L
2010 ANNUAL REPORT
MANUFACTURING
AND DISTRIBUTING
HIGH QUALITY
PHARMACEUTICAL
PRODUCTS
B
COMPANY PROFILE
Lannett Company, Inc. (NYSE Amex:LCI) develops, manufactures and distributes generic prescription
pharmaceutical products in tablet, capsule, topical and oral liquid forms to customers throughout the
United States.
FINANCIAL HIGHLIGHTS
FISCAL YEAR ENDED JUNE 30,
2010
2009
2008
2007
2006
Net Sales
Cost of Sales
Gross Profit
$125,177,949
$119,002,215
$72,403,283
$82,577,591
$64,060,375
83,838,142
73,757,746
56,102,212
61,152,604
35,684,710
41,339,807
45,244,469
16,301,071
21,424,987
28,375,665
Operating Expenses
28,309,788
34,463,600
21,731,605
27,389,396
19,921,747
Operating Income (Loss)
13,030,019
10,780,869
(5,430,534)
(5,964,409)
8,453,918
Net Income (Loss)
$7,821,067
$6,534,245
$(2,318,059)
$(6,929,008)
$4,968,922
Cash, cash equivalents and investments
$22,683,854
$26,982,125
$8,756,847
$8,512,973
$6,089,968
Total current assets
87,734,374
77,311,175
61,583,175
44,483,940
43,486,847
Property, plant and equipment, net
28,628,269
22,897,385
24,734,103
27,443,161
19,645,549
Total assets
Current liabilities
Long-term debt
139,963,797
124,577,121
113,679,264
101,453,265
103,446,330
47,629,669
38,679,005
35,638,552
22,250,243
20,040,608
7,719,827
8,138,768
8,978,834
9,679,965
8,196,692
QUARTERLY SALES TREND
(In Millions of Dollars)
PERCENTAGE NET SALES
(By Customer Type)
$25.6
$29.2
$28.8
$35.4
$31.4
$28.7
$31.3
$33.8
47%
48%
5%
Distributors/Wholesalers
Chain Pharmacies
Mail Order Pharmacies
Q1
FY09
Q2
FY09
Q3
FY09
Q4
FY09
Q1
FY10
Q2
FY10
Q3
FY10
Q4
FY10
LANNETT COMPANY, INC. 2010 ANNUAL REPORT
Arthur P. Bedrosian, J.D.
President and
Chief Executive Officer
DEAR STOCKHOLDERS:
es increased to $11.3 million from $8.4 million in fiscal
2009, reflecting our increased investments in product
development. Selling, general and administrative ex-
penses decreased significantly to $17.4 million from $26.1
million in the prior year primarily due to decreased legal
costs related to our prior patent litigation that was settled
Over the past several years, we have invested in our infra-
in March 2009. Net income increased to $7.8 million, or
structure in order to position our company for continued
$0.31 per diluted share, compared with $6.5 million, or
growth and build real long-term shareholder value. First,
$0.27 per diluted share, for the prior year.
we needed to re-examine the dynamics of the generic
At June 30, 2010, we had approximately $22.7 million
drug industry. Our company operates in an industry
in cash, cash equivalents and investment securities avail-
where sales of products are largely determined by price,
able for sale, and approximately $7.7 million of long term
and price alone; customers have gained greater pricing
debt, including the current portion.
leverage as a result of consolidation; and competition has
increased due to the rising number of foreign drug manu-
PRODUCT APPROVALS/LAUNCHES
facturers entering the U.S. market.
In August 2010, we received FDA approval of Ondanse-
Recognizing this, we implemented a strategy to diver-
tron Injection USP, 2 mg/mL, Single Dose Vials. This is
sify and differentiate Lannett®, in part by targeting areas of
in addition to the approval for Ondansetron, Multi-Dose
the market with fewer competitors and vertically inte-
Vials we received in May. Both the single dose and multi-
grating our operations. Acquiring Cody Laboratories Inc.
dose vials of Ondansetron Injection come from our joint
(Cody), a manufacturer and supplier of pain management
venture with Wintac Ltd. We have delayed the launch of
products, including bulk active pharmaceutical ingredients,
these products, while we negotiate with our supplier for
exemplifies this strategy. We also rededicated our efforts
better pricing in light of the number of approved competi-
to be a high quality manufacturer. This has enabled us to
tors already on the market.
provide the market with critically important medications,
In July 2010, we received FDA approval of Phenter-
while some of our competitors ceased producing these
mine Hydrochloride Blue/White Seed Capsules USP, 30
same products due to failed FDA inspections or violations
mg, which we expect to launch in the second quarter of
of current Good Manufacturing Practices (cGMP).
Fiscal Year 2011. And last December, we received approv-
FINANCIAL HIGHLIGHTS
als for Hydromorphone Hydrochloride Tablets USP, 2 mg,
4mg and 8 mg, which we launched shortly thereafter.
For fiscal 2010, net sales rose to $125.2 million from
We continue to invest in product development and,
$119.0 million in fiscal 2009. The increase was primar-
as of the date of this letter, have 19 product applications
ily driven by increased sales of our pain management
pending at the FDA - two of which we believe are first time
products as well as certain base business pharmaceutical
generics. We have an additional 60 product candidates in
products, including Levothyroxine Sodium. Gross profit
various stages of development. This is the largest number
was $41.3 million compared with $45.2 million for the
of products we have ever had in development and com-
same period in the prior year. The decrease over the prior
pares favorably to companies much larger than Lannett.
year reflected increased royalty expenses related to some
of our products, as well as excess capacity costs incurred
PAIN MANAGEMENT
at Cody during October and November 2009 when the
I am pleased to report that for the full-year fiscal 2010,
DEA did not allot us any quota for Morphine Sulfate Oral
Cody achieved profitability. We continue to build capabiliti-
Solution production. Research and development expens-
ties, develop product candidates and upgrade the
To celebrate Lannett’s ongoing success and in ac-
knowledgment of our long association with the stock
exchange, we were invited to ring the Opening Bell at the
New York Stock Exchange on Monday, November 23, 2009.
And, we were pleased to be recognized by The Phila-
delphia Business Journal in June 2010 as the #1 fastest
growing company in Philadelphia. Our growth in revenue
over recent years was the primary catalyst for the recog-
nition by this local business publication.
A GROWTH COMPANY
Over the past five years, we have experienced a 95%
facilities of our pain management business. Cody is in the
growth rate in revenues to more than $125 million in
final stages of an expansion for producing opioid active
fiscal year 2010 from approximately $64 million in fiscal
pharmaceutical ingredients, which we believe will lead to
year 2006; and over the last year, we have experienced a
improved margins.
6% growth in prescriptions for our products. This rapid
This part of our business, which comprised approxi-
growth has been achieved through strategic partner-
mately 11% of revenues in fiscal 2010, is now facing a
ships and opportunities resulting from certain difficulties
challenging period. The FDA has ordered Lannett, as
our various competitors have experienced with regula-
well as others, to cease manufacturing Morphine Sulfate
tory compliance.
Oral Solution, which will negatively impact our business
Lannett is among the top 20 companies, based on the
for the balance of calendar year 2010. However, we are
number of prescription transactions, for unbranded generic
optimistic about receiving FDA approval in the next sev-
products in the United States, according to data reported
eral months for our New Drug Application for Morphine
by IMS Health in August 2010. Additionally, our Levothy-
Sulfate Oral Solution and expect to re-launch the drug in
roxine Sodium Tablets were recognized by IMS Health as
early calendar year 2011.
Importantly, we expect to see new pain manage-
ment abuse-deterrent drugs coming to market in the near
future. We believe this will breathe new life into the pain
management sector, as prescribers and patients are less
concerned about the potential for abuse.
ACCOMPLISHMENTS AND MILESTONES
In June, Philadelphia Mayor Michael Nutter was a
featured speaker at our ribbon cutting ceremony for the
opening of our new facility, a 66,000 square foot structure
located on seven acres in the Northeast section of Phila-
delphia. The facility provides needed additional office and
warehousing space to facilitate our growing business.
Moving our warehousing operations out of our existing
Torresdale facility has freed up approximately 28,000
square feet for future manufacturing expansion.
LANNETT COMPANY, INC. 2010 ANNUAL REPORT
the 18th most prescribed pharmaceutical product, includ-
drugs, bode well for our company. We are confident that
ing both branded and generic products, in the U.S.
the investments we have and continue to make in our com-
Lannett is a quality-conscious company, with a robust
pany will allow us to best serve the patients who use our
pipeline, excellent prospects for long term growth and a
products and shareholders alike.
dedicated team.
OUTLOOK
On behalf of the many talented and hard working indi-
viduals who comprise the Lannett family, please know that
we are committed to building upon our strong foundation
We continue to review our needs for additional funds to
and advancing our business. We look forward to updating
more rapidly to exploit the potential for vertically integrat-
you on our progress as we move forward.
ing our operations. We believe vertically integrating the
company would significantly increase our prospects for
Sincerely,
profitable growth. We are also exploring potential acquisi-
tions of complementary products and/or companies, and
evaluating the benefits of upgrading our facilities and
Arthur P. Bedrosian, J.D.
expanding our pain management business.
President and
We have substantially strengthened our company’s
Chief Executive Officer
ability to deliver value and generate solid financial results.
Testament to management’s and the board of directors’
belief in Lannett’s long-term future, a share repurchase pro-
gram amounting to $5 million was re-authorized late last
year. During the first quarter of fiscal 2011, we repurchased
approximately 20,000 shares of Lannett common stock in
the open market.
Our strong pipeline, combined with favorable demo-
graphics for both pain management products and generic
PRODUCTS
NAME
Acetazolamide Tablets
Amantadine SoftGel Capsules
Baclofen Tablets
Bethanechol Chloride Tablets
Butalbital, Aspirin and Caffeine Capsules
MEDICAL INDICATION
Glaucoma
Parkinson’s Disease
Muscle Relaxer
Urinary Retention
Migraine Headache
EQUIVALENT
Diamox®
Symmetrel ®
Lioresal®
Urecholine®
Fiorinal®
Butalbital, Aspirin, Caffeine with Codeine Phosphate Capsules
Migraine Headache
Fiorinal w/Codeine #3®
Clindamycin HCl Capsules
C-Topical™ Solution
Codeine Sulfate Tablets
Danazol Capsules
Dicyclomine Tablets
Dicyclomine Capsules
Digoxin Tablets
Dipyridamole Tablets
Doxycycline Tablets
Doxycycline Hyclate Tablets
Antibiotic
Pain Management
Pain Management
Endometriosis
Irritable Bowels
Irritable Bowels
Congestive Heart Failure
Anticoagulant
Antibiotic
Antibiotic
Esterified Estrogen & Methyltestoterone Tablets
Hormone Replacement
Hydrochlorothiazide Tablet
Hydromorphone HCl Tablets
Levothyroxine Sodium Tablets
Morphine Sulfate Oral Solution
OB-Natal® ONE SoftGel Capsules
Oxycodone HCl Oral Solution
Phentermine HCl Tablets
Phentermine HCl Capsules
Pilocarpine HCl Tablets
Primidone Tablets
Probenecid Tablets
Rifampin Capsules
Terbutaline Sulfate Tablets
Unithroid® Tablets
Ursodiol Capsules
Diuretic
Pain Management
Thyroid Deficiency
Pain Management
Pregnancy
Pain Management
Obesity
Obesity
Dryness of the Mouth
Epilepsy
Gout
Antibiotic
Bronchospasms
Thyroid Deficiency
Gallstone
Cleocin®
N/A
N/A
Danocrine®
Bentyl®
Bentyl®
Lanoxin®
Persantine®
Adoxa®
Periostat®
Estratest®
Hydrodiuril®
Dilaudid®
Levoxyl®/Synthroid®
Roxanol®
N/A
Roxicodone®
Adipex-P®
Fastin®
Salagen®
Mysoline®
Benemid®
Rifadin®
Brethine®
N/A
Actigall®
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
⌧ ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2010
OR
(cid:134) 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
Registrant’s telephone number, including area code: (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 (cid:134) No ⌧
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 (cid:134) No ⌧
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 ⌧ No (cid:134)
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. (cid:134)
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer (cid:134)
Non-accelerated filer (cid:134)
(Do not check if a smaller reporting company)
Accelerated filer (cid:134)
Smaller reporting company ⌧
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data
File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for
such shorter period that the registrant was required to submit and post such files). Yes (cid:134) No (cid:134)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12B-12 of the Exchange Act). Yes (cid:134) No ⌧
Aggregate market value of common stock held by non-affiliates of the registrant, as of December 31, 2009 was $60,310,315 based on the
closing price of the stock on the NYSE - AMEX.
As of September 17, 2010, there were 25,238,882 shares of the registrant’s common stock, $.001 par value, outstanding.
TABLE OF CONTENTS
PART I
PART II
PART III
PART IV
ITEM 1. DESCRIPTION OF BUSINESS.....................................................................................................................
ITEM 1A. RISK FACTORS..........................................................................................................................................
ITEM 2. DESCRIPTION OF PROPERTY ...................................................................................................................
ITEM 3. LEGAL PROCEEDINGS ...............................................................................................................................
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............................................................................................................................
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 ..............................................................................
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, ...........................................................................
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
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26
26
28
28
41
41
41
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60
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65
F-1
2
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.
ITEM 1.
DESCRIPTION OF BUSINESS
Business Overview
PART I
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 branded pharmaceutical products. We report financial information on a quarterly and fiscal year basis with the most recent
being the fiscal year ended June 30, 2010. All references herein to a “fiscal year” or “Fiscal” refer to the applicable fiscal year ending
June 30.
According to data reported by IMS Health in August 2010, we are currently among the top 20 companies, based on number of
prescription transactions, for unbranded generic products in the United States. We intend to grow our business organically as well as
through strategic partnerships. Additionally, our Levothyroxine Sodium tablets (“Levo”) were recognized by IMS Health as the 18th
most prescribed pharmaceutical product, including both branded and generic products, in the U.S. over the past year, reaching
approximately 23 million prescriptions through June 2010. This product line represents approximately 0.6% of the domestic
prescription market. Over the last year, we have experienced a 6% growth in prescriptions for our products. In addition, Levo has
experienced a 11% annual growth during that period.
Over the past five years, we have experienced a 95% growth in our revenues from approximately $64 million in fiscal year 2006 to
over $125 million in fiscal year 2010. This rapid growth has been achieved primarily through strategic partnerships and opportunities
resulting from certain difficulties that a number of our competitors have experienced with regulatory compliance issues.
Competitive Strengths
Proven Ability to Develop Successful Products and Achieve Scale in Production. We believe that our ability to select viable products
for development, efficiently develop such products, including obtaining any applicable regulatory approvals, vertically integrate
ourselves into certain specialty markets and achieve economies in production are all critical for our success in the generic
pharmaceutical industry in which we operate. We intend to focus on long-term profitability while seeking to secure market positions
with fewer challenges from competitors. Two key examples are morphine sulfate oral solution and hydomorphone tablets.
Efficient Development Systems and Manufacturing Expertise for New Products. We believe that our manufacturing expertise, low
overhead expenses and efficient product development, manufacturing and marketing capabilities can help us remain competitive in the
3
general pharmaceutical market. We intend to dedicate significant capital toward developing new products because we believe our
success is linked to our ability to continually introduce new generic products into the marketplace. Over time, if the market for a
specific product remains stable and consumer demand remains consistent, additional generic manufacturing companies will seek to
enter and participate in the market by developing the product and seeking regulatory approval for its sale. Competition from new and
other market participants for the manufacture and distribution of certain products would likely harm our market share with respect to
such products as well as force us to reduce our selling price for such products due to their increased availability. As a result, we
believe that our success depends on our ability to properly assess the competitive effect of new products, including market share, the
number of competitors and the generic unit price erosion. We intend to reduce our exposure to competitive influences that may
negatively affect our sales and profits, including the potential saturation of the market for certain products, by continuing to emphasize
maintenance of a strong research and development (“R&D”) pipeline. We believe that it is in our best interest to avoid becoming
materially dependent on the sale of a single product.
Mutually Beneficial Supply and Distribution Arrangements. In 2004, we entered into an exclusive distribution agreement with Jerome
Stevens Pharmaceuticals (“JSP”) covering four different product lines. Two of these product lines, Levo and Digoxin, collectively
accounted for approximately 58% of our net sales in fiscal year 2010 and both products have experienced significant growth in sales
over the past few years. Distribution agreements with other manufacturers have also increased our net sales in recent years.
Dependable Supplier to our Customers. We believe we are viewed within the generic pharmaceutical industry as a strong, dependable
supplier to our customer base. We have cultivated strong and dependable customer relationships by maintaining adequate inventory
levels, employing a responsive order filling system and prioritizing timely fulfillment of those orders. A majority of our orders are
filled and shipped either on the day of, or the day following, the date that we receive the order.
Strong Track Record of Obtaining Regulatory Approvals for New Products. During the past two fiscal years, we have received 5
approved Abbreviated New Drug Applications (each, an “ANDA”) from the Food and Drug Administration (the “FDA”). We expect
to receive several more during the next fiscal year. These regulatory approvals will enable us to manufacture and supply a broader
portfolio of generic pharmaceutical products.
Reputation for Regulatory Compliance. We have a strong track record of regulatory compliance and we believe that we have strong
effective regulatory compliance capabilities and practices through hiring qualified individuals and implementing strong current Good
Manufacturing Practices (“cGMP”). During the last two fiscal years, at least three of our competitors have experienced plant closures
and product recalls due to FDA inspections that found violations of cGMPs at their facilities. Two of our competitive strengths, our
agility in responding quickly to market events and a strong reputation for regulatory compliance, positioned us to avail ourselves of
these market opportunities.
In addition, narcotics or “controlled drugs” are subject to a rigorous regulatory compliance regimen. We are one of seven companies
in the U.S. that have been granted a license from the U.S. Drug Enforcement Administration (“DEA”) to import raw poppy straw for
conversion into active pharmaceutical ingredients (“API”). Such licenses are renewed annually, but non-compliance could result in a
license not being renewed. As a result, we believe that our strong reputation for regulatory compliance allows us to have a
competitive edge in managing the production and distribution of narcotics and controlled drugs.
Business Strategies
Continue to Broaden our Product Lines Through Internal Development and Strategic Partnerships. We are focused on increasing our
market share in the generic pharmaceutical industry while concentrating additional resources on the development of new products,
including narcotics and controlled drugs. We hope to continue our efforts to improve our financial performance by expanding our line
of generic products, increasing unit sales to current customers and reducing overhead and administrative costs.
We have targeted three strategies for expanding our product offerings: (1) deploying our experienced R&D staff to develop products
in-house, (2) entering into additional product development agreements or strategic partnerships with third-party product developers
and formulators and (3) purchasing ANDAs from other generic manufacturers that no longer seek to manufacture a specific product.
We expect that each method will facilitate our identification, selection and development of additional generic pharmaceutical products
that we may distribute through our existing network of customers.
We have several existing supply and development agreements with both international and domestic companies, and are currently in
negotiations on similar agreements with additional international companies, through which we can market and distribute future
products. We intend to capitalize on our strong customer relationships to build our market share for such products.
4
Improve our Operating Profile in Certain Targeted Specialty Markets. In certain situations, we may increase our focus on certain
specialty markets within the generic pharmaceutical industry. By narrowing our focus to specialty markets, we can provide increased
product alternatives in categories with relatively few other market participants. We plan to strengthen our relationships with strategic
partners, including providers of product development research, raw materials, API and finished products. We believe that mutually
beneficial strategic relationships in such areas, including potential financing arrangements, partnerships, joint ventures or acquisitions,
could enhance our competitive advantages in the generic pharmaceutical market.
Leverage Ability to Vertically Integrate as a Manufacturer, Supplier and Distributor of Narcotics and Controlled Substances. We
view our April 2007 acquisition of Cody Laboratories, Inc. (“Cody Labs”or “Cody”) as an important step in becoming a vertically
integrated narcotics manufacturer and distributor by allowing us to concentrate on developing and completing our dosage form
manufacturing in order to reduce our narcotic API costs. In July 2008, the DEA granted Cody Labs a license to directly import raw
poppy straw for conversion into API and/or various pharmaceutical products. Only six other companies in the U.S. have been granted
this license to date. This license allows us to avoid increased costs associated with buying narcotic API from other manufacturers.
We anticipate that we can use this license to become a vertically integrated manufacturer of narcotic products, as well as a supplier of
API to the pharmaceutical industry. We believe that the aging domestic population may result in a higher demand for pain
management pharmaceutical products and that we will be well-positioned to take advantage of this increased demand.
Cody Labs’ manufacturing expertise in narcotic APIs will allow us to build a market with limited domestic competition. We
anticipate that the demand for narcotics and controlled drugs will continue to grow with the “Baby Boomer” generation demographics
and that we are well-positioned to take advantage of these opportunities by concentrating additional resources in the narcotic area.
Key Products
All of our products currently manufactured and/or sold are prescription products. Of the products listed in the table entitled “Current
Products” below, those containing Levo, Digoxin, Butalbital, Cocaine and Morphine Sulfate were our key products, collectively
accounting for approximately 75%, 71% and 74% of our net sales in fiscal years 2010, 2009 and 2008, respectively. In fiscal year
2006, we began selling Sulfamethoxazole w/ Trimethoprim (“SMZ/TMP”). Because of a market opportunity, our sales of SMZ/TMP
increased from 3% of our net sales in fiscal year 2006 to 19% of our net sales in fiscal year 2007, but declined to 9% of our net sales
in fiscal year 2008. SMZ/TMP is not factored among our key products because the applicable supply agreement expired in
August 2008 and was not renewed. In fiscal year 2009, we began selling our prenatal vitamin, OB Natal One, which was the generic
version to a brand name prenatal vitamin. During the launch year of 2009, we sold approximately $12.6 million in net sales of the
product. During our fiscal year 2009, the brand equivalent was withdrawn from the marketplace. Since the brand company withdrew
their detailing salesforce, we have seen a significant drop in sales of our OB Natal One product. OB Natal One is not factored among
our key products because the Company expects to see continued declining sales for this product as obstetricians prescribe other
available prenatal vitamins.
Our products containing Levo are produced and marketed with 12 varying potencies. In addition to generic Levo tablets, we also
market and distribute Unithroid tablets, a branded version of Levo, which is produced and marketed with 11 varying potencies. Both
generic Levo tablets and Unithroid tablets are manufactured by JSP. We began buying generic Levo from JSP and selling it to our
customers in April 2003. In September 2003, we began buying the branded Unithroid tablets from JSP and selling them to our
customers. Levo tablets are used to treat hypothyroidism and other thyroid disorders. Levo remains one of the most prescribed drugs
in the U.S. and is used by over 13 million patients of various ages and demographic backgrounds. Side effects from Levo are rare, but
may include allergic reactions, such as rash or hives. We signed a distribution agreement with JSP in March 2004 that granted us
exclusive distribution rights to Levo tablets through March 2014 (the “JSP Distribution Agreement”). In June 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®. Net sales of this product have
grown rapidly in recent years from approximately $35 million in 2007 to almost $51 million in 2010. In our distribution of these
products, we compete with two branded Levo products—Abbott Laboratories’ Synthroid® and Monarch Pharmaceutical’s Levoxyl®—
as well as generic products from Mylan and Sandoz.
Digoxin tablets are produced and marketed with two different potencies (0.125 and 0.25 milligrams (“mg”) per tablet). This product
is manufactured by JSP and we distribute it under the JSP Distribution Agreement. We began buying this product from JSP and
selling it to our 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. Net
sales of this product have increased from approximately $4.7 million in 2007 to $21.0 million in 2010.
5
We distribute two products containing Butalbital. We have manufactured and sold one of the products, Butalbital with Aspirin and
Caffeine capsules, for more than eighteen years. The other Butalbital product, Butalbital with Aspirin, Caffeine and Codeine
Phosphate capsules, is manufactured by JSP. We began buying this product from JSP and selling it to our customers in
December 2002. Both Butalbital 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. Although new innovator drugs to treat migraine headaches have been introduced
by brand name drug companies, we believe that 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®, we expect to
continue to produce and sell our generic Butalbital products.
Morphine Sulfate liquid oral solution is produced and marketed in three different size containers (20 mgs per mL in 30, 120 and 240
mL bottles). We manufacture these liquid dosage forms at our Cody Labs subsidiary and we are currently finishing the manufacturing
methods and capabilities to make the API form also at Cody. Sales of Morphine Sulfate approximated 5% of Lannett’s Net Sales
during Fiscal 2010. This drug is prescribed primarily for the management of pain in adults where other products or delivery methods
are not tolerable to the patient. Common side effects of this drug include respiratory and circulatory depression. As recently as
March of 2009, seven different companies, including Lannett, were manufacturing and/or distributing this product. As a result of
recent actions by the FDA (see Item 1. Government Regulation), at least five of those companies, including Lannett, have left the
market by July 2010. Only one company has an approved NDA for this product and is currently selling it, and Lannett expects to
become the second approved manufacturer within the next several months. If the FDA approves our current NDA application on
Morphine Sulfate (see Item 1A. Risk Factors), Lannett will be vertically integrated on this product line.
Cocaine Topical Solution (“C-Topical”) is produced and marketed in two different strengths and two different size containers. (4% per
4 and 10 ml bottles, and 10% per 4 and 10 ml bottles). We manufacture these liquid dosage forms at our Cody Labs subsidiary and we
expect to complete finishing the manufacturing methods and capabilities to make the API form also at Cody within the next fiscal
year. Sales of C-Topical approximated 5% of Lannett’s Net Sales during Fiscal 2010. This drug is utilized primarily for the
anesthetization of the patient during ear, nose or throat surgery. It also works as a vasoconstrictor during the surgery. The only other
company that was marketing this product announced during our fiscal 2010 year that they were withdrawing from the marketplace.
Validated Pharmaceutical Capabilities
Our manufacturing facility consists of 31,000 square feet on an approximately 3.5-acre parcel of land that we own. In addition, we
own a 63,000 square foot building on approximately 3.0 acres located within one mile of our manufacturing facility that houses
packaging, research and development and possibly additional manufacturing space in the future. In June 2006, we leased a third
building located several miles from our manufacturing facility, consisting of 66,000 square feet on approximately 7.3 acres. We
purchased this building in October 2009 for approximately $3.8 million, plus the cost of fit out of approximately $2.0 million. A
significant portion of the purchase price and fit out costs are expected to be financed through a series of loans with a bank and a
Pennsylvania state run development agency. Construction was substantially complete by June 30, 2010. The financing will be
competed shortly. This new facility is being used for certain administrative functions, warehouse space, shipping and possibly
additional manufacturing space in the future.
The manufacturing facility of our wholly-owned subsidiary, Cody Labs, consists of an approximately 73,000 square foot structure
located on approximately 16 acres in Cody, Wyoming. Cody Labs leases the facility from Cody LCI Realty, LLC, Wyoming, which
is 50% owned by us and 50% by an officer of Cody Labs and his former spouse. Cody Labs’ manufacturing facility currently has
capacity for further expansion, both inside the existing structure, as well as by building outside the current structure.
We have adopted many FDA regulations relating to cGMPs in the last several years, and we believe we are operating our facilities in
material compliance with the FDA’s cGMP regulations. In designing our 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 we use. In addition, our Quality Control laboratory
facilities are equipped with high precision instruments, such as automated high-pressure liquid chromatographs, gas chromatographs,
robots and laser particle size analyzers.
We continue to pursue our comprehensive plan for improving and maintaining quality control and quality assurance programs for our
pharmaceutical development and manufacturing facilities. The FDA periodically inspects our production facilities to determine our
compliance with the FDA’s manufacturing standards. Typically, after completing its inspection, the FDA will issue us a report,
entitled a Form 483, containing observations of any possible violations of cGMPs. The FDA’s observations may be minor or severe in
6
nature and the degree of severity is generally determined by the time necessary to remediate the cGMP violation, any consequences to
the consumer of the products, and whether the observation is subject to a Warning Letter from the FDA. By strictly complying with
cGMPs and the various FDA guidelines, and Good Laboratory Practices (“GLPs”), as well as adherence to our Standard Operating
Procedures, we have successfully minimized the number of observations in our FDA inspections in recent years.
Research and Development Process
Over the past several years, we have consistently devoted resources to R&D projects, including new generic product offerings. The
costs of these R&D efforts are expensed during the periods incurred. We believe that such investment expense may be recovered in
future years when we receive marketing approval from the FDA to distribute such products. In addition to using cash generated from
our operations, we have entered into 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. We
have embarked on a plan to grow in future years. In addition to organic growth to be achieved through our own R&D efforts, we have
also initiated marketing projects with other companies in order to expand future revenue. We expect that our growing list of generic
products under development will drive future growth. Over the past several years, we have hired additional personnel in product
development, production, formulation and the R&D laboratory. We also intend to use our R&D infrastructure to continually devote
resources to additional R&D projects. The following steps outline the numerous stages in the generic drug development process:
1.) Formulation and Analytical Method Development. After a drug candidate is selected for future sale, product development
scientists 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 our
subsequent development process. Various formulations are tested in the laboratory to measure results against the innovator
drug. During this time, we may use reverse engineering methods on samples of the innovator drug to determine the type and
quantity of inactive ingredients. During the formulation phase, our R&D chemists begin to develop an analytical, laboratory
testing method. The successful development of this test method will allow us 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 Chemistry, Manufacturing and Controls section of the
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, we 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 dosages to be
created during the production cycle. We attempt 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 our
commercial manufacturing facilities. During this manufacturing process, we 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 our ANDA submitted to the
FDA.
3.) Clinical testing. After a successful scale-up of the generic drug batch, we schedule and perform bioequivalency and in some
cases 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 us to determine the “success” of the
generic drug product. Success, in this context, means that we are able to demonstrate that our product is comparable to the
innovator product in dosage form, strength, route of administration, quality, performance characteristics and intended use.
Since bioequivalence (meaning that the product performs in the same manner and in the same amount of time as the
innovator drug) and a stable formula are the primary requirements for a generic drug approval (assuming the manufacturing
plant is in compliance with the FDA’s cGMPs), lengthy and costly clinical trials proving safety and efficacy, which are
required by the FDA for innovator drug approvals, are typically unnecessary for generic companies. If the results are
successful, we 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”). The
Hatch-Waxman Act amended the Federal Food, Drug and Cosmetic Act (“FDCA”) to permit FDA to review and approve an
ANDA for a generic copy of a drug product, which previously received FDA approval through its new drug approval
process, without having the generic drug company conduct costly clinical trials. An ANDA is a comprehensive submission
that contains, among other things, data and information pertaining to the active pharmaceutical ingredient, drug product
7
formulation, specifications and stability of the generic drug, as well as analytical methods, manufacturing process validation
data, and quality control procedures.
According to a June 2010 presentation given by the FDA’s Office of Generic Drugs, the current FDA review time for ANDAs exceeds
26 months. While we have received approval for some of our ANDAs in 14 months, we have also waited longer than 3 years before
receiving approval. Subsequently, the FDA advised that electronic submissions of applications may shorten the approval process. We
currently file our ANDAs and NDAs electronically. ANDAs and NDAs submitted for our products may not receive FDA approval on
a timely basis, if at all.
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 (i) that no patent was filed for the listed drug (a “paragraph I” certification), (ii) that the patent has
expired (a “paragraph II” certification), (iii) 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 (iv) 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 must be provided to each owner of the patent that is
the subject of the certification and to the holder of the approved ANDA to which the ANDA refers. A paragraph IV certification can
trigger an automatic 30 month stay of the ANDA if the innovator company files a claim which would delay the approval of the generic
company’s ANDA. Currently, we have filed no paragraph IV certifications with our ANDAs.
Sales and Customer Relationships
We sell our pharmaceutical products to generic pharmaceutical distributors, drug wholesalers, chain drug retailers, private label
distributors, mail-order pharmacies, other pharmaceutical manufacturers, managed care organizations, hospital buying groups,
governmental entities and health maintenance organizations. We promote our products through direct sales, trade shows, trade
publications and bids. We also license the marketing of our products to other manufacturers and/or marketers in private label
agreements.
We continue to expand our sales to major chain drug stores. Our policies of maintaining an adequate inventory, employing a
responsive order filling system and prioritizing timely fulfillment of those orders have contributed to a strong reputation among our
customers as a dependable supplier of high quality generic pharmaceuticals. In addition, our subsidiary Cody Labs sells APIs to
dosage form manufacturers.
Some of our new generic products were developed and are manufactured by us while other products were developed and
manufactured by other companies. The products currently manufactured by us and those manufactured by others are identified in the
section entitled “Current Products” in Item 1 of this Form 10-K.
Management
We have been focused on increasing the size and quality of our management team in anticipation of continuing our growth. We have
hired experienced personnel from large, established, brand pharmaceutical companies as well as competing generic companies to
complement the skills and knowledge of the existing management team. As we continue to grow, additional personnel may need to be
added to our management team. We intend to hire the best people available to expand the knowledge base and expertise within our
personnel ranks.
