10-Q 1 a17-21129_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 SEPTEMBER 30, 2017

 

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

 

FOR THE TRANSITION PERIOD FROM                  TO

 

Commission File No. 001-31298

 

LANNETT COMPANY, INC.

(Exact Name of Registrant as Specified in its Charter)

 

State of Delaware

 

23-0787699

(State of Incorporation)

 

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

 

9000 State Road

Philadelphia, PA 19136

(215) 333-9000

(Address of principal executive offices and telephone number)

 

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

 

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

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

Emerging growth company o

 

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

 

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

 

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

 

Class

 

Outstanding as of October 31, 2017

 

Common stock, par value $0.001 per share

 

37,667,411

 

 

 

 



Table of Contents

 

Table of Contents

 

 

Page No.

PART I. FINANCIAL INFORMATION

 

 

 

 

 

ITEM 1.

FINANCIAL STATEMENTS

 

 

 

 

 

 

 

Consolidated Balance Sheets as of September 30, 2017 (unaudited) and June 30, 2017

3

 

 

 

 

 

 

Consolidated Statements of Operations (unaudited) for the three months ended September 30, 2017 and 2016

4

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income/Loss (unaudited) for the three months ended September 30, 2017 and 2016

5

 

 

 

 

 

 

Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the three months ended September 30, 2017

6

 

 

 

 

 

 

Consolidated Statements of Cash Flows (unaudited) for the three months ended September 30, 2017 and 2016

7

 

 

 

 

 

 

Notes to Consolidated Financial Statements (unaudited)

8

 

 

 

 

 

ITEM 2.

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

26

 

 

 

 

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

33

 

 

 

 

 

ITEM 4.

CONTROLS AND PROCEDURES

34

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

ITEM 1.

LEGAL PROCEEDINGS

35

 

 

 

 

 

ITEM 1A.

RISK FACTORS

35

 

 

 

 

 

ITEM 6.

EXHIBITS

35

 

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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)

 

 

 

 

 

September 30, 2017

 

June 30, 2017

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

92,461

 

$

117,737

 

Investment securities

 

23,973

 

27,091

 

Accounts receivable, net

 

243,326

 

204,066

 

Inventories

 

125,390

 

122,604

 

Prepaid income taxes

 

13,494

 

16,703

 

Other current assets

 

9,325

 

6,592

 

Total current assets

 

507,969

 

494,793

 

Property, plant and equipment, net

 

249,276

 

243,148

 

Intangible assets, net

 

447,797

 

453,861

 

Goodwill

 

339,566

 

339,566

 

Deferred tax assets

 

48,592

 

52,753

 

Other assets

 

22,587

 

19,191

 

TOTAL ASSETS

 

$

1,615,787

 

$

1,603,312

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

49,229

 

$

44,720

 

Accrued expenses

 

13,042

 

12,499

 

Accrued payroll and payroll-related expenses

 

6,706

 

4,833

 

Rebates payable

 

47,336

 

44,593

 

Royalties payable

 

2,480

 

3,015

 

Restructuring liability

 

4,498

 

5,431

 

Settlement liability

 

14,500

 

17,000

 

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

 

63,556

 

60,117

 

Total current liabilities

 

201,347

 

192,208

 

Long-term debt, net

 

831,665

 

843,530

 

Other liabilities

 

6,504

 

6,452

 

TOTAL LIABILITIES

 

1,039,516

 

1,042,190

 

Commitments and contingencies (Note 12 and 13)

 

 

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

 

 

 

 

Common stock ($0.001 par value, 100,000,000 shares authorized; 37,672,233 and 37,528,450 shares issued; 37,034,055 and 36,919,296 shares outstanding at September 30, 2017 and June 30, 2017, respectively)

 

38

 

37

 

Additional paid-in capital

 

295,282

 

292,780

 

Retained earnings

 

291,031

 

277,774

 

Accumulated other comprehensive loss

 

(221

)

(222

)

Treasury stock (638,178 and 609,154 shares at September 30, 2017 and June 30, 2017, respectively)

 

(9,859

)

(9,247

)

Total stockholders’ equity

 

576,271

 

561,122

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

1,615,787

 

$

1,603,312

 

 

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

 

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LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(In thousands, except share and per share data)

 

 

 

Three Months Ended
September 30,

 

 

 

2017

 

2016

 

 

 

 

 

 

 

Net sales

 

$

154,961

 

$

161,559

 

Cost of sales

 

79,553

 

70,820

 

Amortization of intangibles

 

7,737

 

8,887

 

Gross profit

 

67,671

 

81,852

 

Operating expenses:

 

 

 

 

 

Research and development expenses

 

7,409

 

12,371

 

Selling, general and administrative expenses

 

19,038

 

21,260

 

Acquisition and integration-related expenses

 

18

 

1,391

 

Restructuring expenses

 

527

 

2,052

 

Intangible asset impairment charge

 

 

65,084

 

Total operating expenses

 

26,992

 

102,158

 

Operating income (loss)

 

40,679

 

(20,306

)

Other income (loss):

 

 

 

 

 

Investment income

 

1,164

 

1,027

 

Interest expense

 

(20,912

)

(22,994

)

Other

 

(251

)

3

 

Total other income (loss)

 

(19,999

)

(21,964

)

Income (loss) before income tax

 

20,680

 

(42,270

)

Income tax expense (benefit)

 

7,423

 

(12,882

)

Net income (loss)

 

13,257

 

(29,388

)

Less: Net income attributable to noncontrolling interest

 

 

20

 

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

 

$

13,257

 

$

(29,408

)

 

 

 

 

 

 

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

 

 

 

 

 

Basic

 

$

0.36

 

$

(0.80

)

Diluted

 

$

0.35

 

$

(0.80

)

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

Basic

 

36,992,064

 

36,699,267

 

Diluted

 

37,730,656

 

36,699,267

 

 

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

 

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LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

(In thousands)

 

 

 

Three Months Ended
September 30,

 

 

 

2017

 

2016

 

 

 

 

 

 

 

Net income (loss)

 

$

13,257

 

$

(29,388

)

Other comprehensive income (loss), before tax:

 

 

 

 

 

Foreign currency translation gain (loss)

 

1

 

(3

)

Total other comprehensive income (loss), before tax

 

1

 

(3

)

Income tax related to items of other comprehensive income

 

 

 

Total other comprehensive income (loss), net of tax

 

1

 

(3

)

Comprehensive income (loss)

 

13,258

 

(29,391

)

Less: Total comprehensive income attributable to noncontrolling interest

 

 

20

 

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

 

$

13,258

 

$

(29,411

)

 

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

 

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LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

(In thousands)

 

 

 

Common Stock

 

Additional

 

 

 

Accumulated
Other

 

 

 

Total

 

 

 

Shares
Issued

 

Amount

 

Paid-In
Capital

 

Retained
Earnings

 

Comprehensive

Loss

 

Treasury
Stock

 

Stockholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, June 30, 2017

 

37,528

 

$

37

 

$

292,780

 

$

277,774

 

$

(222

)

$

(9,247

)

$

561,122

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares issued in connection with share-based compensation plans

 

144

 

1

 

313

 

 

 

 

314

 

Share-based compensation

 

 

 

2,189

 

 

 

 

2,189

 

Purchase of treasury stock

 

 

 

 

 

 

(612

)

(612

)

Other comprehensive income, net of tax

 

 

 

 

 

1

 

 

1

 

Net income

 

 

 

 

13,257

 

 

 

13,257

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, September 30, 2017

 

37,672

 

$

38

 

$

295,282

 

$

291,031

 

$

(221

)

$

(9,859

)

$

576,271

 

 

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

 

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LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)

 

 

 

Three Months Ended
September 30,

 

 

 

2017

 

2016

 

OPERATING ACTIVITIES:

 

 

 

 

 

Net income (loss)

 

$

13,257

 

$

(29,388

)

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

 

 

 

 

 

Depreciation and amortization

 

13,778

 

14,317

 

Deferred income tax expense (benefit)

 

4,161

 

(3,432

)

Share-based compensation

 

2,189

 

2,456

 

Excess tax benefits on share-based compensation awards

 

 

(644

)

Intangible asset impairment charge

 

 

65,084

 

Loss on sale of assets

 

234

 

2

 

(Gain) on investment securities

 

(864

)

(808

)

Amortization of debt discount and other debt issuance costs

 

5,017

 

5,288

 

Other noncash expenses

 

 

474

 

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

 

 

 

 

 

Accounts receivable, net

 

(39,260

)

15,241

 

Inventories

 

(2,786

)

(12,847

)

