U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB/A
AMMENDMENT #2
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________TO
Commission File No. 0-9036
LANNETT COMPANY, INC.
(Name of small business issuer in its charter)
STATE OF DELAWARE 23-0787-699
State of Incorporation I.R.S. Employer I.D. No.
9000 STATE ROAD
PHILADELPHIA, PENNSYLVANIA 19136
(215) 333-9000
(Address of principal executive offices and telephone number)
Securities registered under Section 12(b) of the Exchange Act:
NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, $.001 PAR VALUE
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 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[ ]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.
Yes[ ] No [X]
The issuer had net sales of $42,486,758 for the fiscal year ended June 30,
2003.
As of August 26, 2003, the aggregate market value of the voting stock held
by non-affiliates was approximately $106,812,000 computed by reference to the
closing price of the stock on the American Stock Exchange.
As of August 26, 2003, there were 20,045,390 shares of the issuer's common
stock, $.001 par value, outstanding.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Lannett Company, Inc. (the "Company") was incorporated in 1942 under the
laws of the Commonwealth of Pennsylvania. In 1991, the Company merged into
Lannett Company, Inc., a Delaware corporation. The sole purpose of the merger
was to reincorporate the Company as a Delaware corporation. The Company
develops, manufactures, packages, markets and distributes pharmaceutical
products sold under generic chemical names. References herein to a fiscal year
refer to the Company's fiscal year ending June 30.
Historically, the Company has competed for an increasing share of the
generic market. During each of the fiscal years ended June 30, 2003 and 2002,
the Company surpassed its historical highs in terms of net sales, gross profit,
operating income, net income and total market capitalization value. This growth
is a result of additions to the Company's line of generic products, new
customers, higher unit sales, increased product prices and a management focus on
minimizing unnecessary overhead and administrative costs. Some of the new
generic products sold by Lannett during Fiscal 2003 and Fiscal 2002 were
developed and are manufactured by Lannett while others are manufactured by
Jerome Stevens Pharmaceutical, Inc. ("JSP"), one of Lannett's primary suppliers.
The products manufactured by Lannett and those manufactured by JSP are
identified in the section entitled "PRODUCTS" in Item 1 of this Form 10-KSB.
Over the past several years, Lannett has consistently invested a portion
of its profits into research and development ("R&D") projects, including new
generic product offerings. The cost of these R&D efforts are expensed during the
periods incurred. However, the Company believes that such investments may be
paid back in future years as it submits applications to the Food and Drug
Administration ("FDA"), if it receives marketing approval from the FDA to
distribute such products. In addition to profits earned on new products
internally developed and manufactured, the Company sells products that are
manufactured by JSP. The products are sold with the Lannett label and logo and
to the same customers and the same distribution channels as the products
internally manufactured. The Company has made no previous investments in R&D for
these products because such investments were paid by JSP, the owner of the
FDA-approved licenses. In addition to using cash generated from its operations,
the Company has entered into a number of financing agreements with third parties
to provide for additional cash when it is needed. These financing agreements are
more fully described in the section entitled "LIQUIDITY AND CAPITAL RESOURCES"
in Item 6 of this Form 10-KSB. The Company has embarked on an industrious plan
to grow in future years. In addition to organic growth to be achieved through
its own R&D effects, the Company has also initiated marketing projects with
other companies in order to expand future revenue projections. The Company,
however, expects that its growing list of generic drugs under development will
drive future growth. The Company also intends to use the infrastructure it has
created, and to continually reinvest a portion of its profits into additional
R&D projects. The following strategies highlight Lannett's plan:
RESEARCH AND DEVELOPMENT
There are numerous stages in the generic drug development process:
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1.) Formulation and Analytical Method Development: Once a drug candidate
is selected for research, product development scientists perform
various experiments on the active ingredient. These experiments
include the creation of a number of product recipes to determine
which recipe will be most suitable for the Company's subsequent
development process. Various recipes, or formulations, are tested in
the laboratory to measure results against the innovator drug. During
this time, the Company may use reverse engineering methods on
samples of the innovator drug to determine the type and quantity of
inactive ingredients in the brand named drug. During the formulation
phase, the Company's research and development chemists begin to
develop an analytical, laboratory testing method. The successful
development of this test method will allow the Company to test
developmental and commercial batches of the product in the future.
All of the information used in the final formulation, including the
analytical test methods adopted for the generic drug candidate, will
be included as part of the documentation submitted to the FDA in the
generic drug application.
2.) Scale-up: After the product developments scientists and the R&D
chemists agree on a final formulation to use in moving the drug
candidate forward in the developmental process, the company will
attempt to increase the batch size of the product. The batch size
represents the standard magnitude to be used in manufacturing a
batch of the product. The determination of batch size will affect
the amount of raw material that is input into the manufacturing
process, and the number of expected tablets or capsules to be
created during the production sequence. The Company attempts to
determine batch size based on the amount of active ingredient in
each dosage, the available production equipment and unit sales
projections. The scaled-up batch is then generally produced in the
Company's commercial manufacturing facilities. During this
manufacturing process, the Company will document the equipment used,
the amount of time in each major processing step and any other steps
needed to consistently produce a batch of that product. This
information, generally referred to as the validated manufacturing
process, will be included in the Company's generic drug application
submitted to the FDA.
3.) Clinical testing: After a successful scale-up of the generic drug
batch, the Company then schedules and performs clinical testing
procedures on the product. These procedures, which are generally
outsourced to third parties, include testing the absorption of the
generic product in the human bloodstream, compared to the absorption
of the innovator drug. The results of this testing are then
documented and reported to the generic company to determine the
"success" of the generic drug product. Success, in this context,
means the successful comparison of the generic company's product
related to the innovator product. Since bioequivalence and a stable
formula are the primary requirements for a generic drug approval
(assuming the manufacturing plant is in compliance with the FDA's
manufacturing quality standards), lengthy and costly clinical trials
proving safety and efficacy, which are generally required by the FDA
for innovator drug approvals, are unnecessary for generic companies.
If the results are successful, the Company will continue the
collection of documentation and information for assembly of the drug
application.
4.) Submission of the ANDA for FDA review and approval: The Abbreviated
New Drug Application (ANDA) process became formalized under The Drug
Price Competition and Patent Term Restoration Act of 1984, also
known as the Hatch-Waxman Act. An ANDA represents a generic drug
company's application to the FDA to manufacture and/or distribute a
drug, which is the generic equivalent to an already-approved brand
named ("innovator") drug. Once bioequivalence studies are complete,
the generic drug company submits an ANDA to the FDA for marketing
approval.
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In a presentation to the Generic Pharmaceutical Association on March 2,
2004, Gary J. Buehler, R.Ph., and Director of the FDA's Office of Generic Drugs,
said that the median approval time for a new ANDA for the FDA's Fiscal 2003 year
was 17.3 months. When including the amount of time necessary to develop the
generic drug, and prepare the ANDA submission, the Company estimates that the
total development and approval time of a generic drug may take three years or
more. Additionally, there is no guarantee that the FDA will approve a company's
ANDA.
When a generic drug company files an ANDA to the FDA, it must certify that
no patents are listed in the Orange Book, the FDA's reference listing of
approved drugs, or listed patents have expired. If there are patents covering
some aspect of the innovator drug, the applicant must state whether it is
seeking approval for marketing after the expiration of the Orange Book patents;
or the patents listed therein are invalid, unenforceable, or not infringed --
usually referred to as a Paragraph IV Certification. ANDA's containing Paragraph
IV certifications frequently result in legal actions by the innovator drug
companies. These legal activities may delay the approval of the generic
company's ANDA. Currently, Lannett has not filed any Paragraph IV certifications
in its ANDAs because the ANDAs submitted did not contend with any patents for
the applicable innovator drugs.
Lannett conducts R&D activities in carefully targeted areas where its
qualified research personnel have accumulated a related body of expertise. Such
targeted areas include solid oral dosage forms. During Fiscal 2003 and 2002, the
Company has hired additional experienced personnel in product development,
production, formulation and the R&D laboratory. Lannett believes that its
ability to select appropriate products for development, develop such products on
a timely basis, obtain FDA approval, and achieve economies in production will be
critical for its success in the generic industry. Generally, Lannett believes in
avoiding the well-known billion dollar drugs. The strategy involves a
combination of decisions focusing on long-term profitability and a secure market
position with fewer challenges from competitors. In addition to its market
strategy, the Company pursues long-term alliances with API (active
pharmaceutical ingredient) suppliers, whereby the Company attempts to arrange to
have an API made for it on an exclusive basis. This practice has the effect of
limiting competition without violating any federal antitrust laws. Other API
manufacturers may produce the chemical ingredient for other generic competitors,
but the Company believes that entering into exclusive arrangements when possible
will prevent a specific API manufacturer from soliciting additional customers
for their API, thereby reducing the number of generic competitors for the
finished dosage product. At this time, Lannett has no exclusive agreements for
APIs for its current commercial products. Lannett does have exclusive agreements
for APIs for two of its developmental products, which the Company does not
believe to be material in nature.
Competition in generic pharmaceutical manufacturing will continue to grow
as more pharmaceutical products lose patent protection. However, the Company
believes with strong technical know-how, low overhead expenses, and efficient
product development, manufacturing and marketing, it can remain competitive. It
is the intention of the Company to reinvest as much capital as possible to
develop new products since the success of any generic pharmaceutical
manufacturer depends on its ability to continually introduce new generic
products to the market. Over time, if a generic drug market for a specific
product remains stable and consumer demand remains consistent, there is
likelihood that additional generic manufacturing companies will pursue a generic
product market by developing the generic drug, submitting an ANDA, and
potentially receiving marketing approval from the FDA. If this occurs, the
generic competition for
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the drug increases, and a company's market share may drop. In addition to
reduced unit sales, the unit selling price may also drop due to the product's
availability from additional suppliers. This may have the effect of reducing a
generic company's future net sales of the product. Due to these factors that may
potentially affect a generic company's future results of operations, the ability
to properly assess the competitive effect of new products, including market
share, the number of competitors and the generic unit price erosion, is critical
to a generic company's R&D plan. A generic company may be able to reduce the
potential exposure to competitive influences that negatively affect its sales
and profits by having several drug candidates in its R&D pipeline queue. As
such, a generic company may be able to avoid becoming materially dependent on
the sales of one drug. The Company has invested approximately $2.6 million and
$1.7 million, respectively, in Fiscal 2003 and Fiscal 2002, or 12% and 14%,
respectively, of its Fiscal 2003 and Fiscal 2002 pre-tax income, exclusive of
R&D expenses, in R&D resources related to several R&D projects. These costs are
expensed in the period incurred. During Fiscal 2003 and Fiscal 2002, no
individual R&D project incurred costs in excess of materially significant
amounts. Additionally, no individual R&D product candidate is expected to be
materially significant to the Company's results of operations. For more
information regarding Lannett's R&D projects, please see the section entitled
`PRODUCTS' of Item 1 in this Form 10-KSB.
Unlike the branded, drug-discovery companies, Lannett currently does not
own proprietary drug patents. However, the typical intellectual property in the
generic drug industry are the ANDAs that generic drug companies own.
VALIDATED PHARMACEUTICAL CAPABILITIES
Lannett's quality manufacturing facility consists of 31,000 square feet on
3.5 acres owned by the Company. In July 2003, the Company signed a lease
purchase agreement for a 63,000 square feet building located at 9001 Torresdale
Avenue, Philadelphia, Pennsylvania. The renovation of the building has been
initiated; and the Company expects to begin to move some of its staff and
operations into that building in Fiscal 2004. Lannett currently leases another
24,000 square feet approximately 2 miles from the Company's headquarters (9000
State Road). This leased facility serves as the Company's main warehousing
operation, and also houses certain R&D personnel. This facility's lease expires
in April 2004, at around which time the Company plans to move its operations to
the Torresdale Avenue building. The Company intends to renew its lease on a
short-term basis on the rented property after April 2004.
Many FDA regulations relating to cGMP (current Good Manufacturing
Practices) have been adopted by the Company in the last several years. In
designing its laboratory, full attention was given to material flow, equipment
and automation, quality control and inspection. A granulator, an automatic film
coating machine, high-speed tablet presses, blenders, encapsulators, fluid bed
dryers, high shear mixers and high-speed bottle filling are a few examples of
the sophisticated product development, manufacturing and packaging equipment the
Company uses. In addition, the Company's Quality Control laboratory facilities
are equipped with high precision instruments, like automated high-pressure
liquid chromatographs, gas chromatographs and laser particle sizers.
Lannett continues to pursue its comprehensive plan for improving and
maintaining adequate quality control and quality assurance programs for its
pharmaceutical development and manufacturing facilities. The FDA periodically
inspects the Company's production facilities to determine the Company's
compliance with the FDA's manufacturing standards. Typically, after the FDA
completes its inspection, it will issue the Company a report, entitled a Form
483,
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containing the FDA's observations of possible violations of cGMP. Such
observations may be minor or severe in nature. The degree of severity of the
observation is generally determined by the time necessary to remediate the cGMP
violation, and not have a serious impact upon the consumer of the Company's drug
products, and whether the observation is subject to a Warning Letter from the
FDA and/or attempts by the FDA to shutdown a manufacturing plant. By strictly
enforcing the various FDA guidelines, namely Good Laboratory Practices, Standard
Operating Procedures and current Good Manufacturing Practices, the Company has
successfully reduced the number of observations in its latest FDA inspection.
The Company believes that such observations are minor in nature, and will be
remediated in a timely fashion with no material effect on Lannett's results of
operations.
SALES AND CUSTOMER RELATIONSHIPS
The Company sells its pharmaceutical products to generic pharmaceutical
distributors, drug wholesalers, chain drug retailers, prime vendors, private
label distributors, mail-order pharmacies, other pharmaceutical manufacturers,
managed care, hospital buying groups and health maintenance organizations. It
promotes its products through direct sales, the Internet, trade shows, trade
publications, and bids. The Company also licenses the marketing of its products
to other manufacturers and/or marketers in private label agreements.
In Fiscal 2003 and 2002, the Company's record sales levels can be
attributed to growth in most market segments. The Company continued to expand
its sales to the major chain drug stores, including CVS, Eckerd, Rite Aid and
Walgreen's. The mail order segment continued to be one of the fastest growing
classes of the Company's distribution efforts. Such companies, as Medco Health,
Express Scripts, Caremark and AdvancePCS were leaders in the Company's sales
growth. Lannett also increased its sales in the wholesaler segment led by
AmerisourceBergen, Cardinal Health and McKesson Corporation. Lannett is
recognized by its customers as a dependable supplier of high quality generic
pharmaceuticals. The Company's policy of maintaining an adequate inventory and
fulfilling orders in a timely manner has contributed to this reputation. The
Company believes that retail-level consumer demand dictates the total volume of
sales for various products. In the event that the Company's wholesale and retail
customers adjust their purchasing volumes, the Company believes that consumer
demand will be fulfilled by other wholesale or retail sources of supply. As
such, Lannett attempts to obtain strong relationships with most of the major
retail chains, wholesale distributors and mail-order wholesalers in order to
facilitate the supply of the Company's products through whatever channel the
consumer prefers. Although the Company has agreements with several customers
governing the transaction terms of its sales, there are no agreements with
customers which would require them to purchase any of the Company's products in
the future.
MANAGEMENT
As the Company continues to grow, additional managers will be hired to
complement the Company's skilled team. These new managers will serve in a
variety of functions, including Research, Sales, Finance, Quality Control,
Quality Assurance, Regulatory Compliance and Production. Ultimately, the
execution of a sound business strategy requires a capable and knowledgeable
management team.
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PRODUCTS
As of the date of this filing, the Company manufactured and/or distributed
twenty-three products:
NAME OF PRODUCT MANUFACTURE SOURCE MEDICAL INDICATION EQUIVALENT BRAND
1.) Butalbital, Aspirin and
Caffeine Capsules Lannett Migraine Headache Fiorinal(R)
2.) Butalbital, Aspirin, Caffeine
with Codeine Capsules JSP Migraine Headache Fiorinal(R)
w/ Codeine
3.) Digoxin 0.125 mg Tablets JSP Heart Failure Lanoxin(R)
4.) Digoxin 0.25 mg Tablets JSP Heart Failure Lanoxin(R)
5.) Primidone 50 mg Tablets Lannett Epilepsy Mysoline(R)
6.) Primidone 250 mg Tablets Lannett Epilepsy Mysoline(R)
7.) Dicyclomine 10 mg Capsules Lannett Irritable Bowels Bentyl(R)
8.) Dicyclomine 20 mg Tablets Lannett Irritable Bowels Bentyl(R)
9.) Acetazolamide 250 mg Tablets Lannett Glaucoma Diamox(R)
10.) Prednisolone 5 mg Tablets Lannett Corticosteroid Not applicable
11.) Diphenoxylate with Atropine
Sulfate Tablets Lannett Diarrhea Lomotil(R)
12.) Isoniazid 300 mg Tablets Lannett Tuberculosis Not applicable
13.) Levothyroxine Sodium 0.025 mg Tablets JSP Thyroid Deficiency Unithroid(R)
14.) Levothyroxine Sodium 0.050 mg Tablets JSP Thyroid Deficiency Unithroid(R)
15.) Levothyroxine Sodium 0.075 mg Tablets JSP Thyroid Deficiency Unithroid(R)
16.) Levothyroxine Sodium 0.088 mg Tablets JSP Thyroid Deficiency Unithroid(R)
17.) Levothyroxine Sodium 0.100 mg Tablets JSP Thyroid Deficiency Unithroid(R)
18.) Levothyroxine Sodium 0.112 mg Tablets JSP Thyroid Deficiency Unithroid(R)
19.) Levothyroxine Sodium 0.125 mg Tablets JSP Thyroid Deficiency Unithroid(R)
20.) Levothyroxine Sodium 0.150 mg Tablets JSP Thyroid Deficiency Unithroid(R)
21.) Levothyroxine Sodium 0.175 mg Tablets JSP Thyroid Deficiency Unithroid(R)
22.) Levothyroxine Sodium 0.200 mg Tablets JSP Thyroid Deficiency Unithroid(R)
23.) Levothyroxine Sodium 0.300 mg Tablets JSP Thyroid Deficiency Unithroid(R)
All of the products currently manufactured and/or sold by the Company are
ethical, or prescription products. Of the products listed above, those
containing butalbital, digoxin, primidone and levothyroxine sodium were the
Company's key products, contributing to more than 95% of the Company's total net
sales in Fiscal 2003.