8
Current Products
As of the date of this filing, we manufactured and/or distributed the following products:
Name of Product
1
2
3
4
5
6
Acetazolamide Tablets ...............................................................
Amantadine SoftGel Capsules ...................................................
Baclofen Tablets ........................................................................
Bethanechol Chloride Tablets ....................................................
Butalbital, Aspirin and Caffeine Capsules .................................
Butalbital, Aspirin, Caffeine with Codeine Phosphate
Capsules ....................................................................................
Clindamycin HCl Capsules ........................................................
7
C-Topical ™ Solution ................................................................
8
9
Codeine Sulfate Tablets .............................................................
10 Danazol Capsules.......................................................................
11 Dicyclomine Tablets ..................................................................
12 Dicyclomine Capsules................................................................
13 Digoxin Tablets..........................................................................
14 Dipyridamole Tablets.................................................................
15 Doxycycline Tablets ..................................................................
16 Doxycycline Hyclate Tablets .....................................................
17 Esterified Estrogen & Methyltestoterone Tablets ......................
18 Hydrochlorothiazide Tablet .......................................................
19 Hydromorphone HCl Tablets.....................................................
20 Levothyroxine Sodium Tablets ..................................................
21 Morphine Sulfate Oral Solution .................................................
22 OB-Natal ® ONE SoftGel Capsules ..........................................
23 Oxycodone HCl Oral Solution ...................................................
24 Phentermine HCl Tablets ...........................................................
25 Phentermine HCl Capsules ........................................................
26 Pilocarpine HCl Tablets .............................................................
27 Primidone Tablets ......................................................................
28 Probenecid Tablets.....................................................................
29 Rifampin Capsules .....................................................................
30 Terbutaline Sulfate Tablets ........................................................
31 Unithroid® Tablet......................................................................
32 Ursodiol Capsules ......................................................................
Medical Indication
Glaucoma
Parkinson’s Disease
Muscle Relaxer
Urinary Retention
Migraine Headache
Migraine Headache
Antibiotic
Anesthetic
Pain Management
Endometriosis
Irritable Bowels
Irritable Bowels
Congestive Heart Failure
Anticoagulant
Antibiotic
Antibiotic
Hormone Replacement
Diuretic
Pain Management
Thyroid Deficiency
Pain Management
Pregnancy
Pain Management
Obesity
Obesity
Dryness of the Mouth
Epilepsy
Gout
Antibiotic
Bronchospasms
Thyroid Deficiency
Gallstone
Equivalent Brand
Diamox®
Symmetrel ®
Lioresal®
Urecholine®
Fiorinal®
Fiorinal w/ Codeine #3®
Cleocin®
N/A
N/A
Danocrine®
Bentyl®
Bentyl®
Lanoxin®
Persantine ®
Adoxa®
Periostat®
Estratest®
Hydrodiuril®
Dilaudid®
Levoxyl®/ Synthroid®
Roxanol®
N/A
Roxicodone®
Adipex-P®
Fastin®
Salagen®
Mysoline®
Benemid®
Rifadin®
Brethine®
N/A
Actigall ®
Unlike the branded, innovator companies, we do not develop new molecules. However, we have filed and received two patents for
APIs at our Cody, Wyoming manufacturing facility, with an additional patent pending.
In fiscal years 2010 and 2009, we received five and four ANDA approvals from the FDA, respectively. The following summary
contains more specific details regarding our latest ANDA approvals. Market data is obtained from Wolters Kluwer.
In March 2008, we received a letter from the FDA with approval to market and launch Rifampin Capsules 150mg and 300mg.
Rifampin is the generic version of Rifadin® and is used to reduce the number of meningococcal bacteria in the nose and throat.
According to Wolters Kluwer, total sales of generic Rifampin Capsules 150mg and 300mg at AWP were $35 million in 2007.
In April 2008, we received a letter from the FDA with approval to market and launch Dipyridamole Tablets 25mg, 50mg and 75mg.
Dipyridamole is the generic version of Persantine® and is used to reduce the formation of blood clots in people who have had heart
valve surgery. According to Wolters Kluwer, total sales of generic Dipyridamole Tablets 25mg, 50mg and 75mg at AWP were $45
million in 2007.
In August 2008, we received a letter from the FDA with approval to market and launch Doxycycline Monohydrate Tablets, 75mg and
150 mg, the generic equivalent of Adoxa® and used for the treatment of bacterial infections. According to Wolters Kluwer, combined
sales of generic Doxycycline Monohydrate Tablets, 75 mg and 150mg, were $25.8 million in 2007.
9
In December 2008, we received a letter from the FDA with approval to market and launch Ursodiol 300 mg Capsules, the generic
equivalent of Actigall® and indicated for patients with radiolucent noncalcified gallbladder stones, and for the prevention of gallstone
formation in obese patients experiencing rapid weight loss. According to Wolters Kluwer, combined sales of generic and brand
Ursodiol were $128.2 million for the 12 months ending October 2008.
In May 2009, we received a letter from the FDA with approval to market and launch Pilocarpine HCI Tablets 7.5 mg, the generic
equivalent of Salagen®. Pilocarpine HCI tablets are indicated for (1) the treatment of symptoms of dry mouth from salivary gland
hyprfunction caused by radiotherapy for cancer of the head and neck and (2) the treatment of symptoms of dry mouth in patients with
Sjogren’s syndrome. According to Wolters Kluwer, combined sales of generic and brand Pilocarpine HCI Tablets 7.5mg at AWP were
$2.5 million in 2008.
In December 2009, Lannett a letter from the FDA with approval to market and launch Hydromorphone Hydrochloride Tablets USP, 2
mg, 4 mg and 8 mg, the generic equivalent of Purdue Pharmaceuticals’ (formerly Abbott’s) Dilaudid® Tablets 2 mg, 4 mg and 8 mg.
According to Wolters Kluwer, U.S. sales in 2008 of both generic and brand Hydromorphone Hcl Tablets, 2 mg, 4 mg and 8 mg were
$170 million at Average Wholesale Price. Hydromorphone Hcl tablets are indicated for the management of pain in patients where an
opioid analgesic is appropriate.
In April 2010, we received a letter from the FDA with approval to market and launch Ondansetron Injection USP, 2 mg/mL, Multi-
Dose Vials. Ondansetron Injection USP, 2 mg/mL is the generic equivalent of GlaxoSmithKline’s Zofran® Injection, 2 mg/mL.
Ondansetron Injection, USP 2 mg/mL is indicated for the prevention of postoperative nausea and vomiting and for the prevention of
chemotherapy-induced nausea and vomiting. For the 12 months ended December 2009 U.S. sales of Ondansetron Injection USP, 2
mg/mL, were approximately $58 million at Average Wholesale Price (AWP). A launch date for the product has not yet been set.
In July 2010, we received a letter from the FDA with approval to market and launch Phentermine Hydrochloride Blue/White Seed
Capsules USP, 30 mg, the generic equivalent of Sandoz, Inc.’s Reference Listed Drug (RLD) Phentermine Hcl Capsules USP, 30 mg.
According to Wolters Kluwer, U.S. sales of Phentermine Hcl Capsules USP, 30 mg in 2009 were approximately $36.5 million at
Average Wholesale Price (AWP). This does not include sales of Phentermine made directly to consumers through clinics.
Phentermine Hcl is indicated as a short-term adjunct in a regimen of weight reduction based on exercise, behavioral modification and
caloric restriction in the management of exogenous obesity for patients with an initial body mass index > 30 kg/m2, or > 27 kg/m2 in
the presence of other risk factors (e.g., hypertension, diabetes, and hyperlipidemia).
In August 2010, we received a letter from the FDA with approval to market and launch Ondansetron Injection USP, 2 mg/mL, Single-
Dose Vials. Ondansetron Injection USP, 2 mg/mL is the generic version of GlaxoSmithKline’s Zofran Injection, 2 mg/mL.
Ondansetron Injection, USP 2 mg/mL is indicated for the prevention of postoperative nausea and vomiting and for the prevention of
chemotherapy-induced nausea and vomiting. For the 12 months ended December 2009, Ondansetron Injection USP, 2 mg/mL had
U.S. sales of approximately $58 million at Average Wholesale Price. A launch date for the product has not been set.
We have additional products 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. Our
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 that we are currently developing is dependent on numerous factors, including but not limited to,
the complexity of the active ingredient’s chemical characteristics, the price of the raw materials and the FDA-mandated requirement
of bioequivalence studies (depending on the FDA’s Orange Book classification). The estimated cost to develop a new generic product
ranges from approximately $100,000 to $1.7 million.
In addition, as one of the oldest generic drug manufacturers in the country formed in 1942, we currently own several ANDAs that are
dormant on our records for products which we do not manufacture and market. Occasionally, we review such ANDAs to determine if
the market potential for any of these older drugs has recently changed to make it attractive for us to reconsider manufacturing and
selling. If we decide to introduce one of these products into the consumer market, we must review the original ANDA and related
documentation to ensure that the approved product specifications, formulation and other factors meet current FDA requirements for
the marketing of the applicable drug. Generally, in these situations, we 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. We would then redevelop the product and submit it to the FDA for supplemental
approval. The FDA’s approval process for an ANDA supplement is similar to that of a new ANDA.
10
In addition to the efforts of our internal product development group, we have 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. We intend to ultimately transfer the formulation
technology and manufacturing process for all of these R&D products to our own commercial manufacturing sites. We initiated these
outsourced R&D efforts to complement the progress of our own internal R&D efforts.
The majority of our R&D projects are being developed in-house under our direct supervision and with our own personnel.
Accordingly, we do not believe that our outside contracts for product development or manufacturing supply are material in nature, nor
are we substantially dependent on the services rendered by such outside firms. Since we have no control over the FDA review
process, our 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 our 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 Form
10-K.
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
ANDA
ANDA supplement
ANDA
Preliminary Investigational New Drug
ANDA supplement
ANDA
ANDA
Number of Products
21
10
5
3
3
4
35
We incurred R&D expenses of approximately $11,251,000 in fiscal year 2010, $8,427,000 in fiscal year 2009, and $5,173,000 in
fiscal year 2008. The R&D spending includes spending on bioequivalence studies, internal development resources as well as
outsourced development. While we manage all R&D from our principal executive office in Philadelphia, we have also been taking
advantage of favorable development costs in other countries. We have strategic partnerships with various companies that either act as
contract research organizations or API suppliers as well as dosage form manufacturers. In addition, U.S.-based research organizations
have been engaged for product development to enhance our internal development. Fixed payment arrangements are established with
these development partners, and can range from $90,000 to $575,000 to develop a drug. Development payments are normally
scheduled in advance, based on milestones.
Raw Materials and Finished Goods Inventory Suppliers
Our use of raw materials in the production process consists of using pharmaceutical chemicals in various forms that 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 we purchase for the production process, we purchase certain finished dosage inventories, including
capsule, tablet and oral liquid products. We sell these finished dosage products directly to our customers along with the finished
dosage products manufactured in-house. If suppliers of a certain material or finished product are limited, we will generally take
certain precautionary steps to avoid a disruption in supply, such as finding a secondary supplier or ordering larger quantities.
Our primary finished product inventory supplier is JSP in Bohemia, New York. Purchases of finished goods inventory from JSP
accounted for approximately 77% of our inventory purchases in fiscal year 2010, 71% in fiscal year 2009 and 71% in fiscal year 2008.
On March 23, 2004, we entered into the JSP Distribution Agreement 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 our common stock. The products covered under the
JSP Distribution Agreement include Butalbital, Aspirin, Caffeine with Codeine Phosphate Capsules, Digoxin Tablets and Levo
Tablets, sold generically and under the brand name Unithroid®. The initial term of the JSP Distribution Agreement is ten years,
11
beginning on March 23, 2004 and continuing through March 22, 2014. See note 17 to our consolidated financial statements for more
information on the terms, conditions and financial impact of the JSP Distribution Agreement.
During the term of the JSP Distribution Agreement, we are required to use commercially reasonable efforts to purchase minimum
dollar quantities of JSP’s products that we distribute. The minimum quantity to be purchased in the first year of the JSP Distribution
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 JSP Distribution Agreement. We have met each applicable minimum purchase requirement to date, but there is no
guarantee that we will be able to continue to do so in the future. If we do not meet the minimum purchase requirements, JSP’s sole
remedy is to terminate the JSP Distribution Agreement.
In August 2005, we entered into a three year 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 1%, 14% and 23% of our costs of purchased inventory in fiscal years 2009, 2008 and 2007, respectively. Following its
expiration on August 21, 2008, the agreement was not renewed.
We have entered into definitive supply and development agreements with certain international companies, including Wintac of India,
Orion Pharma of Finland, Azad Pharma AG, Swiss Caps of Switzerland and Pharma 2B (formerly Pharmaseed) and The GC Group of
Israel, as well as certain domestic companies, including Banner Pharmacaps, Cerovene and Inverness. We are currently in negotiations
on similar agreements with other international companies, through which we will market and distribute future products manufactured
in-house or by third parties. We intend to capitalize on our strong customer relationships to build our market share for such products.
Customers and Marketing
We sell our products primarily to wholesale distributors, generic drug distributors, mail-order pharmacies, group purchasing
organizations, chain drug stores and other pharmaceutical companies. The pharmaceutical industry’s largest wholesale distributors,
McKesson, Cardinal Health and Amerisource Bergen, accounted for 9%, 7%, and 11%, respectively, of our net sales in fiscal year
2010 and 7%, 9% and 7%, respectively, of our net sales in fiscal year 2009. Our largest chain drug store customer, Walgreens,
accounted for 26% and 28% of net sales in fiscal year 2010 and fiscal year 2009, respectively. We perform ongoing credit evaluations
of our customers’ financial condition, and have experienced no significant collection problems to date. Generally, we require no
collateral from our customers.
Sales to 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.” We enter into definitive agreements with our indirect customers to establish pricing for certain covered products. Under
such agreements, the indirect customers independently select a wholesaler from which to purchase the products at these agreed-upon
prices. We 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, see 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 our books as sales to the wholesale customers.
We believe 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, we believe that consumer demand will be fulfilled by other wholesale or retail
sources of supply. As a result, we attempt to develop and maintain strong relationships with most of the major retail chains, wholesale
distributors and mail-order pharmacies in order to facilitate the supply of our products through whatever channel the consumer prefers.
Although we have agreements with customers governing the transaction terms of our sales, there are no minimum purchase quantities
applicable to these agreements.
We promote our products through direct sales, trade shows and bids. We also market our products through private label arrangements,
under which we manufacture our products with a label containing the name and logo of a customer. This practice is commonly
referred to as “private label business.” Private label business allows us to leverage our internal sales efforts by using the marketing
services from other well-respected pharmaceutical dosage suppliers. The focus of our sales efforts is the relationships we create with
our customer accounts. Strong and dependable customer relationships have created a positive platform for us to increase our 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 years 2010, 2009 and 2008, our
advertising expenses were immaterial. When our sales representatives make contact with a customer, we will generally offer to
supply the customer our 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 our supply of a
product, the customer typically expects a high standard of service, including timely receipt of products ordered, availability of
convenient, user-friendly and effective customer service functions and maintaining open lines of communication.
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Competition
The manufacturing and distribution of generic pharmaceutical products is a highly competitive industry. Competition is based
primarily on price, service and quality. Our competitive advantage is based on our ability to provide strong and dependable customer
service by maintaining adequate inventory levels, employing a responsive order filling system and prioritizing timely fulfillment of
those orders. We ensure that our products are available from national suppliers as well as our own warehouse. The modernization of
our facilities, hiring of experienced staff and implementation of inventory and quality control programs have improved our
competitive cost position over the past five years.
We compete with other manufacturers and marketers of generic and brand drugs. Each product manufactured and/or sold by us has a
different set of competitors. The list below identifies the companies with which we primarily compete with respect to each of our
major products.
Product
Primary Competitors
Butalbital with Aspirin and Caffeine, with and without
Codeine Phosphate Capsules .......................................................................
Watson and Breckenridge
C_Topical™ Solution .................................................................................. None
Digoxin Tablets............................................................................................ GlaxoSmithKline, Impax, Caraco and Westward
Doxycycline Hyclate and Monohydrate Tablets.......................................... Par, Mylan, Sandoz and Ranbaxy
Levothyroxine Sodium Tablets.................................................................... Abbott, Monarch, Mylan, Sandoz and Forest
Morphine Sulfate Liquid Oral Solution ....................................................... Roxane and Mallinckrodt
Primidone Tablets ........................................................................................ Watson, Qualitest, URL, Westward, Amneal and Impax
Rifampin Capsules....................................................................................... Sandoz and Versapharm
Unithroid® Tablets ...................................................................................... Abbott, Monarch, Mylan and Sandoz
Government Regulation
Pharmaceutical manufacturers are subject to extensive regulation by the federal government, principally by the FDA, and, in cases of
controlled drugs, the DEA, and to a lesser extent, by other federal regulatory bodies and state governments. The FDCA, the
Controlled Substance Act (the “CSA”) and other federal statutes and regulations govern or influence the testing, manufacture, safety,
labeling, storage, record keeping, approval, pricing, advertising, and promotion of our 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 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. The
new drug approval process generally involves:
•
completion of preclinical laboratory and animal testing in compliance with the FDA’s GLP regulations;
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•
•
•
•
submission to the FDA of an Investigational New Drug (“IND”) application for human clinical testing, which
must become effective before human clinical trials may begin;
performance of adequate and well-controlled human clinical trials to establish the safety and efficacy of the
proposed drug product for each intended use;
satisfactory completion of an FDA pre-approval inspection of the facility or facilities at which the product is
produced to assess compliance with the FDA’s cGMP regulations; and
submission to and approval by the FDA of an NDA.
The results of preclinical tests, together with manufacturing information and analytical data, are submitted to the
FDA as part of an IND, which must become effective before human clinical trials may begin. Further, each clinical
trial must be reviewed and approved by an independent Institutional Review Board. Human clinical trials are
typically conducted in three sequential phases that may overlap. These phases generally include:
•
•
•
Phase I, during which the drug is introduced into healthy human subjects or, on occasion, patients and is tested
for safety, stability, dose tolerance, and metabolism;
Phase II, during which the drug is introduced into a limited patient population to determine the efficacy of the
product in specific targeted indications, to determine dosage tolerance and optimal dosage, and to identify
possible adverse effects and safety risks; and
Phase III, during which the clinical trial is expanded to a larger and more diverse patient group at
geographically dispersed clinical trial sites to further evaluate clinical efficacy, optimal dosage, and safety.
The drug sponsor, the FDA, or the independent Institutional Review Board at each institution at which a clinical trial
is being performed may suspend a clinical trial at any time for various reasons, including a belief that the subjects
are being exposed to an unacceptable health risk.
The results of preclinical animal studies and human clinical studies, together with other detailed information, are
submitted to the FDA as part of the NDA. The NDA also must contain extensive manufacturing information. The
FDA may approve or disapprove the NDA if applicable FDA regulatory criteria are not satisfied or it may require
additional clinical data. Once approved, the FDA may withdraw the product approval if compliance with pre- and
post-market regulatory standards is not maintained or if problems occur or are identified after the product reaches
the marketplace. In addition, the FDA may require post-marketing studies to monitor the effect of approved products
and may limit further marketing of the product based on the results of these post-marketing studies. The FDA has
broad post-market regulatory and enforcement powers, including the ability to levy fines and civil penalties, suspend
or delay issuance of approvals, seize or recall products, and withdraw approvals.
Satisfaction of FDA new drug approval requirements typically takes several years, and the actual time required may
vary substantially based upon the type, complexity, and novelty of the product or disease. Government regulation
may delay or prevent marketing of potential products for a considerable period of time and impose costly procedures
upon a manufacturer’s activities. Success in early stage clinical trials does not assure success in later stage clinical
trials. Data obtained from clinical activities is not always conclusive and may be subject to varying interpretations
that could delay, limit, or prevent regulatory approval. Even if a product receives regulatory approval, later
discovery of previously unknown problems with a product may result in restrictions on the product or even complete
withdrawal of the product from the market.
• 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 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. The FDA will approve the generic product as suitable
for an ANDA application if it finds that the generic product does not raise new questions of safety and effectiveness as
compared to the innovator product. A product is not eligible for ANDA approval if the FDA determines that it is not
equivalent to the referenced innovator drug, if it is intended for a different use, or if it is not subject to an approved Suitability
Petition. However, such a product might be approved under an NDA, with supportive data from clinical trials.
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In addition to establishing a new ANDA procedure, the Hatch-Waxman Act created statutory protections for approved brand
name drugs. Under the Hatch-Waxman 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. Upon NDA approval, the FDA lists in its
Orange Book the approved drug product and any patents identified by the NDA applicant that relate to the drug product. Any
applicant who files an ANDA seeking approval of a generic equivalent version of a drug listed in the FDA’s Orange Book
before expiration of the referenced patent(s), must certify to the FDA that (1) no patent information on the drug product that
is the subject of the ANDA has been submitted to the FDA; (2) such patent has expired; (3) the date on which such patent
expires; or (4) such patent is invalid or will not be infringed upon by the manufacture, use, or sale of the drug product for
which the ANDA is submitted. This last certification is known as a Paragraph IV certification. A notice of the Paragraph IV
certification must be provided to each owner of the patent that is the subject of the certification and to the holder of the
approved NDA to which the ANDA refers. Before the enactment of the Medicare Prescription Drug Improvement and
Modernization Act of 2003 (the “MMA”), which amended the Hatch-Waxman Act, if the NDA holder or patent owner(s)
asserted a patent challenge within 45 days of its receipt of the certification notice, the FDA was prevented from approving
that ANDA until the earlier of 30 months from the receipt of the notice of the paragraph IV certification, the expiration of the
patent, when the infringement case concerning each such patent was favorably decided in an ANDA applicant’s favor, or
such shorter or longer period as may be ordered by a court. This prohibition is generally referred to as the 30-month stay. In
some cases, NDA owners and patent holders have obtained additional patents for their products after an ANDA had been
filed but before that ANDA received final marketing approval, and then initiated a new patent challenge, which resulted in
more than one 30-month stay.
The MMA amended the Hatch-Waxman Act to eliminate certain unfair advantages of patent holders in the implementation of
the Hatch-Waxman Act. As a result, the NDA owner remains entitled to an automatic 30-month stay if it initiates a patent
infringement lawsuit within 45 days of its receipt of notice of a paragraph IV certification, but only if the patent infringement
lawsuit is directed to patents that were listed in the FDA’s Orange Book before the ANDA was filed. An ANDA applicant is
now permitted to take legal action to enjoin or prohibit the listing of certain of these patents as a counterclaim in response to
a claim by the NDA owner that its patent covers its approved drug product.
If an ANDA applicant is the first-to-file a substantially complete ANDA with a paragraph IV certification and provides
appropriate notice to the FDA, the NDA holder, and all patent owner(s) for a particular generic product, the applicant may be
awarded a 180-day period of marketing exclusivity against other companies that subsequently file ANDAs for that same
product. A substantially complete ANDA is one that contains all the information required by the Hatch-Waxman Act and the
FDA’s regulations, including the results of any required bioequivalence studies. The FDA may refuse to accept the filing of
an ANDA that is not substantially complete or may determine during substantive review of the ANDA that additional
information, such as an additional bioequivalence study, is required to support approval. Such a determination may affect an
applicant’s first to file status and eligibility for a 180-day period of marketing exclusivity for the generic product. The MMA
also modified the rules governing when the 180-day marketing exclusivity period is triggered or forfeited and shared
exclusivity. Prior to the legislation, the 180-day marketing exclusivity period was triggered upon the first commercial
marketing of the ANDA or a court decision holding the patent invalid, unenforceable, or not infringed. For ANDAs accepted
for filing before March 2000, that court decision had to be final and non-appealable (other than a petition to the U.S. Supreme
Court for a writ of certiorari). In March 2000, the FDA changed its position in response to two court cases that challenged the
FDA’s original interpretation of what constituted a court decision under the Hatch-Waxman Act. Under the changed policy,
the 180-day marketing exclusivity period began running immediately upon a district court decision holding the patent at issue
invalid, unenforceable, or not infringed, regardless of whether the ANDA had been approved and the generic product had
been marketed. In codifying the FDA’s original policy, the MMA retroactively applies a final and non-appealable court
decision trigger for all ANDAs filed before December 8, 2003 leaving intact the first commercial marketing trigger. As for
ANDAs filed after December 8, 2003, the marketing exclusivity period is only triggered upon the first commercial marketing
of the ANDA product, but that exclusivity may be forfeited under certain circumstances, including, if the ANDA is not
marketed within 75 days after a final and non-appealable court decision by the first-to-file or other ANDA applicant, or if the
FDA does not tentatively approve the first-to-file applicant’s ANDA within 30 months.
In addition to patent exclusivity, the holder of the NDA for the listed drug may be entitled to a period of non-patent market
exclusivity, during which the FDA cannot approve an ANDA. If the listed drug is a new chemical entity, the FDA may not
accept an ANDA for a bioequivalent product for up to five years following approval of the NDA for the new chemical entity.
If the listed drug is not a new chemical entity but the holder of the NDA conducted clinical trials essential to approval of the
NDA or a supplement thereto, the FDA may not approve an ANDA for a bioequivalent product before expiration of three
years. Certain other periods of exclusivity may be available if the listed drug is indicated for treatment of a rare disease or is
studied for pediatric indications.
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•
Section 505(b)(2) New Drug Applications: 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 where at least some of information required for approval comes from studies not conducted
by or for the applicant and for which the applicant has not obtained a right of reference. The Hatch-Waxman Act permits the
applicant to rely upon certain preclinical or clinical studies conducted for an approved product. 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 Section 505(b)(2)
applications have with the exception of “Grandfathered drugs” been diminished by the availability of the ANDA process, as
described above.
Additionally, certain products, marketed prior to the Federal Food, Drug and Cosmetic Act may be considered GRASE (“Generally
Recognized As Safe and Effective”) or Grandfathered. GRASE products are those “old drugs that do not require prior approval from
FDA in order to be marketed because they are generally recognized as safe and effective based on published scientific literature.”
Similarly, Grandfathered products are those which “entered the market before the passage of the 1938 act or the 1962 amendments to
the act.” Under the grandfather clause, such a product is exempted from the “effectiveness requirements [of the act] if its composition
and labeling have not changed since 1962 and if, on the day before the 1962 amendments became effective, it was (1) used or sold
commercially in the United States, (2) not a new drug as defined by the act at that time, and (3) not covered by an effective
application.” Recently, the FDA has increased its efforts to force companies to file and seek FDA approval for these GRASE products.
Efforts have included granting market exclusivity to approved GRASE products and issuing notices to companies currently producing
these products. One such current FDA effort includes our currently marketed product, Morphine Sulfate oral solution. Please see
additional discussion regarding our Morphine Sulfate Oral Solution product in Item 1A. Risk Factors, Item 3, Legal Proceedings, and
Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Manufacturing cGMP Requirements
Among the requirements for new drug approval is the requirement that the prospective manufacturer’s methods conform to the FDA’s
cGMP regulations to the satisfaction of the FDA pursuant to a pre-approval inspection before the facility may be used to manufacture
the product. The cGMP regulations must be followed at all times during which the approved drug is manufactured and the
manufacturing facilities are subject to periodic inspections by the FDA and other authorities, including procedures and operations used
in the testing and manufacture of our products to assess our compliance with application regulations. FDA’s cGMP regulations
require among other things, quality control and quality assurance as well as the corresponding maintenance of records and
documentation In complying with the standards set forth in the cGMP regulations, we 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 statutory and regulatory requirements subjects a manufacturer to possible legal or regulatory action, including
but not limited to, the seizure or recall of noncomplying drug products injunctions, consent decrees placing significant restrictions on
or suspending manufacturing operations, and/or civil and criminal penalties. Adverse experiences with the product must be reported
to the FDA and could result in the imposition of market restriction through labeling changes or in product removal. Product approvals
may be withdrawn if compliance with regulatory requirements is not maintained or if problems concerning safety or efficacy of the
product occur following approval.
Other Regulatory Requirements
With respect to post-market product advertising and promotion, the FDA imposes a number of complex regulations on entities that
advertise and promote pharmaceuticals, which include, among others, standards for direct-to-consumer advertising, off-label
promotion, industry-sponsored scientific and educational activities, and promotional activities involving the internet. The FDA has
very broad enforcement authority under the FFDCA, and failure to abide by these regulations can result in penalties, including the
issuance of a warning letter directing entities to correct deviations from FDA standards, a requirement that future advertising and
promotional materials be pre-cleared by the FDA, and state and/or federal civil and criminal investigations and prosecutions.
We are also subject to various laws and regulations regarding laboratory practices, the experimental use of animals, and the use and
disposal of hazardous or potentially hazardous substances in connection with our research. In each of these areas, as above, the FDA
has broad regulatory and enforcement powers, including the ability to levy fines and civil penalties, suspend or delay issuance of
approvals, seize or recall products, and withdraw approvals, any one or more of which could have a material adverse effect on us.
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Outside of the United States, our ability to market a product is contingent upon receiving marketing authorization from the appropriate
regulatory authorities. The requirements governing marketing authorization, pricing, and reimbursement vary widely from country to
country. At present, foreign marketing authorizations are applied for at a national level, although within the European Union
registration procedures are available to companies wishing to market a product in more than one European Union member state. The
regulatory authority generally will grant marketing authorization if it is satisfied that we have presented it with adequate evidence of
safety, quality and efficacy.
DEA Regulation
We maintain registrations with the DEA that enable us to receive, manufacture, store, and distribute controlled substances in
connection with our operations. Controlled substances are those drugs that appear on one of five schedules promulgated and
administered by the DEA under the CSA. The CSA governs, among other things, the distribution, recordkeeping, handling, security,
and disposal of controlled substances. We are subject to periodic and ongoing inspections by the DEA and similar state drug
enforcement authorities to assess our ongoing compliance with DEA’s regulations. Any failure to comply with these regulations could
lead to a variety of sanctions, including the revocation or a denial of renewal of our DEA registration, injunctions, or civil or criminal
penalties.
Fraud and Abuse Laws
Because of the significant federal funding involved in Medicare and Medicaid, Congress and the states have enacted, and actively
enforce, a number of laws whose purpose is to eliminate fraud and abuse in federal health care programs. Our business is subject to
compliance with these laws.
Anti-Kickback Statutes and Federal False Claims Act
The federal health care programs’ Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering,
receiving, or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the
furnishing or arranging for a good or service, for which payment may be made under a federal health care program such as Medicare
or Medicaid. The definition of “remuneration” has been broadly interpreted to include anything of value, including for example gifts,
certain discounts, the furnishing of free supplies, equipment or services, credit arrangements, payment of cash and waivers of
payments. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement
involving remuneration is to induce referrals of federal health care covered business, the statute has been violated. Penalties for
violations include criminal penalties and civil sanctions such as fines, imprisonment, and possible exclusion from Medicare, Medicaid,
and other federal health care programs. In addition some kickback allegations have been claimed to violate the Federal False Claims
Act, discussed in more detail below.
The Anti-Kickback Statute is broad and prohibits many arrangements and practices that are lawful in businesses outside of the health
care industry. Recognizing that the Anti-Kickback Statute is broad and may technically prohibit many innocuous or beneficial
arrangements, Congress authorized the Office of Inspector General of the U.S. Department of Health and Human Services (“OIG”) to
issue a series of regulations, known as “safe harbors.” These safe harbors, issued by the OIG beginning in July 1991, set forth
provisions that, if all their applicable requirements are met, will assure health care providers and other parties that they will not be
prosecuted under the Anti-Kickback Statute. The failure of a transaction or arrangement to fit precisely within one or more safe
harbors does not necessarily mean that it is illegal or that prosecution will be pursued. However, conduct and business arrangements
that do not fully satisfy each applicable safe harbor may result in increased scrutiny by government enforcement authorities such as
OIG.
Many states have adopted laws similar to the Anti-Kickback Statute. Some of these state prohibitions apply to referral of patients for
health care items or services reimbursed by any source, not only the Medicare and Medicaid programs.
Government officials have focused their enforcement efforts on marketing of health care services and products, among other activities,
and recently have brought cases against companies, and certain sales, marketing, and executive personnel, for allegedly offering
unlawful inducements to potential or existing customers in an attempt to procure their business.
Another development affecting the health care industry is the increased use of the federal Civil False Claims Act, and in particular,
action brought pursuant to the False Claims Act’s “whistleblower” or “qui tam” provisions. The False Claims Act imposes liability on
any person or entity who, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment
by a federal health care program. The qui tam provisions of the False Claims Act allow a private individual to bring actions on behalf
of the federal government alleging that the defendant has submitted a false claim to the federal government, and to share in any
monetary recovery. In recent years, the number of suits brought against health care providers by private individuals has increased
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dramatically. In addition, various states have enacted false claims law analogous to the Civil False Claims Act, although many of
these state laws apply where a claim is submitted to any third-party payor and not merely a federal health care program.
