Tableof Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

 

**FOR THE QUARTERLY PERIOD ENDEDSEPTEMBER 30, 2010**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF1934**

 

**FOR THE TRANSITION PERIOD FROM                        TO                         .**

 

**Commission File No. 001-31298**

 

**LANNETT COMPANY, INC.**

(Exact Name of Registrant asSpecified in its Charter)

 

| **State of Delaware**    | ** ** | **23-0787699**             |
|--------------------------|------------|----------------------------|
| (State of Incorporation) |       | (I.R.S. Employer I.D. No.) |

 

**9000 State Road**

**Philadelphia, PA 19136**

**(215) 333-9000**

(Address of principalexecutive offices and telephone number)

 

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

 

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

 

| Large accelerated filer o                     |   | Accelerated filer o         |
|-----------------------------------------------|--------|-----------------------------|
|                                          |   |                        |
| Non-accelerated filer o                       |   | Smaller reporting company x |
| (Do not check if a smaller reporting company) |   |                        |

 

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

 

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

 

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

 
| **Class**                                 | ** ** | **Outstanding as of November 4, 2010** |
|-------------------------------------------|------------|-----------------------------------------------------------------|
| Common  stock, par value $0.001 per share |       | 25,298,503 shares                                               |

** **

 

** **

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**Table of Contents**

 
| ** **                              | ** **                                                                                                                       | **Page No.** |
|-----------------------------------------|----------------------------------------------------------------------------------------------------------------------------------|-------------------|
|                                    |                                                                                                                             |              |
| **PART I.  FINANCIAL INFORMATION** |                                                                                                                             |
|                                    |                                                                                                                             |              |
| **ITEM 1.**                             | **FINANCIAL STATEMENTS**                                                                                                         |              |
|                                    |                                                                                                                             |              |
|                                    | Consolidated  Balance Sheets  as of September 30, 2010 (unaudited) and June 30, 2010                                   | 1                 |
|                                    |                                                                                                                             |              |
|                                    | Consolidated  Statements of Operations (unaudited)  for the three months ended September 30, 2010 and 2009                  | 2                 |
|                                    |                                                                                                                             |              |
|                                    | Consolidated  Statement of Changes in Shareholders’ Equity (unaudited)   for the three months ended September 30, 2010 | 3                 |
|                                    |                                                                                                                             |              |
|                                    | Consolidated  Statements of Cash Flows (unaudited)   for the three months ended September 30, 2010 and 2009                 | 4                 |
|                                    |                                                                                                                             |              |
|                                    | Notes to Consolidated Financial Statements (unaudited)                                                                           | 5                 |
|                                    |                                                                                                                             |              |
| **ITEM 2.**                             | **MANAGEMENT’S DISCUSSION  AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                                  | 27                |
|                                    |                                                                                                                             |              |
| **ITEM 3.**                             | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                                  | 39                |
|                                    |                                                                                                                             |              |
| **ITEM 4.**                             | **CONTROLS AND  PROCEDURES**                                                                                                     | 39                |
|                                    |                                                                                                                             |              |
| **PART II.  OTHER INFORMATION**    |                                                                                                                             |
|                                    |                                                                                                                             |              |
| **ITEM 1.**                             | **LEGAL PROCEEDINGS**                                                                                                            | 40                |
|                                    |                                                                                                                             |              |
| **ITEM 1A.**                            | **RISK FACTORS**                                                                                                                 | 41                |
|                                    |                                                                                                                             |              |
| **ITEM 6.**                             | **EXHIBITS**                                                                                                                     | 48                |
|                                    |                                                                                                                             |              |
| **31.1**                                | **CERTIFICATION  OF PRESIDENT & CHIEF EXECUTIVE OFFICER**                                                               |              |
|                                    |                                                                                                                             |              |   |
| **31.2**                                | **CERTIFICATION  OF CHIEF FINANCIAL OFFICER**                                                                                    |              |
| ** **                              | ** **                                                                                                                       |              |
| **32**                                  | **CERTIFICATION  PURSUANT TO SECTION 906 OF SARBANES OXLEY ACT OF 2002**                                                    |              |

 

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**PART I.  FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**LANNETTCOMPANY, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                              | ** ** | **(Unaudited)**                  | ** **  | ** **                  | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|-------------|-----------------------------|------------|
| ** **                                                                                                                              | ** ** | **September 30, 2010** | ** **  | **June 30, 2010** | ** ** |
| **ASSETS**                                                                                                                              |       |                             |        |                        |       |
| Current  Assets                                                                                                                         |       |                             |        |                        |       |
| Cash  and cash equivalents                                                                                                              |       | $                                | 17,624,554  |                        | $          | 21,895,648 |   |
| Investment  securities - available for sale                                                                                             |       | 212,757                          |        | 604,464                     |       |
| Trade  accounts receivable (net of allowance of $123,192 and $123,192 respectively)                                                     |       | 31,189,099                       |        | 38,324,258                  |       |
| Inventories,  net                                                                                                                       |       | 21,036,591                       |        | 19,056,868                  |       |
| Interest  receivable                                                                                                                    |       | 9,371                            |        | 9,631                       |       |
| Prepaid  taxes                                                                                                                          |       | 498,215                          |        | —                      |       |
| Deferred  tax assets                                                                                                                    |       | 5,133,873                        |        | 5,337,391                   |       |
| Other  current assets                                                                                                                   |       | 2,162,319                        |        | 2,506,114                   |       |
| **Total Current Assets**                                                                                                                |       | 77,866,779                       |        | 87,734,374                  |       |
|                                                                                                                                    |       |                             |        |                        |       |
| Property,  plant and equipment                                                                                                          |       | 51,882,758                       |        | 50,160,114                  |       |
| Less  accumulated depreciation                                                                                                          |       | (22,293,000                      | )           | (21,531,845                 | )          |
|                                                                                                                                    |       | 29,589,758                       |        | 28,628,269                  |       |
|                                                                                                                                    |       |                             |        |                        |       |
| Construction  in progress                                                                                                               |       | 3,680,223                        |        | 2,939,898                   |       |
| Investment  securities - available for sale                                                                                             |       | 183,771                          |        | 183,742                     |       |
| Intangible  assets (product rights) - net of accumulated amortization                                                                   |       | 7,326,945                        |        | 7,785,298                   |       |
| Deferred  tax assets                                                                                                                    |       | 12,524,544                       |        | 12,544,330                  |       |
| Other  assets                                                                                                                           |       | 138,858                          |        | 147,886                     |       |
| **Total Assets**                                                                                                                        |       | $                                | 131,310,878 |                        | $          | 139,963,797 |   |
|                                                                                                                                    |       |                             |        |                        |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                           |       |                             |        |                        |       |
| **LIABILITIES**                                                                                                                         |       |                             |        |                        |       |
| Current  Liabilities                                                                                                                    |       |                             |        |                        |       |
| Accounts  payable                                                                                                                       |       | $                                | 15,763,468  |                        | $          | 16,280,675 |   |
| Accrued  expenses                                                                                                                       |       | 2,498,862                        |        | 3,464,181                   |       |
| Accrued  payroll and payroll related                                                                                                    |       | 2,486,810                        |        | 6,304,465                   |       |
| Income  taxes payable                                                                                                                   |       | —                           |        | 1,479,658                   |       |
| Current  portion of long-term debt                                                                                                      |       | 4,826,601                        |        | 4,851,278                   |       |
| Rebates,  chargebacks and returns payable                                                                                               |       | 13,359,608                       |        | 15,249,412                  |       |
| **Total Current Liabilities**                                                                                                           |       | 38,935,349                       |        | 47,629,669                  |       |
|                                                                                                                                    |       |                             |        |                        |       |
| Long-term  debt, less current portion                                                                                                   |       | 2,834,973                        |        | 2,868,549                   |       |
| Unearned  grant funds                                                                                                                   |       | 500,000                          |        | 500,000                     |       |
| Other  long-term liabilities                                                                                                            |       | 6,558                            |        | 7,864                       |       |
| **Total Liabilities**                                                                                                                   |       | 42,276,880                       |        | 51,006,082                  |       |
| Commitment  and Contingencies, See notes 10 and 11                                                                                      |       | —                           |        | —                      |       |
|                                                                                                                                    |       |                             |        |                        |       |
| **SHAREHOLDERS’ EQUITY**                                                                                                           |       |                             |        |                        |       |
| Common  stock - authorized 50,000,000 shares, par value $0.001; issued and  outstanding, 24,929,131 and 24,882,123 shares, respectively |       | 24,929                           |        | 24,882                      |       |
| Additional  paid in capital                                                                                                             |       | 80,410,648                       |        | 79,862,940                  |       |
| Retained  earnings                                                                                                                      |       | 9,161,071                        |        | 9,564,632                   |       |
| Noncontrolling  interest                                                                                                                |       | 121,421                          |        | 111,982                     |       |
| Accumulated  other comprehensive income                                                                                                 |       | 52,588                           |        | 44,692                      |       |
|                                                                                                                                    |       | 89,770,657                       |        | 89,609,128                  |       |
| Less:  Treasury stock at cost - 130,118 and 110,108 shares, respectively                                                                |       | (736,659                         | )           | (651,413                    | )          |
| **TOTAL SHAREHOLDERS’ EQUITY**                                                                                                     |       | 89,033,998                       |        | 88,957,715                  |       |
|                                                                                                                                    |       |                             |        |                        |       |
| **TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                     |       | $                                | 131,310,878 |                        | $          | 139,963,797 |   |

 

The accompanying notes to the consolidated financial statements are anintegral part of these statements.

 

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**LANNETTCOMPANY, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS (UNAUDITED)**

** **
| ** **                                                           | ** ** | **Three months ended** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                           | ** ** | **September 30,**           | ** ** |
| ** **                                                           | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| ** **                                                           | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net  sales                                                           |       | $                                | 25,395,927 |   | $ | 31,434,989 |   |
| Cost  of sales                                                       |       | 18,900,048                       |       | 19,012,318 |   |
| Amortization  of intangible assets                                   |       | 448,667                          |       | 448,667 |   |
| Product  royalties                                                   |       | 143,271                          |       | 439,774 |   |
|                                                                 |       |                             |       |   |   |
| Gross  profit                                                        |       | 5,903,941                        |       | 11,534,230 |   |
|                                                                 |       |                             |       |   |   |
| Research  and development expenses                                   |       | 2,042,369                        |       | 3,027,841 |   |
| Selling,  general, and administrative expenses                       |       | 4,600,681                        |       | 3,763,161 |   |
| Gain  on sale of investments                                         |       | (12,641                          | )          | — |   |
|                                                                 |       |                             |       |   |   |
| Operating  (loss) income                                             |       | (726,468                         | )          | 4,743,228 |   |
|                                                                 |       |                             |       |   |   |
| Other  income (expense):                                             |       |                             |       |   |   |
| Foreign  currency gain                                               |       | 2,415                            |       | — |   |
| Interest  income                                                     |       | 11,231                           |       | 23,099 |   |
| Interest  expense                                                    |       | (70,844                          | )          | (70,413 | ) |
|                                                                 |       | (57,198                          | )          | (47,314 | ) |
|                                                                 |       |                             |       |   |   |
| (Loss)  income before income tax (benefit) expense                   |       | (783,666                         | )          | 4,695,914 |   |
| Income  tax (benefit) expense                                        |       | (389,544                         | )          | 1,827,650 |   |
| Net  (loss) income                                                   |       | (394,122                         | )          | 2,868,264 |   |
| Less  net income attributable to noncontrolling interest             |       | (9,439                           | )          | (10,894 | ) |
|                                                                 |       |                             |       |   |   |
| Net  (loss) income attributable to Lannett Company, Inc.        |       | $                                | (403,561   | ) | $ | 2,857,370 |   |
|                                                                 |       |                             |       |   |   |
| Basic  (loss) income per common share - Lannett Company, Inc.   |       | $                                | (0.02      | ) | $ | 0.12 |   |
| Diluted  (loss) income per common share - Lannett Company, Inc. |       | $                                | (0.02      | ) | $ | 0.11 |   |
|                                                                 |       |                             |       |   |   |
| Basic  weighted average number of shares                             |       | 24,899,530                       |       | 24,533,562 |   |
| Diluted  weighted average number of shares                           |       | 24,899,530                       |       | 25,054,661 |   |

 

Theaccompanying notes to the consolidated financial statements are an integralpart of these statements.

 

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**LANNETTCOMPANY, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY**

(UNAUDITED)

 
| ** **                                                     | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | ** **  | ** ** | ** **   | ** ** | ** **   | ** ** | **Accum. Other** | ** ** | ** **        | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-------------|------------|--------------|------------|--------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                     | ** ** | **Shares**            | ** ** | ** **     | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Treasury** | ** ** | **Noncontrolling**    | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** |
| ** **                                                     | ** ** | **Issued**            | ** ** | **Amount**     | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Stock**    | ** ** | **Interest**          | ** ** | **Income**        | ** ** | **Equity** | ** ** |
| ** **                                                     | ** ** | ** **            | ** ** | ** **     | ** ** | ** **  | ** ** | ** **   | ** ** | ** **   | ** ** | ** **            | ** ** | ** **        | ** ** | ** ** | ** ** |
| **Balance,  June 30, 2010**                                    |       | 24,882,123            |       | $              | 24,882     |        | $          | 79,862,940   |       | $            | 9,564,632  |                  | $          | (651,413          | )          | $ | 111,982 |   | $ | 44,692 |   | $ | 88,957,715 |   |
|                                                           |       |                  |       |           |       |        |       |         |       |         |       |                  |       |              |       |   |   |
| Shares issued in  connection with employee stock purchase plan |       | 14,610                |       | 15             |       | 54,254      |       | —       |       | —       |       | —                |       | —            |       | 54,269 |   |
| Share based compensation                                       |       |                  |       |           |       |        |       |         |       |         |       |                  |       |              |       |   |   |
| Restricted stock                                               |       | —                |       | —         |       | 174,755     |       | —       |       | —       |       | —                |       | —            |       | 174,755 |   |
| Stock options                                                  |       | —                |       | —         |       | 306,232     |       | —       |       | —       |       | —                |       | —            |       | 306,232 |   |
| Employee stock purchase  plan                                  |       | —                |       | —         |       | 12,499      |       | —       |       | —       |       | —                |       | —            |       | 12,499 |   |
| Shares issued in  connection with restricted stock grant       |       | 32,398                |       | 32             |       | (32         | )          | —       |       | —       |       | —                |       | —            |       | — |   |
| Purchase of treasury  stock                                    |       | —                |       | —         |       | —      |       | —       |       | (85,246      | )          | —                |       | —            |       | (85,246 | ) |
| Other comprehensive  income, net of income tax                 |       | —                |       | —         |       | —      |       | —       |       | —       |       | —                |       | 7,896             |       | 7,896 |   |
| Net (loss) income                                              |       | —                |       | —         |       | —      |       | (403,561     | )          | —       |       | 9,439                 |       | —            |       | (394,122 | ) |
|                                                           |       |                  |       |           |       |        |       |         |       |         |       |                  |       |              |       |   |   |
| **Balance,  September 30, 2010**                          |       | 24,929,131            |       | $              | 24,929     |        | $          | 80,410,648   |       | $            | 9,161,071  |                  | $          | (736,659          | )          | $ | 121,421 |   | $ | 52,588 |   | $ | 89,033,998 |   |

 

Theaccompanying notes to the consolidated financial statements are an integralpart of these statements.

 

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**LANNETTCOMPANY, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(UNAUDITED)

 
| ** **                                                                            | ** ** | **For the three months ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** |
|                                                                                  |       |                                                                       |       |   |   |
| OPERATING  ACTIVITIES:                                                                |       |                                                                       |       |   |   |
| Net  (loss) income                                                                    |       | $                                                                          | (394,122   | ) | $ | 2,868,264 |   |
| Adjustments  to reconcile net (loss) income to net cash used in operating activities: |       |                                                                       |       |   |   |
| Depreciation  and amortization                                                        |       | 1,219,508                                                                  |       | 1,166,604 |   |
| Deferred  tax expense                                                                 |       | 227,143                                                                    |       | 388,427 |   |
| Stock  compensation expense                                                           |       | 493,486                                                                    |       | 297,315 |   |
| Other  noncash expenses (income)                                                      |       | 7,722                                                                      |       | (26,391 | ) |
| Gain  on sale of assets                                                               |       | (12,641                                                                    | )          | — |   |
| Changes  in assets and liabilities which provided (used) cash:                        |       |                                                                       |       |   |   |
| Trade  accounts receivable                                                            |       | 7,135,159                                                                  |       | (1,152,466 | ) |
| Inventories                                                                           |       | (1,979,723                                                                 | )          | (814,863 | ) |
| Prepaid  and income taxes payable                                                     |       | (1,977,873                                                                 | )          | 513,590 |   |
| Prepaid  expenses and other assets                                                    |       | 344,055                                                                    |       | 58,142 |   |
| Accounts  payable                                                                     |       | (517,207                                                                   | )          | (1,155,783 | ) |
| Accrued  expenses                                                                     |       | (965,319                                                                   | )          | 289,880 |   |
| Rebates,  chargebacks and returns payable                                             |       | (1,889,804                                                                 | )          | (871,703 | ) |
| Accrued  payroll and payroll related                                                  |       | (3,817,655                                                                 | )          | (2,195,495 | ) |
| Net  cash used in operating activities                                                |       | (2,127,271                                                                 | )          | (634,479 | ) |
|                                                                                  |       |                                                                       |       |   |   |
| INVESTING  ACTIVITIES:                                                                |       |                                                                       |       |   |   |
| Purchases  of property, plant and equipment (including construction in progress)      |       | (2,462,969                                                                 | )          | (1,067,261 | ) |
| Purchase  of intangible asset (product rights)                                        |       | —                                                                     |       | (500,000 | ) |
| Proceeds  from sale of investment securities - available for sale                     |       | 394,721                                                                    |       | — |   |
| Net  cash used in investing activities                                                |       | (2,068,248                                                                 | )          | (1,567,261 | ) |
|                                                                                  |       |                                                                       |       |   |   |
| FINANCING  ACTIVITIES:                                                                |       |                                                                       |       |   |   |
| Repayments  of debt                                                                   |       | (58,253                                                                    | )          | (136,285 | ) |
| Proceeds  from issuance of stock                                                      |       | 54,269                                                                     |       | 185,943 |   |
| Purchase  of treasury stock                                                           |       | (85,246                                                                    | )          | (69,120 | ) |
| Net  cash used in financing activities                                                |       | (89,230                                                                    | )          | (19,462 | ) |
|                                                                                  |       |                                                                       |       |   |   |
| Effect  of foreign currency rates on cash and cash equivalents                        |       | 13,655                                                                     |       | — |   |
|                                                                                  |       |                                                                       |       |   |   |
| NET  DECREASE IN CASH AND CASH EQUIVALENTS                                            |       | (4,271,094                                                                 | )          | (2,221,202 | ) |
|                                                                                  |       |                                                                       |       |   |   |
| CASH  AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                       |       | 21,895,648                                                                 |       | 25,832,456 |   |
|                                                                                  |       |                                                                       |       |   |   |
| CASH  AND CASH EQUIVALENTS, END OF PERIOD                                             |       | $                                                                          | 17,624,554 |   | $ | 23,611,254 |   |
|                                                                                  |       |                                                                       |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION -                                   |       |                                                                       |       |   |   |
| Interest  paid                                                                        |       | $                                                                          | 100,856    |   | $ | 41,762 |   |
| Income  taxes paid                                                                    |       | $                                                                          | 1,361,186  |   | $ | 925,633 |   |

 

Theaccompanying notes to the consolidated financial statements are an integralpart of these statements.

 

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**LANNETT COMPANY, INC.  AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED**

 

**Note 1.  Interim FinancialInformation**

 

The accompanying unaudited financial statements have been prepared inaccordance with U.S. generally accepted accounting principles for presentationof interim financial statements and with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, the unaudited financialstatements do not include all the information and footnotes necessary for acomprehensive presentation of the financial position, results of operations,and cash flows for the periods presented. In the opinion of management, theunaudited financial statements include all the normal recurring adjustmentsthat are necessary for a fair presentation of the financial position, resultsof operations, and cash flows for the periods presented.  Operating results for the three months ended September 30,2010 are not necessarily indicative of the results that may be expected for thefiscal year ending June 30, 2011. You should read these unauditedfinancial statements in combination with the other Notes in this section; “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”appearing in Item 2; and the Financial Statements, including the Notes to theFinancial Statements, included in our Annual Report on Form 10-K for thefiscal year ended June 30, 2010.

 

**Note 2.  Summary of SignificantAccounting Policies**

 

LannettCompany, Inc., a Delaware corporation, and subsidiaries (the “Company” or “Lannett”),develop, manufacture, package, market, and distribute active pharmaceuticalingredients as well as pharmaceutical products sold under generic chemicalnames.  The Company manufactures solidoral dosage forms, including tablets and capsules, topical and oral solutions,and is pursuing partnerships and research contracts for the development and productionof other dosage forms, including ophthalmic, nasal and injectable products.

