of the
VIE. The risks associated with our interests in this VIE is limited to a decline in the value of the land and
93
building as compared to the balance of the mortgage note on that property, up to Lannett’s 50% share of
the venture. Realty owns the land and building, and Cody leases the building and property from Realty
for $15,000 per month. All intercompany rent expense is eliminated upon consolidation with Cody.
The Company is not involved in any other VIE of which Lannett is primary beneficiary.
Note 14. Employee Benefit Plan
The Company has a defined contribution 401k 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, but not to exceed 4% of the employee’s compensation for the Plan year.
Contributions to the Plan during the years ended June 30, 2007, 2006 and 2005 were $375,000, $240,000,
and $246,000, respectively.
Note 15. Employee Stock Purchase Plan
In February 2003, the Company’s shareholders 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 1,125,000 shares of the Company’s common stock for issuance
under the ESPP. As of June 30, 2007, 87,978 shares have been issued under the ESPP. Compensation
expense of $33,322, $43,975, and $24,829 has been recognized in fiscal years 2007, 2006 and 2005,
respectively, relating to the ESPP.
Note 16. Long-Term Incentive Plan (The “Plan”)
In 2007, the shareholders of the Company approved the 2006 Long-term Incentive Plan (The “Plan”). The
purpose of the Plan is to enable management of the “Company to (i) own shares of stock in the Company,
(ii) participate in the shareholder value which has been created, (iii) have a mutuality of interest with other
shareholders and (iv) enable the Company to attract, retain and motivate key management level employees of
particular merit. The Plan authorizes the Committee to grant both stock and/or cash-based awards through
(i) incentive and non-qualified stock options and/or (ii) restricted stock, and/or long-term performance awards
to participants. With respect to the stock options and stock grants, 2,500,000 shares will be set aside for stock
option grants and/or restricted stock awards.
94
Note 17. Income Taxes
The provision for income taxes consists of the following for the years ended June 30,
2007
2006
2005
Current Income Taxes
Federal
State and Local Taxes
Total
Deferred Income Taxes
Federal
State and Local Taxes
Total
$
(771,913)
-
(771,913)
$
822,617
-
822,617
$
(815,930)
-
(815,930)
1,503,322
276,520
1,779,842
2,281,537
457,021
2,738,558
(16,861,925)
(3,368,047)
(20,229,972)
Total
$
1,007,929
$
3,561,175
$
(21,045,902)
A reconciliation of the differences between the effective rates and statutory rates is as follows:
Federal income tax at statutory rate
State and local income tax, net
Nondeductible expenses
Change in valuation allowance
Other
Income taxes expense
2007
2006
2005
35.0%
0.0%
-4.4%
-45.1%
-2.5%
-17.0%
35.0%
3.5%
3.0%
0.0%
0.2%
41.7%
35.0%
4.1%
0.0%
0.0%
0.0%
39.1%
The principal types of differences between assets and liabilities for financial statement and tax return
purposes are accruals, reserves, impairment of intangibles, accumulated amortization, accumulated
depreciation and stock compensation which began in Fiscal 2006. A deferred tax asset is recorded for the
future benefits created by the timing of accruals and reserves and the application of different amortization
lives for financial statement and tax return purposes. A deferred tax asset valuation allowance was
established based on the likelihood that it is more likely than not that the Company will be unable to realize
certain of the deferred tax assets. A deferred tax liability is recorded for the future liability created by
different depreciation methods for financial statement and tax return purposes.
