Lannett Company Inc (LCI) 2010 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the Lannett Company fiscal 2010 first quarter conference call. (Operator Instructions) I will now turn the call over to Mr. Robert Jaffe. Mr. Jaffe, you may begin.

Thank you, operator. Good afternoon, everyone, and thank you for joining us today to discuss Lannett Company's fiscal 2010 first quarter financial results. On the call today are Arthur Bedrosian, President and CEO, and Keith Ruck, Chief Financial Officer. Please be advised that this conference call is being broadcast live on the internet at www.lannett.com. A playback of this call will be available for three months and may be accessed on the internet at Lannett's website. I would like to make the cautionary statement and remind everyone that all of the information discussed on the call today is covered under the Safe Harbor Provisions of the Litigation Reform Act.

The Company's discussion today will include forward-looking information reflecting management's current forecast of certain aspects of the Company's future and our actual results could differ materially from those stated or implied. This afternoon, Arthur will review the Company's business highlights and Keith will discuss the financial results for the quarter in more detail, followed by Arthur making some concluding remarks. We will then open the call for questions. With that said, let me now turn the call over to Arthur Bedrosian. Arthur?

Thank you Robert, and good afternoon, everyone. The economic environment continues to pose challenges for the American industry, but I'm pleased to report that Lannett has solid performance in the first quarter of fiscal 2010. Our solid performance was the result of strong sales of Lannett's key products, specifically thyroid and pain management products. We also benefited from our adherence to current good manufacturing practice standards, which helped us capture market share from our competitors and enabled us to deliver important medication to the marketplace. It is during these times that our strict adherence to high standards of manufacturing is absolutely imperative. There is no room for error when it comes to delivering the highest quality products to our customers. During the quarter, the FDA completed its cGMP, that's current Good Manufacturing Practice, compliance inspection of our Cody Laboratories subsidiary. Cody is a manufacturer and supplier of bulk active pharmaceutical ingredients and finished dosage formed products. The two-week-long FDA inspection resulted in two minor 483 observations, neither of which prevents Cody from continuing to manufacture products and both of which have already been remediated. The positive inspection results were a key step in clearing the way for FDA approval of our pending application for Hydromorphone tablets, as well as future product applications.

As we discussed in the last earnings call, we were able to secure the FDA's help in resolving an issue over our quota, with the DEA favorably. We have helped FDA alleviate shortages in Digoxin tablets, Oxycodone and Morphine Sulfate oral solutions. Working hand in hand with our regulators is not without its attendant frustrations, but we continue to be proactive in our relationship. Before I turn the call over to Keith, I would like to welcome back Bill Farber. Bill has resumed his role as the Company's Chairman of the Board, after taking a leave of absence for health reasons. I would also like to note two changes to our management team. We named Keith Ruck as Chief Financial Officer in October 2009. Keith has served as our interim CFO since April and became a great asset to our team. He has an extensive financial background and expertise in identifying key areas specific to enhance operating efficiencies. We also named Stephen Kovary as our Vice President of Operations in September 2009. Stephen is an industry veteran who brings a depth -- deep breadth of operations, plan management and manufacturing experience to our Company to replace our former colleague who retired. We are excited about these appointments and believe they will enhance the performance of our Company in the years ahead. With that, I would like to turn the call over to Keith for an overview of our first quarter financial performance. Keith?

Thank you, Arthur, and good afternoon, everyone. For the fiscal 2010 first quarter ended September 30, 2009, net sales rose 23% to $31.4 million compared with $25.6 million in the same period for fiscal 2009. Net income increased to $2.9 million, or $0.11 per diluted share compared with a net income of $1.2 million, or $0.05 per diluted share for the prior year. Gross profit increased to $11.5 million compared with $9 million in the same period in the prior year. R&D expenses were $3 million versus $1.9 million in fiscal 2009. The increase in R&D expenses is mostly related to an increase in the number of drugs in development. SG&A expenses decreased to $3.8 million from $4.9 million for the prior year, primarily related to a reduction in legal fees. With that brief financial overview, I would now like to turn the call back over to Arthur. Arthur?

Thank you, Keith. Our first quarter performance is the result of hard work and dedicated employees who tirelessly focused on quality and integrity. We are off to a good start in fiscal 2010. We continue to seek out opportunities to grow and enhance our business and further differentiate ourselves as a leader in the generic pharmaceutical industry. As always, I would like to thank our customers, employees, and shareholders for their continued support. With the time available, we would like to address any questions you may have. Operator?

Thank you. We will now begin the question and answer session.

(Operator Instructions) Our first question comes from Scott Henry from Roth Capital. Please go ahead.

Thank you, and good afternoon. Guys, just starting first on Levothyroxine, just it's such an important part of your business, looking at kind of the monthly data, which isn't perfectly reliable, but it's kind of the best I have, it looks like that product is still doing very well, still growing 20% year-over-year. Can you comment on how you see the trends going with that product, just in general and if the data I'm looking at is in fact accurate?

Well, yes. First of all, as you know, we distribute the product for our colleagues Jerome Stevens Pharmaceutical company, and their product has never had a recall, never had a batch failure, and none of the other brands on the market can say that. Generally speaking, the products that Jerome Stevens supplies us has been gaining market share year after year after year, and what's happened is the attention to this product that the FDA has brought a couple of years ago when they instituted a new tighter requirement for the assay, it used to be within 10%, so it could be 90% to 110% of label claim. Now it's got to be between 95% and 105% of label claim. Not all of the competing products are able to meet that. Some of them meet it by reducing their expiration dates, and others, we believe, are going to be dropping out of the product. As the companies drop out, or as they stay in the item depending on whether they reduce their expiration date, we seem to be capturing more market share because of the stability of our product. And in addition, we're also capturing market share away from the innovator products. Both Synthroid and Levoxyl, the two innovator brands are actually reducing in the marketplace as the generic market increases their share of that market. So you're seeing an erosion of the brand market, you're seeing growth in the generic market from that perspective. You're also seeing growth on our product because our product has been well known to be the most stable product on the marketplace. I believe those have combined to show the sales accretion we referred to. I don't believe it's exactly 20%, but it's somewhere in that area and we believe it continues to grow that way throughout the next few years.