 

***Use of Estimates —***The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

***Principles of Consolidation***- Theconsolidated financial statements include the accounts of the operating parentcompany, Lannett Company, Inc., and its wholly owned subsidiaries, as wellas the consolidation of Cody LCI Realty, LLC, a variable interest entity. See Note 16 regarding the consolidation of this variable interest entity.  All intercompany accounts and transactionshave been eliminated.

 

***Foreign Currency Translation -***The local currency is thefunctional currency of its foreign subsidiary. Assets and liabilities of theforeign subsidiary are translated into U.S. dollars at the period-end currencyexchange rate and revenues and expenses are translated at an average currencyexchange rate for the period. The resulting translation adjustment is recordedin a separate component of shareholders’ equity and changes to such areincluded in comprehensive income. Exchange adjustments resulting fromtransactions denominated in foreign currencies are recognized in theconsolidated statements of operations.

 

***Reclassifications*** - Certainprior year amounts have been reclassified to conform to the current yearfinancial statement presentation.

 

***Revenue Recognition*** - The Companyrecognizes revenue when its products are shipped.  At this point, titleand 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 

 

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determinable. Accruals for these provisions are presented in the consolidated financialstatements as rebates, chargebacks and returns payable and reductions to netsales. The change in the reserves for various sales adjustments may not beproportionally equal to the change in sales because of changes in both theproduct and the customer mix. Increased sales to wholesalers will generallyrequire additional accruals as they are the primary recipient of chargebacksand rebates. Incentives offered to secure sales vary from product to product.Provisions for estimated rebates and promotional credits are estimated basedupon contractual terms.  Provisions for other customer credits, such asprice adjustments, returns, and chargebacks, require management to makesubjective judgments on customer mix. Unlike branded innovator drug companies,Lannett does not use information about product levels in distribution channelsfrom third-party sources, such as IMS and Wolters Kluwer, in estimating futurereturns and other credits. Lannett calculates a chargeback/rebate rate based oncontractual terms with its customers and applies this rate to customer sales. The only variable is customer mix, and this assumption is based on historicaldata and sales expectations.

 

***Chargebacks***— The provision forchargebacks is the most significant and complex estimate used in therecognition of revenue.  The Companysells its products directly to wholesale distributors, generic distributors,retail pharmacy chains, and mail-order pharmacies.  The Company also sells its productsindirectly to independent pharmacies, managed care organizations, hospitals,nursing homes, and group purchasing organizations, collectively referred to as “indirectcustomers.”  Lannett enters intoagreements with its indirect customers to establish pricing for certainproducts.  The indirect customers thenindependently select a wholesaler from which to actually purchase the productsat these agreed-upon prices.  Lannettwill provide credit to the wholesaler for the difference between theagreed-upon price with the indirect customer and the wholesaler’s invoice priceif the price sold to the indirect customer is lower than the direct price tothe wholesaler.  This credit is called achargeback.  The provision forchargebacks is based on expected sell-through levels by the Company’s wholesalecustomers to the indirect customers and estimated wholesaler inventorylevels.  As sales to the large wholesalecustomers, such as Cardinal Health, AmerisourceBergen, and McKesson increase,the reserve for chargebacks will also generally increase.  However, the size of the increase depends onthe product mix and the amount of those sales that end up at indirect customerswith which the Company has specific chargeback agreements.  The Company continually monitors the reservefor chargebacks and makes adjustments when management believes that expectedchargebacks on actual sales may differ from actual chargeback reserves.

 

***Rebates***— Rebates are offered to theCompany’s key chain drug store, distributor and wholesaler customers to promotecustomer loyalty and increase product sales. These rebate programs provide customers with rebate credits uponattainment of pre-established volumes or attainment of net sales milestones fora specified period.  Other promotionalprograms are incentive programs offered to the customers.  At the time of shipment, the Companyestimates reserves for rebates and other promotional credit programs based onthe specific terms in each agreement. The reserve for rebates increases as sales to certain wholesale andretail customers increase.  However,since these rebate programs are not identical for all customers, the size ofthe reserve will depend on the mix of customers that are eligible to receiverebates.

 

***Returns —*** Consistent with industrypractice, the Company has a product returns policy that allows customers toreturn product within a specified period prior to and subsequent to the product’slot expiration date in exchange for a credit to be applied to futurepurchases.  The Company’s policy requiresthat the customer obtain pre-approval from the Company for any qualifyingreturn.  The Company estimates itsprovision for returns based on historical experience, changes to businesspractices, and credit terms.  While suchexperience has allowed for reasonable estimations in the past, history may notalways be an accurate indicator of future returns.  The Company continually monitors theprovisions for returns and makes adjustments when management believes thatactual product returns may differ from established reserves.  Generally, the reserve for returns increasesas net sales increase.  The reserve forreturns is included in the rebates, chargebacks and returns payable account onthe balance sheet.

 

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***Other Adjustments —*** Otheradjustments consist primarily of price adjustments, also known as “shelf stockadjustments,” which are credits issued to reflect decreases in the sellingprices of the Company’s products that customers have remaining in theirinventories at the time of the price reduction. Decreases in selling prices are discretionary decisions made bymanagement to reflect competitive market conditions.  Amounts recorded for estimated shelf stockadjustments are based upon specified terms with direct customers, estimateddeclines in market prices, and estimates of inventory held by customers.  The Company regularly monitors these andother factors and evaluates the reserve as additional information becomesavailable.  Other adjustments areincluded in the rebates, chargebacks and returns payable account on the balancesheet.

 

The following tables identify the reserves for each major category ofrevenue allowance and a summary of the activity for the three months ended September 30,2010 and 2009:

 

**For the three months ended September 30, 2010**

 
| **Reserve Category**                                                                   | ** ** | **Chargebacks** | ** ** | **Rebates** | ** ** | **Returns** | ** ** | **Other**  | ** ** | **Total**   | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------|------------|-------------|------------|-------------|------------|------------|------------|-------------|------------|
|                                                                                        |       |            |       |        |       |        |       |       |       |        |       |
| Reserve  Balance as of June 30, 2010                                                   |       | $               | 6,282,127  |        | $          | 3,566,031   |       | $          | 5,401,254  |        | $          | — |   | $ | 15,249,412 |   |
| Actual  credits issued related to sales recorded in prior fiscal years                      |       | (6,112,838      | )          | (2,558,582  | )          | (1,151,174  | )          | —     |       | (9,822,594  | )          |
| Reserves  or (reversals) charged during Fiscal 2011 related to sales in prior fiscal  years |       | —          |       | —      |       | —      |       | —     |       | —      |       |
| Reserves  charged to net sales during Fiscal 2011 related to sales recorded in Fiscal  2011 |       | 11,960,878      |       | 3,776,169   |       | 2,987,308   |       | 1,663,371  |       | 20,387,726  |       |
| Actual  credits issued related to sales recorded in Fiscal 2011                             |       | (7,056,592      | )          | (2,347,273  | )          | (1,387,700  | )          | (1,663,371 | )          | (12,454,936 | )          |
| Reserve  Balance as of September 30, 2010                                              |       | $               | 5,073,575  |        | $          | 2,436,345   |       | $          | 5,849,688  |        | $          | — |   | $ | 13,359,608 |   |

 

**For the three months ended September 30, 2009**

 
| **Reserve Category**                                                                   | ** ** | **Chargebacks** | ** ** | **Rebates** | ** ** | **Returns** | ** ** | **Other** | ** ** | **Total**  | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------|------------|-------------|------------|-------------|------------|-----------|------------|------------|------------|
|                                                                                        |       |            |       |        |       |        |       |      |       |       |       |
| Reserve  Balance as of June 30, 2009                                                   |       | $               | 6,089,802  |        | $          | 2,537,746   |       | $         | 5,106,992  |       | $          | — |   | $ | 13,734,540 |   |
| Actual  credits issued related to sales recorded in prior fiscal years                      |       | (4,767,581      | )          | (1,852,708  | )          | (1,147,720  | )          | —    |       | (7,768,009 | )          |
| Reserves  or (reversals) charged during Fiscal 2010 related to sales in prior fiscal  years |       | —          |       | —      |       | —      |       | —    |       | —     |       |
| Reserves  charged to net sales during Fiscal 2010 related to sales recorded in Fiscal  2010 |       | 10,272,936      |       | 4,066,855   |       | 1,140,128   |       | 407,784   |       | 15,887,703 |       |
| Actual  credits issued related to sales recorded in Fiscal 2010                             |       | (7,000,389      | )          | (1,789,955  | )          | —      |       | (407,784  | )          | (9,198,128 | )          |
| Reserve  Balance as of September 30, 2009                                              |       | $               | 4,594,768  |        | $          | 2,961,938   |       | $         | 5,099,400  |       | $          | — |   | $ | 12,656,106 |   |

 

The total reserve for chargebacks, rebates, returns and otheradjustments decreased from $15,249,412 at June 30, 2010 to $13,359,608 at September 30,2010.  The decrease in total reserves wasdue to a decrease in the rebates reserve as a result of a decrease in overallsales, and a decrease in chargeback reserves due primarily to a decrease ininventory levels at wholesaler distribution centers.

 

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The Company ships its products to the warehouses of its wholesale andretail chain customers.  When the Company and a customer enter into anagreement for the supply of a product, the customer will generally continue topurchase the product, stock its warehouse(s), and resell the product to its owncustomers.  The Company’s customer will reorder the product as its warehouseis depleted.  The Company generally has no minimum size orders for itscustomers.  Additionally, most warehousing customers prefer not to stockexcess inventory levels due to the additional carrying costs and inefficienciescreated by holding excess inventory.  As such, the Company’s customerscontinually reorder the Company’s products.  It is common for the Company’scustomers to order the same products on a monthly basis.  For genericpharmaceutical manufacturers, it is critical to ensure that customers’warehouses are adequately stocked with its products.  This is importantdue to the fact that several generic competitors compete for the consumerdemand for a given product.  Availability of inventory ensures that amanufacturer’s product is considered.  Otherwise, retail prescriptionswould be filled with competitors’ products.  For this reason, the Companyperiodically offers incentives to its customers to purchase its products. These incentives are generally up-front discounts off its standard prices atthe beginning of a generic campaign launch for a newly-approved ornewly-introduced product, or when a customer purchases a Lannett product forthe first time.  Customers generally inform the Company that suchpurchases represent an estimate of expected resale for a period of time. This period of time is generally up to three months.  The Company recordsthis revenue, net of any discounts offered and accepted by its customers at thetime of shipment.  The Company’s products generally have 24 months or 36months of shelf-life at the time of manufacture.  The Company monitors itscustomers’ purchasing trends to attempt to identify any significant lapses inpurchasing activity.  If the Company observes a lack of recent activity,inquiries will be made to such customer regarding the success of the customer’sresale efforts.  The Company attempts to minimize any potential return (orshelf life issues) by maintaining an active dialogue with the customers.

 

Theproducts that the Company sells are generic versions of brand nameddrugs.  The consumer markets for such drugs are well-established marketswith many years of historically-confirmed consumer demand.  Such consumerdemand may be affected by several factors, including alternative treatments andcosts.  However, the effects of changes in such consumer demand for theCompany’s products, like generic products manufactured by other genericcompanies, are gradual in nature.  Any overall decrease in consumer demandfor generic products generally occurs over an extended period of time. This is because there are thousands of doctors, prescribers, third-partypayers, institutional formularies and other buyers of drugs that must changeprescribing habits and medicinal practices before such a decrease would affecta generic drug market.  If the historical data the Company uses and theassumptions 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 couldchange.  However, management believes that these estimates are reasonablebased upon historical experience and current conditions.

 

***Cash and cash equivalents —***The Company considers allhighly liquid securities purchased with original maturities of 90 days or lessto be cash equivalents.  Cash equivalentsare stated at cost, which approximates fair value, and consist of certificatesof deposit that are readily convertible to cash. The Company maintains cash andcash equivalents with several major financial institutions. Such amountsfrequently exceed Federal Deposit Insurance Corporation (“FDIC”) limits.

 

***Accounts Receivable*** - The Company performsongoing credit evaluations of its customers and adjusts credit limits basedupon payment history and the customer’s current credit worthiness, asdetermined by a review of current credit information. The Company continuouslymonitors collections and payments from its customers and maintains a provisionfor estimated credit losses based upon historical experience and any specificcustomer collection issues that have been identified. While such credit losseshave historically been within both the Company’s expectations and theprovisions established, the Company cannot guarantee that it will continue toexperience the same credit loss rates that it has in the past.

 

***Fair Value of FinancialInstruments*** - The Company’s financial instruments consistprimarily of cash and cash equivalents, accounts receivable, accounts payable,accrued expenses and debt obligations. The carrying values 

 

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of these assets andliabilities approximate fair value based upon the short-term nature of theseinstruments.  The Company has estimatedthat the fair value of long-term debt associated with the 20 year mortgage onits land and building in Cody, Wyoming approximates the discounted amount offuture payments to the mortgage-holder.

 

***Investment Securities*** - The Company’sinvestment securities consist of marketable debt securities, primarily in U.S.government and agency obligations.  All of the Company’s marketable debtsecurities are classified as available-for-sale and recorded at fair value,based on quoted market prices.  Unrealized holding gains and losses arerecorded, net of any tax effect, as a separate component of accumulated othercomprehensive income.  No gains or losses on marketable debt securitiesare realized until they are sold or a decline in fair value is determined to beother-than-temporary.  The Company reviews its marketable securities anddetermines whether the investments are other-than-temporarily impaired. If theinvestments are deemed to be other-than-temporarily impaired, the investmentsare written down to their then current fair market value with a new cost basisbeing established. There were no securities determined by management to beother-than-temporarily impaired during the three months ended September 30,2010 or the fiscal year ended June 30, 2010.

 

***Shipping and HandlingCosts*** — The cost ofshipping products to customers is recognized at the time the products areshipped, and is included in cost of sales.

 

***Research and Development***— Research anddevelopment expenses are charged to operations as incurred.

 

***Intangible Assets***— In March 2004,****the Company entered into an agreement with Jerome StevensPharmaceuticals, Inc. (JSP) for the exclusive marketing and distributionrights in the United States to the current line of JSP products in exchange forfour million (4,000,000) shares of the Company’s common stock.  As a result of the JSP agreement, the Companyrecorded an intangible asset for the exclusive marketing and distributionrights obtained from JSP.  As of September 30,2010 and June 30, 2010, management concluded the carrying value of theintangible asset was less than its fair value and, therefore, no impairment wasrequired.  The Company will incur annualamortization expense of approximately $1,785,000 for the JSP intangible assetover the remaining term of the agreement.

 

OnApril 10, 2007, the Company entered into a Stock Purchase Agreement toacquire Cody by purchasing all of the remaining shares of common stock of Cody.The consideration for the April 10, 2007 acquisition was approximately$4,438,000, which represented the fair value of the tangible net assetsacquired. The agreement also required Lannett to issue to the sellers up to120,000 shares of unregistered common stock of the Company contingent upon thereceipt of a license from a regulatory agency. This license was subsequently received in July 2008 and triggeredthe payment of 105,000 shares (87.5% of the 120,000 shares to be issued as theCompany already owned 12.5% of Cody) of Lannett stock to the former owners ofCody Labs, which was completed in October 2008.  Therefore, the Company recorded an intangibleasset related to the acquisition of a drug import license in the originalamount of $581,175 and recorded a corresponding deferred tax liability ofapproximately $150,700 due to the non-deductibility of the amortization for taxpurposes.  The Company has assigned a 15year life to this intangible asset based on average life cycles of Lannettproducts.

 

In January 2005, Lannett Holdings, Inc. entered into anagreement in which the Company purchased for $100,000 and future royaltypayments the proprietary rights to manufacture and distribute a product forwhich Pharmeral, Inc. owned the ANDA. In May 2008, the Company and Pharmeral waived their rights to anyroyalty payments on the sales of the drug by Lannett under Lannett’s currentownership structure.  Should Lannettundergo a change in control transaction with a third party, this royalty willbe reinstated.  In Fiscal 2008, theCompany obtained FDA approval to use these proprietary rights.  Accordingly, the Company originallycapitalized these purchased product rights as an indefinite lived intangibleasset and tested this asset for impairment at least on an annual basis.  During the fourth quarter of fiscal 2009, itwas determined that this intangible asset no longer has an indefinitelife.  No impairment existed because theestimated fair value exceeded the carrying amount on that date. Accordingly,the $100,000 carrying amount of this intangible asset is being amortized on astraight line basis prospectively over its 10 year remaining estimated usefullife.

 

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InAugust 2009, the Company acquired eight new ANDAs covering three separateproduct lines from another generic drug manufacturer for a purchase price of$500,000.  The Company began shipping oneof these product lines in October 2010 and it is expected that the Companywill be able to produce the other two product lines by the second half ofFiscal 2011.  Amortization will beginwhen the Company starts shipping these products.  An intangible asset that is not subject toamortization shall be tested for impairment annually or more frequently ifevents or changes in circumstances indicate that the asset might beimpaired.  An impairment loss is measuredas the excess of the asset’s carrying value over its fair value, calculatedusing a discounted future cash flow method. Our discounted cash flow models are highly reliant on variousassumptions which are considered level 3 inputs, including estimates offuture cash flow (including long-term growth rates), discount rate, andexpectations about variations in the amount and timing of cash flows and theprobability of achieving the estimated cash flows.  As of September 30 and June 30,2010, no impairment existed with respect to these assets.

 

Forthe three months ended September 30, 2010 and 2009, the Company incurredamortization expense of approximately $458,000 and $458,000, respectively. Asof September 30, 2010 and June 30, 2010, accumulated amortizationtotaled approximately $9,916,000 and $9,458,000, respectively.

 

Futureannual amortization expense consists of the following as of September 30,2010:

 
| **Fiscal Year Ending June 30,** | ** ** | **Annual Amortization   Expense** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------|------------|
| 2011                                                |       | $                                           | 1,375,059  |   |
| 2012                                                |       | 1,833,412                                   |       |
| 2013                                                |       | 1,833,412                                   |       |
| 2014                                                |       | 1,387,245                                   |       |
| 2015                                                |       | 48,745                                      |       |
| Thereafter                                          |       | 349,072                                     |       |
|                                                |       | $                                           | 6,826,945  |   |

 

Theamounts above do not include the ANDAs purchased in August 2009 for$500,000 as amortization will begin when the Company starts shipping theseproducts.  As noted above, the Companybegan shipping one of these product lines in October 2010.

 

***Advertising Costs*** - The Companycharges advertising costs to operations as incurred.  Advertising expense for the three monthsended September 30, 2010 and 2009 was approximately $19,000 and $10,000,respectively.

 

***Income Taxes***- The Company uses theliability method to account for income taxes. Deferred tax assets andliabilities are determined based on the difference between the financialstatement and tax bases of assets and liabilities as measured by the enactedtax rates which will be in effect when these differences reverse.  Deferred tax expense/(benefit) is the resultof changes in deferred tax assets and liabilities.  The Company may recognize the tax benefitfrom an uncertain tax position claimed on a tax return only if it is morelikely than not that the tax position will be sustained on examination by thetaxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financialstatements from such a position should be measured based on the largest benefitthat has a greater than 50% likelihood of being realized upon ultimatesettlement. The authoritative standards issued by the FASB also provideguidance on de-recognition, classification, interest and penalties on incometaxes, accounting in interim periods and requires increased disclosures.

 

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***Segment Information***- The Companyoperates one business segment - generic pharmaceuticals; accordingly theCompany has one reporting segment.  TheCompany aggregates its financial information for all products and reports asone operating segment.  The followingtable identifies the Company’s approximate net product sales by medicalindication for the three months ended September 30, 2010 and 2009:

 
| ** **                  | ** ** | **For the Three Months Ended   September 30,** | ** ** |
|-----------------------------|------------|------------------------------------------------------------------------------|------------|
| **Medical Indication** | ** ** | **2010**                                                                     | ** ** | **2009** | ** ** |
|                        |       |                                                                         |       |   |   |
| Migraine  Headache          |       | $                                                                            | 2,525,000  |   | $ | 2,663,000 |   |
| Epilepsy                    |       | 521,000                                                                      |       | 611,000 |   |
| Prescription  Vitamin       |       | 869,000                                                                      |       | 1,489,000 |   |
| Heart  Failure              |       | 3,229,000                                                                    |       | 4,852,000 |   |
| Thyroid  Deficiency         |       | 10,336,000                                                                   |       | 13,024,000 |   |
| Antibiotic                  |       | 1,381,000                                                                    |       | 1,661,000 |   |
| Pain  Management            |       | 2,900,000                                                                    |       | 3,880,000 |   |
| Other                       |       | 3,635,000                                                                    |       | 3,255,000 |   |
|                        |       |                                                                         |       |   |   |
| Total                       |       | $                                                                            | 25,396,000 |   | $ | 31,435,000 |   |

 

***Concentration of Market and Credit Risk*** - Five of theCompany’s products, defined as generics containing the same active ingredientor combination of ingredients, accounted for approximately 41%, 13%, 10%, 4%and 3%, respectively of net sales for the three months ended September 30,2010.  Those same products accounted for41%, 15%, 8%, 3% and 5% respectively, of net sales for the three months ended September 30,2009.

