In addition to historical information, this Form 10-K contains forward-looking information. The forward-looking information is subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause such a difference include, but are not limited to, those discussed in the following section, entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations." Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date of this Form 10-K. The Company undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that may occur. Readers should carefully review the risk factors described in other documents the Company files from time to time with the SEC, including the Quarterly Reports on Form 10-Q to be filed by the Company in Fiscal 2010, and any Current Reports on Form 8-K filed by the Company.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties and potentially result in materially different results under different assumptions and conditions. We believe that our critical accounting policies include those described below. For a detailed discussion on the application of these and other accounting policies, refer to Note 1 in the Notes to the Consolidated Financial Statements included herein.

Consolidation of Variable Interest Entity - The Company consolidates any Variable Interest Entity ("VIE") of which we are the primary beneficiary. The liabilities recognized as a result of consolidating a VIE do not represent additional claims on our general assets; rather, they represent claims against the specific assets of the consolidated VIE. Conversely, assets recognized as a result of consolidating a VIE do not represent additional assets that could be used to satisfy claims against our general assets. Reflected in the June 30, 2009 and 2008 balance sheets are consolidated VIE assets of $1.9 million and $1.9 million, respectively, which is comprised mainly of land and a building. VIE liabilities primarily consist of a mortgage on that property in the amount of $1.7 million and $1.7 million at June 30, 2009 and 2008, respectively. This VIE was initially consolidated by Cody, as Cody has been the primary beneficiary. Cody has then been consolidated within Lannett's financial statements since its acquisition in April 2007.

Revenue Recognition - The Company recognizes revenue when its products are shipped. At this point, title and risk of loss have transferred to the customer and provisions for estimates, including rebates, promotional adjustments, price adjustments, returns, chargebacks, and other potential adjustments are reasonably determinable. Accruals for these provisions are presented in the consolidated financial statements as rebates and chargebacks payable and reductions to net sales. The change in the reserves for various sales adjustments may not be proportionally equal to the change in sales because of changes in both the product and the customer mix. Increased sales to wholesalers will generally require additional accruals as they are the primary recipient of chargebacks and rebates. Incentives offered to secure sales vary from product to product. Provisions for estimated rebates and promotional credits are estimated based upon contractual terms. Provisions for other customer credits, such as price adjustments, returns, and chargebacks, require management to make subjective judgments on customer mix. Unlike branded

innovator drug companies, Lannett does not use information about product levels in distribution channels from third-party sources, such as IMS Health and Wolters Kluwer, in estimating future returns and other credits. Lannett calculates a chargeback/rebate rate based on contractual terms with its customers and applies this rate to customer sales. The only variable is customer mix, and this assumption is based on historical data and sales expectations. The chargeback/rebate reserve is reviewed on a monthly basis by management using several ratios and calculated metrics. As we continue to obtain additional information about our historical experience for chargebacks, rebates and returns, we also update our estimates of the required reserves.

Chargebacks - The provision for chargebacks is the most significant and complex estimate used in the recognition of revenue. The Company sells its products directly to wholesale distributors, generic distributors, retail pharmacy chains, and mail-order pharmacies. The Company also sells its products indirectly to independent pharmacies, managed care organizations, hospitals, nursing homes, and group purchasing organizations, collectively referred to as "indirect customers." Lannett enters into agreements with its indirect customers to establish pricing for certain products. The indirect customers then independently select a wholesaler from which to actually purchase the products at these agreed-upon prices. Lannett will provide credit to the wholesaler for the difference between the agreed-upon price with the indirect customer and the wholesaler's invoice price if the price sold to the indirect customer is lower than the direct price to the wholesaler. This credit is called a chargeback. The provision for chargebacks is based on expected sell-through levels by the Company's wholesale customers to the indirect customers and estimated wholesaler inventory levels. As sales by the Company to the large wholesale customers, such as Cardinal Health, AmerisourceBergen, and McKesson, increase, the reserve for chargebacks will also generally increase. However, the size of the increase depends on the expected mix of product sales to the indirect customers. The Company continually monitors the reserve for chargebacks and makes adjustments when management believes that expected chargebacks on actual sales may differ from the amounts that were assumed in the establishment of the chargeback reserves.

Rebates - Rebates are offered to the Company's key chain drug store and wholesaler customers to promote customer loyalty and increase product sales. These rebate programs provide customers with rebate credits upon attainment of pre-established volumes or attainment of net sales milestones for a specified period. Other promotional programs are incentive programs offered to the customers. At the time of shipment, the Company estimates reserves for rebates and other promotional credit programs based on the specific terms in each agreement. The reserve for rebates increases as sales to rebate-eligible customers are recognized and decreases when actual rebate payments are made. However, since rebate programs are not identical for all customers, the size of the reserve will depend on the mix of sales to customers that are eligible to receive rebates.

