10-Q 1 a16-23340_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2016

 

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

 

FOR THE TRANSITION PERIOD FROM              TO                       

 

Commission File No. 001-31298

 

LANNETT COMPANY, INC.

(Exact Name of Registrant as Specified in its Charter)

 

State of Delaware

 

23-0787699

(State of Incorporation)

 

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

 

9000 State Road

Philadelphia, PA 19136

(215) 333-9000

(Address of principal executive offices and telephone number)

 

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

 

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

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

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

 

Class

 

Outstanding as of January 31, 2017

Common stock, par value $0.001 per share

 

37,189,492

 

 

 



Table of Contents

 

Table of Contents

 

 

 

Page No.

PART I. FINANCIAL INFORMATION

 

 

 

 

ITEM 1.

FINANCIAL STATEMENTS

 

 

 

 

 

Consolidated Balance Sheets as of December 31, 2016 (unaudited) and June 30, 2016

3

 

 

 

 

Consolidated Statements of Operations (unaudited) for the three and six months ended December 31, 2016 and 2015

4

 

 

 

 

Consolidated Statements of Comprehensive Income (unaudited) for the three and six months ended December 31, 2016 and 2015

5

 

 

 

 

Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the six months ended December 31, 2016

6

 

 

 

 

Consolidated Statements of Cash Flows (unaudited) for the six months ended December 31, 2016 and 2015

7

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

8

 

 

 

ITEM 2.

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

30

 

 

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

48

 

 

 

ITEM 4.

CONTROLS AND PROCEDURES

48

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

ITEM 1.

LEGAL PROCEEDINGS

49

 

 

 

ITEM 1A.

RISK FACTORS

49

 

 

 

ITEM 6.

EXHIBITS

49

 

2



Table of Contents

 

PART I.  FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

LANNETT COMPANY, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

 

 

(Unaudited)

 

 

 

 

 

December 31, 2016

 

June 30, 2016

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

247,253

 

$

224,769

 

Investment securities

 

11,870

 

14,094

 

Accounts receivable, net

 

222,986

 

211,722

 

Inventories

 

130,238

 

114,904

 

Deferred tax assets

 

45,375

 

40,892

 

Other current assets

 

7,886

 

6,434

 

Total current assets

 

665,608

 

612,815

 

Property, plant and equipment, net

 

227,053

 

216,638

 

Intangible assets, net

 

470,065

 

575,503

 

Goodwill

 

339,566

 

333,611

 

Deferred tax assets

 

31,782

 

11,556

 

Other assets

 

18,848

 

13,895

 

TOTAL ASSETS

 

$

1,752,922

 

$

1,764,018

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

43,772

 

$

34,720

 

Accrued expenses

 

11,662

 

9,247

 

Accrued payroll and payroll-related expenses

 

8,910

 

10,572

 

Rebates payable

 

36,785

 

21,894

 

Royalties payable

 

3,550

 

5,127

 

Restructuring liability

 

5,347

 

4,130

 

Settlement liability

 

8,000

 

7,000

 

Income taxes payable

 

1,483

 

743

 

Acquisition-related contingent consideration

 

35,000

 

35,000

 

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

 

178,239

 

178,236

 

Total current liabilities

 

332,748

 

306,669

 

Long-term debt, net

 

867,221

 

883,612

 

Settlement liability

 

9,167

 

12,526

 

Other liabilities

 

7,136

 

6,754

 

TOTAL LIABILITIES

 

1,216,272

 

1,209,561

 

Commitments and Contingencies (Note 13 and 14)

 

 

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

 

 

 

 

Common stock ($0.001 par value, 100,000,000 shares authorized; 37,443,721 and 37,150,165 shares issued; 36,838,519 and 36,604,202 shares outstanding at December 31, 2016 and June 30, 2016, respectively)

 

37

 

37

 

Additional paid-in capital

 

288,906

 

283,301

 

Retained earnings

 

257,119

 

278,355

 

Accumulated other comprehensive loss

 

(257

)

(295

)

Treasury stock (605,202 and 545,963 shares at December 31, 2016 and June 30, 2016, respectively)

 

(9,155

)

(7,349

)

Total Lannett Company, Inc. stockholders’ equity

 

536,650

 

554,049

 

Noncontrolling interest

 

 

408

 

Total stockholders’ equity

 

536,650

 

554,457

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

1,752,922

 

$

1,764,018

 

 

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

 

3



Table of Contents

 

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(In thousands, except share and per share data)

 

 

 

Three months ended

 

Six months ended

 

 

 

December 31,

 

December 31,

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

170,944

 

$

127,059

 

$

332,503

 

$

233,492

 

Cost of sales

 

75,154

 

51,800

 

145,974

 

80,619

 

Amortization of intangibles

 

7,737

 

3,614

 

16,624

 

3,801

 

Gross profit

 

88,053

 

71,645

 

169,905

 

149,072

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development expenses

 

9,939

 

9,069

 

22,310

 

15,597

 

Selling, general and administrative expenses

 

18,069

 

14,666

 

39,329

 

30,202

 

Acquisition and integration-related expenses

 

1,027

 

17,585

 

2,418

 

21,527

 

Restructuring expenses

 

1,712

 

 

3,764

 

 

Intangible asset impairment charges

 

23,000

 

 

88,084

 

 

Total operating expenses

 

53,747

 

41,320

 

155,905

 

67,326

 

Operating income

 

34,306

 

30,325

 

14,000

 

81,746

 

Other income (loss):

 

 

 

 

 

 

 

 

 

Investment income (loss)

 

1,021

 

975

 

2,048

 

(135

)

Interest expense

 

(23,333

)

(11,772

)

(46,327

)

(11,832

)

Other

 

(266

)

(30

)

(263

)

(30

)

Total other loss

 

(22,578

)

(10,827

)

(44,542

)

(11,997

)

Income (loss) before income tax

 

11,728

 

19,498

 

(30,542

)

69,749

 

Income tax expense (benefit)

 

3,542

 

5,958

 

(9,340

)

23,013

 

Net income (loss)

 

8,186

 

13,540

 

(21,202

)

46,736

 

Less: Net income attributable to noncontrolling interest

 

14

 

20

 

34

 

35

 

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

 

$

8,172

 

$

13,520

 

$

(21,236

)

$

46,701

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Basic

 

$

0.22

 

$

0.37

 

$

(0.58

)

$

1.28

 

Diluted

 

$

0.22

 

$

0.36

 

$

(0.58

)

$

1.25

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

36,810,388

 

36,388,542

 

36,754,828

 

36,349,597

 

Diluted

 

37,676,370

 

37,388,450

 

36,754,828

 

37,401,878

 

 

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

 

4



Table of Contents

 

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

(In thousands)

 

 

 

Three months ended

 

Six months ended

 

 

 

December 31,

 

December 31,

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

8,186

 

$

13,540

 

$

(21,202

)

$

46,736

 

Other comprehensive income, before tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation gain

 

41

 

42

 

38

 

26

 

Total other comprehensive income, before tax

 

41

 

42

 

38

 

26

 

Income tax related to items of other comprehensive income

 

 

 

 

 

Total other comprehensive income, net of tax

 

41

 

42

 

38

 

26

 

Comprehensive income (loss)

 

8,227

 

13,582

 

(21,164

)

46,762

 

Less: Total comprehensive income attributable to noncontrolling interest

 

14

 

20

 

34

 

35

 

Comprehensive income (loss) attributable to Lannett Company Inc.

 

$

8,213

 

$

13,562

 

$

(21,198

)

$

46,727

 

 

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

 

5



Table of Contents

 

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

(In thousands)

 

 

 

Stockholders’ Equity Attributable to Lannett Company Inc.