Prepaid income taxes

 

3,261

 

(22,252

)

Other assets

 

(6,262

)

(1,640

)

Rebates payable

 

2,743

 

(1,791

)

Royalties payable

 

(535

)

(969

)

Restructuring liability

 

(933

)

637

 

Accounts payable

 

2,009

 

9,267

 

Accrued expenses

 

543

 

(958

)

Accrued payroll and payroll-related expenses

 

1,873

 

(1,625

)

Net cash provided by (used in) operating activities

 

(1,575

)

36,412

 

INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of property, plant and equipment

 

(12,053

)

(9,945

)

Proceeds from sale of property, plant and equipment

 

15

 

33

 

Purchase of intangible asset

 

(2,038

)

 

Proceeds from sale of investment securities

 

27,822

 

15,703

 

Purchase of investment securities

 

(23,840

)

(12,182

)

Net cash used in investing activities

 

(10,094

)

(6,391

)

FINANCING ACTIVITIES:

 

 

 

 

 

Repayments of long-term debt

 

(13,310

)

(13,308

)

Proceeds from issuance of stock

 

314

 

1,355

 

Excess tax benefits on share-based compensation awards

 

 

644

 

Purchase of treasury stock

 

(612

)

(1,798

)

Net cash used in financing activities

 

(13,608

)

(13,107

)

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

 

1

 

(3

)

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

 

(25,276

)

16,911

 

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

117,737

 

224,769

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

92,461

 

$

241,680

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

 

 

 

 

 

Interest paid (net of capitalized interest of $457 thousand and $751 thousand for the three months ended September 30, 2017 and 2016, respectively)

 

$

15,714

 

$

17,373

 

Income taxes paid, net

 

$

231

 

$

12,802

 

Credits issued pursuant to a Settlement Agreement

 

$

2,500

 

$

 

 

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

 

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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 months ended September 30, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2018.  These unaudited financial statements should be read in combination with the other Notes in this section; “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in Item 2; and the Consolidated Financial Statements, including the Notes to the Consolidated Financial Statements, included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017.  The Consolidated Financial Statements for the fiscal year ended June 30, 2017 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 (“UCB”).  KUPI is a specialty pharmaceuticals manufacturer focused on the development of products that are difficult to formulate or utilize specialized delivery technologies.  Strategic benefits of the acquisition include expanded manufacturing capacity, a diversified product portfolio and pipeline and complementary research and development expertise.

 

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

 

Note 3.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

The Consolidated Financial Statements have been prepared in conformity with United States generally accepted accounting principles (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

 

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benefit of the asset, the various characteristics of the asset and projected future cash flows.  Significant judgment is employed in determining the assumptions utilized as of the acquisition date and for each subsequent measurement period.  Accordingly, changes in assumptions described above could have a material impact on our consolidated results of operations.

 

Reclassifications

 

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

 

Use of estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant estimates and assumptions are required in the determination of revenue recognition and sales deductions for estimated chargebacks, rebates, returns and other adjustments including a provision for the Company’s liability under the Medicare Part D program.  Additionally, significant estimates and assumptions are required when determining the fair value of long-lived assets, including goodwill and intangible assets, income taxes, contingencies, 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.  Realized and unrealized gains and losses are included in the Consolidated Statements of Operations under Other income (loss).

 

Allowance for doubtful accounts

 

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

 

Inventories

 

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

 

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Property, Plant and Equipment

 

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

 

Intangible Assets

 

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

 

Valuation of Long-Lived Assets, including Intangible Assets

 

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

 

In-Process Research and Development

 

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

 

Goodwill

 

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

 

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 months ended September 30, 2017 and 2016:

 

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Table of Contents

 

(In thousands)

 

Three Months Ended
September 30,

 

Medical Indication

 

2017

 

2016

 

Antibiotic

 

$

3,349

 

$

3,780

 

Anti-Psychosis

 

14,991

 

17,320

 

Cardiovascular

 

11,306

 

12,694

 

Central Nervous System

 

8,818

 

10,350

 

Gallstone

 

6,564

 

12,883

 

Gastrointestinal

 

14,553

 

18,052

 

Glaucoma

 

2,668

 

5,783

 

Migraine

 

15,015

 

7,160

 

Muscle Relaxant

 

3,791

 

3,532

 

Pain Management

 

5,761

 

6,608

 

Respiratory

 

1,647

 

2,213

 

Thyroid Deficiency

 

47,214

 

39,838

 

Urinary

 

2,997

 

5,101

 

Other

 

12,696

 

11,182

 

Contract manufacturing revenue

 

3,591

 

5,063

 

Total

 

$

154,961

 

$

161,559

 

 

Customer, Supplier and Product Concentration

 

The following table presents the percentage of total net sales, for the three months ended September 30, 2017 and 2016, for one 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:

 

 

 

2017

 

2016

 

 

 

 

 

 

 

Product 1

 

30

%

25

%

 

The following table presents the percentage of total net sales, for the three months ended September 30, 2017 and 2016, for certain of the Company’s customers which accounted for at least 10% of net sales in any of those periods:

 

 

 

2017

 

2016

 

 

 

 

 

 

 

Customer A

 

27

%

28

%

Customer B

 

20

%

20

%

 

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 33% and 37% of the Company’s inventory purchases during the three months ended September 30, 2017 and 2016, respectively.  See Note 21 “Material Contracts with Suppliers” for more information.

 

Revenue Recognition

 

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

 

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Table of Contents

 

Net Sales Adjustments

 

When revenue is recognized a simultaneous adjustment to gross sales is made for estimated chargebacks, rebates, returns, promotional adjustments and other potential adjustments.  These provisions are primarily estimated based on historical experience, future expectations, contractual arrangements with wholesalers and indirect customers and other factors known to management at the time of accrual.  Accruals for provisions are presented in the Consolidated Financial Statements as a reduction to gross sales with the corresponding reserve presented as a reduction of accounts receivable or included as rebates payable, depending on the nature of the reserve.  The reserves, presented as a reduction of accounts receivable, totaled $184.1 million and $175.8 million at September 30, 2017 and June 30, 2017, respectively.  Rebates payable at September 30, 2017 and June 30, 2017 totaled $47.3 million and $44.6 million, respectively, for certain rebate programs, primarily related to Medicare Part D and Medicaid and certain sales allowances and other adjustments paid to indirect customers.

 

Cost of Sales, including Amortization of Intangibles

 

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

 

Research and Development

 

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

 

Contingencies

 

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

 

Restructuring Costs

 

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

 

Share-based Compensation

 

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

 

Self-Insurance

 

Effective January 1, 2017, the Company self-insures for certain employee medical and prescription benefits.  The Company also maintains stop loss coverage with third party insurers to limit its total liability exposure.  The liability for self-insured risks is primarily calculated using independent third party actuarial valuations which take into account actual claims, claims growth and claims incurred but not yet reported.  Actual experience, including claim frequency and severity as well as health-care inflation, could result in different liabilities than the amounts currently recorded.  The liability for self-insured risks under this plan as of September 30, 2017 totaled $2.1 million and was not material to the financial position of the Company as of June 30, 2017.

 

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Table of Contents

 

Income Taxes

 

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

 

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

 

Earnings (Loss) 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 consist of stock options, unvested restricted stock and performance-based shares and an outstanding warrant.  Anti-dilutive securities are excluded from the calculation.  Dilutive shares are also excluded in the calculation in periods of net loss because the effect of including such securities would be anti-dilutive.

 

Comprehensive Income (Loss)

 

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

 

Recent Accounting Pronouncements

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers.  The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The authoritative guidance is effective for annual reporting periods beginning after December 15, 2017.  Based on a preliminary review of the contracts representing a substantial portion of our revenues, the Company does not expect the guidance to have a material impact on our disclosures or the timing and recognition of our revenues.  The Company intends to use the modified retrospective approach upon implementation.