Returns - Consistent with industry practice, the Company has a product returns policy that allows certain customers to return product within a specified period prior to and subsequent to the product's lot expiration date in exchange for a credit to be applied to future purchases. The Company's policy requires that the customer obtain pre-approval from the Company for any qualifying return. The Company estimates its provision for returns based on historical experience, adjusted for any changes in business practices or conditions that would cause management to believe that future product returns may differ from those returns assumed in the establishment of reserves. Generally, the reserve for returns increases as sales increase and decrease when credits are issued or payments are made for actual returns received. The reserve for returns is included in the rebates, chargebacks and returns payable account on the balance sheet.

Other Adjustments - Other adjustments consist primarily of price adjustments, also known as "shelf stock adjustments," which are credits issued to reflect decreases in the selling prices of the Company's products that customers have remaining in their inventories at the time of a price reduction. Decreases in selling prices are discretionary decisions made by management to reflect competitive market conditions. Amounts recorded for estimated shelf stock adjustments are based upon specified terms with direct

customers, estimated declines in market prices, and estimates of inventory held by customers. The Company regularly monitors these and other factors and evaluates the reserve as additional information becomes available. Other adjustments are included in the rebates, chargebacks and returns payable account on the balance sheet. When competitors enter the market for existing products, shelf stock adjustments may be issued to maintain price competitiveness.

The following tables identify the reserves for each major category of revenue allowance and a summary of the activity for fiscal years 2009, 2008 and 2007. Unless we have specific information to indicate otherwise, actual credits issued in a given year are assumed to be related to sales recorded in prior years based on the Company's returns policy.

For the Year Ended June 30, 2009



Reserve Category               Chargebacks       Rebates        Returns         Other          Total
Reserve Balance as of
June 30, 2008                  $  4,049,407    $   632,314    $ 13,642,589    $    2,107    $ 18,326,417

Actual credits issued
related to sales recorded
in prior fiscal years            (3,954,794 )     (632,314 )   (12,853,342 )           -     (17,440,450 )

Reserves or (reversals)
charged during Fiscal 2009
related to sales in prior
fiscal years                              -              -           2,107        (2,107 )             -

Reserves charged to net
sales during Fiscal 2009
related to sales recorded
in Fiscal 2009                   35,391,475     12,141,204       4,315,638       204,119      52,052,436

Actual credits issued
related to sales recorded
in Fiscal 2009                  (29,396,286 )   (9,603,458 )             -      (204,119 )   (39,203,863 )

Reserve Balance as of
June 30, 2009                  $  6,089,802    $ 2,537,746    $  5,106,992    $        -    $ 13,734,540

For the Year Ended June 30, 2008



Reserve Category               Chargebacks       Rebates         Returns         Other         Total
Reserve Balance as of
June 30, 2007                  $  4,649,478    $    871,339    $    113,313    $  52,234    $  5,686,364

Actual credits issued
related to sales recorded
in prior fiscal years            (4,556,488 )    (1,741,804 )    (4,909,659 )          -     (11,207,951 )

Reserves or (reversals)
charged during Fiscal 2008
related to sales in prior
fiscal years                              -         870,465       5,892,805      (50,000 )     6,713,270

Reserves charged to net
sales during Fiscal 2008
related to sales recorded
in Fiscal 2008                   26,126,995       7,999,232      12,546,130      473,423      47,145,780

Actual credits issued
related to sales recorded
in Fiscal 2008                  (22,170,578 )    (7,366,918 )             -     (473,550 )   (30,011,046 )

Reserve Balance as of
June 30, 2008                  $  4,049,407    $    632,314    $ 13,642,589    $   2,107    $ 18,326,417

For the Year Ended June 30, 2007



Reserve Category               Chargebacks       Rebates        Returns          Other          Total
Reserve Balance as of
June 30, 2006                  $ 10,137,400    $ 2,183,100    $    416,000    $   275,600    $ 13,012,100

Actual credits issued
related to sales recorded
in prior fiscal years           (10,170,000 )   (1,800,000 )    (5,578,000 )     (250,000 )   (17,798,000 )

Reserves or (reversals)
charged during Fiscal 2007
related to sales in prior
fiscal years                              -       (300,000 )     3,572,313              -       3,272,313

Reserves charged to net
sales during Fiscal 2007
related to sales recorded
in Fiscal 2007                   28,034,000      9,562,000       1,703,000      1,044,800      40,343,800

Actual credits issued
related to sales recorded
in Fiscal 2007                  (23,351,922 )   (8,773,761 )             -     (1,018,166 )   (33,143,849 )

Reserve Balance as of
June 30, 2007                  $  4,649,478    $   871,339    $    113,313    $    52,234    $  5,686,364

Reserve Activity 2009 vs. 2008

The total reserve for chargebacks, rebates, returns and other adjustments decreased from $18,326,417 at June 30, 2008 to $13,734,540 at June 30, 2009. The decrease in the reserve balance was primarily the result of our decision to record during the fourth quarter of Fiscal 2008 a $10,536,000 provision for the expected return of 100% of the shipments of Prenatal Multivitamin. Our expectation that all of the product would be returned was based on our inability to have the product specified as a brand equivalent, and information from our customers regarding their intentions to return the product. Substantially all of these products were returned in Fiscal 2009. Partially offsetting this decrease was an increase primarily due to an increase in sales volume in Fiscal 2009.