 

 

 

 

 

 

 

Common Stock

 

Additional

 

 

 

Accumulated
Other

 

 

 

Stockholders’
Equity

 

 

 

Total

 

 

 

Shares
Issued

 

Amount

 

Paid-In
Capital

 

Retained
Earnings

 

Comprehensive
Loss

 

Treasury
Stock

 

Attributable to
Lannett Co., Inc.

 

Noncontrolling
Interest

 

Stockholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, June 30, 2016

 

37,150

 

$

37

 

$

283,301

 

$

278,355

 

$

(295

)

$

(7,349

)

$

554,049

 

$

408

 

$

554,457

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares issued in connection with share-based compensation plans

 

294

 

 

1,785

 

 

 

 

1,785

 

 

1,785

 

Share-based compensation

 

 

 

4,173

 

 

 

 

4,173

 

 

4,173

 

Excess tax benefits on share-based compensation awards

 

 

 

705

 

 

 

 

705

 

 

705

 

Purchase of noncontrolling interest

 

 

 

(1,058

)

 

 

 

(1,058

)

(442

)

(1,500

)

Purchase of treasury stock

 

 

 

 

 

 

(1,806

)

(1,806

)

 

(1,806

)

Other comprehensive income, net of income tax

 

 

 

 

 

38

 

 

38

 

 

38

 

Net income (loss)

 

 

 

 

(21,236

)

 

 

(21,236

)

34

 

(21,202

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2016

 

37,444

 

$

37

 

$

288,906

 

$

257,119

 

$

(257

)

$

(9,155

)

$

536,650

 

$

 

$

536,650

 

 

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

 

6



Table of Contents

 

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)

 

 

 

Six Months Ended
December 31,

 

 

 

2016

 

2015

 

OPERATING ACTIVITIES:

 

 

 

 

 

Net income (loss)

 

$

(21,202

)

$

46,736

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

27,963

 

8,119

 

Deferred income tax expense (benefit)

 

(24,709

)

1,743

 

Share-based compensation

 

4,173

 

6,398

 

Excess tax benefits on share-based compensation awards

 

(705

)

(1,034

)

Intangible assets impairment charges

 

88,084

 

 

Loss on sale of assets

 

267

 

26

 

Loss (gain) on investment securities

 

(1,697

)

334

 

Amortization of debt discount and other debt issuance costs

 

10,509

 

2,662

 

Other noncash expenses

 

1,056

 

 

Changes in assets and liabilities which provided (used) cash, net of acquisition:

 

 

 

 

 

Accounts receivable, net

 

(17,219

)

5,306

 

Inventories

 

(15,334

)

5,996

 

Prepaid income taxes/Income taxes payable

 

1,827

 

(13,652

)

Other assets

 

(7,099

)

(2,459

)

Rebates payable

 

14,891

 

5,184

 

Royalties payable

 

(1,577

)

2,684

 

Restructuring liability

 

1,217

 

 

Settlement liability

 

(3,000

)

 

Accounts payable

 

9,052

 

(4,937

)

Accrued expenses

 

2,415

 

5,636

 

Accrued payroll and payroll-related expenses

 

(1,662

)

(7,117

)

Net cash provided by operating activities

 

67,250

 

61,625

 

INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of property, plant and equipment

 

(21,324

)

(10,629

)

Proceeds from sale of property, plant and equipment

 

33

 

10

 

Acquisition, net of cash acquired

 

 

(929,581

)

Proceeds from sale of investment securities

 

31,019

 

21,374

 

Purchase of investment securities

 

(27,098

)

(22,227

)

Net cash used in investing activities

 

(17,370

)

(941,053

)

FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from issuance of debt

 

 

910,610

 

Repayments of long-term debt

 

(26,618

)

(22,817

)

Purchase of noncontrolling interest

 

(1,500

)

 

Proceeds from issuance of stock

 

1,785

 

2,689

 

Payment of debt issuance costs

 

 

(32,716

)

Excess tax benefits on share-based compensation awards

 

705

 

1,034

 

Purchase of treasury stock

 

(1,806

)

(908

)

Net cash provided by (used in) financing activities

 

(27,434

)

857,892

 

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

 

38

 

26

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

22,484

 

(21,510

)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

224,769

 

200,340

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

247,253

 

$

178,830

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

 

 

 

 

 

Interest paid (net of amounts capitalized)

 

$

34,986

 

$

5,569

 

Income taxes paid

 

$

13,553

 

$

34,950

 

 

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

 

7



Table of Contents

 

LANNETT COMPANY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 1.  Interim Financial Information

 

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for the presentation of interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, the unaudited financial statements do not include all the information and footnotes necessary for a comprehensive presentation of the financial position, results of operations and cash flows for the periods presented.  In the opinion of management, the unaudited financial statements include all the normal recurring adjustments that are necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented.  Operating results for the three and six months ended December 31, 2016 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2017.  These unaudited financial statements should be read in combination with the other Notes in this section; “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in Item 2; and the Consolidated Financial Statements, including the Notes to the Consolidated Financial Statements, included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016.  The Consolidated Financial Statements for the fiscal year ended June 30, 2016 were derived from audited financial statements.

 

Note 2.  The Business And Nature of Operations

 

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

 

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

 

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

 

Note 3.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

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

 

Principles of consolidation

 

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

 

Business Combinations

 

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

 

8



Table of Contents

 

Reclassifications

 

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

 

Use of estimates

 

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

 

Foreign currency translation

 

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

 

Cash and cash equivalents

 

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

 

Investment securities

 

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

 

Allowance for doubtful accounts

 

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

 

Inventories

 

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

 

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Table of Contents

 

Property, Plant and Equipment

 

Property, plant and equipment are stated at cost less accumulated depreciation.  Depreciation is computed on a straight-line basis over the assets’ estimated useful lives.  Depreciation expense for each of the three months ended December 31, 2016 and 2015 was $5.5 million and $2.4 million, respectively.  Depreciation expense for each of the six months ended December 31, 2016 and 2015 was $10.6 million and $4.2 million, respectively.

 

Intangible Assets

 

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

 

Valuation of Long-Lived Assets, including Intangible Assets

 

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

 

In-Process Research and Development

 

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

 

Goodwill

 

Goodwill, which represents the excess of purchase price over the fair value of net assets acquired, is carried at cost.  Goodwill is tested for impairment on an annual basis on the first day of the fourth quarter of each fiscal year or more frequently if events or changes in circumstances indicate that the asset might be impaired.  The Company first performs a qualitative assessment to determine if the quantitative impairment test is required.  If changes in circumstances indicate an asset may be impaired, the Company performs the quantitative impairment test.  In accordance with accounting standards, a two-step quantitative method is used for determining goodwill impairment.  In the first step, the Company determines the fair value of our reporting unit (generic pharmaceuticals).  If the net book value of our reporting unit exceeds its fair value, the second step of the impairment test which requires the hypothetical allocation of our reporting unit’s fair value to all of its assets and liabilities using the acquisition method prescribed under authoritative guidance for business combinations would then be performed.  Any residual fair value is allocated to goodwill.  An impairment charge is recognized to the extent that the estimated fair value of our reporting unit’s goodwill is less than its carrying amount.  The judgments made in determining the estimated fair value of goodwill can materially impact our results of operations.  The Company’s fair value assessments are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows.