 

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

 

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

 

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

 

Note 4.  Restructuring Charges

 

2016 Restructuring Program

 

On February 1, 2016, in connection with the acquisition of KUPI, the Company announced a plan related to the future integration of KUPI and the Company’s operations. The plan focuses on the closure of KUPI’s corporate functions and the consolidation of manufacturing, sales, research and development and distribution functions. The Company estimates that it will incur an aggregate of up to approximately $20.0 million in restructuring charges for actions that have been announced or communicated since the 2016 Restructuring Program began.  Of this amount, approximately $11.0 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 months ended September 30, 2017 and 2016 were as follows:

 

 

 

Three

 

Three

 

 

 

Months Ended

 

Months Ended

 

(In thousands)

 

September 30, 2017

 

September 30, 2016

 

Employee separation costs

 

$

(590

)

$

1,157

 

Contract termination costs

 

 

 

Facility closure costs

 

1,117

 

895

 

Total

 

$

527

 

$

2,052

 

 

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

 

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

 

(In thousands)

 

Employee
Separation Costs

 

Contract
Termination
Costs

 

Facility Closure
Costs

 

Total

 

Balance at June 30, 2017

 

$

5,431

 

$

 

$

 

$

5,431

 

Restructuring Charges (Credits)

 

(590

)

 

1,117

 

527

 

Payments

 

(343

)

 

(1,117

)

(1,460

)

Balance at September 30, 2017

 

$

4,498

 

$

 

$

 

$

4,498

 

 

Note 5.  Accounts Receivable

 

Accounts receivable consisted of the following components at September 30, 2017 and June 30, 2017:

 

(In thousands)

 

September 30,
2017

 

June 30,
2017

 

Gross accounts receivable

 

$

428,681

 

$

380,653

 

Less Chargebacks reserve

 

(79,274

)

(79,537

)

Less Rebates reserve

 

(45,312

)

(43,023

)

Less Returns reserve

 

(45,421

)

(42,135

)

Less Other deductions

 

(14,057

)

(11,096

)

Less Allowance for doubtful accounts

 

(1,291

)

(796

)

Accounts receivable, net

 

$

243,326

 

$

204,066

 

 

For the three months ended September 30, 2017, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns and other deductions of $254.7 million, $78.5 million, $10.4 million and $12.4 million, respectively.  For the three months ended September 30, 2016, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns and other deductions of $198.5 million, $69.5 million, $6.8 million and $15.5 million, respectively.

 

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Table of Contents

 

Note 6.  Inventories

 

Inventories at September 30, 2017 and June 30, 2017 consisted of the following:

 

(In thousands)

 

September 30,
2017

 

June 30,
2017

 

Raw Materials

 

$

59,128

 

$

57,442

 

Work-in-process

 

19,286

 

15,676

 

Finished Goods

 

46,976

 

49,486

 

Total

 

$

125,390

 

$

122,604

 

 

Inventories were reduced by $5.3 million and $4.5 million at September 30, 2017 and June 30, 2017, respectively for excess and obsolete inventory amounts.  During the three months ended September 30, 2017 and 2016, the Company recorded provisions for excess and obsolete inventory of $2.2 million and $3.3 million, respectively.

 

Note 7.  Property, Plant and Equipment

 

Property, plant and equipment at September 30, 2017 and June 30, 2017 consisted of the following:

 

(In thousands)

 

Useful Lives

 

September 30,
2017

 

June 30,
2017

 

Land

 

 

$

6,191

 

$

6,191

 

Building and improvements

 

10 - 39 years

 

108,740

 

108,730

 

Machinery and equipment

 

5 - 10 years

 

142,885

 

142,086

 

Furniture and fixtures

 

5 - 7 years

 

2,987

 

2,953

 

Less accumulated depreciation

 

 

 

(76,809

)

(71,461

)

 

 

 

 

183,994

 

188,499

 

Construction in progress

 

 

 

65,282

 

54,649

 

Property, plant and equipment, net

 

 

 

$

249,276

 

$

243,148

 

 

Depreciation expense for the three months ended September 30, 2017 and 2016 was $5.7 million and $5.1 million, respectively.

 

During the three months ended September 30, 2017 and 2016, 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 $1.0 million at September 30, 2017 and June 30, 2017.

 

Note 8.  Fair Value Measurements

 

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

 

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

 

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

 

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Table of Contents

 

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

 

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

 

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

 

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

 

 

 

September 30, 2017

 

(In thousands)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

Equity securities

 

$

23,973

 

$

 

$

 

$

23,973

 

Total Assets

 

$

23,973

 

$

 

$

 

$

23,973

 

 

 

 

June 30, 2017

 

(In thousands)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

Equity securities

 

$

27,091

 

$

 

$

 

$

27,091

 

Total Assets

 

$

27,091

 

$

 

$

 

$

27,091

 

 

Note 9.  Investment Securities

 

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

 

The Company had a net gain on investment securities of $864 thousand during the three months ended September 30, 2017, which included an unrealized gain related to securities still held at September 30, 2017 of $37 thousand.

 

The Company had a net gain on investment securities of $808 thousand during the three months ended September 30, 2016, which included an unrealized gain related to securities still held at September 30, 2016 of $557 thousand.

 

Note 10.  Goodwill and Intangible Assets

 

The changes in the carrying amount of goodwill for the three months ended September 30, 2017 are as follows:

 

(In thousands)

 

Generic
Pharmaceuticals

 

Balance at June 30, 2017

 

$

339,566

 

Goodwill acquired

 

 

Impairments

 

 

Balance at September 30, 2017

 

$

339,566

 

 

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Table of Contents

 

Intangible assets, net as of September 30, 2017 and June 30, 2017, consisted of the following:

 

 

 

Weighted

 

Gross Carrying Amount

 

Accumulated Amortization

 

Intangible Assets, Net

 

(In thousands)

 

Avg. Life
(Yrs.)

 

September 30,
2017

 

June 30,
2017

 

September 30,
2017

 

June 30,
2017

 

September 30,
2017

 

June 30,
2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Definite-lived:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cody Labs import license

 

15

 

$

582

 

$

582

 

$

(357

)

$

(347

)

$

225

 

$

235

 

KUPI product rights

 

15

 

434,000

 

434,000

 

(50,519

)

(43,286

)

383,481

 

390,714

 

KUPI trade name

 

2

 

2,920

 

2,920

 

(2,703

)

(2,338

)

217

 

582

 

KUPI other intangible assets

 

15

 

19,000

 

19,000

 

(2,345

)

(2,028

)

16,655

 

16,972

 

Silarx product rights

 

15

 

10,000

 

10,000

 

(1,556

)

(1,389

)

8,444

 

8,611

 

Other product rights

 

15

 

2,691

 

653

 

(365

)

(355

)

2,326

 

298

 

Total definite-lived

 

 

 

$

469,193

 

$

467,155

 

$

(57,845

)

$

(49,743

)

$

411,348

 

$

417,412

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Indefinite-lived:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

KUPI in-process research and development

 

 

$

18,000

 

$

18,000

 

$

 

$

 

$

18,000

 

$

18,000

 

Silarx in-process research and development

 

 

18,000

 

18,000

 

 

 

18,000

 

18,000

 

Other product rights

 

 

449

 

449

 

 

 

449

 

449

 

Total indefinite-lived

 

 

 

36,449

 

36,449

 

 

 

36,449

 

36,449

 

Total intangible assets, net

 

 

 

$

505,642

 

$

503,604

 

$

(57,845

)

$

(49,743

)

$

447,797

 

$

453,861

 

 

For the three months ended September 30, 2017 and 2016, the Company recorded amortization expense of $8.1 million and $9.3 million, respectively.

 

In the first quarter of Fiscal 2018, the Company filed a 505(b)(2) New Drug Application with the FDA for Cocaine Hydrochloride Topical Solution.  The Company paid a $2.0 million filing fee to the FDA along with the application, which was capitalized as an intangible asset that will be amortized over a 15-year useful life period.

 

Future annual amortization expense consisted of the following as of September 30, 2017:

 

(In thousands)
Fiscal Year Ending June 30,

 

Amortization Expense

 

2018

 

$

23,530

 

2019

 

31,082

 

2020

 

31,074

 

2021

 

31,074

 

2022

 

31,074

 

Thereafter

 

263,514

 

 

 

$

411,348

 

 

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Table of Contents

 

Note 11. Long-Term Debt

 

Long-term debt, net consisted of the following:

 

 

 

September 30,

 

June 30,

 

(In thousands)

 

2017

 

2017

 

Term Loan A due 2020

 

$

250,938

 

$

254,375

 

Unamortized discount and other debt issuance costs

 

(14,808

)

(16,238

)

Term Loan A, net

 

236,130

 

238,137

 

Term Loan B due 2022

 

718,045

 

727,881

 

Unamortized discount and other debt issuance costs

 

(59,653

)

(63,106

)

Term Loan B, net

 

658,392

 

664,775

 

Revolving Credit Facility due 2020

 

 

 

Other

 

699

 

735

 

Total debt, net

 

895,221

 

903,647

 

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

 

(63,556

)

(60,117

)

Total long-term debt, net

 

$

831,665

 

$

843,530

 

 

Long-term debt amounts due, for the twelve month periods ending September 30 are as follows:

 

 

 

Amounts Payable

 