The Company has two products containing butalbital. One of the products,
Butalbital with Aspirin and Caffeine capsules has been manufactured and sold by
Lannett for more than five years. The other butalbital product, Butalbital with
Aspirin, Caffeine and Codeine Phosphate capsules is manufactured by JSP. Lannett
began buying this product from JSP and selling it to its customers in December
2001. Both products, which are in orally-administered capsule dosage forms, are
prescribed to treat tension headaches caused by contractions of the muscles in
the neck and shoulder area and migraine. The drug is prescribed primarily for
adults of various backgrounds. Migraine headache is an increasingly prevalent
condition in the United States. As such conditions continue to grow, the demand
for effective medical treatments will continue to grow. Common side effects of
drugs which contain butalbital include dizziness and drowsiness. The Company
notes that although new innovator drugs to treat migraine headache have been
introduced by brand name drug companies, there is still a loyal following of
doctors and consumers who prefer to use butalbital products for treatment. As
the brand name companies continue to promote products containing butalbital,
like Fiorinal(R), the Company expects to continue to produce and sell its
generic butalbital products.
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The Company has two products containing digoxin. These products are
manufactured by JSP. Lannett began buying this product from JSP, and selling it
to its customers in September 2002. Digoxin tablets are used to treat congestive
heart failure in patients of various ages and demographic backgrounds. The
beneficial effects of digoxin result from direct actions on cardiac muscle, as
well as indirect actions on the cardiovascular system mediated by effects on the
autonomic nervous system. Side effects of digoxin may include apathy, blurred
vision, change in heartbeat, confusion, dizziness, headache, loss of appetite,
nausea, vomiting and weakness.
The Company has two products containing primidone. These products were
developed and manufactured by Lannett. Lannett has been manufacturing and
selling primidone 250 milligram tablets for more than five years. Lannett began
selling primidone 50 milligram tablets in June 2001. Both products, which are in
orally-administered tablet dosage forms, are prescribed to treat convulsion and
seizures in epileptic patients of all ages and backgrounds. Common side effects
of primidone include lack of muscle coordination, vertigo and severe dizziness.
The Company has eleven products containing levothyroxine sodium. The
levothyroxine sodium products are manufactured by JSP. Lannett began buying this
product from JSP, and selling it to its customers in April 2003. Levothyroxine
Sodium Tablets are used to treat hypothyroidism and other thyroid disorders. It
is currently one of the most prescribed drugs in the United States with over 13
million patients of various ages and demographic backgrounds. Side effects from
levothyroxine sodium are rare, but may include allergic reactions, such as rash
or hives. With its distribution of this product, Lannett competes in a market
which is currently controlled by two branded Levothyroxine Sodium tablet
products--Abbott Laboratories' Synthroid(R) and Monarch Pharmaceutical's
Levoxyl(R). JSP's Levothyroxine Sodium product, which JSP registered under the
brand name Unithroid(R) was the first FDA approved (August 2000) Levothyroxine
Sodium Tablet formulation. Both Synthroid(R) and Levoxyl(R) were approved by the
FDA in the following years. Currently, Synthroid(R) and Levoxyl(R) control the
majority of the market. However, JSP has applied to the FDA, through supplements
to its NDA, to approve its product's bioequivalence to both Synthroid(R) and
Levoxyl(R). If the FDA approves JSP's supplemental applications, Lannett expects
the sales of its marketed Levothyroxine product to increase, relative to the
market size of the two dominant brands.
Additional products are currently under development. These products are
all orally-administered, solid-dosage (i.e. tablet/capsule) products designed to
be generic equivalents to brand named innovator drugs. The Company's
developmental drug products are intended to treat a diverse range of
indications. One of these developmental products, an orally-administered obesity
product, represents a generic ANDA currently owned by the Company, but not
currently manufactured and distributed for commercial consumption. As one of the
oldest generic drug manufacturers in the country, formed in 1942, Lannett
currently owns several ANDAs for products which it does not manufacture and
market. These ANDAs are simply dormant on the Company's records. Occasionally,
the Company reviews such ANDAs to determine if the market potential for any of
these older drugs has recently changed, so as to make it attractive for Lannett
to reconsider manufacturing and selling it. If the Company makes the
determination to introduce one of these products into the consumer marketplace,
it must review the ANDA and related documentation to ensure that the approved
product specifications, formulation and other features are feasible in the
Company's current environment. Generally, in these situations, the Company must
file a supplement to the FDA for the applicable ANDA, informing the FDA of any
significant changes in the manufacturing process, the formulation, the raw
material supplier or another major feature of the previously-approved ANDA. The
Company would then redevelop the product and submit it to the FDA for
supplemental approval. The FDA's approval process for ANDA supplements is
similar to that of a new ANDA.
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Another developmental product, also an orally-administered obesity
product, is a new ANDA submitted to the FDA in July 2003 for approval. In a
presentation to the Generic Pharmaceutical Association on March 2, 2004, Gary J.
Buehler, R.Ph., and Director of the FDA's Office of Generic Drugs, said that the
median approval time for a new ANDA for the FDA's Fiscal 2003 year was 17.3
months. Since the Company has no control over the FDA review process, management
is unable to anticipate whether or when it will be able to begin commercially
producing and shipping this product.
The remainder of the products in development represent either previously
approved ANDAs that the Company is planning to reintroduce (ANDA supplements),
or new formulations (new ANDAs). The products under development are at various
stages in the development cycle--formulation, scale-up, and/or clinical
testing. Depending on the complexity of the active ingredient's chemical
characteristics, the cost of the raw material, the FDA-mandated requirement of
bioequivalence studies, the cost of such studies and other developmental
factors, the cost to develop a new generic product varies. It can range from
$100,000 to $1 million. Some of Lannett's developmental products will require
bioequivalence studies, while others will not--depending on the FDA's Orange
Book classification. Since the Company has no control over the FDA review
process, management is unable to anticipate whether or when it will be able to
begin producing and shipping additional products.
In addition to the efforts of its internal product development group,
Lannett has contracted with two outside firms (Pharmatek Laboratories Inc. in
California and The PharmaNetwork LLC in New Jersey) for the formulation and
development of several new generic drug products. These outsourced R&D products
are at various stages in the development cycle--formulation, analytical method
development and testing and manufacturing scale-up. These products are
orally-administered solid dosage products intended to treat a diverse range of
medical indications. It is the Company's intention to ultimately transfer the
formulation technology and manufacturing process for all of these R&D products
to the Company's own commercial manufacturing sites. The Company initiated these
outsourced R&D efforts to compliment the progress of its own internal R&D
efforts.
The Company is also developing a drug product that does not require FDA
approval. The FDA allows generic manufacturers to manufacture and sell products
which are equivalent to innovator drugs which are grand-fathered, under FDA
rules, prior to the passage of the Hatch-Waxman Act of 1984. The FDA allows
generic manufacturers to produce and sell generic versions of such
grand-fathered products by simply performing and internally documenting the
product's stability over a period of time. Under this scenario, a generic
company can forego the time and costs related to a FDA-mandated ANDA approval
process. The Company currently has one product under development in this
category. The developmental drug is an orally-administered, prescription solid
dosage product.
The Company has also contracted with Spectrum Pharmaceuticals Inc., based
in California, to market generic products developed and manufactured by Spectrum
and/or its partners. The first applicable product under this agreement is
ciprofloxacin tablets, the generic version of Cipro(R), an anti-bacterial drug,
marketed by Bayer Corporation, prescribed to treat infections. The Company has
also initiated discussions with other firms for similar new product initiatives,
in which Lannett will market and distribute products manufactured by third
parties.
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Lannett intends to use its strong customer relationships to build its market
share for such products, and increase future revenues and income.
The majority of the Company's R&D projects are being developed in-house
under Lannett's direct supervision and with Company personnel. Hence, the
Company does not believe that its outside contracts for product development,
including those for Pharmatek Laboratories Inc. and The PharmaNetwork LLC, or
manufacturing supply, including Spectrum Pharmaceuticals Inc., are material in
nature, nor is the Company substantially dependent on the services rendered by
such outside firms. Since the Company has no control over the FDA review
process, management is unable to anticipate whether or when it will be able to
begin producing and shipping such additional products.
The following table summarizes key information related to the Company's R&D
products. The column headings are defined as follows:
1.) Stage of R&D - Defines the current stage of the R&D product in the
development process, as of the date of this filing.
2.) Regulatory Requirement - Defines whether the R&D product is or is
expected to be a new ANDA submission, an ANDA supplement, or a
grand-fathered product not requiring specific FDA approval.
3.) Number of Products - Defines the number of products in R&D at the
stage noted. In this context, a product means any finished dosage
form, including all potencies, containing the same API or
combination of APIs and which represents a generic version of the
same Reference Listed Drug (RLD) or innovator drug, identified in
the FDA's Orange Book.
STAGE OF R&D REGULATORY REQUIREMENT NUMBER OF PRODUCTS
------------ ---------------------- ------------------
FDA Review ANDA 7
FDA Review ANDA supplement 1
Clinical Testing ANDA 4
Scale-Up Grand-fathered 1
Scale-Up ANDA supplement 5
Scale-Up ANDA 2
Formulation/Method Development ANDA 9
RAW MATERIAL AND INVENTORY SUPPLIERS
The raw materials used by the Company in the production process consist of
pharmaceutical chemicals in various forms, which are generally available from
various sources. FDA approval is required in connection with the process of
using active ingredient suppliers. In addition to the raw materials purchased
for the production process, the Company purchases certain finished dosage
inventories, including capsule and tablet products. The Company then sells these
finished dosage products directly to its customers along with the finished
dosage products internally manufactured.
Currently, the only finished product inventory supplier of the Company is
Jerome Stevens Pharmaceuticals, Inc. (JSP), in Bohemia, New York. Purchases of
finished goods inventory from JSP accounted for approximately 62% of the
Company's inventory purchases in Fiscal 2003. During Fiscal 2003, the Company
did not have a supply agreement with JSP.
Another supplier, Siegfried (USA) Inc., which supplies primidone and
butalbital, the raw materials in the Company's commercial products containing
the same ingredient name, to the Company, accounted for 12% of the Company's
inventory purchases in Fiscal 2003. Purchases of
10
finished goods inventory from JSP accounted for approximately 26% of the
Company's inventory purchases in Fiscal 2002. Siegfried (USA) Inc. supplied 30%
of the Company's inventory purchases in Fiscal 2002. Generally, the raw
materials purchased from suppliers are available from a number of vendors. The
finished products purchased from JSP may not be available from other sources due
to the limited number of FDA approvals of competitive products. If suppliers of
a certain material or finished product are limited, the Company will generally
take certain precautionary steps to avoid a disruption in supply. This includes
building a satisfactory inventory level, and obtaining contractual supply
commitments. The Company currently has an agreement with Siegfried (USA) Inc.
for the supply of primidone. The agreement is a standard supply agreement
evidencing the terms of the supply of material. There are no guaranteed purchase
volume commitments; however the agreement does require Lannett to purchase 100%
of its primidone raw material requirements from Siegfried. The price of the
material may vary depending on the quantity of material purchased during the
term of the agreement. The term of the agreement is October 1, 2002 through
December 31, 2003. At the expiration of the term, the Company expects to renew
the supply agreement for an additional period under terms similar to the old
agreement. In the interim, Siegfried (USA) Inc. is continuing to supply raw
materials to the Company under terms similar to the old agreement The agreement
is included in the Exhibits of this Form 10-KSB.
11
CUSTOMERS AND MARKETING
The Company sells its products primarily to wholesale distributors,
generic drug distributors, mail-order pharmacies, drug chains, and other
pharmaceutical companies. Sales of the Company's pharmaceutical products are
made on an individual order basis. One customer, Cardinal Health, one of the
largest wholesale distributors in the country, accounted for approximately 13%
of net sales in Fiscal 2003. Another customer, Qualitest Pharmaceuticals, a
large private-label wholesale distributor, accounted for approximately 12% and
22% of net sales in Fiscal 2003 and Fiscal 2002, respectively. Another customer,
United Research Laboratories, a large private-label wholesale distributor,
accounted for 19% of net sales in Fiscal 2002. The Company performs ongoing
credit evaluations of its customers' financial condition, and has experienced no
significant collection problems to date. Generally, the Company requires no
collateral from its customers. As previously noted, a significant portion of
Lannett's sales were to wholesale customers, such as Cardinal Health. Sales to
these wholesale customers include "indirect sales," which represent sales to
third-party entities, such as 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. This credit is called a
chargeback. For more information on chargebacks, see the section entitled
"Chargebacks" in Item 6, "Management's Discussion and Analysis of Financial
Condition and Results of Operations, Significant Accounting Policies" of this
Form 10-KSB. These indirect sale transactions are recorded on Lannett's books as
sales to the wholesale customers. This has the effect of over-emphasizing the
sales volume attributable to such wholesalers because it includes such "indirect
sales." The Company believes that retail-level consumer demand dictates the
total volume of sales for various products. In the event that the Company's
wholesale and retail customers adjust their purchasing volumes, the Company
believes that consumer demand will be fulfilled by other wholesale or retail
sources of supply. As such, Lannett attempts to obtain strong relationships with
most of the major retail chains, wholesale distributors and mail-order
wholesalers in order to facilitate the supply of the Company's products through
whatever channel the consumer prefers. Although the Company has agreements with
several customers governing the transaction terms of its sales, there are no
long-term supply agreements with customers which would require them to purchase
the Company's products.
The Company promotes its products through direct sales, the Internet,
trade shows, trade publications, and bids. The Company also markets its products
through private label arrangements, whereby Lannett produces its products with a
label containing the name and logo of a customer. This practice is commonly
referred to as private label business. It allows the Company to expand on its
own internal sales efforts by using the marketing services from other
well-respected pharmaceutical dosage suppliers. The focus of the Company's sales
efforts are the relationships it creates with its customer accounts. Strong
customer relationships have created a positive platform for Lannett to increase
its sales volumes. Advertising in the generic pharmaceutical industry is
generally limited to trade publications, read by retail pharmacists, wholesale
purchasing agents and other pharmaceutical decision-makers. Historically and in
Fiscal 2003 and 2002, the Company's advertising expenses were immaterial. When
the customer and the Company's sales representatives make contact, the Company
will generally offer to supply the customer its products at fixed prices. If
accepted, the customer's purchasing department will coordinate the purchase,
receipt and distribution of the products throughout its distribution centers and
retail outlets. Once a customer accepts the Company's supply of product, the
customer generally expects a highs standard of service. This service standard
includes shipping product in a timely manner on receipt of customer purchase
orders, maintaining convenient and effective customer service functions and
retaining a mutually-beneficial dialogue of communication. The Company believes
that although the generic pharmaceutical industry is a commodity industry, where
price is the primary factor for sales success, these additional service
standards are equally important to the customers that rely on a consistent
source of supply.
12
COMPETITION
The manufacture and distribution of generic pharmaceutical products is a
highly competitive industry. Competition is based primarily on price, service
and quality. The Company competes primarily on this basis, as well as by
flexibility (reacting to customer needs quickly and decisively--for example
shipping product via overnight delivery when the customer is in critical need of
inventory), availability of inventory, and by the fact that the Company's
products are available only from a limited number of suppliers. The
modernization of its facilities, hiring of experienced staff, and implementation
of inventory and quality control programs have improved the Company's
competitive position over the past five years.
The Company competes with other manufacturers and marketers of generic
drugs. Each product manufactured and/or sold by Lannett has a different set of
competitors. The list below identifies the companies in which Lannett primarily
competes for each of its major products.
Product Primary Competitors
------- -------------------
Butalbital with Aspirin and Caffeine, Watson Pharmaceuticals Inc., Anabolic Laboratories, Inc.
with and without codeine phosphate capsules (marketed by Breckenridge Pharmaceutical, Inc.)
Digoxin tablets GlaxoSmithKline, Amide Pharmaceutical, Inc. (marketed by
Bertek Pharmaceuticals Inc.), Caraco Pharmaceutical
Laboratories, Inc.
Primidone tablets Watson Pharmaceuticals Inc.
Levothyroxine Sodium tablets Abbott Laboratories, Monarch Pharmaceuticals
GOVERNMENT REGULATION
Pharmaceutical manufacturers are subject to extensive regulation by the
federal government, principally by the FDA and the Drug Enforcement Agency
("DEA"), and, to a lesser extent, by other federal regulatory bodies and state
governments. The Federal Food, Drug and Cosmetic Act, the Controlled Substance
Act and other federal statutes and regulations govern or influence the testing,
manufacture, safety, labeling, storage, record keeping, approval, pricing,
advertising and promotion of the Company's generic drug products. Noncompliance
with applicable regulations can result in fines, recall and seizure of products,
total or partial suspension of production, personal and/or corporate prosecution
and debarment, and refusal of the government to approve new drug applications.
