| LANNETT CO INC ITEM 1A RISK FACTORS We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control |
| The following discussion highlights some of these risks and others are discussed elsewhere in this report |
| These and other risks could materially and adversely affect our business, financial condition, operating results or cash flows |
| RISKS ASSOCIATED WITH INVESTING IN THE BUSINESS OF LANNETT If we are unable to successfully develop or commercialize new products, our operating results will suffer |
| Our future results of operations will depend to a significant extent upon our ability to successfully commercialize new generic products in a timely manner |
| There are numerous difficulties in developing and commercializing new products, including: • developing, testing and manufacturing products in compliance with regulatory standards in a timely manner; • receiving requisite regulatory approvals for such products in a timely manner; • the availability, on commercially reasonable terms, of raw materials, including active pharmaceutical ingredients and other key ingredients; • developing and commercializing a new product is time consuming, costly and subject to numerous factors that may delay or prevent the successful commercialization of new products; • experiencing delays or unanticipated costs; and • commercializing generic products may be substantially delayed by the listing with the FDA of patents that have the effect of potentially delaying approval of the off-patent product by up to 30 months, and in some cases, such patents have issued and been listed with the FDA after the key chemical patent on the branded drug product has expired or been litigated, causing additional delays in obtaining approval |
| As a result of these and other difficulties, products currently in development by Lannett may or may not receive the regulatory approvals necessary for marketing |
| If any of our products, when developed and approved, cannot be successfully or timely commercialized, our operating results could be adversely affected |
| We cannot guarantee that any investment we make in developing products will be recouped, even if we are successful in commercializing those products |
| 14 _________________________________________________________________ [46]Table of Contents Our gross profit may fluctuate from period to period depending upon our product sales mix, our product pricing, and our costs to manufacture or purchase products |
| Our future results of operations, financial condition and cash flows depend to a significant extent upon our product sales mix |
| Our sales of products that we manufacture tend to create higher gross margins than do the products we purchase and resell |
| As a result, our sales mix will significantly impact our gross profit from period to period |
| Factors that may cause our sales mix to vary include: • the amount of new product introductions; • marketing exclusivity, if any, which may be obtained on certain new products; • the level of competition in the marketplace for certain products; • the availability of raw materials and finished products from our suppliers; and • the scope and outcome of governmental regulatory action that may involve us |
| The profitability of our product sales is also dependent upon the prices we are able to charge for our products, the costs to purchase products from third parties, and our ability to manufacture our products in a cost effective manner |
| If branded pharmaceutical companies are successful in limiting the use of generics through their legislative and regulatory efforts, our sales of generic products may suffer |
| Many branded pharmaceutical companies increasingly have used state and federal legislative and regulatory means to delay generic competition |
| These efforts have included: • pursuing new patents for existing products which may be granted just before the expiration of one patent which could extend patent protection for additional years or otherwise delay the launch of generics; • using the Citizen Petition process to request amendments to FDA standards; • seeking changes to US Pharmacopoeia, an organization which publishes industry recognized compendia of drug standards; • attaching patent extension amendments to non-related federal legislation; and • engaging in state-by-state initiatives to enact legislation that restricts the substitution of some generic drugs, which could have an impact on products that we are developing |
| If branded pharmaceutical companies are successful in limiting the use of generic products through these or other means, our sales may decline |
| If we experience 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 proprietary rights and may prevent us from manufacturing and selling some of our products |
| The manufacture, use and sale of new products that are the subject of conflicting patent rights have been the subject of substantial litigation in the pharmaceutical industry |
| These lawsuits relate to the validity and infringement of patents or proprietary rights of third parties |
| We may have to defend against charges that we violated patents or proprietary rights of third parties |
| This is especially true in the case of generic products on which the patent covering the branded product is expiring, an area where infringement litigation is prevalent, and in the case of new branded products where a competitor has obtained patents 15 _________________________________________________________________ [47]Table of Contents for similar products |
| Litigation may be costly and time-consuming, and could divert the attention of our management and technical personnel |
| In addition, if we infringe on the rights of others, we could lose our right to develop or manufacture products or could be required to pay monetary damages or royalties to license proprietary rights from third parties |
| Although the parties to patent and intellectual property disputes in the pharmaceutical industry have often settled their disputes through licensing or similar arrangements, the costs associated with these arrangements may be substantial and could include ongoing royalties |
| Furthermore, we cannot be certain that the necessary licenses would be available to us on terms we believe to be acceptable |
| As a result, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling a number of our products, which could harm our business, financial condition, results of operations and cash flows |