(In thousands)

 

to Institutions

 

2018

 

$

63,556

 

2019

 

67,000

 

2020

 

67,008

 

2021

 

211,390

 

2022

 

39,407

 

Thereafter

 

521,321

 

Total

 

$

969,682

 

 

Note 12.  Legal, Regulatory Matters and Contingencies

 

Connecticut Attorney General Inquiry

 

In July 2014, the Company received interrogatories and subpoena from the State of Connecticut Office of the Attorney General concerning its investigation into the pricing of digoxin.  According to the subpoena, the Connecticut Attorney General is investigating whether anyone engaged in any activities that resulted in (a) fixing, maintaining or controlling prices of digoxin or (b) allocating and dividing customers or territories relating to the sale of digoxin in violation of Connecticut antitrust law.  In June 2016, the Connecticut Attorney General issued interrogatories and a subpoena to an employee of the Company in order to gain access to documents and responses previously supplied to the Department of Justice.  In December 2016, the Connecticut Attorney General, joined by numerous other State Attorneys General, filed a civil complaint alleging that six pharmaceutical companies engaged in anti-competitive behavior related to Doxycycline Hyclate and Gliburide.  The Company was not named in the action and does not compete on the products that formed the basis of the complaint.  On October 31, 2017, the state Attorneys General filed a motion for leave to amend their complaint to add numerous additional defendants, including the Company, and claims relating to 13 additional drugs.  The claim relating to Lannett involves alleged price-fixing for one drug, doxycycline monohydrate, but did not involve the pricing for digoxin.  The state Attorneys General also allege that all defendants were part of an overarching, industry-wide conspiracy to allocate markets and fix prices generally.  None of the defendants, including the Company, has responded yet to the motion of the state Attorneys General.

 

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 years 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.

 

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

 

Texas Medicaid Investigation

 

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

 

Government Pricing

 

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

 

AWP Litigation

 

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

 

EPA Violation Notice

 

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

 

Private Antitrust and Consumer Protection Litigation

 

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

 

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In addition to the lawsuits brought by private plaintiffs, the Attorneys General of 45 states, the District of Columbia and Puerto Rico have filed parens patriae lawsuits alleging price-fixing conspiracies by various generic pharmaceutical manufacturers, but not involving the Company.  The JPML has consolidated the suits by the state Attorneys General in the Eastern District of Pennsylvania as part of the multidistrict litigation. The original lawsuits did not name the Company, but the state Attorneys General on October 31, 2017 filed a motion with the District Court for leave to amend their complaint to add numerous additional defendants, including the Company, and claims relating to 13 additional drugs.  The claim relating to Lannett involves alleged price-fixing for one drug, doxycycline monohydrate, although the state Attorneys General allege that all defendants were part of an overarching, industry-wide conspiracy to allocate markets and fix prices generally.  None of the defendants, including the Company, has responded yet to the motion of the state Attorneys General.

 

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

 

Shareholder Litigation

 

In November 2016, a putative class action lawsuit was filed in the United States District Court for the Eastern District of Pennsylvania against the Company and two of its officers claiming that the Company damaged the purported class by including in its securities filings false and misleading statements regarding the Company’s drug pricing methodologies and internal controls.  An amended complaint was filed in May 2017, and the Company filed a motion to dismiss the amended complaint in September 2017.  The response to the motion to dismiss is due to be filed in November 2017.  The Company cannot reasonably predict the outcome of the suit at this time.

 

Patent Infringement (Paragraph IV Certification)

 

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

 

Zomig®

 

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

 

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

 

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

 

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

 

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

 

Thalomid®

 

The Company filed with the Food and Drug Administration an ANDA No. 206601, along with a paragraph IV certification, alleging that the fifteen patents associated with the Thalomid drug product (U.S. Patent Nos. 6,045,501; 6,315,720; 6,561,976; 6,561,977; 6,755,784; 6,869,399; 6,908,432; 7,141,018; 7,230,012; 7,435,745; 7,874,984; 7,959,566; 8,204,763;  8,315,886; 8,589,188 and 8,626,53) are invalid, unenforceable and/or not infringed.  On January 30, 2015, Celgene Corporation and Children’s Medical Center

 

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Corporation filed a patent infringement lawsuit in the United States District Court for the District of New Jersey, alleging that the Company’s filing of ANDA No. 206601 constitutes an act of patent infringement and seeking a declaration that the patents at issue are valid and infringed.  The Company filed an answer and affirmative defenses, and an amended answer to the complaint.

 

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

 

SUPREP®

 

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

 

In March 2017, Braintree Laboratories, Inc. (“Braintree”) filed a patent infringement lawsuit in the United States District Court for the District of Delaware (C.A. No. 1:17-cv-00293-GMS), alleging that the Company’s filing of ANDA No. 209941 constitutes an act of patent infringement and seeking a declaration that the patent at issue was infringed by the submission of ANDA No. 209941.  The Company answered the complaint denying infringement and raising invalidity as a defense, and has filed counterclaims seeking a declaration of non-infringement and invalidity.  The matter is currently scheduled for a 4-day bench trial beginning on January 22, 2019.  On July 28, 2017, the Company filed a motion for judgment on the pleadings, seeking a ruling that its ANDA product does not infringe the Braintree patent and seeking judgment as a matter of law.  Braintree has opposed the motion and has alternatively requested that the Court delay its decision on the motion until discover is taken.  The Company has opposed Braintree’s request to delay the decision.  All motions remain pending at this time.

 

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 13.  Commitments

 

Leases

 

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

 

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

 

(In thousands)

 

Amounts Due

 

Remainder of 2018

 

$

1,185

 

2019

 

1,805

 

2020

 

1,853

 

2021

 

1,472

 

2022

 

1,080

 

Thereafter

 

5,238

 

Total

 

$

12,633

 

 

Other Commitment

 

During the third quarter of Fiscal 2017, the Company signed an agreement with a company operating in the pharmaceutical business, under which the Company agreed to provide up to $15.0 million in revolving loans for the purpose of expansion and other business needs.  The decision to provide any portion of the revolving loan is at the Company’s sole discretion.  At any time after the outstanding revolving loan balance is equal to or greater than $7.5 million, the Company has the option to convert the first $7.5

 

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million into a 50% ownership interest in the entity.  As of September 30, 2017, $3.5 million was outstanding under the revolving loan. The board of the entity is comprised of five members, two of which are employees of the Company.  Based on the guidance set forth in ASC 810-10 Consolidation, the Company has concluded that it has a variable interest in the entity.  However, the Company is not the primary beneficiary to the entity and as such, is not required to consolidate the entity’s results of operations.

 

Note 14.  Accumulated Other Comprehensive Loss

 

The Company’s Accumulated Other Comprehensive Loss was comprised of the following components as of September 30, 2017 and 2016:

 

(In thousands)

 

September 30,
2017

 

September 30,
2016

 

Foreign Currency Translation

 

 

 

 

 

Beginning Balance, June 30

 

$

(222

)

$

(295

)

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

 

1

 

(3

)

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

 

 

 

Other comprehensive income (loss), net of tax

 

1

 

(3

)

Ending Balance, September 30

 

(221

)

(298

)

Total Accumulated Other Comprehensive Loss

 

$

(221

)

$

(298

)

 

Note 15.  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, a warrant and treats unvested restricted stock and performance-based shares 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
September 30,

 

(In thousands, except share and per share data)

 

2017

 

2016

 

 

 

 

 

 

 

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

 

$

13,257

 

$

(29,408

)

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

36,992,064

 

36,699,267

 

Effect of potentially dilutive options and restricted stock awards

 

738,592

 

 

Diluted weighted average common shares outstanding

 

37,730,656

 

36,699,267

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic

 

$

0.36

 

$

(0.80

)

Diluted

 

$

0.35

 

$

(0.80

)

 

The number of anti-dilutive shares that have been excluded in the computation of diluted earnings per share for the three months ended September 30, 2017 and 2016 was 3.0 million and 4.3 million, respectively.

 

Note 16.  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.