 

Fourof the Company’s customers accounted for 23%, 13%, 9%, and 9%, respectively, ofnet sales for the three months ended September 30, 2010, and 25%, 12%, 8%,and 8%, respectively, of net sales for the three months ended September 30,2009.  At September 30, 2010, fourcustomers accounted for 64% of the Company’s accounts receivable balances.  At June 30, 2010, four customersaccounted for 69% of the Company’s accounts receivable balances.

 

***Share-based Compensation -***The Company recognizescompensation cost for share-based compensation issued to or purchased byemployees, net of estimated forfeitures, under share-based compensation plansusing a fair value method.

 

AtSeptember 30, 2010, the Company had three stock-based employeecompensation plans (the “Old Plan,” the “2003 Plan,” and the 2006 Long-termIncentive Plan, or “2006 LTIP”).

 

AtSeptember 30, 2010, there were 2,058,851 options outstanding.  Of those, 1,032,925 were options issued underthe 2006 LTIP, 820,693 were issued under the 2003 Plan, and 205,233 under theOld Plan.  There are no further sharesauthorized to be issued under the Old Plan. 1,125,000 shares were authorized to be issued under the 2003 Plan, with49,365 shares under options having already been exercised under that plan sinceits inception, leaving a balance of 254,942 shares in that plan for futureissuances.  2,500,000 shares wereauthorized to be issued under the 2006 LTIP, with 94,725 shares under optionshaving already been exercised under that plan since its inception.  At September 30, 2010, there were237,500 nonvested restricted shares outstanding which were issued under the2006 LTIP, with 372,689 shares having already vested under that plan since itsinception.  At September 30, 2010, abalance of 762,161 shares is available in the 2006 LTIP for future issuances.

 

Duringthe fiscal year ended June 30, 2010, the Company awarded 237,500 shares ofrestricted stock to management employees under the 2006 LTIP which vest inequal portions on October 29, 2010, 2011 and 2012.  

 

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Stockcompensation expense of $144,787 was recognized during the three months endedSeptember 30, 2010 related to these shares of restricted stock.

 

Duringthe fiscal year ended June 30, 2008, the Company awarded 209,264 shares ofrestricted stock to management employees under the 2006 LTIP, of which 74,464of these shares vested 100% on January 1, 2008, and the remainder vestedin equal portions on September 18, 2008, 2009 and 2010.  Stockcompensation expense of $29,968 and $43,007 was recognized during the threemonths ended September 30, 2010 and 2009, respectively, related to theseshares of restricted stock.

 

TheCompany measures the fair value of share-based compensation cost for optionsusing the Black-Scholes option pricing model. The following table presents the weighted average assumptions used toestimate fair values of the stock options granted and the estimated forfeiturerates during the three months ended September 30:

 
| ** **                                   | ** ** | **Incentive Stock   Options** | ** ** | **Non-qualified   Stock Options** | ** ** | **Incentive Stock   Options** | ** ** | **Non-qualified   Stock Options** | ** ** |
|----------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------|------------|
| ** **                                   | ** ** | **FY 2011**                        | ** ** | **FY 2011**                            | ** ** | **FY 2010**                        | ** ** | **FY 2010**                            | ** ** |
| Risk-free interest rate                      |       | —                                  | %          | —                                      | %          | 2.4                                     | %          | —                                      | %          |
| Expected volatility                          |       | —                                  | %          | —                                      | %          | 67.1                                    | %          | —                                      | %          |
| Expected dividend yield                      |       | —                                  | %          | —                                      | %          | —                                  | %          | —                                      | %          |
| Forfeiture rate                              |       | —                                  | %          | —                                      | %          | 5.0                                     | %          | —                                      | %          |
| Expected term                                |       | n/a                                     |       | n/a                                         |       | 5.0 years                               |       | n/a                                         |       |
| Weighted average fair value at date of grant |       | $                                       | —     |                                        | $          | —                                  |       | $                                           | 4.86       |   | $ | — |   |
|                                              |            |                                         |            |                                             |            |                                         |            |                                             |            |  |  |  |  |

 

Expectedvolatility is based on the historical volatility of the price of our commonshares since the date we commenced trading on the NYSE-Amex, April 2002,or a historical period equal to the expected term of the option, whichever isshorter.  We use historical informationto estimate expected term within the valuation model.  The expected termof awards represents the period of time that options granted are expected to beoutstanding.  The risk-free rate for periods within the expected life ofthe option is based on the U.S. Treasury yield curve in effect at the time ofgrant.  Compensation cost is recognized using the straight-line methodover the vesting or service period and is net of estimated forfeitures.

 

Theforfeiture rate assumption is the estimated annual rate at which unvestedawards are expected to be forfeited during the vesting period. This assumptionis based on our historical forfeiture rate. Periodically, management willassess whether it is necessary to adjust the estimated rate to reflect changesin actual forfeitures or changes in expectations. For example, adjustments maybe needed if forfeitures were affected by turnover that resulted from abusiness restructuring that is not expected to recur.  The Company will incur additional expense ifthe actual forfeiture rate is lower than originally estimated. A recovery ofprior expense will be recorded if the actual rate is higher than originallyestimated.

 

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Thefollowing table presents all share-based compensation costs recognized in ourstatements of operations, substantially all of which is reflected in theselling, general and administrative expense line:

 
| ** **                    | ** ** | **Three Months Ended  September 30,** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|
| ** **                    | ** ** | **2010**                                             | ** ** | **2009** | ** ** |
| Share based compensation      |       |                                                 |       |   |   |
| Stock options                 |       | $                                                    | 306,232    |   | $ | 232,868 |   |
| Employee stock purchase plan  |       | 12,499                                               |       | 21,440 |   |
| Restricted stock              |       | 174,755                                              |       | 43,007 |   |
| Tax benefit at statutory rate |       | 31,467                                               |       | 27,604 |   |
|                               |            |                                                      |            |  |  |  |  |

 

Optionsoutstanding that have vested and are expected to vest as of September 30,2010 are as follows:

 
| ** **                        | ** ** | **Awards** | ** ** | **Weighted -  Average  Exercise  Price** | ** ** | **Aggregate  Intrinsic  Value** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** |
|-----------------------------------|------------|------------|------------|-----------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------|------------|
| Options vested                    |       | 1,306,240  |       | $                                             | 7.96       |                            | $          | 330,755                                             |       | 5.1 |   |
| Options expected to vest          |       | 694,084    |       | $                                             | 6.55       |                            | $          | 106,299                                             |       | 9.0 |   |
| Total vested and expected to vest |       | 2,000,324  |       | $                                             | 7.47       |                            | $          | 437,054                                             |       | 6.5 |   |

 

Asummary of nonvested restricted stock award activity as of September 30,2010 and changes during the three months then ended, is presented below:

 
| ** **                           | ** ** | **Awards** | ** ** | **Weighted  Average Grant  Date Fair Value** | ** ** |
|--------------------------------------|------------|------------|------------|-------------------------------------------------------------|------------|
| Nonvested at July 1, 2010       |       | 269,898    |       | $                                                           | 1,778,814  |   |
| Granted                              |       | —     |       | —                                                      |       |
| Vested                               |       | (32,398    | )          | (130,564                                                    | )          |
| Forfeited                            |       | —     |       | —                                                      |       |
| Nonvested at September 30, 2010 |       | 237,500    |       | $                                                           | 1,648,250  |   |

 

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Asummary of award activity under the Plans as of September 30, 2010 and2009, and changes during the three months then ended, is presented below:

 
| ** **                                                 | ** ** | **Incentive Stock Options** | ** ** | **Nonqualified Stock Options** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------------|------------|
| ** **                                                 | ** ** | ** **                            | ** ** | ** **                               | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                                 | ** ** | ** **                            | ** ** | **Weighted-**                            | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                 | ** ** | ** **                            | ** ** | **Average**                              | ** ** | **Aggregate** | ** ** | **Remaining** | ** ** | ** ** | ** ** | **Average** | ** ** | **Aggregate** | ** ** | **Remaining** | ** ** |
| ** **                                                 | ** ** | ** **                            | ** ** | **Exercise**                             | ** ** | **Intrinsic** | ** ** | **Contractual** | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Intrinsic** | ** ** | **Contractual** | ** ** |
| ** **                                                 | ** ** | **Awards**                            | ** ** | **Price**                                | ** ** | **Value** | ** ** | **Life** | ** ** | **Awards** | ** ** | **Price** | ** ** | **Value** | ** ** | **Life** | ** ** |
|                                                       |       |                                  |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Outstanding  at July 1, 2010                          |       | 1,309,254                             |       | $                                        | 6.11       |   |   |   |   |   | 749,597 |   | $ | 9.77 |   |   |   |   |   |
| Granted                                                    |       | —                                |       | $                                        | —     |   |   |   |   |   | — |   | $ | — |   |   |   |   |   |
| Exercised                                                  |       | —                                |       | $                                        | —     |   |   |   |   |   | — |   | $ | — |   |   |   |   |   |
| Forfeited,  expired or repurchased                         |       | —                                |       | $                                        | —     |   |   |   |   |   | — |   | $ | — |   |   |   |   |   |
| Outstanding  at September 30, 2010                    |       | 1,309,254                             |       | $                                        | 6.11       |   | $ | 353,362 |   | 7.3 |   | 749,597 |   | $ | 9.77 |   | $ | 89,926 |   | 5.2 |   |
| Outstanding  at September 30, 2010 and not yet vested |       | 599,953                               |       | $                                        | 6.45       |   | $ | 112,533 |   | 8.9 |   | 152,658 |   | $ | 6.99 |   | $ | — |   | 9.1 |   |
| Exercisable  at September 30, 2010                    |       | 709,301                               |       | $                                        | 5.83       |   | $ | 240,829 |   | 5.9 |   | 596,939 |   | $ | 10.48 |   | $ | 89,926 |   | 4.2 |   |

 
| ** **                                                 | ** ** | **Incentive Stock Options** | ** ** | **Nonqualified Stock Options** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------------|------------|
| ** **                                                 | ** ** | ** **                            | ** ** | ** **                               | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                                 | ** ** | ** **                            | ** ** | **Weighted-**                            | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                 | ** ** | ** **                            | ** ** | **Average**                              | ** ** | **Aggregate** | ** ** | **Remaining** | ** ** | ** ** | ** ** | **Average** | ** ** | **Aggregate** | ** ** | **Remaining** | ** ** |
| ** **                                                 | ** ** | ** **                            | ** ** | **Exercise**                             | ** ** | **Intrinsic** | ** ** | **Contractual** | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Intrinsic** | ** ** | **Contractual** | ** ** |
| ** **                                                 | ** ** | **Awards**                            | ** ** | **Price**                                | ** ** | **Value** | ** ** | **Life** | ** ** | **Awards** | ** ** | **Price** | ** ** | **Value** | ** ** | **Life** | ** ** |
|                                                       |       |                                  |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Outstanding  at July 1, 2009                          |       | 958,909                               |       | $                                        | 5.60       |   |   |   |   |   | 626,772 |   | $ | 10.52 |   |   |   |   |   |
| Granted                                                    |       | 20,000                                |       | $                                        | 8.48       |   |   |   |   |   | — |   | $ | — |   |   |   |   |   |
| Exercised                                                  |       | (36,100                               | )          | $                                        | 4.23       |   |   |   |   |   | — |   | $ | — |   |   |   |   |   |
| Forfeited,  expired or repurchased                         |       | (6,400                                | )          | $                                        | 5.38       |   |   |   |   |   | — |   | $ | — |   |   |   |   |   |
| Outstanding  at September 30, 2009                    |       | 936,409                               |       | $                                        | 5.71       |   | $ | 2,217,739 |   | 7.2 |   | 626,772 |   | $ | 10.52 |   | 551,242 |   | 5.3 |   |
| Outstanding  at September 30, 2009 and not yet vested |       | 350,474                               |       | $                                        | 4.64       |   | 1,015,723 |   | 8.7 |   | 63,067 |   | $ | 4.51 |   | 187,483 |   | 8.1 |   |
| Exercisable  at September 30, 2009                    |       | 585,935                               |       | $                                        | 6.36       |   | $ | 1,202,016 |   | 6.3 |   | 563,705 |   | $ | 11.19 |   | 373,133 |   | 4.9 |   |

 

Optionswith a fair value of $342,556 vested during the three months ended September 30,2010.  As of September 30,2010, there was $2,786,917 of total unrecognized compensation cost related tononvested share-based compensation awards granted under the Plans.  Thatcost is expected to be recognized over a weighted average period of 2.0years.  The Company issues new shareswhen stock options are exercised.

 

***Unearned Grant Funds*** — The Companyrecords all grant funds received as a liability until the Company fulfills allthe requirements of the grant funding program.

 

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***Earnings (loss) per Common Share***— A dualpresentation of basic and diluted earnings (loss) per share is required on theface of the Company’s consolidated statement of operations as well as a reconciliationof the computation of basic earnings (loss) per share to diluted earnings pershare.  Basic earnings (loss) per shareexcludes the dilutive impact of common stock equivalents and is computed bydividing net income (loss) by the weighted-average number of shares of commonstock outstanding for the period. Diluted earnings per share include the effect of potential dilution fromthe exercise of outstanding common stock equivalents into common stock usingthe treasury stock method.  Areconciliation of the Company’s basic and diluted income (loss) per sharefollows:

 
| ** **                                                        | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                        | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
| ** **                                                        | ** ** | **Net (Loss)  Attirbutable to  Lannett**       | ** ** | **Shares** | ** ** | **Net Income  Attirbutable to  Lannett** | ** ** | **Shares** | ** ** |
| ** **                                                        | ** ** | **(Numerator)**                                          | ** ** | **(Denominator)** | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** |
|                                                              |       |                                                     |       |   |   |   |   |   |   |
| Basic  (loss) earnings per share factors                          |       | $                                                        | (403,561   | ) | 24,899,530 |   | $ | 2,857,370 |   | 24,533,562 |   |
|                                                              |       |                                                     |       |   |   |   |   |   |   |
| Effect  of potentially dilutive option and restricted stock plans |       | —                                                   |       | — |   | — |   | 521,099 |   |
|                                                              |       |                                                     |       |   |   |   |   |   |   |
| Diluted  (loss) earnings per share factors                        |       | $                                                        | (403,561   | ) | 24,899,530 |   | $ | 2,857,370 |   | 25,054,661 |   |
|                                                              |       |                                                     |       |   |   |   |   |   |   |
| Basic  (loss) earnings per share                                  |       | $                                                        | (0.02      | ) |   |   | $ | 0.12 |   |   |   |
| Diluted  (loss) earnings per share                                |       | $                                                        | (0.02      | ) |   |   | $ | 0.11 |   |   |   |

 

Dilutiveshares have been excluded in the weighted average shares used for thecalculation of earnings per share in periods of net loss because the effect ofsuch securities would be anti-dilutive. The number of anti-dilutive shares that have been excluded in thecomputation of diluted earnings per share for the three months ended September 30,2010 and 2009 were 2,296,351 and 352,845, respectively.

 

**Note 3.  New Accounting Standards**

 

InJune 2009, the Financial Accounting Standards Board (“FASB”) issuedauthoritative guidance for determining whether an entity is a variable interestentity and modifies the methods allowed for determining the primary beneficiaryof a variable interest entity. This guidance requires an enterprise to performan analysis to determine whether the enterprise’s variable interest orinterests give it a controlling financial interest in a variable interestentity. It also requires ongoing reassessments of whether an enterprise is theprimary beneficiary of a variable interest entity.  The authoritative guidance is effective forthe annual reporting period that begins after November 15, 2009. We do notexpect the adoption of this authoritative guidance to have a significant impacton our consolidated financial statements.

 

InJanuary 2010, the FASB issued authoritative guidance which requiresreporting entities to make new disclosures about recurring or nonrecurringfair-value measurements including significant transfers into and out of Level 1and Level 2 fair-value measurements and information on purchases, sales,issuances, and settlements on a gross basis in the reconciliation of Level 3fair- value measurements. The FASB’s Accounting Standards Update (“ASU”) 2010-6is effective for annual reporting periods beginning after December 15,2009, except for Level 3 reconciliation disclosures which are effective forannual periods beginning after December 15, 2010. We do not anticipatethat this update will have a material impact on our consolidated financialstatements.

 

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**Note 4.  Inventories**

 

TheCompany values its inventory at the lower of cost (determined by the first-in,first-out method) or market, regularly reviews inventory quantities on hand,and records a provision for excess and obsolete inventory based primarily onestimated forecasts of product demand. The Company’s estimates of future product demand may fluctuate, in whichcase estimated required reserves for excess and obsolete inventory may increaseor decrease.   If the Company’s inventoryis determined to be overvalued, the Company recognizes such costs in cost ofgoods sold at the time of such determination. Likewise, if inventory isdetermined to be undervalued, the Company may have recognized excess cost ofgoods sold in previous periods and would recognize such additional operatingincome at the time of sale.

 

Inventories consist of the following:

 
| ** **         | ** ** | **September 30, 2010** | ** ** | **June 30, 2010** | ** ** |
|--------------------|------------|----------------------------------|------------|-----------------------------|------------|
|               |       |                             |       |                        |       |
| Raw materials      |       | $                                | 7,840,599  |                        | $          | 5,183,735 |   |
| Work-in-process    |       | 2,588,395                        |       | 2,375,396                   |       |
| Finished goods     |       | 9,865,669                        |       | 10,527,630                  |       |
| Packaging supplies |       | 741,928                          |       | 970,106                     |       |
|               |       | $                                | 21,036,591 |                        | $          | 19,056,868 |   |

 

The preceding amounts are net of excess and obsolete inventory reservesof $3,115,605 and $2,481,810 at September 30, 2010 and June 30, 2010,respectively.

 

Recently,the FDA has increased its efforts to force companies to file and seek FDAapproval for GRASE or Grandfathered products. GRASE products are those “olddrugs that do not require prior approval from FDA in order to be marketedbecause they are generally recognized as safe and effective based on publishedscientific literature.” Similarly, Grandfathered products are those which “enteredthe market before the passage of the 1906 act, the 1938 act or the 1962 amendmentsto the act.”  Efforts have includedgranting market exclusivity to approved GRASE or Grandfathered products andissuing notices to discontinue marketing certain products to companiescurrently producing these products. Lannett currently manufactures and markets several products that areconsidered GRASE or Grandfathered products, including Morphine Sulfate OralSolution.  The Company is currentlylitigating the issue of Grandfathered drugs with the FDA.  The FDA is currently undertaking activities toforce all companies who manufacture Morphine Sulfate Oral Solution to fileapplications and seek approval for this product or remove their product fromthe market.  As of July 24, 2010,Lannett has stopped manufacturing and distributing Morphine Sulfate OralSolution and as of September 30, 2010, the Company has approximately $2.0million of Morphine Sulfate Oral Solution finished goods inventory.  Lannett has filed a 505(b)(2) New DrugApplication and currently awaits FDA approval on the submission.  If the Company is rejected on its currentapplication, if the current application takes significantly longer than elevenmonths to be approved, or if the FDA were to prevail on the current lawsuitfiled by Lannett which seeks determination that Morphine Sulfate Oral Solutionis a Grandfathered product, the Company is at risk of losing some or all of theapproximately $2.0 million of Morphine Sulfate Oral Solution inventory as of September 30,2010.  Lannett also has approximately$2.7 million of inventory value at September 30, 2010 of otherGrandfathered products which would also be at risk if the FDA were to pursueenforcement actions on these products similar to their actions on MorphineSulfate Oral Solution.

 

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**Note5.  Property, Plant and Equipment**

 

Property, plant and equipment are stated at cost.  Depreciation is provided for by thestraight-line method for financial reporting purposes over the estimated usefullives of the assets.  Depreciationexpense for the three months ended September 30, 2010 and 2009 wasapproximately $762,000 and $708,000, respectively.

