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LCI > SEC Filings for LCI > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for LANNETT CO INC


9-May-2013

Quarterly Report


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

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, 2012.

This Report on Form 10-Q and certain information incorporated herein by reference contain 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, the regulatory environment, reliance on key strategic alliances, availability of raw materials, fluctuations in operating results and other risks detailed from time to time in the Company's filings with the Securities and Exchange Commission. 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.

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:

Revenue Recognition - The Company recognizes revenue when its products are shipped. At this point, title and risk of loss have transferred to the customer and provisions for estimates, including rebates, promotional adjustments, price adjustments, returns, chargebacks, and other potential adjustments are reasonably determinable. Accruals for these provisions are presented in the consolidated financial statements as rebates, chargebacks and returns payable and reductions to net sales. The change in the reserves for various sales adjustments may not be proportionally equal to the change in sales because of changes in both the product and the customer mix. Increased sales to wholesalers will generally require additional accruals as they are the primary recipient of chargebacks and rebates. Incentives offered to secure sales vary from product to product. Provisions for estimated rebates and promotional credits are estimated based upon contractual terms. Provisions for other customer credits, such as price adjustments, returns, and chargebacks, require management to make subjective judgments on customer mix. Unlike branded innovator drug companies, Lannett does not use information about product levels in distribution channels from third-party sources, such as IMS and Wolters Kluwer, in estimating future returns and other credits. Lannett calculates a chargeback/rebate rate based on contractual terms with its customers and applies this rate to customer sales.

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. If the price paid by indirect customers is lower than the price paid by the wholesaler, Lannett will provide credit, called a chargeback, to the wholesaler for the difference between the contractual price paid by the indirect customers and the wholesaler purchase price. 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 to the large wholesale customers, such as Cardinal Health, AmerisourceBergen, and McKesson increase (decrease), the reserve for chargebacks will also generally increase (decrease). However, the size of the increase (decrease) depends on the product mix and the amount of those sales that end up at indirect customers with which the Company has specific chargeback agreements. The Company continually monitors the reserve for chargebacks and makes adjustments when management believes that expected chargebacks on actual sales may differ from actual chargeback reserves.


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Rebates - Rebates are offered to the Company's key chain drug store, distributor 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. As a result of the Patient Protection and Affordable Care Act ("PPACA") enacted in the U.S. in March 2010, the Company participates in a new cost-sharing program for certain Medicare Part D beneficiaries designed primarily for the sale of brand drugs and certain generic drugs if their FDA approval was granted under a New Drug Application ("NDA") or 505(b) NDA versus an Abbreviated New Drug Application ("ANDA"). Because our drugs used for the treatment of thyroid deficiency and our Morphine Sulfate Oral Solution product were approved by the FDA as a 505(b)(2) NDA, they are considered "branded" drugs for purposes of the PPACA. Drugs purchased under this program during Medicare Part D coverage gap (commonly referred to as the "donut hole") result in additional rebates. 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 (decreases) as sales to certain wholesale and retail customers increase (decrease). However, since these rebate programs are not identical for all customers, the size of the reserve will depend on the mix of customers that are eligible to receive rebates.

Returns - Consistent with industry practice, the Company has a product returns policy that allows customers to return product within a specified period 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, changes to business practices, and credit terms. While such experience has allowed for reasonable estimations in the past, history may not always be an accurate indicator of future returns. The Company continually monitors the provisions for returns and makes adjustments when management believes that actual product returns may differ from established reserves. Generally, the reserve for returns increases (decreases) as net sales increase (decrease). The reserve for returns is included in the rebates, chargebacks and returns payable account on the balance sheet.

Other Adjustments - Other adjustments consist primarily of price adjustments, also known as "shelf-stock adjustments," which are credits issued to reflect decreases in the selling prices of the Company's products that customers have remaining in their inventories at the time of the price reduction. Decreases in selling prices are discretionary decisions made by management to reflect competitive market conditions. Amounts recorded for estimated shelf stock adjustments are based upon specified terms with direct customers, estimated declines in market prices, and estimates of inventory held by customers. The Company regularly monitors these and other factors and evaluates the reserve as additional information becomes available. Other adjustments are included in the rebates, chargebacks and returns payable account on the balance sheet.