The increase in chargeback and rebate reserves between June 30, 2008 and June 30, 2009 was primarily due to an increase in sales volume in 2009, as well as a change in our sales mix. The following tables

compare the year-end reserve balances in fiscal years 2009 and 2008 and the gross sales mix in Fiscal 2009 and Fiscal 2008.

                                     Fiscal Year Ended June 30,
                             2009               %            2008           %
Chargeback reserve   $          6,089,802         44 % $       4,049,407     22 %
Rebate reserve                  2,537,746         19 %           632,314      3 %
Return reserve                  5,106,992         37 %        13,642,589     74 %
Other reserve                           -          0 %             2,107      0 %
                     $         13,734,540        100 % $      18,326,417    100 %

                       Fiscal Year ended June 30,       Fiscal Fourth Quarter
                             2009             2008           2009          2008
Chain drug stores                      37 %       34 %                33 %   35 %
Mail Order                              4 %        4 %                 3 %    4 %
Wholesalers                            59 %       62 %                64 %   61 %

Reserve Activity 2008 vs. 2007

The total reserve for chargebacks, rebates, returns and other adjustments increased from $5,686,364 at June 30, 2007 to $18,326,417 at June 30, 2008. The increase in the reserve balance was primarily the result of our decision to record during the fourth quarter of Fiscal 2008 a $10,536,000 provision for the expected return of 100% of the shipments of Prenatal Multivitamin. Our expectation that all of the product would be returned was based on our inability to have the product specified as a brand equivalent, and information from our customers regarding their intentions to return the product. Also during Fiscal 2008 we increased our estimated returns reserve by approximately $3.0 million, based on an analysis of our historical returns experience, the average lag time between sales and returns and our understanding of the buying patterns and inventory practices of both our direct and indirect customers. This change in estimate incorporated new information that has allowed us to better estimate the average length of time between product sales and returns. As this change resulted from new information that has allowed us to better estimate the average length of time between product sales and returns, we consider it to be a change in estimate as defined in SFAS 154: Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No. 3.

During Fiscal 2008, we also experienced an unanticipated increase in our returns compared to historical experience that required us to record a provision of approximately $3.0 million in fiscal year 2008 for returns related to sales in prior years. We believe, however, that this increase in returns was largely related to certain specific nonrecurring events.

The decline in chargeback and rebate reserves between June 30, 2007 and June 30, 2008 was due in part to a change in our sales mix away from wholesalers and toward the chain drug stores as well as a decrease in inventory levels at wholesaler distribution centers. The following tables compare the year-end reserve balances in Fiscal 2008 and Fiscal 2007 and the sales mix in Fiscal 2008 and Fiscal 2007.

                                     Fiscal Year Ended June 30,
                             2008               %            2007           %
Chargeback reserve   $          4,049,407         22 % $      4,649,478      82 %
Rebate reserve                    632,314          3 %          871,339      15 %
Return reserve                 13,642,589         74 %          113,313       2 %
Other reserve                       2,107          0 %           52,234       1 %
                     $         18,326,417        100 % $      5,686,364     100 %

                       Fiscal Year ended June 30,       Fiscal Fourth Quarter
                             2008             2007           2008          2007
Chain drug stores                      34 %       24 %               35 %    34 %
Mail Order                              4 %        4 %                4 %     4 %
Wholesalers                            62 %       72 %               61 %    62 %

Accounts Receivable - The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customer's current credit worthiness, as determined by a review of current credit information. The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified. While such credit losses have historically been within both the Company's expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same credit loss rates that it has in the past.

The Company also regularly monitors accounts receivable ("AR") balances by reviewing both net and gross day's sales outstanding ("DSO"). Net DSO is calculated by dividing gross accounts receivable less the reserve for rebates, chargebacks, returns and other adjustments by the average daily net sales for the period. Gross DSO shows the result of the same calculation without regard to rebates, chargebacks, returns and other adjustments.

The Company monitors both net DSO and gross DSO as an overall check on collections and to assess the reasonableness of the reserves. Gross DSO provides management with an understanding of the frequency of customer payments, and the ability to process customer payments and deductions. The net DSO calculation provides management with an understanding of the relationship of the AR balance net of the reserve liability compared to net sales after charges to the reserves during the period. Standard payment terms offered to customers are consistent with industry practice at 60 days. Net eliminates the effect of timing of processing, which is inherent in the gross DSO calculation.