 

Property, plant and equipment consist of the following:

 
| ** **                 | ** ** | ** **            | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|----------------------------|------------|-----------------------|------------|------------------------|------------|-------------------|------------|
| ** **                 | ** ** | **Useful Lives** | ** ** | **2010**               | ** ** | **2010**          | ** ** |
| Land                       |       | -                     |       | $                      | 1,375,103  |              | $          | 1,375,103 |   |
| Building  and improvements |       | 10  - 39 years        |       | 23,970,883             |       | 23,101,751        |       |
| Machinery  and equipment   |       | 5  - 10 years         |       | 25,436,336             |       | 24,638,754        |       |
| Furniture  and fixtures    |       | 5  - 7 years          |       | 1,100,436              |       | 1,044,506         |       |
|                       |       |                  |       | $                      | 51,882,758 |              | $          | 50,160,114 |   |
| Accumulated  depreciation  |       |                  |       | (22,293,000            | )          | (21,531,845       | )          |
|                       |       |                  |       | $                      | 29,589,758 |              | $          | 28,628,269 |   |

 

**Note 6.  Investment Securities - Available-for-Sale**

 

OnJuly 1, 2008, the Company adopted the authoritative guidance whichclarifies the definition of fair value, establishes a framework for measuringfair value, and expands the disclosures on fair value measurements. Fair valueis defined as the exchange price that would be received for an asset or paid totransfer a liability (an exit price) in the principal or most advantageousmarket for the asset or liability in an orderly transaction between marketparticipants on the measurement date. The authoritative guidance alsoestablishes a fair value hierarchy which requires an entity to maximize the useof observable inputs and minimize the use of unobservable inputs when measuringfair value. Three levels of inputs were established that may be used to measurefair value:

 

Level 1— Quoted prices in active markets for identical assets or liabilities.  The Company does not have any Level 1available-for-sale securities as of September 30, 2010 or June 30,2010.

 

Level 2— Observable inputs other than Level 1 prices, such as quoted prices forsimilar assets or liabilities; quoted prices for identical or similarinstruments in markets that are not active; or model-derived valuations whoseinputs are observable or whose significant value drivers are observable. TheCompany’s Level 2 assets and liabilities primarily include debt securitieswith quoted prices that are traded less frequently than exchange-tradedinstruments, corporate bonds, U.S. government and agency securities andcertain mortgage-backed and asset-backed securities whose values are determinedusing pricing models with inputs that are observable in the market or can bederived principally from or corroborated by observable market data.  The fair value of the Company’savailable-for-sale securities in the table below are derived solely from Level2 inputs.

 

Level 3— Unobservable inputs that are supported by little or no market activity andthat are financial instruments whose values are determined using pricingmodels, discounted cash flow methodologies, or similar techniques, as well asinstruments for which the determination of fair value requires significantjudgment or estimation. The Company does not have any Level 3available-for-sale securities as of September 30, 2010 or June 30,2010.

 

Ifthe inputs used to measure the financial assets and liabilities fall withinmore than one level described above, the categorization is based on the lowestlevel input that is significant to the fair value measurement of theinstrument.

 

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The amortized cost, gross unrealized gains and losses, and fair valueof the Company’s available-for-sale securities are summarized as follows:

 

September 30, 2010

Available-for-Sale

 
| ** **              | ** ** | **Amortized Cost** | ** ** | **Gross Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|-------------------------|------------|-------------------------|------------|----------------------------------|------------|-------------------------------|------------|---------------------|------------|
|                    |       |                    |       |                             |       |                          |       |                |       |
| U.S. Government  Agency |       | $                       | 208,671    |                             | $          | 4,086                         |       | $                   | —     |   | $ | 212,757 |   |
| Corporate Bonds         |       | 179,507                 |       | 4,264                            |       | —                        |       | 183,771             |       |
|                    |       | $                       | 388,178    |                             | $          | 8,350                         |       | $                   | —     |   | $ | 396,528 |   |

 

June 30, 2010

Available-for-Sale

 
| ** **              | ** ** | **Amortized Cost** | ** ** | **Gross Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|-------------------------|------------|-------------------------|------------|----------------------------------|------------|-------------------------------|------------|---------------------|------------|
|                    |       |                    |       |                             |       |                          |       |                |       |
| U.S. Government  Agency |       | $                       | 590,751    |                             | $          | 13,713                        |       | $                   | —     |   | $ | 604,464 |   |
| Corporate Bonds         |       | 179,507                 |       | 4,235                            |       | —                        |       | 183,742             |       |
|                    |       | $                       | 770,258    |                             | $          | 17,948                        |       | $                   | —     |   | $ | 788,206 |   |

 

The amortized cost and fair value of the Company’s currentavailable-for-sale securities by contractual maturity at September 30,2010 and June 30, 2010 are summarized as follows:

 
| ** **                             | ** ** | **September 30, 2010** | ** ** | **June 30, 2010**      | ** ** |
|----------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **Available for Sale** | ** ** | **Available for Sale** | ** ** |
| ** **                             | ** ** | **Amortized**                    | ** ** | **Fair**                         | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| ** **                             | ** ** | **Cost**                         | ** ** | **Value**                        | ** ** | **Cost** | ** ** | **Value** | ** ** |
| Due in one year or less                |       | $                                | 208,671    |                             | $          | 212,757 |   | $ | 590,751 |   | $ | 604,464 |   |
| Due after one year through five years  |       | 179,507                          |       | 183,771                          |       | 179,507 |   | 183,742 |   |
| Due after five years through ten years |       | —                           |       | —                           |       | — |   | — |   |
| Due after ten years                    |       | —                           |       | —                           |       | — |   | — |   |
|                                   |       |                             |       |                             |       |   |   |   |   |
| Total available-for-sale securities    |       | 388,178                          |       | 396,528                          |       | 770,258 |   | 788,206 |   |
| Less current portion                   |       | 208,671                          |       | 212,757                          |       | 590,751 |   | 604,464 |   |
|                                   |       |                             |       |                             |       |   |   |   |   |
| Long term available-for-sale securites |       | $                                | 179,507    |                             | $          | 183,771 |   | $ | 179,507 |   | $ | 183,742 |   |

 

TheCompany uses the specific identification method to determine the cost ofsecurities sold. For the three months ended September 30, 2010, theCompany had realized gains of $12,641, whereas for the three months ended September 30,2009, the Company had no realized gains or losses.

 

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Asof September 30, 2010 and June 30, 2010, there were no securitiesheld from a single issuer that represented more than 10% of shareholders’equity.  As of September 30, 2010,there were no individual securities in a continuous unrealized loss position.

 

**Note 7. Bank Line of Credit**

 

TheCompany has a $3,000,000 line of credit from Wells Fargo, N. A., formerlyWachovia Bank, N.A. (“Wells Fargo”) that bears interest at the prime interestrate less 0.25% (3.00% at September 30, 2010 and June 30, 2010,respectively). As of September 30, 2010 and June 30, 2010, theCompany had $3,000,000 of availability under this line of credit.  The line of credit is collateralized bysubstantially all of the Company’s assets.  The agreement containscovenants with respect to working capital, net worth and certain ratios, aswell as other covenants.  As ofSeptember 30, 2010, the Company was not in compliance with all financialcovenants under the agreement, but received a waiver from its lendinginstitution with respect to the failed covenant as of September 30, 2010.The noncompliance was caused by the direct use of cash to purchase and fit outLannett’s third facility during the December 2009, March 2010 and June 2010quarters over a period where the Company experienced reduced earnings caused bythe DEA withholding production quota for Morphine Sulfate Oral Solution and theFDA actions barring Lannett from shipping Morphine Sulfate Oral Solution. As aresult of the expected refinancing of the $4.5 million PIDC Regional Center, LPIII loan which is due on January 1, 2011, the Company will considerrenegotiation of its current covenant requirements.

 

Theexisting line of credit, which was scheduled to expire on November 30,2010, was renewed and extended during the first quarter of Fiscal 2011 toNovember 30, 2011.   As part of the renewal agreement lastfiscal year, the Company is no longer required to maintain any minimum depositbalances with Wells Fargo, and the availability fee on the unused balance ofthe line of credit was reduced to 0.375%.

 

**Note 8.  Unearned Grant Funds**

 

InJuly 2004, the Company received $500,000 of grant funding from theCommonwealth of Pennsylvania, acting through the Department of Community andEconomic Development.  The grant funding program requires the Company touse the funds for machinery and equipment located at their Pennsylvanialocations, hire an additional 100 full-time employees by June 30, 2006, operateits Pennsylvania locations a minimum of five years and meet certain matchinginvestment requirements.  If the Company fails to comply with any of therequirements above, the Company would be liable to repay the full amount of thegrant funding ($500,000).  The Company has recorded the unearned grantfunds as a liability until the Company complies with all of the requirements ofthe grant funding program.  As ofSeptember 30, 2010, the Company has had preliminary discussions with theCommonwealth of Pennsylvania to determine whether it will be required torepay any of the funds provided under the grant funding program.  Based oninformation available at September 30, 2010, the Company has recorded thegrant funding as a long-term liability under the caption of Unearned GrantFunds.

 

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**Note 9.  Long-Term Debt**

 

Long-term debt consists of the following:

 
| ** **                                                                 | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                                 | ** ** | **2010**               | ** ** | **2010**          | ** ** |
| PIDC Regional Center, LP III loan                                          |       | $                      | 4,500,000  |              | 4,500,000  |   |
| Pennsylvania Industrial Development Authority loan                         |       | 914,726                |       | 933,820           |       |
| Pennsylvania Department of Community &  Economic Development loan |       | 61,923                 |       | 88,141            |       |
| Tax-exempt bond loan (PAID)                                                |       | 555,000                |       | 555,000           |       |
| First National Bank of Cody mortgage                                       |       | 1,629,925              |       | 1,642,866         |       |
|                                                                       |       |                   |       |              |       |
| Total debt                                                                 |       | 7,661,574              |       | 7,719,827         |       |
| Less current portion                                                       |       | 4,826,601              |       | 4,851,278         |       |
|                                                                       |       |                   |       |              |       |
| Long term debt                                                             |       | $                      | 2,834,973  |              | $          | 2,868,549 |   |
|                                                                            |            |                        |            |                   |            |  |  |

 
| ** **                                                                 | ** ** | **September 30,** | ** ** | **June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------|------------|-------------------|------------|
| **Current Portion of Long Term Debt**             | ** ** | **2010**               | ** ** | **2010**          | ** ** |
| PIDC Regional Center, LP III loan                                          |       | $                      | 4,500,000  |              | $          | 4,500,000 |   |
| Pennsylvania Industrial Development Authority loan                         |       | 77,600                 |       | 77,091            |       |
| Pennsylvania Department of Community &  Economic Development loan |       | 61,923                 |       | 88,141            |       |
| Tax-exempt bond loan (PAID)                                                |       | 130,000                |       | 130,000           |       |
| First National Bank of Cody mortgage                                       |       | 57,078                 |       | 56,046            |       |
|                                                                       |       |                   |       |              |       |
| Total current portion of long term debt                                    |       | $                      | 4,826,601  |              | $          | 4,851,278 |   |

 

In December 2005, the Company financed $4,500,000 through thePhiladelphia Industrial Development Corporation (PIDC). The Company pays abi-annual interest payment at a rate equal to two and one-half percent perannum.  The outstanding principal balance is due and payable onJanuary 1, 2011.  The Companyintends to refinance this loan prior to its maturity date.

 

The Company financed $1,250,000 through the Pennsylvania IndustrialDevelopment Authority (PIDA).  The Company is required to make equalpayments each month for 180 months starting February 1, 2006 with interestof two and three-quarter percent per annum.

 

An additional $500,000 was financed through the Pennsylvania Departmentof Community and Economic Development Machinery and Equipment Loan Fund. The Company is required to make equal payments for 60 months startingMay 1, 2006 with interest of two and three quarter percent per annum.

 

In April 1999, the Company entered into a loan agreement (the “Agreement”)with a governmental authority, the Philadelphia Authority for IndustrialDevelopment (the “Authority” or “PAID”), to finance future construction andgrowth projects of the Company. The Authority issued $3,700,000 in tax-exemptvariable rate demand and fixed rate revenue bonds to provide the funds tofinance such growth projects pursuant to a trust indenture (“the TrustIndenture”).  A portion of the Company’s proceeds from the bonds was usedto pay for bond issuance costs of approximately $170,000.  The TrustIndenture requires that the Company repay the Authority loan throughinstallment payments beginning in May 2003 and continuing throughMay 2014, the year the bonds mature. The bonds bear interest at thefloating variable rate determined by the organization responsible for sellingthe bonds 

 

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(the “remarketing agent”).  The interest rate fluctuates on aweekly basis.  The effective interest rate at September 30, 2010 and June 30,2010 was 0.49% and 0.52%, respectively.

 

The Company has executed Security Agreements with Wells Fargo, PIDA andPIDC in which the Company has agreed to pledge substantially all of its assetsto collateralize the amounts due.

 

TheCompany is the primary beneficiary to a variable interest entity (“VIE”) calledCody LCI Realty, LLC.  See Note 16, Consolidation of Variable InterestEntity for additional description.  The VIE owns land and a building whichis being leased to Cody.  A mortgage loan with First National Bank of Codyhas been consolidated in the Company’s financial statements, along with therelated land and building.  Principal and interest payments of $14,782, ata fixed interest rate of 7.5%, are being made on a monthly basis throughJune 2026.  The mortgage loan is collateralized by the land andbuilding.

 

Long-termdebt amounts due, for the twelve month periods ending September 30 are asfollows:

 
| **Twelve**             | ** ** | **Amounts Payable** | ** ** |
|------------------------|------------|--------------------------|------------|
| **Month Periods** | ** ** | **to Institutions** | ** ** |
|                   |       |                     |       |
| 2011                   |       | $                        | 4,826,601  |   |
| 2012                   |       | 276,284                  |       |
| 2013                   |       | 288,522                  |       |
| 2014                   |       | 305,716                  |       |
| 2015                   |       | 163,608                  |       |
| Thereafter             |       | 1,800,843                |       |
|                   |       |                     |       |
|                   |       | $                        | 7,661,574  |   |

 

**Note10.  Contingencies**

 

InJanuary 2010, the Company initiated an arbitration proceeding againstOlive Healthcare (“Olive”) for damages arising out of Olive’s delivery ofdefective soft-gel prenatal vitamin capsules. The Company seeks damages in excess of $3.5 million. Olive has deniedliability and filed a counterclaim in February 2010 for breach ofcontract.

 

InJune 2008, the Company filed a declaratory judgment suit inthe Federal District Court of Delaware (Civil Action No. 08-338 (JJF))against KV Pharmaceuticals, DrugTech Corp. and Ther-Rx Corp (collectively,“KV”).  The complaint sought declaratory judgmentfor non-infringement and invalidity of certain patents owned by KV. The complaint further sought declaratory judgment of anti-trust violationsand federal and state unfair competition violations for actions taken by KV insecuring and enforcing these patents.  After the complaint was filed,KV countered with a motion for a Temporary Restraining Order (“TRO”) toprevent the Company from launching its Multivitamin with Mineral Capsules(“MMCs”), due to alleged patent and trademark infringement issues.  TheTRO was heard and, ultimately, resulted in a conclusion by the court that theCompany’s product label on the MMCs should be modified.  KV alsocountered with claims of infringement by the Company of KV’s patents seekingthe Company’s profits for sales of MMCs or other monetary relief, preliminaryand permanent injunctive relief, attorney’s fees and a finding of willfulinfringement. In March 2009, the Company and KV settled thelitigation.  In light of the withdrawalof KV’s innovator prenatal product due to FDA enforcement actions, and theresulting anticipated decline in sales and declining market for writtenprescription, the Company decided it was pointless to continue the litigationand entered into the settlement arrangement with KV.  Pursuant to the settlement, the Companyreceived a license from KV and became an authorized generic 

 

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provider.  During the terms of the license, the Companyis to pay KV a royalty on all future sales of its Prenatal vitaminproduct.  Lannett will cease offering itsPrenatal vitamin product if and when the brand is restored to themarketplace.  In May 2010, theCompany filed an action for declaratory relief in the Delaware Superior Courtagainst KV seeking a declaration that KV breached its obligations under asettlement agreement entered into with the Company (the “Binding Agreement”).  In June 2010, KV filed a counterclaim tothe complaint and asserted claims for breach of contract, declaratory judgment,negligent misrepresentation and fraud in connection with the Binding Agreement,alleging among other things that the Company has improperly withheld royaltiesfrom KV arising out of its sales of a pre-natal vitamin product.  KV filed a motion for summary judgment, whichthe Company opposed.  The Court has not yet held a hearing on the motionor ruled on it.

 

**Note11.   Commitments**

 

***Leases***

 

InJune 2006, Lannett signed a lease agreement on a 66,000 square footfacility located on approximately seven acres in Philadelphia.  The Company purchased this building in October 2009for approximately $3.8 million plus the cost of fit out of approximately $2.0million.  A significant portion of thepurchase price and fit out costs are expected to be financed through a seriesof loans with a bank and a Pennsylvania state run development agency. Theseloans can not be put in place until all construction has been completed and aproper certificate of occupancy has been obtained, due to a requirement by thestate run development agency. Construction was substantially complete by June 30, 2010. Acertificate of occupancy was obtained by September 2010.  The financing is expected to be completed andfunded by the second quarter of Fiscal 2011. This new facility is being used for certain administrative functions,warehouse space, shipping and possibly additional manufacturing space in thefuture.

 

Lannett’ssubsidiary, Cody leases a 73,000 square foot facility in Cody, Wyoming.  This location houses Cody’s manufacturing andproduction facilities. Cody leases the facility from Cody LCI Realty, LLC, aWyoming limited liability company which is 50% owned by Lannett.   See Note 16.

 

Rentaland lease expense for the three months ended September 30, 2010 and 2009was approximately $22,000 and $82,000, respectively.

 

***Employment Agreements***

 

TheCompany has entered into employment agreements with Arthur P. Bedrosian,President and Chief Executive Officer, Keith R. Ruck, Vice President of Financeand Chief Financial Officer, Kevin Smith, Vice President of Sales andMarketing, William Schreck, Senior Vice President and General Manager, ErnestSabo, Vice President of Regulatory Affairs and Chief Compliance Officer, andStephen Kovary, Vice President of Operations.  Each of the agreements providefor an annual base salary and eligibility to receive a bonus.  The bonusamounts of these executives are determined by the Board of Directors. Additionally, these executives are eligible to receive stock options andrestricted stock awards, which are granted at the discretion of the Board ofDirectors, and in accordance with the Company’s policies regarding stock optionand restricted stock grants.  Under theagreements, these executive employees may be terminated at any time with orwithout cause, or by reason of death or disability.  In certaintermination situations, the Company is liable to pay severance compensation tothese executives of between 18 months and three years.

 

Duringthe third quarter of Fiscal Year 2009, the Company’s former Vice President ofFinance, Treasurer, Secretary and Chief Financial Officer resigned.  As part of his separation agreement, theCompany is obligated to pay to him approximately $670,000 to settle anyoutstanding obligations from his employment agreement, including any salary, 

 

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bonus,vacation, stock options and medical benefits. Of this amount, $300,440 was paid in Fiscal 2009 with $165,000designated for the payment of pro rated bonus, and $11,440 was designated forthe payment of accrued but unused paid time off.  As part of the settlement, $124,000 wasdesignated as the portion of the settlement related to the repurchase of hisoutstanding stock options. The Company therefore charged this amount toAdditional Paid in Capital, as it represents the fair value of the optionsrepurchased on the repurchase date. Additional payments totaling approximately $369,000 for severance andbenefits were paid in the first quarter of Fiscal 2011 pursuant to theseparation agreement.

 

***Fiscal 2010 Bonus***

 

TheCompany accrued approximately $4,812,000 of incentive compensation costs at June 30,2010, of which approximately $3,421,000 was paid in cash during the firstquarter of Fiscal 2011. The remaining $1,391,000 is expected to be paid inunrestricted shares of Company stock, and which shares are expected to vestimmediately upon grant.  These shareswill only be granted upon the timely approval by the FDA of Lannett’s 505(b)(2) NewDrug Application to manufacture and distribute its Morphine Sulfate OralSolution product. The determination of the actual payment of this portion ofthe bonus is at the discretion of the CEO, dependent on the timing of theapproval and the financial results of the Company dictated by the eventssurrounding the approval.

 

**Note 12.  Comprehensive (Loss)Income**

 

The Company’s other comprehensive (loss) income is comprised ofunrealized gains (losses) on investment securities classified asavailable-for-sale as well as foreign currency translation adjustments.  There is no other comprehensive income (loss)attributable to the noncontrolling interest. The components of comprehensive (loss) income and related taxes consistedof the following:

 
| ** **                               | ** ** | **For the Three Months Ended  September 30,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **2010**                                                               | ** ** | **2009** | ** ** |
| ** **                               | ** ** | ** **                                                             | ** ** | ** ** | ** ** |
| Net (Loss) Income                        |       | $                                                                      | (394,122   | ) | $ | 2,868,264 |   |
| Foreign currency translation adjustments |       | 13,655                                                                 |       | — |   |
| Unrealized holding loss on securities    |       | (9,598                                                                 | )          | (3,751 | ) |
| Tax effect                               |       | 3,839                                                                  |       | 1,500 |   |
|                                     |       |                                                                   |       |   |   |
| Total Other Comprehensive Income (Loss)  |       | 7,896                                                                  |       | (2,251 | ) |
|                                     |       |                                                                   |       |   |   |
| Total Comprehensive (Loss) Income        |       | $                                                                      | (386,226   | ) | $ | 2,866,013 |   |

 

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**Note 13.   Employee Benefit Plan**

 

The Company has a defined contribution 401kplan (the “Plan”) covering substantially all employees.  Pursuant to thePlan provisions, the Company is required to make matching contributions equalto 50% of each employee’s contribution, but not to exceed 4% of the employee’scompensation for the Plan year.  Contributions to the Plan during thethree months ended September 30, 2010 and 2009 were $140,000 and $153,000,respectively.