The FDA also has the authority to revoke previously approved drug products.
Generally, FDA approval is required before a prescription drug can be
marketed. The approval procedures are quite extensive. A new drug is one not
generally recognized by qualified experts as safe and effective for its intended
use. New drugs are typically developed and submitted to the FDA by companies
expecting to brand the product, and sell it as a new medical treatment. The FDA
review process for new drugs is very extensive; and it requires a substantial
investment to research and test the drug candidate. However, less burdensome
approval procedures may be used for generic equivalents. Typically, the
investment required to develop a generic drug is less costly than the brand
innovator drug. There are currently three ways to obtain FDA approval of a drug:
13
NEW DRUG APPLICATIONS ("NDA"): Unless one of the two procedures discussed in the
following paragraphs is available, a manufacturer must conduct and submit to the
FDA complete clinical studies to establish a drug's safety and efficacy.
ABBREVIATED NEW DRUG APPLICATIONS ("ANDA"): An ANDA is similar to an NDA, except
that the FDA waives the requirement of complete clinical studies of safety and
efficacy, although it may require bioavailability and bioequivalence studies.
The FDA has recently stated that the average review and approval time for a new
ANDA is approximately 18 months. "Bioavailability" indicates the rate of
absorption and levels of concentration of a drug in the bloodstream needed to
produce a therapeutic effect. "Bioequivalence" compares one drug product with
another, and indicates if the rate of absorption and the levels of concentration
of a generic drug in the body are within prescribed statistical limits to those
of a previously approved drug. Under the Drug Price Act, an ANDA may be
submitted for a drug on the basis that it is the equivalent of an approved drug,
regardless of when such other drug was approved. The Drug Price Act, in addition
to establishing a new ANDA procedure, created statutory protections for approved
brand name drugs. Under the Drug Price Act, an ANDA for a generic drug may not
be made effective until all relevant product and use patents for the brand name
drug have expired or have been determined to be invalid. Prior to enactment of
the Drug Price Act, the FDA gave no consideration to the patent status of a
previously approved drug. Additionally, the Drug Price Act extends for up to
five years the term of a product or use patent covering a drug to compensate the
patent holder for the reduction of the effective market life of a patent due to
federal regulatory review. With respect to certain drugs not covered by patents,
the Drug Price Act sets specified time periods of two to ten years during which
ANDAs for generic drugs cannot become effective or, under certain circumstances,
cannot be filed if the brand name drug was approved after December 31, 1981.
Lannett, like most other generic drug companies, uses the ANDA process for the
submission of their developmental generic drug candidates.
PAPER NEW DRUG APPLICATIONS ("PAPER NDA"): For a drug that is identical to a
drug first approved after 1962, a prospective manufacturer need not go through
the full NDA procedure. Instead, it may demonstrate safety and efficacy by
relying on published literature and reports. The manufacturer must also submit,
if the FDA so requires, bioavailability or bioequivalence data illustrating that
the generic drug formulation produces the same effects, within an acceptable
range, as the previously approved innovator drug. Because published literature
to support the safety and efficacy of post-1962 drugs may not be available, this
procedure is of limited utility to generic drug manufacturers. Moreover, the
utility of Paper NDAs has been further diminished by the recently broadened
availability of the ANDA process, as described above.
Among the requirements for new drug approval is the requirement that the
prospective manufacturer's methods conform to the FDA's current good
manufacturing practices ("CGMP Regulations"). The CGMP Regulations must be
followed at all times during which the approved drug is manufactured. In
complying with the standards set forth in the CGMP Regulations, the
Company must continue to expend time, money and effort in the areas of
production and quality control to ensure full technical compliance. Failure to
comply with the CGMP Regulations risks possible FDA action such as the seizure
of noncomplying drug products or, through the Department of Justice, enjoining
the manufacture of such products.
14
The Company is also subject to federal, state and local laws of general
applicability, such as laws regulating working conditions, and the storage,
transportation or discharge of items that may be considered hazardous
substances, hazardous waste or environmental contaminants. The Company monitors
its compliance with all environmental laws. Compliance costs are charged against
operations when incurred. The Company incurred no monitoring costs during the
years ended June 30, 2003 and 2002.
RESEARCH AND DEVELOPMENT
During Fiscal 2003 and Fiscal 2002, the Company incurred research and
development costs of approximately $2,575,000 and $1,749,000, respectively.
EMPLOYEES
The Company currently has 160 employees, of which 158 are full-time.
SECURITIES EXCHANGE ACT REPORTS
The Company maintains an Internet website at the following address:
www.lannett.com. The Company makes available on or through its Internet website
certain reports and amendments to those reports that are filed with the SEC in
accordance with the Securities Exchange Act of 1934. These include annual
reports on Form 10-KSB, quarterly reports on Form 10-QSB and current reports on
Form 8-K. This information is available on the Company's website free of charge
as soon as reasonably practicable after the Company electronically files the
information with, or furnishes it to, the SEC. The contents of the Company's
website are not incorporated by reference in this Annual Report on Form 10-KSB
and shall not be deemed "filed" under the Securities Exchange Act of 1934.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's headquarters, administrative offices, quality control
laboratory, and manufacturing and production facilities, consisting of
approximately 31,000 square feet, are located at 9000 State Road, Philadelphia,
Pennsylvania.
In December 1997, the Company entered into a three-year and three-month
lease for a 23,500 square foot facility located at 500 State Road, Bensalem
Bucks County, Pennsylvania. This facility houses laboratory research,
warehousing and distribution operations. The leased facility is located
approximately 1.5 miles from the Company headquarters in Philadelphia. In
January 2001, the Company extended this lease through April 30, 2004. The
Company does not expect to extend the term on this lease beyond April 30, 2004.
On July 1, 2003, the Company entered into a lease for a 62,000 square foot
facility at 9001 Torresdale Avenue, Philadelphia, Pennsylvania, approximately 1
mile from the Company's headquarters. The lease expires on November 30, 2003;
and the Company has the contractual right and option to purchase the facility at
any time during the lease term. The Company currently expects to exercise this
purchase option prior to the lease termination date of November 30, 2003. Prior
to the expiration of the lease term at 500 State Road, the Company is planning
to move all operations currently performed at 500 State Road to 9001 Torresdale
Avenue. In addition to the laboratory research, warehousing and distribution
operations currently performed at 500 State Road, other operational functions
may be moved from the Company headquarters to 9001 Torresdale Avenue. This move
will occur gradually, and will allow the Company to maximize its FDA approved
production facility at 9000 State Road for production output.
15
ITEM 3. LEGAL PROCEEDINGS
REGULATORY PROCEEDINGS
The Company is engaged in an industry which is subject to considerable
government regulation relating to the development, manufacturing and marketing
of pharmaceutical products. Accordingly, incidental to its business, the Company
periodically responds to inquiries or engages in administrative and judicial
proceedings involving regulatory authorities, particularly the FDA and the DEA.
EMPLOYEE CLAIMS
A claim of retaliatory discrimination has been filed by a former employee
with the Pennsylvania Human Relations Commission ("PHRC") and the Equal
Employment Opportunity Commission ("EEOC"). The Company was notified of the
complaint in March 1997. The Company has denied liability in this matter. The
PHRC has made a determination that the complaint against the Company should be
dismissed because the facts do not establish probable cause of the allegations
of discrimination. The matter is still pending before the EEOC. At this time,
management is unable to estimate a range of loss, if any, related to this
action. Management believes that the outcome of this claim will not have a
material adverse impact on the financial position or results of operations of
the Company.
A claim of discrimination has been filed against the Company with the EEOC
and the PHRC. The Company was notified of the complaint in June 2001. The
Company has filed an answer with the EEOC denying the allegations. The EEOC has
made a determination that the complaint against the Company should be dismissed
because the facts do not establish probable cause of the allegations of
discrimination. The matter is still pending before the PHRC. At this time,
management is unable to estimate a range of loss, if any, related to this
action. Management believes that the outcome of this claim will not have a
material adverse impact on the financial position or results of operations of
the Company.
A claim of discrimination has been filed against the Company with the PHRC
and the EEOC. The Company was notified of the complaint in July 2001. The
Company has filed an answer with the PHRC denying the allegations. The PHRC has
made a determination that the complaint against the Company should be dismissed
because the facts do not establish probable cause of the allegations of
discrimination. The matter is still pending before the EEOC. At this time,
management is unable to estimate a range of loss, if any, related to this
action. Management believes that the outcome of this claim will not have a
material adverse impact on the financial position or results of operations of
the Company.
DES CASES
The Company is currently engaged in several civil actions as a
co-defendant with many other manufacturers of Diethylstilbestrol ("DES"), a
synthetic hormone. Prior litigation established that the Company's pro rata
share of any liability is less than one-tenth of one percent. The Company was
represented in many of these actions by the insurance company with which the
Company maintained coverage during the time period that damages were alleged to
have occurred. The insurance company denies coverage for actions alleging
involvement of the Company filed after January 1, 1992. With respect to these
actions, the Company paid nominal damages or stipulated to its pro rata share of
any liability. The Company has either settled or had dismissed approximately 250
claims. An additional 283 claims are currently being defended. At this time,
management is unable to estimate a range of loss, if any, related to these
actions. Prior settlements had been in the $500 to $3,500 range. Management
believes that the outcome of these cases will not have a material adverse impact
on the financial position or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters have been submitted to a vote of the Company's security holders
during the quarter ended June 30, 2003.
16
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
On April 15, 2002, the Company's common stock began trading on the
American Stock Exchange. Prior to this, the Company's common stock traded in the
over-the-counter market through the use of the inter-dealer "pink-sheets"
published by Pink Sheets LLC. The following table sets forth certain information
with respect to the high and low daily closing prices of the Company's common
stock during Fiscal 2003 and 2002, as quoted by the American Stock Exchange (on
and after April 15, 2002) and Pink Sheets LLC (prior to April 15, 2002). Such
quotations reflect inter-dealer prices without retail mark-up, markdown or
commission and may not represent actual transactions. All share and per share
amounts on this Annual Report and Form 10-KSB have been adjusted to reflect a
three-for-two stock split, which was effective on February 14, 2003.
FISCAL YEAR ENDED JUNE 30, 2003
HIGH LOW
-------- --------
First quarter .......................................................... $ 7.41 $ 4.63
Second quarter ......................................................... $ 13.97 $ 5.67
Third quarter .......................................................... $ 15.52 $ 11.05
Fourth quarter ......................................................... $ 23.44 $ 11.36
FISCAL YEAR ENDED JUNE 30, 2002
HIGH LOW
-------- --------
First quarter .......................................................... $ 1.33 $ 0.69
Second quarter ......................................................... $ 2.69 $ 1.13
Third quarter .......................................................... $ 3.77 $ 2.13
Fourth quarter ......................................................... $ 8.00 $ 3.50
HOLDERS
As of August 26, 2003, there were approximately 302 holders of record of
the Company's common stock.
DIVIDENDS
The Company did not pay cash dividends in Fiscal 2003 or 2002. The Company
intends to use available funds for working capital, plant and equipment
additions, and various product extension ventures. It does not anticipate paying
cash dividends in the foreseeable future.
17
EQUITY COMPENSATION PLAN INFORMATION
The following table summarizes the equity compensation plans as of June 30,
2003.
Number of securities
remaining available for
future issuance under
Number of securities to be Weighted average equity compensation
issued upon exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
warrants and rights warrants and rights column (a)
Plan Category (a) (b) (c)
------------- --- --- ---
Equity Compensation plans 411,939 $7.48 2,206,967
approved by security
holders
Equity Compensation plans - - -
not approved by security
holders
Total 411,939 $7.48 2,206,967
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
In addition to historical information, this Form 10-KSB 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-KSB. The
Company undertakes no obligation to publicly revise or update these
forward-looking statements to reflect events or circumstances, which arise
later. Readers should carefully review the risk factors described in other
documents the Company files from time to time with the Securities and Exchange
Commission, including the Quarterly reports on Form 10-Q to be filed by the
Company in Fiscal 2004, and any Current Reports on Form 8-K filed by the
Company. All share and per share amounts on this Annual Report and Form 10-KSB
have been adjusted to reflect a three-for-two stock split, which was effective
on February 14, 2003.
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.
18
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, see Note 1
in the Notes to the Consolidated Financial Statements included herein.
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 reductions to net sales and accounts receivable.
Accounts receivable are presented net of allowances relating to these
provisions, which were approximately $2,772,000 and $630,000 at June 30, 2003
and June 30, 2002, respectively. The change in the reserves for various sales
adjustments was not proportionally equal to the change in sales from Fiscal 2002
to Fiscal 2003 because of changes in the product mix and the customer mix.
Provisions for rebates, promotional and other credits are estimated based on
historical payment experience, estimated customer inventory levels and contract
terms. Provisions for other customer credits, such as price adjustments, returns
and chargebacks require management to make subjective judgments. Unlike branded
innovator companies, Lannett does not use information about product levels in
distribution channels from third-party sources, such as IMS Health and NDC
Health in estimating future returns and other credits. These provisions are
discussed in more detail below and in the Notes to the Consolidated Financial
Statements.
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. 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 to the large wholesale customers, such as Cardinal
Health, AmerisourceBergen and McKesson Corporation, increase, the reserve for
chargebacks will also generally increase. However, the size of the increase
depends on the product mix. The Company continually monitors the reserve for
chargebacks and makes adjustments when it believes that actual chargebacks may
differ from estimated reserves.
REBATES - Rebates are offered to the Company's key customers to promote
customer loyalty and encourage greater 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.
19
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 certain wholesale and retail customers
increase. However, these rebate programs are tailored to the customers'
individual programs. Hence, the reserve will depend on the mix of customers that
comprise such rebate programs.
RETURNS - Consistent with industry practice, the Company has a product
returns policy that allows select 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 it believes that
actual product returns may differ from established reserves. Generally, the
reserve for returns increases as net sales increase.
PRICE ADJUSTMENTS - Price adjustments, also known as "shelf stock
adjustments," 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.
The following table identifies the reserves for each major category of
revenue allowance:
Reserve Category/
Period Ended Chargebacks Rebates Returns Other Total
------------ ----------- ------- ------- ----- -----
June 30, 2003 $ 1,638,079 $ 889,808 $ 210,000 $ 33,800 $ 2,771,687
September 30, 2003 $ 3,127,799 $ 1,283,924 $ 230,000 $ 500,000 $ 5,141,723
December 31, 2003 $ 2,236,466 $ 1,294,170 $ 260,000 $ 150,000 $ 3,940,636
March 31, 2004 $ 2,181,185 $ 1,283,815 $ 285,000 $ 50,000 $ 3,800,000
The Company ships its products to the warehouses of its wholesale and
retail chain customers. When the Company and a customer come to an agreement for
the supply of a product, the customer will generally continue to purchase the
product, stock its warehouse(s) and resell the product to its own customers. The
Company's customer will continually reorder the product as its warehouse is
depleted. Lannett generally has no minimum size orders for its customers.
Additionally, most warehousing customers prefer not to stock excess inventory
levels due to the additional carrying costs and inefficiencies created by
holding extra inventory. As such, Lannett's
20
customers continually reorder the Company's products. It is common for Lannett's
customers to order the same products on a monthly basis. For generic
pharmaceutical manufacturers, it is critical to ensure that customers'
warehouses are adequately stocked with its products. This is important due to
the fact that several generic competitors compete for the consumer demand for a
given product. Availability of inventory ensures that a manufacturer's product
is considered. Otherwise, retail prescriptions would be filled with competitors'
products. For this reason, the Company periodically offers incentives to its
customers to purchase its products. These incentives are generally up-front
discounts off its standard prices at the beginning of a generic campaign launch
for a newly-approved or newly-introduced product, or when a customer purchases a
Lannett product for the first time. Customers generally inform the Company that
such purchases represent an estimate of expected resales for a period of time.
This period of time is generally up to three months. The Company records this
revenue, net of any discounts offered and accepted by its customers, and net of
any estimated returns and other credits, at the time of shipment. The Company's
products have either 24 months or 36 months shelf-life at the time of
manufacture. The Company monitors its customers' purchasing trends to attempt to
identify any significant lapses in purchasing activity. If the Company observes
a lack of recent activity, inquiries will be made to such customer regarding the
success of the customer's resale efforts. The Company will attempt to minimize
any potential return (or shelf life issues) by maintaining an active dialogue
with the customers.
The products that the Company sells are generic versions of brand named
drugs. The consumer markets for such drugs are well-established markets with
many years of historically-confirmed consumer demand. Such consumer demand may
be affected by several factors, including alternative treatments, cost, etc.
However, the effects of changes in such consumer demand for Lannett's products,
like generic products manufactured by other generic companies, are gradual in
nature. Any overall decrease in consumer demand for generic products generally
occurs over an extended period of time. This is because there are thousands of
doctors, prescribers, third-party payers, institutional formularies and other
buyers of drugs that must change prescribing habits, and medicinal practices
before such a decrease would affect a generic drug market. If the historical
data the Company uses, and the assumptions management makes to calculate its
estimates of future returns, chargebacks and other credits do not accurately
approximate future activity, its net sales, gross profit, net income and
earnings per share could change. However, management believes that these
estimates are reasonable based upon historical experience and current
conditions.