The following table shows the results of these calculations for the fiscal years ended June 30, 2009, 2008 and 2007:

Fiscal Year Ended June 30, 2009 2008 2007 Net DSO (in days) 55 65 72 Gross DSO (in days) 53 70 74

The level of both net and gross DSO at June 30, 2009 is slightly lower than the Company's expectation that DSO will be in the 60 to 70 day range based on 60 day payment terms for most customers due to significantly higher average daily sales in the fourth quarter of Fiscal 2009 which were collected by June 30, 2009.

Inventories - The Company values its inventory at the lower of cost (determined by the first-in, first-out method) or market, regularly reviews inventory quantities on hand, and records a provision for excess and obsolete inventory based primarily on estimated forecasts of product demand and production requirements. The Company's estimates of future product demand may prove to be inaccurate, in which case it may have understated or overstated the provision required for excess and obsolete inventory. In the future, if the Company's inventory is determined to be overvalued, the Company would be required to recognize such costs in cost of goods sold at the time of such determination. Likewise, if inventory is determined to be undervalued, the Company may have recognized excess cost of goods sold in previous periods and would be required to recognize such additional operating income at the time of sale.

New Accounting Pronouncements -

In June 2007, the Emerging Issues Task Force ("EITF") reached a final consensus on EITF Issue No. 07-3, "Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities" ("EITF 07-3"). EITF 07-3 was effective for our fiscal year beginning July 1, 2008. EITF 07-3 requires non-refundable advance payments for future research and development activities to be capitalized until the goods have been delivered or related services have been performed. As the guidance in EITF 07-03 is consistent with our existing policy, EITF 07-03 did not have any impact on our financial statements or related disclosures.

In November 2007, the EITF reached a final consensus on EITF Issue No. 07-1, "Accounting for Collaborative Arrangements Related to the Development and Commercialization of Intellectual Property" ("EITF 07-1"). EITF 07-1 will be effective for our fiscal year beginning July 1, 2009 and interim periods within that fiscal year. Adoption is on a retrospective basis to all prior periods presented for all collaborative arrangements existing as of the effective date. We are currently evaluating the impact of adopting EITF 07-1 on our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations" ("FAS 141(R)"). FAS 141(R) significantly changes the accounting for business combinations in a number of areas including the treatment of contingent consideration, contingencies, acquisition costs, in-process research and development and restructuring costs. In addition, under FAS 141(R), changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a business combination after the measurement period will impact income tax expense. In April 2009, FAS 141(R) was amended by FASB Staff Position FAS 141R-1, "Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies," ("FSP FAS 141(R)-1") to address application issues regarding the accounting and disclosure provisions for contingencies. FSP FAS 141(R) amends FAS 141R by replacing the guidance on the initial recognition and measurement of assets and liabilities arising from contingencies acquired or assumed in a business combination. FSP FAS 141(R)-1 also amends FAS 141R's subsequent accounting guidance for contingent assets and liabilities recognized at the acquisition date and amends the disclosure requirements for contingencies. FAS 141(R) and FSP FAS 141(R)-1 apply prospectively to business combinations for which the acquisition date is on or after the beginning of the fiscal year beginning July 1, 2009. Early application is not permitted. The effect of these standards on our consolidated financial statements will depend on the nature and terms of any business combinations that occur after the effective date.

In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements" ("FAS 160"). FAS 160 amends Accounting Research Bulletin No. 51 to establish accounting

and reporting standards for the noncontrolling (minority) interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and establishes a single method of accounting for changes in a parent's ownership interest in a subsidiary that do not result in deconsolidation. FAS 160 is effective for our fiscal year beginning July 1, 2009. We do not expect the adoption of FAS 160 to have a significant impact on our consolidated financial statements.

In April 2008, the FASB issued FASB Staff Position No. FAS 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP FAS 142-3"). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, "Goodwill and Other Intangible Assets". The FSP is intended to improve the consistency between the useful life of a recognized intangible asset under Statement 142 and the period of expected cash flows used to measure the fair value of the asset under FAS 141(R) and other U.S. generally accepted accounting principles. The new standard is effective for our financial statements issued for fiscal years and interim periods beginning July 1, 2009. We do not expect the adoption of FSP FAS 142-3 to have a significant impact on our consolidated financial statements.

In April 2009, the FASB issued FASB Staff Position (FSP) FAS 115-2 and FAS 124-2, "Recognition and Presentation of Other-Than-Temporary Impairments," to make the guidance on other-than-temporary impairments of debt securities more operational and improve the financial statement disclosures related to other-than-temporary impairments for debt and equity securities. The FSP clarifies the interaction of the factors that should be considered when . . .