 

**Note 14.   Employee Stock Purchase Plan**

 

InFebruary 2003, the Company’s shareholders approved an Employee StockPurchase Plan (“ESPP”).  Employees eligible to participate in the ESPP maypurchase shares of the Company’s stock at 85% of the lower of the fair marketvalue of the common stock on the first day of the calendar quarter, or the lastday of the calendar quarter.  Under the ESPP, employees can authorize theCompany to withhold up to 10% of their compensation during any quarterlyoffering period, subject to certain limitations.  The ESPP was implementedon April 1, 2003 and is qualified under Section 423 of the InternalRevenue Code.  The Board of Directors authorized an aggregate total of1,125,000 shares of the Company’s common stock for issuance under theESPP.  As of September 30, 2010, 231,803 shares have been issuedunder the ESPP.  Compensation expense of $12,499 and $21,440 relating tothe ESPP was recognized for the three months ended September 30, 2010 and2009, respectively.

 

**Note 15.  Income Taxes**

 

TheCompany uses the liability method to account for income taxes.  Deferred tax assets and liabilities aredetermined based on the difference between the financial statement and taxbases of assets and liabilities as measured by the enacted tax rates which willbe in effect when these differences reverse. Deferred tax expense/(benefit) is the result of changes in deferred taxassets and liabilities.

 

Theprovision for federal, state and local income taxes for the three months ended September 30,2010 and 2009 was tax (benefit) expense of approximately $(390,000) and$1,828,000, respectively, with effective tax rates of 50% and 39%,respectively.  The effective tax rate forthe three months ended September 30, 2010 was higher compared to the threemonths ended September 30, 2009 due primarily to nondeductible incentivestock option compensation expenses relative to the expected pretax income forFiscal 2011. The Company expects its overall effective tax rate will beapproximately 48% to 50% for the full year ended June 30, 2011.

 

TheCompany may recognize the tax benefit from an uncertain tax position claimed ona tax return only if it is more likely than not that the tax position will besustained on examination by the taxing authorities, based on the technicalmerits of the position.  The tax benefitsrecognized in the financial statements from such a position should be measuredbased on the largest benefit that has a greater than 50% likelihood of being realizedupon ultimate settlement. The authoritative standards issued by the FASB alsoprovide guidance on de-recognition, classification, interest and penalties onincome taxes, accounting in interim periods and requires increased disclosures.

 

Asof September 30, 2010 and June 30, 2010, the Company reported totalunrecognized tax benefits of $399,034. As a result of the positions taken during the period, the Company hasnot recorded any interest and penalties for the period ended September 30,2010 in the statement of operations and no cumulative interest and penaltieshave been recorded either in the Company’s statement of financial position asof September 30, 2010 and June 30, 2010. The Company will recognizeinterest accrued on unrecognized tax benefits in interest expense and anyrelated penalties in operating expenses. The Company does not believe that the total unrecognized tax benefitswill significantly increase or decrease in the next twelve months.

 

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The Company files income tax returns in theUnited States federal jurisdiction, Pennsylvania, New Jersey andCalifornia.  The Company’s tax returns for Fiscal 2006 and prior generallyare no longer subject to review as such years generally are closed. The Companybelieves that an unfavorable resolution for open tax years would not bematerial to the financial position of the Company.

 

**Note 16. Consolidation of Variable Interest Entity**

 

Lannett consolidates any Variable Interest Entity (“VIE”)of which it is the primary beneficiary. The liabilities recognized as a resultof consolidating a VIE do not represent additional claims on our generalassets; rather, they represent claims against the specific assets of theconsolidated VIE. Conversely, assets recognized as a result of consolidating aVIE do not represent additional assets that could be used to satisfy claimsagainst our general assets. Reflected in the September 30, 2010 and June 30,2010 balance sheets are consolidated VIE assets of approximately $1.9 millionand $1.9 million, which are comprised mainly of land and building. VIEliabilities consist of a mortgage on that property in the amount ofapproximately $1.6 and $1.6 million at September 30, 2010 and June 30, 2010,respectively.

 

Cody LCI Realty LLC (“Realty”) is the only VIE thatis consolidated.  Realty had been consolidated by Cody prior to itsacquisition by Lannett.  Realty is a 50/50 joint venture with a formershareholder of Cody.  Its purpose was to acquire the facility used byCody.  Until the acquisition of Cody in April 2007, Lannett had notconsolidated the VIE because Cody Labs had been the primary beneficiary of theVIE.  The risks associated with our interests in this VIE is limited to adecline in the value of the land and building as compared to the balance of themortgage note on that property, up to Lannett’s 50% share of the venture. Realty owns the land and building, and Cody leases the building and propertyfrom Realty for $20,000 per month effective October 2009, when the leaseincreased from $15,000 per month.  Allintercompany rent expense is eliminated upon consolidation with Cody.  The Company is not involved in any other VIE.

 

**Note 17.  Related PartyTransactions**

 

The Company had sales of approximately $177,000 and $213,000 during thethree months ended September 30, 2010 and 2009, respectively, to a genericdistributor, Auburn Pharmaceutical Company (“Auburn”).  Jeffrey Farber (the “related party”), who isa current board member and the son of the Chairman of the Board of Directorsand principal shareholder of the Company, is the owner of Auburn.  Accounts receivable includes amounts due fromthe related party of approximately $164,000 and $161,000 at September 30, 2010and June 30, 2010, respectively.  Inthe Company’s opinion, the terms of these transactions were not more favorableto the related party than would have been to a non-related party.

 

In January 2005, Lannett Holdings, Inc. entered into anagreement in which the Company purchased for $100,000 and future royaltypayments the proprietary rights to manufacture and distribute a product forwhich Pharmeral, Inc. (“Pharmeral”) owned the ANDA.  In Fiscal 2008, the Company obtained FDAapproval to use the proprietary rights. Accordingly, the Company originally capitalized these rights as anindefinite lived intangible asset and tested this asset for impairment at leaston an annual basis.  During the fourthquarter of Fiscal 2009, it was determined that this intangible asset no longerhas an indefinite life.  No impairmentexisted because the estimated fair value exceeded the carrying amount on thatdate. Accordingly, the $100,000 carrying amount of this intangible asset is beingamortized on a straight line basis prospectively over its 10 year remainingestimated useful life.

 

Arthur Bedrosian, President and Chief Executive Officer, currently owns100% of Pharmeral.  This transaction wasapproved by the Board of Directors of the Company and in their opinion theterms were not more favorable to the related party than they would have been toa non-related party. In May 2008, Mr. Bedrosian and Pharmeral waivedtheir rights to any royalty payments on the sales of the drug by Lannett underLannett’s current ownership 

 

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structure.  Should Lannettundergo a change in control where a third party is involved, this royalty wouldbe reinstated. The registered trademark OB-Natal® was transferred to Lannettfor one dollar from Mr. Bedrosian.

 

LannettCompany, Inc. paid a management consultant who is related toMr. Bedrosian $37,100 in fees during the three months ended September 30,2010 and $21,420 in fees and $ 4,533 in reimbursable expenses during the threemonths ended September 30 2009.  Thisconsultant provided management, construction planning, laboratory set up andadministrative services in regards to the Company’s initial set up of itsBio-study laboratory in a foreign country. It is expected that this consultant will continue to be utilized intoFiscal 2011. In the Company’s opinion, the fee rates paid to this consultantand the expenses reimbursed to him were not more favorable than what would havebeen paid to a non-related party.

 

**Note 18.  Material Contract withSupplier**

 

JeromeStevens Pharmaceuticals agreement:

 

TheCompany’s primary finished product inventory supplier is Jerome StevensPharmaceuticals, Inc. (“JSP”), in Bohemia, New York.  Purchases of finished goods inventory fromJSP accounted for approximately 56% and 67% of the Company’s inventorypurchases during the three months ended September 30, 2010 and 2009,respectively.  On March 23, 2004,****the Company entered into an agreement with JSP for theexclusive distribution rights in the United States to the current line of JSPproducts, in exchange for four million (4,000,000) shares of the Company’scommon stock.  The JSP products coveredunder the agreement included Butalbital, Aspirin, Caffeine with CodeinePhosphate capsules, Digoxin tablets and Levothyroxine Sodium tablets, soldgenerically and under the brand name Unithroid®.  The term of the agreement is ten years,beginning on March 23, 2004 and continuing through March 22, 2014.  Both Lannett and JSP have the right toterminate the contract if one of the parties does not cure a material breach ofthe contract within thirty (30) days of notice from the non-breaching party.

 

Duringthe term of the agreement, the Company is required to use commerciallyreasonable efforts to purchase minimum dollar quantities of JSP’s productsbeing distributed by the Company.  Theminimum quantity to be purchased in the first year of the agreement was $15million.  Thereafter, the minimumquantity to be purchased increases by $1 million per year up to $24 million forthe last year of the ten-year contract. The Company has met the minimum purchase requirement for the first sixyears of the contract, but there is no guarantee that the Company will be ableto continue to do so in the future. If the Company does not meet the minimumpurchase requirements, JSP’s sole remedy is to terminate the agreement.

 

Underthe agreement, JSP is entitled to nominate one person to serve on the Company’sBoard of Directors (the “Board”) provided, however, that the Board shall havethe right to reasonably approve any such nominee in order to fulfill itsfiduciary duty by ascertaining that such person is suitable for membership onthe board of a publicly traded corporation. Suitability is determined by, butnot limited to, the requirements of the Securities and Exchange Commission, theAmerican Stock Exchange, and other applicable laws, including the Sarbanes-OxleyAct of 2002.  As of September 30, 2010,JSP has not exercised the nomination provision of the agreement.

 

TheCompany’s financial condition, as well as its liquidity resources, are verydependent on an uninterrupted supply of product from JSP.  Should there be an interruption in the supplyof product from JSP for any reason, this event would have a material impact tothe financial condition of Lannett.

 

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**ITEM 2.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

***Introduction***

 

Thefollowing information should be read in conjunction with the consolidatedfinancial statements and notes in Part I, Item 1 of this Quarterly Report andwith Management’s Discussion and Analysis of Financial Condition and Results ofOperations contained in the Company’s Annual Report on Form 10-K for the fiscalyear ended June 30, 2010.

 

ThisReport on Form 10-Q and certain information incorporated herein by referencecontain forward-looking statements which are not historical facts made pursuantto the “safe harbor” provisions of the Private Securities Litigation Reform Actof 1995. Forward-looking statements are not promises or guarantees andinvestors are cautioned that all forward-looking statements involve risks anduncertainties, including but not limited to the impact of competitive productsand pricing, product demand and market acceptance, new product development, theregulatory environment, including without limitation, reliance on key strategicalliances, availability of raw materials, fluctuations in operating results andother risks detailed from time to time in the Company’s filings with the Securitiesand Exchange Commission. These statements are based on management’s currentexpectations and are naturally subject to uncertainty and changes incircumstances. We caution you not to place undue reliance upon any suchforward-looking statements which speak only as of the date made. Lannett isunder no obligation to, and expressly disclaims any such obligation to, updateor alter its forward-looking statements, whether as a result of newinformation, future events or otherwise.

 

***Critical Accounting Policies***

 

Thediscussion and analysis of our financial condition and results of operationsare based upon our consolidated financial statements, which have been preparedin accordance with accounting principles generally accepted in the UnitedStates of America. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amount of assets andliabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities at the date of our financial statements. Actual results maydiffer from these estimates under different assumptions or conditions.

 

Critical accounting policies are defined as those that are reflectiveof significant judgments and uncertainties, and potentially result in materiallydifferent results under different assumptions and conditions.  We believe that our critical accountingpolicies include those described below.

 

***Revenue Recognition*** — The Companyrecognizes revenue when its products are shipped.  At this point, titleand risk of loss have transferred to the customer and provisions for rebates,promotional adjustments, price adjustments, returns, chargebacks, and otherpotential adjustments are reasonably determinable.  Accruals for theseprovisions are presented in the consolidated financial statements as rebates,chargebacks and returns payable and as reductions to net sales. The change inthe reserves for various sales adjustments may not be proportionally equal tothe change in sales because of changes in both the product and the customermix. Increased sales to wholesalers will generally require additional accrualsas they are the primary recipient of chargebacks and rebates. Incentivesoffered to secure sales vary from product to product. Provisions for estimatedrebates and promotional credits are estimated based upon contractualterms.  Provisions for other customer credits, such as price adjustments,returns, and chargebacks, require management to make subjective judgments oncustomer mix. Unlike branded innovator drug companies, Lannett does not useinformation about product levels in distribution channels from third-partysources, such as IMS and Wolters Kluwer, in estimating future returns and othercredits. Lannett calculates a chargeback/rebate rate based on contractual termswith its customers and applies this rate to customer sales.  The onlyvariable is customer mix, and this assumption is based on historical data andsales expectations.  The chargeback/rebate reserve is reviewed on amonthly basis by management using several ratios and calculated metrics. As we continue to obtain additional information about our historical experiencefor chargebacks, rebates and returns, we also update our estimates of therequired reserves.

 

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***Chargebacks***— The provision forchargebacks is the most significant and complex estimate used in therecognition of revenue.  The Company sells its products directly towholesale distributors, generic distributors, retail pharmacy chains, andmail-order pharmacies.  The Company also sells its products indirectly toindependent pharmacies, managed care organizations, hospitals, nursing homes,and group purchasing organizations, collectively referred to as “indirectcustomers.”  Lannett enters into agreements with its indirect customers toestablish pricing for certain products.  The indirect customers thenindependently select a wholesaler from which to actually purchase the productsat these agreed-upon prices.  Lannett will provide credit to thewholesaler for the difference between the agreed-upon price with the indirectcustomer and the wholesaler’s invoice price if the price sold to the indirectcustomer is lower than the direct price to the wholesaler.  This credit iscalled a chargeback.  The provision for chargebacks is based on expectedsell-through levels by the Company’s wholesale customers to the indirectcustomers and estimated wholesaler inventory levels.  As sales by theCompany to the large wholesale customers, such as Cardinal Health,AmerisourceBergen, and McKesson, increase, the reserve for chargebacks willalso generally increase.  However, the size of the increase depends on theexpected mix of product sales to the indirect customers. The Companycontinually monitors the reserve for chargebacks and makes adjustments whenmanagement believes that expected chargebacks on actual sales may differ fromthe amounts that were assumed in the establishment of the chargeback reserves.

 

***Rebates***— Rebates are offered to theCompany’s key chain drug store and wholesaler customers to promote customerloyalty and increase product sales.  These rebate programs providecustomers with rebate credits upon attainment of pre-established volumes orattainment of net sales milestones for a specified period.  Otherpromotional programs are incentive programs offered to the customers.  Atthe time of shipment, the Company estimates reserves for rebates and otherpromotional credit programs based on the specific terms in eachagreement.  The reserve for rebates increases as sales to rebate-eligiblecustomers are recognized and decreases when actual rebate payments aremade.  However, since rebate programs are not identical for all customers,the size of the reserve will depend on the mix of sales to customers that areeligible to receive rebates.

 

***Returns —*** Consistent with industrypractice, the Company has a product returns policy that allows certain customersto return product within a specified period prior to and subsequent to theproduct’s lot expiration date in exchange for a credit to be applied to futurepurchases.  The Company’s policy requires that the customer obtainpre-approval from the Company for any qualifying return.  The Companyestimates its provision for returns based on historical experience, adjustedfor any changes in business practices or conditions that would cause managementto believe that future product returns may differ from those returns assumed inthe establishment of reserves.  Generally, the reserve for returnsincreases as sales increase and decrease when credits are issued or paymentsare made for actual returns received.  The reserve for returns is includedin the rebates, chargebacks and returns payable account on the balance sheet.

 

***Other Adjustments —*** Other adjustments consistprimarily of price adjustments, also known as “shelf stock adjustments,” whichare credits issued to reflect decreases in the selling prices of the Company’sproducts that customers have remaining in their inventories at the time of aprice reduction.  Decreases in selling prices are discretionary decisionsmade by management to reflect competitive market conditions.  Amountsrecorded for estimated shelf stock adjustments are based upon specified termswith direct customers, estimated declines in market prices, and estimates ofinventory held by customers.  The Company regularly monitors these andother factors and evaluates the reserve as additional information becomesavailable.  Other adjustments are included in the rebates, chargebacks andreturns payable account on the balance sheet.  When competitors enter themarket for existing products, shelf stock adjustments may be issued to maintainprice competitiveness.

 

Thefollowing tables identify the reserves for each major category of revenueallowance and a summary of the activity for the nine months ended September 30,2010 and 2009:

 

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**For thethree months ended September 30, 2010**

 
| **Reserve Category**                                                                  | ** ** | **Chargebacks** | ** ** | **Rebates** | ** ** | **Returns** | ** ** | **Other**  | ** ** | **Total**   | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------|------------|-------------|------------|-------------|------------|------------|------------|-------------|------------|
| Reserve Balance as of June 30, 2010                                                        |       | $               | 6,282,127  |        | $          | 3,566,031   |       | $          | 5,401,254  |        | $          | — |   | $ | 15,249,412 |   |
| Actual credits issued related to sales recorded in  prior fiscal years                     |       | (6,112,838      | )          | (2,558,582  | )          | (1,151,174  | )          | —     |       | (9,822,594  | )          |
| Reserves or (reversals) charged during Fiscal 2011  related to sales in prior fiscal years |       | —          |       | —      |       | —      |       | —     |       | —      |       |
| Reserves charged to net sales during Fiscal 2011  related to sales recorded in Fiscal 2011 |       | 11,960,878      |       | 3,776,169   |       | 2,987,308   |       | 1,663,371  |       | 20,387,726  |       |
| Actual credits issued related to sales recorded in  Fiscal 2011                            |       | (7,056,592      | )          | (2,347,273  | )          | (1,387,700  | )          | (1,663,371 | )          | (12,454,936 | )          |
| Reserve Balance as of September 30, 2010                                                   |       | $               | 5,073,575  |        | $          | 2,436,345   |       | $          | 5,849,688  |        | $          | — |   | $ | 13,359,608 |   |

 

**For the three months ended September 30, 2009**

 
| **Reserve Category**                                                                  | ** ** | **Chargebacks** | ** ** | **Rebates** | ** ** | **Returns** | ** ** | **Other** | ** ** | **Total**  | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------|------------|-------------|------------|-------------|------------|-----------|------------|------------|------------|
| Reserve Balance as of June 30, 2009                                                        |       | $               | 6,089,802  |        | $          | 2,537,746   |       | $         | 5,106,992  |       | $          | — |   | $ | 13,734,540 |   |
| Actual credits issued related to sales recorded in  prior fiscal years                     |       | (4,767,581      | )          | (1,852,708  | )          | (1,147,720  | )          | —    |       | (7,768,009 | )          |
| Reserves or (reversals) charged during Fiscal 2010  related to sales in prior fiscal years |       | —          |       | —      |       | —      |       | —    |       | —     |       |
| Reserves charged to net sales during Fiscal 2010  related to sales recorded in Fiscal 2010 |       | 10,272,936      |       | 4,066,855   |       | 1,140,128   |       | 407,784   |       | 15,887,703 |       |
| Actual credits issued related to sales recorded in  Fiscal 2010                            |       | (7,000,389      | )          | (1,789,955  | )          | —      |       | (407,784  | )          | (9,198,128 | )          |
| Reserve Balance as of September 30, 2009                                                   |       | $               | 4,594,768  |        | $          | 2,961,938   |       | $         | 5,099,400  |       | $          | — |   | $ | 12,656,106 |   |

 

The total reserve for chargebacks, rebates, returns and otheradjustments decreased from $15,249,412 at June 30, 2010 to $13,359,608 atSeptember 30, 2010.  The decrease intotal reserves is due to a decrease in the rebates reserve as a result of adecrease in overall sales, and a decrease in chargeback reserves due primarilyto a decrease in inventory levels at wholesaler distribution centers.

 

Credits issued during the quarter that relate to prior year sales arecharged against the opening balance.  Inaggregate, additional reserves or reversals of reserves have historicallyoffset each other.  The table above showsthe effects of reversals within the rebates, returns and other categories.  It is the Company’s intention that allreserves be charged to sales in the period that the sale is recognized,however, due to the nature of this estimate, it is possible that the Companymay sometimes need to increase or decrease the reserve based on prior periodsales.  If that were to occur, managementwould disclose that information at that time. If the historical data the Company uses and the assumptions managementmakes to calculate its estimates of future returns, chargebacks, and othercredits do not accurately approximate future activity, its net sales, grossprofit, net income and earnings per share could change.  However, management believes that theseestimates are reasonable based upon historical experience and currentconditions.