95
As of June 30, 2007 and 2006, temporary differences which give rise to deferred tax assets and liabilities are
as follows:
Deferred tax assets:
Accrued expenses
Stock compensation expense
Unearned grant funds
Reserves for accounts receivable and inventory
Intangible impairment
State net operating loss
Federal net operating loss
Impairment on Cody note receivable
Accumulated amortization on intangible asset
Valuation allowance
Total
Deferred tax liabilities:
Prepaid expenses
Property, plant and equipment
2007
2006
$
38,078
515,100
195,000
1,239,241
14,381,090
560,752
141,852
2,106,798
1,898,743
$
54,765
319,036
195,000
1,406,407
16,777,944
268,783
-
-
509,911
21,076,654
(2,667,550)
18,409,104
19,531,846
-
19,531,846
73,479
3,129,356
44,029
2,501,705
Net deferred tax asset
$
15,206,269
$
16,986,112
Note 18. Related Party Transactions
The Company had sales of approximately $763,000, $1,143,000, and $590,000 during the years ended June
30, 2007, 2006 and 2005, respectively, to a generic distributor, Auburn Pharmaceutical Company. Jeffrey
Farber (the “related party”), who is a current board member and the son of the Chairman of the Board of
Directors and principal shareholder of the Company, William Farber, is the owner of Auburn Pharmaceutical
Company. Accounts receivable includes amounts due from the related party of approximately $109,000 and
$191,000 at June 30, 2007 and 2006, respectively. In the Company’s opinion, the terms of these transactions
were not more favorable to the related party than would have been to a non-related party.
In January 2005, Lannett Holdings, Inc. entered into an agreement pursuant to which it purchased for
$100,000 and future royalty payments the proprietary rights to manufacture and distribute a product for
which Pharmeral, Inc. owns the Abbreviated New Drug Application. This agreement is subject to Lannett
Holdings, Inc.’s ability to obtain FDA approval to use the proprietary rights. Subsequently the
submission had been approved by the FDA and the marketing begun. The Company has treated this
payment as a prepaid asset, which will be amortized over the term of the agreement. Arthur Bedrosian,
President of Lannett, was formerly the President and Chief Executive Officer and currently owns 100% of
Pharmeral, Inc. This transaction was approved by the Board of Directors of Lannett and, in its opinion;
the terms were not more favorable to the related party than they would have been to a non-related party.
The Company has approximately $1,638,000 of deferred revenue as a result of prepayments on inventory
received from Provell Pharmaceuticals, LLC. Provell is a joint venture to distribute pharmaceutical
products through mail order outlets. Lannett was given 33% ownership of this venture in exchange for
access to Lannett’s drug providers. The investment is valued at zero, due to losses incurred to date by
Provell.
96
Note 19. Material Contracts with Suppliers
Jerome Stevens Pharmaceuticals agreement:
The Company’s primary finished product inventory supplier is Jerome Stevens Pharmaceuticals, Inc.
(JSP), in Bohemia, New York. Purchases of finished goods inventory from JSP accounted for
approximately 63% of the Company’s inventory purchases in Fiscal 2007, 76% in Fiscal 2006 and
62% in Fiscal 2005. On March 23, 2004, the Company entered into an agreement with JSP for the
exclusive distribution rights in the United States to the current line of JSP products, in exchange for
four million (4,000,000) shares of the Company’s common stock. The JSP products covered under
the agreement included Butalbital, Aspirin, Caffeine with Codeine Phosphate capsules, Digoxin
tablets and Levothyroxine Sodium tablets, sold generically and under the brand name Unithroid®.
The term of the agreement is ten years, beginning on March 23, 2004 and continuing through
March 22, 2014. Both Lannett and JSP have the right to terminate the contract if one of the
parties does not cure a material breach of the contract within thirty (30) days of notice from the
non-breaching party.
During the term of the agreement, the Company is required to use commercially reasonable
efforts to purchase minimum dollar quantities of JSP’s products being distributed by the
Company. The minimum quantity to be purchased in the first year of the agreement is $15
million. Thereafter, the minimum quantity to be purchased increases by $1 million per year up to
$24 million for the last year of the ten-year contract. The Company has met the minimum
purchase requirement for the first three years of the contract, but there is no guarantee that the
Company will be able to continue to do so in the future. If the Company does not meet the
minimum purchase requirements, JSP’s sole remedy is to terminate the agreement.
Under the agreement, JSP is entitled to nominate one person to serve on the Company’s Board of
Directors (the “Board”) provided, however, that the Board shall have the right to reasonably
approve any such nominee in order to fulfill its fiduciary duty by ascertaining that such person is
suitable for membership on the board of a publicly traded corporation. Suitability is determined
by, but not limited to, the requirements of the Securities and Exchange Commission, the
American Stock Exchange, and other applicable laws, including the Sarbanes-Oxley Act of 2002.