Okay, thank you for the color on that, Arthur. Shifting over to the pain market, because I know some generic pain players have kind of said that supply has finally caught up to demand and they are no longer seeing those gains from competitors' problems. That being said, it looks like Digoxin, when you look at the numbers, is still doing quite well for you. So I guess my question is, are you still feeling the benefits of supply constraints in the pain market? I guess is that a function of the products you serve because some of the competitors are no longer seeing those gains?

Let me try to correct something. First of all Digoxin is not a pain management product. I presume you know that because you are talking about those two things, but they both are involved in the shortages. The Digoxin markedly continues to capture the majority of the market because two of our major competitors have not reentered the marketplace and another firm that got an approval in July has not launched their product as yet. So we continue to have the majority of the Digoxin market, but we do expect that to change somewhat as more competitors enter the the marketplace. So we are continuing to benefit from that shortage you might say. Of course the shortage has been alleviated.

We now have all the customers that we're supplying and the product is now a stable seller on a routine basis, monthly, no increase, no decrease. We expect the decreases possibly when two people enter the marketplace, but we'll see what happens when that occurs. With regards to the pain management, two of the products were involved with shortages this past year. That was the Oxycodone and Morphine Sulfate oral solution. And with the help of our subsidiary, Cody Laboratories, we were able to double and double again their capacity and we've alleviated that shortage. So there again, we've captured a market share. We hope to keep that market share that we've captured, but we don't see any increases in those two products in the future.

But pain management is an area of our focus and we do expect overall to see an increase in the share of pain management products that we manufacture, that we file applications for, and that we sell and increase our market share on those existing products we have now. For example, we talked about the Hydromorphone tablet. Those should be approved any day now. And while we have the 2 and the 4 milligram on the market currently, the 8-milligram will add to that marketplace and we believe we will increase our market share on Hydromorphone as well. So, yes, there's been some benefit from the shortages from our competitors having their GMP issues. Nevertheless, we are keeping those markets and we still expect to expand into pain management.

Okay, thank you for separating those two questions apart. Certainly made it simpler to follow. Shifting over to OB Natal One, any thoughts -- I mean do you look to just kind of take what you can get as far as KV's problems, or would you like to put any -- are you thinking about any growth initiatives on that product?

No, we're not a brand company, so we're not planning to do anything to increase the sales of the product. We're really just filling the void that's been created by KV's exit from the marketplace. And actually there's been a switch to our product once KV's product was available, so any doctor that preferred the PrimaCare ONE product is now able to use the OB Natal One product in its place. But no, there's no plans at our end to do anything on the brand side. We certainly are looking at introducing other generic prenatal vitamins, though.

Will you ever consider divesting the OB Natal One to perhaps someone that would want to build it out?

If there was an interest, certainly. We're not in that business, as we told you. We would be happy to manufacture the product and do the packaging, but the marketing and the detailed sales force that's required to support these products would be best served by someone that is gifted in that area, you might say. We would be happy to work with any company like that, yes.

Okay. Final question, just as I look at some of the sales dollars data, one product that's grown recently is Phentermine. Any comments on that? Is that sustainable? Will it keep growing? Just any color at all on what may be going on there.

Well, we are expanding the Phentermine product line with additional dosage forms. Actually, the obesity problem in the United States, we all know, is a very severe problem today. So I do expect the sales of Phentermine products to grow. Nevertheless, in the marketplace when they are treating obesity, they tend to switch the products around, trying to start people with a lower dose or switch them between capsule colors and between the capsule and the tablet because there's a -- I wouldn't call it a placebo effect per se, but there's a certain advantage in switching the patients from one to another in terms of weight loss.

It is a difficult, difficult thing for people to lose weight, as we all know. Those people that are overweight certainly understand that problem. And nevertheless, these medications do help, but of course it's not the end-all. It's not the cure for obesity. We do see that growing because of the obesity problem in the United States growing.

Thank you for taking the questions, Arthur.

You're welcome.

Our next question comes from Peter Castellanos from Glacier Partners. Please go ahead.

Yes, Arthur, just a couple questions on, first of all, on the margin side of it. The gross margins were down a fair amount here and I'm just wondering if you could comment on that, just to give us a little bit of guidance. Is that -- do you expect to hold that for this year, or, or am I -- is it a low quarter for you, or whereabouts -- how should we look at this?

Keith, do you want to take this one?

Sure, you're really probably just comparing it to the last two quarters.

Yes.

Other than that, the margins are actually up over quarters prior to that. Your third quarter ended March '09 enjoyed healthy sales of the OB Natal One product without much royalty. So that really benefited that quarter. The fourth quarter ended June benefited if you recall, from a large Digoxin sale in April due to Caraco going out of the marketplace because of their cGMP issues. We had a very strong fourth quarter and it included a one-time hop on the Digoxin sales because that was a recall down to the consumer level. It's not obviously expected every quarter.

Okay. So -- just going forward, should we -- I mean is this about kind of the way the year looks at this point, or is it -- I mean the numbers, like it's 36.7 I think is what I got when I did the math.

I would like it to be. We have some mix issues going on. The OB Natal product, which you could still consider fairly profitable, is declining in sales quarter over quarter. There isn't anyone out there detailing. But we are still enjoying some increased margin on Digoxin, as no one has entered into the marketplace. And Levo continues to be strong and we're not really doing much in that area from a pricing point of view.