 

The rates of reserves will vary, as well as the category under whichthe credit falls.  This variability comesabout when the Company is working with indirect customers to compete with thepricing of other generic companies.  TheCompany has improved its computer systems in order to improve the accuracy oftracking and processing chargebacks and rebates and will continue to look atways for further improvements.  Improvementsto automate 

 

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calculation of reserves will not only reduce the potential for humanerror, but also will result in more in-depth analysis and improved customerinteraction for resolution of open credits.

 

The rate of credits issued is monitored by the Company at least on aquarterly basis.  The Company may changethe estimate of future reserves based on the amount of credits processed, orthe rate of sales made to indirect customers.  The decrease of reserves to $13,359,608 at September 30, 2010 from$15,249,412 at June 30, 2010 is due to the timing of credits being processed bythe customers and by the Company. Approximately $9,823,000 or 64% of the reserve balance from June 30,2010 has been processed through the first three months of Fiscal 2011.  Management estimates reserves based on salesmix.  A comparison to wholesalerinventory reports is performed quarterly, in order to justify the balance ofunclaimed chargebacks and rebates.  TheCompany has historically found a direct correlation between the calculation ofthe reserve based on sales mix, and the wholesaler inventory analysis.

 

***Accounts Receivable******—*** The Company performs ongoingcredit evaluations of its customers and adjusts credit limits based uponpayment history and the customer’s current credit worthiness, as determined bya review of current credit information. The Company continuously monitorscollections and payments from its customers and maintains a provision forestimated credit losses based upon historical experience and any specificcustomer collection issues that have been identified. While such credit losseshave historically been within both the Company’s expectations and theprovisions established, the Company cannot guarantee that it will continue toexperience the same credit loss rates that it has in the past.

 

TheCompany also regularly monitors accounts receivable (“AR”) balances byreviewing both net and gross day’s sales outstanding (“DSO”).  Net DSO is calculated by dividing grossaccounts receivable less the reserve for rebates and chargebacks by the averagedaily net sales for the period.  GrossDSO shows the result of the same calculation without regard to rebates andchargebacks.

 

TheCompany monitors both net DSO and gross DSO as an overall check on collectionsand to assess the reasonableness of the reserves. Gross DSO provides managementwith an understanding of the frequency of customer payments, and the ability toprocess customer payments and deductions. The net DSO calculation provides management with an understanding of therelationship of the AR balance net of the reserve liability compared to netsales after charges to the reserves during the period.  Standard payment terms offered to customersare consistent with industry practice at 60 days.   Net DSO eliminates the effect of timing ofprocessing, which is inherent in the gross DSO calculation.

 

Thefollowing table shows the results of these calculations as of the relevantperiods:

** **
| ** **          | ** ** | **9/30/10** | ** ** | **6/30/10** | ** ** | **9/30/09** | ** ** |
|---------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Net DSO (in days)   |       | 86          |       | 77          |       | 68          |       |
| Gross DSO (in days) |       | 63          |       | 69          |       | 62          |       |

 

Thelevel of net DSO at September 30, 2010 is higher than the Company’sexpectation that DSO will be in the 60 to 70 day range based on 60 day paymentterms for most customers.  The increaseis due to a higher percentage of sales being shipped at the end of the quarter.

 

***Inventories****—* The Companyvalues its inventory at the lower of cost (determined by the first-in,first-out method) or market, regularly reviews inventory quantities on hand,and records a provision for excess and obsolete inventory based primarily onestimated forecasts of product demand and production requirements.  The Company’s estimates of future productdemand may prove to be inaccurate, in which case it may have 

 

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understatedor overstated the provision required for excess and obsolete inventory. In thefuture, if the Company’s inventory is determined to be overvalued, the Companywould be required to recognize such costs in cost of goods sold at the time ofsuch determination. Likewise, if inventory is determined to be undervalued, theCompany may have recognized excess cost of goods sold in previous periods andwould be required to recognize such additional operating income at the time ofsale.

 

***Consolidation of Variable Interest Entity*** — The Companyconsolidates any Variable Interest Entity (“VIE”) of which we are the primarybeneficiary. The liabilities recognized as a result of consolidating a VIE donot represent additional claims on our general assets; rather, they representclaims against the specific assets of the consolidated VIE. Conversely, assetsrecognized as a result of consolidating a VIE do not represent additionalassets that could be used to satisfy claims against our general assets.  Reflected in the September 30, 2010 and June30, 2010 balance sheets are consolidated VIE assets of approximately $1.9million and $1.9 million, respectively, which is comprised mainly of land and abuilding. VIE liabilities consist of a mortgage on that property in the amountof approximately $1.6 and $1.6 million at September 30, 2010 and June 30, 2010,respectively. This VIE was initially consolidated by Cody, as Cody has been theprimary beneficiary.  Cody has then been consolidated within Lannett’sfinancial statements since its acquisition in April 2007.

 

***Results of Operations - Three months endedSeptember 30, 2010 compared with three months ended September 30, 2009***

 

Netsales for the three months ended September 30, 2010 (“Fiscal 2011”) decreased19% to $25,396,000 from $31,435,000 for the three months ended September 30,2009 (“Fiscal 2010”). The following factors contributed to the $6,039,000decrease in sales:

 
| **Medical indication** | ** ** | **Sales volume  change %** | ** ** | **Sales price  change %** | ** ** |
|-----------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| Heart Failure          |       | -30                                  | %          | -4                                  | %          |
| Antibiotics                 |       | -22                                  | %          | 7                                   | %          |
| Prescription Vitamins       |       | -64                                  | %          | 60                                  | %          |
| Epilepsy                    |       | 16                                   | %          | -27                                 | %          |
| Thyroid Deficiency          |       | -1                                   | %          | -19                                 | %          |
| Pain Management             |       | -21                                  | %          | -5                                  | %          |
| Migraine Headache           |       | 4                                    | %          | -8                                  | %          |

 

Salesof drugs used in the treatment of thyroid deficiency decreased by approximately$2,688,000 primarily as a result of a competitive price reduction in order toretain one of our major customers. Included in this amount is a one-time shelf stock adjustment totalingapproximately $1,262,000.  The overalldecrease in sales was also affected by a decrease in sales of drugs for thetreatment of congestive heart failure by approximately $1,623,000 for the threemonths ended September 30, 2010 compared to September 30, 2009 mainly due to adecrease in the volume of bottles shipped, as well as a result of a competitiveprice reduction in order to retain one of our major customers.  Included in this amount is a one-time shelfstock adjustment totaling approximately $154,000.  Sales of drugs used for pain managementdecreased by approximately $980,000 for the three months ended September 30,2010 compared to September 30, 2009. This decrease is primarily the result of$2,800,000 of lost revenues as a result of the FDA’s action to force Lannettand all but one competitor to cease manufacturing and/or distributing MorphineSulfate Oral Solution effective July 24, 2010. Partially offsetting the lost Morphine Sulfate Oral Solution revenueswere an increase in demand for other pain management products includingHydromorphone and Oxycodone which increased $1,199,000 and $666,000,respectively for the three months ended September 30, 2010 compared toSeptember 30, 2009.  Net sales of ourprescription vitamins also decreased by approximately $620,000 due to a lack ofselling activities by the branded drug company.

 

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TheCompany sells its products to customers in various categories.  The table below identifies the Company’sapproximate net sales to each category for the three months ended September 30,2010 and 2009:

 
| ** **                 | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------------|------------|
| **Customer Category** | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
|                       |       |                                                     |       |   |   |
| Wholesaler/ Distributor    |       | $                                                        | 12,717,000 |   | $ | 15,169,000 |   |
| Retail Chain               |       | 11,724,000                                               |       | 14,732,000 |   |
| Mail-Order Pharmacy        |       | 955,000                                                  |       | 1,534,000 |   |
|                       |       |                                                     |       |   |   |
| Total                      |       | $                                                        | 25,396,000 |   | $ | 31,435,000 |   |

 

Thesales to wholesaler/distributor decreased primarily as a result of the FDA’saction to force all but one competitor to cease manufacturing and/ordistributing Morphine Sulfate Oral Solution effective July 24, 2010 asdiscussed above.  The sales to retailchains decreased primarily as a result of the competitive price reductions ontwo products in order to retain one of our major customers as discussed above.

 

Costof sales for the first quarter decreased 2% to $19,492,000 in Fiscal 2011 from$19,901,000 in Fiscal 2010.  The decreasereflected the impact of the 19% decrease in sales.  The decrease in cost of sales was less thanthe decrease in sales due to a change in the mix of products sold.

 

Amortizationexpense primarily relates to the JSP Distribution Agreement.  For the remaining term of the JSPDistribution Agreement, the Company will incur annual amortization expense ofapproximately $1,785,000.

 

Grossprofit margins for the first quarter of Fiscal 2011 and Fiscal 2010 were 23%and 37%, respectively. Gross profit percentage decreased due to the overalldecline in sales described above and due to product mix.  While the Company is continuously striving tokeep product costs low, there can be no guarantee that profit margins will notfluctuate in future periods.  Pricingpressure from competitors and costs of producing or purchasing new drugs mayalso fluctuate in the future. Changesin the future sales product mix may also occur. These changes may affect thegross profit percentage in future periods.

 

Researchand development (“R&D”) expenses in the first quarter decreased 33% to$2,042,000 for Fiscal 2011 from $3,028,000 for Fiscal 2010.  The decrease is primarily due to the timingof milestone achievements for costs of products in development and completedphases for several biostudies.  TheCompany expenses all production costs as R&D until the drug is approved bythe FDA.  R&D expenses may fluctuatefrom period to period, based on R&D plans for submission to the FDA.

 

Selling**,**general and administrative expenses in the first quarterincreased 22% to $4,601,000 in Fiscal 2011 from $3,763,000 in Fiscal 2010.  The increase is primarily due to increasedlegal costs related to the litigation with the FDA regarding the status ofGrandfathered products, including our Morphine Sulfate Oral solution. While theCompany is focused on controlling costs, increases in personnel costs may havean ongoing and longer lasting impact on the administrative cost structure.  Other costs are being incurred to facilitateimprovements in the Company’s infrastructure. These costs are expected to be temporary investments in the future ofthe Company and may not continue at the same level.

 

Interestexpense was flat with $71,000 recorded in the first quarter of Fiscal 2011compared to $70,000 in Fiscal 2010. Interest income in the first quarterdecreased to $11,000 in Fiscal 2011 from $23,000 in Fiscal 2010 due to lowerinterest earned on smaller investment securities balances.

 

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TheCompany recorded an income tax benefit in the first quarter of 2011 of $390,000compared to income tax expense of $1,828,000 in the first quarter of Fiscal2010. The effective tax rate for the three months ended September 30, 2010 was50%, compared to 39% for the three months ended September 30, 2009.  The effective tax rate for the three monthsended September 30, 2010 was higher compared to the three months endedSeptember 30, 2009 due primarily to nondeductible incentive stock optioncompensation expenses relative to the expected pretax income for Fiscal 2011.  The Company expects its overall effective taxrate will be approximately 48% to 50% for the full year ended June 30, 2011.

 

TheCompany reported a net loss attributable to Lannett of approximately $404,000in the first quarter of Fiscal 2011, or $0.02 basic and diluted loss per share,as compared to net income attributable to Lannett of approximately $2,857,000in the first quarter Fiscal 2010, or $0.12 basic and $0.11 diluted earnings pershare.

 

***Liquidity and Capital Resources***

 

The Company has historically financed its operationswith cash flow generated from operations, supplemented with borrowings fromvarious government agencies and financial institutions.  At September 30, 2010, working capital was$38,931,430, as compared to $40,104,705 at June 30, 2010, a decrease of$1,173,275.

 

Net cash used in operating activities of $2,127,000in the first three months of Fiscal 2011 reflected a net loss of $394,000,after adjusting for non-cash items of $1,935,000, as well as cash used bychanges in operating assets and liabilities of $3,668,000.  Significant changes in operating assets andliabilities are comprised of:

 

·                  A decrease in tradeaccounts receivable of $7,135,000 primarily as a result of decreased sales inthe first quarter of Fiscal 2011.

·                  An increase ininventories of $1,980,000 primarily due to returned Morphine Sulfate Oral Solution product as a result of the FDA’saction to force all but one competitor to cease manufacturing and/ordistributing this product effective July 24, 2010.

·                  An increase inprepaid taxes of $498,000 from an income taxes payable balance of $1,480,000due to estimated tax payments made in September 2010 related to Fiscal 2010.

·                  A decrease inaccounts payable of $517,000 due to the timing of payments at the end of themonth.

·                  A decrease inaccrued expenses of $965,000 primarily due to the timing of biostudy andproduct development milestone achievements.

·                  Adecrease in rebates, chargebacks and returns payable of $1,890,000 primarily due to adecrease in the rebates reserve as a result of a decrease in overall sales, anda decrease in chargeback reserves due primarily to a decrease in inventorylevels at wholesaler distribution centers.

·                  A decrease inaccrued payroll and payroll related costs of $3,818,000 primarily related tothe payment in the first quarter of Fiscal 2011 of the Fiscal 2010 accruedincentive compensation costs totaling approximately $3,421,000.

 

Netcash used in investing activities of $2,068,000 for the three months endedSeptember 30, 2010 is mainly the result of purchases of property, plant andequipment of $2,463,000, partially offset by proceeds of $395,000 from the saleof available for sale investment securities.

 

Netcash used in financing activities of $89,000 for the three months endedSeptember 30, 2010 was primarily due to the purchase of shares of treasurystock totaling $85,000 partially offset by proceeds from the issuance of stockof $54,000.  The Company also madescheduled debt repayments of $58,000.

 

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Long-termdebt amounts due, for the twelve month periods ended September 30 are asfollows:

 
| **Twelve**             | ** ** | **Amounts Payable** | ** ** |
|------------------------|------------|--------------------------|------------|
| **Month Periods** | ** ** | **to Institutions** | ** ** |
|                   |       |                     |       |
| 2011                   |       | $                        | 4,826,601  |   |
| 2012                   |       | 276,284                  |       |
| 2013                   |       | 288,522                  |       |
| 2014                   |       | 305,716                  |       |
| 2015                   |       | 163,608                  |       |
| Thereafter             |       | 1,800,843                |       |
|                   |       |                     |       |
|                   |       | $                        | 7,661,574  |   |

 

TheCompany has a $3,000,000 line of credit from Wells Fargo, N.A. (“Wells Fargo”)that bears interest at the prime interest rate less 0.25% (3.00% at September30, 2010 and June 30, 2010, respectively). As of September 30, 2010 andJune 30, 2010, the Company has $3,000,000 of availability under this lineof credit.  The line of credit is collateralizedby substantially all of the Company’s assets.  The agreement containscovenants with respect to working capital, net worth and certain ratios, aswell as other covenants.  As ofSeptember 30, 2010, the Company was not in compliance with all financialcovenants under the agreement, but received a waiver from its lendinginstitution with respect to the failed covenant as of September 30, 2010. Thenoncompliance was caused by the direct use of cash to purchase and fit outLannett’s third facility during the December 2009, March 2010 and June 2010quarters over a period where the Company experienced reduced earnings caused bythe DEA withholding production quota for Morphine Sulfate Oral Solution and theFDA actions barring Lannett from shipping Morphine Sulfate Oral Solution. As aresult of the expected refinancing of the $4.5 million PIDC Regional Center, LPIII loan which is due on January 1, 2011, the Company will considerrenegotiation of its current covenant requirements.

 

Theexisting line of credit, which was scheduled to expire on November 30, 2010,was renewed and extended during the first quarter of Fiscal 2011 toNovember 30, 2011.   As part of the renewal agreement lastfiscal year, the Company is no longer required to maintain any minimum depositbalances with Wells Fargo, and the availability fee on the unused balance ofthe line of credit was reduced to 0.375%.

 

In December 2005, the Company borrowed $4,500,000 through thePhiladelphia Industrial Development Corporation (PIDC). The Company pays abi-annual interest payment at a rate equal to two and one-half percent perannum.  The outstanding principal balance is due and payable onJanuary 1, 2011.  The Companyintends to refinance this loan prior to its maturity date.

 

TheCompany borrowed $1,250,000 through the Pennsylvania Industrial DevelopmentAuthority (“PIDA”).  The Company is required to make equal payments eachmonth for 180 months starting February 1, 2006 with interest of two andthree-quarter percent per annum.  ThePIDA Loan has $914,726 outstanding as of September 30, 2010 with $77,600currently due.

 

TheCompany borrowed $500,000 from the Pennsylvania Department of Community andEconomic Development Machinery and Equipment Loan Fund.  The Company is required to make equalpayments for 60 months starting May 1, 2006 with interest of two and threequarter percent per annum.  As ofSeptember 30, 2010, $61,923 is outstanding and currently due.

 

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InApril 1999, the Company entered into a loan agreement with thePhiladelphia Authority for Industrial Development (the “Authority” or “PAID”),to finance future construction and growth projects of the Company. TheAuthority issued $3,700,000 in tax-exempt variable rate demand and fixed raterevenue bonds to provide the funds to finance such growth projects pursuant toa trust indenture (“the Trust Indenture”). A portion of the Company’s proceeds from the bonds was used to pay forbond issuance costs of approximately $170,000. The Trust Indenture requires that the Company repay the Authority loanthrough installment payments beginning in May 2003 and continuing throughMay 2014, the year the bonds mature. The bonds bear interest at thefloating variable rate determined by the organization responsible for sellingthe bonds (the “remarketing agent”).  Theinterest rate fluctuates on a weekly basis. The effective interest rate at September 30, 2010 was 0.49%.  At September 30, 2010, the Company has$555,000 outstanding on the Authority loan, of which $130,000 is classified ascurrently due.  The remainder isclassified as a long-term liability. In April 1999, an irrevocable letterof credit of $3,770,000 was issued by Wells Fargo to secure payment of theAuthority Loan and a portion of the related accrued interest.  At September 30, 2010, no portion of theletter of credit has been utilized.

 

TheCompany has executed Security Agreements with Wells Fargo, PIDA and PIDC inwhich the Company has pledged substantially all of its assets to collateralizethe amounts due.

 

TheCompany consolidates Cody LCI Realty, LLC, a variable interest entity (“VIE”),for which Cody Labs is the primary beneficiary. See note 16 to our Consolidated Financial Statements for “Consolidationof Variable Interest Entities.”  Amortgage loan with First National Bank of Cody related to the purchase of landand building by the VIE has also been consolidated in the Company’sconsolidated balance sheets.  Themortgage requires monthly principal and interest payments of $14,782, at afixed rate of 7.5%, to be made through June 2026.  As of September 30, 2010, $1,629,925 isoutstanding under the mortgage loan, of which $57,078 is classified ascurrently due. The mortgage is collateralized by the land and building.

 

InJuly 2004, the Company received $500,000 of grant funding from theCommonwealth of Pennsylvania, acting through the Department of Community andEconomic Development.  The grant fundingprogram requires the Company to use the funds for machinery and equipmentlocated at their Pennsylvania locations, hire an additional 100 full-timeemployees by June 30, 2006, operate its Pennsylvania locations a minimumof five years and meet certain matching investment requirements.  If the Company fails to comply with any ofthe requirements above, the Company would be liable to repay the full amount ofthe grant funding ($500,000).  TheCompany has recorded the unearned grant funds as a liability until the Companycomplies with all of the requirements of the grant funding program. As ofSeptember 30, 2010, the Company has had preliminary discussions with theCommonwealth of Pennsylvania to determine whether it will be required to repayany of the funds provided under the grant funding program.  Based on information available atSeptember 30, 2010, the Company has recorded the grant funding as along-term liability under the caption of Unearned Grant Funds.

 

**Prospects for the Future**

 

Genericpharmaceutical manufacturers and distributors are constantly faced by pricingpressure in the marketplace as competitors attempt to lure business fromdistributors, wholesalers and chain retailers by offering lower prices than theincumbent supplier.  Lannett tries todifferentiate itself in the marketplace by complementing its lower costofferings with higher levels of customer service and quality of the products.  But as Lannett enters Fiscal Year 2011, thereis an increasing number of competitors on our key products that are attemptingto supplant Lannett as the preferred vendor. Lannett will continue to evaluate each event as it arises, but anyreductions in either volumes or pricing will have a negative impact on the grossprofit margins of the Company.

 

Duringthe First Quarter of Fiscal 2011, Lannett faced significant pricing challengeson its top two selling products.  Inorder to keep the volume of business with the specific customer involved,Lannett chose to reduce 

 

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itsselling price on both of the products. This price reduction will have a significant impact to the gross profitmargins and profitability of Lannett expected in the future.