Reserve Activity March 31, 2013 vs. March 31, 2012

The following tables identify the reserve for each major category of revenue allowance and a summary of the activity for the nine months ended March 31, 2013 and 2012. 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 nine months ended March 31, 2013

(In thousands)
Reserve Category                  Chargebacks      Rebates      Returns       Other        Total
Reserve Balance as of July 1,
2012                             $       7,063    $   4,436    $   5,540    $        -    $ 17,039

Actual credit issued related
to sales recorded in prior
fiscal years                            (6,586 )     (4,434 )     (2,521 )         (66 )   (13,607 )

Reserve or (reversal) charged
during Fiscal 2013 related to
sales in prior fiscal years               (463 )        139            -            66        (258 )

Reserve charged to net sales
during Fiscal 2013 related to
sales recorded in Fiscal 2013           52,006       17,467        3,363         2,801      75,637

Actual credit issued related
to sales recorded in Fiscal
2013                                   (45,542 )    (13,918 )          -        (2,801 )   (62,261 )

Reserve Balance as of
March 31, 2013                   $       6,478    $   3,690    $   6,382    $        -    $ 16,550


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For the nine months ended March 31, 2012

(In thousands)
Reserve Category                  Chargebacks      Rebates      Returns       Other        Total
Reserve Balance as of July 1,
2011                             $       5,497    $   2,925    $   5,142    $        -    $ 13,564

Actual credit issued related
to sales recorded in prior
fiscal years                            (5,350 )     (3,084 )     (3,426 )        (152 )   (12,012 )

Reserve or (reversal) charged
during Fiscal 2012 related to
sales in prior fiscal years                (54 )        158            -           152         256

Reserve charged to net sales
during Fiscal 2012 related to
sales recorded in Fiscal 2012           50,392       15,405        3,567           488      69,852

Actual credit issued related
to sales recorded in Fiscal
2012                                   (44,092 )    (11,686 )          -          (488 )   (56,266 )

Reserve Balance as of
March 31, 2012                   $       6,393    $   3,718    $   5,283    $        -    $ 15,394

The total reserve for chargebacks, rebates, returns and other adjustments decreased from $17,039 at June 30, 2012 to $16,550 at March 31, 2013. The decrease in the chargeback reserve is due primarily to a decrease in inventory levels at wholesale distribution centers as a result of increased gross sales to indirect customers during the nine months of Fiscal 2013 as compared to Fiscal 2012. The decrease in the rebate reserve is due to the timing of rebates processed during the nine months of Fiscal 2013 as compared to Fiscal 2012. The increase in the return reserve is primarily related to the increase in gross sales during Fiscal 2013. The activity in the "Other" category for the period ended March 31, 2013 includes shelf-stock, shipping and other sales adjustments.

Inventories - The Company values its inventory at the lower of cost (determined by the first-in, first-out method) or market, regularly reviews inventory quantities on hand, and records a provision for excess and obsolete inventory based primarily on remaining product shelf-life and estimated forecasts of product demand. The Company's estimates of future product demand may prove to be inaccurate, in which case it may have understated or overstated the provision required for excess and obsolete inventory.

Income Taxes - The Company accounts for income taxes in accordance with FASB ASC
740. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by presently enacted tax rates which will be in effect when these differences reverse. Deferred tax expense/(benefit) is the result of changes in deferred tax assets and liabilities. The Company may recognize the tax benefit from an uncertain tax position claimed on a tax return only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The authoritative standards issued by the FASB also provide guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. The factors used to assess the likelihood of realization of its net deferred tax assets are the Company's forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. Failure to achieve forecasted taxable income in applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company's effective tax rate on future earnings.

Intangible Assets - Indefinite-lived and definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.

Indefinite-lived intangible assets are considered impaired if the carrying value of the asset is greater than fair value. The fair value is determined by using a discounted cash flow analysis. Definite-lived intangible assets are considered impaired if the carrying value of the asset is greater than the undiscounted cash flows related to the assets. Our cash flow models are highly reliant on various assumptions which are considered level 3 inputs, including estimates of future cash flow (including long-term growth rates), discount rates, and expectations about the amount and timing of cash flows and the probability of achieving the estimated cash flows. As of March 31, 2013 and June 30, 2012, the Company had one indefinite-lived intangible asset in the amount of $149,000. No events or changes in circumstances were identified during the three and nine months ended March 31, 2013 or the fiscal year ended June 30, 2012 that would indicate a need to perform impairment analyses for indefinite or definite-lived intangible assets. As such, no impairment charges were required.


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Definite-lived intangible assets are amortized over the estimated useful lives, generally for periods ranging from 10 to 15 years. The Company continually evaluates the reasonableness of the useful lives of these assets. For the three months ended March 31, 2013, and 2012, the Company incurred amortization expense of $471,000 and $471,000, respectively. For the nine months ended March 31, 2013, and 2012, the Company incurred amortization expense of $1,412,000 and $1,409,000, respectively.