As of June 30, 2007, JSP has not exercised the nomination provision of the agreement. The
agreement was included as an Exhibit in the Current Report on Form 8-K filed by the Company
on May 5, 2004, as subsequently amended.
Management determined that the intangible product rights asset created by this agreement was
impaired as of March 31, 2005. Refer to Note 1 – intangible assets for additional disclosure and
discussion of this impairment.
Other agreements:
In August 2005, the Company signed an agreement with a finished goods provider to purchase, at
fixed prices, and distribute a certain generic pharmaceutical product in the United States.
Purchases of finished goods inventory from this provider accounted for approximately 23% of the
Company’s costs of purchased inventory in Fiscal 2007, and 11% in 2006. The term of the
agreement is three years, beginning on August 22, 2005 and continuing through August 21, 2008.
During the term of the agreement, the Company has committed to provide a rolling twelve month
forecast of the estimated Product requirements to this provider. The first three months of the
rolling twelve month forecast are binding and constitute a firm order.
97
Note 20. Fair Value of Financial Instruments
The Company’s financial instruments consist primarily of cash and cash equivalents, accounts
receivable, accounts payable, accrued expenses and debt obligations. The carrying value of these
assets and liabilities approximates fair value based upon the short term nature of these
instruments.
Note 21. Quarterly Financial Information (Unaudited)
Lannett’s quarterly consolidated results of operations and market price information are shown below:
Fourth
Quarter
Third
Quarter
Second
Quarter
First
Quarter
$
$
$
$
Diluted (Loss) Earnings Per Share
$
(0.11)
$
(0.27)
$
0.04
$
0.05
$
$
$
$
$
$
$
$
Fiscal 2007
Net Sales
Cost of Goods Sold
Gross Profit
Other Operating Expenses
Operating (Loss) Income
Other (Expense) Income
Income Taxes
Net (Loss) Income
Basic (Loss) Earnings Per Share
Fiscal 2006
Net Sales
Cost of Goods Sold
Gross Profit
Other Operating Expenses
Operating Income
Other Income (Expense)
Income Taxes
Net Income
Basic Earnings Per Share
Fiscal 2005
Net Sales
Cost of Goods Sold
Gross (Loss) Profit
Other Operating Expenses
Operating (Loss) Income
Other Expense
Income Taxes
Net (Loss) Income
Basic Earnings (Loss) Per Share
17,390,842
12,624,651
4,766,191
6,960,924
(2,194,733)
(57,978)
322,138
(2,574,849)
(0.11)
19,452,896
9,569,130
9,883,766
8,217,081
1,666,685
(8,632)
808,840
849,213
0.04
9,368,438
12,443,756
(3,075,318)
5,620,448
(8,695,766)
(40,145)
(3,010,067)
(5,725,844)
(0.24)
20,302,576
14,127,421
6,175,155
13,624,219
(7,449,064)
22,898
(818,807)
(6,607,359)
(0.27)
15,737,180
9,404,156
6,333,024
4,252,869
2,080,155
30,906
856,402
1,254,659
0.05
7,603,189
4,266,839
3,336,350
51,888,438
(48,552,088)
(45,194)
(19,438,914)
(29,158,368)
(1.21)
22,916,347
17,402,285
5,514,062
3,965,938
1,548,124
43,828
636,781
955,171
0.04
15,228,767
8,063,974
7,164,793
5,072,060
2,092,733
13,859
842,518
1,264,074
0.05
12,918,522
7,085,479
5,833,043
4,466,319
1,366,724
(54,326)
524,921
787,477
0.03
21,967,826
13,240,394
8,727,432
6,596,168
2,131,264
34,582
867,817
1,298,029
0.05
13,641,532
6,862,785
6,778,747
4,164,402
2,614,345
40,046
1,053,415
1,600,976
0.07
15,011,496
7,620,834
7,390,662
5,149,190
2,241,472
(46,175)
878,156
1,317,141
0.05
Diluted Earnings Per Share
$
0.04
$
0.05
$
0.05
$
0.07
$
$
$
$
$
$
$
$
$
$
$
$
Diluted Earnings (Loss) Per Share
$
(0.24)
$
(1.21)
$
0.03
$
0.05
On March 31, 2007, the Company wrote down $7,775,890 of a note receivable owed by Cody
Laboratories, Inc. The Company determined that the value of the note receivable was impaired, and
on April 10, 2007, it was decided to complete the acquisition of Cody by forgiving the amount of
loans that exceeded the fair value of assets received. At that point, Cody owed Lannett
98
approximately $11,730,000, in the form of notes receivable and prepayments on products and
services. The remaining value of the amounts owed was approximately the value of Cody at the time
of the acquisition.