Okay.

Going forward, do I hope we're going to enjoy these margins? Yes, depending on if someone comes back in on the Digoxin market, and depending on how slowly or quickly the OB Natal product declines will impact our margins.

And just moving on to the SG&A line. As expected, those numbers have come down a lot, just because of the legal expenses I guess passing through now. Is that, that number now, $3.7 million, is that, is that kind of a number that -- what should we use going forward, sort of that level?

I consider the 3.7, 3.8 a basic run rate.

Okay.

As long as nothing happens from a legal point of view, that's, like I said, a basic run rate.

Okay.

Will we have to add a few people here and there?

Right.

As our revenues grow? Probably, but not in line with the revenue growth. We should be able to get continued revenue growth over the existing infrastructure. So it's, it's a basic run rate for us right now and for the foreseeable quarter or so.

And then what percentage of revenue -- what percentage of revenues was Levothyroxine this quarter?

If you -- I'll find that for you and I will--

Okay. Offline I can do it with you. That would be fine. Just turning to Cody for a second, how do the margins on Cody, I mean I know you haven't released those, but I mean are they trending upwards, or are they about the same, or what -- where are we with that now?

I would -- you have to remember, right now Cody is primarily selling to us. So definitely argue you have to look at the combined. That's probably the end consumer as the margins. But Cody, Cody is more, right now I would call them a volume issue. Once they get to a certain volume, we can definitely, as we saw in the third quarter of '09, we saw that they became break-even at I'll say $1 million a month revenue to us. We had some short-term quota issues here that impacted Cody, but they should be back online as we sit here today. So third quarter and on, they are very capable of doing that $1 million a month. Right now, we would estimate the demand is there also, and so I would tell you there's a very good chance of Cody being break-even for -- at least break-even for the third and fourth quarter.

What's the head count there now at Cody?

Arthur, do you know that number?

Yes, it's around 64.

Is that about where you expect the end of the year, or is that--

Well, no, because we are trying to automate the systems there. When we gear it up, to alleviate the shortage, as we know, the immediate problem was making sure that people got Morphine Sulphate because these are people in hospices, we needed to add a lot of labor in order to do a lot of the work that the equipment would do. That equipment has been purchased and it's already at the building. It's being validated and installed, so it should be up and running in another quarter. So I would see that the Company becoming more profitable as it becomes less labor intensive for that gear-up period.

Arthur, also, just while you're on the call, the shelf, I was a little bit confused as to why why you would file that. Can you give us some color on that, what's going on with that shelf?

Well, one of the issues I run into when we talk to the hedge funds is liquidity, everyone's concerned that you have a majority owner, you have the stock tightly held and there's not enough shares traded so if someone wants to buy 50,000 shares, they are unable to execute that purchase. If they finally do get 50,000 shares and want to sell it, they wouldn't be able to find a buyer necessarily. One of the concerns they raised was to put more shares in the marketplace and after discussing that with my Board of Directors, we agreed that we would offer additional shares into the market to help alleviate the liquidity.

So while it does hurt the shareholders that are staying with the shock in the short run, all of the people we've spoken to, all the hedge funds that said they would buy the stock felt that the stock would react positively and probably close much higher once the shares were absorbed into the marketplace. Clearly, we did it to ascertain that there's a demand for our stock out there and a home for those shares. So we felt the first thing we had to do, of course, was get the SEC's permission to sell shares and file the shelf registration once we get that permission. But the only intention is to sell shares eventually when the market's right.

So the trigger is, is the trigger more an event, or is it more just a question of pricing of the stock?

No, more pricing of the stock. We have to be careful. We're all shareholders.

Right.

And we all sympathize with our existing shareholders who don't want to see shares going from markets that just de-value their shares. They certainly would like to know that there's something going to be done with that funds that we've increased so that we may bring into the Company. So we're trying to be careful that we don't just frivolously sell shares just to bring the money in and then have the money sit there. We're being careful. There are some opportunities that we're looking at that we would use the money for, so we're weighing all of those options to determine whether we need to finance it with shares that would be sold into the marketplace or continue to use our own capital. As you know, we have a healthy balance sheet, so we've been using our own money for all of our needs.

Well, frankly, I mean when we saw it, my first thought was, well, he's got an event, he's got something up his sleeve there because I mean there was debt and warrants in this thing. It was more than just additional shares of stock. There was, there was -- it was a large -- it's a large -- a fairly large offering and it really looked like you had something in mind there other than just getting some more shares out.

Nothing immediately, but clearly there are opportunities that we want to be able to take advantage of. And we certainly have been looking for those opportunities and we've -- we want to be ready for them. Let's put it that way. Unfortunately, in this environment, if I have an opportunity and I go to my bank and I need additional money, I'm not going to get the money quickly enough, no matter how good my Company is, banks are not moving quickly and the opportunity could be lost. So we were trying to do a little advanced planning here.

We want to grow the Company. We want to solve the liquidity problem, and that was the reason for the shelf. We do have some things that we're looking at. We do want to grow the Company through acquisition, whether they be other companies or just products or licenses from other companies, we do have some plans to grow the Company clearly and that will take some outside funding, but we don't need the funds. We can use our own money. But the market seemed right. People suggested we should be selling some shares and dealing with the liquidity issue and that's really the main driver, is the liquidity.

Yes. Okay. Just -- my last question, just in terms of in the Q generally you talk about, and -- for some reason I can't pull it up on Edgar, so I -- maybe you haven't filed it yet, but you had two versions of your products in planning, scale-up and a formulations phase. Is there anything -- can you kind of talk about how many products might be in scale-up and how many are in formulation at this point?