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 their 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 the Company's
expectations and the provisions established, the Company cannot guarantee that
it will continue to experience the same credit loss rates that it has in the
past.
INVENTORIES
The Company values its inventory at the lower of cost or market and
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.
21
RESULTS OF OPERATIONS - FISCAL 2003 TO FISCAL 2002
Net sales increased by 69%, from $25,126,214 in Fiscal 2002 to $42,486,758
in Fiscal 2003. Sales increased as a result of additions to the Company's
prescription line of products, including Prednisolone tablets, first marketed in
October 2001, Butalbital with Aspirin, Caffeine and Codeine Phosphate capsules,
first marketed in December 2001, Isoniazid tablets, first marketed in January
2002, Digoxin tablets, first marketed in September 2002 and Levothyroxine Sodium
tablets, first marketed in April 2003. These product additions had the effect of
increasing the total annual sales in Fiscal 2003, compared to Fiscal 2002, due
to the fact that the Company sold the products for longer periods of time in
Fiscal 2003, compared to Fiscal 2002. Of these product additions, Butalbital
with Aspirin, Caffeine and Codeine Phosphate capsules, Digoxin tablets and
Levothyroxine Sodium tablets accounted for approximately $9.7 million of the
increase in net sales from Fiscal 2002 to Fiscal 2003. Additionally, sales of a
portion of the Company's previously marketed products, including Primidone
tablets and Butalbital with Aspirin and Caffeine capsules, increased due to new
customer accounts, increased unit sales, and higher unit sales prices. The
Company raised its sales prices for Primidone 50 milligram tablets in Fiscal
2003 subsequent to an increase in the price of the brand named drug. Generally,
the Company sells its products at the accepted market prices for such products.
If the competitive environment changes, the Company monitors such changes to
determine the effect on the market prices for its products. Such changes may
include new competitors, fewer competitors, or an increase in the price of the
innovator drug. The increase in sales of a portion of the Company's products was
offset by a decrease of approximately $2.6 million in net sales of certain other
products, including pseudoephedrine hydrochloride tablets and
guaifenesin/ephedrine hydrochloride tablets. Due to increased competition for
these two products, and the Company's decision to allocate its production
capacity to higher margin prescription products, the Company discontinued its
production, marketing and distribution of these two products in Fiscal 2003.
Such higher margin products included Primidone 50 and 250 milligram tablets and
Butalbital with Aspirin and Caffeine capsules.
The Company sells its products to customers in various categories. The
table below identifies the Company's net sales to each category.
Customer Category Fiscal 2003 Net Sales Fiscal 2002 Net Sales Fiscal 2001 Net Sales
----------------- --------------------- --------------------- ---------------------
Wholesaler/Distributor $20.6 million $10.4 million $ 6.9 million
Retail Chain $ 9.9 million $ 3.3 million $ 800,000
Mail-Order Pharmacy $ 2.6 million $ 1.1 million $ 300,000
Private Label $ 9.4 million $10.3 million $ 4.1 million
------------- ------------- -------------
Total $42.5 million $25.1 million $12.1 million
Sales in every category, with the exception of `Private Label,' increased during
the past two years. This is a result of the factors described in the previous
paragraph. Sales to `Private Label' customers decreased in Fiscal 2003 as a
result of the Company's successful efforts in growing the Lannett label
accounts. Increasing sales to customers that purchased the Lannett label
products (i.e. the `Wholesale,' `Retail' and `Mail-Order' customer categories)
had the effect of reducing sales to `Private Label' customers.
22
Cost of sales increased by 92%, from $8,452,677 in Fiscal 2002 to
$16,257,794 in Fiscal 2003. The cost of sales increase is due to an increase in
direct variable costs and certain indirect overhead costs as a result of the
increase in sales volume and related production activities. These costs include
raw materials/cost of finished goods purchased and resold, which increased by
approximately $6,308,000, labor and benefits expenses, which increased by
approximately $1,126,000, depreciation expense, which increased by approximately
$140,000 and other miscellaneous production-related expenses, which increased in
total by approximately $231,000. Gross profit margins for Fiscal 2003 and Fiscal
2002 were 62% and 66%, respectively. The decrease in the gross profit percentage
is due to the product sales mix. Incremental sales in Fiscal 2003 of some or all
of the Company's new products were at gross profit percentages less than the
Company's average gross profit percentage from Fiscal 2002. This is a result of
more competition for such drugs, and an erosion in generic market pricing for
such drugs. During Fiscal 2003, a larger percentage of the Company's total net
sales were of JSP-manufactured products, as compared to the percentage of the
Company's total net sales during Fiscal 2002. The Company's average gross profit
margin for the JSP products is less than the average gross profit margin for
products internally manufactured. As such, the change in product sales mix
reduced the gross profit percentage in Fiscal 2003. Depending on future market
conditions for each of the Company's products, changes in the future sales
product mix may occur. These changes may affect the gross profit percentage in
future periods.
Research and development expenses increased by 47%, from $1,748,631 in
Fiscal 2002 to $2,575,178 in Fiscal 2003. This increase is a result of an
increase in the cost of clinical bioequivalence testing fees, which increased by
approximately $261,000, outsourced product development consulting services,
which increased by approximately $300,000, payroll and benefits expenses, which
increased by approximately $202,000, raw materials used in the development and
formulation of new products not yet approved by the FDA, which increased by
approximately $22,000 and miscellaneous other R&D expenses, which increased by a
total of approximately $41,000.
Selling, general and administrative expenses increased by 31%, from
$3,298,564 in Fiscal 2002 to $4,337,558 in Fiscal 2003. This increase is a
result of an increase in the following expenses: payroll and benefits, which
increased by approximately $746,000, consulting services, which increased by
approximately $180,000, travel and entertainment expenses, which increased by
approximately $95,000, investor relations/marketing expenses, which increased by
approximately $166,000, advertising expenses, which increased by approximately
$102,000, professional services fees, which increased by approximately $244,000,
computer support expenses, which increased by approximately $119,000 and
miscellaneous other administrative expenses, which increased by a total of
approximately $430,000. These increases were due to the hiring of additional
administrative employees and a general increase in administrative expenses due
to the growth of the Company in terms of employees, production volume and sales.
These increases were partially offset by a decrease in commissions expense to
outside sales
23
representatives of approximately $1,043,000. In Fiscal 2002, the Company created
its own internal sales and marketing department, replacing the service
previously performed by outside sales brokers. At this time, the Company's
infrastructure includes employee resources for all of the major administrative
functions, with the exception of a general counsel. As the Company continues to
grow in the future, it may consider hiring an employee to fulfill this role,
which is currently performed by outside professional services firms. During
Fiscal 2003, the Company has surpassed its historical highs in terms of net
sales, gross profit, operating income, net income and total market
capitalization value. This growth is a result of additions to the Company's line
of generic products, new customers, higher unit sales, increased product prices
and a management focus on minimizing unnecessary overhead and administrative
costs. Some of the new generic products sold by Lannett during Fiscal 2003 and
Fiscal 2002 were developed and manufactured by Lannett while others are
manufactured by JSP, one of Lannett's primary suppliers. The products
manufactured by Lannett and those manufactured by JSP are identified in the
section entitled "PRODUCTS" in Item 1 of this Form 10-KSB.
As a result of the foregoing, the Company increased its operating income
by 67%, from $11,425,483 in Fiscal 2002 to $19,060,106 in Fiscal 2003.
The Company's income tax expense increased from $3,984,135 in Fiscal 2002
to $7,334,740 in Fiscal 2003 as a result of the increase in taxable income.
The Company reported net income of $11,666,887 for Fiscal 2003, or $0.58
basic and diluted income per share, compared to net income of $7,195,990 for
Fiscal 2002, or $0.36 basic and diluted income per share.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities of $6,652,406 in Fiscal 2003 was
attributable to net income of $11,666,887, as adjusted for the effects of
non-cash items (primarily depreciation and amortization) of $1,399,700 and
changes in operating assets and liabilities totaling ($6,414,181). Significant
changes in operating assets and liabilities were comprised of:
1. an increase in accounts receivable of $4,050,596 due to the increase in
the Company's net sales. The days sales in accounts receivable increased
primarily due to changes in the customer and product mix. In Fiscal 2003,
a portion of the Company's sales were of over-the-counter products,
including pseudoephedrine hydrochloride tablets and guaifenesin/ephedrine
hydrochloride tablets. Sales of these products were made to small
distribution companies that focused on convenience store outlets. The
Company's payment terms for these customers were primarily payment on
delivery of goods, as opposed to extended payment terms offered to larger
customers. As a result of the decrease in sales to these smaller customers
in 2003, the average days sales in accounts receivable increased;
2. an increase in inventories of $3,238,591 due to increases in raw
materials and finished goods inventory. Due to the Company's sales growth,
additional investments were made in raw material and finished goods
inventory. It is the Company's goal to stock an adequate inventory of
finished goods and raw materials. Such a strategy will allow the Company
to minimize stock-outs and back-orders, and to provide a high level of
customer order fulfillment. Additionally, the Company has increased its
inventory carrying amounts of certain raw materials and finished products
to ensure supply continuity;
3. an increase in accounts payable, net of the decrease in accrued
expenses, of $1,799,171 due to the growth of the Company's purchasing
activities to support the overall Company growth, and the Company's
receipt of finished goods inventories in the last quarter of Fiscal 2003.
In April 2003, the Company launched its distribution campaign for
Levothyroxine Sodium tablets. Due to the timing of the Company's receipt
of finished goods inventory related to this new product launch and
beneficial credit payment terms, the Company's accounts payable balance
increased accordingly.
24
The net cash used in investing activities of $2,243,933 for Fiscal 2003
was attributable to $2,618,936 expended for equipment and building additions,
offset by $375,003 in proceeds received from the sale of equipment. The
Company's anticipated budget for capital expenditures in Fiscal 2004 is
approximately $9,300,000. The anticipated capital expenditure requirements will
support the Company's growth related to new product introductions and increased
production output due to expected higher sales levels. As of June 30, 2003, none
of the financing proceeds received from the bonds issued during Fiscal 1999 were
available for future capital expenditures; however approximately $352,000 was
paid by the Company prior to June 30, 2003 for production equipment expected to
arrive, and be placed in service in Fiscal 2004. This balance is included in
Other Assets, as a long-term asset, at June 30, 2003.
The Company had a $4,250,000 revolving line of credit from a shareholder,
William Farber, who is also the Chairman of the Board ("Shareholder Line of
Credit"). The maturity date on the Shareholder Line of Credit was December 1,
2002. The Company did not renew this line of credit because the cash available
from its current and prospective loan agreements and the cash generated from its
operations were estimated to be sufficient to support the Company's anticipated
growth, in terms of cash requirements. The line of credit had a stated interest
rate equal to the prime interest rate plus 1%. At June 30, 2003, the Company had
no amount outstanding and $4,250,000 available under this line of credit. There
was no accrued interest at June 30, 2003 and June 30, 2002.
In April 1999, the Company entered into a loan agreement (the "Agreement")
with a governmental authority, the Philadelphia Authority for Industrial
Development, (the "Authority") to finance future construction and growth
projects of the Company. The Authority issued $3,700,000 in tax-exempt variable
rate demand and fixed rate revenue bonds to provide the funds to finance such
growth projects pursuant to a trust indenture ("the "Trust indenture"). A
portion of the Company's proceeds from the bonds was used to pay for bond
issuance costs of approximately $170,000. The remainder of the proceeds was
deposited into a money market account, which was restricted for future plant and
equipment needs of the Company, as specified in the Agreement. The Trust
Indenture requires that the Company repay the Authority loan through installment
payments beginning in May 2003 and continuing through May 2014, the year the
bonds mature. The bonds bear interest at the floating variable rate determined
by the organization responsible for selling the bonds (the "remarketing agent").
The remarketing agent sets the interest rate, based on its judgment, in order to
sell the bonds at a price (interest rate) equal to the principal amount thereof.
If for any reason the interest rate is not determined by the remarketing agent,
or a court holds the interest rate invalid or unenforceable, the interest rate
will be the rate per annum equal to 85% of the interest rate per annum for 30
day commercial paper having a rating of A-2/P-2 as reported in The Wall Street
Journal on the determination date. The interest rate fluctuates on a weekly
basis. The effective interest rate at June 30, 2003 was 1.2%. At June 30, 2003,
the Company has $3,097,802 outstanding on the Authority loan, of which $718,333
is classified as currently due. The remainder is classified as a long-term
liability. In April 1999, an irrevocable letter of credit of $3,770,000 was
issued by a bank, First Union National Bank (First Union), to secure payment of
the Authority Loan and a portion of the related accrued interest. At June 30,
2003, no portion of the letter of credit has been utilized.
25
In April 1999, the Company authorized and directed the issuance of
$2,300,000 in taxable variable rate demand and fixed rate revenue bonds pursuant
to a trust indenture between the Company and First Union, as trustee (the "Trust
Indenture"). From the proceeds of the bonds, $750,000 was utilized to pay
deferred interest owed to Mr. Farber, the Chairman of the Board of Directors and
Chief Executive Officer of the Company, and approximately $1,440,000 was paid to
a bank to refinance a mortgage term loan and equipment term loans. The remainder
of the proceeds was used to pay bond issuance costs of approximately $109,000.
The Trust Indenture required that the Company repay the bonds through
installment payments beginning in June 1999 and continuing through May 2003, the
year the bonds matured. The bonds bear interest at the floating variable rate
determined by the organization responsible for selling the bonds (the
"remarketing agent"). The interest rate fluctuates on a weekly basis. At June
30, 2003, the Company has no balance outstanding on the bonds.
The Company has a $3,000,000 line of credit from First Union which bears
interest at the prime interest rate less 0.25%. The line of credit was renewed
and extended to November 30, 2003, at which time the Company expects to renew
and extend the due date. At June 30, 2003, the Company had $0 outstanding and
$3,000,000 available under the line of credit. The Company does not currently
expect to borrow cash under this line of credit in the future due to the
available cash on hand, and the cash expected to be provided by its results of
operations in the future. The line of credit is collateralized by substantially
all Company assets. Further, the line of credit and a related letter of credit
contain certain financial covenants (see Notes to Financial Statements, Number
6), including the attainment of standard financial liquidity and net worth
ratios. As of June 30, 2003, the Company successfully met these covenants.
Additionally, it is the Company's opinion that such covenants are not material
in nature.
The Company believes that cash generated from its operations and the
balances available under the Company's existing loans and line of credit as of
June 30, 2003, are sufficient to finance its level of operations, and currently
anticipated capital expenditures. However, to benefit from the low interest
rates in the current financial markets, the Company is planning to finance some
or all of the capital expenditures in Fiscal 2004.
Except as set forth in this report, the Company is not aware of any
trends, events or uncertainties that have or are reasonably likely to have a
material adverse impact on the Company's short-term or long-term liquidity or
financial condition.
PROSPECTS FOR THE FUTURE
The Company has several generic products under development. These products
are all orally-administered, solid-dosage (i.e. tablet/capsule) products
designed to be generic equivalents to brand named innovator drugs. The Company's
developmental drug products are intended to treat a diverse range of
indications. One of these developmental products, an orally-administered obesity
product, represents a generic ANDA currently owned by the Company, but not
currently manufactured and distributed for commercial consumption. As one of the
oldest generic drug manufacturers in the country, formed in 1942, Lannett
currently owns several ANDAs for products which it does not manufacture and
market. These ANDAs are simply dormant on the Company's records. Occasionally,
the Company reviews such ANDAs to determine if the market potential for any of
these older drugs has recently changed, so as to make it attractive for Lannett
to reconsider manufacturing and selling it. If the Company makes the
determination to introduce one of these
26
products into the consumer marketplace, it must review the ANDA and related
documentation to ensure that the approved product specifications, formulation
and other features are feasible in the Company's current environment. Generally,
in these situations, the Company must file a supplement to the FDA for the
applicable ANDA, informing the FDA of any significant changes in the
manufacturing process, the formulation, the raw material supplier or another
major feature of the previously-approved ANDA. The Company would then redevelop
the product and submit it to the FDA for supplemental approval. The FDA's
approval process for ANDA supplements is similar to that of a new ANDA.
Another developmental product, also an orally-administered obesity
product, is a new ANDA submitted to the FDA in July 2003 for approval. The FDA
has recently disclosed that the average amount of time to review and approve a
new ANDA is approximately eighteen months. Since the Company has no control over
the FDA review process, management is unable to anticipate whether or when it
will be able to begin commercially producing and shipping this product.
The remainder of the products in development represent either previously
approved ANDAs that the Company is planning to reintroduce (ANDA supplements),
or new formulations (new ANDAs). The products under development are at various
stages in the development cycle--formulation, scale-up, and/or clinical
testing. Depending on the complexity of the active ingredient's chemical
characteristics, the cost of the raw material, the FDA-mandated requirement of
bioequivalence studies, the cost of such studies and other developmental
factors, the cost to develop a new generic product varies. It can range from
$100,000 to $1 million. Some of Lannett's developmental products will require
bioequivalence studies, while others will not--depending on the FDA's Orange
Book classification. Since the Company has no control over the FDA review
process, management is unable to anticipate whether or when it will be able to
begin producing and shipping additional products.
In addition to the efforts of its internal product development group,
Lannett has contracted with two outside firms (Pharmatek Laboratories Inc. in
California and The PharmaNetwork LLC in New Jersey) for the formulation and
development of several new generic drug products. These outsourced R&D products
are at various stages in the development cycle--formulation, analytical method
development and testing and manufacturing scale-up. These products are
orally-administered solid dosage products intended to treat a diverse range of
medical indications. It is the Company's intention to ultimately transfer the
formulation technology and manufacturing process for all of these R&D products
to the Company's own commercial manufacturing sites. The Company initiated these
outsourced R&D efforts to compliment the progress of its own internal R&D
efforts.