Net sales for the fourth quarter of Fiscal 2007 have decreased as a result of change in sales mix and
customer mix. The Company was able to increase sales to retail drug stores, however the Company
experienced declines in sales to wholesaler customers. This change in mix is a result of purchasing
patterns of wholesalers and revised purchase agreements with the wholesalers.
99
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders of
Lannett Company, Inc. and Subsidiaries
We have audited in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated financial statements of Lannett Company, Inc. and
Subsidiaries referred to in our report dated October 8, 2007. Our audit was conducted for the
purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The
accompanying Schedule II is presented for purposes of additional analysis and is not a required part
of the basic financial statements. This schedule has been subjected to the auditing procedures
applied in the audit of the basic consolidated financial statements and, in our opinion, is fairly stated
in all material respects in relation to the basic consolidated financial statements taken as a whole.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
October 8, 2007
100
Schedule II
Valuation and Qualifying Accounts
For the year ended June 30, 2007
Balance at
Beginning of
Fiscal Year
Charged to
(reduction of)
Expense
Deductions
Balance at
End of Fiscal
Year
$ 250,000
70,000
260,000
$ -
180,000
(186,789)
$ -
-
3,211
$ 250,000
250,000
70,000
$ 1,054,499 $ 1,717,357
(1,515,589)
5,590,425
5,300,000
515,000
$ 1,847,936
2,729,912
805,425
$ 923,920
1,054,499
5,300,000
Description
Allowance for Doubtful
Accounts
2007
2006
2005
Inventory Valuation
2007
2006
2005
101
Exhibit
Number
Description
Method of Filing
Exhibit Index
3.1
Articles of Incorporation
3.2
4
10.1
10.2
10.3
10.4
By-Laws, as amended
Specimen Certificate for
Common Stock
Line of Credit Note dated
March 11, 1999 between the
Company and First Union
National Bank
Philadelphia Authority for
Industrial Development
Taxable Variable Rate
Demand/Fixed Rate Revenue
Bonds, Series of 1999
Philadelphia Authority for
Industrial Development Tax-
Exempt Variable Rate
Demand/Fixed Revenue
Bonds (Lannett Company,
Inc. Project) Series of 1999
Letter of Credit and
Agreements supporting bond
issues between the Company
and First Union National Bank
Incorporated by reference to the Proxy
Statement filed with respect to the Annual
Meeting of Shareholders held on December
6, 1991 (the "1991 Proxy Statement").
Incorporated by reference to the 1991 Proxy
Statement.
Incorporated by reference to Exhibit 4(a) to
Form 8 dated April 23, 1993 (Amendment
No. 3 to Form 10-KSB for Fiscal 1992)
("Form 8")
Incorporated by reference to Exhibit 10(ad)
to the Annual Report on 1999 Form 10-KSB
Incorporated by reference to Exhibit 10(ae)
to the Annual Report on 1999 Form 10-KSB
Incorporated by reference to Exhibit 10(af)
to the Annual Report on 1999 Form 10-KSB
Incorporated by reference to Exhibit 10(ag)
to the Annual Report on 1999 Form 10-KSB
10.5
2003 Stock Option Plan
Incorporated by reference to the Proxy
Statement for Fiscal Year Ending June 30,
2002
10.6
10.7
10.8
Terms of Employment
Agreement with Kevin Smith
Incorporated by reference to Exhibit 10.6 to
the Annual Report on 2003 Form 10-KSB
Incorporated by reference to Exhibit 10 to
the Quarterly Report on Form 10-Q dated
May 12, 2004.