When an entity is determined to have violated the False Claims Act, it may be required to pay up to three times the actual damages
sustained by the government, plus civil penalties of between $5,500 to $11,000 for each separate false claim. There are many
potential bases for liability under the False Claims Act. Liability arises, primarily, when an entity knowingly submits, or causes
another to submit, a false claim for reimbursement to the federal government. The federal government has used the False Claims Act
to assert liability on the basis of inadequate care, kickbacks, and other improper referrals, and improper use of Medicare numbers
when detailing the provider of services, in addition to the more predictable allegations as to misrepresentations with respect to the
services rendered. In addition, the federal government has prosecuted companies under the False Claims Act in connection with off-
label promotion of products. Our future activities relating to the reporting of wholesale or estimated retail prices of our products, the
reporting of discount and rebate information and other information affecting federal, state, and third-party reimbursement of our
products, and the sale and marketing of our products may be subject to scrutiny under these laws. We are unable to predict whether
we will be subject to actions under the False Claims Act or a similar state law, or the impact of such actions. However, the costs of
defending such claims, as well as any sanctions imposed, could significantly affect our financial performance.
HIPAA and Other Fraud and Privacy Regulations
Among other things, the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) created two new federal crimes:
health care fraud and false statements relating to health care matters. The HIPAA health care fraud statute prohibits, among other
things, knowing and willfully executing, or attempting to execute, a scheme to defraud any health care benefit program, including
private payors. A violation of this statute is a felony and may result in fines, imprisonment, and/or exclusion from government-
sponsored programs. The HIPAA false statements statute prohibits, among other things, knowingly and willfully falsifying,
concealing, or covering up a material fact or making any materially false, fictitious, or fraudulent statement or representation in
connection with the delivery of or payment for health care benefits, items, or services. A violation of this statute is a felony and may
result in fines and/or imprisonment.
Pricing
In the United States, our sales are dependent upon the availability of coverage and reimbursement for our products from third-party
payers, including federal and state programs such as Medicare and Medicaid, and private organizations such as commercial health
insurance and managed care companies. Such third-party payers are increasingly challenging the price of medical products and
services and instituting cost containment measures to control or significantly influence the purchase of medical products and services.
This includes the placement of our pharmaceutical products on drug formularies or lists of medications.
Over the past several years, the rising costs of providing health care services has triggered legislation to make certain changes to the
way in which pharmaceuticals, including our products, are covered and reimbursed, particularly by governmental programs. For
instance, recent federal legislation and regulations have created a voluntary prescription drug benefit, Medicare Part D, revised the
formula used to reimburse health care providers and physicians under Part B and have imposed significant revisions to the Medicaid
Drug Rebate Program. These changes have resulted in, and may continue to result in, coverage and reimbursement restrictions and
increased rebate obligations by manufacturers. in addition, there continue to be legislative and regulatory proposals at the federal and
state levels directed at containing or lowering the cost of health care. Examples of how limits on drug coverage and reimbursement in
the United States may cause reduced payments for drugs in the future include:
•
•
•
•
•
changing Medicare reimbursement methodologies;
revising drug rebate calculations under the Medicaid program;
reforming drug importation laws;
fluctuating decisions on which drugs to include in formularies; and
requiring pre-approval of coverage for new or innovative drug therapies.
We cannot predict the likelihood or pace of such additional changes or whether there will be significant legislative or regulatory
reform impacting our products. Nor can we predict with precision what effect such governmental measures would have if they were
ultimately enacted into law. However, in general, we believe that legislative and regulatory reform activity likely will continue.
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We are also subject to federal, state and local laws of general applicability, including laws regulating working conditions and the
storage, transportation, or discharge of items that may be considered hazardous substances, hazardous waste, or environmental
contaminants. We monitor our compliance with all environmental laws. We are in substantial compliance with all regulatory bodies.
As a publicly-traded company, we are also subject to significant regulations and laws, including the Sarbanes-Oxley Act of 2002.
Since its enactment, we have developed and instituted a corporate compliance program based on what we believe are the current best
practices and we continue to update the program in response to newly implemented or changing regulatory requirements.
We operate in a highly regulated environment and are responsible for maintaining compliance with many regulatory requirements.
The U.S. Department of Justice, acting on behalf of the DEA, issued us a letter in August 2008 requesting additional information on
certain record keeping matters regarding a DEA inspection of our facilities. We fully complied with their request and intend to fully
comply with all requests for information that occur from time to time as a normal course of business.
Employees
As of June 30, 2010, we had 305 employees, comprised of 218 employees at Lannett and 87 employees at Cody Labs.
Securities and Exchange Act Reports
We maintain a website at www.lannett.com. We make available on or through our website our current and periodic reports, including
any amendments to those reports, that are filed with the Securities and Exchange Commission (the “SEC”) in accordance with the
Securities Exchange Act of 1934, as amended (the “Exchange Act”). These reports 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 our website free of charge as soon as
reasonably practicable after we electronically file the information with, or furnish it to, the SEC. The contents of our website are not
incorporated by reference in this Form 10-K and shall not be deemed “filed” under the Exchange Act.
ITEM 1A.
RISK FACTORS
We materially rely on an uninterrupted supply of finished products from Jerome Stevens Pharmaceutical (“JSP”) for a
majority of our sales. If we were to experience an interruption of that supply, our operating results would suffer.
Approximately 69% of our fiscal year 2010 sales are of distributed products, primarily manufactured by JSP. Two of theses
products are Levo and Digoxin, which accounted for 41% and 17%, respectively, of our Fiscal 2010 net sales, and 40% and 22%,
respectively, of our net sales for Fiscal 2009. If the supply of these products is interrupted in any way by any form of temporary or
permanent business interruption to JSP, including but not limited to fire or other naturally-occurring, damaging event to their physical
plant and/or equipment, condemnation of their facility, legislative or regulatory cease and desist declaration regarding their operations,
and any interruption in their source of API for their products, our operating results could be materially adversely affected. We do not
have, at this time, a second source for these products.
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, including the FDA and in the case of controlled drugs, the DEA, and state government agencies. The FDCA, the
CSA and other federal statutes and regulations govern or influence the development, testing, manufacturing, packing, labeling, storing,
record keeping, safety, approval, advertising, promotion, sale and distribution of our products.
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. The FDA approval process for a particular product candidate can take several years and requires us to dedicate substantial
resources to securing approvals, and we may not be able to obtain regulatory approval for our product candidates in a timely manner,
or at all. In order to obtain approval for our generic product candidates, we must demonstrate that our drug product is bioequivalent to
a drug previously approved by the FDA through the new drug approval process, known as an innovator drug. Bioequivalency may be
demonstrated in vivo or in vitro by comparing the generic product candidate to the innovator drug product in dosage form, strength,
route of administration, quality, dissolution performance characteristics, and intended use. The FDA may not agree that the
bioequivalence studies we submit in the ANDA applications for our generic drug products are adequate to support approval. If it
determines that an ANDA application is not adequate to support approval, the FDA could deny our application or request additional
information, including clinical trials, which could delay approval of the product and impair our ability to compete with other versions
of the generic drug product.
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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. Furthermore, the FDA also has the authority to revoke drug approvals previously granted and remove these
products from the market for a variety of reasons, including a failure to comply with applicable regulations, the discovery of
previously unknown problems with the product, or because the ingredients in the drug are no longer approved by the FDA.
Recently, the FDA has increased its efforts to force companies to file and seek FDA approval for GRASE products. Efforts
have included granting market exclusivity to approved GRASE products and issuing notices to companies currently producing these
products. Lannett currently manufactures and markets several products that are considered GRASE products, including Morphine
Sulfate. The FDA is currently undertaking activities to force all companies who manufacture Morphine Sulfate to file applications
and seek approval for this product or remove their product from the market. As of July 24, 2010, Lannett has stopped manufacturing
and distributing Morphine Sulfate Oral Solution and as of the date of this Form 10-K, the Company has approximately $2 million of
Morphine Sulfate Oral Solution finished goods inventory. Lannett has filed such an application and currently awaits FDA approval on
the submission. The Company expects approval on this application within the next seven months. But, if the Company is rejected on
its current application, or if the current application takes significantly longer than seven months to be approved, the Company is at risk
of losing the $2 million of Morphine Sulfate Oral Solution inventory recorded on its books as of July 24, 2010, and approximately 5%
to 8 % in future annual Net Sales.
In addition, Lannett, as well as many of our significant suppliers of distributed product and raw materials, are subject to
periodic inspection of facilities, procedures and operations and/or the testing of the finished products by the FDA, the DEA and other
authorities, which conduct periodic inspections to confirm that pharmaceutical companies are in compliance with all applicable
regulations. The FDA conducts pre-approval and post-approval reviews and plant inspections to determine whether systems and
processes are in compliance with cGMP, and other FDA regulations. Following such inspections, the FDA may issue notices on
Form 483 that could cause us or our suppliers 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. The DEA and comparable state-level agencies also heavily regulate the manufacturing, holding, processing,
security, record-keeping, and distribution of drugs that are considered controlled substances. Some of the pain management products
we manufacture contain controlled substances. The DEA periodically inspects facilities for compliance with its rules and regulations.
If our manufacturing facilities or those of our suppliers fail to comply with applicable regulatory requirements, it could result in
regulatory action and additional costs to us.
Our inability or the inability of our suppliers to comply with applicable FDA and other regulatory requirements can result in,
among other things, delays in or denials of new product approvals, warning letters, fines, consent decrees restricting or suspending
manufacturing operations, injunctions, civil penalties, recall or seizure of products, total or partial suspension of sales, and/or criminal
prosecution., Any of these or other regulatory actions could materially harm our operating results and financial condition. 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. Additionally, if the FDA were to undertake additional
enforcement activities with any of Lannett’s GRASE products, their actions could result in, among other things, removal of some of
our products from the market, seizure of products and total or partial suspension of sales. Any of these regulatory actions could
materially harm our operating results and financial condition.
Our manufacturing operations as well as our suppliers manufacturing are subject to licensing by the FDA and/or DEA. If we
or our suppliers were unable to maintain the proper agency licensing arrangements, our operating results would be materially
negatively impacted.
All of our manufacturing operations as well as those of our suppliers rely on maintaining active licenses to produce and
develop generic drugs. Specifically, our Cody Labs operations rely on a DEA license to directly import and convert raw opium into
several APIs or dosage forms. This license is granted for a one year period and must be renewed successfully each year in order for us
to maintain Cody’s current operations and allow the Company to continue to work towards becoming a fully integrated narcotics
supplier. If the Company were unable to successfully renew its FDA and/or DEA licenses, the financial results of Lannett would be
negatively impacted.
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;
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•
•
•
•
receiving requisite regulatory approvals for such products in a timely manner;
the availability, on commercially reasonable terms, of raw materials, including APIs and other key ingredients;
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; 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
been issued and 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.
The generic 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.
The loss of Arthur P. Bedrosian or our other 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 Arthur P. Bedrosian and our other key personnel. If we lose the services of Mr. Bedrosian or our other key
personnel, or if he or they are unable to devote sufficient attention to our operations for any other reason, our business may be
significantly impaired. 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 to help prevent the loss of our key personnel.
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 certain 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.
21
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
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, and our development and sales and marketing efforts could be delayed.
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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 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.
Health care initiatives and other third-party payor cost-containment pressures could cause us to sell our products at lower
prices, resulting in decreased revenues.
Some of our products are purchased or reimbursed by state and federal government authorities, private health insurers and
other organizations, such as health maintenance organizations, or HMOs, and managed care organizations, or MCOs. Third-party
payors increasingly challenge pharmaceutical product pricing. There also continues to be a trend toward managed health care in the
United States. Pricing pressures by third-party payors and the growth of organizations such as HMOs and MCOs could result in lower
prices and a reduction in demand for our products.
In addition, legislative and regulatory proposals and enactments to reform health care and government insurance programs
could significantly influence the manner in which pharmaceutical products and medical devices are prescribed and purchased. We
expect there will continue to be federal and state laws and/or regulations, proposed and implemented, that could limit the amounts that
federal and state governments will pay for health care products and services. The extent to which future legislation or regulations, if
any, relating to the health care industry or third-party coverage and reimbursement may be enacted or what effect such legislation or
regulation would have on our business remains uncertain. For example, the American Recovery and Reinstatement Act of 2009, also
known as the stimulus package, includes $1.1 billion in funding to study the comparative effectiveness of health care treatments and
strategies. If the stimulus package is approved in its current form, this funding will be used, among other things, to conduct, support or
synthesize research that compares and evaluates the risk and benefits, clinical outcomes, effectiveness and appropriateness of
products. Although Congress has indicated that this funding is intended for improvement in quality of health care, it remains unclear
how the research will impact coverage, reimbursement or other third-party payor policies. Such measures or other health care system
reforms that are adopted could have a material adverse effect on our industry generally and our ability to successfully commercialize
our products or could limit or eliminate our spending on development projects and affect our ultimate profitability.
We may need to change our business practices to comply with changes to fraud and abuse laws.
We are subject to various federal and state laws pertaining to health care fraud and abuse, including the federal fraud and
abuse law (sometimes referred to as the “Anti-Kickback Statute”) which apply to our sales and marketing practices and our
relationships with physicians. At the federal level, the Anti-Kickback Statute prohibits any person or entity from knowingly and
willfully soliciting, receiving, offering, or paying any remuneration, including a bribe, kickback, or rebate, directly or indirectly, in
return for or to induce the referral of patients for items or services covered by federal health care programs, or the furnishing,
recommending, or arranging for products or services covered by federal health care programs. Federal health care programs have been
defined to include plans and programs that provide health benefits funded by the federal government, including Medicare and
Medicaid, among others. The definition of “remuneration” has been broadly interpreted to include anything of value, including, for
example, gifts, discounts, the furnishing of supplies or equipment, credit arrangements, payments of cash, and waivers of payments.
Several courts have interpreted the federal Anti-Kickback Statute’s intent requirement to mean that if even one purpose in an
arrangement involving remuneration is to induce referrals or otherwise generate business involving goods or services reimbursed in
whole or in part under federal health care programs, the statute has been violated. The federal government has issued regulations,
commonly known as safe harbors that set forth certain provisions which, if fully met, will assure parties that they will not be
prosecuted under the federal Anti-Kickback Statute. The failure of a transaction or arrangement to fit within a specific safe harbor
does not necessarily mean that the transaction or arrangement will be illegal or that prosecution under the federal Anti-Kickback
Statute will be pursued, but such transactions or arrangements face an increased risk of scrutiny by government enforcement
authorities and an ongoing risk of prosecution. If our sales and marketing practices or our relationships with physicians (such as
physicians serving on our Scientific Advisory Board) are considered by federal or state enforcement authorities to be knowingly and
willfully soliciting, receiving, offering, or providing any remuneration in exchange for arranging for or recommending our products
23
and services, and such activities do not fit within a safe harbor, then these arrangements could be challenged under the federal Anti-
Kickback Statute. If our operations are found to be in violation of the federal Anti-Kickback Statute we may be subject to civil and
criminal penalties including fines of up to $25,000 per violation, civil monetary penalties of up to $50,000 per violation, assessments
of up to three times the amount of the prohibited remuneration, imprisonment, and exclusion from participating in the federal health
care programs. In addition, HIPAA and its implementing regulations created two new federal crimes: health care fraud and false
statements relating to health care matters. The HIPAA health care fraud statute prohibits, among other things, knowingly and willfully
executing, or attempting to execute, a scheme to defraud any health care benefit program, including private payors. A violation of this
statue is a felony and may result in fines, imprisonment and/or exclusion from government-sponsored programs. The HIPAA false
statements statute prohibits, among other things, knowingly and willfully falsifying, concealing or covering up a material fact or
making any materially false, fictitious or fraudulent statement or representation in connection with the delivery of or payment for
health care benefits, items, or services. A violation of this statute is a felony and may result in fines and/or imprisonment. A number
of states also have anti-fraud and anti-kickback laws similar to the federal Anti-Kickback Statute that prohibit certain direct or indirect
payments if such arrangements are designed to induce or encourage the referral of patients or the furnishing of goods or services.
Some states’ anti-fraud and anti-kickback laws apply only to goods and services covered by Medicaid. Other states’ anti-fraud and
anti-kickback laws apply to all health care goods and services, regardless of whether the source of payment is governmental or private.
Due to the breadth of these laws and the potential for changes in laws, regulations, or administrative or judicial interpretations, we
may have to change our business practices or our existing business practices could be challenged as unlawful, which could materially
adversely affect our business.
Certain federal and state governmental agencies, including the U.S. Department of Justice and the U.S. Department of Health
and Human Services, have been investigating issues surrounding pricing information reported by drug manufacturers and used in the
calculation of reimbursements as well as sales and marketing practices. For example, many government and third-party payors,
including Medicare and Medicaid, reimburse doctors and others for the purchase of certain pharmaceutical products based on the
product’s average wholesale price (“AWP”) reported by pharmaceutical companies. While Lannett has only used Suggested
Wholesale Prices since 2000, the federal government, certain state agencies, and private payors are investigating and have begun to
file court actions related to pharmaceutical companies’ reporting practices with respect to AWP, alleging that the practice of reporting
prices for pharmaceutical products has resulted in a false and overstated AWP, which in turn is alleged to have improperly inflated the
reimbursement paid by Medicare beneficiaries, insurers, state Medicaid programs, medical plans, and others to health care providers
who prescribed and administered those products. In addition, some of these same payors are also alleging that companies are not
reporting their “best price” to the states under the Medicaid program. We are not currently subject to any such investigations or actions
and having not used AWP pricing since 2000 would not likely become subject to these investigations.
We may become subject to federal and state false claims litigation brought by private individuals and the government.
We are subject to state and federal laws that govern the submission of claims for reimbursement. The federal False Claims
Act imposes civil liability and criminal fines on individuals or entities that knowingly submit, or cause to be submitted, false or
fraudulent claims for payment to the government. Violations of the False Claims Act and other similar laws may result in criminal
fines, imprisonment, and civil penalties for each false claim submitted and exclusion from federally funded health care programs,
including Medicare and Medicaid. The False Claims Act also allows private individuals to bring a suit on behalf of the government
against an individual or entity for violations of the False Claims Act. These suits, known as qui tam actions, may be brought by, with
only a few exceptions, any private citizen who has material information of a false claim that has not yet been previously disclosed.
These suits have increased significantly in recent years because the False Claims Act allows an individual to share in any amounts
paid to the federal government in fines or settlement as a result of a successful qui tam action. If our past or present operations are
found to be in violation of any of such laws or any other governmental regulations that may apply to us, we may be subject to
penalties, including civil and criminal penalties, damages, fines, exclusion from federal health care programs, and/or the curtailment or
restructuring of our operations. Any penalties, damages, fines, curtailment, or restructuring of our operations could adversely affect
our ability to operate our business and our financial results, action against us for violation of these laws, even if we successfully
defend against them, could cause us to incur significant legal expenses and divert our management’s attention from the operation of
our business.
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.
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For the fiscal year ended June 30, 2010, our three largest customers accounted for 26%, 11% and 9%, 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 that would require them to purchase our
products.
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, as well as the inability to obtain certain insurance coverage for risks faced by Lannett, 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 coverage to mitigate these
costs. These increases, and our increased risk due to increased deductibles and reduced coverage, could have a negative impact on our
results of operations, financial condition and cash flows.
Additionally, certain insurance coverages may not be available to Lannett for risks faced by Lannett. Sometimes the
coverages obtained by Lannett for certain risks may not be adequate to fully reimburse the amount of damage that Lannett could
possibly sustain. Should either of these events occur, the lack of insurance to cover the entire cost to the Company would adversely
affect our results of operations and financial condition.
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.
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 (“FTC”) 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.
ITEM 2.
DESCRIPTION OF PROPERTY
Lannett owns three facilities in Philadelphia, Pennsylvania. Certain administrative functions, manufacturing and production facilities
and our quality control laboratory are located in a 31,000 square foot facility at 9000 State Road in Philadelphia. The second facility
consists of 63,000 square feet, and is located within one mile of the State Road location at 9001 Torresdale Avenue in Philadelphia.
Our research laboratory and packaging functions are located in the second building, which may be used for additional manufacturing
space in the future.
25
In June 2006, we leased a third building located several miles from our manufacturing facility in Philadelphia, consisting of 66,000
square feet on approximately 7.3 acres. We purchased this building in October 2009 for approximately $3.8 million, plus the cost of
fit out of approximately $2.0 million. A significant portion of the purchase price and fit out costs are expected to be financed through
a series of loans with a bank and a Pennsylvania state run development agency. Construction was substantially complete by June 30,
2010. The financing will be competed shortly. This new facility is being used for certain administrative functions, warehouse space,
shipping and possibly additional manufacturing space in the future.
Cody, a wholly-owned subsidiary of Lannett, 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, Wyoming, which is 50% owned by
Lannett and 50% by an officer of Cody Laboratories and his former spouse.
ITEM 3.
LEGAL PROCEEDINGS
In January 2010, the Company initiated an arbitration proceeding against Olive Healthcare (“Olive”) for damages arising out of
Olive’s delivery of defective soft-gel prenatal vitamin capsules. The Company seeks damages in excess of $3.5 million. Olive has
denied liability and filed a counterclaim in February 2010 for breach of contract.
In June 2008, the Company filed a declaratory judgment suit in the Federal District Court of Delaware (Civil Action No. 08-338 (JJF))
against KV Pharmaceuticals, DrugTech Corp. and Ther-Rx Corp (collectively, “KV”). The complaint sought declaratory judgment
for non-infringement and invalidity of certain patents owned by KV. The complaint further sought declaratory judgment of anti-trust
violations and federal and state unfair competition violations for actions taken by KV in securing and enforcing these patents. After
the complaint was filed, KV countered with a motion for a Temporary Restraining Order (“TRO”) to prevent the Company from
launching its Multivitamin with Mineral Capsules (“MMCs”), due to alleged patent and trademark infringement issues. The TRO was
heard and, ultimately, resulted in a conclusion by the court that the Company’s product label on the MMCs should be modified. KV
also countered with claims of infringement by the Company of KV’s patents seeking the Company’s profits for sales of MMCs or
other monetary relief, preliminary and permanent injunctive relief, attorney’s fees and a finding of willful infringement. In
March 2009, the Company and KV settled the litigation. In light of the withdrawal of KV’s innovator prenatal product due to FDA
enforcement actions, and the resulting anticipated decline in sales and declining market for written prescription, the Company decided
it was pointless to continue the litigation and entered into the settlement arrangement with KV. Pursuant to the settlement, the
Company received a license from KV and became an authorized generic provider. During the terms of the license, the Company is to
pay KV a royalty on all future sales of its Prenatal vitamin product. Lannett will cease offering its Prenatal vitamin product if and
when the brand is restored to the marketplace. In May 2010, the Company filed an action for declaratory relief in the Delaware
Superior Court against KV seeking a declaration that KV breached its obligations under a settlement agreement entered into with the
Company (the “Binding Agreement”). In June 2010, KV filed a counterclaim to the complaint and asserted claims for breach of
contract, declaratory judgment, negligent misrepresentation and fraud in connection with the Binding Agreement, alleging among
other things that the Company has improperly withheld royalties from KV arising out of its sales of a pre-natal vitamin product.
In or about July 2008, Albion International and Albion, Inc. filed suit in the United States District Court, District of Utah (Case No.
2:08cv00515) against Lannett asserting claims for patent and trademark infringement, as well as unfair competition, arising out of
Lannett’s use of product that it purchased from Albion and used as an ingredient in its MMC. Lannett filed a motion to dismiss the
complaint on the basis that it purchased the product from Albion and, as such, was authorized to use the product in its MMC. The
Court granted the motion and dismissed the complaint but gave Albion leave to file an amended complaint. In January 2009, Albion
filed an amended complaint. Lannett filed an answer to the complaint and counterclaim, asserting, among other things, that Albion
tortuously interfered with Lannett’s contracts. Subsequent to the filing of the answer and counterclaim, Lannett and Albion reached
an agreement in principal to settle the case. Under terms of the settlement, the parties would each dismiss their claims against each
other and provide releases. In July 2009, the settlement agreement was signed and the case was dismissed.
ITEM 5.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
PART II
On April 15, 2002, the Company’s common stock began trading on the American Stock Exchange (now the NYSE — AMEX). 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 2010 and 2009, as quoted by the NYSE — AMEX. Such quotations reflect inter-
dealer prices without retail mark-up, markdown, or commission and may not represent actual transactions.
26
Fiscal Year Ended June 30, 2010
First quarter .................................................................................................
Second quarter .............................................................................................
Third quarter................................................................................................
Fourth quarter ..............................................................................................
Fiscal Year Ended June 30, 2009
First quarter .................................................................................................
Second quarter .............................................................................................
Third quarter................................................................................................
Fourth quarter ..............................................................................................
High
Low
9.67
8.19
6.45
5.12
4.20
5.00
5.86
7.52
$
$
$
$
$
$
$
$
6.70
4.95
4.17
4.23
2.25
1.79
4.60
4.86
Low
High
$
$
$
$
$
$
$
$
Holders
As of September 17, 2010, there were approximately 249 holders of record of the Company’s common stock.
Dividends
The Company did not pay cash dividends in Fiscal 2010 or Fiscal 2009. 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.
Share Repurchase Program
The following table sets forth certain information with respect to the Company’s Share Repurchase Program.
ISSUER PURCHASES OF EQUITY SECURITIES
(a) Total
Number of
Shares (or
Units)
Purchased
(b) Average
Price Paid
per Share (or
Unit)
(c) Total
Number of
Shares (or
Units)
Purchased as
Part of
Publicly
Announced
Plans or
Programs
$
8,799
—
—
8,799
4.47
—
—
8,799
—
—
8,799
(d) Maximum
Number (or
Approximate
Dollar Value)
of Shares (or
Units) that
May Yet Be
Purchased
Under the
Plans or
Programs
$
4,348,587
Period
April 1 to April 30, 2010....
May 1 to May 31, 2010......
June 1 to June 30, 2010......
On January 27, 2005, the Company’s Board of Directors approved a stock repurchase program which was reauthorized by the Board
of Directors on November 20, 2009. Under the program, the Company is authorized to repurchase up to $5 million of its outstanding
common stock. As of June 30, 2010, the Company has repurchased 110,108 shares of its common stock under the program at an
aggregate purchase price of $651,413.
27
ITEM 6.
SELECTED FINANCIAL DATA
The following financial information as of and for the five years ended June 30, 2010, has been derived from our consolidated financial
statements. This information should be read in conjunction with our consolidated financial statements and related notes thereto
included elsewhere herein. The comparability of information is affected by the items described below.
In Fiscal 2008, we increased our returns reserve by $10.5 million, reflecting our expectation that 100% of the shipments of Prenatal
Multivitamin made in the fourth quarter of Fiscal 2008 would be returned. Our expectation that all of the product would be returned
was based on our inability to have the product specified as a brand equivalent, product complaints and information from our customers
regarding their intentions to return the product.
In Fiscal 2007, the Company wrote-off of a portion of a note receivable due from Cody Labs, and subsequently acquired Cody Labs (a
provider of API). 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.
As of and for the Fiscal Year Ended June 30,
Operating Highlights
Net Sales................................................
Gross Profit............................................
Operating Income/(Loss) .......................
Net Income/(Loss) — Lannett
Company, Inc.....................................
Basic Earnings/(Loss) Per Share —
Lannett Company, Inc........................
Diluted Earnings/(Loss) Per Share —
Lannett Company, Inc........................
Balance Sheet Highlights
Lannett Company, Inc. and Subsidiaries
Financial Highlights
2010
2009
2008
2007
2006
$ 125,177,949
$ 41,339,807
$ 13,030,019
$ 119,002,215
$ 45,244,469
$ 10,780,869
$ 72,403,283
$ 16,301,071
$
(5,430,534) $
$ 82,577,591
$ 21,424,987
(5,964,409) $
$ 64,060,375
$ 28,375,665
8,453,918
$
$
$
7,821,067
0.32
0.31
$
$
$
6,534,245
0.27
0.27
$
$
$
(2,318,059) $
(6,929,008) $
4,968,922
(0.10) $
(0.29) $
(0.10) $
(0.29) $
0.21
0.21
Total Assets ...........................................
Total Debt ..............................................
Long Term Debt, less Current Portion...
Total Stockholders’ Equity ....................
$ 139,963,797
7,719,827
$
$
2,868,549
$ 88,957,715
$ 124,577,121
8,138,768
$
$
7,703,382
$ 77,647,623
$ 113,679,264
8,978,834
$
$
8,186,922
$ 69,321,789
$ 104,656,100
9,679,965
$
$
8,987,846
$ 70,183,175
$ 105,992,064
8,196,692
$
$
7,649,806
$ 75,755,916
ITEM 7.
OPERATIONS
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
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 2011, 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.
28
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.
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
Health and Wolters Kluwer, 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. As we continue to obtain additional information about our historical experience for chargebacks,
rebates and returns, we also update our estimates of the required reserves.
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
by the Company 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 expected mix of product sales to the
indirect customers. The Company continually monitors the reserve for chargebacks and makes adjustments when management
believes that expected chargebacks on actual sales may differ from the amounts that were assumed in the establishment of the
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 rebate-eligible customers are recognized and decreases
when actual rebate payments are made. However, since rebate programs are not identical for all customers, the size of the reserve will
depend on the mix of sales to customers that are eligible to receive rebates.
Returns — Consistent with industry practice, the Company has a product returns policy that allows certain 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, adjusted for any changes in business practices or
conditions that would cause management to believe that future product returns may differ from those returns assumed in the
establishment of reserves. Generally, the reserve for returns increases as sales increase and decrease when credits are issued or
payments are made for actual returns received. The reserve for returns is included in the rebates, chargebacks and returns 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 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
29
factors and evaluates the reserve as additional information becomes available. Other adjustments are included in the rebates,
chargebacks and returns payable account on the balance sheet. When competitors enter the market for existing products, shelf stock
adjustments may be issued to maintain price competitiveness.
The following tables identify the reserves for each major category of revenue allowance and a summary of the activity for fiscal years
2010, 2009 and 2008. Unless we have specific information to indicate otherwise, actual credits issued in a given year are assumed to
be related to sales recorded in prior years based on the Company’s returns policy.
For the Year Ended June 30, 2010
Reserve Category
Reserve Balance as of June 30, 2009 ..........
Chargebacks
$ 6,089,802
$
Rebates
2,537,746
Returns
5,106,992
$
$
Other
Total
$ 13,734,540
—
Actual credits issued related to sales
recorded in prior fiscal years..................
(6,068,639)
(2,537,746)
(3,832,652)
—
(12,439,037)
Reserves or (reversals) charged during
Fiscal 2010 related to sales in prior
fiscal years ..............................................
Reserves charged to net sales during
Fiscal 2010 related to sales recorded in
Fiscal 2010..............................................
Actual credits issued related to sales
—
—
(401,203)
—
(401,203)
48,539,403
16,353,467
4,528,118
1,226,614
70,647,601
recorded in Fiscal 2010..........................
(42,278,440)
(12,787,436)
—
(1,226,614)
(56,292,489)
Reserve Balance as of June 30, 2010 ..........
$ 6,282,127
$
3,566,031
$
5,401,254
$
—
$ 15,249,412
For the Year Ended June 30, 2009
Reserve Category
Reserve Balance as of June 30, 2008 ..........
Chargebacks
Rebates
$ 4,049,407
$
632,314
Returns
$ 13,642,589
Other
$
2,107
Total
$ 18,326,417
Actual credits issued related to sales
recorded in prior fiscal years...................
(3,954,794)
(632,314)
(12,853,342)
—
(17,440,450)
Reserves or (reversals) charged during
Fiscal 2009 related to sales in prior
fiscal years ..............................................
Reserves charged to net sales during Fiscal
2009 related to sales recorded in Fiscal
2009 ........................................................
Actual credits issued related to sales
—
—
2,107
(2,107)
—
35,391,475
12,141,204
4,315,638
204,119
52,052,436
recorded in Fiscal 2009..........................
(29,396,286)
(9,603,458)
—
(204,119)
(39,203,863)
Reserve Balance as of June 30, 2009 ..........
$ 6,089,802
$
2,537,746
$
5,106,992
$
—
$ 13,734,540
30
For the Year Ended June 30, 2008
Reserve Category
Reserve Balance as of June 30, 2007 ..........
Chargebacks
Rebates
Returns
Other
$ 4,649,478
$
871,339
$
113,313
$
52,234
$
Total
5,686,364
Actual credits issued related to sales
recorded in prior fiscal years..................
(4,556,488)
(1,741,804)
(4,909,659)
—
(11,207,951)
Reserves or (reversals) charged during
Fiscal 2008 related to sales in prior
fiscal years ..............................................