Well, I'd be guessing, but clearly we're in the neighborhood of 40 to 45 products that are in product development at any one time. Product development that we do in-house has also added to with outside firms that we have alliances with. So it's hard to tell you at any one moment where we stand with all of them without going through actual documents. This phone call, I could just say that we have probably around 13 products at the Agency. We've been filing them electronically, so we expect quicker approval. At least that's the promise the FDA has made. That when you file electronically, you'll get quicker results. And we're expecting to get some approvals.

We're filing an enormous -- for our Company, we plan to file quite a number of applications this year, actually 12 of them. A good portion of them have already been filed, so we're really on top of the filing. So the process of R&D is moving rather rapidly through the Company, because in our business, without having future products in the Agency waiting for approval, we really don't have a future. We've been working very carefully there. And you'll see that issue as R&D expenses, we continue to plan to spend money for our future because without the products, we're not going to really have one. And all of those things combined would probably give us a pipeline, again, at the Agency, probably at the end of the year, with the 12 we're filing, 13 there, let's say six get approved, there you are. You're looking at maybe 20 will be down at the Agency and on the 47 products, we'll probably have only 30 in R&D left, but we keep adding to that.

The R&D cycle is one that never ends. As soon as we file an application, we add one at the other end and we start on another one. Clearly we're very active in new product development at Lannett. I'm talking internally, as well as with alliances both with Israel, Switzerland, Finland and some other countries. We're doing more elaborate products where the studies alone are very expensive. The bioequivalency studies or the clinical work that we have to do on some generic drugs is also very involved.

Okay, great. Thank you.

And just real quick, I'll follow up. The Levo sales for the quarter were approximately 41% of all of our sales. Compare that to the first quarter in '09, it was about 45%. And our Q will be filed later this week.

Great, thank you.

Our next question comes from Greg Hillman from First Wilshire Securities. Please go ahead.

yes, good morning, gentlemen. Arthur, could you talk about -- go back to pain management a little bit and talk about maybe sales for the quarter. I'm not sure this is the right way to classify them, but sales in API, private label, and wholesale, meaning that would occur under your own label.

Well, the majority of sales are under our label. Matter of fact, most of the narcotic products if you're talking about Lannett sales, I can't think of any narcotic products that we sell under someone else's label. If you're talking about Cody, remember, Cody manufactures the oral solutions for us, so those products you could say are private label for Lannett by our subsidiary. But generally speaking, all of our narcotic products are sold by us.

Our plan is to be vertically integrated in narcotics. Codeine's application to the F -- to the DEA to obtain their import license is being executed as part of our plan. And over the course of our future, you'll see more and more products that we manufacture will be vertically integrated vis-a-vis Cody's manufacturing those raw materials. A perfect clear example would be the Morphine Sulfate solution. Cody will be making the Morphine Sulfate for us soon, that we use within -- that they use in manufacturing Morphine Sulfate solutions. So that product will probably be the first vertically integrated product. The Hydromorphone tablets we spoke about that we're waiting at Lannett for approval, there we use the Codeine raw material. So as soon as we get that approval, the Hydromorphone tablets will be vertically integrated that we sell into the marketplace.

What we're trying to do is follow a path to make sure that when we're filing and getting approvals at the Agency, it's coordinated with what Cody is trying to do as best we can. With quotas from the DEA and some of the difficulties with regards to quotas, it's not that simple. It's not like planning your normal API because you have another layer of bureaucracy you have to go through. But we're working very carefully to make sure that's all integrated and we do see that, that vertical integration will make us a more profitable business. It'll give us control over raw materials which are not the typical APIs where you have quite a number of competitors like say Hydrochlorothiazide or something like that. Here you're limited to the number of people that make APIs on the narcotic side, so it's not as competitive as the other APIs are.

Right, and just in terms of market share, where would your market share be right now for either some of the ones that you, Morphine Sulfate solution or Hydromorphone, what's your market share right now in the various tablet categories?

Well, I can't speak to the Hydromorphone, because we don't sell the 8-milligram yet. We only sell the 2 and the 4. But on the Morphine Sulfate, we're about 26% of the market, so that one has grown dramatically over the prior year. Hydromorphone, we expect to have some growth as well. There's not that much competition in the Hydromorph.

Currently there's a couple of people that are not supplying the product, so I can't explain why they are not supplying it, but nevertheless, if they continue to remain off the market, then my market share will be easier to capture and hopefully easier to sustain as well. But generally speaking, our plan is to just make sure that every time we launch a product, we capture at least 10% of the market for that drug, no matter what drug it is. And then of course by vertically integrating, the more we capture, the more profitable the drug is for us.

Okay, and then just in terms of just your initiatives in the pain management area, I don't know if OxyContin, or Oxycodone is a different drug or that's a brand name or something you're already manufacturing, but I was just wondering do narcotics or pain management have the potential just by itself to double the size of the Company from where it is right now?

Oh, absolutely. First of all the Oxycodone is the raw material in OxyContin. OxyContin is a brand name for a delayed release Oxycodone tablet. We make the Oxycodone solution currently. We're looking at all the Oxycodones because again, any narcotic that's derived from opium is clearly on our radar screen. And one of those products, a matter of fact, most of those products are in some form of R&D within the Company. So we're pursuing the narcotics while we pursue other drugs as well. It's not that the narcotics were the only product.