 

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Note 17.  Share-based Compensation

 

At September 30, 2017, the Company had two share-based employee compensation plans (the 2011 Long-Term Incentive Plan “LTIP” and the 2014 “LTIP”).  Together these plans authorized an aggregate total of 4.5 million shares to be issued.  The plans have a total of 1.7 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 September 30, 2017, there was $11.3 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 2.4 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 three months ended September 30, 2017 and 2016, the estimated annual forfeiture rates used to recognize the associated compensation expense and the weighted average fair value of the options granted:

 

 

 

September 30,
2017

 

September 30,
2016

 

Risk-free interest rate

 

1.9

%

1.1

%

Expected volatility

 

57.4

%

55.6

%

Expected dividend yield

 

 

 

Forfeiture rate

 

6.5

%

6.5

%

Expected term (in years)

 

5.4 years

 

5.2 years

 

Weighted average fair value

 

$

9.06

 

$

15.33

 

 

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

 

A stock option roll-forward as of September 30, 2017 and changes during the three months then ended, is presented below:

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

Weighted-

 

 

 

Average

 

 

 

 

 

Average

 

Aggregate

 

Remaining

 

 

 

 

 

Exercise

 

Intrinsic

 

Contractual

 

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

 

Awards

 

Price

 

Value

 

Life (yrs.)

 

 

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2017

 

1,475

 

$

18.02

 

$

12,212

 

5.7

 

Granted

 

18

 

$

17.40

 

 

 

 

 

Exercised

 

(14

)

$

6.53

 

$

150

 

 

 

Forfeited, expired or repurchased

 

(6

)

$

26.55

 

 

 

 

 

Outstanding at September 30, 2017

 

1,473

 

$

18.09

 

$

10,075

 

5.5

 

 

 

 

 

 

 

 

 

 

 

Vested and expected to vest at September 30, 2017

 

1,470

 

$

18.07

 

$

10,073

 

5.5

 

Exercisable at September 30, 2017

 

1,436

 

$

17.66

 

$

10,057

 

5.4

 

 

Restricted Stock

 

The Company measures restricted stock compensation costs based on the stock price at the grant date less an estimate for expected forfeitures.  The annual forfeiture rate used to calculate compensation expense was 6.5% for the three months ended September 30, 2017 and 2016.

 

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A summary of restricted stock awards as of September 30, 2017 and changes during the three months then ended, is presented below:

 

(In thousands, except for weighted average price data)

 

Awards

 

Weighted
Average Grant -
date Fair Value

 

Aggregate
Intrinsic Value

 

 

 

 

 

 

 

 

 

Non-vested at June 30, 2017

 

334

 

$

30.71

 

 

 

Granted

 

460

 

17.16

 

 

 

Vested

 

(116

)

35.35

 

$

2,452

 

Forfeited

 

(17

)

24.13

 

 

 

Non-vested at September 30, 2017

 

661

 

$

39.72

 

 

 

 

Performance-Based Shares

 

On September 22, 2017, the Company approved and granted performance-based awards to certain key executives.  The stock-settled awards will vest based on relative Total Shareholder Return (“TSR”) over a three year period.  The Company measures share-based compensation cost for TSR awards using a Monte-Carlo simulation model.  The impact of the grant was not material to the consolidated financial statements during the first quarter of Fiscal 2018.

 

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 three months ended September 30, 2017 and 2016, 14 thousand shares and 13 thousand shares were issued under the ESPP, respectively.  As of September 30, 2017, 557 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
September 30,

 

(In thousands)

 

2017

 

2016

 

Selling, general and administrative

 

$

1,787

 

$

1,972

 

Research and development

 

151

 

173

 

Cost of sales

 

251

 

311

 

Total

 

$

2,189

 

$

2,456

 

 

 

 

 

 

 

Tax benefit at statutory rate

 

$

799

 

$

897

 

 

Note 18.  Employee Benefit Plan

 

The Company has a 401k defined contribution plan (the “Plan”) covering substantially all employees.  Pursuant to the Plan provisions, the Company is required to make matching contributions equal to 50% of each employee’s contribution, not to exceed 4% of the employee’s compensation for the Plan year.  Contributions to the Plan during the three months ended September 30, 2017 and 2016 were $562 thousand and $579 thousand, respectively.

 

Note 19.  Income Taxes

 

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

 

The federal, state and local income tax expense for the three months ended September 30, 2017 was $7.4 million compared to an income tax benefit of $12.9 million for the three months ended September 30, 2016.  The effective tax rates for the three months ended September 30, 2017 and 2016 were 35.9% and 30.5%, respectively.  The effective tax rate for the three months ended

 

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September 30, 2017 was higher compared to the three months ended September 30, 2016 primarily due to lower domestic manufacturing deductions relative to expected pre-tax income as well as the impact of excess tax shortfalls related to stock compensation.

 

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

 

As of September 30, 2017 and June 30, 2017, the Company has total unrecognized tax benefits of $6.0 million and $5.9 million respectively, of which $4.2 million would impact the Company’s effective tax rate if recognized.  As a result of the positions taken during the period, the Company has not recorded any interest and penalties for the period ended September 30, 2017 in the statement of operations and no cumulative interest and penalties have been recorded either in the Company’s statement of financial position as of September 30, 2017 and June 30, 2017.  The Company will recognize interest accrued on unrecognized tax benefits in interest expense and any related penalties in operating expenses.  The cumulative amount of unrecognized tax benefits as of September 30, 2017 includes approximately $3.0 million of state reserves related to the acquisition of KUPI, which are expected to be recognized in Fiscal 2018 due to a lapse of statute of limitations.

 

The Company files income tax returns in the United States federal jurisdiction and various states.  The Company’s tax returns for Fiscal Year 2013 and prior generally are no longer subject to review as such years generally are closed.  The Company’s Fiscal Year 2016 federal return is currently under examination by the IRS.  The Company cannot reasonably predict the outcome of the examination at this time.

 

Note 20.  Related Party Transactions

 

The Company had sales of $834 thousand and $856 thousand during the three months ended September 30, 2017 and 2016, respectively, to a generic distributor, Auburn Pharmaceutical Company (“Auburn”).  Jeffrey Farber, Chairman of the Board, is the owner of Auburn.  Accounts receivable includes amounts due from Auburn of $716 thousand and $751 thousand at September 30, 2017 and June 30, 2017, respectively.

 

The Company also had sales of $467 thousand and $67 thousand during the three months ended September 30, 2017 and 2016, respectively, to a generic distributor, KeySource.  Albert Paonessa, a current board member, was appointed the CEO of KeySource in May 2017.  Accounts receivable includes amounts due from KeySource of $491 thousand and $606 thousand as of September 30, 2017 and June 30, 2017, respectively.

 

Note 21.  Material Contracts with Suppliers

 

Jerome Stevens Pharmaceuticals Distribution Agreement:

 

The Company’s primary finished goods inventory supplier is JSP, in Bohemia, New York.  Purchases of finished goods inventory from JSP accounted for 33% and 37% of the Company’s inventory purchases in the three months ended September 30, 2017 and 2016, respectively.

 

On August 19, 2013, the Company entered into an agreement with JSP to extend its initial contract to continue as the exclusive distributor in the United States of three JSP products: Butalbital, Aspirin, Caffeine with Codeine Phosphate Capsules USP; Digoxin Tablets USP; and Levothyroxine Sodium Tablets USP.  The amendment to the original agreement extends the initial contract, which was due to expire on March 22, 2014, for five years through March 2019.  In connection with the amendment, the Company issued a total of 1.5 million shares of the Company’s common stock to JSP and JSP’s designees.  In accordance with its policy related to renewal and extension costs for recognized intangible assets, the Company recorded a $20.1 million expense in cost of sales, which represents the fair value of the shares on August 19, 2013.  If the parties agree to a second five year extension from March 23, 2019 to March 23, 2024, the Company is required to issue to JSP or its designees an additional 1.5 million shares of the Company’s common stock.  Both Lannett and JSP have the right to terminate the contract if one of the parties does not cure a material breach of the contract within thirty (30) days of notice from the non-breaching party.

 

During the renewal term of the JSP Distribution Agreement, the Company is required to use commercially reasonable efforts to purchase minimum dollar quantities of JSP products.  There is no guarantee that the Company will be able to meet the minimum purchase requirement for Fiscal 2018 and in the future.  If the Company does not meet the minimum purchase requirements, JSP’s sole remedy is to terminate the JSP Distribution Agreement.

 

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

 

Cautionary Statement About Forward-Looking Statements

 

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

 

The following information should be read in conjunction with the consolidated financial statements and notes in Part I, Item 1 of this Quarterly Report and with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2017.  All references to “Fiscal 2018” or “Fiscal Year 2018” shall mean the fiscal year ended June 30, 2018 and all references to “Fiscal 2017” or “Fiscal Year 2017” shall mean the fiscal year ended June 30, 2017.