Reserves charged to net sales during Fiscal
2008 related to sales recorded in Fiscal
2008 ........................................................
Actual credits issued related to sales
—
870,465
5,892,805
(50,000)
6,713,270
26,126,995
7,999,232
12,546,130
473,423
47,145,780
recorded in Fiscal 2008..........................
(22,170,578)
(7,366,918)
—
(473,550)
(30,011,046)
Reserve Balance as of June 30, 2008 ..........
$ 4,049,407
$
632,314
$ 13,642,589
$
2,107
$ 18,326,417
Reserve Activity 2010 vs. 2009
The total reserve for chargebacks, rebates, returns and other adjustments increased from $13,734,540 at June 30, 2009 to $15,249,412
at June 30, 2010. The increase in total reserves was due to an increase in the rebates reserve as a result of the timing of credits being
processed by the customers and by the Company, an increase in chargeback reserves due primarily to an increase in inventory levels at
wholesaler distribution centers, and an increase in the return reserves due to an increase in overall sales.
During Fiscal 2010 approximately $424,000 of the original $10,545,000 return reserve recorded in the fourth quarter of Fiscal 2008
for the Prenatal Multivitamin product was applied to accounts receivable for customers who had returned the Prenatal Multivitamin
product during 2010. In addition, the Company reversed approximately $387,000 to net sales in the fourth quarter of Fiscal 2010 as a
result of new information that the Company had received regarding the amount of Multivitamin product that remained to be returned
to the Company. This adjustment left a balance of approximately $17,000 of Multivitamin returns reserve on the consolidated balance
sheet at June 30, 2010.
The following tables compare the year-end reserve balances in fiscal years 2010 and 2009 and the gross sales mix in Fiscal 2010 and
Fiscal 2009.
Chargeback reserve....................................
Rebate reserve............................................
Return reserve............................................
Other reserve..............................................
Chain drug stores .......................................
Mail Order .................................................
Wholesalers ...............................................
Reserve Activity 2009 vs. 2008
2010
6,282,127
3,566,031
5,401,254
—
15,249,412
$
$
Fiscal Year Ended June 30,
2009
%
6,089,802
2,537,746
5,106,992
—
13,734,540
41% $
23%
36%
0%
100% $
%
Fiscal Year ended June 30,
2009
2010
Fiscal Fourth Quarter
2010
2009
32%
4%
64%
100%
37%
4%
59%
100%
31%
4%
65%
100%
44%
19%
37%
0%
100%
33%
3%
64%
100%
The total reserve for chargebacks, rebates, returns and other adjustments decreased from $18,326,417 at June 30, 2008 to $13,734,540
at June 30, 2009. The decrease in the reserve balance was primarily the result of our decision to record during the fourth quarter of
Fiscal 2008 a $10,545,000 provision for the expected return of 100% of the shipments of Prenatal Multivitamin. Our expectation that
all of the product would be returned was based on our inability to have the product specified as a brand equivalent, product complaints
31
and information from our customers regarding their intentions to return the product. Substantially all of these products were returned
in Fiscal 2009 leaving a balance of approximately $828,000 in the Multivitamin return reserve at June 30, 2009. Partially offsetting
this decrease was an increase primarily due to an increase in sales volume in Fiscal 2009.
The increase in chargeback and rebate reserves between June 30, 2008 and June 30, 2009 was primarily due to an increase in sales
volume in 2009, as well as a change in our sales mix. The following tables compare the year-end reserve balances in fiscal years 2009
and 2008 and the gross sales mix for the fourth quarters and full years in Fiscal 2009 and Fiscal 2008.
Chargeback reserve....................................
Rebate reserve............................................
Return reserve............................................
Other reserve..............................................
Chain drug stores .......................................
Mail Order .................................................
Wholesalers ...............................................
2009
6,089,802
2,537,746
5,106,992
—
13,734,540
$
$
Fiscal Year Ended June 30,
2008
%
4,049,407
632,314
13,642,589
2,107
18,326,417
44% $
19%
37%
0%
100% $
%
Fiscal Year ended June 30,
2008
2009
Fiscal Fourth Quarter
2009
2008
37%
4%
59%
100%
34%
4%
62%
100%
33%
3%
64%
100%
22%
3%
74%
0%
100%
35%
4%
61%
100%
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.
The Company also regularly monitors accounts receivable (“AR”) balances by reviewing both net and gross day’s sales outstanding
(“DSO”). Net DSO is calculated by dividing gross accounts receivable less the reserve for rebates, chargebacks, returns and other
adjustments by the average daily net sales for the period. Gross DSO shows the result of the same calculation without regard to
rebates, chargebacks, returns and other adjustments.
The Company monitors both net DSO and gross DSO as an overall check on collections and to assess the reasonableness of the
reserves. Gross DSO 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
AR balance net of the reserve liability compared to net sales after charges to the reserves during the period. Standard payment terms
offered to customers are consistent with industry practice at 60 days. Net DSO eliminates the effect of timing of processing, which is
inherent in the gross DSO calculation.
The following table shows the results of these calculations for the fiscal years ended June 30, 2010, 2009 and 2008:
Fiscal Year Ended June 30,
Net DSO (in days) ........................................................
Gross DSO (in days).....................................................
2010
77
69
2009
55
53
2008
65
70
The level of net DSO at June 30, 2010 is slightly higher than the Company’s expectation that DSO will be in the 60 to 70 day range
based on 60 day payment terms for most customers. The increase is due to a higher percentage of sales being shipped at the end of the
quarter.
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.
32
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, 2010 and 2009 balance sheets are consolidated VIE assets of $1.9 million and $1.9 million, respectively, which is comprised
mainly of land and a building. VIE liabilities primarily consist of a mortgage on that property in the amount of $1.6 million and $1.7
million at June 30, 2010 and 2009, respectively. This VIE was initially consolidated by Cody, as Cody has been the primary
beneficiary. Cody has then been consolidated within Lannett’s financial statements since its acquisition in April 2007.
New Accounting Pronouncements -
In December 2007, the FASB issued authoritative guidance which significantly changes the accounting for business combinations in a
number of areas including the treatment of contingent consideration, contingencies, acquisition costs, in-process research and
development and restructuring costs. In addition, under the guidance, changes in deferred tax asset valuation allowances and acquired
income tax uncertainties in a business combination after the measurement period will impact income tax expense. In April 2009,
updated guidance was issued to address application issues regarding the accounting and disclosure provisions for contingencies. The
authoritative guidance applies prospectively to business combinations for which the acquisition date is on or after the beginning of the
fiscal year beginning July 1, 2009. Early application is not permitted. The effect of this authoritative guidance on our consolidated
financial statements will depend on the nature and terms of any business combinations that occur after the effective date.
In December 2007, the FASB issued authoritative guidance to establish accounting and reporting standards for the noncontrolling
(minority) interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary
is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and
establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in
deconsolidation. We adopted this authoritative guidance effective July 1, 2009. As a result of the adoption, the Company presents
noncontrolling interests as a component of equity on its consolidated balance sheets. Minority interest expense is now shown below
net income under the heading “net income attributable to noncontrolling interest”. Prior year financial statements have been
reclassified to reflect the adoption of this guidance. The adoption of this guidance did not have any other significant impact on our
consolidated financial statements.
In April 2008, the FASB issued authoritative guidance which amends the factors that should be considered in developing renewal or
extension assumptions used to determine the useful life of a recognized intangible asset. The guidance is intended to improve the
consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair
value of the asset. We adopted this authoritative guidance effective July 1, 2009. The adoption of this guidance did not have a
significant impact on our consolidated financial statements.
In June 2009, the FASB issued authoritative guidance for determining whether an entity is a variable interest entity and modifies the
methods allowed for determining the primary beneficiary of a variable interest entity. This guidance requires an enterprise to perform
an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable
interest entity. It also requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity.
The authoritative guidance is effective for the annual reporting period that begins after November 15, 2009, for interim periods within
that first annual reporting period and annual reporting periods thereafter. We do not expect the adoption of this authoritative guidance
to have a significant impact on our consolidated financial statements.
In January 2010, the FASB issued authoritative guidance which requires reporting entities to make new disclosures about recurring or
nonrecurring fair value measurements including significant transfers into and out of Level 1 and Level 2 fair value measurements and
information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair value measurements.
The authoritative guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for Level 3
reconciliation disclosures which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those
fiscal years. We do not anticipate that this update will have a material impact on our consolidated financial statements.
33
Results of Operations — Fiscal 2010 compared to Fiscal 2009
Net sales increased 5% from $119,002,215 in Fiscal 2009 to $125,177,949 in Fiscal 2010. The following factors contributed to the
$6,175,734 increase in sales:
Medical indication
Migraine Headache ......................................................................................................
Antibiotics....................................................................................................................
Prescription Vitamin ....................................................................................................
Pain Management ........................................................................................................
Epilepsy .......................................................................................................................
Heart Failure ................................................................................................................
Thyroid Deficiency ......................................................................................................
Sales volume
change %
Sales price
change %
(6)%
5%
(47)%
138%
(10)%
(19)%
9%
9%
(5)%
(15)%
44%
26%
(1)%
0%
Sales of drugs used for pain management increased by approximately $9,974,000 for Fiscal 2010 compared to Fiscal 2009. This
increase is due to an increased number of products offered as well as a market withdrawal by one of our major competitors. Sales of
drugs used in the treatment of thyroid deficiency increased by approximately $4,485,000 as a result of a continued shift away from
branded drugs towards generic prescriptions. Partially offsetting these increases was a decrease in sales of our prescription vitamins
of approximately $6,929,000 due to a lack of selling activities by the branded drug company. The overall increase in sales was also
affected by a decrease in sales of drugs for the treatment of congestive heart failure by approximately $5,425,000 in Fiscal 2010
compared to Fiscal 2009. This decrease was due to a prior year product recall by several of our major competitors which increased
our Fiscal 2009 revenues. Additional sales can also be attributed to new drugs used for the treatment of gallstones totaling
approximately $2,190,000.
The Company expects to continue increasing the number of products available for sale to its customers, which will require additional
FDA approvals. The Company’s receipt of several approvals by the FDA to offer new products has resulted in more sales of new
products in Fiscal 2010 compared to Fiscal 2009.The Company sells its products to customers in various categories. The table below
presents the Company’s net sales to each category.
Customer Category
Fiscal 2010 Net Sales
Fiscal 2009 Net Sales
Wholesaler/Distributor.......................................................
Retail Chain .......................................................................
Mail-Order Pharmacy ........................................................
Private Label ......................................................................
Total...................................................................................
$
$
$
$
$
58.2 million
60.3 million
6.7 million
0.0 million
125.2 million
$
$
$
$
$
53.8 million
59.0 million
5.8 million
0.4 million
119.0 million
The sales to wholesaler/distributor and retail chain customer categories increased significantly as a result of an increase in the demand
for products for which the Company is the major supplier and also an increase in the number of products available for sale.
Cost of sales increased 14% to $83,838,142 in Fiscal 2010 from $73,757,746 in Fiscal 2009. The increase reflected the impact of the
5% increase in sales as well as additional royalties of approximately $455,180 primarily related to the sale of the prescription
vitamins, our Amantadine product and the final payments under the Provell termination agreement. Additionally, the increase in cost
of sales is attributable to two months of idle capacity costs at our Cody Labs subsidiary being directly expensed to the income
statement during the second quarter of fiscal 2010. In March of 2009, the FDA issued a warning letter to nine companies including
Lannett to remove Morphine Sulfate Oral Solution from the market until someone could submit an application and receive approval
on such application. In April 2009, due to shortages of this fairly necessary drug in the marketplace, the FDA reversed their position
and allowed all seven companies to continue manufacturing and/or marketing Morphine Sulfate up until 180 days after someone
received approval on a Morphine Sulfate application. These actions by the FDA caused the DEA to withhold purchasing and
manufacturing quota from some or all of these nine companies, including Lannett. Although the Company had quota at the time and
quota issues were resolved by December 2009, the Cody Labs facility was left idle for the months of October and November 2009 due
to the lack of Morphine Sulfate quota.
34
Amortization expense primarily relates to the JSP Distribution Agreement. For the remaining term of the JSP Distribution Agreement,
the Company will incur annual amortization expense of approximately $1,785,000.
Gross profit margins for Fiscal 2010 and Fiscal 2009 were 33% and 38%, respectively. Gross profit percentage decreased due to the
decline in sales of the prescription vitamin, the commencement of the related royalty and the Cody Labs idle capacity costs discussed
above. While the Company is continuously striving to keep product costs low, there can be no guarantee that profit margins will not
fluctuate in future periods. Pricing pressure from competitors and costs of producing or purchasing new drugs may also fluctuate in
the future. Changes in the future sales product mix may also occur. These changes may affect the gross profit percentage in future
periods.
Research and development (“R&D”) expenses increased 34% to $11,251,421 in Fiscal 2010 from $8,427,135 in Fiscal 2009. The
increase was primarily due to an increase in the number of drugs in development and preparation for submission to the FDA as well as
increased costs for biostudies. The Company expenses all production costs as R&D until the drug is approved by the FDA. R&D
expenses may fluctuate from period to period, based on R&D plans for submission to the FDA.
Selling, general and administrative (“S, G & A”) expenses decreased 33% to $17,375,320 in Fiscal 2010 from $26,059,104 in Fiscal
2009. The decrease is primarily due to litigation expenses in Fiscal 2009 related to the patent challenge with KV Pharmaceuticals of
approximately $6,537,000 which were not incurred in Fiscal 2010 as the litigation was settled in March 2009. In the third quarter of
Fiscal 2009, the Company also incurred severance costs related to the departure of the Company’s former chief financial officer of
approximately $452,000 which were not incurred in Fiscal 2010. Most of the remaining decrease in S, G &A expense is due to the
reallocation of personnel at Cody Labs during 2010 to production due to their transition during this fiscal year into a more fully
functional manufacturing facility. The costs incurred during fiscal 2009 of getting the Cody facility compliant with FDA cGMP
requirements, as well as the personnel and related expenses incurred to set up laboratories and manufacturing space, and writing and
establishing all policies and procedures were expensed to S, G &A. While the Company is focused on controlling costs, increases in
personnel costs may have an ongoing and longer lasting impact on the administrative cost structure. Other costs are being incurred to
facilitate improvements in the Company’s infrastructure. These costs are expected to be temporary investments in the future of the
Company and may not continue at the same level.
Interest expense decreased to $275,870 in Fiscal 2010 from $321,751 in Fiscal 2009, due to lower levels of long term debt. Interest
income decreased to $62,328 in Fiscal 2010 from $209,188 in Fiscal 2009 due to lower interest earned on smaller investment
securities balances.
The Company recorded income tax expense totaling $4,813,044 in Fiscal 2010 compared to $4,090,716 in Fiscal 2009. The effective
tax rate for Fiscal 2010 was 37.5% compared to 38.3% for Fiscal 2009. The effective tax rate for Fiscal 2010 includes the impact of a
change in Pennsylvania tax law which lowered the Company’s apportionment factor within this state. The impact of this change
caused the Company to reduce its deferred tax assets by approximately $650,000, and therefore increased the effective tax rate by
approximately 5% for Fiscal 2010. The increase in effective tax rate related to this change in Pennsylvania tax law was essentially
offset by the impact of the settlement reached with the IRS related to its review of the federal income tax return for Fiscal 2008. As a
result of the settlement, the Company recorded a refund receivable totaling approximately $421,000 and reduced its liability for
unrecognized tax benefits by approximately $216,000. In addition, the Company amended its Fiscal 2005 income tax return to claim
additional federal income tax credits, which was accepted as timely filed by the IRS. As a result, the Company reduced its income
taxes payable by approximately $528,000 related to this amended income tax return.
At June 30, 2010, the Company has recognized a net deferred tax asset of $17,881,721. The net deferred tax asset is net of a valuation
allowance of $2,016,620 that is related to the Cody notes receivable impairment incurred in conjunction with the acquisition of Cody
Labs. The Company has provided for the valuation allowance related to the notes receivable impairment as this benefit will be
realized only upon the disposition of Cody Labs. As the Company has no current plans to dispose of its holdings in Cody, a full
valuation allowance has been established. The Company expects the remaining net deferred tax assets to be fully realizable based on
the Company’s history and future expectations of generating sufficient taxable income.
The Company reported net income attributable to Lannett of $7,821,067 for Fiscal 2010, or $0.32 basic and $0.31 diluted earnings per
share, compared to net income attributable to Lannett of $6,534,245 for Fiscal 2009, or $0.27 basic and diluted earnings per share.
Results of Operations — Fiscal 2009 compared to Fiscal 2008
Net sales increased 64% from $72,403,283 in Fiscal 2008 to $119,002,215 in Fiscal 2009. The increase was partly due to sales of
approximately $12,569,000 of our prescription vitamins during Fiscal 2009 which was the first year that the Company has offered this
product. In addition to the sales of the prescription vitamins, the following factors contributed to the $46,598,932 increase in sales:
35
Medical indication
Migraine Headache ......................................................................................................
Antibiotics....................................................................................................................
Epilepsy .......................................................................................................................
Heart Failure ................................................................................................................
Thyroid ........................................................................................................................
Sales volume
change %
Sales price
change %
(3)%
51%
2%
159%
28%
(4)%
(43)%
(53)%
36%
(3)%
The increase in product sales can be attributed primarily to three products. Sales of drugs for the treatment of congestive heart failure
increased by approximately $18,847,000 for Fiscal 2009 compared to Fiscal 2008 due to a product recall by several of our major
competitors. For Fiscal 2009, the Company had sales of approximately $12,569,000 of the prescription vitamins, which was the first
year the Company offered this product. Sales of drugs used in the treatment of thyroid deficiency increased by approximately
$9,311,000. The main reason for this increase was due to an increase in sales to one large existing retail chain customer along with
the addition of several new customers at our existing prices.
The Company expects to continue increasing the number of products available for sale to its customers, which will require additional
FDA approvals. The Company’s receipt of several approvals by the FDA to offer new products has resulted in more sales of new
products in Fiscal 2009 compared to Fiscal 2008.
The Company sells its products to customers in various categories. The table below presents the Company’s net sales to each
category.
Customer Category
Fiscal 2009 Net Sales
Fiscal 2008 Net Sales
Wholesaler/Distributor.......................................................
Retail Chain .......................................................................
Mail-Order Pharmacy ........................................................
Private Label ......................................................................
Total...................................................................................
$
$
$
$
$
53.8 million
59.0 million
5.8 million
0.4 million
119.0 million
$
$
$
$
$
30.5 million
37.1 million
4.5 million
0.3 million
72.4 million
The sales to all customer categories except private label increased significantly as a result of an increase in the demand for products
for which the Company is the major supplier and also an increase in the number of products available for sale.
Cost of sales increased 31%, from $56,102,212 in Fiscal 2008 to $73,757,746 in Fiscal 2009. The increase reflected the impact of the
64% increase in net sales as well as the overall fixed nature of some production costs.
Amortization expense primarily relates to the JSP Distribution Agreement. For the remaining term of the JSP Distribution Agreement,
the Company will incur annual amortization expense of approximately $1,785,000.
Gross profit as a percent of net sales increased to 38% in Fiscal 2009 from 23% in Fiscal 2008, due to strong profit margins on the
new prescription vitamin, increased margins for our congestive heart failure medication, and the overall fixed nature of some
production costs versus the 64% increase in revenues. While the Company is continuously striving to keep product costs low, there
can be no guarantee that profit margins will not decline in future periods due to pricing pressure from competitors and costs of
producing or purchasing new drugs. Changes in the product mix may also occur which could affect gross profit as a percent of sales
in future periods.
Research and development (“R&D”) expenses increased 63% to $8,427,135 in Fiscal 2009 from $5,172,715 in Fiscal 2008. The
increase was primarily due to a increase in the production of drugs in development and preparation for submission to the FDA. The
Company expenses all production costs as R&D until the drug is approved by the FDA. R&D expenses may fluctuate from period to
period, based on planned submissions to the FDA.
Selling, general and administrative expenses increased 57% to $26,059,104 in Fiscal 2009 from $16,552,859 in Fiscal 2008. The
increase is primarily due to litigation expenses related to the patent challenge with KV Pharmaceuticals of approximately $6,537,000,
36
incentive compensation costs totaling approximately $4,200,000, and severance costs related to the departure of the Company’s
former chief financial officer of approximately $452,000. While the Company is focused on controlling costs, increases in personnel
costs may have an ongoing and longer lasting impact on the administrative cost structure. Other costs are being incurred to facilitate
improvements in the Company’s infrastructure. These costs are expected to be temporary investments in the future of the Company
and may not continue at the same level.
Interest expense decreased to $321,751 in Fiscal 2009 from $383,267 in Fiscal 2008, due to lower levels of long term debt. Interest
income increased to $209,188 in Fiscal 2009 from $170,040 in Fiscal 2008 due to interest income received on an income tax refund as
well as interest earned on a higher level of investment securities.
The Company recorded income tax expense of $4,090,716 in Fiscal 2009 on a pretax income after noncontrolling interest of
$10,624,961 as compared to an income tax benefit of $3,376,011 in Fiscal 2008 on a pretax loss after noncontrolling interest of
$5,694,070. The inclusion of nondeductible expenses, state income taxes, the effects of federal income tax credits, and a reduction in
the valuation allowance for deferred tax assets were the principal reasons for the effective tax rate of 38.3% in fiscal year 2009.
At June 30, 2009, the Company has recognized a net deferred tax asset of $18,054,474. The net deferred tax asset is net of a valuation
allowance of $2,097,175 that is related to the Cody notes receivable impairment incurred in conjunction with the acquisition of Cody
Labs. The Company has provided for the valuation allowance related to the notes receivable impairment as this benefit will be
realized only upon the disposition of Cody Labs. As the Company has no current plans to dispose of its holdings in Cody, a full
valuation allowance has been established. The Company expects the remaining net deferred tax assets to be fully realizable based on
the Company’s history and future expectations of generating sufficient taxable income.
The Company reported net income attributable to Lannett of $6,534,245 for Fiscal 2009, or $0.27 basic and diluted earnings per share,
compared to a net loss attributable to Lannett of $2,318,059 for Fiscal 2008, or $0.10 basic and diluted loss per share.
Liquidity and Capital Resources
The Company has historically financed its operations with cash flow generated from operations, supplemented with borrowings from
various government agencies and financial institutions. At June 30, 2010, working capital was $40,104,705 as compared to
$38,632,170 at June 30, 2009, an increase of $1,472,535.
Net cash provided by operating activities of $6,941,231 for the year ended June 30, 2010 reflected net income of $8,008,028 after
adjusting for non-cash items of $6,787,846, as well as cash used by changes in operating assets and liabilities of $7,854,643.
Significant changes in operating assets and liabilities are comprised of:
• An increase in trade accounts receivable of approximately $8,802,000 primarily as a result of increased sales in Fiscal
2010 as well as the timing of those shipments resulting in a higher DSO at June 30, 2010. The change in the accounts
receivable balance from June 30, 2009 to June 30, 2010 includes a non-cash decrease of approximately $424,000 related
to the issuance of credits for the returns of the multivitamin product received by the Company through June 30, 2010.
• An increase in inventories of approximately $2,862,000 due to increased stocking levels at both Lannett and Cody Labs
for certain products as of June 30, 2010 that are being carried in order to respond to the increased order volume we are
currently experiencing.
• An increase in income taxes payable of approximately $769,000 primarily related to federal tax provisions in excess of
estimated tax payments made in Fiscal 2010.
• An increase in prepaid expenses and other current assets of approximately $1,908,000 primarily related to the
Company’s payment of $1,406,000 to the FDA that accompanied an initial application for approval of a currently
marketed GRASE product. The Company is currently awaiting a response from the FDA as to whether part or all of the
fee is refundable. The FDA normally has up to six months from date of submission in order to determine if any amounts
are refundable. Accordingly the Company is recording this amount in Other Current Assets. If any part of the fee is not
refundable, and the Company receives approval to market the related product, the Company expects to record the amount
as an intangible asset and amortize it over the estimated product life. If this application is not approved, the Company has
the right to re-file an application for this specific product with no additional fee due.
• An increase in accrued expenses of approximately $1,622,000 due to the timing of payments related to biostudies and
royalties.
• An increase in rebates, chargebacks and returns payable of approximately $1,939,000 primarily due to an increase in the
rebates reserve as a result of the timing of credits being processed by the customers and by the Company, an increase in
chargeback reserves due primarily to an increase in inventory levels at wholesaler distribution centers, and an increase in
the return reserves due to an increase in overall sales, partially offset by the reversal of the multivitamin product return
reserve of approximately $387,000. This increase was partly offset by a non-cash decrease of approximately $424,000
37
related to the issuance of credits for the returns of the multivitamin product received by the Company through June 30,
2010.
• An increase in accrued payroll and payroll related costs of approximately $1,913,000 primarily related to accrual of the
Fiscal 2010 incentive compensation costs partially offset by the payment in the first half of Fiscal 2010 of the Fiscal
2009 accrued incentive compensation costs totaling approximately $4,165,000. Of this amount, approximately $759,000
was settled with the issuance of restricted stock and is therefore excluded from the consolidated statement of cash flows.
Net cash used in investing activities of approximately $10,979,000 for the year ended June 30, 2010 is mainly the result of purchases
of property, plant and equipment of approximately $11,187,000, primarily related to acquired land and buildings to be used as the
Company’s administrative offices and additional warehouse space, as well as the purchase of an intangible asset (product rights) for
$500,000. Partially offsetting these amounts are proceeds from the sale of property, plant and equipment totaling approximately
$368,000 and proceeds from the sale of investment securities totaling approximately $340,000.
Net cash provided by financing activities of approximately $67,000 for Fiscal 2010 was primarily due to proceeds from the issuance
of stock of approximately $756,000 partially offset by the purchase of shares of treasury stock totaling approximately $162,000. The
Company also made scheduled debt repayments of approximately $419,000 and a distribution to noncontrolling interests totaling
approximately $169,000.
The Company has entered into agreements with various government agencies and financial institutions to provide additional cash to
help finance the Company’s operations. These borrowing arrangements as of June 30, 2010 are as follows:
The Company has a $3,000,000 line of credit from Wells Fargo, N. A., formerly Wachovia Bank, N.A. (“Wells Fargo”) that bears
interest at the prime interest rate less 0.25% (3.00% at June 30, 2010 and 2009, respectively). As of June 30, 2010 and 2009, the
Company had $3,000,000 of availability under this line of credit. The line of credit is collateralized by substantially all of the
Company’s assets. The agreement contains covenants with respect to working capital, net worth and certain ratios, as well as other
covenants. As of June 30, 2010, the Company was in compliance with all financial covenants under the agreement.
The existing line of credit, which was scheduled to expire on November 30, 2009, was renewed and extended during the first quarter
of Fiscal 2010 to November 30, 2010. As part of the renewal agreement, the Company is no longer required to maintain any
minimum deposit balances with Wells Fargo, and the availability fee on the unused balance of the line of credit was reduced to
0.375%.
The Company borrowed $4,500,000 from the Philadelphia Industrial Development Corporation (“PIDC”). The Company pays a bi-
annual interest payment at a rate equal to two and one-half percent per annum. The outstanding principal balance is due and payable
on January 1, 2011.
The Company borrowed $1,250,000 through the Pennsylvania Industrial Development Authority (“PIDA”). 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 $933,820 outstanding as of June 30, 2010 with $77,091 currently due.
The Company borrowed $500,000 from 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, 2010, $88,141 is outstanding.
In April 1999, the Company entered into a loan agreement with 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, 2010 was 0.52%. At June 30, 2010, the Company has $555,000 outstanding on
the Authority loan, of which $130,000 is classified as currently due. The remainder is classified as a long-term liability. In
April 1999, an irrevocable letter of credit of $3,770,000 was issued by Wachovia to secure payment of the Authority Loan and a
portion of the related accrued interest. At June 30, 2010, no portion of the letter of credit has been utilized.
The Company entered into agreements (the “2003 Loan Financing”) with Wells Fargo to finance the purchase of the Torresdale
Avenue facility, the renovation and setup of the building, and other anticipated capital expenditures. The Company, as part of the
2003 Loan Financing agreement, is required to make equal payments of principal and interest. The only portion of the loan that
38
remained outstanding at June 30, 2009 was the Equipment Loan, which had an outstanding balance of $80,130 at June 30, 2009. This
loan was fully repaid as of June 30, 2010.
The Company has executed Security Agreements with Wells Fargo, PIDA and PIDC in which the Company has pledged substantially
all of its assets to collateralize the amounts due.
As a result of the acquisition of Cody, the Company consolidates Cody LCI Realty, LLC, a variable interest entity (“VIE”), for which
Cody Labs is the primary beneficiary. See note 12 to our Consolidated Financial Statements for “Consolidation of Variable Interest
Entities.” A mortgage loan with First National Bank of Cody related to the purchase of land and building by the VIE has also been
consolidated in the Company’s consolidated balance sheets. The mortgage requires monthly principal and interest payments of
$14,782, at a fixed rate of 7.5%, to be made through June 2026. As of June 30, 2010, $1,642,866 is outstanding under the mortgage
loan, of which $56,046 is classified as currently due. The mortgage is collateralized by the land and building.
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. As of June 30, 2010, the Company has had preliminary discussions with the Commonwealth of Pennsylvania
to determine whether it will be required to repay any of the funds provided under the grant funding program. Based on information
available at June 30, 2010, the Company has recorded the grant funding as a long-term liability under the caption of Unearned Grant
Funds.
The following table represents annual contractual obligations as of June 30, 2010:
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................................................
$
$
7,719,827
111,176
63,930,000
1,435,553
73,196,556
$
$
4,851,278
50,100
22,572,500
259,213
27,733,091
$
$
554,977
61,076
41,357,500
278,996
42,252,549
$
$
471,652
—
—
244,012
715,664
$
$
1,841,920
—
—
653,332
2,495,252
Purchase obligations primarily relate to the JSP Distribution Agreement. See note 17 to our Consolidated Financial Statements for
more information on the terms, conditions and financial impact of the JSP Distribution Agreement.
Prospects for the Future
Generic pharmaceutical manufacturers and distributors are constantly faced by pricing pressure in the marketplace as competitors
attempt to lure business from distributors, wholesalers and chain retailers by offering lower prices than the incumbent supplier.
Lannett tries to differentiate itself in the marketplace by complementing its lower cost offerings with higher levels of customer service
and quality of the products. But as Lannett enters Fiscal Year 2011, there in an increasing number of competitors on our key products
that are attempting to supplant Lannett as the preferred vendor. Lannett will continue to evaluate each event as it arises, but any
reductions in either volumes or pricing will have a negative impact on the gross profit margins of the Company.
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 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 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.
39
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 and can range from $100,000 to $1.7 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.
The Company views its April 2007 acquisition of Cody Laboratories, Inc. (“Cody Labs” or “Cody”) as an important step in becoming
a vertically integrated narcotics manufacturer and distributor by allowing it to concentrate on developing and completing its dosage
form manufacturing in order to reduce narcotic API costs. In July 2008, the DEA granted Cody Labs a license to directly import raw
poppy straw for conversion into API and/or various pharmaceutical products. Only six other companies in the U.S. have been granted
this license to date. This license allows the Company to avoid increased costs associated with buying narcotic API from other
manufacturers. The Company anticipates that it can use this license to become a vertically integrated manufacturer of narcotic
products, as well as a supplier of API to the pharmaceutical industry. The Company believes that the aging domestic population may
result in a higher demand for pain management pharmaceutical products and that it will be well-positioned to take advantage of this
increased demand.
Cody Labs’ manufacturing expertise in narcotic APIs will allow Lannett to build a market with limited domestic competition. The
Company anticipates that the demand for narcotics and controlled drugs will continue to grow with the “Baby Boomer” generation
demographics and that it is well-positioned to take advantage of these opportunities by concentrating additional resources in the
narcotic area. The sale of pain management products approximated 12% of Net Sales for the third quarter of FY 2010 and 11% of Net
Sales for the full year Fiscal 2010. Additionally, the API and dosage form production of these products were performed at our Cody
Labs operations and, due to the increased volumes of sales on these products, allowed Cody to be profitable during the Company’s
third and fourth quarters of 2010.
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, topical or parenterals intended to treat a diverse range of medical indications. We intend to
ultimately transfer the formulation technology and manufacturing process for all of these R&D products to our own commercial
manufacturing sites. The Company initiated these outsourced R&D efforts to complement the progress of its own internal R&D
efforts.
Occasionally, the Company will work on developing a drug product that does not require FDA approval. Certain prescription drugs
do not require prior FDA approval before marketing. They include, for instance, drugs listed as DESI drugs (Drug Efficacy Study
implementation) which are under evaluation by FDA, Grandfathered Drugs, and prescription multivitamin drugs. A generic
manufacturer may sell products which are chemically equivalent to innovator drugs, under FDA rules by simply performing and
internally documenting the normal research and development involved in bringing a new product to market. Under this scenario, a
generic company can forego the time required for FDA approval.