 

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Segment Information

 

The Company operates in one reportable segment, generic pharmaceuticals.  As such, the Company aggregates its financial information for all products.  The following table identifies the Company’s net sales by medical indication for the three and six months ended December 31, 2016 and 2015:

 

(In thousands)

 

For the Three Months Ended
December 31,

 

For the Six Months Ended
December 31,

 

Medical Indication

 

2016

 

2015

 

2016

 

2015

 

Antibiotic

 

$

4,792

 

$

2,828

 

$

8,572

 

$

5,556

 

Anti Psychosis

 

15,365

 

730

 

32,685

 

3,472

 

Cardiovascular

 

11,975

 

13,082

 

24,669

 

21,385

 

Central Nervous System

 

10,555

 

6,077

 

20,904

 

6,077

 

Gallstone

 

13,425

 

18,719

 

26,308

 

38,691

 

Gastrointestinal

 

18,977

 

8,617

 

37,029

 

8,693

 

Glaucoma

 

5,311

 

6,543

 

11,095

 

13,365

 

Migraine

 

7,863

 

5,705

 

15,023

 

11,247

 

Muscle Relaxant

 

3,004

 

1,393

 

6,536

 

3,054

 

Obesity

 

960

 

851

 

1,795

 

1,830

 

Pain Management

 

7,439

 

8,074

 

14,047

 

16,207

 

Respiratory

 

2,957

 

1,396

 

5,170

 

1,396

 

Thyroid Deficiency

 

45,431

 

37,432

 

85,269

 

78,534

 

Urinary

 

4,693

 

3,378

 

9,794

 

3,593

 

Other

 

10,173

 

9,963

 

20,519

 

18,121

 

Contract manufacturing revenue

 

8,024

 

2,271

 

13,088

 

2,271

 

Total

 

$

170,944

 

$

127,059

 

$

332,503

 

$

233,492

 

 

Customer, Supplier and Product Concentration

 

The following table presents the percentage of total net sales, for the three and six months ended December 31, 2016 and 2015, for certain of the Company’s products, defined as products containing the same active ingredient or combination of ingredients, which accounted for at least 10% of net sales in any of those periods:

 

 

 

For the Three Months Ended
December 31,

 

For the Six Months Ended
December 31,

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

 

 

 

 

 

 

 

 

Product 1

 

27

%

29

%

26

%

34

%

Product 2

 

8

%

15

%

8

%

17

%

 

The following table presents the percentage of total net sales, for the three and six months ended December 31, 2016 and 2015, for certain of the Company’s customers which accounted for at least 10% of net sales in any of those periods:

 

 

 

For the Three Months Ended
December 31,

 

For the Six Months Ended
December 31,

 

 

 

2016

 

2015

 

2016

 

2015

 

 

 

 

 

 

 

 

 

 

 

Customer A

 

28

%

27

%

28

%

27

%

Customer B

 

20

%

18

%

20

%

15

%

 

The Company’s primary finished goods inventory supplier is Jerome Stevens Pharmaceuticals, Inc. (“JSP”), in Bohemia, New York.  Purchases of finished goods inventory from JSP accounted for approximately 39% and 59% of the Company’s inventory purchases during the three months ended December 31, 2016 and 2015, respectively.  Purchases of finished goods inventory from JSP accounted for approximately 38% and 62% of the Company’s inventory purchases during the six months ended December 31, 2016 and 2015, respectively.  See Note 22 “Material Contracts with Suppliers” for more information.

 

Revenue Recognition

 

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

 

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Table of Contents

 

Net Sales Adjustments

 

When revenue is recognized a simultaneous adjustment to gross sales is made for chargebacks, rebates, returns, promotional adjustments and other potential adjustments.  These provisions are primarily estimated based on historical experience, future expectations, contractual arrangements with wholesalers and indirect customers and other factors known to management at the time of accrual.  Accruals for provisions are presented in the Consolidated Financial Statements as a reduction to gross sales with the corresponding reserve presented as a reduction of accounts receivable or included as rebates payable, depending on the nature of the reserve.  The reserves, presented as a reduction of accounts receivable, totaled $179.3 million and $176.1 million at December 31, 2016 and June 30, 2016, respectively.  Rebates payable at December 31, 2016 and June 30, 2016 were $36.8 million and $21.9 million, respectively, for certain rebate programs, primarily related to Medicare Part D, Medicaid and certain sales allowances and other adjustments paid to indirect customers.

 

Cost of Sales, including Amortization of Intangibles

 

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

 

Research and Development

 

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

 

Contingencies

 

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

 

Contingent Consideration

 

Contingent consideration resulting from the KUPI acquisition was recorded at its estimated fair value on the acquisition date.  The Company has agreed to a 50/50 split of the additional tax liabilities UCB will incur associated with the IRS Section 338(H)(10) tax election, up to $35.0 million.  This election is expected to result in additional tax benefits to the Company of approximately $100.0 million.  These fair value measurements represent Level 3 measurements, as they are based on significant inputs not observable in the market.

 

Restructuring Costs

 

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

 

Share-based Compensation

 

Share-based compensation costs are recognized over the vesting period, using a straight-line method, based on the fair value of the instrument on the date of grant less an estimate for expected forfeitures.  The Company uses the Black-Scholes valuation model to determine the fair value of stock options and the stock price on the grant date to value restricted stock.  The Black-Scholes valuation model includes various assumptions, including the expected volatility, the expected life of the award, dividend yield and the risk-free interest rate.  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.

 

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Table of Contents

 

Income Taxes

 

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

 

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

 

Earnings Per Common Share

 

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

 

Comprehensive Income (Loss)

 

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

 

Recent Accounting Pronouncements

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers.  The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The authoritative guidance is effective for annual reporting periods beginning after December 15, 2017.  The Company is continuing to assess the impact this guidance will have on the consolidated financial statements.

 

In July 2015, the FASB issued ASU 2015-11, Inventory — Simplifying the Measurement of Inventory.  ASU 2015-11 requires inventory to be subsequently measured using the lower of cost and net realizable value, thereby eliminating the market value approach.  Net realizable value is defined as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.”  ASU 2015-11 is effective for reporting periods beginning after December 15, 2016 and is applied prospectively.  Early adoption is permitted.  The Company does not believe this guidance will have a material impact on the consolidated financial statements.

 

In September 2015, the FASB issued ASU 2015-16, Business Combinations — Simplifying the Accounting for Measurement-Period Adjustments.  ASU 2015-16 requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined.  ASU 2015-16 also requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date.   ASU 2015-16 is effective for reporting periods beginning after December 15, 2015 and is applied prospectively.  Early adoption is permitted.  The Company elected to early adopt ASU 2015-16 as of March 31, 2016.

 

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Table of Contents

 

In November 2015, the FASB issued ASU 2015-17, Income Taxes — Balance Sheet Classification of Deferred Taxes.  ASU 2015-17 requires all deferred tax assets and liabilities to be classified as noncurrent on the balance sheet.  The guidance may be applied either prospectively or retrospectively.  ASU 2015-17 is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2016.  Early adoption is permitted.  The Company does not believe this guidance will have a material impact on the consolidated financial statements.

 

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

 

In March 2016, the FASB issued ASU 2016-09, Compensation — Stock Compensation: Improvements to Employee Share-Based Payment Accounting.  ASU 2016-09 clarifies several aspects of accounting for share-based compensation including the accounting for excess tax benefits and deficiencies, accounting for forfeitures and the classification of excess tax benefits on the cash flow statement.  ASU 2016-09 is effective for fiscal years beginning after December 15, 2016 and in interim periods within those fiscal years, with early adoption permitted.  The Company is currently in the process of assessing the impact this guidance will have on the consolidated financial statements.

 

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

 

Note 4.  Acquisitions

 

Kremers Urban Pharmaceuticals Inc.

 

On November 25, 2015, the Company completed the acquisition of KUPI, the former U.S. specialty generic pharmaceuticals subsidiary of global biopharmaceuticals company UCB S.A., pursuant to the terms and conditions of a Stock Purchase Agreement.  KUPI is a specialty pharmaceuticals manufacturer focused on the development of products that are difficult to formulate or utilize specialized delivery technologies.  Strategic benefits of the acquisition include expanded manufacturing capacity, a diversified product portfolio and pipeline and complementary research and development expertise.