Share-based Compensation - Share-based compensation costs are recognized over the vesting period based on the fair value of the instrument on the date of grant less an estimate for forfeitures. The Company uses the Black-Scholes option-pricing model to determine the fair value of stock options and the share price on the grant date to value restricted stock. The fair value model includes various assumptions, including the expected volatility, expected life of the awards, and risk-free interest rates. These assumptions involve inherent uncertainties based on market conditions which are generally outside the Company's control. Changes in these assumptions could have a material impact on share-based compensation costs recognized in the financial statements. Refer to Note 17 of our Consolidated Financial Statements for a detailed description of our Black-Scholes weighted average assumptions for the nine months ended March 31, 2013 and 2012.

Results of Operations - Three months ended March 31, 2013 compared with three months ended March 31, 2012

Net sales for the three months ended March 31, 2013 ("Fiscal 2013") increased 27% to $39,022,000 from $30,688,000 for the three months ended March 31, 2012 ("Fiscal 2012"). The following factors contributed to the $8,334,000 increase in sales:

                     Sales volume    Sales price
Medical Indication     change %       change %
Antibiotic                     59 %           51 %
Cardiovascular                 24 %           (9 )%
Gallstone                      (6 )%           4 %
Glaucoma                       14 %           50 %
Gout                         1515 %            1 %
Migraine Headache             (19 )%           9 %
Obesity                         1 %            8 %
Pain Management                (1 )%          24 %
Thyroid Deficiency             15 %           (3 )%

Sales of drugs in the antibiotic medical indication increased by $1,834,000 primarily as a result of both volume and price increases on selected key products within the medical indication. Sales of drugs used for the treatment of thyroid deficiency increased by $1,481,000 primarily as a result of increased volumes. Sales of drugs used for cardiovascular treatment increased by $938,000, driven by increased volumes partially offset by price decreases related to additional rebates on certain products within the medical indication. Sales of products used for pain management increased by $937,000 primarily as a result of a price increase on the Company's C-Topical Solution product partially offset by lower volumes of Oxycodone HCL Oral Solution while the Company awaits FDA approval for this product. Sales of drugs used for the treatment of glaucoma increased by $634,000 mainly due to price increases on key products within this medical indication. Increased sales of drugs used for gout treatment resulting from additional volume also contributed an additional $1,666,000 to the overall increase in sales.

The Company sells its products to customers in various categories. The table below presents the Company's net sales to each category for the three months ended March 31:

Customer Category
(In thousands)             2013       2012

Wholesaler/Distributor   $ 21,592   $ 16,709

Retail Chain               12,810     11,243

Mail-Order Pharmacy         4,620      2,736

Total                    $ 39,022   $ 30,688

The sales to wholesaler/distributor increased primarily as a result of increased net sales in a variety of products including the pain management and gout medical indications as discussed above. Retail chain sales increased primarily as a result of increased sales for the treatment of thyroid deficiency medical indications as discussed above. Mail-order pharmacy sales increased primarily as a result of increased sales of products in the cardiovascular and thyroid deficiency medical indications as discussed above.


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Cost of sales, including amortization and product royalty expense, for the third quarter increased 20% to $23,852,000 in Fiscal 2013 from $19,797,000 in Fiscal 2012. The increase primarily reflected the impact of the 27% increase in sales, partially offset by changes in the mix of products sold.

Amortization expense included in the cost of sales change above primarily relates to the JSP Distribution Agreement. For the remaining term of the JSP Distribution Agreement, the Company will incur annual amortization expense of approximately $1,785,000.

Gross profit margins for the third quarter of Fiscal 2013 and Fiscal 2012 were 39% and 35%, respectively. Gross profit percentage increased primarily due to a change in the mix of products sold as discussed above. While the Company is continuously striving to keep product costs low, there can be no guarantee that profit margins will stay consistent in future periods. Pricing pressure from competitors and costs of producing or purchasing new drugs may also fluctuate in future periods. Changes in the future sales product mix may also occur.

Research and development ("R&D") expenses in the third quarter increased 80% to $5,229,000 for Fiscal 2013 from $2,911,000 for Fiscal 2012. The increase is primarily due to increased costs related to biostudies as a result of the timing of milestone achievements and third party laboratory service costs for products in development. Additional compensation related costs incurred during Fiscal 2013 as compared to Fiscal 2012 also contributed to the increase. The Company expenses all production costs as R&D until the drug is approved by the FDA. R&D expenses may fluctuate from period to period, based on R&D plans for submission to the FDA.