The Company is also developing a drug product that does not require FDA
approval. The FDA allows generic manufacturers to manufacture and sell products
which are equivalent to innovator drugs which are grand-fathered, under FDA
rules, prior to the passage of the Hatch-Waxman Act of 1984. The FDA allows
generic manufacturers to produce and sell generic versions of such
grand-fathered products by simply performing and internally documenting the
product's stability over a period of time. Under this scenario, a generic
company can forego the time and costs related to a FDA-mandated ANDA approval
process. The Company currently has one product under development in this
category. The developmental drug is an orally-administered, prescription solid
dosage product.
The Company has also contracted with Spectrum Pharmaceuticals Inc., based
in California, to market generic products developed and manufactured by Spectrum
and/or its partners. The first applicable product under this agreement is
ciprofloxacin tablets, the generic version of Cipro(R), an anti-bacterial drug,
marketed by Bayer Corporation, prescribed to treat infections. The Company has
also initiated discussions with other firms for similar new product initiatives,
in which Lannett will market and distribute products manufactured by third
parties. Lannett intends to use its strong customer relationships to build its
market share for such products, and increase future revenues and income.
27
The majority of the Company's R&D projects are being developed in-house
under Lannett's direct supervision and with Company personnel. Hence, the
Company does not believe that its outside contracts for product development,
including those for Pharmatek Laboratories Inc. and The PharmaNetwork LLC, or
manufacturing supply, including Spectrum Pharmaceuticals Inc., are material in
nature, nor is the Company substantially dependent on the services rendered by
such outside firms. Since the Company has no control over the FDA review
process, management is unable to anticipate whether or when it will be able to
begin producing and shipping such additional products.
ITEM 7. FINANCIAL STATEMENTS
The Consolidated Financial Statements for the years ended June 30, 2003
and 2002 and Independent Auditor Report filed as a part of this Form 10-KSB are
listed in the Exhibit Index filed herewith.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 8A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in its Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms, and that such
information is accumulated and communicated to management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. Management necessarily applies its
judgment in assessing the costs and benefits of such controls and procedures,
which, by their nature, can provide only reasonable assurance regarding
management's control objectives.
With the participation of management, the Company's Chief Executive Officer and
Chief Financial Officer evaluated the effectiveness of the design and operation
of the Company's disclosure controls and procedures at the conclusion of the
year ended June 30, 2003. Based upon this evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures were effective in ensuring that material information
required to be disclosed is included in the reports that it files with the
Securities and Exchange Commission.
CHANGES IN INTERNAL CONTROLS
There were no significant changes in the Company's internal controls or, to the
knowledge of management of the Company, in other factors that could
significantly affect internal controls subsequent to the date of the Company's
most recent evaluation of its disclosure controls and procedures utilized to
compile information included in this filing.
28
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE
ACT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are set forth below:
Age Position
--- --------
Directors:
William Farber 71 Chairman of the Board and Chief
Executive Officer
Marvin Novick 72 Director
Ronald A. West 69 Director
Myron Winkelman 65 Director
Executive Officers:
Arthur P. Bedrosian 57 President
Larry Dalesandro 31 Chief Financial Officer
WILLIAM FARBER was elected as Chairman of the Board of Directors and Chief
Executive Officer in August 1991. From April 1993 to the end of 1993, Mr. Farber
was the President and a director of Auburn Pharmaceutical Company. From 1990
through March 1993, Mr. Farber served as Director of Purchasing for Major
Pharmaceutical Corporation. From 1965 through 1990, Mr. Farber was the Chief
Executive Officer of Michigan Pharmacal Corporation. Mr. Farber is a registered
pharmacist in the State of Michigan.
MARVIN NOVICK was elected a Director of the Company in February 2000. Mr.
Novick has been an advisor, consultant and financial planner for multiple
companies in the past thirty-five years. He is currently President of R&M
Resources, Inc., an investment and consulting services company. He has served in
this position of this private company since 1988. From 1984 to 1987, he served
as Vice Chairman of Dura Corporation, a major automotive supplier. From 1969 to
1971, he served as Chief Financial Officer of Meadowbrook Insurance Company. In
addition to these positions, he served as Partner of international accounting
firms, J.K. Lasser & Co., and Touche Ross & Co, and Senior Vice President of
Michigan Blue Shield, a major healthcare organization. Mr. Novick holds
Bachelor's and Master's Degrees, and is a member of the American Institute of
Certified Public Accountants.
RONALD A. WEST was elected a Director of the Company in January 2002. Mr.
West is currently a Director of Beecher Associates, an industrial real estate
investment company, R&M Resources, an investment and consulting services company
and North East Staffing, Inc., an employee services company. Prior to this, from
1983 to 1987, Mr. West served as Chairman and Chief Executive Officer of Dura
Corporation, an original equipment manufacturer of automotive products and other
engineered equipment components. In 1987, Mr. West sold his ownership position
in Dura Corporation, at which time he retired from active management positions.
Mr. West was employed at Dura Corporation since 1969. Prior to this, he served
in various financial management positions with TRW, Inc., Marlin Rockwell
Corporation and National Machine Products Group, a division of Standard Pressed
Steel Company. Mr. West studied Business Administration at Michigan State
University and the University of Detroit.
29
MYRON WINKELMAN, R. PH. was elected a Director of the Company in June
2003. Mr. Winkelman has significant career experience in various aspects of
pharmacy and health care. He is currently President of Winkelman Management
Consulting (WMC), which provides consulting services to both commercial and
governmental clients. He has served in this position since 1994. Mr. Winkelman
has recently managed multi-state drug purchasing initiatives for both Medicaid
and state entities. Prior to creating WMC, he was a senior executive with
ValueRx, a large pharmacy benefits manager, and served for many years as a
senior executive for the Revco, Rite Aid and Perry Drug chains. While at
ValueRx, Mr. Winkelman served on the Board of Directors of the Pharmaceutical
Care Management Association. He belongs to a number of pharmacy organizations,
including the Academy of Managed Care Pharmacy and the Michigan Pharmacy
Association. Mr. Winkelman is a registered pharmacist and holds a Bachelor of
Science Degree in Pharmacy from Wayne State University.
ARTHUR P. BEDROSIAN, J.D. was elected President of the Company in May
2002. Prior to this, he served as the Company's Vice President of Business
Development from January 2002 to April 2002, and as a Director from February
2000 to January 2002. Mr. Bedrosian has operated generic drug manufacturing,
sales, and marketing businesses in the healthcare industry for many years. Prior
to joining the Company, from 1999 to 2001, Mr. Bedrosian served as President and
Chief Executive Officer of Trinity Laboratories, Inc., a medical device and drug
manufacturer. Mr. Bedrosian also operated Pharmaceutical Ventures Ltd, a
healthcare consultancy and Interal Corporation, a computer consultancy to
Fortune 100 companies. Mr. Bedrosian holds a Bachelor of Arts Degree in
Political Science from Queens College of the City University of New York and a
Juris Doctorate from Newport University in California.
LARRY DALESANDRO was elected Chief Financial Officer of the Company in
June 2003. Prior to this, he served as the Company's Chief Operating Officer
from November 1999 to June 2003. Mr. Dalesandro joined the Company in January
1999 to manage the Company's financial operations. Previously, he was the
Controller and Director of Financial Reporting of Criterion Communications,
Inc., a technology and new media services firm, Controller of Crown Contractors,
Inc., a contract construction company, and Senior Auditor of Grant Thornton LLP,
an international professional services firm. Mr. Dalesandro graduated Magna Cum
Laude with a Bachelor's of Science Degree in Accountancy from Villanova
University, and is a Certified Public Accountant.
SIGNIFICANT EMPLOYEES
In addition to the directors and executive officers, the following table
identifies certain key employees of the Company.
Name Age Position
---- --- --------
Kevin Smith 43 Vice President of Sales and Marketing
Bernard Sandiford 74 Vice President of Operations
30
KEVIN SMITH joined the Company in January 2002 as Vice President of Sales
and Marketing. Prior to this, from 2000 to 2001, he served as Director of
National Accounts for Bi-Coastal Pharmaceutical, Inc., a pharmaceutical sales
representation company. Prior to this, from 1999 to 2000, he served as National
Accounts Manager for Mova Laboratories Inc., a pharmaceutical manufacturer.
Prior to this, from 1991 to 1999, Mr. Smith served as National Sales Manager at
Sidmak Laboratories, a pharmaceutical manufacturer. Kevin has extensive
experience in the generic sales market, and brings to the Company a vast network
of customers, including retail chain pharmacies, wholesale distributors,
mail-order wholesalers and generic distributors. Mr. Smith has a Bachelors'
Degree in Business Administration from Gettysburg College.
BERNARD SANDIFORD joined the Company in November 2002 as Vice President of
Operations. Prior to this, from 1998 to 2002, he was the President of Sandiford
Consultants, a firm specializing in providing consulting services to drug
manufacturers for Good Manufacturing Practices and process validations. His
previous employment included senior operating positions with Halsey Drug
Company, Barr Laboratories, Inc., Duramed Pharmaceuticals, Inc., and Revlon
Health Care Group. In addition to these positions, Mr. Sandiford performed
various consulting assignments regarding Good Manufacturing Practices for
several companies in the pharmaceutical industry. Mr. Sandiford has a Bachelors
of Science Degree in Chemistry from Long Island University.
To the best of the Company's knowledge, there have been no events under
any bankruptcy act, no criminal proceedings and no judgments or injunctions that
are material to the evaluation of the ability or integrity of any director,
executive officer, or significant employee during the past five years.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors, officers, and persons who own more than 10% of a registered
class of the Company's equity securities to file with the SEC reports of
ownership and changes in ownership of common stock and other equity securities
of the Company. Officers, directors and greater-than-10% stockholders are
required by SEC regulations to furnish the Company with copies of all Section
16(a) forms they file.
Based solely on review of the copies of such reports furnished to the
Company or written representations that no other reports were required, the
Company believes that during Fiscal 2003, all filing requirements applicable to
its officers, directors and greater-than-10% beneficial owners were complied
with, except for the following:
On August 15, 2003, Ronald West reported a purchase of shares in May 2002,
a purchase of shares in July 2002, a sale of shares in November 2002, and
a purchase of shares in January 2003.
On August 15, 2003, Marvin Novick reported a sale of shares in November
2002, a bona-fide gift of shares in December 2002, a sale of shares in
January 2003, and a sale of shares in May 2003. The shares transacted on
the above dates were owned by Margaret Novick, spouse of Marvin Novick.
31
ITEM 10. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table summarizes all compensation paid to or earned by the
named executive officers of the Company for Fiscal 2003, Fiscal 2002 and Fiscal
2001.
Long Term Compensation
----------------------
Annual Compensation Awards Payouts
------------------- ------ -------
(g)
Securities
(a) (f) Under- (h) (i)
Name and (b) (e) Restricted lying LTIP All Other
Principal Fiscal (c) (d) Other Annual Stock Options/ Payouts Compensation
Position Year Salary Bonus Compensation Award(s) SARs Amount Amounts
-------- ---- ------ ----- ------------ --------- ---- ------ -------
William Farber 2003 0 0 0 0 37,500 0 3,000(7)
2002 0 0 0 0 0 0 3,000(7)
Chairman of the
Board of 2001 0 0 0 0 0 0 0
Directors and
Chief Executive
Officer
Arthur P. 2003 179,175(1) 77,500 0 0 114,600 0 0
Bedrosian(2)
2002 64,385 0 0 0 0 0 0
President
2001 0 0 0 0 0 0 0
Larry 2003 134,984(1) 59,675 0 0 74,595 0 0
Dalesandro(3)
2002 116,698(1) 25,000 0 0 0 0 0
Chief Financial
Officer 2001 102,049(1) 5,000 0 0 15,000 0 0
Eugene 2003 67,706(1) 38,874 0 0 7,500 0 141,020(5)
Livshits(4)
2002 126,715(1) 25,000 0 0 0 0 0
Vice President
of Technical 2001 109,669(1) 5,000 0 0 18,000 0 0
Affairs
Kevin Smith(6) 2003 167,187(1) 46,500 0 0 38,760 0 0
Vice President 2002 66,769 0 0 0 15,000 0 0
of Sales &
Marketing 2001 0 0 0 0 0 0 0
(1) Includes matching contribution payments made to the Company's 401(k)
Plan (3% of eligible compensation) for the benefit of the employee
noted.
(2) Mr. Bedrosian joined the Company on January 24, 2002 as Vice
President of Business Development. On May 5, 2002, he was elected
President of the Company.
(3) Mr. Dalesandro joined the Company on January 11, 1999 as Controller.
He was elected Chief Operating Officer on November 1, 1999. On June
18, 2003, he was elected Chief Financial Officer, and voluntarily
resigned the position of Chief Operating Officer.
(4) Mr. Livshits joined the Company on February 20, 1997 as Director of
Analytical Services. He was elected Vice President of Technical
Affairs on November 1, 1999. On January 6, 2003, his employment with
the Company was terminated. The Company agreed to pay him severance
pay at his current rate through December 31, 2003. See footnote (5).
(5) This amount represents $76,230 in severance compensation paid from
January 1, 2003 through June 30, 2003, plus $64,790 in severance
compensation accrued at June 30, 2003.
(6) Mr. Smith joined the Company on January 21, 2002 as Vice President
of Sales and Marketing.
(7) These amounts represent payments to Mr. Farber for participation and
attendance at Board of Director Meetings.
32
OPTION/SAR GRANTS IN FISCAL 2003
(b) (c)
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/SARS
UNDERLYING GRANTED TO (d)
(a) OPTIONS/SARS EMPLOYEES IN EXERCISE OR BASE PRICE (e)
NAME GRANTED (#) FISCAL YEAR ($/SHARE) EXPIRATION DATE
---- ----------- ------------ --------- ---------------
William Farber 37,500 10% $ 7.97 10/28/2012
Chairman of the Board of
Directors and Chief
Executive Officer
Arthur Bedrosian 18,000 3% $ 4.63 7/23/2012
President
Arthur Bedrosian 96,900 25% $ 7.97 10/28/2012
President
Larry Dalesandro 74,595 19% $ 7.97 10/28/2012
Chief Financial Officer
Eugene Livshits 7,500 2% $ 7.97 10/28/2012
Vice President of
Technical Affairs
Kevin Smith 38,760 10% $ 7.97 10/28/2012
Vice President of Sales
and Marketing
33
AGGREGATED OPTIONS/SAR EXERCISES AND FISCAL YEAR-END OPTIONS/SAR VALUES
(e)
VALUE OF
(d) UNEXERCISED
(b) NUMBER OF SECURITIES IN-THE-MONEY
SHARES UNDERLYING UNEXERCISED OPTIONS AT
ACQUIRED (c) OPTIONS AT FY-END FY-END
(a) ON VALUE EXERCISABLE/ EXERCISABLE/
NAME EXERCISE REALIZED UNEXERCISABLE UNEXERCISABLE
---- -------- -------- ------------- -------------
William Farber 37,500/ $ 580,249/
Chairman of the Board of 0 $ 0 0 $ 0
Directors and Chief
Executive Officer
Arthur Bedrosian 0/ $ 0/
President 0 $ 0 114,900 $ 1,833,241
Larry Dalesandro 0/ $ 0/
Chief Financial Officer 5,001 $ 48,860 74,595 $ 1,154,231
Eugene Livshits 0/ 0/
Vice President - of 13,500 $108,520 0 0
Technical Affairs
Kevin Smith 0/ $ 0/
Vice President of Sales 5,000 $ 46,495 48,761 $ 811,166
and Marketing
COMPENSATION OF DIRECTORS
Directors received compensation of $1,000 per Board meeting attended
during Fiscal 2003. There were three Board meetings held in Fiscal 2003. Audit
Committee members received compensation of $1,000 per Audit Committee meeting
attended during Fiscal 2003. There were four Audit Committee meetings held in
Fiscal 2003. Directors are reimbursed for expenses incurred in attending Board
meetings. Directors also receive a monthly allowance of $1,350 to cover the cost
of medical benefits insurance, and automobile expenses. Directors also received
stock options during Fiscal 2003 as compensation for their services. The
following table identifies the stock options granted to directors in Fiscal
2003.
(b) (c)
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/SARS
UNDERLYING GRANTED TO (d)
(a) OPTIONS/SARs RECIPIENTS IN EXERCISE OR BASE PRICE (e)
NAME GRANTED (#) FISCAL YEAR ($/SHARE) EXPIRATION DATE
---- ---------- ----------- -------- ---------------
William Farber 37,500 10% $7.97 10/28/2012
Chairman of the Board of
Directors and Chief
Executive Officer
Marvin Novick 22,500 6% $7.97 10/28/2012
Director
Ronald West 22,500 6% $7.97 10/28/2012
Director
Myron Winkelman - - - -
Director
34
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with Arthur Bedrosian,
Larry Dalesandro and Kevin Smith (the "Named Executives"). Each of the
agreements provide for an annual base salary and eligibility to receive a bonus.
The salary and bonus amounts of the Named Executives are determined by the Board
of Directors. Additionally, the Named Executives are eligible to receive stock
options, which are granted at the discretion of the Board of Directors, and in
accordance with the Company's policies regarding stock option grants.