Incorporated by reference to Exhibit 10.9 to
the Annual Report on 2004 Form 10-KSB
Terms of Employment
Agreement with Arthur
Bedrosian
Terms of Employment
Agreement with Larry
Dalesandro
102
Exhibit
Number
10.9 (Note A)
10.10 (Note A)
Description
Method of Filing
Agreement between Lannett
Company, Inc and Siegfried
(USA), Inc.
Agreement between Lannett
Company, Inc and Jerome
Stevens, Pharmaceutical, Inc.
Incorporated by reference to Exhibit 10.9 to
the Annual Report on 2003 Form 10-KSB
Incorporated by reference to Exhibit 2.1 to
Form 8-K dated April 20, 2004
11
13
21
23.1
31.1
31.2
32
Computation of Earnings Per
Share
Filed Herewith
Annual Report on Form 10-K
Filed Herewith
Subsidiaries of the Company
Filed Herewith
Consent of Grant Thornton,
LLP
Filed Herewith
Filed Herewith
Filed Herewith
Filed Herewith
Certification of Chief
Executive Officer Pursuant to
Section 302 of the Sarbanes-
Oxley Act of 2002
Certification of Chief
Financial Officer Pursuant to
Section 302 of the Sarbanes-
Oxley Act of 2002
Certifications of Chief
Executive Officer and Chief
Financial Officer Pursuant to
Section 906 of the Sarbanes-
Oxley Act of 2002
103
Exhibit 21
Subsidiaries of the Company
The following list identifies the subsidiaries of the Company:
Subsidiary Name
State of Incorporation
Lannett Holdings, Inc.
Cody Laboratories, Inc.
Delaware
Wyoming
104
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have issued our reports dated October 8, 2007 accompanying the consolidated financial
statements and schedule and the effectiveness of internal control over financial reporting included in the
Annual Report of Lannett Company, Inc. and Subsidiaries on Form 10-K for the year ended June 30, 2007.
We hereby consent to the inclusion of said reports in the Registration Statement of Lannett Company, Inc.
and Subsidiaries on Form S-3 (File No. 333-115746, effective May 21, 2004) and on Form S-8 (File No. 33-
79258, effective May 23, 1994, File No. 001-31298, effective April 9, 2002, File No. 33-103235, effective
February 14, 2003, and File No. 33-103236, effective February 14, 2003).
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
October 9, 2007
105
Exhibit 31.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Arthur Bedrosian, certify that:
1.
I have reviewed this report on Form 10-K of Lannett Company, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control
over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and
have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented
in this report our conclusions about the effectiveness of the disclosure controls and procedures, as
of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting
that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal
quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the
registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
/s/Arthur Bedrosian
Date: October 9, 2007
President and Chief Executive Officer
106
Exhibit 31.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Brian Kearns, certify that:
1.
I have reviewed this report on Form 10-K of Lannett Company, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report,
fairly present in all material respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control
over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and
have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of the disclosure controls and procedures, as of
the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that
occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in
the case of an annual report) that has materially affected, or is reasonably likely to materially
affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of
internal control over financial reporting, to the registrant’s auditors and the audit committee of the
registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control
over financial reporting which are reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrant’s internal control over financial reporting.
/s/Brian Kearns
Date: October 9, 2007
Vice President of Finance, Treasurer and Chief Financial Officer
107
Exhibit 32
Certification Pursuant to
18 U.S.C. Section 1350,
as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Annual Report of Lannett Company, Inc. (the “Company”) on Form 10-K
for the year ended June 30, 2007 as filed with the Securities and Exchange Commission on the
date hereof (the "Report"), I, Arthur P. Bedrosian, the Chief Executive Officer of the Company,
and I, Brian Kearns, the Chief Financial Officer of the Company, hereby certify, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
that:
1. The Report complies with the requirements of Section13(a) or 15(d) of the Securities
Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material respects, the financial
condition and results of operations of the Company.