The narcotic market in the United States is about $3 billion and we're $120 million company as of June of last year. So clearly we see a tremendous opportunity for us, not only in the existing old line narcotics like we are currently selling, but all the abuse, the non-abuse narcotics let's talk about that people are coming up with. We've already been working with colleagues in Israel on those products as well and an offering to sell API and formulas to other companies that could market non-abuse narcotics. But with the growth of non-abuse narcotics, we just see another area of brand growth that we will be offering generic equivalents to in the future the Embeda for example, is a product that has -- I believe they used a niacin in there, other people use Naltrexone to try to stop people from abusing narcotics. We're cognizant of the difficulty in the United States for the abuse of prescription drugs that are narcotic based and we're certainly working with the DEA to make sure that we don't do anything to contribute to that.

But nevertheless, pain management is a serious business. It's certainly a needed medication out there, and I do think that you're going to find the market changing towards non-abuse narcotics, where the average person won't be able to grind it up and shoot it up or sniff it or whatever else they are going to do. And I think we're on top of that market. We're already looking at some of those non-abuse products as well for future generic, let's say generickizing those.

And Arthur, what percentage, or Keith, do you know what percentage your sales in the quarter were pain management?

Yes, I -- I'm going to group it as pain management and hold on.

Arthur, that $3 billion you alluded to earlier, was that the generic market for narcotics?

That would be the total market for API and dosage forms. In other words, if you were to total all of the tablets that are sold, capsules that are sold, liquids, and the API market as well, it's roughly about $3 billion. Some of that is not tracked easily. So it's difficult to tell. You can certainly look at the quotas that are given out by DEA, but you cannot ascertain who received all of those quotas. And there's certainly a lot of research that's done in the narcotic area. We believe it's a very strong gap, that it's probably a $3 billion market in total for all narcotics and our plan is to develop more products in that field and specialize within the narcotic area and controlled drug. When I say narcotics, I don't mean just opium-based products. I'm talking about all controlled drugs, whether it's a valium or it's an opium, we're going to be looking at those products.

Okay.

We group the pain management products, just like we would group others like prescription vitamin or thyroid deficiency. The pain management was about 9% of our revenues for the quarter.

Okay, so it's still relatively small in terms of what you aspire.

Yes. Well, only 1% in the first quarter of '09. So there is a fair amount of growth --

And just finally, Arthur, can you just talk about the margins that you would get for API versus your own labeled product in narcotic?

-- the margins in the API field are certainly in the 50% area, so we're talking about raw materials sold to other manufacturers by other API manufacturers that compete with Cody work on at least 50% margins better than that, depends on the drug of course. The competition in our field is less because it's highly regulated and it's very labor intensive in the sense that there's a lot of staff that's required to keep track of quotas and the paperwork that the DEA requires to make sure there's no diversion. And as a result, you don't see these cut throat pricing in the raw material of narcotics that you would find in other kinds of raw material. So that makes it attractive for Cody to be in that segment of the market.

From our point of view on the dosage side, you do see some heavy competition on some dosage forms where the gross profit margins might be as low as 10%, but even that seems to have changed as well, because with the added burden of the regulatory issues you have to deal with, there's been less and less competition. People have dropped out of the narcotics as opposed to just lowering the price and trying to sell more, and the people that remained in narcotics were able to raise prices. So we are -- it was as low as 10%. I tend to see the prices now around 20% to 25% on some of those pain narcotic products that were being given away by people not less than two years ago. So that's the change we're envisioning in the future. There's going to be less competition in those areas and there's going to be more price margins, not only the dosage form, but the raw material, but even if I'm working on a 10% gross profit on the Lannett side, I still have Cody making raw material profit margin that's consolidated in our earnings.

That's an important point. So there's no reason why you couldn't probably get like a 15% share of this entire market at some point.

That's certainly our goal. If not more.

Okay, okay. Thanks Arthur. Your welcome.

Our next question comes from Kevin McDevitt from UBS Financial Services. Please go ahead.

Hi, Arthur. Hey, congratulations that's a great quarter.

Thank you very much.

Can you comment on the progress of moving to the new facility in Philadelphia, whether the budget, the estimates -- whether that's you're tracking on what you expected?

Well, yes -- well actually we're tracking a little bit of a savings. When we originally put out the quotes to move to our other building, the quotes were coming in a little bit higher then we've been able to work them down. With the recession there's a lot of hungry construction workers out there. The quotes that we're getting now have been a little bit less than we had first saw. We still plan to move on time, in the month of December probably going to be maybe a month late on our overall move-in. The warehouse will be moving into the new building first. Then the administrative offices will be in there by February. We had hoped to in there by January. So we're putting the administrative offices off until we get the warehouse setup and we're on budget as far as the work -- the money that we allocated will be on budget, because we haven't really spent any significant sums yet, other than to purchase the building, of course. Keith, could you add anything to that?

Just that the purchase of the building actually occurred in October, October 9. So it did not impact our cash flow in the September quarter. I would agree with Arthur, we continue to refine the budget for the fitout and we hope to have a construction company/general contractor identified probably in about two weeks time.

Thank you. Is there a -- you've talked about the move, helping the margins, being able to manufacture the product and increase your margins because of the facility. Is that -- how long will that take before all that --

That will take a little bit longer. What you're referring to is increasing our batch sizes. The original building that Lannett operates in on State Road has rather small ceilings. That building's been in operation since the 60s. The Torresdale Building, which is the building on the other side of the highway from State Road building has higher ceilings. By removing the warehouse from that building, which occupies about his 28,000 square feet of the 65 roughly, we would be able to use the the higher ceilings to increase the blend to make larger batches. So instead of me making multiples let's say of a million batch I could make a five million batch, or a ten million batch depending on the size of the product. That does reduce costs, but when you increase your batch size, you certainly can scale up, up to ten times but there is some FDA involvement in it and a lot of additional -- that goes on. Again, because we're very careful with regards of our FDA relationships, we want to make sure that when we scale up, we're not going to have any problems with our batch size at that time.