 

TheCompany has several generic products under development.  These products are all orally-administered,topical and parenteral products designed to be generic equivalents to brand namedinnovator drugs.  The Company’sdevelopmental drug products are intended to treat a diverse range ofindications.  As one of the oldestgeneric drug manufacturers in the country, formed in 1942, Lannett currentlyowns several ANDAs for products which it does not manufacture and market.  These ANDAs are dormant on the Company’srecords.  Occasionally, the Companyreviews such ANDAs to determine if the market potential for any of these olderdrugs has recently changed, so as to make it attractive for Lannett toreconsider manufacturing and selling it. If the Company makes the determination to introduce one of theseproducts into the consumer marketplace, it must review the ANDA and relateddocumentation to ensure that the approved product specifications, formulationand other factors meet current FDA requirements for the marketing of thatdrug.  The Company would then redevelopthe product and submit it to the FDA for supplemental approval.  The FDA’s approval process for ANDAsupplements is similar to that of a new ANDA.  Generally, in these situations, the Company must file a supplement tothe FDA for the applicable ANDA, informing the FDA of any significant changesin the manufacturing process, the formulation, or the raw material supplier ofthe previously-approved ANDA.  Recently,the FDA has announced that it will prioritize its review of 3,800 ChemistryManufacturing and Control (“CMC”) supplements in order to make progress onreviewing a backlog of over 2,200 ANDAs. This could negatively impact the sales of existing products.

 

Theproducts under development are at various stages in the developmentcycle—formulation, scale-up, and/or clinical testing.  Depending on the complexity of the activeingredient’s chemical characteristics, the cost of the raw material, theFDA-mandated requirement of bioequivalence studies, the cost of such studiesand other developmental factors, the cost to develop a new generic productvaries and can range from $100,000 to $1.7 million.  Some of Lannett’s developmental products willrequire bioequivalence studies, while others will not—depending on the FDA’sOrange Book classification.  Since theCompany has no control over the FDA review process, management is unable toanticipate whether or when it will be able to begin producing and shippingadditional products.

 

TheCompany views its April 2007 acquisition of Cody Laboratories, Inc. (“CodyLabs” or “Cody”) as an important step in becoming a vertically integratednarcotics manufacturer and distributor by allowing it to concentrate ondeveloping and completing its dosage form manufacturing in order to reducenarcotic API costs. In July 2008, the DEA granted Cody Labs a license todirectly import raw poppy straw for conversion into API and/or variouspharmaceutical products.  Only six othercompanies in the U.S. have been granted this license to date.  This license allows the Company to avoidincreased costs associated with buying narcotic API from othermanufacturers.  The Company anticipatesthat it can use this license to become a vertically integrated manufacturer ofnarcotic products, as well as a supplier of API to the pharmaceuticalindustry.  The Company believes that theaging domestic population may result in a higher demand for pain managementpharmaceutical products and that it will be well-positioned to take advantageof this increased demand.

 

CodyLabs’ manufacturing expertise in narcotic APIs will allow Lannett to build amarket with limited domestic competition. The Company anticipates that the demand for narcotics and controlleddrugs will continue to grow with the “Baby Boomer” generation demographics andthat it is well-positioned to take advantage of these opportunities byconcentrating additional resources in the narcotic area. The sale of painmanagement products approximated 11% of Net Sales for the full year Fiscal2010.  Additionally, the API and dosageform production of these products were performed at our Cody Labs operationsand, due to the increased volumes of sales on these products, allowed Cody tobe profitable for the entire 2010 fiscal year. Due to the FDA’s actions against Morphine Sulfate Oral Solution and aslow down in the demand for one other product that is manufactured at Cody,Lannett expects a decrease in the percentage of sales related to painmanagement products in the short term. At the time 

 

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theFDA approves the Company’s current 505(b)(2) New Drug Application forMorphine Sulfate Oral Solution, the Company expects the portion of net salesrelated to pain management products to increase again.

 

Inaddition to the efforts of its internal product development group, Lannett hascontracted with several outside firms for the formulation and development ofseveral new generic drug products.  Theseoutsourced 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 soliddosage products, topical or parenterals intended to treat a diverse range ofmedical indications.  We intend toultimately transfer the formulation technology and manufacturing process forall of these R&D products to our own commercial manufacturing sites.  The Company initiated these outsourcedR&D efforts to complement the progress of its own internal R&D efforts.

 

Occasionally,the Company will work on developing a drug product that does not require FDAapproval.  Certain prescription drugs donot require prior FDA approval before marketing.  They include, for instance, drugs listed asDESI drugs (Drug Efficacy Study Implementation) which are under evaluation byFDA, Grandfathered Drugs, and prescription multivitamin drugs. A genericmanufacturer may sell products which are chemically equivalent to innovatordrugs, under FDA rules by simply performing and internally documenting thenormal research and development involved in bringing a new product to market.  Under this scenario, a generic company canforego the time required for FDA approval.

 

Morespecifically, certain products, marketed prior to the Federal Food, Drug andCosmetic Act may be considered GRASE (“Generally Recognized As Safe andEffective”) or Grandfathered.  GRASEproducts are those “old drugs that do not require prior approval from FDA inorder to be marketed because they are generally recognized as safe andeffective based on published scientific literature.”  Similarly, Grandfathered products are thosewhich “entered the market before the passage of the 1938 act or the 1962amendments to the act.”  Under thegrandfather clause, such a product is exempted from the “effectivenessrequirements [of the act] if its composition and labeling have not changedsince 1962 and if, on the day before the 1962 amendments became effective, itwas (1) used or sold commercially in the United States, (2) not a new drugas defined by the act at that time, and (3) not covered by an effectiveapplication.” Recently, the FDA has increased its efforts to force companies tofile and seek FDA approval for these GRASE products.  Efforts have included granting marketexclusivity to approved GRASE products and issuing notices to companiescurrently producing these products.

 

TheCompany has entered supply and development agreements with certaininternational companies, including Wintac of India, Orion Pharma of Finland,Azad Pharma AG and Swiss Caps of Switzerland, Pharma 2B (formerly Pharmaseed)of Israel and the GC Group, as well as certain domestic companies, includingJerome Stevens, Banner Pharmacaps, Cerovene, Summit Bioscience LLC andInverness.  The Company is currently innegotiations on similar agreements with other international companies, throughwhich Lannett will market and distribute products manufactured by Lannett or bythird parties.  Lannett intends to useits strong customer relationships to build its market share for such products,and increase future revenues and income.

 

Themajority of the Company’s R&D projects are being developed in-house underLannett’s direct supervision and with Company personnel.  Hence, the Company does not believe that itsoutside contracts for product development and manufacturing supply are materialin nature, nor is the Company substantially dependent on the services renderedby such outside firms.

 

Lannettmay increase its focus on certain specialty markets in the genericpharmaceutical industry.  Such a focus isintended to provide Lannett customers with increased product alternatives incategories with relatively few market participants.  While there is no guarantee that Lannett hasthe market expertise or financial resources necessary to succeed in such amarket specialty, management is confident that such future focus will be wellreceived by Lannett customers and increase shareholder value in the long run.

 

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TheCompany plans to enhance relationships with strategic business partners,including providers of product development research, raw materials, activepharmaceutical ingredients as well as finished goods.  Management believes that mutually beneficialstrategic relationships in such areas, including potential financingarrangements, partnerships, joint ventures or acquisitions, could allow forpotential competitive advantages in the generic pharmaceutical market.  The Company plans to continue to explore suchareas for potential opportunities to enhance shareholder value.

 

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**ITEM 3.*** ***QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

TheCompany has debt instruments with variable interest rates.  The Company has a $3,000,000 line of creditfrom Wells Fargo, N.A. that bears interest at the prime interest rate less0.25% (3.00% at September 30, 2010 and June 30, 2010, respectively).As of September 30, 2010 and June 30, 2010, the Company has$3,000,000 of availability under this line of credit.  The line of credit is collateralized bysubstantially all of the Company’s assets.  The agreement containscovenants with respect to working capital, net worth and certain ratios, aswell as other covenants.  The existingline of credit which was to expire on November 30, 2010, was renewed andextended to November 30, 2011.

 

TheCompany invests in U.S. government agency securities and corporate bonds whichare exposed to interest rate fluctuations. The interest earned on these investments may vary based on fluctuationsin the interest rate.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controls and Procedures***

 

Asof the end of the period covered by this Form 10-Q, management performed,with the participation of our Chief Executive Officer and Chief FinancialOfficer, an evaluation of the effectiveness of our disclosure controls andprocedures as defined in Rules 13a-15(e) and 15d-15(e) of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”). Ourdisclosure controls and procedures are designed to provide reasonable assurancethat information required to be disclosed in the reports we file or submitunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms, and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, to allow timely decisionsregarding required disclosures.

 

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

 

***Change in Internal ControlOver Financial Reporting***

 

There has been no change inthe Company’s internal control over financial reporting during the three monthsended September 30, 2010 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

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**PART II.  OTHER INFORMATION**

 

**ITEM 1.  LEGALPROCEEDINGS**

 

InJanuary 2010, the Company initiated an arbitration proceeding againstOlive Healthcare (“Olive”) for damages arising out of Olive’s delivery ofdefective soft-gel prenatal vitamin capsules. The Company seeks damages in excess of $3.5 million. Olive has deniedliability and filed a counterclaim in February 2010 for breach ofcontract.

 

InJune 2008, the Company filed a declaratory judgment suit inthe Federal District Court of Delaware (Civil Action No. 08-338 (JJF))against KV Pharmaceuticals, DrugTech Corp. and Ther-Rx Corp (collectively,“KV”).  The complaint sought declaratory judgmentfor non-infringement and invalidity of certain patents owned by KV. The complaint further sought declaratory judgment of anti-trust violationsand federal and state unfair competition violations for actions taken by KV insecuring and enforcing these patents.  After the complaint was filed,KV countered with a motion for a Temporary Restraining Order (“TRO”) toprevent the Company from launching its Multivitamin with Mineral Capsules(“MMCs”), due to alleged patent and trademark infringement issues.  TheTRO was heard and, ultimately, resulted in a conclusion by the court that theCompany’s product label on the MMCs should be modified.  KV alsocountered with claims of infringement by the Company of KV’s patents seekingthe Company’s profits for sales of MMCs or other monetary relief, preliminaryand permanent injunctive relief, attorney’s fees and a finding of willfulinfringement. In March 2009, the Company and KV settled thelitigation.  In light of the withdrawalof KV’s innovator prenatal product due to FDA enforcement actions, and theresulting anticipated decline in sales and declining market for writtenprescription, the Company decided it was pointless to continue the litigationand entered into the settlement arrangement with KV.  Pursuant to the settlement, the Companyreceived a license from KV and became an authorized generic provider.  During the terms of the license, the Companyis to pay KV a royalty on all future sales of its Prenatal vitaminproduct.  Lannett will cease offering itsPrenatal vitamin product if and when the brand is restored to themarketplace.  In May 2010, theCompany filed an action for declaratory relief in the Delaware Superior Courtagainst KV seeking a declaration that KV breached its obligations under asettlement agreement entered into with the Company (the “Binding Agreement”).  In June 2010, KV filed a counterclaim tothe complaint and asserted claims for breach of contract, declaratory judgment,negligent misrepresentation and fraud in connection with the Binding Agreement,alleging among other things that the Company has improperly withheld royaltiesfrom KV arising out of its sales of a pre-natal vitamin product.  KV filed a motion for summary judgment, whichthe Company opposed.  The Court has not yet held a hearing on the motionor ruled on it.

 

***Regulatory Proceedings***

 

TheCompany is engaged in an industry which is subject to considerable governmentregulation relating to the development, manufacturing and marketing ofpharmaceutical products.  Accordingly,incidental to its business, the Company periodically responds to inquiries orengages in administrative and judicial proceedings involving regulatoryauthorities, particularly the FDA and the Drug Enforcement Agency.

 

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**ITEM 1A.               RISK FACTORS**

 

**We materially rely on an uninterrupted supply of finishedproducts from Jerome Stevens Pharmaceutical (“JSP”) for a majority of oursales.  If we were to experience aninterruption of that supply, our operating results would suffer.**

 

Approximately69% of our fiscal year 2010 sales are of distributed products, primarilymanufactured by JSP.  Two of thesesproducts are Levothyroxine Sodium (“Levo”) and Digoxin, which accounted for 41%and 17%, respectively, of our Fiscal 2010 net sales, and 40% and 22%,respectively, of our net sales for Fiscal 2009. Sales of Levo and Digoxin accounted for 40% and 13%, respectively, ofour and net sales for the three months ended September 30, 2010, and 41%and 15%, respectively, of our net sales for the three months ended September 30,2009.  If the supply of these products isinterrupted in any way by any form of temporary or permanent businessinterruption to JSP, including but not limited to fire or othernaturally-occurring, damaging event to their physical plant and/or equipment,breakdown and/or delayed replacement or installation of production equipment,condemnation of their facility, legislative or regulatory cease and desistdeclaration regarding their operations, and any interruption in their source ofAPI for their products, our operating results could be materially adverselyaffected.  We do not have, at this time, a second source for theseproducts.

 

**The generic pharmaceutical industry is highly competitive.**

 

Weface strong competition in our generic product business.   Revenues and gross profit derived from thesales of generic pharmaceutical products tend to follow a pattern based oncertain regulatory and competitive factors. As patents for brand name products and related exclusivity periodsexpire, the first generic manufacturer to receive regulatory approval forgeneric equivalents of such products is generally able to achieve significantmarket penetration.  As competing off-patent manufacturers receiveregulatory approvals on similar products or as brand manufacturers launch genericversions of such products (for which no separate regulatory approval isrequired), market share, revenues and gross profit typically decline, in somecases dramatically.  Accordingly, the level of market share, revenue andgross profit attributable to a particular generic product is normally relatedto the number of competitors in that product’s market and the timing of thatproduct’s regulatory approval and launch, in relation to competing approvalsand launches.  Consequently, we must continue to develop and introduce newproducts in a timely and cost-effective manner to maintain our revenues andgross margins.

 

During the First Quarter of Fiscal 2011, Lannett faced significantpricing challenges on its top two selling products.  In order to keep the volume of business withthe specific customer involved, Lannett chose to reduce its selling price onboth of the products.  This pricereduction will have a significant impact to the gross profit margins and profitabilityof Lannett in the future.

 

**Extensive industry regulation has had, and will continue tohave, a significant impact on our business, especially our product development,manufacturing and distribution capabilities.**

 

Allpharmaceutical companies, including Lannett, are subject to extensive, complex,costly and evolving regulation by the federal government, including the FDA andin the case of controlled drugs, the DEA, and state government agencies. The FDCA, the CSA and other federal statutes and regulations govern orinfluence the development,testing, manufacturing, packing, labeling, storing, record keeping, safety,approval, advertising, promotion, sale and distribution of our products.

 

Theprocess for obtaining governmental approval to manufacture and marketpharmaceutical products is rigorous, time-consuming and costly, and we cannotpredict the extent to which we may be affected by legislative and regulatorydevelopments.  We are dependent on receiving FDA and other governmental orthird-party approvals prior to manufacturing, marketing and shipping our products.  The FDA approvalprocess for a particular product candidate can take several years and requiresus to dedicate substantial resources to securing approvals, and we may not beable to obtain regulatory approval for our product candidates in a timelymanner, or at all. In order to obtain approval for our generic productcandidates, we must demonstrate that our drug product is bioequivalent to adrug previously approved by the FDA through the new drug approval process,known as an innovator drug. Bioequivalency may be demonstrated in vivo or invitro by comparing the generic product candidate to the innovator drug productin dosage form, strength, route of administration, quality, dissolutionperformance characteristics, and intended use. The FDA may not agree that thebioequivalence studies we submit in the ANDA applications for our generic drugproducts are adequate to support approval. If it determines that an ANDA 

 

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applicationis not adequate to support approval, the FDA could deny our application orrequest additional information, including clinical trials, which could delayapproval of the product and impair our ability to compete with other versionsof the generic drug product.

 

Consequently,there is always the chance that we will not obtain FDA or other necessaryapprovals, or that the rate, timing and cost of such approvals, will adverselyaffect our product introduction plans or results of operations.  We carryinventories of certain product(s) in anticipation of launch, and if suchproduct(s) are not subsequently launched, we may be required to write-offthe related inventory.  Furthermore, the FDA also has the authorityto revoke drug approvals previously granted and remove these products from themarket for a variety of reasons, including a failure to comply with applicableregulations, the discovery of previously unknown problems with the product, orbecause the ingredients in the drug are no longer approved by the FDA.

 

Additionally,certain products, marketed prior to the Federal Food, Drug and Cosmetic Act maybe considered GRASE or Grandfathered. GRASE products are those “old drugs that do not require prior approvalfrom FDA in order to be marketed because they are generally recognized as safeand effective based on published scientific literature.”  Similarly, Grandfathered products are thosewhich “entered the market before the passage of the 1906 act, 1938 act or the1962 amendments to the act.”  Under theGrandfathered drug clause, such a product is exempted from the “effectivenessrequirements [of the act] if its composition and labeling have not changedsince 1962 and if, on the day before the 1962 amendments became effective, itwas (1) used or sold commercially in the United States, (2) not a newdrug as defined by the act at that time, and (3) not covered by aneffective application.” Recently, the FDA has increased its efforts to forcecompanies to file and seek FDA approval for these GRASE or Grandfatheredproducts.  Efforts have included grantingmarket exclusivity to approved GRASE products or Grandfathered drugs andissuing enforcement actions against companies currently producing theseproducts.  Lannett currently manufacturesand markets several products that are considered Grandfathered drug products,including Morphine Sulfate Oral Solution. The FDA is currently undertaking enforcement actions to force all companieswho manufacture Morphine Sulfate Oral Solution to file applications and seekapproval for their product or remove their product from the market.  As of July 24, 2010, Lannett has stoppedmanufacturing and distributing Morphine Sulfate Oral Solution and as of thedate of this Form 10-Q, the Company has approximately $2.0 million ofMorphine Sulfate Oral Solution finished goods inventory.  Lannett has filed a 505(b)(2) New DrugApplication and currently awaits FDA approval on the submission.  Due to this application, Lannett has anadditional $1.4 million of prepaid assets on its balance sheet as of September 30,2010. The Company expects a refund of at least half of this application fee andapproval on this application within the next few months.  If the Company is rejected on its currentapplication, if the current application takes significantly longer than elevenmonths to be approved, or if the FDA were to prevail on the current lawsuitfiled by Lannett which seeks determination that Morphine Sulfate Oral Solutionis a Grandfathered product, the Company is at risk of losing some or all of theapproximately $2.0 million of Morphine Sulfate Oral Solution inventory and $1.4million prepaid asset recorded on its books as of September 30, 2010, andapproximately 5% to 8 % in projected future annual Net Sales.  Lannett also has approximately $2.7 millionof inventory value at September 30, 2010 of other Grandfathered productswhich would also be at risk if the FDA were to pursue activities on theseproducts similar to their actions on Morphine Sulfate Oral Solution.

 

In addition, Lannett, as well as many of oursignificant suppliers of distributed product and raw materials, is subject toperiodic inspection of facilities, procedures and operations and/or the testingof the finished products by the FDA, the DEA and other authorities, whichconduct periodic inspections to confirm that pharmaceutical companies are incompliance with all applicable regulations. The FDA conducts pre-approval and post-approval reviews and plantinspections to determine whether systems and processes are in compliance withcGMP, and other FDA regulations. Following such inspections, the FDA may issue notices on Form 483that could cause us or our suppliers to modify certain activities identifiedduring the inspection.  A Form 483notice is generally issued at the conclusion of a FDA inspection and listsconditions the FDA inspectors believe may violate cGMP or other FDAregulations.  The DEA and comparablestate-level agencies also heavily regulate the manufacturing, holding,processing, security, record-keeping, and distribution of drugs that areconsidered controlled substances. Some of the pain management products wemanufacture contain controlled substances. The DEA periodically inspectsfacilities for compliance with its rules and regulations. If ourmanufacturing facilities or those of our suppliers fail to comply withapplicable regulatory requirements, it could result in regulatory action andadditional costs to us.

 

Our inability or the inability of our suppliers tocomply with applicable FDA and other regulatory requirements can result in,among other things, delays in or denials of new product approvals, warningletters, fines, consent decrees restricting or suspending manufacturingoperations, injunctions, civil penalties, recall or seizure of products, totalor partial suspension of sales, and/or criminal prosecution., Any of these orother regulatory actions could materially harm our operating results and 

 

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financial condition. Although we have instituted internal compliance programs, if theseprograms do not meet regulatory agency standards or if compliance is deemeddeficient in any significant way, it could materially harm our business**.**  Additionally, if the FDA were toundertake additional enforcement activities with any of Lannett’s GRASEproducts, their actions could result in, among other things, removal of some ofour products from the market, seizure of products and total or partialsuspension of sales.  Any of theseregulatory actions could materially harm our operating results and financialcondition.

 

**Our manufacturing operations as well as our suppliersmanufacturing are subject to licensing by the FDA and/or DEA.  If we or our suppliers were unable tomaintain the proper agency licensing arrangements, our operating results wouldbe materially negatively impacted.**

 

All of our manufacturing operations as well as thoseof our suppliers rely on maintaining active licenses to produce and developgeneric drugs.  Specifically, our CodyLabs operations rely on a DEA license to directly import and convert raw opiuminto several APIs or dosage forms.  Thislicense is granted for a one year period and must be renewed successfully eachyear in order for us to maintain Cody’s current operations and allow theCompany to continue to work towards becoming a fully integrated narcotics supplier.  If the Company were unable to successfullyrenew its FDA and/or DEA licenses, the financial results of Lannett would benegatively impacted.