| If we are unable to obtain sufficient supplies from key suppliers that in some cases may be the only source of finished products or raw materials, our ability to deliver our products to the market may be impeded |
| We are required to identify the supplier(s) of all the raw materials for our products in our applications with the FDA To the extent practicable, we attempt to identify more than one supplier in each drug application |
| However, some products and raw materials are available only from a single source and, in some of our drug applications, only one supplier of products and raw materials has been identified, even in instances where multiple sources exist |
| To the extent any difficulties experienced by our suppliers cannot be resolved within a reasonable time, and at reasonable cost, or if raw materials for a particular product become unavailable from an approved supplier and we are required to qualify a new supplier with the FDA, our profit margins and market share for the affected product could decrease, as well as delay our development and sales and marketing efforts |
| Our policies regarding returns, allowances and chargebacks, and marketing programs adopted by wholesalers, may reduce our revenues in future fiscal periods |
| Based on industry practice, generic drug manufacturers have liberal return policies and have been willing to give customers post-sale inventory allowances |
| Under these arrangements, from time to time, we give our customers credits on our generic products that our customers hold in inventory after we have decreased the market prices of the same generic products due to competitive pricing |
| Therefore, if new competitors enter the marketplace and significantly lower the prices of any of their competing products, we would likely reduce the price of our product |
| As a result, we would be obligated to provide credits to our customers who are then holding inventories of such products, which could reduce sales revenue and gross margin for the period the credit is provided |
| Like our competitors, we also give credits for chargebacks to wholesalers that have contracts with us for their sales to hospitals, group purchasing organizations, pharmacies or other customers |
| A chargeback is the difference between the price the wholesaler pays and the price that the wholesaler’s end-customer pays for a product |
| Although we establish reserves based on our prior experience and our best estimates of the impact that these policies may have in subsequent periods, we cannot ensure that our reserves are adequate or that actual product returns, allowances and chargebacks will not exceed our estimates |
| The design, development, manufacture and sale of our products involves the risk of product liability claims by consumers and other third parties, and insurance against such potential claims is expensive and may be difficult to obtain |
| The design, development, manufacture and sale of our products involve an inherent risk of product liability claims and the associated adverse publicity |
| Insurance coverage is expensive and may be difficult to obtain, and may not be available in the future on acceptable terms, or at all |
| Although we currently maintain product liability insurance for our products in amounts we believe to be commercially 16 _________________________________________________________________ [48]Table of Contents reasonable, if the coverage limits of these insurance policies are not adequate, a claim brought against Lannett, whether covered by insurance or not, could have a material adverse effect on our business, results of operations, financial condition and cash flows |
| Rising insurance costs could negatively impact profitability |
| The cost of insurance, including workers compensation, product liability and general liability insurance, have risen in prior years and may increase in the future |
| In response, we may increase deductibles and/or decrease certain coverages to mitigate these costs |
| These increases, and our increased risk due to increased deductibles and reduced coverages, could have a negative impact on our results of operations, financial condition and cash flows |
| The loss of our key personnel could cause our business to suffer |
| The success of our present and future operations will depend, to a significant extent, upon the experience, abilities and continued services of key personnel |
| If the employment of any of our current key personnel is terminated, we cannot assure you that we will be able to attract and replace the employee with the same caliber of key personnel |
| As such, we have entered into employment agreements with all of our senior executive officers |
| Significant balances of intangible assets, including product rights acquired, are subject to impairment testing and may result in impairment charges, which will adversely affect our results of operations and financial condition |
| Our acquired contractual rights to market and distribute products are stated at cost, less accumulated amortization and related impairment charges identified to date |
| We determined the initial cost by referring to the original fair value of the assets exchanged |
| Future amortization periods for product rights are based on our assessment of various factors impacting estimated useful lives and cash flows of the acquired products |
| Such factors include the product’s position in its life cycle, the existence or absence of like products in the market, various other competitive and regulatory issues and contractual terms |
| Significant changes to any of these factors would require us to perform an additional impairment test on the affected asset and, if evidence of impairment exists, we would be required to take an impairment charge with respect to the asset |
| Such a charge would adversely affect our results of operations and financial condition |
| RISKS RELATING TO INVESTING IN THE PHARMACEUTICAL INDUSTRY Extensive industry regulation has had, and will continue to have, a significant impact on our business, especially our product development, manufacturing and distribution capabilities |
| All pharmaceutical companies, including Lannett, are subject to extensive, complex, costly and evolving regulation by the federal government, principally the FDA and to a lesser extent by the DEA and state government agencies |
| The Federal Food, Drug and Cosmetic Act, the Controlled Substances Act and other federal statutes and regulations govern or influence the testing, manufacturing, packing, labeling, storing, record keeping, safety, approval, advertising, promotion, sale and distribution of our products |