So when will we see the benefit from it? Probably not for one more year in terms of any reduced costs. But that's -- those are not significant. What we did is we planned to make this move because we saw our market share growing and realized that if we moved into the other facility, we can increase our batch sizes as we're increasing our market share. So it's really not something that has to wait for or it's going to be such a major contributor. The real contribution will come when we file and get approval on new items at the new site. Because those don't have to require any additional testing and don't have to scale up anything. I'll be making the larger batches from the beginning. So that's the plan, to move into that building, increase production. We certainly are at somewhat of capacity at our State Road building, so we just need the additional production areas. But we also need it to be able to increase our batch sizes so we can make much larger batches because we're capturing a bigger market.

Thank you. If I remember right, last quarter, there was some asterisks related to the tax expense and I think it was related to tax loss carry-forwards. Is that--

I'll let Keith answer this one.

Pardon? Is that the case this quarter as well?

I will answer your question this way. Last year's income I'll say was shielded from a tax point of view because we had, we had some large reserves from the previous year, the '08 year and specifically the multivitamin reserve that we took. We took the reserve for book purposes in '08. We could not take it for tax purposes until '09, as the customers returned the product, so most of our income last year was shielded by the turning of that deferred tax asset. This year, yes, we have very little NOL carry-forwards. It's actually only what's remaining from the purchase of Cody and it's in a very small amount each year because it's limited by the 382 limitation. So this year we will be paying taxes on it, on a majority of our income this year unless something else changes. But that's what the current forecast looks like.

Okay, thanks. And then my last question is Arthur, you had mentioned that you had 13 -- well, current with the FDA, the Agency, and 12 new, but you also said that, I thought you said six you thought would possibly get approved this year.

That's correct.

Of those six, is there any that are real promising new drugs that at the current pricing level that you see could really add to the sales increase, or market share?

Only two -- the ones I'm thinking about are talking about when you're trying to predict when the FDA is going to approve something, you understand that's not a science. But of the six, two are injectables, at least one is a tablet item that we spoke about the Hydromorphone, but we also have two ophthalmic products that would probably make some contribution to the Company. I just don't know whether those will be approved in time. I believe they will. And also there's two products that we believe we're first to file on. Now, that doesn't mean we did any patent challenges. First to file in our case is there's never been a generic for that product. And those two products we expect to be approved as well. Both of those happen to be in the obesity area.

So before the end of the year, if those are approved, as we expect them to be, we should get a benefit from probably the ophthalmic products and the two obesity products and the Hydromorphone, depends on whether that shortage continues to exist in the marketplace, whereas I said earlier, those couple of people don't seem to be supplying it currently. Then that might be a contributor as well, one that we weren't expecting to be a big contributor. So generally speaking, there's really probably four of the six that we expect to make a contribution. But I'm not talking about any kind of block buster volume of drugs here now. Just they are profitable, they are exclusive if we get the approval for the two products for obesity that I'm speaking about and that could be very helpful to us.

And when you say by the end of the year, you're talking the calendar year?

Yes. No, no, our fiscal year.

Oh, your fiscal year, okay. Okay. Thank you.

You're welcome.

Great job, guys.

Thank you.

Our next question comes from George Gaspar, Private Investor. Please go ahead.

Thank you. Good afternoon.

Hi, George.

Arthur and Keith. I would like to circle back on gross profit, good quarter, it looks to me like your incremental profit on sales gain was 40%, which is pretty good. Do you envision that same trend going forward and expanding sales beyond the $31 million range?

Keith, do you want to take that?

I guess it goes back to what I stated earlier. We -- as Cody comes online with more and more products and more and more volume that they can service us, the margins for the overall for the combined companies will increase. But going forward for the rest of the year, it's going to depend also on what happens with the Digoxin and any competition there of anyone coming back in the market, as well as how quickly the OB Natal product declines or not declines.

Okay, all right. And then a question back on Cody. In past quarters, we you all talked about the pretax profit loss, which if I recall has been in, has been quoted to be in the million per quarter range, and I know you've kind of -- there was a question earlier about Cody profitability and you kind of circled the wagons a little bit, but didn't get to answer the question specifically. Can you tell us the profit situation for the quarter for Cody, the loss?

Well, I'll answer it in a few different ways. One, the $1 million a quarter loss was in previous years.

All right.

I can tell you that Cody is shipping us enough volume that they are not losing money like that. We've had a break-even or a little bit better than break-even quarter on the third quarter and fourth quarter and this first quarter were only slight losses, and I can tell you that -- another way to answer it is that I have not had to send Cody money for probably two quarters now or maybe even more other than for payment of product. Up until then, I was funding a lot of that $1 million loss but now there's enough volume coming out of Cody that they seem to be able to sustain themselves from an operational point of view to the point where I don't have to invest additional cash with them.

Okay.

Again, with that being said, Cody may go on a capital investment path this year, where they may be investing more money in their API and buildout of their facility and I don't think they will be able to fuel all of that with cash from operations.

I see. Okay. Well, that's -- I assume that decision will be made based on some incremental opportunities that are coming along here and some clearances that Arthur was referring to on that facility.

Correct.

My next question is on royalties that were paid in the quarter, there are 439 -- about $440,000 versus zero last year. These royalties, does that have to do with payments on PrimaCare ONE or whatever the deal was, the settlement on that particular situation, or can you spot for us where those royalties were paid to?

Yes, I, I can tell you that those royalties are paid for a few different products. I can tell you that the OB Natal product is declining, so we're paying or accruing less and less royalty there. We also have another product Amantadine which we pay a royalty to and that product is increasing.

I see.

And we have, I'll say, some other situations where we do pay small royalties and that's on that line as well.