 

**If we are unable to successfully develop or commercialize newproducts, our operating results will suffer.**

 

Ourfuture results of operations will depend to a significant extent upon ourability to successfully commercialize new generic products in a timelymanner.  There are numerous difficulties in developing and commercializingnew products, including:

 

·                  developing, testing and manufacturingproducts in compliance with regulatory standards in a timely manner;

 

·                  receiving requisite regulatory approvals forsuch products in a timely manner;  theFDA has recently published that it now takes at least 26 months on average toreview and approve ANDA applications;

 

·                  the availability, on commercially reasonableterms, of raw materials, including APIs and other key ingredients;

 

·                  developing and commercializing a new productis time consuming, costly and subject to numerous factors that may delay orprevent the successful commercialization of new products; and

 

·                  commercializing generic products may besubstantially delayed by the listing with the FDA of patents that have theeffect of potentially delaying approval of the off-patent product by up to 30months, and in some cases, such patents have been issued and listed with theFDA after the key chemical patent on the branded drug product has expired orbeen litigated, causing additional delays in obtaining approval.

 

Asa result of these and other difficulties, products currently in development byLannett may or may not receive the regulatory approvals necessary formarketing.  If any of our products, whendeveloped and approved, cannot be successfully or timely commercialized, ouroperating results could be adversely affected.  We cannot guarantee thatany investment we make in developing products will be recouped, even if we aresuccessful in commercializing those products.

 

**The loss of Arthur P. Bedrosian or our other key personnelcould cause our business to suffer.**

 

Thesuccess of our present and future operations will depend, to a significantextent, upon the experience, abilities and continued services of Arthur P.Bedrosian, our President and Chief Executive Officer, and our other keypersonnel.  If we lose the services ofMr. Bedrosian or our other key personnel, or if he or they are unable todevote sufficient attention to our operations for any other reason, ourbusiness may be significantly impaired. If the employment of any of our current key personnel is terminated, wecannot assure you that we will be able to attract and replace the employee withthe same caliber of key personnel.  Assuch, we have entered into employment agreements with all of our seniorexecutive officers to help prevent the loss of our key personnel.

 

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**Our gross profit may fluctuate from period to perioddepending upon our product sales mix, our product pricing and our costs tomanufacture or purchase products.**

 

Ourfuture results of operations, financial condition and cash flows depend to asignificant extent upon our product sales mix.  Our sales of certainproducts that we manufacture tend to create higher gross margins than do theproducts we purchase and resell.  As a result, our sales mix willsignificantly impact our gross profit from period to period.

 

Factorsthat may cause our sales mix to vary include:

 

·                  the amount of new product introductions;

 

·                  marketing exclusivity, if any, which may beobtained on certain new products;

 

·                  the level of competition in the marketplacefor certain products;

 

·                  the availability of raw materials andfinished products from our suppliers; and

 

·                  the scope and outcome of governmentalregulatory action that may involve us.

 

Theprofitability of our product sales is also dependent upon the prices we areable to charge for our products, the costs to purchase products from thirdparties, and our ability to manufacture our products in a cost effectivemanner.

 

**If branded pharmaceutical companies are successful inlimiting the use of generics through their legislative and regulatory efforts,our sales of generic products may suffer.**

 

Manybranded pharmaceutical companies increasingly have used state and federallegislative and regulatory means to delay generic competition.  Theseefforts have included:

 

·                  pursuing new patents for existing productswhich may be granted just before the expiration of one patent which couldextend patent protection for additional years or otherwise delay the launch ofgenerics;

 

·                  using the Citizen Petition process to requestamendments to FDA standards;

 

·                  seeking changes to U.S. Pharmacopoeia, anorganization which publishes industry recognized compendia of drug standards;

 

·                  attaching patent extension amendments tonon-related federal legislation; and

 

·                  engaging in state-by-state initiatives toenact legislation that restricts the substitution of some generic drugs, whichcould have an impact on products that we are developing.

 

Ifbranded pharmaceutical companies are successful in limiting the use of genericproducts through these or other means, our sales may decline.  If weexperience a material decline in product sales, our results of operations,financial condition and cash flows will suffer.

 

**Third parties may claim that we infringe their proprietaryrights and may prevent us from manufacturing and selling some of our products.**

 

Themanufacture, use and sale of new products that are the subject of conflictingpatent rights have been the subject of substantial litigation in thepharmaceutical industry.  These lawsuits relate to the validity andinfringement of patents or proprietary rights of third parties.  We mayhave to defend against charges that we violated patents or proprietary rightsof third parties.  This is especially true in the case of generic productson which the patent covering the branded product is expiring, an area whereinfringement litigation is prevalent, and in the case of new branded productswhere a competitor has 

 

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obtainedpatents for similar products.  Litigation may be costly andtime-consuming, and could divert the attention of our management and technicalpersonnel.  In addition, if we infringe on the rights of others, we couldlose our right to develop or manufacture products or could be required to paymonetary damages or royalties to license proprietary rights from third parties. Although the parties to patent and intellectual property disputes in thepharmaceutical industry have often settled their disputes through licensing orsimilar arrangements, the costs associated with these arrangements may besubstantial and could include ongoing royalties.  Furthermore, we cannotbe certain that the necessary licenses would be available to us on terms webelieve to be acceptable.  As a result, an adverse determination in ajudicial or administrative proceeding or failure to obtain necessary licensescould prevent us from manufacturing and selling a number of our products, whichcould harm our business, financial condition, results of operations and cashflows.

 

**If we are unable to obtain sufficient supplies from keysuppliers that in some cases may be the only source of finished products or rawmaterials, our ability to deliver our products to the market may be impeded.**

 

Weare required to identify the supplier(s) of all the raw materials for ourproducts in our applications with the FDA.  To the extent practicable, weattempt to identify more than one supplier in each drug application. However, some products and raw materials are available only from a singlesource and, in some of our drug applications, only one supplier of products andraw materials has been identified, even in instances where multiple sourcesexist.  To the extent any difficulties experienced by our suppliers cannotbe resolved within a reasonable time, and at reasonable cost, or if rawmaterials for a particular product become unavailable from an approved supplierand we are required to qualify a new supplier with the FDA, our profit marginsand market share for the affected product could decrease, and our developmentand sales and marketing efforts could be delayed.

 

**Our policies regarding returns, allowances and chargebacks,and marketing programs adopted by wholesalers may reduce our revenues in futurefiscal periods.**

 

Basedon industry practice, generic drug manufacturers have liberal return policiesand have been willing to give customers post-sale inventory allowances. Under these arrangements, from time to time, we give our customers credits onour generic products that our customers hold in inventory after we havedecreased the market prices of the same generic products due to competitivepricing.  Therefore, if new competitors enter the marketplace andsignificantly lower the prices of any of their competing products, we wouldlikely reduce the price of our product.  As a result, we would be obligatedto provide credits to our customers who are then holding inventories of suchproducts, which could reduce sales revenue and gross margin for the period thecredit is provided.  Like our competitors, we also give credits forchargebacks to wholesalers that have contracts with us for their sales tohospitals, group purchasing organizations, pharmacies or other customers. A chargeback is the difference between the price the wholesaler pays and theprice that the wholesaler’s end-customer pays for a product.  Although weestablish reserves based on our prior experience and our best estimates of theimpact that these policies may have in subsequent periods, we cannot ensurethat our reserves are adequate or that actual product returns, allowances andchargebacks will not exceed our estimates.

 

**Healthcare initiatives and other third-party payor cost-containment pressures couldcause us to sell our products at lower prices, resulting in decreased revenues.**

 

Someof our products are purchased orreimbursed by state and federal government authorities, private health insurersand other organizations, such as health maintenance organizations, or HMOs, andmanaged care organizations, or MCOs. Third-party payors increasingly challengepharmaceutical product pricing. There also continues to be a trend towardmanaged health care in the United States. Pricing pressures by third-partypayors and the growth of organizations such as HMOs and MCOs could result inlower prices and a reduction in demand for our products.

 

In addition, legislative and regulatory proposalsand enactments to reform health care and government insurance programs couldsignificantly influence the manner in which pharmaceutical products and medicaldevices are prescribed and purchased.  We expect there will continue to be federal and state laws and/orregulations, proposed and implemented, that could limit the amounts thatfederal and state governments will pay for health care products and services.The extent to which future legislation or regulations, if any, relating to thehealth care industry or third-party coverage and reimbursement may be enactedor what effect such legislation or regulation would have on our businessremains uncertain. For example, the American Recovery and Reinstatement Act of2009, also known as the stimulus package, includes $1.1 billion in funding tostudy the comparative effectiveness of health care treatments and strategies.If the stimulus package is approved in its current 

 

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form, this funding will be used, among other things,to conduct, support or synthesize research that compares and evaluates the riskand benefits, clinical outcomes, effectiveness and appropriateness of products.Although Congress has indicated that this funding is intended for improvementin quality of health care, it remains unclear how the research will impactcoverage, reimbursement or other third-party payor policies. Such measures orother health care system reforms that are adopted could have a material adverseeffect on our industry generally and our ability to successfully commercializeour products or could limit or eliminate our spending on development projectsand affect our ultimate profitability.

 

**We may need to change our business practices to comply withchanges to fraud and abuse laws.**

 

We are subject to various federal and state lawspertaining to health care fraud and abuse, including the federal fraud andabuse law (sometimes referred to as the “Anti-Kickback Statute”) which apply toour sales and marketing practices and our relationships with physicians. At thefederal level, the Anti-Kickback Statute prohibits any person or entity fromknowingly and willfully soliciting, receiving, offering, or paying anyremuneration, including a bribe, kickback, or rebate, directly or indirectly,in return for or to induce the referral of patients for items or servicescovered by federal health care programs, or the furnishing, recommending, orarranging for products or services covered by federal health care programs.Federal health care programs have been defined to include plans and programsthat provide health benefits funded by the federal government, including Medicareand Medicaid, among others. The definition of “remuneration” has been broadlyinterpreted to include anything of value, including, for example, gifts,discounts, the furnishing of supplies or equipment, credit arrangements,payments of cash, and waivers of payments. Several courts have interpreted thefederal Anti-Kickback Statute’s intent requirement to mean that if even onepurpose in an arrangement involving remuneration is to induce referrals orotherwise generate business involving goods or services reimbursed in whole orin part under federal health care programs, the statute has been violated. Thefederal government has issued regulations, commonly known as safe harbors thatset forth certain provisions which, if fully met, will assure parties that theywill not be prosecuted under the federal Anti-Kickback Statute. The failure ofa transaction or arrangement to fit within a specific safe harbor does notnecessarily mean that the transaction or arrangement will be illegal or thatprosecution under the federal Anti-Kickback Statute will be pursued, but suchtransactions or arrangements face an increased risk of scrutiny by governmentenforcement authorities and an ongoing risk of prosecution. If our sales andmarketing practices or our relationships with physicians (such as physiciansserving on our Scientific Advisory Board) are considered by federal or stateenforcement authorities to be knowingly and willfully soliciting, receiving,offering, or providing any remuneration in exchange for arranging for orrecommending our products and services, and such activities do not fit within asafe harbor, then these arrangements could be challenged under the federalAnti-Kickback Statute. If our operations are found to be in violation of thefederal Anti-Kickback Statute we may be subject to civil and criminal penaltiesincluding fines of up to $25,000 per violation, civil monetary penalties of upto $50,000 per violation, assessments of up to three times the amount of theprohibited remuneration, imprisonment, and exclusion from participating in thefederal health care programs.  Inaddition, HIPAA and its implementing regulations created two new federalcrimes: health care fraud and false statements relating to health carematters.  The HIPAA health care fraudstatute prohibits, among other things, knowingly and willfully executing, orattempting to execute, a scheme to defraud any health care benefit program,including private payors.  A violation ofthis statue is a felony and may result in fines, imprisonment and/or exclusionfrom government-sponsored programs.  TheHIPAA false statements statute prohibits, among other things, knowingly andwillfully falsifying, concealing or covering up a material fact or making anymaterially false, fictitious or fraudulent statement or representation inconnection with the delivery of or payment for health care benefits, items, orservices.  A violation of this statute isa felony and may result in fines and/or imprisonment.  A number of states also have anti-fraud andanti-kickback laws similar to the federal Anti-Kickback Statute that prohibitcertain direct or indirect payments if such arrangements are designed to induceor encourage the referral of patients or the furnishing of goods or services.Some states’ anti-fraud and anti-kickback laws apply only to goods and servicescovered by Medicaid. Other states’ anti-fraud and anti-kickback laws apply toall health care goods and services, regardless of whether the source of paymentis governmental or private. Due to the breadth of these laws and the potentialfor changes in laws, regulations, or administrative or judicialinterpretations, we may have to change our business practices or our existingbusiness practices could be challenged as unlawful, which could materiallyadversely affect our business.

 

Certain federal and state governmental agencies,including the U.S. Department of Justice and the U.S. Department of Health andHuman Services, have been investigating issues surrounding pricing informationreported by drug manufacturers and used in the calculation of reimbursements aswell as sales and marketing practices. For example, many government andthird-party payors, including Medicare and Medicaid, reimburse doctors andothers for the purchase of certain pharmaceutical products based on the product’saverage wholesale price (“AWP”) reported by pharmaceutical companies. WhileLannett has only used Suggested Wholesale Prices since 2000, the federalgovernment, certain state 

 

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agencies, and private payors are investigating andhave begun to file court actions related to pharmaceutical companies’ reportingpractices with respect to AWP, alleging that the practice of reporting pricesfor pharmaceutical products has resulted in a false and overstated AWP, whichin turn is alleged to have improperly inflated the reimbursement paid byMedicare beneficiaries, insurers, state Medicaid programs, medical plans, andothers to health care providers who prescribed and administered those products.In addition, some of these same payors are also alleging that companies are notreporting their “best price” to the states under the Medicaid program. We arenot currently subject to any such investigations or actions and having not usedAWP pricing since 2000 would not likely become subject to these investigations.

 

**We may become subject to federal and state false claimslitigation brought by private individuals and the government.**

 

We are subject to state and federal laws that governthe submission of claims for reimbursement. The federal False Claims Actimposes civil liability and criminal fines on individuals or entities thatknowingly submit, or cause to be submitted, false or fraudulent claims forpayment to the government. Violations of the False Claims Act and other similarlaws may result in criminal fines, imprisonment, and civil penalties for eachfalse claim submitted and exclusion from federally funded health care programs,including Medicare and Medicaid. The False Claims Act also allows privateindividuals to bring a suit on behalf of the government against an individualor entity for violations of the False Claims Act. These suits, known as qui tamactions, may be brought by, with only a few exceptions, any private citizen whohas material information of a false claim that has not yet been previouslydisclosed. These suits have increased significantly in recent years because theFalse Claims Act allows an individual to share in any amounts paid to thefederal government in fines or settlement as a result of a successful qui tamaction.  If our past or presentoperations are found to be in violation of any of such laws or any other governmentalregulations that may apply to us, we may be subject to penalties, includingcivil and criminal penalties, damages, fines, exclusion from federal healthcare programs, and/or the curtailment or restructuring of our operations.  Any penalties, damages, fines, curtailment,or restructuring of our operations could adversely affect our ability tooperate our business and our financial results, action against us for violationof these laws, even if we successfully defend against them, could cause us to incursignificant legal expenses and divert our management’s attention from theoperation of our business.

 

**Sales of our products may continue to be adversely affectedby the continuing consolidation of our distribution network and theconcentration of our customer base.**

 

Ourprincipal customers are wholesale drug distributors and major retail drug storechains.  These customers comprise a significant part of the distributionnetwork for pharmaceutical products in the U.S.  This distribution networkis continuing to undergo significant consolidation marked by mergers andacquisitions among wholesale distributors and the growth of large retail drugstore chains.  As a result, a small number of large wholesale distributorscontrol a significant share of the market, and the number of independent drugstores and small drug store chains has decreased.  We expect thatconsolidation of drug wholesalers and retailers will increase pricing and othercompetitive pressures on drug manufacturers, including Lannett.

 

Forthe fiscal year ended June 30, 2010, our three largest customers accountedfor 26%, 11% and 9%, respectively, of our net sales. For the three months endedSeptember 30, 2010, our three largest customers accounted for 23%, 13% and9%, respectively, of our net sales.  The loss of any of these customerscould materially adversely affect our business, results of operations andfinancial condition and our cash flows.  In addition, the Company has nolong-term supply agreements with its customers that would require them topurchase our products.

 

**The design, development, manufacture and sale of our productsinvolves the risk of product liability claims by consumers and other thirdparties, and insurance against such potential claims is expensive and may bedifficult to obtain.**

 

Thedesign, development, manufacture and sale of our products involve an inherentrisk of product liability claims and the associated adverse publicity. Insurance coverage is expensive and may be difficult to obtain, and may not beavailable in the future on acceptable terms, or at all.  Although wecurrently maintain product liability insurance for our products in amounts webelieve to be commercially reasonable, if the coverage limits of theseinsurance policies are not adequate, a claim brought against Lannett, whethercovered by insurance or not, could have a material adverse effect on ourbusiness, results of operations, financial condition and cash flows.

 

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**Rising insurance costs, as well as the inability to obtaincertain insurance coverage for risks faced by Lannett, could negatively impactprofitability.**

 

Thecost of insurance, including workers compensation, product liability andgeneral liability insurance, have risen in prior years and may increase in thefuture.  In response, we may increase deductibles and/or decrease certaincoverage to mitigate these costs.  These increases, and our increased riskdue to increased deductibles and reduced coverage, could have a negative impacton our results of operations, financial condition and cash flows.

 

Additionally,certain insurance coverages may not be available to Lannett for risks faced byLannett.  Sometimes the coveragesobtained by Lannett for certain risks may not be adequate to fully reimbursethe amount of damage that Lannett could possibly sustain.  Should either of these events occur, the lackof insurance to cover the entire cost to the Company would adversely affect ourresults of operations and financial condition.

 

**Significant balances of intangible assets, including productrights acquired, are subject to impairment testing and may result in impairmentcharges, which will adversely affect our results of operations and financialcondition.**

 

Ouracquired contractual rights to market and distribute products are stated atcost, less accumulated amortization and related impairment charges identifiedto date.  We determined the initial cost by referring to the original fairvalue of the assets exchanged.  Futureamortization periods for product rights are based on our assessment of variousfactors impacting estimated useful lives and cash flows of the acquiredproducts.  Such factors include the product’s position in its life cycle,the existence or absence of like products in the market, various othercompetitive and regulatory issues and contractual terms.  Significantchanges to any of these factors would require us to perform an additional impairmenttest on the affected asset and, if evidence of impairment exists, we would berequired to take an impairment charge with respect to the asset.  Such acharge would adversely affect our results of operations and financialcondition.

 

**Federal regulation of arrangements between manufacturers ofbranded and generic products could adversely affect our business.**

 

Aspart of the Medicare Prescription Drug, Improvement, and Modernization Actof 2003, companies are now required to file with the Federal Trade Commission (“FTC”)and the Department of Justice certain types of agreements entered into betweenbrand and generic pharmaceutical companies related to the manufacture,marketing and sale of generic versions of branded drugs.  This newrequirement could affect the manner in which generic drug manufacturers resolveintellectual property litigation and other disputes with branded pharmaceuticalcompanies and could result generally in an increase in private-party litigationagainst pharmaceutical companies or additional investigations or proceedings bythe FTC or other governmental authorities.  The impact of this newrequirement and the potential private-party lawsuits associated witharrangements between brand name and generic drug manufacturers is uncertain,and could adversely affect our business.

 

**ITEM 6. EXHIBITS**

 

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

 

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**SIGNATURE**

 

In accordance with the requirements of the Exchange Act, the registrantcaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
|                           |   | **LANNETT  COMPANY, INC.**                        |
|--------------------------------|--------|--------------------------------------------------------|
|                           |   |                                                   |
| Dated:  November 12, 2010 | By:    | /s/  Arthur P. Bedrosian                               |
|                           |   | Arthur  P. Bedrosian                                   |
|                           |   | President  and Chief Executive Officer                 |
|                           |   |                                                   |
|                           |   |                                                   |
| Dated:  November 12, 2010 | By:    | /s/  Keith R. Ruck                                     |
|                           |   | Keith  R. Ruck                                         |
|                           |   | Vice  President of Finance and Chief Financial Officer |

 

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**Exhibit Index**

 
| 31.1   |   | Certification  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                              |   | Filed  Herewith |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|
|   |   |                                                                                                                                   |   |            |
| 31.2   |   | Certification  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                              |   | Filed  Herewith |
|   |   |                                                                                                                                   |   |            |
| 32     |   | Certifications  of Chief Executive Officer and Chief Financial Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |   | Filed  Herewith |

 

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