The Named Executives' employment may be terminated at any time with or
without cause, or by reason of death or disability; and the Named Executives may
voluntarily resign at any time with or without good reason. In the event of
termination of employment without cause, the Company will provide the Named
Executive with: (a) severance compensation, subject to the Company's standard
payroll withholdings or deductions, for a period of no less than one year, in
the amount of the then current base salary rate, subject to certain limitations;
and (b) continued group health insurance benefits (i.e. medical, dental,
prescription insurance, etc) for the Named Executive and his eligible dependents
for a period of up to six months at no cost to the Named Executive.
In the event of a change in the control of the Company, or if the Company
sells a majority of the ANDAs it owns, the Company will provide the Named
Executives with: (a) a lump sum payment in the amount equal to six months of the
Named Executive's current salary, subject to minimum limitations. In this
scenario, if the Named Executive's employment is terminated without cause, the
Company will provide the Named Executive with severance compensation and
benefits consisting of: (a) severance compensation, subject to the Company's
standard payroll withholdings or deductions, for a period of no less than one
year, in the amount of the then current base salary rate, subject to certain
limitations; (b) continued group health insurance benefits (i.e. medical,
dental, prescription insurance, etc) for the Named Executive and his eligible
dependents for a period of up to one year at no cost to the Named Executive; and
(c) all unvested stock options held by the Named Executive will become one
hundred percent (100%) vested and immediately exercisable as of the date of
termination.
35
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of August 26, 2003, information
regarding the security ownership of the directors and certain executive officers
of the Company and persons known to the Company to be beneficial owners of more
than five (5%) percent of the Company's common stock:
Excluding Options
and Debentures Including Options (*)
------------------------ -------------------------
Name and Address of Number Percent Number Percent of
Beneficial Owner Office of Shares of Class of Shares Class
---------------- --------------- ----------- -------- ----------- ----------
Directors/Executive Officers:
Arthur Bedrosian
9000 State Road
Philadelphia, PA 19136 President 496,860(1) 2.48% 502,860(2) 2.50%
Larry Dalesandro
9000 State Road Chief Financial
Philadelphia, PA 19136 Officer 0 0.00% 0 0.00%
William Farber
9000 State Road Chairman of the
Philadelphia, PA 19136 Board 13,676,679(3) 68.23% 13,714,179(4) 68.10%
Marvin Novick
9000 State Road
Philadelphia, PA 19136 Director 100,000 0.50% 122,500(5) 0.61%
Ronald A. West
9000 State Road
Philadelphia, PA 19136 Director 12,810 0.06% 22,758(6) 0.11%
Myron Winkelman
9000 State Road
Philadelphia, PA 19136 Director 1,000 0.00% 1,000 0.00%
All directors and
executive officers as a group
(6 persons) 14,287,349 71.27% 14,363,297 71.32%
(1) Includes 52,125 shares owned jointly by Arthur Bedrosian and Shari
Bedrosian, Arthur Bedrosian's spouse, and 12,000 shares owned by Talin
Bedrosian, Arthur Bedrosian's daughter.
(2) Includes 6,000 vested options to purchase common stock at an exercise
price of $4.63 per share.
(3) Includes 300,000 shares owned jointly by William Farber and Audrey Farber,
the Secretary of the Company and William's Farber's spouse.
(4) Includes 37,500 vested options to purchase common stock at an exercise
price of $7.97 per share.
(5) Includes 22,500 vested options to purchase common stock at an exercise
price of $7.97 per share.
(6) Includes 9,948 vested options to purchase common stock at an exercise
price of $7.97 per share.
* Assumes that all options exercisable within sixty days have been
exercised, which results in 20,139,113 shares outstanding.
36
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
William Farber, the Chairman of the Board of Directors and Chief Executive
Officer, had provided the Company with a revolving line of credit due December
1, 2002 of $4,250,000, which the Company used to renovate its manufacturing
facility, acquire new equipment, retain new management and provide working
capital. The line of credit had a stated interest rate equal to the prime
interest rate plus 1%. In the Company's opinion, the terms of these transactions
were not more favorable to the related party than would have been to a
non-related party. See MANAGEMENT'S DISCUSSION AND ANALYSIS -- Liquidity and
Capital Resources." Mr. Farber is currently the holder of 13,676,679 shares of
common stock of the Company, or approximately 68% of the Company's issued and
outstanding shares. See "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT."
The Company had sales of approximately $348,000 and $174,000 during the
years ended June 30, 2003 and 2002, respectively, to a generic distributor,
Auburn Pharmaceutical Company (the "related party") in which the owner, Jeffrey
Farber, is the son of the Chairman of the Board of Directors and principal
shareholder of the Company, William Farber. The Company also incurred sales
commissions payable to the related party of approximately $68,000 and $221,000
during the years ended June 30, 2003 and 2002, respectively. Accounts receivable
includes amounts due from the related party of approximately $95,000 and $59,000
at June 30, 2003 and June 30, 2002, respectively. Accrued expenses include
amounts due to the related party of approximately $0 and $8,000 at June 30, 2003
and June 30, 2002, respectively. In the Company's opinion, the terms of these
transactions were not more favorable to the related party than would have been
to a non-related party.
Stuart Novick, the son of Marvin Novick, a Director on the Company's Board
of Directors, was employed by two insurance brokerage companies (the "Insurance
Companies") that provide insurance agency services to the Company. The Company
paid approximately $28,000 and $224,000 during Fiscal 2003 and 2002,
respectively, to the Insurance Companies for various insurance coverage
policies. There were no amounts due to the Insurance Companies as of June 30,
2003 and June 30, 2002. In the Company's opinion, the terms of these
transactions were not more favorable to the related party than would have been
to a non-related party.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) A list of the exhibits required by Item 601 of Regulation S-B to be
filed as a part of this Form 10-KSB is shown on the Exhibit Index
filed herewith.
(b) The Company did not file any reports on Form 8-K during the Quarter
ended June 30, 2003.
37
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Grant Thornton LLP served as the independent auditors of the Company during
Fiscal 2003; and no relationship exists other than the usual relationship
between independent public accountant and client. The following table identifies
the fees paid to Grant Thornton LLP in Fiscal 2003.
AUDIT-RELATED FEES TAX FEES ALL OTHER FEES
AUDIT FEES (1) (2) (3) TOTAL FEES
---------- ------------------ -------- -------------- ----------
Fiscal 2003:
$72,561 $7,700 $ 17,816 $ 45,343 $ 143,420
Fiscal 2002:
$63,833 $ 0 $ 56,087 $ 40,378 $ 160,298
(1) Audit-related fees include fees paid for preparation and participation in
Board of Director meetings, and Audit Committee meetings.
(2) Tax fees include fees paid for preparation of annual federal, state and
local income tax returns, quarterly estimated income tax payments, and various
tax planning services. Included in the Fiscal 2002 fees for this category is
$46,670 paid in connection with services rendered by Grant Thornton LLP in the
Company's application and receipt of a tax refund due to an amended state income
tax return.
(3) Other fees include:
Fiscal 2003 - Fees paid for services rendered in connection with the
Company's application to various local and state entities for benefits
related to the Company's potential facility expansion; and services
rendered in connection with an engagement for interest expense arbitrage
calculations on certain tax exempt bond issues.
Fiscal 2002 - Fees paid for valuation services related to the Company's
creation of its wholly-owned subsidiary, Lannett Holdings, Inc.
The non-audit services provided to the Company by Grant Thornton LLP in Fiscal
2003 were pre-approved by the Company's audit committee. Prior to engaging its
auditor to perform non-audit services, the Company's audit committee reviews the
particular service to be provided and the fee to be paid by the Company for such
service and assesses the impact of the service on the auditor's independence.
38
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
LANNETT COMPANY, INC.
Date: May 10, 2004 By: / s / William Farber
-----------------------------------
William Farber,
Chairman of the Board and
Chief Executive Officer
Date: May 10, 2004 By: / s /Larry Dalesandro
-----------------------------------
Larry Dalesandro,
Chief Financial Officer
Chief Accounting Officer
Date: May 10, 2004 By: / s /Arthur Bedrosian
-----------------------------------
Arthur Bedrosian,
President
Date: May 10, 2004 By: / s /Marvin Novick
-----------------------------------
Marvin Novick,
Director
Date: May 10, 2004 By: / s /Ronald West
-----------------------------------
Ronald West,
Director
Date: May 10, 2004 By: / s /Myron Winkelman
-----------------------------------------
Myron Winkelman,
Director
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signature Date
--------- ----
/ s / William Farber May 10, 2004
-----------------------------------------
William Farber,
Chairman of the Board of Directors and
Chief Executive Officer
/ s / Larry Dalesandro May 10, 2004
-----------------------------------------
Larry Dalesandro,
Chief Financial Officer
/ s / Arthur Bedrosian May 10, 2004
-----------------------------------------
Arthur Bedrosian,
President
/ s / Marvin Novick May 10, 2004
-----------------------------------------
Marvin Novick,
Director
/ s / Ronald West May 10, 2004
-----------------------------------------
Ronald West,
Director
/ s / Myron Winkelman May 10, 2004
-----------------------------------------
Myron Winkelman,
Director
39
EXHIBIT 13
ANNUAL REPORT ON FORM 10-KSB
Report of Independent Certified Public Accountants
Shareholders and Board of Directors
Lannett Company, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Lannett
Company, Inc. and Subsidiaries as of June 30, 2003 and 2002, and the related
consolidated statements of operations, changes in shareholders' equity and cash
flows for each of the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Lannett Company, Inc. and Subsidiaries as of June 30, 2003 and 2002, and the
consolidated results of their operations and cash flows for each of the years
then ended in conformity with accounting principles generally accepted in the
United States of America.
Grant Thornton LLP
Philadelphia, Pennsylvania
August 12, 2003
40
CONSOLIDATED BALANCE SHEETS
JUNE 30,
2003 2002
ASSETS
CURRENT ASSETS:
Cash $ 3,528,511 $ -
Trade accounts receivable (net of allowance for
doubtful accounts of $128,000 and $42,000,
respectively) 8,516,481 4,465,885
Inventories 8,175,798 4,937,207
Prepaid expenses and other assets 367,400 106,170
Deferred tax asset 569,858 300,368
------------ ------------
Total current assets 21,158,048 9,809,630
PROPERTY, PLANT AND EQUIPMENT 11,885,728 10,144,968
Less accumulated depreciation 4,477,928 3,616,044
------------ ------------
7,407,800 6,528,924
OTHER ASSETS 496,696 369,949
------------ ------------
TOTAL ASSETS $ 29,062,544 $ 16,708,503
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ - $ 202,688
Current portion of long-term debt 718,333 596,517
Accounts payable 2,664,616 733,984
Accrued expenses 526,430 657,891
Income taxes payable 63,617 726,552
------------ ------------
Total current liabilities 3,972,996 2,917,632
LONG-TERM DEBT, LESS CURRENT PORTION 2,379,469 3,343,333
DEFERRED TAX LIABILITY 1,112,369 681,489
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock - authorized 50,000,000 shares,
par value $0.001; issued and outstanding,
20,025,871 and 19,894,257 shares, respectively 20,026 19,894
Additional paid-in capital 2,526,077 2,360,261
Retained earnings 19,051,607 7,385,894
------------ ------------
Total shareholders' equity 21,597,710 9,766,049
------------ ------------
TOTAL LIABILITES AND SHAREHOLDERS' EQUITY $ 29,062,544 $ 16,708,503
============ ============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
41
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30,
2003 2002
NET SALES $ 42,486,758 $ 25,126,214
COST OF SALES 16,257,794 8,452,677
------------ ------------
Gross profit 26,228,964 16,673,537
RESEARCH AND DEVELOPMENT EXPENSES 2,575,178 1,748,631
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 4,337,558 3,298,564
LOSS ON SALE OF ASSETS 119,279 63,682
LOSS ON IMPAIRMENT/ABANDONMENT OF ASSETS 136,843 137,177
------------ ------------
Operating profit 19,060,106 11,425,483
------------ ------------
OTHER INCOME/(EXPENSE):
Interest income 2,297 25,135
Interest expense, including $0 and $131,245 to shareholder (60,776) (270,493)
------------ ------------
(58,479) (245,358)
------------ ------------
INCOME BEFORE INCOME TAX EXPENSE 19,001,627 11,180,125
INCOME TAX EXPENSE 7,334,740 3,984,135
------------ ------------
NET INCOME $ 11,666,887 $ 7,195,990
============ ============
Basic earnings per common share $ 0.58 $ 0.36
============ ============
Diluted earnings per common share $ 0.58 $ 0.36
============ ============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
42
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED JUNE 30, 2003 AND 2002
COMMON STOCK
-------------------------- ADDITIONAL
SHARES PAID-IN RETAINED SHAREHOLDERS'
ISSUED AMOUNT CAPITAL EARNINGS EQUITY
BALANCE, JULY 1, 2001 19,809,192 19,809 $ 2,305,972 $ 189,904 $ 2,515,685
Exercise of stock options 85,065 85 54,289 - 54,374
Net income 7,195,990 7,195,990
------------ ------------
BALANCE, JUNE 30, 2002 19,894,257 19,894 2,360,261 7,385,894 9,766,049
Exercise of stock options 131,709 132 165,816 - 165,948
Stock Split-shares repurchased
due to odd quantity holders (95) - (1,174) (1,174)
Net income - - - 11,666,887 11,666,887
---------- ------------ ------------ ------------ ------------
BALANCE, JUNE 30, 2003 20,025,871 $ 20,026 $ 2,526,077 $ 19,051,607 $ 21,597,710
========== ============ ============ ============ ============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
Note: All share amounts have been restated to reflect a 3 for 2 stock split,
effective February 14, 2003.
43
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30,
2003 2002
OPERATING ACTIVITIES:
Net income $ 11,666,887 $ 7,195,990
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 982,188 789,304
Loss on disposal/impairment of assets 256,122 200,859
Deferred tax expense 161,390 723,239
Changes in assets and liabilities which provided (used) cash:
Trade accounts receivable (4,050,596) (99,297)
Inventories (3,238,591) (1,781,098)
Prepaid expenses and other assets (261,230) 24,863
Accounts payable 1,930,632 (183,413)
Accrued expenses (131,461) 87,972
Income taxes payable (662,935) 478,443
------------ ------------
Net cash provided by operating activities 6,652,406 7,436,861
------------ ------------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (2,618,936) (1,952,535)
Deposits paid on machinery and equipment not yet received - (187,665)
Proceeds from sale of property, plant and equipment 375,003 54,000
------------ ------------
Net cash used in investing activities (2,243,933) (2,086,200)
------------ ------------
FINANCING ACTIVITIES:
Net repayments under line of credit (202,688) (1,797,312)
Repayments under line of credit - shareholder - (4,225,000)
Repayments of debt (842,048) (608,372)
Proceeds from debt, net of restricted cash released - 1,225,649
Proceeds from issuance of stock 165,948 54,374
Payments made in lieu of stock split (1,174) -
------------ ------------
Net cash used in financing activities (879,962) (5,350,661)
------------ ------------
NET INCREASE IN CASH 3,528,511 -
CASH, BEGINNING OF YEAR - -
------------ ------------
CASH, END OF YEAR $ 3,528,511 $ -
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION -
Interest paid during year $ 57,688 $ 293,323
============ ============
Income taxes paid $ 7,436,964 $ 2,782,453
============ ============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2003 AND 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Lannett Company, Inc. and subsidiaries (the "Company"), a Delaware corporation,
develops, manufactures, packages, markets and distributes pharmaceutical
products sold under generic chemical names.
The Company is engaged in an industry which is subject to considerable
government regulation related to the development, manufacturing and marketing of
pharmaceutical products. In the normal course of business, the Company
periodically responds to inquiries or engages in administrative and judicial
proceedings involving regulatory authorities, particularly the Food and Drug
Administration (FDA) and the Drug Enforcement Agency (DEA).
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the
accounts of the operating parent company, Lannett Company, Inc., its inactive
wholly owned subsidiary, Astrochem Corporation and its wholly owned subsidiary,
Lannett Holdings, Inc. All intercompany accounts and transactions have been
eliminated.
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 reductions to net sales and accounts
receivable. Accounts receivable are presented net of allowances relating to
these provisions, which were approximately $2,772,000 and $630,000 at June 30,
2003 and June 30, 2002, respectively. Provisions for estimated rebates,
promotional and other credits are estimated based on historical payment
experience, estimated customer inventory levels and contract terms. Provisions
for other customer credits, such as price adjustments, returns and chargebacks
require management to make subjective judgments. These provisions are discussed
in further detail below. If the historical data the Company uses, and the
assumptions management makes to calculate these estimates do not accurately
approximate future activity, its net sales, gross profit, net income and
earnings per share could change. However, management believes that these
estimates are reasonable based upon historical experience and current
conditions.
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 wholesalers. 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. 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 to the large wholesale customers, such as Cardinal
Health, AmerisourceBergen and McKesson Corporation, increase, the reserve for
chargebacks will also generally increase. However, the size of the increase
depends on the product mix. The Company continually monitors the reserve for
chargebacks and makes adjustments when it believes that actual chargebacks may
differ from estimated reserves.
45
REBATES - Rebates are offered to the Company's key customers to promote customer
loyalty and encourage greater 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 certain wholesale and retail customers increase.
However, these rebate programs are tailored to the customers' individual
programs. Hence, the reserve will depend on the mix of customers that comprise
such rebate programs.
RETURNS - Consistent with industry practice, the Company has a product returns
policy that allows select 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 it believes that actual
product returns may differ from established reserves. Generally, the reserve for
returns increases as net sales increase.