 

Company Overview

 

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

 

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

 

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

 

2016 Restructuring Plan

 

On February 1, 2016, in connection with the acquisition of KUPI, the Company announced a plan related to the future integration of KUPI and the Company’s operations (the “2016 Restructuring Program”). The plan focuses on the closure of KUPI’s corporate functions and the consolidation of manufacturing, sales, research and development and distribution functions. The Company estimates that it will incur an aggregate of up to approximately $20.0 million in restructuring charges for actions that have been announced or communicated since the 2016 Restructuring Program began.  Of this amount, approximately $11.0 million relates to employee separation costs, approximately $1.0 million relates to contract termination costs and approximately $8.0 million relates to facility closures costs and other actions.

 

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

 

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

 

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Financial Summary

 

For the first quarter of Fiscal Year 2018, net sales decreased 4% to $155.0 million as compared to the same prior-year period.  Gross profit decreased to $67.7 million compared to $81.9 million in the prior-year period and gross profit percentage decreased to 44% compared to 51% in the prior-year period.  R&D expenses decreased 40% to $7.4 million compared to $12.4 million in the first quarter of Fiscal Year 2017 while SG&A expenses decreased 10% to $19.0 million from $21.3 million.  Acquisition and integration-related expenses decreased to $18 thousand from $1.4 million in the prior-year period.  Restructuring expenses decreased 74% to $527 thousand from $2.1 million.  Operating income for the first quarter of Fiscal Year 2018 was $40.7 million compared to an operating loss of $20.3 million in the first quarter of Fiscal Year 2017, which included a $65.1 million intangible asset impairment charge.  Net income attributable to Lannett Company, Inc. for the first quarter of Fiscal Year 2018 was $13.3 million, or $0.35 per diluted share compared to net loss attributable to Lannett Company, Inc. of $29.4 million or $0.80 per diluted share in the first quarter of Fiscal Year 2017.

 

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

 

Results of Operations - Three months ended September 30, 2017 compared with the three months ended September 30, 2016

 

Net sales decreased 4% to $155.0 million for the three months ended September 30, 2017.  The following table identifies the Company’s net product sales by medical indication for the three months ended September 30, 2017 and 2016:

 

(In thousands)

 

Three Months Ended September 30,

 

Medical Indication

 

2017

 

2016

 

Antibiotic

 

$

3,349

 

$

3,780

 

Anti Psychosis

 

14,991

 

17,320

 

Cardiovascular

 

11,306

 

12,694

 

Central Nervous System

 

8,818

 

10,350

 

Gallstone

 

6,564

 

12,883

 

Gastrointestinal

 

14,553

 

18,052

 

Glaucoma

 

2,668

 

5,783

 

Migraine

 

15,015

 

7,160

 

Muscle Relaxant

 

3,791

 

3,532

 

Pain Management

 

5,761

 

6,608

 

Respiratory

 

1,647

 

2,213

 

Thyroid Deficiency

 

47,214

 

39,838

 

Urinary

 

2,997

 

5,101

 

Other

 

12,696

 

11,182

 

Contract manufacturing revenue

 

3,591

 

5,063

 

Total

 

$

154,961

 

$

161,559

 

 

The decrease in net sales was driven by decreased average selling price of products of $31.8 million, partially offset by increased volumes of $25.2 million.  Average selling prices were impacted by competitive pricing pressure across a number of products, product mix and changes within distribution channels.  Although the Company has benefited in the past from favorable pricing trends, these trends have reversed.  The level of competition in the marketplace is constantly changing and the Company cannot predict with certainty that these trends will continue.

 

In January 2017, a provision in the Bipartisan Budget Act of 2015 required drug manufacturers to pay additional rebates to state Medicaid programs if the prices of their generic drugs rise at a rate faster than inflation.  The provision negatively impacted the Company’s net sales by $5.4 million during the three months ended September 30, 2017, which contributed to the overall decreased average selling price.

 

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The following chart details price and volume changes by medical indication:

 

Medical indication

 

Sales volume
change %

 

Sales price
change %

 

Antibiotic

 

3

%

(14

)%

Anti Psychosis

 

(23

)%

10

%

Cardiovascular

 

48

%

(59

)%

Central Nervous System

 

13

%

(28

)%

Gallstone

 

(16

)%

(33

)%

Gastrointestinal

 

14

%

(33

)%

Glaucoma

 

(3

)%

(51

)%

Migraine

 

129

%

(19

)%

Muscle Relaxant

 

159

%

(152

)%

Pain Management

 

(13

)%

%

Respiratory

 

5

%

(31

)%

Thyroid Deficiency

 

15

%

4

%

Urinary

 

12

%

(53

)%

 

Central Nervous System.  Methylphenidate Hydrochloride Extended Release Tablets (“Methylphenidate ER”)

 

During a teleconference in November 2014, the FDA informed KUPI that it had concerns about whether generic versions of Concerta (methylphenidate hydrochloride extended release tablets), including KUPI’s Methylphenidate ER product, are therapeutically equivalent to Concerta.  The FDA indicated that its concerns were based in part on adverse event reports concerning lack of effect and its analyses of pharmacokinetic data.  The FDA informed KUPI that it was changing the therapeutic equivalence rating of its product from “AB” (therapeutically equivalent) to “BX.”  A BX-rated drug is a product for which data are insufficient to determine therapeutic equivalence; it is still approved and can be prescribed, but the FDA does not recommend it as automatically substitutable for the brand-name drug at the pharmacy.

 

During the November 2014 teleconference, the FDA also asked KUPI to either voluntarily withdraw its product or to conduct new bioequivalence (“BE”) testing in accordance with the recommendations for demonstrating bioequivalence to Concerta proposed in a new draft BE guidance that the FDA issued earlier that November.  The FDA had approved the KUPI product (and originally granted it an AB rating) in 2013, on the basis of KUPI data showing its product met BE criteria set forth in draft BE guidance that the FDA had issued in 2012.  The FDA’s position concerning the KUPI product was the subject of a public announcement by the agency. The Company agreed to conduct new BE studies per the new draft BE guidance.  KUPI submitted the data from those studies to the FDA in June 2015.  The Company continues to pursue the FDA to obtain its decision on the submitted study as well as its response on whether it will restore the AB-rating for our product.

 

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.  The FDA’s notice includes an opportunity for the Company to request a hearing on this matter.  The Company initially had until November 17, 2016 to request the hearing and until December 19, 2016 to submit all data, information and analyses upon which the request for a hearing relies.

 

On November 30, 2016, the Company announced that the FDA granted a 90-day extension to submit documentation related to the hearing request.  On February 22, 2017, the Company announced that the FDA suspended indefinitely the deadline to submit supporting documentation related to the hearing request in order to give the FDA additional time to retrieve documents requested by the Company.

 

The Company intends to continue working to submit data to the FDA to regain the “AB” rating, or to maintain the drug on the U.S. market with a B-level rating, however, there can be no assurance as to when or if the Company will be permitted to remain on the market.  If the Company were to receive the “AB” rating, net sales of the product could increase subject to market factors existing at that time.  The Company also agreed to potential acquisition-related contingent payments to UCB related to Methylphenidate ER if the FDA reinstates the AB-rating and certain sales thresholds are met.  Such potential contingent payments are set to expire after December 31, 2020.

 

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The Company sells its products to customers in various distribution channels.  The table below presents the Company’s net sales to each distribution channel for the three months ended September 30:

 

(In thousands)
Customer Distribution Channel

 

September 30,
2017

 

September 30,
2016

 

Wholesaler/Distributor

 

$

120,801

 

$

124,925

 

Retail Chain

 

18,768

 

20,094

 

Mail-Order Pharmacy

 

11,801

 

11,477

 

Contract manufacturing revenue

 

3,591

 

5,063

 

Total

 

$

154,961

 

$

161,559

 

 

Net sales to wholesaler/distributor and retail chains decreased as a result of the overall decrease in net sales.  Net sales within the various distribution channels remained consistent in the first quarter of Fiscal 2018 as compared to the prior-year period.

 

Cost of Sales, including amortization of intangibles.  Cost of sales, including amortization of intangibles for the first quarter of Fiscal Year 2018 increased 10% to $87.3 million from $79.7 million in the same prior-year period.  The increase was primarily attributable to changes in our product sales mix and increased product royalties, partially offset by lower amortization expense.  Product royalties expense included in cost of sales totaled $6.7 million for the first quarter of Fiscal Year 2018 and $4.8 million for the first quarter of Fiscal Year 2017.  Amortization expense included in cost of sales totaled $7.7 million for the first quarter of Fiscal Year 2018 and $8.9 million for the first quarter of Fiscal Year 2017.  The decrease was primarily due to a lower intangible assets base in the first quarter of Fiscal 2018 as a result of impairment charges in Fiscal 2017.