More specifically, certain products, marketed prior to the Federal Food, Drug and Cosmetic Act may be considered GRASE or
Grandfathered. GRASE products are those “old drugs that do not require prior approval from FDA in order to be marketed because
they are generally recognized as safe and effective based on published scientific literature.” Similarly, Grandfathered products are
those which “entered the market before the passage of the 1938 act or the 1962 amendments to the act.” Under the grandfather clause,
such a product is exempted from the “effectiveness requirements [of the act] if its composition and labeling have not changed since
1962 and if, on the day before the 1962 amendments became effective, it was (1) used or sold commercially in the United States,
(2) not a new drug as defined by the act at that time, and (3) not covered by an effective application.” Recently, the FDA has increased
its efforts to force companies to file and seek FDA approval for these GRASE products. Efforts have included granting market
exclusivity to approved GRASE products and issuing notices to companies currently producing these products.
The Company has entered supply and development agreements with certain international companies, including Wintac of India, Orion
Pharma of Finland, Azad Pharma AG and Swiss Caps of Switzerland, Pharma 2B (formerly Pharmaseed) of Israel and the GC Group,
as well as certain domestic companies, including Jerome Stevens, Banner Pharmacaps, Cerovene, Summit Bioscience LLC and
Inverness. The Company is currently in negotiations on similar agreements with other international companies, through 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.
40
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.
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.
None.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
ITEM 9A.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We carried out an evaluation under the supervision and with the participation of our management, including our chief executive
officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such
term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”), as amended for
financial reporting as of June 30, 2010. Based on that evaluation, our chief executive officer and chief financial officer concluded that
these controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act is recorded, processed, summarized, and reported as specified in Securities and Exchange
Commission rules and forms. There were no changes in these controls or procedures identified in connection with the evaluation of
such controls or procedures that occurred during our last fiscal quarter, or in other factors that have materially affected, or are
reasonably likely to materially affect these controls or procedures.
Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file
or submit under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the rules and
forms of the Securities and Exchange Commission. These disclosure controls and procedures include, among other things, controls
and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is
accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to
allow timely decisions regarding required disclosure.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control
over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the
supervision of, the chief executive officer and chief financial officer and effected by the board of directors and management 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 and includes those policies and procedures that:
•
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and
dispositions of our assets;
41
•
•
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 our management and board of directors;
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition
of our 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. Projections of
any evaluation of effectiveness to future periods are 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.
Our management assessed the effectiveness of our internal control over financial reporting as of June 30, 2010. In making this
assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) in Internal Control-Integrated Framework.
Based on our assessment, our management believes that, as of June 30, 2010, our internal control over financial reporting is effective.
Changes in Internal Control over Financial Reporting
During the quarter ended June 30, 2010, there were no changes in the Company’s internal control over financial reporting (as defined
in Rule 13a-15(f) of the Exchange Act) that materially affected, or are reasonably likely to materially affect, the Company’s internal
control over financial reporting.
Registered Public Accounting Firm Report on Internal Control over Financial Reporting
This Annual Report on Form 10-K does not include an attestation report of the Company’s independent registered public accounting
firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s
independent registered public accounting firm pursuant to an exemption for smaller reporting companies under Section 989G of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
ITEM 9B.
OTHER INFORMATION
None.
42
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:
Directors:
Age
Position
William Farber...........................
78
Chairman of the Board
Ronald A. West..........................
76
Vice Chairman of the Board, Director
Arthur P. Bedrosian ...................
64
Director
Jeffrey Farber.............................
49
Director
Kenneth Sinclair Ph.D. ..............
63
Director
Albert I. Wertheimer, Ph.D........
67
Director
Myron Winkelman .....................
72
Director
Officers:
Arthur P. Bedrosian ...................
64
President and Chief Executive Officer
Keith R. Ruck ............................
49
Vice President of Finance and Chief Financial Officer
Stephen J. Kovary ......................
53
Vice President of Operations
William F. Schreck ....................
61
Senior Vice President and General Manager
Kevin R. Smith ..........................
50
Vice President of Sales and Marketing
Ernest J. Sabo.............................
62
Vice President of Regulatory Affairs and Chief Compliance Officer
William Farber 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 was previously a registered pharmacist in the State of Michigan for more than 40 years
until his retirement from active employment in the pharmaceutical industry.
The Nominating and Governance Committee concluded that Mr. Farber is qualified and should continue to serve, due, in part, to his
long and very successful career in generic drug distribution, having built and managed one of the Country’s leading generic
distribution companies. His skills include cost controls and material handling.
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. Prior
to this, from 1983 to 1987, Mr. West, member of 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 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.
43
The Nominating and Governance Committee concluded that Mr. West is qualified and should continue to serve, due, in part, because
of his long and successful career in the manufacturing sector, both as a senior executive and as a financial manager. In addition to his
financial analytic skills, he is a natural leader with solid experience in corporate governance.
Jeffrey Farber was elected a Director of the Company in May 2006. Jeffrey Farber joined the Company in August 2003 as Secretary.
For the past 14 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.
The Nominating and Governance Committee concluded that Mr. Farber is qualified and should continue to serve, due, in part, to his
significant experience in the generic drug industry and his ongoing role as the owner of a highly regarded and successful generic drug
distributor. His skills include a thorough knowledge of the generic drug marketplace and drug supply chain management.
Kenneth Sinclair, Ph.D., was elected a Director of the Company in September 2005. Dr. Sinclair is currently Professor of
Accounting and Senior Advisor to the College of Business and Economics Dean at Lehigh University, where he began his academic
career in 1972. Dr. Sinclair had served as Chair of Lehigh’s Accounting Department from 1988 to 1994 and 1998 to 2007. He has
taught a variety of accounting courses, including financial and managerial accounting at both the undergraduate and graduate level.
He 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. He has also been heavily involved with strategic planning at both
the College and Department level at Lehigh. 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 with a concentration in Accounting from
the University of Massachusetts.
The Nominating and Governance Committee concluded that Dr. Sinclair is qualified and should continue to serve, due, in part to his
long and distinguished career as an Accounting Academic and his deep understanding of accounting and financial reporting. His skills
also include organizational planning and interpersonal relations.
Albert I. Wertheimer, Ph.D., 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 28 books and more than 380 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 Health Services Research;
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 Buffalo, a Doctorate from Purdue University and a Post Doctoral Fellowship from the
University of London, St. Thomas’ Medical School.
The Nominating and Governance Committee concluded that Dr. Wertheimer is qualified and should continue to serve, due, in part to
his deep understanding of all aspects of pharmacy practice, including retail and manufacturing. His skills include business planning
and a sound knowledge of drug regulation and distribution.
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
44
and the Michigan Pharmacy Association. Mr. Winkelman is a registered pharmacist and holds a Bachelor of Science Degree in
Pharmacy from Wayne State University.
The Nominating and Governance Committee concluded that Mr. Winkelman is qualified and should continue to serve, due, in part to
his experiences with and knowledge of Pharmacy Benefit Administration and Mail Order Pharmacy. His skills include a deep
understanding of government pharmacy benefits and the drug supply chain.
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 a Director 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, Pharmeral, Inc. a
drug representation company selling generic drugs 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.
The Nominating and Governance Committee concluded that Mr. Bedrosian is qualified to serve as a director, in part, because his
experience as our President and Chief Executive Officer has been instrumental in the company’s growth and provides the board with a
compelling understanding of our operations, challenges and opportunities. In addition, his 42-year background in the
generic pharmaceutical industry that encompasses a broad background and knowledge in the underlying scientific, sales, marketing
and supply chain management brings special expertise to the board in developing our business strategies. His recent qualification
to FINRA’s list of arbitrators recognizes his expertise and experience.
Keith R. Ruck joined the Company in September 2008 as Corporate Controller. On March 23, 2009, the Company named Mr. Ruck
Interim Chief Financial Officer. Effective October 13, 2009, Mr. Ruck was appointed and assumed the duties as the Company’s Vice
President of Finance and Chief Financial Officer. Mr. Ruck, a Certified Public Accountant (CPA), has more than 27 years of public
company financial management experience. Prior to joining Lannett, he served as Corporate Controller of Optium Corporation from
April 2007 to September 2008. From 2000 to 2007, he was Vice President - Finance of MAAX KSD Corporation and from 1998 to
2000, he served as Vice President of Finance and Chief Financial Officer of Total Containment, Inc. Mr. Ruck earned a Bachelor of
Science degree in business administration and a Master of Finance degree from LaSalle University.
Stephen J. Kovary R. Ph. joined the Company in September 2009 as Vice President of Operations. Prior to joining Lannett,
Mr. Kovary was the Vice President, Plant Manager for PF Laboratories, a division of Purdue Pharma, LP, since 2003. Formerly,
Mr. Kovary held senior level management positions at Pliva, Inc, Abbott Laboratories, Knoll Pharmaceuticals and Parke-Davis.
Mr. Kovary holds a Bachelor of Science in Pharmacy from the Rutgers University Ernest Mario School of Pharmacy and a Masters in
Business Administration in Management from Fairleigh Dickenson University. Mr. Kovary is a member of the American and New
Jersey Pharmaceutical Associations, the International Society of Pharmaceutical Engineers and the Parenteral Drug Association.
Mr. Kovary is a registered pharmacist in the State of New Jersey and a member of the Alumni Association of the Rutgers University
Ernest Mario School of Pharmacy.
Ernest J. Sabo joined Lannett in March 2005 as Director of Quality Assurance. In May 2008, Mr. Sabo was promoted to Vice
President of Regulatory Affairs and Chief Compliance Officer. Prior to this, he served at Wyeth Pharmaceuticals as Manager of QA
Compliance from 2001 to 2003 and as Associate Director of QA Compliance from 2003 to 2005. Mr. Sabo held former positions as
Director of Validation, Quality Assurance, Quality Control and R&D at Delavau/Accucorp, Inc. from 1993 thru 2001. He has over 30
years experience in the pharmaceutical industry, his background spans from Quality Assurance, Quality Control, Cleaning/Process
Validation and Manufacturing turn-key operations. Mr. Sabo holds a Bachelor of Arts in Biology from Trenton State College (now
known as The College of New Jersey).
William F. Schreck joined the Company in January 2003 as Materials Manager. In May 2004, he was promoted to Vice President of
Logistics. In August 2009, Mr. Schreck has been promoted to Senior Vice President and General Manager. 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.
45
Kevin R. 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 2010, all filing requirements applicable to its officers, directors and greater-than-
10% beneficial owners under Section 16(a) of the Exchange Act were complied with, except for certain Form 4s that were filed late
related to certain stock option and restricted share grants made to the officers of Lannett in the current and prior years, and except for
certain Form 4s related to Mr. William Farber’s gifting of approximately 528,000 shares in October 2009 to a family trust whose
beneficiaries are his grandchildren that were filed late.
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 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. Sinclair, current director of Lannett as well as current Professor of Accounting and
Senior Advisor to the College of Business and Economics Dean at Lehigh University, where he began his academic career in 1972, is
the audit committee financial expert as defined in section 3(a)(58) of the Exchange Act and the related rules of the Commission.
46
ITEM 11.
EXECUTIVE COMPENSATION
The following table summarizes all compensation paid to or earned by the named executive officers of the Company for Fiscal 2010,
Fiscal 2009 and Fiscal 2008.
Name and Principal
Position
(a)
Fiscal
Year
(b)
Salary
(c)
Stock
Awards
(e)
Options
Awards
(f)
Non-equity
incentive plan
compensation
(g)
All Other
Compensation
(i)
Total
(j)
Arthur P. Bedrosian.........................
President and Chief Executive
Officer.........................................
Keith R. Ruck (1) ............................
Vice President of Finance and
Chief Financial Officer...............
Stephen J. Kovary (2)......................
Vice President of Operations...........
William Schreck ..............................
Senior Vice President and
General .......................................
Manager ...........................................
Kevin Smith.....................................
Vice President of Sales and
Marketing ..................................
2010
$
407,410
$
359,384
$
297,390
$
269,750
$
22,367
$ 1,356,301
2009
2008
2010
2009
2008
2010
2009
2008
2010
2009
2008
2010
2009
2008
367,202
324,825
—
122,234
42,381
158,303
189,293
89,550
243,090
128,854
—
156,923
—
—
—
—
—
—
—
22,163
—
97,248
—
—
196,681
177,791
302,729
180,722
170,670
—
68,022
22,603
105,535
206,564
179,455
198,260
200,180
192,005
—
61,490
22,603
105,535
244,365
—
123,500
60,617
—
105,069
—
—
130,000
118,947
—
135,019
130,825
—
43,796
22,099
697,744
627,461
11,257
656,690
1,234
—
22,548
—
—
212,868
—
381,788
—
—
28,159
835,360
18,341
18,044
340,613
362,271
21,985
741,283
21,502
21,495
375,110
380,525
(1) Mr. Ruck was hired on September 8, 2008 as Corporate Controller. Mr. Ruck assumed the title of Interim Chief Financial Officer
on March 23, 2009. Effective October 13, 2009, Mr. Ruck was appointed and assumed the duties as the Company’s Vice President of
Finance and Chief Financial Officer.
(2) Mr. Kovary was hired on September 8, 2009 as Vice President of Operations.
47
(i)
Supplemental All Other Compensation Table
The following table summarizes the components of column (i) of the Summary Compensation Table:
Company
Name and Principal
Position
Fiscal
Year
Match
Contributions
401(k) Plan
Auto
Allowance
Pay in
Lieu of
Housing
Vacation Allowance
Excess Life
Insurances
Sign On
Bonus
Total
Arthur P. Bedrosian........................
President and Chief
Executive Officer ......................
Keith R. Ruck .................................
Vice President of Finance
and Chief Financial
Officer........................................
Stephen J. Kovary...........................
Vice President of
Operations..................................
William Schreck .............................
Senior Vice President
and ............................................
General Manager ............................
Kevin Smith....................................
Vice President of Sales
and .............................................
Marketing........................................
2010
$
8,219
$
13,500
$
—
$
—
$
648
$
—
$
22,367
2009
2008
2010
2009
2008
2010
2009
2008
2010
2009
2008
2010
2009
2008
8,823
8,195
2,499
1,182
—
4,000
—
—
7,918
7,114
6,872
8,371
7,905
7,889
13,500
13,500
8,668
—
—
8,474
—
—
20,993
—
—
—
—
—
—
—
10,800
9,030
10,800
10,800
13,500
13,500
13,500
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
480
404
90
52
—
74
—
—
411
427
372
114
97
106
—
—
—
—
—
43,796
22,099
11,257
1,234
—
10,000
22,548
—
—
—
—
—
—
—
—
—
—
28,159
18,341
18,044
21,985
21,502
21,495
Aggregated Options/SAR Exercises and Fiscal Year-end Options/SAR Values
GRANTS OF PLAN-BASED AWARDS
Estimated Future Payouts
Under Non-Equity Incentive
Plan Awards
Target
($)
(d)
Maximum
($)
(e)
Threshold
($)
(c)
Name
(a)
Grant Date
(b)
Arthur P. Bedrosian.............
President and Chief
Executive Officer ..........
Keith R. Ruck......................
Vice President of Finance
and Chief Financial
Officer ..........................
Stephen J. Kovary ...............
Vice President of
Operations .....................
William Schreck..................
Senior Vice President and
General Manager.................
Kevin Smith ........................
Vice President of Sales and
Marketing ......................
10/29/2009
10/29/2009
11/10/2009
10/13/2009
10/29/2009
10/29/2009
11/10/2009
9/14/2009
10/27/2009
10/29/2009
10/29/2009
11/10/2009
10/29/2009
10/29/2009
11/10/2009
All Other
Stock
Awards:
Number of
Shares of
Stocks or
Units (#)
(i)
All Other
Option
Awards:
Number of
Securities
Underlying
Options (#)
(j)
Exercise
or Base
Price of
Option
Awards
($/sh)
(k)
Grant Date
Fair Value of
Stock and
Options
Awards
(i)
75,000 $
6.94 $
297,390
30,000
23,259
$
$
208,200
151,184
40,000 $
7.98 $
183,612
10,000
3,100
15,000 $
6.94 $
$
$
59,478
69,400
20,150
20,000 $
8.48 $
97,248
15,000 $
7.53 $
64,817
60,000 $
6.94 $
$
$
237,912
104,100
73,691
50,000 $
6.94 $
198,260
$
$
104,100
75,355
15,000
11,337
15,000
11,593
Estimated Future Payouts Under
Equity Incentive Plan Awards
Target
($)
(g)
Maximum
($)
(h)
Threshold
($)
(f)
48
OUTSTANDING EQUITY AWARDS AT JUNE 30, 2010
Option Awards
Stock Awards
Equity
Incentive
Plan
Awards:
Number of
Unearned
Shares,
Units or
Other
Rights
That Have
Not Vested
(#)
(i)
Equity
Incentive
Plan
Awards:
Market or
Payout
Value of
Unearned
Shares,
Units or
Other
Rights
That Have
Not Vested
($)
(j)
Name
(a)
Arthur P. Bedrosian.................
President and Chief Executive
Officer . . . . . . . . . . . . . . .
Keith R. Ruck..........................
Vice President of Finance and
Chief Financial Officer . . . .
Stephen J. Kovary ...................
Vice President of Operations ..
William Schreck......................
Senior Vice President and
General Manager . . . . . . . .
Kevin Smith ............................
Vice President of Sales and
Marketing . . . . . . . . . . . . .
Number of
Securities
Underlying
Unexericised
Options (#)
Exercisable
(b)
Number of
Securities
Underlying
Unexericised
Options (#)
Unexercisable
(c)
Equity
Incentive Plan
Awards:
Number of
Securities
Underlying
Unexericised
Unearned
Options (#)
(d)
Number of
Shares or
Units of
Stock That
Have Not
Vested (#)
(g)
Market
Value of
Shares or
Units of
Stock That
Have Not
Vested ($)
(h)
Option
Exercise
Price ($)
(e)
Option
Expiration
Date
(f)
18,000
96,900
33,000
30,000
25,000
30,000
50,000
10,000
—
5,000
—
—
—
—
—
—
—
—
25,000
20,000
75,000
10,000
40,000
15,000
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
4.63
7.97
17.36
16.04
8.00
6.89
4.03
2.80
6.94
7/23/2012
10/28/2012
10/24/2013
5/11/2014
1/18/2016
11/28/2016
9/18/2017
9/18/2018
10/29/2019
2.79
7.98
6.94
10/17/2018
10/13/2019
10/29/2019
—
20,000
— $
8.48
9/14/2019
17,745
12,000
15,000
33,333
5,333
—
—
38,760
13,000
20,000
12,000
15,000
33,333
5,333
—
—
—
—
16,667
10,667
15,000
60,000
—
—
—
—
—
16,667
10,667
50,000
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
— $
11.27
5.18
6.89
4.03
2.80
7.53
6.94
7.97
17.36
16.04
5.18
6.89
4.03
2.80
6.94
2/18/2013
10/25/2015
11/28/2016
9/17/2017
9/18/2018
10/27/2019
10/29/2019
10/28/2012
10/24/2013
5/11/2014
10/25/2015
11/28/2016
9/18/2017
9/18/2018
10/29/2019
35,534 $
162,390
10,000 $
45,700
18,100 $
82,717
18,100 $
82,717
The options above were granted ten years prior to the option expiration date and vest over three years from that grant date.
49
Employment Agreements
The Company has entered into employment agreements with Arthur P. Bedrosian, President and Chief Executive Officer, Keith R.
Ruck, Vice President of Finance and Chief Financial Officer, Kevin Smith, Vice President of Sales and Marketing, William Schreck,
Senior Vice President and General Manager, Ernest Sabo, Vice President of Regulatory Affairs and Chief Compliance Officer and
Stephen Kovary, Vice President of Operations. Each of the agreements provide for an annual base salary and eligibility to receive a
bonus. The salary and bonus amounts of these executives are determined by the Board of Directors. Additionally, these executives
are eligible to receive stock options and restricted stock awards, which are granted at the discretion of the Board of Directors, and in
accordance with the Company’s policies regarding stock option and restricted stock grants. Under the agreements, these 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 these executives of between 18 months and three years.
During the third quarter of Fiscal Year 2009, the Company’s former Vice President of Finance, Treasurer, Secretary and Chief
Financial Officer resigned. As part of his separation agreement, the Company was obligated to pay to him approximately $670,000 to
settle any outstanding obligations from his employment agreement, including any salary, bonus, vacation, stock options and medical
benefits. Of this amount, $300,440 was paid in Fiscal 2009 with $165,000 designated for the payment of pro rated bonus, and $11,440
was designated for the payment of accrued but unused paid time off. As part of the settlement, $124,000 was designated as the portion
of the settlement related to the repurchase of his outstanding stock options. The Company therefore charged this amount to Additional
Paid in Capital, as it represents the fair value of the options repurchased on the repurchase date. Additional payments totaling
$369,000 for severance and benefits will be paid in Fiscal 2011 pursuant to the separation agreement.
Compensation of Directors
DIRECTOR COMPENSATION
Name
(a)
Fees
Earned
($)
(b)
Stock
Awards
($)
(c)
Options
Awards
($)
(d)
Non-Equity
Incentive Plan
Compensation
($)
(e)
Change in
Pension Value
and Nonqualified
Deferred
Compensation
($)
(f)
All Other
Compensation
($)
(g)
Total
($)
(h)
William Farber........
$
46,000 $
48,375 $
— $
— $
— $
— $
94,375
Ronald A. West.......
70,500
48,375
Jeffrey Farber..........
49,000
48,375
Kenneth Sinclair .....
66,000
48,375
Albert Wertheimer ..
70,500
48,375
Myron Winkelman ..
64,000
48,375
COMPENSATION DISCUSSION AND ANALYSIS
Overview of Our Compensation Program
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
118,875
97,375
114,375
118,875
112,375
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.
50
Important to our compensation program are the decisions of, and guidance from, the Compensation Committee of our Board of
Directors. The Compensation 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 NYSE-AMEX 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 13200 Townsend Road, Philadelphia, Pennsylvania 19154.
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 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. 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 Committee annually reviews recommendations from
their outside consultant, and makes recommendations to the Board about the compensation of non-employee directors. During fiscal
years 2008 and 2009, Lannett used Mercer Consulting Inc. as its consultant. During fiscal year 2010, Lannett used Compensation
Resources Inc. as its consultant.
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 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 individuals who served as Chief Executive Officer and Chief Financial Officer during Fiscal 2010, as well as the other individuals
included in the Summary Compensation Table on page 48, are referred to as the “named executive officers.”
Risk Assessment
The criteria used for the bonus program of operating performance, research and development inclusive of ANDA/NDA submissions,
acceptances of ANDA/NDAs, launches of approved ANDA/NDAs, individual performance goals, along with the weighting of each
element, were assembled by the Company for our industry and were found to be reasonable for the nature of our business. The
Compensation Committee reviews this criteria and a gives final approval to the senior management. It is then presented to the Board
of Directors for final approval.
Operating performance ties in directly with shareholder value. There is no bonus opportunity for management if they do not create
value, so management interests and shareholder value are aligned. The risk of diluting the Company’s operating cash positions
through the awarding of excessive bonus awards is controlled by the imposition of a bonus cash award limit equal to 20% of adjusted
operating income as calculated from its fiscal year-end financial statements.
The R&D component of the criteria looks to the sustainability and growth of the organization. While it could be argued that there is
risk associated with the choice of which products to submit for approval, there is no indication that those risks would be outside what
would be considered normal and reasonable in the course of doing business. The ultimate goal is to be able to sell a product that
positively impacts operating performance, which cannot occur unless the process of submission, approval, and launch is followed. If
submissions do not make it to the approval stage, and if the approved products are not successfully launched, they cannot positively
affect operating performance. Since there is a minimum operating performance (operating profit) level that must be attained before
any payments are made through the bonus plan, there is a check and balance to prevent what could be viewed as a portfolio of “risky”
submittals. The impact on operating performance is created over a period of time based on the total sales, so there needs to be
sustainability with any new launch.
51
The achievement of individual goals as part of the bonus is subject to review and approval by senior management with the CEO being
the final review and approval. This multi-level process reduces the risk of having goals that are not linked to the overall objectives of
the Company and its success. The awarding of a CEO discretionary portion, currently at 5% of the total of the bonus, also requires the
same oversight. The total impact on bonus payout of these parts of the bonus program is significantly less than the operating
performance and R&D parts. Again, there is no bonus payout unless the operating performance (operating profit) minimum goals are
attained.
We believe our bonus program, along with the other elements of our executive compensation program, provides appropriate rewards
and incentives to our executives to achieve our financial, business, and strategic goals. We also believe the structure and oversight of
these programs provides a setting that does not encourage them to take excessive risks in their business decisions.
Our Fiscal 2010 Compensation Program
In Fiscal 2010, 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 objective 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 2010 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 2010 operating income, other
•
targeted corporate goals and individual or departmental objectives,
various forms of equity compensation, including some grants based upon Fiscal 2010 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 2010 Compensation Elements
The table below provides detailed information regarding each element of the Fiscal 2010 compensation program.
Compensation Element Overview
Purpose of the Compensation Element
Base Salary .....
Short-Term
Incentives ........
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.
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 2010, objectives for the Officers
were tied to Lannett’s achievement of operating income
targets, other targeted corporate goals and individual
objectives.
To provide competitive fixed compensation based on
sustained performance in the executive’s role and
competitive market practice.
To motivate and focus our executive team on the
achievement of our annual performance goals.
52
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
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.
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.
401(k) Plan
Executives may participate in Lannett’s
401(k) retirement savings plan, which is available to all
employees. Lannett matches contributions to the Plan,
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.
53
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: automobile allowances in various
amounts to key executives.
We believe these benefits better allow us to attract
and retain superior employees for key positions.
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 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 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.
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 2009 and 2010 compensation for the named executive officers, the Committee relied on market data provided by its
consultants. This information was principally related to two groups of peer companies similar in size to Lannett with revenues one-
half (1/2) to double (2x) that of Lannett. Companies were also added that were deemed business peers. One peer group (Peer Group A)
consists of twenty-nine (29) pharmaceutical companies on a national scale. The other peer group (Peer Group B) consists of twelve
(12) pharmaceutical companies in the Philadelphia and Northeast Region. 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 Groups were:
54
Peer Group A ............................................................
Peer Group B
Auxilium Pharma Inc
BMP Sunstone Corp
Cambrex Corp
Emergent Biosolutions Inc.
Enzon Pharmaceuticals Inc.
Hi Tech Pharmacal Co. Inc.
Interpharm Holdings Inc.
NPS Pharmaceuticals Inc.
Orasure Technologies Inc.
Osi Pharmaceuticals Inc.
Par Pharmaceutical Cos. Inc.
Sucampo Pharmaceuticals Inc.
Akorn Inc..................................................................
Balchem Corp...........................................................
Barr Pharmaceuticals Inc..........................................
Bentley Pharmaceuticals...........................................
Biomarin Pharmaceuticals Inc..................................
Bradley Pharmaceuticals Inc. ...................................
Caraco Pharmaceutical Labs.....................................
Chattem Inc ..............................................................
Cubist Pharmaceuticals Inc.......................................
Impax Laboratories Inc.............................................
Indevus Pharmaceuticals Inc. ...................................
Inspire Pharmaceuticals Inc......................................
Intermune Inc............................................................
Ista Pharmaceuticals Inc. ..........................................
Kensey Nash Corp. ...................................................
Mattrix Initiatives Inc. ..............................................
Medicines Co............................................................
Nektar Therapeutics..................................................
Neogen Corp.............................................................
Noven Pharmaceuticals Inc. .....................................
Obagi Medical ..........................................................
Pain Therapeutics Inc. ..............................................
Pozen Inc. .................................................................
Questcor Pharmaceuticals Inc...................................
Salix Pharmaceuticals Ltd. .......................................
Santarus Inc. .............................................................
Valeant Pharmaceuticals Intl. ...................................
Vertex Pharmaceuticals Inc. .....................................
Vivus Inc. .................................................................
The Committee plans to evaluate the Peer Group periodically 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.
Base salary increases were granted to Mr. Bedrosian for $34,490 effective on August 31, 2009, Mr. Smith for $6,050 effective on
August 31, 2009, and Mr. Schreck for $17,289 effective on August 31, 2009, based on their performance. Mr. Ruck was promoted to
Vice President of Finance and Chief Financial Officer from Corporate Controller effective on October 13, 2009 and received a salary
increase of $40,000 in connection with such promotion. Mr. Kovary was hired on September 8, 2009 as Vice President of Operations
and therefore did not receive a salary increase.
Fiscal 2010 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 2010 operating income goal, other
targeted corporate goals 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 other targeted corporate goals, 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.
55
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
Superior Level..........
Goal Level ...............
Threshold Level .......
Arthur
Bedrosian
120-150%
100-120%
50-100%
Keith
Ruck
120-150%
100-120%
50-100%
Stephen
Kovary
120-150%
100-120%
50-100%
William
Schreck
120-150%
100-120%
50-100%
Kevin
Smith
120-150%
100-120%
50-100%
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 2010 included Company operating income targets and other
targeted corporate goals. 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 2010 and taking into account the
expectations of our annual plan. The Fiscal 2010 operating income and other corporate goals AIBP targets approved by the Committee
are detailed in the table below.
Objective
Operating Profit* ..................................................
R&D Submissions ................................................
R&D Acceptances ................................................
R&D Launches .....................................................
Superior
Goal
Target
$
17.5M $
13.5M $
10
9
8
8
7
6
9.45M
6
5
4
* Operating Profit is defined as Operating Income plus adding back Bonus Expense. For purposes of determining
achievement of the AIBP targets, these measures can exclude certain categories of non-recurring items that the
Committee believes do not reflect the performance of Lannett’s core continuing operations. There were no
adjustments made in Fiscal 2010 for non-recurring items.
All payouts to the named executive officers under the 2010 AIBP were contingent upon the Committee’s review and certification of
the degree to which Lannett achieved the 2010 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 (as defined by the AIBP) attained by Lannett.
The 2010 AIBP program provided that the Committee could, in its discretion: modify, amend, suspend or terminate the Plan at any
time.
Results
In September 2010, the Committee reviewed and certified Lannett’s Fiscal 2010 results for purposes of the AIBP program,
determining that the objectives for operating income and other corporate objectives achieved the Superior goals set at the beginning of
the year, which represented 50% and 25% of the named executive officer total bonus amounts, respectively.
The Committee also reviewed and certified the performance of the named executive officer individual objectives, which represented
20% of their total bonus amounts, determining that these objectives were achieved as described below.
Mr. Bedrosian’s objectives were to oversee the expansion and profitability of the Cody Laboratories subsidiary and increase the
manufacturing of additional APIs, achieve overall cGMP and other agency regulatory compliance, achieve operational efficiency,
monitor headcount, identify new market and product opportunities, increase the response time for Board of Director requests and keep
them abreast of changes in director regulatory compliance, and seek out potential acquisitions, alliances and joint ventures.
Mr. Schreck’s objectives were to reduce verified shipping errors, maintain inventory control measures, and complete the fit out and
personnel move to the Company’s recently acquired Townsend Road facility.
56
Mr. Smith’s objectives were to improve market share of products, increase net sales to at least $123.0 million, decrease obsolete
finished goods inventory through various short date promotions, and improve forecasts for production planning purposes..
Mr. Ruck’s objectives were to achieve a more cohesive accounting department, deliver accurate and timely month-end financial
reports to senior management and the Board of Directors, reduce outside auditor and accounting professional fees and transition into
the role of CFO from his interim role.
Mr. Kovary’s objectives were to assess and reorganize the overall organizational structure, evaluate, improve and track the Company’s
facility and equipment requirements through a more formal capital investment plan, and review and enhance policies and procedures
to ensure regulatory compliance.
In addition, all named executive officers received their 5% CEO discretionary bonus amount.
In calculating the 2010 bonus payments to the named executives as well as the other employees, it was determined that the Superior
Level bonuses could not be paid because the accumulated total of payments to all employees would exceed 20% of the actual
operating income achieved by the Company in Fiscal 2010 (“20% cap”). The Committee, in its discretion, altered the 2010 bonus
payments in two ways as a one-time adjustment: First, the Committee lowered the overall calculation of the payout to the high end of
the Goal Level. Second, it decided to grant unrestricted shares of stock that would make up the difference between the 20% cap and
the amount that employees would have received if the 20% cap were not in place. These unrestricted shares will immediately vest
upon grant, which is anticipated to occur in November 2010. The total value of the 2010 bonus payouts, including the unrestricted
stock grant is expected to approximate 27.5% of the pre-bonus actual operating profit for the 2010 Fiscal Year. The Company
reviewed and altered its current compensation structure, including the AIBP program by the fall of 2010 so that fair compensation can
be paid to its employees starting in Fiscal 2011 and beyond while still respecting the 20% bonus cap requirement.