PRICE ADJUSTMENTS - Price adjustments, also known as "shelf stock adjustments,"
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.
INVENTORIES - Inventories are valued at the lower of cost (determined under the
first-in, first-out method) or market.
PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment are stated at
cost. Depreciation and amortization are provided for by the straight-line and
accelerated methods over estimated useful lives of the assets. Depreciation
expense for the years ended June 30, 2003 and 2002 was approximately $945,000
and $747,000, respectively.
DEFERRED DEBT ACQUISITION COSTS - Costs incurred in connection with obtaining
financing are amortized by the straight-line method over the term of the loan
arrangements. Amortization expense for the years ended June 30, 2003 and 2002
was approximately $37,000 and $42,000, respectively.
SHIPPING AND HANDLING COSTS - The cost of shipping products to customers is
recognized at the time the products are shipped, and is included in COST OF
SALES.
RESEARCH AND DEVELOPMENT - Research and development expenses are charged to
operations as incurred.
46
ADVERTISING COSTS - The Company charges advertising costs to operations as
incurred. Advertising expense for the years ended June 30, 2003 and 2002 was
approximately $118,000 and $16,000, respectively.
INCOME TAXES - The Company uses the liability method specified by Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting 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.
LONG-LIVED ASSETS - SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, provides guidance on when to
recognize and how to measure impairment losses of long-lived assets and certain
identifiable intangibles and how to value long-lived assets to be disposed of.
Impairment losses recognized during the years ended June 30, 2003 and 2002 were
$136,843 and $137,177, respectively (See NEW ACCOUNTING PRONOUNCEMENTS). The
impairment losses recognized during Fiscal 2003 represent a reduction in the net
book value of certain leasehold improvements at the 500 State Road facility. The
Company has made a preliminary decision to move the operations currently
performed at this facility to a new facility at 9001 Torresdale Avenue. As a
result of this decision, the Company expects to abandon certain leasehold
improvements at the 500 State Road building.
EARNINGS PER COMMON SHARE - SFAS No. 128, Earnings Per Share, requires a dual
presentation of basic and diluted earnings per share on the face of the
Company's consolidated statement of income and a reconciliation of the
computation of basic earnings per share to diluted earnings per share. Basic
earnings per share excludes the dilutive impact of common stock equivalents and
is computed by dividing net income by the weighted-average number of shares of
common stock outstanding for the period. Diluted earnings per share includes the
effect of potential dilution from the exercise of outstanding common stock
equivalents into common stock using the treasury stock method. Earnings per
share amounts for all periods presented have been calculated in accordance with
the requirements of SFAS No. 128. A reconciliation of the Company's basic and
diluted earnings per share follows:
2003 2002
--------------------------------- -------------------------------
NET INCOME SHARES NET INCOME SHARES
(NUMERATOR) (DENOMINATOR) (NUMERATOR) (DENOMINATOR)
Basic earnings per share factors $ 11,666,887 19,968,633 $ 7,195,990 19,895,757
Effect of potentially dilutive option
plans and debentures 152,681 122,791
--------------- ---------- -------------- ----------
Diluted earnings per share factors $ 11,666,887 20,121,314 $ 7,195,990 20,018,548
=============== ========== ============== ==========
Basic earnings per share $ 0.58 $ 0.36
Diluted earnings per share $ 0.58 $ 0.36
The number of shares have been adjusted for the Company's 3 for 2 stock split
in February 2003.
Options to purchase 15,525 shares, 10,001 shares, 50,625 shares, 292,755 shares
and 40,815 shares of common stock at $0.75 per share, $2.30 per share, $4.63 per
share, $7.97 per share and $11.27 per share, respectively, were outstanding at
June 30, 2003. Adjusted for the effect of the Company's 3 for 2 stock split in
February 2003, options to purchase 66,533 shares, 23,753 shares, 15,000 shares,
45,000 shares and 1,575 shares of common stock at $0.75 per share, $0.53 per
share, $2.30 per share, $0.92 per share and $2.52 per share, respectively, were
outstanding at June 30, 2002.
47
SEGMENT INFORMATION - The Company reports segment information in accordance with
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information. The Company operates one business segment--generic pharmaceuticals.
In accordance with SFAS No. 131, the Company aggregates its financial
information for all products, and reports on one operating segment. The
Company's products contain various active pharmaceutical ingredients aimed at
treating a diverse range of medical indications. The following table identifies
the Company's net product sales by medical indication for Fiscal 2003 and 2002.
MEDICAL INDICATION FISCAL 2003 FISCAL 2002
------------------ ----------- -----------
Migraine Headache $18,969,000 $14,294,000
Epilepsy 15,279,000 6,446,000
Heart Failure 4,977,000 0
Thyroid Deficiency 902,000 0
Cough/Cold 681,000 3,266,000
Other 1,679,000 1,120,000
----------- -----------
Total $42,487,000 $25,126,000
=========== ===========
CONCENTRATION OF CREDIT RISK AND ACCOUNTS RECEIVABLE - One customer accounted
for approximately 13% of net sales in Fiscal 2003. Another customer accounted
for approximately 12% and 22% of net sales in Fiscal 2003 and Fiscal 2002,
respectively. Another customer accounted for 19% of net sales in Fiscal 2002.
One of the Company's products accounted for approximately 35% and 54%,
respectively, of net sales in fiscal years ended June 30, 2003 and June 30,
2002. Another product accounted for approximately 26% of net sales in fiscal
year ended June 30, 2003. The Company expects these percentages to decrease as
it continues to market additional products.
Credit terms are offered to customers based on evaluations of the customers'
financial condition. Generally, collateral is not required from customers.
Accounts receivable payment terms vary, and are stated in the financial
statements at amounts due from customers net of an allowance for doubtful
accounts. Accounts outstanding longer than the payment terms are considered past
due. The Company determines its allowance by considering a number of factors,
including the length of time trade accounts receivable are past due, the
Company's previous loss history, the customer's current ability to pay its
obligation to the Company, and the condition of the general economy and the
industry as a whole. The Company writes-off accounts receivable when they become
uncollectible, and payments subsequently received on such receivables are
credited to the allowance for doubtful accounts.
STOCK OPTIONS - At June 30, 2003, the Company had two stock-based employee
compensation plans (See Note 9). The Company accounts for stock options under
SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No.
148. Under this statement, companies may use a fair value-based method for
valuing stock-based compensation, which measures compensation cost at the grant
date, based on the fair value of the award. Compensation is then recognized over
the service period, which is usually the vesting period. Alternatively, SFAS No.
123 permits entities to continue accounting for employee stock options
48
and similar equity instruments under Accounting Principles Board (APB) Opinion
25, "Accounting for Stock Issued to Employees." Entities that continue to
account for stock options using APB Opinion 25 are required to make pro forma
disclosures of net income and earnings per share, as if the fair value-based
method of accounting defined in SFAS No.123 had been applied. The following
table illustrates the effect on net income and earnings per share if the Company
had applied the fair value recognition provisions of SFAS No. 123 to stock-based
employee compensation.
FISCAL YEAR ENDED JUNE 30,
2003 2002
Net income, as reported $ 11,666,887 $ 7,195,990
Deduct: Total compensation expense
determined under fair value-based
method for all stock awards (539,029) (90,302)
Add: Tax savings at effecive rate 208,065 32,148
--------------- ---------------
Pro forma net income 11,335,923 7,137,836
=============== ===============
Earnings per share:
Basic, as reported $ 0.58 $ 0.36
=============== ===============
Basic, pro forma $ 0.57 $ 0.36
=============== ===============
Diluted, as reported $ 0.58 $ 0.36
=============== ===============
Diluted, pro forma $ 0.56 $ 0.36
=============== ===============
USE OF ESTIMATES - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
NEW ACCOUNTING PRONOUNCEMENTS
On July 20, 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) 141, Business Combinations,
and SFAS 142, Goodwill and Intangible Assets. SFAS 141 is effective for all
business combinations completed after June 30, 2001. SFAS 142 is effective for
fiscal years beginning after December 15, 2001; however, certain provisions of
this Statement apply to goodwill and other intangible assets acquired between
July 1, 2001 and the effective date of SFAS 142. Major provisions of these
Statements and their effective dates for the Company are as follows:
- all business combinations initiated after June 30, 2001 must use the purchase
method of accounting. The pooling of interest method of accounting is prohibited
except for transactions initiated before July 1, 2001.
- intangible assets acquired in a business combination must be recorded
separately from goodwill if they arise from contractual or other legal rights or
are separable from the acquired entity and can be sold, transferred, licensed,
rented or exchanged, either individually or as part of a related contract, asset
or liability
49
- goodwill, as well as intangible assets with indefinite lives, acquired after
June 30, 2001, are not amortized. Effective July 1, 2002, all previously
recognized goodwill and intangible assets with indefinite lives are no longer
subject to amortization.
- Effective July 1, 2002, goodwill and intangible assets with indefinite lives
are to be tested for impairment annually and whenever there is an impairment
indicator
- all acquired goodwill must be assigned to reporting units for purposes of
impairment testing and segment reporting.
Management's assessment is that these Statements did not have a material impact
on the Company's financial position or results of operations.
In August 2001, the FASB issued SFAS 143, Accounting for Asset Retirement
Obligations. SFAS 143 applies to all entities, including rate-regulated
entities, that have legal obligations associated with the retirement of a
tangible long-lived asset that results from acquisition, construction or
development and (or) normal operations of the long-lived asset. The application
of this Statement is not limited to certain specialized industries, such as the
extractive or nuclear industries. This Statement also applies, for example, to a
company that operates a manufacturing facility and has a legal obligation to
dismantle the manufacturing plant and restore the underlying land when it cease
operation of that plant. A liability for an asset retirement obligation should
be recognized if the obligation meets the definition of a liability and can be
reasonably estimated. The initial recording should be at fair value. SFAS 143 is
effective for financial statements issued for fiscal years beginning after June
15, 2002, with earlier application encouraged. The provisions of this Statement
do not have a material impact on the financial condition or results of
operations of the Company.
The Company adopted the provisions of SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS No. 144 retains the existing requirements to
recognize and measure the impairment of long-lived assets to be held and used or
to be disposed of by sale. However, SFAS 144 makes changes to the scope and
certain measurement requirements of existing accounting guidance. SFAS 144 also
changes the requirements relating to reporting the effects of a disposal or
discontinuation of a segment of a business. SFAS 144 is effective for financial
statements issued for fiscal years beginning after December 15, 2001 and interim
periods within those fiscal years. The adoption of this statement did not have a
significant impact on the financial condition or results of operations of the
Company.
The Company adopted SFAS 145, Rescission of FASB Statements No. 4, 44 and 64,
Amendment of FASB No. 13, and Technical Corrections. SFAS No. 145 changes the
accounting principles governing extraordinary items by clarifying and, to some
extent, modifying the existing definition and criteria, specifying disclosure
for extraordinary items and specifying disclosure requirements for other unusual
or infrequently occurring events and transactions that are not extraordinary
items. SFAS 145 is effective for financial statements issued for fiscal years
beginning after June 15, 2002, with early adoption encouraged. The adoption of
this statement did not have a significant impact on the financial condition or
results of operations of the Company.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" (SFAS 146). SFAS 146 requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS 146 is effective prospectively for exit and disposal activities initiated
after December 31, 2002. The adoption of this statement did not have a
significant impact on the financial condition or results of operations of the
Company.
50
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure, an amendment of FASB Statement No.
123." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
disclosure provisions of SFAS No. 148 have been adopted by the Company during
the quarter ended March 31, 2003. See Note 9.
In November 2002, FASB Interpretation 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others (FIN 45), was issued. FIN 45 requires a guarantor entity, at the
inception of a guarantee covered by the measurement provisions of the
interpretation, to record a liability for the fair value of the obligation
undertaken in issuing the guarantee. The Company previously did not record a
liability when guaranteeing obligations unless it became probable that the
Company would have to perform under the guarantee. FIN 45 applies prospectively
to guarantees the Company issues or modifies subsequent to December 31, 2002,
but has certain disclosure requirements effective for interim and annual periods
ending after December 15, 2002. The Company has not historically issued
guarantees and does not anticipate FIN 45 will have a material effect on its
fiscal 2004 consolidated financial statements.
In January 2002, the FASB issued FASB Interpretation 46 (FIN 46),Consolidation
of Variable Interest Entities. FIN 46 clarifies the application of Accounting
Research Bulletin 51, Consolidated Financial Statements, for certain entities
that do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties
or in which equity investors do not have the characteristics of a controlling
financial interest ("variable interest entities"). Variable interest entities
within the scope of FIN 46 will be required to be consolidated by their primary
beneficiary. The primary beneficiary of a variable interest entity is determined
to be the party that absorbs a majority of the entity's expected losses,
receives a majority of its expected returns, or both. FIN 46 applies immediately
to variable interest entities created after January 31, 2002, and to variable
interest entities in which an enterprise obtains an interest after that date. It
applies in the first fiscal year or interim period beginning after June 15,
2002, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2002. The adoption of FIN 46 did
not have a material effect on the Company's consolidated financial position,
results of operations, or cash flows.
On May 15, 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were
51
previously classified as equity. SFAS No. 150 affects the issuer's accounting
for three types of freestanding financial instruments:
- mandatorily redeemable shares, which the issuing company is
obligated to buy back in exchange for cash or other assets;
- instruments that do or may require the issuer to buy back some of
its shares in exchange for cash or other assets, including put
options and forward purchase contracts; and
- obligations that can be settled with shares, the monetary value of
which is fixed, tied solely or predominantly to a variable such as a
market index, or varies inversely with the value of the issuers'
shares.
SFAS No. 150 does not apply to features embedded in a financial instrument that
is not a derivative in its entirety.
Most of the guidance in SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 is not expected to have a material effect on the
Company's consolidated financial position, results of operations or cash flows.
RECLASSIFICATIONS - Certain reclassifications were made to the 2002 consolidated
financial statements to conform to the 2003 presentation.
2. INVENTORIES
Inventories at June 30, 2003 and 2002 consist of the following:
2003 2002
Raw materials $2,625,463 $2,479,344
Work-in-process 992,330 691,346
Finished goods 4,363,432 1,560,029
Packaging supplies 194,573 206,488
---------- ----------
$8,175,798 $4,937,207
========== ==========
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment at June 30, 2003 and 2002 consist of the
following:
USEFUL LIVES 2003 2002
Land - $ 33,414 $ 33,414
Building and improvements 10 - 39 years 3,487,261 3,124,268
Machinery and equipment 5 - 10 years 7,896,058 6,877,429
Furniture and fixtures 5 - 7 years 146,570 109,857
Construction in Progress - 322,425 -
----------- ------------
$11,885,728 $ 10,144,968
=========== ============
52
4. BANK LINE OF CREDIT
The Company has a $3,000,000 line of credit with a bank that bears interest at
the prime interest rate minus 0.25% per annum (4.00% at June 30, 2003). The line
of credit is due November 30, 2003. The Company expects to extend the maturity
date before the scheduled due date. At June 30, 2003, the Company had $0
outstanding, and $3,000,000 available under the line of credit. The line of
credit is collateralized by substantially all Company assets. Further, the line
of credit and a related letter of credit contain certain financial covenants
(see Note 5).
5. LONG-TERM DEBT
Long-term debt at June 30, 2003 and 2002 consists of the following:
2003 2002
Tax-exempt Bond Loan $3,097,802 $3,700,000
Taxable Bond Loan 239,850
---------- ----------
3,097,802 3,939,850
Less current portion 718,333 596,517
---------- ----------
$2,379,469 $3,343,333
========== ==========
In April 1999, the Company entered into a loan agreement (the "Agreement") with
a governmental authority (the "Authority") to finance future construction and
growth projects of the Company. The Authority has issued $3,700,000 in
tax-exempt variable rate demand and fixed rate revenue bonds to provide the
funds to finance such growth projects pursuant to a trust indenture (the "Trust
Indenture"). The bonds were issued under and secured by a Trust Indenture
between the Authority and a bank, as trustee. A portion of the Company's
proceeds from the bonds was used to pay for bond issuance costs of approximately
$170,000. The remainder of the proceeds was deposited into a money market
account, which was restricted to future plant and equipment needs of the Company
as specified in the Agreement. The Agreement requires the Company to repay the
Authority loan through installment payments beginning in May 2003 and continuing
through May 2014, the year the bonds mature. Such payments will be deposited
into an interest-bearing debt service money market account. The bonds bear
interest at the floating variable rate determined by the organization
responsible for selling the bonds (the "remarketing agent"). The interest rate
fluctuates on a weekly basis. The effective interest rate at June 30, 2003 was
1.2%. The Company has an option to convert the bonds to a fixed rate of interest
under certain conditions. At June 30, 2003, the Company has $3,097,802
outstanding on the Authority loan, of which $718,333 is classified as currently
due. The remainder is classified as a long-term liability. In April 1999, an
irrevocable letter of credit of $3,770,000 was issued by a bank to secure
payment of the Authority loan and a portion of the related accrued interest. At
June 30, 2003, no portion of the letter of credit has been utilized.
53
In April 1999, the Company authorized and directed the issuance of $2,300,000 in
taxable variable rate demand and fixed rate revenue bonds pursuant to a trust
indenture between the Company and a bank, as trustee (the "Trust Indenture
(Taxable)"). From the proceeds of the bonds, $750,000 was utilized to pay
deferred interest owed to the principal shareholder of the Company and
approximately $1,440,000 was paid to a bank to refinance a mortgage term loan
and equipment term loans. The remainder of the proceeds was used to pay bond
issuance costs of approximately $109,000. The Trust Indenture (Taxable) required
the Company to repay the bonds through installment payments beginning in May
2000 and continuing through May 2003, the year the bonds matured.