 

Gross Profit.  Gross profit for the first quarter of Fiscal 2018 decreased 17% to $67.7 million or 44% of net sales.  In comparison, gross profit for the first quarter of Fiscal 2017 was $81.9 million or 51% of net sales.  The decrease in gross profit percentage was primarily attributable to lower average selling price of key products as well as additional product royalties.

 

Research and Development Expenses.  Research and development expenses for the first quarter decreased 40% to $7.4 million in Fiscal Year 2018 from $12.4 million in Fiscal Year 2017.  The decrease is primarily due to lower product development expenses as well as decreased spend related to the C-Topical clinical trials.

 

Selling, General and Administrative Expenses.  Selling, general and administrative expenses decreased 10% to $19.0 million in the first quarter of Fiscal Year 2018 compared with $21.3 million in Fiscal Year 2017.  The decrease is primarily driven by lower incentive compensation-related costs.

 

The Company is focused on controlling operating expenses and has implemented its 2016 Restructuring Plan as noted above, however increases in personnel and other costs to facilitate enhancements in the Company’s infrastructure and expansion may continue to impact operating expenses in future periods.

 

Acquisition and Integration-related Expenses.  Acquisition and integration-related expenses decreased $1.4 million to $18 thousand for the first quarter of Fiscal Year 2018 as compared to the prior-year period.  The decrease was due to the timing of the acquisition of Kremers Urban Pharmaceuticals Inc.

 

Restructuring Expenses.  Restructuring expenses decreased $1.5 million to $527 thousand for the first quarter of Fiscal Year 2018 compared to the prior-year period primarily due to higher employee separation costs incurred in connection with the 2016 Restructuring Program during the three months ended September 30, 2016.

 

Other Income (Loss).  Interest expense for the three months ended September 30, 2017 totaled $20.9 million compared to $23.0 million for the three months ended September 30, 2016.  The decrease was due to a lower weighted-average debt balance in the first quarter of Fiscal 2018 as compared to the prior-year period.  The weighted average interest rate for the first quarter of Fiscal 2018 and 2017 was 8.3% and 7.8%, respectively.  Investment income totaled $1.2 million in the first quarter of Fiscal 2018 compared with investment income of $1.0 million in the first quarter of Fiscal 2017.

 

Income Tax.  The Company recorded income tax expense of $7.4 million in the first quarter of Fiscal Year 2018 as compared to an income tax benefit of $12.9 million in the first quarter of Fiscal Year 2017.  The effective tax rate for the three months ended September 30, 2017 was 35.9%, compared to 30.5% for the three months ended September 30, 2016.  The effective tax rate for the three months ended September 30, 2017 was higher compared to the three months ended September 30, 2016 primarily due to lower domestic manufacturing deductions relative to expected pre-tax income as well as the impact of excess tax shortfalls related to stock compensation.

 

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Net Income (Loss).  For the three months ended September 30, 2017, the Company reported net income attributable to Lannett Company, Inc. of $13.3 million, or $0.35 per diluted share.  Comparatively, net loss attributable to Lannett Company, Inc. in the corresponding prior-year period was $29.4 million, or $0.80 per diluted share.

 

Liquidity and Capital Resources

 

Cash Flow

 

Until November 25, 2015, the date of the KUPI acquisition, the Company had historically financed its operations with cash flow generated from operations supplemented with borrowings from various government agencies and financial institutions.  At September 30, 2017, working capital was $306.6 million as compared to $302.6 million at June 30, 2017, an increase of $4.0 million.  Current product portfolio sales as well as sales related to future product approvals are anticipated to generate positive cash flow from operations, which we expect will be sufficient to service our outstanding debt.

 

Net cash used in operating activities of $1.6 million for the three months ended September 30, 2017 reflected net income of $13.3 million, adjustments for non-cash items of $24.5 million, as well as cash used by changes in operating assets and liabilities of $39.4 million.  In comparison, net cash provided by operating activities of $36.4 million for the three months ended September 30, 2016 reflected net loss of $29.4 million, adjustments for non-cash items of $82.7 million, as well as cash used by changes in operating assets and liabilities of $16.9 million.

 

Significant changes in operating assets and liabilities from June 30, 2017 to September 30, 2017 were comprised of:

 

·                  An increase in accounts receivable of $39.3 million mainly due to increased sales as well as the timing of collections.  The Company’s days sales outstanding (“DSO”) at September 30, 2017, based on gross sales for the three months ended September 30, 2017 and gross accounts receivable at September 30, 2017, was 76 days.  The level of DSO at September 30, 2017 was comparable to the Company’s expectation that DSO will be in the 70 to 80 day range based on customer payment terms.

·                  An increase in other assets totaling $6.3 million primarily due to prepaid FDA user fees as well as additional loans issued to a company operating in the pharmaceutical business. See Note 13 “Commitments” for more information.

·                  An increase in inventories totaling $2.8 million primarily due to the timing of customer order fulfillment.

 

Significant changes in operating assets and liabilities from June 30, 2016 to September 30, 2016 were comprised of:

 

·                  A decrease in accounts receivable of $15.2 million mainly due to the timing of collections and a decrease in gross accounts receivable resulting from decreased sales partially offset by decreases in total revenue-related reserves.  The Company’s days sales outstanding (“DSO”) at September 30, 2016, based on gross sales for the three months ended September 30, 2016 and gross accounts receivable at September 30, 2016, was 71 days.  The level of DSO at September 30, 2016 was comparable to the Company’s expectation that DSO will be in the 70 to 80 day range based on customer payment terms.

·                  An increase in inventories totaling $12.8 million primarily due to the timing of customer order fulfillment.

·                  An increase in accounts payable of $9.3 million due to the timing of payments.

·                  An increase in prepaid income taxes of $22.3 million primarily due to estimated tax payments and current period tax benefits associated with pre-tax losses for the three months ended September 30, 2016.

 

Net cash used in investing activities of $10.1 million for the three months ended September 30, 2017, was mainly the result of purchases of investment securities totaling $23.8 million, purchases of property, plant and equipment of $12.1 million and the purchase of an intangible asset of $2.0 million, partially offset by proceeds from the sale of investment securities of $27.8 million.  Net cash used in investing activities of $6.4 million for the three months ended September 30, 2016, was mainly the result of purchases of investment securities totaling $12.2 million and purchases of property, plant and equipment of $9.9 million, partially offset by proceeds from the sale of investment securities of $15.7 million.

 

Net cash used in financing activities of $13.6 million for the three months ended September 30, 2017 was primarily due to debt repayments of $13.3 million and purchases of treasury stock totaling $612 thousand, partially offset by proceeds from issuance of stock pursuant to stock compensation plans of $314 thousand.  Net cash used in financing activities of $13.1 million for the three months ended September 30, 2016 was primarily due to debt repayments of $13.3 million and purchases of treasury stock totaling $1.8 million, partially offset by proceeds from issuance of stock pursuant to stock compensation plans of $1.4 million and excess tax benefits on share-based compensation awards of $644 thousand.

 

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Credit Facility and Other Indebtedness

 

The Company has previously entered into and may enter future agreements with various government agencies and financial institutions to provide additional cash to help finance the Company’s acquisitions, various capital investments and potential strategic opportunities.  These borrowing arrangements as of September 30, 2017 are as follows:

 

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 Term Loan A in an aggregate principal amount of $275.0 million, Term Loan B 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 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.  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.

 

Refer to the Company’s Form 10-K for the fiscal year ended June 30, 2017 for further details on the Amended Senior Secured Credit Facility.

 

Cody Mortgage

 

Realty owns land and a building which is being leased to Cody Labs.  Realty has a mortgage loan with the First National Bank of Cody related to its land and building.  As of September 30, 2017 and June 30, 2017, the effective rate was 4.5% per annum.  The mortgage is collateralized by the land and building with a net book value of $1.4 million.  As of September 30, 2017, $699 thousand is outstanding under the mortgage loan, of which $149 thousand is classified as currently due.

 

Other Liquidity Matters

 

Material Suppliers

 

During the renewal term of the JSP Distribution Agreement, the Company is required to use commercially reasonable efforts to purchase minimum dollar quantities of JSP products.  There is no guarantee that the Company will continue to meet the minimum purchase requirement for Fiscal 2018 and thereafter.  If the Company does not meet the minimum purchase requirements, JSP’s sole remedy is to terminate the agreement.

 

Cody Expansion

 

In January 2017, the Company announced a $50 million expansion plan in conjunction with Forward Cody to expand operations in Cody, WY.  The project is expected to be completed by the middle of Fiscal 2020.