Dated: October 9, 2007
/s/Arthur P. Bedrosian
Arthur P. Bedrosian,
President and Chief Executive Officer
Dated: October 9, 2007
/s/Brian Kearns
Brian Kearns,
Vice President of Finance, Treasurer, and
Chief Financial Officer
108
Shinu Abraham
Patricia Adamson
Shahbaz Ahmad
Aurea Almazan
Benito Amado
Sheryl Banks
Partha Basumallik
Arthur Bedrosian
Donna Bennett
Joshua Birch
Amin Bowman
Renee Brown
Kevin Burgess
Daniel Burns
Joyce Bustard
Paul Butts
Theresa Carroll
Twanna Carroll
Luvina Carter
Sandra Caserta
Thomas Chacko
Stephen Churchill
Mario Cifolelli
Irma Claudio
Mariola Cobo
John Cook
Philip Cristiano
Deborah Daniels
Tara DaShiell
Juanita Davie
Lilia Delgado
Amy DiCicco
Jeremy Dinh
Frederick Dinnini
Timothy DiPrinzio
Derek Dobson
Dan Dominquez
Robin Dornewass
Robert Ehlinger
Steve Ellingson
John Ewald
Denise Fairman
Johnson Fernandez
Our valuable Lannett Associates
Wallace Ferrell
Romeo Fider
Nina Fleysh
Robert Foley
Yanina Fridman
Henry Furlong
Manoj Gajjar
Alla Gampel
Tsilina Gampel
Mathew George
Edward Glover
Jeffrey Guadagno
Allison Haddock
Mulugetta Haile
Lionel Hampton
Jennifer Hernandez
Kevin Higgins
Aimee Holland
Jamie Holt
Abraham Jacob
Desiree Jefferies
Brian Kearns
Shaheen Khan
Christine Kirn
Jeremy Klein
Marie Klein
Michael Kobel
Laura Koch
Anthony Kozar
Hilda Krekevich
Michael Krekevich
Sabu Kuriakose
Thomas Kuriakose
Sam Kurian
Marc Kurtzman
Duc Lam
Mark Langjahr
Huy Le
Beryldene Liburd
Yuh-Herng Lin
Gregory Liscio
Joseph Lock
Lorraine Locke
Sun Loesch
George Lopac
Christopher Lucas
Arezu Madani
Carol Maio
Beatrice Marengo
Christopher Marks
Jesse Martinez
Richard Matchett
Thomas Mathew
Shean Mathies
Varghese Mattammel
Steven Mays
Patricia McBride
Lynn McBride-Lazicki
Michael McCormick
Jim McMonagle
Raymond Melendez
Rita Melendez
Michelle Miller
John Morales
Mayietta Morris-Moore
Asa Mosby
Daniel Moser
Denise Murphy
John Murphy
Elena Myasnikov
Brian Myers
Joseph Naluparayil
Varsha Narielwala
Barbara Ney
James Nichols
Llewellyn Oblitey
David Oliver
Ravindra Oza
Santhosh Panicker
Sunil Patel
Elena Pena
Zhong Peng
Michael Perreault
Thomas Peters
Michael Phares
Alan Phillips
Barbara Pierce
Kevin Porter
Vincent Post
Suresh Potti
Lauren Quinn
Our valuable Lannett Associates
Saudy Ramos
Heather Regitko
MaryBeth Reilly
Adam Reuter
James Riddick
DelRoy Roach
John Ryman
Ernest Sabo
Carlos Sacanell
Raisa Saltisky
Bernard Sandiford
Caroline Sandlin
Thomas Santella
William Schreck
Daniel Septak
Haroun Sillah
Kevin Smith
Linda Soroka
Francis Spires Jr.
Steven Stein
Kristie Stephens
Catherine Stoklosa
Paulett Strand
Carmen Suarez del Villar
Tracy Sullivan
Jenumon Thomas
Rolland Thomas
Amy Trinidad
Jacqueline Triszczuk
Chau Truong
Anthony Tursi
Ranjana Uparkar
Rony Varughese
Mark Velardo
Nelli Vorobyeva
Kevin Walker
George Wei
Ronald Wenger
Kenneth White
Joyce Williams
Matthew Wilson
Mary Wojtiw
Gerald Woolf
Steven Youmans
Ping Zhong
Isaak Zilberman
Denise Zobnowski
Company Profile
Lannett Company, Inc. (AMEX: LCI) develops, manufactures
and distributes generic prescription pharmaceutical products in
tablet, capsule and oral liquid forms to customers throughout
the United States.