| Under these regulations, we are subject to periodic inspection of our facilities, procedures and operations and/or the testing of our products by the FDA, the DEA and other authorities, which conduct periodic inspections to confirm that we are in compliance with all applicable regulations |
| In addition, the FDA conducts pre-approval and post-approval reviews and plant inspections to determine whether our systems 17 _________________________________________________________________ [49]Table of Contents and processes are in compliance with current Good Manufacturing Practice, or cGMP, and other FDA regulations |
| Following such inspections, the FDA may issue notices on Form 483 that could cause us to modify certain activities identified during the inspection |
| A Form 483 notice is generally issued at the conclusion of a FDA inspection and lists conditions the FDA inspectors believe may violate cGMP or other FDA regulations |
| FDA guidelines specify that a “Warning Letter” is issued only for violations of “regulatory significance” for which the failure to adequately and promptly achieve correction may be expected to result in an enforcement action |
| Any such sanctions, if imposed, could materially harm our operating results and financial condition |
| Under certain circumstances, the FDA also has the authority to revoke previously granted drug approvals |
| Similar sanctions as detailed above may be available to the FDA under a consent decree, depending upon the actual terms of such decree |
| Although we have instituted internal compliance programs, if these programs do not meet regulatory agency standards or if compliance is deemed deficient in any significant way, it could materially harm our business |
| Certain of our vendors are subject to similar regulation and periodic inspections |
| The process for obtaining governmental approval to manufacture and market pharmaceutical products is rigorous, time-consuming and costly, and we cannot predict the extent to which we may be affected by legislative and regulatory developments |
| We are dependent on receiving FDA and other governmental or third-party approvals prior to manufacturing, marketing and shipping our products |
| Consequently, there is always the chance that we will not obtain FDA or other necessary approvals, or that the rate, timing and cost of such approvals, will adversely affect our product introduction plans or results of operations |
| We carry inventories of certain product(s) in anticipation of launch, and if such product(s) are not subsequently launched, we may be required to write-off the related inventory |
| Federal regulation of arrangements between manufacturers of branded and generic products could adversely affect our business |
| As part of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, companies are now required to file with the Federal Trade Commission and the Department of Justice certain types of agreements entered into between brand and generic pharmaceutical companies related to the manufacture, marketing and sale of generic versions of branded drugs |
| This new requirement could affect the manner in which generic drug manufacturers resolve intellectual property litigation and other disputes with branded pharmaceutical companies and could result generally in an increase in private-party litigation against pharmaceutical companies or additional investigations or proceedings by the FTC or other governmental authorities |
| The impact of this new requirement and the potential private-party lawsuits associated with arrangements between brand name and generic drug manufacturers is uncertain, and could adversely affect our business |
| The pharmaceutical industry is highly competitive |
| We face strong competition in our generic product business |
| Revenues and gross profit derived from the sales of generic pharmaceutical products tend to follow a pattern based on certain regulatory and competitive factors |
| As patents for brand name products and related exclusivity periods expire, the first generic manufacturer to receive regulatory approval for generic equivalents of such products is generally able to achieve significant market penetration |
| As competing off-patent manufacturers receive regulatory approvals on similar products or as brand manufacturers launch generic versions of such products (for which no separate regulatory approval is required), market share, revenues and gross profit typically decline, in some cases dramatically |
| Accordingly, the level of market share, revenue and gross profit attributable to a particular generic product is normally related to the number of competitors in that product’s market and the timing of that product’s regulatory approval and launch, in relation to competing approvals and launches |
| Consequently, we must continue to develop and introduce new products in a timely and cost-effective manner to maintain our revenues and gross margins |
| 18 _________________________________________________________________ [50]Table of Contents Sales of our products may continue to be adversely affected by the continuing consolidation of our distribution network and the concentration of our customer base |
| Our principal customers are wholesale drug distributors and major retail drug store chains |
| These customers comprise a significant part of the distribution network for pharmaceutical products in the US This distribution network is continuing to undergo significant consolidation marked by mergers and acquisitions among wholesale distributors and the growth of large retail drug store chains |
| As a result, a small number of large wholesale distributors control a significant share of the market, and the number of independent drug stores and small drug store chains has decreased |
| We expect that consolidation of drug wholesalers and retailers will increase pricing and other competitive pressures on drug manufacturers, including Lannett |
| For the year ended June 30, 2006, our three largest customers accounted for 17prca, 15prca and 5prca respectively, of our net revenues |
| The loss of any of these customers could materially adversely affect our business, results of operations and financial condition and our cash flows |
| In addition, the Company has no long-term supply agreements with its customers which would require them to purchase our products |