Summary of Significant Accounting Policies (Policies)

9 Months Ended

Mar. 31, 2013

Summary of Significant Accounting Policies

Use of Estimates

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, the 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

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 (“Realty”), 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

Foreign Currency Translation — The local currency is the functional currency of the Company’s 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

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

Revenue Recognition

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 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.

Cash and cash equivalents

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.

Accounts Receivable

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

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 remaining product shelf-life and estimated forecasts of product demand.  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 reduces the inventory value and 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 — Property, plant and equipment balances 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 three months ended March 31, 2013 and 2012 was $1,060 and $934, respectively.  Depreciation expense for the nine months ended March 31, 2013 and 2012 was $3,210 and $2,797, respectively.

Investment Securities

Investment Securities — The Company’s investment securities consist of publicly traded equity securities, which are classified as trading.  Investment securities are recorded at fair value based on quoted market prices.  For trading investments, unrealized holding gains and losses are recorded on the consolidated statements of operations.  No gains or losses on investment securities are realized until they are sold or a decline in fair value is determined to be other-than-temporary.  The Company reviews its investment 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 during the nine months ended March 31, 2013 or the fiscal year ended June 30, 2012.

Shipping and Handling Costs

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 — Research and development costs are expensed as incurred.

Intangible Assets

Intangible Assets — Indefinite-lived and definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.  Definite-lived intangible assets are amortized over the estimated useful lives, generally for periods ranging from 10 to 15 years.  The Company continually evaluates the reasonableness of the useful lives of these assets.

Impairments

Impairments — 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 rates, and expectations about the amount and timing of cash flows and the probability of achieving the estimated cash flows.

Advertising Costs

Advertising Costs — The Company charges advertising costs to operations as incurred.  Advertising expense for the nine months ended March 31, 2013 and 2012 was $13 and $26, respectively.

Income Taxes

Income Taxes — The Company accounts for income taxes in accordance with FASB ASC 740.  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 are 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.  The factors used to assess the likelihood of realization are the Company’s forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets.  Failure to achieve forecasted taxable income in applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings.

Medical Indication Information

Medical Indication Information — The Company operates one business segment - generic pharmaceuticals; accordingly the Company aggregates its financial information for all products and reports one reporting segment.  The following table identifies the Company’s net product sales by medical indication for the three and nine months ended March 31, 2013 and 2012:

(In thousands)	For the Three Months Ended March 31,				For the Nine Months Ended March 31,
Medical Indication	2013		2012		2013		2012
Antibiotic	$	3,496	$	1,662	$	6,267	$	4,798
Cardiovascular	6,988		6,050		21,356		11,512
Gallstone	1,390		1,419		4,676		4,286
Glaucoma	1,627		993		4,608		3,093
Gout	1,776		110		2,907		482
Migraine Headache	1,299		1,442		3,995		4,601
Obesity	1,074		979		3,488		2,570
Pain Management	4,980		4,043		14,752		14,609
Thyroid Deficiency	14,024		12,543		42,135		36,788
Other	2,368		1,447		6,696		4,561
Total	$	39,022	$	30,688	$	110,880	$	87,300

Concentration of Market and Credit Risk

Concentration of Market and Credit Risk — The following table identifies products which accounted for at least 10% of net sales in either of the three and nine month periods ended March 31, 2013 and 2012.

	For the Three Months Ended March 31,				For the Nine Months Ended March 31,
	2013		2012		2013		2012
Product 1	36	%	41	%	38	%	42	%
Product 2	12	%	11	%	11	%	4	%
Product 3	10	%	6	%	9	%	9	%

The following table identifies customers which accounted for at least 10% of net sales in either of the three and nine month periods ended March 31, 2013 and 2012, respectively.

	For the Three Months Ended March 31,				For the Nine Months Ended March 31,
	2013		2012		2013		2012
Customer A	16	%	16	%	16	%	18	%
Customer B	11	%	10	%	12	%	11	%
Customer C	10	%	9	%	10	%	12	%
Customer D	9	%	11	%	8	%	10	%

At March 31, 2013 and June 30, 2012, four customers accounted for 68% and 66%, respectively of the Company’s accounts receivable balances, respectively.  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 outstanding balances are stated in the financial statements net of an allowance for doubtful accounts.  Individual balances 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 are determined to have become uncollectible.

Share-based Compensation

Share-based Compensation — Share-based compensation costs are recognized over the vesting period based on the fair value of the instrument on the date of grant less an estimate for forfeitures.  The Company uses the Black-Scholes valuation model to determine the fair value of stock options and the share price on the grant date to value restricted stock.  The fair value model includes various assumptions, including the expected volatility, expected life of the awards, and risk-free interest rates.  These assumptions involve inherent uncertainties based on market conditions which are generally outside the Company’s control.  Changes in these assumptions could have a material impact on share-based compensation costs recognized in the financial statements.