2010 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. The
Committee has not yet determined the amount of both stock options and restricted stock to be granted to executives for this year, but
expects to complete these grants by the second quarter of Fiscal 2011. But when these grants are determined, each will be designed to
emphasize particular elements of the Company’s immediate and long-term objectives and to retain key executives. We will refer to
these grants collectively as the 2010 Long Term Incentive Awards (LTIA). The types of grants will be:
stock options, becoming exercisable over three years (approximately one-third increments on each anniversary) from the date
•
of the grant and having a total term of ten years, and
shares of restricted stock, vesting over three years (approximately one-third increments 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 2010 LTIA will 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
57
and restricted stock awards are intended to align executives’ motivation with stockholders’ best interests. Grants of stock options will
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 will be
contingent upon Lannett achieving annual sales growth and return on invested capital goals. Restricted stock will vest in
approximately one-third increments on the first three anniversaries of the date of the grant.
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.
Lannett matches contributions to the 401(k) plan on a fifty cents on the dollar basis up to 8% of the contributing employee’s base
salary, subject to limitations of the Plan and applicable law. The named executive officers are also provided with car allowances, for
which the taxes are also paid by the Company.
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 $2,000/week for short term disability and $15,000/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, 2010, 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 for Fiscal 2010 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
Myron Winkelman (Chair)
Albert Wertheimer
Ronald West
59
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth, as of July 31, 2010, 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. Although grants of restricted stock under the Company’s 2006 Long Term Incentive Plan (“2006 LTIP”) generally
vest equally over a three year period from the grant date, the restricted shares are included below because the voting rights with
respect to such restricted stock are acquired immediately upon grant.
Name and Address of
Beneficial Owner
Directors/Executive Officers:
William Farber
13200 Townsend Road
Philadelphia, PA 19154 ...............
Ronald A. West
13200 Townsend Road
Philadelphia, PA 19154 ...............
Jeffrey Farber
13200 Townsend Road
Philadelphia, PA 19154 ...............
Kenneth Sinclair
13200 Townsend Road
Philadelphia, PA 19154 ...............
Albert Wertheimer
13200 Townsend Road
Philadelphia, PA 19154 ...............
Myron Winkelman
13200 Townsend Road
Philadelphia, PA 19154 ...............
Arthur P. Bedrosian
13200 Townsend Road
Philadelphia, PA 19154 ...............
William Schreck
13200 Townsend Road
Philadelphia, PA 19154 ...............
Kevin Smith
13200 Townsend Road
Philadelphia, PA 19154 ...............
Office
Excluding Options
Including Options (*)
Number of
Shares
Percent of
Class
Number of
Shares
Percent of
Class
Chairman of the Board
Vice Chairman of the
Board, Director
Director
Director
Director
Director
President and Chief
Executive Officer
Senior Vice President and
General Manager
Vice President of Sales
and Marketing
8,162,487 (1)
32.34% 8,254,987 (1),(2)
32.59%
16,810 (3)
0.07%
71,758 (3),(4)
0.28%
5,703,562 (5)
22.60% 5,751,062 (5),(6)
22.74%
17,500 (7)
0.07%
42,500 (7),(8)
0.17%
18,500 (9)
0.07%
43,500 (9),(10)
0.17%
18,500 (11)
0.07%
58,500 (11),(12)
0.23%
592,358 (13)
2.35%
920,258 (13),(14)
3.60%
38,168 (15)
0.15%
143,580 (15),(16)
0.57%
39,313 (17)
0.16%
198,740 (17),(18)
0.78%
Ernest Sabo
13200 Townsend Road
Philadelphia, PA 19154 ...............
Vice President of
Regulatory Affairs and
Chief Compliance Officer
22,604 (19)
0.09%
63,031 (19),(20)
0.25%
David Farber
6884 Brook Hollow Ct West
Bloomfield, MI 48322 .................
5,705,050 (21)
22.61% 5,727,550 (21),(22)
22.67%
Keith R. Ruck
13200 Townsend Road
Philadelphia, PA 19154 ...............
Vice President of Finance
and Chief Financial
Officer
14,734 (23)
0.06%
19,734 (23),(24)
0.08%
60
Name and Address of
Beneficial Owner
Farber Properties
1775 John R Road Troy, MI 48083
.....................................................
Farber Family LLC
1775 John R Road Troy, MI 48083
.....................................................
Farber Investment LLC
1775 John R Road Troy, MI 48083
.....................................................
Stephen Kovary
13200 Townsend Road
Philadelphia, PA 19154 ...............
All directors and
executive officers as a group
(12 persons)..................................
Office
Excluding Options
Including Options (*)
Number of
Shares
Percent of
Class
Number of
Shares
Percent of
Class
5,000,000 (25)
19.81% 5,000,000
19.81%
528,142(26)
2.09%
528,142
2.09%
Vice President of
Operations
38,000(27)
0.15%
38,000
0.15%
1,899 (28)
0.01%
8,566 (28),(29)
0.03%
14,646,435
58.03% 15,576,214
59.53%
Includes 197,825 shares owned by William Farber’s spouse, Audrey Farber; 14,000 shares owned by William Farber’s
(1)
brother, Gerald G. Farber, and 132,212 shares held by William Farber as custodian for his seven grandchildren. Includes 26,250
shares held in William Farber’s IRA account. Includes 5,000 shares received pursuant to a restricted stock award granted in
September 2007.
Includes 37,500 vested options to purchase common stock at an exercise price of $7.97 per share, 25,000 vested options to
(2)
purchase common stock at an exercise price of $17.36 per share, 25,000 vested options to purchase common stock at an exercise price
of $16.04 per share, and 5,000 vested options to purchase common stock at an exercise price of $6.89 per share.
(3)
Includes 5,000 shares received pursuant to a restricted stock award granted in September 2007.
Includes 9,948 vested options to purchase common stock at an exercise price of $7.97 per share, 15,000 vested options to
(4)
purchase common stock at an exercise price of $17.36 per share, 25,000 vested options to purchase common stock at an exercise price
of $16.04 and 5,000 vested options to purchase common stock at an exercise price of $6.89.
(5)
Includes 5,000,000 shares held by Farber Properties Group LLC (“FPG”). FPG is managed and jointly owned by Jeffrey
Farber and David Farber. David Farber and Jeffrey Farber each disclaim beneficial ownership of 2,500,000 shares held by FPG.
Includes 528,142 shares held by Farber Family LLC (“FFLLC”) which is managed by Jeffrey and David Farber. David Farber and
Jeffrey Farber each disclaim beneficial ownership of these shares. Includes 150 shares held by Jeffrey Farber as custodian for his son
and 10,800 shares held by William Farber as custodian for his children. Also includes 9,500 shares held by Farber Investment
Company (“FIC”), which holds 38,000 shares of common stock. Jeffrey Farber and David Farber each beneficially owns 25% of FIC
and each disclaims beneficial ownership of all but 9,500 shares held by FIC. Also includes 5,000 shares received pursuant to a
restricted stock award granted in September 2007.
Includes 10,000 vested options to purchase common stock at an exercise price of $17.36 per share, 12,500 vested options to
(6)
purchase common stock at an exercise price of $16.04, 20,000 vested options to purchase common stock at an exercise price of $4.55,
and 5,000 vested options to purchase common stock at an exercise price of $6.89.
(7)
Includes 5,000 shares received pursuant to a restricted stock award granted in September 2007.
(8)
purchase common stock at an exercise price of $6.89 per share.
Includes 20,000 vested options to purchase common stock at an exercise price of $4.55 per share and 5,000 vested options to
(9)
Includes 5,000 shares received pursuant to a restricted stock award granted in September 2007.
61
(10)
purchase common stock at an exercise price of $6.89 per share.
Includes 20,000 vested options to purchase common stock at an exercise price of $9.02 per share and 5,000 vested options to
(11)
Includes 5,000 shares received pursuant to a restricted stock award granted in September 2007.
Includes 15,000 vested options to purchase common stock at an exercise price of $17.36, 20,000 vested options to purchase
(12)
common stock at an exercise price of $16.04 and 5,000 vested options to purchase common stock at an exercise price of $6.89 per
share.
(13)
Includes 33,150 shares owned by Arthur Bedrosian’s wife and 1,000 shares owned by his daughter. Mr. Bedrosian disclaims
beneficial ownership of these shares. Includes 14,745 shares received pursuant to a restricted stock award granted in September 2007
and 30,000 shares received pursuant to a restricted stock award granted in October 2009. Also includes 30,074 shares of common
stock held through employee stock purchase plan.
Includes 18,000 vested options to purchase common stock at an exercise price of $4.63 per share, 96,900 vested options to
(14)
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 per share, 30,000 vested options to purchase common stock at an exercise price of $16.04 per share, 25,000 vested options
to purchase common stock at an exercise price of $8.00 per share, 30,000 vested options to purchase common stock at an exercise
price of $6.89 per share, 75,000 vested options to purchase common stock at an exercise price of $4.03 per share, and 20,000 vested
options to purchase common stock at an exercise price of $2.80.
(15)
pursuant to a restricted stock award granted in October 2009.
Includes 7,247 shares received pursuant to a restricted stock award granted in September 2007, and 15,000 shares received
Includes 17,745 vested options to purchase common stock at an exercise price of $11.27 per share, 12,000 vested options to
(16)
purchase common stock at an exercise price of $5.18 per share and 15,000 vested options to purchase common stock at an exercise
price of $6.89 per share, 50,000 vested options to purchase common stock at an exercise price of $4.03 per share, and 10,667 vested
options to purchase common stock at an exercise price of $2.80 per share.
(17)
pursuant to a restricted stock award granted in October 2009.
Includes 8,263 shares received pursuant to a restricted stock award granted in September 2007, and 15,000 shares received
Includes 38,760 vested options to purchase common stock at an exercise price of $7.97 per share, 13,000 vested options to
(18)
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, 12,000 vested options to purchase common stock at an exercise price of $5.18 per share, 15,000 vested options to
purchase common stock at an exercise price of $6.89 per share, 50,000 vested options to purchase common stock at an exercise price
of $4.03 per share, and 10,667 vested options to purchase common stock at an exercise price of $2.80.
(19)
pursuant to a restricted stock award granted in October 2009.
Includes 5,337 shares received pursuant to a restricted stock award granted in September 2007, and 15,000 shares received
Includes 3,260 vested options to purchase common stock at an exercise price of $7.48 per share, 4,000 vested options to
(20)
purchase common stock at an exercise price of $5.18 per share, 7,500 vested options to purchase common stock at an exercise price of
$6.89 per share, 15,000 vested options to purchase common stock at an exercise price of $4.03 per share, and 10,667 vested options to
purchase common stock at an exercise price of $2.80 per share.
(21)
Includes 5,000,000 shares held by FPG. FPG is managed and jointly owned by Jeffrey Farber and David Farber. David
Farber and Jeffrey Farber each disclaim beneficial ownership of 2,500,000 shares held by FPG. Includes 528,142 shares held by
FFLLC which is managed by Jeffrey and David Farber. David Farber and Jeffrey Farber each disclaim beneficial ownership of these
shares. Indirect shares include 7,488 shares held by David Farber as custodian for his children, 16,200 shares held by William Farber
as custodian for his children and 2,850 shares held by David Farber’s spouse. Also includes 9,500 shares held by FIC, which holds
38,000 shares of common stock. Jeffrey Farber and David Farber each beneficially owns 25% of FIC and each disclaims beneficial
ownership of all but 9,500 shares held by FIC.
(22)
to purchase common stock at an exercise price of $16.04 per share.
Includes 10,000 vested options to purchase common stock at an exercise price of $17.36 per share and 12,500 vested options
(23)
stock held through employee stock purchase plan.
Includes 10,000 shares received pursuant to a restricted stock award granted in October 2009 and 1,634 shares of common
62
(24)
Includes 5,000 vested options to purchase common stock at an exercise price of $2.79 per share.
(25)
Farber Properties Group, LLC is managed and jointly owned by Jeffrey Farber and David Farber.
(26)
Farber Family LLC is managed by Jeffrey Farber and David Farber as trustees.
(27)
Farber Investment LLC is beneficially owned 25% each by Jeffrey and David Farber and 50% by Larry Farber.
(28)
Includes 1,899 shares of common stock held through employee stock purchase plan.
(29)
Includes 6,667 vested options to purchase common stock at an exercise price of $8.48 per share.
* Assumes that all options exercisable within sixty days have been exercised which results in 26,167,392 shares outstanding.
Equity Compensation Plan Information
The following table summarizes the equity compensation plans as of June 30, 2010:
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
(a)
Weighted average
exercise price of
outstanding
options, warrants
and rights
(b)
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a))
(c)
Plan Category
Equity Compensation plans approved by
security holders ........................................
Equity Compensation plans not approved
by security holders ...................................
2,058,851
$
—
Total.........................................................
2,058,851
$
7.45
—
7.45
2,561,068
—
2,561,068
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The Company had sales of approximately $679,000, $786,000, and $787,000 during the fiscal years ended June 30, 2010, 2009 and
2008, respectively, to a generic distributor, Auburn Pharmaceutical Company (“Auburn”). 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. Accounts receivable includes amounts due from the related party of approximately $161,000 and $125,000 at
June 30, 2010 and 2009, 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 in which the Company purchased for $100,000 and future royalty
payments the proprietary rights to manufacture and distribute a product for which Pharmeral, Inc. (“Pharmeral”) owned the ANDA.
In Fiscal 2008, the Company obtained FDA approval to use the proprietary rights. Accordingly, the Company originally capitalized
this purchased product right as an indefinite lived intangible asset and tested this asset for impairment on a quarterly basis. During the
fourth quarter of Fiscal 2009, it was determined that this intangible asset no longer has an indefinite life. No impairment existed
because the estimated fair value exceeded the carrying amount on that date. Accordingly, the $100,000 carrying amount of this
intangible asset will be amortized on a straight line basis prospectively over its 10 year remaining estimated useful life. Arthur
Bedrosian, President and Chief Executive Officer of the Company, Inc. currently owns 100% of Pharmeral. This transaction was
approved by the Board of Directors of the Company and in their opinion the terms were not more favorable to the related party than
they would have been to a non-related party. In May 2008, Mr. Bedrosian and Pharmeral waived their rights to any royalty payments
on the sales of the drug by Lannett under Lannett’s current ownership structure. Should Lannett undergo a change in control where a
third party is involved, this royalty would be reinstated. The registered trademark OB-Natal® was transferred to Lannett for one dollar
from Mr. Bedrosian.
During Fiscal Year 2010, Lannett Company, Inc. paid a management consultant, who is related to Mr. Bedrosian, $115,700 in fees
and $16,803 in reimbursable expenses. This consultant provided management, construction planning, laboratory set up and
administrative services in regards to the Company’s initial set up of its Bio-study laboratory in a foreign country. It is expected that
this consultant will continue to be utilized into Fiscal 2011. In the Company’s opinion, the fee rates paid to this consultant and the
expenses reimbursed to him were not more favorable than what would have been paid to a non-related party.
63
Provell Pharmaceuticals, LLC (“Provell”) was a joint venture to distribute pharmaceutical products through mail order outlets. In
exchange for access to Lannett’s drug providers, Lannett initially received a 33% ownership interest in this venture. Lannett’s
ownership interest subsequently decreased to 25% due to the additional issuance of shares by Provell in which Lannett did not
participate. The investment was valued at zero, due to losses incurred through that date by Provell. During June 2009, the Company
terminated its participation in this joint venture. In connection with the termination agreement, the Company was required to pay
Provell ten percent of net sales of certain products for a period of up to twenty-four months. Accounts receivable includes amounts
due from Provell of zero and approximately $55,000 at June 30, 2010 and 2009, respectively. The Company recognized revenues of
zero and approximately $29,000 and $141,000 during the fiscal years ended June 30, 2010, 2009 and 2008, respectively.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Grant Thornton LLP served as the independent auditors of the Company during Fiscal 2010, 2009 and 2008. No relationship exists
other than the usual relationship between independent public accountant and client. The following table identifies the fees incurred for
services rendered by Grant Thornton LLP in Fiscal 2010, 2009 and 2008.
Audit Fees
Audit-Related (1)
Tax Fees (2)
All Other Fees (3)
Total Fees
Fiscal 2010:
Fiscal 2009:
Fiscal 2008:
$
$
$
352,760
295,084
335,894
$
$
$
—
—
5,900
$
$
$
190,401
179,677
78,880
$
$
$
7,574
10,932
49,964
$
$
$
550,735
485,693
470,638
(1) Audit-related fees include fees paid for preparation of an S-8 filing during Fiscal 2008.
(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.
(3) Other fees include:
Fiscal 2010 — Fees paid for review of various SEC correspondences.
Fiscal 2009 — Fees paid for review of various SEC correspondences.
Fiscal 2008 — Fees paid for review of various SEC correspondences.
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.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)
Consolidated Financial Statements and Supplementary Data
(1) The following financial statements are included herein:
PART IV
Consolidated Balance Sheets as of June 30, 2010 and 2009...........................................................................................
Consolidated Statements of Operations for each of the three fiscal years ended June 30, 2010.....................................
Consolidated Statements of Changes in Shareholders’ Equity for each of the three fiscal years ended June 30, 2010..
Consolidated Statements of Cash Flows for each of the three fiscal years ended June 30, 2010....................................
Notes to Consolidated Financial Statements for the three fiscal years ended June 30, 2010 ..........................................
F-2
F-3
F-4
F-5
F-6
Supplementary Data
(2) The following financial statement schedule is included herein
Schedule II — Valuation and Qualifying Accounts……………………………………………………………………….…F-29
(b)
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
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: September 23, 2010
Date: September 23, 2010
LANNETT COMPANY, INC.
By: / s / Arthur P. Bedrosian
Arthur P. Bedrosian,
President and Chief Executive Officer
By: / s / Keith R. Ruck
Keith R. Ruck
Vice President of Finance 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: September 23, 2010
Date: September 23, 2010
Date: September 23, 2010
Date: September 23, 2010
Date: September 23, 2010
Date: September 23, 2010
Date: September 23, 2010
By: / s / William Farber
William Farber,
Chairman of the Board of Directors
By: / s / Ronald West
Ronald West,
Director, Vice Chairman of the Board,
Lead Outside Director
By: / s / Arthur P Bedrosian
Arthur P. Bedrosian,
Director, President and Chief Executive Officer
By: / s / Jeffrey Farber
Jeffrey Farber,
Director
By: / s / Kenneth Sinclair
Kenneth Sinclair,
Director, Chairman of Audit Committee
By: / s / Albert Wertheimer
Albert Wertheimer,
Director, Chairman of Strategic Planning Committee
By: / s / Myron Winkelman
Myron Winkelman,
Director, Chairman of Compensation Committee
65
3.2
4
10.1
10.2
10.3
10.4
Exhibit
Number
Description
Method of Filing
Exhibit Index
3.1
Articles of Incorporation
By-Laws, as amended
Specimen Certificate for Common Stock
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”)
Line of Credit Note dated March 11, 1999 between
the Company and First Union National Bank
Incorporated by reference to Exhibit 10(ad) to the
Annual Report on 1999 Form 10-KSB
Philadelphia Authority for Industrial Development
Taxable Variable Rate Demand/Fixed Rate Revenue
Bonds, Series of 1999
Incorporated by reference to Exhibit 10(ae) to the
Annual Report on 1999 Form 10-KSB
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
10.5
2003 Stock Option Plan
10.6
Employment Agreement with Kevin Smith
10.7
Employment Agreement with Arthur Bedrosian
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
Incorporated by reference to the Proxy Statement for
Fiscal Year Ending June 30, 2002
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.
10.9 (Note A)
Agreement between Lannett Company, Inc and
Siegfried (USA), Inc.
Incorporated by reference to Exhibit 10.9 to the
Annual Report on 2003 Form 10-KSB
10.10 (Note A)
Agreement between Lannett Company, Inc and
Jerome Stevens, Pharmaceutical, Inc.
Incorporated by reference to Exhibit 2.1 to Form 8-K
dated April 20, 2004
10.11
10.12
Terms of Employment Agreement with Stephen J.
Kovary
Incorporated by reference to Exhibit 10.11 to the
Annual Report on 2009 Form 10-K
Agreement of Sale Between Anvil Construction
Company, Inc. and Lannett Company, Inc.
Incorporated by reference to Exhibit 10.12 to the
Annual Report on 2009 Form 10-K
10.13
2007 Long Term Incentive Plan
10.14
Employment Agreement with Keith R. Ruck
Incorporated by reference to the Proxy Statement
dated January 5, 2007
Incorporated by reference to Exhibit 10.1 on Form 8-
K dated October 13, 2009
66
Exhibit
Number
Description
Method of Filing
13
21
23.1
31.1
31.2
32
Annual Report on Form 10-K
Filed Herewith
Subsidiaries of the Company
Filed Herewith
Consent of Grant Thornton, LLP
Filed Herewith
Certification of Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
Filed Herewith
Certification of Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
Filed Herewith
Certifications of Chief Executive Officer and Chief
Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
Filed Herewith
67
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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 balance sheets of Lannett Company, Inc. (a Delaware corporation) and Subsidiaries (collectively,
the Company) as of June 30, 2010 and 2009, and the related consolidated statements of operations, changes in shareholders’ equity,
and statement of cash flows for each of three fiscal years in the period ended June 30, 2010. Our audits of the basic financial
statements included the financial statement schedule listed in the index appearing under Item 15. These financial statements and
financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule 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 financial statements are free of
material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
Company’s internal control over financing reporting. Accordingly, we express no such opinion. An audit also includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the 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, 2010 and 2009, and the consolidated results of its operations and its cash flows
for each of the three fiscal years in the period ended June 30, 2010 in conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ GRANT THORNTON LLP
Philadelphia, Pennsylvania
September 24, 2010
F-1
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2010
June 30, 2009
ASSETS
Current Assets
Cash and cash equivalents ...................................................................................................
Investment securities - available for sale .............................................................................
Trade accounts receivable (net of allowance of $123,192 and $132,000, respectively) ......
Inventories, net.....................................................................................................................
Interest receivable ................................................................................................................
Deferred tax assets ...............................................................................................................
Other current assets..............................................................................................................
Total Current Assets......................................................................................................
$
$
21,895,648
604,464
38,324,258
19,056,868
9,631
5,337,391
2,506,114
87,734,374
25,832,456
347,921
29,945,748
16,195,361
90,425
4,296,929
602,335
77,311,175
Property, plant and equipment .................................................................................................
Less accumulated depreciation ............................................................................................
50,160,114
(21,531,845)
28,628,269
41,431,158
(18,533,773)
22,897,385
Construction in progress ..........................................................................................................
Investment securities - available for sale .................................................................................
Intangible assets (product rights) - net of accumulated amortization.......................................
Deferred tax assets ...................................................................................................................
Other assets ..............................................................................................................................
Total Assets.....................................................................................................................
2,939,898
183,742
7,785,298
12,544,330
147,886
$ 139,963,797
591,685
801,748
9,118,710
13,757,545
98,873
$ 124,577,121
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES
Current Liabilities
Accounts payable .................................................................................................................
Accrued expenses ................................................................................................................
Accrued payroll and payroll related.....................................................................................
Income taxes payable...........................................................................................................
Current portion of long-term debt........................................................................................
Rebates, chargebacks and returns payable ...........................................................................
Total Current Liabilities ...............................................................................................
$
Long-term debt, less current portion........................................................................................
Unearned grant funds...............................................................................................................
Other long-term liabilities........................................................................................................
Total Liabilities ..............................................................................................................
Commitment and Contingencies, See notes 9 and 10
SHAREHOLDERS’ EQUITY
Common stock - authorized 50,000,000 shares, par value $0.001; issued and
outstanding, 24,882,123 and 24,517,696 shares, respectively .........................................
Additional paid in capital.....................................................................................................
Retained earnings.................................................................................................................
Noncontrolling interest ........................................................................................................
Accumulated other comprehensive income .........................................................................
Less: Treasury stock at cost - 110,108 and 82,228 shares, respectively ..............................
TOTAL SHAREHOLDERS’ EQUITY
$
16,280,675
3,464,181
6,304,465
1,479,658
4,851,278
15,249,412
47,629,669
2,868,549
500,000
7,864
51,006,082
16,805,468
1,842,434
5,150,104
711,073
435,386
13,734,540
38,679,005
7,703,382
500,000
47,111
46,929,498
24,882
79,862,940
9,564,632
111,982
44,692
89,609,128
(651,413)
88,957,715
24,518
76,250,309
1,743,565
93,654
24,751
78,136,797
(489,174)
77,647,623
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$ 139,963,797
$ 124,577,121
The accompanying notes to consolidated financial statements are an integral part of these statements.
F-2
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
2010
Fiscal Year Ended June 30,
2009
2008
Net sales....................................................................................................
Cost of sales ..............................................................................................
Amortization of intangible assets..............................................................
Product royalties .......................................................................................
$ 125,177,949
80,890,575
1,794,667
1,152,900
$ 119,002,215
71,272,859
1,787,167
697,720
$
72,403,283
54,080,947
1,784,664
236,601
Gross profit .......................................................................................
41,339,807
45,244,469
16,301,071
Research and development expenses ........................................................
Selling, general, and administrative expenses...........................................
(Gain) loss on sale of investments ............................................................
(Gain) loss on sale of assets ......................................................................
11,251,421
17,375,320
(1,623)
(315,330)
8,427,135
26,059,104
(53,524)
30,885
5,172,715
16,552,859
4,338
1,693
Operating income (loss) ....................................................................
13,030,019
10,780,869
(5,430,534)
Other income (expense):
Foreign currency gain ...........................................................................
Interest income......................................................................................
Interest expense.....................................................................................
Income (loss) before income tax expense (benefit) ..................................
Income tax expense (benefit) ....................................................................
Consolidated net income (loss) .........................................................
Less net income attributable to noncontrolling interest ............................
Net income (loss) attributable to Lannett Company, Inc. .........................
Basic income (loss) per common share - Lannett Company, Inc..............
Diluted income (loss) per common share - Lannett Company, Inc...........
4,595
62,328
(275,870)
(208,947)
12,821,072
4,813,044
8,008,028
(186,961)
—
209,188
(321,751)
(112,563)
10,668,306
4,090,716
6,577,590
(43,345)
$
$
$
7,821,067
$
6,534,245
0.32
0.31
$
$
0.27
0.27
$
$
$
—
170,040
(383,267)
(213,227)
(5,643,761)
(3,376,011)
(2,267,750)
(50,309)
(2,318,059)
(0.10)
(0.10)
Basic weighted average number of shares outstanding.............................
Diluted weighted average number of shares outstanding..........................
24,743,902
25,199,373
24,447,016
24,587,378
24,227,181
24,227,181
The accompanying notes to consolidated financial statements are an integral part of these statements.
F-3
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Common Stock
Shares
Issued
Additional
Paid-in
Amount Capital
Retained
Earnings /
Accum.
(accumulated Treasury Noncontrolling Other Comp.
Income (loss)
Interests
deficit)
Stock
Shareholders’
Equity
Balance, June 30, 2007
24,171,217 $ 24,171 $ 73,053,778 $
(2,472,621) $ (394,570) $
— $
(27,583) $ 70,183,175
Shares issued in connection with
employee stock purchase plan .........
Share based compensation ....................
Restricted stock................................
Stock options....................................
Shares issued in connection with
restricted stock grant........................
Purchase of treasury stock ....................
Other comprehensive income, net
of income tax....................................
Net income (loss) ..................................
38,282
—
—
74,464
—
—
—
38
—
—
75
—
—
—
138,592
134,794
869,921
300,015
—
—
—
—
—
—
—
—
—
—
(74,376)
—
—
—
—
—
—
—
—
—
—
138,630
134,794
869,921
300,090
(74,376)
—
—
—
(2,318,059)
—
—
—
50,309
37,305
—
37,305
(2,267,750)
Balance, June 30, 2008........................ 24,283,963 $ 24,284 $ 74,497,100 $
(4,790,680) $ (468,946) $
50,309 $
9,722 $ 69,321,789
Exercise of stock options ......................
Shares issued in connection with
employee stock purchase plan .........
Share based compensation ....................
Restricted stock................................
Stock options....................................
Employee stock purchase plan.........
Shares issued in connection with
10,800
49,331
—
—
—
restricted stock grant........................
68,602
Shares issued for Contingent
Consideration for Cody Labs
Acquisition .......................................
Stock options repurchased ....................
Purchase of treasury stock ....................
Other comprehensive income, net
of income tax....................................
Net income ............................................
105,000
—
—
—
—
11
49
—
—
—
69
105
—
—
—
—
45,801
114,905
172,028
930,878
81,871
101,331
430,395
(124,000)
—
—
—
—
—
—
—
—
—
—
—
—
—
6,534,245
—
—
—
—
—
—
—
—
(20,228)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
45,812
114,954
172,028
930,878
81,871
101,400
430,500
(124,000)
(20,228)
—
43,345
15,029
—
15,029
6,577,590
Balance, June 30, 2009........................ 24,517,696 $ 24,518 $ 76,250,309 $
1,743,565 $ (489,174) $
93,654 $
24,751 $ 77,647,623
Exercise of stock options ......................
Shares issued in connection with
employee stock purchase plan .........
Share based compensation ....................
Restricted stock................................
Stock options....................................
Employee stock purchase plan.........
Shares issued in connection with
125,600
126
566,659
41,602
—
—
41
—
—
189,217
522,374
1,172,656
52,564
restricted stock grant........................
197,225
197
1,048,765
Shares issued for Contingent
Consideration for Cody Labs
Acquisition .......................................
Tax benefit on stock options
exercised...........................................
Purchase of treasury stock ....................
Distribution to noncontrolling
interests ............................................
Other comprehensive income, net
of income tax....................................
Net income ............................................
—
—
—
—
—
—
—
—
—
—
—
—
—
60,396
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
7,821,067
—
—
—
—
—
—
—
—
(162,239)
—
—
—
—
—
—
—
—
—
—
—
(168,633)
—
186,961
—
—
—
—
—
—
—
—
—
—
566,785
189,258
522,374
1,172,656
52,564
1,048,962
—
60,396
(162,239)
(168,633)
19,941
—
19,941
8,008,028
Balance, June 30, 2010........................ 24,882,123 $ 24,882 $ 79,862,940 $
9,564,632 $ (651,413) $
111,982 $
44,692 $ 88,957,715
The accompanying notes to consolidated financial statements are an integral part of these statements.
F-4
LANNETT COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
OPERATING ACTIVITIES:
Net income (loss) ..............................................................................................
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation and amortization..................................................................
Deferred tax expense (benefit) .................................................................
Stock compensation expense ....................................................................
(Gain) loss on sale of assets......................................................................
(Gain) loss on sale of investments ............................................................
Other noncash (income) expenses ............................................................
Changes in assets and liabilities which provided (used) cash:
Trade accounts receivable ........................................................................
Inventories................................................................................................
Prepaid and income taxes payable............................................................
Prepaid expenses and other assets ............................................................
Accounts payable .....................................................................................
Accrued expenses .....................................................................................
Rebates, chargebacks and returns payable................................................
Accrued payroll and payroll related .........................................................
Deferred revenue ......................................................................................
Net cash provided by operating activities ............................................
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (including
construction in progress)...............................................................................
Proceeds from sale of property, plant and equipment .......................................
Purchase of intangible asset (product rights).....................................................
Proceeds from sale of investment securities - available for sale........................
Purchase of investment securities - available for sale .......................................
Net cash used in investing activities ....................................................
FINANCING ACTIVITIES:
Repayments of debt...........................................................................................
Proceeds from issuance of stock .......................................................................
Tax benefit on stock options exercised..............................................................
Purchase of treasury stock.................................................................................
Repurchase of stock options..............................................................................
Distribution to noncontrolling interests.............................................................
Net cash provided by (used in) financing activities..............................
2010
Fiscal Year Ended June 30,
2009
2008
$
8,008,028
$
6,577,590
$
(2,267,750)
4,888,015
182,075
2,037,844
(315,330)
(1,623)
(3,135)
(8,802,182)
(2,861,507)
768,585
(1,908,110)
(524,793)
1,621,747
1,938,544
1,913,073
—
6,941,231
(11,186,833)
368,463
(500,000)
339,782
—
(10,978,588)
(418,941)
756,043
60,396
(162,239)
—
(168,633)
66,626
5,099,108
2,983,538
1,286,177
30,885
(53,524)
15,110
(5,548,253)
(4,578,103)
2,310,010
46,917
3,719,696
34,806
5,125,610
4,505,949
(982,668)
20,572,848
(1,604,114)
1,500
—
7,408,295
(5,979,257)
(173,576)
(840,066)
160,766
—
(20,228)
(124,000)
—
(823,528)
5,229,358
(4,743,854)
1,029,923
1,693
4,338
9,001
(14,641,004)
2,901,226
1,594,748
(69,679)
1,968,824
563,992
12,640,053
(447,322)
(655,325)
3,118,222
(2,295,817)
21,380
—
2,023,616
(1,140,945)
(1,391,766)
(701,131)
113,422
—
(74,376)
—
—
(662,085)
Effect of foreign currency rates on cash and cash equivalents...............................