Okay. All right. And on the, on the general changes in market picture from an overall generic point of view, how do you feel about the generic market in terms of net pluses and minuses, as you look at the industry and you look at the potential for Lannett within that? I think that's a pretty broad question, but do you have any comments at all on that?

Of course I'm the positive guy. My optimism outstrips -- I just never see the negative in things per se. First of all, when you look in the marketplace, there's been a lot of heavy competition, but there's also been a lot of acquisitions and mergers and I think you're going to find that the people that come into this US market and decide they are going to cut prices end up running into the difficulties of FDA compliance. You get what you pay for sometimes.

You cannot be compliant when you are giving your merchandise away. And at some point, even those people who want to capture market share realize that the companies that they are competing with are not going to lie down and let them take the market. So when they go in there and they cut prices, the generic competitors react by matching those prices. So they gain no market share by doing that. And by reducing the margins overall for everybody, they encounter the added problem of having to meet cGMPs without having the funds to do it with.

So I think there's been a little bit of an awakening in the marketplace where a lot of the foreign companies that came here thought they were going to take candy away from the baby. I haven't seen one American company truly suffering from the foreign invasion of the generic marketplace. And then you have the other side of the coin, generic market's growing dramatically, both demographically it's favorable to generics, plus the government and the recession is helping the generic industry. So when you really look at all the fundamentals, we're in a great spot at the moment to be in within the generic industry, even though there's some cases overcapacity, a lot of competition, lot of approvals per products. It's just -- it forces companies like Lannett to be more selective in the products they go after and the markets they search out.

And in our perspective, looking into the pain management was one of those reasons we went there. We looked at the market. We said where is it going to be 5, 10 years out and then deciding on not wanting to be in that marketplace 5, 10 years out, we decided to vertically integrate and to select pain management as the area to integrate in and we think that's going to sustain us going forward.

Okay, very good question -- or good answer. Lastly on cash, I noticed your cash position dropped about $2 million, but your inventory is up like $900,000 or so. I'm sure there's other places that some of the cash went. It's pretty decent cash management. So when you look at the shelf registration that was referred to earlier, it wouldn't seem like on the basis of your current operations that you would have to go to the shelf unless there was some significant decision on your part to either acquire product or do something unusual. Am I wrong on that? It just looks like you got enough cash flow relative to sales to avoid going to the shelf.

Well, I'm going to answer that. Normally I would let Keith. To answer that question, yes, we do have enough money to fund our operations, but remember, we still have to deal with the liquidity issue on our stock. Our stock doesn't trade enough because there isn't enough shares in the marketplace. And everyone that we speak to, and I'm talking about people like yourselves that have approached us, have all pointed to that liquidity as a major stumbling block to our share price moving ahead. And they said you need to do something to address it and one of the ways you address it is selling shares. Do we want to sell shares at $6 or $7 a share, no of course not. We don't think the Company's worth sixes, we think it's worth a lot more, so why should we sell it $6 to $7. The point they made to us is if you don't sell, your stock won't go to $10. So their argument was you got to look at the big picture.

You got to look at where is your stock going to be because you created liquidity by selling shares into the marketplace. Regardless of whether you needed the money or not at that moment. So there's two factors involved in that. Plus we also wanted to have the flexibility that if we needed to, to get cash quickly, the shelf registration would be approved. It's sitting there, and we can activate it whenever we want, once of course the FDA, excuse me, the SEC had approved it. So there was a two-fold reason to file the shelf and be prepared. And we are signaling to Wall Street that we're going to grow this Company and we intend to continue to grow it. And growing it may mean making an acquisition. Growing it may mean buying additional product licenses. Growing may be doing more joint ventures with companies in different areas of our Company, where we're going to have to put up some money and doing some of the more expensive products that we've talked about, where the bioequivalency work is considerably above what we've been traditionally spending for bioequivalency work. So there's going to be a demand for the money. Conservatively, you use your own assets, except for one point. If I use up the cash that I'm sitting on and then I need money, there's going to be nobody to give me money.

Yes.

So the concern is, I would rather consider those things and not be -- unprepared. I want to be a good Boy Scout and make sure that I have the money available to me and I don't use up all mine. So we're being very careful because, again, you don't want to dilute your existing shareholders for no reason. They need to see the long-term benefit of it, otherwise they are going to selling their shares and running away. We don't want to treat our shareholders that way, we want them to realize when we sell shares, there's a damn good reason we're doing it and it's to grow the business and that's in everyone's long-term interest.

Okay, thank you. Thank you, Arthur and Keith. Your answers have been great. Congratulations. These conference calls are a very important happening involving your Company and I'm sure everybody on the phone asked questions and are listening really appreciate your comments. Thank you.

Okay, thank you.

Our next question comes from Bob Stern, private investor. Please go ahead.

Couple questions on the -- sorry, on the shelf. One, is do you have any idea in terms of timing from the SEC in terms of approval process?

Yes, we believe -- there was a couple questions the SEC raised. We've responded to those questions favorably. The questions weren't on anything serious. And we believe the SEC will be approving the shelf registration very shortly.

And I thought it mentioned in terms of selling shares both either by the Company or by some of the existing shareholders. Any feel for what the split might be?

Keith, is that something we can answer on the conference call?

I can answer it by this. One of the comments the SEC did make is they wanted some indication, so when the registration statement, the estuary amendment is filed, it will have just a, just a very broad breakdown of $80 million by the Company and $70 million by existing shareholders.

Okay, okay. And is -- sorry, two quick last questions. Does the Company intend, or in position to give any kind of guidance for the year at this point?

Generally we have not given guidance in the past and I would say that the Company's position right now is to not give it at the current time.