 

Pursuant to the terms of the Stock Purchase Agreement, Lannett purchased 100% of the outstanding equity interests of KUPI for total consideration of approximately $1.2 billion.

 

The following table summarizes the fair value of total consideration transferred to KUPI shareholders at the acquisition date of November 25, 2015:

 

(In thousands)

 

 

 

Cash purchase price paid to KUPI shareholders

 

$

1,030,000

 

Working capital adjustment

 

(41,605

)

Certain amounts reimbursable by UCB

 

(37,340

)

Total cash consideration transferred to KUPI shareholders

 

951,055

 

12.0% Senior Notes issued to UCB

 

200,000

 

Acquisition-related contingent consideration

 

35,000

 

Warrant issued to UCB

 

29,920

 

Total consideration to KUPI shareholders

 

$

1,215,975

 

 

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Table of Contents

 

The Company funded the acquisition and transaction expenses with proceeds from the issuance of the $910.0 million of term loans, $22.8 million borrowings from a revolving credit facility, the issuance of $250.0 million Senior Notes (see Note 12 “Long-term Debt”) and cash on hand of $94.6 million.  Lannett also issued a warrant with an estimated fair value of $29.9 million.

 

As part of the acquisition, the Company and UCB have agreed to jointly make an election under Section 338(h)(10) of the Internal Revenue Code of 1986, as amended and under the corresponding provisions of state law, to treat the acquisition as a deemed purchase and sale of assets for income tax purposes.  The Company has agreed to reimburse UCB for 50% of the incremental tax cost of making such election, subject to a reimbursement cap of $35.0 million.  This liability has been recorded as acquisition-related contingent consideration on the Consolidated Balance Sheet.  This election is expected to result in additional tax benefits to the Company of approximately $100.0 million.

 

The Company also agreed to contingent payments related to Methylphenidate Hydrochloride Extended Release tablets (“Methylphenidate ER”) provided the FDA reinstates the AB-rating for such product and certain sales thresholds are met.  On October 18, 2016, the Company received notice from the FDA that it will seek to withdraw approval of the Company’s ANDA for Methylphenidate ER.  See Note 11 “Goodwill and Intangible Assets” for more information.

 

The Company used the acquisition method of accounting to account for this transaction.  Under the acquisition method of accounting, the assets acquired and liabilities assumed in the transaction were recorded at the date of acquisition at their respective fair values.

 

The purchase price has been allocated to the assets acquired and liabilities assumed for the KUPI business as follows:

 

(In thousands)

 

Purchase
Price Allocation

 

Cash and cash equivalents

 

$

16,877

 

Accounts receivable, net of revenue-related reserves

 

129,408

 

Inventories

 

84,009

 

Other current assets

 

11,238

 

Property, plant and equipment

 

111,849

 

Product rights

 

427,000

 

Trade name

 

2,920

 

Other intangible assets

 

19,000

 

In-process research and development

 

125,000

 

Goodwill

 

339,425

 

Deferred tax assets

 

4,186

 

Other assets

 

10,218

 

Total assets acquired

 

1,281,130

 

Accounts payable

 

(19,249

)

Accrued expenses

 

(6,079

)

Accrued payroll and payroll-related expenses

 

(21,040

)

Rebates payable

 

(9,816

)

Royalties payable

 

(3,602

)

Other liabilities

 

(5,369

)

Total net assets acquired

 

$

1,215,975

 

 

In the first quarter of Fiscal 2017, the Company recorded a $6.0 million measurement period adjustment to the Returns reserve.

 

Included in the purchase price allocation above are indemnification assets totaling approximately $20.7 million, of which $10.4 million relates to compensation-related payments, $4.9 million relates to unrecognized tax benefits and $5.4 million for chargeback and rebate-related items.  The inventory balance above includes $19.1 million to reflect fair value step-up adjustments.  KUPI’s intangible assets primarily consist of product rights and in-process research and development.  See Note 11 “Goodwill and Intangible Assets.”

 

Amounts allocated to acquired in-process research and development represent the fair value of purchased in-process technology for research projects that, as of the closing date of the acquisition, had not yet reached technological feasibility and had no alternative future use. The fair value of in-process research and development was based on the excess earnings method, which utilizes forecasts of expected cash inflows (including estimates for ongoing costs) and other contributory charges, on a project-by-project basis at the appropriate discount rate for the inherent risk in each project and will be tested for impairment in accordance with the Company’s policy for testing indefinite-lived intangible assets.

 

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Table of Contents

 

Goodwill of $339.4 million arising from the acquisition consists primarily of the value of the employee workforce and the value of products to be developed in the future.  The goodwill was assigned to the Company’s only reporting unit.  Goodwill recognized is expected to be fully deductible for income tax purposes.

 

Unaudited Pro Forma financial results

 

The following supplemental unaudited pro forma information presents the financial results as if the acquisition of KUPI had occurred on July 1, 2014 for the three and six months ended December 31, 2015.  This supplemental pro forma information has been prepared for comparative purposes and does not purport to be indicative of what would have occurred had the acquisition been made on July 1, 2014, nor are they indicative of any future results.

 

 

 

For the Three Months Ended
December 31,

 

For the Six Months Ended
December 31,

 

(In thousands, except per share data)

 

2015

 

2015

 

Revenues

 

$

173,189

 

$

357,155

 

Net income attributable to Lannett Company, Inc.

 

28,810

 

55,129

 

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

 

 

 

 

 

Basic

 

$

0.79

 

$

1.52

 

Diluted

 

$

0.77

 

$

1.47

 

 

The supplemental pro forma earnings for the three months ended December 31, 2015 were adjusted to exclude $23.3 million of acquisition-related costs, of which $17.6 million was incurred by Lannett and $5.7 million was incurred by KUPI, and to include $5.8 million of expense related to the amortization of fair value step-up adjustments to acquisition-date inventory.

 

The supplemental pro forma earnings for the six months ended December 31, 2015 were adjusted to exclude $28.9 million of acquisition-related costs, of which $21.5 million was incurred by Lannett and $7.4 million was incurred by KUPI, and to include $5.8 million of expense related to the amortization of fair value adjustments to acquisition-date inventory.

 

Note 5.  Restructuring Charges

 

2016 Restructuring Program

 

On February 1, 2016, in connection with the acquisition of KUPI, the Company announced a plan related to the future integration of KUPI and the Company’s operations. The plan focuses on the closure of KUPI’s corporate functions and the consolidation of manufacturing, sales, research and development and distribution functions. The Company estimates that it will incur an aggregate of up to approximately $21.0 million in restructuring charges for actions that have been announced or communicated since the 2016 Restructuring Program began.  Of this amount, approximately $12.0 million relates to employee separation costs, approximately $1.0 million relates to contract termination costs and approximately $8.0 million relates to facility closure costs and other actions. The 2016 Restructuring Program is expected to be completed by the end of Fiscal 2019.  The expenses associated with the restructuring program included in restructuring expenses during the three and six months ended December 31, 2016 were as follows:

 

(In thousands)

 

Three Months Ended
December 31, 2016

 

Six Months Ended
December 31, 2016

 

Employee separation costs

 

$

1,004

 

$

2,161

 

Facility closure costs

 

708

 

1,603

 

Total

 

$

1,712

 

$

3,764

 

 

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

 

(In thousands)

 

Employee
Separation Costs

 

Contract
Termination
Costs

 

Facility Closure
Costs

 

Total

 

Balance at June 30, 2016

 

$

3,833

 

$

297

 

$

 

$

4,130

 

Restructuring Charges

 

2,161

 

 

1,603

 

3,764

 

Payments

 

(808

)

(136

)

(1,603

)

(2,547

)

Balance at December 31, 2016

 

$

5,186

 

$

161

 

$

 

$

5,347

 

 

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Table of Contents

 

Note 6.  Accounts Receivable

 

Accounts receivable consisted of the following components at December 31, 2016 and June 30, 2016:

 

(In thousands)

 

December 31,
2016

 

June 30,
2016

 

Gross accounts receivable

 

$

402,901

 

$

388,460

 

Less Chargebacks reserve

 

(82,285

)

(86,495

)

Less Rebates reserve

 

(39,062

)

(32,189

)

Less Returns reserve

 

(44,608

)

(40,593

)

Less Other deductions

 

(13,329

)

(16,851

)

Less Allowance for doubtful accounts

 

(631

)

(610

)

Accounts receivable, net

 

$

222,986

 

$

211,722

 

 

For the three months ended December 31, 2016, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns and other deductions of $217.7 million, $73.5 million, $7.9 million, and $13.9 million, respectively.  For the three months ended December 31, 2015, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns and other deductions of $151.0 million, $42.4 million, $7.1 million, and $8.9 million, respectively.