33,923
—
—
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS.........
(3,936,808)
19,575,744
1,064,371
CASH AND CASH EQUIVALENTS, BEGINNING OF
PERIOD ............................................................................................................
25,832,456
6,256,712
5,192,341
CASH AND CASH EQUIVALENTS, END OF PERIOD ...................................
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION - ..........
Interest paid.......................................................................................................
Income taxes paid..............................................................................................
Lannett stock issued - Fiscal 2009 accrued incentive compensation.................
Lannett stock issued - contingent consideration - Cody Labs acquistion ..........
$
$
$
$
$
21,895,648
$
25,832,456
$
6,256,712
180,186
3,801,987
758,712
—
$
$
$
$
217,463
250,000
—
581,175
$
$
$
$
270,691
—
—
—
The accompanying notes to consolidated financial statements are an integral part of these statements.
F-5
LANNETT COMPANY, INC. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Lannett Company, Inc., a Delaware corporation, and subsidiaries (the “Company” or “Lannett”), develop, manufacture, package,
market, and distribute active pharmaceutical ingredients as well as pharmaceutical products sold under generic chemical names. The
Company manufactures solid oral dosage forms, including tablets and capsules, topical and oral solutions, and is pursuing partnerships
and research contracts for the development and production of other dosage forms, including ophthalmic, nasal and injectable products.
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., and its wholly owned subsidiaries, as well as the consolidation of Cody LCI Realty, LLC, a variable interest entity.
See Note 12 regarding the consolidation of this variable interest entity. All intercompany accounts and transactions have been
eliminated.
Foreign Currency Translation - The local currency is the functional currency of its newly created foreign subsidiary. Assets and
liabilities of the foreign subsidiary are translated into U.S. dollars at the period-end currency exchange rate and revenues and expenses
are translated at an average currency exchange rate for the period. The resulting translation adjustment is recorded in a separate
component of shareholders’ equity and changes to such are included in comprehensive income. Exchange adjustments resulting from
transactions denominated in foreign currencies are recognized in the consolidated statements of operations.
Reclassifications — Certain prior year amounts have been reclassified to conform to the current year financial statement presentation.
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, chargebacks and returns 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.
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
by the Company 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
F-6
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 customers to return product within
a specified period before and after 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 principally on historical experience. However, the Company continually monitors the
provisions for returns and makes adjustments when management believes that future product returns may differ from historical
experience. Generally, the reserve for returns increases as net sales increase. During our fiscal year 2008 we increased our estimated
returns reserve approximately $3.0 million, of which $1.5 million occurred in the fourth quarter, This adjustment was based on an
analysis of our historical returns experience, the average lag time between sales and returns and an evaluation of changing buying and
inventory trends of both our direct and indirect customers. As this change resulted from new information that has allowed us to better
estimate the average length of time between product sales and returns, we consider it to be a change in estimate as defined in GAAP.
The reserve for returns is included in the rebates, chargebacks and returns 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,
chargebacks and returns payable account on the balance sheet.
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, 2010, 2009 and 2008:
For the Year Ended June 30, 2010
Reserve Category
Reserve Balance as of June 30, 2009 .........
Chargebacks
$ 6,089,802
$
Rebates
2,537,746
Returns
5,106,992
$
$
Other
Total
$ 13,734,540
—
Actual credits issued related to sales
recorded in prior fiscal years..................
(6,068,639)
(2,537,746)
(3,832,652)
—
(12,439,037)
Reserves or (reversals) charged during
Fiscal 2010 related to sales in prior
fiscal years .............................................
Reserves charged to net sales during Fiscal
2010 related to sales recorded
in Fiscal 2010........................................
Actual credits issued related to sales
—
—
(401,203)
—
(401,203)
48,539,403
16,353,467
4,528,118
1,226,614
70,647,601
recorded in Fiscal 2010..........................
(42,278,440)
(12,787,436)
—
(1,226,614)
(56,292,489)
Reserve Balance as of June 30, 2010 .........
$ 6,282,127
$
3,566,031
$
5,401,254
$
—
$ 15,249,412
F-7
For the Year Ended June 30, 2009
Reserve Category
Reserve Balance as of June 30, 2008 .........
Chargebacks
Rebates
$ 4,049,407
$
632,314
Returns
$ 13,642,589
Other
$
2,107
Total
$ 18,326,417
Actual credits issued related to sales
recorded in prior fiscal years..................
(3,954,794)
(632,314)
(12,853,342)
—
(17,440,450)
Reserves or (reversals) charged during
Fiscal 2009 related to sales in prior
fiscal years .............................................
Reserves charged to net sales during Fiscal
2009 related to sales recorded in Fiscal
2009 .......................................................
Actual credits issued related to sales
—
—
2,107
(2,107)
—
35,391,475
12,141,204
4,315,638
204,119
52,052,436
recorded in Fiscal 2009..........................
(29,396,286)
(9,603,458)
—
(204,119)
(39,203,863)
Reserve Balance as of June 30, 2009 .........
$ 6,089,802
$
2,537,746
$
5,106,992
$
—
$ 13,734,540
For the Year Ended June 30, 2008
Reserve Category
Reserve Balance as of June 30, 2007 .........
Chargebacks
Rebates
Returns
Other
$ 4,649,478
$
871,339
$
113,313
$
52,234
$
Total
5,686,364
Actual credits issued related to sales
recorded in prior fiscal years..................
(4,556,488)
(1,741,804)
(4,909,659)
—
(11,207,951)
Reserves or (reversals) charged during
Fiscal 2008 related to sales in prior
fiscal years .............................................
Reserves charged to net sales during Fiscal
2008 related to sales recorded
in Fiscal 2008.........................................
Actual credits issued related to sales
—
870,465
5,892,805
(50,000)
6,713,270
26,126,995
7,999,232
12,546,130
473,423
47,145,780
recorded in Fiscal 2008..........................
(22,170,578)
(7,366,918)
—
(473,550)
(30,011,046)
Reserve Balance as of June 30, 2008 .........
$ 4,049,407
$
632,314
$ 13,642,589
$
2,107
$ 18,326,417
The total reserve for chargebacks, rebates, returns and other adjustments increased from $13,734,540 at June 30, 2009 to $15,249,412
at June 30, 2010. The increase in total reserves was due to an increase in the rebates reserve as a result of the timing of credits being
processed by the customers and by the Company, an increase in chargeback reserves due primarily to an increase in inventory levels at
wholesaler distribution centers, and an increase in the return reserves due to an increase in overall sales.
During Fiscal 2010, approximately $424,000 of the original $10,545,000 return reserve recorded in Fiscal 2008 for Prenatal
Multivitamin was applied to accounts receivable for customers who had returned the Prenatal Multivitamin product during 2010. In
addition, the Company reversed approximately $387,000 to net sales in the fourth quarter of Fiscal 2010 as a result of new information
that the Company received regarding the amount of Multivitamin product that remained to be returned to the Company. This
adjustment left a balance of approximately $17,000 of Multivitamin returns reserve on the consolidated balance sheet at June 30,
2010.
The Company ships its products to the warehouses of its wholesale and retail chain customers. When the Company and a customer
enter into 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
F-8
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 multiple generic competitors may 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 generally 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 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.
Cash and cash equivalents — The Company considers all highly liquid securities purchased with original maturities of 90 days or
less to be cash equivalents. Cash equivalents are stated at cost, which approximates market value, and consist of certificates of deposit
that are readily converted to cash. The Company maintains cash and cash equivalents with several major financial institutions. Such
amounts frequently exceed Federal Deposit Insurance Corporation (“FDIC”) limits.
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
estimated 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 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
method for financial reporting purposes over the estimated useful lives of the assets. Depreciation expense for the fiscal years ended
June 30, 2010, 2009, and 2008 was approximately $3,055,000, $3,275,000 and $3,444,000, respectively.
Investment Securities — The Company’s investment securities consist of marketable debt securities, primarily in U.S. government
and agency obligations. All of the Company’s marketable debt securities are classified as available-for-sale and recorded at fair value,
based on quoted market prices. Unrealized holding gains and losses are recorded, net of any tax effect, as a separate component of
accumulated other comprehensive income (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. The Company reviews its marketable securities and determines
whether the investments are other-than-temporarily impaired. If the investments are deemed to be other-than-temporarily impaired, the
investments are written down to their then current fair market value with a new cost basis being established. There were no securities
determined by management to be other-than-temporarily impaired for the fiscal years ended June 30, 2010, 2009 and 2008.
F-9
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 costs are charged to expense as incurred.
Intangible Assets — In March 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 for
the exclusive marketing and distribution rights obtained from JSP. As of June 30, 2010 and 2009, management concluded the
carrying value of the intangible asset was less than its fair value and, therefore, no impairment was required. The Company will incur
annual amortization expense of approximately $1,785,000 for the JSP intangible asset over the remaining term of the agreement.
On April 10, 2007, the Company entered into a Stock Purchase Agreement to acquire Cody by purchasing all of the remaining shares
of common stock of Cody. The consideration for the April 10, 2007 acquisition was approximately $4,438,000, which represented the
fair value of the tangible net assets acquired. The agreement also required Lannett to issue to the sellers up to 120,000 shares of
unregistered common stock of the Company contingent upon the receipt of a license from a regulatory agency. This license was
subsequently received in July 2008 and triggered the payment of 105,000 shares (87.5% of the 120,000 shares as the Company already
owned 12.5%) of Lannett stock to the former owners of Cody Labs, which was completed in October 2008. Therefore, the Company
recorded an intangible asset related to the acquisition of a drug import license in the original amount of $581,175 and recorded a
corresponding deferred tax liability of approximately $150,700 due to the non-deductibility of the amortization for tax purposes. The
Company has assigned a 15 year life to this intangible asset based on average life cycles of Lannett products.
In January 2005, Lannett Holdings, Inc. entered into an agreement in which the Company purchased for $100,000 and future royalty
payments the proprietary rights to manufacture and distribute a product for which Pharmeral, Inc. owned the ANDA. In May 2008,
the Company and Pharmeral waived their rights to any royalty payments on the sales of the drug by Lannett, under Lannett’s current
ownership structure. Should Lannett undergo a major change in control where a third party is involved, this royalty will be reinstated.
In Fiscal 2008, the Company obtained FDA approval to use these proprietary rights. Accordingly, the Company has capitalized this
purchased product right as an indefinite lived intangible asset which is tested for impairment at least on an annual basis. During the
fourth quarter of fiscal 2009, it was determined that this intangible asset no longer has an indefinite life. No impairment existed
because the estimated fair value exceeded the carrying amount on that date. Accordingly, the $100,000 carrying amount of this
intangible asset will be amortized on a straight line basis prospectively over its 10 year remaining estimated useful life. See Note 16
In August 2009, the Company acquired eight new ANDAs covering three separate product lines from another generic drug
manufacturer for a purchase price of $500,000. It is expected that the Company will be able to produce these products by the first half
of Fiscal 2011. Amortization will begin when the Company starts shipping these products. An intangible asset that is not subject to
amortization shall be tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset
might be impaired. An impairment loss is measured as the excess of the asset’s carrying value over its fair value, calculated using a
discounted future cash flow method. Our discounted cash flow models are highly reliant on various assumptions which are considered
level 3 inputs, including estimates of future cash flow (including long-term growth rates), discount rate, and expectations about
variations in the amount and timing of cash flows and the probability of achieving the estimated cash flows. As of June 30, 2010, no
impairment existed.
For the fiscal years ended June 30, 2010, 2009 and 2008, the Company incurred amortization expense of approximately $1,833,000,
$1,824,000, and $1,785,000, respectively.
Future annual amortization expense consists of the following:
Fiscal Year Ending June 30,
2011 .....................................................................
2012 .....................................................................
2013 .....................................................................
2014 .....................................................................
2015 .....................................................................
Thereafter.............................................................
$
$
Annual Amortization Expense
1,833,412
1,833,412
1,833,412
1,387,245
48,745
349,072
7,285,298
The amounts above do not include the ANDA’s purchased in August 2009 for $500,000, as amortization will begin when the
Company starts shipping these products
F-10
Advertising Costs - The Company charges advertising costs to operations as incurred. Advertising expense for the fiscal years ended
June 30, 2010, 2009 and 2008 was approximately $30,000, $48,000, and $9,000, respectively.
Income Taxes - The Company uses the liability method to account for income taxes. Deferred tax assets and liabilities are determined
based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates
which will be in effect when these differences reverse. Deferred tax expense/(benefit) is the result of changes in deferred tax assets
and liabilities. The Company may recognize the tax benefit from an uncertain tax position claimed on a tax return only if it is more
likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the
position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit
that has a greater than 50% likelihood of being realized upon ultimate settlement. The authoritative standards issued by the FASB also
provide guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires
increased disclosures.
Segment Information — The Company operates one business segment - generic pharmaceuticals; accordingly the Company has one
reporting segment. 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, 2010,
2009 and 2008:
Medical Indication
For the Fiscal Year Ended June 30,
2009
2010
2008
Migraine Headache ..................................................................
Epilepsy ...................................................................................
Prescription Vitamin ................................................................
Heart Failure ............................................................................
Thyroid Deficiency ..................................................................
Antibiotic .................................................................................
Pain Management ....................................................................
Other ........................................................................................
$
$
$
9,854,717
2,020,371
5,640,136
20,996,057
52,224,711
6,448,704
14,128,982
13,864,271
9,553,143
1,777,820
12,569,304
26,421,467
47,740,204
6,440,470
4,155,176
10,344,631
10,302,868
3,811,963
—
7,574,240
38,429,663
3,449,429
580,192
8,254,928
Total.........................................................................................
$
125,177,949
$
119,002,215
$
72,403,283
Concentration of Market and Credit Risk — Six of the Company’s products, defined as generics containing the same active
ingredient or combination of ingredients, accounted for approximately 42%, 17%, 8%, 5%, 5%, and 5% of net sales for the fiscal year
ended June 30, 2010. Those same products accounted for 40%, 22%, 8%, 2%, 11%, and 0%, respectively, of net sales for the fiscal
year ended June 30, 2009, and 52%, 10%, 14%, 0%, 0%, and 0%, respectively, for the fiscal year ended June 30, 2008.
Four of the Company’s customers accounted for 26%, 11%, 9%, and 8%, respectively, of net sales for the fiscal year ended June 30,
2010; 28%, 7%, 7%, and 7%, respectively, of net sales for the fiscal year ended June 30, 2009; and 36%, 5%, 6%, and 8%,
respectively, of net sales for the fiscal year ended June 30, 2008. At June 30, 2010, four customers accounted for 69% of the
Company’s accounts receivable balances. At June 30, 2009, four customers accounted for 63% of the Company’s accounts receivable
balances.
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.
Share-based Payments - The Company recognizes 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. Compensation cost related
to share-based payments is included in the income statement in the same line item as the related other compensation costs.
At June 30, 2010, the Company had three stock-based employee compensation plans (the “Old Plan,” the “2003 Plan,” and the “Long-
term Incentive Plan,” or “LTIP”).
F-11
During the fiscal year ended June 30, 2010, the Company awarded 45,000 shares of restricted stock to non-management Board
members under the LTIP which vested immediately. Stock compensation expense of $290,250 was recognized during the fiscal year
ended June 30, 2010, related to these shares of restricted stock.
During the fiscal year ended June 30, 2010, the Company awarded 237,500 shares of restricted stock to management employees under
the LTIP which vest in equal portions on October 29, 2010, 2011 and 2012. Stock compensation expense of $350,346 was recognized
during the fiscal year ended June 30, 2010 related to these shares of restricted stock.
During the fiscal year ended June 30, 2010, the Company awarded 116,725 shares of restricted stock to management employees under
the LTIP which vested immediately in partial settlement of Fiscal 2009 accrued incentive compensation costs totaling $758,712.
During the fiscal year ended June 30, 2009, the Company awarded 30,000 shares of restricted stock to non-management Board
members under the LTIP which vested immediately. Stock compensation expense of $101,400 was recognized during the fiscal year
ended June 30, 2009, related to these shares of restricted stock.
During the fiscal year ended June 30, 2008, the Company awarded 209,264 shares of restricted stock to management employees under
the LTIP, of which 74,464 of these shares vested 100% on January 1, 2008, and the remainder vest in equal portions on September 18,
2008, 2009 and 2010. Stock compensation expense of $172,028, $172,028 and $134,794 was recognized during the fiscal years ended
June 30, 2010, 2009 and 2008, respectively, related to these shares of restricted stock.
The Company measures share-based compensation cost for options using the Black-Scholes option pricing model. The following
table presents the weighted average assumptions used to estimate fair values of the stock options granted during the years ended
June 30 and the estimated annual forfeiture rates used to recognize the associated compensation expense:
Risk-free interest rate...................
Expected volatility .......................
Expected dividend yield...............
Forfeiture rate ..............................
Expected term (in years) ..............
Weighted average fair value ........
Incentive
Stock
Options
FY 2010
Non-
qualified
Stock
Options
FY 2010
Incentive
Stock
Options
FY 2009
Non-
qualified
Stock
Options
FY 2009
Incentive
Stock
Options
FY 2008
Non-
qualified
Stock
Options
FY 2008
2.44%
67%
0.0%
5.0%
2.43%
67%
0.0%
5.0%
2.46%
61%
0.0%
5.0%
2.52%
56%
0.0%
5.0%
4.15%
56%
0.0%
5.0%
4.21%
56%
0.0%
5.0%
5.0 years
5.0 years
5.0 years
5.0 years
5.0 years
$
3.98 $
4.00 $
2.20 $
1.41 $
2.11 $
5.0 years
2.11
At June 30, 2010, there were 2,058,851 options outstanding. Of those, 1,032,925 were options issued under the LTIP, 820,693 were
issued under the 2003 Plan, and 205,233 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 2003 Plan, with 49,365 shares under option having already been exercised
under that plan. 2,500,000 shares were authorized to be issued under the LTIP, with 94,725 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
NYSE - Amex, April 2002, or a historical period equal to the expected term of the option, whichever is shorter. 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 forfeiture rate used to calculate compensation expense was 5% for fiscal years 2010, 2009 and 2008. 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.
F-12
The following table presents all share-based compensation costs recognized in our statements of income, substantially all of which is
reflected in the selling, general and administrative expense line:
Twelve months ended June 30,
2009
2010
2008
Share based compensation
Stock options................................................................................................
Employee stock purchase plan.....................................................................
Restricted stock............................................................................................
Tax benefit at effective rate .............................................................................
$
$
$
$
1,172,656
52,564
812,624
79,611
$
$
$
$
930,878
81,871
273,428
79,560
$
$
$
$
869,921
25,208
134,794
108,127
During Fiscal 2009 as part of the former CFO’s resignation, the Company repurchased all of his 185,000 outstanding stock options.
Therefore, the Company recorded, as incremental stock compensation expense, the previously unrecognized compensation cost
totaling approximately $83,000 related to options for which the requisite service period had not been rendered as of the repurchase
date. See Note 10 for additional information.
Options outstanding that have vested and are expected to vest as of June 30, 2010 are as follows:
Options vested............................................................
Options expected to vest ............................................
Total vested and expected to vest ..............................
Weighted
Average
Exercise
Price
Aggregate
Intrinsic
Value
8.52
6.10
7.48
$
$
$
208,664
217,453
426,117
Awards
1,141,934
871,071
2,013,005
$
$
$
Weighted
Average
Remaining
Contractual
Life
5.1
8.9
6.7
A summary of nonvested restricted stock awards as of June 30, 2010, 2009, and 2008 and changes during the fiscal years then ended,
is presented below:
Nonvested at June 30, 2007 ......................................................
Granted .....................................................................................
Vested .......................................................................................
Forfeited....................................................................................
Nonvested at June 30, 2008 ......................................................
Granted .....................................................................................
Vested .......................................................................................
Forfeited....................................................................................
Nonvested at June 30, 2009 ......................................................
Granted .....................................................................................
Vested .......................................................................................
Forfeited....................................................................................
Nonvested at June 30, 2010 ......................................................
Awards
Weighted
Average Grant -
date Fair Value
—
209,264
(74,464)
(10,000)
124,800
30,000
(68,602)
(9,000)
77,198
399,225
(197,225)
(9,300)
269,898
$
$
—
843,334
(300,090)
(40,300)
502,944
101,400
(256,966)
(36,270)
311,108
2,697,213
(1,192,028)
(37,479)
1,778,814
F-13
A summary of stock option award activity under the Plans as of June 30, 2010, 2009 and 2008 and changes during the years then
ended, is presented below:
Incentive Stock Options
Nonqualified Stock Options
Weighted-
Average
Exercise
Awards
Price
Aggregate
Intrinsic
Value
Weighted
Average
Remaining
Contractual
Life
Awards
Weighted-
Average
Exercise
Price
Aggregate
Intrinsic
Value
Weighted
Average
Remaining
Contractual
Life
Outstanding at July 1,
2009 ........................
Granted .......................
Exercised.....................
Forfeited, expired or
repurchased .............
Outstanding at
958,909 $
507,142 $
(111,796) $
5.60
6.96
4.46 $
298,605
626,772 $
152,658 $
(13,804) $
10.52
6.99
4.97 $ 57,108
(45,001) $
8.75
(16,029) $
16.67
June 30, 2010 ..........
1,309,254 $
6.11 $
348,964
7.5
749,597 $
9.77 $ 88,599
5.5
Outstanding at
June 30, 2010 and
not yet vested ..........
Exercisable at
720,699 $
6.07 $
179,684
8.9
196,218 $
6.20 $ 49,215
June 30, 2010 ..........
588,555 $
6.16 $
170,699
5.9
553,379 $
11.03 $ 39,384
.9.0
4.2
Incentive Stock Options
Nonqualified Stock Options
Weighted-
Average
Exercise
Awards
Price
Weighted
Average
Remaining
Contractual
Life
Aggregate
Intrinsic
Value
Weighted-
Average
Exercise
Awards
Price
Aggregate
Intrinsic
Value
Weighted
Average
Remaining
Contractual
Life
Outstanding at July 1,
2008 ..........................
Granted .........................
Exercised.......................
Forfeited, expired or
repurchased ...............
Outstanding at
991,267 $
187,102 $
(10,800) $
5.76
4.03
4.24 $
11,799
(208,660) $
5.06
703,064 $ 10.16
2.80
37,998 $
—
—
(114,290) $
5.75
—
June 30, 2009 ............
958,909 $
5.60 $ 1,844,125
7.4
626,772 $ 10.52 $ 430,739
5.5
Outstanding at June 30,
2009 and not yet
vested ........................
Exercisable at
478,551 $
4.27 $ 1,234,175
8.6
120,893 $
4.23 $ 317,515
June 30, 2009 ............
480,358 $
6.91 $
609,950
6.2
505,879 $ 12.02 $ 113,224
8.2
4.9
F-14
Incentive Stock Options
Nonqualified Stock Options
Weighted
Average
Exercise
Awards
Price
Aggregate
Intrinsic
Value
Weighted
Average
Remaining
Contractual
Weighted
Average
Exercise
Life
Awards
Price
Weighted
Average
Remaining
Contractual
Life
Aggregate
Intrinsic
Value
501,349 $
496,818 $
—
(6,900) $
7.48
4.03
—
5.67
617,982 $
85,082 $
—
—
11.00
4.03
—
—
991,267 $
5.76 $
6,300
8.0
703,064 $
10.16 $
—
6.5
Outstanding at July 1,
2007 ........................
Granted .......................
Exercised.....................
Forfeited or expired.....
Outstanding at
June 30, 2008 ..........
Outstanding at
June 30, 2008 and
not yet vested ..........
Exercisable at
660,538 $
4.54 $
—
9.0
183,651 $
5.05 $
June 30, 2008 ..........
330,729 $
8.21 $
6,300
6.1
519,413 $
11.96 $
—
—
8.7
5.8
Options with a fair value of approximately $749,000 completed vesting during 2010. As of June 30, 2010, there was approximately
$3,495,000 of total unrecognized compensation cost related to non-vested share-based compensation awards granted under the Plans.
That cost is expected to be recognized over a weighted average period of 1.7 years. The Company issues new shares when stock
options are exercised.
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 — A dual presentation of basic and diluted earnings per share is required on the face of the Company’s
consolidated statement of operations as well as a reconciliation of the computation of basic earnings per 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. A
reconciliation of the Company’s basic and diluted earnings per share follows:
2010
2009
2008
Net Income
Attributable to
Lannett
(Numerator)
Shares
(Denominator)
Net Income
Attributable to
Lannett
(Numerator)
Shares
(Denominator)
Net Loss
Attributable to
Lannett
(Numerator)
Shares
(Denominator)
Basic earnings/(loss) per
share factors ............................ $ 7,821,067
24,743,902 $
6,534,245
24,447,016 $ (2,318,059)
24,227,181
Effect of potentially dilutive
options.....................................
—
455,471
—
140,361
—
—
Diluted earnings/(loss) per
share factors ............................ $ 7,821,067
25,199,373 $
6,534,245
24,587,378 $ (2,318,059)
24,227,181
Basic earnings/(loss) per share.... $
Diluted earnings/(loss) per
share........................................ $
0.32
0.31
$
$
0.27
0.27
$
$
(0.10)
(0.10)
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, 2010, 2009 and 2008 were 1,281,364, 980,781, and
1,949,131, respectively.
F-15
Note 2. New Accounting Standards
In December 2007, the FASB issued authoritative guidance which significantly changes the accounting for business combinations in a
number of areas including the treatment of contingent consideration, contingencies, acquisition costs, in-process research and
development and restructuring costs. In addition, under the guidance, changes in deferred tax asset valuation allowances and acquired
income tax uncertainties in a business combination after the measurement period will impact income tax expense. In April 2009,
updated guidance was issued to address application issues regarding the accounting and disclosure provisions for contingencies. The
authoritative guidance applies prospectively to business combinations for which the acquisition date is on or after the beginning of the
fiscal year beginning July 1, 2009. Early application is not permitted. The effect of this authoritative guidance on our consolidated
financial statements will depend on the nature and terms of any business combinations that occur after the effective date.
In December 2007, the FASB issued authoritative guidance to establish accounting and reporting standards for the noncontrolling
(minority) interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary
is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and
establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in
deconsolidation. We adopted this authoritative guidance effective July 1, 2009. As a result of the adoption, the Company presents
noncontrolling interests as a component of equity on its consolidated balance sheets. Minority interest expense is now shown below
net income under the heading “net income attributable to noncontrolling interest”. Prior year financial statements have been
reclassified to reflect the adoption of this guidance. The adoption of this guidance did not have any other significant impact on our
consolidated financial statements.
In April 2008, the FASB issued authoritative guidance which amends the factors that should be considered in developing renewal or
extension assumptions used to determine the useful life of a recognized intangible asset. The guidance is intended to improve the
consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair
value of the asset. We adopted this authoritative guidance effective July 1, 2009. The adoption of this guidance did not have a
significant impact on our consolidated financial statements.
In June 2009, the FASB issued authoritative guidance for determining whether an entity is a variable interest entity and modifies the
methods allowed for determining the primary beneficiary of a variable interest entity. This guidance requires an enterprise to perform
an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable
interest entity. It also requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity.
The authoritative guidance is effective for the annual reporting period that begins after November 15, 2009. We do not expect the
adoption of this authoritative guidance to have a significant impact on our consolidated financial statements.
In January 2010, the FASB issued authoritative guidance which requires reporting entities to make new disclosures about recurring or
nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and
information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair- value measurements.
The authoritative guidance is effective for annual reporting periods beginning after December 15, 2009, except for Level 3
reconciliation disclosures which are effective for annual periods beginning after December 15, 2010. We do not anticipate that this
update will have a material impact on our consolidated financial statements.
Note 3. Inventories
Inventories at June 30, 2010 and 2009 consist of the following:
Raw Materials ...................................................
Work-in-process................................................
Finished Goods .................................................
Packaging Supplies ...........................................
2010
5,183,735
2,375,396
10,527,630
970,106
19,056,868
$
$
2009
5,755,982
2,846,600
6,664,193
928,586
16,195,361
$
$
The preceding amounts are net of inventory obsolescence reserves of $2,481,810 and $2,744,305 at June 30, 2010 and 2009,
respectively.
F-16
Note 4. Property, Plant and Equipment
Property, plant and equipment at June 30, 2010 and 2009 consist of the following:
Land ...............................................................
Building and improvements ...........................
Machinery and equipment..............................
Furniture and fixtures.....................................
Useful Lives
—
10 - 39 years
5 - 15 years
5 - 7 years
Less accumulated depreciation ......................
Total...............................................................
Note 5. Investment Securities - Available-for-Sale
2010
1,375,103
23,101,751
24,638,754
1,044,506
50,160,114
(21,531,845)
28,628,269
$
$
2009
918,314
17,048,351
22,573,324
891,169
41,431,158
(18,533,773)
22,897,385
$
$
On July 1, 2008, the Company adopted the authoritative guidance which clarifies the definition of fair value, establishes a framework
for measuring fair value, and expands the disclosures on fair value measurements. Fair value is defined as the exchange price that
would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or
liability in an orderly transaction between market participants on the measurement date. The authoritative guidance also establishes a
fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs
when measuring fair value. Three levels of inputs were established that may be used to measure fair value:
Level 1 — Quoted prices in active markets for identical assets or liabilities. The Company does not have any Level 1 available-
for-sale securities as of June 30, 2010 or June 30, 2009.
Level 2 — Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices for
identical or similar instruments in markets that are not active; or model-derived valuations whose inputs are observable or whose
significant value drivers are observable. The Company’s Level 2 assets and liabilities primarily include debt securities with quoted
prices that are traded less frequently than exchange-traded instruments, corporate bonds, U.S. government and agency securities and
certain mortgage-backed and asset-backed securities whose values are determined using pricing models with inputs that are observable
in the market or can be derived principally from or corroborated by observable market data. The fair value of the Company’s
available-for-sale securities in the table below are derived solely from Level 2 inputs.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are financial instruments whose values
are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the
determination of fair value requires significant judgment or estimation. The Company does not have any Level 3 available-for-sale
securities as of June 30, 2010 or June 30, 2009.
If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is
based on the lowest level input that is significant to the fair value measurement of the instrument.
The amortized cost, gross unrealized gains and losses, and fair value of the Company’s available-for-sale securities as of June 30,
2010 and June 30, 2009:
June 30, 2010
Available-for-Sale
Amortized Cost
Gross Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
U.S. Government Agency ..........................................
Corporate Bonds ........................................................
$
$
590,751
179,507
770,258
$
$
13,713
4,235
17,948
$
$
—
—
—
$
$
604,464
183,742
788,206
F-17
June 30, 2009
Available-for-Sale
Amortized Cost
Gross Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
U.S. Government Agency ..........................................
Asset-Backed Securities.............................................
$
$
928,910
179,507
1,108,417
$
$
40,352
900
41,252
$
$
—
—
—
$
$
969,262
180,407
1,149,669
The amortized cost and fair value of the Company’s current available-for-sale securities by contractual maturity at June 30, 2010 and
June 30, 2009 are summarized as follows:
June 30, 2010
Available for Sale
June 30, 2009
Available for Sale
Amortized
Cost
Fair
Value
Amortized
Cost
Due in one year or less...............................................
Due after one year through five years........................
Due after five years through ten years .......................
Due after ten years .....................................................
Total available-for-sale securities ..............................
Less current portion ...................................................
Long-term available-for-sale securities......................
$
$
590,751
179,507
—
—
770,258
590,751
179,507
$
$
604,464
183,742
—
—
788,206
604,464
183,742
$
$
338,159
770,258
—
—
1,108,417
338,159
770,258
$
$
Fair
Value
347,921
801,748
—
—
1,149,669
347,921
801,748
The Company uses the specific identification method to determine the cost of securities sold. For the fiscal years 2010 and 2009, the
Company had realized gains of $1,623 and $53,524, respectively, whereas for fiscal year 2008, the Company had realized losses of
$4,338.
As of June 30, 2010 and 2009, there were no securities held from a single issuer that represented more than 10% of shareholders’
equity. As of June 30, 2010, there were no individual securities in a continuous unrealized loss position.
Note 6. Bank Line of Credit
The Company has a $3,000,000 line of credit from Wells Fargo, N. A., formerly Wachovia Bank, N.A. (“Wells Fargo”) that bears
interest at the prime interest rate less 0.25% (3.00% at June 30, 2010 and 2009, respectively). As of June 30, 2010 and 2009, the
Company had $3,000,000 of availability under this line of credit. The line of credit is collateralized by substantially all of the
Company’s assets. The agreement contains covenants with respect to working capital, net worth and certain ratios, as well as other
covenants. As of June 30, 2010, the Company was in compliance with all financial covenants under the agreement.