Annual repayments of debt, including sinking fund requirements, as of June 30,
2003 are as follows:
YEAR ENDING AMOUNTS PAYABLE
JUNE 30, TO INSTITUTIONS
2004 $ 718,333
2005 706,667
2006 678,333
2007 300,000
2008 108,333
Thereafter 586,136
----------
$3,097,802
==========
6. LINE OF CREDIT PAYABLE TO SHAREHOLDER
On October 1, 2001, a debt modification agreement was consummated, by and
between, the Company and its principal shareholder relating to the line of
credit agreement described below. The Company and its principal shareholder had
previously modified the debt agreement relating to the line of credit as of
March 15, 1993, August 1, 1994, May 15, 1995, December 31, 1995, June 30, 1996,
November 1, 1996, September 9, 1997, June 30, 1998, December 30, 1998, December
31, 1999 and October 1, 2000. In each of the modifications, the maturity date of
the debt was extended.
The Company had a $4,250,000 revolving line of credit from a shareholder who is
also the Chairman of the Board ("Shareholder Line of Credit"). The maturity date
on the Shareholder Line of Credit was December 1, 2002. The Company did not
renew this line of credit because the cash available from its current and
prospective loan agreements, and the cash generated from its operations were
estimated to be sufficient to support the Company's anticipated growth, in terms
of cash requirements. At June 30, 2002, the Company had no amount outstanding
and $4,250,000 available under this line of credit.
The interest rate on the line of credit was the prime rate published by Michigan
National Bank plus 1% per annum. Interest expense during the years ended June
30, 2003 and 2002 was approximately $0, and $131,245, respectively. Accrued
interest at June 30, 2003 and June 30, 2002 was $0. The line of credit was
collateralized by substantially all Company assets, and was subordinated to the
bank letters of credit and line of credit.
54
7. INCOME TAXES
The provision for income taxes consists of the following for the years ended
June 30.
2003 2002
Current Income Taxes $ 7,173,350 $ 3,260,896
Deferred Income Taxes 161,390 723,239
------------ -----------
$ 7,334,740 $ 3,984,135
============ ===========
A reconciliation of the differences between the effective rates and statutory
rates is as follows:
2003 2002
Federal income tax at statutory rate 35.0% 34.0%
State and local income tax, net 6.5% 3.1%
Other -2.9% -1.5%
---- ----
Income taxes expense/(benefit) 38.6% 35.6%
==== ====
The principal types of differences between assets and liabilities for financial
statement and tax return purposes are net operating loss carryforwards and
accumulated depreciation. As of June 30, 2003, the Company has utilized all of
its available federal net operating loss carryforwards of approximately
$2,457,000. A deferred tax liability is recorded for the future liability
created by different depreciation methods for financial statement and tax return
purposes. As of June 30, 2003 and 2002, temporary differences which give rise to
deferred tax assets and liabilities are as follows:
2003 2002
Deferred tax assets:
Accrued expenses $ 30,077 $ 38,370
Reserves for Accounts Receivable and Inventory 539,781 261,998
----------- -----------
569,858 300,368
Valuation allowance - -
----------- -----------
Total 569,858 300,368
Deferred tax liability - Accumulated Depreciation on
Property, Plant and Equipment 1,112,369 681,489
----------- -----------
Net deferred tax liability $ (542,511) $ (381,121)
=========== ===========
8. STOCK OPTIONS
In Fiscal 1993, the Company adopted the 1993 Long-Term Incentive Plan (the "1993
Plan"). Pursuant to the 1993 Plan and its amendments, employees and
non-employees of the Company may be granted stock options, which qualify as
incentive stock options, as well as stock options which are nonqualified. The
exercise price of the options granted were at least equal to the fair market
value of the common stock on the date of grant. There were 2,000,000 shares
originally reserved for under the 1993 Plan. Of this amount, options for 390,419
shares were granted, and were either exercised by the recipient, or are
currently outstanding. Pursuant to the plan provisions, the 1993 Plan terminated
on February 13, 2003. No additional shares were granted under this Plan after
this date.
In February 2003, the Company adopted the 2003 Incentive Stock Option Plan (the
"2003 Plan"). Pursuant to the 2003 Plan, employees and non-employees of the
Company may be granted stock options which may qualify as incentive stock
options, as well as stock options which are nonqualified. The exercise price of
the incentive stock options is at least the fair market value of the common
stock on the date of grant. The exercise price of nonqualified options may be
above or below the fair market value of the common stock on the date of the
grant. The options generally vest over a three-year period and expire no later
than 10 years from the date of grant. There are 1,125,000 shares reserved for
under the 2003 Plan. Of this amount, options for 40,815 shares were granted in
Fiscal 2003, and were either exercised by the recipient, or are currently
outstanding. Options for 1,084,185 shares remain available for grants under the
Plan.
55
A summary of the status of the combined options for both the 1993 Plan and the
2003 Plan, as of June 30, 2003 and 2002, and the changes during the years then
ended is represented below:
2003 2002
------------------------ -----------------------
WEIGHTED AVG. WEIGHTED AVG.
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
Outstanding beginning of year 151,860 $ 0.94 226,875 $ 0.73
Granted 398,820 7.82 15,000 2.30
Exercised (131,709) 1.26 (85,014) 0.63
Terminated (9,250) 3.74 (5,001) 0.53
-------- -------
Outstanding end of year 409,721 $ 7.47 151,860 $ 0.94
======== ========== ======= ==========
Options exercisable at year-end 98,025 $ 6.82 95,933 $ 0.77
======== ========== ======= ==========
Weighted average fair value of options
granted during the year $ 7.82 $ 2.30
========== ==========
Note: The number of shares and the prices per share in the above table have been
adjusted proportionately, based on the Company's 3 for 2 stock split in February
2003.
OPTIONS OUTSTANDING AT JUNE 30, 2003 OPTIONS EXERCISABLE AT JUNE 30, 2003
------------------------------------- ------------------------------------
EXERCISE # OF AVERAGE AVERAGE # OF AVERAGE AVERAGE
PRICE SHARES LIFE PRICE SHARES LIFE PRICE
$ 0.75 15,525 6.4 $ 0.75 15,525 6.4 $ 0.75
$ 2.30 10,001 8.5 $ 2.30 0 8.5 $ 2.30
$ 4.63 50,625 9.0 $ 4.63 0 9.0 $ 4.63
$ 7.97 292,755 9.3 $ 7.97 82,500 9.3 $ 7.97
$ 11.27 40,815 9.7 $ 11.27 0 9.7 $ 11.27
------- ------
409,721 98,025
------- ------
The fair value of the options granted were estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions for grants
during the years ended June 30, 2003 and 2002: risk-free interest rates ranging
from 3.89% to 5.15%, expected volatility of 79.1% and 70.6%, dividend yield of
0%, and expected life of 10 years.
The Company accounts for stock options under SFAS No. 123, "Accounting for
Stock-Based Compensation," as amended by SFAS No. 148. Under this statement,
companies may use a fair value-based method for valuing stock-based
compensation, which measures compensation cost at the grant date, based on the
fair value of the award. Compensation is then recognized over the service
period, which is usually the vesting period. Alternatively, SFAS No. 123 permits
entities to continue accounting for employee stock options and similar equity
instruments under Accounting Principles Board (APB) Opinion 25, "Accounting for
Stock Issued to Employees." Entities that continue to account for stock options
using APB Opinion 25 are required to make pro forma disclosures of net income
and earnings per share, as if the fair value-based method of accounting defined
in SFAS No.123 had been applied. This disclosure is presented in Note 2.
56
9. EMPLOYEE STOCK PURCHASE PLAN
In February 2003, the Company's shareholders 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 1,125,000 shares (adjusted for the Company's 3
for 2 stock split in February 2003) of the Company's common stock for issuance
under the ESPP. As of June 30, 2003, no shares have been issued under the ESPP.
As of June 30, 2003, employees participating in the ESPP have been granted
options to purchase 2,218 shares.
10. EMPLOYEE BENEFIT PLAN
The Company has a defined contribution 401k plan (the "Plan") covering
substantially all employees. Pursuant to the Plan provisions, the Company is
required to make matching contributions equal to each employee's contribution,
but not to exceed 3% of the employee's compensation for the Plan year.
Contributions to the Plan during the years ended June 30, 2003 and 2002 were
$103,077 and $86,222, respectively.
11. CONTINGENCIES
The Company monitors its compliance with all environmental laws. Any compliance
costs which may be incurred are contingent upon the results of future site
monitoring and will be charged to operations when incurred. No monitoring costs
were incurred during the years ended June 30, 2003 and 2002.
The Company is currently engaged in several civil actions as a co-defendant with
many other manufacturers of Diethylstilbestrol ("DES"), a synthetic hormone.
Prior litigation established that the Company's pro rata share of any liability
is less than one-tenth of one percent. Due to the fact that prior litigation
established the "market share" method of prorating liability amongst the
companies that manufactured DES during the drug's commercial distribution, which
ended in 1971, management has accepted this method as the most reasonably
expected method of determining liability for future outcomes of claims. The
Company was represented in many of these actions by the insurance company with
which the Company maintained coverage (subject to limits of liability) during
the time period that damages were alleged to have occurred. The Company has
either settled or had dismissed approximately 250 claims. An additional 283
claims are currently being defended. Prior settlements have been in the range of
$500 to $3,500. Management believes that the outcome will not have a material
adverse impact on the consolidated financial position or results of operations
of the Company.
In addition to the matters reported herein, the Company is involved in
litigation which arises in the normal course of business. In the opinion of
management, the resolution of these lawsuits will not have a material adverse
effect on the consolidated financial position or results of operations.
57
12. COMMITMENTS
In January 1997, the Company entered into an operating lease for
additional space at 500 State Road, in Bensalem, Pennsylvania. Currently, this
leased facility houses the shipping and receiving department, warehousing, and
the research and development laboratory. The lease was extended through April
30, 2004. On July 1, 2003, the Company entered into another lease for a 62,000
square foot facility at 9001 Torresdale Avenue, Philadelphia, Pennsylvania,
approximately 1 mile from the Company's headquarters. The lease expires on
November 30, 2003; and the Company has the contractual right and option to
purchase the facility at any time during the lease term. The Company currently
expects to exercise this purchase option prior to the lease termination date of
November 30, 2003. The purchase price of this facility is included in the
Company's estimate of $9.3 million in capital expenditures in Fiscal 2004 (See
LIQUIDITY AND CAPITAL RESOURCES). Prior to the expiration of the lease term at
500 State Road, the Company is planning to move all operations currently
performed at 500 State Road to 9001 Torresdale Avenue. In addition to the
laboratory research, warehousing and distribution operations currently performed
at 500 State Road, other operational functions may be moved from the Company
headquarters to 9001 Torresdale Avenue. This move will occur gradually, and will
allow the Company to maximize its FDA approved production facility at 9000 State
Road for production output. In addition to these two facility leases, the
Company also has an operating lease, expiring in 2005, for office equipment.
Future minimum lease payments under these agreements are as follows:
YEAR ENDING JUNE 30, AMOUNT
2004 248,382
2005 11,935
---------
$ 260,317
=========
Rental expense for the years ended June 30, 2003 and 2002 was $138,000 and
$124,000, respectively.
13. RELATED PARTY TRANSACTIONS
The Company had sales of approximately $348,000 and $174,000 during the years
ended June 30, 2003 and 2002, respectively, to a distributor (the "related
party") in which the owner is a relative of the Chairman of the Board of
Directors and principal shareholder of the Company. The Company also incurred
sales commissions payable to the related party of approximately $68,000 and
$221,000 during the years ended June 30, 2003 and 2002, respectively. Accounts
receivable includes amounts due from the related party of approximately $95,000
and $59,000 at June 30, 2003 and June 30, 2002, respectively. Accrued expenses
include amounts due to the related party of approximately $0 and $8,000 at June
30, 2003 and June 30, 2002, respectively.
58
LANNETT COMPANY, INC.
SUPPLEMENTARY QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Lannett's unaudited quarterly consolidated results of operations, and market
price information are shown below:
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
FISCAL 2003
Net Sales $ 12,157,035 $ 11,019,906 $ 10,183,161 $ 9,126,656
Cost of goods sold 4,479,690 3,976,519 3,965,474 3,836,110
------------ ------------ ------------ ------------
Gross Profit 7,677,345 7,043,387 6,217,687 5,290,546
Other Operaing Expenses 2,020,151 1,750,420 1,791,829 1,350,336
------------ ------------ ------------ ------------
Operating Income 5,657,194 5,292,967 4,425,858 3,940,210
Other Income/(Expense) (154,087) (123,253) (13,321) (23,940)
Income Taxes 2,406,418 1,914,081 1,649,624 1,364,617
------------ ------------ ------------ ------------
Net Income 3,096,689 3,255,633 2,762,913 2,551,653
============ ============ ============ ============
Basic earnings per share $ 0.15 $ 0.16 $ 0.14 $ 0.13
============ ============ ============ ============
Diluted Eranings per share $ 0.15 $ 0.16 $ 0.14 $ 0.13
============ ============ ============ ============
Market Price per share
High $ 23.44 $ 15.52 $ 13.97 $ 7.41
============ ============ ============ ============
Low $ 11.36 $ 11.05 $ 5.67 $ 4.63
============ ============ ============ ============
FISCAL 2002
Net Sales $ 7,023,812 $ 8,638,229 $ 5,391,341 $ 4,072,832
Cost of goods sold 2,593,663 2,075,856 2,236,715 1,546,444
------------ ------------ ------------ ------------
Gross Profit 4,430,149 6,562,373 3,154,626 2,526,388
Other Operaing Expenses 1,275,188 1,623,557 1,136,340 1,012,108
------------ ------------ ------------ ------------
Operating Income 3,154,961 4,938,816 2,018,286 1,514,280
Other Income/(Expense) (220,166) (32,252) (84,404) (109,395)
Income Taxes 952,854 1,862,281 677,290 491,710
------------ ------------ ------------ ------------
Net Income 1,981,941 3,044,283 1,256,592 913,175
============ ============ ============ ============
Basic earnings per share $ 0.10 $ 0.15 $ 0.06 $ 0.05
============ ============ ============ ============
Diluted Eranings per share $ 0.10 $ 0.15 $ 0.06 $ 0.05
============ ============ ============ ============
Market Price per share
High $ 8.00 $ 3.77 $ 2.69 $ 1.33
============ ============ ============ ============
Low $ 3.50 $ 2.13 $ 1.13 $ 0.69
------------ ------------ ------------ ------------
59
EXHIBIT INDEX
Exhibit
Number Description Method of Filing Page
------- --------------------------------- ------------------------------------------------ ----
3.1 Articles of Incorporation Incorporated by reference to the Proxy Statement
filed with respect to the Annual Meeting of
Shareholders held on December 6, 1991 (the "1991
Proxy Statement"). -
3.2 By-Laws, as amended Incorporated by reference to the 1991 Proxy
Statement. -
4 Specimen Certificate for Common Incorporated by reference to Exhibit 4(a) to
Stock Form 8 dated April 23, 1993 (Amendment No. 3 to
Form 10-KSB for Fiscal 1992) ("Form 8") -
10.1 Line of Credit Note dated March Incorporated by reference to Exhibit 10(ad) to
11, 1999 between the Company and the Annual Report on 1999 Form 10-KSB -
First Union National Bank
10.2 Philadelphia Authority for Incorporated by reference to Exhibit 10(ae) to
Industrial Development Taxable the Annual Report on 1999 Form 10-KSB -
Variable Rate Demand/Fixed Rate
Revenue Bonds, Series of 1999
10.3 Philadelphia Authority for Incorporated by reference to Exhibit 10(af) to
Industrial Development the Annual Report on 1999 Form 10-KSB -
Tax-Exempt Variable Rate
Demand/Fixed Revenue Bonds
(Lannett Company, Inc. Project)
Series of 1999
10.4 Letter of Credit and Agreements Incorporated by reference to Exhibit 10(ag) to
supporting bond issues between the Annual Report on 1999 Form 10-KSB -
the Company and First Union
National Bank
10.5 2003 Stock Option Plan Incorporated by reference to the Proxy Statement
for Fiscal Year Ending June 30, 2002 -
10.6 Terms of Employment Agreement Filed Herewith 54-55
with Kevin Smith
60
Exhibit
Number Description Method of Filing Page
------------- --------------------------------- ---------------- ----
10.7 Terms of Employment Agreement Filed Herewith 56-57
with Arthur Bedrosian
10.8 Terms of Employment Agreement Filed Herewith 58
with Larry Dalesandro
10.9 (Note A) Agreement between Lannett Filed Herewith
Company, Inc and Siegfried
(USA), Inc.
11 Computation of Earnings Per Share Filed Herewith 59
13 Annual Report on Form 10-KSB Filed Herewith 29-51
21 Subsidiaries of the Company Filed Herewith 60
31.1 Certification of Chief Executive Filed Herewith 61-62
Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Filed Herewith 63-64
Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32 Certifications of Chief Filed Herewith 65
Executive Officer and Chief
Financial Officer Pursuant to
Section 906 of the
Sarbanes-Oxley Act of 2002
Note A: Portions of Exhibits 10.9 have been omitted pursuant to a request for
confidential treatment. Complete copies of this agreement, including the
redacted portions, have been filed with the Securities and Exchange Commission.
61