 

For the six months ended December 31, 2016, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns, and other deductions of $416.2 million, $143.0 million, $14.7 million, and $29.3 million, respectively.  For the six months ended December 31, 2015, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns, and other deductions of $239.6 million, $70.2 million, $10.8 million, and $15.3 million, respectively.

 

Note 7.  Inventories

 

Inventories at December 31, 2016 and June 30, 2016 consisted of the following:

 

(In thousands)

 

December 31,
2016

 

June 30,
2016

 

Raw materials

 

$

52,270

 

$

47,881

 

Work-in-process

 

18,600

 

20,207

 

Finished goods

 

59,368

 

46,816

 

Total

 

$

130,238

 

$

114,904

 

 

The reserve for excess and obsolete inventory was $6.1 million and $6.9 million at December 31, 2016 and June 30, 2016, respectively.

 

Note 8.  Property, Plant and Equipment

 

Property, plant and equipment at December 31, 2016 and June 30, 2016 consisted of the following:

 

(In thousands)

 

Useful Lives

 

December 31,
2016

 

June 30,
2016

 

Land

 

 

$

6,191

 

$

6,191

 

Building and improvements

 

10 - 39 years

 

105,637

 

103,496

 

Machinery and equipment

 

5 - 10 years

 

134,239

 

120,272

 

Furniture and fixtures

 

5 - 7 years

 

2,673

 

2,904

 

Less accumulated depreciation

 

 

 

(64,049

)

(53,598

)

 

 

 

 

184,691

 

179,265

 

Construction in progress

 

 

 

42,362

 

37,373

 

Property, plant and equipment, net

 

 

 

$

227,053

 

$

216,638

 

 

During the three and six months ended December 31, 2016 and 2015, the Company had no impairment charges related to property, plant and equipment.  Property, plant and equipment, net included amounts held in foreign countries in the amount of $924 thousand and $1.0 million at December 31, 2016 and June 30, 2016, respectively.

 

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Note 9.  Fair Value Measurements

 

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

 

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

 

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

 

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

 

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

 

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

 

The Company’s recurring and nonrecurring assets and liabilities measured at fair value at December 31, 2016 and June 30, 2016, were as follows:

 

 

 

December 31, 2016

 

(In thousands)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

Equity securities

 

$

11,870

 

$

 

$

 

$

11,870

 

Intangible Assets - KUPI IPR&D (a)

 

 

 

18,000

 

18,000

 

Total Assets

 

$

11,870

 

$

 

$

18,000

 

$

29,870

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Acquisition-related contingent consideration

 

$

 

$

 

$

35,000

 

$

35,000

 

Total Liabilities

 

$

 

$

 

$

35,000

 

$

35,000

 

 

 

 

June 30, 2016

 

(In thousands)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

Equity securities

 

$

14,094

 

$

 

$

 

$

14,094

 

Total Assets

 

$

14,094

 

$

 

$

 

$

14,094

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Acquisition-related contingent consideration

 

$

 

$

 

$

35,000

 

$

35,000

 

Total Liabilities

 

$

 

$

 

$

35,000

 

$

35,000

 

 


(a) Intangible assets related to KUPI’s IPR&D with a carrying amount of $41.0 million were written down to a fair value of $18.0 million due to an impairment charge of $23.0 million recorded in the second quarter of Fiscal 2017.

 

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Note 10.  Investment Securities

 

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

 

The Company had a net gain on investment securities of $888 thousand during the three months ended December 31, 2016, which primarily consisted of realized gains.  The Company had a net gain on investment securities of $862 thousand during the three months ended December 31, 2015, which included an unrealized gain related to securities still held at December 31, 2015 of $838 thousand.

 

The Company had a net gain on investment securities of $1.7 million during the six months ended December 31, 2016, which included an unrealized gain related to securities still held at December 31, 2016 of $557 thousand.  The Company had a net loss on investment securities of $334 thousand during the six months ended December 31, 2015, which included an unrealized loss related to securities still held at December 31, 2015 of $405 thousand.

 

Note 11.  Goodwill and Intangible Assets

 

The changes in the carrying amount of goodwill for the six months ended December 31, 2016 are as follows:

 

(In thousands)

 

Generic
Pharmaceuticals

 

Balance at June 30, 2016

 

$

333,611

 

Measurement-period adjustments

 

5,955

 

Balance at December 31, 2016

 

$

339,566

 

 

In the first quarter of Fiscal 2017, the Company recorded a $6.0 million measurement-period adjustment to the Returns reserve.

 

Intangible assets, net as of December 31, 2016 and June 30, 2016, consisted of the following:

 

 

 

Weighted

 

Gross Carrying Amount

 

Accumulated Amortization

 

Intangible Assets, Net

 

(In thousands)

 

Avg. Life
(Yrs.)

 

December 31,
2016

 

June 30,
2016

 

December 31,
2016

 

June 30,
2016

 

December 31,
2016

 

June 30,
2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Definite-lived:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cody Labs import license

 

15

 

$

582

 

$

582

 

$

(328

)

$

(309

)

$

254

 

$

273

 

KUPI product rights

 

15

 

434,000

 

427,000

 

(28,819

)

(17,119

)

405,181

 

409,881

 

KUPI trade name

 

2

 

2,920

 

2,920

 

(1,608

)

(878

)

1,312

 

2,042

 

KUPI other intangible assets

 

15

 

19,000

 

19,000

 

(1,395

)

(762

)

17,605

 

18,238

 

Silarx product rights

 

15

 

10,000

 

10,000

 

(1,056

)

(722

)

8,944

 

9,278

 

Other product rights

 

14

 

653

 

653

 

(333

)

(311

)

320

 

342

 

Total definite-lived

 

 

 

$

467,155

 

$

460,155

 

$

(33,539

)

$

(20,101

)

$

433,616

 

$

440,054

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Indefinite-lived:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

KUPI in-process research and development

 

 

$

18,000

 

$

117,000

 

$

 

$

 

$

18,000

 

$

117,000

 

Silarx in-process research and development

 

 

18,000

 

18,000

 

 

 

18,000

 

18,000

 

Other product rights

 

 

449

 

449

 

 

 

449

 

449

 

Total indefinite-lived

 

 

 

36,449

 

135,449

 

 

 

36,449

 

135,449

 

Total intangible assets, net

 

 

 

$

503,604

 

$

595,604

 

$

(33,539

)

$

(20,101

)

$

470,065

 

$

575,503

 

 

For the three months ended December 31, 2016 and 2015, the Company recorded amortization expense of $8.1 million and $3.8 million, respectively.  For the six months ended December 31, 2016 and 2015, the Company recorded amortization expense of $17.4 million and $3.9 million, respectively.