The existing line of credit, which was scheduled to expire on November 30, 2009, was renewed and extended during the first quarter
of Fiscal 2010 to November 30, 2010. As part of the renewal agreement, the Company is no longer required to maintain any
minimum deposit balances with Wells Fargo, and the availability fee on the unused balance of the line of credit was reduced to
0.375%.
Note 7. Unearned Grant Funds
In July 2004, the Company received $500,000 of grant funding from the Commonwealth of Pennsylvania (the “Commonwealth”),
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 failed 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 is recording the unearned grant funds as a liability until the Company reaches a formal agreement
with the Commonwealth as to whether it complied with all of the requirements of the grant funding program. As of June 30, 2010, the
Company has had preliminary discussions with the Commonwealth to determine whether it will be required to repay any of the funds
provided under the grant funding program. Based on information available at June 30, 2010, the Company has recorded the grant
funding as a long-term liability under the caption of Unearned Grant Funds.
F-18
Note 8. Long-Term Debt
Long-term debt 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 mortgage ....................................................................................
$
$
June 30,
2010
4,500,000
933,820
88,141
555,000
—
—
1,642,866
June 30,
2009
4,500,000
1,002,607
182,831
680,000
80,130
—
1,693,200
Total debt .................................................................................................................................
Less current portion .................................................................................................................
7,719,827
4,851,278
8,138,768
435,386
Long term debt.........................................................................................................................
$
2,868,549
$
7,703,382
Current Portion of Long Term Debt
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 mortgage ....................................................................................
$
$
June 30,
2010
4,500,000
77,091
88,141
130,000
—
—
56,046
June 30,
2009
—
75,017
103,100
125,000
80,130
—
52,139
Total current portion of long term debt....................................................................................
$
4,851,278
$
435,386
The Company financed $4,500,000 through the Philadelphia Industrial Development Corporation (PIDC). The Company pays a bi-
annual interest payment at a rate equal to two and one-half percent per annum. The outstanding principal balance is due and payable
January 1, 2011. The Company intends to refinance this loan prior to its maturity date.
The Company financed $1,250,000 through the Pennsylvania Industrial Development Authority (PIDA). 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.
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.
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, 2010 and 2009 was 0.52% and 0.62%,
respectively.
The Company entered into agreements (the “2003 Loan Financing”) with Wells Fargo to finance the purchase of the Torresdale
Avenue facility, the renovation and setup of the building, and other anticipated capital expenditures. The Company, as part of the
2003 Loan Financing agreement, is required to make equal payments of principal and interest. The only portion of the loan that
remained outstanding at June 30, 2009 was the Equipment Loan which had an outstanding balance of $80,130 at June 30, 2009. This
loan was fully repaid as of March 31, 2010.
F-19
The Company has executed Security Agreements with Wells Fargo, PIDA and PIDC in which the Company has agreed to pledge
substantially all of its assets to collateralize the amounts due.
As part of the Cody acquisition, the Company became primary beneficiary to a variable interest entity (“VIE”) called Cody LCI
Realty, LLC. See Note 12, 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
statements, along with the related land and building. Principal and interest payments of $14,782, at a fixed interest rate of 7.5%, are
being made on a monthly basis through June 2026. The mortgage loan is collateralized by the land and building.
Long-term debt amounts are due as follows:
Fiscal Year Ending
June 30,
Amounts Payable
to Institutions
2011 .........................................................................................
2012 .........................................................................................
2013 .........................................................................................
2014 .........................................................................................
2015 .........................................................................................
Thereafter.................................................................................
$
4,851,278
274,434
280,543
310,036
161,616
1,841,920
$
7,719,827
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 the Philadelphia and Pennsylvania Industrial Development Authorities.
Note 9. Contingencies
In January 2010, the Company initiated an arbitration proceeding against Olive Healthcare (“Olive”) for damages arising out of
Olive’s delivery of defective soft-gel prenatal vitamin capsules. The Company seeks damages in excess of $3.5 million. Olive has
denied liability and filed a counterclaim in February 2010 for breach of contract.
In June 2008, the Company filed a declaratory judgment suit in the Federal District Court of Delaware (Civil Action No. 08-338 (JJF))
against KV Pharmaceuticals, DrugTech Corp. and Ther-Rx Corp (collectively, “KV”). The complaint sought declaratory judgment
for non-infringement and invalidity of certain patents owned by KV. The complaint further sought declaratory judgment of anti-trust
violations and federal and state unfair competition violations for actions taken by KV in securing and enforcing these patents. After
the complaint was filed, KV countered with a motion for a Temporary Restraining Order (“TRO”) to prevent the Company from
launching its Multivitamin with Mineral Capsules (“MMCs”), due to alleged patent and trademark infringement issues. The TRO was
heard and, ultimately, resulted in a conclusion by the court that the Company’s product label on the MMCs should be modified. KV
also countered with claims of infringement by the Company of KV’s patents seeking the Company’s profits for sales of MMCs or
other monetary relief, preliminary and permanent injunctive relief, attorney’s fees and a finding of willful infringement. In March
2009, the Company and KV settled the litigation. In light of the withdrawal of KV’s innovator prenatal product due to FDA
enforcement actions, and the resulting anticipated decline in sales and declining market for written prescription, the Company decided
it was pointless to continue the litigation and entered into the settlement arrangement with KV. Pursuant to the settlement, the
Company received a license from KV and became an authorized generic provider. During the terms of the license, the Company is to
pay KV a royalty on all future sales of its Prenatal vitamin product. Lannett will cease offering its Prenatal vitamin product if and
when the brand is restored to the marketplace. In May 2010, the Company filed an action for declaratory relief in the Delaware
Superior Court against KV seeking a declaration that KV breached its obligations under a settlement agreement entered into with the
Company (the “Binding Agreement”). In June 2010, KV filed a counterclaim to the complaint and asserted claims for breach of
contract, declaratory judgment, negligent misrepresentation and fraud in connection with the Binding Agreement, alleging among
other things that the Company has improperly withheld royalties from KV arising out of its sales of a pre-natal vitamin product.
In or about July 2008, Albion International and Albion, Inc. filed suit in the United States District Court, District of Utah (Case
No. 2:08cv00515) against Lannett asserting claims for patent and trademark infringement, as well as unfair competition, arising out of
Lannett’s use of product that it purchased from Albion and used as an ingredient in its MMC. Lannett filed a motion to dismiss the
complaint on the basis that it purchased the product from Albion and, as such, was authorized to use the product in its MMC. The
Court granted the motion and dismissed the complaint but gave Albion leave to file an amended complaint. In January 2009, Albion
filed an amended complaint. Lannett filed an answer to the complaint and counterclaim, asserting, among other things, that
F-20
Albion tortuously interfered with Lannett’s contracts. Subsequent to the filing of the answer and counterclaim, Lannett and
Albion reached an agreement in principal to settle the case. Under terms of the settlement, the parties would each dismiss their claims
against each other and provide releases. In July 2009, the settlement agreement was signed and the case was dismissed.
Note 10. Commitments
Leases
In June 2006, Lannett signed a lease agreement on a 66,000 square foot facility located on approximately seven acres in Philadelphia.
The Company purchased this building in October 2009 for approximately $3.8 million plus the cost of fit out of approximately $2.0
million. A significant portion of the purchase price and fit out costs are expected to be financed through a series of loans with a bank
and a Pennsylvania state run development agency. Construction was substantially complete by June 30, 2010. The financing will be
competed shortly. This new facility is being used for certain administrative functions, warehouse space, shipping and possibly
additional manufacturing space in the future.
Lannett’s subsidiary, 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 Wyoming limited liability company which is 50% owned
by Lannett. See Note 12.
Rental and lease expense for the years ended June 30, 2010, 2009 and 2008 was approximately $156,000, $449,000, and $449,000,
respectively.
Contractual Obligations
The following table represents annual contractual obligations as of June 30, 2010:
Total
Less than 1
year
1-3 years
3-5 years
Years
More than 5
Long-Term Debt ....................................
Operating Leases....................................
Purchase Obligations .............................
Interest on Obligations...........................
Total.......................................................
$
7,719,827
111,176
63,930,000
1,435,553
$ 73,196,556
$
4,851,278
50,100
22,572,500
259,213
$ 27,733,091
$
554,977
61,076
41,357,500
278,996
$ 42,252,549
$
$
471,652
—
—
244,012
715,664
$
$
1,841,920
—
—
653,332
2,495,252
The purchase obligations above are primarily due to the agreement with Jerome Stevens Pharmaceuticals, Inc. (“JSP”). If the
minimum purchase requirement is not met, JSP has the right to terminate the contract within 60 days of Lannett’s failure to meet the
requirement. If JSP 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. If either party were to terminate the purchase agreement, there would be a
significant 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, Keith R.
Ruck, Vice President of Finance and Chief Financial Officer, Kevin Smith, Vice President of Sales and Marketing, William Schreck,
Senior Vice President and General Manager, Ernest Sabo, Vice President of Regulatory Affairs and Chief Compliance Officer and
Stephen Kovary, Vice President of Operations. Each of the agreements provide for an annual base salary and eligibility to receive a
bonus. The salary and bonus amounts of these executives are determined by the Board of Directors. Additionally, these 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, these 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 these executives of between 18 months and three years.
During the third quarter of Fiscal Year 2009, the Company’s then current Vice President of Finance, Treasurer, Secretary and Chief
Financial Officer resigned. As part of his separation agreement, the Company was obligated to pay to him approximately $670,000 to
settle any outstanding obligations from his employment agreement, including any salary, bonus, vacation, stock options and medical
benefits. Of this amount, $300,440 was paid in Fiscal 2009 with $165,000 designated for the payment of pro rated bonus, and $11,440
was designated for the payment of accrued but unused paid time off. As part of the settlement, $124,000 was designated as the portion
F-21
of the settlement related to the repurchase of his outstanding stock options. The Company therefore charged this amount to Additional
Paid in Capital, as it represents the fair value of the options repurchased on the repurchase date. Additional payments totaling
approximately $369,000 for severance and benefits will be paid in Fiscal 2011 pursuant to the separation agreement.
Note 11. Comprehensive Income (Loss)
The Company’s other comprehensive income (loss) is comprised of unrealized gains (losses) on investment securities classified as
available-for-sale as well as foreign currency translation adjustments. There is no other comprehensive income (loss) attributable to
the noncontrolling interest. The components of comprehensive income (loss) and related taxes consisted of the following as of
June 30, 2010, 2009 and 2008:
2010
For Fiscal Year Ended June 30,
2009
2008
Net Income (Loss) ...............................................................
Foreign currency translation adjustments ............................
Unrealized holding (loss) gain on securities ........................
Tax effect .............................................................................
$
$
8,008,028
33,923
(23,304)
9,322
$
6,577,590
—
25,049
(10,020)
(2,267,750)
—
62,174
(24,869)
Total Other Comprehensive Income ....................................
19,941
15,029
37,305
Total Comprehensive Income (Loss)...................................
$
8,027,969
$
6,592,615
$
(2,230,445)
Note 12. 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 each of the June 30, 2010 and 2009 balance sheets are
consolidated VIE assets of approximately $1.9 million and $1.9 million, respectively, which are comprised mainly of land and a
building. VIE liabilities consist primarily of a mortgage on that property in the amount of $1.6 million and $1.7 million at June 30,
2010 and 2009, respectively.
Cody LCI Realty LLC (“Realty”) is the only VIE that is consolidated. Realty had been consolidated by Cody prior to its acquisition
by Lannett. Realty is a 50/50 joint venture with a former shareholder of Cody. 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 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 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 $20,000 per month effective October 2009, when the lease increased from
$15,000 per month. All intercompany rent expense is eliminated upon consolidation with Cody. The Company is not involved in any
other VIE.
Note 13. 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, 2010, 2009 and 2008 were
approximately $395,000, $330,000, and $350,000, respectively.
Note 14. 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, 2010, 217,193
shares have been issued under the ESPP. Compensation expense of $52,564, $81,871, and $25,208 was recognized in fiscal years
2010, 2009 and 2008, respectively, relating to the ESPP.
F-22
Note 15. Income Taxes
The provision (benefit) for income taxes consists of the following for the fiscal years ended June 30:
2010
2009
2008
Current Income Taxes
Federal ......................................................................
State and Local Taxes ...............................................
Total......................................................................
Deferred Income Taxes
Federal ......................................................................
State and Local Taxes ...............................................
Total......................................................................
Total ..................................................................
$
$
4,056,458
574,511
4,630,969
(795,969)
978,044
182,075
4,813,044
$
$
$
1,074,723
32,455
1,107,178
1,367,843
—
1,367,843
3,151,911
(168,373)
2,983,538
4,090,716
$
(3,986,449)
(757,405)
(4,743,854)
(3,376,011)
A reconciliation of the differences between the effective rates and federal statutory rates is as follows:
Federal income tax at statutory rate ....
State and local income tax, net............
Nondeductible expenses......................
Change in valuation allowance ...........
Income tax credits ...............................
Change in tax laws..............................
Other ...................................................
Income tax expense.............................
2010
2009
2008
34.0%
3.7%
2.1%
(0.6)%
(8.2)%
5.0%
1.5%
37.5%
34.0%
(0.4)%
2.3%
(0.7)%
(1.6)%
—%
4.7%
38.3%
35.0%
2.4%
(3.5)%
6.2%
15.3%
—%
3.9%
59.3%
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 expense. 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.
F-23
As of June 30, 2010 and 2009, 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...........................................................................................................
Reserve for returns...............................................................................................................
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.................................................................................................................................
2010
2009
$
474,679
928,133
186,653
2,016,324
3,485,512
10,324,148
—
1,093,056
2,016,620
2,017,657
22,542,782
(2,016,620)
20,526,162
118,965
740,687
194,109
1,982,629
2,748,381
11,929,502
74,255
1,156,131
2,097,175
1,977,804
23,019,638
(2,097,175)
20,922,463
Deferred tax liabilities:
Prepaid expenses..................................................................................................................
Property, plant and equipment .............................................................................................
Other ....................................................................................................................................
70,904
2,539,961
33,576
69,199
2,756,793
41,997
Net deferred tax asset...............................................................................................................
$
17,881,721
$
18,054,474
On April 10, 2007, the Company entered into a Stock Purchase Agreement to acquire Cody by purchasing all of the remaining shares
of common stock of Cody. The consideration for the April 10, 2007 acquisition was approximately $4,438,000, which represented the
fair value of the tangible net assets acquired. The agreement also required Lannett to issue to the sellers up to 120,000 shares of
unregistered common stock of the Company contingent upon the receipt of a license from a regulatory agency. This license was
subsequently received in July 2008 and triggered the payment of 105,000 shares of Lannett stock to the former owners of Cody Labs,
which was completed in October 2008. Therefore, the Company recorded an intangible asset related to the acquisition of a drug
import license in the original amount of $581,175 and recorded a corresponding deferred tax liability in the amount of $150,675 due to
the non-deductibility of the amortization for tax purposes.
In the third quarter of Fiscal 2008, the Company adjusted the original purchase price allocation for Cody, as a result of a study and
additional analysis of assets acquired. The result of this study was to increase the deferred tax assets by $1,255,065 and decrease the
value of Cody’s property, plant and equipment by the same amount. The increase in deferred tax assets related to Cody’s federal net
operation loss (NOL) carry forwards totaling approximately $3,774,000 at the date of acquisition with $1,902,000 expiring in 2026
and $1,872,000 in 2027. At June 30, 2010, the remaining gross deferred tax asset is $3,214,870. The income tax benefit associated
with the NOL carry forwards has been recognized in accordance with Section 382 of the Internal Revenue Code of 1986.
The Company may recognize the tax benefit from an uncertain tax position claimed on a tax return only if it is more likely than not
that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax
benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater
than 50% likelihood of being realized upon ultimate settlement. The authoritative standards issued by the FASB also provide guidance
on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities,
accounting for interest and penalties associated with tax positions, and income tax disclosures.
F-24
A reconciliation of the beginning and ending amount of gross unrecognized tax benefits (exclusive of interest and penalties) is as
follows:
Balance at June 30, 2008 ......................................................................................
Additions for tax positions of the current year......................................................
Additions for tax positions of prior years .............................................................
Reductions for tax positions of prior years ...........................................................
Settlements............................................................................................................
Lapse of statute of limitations...............................................................................
Balance at June 30, 2009 ......................................................................................
Additions for tax positions of the current year......................................................
Additions for tax positions of prior years .............................................................
Reductions for tax positions of prior years ...........................................................
Settlements............................................................................................................
Lapse of statute of limitations...............................................................................
Balance at June 30, 2010 ......................................................................................
$
$
$
—
65,033
232,630
—
—
—
297,663
24,295
292,695
—
(215,619)
—
399,034
As of June 30, 2010 and 2009, the Company reported total unrecognized benefits of $399,034 and $297,663, respectively. As a result
of the positions taken during the period, the Company has not recorded any interest and penalties for the period ended June 30, 2010
in the statement of operations and no cumulative interest and penalties have been recorded either in the Company’s statement of
financial position as of June 30, 2010 and 2009. The Company will recognize interest accrued on unrecognized tax benefits in interest
expense and any related penalties in operating expenses. The Company does not believe that the total unrecognized tax benefits will
significantly increase or decrease in the next twelve months.
The Company files income tax returns in the United States federal jurisdiction, Pennsylvania, New Jersey and California. The
Company’s tax returns for Fiscal 2005 and prior generally are no longer subject to review as such years generally are closed. The IRS
has completed its review of the federal income tax return for Fiscal 2008. The Company recorded a refund receivable totaling
approximately $421,000 and reduced its liability for unrecognized tax benefits by approximately $216,000 as a result of the settlement
agreement reached with the IRS. In addition, the Company amended its Fiscal 2005 income tax return to claim additional federal
income tax credits, which was accepted as timely filed by the IRS. As a result, the Company reduced it income taxes payable by
approximately $528,000 related to this amended income tax return. The Company believes that an unfavorable resolution for open tax
years would not be material to the financial position of the Company.
Note 16. Related Party Transactions
The Company had sales of approximately $679,000, $786,000, and $787,000 during the fiscal years ended June 30, 2010, 2009 and
2008, respectively, to a generic distributor, Auburn Pharmaceutical Company (“Auburn”). 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. Accounts receivable includes amounts due from the related party of approximately $161,000 and
$125,000 at June 30, 2010 and 2009, 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 in which the Company purchased for $100,000 and future royalty
payments the proprietary rights to manufacture and distribute a product for which Pharmeral, Inc. (“Pharmeral”) owned the ANDA.
In Fiscal 2008, the Company obtained FDA approval to use the proprietary rights. Accordingly, the Company originally capitalized
these rights as an indefinite lived intangible asset and tested this asset for impairment at least on an annual basis. During the fourth
quarter of Fiscal 2009, it was determined that this intangible asset no longer has an indefinite life. No impairment existed because the
estimated fair value exceeded the carrying amount on that date. Accordingly, the $100,000 carrying amount of this intangible asset
will be amortized on a straight line basis prospectively over its 10 year remaining estimated useful life. Arthur Bedrosian, President
and Chief Executive Officer currently owns 100% of Pharmeral. This transaction was approved by the Board of Directors of the
Company and in their opinion the terms were not more favorable to the related party than they would have been to a non-related party.
In May 2008, Mr. Bedrosian and Pharmeral waived their rights to any royalty payments on the sales of the drug by Lannett under
Lannett’s current ownership structure. Should Lannett undergo a change in control where a third party is involved, this royalty would
be reinstated. The registered trademark OB-Natal® was transferred to Lannett for one dollar from Mr. Bedrosian.
During Fiscal Year 2010, Lannett Company, Inc. paid a management consultant, who is related to Mr. Bedrosian, $115,700 in fees
and $16,803 in reimbursable expenses. This consultant provided management, construction planning, laboratory set up and
administrative services in regards to the Company’s initial set up of its Bio-study laboratory in a foreign country. It is expected that
F-25
this consultant will continue to be utilized into Fiscal 2011. In the Company’s opinion, the fee rates paid to this consultant and the
expenses reimbursed to him were not more favorable than what would have been paid to a non-related party.
Provell Pharmaceuticals, LLC (“Provell”) was a joint venture to distribute pharmaceutical products through mail order outlets. In
exchange for access to Lannett’s drug providers, Lannett initially received a 33% ownership interest in this venture. Lannett’s
ownership interest subsequently decreased to 25% due to the additional issuance of shares by Provell in which Lannett did not
participate. The investment was valued at zero, due to losses incurred through that date by Provell. During June 2009, the Company
terminated its participation in this joint venture. In connection with the termination agreement, the Company was required to pay
Provell ten percent of net sales of certain products for a period of up to twenty four months. Accounts receivable includes amounts
due from Provell of zero and approximately $55,000 at June 30, 2010 and 2009, respectively. The Company recognized revenues of
zero and approximately $29,000 and $141,000 during the fiscal years ended June 30, 2010, 2009 and 2008, respectively.
Note 17. 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 77% of the Company’s inventory purchases in Fiscal
2010 and 71% in Fiscal 2009 and 2008. 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 $15.0 million. Thereafter, the minimum quantity to be purchased increases by $1.0 million per year up to $24.0 million
for the last year of the ten-year contract. The Company has met the minimum purchase requirement for the first six 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, 2010, JSP has not exercised the nomination provision of the
agreement.
The Company’s financial condition, as well as its liquidity resources, are very dependent on an uninterrupted supply of product from
JSP. Should there be an interruption in the supply of product from JSP for any reason, this event would have a material impact to the
financial condition of Lannett.
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. The term of the agreement was three years, beginning on August 22, 2005 and
continuing through August 21, 2008. Following its expiration on August 21, 2008, the agreement was not renewed. Purchases of
finished goods inventory from this provider accounted for approximately 1% of the Company’s costs of purchased inventory in Fiscal
2009 and 14% in Fiscal 2008.
Note 18. 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 values of these assets and liabilities approximate fair value based upon the short-term
nature of these instruments. The Company has estimated that the fair value of long-term debt associated with the 20 year mortgage on
its land and building in Cody, Wyoming approximates the discounted amount of future payments to the mortgage-holder.
F-26
Note 19. Quarterly Financial Information (Unaudited)
Lannett’s quarterly consolidated results of operations are shown below:
Fiscal 2010
Net Sales ....................................................................
Cost of Goods Sold ....................................................
Gross Profit ............................................................
Other Operating Expenses .........................................
Operating Income ......................................................
Other Expense............................................................
Income Tax Expense..................................................
Less net income attributable to noncontrolling
interest...................................................................
Net Income — Lannett Company, Inc. ......................
Earnings Per Share — Lannett Company, Inc. ..........
Basic ..................................................................
Diluted ...............................................................
Fiscal 2009
Net Sales ....................................................................
Cost of Goods Sold ....................................................
Gross Profit ............................................................
Other Operating Expenses .........................................
Operating Income ......................................................
Other (Expense) Income ............................................
Income Tax Expense..................................................
Less net income attributable to noncontrolling
interest....................................................................
Net Income — Lannett Company, Inc. ......................
Earnings Per Share — Lannett Company, Inc. ..........
Basic ..................................................................
Diluted ...............................................................
Fiscal 2008
Net Sales ....................................................................
Cost of Goods Sold ....................................................
Gross Profit ............................................................
Other Operating Expenses .........................................
Operating Loss...........................................................
Other (Expense) .........................................................
Income Tax (Benefit).................................................
Less net income attributable to noncontrolling
interest....................................................................
Net Loss — Lannett Company, Inc. ..........................
Loss Per Share — Lannett Company, Inc..................
Basic ..................................................................
Diluted ...............................................................
Fourth
Quarter
Third
Quarter
Second
Quarter
First
Quarter
$
$
$
$
$
$
$
$
$
33,760,023
22,428,694
11,331,329
7,014,146
4,317,183
(57,124)
1,288,071
155,737
2,816,251
0.11
0.11
Fourth
Quarter
35,448,874
21,835,563
13,613,311
9,722,714
3,890,597
(69,110)
1,393,983
6,968
2,420,536
0.10
0.10
Fourth
Quarter
20,748,799
17,878,596
2,870,203
5,553,598
(2,683,395)
(98,691)
(2,554,889)
$
$
$
$
$
$
$
$
$
31,266,224
20,868,954
10,397,270
7,725,372
2,671,898
(42,310)
527,327
9,407
2,092,854
0.08
0.08
Third
Quarter
28,761,316
17,154,288
11,607,028
9,434,449
2,172,579
2,537
851,310
9,324
1,314,482
0.05
0.05
Third
Quarter
16,579,512
12,682,018
3,897,494
5,739,007
(1,841,513)
(29,786)
(615,454)
$
$
$
$
$
$
$
$
$
28,716,713
20,639,735
8,076,978
6,779,268
1,297,710
(62,199)
1,169,996
10,923
54,592
0.00
0.00
Second
Quarter
29,224,372
18,201,534
11,022,838
8,489,249
2,533,589
(25,548)
925,433
9,546
1,573,062
0.06
0.06
Second
Quarter
17,534,942
13,107,326
4,427,616
5,201,499
(773,883)
(43,647)
(159,983)
31,434,989
19,900,759
11,534,230
6,791,002
4,743,228
(47,314)
1,827,650
10,894
2,857,370
0.12
0.11
First
Quarter
25,567,653
16,566,361
9,001,292
6,817,188
2,184,104
(20,442)
919,990
17,507
1,226,165
0.05
0.05
First
Quarter
17,540,030
12,434,272
5,105,758
5,231,858
(126,100)
(46,746)
(45,685)
50,309
(277,506) $
—
(1,255,845) $
—
(657,547) $
—
(127,161)
(0.01) $
(0.01) $
(0.05) $
(0.05) $
(0.03) $
(0.03) $
(0.01)
(0.01)
$
$
$
$
$
$
$
$
$
$
$
$
In the second quarter of Fiscal 2010 gross profit margins were 28%. The gross profit percentage decreased due to the decline in sales
of prescription vitamins and two months of idle capacity costs at our Cody Labs subsidiary being directly expensed to the income
F-27
statement. In March 2009, the FDA issued a warning letter to seven companies including Lannett to remove Morphine Sulfate oral
solution from the market until someone could submit an application and receive approval on such application. In April 2009, due to
shortages of this fairly necessary drug in the marketplace, the FDA reversed their position and allowed all seven companies to
continue manufacturing and/or marketing Morphine Sulfate up until 180 days after someone received approval on a Morphine Sulfate
application. These actions by the FDA caused the DEA to withhold purchasing and manufacturing quota from some or all of these
seven companies, including Lannett. Although the Company had quota at that time, and quota issues were resolved by
December 2009, the Cody Labs facility was left idle for the months of October and November 2009 due to the lack of Morphine
Sulfate quota.
The effective tax rate in the second quarter of Fiscal 2010 was 95% due primarily to a change in Pennsylvania tax law which lowered
the Company’s apportionment factor within this state. The impact of this change caused the Company to reduce its deferred tax assets
by approximately $650,000, and therefore increased the effective tax rate by 11% for the six months ended December 31, 2009, which
in turn, had a significant impact on the second quarter of Fiscal 2010.
The Company recorded income tax expense of $527,000 in the third quarter of Fiscal 2010 resulting in an effective tax rate of 20%
due primarily to the settlement reached with the IRS related to its review of the federal income tax return for Fiscal 2008. As a result
of the settlement, the Company recorded a refund receivable totaling approximately $421,000. The Company also reduced its liability
for unrecognized tax benefits by approximately $216,000 as a result of the IRS settlement.
In the fourth quarter of Fiscal 2008 net sales increased largely due to a product recall of one of Lannett’s competitors. Also during the
fourth quarter of Fiscal 2008, the Company increased its returns reserve by $10.5 million, reflecting its expectation that 100% of the
shipments of Prenatal Multivitamin made in the fourth quarter would be returned. The Company’s expectation that all of the product
would be returned was based on its inability to have the product specified as a brand equivalent, product complaints and information
from its customers regarding their intentions to return the product. Through June 30, 2010, approximately $10.1 million of the
Multivitamin product had been returned. In the fourth quarter of Fiscal 2010, the Company reversed approximately $387,000 to net
sales as a result of new information that the Company received regarding the amount of Multivitamin product that remained to be
returned to the Company. This adjustment left a balance of approximately $17,000 of Multivitamin returns reserve on the
consolidated balance sheet at June 30, 2010.
In addition, the Company increased the returns reserve in the fourth quarter of Fiscal 2008 by approximately $1.5 million based on an
analysis of its historical returns experience, the average lag time between sales and returns and an evaluation of changing buying and
inventory trends of both its direct and indirect customers. As this change resulted from new information that the Company had
received regarding the amount of Multivitamin product that remained to be returned to the Company. The Company considers this to
be a change in estimate as defined by the FASB’s authoritative guidance.
F-28
Schedule II - Valuation and Qualifying Accounts
For the years ended June 30:
Description
Allowance for Doubtful Accounts
2010 ...........................................................................
2009 ...........................................................................
2008 ...........................................................................
Inventory Valuation
2010 ...........................................................................
2009 ...........................................................................
2008 ...........................................................................
Deferred Tax Asset Valuation Allowance
2010 ...........................................................................
2009 ...........................................................................
2008 ...........................................................................
Balance at
Beginning of
Fiscal Year
Charged to
(reduction of)
Expense
Deductions
Balance at
End of Fiscal
Year
$
$
$
$
$
$
132,000
207,151
250,000
2,744,305
1,642,668
923,920
2,097,175
2,314,498
2,667,550
$
$
—
(87,913)
48,284
1,279,781
2,004,403
2,679,902
8,808
(12,762)
91,133
1,542,276
902,767
1,961,154
(80,555) $
(217,323)
(353,052)
—
—
—
$
$
$
123,192
132,000
207,151
2,481,810
2,744,305
1,642,668
2,016,620
2,097,175
2,314,498
F-29
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The following list identifies the subsidiaries of the Company:
Subsidiary Name
State of Incorporation
Subsidiaries of the Company
Lannett Holdings, Inc......
Cody Laboratories, Inc....
Delaware
Wyoming
Exhibit 21
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have issued our report dated September 24, 2010, with respect to the consolidated financial statements and schedule included in
the Annual Report of Lannett Company, Inc. and Subsidiaries on Form 10-K for the fiscal year ended June 30, 2010. We hereby
consent to the incorporation by reference of said report in the Registration Statements of Lannett Company, Inc. and Subsidiaries on
Forms S-3 (File No. 333-115746, effective May 21, 2004, and File No. 333-162318, effective October 2, 2009) and on Forms S-8
(File No. 333-103235, effective February 14, 2003, File No. 333-103236, effective February 14, 2003, and File No. 33-147410,
effective November 15, 2007).
Exhibit 23.1
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania
September 24, 2010
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Arthur P. Bedrosian, certify that:
1.
I have reviewed this report on Form 10-K of Lannett Company, Inc.;
Exhibit 31.1
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 P. Bedrosian
Date: September 23, 2010
President and Chief Executive Officer
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Keith R. Ruck, certify that:
1.
I have reviewed this report on Form 10-K of Lannett Company, Inc.;
Exhibit 31.2
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/Keith R. Ruck
Date: September 23, 2010
Vice President of Finance and Chief Financial Officer
Certification Pursuant to
18 U.S.C. Section 1350,
as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32
In connection with the Annual Report of Lannett Company, Inc. (the “Company”) on Form 10-K for the year ended June 30, 2010 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, Keith R. Ruck, the Vice President of Finance and 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: September 23, 2010
/s/Arthur P. Bedrosian
Arthur P. Bedrosian,
President and Chief Executive Officer
Dated: September 23, 2010
/s/Keith R. Ruck
Keith R. Ruck,
Vice President of Finance and
Chief Financial Officer
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BOARD OF DIRECTORS
William Farber
Chairman of the Board
Ronald West
Vice Chairman and L ead Director
Director, Beecher Associates
Arthur P. Bedrosian, J.D.
President, Chief Executive Officer and Director,
Lannett Company, Inc.
Jeffrey Farber
President, Auburn Pharmaceutical
Kenneth Sinclair, Ph.D.
Professor of Accounting,
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 and Director
William Schreck
Senior Vice President and General Manager
Kevin Smith
Vice President—Sales & Marketing
Ernest Sabo
Vice President—Regulatory and Corporate Compliance
Keith R. Ruck
Vice President of Finance and Chief Financial Officer
Stephen J. Kovary
Vice President—Operations
CORPORATE INFORMATION
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 350
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 NYSE Amex 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 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.
Lannett Company, Inc.
9000 State Road
Philadelphia, PA 19136
(215) 333-9000, (800) 325-9994
Fax (215) 333-9004
www.lannett.com