 

Future Acquisitions

 

We are continuously evaluating the potential for product and company acquisitions as a part of our future growth strategy.  In conjunction with a potential acquisition, the Company may utilize current resources or seek additional sources of capital to finance any such acquisition, which could have an impact on future liquidity.

 

We may also from time to time depending on market conditions and prices, contractual restrictions, our financial liquidity and other factors, seek to prepay outstanding debt or repurchase our outstanding debt through open market purchases, privately negotiated purchases, or otherwise.  The amounts involved in any such transactions, individually or in the aggregate, may be material and may be funded from available cash or from additional borrowings.

 

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Research and Development Arrangements

 

In the normal course of business, the Company has entered into certain research and development and other arrangements.  As part of these arrangements, the Company has agreed to certain contingent payments which generally become due and payable only upon the achievement of certain developmental, regulatory, commercial and/or other milestones.  In addition, under certain arrangements, we may be required to make royalty payments based on a percentage of future sales, or other metric, for products currently in development in the event that the Company begins to market and sell the product.  Due to the inherent uncertainty related to these developmental, regulatory, commercial and/or other milestones, it is unclear if the Company will ever be required to make such payments.

 

Critical Accounting Policies

 

The preparation of our consolidated financial statements in accordance with accounting principles generally accepted in the United States and the rules and regulations of the U.S. Securities & Exchange Commission requires the use of estimates and assumptions.  A listing of the Company’s significant accounting policies are detailed in Note 3 “Summary of Significant Accounting Policies.”  A subsection of these accounting policies have been identified by management as “Critical Accounting Policies.”  Critical accounting policies are those which require management to make estimates using assumptions that were uncertain at the time the estimates were made and for which the use of different assumptions, which reasonably could have been used, could have a material impact on the financial condition or results of operations.

 

Management has identified the following as “Critical Accounting Policies”:  Revenue Recognition, Inventories, Income Taxes, Valuation of Long-Lived Assets, including Goodwill and Intangible Assets, In-Process Research and Development and Share-based Compensation.

 

Revenue Recognition

 

The Company recognizes revenue when title and risk of loss have transferred to the customer and provisions for estimates, including rebates, promotional adjustments, price adjustments, returns, chargebacks and other potential adjustments are reasonably determinable.  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.

 

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.  The reserves presented as a reduction of accounts receivable totaled $184.1 million and $175.8 million at September 30, 2017 and June 30, 2017, respectively.  Rebates payable at September 30, 2017 and June 30, 2017 totaled $47.3 million and $44.6 million, respectively, for certain rebate programs, primarily related to Medicare Part D, Medicaid and certain sales allowances and other adjustments paid to indirect customers.

 

The following table identifies the activity and ending balances of each major category of revenue-related reserve for the three months ended September 30, 2017 and 2016:

 

Reserve Category
(In thousands)

 

Chargebacks

 

Rebates

 

Returns

 

Other

 

Total

 

Balance at June 30, 2017

 

$

79,537

 

$

87,616

 

$

42,135

 

$

11,096

 

$

220,384

 

Current period provision

 

254,689

 

78,455

 

10,437

 

12,364

 

355,945

 

Credits issued during the period

 

(254,952

)

(73,422

)

(7,151

)

(9,403

)

(344,928

)

Balance at September 30, 2017

 

$

79,274

 

$

92,649

 

$

45,421

 

$

14,057

 

$

231,401

 

 

Reserve Category
(In thousands)

 

Chargebacks

 

Rebates

 

Returns

 

Other

 

Total

 

Balance at June 30, 2016

 

$

86,495

 

$

54,084

 

$

40,593

 

$

16,851

 

$

198,023

 

Measurement-period adjustments

 

 

 

5,955

 

 

5,955

 

Current period provision

 

198,500

 

69,486

 

6,847

 

15,454

 

290,287

 

Credits issued during the period

 

(212,649

)

(69,028

)

(5,531

)

(20,773

)

(307,981

)

Balance at September 30, 2016

 

$

72,346

 

$

54,542

 

$

47,864

 

$

11,532

 

$

186,284

 

 

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For the three months ending September 30, 2017 and 2016, as a percentage of gross sales the provision for chargebacks was 50.2% and 44.4%, the provision for rebates was 15.5% and 15.6%, the provision for returns was 2.1% and 1.5% and the provision for other adjustments was 2.4% and 3.5%, respectively.

 

The increase in total reserves from June 30, 2017 to September 30, 2017 was primarily due to increased net sales in the first quarter of Fiscal 2018 as compared to the fourth quarter of Fiscal 2017.  The activity in the “Other” category for the three months ended September 30, 2017 and 2016 includes, shelf-stock, shipping and other sales adjustments including prompt payment discounts.  Historically, we have not recorded any material amounts in the current period related to reversals or additions of prior period reserves.  If the Company were to record a material reversal or addition of any prior period reserve amount, it would be separately disclosed.

 

Refer to the Company’s Form 10-K for the fiscal year ended June 30, 2017 for a description of our remaining Critical Accounting Policies.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

On November 25, 2015, in connection with the acquisition of KUPI, the Company entered into a Senior Secured Credit Facility, which was subsequently amended in June 2016.  Based on the variable-rate debt outstanding at September 30, 2017, each 1/8% increase in interest rates would yield $1.2 million of incremental annual interest expense.

 

A mortgage loan with First National Bank of Cody has been consolidated in the Company’s financial statements, along with the related land and building.  The mortgage requires monthly principal and interest payments of $15 thousand.  As of September 30, 2017 and June 30, 2017, the effective interest rate was 4.5% per annum.  The mortgage is collateralized by the land and building with a net book value of $1.4 million.  As of September 30, 2017, $699 thousand is outstanding under the mortgage loan.

 

The Company invests in equity securities, U.S. government agency securities and corporate bonds, which are exposed to market and interest rate fluctuations.  The market value, interest and dividends earned on these investments may vary based on fluctuations in interest rate and market conditions.

 

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ITEM 4.  CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this Form 10-Q, management performed, with the participation of our Chief Executive Officer and Chief Financial Officer, an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.

 

Based upon the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that Lannett’s disclosure controls and procedures were effective as of the end of the period covered by this report.

 

Change in Internal Control Over Financial Reporting

 

During the third quarter of Fiscal 2017, the Company completed the carve-out of data and software systems supporting the operations of KUPI from the hosted environment of UCB.  The integration of the Company’s entities into a single consolidated system is planned in phases and is expected to be completed in Fiscal 2018.  As such, internal controls have and will continue to change in various functional areas within the Company.  However, management has taken steps to ensure that any changes to the design and implementation of internal controls continue to function appropriately.  There have been no other changes in Lannett’s internal control over financial reporting during the three months ended September 30, 2017, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II.  OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

Information pertaining to legal proceedings can be found in Note 12 “Legal, Regulatory Matters and Contingencies” of the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q and is incorporated by reference herein.

 

ITEM 1A.  RISK FACTORS

 

Lannett Company, Inc’s Annual Report on Form 10-K for the fiscal year ended June 30, 2017 includes a detailed description of its risk factors.

 

ITEM 6.  EXHIBITS

 

(a)                          A list of the exhibits required by Item 601 of Regulation S-K to be filed as a part of this Form 10-Q is shown on the Exhibit Index filed herewith.

 

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Exhibit Index

 

31.1

 

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

Filed Herewith

 

 

 

 

 

31.2

 

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

Filed Herewith

 

 

 

 

 

32

 

Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

Filed Herewith

 

 

 

 

 

101.INS

 

XBRL Instance Document

 

 

 

 

 

 

 

101.SCH

 

XBRL Extension Schema Document

 

 

 

 

 

 

 

101.CAL

 

XBRL Calculation Linkbase Document

 

 

 

 

 

 

 

101.DEF

 

XBRL Definition Linkbase Document

 

 

 

 

 

 

 

101.LAB

 

XBRL Label Linkbase Document

 

 

 

 

 

 

 

101.PRE

 

XBRL Presentation Linkbase Document

 

 

 

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SIGNATURES

 

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

LANNETT COMPANY, INC.

 

 

 

Dated: November 8, 2017

By:

/s/ Arthur P. Bedrosian

 

 

Arthur P. Bedrosian

 

 

Chief Executive Officer

 

 

 

 

 

 

Dated: November 8, 2017

By:

/s/ Martin P. Galvan

 

 

Martin P. Galvan

 

 

Vice President of Finance, Chief Financial Officer and Treasurer

 

 

 

 

 

 

Dated: November 8, 2017

By:

/s/ G. Michael Landis

 

 

G. Michael Landis

 

 

Director of Finance and Principal Accounting Officer

 

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