 

On October 18, 2016, the Company received a notice from the FDA indicating that the FDA will seek to withdraw approval of the Company’s Methylphenidate ER ANDA.  As a result of the notice, the Company performed an impairment analysis including a review of revised net sales projections for Methylphenidate ER.  This analysis resulted in the Company recording a $65.1 million impairment charge in the first quarter of Fiscal 2017.

 

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In the second quarter of Fiscal 2017, the Company abandoned a project within KUPI’s in-process research and development portfolio.  The value assigned to the project was $23.0 million.  Accordingly, the Company recorded a $23.0 million impairment charge in the second quarter.

 

Future annual amortization expense consisted of the following as of December 31, 2016:

 

(In thousands)
Fiscal Year Ending June 30,

 

Annual Amortization Expense

 

2017

 

$

16,204

 

2018

 

31,530

 

2019

 

30,946

 

2020

 

30,938

 

2021

 

30,938

 

Thereafter

 

293,060

 

 

 

$

433,616

 

 

Note 12.  Long-Term Debt

 

Amended Senior Secured Credit Facility

 

On November 25, 2015, in connection with its acquisition of KUPI, Lannett entered into a credit and guaranty agreement (the “Credit and Guaranty Agreement”) among certain of its wholly-owned domestic subsidiaries, as guarantors, Morgan Stanley Senior Funding, Inc., as administrative agent and collateral agent and other lenders providing for a senior secured credit facility (the “Senior Secured Credit Facility”).

 

The Senior Secured Credit Facility consisted of a Term Loan A facility in an aggregate principal amount of $275.0 million, a Term Loan B facility in an aggregate principal amount of $635.0 million and a revolving credit facility providing for revolving loans in an aggregate principal amount of up to $125.0 million.  On April 8, 2016, the Company drew down the full $125.0 million Revolving Credit Facility for working capital and other general purposes.  The entire balance of the Revolving Credit Facility loan is outstanding as of December 31, 2016.

 

On June 17, 2016, Lannett amended the Senior Secured Credit Facility and the Credit and Guaranty Agreement to raise an incremental term loan in the principal amount of $150.0 million (the “Incremental Term Loan”) and amended certain sections of the agreement (the “Amended Senior Secured Credit Facility”). The terms of this Incremental Term Loan are substantially the same as those applicable to the Term Loan B facility.  The Company used the proceeds of the Incremental Term Loan and cash on hand to repurchase the outstanding $250.0 million aggregate principal amount of Lannett’s 12.0% Senior Notes due 2023 (the “Senior Notes”) issued in connection with the KUPI acquisition.

 

The Term Loan A Facility will mature on November 25, 2020. The Term Loan A Facility amortizes in quarterly installments (a) through December 31, 2017 in amounts equal to 1.25% of the original principal amount of the Term Loan A Facility and (b) from January 1, 2018 through September 30, 2020 in amounts equal to 2.50% of the original principal amount of the Term Loan A Facility, with the balance payable on November 25, 2020.  The Term Loan B Facility will mature on November 25, 2022.  The Term Loan B Facility amortizes in equal quarterly installments in amounts equal to 1.25% of the original principal amount of the Term Loan B Facility with the balance payable on November 25, 2022.  Any outstanding Revolving Loans will mature on November 25, 2020.

 

The Amended Senior Secured Credit Facility is guaranteed by all of Lannett’s significant wholly-owned domestic subsidiaries (the “Subsidiary Guarantors”) and is collateralized by substantially all present and future assets of Lannett and the Subsidiary Guarantors.

 

The interest rates applicable to the Amended Term Loan Facility are based on a fluctuating rate of interest of the greater of an adjusted LIBOR and 1.00%, plus a borrowing margin of 4.75% (for Term Loan A Facility) or 5.375% (for Term Loan B Facility).  The interest rate applicable to the Revolving Credit Facility is based on a fluctuating rate of interest of an adjusted LIBOR plus a borrowing margin of 4.75%.  The interest rate applicable to the unused commitment for the Revolving Credit Facility was initially 0.50%.  Beginning March 2016, the interest margins and unused commitment fee on the Revolving Credit Facility are subject to a leveraged based pricing grid.

 

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The Amended Senior Secured Credit Facility contains a number of covenants that, among other things, limit the ability of Lannett and its restricted subsidiaries to: incur more indebtedness; pay dividends; redeem stock or make other distributions of equity; make investments; create restrictions on the ability of Lannett’s restricted subsidiaries that are not Subsidiary Guarantors to pay dividends to Lannett or make intercompany transfers; create negative pledges; create liens; transfer or sell assets; merge or consolidate; enter into sale leasebacks; enter into certain transactions with Lannett’s affiliates; and prepay or amend the terms of certain indebtedness.

 

The Amended Senior Secured Credit Facility contains a financial performance covenant that is triggered when the aggregate principal amount of outstanding Revolving Credit Facility and outstanding letters of credit as of the last day of the most recent fiscal quarter is greater than 30% of the aggregate commitments under the Revolving Credit Facility.  The covenant provides that Lannett shall not permit its first lien net senior secured leverage ratio as of the last day of any four consecutive fiscal quarters (i) from and after December 31, 2015, to be greater than 4.25:1.00 (ii) from and after December 31, 2017 to be greater than 3.75:1.00 and (iii) from and after December 31, 2019 to be greater than 3.25:1.00.

 

The Amended Senior Secured Credit Facility also contains a financial performance covenant for the benefit of the Term Loan A Facility lenders which provides that Lannett shall not permit its net senior secured leverage ratio as of the last day of any four consecutive fiscal quarters (i) prior to December 31, 2017, to be greater than 4.25:1.00, (ii) as of December 31, 2017 and prior to December 31, 2019 to be greater than 3.75:1.00 and (iii) as of December 31, 2019 and thereafter to be greater than 3.25:1.00.

 

The Amended Senior Secured Credit Facility also contains certain affirmative covenants, including financial and other reporting requirements.

 

In connection with the Senior Secured Credit Facility and the Senior Notes, the Company incurred an initial purchaser’s discount of $72.1 million and debt issuance costs of $32.7 million.  These costs are recorded as a reduction of long-term debt in the Consolidated Balance Sheet.  In connection with the amendment to the Senior Secured Credit Facility and raising the Incremental Term Loan, the Company capitalized $14.0 million of initial purchaser’s discount and other fees and expensed $2.2 million of legal and other expenses.

 

Long-term debt consisted of the following:

 

 

 

December 31,

 

June 30,

 

(In thousands)

 

2016

 

2016

 

Term Loan A due 2020

 

$

261,250

 

$

268,125

 

Unamortized discount and other debt issuance costs

 

(19,109

)

(22,104

)

Term Loan A, net

 

242,141

 

246,021

 

Term Loan B due 2022

 

747,554

 

767,226

 

Unamortized discount and other debt issuance costs

 

(70,039

)

(77,273

)

Term Loan B, net

 

677,515

 

689,953

 

Revolving Credit Facility due 2020

 

125,000

 

125,000

 

Other

 

804

 

874

 

Total debt, net

 

1,045,460

 

1,061,848

 

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

 

(178,239

)

(178,236

)

Total long-term debt, net

 

$

867,221

 

$

883,612

 

 

Debt amounts due, for the twelve month periods ending December 31 are as follows:

 

 

 

Amounts Payable

 

(In thousands)

 

to Institutions

 

2017

 

$

178,239

 

2018

 

66,996

 

2019

 

67,003

 

2020

 

232,010

 

2021

 

39,518

 

Thereafter

 

550,842

 

Total

 

$

1,134,608

 

 

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Note 13.  Legal, Regulatory Matters and Contingencies

 

Richard Asherman

 