Okay. And then the last is more I guess a comment in terms of -- I very much appreciate the conference calls that the last caller said and your comments on the shelf were spot-on in terms of understanding. The only thing I guess that's still a little bit gnawing at me and I have been a shareholders of the Company for probably seven years, and somebody therefore who remembers when the share price was when there was a share price was double this price and the same or fewer shares, and so well, I hear the argument in terms of increasing the flow. and I certainly get that, if some of the existing shareholders were to sell some of their stock there's still part of me that wonders if the Company's selling the stock-- as long as the Company is doing as well as it seems to be doing now, it's turned and prospects seem good, I just -- there's that part of me that wonders if selling shares is really needed to help move, spark the Company's share price, particularly when the Company is doing as well as it is.

Well, Mr. Stern, if I may, when we went out to see the hedge funds and other potential shareholders, end shareholders, the questions come up and their attitude was they wanted to invest in Lannett. They liked the Lannett story, but they kept raising that same issue. And I discussed, because, remember, I'm another shareholder as well.

Right.

I said what's the point of just diluting? Why should I sell shares at a price that we don't feel is comfortably a good price for the Company to sell shares at? What's the benefit to me? He said the benefit is I can buy stock in your Company and you'll end up with a $10 share price instead of a $6 share price. So I said, yes, but a lot of times people say they will buy and then -- you disappear. Not interested in the marketplace.

Right.

But quite frankly, we got enough of an assurance from people that that was not the case. They said you have a very good story. You have a very good opportunity to grow your business, unlike some of the bigger generic companies, your growth is more reasonably achievable and there's no downside. I'm saying this is what they said to me. There's really no downside to your stock.

So we don't see the big risk here in investing the Company. They understood that it's a three to five-year investment on their part because they know that the typical application at the Agency, a year to file it and one to two years for them to approve it is a timeframe no one could do anything about. So they realized that our business really is a long-term view. And that was their point. They said while some shares might get sold, that you're going to sell in the marketplace. We're telling you, most hedge funds are just like we are, we want to long-term hold your stock. We see your stock going up in value, but you need to do something to free up the shares.

You need to do something about the overhang, the overhang referring to the majority owner shares, because there's always a fear that if they go to buy stock, would the majority owner then go out and sell? So we're comfortable that if the majority owner were selling shares at the same time as the Company, that would alleviate that concern. We, we certainly listen to the people that are going to become our shareholders of the future before we talked about doing the shelf. So we've done our homework. We've certainly looked at your point of view and, remember, most of the insiders are big shareholders. So we think just like you. What's in the best interest of all the shareholders? And we came to the conclusion the shelf ultimately was in the best interest.

Okay, thank you.

You're welcome, sir.

Our next question comes from Greg Hillman from First Wilshire Securities. Please go ahead.

Yes, Arthur, just one other comment about the liquidity thing on the stock. Another thing you could do would be stock dividend, but just a little one like a 10% stock dividend per quarter. And that way you wouldn't go too far away from the number of current shares outstanding, but you would be giving shareholders more share and gradually increasing the flow out there and that would be another way that wouldn't exclude you from doing a stock offering if you need the money, too, but that would be another way to increase liquidity.

Good point, yes. That was brought up and matter of fact, some other company recently did a offer -- I mean, what do you call it, a dividend, and that was Coach. Their reasoning was to reassure the public that in these tough times they were doing well as a company so there's that aspect as well when you give out money to your shareholders, they certainly enjoy it and they realize the Company's growing.

Yes, no, it wouldn't be money--

Talking about stock.

Stock dividend, yes, just increases theoretically wouldn't do anything, but actually it could help you achieve your gain of liquidity and companies have more liquidity do trade at higher valuation. That would be something else to consider.

Okay, thank you.

Our next question comes from Peter Castellano from Glacier Partners. Please go ahead.

Hey, Arthur, I don't want to beat this thing to death, but I just feel like I need to comment on this. This business about funds telling you that you don't have enough liquidity and what have you we're a small fund and we've got in the last six months, we've got now we have over 100,000 shares. That's not an issue for us and any guy that tells you that is just, I mean is, is just blowing smoke at you. You've got in our numbers this year, we've got you modeled like somewhere around $0.35 to $0.40 this year. So the stock is in the mid teens in a forward price earnings ratio, that's not so bad -- it's not going to go to 30 times earnings because you've got more liquidity out there.

Right.

So I mean I think this business about talking about hedge funds telling us that was we need more shares and stuff like that, I think you ought to can that and really just focus on some what the real reason is and what's really going on with why you need to sell those shares. Because your multiple's not going to go up if you sell more stock. It's going to go up if you got an acquisition or if you've got something, a product or some other reason for it. But I've been in the business for 40 years. I was an institutional salesman. I was on the research side of it, I run money now, and -- that's a lot of baloney when these guys tell you that we're, we can't buy your stock because it's too -- it's too thin or what have you. I mean I realize it may be the case in some instances, but it's not -- it's a bogus issue.

I don't disagree with you in the sense that if you're doing well as a company and you increase your shares and earnings and your sales volume people are just going to buy the stock regardless of what the share is or not. There's always a seller and there's always a buyer. That is the consensus, but again, I have no way to know whether people --

What can I tell you? We own -- maybe we -- maybe we don't understand the business.

No, maybe the people saying that, it's a polite way not to buy the stock or tell you that they are not interested. But rather than saying I'm not interested in your Company, they use that as an excuse, so it's certainly is possible.

Anyway.

But I will consider what you're saying and discuss it internally with my senior managers.

Okay.

I appreciate the advice. Thank you.

We have no further questions at this time.

Okay. Thank you, all, for joining us today. If anyone has any further questions, please do not hesitate to contact the Investor Relations team at Lannett. That concludes our call, and thanks again for joining us today.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may all disconnect.