Drug Development Pipeline
FORMULATION
SCALE-UP
CLINICAL TESTING
FDA PENDING
42 Products
8 Products
3 Products
18 ANDAs*
*Abbreviated New Drug Application
BOARD OF DIRECTORS
CORPORATE INFORMATION
William Farber, R.Ph.
Chairman of the Board
Ronald West
Vice Chairman
Director, Beecher Associates
Arthur P. Bedrosian, J.D.
President and Chief Executive Officer, Lannett Company, Inc.
Jeffrey Farber
President, Auburn Pharmaceutical
Garnet Peck, Ph.D.
Professor Emeritus, Purdue University
Department of Industrial and Physical Pharmacy
Kenneth Sinclair, Ph.D.
Professor and Chair of the Accounting Department,
Lehigh University
Albert Wertheimer, Ph.D.
Professor, Temple University School of Pharmacy,
Director, Center for Pharmaceutical Health Services Research
Myron Winkelman, R.Ph.
President, Winkelman Management Consulting, Inc.
MANAGEMENT TEAM
Arthur P. Bedrosian, J.D.
President, Chief Executive Officer, Director
Brian Kearns
Chief Financial Officer,
Vice President—Finance, Treasurer, Secretary
Bernard Sandiford
Vice President—Operations
William Schreck
Vice President—Logistics
Kevin Smith
Vice President—Sales & Marketing
Corporate Headquarters
9000 State Road
Philadelphia, PA 19136
(215) 333-9000
Independent Registered Public Accounting Firm
Grant Thornton LLP
2001 Market Street
Two Commerce Square, Suite 3100
Philadelphia, PA 19103
Legal Counsel
Fox Rothschild LLP
2000 Market Street
Philadelphia, PA 19103
Investor Relations
PondelWilkinson Inc.
1880 Century Park East, Suite 700
Los Angeles, CA 90067
(310) 279-5980
Transfer Agent and Registrar
Registrar and Transfer Company
10 Commerce Drive
Cranford, NJ 07016
(800) 368-5948
Securities Listing
The common stock of Lannett Company, Inc. is traded on
the American Stock Exchange under the symbol “LCI.”
Annual Report and Form 10-K
Additional copies of this annual report
and the Company’s Form 10-K may be
obtained without charge and the exhibits
to the Form 10-K may be obtained for a
nominal fee by writing to:
Lannett Company, Inc.
Investor Relations
9000 State Road
Philadelphia, PA 19136
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements in “Item 1A – Risk Factors”, “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and in other statements located elsewhere in this Annual Report. Any statements made in this Annual Report that are not statements of historical fact or that refer to estimated
or anticipated future events are forward-looking statements. We have based our forward-looking statements on our management’s beliefs and assumptions based on information avail-
able to them at this time. Such forward-looking statements reflect our current perspective of our business, future performance, existing trends and information as of the date of this filing.
These include, but are not limited to, our beliefs about future revenue and expense levels and growth rates, prospects related to our strategic initiatives and business strategies,
express or implied assumptions about government regulatory action or inaction, anticipated product approvals and launches, business initiatives and product development activities,
assessments related to clinical trial results, product performance and competitive environment, and anticipated financial performance. Without limiting the generality of the forego-
ing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,” “estimate,” “continue,” or “pursue,” or the negative other variations thereof or
comparable terminology, are intended to identify forward-looking statements. The statements are not guarantees of future performance and involve certain risks, uncertainties
and assumptions that are difficult to predict. We caution the reader that certain important factors may affect our actual operating results and could cause such results to differ
materially from those expressed or implied by forward-looking statements. We believe the risks and uncertainties discussed under the “Item 1A - Risk Factors” and other risks
and uncertainties detailed herein and from time to time in our SEC filings, may affect our actual results.
We disclaim any obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. We also may make additional disclosures in
our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and in other filings that we may make from time to time with the SEC. Other factors besides those listed here could also
adversely affect us. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995, as amended.
Quality
Manufacturing & Production
Customer Service
Teamwork
Integrity
Research & Development
Professionalism
Reliability & Trust
Lannett Company, Inc.
9000 State Road
Philadelphia, PA 19136
(215) 333-9000, (800) 325-9994
Fax (215) 333-9004
2 0 0 7 A N N U A L R E P O R T