On April 16, 2013, Richard Asherman (“Asherman”), the former President of and a member in Realty, filed a complaint (“Complaint”) in Wyoming state court against the Company and Cody Labs.  At the same time, he also filed an application for a temporary restraining order to enjoin certain operations at Cody Labs, claiming, among other things, that Cody Labs was in violation of certain zoning laws and that Cody Labs was required to increase the level of its property insurance and to secure performance bonds for work being performed at Cody Labs.  Mr. Asherman claimed Cody Labs was in breach of his employment agreement and was required to pay him severance under his employment agreement, including 18 months of base salary, vesting of unvested stock options and continuation of benefits.  Mr. Asherman also asserted that the Company was in breach of the Realty Operating Agreement and, among other requested remedies, he sought to have the Company (i) pay him 50% of the value of 1.66 acres of land that Realty previously agreed to donate to an economic development entity associated with the City of Cody, Wyoming, which contemplated transaction has since been avoided and cancelled.  Although Mr. Asherman originally sought to require that Lannett acquire his interest in Realty for an unspecified price and/or to dissolve Realty, those claims have been dismissed.  In October 2016, the Company and Mr. Asherman reached a tentative agreement in principle to resolve their disputes.  On November 30, 2016, the parties agreed to a settlement payment in full and final satisfaction of the claims filed by Asherman without an admission of liability by either party.  As part of this settlement, the Company purchased the remaining noncontrolling interest in Realty, free and clear of all liens, claims and encumbrances.

 

Connecticut Attorney General Inquiry

 

In July 2014, the Company received interrogatories and subpoena from the State of Connecticut Office of the Attorney General concerning its investigation into pricing of digoxin.  According to the subpoena, the Connecticut Attorney General is investigating whether anyone engaged in any activities that resulted in (a) fixing, maintaining or controlling prices of digoxin or (b) allocating and dividing customers or territories relating to the sale of digoxin in violation of Connecticut antitrust law.  In June 2016, the Connecticut Attorney General issued interrogatories and a subpoena to an employee of the Company in order to gain access to documents and responses previously supplied to the Department of Justice.  The Company maintains that it acted in compliance with all applicable laws and regulations and continues to cooperate with the Connecticut Attorney General’s investigation.

 

Federal Investigation into the Generic Pharmaceutical Industry

 

In fiscal year 2015 and 2016, the Company and certain affiliated individuals each were served with a grand jury subpoena relating to a federal investigation of the generic pharmaceutical industry into possible violations of the Sherman Act.  The subpoenas request corporate documents of the Company relating to corporate, financial and employee information, communications or correspondence with competitors regarding the sale of generic prescription medications and the marketing, sale, or pricing of certain products, generally for the period of 2005 through the dates of the subpoenas.

 

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

 

Texas Medicaid Investigation

 

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

 

Government Pricing

 

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

 

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Table of Contents

 

AWP Litigation

 

The Company and some of our competitors have been named as defendants in lawsuits filed in 2016 alleging that the Company and a number of other generic pharmaceutical manufacturers caused the Average Wholesale Prices (AWPs) of our and their products to be inflated, thereby injuring government programs, entities and persons who reimbursed prescription drugs based on AWPs.  The Company stopped using AWP as a basis for establishing prices in or around 2002 and the bulk of prescription drugs manufactured by the Company was sold under private label. The Company disputes these allegations and does not believe that the ultimate resolution of these lawsuits will have a significant impact on our financial position, results of operations or cash flows.

 

Private Antitrust and Consumer Protection Litigation

 

The Company and certain competitors have been named as defendants in 22 lawsuits filed in 2016 alleging that the Company and certain generic pharmaceutical manufacturers have conspired to fix prices of generic digoxin and doxycycline.  These cases have been consolidated in the United States District Court for the Eastern District of Pennsylvania.  In January 2017, the Court granted the United States leave to intervene in the consolidated case.

 

In December 2016, four purported class action lawsuits were filed in the United States District Court for the Southern District of New York against the Company and other manufacturers and distributors of generic levothyroxine on behalf of direct and indirect purchasers.  The cases generally allege that the Company and other manufacturers and distributors conspired to fix prices for generic levothyroxine products in violation of the federal Sherman Act, various state antitrust laws, and various state consumer protection statutes.  In December 2016 and January 2017, three additional purported class action lawsuits in the United States District Court for the Eastern District of Pennsylvania against the Company and other manufacturers and distributors of generic levothyroxine on behalf of direct purchasers, asserting substantially similar claims for violation of the federal Sherman Act and claims for damages as the suits filed in the Southern District of New York.

 

On January 30, 2017, the Company and two other sellers of generic ursodiol were named as defendants in a purported class action lawsuit filed in the District of New Jersey on behalf of indirect purchasers of ursodiol.  The case generally alleges that the Company and the other defendants conspired to fix prices for generic ursodiol products in violation of the federal Sherman Act, various state antitrust laws and various state consumer protection statutes.

 

The Company believes that it acted in compliance with all applicable laws and regulations.  Accordingly, the Company disputes the allegations set forth in these class actions.  The Company does not believe that the ultimate resolution of these lawsuits will have a significant impact on our financial position, results of operations or cash flows.

 

Shareholder Litigation

 

In November 2016, a suit was filed against the Company and two of its officers claiming that the Company in its securities filings made false and misleading statements in connection with its drug pricing methodologies and internal controls with respect to drug pricing methodologies causing damage to the plaintiff.  The complaint has not yet been served, but based upon the allegations as pleaded, the Company will be filing a motion to dismiss.  The Company cannot reasonably predict the outcome of the suit at this time.

 

Patent Infringement (Paragraph IV Certification)

 

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

 

Zomig®

 

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

 

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

 

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

 

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

 

A trial was conducted in September 2016.  Post-trial briefing has been completed and the court is expected to issue its decision in the next few months.

 

Thalomid®

 

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

 

A mediation before a magistrate judge was held on January 6, 2017 but a settlement was not reached.  Discovery on the merits is underway.

 

Dilaudid®

 

The Company filed with the Food and Drug Administration an ANDA No. 207108, along with a paragraph IV certification, alleging that US Patent 6,589,960 associated with the Dilaudid® (hydromorphone oral solution) would not be infringed by the Company’s proposed hydromorphone oral solution product and/or that the patent is invalid.  On August 8, 2015, Purdue Pharmaceutical Products L.P, Purdue Pharma L.P and Purdue Pharma Technologies Inc. (“Purdue”) filed a patent infringement lawsuit in the United States District Court for the District of New Jersey, alleging that the Company’s filing of ANDA No. 207108 constitutes an act of patent infringement and seeking a declaration that the patent at issue was infringed by the submission of ANDA No, 207108.  The Company and Purdue have reached a settlement and the case was dismissed with prejudice in October 2016.

 

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

 

Other Litigation Matters

 

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

 

Note 14.  Commitments

 

Leases

 

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

 

Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) for the remainder of Fiscal 2017 and the twelve month periods ending June 30 thereafter are as follows:

 

(In thousands)

 

Amounts Due

 

Remainder of 2017

 

$

796

 

2018

 

1,142

 

2019

 

1,080

 

2020

 

1,080

 

2021

 

1,080

 

Thereafter

 

6,318

 

Total

 

$

11,496

 

 

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Table of Contents

 

Note 15.  Accumulated Other Comprehensive Loss

 

The Company’s Accumulated Other Comprehensive Loss was comprised of the following components as of December 31, 2016 and 2015:

 

(In thousands)

 

December 31,
2016

 

December 31,
2015

 

Foreign Currency Translation

 

 

 

 

 

Beginning Balance, June 30

 

$

(295

)

$

(295

)

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

 

38

 

26

 

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

 

 

 

Other comprehensive income (loss), net of tax

 

38

 

26

 

Ending Balance, December 31

 

(257

)

(269

)

Total Accumulated Other Comprehensive Loss

 

$

(257

)

$

(269

)

 

Note 16.  Earnings (Loss) Per Common Share

 

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

 

 

 

Three Months Ended
December 31,

 

(In thousands, except share and per share data)

 

2016

 

2015

 

 

 

 

 

 

 

Net income attributable to Lannett Company, Inc.