Selling, general and administrative ("SG&A") expenses in the third quarter decreased 7% to $5,245,000 in Fiscal 2013 from $5,616,000 in Fiscal 2012. The decrease is primarily due to decreases in legal and outsourced sales and marketing expenses, partially offset by increased compensation related costs incurred in Fiscal 2013, as compared to Fiscal 2012. While the Company is focused on controlling costs, increases in personnel costs may have an ongoing and longer lasting impact on the administrative cost structure as the Company continues to grow and expand. Other costs are being incurred to facilitate improvements in the Company's infrastructure. These costs are expected to be temporary investments in the future of the Company and may not continue at the same level.

Interest expense totaled $59,000 in the third quarter of Fiscal 2013 compared to $64,000 in Fiscal 2012. Interest and dividend income totaling $22,000 was down slightly compared to $28,000 in the third quarter of Fiscal 2012. The Company also recorded a gain on investment securities, during the third quarter of Fiscal 2013, totaling $538,000, of which $185,000 was unrealized and $353,000 was realized. In comparison, during the third quarter of Fiscal 2012, the Company recorded a gain on investment securities totaling $466,000, of which $105,000 was unrealized and $361,000 was realized.

The Company recorded income tax expense in the third quarter of Fiscal 2013 of $1,327,000 compared to income tax expense of $1,057,000 in the third quarter of Fiscal 2012. The effective tax rate for the three months ended March 31, 2013 was 25%, compared to 38% for the three months ended March 31, 2012. The effective tax rate for the three months ended March 31, 2013 was lower compared to the three months ended March 31, 2012 due primarily to an increase in benefits related to research and experimentation credits in Fiscal 2013, as compared to Fiscal 2012, as a result of a tax law extension passed in early 2013, with a retroactive January 1, 2012 effective date. An increase in disqualifying dispositions of incentive stock options in Fiscal 2013, as compared to Fiscal 2012, provided additional benefits. The overall decrease was partially offset by the effects of a Pennsylvania tax law change which lowered the Company's apportionment factor within the state. The impact of this change caused the Company to reduce its deferred tax assets by $232, and therefore increased the effective tax rate by 1.5% for the three months ended March 31, 2013. The Company expects its overall effective tax rate will be approximately 35% to 37% for the full year ended June 30, 2013.

The Company reported a net income attributable to Lannett of $3,947,000 in the third quarter of Fiscal 2013, or $0.14 basic and diluted earnings per share, as compared to net income attributable to Lannett of $1,718,000 in the third quarter Fiscal 2012, or $0.06 basic and diluted earnings per share.


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Results of Operations - Nine months ended March 31, 2013 compared with nine months ended March 31, 2012

Net sales for the nine months ended March 31, 2013 ("Fiscal 2013") increased 27% to $110,880,000 from $87,300,000 for the nine months ended March 31, 2012 ("Fiscal 2012"). The following factors contributed to the $23,580,000 increase in sales:

                     Sales volume    Sales price
Medical Indication     change %       change %
Antibiotic                     22 %            9 %
Cardiovascular                 93 %           (7 )%
Gallstone                       5 %            4 %
Glaucoma                        5 %           44 %
Gout                          499 %            4 %
Migraine Headache             (19 )%           6 %
Obesity                        51 %          (15 )%
Pain Management               (27 )%          28 %
Thyroid Deficiency             11 %            3 %

Sales of drugs for cardiovascular treatment increased by $9,844,000 primarily due to increased volumes related to a product used for the treatment of hypertension which commenced shipping at the end of December 2011. Sales of drugs used for the treatment of thyroid deficiency increased by $5,347,000, primarily as a result of both volume and price increases on key products within this medical indication. Sales of drugs used for the treatment of glaucoma increased by $1,515,000 mainly due to price increases on key products within the medical indication. Sales of drugs in the antibiotic medical indication increased by $1,469,000 primarily as a result of both volume and price increases on selected key products within the medical indication. Increased sales of drugs used for gout treatment resulting from additional volume also contributed an additional $2,425,000 to the overall increase in sales. Products used in the management of obesity increased by $918,000, which was largely due to increased volumes related to products launched in October 2011 and April 2012. Sales related to pain management products were relatively flat in the first nine months of Fiscal 2013 compared to Fiscal 2012. Additional pain management sales as a result of a price increase on the Company's C-Topical Solution product were offset by lower volumes shipped of Morphine Sulfate Oral Solution and Oxycodone . . .

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