 

$

8,172

 

$

13,520

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

36,810,388

 

36,388,542

 

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

 

865,982

 

999,908

 

Diluted weighted average common shares outstanding

 

37,676,370

 

37,388,450

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic

 

$

0.22

 

$

0.37

 

Diluted

 

$

0.22

 

$

0.36

 

 

 

 

Six Months Ended
December 31,

 

(In thousands, except share and per share data)

 

2016

 

2015

 

 

 

 

 

 

 

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

 

$

(21,236

)

$

46,701

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

36,754,828

 

36,349,597

 

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

 

 

1,052,281

 

Diluted weighted average common shares outstanding

 

36,754,828

 

37,401,878

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic

 

$

(0.58

)

$

1.28

 

Diluted

 

$

(0.58

)

$

1.25

 

 

The number of anti-dilutive shares that have been excluded in the computation of diluted earnings per share for the three months ended December 31, 2016 and 2015 were 3.0 million and 2.6 million, respectively.  The number of anti-dilutive shares that have been excluded in the computation of diluted earnings per share for the six months ended December 31, 2016 and 2015 were 4.4 million and 2.6 million, respectively.

 

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Note 17.  Warrant

 

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

 

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

 

Note 18.  Share-based Compensation

 

At December 31, 2016, the Company had two share-based employee compensation plans (the 2011 Long-Term Incentive Plan “LTIP” and the 2014 “LTIP”).  Together these plans authorized an aggregate total of 4.5 million shares to be issued.  The plans have a total of 2.1 million shares available for future issuances.

 

The Company issues share-based compensation awards with a vesting period ranging up to 3 years and a maximum contractual term of 10 years.  The Company issues new shares of stock when stock options are exercised.  As of December 31, 2016, there was $9.8 million of total unrecognized compensation cost related to non-vested share-based compensation awards.  That cost is expected to be recognized over a weighted average period of 2.0 years.

 

Stock Options

 

The Company measures share-based compensation cost for options using the Black-Scholes option pricing model.  The following table presents the weighted average assumptions used to estimate fair values of the stock options granted during the six months ended December 31, 2016 and 2015, the estimated annual forfeiture rates used to recognize the associated compensation expense and the weighted average fair value of the options granted:

 

 

 

Six Months Ended

 

 

 

December 31, 2016

 

December 31, 2015

 

Risk-free interest rate

 

1.1

%

1.7

%

Expected volatility

 

55.6

%

48.3

%

Expected dividend yield

 

0.0

%

0.0

%

Forfeiture rate

 

6.5

%

6.5

%

Expected term (in years)

 

5.2 years

 

5.2 years

 

Weighted average fair value

 

$

15.33

 

$

26.24

 

 

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

 

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Table of Contents

 

A stock option roll-forward as of December 31, 2016 and changes during the six months then ended, is presented below:

 

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

 

Awards

 

Weighted-
Average
Exercise
Price

 

Aggregate
Intrinsic
Value

 

Weighted
Average
Remaining
Contractual
Life (yrs.)

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2016

 

1,730

 

$

16.77

 

$

19,524

 

6.3

 

Granted

 

11

 

$

31.30

 

 

 

 

 

Exercised

 

(190

)

$

6.54

 

$

4,325

 

 

 

Forfeited, expired or repurchased

 

(19

)

$

31.40

 

 

 

 

 

Outstanding at December 31, 2016

 

1,532

 

$

17.96

 

$

14,370

 

6.2

 

 

 

 

 

 

 

 

 

 

 

Vested and expected to vest at December 31, 2016

 

1,525

 

$

17.85

 

$

14,370

 

6.2

 

Exercisable at December 31, 2016

 

1,379

 

$

15.64

 

$

14,370

 

6.0

 

 

Restricted Stock

 

The Company measures restricted stock compensation costs based on the stock price at the grant date less an estimate for expected forfeitures.  The annual forfeiture rate used to calculate compensation expense was 6.5% for the six months ended December 31, 2016 and 2015.

 

A summary of restricted stock awards as of December 31, 2016 and changes during the six months then ended, is presented below:

 

(In thousands)

 

Awards

 

Weighted
Average Grant -
date Fair Value

 

Aggregate
Intrinsic Value

 

 

 

 

 

 

 

 

 

Non-vested at June 30, 2016

 

167

 

$

48.22

 

 

 

Granted

 

275

 

$

25.03

 

 

 

Vested

 

(76

)

$

43.80

 

$

2,326

 

Forfeited

 

(18

)

$

37.13

 

 

 

Non-vested at December 31, 2016

 

348

 

$

31.38

 

 

 

 

Employee Stock Purchase Plan

 

In February 2003, the Company’s stockholders approved an Employee Stock Purchase Plan (“ESPP”).  Employees eligible to participate in the ESPP may purchase shares of the Company’s stock at 85% of the lower of the fair market value of the common stock on the first day of the calendar quarter, or the last day of the calendar quarter.  Under the ESPP, employees can authorize the Company to withhold up to 10% of their compensation during any quarterly offering period, subject to certain limitations.  The ESPP was implemented on April 1, 2003 and is qualified under Section 423 of the Internal Revenue Code.  The Board of Directors authorized an aggregate total of 1.1 million shares of the Company’s common stock for issuance under the ESPP.  During the six months ended December 31, 2016 and 2015, 27 thousand shares and 11 thousand shares were issued under the ESPP, respectively.  As of December 31, 2016, 512 thousand total cumulative shares have been issued under the ESPP.

 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

December 31,

 

December 31,

 

(In thousands)

 

2016

 

2015

 

2016

 

2015

 

Selling, general and administrative expenses

 

$

1,251

 

$

1,494

 

$

3,223

 

$

5,380

 

Research and development expenses

 

152

 

201

 

325

 

389

 

Cost of sales

 

314

 

329

 

625

 

629

 

Total

 

$

1,717

 

$

2,024

 

$

4,173

 

$

6,398

 

 

 

 

 

 

 

 

 

 

 

Tax benefit at statutory rate

 

$

627

 

$

729

 

$

1,523

 

$

2,303

 

 

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Table of Contents

 

Note 19.  Employee Benefit Plan

 

The Company has a 401k defined contribution plan (the “Plan”) covering substantially all employees.  Pursuant to the Plan provisions, the Company is required to make matching contributions equal to 50% of each employee’s contribution, not to exceed 4% of the employee’s compensation for the Plan year.  Contributions to the Plan during the three months ended December 31, 2016 and 2015 were $492 thousand and $188 thousand, respectively.  Contributions to the Plan during the six months ended December 31, 2016 and 2015 were $1.1 million and $437 thousand, respectively.

 

Note 20.  Income Taxes

 

The Company uses the liability method to account for income taxes.  Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse.  Deferred tax expense (benefit) is the result of changes in deferred tax assets and liabilities.

 

The federal, state and local income tax expense for the three months ended December 31, 2016 and 2015 was $3.5 million and $6.0 million, respectively.  The effective tax rates for the three months ended December 31, 2016 and 2015 were 30.2% and 30.6%, respectively.  The federal, state and local income tax benefit for the six months ended December 31, 2016 was $9.3 million compared to income tax expense of $23.0 million for the six months ended December 31, 2015.  The effective tax rates were 30.6% and 33.0%, respectively.  The effective tax rate for the six months ended December 31, 2016 was lower compared to the six months ended December 31, 2015 primarily due to higher domestic manufacturing deductions and research and experimentation credits relative to expected annual pre-tax income, partially offset by the effect of changes in the Company’s state tax profile as result of the KUPI acquisition.

 

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.